Where to invest in FY 2018–19?

Once upon a time, there lived three friends — Ena, Meena, and Deeka, in the Mumbai city. They hailed from different parts of India and became friends at their job. They shared their apartment, commute to the office, gossips and what-nots.

Recently, they came across this famous post on investment, which has scaled heights of readership of 75 views in 2 months, falling short by a whisker to be termed as world famous, or viral, if you say so.

The post talked about investment approach and factors of an investment instrument, and promised of talking about different instruments in next post.

The post almost changed their life, ie they started getting more change from shopkeepers and also they eagerly started waiting for the next part of the post.

But the author being a highly intelligent, but overly lethargic and lazy, was not publishing it.

So they took the matters in their hand. First they thought of threatening him but instead decided to study different investment options available at hand.

Usual googling was throwing options mentioned by the intelligent author.

It appeared that deciding the purpose or goal of investment is the pre-requisite for deciding on the instrument.

So, they thought of goals. What could be that? Ena wanted new bike and phone, Meena wanted to repay her vehicle loan and also save for a vacation, Deeka wanted to save in-case he gets fired, etc.

With these many goals at hand, they thought of grouping them in broad categories. .

Bucket 1 — Contingency
Fund to tackle a situation where you are out of business or job and you have to sustain you and your family for 5 months.

This period is where one would be under pressure to find new job/business, and all energy and efforts would and should be diverted there.

The contingency fund will take care of sustaining for that period.

Bucket 2 — Debts
All three were having education loans from a bank, and Meena also had a vehicle loan from a finance company. All were aware of the cost of the loan, generally 10–15% per year.

Bucket 3 — Short-term goals
The definition of short-term and long-term was subjective, however, for the sake of their discussion, they defined short term as 1–3 years. Eg, Buying vehicle, electronics, going for a vacation, etc.

Bucket 4 — Long-term goals
Long-term goals were settled for more than 3 years. Eg Children’s education, marriage, saving for retirement, some business opportunity, etc.

A quick recap of their life-changing post reminded them that each instrument comes with its rate of return, ease of liquidity, maintenance, tax implication and tenure. They dug for few minutes, understood some terms and came up with following pointers.

• Section 80C — Its a clause in Income-tax Act, which allows exemption of 1,50,000 from your taxable income, if one invests in an instrument as prescribed by that section. Few examples — PF, PPF, Insurance premium, ELSS, etc.
• Liquidity — Measure of how easily you can get the invested money back.
• Maintenance — This includes efforts for maintaining (online/offline), tracking, holding and evaluating the instrument.
• Indexation — Some instruments, if invested for certain period, its gain is considered as long-term. In most of the cases, these gain gets related to inflation, which eases the tax on it.
• Interest gets added to your income — Means the taxable income increases by that amount. The final tax is calculated on the taxable income. So, if you are in 30% bracket, the addition will attract 30% tax.

With these in sight, they ventured to find the options of investment.

The intelligent author could have done it way better, but he seemed to have invested his time badly.

Ena took those with known outcome and relatively safe options.

He explained that these instruments are offered by banks and Indian Post.

Money in the saving account is the most fluid instrument, second only to cash.

FD & Recurring deposits comes with commitment — ranging from few days to years. Typically, higher the commitment — higher the return. Encashing post-tenure is very easy, and even before maturity, the withdrawal is possible in a day — but the return will be less than promised.

He concluded with tax implications. All interest on bank & post products is taxed, barring first 10k interest of savings account.

Meena asked about PPF, which Ena had mentioned in the chart.

Ena: Oh, I forgot. PPF is kind of a saving account, but with very long lock-in periods, interest rate of 7.6% and its interest is tax-free.

Cool, said the rest of two.

Next was Meena, who took instruments with uncertain returns and difficult to manage.

The instruments Meena took were Property (house /flat /farm /plot /commercial space) and gold.

She further explained — Buying a property requires a large amount to start. That’s an entry barrier. Also, Physical maintenance of property calls for extra expense on wear and tear, property tax, security.

Gold can be bought in physical or paper form(bond). Physical gold’s maintenance demands security.

Both of these instruments have to be tracked for its market value regularly. Is it up or down? Has it peaked?

Also, the property market is not structured. The valuation is generally not backed by an authentic source.

Liquidation of the property is time-consuming — often takes months for getting the desired price. Liquidation of gold is relatively easy.

The return is generally good if held for long periods.

Ena brought another factor, which rest of two agreed, that these instruments also have some form of emotional attachment of possessor.

Last was Deeka. He took shares and mutual funds — man, there were many.

First, he explained what is a share. When you buy a share (noun) of a company, say Tata Steel Ltd., you share(verb) ownership of it. Shares are of two types — listed and private. The listed ones are traded at institutes called stock exchanges, eg. BSE, NSE.

Meena asked, “How do you earn from share market?”

Deeka replied — one way is just like property. You buy and sell, the difference is your gain. Another is through the dividend. Companies doing well pay dividends to shareholder.

Both Ena and Meena asked if it’s easy to earn than from it? How would one know when to buy and sell?

Deeka shrugged his shoulders and said, one way is through hearsay, like property. Buy this, and it will swell in 5 years, etc.

Another, and seemingly proper way is through a thorough study of companies, share market, economy and ‘a secret sauce’ may be sufficient for earning from shares,

Deeka moved ahead to explain what is a mutual fund. You can consider crowd-sourcing, he said. You alone can buy a limited number of shares of few companies. Collectively, multiple people pour money to create a fund, and It deals in shares on your behalf. When you invest, you get ‘units’. The pool of money is managed by a professional team. These, he said, are Equity mutual funds.

Debt mutual funds operate in a similar way but deal in bonds and other fixed-income securities. Liquid mutual funds, a type of debt fund, deals in short-term fixed income bonds.

Here too, one can earn through buy and sell, and through dividend, if opted for. As mutual funds are managed by professionals, the groundwork is done by them. You pay for their efforts, which gets reflected in the price of ‘units’.

Phew — all of them completed their analysis and got some understanding of options available.

Next day, they started with using the armors.

First — low hanging fruit — contingency funds. All agreed to have a fund for this. It should be available immediately — so easy on liquidity.

Easy on liquidity are saving accounts and liquid MFs.

Interest earned in saving accounts is taxfree till 10k. So, one can keep the fund in savings up to 10k worth of interest and rest can be kept in a liquid fund, as after three years, its gain can gain indexation benefit, reducing the tax on it.

Next, there are three buckets — debts, short-term goals and long-term goals.

Ena & Deeka suggested, lets square-off the loans first and get rid of the “burden”. But Meena differed.

She said — Debt is money borrowed, that comes with its cost. The more you delay to repay, the more it would cost you. So is debt a bad thing? Yes, if it is from a sahukaar like in Mother India. But otherwise, from a financial institute, it’s not that bad.

Especially for education and buying residential property, the cost of debt is less. Consider this — a home loan costs you 8.3% per year, and its interest is useful in reducing your taxable income. So effective interest further reduces. If on other hand, other instrument can give 12% post-tax returns, would it be beneficial to repay the loan in a hurry? You can earn around 5% through this. So consider repaying debts through this lens too.

That sounded interesting to Ena & Deeka.

Considering that the debts should be taken care of considering cost-vs-other_options, , next are short and long-term goals.

Ena said, my short-term goal is saving for a new vehicle I want to buy after 3 years. The options are FDs, RDs, gold, shares or MFs. I ruled out property as entry barrier is high, and selling is troublesome.

Even gold seems improbable as I am not sure how much its rate would appreciate in three years.

FDs and Debt MFs seem nice. FD has fixed returns, so that helps in planning, but post-tax, when considered with inflation, it is a turndown.

How?, asked Deeka.

Ena explained, “Say you kept Rs. 100 in FD for a year. After 1 year, in best case, it will be 108 -0 (tax) -6(inflation) = 102. In worst case, it would be 106 –1.8 (tax) –8(inflation) = 96.2. ”

Deeka added that, Debt MFs do have reasonable amount of surety and good MFs have returned steady returns of 9+%, post-tax.

But still the inflation problem remains. Shares and Equity MFs do give average returns of 12–18% post-tax but have risks too.

All three were confused.

Ok, lets see what we have for long term.

Ena convincingly declared that he would go with property. Either a flat or plot or shop. Ofcourse, he said, after buying my first house, for living. He said, in long-term, say after 15–20 years, it would give handsome returns.

However, Meena had a different view. She was convinced about buying the house for living, but for investment, she was worried of high maintenance — property tax, security, cost of the loan, wear and tear of property — All this may take away the sheen from the appreciation.

She gave an example. Let’s say you buy another 2BHK for 60 lakhs. You gave 10lakh from your pocket and 50lakhs through a loan.

Extra cost = 415000 (8.3% interest) + 10000 (property tax) + 25000 (society maintenance) + 5000 (house maintenance) = 455000 per year

Rent income = 2.5 lakh per year— 50000 income tax (@20%) = 200000 per year
Per year expense on new home = 455000–200000 = 3,55,000

She gave a disclaimer that the cost and rent are average values and increase in rent per year is adjusted for the increase in expense.

So, your house has to appreciate at a rate, which should cover this expense, and also give you decent 10% return. For this, your property should appreciate ~16% per year, every year.

So, a house bought for 5000 rs per sq.feet should be 5800 next year, 6700 next and 7800 next. Do your math.

Ena and Deeka scratched their head. Deeka said, hey but my friend’s dad’s investment in plots doubled in 5 years.

Well, if you are sure of such returns, you should certainly go ahead. But point to be noted, my-lord is ‘sure’. How can one be sure of the property market?

What else do we have?

Meena explained her golden approach — buy 50 tola ka haar. You know, its Raaja maharaja ka wealth., and I am so fond of ashrafiya and Sone k sikke.

Ena twitched. It too has security cost. If ornaments are bought, it comes with making and dilution charges. And again, the sole reliance on that day when the gold rate will increase, or that doomsday when gold will be king of currency or currency of king.

Well, we are left with shares, said Deeka. Shares too are high maintenance in terms of tracking it. What to buy, when to buy, when to sell, etc. You can learn through reading and trying. Equity MFs are good option, but spotting good MFs, and further tracking it, is again time-consuming.

All three were confused here — Shares, property and gold — good for long-term, as cuts the inflation impact, but returns of all three depends on their respective markets, and requires study.

I think we should now call the guy

And they called me.

I liked their division of goals and analysis of instruments and congratulated them that they are almost there, just a small clarification and you will be there.

I said that from a distance, share, gold, and property, looks scary and difficult, and they indeed are.

But what tilts in favor of equity market is
a) low entry barrier — you can start with few hundreds of rupees.

b) variety — so many companies in share market

b) data — the variety and depth of historical and contemporary data for studying is enormous.

c) outsource — you can easily outsource all the dealings in shares to MFs, for a fee, which is negligible considering the returns.

I was not willing to invest time in studying these many numbers of companies and lot many other things.

But, I studied the returns of Equity mutual funds. The returns were tax friendly, nullifying inflation and still returning handsomely.

There is a risk, but in long term, it is averaging. I studied returns of last five years and got convinced that good schemes do return 12–20% per year.

To explain in your analogy, right now, my contingency fund bucket is spread in the savings account and liquid fund.

I have defined my short-term as 1 year. Money allocated for these goals are in liquid fund.

Rest of the surplus for long-term goals buckets are invested in different types of MFs.

Depending on the size of bucket, ie goal, it would take time. But with better instruments, it may take less time to fill the bucket.

Ena asked, “But choosing MFs demands time right?”

Yes, I said, though the exercise, is not as tiresome as that of shares. Even for a lazy creature like me, it is manageable.

Meena asked, “So, how to pick and choose MFs?”

Stay tuned, i said :).

Next part of this post can be read here.

Please provide your feedback in the comment section. It will help me improve. You can also email me at dhruvdesaai@gmail.com.