COMPLIMENTARY TO THE READERS OF MINT
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mint money's guide to understanding
financial freedom MINT MONEY’S GUIDE to understanding SERIES
editor's note
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D
Monika Halan Editor, Mint Money
P. Arora was the average Delhi DDA (Delhi Development Authority) flat uncle who went to office at 9am every working day morning, taking a chartered bus and returning home by the 5.15pm bus. Holidays at the hometown in Punjab and two boys raised to be doctor and engineer. During his years of diligent ant-like work, he dreamed of his retirement, when he would do what he wanted to and not what was “right” for his family. At 58, he attended the office farewell party and was escorted home to live out the rest of his life quietly. At 70, Arora is the hottest old man in the neighbourhood. Morning walkers tease him, calling him DP Buffet. Arora was on a pension and got a lump sum as his retirement benefit. He bought all that he needed to sustain himself and his wife for the next 20 years and kept R5 lakh for his secret love: stocks. He opened an online trading account and told his fussing wife to assume that he was in office between market hours. He was so good at doing what he believed he was born to do—trade stocks—that his profits soon overtook his lifetime earnings. True story. But very few are able to clearly define what financial freedom means for them and how they want to use it. For some it is freedom from worry. For some it is freedom from the boss. For others it is freedom to follow their heart and not work a job to pay the bills. The third book of the Mint Money Guide to Understanding Series gives you a road map to understanding financial freedom. In Chapter 2, you will understand the importance of insurance as a companion as you walk the road to financial freedom. It will list out the basic protection you need to have in place. Chapter 3 will give you five investing ideas that allow you to build your financially free corpus—that pool of money that pays the bills without you having to go to work. Chapter 4 tells you the importance of getting freedom from the landlord and become a home owner yourself. Chapter 5 is important for the young stuff that is used to flashing the card for lifestyle needs—it tells you how to get freedom from debt. Chapter 6 is where you learn about the most efficient corpus-building options to target your retirement. Chapter 7 is a little grim. It talks about freedom after your death, for your heirs to use your wealth without having to fight. As always, the Mint Money team is very happy to hear from you with new ideas, suggestions and critiques. Keep writing to us mintmoney@ livemint.com and we’ll keep changing the content to suit your needs.
Very few are able to clearly define what financial freedom means for them and how they want to use it. We give you a comprehensive break-free plan.
1 | august-SEPTEMBER, 2010
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17
l Free yourself from the discom-
FREEDOM FROM RETIREMENT WORRIES
l When to buy a house
l Strategy to building up a
fort of dealing with a landlord
l Merits of owning a house
PAGE
19
FREEDOM FROM DEBT
l How much debt is sustainable
PAGE
l When do you cross the danger
mark? l How to get back on track l What debts to get rid off first
FREEDOM FROM RISK Monika Halan Editor, Mint Money Authors Bindisha Sarang Deepti Bhaskaran Devesh Chandra Srivastava Harshada Karnik Kayezad E. Adajania Prashant Mukherjee Desk Saif Shahin Nidhi Sinha Saurabh Kumar DESIGN TEAM Abel Robinson Manoj Madhavan Jayachandran Uttam Sharma
Cover illustration Jayachandran/Mint
l Five insurance covers that
you must have to protect you during your journey l Financial freedom from risk to life l Financial freedom from risk to assets
12
PAGE
EDITORIAL TEAM
FREEDOM FROM investing worries
l Five great investing ideas l Equity—index funds,
exchange-traded funds and equity diversified funds l Debt- non-convertible debentures, fixed deposits, Public Provident Fund, post office schemes 2 | august-SEPTEMBER, 2010
l Should you invest in NPS?
decent retirement corpus
23
PAGE
FREEDOM FROM THE LANDLORD
04
21
PAGE
PAGE
CONTENTS
FREEDOM FROM ESTATE PLANNING
l When should you create a will? l How can you make a will? l Do you need a trust or a will ?
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Freedom from
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Risk
Protecting yourself and your assets against risks is as important as building assets. Here are five insurance covers that you must have to make a risk-free journey on the road to financial freedom.
t is easy to confuse financial freedom with just building assets, but the road to the destination needs co-travellers that protect you over the journey. One of the most important but least understood companions is called insurance. There are five core insurance covers that anybody walking towards the goal of financial freedom needs to use. You need to protect your life and loans so that your family is financially free in case of an untimely event. You need to protect your and your family’s health-related expenditure so that an accident or illness does not mean that you have to dip into your savings to fund it. Protection for your assets against theft, accident and other damage is also important.
Insuring Yourself
1. Life Insurance: If you have dependants, who look up to you for financial help, a life insurance 4 | august-SEPTEMBER, 2010
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financialfreedom cover is a must. Typically, if you have young children, old parents who are managing on a meagre pension or a spouse who doesn’t earn, and you are not in the same league as the Ambanis or the Tatas, life insurance is a must for you. A term insurance plan is what we recommend for you. A term plan is the cheapest and most basic form of life insurance. It only charges you for the cover that you choose— in insurance parlance it is called the sum assured—and does not return any money on the expiry of the policy term. On death, during the policy term it pays the sum assured to your nominee or beneficiary—the person you appoint in your policy who gets the policy proceeds. Other plans that offer investment are also popular. These range from the less popular traditional plans to the more popular unitlinked insurance plans (Ulips). We recommend you to keep the two needs separate and buy a term plan for your insurance needs. Other plans that offer you an investment component, typically, cost you dear or give too little insurance. For example, for a 30-year-old, a term plan would cost around R2,912 for a sum assured of R10 lakh and a tenor of 30 years; an endowment plan would charge R31,368 for the same sum assured and tenor. You could also buy a term plan online. ICICI Prudential Life Insurance Co. Ltd and Aegon Religare Life Insurance Co. Ltd have term plans that can be bought online. Term plans are available until 60-65 years of age. Once you retire, your financial worth for your dependants decreases as you would have discharged all your financial responsibilities by then and your dependants, such as your children, may have started earning. Under section 80C of the Income-tax Act, premiums that you pay towards your life insurance qualify for a tax deduction of up to R1 lakh. As a rule of thumb, financial planners recommend that you have insurance cover equal to 12-15 times your annual expenses or 8-10 times your annual income. However, if you have debt riding on you, then you should factor in that as well. You could consider buying a decreasing term cover in order to cover a huge debt liability, such as a home loan. This plan comes in
mint money
Health insurance strategy Buy a basic health insurance plan, which is an indemnity policy and reimburses all the medical costs incurred during hospitalization While buying health insurance for other members of your family, buying policy from the same insurer could entitle you to a discount of up to 10% of your premium If you are sufficiently insured, then you could consider a floater policy to bump up your cover and cover other members of your family You could also bump up your basic policy by adding defined benefit plans such as critical illness plans. Critical illness plans that come with a death benefit give you tax benefits of up to R1 lakh under section 80C
the form of reducing balance where the tenor of insurance is the same as the tenor of the debt and the cover keeps decreasing as you keep paying off the debt. You can get this cover either by paying a single premium or by paying regular premiums. Banks typically bundle a single premium policy with the loan and pay the premium on your behalf. The amount of premium gets added to your total debt liability, which you pay through an increased equated monthly instalment (EMI). We recommend you pay it yourself. You could consider a regular premium policy if a single premium payment puts a financial strain on you. A regular premium policy lends flexibility as you can stop paying premiums if you are sure you will be able to prepay your loan. Health insurance: With medical bills looking similar to five-star hotel bills, having a health insurance policy will ensure that a medical emergency does not put any financial strain on you. While many variants of health insurance covers are being sold in the market, we recommend the most basic health insurance policy. Commonly referred to as a mediclaim policy, it is an indemnity cover that pays for your expenses incurred during,
before and after hospitalization. Earlier, mediclaims only reimbursed medical bills—this meant that you had to foot the bill and then the insurer would pay it back to you. The process has now become cashless. You just inform your hospital, and it will take it up directly with your third-party administrator (TPA), the intermediary who settles your claim between the hospital and the insurer. Even a three-month-old can take a mediclaim policy. Insurers, typically, insure children as dependants of their parents. This can happen either by paying an extra premium as an add-on cover to the parent’s individual policy, or by adding the child under a floater plan. In such a plan, the cover is the same for all the members of a family. If one member makes a claim, the sum insured is reduced on the entire family by the amount he claims. Defined benefit plans are hybrid health insurance policies that give you cash benefits on medical emergency. Mainly, these plans can be categorized as critical illness plans, hospital cash plans and savings plans. A critical illness policy is the most popular of these. It gives you a one-time benefit if you suffer from any specified critical illness, such as a heart attack, cancer,
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diabetes, kidney failure, major organ transplant or paralysis. Hospital cash policy works as a buffer, providing you a pre-defined daily cash benefit, irrespective of the costs you incur at the hospital. A health-cum-savings plan is a combination of defined benefit plans that also invests a part of your premium or returns the premium at the end of the policy tenor. While a regular health insurance policy runs for a year and is to be renewed every year, defined benefit policies are long-term, have a standard premium for a certain number of years and are offered mostly by life insurance companies. Your strategy: Begin with buying a basic mediclaim policy and top it up with a floater for your family. Do not hinge on the group insurance cover offered by your employer as a job change could leave you uninsured. Since portability in health insurance is still some time away, you may not be able to carry over the benefits to the new insurance you get with the new job. Additionally, if your family has a history of serious ailments or if your lifestyle is stressful, then you can top up your health insurance portfolio with a critical illness plan.
Sum assured (R lakh)
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Kotak Preferred Term Plan
12,685
Kotak Preferred Term Plan
16,600
Kotak Preferred Term Plan
20,516
Kotak Preferred Term Plan
24,431
Kotak Preferred Term Plan
32,263
11,719
Kotak Preferred Term Plan
15,304
Kotak Preferred Term Plan
18,889
Kotak Preferred Term Plan
22,474
Kotak Preferred Term Plan
29,643
Kotak Preferred Term Plan
Kotak Preferred Term Plan
Kotak Preferred Term Plan
5,636
5,267
8,769
Kotak Preferred Term Plan
Kotak Preferred Term Plan
8,135
4,595
4,227
Kotak Preferred Term Plan
Kotak Term Plan
Kotak Term Plan
Kotak Preferred Term Plan
2,599
2,418
7,203
Kotak Term Plan
Kotak Term Plan
6,701
32
30 years
35,131
Kotak Preferred Term Plan
26,582
Kotak Preferred Term Plan
22,308
Kotak Preferred Term Plan
18,034
Kotak Preferred Term Plan
13,760
Kotak Preferred Term Plan
9,486
Kotak Preferred Term Plan
7,776
Kotak Preferred Term Plan
6,067
Kotak Preferred Term Plan
5,070
Kotak Term Plan
2,831
Kotak Term Plan
34
33,972
Aegon Religare -iTerm Plan
25,479
Aegon Religare -iTerm Plan
21,233
Aegon Religare -iTerm Plan
16,986
Aegon Religare -iTerm Plan
13,153
Aegon Religare -iTerm Plan
8,769
Aegon Religare - iTerm Plan
8,565
Kotak Preferred Term Plan
6,679
Kotak Preferred Term Plan
5,625
Aegon Religare - iTerm Plan
3,044
Aegon Religare - iTerm Plan
36
38,164
Aegon Religare -iTerm Plan
28,623
Aegon Religare -iTerm Plan
23,852
Aegon Religare -iTerm Plan
19,082
Aegon Religare -iTerm Plan
14,725
Aegon Religare -iTerm Plan
9,817
Aegon Religare -iTerm Plan
9,403
Kotak Preferred Term Plan
7,307
Kotak Preferred Term Plan
6,309
Aegon Religare -iTerm Plan
3,386
Aegon Religare -iTerm Plan
38
42,576
Aegon Religare -iTerm Plan
31,932
Aegon Religare -iTerm Plan
26,610
Aegon Religare -iTerm Plan
21,288
Aegon Religare - iTerm Plan
16,462
Aegon Religare -iTerm Plan
10,975
Aegon Religare -iTerm Plan
10,330
Kotak Preferred Term Plan
8,002
Kotak Preferred Term Plan
7,037
Aegon Religare -iTerm Plan
3,750
Aegon Religare -iTerm Plan
40 years
47,650
Aegon Religare - iTerm Plan
35,737
Aegon Religare - iTerm Plan
29,781
Aegon Religare - iTerm Plan
23,825
Aegon Religare - iTerm Plan
18,282
Aegon Religare - iTerm Plan
12,188
Aegon Religare - iTerm Plan
11,361
Kotak Preferred Term Plan
8,769
Kotak Preferred Term Plan
7,853
Aegon Religare -iTerm Plan
4,147
Aegon Religare -Term Plan
42
53,385
Aegon Religare - iTerm Plan
40,039
Aegon Religare - iTerm Plan
33,366
Aegon Religare - iTerm Plan
26,693
Aegon Religare - iTerm Plan
20,516
Aegon Religare - iTerm Plan
13,677
Aegon Religare - iTerm Plan
12,580
Kotak Preferred Term Plan
9,059
Kotak Preferred Term Plan
8,802
Aegon Religare -iTerm Plan
4,622
Aegon Religare -iTerm Plan
44
59,783
Aegon Religare - iTerm Plan
44,837
Aegon Religare - iTerm Plan
37,364
Aegon Religare - iTerm Plan
29,891
Aegon Religare - iTerm Plan
22,998
Aegon Religare - iTerm Plan
15,332
Aegon Religare - iTerm Plan
14,063
Kotak Preferred Term Plan
10,809
Kotak Preferred Term Plan
9,927
Aegon Religare - iTerm Plan
5,217
Aegon Religare - iTerm Plan
46
66,842
Aegon Religare - iTerm Plan
50,131
Aegon Religare - iTerm Plan
41,776
Aegon Religare - iTerm Plan
33,421
Aegon Religare - iTerm Plan
25,645
Aegon Religare - iTerm Plan
17,096
Aegon Religare - iTerm Plan
15,795
Kotak Preferred Term Plan
12,122
Kotak Preferred Term Plan
11,096
Aegon Religare - iTerm Plan
5,813
Aegon Religare - iTerm Plan
48
74,342
Aegon Religare - iTerm Plan
55,757
Aegon Religare - iTerm Plan
46,464
Aegon Religare - iTerm Plan
37,171
Aegon Religare - iTerm Plan
28,457
Aegon Religare - iTerm Plan
18,972
Aegon Religare - iTerm Plan
17,836
Kotak Preferred Term Plan
13,666
Kotak Preferred Term Plan
12,420
Aegon Religare - iTerm Plan
6,475
Aegon Religare - iTerm Plan
50 years
Source: Apnapaisa.com
How to use this data: For a 40-year-old who wants a cover of R60 lakh, the lowest premium is given. The tenor is 30 years for a 30-year-old, 20 years for a 40-year-old and 10 years for a 50-year-old person. Note: Aegon Religare - iTerm Plan is available online only; premiums as on 12 August 2010
200
150
125
100
75
50
40
30
20
10
CHEAPEST TERM INSURANCE COVERS
Premiums in R for the cheapest term insurance covers for different sums assured. The term of the policy is 60 years minus the age.
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the cheapest premium rates for a basic health insurance policy 1 lakh
Age
sum insured
2 lakh
5 lakh
20-25
Royal SundaramHealth Shield
1,150
Royal SundaramHealth Shield
1,850
Bharti AXASmart Health Plan Basic
3,436
26-30
Apollo MunichEasy Health Individual Standard
1,208
Bharti AXASmart Health Plan Basic
1,955
Bharti AXASmart Health Plan Basic
3,436
31-35
Apollo MunichEasy Health Individual Standard
1,208
Bharti AXASmart Health Plan Basic
1,955
Bharti AXASmart Health Plan Basic
3,436
36-40
Star HealthMedi Classic
1,489
Apollo MunichEasy Health Individual Standard
2,647
Future GeneraliHealth Suraksha Basic
5,672
41-45
Star HealthMedi Classic
1,489
Apollo MunichEasy Health Individual Standard
2,647
Future GeneraliHealth Suraksha Basic
5,672
46-50
Future GeneraliHealth Suraksha Basic
2,508
Future GeneraliHealth Suraksha Basic
4,058
Future GeneraliHealth Suraksha Basic
9,060
51-55
Future GeneraliHealth Suraksha Basic
2,508
Future GeneraliHealth Suraksha Basic
4,058
Future GeneraliHealth Suraksha Basic
9,060
56-60
Star HealthMedi Classic
3,309
National InsuranceParivar for Family
5,655
Future GeneraliHealth Suraksha Basic
12,210
Premiums and sum insured in R
A hospital cash plan can be easily avoided if you have emergency funds for six to eight months of expenses. Under section 80D of the Income-tax Act, your premiums qualify for tax deduction up to R15,000 and an additional R20,000 if you buy health insurance for your parents who are senior citizens. If you are a senior citizen, you can claim up to R20,000 as tax deduction, and R40,000 if you buy health insurance for your parents also. Additionally, in the case of a defined benefit plan offered by a life insurance company that pays a lump sum on death, your premiums will also qualify for tax benefits up to R1 lakh under section 80C. Personal accident cover: This gives you a financial compensation against an accident that may leave you temporarily or permanently crippled. The idea is to provide you an income stream that you lose on account of a disability. Typically, a personal accident policy covers you against death, permanent disability, permanent partial disability and temporary total disability. For death or permanent disability, it pays you a lump sum compensation. For temporary disability, it pays you a weekly compensation of around 1% of the sum insured for up to 104 weeks. This policy offers you a cover of up to 120 times your monthly salary and the premiums you pay depend on the occupation category you fall under.
Source: Apnapaisa.com
You can also get a personal accident cover as a rider with your life insurance policy. But you will lose the benefit if the policy lapses—the cover will be available only till the time your policy lasts. For a stand-alone personal accident policy, the premiums are decided on the basis of occupation and the extent of cover you opt for. The more risky your occupation, the higher will be your premium. For an individual in, say, information technology or the media industry, which require limited fieldwork, the premium will be around R175 per lakh of the sum insured for a cover that includes death, permanent disability, permanent partial disability and temporary total disability.
II. Insuring Your Assets
Home insurance: If you own a house, this is a must for you. A basic householder’s policy, which is primarily a fire insurance cover, covers your house and its contents against fire and allied perils, such as flood, earthquake, lightning and storm. You can either opt for a stand-alone fire insurance policy (FIP), or a more inclusive householder package policy (HHP). FIP only protects the building and the contents of your house against fire and allied perils, while HHP covers the contents of the house against burglary and mechanical or electronic breakdown as well. Additionally, HPP offers covers, such as public liabil-
You can also get a personal accident cover as a rider with your life insurance. But you lose the benefit if the policy lapses ity due to your negligence, personal accident, workmen’s compensation (against injury or death of domestic help) and baggage loss. The insurer gives you a discount on your premium if you choose more covers. Typically, an HPP has around 10-12 sections and you can get a discount of up to 20% by opting for at least six sections. While your premiums vary depending on the cover that you choose, the fire insurance component that covers your house and contents comes for about 50 paise per R1,000 sum insured. Motor insurance: A third-party insurance—that covers you in case your vehicle damages life or property of a third party—is mandatory before you drive your car out of the showroom, according to Motor Vehicles Act, 1988. But you shouldn’t stop at what is mandatory. Go for a comprehensive plan that, apart from third-party cover, gives you an own-damage (OD) cover, covers damage to or theft of the vehicle, and also covers the passengers. The cost of covering passengers and a paid driver comes to around R250 and is
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optional. Don’t ignore this cover just to get a small discount. Since the insurance industry got de-tariffed, insurers have begun to pack in additional benefits. The add-on offerings vary a lot in the market—from insuring you against any depreciation on vehicle parts to offering you personal accident cover and medical insurance. However, opt for add-ons that you really need. For instance, if your insurer offers you a depreciation cover, lap it up. Normally, on damage of plastic or metal parts, the insurer only pays the depreciated value. Having a depreciation cover will pay for the cost of replacing that part. You may also consider covers that protect your no-claim bonus in case of a claim, or a cover that gives you another car for as long as your car is getting fixed at the workshop after an accident. Currently the practice is to decide your premium for OD broadly on five parameters: age of the vehicle, model, value of the vehicle (also referred to as the insured depreciated value, or IDV), location and the deductible (your part of the claim amount) you agree to pay. But moving on, the filters will only get more personal, such as what you do for a living, where you live, your age and how many people drive the insured vehicle. In future, how disciplined you are as a driver and what risk you pose to the insurer will be the key in deciding your premium.
financialfreedom REALESTATE
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Freedom from
investing worries T
[
here are many investment ideas floating in the market that will help you multiply your wealth. Some of them come with risks, others are relatively less risky or even without risk. But lost amid the sea of options are those that can also free you of the tedium of monitoring stock markets or relying on the fancies of fund managers.
I. Freedom from the fund manager
Index funds and exchange-traded funds (ETFs): The success of your mutual fund (MF) schemes depends on how good or bad your fund manager is. In Western coun-
Five great investing ideas to spare you time, cost and effort as you try and make sense of the thousands of product pitches that come at you every day. We tell you which ones to opt for.
tries such as the US, actively managed funds—where your fund manager decides which scrips to buy and when—haven’t done as well as passively managed funds. But India has seen a fair share of fund managers tasting success. Yet, you cannot escape the whims and fancies of your fund manager; at the end of the day you are at their mercy. This is not necessarily a bad thing, but if you wish to avoid taking on the fund manager risk, we suggest you buy passive funds. These come in the form of index funds and ETFs. What are they? Typically, every MF scheme has a fund manager. These are the guys who man-
]
age your funds full time. They track the stock markets, companies and industries day in and day out and decide which stocks to buy or sell, and when. Passive funds, on the other hand, do not really have a fund manager. Like every MF scheme, passive funds have a benchmark index and their job is to simply mimic this index. They aim to buy and sell scrips in the same proportion as they lie in the benchmark index. For instance, ICICI Prudential Nifty Index Fund’s (IPIF) benchmark index is the Nifty index. Since Nifty has 50 scrips, IPIF will also invest its entire corpus in these 50 scrips in the same proportion. Even if the
12 | august-SEPTEMBER, 2010
fund manager does not like any scrip on Nifty, he doesn’t have a choice. He also cannot buy more of any Nifty scrip if he wishes to. What’s the outcome? If the benchmark index goes up, your index fund goes up by almost the same margin. If the benchmark index goes down, your index fund goes down by almost the same margin. ETFs are close cousins of index funds, but follow a different mechanism. You cannot buy or sell ETF units directly with the fund house unless you’re a large investor. The fund house appoints market makers in the stock market. This market maker would hand over a prefixed basket of shares; typically
financialfreedom REALESTATE
mint money shares that are a part of the ETF’s benchmark index and in the same proportion as they lie in the index plus a bit of cash. The ETF, in return, hands over ETF units to market makers who sell these units on the stock exchange (on which the ETF gets listed), where you can buy or sell. ETF units can be bought and sold just like an equity share. Which one to opt for? An ETF has a better mechanism than an index fund. While the latter can be manipulated (the fund manager can decide on the level of cash he wants to hold, for instance), an ETF is sealed from the fund manager’s decisions because an ETF unit can be created only when they are exchanged against a fixed basket of stocks as defined in the scheme’s offer document. As an ETF cannot hold more cash than what the offer document allows, it mimics its benchmark index as closely as possible. As a result, an ETF’s tracking error (the difference between an index and a passive fund’s performance) is lower compared with an index fund. On the other hand, you compulsorily need a demat account to buy and sell ETFs as they are available only on the stock exchanges. Index funds can be bought in the old fashioned way through your agent or directly with your fund house by filling up a form. You can also invest in index funds through systematic investment plans, or SIPs. ETFs do not facilitate SIPs as they are available only on the stock exchanges, though certain brokerages allow you to do an SIP through them if you have an account with them. Use an ETF to invest in gold: Experts suggest that every individual must have at least 5-8% exposure on gold. Until recently, buying physical gold in the form of jewellery and bars or coins was the only option for investors. But as global financial markets have evolved, ETFs have proved to be the ideal way to invest in gold. Investing in gold ETFs will give the investor all the advantages of investing in gold, while eliminating drawbacks of holding physical gold. When you buy gold from a bank or a jewellery shop, you have to pay a premium. And when you try to re-sell, banks don’t buy them back and the jewellers offer you a huge discount. By investing in
You compulsorily need a demat account to buy and sell ETFs as they are available only on the stock exchanges ETFs, you can rest assured that you can buy and sell the units in real time as it is traded in the stock exchange. Therefore, it obliterates the concern of liquidity. Storing also becomes a huge problem when you buy physical gold. Investing in ETFs saves on storage
Quantum, HDFC, ICICI Prudential, Religare, SBI and Kotak Gold ETF. Investing in a gold ETF is as simple as investing in shares. You need to open a demat account with a bank or a brokerage house. Once that is done, you can either directly purchase ETF units online or call up your broker and place an order. Investment in gold has multiplied returns by around four times in the past decade. In 2001, gold prices were around R4,000 per 10g. Today, they stand at around R18,000 per 10g. In the last 10 years, the annualized returns on gold are around 18-19%, which is
cost and eliminates the fear of theft as well. A gold ETF is a financial instrument like a mutual fund whose value depends on the price of gold. It is a passively managed fund designed to provide returns that would closely track the returns from physical gold. Typically, the price of one unit of a gold ETF reflects the price of 1g of gold, though there are some gold ETFs whose price is equal to half a gram of gold. As the price of gold rises, the price of the ETF also goes up and vice-versa. However, the units of a gold ETF have to be purchased or sold on the stock market, just as shares, for which one needs to have a demat account. There are nine gold ETFs available in India— Benchmark, Reliance, UTI, 13 | august-SEPTEMBER, 2010
better than many other asset classes. According to the Association of Mutual Funds in India, over the last one year, the assets under management (AUM) towards gold ETFs have grown by at least 1.5 times. The AUM as on 31 July 2010 stands at R1,972 crore. Wealth creation tool: Although actively managed funds have had their share of success in India, passive funds are a potent tool to multiply your wealth if you give it time. It’s well chronicled that over a period of time, equities outperform all other asset classes. What is not as commonly known is that your chances of making a loss goes down as your holding period goes up. For instance, if you would have invested in the Sensex (assuming Sensex values are akin to an MF’s net asset value) for a period of one year any time since April 1979 when Sensex started, you would have made losses 2,026 times out of a total of 6,784 one-year holding periods—or 30% of the times. But if you would have stayed invested for any seven-year time period between 1979 till date, you would have lost money only 418 times (or 7% of the times) out of a total of 5,635 seven-year time periods available. The clincher: you would not have lost anything if you stayed invested for 14 years or more. An investment in Sensex for any 14-year time period or more since
financialfreedom its inception would have been profitable. Where to buy index funds: From agents, financial advisers, financial planners, online share broking firms or mutual fund investment platforms, share brokers who sell mutual funds, registrars and transfer agents such as Karvy Computershare Pvt. Ltd and Computer Age Management Services Ltd, or directly from mutual funds. Where to buy ETFs: From stock exchanges through stock brokers or online brokerages.
II. Freedom from risky stock market investing Large-cap equity diversified funds: Investing in equity markets require skill. You need to be able to study a company’s financial statement, such as balance sheets and profit and loss accounts. There are other aspects you need to understand, too, such as the nature of business in which a company operates, competition, its own working style and market perception. How do you free yourself from such rigmarole and still participate in India’s growth story? Look at diversified equity funds. These are MF schemes that pool your money and collectively invest it in equity markets. They invest in all sorts of companies and sectors. Most of them are large-cap funds that invest in large and wellestablished companies. Next are the mid- and small-cap funds that invest in medium- and small-sized companies. Large-cap funds are less risky than mid-cap funds and also less volatile on account of the high pedigree of the companies they invest in. Mid-cap stocks can give you phenomenal returns, but in falling markets, most of these mid-cap scrips get illiquid and lose a lot of value. On the back of rising markets in 2007, mid-cap funds returned 62.10% against 57.74%. But in 2008 when markets fell on account of the global credit crisis, large-cap funds lost 53% against a loss of 60% by mid-cap funds. Typically, you should have both large and mid-cap funds in your portfolio; the ratio should depend on your risk profile. The higher your risk profile, the higher should be your investments in mid-cap funds. Where to buy it: From agents, financial advisers, financial plan-
mint money TRACKING THE BENCHMARK
Name of index funds
Net asset value (R)
Expense ratio (%)
AUM (R cr)
Benchmark S&P CNX 500
19.39
1.50
Birla SunLife Index
54.46
1.50
Canara Robecco Nifty Index
28.85
Franklin India Index BSE Sensex
51.31
Franklin India Index NSE Nifty
Returns (%) 1 year
3 year
93.32
22.56
na
30.51
22.77
7.65
1.00
8.33
22.45
7.32
1.00
61.25
21.39
7.45
42.99
1.00
134.10
23.08
7.54
HDFC Index Nifty
47.60
1.00
44.53
21.82
4.41
HDFC Index Sensex
152.00
1.00
47.87
20.8
3.72
ICICI Prudential Index Retail
50.65
1.50
86.51
23.28
9.28
ICICI Prudential Nifty Junior Index
10.49
1.50
5.90
na
na
IDBI Nifty Index
10.39
na
151.43
na
na
IDFC Nifty
10.39
na
4.57
na
na
LICMF Index Nifty
30.14
1.49
70.36
21.44
4.28
LICMF Index Sensex
34.01
1.39
31.79
21.41
3.58
Magnum Index
46.63
0.77
29.08
22.95
6.11
Principal Index
37.37
1.00
23.27
22.83
6.61
Quantum Index
550.37
0.75
1.36
23.26
na
Tata Index Nifty A
32.61
1.50
9.58
22.90
6.79
Tata Index Sensex A
44.37
1.50
5.98
20.71
5.64
Tata Index Sensex B
14.39
0.75
0.16
24.09
na
Taurus Nifty Index
10.35
na
6.82
na
na
UTI Master Index
56.40
0.75
66.86
21.39
6.45
UTI Nifty Index
34.07
1.22
225.56
22.50
7.04
Annualized returns as on 12 August 2010.
ners, online share broking firms or online mutual fund investment platforms, share brokers who sell mutual funds, registrars and transfer agents such as Karvy Computershare Pvt. Ltd and Computer Age Management Services Ltd (CAMS) or directly from mutual funds.
III. Freedom from long lock-ins and income volatility
Non-convertible debentures (NCDs): These are debt instruments issued by a company to solicit money from investors. NCDs are loans raised by a company. If you wish to earn a regular income—something as good as guaranteed—this is one of the assured-return products that promises to pay a little more than bank fixed deposits (FDs). Like company FDs, NCDs come with a credit rating that signifies the capability of the company to make timely interest payments and principal on redemption. Over the past year, non-banking
Source: Value Research
FUND FACT Growth
What is ‘growth’?
Simply put, it means a rise, expansion, escalation or development. But in mutual fund (MF) parlance, it could mean several things. It could either mean a scheme, a plan or even a philosophy. When you wish to invest in MFs, make sure you know which growth you are looking for and opt for the right one. …when it’s a name
Many equity schemes have the word ‘growth’, such as HDFC Growth fund. These are some of the simplest names that you can find in equity funds. The other word most frequently used by funds is ‘equity’, such as HDFC Equity Fund. A fund could have two schemes, one each a ‘growth’ and ‘equity’ fund; different management styles though both invest in equities.
14 | august-SEPTEMBER, 2010
…when it’s a plan
Most funds have two plans or options in them; dividend and growth. While the dividend plan aims to distribute dividends on a periodical basis as and when funds have distributable profits, the growth option accumulates your gains. Returns from both plans are the same as they share a common portfolio. …when it’s a style of managing funds
Sometimes, fund houses have two broad management styles; growth and value. Here, growth means that the fund house invests in stocks growing at a faster rate and market favourites. These are aggressive funds. A ‘value’ fund invests in fundamentally sound stocks that are ignored by the market but where a potential of a price hike exists. These are slightly conservative funds.
financialfreedom
mint money finance companies such as L&T Finance Ltd, a subsidiary of the construction firm Larsen and Toubro Ltd, and Shriram Transport Finance Co. Ltd have hit the markets with NCDs. Typically, a single NCD issue gives several options. Each option has a slightly different interest rate, interest payment frequency and tenor. You need to make a choice depending on your needs and the option whose terms you like. For instance, when Shriram Transport Finance Co. Ltd issued NCDs in May 2010, it offered four options that redeemed between five and seven years, depending on the option you chose. Each of the options had different implications, such as annual interest and phased redemption in one option to another that offered to double your money at the end of the tenor. An NCD is, typically, a secured debenture, unlike a company FD, where, if a default happens, there’s very little that investors can do. Sometimes, certain options within a particular NCD issue can be unsecured. Usually, a well-managed NCD comes with a credit rating. Interest earned on NCDs is taxed at your normal income-tax rates. Typically, NCDs are listed on the stock exchanges where you can sell them if you need your money urgently. As they are listed on the stock exchanges, it’s mandatory to hold them in demat form. Company FDs may offer higher interest rates than L&T Finance NCD, but most of them are not rated, which could be risky. A bank FD is secured to a maximum limit of R1 lakh, though they are perceived to be one of the safest institutions on account of stringent regulations. Where to buy it: From agents or brokers who sell NCDs (during the initial offer period).
IV. Freedom from high-risk investment
Public Provident Fund (PPF): This is one of the best savings vehicles for long-term goals, such as retirement, higher education and so on. It’s a government-backed instrument and, hence, returns are assured. The term of this instrument is 15 years and you earn 8% interest per annum. The beauty of this instrument is that not only are fresh investments (up to a maximum of R70,000 a year) eligible for tax
TOP PERFORMERS Name of exchange-traded funds
Net asset value (R)
Expense ratio (%)
AUM (R cr)
1,059.58
0.50
80.14
Returns 1 year
3 year
47.72
16.65
Equity ETF Banking BeeS ICICI Prudential Spice
189.47
0.80
1.00
21.07
7.39
Nifty Junior BeeS
118.04
1.00
175.10
44.88
10.72
PSU Bank BeeS
411.57
0.74
7.41
56.73
na
Benchmark Nifty BeeS*
552.79
0.50
435.13
23.68
10.40
Shariah BeeS
123.68
0.73
1.18
15.77
na
UTI Sunder
577.17
0.50
0.67
24.14
9.03
Kotak Nifty ETF
549.29
0.50
38.13
na
na
Kotak PSU Bank ETF
434.74
0.65
32.60
60.89
na
Kotak Sensex ETF
184.89
0.50
20.42
22.30
na
Motilal Oswal Most Shares M50 ETF
78.77
na
33.21
na
na
Reliance Banking ETF
1,079.00
0.35
12.83
47.45
na
Hang Seng BeEs
1,303.70
1.00
55.16
na
na
Benchmark Mutual Fund - Gold Benchmark ETF
1,772.82
1.00
985.06
20.65
26.10
Kotak Mutual Fund- Gold ETF
1,771.28
1.00
134.36
20.68
25.95
Quantum Gold Fund -ETF
881.4
1.00
20.20
20.67
na
GOLD ETF
Reliance Mutual Fund - Gold ETF
1,723.1
1.00
274.33
20.67
na
SBI Mutual Fund- SBI Gold ETF
1,806.85
1.70
116.24
20.26
na
UTI Mutual Fund- UTI Gold ETF
1,771.64
1.00
350.00
20.72
26.02
Religare Mutual Fund- Religare Gold ETF
1,821.15
1.00
35.57
na
na
Annualized returns as on 12 August 2010; *as on 18 August
deduction benefits under section 80C, but interest earned on investments are also eligible for tax benefits. Interest income earned is reinvested in the same PPF account. You can invest in a PPF in your child’s name, especially if you are planning her higher education. Assume you’re planning to save for your child’s postgraduate management course once she turns 21. Assume that a two-year full-time management course that costs R5 lakh today would cost around R16 lakh after 20 years, assuming the rate of inflation is 5%. A newborn child would have around 20 years to make that kind of money, in which case, a yearly contribution of R33,000 is required. On the other hand, if you were to wait till the child turns, say five, you’d have to contribute R55,000 every year to reach your goal of R16 lakh when your child turns 20. Given the tax advantage and high assured returns backed by the government’s guarantee, PPF is a potent tool to plan for your financial goals. You can make your PPF invest-
Source: Value Research
FUND FACT
Passive funds can't disclose tracking error
As passive funds, such as index and exchange-traded funds, are mandated to mimic their benchmark indices, there’s no straight forward way to tell which index fund is better than the other. One of the very few ways to see how good or bad an index fund is its tracking error. What is tracking error?
The deviation of an index fund’s performance from its benchmark index is measured by a number called tracking error (TE). Passive funds incur TE for several reasons. They pay brokerages to brokers to buy and sell scrips that increased their costs that eventually reduce their net asset values. Cash holdings also contribute to TE as a higher TE impacts the performance. The lower the TE, the better is a passive fund. Disclosure standards
The capital market regulator, Securities and Exchange Board of India (Sebi) mandates a disclosure
15 | august-SEPTEMBER, 2010
of several portfolio attributes that enables investors to track their mutual fund investments efficiently. Unfortunately, TE is not one of them. Different fund houses have different standards; some disclose every month diligently and others conveniently avoid. The periodicity of calculation also differs; some give 1-year TE, others give 3-year TE. The solution
A TE of up to 2% is generally acceptable, though few index funds cross this limit. As TE is the best indicator to differentiate one index from another, a regular and standardized disclosure helps.
financialfreedom
mint money The guaranteed basket
Name of the scheme
Min. investment
Max. investment
Returns
Tenor
Features
Post Office Monthly Income Scheme
R1,500
R4.5 lakh in single account and R9 lakh in joint account
8% per annum, payable monthly
6 years
If withdrawn after one year but before 3 years, the fee is 2% of the deposit. If withdraw after 3 years but before maturity, the fee is 1% of the deposit. However, if there is no withdrawal, then a bonus of 5% on principal amount is paid on maturity
Public Provident Fund
R500 every year
R70,000 in a year
8% per annum, compounded annually
15 years
Deduction under section 80C of the Income-tax Act. Withdrawal is permissible from seventh fiscal year from the year of opening; limited to one in a fiscal year
Senior Citizens Savings Scheme
R1,000
R15 lakh
9% per annum, payable quarterly
5 years
If account closed before 2 years, the fee is 1.5% of balance amount. After 2 years, the fee is 1% of balance amount. Tax is deducted at source on interest if the interest amount is at least R10,000 per annum. Deduction allowed under section 80C of the Income-tax Act.
FUND FACT
your MF is supposed to publicly account for its investor complaints We wouldn’t be surprised if you tell us you’ve lodged a complaint with your mutual fund (MF) at some point of time. It could have been wrong allocation of units, dividend payments not received, wrong bank accounts mentioned in your account or your name being misspelt. We hope MFs are resolving your complaints, but there’s a way by which you will now be able to keep a track of how well or otherwise your MF is doing, in terms of complaints it gets and those that they resolve. New rules
Effective 2011, MFs will be mandated to disclose the total number of complaints they have received and resolved. In a circular that capital market regulator, the Securities and Exchange Board of India (Sebi) issued on 13 May 2010, MFs will have to disclose details of such complaints within two months of the close of the financial year. To ensure that you’ll be able to effectively compare data provided by one fund house from another, Sebi has also specified a common format. Although by the time Sebi issued the circular, it was already a month past the end of the 2009-2010 (March-end) financial year, Sebi asked fund houses to give the 2009-2010 details by 30 June 2010. Give me the details
It’s not just about the number of complaints you’ll get to see. In a move that has transparency written all over it, Sebi wants MFs to disclose details of their track record for that particular financial year. The complains will need to sorted into seven categories ranging from
non receipt of dividends, account statements to discrepancies in account statements and non receipt of redemption proceeds. Not only would MFs be required to disclose the number of complaints that the have received under each of these categories, they would also be required to disclose the number of complaints pending. Your MF will also tell you how quickly it resolved various complaints and if not, then for how long they have been kept pending. It’s a whole host of information at your doorstep, but this is one more way to check the quality of investor service of the fund house in which you’re invested in. Where to get it?
Mutual Funds will have to disclose their complaint details on their own websites. Additionally, they will also have to mention in their annual reports that they send you every year. If you wish to compare the information across fund houses, you can go to the website of Association of Mutual Funds of India (Amfi) MF industry’s trade body- and select the fund house whose details you wish to see.
ments once a year or as many times as you want in a year. Your annual contributions can be the same or different. Once your 15-year term is over, you can extend the term in batches of five years. Where to buy it: From public sector banks and post offices.
V. Freedom from old-age income uncertainty
Senior Citizen’s Saving Scheme (SCSS): The government’s SCSS is probably the best investment for a senior citizen if you’re looking for assured returns. Among all the assured-return schemes provided by the government, SCSS offers the highest interest rate of 9%, payable to you on a quarterly basis. You can put a minimum of R1,000 and a maximum of R15 lakh. Every quarter, your SCSS will pay you interest. If you invest R5 lakh in SCSS, your annual interest will work out to be R45,000. This works to be R3,750 per month or R11,250 per quarter. The scheme’s tenor is five years. When you invest in SCSS, you will be given a separate passbook in addition to your bank account’s passbook. Your SCSS account will also have an account number. The interest you earn on your SCSS will be transferred to your bank’s savings account. You must remember to update your SCSS passbook every time your SCSS pays you interest. You can hold an account in a single name or as a joint account. But both holders of the joint account should be senior citizens. You can appoint your son or daughter as a nominee, even though they may not be senior citizens. Where to buy it: The SCSS is available with major public sector banks and banks such as ICICI Bank Ltd. However, you need to check with your bank branch
16 | august-SEPTEMBER, 2010
about its availability. Post offices too sell SCSS. Bank FDs and Post Office Monthly Income Scheme (POMIS): An assured return scheme is any retiree’s dream. Bank FDs and POMIS are two such instruments that do not have an age requirement. POMIS pays an interest of 8% per annum, payable monthly, and its tenor is six years. Additionally, you also get a 5% bonus on maturity. For instance, if you invest R5 lakh in POMIS, you will earn R3,333 per month. At the end of six years, you will get your principal plus R25,000 as bonus, or a sum of R5.25 lakh. For a similar tenor, bank FDs now offer interest rates of around 7.5%. Many banks, such as HDFC Bank Ltd, IDBI Bank Ltd, Kotak Mahindra Bank Ltd and so on, increased their interest rates recently. Senior citizens get an additional 50 basis points. Hundred basis points make a percentage point. Another interesting option is the tax-saving FD. First introduced in the 2006 budget, tax-saving FDs allow investments up to R1 lakh. On account of tax deduction benefits, tax-saving FDs come with a lock-in of five years. These days, many tax-saving FDs also offer an interest rate of 7.5-8%. More banks are expected to raise their FD rates in the coming months. Although POMIS offers assured returns that carry the government’s backing, investing in them can be a hassle. Most post offices aren’t yet computerized. As a result, records in passbooks have to be maintained and updated manually. Human errors and bad handwriting add to the problems of investors, specially senior citizens. Where to buy it: Banks and post offices
financialfreedom
mint money
Freedom from the
landlord
[
If you can afford a higher rent, why not buy a house and use the same money to service home loan EMIs instead. Cut your renting woes and settle in your own home.
17 | august-SEPTEMBER, 2010
]
financialfreedom
T
here was a time when your income was just about enough to meet your daily needs. You lived in a rented accommodation and only had basic furniture. It was easy for you to shift your place according to your needs. Life was simple. But life doesn’t remain that simple. As your income grew, you bought assets such as a refrigerator, washing machine, television and costly furniture. You now required paid help to move your assets while shifting your house. And the last time you shifted, your furniture got scratches during transportation; some of it may have even been damaged. That is not the end of your woes if you are looking for a rented apartment. You will need a property dealer’s help to find a house. The dealer would take you to different landlords and show you a number of houses. But often, the dealer would work for his and the landlord’s interests, not yours. He would show you only those houses that command a high rent. Once you select a property, a month’s brokerage has to be paid to the dealer. Landlords in Delhi-National Capital Region (NCR) usually take a month’s rent in advance in addition to two months’ rent as a security deposit. Mumbai’s rental market is more expensive compared with other cities. Here, landlords ask for a security deposit equivalent to 12 months of rent. Although the deposit is refundable, it is not easy for everyone to pay such a huge sum at one go. After going through the trouble of finding a suitable house, you need to do some paperwork before you can move in. A lawyer or a property dealer will help you prepare the rent agreement with your landlord. The usual rent agreement allows you to stay in a house for 11 months. If your landlord agrees to renew the rent agreement, the rent increases by 10% every year. The landlord also needs to verify your permanent address before letting you in. For this, he will submit your details at the local police station. Verification is a must these days. You may end up with a landlord who becomes your best friend. But not everybody is that
mint money
lucky. He may not be prompt in resolving any problems you may have with the house—such as a broken window or a malfunctioning tap. Frequent visits to check whether you are keeping the house clean may also be irritating. If the growth in income has allowed you to pay higher rent, why not take a home loan and pay the equated monthly instalment (EMI) instead? All you need is 15-20% of the total value of the property to purchase it. But there are several factors you must bear in mind before you take the plunge. Affordability is a key concern while shopping for anything, particularly a house. The location affects the price of a property—the reason why houses located in the heart of any city are costlier than those in the suburbs. You need to bear in mind that the EMIs you pay on your home loan doesn’t exceed a certain percentage of the income. That said, buying a property has many advantages, not just for those who want freedom from their landlord but also as an investment.
Appreciating asset: Real estate—land or building, residential or commercial—has helped investors create long-term wealth. Unless you have bought right at the top of a property price bubble, investment in real estate will finally pay off in the long term, no matter what or where you bought. The pressure of development, inflation and growth ensure this.
Inflation-indexed income: A big advantage of real estate over other investments is that it can produce regular monthly income in the form of rentals. Unlike other investments, you have the ability to control the income from rent. You can increase or decrease the rent based on changing market conditions in order to maximize income. Also, as the underlying demand for property
A big advantage of real estate over other investments is that it can GENERATE regular monthly income
when inflation works in your favour The burden of your EMI only decreases as years go by. While your income increases, inflation decreases the purchasing power of the EMI you pay. This is how the value drops over a period. EMI
Year 1
21,329 21,329 21,329
Year 5
15,653 21,329
Year 10
11,488 21,329
Year 15 Year 20
Value of your EMI
8,431 21,329 6,188
Inflation assumed at 6%; for the purpose of illustration, we are assuming fixed EMI; figures in R
exceeds supply, rentals aren’t likely to drop correspondingly even during a slump. Rental income is inflation-indexed and will rise over time, making a rent-bearing piece of real estate an ideal slice of a retirement portfolio.
Tax break on financing: To encourage individuals to live in their own homes, the government has given a tax break on home loans. Interest up to R1.5 lakh on a home loan is a deduction you can claim from your income. If there is a joint loan in two names, both can claim deductions of R1.5 lakh each, making it a tax advantage of R3 lakh for a couple. This is true if you live in the house you have bought on a loan—if you rent it
18 | august-SEPTEMBER, 2010
out, the entire interest becomes a deduction. But remember, the rent will get added to your income and you will pay higher tax. So, if you are convinced with the logic of investing in property, your next step should be towards finding an investment destination rather than a rental destination. All you need to understand is this does not require a lot of money. Buying a property may also add to your financial freedom. While you manage your property, it grows in value over a long period. If you buy a second property, you can rent it out and ease your EMI burden through that income. And just as the landlords of your past, you can now increase the rent by 10% every year.
financialfreedom
mint money
Freedom from
Debt [
Most of us have a debt burden in some form or another. In fact, to maintain a certain lifestyle, it is unavoidable at times. But the danger of falling into a debt trap is best kept at an arm’s length. Here’s how not to cross the thin line.
19 | august-SEPTEMBER, 2010
]
financialfreedom
A
merican columnist Earl Wilson once said, “Today, there are three kinds of people: the have’s, the have-not’s and the have-not-paid-for-whatthey-have’s.” The likelihood that most of us fit into the third kind cannot be ruled out. Our homes, cars, education, vacations and more are on loans or credit. With the economy growing at 8.5% annually, urban Indians today have more money in their hands than any generation before them. Crazy consumerism, mall mania and “buy now, pay later” schemes have increased. And that poses some obvious questions.
l
l
How much debt is sustainable? There are basically two types of debt: good debt—such as a home loan with which you buy an appreciating asset—and bad debt—such as a car loan with which you buy a depreciating asset. When you take a debt, know the kind of debt you are getting into. Having said that, the amount of debt you can comfortably afford to take should not exceed 40% of your salary after you have taken the expenses into account. So, if you earn R1 lakh a month (take home) and your living expenses are R30,000, then the total equated monthly instalments (EMIs) you pay should not exceed 40% of the remaining R70,000—that is R28,000. You should always leave a cushion amount over and above your expenses and total EMI payments.
l
How to get yourself back on track
l The first step is to accept that you are in a debt trap. Most of us go into denial about our own faults and realize the problem only when it’s a struggle to pay just the interest on a ballooning credit card debt and battling calls of recovery agents becomes routine. Look at "Debt Test" to find out if you are in a debt trap. l Get all your paper work together. Segregate your papers in three sets. The first set is your assets, such as saving accounts, fixed deposits and investment. The second is of all your debts, such as home loan, credit cards, personal loan, auto loans and other loans. The third set will
l
l
mint money
include all your current expenses, dues and pending bills, such as house rent, cellphone bill, electricity bill and the like. Calculate and prioritize debt. It’s important to know the exact amount you owe. Calculate your total debt. Categorize them into two—necessities and others. Debts that, if not paid immediately, can hinder your daily life fall under necessities. These would include your current dues and bills and secured debt such as a home loan. Also, ensure you pay more than the minimum amount due on your credit cards. Once you have paid off these, prioritize other debts, starting from the one with the highest interest rate to the one with the lowest. Make sure that you pay at least the minimum monthly dues on all your debts apart from the one with the highest interest rate. Pay as much extra as possible towards the first (highest) debt. Then focus on the debt with the next highest interest rate and so on. Remember, a credit card is the most expensive debt. Call your banks and request them to reduce the rate of interest. If they don’t, look for the balance transfer option on the credit card. The rate of interest that you pay on a balance transfer is much lower—0.75-1.49% per month—compared with 3.5% per month (up to 45% per annum) on a regular credit card. You may even apply for a personal loan and pay off the credit card debt as the rate of interest on a personal loan is lower at 12-25% per annum. Volunteer to take help. When debt goes out of hand, sooner or later you will have to face the recovery agents. Dealing with them may not be a pleasant experience. So, if you find it difficult to handle your own debt, seek help. There are a number of consumer credit counselling agencies in the country and their services are free. Maintain emergency funds. While getting out of debt should be your topmost priority in these difficult times, ensure that you never run dry on emergency funds. Even as you try and pay off your debt, don’t break your emergency cash
fund. If you don’t have an emergency cash fund, keep aside some amount for contingency even as you repay your debt. Buying health insurance will ensure that emergency
funds don’t get exhausted in case of medical needs. l Avoid more debt. Or else you will be digging a debt trap so deep that getting out of it may become impossible.
Should you prepay? Which loan should WHICH LOANS SHOULD YOU you close first? PREPAY? Ask financial planners and they will tell you that prepaying any loan is always a good idea. As a general thumb rule, even if you cannot prepay the entire loan in one go, it makes sense to prepay at least a part of the principal amount. It reduces the total amount of interest you pay, which means your total loan costs less. Some planners also suggest that if you have surplus funds and by investing that you can get guaranteed returns of around 5% more than what you would have saved in interest if you paid the loan, only then does it make sense to go ahead and invest that surplus, otherwise simply prepay the loan. For instance, if the interest you pay on your car loan is 10%, then you should invest in an instrument that gives you a minimum of 15% interest—otherwise just pay off the loan. So calculate the net interest rate at which you are paying interest after accounting for tax breaks. Then calculate the net guaranteed return you expect to earn on the funds that you would use for prepayment. You need to take taxes into account. If the net return on your investment is lower than the net rate of interest you are paying on your loan, choose to prepay the loan principal, in part or whole. For fixed rate loans, as a general rule, it’s better to borrow when the rate of inflation is high and repay when it is falling.
The first loan, or debt, that you need to free yourself from is credit card debt. This is the most expensive debt, with the interest rate running as high as 45% per annum. The next loan you should prepay is the car loan, which on an average runs for five years or so. Some lenders charge you a prepayment fee: make sure you negotiate and get a waiver on that. A home loan runs for a longer tenor than any other loan and the likelihood of interest rate fluctuation is the highest. But a home loan gives you tax deductible benefits, so the last loan you should prepay, if at all, is your home loan. If you have an education loan running as well, then it should be prepaid after the car loan and before the home loan, considering the tenor and interest rates. We recommend that you take a personal loan with a fixed interest rate that is lower than the education loan interest and pay off the education loan. Remember to keep servicing your EMIs for all loans and do not default on any of them; pay off anything extra you may have towards credit cards, then personal loan, car loan, education loan, and home loan, in that order.
Debt Test You know you have crossed the danger mark when You've spent up your credit limit on your credit card You use overdraft on salary every now and then You borrow money in crisis since you don’t have an emergency fund You use credit cards to pay for everyday expenses You pay only minimum amount due
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on your credit cards every month You have creditors calling you up about an unpaid bill or EMIs Your spending habits are a secret and your family doesn’t know about them You often argue at home about money matters You indulge in comfort shopping
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Freedom from
retirement worries S
ocial security is a benefit that eludes most Indians. Not because they seek joint family support in the sunset years, but due to sheer lack of viable instruments. However, with the onset of the New Pension System (NPS), this space is changing fast. NPS is a pure retirement product and arguably one of the cheapest retirement vehicles available. Because of a weak distribution infrastructure, NPS has not really taken off. However, if you are looking to invest for your retirement days, NPS is the scheme for you.
About NPS It is a pure defined contribution product with a lock-in till you are 60 years of age. You can begin with a minimum annual contribution of R6,000 in the funds and fund managers of your choice. There are six fund managers to choose from:
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Investing for your retirement years is not all it takes to ensure your sunset years are smooth. Channelizing your savings into a regular income that can sustain you comfortably is another challenge.
ICICI Prudential Pension Fund Management Co. Ltd, IDFC Pension Fund Management Co. Ltd, Kotak Mahindra Pension Fund Ltd, Reliance Capital Pension Fund Ltd, SBI Pension Funds Pvt. Ltd and UTI Retirement Solutions Ltd. You choose from two investment strategies: Active choice: You Active choice: You can allocate your funds
across three fund options—equity (E), a maximum of 50% can be invested in equities, the rest goes to debt; fixedincome instruments other than government securities (C); and government securities (G). Auto choice: In this, the system automatically begins with a maximum exposure to
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financialfreedom equity at 50% until the age of 35 years, tapering off to 10% by age 55 in order to lend stability to your investment as you near maturity. On maturity, you get 60% of the fund value as lump sum and the remaining 40% goes into buying an annuity product, which gives you a regular income or pension. If you wish to withdraw early, the system discourages you by giving you just 20% in your hands and annuitizing 80% of the corpus. However, if you need cash and, at the same time, wish to enjoy the benefits that NPS gives, you could subsequently invest in a Tier II account of NPS. Tier II works like a savings account from which you can keep withdrawing according to your requirement. This account invests your money in the same funds and the same six fund managers that manage your pension account manage your money. The only difference is that a Tier II account provides liquidity. NPS has two sets of charges— flat and variable. You will have to pay about R470 as a flat charge every year, but this is expected to come down as volumes go up. The annual variable charge is 0.0075% of the fund value custodian charges and 0.0009% management charges—the lowest in the industry.
Retirement strategy If you are a salaried individual, start with your Employees’ Provident Fund (EPF) contribution. EPF gives
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an unmatched 8.5% guaranteed returns and your contribution is doubled since your employer matches your contribution—you contribute 12% of your basic plus house rent allowance. The second risk-free and taxfree return vehicle is the Public Provident Fund, which gives a guaranteed 8% over a tenor of 15 years. After you have exhausted these two vehicles, you may invest in NPS if you are not an aggressive investor since NPS covers the debt and balanced fund space. In terms of cost, NPS beats other market-linked options, such as mutual funds and unit-linked pension plans (ULPPs). With a favourable tax treatment as proposed by the draft Direct Taxes Code, NPS will also become tax exempt on maturity. At present, the Tier I account of NPS enjoys tax deduction benefits of up to R1 lakh under section 80CCD of the Income-tax Act. However, on maturity, the amount that you get as lump sum is taxable in your hands. But watch out for ULPPs as the insurance regulator, Insurance Regulatory and Development Authority (Irda), has proposed new caps on charges, strict lock-ins and a guaranteed return of 4.5% on the product. But if you are an aggressive investor, ULPP may still not be meant for you. The guarantee on the product will force the insurers to swing more towards debt.
Why you should use NPS as a long-term retirement option Assume that a 30-year-old makes an annual contribution of R1 lakh under each of these plans for 30 years. At a growth rate of 10%, she would be richest in an NPS. Final corpus (R cr) Internal rate of return (IRR) (%)
NPS
1.8
MF pension plan
1.14
Insurance pension plan
1.33
9.97 7.65 8.44
IRR is the real rate of return or the post cost return on a financial product; NPS: New Pension System
Turn that corpus into pension But for true freedom you need to take your investment strategy a step further and spin that investment corpus into a regular income-generating vehicle. At the same time you need to ensure that a part of your corpus is invested to stay afloat the inflationary tides. Which is why you need to invest a small portion of your portfolio in equities while most stays in debt. Your debt portfolio is the one that will fetch you an income. The idea is to earn an income through the interest while keeping the principal risk-free. In the top rung is Senior Citizens’ Savings Scheme
(SCSS), which gives you an assured return of 9% per annum, payable quarterly. The scheme is available for five years and you have the option to extend it by three years. The maximum you can invest in SCSS is R15 lakh and we recommend you exhaust this limit before you turn to the second rung products. In the second rung, you can choose between the Post Office Monthly Savings Scheme (POMIS) and banks fixed deposit (FD) schemes. The argument in favour of POMIS is that it offers a 8% guaranteed return per annum, payable monthly. At the end of the term— six years—your principal gets boosted by another 5% that increases the effective yield to 8.9%. However, financial planners cite administrative glitches that come in the way of recommending POMIS over FDs, which give a comparable rate of around 8-9%. But your debt portfolio is not all you still need an equity kicker to tide over inflationary pressures and re-investment risk of debt products. You need equity exposure too. You could consider well-diversified mutual funds, index funds or even exchange-traded funds. While at this stage you may not need a life insurance policy for a lack of any financial dependants, a health insurance policy that will take care of your hospitalization expenses is absolutely necessary.
Retirement Options to Choose From Min-max contribution Term
Entry load
Annual cost
Invests in
Return
Employees' Provident Fund (EPF)
Min: 12% of R6,500 (basic pay + DA; Max: 12% of basic salary + DA
60 minus the investor's age
None
No charge
G-secs & debt products
8.5% per annum
Public Provident Fund (PPF)
R500-70,000
15 yrs, can be extended by 5 yrs
None
No charge
G-secs
8% per annum
Mutual fund pension plans
Min: R500
60 minus the investor's age
None
2.25-2.50% of the fund value
G-secs, debt products & equity up to 40% of your portfolio
Marketlinked
Insurance pension plans *
Min: around R10,000
Up to 75 minus the investor's age
Up to 25% of first year premium, 0-10% thereafter
Recurring fund management charge of up to 1.35% and administration charge
G-secs, debt products & equity up to 100% of your portfolio
Marketlinked
New Pension System (NPS)
Min: R6,000
60 minus the investor's age
R50 deducted from fund value as account opening charges, R40 as initial registration charge
Fixed charges: R350 and R10 deducted from the fund value as CRA charges. R20 per transaction at the point of presence. Variable charges: custodian charges of 0.0075-0.05% per annum. Fund management charge of 0.0009% per annum
G-secs, debt products & equity up to 50% of your portfolio
Marketlinked
Note: All the instruments mentioned in the table enjoy the exempt-exempt-exempt (EEE) status, except mutual fund pension plans and NPS that come under exempt-exempt-taxable. However, the draft Direct Taxes Code guidelines propose to bring NPS under EEE. * The overall cost cap of 3% if the term is less than 10 years and 2.25% if the term is at least 10 years. However, beginning September, pension plans will have a minimum guaranteed return of 4.5% on maturity and will have caps on charges not just on maturity but every year after the fifth year. Also, premature withdrawal will not be allowed. Any premature withdrawal will mean that you annuitize two-thirds of the withdrawn corpus; CRA: Central record-keeping agency; G-secs: government securities; DA: dearness allowance
22 | august-SEPTEMBER, 2010
financialfreedom
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Freedom after
your death
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You don’t want the house you carefully and lovingly built over your lifetime locked into a dispute after your death. Plan your succession to make sure your assets go to the right people.
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W
e put in a lot of hard work to earn our income, which we then use to acquire assets. But these assets aren’t just deposits of money, they also become vaults of our emotion. The first car, the first gold necklace and, of course, the first house are not just physical assets accumulated on the back of improving pay cheques. They embody our feelings, our associations with the people we love and the places we don’t want to forget. After living in rented premises for a decade, when you first booked your own house, it was not just about postponing the foreign trip and cutting down on movies and dinners to be able to pay the equated monthly instalments (EMIs) on time. It was also about how the road always led to the site every morning when you went for a walk, how every weekend you invariably found yourself in a home decor store and how your child rode his first bicycle alone on the lawn. But in the long run, we are all dead. What happens to all the wealth and assets, in which you invested not just your money, but also your emotions? In your absence, your sons and daughters, aunts, granddaughters and even servants are likely to lay claim to your assets. The result: Your home is going to get locked in litigation and the garden where you had tea every morning is going to be overgrown with weeds.
When and why do you need to plan your succession? We carry on under the assumption that we have a long life ahead, but the fact is that life is uncertain. So, if not from Bollywood movies, you can certainly learn this lesson from all the high-profile family feuds that you have seen—the most recent being the spat between the two Ambani brothers—and have your succession plan in place. This will ensure that when you die, your near and dear ones don’t have to face monotonous paperwork, unfriendly officials and complicated litigation to add to the trauma of the loss. Usually, chalking out a succession plan is not very difficult if the assets you want to bequeath to your heirs are small. So long as your bank accounts and fixed
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deposits have a nominee, the bank will release the money to him— although a nominee is only a guardian of the assets until the lawful beneficiary can be determined. However, if your assets run into a few lakhs, your portfolio includes an array of assets, and you want your beneficiaries to be not just your children but also an organization you have been associated with, your domestic help’s daughter and your great aunt’s grandchild, then it’s best that you have a will.
in the will, or anything acquired after the will was made, also goes to the intended beneficiary. The will may be stored in a safe place, such as a bank locker, or be entrusted to a professional legal custodian, who executes it finally. It’s good to ensure that at least one unbiased and uninterested person is aware of the will. The executor must have no personal interest in the assets so that he can execute it in a fair manner.
How do you plan your succession?
A will can be registered with the sub-registrar’s office. However, an unregistered will, if drafted correctly, is also perfectly valid. Most people feel more secure if the will is registered. But if you prepare a new will that is duly signed and authenticated but not registered, following an older will that was registered, the new will is valid and the older one is null and void. Before a will can be executed, it goes through a probate—a process by which a copy of the will is certified under the seal of a competent court with a grant of its administration to the executor of the testator. In case of a simple will that is not objected to, a probate is not compulsory in every state. Wherever it is, the will is first published in a leading local daily. Any objection to it has to be conveyed to the court within the stipulated time. If there is no objection, then the court certifies the will, determines the beneficiaries and directs the distribution. The process takes a minimum of six months. A trust created to pass on your wealth is a private one and needs to have at least two trustees. The laws for its registration differ from state to state. For instance, in Mumbai and Delhi it is not compulsory to register the trust, but many people prefer to register it to make it more authentic. A trust does not have to go through a probate. The trust deed immediately comes into effect and the trustees take over and begin execution. Thus, the chances of your assets getting locked due to court procedures are minimal.
Succession planning can be done through a will or a trust. While wills are more common, trusts are adopted for specific purposes. Wills offer a hassle-free way of passing on your assets to the beneficiaries, who can then manage it on their own. A trust comes into the picture when the beneficiary is a minor or a person incapable of taking care of himself due to mental or physical disabilities and may, thus, need a regular income for self-maintenance.
How do you write a simple will? Writing a will is not a complicated process at all. All you need to do is list out all your assets and assign each of these to a beneficiary. The assets you hand down in a will can include financial assets such as shares and securities, bonds and debentures and bank fixed deposits, and physical assets such as gold jewellery and bars, immoveable property, business ownerships and interests, as well as things with an emotional value—such as a grandfather clock or a rocking chair. You may create a will on your own with the help of Web portals or through a professional legal firm. The will can be handwritten or printed, but each page needs to be signed by a witness and a testator. Also, the number of pages should be declared. There are two other things you need to remember while writing your will. First, if you are revising the will, it is advisable to cite previous wills and declare them null and void to leave no room for ambiguity. You should also destroy old wills. Add a miscellaneous clause as well, just to make sure that any asset missing
Should you register your will?
How useful is a trust? Since a trust deed can be worded exactly according to your wishes, you have the freedom to regulate who gets what and when, what
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proportion of the assets are to be unlocked, and when the trust is to be dissolved. This works better than a will as the beneficiary is not required to deal with the nitty-gritty. The trustee appointed by you will handle the legal technicalities. But a trust has its own share of problems. If you set aside assets and create an irrevocable trust during your lifetime, the assets are locked forever. They are out of bounds for you as well—even if you need them. However, if you wish the trust to be dissolved at some point, you may word the trust deed thus and create a revocable trust.
What is the difference between a nominee and a beneficiary? When financial assets are created, its best to create them as a joint asset. Banks and non-banking finance companies will also encourage you to have a nominee. But few realize that the nominee may not be the ultimate beneficiary of the assets. He is a mere trustee, who will act as a legal guardian of the assets until the beneficiary is determined. However, funds are released faster if you bequeath the assets to the nominee.
glossary Testator A person who creates the will Intestate A person who dies without creating a valid will Executor A person who is chosen by the testator to ensure that the directions in the will are carried out as per his/her wishes Beneficiary A person who stands to gain from the will or the trust Nominee In case of financial assets, a nominee is a trustee or a caretaker of the assets till an end beneficiary is determined Trustee A trustee is someone appointed as a caretaker/ guardian of the assets. The testator appoints someone he confides in to administer his assets Administrator A person appointed by the court to administer the will when there is no executor