6 Tips for Year-End Tax Planning

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“The avoidance of taxes is the only pursuit that still carries any reward”

—JM Keynes

There is a very thin line between tax planning and tax avoidance. The purpose of this post is not to ask you to go for tax avoidance but rather tax planning which means planning our tax affairs in such a way so as to take full advantage of exemptions and deductions provided and minimize the tax impact on our income within the confines of law.

Here I present a few tips on year-end tax planning which can help you make the most of existing tax breaks:

1. Let your dud stocks help you save tax
Since long-term capital gains from stocks sold on stock-exchange is exempt from tax; long term capital losses from the stocks is also not allowed to be set-off and / or to be carried forward. Therefore you should convert your short term unrealized losses from stocks into actual loss and reduce your tax liability.

What if you want to retain the loss making stocks for a long term? It’s very simple—just sell it on or before March 31 and buy it back any time from 1st April onwards. In other words, book temporary loss for tax purpose.

In simple words, it is always preferable to book short term capital losses at the end of financial year on your loss making stocks (even if you want to keep them for long term and don’t want to dispose) and buy them in next financial year. By that way, you will be able to lower your capital gains (by utilizing these losses for setting off against your other capital gains) and consequently lowering your tax liability.


2. Use bonus-stripping
Do you know that bonus shares also provide tax arbitrage opportunity? How? What is the relationship between issue of bonus shares and saving tax?

The practice of buying the shares at cum-bonus price and selling the ‘original shares’ at ex-bonus price and booking short term losses in the process is called ‘bonus stripping’ and similar to ‘dividend stripping’.

As per the current IT provisions, while ‘dividend stripping’ under section 94(7) covers both shares as well as mutual fund units, ‘bonus stripping’ as per section 94(8) includes only mutual funds units. Put another way, tax laws allow ‘bonus stripping’ in case of equity shares.

So, if during the financial year, you’ve purchased any shares against which company has further allotted you bonus shares, then you must sell the ‘original holdings’ and book short term capital loss.

But how does it help save tax? Let me explain with the help of an example, suppose you purchased 100 shares of ABC ltd at a price of Rs 300 per share in the month of November 2009. Later on, in the month of January 2010 when the price was ruling at Rs 350 per share, the company came with 1:1 bonus and you were allotted 100 additional shares so that after the bonus issue, you held 200 shares at the adjusted ex-bonus market price of Rs 175 and now the market price is ruling at, say, Rs 200 per share. Now, if you sell the original 100 shares and keep the ‘bonus shares’, you can book a short term capital loss of Rs 10,000 (Rs 20,000 – Rs 30,000) for tax purposes.

Your next question will be: Won’t this tax benefit get set-off against gains from selling bonus shares? Yes, only if sell the bonus shares before one year from the date of allotment. On the other hand, if you sell the bonus units after a period of 12 months, the capital gains will be long term and therefore completely exempt.


3. Invest your short term surplus in FMPs
By investing in a Fixed Maturity Plans (FMPs) at the end of the financial year (i.e., the month of February & March), you an avail double indexation benefit by holding the investments for just 13-15 months.

In other words, at the end of a financial year, Fixed Maturity Plan with duration of 13-14 months becomes the best debt option due to associated double indexation benefit. For more details, see the previous post.


4. Advance tax payment: Way out
Note that even though TDS is being deducted by your employer on your salary income, you are liable for payment of advance tax on your other income like interest, capital gains etc if the tax liability exceeds Rs 5,000.

It is good, if you can calculate tax on your other income and pay the advance tax by yourself. But if you want to avoid the hassle, there’s a way out. You can submit the particulars of ‘other income’ to your employer and request him to deduct tax on your additional income. The employer cannot refuse because it’s a right provided to you under income tax law.


5. Get Form-16, even if tax on your salary income is ‘nil’
Form -16 is more important than your tax-return. Now-a-days everybody asks for it as proof of your income. So how to ensure that your employer issue you a Form-16 even when your salary income is below the basic exemption limit. In other words, how to force the employer to deduct a nominal amount of tax and issue you a TDS certificate in ‘Form-16’

There are two possible scenarios:

o Your income is below taxable limit without availing section 80 deductions: Submit a declaration showing other income such as capital gains, income from house property, interest on savings account, bank FDs, NSC, KVP and NCDs (if any).

o Your salary income goes below taxable limit only after availing section 80 deductions: Don’t submit any proof for tax savings or submit so much evidence so as to bring your taxable salary income to such a level which is marginally higher than basic exemption limit.

In both the cases, your employer would be forced to deduct TDS from your salary income and issue you a TDS certificate in ‘Form-16’.


6. Avail depreciation benefit on cars, books & computers
If you’re a professional and planning to buy a new car, books or a computer, consider purchasing on or before March 31 to avail depreciation benefit for 6 months and thereby save tax.


Also see:

1. Salary TDS: FAQs
2. Tax implications of house sale
3. Budget 2010 – Impact on individuals

Where to park your money required after one year?

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I am planning to purchase a house very soon but that time duration could go to a year or more, in the meanwhile I have around 10L laying in my saving account. Any advice .to use it wisely, I have already invested in generally most of fund like PPF, Bonds, FD, ELSS etc.__Vinod


There are plenty of options available for parking your surplus funds depending upon the duration for which you can spare your money. Here the discussion is limited to investment of surplus funds when the time horizon is one year plus, say, around 13-14months.

Your first option is to stay invested in the savings account where you’ll get an interest rate of 3.5% p.a.

If absolute safety of your capital is important to you, then the other safe option is fixed deposits (FDs) of banks which are currently offering interest rate of around 6.5% for one year.

If you’re looking for higher post-tax returns, then you should consider investing in Fixed Maturity Plans of mutual funds. The major difference between FMPs and other debt funds is that due to holding of instruments till maturity FMPs are least exposed to interest rate risk. Further, FMPs floated in last quarter of a financial year with duration of 13-14 months offer the benefit of double indexation which makes them even more tax efficient.

Let me explain how does it work—as you know that mutual fund debt schemes are tax efficient as compared to bank saving and fixed deposits. While interest from FDs and savings account is taxable at your marginal tax rate (MTR), the gains from debt funds are taxed in the form of dividend distribution tax (DDT) if dividend option is chosen and / or Capital gains in case of growth option. Further, capital gains from mutual funds are of two types: short term (up to one year) and long term (more than one year). While short term capital gains (STCGs) are taxed at the marginal tax rate, long term capital gains are taxed either at the rate of ten per cent without indexation or 20% with indexation.

Further, when you invest at the end of financial year in an FMP which will mature just after the end of the next financial year, you get entitled for double indexation benefit making your capital gains virtually tax free. For example, if you invest in an FMP in March 2010 and it matures in April 2011, your investment gets spread over three financial years and you get entitled for indexation for 2 years i.e., FY 2010-11 and 2011-12.

At the end of the year even if FMPs deliver return equivalent to one year bank FDs, your post-tax yield will be considerably higher than that of a FD. Assuming tax on FMP to be virtually ‘nil’ after considering double indexation benefit, the post yield of FMP will be same as pre-tax yield i.e., 6.5 per cent as against post-tax returns of 5.16% and 4.49% from bank FD for an individual in the middle tax bracket and highest tax bracket respectively.

However, although FMPs are now listed on the stock exchange, trading volumes are low and therefore exit is difficult and might have to exist at a discount to the NAV, so invest if you can remain invested till the date of maturity.

In short, for an individual in the middle or highest tax bracket with a time horizon of slightly more than a year and that too at the end of a financial year, there’s nothing to beat FMPs with better returns which are tax efficient and carry negligible interest rate risk and low credit risk.

On the other hand, for an individual with zero taxable income or in the lowest tax bracket of 10%, it will be better to invest in bank FDs instead of FMPs because the marginally higher returns, if any, from FMPs will not matter much due to credit risk involved (although low) and poor liquidity.


P.S. Today is March 27, 2010; you still have 4 days left to invest in FMPs and avail double indexation benefit.


Also Read:

1. Is it worth investing in KVPs?
2. 5 things to avoid while investing in equity diversified funds
3. What is the right time to buy a home?
4. Mutual Fund Tax Benefits

Selling your house: Know the tax implications

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I have purchased a house in July 2005. I now want to sell this house and buy a bigger house. I will be completing 5 years on March 31 2011. What will be tax implication? I need to do this right now as I am getting a good deal on my existing house and the new one I am planning to buy.__Anonymous


Are you planning to sell your house? Before you take the decision, it is important that you know the tax implications. Understanding tax consequences of selling your house is as important as knowing about tax considerations while buying a property.

First thing to understand is that when you sell your house for a value more than it was purchased, there will be profit which is called ‘capital gains’ in tax parlance and you’ll have to pay tax on it. However, this tax liability can be reduced or altogether eliminated. How? Read on…

Here are two major factors which are important from tax planning point of view:

Holding period of the existing house
You should wait for a period of at least three years before selling your residential house so that capital gains arising from the sale are considered as long term and you can minimize or altogether avoid paying any tax on the capital gains so generated. There are three specific benefits available against long term capital gains (LTCGs) as compared to short term capital gains (STCGs):

1. Benefit of indexation: Cost of purchase for the purpose of calculating the LTCGs is eligible to get the benefit of indexation, which takes into account inflation. Cost inflation index (CII) are notified by the central government for every finanial year (FY). For example, CII for the FY 2009-10 is 632 and that of 2000-01 is 406. So for a house acquired for, say, 30 lakh in the FY 2000-01 and sold in the FY 2009-10, the indexed purchase cost would work out to be 46.70 lakh (30,00,000 * 632 / 406). In simple words, your purchase cost is proportionately increased to account for inflation which reduces your capital gains by the same amount (Rs 16.70 lakh in the above example).

2. Fixed rate of tax: The rate of tax applicable on LTCGs from sale of residential house is 20% irrespective of your marginal tax rate. There can be substantial saving if your income already falls in highest tax slab of 30%.

3. Exemption under section 54 & 54EC: Discussed in next paragraphs

However, if any home loan was availed to finance the purchase of your house under sale, then know that you need to wait for at least 5 years (from the end of financial year in which house property was acquired) before selling it; otherwise, you’ll lose tax deduction claimed under section 80C for repayment of housing loan.


Reason behind sale of existing house
Are you going to buy another house or the just booking profits on a residential house initially purchased for investment purpose? There are two tax saving options available depending upon the purpose behind the sale of residential house:

Tax Saving Option 1: Purchase / construction of another residential house
If you intend to purchase or construct another house, then you’re entitled to claim the exemption / deduction of the capital gains as per section 54 of IT Act subject to certain conditions.

Conditions for availing deductions u/s 54
1. Time limit of purchase / construction of another house: It should be purchased within one year before or 2 year after the ‘date of transfer’ of house. On the other hand, if you would like to construct, then construction should be completed within 3 years of the date of transfer even though it can be commenced before the sale.

2. How much maximum exemption is available: You don’t have to invest the entire sale proceeds for the purchase / construction of the new house. To avail complete tax exemption, the maximum amount that needs to be invested in new house is limited to the amount of capital gains. If you invest less, then the unutilized portion will be taxable.

3. Capital Gains account scheme: What if by the time of return filing, you’ve not utilized the money but you do intend to buy / construct a new house during next year or within the maximum time period allowed? In such a case, the amount should be deposited in “Capital gains account scheme, 1988” (CGAS) with any nationalized bank before the due date of filing of return and later on this amount can be withdrawn to be so utilized. The amount once withdrawn should be utilized within sixty days otherwise it should be re-deposited.

Two types of accounts can be opened under CGAS:

i.) Deposit Account A: It is similar to savings account. Interest rate is same as applicable to normal savings account. The interest is taxable.

ii.) Deposit Account B: This one is like a fixed deposit account. The interest can be either cumulative or non-cumulative. Rate of interest is also same as paid on normal FDs. The interest is taxable.

Now, what if the amount so deposited in CGAS is not utilized—wholly or partly—for the new residential house during the stipulated period? The unutilized amount will be charged to tax in the year in which the period of three years expires.


4. Further restriction on sale of new house: The new residential house can’t be sold before a period of three years from the date of its acquisition or completion of construction.


Tax Saving Option 2: Investment in REC / NHAI Bonds
If you do not wish to acquire another house, there’s another option to save tax on the capital gains—invest the capital gains in infrastructure bonds of REC / NHAI as per section 54EC of IT Act.

Following are the conditions applicable and other feature of such bonds:

1. Lock-in-period: 3 years from the date of transfer. The bonds are neither listed nor otherwise transferable.

2. Maximum Exemption: Maximum amount that can be invested is Rs 50 lakh.

3. Taxation: There is no tax deduction at source; however, interest income on these bonds is taxable on annual basis.

4. Rate of Interest: The current bond issues (REC 54EC Capital Gain Tax Exemption Bonds Series VIII and NHAI 54EC Capital Gains Bonds Series-X) open for subscription till 31st March 2010 are offering a simple interest rate of 6.25% p.a. which is to be paid on June 30 every year.


For futher discussion, wait for part-2.


Also see:

1. What is the right time to buy a house?
2. 4 Ways to claim both - HRA & home loan tax benefit
3. 12 Tips to file your tax returns

Budget 2010-11: Impact on Individuals

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Unlike every financial year, there are not too many significant changes (except hike in tax slabs) proposed by budget 2010. Nevertheless, there are many minor changes having a direct bearing on your finances. All such known and little-known changes are outlined below:

Budget 2010 Review: Proposals Impacting All Individuals
1. Changes in tax-slabs: Reduction in tax liability is uniform for individual taxpayers (i.e., male, female and senior citizens) with the same income level. Unfortunately, there is no change in the tax liability of individuals having income up to Rs 3 lakh. The exact savings due to widening of the tax slabs is as follows:

Income--------------------Savings

3 lakh------------------------nil
5 lakh------------------------20,600
10 lakh-----------------------51,500
20 lakh-----------------------51,500

To calculate the exact impact on your existing taxable income, use this tax impact calculator:


2. Infrastructure Bonds: Additional deduction of Rs 20,000 (u/s 80CCF) allowed for investment in long term infrastructure funds to be notified by the central government. This is also another interesting move which can lower your tax liability by as much as Rs 6,180 in addition to the reduction in tax liability up to a maximum amount of Rs 51,500 due to hike in tax slabs.

3. Gift of immovable property: Last year budget (Budget 2009) introduced taxation of gifts in kinds which also included transfer of immovable property without consideration or inadequate consideration effective from October 1, 2009. Now, budget 2010 has further amended the section 56(2)(vii) retrospectively to exclude immovable property transactions involving inadequate consideration (below stamp duty value). In other words, now tax will be imposed only if the transfer of immovable property is without any consideration.

4. Gift of Bullion: For those who thought that if gift of jewellery comes under the tax net, why not start receiving gifts in bullion?... Sorry, now this loophole is being plugged. Effective from June 1, 2010, the definition of ‘property’ under section 56 will include ‘bullion’.

5. New SARAL Form: ITR SARAL-II form consisting of two pages meant for individual salaried taxpayers will be introduced shortly which will make it easier for you to file the tax return on your own.

6. Joining bonus for NPS: One little known feature introduced by budget 2010 is the first time introduction of direct subsidy for individuals to encourage them to subscribe to New Pension Scheme (NPS). According to this innovative proposal , any individual who opens a NPS account during the FY 2010-11 with a minimum contribution of Rs 1,000 and maximum contribution of Rs 12,000 p.a. , government will co-contribute Rs 1,000 per year. And the incentive scheme will continue for another 3 years.

7. Housing Loan Subsidy: To provide a boost to affordable housing, the one per cent home loan subsidy introduced last year will continue for another one year. It is available on housing loan less than 10 lakh for purchasing property costing up to Rs 20 lakh.

8. Service tax on Property: This is the most controversial provision of budget 2010. Selling of under construction property by the developers / builders will now attract service tax thereby raising the cost of property. Consequently, installment purchase of immovable property will become liable for service tax. However, if the entire consideration is paid after completion of construction, then there won’t be any service tax.

It will result in additional tax outgo and consequent increase in the value of flats under construction by about 3.4% of price as service tax @ 10.3% will be charged on 1/3 portion of the total sale value.

Now property buyers will face another dilemma i.e., whether to go in for a constructed property (which is more expensive) or under-construction property and pay the service tax?


Budget Changes Impacting Small businesses & Professionals
1. Audit Compliance: There is a fifty per cent hike in the threshold limit for compulsory audit of books as per section 44AB of IT Act. Now audit will be required only if turnover / gross receipts exceeds Rs 60 lakh for business and Rs 15 lakh for professionals as against the present limits of Rs 40 lakh and Rs 10 lakh respectively.

2. Presumptive taxation: Ceiling for presumptive taxation of small businesses (under section 44AD of the IT Act) increased from current turnover / gross receipts of Rs 40 lakh to 60 lakh per annum.

3. TDS: The threshold limit for tax deduction at source (TDS) stands increased (effective from 1st July, 2010) as follows:

Payment--------------------------------------------Existing----- Proposed

Contractors (single transaction)--------------- 20,000---------30,000

Contractors (multiple transactions)------------50,000---------75,000

Fees for professional & technical services----20,000--------30,000

Rent---------------------------------------------120,000------ 180,000

Insurance Commission--------------------------- 5,000---------20,000

Commission / brokerage------------------------ 2,500----------5,000


Also see:

1. Tax Rates / Slabs FY 2010-11
2. Impact of DTC on PPF
3. TDS Salary - FAQs

Is it worth Investing in Kisan Vikas Patra (KVP)?

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So, you never gave a serious thought to Kisan Vikas Patra (KVP) as an alternative debt instrument because you did think that it is only meant for farmers...Didn't you? I’ve also been so busy promoting PPF that KVP almost escaped attention. But then Purab asked [see: What is right time to buy a home?],

“I have 3 Lakh to invest, how is Kisan vikas patra for mid/long term investment.”

Let me rephrase the question

Other than the tax-saving debt instruments available for investments (e.g. PPF, NSC, Bank FDs), which debt instruments can be regarded as good from medium to long term investment point of view?

Due to the current low-interest rate regime, small savings instruments have once again started looking attractive. KVP is also a small saving instrument available at post offices offering a pre-tax return of 8.41% per annum (your money doubles in 8 years & 7 months).


Basic Features:
1. Easy to purchase: Available in denominations of Rs 100, Rs 500, Rs 1000, Rs 5000, Rs 10,000 and Rs 50,000. No a/c opening hassles are involved. Just go to a post office fill a form, hand over the cash or cheque / DD and you’re done. Further there is no limit as to number of KVP certificates you can purchase or maximum amount you can invest.

2. Post-tax Yield: The interest is taxable on annual basis (although no TDS is involved). The post-tax yield from KVP depends on the marginal tax rate that will be applicable to you.

3. Premature encashment is possible just after 2.5 years (2 years & 6 months) but it is very costly—see the table:

Period--------------------------Yield---------------Reduction in Yield

Up to 2.5 years -----------------NA--------------------------NA

2.5 years to 3 years-------------6.5%-----------------------1.91%

3.5 years to 4.5 years-----------7.0%----------------------1.41%

5 years to 6 years----------------7.5%----------------------0.91%

6.5 years to 8 years--------------8.0%----------------------0.41%

8 years & 7 months--------------8.4%----------------------nil


4. Loan facility is also available against KVP by pledging it with the bank.


Comparison with PPF & NSC:
No doubt PPF, NSC, Tax-saving bank FDs have an edge over KVPs due to associated tax benefits. But once you exhaust your section 80C limit & PPF investment limit, investing in KVP becomes an attractive proposition.

KVP vs. PPF
PPF maintains its superiority over all other small-saving schemes (even ignoring the section 80C tax benefit) because the post-tax yield of PPF is substantially higher than all other debt instruments. PPF is the only debt instrument (other than the EPF), where your interest income is completely exempt. Accordingly the tax-free interest of 8% from PPF is much better than 8.41% taxable interest from KVP. However, if your total income is either nil or less than basic exemption limit, then KVP will score over PPF.

Even after implementation of Direct Tax Code (DTC) which will make the PPF withdrawals taxable, post-tax returns of PPF will be better than KVP.

KVP vs. NSC
Now, let’s come to KVP vs. NSC. Isn’t NSC a better debt instrument than KVP (even after ignoring section 80C tax benefit on the amount invested in NSC)? …Let’s see

1. Returns: Yield is 8.40% from KVP as against 8.16% from NSC.

2. Taxation: First, NSC is one of the eligible instrument u/s 80C i.e., the amount of your income invested in NSC gets exempted from tax. Second, returns of both the instruments are chargeable to tax. But unlike KVP, NSC interest is again eligible for deduction u/s 80C. But if your section 80C limit is already exhausted, then this tax benefit offered on NSC is of no good.

In short, considering tax benefits NSC is undoubtedly better than KVP (Note: there won’t be any more tax benefit on NSC after implementation of DTC). However, if tax is not the criteria, then KVP returns are a little better than NSC and with a longer investment period of about 2.5 years.


Comparison with other Debt Instruments:
Over the last year, returns offered on bank FDs are steadily coming down. At present 5- to 10-yr bank FDs are offering interest in the range of 7.25% to 7.75%.

The YTM of non-convertible debentures is also coming down. The following is the maximum YTM of NCDs issues during last one year

TATA Capital NCD -------------->12%
Shriram Transport NCD--------->11.50%
L&T Finance NCD (1st issue)--->10.50%
L&T Finance NCD (2nd Issue)-->8.58%

Although the YTM of 8.58% (accompanied with interest rate risk) on the L&T finance NCD 2nd issue in February 2010 was almost at par with KVP, the duration was 3 years as against almost 9 years of KVP.

Coming to medium and long term debt mutual funds, the 5-Yr category average returns are somewhere between (As on March 2010) 6 and 7 percent with some tax benefit due to tax arbitrage. Moreover, when there are chances of increasing interest rates, it is very risky to invest in long term debt funds.

So, due to above reasons, KVPs have started looking very attractive debt instrument offering relatively better returns without any risk.


Conclusion:
In a nutshell, if you’ve completed your tax savings and are looking for a debt instrument offering assured good returns combined with safety and liquidity then KVP is a good choice.

In other words, invest in KVP if you’re done with your tax saving investments and further exhausted your PPF investment limit (including your spouse & children) but make up your mind that you’ll remain invested till the maturity because if you make a premature exit, your effective yield will be considerably lower (the facility of making an early exit can be exercised in an emergency by sacrificing some returns).


Also see:

1. Practical Tips for Investing in FDs
2. Why should you invest in gold ETFs?

5 things you should avoid while investing in Equity mutual funds

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Ok, choosing the best equity fund or ELSS for the purpose of investing in mutual funds is no-doubt very important but what are the other important considerations to be kept in mind while investing in them.

So, continuing the discussion, this post is going to tell you about 5 things to avoid while investing in equity mutual funds.

5 things to avoid while investing in Equity funds:

1. Avoid Duplication
Before Investing in a good mutual fund, you must look at its top 10 stock holdings and also top 5 sector holdings...Why? To avoid duplication. The basic purpose behind investment through the medium of mutual funds is to diversify the investment portfolio. Diversification helps in de-risking of stock portfolio but having multiple funds in your portfolio with the same stocks defeats the purpose of diversification i.e., your investment portfolio becomes as good as an undiversified portfolio.

Therefore, while investing in equity funds, give a look at the underlying stocks. Let’s say you’ve all the three top / best performing equity funds in your portfolio. Further suppose that out of the top 10 stock holdings six (say, ICICI Bank, SBI, Reliance Industries, Infosys, HUL and HDFC) are common to all the three funds; it’ll be as good as investing in just one of the funds.

First ask yourself, why do we need to go for multiple funds? By investing in similar schemes, you don’t do much of a diversification in the real sense. The best way is to have two or at the most 3 top rated equity diversified funds (multi / large Cap) having different stock portfolio and / or 1-2 equity diversified (mid & small Cap), according to your risk profile (remember mid & small cap funds are riskier than multi / large-cap funds).


2. Avoid Laggards
Rather than chasing top-performers, it is more important to look for consistent good performers and avoid non-performers. In other words, avoiding laggards or weeding out consistent under-performers is more important than running after the best equity mutual funds.

First ask yourself: Is it really important to run after the best performing funds? Is it worth the time, effort and cost involved; or, is there any better way to make your mutual fund portfolio better & efficient?

As already explained in the earlier post, the best is always a relative term (there is no absolute best) and this relativity can make your performance look pale not because you’re not doing good but others are doing better than you.

There are two implications:
a) We should consider both relative as well as absolute performance.
b) It is more important to avoid the laggards / worst performers than to choose the best performer.

You’ve nothing to worry about so long as your portfolio contains 4 & 5 rated funds. If a fund is rated 3 star, then hold on and keep it on your watch list. No urgency to dump it immediately. If a fund is rated 1 star or 2 star, it shows consistent poor performance. You must act immediately to weed it out.


3. Avoid Sectoral & Thematic Funds
Avoid sectoral and thematic funds because these are the riskiest equity funds. If you’re already invested in them or would like to invest in them, restrict your exposure to a maximum of 10%.


4. Avoid New Funds
First never invest in a NFO. Second, go for a diversified equity fund with a track record of 5 or more years and having 4 or 5 star rating. You might also consider other 5 star rated funds having track record of less than 5 years. But it is better to avoid any fund less than 3 year old.


5. Avoid Frequent Churning
Know that there is a cost attached to shuffling portfolio. You should have clear reasons for reshuffling the portfolio. Simply because the fund ratings have dropped from 5-star to 4-star or from 4-star to 3-star is not a good enough reason. In other words, so long as your portfolio doesn’t hold any 1-2 star rated fund you’ve no reason to worry and there is no need to reshuffle funds. As already discussed, chasing short term top performance is a mirage.


Also see:

1. How to choose best equity funds

2. 10 Mutual Fund investing principles

3. 5 guidelines for investing in ELSS

Answers to Money Teaser # 3: Retail Banking

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Sorry, for making you wait for so long. Anyway here’s the answer to Money Teaser #3:

Q-1: Why do the lenders quote flat rate of interest instead of reducing balance rate?
Ans: So that it becomes easier for the borrower to calculate the EMI without the help of a calculator.


Q-2: Why do the banks charge pre-payment penalty?
Ans 2: Because it takes a lot of resources to find another GENUINE BORROWER who really needs the funds.


Q-3: Why do banks continue to offer you personal loans while your savings and FD accounts are overflowing with cash?
Ans: Banks very well know that those are your emergency funds.


Q-4: Why do banks offer teaser loans (fixed-cum-floating-rate schemes with artificially low interest rate in the initial fixed period)?
Ans: This is the sacrifice being made by banks to revive the real-estate market and the Indian economy. Further banks have employed astrologers who can predict with certainty your future salary increments.


Q-5: What makes the banks sure that despite teaser loans being similar to sub-prime mortgage, these won’t lead to large-scale default in future?
Ans: Presence of black money in property deals. Cash or ‘black’ component provides the banks with automatic margin-of-safety / additional cushion.

Anyway, if anything goes wrong government is always there to bail them out with the help of tax-payers money—rescue of US banks on the brink of collapse by the U.S. government has given them a boost. So there is nothing to lose by excessive risk taking.


Q-6: Why do banks offer lower rates to potential customers as compared to the current customers?
Ans: Gifts are meant for girlfriends and not wives.


Q-7: Why the banks have shifted focus from corporate lending to retail lending?
Ans: Unlike corporate, it is much easier to recover money from retail borrowers (just hire some goons!).


Q-8: Finally, what is the definition of retail banking?
Ans: Just reversal of corporate banking. Earlier the main function of banks was to collect deposits from individuals and lend it for business purposes (in the process earning a small margin). Now they collect deposits from corporate, mutual funds and HNIs and lend it to retail customers.

So while focus of corporate banking was lending to businesses for production & distribution of products and services, retail banking focus is to lend for consumption purposes (to make sure that the goods produced are also consumed). Besides, like other businesses banks also need to diversify, counter competition and expand banking business (every company wants to grow too big to fail!).

So, retail banking means to hire relationship managers whose job profile read something like this:

1. To spread the spend-now-pay-later credit culture of US by offering free plastic money (virtually free), so that people enjoy the present without worrying about our future. (In the long run, we’re all dead __ Keynes).

2. To issue chargeable Debit card instead of the free ATM card.

3. To give loans to people who don’t need them for things which they can do without.

4. To do financial planning & wealth management of unwilling customers by cross-selling ULIPs, mutual funds & PMS. (After all, they’re doing your financial planning in minutes and that too free of cost so that you don’t have to hire a financial planner)

I hope you enjoyed it!!


Also see:

1. Money Teaser #2: Life Insurance
2. Answers to Money Teaser