Revisiting my Debt portfolio

This week I decided to do an overall audit of my Debt portfolio. The review was necessitated mainly by the changes in the Small Savings Schemes rates which were brought about. However, it is generally a good idea to do an audit in the beginning of a Financial year to see if any changes are required in the current plan.

As many of the regular readers will know, I have 3 portfolios namely Debt, MF and stocks. In my current state of Financial Independence, the debt portfolio plays a very important role. My main objective here is to get enough regular income out of this so that I do not have to depend on my active income through Consulting for my day to day expenses. As I have no real fresh investments planned for the Debt part, the only other objective is capital appreciation. So, if my Debt portfolio shows some appreciation after the withdrawals I make from it I will be happy enough.

In this post, I am not getting into the rationale of my current investments for the portfolio. Interested readers will need to go through my blog to search for the relevant posts. The audit only looks at what I have and what changes I plan to make.

• Tax free bonds are about 12.5 % of my debt portfolio. These are bonds from 2013 and carry a coupon rate of 8.8 %. There is no real need to change this and it remains a good part of my interest income in the years to come.
• PPF forms about 20 % of my debt portfolio. The reduction in rates to 8.1% means that I will now earn significantly less out of this. This will not impact my usage of money as I was not planning to withdraw in the near future. My plan is to keep investing for now and take a call in 2019 when the account reaches the current maturity date.
• FMP schemes form about 45 % of my debt portfolio. The plan was to use the capital gains from here as my regular use and reinvest the principal. I plan to keep doing the same though the reinvestment will not make sense in FMP now.
• Other Debt funds form about 12.5 % of my portfolio and the issues here are similar to FMP, as outlined above.
• POMIS and some FD form the last 10 % of the portfolio and this will be unchanged.

The good thing is my income from Debt portfolio would not have been compromised a great deal. While PPF interest will be lower, FMP and POMIS rates are pretty much locked in and will therefore not reduce in any significant manner. Going forward, the real issue I will have to decide on is how do I redeploy my principal amount redeemed through the FMP maturity. The options I have thought of are Ultra short term funds, Balanced MF, Arbitrage funds and Equity Savings Funds. Each of these have their pros and cons and I need to look at what strategy will involve the minimum risk.

Of course, with the rates likely to decline further over the next couple of years, somer other strategies will probably be needed in my next annual review.

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Reduction in rates – what should you do?

The human mind is essentially selfish and complains about anything and everything that even remotely affects its interest. The reduction in rates which were announced yesterday, brought this point home to me with a great deal of clarity. Anyone with a smattering a knowledge of economics and business would have known that such rate cuts were inevitable. Yest when the actual announcement came the Electronic media and social media treated this as a full scale catastrophe and even something that would cause ruination of the middle class. My advice to all such people will be – “Stop the scare mongering, wake up and smell the coffee.”

Why do I say that the interest rate reductions were inevitable and should have been something any reasonably intelligent investor should have anticipated? Consider the following indicators of the economy over the last 1 year and more:-

• Inflation headline numbers have been coming down progressively and is roughly in line with the targets that the government had set. Yes, we can argue that the CPI figures do not reflect the real situation etc but those are the figures used in policy making by the government.
• Based on the inflation numbers the RBI has already made several rate cuts and a couple of more cuts may be in the offing in 2016.
• Deposit rates in the banks have already been reduced over the last year. SBI rates are below 7.5% even today and private banks are also not offering more than 8%.
• Tax free bonds which were at 9% in earlier years were being offered at 7.69% at the higher end from all companies that brought them to the market this year.
• Based on all of these, it would simply not have been possible for the government to continue the artificially high rates in the Small Savings Schemes. These rates have to be aligned to the real economy, the government cannot prop these up by subsidies.

Having understood this, let us now focus on what can be done. Firstly, at a conceptual level we simply have to understand that these rates will now get linked to the markets. So in the given context it is quite possible that there may well be a further downward revision in the rates over the next one year or so. However, as the inflation comes down the real rate of return will hopefully increase and therefore the investor is not necessarily any worse off. Secondly, it is not the responsibility of the government to prop up the rates artificially by subsidizing the interest rates. We must look at these products as something the government is selling and make our own decisions as to whether we want to invest in these or not.It is our money and our decision, there will be very little point in blaming the government if the rates continue to go lower because of the economy and business context.

For people who are retired and depend on these schemes and others for a regular income, they can lock in their money into POMIS and SCSS even now to avail of the higher rates of interest. Both the lock ins will be fairly long term at their age profile and therefore they must be sure about not needing the capital in an emergency situation. People having PPF can continue to withdraw from it, though the rates will be lower. For such people fresh investments can simply be the minimum to keep the account running.

What about the rest of the people who are having a debt portfolio, not with a view to earn a regular income but to grow it as part of retirement corpus in future. I an outlining overall strategies for a variety of instruments, choose your options based on your need and attitude.

• PF is a must for all salaried people and they can additionally have PPF. Till the EEE structure of PPF undergoes a change this is the best debt product.
• Professionals and business people should have PPF accounts for themselves and their spouses – try to contribute the maximum amount permitted.
• People blessed with a daughter must contribute in SSY. Given the nature and purpose of the product SSY will always have a higher interest rate compared to other products.
• Debt MF of the category Liquid funds and MIP do not make much sense now and are best avoided for most investors.
• Short term debt funds are likely to have higher returns in the medium term due the interest rates declining further but they do represent some credit risk. Additionally with the rise in the Cost Inflation Index becoming tempered due to lower inflation numbers, some tax impact will be there even after indexation.
• FMP will still be a good idea if you are OK with 7-8% returns, but the time window will probably be only the next 1 month or so.
• Tax free bonds are probably now over for this year but, if NHAI does come up with one more scheme, definitely invest in it. For people in the 30% tax bracket, the pre tax yield is in double digits and no product gives you so much today. This is particularly applicable to people who have a need for regular income.
• Avoid products like Hybrid funds and Gilt funds if you do not understand them.
• Finally if you have some risk appetite go with Equity Saving funds and Arbitrage funds for some fresh investments.

In conclusion, while you do need to reassess your investments and maybe tinker with a few things, there is no need for large scale panic and significant overhaul of your portfolio.

In the next post I will outline my own strategies for tackling the current situation.

The million Dollar question of retirement

One of the great imponderables in the personal finance space is the question – how much do you need in retirement? There are several ways which are commonly used to arrive at an answer. In the US context, one figure that many planners throw around is 1 million Dollars, provided you have your own house. Of late, I am seeing a lot of people in India suggesting this figure for retirement in India also.

Now, in something like a retirement corpus, the more is always the merrier. As such, there is absolutely no problem in investing more for retirement, in fact it should really be a goal to invest as much as you can. However, two aspects are critical to examine in terms of how this figure may not be a good thing. Firstly, many investors will be hard pressed to invest beyond their means to arrive at such a corpus, thereby creating a situation where they have to compromise on living a good life today. Secondly, while a focus on saving and investing for this amount can be worthwhile, it will seriously limit any risk taking ability of the investor, thus limiting oneself in many cases to a job or career that one may not be overly excited about.

My principal objection to the above figure is that it is in another currency. So while the $ was at 50, the figure was 5 crores and today it is at 6.7 crores etc. This can be seen as a good hedge for our inflation but there are obviously far better ways to address that. Also, it is not a good idea in general, to have a moving goal post. Now, let us come down to what an amount of 1 M $ will mean for retirement corpus in real terms:-

• Let us assume a corpus of 6.7 crores, zero real rate of return and 30 years of retired life for which you need income.
• The amount you can theoretically spend each year will then be about 22 lacs. Note that this is in current prices.
• I am sure there are some people who have an expense of 22 lacs a year today, but it will be safe to say that their numbers are minuscule.
• If you assume an annual expense of 10 lacs then the corpus comes to 3 crores, which is less than half of the 1 M $ figure.
• If the real rate of return is 2 % then you will need much less than 3 crores.

The reality is most of us spend far less than 10 lacs a year, exclusive of accommodation expenses. So a far better way will be to estimate your monthly expenses at retirement, bump it up by a few percentage points and arrive at a corpus. As an example, if you are spending 7 lacs per year today, you can inflate it by 15% and look at 8 lacs as your annual expenditure. Remember, it is not the amount you are spending at your peak level of expenditure, it is the amount you will need when you are retired.

To take my personal example, for the past few years my annual expenses have actually been at the range of 20 lacs plus. However, a large part of this is due to the educational expenses for my children. When I do retire completely, these expenses will not be there and my estimate of 8 lacs annually should hold quite comfortably. As such, while I am probably going to be quite close to the US figure, I do not think I need so much.

Do not get swayed by fads that do not have any substantive basis. Your situation is unique – look at it and deal with it accordingly.

Building a passive income stream from scratch

This post is inspired through a discussion I had yesterday with a long time friend. He is considering to get out of his current corporate job and wanted to set up a passive income stream that will take care of his regular expenses. When I pointed him to my posts on this topic he said that, while he had read those posts and understood the situation from my context, he needed to set this up from scratch.

The discussion set me thinking and I wanted to look at a situation which many people may be facing when they are nearing retirement or are considering an early retirement. While generalization is always difficult, a typical situation of such a person may be as follows.

• The person has an own home which is fully paid for by now.
• He has a PPF account for a long time but has not contributed the maximum in a regular manner. Current balance in the account is 24 lacs (say).
• His children are either independent or in college. In the latter case he has made arrangements for the remainder of their education expenses through FD etc. This is not linked to the passive income that he wants to have.
• Fixed deposit amount is 20 lacs, PO MIS is 9 lacs in a joint account.
• PF and gratuity will come to 1 crore when he withdraws it.
• MF portfolio is 20 lacs and stock portfolio is 6 lacs.

Based on this, how should the money be deployed so as to get a passive income of about 7 lacs a year? There may be many ways but the framework suggested below is a good one:-

• Keep the current MF and stock portfolio intact for the long term. You may need it for situations such as long term care, beyond the age of 80.
• New investments in PPF are not needed but keep the account active by paying a small subscription every year. This is your fall back mechanism if you suddenly need money for some unforeseen event. Also the interest of 2 lacs a year is tax free.
• 9 lacs of PO MIS will give an interest of 75300 every year. Use this for your income.
• FD of 15 lacs can be put in Senior citizen scheme if you are eligible. The interest from this will be about 1.35 lacs.
• Divide the 1 crore obtained from PF and gratuity as follows:
  • 30 lacs in tax free bonds. This will give you an income of 2.3 lacs per year.
  • 30 lacs in some dividend paying debt scheme such as Monthly Income Plan or Balanced funds. This will give you an income of 2.4 lacs odd.
  • 10 lacs in a Liquid fund. Income from this will be about 70000 a year.
  • Rest 30 lacs can be put in FMP or other Debt MF (short term) in the Growth option. After 3 years you can use the capital gain for consumption and reinvest the principal amount. This is mainly for discretionary expenses such as a vacation abroad etc.

What about inflation? Well, you have enough hedges in the plan for that. PPF can be drawn into, LTCG from FMP or debt funds are there and equity part will hopefully grow. Also over a period of time the 7 lacs needed in current terms may not suffer as much from inflation as we think. However, even if it does, the plan above is likely to cover it.

Note that the above is a low risk plan where your passive income is pretty much assured. Other options where you put more money into equity are possible but they come with a higher risk. You do want peace of mind when you are at this stage in life!!

So with an overall asset base of 1.79 crore (plus house), you can comfortably generate a passive income of 7 lacs and take care of the future also. I hope this convinces people that you do not necessarily need 5-6 crores to have a decent retired life. More importantly, you can lead the life you need to lead at the right time for yourself and your family.

An asset base of even 1.5 crores, deployed creatively, may well be enough for this person to retire. Take this framework as a reference and arrive at your own plans for that.

Education loan for an IIM – A personal perspective

Some of the readers who are familiar with my profile, will know that I have done my PGDM from IIM Calcutta. That was a long time back now, I passed out in 1988 after having secured admission in 1986, immediately after completing my BE in Computer Science & Engineering from Jadavpur university. In those days education was greatly subsidized and my father was able to foot the cost of both my professional courses as well as the MBBS which my sister did around the same time – all this with being an Engineer in SAIL.

Times have changed a great deal today. Education in quality private colleges is an expensive affair and if you want to know more you can read up some of my posts on this subject in my blog. Though the IIM s are not really private, nowadays they are not being subsidized by the government and are therefore forced to hike up their fees considerably in the past few years. This, of course, is quite justified as the older IIM’s are way ahead of other management institutions in terms of branding as well as quality of education.

For the reader who may not be aware of the IIM’s let me give a brief introduction. These started in early 1960’s with Calcutta and Ahmedabad being the first 2. Bangalore was established in 1973, Lucknow in 1985, Indore in 1991 and Kozhikode in 1997. These six are normally referred to as the “old” IIM. Shillong and 6 others which were established in 2007 and 2011 respectively are termed the “new” IIM. Finally the latest 6 which have just started in 2015 are termed as the “baby” IIM. In terms of fees A/B/C are in the range of 20 lacs for the course, L/K/I about 14 lacs and the rest between 11 and 13 lacs. Of course, you need to add another couple of lacs for living and other expenses such as travel over the two years one will need to spend there.

Are the expenses worth it? Definitely so, as any student doing well in the course will have a head start in terms of his/her career. An average salary of 18-20 lacs is the norm in the older institutes and, even with some of this being variable, it is a great starting point. Contrast this to even a good Engineer, starting with 6-8 lacs a year and working at least 4-5 years to reach a similar level. But, more than the money it is really the change that such education brings about in you as a person that I consider critical. It sets you apart from most others and is a lifelong asset.

Coming back to the point of this post – I have been thinking about all this as my daughter Rinki, who is in the final year of her BE course in BITS, is seeking admission into an IIM or XLRI this year. She has applied to only the older IIM’s and as she has a few calls, we are hopeful about her converting at least a couple of them. Given her track record in Education so far, it is very likely to be one of the better ones. I am therefore looking at the need for funds and education loan seems to be a good option. Even though I am able to fund this expense for my daughter, as a matter of principle I believe that children should take responsibility for their PG education expenses, of course with their parents being guarantors who can cover for paying the EMI should there be any problems.

Based on the requirement of 20 lacs, it seems that the best loan available in the market today is the SBI Scholar loan. You can get a loan up to 20 lacs without collateral for the institutes we are looking at. The rates are attractive at 9.7% and there is a further reduction in the rate for women students. The student has to start paying the EMI only after she gets a job, though the interest will obviously be charged from the point of time the money is actually disbursed. For a 20 lac loan paid over 3 years the EMI will come to 65000 or so, which is not a problem given the likely jobs that people get. The interest paid is completely tax exempt and there is no cap on it.

Of course, an option is to pay for the course directly without getting into this loan issue. A lot of people have told me that it will be a good idea to do so as it leaves the child free without any burden of EMI at the start of her career. As there are a couple of months to go for actual results of admission, I am still thinking about it. On the balance I think I will treat her as an adult, take the loan but give her the confidence that I will cover for it should she decide to do something on her own etc. I do want her to be responsible but at the same time, do not want her to be constrained because of the loan. If she does not want to do a regular job and wants to have a start-up of her own, I will take care of the loan.

Overall, I am quite happy with the conclusion I have reached on this. More importantly, I am happy that my daughter and I are on the same page on this, though she keeps telling me I should not preempt such plans, rather wait till she gets a final admit somewhere. 

PPF investment – it is still the best

The one scary aspect of the budget this time was the rumors that PPF withdrawals may be taxed. Fortunately these rumors turned out to be untrue, but I have had several questions from people asking if I have changed my opinion on PPF being the best investment in the debt space. After giving due consideration to all aspects, my opinion is that PPF remains the best instrument in the debt space, only bettered by SSY for people who have a girl child below the age of 10. As i have written several posts on PPF earlier, I am not going to explain the features and benefits of PPF here – do read those posts if you are interested.

Let me start by the fundamental issue first. Even though PPF has been spared this time, is it likely that it may be taxed in the future? I think the answer to this question is YES. Even though it is going to be a politically difficult decision to tax PPF withdrawals, it is likely that at some point in time the government will have to do it. This has been a suggestion made long back by the Kelkar committee and I think the EET treatment will be finalized in some years to come, maybe sooner than later.

Why then do I say that it is still the best instrument? Well, my reasons are as follows:-

• Whenever the PPF withdrawal becomes a tax liability, it will always be with prospective effect. For example, if it were to become taxable from the next FY then your accumulated amount in PPF account could still be withdrawn without any tax impact. So, there is absolutely no need to close your PPF accounts thinking that you may need to pay taxes on your current corpus.
• As was explained in the case of PF, even when PPF withdrawal is taxable, you will  be having tax liability on 60 % of the interest. The principal amount as well as 40% of the interest continues to be tax exempt.
• The flexibility associated with PPF means you can stop your contribution at any time and also withdraw in a phased manner. When you are not having active income your PPF withdrawal can be phased, so as to ensure you minimize your tax impact.

Based on the above, I do not see any need to change the PPF strategy that I had advocated earlier. In fact, this is how I plan to use PPF for my own purpose:-

• Continue investing 1.5 lacs every year for both myself and my wife. This will either come from some active income through consultancy or from FMP redemption.
• I do not see a need for any withdrawals now, but may start to do so after another 5 years, for my discretionary expenditure.
• In my case, I will stop the contribution or reduce it when the interest on fresh contribution becomes taxable to the extent of 60%. However, this is purely due to my stage in life. Anyone below 45 or so, should logically keep contributing.

That in essence is what most of the readers should do also. There is no real need to be in a tizzy due to the confusion in the budget. PPF remains the best investment of it’s kind, continue to invest in it with confidence.

Financial independence is an imperative

Last week I got talking to an old friend of mine about the budget and the conversation soon turned to financial independence. Fortunately for both of us, we are financially independent though still actively earning though activities we love to do. I wanted to capture the summary of our conversation as I think it will help many readers of the blog.

In very simple terms, financial independence is a state where you do not need to work actively for generating an income. Note that this does not mean you should not be working – you may well do so and earn money out of such work. However, even if you were not working in a similar manner you would still be able to lead the life that you wanted to. So, contrary to what many people think, financial independence is not synonymous with early retirement. Of course, you better not think of early retirement unless you are financially independent but that is as far as it goes. You can be in a FI state and continue with your job and business for as long as you want. In my personal situation I am in a state of FI but I do take up consultancy assignments that are of interest to me. What I earn through this is either invested or used for charitable causes that are dear to me. However, I do not depend on this income to fund the lifestyle I have decided to have, now or in the future.

Many people ask me whether it is necessary for them to get to the FI state if their plan is to work till 60 or more. Surely you need to be FI only when you are no longer having an active income? This is unfortunately a fallacy and you need to understand this well. Let us look at some of the things that may create the need for being in an FI state as early as you can:-

• You may be in a job or career that you do not like much. Your being in an FI state will enable you to look at options in a much bolder way.
• There may be a passion you have which you want to convert into a business. Once you are in an FI state you will be able to take a plunge in a much easier manner.
• In the private sector today job losses are an unfortunate reality. Your ability to cope with such a mishap is significantly more when you are in an FI state.
• If something were to happen to you, the family is covered by insurance. It will however be a much better situation if you are in the FI state. Think of this as the ultimate insurance option that you can gift your family.

Now that we have established that being in an FI state is an imperative, let us see how we can get there. I will take an example of a person with a family of 4. Ravi is 40 years old with 2 children of 12 years. His details are as follows, to arrive at his FI figure.

• Current expenses are 10 lacs per year. When his children go to an Engineering college it will go up to 18 lacs per year.
• After they pass out the expenses will be 8 lacs per year.
• All of the above are expenses in the current terms.
• For being FI today Ravi needs 6 years @ 10 lacs, 4 years @ 18 lacs and finally 30 years @ 8 lacs. Here it is assumed that Ravi and his wife will live till they are 80.
• So for Ravi to be in the FI state today he needs 3.72 crores in current money.
• Now, Ravi may have about 2 crores totally, including his current value of PF accrued. This means he will need to accumulate an additional 1.72 crores to be in an FI state.

 

You can go ahead and calculate your FI number, compare it with your present portfolio and see how you are doing. Based on this you can then figure out a way to bridge the gap. If the figure appears large do not despair. The example given is a worst case scenario, assuming zero real rate of returns. If there is a 2 % real rate of return, the calculations change dramatically.

Financial independence is an imperative for all of us, irrespective of our life situation or for how long we want to work. In simple terms you will be able to enjoy a significantly richer and fuller life when you are in an FI state.