As we progress through life, our income, spending, lifestyle and aspirations change. Accordingly, financial planning through different stages of life should be a dynamic process. Our savings and investment plans should change in different stages of life in line with our risk tolerance and specific short term and long term financial objectives. Life and health insurance are often the ignored elements in our financial planning. However, life and health insurance are as important as savings and investments in every stage of our lives. In this article, we will discuss how to plan your investment and insurance in different stages of life. Please note that these are general guidelines only.
When you are single
- Investment: Since you have no liabilities at this stage of life, your risk tolerance is high. You should invest the major portion of your savings in equity, with a long term investment horizon. Unless you have requisite experience and expertise, avoid investing directly in stocks. Instead you should invest in good diversified equity mutual funds through systematic investment plans (SIPs). SIP is the ideal investment option in this stage of life because it will help you inculcate disciplines savings habit and benefit you in the long term through the power of compounding (please read our article, Retirement Planning through Mutual Fund Systematic Investment Plans). You should also make some debt investments like fixed deposits, fixed maturity plans, income funds etc if you have short term goals (e.g. buying a vehicle, saving for higher education etc). At this stage of life, your allocation to equity investment should be 75 – 80% and the allocation to debt investment should be 20 – 25%. However, if you have dependent parents then you should increase your allocation to debt investments.
- Life Insurance: Even if you have no dependents, if you plan to get married in a few years it is prudent to buy life insurance. Some people may argue, if I have no dependents why should I buy life insurance. It is a valid argument. You may wait till you marry to buy life insurance. However, it is often prudent to buy life insurance even before you get married as the younger you are, the lower will be your insurance premium. The cost savings over the term of your insurance policy can be quite substantial. How much cover or sum assured should you buy? The sum assured will depend on how much income your dependents will need. If you do not have any dependent, you can buy a sum assured of 10 times your gross annual income. If you have dependent parents, make sure the sum assured covers their financial needs, in the event of an unfortunate death. For life insurance opt for a term plan, instead of insurance cum savings plans like endowment plans (please read our article, Taking term plan can be a smart Insurance choice).
- Health insurance: Even if you are covered under your employer’s group health plan, you should check what kind of benefits your employer’s group insurance policy offers and evaluate if you need to buy separate Mediclaim. If you have dependent parents, you should buy a family floater plan that provides comprehensive protection including critical illnesses.
When you are married and before you have children
- Investment: Marriage brings additional responsibilities and financial commitments. While equities should continue to be overweight in your asset allocation, you should reduce your equity allocation to 65 – 70% and increase the debt allocation to 30 -35%. This is also the stage of life, when you want to buy your home. A portion of your savings will go towards servicing home loan EMIs and the balance should be allocated to investments. One should try to invest in real estate as early as possible, for a number of reasons. (1) If you invest early, as you progress in your career and your disposable income grows, you will be able to prepay a greater portion of your home loan principal balance and thereby reduce your interest expense over the term of the loan. (2) Also you will be debt free earlier in life. (3) You will get the benefit of capital gains, since real estate appreciates in value over time. (4) You will be able to save on taxes, both under Section 80C for principal repayment and under Section 24 for interest payment, for self occupied property. Windfall gains like bonus payments, profits from short investments etc should be used to prepay the home loan and reduce your interest burden. Since a house purchase usually calls for a big financial commitment, both the total purchase consideration and property selection require careful evaluation. You must ensure that you do not overstretch yourself. Other financial goals like retirement planning are equally important.
- Life Insurance: Once you are married you should ensure that you have adequate life insurance. Your sum assured should meet the income needs of your dependents in the event of an untimely death. For example, if your current income is
र 20 lacs, assuming a post tax annual return of 8%, you will need an insurance cover of र 2.5 crores. You should always add an additional amount, as a guard against inflation. As a thumb rule you may add your annual salary as the additional inflation guard. Your total cover, including inflation guard, in the example above should be र 2.7 crores. If you have a home loan, your sum assured should also cover the outstanding loan. As discussed earlier, term plan is the best life insurance option.
- Health insurance: Even if you are covered by your employer’s group health insurance plan, it is prudent to buy a separate Mediclaim plan for your family. Usually the group health insurance plans offered by employers are basic plans. You should check if your group health insurance provides comprehensive coverage of major healthcare needs. Among other things check, what is the total sum insured? Are critical illnesses covered? What are the exclusions? If your group health insurance plan is not adequate for your needs, you should buy a separate family floater plan. If you already have a family floater for you and your parents make sure your spouse is also included in the plan.
When you have children and while they are growing up
- Investment: Once you have children your responsibilities increase further. You should aim to reduce your debt by prepaying your home loan. Pre-payment reduces your interest expense and leaves you with more money for your investments. When you prepay your home loan, you have two options. One, to pay the same EMI and reduce the tenure of your loan. Second, to reduce your EMI and keep the original tenure of the loan. Paying the same EMI and reducing the tenure of the loan, will result in lower interest expense over the tenure of the loan. Since in this stage of life your income is higher, you should prepay your loan on a regular basis from your savings, rather than wait to accumulate a corpus or a windfall gain. If you prepay on regular basis, you will be able to reduce your interest expense. Please read our article, Should you Pre Pay your Home Loan, to know more about the benefits of pre-paying. As far as your investments are concerned, you should reduce your allocation to equity further and increase the allocation to debt investments. Your average asset allocation at this stage of life should be 60% to equity and 40% to debt investments. Remember that the 60% equity and 40% debt split is the average asset allocation during the period when your children are growing up. Start with a higher allocation to equities when your children are young and reduce it gradually to 50 – 55% by the time they are ready to go to college. Start saving for children's education and marriage through systematic investment plans in a diversified equity fund. You can also opt for child plans. You can read about child plans in our article, Investing for the future of your children.
- Life Insurance: Enhance your sum assured to meet future obligations like children’s higher education and marriage. At this stage of life, you should also evaluate and increase your sum assured adequately to meet the current lifestyle needs of your family and buy additional term insurance if needed.
- Health insurance: You should include your children in your family floater plan.
In this article, we have discussed some general guidelines for planning investments and insurance at different stages of life. Taxation is an important consideration when you plan for investments. For tax planning through different stages of life, please read our articles, Tax Planning at different stages of life: Part 1 and Tax Planning at different stages of life: Part 2. In the next part of this article, we will discuss financial planning in the next 2 stages of life, when your children are grown and when you retire.