Monday, 25 March 2013
Investing in FD's is a losing long term proposition | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Ajit Dayal discusses why investing in Fixed Deposits is not as attractive as investing in stock markets. With the equity markets in the "doldrums", there have been a series of articles in the popular press about how investing in Fixed Deposits and in bank accounts is far superior to investing in stock markets. As for gold, it is seen as some barbaric relic that only fools would throw their money at. These arguments are flawed and distort the facts. Readers of the Honest Truth are familiar with the table that is there at the end of every Honest Truth. Suggested allocation in Quantum Mutual Funds (after keeping safe money aside)
Based on Table 1, it is obvious that investors should have exposure to various asset classes. The percentage allocated to each asset class may vary depending on the individual situation of the investors. At the end of the day any investment we make is for:
Shilpa's choice But all of us have a "consumption basket" - we all consume things and, as long as we live, will increasingly consume things. The price we pay for our consumption basket is likely to increase over time - the effects of inflation. Let's take the example of Shilpa, a typical consumer and see how thecost of her consumption basket has changed over time (Table 2). The start year is assumed as 1990. That is just before the Great Indian Reforms of in 1991 when most services or products were provided by either government monopolies or by a few licensed private sector cartels.
Fully aware the costs of enjoying her consumption basket over time will increase; Shilpa knew she had to invest her savings. For arguments sake let's assume that Shilpa had 3 extreme choices:
As Table 3 indicates, the annual cost of her consumption basket in 2011 is Rs 263,000 v/s Rs 42,194 in 1990 - that is an increase of 613% in 21 years, an average price increase of 9% per year over the past 21 years. If Shilpa could use gold to pay for her consumption, she would have needed 200 grammes of gold in 1990. To maintain her "consumption basket" in 2011 she would need only 112 grammes of gold. This is so because the price of gold has surged by 1,098% over that same 21 year time period - an average rate of return of 12% per year for the past 21 years. This is higher than the increase of 9% in the prices of the items in Shilpa's consumption basket. If Shilpa could pay for her consumption with units of "BSE 30 Index" then she would have needed 46 baskets of the BSE-30 Index in 1990. To maintain her "consumption basket" in 2011, she would need only 15 baskets of the BSE-30 Index. This is because the BSE-30 Index has surged by 1,888% over that same 21 year time period - an average rate of return of 15% per year for the past 21 years. This is higher than the increase of 9% in the prices of the items in Shilpa's consumption basket. If Shilpa could pay for her consumption with units of Fixed Deposits or "FDs" then she would have needed 40 baskets of the FDs in 1990. To maintain her "consumption basket" in 2011, she would need a larger number of 70 baskets of the FDs. This is because, while the FDs may have given an average return of 6% after tax, they are below the nearly 9% increase in the prices of goods that Shilpa consumes. This is lower than the increase of 9% in the prices of the items in Shilpa's consumption basket. Note the risks But before you go rushing to buy equity shares or gold, note that both these asset classes can be in the dumps for a long period of time. Or, conversely, can also be "at peaks" for a short period of time. Changes in tax laws will also influence where people could save. If investing in FD's was to become tax free, then maybe Indians like Shilpa would see the benefit of investing in them. Similarly, gold may now attract an import tax and a wealth tax. Shilpa's consumption basket could change. But the biggest risk is, in my opinion, is not diversifying the surplus savings we have into a range of instruments that can give you a steady, decent return and an opportunity to live through some tough times. Disclaimer: The Honest Truth is authored by Ajit Dayal. | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| CONSUMER BASKET | 1990 | 2000 | 2010 | 2011 |
| TOTAL SPENDING PER ANNUM | 42,914 | 118,500 | 222,250 | 263,000 |
| Price of gold, INR/10 grammes | 2,145 | 4,012 | 17,940 | 23,544 |
| Units ( Grams) of gold to consume my basket | 200 | 295 | 124 | 112 |
| BSE SENSEX | 942 | 4,606 | 18,207 | 17,778 |
| Unitsof BSE-30 Index to consume my basket | 46 | 26 | 12 | 15 |
| Fixed Deposit Basket Index Value (Value of initial investment Jan 1, 1990 =1000) (SBI 1 Year Deposit Rate)* | 1,064 | 2,220 | 3,550 | 3,769 |
| Unitsof FD Basket to consume my basket | 40 | 53 | 63 | 70 |
However, is this right strategy to have? Certainly not if one is confident that
the current growth rate in India is just an aberration and days of higher growth
rate of 7%-8% are only a matter of time. In that case, there could be no better
to time to invest in Indian stocks than now we believe.
And our belief stems from a study that we have carried out based on historical data. You see, since the year 1992-93, there have been only six financial years (excluding FY13) where the economy has grown below 6%. And investments made during the end of these years have on average yielded returns of 19% over the next 12 months. Even from a three year perspective, returns have averaged in the region of 17%. Thus, as can be seen, a weak economy is not the time to avoid stocks. In fact, investments made at such times are likely to yield the best results over the medium to long term as most stocks are priced poorly given the weak economic environment. Therefore, smart investors who are able to take advantage of this opportunity are the ones that end up creating good deal of wealth for themselves.
Consequently, one's best chance at generating returns does not lie in heeding Mr Feldstein's advice. It instead lies in taking an exposure in Indian equities if one is confident of its long term growth story.
And our belief stems from a study that we have carried out based on historical data. You see, since the year 1992-93, there have been only six financial years (excluding FY13) where the economy has grown below 6%. And investments made during the end of these years have on average yielded returns of 19% over the next 12 months. Even from a three year perspective, returns have averaged in the region of 17%. Thus, as can be seen, a weak economy is not the time to avoid stocks. In fact, investments made at such times are likely to yield the best results over the medium to long term as most stocks are priced poorly given the weak economic environment. Therefore, smart investors who are able to take advantage of this opportunity are the ones that end up creating good deal of wealth for themselves.
Consequently, one's best chance at generating returns does not lie in heeding Mr Feldstein's advice. It instead lies in taking an exposure in Indian equities if one is confident of its long term growth story.
| CONSUMER BASKET | 1990* | 2000 | 2010 | 2011 |
| Food and personal care (Grocery bill) | 10,167 | 20,000 | 37,500 | 42,500 |
| Taxis / Trains / Local air travel | 3,696 | 8,750 | 11,250 | 15,000 |
| Clothes, shoes | 964 | 2,500 | 3,750 | 4,250 |
| Going out (Recreation and Cultural activities) | 402 | 1,250 | 4,500 | 6,250 |
| Rent / Accommodation cost | 10,000 | 40,000 | 70,000 | 80,000 |
| Electricity | 2,000 | 5,000 | 8,000 | 9,000 |
| Telephone / Mobile phone bills | 3,500 | 6,500 | 9,000 | 10,000 |
| Medical expenses | 2,000 | 5,000 | 6,500 | 8,000 |
| Education | 500 | 2,000 | 3,000 | 3,000 |
| Electronic items | 880 | 2,500 | 18,750 | 22,500 |
| Holidays (Hotels and Restaurants) | 8,805 | 25,000 | 50,000 | 62,500 |
| TOTAL SPENDING PER ANNUM | 42,914 | 118,500 | 222,250 | 263,000 |
Saturday, 23 March 2013
Saturday, 2 March 2013
Investments which qualifies for deduction u/s. 80C
Under this section, you can invest a maximum of Rs l lakh and if you are in the highest tax bracket of 30%, you save a tax of Rs 30,000. The various investment options under this section include:
Provident Fund (PF) & Voluntary Provident Fund (VPF: PF is automatically deducted from your salary. Both you and your employer contribute to it. While employer’s contribution is exempt from tax, your contribution (i.e., employee’s contribution) is counted towards section 80C investments. You also have the option to contribute additional amounts through voluntary contributions (VPF).
Public Provident Fund (PPF): Among all the assured returns small saving schemes, Public Provident Fund (PPF) is one of the best. Current rate of interest is 8.60% tax-free and the normal maturity period is 15 years. Minimum amount of contribution is Rs 500 and maximum is Rs 1,00,000. A point worth noting is that interest rate is assured but not fixed.
Life Insurance Premiums: Any amount that you pay towards life insurance premium for yourself, your spouse or your children can also be included in Section 80C deduction. Please note that life insurance premium paid by you for your parents (father / mother / both) or your in-laws is not eligible for deduction under section 80C. If you are paying premium for more than one insurance policy, all the premiums can be included. It is not necessary to have the insurance policy from Life Insurance Corporation (LIC) – even insurance bought from private players can be considered here.
Equity Linked Savings Scheme (ELSS): There are some mutual fund (MF) schemes specially created for offering you tax savings, and these are called Equity Linked Savings Scheme, or ELSS. The investments that you make in ELSS are eligible for deduction under Sec 80C.
Home Loan Principal Repayment: The Equated Monthly Installment (EMI) that you pay every month to repay your home loan consists of two components – Principal and Interest.The principal component of the EMI qualifies for deduction under Sec 80C. Even the interest component can save you significant income tax – but that would be under Section 24 of theIncome Tax Act. Please read “Income Tax (IT) Benefits of a Home Loan / Housing Loan / Mortgage”, which presents a full analysis of how you can save income tax through a home loan.
Stamp Duty and Registration Charges for a home: The amount you pay as stamp duty when you buy a house, and the amount you pay for the registration of the documents of the house can be claimed as deduction under section 80C in the year of purchase of the house.
National Savings Certificate (NSC): National Savings Certificate (NSC) is a 6-Yr small savings instrument eligible for section 80C tax benefit. The interest accrued every year is liable to tax (i.e., to be included in your taxable income) but the interest is also deemed to be reinvested and thus eligible for section 80C deduction.
Infrastructure Bonds: These are also popularly called Infra Bonds. These are issued by infrastructure companies, and not the government. The amount that you invest in these bonds can also be included in Sec 80C deductions.
Pension Funds – Section 80CCC: This section – Sec 80CCC – stipulates that an investment in pension funds is eligible for deduction from your income. Section 80CCC investment limit is clubbed with the limit of Section 80C – it maeans that the total deduction available for 80CCC and 80C is Rs. 1 Lakh.This also means that your investment in pension funds upto Rs. 1 Lakh can be claimed as deduction u/s 80CCC. However, as mentioned earlier, the total deduction u/s 80C and 80CCC can not exceed Rs. 1 Lakh.
5-Yr bank fixed deposits (FDs): Tax-saving fixed deposits (FDs) of scheduled banks with tenure of 5 years are also entitled for section 80C deduction.
Senior Citizen Savings Scheme 2004 (SCSS): A recent addition to section 80C list, Senior Citizen Savings Scheme (SCSS) is the most lucrative scheme among all the small savings schemes but is meant only for senior citizens. Current rate of interest is 9% per annum payable quarterly. Please note that the interest is payable quarterly instead of compounded quarterly. Thus, unclaimed interest on these deposits won’t earn any further interest. Interest income is chargeable to tax.
5-Yr post office time deposit (POTD) scheme: POTDs are similar to bank fixed deposits. Although available for varying time duration like one year, two year, three year and five year, only 5-Yr post-office time deposit (POTD) qualifies for tax saving under section 80C. The Interest is entirely taxable.
NABARD rural bonds: There are two types of Bonds issued by NABARD (National Bank for Agriculture and Rural Development): NABARD Rural Bonds and Bhavishya Nirman Bonds (BNB). Out of these two, only NABARD Rural Bonds qualify under section 80C.
Unit linked Insurance Plan: ULIP stands for Unit linked Saving Schemes. ULIPs cover Life insurance with benefits of equity investments. They have attracted the attention of investors and tax-savers not only because they help us save tax but they also perform well to give decent returns in the long-term.
Others: Apart form the major avenues listed above, there are some other things, like children’s education expense (for which you need receipts), that can be claimed as deductions under Sec 80C.
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