Archives April 2020

For most people, finance is the second most worrying factor, next to health. Throughout one’s active career, we face uncertainties about our future income, job, rising costs and desired returns from assets. On the other hand, various liabilities and expenses arise all through our lives. At times, when incomes match expenses, we get by. At other times, when there is a mismatch, it gives rise to stress about our finances. Such situations could be addressed if only we plan our financial journey.

How does a financial plan help?
A plan of your finances is very much like any other plan you make in your life. It has a goal, a purpose and more importantly a method to help you achieve each of your goals with reasonable ease. In its simplest form, a financial plan gives you the focus to secure your financial future.

When your money matters are in order, it frees up your mind and you tend to better focus on various other aspects of your life. This allows you to be successful and happy in whatever you choose to do. Hence, financial Wellness is all about “being-at-peace” with your finances.

How could YOU attain financial wellness?
The evolution of financial market in India presents new investing opportunities to YOU as an investor. From the traditional and time-tested bank fixed deposits, today’s markets have rapidly grown to present a plethora of financial products to investors like you.

Although you may have an overall understanding of popular products, investing in them requires deeper knowledge of the finance triology risk-return-tenure. However, with good quality guidance, today it is practically possible to make your money work smarter for you and create lasting wealth. Once you see that your plan works, you become a confidant investor and attain peace with your finances.

The single most investing challenge faced by investors today is “free-advise”. Here is a look at the issues, consequences and impact caused to you by such free advise.

1. Wealth erosion occurs when you are are looking for an investment product but sold an insurance policy.
2. A product-mismatch occurs when say you are looking to open a bank locker but your bank pushes you to sign up for a 20 year premium paying pension product.
3. A risk-mismatch occurs when you look to enhance your returns in safe products, but you are sold an equity savings fund – you are pushed to buy a high risk product on the pretext of returns.
4. An asset allocation mismatch occurs when someone prods you to buy your third property or gold without understanding your allocation is low to liquid assets.

So, at the end of 10-15 years, you hold many investments, some with positive returns, some negative and others with no idea on returns. As an investor, you find it nearly impossible to comprehend exactly how much return all of these investments collectively gave you – why?

Because the above approach is based on free advise whereby a product is pushed to you without trying to understand your actual needs, goals, risk ability & return expectations. Items (1) to (6) belongs to product-based-investing & (7)&(8) are returns-based-investing. These approaches often leave investors’ with a basket load of products that are not aligned to the timeline in which they actually need the “cash” to spend for their liabilities (like child’s education or retirement).

A goal-based investing approach gives you undeterred focus on your big picture and help you wisely invest towards fulfilling those goals at timeline(s) they become due.

As we progress in life, we make investments and derive income from multiple sources – wages, interest, rent, capital gains and so forth. And we are liable to pay tax on all such incomes, albeit at different rates. While all these incomes are “money”, the tax law distinguishes them into 2 categories – Cash Assets & Capital Assets.

Certain assets such as fixed deposits and recurring deposits form cash assets. These assets are generally regarded as safe, offer moderate returns and are taxed based on your income slab. On an average, about 60-70% of one’s financial assets is held in fixed deposits, which are highly taxed (30%).

Physical assets such as property, land, gold and capital market instruments such as stocks, bonds & mutual funds form capital assets. From a tax perspective, capital assets are more tax friendly than cash assets.

First, we understand the tax liabilities arising from various sources of your current year’s income and recommend investing in suitable tax saving instruments in a structured manner. This enables you to obtain the dual benefit of saving tax as well as gaining better ROI from these investments.

Next, we delve into your existing asset structure and identify areas of major tax leaks. Our tax planning could show how a simple re-structuring of your assets could help you not only save tax, but also double / treble your returns!!

The focus here is to save tax outgo from your hard earned income accumulated over several years of your career and make your money work smarter for you. This is where we could add significant value to you in saving excess taxes year-over-year for many years to come.

While resident taxation is sufficiently complex, needless to describe the state of NRIs as they are far more stretched on time to attend to tax matters in more than one country. This is an area we could be of assistance to NRIs – from determining if they are liable to file their tax returns in India to covering tax aspects of investments, capital gains and repatriation (with DTAA as applicable). Planner’s value-add comes in specifically to returning NRIs who needs advice on tax implications of their overseas income/assets in India and in preserving their dollar-investments against rupee depreciation.

Typically individuals are led to buying high risk products with a hope of high return, especially after markets have peaked out. This approach leads to low returns or losses to investors. As a result, they stay out of capital markets due to the mis-trust created by their sour experiences. A win-win solution to this problem is to move from product-based investing to goal-based investing.

Based on client’s investment preferences, Planner builds a customized portfolio with a mix of instruments such as Mutual Funds, Bonds, Equities, ETFs, Gold, Silver, Small savings / Post office instruments, bank term deposits and overseas assets.

While traditional instruments like bank FDs and post office savings need no expert monitoring, certain other products such as mutual funds need to be continually monitored by an expert due to changing market dynamics. Even within mutual funds, debt funds exhibit a completely different behavior when compared to equity mutual funds.

Given that most investors have about 50-70% of their portfolio in debt instruments, managing them periodically in light of the above debt market dynamics becomes a defacto mandate. The recent overnight closing down of 6 debt funds by Franklin (in Apr’2020) are the exact scenarios where your investment advisor could help you tide over poor fund choices. This is why investment management is an on-going process and requires investors’ portfolio to be managed by an expert continually.

The rise of the new middle class has opened up the Indian financial market with a new range of products that the previous generation had not heard of. As experienced by us, some of the new instruments offer outstanding returns beating inflation in the long-run while others have depleted our personal wealth. This has led to a mis-conception that new financial instruments are loss-making and that it is better to stay away from them. However, with expert guidance and adequate knowledge on the new financial products, investors could reap good returns in the long term.

Some of the questions individuals raise go deep in unearthing their real financial need, for example:

Today, Financial experts help address these fundamental questions for clients. We have the necessary knowledge, expertise and tools to evaluate the various investment products available in the market and to recommend suitable products based on your risk appetite.

What areas of personal finances are covered?

Wealth building is a critical exercise in ensuring your long term financial security.  Primarily it equips you with sound knowledge to make informed investment decisions that are right for you!

With interest rates falling further and holding period for capital gains reduced from 3 to 2 years in the budget, new buyers and upgraders are looking to get the best realty deals. However, not all is done upon locating the property to buy. Choosing a right home loan product is vital to ensure that your hard earned money does not pay for exorbitant interest costs.

Home Loan – Product

A home loan comes with a variety of options and bargains but borrowers are not usually presented with all the available choices to make an informed choice. They are usually sold a product which may not suit them best. Let us take a case of a new buyer (or) an upgrader who seeks a loan of Rs.30 Lacs. This buyer is typically coerced into a 30-year “Fixed interest rate home loan” based on the lowest EMI option of Rs.23k per month. As this amount is close to the rental outgo of the buyer, s/he readily tends to accept the product.

A “Fixed” interest rate is in favor of the borrower if only the macro-economic condition is in a low interest rate era (2017). Longer tenure means lower EMI, but it also means higher interest payments to the bank. Shorter tenure means higher EMI, but an overall reduced interest outgo for the borrower.

Low interest rate era

When we are borrowing in a low interest rate era as in 2017, then the interest outgo of fixed rate (A) & floating rate (B) is almost similar for a 30 year tenure. In either cases you’d be paying a whopping Rs.54 Lacs in interest on a Rs.30 Lacs loan. So, it is advisable to reduce the tenure to 15 years. If you do so, your EMI goes up from Rs.23k to Rs.30k p.m, while your total interest outgo is reduced from Rs.54 Lacs to Rs.25 Lacs, in cases (C) & (D) . Though in a low interest rate era, the difference in interest between (C) & (D) is not much, any further fall in interest rates could work to your advantage. So, pick a floating rate option with shorter tenure (D).

High interest rate era

If you were to borrow during a high interest rate era such as in 2013, then floating rate (Q) is way better than fixed rate (P) for a 30 year loan tenure. You may note that in fixed rate (P), you’d be paying Rs.50 Lacs interest (vs) the floating rate (Q) case, where you’d not only be paying a lower interest of Rs.37 Lacs, but you’d also be able to close your loan in 20 years. However, a prudent choice would be to go in for floating rate with lower tenure (S) to ensure you pay the least interest of Rs.25 Lacs on a Rs.30 Lacs loan and close your loan in 13 years. So, when you are in a high interest era too, it counts to choose a floating rate loan with a shorter tenure (S). 

Could total interest outgo be reduced further?

When you get some handy cash or bonus, you may want to quickly make a pre-payment to your home loan. Pre-payments done within the first 1/3rd period of the loan tenure (Eg. in the 5th year for a 15yr loan tenure) significantly reduces your interest outgo. The above table shows that prepaying even Rs.6L (20% of loan) at the end of 5 years, helps to significantly lower both the interest outgo as well as loan tenure across all scenarios.

While pre-payments are allowed at ZERO charges in a floating rate product, fixed rate borrowers may be charged a 2-4% penalty on pre-payments, if it is not from their “own source” of funds. The reason is in the floating rate case, borrowers already bear the interest rate risks, while in the fixed rate case, the banks bear that risk and hence require to be compensated. However do note that the banks have made the pre-payment process quite painful for fixed rate borrowers. Another reason to pick a floating rate home loan.

Before signing up..

The interest rates on your bank FDs will tell you in which era of interest rates you are placed. Ensure to get a couple of amortization (home loan) quotations & check on pre-payment options before signing up with your bank/housing finance company. Then, pick the best quote with a lower tenure even if it means a slightly higher EMI initially (your salaries will only go up with time & you’ll learn to spend wisely). Just ensure to keep 6 months of EMI in a FD for any contingencies and buy a single premium home loan insurance to cover your loan amount. Alternatively, you could also consult your financial planner before choosing a home loan product. You’re then all set to sit back & enjoy your new home!

Risks

Mutual Funds invest in securities such as stocks and bonds which are actively traded in the stock exchanges. Hence the risks involved in investing in the underlying stocks and bonds are applicable to the Mutual funds holding these securities.

• Equity funds would carry the highest risk since they are subject to volatility in the stock markets due to micro or macro-economic factors.
• Debt funds invest in government and corporate bonds, so they carry moderate to low risks. These funds are subject to macro-economic performance of the country (fiscal and trade deficit), interest rate situation, inflation, forex currency fluctuation and so on.
• Liquid funds carry the least risk since their tenure is low and most of them invest in sovereign gilt (government papers) which carries very low risk of default (for India at the moment).

Costs

The fund house charges you a fee as a fund manager actively manages your funds. There are annual expenses, management fees, distributor fees (upfront commission, trail commission etc), which are all lumped together and published as “Expense Ratio” of the fund. The expense ratio could range from 0.5% to 2.75% depending on the fund category. Generally ETF funds, gilt and passive funds charge a low fee while equity funds charge high fees. You do not need to pay the various fees explicitly but it all gets deducted from your units’ NAV value at the end of each day. Be aware that a very high expense ratio + average performance could erode your wealth, so when choosing a fund, you need to consider a fund’s expense ratio in addition to its performance.

Returns

Returns are commensurate with risks and investment horizon of the funds. For example, it is not prudent to invest Rs.5Lacs in equity funds if you need the money within 2-3 years. Similarly if you’re looking at wealth creation, it does not make sense to invest in gilt funds – for this goal, equity funds with 7-10years horizon is more suited as it could provide a CAGR (Compounded Annual Growth Rate) of 15-20%, which could not only beat inflation but also multiply your investment by 4x-6x.

Buy thru a distributor or online platform or direct from the fund house?

If you are investing through your bank or any of the popular brokers, they act in the capacity of a distributor. This means they get to earn commission by selling funds to you. There could be a window of opportunity for conflict of interest or mis-selling, so you need to be careful when buying funds via distributors. These days several online portals & mobile apps provide free accounts where by you are not charged anything for buying and holding funds via their portal (but you still pay higher expense ratio compared to direct plans). If your choice of say 8 funds is limited to a max of 5 different fund houses or AMCs (Asset Management Companies), check with your financial planner to see how much you could save (in thousands) if you switch to direct plans!

Saving and investing are two words used interchangeably, but they are indeed quite different from each other. While we stand to benefit from being a saver in certain financial aspects, it pays big to play the investor role in all the major areas of our finances, as can be seen in this article.

When to be a saver?

When buying depreciating assets such as white goods, gadgets & vehicle(s), it helps to be a saver. Even if you do not have 100% purchase money, try to save up to 70% of the cost of the depreciating asset and then make the purchase. This way your loan / EMI liabilities would be low and you could also quickly re-pay the balance amount, there by incurring minimal interest costs.

When to be an Investor?

When buying appreciating assets such as a home, it helps to be an investor. An investor too saves to pay for an initial down payment and takes a loan to complete his home purchase. Lets say Jai had saved Rs.10 Lacs in 2005 and made it as down payment to buy a home in 2005, by taking a 7 year home loan for Rs.40 Lacs. Although he incurs a total interest cost of Rs.13Lacs to repay his home loan, the appreciation of his property to Rs.80Lacs offsets the interest cost, there by making his investment worth the loan.

It seems to be simple to classify physical assets as appreciating or depreciating and decide to be an investor or a saver. But what about financial assets? How could you determine whether a financial product is appreciating or not? The secret lies in the mechanics of whether the product works on simple interest or compound interest.

Recurring deposits of Bank, Post office, provident fund schemes such as EPF, PPF & capital instruments like Mutual Funds are some examples of financial products that gives returns based on compound interest. A good investor would choose a product that provides him/her with returns that compound annually, where both the principal & the interest work hard to multiply your money over time.

To attain financial success, you only need to identify appreciating assets that compound annually and add them to your portfolio!

In Part-I, we explored 4 major leakages, which if prevented, could go a long way in saving your hard earned money. In this article, we are going to see 4 smaller but recurring leakages, which if left unnoticed, could deprive you of a significant contribution to your long term wealth.

Leak 5 – Tax outgo

EPF/PPF, children’s education fees & any home loan principal you pay takes care of your income tax rebate in section 80c. However, for those in the middle years of their career, who have completed their EMI liabilities, you may wonder if there are avenues beyond section 80c to save tax. This requires a fundamental shift in viewing assets as cash (or) capital assets. Cash assets such as bank FDs are draining on tax, so you may consider switching a part of them to tax efficient capital assets such as debt funds to plug the tax leakage.

Lets say Guru has Rs.25Lacs in bank Fds and he falls in the 30% income tax bracket. At 7% interest, he earns Rs.1.75Lacs on which he needs to pay Rs.54000 as tax – so his post tax returns is only 4.82%. Instead if he moves his Rs.25Lacs to a good quality debt fund, which offers a 7-7.5% return, he does not incur any tax outgo until he redeems his units.

By moving to good quality debt funds, over a 3 year period, Guru could have saved Rs.1.63 Lacs in taxes. And his Rs.25Lacs portfolio could have grown to Rs.31Lacs, in comparison to his FD plus re-invested interest at Rs.28.6Lacs. And imagine his tax savings over a 10 year period could add up to Rs.5.4Lacs (Rs.54k * 10)!

Leak 6 – Regular Plans of Mutual Funds

When you are a new investor in capital market instruments, there are many procedures such as KYC, extended-KYC & FATCA to be completed, may be more. So, it makes sense to start investing with your bank or broker, who could help complete these paper work for you. Such funds when bought through your bank or other distributors form “Regular Plans”. The expense ratio on these plans are higher than their “Direct Plan” twin.

Over time, with continued investing, your portfolio grows to a decent size say Rs.30Lacs – by then you may have gained knowledge of mutual funds & it would be a better idea to start switching to direct plans. The difference in expense ratio between regular plans & direct plans could be 1-1.25% on equity funds, which could trickle up to few lakhs over a 10 year period. However, it might help to review your portfolio with experts on an annual basis to ensure your portfolio has good mix of funds. Direct plans help you save the leak from the higher expense ratio of regular plans.

Leak 7 – Credit Card & Bank Accounts

Pay your credit card bills on time, always in full, unless it is a 0% interest purchase. Otherwise you will end up paying more interest like in the home loan case. Most people may also have 5 bank accounts in different cities, although they may use only 1 or 2 frequently. And in case you leave Rs.20000 as minimum balance in each account, your combined minimum savings account balance itself would be Rs.1Lac, earning a low 3.5%.

For each account, you may also have debit/credit cards, demat accounts or mutual fund folios. If left unnoticed, banks would be charging you up to a total of Rs.2000 per year per account. So, plug such smaller leaks too and use the saved Rs.5-6k to donate or even spend it on yourself. Even if this is too small a savings for you to ignore, do not neglect the fact that least used or unused accounts become victims of bank account frauds.

Leak 8 – Jewels

This is the only product in the country where someone daringly puts up a front page full size ad saying “only 10% wastage” and we still go for the purchase without one question. Alright, you paid for a 10% wastage, now are you being handed over the wastage gold as scrap? NO. Imagine a fund house or mobile company puts up a similar ad saying “only 10% wastage” – would any of us buy such a mutual fund or mobile? So, while we buy gold jewels for the love of gold and the pride of wearing it, be a little mindful before investing a good part of your hard earned money in gold jewels and save the leakage, especially in old gold exchanges.

Is that all?

Not really, in every transaction that you come across in life, price could be inflated due to many factors – brand (white goods), season (air-ticket, hotels), premium for reputed schools (admission / non-tuition fees) etc. It would help if we remember the tag-line “buyer beware” whenever we make a purchase. It might not be possible for us to fix all leaks, but the secret is to fix the big & recurring leaks. Remember there is no right or wrong choice here, it is all about making an informed choice – after all it is your earnings and so the choice is yours to make!

In this article, we are going to look at increasing your savings, while keeping income constant, by plugging the leaks on the expenditure side.

Income – Savings = Expenditure

Most of you may be familiar with this arithmetic, “Income – Expenditure = Savings”. The problem with this math is expenses being variable, savings too becomes variable. This is not good for your financial health in the long run. So, it is important to first select a certain fixed percentage (10% or 30%) of your income as savings and then spend the balance.

Leak 1 – Insurance policies

Insurance is required only to compensate you for any loss, other than term & medical policy, rest are not required for an individual. Insurance is not an investment, there is no such thing as saving through an insurance policy. So, in a bid to save tax, do not keep buying insurance policies that you do not understand. The nature of the product is very complex, returns/bonuses are unpredictable and it is one of the most mis-sold instruments in the country. So, save yourself from creating a recurrent leak.

Leak 2 – Rent (vs) EMI’s interest

Just as the rent that you pay never comes back to you, the interest part of your EMI too never comes back. So, when going for a home loan, ensure that the interest part of your EMI does not significantly exceed your rent payout.

Lets say Vijay earns Rs.70000 p.m. And he is evaluating 2 loan plans – Loan-A at Rs.30Lac / 15 years tenure / EMI Rs.30000 p.m. Loan-B at Rs.60Lac / 30 years tenure / EMI Rs.47000 p.m. Vijay would be re-paying a total interest of Rs.24Lacs on Loan-A and Rs.1.1Cr on Loan-B over the respective loan tenures. This means he is paying a monthly average interest of Rs.13k on Loan-A & Rs.30k on Loan-B, which he would never get back.

If Vijay is currently paying a monthly rent of Rs.15000, Loan-A might be right for him. He could possibly stretch his loan to Rs.40Lacs, paying an average interest of Rs.18k p.m. In case he stretches it to Rs.60Lacs in Loan-B, it could lead to the biggest wealth destruction for him. We shall see about this in detail in a future article.

Leak 3 – Home Loan Pre-payment

Many of us get bonuses each year during the tenure of our home loan. How many of us utilize it to pre-pay the loan and how many of us use it to buy a vehicle/white goods/jewellery?

Lets say Raj has a home loan for Rs.30Lacs / 15years / EMI Rs.30k. And he used his bonus of Rs.6Lacs to pre-pay his home loan, in the 4^th year of loan tenure. This translates to a savings of Rs.8Lacs in his total interest outgo – I.e, it plugs 33% of his leak in interest outgo.

Although your bank makes it difficult for you to pre-pay or foreclose the home loan, go in for a pre-payment – even a smaller amount of say Rs.2Lacs helps you to save a big leak. The secret here is to make maximum pre-payments within 1/3rd of your loan tenure – I.e if you have a 15 year loan tenure, try to make smaller pre-payments before the 6^th year to reduce your interest liability by 30-50%. Multiple home loan pre-payment(s) is your best aid in wealth building.

Leak 4 – Vehicle

Similarly, when your home loan EMI is active, try avoiding additional big ticket loans, especially one for a depreciating asset like vehicle. Try to car-pool or use cab-hailing services such as ola & uber. If you must buy a car, go for a re-sale vehicle. This way you could instantly save 30% on your purchase, say you could get a Rs.7L car at Rs.4.8L and plug in the high interest leakage on your car loan.

Do these changes really make a difference?

Long term wealth building is always about making every financial decision count. If you save Rs.8Lacs interest outgo from your home loan in the 4^th year like Raj and invest it in equity mutual funds, it could be worth Rs.26 Lacs (at 12% p.a return) by the time your home loan ends.

Instead if you get caught unknowingly in an ill-structured home loan, you forego yourself of the opportunity to increase your portfolio value by Rs.26Lacs. Similarly if you are mis-sold an insurance policy, you lose the opportunity to double your money immediately. Such is the power of plugging big leaks – they help to increase your savings even if your income is constant. In Part-II, we shall explore plugging some more money leaks.