Kavitha Menon's Blog

Assessing Tax impact while choosing investments

2024-03-07T04:27:00.000-08:00

Assessing Tax impact while choosing investment vehicles

My client, a media professional, had a desire to own his own stocks and when he received an inheritance , he immediately opened an account a Portfolio Management Scheme . As luck had it , markets rallied and the PMS delivered spectacular returns . All was well till it was time to file the year’s ITR. His annual taxable income was 48 lakhs and a long term capital gains of 6 lakhs had been booked in the month of Dec 2022 . At a 10 % long term capital gain tax , with one lakh exemption , my client was happy that the extra tax liability was only Rs.50,000 . To his surprise his CA asked him to deposit 1.77 lakhs extra in taxes . How did the tax amount jump up from Rs.50,000 to 2.23 lakhs ?. The tax payable was more than four times the amount anticipated by my client. The culprit was the capital gain that took his total income above 50 lakhs , a slab that attracts a 10 % surcharge on total taxes. Look at the table below to see impact of unplanned capital gains on total taxes

	Income at 48 lakhs		Income at 1.95 cr
	Normal rate	Post Additional Capital Gain	Normal rate	Post Additional Capital Gain
Capital gain		600000		600000
Income from profession	4800000	4800000	19500000	19500000
Tax on Capital Gain		50000		50000
Tax on Income from Profession	1522500	1522500	5932500	5932500
Total Taxes	1522500	1572500	5932500	5982500
Applicable Surcharge	%	25%	15%	25%
Post surcharge Tax payable	1522500	1965625	6822375	7478125
education cess	4%	4%	4%	4%
Total Tax payable	1583400	2044250	7095270	7777250
Difference in tax		460850		681980

My client ended up paying 4.6 lakhs in taxes , thereby wiping away a large part of the capital gains made.If he fell in the higher income brackets , this impact could be much higher. Look at the above table- if he had income of 1.95 cr, a capital gain of six lakhs could impact his total taxes by 6.8 lakhs ( wiping out the entire capital gain made ).

The point of this story is that your tax situation is a vital criteria in selection of investment product . While HNIs flock to PMS due to customized portfolio construction, the benefits of such unique portfolios have to be evaluated against the costs associated with them . Taxation on the capital gains is inevitable , but like in my clients case it can have an adverse impact on overall tax outgo. If you have made a one time large professional or business income , or if you have had a property sale or any similar large income in year or if you belong to the higher income slabs ,the impact of unplanned capital gains can be severe. Not only are you impacted by higher surcharges , but also higher penalties as many times capital gains from PMS are reported late and cause a problem in advance tax payments of HNI clients.

To overcome the tax issue with PMS, many large fund managers have created Cat III AIFS with the same themes as the PMS. CAT III AIFs pay tax at the fund level. The gains on exiting an AIF don’t get taxed investors hands ( as the fund has already paid taxes on your behalf). Also you don’t have to account for the capital gains and dividends in your books. This is a huge relief from the book keeping point of view as well. An important point to remember is that CAT III Aifs pay a 15 % surcharge on capital gains and 37% surcharge on dividends and other income irrespective of your actual tax slab.

In the case of mutual funds, sale action within the fund attracts no tax , thereby making it the most tax efficient . However you may not find the unique portfolio strategies that PMS and AIFs offer .

To sum up , you have to measure impact of taxes into your returns before choosing the right vehicle for equity investments. Such impact has to be calculated on overall income and not just at a product level.

Debt Alternatives

2023-02-24T07:35:00.003-08:00

As India moves towards becoming a 5 trillion-dollar economy, investors have much to gain by participating in this big growth decade via equities. But equities are essentially long gestation investments and come with their fair share of volatility. For investors looking at fixed income to park short term funds or wanting higher returns while diversifying from equities, traditional fixed income instruments and mutual funds offer limited options.

On one hand there is demand for products with higher returns in the fixed income space. On the other hand, is a growing requirement of funds by business owners and individuals for purposes that aren’t traditionally covered by banks or NBFCs. For example, Corporates both in traditional and new age business require high quality and different types of capital when they go through special situations like liquidity crunch, bankruptcy, promotor buy backs etc. Similarly on the retail side, our young consuming population needs quick and easy access to loans to fund their aspirations as well as unique personal situations such as marriages, medical emergencies etc. Not all of them can be serviced by banks due to their stringent lending norms.

Enter a new breed of NBFCs and Asset management companies that are investing in asset classes that traditional lenders do not want to entertain, while at the same time giving access to investors in high yielding regulated avenues. They are leveraging technology as well as legal frameworks available for recoveries, to bring together lenders and borrowers.

I would like to call this space ‘Debt Alternatives’, as these investment products, like traditional debt instruments have a fixed return component or some characteristics of debt instruments, but have a higher risk associated in terms of credit risk or execution risk and will require a lot more due diligence. There is a demand for these innovative and flexible products in the debt space from investors, both retail as well as HNIs and institutions.

Here is list of the alternatives that have become very popular in the last few years. Each have a unique structure and risk associated with them. I have only roughly touched upon them in this article.

Broadly Alternatives are available on Retail Platforms and on AIFS. On the retail platforms ticket sizes are as small as Rs.1000. Under AIFs, an investment vehicle for sophisticated and HNI investors, the minimum investment is 1 crore by regulation.

Under Retail Platforms, following are two of the most popular variants

1. 1) P2P or Peer to Peer: These companies leverage technology to bring together lenders and borrowers. Borrowers could be retail /small ticket consumers taking loans for purchasing white goods or small businesses who need short term capital etc. P2P has now started offering fixed yield products in which the risk remains with lender but the NBFC makes a pool of investments on behalf of the investor, manages risk and in return takes a very high fee. Not all P2P have the same risk management systems and it is important to evaluate the merits of each of these individually. Across P2P the RBI mandates a limit of 10 lakhs for lenders, while with a CA certificate the limit can be enhanced to 50 lakhs.

2. 2) Alternative debt platforms : These platforms source and curate debt products from business that require funding but find it difficult to get the same from traditional banking systems. Some of their issues are covered/secured by adequate assets or revenue inflows, and sometimes even rated. Each issue has to be evaluated on merit. These platforms allow investors to participate in leasing assets (office equipment/company vehicles etc) in addition to corporate debt, Invoice discounting, and Real Estate debt. This was erstwhile a highly fragmented space dominated by small time market makers and businessmen and today thanks to technology is available to a lay investor.

In the AIF space, Real Estate debt funds, Venture working capital Funding, Special situation funding, and stressed assets are all products seeing a lot of traction. In addition to above, AIF investing in pre InvITs space, Long Short funds, NBFC/microfinance debt, Commodity Arbitrage are also jostling for allocations on the debt side of HNI portfolios. Returns can vary from close to mutual fund debt to near equity returns. Gestation period for these AIF products can also vary from short term, as little as a month, to 10 years. Risks also varies depending on the structure of these products. The space is evolving rapidly and it is interesting to watch the innovation and how regulators are facilitating it while at the same time protecting Investors. Will share my ideas on these products, in detail, in upcoming blogs.

2022-09-10T06:10:00.001-07:00

Factor Investing: An introduction

Factor investing, is an asset pricing and portfolio construction approach that involves targeting specific drivers of returns. There are five main factors associated with higher returns that are widely used in factor ETF strategies: value, small-caps, momentum, low volatility and quality (which is also known as dividend payers). A sixth factor, yield, is sometimes included in the main factor definition count.

For the purpose of our writeup today, we will be focussing exclusively on factor-based ETFs with some compelling statistics that should help you as an investor to:

- Critically evaluate performance of large cap investments in managed funds

- Usher in ETFs as a cost effective and promising part of your core portfolio

We will also restrict this analysis of funds to the large cap space. It is likely that in a few years midcap and small cap indexes will start outperforming their managed peers, but so far data points to a reasonably high Alpha in this space and making a choice of a good fund manager is all it takes. However, today’s story is about large cap investments.

I have in the table below tabulated performance of all factor-based indexes

Scheme Name	Minimum	Maximum	Average	Std.Deviation	RPUR

Nifty Next 50 TRI	-15.6	76.5	18.0	15.1	1.2
Nifty 200 Momentum 30 Index TRI	-10.1	49.0	17.3	9.2	1.9
NIFTY Alpha Low Volatility 30 TRI	-5.6	40.8	17.0	8.4	2.0
Nifty 100 Low Volatility 30 TRI	-3.9	38.6	15.3	6.3	2.4
Nifty 50 Value 20 TRI	1.6	41.3	14.8	6.4	2.3
Nifty 100 TRI	-6.5	64.5	16.0	12.5	1.3
Nifty 50 TRI	-15.2	62.1	15.0	13.3	1.1

*Rolling returns from Jan1 2010 to Aug 30,2022

*RPUR is return per unit of risk

The names of the funds reflect the factors on which they are based. Factor investing is also called smart beta investing as weightages of the stocks are changed as per their factor based scores.

From the table above one can see how two of the factors seem to have driven the best return per unit of risk, the low volatility factor (a technical factor) and the Nifty Value 20. The Low Volatility fund focuses on top 100 while NV20 creates its portfolio from Nifty’s 50. NV20 short lists companies from the Nifty 50 on the basis of four value parameters.1. Return on Equity 2. Price to book 3. Price to Earnings and 4. Dividend Yield. On the basis of their rating on above parameters stocks from the Nifty 50 are weighed and ranked and the best 20 make way into your portfolio.

It is fascinating as to how simple factor based ETFs can consistently outperform not only the indices against which they are benchmarked, but also managed large cap funds. The outperformance is not only in the returns department but also in the risk space. I pick NV20 ETF for comparison with managed funds. Let me show you the numbers

Name	Low	High	Average	St. Dev.	Sharpe
Mirae Asset Large Cap Fund (G)	2.80%	23.69%	15.14%	16.72%	0.48
SBI BlueChip Fund (G)	-0.65%	20.21%	11.71%	17.19%	0.25
Franklin India Bluechip Fund - (G)	-1.51%	17.61%	9.61%	18.27%	0.21
HDFC Top 100 Fund (G)	0.19%	18.15%	10.96%	17.28%	0.43
Nippon India Large Cap Fund (G)	-0.39%	19.07%	11.31%	18.43%	0.33
DSP Top 100 Equity Fund (G)	-1.37%	15.55%	9.35%	16.97%	0.36
Nippon India ETF Nifty 50 Value 20	5.42%	32.27%	20.48%	18.35%	0.36

· Three year rolling returns from 11 July 2015 to September 5,2022

The difference in returns and risk parameters is stark. For more or less similar standard deviation the NV20 delivers far superior returns over three year rolling periods since inception. Also, there are no negative return three-year periods since its inception.

Managed funds typically charge anything between 1.5% to 2 % in management fee for regular plans. Compared to these ETF charge 0.10% to 0.3%.

To an investor who doesn’t want to manage large cap portfolios, factor based ETFs are a good venue to start. Stock rebalancing happens automatically and at no cost to you. The fund management fees are also a fraction of that of managed funds. Because rebalancing is done by the funds, there is no tax outgo for the investor.

For HNIs who own large core portfolios in bluechips, dividends and capital gains are adding heavily to tax outgoes (not to mention putting additional tax burden via surcharges). For them, instead of buying 15-20 different stocks, a single portfolio via a factor fund may make a lot more sense.

There are a few drawbacks however. The most glaring of them is liquidity and costs of transactions. ETFS as they are today, don’t usually list at true price and there could be an enormous gap in actual NAV and traded price. Fund houses usually create units for large Investments, but for the smaller amounts do consider the funds that in turn invest in ETFs. There is only a very slight difference in NAVs and really doesn’t impact returns for long term investors. For example, Nippon Nifty NV 20 Fund is a FOF that invests in Nippon NV 20 ETF.

For any queries feel free to throw in an email and I will be happy to guide you further.

2020-09-13T06:22:00.002-07:00

Five things to do in the current stock market scenario-

My client was nervous. As the head of a leading consultancy firm he was aware of the state of affairs of the economy and specifically of his clients who were bleeding thanks to the impact of lockdown . He wanted to know my view on how to tackle the portfolio given the the stunning rally of stock markets across the globe . Like many a baffled investor he was sure that the markets were in bubble and unrealistic . While the rally has been sudden and unexpected there are justifications galore supporting it too. And as with every investor my client was afraid that there will be reversal to the mean.

What should investors do when Nifty is reaching new highs daily?

I will share my two cents on how to deal with the current situation.

1. Prepare yourself for volatility especially in equity – We aren’t exactly in a cheap market reeling from covid hit economy. Valuation ratios are on the top end of acceptable ranges and reversion to mean in the form of correction/crashes is inevitable. You must decide how much risk is acceptable to you basis your financial situation. For risk averse investors I recommend bringing down allocations in equity , booking profits or rebalancing

2. Remember that there will always be opportunity to invest in good ideas -Bull or bear market, the patient investors always wins. Opportunities for investment will come. Wait for them. Research, understand and reflect. If you know what you own or want to own, market movements are of no consequence .At best they will offer significant opportunities.

3. Focus on a good asset allocation plan. Rigorously re-allocate. Evaluate minutely your choices and rationale. If you are doing SIPs, rejig, relocate depending on your financial goals and cash flow requirements. Rebalancing portfolio will help you bear losses in the midst of volatile markets. A good mix will also ensure lower volatility of overall returns.

4. Cash is an ASSET!!! It is your gunpowder, the arsenal u collect to use at the right opportunity. Without cash you will have to accept normal returns on your asset of choice .Market timing is impossible but you can look for value. While you are looking or in the absence of value choose cash. Also should you be worried about your future cash flows, then bumping up your contingency reserves with cash savings is great. You can park cash savings in the form of bank fixed deposits /liquid funds.

5. Accept Regret , Don’t Act on it - Regret is part of stock market investing .Didn’t buy or didn’t buy enough , didn’t sell on time, sold early and all variations in between are normal .Warren Buffet missed the entire tech rally of the last decade, didn’t he ? And he is the master investor of our times! FOMO or the fear of missing out can lead itself into terrible investment mistakes and losses that are irrecoverable. If u have missed an opportunity another one will come your way.

While I write this piece SEBI has decided to make it mandatory for Multicap funds to move minimum 25% in Small Caps and minimum 25% in midcaps, causing quite a flurry in fund management circles.

Some were gleefully cheering the move as it would lead to a rally in already richly priced quality midcap and small cap funds, while others lamented that it will cause immense investor grief and mistrust. AMCs plan to make presentations to SEBI against this diktat, with recommendations of mergers /change in classifications etc. I will update readers when there is more clarity, and leave with a warning that it is a bad idea to jump into midcap /small cap via funds or directly in anticipation of this RS.42,000* cr bonanza which might not materialize.

* Assuming 30% of the 1.46 lakh cr invested in multicaps will need moving to mid and small cap stocks

2020-08-27T03:19:00.001-07:00

Reduce tax impact on Debt Mutual Funds

In the last couple of years some changes made in tax rules for dividends in mutual funds have made the dividend option of debt plans very unattractive. While dividend distribution tax has been done away with, mutual funds now deduct TDS (10%) and Stamp duty (.005%) every time dividends are paid and reinvested respectively. Besides the dividends are fully taxable in the hands of the investor.

Clearly dividend options is not an option anymore and as an investor you must ensure you move lock stock into the growth option

Short term capital gains (if the units are sold before three years) in debt mutual funds are taxed as per applicable tax rate of the investor. Therefore, if your tax rate is 30% then short term capital gains tax on debt fund is 30% + 4% cess. Long term capital gains of debt fund are taxed at 20% with indexation. With some management , the overall effective tax payout can be brought down considerably.

Let me explain with an example. Astute investor Mrs. A has been saving money in HDFC low duration fund since 2017. This is the list of her transactions

Transaction Date	Type	Transaction price	Amount invested	Units	Capital Gain	Capital Gain type	Tax payable
July 25 2017	Buy	36.3758	100000	2749.08
January 15 2020	Buy	43.5275	100000	2297.40
June 25 2017	Sell	45.2692	-50000	-1104.50	9822.8	Short term	3241.522
July 27 2020	Sell	45.773	-50000	-1092.35	10265.0	Long term	1326.281

Note the difference in tax amounts in a matter of just one month. Tax on units sold in July is less than half the tax paid on units sold in June.

I point out to Ms. A that she should have waited a month to make the withdrawal .But an astute investor that Ms. A is, she asked me why even sell the longer term units and that she should be allowed to sell from units purchased in Jan 2020. She shares the following chart if she is allowed to sell units bought in Jan

Transaction Date	Type	Transaction price	Amount invested	Units	Capital Gain	Capital Gain type	Tax payable
July 25 2017	Buy	36.3758	100000	2749.08
January 15 2020	Buy	43.5275	100000	2297.40
June 25 2017	Sell	45.2692	-50000	-1104.50	1923.7	Short Term	634.8257
July 27 2017	Sell	45.773	-50000	-1092.35	2452.9	Short Term	809.4455

She points out she would end up paying on Rs. 1445 in taxes, if the units purchased in Jan 2020 are sold, versus Rs.4568 if she withdraws her older units. She is right. However Ms. A made the Jan investment in the same folio as her previous purchase. As per tax law, tax on units sold follows the FIFO (First in First out) method to calculate purchase cost. Sadly she will end up paying three times the tax because she did not plan her withdrawals.

How could Mr. A Plan her investments and withdrawals to ensure minimization of tax.

1. She can bunch her debt purchases in a single fund /single folio in short periods of time. For those with a high frequency of purchases use a three month to six month time frame to add in a single fund/single folio. Thereafter either use another folio (if u want the same plan) or spread your investments over several fund houses in similar themed funds. In our example Mr. A should have made the Jan purchase in either a different scheme or a diff fund. That would have separated her recent purchase from the older one

2. Always withdraw from the latest investment done .Your youngest investments will have the least accumulated capital gains and also u will give time to your older investments to become long term (complete three years)

Going forward, for my clients I plan to accumulate funds in one liquid fund and thereafter move them to more than one different longer debt fund. Client's Debt portfolio will look like it has a lot more funds than in the past and will need some study of ageing before transactions are done.

In case of withdrawals it is best to contact your investment advisor and they will advise and help you execute the sale/redemption or you must maintain a ageing chart of investments .You may check the date of purchase to ensure that you sell your most recent purchases and aren’t selling any units that are close to completing three years.

Painful Reality

2013-04-21T23:09:00.003-07:00

For a large number of Mumbaikars owning a property in the city has become a distant dream .

A quick search on a couple of real estate portals reveals that median prices for two BHK apartments is Rs. 1.5 crore in the western suburbs . Buying properties involve a black component the percentage of which can be as high as 60% to a reasonable 30%. A mere 30 % black component in a deal of 1.5 crore equals 50 lakhs . This becomes part of the money that a home buyer funds from his savings . The real bummer is that the bank will provide loan only on the white component . Which means it will fund only 80% of the 1 crore white component in our example . Thus over and above the 50 lakhs( black) , our home buyers will have to fund a further 20 lakhs from pocket . (No wonder home loans are the safest assets for bankers !!)

Isn’t it wonderful that such a large number of Mumbaikars seem to have this kind of money to buy homes?. Reality is that it is small number of investors who are keeping reality prices sky high in our City . Willingly or otherwise these investors have put property prices into a upward spiral . Picture this . An investor buys a property of Rs.2 crores and in three years his property appreciates to 3 cr. If he chooses to sell he ends up paying long term capital gains tax. To save this tax he has only three options

1.. Invest in Rec bonds – However there is a cap of Rs.50 lakhs on such investments per annum . Also the yields are very poor not to mention taxable . Post tax yields work out to about 3.99 % for those in the highest tax bracket .Not really an option when compared to option 2.

2. Invest in another Property- Investing in yet another residential property will ensure that you pay no tax on the capital gain

3. Take the capital gain in black -Now this amount, being 1 crore in our example, needs to be deployed somewhere . Where else can one deploy such a large amount of cash but in another property !

All three option lead to only one door , i.e buying more property .

Sadly even end users, often salaried individuals are forced to convert their hard earned tax paid white money into black, in order to buy real estate. Because buying a bigger property involves cash they are forced to ask for cash in the sale transaction of their existing property( if at all ).

This rotation of black money in residential real estate has been partly responsible for escalating prices. (The other big part being dirty money, thanks to politician-builder nexus, that gets invested into real estate)

An efficient market works on the principle of demand and supply and price is a reflection of the same. Since black money is what drives real estate in Mumbai, property prices will never reflect the true picture of demand and supply.

Lack of better opportunities to deploy capital gains from residential property sale and needless to say black money , has been the cause of this upward spiral in prices .Curbing the latter is a matter of political will for its roots are entrenched in corruption and opacity of our laws .For the former ,it is beyond comprehension as to why the government seeks to retain this limit of Rs.50 lakhs for capital tax savings in REC and other similar bonds. One of the simplest things the government can do is get rid of the cap on investments under section 54 . If full tax saving is allowed for investments in bonds issued by infrastructure companies/projects coupled with reasonable returns , funds would flow from non productive and currently speculative reality sector to more productive and fund starved sectors like infrastructure. Also the option to save capital gains by investing in another property should be given only for self-use properties.

In any case overpricing in any asset does correct itself in due course of time . Gold is a case in the point . Indeed real estate prices in our city will sooner than later succumb to the law of economics . It’s only a matter of time and patience.

PS :came across a wonderfully written article on the same lines .. do read http://www.firstpost.com/investing/why-property-is-the-biggest-con-job-on-investors-696373.html

Why you should not invest in Equities

2013-04-03T02:06:00.000-07:00

You haven’t heard this one before!- Contrary to what you would have heard from every TV channel and investment advisor – financial planners included about how important it is to invest in equities to achieve long term goals. Here is why you should not invest in equities.

Its lucrative because it looks complicated – Not lucrative for you but for an assortment of TV channels that offer running minute to minute commentaries on stock markets, stock brokers who make intelligent predictions on the next market movement and of course fund managers who are in the asset collection business. All the above would like you to believe that without equity you are going to be poorer than your neighbor Not necessarily true. Most people will get rich because of higher income & higher savings relative to expenses.

Don’t understand it , don’t invest -The word ‘Equities’ is generic and encompasses all kinds of companies with no real grading . Do you know how to pick the right kind? .Not only do equity investments require a lot of research and understanding valuations but also a deep interest in making money through participation in successful businesses. Not everybody’s cup of tea.

Equities is not a three to four year investment vehicle- A lumpsum invested at the peak of any market cycle will have a longer waiting period. Say an investment made in HDFC Equity Fund (one of the best performing equity schemes for almost two decades) at the peak of the 2003-2007 rally would sit on a negative return of- 2% CAGR even after a waiting period of five years .Think what happens if you made grand plans based on a high expected return. It is possible that a bad market cycle lasts longer than your holding period.

Losing capital is no fun .Of course equities beat inflation, but there are quality companies that can do that and businesses that have eroded client wealth . You don’t have to look back too far to see how the one time darlings of the stock market, during the bull run of 2003 -2007 are faring pretty bad on the returns chart. It could take years(or never) before stocks like Suzlon, Unnitech , RCom and many others will see the price highs of their heydays. The same holds true for several equity mutual funds and products like PMS/Insurance Ulips etc.

A game of patience -Another side of the same coin is when good quality companies do nothing for investor wealth because overall sentiment in their line of business/macro factors is bad .Or sometimes they just keep losing share value for no apparent reason . Such companies may take years before delivering returns to investors. Without the right guidance it is common to see investors sell such stock out of sheer frustration .Investors start believing that they must have missed something and low valuations are a reflection of a badly managed company .Do you have the stomach for waiting for years, sometimes bang in the middle of a galloping bull market , happy to see your stock doing nothing , while unknown stocks may be taking double digit jumps on a daily basis ?.

Without doubt good quality equities fight inflation and can create true wealth in the long run. But you must invest in equity only with a clear understanding of the business, valuations, and tentative holding period. You need to do all of this with strict planned allocations to the whole asset class ,as well as to individual stocks/products/funds. And in addition to all the above you need to reign in emotional biases. If you don’t have the time for such equity management you can hire an advisor – on fee basis .Such an advisor can conduct all the research required, be it in direct stocks or in picking products/mutual fund schemes managed by smart fund managers. He/she can hand hold you through market cycles and ensure you take the right decisions.

Finally the important question is whether equities is the right asset class for you .Don’t get swayed by thumb rules in asset allocations .Most of us will still achieve our life’s goals with debt investments. You may have to earn more and save a lot more . But it beats losing money and realizing too late that equity investments were not for you.

2011-12-15T04:22:00.000-08:00

Tax Laws related to Gifts

Gifts can mean taxes for the receiver as well as the giver .Iif you know laws related to gifts given or received you can avoid taxes or minimize their impact.

I. Some gifts do not attract any taxes for the receiver. These gifts include

Gifts from a relative. Relatives include
- Spouse of the individual;
- Brother or sister of the individual;
- Brother or sister of the spouse of the individual;
- Brother or sister of either of the parents of the individual;
- Any lineal ascendant or descendant of an individual;
- Any lineal ascendant/descendant of spouse of the individual
Gifts received the occasion of the marriage of the individual, or
Gifts received under a will or by way of inheritance,
Gifts received in contemplation of death of the payer.

The Problem of Clubbing of Income

Some points to remember

-Income from gift given to minor is clubbed with the income of the spouse who is earning the higher income. He/she however gets an exemption on taxes up to Rs. 1,500 in respect of each minor child u/s 10(32). All the income of physically or mentally handicapped minor child will be directly assessed in the hands of the child. A minor earning income by way of manual work or an activity involving application of his skill, talent or specialized knowledge and experience, is directly assessed in the hands of the child. However the income arising from his investments will suffer clubbing.

-In the case of spouse or daughter-in-law, income on income is not clubbed unless it crosses the minimum threshold of Rs. 50,000. In other words, instead of investing in your own name, and pay tax thereon, it is better to give a gift, pay tax on the original corpus gifted (you would anyways pay taxes on the income had it been invested in your name) and keep on building a corpus for your spouse. II. When Gifts received will be taxed

Any individual who receives gifts from non-relatives whether in cash or kind for a value of over Rs.50000 will have the value of such gifts added to his income and taxed accordingly. The gifts received by a son-in-law from his parent-in-law also fall in this category.

Conclusion

Firstly gifting to minors is absolutely avoidable as it doesn't give any real tax benefit as the whole income is clubbed with that of parents. Secondly you can gift a non earning spouse; funds for investments in equity which if kept for the long term will be tax-free. Since income on income is not taxable for gifts to spouse, you could look at locking in gains from equity into fixed deposits without any clubbing implication. Thirdly it will be a much better idea to gift assets to close relatives through Will. This of course doesn't include gifts in cash that is meant for immediate expenses of the receiver like education or medical care. It refers to financial and real assets for which you can plan taxes by investing in tax efficient/tax saving instruments. This way your family will enjoy a larger inheritance and need not share its benefits with the government.

Using the Internet for property purchases

2011-11-14T23:25:00.000-08:00

Property investments have to be carefully considered and evaluated. There are many online sites that help you make preliminary inquiries about location, prices and deals in property markets. Here are a few such websites that you must go through for preliminary investigations about the property that interests you.

1. Property Search Portals

There are several websites dedicated to listing properties directly from builders, property owners as well as from agents/brokers. These sites help you scan through hundreds of properties from the comfort of your home. Mainly the features they offer are

Facilitating search amongst several properties by sorting them on the basis of price, location, covered area etc.
Providing information about amenities, local infrastructure like schools or hospitals, connectivity and price history.
Sites like magicbricks.com, a leading real estate portal, help you not only search but also register your requirements, which is in turn relayed to listed property owners that match your criteria. Such registration of requirements is free. As and when matches are found, the website sends emails or sms to you. Either you may contact property owners or allow them to contact you. After initial discussions of phone you may visit the property site for an inspection and decide if the property suits your requirements.
You can use these websites to search for properties available on rent/lease as well.
Identifying Trends - Not only will such information help potential buyers but also owners of property to identify ongoing trends in rentals or price of properties similar to their own.

2. Group buying Portals

To get great discounts on property purchase, one can join a group booking channel like Groffr.com and Discountedflats. These websites allow individuals to form groups large enough to negotiate great deals while buying from builders in their new residential projects. Thus individual retail investors get to participate in pre launch offers which were earlier offered only to investors. Deals could include not only huge discounts on price, but also waiver of various ancillary expenses like registration costs, brokerages etc. In fact you can negotiate for great home loan rates too, on sites like GNBIndia.com that facilitate group bargaining with loan providers.

3. Discussion forums/Groups

The net enables forming of groups by people who are invested in a certain project. These groups help exert pressure on the builder for project completion on time and for keeping of all promises that were made at the time of signing of agreement. One can look for groups on blogs, social networking media and discussion forums. It is easy to conduct a search on the web for such groups to find out experiences of other consumers. Verification of builder's reputation and past construction quality can also be checked.

It is important to note that the internet should only be used as a search tool, an aid to understand trends and for short listing properties thereby reducing the need for endless site visits. However physical inspection of the property and related papers is an absolute must.

Know your Credit Score - Your Cost of funds may depend on it.

2011-11-02T22:46:00.000-07:00

My client complained that he was being offered a ridiculously high rate of interest on his car loan. It was surprising because he was a 'Privileged' customer of his bank and had no other liabilities. On enquiry, he was told that he was offered a higher rate due to bad CIBIL score. What is a CIBIL score and how did it impact my client's rate of interest on his car loan?

CIBIL stands for Credit Information Bureau (India) Ltd. It collects information about borrowers like my client from all Banks and lending Institutions operating in India, collates such data and creates, maintains and distributes a report on credit history of commercial and consumer borrowers like credit card users, home loan or personal loan borrowers.

Their report called Credit Information Report (CIR) is a factual record of a borrower's credit payment history compiled from information received from different credit grantors. Its purpose is to help credit grantors make informed lending decisions - quickly and objectively. For Example when a banker needs to evaluate a borrower's capacity to repay, the payment history of such borrower spread over different loans with different institutions can give it a good picture of fiscal discipline and ability of the borrower to repay. It can thus avoid repeated defaulters and pursue quality clients for its loans portfolio.

CIBIL also offers a credit score in the range of 300 -900. The higher the score, the better are your chances of getting a loan from a bank. Having unsecured loans, such as a personal loan, and poor credit card usage, or defaults in EMI payments, or a bad payment history could lead to a poor score. For example: If you had to settle a credit bill at 50 % of dues, the matter although settled will reflect in your credit history and prevent other banks from issuing a credit card or unsecured loans to you. You can see how this report has now become one of the most important criteria by lenders while providing loans or any credit facility.

Any borrower including a user of credit card will have his credit history included in the database of CIBIL. This data can be shared by all member clients of CIBIL. Here are few of the reasons why you must know your CIBIL score:

Bargain for better rates -If you have a good credit score, you can bargain for a lower interest rate on practically all loans.
Find out discrepancies - Sometime old issues that have been settled with the banker may still appears in your credit history, if your lender has by error or otherwise failed to update settlement of these issues in your record. For example in my clients case, his old dispute with a bank related to their credit card and a personal loan, which was pretty much settled, was still showing as an outstanding in his CIBIL report. The amount involved was large enough to get his score down. CIBIL has a dispute redressal system for such errors. On lodging a complaint with them, CIBIL follows up with the bank for data validation, and the bank needs to reply in 30 days after which the new record is updated.
Gauge your loan worthiness - How a lender looks at your credit worthiness is very much dependant on your CIR and Credit Score. A low number could mean difficulty in getting credit at reasonable costs despite eligibility
Checking for Fraud - It is shocking but true that identity theft is a reality in the credit business. It is not unlikely that your credit report may have details of loans that have never been taken by you. Checking your CIR will help you detect and report such frauds early in time.
Measure improvements in credit score - By paying EMIs regularly, repaying personal loans, avoiding outstanding credit card payments and reducing the number of cards in your name you can improve your credit score. Tracking your score regularly will help measure the improvement in your score.

You can ask for your CIR by following instructions in the link given below http://www.cibil.com/web/credit-score.html

Remember that it is not only lenders that are sharing your credit info. CIBIL is also partnering with telecom, mutual funds and insurance companies to share your credit history. Your CIR can affect the quality of services and products from these entities as well.

Peer Pressure - Don't let it direct your Financial Decisions

2011-10-19T00:20:00.000-07:00

Peer groups include family, work colleagues, friends etc who influence our decisions with respect to several aspects of our lives. It is natural behavior to conform to general norms followed by these groups. Unfortunately pressure to conform to peer group norms can cause severe damage to financial wealth. Common money mistakes that one makes due to peer pressure can be avoided if you can recognize them and taken corrective and preventive action. I have enumerated such mistakes that investors make due to peer pressure.

1) Making money decisions to maintain status in society:

Here's an example of a client who was born into a rich business family, lived in South Mumbai and had a roaring family business. In his mid forties a family dispute broke up the entire business and he found himself left with no assets and no business. He had no means of starting afresh and had taken heavy private loans at ridiculously high rates of interest to fund high living expenses. He did have one asset and that was his home in one of Mumbai's plushest localities. I suggested he sell, buy a cheaper apartment in the suburbs and using the balance funds to repay debt and fund future living expenses till he could find work or set shop again. It was completely doable from my point of view, but my client couldn't agree. For him such an action would mean admitting his despondency and quitting his high flying circle of friends and clubs. Such a move could cost him his reputation and status in society. Sadly none of his friends/society or reputation would help fund his living expenses, nor would they care for his child's education or pay for medical bills.

Spending on extravagant marriages/parties/religious functions, buying a car you cannot afford , buying a larger apartment or the latest gizmos to impress friends or family, or putting your child in an expensive school because there is where the neighbors kids are enrolled are all examples of spending to maintain societal status. Living beyond your means is like cancer. You can only accept the reality of your problem, nip it at the bud and start anew, else it destroys all your wealth and with it, all your happiness and peace. Not all the status in society is worth the loss of your own family's well being and future prosperity.

2) Making investments to avoid feeling left out:

Peer pressure plays a notorious role in making people take wrong investment decisions. Humans are genetically built to work in groups. We like being part of the herd and there is a sense of safety in following one. It is therefore natural for us to feel very safe and confident to buy a product which everyone around us has taken. Besides we do not wish to be left out. The truth however is that a product suitable for your colleague, friend or your cousin need not be suitable for you. I know live cases of well paid senior executives in a cash crunch. They invest in long gestation investments, like property (on an EMI of course!) and Insurance products, and end up stifled for cash expenses. All this because they kept taking investment advise from one colleague after another without looking into the differences in personal financial situation and cash flows.

3) Taking loans to fund fancy expenses or purchases beyond your means:

I am a great advocate of work - life balance and always make space for expenses related to vacations and luxuries in any financial plan. However the underlying principle is to spend for such expenses from savings and not from loans. Taking a large loan to buy a fancy car may be great for your colleague. However what if you still have a huge EMI going on, while he doesn't. You could get into severe distress if you follow a 'Me too' approach with respect to purchases that require huge financial outlays and hence loans. People make these mistake all the time especially when it comes to expenses like vacation homes, land purchases, electronic gadgets and time share schemes.

4) Giving loans to friends and Family -
This is a unique problem faced by Indians . The Great Indian Family works in strange ways where the well off are expected to give loans or gifts to their not so well off cousins , aunts , uncles and miscellaneous relations not forgetting friends and colleagues. There is no harm in financially helping friends and family, but in my experience , you cannot treat such aids as repayable loans, because they are rarely repaid .Give only as much as you can possibly afford , without any damage to your immediate family's welfare. If you must consider giving a loan , atleast have a fair assessment of the persons repayment capacity. If you don't , the result will be disappointment and anger when the loans are not paid back.

Most of us will find it difficult to access the impact of our money decisions on long term wealth. It will be nice to consult a Financial Planner who can give you a clear view of your situation. Bottom line is that you are unique and so is your financial plan. Your investments and expenses must reflect your unique situation and cater to the fulfillment of those goals that really matter.A plan will give you a fair idea of how much you must save ,where to invest and how much you can spend or give away,thus helping you take logical decisions rather than those based on external expectations . Finally it's about enjoying everything ,but within your means.

Care for parents - Helping them financially

2011-10-03T23:20:00.000-07:00

As parents retire and age, adult children have the additional responsibility of looking after their physical, emotional and financial well-being. Care for parents, whether independent or dependant, includes three important areas

Medical Care
Investment and Income Management and
Estate Planning

I have expanded briefly on these areas.

Medical Care
Everyone goes through a stage which requires long term medical care of parents. One needs to plan on financial aspects of such care. In the good old days of joint families, at least physical care was never an issue as miscellaneous aunts and siblings could take care of the elderly. In the absence of such a support structure, it is necessary to plan in advance for a scenario where one of your parents would require long term medical care. The cost of care includes not only actual medical expenses but also the cost of lost hours of work and the cost of arranging external arrangements like appointing full time nurse, infrastructure for support etc. I strongly recommend medical insurance where possible. Such insurance may be expensive for the elderly, but invaluable when it comes to covering recurring medical expenses. You get tax deduction up to Rs.15,000 for insurance purchased for parents (increased to Rs.20, 000 if parents are senior citizens i.e. above 60 years of age).

Such mediclaim needs to be supplemented by a medical fund. Many expenses including home care are not covered by mediclaim.You may put aside a small sum of money every month from your salary towards such a fund or if your parents already have funds available with them, you can create an account with self or sibling as second holder. This will help you operate the account in case your parents are physically unable to operate the same at the time of emergency. Ideally such funds should be fully invested in debt instruments. Besides this you and your siblings must be aware of what needs to be done in case of a sudden emergency. It is important to keep documents containing medical history, insurance papers and phone numbers of doctors and hospitals handy.

Managing Investments
You can help parents with their finances without compromising their financial independence, especially as they enter the retirement stage. Help should ideally be advisory in nature. Provide your parents with options, inform them of the pros and cons but let them decide .Help them invest in inflation hedged assets like equities to ensure that they no not outlive their savings. It would help to get a financial plan from an independent financial planner. This way you not only evaluate their financial situation, but will also be able to plan the size of your own medical and contingency funds.

Estate Planning
Indians rarely discuss estate planning with their parents. It is important to tread carefully in bringing this up with your parents. This is their money. You could open the topic by informing them of your own estate plan, discussing advantages of having one or by enumerating examples of the troubles of not having a Will in place. If you feel they're uncomfortable talking with you, ask them to see a financial planner. It is important to ensure that their wishes concerning their assets and belongings are fulfilled. A good estate attorney can help them update their wills, or create them if this has not yet been addressed. Once a will is created, appointment of nominees and second holders in line with the Will is important.

At least one family member should be aware about all assets, liabilities, sources of income, loans given or taken by the parent. This will assist a great deal in arranging funds in case of emergencies as well distribution of estate in case of death.

Financial well-being of adult children as well as their elderly parents depends on a well thought of plan. Start planning now- sooner the better.

Three steps to secure your child's financial future

2011-08-16T21:51:00.000-07:00

While making financial plans, young couples are eager to start saving for their children's future and this is often on their top priority list. They want to be ready when their child will need financial assistance to purse expensive higher study courses. With a little bit of planning they can secure their child's future with the following three step process.

Investment Planning:
Step one of the process involves knowing firstly how much you will need to save and secondly which instruments are right.

How much to save - Lets say an engineering degree will cost approx Rs.10 lakhs (including cost of tuition, books etc) while an Masters abroad can cost another 20-25 lakhs today. A similar course, 15 years from now, at a 10 % rate of inflation will cost Rs.41 lakhs and Rs. 83 lakhs respectively. Use this calculator given below to find out how much you will need to save for your child's future.

Download Calculator [xls].

Choice of investment vehicle - It is a known fact that cost of education has gone up by a faster rate than general inflation and hence you need to invest in inflation hedged assets ,preferably equity. Simply because a plan is called a child benefit plan, doesn't make it the best plan for your child's future. Consult a financial planner and like in any other investment choice, choose the most cost effective investment option. My general recommendation to parents is that a SIP in a regular balanced fund or in a mix of debt and equity will be adequate .Avoid insurance products and debt heavy products.

A reminder - Investment planning for children should always be priority number two on your goal list coming after you have planned your own retirement, medical fund etc. There always is the option of taking education loans, an alternate source of funding for education that is not available for retirement needs. Also your child may take up career choices that do not require all the outlay you planned for .Contrary to this retirement is a definite and known event and resources required will not vary significantly from your financial plan.
Risk cover:
Young parents either ignore the need of covering their child's future with insurance or end by buying expensive child insurance policies that do not work best for them. Cover your life for a sum equivalent to current costs of higher education with a simple term cover. Insurance should also include medical, disability and critical illness covers. This will ensure that at no point will you have to use your child's fund for an unexpected contingency.
Estate Planning:
Today families no longer live jointly and common meeting grounds are few and far in between. In the tragic event of loss of both parents, a child needs a caretaker and guardians to not only manage his parent's estate, but also to look after his well being till he/she attains majority. A close family member, preferably a sibling or close family friend should be appointed guardian of your child in your will. You must also and seek their consent for appointment as guardians to your children. Such appointed guardian will be the custodian of your wealth and caretaker of your child/children till they attain 18 years of age.

Vacation home - from an Investment Point of View

2011-07-25T23:55:00.000-07:00

We all love the idea of home away from home. Away from the pollution and fast life of the city, a vacation home seems to be a perfectly romantic way to spend a weekend every now and then. But are they really good investments?

To evaluate a vacation home as an investment option, consider the following

Liquidity - Vacation homes are tough to sell. The developer from whom you may be planning to or already purchased the apartment can use several marketing tools like advertising in national dailies, attractive brochures and events to market his homes. You on the other hand have no such resources except utilizing the services of a broker. Think in terms of future demand or rental demand and the investment prospect looks less rosy.
Transportation - A back breaking, nerve wreaking joyride is not something you would look forward to after a hard week at work .Your location needs to have good roads or other means of transportation like railways that will take you there without stress and in a comfortable time frame.
Amenities - Basic amenities like power and water supply are issues when it comes to vacation homes. Unfortunately most locations do need facilities like generators, water harvesting and the likes. A large complex with benefits like a club house, mini hospital etc is preferable to smaller standalone projects. But you will pay for these all year around, despite the fact that you may barely be living there for a few weeks.
Protection and insurance - An apartment locked away at a far away destination is at greater risk of theft and break-ins. You will have to buy insurance for the same. If you buy land then protecting your land from encroachments is a constant challenge. Another important point is that most vacation homes are fraught with risks like problems with environment clearances and unclear title deeds. Getting documents checked by a competent legal expert is necessary.
Maintenance - A vacation home will need the same care and attention of your primary home. Apart from regular maintenance you will have to spend on house keeping too. Some developers /property management companies are offering fully serviced apartments, but these come with a hefty price.

You can compare the costs involved in buying a vacation home with the option of simply putting you money in a bank and going on vacations to a choice of destinations ,fully serviced hotel rooms with food and drinks and all amenities with absolutely no hassles or maintenance costs.

Unless you intend to utilize the property frequently and for long periods at a stretch, or intend to live there post retirement, a vacation home will be a white elephant. You can try renting out the apartment during weekends to tourists, but in my opinion the logistics of managing such business is a put off. Over time your property may appreciate in value but such appreciation will be lesser than a similarly priced property in a far flung suburb of your city where there will be growing rental demand. Not to mention it will cheaper to pay for holidays as you go rather than make large investments in a property that you will rarely use.

Finally don't get swayed by guaranteed return assurance from some developers. Coming from the builder/developer community, I assure you they mean nothing. Try finding out how they plan to pay the guaranteed money and you will get your answer.

Buy a vacation home by all means, but not as an investment. It can at best be a personal asset that you utilize for family outings but definitely not with an idea of getting investments returns.

Rent versus buying a home:

2011-07-12T07:48:00.000-07:00

First time property buyers face the dilemma of whether it would be more prudent for them to buy property or continue living on rent. Indeed it is cheaper to rent a house for a lesser amount than the EMI. You could invest this difference between the rent you pay and the EMI, let it grow and later on buy a house. On the link below is a calculator that allows you to compare the two options and see which one is beneficial for you.

https://www.ppfas.com/research/ereports/week/110711/rent-vs-buy-calculator.xls.

For most young couples buying a house will always be the better of the two options even if it means paying EMIs over long periods of time. The benefits of owning your home are

-You are investing in a growing asset

-Your income will eventually increase and accommodate the EMIs far more easily than they appear to in the beginning of the loan period

-Finding new apartments to rent every two to three years is time consuming .The inconvenience caused to family specially when there are young children and when both spouses are working, needs to be considered.

-Rents will rise every other year and eventually there will be little difference between EMI and rent.

-There are a lot of emotional considerations for buying your own house and that takes precedence over the financial ones especially when it comes to your first home.

Renting is a good option in the following scenarios

-You have been posted in a city other than that of your permanent residence for work reasons and don't intend to live there for long.

-Your rented place offers you a very tangible benefit. For example saving in commuting time and hence better productivity at work or networking. If living in an location where u cannot buy but only rent, offers you a chance to grow your business or move up in your career then you might as well ignore the financial costs of renting. After your entire career is a far better and bigger investment than any other.

If you fall into the must rent category I suggest you could still consider buying a first home. Such property could be in a cheaper location or of a smaller size. You could even rent out this property, thus creating an alternate income stream.

Some financial dos and don'ts when buying your first home

Do not take personal loans or take a loan against insurance policies/stocks etc, fund the stamp duty/down payment and cost of doing up the home interiors. Save for these in a planned manner. Buy a home that fits your budget and loan paying capacity. Over leverage will only cause damage to your peace of mind and ability to service these debts

Do not exhaust your emergency fund- you must have three to six months expenses and EMIs in a bank FD and liquid mutual fund

Do buy adequate life, medical and critical illness cover while taking a loan

Use bonuses, increments to prepay loan. Even paying two extra EMIs a year will bring down the tenure of a 20 year loan to 13 years. Your priority should be to repay the loan before committing to long term savings

Being Realistic About Equity

2011-06-28T04:43:00.000-07:00

My client was concerned. After five years of systematically investing in equity funds his IRR or annualized return was a mere 7%. He isn't sure if investments in equity mutual funds are right for him anymore. Many investors started off with SIPs in equity under the notion that they are entitled to a 20-25% return on a compounded basis and anything below this is too poor.

Despite years of market experience behind us , investors seem to have very unreal expectations from equity investments . Unfortunately many also tend to shy away from equity investments when such expectations are not met . Equities are the best long term assets to invest in provided you are clear about the time frame of investments, expected returns , portfolio quality and lastly whether your financial situation allows for such long term investments.

Being Realistic about the Time frame - Every analyst or fund manager would tell us that we need to give a minimum 3 to 5 years while investing in equities. Five years is a reasonably long period, but in the equity world it is the shortest possible time frame. Indeed as financial planners we always allocate higher equity investments to goals that are the furthest away in time, possibly 10 to 15 years away. One could trade for short term gains, but that is speculation, not investment, and beyond my scope of advise .

Being Realistic about returns - When risk free bonds (10 year G SECS) offer 8% return, equities should offer returns in excess of this by a number called risk premium. In India historically this premium is in the range of 6%to 7%. This in turn means reasonable range of expected returns in equities is between 12 %to 15%. Yes there are years in which you could see a 25% return, but this is abnormal and the return will eventually revert to the mean return range of 12% to 15%.

Realistic assessment of the quality of your portfolio - If you are stuck with a bad fund manager, or a poor quality portfolio it is unlikely that even a 12 to 15% return will be achieved. Lets say you have an infrastructure portfolio consisting of real estate and highly leveraged infrastructure stocks that have lost 3/4th of their value since 2007. Even waiting for another ten years may not bring your capital back to par. Hence it turns out that you do need a good fund manager or good stock picking skills to achieve reasonable returns in equities.

Being realistic about your financial situation - Lastly equities have to be part of a plan. If you have a huge outstanding loan, or have irregular income flows or an unstable job, you must have a lower allocation to equities. You are more likely to be ruffled by lower returns if all you have invested is in equities and very little in anything else. Having an allocation to debt brings stability to your portfolio and allows you to invest when valuations are attractive. If you don't have debt, then start accumulating some. Allocate equities only to longer financial goals like retirement and wealth building and remember to re-balance periodically.

My client needs to continue investing in equities via SIPs. He must however review his MF portfolio and get rid of some of the thematic funds he had invested in. If he continues investing systematically in diversified well managed funds he is more likely to achieve his financial goals.

2011-06-13T05:15:00.000-07:00

Financial do's and don'ts before you turn entrepreneur

Planning to turn entrepreneur? You have got to be prepared for a period of sporadic to zero income - a world apart from the comfortable space of monthly pay cheques. Financial planning will take care of the crucial transition period in which monthly credits to your bank account will stop. Here are some important dos before taking that long break.

1. Maintain a fund equivalent to the period for which you believe your business will not bring in positive cash flows. To do this you will have to make a budget and plan expenses on both the personal front as well as for your business. Only then can you define a time frame in which the business will start making enough to meet expenses. Add a margin of a few months' expenses to make it safer. If you are planning a break of say two years, you need to maintain at least two years worth of basic expenses in a liquid fund. A Systematic Withdrawal from this fund that will take care of the monthly bills.

2. Ensure you are covered for any medical contingency - An adequate medical insurance for self and family is a must. Add a critical illness cover for both self and spouse and dependants. This will ensure that should there be any unfortunate illness in the family, your business plans will not take a back seat.

3. Pay off all outstanding loans - When you are on your way to taking risks and being your own boss, you would not want to be saddled with loans .In times where cash flows are uncertain, paying loan EMIs can be quite a strain .It is highly recommended that all loans, including home loans be repaid before taking the plunge.

4. Have written contracts when entering into partnerships - For wannabe entrepreneurs the easiest way to lose money in a new venture is get into a partnership and not have a written contract with partners. For example if you take a bank loan all the parties are jointly and severally liable for the loan. Should your partner, for whatever reasons be unable to repay his/her share in the loan you are liable to pay full installment. Similarly should the business unfortunately wind up, the distribution of assets becomes an issue .If you are entering into business with friends or family members, it is highly recommended that the terms of partnership are clearly laid out right in the beginning .

5. Buy insurance to cover business assets - One of biggest mistakes new entrepreneurs make is not taking adequate insurance for business assets like premises, inventory, etc. One stroke of bad luck can bring a young business down for good. Protect your business assets from all foreseeable risks like fire, burglary, floods etc with insurance.

6. Lastly be frugal - You have opted for the road less traveled. It needs making a few sacrifices for bigger gains latter. Being frugal in the initial period would mean, not buying the fancy car you wanted, or buying expensive equipment, or spending on office interiors until your business breaks even and starts making money. Do not make decisions that will wipe out all your savings or leave you with huge debt.

A little planning will help smoothen the transition period from employee to employer. The same holds true even if you are simply taking a sabbatical from work, or taking a course to further upgrade your skills.

Circle of Debt .

2011-05-31T01:04:00.000-07:00

Last week, we received a call from a lady who wanted to get financial planning done for her family. She was a smart and educated woman working as a top executive in a well known company, while her husband was running a successful business. One look at their joint income gives one an impression of an upper class well off couple. However our client wanted to meet us because they were in the middle of a financial crisis. The couple spent a very large part of their income paying off debt in the form of personal loans, EMIs and funding of a very expensive lifestyle. There were no savings while loans and EMIs were related to purchase of gadgets and cars and some land that was turning into a white elephant.

When in a debt crisis, following suggestions could help. They need to be however implemented with a time bound plan.

Restructuring -
You can speak to your bank or creditor to restructure the debt such that they can be paid off over a longer duration or at a reduced rate. Banks /creditors are more than eager to ensure that they get back their money and will help you redo the repayment schedule in way that does not choke your repayment ability. In the worst case scenario you can speak to them for a one time settlement (as in the case of credit card over dues). The creditor will in this case settle for a much lower rate of interest with better terms for you.

Selling Assets -
The first assets that must go are the ones bought on leverage. So the 15 lakh car that you bought on loan must go (even if it means that you lose a couple of lakhs in depreciation). Illiquid land may take time, but the effort to sell at reasonable market prices is important. It doesn't matter that you may be sitting on losses in a particular asset be it property or equities. If liquidation helps bring in positive cash to repay debt, then it must be done. This also means that if you need to sell the house in which you live, then do so. You can always move into a smaller apartment or rented apartment till you swim out of your situation .

Paying expensive loans first -
Costliest loans like personal loans and credit card loans need to go first.

Reducing expenses or increasing income -
Needless to say, you can increase your repayment capacity by either reducing expenses that are discretionary in nature and/or by increasing income. Taking up part time jobs, a second career or having more earning family members are some ways in which one can increase debt repayment ability.

To implement these suggestions, it is important to take the whole family (including children) in confidence. There needs to be firstly an acceptance that the situation is out of hand and then commitment from all family members to a long term solution. Most clients whom I have counseled on debt restructuring and repayments seems to find it shocking that I suggest that they sell off assets. There is a lot of societal and family pressure due to which people shy away from making their situation known. Besides because we work closely with stock markets, the general perception is that a financial planner will conjure funds by taking (speculative) big bets in the stock market.

Paying off debt and getting out of a crisis, requires a lot of financial discipline and the changes in lifestyle can be quite painful. However the peace of mind that a debt free life can give you is well worth the effort. Living within your means and avoiding over leverage are the best ways to avoid getting into a debt trap in the first place.

A 3 step guide to planning your retirement

2011-05-20T22:09:00.000-07:00

This article is an attempt to simplify the process of retirement planning in three basic steps

Step One: Knowing what you will need at retirement and how much to save.

The link given below takes you to a retirement calculator and will help calculate your retirement corpus as well as the amount required to be saved by you to achieve this goal. But before going to the calculator you need to be ready with the following.

1. Retirement Age

2. Your current expenses: Remember to remove expenses related to children's education, EMIs and insurance premiums that you may not pay after retirement.

3. Life Expectancy: Generally financial planners take life expectancy upto 85 years. This is an important input from the point of view of calculating the corpus required at retirement.

4. Pre retirement returns - Based on your past experience with investments or with the help of a financial advisor you could arrive at the returns that you will be able to get from investments during your working life. Remember to incorporate a good asset allocation plan before deciding on a target Pre retirement return

5. Post retirement assets - Post retirement is a time when you will need to start earning returns from your investments. This means that a large part of your savings needs to be in income generating and liquid assets with a higher degree of safely. Asset allocation in the retirement stage may tilt towards larger debt holdings. Return assumptions in this stage must reflect these changes

6. Annual increase in Income - Annual increments, increase in profits, professional income etc mean increased capacity to save as you grow older. When one is young the rate of increase in income is generally very high (sometimes over 25 % annually). This may not last till your retirement age and you may want to take a more conservative figure while inputting this number. Last three years increments could be a good benchmark.

7. Inflation - Your annual money needs are going to increase without a corresponding increase in standard of living thanks to inflation. On an average inflation rate since 1980's have been about 8 %. You can safely assume this to be the rate of increase in expenses.

Input these into the financial calculator link below to arrive at the amount you need to save every year to meet your retirement goals. Note: the amount of savings arrived in the calculator needs to be increased every year by the rate of increase in income.

Financial Calculator

Step 2: Choose your investment vehicles

Shortlist assets in which you would invest to achieve the target pre retirement return. As always if your retirement is more than ten years from now, a large allocation to equity is always a good idea. I recommend real estate too, provided your savings are large enough to accommodate the extra EMIs. Within asset classes choose the right vehicle, be it mutual funds, portfolio management schemes, bank fds or insurance.

Step 3: Rebalance and review periodically

The probability of achieving your goals is higher if you periodically rebalance your portfolio between debt and equity. Keeping some proportion debt in your portfolio helps you invest in down times and book profits during market highs. Review investments so that you can take timely exits out of the non performing ones and add to ones doing well for you.

Why Retirement Planning Is Important

2011-05-02T04:03:00.001-07:00

When young couples make financial plans, their goals revolve around buying a home, vacations, a car, their child's education and lastly retirement. Almost always retirement is the least prior goal in their plan while the reverse is true for those in their forties. Irrespective of how old you are, retirement is the most important goal to plan for. One of the discretions we make as financial planners is to always put, first emergency fund and then the retirement fund as the most prior goals irrespective of clients own preferences. I am listing a few reasons for doing that -

Our life expectancy is rising: This means that with increased life you need money to last you for that increased lifespan. Our life span has risen from 44 years in the 1940s to 74 years in 2011.That is the average age. Most individuals have a working life of around 30 odd years would have an equivalent number of retirement years. Of course one can work till one dies, but that should happen out of choice, and not compulsion.
We don't have adequate social security: Less than 10 % of our working population has access to provident fund and other retirement funds. Even for those who do, the benefits may not be enough to sustain their current standard of living. The government provides us with neither pension nor medical benefits after our working lives (though it doesn't forget to take taxes on our income for as long as we are working and earning)
Nuclear families: Today educated Indians are not location bound. It is most likely that parents and kids no longer live in the same locality, town or even country. Most of the couples I meet, do not wish to depend on their children post retirement. The breakdown of the joint family system has meant that overheads and general living expenses that was once shared by many family members, has to be borne by self and spouse.
While your returns compound, so do costs: the cost of living and most importantly medical expenses have been rising at a rate far in excess of the increase in our income levels. Unless you account for inflation, in both your choice of investments and in the amount to save, your retirement plan could be going downhill.
No one gives you a loan for retirement: There is no way to fund your lifestyle post retirement except from your own money. Your income streams from salary will shut down and unless you own assets that bring in cash, you will pretty much have to resort to stuff like reverse mortgages (which I consider to be a kind of last resort).

The golden rules of investments apply here as well. Invest early, regularly, adequately and in assets that generate real returns. Being too conservatively would result in an inadequate pool of money for your golden years. This means that assets like equities and real estate make for the best retirement assets.

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Why pay fees for investment advice?

2011-04-05T01:49:00.000-07:00

"Your charges are way too high!" Said my client, when I recommended he get himself a plan made. Every month he would call me to ask about appropriate instruments to put his savings into. As a financial planner I know such advise based on limited information about his financial situation was not only inappropriate but could also be detrimental to his long term wealth. He however was happy that he was earning well, saving regularly and was well versed with investments and hence was ok with the current set up.

I would like to compare investor's relationship with their advisors with that of a patient with a chemist and a family doctor. You go to a doctor for advice, take a prescription to the chemist and buy a product. But hey! You need to pay your doctor a fee and plus pay your chemist a margin on the product purchased. Would it not be really smart to simply ask the chemist for a prescription? He is earning a profit from the product isn't he!

When it comes to money matters, investors seem to prefer advice from an assortment of relationship managers from their bank, their neighborhood insurance agents, brokers and even their tax consultants, whose interests do not lie in creating wealth for the investor. Rather many of these 'Commission based Advisors' push only those products that offer the highest commission to them. They have no idea about your financial situation, nor are they equipped technically to understand the many facets of wealth management. It is easy to see how most bank relationship managers have stopped selling equity mutual funds since upfront commissions have been abolished. Their focus is now on the more lucrative insurance policies, PMS or structured products where commissions/ fees are still high or unregulated.

It is therefore necessary to appoint an investment advisor who advises you based on your unique personal situation on a fee basis. Like the Family doctor who knows your unique health problems, the financial planner knows your aspirations and goals. Advise is unbiased and not commission or transaction based.

A 'do-it –yourself' when it comes to wealth management is absolutely possible for some, but for many it may be a flawed idea. Mastering personal finance requires many hours of research and learning. For most, it's not worth the time and ongoing effort.

In an increasingly complex world as your wealth grows, a financial planner having a holistic picture of your financial health will be able to bring in specialized expertise on various asset classes, tax and estate issues. He/she will help you save not just time in researching and finding out these products, but will also help you save a lot of money by avoiding investment mistakes. Financial planners can also help you remain disciplined about your financial strategies. Even if you know the basics, it's a comfort to know that you have someone keeping watch over your money. None of this can be expected from a commission based advisor whose relationship with you is purely transactional.

Appointing a financial planner is easy given that bodies like the FPSB (Financial Planning Standards Board) offer certifications and list their members online. You could also seek references from friends or family members for a good advisor.

As investors we need to move out of the old world ways of commission based selling and learn to pay for financial advice. If you are been given free advice then you are paying by buying expensive products and the cost of mistakes in wealth management is very high. There is no free lunch.

Don't pay for Investment Packaging !

2011-03-22T00:59:00.000-07:00

It is a well known fact that expensive products like ULIPs and endowment products can considerably reduce your wealth pool over long durations of time. Let me explain with an example. Take two equity funds with 1 lakh each invested in the same portfolios, one being a regular diversified equity fund having a 2 % expense structure while the other being a ULIP product having a 4 % expense structure. Let's assume that equities deliver a 17 % compounded annual return over a 20 year period. The end value of the regular equity fund will be approx Rs.16 lakhs at the end on term while the ULIP product with the same portfolio will notch a mere Rs.11 lakhs at the end of term. The difference in returns is approximately Rs.5 lakhs. With Annuities or SIPs this difference in wealth will only accentuate disproportionately over time. Typically any product that creates a package for you will be expensive. A ULIP is an investment plus insurance package, a MIP is a debt plus equity package, a capital protected structure is a call option plus debt package and there could be many more such examples.

Packages appeal to us because they are convenient, don't require planning (typically most ulip purchases are last minute rush investments to meet the years tax savings target) and almost always are sold as a one point solution to financial expenses that every individual needs to plan for. The most fantastic examples of product packaging are child insurance plans and retirement plans. TV ads lecturing parents on their supreme duty of buying insurance schemes to ensure their child's education needs and a dignified retirement aren't necessarily telling you everything. A look at the details of these products will tell you that these come with huge front loaded distribution expenses. I assure you that you will not like to have these expenses paid from your child's future education fund or your retirement corpus. Don't let creative ads fool you into wrong products. A plain vanilla equity fund along with term insurance will do the same job as a child plan or a retirement plan, at a much cheaper rate.

How do you evaluate whether you are investing in an expensive product? - Unpack it! List the various benefits and find the cost of each benefit ,as if you intend to buy them independently.Let me give you an example of how to unpack a ULIP product. Given your age, say 32 and sum assured, say Rs.10 lakhs ask your insurance advisor to give you a table of investment value. The advisor will give you a table showing investment end value at 6 % and 10 % (as per IRDA guidelines) for say 20 years. For the same sum assured find the price of cheapest term cover. The cheapest term cover for a male of age 32 for twenty years would be approximately Rs2000 annually. The remaining 98000 may be invested in mutual funds assuming 6 % and 10 % for the next 20 years. Find the end value at both rates using Future value of Annuity formula or simply use an excel sheet. You can then see how much more you would be paying for product packaging in ULIP as compared to the unpackaged term insurance plus mutual fund combination.

You can compare almost any packaged product with the unpacked one in the same fashion. Do evaluate the costs /expenses paid by you for the convenience of investing in a packaged product as it has a definite impact on your long term financial goals.

Past performance does not guarantee future results

2011-03-07T09:50:00.000-08:00

What's your opinion on silver? Since equities don't seem to be doing much why don't we switch to gold and silver?" asked my client of several years. This was coming from a client, who had earned rock solid returns from his investments under our PMS, had an asset allocation plan and had benefited tremendously from regular rebalancing of his portfolio. I didn't have an opinion on silver prices. My only fear was that it was moving up too fast for comfort and as an advisor I am averse to suggesting commodities specially ones that have had a speculative run.

It is mandatory for every investment scheme that publishes returns to declare that past returns are no guarantee for future returns. Then why do investors seem to chase those assets that have already had a superb run. Despite years of historical evidence that the best returns are earned when a particular asset class has been badly trashed and at rock bottom, investors seem to care less. There is an enigma about investing in the bubbling asset that escaped their portfolios.

Even if one were choosing equity mutual funds, many investors tend to base their investment decisions based on ratings published by several research agencies. Most of the ratings are based on past performance. You only need to look at a couple of these published issues to realize how easily ratings keep changing and new funds are brought into the top rated list.

Past returns do help in investment planning but should not be the only guiding factor. .Even when using past data you must look at long term data as only this can help you analyze asset attributes in terms of future returns and volatility. In fact looking at returns over market cycles helps give you an idea of performance rather than complicated data like beta, standard deviation or alpha which are widely published. While investing in equity funds you must also consider

1. Scheme objective or principles on which money is managed

2. Costs involved

3. Flexibility in the hands of fund manager to take advantage of market volatility and value.

4. Fund managers tenure with the scheme

5. What factors led to superior performance in the past and if the same conditions will continue in the future.

As you can see not all factors are objective. In long term assets like equity it is very easy for investors to get anchored to past returns. An investor who has had a fabulous 50 % return on equity in the last year need not assume similar returns in the next. Some day the returns will revert to mean. It is best that investors understand this while making financial plans.

If you are investing in an asset on the back of momentum in that asset, be sure that you can time markets and take a timely exit or you can set yourself back by several years in terms of wealth creation. For the majority of us we must let our Financial Plan decide what assets and when to invest in. Have a good asset allocation plan and rebalance portfolio periodically. This is a sure way of ensuring future performance of your portfolio.

Valuation of Property Investments

2011-02-21T01:57:00.000-08:00

Kavitha Menon | kavitha@ppfas.com

Like equity, property purchased for investment purposes needs to be evaluated both quantitatively and qualitatively. Of the most common and simple ways of quantitatively evaluating value of a property is by rental yield. Both potential buyers as well sellers can use this tool to decide on the true price of a property.

Here is how you calculate rental yields

Net Rental Income = Monthly Rental X12
       Less: 1) Rent for the Period Unoccupied
       Less: 2) Brokerage Expenses
       Less: 3) Maintenance Expenses
       Less: 4) Tax payable on rental income
       Less: 5) Repairs and Maintenance expenses amortized

Net Rental Yield = Net Rental Income/Current Property Value

Needless to say a high rental yield indicates an undervalued property while very low rental yields could mean that the property is overvalued.

If you intend to fund the purchase of property with a mortgage loan you could look at how much positive cash flows the property generates for you by doing the following.

Cash In hand = Net Rental Income
       Less: Interest Cost
       Add: Taxes benefits if any (for example 1.5 lakhs tax exemption given on interest payments on a housing loan).

The reciprocal of rental yield is Price to Earnings or P/E, a concept most equity investors are familiar with. Factors like quality of construction, amenities, proximity to commercial space, connectivity, local infrastructure like schools and hospitals have to be taken into account while assigning an appropriate P/E to property. The higher the number of positive factors the more liquid your property is and higher would be the P/E. For example localities that are better connected will command a higher P/E as compared to one in a far flung suburb. This is very similar to stocks where P/E of quality business is always higher than industry averages as investors are willing to pay a premium for well run companies. Similarly high rental yields could mean stability of income flows and appreciation, while zero to low rentals are ok only if there are solid reasons for capital appreciation .

Property investments offer both capital appreciation and rental yields .However just like in any investment, besides evaluating value, a thorough study of risks is a must. Since the outlay is very high you must ensure that your finances, in terms of maintaining sufficient contingency funds, future cash flows etc are taken into consideration before taking the plunge.

Why we fear equity market corrections -

2011-02-06T23:43:00.001-08:00

Asset bubbles have been around for centuries. Although we humans have grown in leaps and bounds in areas of science and technology, when it comes to stock market behavior our instincts are as primitive as ever. As always the ongoing correction and volatility have started sending blood pressures soaring. Investors want to know, to what level will the market correct? How long will the trend last? , will FII dump stocks like they did in the 2008 meltdown? Unfortunately I don’t have the answers .Neither do the gaggle of fundamental and technical analysts offering you their expert views on various market channels .

Corrections are only a mechanism to purge the market of all imperfections and excesses. It is a friend of the value picker and long term investor. Then why do we fear market corrections?

1) We are not sure of the real ‘value ‘of the equity we hold. Let take a little example here. Let’s say you and your friend found two beautiful teak wood tables at 'Chor Bazaar' for Rs.10000. You both realize that this solid wood table is a steal at the quoted price, and that you can easily sell the tables at Rs.30000. You buy one each. You friend unfortunately realizes that he needs the money for an urgent errand and due to his urgent need agrees to sell at Rs.8000. What do you do at this stage?

Panic and put your table on sale too
Offer to buy his table and plan to sell both at Rs.30000
Do nothing , but look to selling your table at Rs.30000

While most of us would choose option b and c, in stock markets we rush to do ‘a’ i.e. sell in panic .Its probably because many investors aren’t sure about the true ‘value’ of their investments. A price quoted on the ticker is not necessarily the right price of your equity and unless in distress there is no reason for you to sell or panic about portfolio losses.

2) We have no asset allocation plan – We can’t time markets peaks and lows. In the absence of an asset allocation plan it is unlikely that you will sell when prices are high. Consequently when the cycle reverses you find yourself unable to buy low because you may be fully invested with little cash available to buy afresh.

3) We were speculating – Sadly many investors may not even believe that they are speculating. Speculation is not only about short term trading, F &O or day trading. Not doing your due diligence before buying a stock and relying entirely on a friend/dealer’s tip even if you intend to keep it for the long haul, is speculating.

5) We Over-expect Returns and Underestimate TIME – Returns from equity do not follow a linear pattern in the short term. If your portfolio grows at 15% to 18 % CAGR over reasonable periods of time (5 years plus) you are on your way to great wealth. You cannot earn 100 % every year, nor can you save your portfolio from losing 20 %-30 % in some years. . If you make ‘reasonable returns in reasonable time ‘your mantra, then market movements will stop bothering you.

So here’s the bottom-line - switch off the market news channel , get an asset allocation plan, reassess the portfolio (take the help of a equity advisor if you must), sell the stocks you bought for speculation and use the correction to switch into quality companies backed by improving fundamentals. For keeping things simple, a SIP with a good mutual fund/stock is never a bad idea. And stop looking at your equity portfolio daily. It never helps