Tuesday, 19 March 2013

Are We Really Understood Inflation? and What Returns are we getting from our Investments...Read on

To understand something, we need to dig slightly deeper, this is one such initiative, hope this helps to understand and where we stand all the days...

When I started my career in way back March 1996, 17 years before my salary was Rs. 3000 and I used to spend more than Rs. 2000 for the rent as well as food and transport. No mobile, No internet and No TV in the room. 

Expenses in Mar 1996
 Rs.        -2,000
Expenses after (Yrs)  (1996-2013)
17 Years
Rate of Inflation
Expenses in March 2013
 Rs.         7,400

Assume at 8% inflation, the same amount today will be in the 17 years is Rs. 7,400. Today, we can't eat less than 50 rupees for breakfast, lunch and dinner, so it would be Rs. 4500 for food alone.
Assume rent is Rs. 2500 and mobile; transport and other stuff will easily be over Rs. 7400. So we can comfortably assume 8% inflation in the future too!
Unfortunately, many of the investor will never ever understand two things in finance 1. Inflation 2. Purchasing Power.

1. Inflation: Whatever is your investment vehicle, if it is not beat inflation, then sooner the inflation will eat all the money and you will go bankruptcy?

2. Purchasing Power: Investor will always look at the absolute value and never understand whether the money has the purchase power. Most of the investor will be happy, even if they get the money back after 5 years. At the rate of 8% inflation the value will be 50% only, which means the money has 50% of the purchasing power which investor hardly realize or notice.

I have enclosed excel file to understand the power of inflation much better, by putting inflation versus return to understand better. If something is demonstrated with numbers, generally people understand and relate easily.

1. Money Invested in Insurance Policy for Long Term or Retirement
2. Money Invested in PPF
3. Money Invested in FD
4. Money Invested in Mutual Fund SIP

Inflation Template:
This is the template wherein you can put the current expenses and the number of years and if you want to change the inflation percentage also, you will get future expenses. 

Whole Life Policy, Very Popular one
For 12 Lakhs life cover, the premium will be Rs. 1,04,400 per annum for 15 Years, for 25 years old Male.        
From 6th Year onwards, 3% (approx.) of life cover will be given till 10th year, from 11th year till death or 100 years whichever is earlier.      5% of Sum Assured plus cash incentive (assume 3%), so it would be 96K per annum and I took it as 1 lakh. 
Assume, the investor is living up to 80 years; he will continuously get only 1 lakh as long as he alive. In this case, he will get 1 lakhs for 35 years.

After death Rs 12 Lakhs plus guarantee addition, and it will not be more than double, so it would be 25 Lakhs. If he dies within 15 years, then the investor will get Rs. 12 Lakhs. 

Assume monthly expenses of 20K today in 15 years will be 63K, which means 7.5 lakhs per annum, whereas insurance company is giving 1 lakh and no inflation adjusted payment in the future. This policy will be a disaster, yet it is sold like hot cake, because investor never ever understand what is inflation and what is purchasing power?       

If the same can be put in a mutual fund the maturity value at the end of 40 to 80 increased by 5 years as follows, which is much bigger than whole life policy and the beauty is we can take whatever the amount we want, whereas in whole life policy we have to receive very less amount only.

Maturity Value
 Rs. 44,05,706
 Rs. 70,54,603
Rs. 1,17,21,101
Rs. 1,99,45,066
Rs. 3,44,38,503
                 Rs. 5,99,80,890
Rs.  10,49,95,305
                   Rs. 18,43,26,083
                   Rs. 32,41,34,020

Family PF (Husband and Wife Contribution)
Many of us believe that PPF is one of the best (safe) investment and returns are tax free and almost all the individual open PPF account. I have assumed 8.8% interest throughout, which is not possible for the next 15 years, yet I assume. At the rate of 8% inflation, the PPF money will get drained in 8 years after PPF closure. See the excel sheet attached.

I remember the saying GOOD is not GOOD Enough, When BETTER is Expected.

Popular Investments are FD, Senior Citizen Savings, Post office MIS
Most of the retiree wanted to safe guard their retirement funds to any of the above investments and all the interests are subject to tax, yet I assume 9% post tax return.

For example, if the individual invest 50 Lakhs rupees at the rate of 9% interest, and inflation assumed as 8%, in 11 years entire corpus will get drained, which means he will have no money left if he lives beyond 71 years!

Right Amount Invested in SIP
If you want to retire at 40, you need to save 24K per month for the next 15 years and you can live up to 78 years comfortably. You start doing whatever you like after 40 years.

We are living in the world of nuclear family and it will be worsen in the coming years. Moreover, the Generation Next wanted to retire quickly which translates into more retirement period than working period. If we have not created enough corpus's for our retirement, then future will be a big question mark?

Sunday, 17 March 2013

VRS - Voluntary Retirement Scheme

Why VRS?

It can be two types either the employer feels that the employee is not adding any value because of the current trend and they may give GOLDEN Handshake and give VRS.

Condition: Employer may initiate VRS after completion of 30 years of qualifying service
Sometimes, the employee feel that they wanted to something on their own or their personal life is more important than working till the age of retirement. In both the cases VRS can happen

Condition: Employee can opt for VRS after completion of 20 years of qualifying service.
In a Public Sector or Private Sector companies employee can opt for 10 years of service and it is subject to approval of the employer.

Reasons for VRS

It is a technique used by companies for trimming the workforce employed and it is a common method to dispense the excess man power and improve the performance of the organization.

It is called Golden Exchange

1. Recession in Business
2. Downsizing
3. Realignment of business - due to market conditions
4. Joint Ventures with Foreign collaborations
5. Takeovers and mergers
6. Business re-engineering process
7. Product/Technology Obsolescence

Voluntary Retirement Scheme or The Golden Handshake scheme as is known commonly is another form of retrenchment by employer.

From point of view of employee:

1. Tax free lump sum payment.(Limited to Rs.500000)
2. Early retirement may give time to follow other vocations.
3. More time for family and peace of mind.

From point of view of employer:

1. Reduction in size of workforce, as the position which is once offered for VRS is never ever filled up again.
2. Considerable savings in long term although a huge ad hoc expense.
3. Excess workforce of employer in a department or the company as a whole reduced and only more productive and young people are left.

Conditions to be eligible for VRS:

1. Above 40 years of age or has completed 10 years of service.
2. Cannot join the same organisation or its subsidiaries ever again.

Computation of VRS:

Each company can frame its own scheme but it shall not be violating the norms of Rule 2BA of the Income Tax Act, which prescribes the following:

The payment shall be either of the two amounts computed as per the following ways.

1. Three months’ salary multiplied by number of completed years of service.
2. Monthly emoluments (salary) at the time of retirement multiplied by the number of months left for service.

Salary here will mean - Basic + DA + Commission based on fixed percentage of turnover

It is to be kept in mind that the maximum exemption limit is Rs. 5,00,000 only and if the payment under VRS exceeds this limit then the sum received over and above Rs.5,00,000 will be taxable.

How the Money can be invested

The money can be invested in 4 different instruments

  1. Post office MIS: Jointly husband and wife can put 9 lakhs which gives 8.5% interest which is taxable and the lock in period of 5 years.
  2. For VRS, the entry age is 55 years, others 60 years and it will fetch 9% quarterly compounding, and the investor can receive every quarter interest and paid as cash or direct credit, and the lock in period will be again 5 years and the interests are taxable.
  3. Monthly Income Plan: In mutual fund Monthly Income Plan up to 20% of the investment is invested in an equity and the remaining 80% of the money is in a debt funds, which will earn around 9 to 10% post tax, lock in period is only one year, but if the individual consider this also like other investment tenure of 5 years then it is much more tax efficient and can generate 2% more returns.
  4. Balanced Fund: Some port ion of the money can be invested and this investment is planned for 5 years plus, investor should not look for monthly pay out from the day one and instead if they allow it to grow for 5 years then they can start withdraw around 12% per annum. Depending on the risk the investor can allot the percentage for the same. For VRS their life time post retirement will be bigger than their working period, so this particular investment can’t be avoided.

Thursday, 14 March 2013

Investment Returns Versus Investor Returns!

Whenever I send mails about how the equity mutual fund has performed over a period of time; it is an investment returns, which means the fund has delivered that kind of return, but how many investor has really benefited out of it, hardly any percentage.

I keep wondering, why there is a big disconnects between investment and investor returns. I started applying my mind, looking for the reason and interestingly I found something, I hope it is applicable to majority of the investors.

If you want to become a cricketer, where will you spend all the time, the unanimous answer is; in the ground and do regular practice. Similarly, anybody who wants to excel on something, they invariably spend good amount of time in those areas. In spite of their time and efforts, not everybody is successful in whatever they wanted to achieve in their life.

Like Cricket, most of us today enroll for fitness center and only 2% are committed and they only get good shape and see the desired result. Like Investment return versus investor return, any fitness center can boast that they are very good when it comes to fitness, but whether all the individual enrolled will be benefited, is NEVER!

Today, everybody wanted to multiply their wealth and wanted to live in today’s life style, to do this your income alone will not be sufficient, and you need to invest too.

Why investor has not made return, might be due to the following…

1. Investing on their own, without proper guidance of professional will result in a disaster.
2. Investing without understanding the risk versus reward, and so quit in between.
3. Investment is not goal oriented; the moment some need arises they pull out the money, if it is invested for the sake of investing or bought by force.
4. Hardly spend any time on their investments and expect unreasonable returns.
5. Not willing to know or learn about investment products, which is really very simple.
6. Compare short term savings versus long term investment and draw conclusion.
7. Confused with Insurance and Investment, and investing Insurance for long term.
8. Never understand the importance of term insurance, and do not believe any insurance product is derived out of term insurance.
9. Ignore medical insurance and believe that they will not be hospitalized.
10. No home work is done for choosing an investment or investment advisor and always last minute decision and eventually pays the bigger price, will result lower return in most of their investment.

To succeed in anything you need a coach or professional in those areas, and your time and interest as well as professional’s time will help to achieve anything you wanted.

Mr. Ramakant Achrekar is the Coach for both Sachin Tendulkar and Vinod Kambli, and they started career together and they are equally talented. In the early stages of their life, Kambli promises more talent than Sachin. But, Sachin is very disciplined and committed to whatever he is doing, and he emerged as a genius and the whole world liked him. 

Mr. Ramakant Achrekar is famous because of Sachin Tendulkar, and without Sachin he is like an ordinary coach. The point I wish to make here is, similar to cricket or any other talent could be nurtured, if both of them are working together. Don’t expect magic in your investment, sometimes it happen, but most of the time you have to work hard with your financial advisor or financial planner to get the desired return.

As an individual, you can excel in whatever you are good at. Spend some quality time with your financial advisor to make your resources work. Regular interaction with the advisor would help you to achieve all your financial dreams come true, and then the money will never be a problem in your life.

Making money and creating wealth is a child play, provided if you are disciplined and committed, for our better financial life.

Last but not the least, money is not everything yet it is very important, which address many of our problems in life!