IRDA has come out with a circular on 24 March 2008 reducing the solvency margin on pure risk insurance policies, popularly known as term insurance. The pure term insurance policies would attract lower solvency margin now. Solvency margin is similar to the capital adequacy ratio which are being maintained by banks.
The additional capital freed up by the reduction in solvency margin should help insurance companies to price the pure risk cover cheaper and take it to the various segments of the public.
We expect that the term insurance policies would become cheaper in the months to come. The insurance companies may take a month to implement the new lower premiums due to operational constraints. Good news for the public as well as for the insurance companies!!
Tuesday, March 25, 2008
Sunday, March 23, 2008
Most important lesson from Bear Stearns fiasco - Asset Diversification
Bear Stearns is history now! It has been taken over by JP Morgan Chase for $235 million in a stock swap deal whereby, each individual share of Bear Stearns is valued at $2.00 (USD Two!!) The stock of Bear Stearns have plummeted in value from $160 in March 2007 to $2 in March 2008. The fall is tremendous and it is well beyond the imagination of all.
Most important issue part of the whole episode is how staff members of Bear Stearns have been terribly impacted by the takeover of JP Morgan Chase. Bear Stearns employs 14,000 people across the globe and the staff own more than 30% of the stock of the company. The worst affected lot seems to be them who have lost all their wealth due to this merger.
This throws up an interesting as well an very important point: asset diversification. However confident you are about your company, it is prudent to en-cash part of your share holding in your own company and move it to assets outside your business/industry/sector to provide downside protection. We need to accept the fact that the success or failure of a company are outside the scope, influence and control of ordinary employees, and it is for their good sake they diversify their assets rather than just holding on their employers shares. We have covered the need for asset diversification in our post "Prudential Financial Management". Click here to read the article.
Who in this world would have thought that Bear Stearns would go down in March 2007 when it was quoting at $160? The net worth of the company's Chairman fell from over $1 Billion to just over $12 million in exactly 12 months time.
We have at least 50 companies in India which has provided shares to their employees and made them millionaires over the last 10 years, like Infosys, Wipro, CTS etc. We strongly advise these employee millionaires to convert part of their holdings in their employer company in a orderly and timely manner to diversify into other income generating/capital appreciating assets to avoid a la Bear Stearns!!
Most important issue part of the whole episode is how staff members of Bear Stearns have been terribly impacted by the takeover of JP Morgan Chase. Bear Stearns employs 14,000 people across the globe and the staff own more than 30% of the stock of the company. The worst affected lot seems to be them who have lost all their wealth due to this merger.
This throws up an interesting as well an very important point: asset diversification. However confident you are about your company, it is prudent to en-cash part of your share holding in your own company and move it to assets outside your business/industry/sector to provide downside protection. We need to accept the fact that the success or failure of a company are outside the scope, influence and control of ordinary employees, and it is for their good sake they diversify their assets rather than just holding on their employers shares. We have covered the need for asset diversification in our post "Prudential Financial Management". Click here to read the article.
Who in this world would have thought that Bear Stearns would go down in March 2007 when it was quoting at $160? The net worth of the company's Chairman fell from over $1 Billion to just over $12 million in exactly 12 months time.
We have at least 50 companies in India which has provided shares to their employees and made them millionaires over the last 10 years, like Infosys, Wipro, CTS etc. We strongly advise these employee millionaires to convert part of their holdings in their employer company in a orderly and timely manner to diversify into other income generating/capital appreciating assets to avoid a la Bear Stearns!!
Tuesday, March 18, 2008
Markets in Free Fall!!
The Indian stock markets have gone through a significant correction in the past two months. From the heights of 21,800 in Jan the Sensex has come down to below 15,000 levels. Mid cap and small cap companies have seen even more steep falls in the same time period. This has induced panic amongst several segments of Investors. What should be our current strategy now?
The current fall has been triggered by a combination of factors. A combination of fears of a US recession, turmoil in the US financial markets, poor Industrial growth as shown by the Jan IIP numbers, and uncertainty over the agricultural loan waiver for banks has contributed to such a fall. The exposure of Indian financial institutions like ICICI to volatile US financial instruments have added to the selling pressure.
While each of the above reasons has been analyzed at length in the media, the primary challenge is that of liquidity. Heavy FII selling has played its part. For e.g. BSMA (Bear Sterns) sold for Rs 685 crores on Mar 17th. In such an uncertain environment there is no buying support, further reducing the liquidity.
In the past few years, whenever the markets have underperformed, they have given significant buying opportunities and there has been a strong upside. However, the combination of macro economic factors seems to be extremely negative now.
What not to do?
1. Price averaging – Do not add to companies you hold already just because they have fallen. Averaging prices does not work here.
2. Book profits – Book profits in companies where significant profits are still available.
3. Weed out speculative/momentum stocks – If your portfolio has speculative or momentum driven stocks (Reliance ADAG companies typically fall in this category), then please sell them. Even if this means taking heavy losses, cut your losses. It will avoid further pain in the long run.
4. Do not use 52 Week High/Low Prices as a reference - Please do not buy any scripts because they have fallen 40 or 50% in the last one month. Avoid comparison against early Jan 08 prices. The true value of a stock is not determined by the price fluctuation but by the intrinsic value of the company.
5. Derivatives/Day trading – Avoid derivative trading or intra day equity trading.
6. No leverage – Avoid taking loans to invest in equity.
7. Stop watching NDTV Profit/CNBC – Tracking your stocks on an hourly basis will not change their fortunes. You will also avoid a lot of noise.
Some suggestions:
1. Hold on to fundamentally strong companies in your portfolio – they will rally in the future.
2. Dividends are back in vogue – Several dividend paying companies are available cheap now – Varun Shipping, Ador Fontech, Tamil Nadu News Print etc.
3. Equity Mutual fund SIP – Take limited exposure in the equity markets through SIP schemes of established fund houses. Avoid any NFO schemes now.
4. Sectors to pick -. Agriculture commodities, FMCG, Pharma, Paper, mid cap IT are sectors where top companies should be explored. Do not rush in to buy in large amounts. Stagger your purchases.
5. Hold your nerves – If you have assessed the value of a stock and brought at a price with sufficient margin of safety, then have the nerve to hold on in the face of further losses.
Cash is king. Avoid panic and be cautious. The market is entering new territory where it is linked to international markets and players.
Friday, March 14, 2008
Get to know about Public Provident Funds(PPF)
Today we have a variety of fixed income instruments to consider. Bank fixed deposits are popular. There are several other alternatives including Infrastructure bonds, Post office Monthly Income Scheme (POMIS), Kisan Vikas Patra (KVP), National Savings Certificate (NSC), Provident Fund etc. We would like to profile a popular instrument – Public Provident Fund (PPF).
Overview:
PPF is a scheme started by the government of India in 1968. It encourages the public to save money for the long term. Generous tax breaks are available and it is currently the only instrument enjoying EEE benefits (tax exemption on the initial amount invested, interest which accumulates and the final amount which is withdrawn). It is also exempt from wealth tax.
1. The annual interest rate is reviewed on an annual basis. The current rate is 8%.
2. The minimum amount to be invested is Rs 500 per year and the maximum is Rs 70,000 per year.
3. There is a lock in period for fifteen years. Partial withdrawals are permitted after five years. It is also possible to take loans for the partial amount after one year.
4. After 15 years from the date of making the initial deposit, the depositor can opt for extension of the PPF account for a further period of 5 years.
PPFAdvantages:
1. Tax breaks - The product offers great post tax returns. To obtain 8% post tax returns, we need to invest in instruments which offer 11%+ pre tax returns (for those in the 30% tax slab). Risk free instruments offering such returns are not readily available.
2. Safety - Since the product has government backing, it has the highest safety.
3. Flexibility – We can invest what we can spare each year. It offers flexibility to investors to manage liquidity surplus/shortfalls. Suitable for those who have non-regular incomes as they can deposit part of their one-off income here, with a minimum amount of Rs500 every year.
4. Reach – Easy access for the product through the SBI office/post offices.
5 Nomination facility is available on PPF deposits.
Disadvantages:
1. Flexible returns – The annual interest rate varies depending on the government decision. In the last decade interest rates where as high as 12%, in line with the market rates.
2. Lock In- There is a lock in for fifteen years. While the withdrawal/loan provisions provide partial mitigation the funds are still locked in for fifteen years.
3. Documentation – Careful scrutiny of the pass book entries is required. Manual ledger entries are posted, which are prone to errors.
4. NRI’s cannot open a PPF account. Therefore, if you are planning to go on a long term trip which would make your residential status as "NRI", it is better to open an account before you leave the shores of India.
Points of Interest:
1. Minimum investments are required each year. While exceptions are possible it makes sense to invest at least the minimum amount.
2. Investing in the beginning of the month before 5th day is advisable to get higher interest.
3. While the individual limit is Rs 70,000 per year, it is possible to open separate PPF accounts for self, spouse and the HUF (more on HUF’s later)
4. Goal centric planning is possible – The lack of liquidity can be used to plan investments for a long term goal like children’s education.
5. NRI’s can continue to invest in PPF accounts opened prior to getting their residential status changed to NRI only on a "non-repatriation" basis.
Summary:
PPF is a great savings instrument for those in the highest tax bracket. It offers a combination of unmatched security, excellent returns and flexibility. It also inculcates a regular savings habit. If we park a portion of funds which are not required immediately then the lack of liquidity is a blessing as it allows the corpus to accumulate.
We strongly urge readers to open a PPF account at the soonest. While it does not have the glamour of equity or real estate investments, systematic savings in this risk free security will help us in the long run.
Overview:
PPF is a scheme started by the government of India in 1968. It encourages the public to save money for the long term. Generous tax breaks are available and it is currently the only instrument enjoying EEE benefits (tax exemption on the initial amount invested, interest which accumulates and the final amount which is withdrawn). It is also exempt from wealth tax.
1. The annual interest rate is reviewed on an annual basis. The current rate is 8%.
2. The minimum amount to be invested is Rs 500 per year and the maximum is Rs 70,000 per year.
3. There is a lock in period for fifteen years. Partial withdrawals are permitted after five years. It is also possible to take loans for the partial amount after one year.
4. After 15 years from the date of making the initial deposit, the depositor can opt for extension of the PPF account for a further period of 5 years.
PPFAdvantages:
1. Tax breaks - The product offers great post tax returns. To obtain 8% post tax returns, we need to invest in instruments which offer 11%+ pre tax returns (for those in the 30% tax slab). Risk free instruments offering such returns are not readily available.
2. Safety - Since the product has government backing, it has the highest safety.
3. Flexibility – We can invest what we can spare each year. It offers flexibility to investors to manage liquidity surplus/shortfalls. Suitable for those who have non-regular incomes as they can deposit part of their one-off income here, with a minimum amount of Rs500 every year.
4. Reach – Easy access for the product through the SBI office/post offices.
5 Nomination facility is available on PPF deposits.
Disadvantages:
1. Flexible returns – The annual interest rate varies depending on the government decision. In the last decade interest rates where as high as 12%, in line with the market rates.
2. Lock In- There is a lock in for fifteen years. While the withdrawal/loan provisions provide partial mitigation the funds are still locked in for fifteen years.
3. Documentation – Careful scrutiny of the pass book entries is required. Manual ledger entries are posted, which are prone to errors.
4. NRI’s cannot open a PPF account. Therefore, if you are planning to go on a long term trip which would make your residential status as "NRI", it is better to open an account before you leave the shores of India.
Points of Interest:
1. Minimum investments are required each year. While exceptions are possible it makes sense to invest at least the minimum amount.
2. Investing in the beginning of the month before 5th day is advisable to get higher interest.
3. While the individual limit is Rs 70,000 per year, it is possible to open separate PPF accounts for self, spouse and the HUF (more on HUF’s later)
4. Goal centric planning is possible – The lack of liquidity can be used to plan investments for a long term goal like children’s education.
5. NRI’s can continue to invest in PPF accounts opened prior to getting their residential status changed to NRI only on a "non-repatriation" basis.
Summary:
PPF is a great savings instrument for those in the highest tax bracket. It offers a combination of unmatched security, excellent returns and flexibility. It also inculcates a regular savings habit. If we park a portion of funds which are not required immediately then the lack of liquidity is a blessing as it allows the corpus to accumulate.
We strongly urge readers to open a PPF account at the soonest. While it does not have the glamour of equity or real estate investments, systematic savings in this risk free security will help us in the long run.
Wednesday, March 12, 2008
Adding an International flavor to your investments through Mutual Funds!!
One of the fundamental principles of equity investing is diversification. Investing in an index fund for e.g. will help us diversify the portfolio away from specific stocks or sectors. With the Indian markets going through tough times does it make sense for us to invest outside? Today the investor is lucky to have opportunities to invest directly or through mutual funds. This post looks at Indian funds with direct exposure in International stocks.
Regulations:
The Indian government has allowed mutual funds to have international exposure of upto five billion dollars. In the second half of 2007 eleven overseas funds raised 2.2. billion dollars. Of course only a part of it will be invested outside. If the fund invests more than 35% of the assets abroad then it will not be considered to be an equity fund.
Advantages:
The advantage these funds offer is the chance to invest in foreign companies. They could have an emerging market focus or could be in large companies in the developed economies. In scenarios when the Indian market suffers a steep fall, there will be a cushion. Also investing in specific themes is possible. For e.g. DSPML World Gold fund invests in gold mining and producing companies. The mechanism is being followed is to invest in Merrill Lynch International Investment Funds - World Gold Fund (MLIIF -WGF). According to September portfolio of the fund, the top three companies where the fund invested are Australia-based Newcrest Mining, Canada-based Barrick Gold and China's Zinjin Mining.
Disadvantages:
The downside is lack of understanding of the markets and the mechanism for investing. The transparency levels are lower. While some funds invest directly in foreign companies, other invest in indices. This is popular with International fund houses. For e.g. Principal invests in PGIF Emerging Markets Equity Fund as a vehicle. This could also lead to conflict of interest issues. The investor also takes on currency risk as he is exposed to exchange fluctuations.
Performance:
Most of the funds have a short track record of less than one year. The oldest funds in the Indian market in this category are Templeton India Equity Income and Principal Global Opportunities Fund. A quick review of the returns reveals that they have outperformed their category in the past three months. However over a one year period, the Indian indices outperform the Principal fund. What this reveals is these funds offer greater protection during downside in the Indian markets.
A look at the portfolio of the Templeton fund reveals that it has invested in stocks like Anglo American PLC (USA), Ternium SA (South Africa), United Micro Electronics Corporation (Taiwan), Samsung Heavy Industry (Korea) etc. The fund has outperformed the Indian Indices since it’s inception. The DSP Gold Fund has delivered returns comparable to Gold ETF’s in the market.
Conclusion:
International funds have a definite part to play in our portfolios. While they need not be core holdings, it is worthwhile investing in them through the SIP route. We like the Templeton India Equity fund. A good track record, greater transparency and an emerging market focus are favorable pointers. The fund manager, Mark Mobius has proven expertise in investing in emerging markets. The fund has a decent corpus of Rs 1500 crores, available for investment. It would be a good long-term addition to a portfolio.
Regulations:
The Indian government has allowed mutual funds to have international exposure of upto five billion dollars. In the second half of 2007 eleven overseas funds raised 2.2. billion dollars. Of course only a part of it will be invested outside. If the fund invests more than 35% of the assets abroad then it will not be considered to be an equity fund.
Advantages:
The advantage these funds offer is the chance to invest in foreign companies. They could have an emerging market focus or could be in large companies in the developed economies. In scenarios when the Indian market suffers a steep fall, there will be a cushion. Also investing in specific themes is possible. For e.g. DSPML World Gold fund invests in gold mining and producing companies. The mechanism is being followed is to invest in Merrill Lynch International Investment Funds - World Gold Fund (MLIIF -WGF). According to September portfolio of the fund, the top three companies where the fund invested are Australia-based Newcrest Mining, Canada-based Barrick Gold and China's Zinjin Mining.
Disadvantages:
The downside is lack of understanding of the markets and the mechanism for investing. The transparency levels are lower. While some funds invest directly in foreign companies, other invest in indices. This is popular with International fund houses. For e.g. Principal invests in PGIF Emerging Markets Equity Fund as a vehicle. This could also lead to conflict of interest issues. The investor also takes on currency risk as he is exposed to exchange fluctuations.
Performance:
Most of the funds have a short track record of less than one year. The oldest funds in the Indian market in this category are Templeton India Equity Income and Principal Global Opportunities Fund. A quick review of the returns reveals that they have outperformed their category in the past three months. However over a one year period, the Indian indices outperform the Principal fund. What this reveals is these funds offer greater protection during downside in the Indian markets.
A look at the portfolio of the Templeton fund reveals that it has invested in stocks like Anglo American PLC (USA), Ternium SA (South Africa), United Micro Electronics Corporation (Taiwan), Samsung Heavy Industry (Korea) etc. The fund has outperformed the Indian Indices since it’s inception. The DSP Gold Fund has delivered returns comparable to Gold ETF’s in the market.
Conclusion:
International funds have a definite part to play in our portfolios. While they need not be core holdings, it is worthwhile investing in them through the SIP route. We like the Templeton India Equity fund. A good track record, greater transparency and an emerging market focus are favorable pointers. The fund manager, Mark Mobius has proven expertise in investing in emerging markets. The fund has a decent corpus of Rs 1500 crores, available for investment. It would be a good long-term addition to a portfolio.
Tuesday, March 11, 2008
Where to park your additional income generated out of proposed tax cuts in Budget 2008?
The recent budget has lot of goodies for tax paying individuals in the form of reduced income tax payouts through enlarged tax slabs. The new tax slabs are as follows:
Up to Rs150, 000 - NIL
150,000 to 300,000 - 10%
300,000 to 500,000 - 20%
Above 500,000 - 30%
The surcharge and education cess at 10% and 3% remains unaltered.
Due to the expanded income range for all the tax rates, there is a significant savings to individuals in the form of reduced taxes. Let’s assume, a person earning Rs600, 000 per annum, would be able to enjoy lower taxes to the extent of around Rs48, 000 p.a, which translates into Rs4, 000 per month. This is a real bonus! Now the question that comes up is how to utilize the same by prudently investing it in wealth generation avenues.
We think the surplus funds need to deployed in the following areas (depending on the individual’s situation a specific area takes priority)
Repayment of credit card outstanding:
For those who have outstanding credit card dues, it is better that you start re-paying it. Credit card dues have interest rates in excess of 30% p.a and cutting them should be the first priority.
Health Insurance:
It is vital to look at the Health Insurance coverage for self and families. In our opinion, medical costs can create big erosion in wealth in case of unfortunate major medical conditions. We strongly urge people to opt for a Health Insurance Floater policy for the family.
There is an additional deduction that has been announced in the budget with regard to the payment of health insurance premium for parents under sec 80 D up to Rs15, 000/- p.a. Further, the government has proposed that if either of such individual tax payer's parents is a senior citizen, the deduction would be allowed up to Rs 20,000. Please note that this is in addition to the already existing deduction of Rs15, 000 available for health insurance premiums.
Increasing the retirement nest egg:
The savings generated out of tax cuts should be canalized for increasing the retirement nest egg. If you don’t have a pension from your employer, which is mostly the case nowadays, we strongly urge you to start a pension plan with Insurance companies to create a retirement corpus. In case of retirement plans, we suggest that you go for pure pension plans instead of bundled products like pension plan with life insurance cover.
Increase your EMI's on housing loans:
If you are having sufficient leeway in your housing loan repayment, then you can also look at the possibility of increasing the monthly EMI's on your housing loan. It can help you to get higher tax deduction on principal repayment as well as help to reduce the loan amount/tenure as well as enhanced tax deductions on interest payments.
Planning for children’s future:
Children education and marriage related expenditure is known expenditure in the long run. Increasing contributions to the savings for these goals will help.
Contribute to charity:
It is a good idea to contribute 10% of your tax breaks to eligible charity. It helps us to contribute something back to the society and at the same time provides you further tax benefits in the form of deductions u/s 80G of the Income Tax Act.
Up to Rs150, 000 - NIL
150,000 to 300,000 - 10%
300,000 to 500,000 - 20%
Above 500,000 - 30%
The surcharge and education cess at 10% and 3% remains unaltered.
Due to the expanded income range for all the tax rates, there is a significant savings to individuals in the form of reduced taxes. Let’s assume, a person earning Rs600, 000 per annum, would be able to enjoy lower taxes to the extent of around Rs48, 000 p.a, which translates into Rs4, 000 per month. This is a real bonus! Now the question that comes up is how to utilize the same by prudently investing it in wealth generation avenues.
We think the surplus funds need to deployed in the following areas (depending on the individual’s situation a specific area takes priority)
Repayment of credit card outstanding:
For those who have outstanding credit card dues, it is better that you start re-paying it. Credit card dues have interest rates in excess of 30% p.a and cutting them should be the first priority.
Health Insurance:
It is vital to look at the Health Insurance coverage for self and families. In our opinion, medical costs can create big erosion in wealth in case of unfortunate major medical conditions. We strongly urge people to opt for a Health Insurance Floater policy for the family.
There is an additional deduction that has been announced in the budget with regard to the payment of health insurance premium for parents under sec 80 D up to Rs15, 000/- p.a. Further, the government has proposed that if either of such individual tax payer's parents is a senior citizen, the deduction would be allowed up to Rs 20,000. Please note that this is in addition to the already existing deduction of Rs15, 000 available for health insurance premiums.
Increasing the retirement nest egg:
The savings generated out of tax cuts should be canalized for increasing the retirement nest egg. If you don’t have a pension from your employer, which is mostly the case nowadays, we strongly urge you to start a pension plan with Insurance companies to create a retirement corpus. In case of retirement plans, we suggest that you go for pure pension plans instead of bundled products like pension plan with life insurance cover.
Increase your EMI's on housing loans:
If you are having sufficient leeway in your housing loan repayment, then you can also look at the possibility of increasing the monthly EMI's on your housing loan. It can help you to get higher tax deduction on principal repayment as well as help to reduce the loan amount/tenure as well as enhanced tax deductions on interest payments.
Planning for children’s future:
Children education and marriage related expenditure is known expenditure in the long run. Increasing contributions to the savings for these goals will help.
Contribute to charity:
It is a good idea to contribute 10% of your tax breaks to eligible charity. It helps us to contribute something back to the society and at the same time provides you further tax benefits in the form of deductions u/s 80G of the Income Tax Act.
Thursday, March 6, 2008
Liquid Plus funds – a better option to park your short term funds!!
One of the most common issues faced by all of us is how to efficiently manage short term liquidity. Normally we leave the funds lying in our Saving Bank account which earns a low interest rate of 3.5% that too, on the lowest balance in the month. One of the efficient ways of managing short term funds is to park it in "Liquid mutual funds". Liquid mutual funds have emerged as an attractive alternative to park funds needed at short notice. The post tax returns are better than savings bank accounts.
Liquid mutual funds park their assets in debt securities which earns interest in relation to the prevailing interest rates in the economy. There are two types of liquid funds, namely, Liquid Funds and Liquid Funds Plus. Liquid funds cannot have debt securities with more than 1 year maturity. Liquid Plus funds can hold debt securities in their portfolio with more than 1 year maturity.
In the 2007 Union Budget the dividend distribution tax (DDT) for liquid funds was increased from 14.03% to 28.30%. For liquid plus funds the DDT remains at 14%. This has made liquid plus funds more attractive. This has lead to the announcement of a flurry of liquid plus funds by different fund houses. Redemption is possible in a couple of days. The tax treatment for liquid funds makes it attractive to opt for a regular dividend payout option.
Returns:
In terms of returns, liquid plus funds compare favorably with category returns of 8.31% over the last one year. Of the available options, funds like Canara Robeco Liquid Plus Retail and HDFC Cash Management Saving Plus Retail have a good three year track record. Due to favorable returns, these funds have seen significant inflows. Reliance Mutual Funds liquid plus funds manages a total corpus of more than Rs6000 crores. Amongst the top twenty mutual funds (by AUM), there are four liquid plus funds.
Suitability of the product:
They are suitable for investors with surplus short-term funds and not sure when it would be required. A liquid fund provides excellent opportunity to park your short term funds at a higher rate compared to savings bank account. It also provides you with the flexibility to break the investment partially without compromising on the returns based on your funds requirement. It is also tax efficient compared to bank deposits which are taxed at a higher rate (say at 30% for income in excess of Rs2.5 lakhs for Financial year 2007-08).
However please note that the time for redemption of a liquid plus fund is a week. They also attract marginally higher administration charges (around 20 basis points) than liquid funds.
For parking short-term funds, we can also look at other categories of funds like arbitrage funds, which we will discuss later.
Liquid mutual funds park their assets in debt securities which earns interest in relation to the prevailing interest rates in the economy. There are two types of liquid funds, namely, Liquid Funds and Liquid Funds Plus. Liquid funds cannot have debt securities with more than 1 year maturity. Liquid Plus funds can hold debt securities in their portfolio with more than 1 year maturity.
In the 2007 Union Budget the dividend distribution tax (DDT) for liquid funds was increased from 14.03% to 28.30%. For liquid plus funds the DDT remains at 14%. This has made liquid plus funds more attractive. This has lead to the announcement of a flurry of liquid plus funds by different fund houses. Redemption is possible in a couple of days. The tax treatment for liquid funds makes it attractive to opt for a regular dividend payout option.
Returns:
In terms of returns, liquid plus funds compare favorably with category returns of 8.31% over the last one year. Of the available options, funds like Canara Robeco Liquid Plus Retail and HDFC Cash Management Saving Plus Retail have a good three year track record. Due to favorable returns, these funds have seen significant inflows. Reliance Mutual Funds liquid plus funds manages a total corpus of more than Rs6000 crores. Amongst the top twenty mutual funds (by AUM), there are four liquid plus funds.
Suitability of the product:
They are suitable for investors with surplus short-term funds and not sure when it would be required. A liquid fund provides excellent opportunity to park your short term funds at a higher rate compared to savings bank account. It also provides you with the flexibility to break the investment partially without compromising on the returns based on your funds requirement. It is also tax efficient compared to bank deposits which are taxed at a higher rate (say at 30% for income in excess of Rs2.5 lakhs for Financial year 2007-08).
However please note that the time for redemption of a liquid plus fund is a week. They also attract marginally higher administration charges (around 20 basis points) than liquid funds.
For parking short-term funds, we can also look at other categories of funds like arbitrage funds, which we will discuss later.
Monday, March 3, 2008
Life Insurance - a primer!!
Life Insurance is an important part of personal financial planning. The important question of what is the quantum of adequate insurance cover to be taken by individuals?
There is no hard and fast rule to determine the exact amount of insurance cover to be availed by an individual. It varies from individual to individual. Calculating the Human Life Value and determination of the amount of the insurance cover is one of the popular ways of arriving at the life cover. But one should also look at the family set up of the individual, his financial and non-financial commitments, number of dependents, his assets and liabilities, nature of life-style before we decide on the life cover for a person. In our opinion, one should have life insurance to provide the dependants with the same level of lifestyle even in the absence of the insured.
When we are convinced that life cover is important, the next question which immediately comes up is what kind of policies one should take? As we believe that life insurance is only a risk cover and it should never be looked upon as an investment, we strongly recommend individuals to go for pure risk cover policies, which are popularly known as "Term Insurance". The advantages of term insurance are:
Premiums are very low and the individual can have a higher risk cover.
Ease of understanding the products and there is no hidden cost.
So is it not worthwhile to look at various kinds of policies like endowment, money back, whole-life policy etc.? If you are an individual who can stick to fundamental discipline in your investments, term insurance would suffice. But we don’t live in an ideal world; therefore, we can look at other options like endowment and other money-back policies. But you should remember that the investment returns on these insurance policies, historically, has not been very high.
Another popular category of Insurance product which is being marketed very aggressively in the last few years are Unit Linked Insurance Plans, popularly known as ULIP's. ULIP's are insurance products which consist of risk cover and an investment portion. The investment portion can be linked to debt market or equity markets or a combination of both in India. The investment portion which is related to equity markets have given very high returns in the last 3-4 years and has helped the insurance companies to market ULIP as a magical product. But we should all remember that the upward movement of the stock markets cant happen forever and you have to temper your expectations going forward. If you are looking at ULIP's as a short-cut to investments in stock markets, it is not. We believe hat ULIP's should be taken by individuals who are able to wait for the full term and allow the investments to run for a longer tenure to fully capitalize it.
To conclude, we believe:
1. In our opinion, one should have adequate life insurance coverage to provide the dependants with the same level of lifestyle even in the absence of the insured.
2. Life insurance is only a risk cover and it should never be looked upon as an investment.
3. You should remember that the investment returns on insurance policies, historically, has not been very high.
4. We believe hat ULIP's should be taken by individuals who are able to wait for the full term and allow the investments to run for a longer tenure to fully capitalize the equity opportunities and also to absorb the high front-loaded costs.
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