How to overcome financial DISASTERS

Planning for future is an integral part of the life of an individual. It gives direction to the life and charts out future course of action.Planning is the process of thinking about and organising the activities required to achieve a desired goal. It involves the creation and maintenance of a plan. As such, planning is a fundamental property of intelligent behaviour. It is rightly said: Well planned is half done.

Planning is very effective when all the outcomes in the future take place as contemplated. The problem arises when there is a deviation in form of unexpected events like accident, illness or death in the journey of life of an individual. Such events have a devastating impact on all aspects of life including the path of attaining one's financial goals in life.

Financial planning entails achievement of life goals to ensure financial well-being of the individual and dependents. These goals include long term goals like retirement, children's marriage, buying a house and short-term goals like buying a car or going on a vacation etc. It needs planning over a period of time during which an individual needs to earn save and invest. Allocating one-third of the income each towards investment, expenses and debt servicing will ensure that one stays on course toward the achievement of financial goals.

Unfortunate events have the potential of changing course of one's life both emotionally and financially while it is very difficult to safeguard the emotional quotient of an individual, the financial impact of the contingency can be minimised through proper management of finances by the process of financial planning.

Unfortunate events can occur in any of the following forms:

1. Natural disaster

2. Personal accident leading to death/disability

3. Chronic illness leading to disability

4. Business or investment loss.

The writer is working with Financial Planning Standards Board India (FPSB India) in the capacity of Vice Chairman and Chief Executive Officer. The views expressed here are personal, and do not necessarily represent that of the organisation. FPSB India is the sole marks licensing authority for the CFP marks in India, through agreement with US-based FPSB Ltd. 

1. Natural disaster/Accident

In case of natural disaster or accident insurance becomes a major tool for protection which is the way of pooling the risk amongst the individuals sharing the same risk characteristics. Every year thousands of crores of rupees are wasted due to natural calamities like flood and lakhs of individuals are impacted.

Thus it is very important that one keeps himself/herself protected against such peril by taking appropriate insurance policy. The same applies to accidents also which can result in death/disability. Taking a life insurance policy with rider for disability is imperative in this case.

The amount of cover that needs to be taken in the policy may differ from individual to individual and should be decided only in consultation with an expert. Accident insurance is also available as a standalone product with most of the providers.

In addition there are tax benefits available under section 80 C of the income tax act for the premium paid for life insurance policies. More than 3 lakh people die every year in India due to accidents.

2. Chronic illness

Taking an appropriate health insurance policy is the most preferred solution to this risk. The penetration of health insurance is low in India and according to a report of World Health Organisation in 2006, 72 per cent of the hospital expenses in India are out of the pocket. In addition deduction can be claimed under section 80D and 80 DD of the Income Tax Act from the taxable income for the premium paid for health insurance for self and dependent parents.

For self this benefit can be up to a limit of Rs 15,000 or Rs 20,000 if the assesse or the spouse is over 60 years of age (senior citizen). For parents a separate limit of Rs 15, 000 is admissible under section 80D and Rs 20,000 if one's parents are senior citizens.

Furthermore deduction can also be claimed under section 80DD and Section 80DDB of the income tax act for the amount spent on treatment in such cases.

3. Loss of income/Earning potential

In addition to the factors mentioned above income or earning potential can also be lost due to adverse economic conditions resulting in loss of employment for some time. There are insurance plans available which can take care of necessary expenditures like EMI payment and household expenditure; one should keep a minimum amount in cash or near cash investments to be free from anxiety during such periods.

Generally holding eleven months monthly expenditure in cash or near cash investments such as liquid schemes of mutual funds should be appropriate.

4. Business/Investment loss

There is a possibility of loss in business/investment, and hence diversification becomes the key word. Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique lies in the reasoning that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. This would mean expanding the investment horizon beyond one asset class so that one is not exposed to the adverse movements of one asset class at a point in time.

In terms of business diversification, expanding the business in not so closely related areas so that slowdown in one is offset by the demand in other can be termed as diversification. This is also called horizontal diversification in management terms. Income-tax Act, 1961 also provides provision for the set off of the business /investment losses for a period of 8 years.

As an example of the same if we take the case of a 35 year old individual in Mumbai whose monthly income is Rs 75,000. His family comprises his 32 year old wife and 7 year old son. He spends his income as per the one-third rule where he spends Rs 25000 on household expenses, invests Rs 25,000 for the achievement of future goals and Rs 25000 goes every month towards the payment of housing loan for the house in which he stays.

The outstanding loan amount is Rs 15,00,000 and the market value of house Rs 70,00,000. His other assets include life insurance policies, jewellery worth Rs 15 lakh, a car having market value of Rs 6 lakh.

In addition to planning investment to achieve his future financial goals he must do the following to secure himself against unfortunate events.

In addition to the above, he may also ask his spouse to take up some income generating activity in her spare time which can provide some respite during loss of income. Keeping some portion of assets like gold or jewellery which can be monetised easily by selling or going for a loan may also be a wise option.

Important documents like investment and property documents also need to be safeguarded during such events and thus keeping a copy of all such documents in digital format by scanning them may be a good option. Keeping one copy with self and other with the financial planner may be a good idea.

A point to note here is that insurance penetration in our country is very low at 4.6 percent of GDP as insurance premium in 2010; the level is above 10 per cent for most of the developed countries, Insurance density, which means the per capita spending on insurance is far below the levels of developed countries. This means in general we have an inadequate protection for our population, which needs to be taken care of. The diversion of funds towards insurance sector will also provide the funds for the long term requirements in the infrastructure related sectors which will led to the growth in the crucial sectors of the economy.

Thus we can say that while planning for your life goals is a good idea, at the same time one should always be prepared for any exigency. Consulting a competent professional like a certified financial planner or CFP professional should be given preference as he/she is equipped to understand the financial needs of the individual and providing for exigencies as well.