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1. What is FIRE with respect to financial planning?
Correct option is A - The concept of Financial Independence Retire Early encourages aggressive saving and investing and a frugal lifestyle so that you can reach your retirement corpus by the time you are in your 30s or 40s. Once you have the funds you need, you are then free to spend your life as you choose. While this strategy may not be for everyone, due to the rigour involved, you can adopt it partially to make your post-retirement life financially secure.
2. What are the conditions that banks check when issuing credit cards?
Correct option is C - When issuing credit cards banks ask you for your salary or income statement as the first step. The type of card you are issued and the credit limit is based on your income. Next banks will look at your credit score and if you have a high score your chances vastly improve. If you already have a credit card and have been regular with your repayments, that acts in your favour too.
3. When it comes to buying a car, what is the 20-4-10 rule?
Correct option is B - When taking a loan to buy a car, keep these points in mind. Pay 20% of the car’s cost as a down payment, even if you are eligible for a 100% loan from your bank. Because if you take a big loan, your EMI will be higher, which may put pressure on your monthly budget. If you don’t have 20% for the down payment, wait till you save up the required amount. Today, most lenders offer car loans of up to 7 years. But ideally, keep your loan tenure up to about 4 years, to reduce your interest payment. Lastly, make sure that your repayment on the car loan is not more than around 10% of your take-home pay.
Correct option is C - Ideally, your income post-retirement, i.e. the money you earn from your corpus should be 80% of your last drawn income. If not you may be forced to downgrade your lifestyle. And to generate this income, your retirement corpus should be at least 20 times your last annual income. It can even go up to 30 times, given that inflation is a constant worry.
Correct option is A - When selecting the asset class to invest in you should know what type of an investor you are. In other words, you should know your risk profile. Your risk profile takes into account your age, income, goals, number of dependents, risk tolerance level and so on. It helps to know whether you are conservative, moderate or aggressive as an investor. Based on your risk profile you can decide how much you should invest in financial assets such as equity and fixed income, alternate assets such as gold or real estate or how much to keep in liquid instruments.
6. How often should you review and revise your asset allocation plan?
Correct option is B - Your asset allocation plan tells you how much funds to invest in different kinds of assets – equity, debt, gold, cash, etc, based on your goals. Hence, it needs to be reviewed and revised (if required) only once a year. If you review your plan and change your investments frequently, you will not get the optimum returns. On the other hand, if you don’t review your plan once a year, you may miss out on investments that are not performing well. However, if there is any change in your life, such as a promotion leading to higher income, a layoff or a medical emergency, then you should review your plan and change your asset allocation accordingly.
Correct option is A - Asset diversification means investing in multiple asset classes and multiple instruments based on your goals and the likely returns from your investments. This is based on the principle, “Don’t put all your eggs in one basket”. Asset classes include equities (equity mutual funds, stocks, ETFs) fixed income (Fixed Deposits, debt mutual funds, Public Provident Fund), cash (Savings Account, liquid mutual funds), hybrid (NPS, ULIPs, hybrid funds), gold and real estate.
8. What is an asset allocation plan and how does it help?
Correct option is B - An asset allocation plan tells you how much to invest in various savings and investment instruments and for how long. It takes into account the time for each goal and the likely returns from your investments. For instance, for buying a car after three years you can invest in an FD, while for your retirement 35 years down the line, you can look at a mix of equity MFs and PPF.
9. How much health insurance coverage should you ideally have?
Correct option is C - The thumb rule is to have 50% of your annual income as your health insurance coverage. But it also depends on a host of other factors such as your age, your existing medical condition, where you live, the number of family members (in case of a family floater plan) and any employer-provided health cover.
Correct option is A - If you are the sole breadwinner of your family, you should have at least 10 times of annual income as your life insurance coverage. And this should be a pure risk cover, i.e. a term plan, not including any other insurance-cum-savings you may have. Today, given the rising inflation and expenses the cover can increase to 20 times gradually over a period of time, especially if you have a lot of dependents in your family. The insurance coverage could also vary with age, as your expenses, income and investments too will change over time.
11. How much of your income should you use for repaying loans? In other words, what should your debt-to-income ratio be?
Correct option is C - Ideally, the EMIs on all your loans should not exceed 40% of your take-home pay. If your take-home salary is Rs 1 lakh, you should not be paying more than Rs 40,000 as EMI for all your loans – home loan, car loan, personal loan, etc. This is essential to ensure that you can repay all your loans comfortably. Even lenders will consider your existing EMIs when offering a long-term loan, such as a home loan, to ensure that you can repay your loan smoothly. But if yours is a double-income family, or if you have more than one source of income, say salary plus rental income, you can afford to pay more towards EMIs.
Correct option is B - The rule of 72 is used to find out the approximate time taken to double your investment based on the rate of return. Conversely, it can also be used to find out the expected rate of return for an investment over a given time period. Say a Fixed Deposit offers 7% and you invest Rs 1 lakh. Then using the rule of 72 (72/return on investment i.e. 7) your investment of Rs 1 lakh will take more than 10 years to become Rs 2 lakh. You can use this formula when deciding how long to invest for each goal. You can also use it to find out how much you need to invest in different asset classes. But you must also calculate the impact of inflation and tax on your returns when investing.
Correct option is A - Ideally, your emergency fund should cover expenses for 6 months to one year. It should be kept in investments that are easy to withdraw as and when required, such as savings accounts or liquid mutual funds. Since these investments don’t offer high returns it is not advisable to keep huge amounts in them. For larger amounts or investments of longer than one year, you can look at short-term debt funds or Fixed Deposits.
Correct option is B - An Emergency Fund is money set aside to meet essential expenses in case you lose your job due to a major illness, or a layoff in your company. Expenses should include regular household expenses – monthly groceries, utility payments, children’s school fees, etc and loan and insurance payments.
15. In your monthly budget how much should go towards needs, wants and savings, respectively?
Correct option is A - From your monthly budget, keep aside 50% for your needs, i.e. your essential expenses. These include monthly groceries, utility payments, loan repayments, insurance premiums and so on. Then, allocate 30% for your wants i.e. things that make your life more comfortable. For example, eating out, a holiday, a luxury gadget, etc. The rest 20% should be for your savings and investments.
This will include saving for emergency needs as well as investments for long-term goals. If you feel you don’t need 30% for your wants, feel free to allocate more towards your essential needs or savings and investment.
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