An Introduction to Savings and Investments – Part 1

Managing your money involves optimising your earnings by planning your spending and investing your surpluses wisely. You can manage your spending and savings by budgeting for it and sticking to your budget. A Rupee saved is a Rupee earned. Saving involves certain amount of investment savvy for asset allocation to get optimum returns. There is no magic wand for this, nor does one person’s approach suit all. There are professional wealth managers as well as relationship managers of financial organizations who are willing to manage your surpluses. But you cannot blindly give management of your money to them. They make a living out of the management fees they charge and commissions and incentives they earn. Hence, sometimes they may give you advice which may not be entirely to your benefit. This article attempts to give some tips to young professionals and salaried who have regular investible surpluses, but no clue on how to manage it. It is also meant for middle class folks whose investible surpluses are modest and do not come under the ambit of wealth and portfolio management, where the threshold limits for investments are quite high.



First of all, you have to decide about your financial goal and the time span within which to achieve it. The main focus should be to achieve the goal by allocating money to investments   that provide a hedge against inflation, are tax efficient, and capital invested is at minimum risk coupled with good returns. I use the word “minimum risk” because risk is something that can be mitigated, but not eliminated altogether. Then, there is also the concept of opportunity loss. That is, not selecting the right investment at the most opportune time.Part of your asset allocation should be such that sufficient liquidity is available for unforeseen and emergency situations. The financial goal could be to save for old age, own a house, provide for education of your children and health care for the family. The time span to achieve the goal would be the productive years of your life. The planning has to start at the beginning of your career. Necessarily, majority of us may have to make a modest beginning at the start of one’s career and manage the money ourselves.

Liquidity and return on investment

Do not keep large amounts of money in savings account. On the plus side, it provides you liquidity for unforeseen and urgent requirements. Interest on savings account is tax-free up to ₹10,000 PA. To earn this tax-free interest income, you may need to keep an average balance of ₹2,50,000 PA in the savings account with 4% interest. On the downside, the interest on savings account is 4 to 7% PA, and after adjusting for inflation it has a negative carry. Most of the top banks offer only 4% PA. Some other asset class including bank FD would have given a much better ROI even post tax. So what does one do?

There are several alternatives. One is to go for a sweep account, a variation of  which is also called as flexi-deposit account or unfixed deposit by some banks. Here, any balances in savings account above an agreed amount are transferred to a term deposit account and in case of need the term deposit is broken and money needed is credited to the savings account in what is called as ‘reverse sweep’. The portion of the deposit which is left unbroken continues to earn interest at the pre-agreed higher rate. The amount of deposit which is subjected to reverse sweep is also paid interest for the period run less penalty for foreclosure, if any. Set up a threshold limit for sweep facility based on your expenditure budget. Ensure that swept amount in term deposit does not give an interest income of more than ₹10,000 PA, so that it is not subjected to TDS. This avoids the hassle of getting IT refund or depositing the additional tax based on your tax slab when compiling your tax return at the last minute.

Second alternative is to review your account and create short-term deposits in small round sums (which give you more than 4%) periodically through internet banking based on your expenditure budget. Do not go for auto renewal option and get the maturity proceeds credited to your savings account. You can deploy the term deposit proceeds in better yielding and tax efficient investments, and at the same time you continue to create short term deposits every month. Only, ensure that interest income is kept within ₹10,000 PA on the short term deposits. Many banks offer closure before maturity option for e-deposits through internet banking. In an emergency one can resort to that facility. Hence the embedded option gives you liquidity through internet banking during the tenure of the e-deposit.

Third alternative is opt for an SIP in tax saving mutual funds or Equity Linked Savings Scheme (ELSS) along with e-FD, based on your expenditure budget. This tip is for those who have a much larger monthly income. The bank e-FD will provide you liquidity and you will get tax rebate for money invested in ELSS for the financial year. After each SIP monthly installment completes 3 years you can redeem it and re- deploy the funds. Plus, there will be no capital gains tax. If you have opted for dividend instead of growth, the dividend will be tax-free in your hands. Many people used to park funds in debt mutual funds through SIP since it is perceived to be less risky compared to an equity mutual fund. But the changes in the budget 2014 has made it unattractive.The budget proposes to increase the long-term capital gain tax on debt mutual funds from 10 per cent to 20 per cent. It is also proposed to increase the minimum holding period for debt mutual funds to qualify for long-term capital gains tax to 36 months, from 12 months at present. Many debt mutual funds are taking Systematic Withdrawal Plan (SWP) off the table due to this proposed change. Capital gains arising before completion of 36 months will be added to your income and taxed at the tax rate for the tax slab you are in.

Housing is a necessity as well as an investment option

One of my retired Bank colleagues met me few days back, and lamented the fact that he does not own a house and continues to dwell in a rented house. He said those days when he was younger, house sites under gram panchayat were available @ ₹ 75 per square feet. A 30×40 site in Amruthahalli, Bangalore North could be bought at ₹90,000. Instead of buying a site, he invested his surpluses in NSC, PPF etc. to bring down his tax liability. Where the maturity proceeds of these NSC/PPF etc. have gone, he is not able to recall. Fact is, he never planned his expenditure or investments. Had he invested his money in a site and built a house taking a bank loan, the real estate would have been worth more than a crore and he would have had a house of his own, instead of being at the mercy of landlords. In the fag end of his career, at the time of retirement, he would have also got tax rebate for residual housing loan liability (interest plus principal outstanding). He tells me he had to pay tax on his leave encashment and he finds that a large portion of his pension goes for rent.

Moral of the story is, do not look for immediate tax gain by making long term tax saving investments. But if you have the margin money, and sufficient surplus after meeting EMI, take a housing loan and create an asset which gives fantastic capital appreciation compared to any other asset class and gives tax relief to boot! The pride and security in owning a house is a bonus!

A bundled product in housing providing life insurance cover

Some banks provide a bundled product of life insurance plus housing loan. The insurance premium will be charged upfront and premiums will be recovered along with housing loan EMI. The advantage is that you will not feel the pain of paying the insurance premium at one go, but you have a triple benefit. Insurance premium paid qualifies for rebate u/s 80C of IT act. In the unfortunate event of death of the borrower, the insurance proceeds will clear the loan without causing a financial burden to the bereaved family. Lastly, you end up with long term savings through maturity proceeds of the policy in your sunset years. I would advise you to go for such a bundled product, as advantages are manifold.

Even though it may appear comparatively more expensive, it is always safer to invest in projects of top builders. The construction will be of better quality and they also provide you the completion certificate from the BBMP. Resale value of such properties is also much higher. You can also avail IT rebate on Pre-EMI for 5 years after the possession of the property.

Investment in equity shares and mutual funds

Among all asset class the risk reward ratio is said to be tilted in favor of the stock market. But as an investor one should look at stock specific returns and not the index. If you must invest on your own, rather than through a mutual fund, invest in frontline stocks that have a consistent dividend and bonus record, are not high beta stocks, have professional managements and engaged in sectors which are not purely cyclical. Be a long term investor and do not be swayed by daily price fluctuations. Warren Buffett principle of investing in beaten down stocks in a market downturn is a good way of entering the market. Many small investors make the mistake of entering when markets are high and rue the fact when markets go down. You need to zero in on a good stock, track it over a period and buy when it is down.

But understand one thing, the dividend yield on frontline stocks is low. What you should look for is capital appreciation, increased dividends and bonuses. A friend of mine had 5000 shares of an FMCG company which he was holding since more than two decades. His original investment was ₹4800 for 100 shares which grew to 5000 shares due to bonuses and share splits. In 2003, he felt that it was a widows share with prices moving in a narrow groove up to ₹180 or so. So he sold off his entire holding. Today the price is ₹740. I have not factored the high dividend payouts. The moral of the story is investing requires patience. Do not listen to stock tips and alerts. I have come across tips from 2 different brokerages on the same day, one advocating a  buy on a company share and another advocating a sell on the same share. This is mighty confusing to a lay man. I remember one stock analyst saying about 7 years back that an automobile company shares are a dud investment and only good thing about it is, its subsidiary which was a major IT company. Eventually the subsidiary became an independent listed company, and the automobile company re-invented itself through product innovation in a niche segment of SUV / MPV and tractors and gave bonuses and handsome dividends and stock price has since moved in one direction — Up! One should take a long term view as an investor.

Instead of directly investing in stocks one should look at investing in equity mutual funds. As the advertisement says, mutual funds are subject to market risks. But in the hands of a good fund manager, you can hope to see your investment give a handsome Compound Annual Growth Rate (CAGR). Invest in growth funds rather than dividend payout. Invest in funds having high NAV rather than low NAV. Do not invest in funds whose investment rationale you can not understand and are more risk prone. A good example is a contrarian fund.

Small savings can be lifesavers

PPF, NSC are very popular small saving schemes. These are long term investment options for the salaried as well as HNI, from a tax angle as well as returns angle. Every HNI should have a PPF in their portfolio.

In PPF one can invest a minimum of ₹500 up to a maximum of ₹1,50,000 any time during the financial year. The annual investment is deductible under section 80C of IT act. The interest on PPF is currently 8.7% PA accrued yearly. The interest is tax free. It cannot be attached by a court. The maturity proceeds of PPF is wealth-tax free. The tenure of a PPF account is 15 years. Withdrawal from PPF accounts are permitted after 5 years. One can also take a loan on PPF balance after one year for specific purposes like investing in a house property. You need not go to a post office for opening a PPF account, as account can be opened with designated bank branches and give standing instructions for transfer to PPF account. Nomination facility is available. This savings instrument gives you the benefit of compounding interest. It is advisable to invest in this scheme for a rainy day. I recommend this to HNI  because of the tax break and the high return.

The current budget proposal includes introduction of NSC with attached life insurance cover and reintroduction of KVP. The scheme details are not yet announced. KVP was earlier withdrawn since it had no investment ceiling, no TDS and it was a bearer bond. It will be interesting to see how the scheme works. Too early to comment on merits and demerits of these new small savings options.

Conclusion

A subject like this cannot be covered in a single abridged article. One can go on about several investment options like debt market securities, tax free bonds, hybrid instruments, recurring deposits, structured products, overseas investments, IPO, gold etc. Some of these investment options will be covered in the later articles. Watch out for it!