How well you know your insurance policy?


Ask most individuals who own an insurance policy about the details pertaining to the same and the most likely answer would be ‘I will have to ask my insurance agent about it.’ Ask these same individuals about which riders have they evaluated while buying their policy and the answer would be even more blurred.

While it is important for any individual to have an insurance policy to cover his life, it is equally important to evaluate the rider options available to him while buying the policy.

What are riders?
Riders, in layman parlance, are additional benefits available to an individual to compensate him for losses. These are in addition to the life insurance cover taken by him. There are various riders available to an individual like Accidental Death Benefit rider, Critical Illness Benefit rider, Waiver of Premium rider, Permanent Disability Benefit rider, etc. It is important that individuals evaluate each option carefully before deciding which one to opt for.

For example, in the case of say, a CIB rider, insurance companies have a list of illnesses that are covered by the rider. An individual must enquire about the list of illnesses covered by the rider so as to make an informed decision.

To extend the example, another point worth considering about the CIB rider is in the way CIB proceeds are disbursed. Some insurance companies take the rider premium to create a separate account for an individual for the same. Which means that if the individual was to fall ill and the illness was classified as a critical illness, he would stand to get an amount equivalent to that for which he has been covered by the CIB rider.

In case of some insurance companies, this amount would be over and above the sum assured. While with other companies this amount would be deducted from the sum assured and the life cover available to the individual would stand revised downwards to the extent of the CIB amount disbursed.

The point of disbursement also becomes important while opting for a CIB rider. While some companies make the CIB payment on the first occurrence of critical illness during the term of the policy, other companies make the payment only after an individual has managed to survive for a specified number of days (say 30 days) after the date of the claim.

In view of this, it is important that an individual knows his needs and opts for a rider accordingly. For example, if he already has a mediclaim worth, say Rs 500,000 and he’s not married, then opting for a CIB rider wouldn’t make prudent sense. Also, another positive in favour of riders vis-à-vis medical insurance is that the entire rider money is given in the hands of the insured irrespective of the expenses incurred as opposed to medical policies wherein only the actual expenses are reimbursed.

Another noteworthy point in case of PDB riders: please check how the respective companies define permanent disability before adding it to your life insurance premium. Some companies give the benefit amount of PDB only if, say, there’s permanent loss of use of 2 limbs and a permanent and immediate inability to work. In layman parlance, it means an individual will not benefit from the PDB rider if he loses only 1 limb (i.e. 1 leg or 1 hand).

In case of child plans, single parents or families with a single earner could especially benefit by opting for the WOP rider. This rider waives all the future premiums if the premium payer (i.e. the parent in this case) expires before the completion of the policy term. The policy remains in force and the child is entitled to the benefits on maturity.

So does all this talk on riders being beneficial mean that medical insurance is not necessary? Not at all. All we are trying to say is that individuals should evaluate their medical insurance options vis-à-vis riders and opt for those which make practical financial sense. Careful planning on this front might even lead individuals to alter their course of action and thereby secure their financial future.

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How to select the right tax-saving mutual fund

Most investors
select tax-saving funds (also called equity-linked saving schemes – ELSS) for
the Section 88 (of the Income Tax Act) benefit.

As blunt as that may sound, it is the main reason why tax-saving funds find
their way into investor portfolios.

We are not saying there is anything wrong with that, but equities are too
risky an investment to let tax breaks dictate your

decision-making.

Once investors appreciate that the tax benefit is just an add-on, they will
treat tax-saving funds at par with regular diversified equity funds.

In other words, they will use the same yardstick to select a tax-saving fund
as they would any diversified equity fund.

Which means that performance, investment style, expenses and other critical
parameters come into play and ‘tax benefit’ takes a back seat. We have tried to
outline some of the key parameters that need evaluation before you select the
right tax-saving fund.

1. Performance

Among other things, investors must evaluate the tax-saving fund on NAV
returns. While performance isn’t everything, it is nonetheless a critical
parameter on which a fund must redeem itself before you can consider investing
in it.

The fund must have put in a solid performance vis-à-vis the benchmark index
(Sensex, Nifty, BSE 200, as the case maybe) as also
its peer group. And since tax-saving funds have a 3-year lock-in, this performance
must stand out over longer time frames 3-year, 5-year.

In reality, all equity-linked investments need to be considered with a 3-5
year investment horizon, but ironically it takes a lock-in in a tax-saving fund
for investors to evaluate equity funds over that ‘extended’ a timeframe.

While evaluating performance, you need to put a premium on consistency
across market phases. Most, if not all, funds do well during a bull run, and
most funds do just as poorly during a market slump. Choose tax-saving funds
that have put in a reasonable show during the upturns and the downturns.

For this you need to look at calendar year returns, not just compounded
annual growth returns (CAGR).

2. Investment approach

Equally important, if not more important than NAV returns, is the investment
style and approach of the fund manager. Typically, mutual funds are either
managed through strong systems and processes or they are managed with a strong
individualistic trait, wherein the fund manager has sufficient leeway to make
investment decisions.

Of the two styles, the first one is preferable as there is greater emphasis
on an investment team that follows a well-defined process that is known to the
investor before hand and does not come as a shock to him at a later stage.

To cite an example, Sundaram Tax Saver has a
well-defined investment process that does not allow the fund manager to invest
more than 5 per cent of net assets in a single stock.

While this may be a defensive investment strategy, it also gives a lot of
comfort to the investor who knows well in advance the risk levels associated
with the fund.

Given that you invest in a tax-saving fund with a minimum 3-year commitment,
there is merit in selecting conservatively managed funds that look for
undervalued stocks as the fund manager has the luxury of taking longish
investment calls.

3. Volatility and risk-return

Great NAV (net asset value) returns in isolation do not amount to much. A
fund could have done exceedingly well during a bull run by pursuing an aggressive
investment strategy and could have slumped as hard during the bear phase after
that.

What this means to the investor is that his fund’s NAV is up sharply one
month and down even more sharply the next month. This is the kind of turbulence
that most investors can do without.

Admittedly, equity funds cannot really eliminate turbulence in their
performance given the nature of equities. But it can be kept under control by
pursuing a disciplined investment approach. You need to identify funds that
have a lower ‘standard deviation’ — a measure used to gauge volatility in NAV
performance.

Likewise, look for tax-saving funds that have rewarded investors more per
unit of risk taken by them. This is calculated by the Sharpe Ratio; a higher
Sharpe Ratio indicates that the risk-return trade off has worked in the
investor’s interest.

So a lower standard deviation and a higher Sharpe Ratio make for an ideal
mutual fund investment.

4. Expenses

Managing a fund entails costs like fund manager’s salary, marketing/advertising
costs and administration costs. The cost of investing in a mutual fund is
measured by the expense ratio. The ratio represents the percentage of the
fund’s assets that go purely towards the cost of running the fund.

Typically, tax-saving funds have expense ratios in the region of 2.25-2.50
per cent. A lower expense ratio has a positive impact on the returns of the
fund as the NAV (net asset value) is calculated after deducting the expenses.

5. Other parameters

Some other parameters that you must look at are entry load and track record
of the asset management company. Most tax-saving funds have an entry load of
2.00-2.25 per cent. Some fund houses waive off the entry load on investments
made through SIPs (systematic investment plans).

Likewise track record and asset management pedigree also need to be given
due weightage. A fund house that has been embroiled
in a controversy in the past can be given the miss. Likewise, a fund house that
has just been launched can be considered only after you have exhausted other
options.

Remember, with a tax-saving fund, the fund house needs to have a minimum
3-year track record over which it should have witnessed market upturns and
downturns.

Investing in tax-saving funds must be given its due research and planning. By
only playing the tax benefit angle, you run the risk of settling for a
compromise and forfeiting the opportunity of making a great equity investment.

Your tax-saving fund shopping list:

  • 1. Less than 40% of net
    assets in the top 10 stocks of the portfolio.
  • 2. Expense ratio less than
    2.25%.
  • 3. Standard deviation of less
    than 6.00%.
  • 4. Sharpe Ratio higher than
    0.60%.
  • 5. Compounded growth of over
    25% over 5-year.

Table 1: Leading Tax-Saving Mutual Funds

Tax-Saving Funds

NAV (Rs)

Assets (Rs cr)

1-Yr (%)

3-Yr (%)

SD (%)

SR (%)

HDFC Tax Plan 2000

 41.35

 46.2

 65.1

 64.6

6.63

0.71

Birla Equity Plan

 30.50

 38.8

 36.1

 51.7

7.69

0.60

Pru ICICI Tax Plan

 35.69

 35.4

 41.0

 51.6

8.44

0.54

Magnum Tax Gain

 27.35

 60.9

 60.0

 49.2

8.22

0.58

HDFC Tax Saver

51.61

 29.0

 50.2

48.6

6.01

0.71

Principal Tax Savings

 33.19

 75.1

 38.6

 47.6

6.17

0.56

Tata Tax Saving Fund

 27.00

 45.0

 31.9

 44.4

7.20

0.56

Sundaram Tax Saver

 14.89

 7.0

 40.6

 44.3

6.61

0.57

Franklin Taxshield

 57.72

 113.9

 39.4

 42.6

6.14

0.59

Alliance Tax Relief

 113.76

 19.1

 35.4

 42.4

 7.41

 0.49

(Source: Credence Analytics. NAV data as on Nov 9, 2004. Growth over 1-Yr is compounded annualised. The Sharpe Ratio is a measure of the returns
offered by the fund vis-à-vis those offered by a risk-free instrument. Standard
deviation highlights the element of risk associated with the fund.)

This article forms a part of the latest issue of Money Simplified – The
Definitive Guide to Tax Panning. Click here to download, for FREE, the complete guide.

 

FAQs: Income tax and equity shares


Is there any tax implication while making an investment in shares? Are investors in shares entitled to any tax benefits?

There is no tax implication while making an investment in shares. There is a actually tax benefit while investing in some pre-approved companies as mentioned in the third point below.

The tax implication arises only at the time of sale of shares as under:

  • If certain eligible equity shares are purchased on or after March 1, 2003 but before March 1, 2004 — and hence for a period of 12 months or more — then the gain on the sale of such shares will be entitled for exemption under Section 10(36) of the Income Tax Act, 1961 by eligible equity shares.

This refers to any equity share which forms part of the BSE 500 index of the Bombay Stock Exchange and the transaction of purchase and sale entered into through a recognised stock exchange in India; any equity share allotted through a public issue on or after March 1, 2003 and listed on a recognised stock exchange in India before March 1, 2004 and the transaction of such shares if entered into through a recognised stock exchange in India.

  • After October 1, 2004, equity shares which have been sold to a recognised stock exchange and on which Securities Transaction Tax has been paid would be entitled to exemption from long-term capital gains under Section 10 (38) of the Income Tax Act, 1961.

Similarly, in case of short-term capital gain of such shares the gains shall be taxed only at 10 per cent.

  • Under Section 88(2), any subscription to equity shares or debentures forming part of any eligible issue of capital approved by the court; or an application made by a public company or subscription to such eligible issue by a public finance institution in a prescribed form; would be eligible to deduction subject to the conditions of this section.

Also subscription to any unit of a mutual fund approved by the board in respect of any mutual fund referred to in Clause (23D) of Section 10 would also be entitled for deduction.

What is the capital gains liability arising on sale of shares, i.e. long-term/short-term?

Up to September 30, 2004, long-term capital gain shall be taxed at 20 per cent of indexed cost and short-term capital gain shall be indexed at the normal rate of taxation.

On or after October 1, 2004, in case of shares credited through a recognised stock exchange the long-term capital gain on transactions, which have suffered STT would be nil and in case of transactions resulting in short-term capital gain, the tax would be at the rate of 10 per cent.

In case of shares, which are not transacted through a recognised stock exchange and on which STT has not been paid, the law prior to October 1, 2004 would continue to be applicable.

Can short-term capital gains be set-off by investing in capital gains bonds?

No. Short-term capital gains cannot be set off by investing in capital gains bonds under Section 54EC. This benefit is only in respect of long-term capital gain.

In case of a capital loss (short-term/long-term), for what duration can the same be carried forward by investors?

A capital loss (short-term/long-term) can be carried forward for a maximum period of 8 years from the assessment year in which the loss was first incurred.

A short-term capital loss can be set off against any capital gain (long-term and short-term). However, a long-term capital loss can be set off only against a long-term capital gain.

What is the STT (Securities Transaction Tax) and how does it work? Are investments made prior to the STT regime eligible for the long-term capital gains tax waiver as well or is this facility available only to post – STT investments?

The Securities Transaction Tax has been introduced by Chapter VII of the Finance Act (No.2) Act, 2004. This provides for a levy of a transaction tax on the value of certain transactions. These transactions include the purchase and sale of equity shares in a company, purchase and sale of units of an equity growth fund sale of a unit of an equity growth fund to the mutual fund and sale of a derivative.

The transaction tax will be payable on all transactions that have taken effect from 1st October 2004.

Effect of levy of STT:

  • Long-term capital gain, arising to an investor from the sale of these specified securities, shall be exempt from tax under section 10(38).
  • Correspondingly, long-term capital loss, arising from these specified securities shall not be entitled to set-off against any other gain/income. This loss shall lapse.
  • Short-term capital gain, arising to an investor (including foreign institutional investors) from the sale of such securities, shall be charged at 10 per cent.
  • This exemption of long-term capital gain is available to all assesses including FIIs.
  • This exemption is available only to those assessees, who hold these specified securities as capital asset (investments) and not as stock-in-trade.
  • Correspondingly, at the year-end, the stock cannot be valued at cost or market value, whichever is lower as it is not stock-in-trade.
  • STT will be applicable only with effect from October 1, 2004. For the earlier period, i. e. from April 1, 2004 to September 30, 2004, the earlier law will be operative.
  • The exemption of long-term capital gain is available only to transactions in relation to the specified securities. Exemption will not be available to transactions that are not specifically mentioned in the list above.
  • The exemption would be available even in respect of specified securities, purchased prior to the introduction of STT but sold after the operative date.
  • The exemption is available to all shares. The earlier exemption, under Section 10(36), was restricted to shares, listed in BSE 500, which were purchased after March 1, 2004 but before April 1, 2004 and sold, after being held for more than twelve months.
  • The exemption is available to all specified securities, sold through a recognised stock exchange. Private deals or transactions, not routed through a recognised stock exchange, will not be covered.
  • The purchase of the specified securities could be through any mode and need not be through a recognised stock exchange.
  • The exemption is not available to other securities, which are not specified, e.g. preference shares, bonds, debenture, etc.
  • The exemption is not available to transactions where STT has not been paid.
  • STT, paid for the purchase and for the sale of the specified securities, will not be available as a deduction. No deduction for the STT is incurred for purchase or sale of the specified securities.
  • Since long-term capital gain would now be exempt from tax, Section 14A would come into play. This means that no expense shall be allowed to be claimed as a deduction in respect of income, which is exempt. For example, expenses like interest, rent, salaries, wages, electricity, telephone, water, etc. and other administrative expenses will not be allowed, as a deduction since the income earned is exempt.

Is the dividend income received from investments in shares taxable?

Dividend received from investment in shares is not taxable in the hands of the recipient. The company distributing the dividend is required to deduct tax from the amount of dividend declared. Such tax deducted will not be entitled to TDS (tax deduction at source) for the recipient.

Do investments in shares have any wealth tax implications?

Investments in shares do not have any wealth tax implications.

Do investments in shares have any gift tax implications?

Investments in shares do not have any gift tax implications. Investment in shares in the name of a person other than the investors has income tax (gift) implications with effect from the fiscal year 2004. These shares will now be treated as income.

Are investments made by NRIs/foreigners subject to the same tax implications as applicable to resident Indian?

Non-Resident Indians are subject to lower rates of taxation. They have an option either to choose the lower rate of tax on the capital gains or to choose the normal rate of tax if they want the cost to be indexed.

This article forms a part of the latest issue of Money Simplified – The Definitive Guide to Tax Panning. Click here to download, for FREE, the complete guide.

FAQs: Income tax & home loans


What tax benefits can one get on a home loan?

Tax benefits can be claimed on both the principal and interest components of the home loan as per the Income Tax Act. These deductions are available to assesses, who have taken a loan to either buy or build a house.

(A) Interest on borrowed capital is deductible as follows:

If the following conditions are satisfied, interest on borrowed capital is deductible up to Rs 150,000,
1. Capital is borrowed on or after April 1, 1999 for acquiring or constructing a property.
2. The acquisition/construction should be completed within 3 years from the end of the financial year in which capital was borrowed.
3. The person extending the loan, certifies that such interest is payable in respect of the amount advanced for acquisition or construction of the house or as refinance of the principal amount outstanding under an earlier loan taken for such acquisition or construction.

If the conditions stated above are not satisfied, then the interest on borrowed capital is deductible up to Rs 30,000.

However the following conditions have to be fulfilled,
1. Capital is borrowed before April 1, 1999 for purchase, construction, reconstruction repairs or renewal of a house property.
2. Capital should be borrowed on or after April 1, 1999 for reconstruction, repairs or renewals of a house property.
3. If the capital is borrowed on or after April 1, 1999, but construction is not completed within 3 years from the end of the year in which capital is borrowed.

(B) In addition to the above, the principal repayment of the loan/capital borrowed is eligible for rebate under Section 88 up to Rs 20,000.

A person avails deductions allowed under Section 24 in respect of his self-occupied house property and he takes an additional loan for extension/addition to the same house; can he claim benefits from the interest deduction on the additional loan taken?

The maximum deduction permissible in a financial year for the original loan (if any) plus for any additional loans taken is Rs 150,000.

Hence, if the person’s deductions on the existing loan are less than Rs 150,000, then he can claim further benefits from the additional loan taken, subject to the upper limit of Rs 150,000 for a financial year.

If a person fails to make EMI (equated monthly instalments) payments on his home loan; can he claim tax benefits on the interest payable under Section 24 and rebate under Section 88 of the Income Tax Act?

Tax benefits under Section 24 and rebate under Section 88 of the Income Tax Act can be claimed only when the payment is made. If a person fails to make EMI payments, he cannot claim tax benefits for the same.

If a home loan is taken by a father and the loan has been sanctioned on the basis of his son’s salary, can the son claim tax rebate & deduction in respect of the interest payments?

According to the Income Tax Act, the person who has taken the loan can claim tax rebates. Hence in this case only the father will be eligible for the tax rebate.

If a fresh loan is taken to repay an existing loan, which was taken for constructing a house. Can the interest on the fresh loan be claimed as a deduction?

Tax deductions can be claimed on home loan interest payments subject to an upper limit of Rs 150,000 for a financial year. Interest on the fresh loan can be claimed as a deduction subject to the stated upper limit.

Does interest on a loan taken for repairs, renewals or reconstruction also qualify for the deduction of Rs 150,000?

Yes, the interest on a loan taken for repairs, renewals or reconstruction also qualifies for the deduction of Rs 150,000.

Can a husband and wife (both are tax payers with independent income sources) get tax deduction benefit in respect of the same housing loan?

Yes, both the husband and wife (being tax payers with independent income sources) can get tax deduction benefit in respect of the same loan.

If a person were to buy a house on a loan, and sell it within (a) the same year (b) after 3 years, what will be the tax implications of the same?

If a person buys a house and sells it within the same year/after 3 years, and if any profit is made, then a capital gains liability arises on the same.

Let us take an example to better understand the same. Suppose you purchase a house for Rs 500,000 by taking a loan and sell it in the same year for Rs 700,000; then you make a profit of Rs 200,000.

On this profit, you will be liable to pay short-term capital gains tax since the sale took place in the same year. But if the sale takes place after 3 years, then a long-term capital gains liability will arise.

The long-term capital gains liability can be avoided by investing the profit amount (after factoring in the indexation benefits) in capital gains bonds or by investing in a house property as specified under Section 54.

Under what circumstances can the tax benefit for taking a home loan towards purchase of a property be denied?

If it is proven that the home loan is simply an arrangement between the loan-seeker and the builder or with a third party for the purpose of claiming tax benefits, then tax benefits will not be allowed. Benefits previously claimed will be clubbed with the income and taxed accordingly.

This article forms a part of the latest issue of Money Simplified – The Definitive Guide to Tax Panning. Click here to download, for FREE, the complete guide.

Equities: 8 investing tips!


The stock market ‘meltdown’ witnessed since the start of 2005 (notwithstanding the recent marginal recovery) has once again brought to the forefront an inherent weakness existent in our markets.

This is the fact that foreign institutional investors, indisputably and almost entirely, dominate the Indian stock market sentiments and consequently the market movements.

In this article, we make an attempt to list down a few points that would aid an investor in mitigating the risks and curtailing the losses during times of volatility as large investors (read FIIs) enter and exit stocks.

Considering the Indian stock market behaviour over the previous fortnight, it would not be entirely inappropriate to state that the 600+ points (9%) correction witnessed in 10 trading sessions was almost as bad (if not worse) as the single-day near 800-points (16%) crash (!) seen on May 17, 2004.

This is because, in either scenario, it is primarily the retail/small investor community, which gets affected the worst as they are generally among the late entrants to a bull run (i.e. near the peak) and amongst the last to exit in a correction.

However, some amount of stock market prudence and a disciplined approach could go a long-way in protecting one’s capital. Listed below are a few points.

1. Manage greed/fear: This is an important point, which every investor must keep in mind owing to its great influencing ability in equity investment decisions. This point simply means that in a bull run control the greed factor, which could entice you, the investor, to compromise with your investment principles.

By this we mean that while an investor could get lured into investing in penny and small-cap stocks owing to their eye-popping returns, it must be noted that these stocks have the potential to wipe out almost the entire invested capital.

Another way greed affects investor behaviour is when they buy/hold stocks above the price justified by its fundamentals.

Similarly, in a vice-versa scenario (bear market), investors must control their fear when stock markets turn unfavourable and stock prices collapse. Panic selling would serve no purpose and if the company has strong fundamentals, the stock is more than likely to bounce back.

It is apt to note here what Warren Buffet, the legendary investor, had to say when he was asked about his abstinence from the software sector during the tech boom: ‘It means we miss a lot of very big winners but it also means we have very few big losers. We’re perfectly willing to trade away a big payoff for a certain payoff.’

2. Avoid trading/timing the market: This is one factor, which many experts/investors claim to have understood but are more often wrong than right. We believe that it is rather impossible to time the market on a day-to-day basis and by adopting such an approach an investor would most probably be at the losers’ end at the end of the day.

In fact, investors should take advantage of the huge volatility that is witnessed in the markets time and again. In Benjamin Graham’s (pioneer of value investing and the person who influenced Warren Buffet) words: ‘Basically, price fluctuations have only one significant meaning for the ‘true’ investor. They provide him an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market.’

3. Avoid action based on rumours/sentiments: Rumours are a part and parcel of stock markets, which do influence investor sentiments to some extent. However, investing on the basis of this could prove to be detrimental to an investors’ portfolio, as these largely originate from sources with vested interests, which more often than not, turn out to be false.

This then leads to carnage in the related stock(s) leaving retail investors in the lurch. However, if we consider this from another point of view, when sentiments turn sour but fundamentals remain intact, investors could take the opportunity to build a fundamentally strong portfolio.

This scenario is aptly described by Warren Buffet: ‘Be fearful when others are greedy and be greedy when others are fearful.’

4. Avoid emotional attachment/averaging: It is very much possible that the company you have invested in fails to perform as per your expectations. This consequently gets reflected on the stock price.

However, in such a scenario, it would not be wise to continue to hold onto the stock/buy more at lower levels on the back of expectations that the company’s performance may improve for the better and the stock would provide an opportunity to exit at higher levels.

Here it is advisable to switch to some other stock, which has promising prospects. In Warren Buffet’s words: ‘Should you find yourself in a chronically-leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.’

5. Avoid over-leveraging: This behaviour is typical in times of a bull run when investors invest more than what they can manage with the hope of making smart returns on the borrowed money. Though this move may sound intelligent, it is smart only till the time markets display a unidirectional move (i.e. northwards).

However, things take a scary turn when the markets reverse direction or move sideways for a long time. This is because it leads to additional margin calls by the lender, which might force the investor to book losses in order to meet the margin requirements.

In a graver situation, a stock market fall could severely distort the asset allocation scenario of the investor putting his other finances at risk.

6. Keep margin of safety: In Benjamin Graham’s words: ‘For ordinary stocks, the margin of safety lies in an expected ‘earning power’ considerably above the interest rates on debt instruments.’ However, having a stock with a high margin of safety is no guarantee that the investor would not face losses in the future.

Businesses are subject to various internal and external risks, which may affect the earnings growth prospects of a company over the long-term. But if a portfolio of stocks is selected with adequate margin of safety, the chances of losses over the long term are minimised.

Graham further says: ‘While losing some money is an inevitable part of investing, to be an ‘intelligent investor,’ you must take responsibility for ensuring that you never lose most or all of your money.’

7. Follow research: The upswing in the stock markets attracts many retail investors into investing into equities. However, picking fundamentally strong stocks is not an easy task.

In fact, it is even more difficult to identify a stock in a bullish market, when much of the positives are already factored into the stock price, making them an expensive buy. It is very important to understand here that owning a stock is in effect, owning a part of the company.

Hence, a detailed and thorough research of the financial and business prospects of the company is a must. Given the fact that on most occasions, research is influenced by vested interests, the need of the hour is unbiased research.

Information is power and investors need to understand that unless impartially represented (in the form of research) it could be misleading and detrimental in the long run.

8. Invest for the long term: Short-term stock price movements are affected by various factors including rumours, sentiments, market perception, liquidity, etc, however, in the long-term, stock price tends to align themselves with its fundamentals.

Here it must be noted what Benjamin Graham once said: ‘. . . In the short term, the market is a ‘voting’ machine (whereon countless individuals register choices that are product partly of reason and partly of emotion), however in the long-term, the market is a ‘weighing’ machine (on which the value of each issue (business) is recorded by an exact and impersonal mechanism).’

Of course, it must be noted that the above list is not exhaustive and there may be many more points that an investor needs to understand and follow in order to be a successful investor.

Further, the above points are not just a read but needs to be practiced on a consistent basis. While making wealth in the stock markets was never an effortless exercise, it becomes all the more difficult when stock markets/stock prices are at newer highs.

Equitymaster.com is one of India’s premier finance portals. The web site offers a user-friendly portfolio tracker, a weekly buy/sell recommendation service and research reports on India’s top companies.

How to invest and save tax!


Tax-paying individuals are also ‘investors.’ Investors are also taxpayers. That is why its funny when individuals do not apply common rules of investing while planning for taxes.

At the end of the day, you are a successful investor if you have drawn a tax-efficient investment strategy in line with your investment objective and risk profile. Here we do just that for you.

The tax-paying investor has a slew of investment options at his disposal. You have tax-saving mutual funds (ELSS, or Equity Linked Savings Schemes), life insurance, post-office schemes and infrastructure bonds, among other options.

Some of these options like tax-saving mutual funds and post-office schemes are at extreme ends of the risk-return spectrum. On the other hand, while infrastructure bonds and post-office schemes both fall within the gamut of fixed income instruments, they are far from similar and the nuances with each require deliberation before you choose to invest in either or both.

While this may look complicated, it isn’t if you get down to the brass tacks of investing.

Ask yourself some fundamental investment-related questions. Can you take on some risk? If you can, investing a portion in tax-saving funds could be a good idea. If you can’t, then post-office schemes — National Savings Certificate (NSC) and Public Provident Fund (PPF) should fit your risk profile ideally.

Are you insured as yet, if you aren’t insured, then you can consider taking a life insurance policy on priority and get a tax benefit too!

To understand how you can better allocate assets within the entire gamut of tax-saving instruments, we have divided the tax-paying community into three distinct age profiles.

The reason we have chosen age as the distinguishing criteria is because appetite for risk and therefore the expected return, flows largely from one’s age — lower the age, higher the risk appetite.

If you are between 25-35 years of age:

You are young and probably married, maybe even with kids. If you are the sole breadwinner in the family then your position in the family assumes even more importance.

If you aren’t insured already, then getting a life cover should be your most important priority. This will put your family in a better position to counter an eventuality in your absence.

For a detailed insurance strategy read ‘An insurance strategy for you’ — tomorrow.

A tax-saving mutual fund (ELSS) fits well into your risk profile given that you are young and have age on your side. You can consider investing up to the entire Rs 10,000 limit.

You can put smaller amounts in PPF and NSC. Consider investing in both in a good mix to benefit from interest rate movements in either direction. The interest rate in NSC is locked for 6 years, while it is revised at regular intervals with prospective effect in a PPF.

For instance, if you have invested in NSC and PPF two years ago, today you would be drawing interest at 9% p.a. in your NSC, and at 8% p.a. in your PPF.

However, if the interest rate scenario was to turn and rates were to rise, then you would benefit by investing in PPF wherein rates could be revised upwards, as opposed to investing in NSC wherein rates are locked.

You can give infrastructure bonds a miss. The yield is unattractive and a study done by Personalfn in this issue of the Money Simplified shows that you are better off paying tax and investing in diversified equity funds or balanced funds depending on your risk profile.

You might want to consider buying property at this stage even if you already own one. You can buy the property on a home loan and get a tax benefit on the same under Section 88.

You would have created an important asset that you can give out on lease/rent and earn more than you would have earned in a debt fund.

If you are between 35-45 years of age:

Review your insurance portfolio. You may need to consolidate by taking additional insurance as you move up the ‘lifestyle chain’ and your personal net worth witnesses a surge.

The insurance policy you bought 10 or even 5 years ago, is no longer sufficient to cover your life.

At this age, tax-saving funds can still be considered. You still have age on your side and tax-saving funds in any case have a Rs 10,000 limit (for claiming tax benefits).

Our view on NSC and PPF is the same — maintain a good mix. If you have about 1-3 years left before your PPF matures, you may consider increasing your PPF allocation as you would be getting the money back a lot sooner than the minimum 7 years.

If you are over 45 years of age:

At 45 years or above, your insurance needs are probably taken care of already. If they aren’t then, you can bridge the shortfall by taking some additional term insurance.

Ensure you have a pension policy in place as retirement is less than 15 years away and your investments need to be more retirement-oriented.

A good thing for the tax-paying investor is that tax benefits related to ‘Pension’ fall under a different Section (Section 80 CCC) as opposed to other forms of life insurance that attract tax benefits under Section 88. What this means is that you can buy pension and term insurance for instance, and still get a dual tax benefit.

You can invest in an ELSS provided you aren’t too close to retirement (around 60 years), in which case the risk-return profile of the mutual fund scheme would work against your own.

At this stage, your PPF account is probably close to maturity in which case it makes more sense to increase investments in PPF. You not only get a tax benefit, but can also make withdrawals relatively sooner.

Having read our recommended asset allocation for investing to save tax, there are some important pointers for investors:

Exhaust the Rs 100,000 investment limit by first taking life insurance before considering any other investment.

Tax-saving funds can be considered depending on your age. If you are over 55 years old you may want to reduce allocations to tax-saving funds.

Maintain a good mix of NSC and PPF to ensure that you can benefit from interest rate movements either ways.

Infrastructure bonds can be ignored. Pay the tax instead and invest in diversified equity funds, balanced funds or even MIPs depending on your risk profile.

Consider taking a property on a loan. You will get tax benefits on the loan for creating an asset that can generate revenues for you going forward.

This article forms a part of the latest issue of Money Simplified – The Definitive Guide to Tax Panning. Click here to download, for FREE, the complete guide.

How to manage your money better!


If you have sold any capital asset, like a house property, at a profit, it may not be time to rejoice just yet. Sale of capital assets comes with a string attached, i.e. the capital gains liability.

If the asset has been sold within 36 months from the date of purchase, a short-term capital gains liability arises; alternatively a sale after a 3-year period is subject to a long-term capital gains liability.

Let us take an example to understand this. Suppose you had purchased a house property in March 1994 for Rs 10,00,000 and sold the same 10 years hence in March 2004 for Rs 25,00,000. Your profit would be Rs 15,00,000; after factoring in the benefits on account of indexation the same would be Rs 602,459 (See Table 1).

The tax rate for long-term capital gains is 20 per cent; hence, the tax liability would be Rs 120,492.

Table 1

Cost of Purchase (Rs)

1,000,000

Sale Proceeds (Rs)

 2,500,000

Date of Purchase

01-Mar-94

Date of Sale

01-Mar-04

Cost Inflation Index for the year of purchase

244

Cost Inflation Index for the year of sale

463

Sale Proceeds (Rs)

 2,500,000

Less: Indexed Cost of Purchase (Rs)

 1,897,541

Long term capital gains chargeable to tax (Rs)

 602,459

Long term capital gains tax @ 20%

 120,492

Source: http://www.personalfn.com

Now let us examine some of the options available to the assessee in the given situation:

1. Invest in capital gains bonds

Assesses can avoid paying long-term capital gains tax by investing the profit on sale (i.e. Rs 602,459 in the case above), in capital gains bonds within a stipulated period of time.

These bonds are issued by specified institutions and the benefit is available under Section 54EC of the Income Tax Act. Investments should be made within a period of 6 months from the date when the capital asset was sold.

Investors are required to stay invested in the 54 EC bonds for a 3-year period from the date of investment. Failure to do so negates the tax benefits claimed.

In Table 2 we have demonstrated the working of these bonds. The Rural Electrification Corporation Ltd offers 5-year bonds with a coupon rate of 5.15 per cent for the first 3 years. Investors have the liberty to redeem their investments at the end of 3 years without any adverse impact on the tax benefits claimed.

After factoring tax benefits, capital gains bonds deliver a return of 13.27 per cent on a CAGR basis. While the returns may not seem very lucrative as compared other options, if not paying taxes is of vital importance to you, this investment makes a lot of sense.

Table 2

Amount invested (Rs)

602,459

Tax saved at time of investing (Rs)

120,492

Coupon rate

5.15%

Tenure (years)

3

Maturity proceeds (Rs)

700,415

3-year CAGR Returns*

13.27%

Source: http://www.personalfn.com. * Returns adjusted for tax benefits

2. Pay tax and invest in other avenues

Some might believe that investing in capital gains bonds is not a smart proposition since it involves blocking a significant sum of money and fails to deliver proportionate returns.

In such a scenario, you can consider paying up tax and investing the balance profits in avenues like mutual funds.

The 3-year performance for categories like diversified equity and balanced funds is undeniably an impressive one. Despite the fact that the 3-year period is a good indicator, historical returns are simply that, historical!

Secondly, investing in equity-oriented schemes also involves taking on higher risk. For those who attach greater importance to returns vis-à-vis tax saving and have the stomach to take risk, mutual funds can be a rewarding option.

Table 3
 

Returns*

3-year

Diversified Equity Funds

HDFC Top 200

50.84%

Franklin India Bluechip

45.89%

Sundaram Growth

43.22%

Balanced Funds

HDFC Prudence Fund

41.57%

DSP ML Balanced

32.58%

FT India Balanced

32.27%

Source: Credence Analytics; * Returns are Compounded, Annualised
NAV data as on October 29, 2004

3. Invest in a residential property

Long-term capital gains can be employed to acquire a residential property. If the requisite conditions including the time duration within which the gains have to be invested in buying/constructing a property are fulfilled, the assessee is exempt from paying any capital gains tax.

Similarly the new property should not be transferred within a 3-year period from the date of original transfer or construction; else the amount of capital gains claimed as exempt will be treated as being taxable in the year of transfer.

Detailed provisions governing this clause can be found under Sections 54F and 54H of the Income Tax Act.

As you would have realised there is more to managing capital gains liability than just investing in tax-saving bonds.

Adopt a strategy that best suits your needs and serves your interests; and capital gains tax management won’t be another dreary tax-planning chore.

This article forms a part of the latest issue of Money Simplified – The Definitive Guide to Tax Panning. Click here to download, for FREE, the complete guide.