In this age of disposable incomes and condoned extravagance, it is easy to justify bingeing. Spending surges may be forgivable around festive season, but it’s not as easy to overlook the effects of financial splurging.For most people, financial decisions pertaining to investing, buying insurance or taking loans, are an erratic, rather than an informed and planned, process. In their zeal to ensure that they don’t run short of funds for their goals, or out of ignorance about insurance and investment avenues, or simply lured by the easily available credit, investors end up with bulky, skewed portfolios.This means that they have innumerable stocks and dozens of mutual funds, have invested all their savings in real estate or fixed deposits, have bought 6-8 traditional life insurance plans with exorbitant premiums, or have taken 4-5 loans at high interest rates. Take 42-year-old Amol Tainwala, who has a portfolio skewed heavily towards real estate (46%) with three flats and four plots. “I did it on the advice of my family, but have been moving to equity in the past six months,” says the Bengaluru-based businessman.
In Pic: Amol Tainwala 42, BengaluruWhat’s too much?Real estate: 3 flats and 4 plots of land% of portfolio: 46%Debt: FDs, PPF, post office schemes% of portfolio: 33%Equity: 30 stocksWhat should he do?Create asset allocation, with 60% in equity, 20% in real estate, and 20% in debt.Real estate: Sell some property and increase exposure to equity.Equity: Sell stocks and invest in equity-oriented mutual funds.Debt: Cut debt, increasing it closer to financial goalsIn excess, these products are not only difficult to manage but, more importantly, can derail financial planning. “Most people don’t even know how many stocks or funds they have till they go to a financial adviser. Even then, they don’t ask the right questions and advisers don’t give them appropriate answers,” says Nitin Vyakaranam, CEO, ArthaYantra.The adverse impact of bingeing on financial products includes exposure to high risk and low returns, jeopardising your savings and neutralising your efforts to meet goals. To help you understand how debilitating bingeing can be, go through the following pages.Whether it is investment, insurance or loans, the first step is to question the purpose of buying in bulk. If it is not fulfilling your requirements, you probably need to downsize or junk it. Find out how much is too much for you, and what to do about it.Also Read: How to determine asset allocation of your portfolioInvestmentsInvesting right is the cornerstone of financial stability and, yet, the art remains elusive to most investors. When they begin earning, money is randomly put in various instruments on the advice of well-meaning, but ill-informed, family and friends. It is a blind corpus-building exercise without any understanding of the instrument or purpose of investment.So the first question to ask is not where you should invest, but why? Identify the goals you want to invest for, the goal values, and time frames for achieving each. Once you know the amount you need and the time you require, the next logical step is to identify the instruments. But before you rush into a fixed deposit or mutual fund, consider the asset class. Enter asset allocation, the antidote to bingeing.Asset allocation is simply a strategy to apportion your money in a way that you can balance risk and return. So you pick from various asset classes like equity, debt, real estate, gold and cash, and distribute your money to generate optimum returns by not being exposed to too much of any one class. “How much you hold in which type of investment matters more than the actual names, stocks and funds you may have,” says Uma Shashikant, Chairperson, The Centre for Investment Education and Learning.Though asset allocation is a dynamic process unique to every person, it can be decided by age, goal horizons and your risk appetite. The younger you are, the more your ability to take risk since most goals are in the distant future. So you can invest heavily in equity to ensure high returns, and put a small percentage in debt for stability. As you grow older or approach goals, you will need to safeguard your capital, so move to higher debt and lower equity.Also Read: What should be your asset allocation?Even if you get your asset allocation right, you could go wrong by bingeing on the wrong instrument or through inefficient manner of investing. This could result in lower returns because replication could lead to higher expenses or taxation.EquityMutual funds: For Ahmedabad-based Nishit Dalal, it’s a double whammy. At his age, he should have about 60% of his portfolio in equity, 20% in debt and about 20% in real estate. However, Dalal has got his math wrong because he has discounted his investment in a second property, which has skewed his portfolio towards real estate. While he believes he is investing 80% in equity through mutual funds, his equity share is actually only 20%, with nearly 60% going to real estate and 10% to debt.The 41-year-old has not only got his asset allocation wrong, but also the manner of investing. He is investing in equity through 25 mutual funds. “These are random picks on the advice of an agent who does everything for me, including filling up forms,” says Dalal. Explains Vyakaranam: “Bingeing can happen not only at the asset class level, but also at the instrument level. People think mutual fund is an asset class, not an instrument. By picking a lot of funds, you are replicating the same stocks.”
In Pic: Nishit Dalal 41, AhmedabadWhat’s too much?Equity: 25 mutual funds worth Rs 19.9 lakhInsurance: 6 traditional life insurance plans with a cover of Rs 21.5 lakhWhat should he do?Equity: Prune MF portfolio to 6-7 schemes, with equity-debt ratio of 60:40. Avoid sectoral/thematic funds.Insurance: Surrender all 6 plans. Buy a term plan of Rs 1 crore.“You need a maximum of 8-10 funds,” says Priya Sunder, Director, PeakAlpha Investment Services. “You can start with a 4:3:1 mix of equity, debt and liquid funds, and gradually increase the ratio to 6:3:1,” she adds. For most investors, 6-7 funds should be more than enough as it helps avoid duplication and makes it easier to monitor and manage the fund portfolio.On the other hand, if you are overexposed to equity, especially if you are close to your goals, you could open your finances to risk and market volatility. So follow the asset allocation as per your age bracket and proximity to goals and slash equity.Stocks: As with mutual funds, you don’t need a very big stock portfolio. Around 15-16 stocks should be good enough for Rs 40-50 lakh of investment. This is because diversification can help reduce the risk only to a certain limit. “Sometimes the value of all the stocks is not even Rs 1 lakh, so even if it doubles in value, the difference to your portfolio will be marginal. If you have a large number of stocks, either reinvest only in stocks with high conviction, or redeem them and invest in mutual funds,” advises Sunder.
In Pic: Priya Sunder, Director, PeakAlpha Investment Services”Sometimes the value of all your stocks is not even Rs 1 lakh, so even if it doubles in value, the difference to your portfolio will be marginal.”This is the reason Bengaluru’s 38-year-old Ravikiran would do well to move to mutual funds. He has invested in 20 stocks with a value of only Rs 70,000 and has little idea about stock investment.DebtInvestors also love to binge on fixed deposits and post office schemes. Take Tainwala, who has 33% of his portfolio in the PPF, fixed deposits and post office schemes, when it should not be more than 20%. If in your 20s, 30s or 40s, you have a higher percentage in debt than equity, you are dragging down your portfolio by sacrificing high returns, which could be crucial for achieving long-term goals.“As an asset class, debt provides stability and hedge against volatility, and should only be in short duration or liquid instruments,” says Vyakaranam. This exposure can be achieved through mutual funds as well. “Debt should be seen as a replacement for fixed deposits and not as a long duration investment. You should not be invested in debt instruments with more than three years’ duration,” says Sunder. Within mutual funds, you can do this by investing in liquid and short-term funds.With the recent increase in interest rates on the PPF and other small savings schemes, you may feel tempted to overdose on these. But unless you are in an age group where you require a high debt exposure or the scheme allows you to lock in at the high rate for a longer duration, don’t think of over-investing. This is because schemes like the PPF and NSC are market-linked and the rates will keep changing every quarter.Real estate“Do not deploy money in physical assets like real estate because not only is it an illiquid asset but the returns are likely to go down in the future,” says Sunder. Similar advice from countless experts does not stop Indians from bingeing on property. “I was advised by my family to buy real estate early on in my career,” says Tainwala. Businessman Ravikiran’s two houses make up 93% of his portfolio. While it is a good idea to buy a house to live in, investing in real estate doesn’t make sense for several reasons.
In Pic: Ravikiran 38, BengaluruWhat’s too much?Real estate: 2 houses% of portfolio: 93%Stocks: 20 worth Rs 70,000Insurance: 4 traditional life insurance plans with a cover of Rs 6 lakhWhat should he do?Property: Sell one house and invest in equity for long-term goals.Stocks: Sell stocks and invest in mutual funds.Insurance: Surrender 3 plans. Buy term plan of Rs 1.1 crore.It is not only an unpredictable asset class because the growth is highly location-specific, but is also an underperforming class since its returns do not match those of equity. It is also highly illiquid and has a high upkeep cost, which includes taxes, utilities and renovations. Finally, it is invariably acause of family disputes. So avoid bingeing in real estate.GoldGiven the current market volatility, many people might be lured into buying gold. “It is after all a hedge and you can have 5-10% in your portfolio,” says Vyakaranam. But beyond that, it’s best to stay away from the metal. “Do not buy it as an investment and, if at all, have it as bond, gold fund or ETF,” says Sunder. Of late, it has given poor returns (0.5% CAGR in the past five years), is difficult to store and incurs additional costs and charges when sold.InsuranceTraditional insurance policies: There are three reasons why investors binge on traditional life insurance policies, which can be endowment or money-back plans. One, they do not know the difference between protection and investment. Two, since these offer tax incentives in the form of Section 80C deduction and tax-free maturity benefits, they are readily picked up during the tax-saving season. Three, the low awareness and lack of alternate investment avenues for Gen X and baby boomers resulted in their sole dependence on LIC’s traditional policies, a habit that continues with the millennials.Dalal blames the first reason for his six traditional policies, all of which are endowment plans, providing a combined cover of Rs 21.5 lakh at an annual premium of nearly Rs 75,000. “At the time of buying these, I did not know the difference between insurance and investment, and was also unaware about term plans,” says Dalal, who is going to surrender all the policies this month and will buy a term plan instead.The ‘guaranteed return’ policies are a mix of life insurance and investment. They not only offer an inadequate cover at a high premium, but also give poor returns (5-6%), which do not beat inflation. If you depend on these to achieve long-term goals, you will expose yourself to the risk of not being able to muster sufficient corpus. The best option for long-term goals is to invest in equities and, for life insurance, buy a term plan, which is a pure protection instrument.If you have made the mistake of buying traditional plans, and have held these for more than three years, it will be a good idea to surrender these. This is because by investing the premium that you would otherwise put in these plans, you will build a bigger corpus, despite losing some money as surrender charges. Also Read: Guide on surrendering life insurance policyIf, however, you are close to maturity, you will have to calculate the surrender value and check whether you will earn more by reinvesting. “Surrendering these plans is not difficult at all. If you call up the company, they will calculate the surrender value that is due to you and you can take a call on it,” says Sumit Rai, MD and CEO, Edelweiss Tokio Life Insurance.Ulips: Unit-linked insurance plans are also favourites, especially of late, since they are offering better tax benefits than equity funds, comparable returns and low charges. So if it fits in with your insurance requirements at a certain lifestage or a particular goal, it may make sense to buy a Ulip. “For instance, you can buy child Ulips since these offer assurance that the premiums will continue and the goal will not be affected if you were to die,” says Sunder. “However, understand that these are fundamentally insurance products and you should not mix insurance and investment,” adds Vyakaranam.LoansAll loans are not bad because some like home and education loans can help build an asset or lead to better career prospects. However, taking too many loans, big and expensive, can lead to a debt trap that you may find difficult to get out of. The first step, therefore, is to ensure you do not land yourself in such a situation. Calculate the percentage of your income that will go into servicing the EMIs (see How much EMI can you afford?). Combined, these should not be more than 45-50% of your total monthly income. “As credit is freely available, people are optimising all their resources and buying on EMIs. This can become a problem in the next few years,” says Vyakaranam.How much EMI can you afford?All Loans: not more than 50% of net income.
“Second, be prudent about the type of loans you take. Do not take expensive personal loans, or for depreciating assets like cars,” says Sunder. It goes without saying that you should not roll your credit card dues as well since you are paying a high 3-4% per month on this amount. Third, do not borrow to splurge or invest. So avoid taking loans for vacation or expensive gadgets. Try to save for these and if your income does not allow you to do so, eschew these expenses. Similarly, never borrow to invest, especially in the stock market. Finally, try to keep the loan term short. In case of bigger loans, most people are tempted to go for a lower EMI to maintain easy cash flow. But the longer the tenure, the higher the interest component and greater the final outgo. So unless the tax benefits are significant, try to repay the loan at the earliest.If you do land yourself in a situation where you are finding it hard to service all the EMIs, take remedial measures immediately.Repay more expensive loans: List out the outstanding loans and pay off the most expensive one first. While credit cards are the most expensive at 36-48% annually, personal loans can range from 11-15% and combined with the processing fee ranging from 0.25-2%, become more expensive. If the credit card loan is huge, convert it into a personal loan, which will be less expensive.Take loans against assets: Loans taken against assets such as property, insurance, bonds, securities, etc, are cheaper and can be used to pay off the more expensive loans. For instance, loan against property can range from 11-15% (excluding processing fee) and can be used to repay the more expensive credit card loan.Prepay bigger loans: For getting rid of big home loans, try various prepayment options. Increase your EMI incrementally every year to reduce the tenure drastically. For instance, increasing the EMI by 5% every year for a Rs 50 lakh loan taken for 25 years, can reduce the term to 13 years and three months.Increase EMI, prepay big home loanBy raising the EMI even by 5% every year, you can cut down the tenure of a Rs 50 lakh loan from 25 years to nearly 13 years.
Liquidate low-yield investments: Encash low-yield investments such as fixed deposits or gold to repay high-cost loans.
Read more: economictimes.indiatimes.com