Murder weapons of mid-life financial c₹ises

June 28, 1914:  The heir to the Austro-Hungarian empire narrowly survived a bomb attack on the streets of Bosnia, as his car managed to speed away in the nick of time.

Subsequently, as a precautionary measure, it was decided that his motorcade would proceed out of the city along a different route. However, the Czech driver failed to grasp the new route plan put together by the German-speaking security officials. 

This confusion resulted in the driver taking a wrong turn, and the car found itself passing right by the spot where a 19-year-old would-be assassin had stationed himself; the failed assassination attempt that morning had been carried out by a co-conspirator of this man. This man fired two shots from point-blank range, killing the royal couple.

This incident resulted in the Austro-Hungarian Empire declaring war on Serbia and inciting a chain reaction that eventually caused World War I. It may sound strange, but this is how a wrong turn led to one of the biggest catastrophes of the last century.

This blog dwells upon the wrong turns or reckless financial decisions we often make during the initial phase of our careers, which have ramifications on our later lives. The author calls these decisions murder weapons, and suggests a few preventive steps.

Murder weapon 1: Excessive credit card debt

Once availed, a privilege is challenging for the human mind to retreat from. With a credit card in hand, every desire becomes a want. Convenience starts taking priority over cost. 

We start consuming benefits that are not based on the current availability of cash but on expected future flows. 

Initially, we strive for discipline, paying our dues on time. Then, somewhere down the line, our long-desired aspirations suddenly start taking control. It may be an expensive accessory, a vacation abroad, or anything requiring a few months or years of our current earnings. But the bank comes to our rescue, offering us the facility of paying only the minimum amount due.

It sounds like a good plan, as we feel we will be able to save from our earnings and settle all our dues over the next few months. Instead, what often happens is that we start behaving rationally for the next few weeks, until something turns up that makes it too difficult to resist one more swipe of the card. Eventually, this goes on and on, and at some point, we find ourselves struggling to pay even the minimum amount due. 

Finally, we turn to an additional credit card from a different bank to bail us out, digging ourselves even deeper into a hole. 

What to do instead

1. A strict freeze on any further spending on the card after any high-value purchase.

2. Once dues are settled, stick only to one card for emergencies and surrender any additional card(s).

3. The next time you get a call for a card with a tempting life-time free offer, block the number. Ultimately, someone is trying to sell you debt.

Murder weapon 2: Insurance as an investment 

Time and again, insurance is sold or rather mis-sold as an investment product, and we often buy it to satisfy an emotional sales appeal of a family member, friend, or agent.

Though life and health insurance are indeed products you should buy right after you get your very first pay cheque, they should only be bought after thorough discussions with a qualified financial advisor. 

The core reason for buying insurance is protection against unforeseen events.  

A term plan, which is cheaper than any traditional or ULIP plan, helps keep families going with reasonably large payouts in the event of the untimely demise of an earning member. 

However, the primary objective of owning insurance is often misrepresented, and we get distracted by the temptation of recovering the insurance cost with an added interest element. And this despite the fact that the returns can be ridiculously lower than any pure investment product.

Psychologically, human minds are wired to avoid losses. With term insurance, we get nothing if we survive. Our mind perceives this as a potential future loss and tends to avoid buying such products. Consequently, we buy insurance policies as investments or for tax savings, but the chief objective of safety is usually overlooked.

A qualified financial advisor can help explain the rationale for buying insurance and investment separately, and can demonstrate how un-clubbing them can offer the best results.

What to do instead

1. Buy a term and health insurance immediately once you start earning after consulting your financial advisor. This will leave you with less funds to indulge any emotional desire to buy an unwise policy.

2. Know the exact amount your family will get (technically called the 'sum assured') in the event of any casualty, and evaluate whether that is sufficient to meet their expenses indefinitely.

3. Never club insurance with investment. Safety and wealth creation are two different objectives, and they require different dedicated vehicles to achieve the desired result. Buy pure insurance with a term plan and use mutual funds for wealth creation.

Murder weapon 3: Equities for the short term and fixed deposits for the long term

The human mind constantly seeks assurance of success in any activity it embarks on. Consequently, it’s no surprise that we seem to have a natural affinity for fixed deposits, which come with a guarantee.   

However, this guarantee is always offered in the form of a relatively lower interest rate. Therefore, any rational investor must calculate whether the relatively low interest from a fixed deposit will mitigate the impact of inflation.

In contrast, although equities are volatile by nature, they convincingly outperform guaranteed products in the long run. 

Almost everything in life boils down to probability. There is no such thing as absolute certainty. Hence, a rational mind needs to understand how the odds are stacked against it. 

In the Indian context, NIFTY has generated more than 8% returns in 96% of ten-year periods since 1997, with median returns of 14%. Why am I focusing on 8%? Because most fixed deposit rates often hover below 8%.

So, equities are likely to outperform fixed deposits in the long term.

“The strongest of all wars are these two: time and patience.” - Leo Tolstoy. This statement summarises the secret of any investment, as it allows compounding. 

We love letting our fixed deposits compound at a lower rate for a longer duration and equities at a higher rate for a shorter duration. 

This is elementary mathematics, and given a choice, a kid will probably make a more rational decision, as their mind is not cluttered with the unreasonable fear-driven psychology that adults are saddled with. 

Equities can be better owned through mutual funds, but we often struggle to buy the best scheme.

However, there is nothing called the best scheme as it keeps on changing. Instead, we need to absorb the fact that almost all equity schemes have the potential to generate better return than any guaranteed product over long term, and hence it is futile to keep searching for the best scheme.

What to do instead

1. Until you decide, start an SIP in a NIFTY index fund after consulting your financial advisor. Compounding your principle at NIFTY’s rate of return is a phenomenal wealth creation strategy on its own.

2. With the help of your financial advisor, add active funds based on your risk profile to beat NIFTY over a longer duration.

Murder weapon 4: The house of your dreams (or nightmares?)

This is the final nail in the coffin: the desire to own a dream house in an urban set-up, which will suck up a substantial portion of your monthly earnings. 

Does this mean one should not own a house to live in? Definitely not. But while evaluating this once-in-a-lifetime purchase, we often tend to overspend. 

First, buy a house only if you want to live in it; rental income in India is way lower than what you might think.

Many people buy a house as they approach their 40s and commit to EMIs for the next 20 years. In addition, because the initial years of most people’s careers often get spent on seeking materialistic pleasure or making unplanned investments, they often don’t have substantial savings by the time they are ready to buy a house. As a result, a large chunk of this expenditure has to come in the form of a bank loan. Buyers liquidate whatever they have saved to make a down-payment, and then happily sign off on a loan agreement with a sense of pride at finally owning a home. 

This often leaves buyers with very little liquid cash to invest. The golden period of wealth creation is thus spent servicing debt on the house, which is technically owned by the financier until one clears off the last paisa.

What to do instead

Consider availing yourself of a home loan during the initial years of your career. 

1. This will route some potentially frivolous spending into meaningful EMIs, and will eventually help you own an asset.  

2. You might be able to close the loan by your early or mid-40s, which will free you from the mental burden of debt as your kids grow up. 

3. Once the home loan is paid off, you will be left with a substantial portion of your monthly earnings to invest in mutual funds through an SIP.

4. Don’t exhaust your limits by overspending on your home loan; keep your limits open for future contingencies. 

5. Start an SIP along with your home loan to save a sizeable amount of the interest you would otherwise pay on your loan. Consult your financial advisor to understand this strategy further.

Steer your finances in the right direction

Financial irresponsibility early in life can make it difficult for you to get back on track when you're older. So now that you're aware of these common dream-killers, make sure you take the right steps when they rear their heads. Because that's what you'll need to keep your financial life from turning into a war zone.