Rekha sat down on the sofa, exhausted. She had finally put her daughters, Shikha (2 years old) and Sudha (6 years old) to bed. Ever since she lost her husband, Sunil, last year, she had been struggling with finances to sustain the family. Rekha took up small assignments in her spare time to bring money home. Sunil was 35 years old when he expired. Although Sunil had made some investments in the stock markets, Sunil's hospitalization had depleted all their investments. Unfortunately, he had left Rekha and the daughters no financial support. Although Sunil had good earnings, he had failed to purchase insurance or create an emergency fund to protect his wife and children.
Sunil and Rekha's story is a typical example of missing out on 3 critical steps every family must take to achieve financial security before starting their investment journey. They are:
1. Create an Emergency Fund:
An emergency fund implies creating a kitty that is easily accessible in case of a health-related emergency such as hospitalization, dental procedure, etc. or any other emergency such as job loss. The amount allocated towards emergencies should be sufficient to avoid running short of cash during the emergency. It's advisable to allocate about 3-6 months' salary/ income for emergencies. If you are single, you could allocate a lower amount (3-month' s income); if you are married, you must allocate a higher amount (6 months' income if married without children; 12 months' income if married with children). Invest your emergency funds in liquid investments (which can be easily and quickly encashed when an emergency arises). Suitable investments are savings account, Flexi Fixed Deposits, Liquid Mutual Funds, etc. Investing these funds would ensure that they earn some returns till they are needed.
2. Seek protection from insurance:
Life insurance is critical to protect your dependents in case something unfortunate were to happen to you. This will ensure that your loved ones are financially secure in case of any eventuality. Insurance companies offer two kinds of policies – pure risk cover and insurance-cum-risk policies. It's advisable to opt for pure risk insurance cover (Term plans) with add-ons such as disability cover, accidental death cover, and critical illness cover, based on your specific needs. Insurance should be used only for protection and should not be combined with investment. Investment-based policies such as Unit Linked Insurance Plans (ULIPs), endowment plans, etc. are expensive and offer a much lower amount of cover for the same amount of premium as compared to term plans.
To compute the amount of insurance you must purchase, use the ‘income replacement' method. In this method, multiply your current annual income by the number of years left to retirement to compute the amount of insurance you must have. For instance, if your annual income is Rs. 5 lakh and you have 15 years left to retirement, the insurance coverage needed is Rs. 75 lakh (5 x 15).
If you are purchasing insurance for your wife and/or children, it would make sense to register the policy under the Married Women's Property Act, 1874. Once you do so, the policy proceeds cannot be used to pay your debts or form part of your estate. In other words, the policy proceeds are solely meant for your wife and children. Registering the policy under this Act helps avoid any future litigations among family members, creditors, etc.
3. Get health cover:
Having health insurance is a must to ensure that you are not saddled with huge expenses in case of expensive health treatment/hospitalization. Buying health insurance when you are young results in lower premiums and negligible chances of rejection of your application. If you are a corporate employee covered by a corporate health plan, purchase additional health cover since you may lose the corporate health cover in case of a change in employment. Choose a plan that offers coverage for a wide range of medical ailments and expenses (hospitalization, pre, and post-hospitalization care costs, daycare procedure costs, etc.) Ensure that all family members' needs are covered in the health plan. Choose a family floater health policy instead of individual health plans. In the former, there are no sub-limits member-wise. As against this, in individual plans, the amount available to the family member will be restricted to the cover available to him specifically. If you already have a health plan, review it to ensure that you have adequate cover for yourself and your family members (at least Rs. 1 lakh cover per family member). Add a critical illness rider to your plan. In case of critical illness, once the illness is diagnosed, the insurance company pays out the claim amount irrespective of whether treatment/hospitalization is needed or not. Choose a health plan which offers lifelong renewability. Make sure the health plan's network of hospitals and doctors includes your preferences. Select an insurance company that pays out a higher number of claims; also select a cashless claims policy (the insurance company makes payment directly to the hospital) as against reimbursement plan (where you need to make payment to the hospital and then seek reimbursement from the insurance company). Check the pre-existing disease clause (the waiting period till the policy covers a pre-existing disease; a lower wait period is preferable). Health plans usually have sub-limits for every expenditure (e.g. a limit on ambulance costs, room rental costs, etc.). Look for a policy with higher sub-limits, or preferably, no sub-limits on individual expenses. Some health plans require you to pay a specific amount in case of hospitalization. Check this clause to understand how much you need to set aside for this. Read through the exclusions (illnesses that are not covered by the policy) to be aware of the costs of illnesses you will need to bear. Purchase a separate health plan for your elderly family members since insurance companies usually levy certain restrictions on coverage for seniors.
Once you have taken care of these 3 important aspects, you could then consider starting your investment journey.
(The writer is the founder & CIO at Sukhanidhi Investment Advisors, a SEBI registered equity investment advisory firm, based in Hubballi-Dharwad)
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