Some tips to grow your money the safe way

Plain-vanilla fixed income assets can pump up the savings of not only the retired, but also those of young professionals. 

You won’t catch them dead near the stock market. They are very happy putting away their hard-earned savings in fixed deposits, public provident funds, company deposits and so on. And not all of them are retired individuals who do not want the uncertainty of stocks ruining the fun of their sunset years.

There are many young executives, who don’t want to take the extra risk of investing in stocks. While a retired individual wants a monthly income to meet his day-to-day expenses, the working individual looks at building a fixed-income corpus to save for a rainy day or emergencies which may come his way.

 According to India Wealth Report 2010 by Karvy Private Wealth, as much as 66% of Indian wealth, which is around Rs 48 lakh crore, is in fixed income assets.

Compared to this, global investors invested only 58% of their individual wealth in debt instruments during the same period. 

Fixed income investors are generally risk-averse, want safety of principal and do not believe in churning their portfolios too much. They also want their investments to be as simple as possible.

There was a time when fixed-income investors earned as high as 12% by investing in bonds of reputed companies such as Tata Capital and Shriram Transport Finance or fixed deposits (FDs) of companies like Telco (now Tata Motors) and Mahindra Finance.

However, that was during the global financial crisis in 2008-2009. With the crisis receding, earning double-digit interest on FDs is no longer possible.

No wonder, 2010 has been a tough year so far for fixed income investors. Inflation has sky-rocketed and remained in double digits for a major part of the year.

The Reserve Bank of India raised rates five times during the year, in a bid to rein in rising inflation. However, banks were flush with liquidity and did not raise interest rates.

So, while inflation was close to 10%, interest rates were in the range of 6-7% per annum. As a result, investors got negative real returns from their fixed income investments. Simply put, when an investor gets 7% from his FD while the inflation rate is 10%, he actually earns negative returns.

Typically, fixed income investors have choices such as FDs (bank and company FDs), debt mutual funds (liquid funds, income funds, gilt funds, fixed maturity plans) and post office investments like National Savings Certificates and 8% Government of India (GoI) bonds.

Fixed deposits account for 30% of the overall individual wealth in India, while small savings constitute around 7% of the estimated wealth in India. Here, we take a look at some solutions for retired and working individuals:

Retired Individuals: Typically, an individual, who has worked during his active years, receives a lump sum on his retirement. Safety of capital is of prime importance to him. His objective is to generate a monthly income out of this corpus to sustain his lifestyle, some lump sum money for his children’s wedding or education and some surplus money to take care of medical emergencies or to go for a dream vacation as the case may be.

Safety is one of the biggest priorities for retired individuals. The Senior Citizens Savings Scheme, which gives 9% per annum payable quarterly, meets this important need.

 Individuals, aged 60 and above, and retiring employees, aged 55 and above, can invest in the scheme. The scheme has five-year tenure and can be extended further for a period of three years.

The highest return that a retired individual can get with the highest degree of safety from the central government.

However, one must note that premature closure is possible only after one year, with a nominal penalty.

If individuals want a monthly income, they can opt for a post office monthly income scheme (MIS), which gives a return of 8% per annum.

 Here, the maximum limit is Rs 4.50 lakh in a single account and Rs 9 lakh in a joint account. Here, too, premature closure after one year attracts a penalty of 2% while closure after three years attracts a penalty of 1%.

Investors can also look at company FDs, where in some cases the returns can be as high as 9.5-11%, though they do carry a higher risk compared to government schemes.

It is always advisable to invest in companies with AA or AAA rating and spread their investments across a number of companies.

Remember, don’t go by returns alone while zeroing on company FDs, as many retired people often fall victim to bogus companies offering high interest rates. However, when it comes to getting the capital back, they realize that the company has folded up.

When it comes to mutual funds for retired investors, fixed maturity plans (FMPs) and short-term income funds are considered the best bet.

FMPs give you the benefit of indexation and returns could be in the range of 8-8.5% for a 1-3 year tenure.

Working Individuals basically are averse to taking risks and, hence, do not want to invest any money in equity. Also, they may have some loans, like home and car loans, to repay. So, liquidity will be of prime importance to you, as the accumulated surplus money can be used in times of emergencies or fulfill short-term goals like a vacation. 

So, what kind of strategy should such young risk-averse people adopt in a rising-interest rate scenario?

He/she could invest some amount in a post-office MIP, and if he/she does not want the monthly income, he/she could further invest it in a post-office time deposit. In addition to this, he /she may go for company fixed deposits, as they give a slightly higher return than other products.

He/she can invest in short-term income funds, as they offer ample liquidity, are tax-efficient and could give returns of around 7-7.5%. Such investors should invest in a combination of FMPs (fixed maturity plans) and short-term income funds. The duration risk in short-term income funds is low as they have a maturity of 1-2 years. .

However, experts believe that younger people should invest at least a small portion of their corpus in equities, as they can add sheen to their wealth. 

Here are some ways to grow your money without investing in equities

If you have an investment horizon of 6-12 months, then you should opt for short-term income funds that give 6-8% returns

Go for fixed maturity plans (FMPs) of 370 days and reap the benefit of indexation for up to 8%

Invest a part of your money in company deposits for three years and earn returns as high as 10%. However, don’t get swayed by the promise of returns alone. Always stick to a company with an AAA or AA rating

You can switch from short-term income funds or liquid-plus funds to income or gilt funds, depending on the prevailing interest rates

Senior citizens can invest up to Rs 15 lakh in 9% Government Savings Scheme. They can also go for post office monthly income plans that give 8% returns per annum 

Do not make the mistake of keeping too much cash in your savings account as that will earn the lowest interest. 

For greater liquidity, you could invest in Equities. (Share/ Funds) which is though very much uncertain affair as per return is concern!

"I never attempt to make money on the stock market.

I buy on the assumption that they could close the market the next day and not reopen it for five years. "
                                                                                                                        Warren Buffet

Choosing the right tax-saving product!

The tax season is just round the corner! And there are too many tax saving options available broadly categorized under two heads: one equity and two debt products!

There is your financial consultant but more often than not he might suggest only those products that will get him the highest commission!

Obviously you are confused! How about analyzing the right tax saving product for you? Want to know how?

To begin with ask yourself these two questions: your risk tolerance level and what stage in life you are in. But why should you do it in the first place?

Importance of finding your risk profile

Finding answer to this question can lead you to the right tax saving plan! Analyzing your risk tolerance level will help you shape up your investment portfolio and get the best out of it.

Now what is risk tolerance?

Your investments are prone to both positive and negative changes. In the risk of negative changes the big thing is to find out how much you can afford to lose on your investment. This is your risk tolerance level.

How to find your risk tolerance level?

There are two sides to it: one is financial and the other is emotional. The financial risk tolerance level is self explanatory. That is the amount of money you can afford to lose.

If you can afford to lose more money then you have a high risk tolerance level and if you cannot afford to lose huge money your financial risk tolerance is moderate and if you do not want to take risk at all your financial risk tolerance is called low.

Emotional risk tolerance is all about the stress level that you are put into when you lose money on your investment. The more your stress is, the lesser is your risk tolerance.

Investors fall into three categories based on their risk profile:

Conservative, balanced and aggressive

As the name implies conservative investors are averse to taking risk. Typically they have a low risk tolerance and prefer investing in safe havens like Public Provident Fund (PPF), National Savings Certificate (NSC), and Employees Provident Fund (EPF), Endowment plans when it comes to life insurance and on tax-saving bank fixed deposits.

The balanced investors are those who wouldn’t mind taking some amount of risk but still would park their investments in low-risk products like balanced unit linked insurance plan or ULIPs. In other words, their risk tolerance is moderate.

Those investors with the highest risk tolerance levels belong to the aggressive investor’s category. They have an appetite for taking risk. If you belong to this category you could invest in tax saving products like the equity linked savings scheme or ELSS.

Let us see the pros and cons of each of the tax saving products in all three categories of investors.

Products for conservative investors

With low or almost nil risk tolerance level the conservative investors usually go for fixed income products that would secure their investment.

Product	Returns (%)	Pros	Cons
PPF	8% annual tax free return	Min amount: Rs. 500Max amount Rs. 70,000/year for 15 years till it matures. Loan facility available. Enjoys ‘EEE’ status that is ‘exempt-exempt-exempt’ from tax. Your contribution, accumulation and withdrawal are exempt from tax.	Long lock in period. You cannot withdraw until the beginning of the sixth year. The loan amount is limited to a maximum of 25 percent of the balance at the end of the first year.
NSC	8 percent annual pre-tax return	Min amount: Rs 500 per year. No maximum limit. Enjoys ‘exempt-exempt-tax’ (EET) that is no tax on contribution but the interest is taxable on an accrual basis that is on each-year basis.	Maturity period: 6 years. No premature encashment option. Interest income is taxable. The effective post-tax return for the highest tax bracket is only 5.53% every year.
Employees Provident Fund	8.5 percent tax-free returns every year.	PF withdrawal is not taxable if contributions for over five years.’EEE’ status that is the contribution, accumulation and withdrawal is ‘exempt-exempt-exempt’ from tax.	PF withdrawal before five years is taxable. Premature encashment is available but only with conditions.
Endowment plan	Lower returns compared to products like the PPF.	Life coverage and returns.	High premiums. Compared to the premiums that are paid in the first few years the surrender value might be lower.
Tax saving fixed deposit	6 to 8 % returns every year.	Min amount: Rs. 100 but varies with banks. Lock in period: 5 years, comparatively lesser than investing in products like PPF.	TDS is applicable for interest income of more than Rs. 10, 000 in a year. No premature withdrawal.

Products for the balanced investors

The risk tolerance level of these investors is moderate and they invest in low-risk products as the conservative investors and also in unit linked insurance plan or ULIPs.

Product	Pros	Cons
ULIP	Provides both insurance and investment. Long term saving products hence absorbs market volatility. Investing in debt funds is also available. Tax free returns.	Subject to market risk as a percentage is invested in stock markets. For better returns premiums for the entire duration should be paid.

Products for the aggressive investors

These investors with high risk appetite can invest in tax saving products as the conservative and the balanced investors do. Apart from this they can also invest in equity-linked products, which generally do better than the conservative products but returns may vary with funds.

Product	Pros	Cons
Equity-Linked Savings Scheme (ELSS) Invest in Shares	Minimum amount is Rs 500. Lock-in period: Three years. Dividend and returns at maturity are tax-free. No lock in period, less charges etc.	ELSS invests in stock market and hence is prone to market risks. Wrong selection of stocks leads to capital erosion

Importance of having goals

Your stage in life will also have a say in deciding your investment portfolio composition. If you are someone young then you could consider investing in equity like ELSS, ULIP or take a home loan or educational loan to save tax. Once you grow older you can slowly get out of these avenues and invest in fixed income tax saving products like the PPF, FDs etc.

How to use risk profile + goals to choose the right option?

Returns on your investment are important but this alone should not be the driving factor in deciding your investment choice. There is no investment per se that can save you tax and simultaneously secure your investment and give highest return. Your final choice of tax saving investment should be guided by both your risk profile and your goals in life which again depends on the stage of life you are in. Remember, the goal is to have an investment portfolio that can give you decent returns and the risk tolerance level you can handle.

PPF as a tax saver and investment option

On 15 September 2010, the Employees’ Provident Fund Organisation (EPFO) raised the interest rate for EPF accounts by 1% for 2010-11. The organisation increased the interest rate to 9.5% for 2010-11 from 8.5% in the previous year.

This 9.5% is the highest in the last five years. However, one needs to understand that the 1% increase is only for EPF accounts and not for Public Provident Fund (PPF) accounts. A PPF account interest rate will continue to remain 8%.

What is the difference between EPF and PPF?

Where Employees Provident Fund serves all salaried employees, the Public Provident Fund serves everyone- the employed, the unemployed, even children and housewives.

The access to the fund is also quite easy as any post office and some State Bank of India branches can help you open the fund.

The purpose of a provident fund is to provide individuals some form of savings for their retirement years.

Naturally, the EPF and PPF are for long term savings.

What kind of income can I one expect from PPF?

The returns from the fund are in the form of interest paid. The interest rate currently is 8% compounded annually.

However the interest is not paid out but is compounded (like a bank recurring deposit) till the maturity or withdrawal. With the current levels of inflation, the returns from the PPF fund are not very encouraging to me.

Is there any capital appreciation?

Being a typical debt investment, there is no capital appreciation for the investment.

What is the risk involved with this investment?

There is hardly any risk for the capital or the returns from the PPF deposit. The risk however is with inflation which could possibly reduce the value of the returns in the long term and the other disadvantage is the long lock-in period of 15 years.

 How about liquidity of the investment?

The PPF gives very little liquidity too. The fund, as mentioned earlier, is for a minimum of 15 years. This can be extended for a further period of 5 years each indefinitely.

The liquidity is in the form of withdrawals that can be made from the fund from the 7th year onwards. The withdrawal value is however limited to a maximum of 50% of the average of the last 3 years’ fund values. After the 7th year, one withdrawal can be made every year, based on the same condition.

 What happens in the case of the death of the account holder?

In case of death of the account holder before the maturity of the account, the fund will be paid to the nominee/ legal heir.

How is PPF treated for tax?

This is where the PPF scores very high. The PPF comes under the Exempt- Exempt- Exempt category currently.

This means that the amount invested gets tax benefits, the interest is not taxed and this applies for the final maturity amount as well.

The investment gets benefits under Section 80C of the IT Act. The investment however is limited to a maximum of Rs.70,000/- per year per person.

This limit of Rs.70,000/- includes the deposits made in the name of any dependent children.

Are there any other specific benefits that I need to know?

Some other unique benefits from the fund are:

1. There is no wealth tax on the value of the fund.

2. In case of insolvency the money in the fund will not be attached to the assets. So only this investment is truly ours, come what may. (Except for education in a philosophical sense).

This feature can be very useful particularly for business people in high risk industries / businesses. The fund cannot help anyone if there is tax evasion though. 

 How does it score on convenience?

The fund scores high on convenience. As a savings tool, it is incomparable in terms of the flexibility of payment and quantum. You can make up to 12 contributions per year.

Each contribution can be as low as Rs.100/- subject to a minimum of only Rs.500 per year.

There has to be at least one contribution per year.

In case no payment is done for a whole year, there is a charge of Rs.50/- when the next investment is made. The objective is to make savings as comfortable and convenient for the minimum possible investment.

A minor disadvantage is that the fund is yet to go online. So we have to carry our passbook and also face a queue to make the payment every time.

Sumup

PPF is a typical savings tool but one has to invest for the long term. This means that there is an asset class mismatch. But on the convenience side, the fund scores pretty high for the flexibility that it offers.

There are additional unique advantages in the form of wealth tax and insolvency benefits from the Public Provident Fund. On the flip side, the long term (minimum 15 years) of the plan is a limitation.