Look beyond Ulips for your child’s future

Thirty-year-old Amit Goenka had just become a father of a baby girl. After the initial euphoria subsided, he decided to buy an insurance plan — Life Insurance Corporation’s (LIC) Komal Jeevan plan, a child unit-linked insurance plan (Ulip) to secure the future of the family’s newest member.


Child Plans:

He is one amongst the huge tribe of parents who have chosen to put their faith in child Ulips that promise continuity in the funding of the child’s education even in the event of the parent’s death. These schemes have been best sellers for most life insurance companies and thus form an important part of their portfolio.

It is easier to strike a chord with parents by talking about insulating their children’s future from any undesirable events. Consequently, selling child plans is easier as well. Many parents, thus, are completely taken in by the idea of achieving their dream of their child being able to complete his/her education in their absence.

In addition to the sum assured that is paid at the time of the policyholder’s demise, future premiums are waived off and the fund value is made available to the child on maturity. Riders providing for loss of income arising out of the parent’s (the insured) death or disability are also touted as one of the reasons why child plans score over other investment options.

Most companies also offer waiver of premium riders, which ensures that the company continues to pay the premium if the parent passes away. Over a period of, say 15 years, regular investments will ensure that the fund grows into a substantial amount, which may not be possible in case of a one-time , small lump-sum investment.

Mutual Funds:

Like several other parents, Amit, too, had various options to choose from. For instance , simple bank fixed deposits, Public Provident Fund (PPF), Reserve Bank of India (RBI) bonds, diversified equity mutual funds, post office instruments like monthly income scheme (MIS) and, of course, pure equity (stocks).

Most parents, if not all, invest in more than one product to secure the future of their children, provided the pocket permits the luxury.

Many fund houses also offer schemes dedicated for children. “Apart from two child Ulips, I also invested in a mutual fund scheme dedicated for children ,” Amit adds. For instance, UTI Mutual Fund offers CCP Balanced Fund and CCP Advantage Fund.

The two schemes, which collectively manage around Rs 3,000 crore, have given around 12% in the past. Anyone can invest in the name of his/ her child below the age of 15 years. When the child turns 18, s/he has the option of withdrawing the money completely or doing so in a phased manner. Some of the other mutual fund schemes currently available in the market include HDFC Children’s Gift Plan, ICICI Prudential ChildCare, LICMF Children Fund, Magnum Children’s Benefit Plan and Tata Young Citizens.

Look Before You Leap:

Most investment experts are of the view that these funds are not necessarily meant for children. They are more of a marketing gimmick which fund houses adopt to woo investors. After all, even a simple equity diversified fund is capable of generating a similar performance. The table above reflects the performance of such dedicated child mutual fund schemes over the past five years compared to the returns from the equity diversified fund category.

Why Equity?:

Remember, equity is the best- performing asset in the long run. While debt, or income , funds are considered ‘safer’ avenues, their ability to generate higher returns is also constrained . In contrast, equity schemes have the potential to deliver superior returns in the same timeframe. Also, since the children’s needs are a good 10 years or more away, you also have enough time to weather the volatility in the market .

Over the past 15 years, Sensex, the BSE benchmark, has given returns at a compounded annual growth rate (CAGR) of 13%. That is why investment experts want you to seriously consider equity schemes while investing to secure your child’s future.

Child Ulips Are Expensive :

Likewise, while it is convenient to invest in insurance plans, it is an expensive proposition. Financial planners are of the opinion that one should never buy an insurance policy with an investment objective in mind. They may be popular, but they are complex in nature, making an analysis of their performance an arduous task.

“Despite the cap on Ulip charges, the costs cannot be termed reasonable. Also, I don’t see them yielding significantly superior returns to justify the huge charges levied,” points out certified financial planner Amar Pandit. Child ulips are, in fact, costlier than even regular Ulips, owing to features such as waiver-of-premium and loss-of-income riders.

The Ideal Approach:

The best way to increase your kitty is by investing in diversified equity mutual funds with a good track record, as they are flexible instruments that offer the optimum mix of return, liquidity and tax-efficiency . However, the equity component means they come with associated risks. You should go for them if you are willing to stomach any short-term volatility and are prepared to dig in for the long haul.

“There is no doubt that starting a SIP (systematic investment plan) in a diversified equity fund and staying invested over the long-term is the right approach when it comes to financially securing your child’s future,” adds Pandit.

On an average, these schemes are much better positioned to tackle market risks, primarily because the constituents of a diversified equity scheme are determined by the fund manager who tries to encash upon the opportunities thrown open by the market from time to time.

The fund manager is at liberty to reduce the weightage of non-performing or volatile sectors or stocks in the portfolio and increase the weightage of the hot and roaring sectors.

A SIP in a large-cap , equity diversified fund should be combined with a term insurance cover to safeguard your child’s future. Though there is nothing to be gained in monetary terms if you survive the tenure of the policy, you would have ensured a large sum for your child in your absence at a fraction of a Ulip’s cost. However, don’t treat this lightly.

All the attractiveness of death cover, disability cover and so on can be obtained by pure insurance plans designed to cover them. This will make sure that your child’s future remains secure no matter what happens to the parent. Make sure that you have a life cover that is adequate — simply put, the cover should be enough to provide for sustenance of your family.

What must be kept in mind is that investing for a child is no different than investing for yourself. The principles remain the same.
Source:economictimes.com

Is this the right time to break your old FD?

Rising interest rates are always associated with expensive loans and an overburdened borrower. But this is just one side of the coin. The other side of the coin reflects the rising deposit rates, which have added some zing to this safe investment instrument. The bank fixed deposit rates (FDs) have increased in the range of 0.25-1 .5% across tenors. So is this the time to book fresh deposits or break your old one to benefit from the new rates?

Should You Keep Your Old FD?:

There is no single answer to this question. Investors should consider the time left before the date of maturity of their FDs before breaking the FD. For instance, if the FD is nearing maturity, it may not be a prudent decision to opt for a premature withdrawal. You will lose some interest income on that deposit, since the interest rate is calculated on an annualised basis . The loss in the interest income may offset the gain you earn from higher deposit rates.

As Suresh Sadagopan, certified financial planner , Ladder 7 Financial Advisories explains, “If you had invested around four months back for one year at 7.5% and the rate for one-year deposits has gone up to 8%, then on breaking the previous one, the rate applicable for four months, which maybe 5.5% will be applied. So, there is a loss of 2% on annualised interest or 0.66% for the period.”

The second factor to keep in mind is the penalty on premature withdrawals. “If the higher rates are able to compensate the penalties or lower rate for the tenure you have invested for, you could switch. If the rates have gone up by 0.5% and if the premature withdrawal penalty is also 0.5%, then there is no point exiting at this stage,” Sadagopan adds.

Most banks charge a penalty of around 1-2 % on premature withdrawal of fixed deposits. But if a customer has to withdraw before the actual maturity date, the bank may waive off the penalty. For example, SBI levies a penalty of 1% below the rate applicable for the period of time the deposit remains with the bank. “But no bank has a defined list of emergencies under which a customer can be spared from the premature withdrawal penalty. But banks have waived off this penalty for certain unexpected financial emergencies such as illness, death of a family member etc. But this waiver happens on a case-to-case basis and the customer has to convince the bank about the nature of his emergency,” says an industry expert.

Bank FD vs Company FD:

Most of the company FDs still offer a higher interest rate compared to that of bank FDs but one should also consider the financial soundness of the company. The safety and return on company deposits depend on the rating. Usually higher the rating, lower is the return . “Typically the return on an AAA-rated company comes very close to that of a bank deposit as the investor is assured of the company’s financial soundness. At times, public sector banks offer higher returns than company deposits,” says Kartik Jhaveri, certified financial planner, Transcend India.

For example, the rate offered by LIC Housing Finance on a one-year deposit is 7.6%. It is rated FAAA by Crisil, which indicates the highest degree of safety regarding payment of interest and principal. For the same period, SBI is offering 7.75%. Now this rate is comparable because the company has been given a safe rating. Also, in most of the cases, it takes a longer time to get the credit in case you want to break your company FD before its due maturity. But at today’s FD rates, there is not much of a difference, feel financial advisors.

“Also, banks typically give a 0.25%-0 .5% more for senior citizens. Hence, it could be a good idea to consider bank FDs themselves at this point of time,” Sadagopan adds. Bank deposits up to . 1 lakh are covered under the Deposit Insurance and Credit Guarantee Corporation (DICGC), which adds to the safety blanket. However, there is no protection for depositors if a company is in financial trouble as FDs are a part of a company’s unsecured debt.

A company’s non-convertible debenture is a safer bet than a company FD, as it comprises a part of se-cured debt. Company FDs have traditionally offered higher interest rates than those of banks. Companies come out with deposit schemes whenever they require cash to fund their business activities. If these companies are highly cash-strapped , then they will offer even higher rates to woo the public money. One of the biggest risks associated with company deposit rates is the default risk.

Even if the company has a fair reputation in the market, it may not be in a position to pay off your money and interest on time. This is because they tend to invest the money (you park in form of deposits ) for specific use, which carries a higher default risk. Unlike, banks which lend your money to several borrowers and companies, the risk is diversified. So, the impact is lesser.

Hence, in case of company FDs, you have to see if it has been rated by any agency like Crisil, Icra etc. Then, one can look at the number of years in business, profitability of the company, the reputation of the promoters etc. If you know of people who invest in FDs, try to find out if they are prompt in sending the maturity proceeds, interest cheques, and how responsive they are.

How to calculate your actual return?:

Banks are offering 8.6% on one-year deposits. This could be higher depending upon the com-pounding effect. If a bank compounds the interest on a quarterly basis , the actually rate would be higher at around 8.8%. More the number of times a bank compounds the interest, higher is the interest income. But that is not the ultimate realisable return you earn on the deposit. Given that the interest income on bank deposits is fully taxable, the net yield is much lower. If a person is in the highest tax bracket, then the actual return after tax of 30.9% is 5.6%. It will be commensurately higher for those in the lower income slabs. Income from FD is fully taxable as income. Also, bank FDs tend to yield relatively lower interest (in view of their lower risk profile).

“Bank FDs offer assured returns but they are taxable at a slab rate which may go up to 30.9% for individuals under the highest tax bracket. An investor whose income is above . 8 lakh will get the net yield of 5.528% if the FD offers an interest rate of 8% per annum. For instance, if you fall in the 30% tax bracket (income above . 8 lakh in the current financial year), your tax liability will be . 1,236. Now, if you invest . 50,000 and get . 54,000 on maturity with 8% interest, the net yield will actually be 5.528%,” says Pankaj Mathpal, CFP managing director Optima Money Managers.

FDs can’t beat inflation:

Inflation, as an economic indicator, reflects the value of money over a period of time. Inflation has the abil-ity to erode the value of your investments even as you may have earned some return on them. Whenever you invest in an instrument, compute the future value after accounting for inflation of 8-10 % to get accurate results. Let us assume you invested Rs 1,000 in a one-year fixed deposit at 7%.

The value of the deposit will be Rs 1,070. But if the inflation has been 8% of the year, the value of Rs 1,000 decreases by Rs 80. The net value of your money is Rs 990 only. So, the net gain after computing the loss of value due to inflation is actually negative. Bank FDs are an essential ingredient in everyone’s investment kitty.

They act as a good balance in a portfolio. Low risk-free avenues such as bank deposits and small savings have gained prominence due to vagaries of risky instruments linked to equity market. But FDs alone cannot grow the size of your portfolio. Hence, FDs should just be a small component of your investment portfolio. “It should be around 15% for an investor at the start of the career or nearing 30s, 25% for an investor at 40, about 35% for an investor nearing retirement, (another 25% could be in other debt instruments like PPF, debt funds, FMPs etc.),” Sadagopan adds.
source:economictimes.com

Should you buy Infrastructure Bonds?

This question is echoed by many investors. Infrastructure bonds are certainly not new to the Indian taxpayer. They did exist till 2005 when Section 88 of the Income Tax Act was in force. In the last Budget, these bonds were re-introduced under Section 80CCF.

However, there seems to be a mis-conception in your thinking. These bonds do not compete with equity linked savings schemes (ELSS). Tax saving funds fall under Section 80C of the Income Tax Act. Under this section, tax payers get a tax deduction up to Rs1 lakh. These infrastructure bonds will give you an additional tax deduction of Rs20,000, over and above the Rs1 lakh that you are eligible for under Section 80C. In effect, a total tax deduction up to Rs1.2 lakh on your income. So the first thing you must make note of is that you should consider these bonds only if you have exhausted all the limits under Section 80C.

Let’s look at the tax aspect. Do pay attention to the fact that the income earned from these bonds will be added to your taxable income in the year in which you realise it. It is not an EEE (exempt-exempt-exempt) proposition like the Public Provident Fund (PPF). Just like other tax saving instruments like National Savings Certificate (NSC) and 5-year bank fixed deposits, the interest earned is taxed. Under an Equity Linked Savings Scheme (ELSS), long term capital gains tax is nil and dividends are tax free, so there is no tax burden. Neither is there one in the case of PPF. All these options fall under Section 80C, the infrastructure bonds being outside the purview of this section.

There is also the liquidity aspect. These bonds come with a long tenure of 10 years and a lock-in of 5 years. If there is no convenient secondary market, then you will effectively have a lock-in of 10 years. Although some issuers will provide a guaranteed buyback, ensure that you do not need the money for a minimum 5 years.

Unlike other tax saving investments like NSC or PPF, these bonds don’t carry any implicit or explicit government backing. Combined with the tenure of these bonds, it will mean that the continued creditworthiness of the bond issuers is something that investors will have to keep an eye on. Agreed, IFCI, PFC, IDFC and L&T Infrastructure are sound companies, but we are taking a view over a decade here.

Only after you look at these aspects should you make a decision on whether or not to invest in the bonds. A tax-saving investment has to be an investment first and a tax saver later, in the sense that if you wouldn’t be investing in that asset otherwise, then you shouldn’t do so just because it’s saving some tax. Moreover, the upper limit of Rs20,000 means that many taxpayers in the upper tax bracket will find the quantum of additional tax savings to be marginal.

source: valueresearchonline.com