Look at the tax angle and the returns are often higher than the more popular debt options
Several Fixed Maturity Plans (FMPs) have been coming into the market for over three months. Let us examine what these are and why they may be useful.
FMPs typically are debt-oriented products, comprising bank certificate of deposits (CDs), commercial papers (CPs) issued by companies, structured obligations, debentures and bonds, pass-through certificates and so on. The duration can be a month to five years. As the name suggests, these are closed-ended products, comparable to bank fixed deposits (FDs) most retail investors opt for. They are sometimes called by slightly different names - Fixed Tenure Fund, Fixed Horizon Fund. The monthly and quarterly FMPs are also called interval funds.
POSITIVES
FMPs are yet to become as popular as FDs with investors. However, there are some significant advantages of investing in these. Firstly, FMPs come in all kinds of tenures, from a month to five years. FDs can match this to a great extent, though the choice of tenures with FMPs is much more. Second, as opposed to FDs, the risk profile would be lower here. This is because FDs are with one institution and, so, pose a risk. If it is with a company instead of a bank, the risk is a bit higher. Instead, FMPs invest in a varied mix of CPs, CDs, debentures, which brings down the risk profile of the portfolio. Also, the fund manager ensures the maturity profile is more or less matched with the FMP's tenure and, hence, interest rate risk is almost eliminated. In most FMPs, a small proportion is invested in equity (for instance, Franklin Templeton Fixed Tenure Series). Clearly, the investor needs to understand what the FMP asset allocation would be and then invest.
Third and important, FMPs can offer a higher post-tax return as compared to FDs. For those in the highest tax bracket, FMPs will be very advantageous. In case of FMPs, the dividends distributed by the fund house are taxed in the latter's hands itself. Dividend Distribution Tax is 14.16 per cent now. The dividend received in the hands of the investor are not taxable. Hence, the investor effectively pays only 14.16 per cent tax, as opposed to the 31 per cent he would have paid for interest received from FDs, as they are treated as income and clubbed accordingly. Also, one could take advantage of indexation for FMPs of longer durations.
Indexation works like this: If one invests Rs100 today and takes it out after a year, getting Rs108, the profit is Rs 8. However, the value of Rs 100 last year is not the same today, as inflation has eroded the value. If inflation is at 7 per cent, then Rs 100 last year would be equivalent to Rs 107 today. Then, rightfully, only Rs 1 is the profit. The indexation principle takes this into account. The cost inflation index to be used for such calculations is published by the income tax department.
TAX FACTOR
The tax on short-term capital gains (for investments of less than 12 months duration) for an individual is as in the applicable income tax slab rate. Long-term capital gains would be taxed at 10 per cent without indexation or 20 per cent with indexation. Hence, one can calculate and pay tax on whichever turns out to be less. In this example, a 20 per cent tax on a rupee is 20 paise; a 10 per cent tax without indexation on long-term capital gains works out to 80 paise. Hence, the 20 per cent with indexation is more beneficial for the investor. In this example, the net return for the investor is 7.8 per cent. Had the same investor invested in an FD yielding eight per cent and assuming he is in the highest tax slab, he would have to pay 31 per cent as tax.The return would then be only 5.52 per cent. A major difference, which is why FMP is a good investment option.
Coming to liquidity, previously fund houses used to accept premature redemptions, albeit with an exit load. Now, that has been stopped and FMPs are listed on the stock market. An investor who wants to redeem can directly sell on the stock market. However, this portion of the market is not liquid and may pose difficulty if a person requires money before maturity. Hence, invest money only when sure of staying invested till maturity.
It should also be clear to the investor that for tenures less than a year, a dividend distribution option may be better, as the tax incidence would be 14.16 per cent (paid by the MF), instead of their slab rate. The investor would be better off paying tax and be in the growth option, if their slab rate is the first slab, that is,10 per cent. For tenures more than a year, taking advantage of indexation would clearly be a better option, for most tax payers.
FMPs seem to be the best kept secret, with not too many knowing about the potential for much higher post-tax returns, without taking much higher risks. FMPs are a viable alternative to FDs and other debt investment options. Investors would do well to harness the potential for higher returns these offer.
Published in Business Standard on 7/11/2010
06 December, 2010
Chasing IPOs
Unless you have the means to analyse them, better opt for listed companies.
Chasing rainbows is a pleasure though there may be nothing at the journey’s end. The IPO (Initial Public Offering) game is similar. Investors chase the elusive rainbow and mistake all IPOs to be a pot of gold.
Somehow, IPOs, FPOs (Follow-on Public Offers) and rights issues have a draw with people that is beyond comprehension. The interest may not always merit the returns. Most people, for some reason, assume a public offer of shares has to be cheap and hence a good idea to participate. This is probably a hangover of the past, when the Controller of Capital Issues used to set the price for a public offer and getting an allotment was like winning a jackpot.
Today, IPOs are aggressively priced. For investors looking for listing gains, possibility of a loss is more or less 50 per cent (if you look at, say, the one-year history). In fact, a CARE Research study on the performance of 116 IPOs issued between August 2007 and 2010 indicates that in about 35 per cent of cases, the current traded price is above the upper band of the IPO price, while 62 per cent is below the IPO price. Investing in IPOs should not be the only strategy.
Fallacies
Investors may want to pick and choose between IPOs. But information about these companies may not be available freely, apart from their own prospectus. Not many investors can use information from this one source to establish if the IPO’s price is right, and can make an informed investment decision. If such were their prowess in identifying companies with underlying value, they would be milionaires many times over and need not resort to investing through IPOs anyway. A better strategy would be to choose from among the listed companies, whose performance is known and on whom even more data is available in the public domain.
If, on the other hand, they are relying on the analysis provided by various market mavens, the result can be confusing – for there are divergent and opposite recommendations. During an IPO, one can expect many planted good reviews too. Afterall, the company, their investment bankers, underwriters and the stock broking community are all direct and obvious beneficiaries. So, expect peans being sung in praise of the IPOs.
Most retail investors subscribe to various IPOs based on the ratings given by rating agencies. Incidentally, Reliance Power got rave reviews and even Crisil gave it a 4/5 rating. The stock listed below its issue price and is still quoting lower than its issue price. With the ratings going wrong, investors could end up owning a portfolio of companies without any underlying rationale. If this portfolio is not diversified across sectors, the risk profile increases.
Hope and greed
The other fallacy in investing in IPOs is looking for listing gains. That is gambling, not investing. Losses are as much a possibility as seen in the Reliance Power issue. One reasoning why IPOs seem attractive is because, choosing from among 3,000 companies that are already listed seems a herculean task. In the case of IPOs, the decision making process gets simplified, as there are just the IPO candidates to choose from. In addition, there is nothing to do except read some reviews and make up your mind. Some investors may not even do that – they just follow their friend or colleague who is applying for the IPO. They always find enough justifications for investing in IPOs – foreign institutional investors, (FIIs) are investing, there are enough favourable recommendations and brokers and other intermediaries are optimistic about IPOs.
It may be a far better idea to invest in the existing universe of stocks, about which performance history exists. Even if investors want to invest in stocks that came out with IPOs, they could wait until its listing, give it some time for price discovery and stabilisation. That way, they may even end up buying below IPO prices. Even if the price is up, one could check if the equity is good to invest at that price and then invest. lets remember, the IPO stock will be available even in future. Retail investors could even consider good mutual fund schemes to invest in if the IPO does not live up to its expectations.
Published in Business Standard on 31/11/2010
Chasing rainbows is a pleasure though there may be nothing at the journey’s end. The IPO (Initial Public Offering) game is similar. Investors chase the elusive rainbow and mistake all IPOs to be a pot of gold.
Somehow, IPOs, FPOs (Follow-on Public Offers) and rights issues have a draw with people that is beyond comprehension. The interest may not always merit the returns. Most people, for some reason, assume a public offer of shares has to be cheap and hence a good idea to participate. This is probably a hangover of the past, when the Controller of Capital Issues used to set the price for a public offer and getting an allotment was like winning a jackpot.
Today, IPOs are aggressively priced. For investors looking for listing gains, possibility of a loss is more or less 50 per cent (if you look at, say, the one-year history). In fact, a CARE Research study on the performance of 116 IPOs issued between August 2007 and 2010 indicates that in about 35 per cent of cases, the current traded price is above the upper band of the IPO price, while 62 per cent is below the IPO price. Investing in IPOs should not be the only strategy.
Fallacies
Investors may want to pick and choose between IPOs. But information about these companies may not be available freely, apart from their own prospectus. Not many investors can use information from this one source to establish if the IPO’s price is right, and can make an informed investment decision. If such were their prowess in identifying companies with underlying value, they would be milionaires many times over and need not resort to investing through IPOs anyway. A better strategy would be to choose from among the listed companies, whose performance is known and on whom even more data is available in the public domain.
If, on the other hand, they are relying on the analysis provided by various market mavens, the result can be confusing – for there are divergent and opposite recommendations. During an IPO, one can expect many planted good reviews too. Afterall, the company, their investment bankers, underwriters and the stock broking community are all direct and obvious beneficiaries. So, expect peans being sung in praise of the IPOs.
Most retail investors subscribe to various IPOs based on the ratings given by rating agencies. Incidentally, Reliance Power got rave reviews and even Crisil gave it a 4/5 rating. The stock listed below its issue price and is still quoting lower than its issue price. With the ratings going wrong, investors could end up owning a portfolio of companies without any underlying rationale. If this portfolio is not diversified across sectors, the risk profile increases.
Hope and greed
The other fallacy in investing in IPOs is looking for listing gains. That is gambling, not investing. Losses are as much a possibility as seen in the Reliance Power issue. One reasoning why IPOs seem attractive is because, choosing from among 3,000 companies that are already listed seems a herculean task. In the case of IPOs, the decision making process gets simplified, as there are just the IPO candidates to choose from. In addition, there is nothing to do except read some reviews and make up your mind. Some investors may not even do that – they just follow their friend or colleague who is applying for the IPO. They always find enough justifications for investing in IPOs – foreign institutional investors, (FIIs) are investing, there are enough favourable recommendations and brokers and other intermediaries are optimistic about IPOs.
It may be a far better idea to invest in the existing universe of stocks, about which performance history exists. Even if investors want to invest in stocks that came out with IPOs, they could wait until its listing, give it some time for price discovery and stabilisation. That way, they may even end up buying below IPO prices. Even if the price is up, one could check if the equity is good to invest at that price and then invest. lets remember, the IPO stock will be available even in future. Retail investors could even consider good mutual fund schemes to invest in if the IPO does not live up to its expectations.
Published in Business Standard on 31/11/2010
Should you pay for advice?
Should you pay for advice?
Suresh Sadagopan / Mumbai October 24, 2010, 0:45 IST
Yes, a good financial advisor costs money. But he takes the responsibility of ensuring your financial stability
The word ‘free’ has a soul-stirring universal ring. Something for nothing is music to the ears. Yet, there are no free lunches. So, the one-on-one free offer or buy-a-shampoo and get-a-soap free kind of offers have already been priced in the costs. Some of them may be genuine offers, where they may offer “something extra” by reducing their profit margins. But a promotional expense, not altruism.
It is, then, surprising that people are looking for ‘free’ advice, when they invest. Managing finances is a very important function. We all work to earn our money, to be able to meet goals. Then, why be callous about how to manage the money earned?
Question hour
* Does he/she understand your specific issues?
* Does he/she have knowledge about the product, its benefits and costs?
* Does he/she have the necessary experience. Has he/she invested in people, systems and processes?
* Does he/she answer tough questions such as – Will you be paid a commission for selling this product?
* Is he/she willing to provide references?
Either the person concerned should go through all the appropriate options, do a proper study of the products available and go for the one best suited for the goal in question. A lot of times, this is only on paper. Most investors are just not interested in doing this due-diligence. In fact, most do not have any specific plan to achieve goals.
Hence, in financial services, the various distributors play a role and decide what investors get to invest in. If it is an insurance agent who approaches and convinces a person, then it is an insurance product which gets sold. If it were a mutual fund advisor, the investor would have been convinced about the ability of one or the other scheme that will solve his problems. The point is, the investor is investing depending on who is approaching him and convincing him and not according to any well-thought strategy.
Most take it for granted that the financial advice and counselling is a “free” service from the advisor. But any advisor will have a vested interest in selling his product, as that is what is going to earn revenue, especially in a situation, where advisory fees are conspicuous by their absence. Hence, there will be an inherent bias in the recommendations. Also, many people buy from their friends and relatives. Here, even the rudimentary matching of client goals with appropriate options goes out of the window. Typically, in a meeting where a friend/relative is the advisor, most of the time is spent on extraneous matters and very little on discussing the product features and benefits. Even lesser time is spent on matching with goals. The client himself says in most cases - “You know about us and will know if this suits us. Just tell us where to sign and you handle the rest!” Proper advice can make a world of difference. But good advice may have to be paid for. Most people are unwilling to do so. They have never paid for financial advice. They have paid doctors, lawyers, architects, etc., but never a financial advisor. Without appropriate advice, one tends to make many mistakes, like getting into costly or patently inappropriate products. Such actions can really be costly for the investor - the price he would pay would most probably be far in excess of the fee which he would have paid to a advisor. Again, assuming you are willing to pay, you still need to choose a good one to advice you.
You should do due diligence before hiring one. Ask relevant questions, seek references, and importantly see if he/she is throwing numbers at you or genuinely understands your financial situation.
Published in Business Standard on 24/10/2010
Suresh Sadagopan / Mumbai October 24, 2010, 0:45 IST
Yes, a good financial advisor costs money. But he takes the responsibility of ensuring your financial stability
The word ‘free’ has a soul-stirring universal ring. Something for nothing is music to the ears. Yet, there are no free lunches. So, the one-on-one free offer or buy-a-shampoo and get-a-soap free kind of offers have already been priced in the costs. Some of them may be genuine offers, where they may offer “something extra” by reducing their profit margins. But a promotional expense, not altruism.
It is, then, surprising that people are looking for ‘free’ advice, when they invest. Managing finances is a very important function. We all work to earn our money, to be able to meet goals. Then, why be callous about how to manage the money earned?
Question hour
* Does he/she understand your specific issues?
* Does he/she have knowledge about the product, its benefits and costs?
* Does he/she have the necessary experience. Has he/she invested in people, systems and processes?
* Does he/she answer tough questions such as – Will you be paid a commission for selling this product?
* Is he/she willing to provide references?
Either the person concerned should go through all the appropriate options, do a proper study of the products available and go for the one best suited for the goal in question. A lot of times, this is only on paper. Most investors are just not interested in doing this due-diligence. In fact, most do not have any specific plan to achieve goals.
Hence, in financial services, the various distributors play a role and decide what investors get to invest in. If it is an insurance agent who approaches and convinces a person, then it is an insurance product which gets sold. If it were a mutual fund advisor, the investor would have been convinced about the ability of one or the other scheme that will solve his problems. The point is, the investor is investing depending on who is approaching him and convincing him and not according to any well-thought strategy.
Most take it for granted that the financial advice and counselling is a “free” service from the advisor. But any advisor will have a vested interest in selling his product, as that is what is going to earn revenue, especially in a situation, where advisory fees are conspicuous by their absence. Hence, there will be an inherent bias in the recommendations. Also, many people buy from their friends and relatives. Here, even the rudimentary matching of client goals with appropriate options goes out of the window. Typically, in a meeting where a friend/relative is the advisor, most of the time is spent on extraneous matters and very little on discussing the product features and benefits. Even lesser time is spent on matching with goals. The client himself says in most cases - “You know about us and will know if this suits us. Just tell us where to sign and you handle the rest!” Proper advice can make a world of difference. But good advice may have to be paid for. Most people are unwilling to do so. They have never paid for financial advice. They have paid doctors, lawyers, architects, etc., but never a financial advisor. Without appropriate advice, one tends to make many mistakes, like getting into costly or patently inappropriate products. Such actions can really be costly for the investor - the price he would pay would most probably be far in excess of the fee which he would have paid to a advisor. Again, assuming you are willing to pay, you still need to choose a good one to advice you.
You should do due diligence before hiring one. Ask relevant questions, seek references, and importantly see if he/she is throwing numbers at you or genuinely understands your financial situation.
Published in Business Standard on 24/10/2010
Festive Binge can lead you to debt trap
Beware, impulse buying could spin your financial budgeting out of control.
Look around and you will find a million things you could spend on. The malls have a soothing effect for frayed nerves and people flock these places for entertainment and shopping. At times, we end up buying things even when we didn’t intend to. A simple session of window shopping could see us emptying our pockets and spin our monthly budget out of control. Lots of stuff bought on an impulse is never used and may not prove to be a prudent buy.
The easy availability of loans has made it easy for us to make purchases without planning for them. Almost everything is available on credit, from pizzas to overseas holidays, making enjoy now, pay later, a well-accepted motto today. But if you do not have enough cash flow to service the loans or if most of it is tied up in servicing of loans, managing finance can be difficult.
So, even while taking credit, one needs to be sure of the following aspects.
# Requirement: Whether the object or service in consideration is really required. And even if it is, should it be availed now or can be postponed for a later date.
# Loan warranted or not: A loan has to be paid off. So unless urgently required, there is no point in taking a loan for the object or service.
# Paying a reasonable rate: One needs to know, if the loan can be serviced easily or not. So check the outgoings per month besides having clarity on the loan repayment period. Many of us are unaware of the actual cost of the debts we have. For instance, loans which charge a flat 10 per cent may have other costs like the processing fees, late payment fees and so on. People are also ignorant of the interest they end up paying on revolving credit.
# Pre-payment options: Know the pre-payment options on the loan. If opting for a loan to tide over a temporary financial crisis, then a prepayment option with low penalties, is a good idea.
Planning ahead
If you really need to buying something, you could always put aside a small sum every month for a year before buying it. This way, the object of desire can be enjoyed sans any guilt.
But if you have taken a loan, consider converting it to a lower cost one. For instance, it may be a good idea to pay off credit card debts by taking a personal loan. There are loans that have a long tenure and are typically lower cost, like home loans. In the descending order of priority, if one wants to settle debts, credit card debt, personal loans, vehicle loans and home loans are the way to go.
However, not all loans need to be repaid in a rush. A loan availed at a cheaper rate can be retained.For instance, suppose a home loan interest rate is nine per cent. The actual interest incidence will be even less, due to the tax advantages. Hence, it may be a better idea to invest the money elsewhere, where the amount can earn a higher interest.
Facing financial crisis
One needs to explore ways to tide over a financial crisis without opting for a loan. If your bank gives an overdraft facility, it may be a good idea to use it. It will charge you only for the amount borrowed and for the number of days it is borrowed. Family and friends can also be a source of support. If you are confident of repaying in good time, by all means take the cash they are offering.
Stay away from unwanted debts. If taking loans is inevitable, look around for appropriate ones. This knowledge is worth its weight in gold.
Published in Business Standard on 17/10/2010
Look around and you will find a million things you could spend on. The malls have a soothing effect for frayed nerves and people flock these places for entertainment and shopping. At times, we end up buying things even when we didn’t intend to. A simple session of window shopping could see us emptying our pockets and spin our monthly budget out of control. Lots of stuff bought on an impulse is never used and may not prove to be a prudent buy.
The easy availability of loans has made it easy for us to make purchases without planning for them. Almost everything is available on credit, from pizzas to overseas holidays, making enjoy now, pay later, a well-accepted motto today. But if you do not have enough cash flow to service the loans or if most of it is tied up in servicing of loans, managing finance can be difficult.
So, even while taking credit, one needs to be sure of the following aspects.
# Requirement: Whether the object or service in consideration is really required. And even if it is, should it be availed now or can be postponed for a later date.
# Loan warranted or not: A loan has to be paid off. So unless urgently required, there is no point in taking a loan for the object or service.
# Paying a reasonable rate: One needs to know, if the loan can be serviced easily or not. So check the outgoings per month besides having clarity on the loan repayment period. Many of us are unaware of the actual cost of the debts we have. For instance, loans which charge a flat 10 per cent may have other costs like the processing fees, late payment fees and so on. People are also ignorant of the interest they end up paying on revolving credit.
# Pre-payment options: Know the pre-payment options on the loan. If opting for a loan to tide over a temporary financial crisis, then a prepayment option with low penalties, is a good idea.
Planning ahead
If you really need to buying something, you could always put aside a small sum every month for a year before buying it. This way, the object of desire can be enjoyed sans any guilt.
But if you have taken a loan, consider converting it to a lower cost one. For instance, it may be a good idea to pay off credit card debts by taking a personal loan. There are loans that have a long tenure and are typically lower cost, like home loans. In the descending order of priority, if one wants to settle debts, credit card debt, personal loans, vehicle loans and home loans are the way to go.
However, not all loans need to be repaid in a rush. A loan availed at a cheaper rate can be retained.For instance, suppose a home loan interest rate is nine per cent. The actual interest incidence will be even less, due to the tax advantages. Hence, it may be a better idea to invest the money elsewhere, where the amount can earn a higher interest.
Facing financial crisis
One needs to explore ways to tide over a financial crisis without opting for a loan. If your bank gives an overdraft facility, it may be a good idea to use it. It will charge you only for the amount borrowed and for the number of days it is borrowed. Family and friends can also be a source of support. If you are confident of repaying in good time, by all means take the cash they are offering.
Stay away from unwanted debts. If taking loans is inevitable, look around for appropriate ones. This knowledge is worth its weight in gold.
Published in Business Standard on 17/10/2010
Helping friends doesn't add to your wealth
Seek professional help for investment advice
Money plays an important role in people’s lives. Yet, when one has it, it is seldom given the importance it deserves. People look forward to earning more money rather than managing the money that they already have. This is probably why, money in bank accounts, is not deployed for an extended period of time. People don’t realise they are missing an opportunity to earn profits on them.
The money lies around till they hear about some good investment or insurance ideas from friends and family. Many of us have friends and relatives working in the financial services sectors, who approach us for business. More often than not, they get both attention and business from us. While putting one’s money into any of the “amazing schemes” that one hears, most don’t really care to understand what the scheme means, what the risks involved are, how the scheme works and so on. The reason for this carefree attitude is the blind faith one has in their friends or relatives. Everyone likes to believe, our friends and relatives will do the best for us.
This is a classic problem that we all face today. Most times, our relative or friend has just joined the insurance or finance business. When a person is stepping into a new business, he or she is desperately looking for business. They have to sell the products they have taken up. They are looking for support from their friends and relatives. A newcomer typically spends the first six to twelve months, tapping this ready market of his close ones. Even companies hiring agents are betting on making initial business from the newbie’s inner circle.
As supportive relatives and friends, most people succumb to such proposals even though at a loss. A person may take an insurance policy with a premium of Rs 15,000 per annum, just to please their relative. Later, when they find the product unsuitable to their needs, they still stick to it. You cannot walk out on your relative or friend. If it is a traditional product, they had bought before the new insurance regime, they will have to pay the premium for three years before surrendering. After having spent Rs 45,000 for three years, all they may get is Rs 15,000. That's a lot of money to lose simply because you cannot say ‘no’ to your relative or friend. The money lost is with the insurance company. The relative has probably made Rs 4,000- 5,000 from what has been paid in three years.
Relatives and friends may not be selling what is good for the person - they may be pushing what they have to sell. A person from insurance will sell insurance policies to you, whether you require insurance or not. There are other problems too. When you invest in a financial product, you require proper servicing, over the tenure of the product. A newbie, especially those who plan to take up the job on a part time basis, may not be in the system after a year. In insurance, the drop-out rates are very high. Even when a person does not drop out, if he does not conduct his business seriously, it will impact the service levels. What’s worse, since this person is known, he cannot be taken to task.
When it comes to investing money, it makes sense to choose advisors who can help by giving out the right information and can be pulled up in case they don’t perform. One must have the freedom to change one’s advisor if need be. After all, it is a good amount of money at stake. Do give relatives and friends some business, but only if, they are able to stand scrutiny. Else, one should think of other ways to help them but it is best to keep one’s money with professionals. Mixing money and personal relationships can bring more problems than pleasure.
Published in Business Standard on 10/10/2010
Money plays an important role in people’s lives. Yet, when one has it, it is seldom given the importance it deserves. People look forward to earning more money rather than managing the money that they already have. This is probably why, money in bank accounts, is not deployed for an extended period of time. People don’t realise they are missing an opportunity to earn profits on them.
The money lies around till they hear about some good investment or insurance ideas from friends and family. Many of us have friends and relatives working in the financial services sectors, who approach us for business. More often than not, they get both attention and business from us. While putting one’s money into any of the “amazing schemes” that one hears, most don’t really care to understand what the scheme means, what the risks involved are, how the scheme works and so on. The reason for this carefree attitude is the blind faith one has in their friends or relatives. Everyone likes to believe, our friends and relatives will do the best for us.
This is a classic problem that we all face today. Most times, our relative or friend has just joined the insurance or finance business. When a person is stepping into a new business, he or she is desperately looking for business. They have to sell the products they have taken up. They are looking for support from their friends and relatives. A newcomer typically spends the first six to twelve months, tapping this ready market of his close ones. Even companies hiring agents are betting on making initial business from the newbie’s inner circle.
As supportive relatives and friends, most people succumb to such proposals even though at a loss. A person may take an insurance policy with a premium of Rs 15,000 per annum, just to please their relative. Later, when they find the product unsuitable to their needs, they still stick to it. You cannot walk out on your relative or friend. If it is a traditional product, they had bought before the new insurance regime, they will have to pay the premium for three years before surrendering. After having spent Rs 45,000 for three years, all they may get is Rs 15,000. That's a lot of money to lose simply because you cannot say ‘no’ to your relative or friend. The money lost is with the insurance company. The relative has probably made Rs 4,000- 5,000 from what has been paid in three years.
Relatives and friends may not be selling what is good for the person - they may be pushing what they have to sell. A person from insurance will sell insurance policies to you, whether you require insurance or not. There are other problems too. When you invest in a financial product, you require proper servicing, over the tenure of the product. A newbie, especially those who plan to take up the job on a part time basis, may not be in the system after a year. In insurance, the drop-out rates are very high. Even when a person does not drop out, if he does not conduct his business seriously, it will impact the service levels. What’s worse, since this person is known, he cannot be taken to task.
When it comes to investing money, it makes sense to choose advisors who can help by giving out the right information and can be pulled up in case they don’t perform. One must have the freedom to change one’s advisor if need be. After all, it is a good amount of money at stake. Do give relatives and friends some business, but only if, they are able to stand scrutiny. Else, one should think of other ways to help them but it is best to keep one’s money with professionals. Mixing money and personal relationships can bring more problems than pleasure.
Published in Business Standard on 10/10/2010
Watch out before you cash in on your future income
Holidays and LCDs on EMIs and many other goodies on credit cards and a home bought with a huge dollop of loan, are all commonplace now. No one really worries about such things any longer. Being in debt is almost fashionable today. Also, in most cases, it is not possible to avoid it – like in the case of buying a home. Most people today want to buy a home early in their lives... that means, they may not have too much money to pay upfront and a bulk of it will have to come from a loan.
Everything done in right quantities is good. Brandy and wine, they say, have medicinal benefits, if had in the right quantities. But many people stretch the definition of “right quantity” and end up getting sozzled... and that is where the problem lies. Loans may be needed in certain situations. But, they need to be managed properly so that they don’t get the better of you.
When you take debt, you are essentially cashing in on future income. So, one needs to clearly weigh whether it is a good idea to draw on the future income. The most important thing then before assuming debt is to be clear about the pressing need for the object/service and the conviction that assuming debt is the best or the only option.
Today, loans are available quite easily. Hence, the temptation to just go around, get a loan and get your favourite toy or indulgence, is irresistible. That is why one needs to be careful. In the need to keep up with the Kapoors and Sharmas, one should not get sucked into the vortex of debt.
Again, there are benign loans like home loans, where an asset is created... there are others which can be worrisome – like credit card debt, personal loans etc. Going for a refrigerator on a loan may be justifiable – for it has become a necessity today. But assuming a loan for acquiring a huge LCD TV or a holiday abroad, falls under the “worrisome” category.
Easy serviceability of the loan is an important parameter. It is important to ensure that the EMIs can be paid without problems, from your income. Generally, around 40% of the net salary towards home loan servicing would be fine. For double income families, the portion of the income towards servicing home loans can go higher, as only a small fraction of their joint income may be needed for normal household expenses. However, in such cases, there will be a compulsion for both to work for extended periods of time and any break in one person’s earnings, can prove to be disastrous.
Other loans can be taken, based on cashflows. However, it is a better idea to start saving for it and then buying it. For instance, it is a good idea to save `3,000 per month for a year and then buy an LCD TV, instead of going for it with a loan. The end result is the same. But, in the second case, it is a more self-reliant and disciplined way of enjoying life.
If debt taken together is over 60% of one’s income, then it is a danger zone. Most look around for the cheapest debt. But the question to ask is, do I need to assume this debt. Anything done within limits, is good. Beyond limits, it becomes poison.
Published in The Economic Times, 7/10/2010
Everything done in right quantities is good. Brandy and wine, they say, have medicinal benefits, if had in the right quantities. But many people stretch the definition of “right quantity” and end up getting sozzled... and that is where the problem lies. Loans may be needed in certain situations. But, they need to be managed properly so that they don’t get the better of you.
When you take debt, you are essentially cashing in on future income. So, one needs to clearly weigh whether it is a good idea to draw on the future income. The most important thing then before assuming debt is to be clear about the pressing need for the object/service and the conviction that assuming debt is the best or the only option.
Today, loans are available quite easily. Hence, the temptation to just go around, get a loan and get your favourite toy or indulgence, is irresistible. That is why one needs to be careful. In the need to keep up with the Kapoors and Sharmas, one should not get sucked into the vortex of debt.
Again, there are benign loans like home loans, where an asset is created... there are others which can be worrisome – like credit card debt, personal loans etc. Going for a refrigerator on a loan may be justifiable – for it has become a necessity today. But assuming a loan for acquiring a huge LCD TV or a holiday abroad, falls under the “worrisome” category.
Easy serviceability of the loan is an important parameter. It is important to ensure that the EMIs can be paid without problems, from your income. Generally, around 40% of the net salary towards home loan servicing would be fine. For double income families, the portion of the income towards servicing home loans can go higher, as only a small fraction of their joint income may be needed for normal household expenses. However, in such cases, there will be a compulsion for both to work for extended periods of time and any break in one person’s earnings, can prove to be disastrous.
Other loans can be taken, based on cashflows. However, it is a better idea to start saving for it and then buying it. For instance, it is a good idea to save `3,000 per month for a year and then buy an LCD TV, instead of going for it with a loan. The end result is the same. But, in the second case, it is a more self-reliant and disciplined way of enjoying life.
If debt taken together is over 60% of one’s income, then it is a danger zone. Most look around for the cheapest debt. But the question to ask is, do I need to assume this debt. Anything done within limits, is good. Beyond limits, it becomes poison.
Published in The Economic Times, 7/10/2010
Hope after the nightmare
Investing in a stock like Mahindra Satyam requires a strong stomach. But there are long-term rewards.
When the Satyam scandal broke out in January, 2009, it stunned everyone. The scandal that was done with allegedly active collusion and participation from several senior functionaries, made investors quite jittery. Even external auditors were not able to find the frauds committed. This is a major problem for shareholders, who are not involved in the direct running of the company.
However, in every misfortune, some will always win. For instance, when there is an earthquake and houses are destroyed, builders and cement companies will benefit immensely. Similarly, when there is turmoil, there are those who would be willing to take the risk, for the chance of a windfall profit. But for that, they need to have a very high risk appetite.
------------------------------------------------------------------------------------
KEEP A HAWK’S EYE ON:
* The impact of a scandal on the company’s financials
* The commitment of the management to turmoil resolution
* If the company is professionally managed and transparent
* If the company has opened up communication channels with employees, stockholders and customers
* Legal cases and the impact. Getting stuck in a financial suit has the capability to cripple the company
------------------------------------------------------------------------------------
Warren Buffet, the legendary investor, poured in billions at the height of gloom in 2008. Earlier this year, he purchased 77 per cent of Burlington Northern railroad for about $26 billion, when the economy was not in a very good shape. That is a real long-term bet, in vintage Buffett style. He is willing to wait decades to get returns from his investment. It is all about value.
Similarly, when a company is in doldrums due to a scandal, the intrinsic value will typically fall below its fair value. There is bound to be bad press, which will depress the prices and create tremendous gloom around the company. This is fertile hunting ground for the intrepid investor. However, a savvy investor would invest after due diligence.
GETTING IT RIGHT
What does a savvy investor do? How does he assess whether a company in the midst of a scandal is worth investing in?
One of the prime things to evaluate is whether the scandal is so large as to destabilise the company itself. If it is, the risks are very high indeed. The second thing to look at is the response from the A-team in the company– they would be required to hold fort and steer the company clear from the storm. A committed A-team, is a positive aspect. Here, depth of management becomes critical. Owner-driven companies may have shallow structures and pose major questions about the recovery. There are even more questions if the main owner is implicated, as in the Satyam scandal.
The third thing to look for is the intention of the team to sort the problem and their resolve to come clean and tidy the situation. Here, communication plays a major role. A good team will open channels of communication with employees, shareholders, customers and other stakeholders and clearly inform them about the steps being taken to resolve the crisis. The fourth thing to look at is the nature of charges against the company or the management and the extent of monetary damage. In such situations, there is potential for a plethora of legal cases, which can cripple the company. This, by itself, is a major determinant of whether a company will be able to stand up ever again or not. This assessment could be tricky.
If a new management is brought in, which has credibility, it is to be seen as an extremely positive step. A credible management will re-infuse confidence all round and give the company the chance to stand up again. If there is a move to protect the brand by the new management, it is an entirely positive move. Towards this end, the management might delink the scandal and its perpetrators from the brand, through skillful communication. Ultimately, the brand persona is invaluable and is what enables sale of products and services.
ESSENTIALS
Keeping the flock of clients intact is a challenge for battered firms. However, appropriate interventions and proper communication which isolate the criminal act and delinks it from what the company otherwise stands for, as also seeking their support and co-operation, will be positive for the company. This will help in retaining clients. Similarly, acquiring new clients could be a challenge and the management’s effectiveness in combating the problem will come to the fore in how well they do this.
Employees with deep understanding and experience are an asset for any organisation. It is important that the current employees are retained and their fears assuaged. If successful, this will be one of the greatest positives and give the company its best chance at revival.
An investor who wants to benefit from the huge plunge in share prices in a tainted company has to be hawk-eyed and needs to look at all these parameters before coming to a conclusion and then decide if the company is worth investing in. Admittedly, this is not everyone's cup of tea. There are huge risks involved. The potential for returns is also enormous, if the call turns out right. It could be a multi-bagger overtime, as such companies would be typically available at a deep discount to their intrinsic value.
Published in Business Standard on 3/10/2010
When the Satyam scandal broke out in January, 2009, it stunned everyone. The scandal that was done with allegedly active collusion and participation from several senior functionaries, made investors quite jittery. Even external auditors were not able to find the frauds committed. This is a major problem for shareholders, who are not involved in the direct running of the company.
However, in every misfortune, some will always win. For instance, when there is an earthquake and houses are destroyed, builders and cement companies will benefit immensely. Similarly, when there is turmoil, there are those who would be willing to take the risk, for the chance of a windfall profit. But for that, they need to have a very high risk appetite.
------------------------------------------------------------------------------------
KEEP A HAWK’S EYE ON:
* The impact of a scandal on the company’s financials
* The commitment of the management to turmoil resolution
* If the company is professionally managed and transparent
* If the company has opened up communication channels with employees, stockholders and customers
* Legal cases and the impact. Getting stuck in a financial suit has the capability to cripple the company
------------------------------------------------------------------------------------
Warren Buffet, the legendary investor, poured in billions at the height of gloom in 2008. Earlier this year, he purchased 77 per cent of Burlington Northern railroad for about $26 billion, when the economy was not in a very good shape. That is a real long-term bet, in vintage Buffett style. He is willing to wait decades to get returns from his investment. It is all about value.
Similarly, when a company is in doldrums due to a scandal, the intrinsic value will typically fall below its fair value. There is bound to be bad press, which will depress the prices and create tremendous gloom around the company. This is fertile hunting ground for the intrepid investor. However, a savvy investor would invest after due diligence.
GETTING IT RIGHT
What does a savvy investor do? How does he assess whether a company in the midst of a scandal is worth investing in?
One of the prime things to evaluate is whether the scandal is so large as to destabilise the company itself. If it is, the risks are very high indeed. The second thing to look at is the response from the A-team in the company– they would be required to hold fort and steer the company clear from the storm. A committed A-team, is a positive aspect. Here, depth of management becomes critical. Owner-driven companies may have shallow structures and pose major questions about the recovery. There are even more questions if the main owner is implicated, as in the Satyam scandal.
The third thing to look for is the intention of the team to sort the problem and their resolve to come clean and tidy the situation. Here, communication plays a major role. A good team will open channels of communication with employees, shareholders, customers and other stakeholders and clearly inform them about the steps being taken to resolve the crisis. The fourth thing to look at is the nature of charges against the company or the management and the extent of monetary damage. In such situations, there is potential for a plethora of legal cases, which can cripple the company. This, by itself, is a major determinant of whether a company will be able to stand up ever again or not. This assessment could be tricky.
If a new management is brought in, which has credibility, it is to be seen as an extremely positive step. A credible management will re-infuse confidence all round and give the company the chance to stand up again. If there is a move to protect the brand by the new management, it is an entirely positive move. Towards this end, the management might delink the scandal and its perpetrators from the brand, through skillful communication. Ultimately, the brand persona is invaluable and is what enables sale of products and services.
ESSENTIALS
Keeping the flock of clients intact is a challenge for battered firms. However, appropriate interventions and proper communication which isolate the criminal act and delinks it from what the company otherwise stands for, as also seeking their support and co-operation, will be positive for the company. This will help in retaining clients. Similarly, acquiring new clients could be a challenge and the management’s effectiveness in combating the problem will come to the fore in how well they do this.
Employees with deep understanding and experience are an asset for any organisation. It is important that the current employees are retained and their fears assuaged. If successful, this will be one of the greatest positives and give the company its best chance at revival.
An investor who wants to benefit from the huge plunge in share prices in a tainted company has to be hawk-eyed and needs to look at all these parameters before coming to a conclusion and then decide if the company is worth investing in. Admittedly, this is not everyone's cup of tea. There are huge risks involved. The potential for returns is also enormous, if the call turns out right. It could be a multi-bagger overtime, as such companies would be typically available at a deep discount to their intrinsic value.
Published in Business Standard on 3/10/2010
Falling prey to brandwagon
Don’t let marketers make up your mind; check aims, alternatives and ask why
Mindshare is an important aspect of marketing. The right positioning of the company, its brands, products and other intangible assets is extremely critical to the success of the enterprise.
Positioning: The battle for your mind, a seminal book by Jack Trout and Al Ries, was a runaway hit in the 1980s. It gave an insight on how marketers should get into the mind of the consumer and sculpt a desirable image of their brand. Sometimes, the associations created are so strong that a category itself is identified with a brand, like Xerox. The branding proved good in the photocopying business but worked against the company in other areas.
Sometimes, the association with a brand is so strong that no other brand is able to penetrate the market. In financial services category too, there are several carefully cultivated niche areas for instance the retirement planning space. Thanks to the age-old association of pension with old age, retirement and pension became synonymous, among people. This was a ready, fecund environment, which the life insurance companies, mainly, have latched on to. They understood the association and milked it for what it was worth.
So, are pension products good for retirement? Sure. But are they the only way to take care of retirement planning? Hardly. Retirement planning is a much wider area, where pension products are only one of the options. Also used for retirement planning are provident fund (PF), gratuity and other retiral benefits that one gets. Apart from that, one's investments in various areas like fixed deposits (FDs), bonds, equity, mutual funds (MFs), property and so on will help in retirement.
In fact, pension products, till date (till the proposed new version of direct taxes code gets implemented), have a huge disadvantage. The annuities are taxable as income, which depresses the returns. Once the pension starts, one cannot access the corpus, making the product inflexible. Compared to pension products, many other products, notably equity and equity-oriented MFs give better tax-free returns. They are also flexible on accessing the corpus. So, why do individuals who have bought a pension product consider it enough for their retirement planning?
LOSING RATIONALITY
Thought processes are very difficult to change. Besides most people have little interest in financial matters .The general tendency is to get over with finance-related decisions as soon as possible. The other reason is the tendency to replicate what a friend, colleague or well-wisher may have done. If an acquaintance has bought a pension plan, so would they. Others may invest in an FD, tax savings scheme, insurance simply because their peers advised them to. This, without giving any thought to whether the investment is really relevant for their situation.
Another goal targeted successfully by financial services companies is child education and future planning. Emotional strings are pulled here, to good effect. You see advertisements depicting a father holding his kid, and the kid spreading his hands, indicating probably what he will become - a pilot. The cue to the parent is to save and promote the child’s ambition.There are umpteen variations of these advertisements, all very heart rendering. Insurance companies have won this space for themselves, hands down. There are many parents who want secure their child’s future through specific children’s insurance plan, a savings plan or gold schemes advertised in the media.
People tend to think of such insurance products as the primary tool to achieve their children-related goals. As a matter of fact, the security a child plan affords can easily be bettered by a simple term plan. The investments for the child can be done in a basket of products, which will help build the corpus required to fund the goals, be it education, marriage and so on. While an insurance product might be one solution, it need not be the only solution or even the best one. But investing in a plan evocatively called ‘Little Angels’ or ‘Clever Geniuses’ or some such thing is somehow more appealing than investing in bland products like FDs, bonds or MFs.
Financial services and products are rarely evaluated rationally and thoroughly before a decision is taken. There is a small minority who evaluate products that are advertised and ask their financial planners all the right questions before they take a decision.
HOMING OUT
Having a roof over one’s head is a basic need. But for most people looking to buy property, buying a home is always an emotional decision (except for an investor). A home is bought in one city even though the person has been switching jobs every two-three years and not necessarily in the same city. The decision to buy a house is based on the “look and feel” of the property and not the price alone. Most people justify the price and other parameters quoting their tax savings, the rent saved, avoidance of the inconvenience of frequent shifts and so on.
The calculations would mostly prove otherwise. They forget the long-term liability they are assuming and keep talking of the asset they are creating. The builders have realised that price is not really a factor in decision making these days. Most are looking at a certain elan and an have-arrived-look to their property. Which is what the builders give them.
Al Ries would be extremely pleased with most of the financial services players today, for understanding the positioning concept and creating a hugely successful industry, in the process.
Published in Business Standard on 26/9/2010
Mindshare is an important aspect of marketing. The right positioning of the company, its brands, products and other intangible assets is extremely critical to the success of the enterprise.
Positioning: The battle for your mind, a seminal book by Jack Trout and Al Ries, was a runaway hit in the 1980s. It gave an insight on how marketers should get into the mind of the consumer and sculpt a desirable image of their brand. Sometimes, the associations created are so strong that a category itself is identified with a brand, like Xerox. The branding proved good in the photocopying business but worked against the company in other areas.
Sometimes, the association with a brand is so strong that no other brand is able to penetrate the market. In financial services category too, there are several carefully cultivated niche areas for instance the retirement planning space. Thanks to the age-old association of pension with old age, retirement and pension became synonymous, among people. This was a ready, fecund environment, which the life insurance companies, mainly, have latched on to. They understood the association and milked it for what it was worth.
So, are pension products good for retirement? Sure. But are they the only way to take care of retirement planning? Hardly. Retirement planning is a much wider area, where pension products are only one of the options. Also used for retirement planning are provident fund (PF), gratuity and other retiral benefits that one gets. Apart from that, one's investments in various areas like fixed deposits (FDs), bonds, equity, mutual funds (MFs), property and so on will help in retirement.
In fact, pension products, till date (till the proposed new version of direct taxes code gets implemented), have a huge disadvantage. The annuities are taxable as income, which depresses the returns. Once the pension starts, one cannot access the corpus, making the product inflexible. Compared to pension products, many other products, notably equity and equity-oriented MFs give better tax-free returns. They are also flexible on accessing the corpus. So, why do individuals who have bought a pension product consider it enough for their retirement planning?
LOSING RATIONALITY
Thought processes are very difficult to change. Besides most people have little interest in financial matters .The general tendency is to get over with finance-related decisions as soon as possible. The other reason is the tendency to replicate what a friend, colleague or well-wisher may have done. If an acquaintance has bought a pension plan, so would they. Others may invest in an FD, tax savings scheme, insurance simply because their peers advised them to. This, without giving any thought to whether the investment is really relevant for their situation.
Another goal targeted successfully by financial services companies is child education and future planning. Emotional strings are pulled here, to good effect. You see advertisements depicting a father holding his kid, and the kid spreading his hands, indicating probably what he will become - a pilot. The cue to the parent is to save and promote the child’s ambition.There are umpteen variations of these advertisements, all very heart rendering. Insurance companies have won this space for themselves, hands down. There are many parents who want secure their child’s future through specific children’s insurance plan, a savings plan or gold schemes advertised in the media.
People tend to think of such insurance products as the primary tool to achieve their children-related goals. As a matter of fact, the security a child plan affords can easily be bettered by a simple term plan. The investments for the child can be done in a basket of products, which will help build the corpus required to fund the goals, be it education, marriage and so on. While an insurance product might be one solution, it need not be the only solution or even the best one. But investing in a plan evocatively called ‘Little Angels’ or ‘Clever Geniuses’ or some such thing is somehow more appealing than investing in bland products like FDs, bonds or MFs.
Financial services and products are rarely evaluated rationally and thoroughly before a decision is taken. There is a small minority who evaluate products that are advertised and ask their financial planners all the right questions before they take a decision.
HOMING OUT
Having a roof over one’s head is a basic need. But for most people looking to buy property, buying a home is always an emotional decision (except for an investor). A home is bought in one city even though the person has been switching jobs every two-three years and not necessarily in the same city. The decision to buy a house is based on the “look and feel” of the property and not the price alone. Most people justify the price and other parameters quoting their tax savings, the rent saved, avoidance of the inconvenience of frequent shifts and so on.
The calculations would mostly prove otherwise. They forget the long-term liability they are assuming and keep talking of the asset they are creating. The builders have realised that price is not really a factor in decision making these days. Most are looking at a certain elan and an have-arrived-look to their property. Which is what the builders give them.
Al Ries would be extremely pleased with most of the financial services players today, for understanding the positioning concept and creating a hugely successful industry, in the process.
Published in Business Standard on 26/9/2010
Add the equity edge to your portfolio
Debt is not enough since inflation will eat into the returns.
If you want to enjoy your retirement years, you need to think and plan for it now. The earlier you plan, the better. There is no social security system in India. All the taxes a person pays through out his life counts for nothing. But this fact is known from day one.
It is not just prudent, but necessary to take positive action to shore up one’s finances. Most people think, they already do since they save in fixed deposits (FDs), small post office saving schemes, government bonds, debentures and the like. These investments may have sufficed some decades earlier, when the life expectancy was lower.
Over time, medical advances and the general rise in the standard of living have ensured that many live decades into their retirement. While this is definitely good news, what follows is not. Since people live 20-30 years into retirement, they need that much more money to see them through their golden years. The amount one would need to set aside for any medical expenses today is much more given the high medical costs. Besides, with the general standard of living going up, one needs sufficient money to maintain it. Many also want to leave a legacy for their children.
GAINING FROM EQUITIES
* Benefit from dividend-paying companies
* Book profits in rising markets
* Set threshold limits / triggers on stocks
* Use systematic withdrawal plans to receive a steady income
In such a scenario, if a person has invested all his money in debt instruments like FDs and small savings only, his post-tax returns would translate to 5.5 per cent or thereabouts. This does not even come near the present inflation figures – which means his real returns from all his life long investments are in the negative.
Let’s understand this by way of an example. Ravi aged 45 years has a monthly expense of around Rs 30,000 today. He expects to retire by 60. He also estimates that his expenses after retirement will come down by 30 per cent. This is because, there will be no education, marriage and other expenses related to his children who will be independent by then. Assuming a seven per cent composite inflation over the period till his retirement, this translates into a requirement of Rs 57,950 per month in the first year of retirement. If he is to generate this amount without dipping into his corpus, he needs to have a corpus of Rs 1.26 crore (without adjusting for inflation), at the time of retirement. In case, this corpus is kept aside, it could earn the same amount (by way of interest) in perpetuity. But in case, he plans to use the interest and the principal amount itself over a 30-year period, then he needs Rs 1.02 crore at the time of retirement. This does not account for any major medical emergencies in this period.
Now, if some portion of his money is invested in equity-oriented assets which give a long-term return of 12 per cent, post-tax, and 40 per cent of the portfolio is allocated to such assets, then the corpus required at the time of retirement is Rs 78.25 lakh, assuming that he will use the corpus and the returns from the corpus in this period. But such a suggestion generally leads to the next question troubling investors. Isn’t the equity market prone to fluctuations? How can I put my retirement corpus into that and trust it to give me good returns? What if I lose my money?
LONG-TERM THINKING
Planning for the retirement corpus means planning for a corpus that will help a person sustain for over 20 to 30 years. That’s really a long period requiring a long- term strategy. When one has time on one’s side, he must use the benefits of equity-oriented assets that perform well in the long -term. This has been the case with stock markets within India and elsewhere in the world too. So, even though there may be fluctuations in the short-term, equity assets will give decent returns over time. There is no reason to panic about the erosion of capital when the market plummets. Given the long timeframe, it is bound to go down sometimes and climb upwards at other times. Staying invested, secure in the knowledge that what has gone down will eventually come up, is the crux of success here. Hence, a person readying for the retirement phase, needs to insulate himself for a few years from the fluctuations of the equity portion of his portfolio. Given time, the equity portion will do well enough to ensure decent returns.
EARNING FROM EQUITIES
How to get money out of equity assets in the retirement period is another question. One way to earn is through dividends. So stay invested in good companies that give out good dividends. However, one cannot depend on dividends as a regular income. One could also book profits when the market is doing well. Smart investors book profits in companies that may not be able to sustain the outlook (even if it is good currently). You can set a threshold limit for a stock’s rise, say 20 percent for a particular stock and book profits when it crosses the limit. In equities, it is possible to set triggers as is possible in case of some mutual fund (MF) schemes too. In funds, where setting a trigger is not possible, plain monitoring and profit booking will work. In MFs, there is a systematic withdrawal plan (SWP) option, too, through which one can set up a target to receive a fixed sum, for a specified period. This will ensure a steady flow to take care of the expenses.
For instance, if Rs 12 lakh were invested in an equity-oriented fund and the fund has given 12-plus per cent returns, it can potentially support Rs 10,000 per month. To be safe, one can draw down a lower sum per month, like Rs 8,000. A third option would be a simple method of weeding the non-performing ones from time to time and using the proceeds. That way, the portfolio will stay healthy and perform well.
Re-balancing is important. One needs to maintain an appropriate level of exposure between equity and debt assets. If the desired ratio is 40:60, one can look at the portfolio re-balancing every three to six months to preserve that. If these are done, the retiree can put up his legs and and smile like the happy seniors who grace the pension policy advertisements.
Published in Business Standard / September 19, 2010
If you want to enjoy your retirement years, you need to think and plan for it now. The earlier you plan, the better. There is no social security system in India. All the taxes a person pays through out his life counts for nothing. But this fact is known from day one.
It is not just prudent, but necessary to take positive action to shore up one’s finances. Most people think, they already do since they save in fixed deposits (FDs), small post office saving schemes, government bonds, debentures and the like. These investments may have sufficed some decades earlier, when the life expectancy was lower.
Over time, medical advances and the general rise in the standard of living have ensured that many live decades into their retirement. While this is definitely good news, what follows is not. Since people live 20-30 years into retirement, they need that much more money to see them through their golden years. The amount one would need to set aside for any medical expenses today is much more given the high medical costs. Besides, with the general standard of living going up, one needs sufficient money to maintain it. Many also want to leave a legacy for their children.
GAINING FROM EQUITIES
* Benefit from dividend-paying companies
* Book profits in rising markets
* Set threshold limits / triggers on stocks
* Use systematic withdrawal plans to receive a steady income
In such a scenario, if a person has invested all his money in debt instruments like FDs and small savings only, his post-tax returns would translate to 5.5 per cent or thereabouts. This does not even come near the present inflation figures – which means his real returns from all his life long investments are in the negative.
Let’s understand this by way of an example. Ravi aged 45 years has a monthly expense of around Rs 30,000 today. He expects to retire by 60. He also estimates that his expenses after retirement will come down by 30 per cent. This is because, there will be no education, marriage and other expenses related to his children who will be independent by then. Assuming a seven per cent composite inflation over the period till his retirement, this translates into a requirement of Rs 57,950 per month in the first year of retirement. If he is to generate this amount without dipping into his corpus, he needs to have a corpus of Rs 1.26 crore (without adjusting for inflation), at the time of retirement. In case, this corpus is kept aside, it could earn the same amount (by way of interest) in perpetuity. But in case, he plans to use the interest and the principal amount itself over a 30-year period, then he needs Rs 1.02 crore at the time of retirement. This does not account for any major medical emergencies in this period.
Now, if some portion of his money is invested in equity-oriented assets which give a long-term return of 12 per cent, post-tax, and 40 per cent of the portfolio is allocated to such assets, then the corpus required at the time of retirement is Rs 78.25 lakh, assuming that he will use the corpus and the returns from the corpus in this period. But such a suggestion generally leads to the next question troubling investors. Isn’t the equity market prone to fluctuations? How can I put my retirement corpus into that and trust it to give me good returns? What if I lose my money?
LONG-TERM THINKING
Planning for the retirement corpus means planning for a corpus that will help a person sustain for over 20 to 30 years. That’s really a long period requiring a long- term strategy. When one has time on one’s side, he must use the benefits of equity-oriented assets that perform well in the long -term. This has been the case with stock markets within India and elsewhere in the world too. So, even though there may be fluctuations in the short-term, equity assets will give decent returns over time. There is no reason to panic about the erosion of capital when the market plummets. Given the long timeframe, it is bound to go down sometimes and climb upwards at other times. Staying invested, secure in the knowledge that what has gone down will eventually come up, is the crux of success here. Hence, a person readying for the retirement phase, needs to insulate himself for a few years from the fluctuations of the equity portion of his portfolio. Given time, the equity portion will do well enough to ensure decent returns.
EARNING FROM EQUITIES
How to get money out of equity assets in the retirement period is another question. One way to earn is through dividends. So stay invested in good companies that give out good dividends. However, one cannot depend on dividends as a regular income. One could also book profits when the market is doing well. Smart investors book profits in companies that may not be able to sustain the outlook (even if it is good currently). You can set a threshold limit for a stock’s rise, say 20 percent for a particular stock and book profits when it crosses the limit. In equities, it is possible to set triggers as is possible in case of some mutual fund (MF) schemes too. In funds, where setting a trigger is not possible, plain monitoring and profit booking will work. In MFs, there is a systematic withdrawal plan (SWP) option, too, through which one can set up a target to receive a fixed sum, for a specified period. This will ensure a steady flow to take care of the expenses.
For instance, if Rs 12 lakh were invested in an equity-oriented fund and the fund has given 12-plus per cent returns, it can potentially support Rs 10,000 per month. To be safe, one can draw down a lower sum per month, like Rs 8,000. A third option would be a simple method of weeding the non-performing ones from time to time and using the proceeds. That way, the portfolio will stay healthy and perform well.
Re-balancing is important. One needs to maintain an appropriate level of exposure between equity and debt assets. If the desired ratio is 40:60, one can look at the portfolio re-balancing every three to six months to preserve that. If these are done, the retiree can put up his legs and and smile like the happy seniors who grace the pension policy advertisements.
Published in Business Standard / September 19, 2010
Saving tax when selling property
Property investments have gained currency these days. In the past five years or so, property values have shot through the roof. There are many who are hence investing in property these days.
Property is sold either to buy another property – probably a bigger residence or a better locality or both. It may also be to simply book a profit, when the valuations have become attractive.
Vikram was doing the latter. He was getting transferred out on Mumbai, to his hometown – Delhi. He had bought his residential property in a Mumbai suburb, about 6 years back. Now, he is interested in selling it as he plans to settle down in Delhi and he even has a buyer for it. He is seriously considering that, but wanted to know a bit about the tax matters surrounding sale of property. He wanted to know his options.
When a property is sold and the profits are retained, taxes have to be paid. In property transactions, normal income tax does not apply; capital gains taxes apply. For properties sold after 3 years of acquisition, Longterm Capital Gains ( LTCG ) applies. Short term capital gains apply for properties sold less than 36 months after it is bought. Short term capital gains are at the applicable tax rates for an individual. Longterm capital gains are 20% after applying the cost inflation index. Cost inflation index is applied to compensate for the effect of inflation, over time.
He has the option of paying the tax computed after indexation @ 20% and invest in a good instrument and earn good returns. If he invests in Equity Mutual Fund Schemes for instance, he will be able to get good double digit, tax free returns. This is a good option too, as one need not invest in low-yielding propositions, for the sake of saving tax or be forced to invest in another property. But then many people want to save taxes at all costs.
If Vikram does not want to pay tax, he also can invest the gains in Capital Gain bonds ( under Sec 54EC ). These bonds are issued by entities like Rural Electrification Corporation ( REC ), National Housing Boad ( NHB) etc. There is a six month window in which to purchase these bonds. Currently, they yield about 6% and have a lockin period of 3 years. The problem in this case is that though Vikram would be able to save tax by investing in these bonds, he is also potentially losing, as the interest rate on these bonds are low. The income from these bonds are however taxable. Also, the maximum one can invest in a capital gain bond is Rs.50 Lakhs for a Financial year. However, if the transaction has happened after 1st October of the year, then the window flows to the next financial year too allowing one to invest upto Rs.1 Crore.
Vikram has another way of saving tax too. He can buy another property for the value of capital gains. This comes under Section 54 of IT Act. When buying such a property, it can be bought one year prior to the sale or within two years after the sale. In case of construction of property, the time allowed is three years from the date of sale. The capital gains need to be deposited in a Capital Gains Depost Account before the date for filing returns. Any unutlised amount of this capital gain after the stipulated period, will be charged to income tax in the “previous year” at the end of the three year period. So, part utilization is possible too.
Vikram also wants to know if he can sell in Mumbai and buy in Delhi. It is permitted to buy anywhere in the country. There is a bit of ambiguity on whether one can invest the proceeds on one residential property or more than one. From a strict reading of the clauses, it is safe to assume that the proceeds need to be invested in a single residential property.
Now Vikram’s friend Gaurav has another problem. He has sold a commercial property and would like to save on Capital Gains tax. This is possible too under Section 54F of the IT Act. This is applicable for Capital assets, other than a residential property.
There is one major difference as compared to the sale of residential property and the capital gains treatment there on. Here, Gaurav will have to invest the entire proceeds from the sale into a residential property. The time frames for investment remain the same as in the case of sale of residential property. This however will work if he does not own more than one residential house on the date of transfer of the original asset, excluding the one he would purchase to save capital gains tax.
It is now upto Vikram to make up his mind whether he wants to buy a property or pay the tax and invest elsewhere. He has his options open now.
Published in Business Standard, 6/9/2010
Property is sold either to buy another property – probably a bigger residence or a better locality or both. It may also be to simply book a profit, when the valuations have become attractive.
Vikram was doing the latter. He was getting transferred out on Mumbai, to his hometown – Delhi. He had bought his residential property in a Mumbai suburb, about 6 years back. Now, he is interested in selling it as he plans to settle down in Delhi and he even has a buyer for it. He is seriously considering that, but wanted to know a bit about the tax matters surrounding sale of property. He wanted to know his options.
When a property is sold and the profits are retained, taxes have to be paid. In property transactions, normal income tax does not apply; capital gains taxes apply. For properties sold after 3 years of acquisition, Longterm Capital Gains ( LTCG ) applies. Short term capital gains apply for properties sold less than 36 months after it is bought. Short term capital gains are at the applicable tax rates for an individual. Longterm capital gains are 20% after applying the cost inflation index. Cost inflation index is applied to compensate for the effect of inflation, over time.
He has the option of paying the tax computed after indexation @ 20% and invest in a good instrument and earn good returns. If he invests in Equity Mutual Fund Schemes for instance, he will be able to get good double digit, tax free returns. This is a good option too, as one need not invest in low-yielding propositions, for the sake of saving tax or be forced to invest in another property. But then many people want to save taxes at all costs.
If Vikram does not want to pay tax, he also can invest the gains in Capital Gain bonds ( under Sec 54EC ). These bonds are issued by entities like Rural Electrification Corporation ( REC ), National Housing Boad ( NHB) etc. There is a six month window in which to purchase these bonds. Currently, they yield about 6% and have a lockin period of 3 years. The problem in this case is that though Vikram would be able to save tax by investing in these bonds, he is also potentially losing, as the interest rate on these bonds are low. The income from these bonds are however taxable. Also, the maximum one can invest in a capital gain bond is Rs.50 Lakhs for a Financial year. However, if the transaction has happened after 1st October of the year, then the window flows to the next financial year too allowing one to invest upto Rs.1 Crore.
Vikram has another way of saving tax too. He can buy another property for the value of capital gains. This comes under Section 54 of IT Act. When buying such a property, it can be bought one year prior to the sale or within two years after the sale. In case of construction of property, the time allowed is three years from the date of sale. The capital gains need to be deposited in a Capital Gains Depost Account before the date for filing returns. Any unutlised amount of this capital gain after the stipulated period, will be charged to income tax in the “previous year” at the end of the three year period. So, part utilization is possible too.
Vikram also wants to know if he can sell in Mumbai and buy in Delhi. It is permitted to buy anywhere in the country. There is a bit of ambiguity on whether one can invest the proceeds on one residential property or more than one. From a strict reading of the clauses, it is safe to assume that the proceeds need to be invested in a single residential property.
Now Vikram’s friend Gaurav has another problem. He has sold a commercial property and would like to save on Capital Gains tax. This is possible too under Section 54F of the IT Act. This is applicable for Capital assets, other than a residential property.
There is one major difference as compared to the sale of residential property and the capital gains treatment there on. Here, Gaurav will have to invest the entire proceeds from the sale into a residential property. The time frames for investment remain the same as in the case of sale of residential property. This however will work if he does not own more than one residential house on the date of transfer of the original asset, excluding the one he would purchase to save capital gains tax.
It is now upto Vikram to make up his mind whether he wants to buy a property or pay the tax and invest elsewhere. He has his options open now.
Published in Business Standard, 6/9/2010
16 September, 2010
Responsible access to credit
There has been a sea change in the perception with regards to taking loans, these days. The market has opened up significantly in the last two decades. Home loans have been around for long. It is a secure loan and attracts the lowest interest. Vehicle loan too is a secure loan and is available at comparatively low rates. Many times, the car manufacturer themselves subsidise the loan, to sweeten the deal. The delinquency in the home segment is lower than vehicle segment due to the Indian consumers’ penchant for treating the home as a sacred investment and hence would not jeopardize that.
But, personal loan and credit card loans are different. They are both unsecured loans. What’s more, these days personal loans are available without collateral or guarantors and minimum documentation. With rising consumerism and aspirations, personal loans and credit card spends are increasingly the poison of choice. Add to that, cut throat competition, which pushes the lenders to dive deep into the city’s unseen folds and source customers. The cream has long gone. What is left now are the riskier ones who have now become “eligible” for loans. Apparently, people earning as low as Rs.3000/-pm, can now get a personal loan. By it’s very nature, people who have to take recourse to personal loans may not be financially very sound. Add to that the fact that there are no guarantors or collateral and the fact that the loans are being sourced increasingly from the lower middleclass to lower than that. Also, now recovery agents have been restrained and banks have to go through the legal redressal mechanisms, which is notoriously slow. The upshot – rising defaults.
Credit card debt is similar. It is very easy to get carried away by the plastic sliver in one’s hands. Since, one does not count out the money and just need to swipe, one does not realize the outgo. When it comes to payment, many times, there isn’t enough money to settle the outstanding in one shot. Hence, people go on revolving credit. That works for some time, till more goods have been bought and the revolving credit payable every month itself is a huge figure. Then defaults happen. Credit cards are also easy to come by. Customers are serenaded with offers of lifetime free credit cards and sugary sweet offers. Even here, the penetration has gone all the way down to those who may not be eligible for a credit card in the first place.
By stretching themselves and defaulting on loans, customers are doing untold damage to their credit worthiness – for everything is being captured today and is being reported in one’s credit history. Defaults damage one’s credibility, making loans in future difficult to get and/ or high cost. This could bar them from any access to capital, should they require it, anytime in future.
The previous generation can teach us a thing or two here… living within one’s means is something that today’s senior citizen’s vouch by. No holidays on EMI, fancy white goods on easy loans for them. While enjoying the good things in life, we all need to watch out and make sure we don’t cross the line. Once we are on the other side, we are damaged goods… forever condemned by these institutions who will not extend their line of credit. If that sounds like Armageddon, it is!
Published in The Economic Times of 16/09/2010
But, personal loan and credit card loans are different. They are both unsecured loans. What’s more, these days personal loans are available without collateral or guarantors and minimum documentation. With rising consumerism and aspirations, personal loans and credit card spends are increasingly the poison of choice. Add to that, cut throat competition, which pushes the lenders to dive deep into the city’s unseen folds and source customers. The cream has long gone. What is left now are the riskier ones who have now become “eligible” for loans. Apparently, people earning as low as Rs.3000/-pm, can now get a personal loan. By it’s very nature, people who have to take recourse to personal loans may not be financially very sound. Add to that the fact that there are no guarantors or collateral and the fact that the loans are being sourced increasingly from the lower middleclass to lower than that. Also, now recovery agents have been restrained and banks have to go through the legal redressal mechanisms, which is notoriously slow. The upshot – rising defaults.
Credit card debt is similar. It is very easy to get carried away by the plastic sliver in one’s hands. Since, one does not count out the money and just need to swipe, one does not realize the outgo. When it comes to payment, many times, there isn’t enough money to settle the outstanding in one shot. Hence, people go on revolving credit. That works for some time, till more goods have been bought and the revolving credit payable every month itself is a huge figure. Then defaults happen. Credit cards are also easy to come by. Customers are serenaded with offers of lifetime free credit cards and sugary sweet offers. Even here, the penetration has gone all the way down to those who may not be eligible for a credit card in the first place.
By stretching themselves and defaulting on loans, customers are doing untold damage to their credit worthiness – for everything is being captured today and is being reported in one’s credit history. Defaults damage one’s credibility, making loans in future difficult to get and/ or high cost. This could bar them from any access to capital, should they require it, anytime in future.
The previous generation can teach us a thing or two here… living within one’s means is something that today’s senior citizen’s vouch by. No holidays on EMI, fancy white goods on easy loans for them. While enjoying the good things in life, we all need to watch out and make sure we don’t cross the line. Once we are on the other side, we are damaged goods… forever condemned by these institutions who will not extend their line of credit. If that sounds like Armageddon, it is!
Published in The Economic Times of 16/09/2010
Are you buying a property to save taxes ?
Saving tax is a pet preoccupation with our citizenry. Sometimes it borders on the ridiculous. People will go to any extent to save taxes. While saving taxes is a legitimate exercise, one needs to evaluate whether it makes sense to make certain investments, primarily to save tax.
Investments by definition is something that needs to give a reasonable return, after taxes. Also, investments have other aspects which need to be considered like tenure, liquidity, risk potential, returns, suitability for meeting goal requirements etc. Tax efficiency is but one such aspect.
Due to the rapid property value rise in the past five years, many have assumed that it will continue it’s upward rise, uninterrupted. It won’t. Also, it will not be able to rise at a compounded 20%, like it has risen in the past few years. It’s most likely to settle at a sedate single digit long-term growth rate of maybe 7-8%. Massive increases in property prices have stalled the markets and transactions have come down. It has to come down, pause a bit for income to catch up and move. So, in light of this, we need to evaluate whether investing in a property for primarily saving taxes is a great idea.
Property is bought for residential use and as an investment. If it is for use as one’s home, then tax considerations recede into the background… for one will anyway go in for it, for personal consumption. Tax concessions over and above that, is icing on the cake. Let us examine what are the tax concessions for a self occupied property.
For a self-occupied property ( where the whole or part is not let out & no benefit is derived from it ), the maximum interest permissible to be set off would be Rs.1.5 Lakhs. This is subject to the condition that the capital is borrowed on or after April 1, 1999. The deduction is Rs.30,000/- pa for capital borrowed towards acquiring home property before April 1, 1999. Also, the acquisition / construction should be completed within 3 years from the end of the Financial Year in which capital was borrowed. The loan agency needs to certify in respect of the interest payable against the loan taken for acquisition of house property. So, in case a person is taking a loan of Rs.50 Lakhs and the interest in the first year comes to Rs.5 Lakhs, he could avail a deduction of only Rs.1.5 Lakhs. The tax saved at the highest bracket is Rs.46,350/- assuming that the borrower is in the highest tax slab. Hence, if tax saving is the preeminent consideration, it is going to be met, only to a small extent. In this situation, an EMI of in the region of Rs.50,000/-pm would also be added on and has to be carried on for years – maybe two decades!
Again people have the view that it is still a good idea as an asset gets created. Most again have the view that when one starts paying an EMI, the surplus cash that one has gets used up and the chances of frittering away any surpluses comes down. While this is true, it also creates a long-term liability. This creates a problem in case of any income disruption. Especially in a situation when the loan taken requires two people to work ( which today, is mostly the case ), it snatches away the possibility of one person stopping work. If the husband and wife are working, and they have a small child at home, both of them have to continue working even if the lady wants to stay back to take care of the child. This is being played out across the country today.
Also, people are very mobile and their careers can take them to various cities or even abroad, over time. If they have invested in one city say Mumbai and they get transferred to say Delhi, they will have to put the house in Mumbai on rent and rent out another in Delhi. This again is happening in a lot many cases, in view of the increased mobility and churn. This beats the very purpose of buying the home in the first place. Also, the argument that in future the homes will become so costly as to be unaffordable is also untenable. As it is, even today the prices in many suburban areas is unaffordable for most middle class households. Assuming a long-term increase of 7-8% in property, it can clearly be bought at a later point when one has dropped anchor. Till such time, it may be a good idea to stay in rented properties, which typically are available at reasonable prices ( typically the annual rental is about 3-4% of the value of the property ). This gives one the flexibility and freedom to pursue opportunities unhindered.
In summary, buying a residential property for residential purposes makes sense if,
1. One is clear that this is the city in which they want to settle.
2. They are getting the property at a fair value.
3. They are clear that they can shoulder the responsibility of repaying the loans for an extended period of time.
Published in Business Standard on 12/09/2010
Investments by definition is something that needs to give a reasonable return, after taxes. Also, investments have other aspects which need to be considered like tenure, liquidity, risk potential, returns, suitability for meeting goal requirements etc. Tax efficiency is but one such aspect.
Due to the rapid property value rise in the past five years, many have assumed that it will continue it’s upward rise, uninterrupted. It won’t. Also, it will not be able to rise at a compounded 20%, like it has risen in the past few years. It’s most likely to settle at a sedate single digit long-term growth rate of maybe 7-8%. Massive increases in property prices have stalled the markets and transactions have come down. It has to come down, pause a bit for income to catch up and move. So, in light of this, we need to evaluate whether investing in a property for primarily saving taxes is a great idea.
Property is bought for residential use and as an investment. If it is for use as one’s home, then tax considerations recede into the background… for one will anyway go in for it, for personal consumption. Tax concessions over and above that, is icing on the cake. Let us examine what are the tax concessions for a self occupied property.
For a self-occupied property ( where the whole or part is not let out & no benefit is derived from it ), the maximum interest permissible to be set off would be Rs.1.5 Lakhs. This is subject to the condition that the capital is borrowed on or after April 1, 1999. The deduction is Rs.30,000/- pa for capital borrowed towards acquiring home property before April 1, 1999. Also, the acquisition / construction should be completed within 3 years from the end of the Financial Year in which capital was borrowed. The loan agency needs to certify in respect of the interest payable against the loan taken for acquisition of house property. So, in case a person is taking a loan of Rs.50 Lakhs and the interest in the first year comes to Rs.5 Lakhs, he could avail a deduction of only Rs.1.5 Lakhs. The tax saved at the highest bracket is Rs.46,350/- assuming that the borrower is in the highest tax slab. Hence, if tax saving is the preeminent consideration, it is going to be met, only to a small extent. In this situation, an EMI of in the region of Rs.50,000/-pm would also be added on and has to be carried on for years – maybe two decades!
Again people have the view that it is still a good idea as an asset gets created. Most again have the view that when one starts paying an EMI, the surplus cash that one has gets used up and the chances of frittering away any surpluses comes down. While this is true, it also creates a long-term liability. This creates a problem in case of any income disruption. Especially in a situation when the loan taken requires two people to work ( which today, is mostly the case ), it snatches away the possibility of one person stopping work. If the husband and wife are working, and they have a small child at home, both of them have to continue working even if the lady wants to stay back to take care of the child. This is being played out across the country today.
Also, people are very mobile and their careers can take them to various cities or even abroad, over time. If they have invested in one city say Mumbai and they get transferred to say Delhi, they will have to put the house in Mumbai on rent and rent out another in Delhi. This again is happening in a lot many cases, in view of the increased mobility and churn. This beats the very purpose of buying the home in the first place. Also, the argument that in future the homes will become so costly as to be unaffordable is also untenable. As it is, even today the prices in many suburban areas is unaffordable for most middle class households. Assuming a long-term increase of 7-8% in property, it can clearly be bought at a later point when one has dropped anchor. Till such time, it may be a good idea to stay in rented properties, which typically are available at reasonable prices ( typically the annual rental is about 3-4% of the value of the property ). This gives one the flexibility and freedom to pursue opportunities unhindered.
In summary, buying a residential property for residential purposes makes sense if,
1. One is clear that this is the city in which they want to settle.
2. They are getting the property at a fair value.
3. They are clear that they can shoulder the responsibility of repaying the loans for an extended period of time.
Published in Business Standard on 12/09/2010
06 September, 2010
How do I save tax when I sell a property
Property investments have gained currency these days. In the past five years or so, property values have shot through the roof. There are many who are hence investing in property these days.
Property is sold either to buy another property – probably a bigger residence or a better locality or both. It may also be to simply book a profit, when the valuations have become attractive.
Vikram was doing the latter. He was getting transferred out on Mumbai, to his hometown – Delhi. He had bought his residential property in a Mumbai suburb, about 6 years back. Now, he is interested in selling it as he plans to settle down in Delhi and he even has a buyer for it. He is seriously considering that, but wanted to know a bit about the tax matters surrounding sale of property. He wanted to know his options.
When a property is sold and the profits are retained, taxes have to be paid. In property transactions, normal income tax does not apply; capital gains taxes apply. For properties sold after 3 years of acquisition, Longterm Capital Gains ( LTCG ) applies. Short term capital gains apply for properties sold less than 36 months after it is bought. Short term capital gains are at the applicable tax rates for an individual. Longterm capital gains are 20% after applying the cost inflation index. Cost inflation index is applied to compensate for the effect of inflation, over time.
He has the option of paying the tax computed after indexation @ 20% and invest in a good instrument and earn good returns. If he invests in Equity Mutual Fund Schemes for instance, he will be able to get good double digit, tax free returns. This is a good option too, as one need not invest in low-yielding propositions, for the sake of saving tax or be forced to invest in another property. But then many people want to save taxes at all costs.
If Vikram does not want to pay tax, he also can invest the gains in Capital Gain bonds ( under Sec 54EC ). These bonds are issued by entities like Rural Electrification Corporation ( REC ), National Housing Boad ( NHB) etc. There is a six month window in which to purchase these bonds. Currently, they yield about 6% and have a lockin period of 3 years. The problem in this case is that though Vikram would be able to save tax by investing in these bonds, he is also potentially losing, as the interest rate on these bonds are low. The income from these bonds are however taxable. Also, the maximum one can invest in a capital gain bond is Rs.50 Lakhs for a Financial year. However, if the transaction has happened after 1st October of the year, then the window flows to the next financial year too allowing one to invest upto Rs.1 Crore.
Vikram has another way of saving tax too. He can buy another property for the value of capital gains. This comes under Section 54 of IT Act. When buying such a property, it can be bought one year prior to the sale or within two years after the sale. In case of construction of property, the time allowed is three years from the date of sale. The capital gains need to be deposited in a Capital Gains Depost Account before the date for filing returns. Any unutlised amount of this capital gain after the stipulated period, will be charged to income tax in the “previous year” at the end of the three year period. So, part utilization is possible too.
Vikram also wants to know if he can sell in Mumbai and buy in Delhi. It is permitted to buy anywhere in the country. There is a bit of ambiguity on whether one can invest the proceeds on one residential property or more than one. From a strict reading of the clauses, it is safe to assume that the proceeds need to be invested in a single residential property.
Now Vikram’s friend Gaurav has another problem. He has sold a commercial property and would like to save on Capital Gains tax. This is possible too under Section 54F of the IT Act. This is applicable for Capital assets, other than a residential property.
There is one major difference as compared to the sale of residential property and the capital gains treatment there on. Here, Gaurav will have to invest the entire proceeds from the sale into a residential property. The time frames for investment remain the same as in the case of sale of residential property. This however will work if he does not own more than one residential house on the date of transfer of the original asset, excluding the one he would purchase to save capital gains tax.
It is now upto Vikram to make up his mind whether he wants to buy a property or pay the tax and invest elsewhere. He has his options open now.
Published in Business Standard on 5/9/2010
Property is sold either to buy another property – probably a bigger residence or a better locality or both. It may also be to simply book a profit, when the valuations have become attractive.
Vikram was doing the latter. He was getting transferred out on Mumbai, to his hometown – Delhi. He had bought his residential property in a Mumbai suburb, about 6 years back. Now, he is interested in selling it as he plans to settle down in Delhi and he even has a buyer for it. He is seriously considering that, but wanted to know a bit about the tax matters surrounding sale of property. He wanted to know his options.
When a property is sold and the profits are retained, taxes have to be paid. In property transactions, normal income tax does not apply; capital gains taxes apply. For properties sold after 3 years of acquisition, Longterm Capital Gains ( LTCG ) applies. Short term capital gains apply for properties sold less than 36 months after it is bought. Short term capital gains are at the applicable tax rates for an individual. Longterm capital gains are 20% after applying the cost inflation index. Cost inflation index is applied to compensate for the effect of inflation, over time.
He has the option of paying the tax computed after indexation @ 20% and invest in a good instrument and earn good returns. If he invests in Equity Mutual Fund Schemes for instance, he will be able to get good double digit, tax free returns. This is a good option too, as one need not invest in low-yielding propositions, for the sake of saving tax or be forced to invest in another property. But then many people want to save taxes at all costs.
If Vikram does not want to pay tax, he also can invest the gains in Capital Gain bonds ( under Sec 54EC ). These bonds are issued by entities like Rural Electrification Corporation ( REC ), National Housing Boad ( NHB) etc. There is a six month window in which to purchase these bonds. Currently, they yield about 6% and have a lockin period of 3 years. The problem in this case is that though Vikram would be able to save tax by investing in these bonds, he is also potentially losing, as the interest rate on these bonds are low. The income from these bonds are however taxable. Also, the maximum one can invest in a capital gain bond is Rs.50 Lakhs for a Financial year. However, if the transaction has happened after 1st October of the year, then the window flows to the next financial year too allowing one to invest upto Rs.1 Crore.
Vikram has another way of saving tax too. He can buy another property for the value of capital gains. This comes under Section 54 of IT Act. When buying such a property, it can be bought one year prior to the sale or within two years after the sale. In case of construction of property, the time allowed is three years from the date of sale. The capital gains need to be deposited in a Capital Gains Depost Account before the date for filing returns. Any unutlised amount of this capital gain after the stipulated period, will be charged to income tax in the “previous year” at the end of the three year period. So, part utilization is possible too.
Vikram also wants to know if he can sell in Mumbai and buy in Delhi. It is permitted to buy anywhere in the country. There is a bit of ambiguity on whether one can invest the proceeds on one residential property or more than one. From a strict reading of the clauses, it is safe to assume that the proceeds need to be invested in a single residential property.
Now Vikram’s friend Gaurav has another problem. He has sold a commercial property and would like to save on Capital Gains tax. This is possible too under Section 54F of the IT Act. This is applicable for Capital assets, other than a residential property.
There is one major difference as compared to the sale of residential property and the capital gains treatment there on. Here, Gaurav will have to invest the entire proceeds from the sale into a residential property. The time frames for investment remain the same as in the case of sale of residential property. This however will work if he does not own more than one residential house on the date of transfer of the original asset, excluding the one he would purchase to save capital gains tax.
It is now upto Vikram to make up his mind whether he wants to buy a property or pay the tax and invest elsewhere. He has his options open now.
Published in Business Standard on 5/9/2010
Crossed 45 and Panicking...
For many, realization dawns that they need to do something fast to secure their future when they cross 45. What can they do? Read on…
It was when Vatsal comfortably reclined in his easy-chair that it hit him… he was somehow feeling uneasy. When he thought about it, he understood why. The easy-chair brought back memories of his uncle back in his home town, who was having money problems. His uncle was a pensioner – but it was not enough. He was somehow managing with it.
Vatsal was acutely aware of his situation. He has not been a great saver till this point. At 47, it occurred to him that the time is running out. His situation is in stark relief, compared to the position of many of his friends and colleagues. His only asset is his home and some savings in FD, MF, Equity etc., all amounting to about Rs.7.5 Lakhs. His PF accumulation is showing about Rs.11 Lakhs. His only liability is a home loan of Rs.3 Lakhs.
In his case, he has had a load of responsibilities… he had to support his parents, brothers, sisters as his father had retired, even when his children were still studying. That has not given him too much of a chance to save. But Vatsal is determined not to follow his uncle’s footsteps. He does not want to spend his retirement years in penury.
There are many like Vatsal who are on the wrong side of 40 and are panicking now, when they realize that they are but a decade away from retirement and the bank balance is more like a worn out mattress than a feather bed. What do they focus on?
Cover your bases – The first thing to do is to ensure that the family is covered medically… for this is one thing that can make a pauper out of even the well -endowed. A medical insurance cover of at least Rs.5 Lakhs for adults and Rs.3 Lakhs for dependant children is a good idea. Critical illness cover, Hospital cash etc. are good to have bells & whistles.
Is the family security ensured? A family has a lifestyle and future expectations based on a certain amount of income coming in, every month. If suddenly that were to stop, it puts a huge pressure on them. Their cherished goals, suddenly become impossible to meet… reason why, a person needs to take adequate insurance. But how much ? A ball park figure would be about 7 -8 times gross income for someone about 45 years. Add to that any liabilities and subtract insurances already there.
Drive away the retirement blues - Am I sufficiently funded for Retirement is a question that keeps the 45+ awake at night. Suddenly, this has become a looming concern for them. There is a way to estimate and act on this. Project what the expenses will be ( say Rs.6 Lakhs )in the first year of retirement. Multiply that by 12. That ( Rs.72 Lakhs ) should be the corpus at retirement. Now add a 25% buffer for inflation. The corpus needed becomes Rs.90 Lakhs. Assuming that retirement benefits will amount to Rs.20 Lakhs, another Rs.70 Lakhs need to be found. Suppose 13 years of earning life is left, Rs.25,700/- needs to be saved every month to retirement ( this can be done in a spreadsheet or using one of the calculators freely available these days ). So, you can estimate how much is needed for the golden years.
What about other goals ? There may be other goals like Children’s education. In Vatsal’s case, he has a son studying in 1st year Engineering. He needs to fund for the next three years. Estimate is about Rs.4 Lakhs for these three years. He can easily meet this from his savings and surpluses in these years. But if the amounts are huge, the recourse would be to take a loan, draw from PF, save up every month to meet the goal…
Liquidity position – It is a good idea to have atleast three months expenses as liquidity. A portion of this, say 2 months expenses can be in the bank and the rest can be in a ultra short term funds ( to earn a little more ). This can be brought down, if one has access to overdraft, which some banks offer. A good idea would also be opting for sweep in deposits, which bear a higher interest than Savings account. Here money becomes accessible on demand and earns, till that point.
It would be a good idea to provide for any lumpsum payments one has to make – like Insurance premium payments, fees for education, travel etc. According to the time the money is required, it can be invested in debt funds, FDs or other instruments.
Investments – It is important to choose the right places to invest, especially if one has not done too much savings till that point. The good news is that, the last few years can make all the difference in one’s savings for – loans get over in this stage, income is high, expenses related to education comes to an end in this period and lifestyle related expenses moderate. Hence, in the last decade or so, the savings that one can do will be much more than what one has done till that point.
Typically, it is good to invest about 50% of the surplus in Equity / Equity oriented assets. Land / property investments can also be a good idea – but due diligence needs to be done here before investing as all properties do not appreciate to the same extent. Investing in Gold is a hot topic today. Do it to the extent of 5-10 % of the portfolio. In case of debt instruments like FD, bonds, NSC etc., calculate the net return after taxes and decide the place to invest. PPF may be a good idea as it gives 8% tax free returns… could be a good vehicle to plan one’s retirement. So would be the NPS, for funding one’s retirement.
Vatsal was happy that there is a roadmap, a plan which he could follow. He was happier that he would be able to achieve his goals, if he followed this rather simple path. With a decade or more to retirement, things can still be made to work. And that should give solace to the 45 somethings.
Published in Business Standard on 25/8/2010
It was when Vatsal comfortably reclined in his easy-chair that it hit him… he was somehow feeling uneasy. When he thought about it, he understood why. The easy-chair brought back memories of his uncle back in his home town, who was having money problems. His uncle was a pensioner – but it was not enough. He was somehow managing with it.
Vatsal was acutely aware of his situation. He has not been a great saver till this point. At 47, it occurred to him that the time is running out. His situation is in stark relief, compared to the position of many of his friends and colleagues. His only asset is his home and some savings in FD, MF, Equity etc., all amounting to about Rs.7.5 Lakhs. His PF accumulation is showing about Rs.11 Lakhs. His only liability is a home loan of Rs.3 Lakhs.
In his case, he has had a load of responsibilities… he had to support his parents, brothers, sisters as his father had retired, even when his children were still studying. That has not given him too much of a chance to save. But Vatsal is determined not to follow his uncle’s footsteps. He does not want to spend his retirement years in penury.
There are many like Vatsal who are on the wrong side of 40 and are panicking now, when they realize that they are but a decade away from retirement and the bank balance is more like a worn out mattress than a feather bed. What do they focus on?
Cover your bases – The first thing to do is to ensure that the family is covered medically… for this is one thing that can make a pauper out of even the well -endowed. A medical insurance cover of at least Rs.5 Lakhs for adults and Rs.3 Lakhs for dependant children is a good idea. Critical illness cover, Hospital cash etc. are good to have bells & whistles.
Is the family security ensured? A family has a lifestyle and future expectations based on a certain amount of income coming in, every month. If suddenly that were to stop, it puts a huge pressure on them. Their cherished goals, suddenly become impossible to meet… reason why, a person needs to take adequate insurance. But how much ? A ball park figure would be about 7 -8 times gross income for someone about 45 years. Add to that any liabilities and subtract insurances already there.
Drive away the retirement blues - Am I sufficiently funded for Retirement is a question that keeps the 45+ awake at night. Suddenly, this has become a looming concern for them. There is a way to estimate and act on this. Project what the expenses will be ( say Rs.6 Lakhs )in the first year of retirement. Multiply that by 12. That ( Rs.72 Lakhs ) should be the corpus at retirement. Now add a 25% buffer for inflation. The corpus needed becomes Rs.90 Lakhs. Assuming that retirement benefits will amount to Rs.20 Lakhs, another Rs.70 Lakhs need to be found. Suppose 13 years of earning life is left, Rs.25,700/- needs to be saved every month to retirement ( this can be done in a spreadsheet or using one of the calculators freely available these days ). So, you can estimate how much is needed for the golden years.
What about other goals ? There may be other goals like Children’s education. In Vatsal’s case, he has a son studying in 1st year Engineering. He needs to fund for the next three years. Estimate is about Rs.4 Lakhs for these three years. He can easily meet this from his savings and surpluses in these years. But if the amounts are huge, the recourse would be to take a loan, draw from PF, save up every month to meet the goal…
Liquidity position – It is a good idea to have atleast three months expenses as liquidity. A portion of this, say 2 months expenses can be in the bank and the rest can be in a ultra short term funds ( to earn a little more ). This can be brought down, if one has access to overdraft, which some banks offer. A good idea would also be opting for sweep in deposits, which bear a higher interest than Savings account. Here money becomes accessible on demand and earns, till that point.
It would be a good idea to provide for any lumpsum payments one has to make – like Insurance premium payments, fees for education, travel etc. According to the time the money is required, it can be invested in debt funds, FDs or other instruments.
Investments – It is important to choose the right places to invest, especially if one has not done too much savings till that point. The good news is that, the last few years can make all the difference in one’s savings for – loans get over in this stage, income is high, expenses related to education comes to an end in this period and lifestyle related expenses moderate. Hence, in the last decade or so, the savings that one can do will be much more than what one has done till that point.
Typically, it is good to invest about 50% of the surplus in Equity / Equity oriented assets. Land / property investments can also be a good idea – but due diligence needs to be done here before investing as all properties do not appreciate to the same extent. Investing in Gold is a hot topic today. Do it to the extent of 5-10 % of the portfolio. In case of debt instruments like FD, bonds, NSC etc., calculate the net return after taxes and decide the place to invest. PPF may be a good idea as it gives 8% tax free returns… could be a good vehicle to plan one’s retirement. So would be the NPS, for funding one’s retirement.
Vatsal was happy that there is a roadmap, a plan which he could follow. He was happier that he would be able to achieve his goals, if he followed this rather simple path. With a decade or more to retirement, things can still be made to work. And that should give solace to the 45 somethings.
Published in Business Standard on 25/8/2010
25 August, 2010
Soaring twenties...
I have just got my precious wings. I can fly. I’m soaring high and what a thrill it is ! These wings… they allow me to soar, dive, glide, coast… these wings have released me, given me the freedom, helped me measure the world with my flaps…
Rahul was reading a novel where the young eagle who has started doing it’s sorties high up, is feeling the exhilaration of it’s new found skill & the thrills… Rahul could not but help comparing this eagle with his situation. He is young too, foot-loose & fancy free. He is soaring high and is enjoying the freedom in this new city. No one to tell him what to do; no boring books to pore over... The pay packet he gets in his IT company is far more than he could have imagined three years ago. At 24, Rs.32,000/-pm is a lot of money – especially when his parents are still working and are pretty well off, by themselves.
So, he is flapping around and doing a few tricks with his money, without a care in the world. Entertainment, fine dining, excursions & gadgets are currently claiming most of his money. He has heard about investment. Yes. But that’s still a distant thought. He has just about started working. Why not flap around for a few more years before settling into the boring saving routine, is his thought. Give me a life, he tells Vishnu, when he broaches the subject of savings.
There are many Rahuls, who are buoyed by the hot air currents and are gliding comfortably. But there are Vishnus too, who have their share of fun, but have also started to take some interest in their finances.
A bit of this won’t hurt – Vishnu has been telling Rahul to put aside just Rs.3,000/-pm, unsuccessfully. He is doing about Rs.7,000/-pm, since the past year. Not that Vishnu does not enjoy life… he has his fun too. He invests first and then spends the rest. That way, there is no guilt and there is something to fall back on.
But what fallback do you need, Rahul keeps asking. For Vishnu, the crisis of 2008 is still fresh in memory and he was aware of many who lost their jobs then. Rahul & Vishnu were not affected at all… but then the jolt was real. That’s when Vishnu decided to put aside some money for a rainy day. He had heard of some two good funds from his friend’s father and decided to invest in them on a monthly basis. He has accumulated over a lakh by now and feels safe. He is thinking of opening a PPF account, again something he has heard of and wants to get off the blocks. He wants to invest upto Rs.70,000 of the bonus, and spend the rest. He has heard ( correctly )that one can invest upto Rs.70,000/- in a year.
He does not know what his longterm goals are yet, but he may require money while getting married, for buying a home, for setting up an establishment and for his children… He just knows that one requires money and has set the ball rolling.
A safety net to cushion the drop - Vishnu does not again have any dependants. He has heard that life insurance is not needed if there are no dependants. The company is offering medical insurance of Rs.1 Lakh to all employees. Vishnu does not hence see the need for Medical insurance. Rahul however has taken a medical insurance of Rs.3 Lakhs personally, as he feels the insurance from the company is miniscule.
Vishnu does not think so. Rahul is ofcourse tempered by the predicament faced by his cousin, Vipul who is of the same age group. He had to undergo a hernia operation and had to shell out some 60,000/- bucks, as he did not have a medical cover. Rahul then and there decided to take further medical cover – he has heard enough scary stories of people becoming paupers paying hospitals and doctors.
Collision course – Vishnu has also heard of Accident insurance, but never thought much of it. His friend Amol however, is all for it. In fact he has taken a Rs.25 Lakh cover and is covered for death, disability, hospitalization due to an accident etc. Amol believes it is money well spent as he is an avid biker. Vishnu too straddles a Yamaha, but is not convinced. Accidents happen… but not to me, is his favourite line!
Rahul, Vishnu & Amol are going for dinner now. They have made some right moves and have not done some, which they should have. Rahul feels he is soaring like the eagle on his Pulsar… he has grown wings no doubt and is enjoying the freedom, youth and money has conferred on him. He calls them hot currents. Can they learn from each other? They can. Overtime, they will.
Published in moneycontrol.com on 23/8/2010
Rahul was reading a novel where the young eagle who has started doing it’s sorties high up, is feeling the exhilaration of it’s new found skill & the thrills… Rahul could not but help comparing this eagle with his situation. He is young too, foot-loose & fancy free. He is soaring high and is enjoying the freedom in this new city. No one to tell him what to do; no boring books to pore over... The pay packet he gets in his IT company is far more than he could have imagined three years ago. At 24, Rs.32,000/-pm is a lot of money – especially when his parents are still working and are pretty well off, by themselves.
So, he is flapping around and doing a few tricks with his money, without a care in the world. Entertainment, fine dining, excursions & gadgets are currently claiming most of his money. He has heard about investment. Yes. But that’s still a distant thought. He has just about started working. Why not flap around for a few more years before settling into the boring saving routine, is his thought. Give me a life, he tells Vishnu, when he broaches the subject of savings.
There are many Rahuls, who are buoyed by the hot air currents and are gliding comfortably. But there are Vishnus too, who have their share of fun, but have also started to take some interest in their finances.
A bit of this won’t hurt – Vishnu has been telling Rahul to put aside just Rs.3,000/-pm, unsuccessfully. He is doing about Rs.7,000/-pm, since the past year. Not that Vishnu does not enjoy life… he has his fun too. He invests first and then spends the rest. That way, there is no guilt and there is something to fall back on.
But what fallback do you need, Rahul keeps asking. For Vishnu, the crisis of 2008 is still fresh in memory and he was aware of many who lost their jobs then. Rahul & Vishnu were not affected at all… but then the jolt was real. That’s when Vishnu decided to put aside some money for a rainy day. He had heard of some two good funds from his friend’s father and decided to invest in them on a monthly basis. He has accumulated over a lakh by now and feels safe. He is thinking of opening a PPF account, again something he has heard of and wants to get off the blocks. He wants to invest upto Rs.70,000 of the bonus, and spend the rest. He has heard ( correctly )that one can invest upto Rs.70,000/- in a year.
He does not know what his longterm goals are yet, but he may require money while getting married, for buying a home, for setting up an establishment and for his children… He just knows that one requires money and has set the ball rolling.
A safety net to cushion the drop - Vishnu does not again have any dependants. He has heard that life insurance is not needed if there are no dependants. The company is offering medical insurance of Rs.1 Lakh to all employees. Vishnu does not hence see the need for Medical insurance. Rahul however has taken a medical insurance of Rs.3 Lakhs personally, as he feels the insurance from the company is miniscule.
Vishnu does not think so. Rahul is ofcourse tempered by the predicament faced by his cousin, Vipul who is of the same age group. He had to undergo a hernia operation and had to shell out some 60,000/- bucks, as he did not have a medical cover. Rahul then and there decided to take further medical cover – he has heard enough scary stories of people becoming paupers paying hospitals and doctors.
Collision course – Vishnu has also heard of Accident insurance, but never thought much of it. His friend Amol however, is all for it. In fact he has taken a Rs.25 Lakh cover and is covered for death, disability, hospitalization due to an accident etc. Amol believes it is money well spent as he is an avid biker. Vishnu too straddles a Yamaha, but is not convinced. Accidents happen… but not to me, is his favourite line!
Rahul, Vishnu & Amol are going for dinner now. They have made some right moves and have not done some, which they should have. Rahul feels he is soaring like the eagle on his Pulsar… he has grown wings no doubt and is enjoying the freedom, youth and money has conferred on him. He calls them hot currents. Can they learn from each other? They can. Overtime, they will.
Published in moneycontrol.com on 23/8/2010
22 August, 2010
How do I decide if prepaying the home loan is better or investing my surplus is better?
Taking a loan is taboo in India. We have a cultural milieu, which equates living without any debts, as a sign of righteous living. Understandably so. In the past, getting into a loan would have sucked one into a quagmire, as the interest rates charged were usurious. Plus there was a stigma attached to being in debt. You can hold your head high, if you are debt free. That’s the ethos... reason why HDFC Standard Life’s “Sar Utha ke jiyo”, connected so well with people. It was spot on, about being independent and fending off for oneself.
So it’s easy to understand why, when people do take loans ( even home loans ), they want to pay it off at the earliest. Those who take loans are on pins and needles. They do not want the Damocles sword over their head. Even in a benign loan like a home loan, they would rather pay-off, first thing.
Let’s find out if paying off home loans is good and if it is, in what circumstances.
Paying off home loans has to be carefully weighed. It depends on the interest rate being charged, the quantum of loan taken, tenure of the loan, if it is fixed or floating, what percentage of salary is the EMI on the loan etc.
1. One of the most important things to look for is the serviceability issue. Typically, if the home loan EMI is upto 40% of the net income, it is deemed comfortable. The higher the percentage, the worse off it is. It would be a good idea to bring down the home loan to a 40% level. But, if there are other loans where you are paying a higher interest rate, it would be a better idea to pay off those. Paying off an auto loan or a personal loan may be a good idea as the interest does not give you any tax breaks either.
2. There is an equally valid argument for not prepaying a home loan, if you have investment options which will yield higher returns as compared to the home loan. For instance, if the home loan interest rate is 9.75% fixed and there are options where the investor could potentially earn 12%, like Equity Mutual Funds, (s)he could invest the money and retain the loan. Even investment in PPF ( @ 8% post-tax interest ) could be a good idea as the effective home loan interest rate could be less than 8% considering the fact that interest upto Rs.1.5 Lakhs ( under Sec 24(B) ) is deductible against the gross taxable income. In this case, the effective interest rate could be less than 8%, making PPF a good option.
3. A lot depends on the quantum of loan too. If the loan is huge, it may be a good idea to reduce the loan. For instance if a person has taken, say, a Rs.1 Crore loan, it may be a good idea to prepay and bring down the exposure. This argument will hold good even for a high income earner. Let us say, a person has taken a loan of Rs.1 Crore and (s)he is earning Rs.2 Lakhs net income per month, the ballpark home loan may come to under Rs.1 Lakh a month. This may look comfortable.
However, this person is exposed if there is a loss of job or the income reduces in future, for some reason. Even in a situation where (s)he has to go on leave without pay, this EMI may be a millstone around the neck. In such situations, one could consider prepaying even if the home loan EMI is only 40% of the net monthly income. In this instance, 40% would mean an EMI of Rs.80,000/- and a loan of over Rs.80 Lakhs. In this situation, it would be a good idea to prepay if one has the money for reasons explained above.
4. A lot will depend on whether the home loan is a fixed or a floating rate loan. Typically, if it is fixed at a fairly low level, say 10% or less, it may be a good idea to allow the loan to continue and invest any surpluses one may have. Beyond 10%, the effective rate has to be calculated taking into account the tax benefits and then decide whether it makes sense or not. For a floating rate loan, a lot depends on the prognosis for the future and where the loan rate has reached. Suppose the rate is at 12%, it may make sense to start paying up. If interest rates are expected to go up, it will be a trigger to see if prepayment makes sense.
5. For those with variable incomes, like those in business, the risk of a huge loan is pronounced. They should consider prepaying loans, especially if their exposure is very high and the potential fluctuations are expected to be major, irrespective of other factors. Again if the loan has been taken at very attractive levels like say 7.75% fixed for the tenure, they could consider investing elsewhere, which keeps the option to prepay whenever they want.
6. Sometimes, due to interest rate fluctuations, the balance tenure may go beyond ones retirement age. In such situations, prepayment or increasing one’s EMI would be a good idea to bring down the tenure down to the balance working life.
If one has decided to prepay a loan, a good way would be to hike the EMI, where possible. This ensures that the loan gets cleared in an accelerated manner and will work even in cases where lumpsum prepayments are not possible.
Over the years people have started losing their aversion towards loans, which is one of the reasons real estate is booming. But, given a chance people want to repay. They can, after taking into account the various factors discussed here. One need not be paranoid about loans… one just has to be careful.
Published in Business Standard on 22/8/2010
So it’s easy to understand why, when people do take loans ( even home loans ), they want to pay it off at the earliest. Those who take loans are on pins and needles. They do not want the Damocles sword over their head. Even in a benign loan like a home loan, they would rather pay-off, first thing.
Let’s find out if paying off home loans is good and if it is, in what circumstances.
Paying off home loans has to be carefully weighed. It depends on the interest rate being charged, the quantum of loan taken, tenure of the loan, if it is fixed or floating, what percentage of salary is the EMI on the loan etc.
1. One of the most important things to look for is the serviceability issue. Typically, if the home loan EMI is upto 40% of the net income, it is deemed comfortable. The higher the percentage, the worse off it is. It would be a good idea to bring down the home loan to a 40% level. But, if there are other loans where you are paying a higher interest rate, it would be a better idea to pay off those. Paying off an auto loan or a personal loan may be a good idea as the interest does not give you any tax breaks either.
2. There is an equally valid argument for not prepaying a home loan, if you have investment options which will yield higher returns as compared to the home loan. For instance, if the home loan interest rate is 9.75% fixed and there are options where the investor could potentially earn 12%, like Equity Mutual Funds, (s)he could invest the money and retain the loan. Even investment in PPF ( @ 8% post-tax interest ) could be a good idea as the effective home loan interest rate could be less than 8% considering the fact that interest upto Rs.1.5 Lakhs ( under Sec 24(B) ) is deductible against the gross taxable income. In this case, the effective interest rate could be less than 8%, making PPF a good option.
3. A lot depends on the quantum of loan too. If the loan is huge, it may be a good idea to reduce the loan. For instance if a person has taken, say, a Rs.1 Crore loan, it may be a good idea to prepay and bring down the exposure. This argument will hold good even for a high income earner. Let us say, a person has taken a loan of Rs.1 Crore and (s)he is earning Rs.2 Lakhs net income per month, the ballpark home loan may come to under Rs.1 Lakh a month. This may look comfortable.
However, this person is exposed if there is a loss of job or the income reduces in future, for some reason. Even in a situation where (s)he has to go on leave without pay, this EMI may be a millstone around the neck. In such situations, one could consider prepaying even if the home loan EMI is only 40% of the net monthly income. In this instance, 40% would mean an EMI of Rs.80,000/- and a loan of over Rs.80 Lakhs. In this situation, it would be a good idea to prepay if one has the money for reasons explained above.
4. A lot will depend on whether the home loan is a fixed or a floating rate loan. Typically, if it is fixed at a fairly low level, say 10% or less, it may be a good idea to allow the loan to continue and invest any surpluses one may have. Beyond 10%, the effective rate has to be calculated taking into account the tax benefits and then decide whether it makes sense or not. For a floating rate loan, a lot depends on the prognosis for the future and where the loan rate has reached. Suppose the rate is at 12%, it may make sense to start paying up. If interest rates are expected to go up, it will be a trigger to see if prepayment makes sense.
5. For those with variable incomes, like those in business, the risk of a huge loan is pronounced. They should consider prepaying loans, especially if their exposure is very high and the potential fluctuations are expected to be major, irrespective of other factors. Again if the loan has been taken at very attractive levels like say 7.75% fixed for the tenure, they could consider investing elsewhere, which keeps the option to prepay whenever they want.
6. Sometimes, due to interest rate fluctuations, the balance tenure may go beyond ones retirement age. In such situations, prepayment or increasing one’s EMI would be a good idea to bring down the tenure down to the balance working life.
If one has decided to prepay a loan, a good way would be to hike the EMI, where possible. This ensures that the loan gets cleared in an accelerated manner and will work even in cases where lumpsum prepayments are not possible.
Over the years people have started losing their aversion towards loans, which is one of the reasons real estate is booming. But, given a chance people want to repay. They can, after taking into account the various factors discussed here. One need not be paranoid about loans… one just has to be careful.
Published in Business Standard on 22/8/2010
19 August, 2010
Planning for dependants with special needs
When you are given challenges in life, God wants you to meet them and rise higher. We all understand the philosophy… but that does not make taking care of a disabled dependant & planning for their future, any easier.
For families with disabled dependants, the challenge is two-fold. Firstly, see if they can be trained so that they can join the mainstream. This can happen if the individual in question is not mentally affected and the problem is only in terms of lack of vision/ hearing etc. The chances of rehabilitating such a person is much higher than in the case of a person who is deaf & dumb or is mentally ill or afflicted.
Hence, what is required to be done for these two different categories of people , is going to be different.
Planning for the physically challenged - For this category, there are going to be special needs throughout life. For instance, a person with malformed limbs will have to move around in a wheelchair. For this person to travel around, one would have to make a provision for a specially modified vehicle. Lots of these people also travel by public transport these days. Railways has provided a small compartment for them and BEST buses have a couple of seats reserved for them.
Apart from this, there can be a need for special tutoring ( in case the person concerned is blind / deaf, spastics etc. ). There can be a need for attendants, in case the family consists of working couples. Any home they would move into also may require modification depending upon the person’s incapacity.
From the family point of view, they need to plan for the future of such dependants, apart from planning for their own retirement. This is a constant source of worry for the parents/ guardians, of such dependants. They are also constantly worried about the financial future of their wards. Planning for the physically challenged is an easier job. They would understand and be able to manage money. For this category, it is a good idea to build a supplementary stream of income, along the way as their income may/ maynot be sufficient to meet their needs.
How to plan their finances –
1) A good idea in such cases would be build a corpus and ensure that a certain sum of money comes to them regularly. This will ensure that they feel secure and do not have to come to the parents for every need. For instance, a Post Office MIS of Rs.6 Lakhs, will give them Rs.4000/- a month on a consistent basis, which will be in addition to what they are able to earn. The investments can also be in regular dividend paying FDs, MIPs etc.
2) Another idea would be to invest in Equity / MFs ( Dividend payout option ), where (s)he get some payouts, from time to time. This is however not a dependable, regular source.
3) Corpus accumulation for their future can be through PPF, FDs, investments in Equity shares, Mutual Fund units etc.
4) Invest in annuity products for them, which starts when the parent retires. It will be a good idea to start 2-3 annuity plans which vests 3-5 years apart from each other, as the payouts start adding up over time, somewhat nullifying the effect of inflation. For instance, the first annuity of Rs.3,000/-pm starts in 10 years from now, another annuity for another Rs.2000/-pm can start three years from then , partly compensating for inflation. Another one can start in another three years. The idea of staggering is also that the longer the contribution/ vesting time, the bigger will be the compounding effect and higher the payouts.
5) Invest in special Life Insurance products like Jeevan Aadhar/ Vishwas , which has the option of receiving a portion of the corpus as a pension, when the parent is no more.
Planning for the mentally challenged - This is far more tricky as the dependant would not be in a position to manage the money and is truly dependant for their every need. In this case, corpus accumulation that will last the entire lifetime of the dependant, is an important goal as the possibility of the dependant earning a living is not really there. The products invested in should be fairly simple to manage & administer. Even if the parents are not around, it should be easy for someone else to understand and manage.
Planning the Finances - For this category it could be through annuities or other regular income products, which could be useful especially after the parent’s lifetime. These are recommended as these require the least intervention. Also, trusts can be formed for such dependants, with a close relative/ friend administering it , for the benefit of the dependant. The other option is to admit such dependants in such institutions which will take good care of them, for life. A onetime lumpsum amount or a lumpsum plus a monthly payment needs to be made to such institutions, for this purpose. For-profit and non-profit organizations are operating in this space. A suitable organization can be chosen, according to requirements.
Tax benefits : There are some income tax benefits to give relief to those with handicapped dependants. Rs.50000/- deduction is available for expenditure incurred on a handicapped dependant relative, including payment to specified schemes for their maintenance. If the dependants have severe disability ( blindness, mental retardation etc. ), the deduction allowed would be Rs.1 Lakh. This comes under Sec 80DD.
Published in Business Standard on 15/8/2010
For families with disabled dependants, the challenge is two-fold. Firstly, see if they can be trained so that they can join the mainstream. This can happen if the individual in question is not mentally affected and the problem is only in terms of lack of vision/ hearing etc. The chances of rehabilitating such a person is much higher than in the case of a person who is deaf & dumb or is mentally ill or afflicted.
Hence, what is required to be done for these two different categories of people , is going to be different.
Planning for the physically challenged - For this category, there are going to be special needs throughout life. For instance, a person with malformed limbs will have to move around in a wheelchair. For this person to travel around, one would have to make a provision for a specially modified vehicle. Lots of these people also travel by public transport these days. Railways has provided a small compartment for them and BEST buses have a couple of seats reserved for them.
Apart from this, there can be a need for special tutoring ( in case the person concerned is blind / deaf, spastics etc. ). There can be a need for attendants, in case the family consists of working couples. Any home they would move into also may require modification depending upon the person’s incapacity.
From the family point of view, they need to plan for the future of such dependants, apart from planning for their own retirement. This is a constant source of worry for the parents/ guardians, of such dependants. They are also constantly worried about the financial future of their wards. Planning for the physically challenged is an easier job. They would understand and be able to manage money. For this category, it is a good idea to build a supplementary stream of income, along the way as their income may/ maynot be sufficient to meet their needs.
How to plan their finances –
1) A good idea in such cases would be build a corpus and ensure that a certain sum of money comes to them regularly. This will ensure that they feel secure and do not have to come to the parents for every need. For instance, a Post Office MIS of Rs.6 Lakhs, will give them Rs.4000/- a month on a consistent basis, which will be in addition to what they are able to earn. The investments can also be in regular dividend paying FDs, MIPs etc.
2) Another idea would be to invest in Equity / MFs ( Dividend payout option ), where (s)he get some payouts, from time to time. This is however not a dependable, regular source.
3) Corpus accumulation for their future can be through PPF, FDs, investments in Equity shares, Mutual Fund units etc.
4) Invest in annuity products for them, which starts when the parent retires. It will be a good idea to start 2-3 annuity plans which vests 3-5 years apart from each other, as the payouts start adding up over time, somewhat nullifying the effect of inflation. For instance, the first annuity of Rs.3,000/-pm starts in 10 years from now, another annuity for another Rs.2000/-pm can start three years from then , partly compensating for inflation. Another one can start in another three years. The idea of staggering is also that the longer the contribution/ vesting time, the bigger will be the compounding effect and higher the payouts.
5) Invest in special Life Insurance products like Jeevan Aadhar/ Vishwas , which has the option of receiving a portion of the corpus as a pension, when the parent is no more.
Planning for the mentally challenged - This is far more tricky as the dependant would not be in a position to manage the money and is truly dependant for their every need. In this case, corpus accumulation that will last the entire lifetime of the dependant, is an important goal as the possibility of the dependant earning a living is not really there. The products invested in should be fairly simple to manage & administer. Even if the parents are not around, it should be easy for someone else to understand and manage.
Planning the Finances - For this category it could be through annuities or other regular income products, which could be useful especially after the parent’s lifetime. These are recommended as these require the least intervention. Also, trusts can be formed for such dependants, with a close relative/ friend administering it , for the benefit of the dependant. The other option is to admit such dependants in such institutions which will take good care of them, for life. A onetime lumpsum amount or a lumpsum plus a monthly payment needs to be made to such institutions, for this purpose. For-profit and non-profit organizations are operating in this space. A suitable organization can be chosen, according to requirements.
Tax benefits : There are some income tax benefits to give relief to those with handicapped dependants. Rs.50000/- deduction is available for expenditure incurred on a handicapped dependant relative, including payment to specified schemes for their maintenance. If the dependants have severe disability ( blindness, mental retardation etc. ), the deduction allowed would be Rs.1 Lakh. This comes under Sec 80DD.
Published in Business Standard on 15/8/2010
Investment does not always work like in textbooks
Wisdom, they say, comes out of experience. But is the same wisdom applicable to you as well? Sometimes, it may. But there is no thumb rule that it will always do. For instance, John Bogle’s famous book ‘Common Sense on Mutual Funds’ has argued that over time, index funds will always outperform actively-managed mutual funds. And while this can work consistently in a more developed market such as the US, results in the Indian market may not be that convincing
If we look at investment wisdom as handed down by the gurus, there is a gap between what one could expect and what actually happens.
Invest for keeps - The Sage of Omaha – Warren Buffett, is a great believer of investing for the long-term. In fact, he says, if it is a really good investment and works, he advocates investment for ever. He has quoted Coca-Cola as an example, where he has kept his investments for decades.
This does not always work. Many companies, which are in a commanding position at one point, do not remain there forever. Changes like technological developments can undermine a company’s market position ( Kodak, Xerox ), may reach the end of the product cycle and mature.
There are companies that are able to emerge winners and there are those who fall by the wayside. NOCIL, ORKAY, Nirlon, Dunlop were bluechips of yester years; but fell by the wayside for a number of reasons. So, if one were invested in them and just continued to hold, it would have resulted in value erosion. What Buffett said will work in some cases, not universally. You will constantly need to keep evaluating, if such stocks should have a place in your portfolio.
Index investing is the best bet - This is a truism that has worked only partially in India. This has been substantially true in the US. Even factoring the higher expenses, actively managed funds do offer higher returns over index. For instance, the average returns of all large-cap diversified beat the index, in one, two, three-year performances. Only five-year performance, the index had done better than the average performance of all the large-cap diversified funds. Now, ten year returns for Sensex & NIFTY are 15.79% & 15.21% respectivey. The average for all diversified equity funds is 22.03%. If you look at the top performers like HDFC Top 200 Fund, Reliance Vision Fund, they are all at 30%. That’s almost double of what the index offers!
What index investing, however, does for the investors here is to do away with the fund picking acumen of the fund manager and lower the cost of managing such a fund. But should it be the only part of your portfolio, I doubt it.
Timing it to a nicety – How we wish, we entered and exited the market, always at the right time. And technical chartists would have us do just that. Every day, television channels and newspapers have chartists telling investors ‘buy, sell or hold’. The only problem: Future is projected on the basis of past data. True, it will work sometimes. But not always. For retail investors, it’s a completely unreliable tool.
No wonder, even the Securities and Exchange Board of India asks mutual funds to say – Past performance is not a reflection of future performance – in their advertisements.
On a lighter note, as Fred Schwed writes in his investment classic ‘Where are the Customer’s Yachts?’ – “In our moments of sober thought we all realise that booms are bad things, not good. But nearly all of us have a secret hankering for another one. Another little orgy wouldn't do us any harm, would it? This is quite human, because in the last boom we acted so silly. If we are old enough, we probably acted silly in the last three. We either got in too late, or out too late, or both. But now that we are experienced, just give us one more shot at a good reliable, runaway boom.” Only problem – there is nothing called a good, runaway yet reliable boom that one can enter and exit, exactly at the right time.
Value investing principle – Another commonly-touted idea. The problem is in the term ‘Value’ itself. Value lies in the eyes of the beholder. At the height of the dot-com boom, companies with price-earnings (P/E) multiples of even 200, found takers. So any stock that would have quoted at 75 P/E would have been seen as a true value proposition. It is also very dependent on the industry in which the company operates, as well as their growth potential. Also, value could be derived from replacement value (as popularised by Harshad Mehta ), Book value to price principle, price-earning to growth ratio etc. Value can also be a by product of softer aspects like brand salience (Apple, Sony), quality of management (GE, HUL), innovation (Apple, 3M). That’s precisely why a lay investor is not able to get it right.
Catch them young and watch them grow – We all want to invest in the next Reliance Industries or Infosys, right? The place to look for are the sunrise sectors and good companies there. But identifying the future sunrise sector is fraught with danger. Does bio-informatics qualify for a sunrise sector? It probably does, because it is an emerging area. So does, clean energy technologies, nano technology, contract research and manufacturing in pharma, genetic engineering etc. But, even companies in far more low tech areas may be sunrise sectors too - agriculture and agro-based industries, water based industries, environment management based industries etc. Now, identifying the sectors of the future correctly, is a challenge by itself. Then putting money in the right company is even more of a challenge – as many of them would be unlisted companies and too much information about them would not be available in public domain. That is why, these companies have a fair ownership by venture capitalists, private equity investors and others, who are savvy and who will be able to invest in early stages. There may be very few in public domain and they could be expensive.
Hence, a lot of what the analysts and gurus say, cannot that easily be replicated by a regular investor. While, there is no denying that gurus have been able to do it, the normal investor still finds them a challenge. Remember, there is an important difference: Investing is a full-time profession for gurus and analysts, it’s not the same for you. For you, there needs to be an investing strategy that is consistent with your risk-appetite, time horizon and so on. Keep it simple.
Published in Business Standard on 8 August, 2010
If we look at investment wisdom as handed down by the gurus, there is a gap between what one could expect and what actually happens.
Invest for keeps - The Sage of Omaha – Warren Buffett, is a great believer of investing for the long-term. In fact, he says, if it is a really good investment and works, he advocates investment for ever. He has quoted Coca-Cola as an example, where he has kept his investments for decades.
This does not always work. Many companies, which are in a commanding position at one point, do not remain there forever. Changes like technological developments can undermine a company’s market position ( Kodak, Xerox ), may reach the end of the product cycle and mature.
There are companies that are able to emerge winners and there are those who fall by the wayside. NOCIL, ORKAY, Nirlon, Dunlop were bluechips of yester years; but fell by the wayside for a number of reasons. So, if one were invested in them and just continued to hold, it would have resulted in value erosion. What Buffett said will work in some cases, not universally. You will constantly need to keep evaluating, if such stocks should have a place in your portfolio.
Index investing is the best bet - This is a truism that has worked only partially in India. This has been substantially true in the US. Even factoring the higher expenses, actively managed funds do offer higher returns over index. For instance, the average returns of all large-cap diversified beat the index, in one, two, three-year performances. Only five-year performance, the index had done better than the average performance of all the large-cap diversified funds. Now, ten year returns for Sensex & NIFTY are 15.79% & 15.21% respectivey. The average for all diversified equity funds is 22.03%. If you look at the top performers like HDFC Top 200 Fund, Reliance Vision Fund, they are all at 30%. That’s almost double of what the index offers!
What index investing, however, does for the investors here is to do away with the fund picking acumen of the fund manager and lower the cost of managing such a fund. But should it be the only part of your portfolio, I doubt it.
Timing it to a nicety – How we wish, we entered and exited the market, always at the right time. And technical chartists would have us do just that. Every day, television channels and newspapers have chartists telling investors ‘buy, sell or hold’. The only problem: Future is projected on the basis of past data. True, it will work sometimes. But not always. For retail investors, it’s a completely unreliable tool.
No wonder, even the Securities and Exchange Board of India asks mutual funds to say – Past performance is not a reflection of future performance – in their advertisements.
On a lighter note, as Fred Schwed writes in his investment classic ‘Where are the Customer’s Yachts?’ – “In our moments of sober thought we all realise that booms are bad things, not good. But nearly all of us have a secret hankering for another one. Another little orgy wouldn't do us any harm, would it? This is quite human, because in the last boom we acted so silly. If we are old enough, we probably acted silly in the last three. We either got in too late, or out too late, or both. But now that we are experienced, just give us one more shot at a good reliable, runaway boom.” Only problem – there is nothing called a good, runaway yet reliable boom that one can enter and exit, exactly at the right time.
Value investing principle – Another commonly-touted idea. The problem is in the term ‘Value’ itself. Value lies in the eyes of the beholder. At the height of the dot-com boom, companies with price-earnings (P/E) multiples of even 200, found takers. So any stock that would have quoted at 75 P/E would have been seen as a true value proposition. It is also very dependent on the industry in which the company operates, as well as their growth potential. Also, value could be derived from replacement value (as popularised by Harshad Mehta ), Book value to price principle, price-earning to growth ratio etc. Value can also be a by product of softer aspects like brand salience (Apple, Sony), quality of management (GE, HUL), innovation (Apple, 3M). That’s precisely why a lay investor is not able to get it right.
Catch them young and watch them grow – We all want to invest in the next Reliance Industries or Infosys, right? The place to look for are the sunrise sectors and good companies there. But identifying the future sunrise sector is fraught with danger. Does bio-informatics qualify for a sunrise sector? It probably does, because it is an emerging area. So does, clean energy technologies, nano technology, contract research and manufacturing in pharma, genetic engineering etc. But, even companies in far more low tech areas may be sunrise sectors too - agriculture and agro-based industries, water based industries, environment management based industries etc. Now, identifying the sectors of the future correctly, is a challenge by itself. Then putting money in the right company is even more of a challenge – as many of them would be unlisted companies and too much information about them would not be available in public domain. That is why, these companies have a fair ownership by venture capitalists, private equity investors and others, who are savvy and who will be able to invest in early stages. There may be very few in public domain and they could be expensive.
Hence, a lot of what the analysts and gurus say, cannot that easily be replicated by a regular investor. While, there is no denying that gurus have been able to do it, the normal investor still finds them a challenge. Remember, there is an important difference: Investing is a full-time profession for gurus and analysts, it’s not the same for you. For you, there needs to be an investing strategy that is consistent with your risk-appetite, time horizon and so on. Keep it simple.
Published in Business Standard on 8 August, 2010
06 August, 2010
Cashless Hospitalisation withdrawal by PSU insurers...
There was this furore over the withdrawal of cashless settlements, in case of Medical insurance polices by PSU insurers. Newspaper & Magazine headlines screamed sensationally - “ take cash with you, even if you are cashless”.
The root problem has been around for long. Only that, it has now boiled over. Medical Insurance is an area where insurers have been making losses. Overcharging by hospitals and doctors & various frauds, has been prevalent, in those cases who have medical insurance.
Finally, PSU insurers pulled the plug and withdrew cashless settlement in all, but a selected list of Preferred Provider Network (PPN). This was met with howls of protest. FICCI came out strongly that the insurers cannot unilaterally withdraw something they have promised to their policyholders. Hospitals understandably protested. Policy holders got worried about this sudden turn of events.
Many policy holders were serenaded with offers from private insurers, who made a virtue of the fact that Cashless settlement are still available through them, across the board. I have been fielding queries from people who want to know if they should go to private insurers, due to the cashless option being available across the board, in their case. I have been counseling them not to take hasty decisions, as 1) what has happened with PSU insurers can happen with private insurers as well, because the overbilling problem is faced by both 2) PSU insurers may soon negotiate with all major hospitals and bring them back on board – it’s just a matter of time. PSU insurer’s premiums have generally tended to be lower and that is in the interest of the policyholder.
Policyholders have traditionally turned a blind eye to charges, as long as they could be covered by the policy. This is a serious mistake ethically and even in their interest. If there is overcharging, the balance amount in the Sum Assured available for claims in the year, reduces; also, premium can go up more due to the higher claims. It is in the interest of the policy holders to look out for padding in the charges. We all have access to someone in the medical field. We can ask around and find out, how much a particular procedure could cost. One would atleast get a ballpark figure, that way. Ideally, if it is not an emergency, find out in advance what the hospitals and doctors would charge for the particular treatment. If you have done this exercise properly, you could save a packet. Knowledge is power. The charges can be brought down, using these as bargaining chips. I know people who have done it.
Another odious practice is the principle of charging everything based on the class of room, one is admitted in. For instance, a person from general ward is charged less for the same procedure by the same doctor, in the same operation theatre, with the same facilities as compared to another from a Deluxe room. There is no logic here – it is just that those in deluxe room can afford to pay more. This is the system that has gained root and has been followed without questions. This is a matter the health ministry needs to address. Loot the rich ( or relatively better off ), seems to be the motto... Our government does that too - for paying taxes, you don’t get anything in return, except for the “possibility” of good governance, which is marked by it’s absence. For now, if you want to pay less choose the lower level room or general ward.
Insurance companies need to address it by negotiating with various hospitals, which they will, as it is a matter of survival. It is ironical that insurance companies are overcharged by hospitals, when they give them so much business. If anything, they should be given volume discounts. There is a saying which goes – the child that cries will get the milk. The insurance companies have only now started… hospitals & doctors will have to fall in line… or lose business to others who are sensible enough to see reason.
Published in Moneycontrol.com on 4/8/2010
The root problem has been around for long. Only that, it has now boiled over. Medical Insurance is an area where insurers have been making losses. Overcharging by hospitals and doctors & various frauds, has been prevalent, in those cases who have medical insurance.
Finally, PSU insurers pulled the plug and withdrew cashless settlement in all, but a selected list of Preferred Provider Network (PPN). This was met with howls of protest. FICCI came out strongly that the insurers cannot unilaterally withdraw something they have promised to their policyholders. Hospitals understandably protested. Policy holders got worried about this sudden turn of events.
Many policy holders were serenaded with offers from private insurers, who made a virtue of the fact that Cashless settlement are still available through them, across the board. I have been fielding queries from people who want to know if they should go to private insurers, due to the cashless option being available across the board, in their case. I have been counseling them not to take hasty decisions, as 1) what has happened with PSU insurers can happen with private insurers as well, because the overbilling problem is faced by both 2) PSU insurers may soon negotiate with all major hospitals and bring them back on board – it’s just a matter of time. PSU insurer’s premiums have generally tended to be lower and that is in the interest of the policyholder.
Policyholders have traditionally turned a blind eye to charges, as long as they could be covered by the policy. This is a serious mistake ethically and even in their interest. If there is overcharging, the balance amount in the Sum Assured available for claims in the year, reduces; also, premium can go up more due to the higher claims. It is in the interest of the policy holders to look out for padding in the charges. We all have access to someone in the medical field. We can ask around and find out, how much a particular procedure could cost. One would atleast get a ballpark figure, that way. Ideally, if it is not an emergency, find out in advance what the hospitals and doctors would charge for the particular treatment. If you have done this exercise properly, you could save a packet. Knowledge is power. The charges can be brought down, using these as bargaining chips. I know people who have done it.
Another odious practice is the principle of charging everything based on the class of room, one is admitted in. For instance, a person from general ward is charged less for the same procedure by the same doctor, in the same operation theatre, with the same facilities as compared to another from a Deluxe room. There is no logic here – it is just that those in deluxe room can afford to pay more. This is the system that has gained root and has been followed without questions. This is a matter the health ministry needs to address. Loot the rich ( or relatively better off ), seems to be the motto... Our government does that too - for paying taxes, you don’t get anything in return, except for the “possibility” of good governance, which is marked by it’s absence. For now, if you want to pay less choose the lower level room or general ward.
Insurance companies need to address it by negotiating with various hospitals, which they will, as it is a matter of survival. It is ironical that insurance companies are overcharged by hospitals, when they give them so much business. If anything, they should be given volume discounts. There is a saying which goes – the child that cries will get the milk. The insurance companies have only now started… hospitals & doctors will have to fall in line… or lose business to others who are sensible enough to see reason.
Published in Moneycontrol.com on 4/8/2010
Cashless settlement withdrawal & issues surrounding it
Would you like if a shopkeeper offers you a product at one price and the next buyer at a 50% discount? Well… no one likes it. But this practice happens in a few industries. Airlines & hospitals are prime examples. An airline seat on which you may be sitting may have been sold on one price and your co-passenger may have bought it at maybe half the price. Airlines justify on the basis of the fact that this passenger booked in advance and hence got a special price.
Now, look at hospitals... If you are admitted in a hospital and an operation needs to be performed, the price varies depending on which ward you are admitted in. If you are from the general ward, you pay a lower amount for an operation and you pay a much higher amount if you happen to be from a deluxe room. The charges can be substantially higher. This, inspite of the fact that the doctor, operation theatre etc. are all the same. This unsavory practice has been there for a very longtime and doctors bristle when someone even question this. Robbing the rich ( or the relatively well-off ) is an art perfected since the days of Robinhood… and this has got entrenched so much that it is an accepted practice & cannot even be questioned!
Now, the second problem… Many hospitals have ostensibly been charging a high amount if a patient has insurance and entirely a different ( and lower ) amount, if they don’t. This has been one of the worst kept secrets and has been bleeding the insurance companies. It’s ironical that insurance companies are charged higher rates… they should actually be charged lower rates and get quantity discount, as they provide huge business to various hospitals. After bleeding for a longtime, PSU insurers have decided to stop cashless settlement in all, but a select list of Preferred Provider Network ( PPN ), where cashless will be applicable. Private insurers are still having cashless facility.
There are several questions in the mind of the consumer.
Do I now go to the private insurers now – They are offering cashless settlement across hospitals today, as against the PSU insurers – granted. This alone cannot be a determinant. Today it is PSU insurers. Tomorrow, it can be private insurers. PSU insurers have got affected most in this, as their premiums have been comparatively less. Some hospitals accuse the insurers of not having ailment based cover and having just a value based cover, due to which insured goes for expensive treatments… Some hospitals claim that charges can vary from hospital to hospital, based on facilities available. But the issue is that hospitals have different tariffs for those having insurance and those without.
Insurers need to fix up specific and low tariff rates with hospitals, like CGHS has done with various hospitals. In future, most people would have insurance cover and business from insurance companies will become, bigger & bigger for hospitals. Hence, they should provide volume discounts like it happens in every business.
Ignore inflated bills at your peril - Another problem noticed with patients who have insurance is that they do not bother much, as long as the bill gets settled in a cashless manner. Inflated claims by hospitals reduces the residual cover available for the year. Also, inflated claims result in more extra premium charged, in the next year. Signing the bills without checking will also expose the insured to allegations of fraudulent claims, if some procedure was not done and claimed for. These things are happening today. It is in one’s own interest to ensure that excessive or fraudulent claims are not made. The insured can take the help of the medical professionals in an insurance company or could get the same checked by an external medical professional, before signing papers, put before them. They should resist any attempts by doctors or hospitals into pressuring them to sign on the dotted line.
Keep some cash… Till the dust settles down, it would be a good idea to pay the bills and get reimbursed later. That way the bills will be more in line with the services availed. Also, it is a good idea to find out in advance, the rates for procedures & fees of doctors, fix it up and then only go ahead. In all cases, except emergency cases, this should be possible. This can help you get a fix on how much it would cost and be ready with the finances.
Be flexible - Lots of people are attached to their doctors… and doctors recommend certain hospitals. It will be a good idea to be flexible and be willing to move to a different doctor or hospital, if you know your current preferred doctor/ hospital is over-charging. There is nothing better than a bit of competition – get quotes from different doctors & hospitals. You will be able to save quite a packet by just asking around.
Best thing one could do today is to ensure good health by a combination of exercise, good working habits, healthy eating habits, avoiding/ cutting down on smoking/ drinking etc. Health is wealth. An apple a day keeps the doctor away. Eat apples – that’s the best finance tip you can get today!
Published in DNA Money on 6/8/2010
Now, look at hospitals... If you are admitted in a hospital and an operation needs to be performed, the price varies depending on which ward you are admitted in. If you are from the general ward, you pay a lower amount for an operation and you pay a much higher amount if you happen to be from a deluxe room. The charges can be substantially higher. This, inspite of the fact that the doctor, operation theatre etc. are all the same. This unsavory practice has been there for a very longtime and doctors bristle when someone even question this. Robbing the rich ( or the relatively well-off ) is an art perfected since the days of Robinhood… and this has got entrenched so much that it is an accepted practice & cannot even be questioned!
Now, the second problem… Many hospitals have ostensibly been charging a high amount if a patient has insurance and entirely a different ( and lower ) amount, if they don’t. This has been one of the worst kept secrets and has been bleeding the insurance companies. It’s ironical that insurance companies are charged higher rates… they should actually be charged lower rates and get quantity discount, as they provide huge business to various hospitals. After bleeding for a longtime, PSU insurers have decided to stop cashless settlement in all, but a select list of Preferred Provider Network ( PPN ), where cashless will be applicable. Private insurers are still having cashless facility.
There are several questions in the mind of the consumer.
Do I now go to the private insurers now – They are offering cashless settlement across hospitals today, as against the PSU insurers – granted. This alone cannot be a determinant. Today it is PSU insurers. Tomorrow, it can be private insurers. PSU insurers have got affected most in this, as their premiums have been comparatively less. Some hospitals accuse the insurers of not having ailment based cover and having just a value based cover, due to which insured goes for expensive treatments… Some hospitals claim that charges can vary from hospital to hospital, based on facilities available. But the issue is that hospitals have different tariffs for those having insurance and those without.
Insurers need to fix up specific and low tariff rates with hospitals, like CGHS has done with various hospitals. In future, most people would have insurance cover and business from insurance companies will become, bigger & bigger for hospitals. Hence, they should provide volume discounts like it happens in every business.
Ignore inflated bills at your peril - Another problem noticed with patients who have insurance is that they do not bother much, as long as the bill gets settled in a cashless manner. Inflated claims by hospitals reduces the residual cover available for the year. Also, inflated claims result in more extra premium charged, in the next year. Signing the bills without checking will also expose the insured to allegations of fraudulent claims, if some procedure was not done and claimed for. These things are happening today. It is in one’s own interest to ensure that excessive or fraudulent claims are not made. The insured can take the help of the medical professionals in an insurance company or could get the same checked by an external medical professional, before signing papers, put before them. They should resist any attempts by doctors or hospitals into pressuring them to sign on the dotted line.
Keep some cash… Till the dust settles down, it would be a good idea to pay the bills and get reimbursed later. That way the bills will be more in line with the services availed. Also, it is a good idea to find out in advance, the rates for procedures & fees of doctors, fix it up and then only go ahead. In all cases, except emergency cases, this should be possible. This can help you get a fix on how much it would cost and be ready with the finances.
Be flexible - Lots of people are attached to their doctors… and doctors recommend certain hospitals. It will be a good idea to be flexible and be willing to move to a different doctor or hospital, if you know your current preferred doctor/ hospital is over-charging. There is nothing better than a bit of competition – get quotes from different doctors & hospitals. You will be able to save quite a packet by just asking around.
Best thing one could do today is to ensure good health by a combination of exercise, good working habits, healthy eating habits, avoiding/ cutting down on smoking/ drinking etc. Health is wealth. An apple a day keeps the doctor away. Eat apples – that’s the best finance tip you can get today!
Published in DNA Money on 6/8/2010
02 August, 2010
Are you buying insurance? Be aware of these…
Insurance Salesmen have been master sellers – that’s an acknowledged fact. They have been selling an intangible product quite successfully for decades, after broaching a subject the customer does not want to hear – death. While their legerdemain is appreciated, they also have their fair share of detractors. They tend to stick on like limpets and keep following up for many moons. Customers take these in their stride. Problems arise when misselling/ misrepresentation & sales spiels, bordering on lies or worse still actual lies are used while engaging with clients.
Customers need to be careful here and need to understand when they are being taken for a spin in a buggy. Here are some tricks you will readily recognize and some that are clearly new.
1. You just sign here, we’ll fill the rest – To start with, this is not really a trick. Many well-meaning insurance agents genuinely want to make the process simple, for their customers. The trouble starts when the agent fills in even the medical related information and mentions that the client is in perfect health. For small Sum Assured, the policy will also get issued based on the declaration of good health. So, if the client has some problems which are not mentioned in the form, it then can cause problems later on. Lesson – fill the form accurately, yourself.
2. The churn that earns ( for them ) – Agents are chasing business all the time. There is always the urge to harvest business from existing customers. But existing clients may not always have money to invest in new business. That’s when some agents resort to the churn game. They urge customers to surrender an existing product ( read ULIP ) and invest in another ( again ULIP ). Insurance products have a front loaded charge structure, customers pay the charges all over again and the agents enjoy their commissions. Lesson – Clarify for yourselves, if you need to cancel your policy at all… and if you need to get into another similar policy.
3. First two ( monthly ) premiums will be paid… – This is a magic word insurance agents use to “soften” their clients. The lure of something free is too hard to resist that customers sign up after putting up just a token resistance. Tax savings is another masterkey used along with the first lure to sign up clients. Lesson – Look at the gift horse, in it’s mouth… examine the product you are getting into. You will still have to pay the rest of the premiums.
4. You get fantastic returns; insurance is a bonus – ULIPs have given good returns over longer tenures… as has equity / MF Schemes. Insurance agents hype up the product and position insurance as a kind of a freebie. Fact is that, you will have to pay for your insurance. ULIP returns does not include any charges. If charges are factored in, the returns will be far less alluring, especially in the initial years. Lesson – Don’t get carried away by returns alone; factor in the charges and then see if it makes sense.
5. The product is getting discontinued – Customers keep listening to this at regular intervals. Just before the end of June, the agents were urging their customers to take the policy ( pension plans ) before insurance becomes mandatory! Now, agents are telling their clients to go for a policy before 1st September, 2010 as then there will be a five year lock-in period. What they do not tell them is that the charges will be much lower in the new products and surrender will be possible, even after a year, at 12.5 -15% charges ( which keep going down ). Lesson – Find out the correct situation before putting in your money.
6. Take this on your child / wife - If they find that the earning member cannot be insured, agents typically suggest that the insurance policy be taken on the spouse / child. They also justify saying that the premiums could be lower for child / spouse! But the point is, the earning member is the one who should be insured. No point insuring the spouse and child. It is a waste of money as the insurance premium paid, however small, serves no useful purpose. Lesson – If you are looking for investment only, don’t succumb to such sales pitches.
7. Sovereign guarantee – LIC agents have been using this. Guarantee in a traditional product is only for the Sum Assured. Every insurance company ( including private players ) guarantees the payout of the Sum Assured. It is only the bonus payout that is not guaranteed. For ULIPs, this anyway does not apply. Lesson – This is just much ado about nothing.
8. LIC will be around; it has government support – I do not know where this is coming from. Being around for 50 years does not guarantee that the company will be there for the next 50 years. If being big is an advantage, AIG did not find any. If being a government company is an advantage, ask the customers of erstwhile UTI and how much they lost when it unraveled. UTI, IDBI, ICICI – all government owned companies then - had various kinds of bonds and other assured return products. They withdrew midway leaving those who have invested in their schemes, in the lurch. Where was the government support there? Lesson – It’s pure apple sauce to think that a Government supported entity alone will survive or their products come with some special assurance that is not there in others.
9. The art of packaging – There are very cleverly packaged schemes , attractively named like Jeevan Arundhati, Jeevan Kuber or something like these, which are nothing but several LIC products put together. These are not LIC plans. They are conjured-up plans by putting together a few insurance products of LIC . Also, interestingly, the payouts which come in at various points are assumed to be invested in NSC, PPF, RBI Bonds etc. Also, they take the income-tax 80C advantages , which most people anyway have exhausted in other ways. Then they calculate the returns and inform you that this amazing product will return 8 or 8.5%!. Don’t be misled by this. The higher returns are because of these other products, income tax savings assumptions & not through the insurance that you are buying. Lesson – Find out what you are getting into. Clearly understand the product before signing up.
10. Returns as high as 30% - IRDA mandates that benefit illustrations show a return using 6% & 10%. But this is followed in the breach. You will find fancy illustrations, assuming 16%, 24%, 30%... If confronted, they explain that it is to give the customer an “realistic picture” as to what they will get if the returns are such and such! I thought IRDA came up with it’s diktat, to precisely to stop conning clients, luring them with the promise of fancy returns. You would have thought some low level agents do it. No. Many high level banks do it. The most recent one I came across is from a private bank that people would like to trust because they are “conservative”. Lesson - Anything that looks too good to be true is probably not. Beware!
As a customer, a basic level of Financial Awareness and literacy would be absolutely essential. Reading up, visiting appropriate sites, starting to read the brochures that you have till now junked without a second look, will help. If all this is beyond your ken, take the help of a genuine investment consultant or Financial Planner. Anyone can sport these tags today and finding a genuine consultant is again a challenge. That is why, people just go to their banks to renew their FDs, instead of worrying about complex financial products. But when they do go to the banks, they get sold insurance, MF schemes and lots of others they cannot even articulate. That brings them to square one. A bit like snakes and ladders, what?!
A version of this was published under the title "Come into my parlour" in August 2010 edition in Money Today
Customers need to be careful here and need to understand when they are being taken for a spin in a buggy. Here are some tricks you will readily recognize and some that are clearly new.
1. You just sign here, we’ll fill the rest – To start with, this is not really a trick. Many well-meaning insurance agents genuinely want to make the process simple, for their customers. The trouble starts when the agent fills in even the medical related information and mentions that the client is in perfect health. For small Sum Assured, the policy will also get issued based on the declaration of good health. So, if the client has some problems which are not mentioned in the form, it then can cause problems later on. Lesson – fill the form accurately, yourself.
2. The churn that earns ( for them ) – Agents are chasing business all the time. There is always the urge to harvest business from existing customers. But existing clients may not always have money to invest in new business. That’s when some agents resort to the churn game. They urge customers to surrender an existing product ( read ULIP ) and invest in another ( again ULIP ). Insurance products have a front loaded charge structure, customers pay the charges all over again and the agents enjoy their commissions. Lesson – Clarify for yourselves, if you need to cancel your policy at all… and if you need to get into another similar policy.
3. First two ( monthly ) premiums will be paid… – This is a magic word insurance agents use to “soften” their clients. The lure of something free is too hard to resist that customers sign up after putting up just a token resistance. Tax savings is another masterkey used along with the first lure to sign up clients. Lesson – Look at the gift horse, in it’s mouth… examine the product you are getting into. You will still have to pay the rest of the premiums.
4. You get fantastic returns; insurance is a bonus – ULIPs have given good returns over longer tenures… as has equity / MF Schemes. Insurance agents hype up the product and position insurance as a kind of a freebie. Fact is that, you will have to pay for your insurance. ULIP returns does not include any charges. If charges are factored in, the returns will be far less alluring, especially in the initial years. Lesson – Don’t get carried away by returns alone; factor in the charges and then see if it makes sense.
5. The product is getting discontinued – Customers keep listening to this at regular intervals. Just before the end of June, the agents were urging their customers to take the policy ( pension plans ) before insurance becomes mandatory! Now, agents are telling their clients to go for a policy before 1st September, 2010 as then there will be a five year lock-in period. What they do not tell them is that the charges will be much lower in the new products and surrender will be possible, even after a year, at 12.5 -15% charges ( which keep going down ). Lesson – Find out the correct situation before putting in your money.
6. Take this on your child / wife - If they find that the earning member cannot be insured, agents typically suggest that the insurance policy be taken on the spouse / child. They also justify saying that the premiums could be lower for child / spouse! But the point is, the earning member is the one who should be insured. No point insuring the spouse and child. It is a waste of money as the insurance premium paid, however small, serves no useful purpose. Lesson – If you are looking for investment only, don’t succumb to such sales pitches.
7. Sovereign guarantee – LIC agents have been using this. Guarantee in a traditional product is only for the Sum Assured. Every insurance company ( including private players ) guarantees the payout of the Sum Assured. It is only the bonus payout that is not guaranteed. For ULIPs, this anyway does not apply. Lesson – This is just much ado about nothing.
8. LIC will be around; it has government support – I do not know where this is coming from. Being around for 50 years does not guarantee that the company will be there for the next 50 years. If being big is an advantage, AIG did not find any. If being a government company is an advantage, ask the customers of erstwhile UTI and how much they lost when it unraveled. UTI, IDBI, ICICI – all government owned companies then - had various kinds of bonds and other assured return products. They withdrew midway leaving those who have invested in their schemes, in the lurch. Where was the government support there? Lesson – It’s pure apple sauce to think that a Government supported entity alone will survive or their products come with some special assurance that is not there in others.
9. The art of packaging – There are very cleverly packaged schemes , attractively named like Jeevan Arundhati, Jeevan Kuber or something like these, which are nothing but several LIC products put together. These are not LIC plans. They are conjured-up plans by putting together a few insurance products of LIC . Also, interestingly, the payouts which come in at various points are assumed to be invested in NSC, PPF, RBI Bonds etc. Also, they take the income-tax 80C advantages , which most people anyway have exhausted in other ways. Then they calculate the returns and inform you that this amazing product will return 8 or 8.5%!. Don’t be misled by this. The higher returns are because of these other products, income tax savings assumptions & not through the insurance that you are buying. Lesson – Find out what you are getting into. Clearly understand the product before signing up.
10. Returns as high as 30% - IRDA mandates that benefit illustrations show a return using 6% & 10%. But this is followed in the breach. You will find fancy illustrations, assuming 16%, 24%, 30%... If confronted, they explain that it is to give the customer an “realistic picture” as to what they will get if the returns are such and such! I thought IRDA came up with it’s diktat, to precisely to stop conning clients, luring them with the promise of fancy returns. You would have thought some low level agents do it. No. Many high level banks do it. The most recent one I came across is from a private bank that people would like to trust because they are “conservative”. Lesson - Anything that looks too good to be true is probably not. Beware!
As a customer, a basic level of Financial Awareness and literacy would be absolutely essential. Reading up, visiting appropriate sites, starting to read the brochures that you have till now junked without a second look, will help. If all this is beyond your ken, take the help of a genuine investment consultant or Financial Planner. Anyone can sport these tags today and finding a genuine consultant is again a challenge. That is why, people just go to their banks to renew their FDs, instead of worrying about complex financial products. But when they do go to the banks, they get sold insurance, MF schemes and lots of others they cannot even articulate. That brings them to square one. A bit like snakes and ladders, what?!
A version of this was published under the title "Come into my parlour" in August 2010 edition in Money Today
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