Need regular income? There are better options to FD

In the last post I had said that we will need to look at a category separately, those who are retired or otherwise and seek regular income for their expenses. Most of these people keep their money in Bank FD’s. Some look at slightly riskier options of corporate FD or NCD in order to earn a little more interest. In this post I will examine options such people have in looking at other instruments.

Now, to give some structure to the discussions let us assume the investor will need 6 lacs per year for his expenses, given that he has a home to stay in and his children being settled financially. If he has 1 crore out of his retirement proceeds or other assets, one option will be to put it in FD. As a senior citizen he will probably get a rate of 7.5 % per year today. So he gets 7.5 lacs in a year which will be good enough for his expenses. As a senior citizen his taxes on this will be 60000 Rs, can also get reduced if he invests in 80 C instruments, medical insurance etc.

So, if this seems to work, why should they just not do it? Firstly, there is no guarantee that the interest rates will not go down further. Secondly, inflation is always going to be a factor and even with a 6 % inflation the costs will double in 12 years time. Thirdly, as no one can predict the life span it will always be better to have some growth factored into your portfolio. In the FD scenario there is absolutely no growth. Fourthly, with increasing expenses you will soon be eating into the capital and may reach a situation that you run out of money long before your passing away.

Let me outline some alternatives with the pros and cons that the investor can look at. I will not go into too much theory here, those are all available in my blog or in the public domain. 

• Keep the money in the dividend option of MIP funds. These funds mostly give a monthly dividend which will be tax free in your hands. However, there is a Dividend Distribution Tax the fund house has to pay.
• You can also use the Growth option of MIP and redeem to the extent you need money every month. It will be better to do this after your investment has crossed 3 years as you can get the benefit of LTCG indexation.
• If you have planned earlier then set up 3 year FMP. As they mature you can use the capital gains for your regular expenses and reinvest the Principal amount in other FMP. With the rates coming down you may want to invest in dual advantage FMP to get incrementally better returns, though with some element of risk.
• You can put your money in ICICI Balanced Advantage or similar funds which allow selection of dividend in a defined manner. At a rate of 9 % your returns will be adequate for your expenses and dividends are tax free in your hands. However, as the equity exposure is significant here, the element of risk is also high.
• The above strategy can be also used with Equity Savings Funds, Dynamic Funds or even pure Equity funds as long as you are able to afford the risk.
• Finally, you can of course try a combination of the above.

How do I invest myself ? Well, for several years now I have no Fixed income product except for Post Office MIS and that was done with a specific purpose in mind. My alternatives have been in FMP, Balanced funds, Gilt funds, MIP, Equity Savings Funds and so on.  For the debt space, I feel I have got a good balance between decent returns and good tax efficiency.

I will write in some details on these later on and also share a couple of real life case studies.

So what is the alternative to FD’s ?

In the last post I wrote about why FD as an investment is not at all a suitable one. It offers low returns and is clearly not tax efficient. The natural question therefore is, which are the investments to replace traditional bank FD? In this post I will try to answer the same.

Let us first look at why do people invest in FD. There can be many reasons but 3 of them are the most common ones:-

1. Many people simply do not know of any options for savings and think this is a safe way which will also earn some returns.
2. Some investors look at FDs as a good place for an Emergency fund and also for any goal that may be coming up in the next 1-5 years.
3. Retired people and others who want a regular source of income keep their money invested in FD for the longer term.

In this post I will deal with the first two as the last one is more complex in nature and deserves to be dealt with separately.

For the first category of people, if they are able to keep the money for long term, my recommendation will be PPF. The returns here are more than FD today and they are tax free. Moreover you get 80 C benefits with PPF, so if you have not exhausted your 1.5 lac limit through other means, this is a great benefit. Also, though PPF is for a 15 year term, you can make withdrawals after 6 years. Finally, if you start early, this will be a great backup to your MF redemption, in the years which are not good for equity.

What if you do not want a long term product such as PPF? Well, one option can be Arbitrage funds which will probably give you returns of around 7 %. While this is pretty much the same as FD, the tax treatment is much better as you will not be paying any taxes on the capital gains after one year. You can therefore park your money here and redeem it in a tax free manner for any needs in an ongoing basis. Arbitrage funds are also quite risk free as far as your capital is concerned, unlike equity funds.

Regular Debt funds or FMP, MIP etc will work if your time frame is at least 3 years. This is the time you need to keep your money to get indexation benefits for LTCG. Note here that with the Cost Inflation Index ( CII ) being dampened due to lower inflation numbers, you will still need to pay some taxes but this would be on a much lower scale. Also, as the interest rates will go up, Debt funds and MIP are likely to have a lower return. We are pretty much at the bottom of the cycle and rates will go up in the next 1-2 years. Finally MIP will do very well if equities are doing well but therein lies the risk too.

In conclusion for the first category of people, use the following strategies:-

• If you are OK with a little risk go for MIP and Debt funds.
• If you are having lower risk taking ability but can wait 3 years or more go for FMP. Here too you can look at Dual Advantage FMP if some risk is all right.
• In case you do not have 3 years and are looking at moderate but steady returns, look at Arbitrage funds.
• If you just want to save and are not going to need the money for long, look at PPF.

What about category 2 people? Many financial planners will advise you to withdraw from equity and part the money in debt some 3 years before your goal etc. I have never found any sense in this as you might really be losing out on growth by such actions. At the same time being purely in equity is not a good idea either. You need to take some middle path which balances the needs of both growth and safety.

• Higher risk takers can try Equity Savings Funds or Balanced Funds.
• Moderate risk takers can try MIP, Dual Advantage FMP, Debt funds
• Risk averse investors can try FMP, Liquid funds, Arbitrage funds

Note here that the higher risk options are more suited to 3 years plus time frame.

So, there you have it. Now that you know what to do with your money which is in bank FD’s, go ahead and stop those. You will soon thank me for having written this post !!

Do you still invest in Fixed deposits? Need to change

As the readership of my blog and also the Facebook group has increased, I get a lot of queries from readers on how should they go about making a financial plan and their investments. There are also many requests from my friends and relatives in terms of reviewing their current investments and make suggestions on the same.

One of the things which surprises me every time I see it is the continued fascination that many investors still retain for Fixed deposits. Yes, I understand that they are perceived to be safe and highly liquid but from an overall financial perspective they really do not make any sense at all. Let me give you a few examples to illustrate my point.

• A senior IT executive working in an MNC from Bangalore, had more than 30 lacs in FD. He said he was keeping it handy for his daughter’s higher education or marriage as the case may be.
• Another IT professional from Kolkata working in TCS was having more than 20 lacs in FD. He said it was a combination of Emergency and contingency fund.
• A cousin of mine, who is a Doctor with a private practice, recently approached me for suggestions on how he should invest 35 lacs that he got from FD maturity.

Note that these are people who are well educated, see TV a fair amount, read financial and other newspapers and are exposed to various financial blogs. If despite these they are investing in FD as a main channel then one can well imagine what most other investors from small towns or villages are doing. So while the Mutual fund SIP figures have greatly grown, the number of investors in FD and the amount of money they have in these deposits are still a mind boggling number.

But why am I saying that you should avoid FD in the main? Note that I have no issues if you have some 2-3 lacs in FD for Emergency purposes, though even that is not strictly necessary. Let me take the case of my cousin who had 35 lacs in FD till June of this year. 

• The older FDs were at a higher interest rate so he was getting 9 % interest on them. 
• His annual earning out of the 35 lacs was 3.15 lacs. All of this was taxable at 30 % as his other income is significantly more than 10 lacs.
• The effective return was therefore only 6.3 %.

When the older FDs matured his banker told him that the best possible rates were 6.9 % in his bank. That would mean an effective rate of less than 5 %. It finally dawned on my cousin that it was really against common sense to renew the FDs. Even though he was told by his banker that other options are risky, he stuck to his guns about the renewal.

Are you like any of these examples listed above? Do you have a lot of money in FD and are paying taxes on the interest earned? If you are not paying taxes it is worse as the IT authorities are keeping a very close watch on all the FDs, even where a Form 15H or 15G has been submitted.

I think all readers are convinced by now that FD is really not a good idea. But the natural question then is, what do we invest in then? Will it be safe? What about liquidity? There are fortunately good answers to all these questions. I will write about it in the next post.

 

FMP investments may not pay off now

Followers of my blog will know that I have significant investments in Fixed Maturity Plans of fund houses. These were undoubtedly the best instruments till 2014 where the LTCG indexation was available after 1 year as opposed to 3 years for other debt funds. In that period all capital gains from FMP were akin to tax free income for me

While the Finance minister changed the LTCG time frame to 3 years in the budget of 2014, FMP was still a viable instrument if you were willing to hold it for 3 years. The reasonable returns, coupled with the indexation benefits made it more attractive than many other Debt funds. Personally, I rolled over all my FMP investments to 3 years and that worked quite well for me – I used the capital gains for my regular expenses, mostly discretionary ones, and reinvested the principal amount in FMP or other hybrid funds. Of late I have preferred Hybrid funds rather than pure Debt focused FMP.

So why do I say now that this is no longer something which can pay off? There are two broad trends in this space that forms the basis of my opinion. Firstly, with the lowering of inflation and consequently the interest rates any fresh FMP will be likely to give returns only between 7 % and 7.5 %. Remember that by it’s very nature FMP’s invest in securities at the start of term and hold it till maturity. While this provides good downside protection, it obviously does not work well when the interest rate cycle reverses direction. For example even if the interest rates increase by 100 basis points next year, the 3 year FMP I start now will not get any benefit from the same. 

Secondly, with the inflation rates in the economy having a downward trend, the Cost Inflation Index is rising at a much slower pace than before. As a result the indexation benefits one was used to getting earlier will be significantly lower now. In real terms this means higher capital gains after indexation and therefore a higher tax liability. These two factors combined will mean that your effective post tax returns from FMP will be much lower than it used to be 2 years back.

Let me try to illustrate this with a real life example from my portfolio below:-

• An ICICI FMP bought in November 2013 and rolled over subsequently has now matured in July 2017.
• Purchase cost was 1 lac, Redemption was done at 1, 34, 529 Rs and the indexed purchase cost with application of new CII was 1, 19, 809 Rs.
• Capital gains after indexation is therefore 14, 720 Rs. Tax on it @ 20 % is 2944 Rs.
• Effective returns over 3.5 years is therefore 31.5 %
• CAGR over this period will be only 8 %

Now while a post tax return of nearly 8 % is definitely not bad in today’s scenario, remember that this will keep getting worse and will be a lot lower for an FMP you are entering today for the next 3 years.

Now if we agree that FMP is not the preferred instrument of investment right now, the question remains as to where can we invest then? I will recommend Hybrid funds that have some exposure to equity apart from debt. Look at the following options:-

• Dual Advantage Funds among FMP space
• Equity Savings Funds
• Monthly Income Plans
• Dynamic Funds

All these will come with some risk exposure but 3 years on our markets should be doing better than today anyway.

New Cost Inflation Index – know about it

One of the important aspects in personal finance is to keep track of the regulatory and policy changes in order to see if they affect you in any manner. While a lot of these changes are announced in the budget speech of the Finance minister, several of these can and do happen throughout the year. One such thing which many of us have missed is the new Cost Inflation Index ( CII ) with the new base year ( FY 2001-2002 ). Let us see what the changes are and what does this mean to you.

For those who are interested in the CBDT notification of the new CII read here. In simple terms the base year for the earlier CII was 1981 and the base was taken as 100. Every year the government announced the CII for that FY. In the year 2016-2017, the index was at 1125. In real terms it meant that if you had acquired an asset for 100 Rs in 1981 and was selling it in 2016, then you could take the cost of the asset to be 1125 Rs and look at your capital gains accordingly. Let me give a real life example to make this clear.

• Assume you bought a 3BHK flat in Kolkata for 18 lacs in 2001.
• You wanted to sell it in 2016 for 1 crore.
• CII in 2001 was 426 and in 2016 was 1125.
• The indexed purchase cost to be taken in 2016 will be 1125/426 x 18 lacs or 47.53 lacs. The capital gain will therefore be 53.47 crores.
• You can use the capital gain in buying another property or invest it in Capital gains bonds to avoid taxation.
• In case you do not do the above you will be charged at 20 % tax on the capital gain.

What are the changes then? As I said before, the new base year is 2001-2002 and the base is taken to be 100 for that year. The CII for subsequent years have now been recalculated and for the current FY 2017-2018 it is 272. Any asset sale being done in this year will be governed by the new Index for the purpose of capital gains determination and taxation.

Let us take the previous example now and assume that you sell the flat in 2017, instead of 2016. The indexed purchase price now will be 272/100 x 18 lacs or 48.96 lacs. For an apple to apple comparison if we took the 2016 CII of 264 then the indexed purchase price will be 2.64 x 18 lacs or 47.52 lacs. This is virtually the same as with the old CII.

How will the impact be on the Long term Capital Gains calculation of Debt funds or Bonds etc? I will cover this in the next post.

File your Tax returns – it is right and also wise

For all tax paying people July 31st now looms as the deadline, by which you need to submit your tax returns for last FY. New tax payers find it quite overwhelming, many people just avoid it through ignorance or laziness and others depend on their CA or Tax consultants to get it done. It is important to understand the need for filing tax returns and also how one can do it in a fairly easy manner.

First things first – why do we need to file a tax return in addition to paying our taxes? The answer is simple too – our tax deductions are automatic in some cases, partial in others and not there at all in some. It is therefore important for the IT authorities to determine whether you have taken all of your income into account and paid relevant taxes for the same. A few examples will make it clear :-

• For your salary income TDS is deducted as per your tax calculations fully.
• For your rental income of any property there is no TDS unless rent is more than 50000 per month. Here too the TDS is at 10 %.
• For your FD interest TDS is charged at 10 %.
• For your PO MIS interest, no TDS is deducted.
• For your Savings bank interest, no TDS is deducted.

As you can see from here if you just depend on TDS and think you have paid all your taxes, you are quite mistaken. Ideally you should be calculating your tax liability based on your overall income, during the year, and pay advance taxes to cover up the additional tax payment required. These advance taxes can be paid any time during the year and for a quarter the cut off date is normally 15th of the last month. So for the second quarter of this FY, the advance tax payment deadline should be 15th September. If you have extra taxes to be paid, based on your first quarter income then make sure that you pay it off by that date. For the last quarter of the FY, the date is 15th March.

However, if you have not done it this way in the last FY then what is your choice now? You need to file your tax returns with accurate information so that your total tax liability for last FY can be determined. If the tax deposited so far is less than this, you will need to pay the balance tax. This is easily done in the income tax website. In case you do not have an account there, create it using your PAN for registration.

What happens if you do not file the tax return? For one there is no real option and you will be fined heavily if you delay filing beyond July 31st. Also anything associated with your PAN can always come under scrutiny and the first thing IT authorities will check is your Tax return form. If you have not filed it, or filed it with inaccurate information then you are going to face a much sterner examination.

So all said and done, you will need to file your tax returns. In case you are not up to doing it yourself use a Tax Return Professional ( TRP ) to help you. You can, of course, go to a CA but they are more expensive and unless you have multiple sources of incomes that need complex book keeping I will not advise it.

In the next few posts I will show you how you can take care of your income tax and learn enough to calculate your taxes and file returns on your own. It is actually quite simple to do once you lose your initial reluctance.

 

 

Cash flow planning is key to a good financial plan

Many of my readers keep asking me as to why I do not have different portfolios allocated to different goals of mine. I have explained this in other posts so will not repeat the basic arguments here. Suffice it to say, multiple portfolios will most likely lead to sub-optimal returns and I do not look upon it as smart financial planning at all. In fact if you really look at how you go about your life and the finances you need ta take care of your plans, the most important aspect is really cash flows.

While cash flows are kind of implicit in goal based planning – we are asked to redeem our financial investments to cater for the expenses linked to a goal – it is important to understand the true nature of it. In a recent discussion with a friend it struck me that most people do not have a clear idea about it at all and do not understand how to go about it. When I was thinking of how to explain this to my readers, I thought of how we use water in our daily lives. This is an analogy I have used in one of my earlier posts and can be used well here.

Let us assume a normal middle class household in India where we have different types of expenses such as listed below:-

• Regular monthly expenses such as food, groceries, utility bills, transportation etc.
• Quarterly or biannual expenses such as school or college fees.
• Annual expenses such as Insurance premiums, TV subscription etc.
• Irregular expenses such as clothing, purchases of personal discretion.
• Large expenses such as White goods, Vacations abroad etc
• Goals such as College admission, marriages etc.

To personalise this example let me relate it to you as a reader. For the next 12 months, list out all possible cash needs you have out of these categories. For example you may have something looking like this:-

• Monthly household expenses @ 40000, Annual costs = 4.8 lacs
• School fees @ 10000, Annual costs = 1.2 lacs
• Insurance premiums, TV service etc, Annual costs = 1 lac
• Vacations, White goods, Annual costs = 1 lac
• No large goals in next 12 months.

What does this really mean? In cash flow terms, your outflow will be to the tune of 8 lacs. So if you have got 8 lacs and more from your salary or business you are fine, right? This is unfortunately not true at all – understand that your outflows on large goals are not there now but they will occur at some point in time. When it does you have to spend and that amount may not be possible from your normal cash inflow. Let us say your son will go to a college that costs 5 lacs a year for 4 years. If this amount can be catered for through your active income, you are home and dry. If not then you must invest in the years before he gets to college so that when the time comes you have access to the money. Similarly you need to plan for your retirement – at that time you have no active income but your household expenses remain there. So, you must have some alternate source of cash inflow so that you are able to sustain your expenses.

Where does cash inflow come from? Well, there can be several sources, but some of the more common ones are as follows:-

• Salary from your job
• Income from business or profession
• Income from hobbies or other interests ( blogging etc)
• Interest income, dividends
• Rental income
• Capital gains from selling an asset
• Redeeming financial instruments

Where does the water analogy come in? Well, you can think of regular cash flows as the water that is supplied to your house every day by the City corporation. Most of your needs are met by that. However, you also store some water for an emergency that may occur. In case you are planning to clean your house thoroughly, you will plan to arrange for availability of water etc. What happens if you are having a big function at your house and you need to have a lot of water? Well, in case you have stored it in a tank etc you can use that. Alternately you can get some water tankers to get water for you. This is similar to redeeming financial instruments for a large goal. You can also stretch the thought process to look at these tankers as a loan – in that case you have to pay back the water just as you pay back through EMI for the loans.

The bottom line is this – your cash inflows either in term of current income or income from past investments or loans must match your cash outflow needs at all points in time. With the water analogy we have to look at running water, water stored earlier or water obtained from external sources such as tankers to take care of our needed consumption.

Pretty simple really, if you think of it a little and then the entire financial planning just becomes an exercise in cash flow management. How do we factor in investments into this? Well, I will cover that in another post as this one has already got quite long.