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.

 

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.

A life plan must precede a financial plan

With the increasing readership of my blog, I get a lot of requests to either make financial plans for people or to review an existing financial plan that was made by someone for them. What strikes me as amazing is that people by and large focus greatly on their financial goals and almost take their life goals for granted. This flies in the face of the obvious reality – your finances are there to support your life goals and therefore must come after you have thought through your life goals.

The first thing which surprises me is that people project their lives for the next 30 years or so without having the ambition to do more with it. Let us say you have passed out of college and got a job. While it may be a job which you like, you may still look at ways and means of improving it. An IT person who started his career just 5 years back may already be finding himself in the cross roads. There is no guarantee that your current job will last for 10 years, let alone 30. It is therefore imperative that you fix your life goals based on your current skills, future skills you may need to acquire and the kind of work you want to do. It may be necessary for you to take up your first job for many reasons, but there will be equally good reasons as to why you may want to do other things.

The same goes for people who are in their mid career with a family. Yes, changing your life direction may be more difficult now but it is not impossible by any means. I had a friend who was a hotel manager for 10 years, worked in Rediff for another 10 years, went on to do an MBA abroad and is now a professor in an US Business school. Note that the latter career moves were all done when he had a family. Another friend of mine who is from an IIT and an IIM, went to the US recently to pursue a second MBA as he was not happy with how his career was shaping up. In his case too he took his wife and a young daughter to the US. There is no doubt that these people had to go through a lot of tough times but they were clear as to what they wanted to achieve.

Changing careers are getting much more common nowadays than ever before. I just came to know of a Doctor, who practised for 7 years after his MBBS and has now got into IIM Ahmedabad for their one year Executive program. He wants to be associated with Health care but not as a practising Doctor and felt that an Executive MBA will give him the opportunities that he is seeking out.

The problem with financial plans is that they are done assuming people will proceed in their lives linearly. They will start with a job, increase their salaries every year, get married, invest and increase their investments, plan their finances, home buying and have other goals such as children’s education, marriage and retirement. This does not at all cater to real life and real people. For example, I started working at 24 and always wanted to retire at 45, or at least be financially independent by then. If I had been to a financial planner, he would probably have told me that I needed to work for 35 years and early retirement was just not possible in India.

The logic can get extended to any particular passion you have in life. Earlier it was difficult to take up your passion due to lack of resources and opportunity. However, many people nowadays want to take up their passion after they have fulfilled most of their responsibilities. I know of people who have taken up travel, reading, teaching and several other interest areas at a relatively late stage in life and have done very well in them.

So the point is your life plan must be dynamic in nature to fulfil the aspirations you have. We will not meet all our aspirations but there should be a clear and concerted attempt to do so. The financial plan must adapt to your life journey not the other way round. You need a financial planner who understands this.

How does one go about doing this? Let that be the subject of another post.

IndiGrid InvIT Fund IPO – should you invest ?

In the investment world we are all looking at newer ways to invest, always hoping that the next product coming across will hopefully give us better returns than our earlier ones. In this context the Infrastructure Investment trust bond issue from IRB Infra generated a lot of interest in the market and was oversubscribed 8.6 times, despite the high ticket size of 10 lacs. Close on it’s heels we have the IndiGrid InvIT fund IPO, open from 17th to 19th of this month.

To begin with, Infrastructure projects such as ports, roads, power projects and other kinds of construction are normally on a massive scale and need a lot of funding. These are also long gestation projects where the returns will only come after a certain number of years. If you look at NHAI for example, the several companies started by it for the different projects are all technically running at a loss, due to the high interest rates and depreciation that they have to deal with. Their loans are huge and though the marginal profits on EBITDA are very good, progress in some of these projects have been slow due to the adequate availability of cash at the right times.

The idea of an Infrastructure Investment Trust ( InvIT ) is to restructure these loans by paying it off with the investment they will get in the trust. The Trust will then have an arrangement with these companies to get returns from them through the profits generated. Investors in InvIT will get their returns through dividends, buyback etc. As all these companies are having pretty much assured revenue over a period of time, the returns are likely to be good.

The below information about the IndiGrid InvIT Fund IPo, is taken from the website http://www.chittorgarh.com and a few other sources of publicly available information:-

Incorporated in 2016, IndiGrid InvIT Fund is an infrastructure investment trust (“InvIT”) established to own inter-state power transmission assets in India. They are focused on providing stable and sustainable distributions to their Unitholders.

Sterlite Power Grid Ventures Ltd, sponsor of IndiGrid InvIT Fund is one of the leading independent power transmission companies operating in the private sector, with extensive experience in bidding, designing, financing, constructing and maintaining power transmission projects across India.

Company’s sponsor owns 11 inter-state power transmission projects with a total network of 30 power transmission lines of approximately 7,733 ckms and nine substations having 13,890 MVA of transformation capacity. Some of these projects have been fully commissioned, while others are at different stages of development. They recently won bids for two transmission projects in Brazil,

Of the 11 inter-state power transmission projects owned by the Sponsor, they will initially acquire two projects with a total network of eight power transmission lines of 1,936 ckms and two substations having 6,000 MVA of transformation capacity across four states (the “Initial Portfolio Assets”).

Objects of the Issue:

The object of the issue are to:

1. providing loan to BDTCL and JTCL for repayment or pre-payment of debt (including any accrued interest and any applicable penalties) of banks, financial institutions, SGL1, SGL2;
2. repayment of any other long term and short term liabilities and capital expenditure creditors.

Comparision of InvITs

Comparision of InvITs (IRB InvITs & IndiGrid InvIT)
Particulars IRB InvITs IndiGrid InvIT
Price band Rs. 100-102 Rs. 98-100
Issur Size Rs. 5921 cr. Rs. 2250 cr.
Sector Toll Road constructions Power Transmission
Likely yield 8 to 12% 10 to 15%
Entry Level At a Premium At par value
Tenure 16 years 35 years
Corporate Ratings AAA/Stable AAA/Stable
Proportionate Allotment 75% of the issue (i.e. except retail) 75% of the issue (i.e. except retail)
Risk Factors Inflation, Traffic Volume, Govt. policies Load Availability, Market trends
Market perception Bearing Risk as above Considered as Safe asset class Globally
Promoter IRB Group Sterlie Group

Should you be applying to this issue? Well, if you have not got an allotment in the IRB InvIT IPO then you should definitely look at it. The one thing which may be a spoiler here is that the yields are primarily going to be in terms of interest and this will be taxable in the hands of the investor.

In case you are not yet fully invested in equities through MF and stocks, you may want to delay investment in InvIT’s for now. Focus on building your equity investments and you can then look at future InvIT issues. There will surely be many more soon.

 

A case study from recent AIFW post

It always surprises me a little to see the reactions of people in Facebook groups when a group member asks a simple query. Some members assume that the questioner needs to get knowledge by reading blog posts of some other members first, others advise him to go to a fee only financial planner and even give him a list, yet others tell him that one should just keep working and not think of retiring.

To come back to the recent query, here are the salient facts shared by the person who wanted advice on whether he will be able to gain Financial independence in 6 years:-

  • He has 1.2 crores in FD and another 30 lacs in equity etc
  • Can invest 20000 per month for next 6 years
  • Has a child in class 7, who should be going to college in 6 years
  • Has his own house and loans will be paid for by the time he is 50.
  • Current costs are 1 lac per month, 15000 for child and includes loan repayments.

Let me come to the question as to whether he will be able to be financially independent by the time he is 50. For this we will calculate his Financial Independence Number (FIN) in the following manner.

  • His base cost at 50 will be lower than 1 lac as child cost will be gone and so will the loan repayment. However, let us take it at 1 lac to take care of inflation etc.
  • For retirement of 30 years his cost will be 3.6 crores at zero real rate of return
  • For child higher education we can take 20 lacs
  • For asset replacement etc we can take 20 lacs
  • Total FIN therefore comes to 4 crores.

Fortunately, in real life we do not need to go with financial planner and/or calculators blindly and can use some experience and common sense. It is difficult to tell others what to do as they will have their own goals and ways. However, if I were in his place, I would be doing the following:-

  • As his child’s college education is 6 years away, I will put 10 lacs in an Aggressive Balanced fund like HDFC Prudence. This amount will take care of the 20 lacs that will be required for the child’s graduation.
  • I will redeploy the 1.1 crore left in FD to different types of Debt funds. Assuming a CAGR of 8 % this will grow to an amount of 1.75 crores.
  • His current equity investment will grow to 60 lacs if we take 12 % CAGR over 6 years.
  • 20000 SIP @ 12 % returns will grow to about 21 lacs in 6 years.
  • So at 50 years he will have 1.75 crores in Debt and 81 lacs in equity

Let us now look at deployment of corpus. In the first 10 years of retirement, his strategy can be the following:-

  • Interest from Debt portion will be to the tune of 14 lacs @ 8 % returns. This is definitely possible if he is into good quality Debt instruments.
  • As his child is in college and he is still relatively young, I will not reinvest this 2 lacs but spend it in discretionary expenditure such as travel or asset replacement.
  • At the end of 10 years, he will be 60 so the activities will reduce and on the balance his medical expenses may grow. I think an annual expense of 18 lacs will be enough. There is no need to calculate this by inflation formula – makes no sense at all to do so.
  • Assuming a 12 % return on equity his equity corpus will be 2.51 crores.

In the next decade his deployment can be as follows:-

  • Keep using the interest from Debt instruments and take out the remaining required amount from redeeming the principal.
  • Even after you finish the decade you will have some amount left in Debt instruments. I suggest you donate it to a charity of your choice.
  • Your equity investments would have grown to more than 7 crores by now and will be more than enough to last your life as well as live a legacy.

So to come back to the basic query – will you have enough to retire at 50? You bet you will. Now just shut out all the negative people with negative comments from your mind and go ahead with the plan. Honestly, if you are able to get the selection of instruments done on your own, you do not even need a Financial planner.

Will be happy to receive comments, feedback and criticism on the post.

A contrarian case study on retirement

I have been writing this blog for more than a month now and have come across many individuals, with different and unique financial situations. I also get pulled in for advice on how to deal with several financial issues. I think it will be a good idea to share some real life situations with my readers so that it helps them in their financial journey.

The first one that comes to mind is of a recently retired person who was introduced to me by a friend. For the purposes of this discussion we will call him Aloke. Some background of Aloke will be in order before we get to the case itself.

  • Aloke is an Engineer by profession and has worked in different manufacturing companies for about 35 years before retiring last year.
  • His wife is a homemaker and he has one son who is a CA, working now in a reputed audit firm in Mumbai.
  • Aloke has a 3 BHK apartment in West Hyderabad and wants to settle there.
  • He has never been in equity, most of his investments were in PF and PPF. All expenses except the apartment was always from his active income or from FD / RD which he had set up for larger expenses.
  • His current expenses are 5 lacs a year and he thinks if that is adjusted for inflation he will be pretty ok with it.
  • He got his PF in 2013 which amounted to about 1 crore. He had put all of it into Tax free bonds that were giving an interest of 9 % then.
  • His PPF is presently having 45 lacs.

Aloke came to me as he was confused with all kinds of strategies that were being told to him by financial planners. Many wanted him to sell his funds in the secondary market and put the money into different buckets etc. This is an amazingly bad idea as he is getting a tax free income of 9 lacs and will be getting it for the next 17 years !!

Here is what I suggested to him.

  • Continue with the current situation till the tenure of the tax free bonds run out. By that time he will be 80 years old.
  • For the surplus each year, put 1.5 lacs into PPF and the rest in a multi cap mutual fund such as ICICI Value Discovery or SBI Emerging Blue Chip.
  • Assuming 6 % annual inflation, Aloke will be able to carry on the MF investment till year 6 by which his investment will be about 9 lacs.
  • PPF can be carried out till year 9 when his expenses will get to 9 lacs a year.
  • From the years 10 through 17 he will need to withdraw from his MF fully and PPF partially to fund extra 32 lacs of expenses.
  • At the end of 17 years, when Aloke is 80, he  will have 1.5 crores in PPF and 1 crore from redemption of tax free bonds.
  • Even with annual expenses of 20 lacs then, this will definitely last him comfortably till the rest of his lifetime.

Understand that the plan is specific to Aloke who does not really want any risks, does not want to worry about taxes and is comfortable with his present lifestyle. It is not always important to have 5 crores or chase equity returns. There is a financial plan present for each person and situation, you just need to use some knowledge to get there.