Before going on a holiday, you usually have a checklist to ensure that your travel is comfortable. You make sure that you’ve packed that extra pair of socks, kept the e-ticket printouts and so on. Even before buying a consumer product, such as a digital camera, you do research on the difference between a digital zoom and an optical zoom. But when it comes to buying financial products, you rely either on the agent or the bank’s relationship manager. Partly because money can be a boring thing to look into or you may think you just don’t have the acumen for personal finance. To help solve these problems, we bring you a quick checklist of things to look into before buying a financial product. To know more, read on.
What’s the real return
You defer consumption today to get more at a future date. “While choosing a financial product, the fundamental decision is the potential returns of the product,” says Karthik Jhaveri, a Mumbai-based certified financial planner. Even as you look at the returns as an important parameter, the type of return matters.
Jhaveri adds: “Don’t just look at the nominal rate of return, but take into account the post-tax return.” Just because the product promises higher returns does not mean that returns which you may get, work well for you. For instance, though a fixed deposit (FD) offers an 8% rate of return for a one-year deposit and you fall under highest tax bracket, the actual return you get will fall down to 5.3% post-tax. Or take for instance IFCI Ltd bond which hit the market this month. Here you get an yield of 10.50% over 10 years and 10.75% for 15 years. But if you look at the post-tax returns for the middle tax bracket, the returns falls to 8.33% over 10 years and 8.53% over 15 years. For highest tax bracket, the post-tax returns are even lower—7.25% over 10 years and 7.42% over 15 years. So, do not get swayed by stated returns but see the tax bite to know the real rate of return.
You also need to factor in the rate of inflation while taking into account your expected returns. For instance, if inflation is higher than the interest you earn on an FD or a bond, then you might just end up losing money due to reduced purchasing power.
To illustrate, say the inflation is 12% while your FD gives you 10%. Though the double-digit return may make you feel happy, you are actually losing about two percentage points of purchasing power.
Another important criterion to look into is the liquidity of the product. In simple terms, liquidity means, how easy it is to get your money out of the investment without losing value. Jhaveri says, “Look at the liquidity and the flexibility the product offers you. See if there is any lock-in period or can you exit the product anytime.” The type of product you choose should depend upon your investment goals and hence you will need to see how long you need to remain invested in the product.
For instance, if you are looking to invest for a medium- or short-term goal, putting all your funds in Public Provident Fund won’t make any sense. Pankaj Mathpal, managing director, Optima Money Manager, a Mumbai-based financial planning firm, says, “PPF is a long-term product with 8% tax-free interest but it has a poor liquidity. See if the product offers you enough liquidity to meet your goal.”
If you are looking to tap into your investments in the short term, investing into a liquid fund makes more sense, instead of investing in an FD.
Without any doubt, one of the most important parameter to look into while buying a financial product is cost. Sadique Neelgund, a Mumbai-based certified financial planner and founder of Networkfp.com, an online portal for certified planners, says, “When you want to invest in equity via stocks, mutual funds or exchange-traded funds, cost structure and your comfort level and knowledge of these instruments play a very important role.”
While cost isn’t a big deal for most fixed-return products, it becomes a very important parameter when investing in a market-linked product. There is cost to be paid at each stage for most financial products.
“Look at the entry cost of the financial product. The lower the entry cost the better it is. Zero is the best,” says Kiran Telang, founder, ABT Capital Advisors, a Mumbai-based financial planning firm. While MFs come with a zero entry cost, for unit-linked insurance plans (Ulips) you still will have to shell out an entry cost or front load of 5-10%. For stocks, brokerage on delivery is usually in the range of 0.10-0.50%.
After entry costs are taken into account, there is a cost of staying invested. For instance, there is a running cost usually which is charged when you invest in an MF. This is included in the net asset value (NAV) itself. “Even as you look at cost, it’s important to look at how the cost is charged,” says Ranjit Dani, a Nagpur-based certified financial planner. “For instance, with Ulips you pay a cost as a deduction of units. This is wealth destruction.” Also, equity MFs can charge a fund management fee up to a maximum of 2.50% of the asset under management per year. In case of insurance, you will have to shell out charges of around 2.25% per year for a 15-year policy. Keep in mind that these charges dip your returns and the lower they are the better it is.
The third type of charge you pay is when you exit the investment. For instance, in MFs you will have to bear an exit load of 1% in case of equity-oriented MFs if you exit before one year. Same applies to monthly income plans. For debt-oriented MFs, it can vary as per the exit period. While there is no charge to exit Ulips after five years, if you exit before that you will have to pay up to Rs 6,000 as cost.
For FDs, look into premature withdrawal penalties. Most banks charge a penalty for breaking an FD. Dani says, “Look at all charges and take a holistic view on the total cost of the product before investing.”
Ease of transaction
Today, time is the most valuable asset and hence the ease of buying and transacting a financial product is an important parameter to look into. Jhaveri says, “See if the product can be bought with ease. Is there an online option to buy? Does it have minimal paperwork required?” With investing taking the online route, buying most financial products has become easy.
Online: Online broking portals such as ICICIDirect.com and Sharekhan.com let you buy equities, funds and bonds online. Dedicated mutual fund portals, such as FundsIndia.com and Fundsupermart.co.in let you invest in MFs at the click of a button. Net banking allows you to buy FDs and request for loans from the comfort of your home. Insurance portals, such as Policybazaar.com and Click2insure.com allow you to compare and buy policies across insurers.
ATM: Automated teller machines (ATMs) too have made buying and requesting for financial products easy. You can open an FD at an ATM. Some banks even allow you to buy and redeem units of MFs at ATMs.
Agents and financial planners: Though to buy financial products offered by post offices, you still need to visit local post office, there are agents or brokers who can help you. Also many financial planners help you buy investments and insurance policies without you going through all the paperwork.
This is a basic checklist for buying financial products. You can add to this checklist based on your individual profile and requirement. Now that you know how to go about, happy shopping.