Debt returns going south poses a great challenge for investors

2018 has indeed been a rather sad year for equity related investments. The indices by themselves have given poor returns, the broader markets have under-performed more significantly and select stocks have really tanked in a brutal manner. However, people investing in equity for a long time, such as me, can take this in their stride knowing that a good year in 2019 or after can redress this to some extent. 

There is however, another issue which many of us miss badly. Not only have equity returns plummeted, Debt returns have gone south too. Let us look at some data for the best performing funds in different categories to first understand the factual context :-

  • For long term Debt funds the best one year returns are between 2.6 % and 3.5 %.
  • For same category 3 year returns are between 6.5 % and 7.1 %. Returns for 5 years range between 7.9 % and 9.1 %.
  • For short term Debt funds the best one year returns are between 5.9 % and 6.2 %.
  • For same category 3 year returns are between 7.3 % and 7.6 %. Returns for 5 years range between 8.4 % and 8.7 %.

So what does this mean in real terms to an investor who has parked some of his money in Debt funds as part of his asset allocation? Firstly, while the 5 year returns still look good for the best performing Debt funds, these will now start to get impacted by the poor current performance. Secondly, if you are parking your money for 2-3 years then Long term Debt funds are a really bad idea, you might as well keep your money in FD or Post office. Thirdly, if you are looking at some regular income and had assumed you will get 8 % every year, you really need to rethink your strategy.

How dramatic has been the change over the last 5 years or so? Let me illustrate this by a personal example. As many of you know, I have substantial investments in FMP type of products as I like the relative stability they bring to expected returns. As and when they get redeemed, I reinvest the Principal and use the capital gains for my regular expenses in my current FI state. Now look at the following data :-

  • Recently there was a redemption of an FMP – ICICI Capital protection plan, where I had invested 2 lacs. This was a 5 year plan.
  • Yesterday I received 3.21 lacs for it and the XIRR was 9.93 % over the 5 year period.
  • An exactly similar scheme I had invested in December 2016 now has an XIRR of 5.26 % only.

It will be obvious from the above that the first investment suited my situation perfectly and the second is really not doing so. As I had said earlier, dramatic recovery from this 5.26 % XIRR is unlikely. At best I can hope for is 6 % or so and this will hardly be very worthwhile, given the lock-in period of 3 years plus.

So the question remains as to where should one put his or her money? More specifically for me, where should I put my 2 lacs now? Actually, it is about 3 lacs as I do not really need the capital gains amount for my regular expenditure. 

I will try to address this in the next post.

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PPF versus ELSS is a false comparison

As most of the readers of this blog know, I have been a great fan of PPF over a long time now. Apart from the obvious EEE benefits that it brings to the table, I use PPF as a great foundation to my portfolio. Once it had crossed the 15 year period with a substantial corpus, the benefits of compounding are visibly evident every year and it is a great hedge against any forced distress sale of my equity assets in the event of a market crash.

PPF has been in the news last week as the interest rates for Small Savings Schemes were increased for the next quarter. While this was always on the cards, many investors were skeptical as to whether the government will actually do it. In this case, I think the government was somewhat forced to do it as there are many other reasons why the policy rates need to be hiked. Be that as it may, the reality is that PPF and other schemes will have fluctuating rates over the next decade or so. I see the rates being at a median of 8.5 % with a spread of 0.7 % either way, depending on the situation.

As usual, there were a lot of articles in blogs and postings in Facebook and WhatsApp groups as to whether one should invest in PPF or ELSS for 80 C benefits. This is a very old debate but as the blog has a lot of new readers this year, let me try and address it once more. Firstly, the comparison by itself makes no sense. People are comparing on returns and then coming to the conclusion that ELSS will make you a great deal richer if you invest for 10 years etc. As the English proverb says you cannot compare Apples with Oranges for they are very different fruits in every manner. PPF is a classical debt product and has compounding as the basic benefit, even though the rate of returns will be conservative. ELSS is an Equity product with inherent risk and volatility, having the potential of high returns over a long term duration. This essentially means that their presence in your investment plans must be for very different reasons – just because they both qualify for 80 C exemptions they cannot be compared directly.

Secondly, it makes great sense to invest in both even if it means you exhaust your 80 C limits. If you are having a PF account and cover about 1 lac through it then look at investing the rest 50 K in PPF. I am assuming here that you can invest in equity separately and, if so, look at other MF schemes for your equity investments. There is no need to invest in ELSS just for the 80 C exemptions. Of course, If you do not have surplus after 80 C investments then try to divide your investments between PPF and ELSS. In my opinion even investors who have a PF account must open a PPF account. You can decide on the investment amount based on your context.

Thirdly, some people compare the lock in period of 3 years versus 15 years and so on. Again the comparison is baseless for we are comparing products from two very different asset classes. In any event, for most investors, these are long term investments for future goals and they do not really want to redeem these investments in the next 3 years etc. In fact, the 15 year lock in period of PPF can be seen as an advantage here as you will be having a long term debt product where you can invest every year.

Fourthly, let me give you an example on the returns front, so that people understand the basic difference between the two products :-

  • Assume that an investor has 50 lacs in a PPF account today and he also has 50 lacs in a MF portfolio. He has built this over the last 15 years or so.
  • Let us take the current PPF rate of 8 % and Equity returns at 12 %.
  • In 9 years time PPF will be 1 crore and Equity MF portfolio will be 1.38 crores. After paying taxes on Capital gains for MF, it will be about 1.34 crores.
  • However, let us just assume that in the 7th year the MF portfolio tanks by 15 % as there is a market crash. In the 8th year there is no increase and in the 9th year it again tanks by 10 %. This is not unusual, can happen very easily with equities.
  • In this case, the equity MF portfolio will be at 76 lacs by the end of 9th year.

The point is, equity as an asset class has both volatility and risk as it’s characteristic and the investor needs to understand this. In the above example, if you had a goal of 1 crore in 9 years then PPF will get you there. Equity MF can also get you there handsomely with a big surplus BUT there is a risk that you may not reach your goal too. This is the most important reason for investing in debt products such as PPF. They prevent you from redeeming your equity portfolio at the wrong time due to your needing money for one of your life goals.

So there you have it – next time an expert tells you to junk PPF and put all your money into ELSS, explain to him why that is a bad idea. As I said, you do not need equity or debt investments, both should be part of your portfolio. In fact, PPF is a must have investment and you can have any MF schemes based on your preference, it does not have to be ELSS.

Should you invest in Tata Capital NCD’s

While debt investments are a must in any investment portfolio, in the current financial climate it is a somewhat difficult task to get the right type of returns. The tried and tested avenues are giving low returns right now and the ones with higher returns, such as some Corporate FD’s, come with their fair share of risks attached. In this scenario, people looking at fixed income for their regular retirement expenditure are the hardest hit.

Tata Capital Financial Services Limited ( TCFSL ) is a trusted name in the area of financial services and they are coming up with some Non Convertible Debenture (NCD) which may well be worth a look. Let us first look at the salient features of these NCD’s and then I will outline as to whether it will be a good idea to invest in them.

  • Issue size is Rs 6000 crores in secured redeemable NCD and the face value of each NCD is Rs 1000 . Unsecured, subordinate rated NCD part is Rs 1500 crores.
  • Issue opens today and will close on September 21st. However, allotment is on first come first served basis.
  • Minimum lot is 10 debentures and you can increase it by any amount thereafter.
  • The NCD’s will be listed in both BSE and NSE.
  • 3 year, 5 year and 10 year coupon rates for retail investors are 8.8 %, 8.9 % and 9.1 % respectively.
  • The 10 year NCD invests in Unsecured, subordinated, rated and listed securities.
  • Retail investors can invest up to Rs 10 lacs in this issue, HNI investors can put in more money than that. Coupon rates for both categories are the same.
  • Ratings of these NCD’s are AAA from both CRSIL and CARE.
  • You must have a Demat account to invest in these NCD’s.
  • Income from these will be treated as interest income and treated accordingly for the purposes of taxation.
  • Capital gains will follow taxation treatment for Debt investments – your slab rate without indexation if held for lass than a year and 10 % without indexation if held for more than a year.
  • There will be no TDS on paid out interest, which is annual in nature.

Based on the above, who should look at investing in these NCD’s? I think it will make sense to people who are looking for regular passive income, whether they are in the FI state or retired. Choose the secured route and 5 years tenure only, I am generally uncomfortable with unsecured securities.

For retired people who have maxed out their VVY, SCSS, Tax free bonds and PPF from where they get regular income and still need some amount to run their regular expenses, this can be a really good option. As the payout is annual, you can use it for goals which are annual in nature – examples can be a vacation, health insurance premium etc. The company is a completely trustworthy one and you need not have any worries about your payments. Go ahead and invest in this with confidence.

For others too, if you are looking at 89000 Rs every year for some expenditure, it will be a good idea to invest. It will work out the best for people in the 10 % or 20 % tax bracket. In any case you are having FD’s then it is a good idea to put the money here.

I will be happy to answer any queries on this investment.

PPF investments – what should your strategy be now?

Readers who have been with the blog since it’s inception will know that PPF is one of my favorite debt instruments. New readers may want to read the post on Why you must invest in PPF. As this post attracted a lot of feedback and comments, I had to do A follow-up post on PPF. Finally as readers wanted to know how I had used PPF for my own financial planning, I did the final post on PPF – A personal perspective. Apart from these there are several other posts in my blog which will give you an idea about how you can use PPF in retirement etc. Read through them and you will realize the power of this simple but powerful investment. Now several people have asked me what is likely to happen to the PPF rates in the current interest rate regime and whether investing in it is still a good idea or not.

Before we get to the strategies of how to deal with PPF, let us first look at the historical rates of PPF over the last 30 years. It will be interesting to see that, in general, PPF rates have tended to be sticky and except for a brief period when the NDA government tried to link it to prevailing interest rates in the market, changes have been fairly rare. Look at the data:-

  • Between 1986 and 2000 the rate was fixed at 12 %
  • Between 2000 and 2003 it went down every year and dropped from 11 % to 8 %
  • Between 2003 and 2011 the rate remained at 8 %
  • Since 2011 the rates have not changed for long and stayed at 8.7 %
  • With the market linking, the rates were really outside government control and dropped to 8.1 %, 7.8 % and 7.6 % in a few quarters

It is important to note that with the RBI signalling a turnaround in the interest rates of late and recommending that the small savings rate be bought in line with the bank FD rates, a change in the PPF rates is imminent. Politically the NDA formation believes in aligning rates of such instruments to the market rates, as they demonstrated the previous time, on the downward route. I fully expect the rates to go up to 8 % by end of year and maybe even higher around the next budget.

So what should a new investor do now? I believe that despite the rate cuts that will definitely happen from time to time, PPF remains the best debt instrument that you can invest in due to the EEE tax treatment that it gives you. Remember that you are getting less than 7.5 % from Bank FD and and after taxes it will only be a little more than 5 %, if you are in the highest tax bracket. You can invest in debt funds where the returns will improve with falling rates, but remember that with lowered inflation the cost inflation index will also increase less and the effective taxation of LTCG in debt funds may increase. Also, PPF is a long term instrument that builds investment discipline. But most importantly, over a period of time it builds you a suitable corpus that you can tap into at the time of your goals. should the time not be a right one for redemption of equities due to the markets doing badly. This is really the biggest risk in equity investment and PPF gives you a cover for it. My suggestion to all new investors will therefore still be to open a PPF account as early as they can and maximize their contribution there.

As far as existing investors are concerned, the choice is really simple. You should simply continue investing in it without worrying too much about the rates. You are doing this as part of a financial plan and need to stick with it. In the long term these changes in interest rates will keep happening and, despite the inevitable lower returns, PPF remains the most attractive instrument for the reasons mentioned earlier in the post.

The other aspect many investors have queries on is whether PPF is better than ELSS. I see this as a completely illogical comparison as the instruments below to completely different asset classes with diametrically opposite characteristics. You need to invest in BOTH equity and debt, it is never only one of them. Yes, they both qualify for 80 C deductions but that is about all. With capital gains from ELSS being taxed now, it makes more sense to choose the best equity MF possible and not be hamstrung to some ELSS fund just because you want to take the 80 C benefits. So go ahead and invest in PPF for debt and identify the best possible MF schemes for investing in equity. This combination is good and all investors must look at it.

In summary, do not get unduly excited by the coming rate changes of PPF to 8 % or greatly disheartened if rates again drop to7.5 % some quarters later. Continue with it if you are an existing investor and open a PPF account now if you do not have one yet. You will never regret it, I have not in 24 years.

PPF is a much maligned product due to investor ignorance

My post on PPF received quite an good response yesterday, in fact more than 500 visitors on a single day made it the most popular day for my blog. While many have appreciated the article and had nice things to say about it, there were several queries that were raised about it too. I thought it will be a good idea to cover these in a post for the benefit of all readers.

Maximizing PPF contribution is a stretch at the beginning of my career, should I really be attempting it?

  • How much you are able to put in PPF is a function of your income, expenses and other investments.
  • The long term compounding effect of PPF will grow your initial contributions the most.
  • Inculcating a habit of contributing to PPF is a good investment discipline that will be of use to you.
  • Maximizing the initial contributions will ensure that your PPF corpus reaches a healthy stage by the time you may need to withdraw from it for your goals.

I can withdraw money from PPF only after 6 years, what about goals that may be sooner than that?

  • Well, firstly PPF being a long term instrument withdrawal from it is not the preferred option. This is to be used as an option when it is not appropriate to redeem equity due to market conditions etc.
  • For goals that are in the next 2-3 years you need to plan other financial instruments like debt funds etc.
  • However, for an ongoing PPF account short term goals can be planned through PPF quite easily. You can just increase your contribution in an account ( maybe that of your spouse) which is not being maximized, earn tax free returns on it and withdraw the goal amount tax free when your goal arrives. Use this for goals like vacation or car purchase.
  • Finally, even though you can withdraw only after 6 years there is a possibility of taking a loan from it after 3 years. Again, I would not recommend it as it defeats the long term compounding objective but it is available in extreme cases.

When should I start a PPF account and when should I stop it?

  • I thought I had addressed it in my post but let me repeat it here. You need to start a PPF account as early as possible, even if cannot contribute a lot in it.
  • I started my PPF account when I was 29 and I consider that very late. My daughter is going to be 24 soon and she already has opened her PPF account. So has my son who is 21 and is still doing his internship !!
  • You do not need to stop a PPF account ever, just keep extending it for blocks of 5 years. When you need money out of the account simply withdraw the needed amount. You can withdraw a total of 60 % of your maturity balance prior to the extension. So if I have completed 15 years and have 30 lacs in my account, I will be able to withdraw 18 lacs over the next 5 years.
  • Unless you feel you need more money that this for your use, simply continue the account.

I already cover my 80C limits through my PF contributions, should I still try to maximize my PPF?

  • If you are in a happy situation that your PF contribution is more than 1.5 lacs a year, you can surely afford to maximize your PPF contribution too.
  • Remember that PPF and PF have different roles to play in your overall financial portfolio. I believe that PF should be kept strictly for retirement purpose and PPF used more flexibly for goals that come prior to retirement.
  • Maximizing your PPF contribution will really let your compounding work in the most effective manner.

Should I contribute to PPF or look at something like NPS as an option?

  • Again, NPS is a very different product from PPF and one should invest in it for retirement purposes.
  • NPS can be a good option to PF as it allows some exposure to equity for people who earlier did not have that exposure when contributing to PF.
  • Invest in PPF for the right reasons, most of these were covered extensively in the original post.

PPF gives only 7.6 % interest, why not invest in other products like Mutual Funds?

  • Understand that PPF is part of your debt portfolio, so you can only compare it to Debt Mutual funds. You should definitely be investing in Equity MF but that is a different story altogether.
  • Compared to Debt MF PPF has the basic benefit of being an EEE instrument as far as taxation goes.
  • PPF does not have fluctuating returns and this is a very important consideration for compounding to work effectively.
  • It creates a great habit of investing regularly. Even if I wanted to, I do not know how easy it will be to put 1.5 lacs in a Debt MF every year. I find that quite easy to do with PPF.

Why did you close your wife’s PPF account, when you are advising to continue it forever?

  • Well, this shows the reader was paying attention while reading which is great.
  • Normally, I would not advocate closing a PPF account on maturity but there can be situations where it makes sense.
  • In this particular case we needed the money for making the down payment for our Chennai apartment. Availability of this money meant we had to take a loan of 15 lacs, not something closer to 30 lacs.

Can you share the details of your personal experience of using your PPF account?

I have no problems with sharing it but will do so in my next post. In the meantime keep your comments coming.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.

PPF investment is a must for every investor

I have been a supporter of PPF for a long time now and it has been a cornerstone of my financial planning since my early days of investing. It is also a topic over which I have had several debates with many of my friends. The commonly held view is that PPF is an old and stodgy product, rates are controlled by government, it is essentially having poor liquidity and is not something that you need if you are having PF.

Let me explain in this post how I have used PPF and why I think you must have it in your portfolio. I will do this by explaining some of the aspects of PPF and drawing upon my own experience in this.

The first thing to understand about PPF is that it is a long term product and needs to be viewed and used as such. The normal term of a PPF account is 15 years and this can be extended indefinitely in terms of 5 year periods. That being the case, you need to open a PPF account as quickly as possible and keep it going for as long as you can. You must also do the same for your spouse at the earliest opportunity. I had opened a PPF account in February 1994 and it is now in its’ 24th year. My wife has had her PPF account mature a few years back and we have opened another one for her 6 years back.

The second important aspect of PPF is the taxation, which is EEE mode and therefore quite unique among all investment options. This essentially means that you get tax benefits on investment, on the interest earned and also on maturity. LIC policies and PF also give you similar benefits but are nowhere near as flexible as PPF. While one can argue that the government policies can change, PPF is the saving option available to the vast number of workers in the unorganized sector and the chances of this happening are really quite slim.

The third important aspect of PPF is that it is a product that demonstrates the compounding principle like no other product does. You can keep investing in PPF over the years and the compounding logic will work its’ magic quietly. The longer you keep your account going, the more you benefit from it. When I look at my own planning, if I keep my investments going in the PPF account for another 10 years, about 50 % of my retirement expenses can be met from this avenue itself.

The fourth important aspect is PPF instills a sense of disciplined investment of a fixed amount every year. Though the amount you can invest is flexible, once you get into the habit of investing the maximum amount at a particular time you will always do it. Human beings are creatures of habit and once it is formed you will tend to follow it diligently. I invest 1.5 lacs every year by the 5th of April and have known many others who do the same.

The fifth important aspect of PPF is the stability that it provides to your portfolio. While there are other instruments that provide far greater returns on your investment, none of these are giving guaranteed steady returns like PPF does. Over a period of time this builds up to a very substantial figure and serves as a hedge for the fluctuations in the other parts of your portfolio. Investing 1.5 lacs regularly in PPF for 35 years will end up as a corpus of 3.28 crores !!

However, while I like PPF for all of the other things, the real importance of it to me lies in the way I can use it in my overall financial planning. There are really 3 definitive uses that I have of PPF in my financial planning and they are as follows:-

  1. In my current state of financial independence it provides me with a buffer that I can use should other things go wrong. For example, I earn a fair amount of dividend income from my stock portfolio. While this is good, there can be years where the dividend is less due to market conditions. In such a case, I can withdraw some amount from my PPF to meet the shortfall. Note that this is tax free.
  2. I have explained several times that the greatest danger of wealth destruction lies in selling equity at the wrong time. Yet many of us are forced to do it in order to meet a goal. Having a PPF account for a long time ensures that I have enough in it to meet any of my goals save retirement. This means I am free from the vagaries of the stock market. If my goal arrives at a time when the markets have crashed, I simply use money from my PPF.
  3. Once I retire I may or may not keep putting the full amount in PPF depending on funds availability. However, I will continue both of our accounts as it gives me tax free interest at a good rate. In this respect, it is similar to the tax free bonds that some of you may have invested in. I will withdraw money from it as needed and in the end it can be a pretty neat sum for my grandchildren.

Let me now suggest an innovative way of using PPF for short term goals. You may have PPF accounts which you are not funding fully today. Let us say you want to take a vacation abroad in 5 years time. The normal way will be to invest in debt funds or RD / FD etc. However, these involve fairly complex transactions in terms of purchase mechanics and taxation. A far simpler way will be to fund your PPF account with the required amount every year. You earn tax free interest and can simply withdraw the money when the goal is at hand.

My recommendation is that anyone should open a PPF account as early as possible, contribute to it as much as they can, keep it going forever and withdraw from it based on their financial plan. It may not be glamorous or exciting but this is one solid investment that you can depend on and will always stand you in good stead.

I will be happy to answer any specific query that readers may have on investing in PPF.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.

Asset allocation is critical for all investors now

One of the main reasons stock market and other bubbles get created is that we all love good times and good stories. It gives us an emotional kick to see that a stock that we hold has gone up by 10 % in a couple of trading sessions and the MF portfolio we hold has been clocking impressive gains over the last few months. In our heart of hearts and also in our rational minds we do know that the party will end, sooner rather than later, but it is far more exciting to believe that it somehow will not.

We all understand asset allocation at a fundamental level so I am not going into details. However, in simple terms for most portfolios of investors, the following need to be kept in mind when we are looking at asset allocation:-

  • Assuming you have 2 main asset classes Debt and Equity, decide on an asset allocation for yourself. 
  • In my view you must have at least 35% in Debt. This is fairly easy once you take your PF account money into consideration.
  • Periodically review to see if the allocation has got skewed by more than 5 %. In such cases sell from the higher asset and buy into the lower one.
  • For example, right now due to the run up in the markets your equity allocation may be 72% and debt 28 %. Sell off some equity and put it into a debt product such as Liquid fund etc. This provides your partial hedge against a market downturn.
  • What to sell? Again, look at stocks or MF which have run up the most and use your judgement as to which looks like the best bet.

What is my take on the current situation? I feel that there is a little more steam left in the markets yet, the Nifty may well reach 11800 levels by end of this month. However, beyond that or even before there is every likelihood of a correction to 11000 levels and below.I do not believe that we will really see a crash in the Indian markets in the near future, unless there is a change of power at the centre.

Based on the above premise take a serious look at your asset allocation this week and next. It is tough to sell something which is doing so well but you are really protecting some gains and limiting your future losses by doing so. Many people may tell you that you should simply hold and that the gains will again come back in the future. However, that is speculative and asset allocation is a way better strategy which is also a proven one.

I am sure you have never done it in the case of your MF portfolio built up through SIP – one more reason why the way SIP is done and administered, leaves a real lot to be desired.

The reality of any bull market is that there will be intermediate cuts – some not so deep and the others fairly deep. At such points you have opportunity to add more to your portfolio in a productive manner, as long as you have cash to do so. Being conscious of asset allocation and having a strategy for the same allows you to do just that.