Are you paying Income tax on Interest Income?

As part of direct taxes, all of us are paying Income tax to Government of India. Income tax is levied on following two parts of income:

1. Earned income which is earned by us in a financial year(Apr to Mar)
2. And the interest income which gets accrued on our savings / investments

There is hardly any scope to save income tax on earned income beyond what is available as part of deductions in different sections of Income tax Act e.g section 80 C, 80 D etc

But how much Income tax we pay on our interest income depends entirely on us. Most of our money either keeps lying in Saving Bank Account(SBA) or Bank FDs and we land up paying almost 31% of interest income as Income tax. 

So is there any way out?

Instead of keeping surplus money in Saving Bank Account or Bank FDs, we may like to invest this money in debt mutual funds. There is no tax liability as long as you remain invested in debt mutual funds(no TDS). If you remain invested for at least three years, you qualify for long term capital gains (LTCG). Should there be any requirement for redemption after three years, you get tax advantage on LTCG due to indexation and flat tax rate of 20%. Effective tax rate works out to be approx 8-9 % for people in 30% tax bracket.

let’s understand through an example. Let us assume we invested Rs 1 Lakh for 3 years and 1 day in a short duration debt fund in FY 2014 – 15 and redeemed in FY 2017 – 18. Assuming annualized pre-tax return was 7% compounded for these three years, tax calculations would be as shown below:  

In case of Bank FD, tax liability would have been Rs 6751/- assuming same rate of interest thus saving almost 73% on taxation.

And  on top of it, you get better returns on debt mutual funds as compared to SBA / Bank FDs.

Think over it…

Goal Based Investments

With Nifty benchmark indices NIFTY 50 in correction mode for almost a month now, we are witnessing gains in our equity based portfolios getting eroded substantially, more so in mid and small cap. Nifty benchmark index has fallen almost 9% from its recent high and Mid & Small cap index has lost 28% and 44% respectively from their all time high made in Jan 2018.

Although it does create apprehensions and some sort of panic in the mind towards future outlook of our investments, it should not worry us especially if we are into Goal Based Investments. So what is this concept of Goal Based Investments?

When we begin our journey towards savings and investments, there has to be some future purpose of these investments, some events like Children’s Education, their Marriages, Retirement Planning etc which we want to finance in future by sacrificing our today’s spending. Let’s call these as future goals which we want to achieve through our investments over the available time horizon. Investment without a goal is like boarding a train without knowing the destination.

Hence Goal Based Investments allow us to invest towards achieving the desired goals in the available time horizon by choosing the correct asset allocation(equity, debt, mix of both, gold) with optimum risk through a Systematic Investment Plan.

A few of the behavioral and financial reasons for choosing goal based investments are :

1. Optimum Savings. Once the goals are decided well in advance, we know how much money needs to be saved regularly, nothing more nothing less.

2. Start Saving Early to get More. Sooner we start saving towards a goal, lesser savings would be required due to power of compounding. e.g If a child’s education requires 50 lac after 20 years, we need to save only Rs 5,500 pm if we start today as against an amount of Rs 10,600 pm if we start after 5 years  and Rs 22,500 pm if we start after 10 years (Assuming 12% return P.A.).

3. Tangible Outcome. We are more likely to save and invest towards achieving a definite goal rather than saving without a purpose.

4. Avoids Debt and Better Management of Assets and liabilities. By mapping tomorrow’s liabilities with assets of today, we avoid getting into debt trap. It also helps us in better budgeting thereby meaning how much we can afford to spend today as against how much we want to spend.

5. Optimum Returns. Goal based investment gives us the opportunity to match our time horizon with asset allocation by taking optimum risk. If there is a mismatch in allocation, we may save too much or too little, missing out on returns with conservative allocation or missing out on goals with too much of risk.

Goal based investments provide us with an opportunity to work towards achieving our future goals rather than chasing returns and give us  peace of mind during such turbulent and volatile market conditions.
Happy Investing!!

Are your Investments in Debt Mutual Funds at Risk?


When we plan out the investments across different asset classes keeping in view the risk profile and financial goals of an investor, invariably part of the investments go in the debt mutual funds. How much of it will get invested in debt funds depends on risk appetite and  time available to achieve desired financial goals. It is supposed to be almost risk free investment giving better returns than bank FD with tax advantage. (https://letsinvestwisely.com/are-you-paying-income-tax-on-interest-income/)

However, in last almost 9 to 10 months, ever since ILF&S first defaulted on its credit payment( both on interest as well as principal), lot many companies like DHFL, ADAG group companies etc have defaulted on credit payment thus making rating agencies like CRISIL, CARE  down grade their ratings on Non convertible debuntures (NCD), Commercial Papers(CP) etc.

So what is the effect of this on the NAV of those mutual fund schemes who had investments in debt instruments of these companies?

As per the SEBI directions , any  BBB-  and downward ratings by rating agencies, mutual fund schemes having investments in thesecompany’s debt paper will have to compulsorily mark down the NAV by 75% to 100% of their total investments in that company as part of mark to market losses.

In last few months, you may have noticed that NAV of quite a number of debt mutual fund schemes had to be marked down, in some cases quite heavily.

So what does it mean to us? Should we stop investments in debt mutual fund schemes?  Definitely NO.

The answer lies in selecting good debt mutual fund schemes having investments in Govt / PSU / top quality companies with only highest ratings of AAA(for long duration debt paper) / A1+( for short duration debt instruments). One must ensure that choosen debt mutual fund scheme has 100% investments  in AAA / A1+ rated companies only. One should take out some time and review existing investments in debt mutual fund schemes and take a call accordingly.

It is important and beneficial to invest in debt mutual funds especially in today’s environment where interest rate cycle is going southward( beneficial for debt market) and equity market is poised for big correction, in fact the broader stock market(equity) is already down heavily in last almost eighteen months, Nifty Mid cap 400 and Nifty small cap 250 bench mark indices have already corrected by 20% and 30.33% from their 52 weeks high respectively.


Should you invest in insurance related products?

During my recent interaction with officers at different locations, I came to know that many of us have invested our hard earned money in insurance related products. The reasoning given was simple, you get dual benefits i.e your life gets insured and you also get maturity benefits if you survive the policy period. On the face of it, it looks like a good option. But in reality is it? Let’s see.

Let’s first understand the basic concept of life insurance. It is an instrument which provides protection against those risk events which can destroy or diminish the value of human life as an asset. These risk events may be dying too earlyliving too long and living with disability. The Human life Value(HLV) concept considers human life as a kind of property or asset that earns an income.

It thus measures the value of human life based on an individual’s expected net future earnings. Net earnings mean income a person expects to earn each year in future, less the amount he/she would spend on self. Thus, it indicates the economic loss a family would suffer if the wage earner were to die prematurely and accordingly quantum of insurance required would be calculated. In general, we can say that amount of insurance should be around 10 to 15 times one’s annual income. And to cover the risk of life, we need to pay the cost of risk (calculated based on mortality factor) termed as premium.

Now having understood the concept and need of life insurance, let’s see what are the options available to us:

  • Term Insurance. Under term insurance, only the risk of life gets covered without having any maturity benefits on survival. In case of death during the policy period, sum assured is given to the nominee. Premium paid towards the policy  covers only the cost of risk of life.
  • Variants of life insurance policies to cover risk of life as well as provides investment options( e.g endowment, money back policies with conventional investment options and Unit Linked Insurance Plan etc). All such policies provide sum assured in case of death during the policy period and maturity amount on survival. Premium paid towards such policies has two components, firstly, the cost to cover the risk of life and secondly, the invest able portion called as cash value component. Now what you get as maturity value on survival is only the cash value component of the premium with annualised returns of not more than 5-6%.
  • To understand how the finances work at the back end in both cases, let’s take an example of a 28 years old individual seeking life insurance policy primarily to cover the risk of his life for next 20 years with a sum assurance of Rs 2.1 crore(guaranteed returns on death during the policy period)
  • An investment cum life insurance policy( e.g endowment, money back etc) will have an annual premium of Rs 10 lakhs for all the twenty years. Maturity amount on survival, although not guaranteed, is indicated as Rs 4.02 crore assuming 8% annualised returns and Rs 2.56 crore assuming 4% annualised returns during the period of policy(These indicative figures are as per guidelines issued by IRDAI). Mind you, a premium of Rs 2 crore would have been paid by the individual in twenty years.
  • On the other hand, term insurance plan would cost an annual premium of only Rs 11454/- with no maturity benefits. Sum assured in both the cases remain same as Rs 2.1 crore. If the balance amount of Rs 9,88,456 ( difference of premium in both cases per annum) is invested in a index based mutual fund giving say 12% annualised returns for next twenty years, he will have a maturity corpus of Rs 7.12 crore.( Nifty benchmark index fund has given 12.54% annualised returns during last twenty years).
  • Wouldn’t it be better for him to go for term insurance and pay yearly premium of Rs 11454 and invest the saved amount of premium in better investment options? 

Recommendations

  • Life Insurance is only meant to cover the risk of life and not an option for investments. There are much better options available for investments.
  • As a matter of principle, any insurance policy offering maturity value on survival should never be taken.
  • Life insurance policy should always be taken from a known person who can do hand holding in case of requirement. Known registered consultant can understand your requirements and suggest a solution best suited to meet your requirements. Moreover he would be available to the nominee to guide him or her at the time of submitting the claim papers and assist the family to get the claim processed in case of unfortunate death of the policy holder, which will not be the case should you buy your policies from commercial websites like policy bazaar etc.
  • It is a misplaced belief for many of us that there is no commission involved while buying an insurance policy from such sites. Had this been the case, how do you think they run their business and pay hefty fees to film stars for promoting their cause? 

Am I financially ready to bear the cost of upbringing children….?

Well friends, most of the times it’s an emotional decision for a couple to start a family but rarely we take stock of our finances before we actually take a plunge. Now lets try and understand the quantum of money required to be saved and invested to meet financial goals associated with upbringing of children. Let’s do it with a case study.

Assuming a person gets an employment at the age of 23 years in Dec 2018 after finishing his graduation and plans to get married by the end of year 2021(26 years of age). Couple enjoys their married life and decides to have their first baby by year 2025( four years of marriage) and second baby by 2027(six years of marriage). Let’s see how much money they would require to save and invest on monthly basis to plan for the future requirements of their two children.

In the above example we have seen that a proper financial planning is required to be done and required amount of money needs to be invested in an appropriate financial instruments( I have assumed 7.5% annual returns in debt instruments to include bank FD, PPF etc and 12% annual returns in equity mutual funds over a longer period of time). Although the requirement of funds seems to be high but with proper planning and regular investments, these targets can easily be met.

Moreover financial planning will help us decide weather to have two children or settle for only one . At this stage, it may not be out of place to mention the importance of retirement planning. Just to give an example if this person is spending Rs 25000/- per month today, he would require approx Rs 3.06 lakhs per month at the age of 60 years with an average inflation of 7% per annum. Assuming his life span is 85 years, he has to have a corpus of approx Rs 8.17 crores by the time he retires at the age of 60 years to sustain upto 85 years of age( assuming 8% of annual returns and inflation of 7% post his retirement). And to accumulate the corpus of Rs 8.17 crores, he needs to invest Rs 11885/- per month over a period of next 37 years upto the age of 60.( assuming 12% annual returns on investments)

So financial plan will not only help us achieve our financial goals but may help us take important life decisions too.

Consolidate Investments through Comprehensive Financial planning

Most of us have been investing in different asset classes over a period of time, using different platforms, some manual, some online and now it’s becoming difficult to monitor all of these. To add to the irony, we have no clue why did we make these investments and what was our investment goal(s). We tend to invest just like that because we have surplus money and  lot of recommendations are floating around  in media(TV/print/social).

Most of the time we will find that these investments have some how been forced upon us by relationship managers/ wealth management teams from banks, insurance agents and people from various commercial websites. At times we ourselves go ahead and make investments just to oblige our Bankers or friends/known people.

Challenges

  • All the investments are scattered and not available on a single platform
  • Difficult to keep track of all these investments and monitor their performance
  • In the name of diversification, investments in far too many mutual fund schemes
  • Investments done which are not in tune with our risk profile and do not contribute towards our short and long term financial goals

So what is the way out ? Answer lies in a  comprehensive financial planning. 

Comprehensive Financial Planning

A financial plan is a road map to help us define our financial life goals and provides an integrated and logical approach to achieve these goals(e.g children’s education, their marriage, foreign vacations  etc )

Comprehensive Financial Planning involves :

  • Detailed review and analysis of all the facets of our present financial situation. This  includes areas such as cash flow management, risk management, investment management, insurance planning and tax management.
  • Discussion, understanding and prioritization of short and long term financial goals.
  • The development of a plan including linking of all existing investments and additional financial products needed to take us from where we are today to where we need to be in future to meet our desired financial goals.

Advantages of having a Financial Plan

  • Optimizes surplus cash flow which can be utilized towards fresh investments in consonance with risk profile of an individual, towards meeting financial goals.
  • Evaluates, assess and consolidates all existing investments for their performance and link these with financial goals. Non performing assets can be liquidated.
  • It provides real time tracking of all investments on a single platform and updates the progress of achieving designated goals.
  • Ensures continuation with investments during market volatility and avoids unwanted redemption  to fulfill insignificant desire(s). 
  • Provides total peace of mind by reducing financial stress.

“ If you want to know your past, look into your present conditions. If you want to know your future, look into your present  actions ”

                                                                                  A Chinese Proverb

Classification and Investment Portfolio of Debt Mutual Funds

As we all understand debt mutual funds are ideal investment options for short term investments. Their risks are much lower than equity or equity oriented funds, they have the potential to generate superior returns compared to traditional fixed income products and they enjoy a significant tax advantage over bank savings and Fixed Deposits. But how many of us know that there are around 15 to 16 different categories of debt mutual funds with different investment strategies. Let’s have a look at them:

  • Debt Overnight Funds. Invest in only those securities which are having maturity of only one day. 
  • Debt Liquid Funds. Invest in securities having maturity of upto 91 days.
  • Debt Ultra Short Term Funds. Invest in debt and money market instruments(treasury bills, commercial papers etc) which are maturing between 3 to 6 months. I am deliberately not getting into technical term of Macaulay Duration.
  • Debt Low Duration Funds. Invest in debt and money market instruments which are maturing between  6 to 12 months.
  • Debt Money Market Funds. Invest in debt and money market instruments having maturity of upto one year.
  • Debt Short Term Funds. Invest in debt and money market instruments which are maturing between1 to 3 years.
  • Debt Medium Term Funds. Invest in debt and money market instruments which are maturing between 3 to 4 years.
  • Debt Medium to Long Term Funds. Invest in debt and money market instruments which are maturing between 4 to 7 years.
  • Debt Long Term Funds. Invest in debt and money market instruments which are maturing in more than 7 years.
  • Debt Dynamic Funds. Invest across the duration.
  • Debt Corporate Bond Funds. Invest minimum 80% of the total assets in highest rated corporate bonds.
  • Debt Credit Risk Fund. Invest minimum 65% of the total assets in corporate bonds, although in below highest rated instruments.
  • Debt Banking and PSU Funds. Minimum 80% of the total assets needs to be invested in debt instruments of Banks, PSU and Public Financial Institutions.
  • Debt Gilt Funds. Minimum 80% of the assets need to be invested in Government securities(G-sec) across all maturities.
  • Debt Floater Funds. Minimum 65% of the assets need to be invested in floating rate instruments.

Each of these debt mutual funds generate different return on Investments based on the prevailing interest cycle and anticipated movement of interest rate in future. One needs to choose an appropriate debt fund keeping in mind risk appetite and expected returns.

Happy Investing!!

Investment Opportunities Post Budget FY19-20

Interim Budget for FY19-20 was presented today in the parliament by the Finance Minister. During his budget speech, he has laid down the road map of economic activities for the country over the next 10 years or so. Important highlights of the speech affecting investments are as given below :

1. Indian GDP is poised to become $ 5 trillion from existing $ 2.5 trillion by 2024 and by 2032, it will touch $ 10 trillion. That means Indian businesses will grow four times in next 13 years.

2. To give a boost to Real estate sector, following major announcements have been made:

a. As per existing rules, income tax on notional rent is to be levied on second residential house even if the house is not rented out. That provision has been taken out, meaning thereby, we need NOT pay income tax on notional rent if the house is not rented out and can show both the residential houses as self occupied.

b. Earlier, to save income tax, Long term capital gains(LTCG) accrued by selling a house were being utilised in buying a residential house under section 54 of income tax act. Now, instead of one residential house, we can buy two residential houses with Long term capital gains with a condition of LTCG not exceeding 2 Crore. This exemption will be allowed only once in a life time.

3. In the light of the above, It is the right time to start allocating a substantial portion of investments towards equity mutual funds which are going to generate enormous wealth as Indian economy is poised to grow four times in next 13 years or so.
An opportunity to acquire a real estate asset under distress sales may be considered for investments. 

Happy Investing!!

Highlights of Interaction with Armed Forces Officers

During last two weeks or so, I had the privilege to visit and interact with Armed Forces Officers at Indian Institute of Foreign Trade(IIFT), New Delhi, Meerut, Pannagarh and Mumbai (Kalina) Military Garrisons. During the course of my presentation and subsequent interaction with Officers, I realized that the concept of Personal Financial Planning is not clear to most of us and we are not planning and channelizing our resources towards achieving our desired financial goals.

Important highlights of my interaction are as given below:

1. Contribution to DSOPF. Itstill remains the most preferred option for investments. Although some part of the investments must go towards DSOPF but investments in equity through equity mutual funds can not be ignored. Equity has been the largest wealth creator in the past. Investments in equity Mutual Fund through SIP will create enormous wealth  in the times to come as India is all set to double its GDP from existing 2.5 trillion dollars to almost 5 trillion dollars by 2025.

2. Goal Based Investments. Investments are being done in an adhoc manner without linking them with  future financial goals. Such investments have an inbuilt risk of getting redeemed prematurely at the slightest volatility in the stock market or to fulfill any insignificant desire. Under such conditions it is rarely feasible to achieve one’s financial goals. Investments based on financial goals is the only way out to meet your desired targets.

3. Investments not in line with Risk Profile.  Selection of an Asset class is directly related to an individual’s risk profile. An individual averse to risk should not allocate high proportion of investments into equity as he or she will not be able to handle the volatility in the market. I have observed that officers having low risk appetite and who invested in the equity mutual funds in last year or so are finding it very difficult to see their capital being eroded. For them , investments in debt mutual funds would have been a better option. So investments based on risk profile is very important factor.

4. Loan, a Biggest Culprit.  A large number of officers tend to take loan to buy an expensive car, to take personal loan or credit card loan to buy house hold articles/ go on foreign vacations. Cost of borrowing money is huge and it prevents an individual to plan their investments to achieve other important goals in their life since most of the money goes in paying the EMI. For  example,  a car loan of Rs 10 lakhs @ 9% for 7 years will have an EMI of Rs 16000. Invariably we are tempted to change our old car by the time loan period of 7 years is going to be over and we end up taking fresh loan to buy a new car. This process carries on almost throughout our earning life. Had we not taken this car loan and invested this amount of Rs16000/- pm @ 9% for twenty years, it would have generated a corpus of Rs 1.02 Crore.

5. Investments in Insurance Products.  Most of us have invested our large amount of money in different insurance products but unfortunately all these products are not pure life risk coverage products. Bulk of the premium in such insurance products go towards investments and the rate of return (RoI) is not more than 5-6% at max. Aim of insurance is only to protect against the risk of life and definitely not an option for investments. There are much better options available for investments. Term Insurance is the only option which one should exercise to protect against the risk of life.

6. Direct Investments in Stock Market.  I have come across Officers who are directly investing their hard earned money into buying stocks without professional competence in understanding the balance sheet of the business in which they are putting their money, purely based on hear say/ tips from friends and recommendations through other websites etc. Most of them are into great losses and the most unfortunate part is that they are not even aware of their present situation. Direct investments in stocks require great deal of acumen in understanding the company’s business, regular monitoring and high risk appetite. For people like us, better route may be through equity mutual funds.

7. Inadequate Financial Awareness.  Lack of financial awareness restricts the investment options. It is very essential that all of us must devote some time to read books/ magazines/journals on the subject. More we are aware financially, better we can manage our money.

It is my sincere request to one and all to devote some time  on management of money with the aim of making money work for us rather than we working for money all the time.
Happy Investing!