Are Your “Smart” Financial Steps Really Smart? Find out

What you think is a wise financial decision on this Diwali, whether it be saving, investing, or buying insurance, can result in loss of performance and losses for your portfolio. ET Wealth tells you how to stay away from these movements.

1. Disciplined investing

You are buying endowment insurance to fund your child’s educational goal because you believe it will force disciplined investment and help you build a large corpus.

How is it backfiring?

The fact that you are overlooking is that it offers extremely low returns of 4-5% and you may be lacking the corpus you want. You could build a much larger corpus by investing in an equity fund with over 12% returns over the long term.

Low returns with investment plan

Monthly Premium: Rs 8,000

Duration: 20 years

Assumed return: 5%

Corpus built with foundation plan: Rs 28.8 lakh

Corpus built with stock funds @ 12%: Rs 72.9 lakh

2. Opt for lower EMI

When taking out a home loan, opt for a lower EMI and longer term to ensure smoother cash flow.

How is it backfiring?

In the end, you pay a higher loan because the longer the term, the higher the interest and thus the higher the price you will pay for the house.

You pay more for the house

If you are taking out a home loan of Rs 30 lakh @ 9%

For a term of: 25 years

EMI: Rs 25,176

You will repay: Rs 75.53 lakh

For a term of: 20 years

EMI: Rs 26,992

You will repay: Rs 64.78 lakh

3. Avoid risks

You want to protect your investment from market risk, so invest in fixed-term deposits instead of mutual funds.

How is it backfiring?

Security comes at the cost of poor returns as you expose your investment to a decline in performance. This means that taxes will detract from your overall return as interest will be added to your income and taxed according to your tax certificate. You can avoid this by investing in a debt security fund that has post-indexed capital gains taxed at 20% if held for more than three years.

Tax eats its way on FD income

Fixed deposit: Rs 2 lakh

Corpus after 3 years @ 7.5% (quarterly): Rs 2.49 lakh

Corpus after tax (in 30%) from Rs 14,983: Rs 2.34 lakh

Corpus in debt fund @ 8% after 3 years, with Rs 6,293 tax and indexation: Rs 2.45 lakh

4. Select the lowest premium

You buy health insurance by choosing the lowest premium because you think you will pay less for similar benefits.

How is it backfiring?

The plan can be cheap because it has a higher deductible or co-payment that is a percentage of the amount insured that you pay out of pocket. In addition to the premium, you should also consider functions such as lower limits and claims settlement rate. Instead, you can take out basic insurance and then opt for additional insurance, which, thanks to the high deductible, offers large coverage for a low premium.

You are paying more out of your pocket

For basic health insurance from Rs 5.5 lakh for a 30 year old

Annual Premium: Rs 6,257

Deductible: Nile

Net coverage: Rs 5.5 lakh

For a high deductible (charge) of Rs 5.5 lakh

Annual Premium: Rs 2,832

Deductible: Rs 2 lakh

Net coverage: Rs 3.5 lakh

5. Save more for emergencies

You build a large emergency fund by keeping a large amount of cash at home or in a savings bank account.

How is it backfiring?

An emergency corpus should correspond to the expenditure of 3-6 months and should be invested in a liquid or short-term fund. So if you keep Rs 6 lakh in bank balance instead of Rs 3 lakh, you will get lower interest on the extra Rs 3 lakh. If invested in an equity fund, it could offer higher returns.

You pay high opportunity costs

If you put Rs 3 lakh for three years in:

Savings account @ 4%: Rs 3.37 lakh

Debt Fund @ 6%: Rs 3.57 lakh

Stock Fund @ 12%: Rs 4.22 lakh

6. Escape the volatility

You cash in on your mutual fund SIPs when the market experiences volatility or goes into a bear phase because you don’t want to lose any money.

How is it backfiring?

The main purpose of investing through SIPs is to average the cost of buying during the ups and downs of the market. If you move out during the downturns, you will lose the opportunity to buy at a low price, which will detract from your returns.

Exit leads to losses

For example, suppose you started investing Rs 10,000 in the HDFC stock fund through SIPs in November 2014.

Corpus in September 2016 if you quit in February 2016 and reinvested in March 2016: Rs 2.11 lakh

Return in September 2016 if you haven’t stopped investing: Rs 2.57 lakh

7. Buy cheap penny stocks

They buy penny stocks because they are available at an attractive low price and have potential for growth.

How is it backfiring?

These stocks are high volatility, low liquidity and can result in large losses, especially if you do not have the expertise to research and rule out safer bets.

Big losses in the end

Source: ETIG database & Bloomberg. Data as of October 24, 2018. Filters used: price less than 10 rupees, market capitalization greater than or equal to 10 billion rupees.

8. Opt for lower interest rates

To pay off your large credit card debt, switch to a different credit card with lower or no interest rates.

How is it backfiring?

Repaying your card debt by switching to a low-interest card is a good step, but it may not work if you don’t pay the amount within the interest vacation time. The low interest term ranges from two months to a year, after which the regular interest rate is calculated. There is also a processing fee that is a percentage of the amount due or a flat-rate amount.

You pay back more

Credit Card Debt: Rs 2 lakh

Processing Fee: Rs 2,000 @ 1% of Rs 2 lakh

Lower interest for 3 months: 0.99%

If you repay @ 3% per month with the previous card in 3 months: Rs 2.06.001

If you repay the full amount with a new card within 12 months: 2.06.995 rupees

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