Fwd: 17 / 11 / 15. FINANCIAL UPDATE -How to set your financial goals ? and What is Real Return and How Inflation eats your money
LUGI CHENNAITEAM
How to set your financial goals ?
One of the most important part of financial planning is goal setting . The first step involved is to know where you want to go ? If you have no goals set , then you will be randomly investing and as your goals in life comes along the way, you fulfill them. It can happen many times that you are not prepared and some important goals is near by, however you didn’t give much thought to it from many years or months and at the end you have to take decisions in hurry, which you don’t want to take. By setting your financial goals in advance you can get a good idea of what lies in future and start preparation for it (Goal of financial planning)
What is goal setting ?
Goal setting is a process of defining your goals in Life. There are many important and intuitive characteristics of any goal, which makes it SMART . Lets see what those 5 important element of goal setting is .
Specific : Your goals should be specific and not a very general one, It should contain detailed information and should not leave a room for further questions . “I want to buy a house” is a very general goal , however “I want to buy a 3 BHK Flat in Karvenagar area in Pune costing around 35 lacs within next 5 yrs” is a more specific goal which gives a clear picture to you . Look at returns from Real Estate in India
Measurable : Your goals should be measurable in terms of “How many” or “How much”. It should not happen that you have a rough idea of the goal. Many people I talk with; say “I want to buy a big house” . It’s a great thing to dream for a big house, but at some point in life you will actually decide the actual size and how many rooms and what will be the area. Not having a clear view means no idea of how much it will cost and then you can’t save for it properly . “I want to buy a 4 BHK house in 5 yrs” will mean you can exactly find out how much you need to save per month so that you can achieve the goal with higher accuracy, you should be able to track your goal. That means goal being measurable .
Achievable : This mainly means that your goals should be achievable given your current situation. When financial planners start working with some client, one of the major issues is targeting unrealistic goals in life. Just because you are hiring a financial planner does not mean that he is a magician and will somehow create a strategy for you . If you are saving Rs 20,000/ month , dont target “3 BHK House in 5 years without loan” as one of the goal because it’s not possible given your current situation. If you put a lot of unattainable goals, the first thing is you will not be able to define how you can achieve them in the first hand.
Relevent : What will happen, if you always wanted to become IAS officer, whereas your goal is “To crack CAT exam” ? If this happens , you will start with some enthusiasm in start but at some point, it would be tough to sustain the enthusiasm and energy, because that’s not you really wish to and even if you some day achieve that goal which you planned, it would not make sense because it’s not aligned with your life objectives. This is very much true for financial goals also. You have to make sure your goals are very much what you wish in life . Lets see some of my personal goals in life .
a) As I like to travel a lot so I would like to generate enough money in next 15-20 yrs , so that I can travel to different countries every 6 months .
b) I would like to build a Farm Land by year 2035, where I can personally do “Vegetable Agriculture”. (I personally have experience of growing things like corn, potato, tomato, carrots, radish, peanuts, cabbage, cauliflower, chana, almost all green vegetables, pulses, peas , onion , garlic) . Yes I have done it in UP at my hometown as a hobby. Do you know hybrid tomato seeds can cost upto Rs 75,000/KG 
so we bought 1 gm 
.
c) I would not like to save much for my child marriage, as I would like to encourage them for love marriage and settle things with a simple ceremony , that’s all . I dont believe in lavish marriges anyways .
d) I have no long-term goals of buying house, I would rather like to live in rent for long and build a corpus in pure equity + debt . If things changes and one day I feel real estate is something which should really be part of my portfolio, I will change my mind .
vegSeriously, do you want to buy that 55 lacs flat which is ‘almost’ out of city and commands a rental yield of not even 3% ? Do you ?
Timely : Imagine your goal is like “I would like to buy car of 5 lacs”, Fine ! . Now what do you do ? Do you save 5,000 per month or 20,000 and for how long , It’s important to set a time line so that you have a clear idea of how much does it take to achieve some goal. You can calculate the investment needed for that (See how to calculate) .
Goal setting is a process of defining your goals in Life. There are many important and intuitive characteristics of any goal, which makes it SMART . Lets see what those 5 important element of goal setting is .
Specific : Your goals should be specific and not a very general one, It should contain detailed information and should not leave a room for further questions . “I want to buy a house” is a very general goal , however “I want to buy a 3 BHK Flat in Karvenagar area in Pune costing around 35 lacs within next 5 yrs” is a more specific goal which gives a clear picture to you . Look at returns from Real Estate in India
Measurable : Your goals should be measurable in terms of “How many” or “How much”. It should not happen that you have a rough idea of the goal. Many people I talk with; say “I want to buy a big house” . It’s a great thing to dream for a big house, but at some point in life you will actually decide the actual size and how many rooms and what will be the area. Not having a clear view means no idea of how much it will cost and then you can’t save for it properly . “I want to buy a 4 BHK house in 5 yrs” will mean you can exactly find out how much you need to save per month so that you can achieve the goal with higher accuracy, you should be able to track your goal. That means goal being measurable .
Achievable : This mainly means that your goals should be achievable given your current situation. When financial planners start working with some client, one of the major issues is targeting unrealistic goals in life. Just because you are hiring a financial planner does not mean that he is a magician and will somehow create a strategy for you . If you are saving Rs 20,000/ month , dont target “3 BHK House in 5 years without loan” as one of the goal because it’s not possible given your current situation. If you put a lot of unattainable goals, the first thing is you will not be able to define how you can achieve them in the first hand.
Relevent : What will happen, if you always wanted to become IAS officer, whereas your goal is “To crack CAT exam” ? If this happens , you will start with some enthusiasm in start but at some point, it would be tough to sustain the enthusiasm and energy, because that’s not you really wish to and even if you some day achieve that goal which you planned, it would not make sense because it’s not aligned with your life objectives. This is very much true for financial goals also. You have to make sure your goals are very much what you wish in life . Lets see some of my personal goals in life .
a) As I like to travel a lot so I would like to generate enough money in next 15-20 yrs , so that I can travel to different countries every 6 months .
b) I would like to build a Farm Land by year 2035, where I can personally do “Vegetable Agriculture”. (I personally have experience of growing things like corn, potato, tomato, carrots, radish, peanuts, cabbage, cauliflower, chana, almost all green vegetables, pulses, peas , onion , garlic) . Yes I have done it in UP at my hometown as a hobby. Do you know hybrid tomato seeds can cost upto Rs 75,000/KG so we bought 1 gm .
c) I would not like to save much for my child marriage, as I would like to encourage them for love marriage and settle things with a simple ceremony , that’s all . I dont believe in lavish marriges anyways .
d) I have no long-term goals of buying house, I would rather like to live in rent for long and build a corpus in pure equity + debt . If things changes and one day I feel real estate is something which should really be part of my portfolio, I will change my mind .
vegSeriously, do you want to buy that 55 lacs flat which is ‘almost’ out of city and commands a rental yield of not even 3% ? Do you ?
Timely : Imagine your goal is like “I would like to buy car of 5 lacs”, Fine ! . Now what do you do ? Do you save 5,000 per month or 20,000 and for how long , It’s important to set a time line so that you have a clear idea of how much does it take to achieve some goal. You can calculate the investment needed for that (See how to calculate) .
Example of Goal setting
Very simple way of doing this is to categorize your goals in Short Term , Mid Term and Long Term and each of them will have “High Priority” and “Low Priority” . This way you have a clear idea of what is important and first preference in all the time frame , For example .
- “I want to buy a Car worth 6 lacs in next 5 yrs, which can accommodate around 5-6 people” can be a High priority , Mid Term goal , where as
- “I would like to take a 2 weeks vacation in Kerela with my family worth 50k , can be a Low priority, Mid term goal .
Let us see the full example of Goal settings
High Priority
Low Priority
Short Term (<3yrs)
- Sister Marriage contribution: 3 lacs in 2012
- Buy a Car in 2013 : Rs 3.5 lacs
Mid Term (3-6yrs)
- Initial Child Expenses : Rs 2 lacs in 2015
- Abroad vacation with spouse : 5 lacs in 2016
- Invest in a unique startup idea in year 2016 : Rs 2 lacs
Long Term (7+yrs)
- Child Higher Education : 40 lacs in 2035
- 60% down payment money for a house : Rs 45 lacs in 2025
- Retirement Corpus : 5 crores in 2035
- House in a small town : Rs 15 lacs in 2025
- Passive monthly income of Rs 50,000 per month starting in year 2030
You might want to look at subra’s post on Financial Resolution , it gives a good idea of how you should start and stick to financial goals .
Very simple way of doing this is to categorize your goals in Short Term , Mid Term and Long Term and each of them will have “High Priority” and “Low Priority” . This way you have a clear idea of what is important and first preference in all the time frame , For example .
- “I want to buy a Car worth 6 lacs in next 5 yrs, which can accommodate around 5-6 people” can be a High priority , Mid Term goal , where as
- “I would like to take a 2 weeks vacation in Kerela with my family worth 50k , can be a Low priority, Mid term goal .
Let us see the full example of Goal settings
| High Priority | Low Priority | |
| Short Term (<3 yrs) |
|
|
| Mid Term (3-6 yrs) |
|
|
| Long Term (7+ yrs) |
|
|
You might want to look at subra’s post on Financial Resolution , it gives a good idea of how you should start and stick to financial goals .
Importance of Goal Setting with an Example
Even though it looks nonsense, you need to understand its importance and its impact. Financial Planning is all about achieving goals in the best possible manner by considering your current situation. If you do not have a goal set with some target amount and target date, then you don’t have a clear idea of reaching there.
Imagine a goal of “Child Education” which costs Rs 10 lacs in today’s value. If your target date is after 25 yrs, then considering a 10% education inflation (historically it stands at 10%), the target amount will be 1.08 crores { 10 X (1 + 10% ) ^ 25 }. Now lets take 3 scenarios with return assumption of 12% per annum .
1) You plan for it and start saving for next 25 yrs
In this case , you will have to save Rs 5,710 per month for next 25 yrs . So you can start an SIP today and consistently start investing for this goal . If you get 12% over long-term , and you do not deviate from your goal and consistently invest with discipline , you can reach the target .
2) You plan for it and save more in the starting years
In this case , lets assume you can save more money in the starting 10 yrs and then do leave your money to grow for next 15 yrs , then you just need to save 7,800 per month for next 10 yrs and then leave the money to grow for next 15 yrs .
3) You do not plan for it and start saving at later point
Incase you do not plan for it and lose the starting years of your earning life and once your child is 9-10 yrs old (suppose you lose 10 yrs) and then you start thinking about the higher education , then to meet the same goal you need to save 21,500 per month for next 15 yrs .
Even though it looks nonsense, you need to understand its importance and its impact. Financial Planning is all about achieving goals in the best possible manner by considering your current situation. If you do not have a goal set with some target amount and target date, then you don’t have a clear idea of reaching there.
Imagine a goal of “Child Education” which costs Rs 10 lacs in today’s value. If your target date is after 25 yrs, then considering a 10% education inflation (historically it stands at 10%), the target amount will be 1.08 crores { 10 X (1 + 10% ) ^ 25 }. Now lets take 3 scenarios with return assumption of 12% per annum .
1) You plan for it and start saving for next 25 yrs
In this case , you will have to save Rs 5,710 per month for next 25 yrs . So you can start an SIP today and consistently start investing for this goal . If you get 12% over long-term , and you do not deviate from your goal and consistently invest with discipline , you can reach the target .
2) You plan for it and save more in the starting years
In this case , lets assume you can save more money in the starting 10 yrs and then do leave your money to grow for next 15 yrs , then you just need to save 7,800 per month for next 10 yrs and then leave the money to grow for next 15 yrs .
3) You do not plan for it and start saving at later point
Incase you do not plan for it and lose the starting years of your earning life and once your child is 9-10 yrs old (suppose you lose 10 yrs) and then you start thinking about the higher education , then to meet the same goal you need to save 21,500 per month for next 15 yrs .
Learning
The most important learning we should take from this article is that planning for a goal gives a direction and enables us to start thinking in that direction. We spread out the effort of achieving that goal in different stages, rather than struggling at the end when that goal is near .
Comments , share your thoughts on setting financial goals , what are the problems in real life which does not encourage us for setting the goals in this manner , Is it realistic ?
The most important learning we should take from this article is that planning for a goal gives a direction and enables us to start thinking in that direction. We spread out the effort of achieving that goal in different stages, rather than struggling at the end when that goal is near .
Comments , share your thoughts on setting financial goals , what are the problems in real life which does not encourage us for setting the goals in this manner , Is it realistic ?
What is Real Return and How Inflation eats your money
Recently all news dailies carried the headlines : ‘inflation rate has crossed double digits’. This indeed is worrying. So what is inflation and how does it affect the common man. In simple terms inflation is nothing but rise in the general level of prices of goods and services in an economy. What leads to this rise in the price of goods? It is ‘too much money chasing too few goods’ which leads to the rise in the prices of goods. It is a simple demand-supply mismatch. Because of inflation, our paper money or currency starts losing its value.
Some 15 years back when I saw my first movie in a movie hall it cost me Rs 15 to watch that movie. Now 15 years down the line, to watch the same movie in a multiplex, it costs me about Rs 225. So in 15 years the cost of watching a movie has multiplied 15 times. Now it might cost you Rs 15 just to park your car in the multiplex basement, forget about watching the movie in Rs 15. That’s inflation for you.
Recently all news dailies carried the headlines : ‘inflation rate has crossed double digits’. This indeed is worrying. So what is inflation and how does it affect the common man. In simple terms inflation is nothing but rise in the general level of prices of goods and services in an economy. What leads to this rise in the price of goods? It is ‘too much money chasing too few goods’ which leads to the rise in the prices of goods. It is a simple demand-supply mismatch. Because of inflation, our paper money or currency starts losing its value.
Some 15 years back when I saw my first movie in a movie hall it cost me Rs 15 to watch that movie. Now 15 years down the line, to watch the same movie in a multiplex, it costs me about Rs 225. So in 15 years the cost of watching a movie has multiplied 15 times. Now it might cost you Rs 15 just to park your car in the multiplex basement, forget about watching the movie in Rs 15. That’s inflation for you.
Explanation
Let’s take a simple example to understand this. Suppose you have a currency note of Rs 100. Assume that as on today with this currency note of Rs 100 you can buy 1 dozen apples (mind you this is just an example. In real life good quality apples are much more costly and I doubt if Rs 100 will even buy you half a dozen of good quality apples). But you don’t need these apples as on today and need them 1 year down the line. So you don’t buy the apples today as you can’t store them for one year as they will get spoilt. So you invest this Rs 100 for 1 year in a bank fixed deposit which will fetch you 8% at the end of 1 year. Now at the end of 1 year you have Rs 108. But let’s assume that inflation as compared to last year has risen by 10%. This effectively means cost of living or general prices of products have risen by 10%. So now the same 1 dozen apples which were costing you Rs 100 about one year back will now cost you Rs 110. Your money has grown by 8% (Rs 100 has become Rs 108) but the prices of apples have gone up by 10% (price increased from Rs 100 to Rs 110). So to buy the same 1 dozen of apples now (1 year down the line) you will have to put an additional Rs 2 from your pocket. This effectively means your currency or paper money has lost value. This is because of the effect of inflation. If the cost of living goes on increasing at this rapid rate every year, then 10 years down the line I doubt whether the same Rs 100 rupees will be able to buy even a single apple, forget about buying 1 dozen apples with Rs 100.
Had you bought the apples last year you would have managed to buy 1 dozen apples for Rs 100. But since you are buying them one year down the line and the return on investment (8%) that you have earned is less than increase in inflation (10%), you have to put more money from your pocket. So inflation erodes the value of your money over a period of time if the money is not invested wisely.
Let’s take a simple example to understand this. Suppose you have a currency note of Rs 100. Assume that as on today with this currency note of Rs 100 you can buy 1 dozen apples (mind you this is just an example. In real life good quality apples are much more costly and I doubt if Rs 100 will even buy you half a dozen of good quality apples). But you don’t need these apples as on today and need them 1 year down the line. So you don’t buy the apples today as you can’t store them for one year as they will get spoilt. So you invest this Rs 100 for 1 year in a bank fixed deposit which will fetch you 8% at the end of 1 year. Now at the end of 1 year you have Rs 108. But let’s assume that inflation as compared to last year has risen by 10%. This effectively means cost of living or general prices of products have risen by 10%. So now the same 1 dozen apples which were costing you Rs 100 about one year back will now cost you Rs 110. Your money has grown by 8% (Rs 100 has become Rs 108) but the prices of apples have gone up by 10% (price increased from Rs 100 to Rs 110). So to buy the same 1 dozen of apples now (1 year down the line) you will have to put an additional Rs 2 from your pocket. This effectively means your currency or paper money has lost value. This is because of the effect of inflation. If the cost of living goes on increasing at this rapid rate every year, then 10 years down the line I doubt whether the same Rs 100 rupees will be able to buy even a single apple, forget about buying 1 dozen apples with Rs 100.
Had you bought the apples last year you would have managed to buy 1 dozen apples for Rs 100. But since you are buying them one year down the line and the return on investment (8%) that you have earned is less than increase in inflation (10%), you have to put more money from your pocket. So inflation erodes the value of your money over a period of time if the money is not invested wisely.
Nominal Returns and Real Returns
At the time of making investments you should make sure that, you earn a return which is higher than the inflation rate. Many people while measuring the returns on their investment forget to consider the effect of inflation. In the above example if we don’t consider the effect of inflation then our investment in the bank fixed deposit has earned 8% return. But this is not the correct way of measuring returns. This is just the nominal return. The return calculated after considering the effect of inflation is known as the real return. Real return can be calculated using the following formula
Here r is the rate of return (8%) and i is the inflation rate (10%)
1.08 / 1.10 is 0.9818
0.9818 – 1 is -0.01818
-0.01818 * 100 is -1.8181
So the effective or real return earned on this investment is -1.8181%
So even on the face of it, it seems that your investment has made a return of 8% (nominal return). After considering the inflation rate (10%), the real return is a negative 1.81. Which means actually on maturity you did not make any money, infact your money has lost value due to inflation. Surprised and hence the name of the article – ‘Inflation – The Silent Monster’ – inflation silently erodes the value of your money if you don’t invest wisely. So consider the effect of inflation while measuring your returns on maturity. Use following calculator to find your real investments real return .
At the time of making investments you should make sure that, you earn a return which is higher than the inflation rate. Many people while measuring the returns on their investment forget to consider the effect of inflation. In the above example if we don’t consider the effect of inflation then our investment in the bank fixed deposit has earned 8% return. But this is not the correct way of measuring returns. This is just the nominal return. The return calculated after considering the effect of inflation is known as the real return. Real return can be calculated using the following formula
Here r is the rate of return (8%) and i is the inflation rate (10%)
1.08 / 1.10 is 0.9818
0.9818 – 1 is -0.01818
-0.01818 * 100 is -1.8181
So the effective or real return earned on this investment is -1.8181%
So even on the face of it, it seems that your investment has made a return of 8% (nominal return). After considering the inflation rate (10%), the real return is a negative 1.81. Which means actually on maturity you did not make any money, infact your money has lost value due to inflation. Surprised and hence the name of the article – ‘Inflation – The Silent Monster’ – inflation silently erodes the value of your money if you don’t invest wisely. So consider the effect of inflation while measuring your returns on maturity. Use following calculator to find your real investments real return .
Children Education Cost Inflation
Whenever the Weekly or Monthly Inflation Number is declared by the Government, the number represents average inflation which takes into account the rise in the average cost of living. This is a much broader number. If we break down this broad number into different components then we realise that different components have varied impact on individuals. All people are impacted by common things like food inflation and fuel inflation. People who have small children have to prepare themselves for Children Education Cost Inflation and Children Marriage Cost Inflation. So how do Children Education Cost Inflation and Children Marriage Cost affect and why do parents have to plan for this? Let us try to understand this with the help of a case study.
5 Easy Steps to do your Child’s Education Planning
Sample Case Study
- Let us take the example of Ajay. He wants to make his 1 year daughter, Priyanka a MBA when she grows up. Priyanka will take admission for the MBA course when she turns 21 years old. So Ajay has 20 years in hand to plan for Priyanka’s education.
- The MBA course as on today costs Rs 4,00,000. If we assume that education costs (inflation) will rise by 8% every year, then the same MBA course will cost a whopping Rs 18,64,382 after 20 years.
- To accumulate this Rs 18,64,382 in 20 years, Ajay will have to make a monthly investment of Rs 2046 per month if his investments earn a return of 12%. So even though the amount of Rs 18.64 Lakhs seems huge on its face, with regular investments, and the magic of compounding over a period of 20 years, this mammoth target can be achieved with investments of as low as Rs 2046 per month. But the secret to success is to start early and make regular and disciplined investments.
- If the returns earned by our investments are 15% then the investment amount further falls to Rs 1421 per month. Historically equities have given annual returns in the range of 15% over a long period of time.
- If the target of Rs 18.64 Lakhs has to be achieved without taking much risk through a Public Provident Fund (PPF) account which guarantees a return of 8%, then this target can be achieved with a monthly investment of Rs 3276 per month.
Whenever the Weekly or Monthly Inflation Number is declared by the Government, the number represents average inflation which takes into account the rise in the average cost of living. This is a much broader number. If we break down this broad number into different components then we realise that different components have varied impact on individuals. All people are impacted by common things like food inflation and fuel inflation. People who have small children have to prepare themselves for Children Education Cost Inflation and Children Marriage Cost Inflation. So how do Children Education Cost Inflation and Children Marriage Cost affect and why do parents have to plan for this? Let us try to understand this with the help of a case study.
5 Easy Steps to do your Child’s Education Planning
Sample Case Study
- Let us take the example of Ajay. He wants to make his 1 year daughter, Priyanka a MBA when she grows up. Priyanka will take admission for the MBA course when she turns 21 years old. So Ajay has 20 years in hand to plan for Priyanka’s education.
- The MBA course as on today costs Rs 4,00,000. If we assume that education costs (inflation) will rise by 8% every year, then the same MBA course will cost a whopping Rs 18,64,382 after 20 years.
- To accumulate this Rs 18,64,382 in 20 years, Ajay will have to make a monthly investment of Rs 2046 per month if his investments earn a return of 12%. So even though the amount of Rs 18.64 Lakhs seems huge on its face, with regular investments, and the magic of compounding over a period of 20 years, this mammoth target can be achieved with investments of as low as Rs 2046 per month. But the secret to success is to start early and make regular and disciplined investments.
- If the returns earned by our investments are 15% then the investment amount further falls to Rs 1421 per month. Historically equities have given annual returns in the range of 15% over a long period of time.
- If the target of Rs 18.64 Lakhs has to be achieved without taking much risk through a Public Provident Fund (PPF) account which guarantees a return of 8%, then this target can be achieved with a monthly investment of Rs 3276 per month.
Importance of Starting Early
It is very important for the parent to start investing for the child’s future as early as possible. Starting early allows his money the much required time to grow and reap the benefits of compounding. Let us consider the above example of Ajay planning to accumulate money for Priyanka’s MBA course.
- His goal is to accumulate Rs 18,64,382 in 20 years. To accumulate this Rs 18,64,382 in 20 years, Ajay will have to make a monthly investment of Rs 2046 per month if his investments earn a return of 12%.
- If Ajay delays the investment plan and starts investment when the daughter is 6 years old, then in this case he will have 15 years to achieve his goal. In this case the monthly investments that he will have to make will rise to Rs 3956 per month to achieve his same target of Rs 18.64 Lakhs if his investments earn a return of 12%.
- If Ajay delays the investment plan and starts investment when the daughter is 11 years old, then in this case he will have 10 years to achieve his goal. In this case the monthly investments that he will have to make will rise to Rs 8400 per month to achieve his same target of Rs 18.64 Lakhs if his investments earn a return of 12%.
- If Ajay delays the investment plan and starts investment when the daughter is 16 years old, then in this case he will have 5 years to achieve his goal. In this case the monthly investments that he will have to make will rise to a whopping Rs 23205 per month to achieve his same target of Rs 18.64 Lakhs if his investments earn a return of 12%.
Use this Goal Planner Calculator to Plan your future goals .
The below table shows the monthly investment that will be required by Ajay to achieve his goal of Rs 18.64 Lakhs based on his investment time horizon. It is assumed that the investments will earn 12% in all the scenarios.
Investment Time Horizon (Years) Return (%) Monthly Investment Required 20 12 Rs 2,046 15 12 Rs 3,956 10 12 Rs 8,400 5 12 Rs 23,205
The sooner the parent starts planning for the child’s education and marriage the better. These are long term goals and need proper planning. This is the best gift that parents can give to their children. As a parent the sooner you sow the seeds of early investments, the bigger will be the fruit the tree will bear which will take care of your child’s all future needs, primarily education and marriage expenses.
It is very important for the parent to start investing for the child’s future as early as possible. Starting early allows his money the much required time to grow and reap the benefits of compounding. Let us consider the above example of Ajay planning to accumulate money for Priyanka’s MBA course.
- His goal is to accumulate Rs 18,64,382 in 20 years. To accumulate this Rs 18,64,382 in 20 years, Ajay will have to make a monthly investment of Rs 2046 per month if his investments earn a return of 12%.
- If Ajay delays the investment plan and starts investment when the daughter is 6 years old, then in this case he will have 15 years to achieve his goal. In this case the monthly investments that he will have to make will rise to Rs 3956 per month to achieve his same target of Rs 18.64 Lakhs if his investments earn a return of 12%.
- If Ajay delays the investment plan and starts investment when the daughter is 11 years old, then in this case he will have 10 years to achieve his goal. In this case the monthly investments that he will have to make will rise to Rs 8400 per month to achieve his same target of Rs 18.64 Lakhs if his investments earn a return of 12%.
- If Ajay delays the investment plan and starts investment when the daughter is 16 years old, then in this case he will have 5 years to achieve his goal. In this case the monthly investments that he will have to make will rise to a whopping Rs 23205 per month to achieve his same target of Rs 18.64 Lakhs if his investments earn a return of 12%.
Use this Goal Planner Calculator to Plan your future goals .
The below table shows the monthly investment that will be required by Ajay to achieve his goal of Rs 18.64 Lakhs based on his investment time horizon. It is assumed that the investments will earn 12% in all the scenarios.
| Investment Time Horizon (Years) | Return (%) | Monthly Investment Required |
| 20 | 12 | Rs 2,046 |
| 15 | 12 | Rs 3,956 |
| 10 | 12 | Rs 8,400 |
| 5 | 12 | Rs 23,205 |
The sooner the parent starts planning for the child’s education and marriage the better. These are long term goals and need proper planning. This is the best gift that parents can give to their children. As a parent the sooner you sow the seeds of early investments, the bigger will be the fruit the tree will bear which will take care of your child’s all future needs, primarily education and marriage expenses.
Children’s Marriage Planning
Like education it is the same story for children’s marriage expenses (inflation). If you as a parent feel that today your daughter’s marriage will cost you Rs 7,00,000 then the same marriage will cost Rs 11.27 Lacs 5 years down the line if expenses increase (inflation) at the rate of 10%.
Sample Case Study
Let us consider the following case study to understand this thing better in simpler terms.
- Sharon has an 8 year old daughter Mini. Sharon needs to accumulate funds for her daughter’s marriage. The marriage is planned 16 years from now.
- According to Sharon, as on today, Mini’s marriage will cost Rs 4,00,000. If inflation (rise in costs) of 5% is assumed the same marriage will cost Rs 8,73,150 after 16 years.
- If Sharon wants to make a one time investment which will give her Rs 8,73,150 on maturity after 16 years, she will have to make a lumpsum investment of Rs 1,42,429 (assuming the investment earns a return of 12% p.a.).
But many of us don’t have lumpsum amount to invest and we prefer to make monthly investments. To accumulate this Rs 8,73,150 over a period of 16 years Sharon will have to invest Rs 1,615 per month if her investments will earn a return of 12% p.a.
Watch this video which shows you the effects of Inflation in Zimbabwe and how the paper money has lost all its value.
Like education it is the same story for children’s marriage expenses (inflation). If you as a parent feel that today your daughter’s marriage will cost you Rs 7,00,000 then the same marriage will cost Rs 11.27 Lacs 5 years down the line if expenses increase (inflation) at the rate of 10%.
Sample Case Study
Let us consider the following case study to understand this thing better in simpler terms.
- Sharon has an 8 year old daughter Mini. Sharon needs to accumulate funds for her daughter’s marriage. The marriage is planned 16 years from now.
- According to Sharon, as on today, Mini’s marriage will cost Rs 4,00,000. If inflation (rise in costs) of 5% is assumed the same marriage will cost Rs 8,73,150 after 16 years.
- If Sharon wants to make a one time investment which will give her Rs 8,73,150 on maturity after 16 years, she will have to make a lumpsum investment of Rs 1,42,429 (assuming the investment earns a return of 12% p.a.).
But many of us don’t have lumpsum amount to invest and we prefer to make monthly investments. To accumulate this Rs 8,73,150 over a period of 16 years Sharon will have to invest Rs 1,615 per month if her investments will earn a return of 12% p.a.
Watch this video which shows you the effects of Inflation in Zimbabwe and how the paper money has lost all its value.
Conclusion
Last but not the least to end the article here is something for you all to ponder over your money in the bank savings account is earning an annual return of 3.5% and the annual average inflation rate (increase in cost of living) is 5-6%. So if you calculate the real return how much is negative return that you are making or how much is the value that your money is losing???? Think about it
Last but not the least to end the article here is something for you all to ponder over your money in the bank savings account is earning an annual return of 3.5% and the annual average inflation rate (increase in cost of living) is 5-6%. So if you calculate the real return how much is negative return that you are making or how much is the value that your money is losing???? Think about it
How Insurance Companies Work – The Ultimate Guide to understand their Business Model
I have written almost every possible article on Life Insurance and even Health Insurance, but strangely I still find a lot of investors asking questions which clearly shows that somehow, somewhere they do not understand what is the underlying business model of insurance business and how are the products designed overall. Let me use simple stories and recreate some examples which will show you how things work in any insurance business. Lets move on ..
I see a lot of people saying something like – “How can these companies offer 1 crore term plan by charging just a small premium of Rs 10,000. Its surely a racket!”
Then a lot of people still feel that insurance companies are cheats and they will not pay out when a claim arises, just to make sure that they do not have to pay a big amount from their pocket. I am not advocating any insurance company here, nor am I saying that I have a solution to your doubts. All I can do is share what insurance is all about. This should surely help you understand the business model of insurance companies and how they make money. You can then choose to trust the system or reject it. Note that In our100moneyactions program we have one of the tasks as completing your life insurance and health insurance with basic support system, So if you have still not registered for it, do it now.
Insurance Centuries Back – Lets go back in History
Insurance as a concept, is not a new thing in this world. It’s been in existence for centuries. Let me start with story which will give you some idea about insurance business and its evolution. Long back, there were businessmen all over the world, who traveled from one country to another for doing trade and business . They sent their stocks, inventories and material across globe on boats and ships. A lot of times when they used to send their ship from Point A to Point B, it so happened, that some ship drowned and everything on the ship got wiped out.
And this happened 10% of the time on an average. Out of every 10 ships which started from Point A, only 9 reached the destination and one businessmen almost surely went bankrupt. So you can see that the certainty was about the loss of 1 ship, but there was uncertainty about “whose” ship it will be (just like there is certainty that one an average 1-2 person will die in a city in accident for sure, but who will it be is not sure) .
So all the businessmen started to think over the issue and they found the solution. They started collecting 10% worth of the stocks from each of them, collected it in a bag. When each of 10 businessmen did this, the bag was full of money which would compensate any ship owner who was the unlucky one and lost his ship. If there was no accident and all the 10 ships arrived safely at their destination, there was no issue at all. But when there was a ship lost, the whole bag of money was given to the one who was affected, which meant that he didn’t suffer other than temporary shock and resentment.
So now if you see closely, you can relate this with insurance. These businessmen were doing nothing but mutually insuring their risk by pooling in the money (premium) and then compensating the unlucky business man in case of a disastrous eventuality (sum assured equal to 1 ship worth).
Any ship owner, who did not wanted to participate in this (thinking he would loose that 10% money if his ship was safe), was free not to participate, but then he was just taking a huge risk of wiping out everything he owned and going bankrupt.
So you learnt – What is Insurance exactly !
So you are still not clear about the concept of insurance with this small but simple story? Let me now rephrase it in modern terms.
Insurance is all about transferring the risk to someone else, by paying a small cost called a premium. The person who runs the insurance business (for profit!), takes care of all the research and data which makes the business viable in long term. Let me attempt to build a simple (imaginative) job loss insurance business right in front of you.
Job Loss Insurance for Software Industry
Let’s say, I decide to launch an insurance product called “Job Loss Insurance” for IT professionals . So, I research and find out that out of every 100 people in IT sector sector, 3 lose their job each year for some reason or the other, but then they are able to secure another job within 6 months (just an assumption). Now assuming that the average salary of a software professional is Rs 50,000 per month, it means that I can create a job loss insurance product which says –
“Pay a premium X each year and in case you lose your job, we will pay you 6 months salary to you, so that you can keep your mind cool and search for another job and pay your home loan EMI, children school fees and other commitments.”
Why am I suddenly feeling that some of the IT guys reading this really want this kind of product …
Anyways, so I know that out of 100 people, 3 people on an average will lose their jobs who would need 6 months of oxygen till they find another job (50k X 6 months = 3 lacs) . So, I would need 9 lacs to pay all these 3 claims which will arise each year. So now, I need a market of 100 people to whom I can pitch this product and generate 9 lacs of total money. Which means that I will have to price it as Rs 9,000 per person per year. In short 100 people will pool in Rs 9,000 and generate 9 lacs and then out of those 100 people, 3 will loose the job and file for a claim.
But wait, where is my profit ? I am not doing a charity ! Its a business for me ! . So for that reason, I will not charge Rs 9000, I will charge Rs 12,000 per year. So I keep a cool Rs 3 lacs as profit!
But , There is a problem …
Each year, its not that, only 3 out of 100 will loose the job! It could be 4 or 5 in some year and it can be 1 or 2 or even ZERO! in some other year. The 3/100 was just an average over long term . So while I know that a particular year can be very very bad or very very good, over a 10-20 yrs period, the average will be 3/100.
So, I will make sure that I keep sufficient capital with me before starting the business (what if in first year itself, there are 6 job losses out of 100). That’s the reason, why there are IRDA norms that a particular amount of net worth should be there with every insurance company before they get a licence and its calledSolvency Ratio.
So now, based on their premium pricing strategy and overall experience in next many years, an insurance company is very profitable in long run (high probability) or they suffer a loss. That might explain, why most of the new insurance companies are in a loss at the moment (insurance is a long term business, very long term).
Premium Increase for some customers
Now a lot of people wonder, why insurance companies increase the premium for some customers (called as loading the premium) . Let me show you with same example.
Now as per my data research, There might be a category of IT guys who have a higher changes of 5/100 job loss and that one is Software Engineer whose company is not US based and they are into Embedded systems . So in short a IT guy who is into Embedded systems with a Non-US based company is more dangerous customer to me . While I will still give him insurance, but I cant charge him same premium like every other IT guy. So I would charge him not 12,000 per year, but 24,000 per year – because he is risky! .
While he might not get fired by his company, I am taking a very high risk against him and I deserve to be paid more, otherwise it does not make any business sense to me. Now if he hides this information from me and does not tell me before hand while filling up the form that he is working in embedded systems, that too with a company which is not US based (guys, just a random assumption, don’t take it seriously), should I be paying him any insurance money if he actually loses his job? the answer is rude NO. I can’t be emotional here and look at your tears! You cheated me, so you pay for it!
This might explain to you, why insurance companies apply loading, when you tell them you are a smoker, or you drink, or you are obese or you are working for the Army!. You are a high risk customer, and as per business rules, they will definitely increase your premium, even you will do the same, if you started up a insurance business. Wont you ?
Will company really pay me at the time of claim ?
Yes, it will. Because for you 1 crore at Rs 8,000 per year might look very absurd, its actually not . Because Insurance is a volume’s game. One individual case is not going to affect a company, because it was already factored in. It was known to happen. Thats why the premium was collected and you will be paid because thousands like you will NOT file for claim. My premiums might be used to pay your claims! . So Like in my example, when a person loses his job, I know that he is part of that small group which is surely going to lose his job. I will not be worried paying you 50,000 per month for next 6 months even if you paid me just 12,000 in a year. I know for sure, that the rest of the 97 people will not lose their jobs and I can surely pay you what you are insured for.
Amount Accumulates and grows into a big pool
If in the first year, less than 3 people lose the job, then I have extra money left at the end of the year and I can carry forward this money into future for those bad years when more than 3 people will lose the job. I can also invest this money, which will grow over time, and If I have done my research right, I am surely going to be profitable over long term.
But my research will be different than your research, you might find different kind of data, may look at the job loss data differently, may look at scenarios in other ways, which does not match my philosophy and hence you might charge Rs 15,000 per year and not 12,000 per year, or you can charge Rs 8,000 per year and not 12,000 per year like me.
Which explains why premiums are different for different companies.
Auto Insurance – They know all the data that if a car is older than X number of years, what the chances of it crashing into another one, and then how many premium makes the business viable and profitable.
Health Insurance – Health insurance companies know the data about the hospitalization charges, the probability of a person of certain age to get hospitalized in next X yrs and all those kinds of data. So when they price their policies, they are smarter than you. You might look at an individual case of yours and feel that you will profit from it (which can be the case), but surely its will not be a loss making proposition for the company either (over a long term, collectively). If you are still uninsured, you can compare and buy health insurance from Coverfox website
Life Insurance – They know how many people out of 100, will die on an average in a year and within how many years. So if a big number of people pay for some years at least, it will be enough to pay the dead ones families.
Credit Card Insurance – There are insurance businesses around insuring credit cards. They know on an average out of 100 credit cards, how many are lost and on an average what is the loss amount. So they keep the premium such that they still make profits over a lot of customers.
Conclusion
I would like to conclude this article by telling you to understand the business model of insurance companies. Once you get it, suddenly all the doubts you had over years will go away. Insurance is a very strong concept which is a win-win model for the companies and for customers. At-least we used some stories and examples in this article which was just for illustration purpose and dont start arguing the data and numbers from examples .