Emergency Fund

In the last blog on Investment Planning I had mentioned about creating an emergency fund. The size of the emergency fund should ideally be equal to 3 to 6 months of one’s monthly income. While liquidity should be given utmost importance, one can also try to earn decent returns from the emergency fund. Today we will explore the various options of maintaining an emergency fund.

Cash: Cash is king in emergency fund. One should keep some cash at home. This is necessary in the event of ATMs running out of cash or during natural calamities like floods where reaching an ATM or bank is not feasible.

Pros: Cash-in-hand can come handy in case of natural calamities or events like demonetisation. It is the most liquid option especially in case of ATMs/banks not available in the vicinity of your residence.

Cons: Cash at home does not earn any returns. Also there is risk of losing the cash in case of theft.

Bank accounts: Bank accounts with net banking facility and debit cards are also a good option. Some banks also provide fixed deposit with sweep-in facility. Sweep-in FDs can be instantly redeemed. There is no lock in period for these FDs.

Another interesting option is of Payment Banks. Payment Banks (PB) accept deposits up to Rs. 1 lakh. In the view of lesser infrastructure costs, these banks offer interest around 7% on the account balance. Airtel Payment bank, PayTM are two operational PBs among the 15 approved PBs. While Airtel pays 7 % interest, PayTM pays 4% interest.

Another option that one can consider is Digisavings bank account by Development Bank of Singapore. Even though this is not a PB, it still offers 7% interest on amount up to Rs. 1 lakh. The only downside of DBS is that it doesn't have any branches and in case of any technical issues it will be difficult to access your funds.

Pros: With most merchants, hospitals adopting the digital payment methods of swipe machines, PayTM etc debit cards, virtual cards are the way to go. Also the underlying balance earns returns.

Cons: Interest earned through FDs is to be added to your income and taxed as per your tax slab. Interest earned through Savings Account is exempted up to Rs. 10000. Income in excess of Rs. 10000 is to be added to your income and taxed as per your tax slab. So plan the amount that should be maintained in the savings account in the view of taxation.

Gold: The yellow metal is all time favorite in the Indian household. Gold is usually bought & stored as gold coins, bars or in the form jewelry. Gold can also be bought in the digital form of Sovereign Gold Bonds issued by Government of India, Gold Exchange Traded Funds (ETFs), through online platforms like Riddhi Siddhi Bullions Limited (RSBL), PayTM etc. While RSBL & PayTM offer the option of converting E-gold to gold coins, Sovereign Gold Bonds and ETFs cannot be converted to physical gold.

Pros: Gold has universal acceptance unlike currency. It can be easily used as collateral to raise funds. And in the rare event of displacement due to war, natural calamity gold can come to the rescue.

Cons: Like cash even gold is prone to theft. Also to safeguard gold one might have to buy safety lockers or rent lockers in bank. Both these options entail expenses.

Debt Mutual Funds with instant redemption: The duration between redemption from mutual funds and amount actually getting credited to your account depends on the type of mutual fund. For debt mutual funds this duration is T+1 where ‘T’ is the business day on which the order is executed. Few mutual fund companies usually known as Asset Management Company (AMC) have come up with option of mutual funds with instant redemption. These are basically Liquid Mutual Funds categorized under debt mutual funds with lowest risk. The returns range from 7-8%. Currently Birla Sunlife and Reliance Nippon Capital provide the instant redemption facility. Reliance AMC provides facility of debit card which is linked to your liquid fund.

Pros: The duration of redemption to transfer is about 30 minutes. This even works on non-business days that are weekends, bank holidays. The rate of return is also slightly higher than FD rates. In case of Reliance fund, redemption order can also be placed using the App of the AMC. More AMCs are expected to follow the suit. 

Cons: Redemption within 36 months of investing are treated as short term capital gains. These are to be added in your regular income for taxation. So each swipe or ATM withdrawal which essentially leads to redemption will be a taxable act.

Arbitrage funds: The meaning of arbitrage is to buy a commodity from one market and sell in other to earn profits due to the price difference. Arbitrage funds are equity funds which spot and exploit the price differences in a stock in various markets to earn profits. They also invest in short term deposits, in absence of arbitrage opportunities, to earn returns.

Pros: As they invest at least 65% of the portfolio in equities, they are treated as equity funds. Redemption within 1 year of investing are short term capital gains and are taxed 15%. Long term capital gains (the gains if the redemption is after 12 months) are tax free.

Cons: For equity mutual funds the duration for redemption is T+3 i. e. 3 days from the order getting executed. So the funds would not be available at short notice as in case of cash. So this option could be more beneficial for people in the higher tax brackets.

So these are the options to maintain the emergency fund. One should use the best possible combination of the various options mentioned above. This will serve the purpose of liquidity and earn decent returns.

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Blogs by वित्तसिद्धि 

Investment Planning

In the last blog we learnt about various investment classes. Now let’s explore what is Investment Planning. Investment plan is like your vacation itinerary where great deal of effort is taken to ensure maximum comfort and joy at optimum expenses.

But before we do that I would want you to know about a very important and integral part of investment planning - emergency fund. Emergency fund simply means an amount kept separately for unforeseen situations. This is a fall back fund to keep your investment process unaffected by the unforeseen incident. You can manage without emergency fund only if you have health insurance, motor insurance, personal accident insurance, home insurance, term insurance and a set of reliable good friends and relatives. But if you don’t, then please maintain an emergency fund of about 6 months of your monthly income. This can be kept as cash at home, in savings account or any other option where liquidity is high.

Now having said that let us start with the steps in investment planning. The investment options available are PPF, fixed deposits, postal deposits, recurring deposits, government bonds, tax free bonds, stocks, derivatives, gold, real estate, mutual funds. That is quite an exhaustive list to choose from. Following points should be considered before zeroing on the investment option:

Goal: If the WHY is clear the HOW becomes easy. So WHY are you investing? Are you investing for buying a home, for your child's education, for upgrading your car, for going on a world tour, for your post retirement life or just to create wealth? Every of the above goals can be linked with the time period to achieve the goal and the priority in your goal list. So someone would prioritize world tour over retirement or vice versa. Defining the goal and deciding the priority is completely dependent on YOU.

Target amount: Once the goal list is finalized, the next step is deciding the target amount. How much would each goal cost you? Let's say you want to buy a new car 3 years from now. A car of your choice worth Rs. 5 lakhs now would cost you more than Rs. 6.5 lakhs after 3 years.

So while deciding the target cost one ought to consider the effect of inflation. Inflation reduces the purchasing power of your money. Do not consider the Wholesale Price Index (WPI) or Consumer Price Index (CPI). WPI is based on the price prevailing in the wholesale markets or the price at which bulk transactions are made. The CPI is based on the final prices of goods at the retail level. But these inflation indicators should not be blindly considered in investment planning. Inflation rate should depend on the underlying expense. For example, the inflation rate of medical expenses is way higher than inflation rate of electronic goods. So inflation rate in your investment plan should depend on the nature of the goal and the underlying goods and services.

Post tax returns: I have deliberately used the term 'post tax'. People usually ignore the tax that will have to be paid on the returns earned on the investment. Returns on investments are classified based on nature of rate of return. If at the time of investment, the rate of return is known, the returns are classified as interest income. If the returns are unknown, they are classified as capital gains. As a thumb rule you can remember that tax rules favor capital gains over interest income. But there are exceptions too. Interest income from tax free bonds, PPF, PF is tax free.

You earn interest income from recurring deposits, company deposits and fixed deposits. Capital gains are earned from real estate, gold, stocks, derivatives, mutual funds. Even though the tax rules might change in the future, one should always choose investment options based on the post-tax returns.

Risk: We usually come across the statement – no risk no gain. In the investment world the word risk is usually related to the safety of the capital invested. So if the investment is risk free, as in case of a fixed deposit, there is an assurance that the capital won't erode and earns some returns. On the other hand in risky investments (or bets), like in case of equities, there is possibility that the capital will be eroded.

One should not think that risk is limited to investment options only. It is also a RISK when you fall short of the target amount of your goal. This might be due to the wrong choice of investments. You might have to let go off the goal or bridge the gap by borrowing. But all things cannot be funded by borrowed money. While you can fund your child’s education by an education loan, no one will lend you for your post retirement expenses.

There is one more facet to risk. What sugar intake is for a diabetic patient is risk for the investor. You might love to eat sweet things but your medical condition won't allow. Similarly you might love to take risk in your investments but your financial conditions won't allow you.

So choosing the right investment option with the right amount to be invested for the right period is an effective way to counter risk. At the end I bring the simplest known formula for you to remember. For goals with time frame up to 3 years go for debt options. For 3 to 7 years go for combination of debt and equity. And for goals farther than 7 years go for equity.

Happy planning and investing!

P S: If you like this blog, please share it with your friends and family. And if you want to reread and share the earlier blogs please use the link given below. In case of you have any queries or you want to share any experience or alternate views do not forget to comment on the blogs.

VittaSiddhi

Where does your money workout?

In the previous blogs we have learnt about various must-have insurance covers. Today we will explore various classes of investments. Everyone might be aware about some or all of them. But we will look at those through a different perspective – the workout way.

So does your money workout? That seems to be a weird question. We sweat out in the gyms and not our money. But I believe that money is like a body muscle and needs some serious workout in order to grow in size. So how can the money workout? I have drawn some parallels between the various investment options and the types of workout.

1) Idling away: Now this is really not a type of workout. As the word suggests it means doing nothing with your money. When you hoard money at home, in lockers or just in savings account (earning at 4% p.a.) the money does not workout at all. It is similar to lying on sofa thinking about all the gyms you can join. So the money muscle does not grow in this case.

Everyone knows the benefits of a regular workout. But only a few take the sincere efforts to actually learn the workout techniques and practise them regularly. The reasons might be pure lethargy, procrastination, lack of time, ‘I am fit’ (dis)belief. In similar way, everyone knows the importance of investments. But very few really take the effort to give the right kind of workout to their investments. The reasons here are quite similar.

2) Yoga: Doing regular Yogasanas and Pranayaam is definitely helpful. It relieves the stress, corrects posture, enhances blood circulation and calms our mind. But this does not build big muscles. Yoga resembles the debt category of investments. Debt is when you lend money to someone and earn nearly fixed interest income. The debt workout (FDs, RDs, Company deposits, Debt Mutual Funds, PPF etc) calms down your money. It does better than just idling away but still lacks in building the big muscles.

3) Daily chores: These are the part and parcel of our daily routines. This may be walking to the railway station, washing your vehicle, climbing the stairs, mopping the floor etc. But these have limitations. They exhaust you. People opine that this is better than doing no exercises. Many use only these ways to workout. Even if the muscles grow, their growth is anything but stupendous.

We can relate daily chores to investors' love for real estate and gold. These form the major chunk of most Indian investors’ portfolio. Some believe that gold and real estate are the only ways to make your money workout harder. You will find many of them boasting how this way of workout grew bigger money muscles. You would often find someone telling you that the value of property bought in 1960's has grown 100 times. But if calculated rationally the growth is just about 10% per year.

4) Weight training: This involves lifting, pulling and pushing heavy weights to build the biceps, triceps, chest, back, shoulders, legs. This is quite draining and if done without proper guidance can lead to injuries and strains. Most youngsters hit the gyms because it looks cool. But sooner the excitement fizzles out and attrition rate increases.

Now this can be compared to equity investments. Equity is your ownership in a business. The business may or may not be listed on a stock exchange. The equity workout of money seems to be cool and something which can be boasted off. Extraordinary money muscle growth is expected in shorter duration. But without proper guidance the strains (read losses) increase and drive away the money from the equity gyms.

Funny enough is the way, a gym goer checks his muscles in the mirrors to actually feel satisfied with the growth. Similar to this, money looks into the mirror (market rise) to check the growth. Few are satisfied but most are dejected. And so the attrition rates are high here. But this grows really big muscles over time. And if continued under proper guidance, it can be highly effective. To cite an example, HDFC Bank has multiplied 30 times in the last 15 years delivering yearly return of 25%. So Rs. 10,000 invested in the year 2000 would have grown to around Rs.2,84,000 today.

But one cannot always hit the gym. Gloomy environment during the rainy season or some sprains may keep you away from gym just like the unfavourable market conditions keep money away from the equity markets. Nonetheless one should continue with the workout.

Also sometimes we feel that the muscle growth has stopped. We then massage our body to relieve the stresses and pave way for further growth. So when the money workout doesn't yield good results over a prolonged period of time, it should be given a massage too. Massage given to money is known as re-balancing where you give the debt work out or engage the money in daily chores or just keep the money idle.

Ideally the money should workout in all the possible ways. So let your money workout vigorously even if you prefer the Yogasanas & daily chores.

Some more Insurances

Hello Friends. In the previous blog we read about the importance of term insurance. Today we would explore about some other types of insurance.

These insurance covers are important for every individual. There is awareness about these but there are misconceptions too. Also the insurance penetration of these is very less as compared to life insurance. So let us explore more.

1) Health insurance: This is commonly known as ‘mediclaim’. This is very popular among salaried employees as it is usually provided as a group cover by the employer. A health insurance cover pays for your medical expenses, if you are hospitalized for more than 24 hours. If you opt for a network hospital the claims are usually settled as cashless claims. But if you opt for a non-network hospital, the expenses are reimbursed by the insurer.

Due to the push given by the central government with launch of schemes, the insurance penetration has increased. But with nearly 70% of the medical expenses being paid out of the pocket, the situation still looks grave.

Usually people covered by employer do not buy personal health insurance. But with one big hospitalization of an insured family member, the other family members are left high and dry. Also the corporate cover would not take care of your expenses if you leave the job or in case of unfortunate loss of job. For the self employed people with irregular cash flows, hospitalization would put pressure on the finances.

So it is always better to buy health insurance even if you are covered by the employer. One can buy an individual cover or a family floater depending on the family size and age. The extent of cover should depend on the city you live in. So someone staying in a metro city should opt for a higher cover than someone staying in a tier 2 city. The more evolved investors might also want to look at critical illness cover which would cover expenses related to cancer treatments, kidney failure, paralysis etc.

2) Personal accident insurance: This is popular among the vehicle owners. This is usually bought along with the motor insurance as a comprehensive package. But should it be restricted to the vehicle owners? I believe it is as important as life & health insurance. While the term insurance pays your dependents on your death, the health insurance pays for your hospitalization. But what if your meet with an accident and are rendered jobless due to loss of a limb? The term insurance would not pay you as you are alive. The health insurance would have paid for your hospital stay and up to 60 days after being discharged. Who would compensate you for the loss of income in this case?

A personal accident policy takes care of you in this situation. It pays for accidental death, permanent total disablement, permanent partial disablement, temporary total disablement, broken bones. The accident does not necessarily mean being hit by car or a bike. You can claim even if you trip down the stairs, fall off from the bicycle etc.

The good part is the premium is not linked to your age; rather it is a function of your occupation. The premium for personal accident cover of 10 lakhs for a person with administrative type of job is well below Rs.1000 per annum. With low yearly premiums this cover is a must-have even if you do not have financial dependents.

3) Home Insurance: This is usually sold along with the home loan. The home loan lender insures the mortgaged asset (your home) from fire and natural calamities. What if the home loan is cleared? What if you are staying in a rented accommodation? Should not you insure your home and/or its contents? The answer is a plain ‘Yes’.

A home insurance covers the structure and its contents from fire and natural calamities. If only the structure is covered, the insurer will pay for the cost of reconstruction. If the contents (domestic appliances, furniture etc) are covered, the insurer will pay for those too. You can also choose to cover your home from burglary too. It is always better to opt for ‘reinstatement’ type of cover instead of ‘depreciated cost’ type of cover.

With the portfolio of Indian investors being heavily tilted towards real estate, one major calamity can pose serious threat to the savings. So it is prudent to insure your home and its contents. If you are staying in a rented accommodation at least insure the contents. Do not wait for the next floods, landslides, earthquake to wake up to an uninsured home.

Finally insurance is a subject matter of solicitation. An insurance product is not a packaged item like soap. It can be suited to the requirements of the buyer. So the obligation of understanding the terms and conditions of the insurance policy lies with the buyer i.e. you.

So these are the basic insurance requirements before you begin the investment planning process.

Are you insured enough?

In the previous blog we read about aligning tax saving investments with goals. If you haven't read it click here. Today we will read about an important step before planning the investments.

So what is more important than planning the investments? It is insurance. But wait, haven't we all bought life insurance as an investment? So let me clarify one thing: insurance is not an investment, it is an expense.

Usually the family insurance agent or the friendly bank executive proposes a tax saving instrument which secures the future of your family and pays you periodically or on maturity. But have we thought who needs insurance and how much should be the insurance cover? Probably this doesn't cross the mind as the focus is merely on the tax saving part.

So who needs insurance? If someone is dependent on you financially, you need insurance. The idea is if you die, your dependents should be able to pay off the debts and maintain the standard of living.

So how much would be enough? Ideally the life cover should at least be 5 to 6 times your gross annual income. So someone with pay package of 10 lakhs should buy a life insurance cover of at least 60 lakhs. Now if you calculate the premium of an endowment, ULIP or money-back policy with sum insured of 60 lakhs the yearly premium would run into lakhs. So should the idea of life insurance be dropped? No. There's a way out. Buy a term plan.

A term plan offers you a higher sum assured for a specified number of years at much lower cost. The premium paying frequency can be annual/semiannual or one time. The annual premium for 60 lakhs cover for 30 year old male will work out to be around 5-7k. The cover is valid as long as you pay the premiums. There are no survival benefits for a simple term plan. It simply means that the term plan has no maturity value.

So why doesn't the insurance agent propose this product? The commissions are very less as compared to the endowment plans. And what if you still insist on buying a term plan? He would convince you that the premiums paid will be waste and you won't get anything back if you survive the term.

But let us think differently for a moment. What is more important - getting meagre survival benefits at higher costs or higher sum assured at lower cost? I would prefer the latter.

And what if you don't have dependents? Don't buy life insurance. So if housewives, retirees, youngsters don't have financial dependents they should not buy life insurance.

There are some more steps before starting investment planning about which we will learn in upcoming blogs.

Till then keep sharing ideas, experiences and alternate views.

Prasad Patwardhan

Look beyond 80C

As the financial year end draws near the salaried people have to submit the proofs of investments to their employer. Often it is called the season of tax savings.

For many of us, investment is equivalent and limited to tax saving products. But have we given a thought whether the products which we use to save tax will help us reach our goals? Or we just 'invest' without giving a thought to what our goals are? Setting a financial goal is deciding how much money is required for what and when.

For those who cannot save and invest beyond the section ‘80C’, it becomes even more important to choose the right products. The 80C category popularly contains our life insurance premiums & ULIPS, contributions to PPF & post office schemes, ELSS etc.

Let us think differently for a moment. Instead of saving tax, should one pay the legitimate tax and invest the balance amount in products outside the gamut of 80C? I believe this can help people achieve their goals. Else the same people fall into the debt trap of personal loans, credit card loans to buy a home, pay school fees etc. Basic calculation shows, for those in 10% & 20% tax brackets the maximum tax saved is 15k & 30k respectively. The interest paid on the personal loans will easily be more than the tax saved.

So give a thought to all these before buying the new exotic tax saving product or paying the hefty premiums.

For the insurance part one should look at term plans. We will learn about this later.

And yes please share ideas, experiences and alternate views.

Prasad Patwardhan

Mental Accounting

Are you prone to mental accounting?

Mental accounting sounds like a mixture of psychology and finance. And indeed it is. It is a part of behavioural finance. Subconsciously we all are prone to mental accounting. So is it good? Or is it bad? Let’s explore.

What is mental accounting?

Mental accounting in simple terms is treating your money differently based on the source and the purpose.

What are the types of mental accounting?

While spending:

People spend every bit of the salary very cautiously. They try not to exceed the budget. As the month end nears, spending reduces.

But compare this with spending the money won through lotteries or annual bonus or tax returns. People simply tend to 'splurge' this money.

In reality money 'won' or 'earned' has the same purchasing power and so needs to be treated equally. Rs.500 of salary will buy the same pizza as will Rs.500 of bonus. But we tend to ignore this fact and fall for instant gratification.

People find it painful to part away with their cash. Compared to this, the use of cards (credit or debit) is ‘painless’. So most people tend to overbuy or overspend by using cards. With many 'use now pay later' schemes designed to promote 'cashless' economy coming up, many of us may fall prey to overspending.

Sometimes people compare the price of products in percentage terms. So the price of accessories of a car may seem only to be a fraction when compared to that of the car. The mind that happily accepts Rs.100 discount on laptop cover, gets easily dejected by the idea of Rs.100 off on the laptop.

While investing:

With easy access to credit many of us may be servicing some kind of a loan. It can be a car loan, a personal loan or a home loan. While servicing the high interest bad loans (loans taken for depreciating assets) the investments are done in low return avenues. So the interest or returns from these investments are eaten up by the interest payment of loans. Effectively money is lost in this process. Ideally it would be better to clear the loans with the highest interest first to earn some positive returns from the investments.

Some people trade in stock markets. Rising markets are cheered. But when markets fall, the profits which could have been pocketed diminish. Investors who lose money, opine that the lost money was never theirs as they had never ‘earned’ those profits. When profits on an investment turn into losses, inexperienced traders tend to hold the loss making bets as they simply cannot write off these bad investments.

The good part:

Mental accounting is about compartmenting money. So when this compartmenting is linked to a particular goal, mental accounting is good. For e.g. if some part of salary is allocated to retirement fund or new home or child’s education, that money is seldom used for other purposes.

When fund of an NGO, charitable trust, educational trust, public exchequer etc. is at one’s disposal it is expected to be used wisely. The person responsible should consciously make an effort to treat this fund as someone else’s money. Mental accounting helps to separate this fund into ‘my money’ and ‘not my money’.

In a nutshell:

Treat you money equally and spend it wisely.

Please share ideas, experiences and alternate views.

Prasad Patwardhan

Have you UPIed?

Unified Payment Interface

UPI stands for Unified Payment Interface. It is an effective way to move towards a ‘less’ cash society. One may even add that it is the most effective way to reduce dependence on Visa/Mastercard/American Express and the closed/semi-closed wallet systems. So let’s explore more about UPI.

What are the pre-requisites?

1) Android smartphone with internet connection (UPI is currently unavailable on iOS, Windows platform)

2) UPI app of any bank/mobile banking app

3) Virtual Payment Address (VPA). This is a unique address which is to be created while using the UPI application. This is just like an email address (e.g. prasad@icici) but an email address for your money.

Steps for Registration:

1) User downloads the UPI application from the App Store / Banks website.

2) User creates his/ her profile by entering details like name, virtual id (payment address), password etc.

3) User goes to “Add/Link/Manage Bank Account” option and links the bank and account number with the virtual ID.

What are the benefits of UPI?

UPI can be used to transfer money to peers, make merchant payments, COD payments (currently available for Flipkart). This is very similar to IMPS but with lesser charges and without the need of account numbers & IFSC codes. You just need the VPA of the receiver or the QR code generated by the merchant. Also the VPA can be linked to any bank account. The money is debited from giver's account and credited to the receiver's account.

The biggest benefit is that the money does not get locked into closed/semi-closed wallet systems like Ola money, PayTM, FreeCharge etc. Since no PoS (swipe) machine is required it can be easily used by small vendors helping them go 'digital'. UPI can easily replace petty cash transactions. The money saved by avoiding PoS machines and consequent charges paid to Visa/Mastercard/American Express can be passed on to the customers.

Add on benefit:

Since you are less dependent on credit cards you are less prone to mental accounting.

Please share ideas, experiences and alternate views.

Prasad Patwardhan