FMP investments may not pay off now

Followers of my blog will know that I have significant investments in Fixed Maturity Plans of fund houses. These were undoubtedly the best instruments till 2014 where the LTCG indexation was available after 1 year as opposed to 3 years for other debt funds. In that period all capital gains from FMP were akin to tax free income for me

While the Finance minister changed the LTCG time frame to 3 years in the budget of 2014, FMP was still a viable instrument if you were willing to hold it for 3 years. The reasonable returns, coupled with the indexation benefits made it more attractive than many other Debt funds. Personally, I rolled over all my FMP investments to 3 years and that worked quite well for me – I used the capital gains for my regular expenses, mostly discretionary ones, and reinvested the principal amount in FMP or other hybrid funds. Of late I have preferred Hybrid funds rather than pure Debt focused FMP.

So why do I say now that this is no longer something which can pay off? There are two broad trends in this space that forms the basis of my opinion. Firstly, with the lowering of inflation and consequently the interest rates any fresh FMP will be likely to give returns only between 7 % and 7.5 %. Remember that by it’s very nature FMP’s invest in securities at the start of term and hold it till maturity. While this provides good downside protection, it obviously does not work well when the interest rate cycle reverses direction. For example even if the interest rates increase by 100 basis points next year, the 3 year FMP I start now will not get any benefit from the same. 

Secondly, with the inflation rates in the economy having a downward trend, the Cost Inflation Index is rising at a much slower pace than before. As a result the indexation benefits one was used to getting earlier will be significantly lower now. In real terms this means higher capital gains after indexation and therefore a higher tax liability. These two factors combined will mean that your effective post tax returns from FMP will be much lower than it used to be 2 years back.

Let me try to illustrate this with a real life example from my portfolio below:-

  • An ICICI FMP bought in November 2013 and rolled over subsequently has now matured in July 2017.
  • Purchase cost was 1 lac, Redemption was done at 1, 34, 529 Rs and the indexed purchase cost with application of new CII was 1, 19, 809 Rs.
  • Capital gains after indexation is therefore 14, 720 Rs. Tax on it @ 20 % is 2944 Rs.
  • Effective returns over 3.5 years is therefore 31.5 %
  • CAGR over this period will be only 8 %

Now while a post tax return of nearly 8 % is definitely not bad in today’s scenario, remember that this will keep getting worse and will be a lot lower for an FMP you are entering today for the next 3 years.

Now if we agree that FMP is not the preferred instrument of investment right now, the question remains as to where can we invest then? I will recommend Hybrid funds that have some exposure to equity apart from debt. Look at the following options:-

  • Dual Advantage Funds among FMP space
  • Equity Savings Funds
  • Monthly Income Plans
  • Dynamic Funds

All these will come with some risk exposure but 3 years on our markets should be doing better than today anyway.

New Cost Inflation Index – know about it

One of the important aspects in personal finance is to keep track of the regulatory and policy changes in order to see if they affect you in any manner. While a lot of these changes are announced in the budget speech of the Finance minister, several of these can and do happen throughout the year. One such thing which many of us have missed is the new Cost Inflation Index ( CII ) with the new base year ( FY 2001-2002 ). Let us see what the changes are and what does this mean to you.

For those who are interested in the CBDT notification of the new CII read here. In simple terms the base year for the earlier CII was 1981 and the base was taken as 100. Every year the government announced the CII for that FY. In the year 2016-2017, the index was at 1125. In real terms it meant that if you had acquired an asset for 100 Rs in 1981 and was selling it in 2016, then you could take the cost of the asset to be 1125 Rs and look at your capital gains accordingly. Let me give a real life example to make this clear.

  • Assume you bought a 3BHK flat in Kolkata for 18 lacs in 2001.
  • You wanted to sell it in 2016 for 1 crore.
  • CII in 2001 was 426 and in 2016 was 1125.
  • The indexed purchase cost to be taken in 2016 will be 1125/426 x 18 lacs or 47.53 lacs. The capital gain will therefore be 53.47 crores.
  • You can use the capital gain in buying another property or invest it in Capital gains bonds to avoid taxation.
  • In case you do not do the above you will be charged at 20 % tax on the capital gain.

What are the changes then? As I said before, the new base year is 2001-2002 and the base is taken to be 100 for that year. The CII for subsequent years have now been recalculated and for the current FY 2017-2018 it is 272. Any asset sale being done in this year will be governed by the new Index for the purpose of capital gains determination and taxation.

Let us take the previous example now and assume that you sell the flat in 2017, instead of 2016. The indexed purchase price now will be 272/100 x 18 lacs or 48.96 lacs. For an apple to apple comparison if we took the 2016 CII of 264 then the indexed purchase price will be 2.64 x 18 lacs or 47.52 lacs. This is virtually the same as with the old CII.

How will the impact be on the Long term Capital Gains calculation of Debt funds or Bonds etc? I will cover this 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.

Funding my daughter’s marriage

Now that my daughter Rinki is going to be 23 soon, it is time to start thinking that she will get married in a few years. Of course, given the fact that she is in the second year of her BM program at XLRI and will probably work a few years before getting married, I think we are still looking at another 4 years or so, maybe 5. However, given the kind of expenses it entails one must plan for it in advance.

As my regular readers will know well I do not have separate portfolios assigned to specific financial goals. I simply have 3 portfolios of Debt, Stocks and MF where I invest in and take out money from these as and when needed. So far this has really not been needed as I have always had enough to spend from my active income. This is true even in my current state of Financial independence but may not remain so at the point of time my daughter gets married. There is thus a need to plan for this.

In general, my idea always had been that I will pay for my children’s graduation, no matter how much it cost, and also a reasonable amount in their marriage. Post graduation was something I wanted my children to fund themselves, normally through a bank loan or even taking some money as a loan from me. I did not see much point in paying high interest rates to the banks. This will burden the child with high EMI and restrict his or her freedom to make the right choices.

Based on all of these, when Rinki got admitted to XLRI we took a 12 lacs loan even though the course fees were in the range of 22 lacs. The idea was that I will pay much of the first year fees and she would get it paid by the bank in the second year. Total costs for the first year was 10.5 lacs and we took only 50000 from the bank. This was needed to keep the loan valid. In the second year the fees to be paid are as follows – 4.71 lacs in June, 2.5 lacs in August and 2.5 lacs in November. Right now we have paid the first 4.71 lacs through our own resources – Rinki had some internship money from her Summer stint in GE, one of the FMP I had earlier done for her reached maturity and a FD I had done some years back matured now. Under ordinary circumstances I may have needed the money for my expenses but as my active income is going well in 2017 the flexibility is quite a lot more.

With the above backdrop and the assumption that Rinki is likely to get a job which will pay her at least the median salary in XLRI, I have worked out the following plan with her

  • We will try to restrict the bank loan to 4.5 lacs or so.
  • In the first year of her job, she will pay back the loan in full. Along with the interest this may come to 40000 per month.
  • Assuming that she gets a take home salary of 1.2 lacs per month and needs to spend about 40000 on regular expenses, she will still have 40000 left as surplus in year 1.
  • From year 2 the surplus is obviously a lot more.

What about the money I have paid for her PG education? It will amount to about 14 lacs and I do not want her to pay it back to me. I have asked her to invest it in a portfolio of 4-5 MF over the next 3 years @ 40000 per month. Over this period the amount of the corpus will be 17.4 lacs and in 4 years it will be about 20 lacs. This is the amount I plan to utilise for her marriage. Yes, the costs may be more and if so, I will fund the gap.

What if she decides not to get married at all or get married later. Well, in the first case the money is her’s to use in any manner she wants to. In the second case, the money will remain invested and we will be using it as and when she gets married.

For my son the issues will be simpler as the marriage expenses are likely to be lower. Also, like I did for myself, I am hoping he will be able to foot the bill to some extent, if not for all of it like I did. That is way down the future though, at least 8 years if not more.

Saving for your own marriage or education? Here’s how

Our social norms and practices have undergone huge changes in the past decade or so and this is a continuous process. One area where this is seen quite starkly is how marriages are arranged and carried out today. In the older days the parents were most likely to find a match for their child, arrange the marriage logistics and of course pay for the same. Given the fact that people married relatively young, especially the women, it made sense to do this then.

Times have changed greatly now, especially in urban India. The incomes have increased manifold but so have the responsibilities of parents. Increased cost of school education, high graduation costs and not really being able to depend on children for the retired years like before has created a need for funding retirement to a much greater extent than ever before. Also, as children nowadays prefer to choose their own partners and have their own ideas about how the marriage should take place. In this kind of situation it makes a lot of sense for the children to plan for their own marriage expenses. Of course the parents will give gifts etc as per their financial bandwidth but in case there is a seriously expensive wedding, that needs to be planned by the child.

So, let us say you are just out of college and are in a job which pays you about 50000 Rs a month. How do you go about planning your life at 22, when many things are not really firmed up for the near term or far term? For example, you may want to do an MBA, may have ideas to start something on your own in a few years time or may have an idea of getting married in 6-8 years time. While you do not have to decide exactly on what course of action you want to follow, it will be important for you to invest from the beginning in a fairly disciplined manner. This will enable you to have the financial ability to do the spend when required.

How do you start? We will assume that your initial salary is 50000 a month and this will increase at 10 % every year. You should be doing the following:-

  • You really do not need insurance so do not spend on it. For debt investments your PF is adequate but as a matter of good habit open a PPF account and put 5000 every month in it.
  • With the above and your monthly expenditure you should still be able to invest 10000 per month in MF fairly easily. In case you can do more, all the better.
  • With every passing year increase this amount by 5000 Rs per month. This should not be difficult with your annual increments or job changes, if any.
  • Assuming you plan to work for 5 years before you need the money and it grows at 12 % every year how does it look?
    • Initial 10000 for 5 years will grow to 8.24 lacs
    • Next 5000 for 4 years will grow to 3.09 lacs
    • Next 5000 for 3 years will grow to 2.17 lacs
    • Next 5000 for 2 years will grow to 1.36 lacs
    • Final 5000 for 1 year will grow to 0.64 lacs
  • So in 5 years you will have a corpus of 15.5 lacs.
  • You will also have about 5 lacs in your PPF account

With this in place you can easily plan for your marriage or higher education. For example if you want to do an MBA from ISB the cost is about 30 lacs today. You can use part of your corpus and also take an Education loan. In case you are looking at funding your marriage, the amount in your corpus should be adequate for most weddings.

Now many financial planners will tell you that you must not put money in equity for 5 years etc. Do not listen to them at all. Firstly you are creating an MF portfolio which you may or may not want to redeem in 5 years time. So, strictly speaking there is no real need to think of it as 5 years. If you do not need the money, you just continue with the portfolio as normal. Just to motivate you a little more, if you keep investing 10000 for 25 years, at a return of 12 %, you will end up with 1.9 crores from just here.

I hope this has given all the new earners a lot of food for thought. You need to be in charge of your finances now. So far your life events have been largely managed and almost wholly funded by your parents. Now is the time to really chart out your own course and depend on your own resources for the same.

Once you make up your mind to do this, success is almost guaranteed.

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.