Each week I try and answer generic questions on personal finance. Here is part one of this week’s edition. You can use the form below to ask your questions.
Shrirang: Sir, I have my home loan currently going on which will be completed end of the year. The EMI costs about 40% of my current salary. My current expenses are about 35% of my current salary. I am looking to start doing investment for my retire plan. How could i start to proceed? Your help is appreciated.
Pattu: Switch off all distractions and get some alone time. Think about all your future money needs – in the next year, Next few years, many years later and so on. Recurring needs and non-recurring needs. Write them down on a piece of paper. Then ask yourself if you have enough life insurance, health insurance, emergency fund. Once you get that in order, focus on how much you need to be investing for each of your goals and start.
This will help: A Personal Finance Self-Evaluation Checklist
This is a slide I use in the investor workshops. Your family is in the centre. Start protecting them from the outside.
Inflation insurance simply refers to long-term investing taking inflation into account.
These steps are explained here DIY Personal Finance: How long does it take anyway?
Action plan insurance refers to sharing everything with a spouse or relative. So that they can take over at any time if you are busy (not just dead!)
Arun Senthilraja: Hi Pattu Sir, I’m a regular reader of your blog daily and have utilised most of the resources very beneficial, thank you sir. My question: I use your Financial Goal variable asset allocation calculator to decide my asset allocation. My asset allocation is 60% equity and 40% debt. Can I consider EPF, PPF monthly investments as part of debt % allocation? The calculator suggests 20% on taxable fixed income and 20% on tax-free fixed income. I’m investing for 2 different long term goals and with current debt market downtrend can I increase the percentage allocation to PPF as it is tax-free and both my goals are 15 years from now. If my EPF and PPF investment covers 40% of debt allocation do I need a debt fund? I understand debt fund is used for portfolio rebalancing, just want to know if I can keep debt MF investment to a minimum.
Pattu: Yes you should consider EPF and PPF as part of debt. You can increase the allocation to tax-free fixed income and if you can do this, there is no need for a debt fund. Down the line, you can add a debt fund for rebalancing. In my case, NPS almost entirely makes up the 40%. I have a PPF account and so has my wife. I just invest enough to maintain these. When I wish to rebalance from equity, I shift some portion to these two ppf accounts. Of course, there are investment limitations. When these are breached a debt fund can be added. No hurry.
Divya: We are investing in equity (70%) and debt (30%) For debt using ppf and for equity using SIP for last 5.5 years. In equity SIP We are investing in hdfc top 200 and icici pru dynamic. Cams shows returns of around 16% seeing these results We want to increase investment and We thought it’s been 5 years so need to think of rebalancing (reading from your blog inspired us) so thought of meeting financial planner. The financial planner suggested to switch from both funds and invest other 4 large cap funds when I check those each having overlapping in the range of 25-55. My husband think we need diversification in large, mid, small, multi, balanced funds. I think if fund is giving good returns then why we need to switch funds. Can you please tell us in equity what should be ideal allocation and what should we do about this.
Pattu: Is your financial planner a SEBI registered fee-only planner? Did he suggest invest in direct plans or regular plans? If your current funds are doing well, there is no need to shift and definitely not to four large cap funds!! I generally do not like to comment on financial planner advice, but I do not like the suggestions here.
Neeraj Kukreja: Sir, I want to ask whether we actually need multi-cap funds in our portfolio. Can a large cap, amid cap and a small cap replace them? Can u provide a study on this which shows the return difference in these two types: one investing in 2 multi-cap funds or other with 1 each large, mid and small cap for longer term?
Pattu: I made this graph for a discussion on AIFW for a different question. I guess it can be used as such here. These are current trailing 5-year returns of different equity funds. Notice that multi-cap funds share the properties of large-cap and mid-cap funds. So you can either have two of those funds or just one multi-cap fund. I don’t think it will make too much difference either way. The return (%) is in the vertical axis. The horizontal axis represents the category.
Senthik: For a 1-year goal, monthly contribution. instead of RD can we choose ultra short-term funds that invest in banks and psu bonds
Pattu: Will not make any difference in terms of taxation. You may earn a bit more with ultra-short term funds. But that money will be spent in a year. So no great addition to you wealth. So choose an option which allows you to sleep in peace.
Meena Shivram: I have a few queries related to debt instruments like bonds and debt funds. 1. What is the difference between Tax saver bonds and Tax-free bonds? 2. Are they better than short-term or ultra short term debt funds in terms of returns, volatility and interest rate sensitivity? 3. Do bonds give better post-tax returns than FDs? 4. Lastly, how do we select the right kind of bonds suited for our needs?
- What is the difference between Tax saver bonds and Tax-free bonds?
Tax saver bond is one in which we can reduce tax liability by buying them. The interest income received is taxable as per slab.
Tax-free bond is one in which interest received is tax-free. No tax saving is possible by buying them.
- Are they better than short-term or ultra short term debt funds in terms of returns, volatility and interest rate sensitivity?
There is no free lunch. The price we pay for no volatility and no interest rate sensitivity by buying such bonds is the long lock-in. If I had a large corpus at my disposal where I can spare a few lakhs (or a few crores, while we are dreaming …), I will buy some tax-free bonds (if I can) and get some nice tax-free annual income. Not suitable for many, though. Locking corpus up is a bad idea. Liquidity is the no 1 priority in any investment.
- Do bonds give better post-tax returns than FDs? Depends on when they were introduced and when we buy them – either from the primary or secondary market.
- Lastly, how do we select the right kind of bonds suited for our needs? As mentioned above, do not buy bonds, unless you can lock-up the money. A debt mutual fund is a better option. Sure there risks, but we cannot allow that to suffocate us.
Maninder Singh: Dear Sir I have been a regular reader of your blogs after reading your book. And I feel enriched with some knowledge on Mutual Funds and also a bit confused especially on debt funds! Also, you are quite against to NPS while some of blogs on Tier II of NPS are putting the positive notes especially for debt funds. In this regard. I have many questions. Firstly, the links for blogs putting the positive news about tier II of NPS are: http://economictimes.indiatimes.com/wealth/invest/low-cost-nps-tier-ii-has-beaten-direct-mfs/articleshow/53349849.cms https://www.valueresearchonline.com/story/h2_storyView.asp?str=31674 I request you to put light on: 1. Being a state Govt Employee money is invested in 15% Equity only, Whether it is advised (and permitted) to shift to auto choice? 2. Whether a person should try to invest in Tier-II (especially lump sum) as these funds have very low fund management charges? 3. What are the taxation rules on the capital gain from Tier II investment? Regards Maninder
Pattu: I am a govt servant myself and covered by mandatory NPS for the past 10Y. About 40-45% of my retirement corpus is locked in there. Which is the difference between theoretical financial independence and practical! I cannot quit and do what I like because of this lock-in. It is suffocating. This is whay I keep saying stay away from Corporate NPS, if You Wish to Retire ASAP!
As of now, the 15% equity limit cannot be changed by govt servants. Even if we can, I will leave it as is, use NPS as pure debt and focus on equity separately.
Stay away from Tier 2 as the taxation is not clear. Ignore media reports on this and everything else. Excuse me for not reading the links you sent.
Low fund management charges do not imply quality fund management. That is the problem. Do not invest in NPS anymore than you have to.
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