The rate of inflation should decline to zero sometime in the next six months, going by the chief economist of a leading private sector bank I was talking to the other day. Part of it would be due to the high base effect, of course, but an equally significant part would be on account of the sharp decline in prices of almost all commodities, especially of oil, which augurs well with regard to the inflation expectation of a commodity importing country such as ours.
With inflation no longer a threat, the government can pull out all stops to encourage growth and limit the collateral damage the recession-ravaged West can wreak on our economy. Indeed, the ball is already in play.
Last week, the Centre and the Reserve Bank of India (RBI) announced a coordinated stimulus package - monetary easing complemented with fiscal sops is expected to release a huge amount of liquidity that would hopefully ease the flow of funds through the financial pipelines of our economy.
Key amongst the various measures announced were a cut in the rate at which banks borrow from the RBI (repo rate) to the lowest ever of 5%. Simultaneously, the rate which RBI pays banks to park their idle funds (reverse repo rate) was also slashed to 4%, thereby sending a very strong signal to banks that the RBI is going to systematically disincentivise them from using it as a safe-keeper of their money.
With bond yields dipping to as low as 4.86%, banks spooked by counter party risk will at last be forced to use their assets for productive purposes such as lending, thereby kick-starting the credit cycle in the economy. At the same time, the cash reserve ratio, which is the share of deposits that banks need to park with the RBI, has been brought down in five successive cuts to 5%. The aggregate liquidity that has been released into the system due to monetary actions undertaken so far is expected to be in the region of Rs 3 lakh crore.
What does all this mean for us retail investors? Well, first and foremost, it is almost a given that such strong measures will without any doubt see a sharp drop in interest rates. In fact, K V Kamath of ICICI Bank has gone on record saying he expects interest rates to fall up to 5 percentage points over the next six months. Therefore, investors who intend to park their money in bank deposits should hurry, if they haven't invested already.
With bank deposit rates coming off, alternate investments such as company fixed deposits (FDs) would suddenly start seeming attractive. Though monetary policy is being eased, some corporates, especially in the real estate and construction sectors, would find raising money from traditional sources difficult. Offering the retail investor a higher rate on corporate FD would be the immediate recourse adopted and it is here that a retail investor should take care. An attempt to earn marginally higher return could well prove to be one in which the capital itself may get unstuck. Realise that company FDs are unsecured loans and not subject to a charge on the fixed assets of the company concerned. There is a reason why banks are chary of lending to corporates and investors must undertake the necessary due diligence.
If I were you, I would prefer to put my money in gilt and long-term bond funds. Over the next 12 months or so, this is the space that offers the highest potential for safe yet attractive returns.
This is because interest rates and prices of fixed income instruments share an inverse relationship. When the overall interest rates in the economy rise, the prices of fixed income earning instruments fall and vice versa. To illustrate how fluctuations in interest rates affect the returns, let us take the example of an income fund.
We assume that the current NAV of the fund is Rs 10 and its corpus is Rs 1,000 crore. This means that if the fund sells all the assets of the scheme and distributes the money on an equitable basis to all the unit holders, they will receive Rs 10 per unit.
Now, suppose the interest rate falls from 10% to 9%. Immediately thereafter, you wish to invest Rs 1 lakh in the scheme. Realise that the entire corpus of the fund stands invested at an average return of 10%. If the fund sells the units to you at its current NAV of Rs 10, you will be allotted 10,000 units. This will benefit you immensely. You will be a partner in sharing the benefit of the higher returns of 10%, though the fund will be forced to invest your Rs 1 lakh at the lower rate of 9%. This is injustice to the existing investors. Therefore, something has got to be done to protect their interest.
Here comes the 'mark to market' concept. The fund raises its NAV to Rs 11.11. You will be allotted only 9,000 units and not 10,000. The return on 9,000 units @10% would be identical to the return on 10,000 units @9%.In other words, the NAV rises when the interest rates fall.
Indeed, this has already started happening and the one-year return on most funds is already in the region of around 20% p.a. Going ahead, as the yield on government securities has already come off substantially, funds investing in corporate bonds as against gilts are expected to earn better return. The credit spread between gilts and corporate bonds still exists and a 15% annual return in a well-managed income fund of a good pedigree would be a very reasonable expectation.
Source: Live Mint
Monday, January 19, 2009
Should you buy Jeevan Astha ??
It is in school that we are taught the basic difference between simple and compound interest. We are taught the fundamental principle that compound interest and not simple interest is the effective rate of return on any investment.
However, it increasingly seems to me that this is a lesson that is either not learnt well or is forgotten way too early. How else does one explain people falling over each other to invest in what essentially is a fixed deposit that, depending upon the age of the investor, offers at best 7.32% per annum (p.a.) and at worst a 4.32% p.a. return?
Yes, I am talking of LIC's Jeevan Aastha, a policy that seems to have taken the investor community by storm. The simple FD like structure gets complicated on account of the investment being combined with insurance and the usage of differing terminologies such as Basic Sum Assured, Maturity Sum Assured, Guaranteed Additions, Loyalty Additions, Death Benefit, Maturity Benefit and so on.
This week's article analyses Jeevan Aastha and tries to simplify it for the ready understanding of the common investor.
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Basically, Jeevan Aastha is a single premium assurance plan which offers guaranteed benefits on death or maturity. In simple terms, this policy is like a fixed deposit that offers a certain guaranteed return and a certain specific amount of insurance upon the death of the investor.
Anyone between the ages of 13 and 60 years may invest in this policy, which can be taken for a term of either 5 years or 10 years depending on one's choice. As in a fixed deposit, the premium (investment) has to be paid once, at the beginning. In insurance jargon, this is known as a single premium plan.
Now, to understand how Jeevan Aastha works, let's split up the investment and insurance cover. The two are mutually exclusive anyway. In other words, were the investor to survive the term of the plan, the insurance benefit offered by the policy doesn't kick in and vice versa.
Let's first take a case where the investor remains healthy, alive and kicking throughout the term of the plan (5 or 10 years as the case may be). The interest or return on investment as mentioned by LIC is Rs 100 per thousand of Maturity Sum Assured (MSA) per year for a policy of 10 years and Rs 90 per thousand MSA per year for a policy of 5 years term where the MSA is one-sixth of the Basic Sum Assured (BSA).Please note the significance of the words -- Rs 100 per thousand per year. The usage (Rs 100 per thousand) translates into Rs 10 per hundred or 10% per year.
Many unethical, unscrupulous agents are taking this rate of 10% per year and selling Jeevan Aastha as a product that offers 10% p.a tax-free return. And in the current mood of risk aversion, the public is lapping it up. However, note that the 10% is flat per year on a simple basis, meaning there is no interest on interest element (which by the way is the definition of compound interest). Instead the investor gets a flat 10% per year.
In terms of an example, a 30-year-old investor who invests Rs 24,810 will receive Rs 50,000 upon maturity at the end of 10 years, translating into a return of 7.26%. The accompanying table lists the age-wise maximum and minimum potential return on this plan.
Though there is a mention of loyalty addition, the same is variable and not guaranteed and hence not included in the computations. Generally, the same is around 5% over the term of the plan and hence will not materially alter the returns.
Coming to the insurance element, most investors are being led to believe that the insurance amount is six times the premium amount throughout the term. First of all, the insurance amount is six times the MSA plus guaranteed additions (9% or 10% as the case may be). However, this is only for the first year. From the second year onwards till maturity, the death benefit drastically falls to one-third of the above.
Tax tangleThough it is generally believed that insurance policy proceeds are free of tax, as per Sec. 10(10D), if the premium payable on any insurance plan exceeds 20% of the sum assured, the proceeds cease to be exempt and instead will be fully taxable. In the case of Jeevan Aastha, the single premium will always in all cases be more than 20% of the maturity proceeds. Would this not make the maturity amount from the plan fully taxable? A clarification from LIC would be helpful.
To sum Jeevan Aastha is a fixed-return investment plan that would offer a return in the range of 6.75% to 7.25% p.a in most cases. Any investment in this plan should be made with a clear understanding and recognition of this return.
In Nabard's Bhavishya Nirman Bonds, Rs 8,500 grows to Rs 20,000 in 10 years, yielding an after-tax return of 8.29% p.a.
Note that in terms of the example used in the article, an investment of Rs 24,810 would grow to Rs 53,562 if invested in the Public Provident Fund (PPF) scheme. One can invest only Rs 70,000 per year in PPF, of course, whereas there is no upper limit in the case of Jeevan Aastha. Besides, PPF makes for regular investing and one has to put in a minimum of Rs 500 per year to keep the account active.
While it is true that Jeevan Aastha offers insurance along with investment, regular readers of my column would know that I do not encourage combining insurance and investment. Always buy a term plan, which is the most economical insurance that you can buy and then try and optimise your investment returns.
Source : Sandeep Shanbhag DNA Times. Dt 14 Jan 09.
However, it increasingly seems to me that this is a lesson that is either not learnt well or is forgotten way too early. How else does one explain people falling over each other to invest in what essentially is a fixed deposit that, depending upon the age of the investor, offers at best 7.32% per annum (p.a.) and at worst a 4.32% p.a. return?
Yes, I am talking of LIC's Jeevan Aastha, a policy that seems to have taken the investor community by storm. The simple FD like structure gets complicated on account of the investment being combined with insurance and the usage of differing terminologies such as Basic Sum Assured, Maturity Sum Assured, Guaranteed Additions, Loyalty Additions, Death Benefit, Maturity Benefit and so on.
This week's article analyses Jeevan Aastha and tries to simplify it for the ready understanding of the common investor.
window.google_render_ad();
Basically, Jeevan Aastha is a single premium assurance plan which offers guaranteed benefits on death or maturity. In simple terms, this policy is like a fixed deposit that offers a certain guaranteed return and a certain specific amount of insurance upon the death of the investor.
Anyone between the ages of 13 and 60 years may invest in this policy, which can be taken for a term of either 5 years or 10 years depending on one's choice. As in a fixed deposit, the premium (investment) has to be paid once, at the beginning. In insurance jargon, this is known as a single premium plan.
Now, to understand how Jeevan Aastha works, let's split up the investment and insurance cover. The two are mutually exclusive anyway. In other words, were the investor to survive the term of the plan, the insurance benefit offered by the policy doesn't kick in and vice versa.
Let's first take a case where the investor remains healthy, alive and kicking throughout the term of the plan (5 or 10 years as the case may be). The interest or return on investment as mentioned by LIC is Rs 100 per thousand of Maturity Sum Assured (MSA) per year for a policy of 10 years and Rs 90 per thousand MSA per year for a policy of 5 years term where the MSA is one-sixth of the Basic Sum Assured (BSA).Please note the significance of the words -- Rs 100 per thousand per year. The usage (Rs 100 per thousand) translates into Rs 10 per hundred or 10% per year.
Many unethical, unscrupulous agents are taking this rate of 10% per year and selling Jeevan Aastha as a product that offers 10% p.a tax-free return. And in the current mood of risk aversion, the public is lapping it up. However, note that the 10% is flat per year on a simple basis, meaning there is no interest on interest element (which by the way is the definition of compound interest). Instead the investor gets a flat 10% per year.
In terms of an example, a 30-year-old investor who invests Rs 24,810 will receive Rs 50,000 upon maturity at the end of 10 years, translating into a return of 7.26%. The accompanying table lists the age-wise maximum and minimum potential return on this plan.
Though there is a mention of loyalty addition, the same is variable and not guaranteed and hence not included in the computations. Generally, the same is around 5% over the term of the plan and hence will not materially alter the returns.
Coming to the insurance element, most investors are being led to believe that the insurance amount is six times the premium amount throughout the term. First of all, the insurance amount is six times the MSA plus guaranteed additions (9% or 10% as the case may be). However, this is only for the first year. From the second year onwards till maturity, the death benefit drastically falls to one-third of the above.
Tax tangleThough it is generally believed that insurance policy proceeds are free of tax, as per Sec. 10(10D), if the premium payable on any insurance plan exceeds 20% of the sum assured, the proceeds cease to be exempt and instead will be fully taxable. In the case of Jeevan Aastha, the single premium will always in all cases be more than 20% of the maturity proceeds. Would this not make the maturity amount from the plan fully taxable? A clarification from LIC would be helpful.
To sum Jeevan Aastha is a fixed-return investment plan that would offer a return in the range of 6.75% to 7.25% p.a in most cases. Any investment in this plan should be made with a clear understanding and recognition of this return.
In Nabard's Bhavishya Nirman Bonds, Rs 8,500 grows to Rs 20,000 in 10 years, yielding an after-tax return of 8.29% p.a.
Note that in terms of the example used in the article, an investment of Rs 24,810 would grow to Rs 53,562 if invested in the Public Provident Fund (PPF) scheme. One can invest only Rs 70,000 per year in PPF, of course, whereas there is no upper limit in the case of Jeevan Aastha. Besides, PPF makes for regular investing and one has to put in a minimum of Rs 500 per year to keep the account active.
While it is true that Jeevan Aastha offers insurance along with investment, regular readers of my column would know that I do not encourage combining insurance and investment. Always buy a term plan, which is the most economical insurance that you can buy and then try and optimise your investment returns.
Source : Sandeep Shanbhag DNA Times. Dt 14 Jan 09.
Total Recall !! - Should you exit Equity markets ??
One of my friends joined as a lead software architect in a boutique firm last year. He was in charge of their largest client, until last month. Something went wrong with the account for which my friend claims he was not the reason. The point is not that. His annual performance review was due last month. And his supervisor could only recall the mistake my friend did just that week, not the additional billings that he generated in 11 months! So, my friend did not get a salary hike and promotion. Perhaps, you have experienced it as well. Why does this happen?
Psychologists claim that our memory is typically geared to remember only the final episodes of any event. Think of the film you like the most. You, perhaps, liked the movie because of the way it ended. The final episode
Researchers have conducted several experiments to prove the point. In one such experiment, students had to rate the quality of life of two women who had died recently. One had an exceptionally good lifestyle till age 60 and then slumped into merely satisfactory life for the next five years after which she died. The second woman had a good lifestyle till her death at age 55. The students gave the second woman a better lifestyle rating than the first, even though the former had more number of years of exceptionally good lifestyle. Why? The students preferred the final episode to the total movie called life.Learning the hard way
It is the same with investments. Suppose you had entered the market for the first time in 2003. You may have generated handsome profits until mid-January 2008 when the market crashed. The final episode would have stuck in your mind. So, did you immediately take a vow not to enter the market again?
While you cannot control how the market behaves, you certainly can ensure that everything goes well in the month leading to your annual performance review. My friend learnt the hard way on what it means to have it otherwise. You need not.
Source: Hindu Business Line
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