Q1. My income is predictable. Why should I put aside money to create an emergency fund?
Life can throw surprises. No one was expecting a virus to shut the world down. No one expects an accident. The effect on health apart, an unanticipated occurrence can have a serious impact on the financial situation of an individual and even the whole family.
An emergency fund is the essential corpus of money that you should keep aside to deal with the aftermath of any such unexpected happening. Financially speaking, an emergency may be any diversion from one’s regular life, which calls for a sudden big expenditure, not included in the day-to-day budget. Health issues apart, this could be sudden loss of job or a major problem with the car. Without an emergency fund, such an occurrence can derail your life.
Ideally, the emergency fund should be equivalent to at least three to six months of your monthly salary or income. Creating this fund should be a gradual process. It requires a bit of research. You need to take into consideration several factors like your income, expenditure, and the interest the targeted fund can offer you. It is equally important to choose a fund where you can access the money easily, whenever there is a need.
The most common option to create an emergency fund is a savings account or fixed deposit. However, here the interest earned is often below the rate of inflation, effectively eating away your capital. On the other hand, a fund that offers attractive returns may not match your risk profile.
Your financial advisor is in the best position to understand your needs and to recommend a suitable fund that also matches your risk profile. The advisor will also help you track the performance of the fund so that you can switch to another fund if required without compromising your objective.
Q2. I am 24 and have just started my career. Is it possible for me to reach all my financial targets?
It's commendable that you are thinking about your financial goals so early in your career. The only way to reach all your financial goals is to develop a financial plan (as early as you can) and diligently put that plan into action.
A financial plan helps you zero in on what you want to accomplish—for example, buy a home, take annual vacations abroad, or retire early. A financial plan helps you focus on your goals and creates a realistic timeline to achieve those.
As your financial goals evolve over time, your financial plan must adapt to keep pace. It is important to update your financial plan every few years so that your goals are in sync with your actions.
Q3. I am a business person. I have borrowed some capital to expand my business. In case of my sudden demise, I would like my wife and children to have access to certain funds that my creditors should not be able to claim. How do I do this?
The Married Women’s Property Act, 1874 (MWP Act) safeguards a married woman’s property from creditors and family members. As per Section 6 of MWP Act, the husband can buy an insurance policy on his life and create a trust to hold the claim amount on his demise. Only the wife and/or the children can access these funds, which can neither be attached by any court nor claimed by creditors.
Please note that though the husband must pay make all the premium payments, he has no control over the policy as it is effectively the property of the trust created while starting the policy. This trust does not form a part of the husband’s estate. On the death of the policyholder, maturity of the policy or even on surrender of the policy, the benefits will go to the wife and/or children.
The best thing is that it is not required to create a separate trust under trust laws. The trust can be formed by submitting the necessary forms along with the required supporting documents.
Such a policy covered under MWP Act cannot be assigned to any other person. No loan can be taken against such a policy. Also, the decision of attaching MWP act to the policy needs to be done at the time of purchase of the policy only, it is not possible at a later point in time.
Q4. I am 58 years old. Fixed-income securities make up a large portion of my portfolio. How is inflation likely to affect my investments?
Inflation erodes the purchasing power of money. That means you will be able to purchase less and less with the same amount of money over a period. Your concern is valid as those who have retired and have a fixed income are most affected by inflation.
Let us try to understand this with the help of an example.
If the average rate of inflation is 8%, you need to make sure that your investments are earning a minimum of 8% or more, after tax.
Let us assume an investment portfolio of ₹1,00,000, earning returns at 10%. The gross annual return in this case would be ₹10,000. Assuming you are in the highest tax bracket of 30%, your net income after tax would be ₹7,000 (10,000 minus tax of 3,000). Now, with 8% inflation, you are in effect left with a deficit of 1000 (7000 minus the inflation cost of 8000). It means you are not earning any money in real terms.
Therefore, it is always advisable to diversify your investments. Systematic investments through mutual funds are among the best avenues to accumulate wealth for your future. Once you near your retirement, you can slowly transfer your investments from equity to debt to avoid any volatility risk in the equity market.
International Money Matters Pvt Ltd is a SEBI registered investment advisory firm. If you have any personal finance queries, click here to talk to advisors from IMMPL.
Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.