Mutual Funds for Financial Planning?

Although mutual funds carry risks, time & again, it has proven to be one of the best tools to create wealth over long term by carefully choosing funds and aligning them with one’s investment portfolio. In this article, let us understand how mutual funds help in accumulation of wealth.

Wealth Creation using SIPs

Goal based investing
As evident from the above table, it is simple to create wealth using SIPs (Systematic Investment Plans). But tying these investments with your financial goals is important from two aspects – first it helps you to realize that a key milestone such as your children’s education could be built with small regular contributions over a fixed tenure (15 years) instead of having to save several lakhs of rupees in the last 2 years leading to their college admission.

Next it helps you to stick to your investments regardless of market conditions because every investment has a rational financial goal behind it (similar to your term insurance plan). People who do not have a goal behind an investment find it very hard to stick to the plan due to fear of loss and lack of focus.

The goals could be strategic such as child education, wedding expense or building a retirement nest or they could be near term such as buying a house or car. Most investors think that investing is applicable only during the income earning phase of one’s life. However investing is equally important in one’s retirement phase too. Most urbanites live for an average 20 years after retirement and depending on fixed deposits alone would not help them meet their retirement income needs. Whatever be your goal, your financial planner could structure a portfolio that offers you returns that are commensurate with your needs and risk propensity.

Sovereign Gold Bond

**Sovereign Gold Bond Scheme 2020-21 – Series X, XI & XII to open in Jan-Mar’2021

Sovereign Gold Bond Scheme 2020-21 – Series 2 (Tranche 39) @Rs.4540 per gram, will be open for subscription from Monday, May 11, 2020 to Friday, May 15, 2020**

In 2015, the government of India had introduced the gold bond scheme to wean investors away from physical gold to financial (paper) gold. Prior to the introduction of this scheme, the government had rolled out a few other schemes such as gold monetization scheme which did not take off. However after a year of its launch, the gold bond scheme is showing a lot of promise!

What does the scheme offer?
Presently, investors can invest 1gm to a maximum of 4kg in an issue. Every investor will get 2.5% interest paid on their investment. The gold bond comes with a lock-in period of 8 years with an option for early redemption after 5 years. The capital gains arising on redemption of these bonds have been tax exempted. This incentive is offered only from this financial year so as to encourage Indians to shift their investment from physical gold to a financial product. Holding was previously allowed only on paper, but with this tranche, demat holding is allowed as well, bringing it at par with other financial instruments. The demat method of holding brings a host of benefits such as tamper-proof ownership, protection against theft/loss, transfer to legal heirs etc.

How does it compare with physical gold?
Buying of gold involves additional cost such as wastage, weight of precious stones (if any), making charge, GST etc, adding up another 15-20% to the cost of purchase (you could be paying Rs.4500 per gm gold whose market rate is Rs.4200). And when one sells it, s/he must sell it at a discount as similar factors such as wastage, less weight of precious stones & taxes, and get back 15-20% lower than the daily rate (you could get only Rs.3600 per gm for market rate of Rs.4500). All together one loses upto Rs.1000 per gm of gold in the entire transaction.

All of these losses are eliminated in gold bond since you will get the prevailing market price on sale of the bond. In addition, one gets an interest of Rs.100/gm per year of holding the bond. A typical investment of Rs.3Lacs will yield Rs.7.5k interest p.a in addition to providing the host of benefits listed above.

Macro-level Score card
The government has made a great start with this scheme. India’s imports of gold is 1000 Tons ($35bn), of which it re-exports 150 Tons. Approximately 850 Tons of gold is consumed by Indians p.a – assuming 1% of the population (1.3crore people) invest in gold in a year, it works out to 65gm per gold buyer. In the first year of issuing these bonds, the government has attracted investments worth Rs.1,320 Crores for 5 tons of gold from 4.5 Lac investors. This amounts to 11gm (approx) per investor. With more awareness and changing times, hopefully Indians will move to a smarter way of investing in gold and there by reduce the burden on current account deficit!

Is Insurance effective for Tax saving?

Regardless of whether one falls under the 30%, 20% or 10% tax bracket, everyone rushes to save tax by availing the maximum possible exemption of up to Rs.1 Lac via the 80c/ccc/ccd/cce deductions. Due to lack of social security, government encourages savings by granting tax deduction for investing in instruments that help save for retirement. A variety of instruments are eligible for such deduction to cater to the varying risk appetite of the public – eg. PPF, NSC, 5-year Fixed deposit, ULIPs (Unit linked investment plans), Pension plans, ELSS (Equity Linked Savings Scheme) etc. Although most investors use a mixed set of instruments, insurance policies attract greater participation in tax savings.

Savings achieved, but what about returns?
We see a number of tax saving policies spring up in the last 3 months of any financial year from various insurers luring 80C deductions even for single premiums. For someone in the highest tax bracket, Rs.1 Lakh invested in a tax saving insurance scheme helps save Rs.31,200 of your income – but what about the return from your policy? Have you considered higher returns from alternate investments?

As can be seen, PPF (Public Provident Fund) or even ELSS (Equity Linked Savings Scheme) could effortlessly give you 92% more return at the end of 15 years when compared to the return from your insurance policy. Not only that, in the case of PPF, you know exactly how much you’d get back in return at the end of the 15 year term, unlike the insurance policy where you only have an illustrative figue that by no means guarantee anything. So, tax saving using insurance policy works, but don’t you want your returns to be great as well?

Financial Planner’s take!
While it is important to save tax, what is more important is to make sure that tax saving comes as a benefit (or by-product) of an investment and not vice versa. Tax planning is about making sound investment choices which would provide you with reasonably good returns along with the benefit of tax savings. In essence, choosing the right 80C qualifying instrument should not just help you save taxes, but most importantly it must ensure such investments are aligned with your goals!

Is Insurance an effective tool for Retirement Planning?

Insurance firms these days offer to handle all of your life’s financial needs through a broad spectrum of insurance policies across investments, retirement planning and tax savings. Sure, these products are nicely packaged with benefit illustrations depicting your future returns. So, we need to analyze whether insurance products are really “effective” in realizing your investment, retirement & taxation needs.

What constitutes Retirement planning?
Retirement planning is all about accumulating a corpus to take care of your retirement life. Other important life goals such as children’s education, marriage and travel expenses too falls under the retirement planning needs of an individual. The main thread running amongst these needs is that they are all big-ticket items and are placed further out in your life.

Is insurance best suited for accumulating retirement corpus?
Investments for retirement planning are required to provide the best yield in its risk group so as to help you get to your goals without causing significant shortfalls/deficits. The returns of popular insurance products marketed for children education, marriage and pension plans offer much lower yields even when compared to no-risk instruments such as EPF (Employee Provident fund) & PPF (Public Provident fund). The yields from such insurance products barely beat inflation, making insurance policies effectively poor choices for retirement planning. The main criteria for choosing an instrument to meet your retirement goal is, it must accumulate the corpus by compounding at (positive) real rate of return (inflation and tax adjusted return).

You could avail the services of a financial planner to understand the kind of returns to expect from insurance policies that specifically target retirement planning areas such as pension plans, children education and marriage policies. Based on your risk profile the planner would recommend investments in a suitable asset mix and build a customized retirement portfolio which would grow at the required rates to meet your retirement goals. In effect the retirement planning process ensures that you do not hit any major negative surprises at the end of your income earning stage (or) commencement of your retirement!!

Is Insurance an Investment?

Over a 10-15 years time, a working adult typically purchases a variety of policies from his insurance agent. However buying too many insurance policies at different points in one’s life for a short term objective ( saving for 80c) without having a long term goal would only leave you with a mixed portfolio of policies with different premium paying terms, different maturity amounts, maturing at different times. Also most people do not realize that even after putting together all their policies they are under-covered with respect to their life – this is simply because they were not sold the right policies in the first place.

The classic conflict..
The objective of insurance is to provide compensation for loss and no more than that. Whereas the objective of investment is to provide the best returns commensurate with risks undertaken. Despite their conflicting foundation, investors would not choose to keep insurance & investment separate, why? This is because of the structure of the instruments and investor’s behavior response to these instruments.

Market-linked insurance premiums are designed to be very rigid, in the sense you sign the contract saying you’d pay a fixed premium for a fixed tenure and if you choose to drop out early, you accept to lose all or part of your premiums. On the other hand, mutual fund SIPs are designed to be more flexible both in terms of the amount and term – there is also no contract that says you lose all or part of your contributions should you decide to drop off anytime. Yet, investors choose the former over the latter.

Investor behavior!
Investors are usually driven by market sentiments and may hop on and off of mutual fund SIPs (Systematic Investment Plan) depending on market swings. However when they buy a market-linked insurance plan, they are most likely to stick diligently with their premium paying term due to fear of loss of premiums already paid. In a way, investors prefer the rigid “fathering” behavior of insurers and trust insurers to provide superior returns from the same market in which they could have independently invested via flexible Mutual fund SIPs. Surprisingly investor behavior shuns the freedom and flexibility of mutual fund SIPs while chooses the rigid insurance premiums.

Now the story on “returns”
When buying a market linked policy, a portion of the policy holder’s premium goes into buying risk cover (say 25%) and only the rest (75%) goes to buying units of a fund. So, you are already starting with a reduced capital compared to a mutual fund SIP. The life cover portion that the 25% buys would anyway not be adequate to cover your life. Next, even if the units earn the same returns, your insurer would deduct additional fund management costs and provide you only with lower returns than your mutual fund house.

On a cumulative basis, your absolute returns from the market linked insurance policy at the end of the 20 year term could well be 80% lower than your mutual fund SIP over the same term. There are other measurable and comparable attributes that your financial planner could throw light and provide you with the much needed insight. You could then make an informed decision  before buying your next instrument – be it a market linked insurance policy or subscribing to a mutual fund SIP!

Why do we buy Insurance?

Most people start buying insurance policy as a means to buy life cover, as small savings and to avail tax benefits. Some others buy children policy, joint-life policy and health insurance. Those who have a home loan would get a home loan cover for the outstanding loan amount. These days getting a health cover is more prevalant. Pension plans and annuities too have gained popularity in recent times. Infact a good majority of the 400 million Indian urbanites have bought some form of insurance or the other (apart from the mandatory motor insurance).

So, why do we buy insurance?
There is widespread belief among us that the sum assured in a policy means premiums paid are returned with assurance. In a way it is ingrained in our minds that insurance is some form of a “capital-protected” investment compared to other financial products such as mutual funds or equities. And given how religiously the Indian middle class pays their premiums over the last 30 years, insurers have been encouraged to offer a variety of savings plans, investment plans, market linked investment plans, retirement/pension plans and the quick selling tax saving plans (especially in March of every year) as insurance policies. To the extent until the pre-ULIP era, buying an insurance policy was considered a very responsible and prudent financial decision of every household.

What is the outcome?
With the opening up of the insurance sector to private players there are over 300 million policies in force – in 2011-12, 44 million new life policies were issued with a combined premium of Rs.2.87Lac crores (Rs.2.87Trillion). To put in a different perspective, in terms of premiums underwritten annually (life + nonlife), the life insurance segment contributes to 4.1% of India’s GDP. This outcome evidently puts insurance as a preferred financial product of Indian households right behind #1:fixed deposits and #2:gold. In terms of corpus accumulated, LIC policies alone have Rs.15Lac crores while all mutual funds (debt+equity) put together is half that amount @Rs.7.6Lac crores (including corporate accounts).

Some guiding questions..
Now that your insurance policy is no longer a pure risk cover and that it has an element of investment/savings attached to it, inquire along the below lines:

Consult with your advisor to help you find the right answers and guide you to make prudent insurance and investment choices!

Insurance – Basics..

Insurance is a risk cover, it offers monetary protection against unforeseen circumstances primarily loss of life. It offers an immediate estate to the bereaved family to help them meet their life’s needs for a petty sum to be paid periodically called the premium. There are a plethora of policies to suit a variety of people with diverse needs and premium paying capacity. Let us look at them in detail.

What are the types of Insurance?

Broadly there are 3 types of insurance that a policy holder need to be aware of – Life, General & Medical. Life insurance takes care of providing the family with a lump sum upon demise of the policy holder. General insurance is primarily your vehicle, property and travel insurance. Lastly medical insurance provides cover for your hospitalization expenses. Among life policies, there are again different types of policies to cater to the needs of diverse risk groups.

Do you know your insurance portfolio?
Take a quick self-test to check if you know all the policies in your insurance portfolio (by name and by type) and whether you fully understand the features, returns and restrictions they offer/impose on you.

How do you know which policy is suitable to you? Consulting a financial planner could bring clarity, structure and method to buying the right insurance policies that specifically covers your needs & risks. A planner could help you arrive at a life cover based on your needs and premium paying capacity and recommend suitable products. As for your savings, investment and tax planning needs, the planner could work with you and help you choose products that yield higher returns over the same/reduced tenure with equivalent (low) risk characteristics. In many cases clients find that doing an insurance portfolio review with a financial planner has produced outstanding outcomes that are beneficial both in terms of reduced premiums (up to 70%) as well as substantially higher returns (418%) over a 20-25 year time horizon. In this way you could ensure that you get the most out of your insurance portfolio!!

E-File your Tax returns if you do these transactions..

Were you one of the recipients of a letter from the income tax department regarding non-filing of your income tax returns owing to some transactions you have done since 2010? If yes, you are not alone. The department has sent out letters to several lakhs of PAN holders who have done certain transactions, which the department classifies as “high value transactions”.

With effect from FY2016-17, for items (2) to (6), the limits have been revised to Rs.10 Lacs p.a. And post demonetization, the government has banned all cash transactions over Rs.2 Lacs, with a penalty for violation equivalent to the amount of cash transaction.

What should you do?

While many tax evaders have been caught through this exercise, some PAN holders (mainly senior citizens) whose income was below the tax slab were also sent this notice as they may have sold inherited shares for over Rs.1 Lac or have invested over Rs.2 Lacs in Debt Mutual Funds to generate tax efficient retirement income. Nevertheless, such assessees only need to submit a response via the compliance section of the IT portal and file their returns as a safe means to declare their income for the respective year(s).

Who should file a tax return?

If you have done any high value transactions in a year, file your returns, otherwise the department will make you file it. Also, if you forgot to submit form 15G/H, TDS will be withheld on your interest payments – department will send you communication to file your returns – so file a return and claim the refund of the TDS withheld. Other cases where filing of returns is mandatory:

  • Gross total income before deductions exceed Rs.2.5 Lacs (Rs.3Lacs for senior citizens)
  • Long term capital gains from sale of shares, although exempt from tax, must be declared
  • Individuals with incomes of more than Rs.5 Lacs must do electronic filing
  • And ITR-3, 4, 4S, 5, 6, 7 have to be mandatorily e-filed

In the first round, IT department has sent out such letters for transactions done from FY2014-15, however it is learnt that letters are also being sent to assessees for high value transactions from FY2010-11. While you may have filed your returns, do take stock of transactions done by non-working members and senior citizens in your family!

NRI Taxation

When an Indian leaves his/her homeland and stays abroad for more than 240 days in a year (240 days is wef FY20-21, prior to that it is 182 days), s/he becomes a Non-Resident Indian (NRI). NRIs have been given special economic status and they enjoy certain benefits but are also restricted from availing others. Given that NRIs live in different countries, depending on India’s bilateral pacts with the respective countries, investments, repatriation and taxation differs vastly in each case. This becomes complicated for NRIs to make investments and deal with taxation on investment gains. In order to reduce the tax burden of NRIs from being doubly taxed in India as well as in their country of residentship, DTAA (Double Taxation Avoidance Act) was signed by India with over 70 countries.

How are NRIs taxed?
NRIs will have to pay tax on their Indian income, if it arises under any of the heads as described in the Indian IT Act. This may include rental income from house property, business/profession income, capital gains from sale of immovable assets & market securities (short-term & long term rates differ) and interest income. Several tax-reliefs have been made available to NRIs at par with resident Indians. These include 80C, 80CCC (contribution to pension funds), 80CCD (New Pension Scheme), 80D (medical insurance premium for self, family & parents) and 80E (interest on education loan). Tax liability needs to computed by taking into account DTAA provisions applicable in each case.

How does Tax planning help NRIs?
Proper tax planning is critical not only during income accumulation stage of an NRI, but also gains significance in the case of returning back to India post retirement. NRIs typically have assets spread internationally. For returning NRIs, the tax implications of global income in India and in the country where their assets are held would become paramount since their residency changes. They may also have US$ liabilities to pay off for higher education of their children, management of property investments abroad and some insurance obligations.

Apart from income tax, wealth tax aspects of Indian and global assets need to be taken into account. And Indian Income Tax laws change almost every year rendering it impossible for one to follow up with in light of all other responsibilities shouldered. This is where a Financial planner possessing sound knowledge in NRI taxation could add value to NRIs in advising the right investment vehicles to choose during income earning stages as well as during retirement. A Financial planner could proactively plan to ensure their NRI client’s tax liabilities are minimized not just in the year of capital gain or in the year of returning back to India for resettlement, but through out the asset building phase of their lives.

Buying an Investment Property?

For most people a second property is usually an investment property. Once the EMI for the first property is fully paid up or when additional income becomes available, people would start shopping for their second property. Just be aware that as with any investment, past performance is not an indicator for future performance in real estate as well.

Common mistakes when choosing your investment property..
The criteria used for the first home-buy greatly influences the second buy (both positive and negative influences). For example, if you had bought a first home in the city, you might want a second property tucked away from the hustle of the city. You now look for a suburban property which is in a quiet neighbourhood – and choose a property that meets your (self-occupation) criteria. The often forgotten objective at the time of choosing this property is that this is an investment property and not meant for self-occupation. So, when choosing your investment  property you need to keep in mind your potential buyer’s criteria (and not yours). This ensures that your investment is attractive to a potential buyer 5 years or 10 years down the line when you actually sell it. In this way, your property could be sold within a short timespan to the right target segment. Otherwise you would end up with a prolonged sales cycle and this could translate into lost opportunity cost.

Financial checklist for your investment property

The Financial planner advantage While property forms a main component of your investment portfolio remember it is not your only investment. Property is part of your overall investment planning. For people in the younger age group (<40 years age), property could make up to 70-80% of their portfolio, leaving very little to meet their other life-goals. Consulting a financial planner could help address the below issues:

It is also important not to undermine the risks of investing in real estate – it is not a liquifiable asset (not easily sell-able) during economic downturns and there may be periods in which it may not provide rental returns. There have been downturn periods even in the recent 10-20 years where real estate prices have receded and not offered investors with the expected return. Careful planning of your investments and striking a balance between real estate and other assets is critical in ensuring all your financial goals are well attended during your income earning phase. Depriving some of the goals and going overweight on one asset class would be akin to putting all eggs under one nest.