Monday, July 21, 2008

Demystifying Section 80C – Understanding the Options

Welcome to part B of the ‘Demystifying Section 80C’ series. In part A of the series, we discussed about the significance of Section 80C. In part B today we will try understand the versatility of Section 80C and the various options under it.

While section 80C does provide numerous options to invest the one lakh, they are limited to long term investment options. This is instituted to encourage the habit of saving among tax payers.

Let’s discuss the options in brief

  1. Life Insurance Premium

Payment of premium for a life insurance policy for self or spouse or dependent kids can be included under section 80C. Have you been paying insurance premiums without utilizing the section 80C deductions? Time to start taking advantage of this provision. There’s an obvious reason why Insurance comes right on top of my list. It’s never enough stressing the importance of having life cover. More on this in the coming posts.

  1. Equity Linked Saving Schemes (Mutual Funds)

You’re young and ready to take some risk, what better than a scheme that lets you invest in the stock market and gives you tax benefits as well. Equity linked saving schemes are nothing but mutual funds that invest in the stock market and give you the tax benefit under section 80C. Not all mutual funds fall under this scheme. The special feature of the ELSS is that it has a lock in period of three years. This means that you cannot withdraw your money for at least three years. While there is a lock in period, in comparison to other instruments covered under section 80C, ELSS has the lowest lock in period. In addition, an advantage that singles out ELSS as one of the best instruments under section 80C is the fact that under current laws long term capital gains and dividends received from ELSS are tax free!!

  1. Public Provident Fund

A PPF account when opened runs for 15 years and provides a return of 8% per annum. Once opened investors must make contributions every year to keep their PPF accounts active. The minimum amount is Rs. 500 and the maximum is Rs. 70,000. Currently the income (interest) earned on a PPF account is tax free which makes it all the more attractive as an investment option.

Example: If you were to invest Rs. 10,000 every year in a PPF account, you would be investing Rs. 150,000 over a period of 15 years and the future value (Rs. 293,243) of this amount after 15 years at 8% interest is almost double of the present value.

Important note: The deduction made by your company towards ‘Provident Fund’ contribution can also be considered under section 80C.

  1. Term Deposits

A Bank Term Deposit is similar to a fixed deposit except that it has a lock in period of five years. A bank term deposit cannot be encashed before the expiry of five years from the date of the deposit. Do note that while the lock in period is lesser than PPF or NSC, the interest earned is taxable unlike PPF or ELSS.

Let’s take an example:

Total Taxable Income - Rs. 300,000

Income tax without section 80C - Rs. 15,000


Investments under 80C

PF Contribution - Rs. 21,600

Public Provident fund Contribution - Rs. 12,000

(At Rs. 1000 per month)

So far your total exemption under section 80C is Rs. 33,600. To take advantage of the maximum tax exemption available under section 80C you need to make investments of Rs. 66,400 more. If you decide to invest in ELSS using a SIP of Rs. 5600 per month, then

ELSS - Rs. 67,200

(SIP of Rs. 5600 per month)

Total investments - Rs. 100,800

Amount considered under - Rs. 100,000

Section 80C

Income tax with section 80C - Rs. 8,000


While this might seem like a lot of hard work, remember that not only are you saving money in this process you are also forcing yourself to invest!

While there are other options such as National Savings Certificates, Pension Plans, Infrastructure Bonds, payment towards principal repayment in housing loans, etc. in my opinion the four listed above are the most attractive ones. They cater to both a risk-averse as well as a risk-taking investor.

With this we conclude the series on section 80C. Watch this space for more interesting articles in personal finance and how you can make your money work for you.

Thursday, July 17, 2008

Demystifying Section 80C – An Introduction

To the uninitiated, Section 80C is that provision in the Indian Income Tax laws that allows you to make specific investments and exempts that amount from being included in your total taxable income.

Didn't get that?

'Save a part of your income and the taxman won't tax that money.'

'What do you mean he won't tax?'

'I mean he won't tax.'

'Oh, another scam!! My mom already warned me.'

'No it's not another scam! It's there in the Indian Tax Laws! It's that piece of paper/ email your payroll/ HR department sends you at the beginning of every financial year!'

'What mail? The one that asks if I have insurance, mutual funds, deposits, etc… Oh, I was wondering why they want my personal investment details.'

Still in the process of figuring out Section 80C? Welcome to the 'Demystifying Section 80C' series and let's do it together.

Introduction of Section 80C

Indian Tax laws have always provided simple tax saving investment options. But it would be limited to specific amounts in certain instruments. With the introduction of Section 80C, the Indian tax payer now has the freedom to choose the instruments and the proportions.

Section 80C Limits

Yes, of course there's a limit. The government needs to run the country, remember! The individual tax payer can now invest rupees one lakh in the instruments specified in Section 80C in any proportion that he wishes.

Would you like to see how much difference rupees one lakh could make to your taxable income and eventually your tax?

With appropriate investments made as specified in Section 80C.

  • If you are a male tax payer earning up to Rs. 250,000 you do not have to pay any taxes
  • If you are a female tax payer earning up to Rs. 285,000 you do not have to pay any taxes

Even if you are above those limits, the savings from utilizing the provisions of Section 80C should not escape you. Section C provides one of those exceptional opportunities to have your cake and eat it too!! You get to save for the future and you get to save income tax!!

In part two of this series, we will discuss the versatility of Section 80C and the variable investment options available.

Saturday, July 12, 2008

Emergency Fund - A Burning Need

A few weeks back I mentioned that if you are among those people who have absolutely no clue what to do with your money, then a FA is really the best place to start. I stand corrected. A Financial Advisor would be the second best place to start. The first is an Emergency Fund.

The 'What'
Let's start with what is not an emergency fund. It's not some extra stashed awa
y money to be used to pay off your credit card bill or to be used to manage extra expenses during the month or buy a car or a new gadget or throw a party or to buy that Gucci bag! An emergency fund is to be used only in the case of an emergency - an emergency that threatens survival. It could be anything - loss of a job, accident, death, a loved one's emergency. In a culture like ours, we constantly depend on the cushion provided by the immediate family in case of emergencies. But haven't we heard of stories where families being hit by unexpected disasters have struggled to get up and start again. And what if the emergency was a threat to your immediate family and you were to provide that cushion? It's not that an emergency fund will provide solutions to the disaster but it will certainly help you manage your emergency better than if you didn't have the emergency fund.

The 'How Much'

There is no fixed thumb rule on how much is required or sufficient. While a number of books and websites suggest a back up of four months salary, an emergency fund should typically sustain you for at least six months. In the event of an emergency this money should provide for your basic living expenditure, continue paying off your EMIs, insurance premiums and take care of basic medical expenses that may pop up. How much is sufficient also depends on the number of dependents on the money. If you are married then your emergency money should cover expenses for at least six months for your spouse and you. If you have kids then include their expenses too. If you live with your parents/ relatives who depend on your income then don't forget to add them too.

The 'Where' Building an emergency fund may seem like an added burden in the beginning. The truth is that, it will bail you out of the real burden that awaits around the corner. If your budget is too tight to warrant any additional savings, then all the more reason to start an emergency fund. When you can't manage on a bright sunny day, it's going to be impossible on a rainy day. Consciously reduce expenses and set aside a certain amount of money (you can start with as low as Rs. 1000) to build your emergency fund. You can start by simply opening a savings account separate from your primary account.

When I tried to open an additional account with ICICI bank, I realized that the minimum quarterly balance to be maintained is Rs. 10,000. Now if you have even three such accounts this would mean that Rs. 30,000 would be blocked unnecessarily until you close the accounts. A way out of this is to open an account in a public sector bank like SBI where the minimum balance is Rs. 500 for a non-cheque operated account. Make this money as inaccessible as possible, so that you are tempted to use it only in the event of a dire emergency.

Another option that I personally find useful is Recurring Deposits. A recurring deposit will debit your account of a specified amount every month. Once you have built enough using a recurring deposit, move the money to another account or covert it to a medium term fixed deposit. If your bank (like mine) does not offer Recurring Deposits, then go for the option of a simple Fixed Deposit. Most banks these days allow customers to top up their fixed deposits by a minimum amount as and when required. When you've made up your mind to adopt the discipline of saving there will be no shortage in the number of ways you can do it. I know a few people who simply keep their emergency fund in an envelope in a safe and not so easily accessible place.

There are millions of articles on the internet and personal finance books that talk about emergency funds. The common thread that links them all is the stress on starting today and right away.

Friday, July 4, 2008

Got a raise? Don't go shopping now!

It's the first week of July and a number of you must already be armed with your increment letters. While some of you must be delighted, some disappointed and the others neutral, the fact is you've come to posses some extra cash and if you don't act fast this extra money is going to seep into your daily expenses and lose its way. If you want to get the best out of your pay raise, you need to plan and plan right away.

The first thing NOT to do is splurge that extra amount. Even before that amount reaches your salary account by the end of this month, plan in advance what you want to do with the money. Stop thinking of your pay increase as a way to up your lifestyle. Instead of increasing your spending habits, increase your saving habits. This means no new gadgets, new clothes, branded stuff, or visits to an expensive restaurant, etc. with the money. The trick is to continue living like you never got the raise.

When you keep seeing people around you indulging in luxuries and when your credit card bill is bursting at the seams, it may seem easier said than done to pretend like you never got the raise. If it does get difficult, allocate a much smaller percentage (say 10% of the increment) for your expenses, earmark the rest for savings. This way you can pretend like you got a much smaller increment than it actually is.

Decide on where you want to utilize this extra money. There are a number of options depending on your requirements.

1. If you have an outstanding loan (educational loan, car loan, home loan, money borrowed from parents, friends, etc), you could use this extra amount to increase your EMI on the loan. Ensure that this amount is allocated for paying off your debt right at the beginning of the month before you get tempted to start spending it either by setting up an automatic transfer or manually setting aside those funds in a different account.

2. Use this money to set up an emergency fund (if you don't have one already). A salaried person must have an emergency fund equal to at least four months of the individual's monthly compensation. Now that your monthly compensation has increased, so should your emergency fund. Remember that an emergency fund is for a raining day and not to pay your irresponsible over the limit credit card bill. Stash away a portion of your income every month to set up this emergency fund. The best place to store your emergency fund is a savings account. But make sure that this is not the same account as your primary account.

3. Year after year we keep seeing people who declare that they will save the maximum tax exempted amount to their finance departments. Come March and when this hasn't happened they end up paying a lump sum in taxes. Set aside your increment for this very saving.
  • Set up a SIP for an tax saving ELSS fund
  • Use the amount to pay up for your insurance premium
  • Use the amount to buy tax saving deposits
This way you've saved and you don't have to scramble during the last minute to save your hard-earned money from being eaten up by income tax.

4. Set up a Systematic Investment Plan to invest in a mutual fund or index fund. If you already have SIPs running, use the money to top up your investments or delve into a new fund. Remember to do your research before investing.

And about me... I plan to set aside a part of my raise for an emergency fund and a part of it for an ELSS fund

Sunday, June 15, 2008

Personal Finance and Presidents

A break from serious personal finance discussions... actually this one's just as serious. If you were to appoint a Financial Manager for yourself and if you were privy to his personal finance information regarding his assets and liabilities, who would you choose?

One, who has made the wise decisions, saved money for retirement or a raining day and has no liabilities or one who has never invested in the stock market, has money lying around in a savings account and yet pays interest on credit card debts amounting to a hundred thousand dollars? Will your decision change if you got to know that the net worth of the former is just about 1/10th that of the latter? And what if the latter has a higher net worth owing to inheritance rather than self-made like the former?

This should be the question in the minds of millions of Americans who go to poll this year. Are you willing to choose for your country what you would choose for yourself?

And if you still had any doubt… the former is Barack Obama and the latter is John McCain.

Tuesday, June 3, 2008

Personal Financial Advisor - Part B

This is the second in the series on personal financial advisor. In part A, we discussed questions relating to the who and what of a financial advisor. Today's post will aim to discuss your role and how to choose a financial advisor.

What is your role when you have a financial advisor?
Well, this again depends on what role you want to play. While at the two extremes you could passively follow every advice given by your FA or choose to use your FA for just the documentation, what I would suggest is taking the mid way. Do not completely trust your FA to make decisions for you because you know your appetite for risk and capacity to save, not your FA. Do not dismiss your FA's recommendations, because the person talking to you has far more experience in this industry than you do. The underlined statement is 'this is your money' and you alone have to put in the time and effort to make it work for you.

All this said, if you are wondering about my first statement in the beginning of this series about how the lack of time deters people from active investing... Think about it... Is it really the lack of time or the lack of will? A trusted FA will make this process easier for you, will streamline the process so that you don't have to run from pillar to post to put your money in the right place... but the buck stops here... making the decision and signing on the dotted line has to come from you.

How to choose a financial advisor?
There are no hard and fast rules in choosing a FA. At the end of the day, despite having the right qualifications, the chemistry between the two of you may not work out. Personally, I have changed three FAs before discovering our current one. When my husband and I met her for the first time, we really hit it off. What impressed us the most was her knowledge on the subject and her absolute professionalism. In our experience with numerous other FAs, we've always found ourselves calling the shots and expecting the FA to just take notes. For once, we sat up to listen to her and even come back with a revised allocation.

Something I feel is important while choosing a FA, is understanding the investment options that the FA has to offer. Some FAs may only offer mutual funds while another may be specialized in insurance products. Choose a FA who is able to plan your entire portfolio, otherwise you'll find yourself dealing with 2-3 people for different products or may even end up heaping your investments in one asset category alone.

The most important quality to look out for in a FA is undoubtedly his knowledge in the field. But then you can't test this unless you know something about the field yourself. The second most important quality is integrity. This one is easier said than done. It takes a longer time to test integrity than to test knowledge and also has a higher impact. Don't ignore the clues of an unprofessional FA - recommends high commission products, personally uses one product but recommends another one for you, messes up documents, does not provide you with post investment updates, does not follow up on premium dues, ignores you once the transaction is complete.Nonetheless, at the end of the day it may be easy to blame your FA for a wrong turn in your investments, be aware that the loss is however yours alone.

Disclosure: I am not a financial advisor by profession or by practice.

Monday, June 2, 2008

Personal Financial Advisor - Part A

Something that deters most of us from diving into the world of stock markets and investments is the lack of time to do the research and the hassles and the paperwork involved in carrying out the investments. Something that I personally think helps is having a financial planner/ financial advisor/ relationship manager.Being a wide and an important subject, I plan to spread the discussion over two posts. In this post, we will answer the questions - who is a financial advisor and what does he do?

Who is a financial advisor (FA)?
We are talking about a person working for a bank or a brokerage firm and providing general advice on investments and carrying out client’s instructions. While there are people who work as independent FAs, they are generally used by high net worth individuals and by people who know such a trustworthy person. It’s less risky to go with someone working for a bank or brokerage firm since at the end of the day the firm is responsible for the employee’s fraudulent actions.
While some of them work for a fixed fee based on the number of hours put in for a client, a majority of them work on commission basis.

What does a financial advisor do?
Well, what a FA does depends on what you want him to do. If you are among those people who have absolutely no clue what to do with your money, then a FA is really the best place to start. He would typically start by understanding your monthly capacity for saving and then provide you with the details of the minimum instruments you must be invested in such as insurance, tax saving instruments, mutual funds, etc.

Can you take this advice blindly? NO. I wouldn’t rule out the possibility of the FA recommending a product for which he receives a higher commission. The best thing would be to write all this down and ask for some more time to do your research on Google (not another FA who would be thinking on the same lines as the first one). While typically he might advise you on well-known products, it'll save you a lot of headache later.

For example, the first time I came in contact with what we today call a financial advisor was more three years back when I got my first pay check. He was a 'family friend' who was sent by my dad to take out an insurance policy for me. The product he recommended was a money back policy with a huge annual premium and pittance in terms of life cover and of course the assured periodic returns. After paying three huge premiums I had started considering life insurance policies as unnecessary considering the huge premiums and the negative returns. This was until I met my current FA who brought to light the fact the there existed other far far cheaper products (term policy) which though served the same purpose did not offer the high commission that a money back or endowment policy offered to the agent. I was duped and since getting out of the policy now would mean losing far more money, I have to choose to continue contributing to the plan and remind myself every time do my own research.

If you are among those people who like to make their own research and need an someone to just carry out your instructions, then who better than a FA. Papers and filling the same details over and over again can be tedious. A diligent FA who knows his documents, gets the required information from you, fills all the forms, collects your signature,dispatches them correctly and follows up on statements post the investment would be a real asset to you! As a word of caution, don't forget to verify all the information before you sign on the dotted line!

After being duped the first time, the only person I trust to make my financial decisions is my husband (not even my parents). Today before making an investment, we do our research, talk to people, consult our FA, sit on it for sometime and then take the plunge. The other part of the hard work is done by our FA who meticulously sorts our documents, dispatches them, promptly follows up and keeps us up-to-date.

In part B of this series, we will answer questions such as - what is your role when you have a financial advisor and how to choose a financial advisor?

PS: Wherever I have mentioned 'he' in the general sense, it implies 'he/she'. My FA happens to be a woman, so no case of gender bias there.

Disclosure: I am not a financial advisor by profession or by practice.

Sunday, June 1, 2008

Back to blogging

I've been on a long vacation both from blogging and from work for about a year now. During this period I’ve gotten married, traveled to the other side of the globe and relocated back to India (to a city I’ve never been to before). The good news is I’m back and hope to continue writing more often on personal finance in India.

Before you continue reading, do remember that this blog is for the average income professional in India and not particularly aimed at the aggressive investor. If you’ve just started working or have been working for a few years now and haven’t particularly thought about saving, then this blog will help you to get started and assist you on the way.

Tuesday, April 10, 2007

Magical Interest Rates

How many times have you seen this number on a billboard at a traffic signal? How many times have you ignored it, just to look at a more interesting advertisement? Today, we are back to this boring number. Fixed Deposits and Compound Interests

Here’s an old story about compound interest

In the early 1600s, the American Indians sold an island, now called Manhattan in New York, for various beads and trinkets worth about $24. Since Manhattan real estate is now some of the most expensive in the world, it would seem at first glance that the American Indians made a terrible deal. Had the American Indians, however, sold their beads and trinkets, invested their $24 and received 9.5% compounded annual interest, not only would they have enough money to buy back all of Manhattan, they would still have several hundred million dollars left over. That is the power of compound interest over time.

Time and Interest Rate – The two most important aspects of compounded interest.

  1. Rs. 100 at 9% interest compounded quarterly would be Rs. 156.05 in 5 years and Rs. 243.52 in 10 years. With simple interest the same amount at 9% would be Rs. 190. If that doesn’t sound too big, let’s calculate this for an amount of Rs. 200,000

Compound interest – 9% for 10 years – Rs. 487,037.79
Simple Interest – 9% for 10 years – Rs. 380,000

  1. Rs. 100 at 7% interest compounded quarterly would be Rs. 200.16 in 10 years. Hence at 7% interest an amount takes 10 years to double. On the other hand, Rs. 100 at 9% interest compounded quarterly would be Rs. 243.52 in 10 years. At this rate an amount takes just 8 years to double!!

Now that we have the basics of compounding, the following will aid you to make a decision on Fixed Deposits

  1. Are you the first time investor in the process of creating an emergency fund or are you putting away a part of your money in risk-free investments before plunging into riskier investments? What is a better time than this and which is a better tool that this?
  2. A Fixed Deposit or a Term Deposit is an investment tool that allows you to set aside some money in the form of a deposit in a bank or a financial institution or a company and fetches you compounded interest (monthly/quarterly/annually) for the period specified.
  3. Currently, the highest interest rates are being offered over a period of 3-5 years (3 years 3 months being most common). In the case of the investor withdrawing the deposit before the completion of the term, most banks impose a fine known as the pre-closure penalty. This could vary from a small penalty of 0.5-1.5% on the interest earned or a lower interest rate would apply for the short term. In some cases the bank does not allow premature closure of the deposit.
  4. Most banks specify a minimum deposit amount that could range from Rs. 100 up to Rs. 25,000. The most common minimum deposit amount is Rs. 10,000.
  5. The links to the Fixed Deposit information of four significant banks are as follows
    1. State Bank of India
    2. State bank of Mysore
    3. HDFC Bank
    4. ICICI Bank

Also worth considering is the attractive Fixed Deposit scheme from Canara Bank

  1. In the case of all the above schemes interest is compounded quarterly. Hence the effective annual rate of interest is higher than the one specified.
  2. For interest payable above a sum of Rs. 10,000 for an assessment year on all fixed deposits in a bank, tax at the rate of 10% is deducted at source. In the event of the investor not liable to tax a 15H form should be submitted.
  3. The interest rate on Fixed Deposits was as low as 8% during the period December 06. This recent hike in interest rates over the past few months has been due to a number of reasons – good credit growth, tight supply of money, to control liquidity, etc. In addition, as it is commonly known, Feb-Mar is the end of the financial year and is a period wherein banks are hurrying to meet their annual fund targets. For the smalltime investor this means that these attractive interest rates may soon be withdrawn. While most public sector banks have extended their previous 31st March deadline by another month, private sectors are still non-committal about the cut-off date.

Update: April 11th, 2007

Post Archana’s comment I did realize that some clarification was required on the declaration to be filed for no deduction of tax.

For individual residents in India aged 65 and above, a declaration is required in Form 15H to the bank if the tax on his/her estimated income for the financial year is nil.

For citizens below 65, a declaration in Form 15G can be furnished by a depositor if the tax on his estimated total income for the financial year is nil and the aggregate amount of interest credited or paid (or likely to be credited or paid) during the financial year is not more than the maximum amount, which is not chargeable to tax (Rs 1 lakh for male taxpayers and Rs 1.35 lakh for a women). It is important to note that both the above conditions are required to be fulfilled.
Source: The Hindu, Nov 2006

Wednesday, April 4, 2007

About ‘Personal Finance and You’

Are you struggling with your paycheck? Does it never seem to be enough? Are you living from one paycheck to another? Do you have nightmares about not having saved a single rupee in spite of earning money for a couple of years now? Do your parents do your tax saving year after year? Does your money accumulate idly in a current / savings account? If your answer is yes to more than one of the above questions then you seriously need to sit up and rethink about your financial strategy.

Some weeks ago, I expressed interest in my journal to start a blog on Personal Finance. Here I am, with the first post. This blog is currently going through an experimental phase with no structure or specific focus on any single aspect of personal finance. I plan to delve into anything and everything that affects the financials of a salaried individual – long-term saving, short-term saving, saving on taxes, investing and spending wisely.

Here you will find information on savings tools, bargain buys, balanced investing, financial trends and a number of links to other useful personal finance articles and features across the internet. Though most of the posts on this site will focus on personal finance in India, targeting the twenty-something salaried class, it is important to note that the general aspects of personal finance are applicable anywhere in the world and will make perfect sense to just about anyone at whatever age.

Welcome to this website. Join me on this journey towards the discovery of financial independence and how to make money really work for you. Very importantly, please note that all views expressed here are based on my own reading, experiences and research. The same goes for comments and opinions left by readers. I do not work for any personal finance related organization nor is my aim to market any finance related product. My advice to all you readers would be to do your own research before you make a decision.

This is my first venture into something as serious and significant as Personal Finance. With time and with continued learning and discussions I am hoping that this will evolve to cater to the needs of the readers and provide reliable and useful information on all aspects of personal Finance