Busting the Myth Series:Myth No.3: Investing for tax saving- is Investment Planning- Is Financial Planning

Although our current peak income tax rates are at a very reasonable 30% level, it would surprise a few to know that in the 70s they were at a ridiculous 90% plus.

I think our attitude to income tax is a legacy of those times. The majority of us would invest our money anywhere without understanding the merits of investment, if we were told that the investment would save tax.

A case in point.

A few years back there was a tax saving option under a sec called 80ccc. This could be availed only by investing in Pension schemes.

A good way to ensure that people saved for retirement? Yes of course.

The only hitch was that the tax benefit on the investment had a limit of Rs. 10,000 only.

So guess what? Nobody invested more than Rs. 10,000. Lots of 10 and 20-year pensions were bought with a yearly premium of Rs. 10,000. Now imagine after 10 years when the policy matures, the amount vested for an annuity even at an optimistic rate of return (8%), gives Rs. 1.4 Lakhs. What sort of an annuity is this corpus going to generate? Rs. 10,000 p.a.? Is this in any way fulfilling any Retirement plan?

But nobody thought about that. Everyone was focused on saving that Rs. 2000 or 3000 tax for the year. Worse, people felt they were smart by using all the available avenues of tax saving as also satisfied that they were doing their duty towards themselves and their family by investing their savings.

Another case in point is buying Life Insurance policies. Barring a few years of ULIP popularity, the most favoured insurance product is the Endowment Policy. It is an opaque and expensive scheme bought exclusively for tax saving. Bound by IRDA regulations, most of the investments of this product are made in Govt. Bonds. So you are stuck with very low returns for investments being done over a long period of time.

The disadvantage of this product is that firstly, it is very illiquid; you can’t withdraw money for the next 2 decades or more (if you do surrender values apply, which means you lose money) and secondly and more importantly, it is not even fulfilling your insurance requirement adequately. You can never buy adequate insurance with Endowment policies, as they are just too expensive.

The Right Approach

Tax saved is money saved is money earned.

Money saved (not spent) is also money earned.

Money invested and returns generated is money earned.

Ultimately, we save and invest money to spend it on the financial goals we want to achieve, on fulfilling our dreams and aspirations. Do we ever stop to think what they are?

Preparing a financial plan is very critical to start on this path. Once we articulate on paper what is that we are really hankering for or what are our true financial goals, we can get on the path of investment planning. Once we do that our battle is won because the investment plan now gives you choices of investment products, which are in line with your requirements, and in that space there are ample products, which also help you save tax to the maximum limit. 

 

Busting the Myth Series:Myth No.2: Real Estate investment: I can never go wrong with it.

 

This is a sample of an oft repeated conversation at any Financial Advisors office:

Client: I am planning to buy a house.

Advisor: Another one?

Client: Yes.

Advisor: Why?

Client: For “investment”.

Advisor: How will you fund it?

Client: That’s why I have come. I want to sell some stocks and Mutual Funds I am holding. I want your advice on which ones to sell. For the balance amount I will take a loan.

Advisor: (wondering to himself) “Aren’t Stocks and Mutual Funds  investments”

The problem lies in the client assumption that Real Estate is the only asset, which will definitely appreciate, and that too in a big way.

Lets tackle some of the popular misconceptions and issues related to Real Estate.

Real Estate  gives huge returns

Many a times we have seen headlines in newspapers reporting big real estate transactions. For instance one such headline came up in 2012 reporting the sale of a flat in Samudra Mahal building at Worli. The sale was made at a whopping rate of Rs.1,18,000 per sq.ft.The effect was enhanced because the purchase was reported to have been made at a price of mere Rs.700 per sq.ft, albeit in 1970. This is a typical showcase example for fans of Real Estate investments.

However, if you work the numbers you would realise that Rs.700 becoming Rs. 1,18,000 in 42 years gives a return of 12.66%.

Not so impressive now, is it?

Lets take another example. An investment of Rs.100 made in 1979 becomes Rs.19,500 in 2013. The return works out to be 16.76%. Incidentally, this is the return your stock exchange index gave over the period.

The return on Real Estate investment looks big mainly due to the large ticket size, but you need to look at the annualized return

Costs involved

Most people when they buy Real Estate especially as second or third homes, they are eying the rental income that comes with it. But they would do well to consider the costs of buying and maintaining a property.

Cost of acquisition, which includes stamp duty, registration fees, brokerage and lawyers fees can go up to 10% of the cost of property.

Then comes the cost of taking a loan in terms of processing fees and interest payable on loan. The argument of getting tax rebate does not cut any ice because on every Rs. 100 you pay as interest the maximum tax benefit is Rs. 30. Remember that balance Rs. 70 goes out of your pocket and is an additional cost.    

Recurring costs include maintenance costs like repair and painting, property tax and payment of electricity and water bills.

Finally the taxes you pay when you sell the property. If you choose to save tax you are either investing in the low yield Capital Gains bonds for 3 years or are re-investing in some other property. The latter option means you cannot ever cash out.

Other issues to consider

Real Estate transactions are not regulated transactions. The value discovery is difficult and it is left to the individuals entering the transaction. Most of the time it is left to the Builder’s whim or in case of resale the benchmark is the previous known transaction, which may or may not be known.

In an under development project a lot depends on the developer. It is difficult to ascertain whether he has all the requisite permissions. Many a projects are languishing due to misadventures of the builders and the investors are of course the losers. 

Lastly when you get into Real Estate you are taking on a huge financial commitment and entails taking loans and committing to EMIs. If there is a sudden job loss or even a scaling down of income due to recession in your industry do consider whether you would still be able to fulfill the EMI commitments.

Most Important issue

In all this hype about making big money by investing into Real Estate, we forget that our focus for investing is to fulfill our financial goals as and when they appear on the horizon.

What is the point of having one huge investment in a flat which is now worth Rs.3 crores, if for your daughter’s higher overseas education you need Rs.50 lakhs, and have to either sell this property or take an educational loan?

In conclusion, I want to say that this article is not about Real Estate bashing neither is there an attempt to prove that equity investing is superior.

People commit huge resources when they are buying their first home and they should. But when it comes to buying Real Estate as an investment, do consider whether it fits into your asset allocation or whether that piece of property is the biggest investment you have. If latter is the case you could have a problem.

 

 

Hazardous Headlines

Following newspaper advice can be injurious to your financial health

Investment-related newspaper articles are better taken with a pinch of salt. The recent article in The Economic Times stating PPF investment can beat Sensex returns over 20-year is one such piece that shouldn’t be taken at its face value. You can read it here

The all-time highs notched by stock markets have been attracting investors. Those sitting on the fence may be just gearing up to initiate baby steps into equity investments now that the sentiments are improving.

Many may have just found the courage to act on the financial advisor’s admonishment that one should not sweat over short-term fluctuations in the stock market as equity investments reward you over the long term for being a patient investor.

But, have your views about equity – which you had just resorted to for your long-term needs – been shattered by the recent articles in leading newspapers.

“PPF investments can beat Sensex over 20-year period” this and other headlines screaming through the newspaper would be forcing you to rethink the decision of shifting your loyalty to equity investments from the PPF and debt investments such as fixed deposits that you were devoted to so far.

We thought it is essential for us to justify whether the arguments made in the article – “PPF investments beat Sensex over a 20 year period” – hold any weight and what role equity plays in your finances.

The analysis holds true, but on paper alone. Actual investor returns would be way different from what we have seen in the article. Though extensive analysis has been done while presenting the PPF vs Sensex comparison, several aspects of equity and investor behavior have been ignored.

The argument falls flat on many fronts. Firstly, the PPF interest is controlled by the government and it reigned at the 12% level during the initial eight years that the author has considered.

No one can invest in PPF only once, as investments are mandatory each year. Similarly we also hope no one invests in equity only once. Today the most common mode of investing into stock markets is through systematic investment plans in equity mutual funds, where regular sum is invested each month to even out the costs over longer periods. This kind of investments at regular intervals into both PPF and equity haven’t been taken into account in the article.

Apart from index fund investments, very few try to mirror or invest completely into the index. One buys individual stocks or invests into mutual funds that hold a portfolio of varied stocks, whose returns may vary from those generated by the handful of companies that form the Sensex index.

In fact, the same author has mentioned in another article published the same day that equity funds have beaten Sensex by a huge margin. “The Sensex may have given mediocre 9.14 per cent returns since 1994, but …The Franklin India Bluechip Fund, the top performer in the past 20 years, has given an annualised return of 20.17 per cent,” the author writes in ET Wealth.

A lesson learnt here – we shouldn’t go by the sensational headlines alone as the devil always lies in detail.

Also, you may find other articles during different time lines throwing up contradictory results. A sister concern The Times of India wrote in 2007, “If you had invested Rs 1 lakh in October 2002, your investment would have become Rs 14.63 lakh (over five years). A similar amount invested in PPF in 2002 would have become only Rs 1.47 lakh (by 2007).”

This contradictory view point is a result of differing returns during varied time periods. Another lesson learnt – Data can be tortured to reach any conclusion. It is rightly said too much of analysis leads to paralysis.

Our view is that one should always compare apples to apples. Comparing a debt product with equity is a flawed way of looking through the glass.

Also, we have time and again harped on the fact that financial investments should never be skewed to purely debt or equity or real-estate. All these shades of investment in the right proportion help you weave the rainbow of contentment for a healthy financial life.

So should you be looking at PPF or equity? Well, you shouldn’t be looking at either one of them but both of them as these are designed to meet different needs and goals. Allocating appropriate sum to each, apart from other categories is quintessential.

 

 

 

Busting the Myth Series: Myth no. 1 – Gold is the jewel among my investments

Busting the Myth Series

Myth no. 1 – Gold is the jewel among my investments

Hindus believe in the sade teen (3 & 1/2) muhurat basically 4 days when it is considered especially auspicious to buy gold. Then we have Diwali, marriages and a host of other festivals, which keep the jewelers busy.

So Kharidne walon ko kharidne ka bahana chahiye.

It may be either in the form of coins or rings or in the form of jewelry.

Does this buying really constitute investment? When we think of an investment portfolio we generally think in terms of buying at an opportune time and selling when the goal requirement arises or when there is adequate appreciation. Now try and apply this logic to your Gold purchase. Recently the Gold prices reached a high of 32000. Did you in all seriousness even think of selling your wife’s gold ornaments or the family Jewelry inherited from your parents at this time? Will you think of selling when your daughter is seeking admission into an overseas university for higher education, instead of taking a loan?

Most of the Gold purchase ends up being a dead investment and does not make any contribution towards fulfillment of any of your financial goals except possibly gifting it to your daughter in marriage. If that is the aim by all means accumulate physical Gold to fulfill this requirement and no more. And while you are at it do not go overboard. Her happy married life is not linked to the amount of Gold you give her.

Investment in Gold as part of an overall strategy is a different ball game altogether.

Returns history

 

Rupees

 

Rupees

 

Rupees

Year

Per 10 gms

Year

Per 10 gms

Year

Per 10 gms

1970-71

184.96

1985-86

2125.47

2000-01

4474

1971-72

200.16

1986-87

2323.49

2001-02

4579

1972-73

242.57

1987-88

3082.43

2002-03

5332

1973-74

369.33

1988-89

3175.22

2003-04

5179

1974-75

519.19

1989-90

3229.33

2004-05

6145

1975-76

545.21

1990-91

3451.52

2005-06

6901

1976-77

549.82

1991-92

4298

2006-07

9240

1977-78

637.93

1992-93

4104

2007-08

9996

1978-79

791.22

1993-94

4532

2008-09

12890

1979-80

1158.75

1994-95

4667

2009-10

16210

1980-81

1522.44

1995-96

4958

2010-11

21400

1981-82

1719.17

1996-97

5071

2011-12

28100

1982-83

1722.54

1997-98

4347

2012-13

29610

1983-84

1858.47

1998-99

4268

2013-14

29300

1984-85

1983.92

1999-00

4394

   

Consider the Gold price chart above.

The biggest jump in the prices in numerical terms happened in last 10 years from 2004 to 2014 and the appreciation per year was 19%. But nobody invests in Gold for 10 years, so lets look at the longer-term return.

The 10 years prior to that the prices hardly moved. A 20-year period from the 80s till 2004 shows a 5% return. 

A 30 year period from the 80s to 2014 high, show a 9.6% return.

The obvious conclusion is that Gold is a good hedge against inflation. Do not have greater expectations from it.

 Does that mean you should not invest in Gold? Not at all!

In fact, we believe Gold should be a part of every investment portfolio because:

  1. As mentioned earlier, on a long term basis it is a good hedge against inflation
  2. During financial turmoil, it outperforms all other investment assets and hence reduces the overall volatility of the portfolio.

Practically we can’t wait for the next crisis to turn up for our Gold investment to glitter, hence the need for diversification.

A healthy and balanced portfolio will have growth assets like equity and real estate, steady assets like fixed income and debt investments and Gold to add further balance. How much percentage of each asset class in the portfolio? That depends on each individual’s profile.

In its latest Gold Investor report, World Gold Council’s Marcus Grubb, Managing Director – Investment Strategy and Juan Carlos Artigas, Director – Investment Research state, “Our research shows that a 5%-6% allocation to gold is ‘optimal’ for investors with a well-balanced medium-risk portfolio (a 60/40 portfolio in equities, cash and bonds).”

Different forms of investment in Gold

 Gold Exchange Traded Funds (ETFs):

If you have a demat account, you can buy gold in paper form on the stock exchange.

One can purchase gold in multiples of 1 unit. 1 Unit = 1 gram of gold. (A few fund houses also trade in ½ gram gold as one unit.) The price of unit of one gram gold follows the market price of 24 carat gold.

Features of Gold ETFs are listed below:

  • Safety & Storage: Since there is no physical gold involved, it is a safer avenue for investment in gold. So there is no question of storage as well.
  • Less expensive: No making charges or locker charges are applicable in case of ETFs.
  • Affordability: Gold can be bought in as small quantity as 1 gram.
  • Purity: ETFs guarantee purity of gold, usually 99.5%.
  • On redemption: One can get the money on redemption of Gold ETFs & not the physical gold. (Except one fund house – Motilal Oswal)
  • Wealth Tax: Gold ETFs do not attract any wealth tax liability.

Gold Mutual Funds:

Investing in gold mutual funds is like investing in any other actively managed mutual fund. It is useful for investors who do not have a Demat account.

The features are as follows:

  • Ease of Operation: No Demat a/c is required.
  • Safety & Security: Since no physical gold is involved it is safer to invest in gold mutual funds.
  • Less expensive: No making charges or locker charges are applicable.
  • Redemption Process: On redemption, the amount of funds will be dependent on the closing NAV of the fund.
  • Wealth Tax: Gold Mutual Funds do not attract any wealth tax liability.

 

The above article in Mindmap form.

 

 

Are working women really Financially empowered?

It is a mistaken belief that if you are earning an income, you are financially empowered.

A working woman may be financially independent but if her money decisions are being made by her spouse, parents or in-laws, she cannot be considered as financially empowered.

 The belief that they do not understand anything about finances but that their spouses do, leads many women to blindly accept all money decisions taken on their behalf.

These women need to understand that finally they are responsible for their money and if the person on whom they are so completely dependent passes away or does not manage the money well, they are the ultimate sufferer.

Financial empowerment comes from understanding the implications of their financial choices and still making those choices. Hence a minimum basic level of financial literacy is definitely required.

This may sound a little overwhelming to the readers; hence there are a few basic easy to do steps, which you can start with.

Reorganise your Financial Life

Step 1. Go through all the investments you and your spouse own; Bank accounts, fixed deposits, Mutual Funds, Demat accounts and even real estate assets including your residential home. Check whether all of them have joint names or at least a nomination. If there is neither on any of these assets this is the first task you have to perform. These are small but tiresome tasks to perform, but just thinking about the repercussions for a moment should galvanise you into action.

Step 2. Go through all the Life Insurance Policy documents. All insurance policies have nominations but policies bought before marriage have one of the parents as nominee. Surely you would want to change this. Another tiresome but a very important task to perform.

Now that you are at it, also check the amount of insurance cover your spouse has. Nowadays, most families are double income families. This generates a feeling of complacency and the thought that even if I die my spouse earns and will be all right so I don’t really need life insurance. But if you observe their lifestyle, asset purchases and the amount of liability and EMIs they take on, it reflects the repayment capacity of dual incomes. If either spouse dies, it is very difficult for the surviving spouse to continue with a suddenly depleted income amount. Hence it is essential to purchase an insurance cover, which will take into consideration the liabilities and the future goals, and the corpus of which will ensure that the loss of income is filled.

Financial decisions can never be adhoc. We believe everyone should have a Financial Plan. However, Financial Planning is done for families and not individuals. If your spouse is reluctant to get into the process, doesn’t “believe” in Financial Planning or is simply lax about the whole issue, you can and should chart your own course.

Basic Steps to Financial Discipline

 1. Create a pool account where both spouses contribute a specific sum towards household expenses including EMI and insurance payments, if any.

2. Create a separate emergency fund equivalent to 4-6 months of the above expenses. In a situation when for any reason the income temporarily stops or is reduced, this fund can act as a buffer. For those of you who are responsible towards an elderly dependent who does not have a medical insurance cover, you may have to increase the emergency fund to cover the eventuality.

3. Buy adequate Life Insurance for the reasons cited above.

4. Buy adequate health insurance even if your Company covers you. Remember, health insurance requirement is most felt in the sunset years but ironically at that time it is most difficult to obtain, so basically you are subsidizing your future claims by paying today’s premiums.

All your remaining income can be saved and invested. Remember however, saving is not investing. In fact, with inflation at 8% and savings interest at 5% you would realize that with every step you take forward you are actually going 2 steps back.

So an investment strategy becomes very important. 

Starting Point to Investments

A good starting point could be Bank FDs. As an income earner you would always be saving money on a monthly basis. Start a monthly investment programme in an equity mutual fund, popularly known as Systematic Investment Plan (SIP). Understand that this is a long term investment. I would link it to your PF or PPF in which a part of your income is deposited every month/ year and you do not even think about it. If you develop the same attitude towards SIP, you will be amazed at what the combination of power of compounding and the efficacy of equity over long term can do for you.   

I have had instances where individuals started with Rs. 10,000 to 15,000 and as they developed confidence slowly increased it over a period of time and in a decade have become crorepatis. This happened of course mainly because they resisted the temptation to withdraw midway through.

Role of Investment Advisor

At this juncture, you need to seek the help of an investment advisor. Do understand that your spouse, friends, colleagues are not your investment advisors. Nor are agents and distributors who talk about the “fantastic products” they have that are just right for you.

A good investment advisor will have conversations about your future goals, aspirations, and your savings/spending habits.

He will work with you to articulate those goals, establish timelines for their fulfillment and create an investment strategy to work on the same.

He will also explain to you his conclusions and the whys of his investment strategies. He is the one who will slowly make you financially literate as he helps you fulfill your goals and aspirations.

After all it is not the accumulation of money but how it can be used to fulfill your goals and aspirations that will bring happiness and fulfillment. 

“Shatayushi Bhava” Is it a blessing or a curse?

This is the traditional blessing showered upon the young by the elderly people. It means “May you live to be 100”.

Obviously, a lot of us do want to be living till 100 or more…

But, is it possible to live till 100?

Dr Aubry de Grey famously said in 2011, “The first person to live up to 150 years of age is already born”. Aubry deGrey is not just a rambling old man. He is a bio medical gerontologist and chief scientist of a foundation dedicated to longevity research.

 Let us see how true it can be and if it is, whether it is really a blessing.

One thing is sure that there has been a dramatic improvement of life spans in last 50 years. E.g. A person born in 1960 had an average life span of 42.45 years, so a lot of them should have been dead by now. But this has not happened because life expectancy has continuously increased, so much so, that for kids born in 2011 the life expectancy is 65.48. These are average figures for the country where, in many backward areas we still have high mortality rates among young children. The life expectancy figures for the metropolitan cities are much higher. And because we are still talking about averages, there is a significant number of people who beat the averages and live well into their 80s and 90s.

Looking at the pace at which life spans are increasing especially in the cities where advanced medical care is easily available, individuals who are in their 30s and 40s and healthy individuals in their 50s can really expect to become “Shatayushi”.

So, is it really a blessing? Implications of living up to 100 years

Most top level busy executives experience a burn out relatively early in their life and talk of retiring in their mid fifties if not earlier. Even expecting that they work as consultants later and earn an income up to age 65, they still have to sustain themselves for 35 more years, with the corpus they accumulate at retirement.

If you are working for 35 years and leading a retired life for 35 years, we can say that you have to earn to spend not only for this month but also for the same month 35 years later, so your one-month income has to sustain 2 months of expenditure. The big problem is that these months are not immediate but are 35 years apart and so the expenses are not the same.

Currently the inflation is in double digits but as we are considering a period of 35 years let us assume an inflation of around 7% (expenses doubling every 10 years) After 35 years the expenses increase by a multiple of 12.33. So if your monthly expense is Rs. 40,000 today, 35 years later it will be Rs. 493200 per month. So 35 years later you will require Rs. 60 lakhs per year just for your expenses.

If this sounds too far fetched, ask your parents what was their monthly expense 35 years earlier, in 1978.

You live long because of the advances in medical science due to which previously fatal diseases can now be cured or at least controlled. This obviously comes with a price. You will have to budget more and more for medical expenses which will definitely eat into your retirement savings.

What needs to be done?

Over a very long time the change in figures whether it is an income or expense number, it is mind-boggling. This is nothing but the compounding effect.

So the simplest solution is to create an investment programme based on your risk profile and time horizon towards your goal and stick to it.

Lets take an example of a 25 year old that has joined the work force and saving and investing Rs. 5000 a month. Let us assume that he doubles this saving every 5 years. This is not difficult to imagine because even at 15% increase, the salary doubles in that period but the expenses do not.

If this investment earns even at 10% per year, the amount available at age 60 is a mind boggling 9.13 crores.

The calculation is as follows:

Additional Amount per month

Total amount per month

No. of years

Total amount at the end of period

5000

35

18900000

5000

10000

30

11300000

10000

20000

25

13200000

20000

40000

20

15100000

40000

80000

15

16500000

80000

160000

10

16300000

Total

91300000

Becoming a shatayushi may depend on your genes, health habits and luck, but becoming a happy and financially stress free shatayushi, you have to remember the following:

  • Invest regularly preferably on a monthly basis. It is the easiest method of investing.
  • Start now. Start with the maximum amount you can, and stay aggressive. Be always on the lookout for increasing your monthly savings.
  • Buy adequate health insurance. Health problems are not only physically debilitating, but also are a drain on your finances. You don’t want an extended hospitalisation to derail your carefully built up corpus for your dream vacation or for your kids’ college fees corpus.
  • Buy adequate life insurance. Ok, you may not become a Shatayushi, but your spouse could very well be and if you really want to fulfill your marriage vows, you have to take care of her even in death because who knows she could be a Shatayushi, and you wouldn’t want her to outlive her income.
  • Consult a personal financial advisor. The above steps are simple but not easy to follow. There is plenty of information on the net but you need to make sense of this information. And your neighbor, friend, office colleague may not be the person to do this.  If at all you want to seek advice, do seek it from a qualified advisor.

“Shatayushi Bhava”

Financial Year Resolutions

At the beginning of New Year 2013, we shared with you our thoughts not only relating to finance but in general as well, in the form of a Mind Map on “Life Worth Living”.

As the new financial year starts, here we once again share a few tips in making our clients’ financial lives easier. 

Financial Year 2013-14 Resolutions:

  • I will collect my statements relating to Income generated in 2012-13 in April 2013 itself:I will submit all the above information to my Tax consultant in the month of April 2013 itself.
    • Form 16, Capital gains statements, Rent receipts etc
    • Income Tax Section 80C eligible investment proofs like ELSS, Insurance receipts, Housing loan statements, updated PPF passbook etc
    • Medical Insurance premia receipts which are eligible for claiming Income Tax Section 80D benefit
    • 2012-13 annual consolidated bank statements for my all single as well as joint bank accounts. (Savings bank interest upto Rs 10,000 p.a. is tax free.)
  • I will do my Tax planning for the year 2013-14 in the month of April 2013 itself, instead of waiting till March 2014 end.
  • I will pay my PPF contribution latest by 5th May 2013 to get interest@8.7% on this contribution for 11 months.
  • I will review my Medical Insurance sum assured and see whether this amount will be enough after 10-20 years to meet any medical emergency.
  • I will review the terms and conditions of my medical insurance to check whether this policy has any sub-limits or expects me to bear a portion of the claim amount (Co-pay condition) and last but not the least, whether I can renew it for life time.
  • I will make an analysis of expenditure pattern in the previous year 2012-13 and categorize them into ‘Essentials’ and ‘Luxury’.
  • I will plan my expenses for 2013-14 on the basis of the above categorization.
  • I will allocate my increments, bonuses and windfall gains received in 2013-14 in three baskets: ‘Loan repayments,’ ‘Investments’ and ‘Indulgences.’
  • I will start the process of preparing a ‘Will’ in April 2013 itself. 
  • I will implement the recommendations given by my Financial Advisor within 15 days.

A Life Worth Living

As is usual, at the beginning of another new year, I got a call from a reporter of a financial portal asking what resolutions I have made in the new year to scale up my business. That made me think whether this is all we should think about all the time; how to make more money, how to be more successful and then focus all our time and energy to achieve that.

We as Financial Planners are not only working for our clients helping them achieve their Financial goals, advising them on their money habits; but many a times we are also counseling them on achieving a work-life balance.

Clients who are especially nearing retirement have a huge dilemma as to how to spend their time after retirement. This is because they have been so consumed with their job/business throughout their working life that they had no time to look at “Life”. They had no time to develop relationships with family and friends, cultivate and indulge in hobbies, their health suffered and they had no existence beyond their work.

To have a life worth living one has to achieve a balance of 4 major aspects of your life; Health, Money, Relationships & Passion. I have tried to capture them on a mind map below.

I would welcome comments on the same.

Have a great 2013, 2014, 2015……

 

 

Protect yourself from….. Yourself

DIYers

Mr. Patel has been dabbling in stocks for the last 25 years. He also sporadically invests in Mutual Funds. His TV is constantly on and he surfs all the business channels. He is known amongst his group of friends as the stock market guy and many times they also seek his advice on stocks. He boasts a lot about the profits he makes on day trading and occasionally on his investments. Curiously, he is most active when markets are bullish and becomes very low key when the sentiment is bad. It appears like he is investing when markets are high and not when they are low, then how does he make money. A closer look of his portfolio reveals that most of the stocks he has are duds accumulated over a period of time because he had bought them as trading tips but he could never make a profit on them. Rather than sell at a loss and admit his mistake he preferred to hold on to them saying, “some time in future they will rise and I will get out of them”.

With a plethora of financial news and views now available in newspapers, TV and internet, a no. of people feel that they understand finance and can take informed financial decisions on their own. They can speak the jargon and sound knowledgeable. Due to this their colleagues, friends and relatives look up to them for advice and the feeling is strengthened. These are what are commonly known as “Do It Yourself”ers or DIYers.

There is another set of DIYers who would sporadically take financial decisions based on the need of the hour e.g. tax saving. They too would typically consult their friends or colleagues.

Busy Executives

Rajiv, a friend complained to me that his bank manager sold him a regular premium policy with a yearly premium of Rs. 2.5 Lakhs, blatantly lying that it was a Single premium product. It was an easy sale because the bank manager knew that Rajiv had a Rs. 6 Lakhs balance in his account. Rajiv just signed on the dotted line. He came to know about the lie next year when the insurance Company sent him the renewal premium notice. He went to have a fight with the bank manager over the blatant fraud. He encountered a different manager who sympathised with him but expressed inability to rectify the situation. The ironical part is Rajiv did not even know the life cover that policy provided or what type of investment it was. 

Rajiv is one of the busy executives/businessmen who do not have time (and inclination?) to look at their finances. Consequently, the idle money in the bank keeps growing and they do feel guilty about it. 

In such situation what happens? The first agent/”advisor”/”consultant” that comes along with a “great” product hits the jackpot. The agent is happy that he makes a sale and the investor is happy that he has done his financial/investment/tax planning. Some agents would claim to the investors that their product does all three.

Dangers of DIYs

  1. They take investment advice from their CAs who are more focused on tax savings. In the process diversification may be sacrificed.
  2. Their other advisors are their own colleagues who will boast to them of how one of their smart investment decisions made them a pile of money (Other Mr. Patels. These colleagues never disclose their failures).
  3. Some do not think beyond real estate.
  4. They are vulnerable to get rich quick schemes touted by various agents.

Guys, you need a Financial Advisor.

It is my experience that it takes a lot to persuade these people to seek the services of a Professional Advisor so instead of doing that I will list a few steps by which they can take control of their own financial management. 

Write down your Goals: 

  • Making money is not a goal. Money is the medium to achieve and enjoy your dreams and goals.
  • So the first task would be to write down your goals when you want to achieve them and what would the amount required be. Give free rein to your dreams and list out as many as possible, but be realistic.
  • The above statement may appear paradoxical but the message here is if the goals are far off enough, you start immediately and commit to and stick to your regular savings and investment strategy you will be surprised what power of compounding can do for you.

Create an investment strategy: 

  • The first step towards this is to make a list of your current investments. Check if you are overly invested in one particular type.
  • Go through your expenses and check how much you can save on a monthly basis. A check of expenses will show you if you are spending too much on your discretionary expense heads. An easy way to do this is total all the withdrawals from your bank passbook for the past year (I hope you don’t have too many bank accounts), deduct the “one off” expenses and divide the remainder by 12 to arrive at average monthly expense.
  • If you have any outstanding housing or any other loans, I assume they are already taken care off by monthly EMIs, which should continue. Never ever avail of minimum pay facility on credit cards or take personal loans. They carry very high interest costs.
  • Commit to a monthly investment program for this saving (first create a emergency buffer in your bank account equivalent to 6 month expenses).

Devise an asset allocation: 

  • There are 2 broad classes of assets:

Growth assets like stocks, equity funds and real estate

Income assets like Bonds, FDs, and debt funds.

  • The thumb rule to follow is that for goals, which are short term, say less than 5 years, investments should go in Income Assets. Anything longer term should be in growth assets.

Remember when you think equity or real estate think not in years but decades.    

Stick to your Plan

This is the most difficult of the steps and there are hundreds of reasons why it could derail.

There are so many self appointed advisors urging you to go for the sure winner stock or scheme. They could scoff at your own investment plan coming up with ill informed reasons for its failure. Sometimes to continue an investment, certain paperwork needs to be completed and due to sheer lethargy that may not happen.     

Those of you who like to be hands on may really enjoy doing all the above steps but if you think it is too much hard work you are better off consulting a professional advisor. 

How to Manage & Invest your Retirement Corpus

We all conjure a happy picture of our post-retirement life. A life free of worries with loved ones and having all the time in the world to indulge in activities missed out on earlier. In our productive working life, we focus on accumulating a corpus that would be sufficient to sustain us post-retirement. However it is equally important how we manage our retirement money to lead a financially stress free life.

One challenge that many retirees face is the selection of investment options to deploy their retirement funds. For the salaried individuals, the total cash inflow at the time of retirement typically runs into lakhs of rupees. This can be in the form of provident fund, pension, superannuation, gratuity, leave encashment, etc. Usually, money also pours in from long term investments like public provident fund (PPF) and insurance policies whose maturity concur with the time of retirement.

The deployment of such huge funds has to be done in a manner which would ensure a regular stream of income in the absence of any salary or business income to meet the day-to-day expenses till lifetime.

Bank Fixed Deposits, Monthly Income Scheme (MIS) and Senior Citizen Savings Scheme (SCSS) are the common avenues where retirees usually park their funds. Here are some additional options which are not commonly considered. These take care of capital protection and help generate a regular monthly income. These are:

1) Annuity:

With huge retirement funds at disposal, retirees face a lot of expectations from their children, relatives and even friends for temporary monetary help. The social fabric of Indian families is such that parents are not absolved of their financial responsibilities towards children even after retirement. Parents selflessly spend a major portion of the retirement funds, be it for children’s marriage or making a down payment for their new home. Later, some parents realize in hindsight that they have compromised on their own financial security and are left with no choice but to depend totally upon their children.

To avoid impulsive decisions, an immediate annuity product is the best option to park in a portion of the retirement funds. The annuitant pays a lumpsum premium towards the price of the policy and the insurance company pays him a uniform payment at regular intervals. It is the most suitable for people who are regular income seekers, not having any pension income and do not want to depend upon children.

While the returns are not attractive (at times even not matching fixed deposit rates), one can bank on a regular monthly income for lifetime. There are various annuity options which provide the annuitant a regular income throughout his lifetime and in some of the options even the spouse continues to get the monthly income after his death.

2) Systematic Withdrawal Plan (SWP) through a Debt Mutual Fund:

This is one of the best ways to ensure a monthly flow of funds and tax efficient too. One can invest in a debt mutual fund and take out money from it every month by choosing for the systematic withdrawal plan. One can also opt for the dividend option of a debt mutual fund which will pay dividend depending upon the fund performance. The returns of a debt mutual fund are linked to interest rates in the market and are not guaranteed. However, they are relatively less risky and volatile compared to equities and have a tax advantage compared to most other fixed income investments. The dividend income from all types of debt mutual funds (barring liquid funds) is taxed at 12.5 per cent plus education cess. The long term capital gains on debt mutual funds are taxed at 10 per cent flat or 20 per cent with indexation.

3) Public Provident Fund (PPF):

Many investors commit the mistake of withdrawing the entire PPF proceeds at the time of retirement. This is because retirees have this common notion that their funds would be blocked for another five years. Not many people know about the withdrawal rules of PPF account after maturity.

If the PPF account is extended for a block of five years after maturity with new contribution every year, the investor is entitled to withdraw a maximum of 60 per cent of the balance outstanding at the commencement of the five year extension. So for instance, a PPF investor has Rs.50 lakh on maturity during retirement. He retains this amount in PPF for an extension of 5 years. He can withdraw a maximum of Rs.30 lakh during the five year block period. Note that the funds can be withdrawn from the PPF account only once a year.

In case the PPF account is extended without contribution, there is no limit for withdrawal.

Withdrawing the interest portion every year and keeping the outstanding balance invested for a block of five years is a smart way to earn tax free income. Locking in money for five years will also ensure discipline.

Busting the Myth of Safe Returns of Retirees:

It is a common tendency of individuals (even HNIs in some cases) post retirement to make all their new investments in fixed income investments. The focus mainly is on capital protection for the retirees. The biggest threat however for the hard earned retirement corpus built painstakingly over a long period of time is losing its value due to inflation. For instance, an item worth Rs.100 today would cost Rs.216 ten years later assuming an inflation of 8 per cent per annum. During the same period, an investment in fixed deposit worth Rs.100 at an interest rate of 9 per cent per annum would fetch a slightly higher amount of Rs.236. Assuming post tax returns, this amount get reduced to Rs.218, Rs.200 and Rs.184 depending upon the 10, 20 and 30 per cent tax brackets, respectively. Thus, a retiree will buy less number of things with the same amount compared to the present.

The second threat one is exposed to is the fluctuation in interest rates. And it is not just bank fixed deposits, the interest rates on all post office saving schemes (including PPF) are being proposed to be linked to market rates every year. So the risk of inflation eating into returns is high and it erodes the investment corpus for real.

It is thus prudent to have some exposure to equities in the overall portfolio. Depending upon the financial situation, a retiree can gradually reduce his equity exposure to a certain extent and increase the debt component in the overall portfolio. The presence of equity can give a real kicker to the overall portfolio over a longer period of time and help beat inflation.

However, investment in equities does not mean seeking thrills in trading. Unless one has a reasonable amount of expertise in the market and not a beginner, a small exposure into direct equity can be taken. Even cash rich companies, having a good long term track record of doling out regular dividends can be invested in.

The overall investment allocation of a retiree would depend upon:

1) Adequacy of the corpus being accumulated which will last till the entire retirement period taking into account inflation.

2) Continuity in monthly stream of income post retirement in the form of pension, house rental income or any part time job.

3) Any chronic illness or consistent health problems which could entail huge medical costs in the future.

4) Any responsibilities pending in the form of debt repayment, children marriage, etc.

A retiree must thus assess his short term and long term needs before deciding on the investment allocation of his retirement funds. He must also assess beforehand the tax slab he is likely to fall under after retirement so as to apportion funds for investment in the most tax efficient manner.