'It's a terrible thing to see and have no vision,' is a quote that's credited to Helen Keller, but an ideology that financial experts would have you keep close to your heart in 2012. As a dense financial fog obscures the road ahead, Anjana Vaswani tells you how to get money-smart this year
$400 million may sound like an inexhaustible pool of wealth, more so when you convert it to rupees (it's over Rs 2,092 crore) but while boxing champ Mike Tyson took 20 years to make it, an extravagant lifestyle ate through his bank account so quickly, that not only did Tyson file for bankruptcy in 2003, he was also $23 million in debt.
What about $15 million (just over Rs 78 crore), the amount that 78 year-old CNN host Larry King was swindled out of? In 2008, King filed a suit against what he dubbed "an unscrupulous insurance brokerage" claiming that its agent convinced him to engage in "highly complex life insurance transactions" and steered him into deals that were against his financial interests.
Stories like these may have you convinced that celebrities just aren't that bright; you'd have known better.
But everyone makes investment mistakes. As financial columnist Jason Zweig points out in his commentary in the updated version of Benjamin Graham's The Intelligent Investor (a book which Warren Buffet has called "the best book on investing ever written"): "There's proof that high IQ and higher education are not enough to make an investor intelligent." Offering an example, Zweig writes, "In 1998 Long-Term Capital Management LP, a hedge fund, run by a battalion of mathematicians, computer scientists and two Nobel prize-winning economists, lost more than $2 billion in a matter of weeks on a huge bet that the bond market would return to normal."
Watching even your smallest expenses, assessing the risk of every investment and limiting your borrowings are three key principles for wealth-building encapsulated in The Snowball, Alice Schroeder's biography of Warren Buffett. Certified Financial Planner, Jai Adiani and Arvind Laddha, MD and CEO, Vantage Insurance Brokers, couldn't agree more.
Draw up a roadmap to your destination
Consider the case of 26 year-old FX artist, Sunny Nair (below), a Dombivli resident, who earns Rs 7 lakh per annum, and used up his savings about a year-and-a-half ago to purchase an apartment in the same area. He resides with his mother and two younger siblings in a family-owned apartment. Adiani says, "It's important to identify life-goals and to try to work out the cost attached to these. As Nair's company provides transport to and from his workplace, a car may not be an immediate need, but Nair isn't married yet, so that may be a financial goal for him. He should chalk out how much he plans to spend on this -- will he spend Rs 1 lakh or Rs 10 lakh or will he keep the ceremony simple and save that cash? Once you have a list of your financial goals and a budget, you can figure out where to spend, how much to save, your risk, and, therefore, where you may invest what sum."
Laddha adds, "Look at the resources that are going to be available to you every month, work out your net monthly savings and identify avenues for investing these. Make an estimate of what these investments will earn you, compare them with what you need to meet the goals you've listed and if there is a shortfall, revisit the income and expenses to see how to increase your savings so as to meet the deficit."
Pointing out that this process may require you to cut a considerable chunk out of your monthly expenses, Laddha says, "It's important to be clear about your risk appetite, i.e. how much capital you're willing to stake for the opportunity to get higher returns. Depending on this, you can then decide how much to invest in high-risk high-return assets or low-risk, safe assets."
> Financial goals and the time you have to achieve these
> Liquidity required for immediate goals, expenses, income tax payments and an emergency fund
> Investments and the tenure and returns for each of these
> Existing assets, for instance, home, health insurance
> Amount/investments you would need to retire comfortably
Where you should invest
Bandra resident Sachin Jain is 36 and currently on a sabbatical. Until recently though, he drew a salary of Rs 12 lakh per annum as the director for Teach For India, a nationwide movement of college graduates and young professionals who dedicate two years of their lives to teaching (full-time) at under-resourced schools. Jain lives with his semi-retired parents, who shuttle between their city home and a farmhouse. He invests Rs 1 lakh in PPF, has accounts at two banks and fixed deposits at each. Additionally, he has invested in 13 mutual funds over the years, which he tells us, "are primarily growth-oriented balanced funds."
Balanced funds are hybrid funds that present a combination of stocks, bonds and debt products in one portfolio -- depending on your risk appetite, you can pick a fund that has a greater equity component and therefore higher-risk associated with it (naturally with the chances of higher returns), or play it safe by picking a fund with a higher fixed-income component. Adiani believes that Jain's selection of funds is ideal given his situation, "and as he can even afford to take higher risks, he can even consider investing in real estate funds." Laddha too highlights, "Investing directly in real estate is also a good option for individuals with higher incomes (Rs 25 lakh or more). The Principal repayment on housing loans falls within Section 80CCC and interest on housing loans up to Rs 1,50,000 is another tax deduction (Section 24)." And both Adiani and Laddha recommend investing in Mediclaim policies and setting aside some portion in a contingency fund.
"In most cases, salaried professionals tend to take pay cheques for granted," Adiani cautions. "Aside from having some money set aside in debt products to look after approaching goals such as marriage, and things like the purchase of a car, if you have a surplus and no major goals or dependents in the future, retirement will be a main goal." Stressing that it's never too early to start planning your retirement, Adiani says it's important to think about how you plan to spend those golden years. "If you hope to travel, you have 24 or 25 years to start saving aggressively to meet this expense."
"The simplest way to create wealth is to invest in equity for the long run -- if your time horizon is about five years or longer, this would be a good choice and if you can afford to stay invested for over 10 or 20 years, then real estate would be a great investment," he says, stressing that investments must be planned with an eye on one's goals. "If you plan to send your children overseas for education, for instance, you should start investing in equity if they're very young as you'll need to maximise returns on your investment for such a high target. Systematic Investment Plans (SIPs) may be a good option if you have calculated the figure you'll need when the time comes."
Most of us don't think twice before tossing out old bills and receipts. According to Adiani, that's a big mistake.
"Professionals need to save bills relevant to expenses, especially as they're entitled to claiming work-expense tax deductions," says Adiani. For example, he says, for anyone who earns fees as a professional, a laptop, mobile phone and conveyance charges would qualify as work expenses.
"Even otherwise, as per the law, you should maintain at least 7 years' worth of paperwork. Even a salaried employee needs to maintain all investment acknowledgement slips." Interest and depreciation are tax-deductible expenses for a profession, so if you maintain records of interest payments (EMI payments on your loan) and your purchase invoice etcetera (when you buy a car, for instance) you can claim a deduction on the depreciation officially." He stresses that this is tax planning and everyone should maximise on their tax savings. "Maintain your IT acknowledgements for 7 years too," he says.
Adiani has noted that far too many people are completely ignorant about investments made by the earning partner. He believes that even teenage children should be informed about where important paperwork is kept.
"They should even have your lawyers' contact details or that of your CA," he says, explaining, "You must be aware of where all your investments are kept. All your mutual fund reports, share portfolios, bond certificates, insurance papers etcetera should be kept safe (in a locker, ideally) and you must inform your spouse/partner about where these are kept. Adiani also suggests that parents ensure their children are nominees in their investments, "and if you can make a proper will -- through a lawyer or a financial planner -- there's nothing like it."
You can never save enough
"I'm fond of recanting -- as opposed to decanting -- the wine I serve our dinner guests. Recanting: Secretly funnelling inexpensive box wines into empty, premium brand bottles kept on hand for the express purpose of impressing guests who care about such superficial stuff. I've done this for years, and no one has ever questioned the authenticity of the wine I serve. Not even wine snobs have enough confidence in their taste buds to question what the label on the fancy bottle is telling them. If you don't believe me, a study by the Stanford Graduate School of Business and the California Institute of Technology essentially proved the same thing." That's one of American author Jeff Yeager's money-saving ideas.
Our experts offer an alternate, more traditional (and also somewhat more dignified) approach to saving, which, according to Adiani, is not just about grocery shopping on the days when supermarkets offer maximum discounts or about dropping by the pub at happy hour. "Tax planning can result in a lot of savings. Look out for the Direct Tax Code, which is likely to be introduced in April this year. It's still just a proposal, but changes in our existing tax laws are imminent. There may be new rules governing taxation on certain investment products (for the benefit of investors) and as we don't have a social security system in place here and our government is very concerned about senior citizens, retirement-oriented savings schemes may also be more favourably taxed. Slab rates may also change drastically if the current proposal is approved."
Laddha says one way to increase your savings as things stand now is, "By increasing your investment in a Public Provident Fund (PPF) account from the erstwhile limit of Rs 70,000 per annum to Rs 1,00,000 per annum. In additional to investing in tax-saving options as laid out by section 80C, investment in specific infrastructure bonds as per section 80CCF is also a good investment idea as such investments (up to Rs 20,000) are exempt from tax." And while he also recommends taking advantage of tax free bonds which are issued by certain Government of India undertakings such as National Highway Authority of India (NHAI), Indian Railways and The Housing and Urban Development Corporation (HUDCO), he's also keen to draw attention to the fact that, in the present economic environment, debt products like FDs have seen an increase in interest rates. "It's worthwhile to take advantage of these and Fixed Maturity Plans (FMP ) -- debt instruments managed by mutual funds that typically invest in government-backed securities, and corporate fixed deposit -- that are tax-efficient and hence also a good investment option."
The Magic of Compounding:
If you invest Rs 100 and earn compounding interest of 9 per cent at the end of the year, you get Rs 109. At the end of the following year however, you have Rs 118.81 as your interest was calculated on Rs 109 now and in just over 8 years you'll have doubled your money.
Major Tax deductions:
Section 80 C: Investments in specified instruments like life insurance, PPF EPF, tax saving mutual funds, home principal repayment, and tuition fees of 2 children etc (deductible up to Rs 1 lakh)
Section 80 CCF: Investment in infrastructure bonds up to Rs 20,000
Section 80 D: Mediclaim up to Rs 15,000 (also entitled to an additional deduction of up to Rs 25,000 more if paying premium for senior parents); if senior citizen, then up to Rs 20,000
Section 80 E: Deduction of interest on educational loan (no limit)
Pros and Cons of different avenues of investment
A good hedge against inflation and investment in shares (Adiani advises strongly against investing more than 10% of your portfolio in gold)
Offers liquidity (especially if you invest in equity traded gold funds which can be bought and sold on the exchange)
Uncertainty of return -- just because gold has been on an upward trend, doesn't mean that this momentum will continue unchecked
Laymen find it difficult to understand the price movement and market trend
Capital is secure Fixed Returns Reasonably liquid assets
Low rate of interest, so returns may not be enough to create wealth for the future
Premature exit could impact returns negatively
Potential for higher returns Liquid assets (you can sell you shares whenever you like; the cash isn't locked in)
High risk involved Uncertain returns The layperson would have limited knowledge of the arena
Generally perceived to offer reasonable safety of capital, though the same is not always true
High returns in the long-term
Uncertainty of return, especially in the short term
This is a very illiquid asset