Looking at fixed income? Consider this investment

In my blog one of the most common queries I get from retired investors and ones planning to be in the FI state , is where one should invest for fixed income. This is expected in the current scenario as most of the Debt investments suffer from some lacuna or the other. Fixed deposit returns are low with inefficient tax treatment, PPF is a great long term product but not for regular income before 15 years, Debt funds are not giving great returns and you need to hold on for 3 years to get indexation benefits.

So, if you have a reasonable sum of money and are looking to put it somewhere for regular income, what are your options? A year back one could have looked at Arbitrage funds or Balanced funds but with the LTCG taxation on equity this does not seem a good idea. Tax free Bonds are not being issued right now and when they are the interest rates will probably be only in the range of 7.5 % to 8 %. In the present scenario one product which can be quite useful to investors is InvIT that is Infrastructure Investment Trusts.

What are InvIT’s? They are instruments for infrastructure developers to raise capital. For investors, InvITs provide (1) an opportunity to invest in a de-risked portfolio of operating infrastructure assets for a superior risk-adjusted return, (2) potential of growth via acquisitions. In simple words these funds take over the significant loans for large Power, Road and other infra projects. The return to the investors are in the form of interest payments, dividends declared, buy back of units and capital appreciation.

Are these Equity or Debt investments? Well, a bit of both really. The revenues are linked to the performance of companies that these trusts invest in so there is an equity nature. At the same time InvIT’s receive annuity from the companies they invest in, which is more like fixed income. As of now there are only two InvIT’s that were floated in the markets in 2017. IRB was for the Road companies and IndiGrid was for the Power companies. The ticket size for investment was 10 lacs for both of these and they were over subscribed. IRB was priced at 102 Rs and IndiGrid at 100 Rs per unit.

If we look at the performance of these companies in terms of their share prices then they are a disappointment. IRB is languishing at 86 Rs and IndiGrid is at 96 Rs. However, the more important parameter is the DPU or Distribution per unit which is something similar to a quarterly interest payment by these trusts. Both the trusts have paid this in a regular manner and in the last quarter the amounts were 3 Rs per unit for them.

I am having 10206 units of IndiGrid and have had overall DPU of 9.56 Rs in the 10 month period of operation over the last FY. The guidance for current FY is 12 Rs. Of course since most of this is interest payment, it will be taxable. In addition these can also offer some dividends which will be tax free in the hands of the investors.

Should you invest in these? Well, if you are a retired person in lower tax brackets then these do seem rather attractive at 12 % returns. Even in the 10 % tax bracket this makes a lot of sense. I think it will be ideal to buy a combination of IRB and IndiGrid. Remember the first is riskier as it depends on toll revenues. If you want to play safe just go for IndiGrid. The ticket size is 5 lac Rs and if you invest around 20 lacs you will be getting an average interest of 20000 per month. It can take care of a fair part of your household expenses. Do remember though that these are unlikely to appreciate much in share value and will not be very liquid so selling them can prove to be a challenge.

On the balance though these are doing rather nicely from the viewpoint of fixed income. I wish I had invested 2-3 times of what I actually did in the IPO and I have definite plans to put in my next 5-10 lacs there when some of my Debt investments mature.


Debt investments – why, where and how

I have been away to my home town for for 2 weeks on and managed to club my daughter’s convocation as well as a trip to Ajodhya hills in Purulia during this time. Was not able to write my blog in this period and saw that quite a few readers had put their queries on Debt investments. So in this first post after the break, let me try to address this issue in a comprehensive manner.

To begin with, do you need debt at all? If the annualised returns from equity investments are in the range of 12 % and more and you are struggling to get even 7-8 % in Debt investments, then why do you really need to invest in it? Well, the most important reason is that your investment growth with equity normally follows a rather tortuous path. Think of a situation where all your money is in equity and there is a market crash, which reduces your portfolio value by 30-40 % and it takes a long time to recover. In this period you may well have goals coming up such as children’s education etc which cannot be postponed. In such a scenario you will be forced to sell your equity investments at the wrong time. Not only will this have a significant negative impact on the growth but there is also a serious opportunity cost involved. Let me try to explain this with an example :-

  • Let us assume I was preparing for my son’s admission into a B school in 2019 and was planning for a portfolio of 22 lacs for the same. I had been doing SIP into 2-3 MF schemes for a long time to achieve this.
  • Due to the upsurge in our markets in Jan 2018, the portfolio value had already reached 21 lacs and I was sure that the portfolio will be well above this figure in 2019 March, when I need the money.
  • Unfortunately, the market corrected a fair amount already and let me assume that it will correct to -30 % till March 2009. 
  • My portfolio value will suddenly be 15 lacs only and I need 7 lacs from elsewhere.
  • I have 100 lacs in my retirement portfolio and was hoping it will increase to 200 lacs in 6 years @ 12 % annual returns. Wanted to retire in 2024.
  • Due to the market downturn, my portfolio for retirement became only 70 lacs by March 2019. On top of it, I also had to take 7 lacs out of it. My retirement portfolio then reduces to only 63 lacs in March 2019.
  • Even with a 12 % return now I will never get back to 200 lacs or anywhere close in my retirement – in fact I will have only about 120 lacs.

In case you are thinking that such things cannot happen, let me tell you from personal experience that such occurrences may well happen for 3-4 times in a 30 year period for which many of us normally invest. I myself have gone through 3 such experiences in 2001, 2008 and 2011 which created quite some difficulty for my plans. Fortunately, my asset allocation had the cushion of debt investments and I also did not need the money for any of my goals.

Well, I hope it is now clear as to why you need Debt investments as part of your portfolio. The issue now is where do you invest it and how. As I have covered it in other posts of my blog, I am only presenting the solution here, rather than giving a full explanation.

  • For all salaried people, PF is a must and you need to make sure that you do not withdraw from it. Keep it only for your retirement.
  • For all others a PPF account is a must. In fact, I will say the salaried people should have one too and others can have one for their spouse as well.
  • If you have a daughter then you can go for SSY as well.
  • Retired people or ones looking at regular income can look at Tax Free Bonds and Senior Citizen’s Savings Scheme along with Vaya Vandana Yojana.
  • Others can look at short term debt funds and also Hybrid type funds such as MIP and Equity Savings Funds.
  • Finally, you can look at long term Gilt funds if your time horizon is really long.

What about the asset allocation? Well, if you are working with an active income you can keep Debt to Equity at 35:65. For people in the FI state it can be 45:55, for retired people 55:45 and for senior citizens above 70 it should be 70:30. Remember that you will definitely need both equity and debt at all stages of your life, unless you have way more assets than you will ever need.

Whichever way you look at it, Debt investments are critical to your financial well being.

Vaya Vandana Yojana is good for senior citizens

One of the good aspects of the current year budget has been the focus on senior citizens. While the tax slabs have not been changed, the exemption of interest income up to 50000 Rs is a good thing for all of them. Another benefit is the extension of Vaya Vandana Yojana for 2 years and changes in the terms.

The VVY was introduced last year and had interest payment up to 8.3 % annually on investment up to 7.5 lac Rs per senior citizen. Now it has been made 15 lacs maximum with flexibility of withdrawal in case of Medical emergencies. The monthly interest is 8 % and the annual yield goes to 8.3 %. You can buy it online or offline through LIC.

How should senior citizens use this? Well, you can invest up to 30 lacs in it now, for both you and your spouse. Along with the Senior citizen saving scheme, where you can potentially put another 30 lacs, this will give you a total interest income of 40000 Rs per month. While all of this is taxable, the tax incidence is practically zero for the couple.

This is something that all senior citizens should take advantage of. With a regular income of 40000 Rs per month assured, they can now think of putting the rest of their money in other mutual funds of different types to add to their income. In case they have a PPF account then there is also a possibility of withdrawing money from there in a tax free manner. With some intelligent structuring it will be quite possible to have an income of up to 80000 or so per month, with low tax incidence.

So, if you are a senior citizen and are looking at regular income, go for VVY. Yes, interest rates may rise but it will take a while to catch up to 8 % and a bird in hand is always worth more than two in the bush.

I will outline in the next post how a corpus of 1.5 crores including PPF can be structured for senior citizens to maximise income with low tax incidence.

Returns on Debt funds are more taxing now – A personal example

As I have written often in this blog, it is quite senseless to invest in FD for investors now, given the double whammy of low interest rates and returns being taxable at your slab rate. In general, investing in Debt funds makes sense – more so, if you are able to hold them for 3 years and get the benefits of indexation.

The above has been my strategy with FMP where the time to maturity is more than 3 years. While this has served me well in the past years, there are some changes in the scenario that all of us need to be aware of. With the lowering of inflation, the newly constituted Cost Inflation Index ( CII ) is less supportive of such a strategy. In fact, when I was doing an audit of my investments this month, I was shocked to notice that despite the indexation benefits, I would still be paying considerable taxes on this account. Now, I am all for paying the right taxes, but it is important to understand the impact.

Let me give you a specific example to see how things stand now:-

  • I had invested in HDFC FMP Series 28 on 21st November 2013
  • It was redeemed on 10th April, 2017
  • Initial purchase value was 3 lacs
  • Redeemed value in 2017 was 3.95 lacs
  • The indexed purchase price was 3.71 lacs as it got 4 years of indexation benefits.
  • The capital gains after indexation was 24000 Rs and tax thereon is 4800 Rs @ 20 %
  • In effect the absolute returns are 90000 in a period of 3 1/2 years.
  • Post tax CAGR is just above 7.5 %, it is 7.56 % to be exact.

Now while this still beats FD by a good distance as far as tax efficiency is concerned, the returns have come down from the past. Two years back it was possible to get CAGR of 8.5 % and more as taxation was minimal, if at all. It is also noteworthy that for FMP the rates are fixed at the start, so the ones starting now will have even lower returns.

What about other Debt funds? I have one from Franklin where the details are as below:-

  • Purchase date was 9th May, 2013 and purchase amount was 2 lacs
  • Current value is 2.92 lacs
  • Indexed value of purchase will be 2.47 lacs, so the capital gain is 45000 Rs
  • Tax on this will be 9000 Rs
  • Post tax CAGR will be nearly the same as the prior example.

Lesson from this for me and you as an investor? Debt funds are likely to give a post tax return of around 8 % or lower in the current context. Factor this into your calculations if you are using them to generate passive income, like I do. In simple terms if you need an income of about 8 lacs a year, you will need to put in 1 crore as capital investment for the debt funds.

It is still a good idea but we have to be conscious of how things change down the line.

My current Debt portfolio

In the past few posts I have written about my equity portfolio, both stocks and Mutual funds and also outlined why a debt portfolio is needed for all investors. In this post I wanted to take stock of my current debt portfolio. 

Before getting into the details of my holdings, let me try and summarise my reasons for having the debt portfolio in the first place:-

  1. It gives me passive income which takes care of my regular expenses along with the dividends I get from my equity investments.
  2. It allows me to let my equity investments grow for a longer time period, thereby increasing the chances of significant gains.
  3. It ensures that even if I need a large amount of money suddenly, I will not have to redeem my equity investments if the markets are having a bad time.

Having said that, I will now outline my current Debt portfolio. Note that I am not going to explain the rationale of these instruments – if you are interested, go through my blog posts and you will find enough material there explaining most instruments.

The major components of my Debt portfolio are as follows:-

  • Tax free bonds form about 13 % of my portfolio today. I get an interest of about 9 % from these bonds and they contribute nearly 25 % of my annual expenses ( without rent and travel ).
  • PPF forms about 27 % of my portfolio today. Both my wife and I have accounts in which we invest the maximum contribution allowed. As of now we do not withdraw from it and have no plans to do it for the next few years.
  • FMP plans and other debt funds form about 40 % of my portfolio today. I use the capital gains from FMP redemption for my expenses and reinvest the principal. As for the Debt funds I just let them grow, they can be useful for any sudden expenses.
  • Infrastructure Investment Funds and POMIS from post office form about 10 % of my portfolio. Income from these are normally used for my stock investments and they are also a backup as Emergency funds.
  • The last 10 % is in a couple of FD still going on, cash in our savings bank accounts and some amounts I have kept in my parent’s and children’s bank account.

You will note from here that the above is fairly simple to manage and the cash flows are automated into my account. Investing in PPF is an annual event, investing the principal amount from FMP redemption is probably 8-10 times in a year.

Apart from all of these I also have some investments in Hybrid funds. With the declining rate cycle it makes sense to do that and my focus on these have been there in the last 3 years or so. I will write about them in another post.

I hope this post will give you an idea as to how you can create your debt portfolio – make it hassle free and it will give you a great deal of peace in your mind.

Debt investments in 2018 – where and why?

In the last two posts I had written about two possible portfolios for MF investments. As readers will be aware the MF portfolio will normally cater to most of our life goals and also take care partly for retirement purpose. At the same time we will need a solid and robust Debt portfolio which gives a stable and strong foundation to our financial edifice. There are several posts in the blog where I have written extensively on the need of debt portfolio, what types of instruments are available and how you can make use of them. In this post I will not repeat those but give my thoughts on the instruments you can use.

Before we get down to the suggested instruments, it will be a good idea to look at the current landscape for the economic occurrences. In an interesting twist the bond yields have been going up and it may reach 7.5 % for the 10 year bonds before the budget. The reduction in interest rates seem to be over for now and, with the prospect of inflation coming down being unlikely, it is quite possible for the rates to rise later this year. Finally, this being the last full year of the present government, there will be a push on infrastructure and other social sector spending. This will normally increase government borrowing in the form of tax free bonds from NHAI and the like.

With the above as a backdrop, let us look at my recommendations now:-

  • For salaried people, continue with your PF or NPS as before. There is no real need to invest the extra 50000 in NPS unless you are fanatical about saving taxes.
  • For others not having the above options, you must have a PPF account. Yes, I know that the rates have dropped to 7.6 % this quarter but it is still the best debt instrument around. Rates will rise once the interest rate cycle turns.
  • If you already have a SSY account continue it, or have a daughter less than 10 years old, open one now. Benefits are similar to PPF with somewhat less flexibility but with a higher interest rate of 8.1 %.
  • Completely avoid FD’s as the rates and tax treatment are both terrible at this point of time. Senior citizens can put 15 lacs in SCSS if they are not having a high tax impact. The current rates of 8.3 % seem attractive.
  • In case bond yields continue to rise there may be a case of putting some amount in FMP. At current returns, this is not a great idea for pure debt FMP.
  • Look at alternative hybrid models if you are still interested in FMP – options can be Dual advantage funds or similar themes.
  • Certain types of Debt MF can give returns in the range of 9-9.5 % this year. If you can hold these for 3 years you will get the LTCG indexation benefits, which make it an attractive investment. Look at Dynamic bond funds for this purpose – most fund houses have them but I will recommend BSL or IDFC.
  • For investors having a shorter time frame look at Franklin Dynamic Accrual Bond.
  • You can also go for Ultra short term or Short term debt funds for 3 years.
  • Avoid long term funds in Debt space, especially the Long term Gilt funds.

I hope with the above guidelines you will be able to structure your debt investments for the year. Remember, debt is important – redeeming equity at the wrong times can be really detrimental to your overall financial portfolio.

I have also got a range of queries as to how people in retirement should look at deploying their resources for optimal returns. Will try to address it in the next post.

How I plan to use my PPF account

With the rate reduction in PPF scheme and the knowledge that it is going to be aligned to market rates every quarter from now on, is it still a good idea to have it in my portfolio? In my audit of investments for last FY that was the main question I was faced with regarding my PPF investments.

Now in terms of personal finance every issue and decision is contextual and the situation of the individual makes all the difference. In my case I have a PPF account since 1994 and my wife has started a second account in 2013 after the first one was matured in 2004. Some details of these accounts are as follows:-

  • My present maturity is in 2019 April and current balance is about 20 % of our total debt portfolio.
  • My wife’s account will mature in 2028 and currently is about 3.5 % of our debt portfolio.
  • Contribution of 1.5 lacs is made every year in the first week of April to both accounts.

Given the tax treatment of PPF at EEE, I see no reason to stop my investments in it even though the interest rates have reduced to 7.8% currently. I think the returns on PPF will go down further to about 7.5% or so, but even that is not a bad rate for an EEE instrument. In the coming years the interest rate cycle is very likely to turn around and at that point in time, PPF will immediately get benefited as the rates are market linked now.

With the investment decision taken, the next issue is how to use the money in the account. So far I have not withdrawn any money out of my account since 1994 and do not plan to do so till the current maturity in April 2019. The same goes for my wife’s account. Her first PPF maturity amount had helped us greatly to boost the down payment that we were able to make for our apartment in Chennai.

So after a lot of thought these are the conclusions I have come to:-

  • Continue my account after 2019 for another 5 years while being open to withdrawals for any emergency post 2019.
  • Assuming that my daughter gets married in the period beyond 2019, such withdrawals can fund her marriage expenses to the extent needed. Even though I have investments in equity for it, a hedge against market crashes is prudent.
  • Withdrawals can also be used for discretionary purposes such as replacement of white goods, vacations outside India etc.
  • As I will normally not need the PPF account withdrawals for my regular expenditure at least till 2024 or so, in the absence of any of the above the money will simply grow.
  • As far as my wife’s PPF account goes it will grow to 40 lacs plus by 2028. At this point if the returns are decent we will continue it. Note that we can withdraw 24 lacs in the subsequent 5 years from her account.
  • Assuming that I can withdraw about twice that amount from my account in 5 years, the total withdrawn amount in 5 years will be 72 lacs. This can be used for a variety of purposes as explained earlier.

How will I fund the 3 lacs per year? As of now, I am doing it from my Consultancy income and hope to do so for the next 5-6 years. Beyond that or in case the income is insufficient in a year, I have plans to fund it through the redemption of debt funds such as FMP etc that keep happening every year.

In the end what does the PPF investment mean to me? Well, it is something from which I can withdraw any time I have an exceptional expense whether due to an emergency or due to an indulgence that we need to do. It also gives me the cushion of not having to redeem my equity investments for fulfilling a goal, when the markets are in a bad situation.

In short it contributes a great deal to my peace of mind.