What can make or break your retirement planning---YOU

 With present high inflation and low business environment, everybody is talking or thinking about their likely retirement picture.

Retirement planning, supposedly, is a road map that helps you understand, visualize and work towards a financially independent post retirement life. Theoretically speaking that is.

A plan template assumes certain factors which are common. However, just like fingerprints, retirement planning roadmap is different for every person. Past experience and current environment can certainly be of some help in devising a strategy which is based on certain guiding principles and lots of commonsense.

Laying down the guidelines—rather than be of help-- may themselves impede the retirement planning process. One of the biggest roadblocks to setting up a workable retirement planning strategy is—YOU.

For instance:-

• You may have assumed average inflation to be 8%, while actual inflation can be and is actually higher than the assumed rate.
• Working with an average rate of return on equity component.
• Visualizing a non-volatile & rather linear debt fund returns.
• Assuming that the PPF and LTCG (Equity) will be tax free forever.
• Ignoring tax on annuity/pension.

And the list goes on and on and on………

None of that is said above will affect your plan as much as you will.

Yes. You and me---we.

It is you and me that can and will make or break the retirement plan-- 

•  Pre-eminence of real estate in the total portfolio 

Indians have been traditionally inclined towards gold and real estate as fail safe investments. You just cannot go wrong with them in your portfolio. 

As if one house used for self-occupation is not enough, people buy a 2^nd.  or even a 3^rd. house for investment. Most people do not realize that many so-called one-time purchases come with regular expenses tagged!  One common example is maintenance charges and other expenses associated with a bigger house.

Nothing wrong with this, everyone wants to enjoy the pleasure of life as they earn more.  However (there is always a however!), any increase in annual expenses (other than that caused by inflation), must be immediately taken into in the retirement plan-something that is given a pass by.

Of course, an increase in annual expenses obviously means we need to invest more each month for building a bigger retirement corpus to account for our present lifestyle.

•  Zero tolerance to compromising present lifestyle 

One of the basic tenets of retirement planning is that you will maintain your present lifestyle into retirement. Calculations for retirement corpus are based on current expenditures and hence, present lifestyle. The idea is to arrive at a retirement corpus that will at least live till you do.

A good figure to compute in spread sheet. What most people fail to realize is that the key requirements of a retirement corpus intended for a future lifestyle, imposes constraints on the individuals present lifestyle.

It is quite common for us to regularly upgrade our car, televisions, mobiles etc. in tune with changes with our incomes. Nothing wrong in that except that it is quite likely that our incremental annual expenses increase at a rate much greater than assumed inflation.  Unfortunately, these additional expenses would increase with inflation too!

It would be prudent to recognize that most lifestyle changes are difficult to reverse and hence must be factored in while planning for retirement. In absence whereof rest assured that your life style in your twilight years will not be as comfortable as your present one.

Hence, beware of yourself. The choices that you make today can impact your future in more ways than you can possibly imagine.

• Pre-eminence of real estate in the total portfolio; and
• Zero tolerance to present lifestyle

are not the only factors that influence your retirement plan.

Watch this space for more as picture abhi baki hai. 

EMPLOYEE PENSION SCHEME---aaal ij not well.

A time bomb is ticking over the retirement years of India’s’ formal workforce—if a recent article in The Economic Times of 02/09/2013 is to be believed. The news article was titled as follows:-

EPS (Employee Pension Scheme) ---Will you get your pension??

Employee Pension Scheme 1995 is in dire straits. There are unconfirmed reports of actuarial valuation showing a deficit of whopping Rs. 54000 crores-- 10 times bigger than the financial black hole that had emerged at the erstwhile Unit Trust of India.

Administered by the Employees' Provident Fund Organization, the EPS is unlike any other pension scheme in the world. Typically, a pension scheme spells out the contributions to be made into a worker's account through his or her career or the pension to be paid out at retirement. If the pension income is fixed, contributions are kept flexible over time to achieve the target income.                                         

The EPS spells out both the contributions as well as benefits, which actuaries consider untenable over time

Ironically, at its inception, the scheme had inherited Rs 9,000 crore as surplus from the Family Pension Scheme of 1971. But design flaws and generous grant of additional relief in its initial years had pushed it into a Rs 22,000 crore deficit by 2004.

The government pumps in around Rs 1100 crore annually as a subsidy towards the scheme. The moot point is how long will the government continue to pump in money into the black hole.

This is how the EPS works:-

The employer contributes 8.33% of the employee’s salary to EPF on behalf of the employee subject to an annual limit of Rs. 6500/-.The monthly amount of Rs. 542/- flowing in to the EPS Is too small to be noticed.

Apart from the abysmally low monthly contribution, what ails the scheme is that all such contributions accumulates in a pension pool from where the employee starts getting lifelong pension upon completion of 10 years of service and 58 years of age.

One primary reason for the swelling deficit in Employee Pensions Scheme is increasing life expectancy as compared to that prevailing in early 90s.

The average Indian male now lives up to 67.3 years and females up to 69.6 years. In 10 years, this would rise to 69.8 and 72.3 years respectively. This is the national average, and life expectancy is higher by around 5 years in metros and other urban centres. By 2030, the average urban Indian would be living till the age of 80, putting more pressure on the pension payments. So, not only will there be more pensioners but they will be drawing the pension for a longer period.

Ticking Time Bomb

The low return is a minor problem compared to the crisis looming in the horizon. The defined benefit model on which the scheme is based is patently unsustainable. Things are not looking too bad right now because there are more contributors than beneficiaries. In 2011-12, for instance, the EPS received contributions worth Rs 14,768 crore and paid out benefits worth Rs 7,859 crore. The scheme's corpus increased 14% to Rs 1, 83,429 crore during the year.

But this situation would change in the coming years as India's demographic dividend transforms into a geriatric nightmare. In 2012, only 8% of the Indian population was above 60 years. Studies have estimated that this figure would rise to 12.4% by 2026 and to 19.1% by 2050. With every passing year, the pool of pensioners will become larger even as the number of contributors will rise at a slower pace.

Night mare continues

The EPFO is now considering raising the contribution limit from Rs 6,500 a year to Rs 10,000 a year and giving a minimum pension of Rs 1,000 a month. Both measures have the potential to dig a deeper hole for the EPS. Raising the limit would cause the pension outgo to shoot up. Retirees who contributed the lower amount of Rs 6,500 a year would be eligible for pension based on the higher limit of Rs 10,000. The last time the limit was raised from Rs 5,000 to Rs 6,500 in 2002, the scheme notched up a deficit of Rs 10,000 crore. This time, a formula must be worked out to adjust the pension accordingly. The minimum pension limit will also put pressure on the scheme as lower income workers are cross subsidized by other members.

Already there are signs that all is not well. In the past 15 years, the scheme has slipped into the red. Experts estimate that it now has a deficit of almost Rs 54,000 crore

Remedy

The Finance Ministry has repeatedly suggested that the EPS subscribers should be allowed to migrate to the New Pension Scheme which has individual accounts for every member. The new Pension scheme works on the principle of defined contribution scheme which is more sustainable.               

The world over, countries and organizations which had promised defined benefits to their citizens and employees are strapped with pension bills they can't afford. A recent example of this is the state of Detroit in USA which has files for bankruptcy. The question every employee needs to ask his HR manager and management is: - IS MY PENSION SAFE?

Investors are lazy, busy or crazy.

One conclusion that we can draw from our many client meets is that investors are lazy, busy or crazy.

We at AIMS believe that most investors (though not all) don’t have the inclination or knowledge to manage money—their hard earned money—on their own and are victims of procrastination & impulsive decisions. Investors today are too busy with their work, family, personal and family obligations to take out time to manage money on their own and third there is too much information overload nowadays that makes them too hyperactive with managing money on their own while successful investing requires patience and consistency.

A.  Let’s see some of the actions by investors which will emphasize that investors are lazy

1. Investment preference for stocks: - Many investors swear by stocks despite being handicapped by factors like lack of research and proper & genuine information about the company they are investing in. They refuse to sell despite a change in fundamentals of the company. They strongly believe in self-healing properties of the stock and believe that everything’s going to turn out fine in the long run. For example there will still be stocks like IVRCL Infra, Pentamedia Graphics etc. in the portfolio of many investors.

2.   Lack of goal based planning: - Investors fail to map their investments to their life’s goals. As a result they fail to act rationally when markets move down. They ultimately end up buying high & selling low rather than doing the opposite. In the process they destroy wealth rather than creating it.

3.    Goals are either not set or are inadequately set: - Such investors either fail to work towards life’s goals or set unrealistic goals

 B.      Actions which will prove that investors are busy.

1.  I have no time. Such investors are too busy in their jobs to think about their life’s goals and investments. They are always on the move. We have even encountered investors who have not filed their income tax returns for last 4-5 years.

2. Investments are made with the sole objective of saving taxes. Investments are usually made towards the fag end of the financial year with the sole objective of saving taxes. They fail to realize that there’s more to investments than saving taxes.

C.      Investors’ actions which can be categorized as crazy

1.   Buying unsuitable products: - Classic example being insurance bought as investment products. Endowment policies of smaller denominations are readily bought rather than term insurance.

2.  Willingness to take credit risk rather than mark to market risk. A recent example of this is the fiasco at NSEL (National Spot Exchange Ltd). Investors are in the danger of losing approximately Rs. 5600 crores—more damning is the fact that nobody including the regulators, the income tax department, and various other government agencies have a clue as to where has the money gone. Till the scam broke out investors were sold commodities like jeera, castor seed etc. as risk free schemes with unrealistic returns.  No body questioned the proposition or the returns as long as the going was good. The entire investment is presently at risk. However, no one is willing to invest in debt or equity funds believing that the markets may go down even further.

3.  Return is the sole criteria for a good investment. Investors are solely guided by returns (which incidentally is nothing but past performance).They never care to look at the portfolio of the fund which is the talk of the town on return only parameter. Which of the two portfolios (not exhaustive) of short term funds of two fund houses of repute would you consider investing in? Fund House B may be generating a higher YTM on account of high risk investment in realty companies and that too with a low rating.

Fund A		Fund B
Portfolio(Rating)	%age of AUM	Portfolio(Rating)	%age of AUM
PFC(AAA)	11.99	HPCL Mittal Pipelines(ICRA AA-)	5.40
National Housing Bank(AAA)	11.22	Mahindra Life Space developers(Crisil A+)	2.36
IDFC(AAA)	11.15	Celica Developers (P) Ltd(BW AA-)	2.22
HDFC(AAA)	8.34	Mahindra World City(A)	1.53
NABARD(AAA)	7.48	Opelina Fin. & Inv (BWR A+)	1.41
LIC HOUSING FIN(AAA)	4.71	Edelweiss Housing (AA-)	1.26
1 year return	9.27%	1 year return	10.97%

*returns as provided by www.valueresearchonline.com

Hence there is a clear need for a professional advisor who can handhold and help investors with managing money. I think the biggest challenge for investors as on today is to find an advisor whom they can trust completely and give all their money to manage. The 'trust' element which is the biggest gap is what we need to work on as a fraternity.

Your search ends at www.investwithaims.com

Are you liable to Wealth Tax?

Wealth Tax!!

Very few tax payers’ in India have heard of it and still fewer pay it.

However, ignore it only at your own risk!

As per Indian Wealth Tax Act, 1957, wealth tax liability arises if market value of some assets (net of liabilities) exceeds Rs. 30 lacs.

The wealth tax act is supposed to bring into the tax net unproductive, non-essential & idle assets held by an assessee.  Two of the biggest obsessions of Indian investors—property & gold thus are naturally included in the definition of wealth and thus are subject to wealth tax. For example if you  own a second house which is not self-occupied nor is given out on rent, then the(market) value of such second house as on the valuation date(net of any liability to acquire such second house) will be subject to wealth tax. Gold, silver, whether bought, gifted or inherited forms part of computation of wealth.

Under Sec 2ea of wealth tax act, 1957 the following “assets” will be included in the definition of wealth:-

• any building or land appurtenant thereto (hereinafter referred to as "house"), whether used for residential or commercial purposes.
•  motor cars
•  jewelry, bullion, furniture, utensils or any other article made wholly or partly of gold, silver, platinum or any other precious metal
• urban land         
• yachts, boats and aircrafts (other than those used by the assessee for commercial purposes) ;
• cash in hand, in excess of fifty thousand rupees, of individuals and Hindu undivided families and in the case of other persons any amount not recorded in the books of account.

Exemptions:-

Following assets will be exempted from being included in the computation of net wealth chargeable to tax:-

• One house(at the option of the assessee where he owns more than one house) or part of the house belonging to the assessee

  

Net wealth to include certain assets (section 4)

In computing net wealth in the hands of an assessee as on the valuation date, following assets inter alia will also be included in the his hands:-

• assets held by spouse of such assessee to whom such assets have been transferred whether directly or indirectly otherwise than for adequate consideration or with an agreement to live apart.
• Assets held by a minor child(not being disable child)

Computation of wealth tax

Section 3(1) lays down that wealth tax shall be computed for every assessment year. Such wealth tax shall be computed on the net (of liabilities) wealth in excess of Rs. 30 lacs at the rate of 1% of such net wealth.

As wealth tax accounts for less than 0.25% of total direct taxes and is minuscule in the total revenue collection.(Last year, it contributed Rs 866 crore to the total revenue collection of Rs 1,038,036 crore). This may be one of the reasons why this tax is not taken very seriously by taxpayers & department alike because the Central Board of Direct Taxes is busy with other, more important, ones, such as corporate tax, income tax, service tax and excise.

However there is a stiff penalty for evading wealth tax. Incorrect declaration of wealth can invite a fine of up to 500% of the evaded tax.

                                               

Why Mutual Funds?

Somehow we always know what we should have done in the past with our investments. But when it comes to taking action now, we are clueless. We think for example that we must have booked some profits when the stock market was at its peak in January. We did not know it then, but know it surely now. We ignore that we have the benefit of hindsight, and almost believe that there has to be a way to figure out what seems so obvious. The truth is that there is no such nice little way to make money, and investors will quarrel with this known wisdom, as they use past data and show how money could have been made.

It is useful to think about ways and means of keeping the level of the market from swaying our investment decisions completely. If your favourite restaurant runs a discount on its Mexican menu, you may not choose to have it for breakfast, lunch and dinner, only because it is cheap, isn’t it? You would surely think that whether you are hungry, and whether you like Mexican cuisine are more important than the rock bottom price. Importantly, your choice of what you will eat will be driven by you, rather than what is on offer. We need to bring that common sense principle into investing as well. To an investor who hates any loss in the value of his portfolio, equity markets are a no-no even if the index is at a very attractive level. Just as my father will refuse to have pizzas for dinner, and my daughter will cringe at porridge. Therefore step one is to ask whether we like to be in the markets at all, and understand why we want to be there. If we figured that what we do with our investments has to stand on its own, driven by our needs and preferences, half the battle is won.

Sadly, just as we sneak in a samosa even as we are working out the fat, we find it so tough to actually implement what is good for us. There are well known behavioral traits that we have, which come in the way. Many of them bias our judgment and our decision. We may like to invest some money into equity at the current levels, having seen that corporate profits are healthy and fundamentals are good. But we will be worried about the fall in price that we have seen. It is so important to see some rise in price, before we buy, because we are led by our recent experiences. We are enthusiastic buyers when markets have moved up, and when everyone else seems to be buying. We seldom buy cheap. Somehow we think it has to be a good thing to do, if many people are doing so. Then, we like what we buy and refuse to accept that we could have a loser on hand. When we see prices falling, we convince ourselves that prices will somehow recover to our price. We are very much clued to our price, that it becomes some kind of mental benchmark. But the market does not know this and is unlikely to care. So we tend to keep losers, and refuse to reckon the loss. If we bought at Rs. 100 and the price fell to Rs. 20, we lost 80%. When we continue to hold what we bought, and hope it will go back to Rs. 100, we are expecting a 400% increase – not realistic isn’t it? At every decision to buy or sell, we need to fight the bias to implement what is good for us, and many of us find it tough to do so.

The moral of the story is, we may have a nice little strategy of investment, but if it is driven only by the level of the market, and not by our needs, there is a risk. That risk becomes higher, when our decisions about the markets are biased and our thinking about the market and the way we make our decisions are far from optimal. When we combine the craving for the right time to buy into the market, with the biases that we suffer, we could put our investments in danger.

There are two things we could do, if we accept that this is a problem, and that we need to do something about it:-

1.       We have a plan that we implement, without caring about where the market went.

2.       We let professionals manage our money, so the call on markets is not biased.

The mutual fund choice is sensible, because it enables us to implement disciplined investing in our own way, leaving the "market watch" to the fund managers. And having the fund managers to watch your money is a nice way to side step the bias. A fund manager is bound by investment processes and risk controls that take care of bias we will suffer when we deal with our own money. Have you noticed that your kids, who cringe about writing one-page of handwriting practice during the holidays, happily do 7 subjects a day in school? There is something about organization, process and discipline that makes a job which is complex for you, simple for others, and makes implementation a breeze.

Free your investments from bias. You will thank yourself.

Driving lessons apply to Investing also

 It was a year since we got the car. After a disastrous stint at the driving school, which made me feel as if the clutch was the most important part of the car, and driving lessons on Sunday, which disturbed the tranquility of my holiday, I took the simple decision - driving was not for me. I hated the thought of not being able to drive. I sat in the car and looked longingly at men who zipped past. My friends disbelieved that an otherwise confident me, was refusing to drive for the fear of the road. Sitting in the front seat of a car has the ability to increase the fears of people like me - every situation looks risky and every maneuver of fellow drivers very skillful, that I simply can’t get it.

Then came my dear friend Babaji, our new driver. Babaji was excellent behind the wheels and loved his job. He loved speed, but was safe to be with. After 6-months of being driven around by him, I asked tentatively, if he could teach me to drive. I told him that I am scared of the roads and worried about accidents. He talks very little, but on this issue, he went on a mini-lecture. He told me that I have to know few rules, exercise judgment and that’s it. Trust me; he got me to drive on the main roads, 2 days after our practice sessions in the deserted roads of Navi Mumbai. It is 3 years now, and I can’t thank Babaji enough, for making me confident to take the driver’s seat.

Now it was my turn to do something for Babaji. So I asked that I teach him what I know – investing. Babaji was not ready for this. He was not able to save much, and did not want to risk his small savings in markets. He reads a lot of newspapers, and told me that there it looks so complex and that he does not want to take any risk. We were on the way to office when I was convincing him, and there was big traffic jam in front of us. Babaji exercised patience as he switched from first gear to second and back. Soon as the road cleared, he sped to save time, overtaking vehicles and using every little space he got. I told him, investing is exactly like driving the road. You have to exercise judgment, you have to assess the scenario and decide, and that’s it. If I can drive, Babaji can surely invest!

The financial markets have many investment options, some are slow some are fast, just like vehicles on the road. There are regulators, licenses and signals in the markets, just as it is in the roads. Before anyone can collect money from investors, regulators have to approve the products and information given to the investors. Babaji quickly pointed out to me, that it does not always work. I told him that it does not always work on the roads either. There could be a truck driver without a license, who is learning to drive on the road. There could be vehicles that have not been serviced. The road itself may have potholes, or even be closed for repairs. Just as you cannot have a perfect road with perfect cars and drivers, you can’t have perfect markets; you have to figure out the way and exercise judgment.

To those who find this tough, there are buses and trains. Public transport that takes you at designated time, from one place to another for a fixed price. That’s what mutual funds do in the financial markets. They offer you specific products at specific prices. You can conveniently choose what you like, at the cost you can pay, and go to the destination you want. I told Babaji that investors tend to be confused on what they want. They get to the market not knowing where they want to go; they get into a bus and expect it to speed like a taxi, and they get off the bus if they find there is a jam, not realizing that they have to take another bus to go to their destination If investors used the same judgment Babaji used on roads, they will be safe in a market that has risks. The logic is the same. The financial markets also have rear view mirrors, maps and most importantly, brakes. So you only have to choose what you want to do and how. Babaji is not fully convinced and remains worried, but overtakes another truck. When I tell him that I find it so risky, he tells me that he knows what he is doing and I must not worry. That’s what it is, you need to find a trustworthy driver like Babaji (for your car and AIMS for your investments), who drives safely and skillfully, has a license and will reach you to your destination, every day, day after day. It is not even required that you learn to drive. If you do, it is an added skill you can use, when there is a need. But some choices ask that you hire and use the skills of others. After all you do not have to own a plane to be able to take a holiday!

Kitna milega?

No matter how much investors would like to know, for many financial products they should not be asking how much returns they will get...

Some time ago Maruti used to run an advertisement campaign where the person asks “kitna deti hai” (how much (mileage) does it give?).

The same question—in a  different context-- is asked by an investor too—how much return will I get or kitna milega?

While advisors try to answer it in their own way, we believe that there are no definite answers to the question if the investor intends to invest in stocks or mutual funds. Advisors idea more often than not is to quote a number that is likeliest to close the sale while not being a commitment.

Investors have to realize that equity does not carry a definitive return matrix. If the investor wants a definitive answer as to the %age return that he can expect, then we believe that the fault lies with him. If he does however expect a particular figure before writing out a cheque for investment, then he should restrict his investments to products that carry an enforceable commitment in black and white. This means bank fixed deposits, postal savings; PPF and so on.

Asking for an estimate or an informal promise on returns from any product that is inherently linked to a market-- be it stocks or anything else-- is inviting trouble. Either you won't get an answer or you'll get a dishonest answer, simply because no real answer exists. In fact, if a salesman is willing to give such an answer, then that itself indicates a problem.

If you are planning to invest in a mutual fund, or any other market-linked financial product then the process that is followed and the earlier track record is actually the best you have-- no matter how hard is it to get used to the idea.