Investing in credit opportunities mutual funds? Know the risks first

Source: The Economic Times

Several funds in the category have clocked more than 10% return over the past one year.

With the central bank signaling a neutral interest rate stance in its latest monetary policy review, the rally in gilt funds has petered out. They have been knocked off their perch by credit opportunities funds, which have emerged the top performers in the debt funds space over the past one year. The category generated an average return of 9.6%.

Gilt funds and credit opportunities funds play on different aspects of the bond market. The former invest in longer maturity government securities that witness high capital appreciation in a softening interest rate environment. The latter focus on interest accrual— the income from coupon payments on underlying bonds—and typically invest in corporate bonds with a higher yield but lower rating (AA or below).

Credit funds can also make some returns from capital gains, by looking for mismatches in the current rating of a bond vis-a-vis its fundamentals. If the credit rating of the underlying bond gets upgraded, due to the improving fundamentals of the underlying company, it results in appreciation in the bond’s market price, boosting the fund’s return. However, this tends to account for a smaller portion of the total return from these funds.

The cost of higher returns

With the interest rate easing all but over, the performance driver for debt funds has shifted from bond price appreciation to income accrual. Besides, what has worked in favour of credit funds is the lower volatility in returns, compared to gilt funds.

Several funds in the category have clocked more than 10% return over the past one year. However, they have taken greater risk to generate these returns, as is indicated by their exposure to lower-rated instruments (see table). BOI AXA Corporate Credit Spectrum and Franklin India Dynamic Accrual have invested 45% and 51% of their portfolio, respectively, in bonds rated ‘A and below’.

HIGHER RETURN, MUCH HIGHER RISK

In a bid to generate higher returns, several credit funds have increased exposure to lower rated bonds. 

Source: Value Research. Data as on 4 Sep 2017

The category’s average exposure to this segment is around 31%. But while BOI AXA has also taken a healthy exposure of 22% in high safety AAA-rated bonds, Franklin India Dynamic has negligible investment in this segment. AAA rating indicates highest level of safety (little risk of default), while A and lower rating signifies a much higher default risk.

Baroda Pioneer Credit Opportunities has loaded up on relatively safer AA rated instruments, comprising 56% of its portfolio, compared to the category average of 50%. Meanwhile, Aditya Birla Sun Life Corporate Bond holds around 40% of its portfolio in AAA-rated instruments—peers’ holdings in the segment is just about 20%.

Why credit quality is a concern

The composition of the underlying portfolio of credit funds assumes great significance in the light of numerous instances of corporate loan defaults and credit rating downgrades. When underlying bonds witness rating downgrade, their price falls sharply, eroding the overall return from the debt fund. Companies may face ratings downgrade owing to deteriorating fundamentals—usually high debt levels and limited traction in cash flows.

Recently, companies such as IDBI Bank and Reliance Communications have seen ratings downgrades. With the credit profile of debt- riddled firms remaining weak, credit funds, in their bid to deliver high returns, are playing a high-risk game. “Many credit funds are now carrying higher credit risk than they started with or intended to carry a few years ago,” says Roopali Prabhu, Head, Investment Products, Sanctum Wealth.

The corporate credit upgrade downgrade ratio remains unfavourable. The terms and conditions governing these bonds have become more complex. And the liquidity position in these funds remains untested in the event of redemption pressure, Prabhu adds. Although credit opportunities funds are mostly immune to unfavourable yield movement, the risk of default in underlying companies continues to be high.

“Unlike in other categories, like dynamic bond funds, the risk is far less visible in credit opportunities funds. In the event of a default, the hit may be significant,” cautions Vidya Bala, Head, Mutual Fund Research, FundsIndia. Investors should not get swayed by the higher returns being offered by this segment.

Lack of opportunity in traditional debt funds that play on interest rate movements does not warrant a complete switch to the credit funds. If you wish to play the credit risk, avoid going for the overly aggressive funds that chase higher yields with concentrated exposure in very low rated instruments. “If already invested in credit funds, rebalance in favour of cleaner credit at this juncture,” says Prabhu.

Personal finance thumb rules to help kick-start your financial planning

Source: The Economic Times

Rules of thumb may come in handy for those who are just beginning their financial planning. Youngsters who have just started their career may get some direction on where and how to make a beginning. For those who are in the middle of their career and don't yet have a proper plan in place, thumb rules can also be helpful. But remember, they only provide a general direction and may not necessarily give you the exact picture.

First rule first
The very first rule of personal finance says: 'Pay yourself first'. It simply means that out of your monthly income, a certain percentage has to be saved before it is spent. 'Income minus savings equal to expenses' should be the rule and not vice-versa.

For this to happen properly, identify your goals, estimate the inflation-adjusted requirement and then find out how much you need to save for them. Now make sure that each month funds move out from your salary towards your goals, and manage your household expenses with what is left. You, in a way, are first paying for yourself, i.e., your goals.

How much to save
As a rule, 10 per cent of the post-tax income of those starting their career at around age 25 can be the starting point. Over time, as the income increases, shoring it up to 15 per cent can give you a good head start and a buffer. As you grow older, and your income rises and financial liabilities add up, make sure you are saving enough towards your goals. In middle age, saving at least 35 per cent of your post-tax income should be the benchmark, as expenses during this period typically increase.

The 50-20-30 Rule
Confused about how much to save and spend each month? Here's how to get started. It's the 50-20-30 Rule, i.e., 50 per cent of your income should go towards living expenses, i.e., household expenses, including groceries; 20 per cent towards savings for your short, medium, long-term goals; and 30 per cent towards spending, including outing, food and travel. The idea is to create outflow buckets for better control. Individuals may tweak the percentage according to their age, circumstances, etc.

The 20/4/10 Rule
This rule helps keep your finances under control when you're buying a new car. Twenty stands for the down payment amount, as 20 per cent of the car price should be paid by you. It's, however, better to make as much down payment as possible. Four stands for the number of years of financing. Although lenders have tenure of up to 7 years, it's better to stick to 4 years. Ten stands for the ideal percentage of your net-take home salary that should go towards car loan EMIs.

Emergency fund
As the name suggests, an emergency can happen anytime and needs immediate action. There could be a setback to one's earning capacity due to a temporary disability or being unemployed for a few months. A medical emergency may crop up at a time when the settlement claim is taking time, or the ailment itself may have a waiting period. In such cases, one may have to arrange for funds to tide over the situation. Whether it's meeting the household expenses or honouring commitment towards EMIs, certain cash outflows are sacrosanct. An emergency fund is not aimed at meeting your planned goals, but it only acts as a safety net.

Although there's no fixed rule on how much emergency cash one would need, ideally 3-6 months' household expenses should be one's emergency fund. The amount should help you to combat financial emergencies.

Life cover
You should ideally have a life cover which is at least 10 times of your annual income. The actual requirement may, however, depend on one's age, goals to be achieved, financial dependents, accumulated wealth, etc.

The most cost-effective way of buying life insurance is through a pure term insurance plan. It is a low premium, high-cover protection plan where the premium goes entirely towards risk coverage, i.e., to cover the mortality risk. Therefore, on surviving the term, one doesn't get anything back as there is no savings portion of the premium. But that should not deter someone from buying a term plan as risk cover through life insurance as it is one of the basic necessities in one's overall financial plan.

How much to save for retirement
Most financial planners suggest a retirement corpus target which is about 20 times of one's annual income. Some feel that 30 times can be a better figure as it will take care of inflation. It gives you a reason to work backwards and estimate how much you need to save from today till you retire.

Still, this rule may leave you disappointed as it takes income and not expenses into account. Also, it may work for those whose retirement is years away than those who are retiring soon.

House price
By keeping three things into consideration, i.e., the take-home income, the down payment amount and the home loan interest rate, one can figure out the worth of the house that one can afford to buy. If one is buying a home with a down payment of 20 per cent and the rest on a home loan, and also keeping the income-to-EMI ratio in mind, the affordability arrives at about 4.5 to 5 times of one's annual income. In other words, one is buying a house which costs about five times of his income. Therefore, when real estate prices go up, affordability becomes a concern, unless income also moves in tandem.

Home loan
Before lending, the lender finds out the borrower's existing loan commitments. Banks don't lend an amount on which the EMIs will be more than 45-50 per cent of the monthly take-home pay. And this includes any other existing EMIs on car or personal loans.

Ranjit Punja, CEO & Co-founder, CreditMantri, says, "Monthly EMI on the home loan should be less than 30% of monthly income. Total EMI obligations (home plus others) should ideally be less than 50% of monthly income."

But what if the existing loan is nearing completion? Satyam Kumar, Co-Founder, Loantap, says, "Loans where only 12 or less EMIs are pending are not factored towards loan eligibility, so you get higher eligibility." The income-to-EMI ratio should be close to 50 per cent and not higher else a lesser loan amount gets sanctioned and it might disturb your household cash flows.

Also, a high credit score may not necessarily be enough for securing a loan on the best terms and conditions. Punja says, "Ensure that your credit score is 750 plus so you can get the best terms."

How much to invest in equity
It's often said that one must use the '100 minus age' approach as far as investing in equities goes. So for a 30-year-old, 70 per cent of his investible surplus should be in equities, while the rest in debt. As one ages, the allocation towards equities falls as it is considered more volatile than debt. It could be a good way to begin but over time, allocation into equities will depend on the tenure of your goals. For long-term goals such as retirement, being aggressive in equities will help, till at least three years before retiring.

Net worth
The authors of the book The Millionaire Next Door had framed this rule to arrive at the required net worth. The net worth, according to them, should equal your age multiplied by your pre-tax income, divided by 10. That number, minus any money that you inherit, should be your net worth for your age and income.

So if you're 40 and make Rs 20 lakh a year, you should have a net worth equal to Rs 80 lakh, assuming you have no inheritance. If you want to secure your position as wealthy, your net worth should be double that number.

Remember, your net worth is your assets minus your liabilities, and your assets include not only your cash, investments and home equity, but also tangible property such as jewellery and furniture. Your house remains a contentious issue as far as adding it to the net worth figure goes. So it's better to exclude it while calculating your net worth, unless you are ready to move to a smaller house in future.

Diversification
When it comes to mutual fund schemes, investors are known to hold a many as 30 different ones. Over-diversification may not necessarily help in obtaining the right result for the portfolio. J.L. Evans and S.H. Archer have shown in their research that most diversification benefits are obtained with about 10 funds. Adding more funds still provides benefits, but the gains seem marginal compared to the drawbacks of managing the enlarged portfolio.

Rule of 72
To calculate the number of years in which your investment will double -- it is known as the rule of 72 -- simply divide 72 by the rate of return that you can generate.
So at 12 per cent return, you can double your money in six years. No. of years = 72/12 = 6.
To know the time required to triple the principal amount, the rule of 114 is used.
The amount of time needed to triple your money would be = 114/12 = 9.5 years.

Rule of 72: Number of years to double = 72/expected return.
Rule of 114: Number of years to triple = 114/expected return.
Rule of 144: Number of years to quadruple = 144/expected return.

Conclusion
There's no 'one size fits all' approach. Your finances need to be personalised according to your risk profile, situations, etc. Once you have made a start using the thumb rule, it is important to review things over time and make any changes to your plan accordingly.

PF withdrawal Rules and Regulations

Source: Bank Bazaar. Com

EPF and EPFO

The Employee Provident Fund (EPF), administered by EPFO (Employee Provident Fund Organization, a statutory body under the labor ministry, ministry of finance), helps employees save a small fraction of their remuneration every month and thereby, build a corpus which is tax exempt for use in the fag end of their lives or retirement. Albeit, EPFO is a long-term savings tool, primarily aimed for a stress-free retirement, salaried employees may choose to withdraw their money in their EPF account to cater to different financial requirements or at the time of any major life events such as weddings, home renovation/alteration and medical treatment among others. All organisations which have employed more than 20 employees should compulsorily register with EPFO. To make the optimum use of the EPF account, salaried employees must be aware of what a provident fund account entails and how it is operated.

Employee Provident fund (EPF)

It is important to note that 12% of the basic pay of a salaried employee (in addition to dearness allowance and cash value of food allowances, if any) is deducted from his or her remuneration on a monthly basis as contribution towards an EPF account. However, from the employer’s contribution, 8.33% is deposited in the Employee Pension Scheme (EPS) while only 3.67% is deposited in the EPF account. The current rate of interest (for financial year 2015-16) for an EPF account is 8.7% p.a. The rate of interest is subject to change every year, as announced every year by EPFO.

EPF account withdrawal: Procedure

If salaried persons wish to withdraw their EPF accounts, they have to submit form 19 to their ex-employers, who in turn, have to sign and attest it. To complete the withdrawal procedure, members have to submit various other documents, namely, resignation letter and a cancelled cheque in addition to form 19 to the EPFO.

EPF withdrawal rules

It is important to note that withdrawal of the EPF account by a salaried employee between switching jobs his or her jobs is illegal. As per PF withdrawal rules, a salaried employee can withdraw a provident fund account on two counts; first, if he or she has no job and second, if two months have elapsed since his or her last employment (not attached to any organization or unemployed for 2 months). Nevertheless, there are cases wherein employees - assuming a cumbersome claims process- may withdraw their EPF account at the time of leaving an organisation. However, apart from the legal angle, experts do not recommend following the aforementioned practice from the perspective of financial management as well in that a salaried employee cannot avail of several benefits of maintaining a provident fund account including tax-free interest, annual compounding and compulsory long-term savings among others. Experts, therefore,, advice employees to instead transfer the EPF balance in their previous employer’s account into the account of their current employer. However, the government of India’s Unique Account Number or UAN simplifies the procedure (management and transfer) given that it is allotted to all salaried employees and will not change throughout their careers. Salaried employees will, therefore, not be provided a new account number when they hop jobs or companies.

EPF withdrawal rules: Purposes

Salaried employees may withdraw money from their EPF accounts for various purposes, subject to certain conditions. Individuals have to furnish several documents in addition to meeting the eligibility criteria as per epf withdrawal rules. The list of purposes and quantum of contribution which can be withdrawn are listed below:

Marriage A salaried person can withdraw for self, siblings and children. He or she should, however, have completed a minimum of seven years of service to withdraw 50% of contribution (thrice in a career).

Medical treatment A salaried person can withdraw up to either six times of his or her monthly salary or total corpus towards medical treatment of self, parents, spouse and children.

Construction/Purchase of plot If a salaried person wishes to withdraw from an EPF account for the purpose of either construction or purchase of a plot, the property must be registered in his or her name, spouse or be jointly held. A minimum of five years of service is required to withdraw an amount which is 24 times the salary of the account holder. For construction of a house, 36 times of the salary of an account holder can be withdrawn. It is important to note that withdrawal for said purpose can be done only once during the service of an account holder.

Home Loan Repayment If a salaried person wishes to withdraw from an EPF account for the purpose of home loan repayment, the house should be registered in his or her name, spouse or be held jointly. A minimum of 10 years of service is required to withdraw up to 36 times of the salary of an account holder.

House renovation/alteration If a salaried person wishes to withdraw from an EPF account for the purpose of house renovation or alteration, the house should be registered in his or her name, spouse or be held jointly. A minimum of five years of service is required to withdraw about 12 times of the monthly remuneration of an account holder.

Retirement An individual must be 54 years old to withdraw up to 90% of the corpus of his or her provident fund account.

Miscellaneous Individuals can choose to withdraw from their EPF account for various other reasons such as premature retirement as a result of any physical or mental disability, migrating abroad for the sake of better employment or settling down in a foreign country.

EPF withdrawal amount: Taxation

If a salaried employee opts for withdrawal after continuous service of five years or above, there will be no TDS deduction on the amount. It is important to note that if withdrawal is made before the completion of five years of continuous service, the amount withdrawn will be taxable. According to newEPF rules announced by the finance minister in budget for financial year 2015-16, EPF withdrawal (taxable) will attract TDS deduction at the rate of 10% (in cases of registered PAN) or up to a maximum of 30% (in cases of unregistered PAN). However, no TDS will be deducted if the withdrawal amount is under Rs.30,000. It is important to note that an individual can submit form 15G during the time of withdrawal if his or her income is less than the basic exemption limit even after the addition of the provident fund withdrawal amount. If a subscriber does not submit his or her PAN, TDS will be deducted at 34% on his or her withdrawn amount. If salaried persons want to avoid TDS, they can submit form no. 15H (senior citizens) or 15G for amount up to Rs.3 lakh and Rs.2.5 lakh respectively (both the said forms are declaration forms which can be used by employees whose income is less than the taxable amount). It is important to note that there will be no TDS deduction in cases of transfer of a provident fund account and termination of an employment contract as a result of failing health (employee), cessation/discontinuation of a business venture (employer) or any other cause which may not be in the domain of an employee.

EPF account withdrawals: Grievances

The Consumer Protection Act encompasses a detailed procedure to resolve various grievances of EPF account holders. An individual or member can log on to the official website of EPFO at www.epfigms.gov.in and click the tab ‘register grievance’. A member can register all kinds of grievances vis-a-vis withdrawal of EPF account, insurance benefit (payment), scheme certificate, transfer of the account, cheque misplacement and PF balance issuance among others.

EPF online direct withdrawal facility

All cumbersome paperwork related to withdrawal of EPF account may be a thing of the past. EPFO aims to launch an online facility for PF withdrawal in 2016. EPFO, which currently has over five crore members, is planning to settle PF claims in three hours after receipt of a withdrawal application (online application will be transferred to the bank accounts of subscribers). To the end, EPFO has become UIDAI’s registrar. While around 92 lakh subscribers provided their Aadhaar numbers, EPFO verified around 64 lakh numbers so far (as of October 2015) for linking it with UANs.

Tax Benefits of National Pension Scheme ( NPS)

Source: Bankbazaar.com

The New Pension Scheme (NPS) is regulated by the Pension Fund Regulatory and Development Authority (PFRDA). NPS is a marked-linked product and therefore, offers returns based on the fund performance. NPS, introduced in 20014, was initially aimed at government employees but was subsequently extended to all citizens in 2009.

Tax Benefits

Finance minister Arun Jaitley, in his budget speech for financial year 2015-16, announced an additional deduction of Rs.50,000 for new pension scheme. As a result, citizens who are in the highest tax bracket (30%) and thereby save Rs.16,000. The new extra deduction announced will take the total deduction allowed in the scheme under section 80C and 80CCD of IT Act, 1961 to Rs. 2 lakh. It is important to note that contribution to the new pension scheme up to Rs.1.5 lakh is not taxed. The new pension scheme has two tiers, namely, tier-I and tier II accounts. While a subscriber cannot withdraw from the tier-I account which is primarily structured for retirement savings, he or she can avail of tax benefits in tier I accounts.

However, tier II account can be opened by a subscriber only if he or she has an active tier I account. A subscriber can withdraw from the tier-II account according to his or her financial requirements. Tier-II account is, therefore, akin to a savings account in many ways. Unlike a ULIP, subscribers in the new pension scheme have the option to choose from various pension fund managers. Subscribers can also shift from one pension fund manager to another one in a year. It is important to note that there are no tax implications when an investor shifts his or her pension fund manager.

Tier I account and tax benefits

Given that a tier-I account under the new pension scheme is primarily aimed at providing post-retirement benefits to the investor and does not allow any withdrawals, it is eligible for various tax benefits. On the other hand, Tier-II account does not allow any withdrawals and does not offer any tax benefits, you can use NPS calculator to get an estimate of your scheme amount

Tier 1 account offers various tax deductions as listed below:

Rs.1,50,000 as per section 80CCD(1)(section 80C) The deduction which may be claimed has to be minimum of 10% of gross income (in case of a self-employed taxpayer) or 10% of salary (in case of the taxpayer being an employee) or Rs.1,50,000.

Rs.50,000 as per section 80CCD(1b) (budget 2015 offers additional tax benefit under section 80CCD of the Income Tax Act,1961). Investors can, therefore, avail of (maximum) a tax benefit of Rs. 2 lakhs.

10% of basic salary + dearness allowance as per section 80CCD(2). An employer’s contribution can be shown as deduction under section 36 I (IV) from business income. The minimum deduction claimed should not be above 10% of the salary while there is no limit in terms of the maximum amount. The deduction applicable as per section 80CCD(2) is, therefore, over and above Rs.1,50,000 as per section 80C and 80CCD(1).

New Pension Scheme and EET system

The new pension scheme fall into the category of the EET (exempt-exempt-tax) system in that contributions are eligible for deduction, withdrawals are fully taxable while returns are exempt from tax.

Self Assessment Tax Explained in FAQ's

1.What is Self Assessment Tax?

Self Assessment tax means any balance tax paid by the assessee on the assessed income after taking TDS and Advance tax into account before filing the Return of income.

2.Who are all liable to pay Self Assessment Tax?

All taxable Individuals and Corporates are liable to pay Self Assessment Tax.

3.When should the Self Assessment Tax be paid?

There are no specific dates to pay Self Assessment Tax. (Non payment of Self Assessment Tax and non filing of the returns within the due date of filing i.e., 31^st July will fetch Interest u/s 234)

4.Why should Self Assessment Tax be paid?

The Tax liability is computed after taking the various deductions & exemptions into account. If the Total Tax Paid (total of TDS & Advance Tax) is less than the Total Tax Liability, it means we owe the balance tax to the government. This has to be paid as Self Assessment Tax.

5.What is the procedure for paying Self Assessment Tax?

Direct Mode of Payment:

Self Assessment Tax can be paid by filling a Tax Payment Challan, ITNS 280. Challan, at designated branches of banks empanelled with the Income Tax Department.

Online Mode of Payment :

Assessee could pay Self Assessment Tax Online through the NSDL website, or Click on this linkhttps://onlineservices.tin.egov-nsdl.com/etaxnew/tdsnontds.jsp

a.Then select Challan No./ITNS 280(Payment of Income Tax & Corporation Tax)

b.Select Tax Applicable as (0021 – Income Tax – Other than Companies)

c.Select Assessment Year (eg. If FY 2014-15, then AY is 2015-16)

d.Then select type of payment as (300) Self Assessment Tax, and fill rest details.

e.Online Payment is allowed only by Net Banking & not by Credit/ Debit cards.

f.Select the correct assessment year

g.Fill in the form and click “Proceed”

h.Fill in the Tax Details

i.Enter the Tax payable amount

j.Confirm & Proceed

6.What if an individual fails to pay Self Assessment Tax?

Income Tax Returns can be filed only if we have paid the Tax due to the government. Further, non payment of Tax is a criminal offence and the individual is liable to be penalized & punished under the court of law. Moreover, Interest will get added to your tax liability till the date of payment of tax.

7.How do an individual know if he/she has already paid Self Assessment Tax?

Once you have paid the Self Assessment Tax, it will reflect on your Form 26AS within 2-3 days of making the payment.

8. What would happen if a person has wrongly paid his/her Self Assessment Tax, instead of Assessment Year 2015 – 2016, they have selected 2014 – 2015?

Selection of wrong Assessment Year while paying tax will result in demand for the amount of tax to be paid for that respective year. It can be corrected through Challan Rectification Process. Please Contact us for further details.