Diversified or concentrated portfolio, that`s the question Source: BUSINESS LINE (17-JAN-11)

B. Venkatesh

Mutual funds portfolios are typically diversified. Self-directed portfolios, on the other hand, are mostly concentrated. Both strive to beat the market. Or in other words, generate alpha. The question is: Which portfolio is more optimal for active management?

This article explains the role of diversified and concentrated portfolios in alpha generation. It then shows why the choice of portfolio construction is dependent on the alpha source and investment style.

Diversified alpha
Alpha is primarily generated by security selection. That is, a portfolio manager will go overweight on a security that she believes will outperform the index of which it is a constituent. There is a fundamental law of active management. It states that the Information Ratio is equal to product of Information Coefficient and square root of breadth.

Information Ratio, to recap, is the residual or excess returns divided by the volatility of residual return - the numerator captures the excess return and the denominator, the risk assumed to generate such returns.

Suffice it to know that the excess (alpha) return is a function of the manager`s skills (Information Coefficient) and her independent investment bets per year (Breadth). According to this argument, a portfolio manager can increase the portfolio`s Information Ratio by spreading her spreads across more stocks and/or increasing her skill.

A portfolio manager`s skill is captured by how close (correlation) her forecast of residual returns is to realized returns. As this variable is not so easy to improve, the manager is left to increase her independent bets to improve the Information Ratio. This is the reason professional managers prefer diversified portfolio.

It then follows that an investor adopting traditional investment style using security selection as the alpha source should strive to have a meaningful collection of stocks to improve Information Ratio.

Suppose we define the portfolio`s risk as the total of market risk and residual risk. We can then state that market returns (beta) is the compensation for market risk and alpha, the compensation for residual risk.

Now, a portfolio`s market risk can be captured by its R-squared, which measures the completeness of the diversification relative to the market or benchmark. A portfolio with R-squared of one will have no residual risk. Research has shown that nearly a third of a typical stock`s behavior can be explained by market factors. In other words, for a typical stock, the R-squared is 0.30. But when large number of such stocks is gathered into a portfolio, the portfolio`s R-squared typically exceeds 0.90.

It follows from this argument that one way to retain more non-market risk exposure and generate non-market returns (alpha) is to have a concentrated portfolio. Two kinds of investors prefer such concentrated portfolios. Hedge funds that engage in arbitrage trades apply quantitative models to place large leveraged bets on fewer assets. Individuals managing self-directed portfolios apply technical analysis to invest in few assets to time the market.

Note that the fundamental law of active management essentially scoffs at market timers as such strategy has low Information Ratio. This is because market timers take large bets on fewer stocks and, hence, have lower breadth. The key to succeeding in market timing strategy is to have strict risk management rules to contain losses.

Conclusion
The above discussion shows that both diversified and concentrated portfolios have the potential to generate alpha. It would be optimal for those who follow technical analysis or other trend-following system to construct concentrated portfolios with strict risk management rules to contain losses on wrong bets. Those who follow traditional form of investing (fundamental analysis, for instance) should prefer diversified portfolio with independent alpha bets that do not largely cancel each other. That is, a factor that drives the excess return on one stock should not lead to negative returns on another. Otherwise, diversification can lead to tighter R-squared making the portfolio a closed indexer.

Save investors from matrix organization Source: BUSINESS LINE (17-JAN-11)

Krishnamurthy Vijayan

One of the positive fallouts of the financial crisis is that we can now question the myth of superior American systems, without losing our reputation for professionalism. Let me pick on one - the matrix organization. It tops my list of bad ideas.

Collective deniability
This structure has evolved to protect the US corporate chieftains from the consequences of their negligence. This is harmful to the most vulnerable external stakeholders i.e., small share fromety. Stringent accountability is the only check on greed, which is the pivot of every decision in their bonus-centric culture.

When the financial crisis broke, one question that was often asked was, ``How is it that the best brains in the developed world, working for the most powerful financial organizations, operating in the best regulated capital markets, blow up investor wealth in such a spectacular manner?`` The answer is lack of central accountability, embodied by the matrix organization.

What`s the matrix

The matrix organization is harmful in any business. But in the financial business, it is the most critical investor risk- he trusts his savings to a company that is run like a coalition government.

The matrix organization is a descendent of two management structures. One is the line and staff structure that the army evolved, to deal with the need for specialist inputs to decision-makers. Here, there are two lines of authority which flow at one time, viz. line authority and staff authority. Power of command, however, remains with the line executive and staffs serves only as counselors.

The second structure is the project matrix organization, which was created to deal with projects that require multiple disciplines. A company creates a flat hierarchy with a team leader and multiple specialists need to quickly and efficiently execute a project.
A permanent matrix organization, on the other hand, is a bureaucracy nightmare. In each business unit (say the Indian subsidiary) there is a CEO, who is supposedly assisted by domain specialists. But each of these specialists does not really take orders from the CEO.

They report into domain empires within the organization. Matrix organizations create a feeling of infallibility, because so many `domain experts` get pulled into making a decision. This fosters a sense of irresponsibility, because everyone believes that someone else who has approved the decision knows what he or she is doing.
Everyone is also secure in the belief that this collective decision-making ensures that the whole organization will be arrayed against anyone who tries to prove that they were wrong.

Even if this does happen, no one can be individually blamed and lose his job or worse. When a `scam` happens in India, people get arrested, cases are fought and life can become living hell for those who are involved. In the developed world, they get fat severance pays and golden parachutes.

Coalition government
In some respects, the matrix organization is exactly like a coalition government - each cabinet minister supposedly reports to the Prime Minister but in fact reports to his party boss first each of whom has his own agenda to maintain his power base in his local city or state.

Like a coalition government, again, the members come together strongly to deny any hint of wrongdoing or negligence. Indeed an external threat is the single unifying force of a matrix organization. No senior executive can be blamed for anything and the only punishment that can be meted out to the one in power is a golden handshake, though smaller fry do get blamed and sacked.

It creates deniability - witness the experience of our investors with multinational financial organizations versus domestic organizations in the various scams that have beset us from time to time. Not one multinational executive has had to face regulatory or legal action, except in the latest one where it was a clear fraud and the perpetrator has been arrested. Even here, it is interesting that the perpetrator is the only one blamed - whereas in the case of Indian institutions, the senior management faces severe action.

Protecting the investor
In India investors are feeling vulnerable and it is necessary for the regulator to think differently and ensure protection by ensuring stringent accountability at the top for all organizations.

Under Indian regulations, the directors are accountable and they take comfort from the managing director or the chief executive officer who is responsible for the acts of omission and commission of his staff; let even multinational financial businesses toe that line.

In this way, investors will get a far better deal when there is built-in due diligence and knowledge based decision making.

(The author is the MD & CEO of IDBI Asset Management. Views, opinions and expressions made are personal.)

Portfolio Analyses: Get your investment to deliver more Source: BUSINESS LINE (17-JAN-11)

I am aged 50. My wife is a homemaker aged 43 and my son is in the final year of his graduation. I am self-employed -running a medical business - and my average monthly income is Rs 1 lakh.

My monthly expenses are Rs 20,000. Besides this, my monthly commitment towards 12 mutual fund schemes is Rs 28,000.

In order to protect my family against any medical emergency I have taken a family floater health policy for Rs 3 lakh. I have taken term insurance for Rs 15 lakh. I have booked a flat for Rs 9 lakh and paid an advance of Rs 3 lakh. For the balance amount, I am planning to take a bank loan and my EMI would be Rs 10,000.

After keeping emergency funds for my business, premium towards all my insurance policies, I have an investable surplus of Rs 20,000 a month. I was working in a company till five years ago. But due to the low salary there, my only savings was in provident fund (PF).

I am planning to retire at 55 and I need present value of Rs 20,000 a month as pension. How much do I need to have at the time of retirement to take care of my family expenses till I reach 85 years?

As my son is interested in doing business, I am planning to set up a shop for him, for which I need to keep a provision for Rs 2 lakh.

I am planning to buy a car and a house in two to three years. The total outgoes for both goals are Rs 28 lakh.

Go through my MF portfolio and please suggest changes.
- Sarveshbabu.
Solutions
Time and again through this column we have suggested to individuals to follow an asset allocation that is based on their risk appetite. It`s generally observed that some individuals have an urge to building multiple immovable asset classes in their portfolio. As you are planning to retire at the age of 55, we strongly advise that you do not buy a second house, that too within few years of the first purchase.

Even in metros such as Chennai and Hyderabad, the current rental yields are 3.5-4%.
Going by the property prices at your home town, rental yields are likely to be lower than in metros and hence will not be a good retirement investment.

We suggest that you build a debt portfolio when the interest rates are ruling high and construct your portfolio in such a way that the maturity proceeds are available for consumption in the succeeding financial year after your retirement.

This would help you in better tax planning to reduce outgo.

When the interest rates are peaking, it may be prudent to start recurring deposits to enjoy higher returns.

Retirement
In 20 years of service, your retirement accumulation has not been significant.

Now, being an entrepreneur, you have the possibility of saving more towards this goal. But your accumulation period would be very short.

You ought to extend your working years to 60.

Even your current savings of Rs 28,000 a month in mutual funds will cover only 70% of your requirement and you need to increase your savings substantially to reach your goal.

As you are 50 plus, it may not be prudent to tilt all your investment towards equity to build a retirement corpus.

Your desire to have Rs 20,000 a month after retirement appears very reasonable based on the current lifestyle and on account of abnormal inflation.

Considering an average inflation of 7%, current annual requirement of Rs 2.4 lakh would be Rs 4.7 lakh in 10 years.

To have such a pension for the subsequent 25 years till the age of 85, you should have a retirement corpus of Rs 1.1 crore at the age of 60 and it should earn an inflation adjusted return of 2% to last till 85 years.

To meet this target you need to save another Rs 20,000 a month in debt funds and recurring deposits and you should ensure that you are generating compounded annualized return of 15% from equity and 9% in debt instruments.

Business and car

To set up the business for your son, you can utilize the chit fund investments and the balance can be used to pay the advance towards buying the car.

It may be prudent to buy a car by taking a loan and paying EMIs from your business income as it can help you to minimize tax outgo. Besides you can also enjoy depreciation benefits on your car and the same can be utilized to pay your car insurance.

Investment

It is admirable to see that you have picked the right schemes. But the only concern is that your portfolio contains 11 schemes and some of the schemes investment objectives are overlapping.

We recommend that you continue your investment in large-cap funds such as HDFC Top 200 and DSPBR Top 100 and in mid- and small- cap space through IDFC Premier Equity and DSPBR Micro cap.

Other SIP investments can be stopped and the money can be invested in large-cap schemes.

Continue your investment in DSPBR World Gold Fund and HDFC Prudence.

Insurance

It`s heartening to see that you have taken a term insurance for Rs 15 lakh; even so your protection is far short of your requirement. Despite working for 20 years your current assets are too low.

To reduce hardship we recommend you to take term insurance for another Rs 35 lakh, but considering the higher premium outgo and your current capability to save, it may be prudent to take a decreasing term insurance product.

For your health insurance, it is better to increase the cover by another Rs 2 lakh.

Sale of property: Taxes thereon

Author: Anil Rego

Capital gains on property have always dogged the average investor because there are numerous nuances that one should look at whilst computing capital gains on property. Property here includes residential property, land, jewelry etc.

Categorization and tax liability

While capital gains on securities are easier to compute and understand, the nuances of capital gains related to property sale is slightly more complex since the computation mechanism is different; including the treatment for short term capital gains.

Capital gains are taxed on the basis of the holding period of the capital asset from the date of purchase. One can bifurcate this assessment under short term capital gains (STCG) and long term capital gains (LTCG). Short-term assets are those that are held for 3 Yrs or lesser and those held for more than the 3 yr period is categorized qualify for long term capital gains.

Capital Asset	STCG	LTCG
Other Assets & Immovable property	Definition: Held for a period not exceeding 36 months from date of Acquisition	Definition: Held for a period exceeding 36 months from date of Acquisition
	Tax Rate: Included in Gross Total Income. Rate applicable as per tax bracket	Tax Rate: 20% with indexation + surcharge & Cess

Computation and exemption

Short Term Capital Gains: If a capital asset is sold within a period of 36 months of acquisition, the computation is fairly simple. The sale consideration is reduced by the Purchase cost and the net amount is added back into income (u/h Short Term capital gains) and is taxed at normal rates.

Long term capital Gains: Sale consideration is reduced by indexed cost of acquisition and improvement. The net amount termed as long term capital gains, can be re-invested in residential property and exemption availed u/s 54 and 54F depending on the type of asset sold.
Indexation and its impact


Indexation is nothing but adjusting the cost of purchase of units to the cost inflation index as on the date of sale. Indexed cost is calculated with the help of a table of cost inflation index that is provided by a notification in the official gazette each year. Indexation essentially adjusts cost for inflation thereby reducing the amount of capital gains.

Here`s is a simple example of how capital gains with indexation would work -

Mr. Sohan, sold his property for a sum of Rs. 60 Lakh in FY2011, this property being bought in FY2007 for ~Rs. 35.94 Lakh. The CII factor for FY2011 is 711 and for FY2007 is 519 and based on this the indexed cost of acquisition is at Rs. 49.24 Lakh. The workings are as mentioned below -

Exemption u/s 54 and 54F

Long term capital gains can avail exemption u/s 54 and 54F, these sections are applicable for different types of asset transfers and the differences / similarities of the section is as mentioned blow -

In both cases, for availing the exemption, re-investment should be made into a residential property and the same should be done within 3 years from the date of transfer (in case of construction of residential property) or 1 year before transfer / 2 years` of transfer (in case of purchase of residential property). In case one is unable to make the re-investment, the amount of capital gains should be parked in capital gain deposit scheme (prior to tax filing date) in any specified bank and enclose the proof of such deposit with the return of income.

Point of difference	Section 54	Section 54F
Asset transferred	Residential House property	Transfer of a long term capital Asset not being a residential house
Amount of exemption	Amount of investment	Amount of investment * Capital gains ; Net consideration
Additional property prior to availing exemption	Yes. The person can hold any number of house property on the date of transfer.	No. The person can hold only one house property other than the new exempted asset, otherwise he cannot claim exemption u/s 54F
Sale of re-invested property within 3 years`	The amount of capital gain exempted from tax on the original asset will be reduced from the cost of acquisition of the new asset	The amount of capital gain which is claimed exempted will be taxed as such in the year in which transfer takes place.
Nature of capital gains in case of the above default	Short term Capital gain	Long term Capital gain.

Source: Incometaxindia.gov

Hope this brief note on tax implication of capital gains arising from sale of property helps you deal with the tax woes that you face.

Money management: What it involves and how a good financial planner can help

With salaries on the rise, it is easy for a person to be lulled into a false sense of security when it comes to financial matters. Most people often forget that record levels of inflation are currently taking a big bite out of these salaries. Regardless of the state of one`s finances, there is never a bad time to create a personal financial plan - a road map that details various life goals and ways to achieve them.

These goals may vary depending on the stage of life a person is in and his or her priorities. They usually consist of saving for a home, retirement, children`s education, vacations, or a variety of other life contingencies.

The financial planning process allows you to step back and take a `big picture` look at where you stand money-wise and to gauge what types of adjustments need to be made to take you closer to your goals.

If you are tackling the exercise actively for the first time, there are a few important points to consider as you get the process off the ground.

Prioritize: Remember that not all financial goals are created equal. Scenarios that are around the corner (e.g. a child`s education) may call for more focused planning and budgeting than those that are in the distant horizon (e.g. caring for an ageing parent).
Prioritizing your goals by their order of importance is also helpful. For example, you may have a second car on your wish list, but can choose to postpone buying this while you save up for a down payment on a home.

Create a budget: A realistic and detailed budget is an excellent tool to keep your financial plan on track on monthly basis. It gives you visibility into your main expense categories and allows you to calibrate your spending levels as required.

Set a target savings rate: `Pay yourself first` is a useful maxim to live by; one that will keep you from overshooting your spending limits while making sure these are in line with your goals.

Review your insurance coverage: How much insurance coverage, such as medical and life, does one really need? The answer depends on a set of variables that includes age, health, number of dependents, and liabilities. An objective review of these factors will enable you to maintain coverage levels that are right for you.

Keep good records: Many people miss out on important tax breaks because they fail to keep records of deductible expenses. Meticulous record keeping will allow you to maximize your deductions and lower your tax bills.

Review your investment options: Combine your propensity for risk with your future cash flow requirements to select investment vehicles that are right for you. A thorough analysis of your own situation will help you create a balanced financial portfolio.

While it is possible to personally tackle some or all of these activities, it requires discipline and a substantial time commitment to make it work. A good financial planner can help you, not just in setting goals, but also in achieving them.

Experienced planners possess a comprehensive understanding of a wide range of investment opportunities. They can study your financial situation, risk tolerance, goals, future cash flow requirements, insurance needs, and investment options before coming up with recommendations and a comprehensive plan tailored to your needs. Their expertise is likely to cover several aspects of financial management, of which the main ones are:

Risk analysis and planning: To evaluate a client`s risk exposure and select appropriate risk management tools that include general, life, medical and disability insurance.

Retirement planning: To help the client with retirement planning, review their retirement employee benefits (e.g. EPF, PPF) and make recommendations to keep their contributions in line with their retirement needs.

Investment planning: To assess the client`s investment needs and risk tolerance and provide suitable solutions aimed at wealth creation.

Tax and estate planning: To guide the client through the nuances of personal taxation and estate planning, including the creation of wills, gifting schemes and joint property ownership.

Advanced financial planning: To incorporate all the aspects of a client`s financial situation in order to create a comprehensive and achievable plan.

`Caveat Emptor` or `Buyer Beware` is a guideline that applies to the hiring of financial planners, as it does in working with other professionals. While there are individuals in the field who operate based on inflated qualifications, there are also many others who truly have the credentials - recognized industry certification, relevant education and work experience, and a clean reputation - to manage your money and make it work harder for you.

The article is contributed by Ashish Prasad, director & chief executive officer (CEO), Indian Institute of Job-oriented Training [IIJT].

Market timing versus asset allocation Source: BUSINESS LINE (24-JAN-11)

B. Venkatesh

Last week, we discussed how diversified and concentrated portfolio structures are both capable of generating alpha. We also explained why market timing is risky because such strategies make large bets on fewer stocks. Several readers responded, stating that market timing was a rewarding asset allocation strategy to generate alpha. This argument raises two questions. One, is market timing same as asset allocation? And two, is it worthwhile pursuing such strategies?

This article explains how market timing is different from asset allocation. It then shows why market timing, though attractive, is risky. It reiterates last week`s discussion - market timing should be pursued by those confident about their strategies and disciplined enough to use risk management to control losses.

Market timing vs asset allocation
Market timing and tactical asset allocation involve moving in and out of an asset class. There is, however, a difference.

Market timing refers to the process wherein the investor shifts between a risky asset such as equity and cash equivalents such as money market funds.

Consider an active trader or a professional money manager who engages in trend-following strategies using technical analysis or quantitative modeling. This trader or money manager would obviously move into equity when she expects the market to do well and move out of equity when she expects prices to decline. Importantly, when this trader is underweight on equity, she is overweight on cash equivalents, otherwise called tactical cash.

Tactical asset allocation, in contrast, refers to the process of shifting between risky assets - equity and bonds. An investor would overweight equity when she believes it would perform well and overweight bonds otherwise. An investor or a professional money manager will engage in tactical asset allocation within the broad framework of strategic asset allocation.

Suppose an investor decides to have a 60-40 equity-bond allocation with a tactical range of 10% for her retirement portfolio. The investor then has a leeway to carry equity exposure between 50 and 70%.

Why is this distinction between market timing and tactical asset allocation important?

Asymmetric returns

Bonds provide higher returns than money market instruments. This means that market timing carries higher levels of underperformance risk compared with tactical asset allocation.

The flip side is that market timing also carries potential for higher reward because of its larger exposure to equity. The question is: Should investors engage in market timing?

Empirical study conducted in this area argues that market timing is risky. There are two reasons to support this argument. One, if the investor or the professional money manager misses the days when the market finishes markedly higher, which happens for about 20%  of the total trading days in a year, the portfolio is likely to underperform its benchmark. And two, if the investor or the money manager is invested on the worst days, the chances of the portfolio recovering losses becomes difficult. This is because of the problem of negative returns-compounding.

Suppose a portfolio is currently worth Rs 15,000, gaining 50% in one year on an initial investment of Rs 10,000.

This portfolio has to give up only a third (33%) of its value to end-up with the initial investment of Rs 10,000.

If the portfolio instead declines 50% in one year to Rs 5,000, it would then require 100% gain to end-up with the initial investment of Rs 10,000! The loss-recovery process is, thus, steeper. And this makes market timing risky.

Conclusion

Market timing is nevertheless rewarding, which drives investors to engage in such strategies. It is, however, important to consider associated risks.

No amount of technical analysis or quantitative modeling is likely to help investors avoid losses due to noise trading. Strict risk management rules are necessary to control losses; for it is the management of losses that differentiates a successful market timer from the rest.

Indians as money managers Source: BUSINESS LINE (24-JAN-11)

We Indians like to rank ourselves among the best in the world at writing software codes or launching space programs, but how good are we at managing our own money? A study released last week by ING, the leading global financial services group, shows that we aren`t as good as we think.

Yes, Indians are more financially literate than their global peers, but slip up when it comes to action on managing their finances - they either postpone decisions or idle their money in savings accounts. These results emerge from the ING Financial Literacy and Consumer Resourcefulness study conducted in collaboration with Epiphany Research in November 2010; it surveyed 5,000 people spread across 10 countries.

At the start of the survey, Indians exuded confidence about their money skills, with a whopping 84% of the respondents claiming they were `rather` or `very` good at managing money. People in other countries were much more diffident with only 59% claiming this.

But that sentiment changed drastically after Indians were put through tests on financial literacy and how they handled their budget, savings and investments. Once they completed the survey, a whopping 57% of the Indians admitted they weren`t `stars` at managing money.

We are, however, good at acing tests. So the majority of Indian respondents got the right answers to trick questions like, ``Tom buys a financial product with which he loans money to a company. What product did Tom buy?`` or ``Is a 1% return compounded on a monthly basis better than 12% compounded yearly?`` (Answers: bond and yes, respectively).

The study showed that 55% of the Indians surveyed had basic financial literacy, ranking 2 {+n} {+d} among 10 countries.

Indians showed great keenness in wanting to become better at managing their finances. However, they seemed to run into a roadblock when it came to actual action.

Between 30 and 40% of the people surveyed said they were prevented from managing their money better as: a) They needed help but were clueless where to get it b) They tended to postpone decisions and c) They didn`t know where to start.

The survey showed that Indians manage their household budget and spending quite meticulously. Nearly two-thirds of the people said that they carefully tracked their finances and made financial decisions only after research.

Indians were also very likely to make a monthly household budget (84% had one) and stay within it as well (87%).

The survey also showed Indians to be much more comfortably placed with respect to their finances than most global counterparts. For one, only 13% of the Indians said they did not have any cash stashed away for emergencies (a third of the global respondents didn`t have any such fund).

Two, Indians were able to spare 20% of their monthly income towards savings, against the global average of 12%. Three, quite a few Indian respondents (41%) felt they weren`t likely to run out of money at the end of the month. Over half said they could fall back on their nest-egg even if they did.

Having firmly established that Indians are big savers, where do they tend to put all that money? Well, this is where they seemed to take a rather passive approach.

While most Indian respondents (95%) owned a savings account and life insurance (84%), far fewer had a pension plan (43%) or an investment product (58%). Life insurance probably figures there because insurance agents are thick on the ground. A full 20% of the respondents admitted to not saving for retirement.

So to draw our own interpretations from this survey, here are a few messages for us Indians:

You may not be as good at managing your money as you think you are.

Get better at money by shaking off that inertia. Seek advice and act on it.

Don`t let a rising pay check and big bank balance lull you into a false sense of security about the long term. Remember, you have to contend with much higher inflation than your cousin in the US. Start moving money out of your savings account into investment options that can earn more.

Think seriously about retirement.

Savings tips for young earners Source: BUSINESS LINE (24-JAN-11)

Janani and Ajay, both in their early twenties, have just begun enjoying the perks of financial freedom. But their respective parents want them to develop a savings habit early into their careers. While Janani`s father wants her to buy a traditional life insurance, covering a major part of her salary surplus, Ajay`s father wants him to pre-pay his education loan at the earliest. Though both parents are right in emphasizing the importance of savings, their suggestions may not really be the best thing. Here`s a brief guideline on how first-time earners can deploy their monthly surpluses effectively.

Insurance: It is not uncommon for first-time earners to buy traditional insurance plans, but most do so without evaluating their merits. Young investors should understand that insurance is for protection and not an investment product, as such. The return from traditional products such as endowment will not even offset inflation, hence it`s not a good investment option for young investors. If you don`t hail from a wealthy family, it is prudent to buy term insurance. Term policies do not give maturity benefits at the end of the policy term, but ensure that the family has financial support in the event of the policyholder`s death. And given the age factor, premiums for term insurance are quite low, making them easily affordable.

For instance, for a 21-year-old male, looking for a sum insured of Rs 25 lakh, the annual premium outgo would only be Rs 3,000 for a 30-year term (young women can get the same for a couple of hundred rupees less). The premium outgo is constant throughout the term of the policy. In contrast, in an endowment policy, even for a sum assured of Rs 2 lakh, the premium outgo will be Rs 9,400. It may also interest you to know that the premium paid for term insurance is allowed as deduction under Section 80C.

Accident insurance: It is also advisable for young adults to have a personal accident cover plan. It`s specially designed to protect you from the following unforeseen events - death, total disability and permanent partial disability. This comprehensive policy will help your family meet its financial commitments in the hour of need. For a cover of Rs 5 lakh, the annual premium will only be Rs 590. And if you aren`t covered under group health insurance, do insure your family.

Credit cards: Some of you may have come across reports of this person who has 66 credit cards! But what`s interesting here is that not only was he effectively managing them all but he was also making profits out of them. The lesson here is that if you aren`t disciplined enough, plastic money can be a curse! Considering their revolving credit concepts, you may end up paying exorbitant interest rates if you aren`t organized.

So, however fashionable it may be to flash your credit cards to buy merchandise, remember to keep your spend well within your means. After all, though credits cards don`t have a bearing on your immediate cash flows, there is no escaping paying them. So ensure that you swipe your credit card only for the amount you are comfortable paying up in that billing cycle.

Emergency fund: Gone are the days when job security was a given. Besides, it is very common for young people to hop jobs or opt for higher studies. It may, therefore, be prudent to set up an emergency fund to fund your requirements during the transition period. You can build the fund by allocating a particular amount every month towards the emergency fund. Make sure that any point in time the emergency funds amount to 2-3 months of your salary credits.

Education loan: With education costs skyrocketing, parents are increasingly taking bank loans to send their children to good colleges. And since education loans are offered with a moratorium period, most parents are eager to close the loan once their wards take up jobs. With interest rates going up to 12%, while it does make sense to repay the debt, don`t rush to repay the loan with your entire surplus as you get tax benefits on such loans. It is important that you understand the priorities and spread your surpluses accordingly.

Tax Planning: By planning your taxes well, you can avail the maximum tax benefits as provided by the income-tax Act. But since each tax planning instrument has a different investment objective, you will have to understand it well before investing. More often than not, individuals give up investment strategies to avail tax benefits. For instance, young investors invest in NSC or bank deposits (interest 8.5%) in the last month of the financial year rather than investing in equity linked saving scheme (ELSS) where they have potential to earn higher returns with lower lock-in period. The category average five-year return of ELSS is 16% against 8.5% for FDs. Also, avoid planning your taxes at the last minute.

Investment: Young investors should understand the risk of investment before committing to it. While it is not advisable to invest in equities before understanding their dynamics, it is not advisable to stay away from them either. Investments in equities, spread over the long-term, have the potential to deliver significantly! And if you aren`t keen on taking up direct exposure to equities, you can consider investing in mutual funds. You can start a SIP on any mutual fund scheme with a good track record. A sum of Rs 3,000 a month can become a crore in 30 years if the fund returns 12% per annum. The savings can also be utilized as margin money while taking a home loan ten years later.