Taking stock of my FI state

Many of you who follow the blog will have an idea about my journey in life so far, but let me summarize for new readers. I was born and brought up in Durgapur ( West Bengal ), studied in St Xavier’s school, Jadavpur university and IIM Calcutta, worked till 2014 end in corporate world with 14 years plus at CXO level. Since then I am working in my own Management Consulting practice. I have 2 children who are doing Post graduation ( Rinki is in XLRI and is an Engineer from BITS Hyderabad) and Graduation ( Ronju is doing a dual course in BITS Goa). I have been financially independent since 2014 and thought it would be a good idea to share the stock taking which I did recently.

The interesting fact is that the last four calendar years 2014 through 2017 have been progressively the most expensive years of my life. This flies in the face of conventional wisdom which will tell you to be conservative on spending when you are no longer doing a regular job etc. When I took the plunge in 2014 end, my thinking was as below:-

  • My total expenses in 2014 was equivalent to 200 units in some scale.
  • If I left out children’s college education, the travel to Australia which we went for in October 2014 and my apartment rent in Hyderabad then the expenses would be equivalent to 100 units.
  • Now, my rent was getting covered by the rent of my Chennai apartment, I had a separate fund for my children’s graduation expenses and we would obviously not go for an Australian vacation every year.
  • Based on this it seemed reasonable that my expenses annually would be in the range of 100 units.
  • As my financial assets would generate more passive income than 100 units, I concluded I had achieved the holy grail of financial independence.

At the end of 2015, I was surprised to see that my overall expenses were in the range of 225 units. A closer examination revealed the following :-

  • Education expenses were higher as I had to pay two semester fees for my son instead of the one in 2014.
  • Expenses otherwise on my children were high, courtesy their being typical college students now. Also, Rinki took up a course for her MBA entrance preparations.
  • However, my other expenses were still below 100 units and this was managed easily through my passive income stream.
  • It thus seemed that my assumptions held true for 2015.

2016 was a completely different story though. My overall expenses shot up to 400 units and change. Analysis of this figure showed up the following:-

  • Educational expenses were very high in the year as Rinki got into XLRI and, after a long deliberation, I decided to fund her first year expenses. We could have taken a loan for the entire expenses but this seemed a better idea for us.
  • Other expenses of children continued to grow. I am fine with their having a good time in college as long as they have the right priorities.
  • Our travel increased a lot in the year – we took more vacations and also traveled a fair bit for Rinki’s admission process.
  • With the declining interest rates the cash flows of my parents got impacted adversely. I chipped in with a greater amount than normal this year.
  • We upgraded our timeshare and there was a one time cost of 1.7 lacs for this.
  • Furniture replacement with a new sofa set, Dining table and balcony chairs were an expense this year.
  • Purchasing a new Android tv, new internet connection, new phone for my wife and a recording set top box also happened during the year.
  • In summary, it was a year with great experiences and they often come at a fairly high cost !!

So what was the conclusion I arrived at from all of this? Well, 2016 was definitely not a typical year and I did not think it will ever repeat in our lives. With Rinki getting the rest of her course done through bank loan, asset purchases not really there except for a Fridge and lesser travel the 2017 expenses will be much lower.

The reality was quite different though. We did not spend 400 units in 2017 but it was still close to 250 units. A closer look revealed the following:-

  • As is their practice, BITS again increased the fees by 12 % and my children’s college expenses continued to rise. I have been rather indulgent on this as I believe one should have a fun college life.
  • As I was earning a pretty decent Active income, I thought it would be good to part pay the Term 4 fees of Rinki. She chipped in with some of her internship earning and this has resulted in the loan amount being only 6.5 lacs.
  • Even though we had not planned for it, Lipi and I went for a vacation to Italy in May for a week. It was a great trip and I was quite happy to pay for it.
  • We also upgraded our Timeshare once again to a one bedroom unit and this too was an unplanned expenditure.
  • Travel within India too was more than we had anticipated. We went to Kumarokom in February, Vizag and Aruku valley in June, Goa in August, Durgapur in September for Pujas and finally Konkan beaches in November. While all these were expensive they created great memories and was totally worth the effort and money.
  • Other than the above, most of our expenses were the regular ones. We did exceed on the Entertainment and dining out part but not alarmingly.

At the same time, the experience of 4 years now set me thinking as to whether I should look at financial independence and retirement cash flows differently. After a lot of reading and deliberation I came up with a better model. You can read about it in this post

I am also working out my likely cash flows in 2018, based on the above model. Should be writing a post on it this week.

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Returns on Debt funds are more taxing now – A personal example

As I have written often in this blog, it is quite senseless to invest in FD for investors now, given the double whammy of low interest rates and returns being taxable at your slab rate. In general, investing in Debt funds makes sense – more so, if you are able to hold them for 3 years and get the benefits of indexation.

The above has been my strategy with FMP where the time to maturity is more than 3 years. While this has served me well in the past years, there are some changes in the scenario that all of us need to be aware of. With the lowering of inflation, the newly constituted Cost Inflation Index ( CII ) is less supportive of such a strategy. In fact, when I was doing an audit of my investments this month, I was shocked to notice that despite the indexation benefits, I would still be paying considerable taxes on this account. Now, I am all for paying the right taxes, but it is important to understand the impact.

Let me give you a specific example to see how things stand now:-

  • I had invested in HDFC FMP Series 28 on 21st November 2013
  • It was redeemed on 10th April, 2017
  • Initial purchase value was 3 lacs
  • Redeemed value in 2017 was 3.95 lacs
  • The indexed purchase price was 3.71 lacs as it got 4 years of indexation benefits.
  • The capital gains after indexation was 24000 Rs and tax thereon is 4800 Rs @ 20 %
  • In effect the absolute returns are 90000 in a period of 3 1/2 years.
  • Post tax CAGR is just above 7.5 %, it is 7.56 % to be exact.

Now while this still beats FD by a good distance as far as tax efficiency is concerned, the returns have come down from the past. Two years back it was possible to get CAGR of 8.5 % and more as taxation was minimal, if at all. It is also noteworthy that for FMP the rates are fixed at the start, so the ones starting now will have even lower returns.

What about other Debt funds? I have one from Franklin where the details are as below:-

  • Purchase date was 9th May, 2013 and purchase amount was 2 lacs
  • Current value is 2.92 lacs
  • Indexed value of purchase will be 2.47 lacs, so the capital gain is 45000 Rs
  • Tax on this will be 9000 Rs
  • Post tax CAGR will be nearly the same as the prior example.

Lesson from this for me and you as an investor? Debt funds are likely to give a post tax return of around 8 % or lower in the current context. Factor this into your calculations if you are using them to generate passive income, like I do. In simple terms if you need an income of about 8 lacs a year, you will need to put in 1 crore as capital investment for the debt funds.

It is still a good idea but we have to be conscious of how things change down the line.

My investment in hybrid funds – why and where?

Readers of my blog will know that in general, I am not fond of mixing asset classes for the purpose of investments. Even in the 3 portfolio strategy that I have, the investments in Debt, MF and stocks are demarcated and carried out separately. I believe strongly in deciding on an asset allocation and sticking to it through different market cycles.

However, after I gave up my regular corporate career by end 2014, I was dependent on some regular passive income to fund my FI state. While I was still earning a decent active income which could potentially take care of all my expenses, I did not want to depend on it. The cash inflow through my active income from Consultancy is used for any discretionary expenses, investment or for some charitable purposes. Most of my Debt investments were in PPF and FMP with a little in short term debt funds. When the FMP schemes matured, I used the capital gains as my passive income and reinvested the principal for 3 years to take advantage of indexation.

With the reduced interest rate cycle being active, investment in pure debt FMP did not seem like a good idea from 2015. The likely returns reduced a lot and I started looking at options for investment. The obvious choice would have been Balanced Funds but that would have skewed my asset allocation as equity oriented Balanced funds invest nearly 65 % of their assets in stocks. This led me to look a little deeper into the hybrid category of funds. While there can be variations to the theme, most of these fund types have 3 types of investments in their portfolios – Debt, equity and arbitraged equity.

The different types of funds will have these 3 investments in different proportions. Some of the common types with their investment weights are as follows:-

  • Dual Advantage FMP which invest in some equity apart from the regular Government papers. The amount of equity will normally be 10-15 %
  • Monthly Income Plans which are similar to Dual Advantage FMP except that they are actively managed and declare dividends more frequently. 
  • Equity Savings Fund which invest equally in Debt, Equity and Arbitraged equity.
  • Debt oriented Balanced funds which have about 30 % Equity and the rest in Debt.
  • Equity oriented Balanced funds which have about 65 % in Equity, rest in Debt.

In the initial years of 2015 and 2016 I did not have too many FMP maturing as I had rolled over most of these for 3 years due to taxation reasons. Most of the redeemed amounts were put in Balanced Funds and Equity Savings Funds. The advantage of these funds is that you can redeem them after a year without having to pay capital gains taxes. In 2017 I had a lot of FMP maturing – I used the principal amounts to make some investments in MIP and the rest in Dual Advantage plans of FMP. Except for using the money from FMP capital gains, I have not used money from any of the other funds listed here, neither have I touched the interest from PPF or POMIS.

What about returns ? Normally they will be within a range and typical values will be :-

  • 12 % – 15 % and more for Balanced Funds.
  • 10 % – 12 % for MIP
  • 11 % – 13 % for Equity Savings Funds
  • 9 % – 11 % for Dual Advantage FMP
  • All of the above are of course market dependent and can go lower if market performs poorly.

After this year, most of my investments will cross 3 years and I can then redeem these in a tax efficient manner. The objective of getting some differential return through hybrid funds is being realised now – my audit of investments for last year established that.

Deploying Retirement corpus – a case study

This post is inspired through a discussion I had some time ago with a long time friend. He was considering to get out of his current corporate job and wanted to set up a passive income stream that would 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 1.8 lacs a year is tax free.
  • 9 lacs of PO MIS will give an interest of 68400 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 1.25 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.

ICICI Value Fund Series 20 NFO is on – Should you invest?

Over the last few years and especially in 2017 many of the Fund houses have come up with a slew of close ended NFO’s. These come with a variety of themes and associated terminology. For example ICICI calls them Value Fund series, Sundaram calls them Micro cap series and Axis calls them Equity advantage series. In this post let us look at why these are in vogue now, what are the pros and cons and finally whether it is a good idea to invest in them.

The first issue is relatively simple to answer : new products get developed based on the likelihood of their success. With a lot of retail and institutional buyers pumping in money, there is always a demand for newer types of funds to invest in. For fund houses, it is an opportunity to have a specific charter which may not be possible to fulfil through their regular funds. For example, one of the ICICI value series funds only wanted to invest in Pharma and IT sectors as these were beaten down significantly over the last six months or so. Now this could be done in one of their existing funds too but for a fund manager to churn the portfolio by selling stocks that are doing well is not always an easy decision to take. Using fresh money in taking such calls is relatively simple. The trend started by end 2014 or so with ICICI and has now percolated to several others.

What are the pros and cons of such funds? Well, for one the mandates here have a lot more clarity compared to a vanilla large cap or mid cap fund. The fact that it is close ended, normally for 3 years, means that the fund manager has time at his disposal to take the calls he wants to take. On the flip side you will not have access to your money for 3 years and this is a problem unless you can definitely do without it for this time. A greater problem may be your inability to shift in case you are not happy with the performance. From my viewpoint, I do not see both these issues as a serious one. Firstly, you should be investing in equity for a much longer term than 3 years. Secondly, the Fund manager is way more qualified to deal with short term performance issues.

Let me now give some details of an investment that I made in one such fund. While the experience may not be repeated for all funds, it does offer certain insights:-

  • I purchased ICICI Prudential Value Fund series 2 on 6/12/2013. Invested amount was 2 lacs in the Dividend option.
  • The idea was to get some regular income as I planned to go for my consultancy practice sometime in 2014.
  • Though it was a 3 year fund, it has now been rolled over and will mature on 31/12/2018.
  • So far total dividends have amounted to 1.75 lacs
  • Current value of the fund is nearly 2.6 lacs

I think it can be said quite safely that this worked out quite well. In fact, I have invested in several follow up NFO from ICICI. Apart from ICICI I have also tried out Axis, Birla Sunlife, Sundaram and UTI for close ended funds. From a personal perspective it works well for me as I get tax free income and also growth from it.

You should be investing in these funds under the following situations:-

  • You have some income requirement every year. Instead of doing FD you can go for close ended funds with dividend option. Note that the dividend is not guaranteed.
  • You have a goal after 3-4 years. This is ideal for such situations. However, in such a case choose the Growth option.
  • You have come into some money and do not want to decide on allocation for 2-3 years as you may need the money then. Go for the growth option here too.
  • Make sure you understand the mandate and therefore the associated risk profile. A micro cap series from Sundaram will obviously be more risky as compared to the Value fund series of ICICI. However, the rewards will vary in a similar trend too.

If you are interested in these funds after reading this post, do consider the ICICI Prudential Value Fund – Series 20 which is open for subscription now and closes on 31st January. It is in areas where there will be definite growth and the industries they are investing in will be likely to do well for the next 5-10 years and maybe even longer. The fund is termed as Rising Bharat Opportunities Fund. The 3 themes will be Build Bharat, Finance Bharat and Rural Bharat – all of these have great potential and are likely to do well in both medium and long term. The 3 year plus close ended NFO may just be the right vehicle for any medium term goal you have. For example, I feel of you want 5 lacs after 3 years, you can just invest 3 lacs in this and wait for 3 years. It is very likely that you will be able to realise an amount close to your goals.

People having surplus money and waiting to invest in some suitable avenue should take hold of this opportunity. A disclaimer I need to make is that I am invested significantly in this series of NFO from ICICI  MF and have plans to invest in this too.

My current Debt portfolio

In the past few posts I have written about my equity portfolio, both stocks and Mutual funds and also outlined why a debt portfolio is needed for all investors. In this post I wanted to take stock of my current debt portfolio. 

Before getting into the details of my holdings, let me try and summarise my reasons for having the debt portfolio in the first place:-

  1. It gives me passive income which takes care of my regular expenses along with the dividends I get from my equity investments.
  2. It allows me to let my equity investments grow for a longer time period, thereby increasing the chances of significant gains.
  3. It ensures that even if I need a large amount of money suddenly, I will not have to redeem my equity investments if the markets are having a bad time.

Having said that, I will now outline my current Debt portfolio. Note that I am not going to explain the rationale of these instruments – if you are interested, go through my blog posts and you will find enough material there explaining most instruments.

The major components of my Debt portfolio are as follows:-

  • Tax free bonds form about 13 % of my portfolio today. I get an interest of about 9 % from these bonds and they contribute nearly 25 % of my annual expenses ( without rent and travel ).
  • PPF forms about 27 % of my portfolio today. Both my wife and I have accounts in which we invest the maximum contribution allowed. As of now we do not withdraw from it and have no plans to do it for the next few years.
  • FMP plans and other debt funds form about 40 % of my portfolio today. I use the capital gains from FMP redemption for my expenses and reinvest the principal. As for the Debt funds I just let them grow, they can be useful for any sudden expenses.
  • Infrastructure Investment Funds and POMIS from post office form about 10 % of my portfolio. Income from these are normally used for my stock investments and they are also a backup as Emergency funds.
  • The last 10 % is in a couple of FD still going on, cash in our savings bank accounts and some amounts I have kept in my parent’s and children’s bank account.

You will note from here that the above is fairly simple to manage and the cash flows are automated into my account. Investing in PPF is an annual event, investing the principal amount from FMP redemption is probably 8-10 times in a year.

Apart from all of these I also have some investments in Hybrid funds. With the declining rate cycle it makes sense to do that and my focus on these have been there in the last 3 years or so. I will write about them in another post.

I hope this post will give you an idea as to how you can create your debt portfolio – make it hassle free and it will give you a great deal of peace in your mind.

My current MF portfolio – Close ended Equity Funds

One of the interesting and fortuitous occurrence in my investment journey is how I started to invest in close ended equity funds. Till 2014 beginning, I had always avoided these funds as I wanted to have the flexibility of getting out of a fund if I wanted to. A combination of my looking for some regular income as well as a need to invest some amount one time, made me look at the ICICI Value Fund Series 2.

You would have been told by many people that close ended equity NFO are a bad idea as they operate for only 3-5 years normally and that is less time for equity investments. Is there data to support this? Yes, it is true that if you pick a 3 year period on a rolling basis, there will be enough instances of low returns or negative returns. At the same time many such periods have also given spectacular returns. So if you are in the right period and with the right fund then it makes sense to go by this route. The ICICI Value fund series also has a mandate for distributing dividends to share profits with investors. This suits me admirably as I was looking at tax free passive income from 2015 onward.

Now to cut a long story short, I have since invested in several of the series so far. The funds have mostly done well and quite a few have given fairly regular dividends. It is important to note that each fund from this series as well as the other fund houses with such schemes are focused on doing things a little differently as compared to open ended funds from the same fund houses. Some of the differences are as follows:-

  • Being close ended there are no redemption pressures and therefore the fund manager can take slightly longer calls.
  • As it is time bound the churning mechanisms are different from open ended funds.
  • Profit booking is implicit as most of them have a mandate to declare dividends.

Let us now look at my portfolio in these funds:-

  • I have started with ICICI Value Fund Series 2 and gone through to Series 19 which was running this month. Have invested in about 14 out of the 18 series.
  • The lowest XIRR has been 15 % and the highest 35 %. Most of the schemes have given an XIRR of over 25 %.
  • There has been good dividends every year from these schemes from 2015 to 2017.
  • Some of the other close ended schemes I have invested in are:
    • BSL Resurgent India fund Series 1 through Series 5
    • Axis Equity Advantage Fund Series 2
    • Sundaram Select Micro cap series 14, 15
    • Similar funds from UTI and SBI fund houses
    • HDFC Housing opportunities fund
  • My total contribution from these in my current portfolio is about 30 %.

These investments are clearly for the more experienced investors who can look at the mandate of these NFO’s and decide whether they want such coverage in their portfolio. There is an element of risk in a market downturn over 3-4 years but, in that scenario, you will do doing badly in all your MF investments through SIP too.

How do you invest in these funds? Well, be on the lookout for NFO, study the mandate carefully and put in only any surplus money you may have. Remember you should not replace your regular SIP with these. However, these can form a great medium term investment for any goals you may have in the next 3-5 years.

So if you are planning an expensive car or a family vacation outside India in 3-5 year time frame these funds may be the best ones for you.