Wednesday, December 03, 2008

Porfolio Structuring Step 3: Build Safeguards

One of the most important things you can do is to build safeguards. That includes things like building a cash nest for contingency, taking insurance cover for life and non-life risk factors. Let us take them one at a time.

1. Contingency Reserve: You need to have a amount set aside in cash to meet any emergency requirements. A good amount to keep aside is 3-6 times your monthly expenses. So, for example, for a monthly expense of 20,000, you can set aside 60,000 to 120,000 as a contingency reserve. DO NOT touch this reserve unless there is an emergency. This is not meant for your day-to-day expenses.

2. Life Insurance: Your requirement for life insurance will depend on your life stage, your current networth (calculated in step 1) and your dependents. Simple back calculation tells you that to get a earning of 100 you approximately need to invest 1200. So, multiply your annual expenses with a factor of 12 to get the amount you need to have insured. But, its always better to have some buffer in hand so for prudency jack up the multiplier to 15-20. So, for an annual expense of 240,000 (monthly 20,000), you will need the following:
@ 12 times = 28,80,000
@ 15 times = 36,00,000
@ 20 times = 48,00,000

The best thing to do is to buy pure term plans from any good, top-of-the-line insurer (e.g. LIC). Do not go for premium refund term plans as they are more expensive than the pure term plans. Use insurance purely as a risk covering tool.

Also, for prudency, break up the total insurance amount into 2-3 policies from different companies, so that you are not exposed to a particular company risk. I.e, if the insurance company goes bankrupt you still have two other companies to look forward to.

3. Medical Insurance: This is another critical factor that a lot of people miss out on while planning for their finances. Here, take the maximum possible cover that you can afford while you are young. If possible, take a family floater plan to reduce the cost. Also, pay for the medical insurance for any financial dependents you may have (parents, in-laws, siblings, children etc)

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