ICICI Securities Page 1 of 194 JCP on Managing Personal Finances
JOINT CERTIFICATION PROGRAM (JCP) ON
MANAGING PERSONAL FINANCES
CURRICULUM
Session 1: Introduction and Steps of Financial Planning
Session 2: Insurance Planning Session 3: Retirement Planning Session 4: Investment Planning Session 5: Tax Planning AND Estate Planning Session 6: Asset Classes & Product Suitability AND Goal Planning Session 7: Summary AND Important Calculations by Our Team Session 8: Assessment Test Session 9: Case Study Contest . ICICI Securities Page 2 of 194 JCP on Managing Personal Finances
SESSION 1: INTRODUCTION AND STEPS OF FINANCIAL PLANNING
Planning doesnt come naturally to most of us. In a way it challenges optimism and compels you to think about uncertainties. Implementing a plan doesnt always guarantee, but it ensures that the odds of success increase manifold.
As we go through various life stages, we aspire to attain various goals. And to achieve them it is imperative that we have a sound financial backing. This is where the concept of financial planning comes in, which helps you achieve your goals.
What is financial planning?
Financial planning is the process of managing ones finances with the objective of achieving life goals. These goals could vary from buying a house to going on a dream vacation to more serious goals like retirement planning or child education planning. A good financial plan requires analyzing the financial status, outlining the goals and understanding the means for achieving these goals.
Setting realistic time horizons to achieve goals and achieving them with discipline and planning is what a good financial plan helps in accomplishing. The ability to mitigate risks when investing is another important facet that financial planning addresses.
Why financial planning?
Financial Planning provides direction and meaning to your financial decisions. One feels more secure and more adaptable to life changes, once they measure that they are moving closer to realization to their goals. Implementing a financial plan offers an unrivalled peace of mind. It removes components of fear and uncertainty from your day-to-day life.
ICICI Securities Page 3 of 194 JCP on Managing Personal Finances It is better to co-relate with an example. Let's assume you go for an overnight 12- hour train journey. What all things do you plan for? Reserving ticket in advance, reaching station well on time, taking food, water, bed spreads, i-pod, books, lock and key, etc. This has become a normal routine for most of us. For a 12-hour journey, we plan so many things properly.
Life is a similar journey for approximately 75 to 80 years; and there are some financial requirements in this journey too like buying a home, car, getting children educated and married, etc. Hence, it is prudent to plan well ahead for all these requirements like a train journey.
The importance of financial planning cannot be overstated. Among others, two aspects matter a lot are - inflation and changing lifestyles.
Inflation is a situation wherein too much money chases a limited number of goods. This leads to a fall in the purchasing power of money. For example, a product that costs Rs. 100 today would cost Rs. 106 a year later, assuming inflation at 6 percent. Over 30 years, assuming that inflation continues to rise at 6 percent, the same product would cost you Rs. 574. Financial planning helps ensure that you are better prepared to deal with the impact of inflation, especially in retirement when expenses continue but sources of income dry up.
The second factor is changing lifestyles. With higher disposable incomes, it is common for individuals to upgrade their standard of living. For example, cars were considered luxuries not too long ago but are a necessity today. Financial planning plays a key role in helping individuals and families, both upgrade and maintain their lifestyle.
Moreover, there are contingencies like medical emergencies or unplanned expenditures. Sound financial planning helps mitigate such circumstances, without straining your finances.
ICICI Securities Page 4 of 194 JCP on Managing Personal Finances To put it in a nutshell, financial planning is all about investing for your goals and maintaining a fair amount of liquidity to make use of any opportunity that may present itself or meet any unforeseen emergencies. Features of financial planning A financial plan enables you to analyze your behavior and help optimize your expenses and savings. Viewing each individual expense as a whole enables you to understand the impact on your long-term financial plan. For example, investing in a certain mutual fund might help increase your returns but might not work out too favorably once its tax implications are considered. A good financial plan helps in setting realistic time horizons to achieve goals and assists in achieving them with discipline. The ability to mitigate risks when investing is another important facet that financial planning addresses. Understanding the risk-taking ability along with achieving long-term goals can often be a fine balance in today's volatile markets and the ever changing global economic factors. Traditional bank deposits do not yield enough returns to beat the soaring inflation rates. Falling equity markets, resulting in erosion of wealth, have added to the woes of investors. It is during such times that disciplined investing and focus on the long-term ensures wealth creation.
Myths about financial planning
Myth 1: I need to have a substantial sum of money/assets before thinking about financial planning
Fact: This myth primarily prevents people taking the first step towards financial planning. Financial planning will in fact help build assets and investments. Investing is only one part of financial planning. Financial plan will help you structure your goals, chart out a road map and above all make you aware of what you need to do to get to your final destination.
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Myth 2: I am already saving enough. Why do I need financial planning?
Fact: If you have saved enough you have already taken the first step towards financial planning. However, saving is just one aspect. A good financial plan will help you understand how much is enough... It will help channel your savings in the right direction and make them work harder and better to achieve your goals. A financial plan will tell you how much of your savings should form part of an emergency fund and how much should be easily liquid-able. This helps in times of emergencies and opportunities.
Myth 3: I cannot afford a financial planner or financial plan.
Fact: Like any professional service like doctor, lawyer etc financial planners also charge for their services. Look at these charges as a proactive investment and not some reactive expenses like doctors fees. A good financial plan will help you save and earn far more money than you would have paid in fees or commissions. And more importantly, beyond the monetary benefits, it will give you peace of mind, time saving, and a better focus on your financial life.
Myth 4: I am too young to worry about financial planning.
Fact: Wouldnt you like to live longer, but not working longer? The earlier you start the greater your chances of achieving your life goals. Hit the field running. With age on your side the amount you need to invest will be low while the risk / return you can take will be higher - thereby, making your money work hard. Just think about this A 25 year old invests Rs 50,000 annually at 10% for 25 years end up with Rs 50 lakh. A 30 year old does the same and ends with just 29 lakh.
Myth 5: I am nearing retirement. Isn't it too late for financial planning?
Fact: While running a marathon you need to start early and break out of the pack, but you also need to conserve energy to finish. Financial Planning will help you keep ICICI Securities Page 6 of 194 JCP on Managing Personal Finances pace with your finances through life. When nearing retirement it can tell you how much energy you still have left and what strategy changes you need to finish the race. A financial plan can help you understand where you stand and forecast how your retirement years will pan out financially.
Myth 6: My children will take care of me post-retirement. I don't need to think about planning for retirement.
Fact: In such scenarios, there may not be a need to save extensively for retirement. But financial independence is always welcome. Moreover, financial planning can help you with your estate planning. You may want to help your grandchildren get the best education and it is important to plan for such goals and invest in instruments accordingly.
Myth 7: I know enough about investing and have good knowledge of markets and financial products.
Fact: It is good to know about the markets and financial products. However, a financial plan is not just about financial products or the markets. A good financial plan considers your risk profile and suggests an asset allocation strategy. It helps you define your goals and suggests an investment strategy based on your risk profile. And importantly, a financial plan if followed will inculcate discipline in your investments and will help you overcome drastic downturns in the markets by a diversified asset allocation mix.
Just consider thisYour asset allocation dictates a 70% equity, 20% debt and 10% cash allocation. If the market moves up your equity allocation goes up which you need to rebalance to the original. The money you have made by booking profits moves to a safer investment. If the market falls and presents an opportunity, you are liquid to invest and not left with un-booked losses.
ICICI Securities Page 7 of 194 JCP on Managing Personal Finances Myth 8: Isn't tax planning the same as financial planning?
Fact: Categorizing financial planning as another term for tax planning is another misconception. Both are distinct but tie-in as well. Tax planning is one component of financial planning. Financial planning will not only cover the most tax-efficient investments but will also help you chose the right instruments for tax planning based on your risk profile. An investor with higher risk profile can look at greater investments in equity-linked tax-saving instruments while risk-averse investors may want more of a fixed income component in his tax planning. Financial planning can help determine this allocation.
Steps of Financial Planning Process
Financial planning requires financial advisors to follow a process that enables acquiring client data, and working with the client to arrive at appropriate financial decisions and plans, within the context of the defined relationship between the planner and the client.
The following is the six-step process that is used in the practice of financial planning. ICICI Securities Page 8 of 194 JCP on Managing Personal Finances
Implement the plan: Explain how the recommendations need to be carried out
Establish relationship: Discuss how we will work together Gather client data: Discuss goals and financial information Develop the plan: Presenting financial planning recommendations Monitor the plan: Periodic Review and Revision Analyze and evaluate financial status: determine what needs to be done to achieve goals
ICICI Securities Page 9 of 194 JCP on Managing Personal Finances 1. Establish and define the client-planner relationship: The financial planning process begins when the client engages a financial planner and describes the scope of work to be done and the terms on which it would be done.
The terms of engagement between client and a partner are usually spelt out in a legal agreement that is signed by both parties.
The general scope of the work includes:
Explaining services provided, the process of planning, and the required documentation Describing how they will be compensated Identifying the responsibilities of the planner and the client in the relationship (discretionary vs. non-discretionary) Deciding on the length of the engagement Discussing any other matters needed to define or limit the engagement's scope
2. Gather client data, including goals: This step involves asking for information about clients financial situation. Planner needs to help define clients personal and financial goals, understand his time frame for results and discuss, if relevant, how he feels about risk. This step is basically about gathering all the necessary information before proceeding any further. It includes collection of:
Client's income status Assets and liabilities status The extent of risk a person is exposed to The extent of insurance that a person has, etc.
3. Analyze and evaluate financial status: In this step, the planner evaluates clients current financial status and analyzes potential scenarios and outcomes. The planner analyzes the information provided by client to assess his current situation and determines what he must do to meet his goals. This could include analyzing his assets, liabilities and cash flow, current insurance coverage, investments or tax strategies.
ICICI Securities Page 10 of 194 JCP on Managing Personal Finances Some examples include:
Identifying short-term goals like buying a house, buying a car, taking a vacation, etc. Identifying long-term goals like childrens education, childrens marriage, retirement, etc. Attributing a financial value to each of these goals Separating realistic and unrealistic goals
4. Develop and present financial planning recommendations: The planner makes an assessment of what is already there, and what is needed in the future and recommends a plan of action. This may include augmenting income, controlling expenses, reallocating assets, managing liabilities and following a saving and investment plan for the future. It involves:
Filling the savings gap Restructuring existing assets into productive/growth assets Making an investment plan, both lump-sum and regular Building a defense mechanism into the plan through insurance
5. Implement the financial planning recommendations: This involves executing the plan and completing the necessary procedure and paperwork for implementing the decisions taken with the client.
Filling the savings gap by inducing the client to save more through systematic investment plan (SIPs), endowments, etc. Restructuring existing assets into productive/growth assets. Get the client into equity products where goals are aggressive. Making an investment plan, both lump-sum and regular. Match them to cash flows. How much of monthly earnings can the client save? How much of his lump-sum receipts can he set aside? Building a defense mechanism into the client's plan through insurance. This is a broader concept. He needs term insurance to cover the risk of dying early but endowment for the risk of living too long the two facets of retirement planning. ICICI Securities Page 11 of 194 JCP on Managing Personal Finances Liabilities and assets need to be insured through sufficient term insurance so that they do not become a burden on the plan Surrendering legacy insurance and consolidating them Making the client's plan tax efficient
6. Monitor the financial planning recommendations: The financial situation of a client can change over time and the performance of the chosen investments may require review. A planner monitors the plan to ensure it remains aligned to the goals and is working as planned and makes revisions as may be required.
Reviewing where insurance coverage has gone out of sync with the plan
Reviewing where portfolio mix has gone out of sync with the plan
Reviewing where the themes mix has gone out of sync with the plan
Reviewing where major macro changes have affected some of the client's plan assumptions ICICI Securities Page 12 of 194 JCP on Managing Personal Finances SESSION 2: INSURANCE PLANNING
An individual undergoes various life stages, each characterized with specific goals. When you are single, usually up to 25 years of age, you start laying the foundation for the financial security of your future. Once you get married and have children, your priority is asset accumulation and wealth generation. And then your pre-retirement and finally the retirement phase are characterized by wealth utilization and distribution.
A proper financial planning at each stage of life leads to a secure financial future. But, we have to consider the time value of money as well. The present value of the money will not be the same in future. For example, your monthly expenses of Rs. 30,000 today will be Rs. 38,288 after five years, assuming inflation at 5%.
All these show that life is constantly changing. Your life stages change and so do goals and priorities. The financial position and the cost of living also changes with time.
In order to have a secure financial future, you have to plan according to these changing situations. But one factor that you are always exposed to at all times is risk.
We live in an uncertain world. Risk is a possibility of any harm, injury, loss, danger or destruction of an individual or their belongings.
There are accidents, mishaps, illnesses, natural disasters happening every day. A person who is happy, healthy and alive today cannot be sure of what will happen tomorrow, as he/she is always exposed to this uncertainty called risk.
From your current age to the age of your retirement, you have some specific goals like buying a new house, getting married, child's education, retirement planning, etc. You always plan your finances to turn your goals into reality. But you are exposed to some possible uncertainties like death, accident, illness, loss of job, etc.
ICICI Securities Page 13 of 194 JCP on Managing Personal Finances So the question is: what should you do to mitigate this risk?
The answer is risk transfer.
Transfer of risk from one individual to another who is willing to bear the risk is called risk transfer. And insurance is the most widely used tool to transfer risk.
To understand the concept of insurance better, let us use an example.
There is a village with 400 houses. The value of each house in the village is Rs. 20,000. Now, every year 4 houses get burnt. Nobody knows which house will be burnt. There is an equal probability of every house getting burnt. Hence the total loss annually due to this fire is Rs 80,000 (Rs 20,000*4).
This is a tricky situation for the villagers as nobody knows whose house will be burnt and the one facing the eventuality is exposed to a great financial mess of Rs. 20,000.
A smart villager comes up with an idea. He asks each house in the village to contribute Rs. 200 each towards a common funds pool. This contribution will generate a corpus of Rs. 80,000 (Rs. 200*400 houses). This way the risk of 4 owners is spread over 400 houses. Thus with a small contribution of Rs 200 per house, the village covers the huge loss of Rs 80,000 of the 4 families whose houses get burnt.
Insurance works on the same concept of forming a pool of funds.
Insurance is a fixed sum of money contributed to form a pool. The money is drawn from the pool to support the one who faces an eventuality. Thus insurance distributes the risk of one individual among a group. This is called risk pooling.
What are the key benefits of insurance?
Insurance provides security and savings. We have seen how insurance secures you by forming a fund pool. Insurance is also a good savings tool. Having an ICICI Securities Page 14 of 194 JCP on Managing Personal Finances insurance cover ensures that you achieve your goal, even in case of an eventuality. Your family and dependents will not be affected financially if you have an insurance cover.
Now, let us see what an insurance company does.
An insurance company brings together people who share the same risk. The risk can be to their life, or their belongings like house, vehicle, etc.
It collects the contribution called the premium from the group of people and pays a compensation or claim to the one who suffers a loss.
Thus by forming a fund pool it spreads the risk of one among a group.
What are the types of insurance?
Insurance is mainly of two types - life insurance and general insurance. General insurance covers a wide range of products like vehicles, fire insurance, house, travel, health, marine, etc.
Now let us see life insurance in detail.
Life insurance Life insurance is a contract in which the insurer agrees to pay the assured sum of money to the insured in case of his/her death. Life insurance covers the risk associated with the life of an individual.
The assured sum which the insurer pays is in consideration of a certain amount called the premium. The premium is either paid in lump sum or as periodical payments.
Need for life insurance Every earning individual needs to support his/her dependents financially for spending their daily expenses, repaying liabilities and achieving all the goals, during his/her lifetime. The regular income earned by the individual is the source ICICI Securities Page 15 of 194 JCP on Managing Personal Finances for achieving all these. Hence, it's very important to protect the family against the loss of the income due to the death of the breadwinner, so that the family's quality of life does not undergo any drastic change.
Individuals have two ways of protecting loss of income due to one's death one, by accumulating sufficient assets, another by taking life insurance, or by a mix of both. Most of the individuals in their early stages of working life might not have accumulated enough assets and hence, it's prudent to have sufficient life cover in place.
How much life insurance should one buy? Life insurance is meant to provide with the enough money to your dependents to replace your income in case you die. Ideally, your life cover must take care of the following things: a) Family expenses till lifetime; b) Liabilities outstanding and c) Family and children goals. This worksheet will help you determine how much coverage you will need: 1. Providing for family expenses till lifetime Annual expenses required for dependents Rs.2,40,000 Number of years for which you wish to provide above expenses 25 years A: Corpus required for funding family expenses Rs.60,00,000 2. Liabilities Outstanding Home loan Rs.15,00,000 B: Corpus required for repaying liabilities Rs.15,00,000 3. Family Goals Child education (todays cost) Rs.8,00,000 Child marriage (todays cost) Rs.10,00,000 C: Corpus required for fulfilling goals Rs.18,00,000 A + B + C = The estimated amount of life insurance you will need Rs.93,00,000
(From this estimated cover, you can deduct existing life cover, if any, and assets that you have accumulated - excluding the ones for your familys use) ICICI Securities Page 16 of 194 JCP on Managing Personal Finances If you are unable to cover all the above three, then cover can be taken at least for some of them, based on the below order of priority: a) Unsecured liabilities; b) Family expenses till lifetime; c) Secured liabilities; d) Children goals; and e) Family goals.
Thumb rule to calculate life cover As a thumb rule, every earning individual has to have a life cover of 10 to 20 times of annual income depending on their age. For people aged from 25 to 40, a life cover equal to 20 times of annual income and for people above the age of 40, a life cover equal to 10 times of annual income would be the thumb rule.
Insurance coverage given by life insurance companies The life insurance companies provide life cover to individuals based on two main factors Age and Income. Since life cover replaces an individual's income for the family, income is the main factor. As age increases, the risk of natural death increases and hence, age too plays a role in determining how much of life cover can be provided to an individual. Apart from these two factors, there are a lot of other factors like personal health, family's medical history, usage of tobacco, etc.
The below is an indicative table which provides the maximum life cover which can be offered based on age. The slabs might vary from one company to another. Age group Maximum life cover offered 18 35 20 times of annual gross income 36 45 15 times of annual gross income 46 55 10 times of annual gross income 56 60 5 times of annual gross income
Consequences of not having sufficient life cover Let us see this with an example. Anil, aged 32, is working in an IT firm and has a family of 3 people Soni, aged 30, house wife; and 2 children Kunal, aged 4 years and Kapil, aged 1 year. Annual income Rs.7 lakh Family's annual expenses Rs.5 lakh ICICI Securities Page 17 of 194 JCP on Managing Personal Finances Home loan outstanding taken by Anil Rs.25 lakh Existing life insurance cover for Anil Rs.10 lakh
On sudden death of Anil due to an accident, the family gets Rs.10 lakh (sum assured) from the life insurance company, which is not sufficient to meet the family's annual expenses and repay the home loan outstanding. The home has to be sold to repay the home loan outstanding amount. Rs.10 lakh will be put in a fixed deposit which will yield around Rs.1 lakh p.a. as interest for meeting daily expenses. The family's lifestyle drastically changes with less amount available for regular expenses. Therefore, it is important to have sufficient life cover.
Which Life Cover to choose? There are several variants of life insurance, ranging from pure protection plans to savings and investment-linked plans. Lets take a look:
Term plans Term insurance is a pure risk cover. It has no element of savings or investment. In the event of death or total and permanent disability, the insureds family gets the sum assured. If the insured survives the policy term, he or she gets nothing.
Term plan, as the name indicates, is for a specific term, and offers the greatest amount of coverage at the lowest premium. This is because the insurer does not provide anything if insured outlives the policy term, i.e. there is no maturity value. Lets understand this with an example: Suppose Kumar takes a term plan when he is 35 years old for a sum assured of Rs. 50 lakh and a term of 10 years. His annual premium is, say, Rs. 7,000. If he dies within the 10-year term, his family will receive Rs. 50 lakh. If he survives the policy term, he would get nothing.
One can select the length of the term for which he or she wants the coverage, right from 5 years up to 30 years. Some companies also offer 40-year term plans.
ICICI Securities Page 18 of 194 JCP on Managing Personal Finances Term plans come in different variants. Heres a quick sheet to understand them. RETURN OF PREMIUM INCREASING PLAN DECREASING PLAN SINGLE PREMIUM CONVERTIBLE TERM PLAN - You get the return of premium at the end of the term, but if you die mid- way, your family gets the sum assured.
- Slightly more expensive than a pure term plan as they promise return of premium. - The sum assured (cover) in this plan increases every year as a person advances in age, while the premium remains constant.
- The core objective of this plan is to beat the rising inflation
- The premium is generally high for this plan
- The cover decreases at a predetermined rate over the period while the premium remains constant.
- The main idea of this plan is that a person's needs for high life cover decreases with age as his liabilities (like home or car loan) decrease or no longer exist. - The premium is normally low for this plan - Ideal for those who have a large amount to spare at the time but are unsure of cash flows in the future.
- This plan lowers the risk of lapse of policy as a result of missed premiums.
- Here you can switch from an initial basic term plan to insurance- cum- investment plan, at a later date.
- Premium may change at the time of conversion.
Endowment plans Endowment plans are a combination of a risk-cover with financial savings. On death or disability during policy term, sum assured plus bonus or guaranteed additions is paid to the beneficiaries. Sum assured is paid even if policyholder survives the policy term. Premiums are generally high for these plans. Endowment plans are quite popular for their survival benefits.
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Money-back or cash-back plans Under this plan, certain per cent of the sum assured is returned to the insured person periodically as survival benefit. On the expiry of the term, the balance amount is paid as maturity value. The life risk may be covered for the full sum assured during the term of the policy irrespective of the survival benefits paid.
Whole-life plans Whole-life plans provide life insurance cover for the entire life of the insured person or up to a specified age. Premium paid is fixed through the entire period. This plan pays out a death benefit so you can be assured that your family is protected against financial loss that can happen after your death. It is also an ideal way of creating an estate for your heirs as an inheritance.
Unit Linked Insurance Plans (ULIP) ULIP is basically a combination of insurance cover and mutual funds. In ULIPs, a certain part of the premium is invested in various equity and debt instruments and the balance is used to provide cover for life.
ULIPs allow policyholders to earn market-linked returns by investing a portion of the premium money in various options. The returns on ULIPs are linked to the performances of the markets and underlying asset classes.
Typically, ULIPs provide with a choice of funds in which you may invest. One also has the flexibility to switch between different funds during the life of the policy.
In the event of death or permanent disability, the sum assured (to the extent one is covered) is given to the policyholder to assure that his family is protected from sudden financial loss. A ULIP has varying degrees of risk and rewards. There are various charges applicable for ULIPs and the balance amount out of the premium is only invested.
Pension Plans Pension plans are basically retirement plans to which individuals make contributions till retirement or for a specified period with an aim to get regular ICICI Securities Page 20 of 194 JCP on Managing Personal Finances income post-retirement. One-third of the corpus accumulated can be withdrawn as a lump-sum and the remaining can be used to buy annuity that will make monthly payments to the holder. An annuity is a contract with an insurance company under which one receives fixed payment on an investment for a lifetime or for a specified number of years.
Annuity Types Annuities can be divided into two types deferred and immediate.
In deferred annuity, you save in a systematic manner to build up sufficient funds for retirement. The withdrawals commence after the retirement of the investor.
In the immediate annuity plan, you invest a lump sum amount as the premium and the insurance company starts paying back annuity immediately. These are suitable for investors who have retired or are nearing retirement, and need steady income from the accumulated retirement corpus.
Annuity Payout Options There are various annuity payment options that you can opt for. You should select the options that suit your specific needs the best. Some of the popular options are:
Life annuity: This option pays you for life. The payment stops when you die. Hence, this option is suitable for someone who does not have any financial dependents.
Life annuity with return of purchase price: This option pays you annuity for life and on death, the initial purchase price (premium paid in the beginning) is returned back to the nominee.
Life annuity for fixed-period guarantees: This option pays an annuity for a guaranteed period of 5, 10 or 15 years (as chosen by you) and thereafter as long as you are alive. This option is ideal for someone who needs money for a fixed period after which dependency on pension money will come down.
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Joint life and last survivor annuity: This option pays annuity throughout your life and on death, continues the annuity during the lifetime of the named spouse. It thus takes care of expenses of both the partners.
Life annuity increasing at a fixed rate: In this option, the annuity amount increases every year at a simple rate, starting at 3 per cent p.a. This options works well for those who have not factored in inflation and need an increasing annuity with each passing year. This option needs a bigger corpus to sustain over the long term.
Riders Riders are additional benefits attached to the basic life insurance policy. They allow you to enhance your insurance cover and help customize your policy to suit your specific needs.
The most common types of riders available are:
Critical illness: This rider provides additional cover to you in the event of a critical illness. Cancer, coronary artery bypass, heart attack, kidney failure, major organ transplant and paralytic strokes are the generally covered illnesses.
Accidental death benefit: It provides an additional sum assured if the policy holder dies due to an accident.
Partial and permanent disability rider: In this rider, a portion of sum assured is paid, in case you are disabled permanently or temporarily, due to an accident. Most policies pay a certain percentage of sum-assured periodically for next 5-10 years.
Waiver of premium rider: This rider waives off future premiums in case you are not able to pay the premiums due to disability or income loss. Put simply, it exempts you from paying premiums until you are ready to work again. This helps protect your policy from getting expired.
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Dos and Donts for buying Life insurance Dos When you buy a life insurance policy you should: Think through why you are buying insurance and what core requirements and expectations Seek and receive advice and options patiently Be open-minded but cautious about the advice and information you gather. Ask lots of questions about the policy options to see what fits your needs. Find out policy details like: Whether it is a Single Premium or Regular Premium policy. Which is the best premium payment frequency that suits you e.g.: Annual, quarterly etc. Whether there is an ECS (Electronic Clearing Service) payment option to make your premium payment safe and easy. Fill the proposal form very carefully and personally Fill it completely and truthfully, remember you are responsible for its contents. Make sure that the information you give cannot be disputed during a claim. Ensure you fill Nomination details. If the form is in one language and you are answering the questions in a different language, ensure the questions are explained correctly to you and that you have understood them completely. Remember you have to give a declaration to this effect in the proposal form. Keep a copy of the completed proposal form you sign and any declarations and terms agreed upon mutually for your records. If you are buying Unit Linked Insurance Policies (ULIPs) ask specific questions about: Various charges, Fund options, Switching of funds; Benefits if you discontinue the policy, Surrender the policy or Make a partial withdrawal of funds. Don'ts: Do not leave any column blank in the proposal form Do not let anyone else fill it up Do not conceal or misstate any facts as this could lead to disputes at the time of a claim Do not miss or delay your premium payment (Source: www.policyholder.gov.in)
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Non-Life / General Insurance We saw life insurance that takes care of the insureds near and dear ones in case of his/her demise. Insurance, other than life insurance, falls under the category of general insurance. General insurance products include policies for health, motor, home and travel among others. Lets take a closer look at some of these areas.
Health insurance Every human being is exposed to various health hazards. Medical emergency can strike anyone without pre-warning. Lifestyle and critical diseases are catching up with people at an early age. Health insurance helps to protect against a future outlay that may be considerably high and unbudgeted for. Hence, the need for an effective health insurance plans. Healthcare today is an expensive affair, making it extremely important to invest in health insurance to protect ones family and finances from the huge dent that a medical emergency can cause. The need for health insurance is gaining prominence among individuals who consider it as a means of obviating health risks that can make inroads into their savings. Even people who strictly follow return on investment policy for their investments are eying health insurance as a hedge against financial shocks due to medical emergencies.
There is a myth associated with health insurance that goes this way: If you are young and looking healthy you dont require health insurance. This is far from the truth. This is the myth that has gripped majority of people. What happens if one suddenly meets with an accident? People feel that if they are young and healthy, they do not require any health insurance. One should always be prepared to deal with such untoward incidents and availing a health insurance policy is the best way.
There are two kinds of health insurance policies available in India: 1. Indemnity: This covers hospitalization expenses incurred on re-imbursement or cashless basis. 2. Benefit: This includes critical illness policies which include the payment of a lump sum amount on the diagnosis of any of the named critical illnesses.
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Benefits of health insurance A good health plan ensures that medical expenses incurred on hospitalization for more than 24 hours are covered by the insurance company. This may include room charges as well as the money spent towards the surgeon, nursing, medicines and other tests.
One can also avail the benefit of a cashless claim, where the hospitalization expenses are directly settled between the hospital and the insurance company.
A health insurance policy also takes care of pre-hospitalization and post- hospitalization expenses. Daily cash allowance and payments for treatment received prior to hospitalization and during the recovery period is extremely beneficial as the insured might not have an alternate source of income during those trying times.
An advantageous policy offers floater plans where the entire family is covered under one policy and allows the coverage of the medical insurance policy to be shared among the family members.
Health insurance offers undeniable benefits which extend beyond conventional hospitalization. Health insurance policies offer a number of benefits such as income tax deduction, long-term discounts, family discounts and no claims bonus. Health insurance premiums offer a tax benefit under Section 80D and there are now products available that are optimized for tax saving. This means that while the insured is safeguarded from medical contingencies, he or she is also reducing tax outgo and saving money on a portion of income.
Types of health insurance policies Insurance companies offer a wide range of health insurance products with varying coverage and cost. There are options available between a conventional hospitalization policy and a benefit policy which pays lump sum amount in case of a pre-specified event or illness. One can also opt for a health insurance policy that offers cashless claims settlement. Such features help cut down out-of-pocket medical expenditures, thus reducing the need for cash during hospitalisation or ICICI Securities Page 25 of 194 JCP on Managing Personal Finances medical emergencies. An individual can select the policy that suits his /her health and budget.
Buying health insurance
It is always better to enroll in a health insurance cover as early as possible. Health insurance premium tends to increase with age more the age, higher the premium. A health insurance policy provides a continuous and adequate lifelong cover against any eventuality, and the premium payable is also very competitive. Any adult above 18 years of age and up to 60 years can buy a health insurance policy, which stands renewable up to 70 years of age. An individual can avail a policy for self along with dependent parents, spouse and kids.
Approaches to buying Sole bread winner of a household should explore options of taking a personal accident or critical illness cover. Such covers ensure lump sum payment in case of a life threatening disease or accident. 3 months and above- Infants above three months till 18 years of age can be enrolled in a Floater Cover under their parents policy. Married person with kids: A family comprising of children and elderly should opt for a cover that offers more than just a normal mediclaim. A cover that takes care of Outpatient Department expenses like vaccination for kids, maternity expenses to regular check ups of elderly members of the family. An individual keen to cover himself and the family against maximum risk exposure should go for a top-up mediclaim cover, which provides higher hospitalization cover sum insured.
Health insurance plans available today are quite user-friendly. You can buy a policy online, renew it online and get details of your claim status. You can also find the list of cashless hospitals pan-India. Also, there is a cashless facility available under the health policy which eases the requirement of cash when you are hospitalized.
ICICI Securities Page 26 of 194 JCP on Managing Personal Finances Dos and Donts for buying Health insurance Dos When you buy a health insurance policy you should: Know that there are restrictions on coverage Pay special attention to terms and conditions in the policy like: The clause excluding pre-existing diseases Waiting period before certain diseases can be covered Restrictions or limits on various expenses relating to hospitalization Co-payment, which means you have to share a part of the claim Pre-conditions for renewal Upper limits for age at entry and for renewal Disclose details of all pre-existing health problems including: Major ailments Conditions like high blood pressure or diabetes The company may want medical test reports depending on age at entry; you should comply with all procedures and documentation requirements Check where and how the medical tests will be carried out Check who should bear the cost for the tests Pay the premium only after the insurer accepts your proposal Renew the policy meticulously for the rest of your life Donts Conceal facts or you could face a dispute at the time of a claim Allow a gap of even one day in your policy renewal or your cover may be insufficient or useless Overseas Health Policy: Dos and Donts Dos Insure well ahead of your travel dates ensuring you have time for medical tests if required by the company Ensure you cover your entire period of stay abroad and all the countries you will be visiting Be aware of what your policy covers and does not cover. These policies cover not only hospitalization but could also cover travel related risks like: Loss of passport Loss of cash Loss of baggage and ICICI Securities Page 27 of 194 JCP on Managing Personal Finances Repatriation expenses Disclose details of all pre-existing health problems including Major ailments Conditions like high blood pressure or diabetes Comply with all procedures and documentation requirements the company may want including medical test reports depending on age at entry. Check where and how the medical tests will be carried out Check who should bear the cost for the tests Pay the premium only after the insurer accepts your proposal Donts Conceal facts or you could face a dispute at the time of a claim (Source: www.policyholder.gov.in)
Motor insurance Motor insurance is the fastest growing general insurance segment in India and worldwide. Motor vehicles are divided into three classes for the purpose of insurance: Private cars, Motor cycles, and Commercial vehicles.
Motor insurance policies are normally taken for a period of one year. However, according to the requirements of the vehicle owner, a policy for a shorter term can be issued. Situations do arise when a person plans to sell off his vehicle within a couple of months and does not intend to renew his policy for another year. In such circumstances, he may go for a shorter period of cover. Short period insurance attracts short period scale for calculating premium and obviously works out costlier than the pro-rata for the said period.
Third party insurance and comprehensive insurance policy are the two types of motor insurance policies available.
Third party insurance: This covers the insured's liability to third parties for death and bodily injury caused by an accident involving the motor vehicle. This refers to the minimum risks that are to be covered under the Motor Vehicles Act. Comprehensive insurance policy: This insurance cover is wider in scope and covers not only accidental damage to the insured's own vehicle but also the loss or damage to the vehicle itself by way of accident, theft and other specified perils. ICICI Securities Page 28 of 194 JCP on Managing Personal Finances
Dos and Donts for buying Motor insurance Dos When you buy a motor insurance policy you should: Know that you can buy this policy through anyone and there is no compulsion to buy it through your vehicle dealer Fill the proposal form yourself even if the vehicle dealer is arranging for the insurance Fill the proposal form carefully and factually and thoroughly Keep a copy of the completed proposal for your records Read the policy brochure/ prospectus carefully to know what is covered and what is not Ask for information about add-on covers that may be available and choose what suits you Give documents such as RC Book, Permit and Driving Licence to the insurance company for verification Ensure that you keep these documents updated from the authorities concerned Donts Dont let anyone else fill your proposal form Dont leave any column blank Dont forget to renew your policy without any break Dont forget to ask for the correct procedure when you buy a used car that already has insurance. Dont make false declarations about the actual use of the vehicle you are insuring (Source: www.policyholder.gov.in)
Home / property insurance A home is usually the largest asset an average person owns during his lifetime. Therefore, it is imperative to secure your home from natural and man-made catastrophe. A home insurance plan ensures you peace of mind by protecting the structure and the contents of your home. Banks generally offer home insurance at the time of taking a home loan. You can purchase a policy from an insurance agent or it can be purchased online. You can also purchase it through ICICI Securities Page 29 of 194 JCP on Managing Personal Finances bancassurance facilities provided by various bank branches and through the tele- sales department of general insurance companies.
The amount of home insurance cover needed is calculated keeping a number of factors in mind. Area of house (in sq. ft.), location of property and approximate rate of construction (in Rs. /sq. ft.) are generally considered by insurance companies. Properties more than 50 years old are not insured. Another point considered while insuring a home is that companies only consider 'pukka/permanent' construction. An individual has to pay the premium every month/quarter/six months according to the sum insured.
Terrorism and additional expenses for rent for alternative accommodation are the optional covers that are available under a home insurance policy. Dos and Donts for buying Property insurance Dos When you buy a property insurance policy you should: Know you can insure only property you own Be sure you have the documents to prove ownership and value at the time of a claim Give a complete and correct description, address and location of the property to be covered Ask the intermediary or insurer to give information and explain the basis of fixing the Sum Insured. It can be Market Value basis where depreciation is taken into account or Reinstatement Value basis where the cost of replacement of the property is taken into account. This is the basis on which the claim is paid. Information regarding add-ons; choose them as per your needs Donts Dont allow anyone else to fill your proposal form Dont conceal or misstate any facts about the property and its fixtures Dont mis-declare the value of your property and face disputes at the time of a claim (Source: www.policyholder.gov.in)
ICICI Securities Page 30 of 194 JCP on Managing Personal Finances Travel insurance In the present scenario domestic as well as overseas travel could pose a risk and the need for insurance is being realized.
For students who wish to pursue studies abroad, taking a travel insurance policy is a necessity. It is better to buy the policy from India as it is more cost effective. It helps the student to seek a waiver from the compulsory university insurance, which in turn will certainly help the student save substantially. Student medical insurance in India costs one-third the amount they have to pay in the US. The waiver form can be downloaded from the university website and sent to the appropriate person indicated. Dos and Don'ts for buying Travel Insurance Dos Plan for your Travel Insurance ahead of time just as you plan for your visa and so on. Take care to fill in the proposal form completely and truthfully after getting the necessary medical tests done and obtaining the medical report as required Plan for the travel period ahead of time and ensure that your insurance covers the entire period If you have to extend the period of cover, plan for it before the cover expires and provide the required documents to the insurer Make sure you have gone through the policy document completely and make a note of the contact details of the agency servicing the claims so that it is handy in the event of an emergency If you are cutting short your travel period, check your policy to see if you are entitled for a refund Donts Dont postpone taking your travel insurance till the last minute Dont get pushed into taking a cover only as recommended by your travel agent Get as much information as possible and exercise your choice Dont get tempted to opt for the cheapest cover as it might not meet your needs (Source: www.policyholder.gov.in) For Further Reading on Insurance, you may refer: http://www.policyholder.gov.in/ http://www.irda.gov.in/ ICICI Securities Page 31 of 194 JCP on Managing Personal Finances SESSION 3: RETIREMENT PLANNING
As one grows older, retirement is an inevitable stage of life. Therefore, it is essential to create a plan that will fulfil ones needs right through ripe old age. Planning for retirement is about ensuring that one has adequate income to meet the expenses post retirement. It is about anticipating ones future requirements and taking the correct steps to enjoy current lifestyle well beyond ones working years.
There are three stages in our life learning, earning and accumulation. In the learning phase we go through our education and complete it. In the next stage i.e. the earning phase, we earn our livelihood, say, from the age of 25 up to 60. So this is a very important phase to accumulate the earned money. In the accumulation phase, we start using up the accrued money, which we have been amassed during the earning stage. Hence, it becomes necessary for us to plan for retirement even while we are in our second stage i.e. the earning phase.
Everybody desires to retire peacefully and lead a fairy tale retired life. But in actuality, the happily ever after or to retire peacefully is a very vague term. Most importantly, you should decide when you want to retire. One may want to retire at the age of 55 or even earlier, or one may want to continue working till 65. It is vital to think about the expenses or needs after retirement. You should know how much amount you will require annually after retirement.
Generally everybody wants to continue the same lifestyle even after retirement. To continue with the same lifestyle a person needs to plan well for retirement.
Factors that necessitate planning for retirement
In the past, larger job opportunities with the government (therefore assured pension) and dependence on joint family ensured that planning for retirement was not the top priority. Today, the changing socio-economic landscape, including the rising rate of inflation and longer life expectancy necessitate planning well for retirement.
ICICI Securities Page 32 of 194 JCP on Managing Personal Finances Retirement planning is the key challenge for all of us. It is the key challenge even for developed nations. The population is aging around the world. Employers are encouraging people to work longer - by increasing the retirement age and curtailing the benefits, such as pensions. In the United States (US), for example, retirement age is gradually increasing to 67 from historic 65. Further, only 15 per cent of the private sector jobs today provide pensions, in 1979 that figure was 38 per cent.
Following are a few key reasons that call for prudent retirement planning:
1. Social changes: The social structure is continuously changing wherein a large number of young working professionals are moving out of their traditional joint families to lead a nuclear family structure. Hence this creates a situation wherein the older members in the family will have to fend for themselves after retirement.
2. Increasing life expectancy: The average life expectancy of an individual has gone up due to advancements in medical sciences and technology. By 2050, life expectancy is projected to reach to 74 years from the current 65 years. This increases the number of years that an individual lives post-retirement. Increased longevity would mean planning for 15 to 20 years of retired life may be, even more.
3. No benefits from employers: Earlier, there were guaranteed pension and medical benefits available from employers. These days, more and more corporates and even governments are moving towards defined contribution system from defined benefit systems. This means, our retirement could be very different from those earlier days or from what our parents experienced. We would need to manage on our own to take care of our needs post retirement. 4. Rising medical expenses: In old age, the need for medical expenses rises. Even simple tests and procedures now cost hundreds of rupees. In the years to come, it would cost even more. Medical inflation is a matter of great concern. The healthcare costs in India are rising steadily at the rate of 18 to 20% every year. This is higher than the overall inflation rate of 6 to 7% as seen in the past few years. This needs to be, and can be managed with the help of retirement planning. ICICI Securities Page 33 of 194 JCP on Managing Personal Finances
5. Increased standard of living: There has been a rise in the standard of living of people in the country. Let us look at examples of increased standard of living:
1. Till a few years ago, cars were considered luxury, but today it is a necessity.
2. Eating out and going to a movie were experiences that people did not enjoy much a few years ago. Now it has become common, and easily cost hundreds of rupees in a day. To maintain this standard of living, it is essential to plan for retirement.
6. Rising inflation: General inflation is another great concern that necessitates the need for retirement planning. For the uninitiated, inflation is the fall in purchasing power of money. Simply put, an increase in the general price level for a considerable period of time is called as inflation. Even a 2 per cent inflation rate will reduce the purchasing power of your money over time.
Let us understand this with an example: About 60 years ago, an average middle class person earned Rs. 600 and was able to support his family comfortably. Now compare the salary with that of a typical middle class family earning today, about Rs. 30,000. So what was Rs. 600 six decades ago is equivalent to Rs. 30,000 now, a 50 times increase. This is inflation. It is essentially a real-life value of money which keeps on reducing.
This kind of price rise will have a deep impact on our finances over a period of time. For example, what will be the cost of 1 litre of milk, which costs Rs. 30 a litre today, after 30 years? Well, assuming inflation to be 5 per cent the price will be Rs. 129.66. Like wise, there will be a continuous price rise over a long period. If you plan to maintain your current lifestyle even after you retire, you will need to build in inflation protection. That may mean saving more for investment purposes or adjusting your current investment strategy to generate a higher return over the long term.
ICICI Securities Page 34 of 194 JCP on Managing Personal Finances
If your monthly expenses today is Rs. 30,000 Years To retirement Actual amount required considering inflation (Rs.) Corpus required at retirement (Rs.) Monthly savings (Rs.) required at 8% 10% 12% 10 53,725 10,749,791 59,298 53,360 47,982 15 71,897 14,385,646 42,338 35,819 30,226 20 96,214 19,251,239 33,617 26,591 20,929 25 128,756 25,762,500 28,161 20,723 15,135 30 172,305 34,476,037 24,320 16,581 11,190 35 230,583 46,136,714 21,396 13,467 8,372 (Note: Inflation taken at 6 percent and post-retirement return at 8 percent)
To offset the effects of inflation, it is necessary to create regular income channels that will provide ample funds to maintain your life style even after retirement. To create such channels, planning your finances in a systematic manner takes precedence. This brings us to the objective of retirement planning.
There may be other reasons as well that may cause some financial hitch during life after retirement. Thus to overcome those hindrances, it is necessary that one makes regular savings and investments.
Where to start? Steps to retirement planning
Before you start planning for retirement there are some aspects that you should be mindful of. Analyzing your current situation and creating a plan accordingly will have great positives. Identifying your current life stage is the first step towards creating your retirement plan. Every life stage has its priorities and so you should examine them. Life stages are mainly segregated as: Single, Married, Married and with kids, and Post-retirement. Each life stage brings with it the challenges and to overcome them proper planning is needed. Especially in the early years of your life, in addition to meeting your current financial needs, you have to plan for your future as well.
ICICI Securities Page 35 of 194 JCP on Managing Personal Finances
Step 1. Identify your life stage
Single: If you are single then your life stage priority must be to lay the foundation for financial security. This is generally the time when you are just entering the workforce and getting adjusted into a professional life. At this stage, chances are that your liabilities will be minimal. This gives you an impetus to save more. Starting to save early on in life helps you build up a sizeable retirement corpus because of the power of compounding that comes into play.
Married and have kids: When you are married and in the subsequent life stage when kids are born, your priority may be to accumulate assets and generate wealth for the future life goals like buying a new house, children's education, children's marriage, among others. Generating wealth is in part related to saving up for your retirement. This process needs to be conducted in a systematic manner such that your life goals are not compromised and at the same time your retirement kitty grows.
Post-retirement: And if you are retired, and no longer working, then you must be utilizing the wealth that you accumulated during your pre-retirement phase. With the advancement in medical care, the average life expectancy is trending higher. To make the wealth that you saved sustainable for your long life, you should look for channels that will keep your resources flush. After identifying your life stage, the next step is to find out how much you will need to fund your retired life.
Step 2. Estimate the cost of retirement / estimate the required retirement corpus
One size does not fit all and it is very difficult to find out actually the amount you will need to save up to be used after retirement. Retirement Planning helps in determining how much money you need to live a comfortable life even after your earning years have stopped, besides ensuring a corpus for that phase of life.
ICICI Securities Page 36 of 194 JCP on Managing Personal Finances There are few simple steps that you can follow to compute an approximate figure that you will need: Arrive at the age at which you wish to retire. (Eg: Current age 30; Retirement age 55) Calculate your current monthly expenses. Eg: Rs. 30,000 p.m. Factor in the inflation rate (Eg: 6% p.a.) and then calculate the monthly expenses that you will need after retirement. (Eg: 128,756 p.m.) Assume a rate of return to be generated from your retirement corpus, i.e. annuity rate. (Eg: 8% p.a.) Now, arrive at the real rate of return from your retirement corpus post- retirement, after negating the effect of inflation. (Eg: [(1+8%)/(1+6%)] 1 = 1.89%) Divide the annual expenses required post-retirement by the real rate of return to arrive at your retirement corpus. (Eg: 128,756 / [1.89%/12] = Rs. 8.17 crore.) This will be the total corpus required. You also need to factor in the investments including provident fund, which you have already made, to arrive at the net corpus required.
Retirement planning worksheet ICICI Securities Page 37 of 194 JCP on Managing Personal Finances EXPENSES TYPE Household Expenses Home Loan Annual EMI Personal Loan EMI's (Annual) Vehicle Loan EMI's (Annual) Education Expenses Entertainment Expenses Medical Expenses Vehicle Maintenance Expenses Holidays Expenses Insurance Premiums Traveling Expenses Systematic Investment Plan (Annual) Other Expenses Total Expenses Planned Retirement Age No of years retirement corpus to be used Existing PF / PPF / Other investments made towards retirement Current Annual Expenses Post- Retirement Annual Expense (in today's cost)
Step 3. Assess how you are prepared for it
Once you have an idea of the required retirement corpus, the next step is to asses how prepared you are currently to meet the retirement needs. Put simply, what sources of retirement income are currently available to you? These could be your Employee Provident Fund (EPF), Public Provident Fund (PPF), gratuity, or pension schemes offered by insurance companies. The amount of income you receive from these sources will depend on the amount you invest, the rate of investment return, and other factors. Finally, if you plan to work during retirement, your job earnings will be another source of income.
Step 4. Calculate the gap
Once you have taken the stock of your current pool of assets, the step is to calculate the gap. Gap/shortfall is calculated as: The required retirement corpus (step 2) minus The available investments (step 3).
ICICI Securities Page 38 of 194 JCP on Managing Personal Finances If there is a short fall, you will need to bridge that up from additional personal retirement savings.
Step 5. Build your retirement fund
When you know roughly how much money youll need, your next goal is to save that amount and build your retirement fund. First, youll have to map out an investment plan that works for you.
Investing should take into consideration your risk profile and the life stage. If you have a long time for your retirement, then it is suggested that you invest a major portion of your portfolio into equity or equity-related products. It has been observed that equity products have given superior returns in comparison to most other investments. Hence, by investing in equity products you will be able to generate a greater corpus till your retirement. However, if you are close to your retirement, it is advisable to invest in debt products because of the certainty of the maturity value.
Illustration: Suppose, a person needs a corpus of 1 crore in his retirement kitty at the age of 60. If he plans at the age of 25, considering returns of 8 percent, he has to save Rs 58,033 per year. If he starts planning at the age of 35 he has to save Rs 1,36,788 every year. And if he starts planning late at the age of 45 he has to save Rs 3,68,295 to reach his goal of Rs 1 crore.
Age/Returns Amount to be invested every year to accumulate Rs 1 crore 8% 10% 12% 25 58,033 36,897 23,166 35 1,36,788 1,01,681 75,000 45 3,68,295 3,14,738 2,68,242
A person in the age group of 25 to 35 can take maximum exposure to equity so as to get better than 8 percent returns. In this age group a person can save more as there are fewer liabilities. A person in the age group 35 to 45 has to take moderate exposure or say 50 percent in equity. And a person above 45 has to take minimum exposure to equity and when he reaches 55 he has to cut down the ICICI Securities Page 39 of 194 JCP on Managing Personal Finances equity exposure gradually. But suppose, if one has started planning for retirement at a late age then to satisfy his goal he has to take equity exposure accordingly, irrespective of his age.
A. Some of the investment options are:
1. Employee provident fund (EPF)
Most companies have EPF for the benefit of employees. An employee can contribute 12 per cent of the salary towards EPF. The employer also contributes 12 per cent of salary. The current rate of interest on EPF is 8.5 per cent. This is a good tool to build a retirement corpus.
2. Public provident fund (PPF)
PPF is another tool to build the retirement corpus. The minimum contribution is Rs. 500 and the maximum is restricted to Rs. 1 lakh per annum. The current rate of interest is 8.7 per cent. The contributions as well as the interest earned are tax free. Its tenure is 15 years and can be renewed by 5 years each time. Moreover, withdrawal facility is also available after 6 years. This is a good tool to fund your retirement if you are not covered by EPF. Even those covered under EPF can also contribute to PPF, for a larger retirement corpus.
3. Pension products from insurance companies
One of the most common investment options for retirement is through pension plans, which come in the form of either endowment plans or ULIPs. In endowment plans, the premiums are being invested into primarily debt instruments only. ULIPs are a combination of mutual funds and insurance cover.
4. New Pension System (NPS)
The New Pension System (NPS) is a new voluntary contributory pension scheme introduced by the Central Government. Under NPS, individuals can open a personal retirement account and can accumulate a pension corpus during their ICICI Securities Page 40 of 194 JCP on Managing Personal Finances work life to meet financial needs post-retirement. These contributions will grow and accumulate over the years, depending on the returns earned on the investment made. When the person retires, he will be able to use these savings to take care of the needs and expenses of his family during old age. The subscribers may use the accumulated pension wealth under the scheme to purchase a life annuity from a life insurance company. Alternatively, depending on the age of the subscriber, a part of the wealth may be withdrawn as lump-sum.
5. Mutual Funds
Mutual funds are a preferred investment route for many due to the attractive returns that they provide. If you have a long time for your retirement, investing in equity mutual funds will generate a sizeable corpus and the long tenure will iron out the risks involved due to volatility. You should invest in those mutual fund schemes that have a good performance track record.
B. Life after retirement If you have already retired or are at the threshold of retirement, it is essential to invest in low-risk instruments so that there is no capital erosion. Hence it makes more sense to invest in instruments with a greater exposure to debt.
Some of the preferred options are:
1. Annuity from insurance companies
An Annuity is a very useful retirement planning tool that offers unique benefits to senior citizens. Annuity is a series of regular payments over a period. An annuity is a contract with an insurance company under which you receive fixed payments on an investment for a lifetime or for a specified number of years. Annuities can be classified into different categories.
On the basis of purpose of the investment, annuities can be termed as deferred or immediate. ICICI Securities Page 41 of 194 JCP on Managing Personal Finances
a. Deferred annuities: In this type of annuity, the investor saves in a systematic manner to build up sufficient funds for retirement. The withdrawals commence after the retirement of the investor. They are best suitable for a long period and not suitable for short term wealth generation.
b. Immediate annuities: The holder of immediate annuity makes one-time lump sum payment, and begins receiving payments immediately. Immediate annuities provide guaranteed flow of income for the rest of life and for a period defined by the investor. It is wise to invest in immediate annuities if you are close to retirement.
On the basis of nature of the investment, annuities can be fixed or variable.
a. Fixed annuities: As the name suggests, holders of fixed annuities receive an assured rate of interest for a certain period. In this case, both interest and principal are guaranteed and the payout amount remains constant throughout the term.
b. Variable annuities: Holders of variable annuities receive varying payouts. This is to take into account the inflation.
Both deferred and immediate annuities can be fixed or variable.
There are various payment options that annuity holders can opt for. You should selection the options that suit your specific needs the best.
Annuity payout options USP Pros Cons Life annuity Income for life You dont risk outliving your corpus Payment stops on death, even if early Life annuity with return of corpus Income for life and principal given to nominee after Nominee gets the money after investors death Low payout because only income is given out ICICI Securities Page 42 of 194 JCP on Managing Personal Finances death Fixed term annuity Guaranteed income for a fixed period Provides income for fixed period as specified by investor Investor is at risk of outliving the chosen term Joint annuity for life After investor dies, partner gets income for life Takes care of expenses of both partners Low payout because term is longer Joint annuity for life with return of corpus After investor dies, partner gets income for life Nominee gets the money after investors death Very low payout Increasing annuity Increased payouts every year Takes inflation into account Needs a bigger corpus to sustain over long term
2. Fixed deposits (FD)
FDs as the name suggests provide a fixed return. This is a low risk instrument by banks and so the returns are also low (7-9 percent). The stability of the returns is what makes this instrument a very attractive one for conservative investors, including retired persons. Besides banks, FDs are now provided by Non-banking Financial Institutions (NBFCs). In comparison, FDs from NBFCs offer higher interest rates. While investing in these FDs it is essential to look at their credit rating. The FDs with a high credit rating will offer you stable and higher returns whereas a low credit score can be slightly risky.
3. Post Office Monthly Income Scheme (PO MIS)
PO MIS currently provides an interest rate of 8.4% percent per annum which is paid monthly. The minimum amount to be invested is Rs. 1,500 and the maximum is Rs. 4.5 lakh. PO MIS has a maturity period of 5 years.
ICICI Securities Page 43 of 194 JCP on Managing Personal Finances 4. Senior Citizens Savings Scheme As the name indicates, this scheme is available for senior citizens. The scheme is available to - 1. Who has attained age of 60 years or above on the date of opening of the account. 2. Who has attained the age 55 years or more but less than 60 years and has retired under a Voluntary Retirement Scheme or a Special Voluntary Retirement Scheme on the date of opening of the account within three months from the date of retirement. 3. No age limit for the retired personnel of Defence services provided they fulfill other specified conditions. Investments can be made in any post-office by opening an account. Only one deposit can be made in each account; the deposit amount shall be a multiple of Rs.1,000 and should not exceed Rs. 15 lakh. The scheme has tenure of 5 years. The account can be extended for a 3 year period by making an application. The current interest rate is 9.20% per annum. Premature closure of account is permitted 1. After one year but before 2 years on deduction of one and a half per cent of the deposit. 2. After 2 years but before date of maturity on deduction of 1 per cent of the deposit. Premature closure is allowed after three years. In case of death of the depositor before maturity, the account is closed and deposit is refunded without any deduction along with interest. 5. Monthly Income Plan (MIP)
MIP of mutual fund is a debt-oriented scheme that aims to provide reasonable returns on a monthly basis through investment in debt (75-80 percent of its corpus) as well as a small portion in equities. MIPs aim to provide investors with regular pay-outs (through dividends). They invest predominantly in interest yielding debt instruments (commercial paper, certificate of deposits, government securities and treasury bills). The debt investments ensure stability and consistency while the equity instruments in the portfolio boost the returns.
Beside the regular investment avenues, there may be other resources that can be tapped to generate income after retirement. This will mainly be an outcome of the investments that you make along your way to fulfil your financial goals. Some of the income sources are:
6. House rentals
ICICI Securities Page 44 of 194 JCP on Managing Personal Finances This can be useful to generate steady returns against your earlier property investment. If you have a second house and if it is rented out, then it is a good source of income during your retired life.
7. Reverse mortgage
A reverse mortgage provides income that people can tap into for their retirement. It is a type of mortgage in which a homeowner can borrow money against the value of his or her home. No repayment of the mortgage (principal or interest) is required until the borrower dies or the home is sold. The transaction is structured so that the loan amount will not exceed the value of the home over the life of the loan. A senior citizen who holds a house or property, but lacks a regular source of income can mortgage his property with a bank or housing finance company (HFC) and the bank or HFC pays the person a regular payment. The advantage is that the person who has mortgaged his property in this manner can continue staying in the house for his life and at the same time receiving the much needed regular payments. So, effectively the property now pays for the owner.
Quick Look Retirement Planning Products Product Return indicative Capital risk Tenor Investment horizon Minimum investment Taxation/ Tax benefits Direct equity 12 15% High No lock-in > 5 years (with active monitoring >3years) - No tax on long-term gains; Short-term gains is 15% Mutual funds - Equity 12 15% High No lock-in; can be redeemed any time 5 years Can be started at Rs. 500 SIP No tax on long-term gains; Short-term gains is 15% ICICI Securities Page 45 of 194 JCP on Managing Personal Finances PMS 12 15% High No lock-in > 3 years Rs. 25 lakh No tax on long-term gains; Short-term gains is 15% ULPP / ULIP 6 10% Medium 5 years > 5 years > Rs. 10,000 per annum Investments under Section 80C are tax exempt ELSS 8 15% Medium 5 years > 3 years Rs. 5,000 lump sum Tax benefits available under Section 80C Structured Products 8 15% Medium 3-5 years > 3 years > Rs.5 lakh Mutual funds - Debt 7 10% Low No lock-in 1-5 years Rs. 500 SIP Short term - as per slab; Long term with indexation - 20% / without indexation - 10% Deposits/ NCD/ Bonds 7 - 9% Low 15 days - 10 years 1-5 years Rs.1,000 As per slab NPS 8 - 9% Low Till the individual is 60 years old > 15 years Rs. 500 per month or Rs.6,000 annually Tax benefits available under ICICI Securities Page 46 of 194 JCP on Managing Personal Finances
Myths about Retirement
Myths are faulty beliefs with no scientific back up. Given below is the list of common myths about retirement and how you can tackle them:
Section 80C; Maturity benefits are taxable Senior Citizen Saving Scheme 9.20% Nil 5 years (extendable for additional 3 years) 5 years Rs.1,000 No; Interest is fully taxable EPF 8.50% Nil Up to an individual's retirement > 15 years 12% of the basic salary Yes; up to Rs.1 lakh PPF 8.70% Nil 15 years > 15 years Rs. 500 Yes; up to Rs.1 lakh under Section 80C PO MIS 8.40% Nil 5 years 5 years Rs. 1,500 No tax benefit under Section 80C 5-year NSC 8.50% Nil 5 years 5 years Rs. 100 Yes; up to Rs.1 lakh under Section 80C 10-year NSC 8.80% Nil 10 years 10 years Rs. 100 Yes; up to Rs. 1 lakh under Section 80C ICICI Securities Page 47 of 194 JCP on Managing Personal Finances Myth 1: I am too young to plan for retirement
Fact: It's never too early to plan for retirement. Lets take a case, wherein a person starts investing Rs12,000 p.a. from the age of 25 years. He will retire with a corpus of Rs 25,43,000 at the age 60.
However, if he starts investing the same amount from age 35 instead, he will retire with a corpus of Rs 10,00,000. A difference of more than Rs 15,00,000!!! No, that is no magic, but simply the power of compounding, described as the eight wonder of the world by Albert Einstein himself. Therefore do not postpone your retirement planning anymore.
Myth 2: I won't live long after retirement
Fact: Everyone believes they will live healthy and retire rich and hate the idea of being dependant on anybody either physically or financially. They claim, I do not want to live beyond age 60, as I do not want to be a burden on anyone. However, the average urban life expectancy is 77 years. In fact in another 20 years life expectancy may increase to 85 years, due to better standard of living and improved health care. This means, even if they plan to retire at age 58, their retired life will be as long as their work life. The longer you live, the longer your money has to be stretched.
Myth 3: I will live healthy
Fact: This is a pre assumption everyone loves to live with. However, due to changing life style, increasing work pressure, high level of stress and faulty food habits, we will have more health related issues than any of our ancestors did.
Thus one also needs to arrange for the increasing health care expenses during old age.
Myth 4: I can rely on my children
ICICI Securities Page 48 of 194 JCP on Managing Personal Finances Fact: Our traditional joint family system is breaking down to nuclear family system due to changing life styles and due to mobility and relocation for better career prospects. In fact, it will be considered as unfair for the children if you are dependant on them during the times of high cost of living.
Everybody will be more happy to be financially secure and independent rather than depend on your children. Adequate savings will preserve your financial freedom. If children take care of you consider it as a bonus.
Myth 5: I don't earn enough to save for retirement
Fact: Just as every drop of water makes a mighty ocean, small amounts if invested regularly, will help you build your retirement nest. If a person aged 35 invests Rs 1000p.m., he will retire with a corpus of Rs 10,00,000 at age 60, assuming returns at the rate of 10% p.a.
Myth 6: I will plan for retirement once I have paid off my auto loan
Fact: One may assume that he will have more money at his disposal, once he has paid off the loans. However, in reality your expenses always outpace your income.
Once you have paid off your one loan, you will probably want to take another loan for some other thing, and the cycle goes on. And, thus retirement planning will get further pushed off, as it does not seem as an immediate need.
Myth 7: I have saved enough money for retirement
Fact: While planning for retirement expenses, one must account for inflation as it will reduce the purchasing power of money over a period of time. For e.g. If a person aged 35 requires Rs 25,000 p.m. to meet his household expenses, he will require Rs 95,000 p.m. to meet the same expenses when he retires at the age of ICICI Securities Page 49 of 194 JCP on Managing Personal Finances 58 and will require Rs 1,92,000 p.m. to maintain the same standard of living by the time he reaches age 70. This is assuming an inflation rate of 6%.
Thus while planning for retirement one should not only aim for an income which will take care of his immediate expenses, but also aim for an income which will keep in pace with inflation.
Case Study of a Pre-Retiree T.K. Pai, 59, is approaching retirement. After having worked for almost 30 years in a public sector, he is about to retire in next 6 months. He is happy, but worried too. Though he would be getting pension and other lump sum retirement accumulations as provident fund and gratuity, he is not sure whether the pension would be sufficient. He is also unsure as in how to best utilize his retirement benefits.
Fortunately, he met a financial planner, who has provided him a clear picture of his finances and ways to lead a peaceful retired life.
Pais key financial assets: Public provident fund (PPF): Rs 12 lakh Bank deposits: Rs 10 lakh Equity: Rs 5 lakh
Pais key financial liabilities include earmarking approximately Rs 10 lakh for daughters marriage in next 2 years and to upgrade his existing 1-BHK apartment to 2-BHK apartment, which would entail an additional lump sum amount of Rs 20 lakh. His wife is dependent on him and he needs to support his daughter for at least next 5 years. ICICI Securities Page 50 of 194 JCP on Managing Personal Finances
Pais financial position (excluding cash) on retirement would be: PPF: Rs 12 lakh Bank FD: Rs 10 lakh EPF: Rs 20 lakh Gratuity: Rs 10 lakh Equity Rs 5 lakh Total: Rs 57 lakh
Considering the life facts that he is on the verge of retirement and has still two goals left to achieve, viz; funding his daughters marriage and upgrading the apartment, it would be better to play conservative than being aggressive on investments.
Contingency fund: It is suggested increasing the cash holding by Rs 2 lakh to bring it up to Rs 3 lakh to ensure that the contingent expenditures are met. The cash holding has to be periodically reviewed and it is suggested that it should be increased gradually to cushion the unforeseen expenditures on account of medical expenditures, etc. Daughters marriage and apartment up-gradation: Pai needs to earmark an amount equal to Rs 30 lakh for his daughters marriage and apartment up- gradation; to be parked in debt instruments either in bank fixed deposits (FDs) or debt mutual funds with floating interest rates to keep the value of the investments intact.
Total expenditure on retirement: Cash holding: Rs 2 lakh Daughter's marriage: Rs 10 lakh Apartment up-gradation: Rs 20 lakh
With this, the financial allocation on retirement would appear as: Expenditure: Rs 32 lakh Retirement investments: Rs 25 lakh
ICICI Securities Page 51 of 194 JCP on Managing Personal Finances The suggested debt-to-equity ratio at this age is: 4:1 i.e. 80% of invest-able amount in debt and balance in equity, which he should further re-balance to more conservative ratio of 9:1 i.e. 90% in debt and balance in equity. The re-balancing to move funds in debt is required for capital protection, which, post retirement is more important than wealth creation.
Accordingly, as suggested, asset allocation on retirement will be:
Pai is advised to invest Rs 5 lakh in diversified equity mutual funds with good track record. For debt investments, his investment strategy needs to take care of capital protection, regular periodic income and liquidity.
SESSION 4: INVESTMENT PLANNING
We all work for money. It is equally important to ensure that money works for us. There are two main ways to make money. 1. We make money by working. 2. Money makes money that is, by way of investments. Investment refers to a commitment of funds to one or more assets as per the goals and risk profile of an individual.
In order to achieve our goals, it is important that we have a sound investment plan in place. Investment plan is nothing but the process of making investments based on our needs.
Why invest?
ICICI Securities Page 52 of 194 JCP on Managing Personal Finances Investing is the best way to secure your future by accumulating wealth for the long term. Investing not only helps you beat the effects of inflation but also helps in generating handsome returns to attain your financial goals. By investing, you let the power of compounding assist you in generating good returns.
How inflation affects you?
Inflation is a fall in the market value or purchasing power of money. Lets understand inflation with a simple example. About 60 years ago, an average Rs. 300 per month was a handsome good amount to support ones family. Today this is no less than Rs. 15,000 in an urban area. The prices increase over time and the value of money, in absolute term, decreases. We get this sense every time we compare the prices of any commodity today with what it was a few years back. This is inflation. So it is essentially a real-life value of money which keeps on reducing.
In technical terms, inflation increases wherever too much money chases too few goods i.e. the purchasing power of money decreases. But it has some serious impact on what we save as we will learn in the effects of inflation. Purchasing power refers to the amount of goods and services a given amount of money can buy. So Rs. 300 would have been sufficient 60 years ago to run a small middle- class nuclear family, while the same Rs. 300 at present is insufficient even for one weeks food for a single person. So the purchasing power of money has gone down in these 60 years. Inflation is nothing but a fall in purchasing power of money.
Another way to look at this is that the money you save for tomorrow needs to grow at a rate, through the investments you make, so that its purchasing power remains or grows over a period of time.
Simply put, an increase in the general price level for a considerable period of time is called as inflation. The two major causes are demand pull factors and cost push factors.
Power of Compounding ICICI Securities Page 53 of 194 JCP on Managing Personal Finances To define compounding, it is the ability of an asset to generate returns, which when re-invested generates further returns. In simple words, when your money is allowed to remain invested for a long period of time, the interests earned will add to the seed capital and will in turn earn further interests. This method of multiplying your investment capital is called compounding.
To work, the compounding process requires two things: (1) re-investing the returns earned, and (2) time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment. Lets take an example to demonstrate the power of compounding: Consider, you have Rs.100 and you invest it at10 percent. Time Principal (Rs.) Interest (Rs.) Total amount (Rs.) After 1 year 100.00 10.00 110.00 After 2 years 110.00 11.00 121.00 After 3 years 121.00 12.10 133.10 After 4 years 133.10 13.31 146.41 After 5 years 146.41 14.64 161.05 Total Compound Interest earned 61.05
Had you invested the same amount at a simple interest of 10 percent for 5 years, you would get only Rs. 50 as interest. The difference is because compounding reinvests the amount earned in order to generate more earnings which is otherwise ignored.
This method of investing is useful to create a corpus for important financial goals. Investing small amounts regularly will not pinch your pocket. If you leave this investment untouched, this will grow into a considerable amount that will fund your goals. To create a large corpus, you need to give time for the money to grow. Hence it is always beneficial to start saving early. Starting early always has its advantages in investing.
Let us consider an example of two friends, Ram and Shyam.
ICICI Securities Page 54 of 194 JCP on Managing Personal Finances Ram Shyam Current age (years) 30 35 Retirement age (years) 55 55 Monthly investment (Rs.) 3,000 5,000 Rate of return (%) 12 12 Corpus accumulated (Rs.) 51,06,620 45,99,287
In the above example, Ram, planning to retire at the age of 55, started investing Rs.3,000 p.m. from the age of 30 for building his retirement corpus. Shyam also planning to retire at the age of 55, realized the importance of investing a little late at the age of 35 and hence, started investing a higher amount of Rs.5,000 p.m. from the age of 35. Though Shyam is investing a higher amount, Ram accumulates higher corpus for the simple reason that he started 5 years ahead of Shyam and the difference is huge - Rs. 5,07,333.
Investment Planning Process Building an investment portfolio largely entails the following steps:
Step 1: Ascertaining risk profile
Every person is unique in various ways. Similarly, your investment capability may not be the same as your sibling, friend or your colleague. You are the best person to understand your own ability to invest and bear the risk associated with it. Risk is a deviation of outcome from the expected standard end result. Risk basically means future issues that can be mitigated or avoided by taking informed decisions.
ICICI Securities Page 55 of 194 JCP on Managing Personal Finances Risk profile can be defined as how much variation in returns from investment can be easily accommodated by you. Do you want a 10 percent or 50 percent return annually to make your portfolio strong and achieve your goals? Are you prepared to accept the impact of volatility in the stock markets? This assessment helps you in understand your risk profile.
You risk profile helps in deciding which asset classes to invest in. An asset class can be a group of securities which have common characteristics risk, maturity, cost of trading, etc. For example, if you have a considerable risk appetite, you can invest in derivatives which are taken as the most risky investments. And based on the knowledge of your risk appetite, you can choose the particular investment to be made. Risk profile is specific to an investor, i.e., your risk profile is unique to you.
After realizing the importance of understanding the risk profile, the next task is to identify it. The factors that affect the risk profile of an investor are: the current income, knowledge about financial markets and investments, age and life stage of the investor, time horizon of your financial goal, certainty of income and in general your attitude to wards taking risks.
Income: Your income has a bearing on your risk profile. It is observed that the higher you earn, higher is your ability to save and/or invest and thus generate wealth. This creates an ample opportunity to take risk to earn higher returns. Hence your risk-ability has a direct relation to your income and accumulated wealth.
Knowledge of financial markets: If you are aware of the workings of the financial markets, chances are that you will not be seeking advice from other sources for your investments. You can gather information from various sources and use your own expertise and skill to put your money to good use. There are high chances of you getting into risky investments since you will have strategies lined up just in case the returns start diminishing. This does not in any way mean that those who do not invest in risky assets are unintelligible about the financial markets. Chances are that you may invest a major portion of your investments in less risky assets and experiment risk with a small part of your portfolio. ICICI Securities Page 56 of 194 JCP on Managing Personal Finances
Time horizon of your goals: It is generally observed that if you are able to wait for a long time for your investments to yield the expected returns, you tend to take greater risks with your investments. This is so because you are not worried about intermittent losses as you have set your eyes on a certain greater return in the long term. Besides, it is mathematically proved that over a long term, you even out the chances of losing money through your investments, thus minimizing your risks. It is recommended that if you need money in the near future you should refrain from investing in risky assets as the inherent nature of volatility of those asset classes can bring down the base value of your investment. Instead, as your goals come within reach, you should move your investments from risky assets into low risk category investments.
Age and life stage: We generally observe in our daily life that youngsters are more prone to excited behaviour and are not afraid of making mistakes. It is because they think that they can start all over again and still be successful. Similarly, in financial investments too, your age plays an important role in your ability to take risks. Wealth is created over a long period of time. The longer you stay invested chances of generating a greater amount of returns are higher, thus bringing your risk to a minimum.
If you are young and single, you will have a greater enthusiasm in taking on risk and invest in assets that bear a great amount of risk, because you do not have any dependents. Instead, if you are married person, you will be cautious in your investments since you will have dependents, you need to set up your family, buy a house, bring up children, and a whole lot of financial goals to be achieved. If you are retired, you will be even more cautious since your regular income flow will have stopped, and you need to create a corpus for your winter of life.
Certainty of income: If you have a secure job or business, you can take higher risks with your investments. You can in this way be almost certain of your future earnings and can plan your financial investments in accordance to a well set plan.
Your attitude towards risk: In general we are risk and loss averse. However few of us are more sensitive to potential losses or actual losses. It is important to be ICICI Securities Page 57 of 194 JCP on Managing Personal Finances comfortable with the investments that you make. Investment into equity is more risky and volatile as compared to investments in fixed deposits, however they promise a potentially higher return too. It is ones comfort level with the risk and reward of ones investment that defines the attitude towards risk. The ability of risk is also dependent on the factors that we discussed above and it is a good idea to follow the life stage asset allocation that we discussed earlier. The broad risk profiles have been discussed in the next section of this chapter.
Analyzing risk profile: Investors are broadly classified into the following categories based on their risk profile:
Conservative Moderate Balanced Aggressive Highly aggressive Let us take a closer look at the various risk profiles.
Conservative: As a conservative investor, you avoid taking undue risks and you are firm on preserving your investment capital. You are always looking for investment avenues which will help generate income to beat inflation and at the same time protect your capital. Since you are risk-averse you prefer investing in avenues where the risk-return is clearly defined.
Moderate: As a moderate investor, you are likely to make investments that have very limited levels of risk and generate moderate returns. You prefer slightly higher returns than in a traditional Bank FD. You are not comfortable with large drops in the value of your investments even for a short while. You are on the lookout for a cautious mix of capital protection and growth that generates steady returns.
Balanced: As a balanced investor, you are willing to accept certain levels of fluctuations in the value of your investments in order to appreciate your returns and achieve your goals. You are ready to accept a certain amount of risk and in most probability you are interested in investing for the long term. You also have a ICICI Securities Page 58 of 194 JCP on Managing Personal Finances fair understanding of the benefits of diversification among various asset classes. Your primary goal is growth of capital and generating income. Your suggested balanced portfolio has an equal allocation of growth and income generating assets. This ensures stability to the portfolio in terms of appreciation in your investment and generating a regular income from it.
Aggressive: As an aggressive investor, you are comfortable with initial fluctuations in the value of your investments to generate high returns. You understand that taking larger risks helps earn higher returns. Hence you prefer investing in avenues such as equity that provide high returns but at the same time pose high risks. Your primary aim is growth of capital. Equities form the base of the portfolio.
Highly Aggressive: You are interested in only high growth and do not mind taking on high levels of risk to achieve your investment objectives. You are not concerned about the market swings as long as the returns show a steep appreciation. The possibility of negative returns does not deter you from investing in high-risk investments to ultimately gain high returns in the long term. Your primary focus is to earn very high returns with no concerns for the associated risk. All investments of your portfolio are in equity and related securities.
Step 2: Identifying appropriate asset allocation according to a risk profile
Asset allocation is the process by which investors can distribute their investment capital between various asset classes within their portfolio. The goal of asset allocation is to create a well-diversified portfolio. That is, one which effectively reduces the overall portfolio risk while maintaining the expected level of returns.
Asset allocation is the process of choosing the right mix of available asset classes for investment. The major asset classes are: Equity, Fixed income or debt, and Cash and cash equivalent. A right asset allocation ensures that an individuals surplus is apportioned among various asset classes that best suits his/her financial objectives. An ideal portfolio should have a mix of all the major asset ICICI Securities Page 59 of 194 JCP on Managing Personal Finances 45% 45% 10% Asset Allocation Moderate Investor Equity Debt Cash 20% 70% 10% Asset Allocation Conservative Investor Equi ty Debt Cash classes in various proportions depending on the persons risk profile, age and time period to achieve the goal.
Thumb rule in asset allocation
This rule is used to find out the percentage of equity allocation in your portfolio. According to this rule,
Percentage of equity allocation in your portfolio (approx) = 100- Your age
For example, if your age is 30 years, then as per this rule your portfolio should have an approximate equity allocation of 70 percent (100-30).
It is based on the assumption that when you are young you have the ability to take more risk because in this life stage people mostly have less or no liabilities.
Asset Allocation as per risk profile
Every individual has different risk profile depending on his/her risk taking ability. If we consider the three major risk profiles, namely aggressive, moderate and conservative, there will be a different asset mix in them.
(This is for illustrative purpose only. Actual allocation may vary)
Generally, the more time you have to achieve the goal, the more aggressive you can be. It means you can allocate more into equity in such cases as you will have
70% 20% 10% Asset Allocation Aggressive Investor Equity Debt Cash ICICI Securities Page 60 of 194 JCP on Managing Personal Finances more time to generate the desired returns. And historically, equity has given more returns in comparison to other asset classes.
It is important to understand the importance of a right asset mix to achieve the goals. One should consider various factors like ones risk taking ability, age and time duration and allocate assets accordingly.
Broad Asset Classes
Equity is a high risk asset class. Volatility in the prices of stocks is very high and this can unnerve many investors. But if you are a disciplined investor with a good amount of risk ability, then this the best type of asset. Over the long term, equities provide the highest returns, provided you dont sway with your emotions as the markets experiences peaks and troughs.
Debt is relatively low-risk asset class. Debt investments, fixed-interest securities historically provide lower returns than equities. They help reduce the overall risk of your portfolio and pay a regular interest income.
Real estate is another major investment class with moderate risk attached with it. The house that you live in or any landed property that you own, constitute this asset class. Even though the risk is moderate, it is susceptible to fluctuations in market demand. The major drawbacks are the time and expense involved in maintaining this asset. But it has the potential to provide you very good returns if traded at the right time.
Cash is another asset class that you hold in your savings account or fixed deposits or other money market investments. This type of asset offers very low returns, but the biggest advantage is that it provides easy access to money when you suddenly need it.
Commodities are raw materials used to create the products consumers buy, from food to furniture to gasoline. Commodities include agricultural products such as wheat and cattle, energy products such as oil and gasoline, and metals such as gold, silver and aluminium. The gold and silver ornaments in your jewellery ICICI Securities Page 61 of 194 JCP on Managing Personal Finances collection constitute this type of asset class. Investing in commodities can be highly risky as the commodities market is highly volatile and work on the basis of market demand.
Alternative Assets is another type of asset class thats fast becoming popular in India. Art, antiques, collectibles etc. are representative investments under this asset class. So if you have inherited any special heirloom from your ancestors, hold on to it as it may be of great value.
Parameter Cash Debt Equity Commoditie s Real Estate Alternativ e Assets Representativ e investments Savings accoun t, Money market funds Governme nt bonds, debt mutual funds Shares, equity mutual funds Gold and precious metals, kitchen and industrial commoditie s Apartment s, flats, land, commercia l property, real estate funds Art, Antiques and Collectible s Risk Low Low High High Medium High Return Low Low High High (but volatile) Medium to High (but cyclical) High (but Indian market is volatile and still needs to mature) Inflation protection Very low Low High High High High Liquidity High High (except for bonds locked in for High (except for ELSS mutual funds - tax Medium to High Low Low ICICI Securities Page 62 of 194 JCP on Managing Personal Finances minimum period) advantage d equity linked funds) Income Yes Yes Yes in case of dividend paying stocks and funds No If you rent out your property or land No Capital appreciation No No Yes (but cyclical) Yes (but cyclical) Yes (but cyclical) Yes (but cyclical)
The asset allocation that works best for you at any given point in your life will depend largely on your life stage, time horizon and your ability to tolerate risk.
Life stage: The different life stages single, married, married with children, pre- retirement and post-retirement are the phases of every persons life. Depending upon which stage you are at, you should make your investments to achieve your life goals based on your needs. If you are young and single, you can afford to be an aggressive investor. If you are middle-aged and married, it is better to take on only moderate risk. If you are retired, it is prudent to stay away from risk as the income sources have depleted.
Time horizon: Your time horizon is the expected number of months, years or decades you will be investing to achieve a particular financial goal. An investor with a longer time horizon may feel more comfortable taking on a riskier, or more volatile, investment because time is not at a premium, and he or she can wait out slow economic cycles and the inevitable ups and downs of our markets. By contrast, an investor saving up for a childs college education in three years will be wary of taking risks because the parent has a shorter time horizon.
Risk tolerance: Risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. The way you perceive risk depends on a lot of factors. You should analyze your risk taking ICICI Securities Page 63 of 194 JCP on Managing Personal Finances ability before taking the plunge to make an investment. An aggressive investor, or one with a high-risk tolerance, is more likely to take greater risk in order to get better potential returns. A conservative investor, or one with a low-risk tolerance, tends to favour investments that will preserve the original investment capital.
Step 3: Have adequate diversification with your asset allocation
When allocating your portfolio between various investments, your goal is to effectively and efficiently diversify your portfolio. By adding different investments in your portfolio, you can reduce the overall portfolio risk while maintaining the average expected return. But for the diversification of capital to be effective it is more than simply adding different investments to the portfolio. They need to be the right kind of investments.
For successful diversification, you need to spread your assets so that the same factors do not affect all the investments in the same way. The ideal situation will be when one asset class is negatively impacted by a systemic risk, another asset class benefits from that same factor. This provides protection to your portfolio.
The investors goal should be to diversify risks and maximize returns, and this can be achieved by investing in several asset classes. Each asset class has its own unique risk and expected return profile. Asset classes react to stimuli such as changes in the economy, government, monetary and fiscal policy, as well as other factors. Depending on the specific class, these factors will impact in different ways.
The correlation between two assets tells how much they will move in tandem. If they are perfectly positively correlated (correlation coefficient of +1), the prices of the assets will move together in lockstep. If they are perfectly negatively correlated (correlation coefficient of 1), their prices will move in opposite directions. And if they have no correlation (0), the two assets will move completely independently from each other. Thus correlation plays a very important role in helping you diversify your portfolio and bringing stability to it.
ICICI Securities Page 64 of 194 JCP on Managing Personal Finances Besides diversification across asset class, it is also recommended that you diversify within asset classes as well. Within stocks, you should diversify across industries and companies. For example, if you invest only in four or five individual stocks, you need at least a dozen carefully selected individual stocks to be truly diversified. Within fixed income investments, you should diversify across different tenure.
Achieving diversification can be challenging, so you may find it easier to diversify within each asset category through mutual funds rather than through individual investments from each asset category. A mutual fund is a pool of money from many investors and invests the money in stocks, bonds or other financial instruments. Mutual funds make it easy for investors to own a small portion of many investments. For example, a Nifty index fund will buy all stocks in the same proportion as the Nifty index.
Taking diversification a step further, the option of diversifying across geographies is also open for Indian investors. You can buy stocks in overseas markets and also invest in other assets like real estate.
Step 4: Stay true to your allocation by regularly rebalancing Asset Allocation is not static. It changes with time, as the age of the investor increases and risk profile changes. Also, whenever there is a change in the portfolio mix due to the returns generated by the various asset classes, there is a requirement for re-balancing the portfolio to bring it back to the initial allocation. If not rebalanced, the portfolio might take a hit on the returns generated over a period of time. Asset class Amount (Rs.) % of allocation Equity 50,000 50% Fixed income 30,000 30% Money market 20,000 20% Total 1,00,000 100% ICICI Securities Page 65 of 194 JCP on Managing Personal Finances 50% 30% 20% Equity Fixed income Money market
After a year, this is how his portfolio looks like: Asset class Returns % p.a Amount (Rs.) with returns % of allocation by year end Equity 30% 65000 55% Fixed income 10% 33000 28% Money market 5% 21000 17% Total 19% 119000 100%
55% 28% 17% Equity Fixed income Money market
The asset allocation pattern has changed from the initial allocation, due to the different returns generated by different asset classes. Hence, we need to re- balance the portfolio back to the initial allocation pattern by selling some equity and investing into fixed income and money market instruments. Let's see the effect of ignoring re-balancing.
Effect of ignoring portfolio re-balancing Given below are 2 scenarios, one if the investor has ignored portfolio re-balancing and another, if the investor has rebalanced his portfolio. In the first case, the asset allocation pattern has changed, whereas in the second case, the investor has sold ICICI Securities Page 66 of 194 JCP on Managing Personal Finances some of his equity portion and increased his fixed income and money market portion to bring back the asset allocation to the initial level. Ignoring Portfolio Rebalancing Re-Balanced Portfolio
Asset class Amount (Rs.) % of allocation Asset class Amount (Rs.) % of allocation Equity 65,000 55% Equity 59,500 50% Fixed income 33,000 28% Fixed income 35,700 30% Money mkt 21,000 17% Money market 23,800 20% Total 1,19,000 100% Total 1,19,000 100% Let's see the effect of both the above scenarios, after completion of Year 2. Ignored Portfolio Rebalanced Portfolio Asset Class Returns Opening bal Closing bal Opening bal Closing bal Equity -11.00% 65,000 57,850 59,500 52,955 Fixed income 15.00% 33,000 37,950 35,700 41,055 Money market 8.00% 21,000 22,680 23,800 25,704 Total 1,19,000 1,18,480 1,19,000 1,19,714 It clearly reflects that had he not rebalanced his portfolio, his second year's returns would be negative. But had he rebalanced the portfolio to the initial asset allocation level, his returns would have been positive. The difference between a rebalanced portfolio and an ignored portfolio can be significant as the duration increases. In this case, portfolio re-balancing is the optimal strategy. But if the stock market rallies in the second year, then the ignored portfolio may realize a greater appreciation in value than the rebalanced portfolio. But by re-balancing, one can nevertheless adhere to his risk-return tolerance level.
Common Risks Involved In Investments
All investment products are designed to make a return and are subject to different types of risks. Risk in simple words means, the chance of a financial loss. The term risk is interchangeable with uncertainty which refers variability of returns associated with a financial asset. ICICI Securities Page 67 of 194 JCP on Managing Personal Finances
Investment risks can be classified into: Systematic risk and non-systematic risk. Risk associated with the overall economy or market is termed as systematic risk. Non-systematic risk is associated with a specific firm or a company. Some of the common investment risks are:
Risks in Equity Investments
Market or economy risk: To some extent the performance of a company depends upon the economy it operates in. In a prospering economy, the companies operating in it will benefit in terms of good performance. In a slowdown, all the sectors will have a damaging impact. Economic risks are reflected in factors such as gross domestic product (GDP) growth, inflation, interest rates, etc.
Industry risk: Industrial growth is always cyclical. It goes through the infancy, expansion, maturity and stagnation stages. Shareholders will be well rewarded when they invest in growing industries, and during the maturity stage the dividends will be less forthcoming. Later, when growth starts retarding, investors may face losses. Industry-specific government regulations too can have an adverse impact on the returns on investments made therein.
Management risk: The management is the most important aspect of a company as it is the face of the enterprise and also gives direction to the course of action. Hence the quality of management has a great say on the companys performance. A change in management can have a serious impact on the policies of the company. An enterprise that can manage competition and prosper in the challenging environment will gain the most.
Business risk: Business risk is a function of the operating conditions faced by an enterprise and the variability these conditions impact the companys profits. Business risk can be both internal as well as external. Internal business risk depends on the efficiency of the company to perform within the confines of the broader environment. External business risk is the result of operating conditions brought onto it by forces beyond the control of the enterprise. ICICI Securities Page 68 of 194 JCP on Managing Personal Finances
Financial risk: Financial risk is the manner in which the enterprise conducts its financial activities. If a company borrows money for business, it has to pay interests till the complete loan is repaid. This can deplete the shareholders portions if it goes beyond a specified limit. Moreover, there can be risks of defaulting and not be able to match up to its liabilities, and as a result turn bankrupt.
Exchange rate risk: Some companies today earn significantly from exports. Any appreciation in the rate of exchange vis--vis the currency in which the exports are billed, will result in reduced earnings for the company. This can adversely affect the share price of the company.
Inflation risk: Rising prices reduces the purchasing power of the common man, resulting in a slowdown in demand in the economy, spanning across sectors. Hence the share price of a company can be severely affected since the lack of demand reduces the expected future earnings of the company.
Interest rate risk: Rising interest rates increase the cost of borrowing, resulting in an increase in prices of products, which in turn will result in a slowdown in demand. Hence a rise in interest rates can negatively affect the share price of a company.
Risks in Debt Investments
Default /credit risk: It refers to the risk of default or non-payment of periodical interest payments and principal on maturity by the issuer. This could be due to business risk or financial risk of the issuer.
Interest rate risk: It is the risk of change in market price of a fixed income security due to change in interest rate in the economy. Interest rate and market price of a fixed income security share an inverse relation. If interest rate increases, price decreases. If interest rate decreases, price increases.
ICICI Securities Page 69 of 194 JCP on Managing Personal Finances Re-investment risk: This is the risk of fall in the interest rate during the period of receipt of interest rates and at maturity. A falling interest rate will provide less lucrative re-investment opportunity of periodical interest payments and maturity amount. If Interest rate rises, reinvestment risk reduces. If Interest rate falls, reinvestment risk increases.
Purchasing power risk: This is the risk caused by the inflation. When the inflation increases, the real return on the fixed-income security decreases. Coupon on fixed income securities compensates for inflation but increasing inflation erodes the purchasing power of periodical interest payments /maturity amount.
Liquidity risk: Where a fixed income security is traded in a secondary market then the risk of it not being sold is known as liquidity risk. This may be due to: Inefficient secondary bond market or Lack of demand.
Call risk: It refers to the risk that a fixed income security may be redeemed before maturity date. This risk is due to falling interest rates and the issuer would like to replace a high cost debt for low cost debt. When a call is exercised then a call premium is paid by the issuer.
Understanding Return Concepts
Absolute Return: The absolute return or simply return is a measure of the gain or loss on an investment portfolio expressed as a percentage of invested capital.
It is calculated as: ( (End Value Beginning Value)/Beginning Value ) x 100
The rate of return is converted into percent terms by multiplying by 100.
Example: You invested Rs. 100 in a stock and it appreciated to Rs. 120. The absolute return would be: ( (120-100)/100) ) x 100 = 20%
ICICI Securities Page 70 of 194 JCP on Managing Personal Finances Annualized Return: Annualized return is a standardized measure of return on investments in which the return is computed as percent per annum (% p.a.).
It is calculated as: (End value - Beginning value)/Beginning value) x 100 x (1/ holding period of investment in years)
All annualized returns are represented as % p.a. If the p.a. is missing, it is usually a simple absolute non-annualized return.
Total Return: Investments can give returns in different forms such as interest income (debentures, bank deposits), dividend (mutual funds, equity shares) and profits on sale (capital gain on selling a house). Total return is the return computed by comparing all forms of return earned on the investment with the principal amount. Thus total return is the annualized return calculated after including all benefits from the investment. Total return can be positive as well as negative.
For example, consider an equity share of face value Rs.10, which yields a dividend of 30%. The share is purchased for Rs. 200, but sold for Rs.190 after one year. Dividends earned= 30% of Rs.10 = Rs.3; Loss on sale= 10 Total return = 3 10 = -7 on investment of 200 Rate of return % p.a. = (-7/200) x 100 = -3.5%
In this example the loss component is greater than the positive dividend earned so the total return becomes negative.
Nominal Rate of Return vs. Real Rate of Return: Suppose we invest Rs.100/- into a Fixed Deposit for 1 year at an interest rate of 7% p.a. At the end of the year, we would get Rs.107/-. This 7% here is referred to as the nominal interest rate.
ICICI Securities Page 71 of 194 JCP on Managing Personal Finances Now suppose the inflation rate is 5% for that year. If we want to buy a basket of goods now, which was costing Rs.100 in the beginning of the year, it would cost us Rs.105/-. So after factoring in inflation, our Rs.100 investment into Fixed Deposit will earn us only Rs.2/-; a real interest rate of only 2%. The relationship between the nominal interest rate, inflation and real interest rate is described by the below Fisher Equation:
r = n i Where r = Real Interest Rate; n = Nominal Interest Rate; i = Inflation Rate
The above formula can be used for low levels of inflation. For higher levels of inflation, the below formula will bring out the exact real interest rate. r = [1+n) / (1+i)] - 1 It is important for us to educate the clients to invest in instruments which will provide a higher real interest rate, which will ensure inflation not eating much into the returns being generated.
Tax Adjusted Return: Tax-adjusted return is the return earned after taxes have been paid by the investor. Since taxes actually reduce the money in the hands for an investor, it is necessary to adjust for them to get a realistic view of returns earned. Suppose an investor earns an interest of 10% on an investment of Rs.1000. If this interest is taxed at 20%, then we calculate tax adjusted return as follows: Nominal interest rate = 10% Interest received = 10% of 1000 = 100 Tax payable = 20% of 100 = 20 Net interest received= 100- 20 = 80 Post tax return = 80/1000 = 8% In general, post tax or tax adjusted return TR = NR * (1-tax rate) TR: tax adjusted return NR: nominal return Session 5: TAX PLANNING AND ESTATE PLANNING
Tax Planning
ICICI Securities Page 72 of 194 JCP on Managing Personal Finances Let us begin by understanding the meaning of tax. Tax is a fee charged by a government on a product, income or activity. There are two types of taxes direct taxes and indirect taxes. If tax is levied directly on the income or wealth of a person, then it is a direct tax e.g. income-tax. If tax is levied on the price of a good or service, then it is called an indirect tax e.g. excise duty. In the case of indirect taxes, the person paying the tax passes on the incidence to another person.
The reason for levy of taxes is that they constitute the basic source of revenue to the government. Revenue so raised is utilized for meeting the expenses of government like defense, provision of education, health-care, infrastructure facilities like roads, dams etc.
It would be nice if we could all pay our taxes with a smile, but unfortunately, this is not so! Therefore, the question arises, how to minimize our tax liabilities? The answer is - through tax planning.
Tax planning is an arrangement of financial activities in such a way that maximum tax benefits, as provided in the income-tax act are availed of. It envisages use of certain exemptions, deductions, rebates and relief provided in the act. It helps reduce tax liabilities considerably.
Tax planning is a logical analysis of a financial situation or plan from a tax perspective, to align financial goals with tax efficiency planning. The purpose of tax planning is to discover how to accomplish all of the other elements of a financial plan in the most tax-efficient manner possible. Tax planning thus allows the other elements of a financial plan to interact more effectively by minimizing tax liability, defines Investopedia.
Before we proceed further, lets take a look at some common terms that we come across in taxation.
Common Terms When It Comes To Taxation
Assessee: Assessee means a person by whom any tax or any other sum of money is payable under the Income Tax Act, 1961. It includes every person in ICICI Securities Page 73 of 194 JCP on Managing Personal Finances respect of whom any proceeding has been taken for the assessment of his income or assessment of fringe benefits. Sometimes, a person becomes assessable in respect of the income of some other persons. In such a case also, he may be considered as an assessee. This term also includes every person who is deemed to be an assessee or an assessee in default under any provision of this Act.
Assessment: This is the procedure by which the income of an assessee is determined by the Assessing Officer. It may be by way of a normal assessment or by way of reassessment of an income previously assessed.
Person: The definition of assessee leads us to the definition of person as the former is closely connected with the latter. The term person is important from another point of view also viz., the charge of income-tax is on every person.
The definition is inclusive i.e. a person includes, an individual; a Hindu Undivided Family (HUF); a company; a firm; an Association of Persons (AOP) or Body of Individuals (BOI), whether incorporated or not; a local authority, and every artificial juridical person e.g., an idol or deity.
Income: Income, in general, means a periodic monetary return which accrues or is expected to accrue regularly from definite sources. However, under the Income-tax Act, 1961, even certain incomes which do not arise regularly are treated as income for tax purposes e.g. Winnings from lotteries, crossword puzzles.
Income normally refers to revenue receipts. Capital receipts are generally not included within the scope of income. However, the Income-tax Act, 1961 has specifically included certain capital receipts within the definition of income e.g. Capital gains i.e. gains on sale of a capital asset like land.
Income means net receipts and not gross receipts. Net receipts are arrived at after deducting the expenditure incurred in connection with earning such receipts. The expenditure which can be deducted while computing income under each head is prescribed under the Income-tax Act. ICICI Securities Page 74 of 194 JCP on Managing Personal Finances
Income is taxable either on due basis or receipt basis. For computing income under the heads Profits and gains of business or profession and Income from other sources, the method of accounting regularly employed by the assessee should be considered, which can be either cash system or mercantile system.
Assessment and previous year: Income earned in a previous year is chargeable to tax in the assessment year. Previous year is the financial year, ending on 31st March, in which income has accrued/ received. Assessment year is the financial year (ending on 31st March) following the previous year. The income of the previous year is assessed during the assessment year following the previous year. For instance, income of previous year 2012-13 is assessed during 2013-14. Therefore, 2013-14 is the assessment year for assessment of income of the previous year 2012-13.
Procedure of Computation o Total Income
Income-tax is levied on an assessees total income. Such total income has to be computed as per the provisions contained in the Income-tax Act. Let us go step by step to understand the procedure of computation of total income for the purpose of levy of income-tax:
Step 1: Determination of residential status: The residential status of a person has to be determined to ascertain which income is to be included in computing the total income.
In the case of an individual, the duration for which he is present in India determines his residential status. Based on the time spent by him, he may be (a) resident and ordinarily resident, (b) resident but not ordinarily resident, or (c) non- resident.
The residential status of a person determines the taxability of the income. For e.g., income earned outside India will not be taxable in the hands of a non- resident but will be taxable in case of a resident and ordinarily resident.
ICICI Securities Page 75 of 194 JCP on Managing Personal Finances Step 2: Classification of income under different heads: The Act prescribes five heads of income. These are shown below:
Income from Salary Income from House property Income from Business or Profession Income from capital gains Income from other sources
These heads of income exhaust all possible types of income that can accrue to or be received by the tax payer. Salary, pension earned is taxable under the head Salaries. Rental income is taxable under the head Income from house property. Income derived from carrying on any business or profession is taxable under the head Profits and gains from business or profession. Profit from sale of a capital asset (like land) is taxable under the head Capital Gains. The fifth head of income is the residuary head under which income taxable under the Act, but not falling under the first four heads, will be taxed. The tax payer has to classify the income earned under the relevant head of income.
Step 3: Exclusion of income not chargeable to tax: There are certain incomes which are wholly exempt from income-tax e.g. agricultural income. These incomes have to be excluded and will not form part of Gross Total Income. Also, some incomes are partially exempt from income-tax e.g. House Rent Allowance, Education Allowance. These incomes are excluded only to the extent of the limits specified in the Act. The balance income over and above the prescribed exemption limits would enter computation of total income and have to be classified under the relevant head of income.
Step 4: Computation of income under each head: Income is to be computed in accordance with the provisions governing a particular head of income. Under each head of income, there is a charging section which defines the scope of income chargeable under that head. There are deductions and allowances prescribed under each head of income. For example, while calculating income from house property, municipal taxes and interest on loan are allowed as deduction. Similarly, deductions and allowances are prescribed under other ICICI Securities Page 76 of 194 JCP on Managing Personal Finances heads of income. These deductions etc. have to be considered before arriving at the net income chargeable under each head.
Step 5: Clubbing of income of spouse, minor child etc.: In case of individuals, income-tax is levied on a slab system on the total income. The tax system is progressive i.e. as the income increases, the applicable rate of tax increases. Some taxpayers in the higher income bracket have a tendency to divert some portion of their income to their spouse, minor child etc. to minimize their tax burden. In order to prevent such tax avoidance, clubbing provisions have been incorporated in the Act, under which income arising to certain persons (like spouse, minor child etc.) have to be included in the income of the person who has diverted his income for the purpose of computing tax liability.
Step 6: Set-off or carry forward and set-off of losses: An assessee may have different sources of income under the same head of income. He might have profit from one source and loss from the other. For instance, an assessee may have profit from his textile business and loss from his printing business. This loss can be set-off against the profits of textile business to arrive at the net income chargeable under the head Profits and gains of business or profession.
Similarly, an assessee can have loss under one head of income, say, Income from house property and profits under another head of income, say, profits and gains of business or profession. There are provisions in the Income-tax Act, 1961 for allowing inter-head adjustment in certain cases. Further, losses which cannot be set-off in the current year due to inadequacy of eligible profits can be carried forward for set-off in the subsequent years as per the provisions contained in the Act.
Step 7: Computation of Gross Total Income: The final figures of income or loss under each head of income, after allowing the deductions, allowances and other adjustments, are then aggregated, after giving effect to the provisions for clubbing of income and set-off and carry forward of losses, to arrive at the gross total income.
ICICI Securities Page 77 of 194 JCP on Managing Personal Finances Step 8: Deductions from Gross Total Income: There are deductions prescribed from Gross Total Income. (See deductions available below in detail).
Step 9: Total income: The income arrived at, after claiming the above deductions from the Gross Total Income is known as the Total Income. It is also called the Taxable Income. It should be rounded off to the nearest multiple of Rs. 10.
Step 10: Application of the rates of tax on the total income: The rates of tax for the different classes of assesses are prescribed by the Annual Finance Act.
For individuals, HUFs etc., there is a slab rate and basic exemption limit. At present, the basic exemption limit is Rs. 2,00,000 for individuals. This means that no tax is payable by individuals with total income of up to Rs. 2,00,000. Those individuals whose total income is more than Rs. 2,00,000 but less than Rs. 5,00,000 have to pay tax on their total income in excess of Rs. 2,00,000 @ 10% and so on. The highest rate is 30%, which is attracted in respect of income in excess of Rs. 10,00,000. Income Tax slabs and rates for financial Year 2013-14
1. Individual Tax Payers (men and women below 60 years) Income (Rs.) Tax rate Up to Rs 2 lakh NIL Rs 2 lakh Rs 5 lakh 10%, less Rs. 2,000 Rs 5 lakh Rs 10 lakh 20% Rs 10 lakh 1 crore 30% Above Rs 1 crore 30% + 10% surcharge
2. Senior Citizens (of 60 years but less than 80 years) Up to Rs 2.5 lakh NIL Rs 2.5 lakh to Rs 5 lakh 10%, less Rs. 2,000 Rs 5 lakh Rs 10 lakh 20% Rs 10 lakh 1 crore 30% ICICI Securities Page 78 of 194 JCP on Managing Personal Finances Above Rs 1 crore 30% + 10% surcharge
3. Very senior citizens (of 80 years and above) Up to Rs 5 lakh NIL Rs 5 lakh Rs 10 lakh 20% Rs 10 lakh 1 crore 30% Above Rs 1 crore 30% + 10% surcharge (Above rates are excluding 3% education cess, which needs to payable on you applicable tax slab)
For firms and companies, a flat rate of tax is prescribed. At present, the rate is 30% on the whole of their total income. The tax rates have to be applied on the total income to arrive at the income-tax liability.
Step 11: Surcharge: Surcharge is an additional tax payable over and above the income-tax. Surcharge is levied as a percentage of income-tax. Surcharge is applicable only in the case of companies. The rate of surcharge for domestic companies is 5% and for foreign companies is 2%, if their total income exceeds Rs. 1 crore.
Step 12: Education cess and secondary and higher education cess on income- tax: The income-tax, as increased by the surcharge, if applicable, is to be further increased by an additional surcharge called education cess@2%. The education cess on income-tax is for the purpose of providing universalized quality basic education. This is payable by all assesses who are liable to pay income-tax irrespective of their level of total income. Further, secondary and higher education cess on income-tax @1% of income-tax plus surcharge, if applicable, is leviable to fulfil the commitment of the Government to provide and finance secondary and higher education.
Step 13: Advance tax and tax deducted at source: Although the tax liability of an assessee is determined only at the end of the year, tax is required to be paid in advance in certain instalments on the basis of estimated income. In certain cases, ICICI Securities Page 79 of 194 JCP on Managing Personal Finances tax is required to be deducted at source from the income by the payer at the rates prescribed in the Act. Such deduction should be made either at the time of accrual or at the time of payment, as prescribed by the Act. For example, in the case of salary income, the obligation of the employer to deduct tax at source arises only at the time of payment of salary to the employees. Such tax deducted at source has to be remitted to the credit of the Central Government through any branch of the RBI, SBI or any authorized bank. If any tax is still due on the basis of return of income, after adjusting advance tax and tax deducted at source, the assessee has to pay such tax (called self-assessment tax) at the time of filing of the return.
Various Deductions Available Under Several Sections
SECTION 80C - PROVIDES FOR A DEDUCTION FROM THE GROSS TOTAL INCOME, OF SAVINGS IN SPECIFIED MODES OF INVESTMENTS.
Deduction under section 80C is available only to an individual or HUF. The maximum qualifying amount is Rs. 1 lakh in respect of deductions under section 80C along with sections 80CCC (in respect of contribution to approved pension fund) and 80CCD(1) (Contribution of employee-assessee to pension scheme of Central Government).
The following are the investments/contributions eligible for deduction:
(1) Premium paid on insurance on the life of the individual, spouse or child (minor or major) and in the case of HUF, any member thereof. This will include a life policy and an endowment policy. However, where the annual premium on insurance policies, other than a contract for deferred annuity, issued on or before 31.3.2012, exceeds 20% of the actual capital sum assured, only the amount of premium as does not exceed 20% will qualify for rebate.
For the purpose of calculating the actual capital sum assured under this clause,
(a) The value of any premiums agreed to be returned or
ICICI Securities Page 80 of 194 JCP on Managing Personal Finances (b) The value of any benefit by way of bonus or otherwise, over and above the sum actually assured, shall not be taken into account.
However, the deduction under section 80C for premium or other payment made on insurance policy, other than a contract for a deferred annuity, shall be restricted to the 10% of the actual sum assured, in case the insurance policy is issued on or after 1st April, 2012.
Also, Explanation to section 80C(3A) has been introduced to provide that, in respect of the life insurance policies to be issued on or after 1st April, 2012, the actual capital sum assured shall mean the minimum amount assured under the policy on happening of the insured event at any time during the term of the policy, not taking into account:
(1) The value of any premium agreed to be returned; or
(2) Any benefit by way of bonus or otherwise over and above the sum actually assured which is to be or may be received under the policy by any person.
In effect, in case the insurance policy has varied sum assured during the term of policy then the minimum of the sum assured during the life time of the policy shall be taken into consideration for calculation of the actual capital sum assured for the purpose of section 80C, in respect of life insurance policies to be issued on or after 1st April, 2012.
The following is a tabular summary of the amendments effected in section 10(10D) and section 80C:
From A.Y.2013-14 In respect of policies issued between 1.4.2003 and 31.3.2012 In respect of policies issued on or after 1.4.2012 ICICI Securities Page 81 of 194 JCP on Managing Personal Finances Exemption u/s 10(10D) Deduction u/s 80C Exemption u/s 10(10D) Deduction u/s 80C Any sum received Under a LIP including the sum allocated by way of bonus is exempt. However, exemption would not be available if the premium payable for any of the years during the term of the policy exceeds 20% of actual Capital sum Assured. Premium paid to the extent of 20% of actual capital sum assured qualifies for deduction u/s 80C. Any sum received under a LIP including the sum allocated by way of bonus is exempt. However, exemption would not be available if the premium payable for any of the years during the term of the policy exceeds 10% of minimum capital sum assured under the policy on the happening of the insured event at any time during the term of the policy Only premium Paid to the extent of 10% of minimum capital assured qualifies deduction 80C. sum for u/s
(2) Premium paid to effect and keep in force a contract for a deferred annuity on the life of the assessee and/or his or her spouse or child, provided such contract does not contain any provision for the exercise by the insured of an option to receive cash payments in lieu of the payment of the annuity.
It is pertinent to note here that a contract for a deferred annuity need not necessarily be with an insurance company. It follows therefore that such a contract can be entered into with any person.
ICICI Securities Page 82 of 194 JCP on Managing Personal Finances (3) Amount deducted by or on behalf of the Government from the salary of a Government employee for securing a deferred annuity or making provisions for his spouse or children. The excess, if any, over one-fifth of the salary is to be ignored.
(4) Contributions to any provident fund to which the Provident Funds Act, 1925 applies.
(5) Contributions made to any Provident Fund set up by the Central Government and notified in his behalf (i.e., the Public Provident Fund established under the Public Provident Fund Scheme, 1968). Such contribution can be made in the name of any persons mentioned in (1) above. The maximum limit of investment is Rs. 1,00,000 in a year.
(6) Contribution by an employee to a recognized provident fund.
(7) Contribution by an employee to an approved superannuation fund.
(8) Subscription to any such security of the Central Government or any such deposit scheme as the Central Government as may notify in the Official Gazette.
(9) Subscription to any Savings Certificates under the Government Savings Certificates Act, 1959 notified by the Central Government in the Official Gazette (i.e. National Savings Certificate (VIII Issue) issued under the Government Savings Certificates Act, 1959).
(10) Contributions in the name of any person specified in (1) above for participation in the Unit-linked Insurance Plan 1971.
(11) Contributions in the name of any person mentioned in (1) above for participation in any Unit linked Insurance Plan of the LIC Mutual Fund, referred to in section 10(23D) in this behalf.
12) Contributions to approved annuity plans of LIC (New Jeevan Dhara and New Jeevan Akshay, New Jeevan Dhara I and New Jeevan Akshay I, II and III) or any ICICI Securities Page 83 of 194 JCP on Managing Personal Finances other insurer (Tata AIG Easy Retire Annuity Plan of Tata AIG Life Insurance Company Ltd.) as the Central Government may, by notification in the Official Gazette, specify in this behalf.
(13) Subscription to any units of any mutual fund referred to in section 10(23D) or from the Administrator or the specified company under any plan formulated in accordance with such scheme notified by the Central Government;
(14) Contribution by an individual to a pension fund set up by any Mutual Fund referred to in section 10(23D) or by the Administrator or the specified company as the Central Government may specify (i.e. UTI-Retirement Benefit Pension Fund set up by the specified company referred to in section 2(h) of the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002 as a pension fund).
For the purposes of (13) and (14) above
(i) Administrator means the Administrator as referred to in clause (a) of section 2 of the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002.
(ii) Specified company means a company as referred to in clause (h) of section 2 of the Unit Trust of India (Transfer of Undertaking and Repeal) Act, 2002.
(15) Subscription to any deposit scheme or contribution to any pension fund set up by the National Housing Bank i.e., National Housing Bank (Tax Saving) Term Deposit Scheme, 2008.
(16) Subscription to any such deposit scheme of a public sector company which is engaged in providing long-term finance for construction, or purchase of houses in India for residential purposes or any such deposit scheme of any authority constituted in India by or under any law enacted either for the purpose of dealing with and satisfying the need for housing accommodation or for the purpose of planning, development or improvement of cities, towns and villages or for both. The deposit scheme should be notified by the Central Government. The Central ICICI Securities Page 84 of 194 JCP on Managing Personal Finances Government has, vide Notification No.2/2007 dated 11.1.2007, specified the public deposit scheme of HUDCO, subscription to which would qualify for deduction under section 80C.
(17) Payment of tuition fees by an individual assessee at the time of admission or thereafter to any university, college, school or other educational institutions within India for the purpose of full-time education of any two children of the individual. This benefit is only for the amount of tuition fees for full-time education and shall not include any payment towards development fees or donation or payment of similar nature and payment made for education to any institution situated outside India.
(18) Any payment made towards the cost of purchase or construction of a new residential house property. The income from such property
(i) Should be chargeable to tax under the head Income from house property;
(ii) Would have been chargeable to tax under the head Income from house property had it not been used for the assessees own residence.
The approved types of payments are as follows:
(i) Any instalment or part payment of the amount due under any self- financing or other schemes of any development authority, Housing Board or other authority engaged in the construction and sale of house property on ownership basis; or Any instalment or part payment of the amount due to any company or a cooperative society of which the assessee is a shareholder or member towards the cost of house allotted to him; or
(a) The Central Government or any State Government; (b) Any bank including a co-operative bank; (c) The Life Insurance Corporation; (d) The National Housing Bank; ICICI Securities Page 85 of 194 JCP on Managing Personal Finances (e) Any public company formed and registered in India with the main object of carrying on the business of providing long-term finance for construction or purchase of houses in India for residential purposes which is eligible for deduction under section 36(1)(viii); (f) Any company in which the public are substantially interested or any cooperative society engaged in the business of financing the construction of houses; (g) The assessees employer, where such employer is an authority or a board or a corporation or any other body established or constituted under a Central or State Act; (h) The assessees employer where such employer is a public company or public sector company or a university established by law or a college affiliated to such university or a local authority or a co-operative society.
(iv) Stamp duty, registration fee and other expenses for the purposes of transfer of such house property to the assessee.
Inadmissible payments: However, the following amounts do not qualify for rebate:
(i) Admission fee, cost of share and initial deposit which a shareholder of a company or a member of a co-operative society has to pay for becoming a shareholder or member; or
(ii) he cost of any addition or alteration or renovation or repair of the house property after the completion of the house or after the house has been occupied by the assessee or any person on his behalf or after it has been let out; or
(iii) Any expenditure in respect of which deduction is allowable under section 24.
(19) Subscription to equity shares or debentures forming part of any eligible issue of capital approved by the Board on an application made by a public company or ICICI Securities Page 86 of 194 JCP on Managing Personal Finances as subscription to any eligible issue of capital by any public financial institution in the prescribed form.
Eligible issue of capital means an issue made by a public company formed and registered in India or a public financial institution and the entire proceeds of the issue are utilised wholly and exclusively for the purposes of any business referred to in section 80-IA(4).
A lock-in period of three years is provided in respect of such equity shares or debentures.
In case of any sale or transfer of shares or debentures within three years of the date of acquisition, the aggregate amount of deductions allowed in respect of such equity shares or debentures in the previous year or years preceding the previous year in which such sale or transfer has taken place shall be deemed to be the income of the assessee of such previous year and shall be liable to tax in the assessment year relevant to such previous year.
A person shall be treated as having acquired any shares or debentures on the date on which his name is entered in relation to those shares or debentures in the register of members or of debenture-holders, as the case may be, of the public company.
(20) Subscription to any units of any mutual fund referred to in section 10(23D)] and approved by the Board on an application made by such mutual fund in the prescribed form. It is necessary that such units should be subscribed only in the eligible issue of capital of any company.
(21) Investment in term deposit.
(1) For a period of not less than five years with a scheduled bank; and
ICICI Securities Page 87 of 194 JCP on Managing Personal Finances (2) Which is in accordance with a scheme framed and notified by the Central Government in the Official Gazette now qualifies as an eligible investment for availing deduction under section 80C.
Scheduled bank means
(1) The State Bank of India constituted under the State Bank of India Act, 1955, or (2) A subsidiary bank as defined in the State Bank of India (Subsidiary Banks) Act1959,or (3) A corresponding new bank constituted under section 3 of the (a) Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, or (b) Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980, or (4) Any other bank, being a bank included in the Second Schedule to the Reserve Bank of India Act, 1934.
(22) Subscription to such bonds issued by NABARD (as the Central Government may notify in the Official Gazette).
(23) five year time deposit in an account under Post Office Time Deposit Rules, 1981; and
(24) Deposit in an account under the Senior Citizens Savings Scheme Rules, 2004.
Termination of Insurance Policy or Unit Linked Insurance Plan or transfer of House Property or withdrawal of deposit:
Where, in any previous year, an assessee:
(i) Terminates his contract of insurance referred to in (1) above, by notice to that effect or where the contract ceases to be in force by reason of not paying the premium, by not reviving the contract of insurance, -
ICICI Securities Page 88 of 194 JCP on Managing Personal Finances (a) In case of any single premium policy, within two years after the date of commencement of insurance; or (b) In any other case, before premiums have been paid for two years; or
(ii) Terminates his participation in any Unit Linked Insurance Plan referred to in (10) or (11) above, by notice to that effect or where he ceases to participate by reason of failure to pay any contribution, by not reviving his participation, before contributions in respect of such participation have been paid for five years, or
(iii) Transfers the house property referred to in (18) above, before the expiry of five years from the end of the financial year in which possession of such property is obtained by him, or receives back, whether by way of refund or otherwise, any sum specified in (18) above,
then, no deduction will be allowed to the assessee in respect of sums paid during such previous year and the total amount of deductions of income allowed in respect of the previous year or years preceding such previous year, shall be deemed to be income of the assessee of such previous year and shall be liable to tax in the assessment year relevant to such previous year.
Further, where any amount is withdrawn by the assessee from his account under the Senior Citizens Savings Scheme or under the Post Office Time Deposit Rules before the expiry of a period of 5 years from the date of its deposit, the amount so withdrawn shall be deemed to be the income of the assessee of the previous year in which the amount is withdrawn.
Accordingly, the amount so withdrawn would be chargeable to tax in the assessment year relevant to such previous year. The amount chargeable to tax would also include that part of the amount withdrawn which represents interest accrued on the deposit. However, if any part of the amount so received or withdrawn (including the amount relating to interest) has been subject to tax in any of the earlier years, such amount shall not be taxed again.
SECTION 80CCC - DEDUCTION IN RESPECT OF CONTRIBUTION TO CERTAIN PENSION FUNDS ICICI Securities Page 89 of 194 JCP on Managing Personal Finances
(i) Where an assessee, being an individual, has in the previous year paid or deposited any amount out of his income chargeable to tax to effect or keep in force a contract for any annuity plan of LIC of India or any other insurer for receiving pension from the fund referred to in section 10(23AAB), he shall be allowed a deduction in the computation of his total income.
(ii) For this purpose, the interest or bonus accrued or credited to the assessees account shall not be reckoned as contribution.
(iii) The maximum permissible deduction is Rs.1,00,000 (However, the overall limit of Rs. 1,00,000 prescribed in section 80CCE will continue to be applicable i.e. the maximum permissible deduction under sections 80C, 80CCC and 80CCD(1) put together is Rs. 1,00,000).
(iv) Where any amount standing to the credit of the assessee in a fund referred to in clause (23AAB) of section 10 in respect of which a deduction has been allowed, together with interest or bonus accrued or credited to the assessees account is received by the assessee or his nominee on account of the surrender of the annuity plan in any previous year or as pension received from the annuity plan, such amount will be deemed to be the income of the assessee or the nominee in that previous year in which such withdrawal is made or pension is received. It will be chargeable to tax as income of that previous year.
(v) Where any amount paid or deposited by the assessee has been taken into account for the purposes of this section, a deduction under section 80C shall not be allowed with reference to such amount.
SECTION 80CCD - DEDUCTION IN RESPECT OF CONTRIBUTION TO PENSION SCHEME OF CENTRAL GOVERNMENT
(i) A New Restructured Defined Contribution Pension System applicable to new entrants to Government service has been introduced. As per the scheme, it is ICICI Securities Page 90 of 194 JCP on Managing Personal Finances mandatory for persons entering the service of the Central Government on or after 1 st January, 2004, to contribute ten per cent their of salary every month towards their pension account. A matching contribution is required to be made by the Government to the said account. The benefit of this scheme is available to individuals employed by any other employer also on or after 1st January, 2004.
(ii) To give effect to the new pension scheme of the Central Government, a new section 80CCD has been inserted.
(iii) This section provides a deduction for the amount paid or deposited by an employee in his pension account subject to a maximum of 10% of his salary.
(iv)The contribution made by the Central Government or any other employer in the previous year to the said account of an employee, is allowed as a deduction in computation of the total income of the assessee. However, the deduction is restricted to 10% of the employees salary.
(v)The entire employers contribution would be included in the salary of the employee. However, deduction under section 80CCD would be restricted to 10% of salary.
(vi)This deduction is now extended also to self-employed individuals. The deduction in the case of a self-employed individual would be restricted to 10% of his gross total income in the previous year.
(vii) Further, the amount standing to the credit of the assessee in the pension account (for which deduction has already been claimed by him under this section) and accretions to such account, shall be taxed as income in the year in which such amounts are received by the assessee or his nominee on
(a) Closure of the account or (b) His opting out of the said scheme or (c) Receipt of pension from the annuity plan purchased or taken on such closure or opting out.
ICICI Securities Page 91 of 194 JCP on Managing Personal Finances (viii) However, the assessee shall be deemed not to have received any amount in the previous year if such amount is used for purchasing an annuity plan in the same previous year.
(ix) No deduction will be allowed under section 80C in respect of amounts paid or deposited by the assessee, for which deduction has been allowed under section 80CCD(1).
Limit on deductions under sections 80C, 80CCC & 80CCD(1) [Section 80CCE]
This section restricts the aggregate amount of deduction under section 80C, 80CCC and 80CCD(1) to Rs. 1 lakh. It may be noted that the employers contribution to pension scheme, allowable as deduction under section 80CCD(2) in the hands of the employee, would be outside the overall limit of Rs. 1 lakh stipulated under section 80CCE.
NEW SECTION 80CCG - ONE TIME DEDUCTION FOR INVESTMENT BY A RESIDENT INDIVIDUAL IN LISTED EQUITY SHARES AS PER NOTIFIED SCHEME
(i) In the Budget Speech, a new scheme was proposed to be introduced to encourage flow of savings in financial instruments and improve the depth of domestic capital market.
(ii) Accordingly, new section 80CCG has been introduced to provide for a one- timen deduction to a resident individual who has acquired listed equity shares in a previous year in accordance with a scheme notified by the Central Government.
(iii) The deduction would be 50% of amount invested in such equity shares or Rs. 25,000, whichever is lower. The maximum deduction of Rs. 25,000 would be available on investment of Rs. 50,000 in such listed equity shares.
(iv)The following conditions have to be satisfied for claiming the above deduction (a) The gross total income of the assessee for the relevant assessment year should be less than or equal to Rs.10 lakh. ICICI Securities Page 92 of 194 JCP on Managing Personal Finances (b) The assessee should be a new retail investor as per the requirement specified under the notified scheme. (c) The investment should be made in such listed shares as may be specified under the notified scheme. (d) The minimum lock-in period in respect of such investment is three years from the date of acquisition in accordance with the notified scheme.
In addition to the above, other conditions may also be prescribed, subject to fulfilment of which, deduction under section 80CCG can be claimed.
(v) If the individual, after having claimed such deduction, fails to comply with any of the conditions in any previous year, say, he sells the shares before three years, then, the deduction earlier allowed shall be deemed to be the income of the previous year in which he fails to comply with the condition. The income shall, accordingly, be liable to tax in the assessment year relevant to such previous year.
(vi) If deduction has been claimed and allowed under this section for any assessment year, the assessee would not be allowed any deduction under this section for any subsequent assessment year.
SECTION 80D - DEDUCTION IN RESPECT OF MEDICAL INSURANCE PREMIUM
(i) As per section 80D, in case of an individual, a deduction is allowed in respect of premium paid to effect or keep in force an insurance on the health of self, spouse and dependent children or any contribution made to the Central Government Health Scheme, up to a maximum of Rs. 15,000 in aggregate. A further deduction of Rs. 15,000 is also allowed in case the premium is paid for the health insurance taken for the health of parents.
An increased deduction of Rs. 20,000 (instead of Rs. 15,000) shall be allowed in case any of the persons mentioned above is a senior citizen i.e. an individual resident in India of the age of 60 years or more at any time during the relevant previous year. Further, deduction would be allowed only if the payment of insurance premium is made in any mode other than cash. ICICI Securities Page 93 of 194 JCP on Managing Personal Finances
(ii) Section 80D has been amended to provide that deduction to the extent of Rs. 5,000 shall be allowed in respect payment made on account of preventive health check-up of self, spouse, dependent children or parents made during the previous year. However, the said deduction of Rs. 5,000 is within the overall limit of Rs. 15,000 or Rs. 20,000, as the case may be.
(iii) In effect the maximum deduction allowable under this section in any assessment year shall be to the extent of Rs. 15,000 for self, spouse and dependent children (Rs. 20,000 in case any of the persons are senior citizen) in respect of the following payments made
(1) To effect or keep in force an insurance on the health of self, spouse or dependent children. (2) On account of contribution to the Central Government Health Scheme (3) On account of preventive health check-up of self, spouse or dependent children.
(iv) A further deduction up to Rs. 15,000 (Rs. 20,000 in case either of parents are senior citizens) is allowable (1) To effect or keep in force an insurance on the health of parents. (2) On account of preventive health check-up of parents.
(v) The maximum deduction allowable in respect of expenditure on preventive health check-up of self, spouse, dependent children and parents would be Rs. 5,000.
(vi) Further it is provided that, for claiming such deduction under section 80D, the payment can be made: (1) By any mode, including cash, in respect of any sum paid on account of preventive health check-up; 2) By any mode other than cash, in all other cases.
SECTION 80E - DEDUCTION IN RESPECT OF INTEREST LOAN TAKEN FOR HIGHER EDUCATION ICICI Securities Page 94 of 194 JCP on Managing Personal Finances
(i) Section 80E provides deduction to an individual-assessee in respect of any interest on loan paid by him in the previous year out of his income chargeable to tax.
(ii) The loan must have been taken for the purpose of pursuing his higher education or for the purpose of higher education of his or her relative i.e. spouse or children of the individual or the student for whom the individual is the legal guardian.
(iii) Higher education means any course of study (including vocational studies) pursued after passing the Senior Secondary Examination or its equivalent from any school, board or university recognised by the Central Government or State Government or local authority or by any other authority authorized by the Central Government or State Government or local authority to do so. Therefore, interest on loan taken for pursuing any course after Class XII or its equivalent, will qualify for deduction under section 80E.
(iv) The loan must have been taken from any financial institution or approved charitable institution.
(v) The deduction is allowed in computing the total income in respect of the initial assessment year (i.e. the assessment year relevant to the previous year, in which the assessee starts paying the interest on the loan) and seven assessment years immediately succeeding the initial assessment year or until the interest is paid in full by the assessee, whichever is earlier.
(vi) Approved charitable institution means an institution established for charitable purposes and approved by the prescribed authority under section 10(23C) or an institution referred to in section 80G(2)(a).
(vii) Financial institution means (1) A banking company to which the Banking Regulation Act, 1949 applies (including a bank or banking institution referred to in section 51 of the Act); or ICICI Securities Page 95 of 194 JCP on Managing Personal Finances (2) Any other financial institution which the Central Government may, by notification in the Official Gazette, specify in this behalf.
SECTION 80G - DEDUCTION IN RESPECT OF DONATIONS TO CERTAIN FUNDS, CHARITABLE INSTITUTIONS ETC.
Where an assessee pays any sum as donation to eligible funds or institutions, he is entitled to a deduction, subject to certain limitations, from the gross total income.
SECTION 80U - DEDUCTION IN THE CASE OF A PERSON WITH DISABILITY
(i) Section 80U harmonizes the criteria for defining disability as existing under the Income-tax Rules with the criteria prescribed under the Persons with Disability (Equal Opportunities, Protection of Rights and Full Participation) Act, 1995.
(ii) This section is applicable to a resident individual, who, at any time during the previous year, is certified by the medical authority to be a person with disability. A deduction of Rs. 50,000 in respect of a person with disability and Rs. 1,00,000 in respect of a person with severe disability (having disability over 80%) is allowable under this section.
(iii) The benefit of deduction under this section has also been extended to persons suffering from autism, cerebral palsy and multiple disabilities.
(iv) The assessee claiming a deduction under this section shall furnish a copy of the certificate issued by the medical authority in the form and manner, as may be prescribed, along with the return of income under section 139, in respect of the assessment year for which the deduction is claimed.
(v) Where the condition of disability requires reassessment, a fresh certificate from the medical authority shall have to be obtained after the expiry of the period mentioned on the original certificate in order to continue to claim the deduction.
SECTION 24 - DEDUCTIONS FROM INCOME FROM HOUSE PROPERTY ICICI Securities Page 96 of 194 JCP on Managing Personal Finances
Income chargeable under the head "Income from house property" shall be computed after making the following deductions, namely:
(a) A sum equal to thirty per cent of the annual value;
(b) Where the property has been acquired, constructed, repaired, renewed or reconstructed with borrowed capital, the amount of any interest payable on such capital:
Provided that in respect of property referred to in sub-section (2) of section 23, the amount of deduction shall not exceed Rs. 30,000.
Provided further that where the property referred to in the first proviso is acquired or constructed with capital borrowed on or after the 1st day of April, 1999 and such acquisition or construction is completed 77[within three years from the end of the financial year in which capital was borrowed], the amount of deduction under this clause shall not exceed Rs. 1,50,000.
As you can see, there are number of deductions/tax-saving instruments available. Which one to choose? As discussed earlier, tax planning is a coherent element of any financial plan. No financial plan is complete without tax planning. Tax planning does not mean only saving taxes. One should be able to achieve goals as well in the tax planning process. Here we look at how proper planning can take care of your taxes and at the same time help you achieve your financial goals.
Financial Goals and Taxes
Tax planning with your financial goals in perspective will make your financial planning wholesome. Let us take a look at the financial goals and the right tax- saving instruments that will aid in achieving those goals.
Insurance and tax benefits:
ICICI Securities Page 97 of 194 JCP on Managing Personal Finances Insurance is one of your most important financial goals and the most widely used tax-saving instrument. You need insurance but buying insurance mindlessly every year just to save on tax is a big drainer on your financial planning process. Your family should be able to live with the same level of comfort even when you are long gone from their lives. Insurance plays a very important role on this front.
Life insurance - A rule of thumb suggests that your life insurance should be at least 8-10 times your gross annual income. A Rs 25 lakh term cover for a 35-year- old costs just around Rs 9,500 per annum or Rs 800 per month (premiums are indicative in nature). Besides, insurance helps you counter some of the exigencies you may face. Insurance are of different types. Life insurance and general insurance are the main distinctions in insurance. With the help of life insurance you will be able to protect the financial needs of your family in case of your death or disability due to accidents. The investment in an insurance plan helps save tax under Section 80C.
Asset protection - General insurance covers various other aspects of life that includes health insurance, asset insurance, travel insurance, etc. Your house may be one your biggest asset financial as well as emotional. Hence it is very important to protect your house from being destroyed due to calamities. By securing asset insurance for your house you will be able to claim for the damages to your house. If you purchase your house with a home loan, a home insurance will help pay off the debt in case of your death or disability and thus your loved ones will not be rendered homeless. You can protect your most valuable asset, your home, by paying just Rs 5,000 per annum for a Rs 50 lakh cover (premiums are indicative in nature). This includes the structure and its contents.
Health guard - Health and wellness form an important aspect of your life. Health insurance helps you save your investment and capital in the event of a critical illness in the family. With health insurance you can also avail tax benefits of Rs 15,000 under Section 80D. If you pay for health insurance of your senior citizen parents then you can avail tax benefits of up to Rs 20,000. Ascertain if your existing health insurance, whether your own or that provided by your employer, is adequate. Remember, if your employer provides the cover it can go away with ICICI Securities Page 98 of 194 JCP on Managing Personal Finances your job. A family of 2 adults and 2 children can get a Rs 2 lakh cover for just Rs 6,300 per annum (premiums are indicative in nature).
Buying a house and tax benefits:
You may want to buy a house to stay in or as an investment option. If a loan has been availed, tax benefits can be claimed for both the principal repayment as well as the interest payment as per the Income Tax Act, 1961. Interest on borrowed capital is deductible up to Rs 150,000. These deductions are available to you under Section 24(b). In addition to this, principal repayment of the loan/capital borrowed is eligible for deduction of up to Rs 100,000 (in a financial year) under Section 80C. You and your spouse (being tax-payers with independent sources of income) can get separate tax deduction benefits with respect to the same home loan. However, it is important that the house is in your joint names. This property can also be looked at as a retirement plan the rent can help build cash flows after retirement.
Childrens education & marriage and tax benefits:
The upbringing of your children, their education and their marriage are some of the responsibilities that you cannot shy away from. These goals are typically over 8-10 years away. Hence you can look at some of the long-term plans while investing in tax-saving instruments. Childrens plans enable your child pursue their dreams, give them strength to face challenges, and the guarantee to live life to its fullest even in the face of uncertainties. Depending on the time horizon for the goal, you may invest in Public provident fund (PPF), National Savings Certificates (NSC), bank deposits or Unit linked insurance plans (ULIPs). For example: If your childs marriage is just 5-6 years away, invest in bank deposits or NSC; if your child is just 3 years of age and there is about 15 years remaining for her higher studies, invest in a PPF. Thus by saving small amounts during a year, you can help your child achieve their dreams. Besides saving, some expenses can also benefit for tax deductions. The tuition fees paid for your childs education can be used to avail deductions. However, the tuition fees here means the annual fees paid to any university or recognized educational institution; it does not include any hostel fee or mess charges or building fund donation. All these tax-saving ICICI Securities Page 99 of 194 JCP on Managing Personal Finances instruments Child plans, ULIPs, PPF, NSC, bank FD, tuition fee are deductible under Section 80C.
Retirement planning and tax benefits:
It is never too late or too early to plan for your retirement. The sooner you start the better. If your investments in tax-saving instruments can help you save up a kitty for your golden years, why not put it to the best use?
To build a Rs 1 crore corpus for retirement by the age of 60 you will need Starting at age 25 at a return of 8% - Rs 58,033 per annum. Starting at age 35 at a return of 8% - Rs 1,36,788 per annum. Starting at age 45 at a return of 8% - Rs 3,68,295 per annum.
Investing in equities is a useful way of creating wealth for the long term. Equity linked saving scheme (ELSS) helps you be invested in equities and avail tax benefits under Section 80C. Mutual funds are fast becoming a popular way to generate wealth by participating in the stock market movements. A caveat here is that the returns are market related and hence there is a risk of losing capital. But over the long term, equities have given the highest returns. If you are risk averse, you may invest in debt instruments like infrastructure bonds, NSC, PPF or Senior Citizen Savings Scheme (SCSS). You may also invest in some pension plan offered by private financial companies. Investments in all these instruments are deductible under Section 80C subject to a maximum of Rs 1 lakh. Your contribution towards employee's provident fund (EPF) also falls within the Rs 1- lakh ambit. You can also ask your organisation to deduct a higher amount towards EPF, over and above the minimum that is normally deducted from your salary.
Summing up
The tax-saving instruments are the very investments that one anyway makes and therefore they need to be integrated into the larger picture in line with your risk profile and financial goals. The tax saving is just the icing on the cake. In other words, while tax deduction is an important aspect to look at, it is more essential ICICI Securities Page 100 of 194 JCP on Managing Personal Finances to consider what you would achieve out of that investment. The purpose of the investment is more important than the investment itself. Always remember to consult a certified financial consultant to plan your taxes as well as for creating a financial plan.
Disclaimer This module is not intended to be a formal opinion of tax consequences, and, thus, may not contain a full analysis of all relevant tax authorities. The conclusions contained in this article are based on our understanding of current tax laws and published tax authorities in effect as of the date of this article, which are subject to change. If the tax laws change, the conclusions and recommendations would likewise be subject to change. I-Sec assumes no obligation to update the article for any future changes in tax law, regulations, or other interpretations and does not intend to do so.
Suggested Readings 1.Bhagwati Prasad, Law and practice of Income Tax, Navaman Prakashan, Aligarh. 2. Mahesh Chandra & S.P. Goyal, Income Tax Law and practice, Himalaya Publishing House, Delhi. 3. Vinod K. Singhania, Monica Singhania, Students Guide to Income Tax, Taxmann Publications Private Ltd. 4. Girish Ahuja & Ravi Gupta, Simplified Approach to Income Tax and Sales Tax, Sahitya Bhawan Publishers and Distributors Ltd., Agra. 5. Dinkar Pagare, Law and practice of income tax, Sultan Chand and sons. Estate Planning
You may have seen or heard of stories of families being affected by legal hurdles after the patriarch passes away. These problems occur when there is no proper inheritance and succession plan in place. A very important aspect of planning your life goals is to plan for the future and for your heirs. This is where estate planning comes in. ICICI Securities Page 101 of 194 JCP on Managing Personal Finances
Estate planning, as the name suggests, is all about creating a plan for your estate assets, including all your holdings in equity, debt, commodities, real estate, gold, and alternate investments like art, gemstones, etc. If you intend to keep your estate assets intact for the sole benefit of your heirs, you have to know how to protect these assets.
What is estate planning?
Estate planning is the process of arranging for the distribution of your asset holdings to your heirs by anticipating and avoiding different scenarios that can create a conflict among them. It attempts to eliminate uncertainties associated with planning for ones estate in the event that he/she becomes incapacitated and for when he/she is deceased. Guardians are often designated for minor children and beneficiaries in incapacity. Estate planning helps preserve the value of your estate for the benefit of your heirs by implementing proven estate and inheritance planning strategies to minimize estate settlement expenses and taxes.
Importance of estate planning
The most common misperception among people about estate planning is that they dont think they have an estate in the first place. For many, the word estate is associated only with big real estate properties and trust funds, but the reality is that your estate is anything you leave behind at death, be it a mansion or mobile home; crores of rupees or just a paltry sum. Now that you realize any of your asset holdings is indeed an estate, it is of utmost importance that you engage in some estate planning with the guidance of a professional.
What happens if there is no estate plan in place?
If you do not take steps to ensure that your estate passes on to those you want it to pass to, a judge will decide who gets what based on the intestacy laws, which are triggered when you die without a Will. A person who dies without making a will is known as intestate.
ICICI Securities Page 102 of 194 JCP on Managing Personal Finances If you have minor children, part of your estate plan will include designating who you would like to serve as guardian for them should they be orphaned If there is no Will containing a guardianship designation, then a judge will need to make the designation based on what he or she decides is in the best interests of your child.
Lets understand the consequences of dying intestate with an example:
Navi Mumbai-based Ram is in his late 40s and is struggling to live life peacefully. His father gifted most of all the belongings to his three daughters during his life time. Ram was said to get his forefathers house (valued at Rs 1 crore). After few months, his father passed away (without having an estate plan in place). Now, Ram`s three sisters are demanding a share in the house. With this, Ram will be left with 1/4th of the house. If there was an estate plan in place by his father, Ram would have got that house as per his fathers wish.
Having an estate plan in place: Benefits
Pune-based Mr. Soneji, 45 is not taking any chances. He has recognized the importance of an estate plan and has one in place. He says that he does not want his loved ones to run around to obtain what belongs to them. So he has planned his estate that specifies in detail how the assets would be divided between his heirs.
Would you like to walk follow Rams fathers footsteps or Mr. Sonejis? The prudent would choose the latter.
Remember, without estate planning a lifetime of work can be destroyed after your life. It will be a very sad experience for the surviving heirs to see a substantial shrinkage in the value of their inheritance, something that could have been avoided through estate planning.
Also, it must be noted that there is no predefined age for starting to create an estate plan. Anyone who has some asset holding in his/her name and is above the age of 18 should create one. ICICI Securities Page 103 of 194 JCP on Managing Personal Finances
How to plan? Tools of estate planning
There are different tools to take care of your assets. Wills and Trusts play important roles in the organization and preservation of your estate. A will is the cornerstone for an estate plan and deals with all matters regarding the distribution of your estate assets. Creative use of wills and trusts can not only protect the interests of your heirs, but can also help reduce the impact of taxes and probate fees.
Tool 1: Wills
Will is a written document in which an individual specifies how his wealth should be distributed or utilised after his death. In India, it is generally noticed that people refrain from creating a will and usually tend to leave the future to fate. This is a thought that should be avoided for the benefit of your heirs.
When a person dies intestate i.e. in the absence of a will, intestacy laws are triggered. Intestacy laws are not concerned with whether you want to provide different gifts to different children, based upon their special needs or other factors. Intestacy laws are not concerned with whether your surviving spouse or partner needs your estates assets in order to provide for his or her basic needs, while your surviving parents have no need for your money whatsoever. In fact, intestacy statutes dont care whether you even have a relationship with your parents or children at all. Intestacy laws also dont care about distributing your estate in a way that provides the maximum tax benefit to those who inherit your estate.
There are numerous such scenarios that might come up in the absence of a Will and that can lead to entirely unwanted, even tragic, outcomes (as we saw in Rams case noted above).
Prevailing succession laws if there is no Will in place
ICICI Securities Page 104 of 194 JCP on Managing Personal Finances The succession laws in India are so diverse and complex that it will create unnecessary hassles for your surviving heirs and the costs incurred in terms of time and money will be immense.
The law of succession in India falls within the realm of personal law. Because of this, we have many different succession laws, each purporting to reflect the diverse and differing aspirations, customs, and traditions of the community to which the statute in question applies.
You have the Hindu Succession Act, the Parsi Succession Act, and the Indian Succession Act (which applies to Christians). As far as Muslims are concerned, the law of succession falls into two broad streams, the Sharia law of succession and the Hanafi law of succession. Both these laws of succession form part of the common law of India and are recognized as having the force of law by virtue of the Sharia Laws (Application) Act.
Writing a Will is the simplest form of Estate Planning.
With a Will, you can make proper arrangement for the protecting and preservation of your assets for the benefit of your family and loved ones. It helps you reduce a lot of hassles for beneficiaries and at the same time ensures that wealth is distributed in the right hands.
Here is the sample of a will:
Sample Will
I Sri._______________________ S/o.____________________ residing at________________________________________________ aged about ________ years _________ by religion, occupation _______________ do make this my last Will and testament.
ICICI Securities Page 105 of 194 JCP on Managing Personal Finances 1. I have not made any will or other testamentary document, but if any made, I hereby revoke all previous Wills and codicils, if any and declare this to be my last Will and testament.
2. I appoint (1) Sri._______________________ S/o.____________________ residing at ________________________________________________ aged about ________ years _________ by religion, occupation _______________aged about ________ years as the executor of this Will and trustees of my estate.
3.My family consists of _____________________
4. My property consists of: (a) (b) (c)
5. I bequeath all my property in whatever form existing at the time of my death to the said executor and trustees to hold the same on trust for the benefit of my wife Smt._____________________ for her life time and till her death as herein after provided.
6. My executors and trustees shall, after spending the necessary money for the management of the said property out of the income thereof, pay the net income to my wife and the same will belong to her absolutely without liability to account for the same. My executor and trustees will also spend out of the corpus of estate such amounts as may be required by my wife for medical expenses or for pilgrimage. But my executor and trustees will not be entitled to sell my immovable property above mentioned or mortgage the same.
7. On the death of my and if she predeceases me then on my death all my estate then existing whether mentioned in this will or not, will belongs to my children, (a) ____________________ (b) ____________________ (c) ____________________ absolutely in equal shares and the trustees for the time being of the said estate under this will shall transfer the same among said children ICICI Securities Page 106 of 194 JCP on Managing Personal Finances by executing proper document or documents.
8. Provided that, if at the time of death of my wife or myself as the case may be any of the said children is a minor, the trustees shall hold the said property on trust until the youngest attains the age of majority and till then the net income of the said property will given or spend for maintenance and education of the said children.
9. My executor and trustees shall obtain probate of this will from a competent court, if required in law and shall pay all the probate duty and other expenses required for such probate and also pay as first charge all my other liabilities by way of taxes or otherwise howsoever.
10. I have made this Will out of my free Will and when I am in sound health and in good understanding and in witness thereof I have put my signature hereunder in the presence of witnesses on this _________ day of _____________ month of ______________ year.
Signed by the within named testator}
Sri. _________________________} opposite in the presence of witnesses,} TESTATOR who in presence and at his request and} in the presence of each other have put} their signature as witnesses hereunder.} 1. Sri. __________________________ Full Address: _________________ . _________________
2. Sri. __________________________ Full Address: _________________ . _________________
Source: Department of Stamps & Registration, Government of Karnataka
Can you make changes to the Will once drafted?
ICICI Securities Page 107 of 194 JCP on Managing Personal Finances Yes, you can change your will as often as you would like. You can do so by using a codicil. It is like an appendix/ a supplement to a will. It is a testamentary instrument intended to alter an already drafted will. You should use a codicil only to make small changes to a Will. Otherwise, it has the potential to complicate the interpretation of the Will. For example, if you have purchased a new asset e.g. a new car after making your will, you can add a codicil to your will mentioning who would inherit that asset.
Key points to ponder while making a will
A Will can be hand written but if possible should be typed (for legibility) It is not necessary to write it on a stamp paper or even get it registered, but its advisable to get it registered. It will cost you just Rs 200-300. It is prudent to name more than one executor to control the estate and allocate it as per your wish. The Will must be signed by you in the presence of at least two witnesses who must also sign the Will at the same time. Their full names and addresses should be given. The executor or beneficiary cannot attest the Will as a witness. The executor of the Will can also be named as a beneficiary and vice versa. Sign each page of the Will Keep your Will in a safe place Review your Will regularly to take care of changes in your financial or family circumstances.
Even when a Will exists, to actually execute it, a probate is required.
Probate of Will
Probate means copy of the will certified under the seal of a court of a competent jurisdiction. Probate of a will when granted establishes the Will from the death of the testator and renders valid all intermediate acts of the executor as such. It is ICICI Securities Page 108 of 194 JCP on Managing Personal Finances conclusive evidence of the validity and due execution of the will and of the testamentary capacity of the testator.
Where a Will was executed by a deceased, succession to his property is regulated by the provisions of the Will. If an executor is named in the Will, he has to get the Will probated as it is mandatory under section 213 of the Indian Succession Act. After obtaining probate, it is the duty of the executor to carry out the distribution of the property in accordance with the provisions of the Will. Probate can be granted only to the executor appointed under a Will as is provided under section 222. If no executor is appointed by the Will, anyone of the persons claiming a right under the Will can file a petition for obtaining letters of administration as is provided under section 219.
Probate can be granted only to the executor appointed by the will. The appointment may be express or implied by necessary implication. It cannot be granted to any person who is a minor or is of unsound mind, nor to any association of individuals unless it is a company satisfies the conditions prescribed by the rules made by the state government.
A probate differs from succession certificate. A probate is issued by the court, when a person dies testate i.e. having made a will and the executor or beneficiary applies to the court for grant of probate. In case a person has not made a will his legal heirs will have to apply to the court for grant of a succession certificate which will be given as per applicable laws of inheritance.
Case study: know here how to ensure smooth transfer of your assets through a will Passing on the baton
A perfect rainy day in July and Jignesh Parekh was busy finalizing his books just before filing his tax returns at his Grant Road office in Mumbai. In his mid-forties, the self-made businessman was chatting with Sumit, his tax consultant to explain how he had donated Rs. 1 lakh to a school and the same will bring him a tax ICICI Securities Page 109 of 194 JCP on Managing Personal Finances break. Sumit readily agreed to rework the tax calculations and finished filing the income tax online much ahead of the deadline of the exchequer.
"I like your idea of donating money to the school," said Sumit getting ready to leave the office.
"School is a necessity. I plan to build one school using money I have earned over my lifetime," Parekh said smiling at Sumit - his friend, philosopher, guide and also tax consultant.
"But have you planned for it? And how about your kids? How are you going to take care of them? God forbid, if you die before building a school how will it go through?" questioned Sumit.
For a moment Parekh was speechless. He knew that creation of wealth is difficult. But now he has realized that conserving it and passing it on to someone is a more difficult job. "I have just plans but there is no concrete step I have taken towards them," Parekh could barely manage to utter.
"If you are around I am sure you will do it the way you want to. But if you are not around, only a will can help you. If you know what you want to do with your wealth, why not consider making a will now?" suggested Sumit.
"Writing a will? That too at this moment? Do you think I am going to die tomorrow," Parekh turned to grab a glass of water. "It is not about death. It is about ensuring ones wishes, even when one is not around. If you know the way you want to dispose off your wish, better prepare a will now. In simple words, Will is a written document in which an individual specifies how his wealth should be distributed or utilized after his death. And the best time to create a will is now a time when you have wealth and know what you want to do with it. It is an extension of your asset allocation plan. It will take care of wealth allocation when you are not around," Sumit explained.
"But how do I write a will? Isnt it too complex a document to write?" Parekh asked. ICICI Securities Page 110 of 194 JCP on Managing Personal Finances
"Not really. A will can be written on a simple piece of paper. Contrary to many misconceptions, it is one of the simplest documents to write. There is no need to involve a lawyer as such while writing a will and it is not at all mandatory to register a will. You can start with a piece of paper and two witnesses. You just have to write down in clear words your wishes. Ambiguity of any type must be avoided at any cost while writing a will. Never use a word which has multiple meanings. Avoid using nick names and pet names in the will," Sumit was wearing his guides hat now.
"Sumit it will be great if you can explain it with an example. But first let us grab a cup of coffee," said Parekh. Sumit sipped coffee and started, "Assume you want to give all the gold jewellery kept in a bank locker to your younger daughter. The same should be mentioned in the will as I wish to give all the gold jewellery kept in the ABC Bank locker number LMN, Fort Branch, Mumbai, to my younger daughter Her full name- who is also known as Hansa. This means that your younger daughter will get only the gold jewellery in the specified locker. She cannot claim other articles kept in the locker if there is no such mention. She cannot also claim any other jewellery made of say Silver, if there is no mention to that effect. I wish to handover all jewellery to my younger daughter is a summary statement and opens up a possibility of disputes." "You may write about conditional transfer of wealth. For example, you may choose to give the second house to your son, if he is married at the time of your death. But in no circumstances can you introduce immoral conditions or impossible conditions for transfer of wealth," Sumit added.
"That looks good. But where should I start?" asked Parekh. "It is better to make a list of your assets and then allocate their ownership as per your wish. The will can be mainly contested on two grounds. One is the ambiguity and second is the possibility of making the testator the individuals who gives away his wealth using a will write a will using coercion or he being under a state of unsound mind. A clearly worded will does away with ambiguity. To deal with the second issue, you can choose for video shooting," explained Sumit.
ICICI Securities Page 111 of 194 JCP on Managing Personal Finances "All that is fine. But who will execute this?" asked Parekh. "Executor is a person who executes your will. Put simply, he will carry out all your directions and ensure that all your wishes are put into reality by getting the wealth transferred as per your will. Appointing an executor ensures that there will be smooth implementation of your wishes. It is better to appoint one who does not have a beneficiary interest in your wealth. In other words, do not appoint an individual who is given some wealth in your will. It is better to appoint a third party preferably a friend or a distant relative who is close to you and your family. Presence of an executor appointed by you not only ensures a quick implementation of your will but also brings down the disputes. You may choose to pay the executor for the execution of the will. But the same must be clearly mentioned in the will. The payout to such an executor should be clearly funded by the testator and the will must have a clear mention of the same. If you forget to appoint an executor, the court will appoint an administrator. The administrator appointed by a court may not be the person you would like to take care of your estate," Sumit replied.
"That sounds good. I would like to appoint you as the executor of my will. So dear Mr. Executor what else do I have to do?" said a relaxed Parekh. "A will must be duly signed by the testator and by witnesses. Never get someone to sign as a witness to a will any individual who is also a beneficiary of the will. Legacy stands lapsed to an individual or his spouse, if he is a witness to the will. This provision is the outcome of conflict of interest. The one who attests the will knows the content of the will and this can bring in conflict of interest. Put simply, the witness to your will and executor of the will should not have a beneficiary interest in the will," Sumit explained it further.
"One last thing what if I missed mentioning something in my will. Say, I forgot to write about one of my assets?" Parekh raised his eyebrows. "You can appoint a residuary legatee. He is a person who will receive whatever not specified in the will but forms a part of your wealth or wherever the legacy has lapsed. For example, if the testator has not mentioned anything about his farm house in the will, and if there is a clear mention of a residuary legatee, then such farm house will go to him. Assume, the testator has mentioned that the flat in which he stays should go to his wife after his death. But it is found out that his wife is dead on the ICICI Securities Page 112 of 194 JCP on Managing Personal Finances date of testators death. In that case, the residuary legatee will get the flat. If the testator has not mentioned a residuary legatee in his will, all such assets and wealth will go to all the legal heirs of the testator," Sumit replied.
Sumit continued, "You may choose to update your will. You can change your will as many times you want. A new will automatically cancels the previous will. Updating your will is a must to reflect changes in your wish-list. For example, you may want to give some share in your wealth to your recently born grandson or you may want to give your recently bought car to your younger son. A simple and clearly written Will will help the executor carry out the testators wishes.
So write one and relax." "Yes, I think, now is the time I should work on my Will," said Parekh thoughtfully.
Documents that work when there is no Will
Succession Certificate: For a succession certificate, one has to apply to a magistrate or a high court. A succession certificate is a document that gives authority to the person who obtains it from a competent court, to represent the deceased for the purpose of collecting debts and securities due to him or payable in his name. Along with death certificate and succession certificate most of the legacy problems pertaining to movable property are solved.
Nominations: Nomination and a death certificate works in case of bank accounts, demat accounts and other financial assets such as insurance policies. The nominee can claim the assets in such accounts where the nomination is registered with the bank. One should note that the will prevails over all the nominations. For example, if an individual has mentioned his sons name as a nominee in his life insurance policy but mentions his wife as a beneficiary of all the proceeds of the life insurance policy, then in that case his son has to ensure that the proceeds reach the wife of the deceased. Nomination thus can be at the most seen as creation of trustees for the safe keeping of assets and not necessarily transfer of ownership rights. But nominations ensure that the wealth stands transferred from the deceased. If there is no will carrying a contrary provision or a claim, the nominee gets to enjoy the asset peacefully. ICICI Securities Page 113 of 194 JCP on Managing Personal Finances
Heres a brief about nomination rules in different investment instruments: Nomination in Bank Savings Account: All bank deposits come with nomination facility. While opening a new account, there is a column for nomination in the same form and you should fill it. However if not done while account opening, it could be done later on or could be changed also. Nomination in Public Provident Fund (PPF) Account: You can nominate more than one person in your PPF account. If you want to change or cancel the nomination, you can do so by using Form F. In case of minor, no nomination could be made.
In case of death of the investor without a nomination, if the balance is up to Rs. 1 lakh, it will be settled to the legal heirs of the deceased on receipt of application in prescribed form, supported with necessary documents without production of succession certificate. If the balance is more than Rs. 1 lakh, it is necessary to produce a succession certificate. Nomination in Mutual Funds: Nomination in mutual funds could be made in the application form itself. Later, you have the provision to change the nominee, by submitting the relevant form for that. A minor can be a nominee provided a guardian is specified.
Please note that the nomination is Folio specific and if you make any further investments in the same folio, the old nomination is applicable to the new units also. Nomination in Insurance Policies:
A life insurance policy holder has the right to nominate a person or persons who shall receive the insured amount in case of death. In fact a nomination is asked at the time of proposal itself. In case of demise, the nominee needs to submit the policy document along with Death certificate, etc.
In insurance policies, to protect the rights of a wife and children or both, an MWP addendum could be used to protect the nominee rights so that a nominee is not superseded by Will or other claimants. It is protected by section 6 of Married Women's Property ICICI Securities Page 114 of 194 JCP on Managing Personal Finances
Mutual agreement: When there is no will and the deceased has left assets that are claimed by a large set of legal heirs, mutual agreements can come to the rescue. Here an agreement is reached at between all legal heirs about enjoyment of the assets, which in turn facilitates smooth transfer of ownership of assets and the peaceful enjoyment of the same. But one must understand that the mutual agreements work only with a succession certificate.
Tool 2: Trusts
A trust can be a valuable estate planning tool in many situations, but many do not know exactly how creating a trust may benefit their estate. For the more affluent, who own businesses governed by families, a trust is a vehicle that provides Act 1874 and such an addendum is usually available with all insurance companies. Nomination in Shares:
The role of nominee is different in the case of shares. Here, in case of death of the shareholder, the nominee will get the right of the shares even though he is not the legal heir. In case of shares /demat a/c, you need to ensure nomination is done in favor of the person whom you want your interest to pass on.
As per the Companies Act, nomination supersedes Will. So, the nominee in your share investment will become the absolute owner after your demise. ICICI Securities Page 115 of 194 JCP on Managing Personal Finances effective and hassle-free wealth management, asset protection and tax efficiency. First, creating a trust involves several people:
Settlor: The person who has the trust created. Trustee: A person or business that manages the trust property for the benefit of the beneficiary. Beneficiary: The person named within the trust documents that will benefit from the trust.
A trust is simply a legal arrangement in which the settlor transfers ownership of property to the trust, the named trustee then manages and controls the assets for the benefit of the named beneficiary. A living trust is a trust that is created while the settlor is still living, and in that case, they may also be the trustee as well as the beneficiary until a triggering event, such as their incapacitation or death, after which named successors take over. This allows a living trust to also act as a mechanism for managing finances in the event you can no longer manage them on your own.
Assets that can be transferred and owned by a trust include real estate, stocks, bonds, valuable personal property and businesses. A trust, in relation to an immovable property, must be in writing and registered.
A trust structure comes with certain inherent advantages. A trust provides the flexibility to be set up in more than one form or in hybrid forms as per the requirement. A trust can be either private or public. A private trust is a trust generally for the convenience and support of individuals of families. Trust can be structured as revocable or irrevocable.
A revocable trust can enable the settlor to exercise control over the property but can be prone to clubbing provisions under the tax laws. An irrevocable trust can provide safeguard against future creditor claims on the assets in case of bankruptcy, since the settlor ceases to have the title to the trust property, yet at the same time enable indirect control over the property through terms of the trust deed. This is one the prime benefits of a trust structure which allows for preservation of your wealth. ICICI Securities Page 116 of 194 JCP on Managing Personal Finances
Summary
Estate planning is a key component of financial planning. It is a mechanism by which you can preserve your asset holdings and pass it on to your heirs and thus meet the needs and goals of your family, while taking into account current estate tax law and other variables. There is no specific age to create an estate plan and anyone who has some asset holding in his/her name should create one. The use of wills and trusts in the right manner enables you in building an estate plan. It is essential that you consult an expert professional in estate planning to take the appropriate steps in creating a plan that suits your needs and desires.
For Further Reading, you may refer: www.vakilno1.com www.indlaw.com www.universaltrustees.co.in
SESSION 6: ASSET CLASSES & PRODUCT SUITABILITY AND GOAL PLANNING Asset Classes & Product Suitability Asset classes refer to the various assets that are available for investment. Each asset class has different risk and return characteristics, and functions in a unique ICICI Securities Page 117 of 194 JCP on Managing Personal Finances way in different market environment. Depending on the risk appetite and investment horizon of an individual, he can choose to invest in a combination of asset classes to optimize his returns. Asset classes include a group of securities with varying degrees of risk. These are: Equity, Fixed Income/Debt, Cash and cash equivalents, Real Estate, Gold and Other Alternative Assets. Under these asset classes, there are several investment products/avenues. This section describes some of these investment products in detail.
A. Products/Avenues under Equity Asset Class Equity (also known as a stock or share) is a portion of the ownership of a company. A share in a corporation gives the owner of the stock a stake in the company and its profits Risk level and potential return is high in this asset class. Liquidity is also high when compared to other asset classes. Long term capital gains (held for more than 1 year) are tax-free. Short term capital gains are taxed at 15 per cent. You can invest directly in equities (individual companies) and could also choose to invest in equity mutual fund schemes. 1. Direct equity/shares Investment products/ Avenues under different asset classes Equity Fixed Income/Debt Cash and cash equivalents Real Estate Gold Alternative Assets Direct equity, Mutual funds (MFs) FDs, Debt MFs, Bonds, small saving schemes, etc. T-Bills, Money market mutual funds, etc. Buying land/flats, Realty MFs, REITs, etc. Buying physical gold, Gold ETFs, etc.
PMS, structured products, art, antiques, etc. ICICI Securities Page 118 of 194 JCP on Managing Personal Finances Equity shares or stocks refer to what a company issues to its owners and which denotes their ownership of the companys business. Investment in shares of companies is investing in equities. Stocks can be bought/sold from the exchanges (secondary market) or via IPOs Initial Public Offerings (primary market). Stocks are the best long-term investment options wherein the market volatility and the resultant risk of losses, if given enough time, is mitigated by the general upward momentum of the economy. A stock is a share in the ownership of a company. At some point every company needs to raise money for its functioning. For this, companies can either borrow it from somebody or raise it by selling part of the company. This is termed as issuing stock or a share. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO). Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful. As you acquire more stocks, your ownership stake in the company becomes greater. Sometimes different words like shares, equity, stocks, etc., are used. A stock is listed on an index, like National Stock Exchange (NSE) or Bombay Stock Exchange (BSE). An index is basically an indicator that gives you a general idea about whether prices of most of the stocks have gone up or down. A stock market is an electronic platform where investors come together to buy and sell their equity shares. Like any other market, here the price of an equity share gets decided upon on a continuous basis, depending on the factors of demand and supply. Stock prices change every day because of market forces of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up, and conversely if there are many sellers then the price goes down. There are two streams of revenue generation from equity investment Dividend and Growth. Periodic payments made out of the company's profits are termed as dividends. The price of a stock appreciates commensurate to the growth posted by the company resulting in capital appreciation. 2. Equity mutual funds ICICI Securities Page 119 of 194 JCP on Managing Personal Finances A mutual fund is a trust that pools together the savings of individuals, and invests it in a variety of equity and debt instruments, according to a specific investment objective as established by the fund. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unit holders. The returns generated by the mutual fund are shared with the investors in proportion to their investments. A mutual fund can generate returns in two ways: A security can pay dividends or interest to the fund (i.e. regular income) or a security can rise in value (i.e. capital appreciation). A fund can also lose money and drop in value. Equity mutual funds are one type of mutual funds and invest a major chunk of the portfolio in shares. Equity funds, also known as growth funds, primarily look for growth of capital with secondary emphasis on dividend. Such funds invest in shares with a potential for growth and capital appreciation. Growth funds generally incur higher risks in an effort to secure more pronounced growth. These are ideal for investors having a long-term investment horizon seeking appreciation over a period of time. Within equity funds, there are various sub-categories, such as equity diversified funds, sectoral funds, index funds and tax-saving funds. Equity diversified funds which invest across different sectors and market capitalizations such as large-cap, mid-cap, and small-cap to achieve capital appreciation. Specialty or sector funds invest in securities of a specific industry or sector of the economy such as such as technology, infrastructure, banking, pharmaceuticals etc. The funds enable investors to diversify holdings among many companies within an industry, a more conservative approach than investing directly in one particular company. These funds are ideal for investors who have already decided to invest in a particular sector or segment. Index funds replicate the portfolio of a particular index such as SENSEX, NIFTY, etc. Their portfolios consist of only those stocks that constitute the index. The percentage of each stock to the total holding is identical to the stocks index weight age. And hence, the returns from such schemes are more or less ICICI Securities Page 120 of 194 JCP on Managing Personal Finances equivalent to those of the Index. These are ideal for investors who are satisfied with a return approximately equal to that of an index. Tax-saving funds or equity-linked saving schemes (ELSS) are similar to equity diversified funds but with tax benefits under Section 80C and a lock-in period of three years. B. Products/Avenues under Debt Asset Class Debt instruments are types of fixed-income avenues that provide stability to your portfolio with indicative rate of return. Investors with low-to-moderate risk appetite, looking to meet their short-to-medium term objectives can consider investing in these instruments. There is wide belief that debt avenues are risk-free instruments. However, thats not the case. No doubt, these instruments offer assured returns, but there are some inherent risks associated with them. Some of these risks are 1. Bank and corporate fixed deposits (FDs) In India, bank fixed deposits have been the default choice for many investors for their noticeable reasons i.e. safety of capital and lack of market risk. Especially when interest rates are higher levels, many rush to park their funds with bank FDs. Of late, corporate FDs also have caught the attention of many on back of their higher returns as compare to bank deposits. But still, development of corporate FDs among retail investors is at nascent stage. Interest rates offered by corporate FDs range between 9-10.50% p.a. Some companies offer interest rates as high as 12% p.a. also. You can choose interest frequency across monthly, quarterly, bi- annual and annual cumulative deposits. Liquidity is high as most of the issuers offer 75% of the investment amount as loan at 2% over the interest rate on the deposit, as well as a pre-mature withdrawal option. However, one should be careful when opting for corporate FDs. One should check the fundamentals of the issuer and credit ratings of schemes offered by ICICI Securities Page 121 of 194 JCP on Managing Personal Finances them and should opt for schemes that have higher credit ratings such as AAA or AA+. 2. Debt mutual funds The most effective option under asset class is debt mutual funds. Debt funds are something suitable for almost all types of investors as there are varieties of schemes available under debt funds. The main objective of these funds is to generate steady returns while preserving your capital. It helps bring stability to your portfolio. These are best suited for the medium to long-term investors who are risk-averse and seek capital preservation and are also more tax efficient. Types of debt mutual funds Gilt funds: Invest in government securities. Investors looking for higher level of safety and reasonable rate of return can consider it. Income funds: Invest majority of amount in liquid, fixed income securities. Investors looking for idyllic debt-oriented schemes for short-term horizon can consider income funds. Short term funds: Invest in short maturity debt and money market securities for time horizon from 3 months to 6 months. Investors with short (3 to 6 months) time horizon and those looking for funds that seeks to provide returns linked to fixed income markets, without taking significant risk. Liquid funds: Also known as money market schemes provide easy liquidity and preservation of capital with time horizon of 1 day to 3 months. Ultra short term funds: Earlier known as liquid plus funds provide easy liquidity and preservation of capital with time horizon of few months to 1 year. Dynamic bond funds: Dynamic bond funds aim to actively manage a portfolio of debt as well as money market instruments so as to provide reasonable returns and liquidity. Floating rate funds: Floating rate funds invest into floating rate debt securities. Most of the debt securities in this type of fund mature within a year. It invests ICICI Securities Page 122 of 194 JCP on Managing Personal Finances 65% to 100% of corpus into floating rate instruments and the rest in other debt securities. Fixed Maturity Plans (FMP): FMPs primarily invest in bonds, corporate debentures, government securities and money market instruments depending upon the tenure of the scheme for time horizon of minimum 30 days to maximum of 1 year; very rarely it comes with the tenure of more than one year. Investors with short term horizon can consider them. Monthly Income Plans (MIPs): MIPs invests the major chunk of funds (at least 80%) into fixed income securities like commercial papers, (CPs), government securities, corporate bonds, and the like, while the remainder is invested into equities. Investors who prefer a dominant debt allocation and like equity exposure to be in large liquid diversified stocks can consider investing in MIPs. There are plethoras of options under debt mutual funds. One should select the funds based on ones financial goals and time horizon. For example: If someone needs funds to meet ultra short-term goals say 3 to 12 months, he may invest in short-term/ultra-short term funds. If you are looking to park money for little longer term, say 15 to 18 months, gilt or income funds can be looked upon. 3. Small saving schemes Small saving schemes offered by the government of India such as EPF, PPF, POMIS, NSC, SSC, etc. form a part of debt instruments. Employees provident fund (EPF) EPF is a good tool to build a retirement corpus.
Your contributions towards EPF are eligible for deduction under section 80C (maximum limit: Rs. 1 lakh). The current interest rate for EPF is at 8.5%. Public Provident Fund (PPF) Account Ideal investment option for both salaried as well as self employed classes. Non-Resident Indians (NRIs) are not eligible. ICICI Securities Page 123 of 194 JCP on Managing Personal Finances Investment up to Rs. 1,00,000 per annum qualifies for Income Tax Rebate under section 80 C of IT Act. The rate of interest on the subscriptions made to the fund on or after 01.12.2011 and balances at credit of the subscriber in the existing PPF account shall bear interest at the rate of eight point seven per cent (8.70%) per annum. Loan facility available from 3rd financial year up to 5th financial year. The rate of interest charged on loan taken by the subscriber of a PPF account on or after 01.12.2011 shall be 2% p.a. However, the rate of interest of 1% p.a. shall continue to be charged on the loans already taken or taken up to 30.11.2011. Withdrawal permitted from 6th financial year. Free from court attachment. An individual cannot invest on behalf of HUF (Hindu Undivided Family) or Association of persons. Type of Account Minimum limit Maximum limit Public Provident Fund(Individual account on his behalf or on behalf of minor of whom he is the guardian) RS. 500 in a financial year RS. 1,00,000 in a financial year Post Office Monthly Income Scheme (MIS) Account Safe & sure way to get a regular monthly income. Specially suited for retired employees/ Senior Citizens or any one with high sum for investment. Rate of interest 8.40%. Maturity Period - Five Years. No Bonus on Maturity w.e.f. 01.12.2011. Auto credit facility to savings bank (SB) Account. Type of Account Minimum limit Maximum limit Single Rs. 1500 Rs. 4.5 lakhs Joint Rs. 1500 Rs. 9 lakhs ICICI Securities Page 124 of 194 JCP on Managing Personal Finances Above scheme operates automatically, if you open a saving bank account and give a request for automatic transfer of Monthly Income Scheme interest to Recurring Deposit through Saving Bank account. National Savings Certificates (NSC) NSC VIII Issue Scheme specially designed for Government employees, Businessmen and other salaried classes who are Income Tax assesses. No maximum limit for investment. No Tax deduction at source. Certificates can be kept as collateral security to get loan from banks. Investment up to RS. 1,00,000 per annum qualifies for IT Rebate under section 80C of Income Tax Act. Trust and HUF cannot invest. Rate of interest 8.50%. Maturity value of a certificate of Rs.100 purchased on or after 1.4.2012 shall be Rs. 151.62 after 5 years. NSC IX Issue No maximum limit for investment. Rs. 100 grows to Rs. 234.35 after 10 years. Minimum Rs. 100 No maximum limit available in denominations of Rs. 100, 500, 1000, 5000 & Rs. 10,000. A single holder type certificate can be purchased by an adult for himself or on behalf of a minor or to a minor. Rate of interest 8.80%. Maturity value of a certificate of Rs.100 purchased on or after 1.4.2012 shall be Rs. 236.60 after 10 years. Senior Citizen Savings Scheme (SCSS) Account A new avenue of investment and return for Senior Citizen. The account may be opened by an individual: 1. Who has attained age of 60 years or above on the date of opening of the account? 2. Who has attained the age 55 years or more but less than 60 years and has retired under a Voluntary Retirement Scheme or a Special ICICI Securities Page 125 of 194 JCP on Managing Personal Finances Voluntary Retirement Scheme on the date of opening of the account within three months from the date of retirement. 3. No age limit for the retired personnel of Defence services provided they fulfil other specified conditions. The account may be opened in individual capacity or jointly with spouse. Non-resident Indians (NRIs) and Hindu Undivided Family (HUF) are not eligible to open an account. The individual may open one or more account in the multiple of Rs.1000, subject to a maximum limit of Rs.15 lakh. No withdrawal shall be permitted before the expiry of a period of five years from the date of opening of the account. The depositor may extend the account for a further period of 3 years. Premature closure of account is permitted: 1. After one year but before 2 years on deduction of 1 % of the deposit. 2. After 2 years but before date of maturity on deduction of 1% of the deposit: Premature closure allowed after three years. In case of death of the depositor before maturity, the account shall be closed and deposit refunded without any deduction along with interest. Interest @ 9.20% per annum from the date of deposit on quarterly basis. Interest can be automatically credited to savings account provided both the accounts stand in the same post office. Interest rounded off to the nearest multiple of rupee one.
Post Maturity Interest at the rate applicable to the deposits under Post Office Savings Accounts from time to time is admissible for the period beyond maturity. Nomination facility is available in the Scheme. The investment under this scheme qualifies for the benefit of Section 80C of the Income Tax Act, 1961 from 1.4.2007. ICICI Securities Page 126 of 194 JCP on Managing Personal Finances Monthly Income Scheme (MIS) and Senior Citizen Saving Scheme (SCSS) are the best for Senior Citizens who desire monthly/quarterly interest. Invest in MIS / SCSS and transfer interest into RD account through SB account through written request and earn a combined interest of 10.5 % (approx.). This is the safest investment option for the Senior Citizens. Post Office Savings Account Any individual can open an account. Cheque facility available. Group Account, Institutional Account, other Accounts like Security Deposit account & Official Capacity account are not permissible. Rate of interest 4% per annum. Post office Time Deposit Account Any individual (a single adult or two adults jointly) can open an account. Group Accounts, Institutional Accounts and Misc. account not permissible. Trust, Regimental Fund or Welfare Fund not permissible to invest. 1 Year, 2 Year, 3 Year and 5 Year Time Deposit can be opened. In case of premature closure of 1 year, 2 Year, 3 Year or 5 Year account on or after 01.12.2011, if the deposit is withdrawn after 6 months but before the expiry of one year from the date of deposit, simple interest at the rate applicable to from time to time to post office savings account shall be payable. In case of premature closure of 2 year, 3 year or 5 year account on or after 01.12.2011, if the deposit is withdrawn after the expiry of one year from the date of deposit, interest on such deposits shall be calculated at the rate, which shall be one per cent less than the rate specified for a period of deposit of 1 year, 2 year or 3 years as mentioned in the concerned table given under Rule 7 of Post office Time Deposit Rules. Rate of interest - 8.20%, 8.20%, 8.30%, 8.40% compounded quarterly for 1,2,3 & 5 years TD account respectively. The investment in the case of 5 years TD qualify for the benefit of Section 80C of the Income Tax Act, 1961 from 1.4.2007. ICICI Securities Page 127 of 194 JCP on Managing Personal Finances Type of Account Minimum Deposit Maximum Deposit 1,2,3 & 5 Year TD Rs.200 and in multiples of Rs. 200 thereafter No limit. 4. Non-convertible debentures (NCDs) NCDs are debt investment instruments that offer high returns with moderate risk while giving you the flexibility of choosing between short and long tenures. An NCD is a fixed-income debt paper issued by a company. In other words, the issuer agrees to pay a fixed interest on your investment. As the name suggests, these debentures cannot be converted into shares of the issuing company like convertible debentures where investors have the option of getting shares in the issuing company on conversion. NCDs have a fixed coupon or interest which is paid to the holder of the instrument at maturity. If you sell an NCD in the secondary market when the interest rate is higher than that being offered by the debenture, your return will be less or even negative as the buyer will pay only that amount which allows him to get the return equal to the prevailing market rate. If the interest rate goes down, your effective return will be higher than that being offered on the NCD. Apart from the risk of lower return or loss of capital, there is the risk of default by the company even though the chances are low as most of the firms are under supervision of the RBI and SEBI. An NCD can be both secured as well as unsecured. For secured debentures, which are backed by assets, in case the issuer is not able to fulfill its obligation, the assets are liquidated to repay the investors holding the debentures. Secured NCDs offer lower interest rates compared with unsecured ones. If you want a regular income from NCDs, you can pick those that pay interest on a monthly, quarterly or annual basis. If you just want to grow your wealth, you can opt for cumulative option where the interest earned is reinvested and paid at maturity. For the purpose of tax, interest is added to an investors income and taxed at marginal rate of tax. With many companies expected to come to market with these instruments, you will have options. Investors with high risk appetite can invest in NCD with five-year horizon to pocket higher coupon rate and a possibility to participate in capital appreciation before maturity, if rates fall. But a ICICI Securities Page 128 of 194 JCP on Managing Personal Finances caveat here, NCDs may not be liquid on stock exchanges, and hence invest in them only with a long-term investment view. 5. Bonds The main types of bonds are zero coupon bond, convertible bond and treasury bills. Zero coupon bonds: A zero-coupon bond is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest payments, or have so-called coupons, hence the term zero- coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the discounted price of the bond and its par (or redemption) value. For example, company ABC Ltd issues bonds having face value and redemption value (value at maturity which the company pays back the investor) of Rs 100. If the bonds are issued at discount at Rs 80 and will be redeemed on maturity, the investor gains Rs 20, the difference between the redemption value and face value. Convertible bonds: Convertible bonds are those types of bonds that offer the customer the option to convert the bond into equity shares at a fixed price after a certain fixed period from the date of issuance. For example, company ABC Ltd can issue convertible bonds of face value Rs 100, offering the option to the investor of converting it into 10 equity shares at a price of Rs 10 per share after 5 years from the date of allotments of the bonds. 6. National Pension system (NPS)
NPS is a defined-contribution product, where your contributions grow and accumulate over the years, depending on the returns earned on the investment made. When you retire, you will be able to use these savings to take care of the expenses post-retirement.
Any citizen of India, whether resident or non-resident, who is in the age bracket of 18-60 years, can subscribe to this product.
ICICI Securities Page 129 of 194 JCP on Managing Personal Finances NPS begins with a mandatory Tier I account, a non-withdraw-able account, which helps you save regularly to build your pension corpus. A Tier II account is like a voluntary savings account, which offers withdrawal facility.
The minimum annual contribution for Tier I account is Rs.6000 (with a minimum monthly contribution of Rs.500). For Tier II account, there is a minimum contribution amount of Rs.250 and the account holder should have minimum balance of Rs.2000 at the end of financial year. There is no upper cap on the contributions for both the NPS accounts.
In case, the said amount is not contributed, except for the year in which the NPS account is opened, the account gets marked as dormant. The same can be re- activated by bringing in the un-contributed amount and a penalty of Rs.100 per year.
NPS is a long-term product. Your savings get accumulated till the age of 60. After you turn 60, you get up to 60% in your hands and the remaining goes into buying annuity to ensure regular payment. Before the age of 60, you can withdraw 20% and rest has to be annuitized. This product discourages early withdrawals, which is crucial for building pension corpus.
NPS is perhaps the most flexible retirement investment option. You can choose your own asset allocation and investment choices as well as the fund manager (from the six designated pension fund managers).
With NPS, you are free to decide as to how your pension wealth is to be invested across three asset classes:
E: Equity, C: Corporate bonds or fixed-income securities other than government securities, and G: Government securities
You can invest in NPS in two ways: ICICI Securities Page 130 of 194 JCP on Managing Personal Finances
Active choice: Here you can specify the investment and allocation pattern among three asset classes E, C and G. Note, a maximum of 50 per cent only is allowed to invest in E (equity) class.
Auto choice: Under this option, the discretion of asset allocation pattern rests with the pension fund manager based on your age. Up to 35 years, 50% is allocated towards equity, 30% in corporate bonds, and 20% in government securities. As the age of subscriber increases, the allocation-mix gradually increases towards fixed income and government securities and decreases towards equity. This gives stability to your portfolio as you near the retirement age.
You can either choose an active option or an auto option. You can also change the investment option from active to auto and vice a versa, once in a financial year. You also have the liberty to switch your pension fund manager if you are not satisfied with the performance of your fund manager, once in a financial year.
What makes NPS an attractive pension product is its low cost and flexibility.
As you can open two accounts for NPS Tier I and Tier II, it gives the most desirable flexibility. You can maintain Tier I account with minimum yearly contribution and invest more in Tier II (having the option of withdrawals). At the age of 60, you can take a call of either transfer full/part of the funds from NPS Tier II to NPS Tier I or you may continue to hold the funds in NPS Tier II account and withdraw the same before or on attending the age of 70. This gives NPS an edge over other retirement products.
Coming to the cost and charges, NPS is perhaps the worlds lowest cost pension scheme. The point of presence (POP) charges for initial registration charges are Rs. 100 with contribution charges (at the time of initial/subsequent) of 0.25 % of the amount subscribed, subject to minimum of Rs. 20 and maximum of Rs. 25,000 plus service tax. POP also provides non-financial services (viz. change/registration of nominee, change of pension fund manager, etc.), for which they are allowed to charge Rs.20 plus applicable service charges. ICICI Securities Page 131 of 194 JCP on Managing Personal Finances
The Central Record-Keeping Agency (CRA) charges include Rs 50 for permanent retirement account (PRA) opening, Rs 190 for annual PRA maintenance charges, Rs. 4 per transaction.
The custodian charge (On asset value in custody) includes 0.0075% p.a. for Electronic segment & 0.05% p.a. for Physical segment and fund management charge of 0.0009% of the fund value per annum.
Apart from its low-cost and flexibility benefits, NPS is also a safe product, strongly regulated by PFRDA under its strict guidelines. You can invest in and maintain records online. All transactions can be tracked online through CRA system. You can check fund and contribution status through CRA website.
Further, you can operate your NPS account from anywhere in the country with the help of your Permanent Retirement Account Number (PRAN) and this number remains the same even if you change jobs or location.
Though NPS scores well in terms of cost and flexibility, it loses some shine when it comes to taxability.
At present, the contributions get tax benefit under Section 80C. However, the withdrawals at maturity are taxable as per income tax slab. However, under DTC, NPS is proposed to have EEE (exempt, exempt, exempt) tax regime, in sync with EPF and PPF, which could make it the best product for pension planning.
C. Products/avenues under Cash Asset Class These are highly liquid and safe instruments which can be easily converted into cash, treasury bills and money market funds are a couple of examples for cash equivalents. 1. Treasury bills (T-Bills) ICICI Securities Page 132 of 194 JCP on Managing Personal Finances Treasury bills are short term bonds, with maturity of one year or less, issued by the government. They are promissory notes issued at discount and for a fixed period. Treasury bills are issued by RBI and sold through fortnightly or monthly auctions at varying discount rate depending upon the bids. 2. Money Market Funds/Liquid Funds For the cautious investor, these funds provide a very high stability of principal while seeking a moderate to high current income. They invest in highly liquid, virtually risk-free, short-term debt securities of agencies of the Indian Government, banks and corporations and Treasury Bills. Because of their short- term investments, money market mutual funds are able to keep a virtually constant unit price; only the yield fluctuates. Therefore, they are an attractive alternative to bank accounts. With yields that are generally competitive with - and usually higher than -- yields on bank savings account, they offer several advantages. Money can be withdrawn any time without penalty. Although not insured, money market funds invest only in highly liquid, short-term, top-rated money market instruments. Money market funds are suitable for investors who want high stability of principal and current income with immediate liquidity. D. Products/Avenues under Real Estate Asset Class Avenues under real estate asset class can be divided into two parts: 1. Direct Investment and 2. Indirect Investment. 1. Direct Investment Historically, Indians have preferred direct way of investing in real estate (buying physical property land, flats/apartments, commercial store, etc). This route offers some of the very best features, including a stream of rental income, potential for capital appreciation, ability to hedge inflation and diversification. Returns: The returns on property investments have been rather spectacular in India. These have largely been driven by real demand though speculation also drives the return. The returns are also magnified because of longer holding periods in real estate, unlike in equities, which being the most liquid asset class, sometimes investments are not held for longer periods. Further, the ability to ICICI Securities Page 133 of 194 JCP on Managing Personal Finances leverage, i.e. taking loan means that while you have invested 20% as your own money, the gain that accrues to you is on the entire 100% of the investment. The returns in real estate depend on the location of the property and demand/supply situation in the city or area. Therefore, assigning a value to the property based on average values may not be correct. You need to have at least 5-year horizon for investing in real estate. For short- term investments, it is purely speculative and one needs to be careful. Risks: Direct investment in property has specific risks. First, as investment in this asset class can be large, it can destabilize your portfolio. Diversifying within real estate (including indirect ways listed below) could help reduce the risk. Liquidity is another risk. A panic sell can drastically bring down the returns. And this can get amplified if the markets are down or the property markets are low. Though in India we havent seen any crash in real estate markets, many developed countries have seen it. For instance, the crash of Japanese asset price bubble from 1990 on has been very damaging to the Japanese economy. The United States, on the other hand, saw housing prices peaked in early 2006, started to decline in 2006 and 2007, and reached new lows in 2012. (Source: Wikipedia). It is extremely difficult to know why or when a country can go through phases of bubble and burst. Hence, it is important that you consider investing into real estate only after analyzing your personal financial profile. Overleveraging is also the risk. Investing in property by taking a mortgage loan can amplify the returns, but can also do the same if the markets go down. For instance, you find a very good deal, and decide to go over-leverage. Say after a period of time, real estate market gets caught into a down cycle (as it moves in cycles), chances are you may lose your money. Further, as investing in real estate is a big-ticket item, it is important that before investing you have a clear picture of your objectives. If your objective is to earn capital gains, a residential property may suit you better as appreciation in property prices are better. On the other hand, if you are looking for a regular ICICI Securities Page 134 of 194 JCP on Managing Personal Finances income, a commercial property may prove to be the better option as it generally carries higher rental yield of ~ 7-8% annually as compared to a 4-5% in case of residential property. Investing directly in real estate requires more time and effort. Its a long process that involves identifying a good location with growth potential, looking for a property, carrying our due diligence, paper work, etc. To avoid these hassles, you may look at some of the indirect ways of investing in real estate listed below: 2. Indirect Investments a) Realty PE funds: In a realty private equity (PE) fund, you just need to put in your money. The rest is taken care of by the fund. These funds typically have tenure of 5-8 years. The returns from these funds depend on the performance of broader real estate market. You can generally expect an average annualised return of 12-15% over the life of the fund. These funds are largely suitable for high net-worth individuals (HNIs) as the minimum ticket size is Rs 1 crore. ICICI Venture, Tata Realty and Infrastructure, Indiareit Fund Advisors, HDFC Real Estate Fund, ASK Property Investment Advisors and Kotak Realty Fund are some of the PE funds in India. b) Realty PMS: Portfolio Management Service (PMS), on the other hand, is a collective pool of investments handled by the portfolio manager. Through PMS, you can get an exposure to a variety of residential and commercial properties such as retail, office spaces and warehouses. It offers much greater diversification as the portfolio manager under PMS can spread the risk over a number of properties, instead of investing in a single property. The profits made on sale are then shared among the investors. This option is suitable for retail investors as the minimum ticket size is Rs 25 lakh. However, in some cases, it is Rs 1crore, or even more, depending on the PMS. c) Real Estate Investment Trusts (REITs): A Real Estate Investment Trust is a company that buys, develops, manages and/or sells real estate assets. REITs allow you to invest in a professionally-managed portfolio of real estate properties. REITs can be classified as equity REIT (investing in properties), mortgage REITs (providing direct debt finance) and hybrid REITs (mix of equity and mortgage). ICICI Securities Page 135 of 194 JCP on Managing Personal Finances An equity REIT typically pools money from various investors to acquire commercial real estate and manages it. The rent collected is the income generated by REIT. REITs are very popular in the developed nations, especially in US, UK, Australia, Japan and Singapore. In India, the concept is yet to take off. d) Real Estate Mutual Funds: A real estate mutual fund (REMF) functions like any other mutual fund. Instead of investing in equities or fixed-income securities, an REMF invests directly in property or indirectly in the equity of real estate companies. There are no pure real estate mutual fund schemes available in India as such. The 10th Five-Year Plan ending in 2007 had proposed that SEBI (Securities and Exchange Board of India) would regulate the real estate mutual funds in India. SEBI then introduced brief guidelines for the same in 2008. However, no consensus has been reached on the valuation norms to be followed. Lack of expertise in valuing the individual land parcels or projects along with inadequate supporting data, complex corporate structure, lack of transparency and high beta nature of stocks due to high sensitivity nature of the sector to dynamic macro variables, and limited number of listed companies is keeping Indian domestic fund managers shying away from taking aggressive sector bet or launching specific real estate mutual fund scheme. Globally, these funds are very popular. e) Realty Stocks: Those with limited funds can consider investing in listed stocks of realty companies. They are the most liquid option. Before investing in realty stocks, it is important that you keep a watch on number of factors. It includes: Whether the sales volume and cash flow of the company are improving, whether it has strong balance sheet (leverage position), whether it has execution capabilities to execute the entire land bank on schedule time, quality of land bank and finally corporate governance. E. Products/Avenues under Gold Asset Class Gold as an asset class plays a significant role in ones investment portfolio. It not only provides hedge against inflation, but also has low correlation with other asset classes such as equity and debt. This makes gold suitable for diversification and asset allocation. ICICI Securities Page 136 of 194 JCP on Managing Personal Finances Avenues under gold asset class also can be divided into two parts. 1. Direct Investment and 2. Indirect Investment. 1. Direct Investment a) Jewellery: This is the most common way of buying gold in India. However, many people buy it for consumption purpose and not for investment as such. The good part about this option is that its the simplest and easiest way to invest in gold. However, it may not qualify for prudent way of investing given the fact that one has to face significant loss of value on sale due to making charges and wastage. The making charges vary from jeweller to jeweller and according to design, but on an average, it is around Rs 200 per gram. One is never able to recover these charges. The purity of gold is another issue. Most of the times, it may not be of the level that is being claimed. There are concerns even with the hallmarked jewellery. Besides, the hallmark certification adds up to the cost. Go for this option if you want to start using the ornaments immediately or give them as a gift. b) Coins, bars & biscuits: These can be bought from jewellers, banks or bullion traders. The big advantage of this form of gold is purity. Most of them come with assay certification (indicating quality) and in tamper-proof packs (prevents damage during transit). You can choose from a range of coins and bars that are generally available from 5 grams to 100 grams. This option is suitable for meeting some distant future goals like your sisters or daughters marriage. But purchase it from a reputed jeweller, who will buy them back when you need the money. 2. Indirect Investment a) Gold ETFs: Gold exchange traded funds (ETFs) as an investment option is gaining popularity in India. These are open-ended mutual funds that put your ICICI Securities Page 137 of 194 JCP on Managing Personal Finances money in physical gold and issue units to you in demat form (opening a demat account with a broker mandatory to invest). Each unit is backed by physical gold held by the custodian of the scheme. One unit represents approximately 1 gram or half gram of gold. Gold ETFs are listed on the NSE and can be purchased and sold on the exchange just as you buy and sell equity shares using the trading platform. Gold ETFs score over physical gold in many ways. First, unlike physical gold, you here are assured of transparency in pricing as there are no making charges or premium involved and units are traded on the exchange. Another advantage is that investments through ETFs do not attract wealth tax provisions. Capital gains are exempt if held for more than one year and short term capital gains tax is applicable if units are sold within one year. Gold ETFs are a cheaper proposition, as there is no entry or exit load on it. However, they have expense ratio, which is usually 1 per cent. b) Gold FoFs: Gold fund of funds (FoFs) invest the corpus in either their own gold ETFs or a foreign gold fund which is the mother fund. Opening a demat account is not mandatory for investing in these funds. However, there are other charges which eat into your overall returns. There is exit load of usually1-2% exit load if the investment is redeemed within a year. And expense ratio ranges between 0.5- 2 per cent. c) e- Gold: e-Gold is a product by the National Spot Exchange Limited (NSEL) wherein you can purchase gold in electronic form in denominations as small as 1 gram and can also be converted into physical gold. One e-gold unit is equal to one gram of gold, which can be bought and sold via the spot exchange (from 10 am till 11.30 pm on weekdays) just like shares, making it a very liquid investment. However, e-Gold loses out to gold ETFs/FoFs when it comes to taxation, as the units need to be held for more than three years to get long-term capital gains tax benefit, unlike gold ETFs/FoFs that need to be held only for one year. e-Gold also invites wealth tax. ICICI Securities Page 138 of 194 JCP on Managing Personal Finances Further, if you want to convert your e-gold units to physical gold, you need to have a minimum of 8 grams or in multiples of 8, 10, 100 grams or 1 kg. Upon conversation to physical gold, VAT and other local taxes are also levied. As per the current rates, VAT is charged at 1 per cent of the value of goods. NSEL currently has only three delivery centres at Ahmadabad, Delhi and Mumbai. In case physical delivery is lifted in Mumbai, octroi at 0.1 % of the value of delivery will also be applicable. Apart from e-Gold, NSEL also offers other e-series products such as e-silver, e- platinum, etc. d) Gold mining stocks: In India, there is only one listed gold mining company - Deccan Gold Mines. If you wish to invest in such more companies, you may look at investing overseas. But keep in mind, the increase in gold prices may not result in increase in share price of gold mining companies. This is because equities are affected by several other factors as well. If you are willing to take risks and understand that gold prices and shares of gold mining companies don't always move together, you could opt for this option. e) Gold futures: Investors with higher risk appetite may trade in gold futures though commodity exchanges like MCX and NCDEX. Basically, a gold futures contract is an agreement to buy (or sell) a certain specified quantity of gold at a price determined today on a specified date in the future. When you buy gold futures, you assume that the price of gold will be higher at the time of maturity. While trading in gold futures offers a significant upside, there is an equal chance of incurring huge losses. As such this option is ideal only for traders and speculators who have a high appetite for risk. f) Gold deposit schemes: If you want to put your physical gold into productive use, you may opt for gold deposit schemes. These schemes are offered by selected banks, which allow you to earn interest on the gold lying idle with you. The gold can be deposited in the form of jewellery, bars or coins. The minimum quantity varies from bank to bank. The tenure of these deposits is typically in the ICICI Securities Page 139 of 194 JCP on Managing Personal Finances range of 3-7 years. The interest is generally low and is exempt from tax. The value of the gold offered is also exempt from wealth tax.
6. Products/avenues under Alternative Assets
1. Portfolio management services (PMS)
Under portfolio management service (PMS), a portfolio manager creates and manages an investment portfolio on your behalf based on your needs, requirements, investment objectives and risk profile. He invests money in shares, debt and other securities. A portfolio manager develops a separate plan for each of his clients unlike mutual funds, wherein a fund manager collectively manages a fund for all its unit holders.
PMS services are primarily offered by banks, asset management companies, brokers and independent wealth management firms, among others. Broadly, there are three types of PMS services available:
Discretionary: Under this service, the portfolio manager himself makes investment decisions and implements them within the purview of an investment strategy.
Non-discretionary: Here, a portfolio manager only recommends investment ideas. The execution is done by a portfolio manager only after taking an investors consent.
Advisory: Under this service, portfolio manager only suggests investment ideas. Choice as well as execution of investments is taken care of by investor himself.
In India, majority of PMS providers offer discretionary services.
Minimum ticket size: Earlier, one could open a PMS account with just Rs 5 lakh. Now, as per the Securities and Exchange Board of India (SEBI) guidelines, the minimum investment amount required to open a PMS account is Rs 25 lakh. ICICI Securities Page 140 of 194 JCP on Managing Personal Finances However, different service providers have different minimum investment requirement ranging between Rs 50 lakh to Rs 1 crore.
For building a truly customized portfolio, you may need to have minimum investment amount of Rs. 1 crore. There is no upper limit on the amount you can invest in a PMS.
Fees and charges: Typically, there are two models for fees: Fixed-fee model and profit-sharing model.
Under fixed-fee model, one-time charges are levied at the time of starting an investment portfolio. It is generally in the range of 2-3% of your investment amount.
Some PMS schemes also have a profit-sharing model (in addition to fixed fees), wherein the service provider charges a certain percentage of profit made over the hurdle rate for a particular period of time. Hurdle rate is the rate of return that the portfolio manager must beat before collecting profit-sharing fees.
Lets understand this with an example: Suppose PMS XYZ has fixed charges of 2% plus a charge of 20% for return generated above 15% (hurdle rate) in the year. In this case, if the return generated in the year by the scheme is 20%, the fees charged by the PMS will be 2% + [(20% - 15%)*20%].
Besides, there are usual charges like brokerage at the time of transactions, management fees and other statutory levies viz., stamp duty, securities transaction tax; service tax etc.
Returns: PMS is a high-risk product and returns are significant only in the long term. Good PMS products can offer slightly better returns than mutual funds in the long run. Remember, as per SEBI rules, a portfolio manager cannot offer/ promise you indicative or guaranteed returns. However, in the long run, well managed portfolios can yield up to 20-25% returns p.a.
ICICI Securities Page 141 of 194 JCP on Managing Personal Finances Lock-ins: Generally, PMS firms do not have lock-ins. However, a portfolio manager can charge exit load, generally in the range of 1.5-2.5% p.a. of the AUM for an early exit. You can also withdraw profits as and when you want, provided you maintain the minimum ticket size.
Documentation and procedure: Signing on these services is like a legal binding arrangement. You will typically be required to go through a registration process, including a bi-partite agreement. Since the portfolio manager will be making transactions on your behalf, you will need to give them a power of attorney. A new demat and bank account will have to be opened exclusively for PMS portfolio. The documentation is broadly standard across all the service providers and is designed to make you aware of the key features and risks involved in your investment.
Suitability: These products are generally offered to HNIs. If you have Rs 25 lakh to invest, want to invest in equities for long term and have a desire for personalized investment solution and greater level of service, you may consider investing in PMS. A portfolio manager prevents you from the dilemmas of where and how to invest your money and helps you reduce overall risk of your investment portfolio. Some of the benefits of PMS include: it excels in individual attention, provides expert advice and personalized asset allocation and is transparent and convenient option. Tax implications: Under PMS, there can be two ways of generating returns: Dividend income and capital gains. Dividends received by shareholders are exempt from tax u/s 10(34) of Income Tax Act. However, a company distributing dividends is liable to pay dividend distribution tax.
Capital gains: Under PMS, each transaction is considered as an independent trade and capital gain taxes are applicable accordingly (whether short term or long term). Long term capital gains (if shares are held more than 1 year) are exempt from tax. Short term capital gains are chargeable at 15%, currently. A comparative look: PMS vs. equity mutual funds vs. direct equities: Parameter PMS Equity MFs Direct Equities Customization Yes Not possible Yes ICICI Securities Page 142 of 194 JCP on Managing Personal Finances Professional Management Yes Yes Yes, if done consciously Concentrated portfolios Yes Not possible Yes, if done consciously Flexibility to move across assets High Limited, minimum equity allocation required at all times Yes Strategies Unique strategies possible Common strategies for all investors N.A. Alignment to investment objective High. Fund manager can truly follow investment strategy Low. Fund manager must provide for unplanned liquidity requirement N.A.
Choosing a PMS provider: Points to ponder
Make sure that the PMS you opt for is SEBI registered. Choose the PMS based on your requirements and personal investment goals. Remember, PMS is not a short-term product. If you are wealthy with the long-term view, you may consider it. It is critical to know the investment philosophy of your portfolio manager. Ensure you keep a tab on what a portfolio manager is doing with your portfolio and how he is diversifying your investments to reap gains. Stay away if your portfolio manager cannot explain you his investment strategy. Ensure that you would be able to see your portfolio on regular basis. Check on the fees and charges of a PMS provider. It is often advisable to go for a fixed and variable fee (profit-sharing) structure. Track the performance record of your portfolio manager. Over the long run, your PMS scheme should outperform its benchmark indices such as Sensex or Nifty. If it is not performing well over a period of 2-3 years, you should switch to a different PMS provider.
2. Structured Products
ICICI Securities Page 143 of 194 JCP on Managing Personal Finances As the name suggests, these are customized products that comprise of various financial instruments - derivatives, shares, bonds and debentures, among others. In simple words, these can be defined as pre-packaged products, which are issued in the form of non convertible debentures (NCDs), whose returns are linked to underlying assets.
The underlying component in a structured product can be interest rates, a specific equity, bond, commodity or an index. As a result, the returns of a structured product are highly sensitive to changes in the value of these underlying assets.
These products are largely suitable for HNIs. You can buy these products from wealth managers. In some cases, a structured product may have a credit rating from rating agency. The minimum investment is usually in the range of Rs 10 lakh-Rs 20 lakh. The wealth manager may charge 0.5-3% of the amount invested as one-time fee. The main payout for structure products is in the form of a coupon or interest rate.
The primary objective of these products is to protect the principal and at the same time give returns linked to equities. However, there are structured products available that do not offer capital protection features. In India, most structured products have principal protection function, meaning protection of principal if the investment is held till maturity.
Lets understand with an example: There is a simple Nifty-linked capital protection structure. You are investing, say, Rs 200 in a product with tenure of 60 months. Of this, Rs 150 is invested in debt securities, yielding a return of 7% per annum. Thus, over a period of 60 months, you could get Rs 60 as interest on these debt securities. Hence, this ensures that your capital of Rs 200 is protected. The balance of Rs 50 (out of Rs 200) is invested in the Nifty index. If the Nifty rises by 20% in 60 months, Rs 50 will become Rs 60. Thus the value of your Rs 200 will be Rs 270 at the end of the period, giving you an absolute return of 35%.
On the other hand, if the Nifty were to fall by say 30%, then Rs 50 invested would become Rs 35, thereby giving you Rs 245 back, giving you an absolute return of ICICI Securities Page 144 of 194 JCP on Managing Personal Finances 22.5%. This strategy ensures that at any given time your capital is protected and you will get Rs 200 back at the end of 60 months.
Risks involved
Credit risk: The primary risk linked to structured products is credit risk or the risk that the issuer may default. This essentially means you take the risk, irrespective of it being a capital-protected structure, that the issuer may not be able to pay you back. SEBI has mandated that credit risk of the issuer should be explicitly mentioned in the offer document.
Market risk: This comes from the underlying part of the structured product. If the underlying asset does not perform as analyzed and estimated, the final payout would vary. For instance, if underlying asset is Nifty, a 5-year structure product may be designed with the analysis that Nifty will return up to 10% during the tenure. If it does not reach that level, final returns would be less.
Despite the risks involved, structured products has a unique proposition, which allows making money regardless of market conditions. Before you choose to buy this product, you need to have some idea where the underlying asset price is headed. You also have to consider other features such as credit rating, coupon rate and tenure. Investments in structured products should be made only after clearly understanding them, risks involved and returns projected.
Suitability: These products are generally suitable for investors who want to diversify their portfolio with lower risk products that protect their principal and still offer the opportunity to realize capital gains. It is also suitable for those who have long-term investment horizon.
3. Private Equity Private equity (PE) is another options, a growing number of HNIs can consider investing in. Private equity can be defined as an equity investment made in a private companies through a negotiated process. It can also be defined as providing medium to long-term finance to potentially high growth companies (quoted and/or unquoted) in exchange for an equity stake in the company. ICICI Securities Page 145 of 194 JCP on Managing Personal Finances
PE funds can be used to develop new products and technologies, to expand working capital, to make acquisitions, or to strengthen a companys balance sheet. Private equity often requires a long-term focus before investments begin to produce any meaningful cash flow if indeed they ever do. Private equity also typically requires a relatively large investment and is available only to qualified investors such as pension funds, institutional investors and wealthy individuals. Private equity can take many forms. The following are some examples:
Angel investors are individual investors who provide capital to startup companies and may have a personal stake in the venture, providing business expertise, industry experience and contacts as well as capital.
Venture capital funds invest in companies that are in the early to mid-growth stages of their development and may not yet have a meaningful cash flow. In exchange, the venture capital fund receives a stake in the company.
Mezzanine financing occurs when private investors agree to lend money to an established company in exchange for a stake in the company if the debt is not completely repaid on time. It is often used to finance expansion or acquisitions and is typically subordinated to other debt.
Buyouts occur when private investors often part of a private equity fund purchase all or part of a public company and take it private, believing that either the company is undervalued or that they can improve the company's profitability and sell it later at a higher price.
Risks involved:
High risk of erosion of capital Illiquid investment, valuation impacted by limited exit routes available Staggered investment, based on drawdown calls which are not pre- determined Long investment horizon Returns dependent on performance of portfolio companies ICICI Securities Page 146 of 194 JCP on Managing Personal Finances Risks related to political, social and economic environment
Suitability: Aggressive investors, who are high risk takers, can consider having 5- 6% exposure of their total equity portfolio in PE funds. It may help may increase the expected returns and reduce risk in the long run.
4. Art, antiques, gems and collectibles One may invest in these options. However, their value can be unpredictable and can be affected by supply and demand, economic conditions, and the condition of an individual piece or collection.
Asset Classes & Product Suitability Based On Investment Horizon
Every investment avenue/ product needs to be held or invested for different time periods, according to the nature of the product.
The below table indicates different investment products and their tenor and ideal investment horizon.
S No Product Tenor Investment Horizon 1 Equity No lock-in > 5 years (>3 years with active monitoring) 2 Mutual Funds Equity No lock-in for open- ended > 5 years 3 Portfolio Management Service (PMS) Lock-in usually < 6 to12 m > 3 years ICICI Securities Page 147 of 194 JCP on Managing Personal Finances 5 Equity Linked Savings Scheme (ELSS) Lock-in 3 years > 3 years 6 Structured Products 3 to 5 years > 3 years 7 Private Equity 5 to 9 years > 5 years 8 Mutual Funds Debt No lock-in for open- ended 1 5 years 9 Fixed Deposits 15 days to 10 years 1 5 years 10 NCD / Bonds 3 to 10 years 3 5 years 11 New Pension System (NPS) Till the age of 60 years > 15 years 12 Senior Citizen Savings Scheme 5 years (extendable by 3 y) 5 years 13 Employees' Provident Fund (EPF) Till retirement > 15 years 14 Public Provident Fund (PPF) 15 years (extendable by 2 terms of 5 years each) > 15 years 15 Post Office MIS 5 years 5 years 16 National Savings Certificate (NSC) 5 years and 8 years 5 years and 8 years
Goal Planning Each individuals aspirations and goals are different and so each one has to plan as per his/her need. Planning your goals gives you a birds eye view of your finances and helps you be better prepared for your future. Lets take a closer look at the process of planning for your goals.
Goal Planning Process
Step 1: Set your goals and list it down ICICI Securities Page 148 of 194 JCP on Managing Personal Finances Setting goals is the very first step to a road of secured future. When you set a financial goal, for example buying a new car or retiring comfortably, you actually define what you want to achieve in life. Most of us have a fair idea on the key financial goals, however writing them down and actually planning for them puts in a rigor and improves the odds. So take out some time and set goals that you may want to achieve.
A goal must be SMART as described by Paul J. Meyer in Attitude is everything. SMART stands for Specific, Measurable, Attainable, Relevant and Time-bound.
Specific: When you set a goal, be particular about it. For example: Instead of saying I want to buy a car, say I want to buy a Honda City (or any other car for that matter).
Measurable: Have a yardstick to measure your goals. In this case clearly the cost of the car. Some goals may be difficult to quantify, for example leading a happy retired life. But there are ways to quantify by calculating the appropriate cost of living at the time of retirement.
Attainable: Choose an attainable goal. Do not set goals that are out of your reach currently. But you can always revise your goals as you progress financially.
Relevant: A relevant goal must represent an objective toward which you are willing and able to work. Its a good idea to divide your goals into discretionary and non-discretionary goals. Prioritize goals that are necessary (non- discretionary) over the good to have (discretionary). Planning for retirement or children education should precede say a goal to buy a new car.
Time-bound: A goal must have a time-limit, a target date. Again this puts the rigor that is required to achieve a plan.
Once you have set SMART goals, it is imperative to write it down on a piece of paper. Written-down goals help you do things that will bring you closer to achieve your goals. A goal that is not written down is just a dream. Write it down. Written goals have a way of transforming wishes into wants; cants into cans; dreams into ICICI Securities Page 149 of 194 JCP on Managing Personal Finances plans; and plans into reality. Dont just think it - ink it! As rightly put by Anonymous.
Step 2: Categorize your goals Divide up your goals, according to how long it will take to meet each goal, into three categories:
Short-term goals (less than a year): These are your immediate needs and wants, such as buying a home theatre next month or a car next year. Since these goals are, by definition, less than a year from being realized, they are relatively easy to estimate and plan.
Medium-term goals (one to five years): These are things that you and your family want to achieve during the next five years. For example: Taking a vacation or renovating your home. These goals require more planning and careful estimation of their costs.
Long-term goals (more than five years): These goals extend well into the future, such as planning for your retirement or for your childs education. These goals require the most planning, including estimating the cost, forecasting your income, and estimating the growth of your investments. You may need expert help to plan for these goals.
Step 3: Prioritize your goals
Dont set too many goals, try to narrow down and set goals that matter you the most. Put simply, prioritize your goals. Heres the general order of priorities based on various life stages: Life stage Investment goals Protection goals Single Planning for own/siblings' marriage Life cover, if there are dependents Personal accident ICICI Securities Page 150 of 194 JCP on Managing Personal Finances Buying a home Planning for Retirement Buying a car Going for a dream vacation Setting up new business cover Medical cover Critical Illness cover Home insurance cover Married (no kids) Buying a home Planning for Retirement Buying a car Going for a dream vacation Setting up new business Life cover Personal accident cover Medical cover Critical Illness cover Home insurance cover Married (young kids) Children's Education Children's Marriage Buying a home Planning for Retirement Buying a car Going for a dream vacation Setting up new Life cover Personal accident cover Medical cover Critical Illness cover Home insurance cover ICICI Securities Page 151 of 194 JCP on Managing Personal Finances business Married (grown-up kids) Children's Education Children's Marriage Planning for Retirement Setting up new business Going for a dream vacation Buying a second home Buying a second car Life cover Personal accident cover Medical cover Critical Illness cover Home insurance cover Married (close to retirement) Planning for Retirement Setting up new business Going for a dream vacation Medical cover Critical Illness cover Home insurance cover Retired Immediate pension Going for a dream vacation Medical cover Critical Illness cover Home insurance cover
Step 4: Estimate the cost of each goal
ICICI Securities Page 152 of 194 JCP on Managing Personal Finances After you assign priority to your goals, it is important to determine the cost of each goal in todays value. For example, if your goal is to buy a house, estimate the cost of it, say e.g. Rs. 50 lakh. The greater the cost of a goal, the more alternative goals must be sacrificed in order to achieve that goal.
Step 5: Project the future cost
To calculate the future cost of your goals, you need to factor into inflation. There are two ways to estimate the rate of inflation for your goal. You may observe current and past inflation rates and make some assumptions as to the rate of inflation for the period of your goal. Or you may find out what experts are predicting in the industry in which you are interested. For example, if your goal is to buy a new car, find out the rate of inflation for the auto industry by reading the financial newspapers. By finding out what it costs today and factoring in the rate of inflation, you can now project the cost of all of your goals in the future. It is crucial that your estimate be as accurate as possible, especially for your long- term goals.
For your short-term goals, inflation is not a big factor, but for your medium- and long-term goals, you need to factor in the inflation so that you have a more accurate estimate of their costs. Inflation can be a very tricky issue in dealing with long-term goals. Even a relatively modest inflation rate can increase the cost of your goal by 2 to 3 times over a 20-year period. However, there is no need to panic, since time is also on your side. If invested properly, the money you will be saving toward that goal can also grow at a rate that will outpace inflation. Step 5: Calculate how much you need to invest regularly to achieve your goals
Once you have some idea about the future cost of your goals, your next step is to determine how much you should put aside each period to meet all your goals. You may want to have a separate investment strategy, however, for your short- and long term goals.
Lets take an example of a short-term goal. You want to buy a car one year down the line and have not made any specific investment towards this goal. Assuming an increase in the cost of the car to be 10%, the future value of Rs. 1,00,000 for ICICI Securities Page 153 of 194 JCP on Managing Personal Finances this goal will be Rs. 1,50,000 after 1 year. So you have to start investing Rs. 5,000 per month for 1 year in an investment avenue which gives you 15% returns. This may help you stick to your plan and make your dream of buying a car into a reality.
Lets take another example of a long term goal, say childs education. Suppose you expect to incur an expense of Rs. 8,00,000 (in today's value) 7 years down the line for your child's education and you have not made any specific investment towards this goal. So, assuming an increase in the cost of education expenses to be 10%, the future value of Rs. 8,00,000 for this goal will be Rs. 15,00,000 after 7 years. So you have to start investing Rs. 5,000 per month for 7 years in an investment avenue which gives you 15% returns. This may help you stick to your plan of saving enough for your children's education.
Step 6: Create a schedule for meeting your goals
List all your goals according to their priority. Then write down the amount of money needed, when you will need it, and how many installments you will need to meet your goals. It will give you a picture of how much money you need to save every month to achieve all your goals.
Things to Keep In Mind While Planning For Goals
1. Start early
Investing early is best explained by the concept of Power of Compounding. There's a famous quote which says 'Compounding is the eighth wonder of the world'. The more time you stay invested and leave it to grow, compounding will work better. Let's understand this with an example. Suppose you invest Rs.1 lakh at 15% p.a and leave it to grow for 5 years, it would have grown to Rs.2.01 lakh. Had you stayed invested for 20 years instead of 5 years, Rs.1 lakh would have ICICI Securities Page 154 of 194 JCP on Managing Personal Finances grown to Rs.16.36 lakh. But had you invested for 30 years, Rs.1 lakh would have grown to Rs.66.21 lakh!
To get more time for the investment to grow, one should start early. The below example clearly brings out why one should start investing early and also tells us why one should not start late. In the below example, Person A, planning to retire at the age of 55, started investing Rs.3,000 p.m from the age of 30 for building his retirement corpus. Person B, also planning to retire at the age of 55, realized the importance of investing a little late at the age of 35 and hence, started investing a higher amount of Rs.5,000 p.m from the age of 35.
Though person B is investing a higher amount, person A accumulates higher corpus for the simple reason that he started 5 years ahead of person B & the difference is a whopping Rs.22.4 lakh!
Particulars Person A Person B Current Age 30 years 35 years Retirement Age 55 years 55 years Investment per month Rs.3,000 Rs.5,000 Rate of Return 15% p.a. 15% p.a. Accumulated Corpus Rs.97,30,589 Rs.74,86,197
Thumb Rules to calculate the compounding effect
i) Rule of 72 This rule is used to calculate the number of years it will take for your lumpsum investment made today to double (grow by 2 times).
No. of years = 72 / Rate of interest E.g.: If you are investing Rs.1 lakh into a fixed deposit (FD) which is giving 9% p.a. compound interest, then it will take 8 years (72 / 9) for it to double i.e.; become Rs.2 lakh. ICICI Securities Page 155 of 194 JCP on Managing Personal Finances
ii) Rule of 114 This rule is used to calculate the number of years it will take for your lumpsum investment made today to triple (grow by 3 times).
No. of years = 114 / Rate of interest E.g.: If you are investing Rs.1 lakh into a mutual fund (MF) which is giving 12% p.a. compound interest, then it will take 9.5 years (114 / 12) for it to triple i.e.; become Rs.3 lakh.
iii) Rule of 144 This rule is used to calculate the number of years it will take for your lumpsum investment made today to quadruple (grow by 4 times).
No. of years = 144 / Rate of interest E.g.: If you are investing Rs.1 lakh into Equity which is giving 15% p.a compound interest, then it will take 9.6 years (144 / 15) for it to quadruple i.e; become Rs.4 lakh.
All the above thumb rules will give you approximate answers only, which you can use for instant calculation.
2. Invest regularly by way of SIP
A systematic investment plan (SIP) is nothing but a planned investment programme. The basic idea of SIP is that it works like a recurring deposit of a bank. In case of recurring deposit of a bank a person invests a fixed amount every month. Similarly, in SIP, you can invest a fixed amount periodically either monthly, quarterly, etc. As the amount is invested every month you get the cost advantage. Investors should remember that no one can time the market, so it is always better to invest systematically to get the advantage of market conditions. When the market is in a downtrend you will receive more number of units and ICICI Securities Page 156 of 194 JCP on Managing Personal Finances when market is in an uptrend, you will receive lesser number of units. So you can average out your buying cost. Further, if you have opted for the Electronic Clearance Service (ECS) or direct debit facility, you dont have to sign a cheque every time; money will be directly debited from your bank account on a particular date chosen by you. If you are opening more than one SIP, it is better to opt for different dates for each SIP, so that you get cost advantage of market conditions at different dates.
Overall, an SIP is a simple device that helps you to save and invest in a disciplined manner without having to time the market.
3. Invest in different products
As the adage goes, Do not put all the eggs in one basket. Look at a mix to achieve your goals: Equities, Mutual funds, Fixed income instruments and Insurance (child plans). Equities have the potential to increase in value over time and can provide your portfolio with the growth necessary to reach your long-term investment goals. Mutual funds (debt and equity) help you meet all your short term and long term goals. Fixed income investments provide you steady returns. Insurance helps plan your life goals. Simultaneously, it provides for your child's future. It is a dependable route that secures the child's future in case of any unfortunate event. Put simply, invest in different investment avenues to build a strong portfolio.
4. Have a proper asset allocation
Your asset allocation should depend on the time horizon of your goal. If the age of your child is, say, 7 years and you are planning for his higher education, a higher equity allocation can be looked at. If your child is 15 years old, since the goal horizon is lesser, you can have a moderate allocation that includes debt (fixed income) investments. For childs marriage, which in most cases will have a long time horizon, an aggressive allocation into equities can be considered.
5. Account for inflation ICICI Securities Page 157 of 194 JCP on Managing Personal Finances
As discussed earlier, it is important to account for inflation while planning for goals. For example, an MBA at a cost of Rs 8 lakh today will cost much more 15 years hence. The value of your money depreciates that is the effect of inflation. When you plan for your goals you should estimate the amount you will actually need in the future and not what it costs currently.
6. Involve your family and child in the planning
Last, but not the least, while planning for your goals, it is important that you involve your family and child in the process. You should sit down with your family to discuss the goals and aspirations of each member. This helps in prioritizing the goals that you wish to achieve. Life Stage Investing To Achieve Your Goals Life stage investing is a great methodology and framework to plan your investments. Asset allocation models, risk taking ability and time-horizons are a function of age and responsibilities. Lets take the case of Ram who is 25 years old. When he starts investing, he is independent and tends to invest smaller amounts. While it is always important to mitigate risk, the risk-taking ability of an investor in this age group is high. As a general thumb rule, desired allocation to equity can be calculated as 100 - age. So, if Ram is 25, then an ideal allocation of his investible surplus to equity can be around 75 percent. As Ram gets older and marries, he and his wife are both earning members and don't have much to spend on. They decide that they want to buy their own house when Ram is around 30 years old. This is the time they need to start looking at their goals and save up for the house. A home loan is definitely on the cards, but they still need to accumulate the required down payment money. It is generally during this phase that most people take their first step into the domain of financial planning. As Ram's family grows, so does his commitments. He needs to start planning for his children's education and other goals. He is now in his mid-30s and has bought a home. He now needs to start saving in a children's education plan while paying ICICI Securities Page 158 of 194 JCP on Managing Personal Finances off his mortgage. This phase is crucial because it largely determines how his children's future will shape up. At the same time, Ram also needs to start planning for his retirement and buying a second home as an investment. However, since his family obligations have increased, it is important to diversify his risk and for this he will have to balance his portfolio. Investing in a retirement plan is on the cards and Ram has to assess his insurance coverage needs to ensure his familys safety in an unfortunate event. Hence, as we can see, life stage investing is all about managing your wealth efficiently and investing in asset classes that suit your life-stage, to achieve your life goals while mitigating risks and avoiding extreme uncertainties. Age Portfolio below 30 80% in equity 10% in cash 10% in fixed income 30 to 40 70% in equity 10% in cash 20% in fixed income 40 to 50 60% in equity 10% in cash 30% in fixed income 50 to 60 50% in equity 10% in cash 40% in fixed income above 60 40% in equity 10% in cash 50% in fixed income Listed here is a broad classification of the different life stages and investment strategies centered on these life stages. ICICI Securities Page 159 of 194 JCP on Managing Personal Finances Single: This is when you are single, in your twenties and working. It is crucial to learn to manage your spending habits and start saving. Remember to save and invest wisely. While a lot of us want to shop, travel and live the good life, it is important to remember that investing in appreciating assets is very important in the long run. When you buy something, ask yourself if it is an appreciating asset. Assets such as stocks, real estate, mutual funds will help you grow your wealth. Wise investments combined with good saving and spending habits will help you achieve your goals relatively early in life and will help you avoid getting into needless and expensive debt later in life. Credit card debt is an example of expensive debt. High interest rates (25-35 percent) eats into savings and erodes wealth. Avoiding such debt early in life will ensure a healthy financial lifestyle in the long run. Investing in equities and equity products with a long-term view will help you achieve high returns. For example, if you want to have a million rupees before you turn 30, you should plan to invest around Rs 10,700 per month in equity mutual funds for 5 years (assuming an annualized rate of return of 18 percent). Hence, you would need to start investing at the age of 25 itself. Married: This is the stage when you are young and just married. It is the time many couples enjoy a double-income and have various life plans and goals in mind. This is an ideal time to combine the incomes and invest a larger amount towards achieving financial goals. Buying a house, car and other purchases are on the agenda. Set time lines, plan your monthly expenses, keep some money aside for contingencies and invest in products that offer a mix of capital protection and appreciation. A good financial plan evolves with your changing needs and goals. As incomes rise and goals change, a financial plan must be updated to reflect new realities and changes. Married, and have kids: This is the stage when your risk-appetite must shift towards being slightly moderate. A shift towards balanced assets that invest some portion in debt is desirable. Children's education goals are the priority and ICICI Securities Page 160 of 194 JCP on Managing Personal Finances one must consider starting investments towards this goal at an early stage. There are various products available that cater to this specific need. Insurance is often treated as an instrument for tax planning and not what it is actually intended for. For example, home insurance is crucial as it ensures your home loan payments in the unfortunate event of the borrower's death. Such policies go a long way in protecting your loved ones. Understanding how much insurance is adequate is essential. A good financial plan will help you understand whether you are under-insured or over-insured. Pre-retirement: A general thumb rule is that 70 percent of your current income is enough to sustain the same lifestyle post-retirement. Like mentioned earlier, it is never too late to start financial planning. If you are in your 50s and plan to retire in a few years, this is a good time to get a 'financial health checkup'. Understanding your true net worth and your goals post-retirement is helpful to know where you stand today. Even investing for the next 10-12 years wisely can make a huge difference. However, it is important to remember that your risk profile at this stage is very different from what it used to be earlier. If you are invested heavily in equity or other higher-risk avenues, it is important to re-balance your portfolio towards a mix of debt, equity, and contingency cash. Generally, an equal allocation to equity and other safer avenues like debt and bank deposits is considered as an ideal asset allocation model at this stage, though a lot also depends on individual situations. Retired: This is the stage which requires the most amount of planning. Considering inflation and increasing life expectancies, it is important to plan well for retirement. Some of the most important retirement goals are to continue to maintain the same or desired standard of living as enjoyed during your working years. During the retirement phase there are certain tax benefits and tax efficient investments that senior citizens must consider investing in. Asset allocation must be done in such a way so as to minimize risk while ensuring returns that stay ahead of inflation. In such a scenario, returns are not sufficient to sustain a ICICI Securities Page 161 of 194 JCP on Managing Personal Finances desired lifestyle. Hence, it is important to have a mix of investments that keep the risk-reward ratio in view. Medical contingencies are often inevitable in this life stage and it is essential to be medically insured and have enough savings to tide over uncertainties. There are also various options such as reverse mortgage which help senior citizens generate steady cash flows from their house without the worry of losing their home as long as they live. Funding For Goals While planning for goals, it is very important to know that how are you aiming to achieve these goals, i.e. through own funds or from borrowed money. If you are going for a loan, then you need to appraise on how much loan can be expected. Goal Type of Loan Margin payment Maximum Loan available Buying a new / resale home Home Loan 20 to 25% 75 to 80% Buying a new car Car Loan 10 to 15% 85 to 90% Buying a resale car Car Loan 25 to 35% 65 to 75% Going on a dream vacation / own or sibling's marriage expenses Personal Loan NIL 100% Own / sibling's marriage expenses (if having own property) Mortgage Loan 40 to 60% 60% (residential property); 40% (commercial property) Buying an investment property Land / Property loan 30 to 40% 65 70% (land); 60% (commercial property)
ICICI Securities Page 162 of 194 JCP on Managing Personal Finances Understanding the concept of Equated Monthly Installment (EMI)
You have to repay the loan borrowed through Equated Monthly Installments (EMIs). The EMI paid will have 2 components principal and interest portion. During the initial years of the repayment tenure, the interest portion will be higher when compared to the principal portion.
During the final few years of the repayment tenure, the interest portion will be lesser and the principal portion would be higher. This can be better understood with an example: Principal amount (Loan) - Rs.10 lakh Interest Rate - 8.5% p.a Tenure- 20 years EMI- Rs.8,679/- Month EMI Principal portion Interest portion 1 8679 1596 7083 50 8679 2255 6424 100 8679 3209 5470 150 8679 4568 4111 200 8679 6501 2178 240 8679 8621 58 If going for a loan, it's better to have an insight on what will be the likely Equated Monthly Installment (EMI), which you will be paying, using the below table.
EMI table for a loan amount of Rs.1 lakh Tenure EMI @ 8% p.a EMI @ 9% p.a EMI @ 10% p.a EMI @ 11% p.a EMI @ 12% p.a EMI @ 13% p.a EMI @ 14% p.a 3 years 3134 3180 3227 3274 3322 3370 3418 5 years 2028 2076 2125 2175 2225 2276 2327 10 years 1214 1267 1322 1378 1435 1494 1553 15 years 956 1015 1075 1137 1201 1266 1332 ICICI Securities Page 163 of 194 JCP on Managing Personal Finances 20 years 837 900 966 1033 1102 1172 1244 Calculating Eligibility for Home Loan Details Example Gross Monthly Income A Rs.45,000 Rental Income B - Other Income C - Total Monthly Income D = A+B+C Rs.45,000 Applicable Fixed Obligation to Income Ratio (FOIR) % E 50% Income available to service loan F = D x E Rs.22,500 Existing Monthly Obligation (Any EMIs currently paid) G Rs.7,500 Net available income for servicing new home loan H = F G Rs.15,000 EMI for Rs.1 lakh at 9% interest rate for 15 years (refer above table) I Rs.1015 Home Loan Amount Eligible J = H / I Rs.14.78 lakh The Fixed Obligation to Income Ratio (FOIR) may change from one company to another.
Aligning Existing Investments towards Goals
Some of you would have already invested money into various avenues with specific goals in mind. In such a case, we need to understand which investments are earmarked for which goals. If you do not have specific earmarking done, then there is a need to align the existing investments towards the goals. For this, we need to classify all goals into:
- Short-term goals (< 3 years) ICICI Securities Page 164 of 194 JCP on Managing Personal Finances
- Medium-term goals (3 to 8 years)
- Long-term goals (> 8 years)
After classifying the goals as above, then suggest existing investments as per the below table:
Goals Existing Investments Short-term goals ( < 3 years ) Short-term FDs, Balanced & Large-cap MFs Medium-term goals ( 3 8 years ) Equity, All Equity MFs, PMS Long-term goals ( > 8 years ) Equity, All Equity MFs, Endowment and unit linked insurance policies, Long- term debt instruments like PPF, FDs, NPS
For very short term goals (< 1 year), it is better to utilize the existing investments, rather than starting to invest afresh.
SESSION 7: SUMMARY AND IMPORTANT CALCULATIONS
Summary
Session 1: Introduction and Steps of Financial Planning
Financial Planning is a process of meeting your life goals through proper management of your finances. ICICI Securities Page 165 of 194 JCP on Managing Personal Finances A good financial plan requires analyzing your financial status, outlining your goals and understanding the means for achieving these goals. Setting realistic time horizons to achieve goals and achieving them with discipline and planning is what a good financial plan helps in accomplishing. The ability to mitigate risks when investing is another important facet that financial planning addresses. Financial Planning provides direction and meaning to your financial decisions. One feels more secure and more adaptable to life changes, once they measure that they are moving closer to realization to their goals. Implementing a financial plan offers an unrivaled peace of mind. It removes components of fear and uncertainty from your day-to-day life. Financial planning is a process consisting of following 6 steps: 1) Establishing and defining the client-planner relationship 2) Gathering client information (current finances and goals) 3) Analyzing and evaluating financial status 4) Developing and presenting the financial plan 5) Implementing the financial plan 6) Monitoring the financial plan
Session 2: Insurance Planning
We live in an uncertain world. We are associated with several risks in life. Risk is a possibility of any harm, injury, loss, danger or destruction of an individual or their belongings. So it is important to insure our life and assets through insurance. Insurance is an important component of financial planning. ICICI Securities Page 166 of 194 JCP on Managing Personal Finances Insurance is mainly of two types-life insurance and general insurance. Life insurance covers the risk associated with the life of an individual. Term Endowment, Money-back, Whole-life, ULIP and Pension plans are various types of life insurance plans. The best way to take a life cover is through a term insurance plan as its a pure protection plan. Ideally, one should have a life cover to take care of: a) Family expenses till lifetime, b) Liabilities outstanding, and c) Family & children goals. As a thumb rule, every earning individual has to have a life cover of 10 to 20 times of annual income depending on their age. Under general insurance, one should take cover for health, vehicle, motor, home and property, and travel insurance.
Session 3: Retirement Planning
As one grows older, retirement is an inevitable stage of life. Therefore, it is essential to create a plan that will fulfil ones needs right through ripe old age. Planning for retirement is about ensuring that one has adequate income to meet the expenses post retirement. ICICI Securities Page 167 of 194 JCP on Managing Personal Finances Increasing life expectancy, no benefits from employers, rising medical expenses and inflation, and increased standard of living are a few factors that necessitate planning for retirement well. Retirement planning is a process that contains following steps: 1. Identifying your life stage 2. Estimating the cost of retirement 3. Assessing how you are prepared for it 4. Calculating the gap 5. Building your retirement fund
Some of the typical retirement investment products are: EPF, PPF, Pension products from insurance companies, NPS, Mutual Funds. Investment options that could be used post retirement for regular income are: Annuity from insurance companies, FDs, Post Office Monthly Income Schemes, Senior Citizens Savings Scheme, Monthly Income Plans, House rentals, Reverse mortgage, etc.
Session 4: Investment Planning
Investing is the best way to secure your future by accumulating wealth in the long term. Investing helps you beat the effects of inflation. An increase in the general price level for a considerable period of time is called as inflation. ICICI Securities Page 168 of 194 JCP on Managing Personal Finances Inflation decreases the surplus amount in the hands of an individual. Invest your money in asset classes that will give you good returns. Investment planning largely entails the following steps: 1. Ascertaining risk profile 2. Identifying appropriate asset allocation according to a risk profile 3. Having adequate diversification with your asset allocation 4. Staying true to your allocation by regularly rebalancing
Patience and discipline are keys to investing. Invest regularly and remain invested for the long term.
Session 5: Tax planning AND Estate Planning
Tax planning is an arrangement of financial activities in such a way that maximum tax benefits are availed of, to reduce tax liabilities considerably. Tax planning is a coherent element of any financial plan. No financial plan is complete without tax planning. Tax planning does not mean only saving taxes. It should also help you achieve your goals in the whole process. Put simply, tax planning should ICICI Securities Page 169 of 194 JCP on Managing Personal Finances be done taking into consideration your various goals, such as insurance (life and health), childs education, retirement, etc. Estate planning, as the name suggests, is all about creating a plan for your estate assets, including all your holdings in equity, debt, commodities, real estate, gold, and alternate investments like art, gemstones, etc. Estate planning is the process of arranging for the distribution of your asset holdings to your heirs by anticipating and avoiding different scenarios that can create a conflict among them. There are different tools to take care of your assets. Wills and Trusts play important roles in the organization and preservation of your estate. A Will is the simplest tool of estate planning. It deals with all matters regarding the distribution of your estate assets. A trust can be a valuable estate planning tool for the more affluent, who own businesses governed by families. A trust is a vehicle that provides effective and hassle-free wealth management, asset protection and tax efficiency.
Session 6: Asset classes & product suitability AND Goal planning
Asset classes refer to the various assets that are available for investment. These include: Equity, Fixed Income/Debt, Cash and cash equivalents, Real Estate, Gold and Other Alternative Assets. Under these asset classes, there are several investment products/avenues. Each asset class has different risk and return characteristics, and functions in a unique way in different market environment. ICICI Securities Page 170 of 194 JCP on Managing Personal Finances Depending on the risk appetite and investment horizon of an individual, one can choose to invest in a combination of asset classes to optimize his returns. Each individuals aspirations and goals are different and so each one has to plan as per his/her need. Planning your goals gives a birds eye view of finances and helps to be better prepared for a secured future. Goal Planning is a process that contains following steps: 1. Setting goals and listing it down 2. Categorizing goals into short, medium and long term goals 3. Prioritizing goals by ranking them 4. Estimating the cost of each goal 5. Projecting the future cost by taking into consideration the rate of inflation 6. Calculating how much one needs to invest regularly to achieve his goals 7. Creating a schedule for meeting all goals Starting early and investing regularly are the keys to achieve various financial goals.
Important Calculations
1. Time Value of Money
It refers to the concept that money available at the present time is worth more than the same amount in the future due to its potential earning capacity.
Example: Let's understand this concept better with an example. If you are given two options A) Receive Rs.10,000 now OR B) Receive Rs.10,000 in 3 years. ICICI Securities Page 171 of 194 JCP on Managing Personal Finances Which one would you choose? Most people would obviously choose Option A and receive the money now, rather than wait for 3 years to receive the same amount. Why? Although the amount is the same, you can do much more with the money if you have it now because over time you can earn more interest on your money.
In this example, if you invest the Rs.10,000 you receive now even at 6% p.a., you would be having Rs.11,910 at the end of 3 years, which is a significant 19.1% more money than Rs.10,000 after 3 years. In the above example, Rs.10,000 to be received now is called the Present Value & Rs.11,910 to be received after 3 years is called the Future Value.
2. Future Value (FV) of a Fixed Amount Formula: FV = PV * (1+i) n
Where PV = Present Value i = Interest n = Number of period
When can you use this?
- To calculate the future value of today's cost of education, marriage, buying a house, car, etc. - To calculate the expected future value of today's lump sum (one-time) investment. Examples:
1) Cost of Engineering today = Rs.5,00,000 (PV); Inflation rate = 10% p.a (i); Number of years = 15 years (n).
FV = 5,00,000*(1+10%)15 = Rs.20,88,624
ICICI Securities Page 172 of 194 JCP on Managing Personal Finances Today's cost of Rs.5 lakh for engineering would cost Rs.20.88 lakh after 15 years @ inflation rate of 10% p.a.
2) Investment into a single premium plan today = Rs.3,00,000 (PV); Rate of return = 15% p.a (i); Term of the plan = 20 years (n).
FV = 3,00,000*(1+15%)20 = Rs.49,09,961
Investment of Rs.3 lakh today into a single premium plan would yield a maturity amount of Rs.49.09 lakh after 20 years @ 15% p.a
How to calculate using MS Excel / Openoffice Calc
Open MS Excel or Openoffice Calc. Go to 'Functions' as shown below.
Choose 'Financial' under 'Category' dropdown and then, choose 'FV' under 'Function' dropdown; and then, click 'Next'.
ICICI Securities Page 173 of 194 JCP on Managing Personal Finances
Enter the following fields:
Rate = 15% (inflation rate / rate of return) NPER = 20 years (Number of period) PMT = Leave it blank (required to be filled only when there are regular payments involved) PV = -3,00,000 (Present Value) (To be entered in negative, since MS Excel will consider this field as an outflow, which needs to be captured in negative in MS Excel)
'Result' field will give the solution 'Future Value'
ICICI Securities Page 174 of 194 JCP on Managing Personal Finances
3. Future Value (FV) of an Annuity (Regular Payment) Formula: FV = PMT * [((1+i) n 1 ) / i]
Where PMT = Regular payment (Fixed amount) per period i = interest rate per period n = Number of payments
When can you use this?
- To calculate the expected future value of regular investments like SIP, Recurring Deposit, Regular premium Insurance policies, etc.
Examples:
1) Annual premium Rs.50,000 Expected Return - 15% p.a Term - 15 years
FV = 50,000 * [((1+15%)15 1) / 15%] = Rs.23,79,020 ICICI Securities Page 175 of 194 JCP on Managing Personal Finances
Investment of Rs.50,000 p.a. into a regular premium plan would yield a maturity amount of Rs.23.79 lakh after 15 years @ 15% p.a.
2) Monthly SIP Rs.3,000 Expected Return 15% p.a. Term 15 years
Investment of Rs.3,000 p.m. into a MF through SIP would yield a maturity amount of Rs.20.05 lakh after 15 years @ 15% p.a.
Note: 'n' refers to number of payments and hence, for monthly investments, 'n' will be no. of years multiplied by 12. Similarly, 'i' refers to interest rate per period and hence, for monthly investments, 'i' will be annual interest rate divided by 12.
How to calculate using MS Excel / Openoffice Calc
Use 'FV' function under 'Financial' category.
Enter the following fields:
Rate = 1.25% (per month) (inflation rate / rate of return) NPER = 180 months (Number of period) PMT = -3000 (per month) (Regular investment per period) (To be entered in negative, since MS Excel will consider this field as an outflow, which needs to be captured in negative in MS Excel) PV = To be left blank (Needs to be filled only if there is a lumpsum investment today)
'Result' field will give the solution 'Future Value'
ICICI Securities Page 176 of 194 JCP on Managing Personal Finances
In the same example, if one invests Rs.2 lakh as a lumpsum today and then, adds the above Rs.3000 p.m into the same instrument for 15 years, then input -2,00,000 in the PV field, and the future value (FV) would be calculated as Rs.38,76,787.
ICICI Securities Page 177 of 194 JCP on Managing Personal Finances
4. Present Value (PV) of a future fixed amount Formula: PV = FV / (1+i) n
Where FV = Future Value i = Interest n = Number of period
When can you use this?
- To calculate the value of lumpsum investment to be made today to build a required corpus in the future.
Example:
Corpus required in the future = Rs.50 lakh (FV); Required after (Term) = 15 years (n); Expected Rate of Return = 15% p.a
PV = 50,00,000 / (1+15%)15 = Rs.6,14,472
An amount of Rs.6.14 lakh needs to be invested as a lumpsum today @ 15% p.a. to build a corpus of Rs.50 lakh in 15 years.
How to calculate using MS Excel / Openoffice Calc
Use 'PV' function under 'Financial' category. Choose 'Financial' under 'Category' dropdown and then, choose 'PV' under 'Function' dropdown; and then, click 'Next'.
Enter the following fields:
Rate = 15% (inflation rate / rate of return) NPER = 15 years (Number of period) ICICI Securities Page 178 of 194 JCP on Managing Personal Finances PMT = Leave it blank (required to be filled only when there are regular payments involved) FV = 50,00,000 (Future Value)
'Result' field will give the solution 'Present Value' (which will come in negative, since MS Excel will consider this field as an outflow, which will be captured in negative in MS Excel)
5. Present Value (PV) of an immediate annuity (Regular Payment) Formula: PV = PMT * [(1-(1 / (1+i) n )) / i]
Where PMT = Regular payment (Fixed amount) per period i = interest rate per period n = Number of payments
When can you use this?
ICICI Securities Page 179 of 194 JCP on Managing Personal Finances To calculate the retirement corpus required today, based on the regular pension amount required in the future for a fixed period To determine how much to invest in an Immediate Annuity plan.
Example:
Pension expected - Rs.25,000 per month (PMT) Interest rate per period - 0.50% (per month) (6% p.a return expected from the corpus) Number of period - 240 months (Pension required for 20 years post- retirement)
For receiving a pension of Rs.25,000 per month for next 20 years, one needs to invest a corpus of Rs.34.89 lakh as of today @ 6% p.a
How to calculate using MS Excel / Openoffice Calc
Use 'PV' function under 'Financial' category.
Enter the following fields:
Rate = 0.60% (per month) (inflation rate / rate of return) NPER = 240 months (Number of period) PMT = 25000 (per month) (Regular payment per period) FV = To be left blank (Needs to be filled only if there is a lumpsum corpus to be left behind after 20 years)
'Result' field will give the solution 'Present Value' (which will come in negative, since MS Excel will consider this field as an outflow, which will be captured in negative in MS Excel)
ICICI Securities Page 180 of 194 JCP on Managing Personal Finances
In the same example, if one wants to leave a lumpsum corpus of Rs.25 lakh behind for the family after getting pension for 20 years, then, input Rs.25,00,000 in the FV field & the corpus required as of today (PV) will be calculated as Rs.42,44,759.
ICICI Securities Page 181 of 194 JCP on Managing Personal Finances 6. Annuity (PMT) Regular Payment
Formula: PMT = FV / [ ( (1+i) n 1 ) / i] or PV * [ i (1+i) n / (1+i) n - 1]
Where FV = Future Value PV = Present Value i = interest rate per period n = Number of periods
When can you use this?
- To calculate the regular investment required to build a corpus in the future - To calculate the regular pension to be received from a corpus (Immediate Annuity) - To calculate EMI to be paid while taking a loan
Examples:
1) Future Value of Child's higher education Rs.40 lakh (FV) No. of years left - 15 years (n)
Interest Rate expected - 15% p.a (i)
PMT (Investment) = Rs.84,068
For building a corpus (FV) of Rs.40 lakh for child's higher education in the next 15 years, one has to invest Rs.84,068 per annum for 15 years.
2) Retirement Corpus available Rs.30 lakh (PV) Interest rate expected - 6% p.a (0.50% p.m) Annuity Rate (i) No. of years pension required 20 years (240 months) (n)
PMT (Pension) = Rs.21,492
ICICI Securities Page 182 of 194 JCP on Managing Personal Finances With a corpus of Rs.30 lakh available, one can get a pension of Rs.21,492 per month at an annuity rate of 6% p.a. for the next 20 years.
3) Home Loan taken Rs.20 lakh (PV) Interest rate - 9% p.a. (0.75% p.m.) (i) Term - 15 years (180 months) (n)
PMT (EMI) = Rs.20,285
For a home loan of Rs.20 lakh taken at an interest rate of 9% p.a., one has to pay an EMI of Rs.20,285 per month for a period of 15 years.
How to calculate using MS Excel / Openoffice Calc
Use 'PMT' function under 'Financial' category.
Enter the following fields:
Rate = 15% p.a ( rate of return) NPER = 15 years (Number of period) PV = To be left blank (to be filled only wherever required) FV = 40,00,000 (FV of child's education after 15 years)
Either PV or FV or both fields, whichever required, needs to be entered.
'Result' field will give the solution 'PMT' Regular investment / payment (which will come in negative, since MS Excel will consider this field as an outflow, which will be captured in negative in MS Excel)
ICICI Securities Page 183 of 194 JCP on Managing Personal Finances
Other practical examples
We can use a combination of some of the above formulae for our practical purposes.
Example 1
Current Age - 30; Planned Retirement Age 55; Monthly pension required after retirement Rs.50,000 No. of years pension required - 20 years (240 months). Annuity Rate expected 6% p.a (0.5% p.m.) How much to invest every year from now till age 55 for the same? Step 1
Use 'PV of Immediate Annuity' formula to find out the retirement corpus required to be built for a pension of Rs.50,000 p.m. for 20 years (240 months) at an annuity rate of 6% p.a. (0.5% p.m.). ICICI Securities Page 184 of 194 JCP on Managing Personal Finances
The corpus to be built till the age of 55 is Rs.69.79 lakh.
Step 2
Now, with the above Rs.69.79 lakh as Future Value to be obtained at his age of 55, use 'PMT (Regular Payment) formula to find out how much regular investment is required every year for building the corpus.
FV = Rs.69.79 lakh; No. of years = 25 years (55 minus 30); Expected Return (RATE) 15% p.a. ICICI Securities Page 185 of 194 JCP on Managing Personal Finances
An annual investment of Rs.32,797 is required from the age of 30 till 55 to get a monthly pension of Rs.50,000 for 20 years after retirement (till age of 75).
Example 2
In the same case as above, if client wants to invest only for 10 years till the age of 40 & then leave it invested till age of 55 and have similar benefits.
Current Age - 30; Planned Retirement Age 55; Regular investment planned till age of 40; Monthly pension required after retirement Rs.50,000 No. of years pension required - 20 years (240 months). Annuity Rate expected 6% p.a. (0.5% p.m.) How much to invest every year from now till age 40 for the same?
Step 1
Same step as in the first example. Use 'PV of Immediate Annuity' formula to find out the retirement corpus required to be built for a pension of Rs.50,000 p.m. for 20 years (240 months) at an annuity rate of 6% p.a. (0.5% p.m.). ICICI Securities Page 186 of 194 JCP on Managing Personal Finances
The corpus to be built till the age of 55 is Rs.69.79 lakh.
Step 2
Use 'PV of future fixed amount' formula to find out how much value this corpus of Rs.69.79 lakh would be at his age of 40, assuming he's staying invested @ 15% p.a. from age 40 till 55.
Expected Return (RATE) 15% p.a. No. of years (NPER) - 15 (55 minus 40) Future Value Rs.69.79 lakh ICICI Securities Page 187 of 194 JCP on Managing Personal Finances
He has to build Rs.8.58 lakh till the age of 40, which when kept invested at 15% p.a for another 15 years till retirement, would give a corpus of Rs.69.79 lakh.
Step 3
Now, use 'PMT (Regular Payment)' formula to find out how much every year he has to regularly invest from his age of 30 till 40 to build this Rs.8.58 lakh.
FV = Rs.8.58 lakh; No. of years = 10 years (40 minus 30); Expected Return (RATE) 15% p.a.
ICICI Securities Page 188 of 194 JCP on Managing Personal Finances
An annual investment of Rs.42,243 is required for 10 years till his age of 40 at 15% p.a. and the same needs to be kept invested at 15% p.a. for another 15 years till his age of 55 to get a monthly pension of Rs.50,000 for 20 years after retirement (till age of 75).
ICICI Securities Page 189 of 194 JCP on Managing Personal Finances SESSION 8: ASSESSMENT TEST
Session 1: Introduction and Steps of Financial Planning
1. Financial planning is ___________ a. Investing to achieve good returns b. Planning to have comfortable retirement c. A process to help you achieve financial goals
2. Analyzing assets and liabilities of clients is a part of ___________ step in the financial planning process? a. Gathering client data, including goals b. Analyzing and evaluating financial status c. Developing and presenting the financial plan
3. Financial planning and tax planning is same. a. True b. False
4. Restructuring existing assets into productive/growth assets by clients is a part of ___________ step in the financial planning process? a. Analyzing and evaluating financial status b. Implementing the financial planning recommendations c. Developing and presenting the financial plan
5. If one is already saving enough, he need not opt for financial planning. a. True b. False
Answers: 1 c; 2 b; 3 b; 4 b; 5 b
ICICI Securities Page 190 of 194 JCP on Managing Personal Finances Session 2: Insurance Planning
1. Which of the following products is a pure insurance product? a. Endowment plan b. Money back plan c. Term plan
2. In ___________ option, you get annuity for life and on death the initial purchase price (premium paid in the beginning) is returned back to the nominee. a. Life annuity b. Life annuity with return of purchase price c. Life annuity for fixed-period guarantees
3. The premium payable on a ULIP is higher for the same sum-assured as a term policy because ___________. a. The period of cover is longer b. A portion of the premium is used for investment c. The risk is higher
4. The term of general insurance policies is typically ___________. a. Decided by the insurer b. One year c. Flexible
5. Health insurance premium tends to decrease with age - more the age, lesser the premium. a. True b. False
Answers: 1 c; 2 b; 3 b; 4 b; 5 b
ICICI Securities Page 191 of 194 JCP on Managing Personal Finances Session 3: Retirement Planning
1. Inflation does which of the following to retirement planning? a. Reduces the periodic savings required b. Increases the retirement corpus required c. Reduces the return generated by an investment
2. The current rate of interest on EPF is ___________ per cent. a. 8.5 b.8.6 c. 8
3. NPS is a voluntary contributory pension scheme introduced by ___________. a. Central Government b. State government c. Reserve Bank of India
4. ___________ is a type of mortgage in which a homeowner can borrow money against the value of his or her home. a. Home loan b. Reverse mortgage c. Loan against property
5. Senior citizens savings scheme can be opted by any individual. a. True b. False
Answers: 1 b; 2 a; 3 a; 4 b; 5 b
ICICI Securities Page 192 of 194 JCP on Managing Personal Finances Session 4: Investment planning
1. As a thumb rule of asset allocation, a person aged 35 years, should have equity allocation of ___________ per cent in the portfolio. a. 60 b. 65 c. 70
2. Equity is a high-risk / low-returns asset class. a. True b. False
3. Risk of default or non-payment of periodical interest payments and principal on maturity by the issuer is ___________. a. Interest rate risk b. Principal risk c. Credit risk
4. A standardized measure of return on investments in which the return is computed as percent per annum is knows as ___________. a. Compounded annual growth rate (CAGR) b. Absolute return c. Annual return
5. ___________ investor avoids taking undue risks and is firm on preserving investment capital. a. Balanced b. Conservative c. Moderate
Answers: 1 b; 2 b; 3 c; 4 c; 5 b
ICICI Securities Page 193 of 194 JCP on Managing Personal Finances Session 5: Tax planning AND Estate Planning
1. Commission received from business forms part of income from ___________. a. Business and profession b. Capital Gains c Other sources
2. Long term capital gain from sale of shares is ___________. a. Taxed at 20% b. Exempt from tax c. Taxed at 15% with indexation
3. For financial Year 2013-14, there is no tax for the income up to Rs. ___________. a. 1,90,000 b. 2,00,000 c. 1,80,000
4. A Will cannot be hand-written. a. True b. False
5. Copy of the Will certified under the seal of a court of a competent jurisdiction is known as ___________. a. Codicil b. Probate c. Succession certificate
Answers: 1 a; 2 b; 3 b; 4 b; 5 b
ICICI Securities Page 194 of 194 JCP on Managing Personal Finances Session 6: Asset classes & product suitability AND Goal planning
1. T-Bills form part of which asset class? a. Debt b. Cash and cash equivalents c. Alternate assets
2. Individuals above the age of 60 years can subscribe to NPS. a. True b. False
3. The minimum ticket size for PMS, according to SEBI guidelines, is Rs. ___________. a. Rs. 1 crore b. Rs. 50 lakh c. Rs. 25 lakh
4. A in SMART goals, stands for ___________. a. Active b. Alternative c. Attainable
5. Rule of ___________ is used to calculate the number of years it will take for your lump sum investment made today to triple (grow by 3 times). a. 114 b.144 c. 141