Money Plants

Friday, March 24, 2006

Is the critical illness rider on your insurance policy worth the extra premium?

If you have bought the critical illness rider and thought it will pay for your medical costs, you thought wrong. A critical illness will NOT pay for your actual medical expenses. It will pay you a lump sum if you suffer from a critical illness to substitute any loss of income during the period of your illness. And that also means that you should have an ‘illness’ which is also ‘critical’ and which would actually put you out of work for a prolonged period of time.

Each medical condition that the rider covers has a very technical interpretation, which a common person may not understand. For instance, it is necessary that there must be an ‘illness’ that meets the definition and at the same time it must be ‘critical’. So a pain in the chest followed by hospitalization does not translate to the ‘definition’ of a heart attack and hence may not be compensated. At the same time, a minor heart attack revealed in an ECG that is ‘not critical’ may not be paid for. Further, any severe non-cardiac chest pain or heart failure or angina would not be covered as these do not fit in the definition of heart attack. As a result, operations like angioplasty and stents are commonly excluded.

Another example: In the case of cancer, common exclusions are cases of benign cancer where the cancer cells can be permanently removed. Further, if the cancer is not malignant, that is, if the cancer does not spread, it might be excluded.

Stroke is commonly defined as a cerebrovascular accident producing permanent neurological deficits lasting more than 30 days. This would specifically exclude strokes due to migraine or brain damage due to external traumatic causes.

What you must remember is that while you maybe diagnosed with a specific illness, your claim would also depend upon the medical process adopted to treat that illness. If the medical process does not entail prolonged absence from your job or work, your claim could be rejected. These details would be available from your agent but he won't tell you till you ask for it.

More critical illnesses covered, the better the policy?
That's a myth. Companies harp about covering 17-20 critical illnesses in their rider. Truth is there are only four illnesses whose occurrence covers 90% of all illnesses - heart attack, stroke, cancer and coronary bypass. So even if you buy the others, chances that you are hit by one of them is very low. Moreover, even these four are riddled with difficult clauses, sometimes making them worthless.

Criticall Illness substitutes mediclaim?
No. If you haven't taken a mediclaim policy just because you already have a critical illness rider, then take no chances. Go buy that mediclaim soon.

Friday, March 10, 2006

Whys, Whats and Hows about IPOs

I think a post on IPOs has been long overdue now. So here goes. Let me take this step by step.

Why does a company issue an IPO?
A company issues an IPO to raise funds in the form of equity capital. Equity capital is a cheap source of funds for the company because there is no obligation to pay back interest or principal as is in case of bank borrowings.

How is the issue procedure?
A company approaches a merchant banker to handle the entire issue. It tells the banker that it wants to raise a certain amount of money from the market. The banker then assesses the value of the company based on its assets, liabilities, future potential etc and arrives at the number of shares the company should issue and at what price or price band.

What is price band?
Here let me introduce the concept of book building. Till a few years ago (say 4-5 years ago) there was no such system as book building being followed. A merchant banker would assess the value of the company and announce the issue price at a fixed amount. Investors could buy the issue at that given price.

However, due to the dynamic nature of the stock markets today, there is no fixed issue price. Instead, the merchant bankers announce a price band or price range which they believe is the ideal range for an issue. Subsequently, investors would send in their bid for the price within that range. Once all the bids have come in, a price 'discovery' happens wherein the lead banker will assess the various bids, quality of bids and decide which price would be most investor friendly (that is, at which price he can keep most investors happy). It need not always be investor friendly, as a company may decide to price it higher in anticipation of demand. The issue price is then fixed at that price.

What next?
After the price is fixed, allotments are made to applications at that price. For those who don't get an allotment, a refund is made. A few days after allotment, the issue is listed in the stock exchange.

What is listing price?
Listing price is the price at which the first trade in the share is done on a stock exchange. The listing price is a function of demand and supply. If there are more buyers than sellers for that share when the stock market opens on the day of listing, the price will be higher than issue price. If there are more sellers than buyers, the price will fall below issue price. Usually, in a bull run, listing prices are often more than issue prices, but that is not a rule.

Through the day, several trades take place which decide the price at which demand and supply meet. It shows how much a buyer is willing to pay for a share and how much a seller expects to make. Thereafter, it's like any other share in the market.

How to go about investing in IPOs? Can I always purchase enough shares in an IPO to my liking?
Retail investors, HNIs and Institutional Investors have separate quotas in an issue. A retail investor should apply through the retail quota and you need to have a demat account. A retail investor has an option to either apply at a price (within the band) or at a cut-off. If you apply at a price and the issue price is decided at a higher price, you don't get any shares. If you apply for cut-off, it means you are ready to buy at any price.

You will not always get enough shares as you applied for. If the issue is oversubscribed, you get shares proportionately or pro rata as it is called.

Is it a good option viz-a-viz a regular share?
Cost-wise there really is no difference. While buying a normal share, you pay buying commission to your broker. While you dont bear this cost directly while buying in an IPO, the cost gets factored into your issue price because the company will bear it and pass it on.

Whether an IPO is a good investment really depends on the quality of the issue. It matters even more in a bull market. The share may list very well because of people who want to make money on listing, but if its not an inherently good scrip, the price will fall eventually. You need to do a lot of homework about the company and consult an expert before investing.

Wednesday, March 08, 2006

Credit card and free insurance

So your credit card claims to offer you free insurance? It offers free death and disability insurance, compensation on loss of luggage, delay of flight etc.?

A few things you must know...
1) Much of that insurance cover would apply in case of death and disability arising out of air travel. A small portion will apply to non-air travel.
2) Claims cannot overlap. That means in case of loss of luggage or delay of flight, if the airline is paying you compensation, the card company won't give you any.
3) You need to keep the card active. That means, you need have used your card at least a few times before making the insurance claim. For instance, to be eligible to avail these claims the card must have been used at least once in the preceding 90 days prior to the date of claim in case of Stanchart. Similar rules apply to all other cards.
4) Hidden tricks are always there. Some card companies offer you an insurance cover and charge you a tiny amount of premium in your monthly bill. The amount per month maybe so small that you may find it irrelevant to dispute. But this is not something you asked for. The card company simply charges you for it and if you don't dispute it, they sign you up for the scheme by default. Beware of these traps. If you find such weird charges, call the company and demand an explanation.

Raise your voices guys. Banks, insurance companies, mutual funds, almost everyone out there is making money based on your ignorance. Wake up. Read the rules. Take a little bit of effort to be a good customer. Challenge fine prints and asterixes. And soon service providers will know its not so easy to trick customers.

Tuesday, February 28, 2006

Budget 06: What does the future hold?

While the Finance Minister has not changed income tax rates for individuals, he has made a few important changes on the savings side. Here are the highlights of the budget impact on personal taxes. Details will trickle in the next few posts. If you have any queries, shoot.

-No change in tax rates
-One-by-six scheme for filing tax returns abolished. Now you would have to file tax returns only if you have income over the tax-exempt limit of Rs 1 lakh (Rs 1.35 lakh for women and Rs 1.85 lakh for senior citizens)
-Ceiling of Rs 10,000 per annum for investments in pension policies under section 80CCC removed. You can now invest up to Rs 1 lakh in pension policies. This will give a boost to your retirement planning.
-Investments in fixed deposits of scheduled banks for a term of more than 5 years is now eligible for a deduction of up to Rs 1 lakh under section 80C. So now, along with investments in Public Provident Fund, National Savings Certificates, Insurance, ELSS, you can also invest in bank fixed deposits.
-Cash transaction tax continues on cash withdrawals of over Rs 25,000 from current accounts
-Section 54EC for reinvestment of sale proceeds of capital asset amended. You can now invest the sale proceeds only in bonds of National Highways Authority of India and Rural Electrification Corporation, to enjoy tax-free capital gains, as against bonds of NABARD, NHB and SIDBI allowed earlier.
-Section 54ED, which allowed you to invest sale proceeds of capital assets in listed equities now abolished.
-You will be required to quote your Permanent Account Number (PAN) in more transactions now
-Service tax increased from 10% to 12%. More services brought under the scope of service tax.

Friday, February 24, 2006

Budget with MoneyPlants

Only 3 days to go before the finance ministers lays out your fortunes for the next financial year. Media is full of wishlists. Whether the FM will hear them all out is another matter. So what are the key realistic expectations from the budget?

1. More clarity on EET - this is the biggest expectation
2. Relaxation of the Fringe Benefit Tax
3. Expand tax deduction limit from Rs 1 lakh
4. Make interest on bank FDs tax free
5. Remove 2% education cess
6. Allow LTA for foreign trips also, now that holiday destinations are all overseas
7. Reintroduce Tax-free Bonds
8. Pass the pension bill

Budget day will solve the mystery. And MoneyPlants will try and make it simple for you.

Tuesday, February 21, 2006

The truth about home loans

The first truth: Your fixed rate loan may not be really fixed
Banks can word their loan agreements quite smartly. If you have taken a fixed rate home loan read the fine print carefully. Some agreements have wordings that say that while your loan is at a fixed interest rate, banks have the free will to increase the rate in case of any unforeseen circumstance. The banker will never tell you what 'unforseen' really means. These loans are also called money market loans.

So if you are taking a fixed rate home loan, make sure you know what it is. While a money market loan is not a bad product, make sure you are not tricked into believing that you got a completely fixed loan.

The second truth:
Your floating rate loan isnt really floating
Floating rate loan theoretically means that your interest rate is linked to an internal benchmark of the bank such as the Prime Lending Rate (PLR). Your floating rate of interest should ideally change if the PLR changes. Or at least, that's what the banker will tell you. This link between the home loan rate and the PLR is only the partial truth. What really happens is slightly different. There is a hidden clause of ‘spread’.

Spread is the difference between the PLR and the home loan interest rate and is unique to each home loan agreement. In case of home loans, the spread is negative, which means, the home loan interest rate is offered at less than the PLR. What banks do is change the spread and not the PLR.

For example, let's say PLR is 10% and spread is 1.5%. Thus, your interest rate is PLR minus spread which is 8.5%. Suppose interest rates in the economy fall. Now the bank announces interest rates to new customers at 7.5%. Now this does not mean that the loan you took at 8.5% will also reduce interest rate to 7.5%. Banks will only change the spread from 1.5% to 2.5% in case of new loans. Thus while new loans are at 7.5%, you will still pay 8.5% because the PLR hasnt changed.

The third truth: The benchmark itself is faulty

Each bank sets its own benchmark, or PLR, for the floating rate loan. PLR is not an external benchmark. It is something that the bank sets on its own. So really, it is in the control of the bank and not related to how exactly interest rates move in the economy.

While taking a home loan, make sure you read all the fine print. Contrary to popular belief, the language is not difficult to understand. It just need a bit of patience.

Tuesday, February 14, 2006

Sensex at 10000. What to do?

The markets are euphoric. 10000 and still counting. You need to read this post if:
1) You have already invested in the markets (since I am not a stocks person, I am assuming you have invested through mutual funds)
2) If you are planning to invest
3) You are not planning to invest

Ya, so basically I have not left out anyone here :-)

Let's take it case by case, starting with those who have already invested in the markets. Take this quiz:
Why have I invested in the markets?
a) To make quick money
b) To accumulate funds for a house I plan to buy this year
c) To build wealth for retirement

What will I do with the money if I sell now?
a) Blow it up on some indulgences
b) Use it to fund my house
c) I am not selling

If you answered both questions in (a), then don't even bother reading ahead. You are using the markets to make a quick buck and that is not what the Money Gardener believes in. Money Gardener has always talked about long term wealth building and that will happen only if you allow your funds to grow over a long time.

Equities should not be gambling dens. Equities, when used wisely, will give the best returns over a longer term of 7-10 years. Markets are at all time highs now, and a short-term correction is inevitable. But over a long term, the markets will just continue to grow.

If you answered both in (b), then this maybe a good time to book some profits. After all, it is important that you don't lose the money you have accumulated for your home. Markets are at all time highs and nobody is able to tell if it will go up further, if so, how much and if so, when.

If you answered both in (c), you are a winner. Just hang on there and the results will show.

What if you haven't invested and are wondering whether you should start doing it now? Time to introspect. Why are you investing?
a) Because everyone else seems to be making money around me
b) Because I need to build wealth

How long will you hold on to your investment?
a) For as long as it takes to make some great profits
b) For at least 7 years

At the risk of sounding repetitive, let me tell you how you fare. If you answered both questions in (a), don't bother investing now.

If you answered both questions in (b), go on and invest. It does not matter at what levels you enter the markets because you are planning to hold on for a long term. Over 7-10 years the sensex could go up to 15000, then fall to 7000 and then rise again to 12000. So patience will pay off.

A tip: Invest through a systematic investment plan.

Now if you were too scared to put your money in equities, I suggest you overcome that fear. Markets are risky in the short run but great for the long run.

So start putting in a little money every month and watch your investments grow over the years. Don't get jittery if there is a small fall. Falls happen. But falls are followed by rises.