2017

Wednesday 27 December 2017

Drawbacks of NPS

National Pension System (NPS) scheme was started by GOI in order to provide financial security and stability during old age when people don't have a regular source of income. The subscription to NPS is rising with the lure of additional tax break but still NPS has not got the traction it was supposed to get.

That is because of some of the drawbacks of NPS and some of the fears of the investors. In this post we’ll see some of these drawbacks so that investor gets the necessary knowledge and make an informed decision.

Points that go against NPS

Here are some of the drawbacks of NPS. Mind you some of these may be perceived as drawbacks by investors and not actually be a drawback if seen from a slightly different angle.

Very long duration – In NPS you need to contribute till the age of 60. If you are starting to contribute at the age of 25 that would mean a duration of 35 years where you invest money in NPS. While I do admit that exit and partial withdrawal rules are a bit complex but it is the long duration of the NPS that will help you to build a big corpus. Also don’t forget some of the amount is going to equity and it is a well documented fact that equities pay in a long term.
You have to see it as a pension plan which should start giving you back only after the age of 60, so long duration should not be a deterrence.
NPS corpus is taxed on maturity – Now this is one sore point and when compared to other long term products available like PPF (which is EEE), the idea of paying tax on the accumulated corpus makes people a bit wary of NPS.
Though there are ways to reduce tax liability, 40% of the corpus can anyway be withdrawn tax free and 40% has to be used to buy annuity. That leaves 20% of the corpus, which if withdrawn, will attract tax at the applicable tax rate. There is another option though, you can use that 20% also to buy annuity then it will not be taxed.

But beware of the fact that the amount you get monthly from the purchased annuity will also be taxed as per the applicable tax rates.

Another way to reduce tax is to defer the withdrawal of lump sum amount of 60%. NPS allows to stay invested till the age of 70 so you can withdraw in instalments and structure it in such a way that your tax liability is reduced.
Mandatory annuity – Another point that is making people not opt for NPS is the mandatory buying of annuity with at least 40% of the corpus. Most of us want to have full control of the amount after investing for so long. Moreover annuity return rate in India are in the range 5.5 – 7 percent. Which means for the amount of 50 Lakhs in annuity your monthly pension will come to about Rs. 30000-32000 and to add to that income from pension is fully taxable.
Partial withdrawal and exit rules - Exit and partial withdrawal rules are not very flexible are another reason given by investors to stay away from NPS.
If you want to exit before attaining the age of 60, at least 80% of the accumulated corpus should be utilized for purchase of an annuity which means you can only withdraw 20% of the corpus.

For partial withdrawal you should have been invested in NPS at least for a period of 10 years. Moreover only 3 withdrawals are allowed during the whole tenure of your NPS subscription that too for very specific reasons like like Child's marriage, higher education, treatment of critical illnesses etc.

There should also be a gap of at least 5 years between two successive withdrawals. Some relaxation in this gap is given only in the case of treatment for specified illness.

These rules put off few investors who want access to their money with in the tenure of subscription. But don’t forget NPS is supposed to be a long term investment exiting in between without any real emergency or partial withdrawal with out specific purpose will dent the effect of compounding where your accumulated corpus (prinicipal + interest) starts earning an interest.
Investment in equity – Many investors are conservative and don’t want to invest in equities. NPS does provide an option through Active choice to put the whole contribution in Government Securities or Corporate Bond Fund. But Active choice means you have to decide on the asset class and the fund manager. Investors find all that research too intimidating and want to go with Auto choice but in Auto choice equity percentage will be there. To avoid this dilemma people go with other debt options rather than opting for NPS.
At the same time there is another group of investor who want to be in control of their investment and want to decide how their contribution is invested. For them 50% cap on equity allocation even in Active choice is a source of concern.

Now we can see it as a balancing act by NPS (50% cap on equity) to keep both classes of investors happy. Investors who prefer equity should opt for some other mutual funds too with more exposure to equity.
Returns are not assured – In NPS returns are market linked. You are not given n black and white that these are your assured returns under NPS. Investors who want to have a clear picture where their money is going and how much they will get after the specific duration find it a bit risky.
This concern is valid in case market crashes in the year you are retiring which would mean a much smaller corpus than planned.

That is also one reason equity percentage is capped to 50% and you can also look into the option of keeping your investment with in NPS till the age of 70 and withdraw only in instalments.

That's all for this topic Drawbacks of NPS. If you have any doubt or any suggestions to make please drop a comment. Thanks!

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Sunday 24 December 2017

Investment Habits to Help You Build Wealth

We all have habits, few of us are even slaves to some habits. Some of these habits are perceived as good habits and some as bad. Like sleeping on time, waking up early, eating healthy are all considered good habits while staying up late at night, smoking, eating junk everyday are considered bad.

We may argue over what can be categorized as bad or good as some of us may say that all their creative thoughts come only late at night and that’s when they get most of the work done. That discussion is relative but one habit is universally good “The habit to invest”. Cultivating a habit to invest consistently and with discipline is good for all and intelligent investment is serious stuff which has a direct impact on - how you tackle with any emergency, your future and your life style.

Here are few habits that will help you create the investing discipline.

Start early – There is no ‘better time’ to start investing. You should start as early as you can, even if you start with a small amount. Never underestimate the power of compounding.
As example – If you put aside Rs. 5000 every month for 15 years and the interest rate you achieve is a modest 9%. Let’s for simplicity’s sake assume that interest is compounded annually on the whole amount, which means on the Rs.60,000 you invested in a year, you are getting 9% interest compounded annually. After 15 years the amount will become close to Rs. 20 lakhs, where principal is 9 Lakhs.

Now consider the same investment for 20 Years. After 20 years you will get close to Rs.34 Lakhs. A difference of Rs.14 Lakhs where you have invested Rs.3 lakhs extra.
Setting investment goals – You will have some short-term goals, some long term goals and you need to plan your investment accordingly for these goals. Also setting goals helps you think clearly in creating a better road map.
You can in fact categorize your goals into three categories -
- Short term goals – Ready cash for any emergency, down payment for, maybe a car, repaying education loan.
- Medium term goals – Savings for buying a house, marriage expenses, overseas holidays.
- Long term goals – Kid’s education, retirement.
Creating a plan – Once you have established your goals, you need to put aside some amount to cater to those goals.
For short term goals you may look into Recurring deposits, fixed deposits, liquid funds.

For medium and long term goals try to put some money into Mutual funds, buy equities if you are confident enough (not buying it just because you got a tip as an SMS or email).

Also look into some risk-free long term investment like Public Provident Fund and Sukanya Samriddhi Yojana (if you have a daughter).
Start spending less – Money saved is money earned. Period. If needed, retrospect objectively on where your income is mostly spent and if that expense can be reduced in any way (maybe better planning) then that should be addressed. In the long run, this will definitely have an impact on your financial situation.
Automating the investment – Most of the banks provide automatic debit for deposits, for mutual funds there are SIPs. When you have facility to put your investment in auto-pilot then why not use it. In fact plan your auto-debit in such a way that in the starting of the month itself money is debited and you don’t see a swell account which may urge you into any unwanted indulgence.
Diversify – Never keep all your eggs in one basket, there are so many vistas for investors – equities, mutual funds, bonds, fixed deposits, real estate, gold, silver to name a few.
Even if your preferred investment is equity there itself there is scope for diversification in form of large caps, mid caps, small caps, sectors. Same way in mutual funds you can create a portfolio of few funds spread among large cap, mid cap, hybrid, multi-cap, debt funds.

Some money in gold and silver also makes sense but that shouldn’t be your primary form of investment.
Stay invested for long – Ride the tide, there will be periods of despair and there will be periods of euphoria. Experience it all, stay invested, don’t run away !!
Every time of despair is an opportunity to average your cost, hunt for stocks which pay good dividend (If you get a stock, with good dividend yield, at a lesser price during stock market crash you have a very good chance of increasing your dividend yield for that stock).

Very few lucky or very well informed people can time the market to perfection, for rest of us it’s the discipline and long term goal.

Also don’t forget the effect of long term compounding as stated in point 1.
Be informed, be flexible – If I have influenced you to stay invested for long I’ll also stress on the point of being informed and be flexible. Be informed about what is going on around you that may give you a good idea about the emerging sectors and the first mover advantage. That will also give you an idea about what is not working. With that knowledge you are well equipped to revise your investment strategy. Being flexible is as important as staying in the game. Sometimes not cutting your losses at the right time may harm you in a big way. So big flexible, accept what is not working try to get rid of non-performing investment before they become a burden you can’t get rid of.

That's all for this topic Investment Habits to Help You Build Wealth. If you have any doubt or any suggestions to make please drop a comment. Thanks!