Bagavad Gita

“Bound by your own Karma, born out of your nature, deeds which out of delusion you wish not to do, you shall do helplessly against your will” O Kaunteya --Bhagavad Gita - Chap: 18 ; Verse: 60

Sunday, November 7, 2010

The Art Of Money Management For A Novice

Chapter 3   Investment Options – Secured Investments

Nothing is impossible for those who perceive the nature and the means
Of their task and proceed with determination.     
                                                                       Thirukkural - Verse 472


Do you want to become rich? A question nobody can give an answer in the negative. But how to become rich? A million dollar question for which there is no definite answer. More than your earnings, thriftiness and savings alone can make anybody rich in the long run. What kind of an investment is needed to become rich? Investments which have the following traits – Safety, Profitability, Liquidity and capital appreciation.

The basic concept of investment does not lie in generating high returns alone. It lies in achieving a sound balance between these four objectives mentioned above. Investment management is not a game of maximizing returns but a game of delicate balancing. Don’t opt for highly profitable investments, if safety element is missing. Also don’t lock up your entire money in illiquid assets. You may need that money at any point of time. Do not put all your money in liquid assets alone.  You need to earn a profit sufficient to cover the depreciation of your net worth caused by inflation. So you should have a balanced approach and your investment options should also be balanced so that it withstands all unforeseen catastrophes in the financial world.  Let us discuss the different options lying before us.

1.     Public  Provident  Fund  ( Duration 15 years)
In State Bank Of India
    I consider this as the best investment available and everybody should start their investment with this government Instrument. “Safety” and “8% compounded annual return” make this investment highly attractive. And, due to the tax benefit (PPF falls under Section 80C), your actual return works out much higher than 8%.
You should start a PPF account in your child’s name on its first birthday. This will be the best Birth day gift. After fifteen years it will be of great help for Higher Education as well as marriage. This account can be extended even after fifteen years, three times, each for a period of 5 years every time.
Limits for investing under PPF
You can invest up to a maximum of Rs 70,000 per annum in a PPF account. The minimum you must put in every year is Rs 500. You can invest the money in 12 installments or as a single payment in a year. Each installment can be any amount, but in multiples of Rs 100 (though not less than Rs 500).
 Accounts in the names of your minor children also can be shown for tax deduction by you under 80C till they attain majority. But all these contributions put together, you can make a maximum claim of 70,000 only. 
*Note 1.
The PPF contribution can be in addition to the EPF deducted in your office, if your are employed. Both contributions together can be Rs.100, 000 - the maximum amount you can claim for tax deduction u/s 80C. You need not look for any other instrument for tax benefit at the end of every financial year.

You need to invest Rs 17,051 per annum to get 500,000 after 15 years.
You need to invest Rs 34,101 per annum to get 1,000,000 after 15 years
You need to invest Rs 68,203 per annum to get 2,000,000 after 15 years

*Note 2.
Interest is calculated on the lowest balance between the fifth and the last day of the month. So make all your deposits before 5th day of the month.
How to open a PPF account ?
PPF accounts can be opened at designated branches of State Bank of India. There are authorized agents for PPF like other instruments. You may get a small cash incentive if you go through them every year (The incentive can fill your NANO KHAZANA). Have all transactions only by cheque.
1. Choose a SBI branch which is authorized to do government business.
Usually any ‘large’ branch with lots of customers should do. Usually newer and smaller branches may not have this clearance.
One doesn’t need to have a Savings Bank account in that branch. Choose your nearest SBI Branch.

2. Procure and submit account opening form and Identity/address Proofs
It would take only 3 minutes to fill. Choose a nominee and get a witness signature. Now you have to submit any one of following Proofs:
§  Passport
§  Pan card
§  Driving license
§  Voter id
§  Ration card
§  Two Passport Size Photographs
Any government issued identity or address proof should do. Keep originals of proof in hand for verification if needed. That’s it! The bank should now be able to open the account. Usually it may take about 20 minutes or so.
3) Get PPF Passbook
A pay-in slip needs to be filled and the initial subscription needs to be credited into your account. A passbook similar to a Savings Book passbook will be issued with your photo affixed and the nominee’s name stated.  PPF rules can be found on the back.
This is all! Your PPF account has been opened now.
*Note 3.
At present PPF is not taxed on withdrawal. But the government is contemplating on this taxation.
Premature closure of a PPF Account is not permissible except in the case of death of the depositor.
Other Features
1.      The benefits of exemption of interest from Income Tax is not available on deposits made in a PPF account after expiry of fifteen years without exercising option in writing for continuance of the account within one year.
2.      PPF accounts can be opened and operated through an authorized agent appointed by the National Savings Organization.
3.      Only local cheques are accepted for deposit and the date of presentation of local cheque and demand draft is treated as date of deposit in the Account.
4.      Balance in PPF account cannot be attached under court decree.
5.      Entire deposit in a PPF account is exempt from the Wealth Tax.
6.      On death of the account holder his nominee(s)/legal heir(s) cannot continue the account. The account has to be closed in such case.

(* Especially for lazy persons who cannot look after their own finance, this is the best option!)
There are many Small Saving schemes available. All of them are short term schemes. Usually busy persons fail to keep record on their maturity date and tend to forget to renew it in time. I am not enamored by any of them. Hence I have not discussed about them here.

2.     Bank Fixed Deposits

This is the second best option for investment. It is more liquid and equal to cash when compared to PPF. You can raise a loan against the deposits for a nominal interest or you can pre-close it during an emergency. But the interest income is liable for tax deduction at source as well as the interest income is taxable. Effective interest rate will be much less than the PPF.
Many private companies are giving more interest for fixed deposits. If the company is good then it is ok. But you cannot raise money against such deposits at times of emergency. If that company defaults then all your earnings will be wiped out. Hence BEWARE of such company deposits and better to avoid them.

3.     Gold

From time immemorial this is considered to be the safest highly liquid option provided you can protect it safely. Appreciation is also there. But it won’t give you any regular income. In the present scenario how you keep gold is more important. By buying jewelry you lose heavily in the value without your knowledge. Buy as 24 karat/22 karat gold coins and keep it in locker.

 The 24 karat gold one ounce Canadian maple leaf coin! 

 This is the absolute best looking gold bullion coin around. The color and shine of this coin is absolutely stunning. The reason this coin looks so great is twofold: First, the coin contains 1 troy ounce of pure 24 karat gold meaning there are no alloys to change the color as with Krugerrands and American Eagles. Second, the way the coin is finished makes it really shine. Because it is so amazing to look at and hold. Each bullion coin portfolio should contain at least one Canadian maple leaf.

The maple leaf coin is pure 24 karat gold. Gold is a soft metal and susceptible to scratches and dents. When you handle the maple leaf, make sure to use extreme care. There is a very good reason Krugerrands and American Eagles are 22 karat gold and that is to protect against scratches and dents. Some of the newer date maple leafs come in a protective plastic sleeve. Make sure to leave the coin in the plastic sleeve so it stays in good condition.  Handle them carefully.

Even a better option is to buy ‘Gold ETF’s.or ‘GETF’

ETFs are instruments that trade like shares and are backed by physical holdings.
India is the world's top consumer of gold, accounting for 20 percent of global demand. Indians’ Gold Exchange Traded Funds (ETFs) are apparently this season’s must-have portfolio item. Market watchers, however, are divided about how much steam the metal has left.
What are Gold ETFs?
Gold ETFs are open-ended mutual fund schemes that will invest the money collected from investors in standard gold bullion (0.995 purity). The investor's holding will be denoted in units, which will be listed on a stock exchange. These are passively managed funds and are designed to provide returns that would closely track the returns from physical gold in the spot market. An investor can buy and redeem the units either directly from the mutual fund, subject to certain stipulations, or from the stock exchange.
For example, in Benchmark Mutual Fund's scheme, the units will be allotted in such a way that the value of each unit will correspond to one gram of gold. Each unit will initially represent one gram of gold though this will come down gradually when gold is sold to meet fund expenses.
Benchmark Mutual Fund allows its investors to buy and redeem the units after the new fund offer, either directly from the fund (subject to certain stipulations), or from the stock exchange.
UTI Mutual Fund's scheme allows investors to redeem units only through authorized participants, or by selling in the secondary market. The price of the units in the secondary market will, to a great extent, reflect the price of one gram of gold.
Other funds such as Tata Mutual Fund expect to allot units at face value (Rs 10,000 - entry load/10). The net asset value (NAV) of these schemes would reflect the value of the underlying gold. The price of these units in the secondary market would reflect the NAV and the supply and demand of the units.
Benchmark and UTI will appoint market makers (authorized participants) who will buy and redeem gold units from the fund as well as in the secondary market. This is expected to keep the price of the units in the secondary market close to the fund's NAV and the spot price of gold.

Now that the gold exchange traded funds (GETFs) are being sold in the market, just like you trade in shares, you will need a ‘demat account. (How to open a demat account? We will discuss later.) Also, you need to register yourself with a broker having membership of the NSE.Once these GETFs are listed, the daily movement in their prices can be checked online like the way you keep track of your equity portfolio.
The price of GETF unit will track the price of physical gold in the international market like the London Bullion Market association. Listing on the NSE will help the buyers and sellers meet on a single platform for trading in GETFs. This will enable them convert their units into cash easily.
Will I have to pay any tax?
Yes and No.
o   Since GETFs are being sold as non-equity (there is no buying/selling of shares) schemes, you should pay dividend distribution tax (DDT).
o   That is dividend will be taxable in the hands of investors if and when these GETFs declare dividends. Simply put, dividend is money distributed to unit holders if the scheme declares a profit.
o   Current law stipulates DDT of a shade over 14 per cent for individual investors and a shade below 22.5 per cent for corporate investors. This tax is inclusive of surcharge and education cess (a type of tax).
o   However, the good news is that there will be no wealth tax or securities transaction tax (STT) when you sell your GETFs.
o   There is no STT because this is a non-equity scheme. STT is applicable only when shares are bought or sold.
o   The case for wealth tax would have existed if you were in possession of gold in physical form. The magic of GETFs lies in this. They convert your money into gold which again is converted into units in demat form.
o   So as a matter of fact you don't own gold in physical form. Hence there is no wealth tax.

**Open a Gold ETF account also on your child’s first birthday and buy few units. Add one or two units every month or whenever you have extra money. After 20 years you will have a good quantity of gold in your investment folio.

        To enlarge the chart place the cursor above and click

4.Real- Estate

Nothing can beat this investment. Your investment will always have appreciation only. It will out beat Gold in terms of appreciation.  (One ground plot in Besant Nagar Chennai in the year 1975 was 18,000 Rs. Today it is more than 3Crores). Compare this appreciation with Gold. But investments in Real Estates have associated risks. Ascertaining the genuine owner of the property is essential before buying. Have a good legal opinion before buying any property.

 This investment can be classified in to two types.
1.      Buying a ground with or without building.
2.      Buying a flat

The real-estate prices in cities are skyrocketing and it has become out of reach for people. Hence buying vacant plots in the outskirts of developing small towns will be an intelligent option. Whenever you buy plots always buy two plots. After twenty years you can sell one plot and from the sale proceeds you can build your dream house.

If you are working in a city and do not own a house then you opt for a small apartment on loan. The monthly pay out should be only equal to the rent you will be paying if you stay in a rented apartment. In a matter of few years you will become the owner of the apartment. The concept of small studio apartments is slowly emerging in metros.

**But if you really want to buy a good house or a big flat in a city then you should find ways and means of making that much of money in right earnest way. Is there any possibility for this?

To answer this query I should talk about risky investments. We will start discussing about it in the forthcoming Chapters.