29 March, 2012

Correct implementation of the new equity scheme is the key

The Finance Minister had delivered a googly in this budget, when he had introduced the Rajiv Gandhi Equity Savings Scheme.  This scheme is supposed to encourage the flow of financial instruments & improve the depth of domestic capital market. The scheme offers an income tax deduction of 50% for investments upto Rs.50,000 by new retail investors, whose annual income is below Rs.10 Lakhs. The scheme has a lock-in period of three years.

This seems to be a belated admission of the dwindling interest that the stock market has seen among our retail investors over the years and an effort to address that to some extent.  Having said that, one is not sure if permitting investors to invest in equities directly, would be such a good idea. It is especially a matter of concern as the scheme seeks to bring into it’s fold, new retail investors.

We need to await some further information on what constitutes a “new retail investor”. But irrespective of the actual definition, what we need to see is if such a scheme would be beneficial in the hands of a new retail investor. A new equity investor is one who by definition knows little about the markets and may rely solely on brokers or others, to guide him. This is fraught with danger as the investors may be misguided and may lose heavily, which will again fan a culture of aversion to equities. This is exactly the opposite of what is sought to be achieved.

If the government is serious about getting retail investors to invest in the stock markets, they should be allowed to invest in Index ETFs, as that is better way to participate in stock market for retail investors.  To provide variety and choice, they can be allowed to invest in different index ETFs. This way, they would not have to choose specific companies to invest in which is an exercise fraught with danger for them. 

The other way of allowing investors to participate in this scheme is through investments in Equity Mutual Fund schemes.  ELSS funds as it is, is a three year lock-in scheme and will hence lend itself admirably to this scheme. From a normal investor’s viewpoint, they also have abundant choice as there are dozens of ETFs to choose from. Since ETFs are managed by professional fund managers, retail investors need not have to worry about the underlying investments being made. 

Even among Mutual Fund schemes, it would be a good idea to open out the index fund category specifically, for this scheme. This kind of investment would take out the fund manager risk and would give market returns to investors, which in the long-term offers good returns.  Another good aspect of investing in this scheme through Mutual funds is the possibility of setting up an SIP. SIP allows an investor to invest small amounts in a disciplined way, month-on-month. SIP also would help the person take advantage of the volatility in the market and bring down the average buying price.

In sum, retail investors should be given a choice to invest in the index oriented instruments rather than individual stocks. This will ensure that those who now come into the market through this scheme stay engaged with the equity markets in times to come and hopefully bring more of their kind, once they taste success.

Published in Moneycontrol.com on 28/3/2012

26 March, 2012

What do you do to set your house in order?

We all tend to get complacent, when the going is good - like what happened to Naresh.  Naresh earned well – all of Rs.1.55 Lakhs a month, after deductions and taxes. The cash inflows, hence, was like the abundant flow of the Ganga. However, all was not that well and Naresh had been feeling the effects of a cash crunch of late.

Naresh could not believe it, at first. He was in denial for a longtime. But, the problems were there for all to see.

Kavita, Naresh’s wife, had been asking him carry out some home improvement work for more than a year. He wanted to do it, ofcourse. But, he has somehow not been able to muster the figure required to do it, which was Rs.2.5 Lakhs.  Naresh has been adding expenses, some needed and others of questionable  merit.

His home has been on a loan for the past year and half and he is now paying an EMI of over Rs.66,000. He has a car loan too, for which he is paying an EMI of Rs.7,700. Apart from that, his family went on a trip abroad, which cost them over Rs.2 Lakhs. Part of that funding was through loan. So, that EMI is adding up to their monthly expenses to the tune of Rs.4,300.

Naresh was in a tight corner and that set him thinking. He resolved to straighten it out and bring his finances back on rails. 

Loan rationalization :  Naresh had a thought. His interest in his home loan was 12.75%. This being the first  residential property, his interest outgo to the extent of Rs.1.5 Lakhs was available as a deduction. But, he had been investing about Rs.5,000 pm in RD, which was yielding about 8%. He figured that he could stop the low-yielding RD and channel this money towards repaying the home loan. 

Expense rationalization :  The family expenses have been ballooning.  In the past couple of years, the expenses have gone up significantly. He had admitted his son to an International school and that sets him back by over Rs.3.5 Lakhs, a year. He has been feeling the effect of this outflow and had been debating if he had bitten off more than he could chew.  He had been mulling about getting him back to his erstwhile CBSE school.  The outflow there would be a fraction of what he is currently incurring. Similarly, he is now mulling about selling his other car, on which he is incurring an annual expense of Rs.20,000 upwards, as his wife seldom travels out and when she does she could always take a rickshaw. 

Lifestyle expenses :  The other item they want to bring down is the amount spent towards entertainment. Their expense on a monthly basis has been in the ballpark of Rs.6,000/-. They want to bring this down by watching movies at Home. They anyway have a LED TV and a home theatre. The last item which they plan to turn their attention to, is their vacations.  They have now decided to only go on domestic vacations for the next few years, until they build a cash chest to pay for their trips abroad.

Goals : Some of their near-term goals were the next thing, they turned their attention to. They wanted to do some home improvement, buy a bigger home in the next three years and contribute money towards Naresh’s sister’s wedding.  After evaluating the goals, they have postponed the home improvement, to start next year. They plan to do it in phases now. For that, they want to start accumulating the required amount. The amount to be accumulated for spending on this for next year is Rs.90,000. They are confident about getting to that figure now.  Kavita also plans to augment the income by working part-time as a lecturer. She was an academic and gave up her job a few years back, when they started a family.

A bigger home seemed difficult to them, for now. That has now been indefinitely postponed. They have decided that they will stay in this home and if absolutely required, will rent out a bigger home and give out the current one on rent. Sister’s marriage can happen anytime. The source for that would be the PF, which Naresh plans to tap.

After doing these, the finances seem to be in much better shape. The challenge in all such cases is implementing the plan and following through, relentlessly. Naresh now is going down to get some pop-corn. Kavita meanwhile is bringing in the drinks, to ready for their film show, with the family. They plan to welcome Shahrukh Khan to their living room. The light dims, the snacks are in their hands and happiness descends, in the Naresh household! 

Article by Suresh Sadagopan   ;  Published in Business Standard on 25/3/2012