Monday, March 30, 2015

Impact of Inflation on Long Term Fixed Deposits

The biggest mistake that a senior citizen can make

 Assuming a person retires at 60 years of age & lives till 85 years (normal life expectancy has gone up to 80-85 years); value of his original Rs.1 crore in FDs is only RS.23.30 lacs after 25 years (adjusted for inflation @6% p.a.). Which means that even during his/her lifetime; value of investment has eroded in purchasing power & also the investor is leaving behind a fraction of the original investment behind for his/her family. Like currently, post rate cut (& prospective rate cuts in future) Bank FDs will be generating lower & lower returns to the investors & hence has reinvestment risk attached to it.
Also, if these investments are supposed to pass onto the beneficiary (either wife or kids) post the death of the investor, he/she is leaving behind corpus of a much lower value (inflation adjusted)

If senior citizens wish to invest their retirement corpus, they should invest in such strategized equity schemes (v/s FDs); opt for SWP of a reasonable amount (say not more than 8-10% p.a. Otherwise they may start dipping into their principal investments) every year & create tax efficient cash flow with the possibility of long term wealth creation - both for themselves as well as for their beneficiaries
• More importantly, after beating inflation & creating wealth, senior citizens can enjoy their lives with more funds in their hands during their lifetime

Starting to save at the age of 35 instead of 50 can mean retiring with four times the wealth.
If one has time to learn just one thing about investing, then it should be this.

Monday, March 16, 2015

Tax-saving tips for buying and selling a property

A joint loan while buying is beneficial; make full use of deductions available while selling
Irrespective of class or income, Indians are fond of buying gold and real estate. Purchasing and selling the metal is a straightforward game but a property, through its lifecycle (buying, owning and selling), can be taxing. If played right, you can reduce the tax outgo.

Tax-saving tips While buying a property

A house is the biggest purchase most people make in their lifetime and the government realises this. To give buyers relief, the government has allowed income tax deductions if the property is bought on a loan. Under Section 80C, the borrower can claim deduction of up to Rs 1.5 lakh. For a self-occupied property, a Rs 2 lakh benefit is available under Section 24 (b) of the Income
Tax Act for interest on the home loan. If the property is not self-occupied, the entire interest paid to the lender can be deducted from income. This applies even if a person borrows money from a friend, his family or a private lender provided appropriate loan document between the borrower and private lender is done and there is either a letter or a confirmation of interest charged by lender.

Problem area: Under the current market conditions, project delays are a common thing. This can cause financial trouble to the borrower. A person can't claim deduction for the interest if his or her house is still under construction. A buyer can, however, get benefit for the principal amount. On possession, the borrower can claim deduction for the interest paid during the pre-construction period. This needs to be done in five equal installments, starting the financial year you are handed the property.

Tip: To take advantage of current laws, a couple should take a joint loan in equal proportion. This will allow each to claim full tax deductions available for the principal and interest. This also applies to a child and a parent.

While you own  a property, bought  with a loan
If it's the borrower's only house and self-occupied, there's no taxation. For those who have two or more houses and these are neither let out nor occupied, the taxation can get tricky.

According to I-T laws, in such cases the owner should take a notional rent value and pay tax on it. There's a prescribed method to calculate the notional value, which takes into consideration the municipal value of the property and the rent control legislation (either of the two) or the prevailing rent in the area for a similar house. In a case of a notional rent, there is no rule to submit a certificate from a third party. However, it's better that a person submits a letter from a broker stating the prevalent rent in the area.
Problem area: If you are claiming housing loan deductions and housing rent allowance (HRA) at the same time, it can cause trouble. Many people claim HRA by showing rent paid to parents or wife (if there's a house in their names). A taxpayer is allowed HRA and loan deductions both under certain conditions. For example if your house is in a different city than that of residence. The department also allows you to claim HRA if you have a house in the same city as your residence, but you need to have a genuine reason. For example, many people in metros such as Delhi and Mumbai own house in far-off suburbs and can find it difficult to commute, owing to the distance. In such case, the person can claim both.

Tip: While calculating the notional value of a second home, you are allowed to claim few deductions such as municipal taxes. Also, an owner can claim deduction of a sum equal to 30 per cent of the value of the house property towards repair and maintenance charges.

While  Selling a Property
When a person sells a property, he or she needs to pay tax on the profits made. If sold within three years of acquisition, the seller needs to pay short-term capital gains tax (STCG). In this case, the profits are combined with the income and taxed on the I-T slab rate.

If the property is held for more than three years, it attracts long-term capital gains tax (LTCG). The tax is levied at 20 per cent (plus surcharge and cess) after adjusting the gains for inflation using the cost inflation index the government issues.

A seller can save entire tax outgo if he or she uses proceeds equivalent to long-term capital gains for buying a new house located within India within one year prior to the sale date or two years from the sale date. If the property is under construction the time period permitted is three years.

The amount used for buying a new property is exempted from tax and if there's any balance, it will be taxed at a flat 20 per cent (plus cess and surcharge). If you are not immediately buying a house, this money needs to be kept in the Capital Gains Account Scheme (CGAS), and withdrawn within the stipulated timeframe.

If you don't want to go for a residential property, you can still save LTCG tax by investing in specified bonds issued by the National Highways Authority of India or Rural Electrification Corp (under section 54/54EC) within six months from the date of sale. These bonds have a lock-in period of three years. Also, the seller can only invest a maximum of Rs 50 lakh in these bonds, while you have to pay tax on the remaining amount.

Problem area: If the seller had inherited the property or it was gifted to him, the capital gain will be computed on the basis of the cost to the previous owner. If the house was purchased before April 1, 1981, the I-T department will consider the acquisition cost by the original owner or the fair market value of the property as on April 1, 1981, whichever is higher.

If a person sells an under-construction property after holding it for over three years, the taxation rules completely change. This is because the I-T department considers the person as a property owner only when he or she has received possession.

Tip: While calculating STCG and LTCG tax on sale of property, one can deduct the money spent on improvement and also cost for acquiring the asset such as stamp duty, legal fees, and payment of brokerage.
  • For property purchases over Rs 50 lakh, buyers need to deduct withholding tax on behalf of the seller
  • This is 1% of the agreement value
  • This amount needs to be deposited with the income tax department
  • Buyer needs to furnish information online in Form 26QB
  • He/she also needs to download TDS certificate (Form 16B) and issue it to the seller
  • Failure to comply results in interest and penalty on the buyer

Monday, March 9, 2015

Buffett Explains Why Volatility is Not Risk and Why Equity is Best

In his annual letter for the year, Warren Buffett explains why mistaking volatility for risk prevents savers from realising that equity is the best investment

It's that time of the year again when Warren Buffett's fan eagerly wait for the pearls of wisdom that the master drops. Around this time of the year, Buffett writes his annual letter to the shareholders of his holding company, Berkshire Hathaway. Besides writing about the companies' performance, the doyen of equity investors always writes entertainingly about a range of business and financial issues.
While those who were looking at his letter for a revelation of who would run Berkshire after him were disappointed, those awaiting a package of wit and wisdom about business and investing were not.
One of the most interesting passages in the new letter is about the superiority of equity investing over the long term. Here's what Buffett says:
Our investment results have been helped by a terrific tailwind. During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% ... Concurrently, the purchasing power of the dollar declined a staggering 87%...
The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities - Treasuries, for example - whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.
Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments - far riskier investments - than widely-diversified stock portfolios that are bought over time ... That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk.
It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. For the great majority of investors, however, who can - and should - invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities... If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things.
Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to 'time' market movements, inadequate diversification and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy.'
What Buffett says here is a simple message, and yet that has proven really, really hard to understand. In fact, it's far less understood in India than in the US. The idea that the volatility is a measure of risk only with reference to a particular time frame is unknown outside a small proportion of investors. We accept without question that equity is riskier than fixed income investments. Some of us qualify this a bit, others equate equity with gambling. In India, we have an investing environment where real (inflation-adjusted) returns from fixed income are tiny, and real return from equity have been huge. A general attitude that equity is unacceptably risky except for dabbling by rich punters does lasting damage to the investing portfolios of most Indians.

Wednesday, March 4, 2015

Lessons from finance gurus

Lessons from finance gurus
Starting early is the easiest and smartest financial lesson. Even leaders of the industry agree 

Anyone who has just joined the workforce for the first time has a list of things to spend on—from clothes to gadgets, and more. Saving and investment rarely feature in this list. This may sound boring and even unimportant, but if you don’t want to be financially lost, you must plan your finances. Here are a few things you can do with your income in the early stages of your career. 

Start early 
When it comes to growing your money, the earlier you start saving and investing, the easier it will be to build a corpus. “You should understand the power of compounding. Unfortunately, people don’t understand it and how starting early will enable lower investment savings,” said Dilshad Billimoria, director, Dilzer Consultants Pvt. Ltd.
Say, you are 25 years old and plan to retire at 60. If your current annual expense is Rs.10 lakh, the expenses in your first year of retirement would be Rs.77 lakh, assuming annual inflation of 6%. So, you will need a corpus of Rs.10.7 crore at age 60, for which you need to invest Rs.28,000 per month till retirement age and earn return of 10% on it. If you delay and start investing only when you turn 30, you would need to save Rs.35,365 per month. So, the later you start, the more you need to save.

Identify goals later 

You may be wondering, why invest when you don’t have goals. Imagining about retirement or any other kind of long-term goal is difficult when you are in your 20s. “Many financial commitments come in the form of events. The older you get, the more difficult it gets to catch up to the expenses. People don’t think about this in their 20s,” said Leo Puri, managing director, UTI Asset Management Co. Ltd. 

How does one overcome this difficulty? 

“It is a simple thing. Generally, your financial goals will include retirement, buying a house, marriage, children, their higher education and marriage, your higher education, travel and spending on gadgets or white goods. Even if none of these make into your list right now, they will soon creep in,” said Suresh Sadagopan, a Mumbai-based financial planner. Even if you don’t have a goal, keep a part of your salary aside to be used for future needs. 

Insure yourself

Once you have decided to save a certain portion of your income, the next step you may assume is to invest. It’s not. the next step should be buying health insurance so that medical liabilities are taken care of. “Life insurance can wait. But you should take medical insurance immediately. You may think that your employer will take care of it. But health issues can occur any time, say, when you are in between jobs. Consider taking health cover of at least Rs.3 lakh, which will cost you under Rs.4,000 per annum,” said Sadagopan. You don’t want to dip into your savings or investments when you have an option to hedge. 

Understand products 

After health insurance comes investing. You must remember that over time, money loses value due to inflation and taxes. So, leaving all your money in a savings account is not prudent. Of course, that doesn’t mean that you invest in any product that gives you higher returns than a savings deposit. You should calculate the returns you get after factoring in inflation and tax. “People don’t understand the difference between real return and nominal return. They misunderstand nominal return to be the real return. Always remember to factor in inflation when you are investing,” said Vivek Dehejia, professor of Economics at Carleton University in Ottawa, Canada. 

So, which product to choose? Since you have time on your side, you are in a better position to take risk. 

Though you should save and invest regular, it doesn’t mean that you can’t indulge. “You can buy a new gadget or go for a vacation, but it doesn’t mean that you go overboard with you credit card and spend more than you can afford,” said Sadagopan. 

If you have basic understanding of financial products and how they work, you will be able to make the right decisions about your money life. Doing so will earn healthy returns.