Should you invest in NPS?

Should you invest in NPS?

National Pension Scheme (NPS) is a retirement scheme. You can contribute to it voluntarily and build a corpus. This will be invested in the markets and the returns will get added to the corpus. It is a scheme to ensure pension post retirement.

Source: http://www.npstrust.org.in. NAV as on 31st Jan, 2019

Performance of NPS Schemes

How have NPS schemes fared?

NPS schemes (Scheme E) that invest more than 50% in stocks have not fared well in the short-term as the market has been volatile. On the other hand they have performed well for the longer term.

NPS schemes that invest in government securities

(Scheme G) have performed well both in short-term and long-term.

As per recent changes, the investment in equity can go up to 75% in active subscription for non-government subscribers. This means potential to earn even higher returns and beat inflation is possible.

Taxation

As per the new proposal, 60% of the total amount that is allowed to be withdrawn after the age of 60 will be fully tax exempt from April 1, 2019. The other 40%  has to be invested in an annuity plan for getting regular pension payouts.

The new proposal makes it similar to products such as PPF which also does not have any tax on withdrawal as per schedule.

Investment up to an additional amount of Rs. 50,000 can be claimed as deduction if invested in NPS apart from 10% that qualifies for deduction under Section 80CCD. But this benefit comes with a clause of a 3-year lock-in period unlike other products such as EPF or PPF.

Liquidity

You cannot exit from the product anytime you wish. Premature withdrawal is allowed under certain conditions –

  • You should be an NPS subscriber for at least for 3 years.
  • The withdrawal amount should not exceed 25% of the contributions made by the subscriber.
  • Withdrawal can happen only a maximum of three times during the entire tenure of subscription for specific reasons such as higher education or marriage of children, purchase or construction of the residential house (in specified conditions) and for treatment of critical illnesses.

The annuity product that you have to invest in may not be the product you want to buy. Usually annuity products have low returns. So NPS is a partially liquid investment.

Conclusion

NPS has become a more attractive product as – 

  • You can invest up to 75% in equity and
  • There are options for partial withdrawal

NPS is at a disadvantage as –

  • It involves a compulsory purchase of annuity product
  • Returns from annuity product are taxable.
  • You have to bear risks such as credit risk and low returns in case of Schemes G and C that invest in government securities and corporate debt respectively and market risks in case of Scheme E

You can allocate a part of your investment portfolio to NPS but ensure that you have a combination of equity mutual funds, debt mutual funds and PPF to have a well-diversified retirement corpus.

Key Takeaways    
  • As per the new ruling,  the NPS withdrawal  of 60% is tax-free.
  • NPS returns (especially of the equity schemes) can beat inflation if market conditions are appropriate
  • Invest in different products such as EPF, PPF, equity funds, debt funds and NPS to have a diversified portfolio that can give you the best returns.

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Review Your Portfolio Before Investment Decisions In A Bear Market

Vinay’s portfolio has taken quite a beating. He had purchased YES Bank at a price of around Rs. 450 per share about 8-9 months back. Today the share is hovering around Rs. 168. Sintex Plastics, which he had purchased in December 2017, has lost about 60% of its value. His portfolios largely comprised of midcap stocks, have lost 40-60% value from their peak. His stock portfolio was doing very well at one point, based on which he significantly increased his investments into stocks. Now, he is unsure as to what to do. Should he buy more of the stocks that he has so that his costs can be averaged?

The stock market has seen quite a few crashes this year. It is highly volatile these days and in a bear phase. The mid and small cap indices lost between 25-35% in a short period. In a bear market, confidence is low and stock prices are not rangebound. They can swing wildly.

In case you are in such a dilemma, here are some action points to bear in mind before making a random or emotional decision –

Review and Adjust Your Portfolio

Its ideal to book profits on your portfolio and hold some cash for deployment on market falls.  You may still want to review the stocks and equity mutual funds in your portfolio so as to remove the duds. You might want to let go of the duds in your portfolio by taking advantage of bear market rallies.

If you have stocks that were bought because of tips, recommendations or just to make quick profits, review them and sell off those that do not seem to have the potential for giving good returns in the long run.  Look to buy good stocks that can gain strongly on a market recovery.

Avoid Panic Selling

Some of us panic and sell off stocks the moment we see that they are losing value. That may not be the best course of action for all stocks. It is not a good idea to exit quality stocks with a good long-term record and good cash flow, , especially at points when they have fallen sharply and their valuations become attractive again.

Don’t Miss Out On Buying Low

Averaging is a smart investment strategy, especially for diversified mutual funds and exchange-traded funds. Systematic Transfer Plans are good to supplement your SIPs when markets have fallen; and you are unable to predict the bottom of markets, but you know it is somewhere around the corner.

Most investors become too fearful on large market falls and miss out the opportunity of buying stocks at their best prices.  Keep in mind that the news flow is likely to very negative at such points.  At the same time, don’t fall into the trap of getting in too early. You can add more of blue chip stocks, high quality funds and ETFs when the prices are down.

Be Practical

If you don’t have the time or find it difficult to track individual stock and the market environment, stick to mutual funds. Seek professional advice if required.  Understand your portfolio, risk tolerance and risk capacity, so that you do not make any hasty decisions that you might regret later on. Work on a disciplined investment style that suits you.

It is difficult to time the market. So investors have to be patient and keep the right investment perspective before making decisions.

In the current market scenario, the prices have fallen quite a bit. It may be time to take some positions slowly. For example, one can invest in blue chip equity funds such as Mirae India Equity and Aditya Birla Sunlife Frontline funds in a phased manner, especially on corrections. One can use a combination of lump sum investment and SIPs to average the costs. When the markets move upward, they can sell off some positions and use that money to invest in debt instruments.

Key Takeaways

    • Understand your risk tolerance; Use an investment style that suits you
    • When markets are volatile, review your portfolio and sell off the bad quality stocks
    • Don’t Panic . Take advantage of market volatility
    • Stay Invested for the long term in fundamentally good stocks, mutual funds and ETFs. Increase allocations on lareger market falls.

ELSS vs Equity Diversified Mutual Funds

Life is all about competition.  Who is the best? Are you good or is your friend better? There is competition even among personal finance products. While most personal finance products are good, which one would help meet financial goals. This is the call you have to make.

This is a story of a fight between two friends, Satish and Suman. Not a physical fight, but an intense competition. Both of them were in their early thirties and worked in reputed IT Firms. They liked to compete with each other and today the fight was which financial product was better. Was it ELSS or equity diversified mutual funds? Satish says ELSS and Suman says equity diversified funds. Who is right?

For those who don’t know, an equity diversified mutual fund invests in stocks across sectors. If you are an aggressive investor, try equity diversified mutual funds. Money is in stocks and there’s a measure of protection as the investment is spread across sectors like pharma, IT, Oil and Gas, Automobiles and so on, called diversification.

Lets take a look at the opponent, Equity Linked Saving Schemes or ELSS. ELSS is a type of equity diversified mutual fund where most of the investment is in stocks. It has a compulsory 3 year lock-in which means you cannot touch this investment for 3 years. What’s special about ELSS is it’s the only tax saving mutual fund. ELSS enjoys a tax deduction under Section 80C of the income tax act, up to Rs 1.5 Lakhs a year. Does this make ELSS better than equity diversified mutual funds? Let’s find out.

ELSS vs Equity Diversified Mutual Funds

ELSS is a long term investment

ELSS has a 3 year lock-in and forces you to stay invested for this time period. Equity is an excellent investment only if you stay invested for the long term. A bare minimum of 3 years is a must. This is where ELSS scores over equity diversified mutual funds.

Equity diversified mutual funds have no lock-in and allows an exit, whenever you wish. This is bad for you as most investors exit when stock markets crash. The key to make money in stocks is to stay invested in the market for the long term. Invest in ELSS with a time horizon of 7 years.

ELSS Saves Tax

Lets say you invest the same amount in an equity diversified scheme and an ELSS. Both of them give the same returns, but ELSS wins over the diversified fund as it enjoys the Section 80C benefit. ELSS is an excellent investment if you fall in the higher tax brackets.

If you fall in the 30% tax bracket, invest up to Rs 1.5 Lakhs a year in ELSS and save Rs 46,800 a year. ELSS enjoys Section 80C tax deduction and beats equity diversified mutual funds.

ELSS is like killing two birds with one stone. You get good returns and you save tax. Top ELSS schemes have given an average of 16-20% over 5 years. This is higher than equity diversified schemes. Then there’s the tax benefit.

Satish earns Rs 11 Lakhs a year and falls in the 30% tax bracket. He invests Rs 1.5 Lakhs a year in ELSS via SIPs. This helps him save 30% on Rs 1,50,000 which is Rs 45,000 + a cess of 4% which is Rs 1,800. Satish saves Rs 46,800 a year by investing in ELSS.

ELSS is a stepping stone to equity diversified mutual funds

In recent times many first-timers are investing in equity. Novice investors are rushing to equity diversified mutual funds without understanding them, in the hope of quick profits.

Why not first invest in ELSS and then try equity diversified mutual funds? ELSS with a compulsory lock-in, forces you to stay invested for the long term. ELSS handholds you and helps get familiar with equity. You can now invest in equity diversified funds with confidence and make a profit.

Today, stock markets are falling and many first-time investors are heading for the exit in panic. Many of these investors have bought high and sold low, taking home immense losses. If these panic-stricken investors had invested in ELSS, they would not have been able to exit the stock market and in a few years, they would have seen profits.

What do you take home from this article?

  • ELSS sticks to the top 500 Companies and an ELSS comparison must be made with large-cap funds.
  • ELSS generally beats large-cap funds as it enjoys a tax advantage.
  • ELSS enjoys true competition from multi-cap funds, which invest in large-cap, mid-cap and small-cap Companies.
  • ELSS funds have locking, but face lesser redemption pressure on market falls and hence could deliver superior returns in the long term.

Loan Against Mutual Funds

There are times in life when you just have to take loans- for a medical emergency, a marriage or a much-needed holiday. You would most likely avail a personal loan which charges high interest and struggle with EMI repayments. This is exactly what happened to Shankar, a 28 year old man, who took a personal loan to go on a holiday.

Shankar a young man had dreams. He lived in the southern part of India, in a town in Kerala. He was a teacher at a nearby school with a take home salary of Rs 20,000 a month and he wanted more from life. He badly wanted to holiday in the North East. So he availed a personal loan of Rs 2 Lakhs from his bank with a tenure of 3 years at an interest rate of 16% a year.

For those who don’t know, a personal loan is a No Reason Loan. Banks don’t ask reasons for availing the loan.  There’s no collateral. The problem is banks charge interest of 14-21% a year on a personal loan. You might not be able to afford the EMIs and fall in a loan trap.

This is exactly what happened to Shankar. After an enjoyable holiday, it was time to think of the personal loan EMIs. He had to pay nearly Rs 7,100 a month for the next 3 years. This didn’t seem a problem till a medical emergency ate up his savings. Shankar struggled with personal loan EMIs and today is in deep debt.

Ideally, one should not take a loan for your wants.  You could take it for your needs.  We suggest you invest towards your vacation and then take your vacation.  However, if you cannot avoid taking a loan, taking a loan using your mutual funds as security, is one option. Use an overdraft facility in your bank account. This will help if you need is only temporary.  There’s no need to redeem mutual fund units and you can continue with SIPs. During a financial emergency, don’t liquidate mutual funds. Just avail a loan against mutual funds.

You can avail a loan against equity mutual funds, debt funds or hybrid mutual funds by approaching a bank or an NBFC and pledging mutual fund units as collateral. The loan is sanctioned based on the Net Asset Value, NAV of the mutual fund units in the folio and the loan tenure. You get loan against mutual funds at an interest rate of just 10-11% a year and as its secured, interest rates are much lower than the commonly availed personal loan. If you have a good credit score and have been a customer at the bank for a really long time, negotiate for a lower interest rate.

If the mutual fund units are in demat form, several online portals are willing to sanction loans within minutes. If the units are in physical form, you might need a loan agreement with the bank. You have to understand lien on mutual funds before we go further. It’s a document that gives the bank the right to sell the mutual fund units. This comes in handy for the bank if you’re not able to repay the loan. The lien grants the bank ownership of the mutual fund units you own. Approach your mutual fund house and request for a lien on mutual fund units in the name of the bank for a lien transfer to the bank.

How to get loan against mutual funds? Simply log on to your internet banking account and select the equity or debt funds you want to hypothecate. Your application is redirected by banks to CAMS or Karvy which verify the mutual fund holdings. The registrar marks a lien against mutual fund units being pledged with a letter send to the bank and a copy marked to you to confirm the lien. The lien is marked against the mutual fund units, so this means you cannot redeem units, until the loan is repaid. You continue to enjoy dividends and other ownership benefits, but you can’t redeem the pledged units. Equity based funds can fetch a loan as high as 50% of the NAV, while for debt funds its 60-70%. Banks allow you to avail a maximum of Rs 20 Lakhs against equity mutual funds.

Don’t make the mistake of not repaying; or the bank will ask the mutual fund to redeem units and take the money. Banks have a list of mutual fund units against which they lend.

Shankar availed a personal loan at an interest of 16%; while you get a loan for just 11% against mutual funds. This is a sizeable savings in interest. Shankar should have invested in mutual funds via SIPs and then gone on holiday. Loan against mutual funds are great when stock markets fall. If you need money in a hurry, just pledge mutual fund units, instead of redeeming them at a loss.

Mutual Funds Better Than FD?

Mahesh is 31 years and works as a lecturer in a top private college. He is well paid and earns Rs 13 Lakhs a year. Mahesh has always invested in FDs and the reason is simple. FDs are safe and offer decent interest. Mahesh stays far away from mutual funds as he believes they invest in stocks making them extremely risky. Is Mahesh Right? Do mutual funds only invest in stocks?

When you say mutual fund, the first thing that come to mind is the equity mutual fund. Mutual funds are not all about stocks. They do invest in fixed income instruments. Let’s take a close look at fixed maturity plans also called FMPs, a type of mutual fund and how they are better than fixed deposits.

FMPs are closed-ended debt funds with a fixed maturity period normally just over 3 years to take advantage of the long term taxation. You can invest in FMPs through a New Fund Offer or NFO. Closed-ended means the FMP has an opening date and a closing date and you must invest within this time. FMPs invest your money in money market instruments like certificates of deposits, commercial paper, corporate bonds, treasury bills among others. They invest in debt instruments and you can check the credit rating before investing.

Mahesh doesn’t like risk in investment. Mahesh asks only this question? Are FMPs safe like FDs? In FDs you already know the maturity value of the invested amount at the time of investment itself, as interest rate is fixed. FMPs offer only indicative yields, but the Yield to Maturity of the portfolio is disclosed regularly. FMPs also invest in safe debt products.  Infact, some of them invest into PSU and Bank deposits/bonds only. You can also choose an FMP with a high credit rating.  Though the NAV is reported daily and may vary in line with movements in interest rates, if you hold to maturity, the returns are largely fixed.

If you want higher returns than FDs and are willing to bear a slightly higher risk, then invest in FMPs. FMPs are low risk investments compared to equity mutual funds. FMPs are listed on the stock exchange, but liquidity may not be available at all times on the exchange and hence are less liquid than FDs.

Mutual Funds vs FDs

When it comes to taxes, FMPs score over FDs, especially if you fall in the highest tax slab. The interest earned in FDs is added to taxable salary and you are taxed as per your tax bracket. Mahesh falls in the 30% tax bracket and FD interest income is taxed at the highest rate or marginal rate of tax.

In FMPs, taxation depends on the type of fund. Choosing the dividend option means you bear the dividend distribution tax, DDT of 28.84%, which is slightly lesser than the marginal rate of tax on FDs. It’s in the growth option of FMPs where tax is saved.

If you quit the FMP before 36 months, gains called short term capital gains are added to taxable income and taxed asper tax bracket. If you stay invested for 3 years or more, gains are called long term capital gains which attract 20% tax with the indexation benefit. Indexation inflates the purchase price of the FMP, saving tax.

If Mahesh invests Rs 10 Lakhs in FDs of 3 year tenure, the interest earned is taxed at the highest tax rate of 30%. If the FD offers 7% interest, this translates to a post-tax yield of 5%, which isn’t much. Lets say Mahesh invests Rs 10 Lakhs in an FMP of same tenure. FMPs can give returns of around 7.25-7.5% a year, though returns aren’t guaranteed. With the indexation benefit, post tax returns are nearly 1.25-1.75% higher than FDs. This makes FMPs a better investment than FDs on a post tax return basis.

Will Mahesh invest in FMPs over FDs for higher returns?  Investing in FDs largely erode your wealth if you consider impact of taxes and inflation. (ie. if you are in the higher tax brackets.)  FMPs are quite safe, especially if you chose a fund that invests in quality debt. FMPs are a smarter option, and may just help you beat inflation on a post tax basis.  That’s a call that Mahesh can take if liquidity is not a requirement for him.

ELSS Saves Tax And Makes You Rich

Heard this great saying by former US President Richard Nixon? “Make sure you pay your taxes; otherwise you can get in a lot of trouble.” Sampath a young 28 year old man, works in an IT firm in Bengaluru. He had never heard of Richard Nixon, but he knew he had to pay taxes.

Sampath earned Rs 12 Lakhs a year. This salary meant he paid a lot in taxes, as he never bothered to do tax planning. He grumbled, he cursed, but he paid his taxes.  All this changed the day a friend introduced him to mutual funds, or more specifically a type of mutual fund called Equity Linked Mutual Funds or ELSS. His friend also told him something he would remember all his life, “A rupee saved is a rupee earned.”

ELSS is an equity diversified mutual fund which invests most of your money in stocks across sectors. An investment in stocks is risky, but investing across sectors called diversification, offers a measure of protection. ELSS has a compulsory lock-in period of 3 years. This means you can’t touch the investment for this time.

Sampath had another problem. Where to invest? He had some money in fixed deposits. Fixed deposits offered decent interest, but you can never get rich, just by investing in FDs.

You must be having a lot of questions, the first one being, how does ELSS save tax? You enjoy the Section 80C deduction up to Rs 1.5 Lakhs a year. ELSS is the only mutual fund which enjoys this benefit. There’s a 10% long term capital gains tax (LTCG) on capital gains exceeding Rs 1 Lakh a year.

ELSS is an excellent investment if you fall in the higher tax brackets. Sampath earned Rs 12 Lakhs a year which put him in the 30% tax bracket.  ELSS saved Sampath Rs 46,800 a year.

Sampath invested Rs 1.5 Lakhs a year in ELSS. Now 30% of Rs 1,50,000 is Rs 45,000. Add a cess of 4% on income tax of Rs 45,000 which translates to Rs 1,800. Sampath saves Rs 46,800 a year by investing in ELSS.

He enjoys the highest returns among Section 80C options with the lowest lock-in. Sampath chooses the best way of investing in ELSS which is through SIPs.

ELSS invests most of the money in stocks. Doesn’t this make it a risky investment? Any investment involves risk. Even FDs are risky as a part of the interest you earn is swallowed by inflation. Equity investments offer high returns at high risk. The key is to stay invested for the long term and cut risk in investment.

ELSS is an excellent investment for a young man like Sampath. He doesn’t have many responsibilities and can stay invested for the long term. This makes ELSS an excellent investment for many youth in India.

Now to the second question. How does investing in ELSS make you rich? Ever heard of compounding returns? Compounding returns are return on return. The returns you get are reinvested to give more returns. Find this difficult to understand?

Let’s see how much Sampath has if he retires at 60, having invested just Rs 8,000 a month in ELSS via SIPs. Sampath has 32 years left till retirement. Let’s assume a conservative return of just 9%. Sampath would have built around Rs 1.77 Crores at retirement from this SIP. Looks a massive amount. Sadly, Sampath will have much less at retirement. Inflation eats up a lot of his returns and if you assume an average inflation of 5% over the period, Sampath will have only Rs 60 Lakhs at retirement.

Here’s the good news. ELSS can give average returns of 12-14% over 3 years and 15-17% over 5 years, depending on the type of ELSS. This is nearly double the returns most conservative investments offer. The longer you stay invested, greater are the returns. The power of compounding ensures you are a Crorepathi at retirement.

ELSS saves tax and makes you rich. You can save Rs 46,800 a year on being in the highest tax bracket. This amount when invested in the ELSS gives returns much above inflation. ELSS combines the double benefits of tax saving and compounding returns to make you rich at retirement.