Infrastructure Bonds - IDFC

Recently IDFC announced public issue of long term infrastructure bonds up to Rs. 3400 crores. These bonds are classified as “long term infrastructure bonds” and are issued under terms of Section 80CCF of the Income Tax Act. Thus investment in these bonds will be eligible for deduction equivalent to the amount invested, subject to maximum of Rs. 20000, from the taxable income. This deduction is over and above Rs. 1,00,000 deduction available under Section 80C.

Issue Details:

The bonds will be issued in four series:

Series	Interest Rate	Interest Pymt.	Buyback Option
Series 1	8.00%	Annually	No
Series 2	8.00%	Cumulative	No
Series 3	7.50%	Annually	Yes
Series 4	7.50%	Cumulative	Yes

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The bonds have the lock in of five years and are proposed to be listed on NSE and BSE on which they can be traded after the lock-in period.  Buy-back option is available after 5 years.  They are fully secured and are rated LAAA by ICRA, indicating highest level of safety.  Interest received is taxable as interest receipts.

The issue is open for subscription from September 30, 2010 till October 18, 2010. It seems to be on first come first serve basis and it is advisable to invest early, in case one is planning to do so.

How to invest?

As per the prospectus, the application forms can be obtained from the company, lead managers, lead brokers or any other broker who is the member of BSE and NSE. Hence it seems that you can get the application forms from your neighbourhood broker.

Whether to invest in this?

The investment gives tax deduction to the extent of principal investment, subject to maximum of Rs. 20,000. Taking the tax benefit in to account, the effective interest rates becomes attractive.

Series	Coupon Rate	Effective Interest Rate*
Series 1	8.00%	11.58%
Series 2	8.00%	11.58%
Series 3	7.50%	10.85%
Series 4	7.50%	10.85%

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*Assuming tax slab of 30.90%

IFCI had earlier issued similar bonds in August 2010 and their coupon rate was 7.85% (with buyback option) and 7.95% (without buyback option). Besides, IFCI and IDFC, LIC & L&T Infrastructure are also planning to raise funds through such bonds. The interest rates for such bonds must be in line with government security of similar maturities and since interest rates are expected to rise in next 6 months horizon, the coupon rate of future issuers may be a slightly higher than IDFC and IFCI issues. However, the difference may not be much.

One must avail Section 80CCF benefit of Rs. 20,000. He may think of investing the entire Rs. 20,000 in one issue or can split it between two issuers.

Suggested weekend readings (September 24, 2010)

Suggested weekend readings on Personal Finance.

From September 2010, new norms kicked in for ULIPs. This article from Mint suggest that not much has change and they still should be the last choice for long term investment in equities (link).

Moneywatch on how re-balancing of portfolio works in investor’s interest (link), one of the fundamentals of portfolio management, which will be covered in more detail later in this blog.

No-nonsense article on age old principle of goal based investing (link) and a hilarious conversation on financial advisory (link). Courtesy: Subramoney

Have a happy weekend.

Where do I invest my savings? [Part 2]

This is continuation of my earlier blog post on investment avenues for retail investor. You can read Part 1 of this post here.
  
7. Exchange Traded Funds or popularly known as ETFs are funds which invest in benchmark index in the same proportion as its constituents. Their performance is similar to the benchmark they track. Since the composition of ETF is similar to the benchmark, they have low tracking error (the difference between ETF’s return and the benchmark’s return) as compared to equity mutual funds and also have low operating cost. It is good investment alternative for those who are not able to choose between various mutual funds or who do not want to bear the risk of fund manager’s performance.

8. Mutual Funds: Whenever any financial advisor approaches retail investor to invest in mutual fund, the investors assumes it to be an equity investment. However, there are mutual funds which invest in debts, mutual fund which invest in equities and also mutual fund which invest in both debt and equity. The debt funds are further divided into short term, medium term or long term depending on their time horizon. Similarly, equity funds can be sector specific or index funds. Thus within mutual fund there are various alternatives available to suit the investment and risk profile of the investor. Moreover, due to various regulatory changes carried out in last one year, mutual funds are now more transparent and cheaper with elimination of loads and curtailment of asset management fees which can be charged by fund houses. An investment in mutual fund which is more than a year old also gets preferential tax treatment. They are easy to invest and liquidity is not a problem.

9. Gold: One should view investment in Gold as a hedge against inflation rather than as wealth-creation investment. It is a type of insurance which will protect you in case the entire financial market crashes. Hence it should form small part of one’s portfolio. 

Real estate (other than the home where ones resides) should also form part of investment avenues but at a later stage of life, once a fair amount of financial corpus gets accumulated. Equity investments should ideally be in the form of mutual funds or ETFs investments, unless one is expert in individual stock picking.

Your suggestions are welcome.

Where do I invest my savings? [Part 1]

Indians, traditionally, are good savers. As per the latest Economic Survey of India, household savings was 22.6% in 2009-10 and has now been stable for past three years. This means Indians, on an average, saves roughly ¼ of their earnings. 

However, the good part ends here. Most of these savings (roughly 50%) goes into fixed deposits and savings account. There is nothing wrong in parking your funds in fixed deposits however; fixed deposits are not an ideal instrument for long term savings. They are capital-protection investment and not wealth creation investment avenues. They provide minuscule returns after adjusting for inflation. And in times like today when inflation is increasing, they offer negative returns i.e. a case where inflation is more than the interest rate. Add to above, the interest earned on fixed deposit is taxable. Hence your actual income after taking into account the inflation and taxes is negligible. On the positive side, it is risk-free and provides liquidity, capital protection and predictability of cash flows.

For long term investment one should look beyond fixed deposits. There are various wealth creation alternatives available which have an ability to provide enhance returns with proportionate increase in risk.  In this post we shall discuss the various alternatives available for an individual investor.  Note that the alternatives discussed here are keeping in mind what should form part of an average individual investor’s portfolio. For high net worth individuals, there may be more exotic alternatives available which are outside the purview of this post.

1. Fixed deposit: The pros and cons of fixed deposits are already discussed above. However, it is better to have funds in fixed deposits rather than in savings account.
2. Provident Fund: It can be in the form of public provident fund (PPF) where an individual can invest up to Rs. 70,000 per annum or Employees Provident Fund (EPF) where employee as well as employer makes periodical contribution. They get preferential treatment in taxation and are good source for retirement savings. It should form part of any individual’s portfolio. The investment earns a good tax-free interest. Generally the rate of interest on EPF is more than PPF, however both have different tenures. 
3. National Savings Certificate (NSC): It provides return of 8% and is virtually risk free. The tenure is for six years and contribution as well as interest earned is tax-free within the limits of Sec 80C of the Income-tax Act.
4. Kisan Vikas Patra (KVP): Similar to NSC, it is risk-free long term investment plan. It provides 8.25% return over an investment horizon of eight years and seven months.  Unlike NSC, premature withdrawals are permitted after two years and six months.  However there is no preferential tax treatment and interest is taxable.
5.  Corporate Debts and Company Fixed Deposits: These are debentures and fixed deposits issued by companies. They are available for the tenure of 1 year to 10 years. Debentures or deposits of good corporate are low risk investments and one can earn higher interest as compare to fixed deposit. Now it is mandatory to list the debenture on stock exchange and is regularly traded albeit with small volumes. Hence liquidity may be a problem for substantial investment.
6. Pension Scheme: Pension plans are offered by mutual funds & insurance companies. However, recently introduced New Pension Scheme beats these plans. As per draft Direct Tax Code Bill, tax treatment for pension plan will be same as that for provident fund .  The investment amount will be deducted from total income, subject to overall limit and will also be exempt from tax at the time of withdrawal. They are good long term investment vehicle wherein your investment is locked till the age of 60 years. It invests part of the money in index funds and it can be actively or passively managed depending on the option you choose.

(to be continued…)

Comments deeply appreciated.

EPF or PPF? – Implications of EPF rate hike to 9.5%

The Central Board of Trustees, Employees Provident Fund (EPF) have recommended an interest rate of 9.5% on EPF for the financial year 2010-11 as against 8.5% which was prevalent for last five years.

The question is whether this rate will be sustainable? Most probably no.

The fund will be achieving return in the range of 8.5% from its corpus and the additional outgo of Rs. 1,600 crores on account of the rate hike of 1.0% will be met by ‘hidden surplus’ cash of Rs. 1,700 crores which was discovered after a comprehensive analysis of EPF scheme’s accounts since its inception. Hence this entire amount will vanish after this year’s interest payout.

Second, a news report says that Company-managed PF trusts, which are required to match the rate declared by EPF, are not happy with this rate hike, since they find it difficult to earn more than 8% and employers will have to contribute additional funds to maintain the interest payout.

Third, the trustees have not yet decided on investing part of the corpus in capital market, which will enable them to achieve higher returns.

All this signals that, unless the trustees agree to park part of the corpus in capital market, it will difficult for them to sustain interest rate of more than 8.5%. Thus this rate hike of 1% will be purely one-time on account of discovering the ‘hidden surplus’ cash.

Which fund gives better returns - EPF or PPF?

Public Provident Fund (PPF), in which any individual can invest up to Rs 70,000 p.a., gives tax-free return of 8%. Now comparing that with EPF tax-free return of 9.5% for this year, it makes sense for salaried employees to contribute more (beyond the mandatory 12% of Basic + DA) to their EPF rather than in PPF for this year. So start pumping more to your EPF through voluntary contribution for this year rather than investing in PPF.

One interesting thing to note is historically the rate of EPF has generally been more than PPF.

Interest Rate Comparison

The above chart shows that most of the time the difference is of 50 basis points where as in some years, the gap widens to as much as 150 basis points. One basis point is one-hundredth of a percentage point. This can make substantial difference in a long run. Hence it seems to be beneficial to invest in EPF more rather than in PPF for retirement savings.  Here retirement savings is important, since tenure of EPF is till retirement, whereas tenure of PPF is for 15 years.

In other announcements, the Trustees have decided to hike the benefit under Deposit Linked Insurance Scheme from present maximum limit of Rs. 1,00,000 to Rs. 1,30,000. This is payable to family of employees who die while in service. It will be calculated at 20 times average monthly wages drawn in preceding 12 months, subject to the cap of Rs. 1,30,000. 

The trustees have also decided to close “inoperative accounts” (no activity in preceding 36 months) and no interest would be credited to such accounts. The number of such accounts is approx. 3 crores.

Life Insurance: Necessity for effective financial planning

How do you view life insurance? Do you view it as insurance or as investment or both as insurance and investment product?

Which type of life insurance you have? Is it in the form of pure term plan, or whole life, endowment policies or unit-linked insurance plans (popularly known as ULIPs)?

How much is your insurance coverage? Will it be adequate for your dependents after your demise?

Life insurance, in India, is generally mis-sold. Over the years, agents have encouraged whole life or endowment policies or the latest rage, ULIPs, without understanding the necessity and requirement of the policy holder. Due to skewed incentives to agents and also insurance companies, such policies were popular and in much demand. IRDA (Insurance Regulatory and Development Authority), which is a regulatory authority for Insurance companies, has tried to close such loopholes in its recent regulatory changes. Hopefully, regulatory landscape in insurance will keep evolving to the benefit of the policy holder.

Herein we will look Life Insurance as one of the means of ensuring financial independence. In case, you have just started your employment or you have got married, it is the right time for you to look for life insurance. Listed below are few points one must consider before buying life insurance policy:

•  Life insurance is an insurance contract between you and the insurance company to ensure that your dependents are able to maintain the standard of living in case of your demise. So take insurance only if you have dependents. Mr. Happy, in his 30s, and having no dependants does not requires life insurance.
•  Important - Keep insurance and investment separate. Insure yourself with a pure term policy and manage your investment separately.
•  ULIPS – No. ULIPs combine insurance and investment. Works the same way as if you have pure term policy + mutual fund investment.
•  If you are studying, you do not need insurance. Applies for your children also. Remember the first point. Insurance only if there are dependents. Your children do not have dependents!
•  Similarly if you are already retired, you do not need life insurance.
• The earlier you start the insurance cover, the less premium you pay. Reason the probability of you outliving the policy term is more. Further, your good health works to your advantage.
• Typically your insurance cover should be 12 times your annual expenses or 10 times your annual salary. Do not worry, it will not cost you much.
•  In case you have an existing debt eg. home loan, the cover should be increased by the debt amount.

Compiled below is annual insurance premium for 30 year old male for policy cover of Rs. 1 Crore with a policy term of 30 years for selected insurance providers.

LIC Amulya Jeevan Plan	Rs. 33,600
Kotak Preferred Term Plan	Rs. 15,304
ICICI Pru iProtech (Online)	Rs. 10,900
Aegon Religare iTerm Plan (Online)	Rs. 10,400*

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* for policy term of 25 years

Above premium excludes service tax and related cess, if any.

As you can notice, it is beneficial to go for online term plans. They are sold directly by Insurance Company online, thus eliminating agent commissions and paperwork leading to reduction in premium amount.

So, why wait? Get yourself adequately covered by a pure term plan.

Do you know how much to save?

You know that it is important to save from your income. You are aware that you need to save for buying a dream home or a car or for child’s education, their marriage and for your post-retirement period. You also know that savings can come handy in case of emergencies. However, what you do not know is how much to save to achieve all this?

Most of us are always in a dilemma as to whether our present savings will be adequate to fulfil our dreams? On the other hand, few rare species have a different dilemma. They worry whether their savings are more than required and thus are denying themselves from the pleasures of the present!!!

Estimating the right amount to save is the first task of any individual financial planning. This post will try to help you in determining your monthly savings to realise your goals in simple three steps.

First step is to prepare a list of goals which you have set for yourselves to achieve. Divide it into three time zones – 

• Short Term (1-5 Years)
• Medium Term (5 – 10 Years) and
• Long Term (>10 Years)

Also determine for which goals you need to start saving from today.

The next step is to determine the amount required (in today’s Rupee term) to achieve those goals.

With the help of the above inputs, the final step is to derive the monthly amount required to save and invest for each of your goals. You may use this file to calculate monthly savings for your goal. The file assumes an inflation rate of 5% and an average return of 12% on your investment. After incorporating the amount for your goal and the time horizon, you will get the monthly savings required to achieve your goal.

Now start investing the above amount every month. Discipline investing will help you to realise your goal timely.

An example to simplify the above.

Anil, age 25, is currently earning Rs. 60,000 per month. He expects his salary to increase 10% every year and he expect to continue his employment till the age of 60 years. He desires to purchase a four wheeler 3 years from today (short term goal). The cost of similar car today is Rs. 8,00,000. He also plans to purchase a vacation home by the time he is 45 years old (long term goal). He expects such home to cost Rs. 75 lakhs in today’s rupee term.

Incorporating the above information in our excel file shows that Anil need to save Rs. 12,500 per month for 3 years to achieve his goal to purchase a car and additional Rs. 20,120 per month for 20 years for his dream vacation home.

You may think saving Rs. 32,620 per month out of salary of Rs. 60,000 is substantial. But with salary increasing 10% every year, the percentage of saving will gradually come down from 54% at present to below 20% in 6 years and below 10% by 14 years. Still in case one is not comfortable with the high quantum of savings, it can be gradually increased as the salary increases.

Your comments and suggestions are welcome.

The Power of Compounding

There is an Internet story going around about a poet who, due to hard times, was no longer able to feed his family. A King, pleased by his recitation, asked him to name his reward. The poet, pointing to the chessboard said, “If you place just one grain of rice on the first square of this chess board, and double it for every square, I will consider myself well rewarded.” King was surprised by this and asked the poet to reconsider his reward. However, poet was satisfied with this reward.

King ordered his courtiers to start placing the grain on the chess board. One grain on the first square, 2 on the second, 4 on the third, 8 on the fourth and so on. The number swelled to 524,288 grains on the 20th square. When they came to the half way mark, the 32nd square, the grain count was 2,147,483,648 i.e. more than 2 billion and soon the count increased to lakhs of crores. Eventually the hapless King had to hand over his entire kingdom to the clever poet.

The story ends with the moral - “Never underestimate the power of compounding. If you stay invested long enough, it’ll work for you. A small sum invested every month from the beginning of your work-life can lead to a very impressive amount at the time of your retirement.”

The power of compounding can work magic to your wealth. It, along with the benefit of time, can multiply your investment.

Let us consider a hypothetical example of Anil and Sunil. Anil started investing Rs. 5,000 per month from the age of 25 years, whereas Sunil was a spendthrift in his early life and started investing at the age of 45 years. He thought by investing more (Rs. 11,667) till the time of his retirement, he will manage to invest the same amount as Anil till retirement. We assume both earn the same amount on their investment, @ 10% p.a. Let us have a look at how their investment grows.

	Anil	Sunil
Investment Start Age (in year)	25	45
Investment amount p.m. (in Rs.)	5,000	11,667
Retirement Age	60 years	60 years
Profit / Interest rate	10%	10%
Total Principal Investment (in Rs.)	21,00,000	21,00,000
Wealth at the age of 60 (in Rs.)	1,89,83,190	48,35,626

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The difference is startling. Anil’s wealth at the age of 60 years is Rs. 1.90 crores whereas Sunil’s wealth is just Rs. 48 lakhs even though both have invested the same principal of Rs. 21 lakhs till their retirement. Anil’s wealth is little less than 4 times the wealth of Sunil.

The above illustration shows the benefit of compounding and investing early. Ideally one should start investment the moment the first salary cheque is received and should continue it periodically.

To benefit from compounding, start saving right now. Determine the amount of monthly savings required to achieve your lifestyle goals and allocate it to different asset class as per your investment and risk profile. Start investing the monthly savings to these assets class by way of standing instructions to Bank and by authorising your Financial Advisor.

Do not know how to determine your investment and risk profile and the amount of monthly savings required to achieve your lifestyle goals?  Don't worry.  Bachhat will cover all this and much more in subsequent posts.  

Do subscribe to the blog to stay updated.  Comments welcome.

What this blog will be all about...?

Bachhat in Devanagiri language means Savings. Savings are the cornerstone of any individual investment strategy. Each individual should be aware about the amount of savings required to achieve its lifestyles goals. Though being a fundamental requirement, very few of us are aware about the quantum of this amount.

Always, we are in a dilemma as to whether our monthly savings are adequate? Whether our savings will enable us to achieve our mid-term and long-term goals and obligations? Are we jeopardising our hard-earned money by putting it in to Equity Markets and other riskier investment products? Are we at risk of having inadequate funds if we invest only in Bank’s Fixed Deposit? How do we make our investment inflation neutral? There are many such questions about money which every individual faces time and again.

This blog, Bachhat, will try to answer the above questions.

Bachhat will start with basic of investing, finance & money and will gradually evolve in to a blog focussed on managing money. Periodically, it will also cover regulatory aspects and amendments and will highlight its implication on your finances.

Bachhat will predominately be written in the context of Indian Investors; however, it will also cover important events in global economy. The principles of investing and finance apply universally and this blog will draw its resources from global investment arena.

I hope that this blog will help you to manage your finances more effectively.

Your comments and suggestions in making this blog more useful & reader-friendly are welcome.

Thanks,
Vishal