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

More than just an SIP

If you are a mutual fund investor, you need no further explanation on what an SIP is. Every fund house aggressively preaches the benefits of systematic investment to whoever gives an ear. Its not-so-common sibling is the STP. But if you thought that this was all there was to fund investing, other than the invest-at-one-go style, which we caution against, by the way, it's time for an update.Fund houses have donned their creative hats and structured innovative ways to supplement the conventional SIP. Here's what is available in the market.

SIP

It's easy, it's convenient and it works for the investor. In a systematic investment plan (SIP), a fixed amount is invested in a fund at a predetermined date, which could be either monthly or quarterly. Not too long ago, daily SIPs were also introduced.

STP

A systematic transfer plan (STP) is a combination of a systematic withdrawal plan (SWP) and SIP. Under a STP, a pre-determined amount is redeemed every month from the fund at regular intervals. For instance, the fund house withdraws a fixed amount at a pre-determined frequency from either a debt or liquid fund, where the investor has invested his/her initial corpus, and channelizes the investment into another fund chosen by the investor. Generally there are two asset classes at work. The initial corpus could rest with a debt or liquid fund and periodically money may be transferred to an equity fund.

DTP

The dividend transfer plan (DTP) resembles the dividend reinvestment plan (DRIP). The dividends that an investor earns in a scheme, gets reinvested in another scheme from the same fund house. Not the same scheme (like dividend reinvestment), just the same fund house. An investor can essentially structure his investments in such a way that dividends from, say, his debt fund get reinvested in an equity fund of his choice.

VIP

The value investment plan (VIP) was introduced by Benchmark Mutual Fund. Before investment is initiated, a target rate of return that has to be achieved monthly is decided. After the first installment, subsequent investments made are based on a formula, which is that the amount invested will be the difference between the target and actual value of investment (see illustration).
So if the market movements are below the desired rate of return, subsequent investment rises to make up the short fall. Benchmark Mutual Fund also has value transfer plan (VTP), where the same strategy is implemented by withdrawing from a debt fund and re-investing the proceeds in an equity fund.

FLEX STP

Introduced by HDFC Mutual Fund, this one is a compromise between SIP and VIP. The initial amount is invested in a debt or liquid fund. After that, it's either the pre-determined installment amount or the difference between amounts invested and value of the invested amount. Like VIP, if the market is on a free-fall your subsequent investments can easily exceed your total planned investment.

Smart STEP

This one, introduced by Reliance Mutual Fund, follows an in-house quantitative model which can judge the “current positioning of the market” based on its intrinsic volatility. Even though the fund house explicitly hasn't stated it, it implicitly suggests that the model can estimate whether the market is over- or under-valued. On a pre-determined day, accordingly to the output from the model, a low, medium or high amount will be invested in the fund. Since they haven't been very forthcoming in sharing the details of the model, we are unable to determine the efficacy of it.

FLEXINDEX

Conceived by HDFC Mutual Fund, investors have to choose four levels of the index at which they would like to deploy their money. If that level is crossed or met, either one-fourth of the total would be invested or a percentage of the total as specified by the investor. If you take a look at our illustration, we failed to deploy our planned investment in any one of the years. So a comparison with other investment strategies is unfair.

SIPs and STPs are not fancy, but they are easy to grasp and get the job done. As in, they don't let the market sentiment affect the investment decision. Their premise is based on the underlying theory that in the long run, equity can deliver superior returns if investments are done rationally in a disciplined fashion.
These innovations are more sophisticated in the sense that the amount invested can be tweaked and the investment can also be timed to some extent. But frankly, after we did a comparison, they appear to be more gimmicky than anything else. To top it all, they will throw your equity:debt planned allocation out of the window.

source: valueresearchonline.com

FMPs - Fixed Maturity Plans

What are FMPs?

These are schemes with a fixed maturity date i.e., they run for a fixed period of time. “This period could range from 15 days to as long as two years or more. Like in an FD, when the period comes to an end, the scheme matures, and your money is paid back to you,” says Sandeep Shanbhag, director, Wonderland Investment Consultants, a tax and financial planning firm.

Most FMPs being launched these days have a maturity period or tenure ranging from a little over a month to a little over a year.

"There are FMPs for one month (up to 35 days), three months (up to 100 days), six months, one year (367-370 days), two years and three years — most common are one month, three months and one-year tenure," says Vijay Chabbria, a chartered financial analyst who runs Prudent Investment Advisors.

What are the returns these FMPs are likely to offer?

"The returns on a three-month FMP are at around 7.25-7.5% per year whereas the returns on a one-year FMP are around 8-8.5%," says the head of fixed income of a mutual fund who declined to be named. This was confirmed by another head of fixed income of a mutual fund and a couple of financial advisors.

It was standard practice among mutual funds to give out indicative returns on FMPs before investors invested. They managed to do this because an FMP which matures in 370 days invests in financial securities maturing in the same time period. This gave mutual funds a fair idea about the returns on offer.

Depending on the return the securities maturing in one year were giving, the FMP gave an indicative yield to the mutual fund distributors. This practice was banned by the Securities and Exchange Board of India (Sebi) in early 2009. Mutual funds, of course have gotten around this by verbally communicating to their distributors on the likely return to be expected on an FMP.

FMPs vs FDs

Most one-year FDs offer a return of around 6.5-7% to ordinary depositors and 7.5% to senior citizens (people over 60). Meanwhile, one-year FMPs offer a return of around 8-8.5%. So, at a very basic level, FMP returns are higher. Once we take into account the tax treatment for the gains made on both FDs and FMPs, the net return earned on an FMP is much better.

Says Shanbhag, “What gives FMPs the edge is the greater tax efficiency they offer. In other words, on a tax-adjusted basis, the return on an FMP is higher than that of a bank FD.” The entire interest earned on an FD is taxable, depending on the tax bracket you fall in. For those falling in the 30.9% highest tax bracket, the real return from a one-year fixed deposit paying an interest of 7% is around 4.84%.

However, the return on an FMP is categorised as a capital gain. So, for a period of more than one year, an FMP is taxable at the rate of 10% without indexation or 20% with indexation, whichever is lower. For instance, an individual invests Rs 50,000 in an FMP. The rate of inflation is 5% and the return on the FMP after 370 days is around 8%. This means that the investor gets Rs 54,000 at maturity, which implies a gain of Rs 4,000.

This gain taxed at the rate of 10% would mean a tax payment of Rs 400 and a net gain of Rs 3,600 which would imply a return of 7.2%. If we take indexation into account, the cost after inflation goes up to Rs 52,500 (Rs 50,000 + 5% of Rs 50,000). So, the capital gain in this case is Rs 1,500 (Rs 54,000 – Rs 52,500). And a 20% tax on this works out to Rs 300, which is lower than the Rs 400 tax that needs to be paid without indexation. So, the net gain is actually Rs 3,700 (Rs 4,000 – Rs 300), or 7.38% (Rs 3,700 expressed as a percentage of Rs 50,000).

Now compare this to 4.84% return you earn in case of a fixed deposit, it tells you very clearly where more money is to be made. As Chabbria puts it, “The tax benefit due to indexation and the fact that interest on bank FDs is fully taxed makes FMPs a good bet.”

How to invest in an FMP?

Mutual funds offer FMPs all the time. “FMPs are more popular towards the end of a particular quarter. The month of September saw a launch of a lot of FMPs. Now, December will see a lot of schemes being launched,” says the head of a fixed income at a mutual fund.

Should you invest now or wait: RBI has increased the repo rate (the rate at which it lends to the commercial banks) by 125 basis points in this financial year. If interest rates are poised to move further up, then it makes sense for investors to wait. If they are not, it makes sense for investors to lock in their money right now. We polled experts to get their view on this. And as is the case usually, they are divided on the issue.

“The short-term interest rates are nearing their peak. This indicates an opportunity to lock in money with a one-to-three-year timeframe,” says Nandkumar Surti, chief investment officer, JP Morgan Asset Management. This is something with which Joydeep Sen, senior V-P, advisory desk-fixed income, BNP Paribas Wealth Management, agrees with. “Returns on short-term financial securities (which FMPs invest in) have already moved up and there is limited scope for returns to go up more.”

It makes some sense to park your money in FMPs right now

But not all share the same opinion. “Short-term interest rates are likely to go up further as the initial public offerings(IPOs) and follow-on public offerings (FPOs) by companies in the stock market will suck out money along with further issuances of certificate of deposits by banks,” says Pankaj Jain, fund manager, fixed income, Taurus AMC.

What this means in simple English is that the demand for money from corporates and banks is likely to go up in the days to come, thus pushing up interest rates further. Adds a head of fixed income of a mutual fund, “I will not be surprised if the returns offered on FMPs with a greater than one-year maturity touch even 9%.”

So, given this disagreement among experts, it makes some sense to park your money in FMPs right now. “You will be better off investing more than half of the money you allocated to FMP now,” says Sen of BNP Paribas Wealth Management. “Why wait for a 20-25 basis point uptick in returns when you really cannot time it?” asks a strategist with a foreign wealth management services provider. The bigger issue is that there is no guarantee that retail investors get enough options in FMP space in the last quarter of the financial year. A bird in hand is better now than two in the bush later is the simple reasoning wealth advisors are offering as they advise investing now.

Risks of investing in an FMP

Generally, considered to be a safe instrument, nonetheless, retail investors should exercise care before committing their funds, given that returns on a bank fixed deposit are more or less guaranteed and returns on an FMP are not.

Given this, it makes sense for investors to invest only in FMPs of mutual funds which have a pedigree and reputation.

source: economictimes.com

Financial Planning - An evolved way out for Asset Allocation

Personal finance revolves around asset allocation. Mix the right assets in the right proportion, and take diversified exposure in each asset class. Over the long term, this should fetch acceptable returns for acceptable risks.

It’s assumed that equity should, in the long run, deliver higher returns than other financial instruments and that compensates for the stock market’s extra volatility. It is also assumed that debt is safer, more stable than equity, hedges against a bad bear market, and offers fixed returns.

Fallacious assumptions

Is that second assumption about the nature of debt true? If a corporate chooses to default on a loan in India, legal recovery is very slow. In effect, Indian non-government debt is not as secure as is presumed.

In theoretical terms, real debt returns depend on inflation and currency stability. Both are volatile variables. Over the past 10 years inflation in India has ranged between 2 per cent and 13-14 per cent. Currency value has also swung a lot. So you don’t have assured real returns in debt.

If you are investing in debt across time frames and instruments, the only reasonable method is via debt mutual funds. Debt mutual portfolios are marked-to-market and inversely correlated with rate movements. If rates rise, a debt fund’s NAV drops. So there may not be even assured nominal returns if rates rise sharply. Such trends can occur over long periods.

So while the basic principles of asset allocation are sound, specific assumptions about safety and return need modification in an imperfect economy like India. Debt in India is more risky than is generally assumed, though admittedly safer than equity.

Many investors also see debt as a hedge against falling equity. But this is a fallacy, as pointed out above. Equity valuations usually fall if interest rates rise. But so does the value of debt. Both debt and equity give positive returns when interest rates fall. So there are long periods when debt and equity returns travel in the same direction. So the counter-cyclical hedging power of debt is limited.

Hence, higher equity weights may be sensible in an Indian environment because debt is relatively more risky than in First World economies. Of course, some allocation to debt is mandatory for any prudent individual.

The way out

But most investors should be willing to take higher equity exposures. One method of dynamic rebalancing could be to use the spread between earnings yield (the inverse of the PE ratio or Earnings/Price as a percentage) and the interest rate yield. Using a one-year fixed deposit rate or a 364-Day Treasury Bill Yield as the interest benchmark, we can compare it to the EP ratio.

A simple allocation rule would be: “If EP ratio is higher than T-Bill Yield, increase equity allocations. If EP ratio is lower than T-Bill yield, increase debt allocation.” This simple rule has worked well through the past decade or so.

It can be smoothed with checks on overall rate trends, and the differential amount. If the differential is large, signals are stronger. Historically since 2000, anybody who has gone overweight in equity in a disciplined fashion when the spread offers buy signals has made excess returns.

Several periods stand out. Between December 2002 and December 2005, the signal was continuously positive while the Nifty gained 200 per cent. Between October 2008 and January 2010, the signal was positive again while the market travelled up 72 per cent. Equally important, it kept equity allocations low during the big bear market of February 2000 to December 2003, when the index lost 40 per cent and again in the bear market of December 2007 to October 2008, as the market lost 60 per cent.

The 364-Day T-Bill seems like a good proxy for long-term returns. It is auctioned twice in the normal month, so there is a continuous flow of regular data points. T-Bill movements anticipate changes in fixed deposit rates. While these instruments are traded far more often by institutions than by individuals, they can be held by individuals. Of course, anyone building a PF portfolio could back-test other debt instruments and timeframes and may find more suitable benchmarks.

The basic point is that the individual should be aware that asset allocation cannot be done blindly following US-centric models. In a developing economy like India, debt is more dangerous than most people assume and the push towards equity should therefore be stronger.

source:valueresearchonline.com

Higher rates can adversely impact your fixed-income savings

BANKS are quick to lower fixed deposit (FD) rates when the interest rates fall, but they take their own sweet time to raise rates when the interest rates rise.

How many times have you heard this refrain from someone, especially a retired aunt or an uncle, in the recent past? With living expenses soaring each day, most investors, especially those who swear by FDs and other relatively safer avenues like company deposits and mutual fund (MF) schemes, are in a fix. The expenses may mount, but their interest income remains steady.

They also have to worry about their investments in debt mutual funds, as a rising interest rate regime is bad news for these schemes.

INTEREST RATE SCENARIO

The Reserve Bank of India (RBI) has started raising the policy rate since February in its effort to contain inflation. It has increased the repo rate (the rate at which it lends to banks) by 1.25%, reverse repo rate (rate it pays to banks) by 1% and cash reserve ratio (the percentage of deposits banks have to keep with RBI) by 1% this calendar year to check easy liquidity.

According to investment experts, the banking regulator is likely to raise rates further. “We expect a 50-basis point increase in policy rates in the near future,” says Nandkumar Surti, chief investment officer, JP Morgan AMC. This means, interest rates — the key variable to watch out for a fixed income investor — are surely north-bound, at least, in the short term.

What do you do in such a scenario? Consider this: you can’t lock the money in long tenure FDs because you can’t take advantage of rising interest rates.

Also, you have to be very careful while investing in MF debt schemes because of the inverse relationship between the price and yield of securities. So, it is crucial that you pick instruments that match your investment horizon and risk appetite.

SHORT-TERM INVESTMENTS

If you are looking to park your money for less than a fortnight, choose a liquid fund.

The liquid-plus option is more suitable for an investment horizon of more than a fortnight. These funds can give better tax-adjusted returns than saving bank accounts. However, don’t treat these funds as investment avenues.

They are meant for parking money temporarily. For short-term investments of three months to a year, you should consider short-term bond funds.

Before investing, take a look at exit loads charged by the schemes, if any, as exit loads erode returns.

MEDIUM-TERM NEEDS

You can consider company deposits and Fixed Maturity Plans for your medium term investment needs. Company deposits pay a little better than bank FDs, but they are more risky. Always look at the credit rating of the company and don’t invest more than 10% of your debt portfolio in a single company. Also, don’t invest in deposits over a year, say investment experts.

Fixed maturity plans (FMPs) are back in vogue. Tight liquidity conditions provide a good entry point for FMP investors these days. Investors can look at FMPs for 370 days, as they can give better tax-adjusted returns. Sure, the absence of indicative yields is a thorny issue.

But remember, the yield on an FMP is a function of the credit quality of the papers in the portfolio and the tenure. One can expect better post-tax yield on an FMP than a corporate FD of similar credit quality for equal tenure.

“Though FMP are listed on stock exchanges, given the low liquidity, you may not get the exit at all or may have to exit at a price substantially less than fair price,” says Richa Karpe, director-investments, Altamount Capital Management. If you cannot remain invested till the FMP matures, avoid investing them.

LONG-TERM INSTRUMENTS

In a rising interest rate scenario, the first thing most advisors will ask you is to stay away from long-term debt schemes.

However, there are many who argue that this need not be the case. “As corporate balance sheets have improved notably, income funds make a good investment sense with a two-to-three years’ horizon,” says Devendra Nevgi, founder and principal partner, Delta Global Partner. With inflation tapering off, long-term rates are likely to ease a bit.

If you do not want to take credit risk, you can look at gilt funds that invest in government securities. Since these are issued by the government, you don’t have to fear default risk.

However, you will be exposed to higher interest rate risk than in an FMP. But gilt schemes are highly liquid. Investors can also look at non-convertible debentures (NCDs) listed on the stock exchanges.

If you choose to invest in an instrument that doubles your money in the long term, say 78 months, you can enjoy long-term capital gains, which are taxed at lower rates compared with regular interest which is added to your income.

source:economictimes.com

Be An Invaluable Player

You Inc.: The Big Picture
Vision This is what a company wants to be in the future. Prominent companies have one. Infosys’ vision is to be a “globally respected corporation that provides best-of-breed business solutions, leveraging technology, delivered by best-in-class people.” Like a successful corporate you need to have a vision statement. Yours could be achieving financial freedom or something comparable. Vision will be shaped by your values
Values Your values would be a reflection of your financial attitude. Here issues such as these are important: What do you want your money to do for you? How long do you want your values to shape and influence your finances? At what point will the values of your wife or children take over from yours? How much risk are you willing to take to achieve your goals? What kind of risks do you see impacting your money in the future? How important is tax-efficiency for you?
Mission Each company needs a mission with a vision. A mission statement mentions things that are actionable; things that it is already doing and in many cases is good at. ITC’s mission is: “To enhance the wealth generating capability of the enterprise in a globalising environment, delivering superior and sustainable stakeholder value.” Wealth creation needs to be your mission.
Goals These are tangible targets of the company, such as being number one in terms of market share or profitability. In your case, they will be financial goals such as acquiring a home, children’s’ higher education and retirement.
Realising Your Goals hree essential things to do to ensure you hit the bull’s-eye and on time
List your goals Figure out an order of decreasing importance—in other words, prioritise
Create the infrastructure for the pursuit of goals. This involves, among other things, selecting the tax advisor, financial advisor, financial planner, ECS mandates for EMIs and SIPs.
Periodically review the progress made towards towards goals (annually for long-term and quarterly for short-term).

***

What makes a company valuable? Smart marketing with popular brands, manageable levels of debt and expenses, consistently high growth of income and profitability, well-managed risks to assets and income, and wealth creation. Like them, can you, too, become more and more valuable and see your share price soar in the stockmarket of life? Of course, corporates create wealth, thanks to the large number of employees who manage the different aspects of their operations. While the top management charts out the growth path and strategy, the marketing section creates and develops brands. The risk management arm works out ways to deal with risks. However, if you were to be the CEO of your own financial outfit—call it You Inc.—you are mostly alone except for tax and financial advisors that you might engage. Despite this apparent lack of organisational muscle, you can run yourself and your finances just as well as successful corporates do.

As with them, creation of wealth through assets, including stocks, equity or other mutual funds, and others will create a large future income. With this you can meet large future expenses, be it admission of your kids to professional courses or regular retirement income. If you do it properly, you can achieve your coveted financial freedom. This edition, coinciding with India’s 63rd Independence Day, provides you a route-map to becoming a wealth creator like a successful company by following some of their essential principles and functions.

The Corporate You: Big Picture

Develop the vision of a CEO... The starting point has to be with you taking over as the chief executive officer (CEO) of You Inc. Like any CEO, you need to have a vision for your organisation. You need to visualise in which direction you want your financial life to head. In short, you will need a vision statement like those of companies. Take the case of much-admired IT major Infosys Technologies that has the vision of being a “globally respected corporation that provides best-of-breed business solutions, leveraging technology, delivered by best-in-class people.” Another FMCG major, Hindustan Unilever (HUL), aims “to earn the love and respect of India by making a real difference to every Indian.” Your vision could be to achieve financial freedom, or something comparable.

...Shaped by your values. What and where you want to be in the future to a great extent is determined by your values, that is, what you think is right or wrong, good and not-so-good, and so on. You will have to grapple with many important questions. What would you want your money to do for you in the future? Should it be about achieving financial freedom? At what point of your life will the values of your wife and children take over from yours? How much risk are you willing to take? These will determine the choice of investment vehicles such as equities, equity mutual funds, balanced funds and gold, among other things that you invest in and the amounts that you are comfortable with. Then, there is the issue of the kind of anticipated risks that impact your finances. This will determine the risk-mitigating tool such as insurance that you take up to manage risks. For instance, if you have a family history of heart attacks, you will need to have adequate health cover early on in life.

Then, there is the issue of the importance of tax-efficiency for you. Would you like to save the last penny you can on taxes, no matter how it impacts other parameters such as returns and liquidity, or are you flexible on that front? You can see that your preferences will impact your vision of your financial future.

...Then a mission. Like corporates, you too should have a mission along with a vision. A mission statement for corporates typically states things that are actionable. What should be the mission statement of You Inc.? We suggest that it be “creating wealth on a sustainable basis”.

Formulate your goals. By having financial goals, you can translate the vision and mission you have into actionables. Companies have different goals, such as securing top market share or profitability in the industry. For You Inc., financial goals can be anything from the acquiring a house in a few years, to securing your kids’ higher education and marriage and your retired life. Once you have goals, you can work out the time when you will need the money along with the amount you will need, you can then work out what you need to do regularly to reach there.

Thereafter, you will need to prioritise them according to proximity and importance. You might feel that acquiring a home is more important than retirement at the moment and, therefore, requires an investment contribution. In some cases, you might have to scale up or scale down your goals. If a three-bedroom apartment looks difficult to buy with rising real estate prices, you might consider buying a smaller apartment at the moment and upgrading it later. After this, you will have to create the arrangements to ensure that you manage to pursue these goals. This would mean working out arrangements, such as having systematic investment plans (SIP) for your equity mutual fund investments. That’s not all. You will need to review the progress towards your goals periodically, maybe once or twice a year.

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Nuts & Bolts
The different roles that you have to don in You Inc.

Be your own Chief Marketing Officer (CMO) Ensure that you market yourself well in the job arena and build up your brand carefully.
Be a Chief Financial Officer (CFO) Like corporates, make meaningful expense allocations and control outflows.
Be a Chief Risk Officer (CRO) Manage risks, not only through insurance but also by providing funds for uninsurable events, just as corporates do.
Be a Chief Investment Officer (CIO) Deploy surpluses into assets to create wealth by balancing of key parameters.

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Being a CMO, CRO, CFO and CIO
To create wealth like corporates, you will also need to supplement your vision by carrying out major corporate functions such as marketing and budgeting, as well as expense, risk and investment management. To make your income grow at a faster clip than your expenses, you need to become You Inc.’s Chief Marketing Officer (CMO) and ensure that you market yourself well in the careers space. You need to build and develop the brand called “You”. The idea is to have the same effect as companies with strong brands and marketing functions that benefit from them with higher-than-average increase in revenues.

Not only does your income have to grow briskly, but your expenses have to be kept as low as possible without you leading a deprived life. This is where you need to be the Chief Financial Officer (CFO) of You Inc. where, like corporates, you make meaningful allocations to current or maintenance expenses while keeping enough away for capital expenses. In your case, capital expenses will be the outflow to create future wealth via investments. A critical function here would be to control fixed costs or outflows, such as loans.

Without managing risks to your life, health, income and assets such as your house, even the best-laid out plans can come to nothing. You will then have to dip into your investments before time. You will need to manage risks like a Chief Risk Officer, who not only manages insurable risks through insurance, but also with provision of funds for uninsurable ones such as a dental surgery.

You need to also be like the Chief Investment Officer (CIO) of your corporation, deploying surpluses meaningfully into assets to create wealth. This can be done through a balance of investment returns, risks, tax efficiency and liquidity.

Source:money.outlook.india

Know the benefits of living in rented house

House rent allowance, or HRA, is a major component of your salary. This is given by an employer to an employee to meet the cost of renting a home.

As a salaried employee you can claim a tax exemption on such an amount. But there are certain conditions that you need to understand to claim such exemptions.

The tax exemption on HRA is computed as the minimum of following three conditions: i) Actual HRA as per you pay slip; ii) 40%/ 50% of your basic salary; iii) The rent amount minus 10% of the salary

If you stay in a metro — Mumbai, Kolkata, Delhi or Chennai — your HRA would be 50% of your salary. In other cities/towns, it would be 40% of salary. For example, if your salary is Rs 40,000 and you live in Mumbai, HRA would be Rs 20,000 (50% of the salary). Let's assume that you pay a rent of Rs 15,000. The amount of rent paid minus 10% of the salary is Rs 6,000. The least of these is Rs 6,000, which would be taken as the HRA exemption. Hence the balance (i.e. rent minus HRA exemption) Rs 9,000 will be taxed.

You can claim exemption on rent given to parents. For example, you live with your parents and pay them rent. This would technically make your parents the landlords. In such an case, one of your parents should declare the rent paid by you in his/her personal income tax return to prevent litigation in future. However, you cannot claim exemption on rent paid to your spouse. Tax experts say that the relationship between a husband and wife is not commercial in nature and they are supposed to stay together.

You should provide your employer with accurate rent information so that the company can credit you with the eligible amount of relief before deducting tax at source. Another alternative is that you can also claim such exemption when you file the tax return and seek a refund.

If you receive HRA for the period during which you were not occupying a rental accommodation, then you can’t claim any tax exemption. In all cases it is advisable for you to maintain rent receipts as they are the only proof for rent payments.

According to Section 195, all Indian income of an NRI is subject to TDS. This rule applies to rent too.

Any resident Indian is subjected to TDS for rents of over Rs 1.20 lakh per annum. “But if you have rented a house from an NRI landlord, the onus is on you to deduct tax at source and pay it to the government.

The TDS is a flat 30.9%,” says Vaibhav Sankla, executive director, Adroit Tax services.

If you have taken a home loan to buy a house, say, in Mumbai, but you reside in another city, you can get tax benefits on your housing loan.

If you have bought a house but stay in a rental accommodation in the same city because your house is not ready for possession, you are entitled to tax benefits on HRA. “You can claim tax benefits on the home loan only if your home is ready to live in during that financial year. Once the construction on your home is complete for possession, the HRA benefit stops,” explains Mr Sankla.

However, if you have bought a house by taking a home loan and stay in a rented accommodation after giving you house on rent, you will be entitled to all the tax benefits mentioned above.

The government had announced the new perquisite rules in December 2009, which are effective retrospectively from April 1, 2009. The value of the perquisite determined in case of furnished accommodation is 10% per annum of the cost of furniture if owned by the employer. In case of hotel accommodation, the perquisite value is to be determined as 24% of the salary paid or payable or actual hotel charges paid by the employer, whichever is lower, for the period during which such accommodation is provided to the employee, explains Vikas Vasal, executive director of KPMG.

So under the new rules, should one opt for rent-free accommodation or claim exemption on HRA? “You should take a decision keeping in view your requirements, salary level, perquisite value and the tax impact,” adds Mr Vasal.

source:economictimes.com

Tax exemption on profit from home sale

Many a time, due to family requirements or due to re-location, a person intends to acquire a new residential house by investing the sale proceeds of his existing house property.

Is the capital gain arising from the sale of the earlier house taxable or can one claim tax exemption?

Who can claim the exemption

In case of an individual or a Hindu Undivided Family (HUF), the capital gains arising from transfer of a long-term capital asset — buildings or lands appurtenant thereto and a residential house — could be claimed as exempt under the provisions of the Act if such capital gains are invested in acquiring another residential house (new residential house).

Time period

The new residential house should be purchased within one year before or two years after the date on which the earlier house is transferred.

Similarly, the new residential house could also be constructed within a period of three years from the date of transfer of the original house.

Exemption limit

The amount of the capital gains that is invested to purchase or construct a new residential house is exempt from tax.

In case the amount of the capital gain is more than the amount of the cost of the new residential house then the balance amount of capital gain would be liable to tax.

Capital gains account scheme

In case the capital gains arising from the sale of the house is not utilised for the purchase or construction of a new residential house, then the tax payer may still claim exemption by depositing such capital gains in a specified account with any bank or institution as per the provisions of the Act. It is pertinent to note that such amount must be deposited under the capital gains account scheme before the due date of furnishing the return of income by the tax payer to claim the necessary exemption.

Further, the amount so deposited in the bank must be utilised for purchase or construction of new residential house within the time period specified above else the balance amount that is not so utilized shall be chargeable to tax in the financial year in which the period of three years from the date of transfer of original house expires.

Caution, if new house is transferred

If the new residential house for which an exemption as has been claimed as above is transferred within a period of three years from the date of its purchase or construction then for the purpose of computation of the capital gains arising from the transfer of the new residential house, the cost of such house shall be reduced by the amount of the capital gains to the extent an exemption has been claimed earlier.

Thus, say if the capital gains arising from the sale of the earlier house were equal to the cost of the new house, and an exemption was claimed for the entire amount of the capital gains. Now, when the new house is transferred within three years, then its cost will be taken as Nil. Therefore, the entire amount of capital gains arising from the sale of the new asset would be liable to tax.

Beneficial provision

If due caution is taken in respect of the time lines for purchase / construction of the new house, deposit of money into capital gains scheme and also in respect of the transfer of the new residential house, the capital gains amount from transfer / sale of the residential house could be claimed as exempt.

Some factors that investors need to track

The annual results season is here and the results from large companies will start coming in from next week. The results reason is crucial as the economic conditions have improved, and the government and Reserve Bank of India (RBI) have started getting out of the economic stimulus schemes. The foreign institutional investors (FIIs) have invested close to 20 billion dollars during the last one year and their confidence in the domestic economy and companies have grown with time.

These are some of the major factors investors should track during the coming results season:

Inflation

The inflation rate has gone to alarming levels during the last couple of months. The RBI has started tightening the monetary policy to control the situation. However, the changes in the monetary policy show an effect with a time lag of a few quarters and therefore it is important to analyse the performance of interest rate sensitive sectors and companies with extra care.

Currency appreciation

The currency has appreciated sharply against the major foreign currencies - dollar, euro, British pound etc. Analysts believe that further appreciation cannot be ruled out as FII inflows are quite robust, and the RBI is not planning to intervene in the Forex markets. Investors should evaluate companies that have exposure to Forex transactions.

Recovery

Most of the developed global economies have come out of recession but the recovery is still quite slow and not convincing. It would take a few more quarters before a clear picture emerges on the global economic front and investors are bound to get some negative news. Therefore, it is important to keep this fact in mind while analysing the results and making buy or sell decisions in the markets. These are some of the significant factors investors should analyse:

Compare performance

The first and most basic strategy is to compare a company's performance with its previous year's performance as well as with its previous quarter's performance. This gives a quick overview of the company's performance and generates questions to help further investigate the results. Investors can compare the results of a company with those of its peers and competitors. This helps in getting a quick feel of the general sector performance, apart from a comparative performance analysis. If the results are unusually good or bad, investors should try to find out the reasons. Investors should discount any one-time issues factored in the company's results that are reflected in its overall results.

Check ratios and parameters

Investors can also look at various parameters and ratios to analyse a company's financial health. For example , the order book, inventory levels, sales numbers etc. Some general information on various ratios and parameters is easily available. Also, follow the quotes of the company's top officials. This helps in getting a sense of what is happening inside the company.

Analyse macroeconomic conditions

Investors with a deeper understanding of economics can look at analysing the impact of various macroeconomic events and the current economic conditions on a company's performance. This will help in identifying and understanding the business-specific and sector-specific challenges.

Markets poised delicately

The domestic markets are at a crucial junction at the moment. They are trading almost near a 24-month high. The expectations from the coming results are very high, fueled by the improvements in the general economic conditions globally. But on the other hand, there is some apprehension on the inflation rate and the way the RBI will handle the current alarming situation. The valuations in the markets are no longer cheap and further upside movements will depend on a company's performance, global economic developments and flows from FIIs.

Source:economictimes.com

Rebalance your portfolio occasionally for better gains

You may find that I correlate investments to driving often, but I do seek simple ways of explaining financial concepts. Portfolio rebalancing can sound complicated, but needs to be done regularly to ensure that one’s investments do not carry risks which are not proportional — neither too high, nor too low — to what one can bear.

So, imagine that while driving a car on the highway at 80 km per hour, you see a red traffic light 200 metres away. You can continue speeding with the slender hope that the traffic light will turn green by the time you reach, and risk a sharp brake if it does not.

Alternatively, you can move to a lower gear, reduce speed and come to a gradual halt as you approach the traffic light.

Rebalancing is the process of restoring your portfolio back to its asset allocation targets. This may become necessary since some of the allocations may fall out of alignment with the original target percentage allocations for various reasons.

By following a disciplined approach to rebalancing, you will find that your portfolio does not overemphasise or de-emphasise one or more asset categories of your portfolio.

When is rebalancing required?

Rebalancing may be required when:
a) positions have become too large or too small;
b) your financial goal(s) have been achieved;
c) your financial objective(s) have changed;
d) your time horizon has changed.

Is there a marked difference?

Let us study an example of a portfolio where you have decided to invest 50% in equities, 40% in debt, 5% in gold and 5% in real estate. You have also decided to rebalance the portfolio at the end of every year. In the past 10 years starting January 2000, your portfolio would have earned you 14.1% pa compounded annually (see table).

It was possible to book some profits in December 2007 and also take the plunge into equity in January 2009 when most others dreaded to tread. Instead of rebalancing, had you invested Rs 100 in January 2000 and stayed put, your portfolio would have grown to Rs 295, or a cool 20% lower than the rebalanced portfolio.

We are not saying that an annual rebalancing is essential: we are highlighting the benefits of this process. So, as you approach the traffic light at a slower pace, and the light turns green, you get the advantage of revving up your car from second gear itself instead.

You do realise that this gives you a headstart to reach your destination faster, with less tension and definitely better fuel efficiency.

Infrastructure bonds: To invest or not to invest?

One of the fresh tax reliefs that have come as an outcome of the budget 2010 is the deduction allowed for investing up to Rs 20,000 in infrastructure bonds. While the FM is stressing on the advantage of the same, the benefits are not neutral for all individuals. Here is a take on the pros and cons of investing in infrastructure bonds for tax saving purposes.

Tax groups post budget 2010.

Tax group 1: Taxable income Rs. 1.6-5 lakhs
Tax group 2: Taxable income Rs. 5-8 Lakhs
Tax group 3: Taxable income above Rs. 8 lakhs.

To understand the pros and cons of tax saving investments we need to look at 4 major parameters:


Parameter 1 : Actual tax saving (let’s take the highest saving possible)

Parameter 2 : Returns from the investment (during the lock in period)

Parameter 3: Opportunity cost (what if you had invested the same money elsewhere?)

Parameter 4: Effect of inflation on the returns on investment (what would the worth of your investment when you redeem/encash it?)

Assumptions

For the sake of parameter two we will have to take an assumption on the lock-in period (as nothing has so far been announced by the Finance Minister). As is generally the case with most tax saving instruments we can assume two scenarios—3 year and 5 year lock-in

Let’s assume the rate of return on infrastructure bonds is 5.5 per cent per annum and overall rate of inflation is 8 per cent.

For people in the 1.6- 5 lakh taxable income group:

As per the new norms the income will be taxed at a rate of 10 per cent for this group.

Parameter 1:

Actual tax saving: 10 per cent of Rs 20,000 = Rs 2000

(If you invest Rs 20,000 in the instrument you get to reduce your taxable income by 20,000 thus giving a 10 per cent benefit)

Parameter 2:

What will be the returns at the end of the lock in period? For a lock in period of 3 years an investment of 20,000 would fetch an income of Rs. 3484. When added to the tax saved you'll get an effective return of Rs 25485 (Rs 20000+3484+2000) on your investment

Parameter 3:

If this same amount were to be invested in a market instrument that fetched a return of 15 per cent, you would get an effective return of Rs 27, 376 (Rs 20000-2000=Rs 18000 invested @15 per cent per annum for 3 years)

Parameter 4:

What would be the minimum amount required to counter inflation at 8 per cent? The amount would be Rs 25, 194.

Thus for a person in the slab of 1.6-5 lakh the benefits of investing in an infrastructure bond as a tax saving instrument will be only Rs 291 (Rs 25485-25194) whereas the benefit out of paying the tax and investing the balance in any decent instrument would be Rs 2182.

Similarly we can calculate the benefits for each segment as well as for a scenario where the lock in period is 5 years as given in the table below.

Slab - 30%
Tax savings - Rs.6,000
Effective Returns(3 yrs/5 yrs) - Rs. 29,485/ Rs.32,139
Investment returns from market after tax ( 3 Yrs/5 Yrs) - Rs. 21,292/Rs. 28,159

Slab - 20%
Tax savings - Rs.4,000
Effective Returns(3 yrs/5 yrs) - Rs. 27,485/Rs. 30,139
Investment returns from market after tax ( 3 Yrs/5 Yrs) - Rs. 24,334/Rs. 32,182

Slab - 10%
Tax savings - Rs.2,000
Effective Returns(3 yrs/5 yrs) - Rs. 25,485/ Rs. 28,139
Investment returns from market after tax ( 3 Yrs/5 Yrs) - Rs. 27,376/Rs. 36,204

Required returns to counter inflation effect - Rs. 25,194/ Rs. 29,387

Bottom-line

If you fall under the Rs 8 lakh taxable income slab, it makes sense to opt for the infrastructure bonds as a tax saving instrument.

If you are under the 5-8 lakh bracket it is advisable to invest in infrastructure bonds only if the period of investment is 3 years, not five years.

If you come under the 1.6-5 lakh bracket it is an absolute no-no to invest in infrastructure bonds for tax saving purpose.

Go online,buying MF units was never this easy

With increased internet penetration , most financial transactions have gone online. Not only online transactions take less effort, they are also easy to organise. Furthermore, a search for a history of transactions is easily possible. These advantages and more are available when you buy mutual funds online.

RESEARCH AVAILABILITY

With several hundred mutual fund schemes on offer, which one to buy is a tough question . Most websites facilitating purchase of mutual funds online offer live research support , which means you can check out the topperforming funds in each category for different time periods.

Comparisons can be done right up to the last NAV. In-house research teams also advise investors based on their individual investment horizons.

This apart, there are readymade asset allocation models you can use to construct your portfolio based on your age and risk appetite, and if you want to keep it simple, you can just mimic these model portfolios. You are also supported with various calculators.

PORTFOLIO TRACKER

Your portfolio is updated on a daily basis. Your entire mutual fund portfolio — be it in equity or debt — is consolidated and can be viewed on a single screen. “The customer’s portfolio is updated daily with the latest NAV and he can also see our research recommendation against the schemes,” says Vineet Arora, head (products and distribution), ICICI Securities. This helps the investor take decisions about his portfolio quickly and with minimum delay.

INTEGRATED PAPERLESS APPROACH

In the physical route, investors are burdened with paperwork and movement of paper. With online, they get the ease of transacting from any corner of the world at any point of time. You can just go online and invest. As internet banking spreads, the integration of your banking account with your mutual fund account also ensures seamless transactions and instant confirmation of transactions.

“When you transact online, you do not have to wait for paper to know whether your cheque is cleared, or something is missing in your form,” says Rajesh Krishnamoorthy, managing director, fundsupermart.com, a website where investors can transact in mutual funds.

INVEST IN SIP/SWP Investing in a systematic investment plan or a systematic withdrawal plan is a pleasure when you do it online. In the case of an emergency , even at the last moment, one can stop a payment. In the physical mode, one would have to fill in forms and send it to registrar, which would require a minimum of two days. An added advantage is automatic reminders that inform you when your SIP gets over.

BUY THROUGH BROKERS With stock brokers now being allowed to buy and sell mutual fund units through the exchange , you can also buy mutual funds by logging on to your trading account. However, it is yet to catch investors’ fancy.

QUERIES

Some websites give you an opportunity to build communities where you can interact with other investors. The communities provide a platform to clarify doubts on investments in mutual funds, financial planning and such other related areas

WHY ONLINE MUTUAL FUNDS ARE CATCHING ON

SEBI abolished entry load on mutual funds in August 2009. Prior to this, whenever investors invested in an equity mutual fund, they were charged an entry load of 2.25%. This amount was deducted from the investor’s investment by the asset management company (AMC) and passed on to the distributor as fees.

However, this has changed after August 2009. Now, distributors can charge an advisory fee from investors for their services and earn a trail fee of 0.5% from the AMC. The reaction of distributors to this move has been mixed. While some distributors charge an advisory fee for their services, others do not. Hence, this has reduced distributor margins.

For example, if a customer wants to invest Rs 10,000 in an equity fund today, a distributor may earn only Rs 50 as trail fees plus advisory fees charged if any, compared to Rs 225 which he earned as entry load plus the trail fees. Fall in margins makes industry players invariably look at boosting business volumes.

As a result, more distributors are going online because it helps to reduce costs and maintain their margins. For example if a customer invests online, he does not interact with an advisor, nor does the advisor have to physically complete the transaction for the customer. This saves valuable manpower cost and other servicerelated costs for the distributor which makes up the biggest component of distribution cost.

Beware of highest-NAV schemes

Over the last few months, one after another, a number of insurance companies have launched ULIPs which promise to repay the investor on the basis of the highest NAV that the fund has achieved. The pitch is that these funds' NAV effectively does not drop. Once a level is achieved, then the investor is assured of getting at least as much, no matter what happens to the market. It's certainly a very attractive idea. From the way insurance companies are stampeding into launching such products, I'm sure investors must be putting down their money in good numbers-in just a couple of months, six ins

urance companies have launched such products. Any investor who is told of this concept will immediately start salivating at the thought. Imagine how rich you could have been had you been invested over the last ten years and had been able to lock your investments at the magical value that the markets achieved on the day when the Sensex touched 20,873!

Any investor thinking about this product would say, "What a wonderful idea!" Why don't all investment schemes-whether mutual funds or ULIPs or even portfolio management schemes offer this kind of a protection on all their products anyway. The answer to this obvious question is simple. There is no free lunch. These products don't actually offer what you think they are offering. That is, they do not offer equity returns that never fall. Instead, they offer an investment system with a very long lock-in (seven to ten years) in which protection is achieved by progressively putting your gains in a fixed income assets which will give returns far more slowly than a pure equity option. The lock-in and the non-equity assets make this a very different kind of investment than the equity-gains-without-losses dream that these funds' advertising seems to imply.

However, even that's not the real reason that these funds are useless. The real reason is that if you are willing to lock-in for seven to ten years, then practically any equity mutual fund would deliver this dream of equity-gains-without-losses. Seven years is a very long time. Over such a period practically any equity portfolio into which any kind of thought has gone would capture substantial gains. This is not mere conjecture. Since at least 1997 the minimum total return that the Sensex has generated over its worst seven is 12 per cent, which was over the seven year period from 6th July 1997 to 5th July 2004. The truth is that in a growing economy like India's it's extremely hard to lose money over a long period like seven years. If you are willing to lock in your money for seven years, then for all practical purposes, you have a guarantee of making a profit.

Of course, this is not a guarantee that is signed in a contract and legally enforceable, but it's the kind of guarantee that any thoughtful investor would be willing to believe in. Mind you, this is also not a guarantee that you will get the highest NAV achieved but again, that's the kind of thing that can't be attained if you want the gains of pure equity anyway.

The most instructive thing in this whole business of guaranteed highest NAV products is the contrast between the illusions spun by those peddling complex financial products and the reality of simple, straightforward investing. It just reinforces one's belief that financial products are being designed whose goal is nothing more than to create a marketing hype which can manipulate the psychology of the ordinary saver.

Source: valueresearchonline.com

Home loan repayment reduces tax liability

You can reduce your income tax burden through the interest you pay on a home loan. Under Section 24 of the Income Tax Act, interest paid up to Rs 1.5 lakhs a year on a home loan can be set off against 'loss' from other heads for a self-occupied property.

In case the property has been acquired before April 1, 1999, interest up to Rs 30,000 a year can be set off. In case the property has been rented out, the entire interest paid is deductible from the taxable income after computing rental income. If the loan is taken for renovation, interest up to Rs 30,000 a year is deductible.

The pre-equated monthly instalment (pre-EMI ) interest amount (the interest amount paid during construction) is deducted under Section 24 of the Income Tax Act equally over five years from the year of completion of construction. It is to be noted that if you have taken a loan only for the land purchase, it is not eligible for any tax benefits.

In case you take a composite loan (for land and house construction), you will be eligible for income tax benefits only after the completion of the construction.

Tax benefits are available on loans to construct a residential property, buy a residential property, extend a house, and for major repairs or renovation of a house. The home loan is disbursed through a number of instalments as the construction progresses.

During the construction period, you have to pay pre-EMI interest every month. The entire pre-EMI interest paid is allowed as a deduction (under Section 24) equally over five years starting from the year in which the construction is completed.

However, for a selfoccupied house, the total deduction allowed towards interest on the home loan is Rs 1.5 lakhs a year. There is no limit for deduction on interest paid towards a second home loan, provided you add the rental income (annual rental value of your second house) to your income. The annual rental value will be the higher of actual rent received a year, municipal value, and fair rent fixed.

Out of the total annual rental value, there is standard deduction of 30 percent available towards maintenance charges and municipal taxes. The insurance premiums paid on the property can be deducted too.

The deduction in respect of principal loan amount repaid is restricted to Rs 1 lakh. In case you have taken a personal loan from a bank and used the money to purchase or construct a house, you can claim tax benefits on both principal and interest paid.

However, if the loan has been borrowed from a friend or relative, you can claim tax benefits on the interest paid only.

Co-owners can claim tax benefits separately, as per the shareholding in the property. If the shareholding is not mentioned in the purchase deed, they can execute an agreement on a requisite stamp paper, mentioning the shares in the property, and claim the benefits separately.

Both can claim deductions up to Rs 1.5 lakhs a year separately towards interest paid for a self-occupied house and the entire interest paid on a rented-out house, after computing rental income received, and also up to Rs 1 lakh towards principal repaid.

Under Section 80C of the Income Tax Act, home loan borrowers can claim a deduction of up to Rs 1 lakh from the taxable income on a loan repaid during the year, along with specified savings instruments.

Along with the other specified savings instruments, a home loan repayment amount, the amount spent on stamp paper and registration costs on registering a house, all up to Rs 1 lakh is deductible from the total income.

If you sell the property within five years from the year in which you started, you lose the tax benefits availed under Section 80C (on the principal loan amount) and the amount will be clubbed to the income of the year in which the property has been sold. However, you will not lose the deductions claimed on interest paid under Section 24.

source:economictimes.com

Strike a balance between different MF schemes

There was a time when investors preferring to invest in equity, had to focus merely on stocks as the portfolio performance depended largely on the market performance of the stocks. In the last decade and half, the options have grown manifold and investors have to choose between stocks and mutual funds (MFs).

Within the MF category, the choice of schemes too has grown substantially with over 1,000 schemes being available from over two dozen mutual fund companies. It goes without stating that the task of building a portfolio of mutual fund schemes is not an easy one.

While the choice is plenty, investors need not chase all stories or themes for their investments. In many cases, the difference between the investment principles of various schemes is very limited and hence investors can limit their options to a few schemes.

For instance, if an investor has decided to invest in a diversified scheme, it would not make sense for him to choose 6-8 diversified schemes though most feel comfortable when they have a bigger basket of instruments.

In reality, a smart mutual fund basket will focus on themes, investment strategy, the fund's ability to counter a downtrend, and most importantly, should have schemes which have a track record of good performance. Every downtrend makes this point increasingly relevant, and for longterm investors, this factor is even a necessity.

How does one go about the task of building an MF portfolio?

Start with a diversified fund as it requires minimum management and holds good for a longer period of time because of the investment being made across sectors. This could be as high as 70 percent of the portfolio if the risk appetite of the investor is low.

Over a period of time, the risk-taking ability generally comes down in line with the age of the investor. The risk capabilities also tend to come down when the corpus gets bigger and accounts for a large chunk of the investor's portfolio. Such investors will have to look at inclusion of debt in their portfolio.

In fact, allocation to debt has to increase over a period of time though it is not a bad idea to maintain debt allocation at all times. Not only will this help in better risk management but also allows investors to take the opportunities arising out of a market downtrend.

Take the case of an investor who had a good percentage of funds in debt funds in October 2008. He would have been one of the few who had the ability to take advantage of the steep market correction if his requirement of funds was not short-term.

Since volatility is an integral part of the equity market, investors, irrespective of their age, will benefit by allocating a portion in debt.

The biggest doubt many mutual fund investors have is whether they should opt for a balanced fund or strike a balance in the portfolio through allocation to debt and equity? The answer is yes and no.

A balanced fund invests up to 35 percent in debt and hence is a medium risk portfolio. This would be ideal for an investor who has earning years of more than 15 to 20.

On the contrary, a retired professional, who wishes to allocate a small portion towards equity, might end up with a higher risk portfolio even if he prefers a balanced fund. Hence, balanced fund should be considered a slightly lower risk option for equity investors, and hence should be viewed as a medium risk option for others. On the other hand, investors looking at striking a balance between various funds should stick to vanilla debt products for their debt allocation.

More importantly, an allocation towards a balanced fund is a good stepping stone for first-time investors who haven't had exposure to equity earlier.

Irrespective of the choice of schemes, one needs to build a portfolio of mutual fund schemes according to their risk-taking abilities and investment tenure as mutual funds, like other investment options, have volatility attached to them.

Source:economictimes.com

Do the due before investing in company FDs

As much as 55% of Indian savings find their way to bank fixed deposits. Over the past one year, fixed deposit interest rates from nationalised banks have gone down from 8-9% to around 6-6.5% now for a period of 1-3 years.

“With fixed deposit rates from banks coming down, investors seeking higher returns from fixed income products are investing in company fixed deposits,” says Aseem Dhru, MD & CEO of HDFC Securities, which has recently started distributing company fixed deposits. Company fixed deposits work for investors seeking assured returns higher than that offered by bank fixed deposits.

Here are some key points you need to keep in mind while investing in company fixed deposits.

Security

Company fixed deposits are unsecured. In case of bank fixed deposits, the Deposit Insurance and Credit Guarantee Corporation of India guarantees repayment of Rs 1 lakh in case of default. There is no such guarantee offered in company deposits and the safety of your deposit depends on the financial position of the company.

This means, as a depositor, you have no lien on any asset of the company, in case it goes into financial difficulties and is wound up. Your turn to get your money back would come only when secured lenders have been paid. So do not invest in unknown companies.

Risk v/s return

Today, investors could expect around 5-8% from income funds, depending upon whether it’s an ultra liquid fund or a long-dated income fund. Schemes like the post office NSC and PPF give you a 8% return, but are locked in for six years and 15 years, respectively.

A corporate like Tata Motors or Mahindra & Mahindra would offer you an interest rate of 8-8.5% while smaller companies like Avon Corporation or Ind Swift offer you an interest of 11-12% for a year. It’s a simple investment philosophy. “You trade return for risk”.

Definitely, the risk involved while investing in smaller companies is higher. Unless you need income regularly, you should prefer cumulative schemes to regular income options since the interest earned automatically gets reinvested at the same coupon rate, resulting in better yields.

Check parentage & financials

You can check with distributors or with friends about the credentials of the promoters and their past track record. Opt for companies that pay dividends and are profit making. Avoid loss-making companies or those who do not pay dividends. If a company has made a one-off exceptional loss in a particular year, but has a good parentage and past track record, you could consider it. Also, it is important to check the servicing standards of the company. How quick are they are in dispatching interest warrants and principal amount is something you should know. However, if the company is relatively new, or has been making losses continuously and its promoters are relatively unknown, then it would be better to avoid it.

Ratings are important

For NBFCs, RBI has made it mandatory to have an ‘A’ rating to be eligible to accept public deposits. Investors should go only for AAA or AA-rated schemes. Go for shorter tenures such as 1-3 years. This way, you can keep a watch on the company’s rating and servicing, and also have your money back in case of an emergency. Watch out for any adverse news on the company you have invested in and take necessary action if need be.

Liquidity

Most companies accept fixed deposits for a period ranging from 1-5 years. Compared to mutual funds or bank fixed deposits, company fixed deposits are rather illiquid. In most cases, premature withdrawal is not allowed before completion of three months. If you wish to withdraw between the third and the sixth month, you get zero interest income.

If you wish to withdraw between the sixth and the 12th month, you get 3% less than the guaranteed return. Also, for those staying in non-metros, in case the company’s banker does not have an account in their respective city, they would have to get a demand draft (DD) issued at a location where the company head office is located.

Similarly, when the company pays back the principal amount, the cheque may take time to clear. FDs are not listed and non-transferable. Interest income from fixed deposits is taxable. So if you are in the highest tax bracket, weigh your options accordingly. If there is a probability, you may need the money before a year, it is beset not to park it in company fixed deposits.

Do not put all eggs in one basket

“Depending on an investor’s risk profile, s/he could consider putting 5-15% of his or her investments in company fixed deposits,” says Anup Bhaiya, MD of Money Honey Financial Services. So if you have Rs 10 lakh to invest, it would then be worthwhile putting around Rs 1 lakh in company deposits for the extra Rs 3,000 per annum.

However, if you have a mere Rs 10,000 to invest, it may not make sense to invest it in company fixed deposits for the extra Rs 300, especially when your next door bank offers you more convenience and flexibility of investments. While opting for company deposits, diversify your risk by spreading your deposit over a large number of companies engaged in different industries. “Overall, investors could have as much as 10% of the total FD investments in one particular company,” says Harish Sabharwal, chief operating officer of Bajaj Capital.

Source:economictimes.com

How to invest in gold and key price drivers

Gold prices surged to a record high above $1,070 an ounce as dollar weakness sparked buying of the precious metal as an alternative asset.

Following are key facts about the market and different ways to invest in the precious metal.

How do I invest?

SPOT MARKET Large buyers and institutional investors generally buy the metal from big banks.

London is the hub of the global spot gold market, with some $18 billion in trades passing through London's clearing system each day. To avoid cost and security risks, bullion is not usually physically moved and deals are cleared through paper transfers.

Other significant markets for physical gold are India, China, the Middle East, Singapore, Turkey, Italy and the United States.

FUTURES MARKETS: Investors can also enter the market via futures exchanges, where people trade in contracts to buy or sell a particular commodity at a fixed price on a certain future date.

The COMEX division of the New York Mercantile Exchange is the world's largest gold futures market in terms of trading volume. The Tokyo Commodity exchange, popularly known as TOCOM, is the most important futures market in Asia.

China launched its first gold futures contract on January 9, 2008. Several other countries, including India, Dubai and Turkey, have also launched futures exchanges.

Exchange-Traded Funds: The wider media coverage of high gold prices has also attracted investments into exchange-traded funds (ETFs), which issue securities backed by physical metal and allow people to gain exposure to the underlying gold prices without taking delivery of the metal itself.

Gold held in New York's SPDR Gold Trust, the world's largest gold-backed ETF, rose to a record high of 1,134.03 tonnes in June. The ETF's holdings are equivalent to nearly half global annual mine supply, and are worth more than $37 billion at today's prices.

Other gold ETFs include iShares COMEX Gold Trust, ETF Securities' Gold Bullion Securities and ETFS Physical Gold, and Zurich Cantonal Bank's Physical Gold.

BARS AND COINS: Retail investors can buy gold from metals traders selling bars and coins in specialist shops or on the Internet. They pay a small premium for investment products, of between 5-20 percent above spot price depending on the size of the product and the weight of demand.

Key price drivers

INVESTORS: Rising interest in commodities, including gold, from investment funds in recent years has been a major factor behind bullion's rally to historic highs. Gold's strong performance in recent years has attracted more players and increased inflows of money into the overall market.

US DOLLAR: The currency market plays a major role in setting the direction of gold, with bullion prices moving in the opposite direction to the US dollar.

Gold is a popular hedge against currency weakness. A weak US currency also makes dollar-priced gold cheaper for holders of other currencies and vice versa.

OIL PRICES: Gold has historicaly had a strong correlation with crude oil prices, as the metal can be used as a hedge against oil-led inflation. Strength in crude prices also boosts interest in commodities as an asset class.

POLITICAL TENSIONS: The precious metal is widely considered a "safe-haven", bought in a flight to quality during uncertain times. Major geo-political events including bomb blasts, terror attacks and assassinations can induce price rises. Financial market shocks, which cause other asset prices to drop sharply, can have a similar effect.

CENTRAL BANK GOLD RESERVES: Central banks hold gold as part of their reserves. Buying or selling of the metal by the banks can influence prices.

On Aug. 7, a group of 19 European central banks agreed to renew a pact to limit gold sales, originally signed in 1999 and renewed for a further five years in 2004. Annual sales under the pact are limited to 400 tonnes, down from 500 tonnes in the second agreement, which expired in late September.

Sales under the agreement were low in the later years of the second pact, however. Gold sales under the second CBGA totalled only 1,883 tonnes, down from 2,000 tonnes under the first agreement.

HEDGING: Several years ago when gold prices were languishing around $300 an ounce, gold producers sold a part of their expected output with a promise to deliver the metal at a future date.

But when prices started rising, they suffered losses and there was a move to buyback their hedging positions to fully gain from higher market prices -- a practice known as de-hedging.

Significant producer de-hedging can boost market sentiment and support gold prices. However, the rate of de-hedging has slowed markedly in recent years as the outstanding global hedgebook shrank.

SUPPLY/DEMAND: Supply and demand fundamentals generally do not play a big role in determining gold prices because of huge above-ground stocks, now estimated at around 158,000 tonnes -- more than 60 times annual mine production.

Gold is not consumed like other commodities. Peak buying seasons in major consuming countries such as India and China exert some influence on the market, but others factors such as the dollar and oil prices carry more weight.

Source:economictimes.com