Diwali is the most popular festival of Hindu community and celebrated all over the world. This festival is for five days commencing from today i.e. Dhanteras (Lord Laxmi Puja) and ends on Bhaubeej. On auspicious days of Diwali, people lit beautiful Diyas (light) at home and celebrate festivals with friends / family members by exchanging gifts, sweets and burn fire-crackers in the evening. Every year we see variety of crackers for sale in the market. Names of this crackers keep changing from popular politicians, movies, cricketers, actors, actresses, etc. for bombs, rockets, fancy sky crackers, etc. This year let’s understand some financial bombs which we tend to have in our portfolio. These financial bombs must be avoided; so, let’s go deeper to identify those bombs and know about them.
List of Financial Bombs is as follows:
Unit Linked Insurance Plan (ULIP Bomb)
This financial bomb is marketed by insurance companies and agents as a unique product that unlike a pure insurance policy, gives investors the benefits of both insurance and investment under a single integrated plan. However, I would like to add that insurer lacks the knowledge of various charges deducted from premium amount and risks involved with this insurance product. The investment proceedings in this scheme is linked with performance in equity markets. So, there is high risk involved on investment returns in this scheme.
Various ULIP Charges deducted from premium are as follows:
|Premium allocation charge||7.5% (approx)|
|Policy administration charge||Rs 70 to 100 per month in the initial 3 to 5 years, afterwards it increases by 4% to 6% every year|
|Fund management charge||1.35%|
|Surrender charge||15% in 1st year ; 5% in 3rd year|
|Agent’s commission||8% to 10%|
Recommendation: We advise to take term insurance, which will save premium cost and remaining amount which you were paying it to ULIP premium shall be invested in equity mutual funds. Buying term insurance will fetch you higher amount of sum assured at a lower cost. Also, investment in mutual funds for long term has a tendency to give better returns. The expense cost charged by AMCs in mutual fund schemes is 1.5% to 3.5%, which is much lower compared to ULIP charges.
Endowment Assurance Policy (Endowment Bomb)
An endowment policy is a life insurance contract between an insurance company and an insurer. Here, insurer receives a lump sum amount after a specified term in contract or on maturity or on death, whichever is earlier. Maturity of this type of policy is ten, fifteen or twenty years up to a certain age limit. This policy also pays high commissions to insurance agents. It is categorized as high charges, but low returns. However, charges are not clearly defined to insurers but its assumed equivalent to ULIP charges. Here, investment from premium proceedings is into debt products issued mainly by government. This fetches returns of 5% to 6% to insurers in the form of bonus. These returns are much lower compare to rising cost of inflation.
Recommendation: We advise to take term insurance which will save premium cost and remaining amount which you were paying it to Endowment premium shall be invested in debt mutual funds scheme. Buying term insurance will fetch you higher amount of sum assured at lower cost, as said earlier. Also, investment in debt mutual funds scheme is much better compared to 5% returns on investment from this policy.
Thematic mutual funds (Thematic bomb)
Objective of thematic mutual fund schemes is to invest the money in companies of one particular sector. There are thematic mutual fund schemes to invest in sectors like infrastructure, FMCG, Oil and Gas, US global companies, pharmaceutical, banks, etc. Fund manager, expects price appreciation in companies with presence in particular sector. Investment in such schemes is high risk and high reward category. However, performance of most thematic mutual fund schemes in last 3 years is disappointing. So, we suggest keeping yourself away from investing in these schemes.
Performance of some thematic mutual funds is given below:
*AUM (Rs Cr)
Birla SL Infrastructure
Baroda Pioneer Infrastructure
UTI Infrastructure Fund
Sundaram Energy Opportunity
|*AUM as on 30th Sep, 2013 ; Returns as on 31st Oct 2013|
|^ Returns over 1 year are Annualised|
Recommendation: We recommend to invest in diversified mutual fund schemes instead of concentrating on investment in one sector through thematic schemes. Fund manager, analyses opportunity across the sectors and pick stocks to form a portfolio which gives higher returns than investing in thematic funds. Risk of investing in a diversified scheme is lower compared to thematic schemes.
Investment in “T” and “Z” group companies (T Bomb and Z Bomb)
BSE has classified companies into various groups for benefit of investors. Through this classification, beware of companies listed on exchange in “T” and “Z” group. Here, “T” group represents scrips which are settled on a trade-to-trade basis as a surveillance measure and “Z” includes companies which have failed to comply with its listing requirements and/or have failed to resolve investor complaints and/or have not made the required arrangements with both the depositories, viz., Central Depository Services (I) Ltd. (CDSL) and National Securities Depository Ltd. (NSDL) for dematerialization of their securities. There are many penny stocks in these groups, which are traded merely on speculation or by operators.
Some companies listed on “T” group are: Ajanta Soya, Alcobex Metals, Ashtavinayak, Basil Infra, Brakes Auto, Doctor Biotech, Dhoot Ind, etc.
Some companies listed on “Z” group are: Alfa exports, ACE Labs, BCL Financial, Cana Glass, Gemini Agritech, IFSL, Iccon Oil, etc.
Recommendation: We advise to invest in large cap stocks if you have fundamentals knowledge to pick right stocks or invest in large and mid cap equity mutual funds scheme.
Chit Funds (Chit Bomb)
Investing in chit funds is very popular in India. Under chit fund, company manages, conducts or supervises, as a foremen, agent or in any other capacity, the funds raised by investors. Such chit fund schemes may be conducted by organised financial institutions or may be unorganized schemes conducted between friends or relatives. Major participation in these schemes is from rural people. They prefer to invest in chit funds since they offer easy liquidity whenever required for emergency.
Popular chit fund scams are: Sahara chit fund, Saradha chit fund, etc.
Recommendation: We recommend investing in a bank or post office Recurring Deposit (RD) schemes or Fixed Deposit (FD) schemes with a bank. This is liquid money for small investors. Premature withdrawal from recurring deposit and fixed deposit schemes is allowed, but there will be some penalty.
Do you think there are additional financial bombs in your portfolio besides we discussed over here? If yes, then feel free to mention in the comments below and we will discuss that in detail.
We expect this Diwali on wards you identify financial bombs in your portfolio and keep them away, so it doesn’t affect your portfolio performance in the long run. We wish Happy Diwali and prosperous new-year to all our readers. Also, we pray to God that all your financial goals are achieved every year.
About the Author:
Abhishek Jaju is MBA (Finance) graduate and equity analyst with an experience of over 6 years in personal finance domain. He can be reached at firstname.lastname@example.org