My 2016 Income audit

As I had said in an earlier post, my expense audit of 2016 showed that it was by far the most expensive year of my life yet. This was somewhat unexpected as my initial idea was for Rinki to either take up a job or to get her B school education funded entirely through an Educational loan. In the actual event, I decided to fund her first year expenses and with several other discretionary expenses adding up, we ended up spending what we did.

While I have not been worried about the figure as it is not really representative of our future expenses, these still needed to be funded from somewhere. When I looked at the income sources from 2016, I was happy to see that I was able to take care of the significant higher expenses through my income and other planned sources, without having to take recourse of redeeming my investments in any unplanned manner. Not that it would have mattered a great deal but it is good to know that my current portfolio can withstand the shock of significantly higher expenses relatively well.

Let me state upfront that this was possible due to the fact that I had some active income in 2016. Of course, I worked full time only in January and then again from June to December part time. If you look at the overall time spent, it would have not been more than 25 % of normal working. In other words if the normal working days in a year are about 220 full days, I probably worked for 55 full days. As my earning out of it was more than 30 % my likely earning should I have worked full time, I guess I was quite productive.

My passive income is through multiple sources and will normally be able to take care of my expenses comfortably. A closer look at the passive income stream in 2016 reveals the following :-

  • Rent from the Chennai apartment was along expected lines and covered up our rent paid in Hyderabad, with a little to spare.
  • Interest from tax free bonds amounted to 2.16 lacs as planned.
  • FMP investment of 26 lacs were redeemed in the year. I have reinvested the principal amounts while using the capital gains as passive income. Amount of capital gain was equal to roughly 7 lacs in the year.
  • Dividends from stocks and some Mutual funds amounted to about 5 lacs in the year.

As far as the educational expenses for children went, I had planned it through some FD in their names which are outside of my net worth calculations. It was fortunate that this was planned liberally and I was able to use some of it for Rinki’s B school expenses. The rest of it was funded through my active and passive income. This will not be there next year as we plan to fund the rest of the XLRI fees through the sanctioned Educational loan from SBI. Ronju will still have 4 semesters to go in BITS, so we will have to pay through 2017 and 2018, but these are already planned for.

In overall terms despite serious changes in plans the expenses were managed through the income generated. By the way it looks, next year should be a lot better in terms of surplus money available to invest more. Realistically, 2018 will probably be the year when I can do without any active income at all.

Tax compliance – most people live in glass houses

This post is going to be politically incorrect and many will view it as a harsh indictment on most people. However, it will also be the complete truth and as usual, I do not care much about public opinion when I am writing these posts. Now that you have been given an early warning and have had a chance to stop reading, let me get on with it.

As all of us know there are only about 4.5 crore people in the country today who file their tax returns. This too is after a great deal of efforts by all relevant authorities, the figure used to be less than 2.5 crores only about 5 years back. Now out of this 4.5 crores there are many who pay no taxes, so the number of tax payers is only about 2.5 crores. Among these also, the number of people paying taxes less than 10000 Rs is significant. Now, it does not take a genius to figure out that there must be tax evasion on a massive scale here. Also, even the people who are paying taxes are probably not fully compliant.

Why do people, who are perfectly well educated and understand the importance of taxes do not take the right attitude of paying taxes. Well, the harsh truth is they want to keep the money themselves due to their wanton greed and crooked nature. However, since they cannot take that stance publicly, due to their own image and the inordinate fear of tax authorities, they will come up with several excuses that sound reasonably clever but are completely flawed in reality. Let us look at some of these :-

  1. Our tax rates are too high, cannot afford to pay so much. Yes, this used to be true decades back but the current rates are quite reasonable.
  2. Tax laws are too complex, do not want to get into it. Truth is that arriving at your taxable income and taxes is fairly simple and you have a slew of professionals who can help you with it.
  3. Taxes paid by me will not be used properly. This may or may not be true, but it cannot be a justification for not paying taxes.
  4. Chances of getting caught are not high. People giving this logic are of course admitting that they want to stay crooked as they probably will escape.
  5. Even after paying taxes I will be harassed by the tax authorities. Truth is only 1 % returns get taken up for scrutiny and that too if there are some red flags in them.

So who are the people who practice tax evasion on a massive scale? Almost all sections of society and some of the notable ones are as follows:-

  • Professionals like Doctors, Lawyers, Consultants, Architects who insist on getting paid by cash, maintain 2 sets of books and seriously under-report their income while seemingly being tax compliant citizens.
  • Small businesses which deal almost entirely in cash, have very little records and almost pay minimal taxes or no taxes.
  • Individual vendors like a Chaat wala or a Fish seller who are of course not in the tax ambit at all. Now, I have my full sympathy for their plight in life, which is tough to say the least, but as far as taxable income goes they need to file returns if their income crosses the threshold of 2.5 lacs in a year.
  • Small companies and big corporate who have stretched the tax laws to the limit, often quite creatively, to ensure their employees can avoid taxes as much as they can.
  • Individuals who rarely report the right income in terms of House property and other financial assets.

What about the people who do pay taxes more or less correctly? Well, firstly their numbers are really pretty limited, most of them are salaried people who can limit the TDS but cannot really avoid it. However, even here there are serious mistakes or malpractices that are common. Let me state a few of them :-

  • Many people getting rent from a house owned by them so not declare it properly. Some under-report it, some believe that for one house the rent does not need to be declared, some show the house as self occupied etc. The rule is very clear, any income you earn must first be reported, exemptions can be looked at later.
  • This is more tricky, but the law is that if you have 2 houses you need to declare some deemed rent for the second house and add it to your income. It does seem frightfully silly but if it is the law then it has to be followed.
  • Most people do not declare income from their Debt instruments such as POMIS etc where there is no TDS provision. The logic again is that it will be difficult for the tax authorities to find out !!
  • For FD where there is TDS, very few people declare the total interest income and pay the taxes beyond the statutory deduction of 10 %.
  • As far as LTC and Medical bills go the malpractices are quite legendary and most readers will be familiar with them.
  • Capital gains earned are often not reported at all or reported wrongly.
  • Savings bank interest are now exempt till 10000 Rs but all such interest earning must be declared and applicable taxes paid on the amount exceeding 10000 Rs.

Are you seeing anything here that you can identify with? If so, I would seriously suggest that you correct this when you are filing your returns next year. Do not listen to people telling you as to how you can avoid taxes, they are crooks of the first order. You should pay taxes properly because it is the right thing to do, not because you can get caught. In any case, with the IT enabling of records, it will become increasingly difficult not to be tax compliant, so you might as well make a virtue out of a necessity.

Not paying taxes due is a sure shot indicator of being a bad citizen. You can pay your dues and then question the government as to how it is using the taxes. They are accountable to you, just as you are accountable to the tax authorities.

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.

You can Manage your finances like a Company does

A Company is known  by the business that it does but very often we judge it by the financial performance that it demonstrates. The 3 most important financial perspectives for a company are it’s Balance sheet, P & L account and Cash flow statement. I think most people will agree that it will be nice for us to be able to manage our own finances like those of a company. In this post I will try to show you a way in which you can do it quite easily.

First things first – what do the 3 financial documents really mean for a company? Well, you can find extensive information on the internet and several books have great explanations, but let me try and explain it like a layman.

  • A Balance sheet is really a record of all the Assets and Liabilities that the company has at any point of time. However, it is typically generated at the end of a financial year. Obviously, it is a good idea if your assets are more than your liabilities, though for businesses just starting up or going through a rough patch this may not be the case.
  • A Profit & Loss statement is for a period, usually annual. It records all revenues and expenses that the company has had in that period. Typically, you would expect revenues to be greater than expenses though that may not always be the case.
  • A cash flow statement records all cash inflows and outflows in a given period of time. Cash inflows are normally from the sales the business generates while the outflows are for the variety of expenses that the company incurs.

Let us now try to look at how these definitions can be related to the personal finance of any individual or family. I will relate this to my situation so that it will be easier for everyone to understand the linkage.

  • Assets for me will be anything that I own which has a monetary value. In other words, if I can sell any of my possessions and convert it to money then it will be an asset. So, by this definition, a home is an asset. A car, the furniture I own, my financial instruments like Stocks and MF units are all assets.
  • Liabilities for me will be anything that I owe to people. So, if I have a housing loan from a bank that is a liability. My credit card outstanding amounts are a liability till I pay them and so are all my other unpaid bills.
  • My Net worth is the difference between my overall assets and liabilities. As I go through life my net worth would normally increase and would probably be the maximum when I retire.
  • My Sales revenues are from any source of Active income that I have. Earlier this used to be from the salary that I received at my work, today it is from the invoices that I raise to my Clients for my Consultancy practice. My Other income revenues are really all the sources of my Passive income, such as dividends, interest, rent etc. My expenses are all the expenses that I incur monthly or annually.
  • From a healthy P & L perspective, my total revenues must exceed my total expenses. As long as this happens I will have some money to invest and this will have a positive impact on my net worth. In case this is not so, I am really depleting my assets which is essentially a bad idea.
  • My cash inflows are there when my Active and Passive incomes get realized. So when a Consultancy invoice gets paid or when I receive interest from my Tax-free bonds it is cash inflow to me. When I pay my rent, my children’s college fees etc it is cash outflow to me.
  • My ability to invest in a month or quarter will depend on whether I have surplus cash available. In other words if my inflows exceed my outflows, I will be able to invest.

I will next do a few posts on strategies you can adopt to run your finances like a company does.

I am happy to see many people have got started out here. Also, become a part of my Facebook group Market Musings where a lot more is discussed on the general market situation and also individual stocks.

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.

Buying a first home – A case study

In the last post we saw the issues related to first time buying of a home. In this post, I wanted to clarify some of the context through a case study. Note that though the names are changed, all other data is accurate.

We are talking of a family of 4 – Ravi, his wife Madhuri and their children Ankit and Naina. Ravi has been working in IT for about 9 years, is 31 years old. Madhuri is a freelance web designer now and the children are 3 and 7 years old. They currently live in Hyderabad in a rented accommodation and are looking at buying their first home. Some data on the case are presented below:-

  • Their total take home income is about 2 lacs per month, out of which Ravi contributes 1.6 lacs.
  • Current 3BHK home in a Gated community costs them 28000 Rs, inclusive of maintenance.
  • Their other monthly expenses ( including one time ones ) come to about 40,000 Rs and they feel it may increase to about 50,000 Rs once Naina goes to a regular school.
  • They are currently able to invest about 1 lac per month, based on their goals. The rest of the money is for Gifts, Charities and indulgences.
  • Ravi is reasonably certain of being in Hyderabad for the next 8-10 years, till Ankit goes to college.
  • They are looking at a home which is a Gated community in West Hyderabad. The total costs will be in the region of 80 lacs and associated expenses like interiors, replacement furniture etc will move it closer to 90 lacs.
  • Ravi can look at a down payment of about 10 lacs and another 10 lacs for the interiots and furniture. He will therefore need a loan of some 70 lacs to buy the apartment.

Now Ravi can get a loan of the needed amount with an EMI of 75000 Rs for 15 years. Over the period of time his overall payment including principle and interest will be about 1.35 crores. Let us now ubnderstand how this will affect the cash flow of Ravi and Madhuri.

  • Once they move into their new home, savings on rent and taxes add up to 34000 Rs.
  • Excess cash needed for EMI will therefore be 44000 Rs per month.
  • As they were having surplus of 30000 Rs for gifts, charities and indulgences, they could look at funding 10000 Rs from that. It can also be more but that will seriously affect their lifestyle.
  • Investments per month will now come down to 66000 Rs as compared to the earlier 1 lac. As their income grows over the period they can bring this up gradually.
  • In the interim period if their expenses go up due to some reasons, investments will suffer further.

On the balance, it seems that Ravi and Madhuri can go for this. Factors to consider will be the stability of Ravi’s job, the ability of Madhuri to get a regular job if needed, adequate life and accident insurance for both of them etc. As long as these are taken care of things should work out fine.

What happens though, when the income of a couple is not at such a high level? Does the equation change? We will look at an alternate case study tomorrow to understand this.

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.

Managing expenses & investments – A basic guide

Conventional wisdom would have you believe that there is an inverse relationship between expenses and investment. that is when expenses increase the availability of money for investments reduces. On closer examination of actual data though, this will only be found to be partially true. Sure, at certain points of time in or lives increased expenses will have a dampening effect on our investments, but there will be periods where both can go up.

In this post, I wanted to give some basic guidelines on how you can manage your expenses and investments over a period of time. As generic guidelines are difficult to relate to, I will refer to my own situation during these same periods to give you a better idea of how things can be managed. If nothing else, you may be able to avoid the mistakes that I have made !!

Stage 1 – The first 5 years of your working life ( 25 – 30 years)

  • You will have reasonable expenses and may want to purchase assets like a bike and other durable for setting up your place. With the salaries of today it will still leave you a reasonable surplus to invest.
  • Start your PPF and put aside some money for future expenses like your marriage etc.
  • Put any additional money available into equity investments, preferably start with MF.
  • In my own case, I did not have any great potential for investments in this period. All that I saved was mainly in FD and this was used during my marriage.

Stage 2 – The next 5 years of your working life ( 30 – 35 years)

  • You are now married and probably have 1-2 children. Your income has grown but so have your expenses. As a result your availability of money for investment may not have grown much.
  • Newer expenses towards insurance and those related to children have now been established.
  • Asset purchases like a car and other things will lead to cash outgo in terms of direct buying or through loans.
  • You have either bought a home or thinking of doing so soon. As this is likely to entail taking a reasonable amount of loan, your EMI would have started or is about to start.
  • Make your financial plan by focusing on goal based investing. You may want to read up the series I have in my blog.
  • Continue investing in PPF and MF, increase the SIP amounts as much as you can afford to. You can also start looking at stocks with any surplus amount available. Start small, but try to invest regularly and increase the amount.
  • Personally, this was a period when both my children were born and that increased the expenses significantly. I started investing in direct stocks ( MF was hardly available then) and continued my investments in PPF.
  • Though my own income increased considerably, my wife gave up her job when our second child was born. This meant the overall money management was still tight. We bought a Maruti Zen car costing 4 lacs, with a loan of 1.5 lacs and managed to pay it off within a year.

Stage 3 – The next 10 years of your working life ( 35 – 45 years)

  • These are broadly the school going years of your children. Your career should be in a good phase now and incomes are increasing significantly.
  • Your expenses continue to be high and the main components are home loan EMI, schooling for children, insurance.
  • Discretionary expenses such as vacations, eating out, entertainment will also peak during this period.
  • Asset purchases remain high, you may replace your first car by 1 or even 2 cars in this period.
  • Try to pay off as much of the home loan that you can. The interest you pay is a greater drag than the tax benefit.
  • Continue your investments in PPF and MF. By now your SIP amount should have reached the maximum level you had planned for. Invest aggressively in direct stocks with the extra money, to build up a robust stock portfolio.
  • We managed to pay off the home loan in about 3 years. This was possible due to a higher down payment due to the money available from my wife’s PPF account maturity.
  • Change of a job increased my income levels considerably. Apart from adding to my reasonable stock portfolio at this time, I started investing in MF through both SIP and one time purchases.
  • Our expenses increased considerably too, discretionary expenses like vacations and eating out contributing the most. Regular expenses like children’s schooling also went up a lot when we admitted them to a good but expensive public school on our shifting to Hyderabad.
  • We bought two cars during this period – a Hyundai Accent in 2002 costing 7.5 lacs and a Toyota Corolla Altis in 2009 costing 14 lacs plus. In both instances there were no loans and full payment was made on purchase.

Stage 4 – The final phase of your work life ( 45 – Whatever )

  • Ideally, your children have completed their schooling or college by the time you decide to finish your work life or do something else that seems more interesting to you.
  • Your expenses remain high due to all the characteristics of the earlier phase till your children complete schooling. At this point they will dip, assuming you are paying for their college education through a goal set up earlier.
  • Discretionary expenses will peak with items such as vacations outside the country.
  • When you redeem for goals follow the guidelines given in other parts of the blog.
  • Continue your investments as before, much of your money should be going into direct stocks now.
  • In case, you want to achieve a state of financial independence before your retirement, set up a passive income stream through your dividends, possible withdrawals from PPF, interest from other debt products etc.
  • We had planned for most expenses through current income, including a vacation to Europe and Australia. The college expenses for my daughter was largely paid through regular income and she is in her final year now. For my son, we have allocated money for his 4 years of college through some insurance policies that will mature in next 2 years.
  • I have set up a passive income stream that will allow me to be financially independent for the next 10 years. IN this period I do not want to touch my equity portfolio which will hopefully grow nicely.

I hope this gives you a good idea of how you can go about things in practical terms. Money management at retirement is a different ball game and I will tackle that in a later post some time.

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Tax free bonds – Who should invest?

Many of you may be knowing that 7 PSU’s are  going to come up with Tax free bonds in the market very soon, maybe starting late July itself. The total value of these bonds are going to be 40,000 crores and the tenure will be 10, 15 and 20 years. The interest rates are likely to be in the range of 8 %, maybe a little less.

There is a lot of interest among investors for the tax free bonds and it is likely to be fully subscribed. The last time they were available in 2013-2014, the bonds were quite successful and even today these sell at a premium in the secondary market. For investors the big question is – should you be investing in these? Before getting into that let us see what are the benefits and drawbacks of the tax free bonds.

  • You are able to lock in your funds at a reasonable interest rate and get tax free money every year.
  • Liquidity of the product is poor as selling in the secondary market will not be easy.
  • Due to the long  lock in you may lose out on rising interest rates at a later date.

This is clearly not a product for wealth creation as the growth will be limited to real returns of 1-2 % or so. The basic attraction of the product is safety of capital as well as tax free income. People who are in the tax brackets of 10 and 20 % may not find much value in this as the lock in periods are rather long.

I think you can look at investing in these bonds if you are an investor with the following characteristics:-

  • You are i.n the 30 % tax bracket and are looking at tax free income.
  • You are trying to set up a passive income stream and want regular and assured income that is tax free.
  • You have got a retirement corpus and want to put part of it in instruments that generate assured and tax free income.
  • You have a long term commitment of an amount and you are looking at a simple means of generating it year on year.

For people in the accumulation and growth phase of their investments, this is not a right product. Invest in financial assets like stock or Mutual Fund which will have higher growth potential. Even for debt option choose products that are liquid.

People looking at long term, regular, assured and tax free income will find this to be an ideal product.

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.