This cyber Monday (30th Nov. 2015) or if you prefer, Buy Nothing Day (Nov. 27th 2015 or Black Friday) resolve to say NO to packaged financial products. There is no need for a pension plan or a child’s education mutual fund or a child’s gift fund (like the one from Axis where one has to invest only in the child’s name. Bad idea- Why you should not invest in your child’s name!)
We all like solved problems. Right from school, when faced with a question, many of tend to search for an ‘example problem’, so that we know how to proceed. When it comes to personal finance, solved problems or ready-made financial products packaged for a specific need can be disastrous.
Some examples are the pension plan and child plan offered by insurers and mutual fund houses. Now Cafemutual reports that many more retirement linked mutual funds are on the anvil. During the PPFAS unitholders meet, Rajeev Thakkar mentioned that such plans might replace ELSSS mutual funds.
If that happens, use such plans only until you need tax breaks (I am assuming that returns from such funds would beat PPF after tax). Choose one with the lowest expense ratio since some of these funds could have an insurance component linked to them. So best to choose one without add-ons.
Want to hear a quote that makes little sense? (from above Cafemutual report – not online anymore)
Sharing the rationale behind offering an insurance cover with the retirement plan, (Dinesh) Khara (CEO SBI mutual) told Cafemutual that it will help investors to save for retirement along with protecting their life. “We want to provide one-stop solution through our retirement plan. We have observed that many investors want to save for retirement but due to other preferences like life insurance they delay investing for the retirement.”
Duh! Most people don’t delay investing for retirement. They just take the easy route and buy dud pension plans offered by insurers (incl SBI life!).
But why? Why should one say no to packaged financial products?
The first step required is a change in mindset
- To quote Subra, “from saving for retirement, people should start investing for retirement”
- Inflation should be recognised as the enemy but also the benchmark for all long-term goals and not just retirement.
- The concept of a pension or an annuity should be eradicated from the mindsets of young investors far away from retirement. Since inflation is the enemy, a constant income in retirement is the very last thing you need in retirement
Next ask the following question:
What is the post-tax return I am likely to get from these pension plans? For the amount that I can invest each month for retirement, is that return enough to get me a large enough corpus. Large enough corpus here means, large enough to generate an income that can be increased at a rate equal to the prevailing inflation.
None of the pension plans offered by insurers can do this. Don’t expect the mutual fund plans to be very different.
In any case, you cannot create wealth (have enough for retirement plus a little extra) with any pension plan. SEBI will most likely limit the exposure in these funds and my guess is that they would resemble debt-oriented balanced funds. Don’t think the gains would be tax free like the insurance product. I think they should be taxed like debt funds (good news for me as my mandatory NPS could also be treated similarly).
A packaged product sold as a tailor-made solution is likely to have a lock-in and exit-load.
The question to ask is, why buy something off the shelf when you make a better product on your own. Subra has a wonderful name for it: the retirement basket.
Put together an aggressive basket that is filled with a productive and liquid asset: equity. You can use the corpus when you want (early retirement or a dire need), and how you want: generate an inflation-proof income with part of it, while the rest grows at a decent pace.
The same arguments – liquidity and flexibility – work for long-term goals like our children’s education. Some people invest in plans in which the money is locked in until the child is 18, forgetting that their child might graduate from school at age 17!
Let us resolve to stay away from all packaged financial products forever.