Here's how to rework your tax strategy

Hello, this is a call from your bank. May I help you with your investment planning, sir? Haven’t you been bothered by such persistent calls? Indeed, the new financial year is here and it’s again time to freshen your investment outlook and rejig the portfolio, particularly in view of the budgetary changes and new opportunities knocking at your door.

True, with the Indian economy on a secular growth path, there have been opportunities galore. Experts too believe that the same can sustain in the current as well as the coming years at more or less the same level, if not higher ones, driven by multiple economic growth drivers which include favourable demographics, consumption demand and investments in infrastructure, which may result in robust corporate earnings. Still, things like volatility in the markets and the uptrend in interest rates have to be factored in before taking a call on investments.

Says Dinesh Thakkar, CMD, Angel Broking, “At the outset, investors should bear in mind that the current phase of spiralling interest rates is bound to have a deflationary effect on all asset classes, including equity and real estate, thus bringing prices of all assets lower to justify relative valuation to returns on risk-free assets like bank FD and bonds. Also, as the cost of money increases, there will be less demand for assets due to less investable surplus, thus putting downward pressures on the prices of all the assets.”

Therefore, to be on the safer side, individuals should first utilise the existing tax-savings avenues fully, i.e. one should make investments up to Rs 1 lakh to avail the benefit of Sec 80C deduction. “These include PF, PPF, NSC, repayment of principal amount of housing loan, and life insurance policy premium, among others,” informs Vikal Vasal, director, KPMG India.

It is advisable that adequate life insurance cover is taken by the individuals, especially where the family is mainly dependent upon the sole earning member. Further, one should also try to avail the tax benefit in respect of mediclaim policies for self and dependants, he says.

From long-term perspective, systematic investment plans (SIP) of mutual funds are also considered a good option as individuals do not have the expertise of analysing the stocks/monitoring the same on regular basis. Also, irrespective of one’s age/income level, one must plan for some regular income after retirement.

Some experts, however, are of the view that budget hardly matters, except for the changes in personal tax structure.
For instance, Devendra Nevgi, CEO & CIO, Quantum Asset Management Company, says, “It’s advisable for an individual not to respond to the daily changing investment scenario. Individual investors have to understand their own risk appetite & time horizon before they take a call on any investment. The costs associated with such investments also have to be lower.”

Rahul Aggarwal, CEO, Optima Risk and Insurance Management Services, agrees. “Good investment planning should be with a long-term view. Any investment, at whichever stage of life, should foremost be done with the objective of long-term financial goals. If this is kept in mind, then the influence of current investment scenario and budgetary changes diminishes on the investment outlook. It is our view that individual investors should look at fixed return securities like fixed deposits, reasonably-priced IPOs and real estate in growth areas of the country. The mix of these will depend upon the risk bearing capacity of the investor,” he says.

But despite the current high volatility in the markets, experts still seem to be bullish on stocks. “Stocks will continue to deliver reasonable returns from the long-term perspective, though it’s difficult for the asset class to repeat its 2006 performance in 2007. Even though the rates of 9% plus growth may not be sustained, India’s growth story continues to remains attractive compared to its global peers, even at a trend growth rate of say 6.5-7% for the next decade. Investors, thus, have to balance there risks & return expectations and be patient in wealth creation,” says Nevgi.

Sivasubramanian K N, senior portfolio manager-equity, Franklin Templeton, also seems to be of the same view. “The rapid upward and downward movements in the stock markets in recent times mean that over the short term, further volatility cannot be ruled out. However, India has much better balance in its growth model than the rest of the Asian region -- giving it a built-in macro resilience that other emerging economies lack. We believe this would help Indian markets over the medium to long term, as investors recognise the underlying strong fundamentals. Any sharp corrections from these levels can be used to increase exposure to equities,” he says.

Surprisingly, the overheated real estate, which has been the darling of investors for the last couple of years, seems to be fast losing its sheen, at least for the time being. “We would advise investors to stay away from the real estate for a year or so due to the recent sharp run-ups in prices. Furthermore, owing to thin liquidity in this asset class, it will take some time for it to get adjusted to a high interest regime,” advises Thakkar.


Likewise, bank deposits seem to be attractive, thanks to the rising interest rates. But, once again, some experts believe it to be a temporary phenomenon as once supply issues are addressed and inflation is tamed, we may see a drop in interest rates.

NEW AVENUES

The good news for investors, however, seems to be the emergence and growth of new investment avenues which till a few years back were missing in a rather controlled economy.

Says Tushar Pradhan, chief investment officer - equities, AIG Global Asset Management Company (India), “Investment avenues become available either when regulation allows a certain class to enter the markets or if by rotation some asset classes become attractive for various reasons. The regulators are evaluating the possibility of allowing real estate mutual funds, and investing in art has already become somewhat popular. However, such alternative investments are peculiar to their class and lay investors should be armed with enough research on them before considering investing in them.”

Also, with the Indian being increasingly integrated with the global economy, “we might see demand developing for sophisticated investment products such as absolute return funds, alpha strategies (including portable alpha), tactical asset allocation (across asset classes/currencies) and quantitative strategies. amongst the institutional segment. From a retail investor perspective, we believe final guidelines for real estate and infrastructure funds will see the emergence of new investment avenues that will help them in participating in the growth potential of the infrastructure/real estate sectors. Also, formulation of overseas investment guidelines might see the launch of dedicated overseas funds and feeder funds,” says Sivasubramanian.

Recently, the government permitted individuals to investment in international markets to the tune of $50,000 per annum, giving them an opportunity to invest in international markets. “Although this option is still nascent and in its first year of operations, we see this avenue opening up significantly over the coming years. People must use it to de-risk themselves from investing in just one country,” advises Thakkar.

Amongst the new avenues that have emerged for individual investors are also the Gold ETFs & capital protection-oriented funds. “Real estate managed funds & ETFs, when allowed, will offer access to retail investors’ exposure to the real estate market. Gold ETF remains a good long-term investment and an inflation hedge. Mutual funds are now offering funds which invest in international markets,” informs Nevgi.

NEED-DRIVEN INVESTMENTS

But whatever be the avenue, experts advise investors to have a medium-to-long-term view while investing in growth markets like India, besides taking into account individual needs also. “We subscribe to the life-cycle theory of investment wherein the stage of one’s life decides exposure to various asset classes, added to the pressures of maintaining a dwelling unit,” says Pradhan.

For example, younger people should have more exposure to equities as they are in the accumulation stage. As one gets older and incomes grow, there is a need for capital preservation and allocation to fixed interest (as opposed to fixed income investments) could be added to.

“In addition, one should also have liquid investments to meet short-term contingencies by way of either bank deposits or liquid funds. However, tax slabs, quantum available for investments and sundry other issues really do make this a very individual affair. Last, but not the least, is the individual’s appetite for risk,” he adds.

HEDGING RISK

However, hefty returns alone should not be the sole criteria for investments. Says Pradhan, “In any scenario, investors should be aware of the products they are buying. Even in equity mutual funds all funds are not alike. One should read the various offer documents to ascertain the appropriateness of the investments to one’s portfolio. Investors will also be well served by educating themselves about expectations of returns to ensure not getting carried away by false claims. For example, there doesn’t exist any investment in the world which can sustain a 25% rate of growth for ever!”

Besides, one should be cautious while making any investment and not just be guided by the trends in the market. Diversifying investments also helps. “One should strive to invest in at least four to five different investment options so that downfall in one does not have a major impact on the long-term plans/funds requirements of the individual,” advises Vasal. No need to mention that precautions and the right approach to investments alone may yield you the desired result.

Make Money & Save On Tax

Except for Equity Linked Savings Schemes (ELSS), all tax saving investments are fixed return. It is interesting to see how in the peak of a bull run, fixed return investments are scorned by investors. Why park your money in a place that gives you a meagre return when the bulls are galloping ahead to give you 60 per cent per annum?

Go back to the five-year period from 1998 to 2002. The Sensex rose wildly and then fell to almost the same level. During these five years, your money would have stagnated in the stock market. If, instead, you had invested in a fixed deposit where you were earning 11 per cent or 12 per cent per annum (which was the rate then), you would have seen your money go up by about 75 per cent.

However lucrative the stock market, it is risky. So in every portfolio it makes sense to allocate some amount of money to fixed return instruments. And, if you can avail of the tax benefit while doing so, so much the better.

Five-Year Bank Deposits
Lock-in period: Minimum 5 years
Safety: High
Instrument: Fixed return
Annual return: Depends on market interest rates
Limit: None

This has been the latest addition to Section 80C. And, for those who love depositing money in the local bank, this one is a real boon. But do make careful note that any deposit with a tenure of less than five years will not be valid for the tax benefit.

As of now, you can expect around 8 per cent on such a deposit. Senior citizens will get 0.5 or 1 per cent more. So while this option scores high on convenience and safety, the hitch is that interest earned on bank deposits is taxed.

Public Provident Fund
Lock-in period: 15 years
Safety: Highest
Instrument: Fixed return
Annual return: 8%
Limit: Rs 500 (min) to Rs 70,000 (max) per FY

Though its interest rate has dropped from 12 per cent to 8 per cent per annum, it is still the darling of the tax saving instruments.

To add to its sheen, it also boasts of the exempt-exempt-exempt criteria, popularly referred to as EEE. What this means is that there is a tax exemption on contributions (when you deposit money), tax exemption on interest earned and tax exemption on withdrawals.

It can't get better than this though it can certainly get worse. In the future, the taxation methodology would shift to EET -- exempt-exempt-taxed -- which means that the withdrawals would be taxed.

National Savings Certificate
Lock-in period: 6 years
Safety: Highest
Instrument: Fixed return
Annual return: 8%
Limit: Rs 100 onwards. No upper limit

On the face of it, this one is identical to the PPF but with a lower tenure. While NSC offers the same interest rate of 8 per cent per annum, it is computed on a half-yearly basis, while PPF on an annual basis. On this point NSC scores.

Let's say on April 1, 2006, you invest Rs 30,000 in both, PPF and NSC. A year down the road, you would have Rs 32,400 in your PPF account but Rs 32,448 in your NSC. As the years go by, the difference becomes all the more pronounced.

But this benefit is nullified when you take the tax benefit of PPF into account. The interest you earn on NSC is taxed but is also eligible for a deduction under Section 80C.

Generally, it is advisable to declare accrued interest on NSC on a yearly basis. So, over the period of six years, you could declare the interest income for each year. In such a case, it does not amount to a huge sum. If the above does not appeal to you, then you can claim the entire amount in the year of maturity under Section 80C.

While PPF is an ongoing account, NSC is a one-time investment available in denominations of Rs 100, Rs 500, Rs 1,000, Rs 5,000 and Rs 10,000.

Employees' Provident Fund
Lock-in period: Dependent on the employment
Safety: Highest
Instrument: Fixed return
Annual return: 8.5%
Limit: 12% of monthly salary with employee given the option to increase contribution

The EPF is a retirement benefit scheme available to salaried employees. Under this scheme, a stipulated amount decided by the government (currently 12 per cent) is deducted from the employee's salary and contributed towards the fund with the employer making an equal contribution.

The flexibility exists for an employee to contribute more than the stipulated amount if the scheme allows for it. However, the employer is under no obligation to increase his contribution. Let's say the employee decides that 15 per cent of his salary must be deducted towards the EPF. In this case, the employer is not obligated to pay any contribution over and above the amount as stipulated, which is 12 per cent.

The amount accumulated in the PF is paid at the time of retirement or resignation. If you have worked continuously for a period of five years, the withdrawal of PF is not taxed.

PF can be transferred from one company to the other if one changes jobs. Even if you have not worked for at least five years but are transferring the PF to the new employer, it is not taxed. What's more, the tenure of employment with the new employer is included in computing the total of five years.

The message: If you withdraw it before completion of five years, you pay tax. Unless your employment is terminated due to ill-health.

Infrastructure Bonds
Lock-in period: Dependent on the bond, three years minimum
Safety: High
Instrument: Fixed return
Annual return: Depends on current market interest rates
Limit: None

The party is over for these. At one time, it was mandatory to invest in them. And financial institutions like ICICI and IDBI garnered phenomenal amounts of money due to this stipulation. Now that the investor has the flexibility to bypass this investment, this is exactly what is being done. And the financial institutions too have not been coming out with issues.

Of course, if you are very risk averse and want your money back as quickly as possible, this one seems to be the only tax saving option suited to both those requirements. Provided of course, the financial institutions do come out with an issue.

Sensex fall is rather a boon in disguise

The three-day continuous fall, a 984 point correction in the benchmark index – Sensex may not be all that bad for the small retail investors. It’s rather a boon in disguise. Here’s why?

December is the month when a lot of small retail investors start their tax planning. With the current 7% plus correction, many equity linked tax savings instruments such as equity linked savings schemes (ELSS) and unit linked insurance plans (ULIPs) have seen massive correction in their net asset values (NAVs).

In many of these funds, the correction in NAV is more than 7%. This is because, these funds invest in the broader market and not just the benchmark indices. And since the second rung (small and mid cap) stocks have fallen much higher than the benchmark indices, NAVs for both ELSS and ULIP schemes have plunged more than 7%.

So suddenly ELSS and ULIPs might see a lot of inflows. Already domestic institutions are sitting on plies of cash, which might start finding its way into the equity market after the current correction.

Tax payout can be cut down by investing into 80C investment vehicles and investments up to Rs 1 lakh in 80C eligible instruments qualify for the same. Assuming a flat 30% tax rate, you can save nearly Rs 30,000 in taxes per annum by investing into 80C instruments.

There are seven investment categories where you can invest to save taxes – provident fund, PPF (public provident fund), NSC (national savings certificate), infrastructure bonds, pension plans, ULIPs (unit linked insurance policies) and ELSS (equity linked savings schemes). But, with a marked rise in the equity market, many small retail investors are being led to invest into the equity linked savings option in order to save taxes.