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Monday, Apr 11, 2016

10 financial mistakes you will regret at age 50

   [Source : The Economic Times]

Every time Amit Acharya reviews his portfolio, he regrets the investments made on his father's advice. "The life insurance plans he recommended will give barely 6% returns," says the Raipur-based MNC manager. Acharya bought his first policy in 2000, when he was 29, and added four more plans as his income grew in the following years. He pours in Rs 1.5 lakh into the five lowyield policies every year even as more lucrative investment opportunities pass him by. "It was a mistake that cannot be undone. I have to pay the premium for the full term," he says.

In Delhi, 43-year-old Ashok Vishwakarma is ruing his decision to join a scheme that promised a neat sum for responding to surveys. Vishwakarma joined SpeakAsia in February 2011, just two months before the scam was busted. The Rs 33,000 he poured into the survey scheme is now as good as gone. "Had I not been greedy and put the money in a fixed deposit, it would have grown to over Rs 50,000 by now," he says.

Investment choices are also influenced by personal experiences. Mumbai-based Prakriti Ojha has stayed away from market-linked products after she incurred losses in a missold Ulip. Now she invests only in the PPF and traditional insurance policies. However, she may regret her decision to avoid equities in later years.

This week's cover story looks at 10 such investing mistakes that young people may regret in later years. Investing in insurance, choosing the wrong investment vehicle or putting money in dubious schemes are only three of these 10 mistakes. Waiting too long to invest, dipping into retirement savings and splurging on needless items are other common mistakes that young people make. In the following pages, we tell you how not to make mistakes that you will regret 15-20 years from now.

Delay investing till income is higher

For young earners, spending is more important than saving. A study of 2,000 professionals by Hyderabad-based financial planning firm, Arthayantra, found that more than 90% don't start planning for retirement in the first five years of their careers. Even by the 10th year, less than 20% would have a retirement plan in place. The consequences of this delay are mind boggling. What one saves in the first few years of starting a career burgeons into a massive amount over the next 25-30 years even though the individual saves more in the later years as his income grows.

If an investor starts an SIP of Rs 5,000 in an equity fund that gives 12% returns, he will accumulate Rs 1.77 crore in 30 years. But if he waits till 28 to start investing, his corpus will be smaller by Rs 56 lakh. Even if he enhances his savings by 10% every year, what he puts away in the first 10 years will account for almost 24% of the total retirement corpus. The longer the delay, the smaller is the corpus.

Many young earners don't start investing because their income is low. This is a fallacy. For a young investor, the smallness of the investment is more than made up by the long time available for the money to grow. The magic of compounding ensures that even a small sum grows into a gargantuan amount over the long term. The investment can be scaled up as the income grows in the coming years.

Taking too little risk with investments

Though there is irrefutable empirical evidence that equities can give high returns in the long term, small investors continue to rely heavily on fixed income investments. Equities account for a very small proportion of the total household savings.

Surprisingly, even young investors who are in a position to invest in stocks, opt for the safety of bank deposits and small savings schemes. This aversion for equities could prove harmful in the long term. If you spend Rs 40,000 a month on household expenses today, even 6% inflation will push that up to Rs 72,000 a month by 2026.

By 2031, the requirement will surge to Rs 96,000 and by 2036, it would be Rs 1.28 lakh a month. This is why even risk averse investors should consider allocating at least 10-15% of their portfolios to equities. "Your money needs to grow at a faster clip than the inflation rate to sustain your lifestyle for several years. This can't be done by parking the entire retirement savings in low yield fixed deposits," says Hemant Rustagi, CEO, Wiseinvest Advisors.

Prakriti Ojha, 31 years, Mumbai

Income: Rs 1.1 lakh a month

Equity exposure: Nil

She is young, earns well and has a steady job. Yet she invests primarily in PPF and bank deposits, something she may regret later in life.

Not following an asset allocation

Not many investors believe in rebalancing. Less than 10% respondents to an online survey said they rebalanced their portfolios regularly. Yet, it is the mantra that ensures high returns at low risk.

Rebalancing is necessary because the returns from different asset classes can vary. The Nifty shot up 31% in 2014, but closed 2015 with a 4% loss. While returns from fixed income have been largely stable, gold has also given volatile returns in the past 10 years. Over time, the differential returns can significantly change the asset mix of your portfolio. Rebalancing restores the portfolio to the original asset allocation, thereby controlling the risk and the returns it will generate.

The rebalancing decision is not easy because it takes a contrarian call. Few investors would have reduced their equity exposure when the markets were making new highs between 2004 and 2007. If they had, their portfolios would not have bled so much in 2008. Similarly, how many would have put more in equities after the bloodbath? Those who did, made good gains when the markets bounced back in 2009. If you rebalance regularly, you will not have any regrets.

Getting lured by dubious schemes

Greed is a very effective driver of investments. SpeakAsia and Stock Guru are just two examples of how investors can be lured by easy money. The fantastic returns promised by the fraudsters should have been a red flag for investors. It is virtually impossible to churn out 10-20% returns every month. Yet, investors didn't see anything wrong in the SpeakAsia promise of easy money for doing virtually nothing or the Stock Guru promise of 20% assured returns per month.

The other basic check is to see whether the scheme is approved by the regulator. All investment schemes must have Sebi approval. Stock Guru had nothing to show in this regard. Fraudsters try to mislead investors by uploading images of PAN cards and certificate of incorporation. But these documents don't mean that the scheme has been approved by Sebi.

Apart from get rich quick schemes, you must ignore mails from scions of deposed African dictators, altruistic accountants and eccentric tycoons. Stick to boring investments like fixed deposits, PPF and mutual funds if you don't want to spend your retirement in penury.

Ankur Sachdeva, 36 years, Del

Lost: Rs 11.6 lakh in Stock Guru scam in 2012

He was initially skeptical and invested Rs 2 lakh in the Stock Guru scheme. When he got back Rs 40,000 in a month, he put in Rs 10 lakh more but got nothing back.

Investing in stocks for short term

We said earlier that small investors are not putting enough in stocks. Even those who do, don't remain invested for long. According to AMFI data, nearly 46% of the investments by small investors in equity funds are redeemed within two years. Out of this, more than 27% gets redeemed within a year. Most investors treat equity investments as short-term gambits, not as avenues of wealth creation.

Do you also share this short-term perspective of equity investments? You may have to lament it later. Small investors often lose their nerve when markets tumble. But serious money can be made by investing in stocks during a market downturn. In November 2008, during the global financial meltdown, you could have bought TCS shares at a throwaway price of Rs 418 apiece. After the 1:1 bonus in 2009, that one share is now worth almost Rs 5,000 (annualized return of 40%). In March 2009, HDFC Bank shares were trading at Rs 850. After the 1:5 stock split in 2011, the annualized return is 32.3%.

To pocket such fantastic gains, the average investor needs to change his perspective. If you are in your 30s, a bear market presents a golden opportunity to make money. Bull markets can make you happy, but bear markets can make you wealthy. We back-tested for the past 10 years and found that mutual fund investors who stopped their SIPs during bearish phases made less money than those who continued investing throughout the 10-year period. Stopping an SIP when markets are down defeats the very purpose of the SIP.

Dipping into PF account

The Employees Provident Fund (EPF) is God's gift to investors. If you are diligent, it can make you a crorepati. A person with a basic salary of Rs 25,000 a month at the age of 25 can accumulate Rs 1.65 crore in the EPF over a period of 35 years. This assumes that his income will rise by 10% every year and the EPF will earn 8.7% returns. Yet, many people are unable to reach the Rs 1 crore milestone in their EPF accounts.

Every time they change jobs, they withdraw their EPF balance. Withdrawing your EPF is financial hara kiri. The money goes into unnecessary expenses and the retirement corpus is back to zero. It's a decision you will regret when you are a few years away from retirement. The silver lining is that a new rule, which comes into effect from 1 May, will make premature withdrawals difficult. Subscribers will not be able to withdraw the employer's contribution till they turn 58.

Radhika Sachdeva, 35 years, Gurgaon

Job changes: Four in the past 12 years

PF Balance: Rs 15 lakh

Despite changing four jobs in the past 12 years, she has never withdrawn her PF. This will help her in retirement.

Treating insurance as investment

The cardinal rule is not to mix insurance with investment. Yet, millions of traditional insurance policies that give the "triple benefits" of life insurance, long-term savings and tax benefits are bought every year. These policies not only give sub-optimal returns of 5-6%, but also force the policyholder into a multi-year commitment. Is there a way out? Yes, you can surrender a policy if you have paid premiums for a minimum number of years. Be ready to suffer a loss when you do this.

You can also convert an insurance policy into a paid-up plan after three years. The policy will continue with a reduced sum assured but you won't have to pay the premiums any further. The paid-up value is given to the policyholder on maturity. The policy turns into a paid-up plan if premiums are not paid for two consecutive years. This is an option Amit Acharya can explore. It is better than paying premiums for the full term and earning 5-6% returns.

Amit Acharya, 45 years, Raipur

Premium paid: Rs 1.5 lakh per annum

Returns expected: 6%

He invested in life insurance policies on the advice of his father. The high premium of these plans prevent investing in other lucrative avenues.

Splurging on items you don't need

As mentioned earlier, young people spend more than they save. But in many cases, they even spend more than they earn. Easy financing options and plastic money prevent young individuals from distinguishing their wants from their needs. They may need to save for retirement, but the newly cell phone they want has come in the way. If this urge to spend gets out of hand, it can prove catastrophic for your finances.

In the table, we have looked at such needless expenses as lost opportunities to invest. So, a Rs 9 lakh car you don't really need will leave your retirement plan poorer by Rs 93 lakh. If you want to avoid these regrets, rein in your spending now. Studies show that people tend to overspend if they use a credit card. To suppress the shopaholic in you, leave your credit card behind when you go to the mall. Take cash instead.

Many young people are not able to save enough because they don't have anything left after all their expenses. Their financial equation is: Income - Expenses = Savings. Legendary investor Warren Buffett offers a simple solution. Change the equation to Income - Savings = Expenses. Instead of saving what is left after your expenses, you should spend what is left after you are done with your savings for the month.

Taking too little life and medical insurance

Well, one may never get to regret taking a low life cover but your dependents will surely feel the impact of this mistake. An adequate life cover ensures that the family goals are not hampered due to the breadwinner's death.

The insurance cover should be big enough to generate income that can take care of the expenses of the family till the policyholder's dependents are self-sufficient. One broad approximation is about 6-7 times the annual income of the individual. But this does not always reflect a person's insurance need. The cover must be big enough to settle loans as well.

Apart from this, the insurance should also provide for crucial financial goals, such as a child's higher education and marriage. These are one-time expenses and their present cost should be taken into account while calculating the cover. Hemant Kumar is the sole breadwinner and has a home loan of Rs 25 lakh. He should not delay buying insurance because premiums shoot up after 40.

Hemant Kumar, 39 years, Noida

Income: Rs 22 lakh per annum

Loans: Rs 25 lakh

Insurance cover: Rs 6 lakh

The sole earner in the family, Kumar needs an insurance cover of at least Rs 1-2 crore. That won't come cheap when he crosses 40.

Not setting up an emergency fund

Everyone needs an emergency fund. You could lose your job, or somebody in the family may need medical care—you never know what lies ahead. It is often argued that you don't need emergency cash if you have a credit card. Though a credit card does come in handy when you face a financial crisis, the cushion that plastic money provides lasts only 15 -30 days, till the bill arrives. If you don't have an emergency fund, you could be forced to liquidate other assets to tide over the crisis.

Experts say one should have at least 2-6 months of expenses in an emergency fund, but this can vary depending on whether your spouse also works or you have a secure job. The best option is a sweep-in bank account or short- term debt funds.

Avoid putting the emergency corpus in equity-linked instruments.If the stock market is down at that point in time, you will be forced to sell at a loss. Recall the situation in 2008, when stock prices crashed and jobs disappeared almost at the same time. If you haven't already established an emergency fund, start putting away 10-15% of your monthly income for this purpose.

Any windfall gain, such as a tax refund or an annual bonus, should also be diverted to it. However, treat this amount as sacrosanct. Under no circumstances should you dip into it for discretionary expenses.

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