personal financial security

8/13/2019 Personal Financial Security

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Reliance Flag Telecom


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Vinod Khosla


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Indus Advisory Partners


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Investment

Services


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Insurance

Services


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Credit

Services


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Investment

Services

Credit

Services

Insurance

Services


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Investment

Services

Why do we invest ?


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What drives us to seekinvestment services ?


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Transactions driver

Precautionary driver

Income driver


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Transactions driver

to save and invest arises from the fact that thet ime patterns of f low of incom e and expendi ture

do not usually match.

Most of us get our income monthly, but wespend daily. Even for those of us who may be inbusiness or profession our income does not come inexactly in keeping with our expenditure.

That is the reason we use a SavingsAccount.


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June 1 June 30

Patterns of f low of income and expend i ture

over one mon th

Expenditure

Income

Excess of income over

expenditure

Excess of expenditure

over expenditure


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Similarly the t ime pattern o f earning incom e dur ingou r l i fetime does not always match the t ime pattern o four

expendi ture dur ing ou r l i fet ime.

In our early carrier our expenditure is usually low; aswe set up a family and home it increases; it continues to

increase as the family grows and its requirements increase; itpeaks at the time of childrens higher education and settlingdown in life; and then it may decrease. The income normallyincreases steadily upto a certain age (retirement, say forinstance), and then it may fall sharply.

Thatswhere we use the Fixed Deposit Account, forinstance.



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Age 25 Age 75

Expenditure

Income


expenditure

Excess of expenditure

over income


expenditure


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In both these cases, because the t imepatterns of f low of our incom e and expend i ture do

not match, we need to carry pu rchasing pow erfrom when we have more of i t to when we have

less o f it.

Investment is therefore used as a

storage of purchasing power, in the short term or longterm.

The driver which causes usto invest for this motive isthe transactions driver.



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to save and invest arises from the investorsdesire

to provide for an unforeseen event. It is very similar to thetransactions driver. But for a difference : while thetransactions driver makes the investor save and invest fora foreseen and planned need in future, the precautionarydriver is about anun foreseen need in future.

The investor only feels the existence of a possibilityof a certain event occurring, which may need him tospend. He does not want to be caught on the wrong foot, if

at all it occurs. And, with that in mind, he would like tomake a provision. It could be a sickness, an accident,anything, or even a desirable event, like an opportunity topurchase something.


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Investing for a rainy day


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Income driver

is very different from the rest of the two. Whenan investor is saving and investing driven by the firsttwo drivers, he is trying to carry his purchasing powerinto future; investment is for him like a fridge where he

can store his purchasing power or money.

But when he saves and invests for incomedriver, he is not trying to carry over his purchasing

power into future; rather, he is trying to increase hisfuture purchasing power. In other words, his solepurpose in saving and investing is to increase hisfuture income.


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How does this happen ?

When an investor saves andinvests, he creates a source ofincome for future.The income fromthis source adds to the income thathe already has, or that he expects tohave in future.


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It is these needs that drive us

to seek investment services :

- the need to carry purchasing power over time;

- the need to provide for a rainy day;

- the need to move to a higher standard of living.


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Can a random basket of

investment services provide a

total investment solution ?


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Therefore the need to pick aninvestment service to match thedriver.


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Why do we buy

insurance ?

Insurance

Services


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What drives us to seek

insurance services ?


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Life and Health

Protection

Pension


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Life and Health Protection

We wish to protect ourselves, that is we and ourhouseholds, against certain adverse events that mayoccur in future, and which may cause financial distressto us and/or our households. This protection can comefrom transferring this risk of financial distress toanother person for a price. It is this need to transfer the

risk which drives us to buy insurance.

The financial distress may be caused due to :


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The financial distress may be caused due to :

Death of the income earner.

Critical illness of the income earner.

Sickness in the household.

Any other event with similar effect.

All these events are uncertain events; that is,

we cannot know with certainty when they will occur, if at

all they occur. In case of death, for instance, we are

certain that it will occur; but we do not know when it will

occur. And this makes a big diffference. Death in itself

may not cause financial distress, but the time at which it

occurs, may be the cause of financial distress. Any

adverse event causes financial distress only when thereexists a dependency relation between the affected

member of the household and the rest of the household

that is only when the household depends on his/her

income for sustenance.


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Pension

Pension is protection against a diametricallyopposite risk as that in the case of Life Protectiondriver. While Life Protection motive drives us to buyinsurance to guard against the risk of dying ( or fallingcritically ill ) too young, the Pension motive drives us tobuy insurance to protect ourselves against the risk ofliving too long.

Living beyond the age at which we can work andearn, needs us to have an alternate source of income.Pension is that alternate source of income.


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Pension, as an alternate source of income, canbe perceived and created in two ways.

One, by creating a corpus from which pensionmay be drawn over a period of time. But here thequantum of pension would depend upon the period forwhich it is drawn. If the quantum of pension is fixed, theperiod also gets fixed. But we may live beyond thisperiod. Thus this approach to pension carries a risk :the same risk of living too long.

And we need to cover this risk Here again as in


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And we need to cover this risk. Here again, as inthe case of Life Protection, we need to transfer this riskto another person, for a price. It is this need to transfer

the risk which drives us to buy insurance. This is thesecond driver of insurance the pension driver.

The risk of living too long is exactly opposite of therisk of dying too young. The same probability table what

the insurers call the mortality table which tells me what is

my chance of dying by age 50, tells me what is my chance of

living beyond age 50. If my chance of dying by age 50 is

30/100, my chance of living beyond age 50 is (100-30)/100,

that is 70/100.


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It is these needs that drive us

to seek insurance services :

- the need to transfer out the risk of dying too young;

- the need to transfer out the risk of living too long.


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But every individualsperception

of risk is different.

In fact the risk that she carries

may be different.

Therefore the need to transfer it,

and the cost of such transfer will be

different.


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One size fits all solution is

therefore inadequate.

Off

the

shelf purchase ofinsurance products is inappropriate.

Therefore a holistic plan for

personal security is what is called for.


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Why do we opt for

credit ?

Credit

Services


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What drives us to seek

credit services ?


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Convenience

We may opt for credit for sheer convenience, ashappens in the case of credit cards : we do not need tocarry cash in our pockets, we can make payments inlumpsum ( as by paying the credit card bill ) instead ofmaking several small payments, etc.


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Financial Efficiency

Financial efficiency could come in two ways :

By overcoming differences in time patterns of

income and expenditure.

By availing credit buy now, pay later we try tomatch the time patterns of income and expenditure, in

short term and long term.


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Here credit works exactly in the same manner asinvestment for transactions driver, but in the oppositedirection. While investment modifies the time pattern

of income to match the time pattern of expenditure,credit modifies the time pattern of expenditure tomatch the time pattern of income.


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The second way in which credit can achieve financialefficiency is :

By trading off on the cost of credit and returnon investment. If the post tax cost of credit is lowerthan the post tax return on the investment, it makessense to invest the surplus income, if any, and borrowfor the expenses.


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Credit

Services

Insurance

Services

Investment

Services


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What is microfinance ?

who do not haveaccess to thesefinancial services asof now.

Microfinance refers to investment,insurance and credit services targetedat low-income clients


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The typical microfinance clients are

low-income persons who do not haveaccess to formal financial serviceproviders. Microfinance clients are typicallyself-employed, often household-basedentrepreneurs.

In rural areas, they are usually smallfarmers and others who are engaged in

small income generating activities such asfood processing and petty trade.


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In urban areas, microfinance clientsare more diverse, and includeshopkeepers, domestics, artisans, streetvendors, etc.

Microfinance clients

are poor andvulnerable non-poorwho have a

relatively stablesource of income.

Access to conventional


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Moreover, informal sources of financialservices may not suitably meet certainneeds, may be exploitative or may excludea certain market segment. Individuals in thisexcluded and under-served marketsegment are the clients of microfinance.

formal financial services

providers, for many reasons, isdirectly related to income: thepoorer you are, the less likelythat you have access.


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microinvestment

microinsurance

microcredit


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Yes. Where the drivers are,there the market is.


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The problem is of scaling downthe delivery model for these services.

The problem of critical minimum size.


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For instance there is a minimumamount for investment minimumannual premium for insuranceand so on the poor and vulnerablenon-poor cannot meet thisminimum requirement.


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This market segment needs

the services in small sizes, and itcan afford to pay the relative price.


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Yes.Technological development,

mainly in information

storage & processing and

communications makes it

possible to scale downwithout increasing the cost

of delivery.


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Name: Gudpally Pultibai


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p y

Hometown: Gudpally VillageChildren: Two sons

First Loan: Rs. 1,500 ($34)Second Loan: Rs. 6,000 ($136)Business: Fishing

Name: SuvarnaAge: 32Children: 2 daughters, married; 1daughter, 7th grade

Hometown: Nandi KandiCurrent Loan: Rs. 10,000 ($227)Loan History: 4 loans (2 IGL and2 MTL), Rs. 23,000 ($521)Business: Grocery Store Owner

Name: Kondapur Saalibai


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Hometown: Kondapur Village,Medak District

Children: One sonFirst Loan: Rs. 4,000 ($91)Current Loan: Rs. 6,000 ($136)Business: Buffalo and

AgricultureName: S.K. Pahima

Age: 25 years old, divorcedChildren: Masan Jani, 7 yearsold; Gau, 5 years oldHometown: Neredparla, AndhraPradesh.Most recent loan: mid-term loan,Rs. 1,945 ($44).Business: Bicycle shop owner.


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Banker IndiaMarch 30 2007


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Banker IndiaSeptember 17 2007


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personal financial security

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