Understanding Debt (the under dog) through Mutual funds(part II of II)

Taxation of long term capital Gains:

As mentioned earlier, unlike interest on Fixed deposits, which is taxed each year on an accrual basis,

in a debt Mutual fund, the gains will be taxed only at the time of withdrawal. This essentially means, you are liable to pay tax only (if) after you withdraw from the fund, now let  me explain how this works with an example.

In the above image, you can clearly see that this investment was done in May 2013 and withdrawn in March 2017, this means that, I am not liable to pay any tax for the financial years ending 31st March 2014, 31st March 2015, 31st March 2016, simply because, while interest from Fixed Deposits is directly added to your overall income, Gains from Debt MF's come under the purview of Capital Gains.

Now as per the Income tax Act, all gains from Debt Mutual funds whose holding period is 36 months or more are classified as long term capital gains. So in this case here is what will happen:

Since I have redeemed after completion of 36 months I need to first need to calculate the indexed cost of acquisition(ICA) for which I will need the cost inflation index of both the years i.e the year in which the investment was made and the year in which it was withdrawn. The cost inflation index is notified by the income tax department each year and is available in this link.

Step 1. In my case the ICA is Rs,1,19,808.31/- which means my inflation adjusted cost of investing in the particular debt fund was not Rs.1,00,000/- but 1,19,808.31.

Step 2. Once you calculate the ICA you have to simply subtract it from the Withdrawal amount to arrive at the Long Term Capital Gain (LTCG)

Step 3. Calculate tax applicable which in this case is 20%
Step 4. Subtract tax amount from withdrawal amount to arrive at your Net Value

Thats it....

(For a detailed calculation please drop me an email on ninadkamatcfp@gmail.com)

We can clearly see that, there is a difference of 1.6% in returns between FD's and debt funds. Now to put this into perspective over the long term, even if you do not invest in Equities considering that you are Risk Averse, a mere 1.6% difference in returns over 10 years in your investment means you have earned about 16% more returns by just switching to a product in the same asset class.

Think about it......

*The tax calculation is for demystifying returns on products discussed above, please consult your Chartered Accountant/Tax Consultant for your personal tax implications as they are most qualified to asses your Tax Situation.
Image source: Income tax website
Fund is mentioned for illustration purpose only. Please consult your financial adviser before investing. 

Understanding Debt (the under dog) through Mutual funds(part I of II)

Hello friends, its been a long time since I've posted anything (worthwhile) on my blog, but recently (last night around 1 am) I had an epiphany about DEBT. I thought I had covered everything in my earlier blog posts, but this epiphany changed everything and has got me thinking......Why do most personal finance related articles only talk about Equities...while Debt is a clear under dog.

To start with....

What is Debt?

Its a sum of money owed or due.

Example: I open a Fixed Deposit worth 1 lac with a bank, the bank becomes a borrower, because it owes me money that I lent it along with some interest.

Please understand, here, I have lent my money to the bank who inturn lends it to some other entity generates profits/reports losses  and then (more so in the Indian Context) pays me a measly interest on that sum which is taxed. Thus a bank is here not for social service/ charity but to make profit. More on this later.......

Lets Continue....

What are the (basic) different Debt instruments/products available:

1. Bonds..............Issued by Government. RBI, Public sector companies etc

2. Fixed Deposits....Issued by banks

3. Corporate Fixed deposits.

While a investor may choose to invest in either of the above products individually, a Debt Mutual fund offers a basket which usually consists of all/some or only one kind of the above product.

For example, a typical Debt fund comprises of (see image, click to enlarge) >>>

Thus a Debt Fund largely sticks to the eternal rule of Financial planning  "Never put all your eggs in one basket" (even if it is a low risk investment product like debt)

Talking about risk,... In the Indian context of investing, we have preferred Bank Fixed deposits the most without acknowledging the fact that a similar product exists in the investments domain which is tax efficient and generates a healthy real rate of return.

This is all the more important now a days as many reputed banks have reported losses in the recent quarters. Thus a mixed bag of Debt securities instead of a one product portfolio should be very helpful to you as an investor.

What are the returns like?

Now here comes the most important question, especially in India....कितना देती हैं ?

Firstly to measure returns, I  have considered a 3 year horizon only, more specifically because of the tax implications

If you look at the 3 yr return, then you might feel that the returns commensurate to that of a bank deposit but what you are not considering here is that unlike a Fixed deposit where your interest would be taxed each year (whether you choose to receive it or accumulate it) in a Debt Mutual Fund it is accounted as a long term capital gain.

Long term capital Gain(LTCG)

Now don't be awed and put off by learning this new term, because its going to help you generate better returns, and best of all, you only have to learn it once.

In Debt mutual fund parlance, any investment that has generated some gains/profits and has completed 36 months i.e 3 yrs  is classified as a  Long Term capital gain. This LTCG has a tax advantage to it, you can use indexation (adjusting the purchase price of an asset by the inflation rate) and avail of a big concession in terms of payment of tax.

To be continued in part II....

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

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SKYPE ID : ninad.kamat

Decoding the National Pension System (Part II of II)

Salient features of NPS

1. Low Cost - The investment management fee is as low as 0.0009% p.a., irrespective of the type of portfolio the account holder desires. Yes, there are some small fees charged for various purposes, but even then it is claimed that the asset management fee for NPS is a fraction of what Mutual Fund companies charge. 

2. Diversified Investment - The corpus will be invested in three asset classes –– Equity (E), Government Securities (G) and Corporate Bonds and Fixed Deposits (C).

3. Dynamic Asset Allocation -  The account holder can opt for an active choice i.e. change the asset mix at any time he desires or opt for a default option called Life Stage Fund, where the asset mix changes automatically depending upon the age of the subscriber. For example at the age of 18 years, the asset allocation would be 50% in E, 30% in C and 20% in G till the investor turns 35 when the ratio of investment in E and C will then decrease annually, while the proportion of G will rise. At 55 years, G will account for 80% while the share of E and C will fall to 10% each.

Because of the link of NPS with equities, you may stagger your investments in some installments like the SIP of a mutual fund. However, take into account that there is a transaction charge of 0.25% or Rs. 20 (whichever is higher) on every contribution.

4. Low annual contribution -  Minimum annual contribution is Rs. 6,000 per FY payable in one or more installments of minimum Rs. 500.

5.Biased Transparency - Transparency could be improved. Whereas Mutual Funds have to announce their NAV's on a daily basis, NPS would announce NAV on a yearly basis.

Now that we have understood the basics of NPS let us continue to calculations and for the sake of simplicity, I am comparing NPS to only Employee Provident Fund EPF(for now).

In the beginning, Rs 5,000 is put into each every month. Taking into consideration rising income, this amount goes up eight per cent every year. The EPF investment earns 8.75 per cent a year and let us assume (no not the aggressive historic return of 20% of equity markets) the NPS achieves a very conservative return of 12.75 per cent.

तीस साल बाद..... , Rs 68 lakh(approx) have been invested in both.

While the EPF account has Rs 2. crore(approx) in it,  the NPS account on the other hand will have Rs 4. crore(approx)in it. 

With 40 per cent of this amount, (Rs. 1.60 crore) the saver will have to compulsorily buy an annuity which will yield a lifelong pension. That leaves Rs 2.4 crore(approx) for a lump sum withdrawal. The tax outgo on the returns will be indexed but even if we assume that it will be ten per cent, we are left with Rs 2.16 crore!

You see, what the magic of conservative equity returns over a long period means!!

It means that even after paying for a lifelong pension-bearing annuity, and even after paying taxes, the saver will be left with a higher lump sum amount than EPF.

Clearly, this passion of savers for the false safety of fixed income returns, and the fear of the false dangers of equity are a prime cause of old-age financial stress among retirees in India. 

So, don't fall for conventional saving options, and embrace the NPS for your retirement savings. Of course, that doesn't change the fact that it's truly unpardonable for the government to give EPF and PPF a free pass on taxes and yet tax NPS at maturity.

With that let us come to the landmark announcement by our Finance minister in this year's budget. 

In order to give a (much needed) fillip to NPS, the FM has proposed a separate deduction of Rs. 50,000 over and above the current deduction of Rs. 1,50,000 available u/s 80CCE for contributions to NPS. Consequently, now it is possible for a taxpayer in the 30% tax bracket to save up to Rs. 15,450 in tax every year over and above what he could do so far. 

There is No Doubt that Retirement Planning should be the Numero Uno Financial Goal in any investors mind especially with rising life expectancy! I hope this tax benefit for NPS provides the boost in this direction.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source Behaviour Gap, PFRDA

Decoding the National Pension System (Part I of II)

This year the finance minister in his budget speech on 28th Feb 2015, made a revolutionary announcement with regards to the National Pension System or NPS. He created a separate window of tax deduction for this financial product aimed at retirement. Now, before we understand this budgetary provision in detail, let us take a look at the product, because even for a financial adviser like me, this product was quite confusing in its first impression.

What is NPS?

NPS or the National pension system was launched on 1st January, 2004 with the objective of providing retirement income to all the citizens. NPS aims to institute pension reforms and to inculcate the habit of saving for retirement among the citizens.

What are the different options available in NPS?

There are two options available, but for those who want to save for retirement and avail tax benefits you have to open Tier I Account.

Why you need to open a NPS A/c?

1. It is transparent - NPS is transparent and cost effective system wherein the pension contributions are invested in the pension fund schemes and the employee will be able to know the value of the investment on day to day basis.

2. It is simple - All the subscriber has to do, is to open an account with his/her nodal office and get a Permanent Retirement Account Number (PRAN).

3. It is portable - Each employee is identified by a unique number and has a separate PRAN which is portable i.e., will remain same even if an employee gets transferred to any other office.

4. It is regulated - NPS is regulated by Pension Fund Regulatory and Development Authority, with transparent investment norms & regular monitoring and performance review of fund managers by NPS Trust.

What are the tax benefits of opening a NPS A/c.?

Presently, the tax treatment for contribution made in Tier I account is Exempted-Exempted-Taxed (EET) i.e., the amount contributed is entitled for deduction from gross total income upto Rs.1.50 lakh (along with other prescribed investments) as per section 80C (as per the provisions of the Income Tax Act, 1961 as amended from time to time).

The appreciation accrued on the contribution and the amount used by the subscriber to buy the annuity is not taxable. Only the amount withdrawn by the subscriber after the age of 60 is taxable.

Additional Benefit Available till 31 March 2017

To encourage people from the unorganised sector to voluntarily save for their retirement the Central Government launched a co-contributory pension scheme, 'Swavalamban Scheme' in the Union Budget of 2010-11. Under Swavalamban Scheme, the government will contribute a sum of Rs.1,000 to each eligible NPS subscriber who contributes a minimum of Rs.1,000 and maximum Rs.12,000 per annum. This scheme is presently applicable upto F.Y.2016-17.\

What are the charges applicable?

To be continued....

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source Businesstoday.in 

Don't invest in Khatkhatem products choose Tax savings mutual funds instead.

A couple of weeks back I had written about an unhealthy concoction of investment products. After reading it one of the readers sent me a couple of queries on a popular messaging platform.

After carefully going through his queries and answers, here are my inputs....

1. I fully agree to his view that I need to make an apple to apple comparison, and the shortfall (27 years hence) is just Rs. 3 lakhs, but imagine that time in future when you will fall short of that same 3 lakhs for your child's wedding/ buying your dream car/house and you have to avail a loan for that purpose even after very well knowing that you could have achieved it easily by avoiding the 'khatkhatem' product.

2. I do not agree to his premise about the hassles of multiple products, as you can easily set up a direct debit (ECS mandate) in your bank account for the specified tenure for both the products, remember this needs to be done only once and the future debits will take place automatically.

3. I also differ from his view that most Indians would never psychologically invest in a term plan, as this article states that sales of online term plans are rising by 40%.

4. It is also important to note that, where pension income receive from insurance companies is taxable, withdrawals from PPF are totally tax free.

While it is great to see that my readers are financially literate (not taking the things I write for granted) and are aware of what is going on, this time I would like to build another perspective, and yes it must include Mutual Funds (what else).

I have talked about tax saving Mutual Funds (ELSS) earlier too but let us put them to use now by preparing a  Retirement Plan for the same friend I was talking about a couple of weeks back.

I have assumed that he is going to invest the same amount of Rs. 61,000/-(70,000 less term insurance premium) per year only on a monthly basis.

So, the investment per month is of Rs. 5,080/-

Let us now assume that in the next 27 yrs we will achieve only half the returns.

So 15% (approx)

Investment amount 

= Rs 5,080 x 12(months) x 27(yrs)

= Rs. 16.45lacs(approx)

Value after 27 years @ 15%

= Rs. 1.86 crores

It is clearly seen that even after applying probability of risk(50%) this investment is still worthwhile and generates better wealth in the long term.

So what are you waiting for.... start a SIP in Tax saving mutual funds today.......

Don't forget to download the friday financials app on android

Disclaimer : Funds are used for depicting long term performance and should not be construed as advice for investment.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source Valueresearch online 

The Khatkhatem of investment products

It's heartening to know, so many of you have visited my blog even though it's been a long time that I have written anything, but believe me, nothing interesting was happening that I would have liked to share with you all, till yesterday.

Case study

Yesterday, (yes I know it was a Holiday but I was working/helping) I was approached by a friend who had been advised by an "insurance adviser/consultant" on a certain investment cum pension product with added life cover from a well reputed insurance company.

In konkani cuisine, there is a very nutritious and ethnic dish called 'khatkhatem', which is essentially a curry of a variety of  vegetables. While the essence of this dish is to provide a nutritious meal to the consumer, the above combination of insurance, investment and pension is totally unhealthy and a recipe for disaster.

Now this (story) product (being from an insurance company) has three parts to it .

1. Pay an annual premium of  Rs.70,000/- for 27 years. After which my friend would get Rs, 68 lakhs at his age of 60.(graphic attached)

2. He was also going to get a life cover of 60 lakhs.

3. Invest the accumulated 68 lakhs in a pension product (of the same company) at the age of 60 to get Rs 5 lakh per anum for his lifetime. (approx 41000 pm in 27 years)

Here is what I had to say to my friend (for the sake of simplicity I advised him in 

1. Contribute the same amount of Rs.70,000/- for 27 years in a simple product like PPF, your gross returns stand at 81.6 lakhs.(graphic attached)

2. Buy a term life cover of Rs 1 crore costing Rs. 15,000 annualy. Your returns even after deducting the term life premia from the PPF investment are 0.55% more and additionally you are getting 9.6 lakhs.

3. Pension always needs to be linked with inflation. If we consider a yearly expense of Rs. 2,40,000 and inflate it by 6%, then in 27 years my friend would need about 11.57 lakhs per anum, what good will that 5 lakh pension for life do if his requirement is more than double of that?

Coming back to the pension requirement from age 60 yrs, if I trace back the retirement corpus my friend needs, based on a yearly expense of 2.4 lakh, a figure of nearly Rs. 2 crore pops up. Mind you this is the inflation adjusted figure unlike a fixed pension beneift.

This friend of mine is risk averse, (In India who isn't?)  Hence my advise to him was, don't invest in Equity Mutual funds, but stick to simple products and you are much better off than falling prey to a mis - seller. In the coming years you can increase your investment whenever your income increases.

Cost: 

The commissions that agents selling mutual funds, Reserve Bank of India and other bonds and Post Office deposits, as compared to that received by insurance agents are a scandal. The commissions are enormous, generally around 15 per cent of first year premiums and 7.5 per cent in the second and 5 per cent from the third year onwards. For a financial product that is supposed to be an investment, this is a shocking level.

The above incident was a clear case of buyer beware. If you buy insurance as investment then your fixation for Guaranteed returns will ultimately pinch you very hard in the pocket, not necessarily right away but surely in the years to come. More importantly, buying illiquid insurance products will only diminish your choice of savings.

So, don't invest in Mutual funds, but don't hit yourself in the foot by buying unhealthy investment products from insurance companies, Agreed that their job is to sell, but it is for you to decide whether that concoction suits your financial life.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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स्वच्छ भारत अभियान

Monday morning I received this forward from one of my friends on a popular messaging application platform on the mobile, it was about committing to the स्वच्छ भारत अभियान....

As a citizen of of India

I Commit that I will not throw

any garbage/waste on road/street

but only in dustbin or location

provided for the same.

I shall also spread this message

to my near and dear ones! 

This is an excellent initiative by our Honorable Prime Minister who himself symbolically wielded the broom on Thursday to launch a nationwide campaign that aims to clean up India in the next five years. The PM chose Valmiki colony in Delhi's heart - a place which was once home to Mahatma Gandhi - to do the sweeping in a small area for a minute, in the company of party colleagues and officials. He said that the स्वच्छ भारत अभियान should clean up the country by 2019, the 150th anniversary of Mahatma Gandhi.

He has further invited a set nine of popular celebrites and bureaucrats including Goa Governor Mridula Sinha, master blaster Sachin Tendulkar, Congress leader Shashi Tharoor, Bollywood actor Aamir Khan, Priyanka Chopra, Salman Khan, Yoga guru Ramdev baba and a team of 'Tarak Mehta ka Ooltah Chashmah'. 

While this mission is about the Gandhian principle of cleanliness, I feel the same applies to our financial life.

Here's how you can clean up your financial mess and streamline your finances by following the 3 simple steps given below:

1. Clean up your Insurance Portfolio:

Most of us have a number of traditional life insurance policies(sometimes only1). Its important to not mix insurance with investments and keep/buy only those Insurance policies which offer pure life cover and nothing in return at the end. This ensures that you are not earning negative real returns and actually utilising your money resources in the most effective manner. Now this does not necessarily mean you need to buy Term cover and go on "Hibernation", diverting surplus funds to better products like PPF, SIP's and taking sufficient Health Insurance is equally important.

2. Clean up your Investment Portfolio:

Over the years we all have "collected" investment products which have been either forced upon us by way of excellent sales and marketing techniques or because of our fixation and affection of fixed and guaranteed returns. This has led to accumulation of many junk investment products which have no defined purpose in our financial life. Take this opportunity to clear the mess and withdraw/redeem such investment products, start from ground zero if need be, by preparing a financial plan.

3. Prepare a Financial Plan

Financial Planning follows a well defined process, hence it can really help you streamline your financial life. In the first step itself it defines your current financial situation(starting from ground zero) followed by developing your financial goals.... (see image).Financial planning provides a road map for your financial life. It can make the journey less stressful, more fun, and more successful. And, you can start right now — even if its only a few steps at a time. If you do not have the time or expertise to prepare a financial plan connect with the right Financial Planner

If you go to see, it is not really necessary to find some or the other reason to start cleaning India or our financial portfolio's for that matter, but its always better to have a mission with a vision. You cannot embark on a journey without a destination. The स्वच्छ भारत अभियान is clearly a mission, and a clean India by 2019 a Vision of our Honorable PM. Although this looks like a herculean task, believe me, its very much achievable, after all you are going to spend 100 hours every year out of the available 8760 hours which is a little more than 1% of the total available time.

Don't forget to add a similar amount of time to clean and streamline your Financial Portfolio. After all this cleaning, I ensure you, you will have achieved peace of mind and increased your productivity multiple times.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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