Your Questions Answered: Opting for no-claims bonus policies, how to get the asset allocation right?

Q1. I am a 32-year-old working woman. While discussing with a friend of mine, I learnt that one should opt for health insurance policies that offer no claim bonus. How does no claim bonus work in health insurance policies?

A no claim bonus (NCB) is a benefit given to a health insurance policy holder for having a claim-free year. NCB is an important consideration when you choose a health insurance policy.

This bonus is cumulative; for every claim-free year, the amount increases. NCB is available for both individual as well as family floater policies. The total NCB may range from 50% to 100% of the original sum assured. Please note that your policy may specify a ceiling on the NCB amount.

To give you an example, suppose your health insurance policy has a sum assured of ₹10 lakhs and your insurer gives you 10% NCB. If there has been no claim during the year, in the second year, your sum assured will be ₹11 lakhs ( ₹10 lakhs + 10% NCB). Again, if there is no claim, your sum assured in the third year will be ₹12 lakhs ( ₹11 lakhs + 10% NCB on basic sum assured of Rs. 10 lakhs).

The insurer may give the NCB in two ways:

Cumulative benefit

The NCB is added to the sum assured without any increase in the premium payable (as in the example above).

Discount in premium

The NCB amount is deducted from the insurance premium without any change in the sum assured.

The idea is to incentivise fewer claims. When there are frequent claims, in addition to denying the NCB, the insurance company may increase the premium.

Given the increasing costs of medical treatment and hospitalisation, NCB gives you the advantage of additional health insurance at no extra cost, which translates into extra financial protection.

Please do remember to read the policy carefully before you sign up. Not all policies offer NCB. It is also important to know the NCB ceiling.

Q2. I am 35 years old, and work with a private company in the IT Industry. While making investments, how important is asset allocation? How should it be done?

Asset allocation means diversifying your investments across different asset classes like equity, debt, insurance, real estate, gold, silver and so on. It depends on factors like time horizon for investment, the goals of investment, and most importantly, one’s risk appetite or risk-bearing capacity. Therefore, asset allocation varies from person to person and one pattern may not suit another.

You must remember that not all asset classes generate returns at the same pace or move in the same direction. Having a right product mix in the portfolio becomes important because of this reason. When you invest in more than one category, you reduce the risk of losing money. If one asset category does not perform well or if there is a lot of volatility in one asset class, you have the chance to counter those lower or negative returns with better returns in some other category. Also, by picking the right mix and proportion of investments, you also limit your losses, thereby controlling the fluctuations in the returns.

Tips to get your asset allocation right

Identify risk tolerance capacity

The first and most important step before deciding on asset allocation is to identify your risk-bearing capacity and how long you can spare the funds. In other words, you need to know when you are likely to need the funds.

Set objectives

Ideally, asset allocation should be based on your financial goals—short term, medium term, or long term. You need to rebalance the portfolio and stay with the original asset allocation to meet your objectives.

Stay invested

As they say, vesting time in the market is more important than trying to time the markets. You need to stay invested to reap benefits.

Review portfolio

You must periodically review the portfolio. However, make sure that you don’t do it too often. Avoid taking decisions based on short-term performance of the assets. Frequent juggling of assets will not help.

Your financial planner can help you choose the right asset classes based on your profile, goals, and risk appetite.

Q3. I am a conservative investor. I have heard about RBI Floating Rate Savings Bonds that offer 7.15% as coupon rate. I understand these are absolutely risk free. Should I invest in these bonds?

The RBI Floating Rate Savings Bonds (Taxable), also known as RBI 7.15% bonds, are a debt instrument, which is risk-free in terms of credit risk.

1. As the name suggests, these bonds have a floating interest rate, which may be reset every 6 months. The base is the National Savings Certificate (NSC) rate, and RBI Bonds’ interest rate is 35 bps (0.01%) higher than the NSC rate. At the time of writing this, the rate is 7.15%, which may change if the NSC rate changes.
2. These bonds are taxable. The interest that you earn on these bonds will be added to your income and taxed as per the slab applicable to you. So, if you fall into the 30% tax bracket, against the coupon rate of 7.15%, for you the effective interest rate after tax would be 4.50%.
3. There is a lock-in period of 7 years for individuals under the age of 60, with no possibility of partial or premature withdrawal. That makes these bonds illiquid. However, for senior citizens, there is a special provision for premature withdrawal, depending on the age and subject to a reduction in interest rate as penalty.
4. These bonds are non-tradable and non-transferrable. However, a nomination facility is available.
5. You cannot avail a loan against these bonds.
6. The interest is payable half-yearly—in January and in July. There is no option of cumulative or monthly or quarterly interest pay-outs.

These bonds are more suitable for investors who are absolutely risk averse and are focused on risk-free, government bonds. Also, it suits those investors who want regular half-yearly pay-outs.

While these bonds are an option when you are looking to diversify your portfolio, you may not want to invest a large amount, given their illiquid nature and taxability. As your investment in these bonds are locked up for 7 years, and the interest rate may vary every 6 months, in the event of an emergency, you may end up having to liquidate other assets offering better yield and growth.

Q4. I am a 30-year-old working woman, looking for a life insurance plan. I have been advised to invest in a ULIP, but my husband thinks I should first opt for a term plan. What do you suggest, ULIP or a term plan?

First let’s understand both options.

Term plan

A term plan is the simplest and most basic form of insurance. It provides insurance coverage or life protection, offering a higher sum assured at a lower premium. A term or a valid period is specified for premium paying as well as for coverage of life. In case the policy holder dies during the term, the sum assured is paid to the nominee. However, no benefit is paid to the policyholder when the policy matures.

Presently, for a slightly higher premium, some term plans offer return of all the premiums paid (minus taxes) at the end of policy term.

ULIP

A Unit-Linked Insurance Plan (ULIP) is a combination of insurance and investment. A small portion of the premium is allocated towards insurance cover, while the larger chunk is invested in available fund options—debt, equity or balanced.

In the event of death, the fund value or the sum assured (whichever is higher), is paid to the nominee. On maturity, the fund value at the end of the tenure is payable to the policy holder.

Today, several ULIPs are available to match different life goals like child’s education, wealth creation and even retirement.

Term plan or ULP?

While choosing between a term plan and a ULIP, you should consider:

Any good returns in the longer run. While choosing between term plan and ULIP, you should identify your requirements and the benefits offered by the two options along with the amount available with you to pay as premium.

Ideally, we would suggest to take a pure term cover first of at least Rs. 1 crore (assuming you have dependents and still not built all the required corpus per your Financial Plan). As seen in the above table, it comes at a very low premium. With the balance amount available you could invest via SIPs (Systematic Investment Plans) into Equity and Hybrid Mutual Funds. Once you have taken the required insurance and have started your SIPs for further diversification you could look to add a ULIP. However, drafting a Financial Plan would help you make this choice more holistically keeping in mind your goals, cashflow, time horizon etc.

Q5. I am a young professional in the medical field, and I have recently started working. My friends and family are suggesting that I should start investing in mutual funds through SIPs and also invest a lumpsum when I have some extra funds. What do you suggest?

Mutual funds offer several benefits.

Professional management

Every mutual fund is a professionally managed pool of funds. The MF manager makes investments based on research and expert analysis.

Accessibility

Anyone can invest in a mutual fund starting with an amount as small as ₹500 through a systematic investment plan (SIP). You may also choose to invest a lumpsum amount.

Diversification of risk

Every MF mainly invests in two asset classes: equity and debt, comprising several stocks or fixed-income instruments. When you invest in an MF, you thus get the benefit of diversification without having to invest a large chunk of money. Also, thanks to the spread across different sectors, the risk is diversified.

Suitability

There are several MF categories and sub-categories available that suit different investor profiles. Pick an MF that suits your objectives, risk appetite and time horizon for investments.

Systematic investments and withdrawals

You may opt to invest in an MF through an SIP. You may also make regular withdrawals through a systematic withdrawal plan (SWP), which can help you meet regular expenses.

Liquidity

An MF offers better liquidity than many other instruments. Most MFs today are open-ended schemes. When you redeem, the proceeds of an equity fund will get credited to your account within 4 working days while that of a debt fund will be credited in 2 working days.

Cost efficient

Compared to directly investing in equities, investing in mutual funds is more cost effective. When you buy stocks, you pay brokerage (which could be high for retail investors) plus security transaction tax (STT). As bulk investors, MF managers can negotiate better rates and transfer the benefit to investors.

Transparency

Mutual funds offer high transparency. An investor can see which securities the MF has invested in. Every asset management company (AMC) publishes monthly factsheets for all their schemes that reveal top holdings, sector-wise holdings, expense ratios and information about the fund manager. Also, the records of an MF are audited.

Disciplined investment

Mutual funds encourage investors to stay invested for a longer period. This helps in generating a compounding effect, yielding higher returns and greater wealth generation. Investing through SIPs delivers a cost-averaging benefit.

Taxability

Mutual funds also offer a tax advantage compared to direct investments. When held for more than 3 years, debt funds attract a long-term capital gains (LTCG) tax at 20% with indexation benefits, and short-term capital gains tax as per the applicable tax rate. When held for more than a year, equity funds enjoy tax exemption up to ₹100,000, and are taxed 10% thereafter. Short-term capital gains (STCG) tax is levied at 15% on equity funds.

Additionally, the investor need not pay LTCG or STCG for any transactions being made by the fund house. The Investor only needs to pay tax when he/she sells or redeems funds from the mutual fund unlike in direct share trading.

Given these advantages, MFs have become one of the most popular investment options, especially for retail investors. These are convenient, hassle-free, and easy to invest in, making MFs a great option for investors who do not have the expertise or time to manage their funds.

Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.

International Money Matters Pvt Ltd is a SEBI registered personal finance firm.