How does inflation affect your investment

Come every friday morning, you get to see inflation numbers in bold figures in the newspapers and television channels. So how does inflation affect a common man and its investments? So lets understand inflation and its impacts.

What is inflation?

To put it in simple terms, inflation is nothing but an increase in cost of living for a person on a yearly basis.

Eg. If inflation is 8%, then theoretically a good which was sold for Rs 100 on the Same Week of a Last Year is now costing Rs 108. So inflation is not a very tricky and difficult to understand , it is as simple as the above example.
If the Inflation is 0 % it means that the good sold now are at the same price of last year. No marginal growth for retailers.

How does inflation affects investments?

Inflation reduces the purchasing power of money. 100 rupees can purchase you more last year than what it can purchase as per the last example (8% inflation).

Inflation also erodes investment. Lets see this with an example.

Eg. Robert invests Rs.1,00,000 in a bank FD fetching him 11% interest rate on yearly basis. Robert is in a income tax bracket of 20%.At the end of one year, he gets back Rs.1,11,000 and he pays 20% of 11,000 as tax.

Amount Invested = 1,00,000
Maturity Amount = 1,11,000
Interest Earned = 11,000
Tax on Interest @ 20% = 2,200
Amount in Hand = 1,08,800

Interest Earned = (8,800/1,00,000) * 100 = 8.8%

If the inflation prevailing is 7%, then

Real rate of return/Inflation adjusted return = 8.8% - 7% = 1.8%

This implies value of money at your hand has increased only by 1.8% and not by 11% or 8.8%.

As we can see in the above example, inflation erodes the return from our investments significantly.


How to reduce the impact of inflation?

We should choose a mix of investment instruments, so that the collective return out of our investment should beat inflation by a good margin of (8-10%) so that real value of our money increases in a significant manner.

Lets rework the same example above by splitting across two investment instruments - debt and equity invested for 12 months or 1 year.

Amount to be invested = 1,00,000
Amount invested in equity = 50,000
Amount invested in debt = 50,000

Interest earned in debt = 11% (or) 5,500
Tax on interest = 20% (or) 1100
Interest - tax = 4,400
Interest earned in equity = 20% (or) 10,000

Total Interest Earned = 14,400 (or) 14.4%

Inflation = 7%
Real rate of return = 14.4% - 7% = 7.4%

So the inflation adjusted return has increased from 1.8% to 7.4% by reallocating the amount in two different modes of investment. The returns mentioned are assumptions, you need to reallocate the %age of amount in each asset class based on interest available during your investment period.

How to calculate your PF balance

There are some savings that we make without our knowledge. Sounds surprising? but that's what is the reality. An employee in an organized sector have mandatory savings like PF,Employer Pension Scheme,Superannuation,Gratuity. From our monthly gross salary, we make a significant contribution to all four of these. Lets see how much we are saving each month unknowingly in a provident fund.


Provident Fund

For all employees who work in an organized sector, following is the PF contribution every month :-

PF contribution by Employee = 12% of basic salary.

PF contribution by Employer = 12% of basic salary.

Employer Pension Scheme

Out of 12% contribution from employer, 8.33% of the contribution (subject to maximum of 541 Rs/month) is invested in employer pension scheme.

Lets take an example and understand this.

Ram's basic salary per month = 15,000

Ram's contribution to PF = 12% of 15,000 = 1,800

Ram's Employer contribution = 12% of 15,000 = 1,800

Employer's contribution to EPS = 8.33% of 15,000 = 1250

This 1250 is higher than the max limit of Rs 541/month and hence

Employer's contribution to EPS = 541

Employer contribution to PF = 1800-541 = 1259

So Total PF contribution to Ram's PF account per month = 1800 + 1259 = 3059


How to calculate your PF balance?

Lets say Ram worked in a firm from April 2007 to March 2008.Let us find out what is his balance as on April 1st 2008.

Interest Rate on PF account = 8.5% (fixed by central govt)

So monthly contribution of 3059 for one year @ 8.5% = 39,828 /-

So in this way you can calculate your return for 'n' number of years for your PF contribution, provided you know your monthly contribution.

Happy Investing !!!

Revisit on National Pension Scheme (NPS)

What is NPS ?

You can regularly invest your money in this and get a lump sum at your retirement and a fixed monthly income for the lifetime . It will work almost the same way as Private Pension Schemes .


Features

- No upper limit of Investment
- Minimum limit of 6,000 per year (Rs 500 per month).
- Annual Fees of .00009% (90 paisa for Rs 10,000) for Manging the fund.
- Tax benefit under sec 80C .
- Any Indian citizen between 18 and 55 years can invest in NPS .


NPS Bodies

- Regulator : The one who will regulate the NPS System .
- Fund Managers : Who will invest the money
- Point of Presence : Responsible for Sales and Marketing .
- Central Record Keeping Agency : Responsible for all the document Keeping work (Record Keeper)


Who will Regulate NPS ?

PFRDA (Pension Fund Regulatory and Development Authority) will monitor and regulate all the activities under NPS . It checks how your money in invested and makes sure that the fund managers are following the rules and guidelines . Its just like "SEBI for Stock Market" .


Who are the Fund Managers ?
There will be 6 Fund houses appointed by Government to manage the funds under NPS . You can choose any one of them to be your Fund Managers . They are :

1. SBI Pension Funds Private Limited.
2. UTI Retirement Solutions Limited.
3. ICICI Prudential Pension Funds Management Company Limited.
4. Religare Pension Fund Limited.
5. IDFC Pension Funds Management Company Limited.
6. Kotak Mahindra Pension Fund Limited.

They will take all the decisions of where the money received under NPS should be invested in the best possible way considering all the rules and regulations set by PFRDA.


Who are Point of Presence ?

The following entities have been approved by PFRDA for appointment as Points of Presence (POPs) under the New Pension System for all citizens other than Government employees covered under NPS .

1. Allahabad Bank
2. Axis Bank Ltd
3. Bajaj Allianz General Insurance Co Ltd
4. Central Bank of India
5. Citibank N.A
6. Computer Age Management Services Private Limited
7. ICICI Bank Ltd
8. IDBI Bank Ltd
9. IL&FS Securities Services Ltd
10. Kotak Mahindra Bank Limited
11. LIC of India
12. Oriental Bank of Commerce
13. Reliance Capital Ltd
14. State Bank of Bikaner & Jaipur
15. State Bank of Hyderabad
16. State Bank of India
17. State Bank of Indore
18. State Bank of Mysore
19. State Bank of Patiala
20. State Bank of Travancore
21. The South Indian Bank Ltd
22. Union Bank of India
23. UTI Asset Management Company Ltd


Who will be the CRA ?

As per the website of PFRDA there is a Contact of negotiation is underway and NSDL/CSDL is expected to be appointed as the CRA.


Investment Options and Structure
- Risky option : The higher allocation in this option will be in Equity .
To decrease the risk , Equity Investment is allowed only to invest in Index funds which tracks Sensex or Nifty . Also the equity exposure is caped at 50% .

- Moderate : IN this options Main exposure would be Corporate debt and Fixed income securities with some exposure in Equity and Govt securities . It will be moderately risky and rewarding .

- Safe : In this option mainly the investment will be done in Govt securities , and very little will be invested in Equity .

There will be a Default option, under which the allocation will be decided as per your age, where Equity Allocation will be high in the start and then it will come down as your age increases . You can also decide your own asset allocation as per your Risk appetite


Cost

There are different kind of Costs in NPS .

- Fund management charges of .0009% per Annam , which is excellent if compared to ULPP's or Mutual funds charges .

- Annual Maintenance charges of Rs 350 and Rs 10 per transaction to CRA (soon , it will be Rs 280 per year , Rs 6 for per transaction) .

- Rs 40 for registration with PoP and Rs 20 per transaction with them .

- There are other small costs too , lets leave it for now .



Now we will see some NEGATIVE points about NPS

1) Taxation Issue
Sadly , As per the current law, the amount received at the end from NPS would be taxable , PFRDA is trying hard with govt to exempt the tax. You will get the 80C benefits on the amount invested in NPS .
Though I assume Govt will make the returns TAX FREE. But till that time we have to wait and watch.
You may have to pay the TAX on your monthly retirement income !!!

2) Not Fixed Income
Though this is called Pension scheme, It actually did not meant a fixed monthly income after retirement. The monthly income may vary from month to month. Or it may happen even for couple of months you may not get any income.
So don't think that you will get fixed monthly Income upon retirement !!!

3) NPS is not at all risk free
This is Defined Contribution scheme and NOT Defined Benefits scheme. So the Risk/Reward is totally bourned by Investor. Government is just to set the regulation on how to manage the funds.
NPS is not at all risk free !!!

4) Conscious decision while choosing FM
The income depends on the Fund Managers that one chooses. As investor has to choose one Fund Manager between 6 appointed Fund Managers. So returns will vary from one FM to other FM depending on how he generates the income for you.
Your returns depends on the Fund Manager that you chooses !!!

5) Not with drawable
Currently NPS is launched with Tier-I plan. In this you cannot withdraw your investment till retirement. After six months NPS Tier-II will be launched, In tier-II you can withdraw partial amount.
Wail till NPS Tier-II is launched !!!

6) Few questions still left unanswered
PFRDA site has given following information about death of PRAN holder.
The amount can be disbursed as pension to SPOUSE of PRAN holder. But what if Spouse also passes away. There is no clear answer for what will happen to the corpus amount left. Will that be given to family members especially children as lump sum or on a monthly pension format? No Idea !!!
Many questions still unclear !!!



If you want to have STRICTLY fixed monthly income after your retirement, This scheme is not for you. Better go for PPF. If you have surplus amount left after you invested in PPF, you can go for this NPS scheme.

I assume over a very longer term (20 years) you will get more profit in NPS compared to PPF.

Tax Planning: Sec 80C

Sec 80c - The most loved Tax Planning Tool

Of all the sections that offer you tax breaks, Section 80C tends to be most popular, since you get an exemption of up to Rs 1 lakh on contributions to a wide range of investments. Given below are the various options under this section.

• Provident Fund, Public Provident Fund
• You get an assured return of 8% per year on your deposits, which is also exempt from tax
• Remember: Money locked in for at least six years in PPF. PPF are desinged for 15 years lockin
  

• NSCs and 5-year bank FDs
• Assured return of 8-9%. In case of NSCs, the cumulative interest earned every year gets further tax deduction because the interest is deemed to be reinvested
• Remember: Interest is fully taxable. Also, your money gets locked in for five-six years
  

• Life insurance policies
• You get insurance cover and tax breaks on premiums paid, plus all income received is tax free under Section 10D
• Remember: Traditional policies currently give annualized return of only 4-5%
  

• Ulips
• Market-linked returns. Combines insurance with investment. Partial withdrawals are allowed after three years and are tax free
• Remember: Ulips levy high charges of 30-40% of annual premium in initial years
  

• ELSS mutual funds
• Market-linked returns. No entry load on direct investments
• Remember: Withdrawals are allowed only after three years and are tax free
  

• Pension plans
• 33% of the corpus can be withdrawn tax free when the plan matures
• Remember: Money locked up for long term. On maturity, at least 66% gets invested to give monthly taxable pension
  

• School fees
• Fees paid to a recognized school or college (playschools do not qualify) gets tax deduction
• Remember: Tax benefits on fees for only two children
  

• Home loan Principal repayment (Interest part comes under different category)
  
• Especially helpful for taxpayers who don’t have investible surplus to save tax because of large home loan EMI
• Remember:Tax benefit only if the house is self-occupied. Can’t claim benefit along with HRA exemption. But if your job involves constant transfers, then you can claim both HRA exemption and the exemption on Home Loan provided you have bought the house in your permanent place of residence.
  

Extraaa Innings on PPF

Few extra things to understand on PPF

1. The tax saving limit under section 80c is 1 lakh and you can invest 1 lakh. For this you have to open account in the name of your spouse or child. You can save 70,000/- in your account and 30,000/- in other account.

2.The time of 15 years is excluding the FY in which you opened the account so in total the time is 16 years.

3.After 16 years also you can continue with the same PPF account and the extension will be in the phases of 5 years each and you can get extension as many times as you want.

4.In case for few years you don't pay minimum Rs Rs 500/- which is to be paid every year, your account is considered as inactive but you can get it activated by paying penalty of Rs 50/- for the no. of years for which it remained inactive along with 500/- deposit.

5.If you keep on depositing Rs 70,000/- every year till maturity period, and as the deposit will attract 8% interest, so you end up getting 21 Lakhs at the end of maturity period.

Till that time you would have paid Rs 70000 for 15 years. So Total payout = 10 Lakhs 50 Thousands Only.