Mutual Fund: Direct vs Regular Plans

After investing in mutual funds for about 3 years, i have learned the difference between direct plan and regular plan quite later and writing this blog so you can make an informed decision while investing your hard earned money.

Direct Plans - As per the SEBI guidance, 2013 onwards all AMCs have started offering direct mutual funds to customers where no intermediary is involved and customer can save some commission which could range from 0.5% to 1%.

Regular Plans - These are the mutual funds which are usually sold by your agent/third party sellers and they get commission from AMCs which at the end of they day gets paid from your holdings.

Apart from the commission part there is no difference between the both. Assets held by the AMC for both the plans will be same and same fund manager will be managing both the plans.

Advocates of regular plans have argued that investors can make wrong decision in selecting the funds which can lead to losses later on which is true. There is some time which investors will have to spend on their own to select funds or they can choose regular plan offered by MF distribtor.

There are financial planners available who can advise you on direct plans as well but they may charge for their services since there is no commission to earn later on.

Let me know if you have any question. Happy Investing !!!

Real Interest Rates - India Vs Brazil

With the war of words raged by S.Swamy against RBI Governer R Rajan, I thought it will be interesting to see if R.Rajan has really done anything wrong. Below are two graphs - first representing the WPI Index and Inflation while second showing the Repo Rate.

As and when there has been increase in the the inflation there has been a equal/relative increase in the repo rate to curb the inflation. During 2008/2009 there was sharp reduction of interest rates because inflation was low and industry was in dire need of rate cuts.

Now though the inflation is within the comfortable limits but it has started to pick up (Jan'16-Mar'16) and it does help to cut rates too quickly to increase it later when situation is not as demanding as it was in 2008.

Brazil Case - In Brazil the economy is already undergoing recession but Central bank has decided to keep the interest rates high to curb inflation which is reducing the buying power of households. As it reads, inflation is near 10.5% while interest rates are kept at 14.25%.

http://www.bcb.gov.br/?INTEREST

http://www.ft.com/intl/cms/s/0/6488250e-e0d6-11e5-96b7-9f778349aba2.html#axzz4A3U3OJWE 

Real Interest Rate

Real Interest Rate = Repo Rate - Inflation Rate

More is the difference between the Repo Rate, the more attractive deposits become and attracts more money to banks and further reducing liquidity in the market which can help to reduce inflation.

In case of Brazil it is close to 4% while in our case it is almost 1.5% which outlines how far our governor has gone to reduce the rates and help businesses which as per S.Swamy, has been ruined by him.

Has he(R.Rajan) gone too far since inflation already showing its heads up and rates could be increased soon to be back on track which will further make S.Sway unhappy?? only time will tell. 

Interest Rate Cycle

RBI main objective as shared by Raghuram Rajan, Current Governor multiple times is to keep inflation within the limits so as not to reduce the buying power of poor in the country.RBI does this by controlling the free flow of money in market via changing repo rate which is the rate at which RBI lends to banks.

Whenever there is a increase in the repo rate, FD Rates/Deposit Rates also increases resulting in depositing more money in banks which will lead to less money available to buy goods thus putting a downward pressure on prices. On the other side when rates are decreased then people have less incentive to save but to spend money which will lead to increase money supply/demand/prices.

Whenever the inflation is within the comfortable limits, RBI usually decreases rates to reduce the borrowing cost which shall improve business activity in the market.

Banks does not always move the rates in the same proportion as per RBI does and usually been seen as front runner to decrease deposit rates and increase lending rates. RBI being the boss has come out with a innovative solution to help consumers which is MCLR. It is marginal cost of lending for bank decided for multiple time periods, Banks can add spread/credit risk premium as per their calculations. Full article is available at below link and i will try to explain it more in my next article.

https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10179&Mode=0

Investment Options

Only way to secure financial freedom is to use your money to make money for you. In financial world there are two kind of investment options for a investor -

• Fixed Incomes Related
• Equity Related

A third type which usually is not recommended for normal investor is called derivatives.

Fixed Income - 

These are the options where returns are fixed and there is no risk(generally) to the principal. Most common of them all are Fixed Deposit or Bonds (Govt.,Corporate). There are alternatives like PPF, EPF,Post Office Savings, NSC and other debt related schemes.

Since there is no risk(generally) to the principal, these are considered the safest investment vehicle .There are many Mutual funds who invest only in debt(FI) securities and are considered most safe.

Equity Related -

Buying a stock/share result in ownership of the company and the returns are not fixed but are linked to company performance. Advantage here is that your returns can be much greater than FI securities however there is risk of losing on the principal if company performs badly.

Mutual funds which invest in stocks are called equity related funds. There could be companies who are not well established yet and are growing, investment in such companies is riskier than Blue Chip companies however the returns could be more as well. 

Risk classification of mutual funds is done based on the kind of stocks they are choosing to build the portfolio.

Derivatives-

These are instruments which derive there value from other securities, other securities are called underlying. Underlying can be FI or Equities and these can be extremely complex, making them difficult to understand. These can be risky and can cause heavy losses in small time if not traded properly.

Tax Planning AY 2015-2016

When it comes to savings, the tax planning is equally important and can lead to good amount of save if you fall in higher tax bracket.  

Please refer below link for this year tax brackets – http://financialfreedomplanningindia.blogspot.com/2016/01/income-tax-slabs-for-ay-2015-2016.html

Various options available for tax savings in are as follows

Generic Options – Usually applicable to all

·         80C – Investment upto 1.5 Lakh is exempted from Tax

·         80DD –

o   Insurance policy for self and family upto 15,000

o   Insurance policy for parents upto 15,000 and  20,000 in case of senior citizens

·         80G – Donations to selected organizations and trusts are exempted from incomes tax

·         Medical Expenses – Medical expense of 15,000 in one financial year is exempted from tax

·         LTA – Leave Travel Allowance can also helps to reduce the tax burden considering that you are salaried and your employer provides this component in your salary.

Other Options – Applicable depending upon individual condition

·         There are other options available like exemption due to disease and disability.

·          Exemption against house rent is available if you are staying in a rented house, Please refer to article in information session which explains this in detail.

·         Exemption interest paid against the home loan, please refer to the article in information session for details of application

	Person A	Person B	Person C
Income	600,000.00	1,000,000.00	1,500,000.00
80C	150,000.00	150,000.00	150,000.00
80DD	15,000.00	35,000.00	35,000.00
80G	-	25,000.00	50,000.00
Medical Expense	10,000.00	10,000.00	10,000.00
HRA	100,000.00	100,000.00	100,000.00
Exempted Income	275,000.00	320,000.00	345,000.00
Taxable Income	325,000.00	680,000.00	1,155,000.00
upto 2,50,000	-	-	-
from 2,50,000 to 5,00,000	7,500.00	43,000.00	25,000.00
from 5,00,000 to 10,00,000	-	36,000.00	100,000.00
beyond 10,000	-	-	46,500.00
Total Tax	7,500.00	79,000.00	171,500.00

Note – These examples are designed with very basic data in mind, for exemptions applicable to you please research further or take advice from financial planner.

Income Tax Slabs for AY 2015-2016

India Income tax slabs 2015-2016 for General tax payers and Women

Income tax slab (in Rs.)	Tax
0 to 2,50,000	No tax
2,50,001 to 5,00,000	10%
5,00,001 to 10,00,000	20%
Above 10,00,000	30%

India Income tax slabs 2015-2016 for Senior citizens (Aged 60 years but less than 80 years)

Income tax slab (in Rs.)	Tax
0 to 3,00,000	No tax
3,00,001 to 5,00,000	10%
5,00,001 to 10,00,000	20%
Above 10,00,000	30%

India Income tax slabs 2015-2016 for very senior citizens (Aged 80 and above)

Income tax slab (in Rs.)	Tax
0 to 5,00,000	No tax
5,00,001 to 10,00,000	20%
Above 10,00,000	30%

Advantage of Time and Power of compounding

Any financial bog cannot be complete without discussing the importance of time and compounding effect. Investment that you are going to make now can have far larger effect than the effect if you start the same investment 3 years later.

Let’s consider a scenario where there are person A, B and C who started earning at the age of 24. Person A believe is little conservative and started investing in FD each year with the amount of 5000 per month while person B has started investing the money in mutual funds making return of 10% and Person C is not making any investment till 28.

Person	A	B	C
Investment/Month	5000	5000	5000
Investment/Year	60000	60000	60000
Started at Age	24	24	28
Rate of Return	8	10	10
Total Money at 40	18.2 Lakh	21.5 Lakh	12.83 Lakh

·         Return Impact - Even a 2% increase in the return can cause a difference of 3.3 Lakh in the overall amount

·         Time Impact -  Starting late by 4 years can reduce the total amount drastically

Lesson to be learned from this example is to start saving early and identify the opportunity which can deliver best returns based on the risk profile. It will help you to achieve your life goals quickly.

Note – Impact of Time and Rate will be much bigger for amounts more than this example and time longer than we have taken in this example.

Mutual Funds

There are multiple types of mutual funds available across the board; it can be classified according to the instruments in which they invest, risk profile, region, Industry etc. The broad classification be done as below -   

·         Equity Funds

o   Large Cap

o   Mid Cap

o   Theme based funds

o   Diversified Equities

·         Debt Funds

o   Gilt Funds

o   Income Funds

o   Dynamic funds

·         Balanced or Mixed funds

Equity Funds – These funds invest in share market and take position as per the fund’s manager view and the category in which fund belongs. Mid cap funds will usually take position in mid cap stocks where they expect high returns.

Debt Funds – They invest in Fixed Income securities, It can be GOI securities or corporate bonds etc. Dynamic funds try to make money by betting on interest rate cycle using duration as a tool

Balanced Funds – There are funds who try to best of both the worlds and have money allocated to both fixed income as well as equities