Inflation – how to tackle it

June 26, 2008

One of the most repeatedly asked question by anybody is – how to tackle this devil which has grown in gigantic proportions?

Most people are unaware of what it is and how it affects them but one thing is for sure, the media has beamed this bad news so continiously that people are more scared than ever. Worse is the situation when we dont know what we are scared off!!

Inflation is simply put as excess money in the country which is chasing few goods. This could be because of prouduction not sufficient or because of too much money with people – net result is the purchasing power of rupees comes down – this is something everybody understands!

Inflation is a essential devil. 3% to 4% is essential for the economic growth of the country but 11% to 14% as of now will hurt the poorest of the poor by reducing their purchasing power while their incomes dont raise proportionately.

The poor man tightens the belt, luxury items are no more purchased, essentials are rationed and the comman man will suffer.

If there is some savings – the retired people etc who have invested in risk averse things like bank FD’s are in for shock as they get negetive returns. Actually the interest paid on FD’s is to give atleast 2% over and above inflation so that your capital remains intact. What reteired people think is that my capital is intact and am living off on the interest portion – WRONG!!!

In current scenario when inflation is at 12% to 14%, your bonds/ FD’s dont give more than 9.75%. This difference is called negetive growth and if it continues for more than 2 years, its a dangerous situation.

So what should common man do for all these – more so the retired people?

Industry experts point out that Gold was one time tested hedging mechanisum but historicaly in the last 20 years, this has not provided very good results. In fact its too much of a risk for common man to purchase, store and sell the same.

Equities are the only life saving mechanisum to beat this devil called inflation. At times of inflation, the corporates increase the cost of products and pass it on to the consumer. But as a owner of the concern you would also be protected as growth would be in line with inflation.  Choose a mutual fund ( balanced one) so that you invest systamatically initially.

RISK is something that needs to be taken for the long term. A pensioner is advised to part 80% in fixed income instruments but 20% should be in equities commited for 7 to 10 years. The growth of this 20% in equities should make the average man break even.

Modern times bring on modern risks and knowledge of the correct nature is imperative to sustain!!

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Thank You SEBI

January 11, 2008

SEBI came up quitely with a wonderfull new year gift to us.

This news came up as article in many newspapers but people are not sure how important it is.

SEBI has been mulling over the issue of abolishing entry loads into mutual funds from very long and finaly in a simple statment told the mutual fund industry to stop collecting the extra money from investors who directly approach the mutual fund house.

Traditionally a distributor/agent would provided educated advice to investors and this extra money ( normally 2.25%) would be partially handed over to that agent/distributor as commission for their service ( Not the entire 2.25% as the AMC tend to claim but right from 0.5% to 1.5% on case basis).

What India is witnessing right now is quite the opposite. The agents are in 8 out of 10 cases, misselling the ill informed investor into new funds where the get hefty commissions (SEBI allows loads upto 6%) on new fund offers ignoring the advice portion.

In a view to curb this malaice, SEBI thinks banning the commission for people who can take educated judgement would definetly in the short run give the agent a run for his business but overall a healthy sign to AMC as their assets under management would grow, investors wealth would grow and only the lazy agent/distributor would be pulled up to serve the industry better.

Three cheers to SEBI.


Safer money, lesser taxes…

August 6, 2007

Most people whom I have met, fall into one of the categories when it comes to investment. Ask them thier risk appetite and strangely it’s either zero risk or full risk with high returns.

A government based security like NSC, FD is the answer to first class of people and equities are the answers to the other set of people. The theme and concern of this post is however the first class of people who get interests but woudnt want to part it as taxes to government.

If one were to invest in any avenue, capital gains come into picture and the only exception is equity mutual funds where there is no taxation of long term capital gains. All other investments are added to your income and taxed at brackets accordingly.

If one were in the highest tax bracket, 33%, any investment into safe avenues like FD, NSC would mean paying taxes at 33% – if there is one avenue by which this can be reduced to 10% of capital gains – there is an instrument – the debt oriented mutual funds.

The medium term debt oriented mutual funds generate returns in the range of 4.5% to 8.5% per annum based on AMC and maturity period of the instruments held. In other words, following are the advantages and disadvantages:

Merits

  • No entry load. Exit loads normally if redeemd before 15-30 days otherwise that is not there too
  • You pay tax at 10% of capital gains instead of 30%
  • Highly liquid, redemptions take 2 to 4 working days only

Demerits

  • Long maturity periods of paper holdings and low rated commercial papers are risky.
  • Scheme choosing should be done with care – Interest rate flactuations are a cause of concern.

Insurance – the motor variety

August 2, 2007

I have a 2 wheeler purchased in 1998 for which insurance renewal had to be done. A visit to the firm got my BP rollercosting…there was a hike of 20% in premium rates from last year!!

There are 2 types of insurance for motor vehicles. Type A – where damage to vehicle including thefts, fires etc is covered and quite highly priced. Type B – where you can not claim any accidents damage etc but the insurance company will cover you in case somebody sues you for accident upto a maximum of 50,000 INR.

On closer scruitiny with 2 other firms offering insurance, to my surprise all of them have raised the premiums and when I requested for a discount since the policy did not have a single claim in the last so many years, the Manager rudely pulled out the book and showed me where it was printed “the company is at its discretion able to judge and set premium levels including complete rejection without reasons”.

That was the last straw. Its like the cops catch you without the cheapest type B insurance and you need to pay fines, sooner or later the insurance firms will catch up with premium rates so high, cops will seem cheeper by fines!!!

This is another way of penalty for using private transport I guess!!


Insurance… Need,Limits

August 1, 2007

So, here am back discussing the most talked about thing Insurance. Some body was asking about when Insurance is needed at all, how to access what is the ideal limit and hence this post.

The basic tenet of insurance is that both you and the insurance company bet on the happening or not happening of a particular event. Insurance is a business tool to safegaurd against events which MAY happen. This is primarily to cover your monetoray costs. For example if the sole bread winner of the family meets with accident, expires there should be a regular flow of funds to meet as if the breadwinner existed.

This should answer- is Insurance needed at all. Do not take insurance for emotional reasons – if you are high networth individual and you dont have financial dependents, you wouldnt be needing insurance in first place.

Under insurance is another malady we come across when endowment policies are sold in India. Note that in India insurance is sold while its brought in developed countries.

I remember my father was insured for 2000 INR ( yes it is two thousand rupees) in 1970 for a term of 20 years… This is a classical example of under insurance using an endowment policy ( money back). Had my father taken a term insurance, he would have got a much bigger coverage. Had something happened to my father, that 2000 is pittence as insurance and defeats the very purpose in first place.

Here are some guidelines

  • Insure every breadwinner to the EXTENT they contributed to monthly income for a period of atleast 10 years. Meaning if your spouse contributes 12,000 INR per month, the insurance should do so similarly with the lumpsum in some FD/debt instrument for a term of 10 years. Thumb rule is 20 times your annual income.
  • Allways take Term insurance, ignore endowment or money backs – they are only investment – ULIP is the same story.
  • Under Insurance is the bane of majority of people. Keep reviewing your needs regulary and upgrade/downgrade according to risks. For example people tend to ignore the loans etc – a classic product is insurance against home loan defaultment due to death of the loan taker.
  • There are some sundry things people take insurance cover like theft for home articles, loss of property/assets from earthquakes,fires including cancellations of ones marraige !!! [ This is the latest straw, you have spent 8 lakhs in advance for your marraige and due to beravement, it stands postponed – you loose all deposits paid to choultry to chowkidars…so here is the helping hand of insurance].

FMP and FD

July 19, 2007

The cycle of debt and equity instruments are at work again. The bank fixed deposit rates are rising once again and people are reportedly flocking back to saving avenues from small savings schemes which are about 2% less than commercial /scheduled bank rates.

Investors are also being offered fixed maturity plans (FMP’s) by allmost all fund houses. This is a mutual fund which can NOT be redeemed until the expiration of the term and hence locks up the funds of tenures offereing good/decent returns. Some are touting this instrument and this post is to clear up the differences between both the bank fixed deposits and mutual fund house FMP’s.

FMP

  • Most of them can not be broken, you can not take loans and depending on the AMC, there may be steep exit loads for window period ( time when the AMC is ready to buy back units) too.
  • You tend to get decent returns about 1% or 2% compared to bank FD’s but have the potential to do better.
  • Since the AMC already pays 14%++ tax to government, depending on the holding you need to pay 10% one time or index it over time. Talk to your advisor about indexing option.
  • You have the RISK of loosing money here.
  • Very much like bank FD’s, there are tenures from 30 days to 3 years!
  • Most AMC prefer this due to SEBI guidelines which state the AMC can NOT collect fat commissions on New fund offers for open type – so the fraud occurs through back door of FMP’s – unless its suited for the customer.
  • Suggested currently for people to park money for short terms falling in highest tax bracket.

Bank Fixed Deposits

  • There is no RISK involved in losing principle if its in a scheduled bank. In other banks, your principle is gauranteed only upto 1 Lakh INR provided the bank has taken insurance for the same. The net total will include all monies from savings bank and fixed deposits. Beware of this!!
  • Suggested for people with lower tax brackets at current scenario.
  • Taxation is done at your levels and could range from 10% to 30%++.
  • Nomination is very important. Ideally a joint account is suggested as in case of death of primary holder, the nomination does not hold much water over a will.

The reason why FMP is touted is that its post tax returns are good compared to FD’s but Risk in both cases need to be considered.


Insurance, Taxes and Investments

July 18, 2007

Strange as it sounds but many people confuse themselves in the name of the above 3 items and either land up with what the agent suggested, invest some where it is GOOD to invest as heard from somebody or crib about it after 2 years!!!

Its amazing how a human being functions when it comes to money matters. I see on an average people fighting and haggling for 1 Re with a vegetable vendor or 1Re at petrol bunk but loose out 100’s of rupees in the above games!.

Games – Off course, unless you dont take to educate yourself about it, most people out there are ready to do a fast con job.

Insurance.

Your agent is only interested in selling you a money back/endowment policy with high premiums and low coverage – do you need it?

Your agent tries to insure everybody in family including your spouse and even the Kid in the name of future returns – what nonsence. Insurance is puraly needed to replace the financial liability which araises in the key earning memebers death or disability – I laugh when policies are taken on one housewifes and 5 year kids!!

Golden rule – “Dont mix investments with insurance”. Treat and respect them seperately. Period.

Ask the agent for term policy which is low premium but gives high coverage and watch the agent disapper never to trouble you again.

Taxes

Yes, upto Rs 1 Lakhs, you need to plan for it.

a) Most people including me forget our salary PF contribution, this by default is ignored and we invest. Kindly take this amount as the starting point.

b) Remove all the LIC, medical policy premiums. If anything is still left – sit down and calculate how much you can save and for how long – All 6 year stuff can go to the popular NSC, PPF types of issues – dont forget that anything deposited in PPF is not taxed, its interest is NOT taxed, its final withdrawal is NOT taxed – the only golden instrument which locks up things and gives it back safely.

c) A wiff of Mutual funds would do good too – save every month from April to next march so that you dont try to time the market and ride out all the ups and downs easily. As any broker would say “tax saving is not done ONLY in march”.
Investments

Now – A Equity Linked Savings Scheme ( ELSS) is NOT the recomended mode of saving and insurance as your agent brain washes you.

Investment needs to be split into debt or safe instruments which are gauranteed NOT to loose money and equity linked instruments for beating that deadly inflation followed by asset class things like land, egoistic entities like gold…

Everybodies ability to save depends on their incomes but the golden rule is a mix is allways suggested based on time horizon one can save money. Your age plays a direct role here. Younger you are – more risk you can take, older you are – debt instruments are preferred.

The pyramid rule applies here very much. First the solid base like savings bank account. This is followed by medium risk investments like Mutual funds etc. The last segment or the cream is the top – pure equities.

So next time, you know what you need and how to evade that salesman!