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we plan for a goal, we assume a rate of return on investments for the goal and plan
investments accordingly. Picking up the long-term average return is a rational
choice. Long term averages are fine (even though long term averages can also change).
However, the sequence of returns matters too. For the same level of long-term return, the actual
output can be very different depending on your investment pattern and of course,
the sequence of returns. And this has implications on your financial planning,
especially during your retirement.
try to understand this with the help of a few examples.
Sequence 1: You earn 8.96% every year for 30 years.
Sequence 2: You earn 6% p.a. for the first 15 years
and 12% p.a. for the next 15 years.
Sequence 3: You earn 12% p.a. for the first 15 years
and 6% p.a. for the next 15 years.
An investment of
Rs 1 lac would grow to Rs 13.72 lacs under all the 3 sequence of returns. The
path taken to reach the final amount will be different. However, at the end of
30 years, you will end up with the same corpus.
Let’s now change
things a bit. Instead of investing lumpsum, you decide to invest Rs 10,000 at
the beginning of each year. Let’s see what happens then.
As you can see, you end up with very different amounts in the three cases. The difference is substantial too. The corpus under Sequence 3 is over 40% higher than the corpus under Sequence 2. This is the sequence of returns risk.
shows that the sequence of returns matters during accumulation phase. It may not matter for lumpsum one-shot
investment, but it clearly matters when your investments are spread out over several
years. And this is likely to be the case for the most of us. By the way, even
for the lumpsum investment, the sequence of returns can affect your behaviour.
For instance, a poor sequence of returns may frustrate you to the extent that
you decide to liquidate your investment. Worse still, you may exit the
investment just before the good times come.
Now, you can’t control this sequence of returns from an asset class that you will experience. All you can do is to tweak your allocation to the asset class based on your market outlook. By the way, your outlook should turn out to be correct too (more often than it turns out to be wrong). Alternatively, you can work with an asset allocation approach and rebalance your portfolio at regular intervals and hope to earn some rebalancing bonus.
the way, the sequence of returns is also a reason that the investors earn
different returns in the same fund. You may be investing in the same fund, but
the quantum and the timing of the investment may be very different.
Retirement/Withdrawals: Sequence of returns pose a much bigger problem
We have seen how the sequence of returns can affect your final portfolio value. However, during the accumulation phase, you at least have an opportunity to make a course correction or take steps so that your goals don’t get compromised. For instance, you can try and invest more when you find that your portfolio is suffering. Moreover, a bad sequence of returns during the early investing years can be quite beneficial (so long as you can control your emotions). However, the biggest advantage is that you are not withdrawing from your portfolio.
During retirement, you must make withdrawals. A poor sequence of returns (especially during the early part), along with withdrawals can spell disaster for your portfolio. You can run out of money.
Let’s see this with an example.
you had accumulated Rs 1 crore for retirement. Let’s say you need Rs 8 lacs per
annum towards your expenses. You withdraw the amount at the end of each year
(for the ease of calculation).
Assume you live in a world of no inflation. With your expense inflation at 0%, your annual expenses stay constant. You assume that you can earn 8% p.a. return (alternatively I could have assumed a rate for inflation and expressed returns as real returns).
If you earn 8% year after year and need to withdraw only Rs 8 lacs per annum, you will never run out of money. You will have Rs 1 crore intact even after 50 years. However, if you are investing in risky assets, this 8% is not guaranteed every year. Over the long term, you may be able to earn 8% p.a. though.
if you earn -10% in the first year and -5% in the second year?
What you had expected: Your Rs 1 crore would become Rs 1.08 crore after the first year. You would withdraw Rs 8 lacs and left with Rs 1 crore. The same cycle will repeat in the second year too and you will still have Rs 1 crore at the end of 2nd year.
What actually happened: Your Rs 1 crore becomes 90 lacs at the end of the first year. You withdraw Rs 8 lacs and you are left with Rs 82 lacs. In the second year, you lose a further 5% and end the year with Rs 77.9 lacs. You withdraw Rs 8 lacs. You are left with Rs 69.9 lacs.
you have lost 30% of the corpus over these two years. Once you start losing money, the odds start
getting against you. This is maths. You have to lose 50% to go from Rs 100 to
Rs 50. However, to go back from Rs 50 to Rs 100, you must go up by 100%.
need Rs 6 lacs of income every year (0% inflation). You want to plan for 30
years. Assuming you can earn 10% return each year, you need Rs 62.21 lacs at
the start of your retirement. Your portfolio will go to zero at the end of 30
let’s assume another sequence of returns with long term CAGR of 10% but with
variable returns. I pick a sequence with poor returns initially.
You run out of money in the 18th year. The initial set of bad returns caused so much damage that you couldn’t recover. Remember, the long term average is still 10% p.a.
poor sequence of returns hurts you more during the early part of retirement
than a bad sequence during the latter part of retirement.
How is this different from accumulation phase?
The difference is that, during the withdrawal phase, you are taking out money from the corpus. Therefore, your losses become permanent. There is no way you can recover the loss once you have sold the investment. The investment may recover per se (your mutual fund or the stock may give roaring returns thereafter) but your portfolio won’t experience the recovery.
By the time good sequence of returns comes around, you may not even have sufficient corpus to benefit from it. Worse still, you may have run out of money.
When you are in the decumulation/withdrawal phase, rupee cost averaging works in reverse (against you). Why? Because when the markets are down, you must sell a greater number of units to maintain the same level of income.
How to reduce Sequence of Returns risk?
There is no way to eliminate the risk completely with volatile investments. You can’t decide the sequence you will experience. You can only try to reduce the impact if a bad sequence comes your way.
During Accumulation Phase
a super-smart investor. Exit equity investments and shift to safer investment
just before equities start doing badly. Get back into equities just before
equities are about to start performing well. The problem is, is this even
If you can’t do the above, it is better to stick with an asset allocation approach and rebalance your portfolio at regular intervals. You can decide your asset allocation depending on your risk appetite, goals and investment horizon. You can make minor tweaks to target asset allocation depending on your market outlook but don’t overdo it. For instance, you may have started with 60:40 (equity:debt) target asset allocation. If the equities look very expensive, you can change the target allocation to say 55:45 or 50:50 or say 40:60. However, taking binary decisions i.e. exiting equities completely or reducing allocation to 5% or 10% if you feel the markets are overvalued, is likely to be counter-productive over the long term.
This is a much bigger challenge because you must withdraw from the corpus. A poor sequence of returns clubbed with withdrawals, can be a disaster for your portfolio.
There can’t be a one-size-fits-solution either. It will depend on your accumulated corpus, income requirement, your risk appetite, and risk-taking ability.
are a few things you can do.
Have a bigger corpus. Or rather plan for longer life, say 40 years instead of 30.
Reduce withdrawals if you encounter a bad series of returns. For an illustration, refer to this post.
If you encounter a poor series of returns, be prepared to work part-time to support expenses. This may be possible if you encounter a bad series during the initial part of retirement. Remember, a bad sequence during the initial years hurts more.
Shun risky investments altogether. Stick with fixed deposits. There will be no sequence of returns risk. However, it will be difficult to beat inflation. Can be a problem unless you have lots of money.
Keep a low percentage of your money in volatile assets such as equities. You may need a bigger corpus.
As advised above for accumulation phase, work with asset allocation approach and rebalance at regular intervals.
Divide your portfolio into buckets. For instance, the money that you need in the next 5 years can go to liquid funds. For the years 6 till 10th year, you can put in ultra-short or low duration bonds funds. For the expenses to be incurred from the 10th till the 15th year, you can put the money in a hybrid (balanced) fund. Anything above can be invested in equities. The idea is to give your volatile assets time to deliver returns. You don’t want to sell them when the markets are down. Do note, at the most basic level, this approach is not much different from an asset allocation approach. However, there can be benefits if we consider the behavioral aspects. It is easy to maintain discipline during a market downturn when you know that your next few years of expenses are taken care off (that money is in less volatile investments).
You can’t choose the sequence of returns you will experience. To an extent, it also depends on your luck. After all, you can’t always choose when you retire. Depending on your portfolio size, market outlook and income requirements, you can merely position your portfolio to reduce the impact.
No parent wants to compromise on their child’s education. In fact, child education is one of the most prominent goals for almost all my clients. Many readers write with their queries about investing for their kids’ child education too. Many want a one-stop solution for their kids’ education. For this reason, many ask about the “Best Child plan” or the best child plan from LIC/SBI/ICICI/HDFC, etc.
Well, the financial services industry does not let go any demand unmet. Therefore, there is no dearth of such child insurance plans. I had written a generic post about the structure of such plans and the issues with some of the prevailing product structures.
this post, let’s pick up a popular child plan from SBI Life, SBI Life Smart
Champ Insurance and see if you must consider this plan for your children’s
Life: Smart Champ Insurance: Salient Features
A non-linked Participating traditional insurance plan.
Structured to fund your children’s education.
Two premium payment options: Single and Limited Premium Payment
Under the limited premium variant, you pay the premium till your child turns 18. In a way, the age of the child determines your premium payment term. The payment term is 18-Age of the child. Policy term is 21-Age of the child
Minimum/Maximum Sum Assured: Rs 1 lacs/ Rs 1 crore
Life insurance is on the life of the parent (and not the child).
There are two insured events: Demise of the parent (proposer), Total and Permanent Disability due to an accident.
Life Smart Champ Insurance: Survival/Maturity Benefit
Under the plan, you pay the premium till such time your child turns 18. The maturity benefits are spread over 4 overs. You get maturity benefit in 4 annual installments starting from the end of the policy year in which your child turns 18. Remember policy term will be till your child turns 21. For instance, if your daughter is 3 years old, you will pay a premium for 15 years and the policy term will be 18 years. Of course, if you choose single premium variant, you must pay the premium just once.
At the end of the policy year in which the child attains 18 years of age: 25% of Sum Assured + 25% of Vested Reversionary Bonuses
At the end of the policy year in which the child attains 19 years of age: 25% of Sum Assured + 25% of Vested Reversionary Bonuses
At the end of the policy year in which the child attains 20 years of age: 25% of Sum Assured + 25% of Vested Reversionary Bonuses
At the end of the policy year in which the child attains 21 years of age: 25% of Sum Assured + 25% of Vested Reversionary Bonuses+ Terminal Bonus, if any
bonus will be announced every year and will keep getting added to the policy. Do
note reversionary bonuses will accrue only during the premium payment term.
Therefore, no bonus will accrue in the last 3 policy years. Terminal bonus will
be applicable only in the final year (when the child turns 21) and will be paid
only with the last installment.
By the way, there is an option to receive the installments earlier at a discounted rate. The cash flows, if such option is exercised, shall be discounted at 6.5%.
Life: Smart Champ Insurance: Death Benefit
of the primary concerns for any parent is, “How would the family manage if I am
not around?”. Since the plan is structured around planning for kid’s education,
the question could be rephrased as, “How will the investments for my daughter’s
education continue if I am not around?”.
the event of the demise of the policyholder during the policy term,
Assured under the policy is immediately paid to the family.
the future premiums are waived.
keep getting added to the policy even after premium waiver comes into effect.
daughter gets the maturity benefits as scheduled (for 4 years starting from the
end of policy year she attains the age of 18)
The pay-out made at the time of demise does not impact the maturity benefit, which is a good thing.
Do note the parent’s demise is just one of the insured events under the plan. The other insured event is Total and Permanent Disability, resulting from an accident. Therefore, if the parent (proposer) were to become totally and permanently disabled (loss of two limbs, loss of both eyes, etc., the family will get the same benefits as in the event of demise. For more on disability insurance, refer to these posts (Post 1Post 2).
permanent disability can severely compromise your earning ability. Therefore,
total and permanent disability to the parent will cause the same problems (or
even worse) so far as your children’s education is concerned. It is good that this plan got this aspect
Structurally, this is how child plans should be. The family gets some lump sum in the event of the death of the parent. The family does not have to worry about any future premium payments as those are waived. The premium waiver does not affect wealth accumulation either. SBI Smart Champ Child insurance plan scores well on this front.
we need to look at the prospective returns too. Let’s see how SBI Smart Champ
fares on this front. Let’s explore this through an illustration.
Illustration: SBI Child Plan (Smart Champ)
copy the illustration from the product brochure. You can check the premium and
prospective benefits for your case on SBI Life website.
You are 35 years old. You are planning to invest for 6-year old daughter’s education. You opt for limited premium payment variant and a Sum Assured of Rs 5 lacs.
Premium before taxes shall be Rs 41,410. After GST, the premium in the first
year shall be Rs 43,273. Annual Premium for the subsequent years shall be Rs
will have to pay the Premium for 12 years (18- 6). You will get life cover for
15 years (policy term).
though we are in 2019, let’s simply go with the illustration provided in the
brochure. Let’s say you purchase the plan on March 1, 2014. You will have to
pay 12 annual installments. Last installment will be paid on March 1, 2025.
Life coverage will be till March 1, 2029.
insurance company will make the payments on March 1 in the years 2026, 2027, 2028
Source: SBI Life Smart Champ Child Insurance Product Brochure
sample has two illustrations. Illustration I is with return on investment of 4%
while Illustration II is with return on investment of 8%. Given the kind of
investments this plan will make, 8% ROI seems a very fair (or even optimistic
assumption). I mean Illustration II might just be the best or very close to the
see how net returns look like with Illustration II.
As you can see, the pay-out comprises two components. 1.25 lacs (25% of Rs. 5 lacs) is guaranteed each year. Remaining is variable and is linked to accrued bonuses. The final installment has an additional component of terminal bonus.
The IRR is this case turns out to be 4.05% p.a. Well, this is way too low.
gives you about 8% p.a.
I appreciate that SBI Life Smart Champ provides life and disability insurance
benefits too, this is still too low a return for a long-term investment. You
must also note that the life and disability insurance amount is not very big
and unlikely to be enough.
The premium for life cover of Rs 50 lacs and a total permanent disability cover of Rs 25 lacs for a 35-year-old (for 15-year policy term) is about Rs 7,000 per annum. You can simply invest the remaining amount in PPF. You will get a higher insurance cover and better investment returns. If PPF gave 8% p.a. and did not have withdrawal restrictions, you could have generated the exact same cash flows as with SBI child plan and still be left with about Rs 1.25 lacs. Clearly, better coverage and better payouts.
A few other points to note
these plans, Sum Assured is linked to your ability to pay premium. Annual
premium (before) for Rs 5 lac cover is Rs 41,410. For Rs 10 lakh cover, the
premium goes up to Rs 82,820. You can go up to Rs 1 crore. However, what if you
cannot afford such a high premium? With these plans, you run the risk of being
under-insured. By the way, this is not a problem with just this plan. This is a
problem with all traditional life insurance plans and even ULIPS too.
What should you do?
I quite like the structure of this plan. It is very easy to understand too. Just that the returns are way too low. Avoid.
ICICI Prudential Future Perfect is a traditional life insurance plan. A part of the maturity amount is guaranteed while the other part is variable and linked to the investment performance. In a way, it is a hybrid product where it retains some features of both non-participating and participating traditional plans.
Let’s find out
more about ICICI Prudential Future Perfect and see if this plan should figure
in your investment and insurance portfolio.
Reversionary Bonus, if any + Terminal Bonus, if any
Maturity benefit (GMB) is known upfront. It depends on your age, policy term, premium payment term and
gender. It may even be lower than the Sum Assured. Now, I could not figure out
how GMB is calculated. The matrix was not shared in the brochure or policy
wordings. However, you can expect GMB to increase with increase in annual
premium and premium payment term and decrease with increase in entry age. The
good part is that you know the GMB upfront. So, you don’t have to break your
head over this.
Additions (GA), as the name suggests, are guaranteed. You know upfront the rate at which these accrue.
During the premium payment term (PPT), the GA will accrue on the premium
payment. After the end of premium payment term, the GA will accrue at the
beginning of the policy year.
Reversionary Bonus is announced every year and gets added to the policy. The quantum will depend on the returns
earned by ICICI Prudential Life Insurance under this policy. Though this bonus
is announced every year, it is paid only at maturity or at the time of demise
of the policyholder. The way Reversionary bonus is applied is very different
from some of the other traditional plans that we have seen. In this case, bonus
is announced as a percentage of GMB + all accrued reversionary bonuses in your
policy. You have Compound Reversionary Bonus (instead of Simple Reversionary
Terminal Bonus is announced (applicable) in the year of maturity or demise. Since this is a new plan, no terminal bonus has yet been announced in this plan (up to FY2019). This is very similar to Final Additional Bonus (FAB) in other insurance plans we have discussed on this blog. As with FAB, the quantum of the terminal bonus depends on your luck. You may get a good amount, or you may get nothing at all. While calculating investment returns, do not bet too much on this.
are the returns like?
is a traditional life insurance plan. Therefore, don’t expect returns to be too
go by an illustration that I generated for a 30-year-old male on ICICI Prudential
annual premium you choose is Rs 50,000 per annum. Premium payment term is 20
years and policy term is 30 years. Sum Assured will be Rs 5 lacs. After including
GST, you will pay a premium of Rs 52,251 in the first year and Rs 51,126 in the
per ICICI website, GMB will be Rs 8.72 lacs. GA will amount to Rs 2.27 lacs. Therefore, the total Guaranteed Maturity Benefit
is Rs 10.99 lacs (GMB+GA). You are sure that this is the minimum you will
get at the time of maturity.
remaining two components of the maturity benefit (reversionary bonus and terminal
bonus) are variables.
For the reversionary bonus, we can look at the bonuses announced in the past to make a reasonable assessment. ICICI has announced a bonus of 2% in 2017 and 2.25% in 2018 and 2019. Let’s assume 2.25% for the entire term for the purpose of your calculation.
last part is the terminal bonus. Since this is a relatively new plan, no
terminal bonus has been announced yet for ICICI Prudential Future Perfect. For
the above illustration, the website showed a potential terminal bonus of 13.12
lacs. This is with the assumed rate of return of 8% on the investments. With
the kind of investments that will be made under this plan (and there is an
insurance angle too), 8% p.a. is a fairly high return. Therefore, it is very unlikely
that terminal bonus will be higher than Rs 13.12 lacs.
at 4%, the website mentions that the terminal bonus will be Rs 5.17 lacs and
reversionary bonus will be NIL.
ICICI Prudential Future Perfect: Illustration
you can see, even a very optimistic scenario about terminal value gives IRR of
5.53% p.a. If you are not lucky with
don’t think it is good enough for such a long-term investment.
can generate far better returns and get a much higher coverage with a mix of PPF
and term life insurance.
a home loan helps you purchase your dream house, an EMI is an unwanted by-product.
If I were to tell you that there is a home loan product where you don’t have to
pay EMI, what would you think?
Don’t get too excited. You still have to make loan payments. Just that your monthly loan payments won’t be the same every month.
stands for Equated Monthly Installment. This means you have to pay the same
amount every month. However, this is not the case with Axis QuikPay Home Loan product,
a home loan product launched recently by Axis Bank.
Under an EMI based loan repayment method (reducing balance loans), a portion of your monthly EMI goes towards payment of monthly interest. Anything left after payment of interest is used towards reducing the principal amount. This cycle continues till such time your loan is repaid. As the loan outstanding goes down with the payment of each EMI, interest portion of the EMI goes down and the principal component goes up every month. For more on how EMI based reducing balance loans work, please refer to this post.
How does Axis QuikPay Home Loan work?
Axis QuikPay Home Loan, there is no concept of EMIs.
Every month, you pay the same amount of principal. The interest component changes every month. This is because the interest is calculated based on the outstanding principal (just like the EMI based repayment).
consider an example. You take Axis QuikPay home loan of Rs 50 lacs at 9% for a
tenure of 20 years.
month, you will repay principal of Rs 50 lacs/ 240 months = Rs 20,833. You calculate
the interest payment by multiplying the monthly interest rate by the Principal
Outstanding at the beginning of the month.
the principal and the interest component to get your monthly payment.
the principal outstanding will go down every month, the interest component will
also go down every month.
What is the benefit?
a regular home loan, a significant portion of your initial loan EMIs goes
towards interest payment. Only a very small portion goes towards principal repayment.
Therefore, the principal outstanding goes down very slowly in the initial
years. Here is how repayment schedule of a regular home loan looks like.
Axis QuikPay Home Loan, principal outstanding will go down much more quickly.
instance, in the regular home loan, you would have repaid only 1.83% of total
loan amount. In the first 5 years, you
would have repaid only 11.29% of the loan amount. Under Axis QuikPay Home loan,
you will repay 5% in the first year and 25% in the first five years.
the principal goes down faster under Axis QuikPay, the total interest that you
pay over the loan tenure will be lower than the regular home loan.
the regular home loan, you will have to pay Rs 44,986X 240 = Rs 1.08 crores. Of
this, Rs 50 lacs is the principal repayment. Therefore, total interest payment
is Rs 57.96 lacs.
Axis QuikPay, you pay a total of Rs 95.18 lacs. Total interest payment of Rs 45.18
So, you save about Rs 11.8 lacs by opting for Axis QuikPay.
Do note the cost of the loan remains the same at 9% p.a. The difference in total interest payment is due to the swifter repayment of principal in the Axis Bank QuikPay loan.
At the same time, you have to see that you have to pay a much higher amount initially in the Axis Loan. You have to look at the affordability of payments too. However, if you have taken a construction linked loan, this won’t be much of a problem since the entire principal will not be released straightway.
What is the catch?
QuikPay Home loan is a fine product. Therefore, it could be a good choice over regular
home loan products provided you can keep up with initial high payments.
The problem, however, is that Axis Bank is charging a higher rate of interest for this loan product. The interest rate is higher by 15 to 20 bps (as compared to regular home loans).
be honest, you shouldn’t pay a higher rate of interest for the following
Axis Bank is not taking any additional risk (as compared to a regular home loan) in offering this loan. Therefore, any interest rate premium is not justified.
Most borrowers close out their home loans much before the contracted tenure. Therefore, in any case, you would want to reduce your principal faster. You already have much flexibility in prepayments in home loans. There is no point in paying a premium.
Prepayment of home loan does not invite any penalty. Therefore, you can replicate the benefit of Axis QuikPay Home Loan under the regular home loan product too. You simply to make the prepayment of (Monthly payment under Axis QuikPay – EMI under regular home loan) and re-amortize your loan amount every month. And for this, you don’t have to pay an additional 15 to 20 bps every month.
you still don’t trust that Axis Bank QuikPay home loan can be replicated with a
regular home loan, check this out.
might argue the bank will limit the number of prepayments in the year and you
may not be allowed to re-amortize the loan every month either. However, that’s
not the point. The point is that you must not pay a higher rate of interest for
this product. After all, you don’t have to make prepayments every month. You
can make those once every quarter or once every six months. That should suffice.
When I checked the press release for Axis Bank Quik Pay home loan, the focus was on interest savings even with marginal higher pricing. If you know your maths, there is no reason to pay a higher rate of interest under Axis QuikPay home loan.
In the future, if Axis Bank chooses to reduce the interest rate on this product and brings it in line with a regular home loan, you can consider this product.
LIC New Jeevan Nidhi (Plan 818) is a pension plan from LIC. You invest for a few years. At maturity, you utilize the accumulated funds to purchase an annuity plan. Simple, isn’t it? Let’s find out more about LIC New Jeevan Nidhi and see if it warrants a place in your investment and insurance portfolio.
LIC New Jeevan Nidhi: Key points
premium payment options: Single Premium and Regular Premium
name suggests, under single premium variant, you need to pay premium just once.
Under regular premium variant, you need to pay the premium every year during the
LIC New Jeevan Nidhi (Plan 818): Eligibility and Important Features
LIC New Jeevan Nidhi (Plan 818):
If the policyholder
dies before the date of vesting (maturity date), the nominee will get the death
benefit from the plan.
If the demise
happens within 5 years of policy purchase: The nominee will get Sum Assured + Accrued Guarantee
If the demise
happens after 5 years of policy purchase but before vesting date: The nominee will get Sum Assured +
Guaranteed Additions + Vested Simple Reversionary Bonuses + Final Additional
Bonus, if any
LIC New Jeevan Nidhi (Plan 818): How
Benefits are paid?
At the time of
vesting (maturity date), you have two options.
You can withdraw up to 1/3rd of the accumulated corpus as lumpsum and use the remaining amount to purchase an immediate annuity plan (LIC Jeevan Akshay, LIC Jeevan Shanti)
You can use the entire amount to purchase a deferred annuity plan (LIC Jeevan Shanti). You can’t make any lumpsum withdrawal if you go with this option.
LIC New Jeevan Nidhi (Plan 818): How Corpus is accumulated?
on the date of vesting (maturity) comprise of the following 4 components.
Assured (You know this
Additions (You know
upfront): These are applicable for the first 5 years and guaranteed at Rs 50
per thousand of Sum Assured every year for the first 5 years.
Reversionary Bonus (Can
vary): Applicable from the 6th year till maturity. Announced by LIC year.
Expressed per thousand of Sum Assured.
Additional Bonus (Luck): Applicable
in the year of maturity or demise
Corpus at Maturity = Sum Assured + Guaranteed Additions + Vested Simple Reversionary
Bonus + Final Additional Bonus, if any
LIC New Jeevan Nidhi (Plan 818): Tax Benefits
You get tax
benefit up to Rs. 1.5 lacs on investment under Section 80CCC of the Income Tax Act.
The benefit under Section 80CCC comes under the overall tax benefit limit of Rs
1.5 lacs under Section 80C.
is exempt from tax at the time of maturity. Since you can’t take out more than
1/3rd as lumpsum under IRDA rules, you can say that lumpsum
withdrawal up to 1/3rd of the accumulated corpus is exempt from tax.
Any income from
annuity purchase is taxed in the year of receipt at your marginal tax rate.
You are 30 years
old. You purchase a regular premium variant. You have chosen the vesting age as
60. Sum Assured of Rs 10 lacs.
Premium for the subsequent
years = 31,474 (inclusive of 2.25% GST)
By the time of vesting,
your accumulated corpus will comprise of
Sum Assured of Rs 10 lacs
Guaranteed Additions of Rs 2.5 lacs. For each year, you will get Rs 50,000 of guaranteed additions (50 X 10 lacs/1000. That makes it Rs 2.5 lacs in 5 years.
Simple Reversionary Bonus: Assume a value of Rs 50 per Rs 1,000 of Sum Assured (though it can change every year). For each year, you will get a bonus of Rs 50,000. For 25 years (30 years- 5 years), you will accumulate Rs 12.5 lacs.
Final Additional Bonus: This depends on your luck. Assuming a value of Rs 200 in the year of maturity, you will get Rs 2 lacs.
That makes it a total
of Rs 27 lacs.
IRR of 6.1% p.a.
Assume you choose
to withdraw 1/3rd as lumpsum and use the remaining amount to
purchase an immediate annuity plan.
You can withdraw Rs
9 lacs tax-free. You use the remaining Rs 18 lacs to purchase an annuity plan. Assuming
you choose a variant that gives you 9% p.a. (without return of purchase price),
you will get Rs 1.62 lacs per annum for life (or Rs 13,500 per month for life).
Should you invest in LIC New Jeevan Nidhi?
For a better assessment of this product, you must break down the product into two parts.
Accumulation phase (before the vesting age)
Withdrawal phase (lumpsum withdrawal and annuity purchase)
We saw in the above
illustration that the IRR for 30 years was about 6%. Even with slightly more optimistic
assumptions, the returns will be in around this level only. Additionally, these
returns are for a 30-year-old. Since there is an insurance angle involved, the
returns will be lower for older investors.
Now, for the accumulation phase, 6% p.a. is clearly bad for a 30-year investment horizon. Remember, annuity purchase is not just limited to LIC New Jeevan Nidhi. You could have invested in a diversified portfolio and use the accumulated money to purchase LIC Jeevan Akshay or LIC Jeevan Shanti. So, there are ways to guarantee you a pension during retirement.
The withdrawal phase is fine in LIC New Jeevan Nidhi. Just that you can’t tweak around with vesting age and that only 1/3rd can be withdrawn lumpsum.
this with NPS
(National Pension Scheme). In my opinion, NPS is a far better product than
LIC New Jeevan Nidhi (so long as you are sure that 60 will be your retirement
NPS provides greater flexibility in terms of the investment amount. You can invest as much as you want.
There are many options to accumulate funds for retirement. There are many options to earn income during retirement. And these can be mutually exclusive. There is no need to club this accumulation and withdrawal phase as it happens in LIC New Jeevan Nidhi.
You can get more information about LIC New Jeevan Nidhi from LIC website.
HDFC Life Sanchay Plus is a Non-participating traditional life insurance plan. That means the payouts are guaranteed. There is no market risk or risk associated with varying annual bonuses. You know upfront what you are getting into. Moreover, it is a deferred payout plan i.e. maturity value is paid over a period of time.
find out more about HDFC Life Sanchay Plus and figure out if this plan should
find a place in your insurance and investment portfolio.
HDFC Life Sanchay Plus comes in
Income: Guaranteed income for a few years
Maturity: Lumpsum at maturity
Long Income: Guaranteed income till the age of 99
Term Income: Guaranteed income for 25 or 30 years
are a few snapshots from the product brochure about the important features of
HDFC Life Sanchay Plus: Variants HDFC Life Sanchay Plus: Eligibility
HDFC Life Sanchay Plus: Death
benefit is the same for all the plans and is payable only if the demise happens
during the policy term.
is the highest of the following:
105% of the total premiums paid
10 times the annualized premium
Guaranteed Sum Assured on Maturity (total premiums payable under the policy)
Sum Assured (Death Multiple times Annualized premium). Death multiple depends in your entry age.
Guaranteed Income, Long Term Income and Life Long Income, there is an
additional parameter. Premium paid with 5% interest, compounded annually.
You can see the life cover depends on your age. Instead of varying returns based on your age, they have varied the life cover based on your entry age. Not bad since they are projecting this plan as an investment plan. Therefore, everyone who purchases the plan will get the same return irrespective of entry age (except in guaranteed maturity benefit). The life cover will vary based on the entry age.
the way, Death benefit of 10 times annual premium ensures that the maturity
amount or any amount paid by the insurance company is exempt from tax.
HDFC Life Sanchay Plus: Maturity
Variant 1: HDFC Life Sanchay
Plus: Guaranteed Maturity Benefit
are three premium payment term (PPT) options. 5 years, 6 years or 10 years.
terms will be 10 years (5 year PPT), 12 years (6 year PPT) and 20 years (10
amount shall be paid at the end of policy term.
Benefit = Guaranteed Sum Assured on Maturity + Guaranteed Additions.
Sum on Maturity is nothing but total annualized premiums paid (net of taxes and
Guaranteed Additions shall be applicable as follows.
take an example.
are 30 years old. You purchase a variant with 10-year payment term and 20-year
pay an annual premium of Rs 1 lac. Including GST, you will pay Rs 1,04,500 in the
first year and Rs 1,02,250 in the subsequent years. You will get the maturity
amount on completion of 20 years.
this case, Guaranteed Sum Assured on Maturity is Rs 10 lacs.
maturity (completion of 20 years), you will get Rs 10 lacs + Rs 14 lacs = Rs 24
lacs. (this amount is exempt from tax).
comes out to 5.56% p.a.
in this variant, the return will depend on your age. If you are 57 at the time
of purchase, your return will only be 5.27% p.a.
Variant 2: HDFC Life Sanchay
Plus: Guaranteed Income
payment term (PPT) options: 10 years and 12 years
Policy Term: 11
years (10-year PPT) and 13 years (12 year PPT)
Under 10-year PPT
variant, payout starts from the end of 12th year until the end of 21st
Under 12-year PPT variant, payout starts from the end of 14th year until the end of 25st year.
Let’s consider an
are 30 years old. You purchase a variant with 10-year payment term. You pay an
annual premium of Rs 1 lac. Including GST, you will pay Rs 1,04,500 in the first
year and Rs 1,02,250 in the subsequent years.
the end of 12th year till the end of 21st year, you will
Rs 2 lacs per annum. That makes it 10 instalments
of Rs 2 lac each. All these instalments shall be exempt from tax.
the event of death of the policyholder, the payments will continue to the
That is an IRR of 5.73% p.a.
not good enough.
Variant 3: HDFC Life Sanchay
Plus: Long Term Income
Premium payment term (PPT) options: 5 years or 10 years
Policy term: 6 years (5 year PPT) or 12 years (10 year PPT)
Under 5-year PPT
variant, payout starts from the end of 7th year until the end of 36th
Under 10-year PPT variant, payout starts from the end of the 14th year until the end of the 36th year.
Let’s consider an
You are 30 years old. You purchase a variant with a 5-year payment term. You pay an annual premium of Rs 1 lac. Including GST, you will pay Rs 1,04,500 in the first year and Rs 1,02,250 in the subsequent years.
From the end of 7th year till the end of the 36th year, you will get Rs 36,000 per annum. That makes it 30 installments of Rs 36,000 each. At the end of the 36th year, you will be returned all the premiums paid too. All these installments shall be exempt from tax.
is an IRR of 5.53% p.a. Not good enough.
the event of death of the policyholder during pay-out terms, the payments will
continue to the nominee. I am not very clear if the nominee will get the
premium payments back or not.
Variant 4: HDFC Life Sanchay
Plus: Life Long Income Option
have an option to pay premium for 5 years or 10 years.
the 6-year premium payment option, you get life cover for 6 years. The insurance
company pays 35% of the annualized premium from the end of 7th year
till such time you turn 99. On completion of 99 years, the insurance company
will return all the premiums paid.
Under the 10-year premium payment option, you get life cover for 11 years. The insurance company pays 100% of the annualized premium from the end of 12th year till such time you turn 99. On completion of 99 years, the insurance company will return all the premiums paid.
What are the returns like?
are 50 years old.
will pay Rs 1.045 lacs as the first-year premium. This includes 4.5% GST. From
the second until the 10th year, you will pay Rs 1.0225 lacs every
year (includes GST of 2.25%).
will get Rs 1 lac each from the end of 12nd year till the end of 49th
year (you turn 99). That is 38 instalments of Rs 1 lac each. Additionally, when
you complete 99 years, you will get an additional Rs 10 lacs back.
you work out the IRR using excel, the return is 6.92% p.a.
are 60 years old.
policy term. First year premium: Rs 1.045 lacs, Subsequent premiums: Rs 1.0225
will get Rs 1 lac each from the end of 72nd year till the end of 99th
year. That is 28 instalments of Rs 1 lac each. Additionally, when you complete
99 years, you will get an additional Rs 10 lacs back.
will be 6.72% p.a.
There is a caveat though
the demise happens during the payout term (after policy term), the payouts will
continue to the nominee till the end of the payout period (till such time the policyholder
would have turned 99). However, as I understand, the nominee will not be
returned the premiums paid. I could not find anything in the policy
wordings that ensured that premiums will be returned to the nominee too. Had
the policyholder survived till the age of 99, he would have got the premiums
99 is a fairly high age. Unless there are some major advances in medical
science, not many policy holders will survive till the age of 99. If the policy
holder were to pass away before the age of 99, there won’t be any return of
will be the net return to the family in that case?
if you bought as a 50-year-old.
if you bought as a 60-year-old
these are post-tax returns. But clearly less attractive than before.
Where HDFC Life Sanchay Plus scores well?
This plan is easy to
understand. You know what you are getting into. I am sure many investors will
appreciate that. Whether the returns are good or bad is a different matter altogether.
The USP of these plans is that the payout from these plans will be exempt from tax. All the pay-outs from the insurance company will be exempt from tax. Remember these pay-outs are guaranteed. Contrast this with an annuity plan such as LIC Jeevan Shanti. Annuities also provide guaranteed pay-outs. However, the payment from an annuity plan is taxable at your marginal tax rate. Now, this may make HDFC Sanchay Plus (or any similar life insurance product) very attractive to retirees.
may be able to lock-in the rate of interest for a very long-term using
Government bonds. However, with Government bonds too, interest is taxed at your
marginal rate. No other income strategy can lock-in the interest income for
such long tenure.
plans also provide insurance during the policy term. Annuity plans don’t
provide any insurance.
annual premium may be hiked if your health condition is not good at the time of
purchasing the plan for the first time. Remember, if your premium is hiked due to
an illness, it does not add to your pay-outs from HDFC Life Sanchay Plus. This
is a problem with any investment and insurance combo product.
Should you invest in HDFC Life Sanchay Plus?
Firstly, you need to
see why you are even contemplating investing in this plan.
If you are looking at wealth creation, this is clearly not the right product. For a long term investment, 5-7% p.a. is clearly not something you must settle for. PPF or EPF will give you much higher returns. You may argue that the PPF interest rate keeps changing. However, 5.56% p.a. is still very low. You can expect much higher returns in equity funds too.
you are looking to add to your life cover, HDFC Life Sanchay Plus is again not a good choice. A life
cover of 10 to 15 times annual cover will not do much for your insurance
If you are looking for income during retirement, Life long income can be an interesting choice for those investors who are looking for guaranteed returns and are also expected to fall in the higher tax bracket. The insurance component, though unnecessary for such investors, is required to make the proceeds tax-free under the extant tax laws. At the same time, you also need to contrast against other retirement income options such as PPF, SCSS, Fixed deposits, PMVVY, Government Bonds, annuities and even Systematic withdrawals from mutual funds.
Apart from Government Bonds and annuities, you cannot lock-in the rate of interest for the long term. HDFC Life Sanchay Plus lets you do that. However, you also need to see if the guaranteed rate is high enough. Between 6% and 7% p.a., it is clearly not shooting through the roof (at least for now).
With SCSS and PMVVY, you will get a higher rate but you bear reinvestment risk since the interest rate is locked in for only 5 and 10 years respectively. Moreover, interest from SCSS and PMVVY is taxable too.
With PPF too, there is some interest rate risk involved. However, for the moment, PPF offers a much higher return than what HDFC Life Sanchay has to offer. Therefore, there is a clear margin that you have. PPF interest is exempt from tax. And PPF is way more flexible than this HDFC life product.
There is no one-size-fits-all solution when it comes to a retirement income strategy. So, you need to look at your requirements and your portfolio to make a choice. If you still can’t make up your mind, seek professional assistance from your financial planner or SEBI registered investment adviser (SEBI RIA).
For my portfolio or the portfolio of my clients, I would stay away from such products. I would rather invest in a diversified portfolio depending upon the clients’ risk profile. Systematic withdrawal from an MF portfolio is a good option. For somebody who wants guaranteed income during retirement, I would prefer to stagger annuity purchases during the course of retirement. With this, you retain greater flexibility with your retirement corpus and potentially higher income by purchasing annuities without return of purchase price.
Most of us have to take home loans to purchase a house. Home loans come in multiple variants. One of the popular home loan variants is a Home Saver Loan. A prominent example is the SBI Maxgain Loan product. In this post, I would briefly touch upon how home saver loan products work and what are the things that you must keep in mind if you have already taken such a loan.
How are Home Saver Loans Structured?
will not go into the details of a specific home loan product such as SBI
MaxGain. Will just discuss the basic structure.
are two types of accounts in Home Saver Loans. Do note nomenclature may vary across
Account: denotes your
actual outstanding amount
Account: You can put money
in this account on your own. Alternatively, any interest savings from the loan EMI
will be added to this account (discussed later). You can withdraw from this
account whenever you want (subject to fulfilment of a few conditions).
For reducing balance loan (like your home loan), interest is calculated every month on the outstanding principal. From your EMI, this monthly interest gets knocked off and anything left is used to reduce the principal amount. For more on how loan EMI payments work, read this post.
home saver loans, interest for the month is calculated on (Loan Outstanding –
Excess Account balance).
take an example.
say you take a loan of Rs 50 lacs. Assume the entire amount is disbursed on Day
1. The loan is for 20 years with the interest rate of 9% p.a. Your EMI will be
How repayment happens in a regular home loan?
outstanding at the beginning of the month = Rs 50 lacs
for the month = Rs 50 lacs X 9%/12 = Rs 37,500
repayment for the month = Rs 44,986 – Rs
37,500 = Rs 7,486
outstanding at the end of the month = Rs 50 lacs – Rs 7,486 = Rs 49,92,514
outstanding at the beginning of the month = Rs 49,92,514
for the month = Rs 49,92,514 X 9%/12 = Rs 37,444
repayment for the month = Rs 44,986 – Rs
37,444 = Rs 7,542
outstanding at the end of the month = Rs 49,92,514 – Rs 7,542 = Rs 49,84,971
this process goes on.
How repayment happens in SBI Maxgain Loan or any Home saver loan?
let’s say you put Rs 5 lacs in your OD (excess) account on the first day.
Account (Outstanding balance) = Rs 50 lacs
Account = Rs 5 lacs
home loan saver, interest for the month is calculated on (Loan Account – Excess
outstanding at the beginning of the month = Rs 50 lacs (Loan Account)
Account = Rs 5 lacs
for the month = (Rs 50 lacs – 5 lacs) X 9%/12 = Rs 33,750
repayment for the month = Rs 7,486 (now, this is as per the original
amortization schedule. No change here)
can see EMI is not fully utilized. 33,750 + 7,486 = Rs 41,236. What happens to
the rest of EMI.
gets added to your Excess Account. Excess Account balance at the end of the month
= Rs 5 lacs + Rs 3,750 = Rs 5,03,750
outstanding at the end of the month = Rs 50 lacs – Rs 7,486 = Rs 49,92,514
outstanding at the beginning of the month = Rs 49,92,514 (Loan Account)
Account = Rs 5,03,750 lacs
for the month = (Rs 49.93 lacs – Rs 5.03 lacs) X 9%/12 = Rs 33,666
repayment for the month = Rs 7,542 (now, this is as per the original
amortization schedule. No change here)
Account balance at the end of the month = Rs 5.03 lacs + (Rs 44,986 – Rs 33,666
– Rs 3,778 = Rs 5,07,528
outstanding at the end of the month = Rs 49,92,514 – Rs 7,542 = Rs 49,84,971
How do SBI Maxgain or Home Saver Loans benefit?
can see principal goes down as per original amortization schedule (unless you
explicitly make a prepayment).
the money in the Excess Account does not qualify as prepayment but gives you
all the benefits of prepayment and more.
you make prepayment under a regular home loan, you lose access to the
prepayment amount. It is gone. Your loan outstanding goes down.
the home saver loan, by keeping the money in Excess Account, you reduce the
interest outgo (effectively what prepayment would have achieved). At the same
time, you don’t lose access to the money. You can take out money from the Excess
Account whenever you want. Just that when you take out the money, your interest
gets calculated accordingly for the month. Do note your loan outstanding does
not go down when you put money in the Excess Account.
Your interest saved becomes interest earned. After all, the interest savings from the EMI get added to your Excess Account. You can withdraw from Excess Account whenever you want. Had you kept the money in a savings account of a fixed deposit (instead of Excess Account), you would have earned a much lower return than the loan interest rate. Moreover, since this is your own money (and not interest), the growth in Excess account due to interest savings won’t be taxed as interest.
these reasons, Excess account (or the OD account) makes for a perfect
destination for short term or emergency funds.
saver loan gives the benefits of prepayment without compromising liquidity or
flexibility with your money.
Things to keep in mind if you have taken a home saver loan
#1 Under Home Saver loan, interest saved is interest earned. If there is no interest to save, there will be no interest earned. When the Excess Account balance is higher than the Principal Outstanding (Loan Account), the extra amount (Excess Account- Loan Account) does not help you save any interest. In SBI Maxgain parlance, book balance will be positive in undr this situation.
Hence, you don’t earn any interest on the extra amount. Therefore, make sure that the Excess Account balance never breaches the Principal outstanding. Let’s say the loan outstanding is Rs 20 lacs. Excess Account has Rs 25 lacs. This extra Rs 5 lacs does help you with anything. You are better off keeping this money in a fixed deposit.
You need to keep an eye on Loan Account and Excess account balances. Loan account balance will go down every
month as per amortization schedule. Excess Account balance will keep going up
due to interest savings that get added every month. So, the difference between excess
account balance and principal outstanding keeps going down every month
automatically. For instance, in the example shared above, the difference went
down by Rs. 11,321 in the second month.
#3 You do not get tax benefits under Section
80C for the money that you have kept in Overdraft (Excess) account. Moreover,
you do not get tax benefits under Section 24 for the interest that you did not pay
#4 You may have to pay a higher rate of
interest as compared to a regular home loan product.
#5 You opt for the Home Saver Loans such as SBI
MaxGain to retain flexibility with your prepayment money. However, there may
be certain pre-conditions before you can make withdrawal from the Excess
Account (Overdraft account). For instance, under SBI MaxGain, you can’t take
out money from the OD account (Excess Account) till such time you have received
possession of the house. Let’s day you have parked Rs 5 lacs in your Excess
Account under SBI Maxgain but you have still not received possession of your
house. In such a case, you can’t take out this Rs 5 lacs from the Excess account.
Defeats the purpose of the loan structure, doesn’t it?
#6 Before those conditions are met, putting
money in Excess account (OD account) is same as making a prepayment since you
lose control over your money. Other such
loan products may have different pre-conditions. You must keep this aspect in
mind. Till such time these conditions are met, put only that money in the
Excess account that you are sure you won’t need till the expected possession of
regular intervals, you bring your portfolio to original asset allocation mix.
say you have Rs 10 lacs to invest. You have two asset classes Equity and Debt.
invest Rs 5 lacs in Equity and Rs 5 lacs in Debt. Asset allocation of 50:50.
the next 1 year, Equity gives 20% returns while Debt gives 5% returns.
investment in Equity grows to Rs 12 lacs. Investment in Debt grows to 10.5
lacs. Total portfolio is 22.5 lacs.
you rebalance, you will have equal amounts in equity and debt i.e. Rs 11.25
achieve this, you will have to sell some portion of Equity and use the proceeds
to purchase some debt.
repeat the exercise every year. And that’s what rebalancing is all about.
How Rebalancing helps?
Rebalancing can help
reduce volatility in your portfolio. In some cases, it can lead to higher
Let’s understand this
with the help of an example.
invest Rs 10 lac on January 1, 1989. You
invest half the amount in a Sensex index fund and the other half in a fixed
deposit that gives you a guaranteed 8% p.a.
8% p.a. for 30 years on a fixed deposits for 30 years sounds unreal but play
along. For the sake of simplicity, let’s ignore taxes. Let’s further assume that
the index fund perfectly replicates performance of the index. I have considered
the Price index (and not the total returns index) for calculations in this
Scenario 1 (You leave the corpus untouched)
5 lacs invested in the Senex index fund on January 1, 1989 grows to Rs. 2.7 crores
as on December 31, 2018. That is a CAGR of 14.2% p.a. over 30 years.
5 lacs invested in the fixed deposit grows to Rs 50. 31 lacs as on December 31,
the two numbers, you have a sum of Rs 3.21 crores. CAGR of 12.26% p.a.
return for the year:
return for the year: -44.94% (2008)
of years with negative returns:
loss more than 15%: 1
deviation of annual returns:
23.84% (Std. deviation is a measure of volatility).
the end of 30 years, your portfolio is 84.3% equity and only 15.6% debt. This
is because equity have given much higher returns over the last 30 years.
Scenario 2 (You rebalance at the end of every
than letting the portfolios grow, you rebalance your portfolio at the end of
each year i.e. you make adjustments so that the asset allocation goes back to
equity has done better during a particular year, you sell some equity and
equity has performed badly (worse than fixed deposits), you take out some money
from the fixed deposit and put that in the index fund.
this approach, at the end of 30 years, you end up with 3.22 crores, slightly
higher than the untouched corpus. CAGR of 12.27%. Clearly, not too big a
difference to bother about.
However, you must also think about how you got there.
return for the year: 45.05%
return for the year: -22.22% (2008)
of years with negative returns:
loss more than 15%: 2
deviation of annual returns:
16.17% (Std. deviation is a measure of volatility).
the path in Scenario 2 is much smoother as compared to Scenario 1.
I don’t care about volatility. I want the best
may argue that you could have stayed put with an all equity portfolio throughout
these 30 years and ended up with Rs 5.41 crores. This number is much higher
than either Scenario 1 or Scenario 2. However, you must note equity investments
have been a clear winner over the last 30 years. We don’t know if the equity
investments will be a winner over the next 30 years by such a wide margin or be
a winner at all.
don’t ignore the volatility. Standard deviation of annual returns (32.34%) is
much higher than Scenario 1 and Scenario 2.
You would have lost more than half your wealth in 2008. You would have
lost more than 15% in 6 out of 30 years. Not sure how many of us have the
courage to stick with our strategy after witnessing such carnage in our
portfolios. I will lose my sleep for sure.
can still afford to ignore volatility of equity when you are in accumulation
phase (before retirement).
However, volatility is extremely important in a decumulation portfolio (post
retirement). A bad sequence of returns in the early part of your retirement and
you will struggle during retirement. For more on this topic, refer to this
the way, it is not that you will always end up with a higher number for an all
equity portfolio. If you had started with Rs 10 lacs on January 1, 1994 and
invested the entire amount in the index fund, you would have ended up with Rs
1.08 crores on December 31, 2018.
you invested in a 50:50 portfolio and rebalanced annually, you would have ended
up with Rs 1.13 crores. Yes, a higher corpus with only 50:50 portfolio over 25
years. I believe 25 years is a long term
for most of us. You can call this Rebalancing bonus. Untouched portfolio
would have given only 88.13 lacs.
reason why this happened was because Sensex returned 9.98% p.a. CAGR during
these 25 years. The difference between FD return (8%) and Sensex return (9.98%)
is not as wide. Of course, the sequence of returns also played its part.
Buy low and selling high
any capital asset, the only way to make money is to Buy low and Sell high. There
is no other way. With rebalancing, this becomes an automatic exercise.
the equities do well during the year, you will have to sell equity at the end
of the year to stick to your target allocation.
forces you to sell equity when the markets have risen and buy equity when the
markets have fallen. Automatic buying low and selling high.
many of us, rebalancing may look like an option for cowards. However, if you
see, this defensive and simple approach of resetting the asset allocation every
year, you also end up with a bigger corpus.
Points to Note
have considered just two assets. You can consider other assets such as gold or
international equities as part of your portfolio mix. Adding asset classes will
result in better diversification.
helps if the correlation between the assets considered is low. In this post, I have considered fixed deposits
give a return of 8% p.a. irrespective of the returns from Sensex. Essentially, I
have considered there is no correlation between equity and debt returns. In the
real world, that may not be the case. Rebalancing won’t serve much purpose if the
correlation between the assets is high. For instance, rebalancing between large
cap equities and small cap equities may not serve as much purpose. Of course, we will have to test this.
primary purpose of rebalancing must be to reduce risk in your portfolio. Rebalancing
may not always result in higher returns. If the returns between the asset classes is very wide as we
saw in 1989-2018 example, you will be better off keeping your portfolio
untouched or keeping 100% in the higher yielding asset. The problem is you
wouldn’t know these returns in advance. Therefore, this can’t be decision factor.
Better to start with an asset allocation approach and rebalance at regular
What is the best asset allocation?
Again, this can only
be told in hindsight. Next 30 years can be very different from the last 30.
However, 50:50 equity: debt (considering only 2 assets) looks a healthy compromise.
destination is financial security and adequate money for your goals including retirement.
There may be many ways to reach there. If the path is too tumultuous, you can
quit the journey and give up on your goal. Regular rebalancing can help make
your journey comfortable and stick to the investment discipline.
the way, many times, rebalancing looks like a contrarian call. Selling equity
when the markets are hitting new highs every day is not that easy. Therefore,
if you can’t do it yourself, seek professional assistance from a financial
planner or a SEBI Registered Investment Adviser.
For many of us,
when we think about investments, the focus is mostly on returns. Not unfair.
Everybody wants adequate reward for the risk taken. However, when you think in
terms of financial goals or financial planning, return is not the only part of the
Let’s look at the
equation for compounding.
A = P * (1+r)^n
Where P is the
amount invested, r is return per annum (period) and n is no. of years
It is quite clear that the amount invested (P) is important too and deserves a lot of attention.
Rs 1 lac will grow to Rs 6.72 lacs in 20 years at 10% p.a.
Rs 2 lacs will grow to Rs 9.32 lacs in 20 years at 8% p.a..
perspective of financial goal planning, investment amount is extremely important.
To arrive at monthly investment required to reach a goal, you need a target
amount, time to goal and a rate of return.
Higher the rate
of return assumed, the less you will need to invest per month.
You can make very
optimistic assumptions about returns and be content with investing a low amount
What are the
Let’s consider an
You need to
accumulate Rs 50 lacs over the next 15 years. How much should you invest every
You are a very
aggressive investor. You believe that you will earn a return of 15% p.a. With this
assumption, you need to invest Rs 8,200 per month. You put 100% into equities.
Your friend is a relatively
conservative investor. He assumes a return of 10% p.a. He needs to invest Rs
12,500 per month. He puts 50% in PPF and 50% in equities. His equity holdings are
same as yours. Just that his portfolio is equally between PPF and equities. He rebalances at regular intervals. There are
limits to how much you can invest in PPF every year but let’s ignore that part.
Who would you
think is more likely to achieve the goal? Perhaps the question is not right. The right
question should be: Who faces greater risk of not meeting his goal? You or
Assuming if PPF
returns 8% p.a. (compounded) and equity investments happen to deliver an IRR of
15% p.a. Both of you will reach your target corpus of Rs 50 lacs. Your friend would
experience a return higher than 9% p.a., so he would end up with a corpus
higher than Rs. 50 lacs. However, by assuming a lower rate of return, he
invested more and built in cushion for himself. He can use excess money for any
of his other goals.
Risk means More things will happen than can happen. (Elroy Dimson)
What if you underestimated
your goal requirement and you need Rs 60 lacs (and not Rs 50 lacs)?
What if the IRR on
equity investments was only 10% and not 15%?
You will end up
with ~Rs 33 lacs. Short by 34%
If the IRR turned
out to be 8% p.a., you will end up with ~ Rs 28 lacs. Short by 44%.
Even though I can’t
say what your friend will end up with because the annual rebalancing can throw
up different results for difference sequence of returns for equity investments.
However, he will be much closer to the goal than you are. Just to cite an
example, if the equities were to give a constant return of 8% p.a., your friend
will have Rs 42.5 lacs at the end of 15 years. Your friend is still short of Rs
50 lacs but is short by far lesser amount. His portfolio would have experienced
lesser volatility too.
You and your friend keep exactly the same portfolio
consider another scenario.
Forget about the
PPF. You and your friend keep the exact same portfolio.
You and your friend
keep exactly the same portfolio. Just the you assumed a return of 15% p.a. on the
same stocks/mutual funds while your friend assumed 10% p.a.
You invest Rs
8,200 per month. Your friend invests Rs 12,500 per month. The two of you invest
in same stocks, on the same date, at the same time and in similar proportion. You
experience the same volatility too.
Since everything else
is same except for the quantum of investment, both of you will experience the
At 15% p.a. IRR,
you have Rs 50 lacs. Your friend has ~Rs 77 lacs at the end of 15 years.
At 10% IRR, you
have Rs 33 lacs (short by Rs 17 lacs). Your friend ends up with Rs 50 lacs.
At 8% IRR, you
have Rs 28 lacs. Your friend ends up with Rs 42.5 lacs.
As you can see, your friend has a better cushion since he invested more. Even if things wrong by a bit, he will still be fine.
Resources are limited
That’s right too. You
do not have infinite resources.
If you can invest
only Rs 50,000 per month, that’s it. Now matter what return assumption you work
with, you cannot invest more than that.
A 10% long term return
assumption might require you to invest Rs 90,000 per month but you can’t invest
more than Rs. 50,000.
However, in my
opinion, even this information has tremendous value.
When you use a reasonable assumption and realize that you are not investing enough, you can take action to manage the situation. You can look for a higher paying job. You can look towards cutting down unnecessary expenses. Rather than making a constant investment, you can increase investments every year with salary hikes.
You can’t treat an illness unless you diagnose it first, can you?
What can you do?
When you are deciding upon amounts to invest for each of the goals, do the following.
Keep your return expectations rational. Don’t work with assumptions of 18%, 20% or 25% equity returns. Such returns may not materialize. As retail investors, we may experience such higher returns over a short period of 2-3 years. However, it is not easy to get such high returns over the long term. You will only end up under-investing for your goals.
A lower return expectation will force you to invest more and build a cushion for your portfolio.
Work with an asset allocation approach. Rebalance at regular intervals. Rebalancing may not always enhance returns but is likely to bring down volatility in your portfolio.
If after working out the numbers, you realize that you are not investing enough, try to remedy the situation.
A couple of caveats
Do not take this to
the other extreme. 10% is more
conservative than 15%. 6% is conservative than 10%. Lower the assumption,
higher the cushion will be. However, as we discussed earlier, we don’t have
infinite resources. Therefore, you need to draw a line.
Your return expectations
will also influence your choice of investments. If you think you will earn 6%
p.a. over the next 20 years, your may end up picking very safe but low yielding
products like bank FDs. This can be harmful
for your long-term goals and may not be the smartest decision.
with limited resources and very conservative assumptions, you may simply give
up or become too obsessed with investing. Neither is good. You need to enjoy your
life too. Money is merely a means to an end, and not an end in itself.
LIC has recently
launched a new participating LIC Navjeevan plan in March 2019. It is a
non-linked participating traditional life insurance plan.
readers will know that I am not a big fan of traditional life insurance. You get
low life coverage and poor returns. By the way, this has nothing to do with LIC.
Such plans from private insurers come with similar issues too.
this post, I will not delve in the various features of the plan. I will briefly
touch upon the product structure and comment on why the product structure is
the way it is.
Salient Features about LIC Navjeevan Plan (Plan 853)
Navjeevan comes in two variants:
Single Premium Variant: You pay the premium just once. Policy
term can range from 10 to 18 years. Available only to investors less than 45
years. Life cover is 10 times Annual Premium.
Variant: You pay premium
for 5 years. Policy term can range from
10 to 18 years. Under the Limited premium variant, you have two options when it
comes to death benefit.
Option 1: Death Sum Assured = 10 times Annual
Option 2: Death Sum Assured = 7 times Annual
Premium (available only if your age at the time of entry is 45 or above)
If your age at the
time of entry in the plan is less than 45 years, you can only pick up Option 1
i.e. Sum Assured will be 10 times annual premium.
If your age at the
time of entry in the plan is 45 years or above, you can pick either Option 1 or
Death Benefit under LIC Navjeevan
If event of death within 5 years from
purchase, your nominee gets Death Sum Assured. If the event of death after 5
years of purchase, your nominee gets Death Sum Assured+ Loyalty Benefit, if
Maturity Benefit under LIC Navjeevan
You get the Base Sum
Assured along with the loyalty benefits, if any. Do note base Sum Assured can
be different from Death Sum Assured. Your premium depends on the base Sum
Assured. Death Sum Assured is the minimum death benefit you get. Death Sum
Assured can affect your return from the plan.
Why this threshold of 45 years under Limited Premium Variant?
For the investors under the age of 45, minimum life cover (Minimum Death Sum Assured) is 10 times Annual premium for regular and limited premium payment plans. This is specified under IRDA Linked Insurance Products Regulations, 2013. Therefore, option 2 cannot be made available to investors under the age of 45 (at the time of entry).
What happens when you pick Option
being same, an investor will earn better returns under Option 2 than under
This is because
you get a lower life cover under Option 2. Therefore, the mortality charges
will be lower under option 2. Traditional life insurance plans are opaque and
do not give the breakup of various charges. However, be rest assured that returns
will be higher under Option 2 than Option 1.
Why would you choose Option 1 over Option 2?
When you know that
the returns under Option 2 will be better than Option 1, why would you choose Option
You may choose to
go with Option 1 because maturity proceeds from Option 2 are taxable. This will
bring down post-tax returns.
Why does this
This happens because
life insurance maturity proceeds are taxable if the Death Benefit (Sum Assured)
is less than 10 times Annual Premium. With Option 2, the Death Sum Assured is
only 7 times Annual Premium.
being same, you will get better pre-tax returns under Option 2. However, option
2 maturity proceeds will be taxed. Therefore, for all you know, post-tax
returns under Option 2 may be lower than option 1.
Do note death
benefit is still exempt from tax even under Option 2. This tax rule only
applies to maturity proceeds.
What about returns under Single Premium variant?
single premium plans, death benefit (Death Sum Assured) is 10 times the Single
Premium. Since there is just one premium paid and the Sum assured is 10 times
that number, a good portion of your investment will go towards mortality
charges. Expect returns in the single premium variants to be the lowest under LIC
Navjeevan. A saving grace is that single premium variant is not offered to
those over 45. The impact of mortality charges (life insurance cover
charges) would have been even higher for such investors.
proceeds will be exempt from tax under Single Premium variant.
The choices and what you should do?
If you are below
45, you have the option of
Single Premium variant and option 1 under Limited Premium Variant. Option 2
under Limited Premium Variant not available to you.
If you are 45 and above, you have both the options under
Limited Premium variants. Single Premium variant not available to you.
You can expect
return ranging from 4% to 7% per annum. The return will also depend on your entry
age, choice of variant and the policy term chosen.
The death benefit
will be exempt from tax under all the variants.
benefit will be exempt only for Single premium and Option 1 under Limited
Even though all
the variants are not available to everyone, expected pre-tax returns would have
looked like this in increasing order (if all the variants were available to
1 under Limited Premium
2 under Limited Premium
I have never been
a proponent of traditional life insurance plans. Life cover is not adequate, and
the returns are low too. My opinion does not change for LIC Navjeevan. Stay