The curious case of Grace Groner and Richard Fuscone
By Manu Nedunkandathil, CFP
Two contrasting lives, but big lesson to learn.
Meet Grace Groner. She was born in 1909 in rural Illinois, America. She was orphaned at the age of 12 and taken care of by a prominent family of the community. She never married nor had any children. She graduated in 1931 entering the workforce at the peak of great depression. She joined Abbott Laboratories as a secretary in 1935 and worked there for the next 43 years.
She had a pretty simple life. Lived in a single bedroom cottage willed to her, bought cloths at rummage sale, never owned a car. But when she passed away in 2010, she left behind over $ 7 million dollars in charity to her alma mater, the Lake Forest college.
And then there is Richard Fuscone who filed for bankruptcy within weeks after Grace Groner passed away. Richard Fuscone went to Dartmouth which is consistently among the highest ranked universities in the United States. Earned his MBA from Chicago and had a very successful career. He was so successful that he retired in 2000 by the age of 40 to pursue personal interest and charity. At the time of his retirement, he was the Vice Chairman of Merril Lynch, Latin American division.
So how did a pro loose it all and a seemingly under qualified secretary beat the pro at his own game to come out as the winner. It seems education and knowledge are just a pale shadow in front of personal behaviour.
Grace Groner did nothing out of the ordinary. In 1935, she purchased three stocks of Abbott Laboratories, the company where she worked for $ 180. She held on to it through recessions and wars, not worrying about market crashes for the next 75 years and even continued to reinvest the dividends.
Lesson learned
Patience and consistency always triumphs. Just the way water cuts through the rock flowing over it through the years, patience and perseverance is sure to get rewarded be it in life or investing in the markets.
For some these qualities come naturally. But for most of us mortals, these qualities have to be cultivated. So, how does an average investor build these qualities?
The good news is that there is a solution. To be a successful investor in the market, one does not need to master the complicated finance formulas and functions. It is as simple as breathing.
The easiest way one can master these qualities is to set goals for your investments and invest in a well-diversified portfolio. These goals can be anything like building retirement corpus, savings for children’s higher education or any long-term goal to which one can identify a need and an emotion.
Linking goals to the investments will make sure that you stay the course till the goal is achieved and help you remain immune to the market noise. The markets have proved that in the long term, the risk of losing money is as good as zero and making real positive returns is the highest.
To put things in perspective, SENSEX has given a return of above 15% CAGR for the period since inception in 1978-79 till 04th December 2019. Which means, in absolute terms Rs. 1 lac invested on 1st April 1978 would have grown to Rs. 4.08 cr in this period.
To be a successful investor you don’t need to be a graduate in economics or finance. Smart investors don’t take actions in haste. They plan, they implement and then they let the time and compounding work for them in their favour.
"When there is nothing clever to do, mistake lies in trying to be clever."
The tax proposals made in the Interim Budget 2019 had stirred a lot of positive emotions for the individual tax payers as soon as they were announced. However, the initial euphoria settled down once the details came out and people understood the effects of the tax proposals on their ultimate tax liability.
However, having said that, there are still some positives from the budget. Here are five takeaways from the tax proposals made in the interim budget for the individual tax payers.
FiveTakeaways
1. Tax rebate limit under section 87A has been increased from present Rs. 3,50,000/- to Rs. 5,00,000/- and maximum tax rebate increased from present Rs. 2,500/- to Rs. 12,500/-. Which implies if one can effectively bring down his taxable income to Rs. 5 lac per annum, his income liability becomes zero.
2. Standard Deduction available to salaried class has been increased from present Rs. 40,000/- to Rs. 50,000/-. A hike of Rs. 10,000/-.
3. TDS limit for interest income from Post Office Savings and Bank Deposits increased from present Rs. 10,000/- to Rs. 40,000/- benefiting a large population of low income group and retirees who park their funds in post office and banks.
4. TDS threshold on rent increased from Rs. 1,80,000/- to Rs. 2,40,000/-.
5. Section 54 exemption on capital gains arising from sale of house property has now been extended to second house property. Provided the capital gains is less than Rs. 2,00,00,000/-. The exemption can only be availed once in a lifetime. Earlier, the exemption on capital gains arising out sale from house property was restricted to Rs. 50,00,000/-.
Being an election year, it was expected of the government to present a pro poor budget. However, the government has done well in limiting its urge to go overboard with unrealistic tax breaks and freebies and thus put pressure on the next government. It has made sure the CAD (Current Account Deficit) is kept well in the desired limit.
In addition, proposals made in terms of yearly direct cash transfer of Rs. 6,000/- to farmers and the tax rebate under section 87A benefiting low income group is going to translate to more cash in the hands to spend leading to increased purchasing power of low income group. This will further have an incremental effect on economic activity which will be good in terms of GDP growth for the country.
One of the asset classes which has proven to be a wealth creator in the long term is Real Estate. With land being a finite commodity and ever growing population, real estate will continue to grow in value in the years to come. Today, be it a common investor or the rich and the wealthy, Real Estate investment is a priority for everyone. Be it a parcel of land, an apartment or a commercial space, everyone is looking to own a piece of the pie.
And why not?
Unlike any other asset class “Real Estate” gives a sense of safety and surety. It is tangible. You can see it and feel it and flaunt it. And if you can hold it for long, the returns can be astronomical.
But, is it as simple as it seems?
Many of us are first time buyers of Real Estate. All of us need a roof above us and there is always a lot of emotions attached to it when one is buying Real Estate for personal consumption. In such cases, emotions and personal preferences overrides any other considerations.
However, if one is looking at buying Real Estate purely as an investment, then there are some factors that need to be considered.
Real Estate Investments : Things to be considered
1. Identifying the right property
Properties within a city don’t have identical growth rates. Two properties under different locations within a city may grow at different pace. It all depends on how the future development in the area pans out. Not everyone is capable to correctly predict the same. So, if you are one of the select few who has a penchant for identifying good properties with chances of higher appreciation, then you must not hesitate. However, if you don’t have the necessary skills to identify good properties, then the selection must be left to experts. The cost will be worth it.
2. Verifying the antecedents of the property
Verifying the legal documents of the property need not be stressed any further, what with all the property dispute cases dragging on in Indian courts for years together. It will be worth while investing in investigating the property antecedents to find any wrong doing by the seller.
It is is an apartment purchase, then the antecedents of the builder needs to be checked. Questions like: –
How many successful projects the builder had delivered?
Have the projects been delivered on time as per promised schedule ?
Whether all the necessary approvals are in place for the construction and has the builder done any variations from the approved plan?
Investing time and money in carrying our due diligence on the matters above will save you a fortune in the future.
3. Liquidity
Though Real Estate is an asset class which can create wealth in the long run, it is not liquid asset. One cannot carry it with self in case of migration neither can he dispose it off immediately in case of any emergency.
More often than not, in times of distress sale, the property in question never fetches the market rates. This is a huge drawback with respect to real estate.
4. Rental Yield
If you are looking at generating regular income through rental income by investing in Real Estate, then, Rental Yield is an important factor to consider. Rental Yield is nothing but rate of return received from the rental income of the investment property. Rental Yield can be further drilled down to Gross Rental Yield and Net Rental Yield.
Gross Rental Yield only accounts for the rental income received from the property for calculating returns, whereas Net Rental Yield not only accounts for the income from the property but also accounts for the expenses incurred to maintain the property like taxes, maintenance expenses etc.
Net Rental Yield can be calculated as follows: –
Net Rental Yield = ((Annual Rental Income – Annual Expenses)/Purchase Price) X 100
Net Rental Yield is a good measure to compare Real Estate investment with returns of alternative investment option like Bank FD, Stocks, Mutual Funds and Gold.
If the Net Rental Yield from the property is less than even the risk free return, then probably an alternative investment option may be considered to better utilise your investible surplus.
5. Encroachment and Land Grabbing
Last but not the least, Encroachment / Land Grabbing is a serious concern when it comes to investing in Real Estate. Especially if the invested property is away from your usual place of residence or city. These take the form of civil disputes and can drag on for years in courts draining your precious resources, time and money.
Property disputes are nothing new to mankind. Disputes related to property have existed since the time man settled down into small villages from being a hunter gatherer. Disputes will continue to arise long after we are gone. Indian courts are a testimony to that fact.
Especially, since the land records to a larger extent are still not computerised, the chances of records being fudged cannot be ruled out. There have been many cases where the owner of the property had lost the ownership of the property or had to sell it below market rates to corrupt individuals or cartels due to lack of physical presence on site coupled with lack of clout in the power corridors.
Hence, if you are looking to invest into a property far away from your domicile, than ensure arrangements are made for keeping your men there or ensure regular visits to stamp your ownership.
Summary
Real Estate asset as a wealth creator cannot be disputed. In line with the basic rules of investment as a matter of diversification, Real Estate as an asset class must find a space in your investment portfolio. However, one may consider the above points before investing into Real Estate.
After all, it is always better to be safe than sorry.
History repeats itself time and again, yet man fails to learn.
Of all the qualities a man possesses, greed is the one which takes him down. And to exploit this very same greed, time and again men of deceit have come come up with new schemes to rob people.
Crypto currency is the new kid in the block which came into being in 2009 and has taken the world by storm in recent years. Everyone is talking about how this new currency is going to change the world and you will lose out if you don’t invest in it.
However, to my knowledge, currency has never been an asset class for investing. The same holds good for crypto currencies too. But before that, can these so called crypto currencies be called currencies at all. To understand this, let us look at the definition of a currency.
Currency is a system of money in general use in a particular country. For any system to be called a currency it must meet two fundamental characteristics. One it should be a store of value and two it should be a common medium of exchange generally accepted.
Which means, if I hold a certain value of currency with me, I should be able to meet my needs on exchange of currency of equal value. However, today I won’t be able to purchase even a needle on the street with any amount of crypto currency in my hands.
It is still not a legal tender for exchange in most countries. Which means it fails to satisfy to the two basic conditions for a currency.
However, in the virtual world, crypto currencies have grown in popularity in recent years because it grants a degree of anonymity to the user.
Governments have started to worry that these currencies are being used for drug dealing, money laundering and tax evasion. Hence, a government action against mainstream use of such currencies cannot be ruled out in the future, which will affect its demand which has been the main reason for its rise in recent years.
In spite of these facts, still crypto currencies or digital assets finds demand from newer investors. And to meet this demand many new currencies are being invented with ICOs (Initial Coin Offering) and crypto exchanges. But this is nothing new. World has seen many such speculative crazes before and will continue to do so.
History is replete with many such events. However, one such notable event is the speculative bubble in the prices of tulip bulbs which happened in Holland in the early seventeenth century.
Tulip was alien to Holland till 1593 when it was introduced to the Dutch by a professor from Vienna. The Dutch were so fascinated by it that soon Tulip mania gripped the whole of Holland pushing the prices of Tulip bulbs ever higher. At the height of its craze which lasted from 1634 to early 1637, everyone from the rich and of the society to the poorest dabbled in Tulips. Everyone imagined that the fascination for Tulips will last forever.
Much like what is happening today with crypto currencies, people who said that the prices of Tulips could not go possibly higher watched with chagrin as their friends and relatives made enormous profits. The temptation was too hard to resist. The prices reached astronomical levels by January of 1637.
However, just like everything else, Tulip bulbs too found financial gravity. And in February of 1637 the prices started falling like a pack of cards. Even government intervention and promise of settling all contracts at 10% of their face value had no effect. The prices declined till the Tulip bulbs were selling no more than the price of common onion. The sanity in the markets were restored.
There are many such speculative events which have happened closer home too. However, the point is if you don’t learn from history you are doomed to repeat it.
This is a story which I heard some time back. One day two friends, an American and a Japanese were feeling adventurous and they decided to go for camping in the forest, which was known for its ferocious tigers. After a whole day of trekking, they finally found a spot in a clearing to camp for the night. They set up their tent there and after a good supper went to sleep. Just as they were drifting into deep sleep, both of them heard a tiger roaring nearby their campsite. They could sense that the tiger was approaching their tent.
Realising that they are in danger, both of them jumped out of their beds. The American started to run. And as he was about to start he decided to look back, and to his surprise, he sees the Japanese wearing his shoes. This made the American laugh and in a sarcastic tone he says, ” Just because you have your shoes on, you are not going to run faster than the tiger”.
To this the Japanese replied, “I don’t need to run faster than the tiger to save my life. As long as I can run faster than you, I am safe”.
For an investor the American (no offences) and the Tiger are like taxes and inflation. One eating away the returns and the other value of money. Your investments will turn to wealth only if it is growing at a pace faster than the taxes and inflation. Otherwise you will never win the race and always end up being eaten by the tiger. The choice is simple. Nobody wants to be eaten by a tiger.
For a growing economy like India, inflation is a reality no one can escape from. But taxes can be managed to reduce its adverse impact on the investments.
Though tax avoidance is a crime, there is no harm in being tax efficient. It is just being smart. Section 80C to 80U falling under chapter VI A of the Income Tax Act, provides for permissible deductions from the gross total income of an assessee.
Since, discussions in detail about all the sections is outside the purview of this blog, I will restrict myself to the section 80C which is related to investments.
Investment products with section 80C benefits
Today an investor is bombarded with various investment products which offer tax relief under section 80C of the income tax act. It is like a child being offered a plate filled with different pastries to choose from. Each one of them looking equally appealing and delicious, making it harder to choose.
However, is it so simple as it looks? Let us look at some of the popular products available in the market and also the pros and cons of each.
S No.
PRODUCT
SECTION
PROS
CONS
1.
5 Year Bank FD
Invested amount is eligible for tax deduction under section 80C with a combined ceiling of Rs. 1,50,000/- in a financial year
Highly Safe
1. Interest accrued every year forms a part of taxable income for that financial year.
2. Nil liquidity – Invested amount gets locked in for five years from the date of investment.
3. In case of rising interest rates, the investor gets locked in for a lower rate for the entire term of FD.
2.
Senior Citizens Savings Scheme (SCSS)
Invested amount is eligible for tax deduction under section 80C with a combined ceiling of Rs. 1,50,000/- in a financial year
Highly Safe
1. Interest accrued every year forms a part of taxable income for that financial year.
2. In case of rising interest rates, the investor gets locked in for a lower rate for the entire term of FD.
3.
National Savings Scheme (NSC)
Invested amount is Eligible for tax deduction under section 80C with a combined ceiling of Rs. 1,50,000/- in a financial year
Highly Safe
1. No liquidity. Invested amount gets locked in for 5 or 10 years as per the term chosen.
2. Interest accrued becomes a part of taxable income for the investor. Since, the entire interest is getting reinvested, it eats into the combined ceiling of Rs. 1.5 lac given for deduction under section 80C.
3. In case of rising interest rates, the investor gets locked in for a lower rate for the entire term.
4.
Insurance Endowment Schemes
Invested amount is eligible for tax deduction under section 80C with a combined ceiling of Rs. 1,50,000/- in a financial year.
1. Safe.
2. Provides insurance cover along with savings.
3. The amount received on maturity is also exempt from taxes vide section 10 (10)D
1. Neither a good investment nor a good insurance.
2. No liquidity. Investor gets locked in for the term of the policy.
3. In case of surrender, investor not only looses insurance cover but also loses out on the investment value.
4. The investor has to pay a service tax on the investments made, which further increases the cost of investment.
5.
Public Provident Fund
Eligible for tax deduction under section 80C with a combined ceiling of Rs. 1,50,000/- in a financial year
1. Highly Safe
2. Comes under EEE category. Which means, the amount invested is eligible for deduction under section 80C with a limit of Rs. 1.5 lacs in a financial year. The interest accrued is tax exempted. And finally the maturity amount is fully exempted from tax.
3. Flexibility to invest variable amounts in each month. Only Rs. 500/- required to be invested in a year to keep the account active.
1. Highly illiquid. The first lock in period is 15 years.
2. Only available for Resident Indians. PPF is not available for NRIs.
6.
ULIPS
Invested amount is eligible for tax deduction under section 80C with a combined ceiling of Rs. 1.5 lac in a financial year
1. The maturity amount is completely tax free.
1. Complex product. Exposed to market related risk.
2. Poor liquidity. Minimum lock in period of 5 years.
3. High cost product. The cost includes fund management charges, policy administration charges, fund allocation charges, mortality charges etc.
7.
NPS (National Pension System)
Invested amount is eligible for tax deduction under section 80C with a combined ceiling of Rs. 1.5 lac in a financial year
1. Can avail an additional tax savings of Rs. 50,000/- under section 80 CCD(1B)
2. Highly regulated product with transparent investment norms and regular monitoring and performance review.
2. Flexible – The subscriber can choose his own investment options and pension funds.
1. Very poor liquidity. Investments are locked in till retirement.
2. Exposed to market related risks.
3. NPS falls under EET category. That means, though the investments and capital gains are exempt from taxes, but the withdrawal is taxable at the time of maturity.
4. On maturity, 40% of accumulated corpus can be withdrawn tax free, but it needs to be used to buy an annuity product. The annuity received from such product will be taxable in the hands of the investor.
8.
Equity Linked Savings Scheme (ELSS)
Invested amount is eligible for tax deduction under section 80C with a combined ceiling of Rs. 1.5 lac in a financial year
1. Has the least lock in period of 3 years among all the products mentioned above.
2. Safe in the long term and highly transparent product.
3. Can achieve inflation beating returns in the long term and hence a wealth creator.
1. Exposed to market related risks. Highly Risky in the short term.
2. On withdrawal, capital gains above Rs. 1,00,000/- attracts tax @ 10% for investments made on or after 1st April 2018.
So, which is the right investment product for tax saving ?
The best or the right investment product is very subjective. The investment product must suit individual risk profile and investment goal. However, having said that, if you look at the lock in periods of each investment product mentioned above, you can see that each tax saving product comes with a lock in period varying between retirement age to 3 years. NPS being the product with the highest lock in period, followed by PPF and so on.
They say “You can’t have your cake and eat it too.” But what if you can??
If you are investing into any of the products above for the purpose of tax saving, invariably, liquidity goes out of the window. So, if you are ready to block your money for the next 15 years or above, why not choose a product which not only saves tax, but also has the least lock in period and having the ability to give higher returns beating the tiger (taxation and inflation) in the long run.
Of all the products mentioned in the list, ELSS is the only product with the least lock in period of 3 years and transparent with its performance and expense details. Though risky in the short term, in the long term ELSS mutual fund schemes have the ability to beat taxation and inflation and give positive returns.
With the help of table below, I have tried to capture performance of a few ELSS schemes for your benefit. To measure the performance, investment is assumed to be made on any day between 21st November 2002 to 20th November 2003 and the value of the same is taken exactly 15 years later in the year 2017-18.
15 Year Rolling Return of a Lump Sum Investment made on any date between 21 November 2002 and 20th November 2003
From the analysis above, it can be observed that, even the worst performing ELSS fund has on an average times given a return of 16.52 % CAGR, with the lowest return being 12.77% CAGR and the highest being 18.35% CAGR in the period of study, which by any standards is way better than any of the conventional tax saving investment products.
To put things in perspective, the average inflation during this period was 7% pa and in the same period, the safest product PPF has grown at an average rate of 8.5% pa. Which implies, in absolute terms, Rs. 1 lac invested in 2002-03 would have become Rs. 3,40,000/- in PPF. Comparing that with investment in the worst performing ELSS scheme, even if you had invested on your worst day it would have become Rs. 6.06 lacs in 15 years. And if lady luck was shining on you and you had invested in any of the top two schemes on the best day of the year, your investment of Rs. 1 lac would have grown to more than Rs. 20 lacs in 15 years.
The moral of the story
As the chief steward of resources of the family, saving tax is important so that your family gets the rightful share of your hard earned money. But, if in the process, if you can create wealth too, then, why not?
Today when the world is talking about increasing work efficiency, isn’t it logical only to ensure that your money is also working as efficiently for you as you are?
Financial planning is a process of meeting your life goals through proper management of your finances. Life goals can be buying your dream home, funding your children’s education, a dream vacation, buying your dream car, building retirement corpus etc. It is a six step process starting with collection and evaluation of data, identifying life goals, formulating a plan of action to meet those goals, implementing the plan and periodic review of the same.
Why is financial planning important?
Failing to plan is planning to fail. Given the fact that we have a limited time in our life span to earn money and create wealth, it becomes very important that the investible surplus is judiciously invested. Financial planning helps in understanding your present and future cash flows. It not only helps in ideal asset allocation based on your specific needs but also ensures that the future cash flows are managed to meet your requirements in time. Further, it helps you in being tax efficient with your investments. And finally it brings a sense of safety and security.
“Give me six hours to chop down a tree and I will spend first four hours sharpening the axe”
– Abraham Lincoln
Can you do your own financial planning?
The answer is yes. You can do your own financial planning provided you have the necessary skill sets and expertise in certain areas of finance. You should be able to judge your own risk appetite and be able to manage your investment portfolio to meet your requirements.
How can a financial planner help you?
You may want to do things on your own, but sometimes seeking help of a professional financial planner/ advisor has it’s own advantages. A professional financial planner is either a Certified Financial Planner (CFPCM) who is certified by Financial Planning Standards Board India (FPSB) or a Registered Investment Advisor (RIA) registered with SEBI.
A professional being an outsider will be able to evaluate the situation without any prejudices and personal biases you may have. He will be objective in his decisions.
A professional financial planner who interacts with markets and client’s financial behaviour day in and day out, is better placed to handle the market volatility and your financial behaviour. Also, he is trained and experienced to custom build a portfolio suited to your risk appetite and expected returns based on your goal time frames.
He can assist you in understanding the effect of one particular financial decision on your other life goals and guide you accordingly. Further, he can assist you in prioritising your goals and give you a realistic picture on your financial health. With his unbiased suggestion on financial products, he will be able to guide you in the right direction to achieve your life goals.
How can you make the financial plan work for you?
Since, you are at the focal point of the financial planning, it is very important that you participate in the entire process whole heartedly. No financial plan can be a success without your participation. A few things that you must keep in mind are as follows: –
Start Early : – You have a limited time to earn and create wealth to meet your life goals. Starting early will help you destress your investment journey. Remember, climbing a steeper slope is far more difficult than climbing a gentle slope.
Define Quantifiable Goals : – Which means the goal defined should be measurable in terms of cost and time. For example you want to buy an apartment. You must be able to define the amount that is required in today’s terms and the time i.e. no. of years that you have to meet the goal.
Be Realisticin Defining Goals : -While defining a goal, you must also consider your current and future cash flows. These cashflows must be able to justify the goal. If the goals cannot be backed by sufficient investments towards it, then it will only be a dream and never will become a reality.
Have Realistic Expectations : – You must not have too high expectations on returns from your investment. Being realistic with the expected returns will help you take right decisions w.r.t your investments. It will also help you avoid any disappointments.
Implement the Plan : – A plan is only a dream without action. The plan must be followed up by action to realise the goals. You must put the plan into action immediately and ensure disciplined adherence to it.
Periodic Review : – Personal finance is essentially dynamic in nature. Hence, you must carry out periodic review of the plan. It not only ensures that things are moving in the right direction, but also gives a heads up in case the plan is off track. This enables you to take timely corrective measures for a course correction. This will ensure timely realisation of your life goals providing you the happiness, safety and security that you need the most.
To summarise, financial planning is a must before setting out on your investment journey. People generally look at the product and the returns it generates in isolation, rather than looking at whether the product is suitable to meet the life goals.
Remember, investing without a plan is like setting out to sail without charting a course for the voyage. You will definitely be sailing but will never reach your destination. So plan you must. After all, life is too short to leave things to chance, Isn’t it?
” If you don’t know where you are going, you’ll end up someplace else.“
Stakes are always high when it comes to your own money. Blindly choosing an investment product is like walking into a casino and placing a bet. You win some, you lose some. But you can never be certain of victory. The only thing certain is that the house always wins.
Understanding an investment product is as important as knowing the right route to take before starting a journey. The right choice will not only make the journey pleasant but also shorten the time required to complete the journey.
To cut the chase, let me list out the five most important factors, which are like thumb rules for any investment. They are as follows: –
Safety
Liquidity
Tax Efficiency
Transparency
Growth
Safety
Safety is the cornerstone of any investment. No investment can be defined as an investment, if the invested capital is lost. This is what the investment guru Mr. Warren Buffett has to say on rules of investing.
“Rule No. 1: Never lose money.
Rule No. 2: Never forget rule No. 1″
Warren Buffet
Liquidity
Liquidity means, one should be able to access his investment without any loss of value and time. What is the use of an investment, if one cannot access it in the hour of need. Liquidity along with safety is the basic foundation for any investment.
Transparency
Transparency in any activity reduces the chances of fraud. Transparency in investments ensures timely and accurate dissemination of information to the investor as to where his money is getting invested, what is the cost involved and how is the investment performing. All this helps in taking an informed decision by the investor, thereby ensuring safety of his investments.
Tax Efficiency
We are all duty bound as citizens to share a portion of our wealth as taxes for the benefit and wellbeing of the nation. However, as chief steward of family resources, one also has a duty towards his family to be as tax efficient as possible. Tax is a hidden and unavoidable cost of investment. Hence, lesser the tax higher will be the return on investment.
Growth
An average person spends only 30 to 35 years from his entire life span actively working and earning. In this limited time, one not only has to provide for the present, but also invest to create wealth for the future. Hence, the most important question to ask when investing for long term is ” whether this investment will translate to wealth or no?”. When you are parting with money today, you are not only sacrificing the use of it today, but also incur an opportunity cost. Investments can only be turned into wealth if it grows at a rate beating inflation and taxation. The real returns in your hands must be positive. Hence, when you are looking at investing for creating wealth in the long term, the rate of growth of the investment is an important factor to consider.
I hope the above guidelines will help you in selecting the right investment product based on your needs.
Remember
“Risk comes not from the known, but from the unknown.”
Before I answer the question, let us try and understand Risk. Risk is defined as a possibility of something bad happening. Every activity involves risk, however safe one may assume it to be. Given this fact, it is only prudent to think of Risk Management. Risk management does not ensure complete elimination of risk, but it aims to minimise the damage in the unfortunate event of occurrence of undesirable event.
To illustrate further, let us take an example of restaurant kitchen. A restaurant kitchen is highly exposed to the risk of major fire. To manage this risk, it is desirable for the restaurant to put in place safe practices like: –
Keeping the column of gas cylinders away from the main cooking area.
Having sufficient number of suitable fire extinguishers placed in the kitchen.
Put in place infrastructure like sprinklers and fire alarms.
Ensuring the staff wears cotton clothing.
Ensure frequent training of staff on fire drills etc.
These practices will not only ensure reduction in the likelihood of risk of fire in the kitchen, but also ensure that the damage caused is considerably reduced in the unfortunate event of fire.
However, inspite of taking all the precautions, the restaurant cannot escape financial loss in the event of breakout of fire.
In another instance, Raju (name changed) aged 30 was diagnosed with terminal pancreatic cancer. The only son to old age parents, a husband and a doting father to a son. Everything was going well for the family until the day Raju was diagnosed with cancer. The young family had never thought of such an unfortunate event to ever strike them let alone plan for it. Being the only bread winner of the family, they spent all their savings on treatment. They even borrowed money from near and dear ones including friends to meet the high cost of treatment of cancer. However, even after putting in all their resources, Raju could not be saved. He passed away leaving behind old parents, a young widow and a 1-year old son.
In both the cases, the damage caused to the restaurant and the emotional loss to the family cannot be prevented. However, financial loss thus caused could have been recovered, if the restaurant and in the second case, if individual was appropriately insured. But the reality is, in hindsight we are all wiser.
In India, the insurance penetration (ratio of premium underwritten to GDP) was only 3.49 % in the year 2016-17 as per the economic survey 2018 (https://timesofindia.indiatimes.com/business/india-business/insurance-penetration-in-india-has-risen-to-3-49-economic-survey-says/articleshow/62696220.cms). This is lower in comparison to other emerging economies of Asia like Malaysia (4.77%), Thailand (5.42%) and China (4.77%). India’s life Insurance penetration is only 2.72% compared to global average of 3.47%.
Why insurance is an important aspect of personal finance?
Insurance plays a vital role in an individual’s life. Just as castles cannot be built on thin air, similarly wealth creation through investing cannot be realised without the strong foundation of risk management and insurance.
Insurance acts as a safety net, a tool to minimise financial loss in the event of occurrence of an undesired event. It not only makes good any financial loss, but also provides peace of mind and thus better utilisation of capital by investing in the right assets.
As an individual, a person is exposed to many risks. However, they can be broadly classified under two heads namely Risk to Health & Risk to Life. Risk to health can be further divided into Primary Health, Personal Accident & Critical Illness.
All the above can cause major dent into one’s personal wealth. Hence, it is prudent to take appropriate insurance covers to mitigate or minimise financial loss in the event of the risks being played out. Let us examine them one by one.
Health Insurance
The rising cost of consultation for common diseases, hospital visits and medication are a cause for concern for many households in India. As per the article posted on moneycontrol.com, health cost in India is set to rise at double the inflation rate in 2018 (https://www.moneycontrol.com/news/business/economy/health-costs-to-be-double-the-inflation-rate-in-2018-survey-2700371.html). A visit to hospital for even a small treatment can burn a hole in one’s pocket.
For the salaried, most of the times the employer provides the basic health cover as a group health policy for his employees. Government is also coming up with various insurance schemes to cover the low-income group and daily wage earners who find taking a health cover on their own unaffordable.
However, individual’s health is his own responsibility. Irrespective of the cover provided by the employer, one should take a private health cover to protect self and family against any unexpected OPD or hospitalisation expenses. This is because most of the times, the cover provided by the employer may not be sufficient enough and also the cover provided by the employer will only last till one remains employed with the same employer. In this uncertain world, where job security is not absolute, one may choose/ forced to leave the current employer. Also one may decide to leave the current employer for better opportunity elsewhere. The new company may or may not provide health cover. In some situations there may be a considerable delay in joining the new employer, which exposes self and family to the high risk of no cover. Further, one may also decide to take a sabbatical or start own venture. Any unexpected hospitalisation during these situations is certain to put huge financial stress on self and family.
While taking a private health cover, it is suggested to take a family floater policy, which is comparatively cheaper than an individual policy. In a family floater policy, the sum insured floats between all the members covered in the policy. Cost of health cover can be further reduced by opting for voluntary deductibles.
An accident may lead to death or worst, it may lead to permanent total disablement leaving self incapable of any gainful employment in future. If the accident leads to Permanent Total Disability, the loss is twofold. One not only has to burden the cost of treatment but also suffer loss of future income to the family.Personal Accident Insurance protects against financial liability arising out of unexpected expenses in the unfortunate event of an accident . It also provides a lump sum payout in case of permanent total disablement to the extent of sum insured which can be of great financial assistance to the family. Hence, Personal Accident Insurance is a must at least for the bread winner of the family.
Critical Illness Insurance
Critical Illness Insurance is aimed at protecting self from the unforeseen expenses in the unfortunate event of contracting diseases which are terminal in nature. Diseases like heart attack, cancer, stroke, kidney failure etc. not only delivers a devastating blow at an emotional level but also drain one’s financial resources.
There are over 30 million heart patients in India and at least 2 lakh heart surgeries are performed every year (https://food.ndtv.com/health/world-heart-day-2015-heart-disease-in-india-is-a-growing-concern-ansari-1224160). The cost of treatment of heart diseases can range anywhere between 5 to 20 lakhs depending on type of treatment and hospital.
A critical illness cover protects the family by paying an upfront payment upon the diagnosis of disease and other benefits like providing cover for hospital expenses and in some cases provide a regular income as a percentage of sum insured for some years. This not only helps the family cope up with the financial stress at the time of initial diagnosis and treatment, but also provides a backup for loss of income.
Life Insurance
Risk to health may or may not happen, but death is certain. The only thing uncertain about death is time.
One must take life insurance if there are financial dependents. If no one is going to be financially affected by your absence, then life insurance need not be taken. Life insurance is like a medicine, if it needs to be taken, it needs to be taken. There is no substitute for it.
Untimely death of the breadwinner of the family can be disastrous for the family. Hence, it is of utmost importance for the breadwinner of the family to take a life insurance.
The right kind of life insurance is pure term cover, which provides a person with high sum assured at the least cost. However, the catch here is that, a term cover does not provide any benefits if the assured survives the term of the policy. But, in the event of death of the life assured, the dependent family gets the sum insured payout in lump sum or monthly payout as opted for at the beginning of the policy. This not only ensures that dependents continue their existing lifestyle, but also ensures all obligations or planned goals of the family are fulfilled, thereby reducing some pain on account of the loss of a dear one.
Care must be exercised while choosing the right amount of sum assured in a term insurance. Ideally, the sum insured must be sufficient enough to provide for dependents future expenses in bread winners absence and also cover any liabilities taken by the bread winner.
Property & Household Insurance
Property insurance is taken to protect the property against the risk of fire, theft and some weather damage. This includes specialised forms of insurance such as Fire Insurance, earthquake insurance, flood insurance, boiler insurance etc.
Home insurance or householder’s insurance provides cover against financial liabilities arising from the damage/ loss of your home or its contents due to natural or man-made reasons.
With the recent events of floods, cyclone and earthquake in the country leading to large scale destruction, no place can be guaranteed to be safe. The loss is huge in case of natural calamities. In the face of such losses, insuring property and house by paying a small premium is the only saner thing to do.
To summarise, Insurance is a must if one wishes to create wealth. It is the first step in personal finance. Understanding the risk and its effective management will go a long way in ensuring financial stability for self and family.
Return in finance/ banking parlance is defined as profit or loss from an investment. To put it in simple words, Return is the amount earned or lost on every single Rupee of investment over time. Now, what exactly is Real Return and why investors should take it seriously.
Real return is the actual return received in hand by the investor after providing for taxation and inflation. Or in simple terms, Real Returns is the return post tax and post inflation. Most of the time investors ignore the effect of taxation and inflation on their investment returns.
Let us take a look at the example below for better understanding: –
An investor in the 30% income tax slab invests Rs 100/- in a bond earning 7% return per annum. Ideally the investor should be receiving Rs. 107/- at the end of year one. However, in reality this is not true. On the Rs. 7/- interest earned, the investor has to pay a tax of Rs. 2.10/-. Which means, the investor only gets Rs. 4.90 in hand reducing his effective returns from 7% to 4.9%.
However, this does not end here. We have still not accounted for inflation during the period. Let us assume an inflation of 5% per annum during the prevailing period (which can be related to Indian situation), the Rupee has got devalued by 5% in the same period. Which implies, Rs. 100/- one year back is today only worth Rs. 95/-.
Now in the above example, did the investor make or lose money? On his investment of Rs. 100/-, his effective in hand returns in absolute purchasing power terms is (Rs. 95.00 + Rs. 4.90) only Rs. 99.90/- after accounting for taxation and inflation, which is nothing but a straight loss.
The stated return on the above investment proposal was 7% per annum. However, the investor’s Real Return was -0.1%. Hence, if the investor continues to invest in this product, he continues to earn negative returns and lose money year on year.
The above example has made it amply clear as to why one should always look at Real Returns before choosing an investment. Ignore Real Returns and you can be certain of poverty. Knowing that will be the difference between working for money and making money work for you. Remember…..An educated investor is a successful investor.
Taxes are a compulsory charge which one has to pay to the government on his/ her income. Most countries have a tax system. Some countries charge it based on a flat percentage on the income earned or a slab based on total income earned by the person.
Taxes are a source of revenue for the government. Any government needs funds to carry out its day to day operations and many of its necessary functions such as providing basic and essentials services, building infrastructure, policing for ensuring law and order etc which cannot be funded by private equity. A government carries out many activities which may not always be profit oriented for the social good, which private businesses may not be inclined to undertake. Further, a government is mandated to ensure equal development of all sections of the society for which it may run numerous welfare schemes. Without any source of income, no government will survive and hence, one cannot just wish away taxes. If one agrees that it requires a certain amount of money to run a household, then one can imagine the amount of money it will requires to run a nation.
“ Taxes, after all, are dues that we pay for the privileges of membership in an organised society.”
— Franklin D. Roosevelt
In India government collects both Indirect and Direct taxes. Indirect taxes are collected by the government from producers of goods or services, but the same is passed on to the final consumer in the form of total price in the supply chain. Direct tax is based on individual’s income. The current tax slabs in India for the assessment year 2018-19 on personal income is as follows: –
ANNUAL INCOME
TAX SLAB
Upto Rs. 2,50,000/-
Nil
Upto Rs. 3,00,000/- (for senior citizens above 60 years of age)
Nil
Upto Rs. 5,00,000/- (for super senior citizens above 80 years of age)
Nil
Between Rs. 2,50,000/- to Rs. 5,00,000/-
5%
Between Rs. 5,00,000/- to Rs. 10,00,000/-
20%
Rs. 10,00,000/- and above
30%
Remember crying over having to share candy with your brother in childhood. Nobody likes a half eaten pie. However, as a responsible and law abiding citizen, one must pay his taxes. We as citizens must equally share the burden of nation building. Tax avoidance is not only morally incorrect but also bad for the nation. However, having said that there is no harm in being tax efficient. Government provides us with various options to reduce our tax liability by providing deductions and exemptions under various sections of the Income Tax Act. One must educate himself or take help of a professional to ensure tax efficiency with his income and investments. After all a penny saved is a penny earned. As a citizen, one is duty bound to pay taxes, but as a bread winner of the family one has a greater responsibility towards his family to be as tax efficient as possible.
“ By law you have the right, by nature you have a duty, and to your family you have an obligation, to be a good steward of all your assets. ”
