MONEY TIPS FOR LOW-RISK INVESTORS
These financial strategies can help optimise the returns from safe investments.
Many equity funds have churned out compound ed annual returns of over 15% in the past 10 years.But Money Khanna is more concerned about the near-zero returns from the three largecap funds she bought 18 months ago. “I have not lost money but my investment has not moved much. A fixed deposit would have at least earned some returns,“ she says. The Mumbai-based executive now invests mainly in the PPF and bank deposits.
There are many reasons why investors prefer to be safe than sorry. Some of them just can't stomach the volatility that comes with stock investments. Khanna is one such investor. She is content with low returns from her investments as long as they are assured. Others may have had a bad experience with stocks, which is why they want to stay away. Take for instance HR professional Prakriti Ojha. She is young, earns reasonably well and doesn't have too many liabilities. But after she lost money in a mis-sold Ulip, she has stayed away from equity investments. “I paid `56,000 between 2009 and 2012 and got back only `40,000 when I surrendered the policy,“ she says. Ojha then vowed to invest only in fixed income instruments that gave assured returns.
There could also be valid reasons for investing in low-risk instruments. Nirbhay Morzaria is young and earns well. But he has major expenses lined up in the next 2-3 years and is therefore investing mostly in debt-based instruments. “I am saving for short-term goals so can't invest in volatile assets,“ he says. Only 15% of his portfolio is in stocks. The risk profile of an individual is determined by a combination of factors . In many cases, the individual makes the wrong investment choices because he is not aware of his risk tolerance. His ability to take risks may be higher than his willingness to do so.
TIPS FOR LOW RISK INVESTORS
Go for tax efficient investments
Bank deposits are all-time favourite investments for those seeking low-risk instruments. They easy to understand, widely available and anyone with a bank ac count can open one. With the spread of Netbanking, they also do not require any paperwork. But bank deposits are very tax inefficient because the entire interest earned is added to your income and taxed at the normal rate. Short-term debt funds can be a better alternative. Although the returns generated from these funds are similar to the interest you earn on FDs, the actual return is higher if you hold them for more than 3 years.
There is a widely held misconception that up to `10,000 earned from bank deposits in a year is tax-free. This is not correct. The exemption under Section 80TTA is only for the interest earned on the savings bank balance, not on fixed deposits and recurring deposits. Also, even though five-year FDs are labelled tax-saving deposits, the interest they earn is fully taxable.
For investors in the 30% tax bracket (taxable income of over `10 lakh a year), the returns from a 3-year FD can be as low as 5.6%. On the other hand, the gains from a debt fund are taxed at 20% after adjusting for inflation. The net gain is close to 200 basis points higher. “Plus, there are ways the capital gains can be set off if you invest in a fund. No such options are available for interest income from FDs,“ says Bhuvana Shreeram, Head, Financial Freedom Golden Practices, a Mumbai-based wealth management fund.
For salaried people, the Voluntary Provident Fund may be a good option.The Employees Provident Fund Organisa tion (EPFO) has recommended an interest rate of 8.95% for the current financial year, which means it will earn equivalent to 12.95% from a bank deposit or bond for subscribers in the highest 30% tax bracket. But keep in mind that the higher rate is for the current year could change in the coming years. Taxfree bonds, on the other hand, offer assured returns for the entire term.
Avoid locking up for long-term
Don't put all your money into long-term options. You never know when you may need it. Some banks levy a penalty on premature withdrawals from a fixed deposit. It's best to split the investments and create a ladder of deposits. If you have `4 lakh to invest, split the amount in four deposits of `1 lakh each for one, two, three and four years. When the 1-year deposit matures, reinvest the maturity proceeds in the 4-year FD. This will ensure liquidity because you have one deposit maturing every year. In case of regular investments, open multiple recurring deposits so that even if you have to close one due to any reason, the others can continue.
Debt funds offer higher liquidity than other long-term options such as PPF and VPF. You can withdraw from the debt fund or reinvest on any day without any restrictions. Online access has made this even more convenient.
Insurance plans force you to save
For some investors, the lack of flexibility can be a boon in disguise. Traditional life insurance plans give very low returns but they also force investors to invest for the long-term. The premium notice that is sent to the policyholder every year instils a discipline that mutual funds can't. “Mutual fund SIPs are usually for 1-2 years. In some cases they may extend to three years. A life insurance plan ensures that the policyholder keeps investing for 15-20 years. He may get 100-150 basis point lower return but at least he doesn't stop investing,“ says R.M. Vishakha, Managing Director and CEO of IndiaFirst Life Insurance Company.
The other good point is that the policyholder cannot dip into the corpus before maturity.“We have seen clients start investing for their child's education only to withdraw the money 2-3 years later to go on a holiday. We recommend insurance plans for such investors. They complain that we are trying to sell them an expensive product but that is not the case. We are just selling them discipline,“ says Sanjiv Bajaj, Managing Director of Bajaj Capital.
Former havens no longer safe
There was a time when gold and real estate were considered the safest investments. Those days are long gone. As the returns of the past three years show, gold is no longer the safe harbour it used to be. Gold prices leapt up 32% in 2011 and hit `34,000 per 10 grams in 2012. But they have consistently slipped after that and the metal is now trading at `26,500 per 10 grams, down almost 22% from the peak. Experts say it is unlikely that gold will bounce back in 2016. If you still want to invest in gold, a better option would be the gold bonds issued by the government. These bonds are linked to the price of gold and give 2.5% extra returns by way of yearly interest.
The same is true for real estate. Property prices are inflated and home loan interest rates are still quite high. Investing in property at current levels is risky because even if the value appreciates by 5-6%, the 9-9.5% interest you will pay on the loan will mean a loss in real terms. However, the real estate market is not uniform and there may still be some pockets that can offer good appreciation.
Don't shun equities altogether
Fixed deposits and PPF may be a safe option but they won't be able to prevent the eroding effect of inflation on your savings. “Your money needs to grow at a faster clip than the inflation rate to sustain your lifestyle for several years. This can't be done by parking the entire retirement savings in low yield fixed deposits,“ says Hemant Rustagi, CEO, Wiseinvest Advisors.
If you spend `40,000 a month on house hold expenses today, even 6% inflation will push that up to `72,000 a month by 2025. By 2030, the monthly requirement will surge to `96,000. By 2035, it would be `1.28 lakh a month.
The only way to beat inflation is to invest in assets that can grow faster. This is why even risk-averse investors should not shun equities completely. You may not have the stomach for the ups and downs of the stock market but experts and statistics say that equities are the only asset class that can beat in flation in the long term.
For risk-averse investors, monthly income plans (MIPs) from mutual funds can be a lowrisk entry point to the equity markets. MIP funds follow a conservative investment strategy, allocating only 10-25% of their corpus to equities and putting the rest 75-90% in safer bonds and other debt instruments. This is why the returns from this category are fairly attractive when the going is good and relatively stable over the long term. In the past one year, when the Nifty has dipped by over 15%, the average MIP fund has given a return of more than 4%. “MIPs give investors good returns if stock markets do well and also protect the downside because of the limited exposure to equities,“ says Vidya Bala, Head of research, FundsIndia.com. As the table shows, investments in the top performing MIP funds have outperformed the PPF in the past three, five and 10 years.
There are many reasons why investors prefer to be safe than sorry. Some of them just can't stomach the volatility that comes with stock investments. Khanna is one such investor. She is content with low returns from her investments as long as they are assured. Others may have had a bad experience with stocks, which is why they want to stay away. Take for instance HR professional Prakriti Ojha. She is young, earns reasonably well and doesn't have too many liabilities. But after she lost money in a mis-sold Ulip, she has stayed away from equity investments. “I paid `56,000 between 2009 and 2012 and got back only `40,000 when I surrendered the policy,“ she says. Ojha then vowed to invest only in fixed income instruments that gave assured returns.
There could also be valid reasons for investing in low-risk instruments. Nirbhay Morzaria is young and earns well. But he has major expenses lined up in the next 2-3 years and is therefore investing mostly in debt-based instruments. “I am saving for short-term goals so can't invest in volatile assets,“ he says. Only 15% of his portfolio is in stocks. The risk profile of an individual is determined by a combination of factors . In many cases, the individual makes the wrong investment choices because he is not aware of his risk tolerance. His ability to take risks may be higher than his willingness to do so.
TIPS FOR LOW RISK INVESTORS
Go for tax efficient investments
Bank deposits are all-time favourite investments for those seeking low-risk instruments. They easy to understand, widely available and anyone with a bank ac count can open one. With the spread of Netbanking, they also do not require any paperwork. But bank deposits are very tax inefficient because the entire interest earned is added to your income and taxed at the normal rate. Short-term debt funds can be a better alternative. Although the returns generated from these funds are similar to the interest you earn on FDs, the actual return is higher if you hold them for more than 3 years.
There is a widely held misconception that up to `10,000 earned from bank deposits in a year is tax-free. This is not correct. The exemption under Section 80TTA is only for the interest earned on the savings bank balance, not on fixed deposits and recurring deposits. Also, even though five-year FDs are labelled tax-saving deposits, the interest they earn is fully taxable.
For investors in the 30% tax bracket (taxable income of over `10 lakh a year), the returns from a 3-year FD can be as low as 5.6%. On the other hand, the gains from a debt fund are taxed at 20% after adjusting for inflation. The net gain is close to 200 basis points higher. “Plus, there are ways the capital gains can be set off if you invest in a fund. No such options are available for interest income from FDs,“ says Bhuvana Shreeram, Head, Financial Freedom Golden Practices, a Mumbai-based wealth management fund.
For salaried people, the Voluntary Provident Fund may be a good option.The Employees Provident Fund Organisa tion (EPFO) has recommended an interest rate of 8.95% for the current financial year, which means it will earn equivalent to 12.95% from a bank deposit or bond for subscribers in the highest 30% tax bracket. But keep in mind that the higher rate is for the current year could change in the coming years. Taxfree bonds, on the other hand, offer assured returns for the entire term.
Avoid locking up for long-term
Don't put all your money into long-term options. You never know when you may need it. Some banks levy a penalty on premature withdrawals from a fixed deposit. It's best to split the investments and create a ladder of deposits. If you have `4 lakh to invest, split the amount in four deposits of `1 lakh each for one, two, three and four years. When the 1-year deposit matures, reinvest the maturity proceeds in the 4-year FD. This will ensure liquidity because you have one deposit maturing every year. In case of regular investments, open multiple recurring deposits so that even if you have to close one due to any reason, the others can continue.
Debt funds offer higher liquidity than other long-term options such as PPF and VPF. You can withdraw from the debt fund or reinvest on any day without any restrictions. Online access has made this even more convenient.
Insurance plans force you to save
For some investors, the lack of flexibility can be a boon in disguise. Traditional life insurance plans give very low returns but they also force investors to invest for the long-term. The premium notice that is sent to the policyholder every year instils a discipline that mutual funds can't. “Mutual fund SIPs are usually for 1-2 years. In some cases they may extend to three years. A life insurance plan ensures that the policyholder keeps investing for 15-20 years. He may get 100-150 basis point lower return but at least he doesn't stop investing,“ says R.M. Vishakha, Managing Director and CEO of IndiaFirst Life Insurance Company.
The other good point is that the policyholder cannot dip into the corpus before maturity.“We have seen clients start investing for their child's education only to withdraw the money 2-3 years later to go on a holiday. We recommend insurance plans for such investors. They complain that we are trying to sell them an expensive product but that is not the case. We are just selling them discipline,“ says Sanjiv Bajaj, Managing Director of Bajaj Capital.
Former havens no longer safe
There was a time when gold and real estate were considered the safest investments. Those days are long gone. As the returns of the past three years show, gold is no longer the safe harbour it used to be. Gold prices leapt up 32% in 2011 and hit `34,000 per 10 grams in 2012. But they have consistently slipped after that and the metal is now trading at `26,500 per 10 grams, down almost 22% from the peak. Experts say it is unlikely that gold will bounce back in 2016. If you still want to invest in gold, a better option would be the gold bonds issued by the government. These bonds are linked to the price of gold and give 2.5% extra returns by way of yearly interest.
The same is true for real estate. Property prices are inflated and home loan interest rates are still quite high. Investing in property at current levels is risky because even if the value appreciates by 5-6%, the 9-9.5% interest you will pay on the loan will mean a loss in real terms. However, the real estate market is not uniform and there may still be some pockets that can offer good appreciation.
Don't shun equities altogether
Fixed deposits and PPF may be a safe option but they won't be able to prevent the eroding effect of inflation on your savings. “Your money needs to grow at a faster clip than the inflation rate to sustain your lifestyle for several years. This can't be done by parking the entire retirement savings in low yield fixed deposits,“ says Hemant Rustagi, CEO, Wiseinvest Advisors.
If you spend `40,000 a month on house hold expenses today, even 6% inflation will push that up to `72,000 a month by 2025. By 2030, the monthly requirement will surge to `96,000. By 2035, it would be `1.28 lakh a month.
The only way to beat inflation is to invest in assets that can grow faster. This is why even risk-averse investors should not shun equities completely. You may not have the stomach for the ups and downs of the stock market but experts and statistics say that equities are the only asset class that can beat in flation in the long term.
For risk-averse investors, monthly income plans (MIPs) from mutual funds can be a lowrisk entry point to the equity markets. MIP funds follow a conservative investment strategy, allocating only 10-25% of their corpus to equities and putting the rest 75-90% in safer bonds and other debt instruments. This is why the returns from this category are fairly attractive when the going is good and relatively stable over the long term. In the past one year, when the Nifty has dipped by over 15%, the average MIP fund has given a return of more than 4%. “MIPs give investors good returns if stock markets do well and also protect the downside because of the limited exposure to equities,“ says Vidya Bala, Head of research, FundsIndia.com. As the table shows, investments in the top performing MIP funds have outperformed the PPF in the past three, five and 10 years.
NEHA PANDEY DEORAS
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