Regular Retirement Income: Best Way To Achieve

When you have worked hard all your life- you’ll want to make sure that you can enjoy your retirement.

Stable cash flow month after month is essential for a financial sound retirement.

The most common way individuals currently planning for regular income

1.      Rental Income – during working years individual accumulate real estate property which can yield a rental Income. The advantage of rental income is its renewable yearly to hedge inflation.

Real estate property is subject to maintenance risk and non occupancy ; but the major disadvantage of rental income is its taxable.

The rental yield currently across most part of the India is 3-4% , means an investment of Rs 1 crore might fetch a rental income of Rs 3-4 lac per year. Considering an average tax rate of 20% (based on tax slab), property management & maintenance expenses, check out is your real estate is really an cash flow generating asset?

2.      Bank FD – Bank FD are by far the most widely used instrument used to generate a regular income. Assume Mr X would like to generate a monthly income of Rs 1 lac; at current interest rate of 7% ; you would need to have Rs 1.71 crore.

Wait we forgot the tax , if you are generating annual income of Rs 12 lac (you will in 30% tax bracket). Assuming a tax rate of 20%, you need to generate a monthly income of Rs 1.2 lac (so that you can pay Rs 20,000 to tax authority & you get to keep Rs 1 lac), for which your retirement corpus will shoot up to Rs 2.05 Crore. So approximately you end up paying an annual tax of 2.4 lac

An NRI enjoy taxation benefit ; but the day the status become Resident, all the NRI deposits have to be replaced to local deposit and the above calculations would be applicable for NRI. 

Mutual fund offers wide variety of investment products with different risk/return combinations and are more tax efficient. Systematic withdrawal plan can be used to effectively generate the regular cash flow from the selected investment product.

1.   Risk Averse Investor- Choose Monthly Income plan ("MIP") – MIP is a debt oriented hybrid fund with approximately 80% investment in bond & 20% investment in Equity. Has potential to generate a return of 8-10% and Long term capital gain tax accounts for 10% (or 20% post indexation)

2.  Moderate risk Investor- Choose Balanced Funds—Balanced fund is an equity oriented hybrid fund with approximately 65% investment in Equity & 35% investment in Bond. Has potential to generate a return of 10-12% and Long term capital gain tax is zero

3.   Risk Takers- Choose Diversified Equity Funds—Diversified Equity portfolio a mix of Large, mid, small cap funds . Has potential to generate a return of 12-15% and Long term capital gain tax is zero

			Mutual Fund
Asset Class	Real Estate	Bank FD	Risk Averse	Moderate Risk	Risk Takers
Asset Portfolio	Rental Properties	Bank FD	MIP	Balanced	Diversified Equity
Long term Expected Return	4%	7%	9%	11%	13%
Annual Cash flow (After Tax)	1,200,000	1,200,000	1,200,000	1,200,000	1,200,000
Applicable Tax	Taxable Income	Taxable Income	Capital Gain	Capital Gain	Capital Gain
Tax Rate	20%	20%	10%	0%	0%
Annual Cash Flow (Before Tax)	1,440,000	1,440,000	1,210,800	1,200,000	1,200,000
Retirement Corpus required (Cr)	3.60	2.06	1.345	1.091	0.923

Conclusion

Mutual fund offers wide variety of schemes in terms bond, equity, gold. It caters to all kind of investor be it risk averse or risk takers. Mutual funds offer better returns, liquidity, transparency and are tax efficient

Mutual fund Systematic Withdrawal Plan is an excellent tool for creating a regular income. The table above is an indication that a risk averse investor through MIP need 1.34 Cr Vs a Bank FD of 2.05 Cr for a generating a monthly cash flow of Rs 1 Lac.

Investment risk is all about volatility of return; you will be better equipped to manage volatility during working years, when you stable income coming in the form of salary; if you don't make your money work for you during your working years; you will never be able to make it work.

Feel free to get in touch with me ( 65708812 / merafundadvisors@gmail.com) for an professional investment advise.  

Best Investment to lose your Capital while planning for retirement

The money we earn could be used to buy things that we need today. Nonetheless, we chose to invest, by reasoning that we would rather use this purchasing power some other time in the future. In this manner, the money that we saved will become our capital. Since that we exercised the option of saving for future, we should be earning enough on the saved capital, to consume more than what we intended to consume now.

Invested capital is essentially trying to protect not your currency notes or bank balance, but the ability of money to buy something for you. Basically, you are trying to protect the purchasing power of your money in the name of capital protection.

What is the biggest risk to capital?

It is the rise in prices, also referred to as inflation. When we say protection of capital, we presume our saving is growing at least in line with the inflation. If the rate of growth (investment returns) of the saved money (capital) is less than the increase in household expenses, then we are simply destroying the capital.

Which investment option surely and certainly destroys our capital?

Well, the first choice of Indian investors is a financial asset called fixed deposits (FDs).

Simple illustration- Suppose you have Rs 1 lakh and you want to spend this money on buying a TV or a refrigerator or on a holiday package. Instead of splurging on these items, you invest the money in fixed deposits for a period of three years.

After three years, your capital has grown from Rs 1 lakh to say Rs 1.21 lakh (annual growth of 7 %). But during the same time period, prices of these three products/services went up by 10 % per year and these now cost Rs 1.30 lakh.

In short, FDs have destroyed your capital. This illustration is from a short-term perspective.

How safe is your Bank FD as a retirement corpus?

Now, imagine the impact of the same thing over your life span. Assume you start earning at the age of 30 Years; and regularly save and invest 33% of your income in the safe heaven Bank FD. The return you generate would at max keep in line with inflation, so logically speaking your two years of saving would take care of 1 year of expenses; so assume you work till 60 years (so you work for 30 years) and when you retire your safe heaven can at max take care of your expenses for 15 years and you will run out of your retirement fund.

Just introspect,

·         Have you started saving from the age of 30

·         Have you kept aside at least 25% of your income as savings since 30 years

·         are you intending to work till 60 and is your job secured till 60 Years

·         Have you deployed your savings to create capital

If your answer is yes for all the above highlighted points, then you can be sure you would retire comfortably; otherwise you need to seriously think of a proper plan.

Bank FD’s are like banyan tree; As banyan tree does not allow any vegetation to thrive below it, FD’s will not allow your capital to grow. So think before investing.

Retirement planning is no more an option, it’s a necessity.For any Investment Planning feel free to get in touch with me on 0965-65708812 /91-9845366753

Mutual Fund’s Monthly Income Plan : An overview

Mutual funds are traditionally classified by the investment asset class they own. Mutual funds which own only stocks (Equity) are called Equity mutual fund. Mutual funds which own only bonds are called bond fund. Mutual funds which own both bonds and stocks are called hybrid fund.

Mutual fund’s Monthly Income plan (“MIP”) is a hybrid Mutual fund which invests in both equity and bond. Typical MIP invests 80-85% in Bond and 15-20% in Equity.

Benefits of investing in Monthly Income Plan Mutual Fund:

• MIP provides stability (from significant bond component) and strives for capital appreciation (from smaller equity component)
• MIP offers automatic rebalancing- Assume equity is growing faster than the bond then weight of equity crosses 15%-20%(prescribed limit); then fund manager would book profit from equity and invest the same in bond
• MIP generates better return than the bank FD or bond fund due to presence of smaller equity component
• MIP fund investment strategy aims at income generation (in terms of Coupon from bond investment and dividend from Equity component)

Potential return and tax effect:

• MIP over last 5 years have generated a CAGR return of 10-12%; the realistic long term expectation going forward could be close to 9-10%.
• MIP are treated as bond fund from tax perspective. Short term capital gain tax at respective income tax slab would be applicable if redeemed (withdrawn) within 3 year and long term capital gain tax of 10% without indexation (or 20% with indexation) is applicable  if redeemed (withdrawn) after 3 year

Potential risk

• MIP invests 80-85% in bonds which is subjected to interest rate volatility and remaining 15-20% in equity which would be deployed mainly into Large Caps; MIP is suitable for conservative (risk averse) investor.

Conclusion: 

MIP is a debt oriented hybrid fund with small exposure to equity and can generate a realistic return of 9-10% (under current circumstances). MIP is a very good alternative for Bank FD as it provides higher after tax return, provides better liquidity and flexibility. A significant corpus in MIP at the time of retirement can provide better monthly after tax retirement cash flow compared to an equivalent corpus in Bank FD.

For any investment related queries/advise feel free to get in touch with me on 0965-65708812/91-9500151529

Balanced Mutual Fund: An overview

Mutual funds are traditionally classified by the investment asset class they own. Mutual funds which own only stocks (Equity) are called Equity mutual fund. Mutual funds which own only bonds are called bond fund. Mutual funds which own both bonds and stocks are called hybrid fund.

Balanced Mutual fund is a hybrid Mutual fund which invests in both equity and bond. Typical Balanced fund invests 65% in stocks and 35% in bond.

Benefits of investing in Balanced Fund:

•     Balanced fund provides twin benefit of growth (from equity component) and stability (from debt component)
•   Balanced fund offers automatic re balancing- Assume equity is growing faster than the bond then weight of equity crosses 65%(prescribed limit); then fund manager would book profit from equity and invest the same in bond
•  Balanced fund offers lower volatility compared to an equity funds
•  Balance fund offers better liquidity and more tax efficient than the bond funds

Potential return and tax effect:

•  Balanced fund over last 5 years have generated a CAGR return of 15-16%; the realistic long term expectation going forward could be close to 12%.
•  Balanced fund are treated as equity fund from tax perspective. Short term capital gain tax of 15% is applicable if redeemed (withdrawn) within 1 year and long term capital gain tax of 0% is applicable  if redeemed (withdrawn) after 1 year

Potential risk

• Balanced fund invests 65% in equities which is subjected to market volatility and hence the fund return would be more volatile compared to a bond fund/bank FD

Conclusion: Balanced fund offers automatic re balancing which allows your investment portfolio to be more balanced in different market conditions.  Balance fund offers good return, provides diversification benefit, offers flexibility and are tax efficient (long term capital gain is zero percent).Balanced fund comes handy in portfolio building and is a good option for first time equity investors.

For any investment related queries/advise feel free to get in touch with me; you can reach me on 0965-65708812/91-9500151529

NRE - FD vs Bond Mutual Fund

Interest rates on NRE - FD’s are on the decline; Interest rate has come down from 9-10% (during FY 2011) to 5.5-6.5% (as of July, 2017). India’s retail Inflation hit a historical low of 1.54% in June and lower inflation level would lead to further cut on the interest rate. NRE-FD rates are most likely to go down further from the current levels. Under these circumstances, an NRI investor would be better off investing in a bond mutual fund rather than NRE-FD.

Return: Bond Fund has potential to generate 2-3% higher return than bank FD

NRE-FD offers fixed return, currently in the range of 5.5%-6.5% (depending on the tenor and size of investment); Bond mutual fund return depends on the interest rate movement and has potential to generate a return of 9-10%. Bond fund can be broadly categorized into short term income funds, long term income funds, floating rate bond funds, gilt funds, and credit opportunities fund. Interest rate movement affect different bond category differently. Investors would be able to generate a 2-3% excess return by appropriate selection of bond fund.

Risk: Bond fund could be a safer bet than Bank FD

RBI’s Deposit Insurance and credit guarantee corporation (DICGC) provides a maximum insurance of Re 1 lac per person per bank  against  all investments such as saving deposit, Recurring and fixed deposit held with the bank. In India, lot of cooperative banks (ex madhavpura mercantile cooperative bank) have failed in the past and depositors have lost money with bankrupt cooperative banks; however as per my knowledge no commercial banks have gone bankrupt, but in future bankruptcy cannot be ruled out with mounting NPA levels and weak credit ratings (lower than AAA) of most commercial banks. While on the other hand, Bond mutual fund provides diversification benefit as fund invests in a portfolio of government bonds and corporate bonds (Generally AAA rating). In my opinion you would be better off investing in bond fund (diversification benefit, better credit rating) than the bank FD (concentration risk, rating depends on bank performance) purely from risk perspective.

Liquidity: NRE FD is illiquid when compared to Bond funds.

Assume Mr X invests in an NRE FD for 5 year period @ 7%; but say at the end of 3.5 years he is in need of money so he decides to redeem his FD, Mr X will lose a lot

·              NRE FD’s pay interest only for the completed year (means Mr X will get the interest for 3 years and loses the interest of the remaining 0.5 years)

·              NRE FD’s pay lower interest of the completed period (assume 3 Yr NRE FD rate was 6.5%) or locked in period (invested @7%)à Mr X will get only 6.5% (as it is lower)

·              NRE RD’s put an prepayment penalty of 0.5-1%

So Mr X would get an interest rate of 5.5%-6% for 3 completed year for the investment redeemed at the end of 3.5 years

While in Bond fund the exit load would generally be in the range of 0.5%-1% if redeemed within 1 year and no exit load for any redemption after 1 year

Flexibility: Bond fund offers more flexibility than bank FD

Bond funds allows Partial withdrawal; lot of fund houses and bond funds to choose from; can create a diversified bond portfolio easily while NRE Bank FD does not allow partial withdrawal, you will be stuck with one or maximum two banks for your NRE FD’s.

Taxation: NRE FD is tax free while bond fund returns (if withdrawn) are taxable

In bond funds, There is no tax on interest income; tax would be levied only on withdrawal/redemption. If Mr X redeems his investment within three year (short term capital gain is applicable, @ applicable tax slab) and if he redeems after three year (long term capital gain is applicable, @ 10%)

Assuming Mr X hardly has any income generated in India; then he would in 0% tax slab, so any redemption within three years would be tax free. And any redemption after three years will fetch 10% on the gain.

Assume NRE FD gives 6% return; Mr X has to generate a pre tax return 6.7% from bond fund (0.67% return would go for tax); so if Mr X deploys in bond fund which can give more than 6.7% he would be better off than investing in NRE FD @ 6%

Conclusion:

 Bond funds are better in terms of after tax return (by 2-3%), liquidity (easy to redeem), flexibility (more options, partial withdrawal facility), lower risk (diversification, better ratings) compared to NRE Bank FD.

Lot of bond funds are available, need to select an appropriate mix depending on market conditions and your investment requirements.

 I advise investors to seriously consider bond fund as an alternative for NRE bank FD, if you would like to be financially better off.

For any investment related queries/advise feel free to get in touch with me; you can reach me on 0965-65708812/91-9500151529

Bank FD vs Bond Mutual Fund: Taxation

Bank FD & Bond Fund both are fixed income securities. The most ignored part while investing in fixed income securities is the effect of taxation. The blog highlights the differences

Tax Effect on Bank FD

Taxes are paid on accrued interest and payable as per the individual tax brackets.

Ex Mr X invest Rs 10 Lac in a bank FD yielding an interest rate of 6%; Mr X is in a 30% tax bracket; then Mr X has to pay an average tax of Rs 18,000/Annum. The effect of tax over 5 year is as shown below

	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Interest Income	60,000	60,000	60,000	60,000	60,000	3,00,000
Tax Effect	Income	Income	Income	Income	Income
Tax Payable rate	30%	30%	30%	30%	30%
Tax Payable	(18,000)	(18,000)	(18,000)	(18,000)	(18,000)	(90,000)
After Tax Interest Income	42,000	42,000	42,000	42,000	42,000	2,10,000

Tax Effect on Bond Mutual Fund:

Taxes are paid only on redemption/withdrawal and the rates depend on the nature of gain. For Bond fund any redemption within three years is considered as short term capital gain (taxed at applicable individual tax bracket) and redemption after 3 years is considered as long term capital gain (taxed at 20% adjusted for indexation benefit- works out close to 10%)

Ex Mr X invest Rs 10 Lac in a bond mutual fund and decides to withdraw 6% income on yearly basis (to match Bank FD Cash flow) ; Mr X falls in a 30% tax bracket; then Mr X has to pay an average tax of Rs 1,730/Annum. (91% lower than bank FD)

	Year 1	Year 2	Year 3	Year 4	Year 5	Total
Withdrawal	60,000	60,000	60,000	60,000	60,000	3,00,000
Capital Gain (at 6% return)	3,396	6,600	9,623	12,474	15,165
Tax Effect	STCG	STCG	STCG	LTCG	LTCG
Tax Payable rate	30%	30%	30%	10%	10%
Tax Payable	(1,020)	(1,980)	(2,887)	(1,247)	(1,516)	(8,650)
After Tax Interest Income	58,980	58,020	57,113	58,753	58,484	2,91,350

 *STCG-Short term capital gain; LTCG- Long term capital gain

Conclusion: Bond Mutual fund taxes are applicable only on redemption while on bank FD’s taxes are applicable on accrued interest; Bank FD taxes would be 10 times higher than that of bond mutual fund. Bond Mutual fund provides higher return, offers better liquidity and most efficient in terms of taxes compared to Bank FD.