HNI

Caveat emptor or “let the buyer beware” sort of sums up what the markets and economies appear to be telling investors as they go into the year of the dragon after an extremely excruciating 2011. Sovereign bankruptcies and downgrades, enhanced market volatility, persistent inflation, policy inaction, governance issue, rising interest costs, washed out equity markets, the list is long.

Most of those issues had continued to exist in 2012. A guide map for investors in that scenario needed to be more structural than specific, flexible than firm. But those times were not ever lasting times and now we are into 2014 with lot of expectations and positivity.
In bad times, opportunities presented will be plenty and visible. One does not require a steroidal push to search and seize them as in normal times. Price of most, if not all, assets – reacting to the mass reactions – are/will be attractive. More the uncertainty, higher is the probability of bargains. Veni, Vidi, Dormivi (I came, I saw, I slept) should not be the mantras of these times.


Irrespective of times, you should be armed with advice on the sectors/companies/funds where the long term story remain intact, cash in portfolio, conviction to go against the herd, a staggered investment approach, and, above all, a longer term horizon, an investor is well poised to create long term wealth. But you have to commit to action; bottom catching is a notional concept and more dependent on luck than astuteness.

Diversification:
Depending on the state of your existing portfolio, you need to continue following an asset allocation model which is suited to your needs. The various asset classes - equity, fixed income, cash, alternates, commodities, real estate - would have been allocated a proportion by you/your advisor. Review the same for a sanity check and then largely stick to it.
You should always allow yourself a leeway to hold liquidity in your portfolio. It is senseless to lock your own funds which you will not be able to access in case of need or emergency.


Ring fence yourself:
The environment is affecting the areas which lead to wealth creation - business performance, returns on investment assets, compensation uncertainties. Unless you have already done so, bad time is a good time to revisit asset holding/protection strategies for your existing pool.
This should not be a practice of only bad times; even in good times you should revisit your portfolio to maximize the returns. You should act like an exuberant person when it comes to your investments.

Approach debt wisely:
Interest rates, while high, are near its peak levels. Combined with uncertainty facing the environment, loan or credit in a portfolio needs to be reviewed carefully. In spite of high levels, debt could still make sense subject to it being used to create assets and not for consumption, returns from proposed asset purchase higher than cost, debt to total own capital ratio to be comfortable, servicing ability. Any existing debt which do not meet these parameters should be considered for reduction (terms for repayment to be considered of course).

Liquidity:
As briefly mentioned earlier, access to liquidity becomes very important in all the times, whether to meet unexpected demands or take advantage of opportunities. Access to liquidity is different from just holding cash. One should explore possibilities of setting of credit lines on ones assets, which can be drawn upon in case of any usage. You can now also lend the securities in your portfolio and earn yields on them and also create liquidity. Such options would help keeping the ammunition ready for any contingency/opportunity.

Why Mutual funds are the best option for you?




Professional Investment Management:
Mutual funds hire full time, high level investment professionals. Funds can afford to do so as they manage large pools of money. The managers have real time access to crucial market information and are able to execute trades or the largest and most effective scale.

Diversification:
Mutual funds invest in a broad range of securities. This limits investment risk by reducing the effect of a possible decline in the value of any one security. Mutual fund unit holders can benefit from diversification techniques usually available only to investors wealthy enough to buy significant positions in a wide variety of securities.

Low Cost:
A mutual fund lets you participate in a diversified portfolio for as little as Rs. 5,000/- and sometimes less. And there is no entry load now in mutual funds; expense towards management of these kinds of funds is very low.

Convenience and Flexibility:
You own just one security rather than many, yet enjoy the benefits of a diversified portfolio and a wide range of services. Fund managers decide what securities to trade, collect the interest payments and see that your dividends on portfolio securities are received and your right exercised. It also uses the services of a high quality custodian and registrar in order to make sure that your convenience remains at the top of your mind.

Personal Service:
One call puts you in touch with a specialist who can provide you with information you can use to make your own investment choices. They will provide you personal assistance in buying and selling your fund units, provide fund information and answer questions about your account status. Our Customer service centers are at your service and our Marketing team would be eager to hear your comments on our schemes.

Liquidity:
In open-ended schemes, you can get your money back promptly at net asset value related prices from the mutual fund itself.

Transparency:
You get regular information on the value of your investment in addition to disclosure on the specific investments made by the mutual fund scheme.


If you are someone who has accumulated wealth through your job or business or have inherited wealth, mutual funds can provide great solutions to put your wealth to work for you for the rest of your life.

You can create a beautifully diversified portfolio using various categories of mutual funds. These investments will then serve you for various needs at all points in life.


Funds as per your requirement



There are various types of funds available and all the funds serve the different purpose.

For parking of your funds
(Option for savings/current account)


Liquid Funds:

The primary objective of the Scheme is to enhance income consistent with a high level of liquidity, through a judicious portfolio mix comprising of money market and debt instruments. The strategy for liquid funds include investments in short investment horizon, which includes cash assets such as treasury bills, certificates of deposit and commercial paper.

Benefits of liquid funds

These kinds of funds have no lock in period.

Withdrawals from liquid funds are processed within 24 hours on business days. The cut-off time on withdrawal is 3 p.m. on business days. It means if you place a redemption request by 3 p.m. on a business day, then the funds will be credited to your bank account on the next business day morning.

Liquid funds have the lowest interest rate risk among debt funds as they primarily invest in fixed income securities with short maturity.
Liquid funds have no entry load and exit loads.

Returns from liquid funds
Liquid funds are among the best investment options for the short term during a high inflation environment. During high inflationary period, the Reserve Bank typically keeps interest rates high and tightens liquidity, helping liquid funds to earn good returns.

Sometimes liquid funds have even offered higher returns than bank fixed deposits of more than one year, which levy a penalty on premature withdrawal.

How to choose a liquid fund

The returns from liquid funds do not vary much as they invest in similar underlying securities. However, when looking for a liquid fund, the past return should not be the only factor for consideration. Other factors like size of the fund, credit quality of underlying securities and track record of the fund house should also be kept in mind.

To invest your funds in fixed income securities
(Best option for Bank FDs)

Debt Funds:
Debt funds are mutual funds that invest in fixed income securities like bonds, treasury bills, CDs, CPs, Government Securities, NCDs, CBLO, PTCs etc.
Diversification and tax arbitrage are two big benefits for which you can go for these kinds of funds instead of traditional investment options like bank FDs and others.

(It is worth to know that if you want to invest in any kind of “Government Securities”, which are the safest fixed income instruments in terms of credence, as it is having a sovereign rating given by each and every rating agency, you can invest in it only through MUTUAL FUND)

Government Securities (G-Secs or Gilts)
Like T-bills, gilts are issued & auctioned by RBI on behalf of the Government. These instruments form a part of the borrowing program approved by parliament in the finance Bill each year (Union Budget). Typically, they have a maturity ranging from 1 year to 30 years. Normally, Government Securities are issued as semi-annual interest bearing dated to market risk. Their prices tend to fall when interest rates rise and their prices go up when interest rates fall. They are also referred to as SLR securities in the Indian markets as they are eligible securities for the maintenance of the SLR ratio by the banks.

The attraction for investments in G-Secs is that they carry the sovereign risk or Zero Default risk and enjoy the greatest amount of safety possible. The returns earned on the government securities are normally taken as the benchmark rates of return and are referred to as the risk free return in financial markets. The risk free rates obtained from the G-Secs rates are often used to price the other non-govt.securities in the financial markets.

With interest rates on bank fixed deposits (FDs) touching 9-9.5 per cent, are you in a fix whether to allocate a part of your investible surplus to the debt fund your financial planner has advised or are you instead tempted to park your money meant for fixed income investment in bank FDs?

I think we forgot to consider tax liability here. So let’s understand the tax implications on both the instruments i.e. FDs and Debt funds.


Liability to pay tax on “Interest earned on FDs”

Many of us who maintain fixed deposits in banks do so out of habit, and often neglect to consider the income we earn from them while calculating our Income for the year. This is a fundamental error that can eventually lead to a notice by the Income Tax department.

Treat interest from FDs just as you would treat income from any other source, e.g. income from rental property. Make sure you declare your FD income conscientiously under “Income from Other Sources” while filing your tax returns. The Form 26AS includes a record of all the TDS payments deducted on your Fixed Deposits. When you file your returns on Clear Tax, Clear Tax automatically imports these entries from the Income Tax Department records.
Remember, FDs will also be taxed at the same rate as the rest of your Gross Income is taxed at. This means, if you are in the 30% tax bracket, you will have to pay 30% tax on your interest income from FDs.

Frequently asked questions regarding taxes on FDs:

Aren’t taxes already deducted on my FDs?

TDS or Tax Deducted at Source is the Income Tax department’s way of automating tax collection, to an extent. The tax on interest from any FD is paid partially via TDS deducted by the bank and the rest is paid as Self-Assessment Tax by the individual.


Banks deduct TDS on interest only if the interest amount for an F.D is greater than Rs.10,000 per year. The rate of TDS deducted by banks is 10% on interest income, provided your PAN number is available with the bank. If the bank doesn’t have your PAN in its records, TDS is deducted at 20% on interest income.

If your total income is below the minimum tax slab (10%), the TDS on FD interest that is deducted by banks can be recovered by claiming a refund for the TDS amount at the time of tax filing.

Alternately, You can submit the “Form 15G” to the bank declaring that since your taxable income for the year will be below the minimum tax slab, the bank shouldn’t deduct TDS on your FD Interest.
 
Senior Citizens are also exempt from paying TDS on FD interest as a special concession by the IT department. They need to submit Form 15H to ensure they aren’t charged TDS on their F.Ds.
 
Individuals in higher tax brackets like 20% or 30% need to pay Self-Assessment Tax over and above the TDS deducted on their interest income.
 
Let’s understand this with an example.
Ashok belongs to the 30% tax bracket and he has an FD with a Bank of Rs 10 lakhs that gives him a 9% interest per annum. So, the interest he earns on the FD for the current financial year is Rs. 90,000 (Remember, banks tax FDs at 10% only)
 
Now, Ashok is liable to pay tax on the interest he earns at the same tax rate as he pays for his Gross Income.
 
Hence total tax Ashok needs to pay on interest earned = 30% of Rs.90,000 = Rs.27,000
 
The Bank deducts TDS of 10% on interest income = 10% of Rs.90,000 = Rs.9000
 
Therefore the balance tax payable by Ashok as Self-Assessment Tax is 27,000 – 9,000 = Rs. 18,000.
 
When to Pay Tax on Interest Income?

Banks deduct TDS on interest as and when interest is accrued, not when interest is paid out. This TDS deducted reflects in your Form 26AS automatically. Hence to prevent confusion in the Form 26AS, it is advisable to pay Self Assessment Tax on your interest income (if applicable) on a yearly basis, and not when the FD matures.


Liability to pay tax on
“Gains generated by investing in Debt Mutual Fund”


 

 

 

Budget 2014 appears to have struck a cruel blow to debt mutual fund investors and distributors. Here is the latest version of the debt mutual fund vs. fixed deposit calculator to evaluate the utility of debt mutual funds.

The finance minister in his budget speech said,
 “In the case of Mutual Funds, other than equity oriented funds, the capital gains arising on transfer of units held for more than a year is taxed at a concessional rate of 10% whereas direct investments in banks and other debt instruments attract a higher rate of tax. This allows tax arbitrage opportunity. This arbitrage has hardly benefited retail investors as their percentage is very small among such Mutual Fund investors. With a view to remove this tax arbitrage, I propose to increase the rate of tax on long-term capital gains from 10 percent to 20 percent on transfer of units of such funds. I also propose to increase the period of holding in respect of such units from 12 months to 36 months for this purpose”.
Does this mean fixed deposits are better than debt mutual funds? Not quite.
The government wants to remove the tax arbitrage that now exists for debt funds.
This seems to be wrong. The 10% without indexation is no longer available. Only the 20% with indexation option is available. Only big blow is that now to take an advantage of indexation, you need to stay invested for more than 3 years.
Let us now find out which instrument is more beneficial.
Let us consider an investment of Rs. 10000000
Fixed deposit interest rate: 9%
Debt mutual fund CAGR: 9%
Tax Slab: 30%

 

 

FD

Debt Fund

Investment Amount

10000000

10000000

Rate of return

9%

9%

Tax rate

30.9%

20% with indexation

Pre tax amount after an yr

10900000

10900000

Post tax amount reinvested after an year

10621900

10900000

Pre tax amount after 2 yrs

11577871

11881000

Post tax amount reinvested after 2 yrs

11282476

11881000

Pre tax amount after 3 yrs

12297899

12950290

Post tax amount withdrawn after 3 years

11984133

12879656

Total gain in 3 yrs on 1 Cr

19,84,133

28,79,656

We have assumed the average inflation of 3 years at 8%
Here you can see that your post tax return is approx 9 lakhs more in case of debt fund on an investment amount of 1 Cr, even if both the instruments have generated the similar rate of return i.e. 9% pre tax.
Two things are very clear from this table.
1, When we talk about FDs, gains here are considered as an interest income. So while computing tax, interest income will be added into “income from other sources” as discussed earlier and taxed as per your tax slab.
2, When we talk about debt funds, gains generated here are considered as a capital gain. So you will be able to take an advantage of indexation [while considering indexation, one has to pay tax only on indexed cost i.e. “real income”(rate of return – inflation rate)].
Let’s understand it in a better way.
What is cost inflation index? Why is it important in calculation of capital gains?

  • Cost inflation index is the most important set of figures that one needs when computing capital gains tax. It is an index that is released by the government every yea
  • Cost inflation index and its use in computing capital gains tax
  • The index helps to compute capital gains tax. Capital gains tax is nothing, but the tax that you have to pay on sale of a capital asset like real estate, gold etc

Lets cite an example...

Say you purchased a flat in Mumbai for Rs 10 lakh in 1990 and sold the same at Rs 50 lakhs in 2014. Now, you have made a cool profit of Rs 40 lakhs from sale of the apartment. This does not mean that you have to pay tax on the entire Rs 40 lakhs. Since, inflation from 1990 to 2014 has escalated the cost of living you have to arrive at a fair value.
The table below shows you the cost inflation index.
So, in the above example the Indexed Cost of Acquisition = (Actual cost of purchase) x (CII Of Year of Sale)/(CII of Year of Purchase).
Therefore the indexed cost of acquisition in the above case would Rs 10 lakhs x 939/199 = Rs 47,18,592.
Therefore you would pay capital gains as follows: Sale price - minus indexed cost of acquisition = Rs 50,00,000 - 47,18,592 = Rs 2,81,400
Therefore the capital gains would be 20 per cent of Rs 2,81,400 = Rs 56,280
Table with Cost Inflation Index since 1981-82

 

Year

Cost Inflation Index

1981-82

100

1982-83

109

1983-84

116

1984-85

125

1985-86

133

1986-87

140

1987-88

150

1988-89

161

1989-90

172

1990-91

182

1991-92

199

1992-93

223

1993-94

244

1994-95

259

1995-96

281

1996-97

305

1997-98

331

1998-99

351

1999-2000

389

2000-01

406

2001-02

426

2002-03

447

2003-04

463

2004-05

480

2005-06

497

2006-07

519

2007-08

551

2008-09

582

2009-10

632

2010-11

711

2011-12

785

2012-13

852

2013-14

939

2014-15

1024


So best way for investing in fixed income securities is through mutual funds, where you are benefited from diversification, tax benefit and capital appreciation.
For creating wealth over a period of time

Equity Funds:

a. General Purpose

The investment objectives of general-purpose Equity schemes does not restrict these funds from investing only in specific industries or sectors. Hence these funds have a diversified portfolio of companies spread across a vast spectrum of industries. While these schemes are exposed to equity price risks, diversified general-purpose equity funds seek to reduce the sector or stock specific risks through diversification. They mainly have market risk exposure.

b. Sector Specific

These schemes restrict their investing to one or more pre-defined sectors, e.g. technology sector. Since they depend upon the performance of select sectors only, these schemes are inherently more risky than general-purpose schemes. They are best suited for informed investors who wish to take a view and risk on the concerned sector.

c. Special schemes

Index schemes The primary purpose of an Index is to serve as a measure of the performance of the market as a whole, or a specific sector of the market. An Index also serves as a relevant benchmark to evaluate the performance of Mutual Funds. Some investors are interested in investing in the market in general rather than investing in any specific fund. Such investors are happy to receive the returns posted by the markets. As it is not practical to invest in each and every stock in the market in proportion to its size, these investors are comfortable investing in a fund that they believe is a good representative of the entire market. Index Funds are launched and managed for such investors.

Tax saving schemes

Investors (Individuals and Hindu Undivided Families ("HUFs") are now encouraged to invest in Equity markets through Equity Linked Savings Scheme (ELSS) by offering them a tax rebate. Units purchased cannot be assigned / transferred/ pledged / redeemed / switched - out until completion of 3 years from the date of allotment of the respective Units.
The Scheme is subject to Securities & Exchange Board of India (Mutual Funds) Regulations, 1996 and the notifications issued by the Ministry of Finance (Department of Economic Affairs), Government of India regarding ELSS.

Investments in ELSS schemes are eligible for deduction under Sec 80C.An example of ELSS scheme is the “Axis Long Term Equity Fund”, “Reliance Tax Saver Fund”, ICICI Prudential Tax Plan” and many more.

There are some other types of schemes also like “Equity Oriented Hybrid Schemes”, “Closed Ended Schemes” etc.

Something worth to know about Equities