How much insurance cover do I need

If we ask a typical agent, they come up with the magical figure of 10 times of annual income. I was also advised this almost an year ago. The logic they probably have is that a person with X income would easily be able to pay "X/some number" amount of premium easily. At least I don't subscribe to this logic.

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Consider Mr X: A typical Indian family man
He is married
30 years
Has a home loan for which monthly installment is 35k
Has a car for which installment is 10k a month
Has dependent parents, non working wife and a one year old girl child
Earns 10 L PA (take home after taxes)
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As per our bright insurance adviser, he should take cover of worth 1 crore.

Suppose Mr X is dead now and his family gets 1 crore. As per current standard of living the monthly expenses would come around 10-15k. Lets take 10k for simplicity of calculation.
Total amount needed monthly 35 + 10 + 10 = 55k
Lets assume that Mr X's family will keep 1 crore in some FDs (considering the 0 risk tolerance) which will safely beat inflation (a big assumption). With 55k as monthly expense, 1 crore would barely last for 15 years. ( I have assumed that car loan will always continue, it will not make much difference int the final conclusion)

This amount doesn't include cost of sudden medical emergencies (which are very likely due to old parents and young child). It doesn't include the cost of education which is going to be very high as time passe and this amount certainly doesn't include the cost of marriage of his girl child.
If we include these factors, the insurance amount should be increased by at least 50 lakhs.
But no adviser will suggest you because they are not trained to do so.

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Now lets take Mr Y, a typical software professional
He is married
30 years
Doesn't have a home loan, his parents have one for him
Has a car for which installment is 10k a month
Has dependent parents
A working wife and a one year old girl child
Earns 10 L PA (take home after taxes)
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Suppose Mr Y is dead now and his family gets 1 crore. As per current standard of living the monthly expenses would come around 10-15k. Lets take 10k for simplicity of calculation.
Total amount needed monthly 10 + 10 = 20k
Lets assume that Mr X's family will keep 1 crore in some FDs and Equity mutual funds (considering there is one earning member, thus some risk can be taken) .
Lets assume 50L is invested in FD (and MIP) and rest is invested in Equity MF (assume 15% CAGR very safe assumption) .With 20k as monthly expense (in this case car loan will actually stop much before), invested 1 crore would last for more than 70 years. And if invested properly, it will last for even more.
Mr Y's wife's earning will easily take care of his daughter's future cash flow needs.

With the help of these two examples, we can easily establish that the magic figure 10 doesn't make any sense. Cover amount should be estimated individual's risk profile and current financial condition.

Term plan and unawareness all around

What do we think when we think of life insurance? I guess endowment plans!!!
This is what one of LIC agents told a couple of days back.
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Manish Sir,
XXX is the best policy.Its features are:
Tax Bft:Deduction u/s80C of Income Tax Act,1961.
Period Covered:For first 20 years(with premium)
After that upto Age of 70 years
(without premium)
Premium: According to Age
Bonus : Rs. 6000 p.a.
Addl. Incentive : Rs. 20,000 after 20 years
Accidental Death : Double the policy amount.
If you take Rs. 1 lakh policy you will get Rs. 2,40,000 after 20 years (if you don\'t die).
If death takes place your legal heirs will get Rs.1,00,000 more then the due amount.
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I calculated premium for sum assured 100,000 for 20 years tenure for me. It comes around Rs. 5660. So if I "invest" 5660 yearly, I will get a tax benefit and my family will get 100,000 or 240,000 depending upon the situation.

Give me a break! My life if worth 240,000? What would my dependents do with 240,000? After all life insurance is a way to protect my from financial loss in future if I don't survive.

How much protection is needed can be roughly estimated; but for the sake of fun, lets take it 10,00,000. For me the premium comes whooping 55,000 per year. Is it really worth?

I guess the 20,000 bonus and 6000 bonus part can be easily ignored. It is just a marketing gimmick.

If we look at historical performance of any endowment policy, none has given more than 6-7% returns compounded annually. If we take the best case scenario of 7% and pay 5660 per year, what I get in the end is 5660*(1+0.07)^20+5660*(1+0.07)^19....5660*(1+0.07)+ which comes around 2,48,276. This is what I get in the end if I survive; If I lose my life in between my family would be showered with 1-2 lakhs and nothing more. This return doesn't not even beat inflation and the insurance amount doesn't cover anything. It wont last even 6 months for my dependents.

By now I have established that endowment policies are not suitable for me. I understand 2,48,000 will not have any meaning after 20 years; So let me think about a plan that doesn't give me anything if I survive but gives a good protection in my absence. Take any term plan for example. I am taking icici's iprotect for illustration purpose.

Sum assured (50,00,000) (this is what my family gets if I die)
Policy term (30 years) (till I am 60) (makes sense, I am sure I will not have any dependents after 60)
Premium only 5600!!!

We dont need to be a finance guru to understand the difference between 100,000 and 50,00,000. The only problem is that I don't get anything if I survive. I lose 1,50,000 over the period of 30 years in this case.

disclaimer: I am not saying that endowment policy is bad and term plan is good. I am not also marketing ICICI's iprotect plan. My only concern is think before you buy!!!

New DTC, a relief for investors

I was very tempted to write about DTC and its implications on normal salaried employees as well as on stock investors but by the time I decide a new draft of DTC was presented. Admittedly, I was little lazy but better late than never. I assume the latest version of DTC in its current form is quite stable and may not need a big change henceforth. In any case it will be applicable from April, 2012, there is still a lot of time to not to think about it.

Affect on investors:
As per one of its clause, the short term capital gain tax will be applicable only on the 50% of the profit thus in effect the tax will be 5%, 10% or 15% dependent upon individual's take home. This move will attract lower income people to come and join the spree of stocks :-)
The long term capital gain tax, as it currently is at 0%, has been not touched in the revised DTC. This is a refresher. SIP investors were literally worried on the prospects of their life time savings being taxed at the time they need the money at the most.

But such things are not in our control and I believe we should not worry at all about them. Whatever comes will be applicable for all, so in effect it will make little less difference.

By the way, does anyone smell a trader's, broker's & mutual funds' lobby?

Interest rates and their effect on stock market

Every now and then we hear about RBI planning to raise interest rates to tame inflation. How does interest rate tame inflation may be little complex if we go into the detail but from a broader perspective a token raise in interest rate tightens the money supply in the market. Now there will be lesser money and the same amount of goods available (in the short run) in the market. The buying power of money increases. This is valid for a short run only. On long runs, producers find ways to tackle; they will either decrease the production or will move to some other rewarding business. Both the steps will bring up the prices.

But how does interest rate affect stock market? For businesses interest rate is the cost of money or funding. If rates increase, they will have to pay more for the money. This will (again short run) bring down corporations margin, thus free cash flow, thus the net profit per share. Since the cash generating power of corporations comes down, the price people would want to pay for the stocks will be less. The market in general comes down.

Rich dad! An example

My favourite book Rich Dad, Poor Dad says "poor dad pays taxes while rich dad coins legal ways to avoid them". The recent change in RIL's holdings glorifies the statement.
Mukesh Ambani restructures his holding in RIL

RIL: Should I accumulate or wait?

Reliance Industries has come down to 980 level. How long should I wait before I pounce on it to see a wonderful retirement :-). Well RIL is not a good dividend paying company as far as my dividend calculations go, so such expectations are unfounded. And due to some whim of mind, I already have RIL at very high price, it will take ages for it to break even (since I am sure of good returns, I am holding on to it).

But lets deliberate on RIL a bit. It has been dropping since 1080 levels and has done absolutely nothing for an year. The probable reason that market is currently punishing RIL--in spite of good results--is that they have created a lot many liabilities and they still need a lot of capital to fund their future acquisitions. Their current spate of buyouts in the US Shale gas field is a risky business anyway. Well to fund their needs, RIL is selling its treasury stocks to LIC @ 950. This is what the investors are more angry at. No one likes thy neighbor getting richer without sharing the profit. I am sure RIL stock will tumble to 960 levels before coming into senses. Even at those levels (15-16 PE), a big company like RIL will be a good buy opportunity for long term.

Let's look at the brighter side of RIL. What is the internet penetration in India? Close to 7%-8%, so if we believe the India will shine someday story--I do believe, not because I am a patriot but because it is my gut feeling--at least internet will be ubiquitous. Who has 4G licenses? Bharti & RIL (I own both). RIL is sitting on the largest gas reserves and RIL has biggest reach in the policy making. They are just waiting for a trigger to start their dysfunctional petrol pumps.

So I am accumulating, are you?

Tata Steel: What should I do now.

Before I go ahead, let me declare that Tata Steel has a comfortable place in my dividend, thus long term, portfolio. I have explained my expectations from a dividend portfolio here. Currently I am sitting on a handsome capital gain with respect to Tata Steel. Now the question is what should I be doing today? Today Tata Steel is going to declare its first quarter results and one doesn't need to be a genius to know that results will be bad. Reason! None of the steel companies have reported profit in the current result season and it is a commodity business, Tata Steel may not do much different. I am sure I will lose 5%-10% in terms of capital reduction today.

Given that this stock is for my long term portfolio, I am not willing to trade my long term vision for 5%-10% change. I will slightly add up my positions. Rationale? If input costs shoot up, these companies will no longer be doing charity, they will increase the price to adjust and Tata Steel being the most respected and the largest will have a cake walk.

Since I thoroughly believe that it will give me double benefit ( good dividend & good capital appreciation) adding up when the prices come down will give me good dividend yield and good capital appreciation.

Update:13/08/2010
Results were as expected. Not very good. I stuck to what I said, I was jumping with joy when people sold it to me at 500.