Focus on goals, but don't lose sight of returns!

Keep in mind the desired returns while planning a financial goal.

Most of us are catalysed into saving money and investing it regularly, if there is a financial goal that we have to meet. That goal could be retirement, buying a home or most often providing for our child's future. Recent research conducted by Aviva Life Insurance and IMRB found that parents, for instance, would like to build up a fund not only for their child's higher education, but also much ahead of that, as the child approaches higher secondary education. A separate Conjoint analysis found that a whopping 82 per cent of the Indians save for their children's education. Goal-based savings may be a good idea, but not when individuals opt for low return avenues just for the sake of safety or guaranteed returns.

Traditional insurance products are one clear instance of the need for safety taking precedence over returns. In many instances, returns from traditional insurance products, without reckoning tax benefits, are quite poor. A typical product for a sum insured of Rs 1 lakh with compounded reversionary bonus of 3 per cent for a term of 15 years will fetch you a final amount of Rs 1.55 lakh. Certainly not a return that will beat the inflation.

If the individual is availing tax benefits on the investment, returns may be slightly higher. The tax bracket apart, the age of the individual too plays an important role in determining net returns. While the bonus is common to all the policyholders, those with a higher age will shell out higher premium, lowering their effective returns.

Consider this. A man aged 30 who has a 3-year old child , plans to buy the recently launched Max New York College Plan for a term of 15 years. For a sum assured of Rs 5 lakh, his total outgo will be Rs 6.06 lakh over the term of the policy. It carries an annual premium of Rs 39,515 and a fixed sum of Rs 900 till maturity.

Living and maturity guaranteed benefit under this plan will be 120 per cent of the sum insured; in this case Rs 6 lakh. The sum assured will be paid to the investor in instalments as child attains 18, until he turns 21. To meet the education needs, 40 per cent of the sum assured is paid in the first and final years and 20 per cent is paid in the second and third years.

Besides, at maturity policyholders will be eligible for reversionary and terminal bonus. Now, the total yield of the plan will be just 3.7 per cent and 7.4 per cent respectively, if the insurer is able to generate returns at 6 per cent and 10 per cent respectively. If you consider a likely return of 8 per cent based on the yield of long-term government securities, your net yield will be 5.6 per cent.

Considering that education expenses will certainly grow with inflation, an even assuming a modest 6 per cent inflation, you are just saving for education and not making an investment that can earn you a return.

Guaranteed returns

While buying a policy with guaranteed additions, individuals should not look at the rate of guaranteed additions alone to evaluate the returns. The actual returns will be far lower. For instance ING Life Insurance recently launched ING Ace Life a non-linked, non-participating, limited premium payment (3 years) endowment plan that provides guaranteed additions for the entire policy term of 10 years. The product assures guaranteed additions of 7 per cent for the annual premium less than Rs 24,000 and 7.75 per cent for premium Rs 24,000 and above.

Under this plan, if an individual aged 24 buys the plan with a sum assured of Rs 1 lakh paying an annual premium of Rs 20,000, at maturity he will receive a guaranteed addition of Rs 78,683 at the end of tenth year.

The effective return at the time of maturity will work out to 3.05 per cent. Though the guaranteed additions appear high at 7 per cent, the actual return is far lower because the guaranteed addition is not based on the death benefit. In this plan, guaranteed additions are calculated on the maturity sum assured; Rs 39,998 in this example. The maturity sum assured is arrived by multiplying the age and the premium per thousand.

So, evaluate net yield at the time of maturity before signing up!

There's nothing wrong in investing systematically every year to reach desired corpus and achieve a financial goal. But what is required is that before planning for a goal one should look at the desired return to reach the goals. Anything without a given rate of return will only end up buying a product which will not helpful to fulfil your goal.

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