There has been flash flood of money into the equities in last couple of years and this snowball is becoming bigger & bigger as it rolls down the hill. Falling interest rates have only pushed normal person to suddenly discover his risk appetite and start pouring money from bank deposit to stock market. While domestic participation is the best thing that can happen to any country’s stock market but are these new joiners well prepared before taking a plunge into the risky world of equities? The side effects of neglecting the risks associated with equities are huge. Let’s try to find out what all should be covered using Maslow’s theory as a parallel.
In human psychology, Maslow’s need hierarchy theory (depicted in the picture) states that we tend to move up the behavioral maturity level after accomplishing initial levels. So once we have overcome physiological needs (like food, clothes & shelter), we move up to safety needs required to secure physiological needs forever. Similarly once safety needs are met, we move to upper levels of the pyramid like self actualization, social respect etc.
In the world of finance, Maslow’s pyramid is very often used to mimic step by step process for investment. In Indian context, where basic thing like insurance is neglected, we believe first step should be insurance followed by contingency funds & then equities. All these steps should be followed properly before investing in equities, so any loss in equities should not jeopardize your basic requirements. Remember when economy is not doing well, it has a trickle down effect on equities and to your job stability as well. One should be well prepared in case such events occur in future. Let’s go to each step one by one to understand their importance.
Step 1: Life Insurance: Insuring one’s life is the first thing everyone must do. Imagine the plight of your dependents without you. If there are loans then it is even more important to have adequate life coverage. Alas, only 30% of Indians have taken insurance which speaks volumes about financial awareness in our country. Most youngsters don’t even think about it as if they are not yet eligible to die. Even in 30%, many folks are inadequately covered from ULIPs. Ideally you should have a coverage to match expected expenses of your family in your absence plus any outstanding loans. So if you have monthly expenses of ₹ 50,000 & no loans, your annual expenses are ₹ 6,00,000 (6 Lakhs). Assuming your family can invest that money at rate of 12% per year, they withdraw only 6% to leave remaining 6% for inflation, you will need ₹ 1 Crore as life coverage. Go for a Term plan which are quite affordable. A healthy non smoker individual around 30 years of age can get ₹ 1 crore life cover at annual premium of approx ₹ 15,000. The best part is that this premium remains fixed, it does not go up or down in subsequent years.
Step 2: Health Insurance: Health is wealth goes the old saying. These days medical costs have gone through the roof and a heart surgery can easily cost ₹ 10 Lakhs. Daily charges of ICU in a good hospital is ₹ 20,000 per day. Even a normal stone operation can cost ₹ 50,000. In India, medical costs are rising at a rate of 12-15% per year. This is one of the highest form of inflation which even a good mutual fund will sweat hard to beat. You can consider Family Floater plans which can reduce the premium but overall coverage can be higher. For a family of 2 adults + 2 kids, 15 Lakhs health insurance will cost you around ₹ 30,000 per year. So in total of 30k+15k= 45k, you can get both health & life insurance coverage. Having these two coverage will largely reduce your risk factors in life which is priceless. These are rough calculations to give you an idea, actual premium may vary a little but not significantly depending upon various factors which goes into underwriting for insurance service providers.
Step 3: Emergency Funds: Once you have life & health covered, you should plan for creating emergency funds to cater at-least up-to 6 months of your expenses. This fund should be parked into a Liquid fund and some portion (say 25%) in a bank saving account. You can invest in a liquid mutual fund which provides ATM for easy withdrawal. Currently Reliance & DSP Blackrock provide such liquid funds. Emergency fund safeguards you in case of a job loss or any other emergency situations. Keep in mind this should never be touched for any purposes apart from real emergency.
Step 4: Payoff your Debt: There is no point in investing with debt on the side. The nature of debt repayments are such that the longer you delay full payment, the more interest you pay. Its advisable to payoff all your debts before you start investing. However in some cases, people want to continue house loan to offset income tax. This may be a good approach only if you are buying a home for yourself to live. If you are doing this for a property investment, it is not a good strategy,
Step 5: Equity: Once you reach here after crossing step 1 to 4, I can guarantee you that your investment decisions will be mature & long term in nature. While to reach here, it may be a little painful or a wait for a year or two but this wait is worth doing. Equity market is not running away, it was here when your were a kid and it will be here in future as well. There is no point in skipping any of these steps since in case of a mishap, you will be pulled down to step 1 like a snake ladder game. It will disrupt your whole planning & you will be back to square one after years of investing. Following these steps will not only give you a peace of mind but also ensure that you are not pulling off money from equities when you need to stay invested. Selling equities prematurely will break whole wealth creation process.
Once you are at step 5, you can plan to invest as per your goals & risk appetite. Whatever you do, stick to your investment goals & risk-return profile. Equity market will go up & down, so chasing will not help as you are always a step behind. You will do much better if you stick to your plan. Equity market will eventually return back in your favor provided you hang in there.
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