Resolution for New Year: Save more, Spend Digitally & Invest In Growth Assets!

This year was quite eventful on domestic as well as international front. In 2016 we have witnessed many unexpected events. This year will be known as the year of Amma, Trump and Modi or in short it will be remembered as the year of ATM. Now when we are entering in 2017, as always every New Year brings with it a new start, a reason to begin again, a time when we promise ourselves to do something different. That's why we make resolutions. We all care about our money after all we spend a significant portion of our life, and a considerable amount of efforts and resources to earn it. So it makes sense to make some resolutions on our financial life as well!

As a rational investor we should keep the following factors in mind before making any financial decisions in the year to come:

1. Save more money

Saving can be viewed as the practice of paying oneself first this money is used for our future needs like marriage/education of children and our own retirement etc. Most people save money, but how much remains an individual choice. We must draw a plan for our financial needs and figure out exactly how much we want to save and how it will be allocated on different kind of savings (cash, equity, gold, etc.). Many tools are available online and for proper planning an expert’s advice should be taken.

2. Spend less cash/ Use Technology

This year we have learn that cash can also be risky investment. So let’s have a digital wallet - We are moving towards the digital era from smart tv, smart watches, smart phones to now smart wallets lets be part of the cashless economy. The next phase is the digital economy. We should keep an eye on upcoming technology which is set to change the face of the financial world. A digital wallet is a necessity, not merely a luxury. It can be net banking on your smart phone. Debit/credit cards or services like PayTM we should learn the new things so as to live comfortably in changing time

3. Start a budget

Budget is very important to have a disciplined financial life. We should create our own budget which will meet your financial needs without stressing your income level. There are many tools/apps available in the market which can guide on spending and investment.

4. Invest Smartly

We should not just save but the money saved should be invested smartly so that it can give good and tax efficient return. We should invest in those assets which have high growth potential. Growth assets are typically those assets that have the potential to give capital appreciation over the long term, as against generating current income. Examples are equity shares, equity mutual funds, real estate etc. These assets help in building wealth. Generally a balance of income assets and growth assets would be required for an investor at any life stage, but the asset allocation will differ. The role of proper asset allocation for achieving investment success is very important, so avail of some of the many tools online or take the help of an expert to get the right mix of assets class. Here are some quick rules of thumb:

5. Mapping Investments with Goals

Financial Goals	Types of Asset Class
SHORT- TERM GOAL (1-5 YEARS)
Buying a Car	Debt & Money Market
Foreign Vacation	Debt & Balanced funds
MEDIUM TERM GOAL (5-15 YEARS)
Buying a House	Balanced & Equities / Diversified Mutual Funds and move to Debt and Cash when goal is nearby
Child's Education	Equities / Diversified Mutual Funds and move to Debt and Cash when goal is nearby
Child's Marriage	Equities Diversified Mutual Funds & Gold and move to Debt and Cash when goal is nearby
LONG TERM GOAL ( 15 YEARS +)
Retirement	Equities / Diversified Mutual Funds and move to Debt and Cash when goal is nearby
Wealth Creation	Equities / Diversified Mutual Funds & Real Estate
Inheritance	Equities / Diversified Mutual Funds & Real Estate

The chart given above is for illustrated purpose only, while choosing the asset class the actual time from and risk appetite is major factor. How long a person can let his/her investments compound is a major factor in determining how large they grow. So it's good to follow the old thumb rule that says INVEST AS EARLY AS POSSIBLE, AS OFTEN AS POSSIBLE...AND AS MUCH AS POSSIBLE!

And Finally…

Much like India's freedom struggle, achieving financial independence is also a slow process and one cannot hope to reach it overnight, over a few weeks or even a few months. However, every step taken in that direction will bring us closer to our goals. As always, before making any investment decisions please consult your financial advisor.

On the threshold of the New Year, we wish that 2017 brings you the needed discipline for a happy financial life!

How to select right mutual fund based on our specific investment needs

Mutual Funds are for everyone and they can cater all kind of requirements. The selection of mutual fund schemes should be based on investment goals. For each investment goal, we should identify the following:-

1. What is the Investment Objective? Capital appreciation or Income generation.
2. What is the Time horizon to achieve the goal? Short term, Medium term or long term, in years.
3. Investor’s risk tolerance level and appetite for volatility
4. Investment style? Is it passive or active, and how much time can be devoted to manage the investments
5. Liquidity needs

In this post, we will discuss on how to construct a optimum mutual fund portfolio based on these considerations. Of the various investment goal related factors, as mentioned above, investment horizon and risk tolerance are interlinked. In general, the shorter the investor's horizon, the less risk an investor should be willing to accept. However, within the same investment horizon, the degree of risk tolerance may be different for different investors.

Let us discuss the various investment options in mutual funds depending on the investment horizon and risk tolerance levels.

·        Investment Horizon less than one year:

If we need to park our cash for just a few months, then we should look at liquid funds, ultra-short term debt funds and arbitrage funds. If we need our funds within one to three months, then you should go for liquid funds. Or If we can wait for 3 to 6 months, then we should go for ultra-short term debt funds. Ultra-short term gives slightly higher returns than liquid funds, but they may be volatile in the very short term (1 to 3 months). Withdrawals from liquid funds are processed within 24 hours on business days Now many mutual funds offer instant redemption (within an hour) upto certain amount (normally upto Rs. 2 lakhs). Therefore, other than the funds we need for our day to day expenses and we can park our surplus cash in liquid or ultra short term debt fund. If an investor is in the highest tax bracket, arbitrage funds could be more tax efficient investment options. Liquid fund returns will be taxed at applicable income tax rate, for investment holding period of less than 3 years. Arbitrage funds returns, on the other hand, for an investment holding period of less than a year will be taxed at 15%. For example, if an investor is in the 30% tax bracket, if an arbitrage fund gives you an annualized return of 7%, while a liquid fund gives you a return of 8%, Still you will be better, from a post tax perspective, investing in the arbitrage fund.

·        Investment Horizon from 1 year to 3 years:

If we can remain invested for one to two three year time horizon, investing in short term income and credit opportunities funds are good investment options. Short term bond funds invest in Commercial Papers (CP), Certificate of Deposits (CD) and short maturity bonds/debentures etc. The average maturities of the securities in the portfolio of short term bond funds are in the range of 2 – 3 years. These funds run predominantly on accrual (hold to maturity) strategy and hence the interest rate risk is low. In the current interest rate scenarios these funds are giving around 8 to 9% returns. However, if yields decline then the returns will be lower. Credit opportunities fund are similar to short term debt funds. However in Credit Opportunities funds, the fund managers lock in a few percentage points of additional yield by investing in slightly lower rated corporate bonds. The average maturities of the bonds in the portfolio of credit opportunities funds are in the range of 2 – 3 years. The fund managers hold the bonds to maturity and so there is very little interest rate risk. Good credit opportunities funds have given double digit returns in the recent past.

·        Investment Horizon from 3 to 5 years:

If our investment horizon is more than 3 years and have low risk tolerance levels then, then investors can look at fixed maturity plans. Fixed maturity plans (FMPs) are close ended schemes that aim to generate income for the investors in a fixed term. Generally FMPs have given better returns than bank fixed deposits even on a pre tax basis. On a post tax basis, FMP returns are even better compared to bank fixed deposits, because FMPs get indexation benefit on taxes. However, investors should note that since FMPs are close ended schemes, there is virtually no liquidity before the fixed term. If liquidity is an important consideration, then investors should opt for open ended income funds. Between FMPs and income fund, the predictability of returns is higher in FMPs. FMPs are particularly suitable, in a high interest regime environment, where you can lock in higher yields. On the other hand, if interest rates are falling, income funds are more suitable. Income funds invest in a variety of fixed income securities such as bonds, debentures and government securities, across different maturity profiles. Their investment strategy is a mix of both hold to maturity (accrual income) and duration calls. This enables them to earn good returns in different interest rate scenarios. However, the average maturities of securities in the portfolio of income funds are in the range of 7 to 20 years. Therefore these funds are highly sensitive to interest rate movements and are suitable for investors with low to moderate risk tolerance levels.

If we have slightly higher risk tolerance then, monthly income plans or Debt oriented balanced funds could be better option. Monthly income plans invest primarily in fixed income instruments, while maintaining a small allocation in equity instruments. They are suitable for investors with moderate risk tolerance, particularly retirees looking for regular income from their investments as well as a bit of capital appreciation.

Equity oriented Balanced funds on the other hand are suitable for investors, with a moderate to high risk tolerance level and a longer time horizon (4 years or more). These funds typically have 65 – 70% of the portfolio invested in equities and the rest in fixed income securities. These funds are suitable for investors, looking for capital appreciation, without assuming substantial risks on the capital invested. These funds are suitable for investors, who are 5 to 10 years away from retirement or other long term financial objectives. On a risk adjusted basis top performing balanced funds have delivered excellent returns compared to diversified equity funds.

·        Investment Horizon of more than 5 years:

 If our investment  horizon is say 5 to 10 years or more, and are willing to take more risks, then equity funds is the way to go. Investors should note that, equity as an asset class provides the highest returns in the long term. However, investors in equity funds do have to contend with volatility, which means that they cannot have a short time horizon. Top performing equity funds have given more than 15% compounded annual returns over the last 10 years, despite intervening bear market periods. Equity funds are suitable for long term financial objectives like, retirement planning, children’s education, children’s marriage, house purchase etc. There are a large number of investment options within equity funds like, large cap funds, multi cap funds, small & midcap funds, diversified equity funds, Equity Linked Savings Schemes (ELSS), Sector or thematic based funds etc. What option is suitable for an individual depends on his/her personal situation, however, we will discuss several considerations which may help you make the appropriate choice:-

·       Many investment experts believe that diversified equity funds, also known as flexicap or multicap funds, comprising of stocks across different market capitalization segments, are the best long term investment options for financial objectives like, retirement planning, children’s education, children’s marriage, house purchase etc. Diversified equity funds carry slightly more risk than large cap funds, but also give higher returns, compared to large cap funds. At the same time, they are not as volatile as small and midcap funds.

·        If tax saving is a consideration, then ELSS is the option. Under Section 80C of Income Tax Act, investment in ELSS up to Rs 1.5 lakh (subject to the overall limit within Section 80C) is eligible for deduction from the taxable income and therefore will qualify as tax saving investment. ELSS funds have a lock in period of 3 years from the date of investment, and therefore will have an impact on the liquidity considerations. While tax saving is a big benefit for ELSS investors, these funds have given excellent returns, over various long term investment.

·    Large cap funds, which comprise mainly of large cap stocks, have the lowest risk among equity funds categories. Large cap funds, to some extent, limit downside risks in bear market conditions. However, in the Indian market context, large cap fund performance is more sensitive to FII activity than small and midcap funds. In fact, in the market correction over the past 10 months, large cap funds have underperformed small and midcap funds.

·        Small and midcap funds are inherently more risky than large cap and diversified equity funds. But these funds have the potential to give higher. However, it is important to ensure an optimal balance, consistent with an individual’s risk tolerance profile, between large, mid and small cap segments in the investment funds should constitute, only a portion of  equity funds portfolio. Though there are no hard and fast rules for allocations to midcap funds, there are some broad guidelines (subject to the personal financial situation and the risk tolerance level of the individual investor):-

o   Very aggressive risk tolerance: 40% large cap / diversified equity and 60% small & midcap

o   Aggressive risk tolerance: 50% large cap / diversified equity and 50% small & midcap

o   Less aggressive risk tolerance: 70% large cap / diversified equity and 30% small & midcap

Conclusion

In this post, we have discussed how we can construct a proper mutual fund portfolio, based on the investment horizon of our various investment goal related factors. A thoughtfully constructed investment portfolio will ensure success in meeting our financial objectives. However as every individual is different and has different needs it is always advisable to discuss with your financial advisor, what investment options are suitable to meet the objectives in your financial plan.

How to improve returns from the idle cash lying in Saving/Current Account

We should not let our money idle in the savings bank account, it can be invested to earn a better returns without compromising liquidity or taking high risks.

After demonetisation about  Rs ten lakh crore is deposited in the last three weeks, the savings bank accounts of Indians are bulging with cash. As government has put restrictions on withdrawals, a large chunk of this money is going to stay put for the next few months, earning a paltry interest of 4% per year. Though the interest on the savings accounts is tax free up to Rs.10,000 per year,  Still it's not a good idea to keep Rs. 2.5 lakh idling in your bank account. The interest it will earn won't be able to beat inflation, and the purchasing power of money will come down. Of course, this money was losing value faster when it was lying in your locker as hard cash.

We have various options to deploy this idle money to earn higher returns without compromising liquidity or incurring high risks. The choice should depend on how soon the money will be needed and income tax bracket and also the willingness to make a little effort.

1. Bank fixed deposit

The simplest and easiest way to deploy saving/current account bank balance is to open a fixed deposit, though the returns may not be very exciting and Banks have already slashed the interest rates on short-term deposits. A one-year deposit in the State Bank of India will now fetch only 4%, which is equal to what a savings bank account earns. The rates for longer term deposits are little higher, but mind it the interest earned on fixed deposits is fully taxable. If an investor is in the highest tax bracket, the post-tax return could be even less than saving interest rate. Also, unless we have a online/Netbanking account, opening a fixed deposit won't be easy at a time when visiting the bank is like entering a war zone.

The best way out is to open a long-term deposit of 3-5 years and break it when money is required, we can also keep small denominations FD so that it can be used if only a part of the money is needed. Most of the banks no longer levy a penalty for premature withdrawals. But interest rate to be paid will be applicable rate for the period we remained invested, which is usually lower than the longer-term rate. Also, if the interest income exceeds Rs. 10,000 in a year, the bank will deduct TDS.

This is fine if a person’s income is above the basic exemption limit of Rs. 2.5 lakh per year. But investors in the zero tax bracket will have to file their returns to get a refund of the TDS, or submit the Form 15 G or H to escape the TDS.

Now for recurring deposits too, the interest earned is fully taxable. These deposits were not subject to TDS, but the rules have now been amended.

An investor can also consider opening a sweep-in bank account, where any excess amount in savings account automatically flows into a fixed deposit. If we withdraw from savings account, the fixed deposit is automatically broken.

2. Liquid funds and ultra-short-term funds

Mutual fund is another smart way of earning more income without compromising on liquidity. We can invest in liquid mutual funds. These are ultra-safe schemes that can deliver up to 7-8% returns in a year. The biggest benefit is that the income from mutual funds is treated as capital gains and taxed at a lower rate if the investment is held for at least three years.

They are also more flexible. We can withdraw small amounts whenever required or invest more when we have surplus cash. Now various online platforms are available through which we can invest and redeem very easily and instantly.

The risk of losing money in a liquid fund is almost negligible. The investment is also very liquid. If you redeem before the cut-off time (usually 12.30 pm), the money is in your bank account the next morning at the latest. There is no minimum investing period either. Some mutual funds also offers instants redemption by which money can be credited to an investors account within 30 minutes (upto Rs. 2 lakhs) including holidays and Sundays.

3. Short-term debt funds

Those who don't need the money for the next 6-12 months can opt for short-term debt funds. These are also debt schemes, but invest in a mix of short term and medium-term bonds. The returns are slightly higher than what liquid funds and ultra short-term debt funds give, but there is also an exit load payable if we redeem before a minimum period that ranges from 3-12 months. In few schemes, the minimum investment period can be up to 36 months. Before investing we should check the exit load of the income fund or where a penalty of 0.5-1 % can pare the returns.

In the current scenario as interest rates are expected to decline, these funds can give attractive returns in the short to medium terms. Even in the long term, they will give better post-tax returns than fixed deposits. However, these funds also carry an interest rate risk. Of late these schemes have delivered good returns because interest rates have been consistently declining. If interest rates rise, these funds can decline, resulting in losses.

4. Arbitrage funds

Arbitrage funds are for those Investors who can hold for one year or more as they offer tax-free returns. These funds invest in stocks and equity instruments but don't carry market risk. The gains are taxed at 15% if redeemed within one year however dividend received is tax free. After one year, the capital gains are  also tax free. Before investments we should also check the exit load of the arbitrage fund, otherwise the penalty of 0.5-1% can pare the returns.

5. Monthly income plans

If an investor can bear certain degree of risk, monthly income plans (MIPs) from mutual funds can be a low-risk entry point to the equity markets. MIP schemes follow a conservative investment strategy, allocating only 10-25% of their corpus to equities and putting the rest in safer bonds and instruments. Their returns are better than debt funds, though they also carry a moderate risk. These funds have exit loads so check the terms and conditions.

Bank deposits were traditionally the only and safer option for the investors to keep money and withdraw as per convenience however now when the bank FD rates are historically low and there is lot of awareness regarding mutual funds, we should look at various type of mutual funds which can give safety as well as better returns compare to traditional products.