Risks in Debt Instruments like FD, RD and Bonds

Do you think investment made in Fixed Deposits, Recurring Deposits and Bonds are really safe?  Of course, investing in Debt Instruments like FD, RD and Bonds are considered as safe.  It protects the Capital and gives you some assured returns.  Though these are safe in terms of protecting the Capital, there is an inflation risk associated with them.  If the rate of returns doesn't match or beat the inflation rate, there is no use in investing in Debts Funds/Instruments. 

What is Inflation?

Inflation is the price increase of the products and services year by year.  It is measured as rate.  For example, if the price of a product, say Television is Rs.35000/- today with the inflation rate of 8% every year it would cost you around Rs.51426/- after 5 years.

How does Inflation affect the returns of Debt Investments?

If you have Rs.35000/- (the cost of television) and invest in Fixed Deposit (FD) for 5 years with the interest rate of 6.85% p.a. (prevailing interest rate of SBI as on February 2019) compounded quarterly, at the maturity you would get around Rs.49155/-.  So it means there is no return you have actually earned from the investment.  If the inflation is more than the interest rate, say 10% you have to pay extra amount to buy the Television.  Here, after 5 years you need to pay Rs.2271/- extra which you need to pay from your pocket, a cost of not beating the inflation.  Debt instruments carry interest rate risk.

Alternative to FD, RD and Bonds

So you have to earn better returns that are more than the inflation rate and also want to protect the Capital.  Where to invest?  You can invest in Debts Mutual Funds.  Debts Mutual Funds are actively managed by Fund Managers who analyze the Inflation risks, the Economic condition and invest wisely to give you better returns than Fixed Deposits and Recurring Deposits.  You can also consider at least 20% or your investments in Equity.  Equity is the only asset class that beat the inflation continuously over the years and suitable for long term investments.

Note: Debt Mutual Funds are also associated with risks and it may or may not give you any assured returns.  Unlike FD, RD and Bonds, Debt Mutual Funds won’t assure you solid returns.  So it is advisable to select hybrid mutual funds.  Hybrid mutual funds invest in both equity and debt instruments.

What is Net Asset Value (NAV)? Valuation of NAV and Its Calculations

Every time you buy units of a Mutual Fund Scheme you pay a price for that.  Let’s discuss only the Price which we actually pay for buying units.  The Price of Fund’s Units is called Net Asset Value (NAV).   

It is the value calculated after taking in to account of all the incomes and expenses, Capital Net worth, Liabilities and the Market price of the shares bought and deposits made.

What is Net Asset?

Net Asset is calculated by deducting all the liabilities of the scheme from its Assets.

What are the Assets and Liabilities of a Scheme?

Market value of the shares, Bonds, Debentures purchased by the scheme and Bank Deposits made by the scheme and other Current Assets it holds as on date are the assets of a mutual fund’s scheme.

Total Share capital (the value of units issued), Profit made, Capital Appreciation of the Shares and Current Liabilities of a scheme are the liabilities.

What is Unit Holders’ Share?

The purchasers of the units of the scheme are the Unit Holders.  Unit Holders’ Share includes the following:

Total Subscribed Capital: Suppose, a scheme sold/issued 10 Crores of Units at Rs.10/- the total Subscribed Share Capital of the scheme is Rs.100 Crores also called Mobilised Capital.

Profit of the Scheme: If the total income of the scheme derived from Interest and Dividends is Rs.7 Crores and Expenses is Rs.5 Crores, the Profit will be Rs.2 Crores.

Capital Appreciation: If the scheme invested Rs.70 Crores (buying price of the shares) out of the mobilized capital of Rs.100 Crores in shares, and the market value of the shares is appreciated by 15% then the value of Capital Appreciation is Rs.10.50 (Market value of the shares invested).

Income and Expenses of a Mutual Funds Scheme is as follows:

Incomes:

Interest Income: Interest received or receivable from Deposits in Banks made by the Scheme

Dividend Income: Dividend received or receivable from securities invested

Capital Gains: Gains from the sale of securities.

Valuation Gains: If Market value of the securities being held is more than the purchased value, it is the Valuation gain for the Scheme

Expenses:

Capital Loss: Losses from the sale of securities held by the Scheme.  When the securities are sold and the value is less than the purchased value, the Scheme suffers loss from Capital.  It is called capital loss.

Valuation Loss: If Market value of the securities being held is less than the purchased value, it is the Valuation loss for the Scheme

Scheme Expenses: Expenses like Distributors commissions, Salary of Employees and Fund Managers, Sales and Promotional Expenses, etc.

Taxes: Dividend distribution tax, Securities Transaction Tax paid by the scheme

Sample Balance Sheet of a Scheme:

In the above sample Balance Sheet, you can find Bonds, Debentures and Bank Deposits (25 + 5) is Rs.30 Crores in which the scheme has invested out of the total available Unit Holders’ Share (100 Crores – 70 Crores).  It has purchased shares worth of Rs.70 Crores and it has appreciated at 15% to be valued for Rs.80.50 Crores.

Calculation of NAV

There are two methods for calculation of NAV.  Before we discuss about the same, we need to find the Unit Holders Share.  The Unit holders share is calculated as below:

Here the Unit Holders Share = Capital + Profit + Capital Appreciation, i.e. Rs.112.50 (100.00 + 2.00 + 10.50)

First method:

Deduct the liabilities except unit holders’ share from total assets and divide it by the number of units sold/issued.

NAV = Total Assets – Liabilities (excluding Unit Holders’ Share) / No. of units issued,

Rs.11.25 = (114.50 – 2.00) / 10 Crores

Second Method:

An another method of calculation NAV is, divide the unit holder’s share by the number of units sold/issued by the scheme.

NAV = Unit Holders’ Share / No. of Units

Rs.11.25 = 112.50 / 10 Crores

So, you have come to know what the NAV of your scheme is.  Whenever you find your NAV is going up and going down, and sometimes not moving at all, don’t be confused just analyse the Balance Sheet.  NAV determines your investment appreciation.  If there is no upward movement of the value of NAV for long time considering the market status, you need to think of exiting from the scheme.

How to Pay ‘No’ Tax for the F.Y. 2019-20

The time has arrived for tax planning for the financial year 2019-20.  It is always wise to plan in advance to save maximum tax or pay no tax at all.  Now the tax exemptions were also announced in the Budget 2019.  So this is the right time to make the analysis for saving tax from your salary and reduce the TDS deductions made by your employer monthly.  Let’s have a detailed report on how to pay ‘No’ tax at all. 

There is no change in the Income tax slab rates for the F.Y.2019-20.  Below is the slab rates for the F.Y.2019-20:

Now let’s see what are the deductions are available to save tax.

Standard Deduction

You can simply deduct standard deduction of Rs.50,000/- from your salary income.  There is no proof required for this deduction.  This deduction is in lieu of medical reimbursement and transport allowance.  Earlier the deduction was Rs.40,000/-.

Interest on Housing Loan deduction

If you’ve availed home loan and paying interest, you can deduct the same from your total income of salary.  The total interest deduction allowed on home loan is Rs.2,00,000/-.

House Rent Allowance (HRA) Exemption Calculation

If you’re paying rent for your residential house, the same is exempted from Income tax as per the computation as given below:

The least of the following is eligible for exemption from your salary:

Ø  Actual HRA Received

Ø  50% of Salary (Basic + DA) in case of metro or 40% in case of other cities

Ø  Actual Rent paid (less)10% of (Basic + DA)

Deductions under 80C

You can claim deduction up to Rs.1,50,000/- under section 80C.  The following investments are eligible for deduction:

Ø  Life Insurance Premium (LIP)

Ø  Children Tuition fees

Ø  Home Loan Principal Repayment

Ø  Tax saving Fixed Deposits (FD) – 5 years lock in period

Ø  Equity Linked Savings Scheme (ELSS) Mutual Funds – 3 years lock in period

Ø  Public Provident Fund (PPF) – 15 years lock in period

Ø  Employee Provident Fund (EPF) – Employee’s contribution

Ø  Unit Linked Insurance Plans (ULIP)

Ø  Sukanya Samriddhi Yojana

Ø  National Savings Scheme (NSC)

Ø  Senior Citizens Savings Scheme (SCSS)

The overall limit of deduction under 80C is Rs.1,50,000/- only.

Other Important Deductions under Income Tax

Ø  Additional contribution to National Pension Scheme (NPS) up to Rs.50000/-

Ø  Employer’s contribution to NPS up to 10% of salary

Ø  Interest income from Savings Account up to Rs.10000/-

Ø  Interest paid on Education loan for 8 years

Ø  Medical Insurance of Rs.25000/- for self, spouse and children and Rs.50,000/- for parents above 60 years of age

Tax Rebate under section 87A

If your total income after all the deductions is Rs.5,00,000/- or lesser, you can claim tax rebate of 5%.  You can claim tax rebate up to Rs.12,500/-.

Example Income Tax Calculation

Budget 2019 for Salaried Employees and Middle Class People

The last budget of the current Government in power at the centre was presented on 1^st February 2019.  This is an interim budget for this year 2019 and the full budget will be presented in by the new government elected in the forthcoming Lok Sabha Election.

Meanwhile, let’s look at the important announcement for the salaried employees and the middle class people who usually gets affected by the budgets.

For Salary Income

There is an increase of Rs.10000/- of Standard Deduction has been announced.  The present standard deducted is Rs.40000/- and it has been increased to Rs.50000/- in lieu of medical reimbursement and transport allowance.  Earlier the medical reimbursement of Rs.15000/- and transport allowance of Rs.19200/- per annum.  Employees need not to provide any proof for availing standard deduction. 

Income Tax Rebate Increased

Availability of Income tax rebate at 5% for the total income of Rs.3,50,000/- has been increased to Rs.5,00,000/-.  This tax rebate is available after all deductions from total income.  So, the available total income tax rebate for the financial year 2019-20 is Rs.12500/- from earlier Rs.5000/-.

Capital Gain Tax Exemption for the Second Residential House Property

The tax exemption for capital gain under Section 54 of the Income Tax Act was available for the investment in only one residential property.  Now you can invest in two residential properties to avail the tax exemption for the capital gains up to Rs.2 Crores.  This can be availed only once in a lifetime of a person as per the Budget.

TDS on Bank Deposits and Post Office Savings

There will be no TDS on the interest earned from savings account, fixed deposits, recurring deposits and other deposits in banks and post offices up to Rs.40000/-.  The same has been increased from Rs.10000/- earlier.

TDS limit for rent payment is also increased from Rs.1,80,000/- to Rs.2,40,000/- per annum.

Income from House Property

For the purpose of income computation for house property, there will be no income tax on notional rent for the second self occupied house.  Earlier, when a person owns two residential house properties, only one house property was considered as self-occupied.  Tax was paid on the second house on notional rent basis even it was not let out.  Now, the same is exempted from tax.  The exemption is available only when the rent is calculated on notional basis otherwise, if you actually let out the property, then tax is to be paid on the rent actually received. 

What is Systematic Withdrawal Plan (SWP) in Mutual Funds?

Systematic Withdrawal Plan (SWP) is a method of withdrawing money at regular intervals from a particular mutual fund scheme.  Just like Systematic Investment Plan (SIP), which allows investors to invest predetermined amount to a particular mutual fund scheme at predetermined date, SWP helps investors to withdraw predetermined amount at a predetermined regular intervals from a particular scheme.

SWP helps investors to redeem only the required amount while staying invested with the scheme for the remaining amount.  When you have generated good return and accumulated a corpus and you need money for your needs, now you want to redeem the required amount.  At the same time you may not want to redeem all the units at one time especially you don’t need the whole amount. 

How Does SWP work?

In SWP, a fixed amount is redeemed every time at the prevailing NAV of a scheme that may vary from time to time.  This will reflect in the number of units redeemed. 

Suppose, you hold 2000 units in a scheme and you redeem Rs.5000/- every month and NAV is Rs.12 in the first month, you would redeem 417 units (5000/12).  In the next month if NAV becomes Rs.10, you would redeem 500 units (5000/10).  So, 1083 (2000–(417+500)) units would remain in your account after two months of withdrawals. 

So when the NAV is higher, you redeem lesser units and when it is higher, you redeem more units.  While the NAV of the scheme increases, redeemed units will become lesser and lesser.  This helps you to stay invested and reap the appreciation of your money.  SWP averages out the value of return in a fluctuating market conditions.  SWP is allowed only in open-ended schemes.

Taxation of SWP

Systematic withdrawals also attract tax either as long term capital gain or short term capital gain.  The withdrawals under SWP is taxed as per First in first out Method (FIFO). 

Where the units of an equity purchased at the beginning of the investment period are redeemed after a year, the gains are considered as long term capital gain are taxed at 10% when the gain is more than Rs.1 Lakh per year.  The gains of units from debt schemes when withdrawn after 36 months are considered as long term gains and are taxed at 20%. 

The gains from equity schemes withdrawn within a year are considered as short term gains, taxed at 15% and the gains from debt schemes withdrawn before 36 months as considered as short term gains, taxed as per income tax slab. 

Systematic Withdrawal Plan is also a tax efficient plan if your gains from equity investments withdrawn under SWP is less than Rs.1 lakh in a year, the gains are not taxed and you can save tax. 

Can you opt for SWP?

Retired people can opt for SWP who want a regular flow of income every month.  Not just retired people but also others who want fixed income every month or every quarter can choose SWP.

SWP is allowed in two ways, one is withdrawal of fixed amount every month/quarter and the other is withdrawing an appreciated amount every month/quarter.   SWP works best when you have accumulated a corpus.  Corpus is the overall appreciation of your investments. 

Constitution and Management of Mutual Funds

The Constituents of every Mutual Fund consist of Sponsor, Trustee, Asset Management Company (AMC), Custodian and Register and Transfer Agents as per the Rules and Regulations of Securities and Exchange Board of India (SEBI).

Sponsor:

Every Mutual Fund has Sponsors who invests capital.  As per the rules and regulations of SEBI, the Sponsors must be in the financial field for five years.  They have to have positive Net worth for those five years.  Their latest Net worth should be more than the money they invest in Asset Management Company (AMC) and they should have profit for three years of out of the five previous years including the latest year. 

Sponsors should have more than 40% of the capital share in AMC and whoever holds more than 40% of share capital are considered as Sponsors as per SEBI.  Sponsors form the Trust and appoint Trustees and Fund Manager for the AMC.

Trustee:

Trustees are appointed by the Sponsors.  Trustees ensure compliance of the rules and regulations of SEBI and are responsible for protecting the interest of the Unit holders.  The Trust must have at least four trustees.  If the trustee is the company it has to have four directors.  Two third of the Trustees/Directors should be independent and not associated with the Sponsor in any way.

What is Asset Management Company (AMC):

Sponsors appoint AMC and Fund Manager who looks after all the day to day operations of the Fund, setting up of offices, recruitment of Employees, Distributors, Advertisement and Sale promotion of the Funds’ Schemes.

Custodian:

Custodians are appointed by Trustees and they keep the physical securities and physical Gold held by the Mutual Funds safe.

Who is Registrar and Transfer Agents (RTA):

                

RTA is responsible for day to day operations of the transactions like processing documents for purchase, sale, switch operations, issuing statement of accounts and resolve the Investors’ queries.

What is Systematic Investment Plan? and Its Benefits

Systematic Investment Plan (SIP) is one of the effective methods of accumulating wealth with regular investments in Mutual Funds.  It is the most effective way of having the habit of regular savings. 

SIP works just like Recurring Deposit (RD) where you invest pre-defined amount for pre-defined interest rate for pre-determined period as offered by banks.  Through SIP, you can invest pre-defined amount for pre-determined period regularly.  Returns are not pre-defined in Mutual Funds as it is linked with the share market.

Benefits of SIP

SIP helps to average the cost price you pay for buying units whenever the market goes up and down.  Whenever the market goes down you have the chance of buying more units for the same price. 

For example If you do SIP of Rs.1000/- on a particular date when the NAV of the scheme is Rs.25/-, you can get 40 units (1000/25) and at the same time if the NAV goes down to Rs.20/- in the next instalment, you can get 50 units (1000/20).  That means to say that you average out the cost of 90 units at Rs.22/- (Rs.2000/90 units).  You averaged the price of the first 40 units at Rs.22/- instead of Rs.25/-.

This averaging out of the price of the units saves you from loss happens when the stock market goes down.  Also, you pay higher price when the price of the NAV goes up.  But regular investment of SIP helps you to average out the cost and make profits in the long run.  It helps even small investors to invest in equity and get the benefit of compounding.  Compounding helps you to earn return on return.

SIP develops the habit of saving and investing money regularly for longer period.  Investment made in equity over the long period of time works better than investment made in Debt instruments.  If you invest through SIP for period more than 3-4 years, you have very less chance of making loss from your investments.  SIP helps for those who earn income from salary as they cannot invest lump sum amount at one time, they can invest a small amount every month.

Tax Implications on SIP investments

In order to get exempted from capital gains tax in equity related investments, you have to stay invested for more than one year.  Long term gains up to Rs.1 Lakh is exempted from tax.  The long term gains more than Rs.1 Lakh is taxed at 10%.  The same rule is applicable for each SIP investment on first-in and first-out basis.  Short-term capital gain tax is applicable for the gains made within one year and taxed at 15% for equity schemes.  Long term gains from debt schemes are taxed at 20% if held for more than 36 months.

How to start SIP

First choose a mutual fund scheme and fill up the application form along with KYC requirements.  You can either fill up the SIP details in a fresh investment or you can submit a SIP form for the existing scheme along with post-dated cheques for pre-defined instalments along with date of SIP for instalment and amount, say, if you have mentioned to invest in 12 instalments for Rs.500/-, you have to submit 12 post-dated cheques with Rs.500/- mentioned in each cheque.  The Mutual Fund will invest the cheques on the specified date and the units will be allotted according the NAV of the scheme on that date.

You can also do SIP through Electronic Clearing System (ECS) by submitting ECS form.  You can also invest through online. 

You can choose to invest monthly or quarterly through SIP.  You can start investing with just minimum of Rs.500/- per month to maximum of any amount you wish and for any number of instalments.  SIP can be done in both open-ended equity and debt schemes.