MF investments and LTCG tax – the real impact

With a lot of heat and dust about the LTCG taxation on equities one aspect of it, namely, the real impact of the tax on an investor’s long term return have largely got very little attention. I was made aware of it through an article by Dhirendra Kumar of Value Research Online and largely agree with what he has said. As many of the investors may have missed out on this, let me try and explain it in this post.

Now, we all know that it is possible for equity to grow at a rate of 12-15 % in a long term period of 10 years and more. Of course, the growth in equity is non-linear, meaning you may well grow 30 % in a year like 2017 and even have negative growth as in 2008 and 2011 etc. If we look deeper into the growth of our MF investments we will see there are clearly 2 parts to it – first is the inflation prevalent in the economy and the second is the real return you get on your investment. For example, if your MF investments have grown by 15 % and inflation during this period was 8 % then your real return is 7 %. In general, your real return can exceed 10 % in a good year for the markets and will be in the range of 4-8 % in other years. Again, if the markets turn negative or are mostly sideways in a year then your real returns may well be negative.

With this backdrop, we will take an example to understand the impact of the recently introduced LTCG tax on equities on your MF returns:

  • An investor starts investing through SIP in one of the popular MF schemes from April 1st 2018. Let us say the amount is 20000 and he wants to do it for 15 years.
  • At 12 % annual returns he will get about 1 crore, which he plans to use for his daughter’s higher education.
  • His overall LTCG will be to the tune of 64 lacs and the tax thereon will be 6.4 lacs.
  • Now if we assume that the inflation component is 6 % and the real returns are also 6 % then the real returns are to the tune of 32 lacs.
  • In effect you are paying 6.4 lacs tax on a 32 lac real gain – this comes to 20 % and not 10 % as most of us are given to understand.
  • This situation could have been corrected if indexation was allowed but that has not been done in the case of LTCG on equities.
  • The 1 lac exemption etc has very little meaning for people looking at a large goal as it will be an insignificant part as compared to the goal amount.
  • In simple terms you are being taxed on inflation too, which is grossly unfair !!

In terms of the goal itself, you will need to increase your monthly SIP amount by 1281 Rs so that you are having the required goal amount after taxation.

So what can you do from your end to see that you minimise the taxes at least? Well, for one, you can spread the redeeming over the years of college so that the impact will be shared over 4 years or so. This will not affect the total tax outgo but you will feel better that your tax payment at one time does not appear so horrendous.

I hope the intelligent readers would have understood the real dangers here. Even if your real return is much lower, say 10 % you still pay a lot of tax. For the above example at 10 % returns your LTCG is 47 lacs and you pay tax of 4.7 lacs. As a percentage of real return you are now talking of well over 30 %. If your real returns are even lower if the market tanks in that year, then the tax paid as a percentage will be even higher.

The conclusion is a simple one – by not allowing for indexation the FM has really dealt a body blow to long term investors who have been investing seriously over the last several years and have played a stellar role in the success of our stock markets.

What strategies can you adopt for your investments? I will take this up in another post.


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.

Retirement corpus needed is a function of real returns

In an earlier post, I had written about how our lifestyle choices in retirement will influence the amount of retirement corpus we need to start our retired life with. I also wanted to write a post with my personal example but, with some other engagements, I have not been able to get down to it. I hope to do it this weekend.

The retirement corpus is also a function of the real rate of return you are able to get. For those who are unaware of the term, the real rate of return is the difference between your return on investments and inflation. So if your portfolio is giving an overall return of 9 % and the inflation in the economy is 7 %, then your real rate of return is 2 %. In one of my earlier posts, I had shown a simple way to calculate a retirement corpus by assuming the real rate of return as zero. Interested people can read the post here.

So in order to recap that post, if you are retiring at any age and have X years to live with an annual expense of Y, then your retirement corpus needed will be XY. For example, I think I will live for 30 years max and my annual expenses may be in the range of 12 lacs per year. According to the formula XY, I will therefore need 3.6 crores. Note that this assumes two things – firstly, my money will only grow at the rate of inflation and, secondly, I will not have any corpus left when I finish the 30 years.

Now, I may not be lucky to have this amount. In this case, I can simply keep trying to earn some active income, hope to get a lottery or depend on my children to tide by my later years. As I do not fancy any of these strategies another option can be to reduce my spending. For example, if I can somehow do with an annual expenditure of 8 lacs then the corpus needed is only 2.4 crores. However, this will now compromise with the lifestyle I want to have, especially in the area of travel. Fortunately, there is a way out of this and I will show you how to do it.

The trick is in organising your money in such a manner that you have some real rate of return. Let us say, I use debt MF and hybrid funds to increase my returns to 8 % and inflation rate for me is 6 %. With this real return of 2 %, it will be quite possible to have a significantly lower corpus retirement. There are calculators available in the public domain which you can use so I am not getting into that. However, here are the outcomes.

Assuming 30 years to live and 12 lacs per year as the annual expense:-

  • With a real return of 0 %, corpus needed is 3.6 crores.
  • With a real return of 1 %, corpus needed is 3.28 crores.
  • With a real return of 2 %, corpus needed is 2.83 crores.
  • With a real return of 3 %, corpus needed is 2.46 crores.

I can go on but you get the point. The idea therefore will be to organise my money to generate a decent level of RRR so that even with a lower corpus there is a chance I get to lead the lifestyle in retirement that I am desirous of. The flip side is this – to generate high RRR, I will need to take more risks in my money and definitely put some of it in equity. This is fine with me as my basic 3 portfolios of Debt, MF and Stocks are something I am quite comfortable with. If you are not fine with the risks you can only deal with RRR of 1 % or so. In that case you will need a higher corpus, a lower annual expenditure or hopefully a pension from the company where you work now.

I will write some more posts on retirement, follow the blog to get those.

So what is the alternative to FD’s ?

In the last post I wrote about why FD as an investment is not at all a suitable one. It offers low returns and is clearly not tax efficient. The natural question therefore is, which are the investments to replace traditional bank FD? In this post I will try to answer the same.

Let us first look at why do people invest in FD. There can be many reasons but 3 of them are the most common ones:-

  1. Many people simply do not know of any options for savings and think this is a safe way which will also earn some returns.
  2. Some investors look at FDs as a good place for an Emergency fund and also for any goal that may be coming up in the next 1-5 years.
  3. Retired people and others who want a regular source of income keep their money invested in FD for the longer term.

In this post I will deal with the first two as the last one is more complex in nature and deserves to be dealt with separately.

For the first category of people, if they are able to keep the money for long term, my recommendation will be PPF. The returns here are more than FD today and they are tax free. Moreover you get 80 C benefits with PPF, so if you have not exhausted your 1.5 lac limit through other means, this is a great benefit. Also, though PPF is for a 15 year term, you can make withdrawals after 6 years. Finally, if you start early, this will be a great backup to your MF redemption, in the years which are not good for equity.

What if you do not want a long term product such as PPF? Well, one option can be Arbitrage funds which will probably give you returns of around 7 %. While this is pretty much the same as FD, the tax treatment is much better as you will not be paying any taxes on the capital gains after one year. You can therefore park your money here and redeem it in a tax free manner for any needs in an ongoing basis. Arbitrage funds are also quite risk free as far as your capital is concerned, unlike equity funds.

Regular Debt funds or FMP, MIP etc will work if your time frame is at least 3 years. This is the time you need to keep your money to get indexation benefits for LTCG. Note here that with the Cost Inflation Index ( CII ) being dampened due to lower inflation numbers, you will still need to pay some taxes but this would be on a much lower scale. Also, as the interest rates will go up, Debt funds and MIP are likely to have a lower return. We are pretty much at the bottom of the cycle and rates will go up in the next 1-2 years. Finally MIP will do very well if equities are doing well but therein lies the risk too.

In conclusion for the first category of people, use the following strategies:-

  • If you are OK with a little risk go for MIP and Debt funds.
  • If you are having lower risk taking ability but can wait 3 years or more go for FMP. Here too you can look at Dual Advantage FMP if some risk is all right.
  • In case you do not have 3 years and are looking at moderate but steady returns, look at Arbitrage funds.
  • If you just want to save and are not going to need the money for long, look at PPF.

What about category 2 people? Many financial planners will advise you to withdraw from equity and part the money in debt some 3 years before your goal etc. I have never found any sense in this as you might really be losing out on growth by such actions. At the same time being purely in equity is not a good idea either. You need to take some middle path which balances the needs of both growth and safety.

  • Higher risk takers can try Equity Savings Funds or Balanced Funds.
  • Moderate risk takers can try MIP, Dual Advantage FMP, Debt funds
  • Risk averse investors can try FMP, Liquid funds, Arbitrage funds

Note here that the higher risk options are more suited to 3 years plus time frame.

So, there you have it. Now that you know what to do with your money which is in bank FD’s, go ahead and stop those. You will soon thank me for having written this post !!

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.


MF buying, index levels and 2017 outlook

To begin with, let me state that I was rather impressed by the readership of my last post as well as the comments posted. I have tried to respond to the individual ones but felt that it would be a good idea to address some common issues. Even before getting into it, let me state that I have no pathological dislike for SIP – in fact as a marketing professional, I feel that SIP has been an outstanding marketing success, so much so that many people even think that SIP is` the product they have invested in !! My only objection comes from the basic fact that SIP is a completely wrong way to buy equity as an asset class.

Let us now get to the objections. They are broadly as follows:-

  • SIP is easy for salaried people as otherwise they cannot say whether they will spend the money or not – I hope this issue is addressed through the real life case study that I shared.
  • People will find it difficult to keep track of index levels etc.
  • How do I know that Nifty will simply not keep climbing and reach 9000 and beyond levels, thereby not giving a chance for people to invest in MF.

In order to understand this, we will need to look at historical levels of the Nifty over the last 2 years or so. 

  • On February 7th 2014, Nifty was at 6023. This was the low point of the UPA and it started to rise from there.
  • On May 16th 2014, after the win of Modi and BJP Nifty hit a level of 7203. At that point most analysts predicted 9000 levels quite soon.
  • On March 5th 2015, Nifty hit a level of 8937. For the first part of Modi regime the Nifty had climbed almost non stop with only occasional blips.
  • On Jan 1st 2016, it was at a level of 7963 and kept going down to below 7000 on the day of the budget which was 29th Feb 2016.
  • Nifty ended 2016 at a level of 8185.

You can see from here that the Nifty has really moved nothing in the last 2 years. Yet we expect it to move by 2000 points or so and that too continuously? We might as well believe in fairies and ghosts 🙂

Coming to the current year, we clearly need to understand that the whole rise and fall of Nifty and other indices are largely FII money driven. With the US and some other markets doing well there will be tough choices for the FII brigade as to where they should put in the money. If the stability of the government and the policies that it espouses seem to resonate well in terms of BJP doing well and the economy showing high growth in terms of the corporate earning then Nifty may well climb again. 

So what is likely to happen? Right now, Nifty fair value is sub 8000 but it is very likely it may have a run up in the period till the budget. If it crosses 8600 or so that will be a major victory for the bulls and may push it up even beyond 9000. However, that is unlikely and I think Nifty levels will oscillate between 7900 and 8500 depending on the budget outcome. If BJP loses UP in addition to Punjab then 7900 is very likely to be breached on the downside. In any case, corporate earning in this calendar year will only improve in Q3 or so due to the demonetization effect and therefore Nifty will probably rise in the last 3 months of the year, given the revival of FII interest in our markets.

The route from today is thus likely to be as follows, 8300 – 8000/8500 – 7700/9000, 8400/9500. I personally think a 10 to 12 % return on the Nifty is quite possible from the start of the year when it was around 8185. Given this it is clear that you do not want to buy at levels of 8800 and 9000 and subject your investments to another year of mediocre returns. That is what they had in 2015 and 2016 when you bought at high levels through SIP and are now seeing much lower levels.

From my perspective I bought in 2016 at very near the lows of the year and avoided buying for most part till the very end. In this year too, I am hoping to buy in the sub 8000 levels of the Nifty and hopefully much lower. In order to do this we will need to track the Nifty over the months and have some idea about some directional trend.

The point is, even if you do not get any chance to invest and have the money in Arbitrage funds you will still make 7 – 8 %. This is more than what the Nifty has done over the last 2 years. In reality the markets will always give you opportunities and you just need to be aware of these.

Let me address this in the next post.

My successful stock picks – a sample

Of late I have been inundated with a lot of requests for sharing my stock portfolio, the price at which I bought the stocks etc. I think these come from two categories of people – some who feel they would be able to learn something from what I had done and others who want to check and probably tell me what I had done wrong and why. Be that as it may, I think both of these types will not get what the want from what I am about to share. These picks are mostly at an earlier point of time and has to be seen in the context of how I operate. However, they do provide some general learning, which may be of use.

Let me start with Mindtree, one of my stock picks in the IT space that I have been very happy with. The details are:-

  • I started investing in Mindtree in July 2007, as it looked to be a rather promising Mid tier IT company. I knew some people in charge there and was confident that the company will do well in the long run.
  • My starting price was 663 and the stock started correcting immediately thereafter. Between 30/7/2007 and 1/11/2007 the stock went down from 663 to 463 and I made a total of 6 purchases each for the same number of shares.
  • My final purchase was after the turmoil of 2008 at a price of 318.
  • After the split my shares doubled and the price was 1500 plus . This was a multiple of 4+ on the invested price. Subsequent to another bonus the CMP is nearly 600 now.
  • I am pretty sure that over the next few years a price of 1000 or so is very achievable for the stock.
  • Mindtree is a good dividend paying company and that is separate from the above.

The next company is the Pharma company Dr Reddys Labs. The details are:-

  • I wanted to have a few Pharma blue chip companies in my portfolio and DRL was an obvious choice.
  • Like Mindtree, most of my investments in DRL were between July 2007 and March 2009. The acquisition price started at 632 and went down to 379 for my last purchase. Average cost of acquisition was 540 Rs.
  • The CMP of DRL today is 3012 Rs and I expect it to go up to 5000 plus in the next 2-3 years.
  • The gains in the stock are of the same scale as those of Mindtree.

The next company is the Automobile market leader Maruti. The details are:-

  • I wanted to have Auto sector represented in my portfolio and Maruti was an obvious choice here.
  • My first purchase was at 741 Rs in June 2007 and the last one was in October 2008 at 515 Rs.
  • CMP of Maruti is nearly 5000 today and it is very likely to cross 6000 in this FY itself.
  • My investment today has multiplied more than 7 times.
  • On an average I get about 20000 Rs dividend per year from this stock.

The next company is also from the Automobile sector and it is M & M. the details are:-

  • I chose this as it complemented Maruti in the commercial vehicles space.
  • I started buying M & M in March 2007 and kept buying till January 2009. My starting point was 723 Rs and the last price I bought it for was 263 Rs. You can imagine the kind of bargain there was, but there were hardly any takers!!
  • After the split adjustment, the current average price is 286 Rs
  • CMP of the stock is 1243 Rs and expectations are for it to reach 2000 Rs sometime in 2016.
  • My investment in this has again multiplied nearly 5 times.
  • This again is a good dividend paying stock, normally declares dividend every quarter.

L & T was my first CD bought way back in 1992. See how it has done so far:-

  • I got 75 shares at the price of 60 Rs each in 1992. This went through bonus/splits etc and today I have 225 shares.
  • This is after I sold some shares in 2007 for 75000 Rs.
  • CMP of L & T is 1518 Rs today and my total realization on a 4500 Rs investment is more than 4 lacs.
  • This is exclusive of the good dividends that L & T normally announces every quarter.
  • There will also be a lot of value unlocking in L & T shares when some of it’s subsidiaries get listed in 2016.

I could go on and list many more but you would have got the point. Of course, I have had spectacular failures too – some of them are Kingfisher Airlines, Reliance Infocom, Teledata Informatics etc. Several of the Infra companies are also not doing well at all but that is a long term play and I am still hopeful of them succeeding.

Many people ask me why I did not continue investing in stocks post 2009 in a significant manner. Firstly, my priorities got focused on my job as CEO of a global company and on my children’s studies as they were getting to a stage where I had to think of their college admissions. Secondly, I thought I had built a good enough portfolio and now it really had to be maintained over a long term. Thirdly due to my thoughts of giving up my corporate career, I needed to invest more in MF and debt products. All such investments have happened since 2008 onward. Finally, after we settled down in Hyderabad my wife got into building a portfolio of her own, though she only holds stocks for short term. Now, I really act as an adviser to her, though it is not easy for us to agree on what price one should buy or sell a stock.

My advise to all investors who are still wondering whether to start with stocks or not – go ahead and begin building a good portfolio over a period of time. Even if 50 % of your picks are successful you will gain much more than any other mode of investment. I absolutely know this in my case and I am sure it’ll be true for you as long as you choose good companies to invest in. No great tips or analysis of ratios is needed – just start with the market leaders first.