Lesson 6: ELSS – The Elixir of Investments

We saw that mutual funds are really a great way to invest in the stock market (through the Equity Diversified Schemes). But there is one more wonderful thing. You can save on tax as well as you invest in the funds. What more can you ask? The ELSS (Equity Linked Saving Scheme) are Equity Diversified Schemes that offer you tax benefits similar to PPF or your Insurance policies. So get ready for the ride.

This category (tax saving funds) is by no means performing any less than the others. So where is the catch? It is in the liquidity. You are locked in for 3 yrs. So you are eligible to sell the units only after 3 yrs. But the good thing is that since you are dealing with equity (shares), experts suggest that it works out in your favour if you stay invested for minimum 3-5 yrs. So the lock-in is no more than a boon to you as you will not be able to withdraw and it works in your favour.

The returns from these funds are quite good (Since there is a 3 yr lock-in the fund manager is also able to better invest the money without any tension that it might be withdrawn prematurely). Some are phenominal and in the range of 40%. The leaders are “HDFC Long Term Advantage Fund”and “Prudential ICICI Tax Plan” followed by State Bank of India’s “Magnum Tax Gain” and a lot of others. In the last year alone “Magnum Taxgain” gave an astounding return of 140% !!!!! and what more, if you consider the tax benefit of 30% you end of getting 170% return on the whole (This is a specific case and is not likely to happen again. But this shows the capability of shares to give great returns). To put it simply. can you guess how many years it would have taken to get the such a return in PPF (8%) or Insurance (4-7%) . Atleast a cool 15 years !! and that is why I am insisting that part of your investment (portfolio) should go into mutual funds (Of course you must know the current staus of the market and the returns before doing so).

ELSS gives you 30% tax advantage, so when you invest 10000 in such a fund, it means you have already got back 3000 Rs as profit and the rest is just an addition. Cool Isnt it. Your ELSS contribution  will be taken in the 1,00,000 limit (Section 80C) and will compete with your PF, PPF, Insurance and Pension  contributions to get a place in the 1,00,000. But don’t you feel they deserve a place……

Lesson 3: Tax Planning

We will take a quick look at all the tax planning that we can do. I will try to make this simple enough without taxing you too much!!, if you do intend to know everything from top to bottom go to Rediff->Getahead->Money

As per the new budget rule we can save upto 1,00,000 and show them for tax saving. Someone might ask, if I save 1,00,000 how much will I save on tax? For most of us the answer is 30000 in that year or 2500 per month. But truly that depends on how much you are earning per annum.(Tax Slabs).

The next question is where all can I save? You can take an LIC policy (Premiums you pay towards a Life Insurance policy), you can open a PPF account  (Public Provident Fund,70000 max ) , NSS, Post Office Savings, Bonds, ELSS (Equity Linked Savings Scheme – Mutual Funds which offer tax benefits), Pension Plan (10000 max), the amount you pay towards your home loan principal, tution fees (24000 max) of your child and a few more. Please bear in mind that your contribution towards your PF account (If you didn’t know, you and your employer contribute equal amount every month to your pension account) also falls in this 1,00,000 limit.

What else? Is that all? NO. There are a few more things. Over and above the 1,00,000 limit you can save the entire amount on your home loan interest part (principal falls in the 1,00,000 limit), Medical bills (15000 max), LTA, HRA, Conveyance, etc.

Since you have so many options don’t fall prey to some intelligent agent attempting to push you to some schemes that gets his maximum benefit.

Lesson 4: Let us begin Investing

It is always a good idea to read all the Investing lessons in order to get the maximum benefit.

Now that we have understood a lot, let us start investing. But wait. There are a few key points to be noted.

1) If suppose, by any chance you are in to credit card debt then stop the idea of investing and go ahead and clear the debt first. (Credit card debt is one where you still have the balance payment on the card that you should have paid a month ago. That means you have paid only the minimum amount and carried forward the rest. To remind you the interest on the credit card debts is in the order of 30-35%. So if are servicing such a loan and trying to invest your money for annual returns of 10-15% it is sheer stupidity.

2) If you have other personal loans that are very high, again stop and try to close them first. Please note that we are not talking of home loans here. but of other personal loans that do not have tax benefit and also have interest rates of 12-20% range. Of course if you do have a home loan and a car loan but still enough money than go to point 3)

3) If suppose you get expelled from your job today, what would you do? The question may seem irrelevant, but you will know its importance soon. What I am trying to tell you is that you should have enough cash in hand (or in savings account of your bank) for emergency situations. It should ideally be capable of handling your family’s 6 months expenses, but it should atleast be enough for 3 months. This emergency cash should NOT be used for ANY OTHER PURPOSE. Not even for helping others in the same situation. In fact you should never feel like having it. (Think that it is not yours till emergency strikes). Believe me, when it comes to money, there may be none left to help you. (You may not be as lucky as I am !?!)

4) Now, you have cleared all your high-interest debts, you have 6 months expense cashed in for emergency and this is the time to start. But remember another golden rule of investment. “Don’t put all your eggs in one basket” – Diversify it. So even if you feel that it is the best option don’t put all your money on just one investment.

First step] Manage your monthly expenditure. By this I mean that you should be in a position to tell that I would need X Rs every month for the expenses. It is difficult to predict the exact amount you would need each month, but with a small buffer you can easily tell the amount. So the first step is to find exactly how much you will spend each month and so how much will be the balance each month that can be used for investing.

Second Step] Whether married or not, the first step must be Life insurance. Time and again we have been cautioned that the LIC agents will do anything in their power to lure you into some stupid scheme. So the best thing is to take a ‘Pure Term Policy’ for the amount you wish to insure. The premium per annum will be very less.  I have taken Anmol Jeevan from LIC for 10 Lakhs and the premium is just 2890 per year. Great isnt it. You can also go to private players. I heard there is a scheme where the premium is very less if you are a non-smoker.

Third Step] Open a PPF account in some nationalized bank. Put the intial amount of 500 Rs atleast and even if you don’t like PPF at all keep the account alive by putting the minimum of 500Rs (max is 70000) every year. For a risk-averse investor PPF is really good. Currently it is the only investment (as far as I know) where the interst also is tax exempt and the principal has tax-benefits.

Fourth Step] The basics are over now. So from now on, where you are going to invest depends on many other factors also like your risk capability, mentality, need, tax planning etc.

Lesson 1: Investment Basics

One thing that I hate doing is to advice others. Because many don’t understand that the final decision is their’s and end up blaming others for the advise they got from them. But ‘Personal Finance’ is more of a hobby to me and so I decided to pen down a few things here. But I highly recommend those who read this to first do a personal survey before committing on to any decision (and later blaming me)

Let us first try to understand a few things. We all know that Investing is to put our money to work for us. There are many places we can do that. Let’s say we put 10000 in our savings account in ICICI, after one year you will get 350 Rs as interest and so the total is 10350. Pretty Good!!!. But wait there is another factor called inflation. Now what is that? It is the purchasing power of your money. Today for 10,000 you are able to buy a few things, but with price rise (inflation) you will not be able to buy them again for the same money. (We hear from our parents that they were able to run the monthly budget with just Rs.30/-) Your money shrinks in value and that sometimes is as high as 8%. So your 10000 is worth only 9200 (though you will still have 10000 in hand) at the end of the year and add to that your 350 giving you only 9550. Pretty Bad.  Right? The 3.5% we get in savings account is called as annual return. Of course almost every saving instrument gives compounded returns. (Interest of first year will also earn interest in the next year and so on)

Now  we will speak of the risk-return-liquidity ratio. The higher the return, more likely higher the risk involved and/or lesser the liquidity (Liquidity refers to how quickly you can get your money). For example, your savings account is the safest and naturally has the poorest return. But it also offers the highest liquidity (Go to an ATM and get the money, as simple as that). Consider fixed deposits in banks, the risk again almost nil, the return is better than savings (5-7%), but the liquidity is compromised. (You need to wait till the fixed deposit term ends). PPF, or public provident fund. Again the liquidity is compromised (15 yr lock-in, 3 years for loan and 7 years for withdrawal) but returns are better (8% currently) and safety is there (no risk). Coming to the stock market, the risk is very high, but the returns can be phenomenal (12% and above, can even go to 100% or more) and the liquidity is normal (You need to sell your shares).

We saw the risk-return-liquidity with respect to the various saving instruments. But there is another part to it. The risk capability and the liquidity need of the individual. (Simply put, Why are you investing?). Say a person in his 20s may be willing to take more risk with his investments than a person in his 50s. Also two persons of the same age may be totally different with respect to risk capability. One may be married and with kids, while another may be saving for his marriage. Also an individual can perceive risk differently. For some a loss of 10000 may not be a loss at all, while some others can not even think of losing a rupee (I am not talking about the rich and poor but of the mentality). That is why I put a disclaimer at the top. Each of us is so different that one is better off not advicing others. Similarly liquidity needs might differ. Some might be investing to buy a car within the next 2 yrs, while some might be investing for retirement.

The magic called ‘Compounding’. When your interests start earning for themselves, the ripple effect is so high that even ‘Einstein’ was shocked. To understand that let us take two guys. One Mr.A started saving 500 Rupees per month when he was just 25 and continued till he was 50. Another Mr.B started a bit late when he was 35 but saved twice as much as Mr.A did i.e. 1000 Rupees per month till he was 50. When they were both 50, Mr.A had 12,76,758 while Mr.B had 5,70,965 Not Even Half!!!. But why?? What did Mr.B do wrong? He started late… Once I saw this written on a hospital van – ‘Time is Life’ in a Heart Attack. Remember this ‘Time is Money’ in investing. When you hear a tremendous amount being forecasted in an investment, it is 99.99% due to compounding only.

I will discuss a few more topics in detail in the other lessons, but thought it better to put down a few words of relevance here.

‘Investing is not gambling’ – If you think so, stop here and please visit a casino.

‘Investing is not tax planning’ – Very important topic, will be discussed in greater detail in the upcoming lessons.

Lesson 2: Investing is not ‘Tax Planning’

 It is a cruel joke that we spend hours together working for an MNC to earn the best salary in the industry (and we are very proud of it too), but spend very less time and effort when it comes to investing the money wisely. The painful fact is that with prudent investing someone earning half as much as we do can go ahead and get a lot more than us.

For many of us Investing has become synonymous with ‘Tax Planning’. when we land in a job, our parents take up the financial planning for us or so they say. The first thing that they advice is to take up a LIC policy and introduce us to some LIC agent who is their friend. That agent is wise enough to lure us into some policy that is good for him (in terms of the comission that he gets) than for us. And he says you will save so much on Tax. Wow!!! How happy we were to escape from tax. We are not to be complained for such a stupid decision to get some endowment policy where we pay around 65K per year for insuring our life for a mere 10 Lakhs. Wait!! Didn’t the LIC agent say that it will also act as investment since if you are alive at the end of the term you would get 13 Lakhs (Wow!!, but believe me this is all due to compounding and not due good annual return).

Tax has been a deadly word for many of us. I still remember that I could not digest the fact that I was going to pay 1500 Rs per month as tax in my first month of pay. I was totally shocked. To me  it seemed that 1500 was good enough to be someone else salary for a month. Hmm.. But then we learnt the hard truth – There is no escape from the Taxman. This is the main reason that we jump on to anything that says ‘Tax Saving’ not knowing what it is and do we stand to benefit from it.

Now let me show with an example why Insurance / Tax Planning / Investment are three different things entirely. Everyone must be insured. Good and all insurance policies including LIC have tax benefits. But never fall for the tax benefit alone. For example let us assume you indeed take the endowment policy we mentioned earlier for 15 years. That means for all the 15 years you will pay 65k and if you alive at the end of 15 yrs you get 13Lakhs, else your family gets 10 Lakhs. You get tax benefit for the entire 65K every year. Great you thought… But let us consider an alternative. Let us assume that you chose a term policy (Where the money you pay is not returned to you if you are alive Hmm..) for 15 Lakhs. For this you pay per annum only 3600 Rupees (way less than the 65k you had to pay for endowment policy). The remaining money you put in PPF for the same 15 yrs. At the end of 15 yrs if you are alive you don’t get any money from LIC (since it is a pure term policy), but from PPF you get 18 Lakhs. Also both you contribution to LIC and to PPF are exempt from tax (65k) Now you see the difference. No difference in the investment tools, both are very safe, both give tax benefits, but just a 5 minutes thinking would have saved 5 Lakhs !!! for you.

I know there are hundreds and hundreds  of people opting for endowment LIC policy and paying more than 50k without even a second thought just because they are too busy earning their money and they thought that it was the only option to save on tax!! How stupid we have been. Please don’t ever think that LIC is the only key to tax saving. NO. There are many wonderful ways to save on tax. We will take a look at them in the next lesson. Until then, Bye from Simon

Personal Finance – Intro

I really don’t know when such a thing happened to me. My only hobby now seems to be ‘Personal finance’ if you could leave anything related to cricket. I have gone to such an extent that I am able to easily advice others in this. But this hobby is helping me in my life very much. But the only person who is affected because of it is my wife. Whenever I understand something new, I never forget to explain it to my wife and she is the only person who will be willing to hear such things and try to understand as much as possible. In the end she would say, “I don’t need to worry anything related to money.” I started it because I could not help being surprised by one Mr.Iyer Vidhyashankaran’s knowledge on tax. He was also like any other employee of Honeywell, but somehow he seemed to know far ahead of others related to tax and savings. Then I started to read about it all during my after-work hours and slowly I began to understand that it was not that difficult. And after quite some study that included anything related to personal finance from PPF to mutual funds, investing in shares to trend trading, credit cards to portfolio allocation and diversifaction, gold funds, MMFs, realty funds, Pure term insurance cover’s advantage etc, I was able to spot mistakes in what Iyer was saying.
The best application of my knowledge came when I decided to take life cover. I approached LIC agent and he came up with an impressive PDF with my name in it and all the schemes that he wanted me to be involved. It also quoted how much I would receive at the end of 5 yrs, 10 yrs, 15,16, etc. I was thoroughly impressed and decided to shell out 3300 Rupees monthly (Close to 40k per year) on it. Then in only of my evening classes in personal finance I came upon the drawbacks of putting lot of money in insurance and of using insurance as a saving mechanism. So i went ahead and opted for a endowment plan where I needed to spend only 12K per annum and i would get the money that I put in at the end of the term. That seemed ok and so I signed the deal with the agent. After just only a few days, I learnt that in Life insurance the best is the ‘Term Policy’ where you get insured for a high value for a very less annual payment, but you forgo all your money if you were to stay alive. I called my agent and asked him to change my policy to pure term policy. As expected he did not approve of it (as he will not get a good commission out of term policies). Still I asked him to go with it and so I ended up with a life cover of 10 Lakhs for just 2800 per year. I later learnt that atleast one third of my first year’s payment goes to the agent and that is why he was pushing me for a 40k per year scheme.
Tasting the first success, I evalutated how much putting the remaining money that I saved in PPF will give me and I was startled at what I learnt, The money was cooly double of what I would have got if I  had gone with LIC. Such a difference with just a little thought (we all know PPF is very safe an investment). Only then I learnt that I had not even known of PPF a year before that. That left me with a thought to ponder. We work day-in and day-out for our monthly salary of X rupees, but give no thoughts on where to put it for investment. A simple mistake means for the full term of say 25 years we are going to lose half of that money. Something like earning X/2 in the place of X. Terrible!!! and then I understood that there is no regular classes or anything like that to educate people on personal finance. Then I started looking more carefully and found that many were dealing with problems of credit card debts and were trying to save for Tax. What would have been left unnoticed by me a year ago seeemed like utter stupidity now. Then I felt lot of gratitude to the guys who had taken steps to put such articles on the web. I felt that as a benefactor, I should do something to help others. So with the help of a website, I created the Tax Planner for 2005-2006. I have it with me and if someone needs it he/she can mail to simon.peter@rediffmail.com. I am also obliged to give the website address that have helped me to uncover many personal finance mysteries.
icicidirect.com
rediff.com – getahead – money
smartmoney.com – tradecraft
personalfn.com
pruicici.com – university
myiris.com
equitymaster.com
to name a few. If there is any query you can also contact me at my mail address. I will do my best to give an answer.