Insurance for Kids - Is it Advisable?

Recently I have come across a number of cases where people have proudly told me, while consulting for financial planning, about insurance plans they have taken for their kids, usually very young and at times just one year old. This set me thinking. What is that makes people take this totally useless step and one which goes against basic idea of Investing - that of wealth creation and that of Risk Management. Mostly, these are endowment type plans and people are just swayed by scenario shown by the friendly neighbourhood insurance agent. "Sir, my kid will get Rs.10 Lakh after 20 yrs and I am paying annual premium of Rs.25000/-. See, I will pay Rs. 5,00,000/-, that too in instalments, and get back 10 Lakh", beamed a proud father of 4 yr old. I could almost see his desire to certify that he had made a smart move. When I told him that this amounted to less than 7% rate of interest, and he would have got Rs.11,44,000/- with the same investment in a plain old PPF, his face justifiably fell.

The reasons why people do this are fairly visible. Every parent wants to do the best for his children and unscrupulous insurance agents take advantage of this weakness. The idea of creating a corpus, thereby implying richness for their kids, is simply irresistible for parents. Lack of basic financial literacy prevents them from evaluating the proposal fully. The basic idea of Insurance is to prevent or lessen the financial loss for survivors (family) in the event of unfortunate demise of the bread earner. The key word is "Bread earner", a contributor to the family kitty in some way. This is the whole idea behind Insurance, nothing less and nothing more. Then how is the death of a children, no doubt an emotional catastrophe, going to impact the financial balance of the family? So it is clear that Insurance for kids is not required at all for risk coverage because there is no (financial) risk at all.

Now comes the question of wealth creation. With more than 300 mutual funds vying for attention and having great history of performance over the years, why does one need these insurance plans for kids, beats me. It is well documented fact that over long time horizons, equity has the best characteristics of beating inflation and creating wealth. When we talk of kids, we already have long time horizons in mind. To take example of our good old sensex, markets have given about 18% growth every year (CAGR) since its inception in 1979-80. If we conservatively take only 15% (this return is there even in last 4 yrs horizon, despite the fall), the accumulated fund value for the "smart" papa in the beginning would have been approx Rs.30 lakhs. What is required is only one thing and that is discipline. Using a plain simple SIP in a combination of mutual funds having good history can give you unmatched returns and ease of mind. One may argue that one can take ULIP plans for children, after all they are also akin to mutual funds and are going to deploy the funds in Equity market only. The problem here is two-fold. One, as explained above, why you should pay mortality charges to insure someone who is not to be insured at all. This will lead to lesser funds for deployment and hence lower accumulated value. Secondly, ULIPs have a high charges structure, much lower transparency and hidden charges, especially in initial years, leading to a considerable loss of for the investor. Now with the SEBI directive of removal of entry load from mutual funds, Mutual Funds have become all the more beneficial over ULIPs.

We are somehow not attuned to the fact that most of the times simple things lead to great results. If we can take care of financial blunders that we make, we can attain our life goals very easily and in a much more stress-free manner.

Happy Investing.

GOLD ETF - Much better way to invest in Gold

Gold has always been fancy of many investors. Gold is a very good hedge against inflation. Financial Planners suggest some percentage of asset allocation in the form of Gold. Especially in troubled times, gold offers a safe heaven and has a negative correlation with equity markets. This implies that when equity markets go down, gold shoots up.

Options for investing in gold
Not too long ago, buying physical gold was the only option for investing in gold. However, the launch of Gold ETFs threw open another option for investors. Gold ETFs are open-ended funds which track prices of gold. They are listed and traded on a stock exchange; hence, they can be bought and sold like stocks on a real-time basis. These funds are passively managed and they mirror domestic gold prices. By enabling investors to invest in gold without holding it in physical form, Gold ETFs offer a rather unique investment opportunity to investors.

Advantages of Gold ETFs
Although the mode chosen for investing in gold would entirely depend on investors, Gold ETFs do offer some distinct advantages vis-à-vis investing in physical gold.
1. Convenience: Gold ETFs are a convenient means of investing in gold. Since there is no delivery involved, investors do not have to worry about the storage and security aspects that are typically associated with investing in physical gold.
2. Quality: As per SEBI regulations, the purity of underlying gold in Gold ETFs should be 0.995 fineness and above. This spares investors the trouble of finding a reliable source to buy gold.
3. No premium: Jewellers and banks generally sell gold at a premium. The premium can be in the range of 5%-10% (inclusive of making charges) in case of jewellers and upto 15% in case of banks. Since Gold ETFs are traded on the stock exchange, they can be bought at the prevailing market rate without paying any premium.
4. Low cost: To store physical gold, one would typically need a locker. This expense is over and above the premium paid at the time of buying physical gold. As for Gold ETFs, a pre-requisite is to have demat and trading accounts with a broker. To maintain these accounts, investors are required to pay annual charges, which vary from broker to broker. Investors also have to pay the brokerage on each trade. Finally, there are annual recurring charges which are charged to the fund. Considering the premium and other charges borne while buying physical gold, investing via Gold ETFs can turn out to be a more cost-effective option.

5. Transparent pricing: The pricing of physical gold varies depending on the vendor. Conversely, Gold ETFs have a transparent pricing mechanism. International gold prices are converted to Indian landed price using the applicable exchange rate. Various duties and taxes are also added to arrive at the landed price of gold.
6. Tax efficiency: In Gold ETFs, long-term capital gains tax is applicable after twelve months from the date of purchase vis-à-vis three years in the case of physical gold. Also, unlike physical gold, investments in Gold ETFs are not subject to Wealth Tax.
7. Resale value: Gold ETFs can be easily sold in the secondary market on a real-time basis (i.e. at the prevailing market price). Whereas, while selling physical gold, the jeweller will deduct making charges (the charge that is added while buying gold). As regards banks, they refuse to buy back gold.
Tax implications
Tax implications on Gold ETFs are same as those on debt mutual funds. A unit of a Gold ETF that is held for less than twelve months is treated as a short-term capital asset. Gains on the same are taxed at the investor’s marginal rate of tax. Units held for more than twelve months are treated as long-term capital assets. Long-term capital gains are taxed at 20% (after allowing for indexation benefit) or 10% (without indexation benefit), whichever is less.

Criteria for selecting a Gold ETF
Following are some of the factors that investors must consider before investing in a Gold ETF.
a. Percentage of holdings in physical gold
Ideally, investors must select a Gold ETF that holds a significant portion of its portfolio in gold over ones that take cash calls i.e. invests in current assets.
b. Expense Ratio
Investors must choose a fund which has a lower expense ratio. Higher expenses translate into lower returns for investors.
c. Lower tracking error
Tracking error is a measure of the difference between returns generated by a Gold ETF and physical gold. Thus a lower tracking error would mean that the fund has delivered in line what an investment in physical gold would have.

As is evident from the above, it is clear that as an investment option, Gold ETFs are a much better option than physical purchase of Gold.

Sanjeev Bhatia (Certified Financial Planner) CFP; info@ezywealthzone.com; www.ezywealthzone.com

MF Entry loads go, What about Insurance Products?

SEBI has recently passed notification that starting 1 August 2009, entry load on all MF schemes will go. Earlier, the entry load, usually in the range of 2.25%, used to be the upfront commission of the broker/advisor. What that meant was that for an investor investing Rs.100/-, Rs.97.75/- went to actual investment and Rs.2.25 was paid to the distributor. This understandably has brought a lot of cheers to the investing community. More deployment means more returns and correspondingly higher amounts at maturity. For an investor putting in Rs.1 Lac lumpsum for 15 years, the maturity amount would be Rs.7,95,398/- with entry load and Rs.8,13,706/- without entry load, a neat difference of Rs.18,308/-(assuming 15% growth). The difference would be more pronounced in case of SIPs. Let us assume an investor investing Rs.5000/- pm in a mutual fund gorwing at 15% pa. The investment horizon is 10 years. The maturity amount would be Rs. 13,45,123 entry load and Rs.13,76,085/- without entry load a difference of Rs.30,961/-.

Loss of upfront commission obviously has distributors up in arms against this order. They fear the loss of livelihood since now they have to negotiate with the customer regarding their commission which will be paid by the investor directly to them through separate cheque. Although there are some procedural hassles in this format, it sure is a welcome step since now investor can decide the quantum of commission paid to broker/advisor/distributor based on SERVICES PROVIDED. This is in contrast to the earlier method where the seller was assured of commission, service or no service. This step will lead to much more maturity in market and lead to drastic reduction in two of the biggest menaces of Mutual Fund Investing. First was the illegal payback/rebating of commission by brokers back to the investor. Second was unjustified churning of mutual fund holdings. The smart distributors made unsuspecting clients sell their existing mutual fund holdings and put in the money in New Fund Offers (NFO) since the NFO gave them much higher commission to the tune of 5-6%. Hopefully, these have now become things of the past.