Saturday, July 1, 2017


The recent demonetisation drive by our government has benefitted banks the most as SBI alone reported garnering deposits more than Rs. 1.2 lakh crores in 10 days. It has been estimated that the combined banking system will receive deposits of more than Rs. 4 lakh crore. By curbing the cash withdrawal limit, the biggest impact will be on the consumption which is expected to bring down inflation below 4% by December end. The chain effect of all this is expected to lead RBI to reduce rates in the next monetary policy meet scheduled in December 2016.
Banks have already started reducing interest rates on deposits as they now have excess money which must be ultimately lent to borrowers. Our country’s biggest bank – SBI has already reduced rates on fixed deposits to less than 6% for tenures of 1 year and above. Other banks are expected to follow and reduce their interest rates too. Where does this leave the investors, who have been religiously investing in Bank Fixed deposits for safety and fixed income purpose? Do fixed income investors have an alternative now which can help them earn better than FDs and provide the safety net that banks used to provide? The answer lies in Debt Mutual funds.
Debt mutual funds are schemes which invest predominantly in fixed income instruments such as treasury bills, certificate of deposit, debentures, corporate and government bonds, etc. Depending on the nature of the scheme the investments are done accordingly.
Investors can invest in these debt schemes as per their time horizon and after understanding the risk factors associated with it.
1.       Liquid Funds: These funds ideally invest in very short term securities such as treasury bills issued by RBI and Certificate of deposit which carry a fixed return. These funds are ideal for investors who want to keep aside idle cash rather than maintain in savings account. Also, if you have plans to do a major purchase in next 1-2 months then too the funds can be maintained in these funds as the funds get credited into the account the next day on redemption. Secondly these funds are currently providing a return in the range of 7-8% annualised which is much more than savings account.

2.       Ultra-short term funds: These funds invest in securities of duration ranging from 3 months to 6 months and primarily invest in debentures, certificate of deposits and commercial papers too. If you have a 3 to 6 month holding period, then these funds are ideal with a return potential like liquid funds and higher at times.
3.       Short Term funds: If one has a time horizon of 1 to 2 years then these funds are ideal as they invest in securities of slightly higher duration which can be more than 1 year. These funds invest in debentures, bonds and even government securities. These funds are ideal investments against 1-2 year Fixed deposits as they return more than ultra-short term funds. These are much safer than most other long term debt funds.
4.       Accrual funds: These funds are also known as credit opportunities funds as these funds primarily invest in debentures and bonds of corporates. The ideal tenure for such funds should be 3 years and above as these funds invest in rated bonds with the intention of earning a regular fixed income (accrual). While investing in these funds care should be taken to check the ratings of the securities held in the portfolio and only those holding AAA rating should be considered. Some of the securities in the portfolio may face credit risk and hence investors with utmost safety in mind should avoid such funds.

5.       Dynamic Bond funds: To overcome the risk faced by Gilt funds, Dynamic bond funds have been created. These funds dynamically manage the different bonds in the portfolio as per market trends and situations. In the current situation, these bonds are best suited to ride the trend and give better returns.

First time investors will do well to stick with ultrashort and Short term debt funds and the level of safety is high and returns volatility is minimum. For investing in accrual and dynamic bond funds, one has to understand the pros and cons of  how these funds perform in changing interest rate scenarios and therefore should be considered only by an informed investor.

Apart from good returns over Fixed deposits, debt funds have a more favourable taxation structure. If the debt funds are held for more than 3 years, then the gains on the funds are categorised as long term capital gain and tax must be paid at 10% on the gains or 20% after indexation. This is much lower than FDs as the entire income on deposits gets clubbed with your income and you are taxed as per your slab. In times of need you need not withdraw the entire amount like FDs but redeem what you need and rest remains invested. This is a good time to diversify beyond FDs but first do your due diligence and consult your financial advisor to select the right funds as per your needs.

Is it right to buy insurance policies for children?

Mr. Rao (31) recently walked into his bank to open an account for his 2-year-old daughter. During the account, opening formalities, he was suggested by the bank executive to buy a Children’s insurance policy which according to the executive could take care of his daughter’s educational funding requirement.  After a session of Q & A, Mr. Rao promptly gave the go ahead for the insurance policy and purchased a Rs. 5 lakh sum assured insurance policy for an annual premium of Rs. 30000. Similarly, Mrs. Smita (34) was advised by her life insurance advisor to buy an insurance policy for her twin sons aged 1 year. Many a times insurance purchase is an emotional affair in India. The main bread earner may not be sufficiently insured but he would like to take a policy for his son/daughter as soon as he or she is born. No investment logic works in front of emotions. The belief that the insurance policy will enable a forced saving for the child/ children’s educational funding is partly true but is it the right investment for the child? To answer this question, we need to understand how the children’s insurance policies work.
Insurance policies are of two types viz- Traditional and Unit Linked. Traditional insurance policies are those insurance policies where the monies that you pay as premium are invested as per the regulations set by IRDA. These policies have to invest namely in Government bonds and approved securities of select Public sector institutions including social / infrastructure sector. These policies are non -transparent and announce an accrued bonus rate each year based on the performance of the company. They facilitate payment of a part of the sum assured at certain milestone age of the child for example, 20 – 25% of the sum assured will be payable when the child turns 18, 20 etc to facilitate the payment of higher education fees. At the current bonus levels the best annualised return calculated for the entire holding period ranges between 4.5 to 6%. Going ahead with falling interest rates, the bonus rates will fall further thereby further reducing the overall return. Of course, insurance advisors will argue that it also offers tax benefits and premium waiver in case the insured parent (proposer) dies in between, but then how many people today depend on the insurance premiums to complete their tax savings of paltry Rs. 1.50 lakhs per annum when there are better options available. The second type of insurance policies are unit linked polices which provide a range of investment options to choose from within the policy. For example, you could choose to invest in an equity fund which comprises of 100% shares or balanced funds where the equity allocation can be upto 65% and rest into government bonds and securities. These policies are more transparent in terms of disclosure. They provide a regular unit statement like mutual funds and one knows the status of the investment at any point of time. But unit linked plans do not provide any guaranteed amount at maturity as the risk is borne by the policy holder. Here one has the flexibility of changing funds regularly and there is a possibility of earning much more than traditional policies but one needs to keep a few things in mind while buying unit linked children’s plans.
1.       The policy will charge towards insurance (mortality charges), fund management and administration which will reduce your overall return
2.       Understand the risk-reward equation particularly if you are opting for equity oriented funds
3.       Unit linked polices will work only if held for its complete term as the stock market is very volatile in the short term but performs better in the longer term.
The bread earner of the family needs insurance protection not the child as he is the income earner and his/her death might result in financial loss. So, ensure good level of insurance protection for self-first with the help of term insurance which is the cheapest form of insurance and to meet the investment needs of the child for his future educational expenses, start investing in systematic investment plans (SIP) in good balanced and equity funds. Remember to keep the investment period longer to coincide with the milestone years of the child to ensure better returns. To ensure tax benefits these SIPS can be done in Tax saving mutual funds known as ELSS funds (Equity linked savings scheme).

IF you aren’t a disciplined investor, then unit linked plans might be the best solution for your children’s goals as the contributions (Premiums) tend to get paid regularly and due to the emotional connect with children, people don’t touch these investments. Due to IRDA’s constant intervention nowadays most unit linked policies charges have reduced substantially. Take some time to understand the policies as once you complete the 15 days free look in period of the policy, you cannot do anything for 3 years in case of the traditional policy and 5 years in case of unit linked policies.