Non-convertible debentures (NCD) and yield to maturity(YTM)

Non-convertible debentures or NCD are company fixed deposits, basically it is like you are giving a loan to the company, in return the borrowing company pays you interest on the capital.

Even though NCD’s are like fixed deposits in a financial institution, they are not completely risk-free. So one must check the CRISIL rating and company history, company balance sheet and past company record before investing in NCD’s. Normally NCD’s come with a maturity date and a rate of interest (referred to as coupon)

NCD’s are listed in the stock market as well so these are highly liquid in nature. One can trade NCD’s on the stock exchange.

Yield to maturity(YTM) is the return rate of interest which the investor will receive, if the NCD is held until maturity. Normally the interested accumulated is re-invested so the YTM compounds over time.

A rule of thumb is to choose a NCD which has a AAA CRISIL rating and invest only if the YTM is more than the FD rates in public financial institutions.

Any income earned from NCD’s are taxable at a fixed rate of 10% (with indexation) if sold after 1 year of holding. If sold in the same financial year then the profit is added to the taxable income and tax charged will be treated as per the income slabs.

  

Income tax and tax-saving instruments

The government takes away little of what we earn to create a working capital by imposing income tax on taxable income of individuals. The government deploys this working capital, diversifying this in various sectors as needed to run the country’s expenditure. With the money they collect, the government provides at least but not limited to police services, border security, hospitals, roads and railways, housing for the needy, cleanliness of city, service job creation, manages import and exports and creates emergency/contingency funds.

The government creates budget forecast on the budget day for the next financial year, in anticipation that they will collect enough tax revenue, so as to be meet the country’s expenses. There is always a risk involved as the government is forecasting for tomorrows needs based on today’s assumptions.

Paying income tax is obligation of every individual who earns more than the minimum taxable income as announced in the financial budget.

Income tax is levied on taxable income of the individual. The government has created instruments to stifle the taxable income, a smart investor should deploy these instruments to reduce his/her tax burden.

There are lot of instruments available like tax-saving bonds, tax saving Fixed Deposits, National Saving Certificate, Public Providend Fund, Post Office Scheme, ULIPs, ELSS, Employer's Providend Fund, Life Insurance. Each instrument have their pros and cons, so one should think it out before parking funds in any of these instruments.

In spite of its non-liquid nature, I personally am very fond of the PPF and tax saving Fixed Deposits instruments.

A rule of thumb is to plan your tax-saving instruments and never leave it for the last hour. 

Future value and power of compounding

Future value (FV), as the name speaks for itself, is the value on a future specific date.Based on some formulas it is possible to find the present value (PV) of a FV.

Rate of return(r) is an important parameter to depict the FV.The formula is:

FV = PV (1+i) ^n

e.g: Invest Rs 1000 to draw interest for 20 years at 10% compounded annually

FV = 1000 (1.10)^20    = Rs 6727.50

Now if  this same was compounding quarterly (every three months) instead of annually then:

FV = 1000 (1.025)^80    = Rs 7209.56

In other words, compounding quarterly gives 7 percent more in the above example.

The power of compounding is substantial.Always opt for compounding  with quicker compounding tenure.

Risk Appetite of a indivudual

Investment is always bundled with some sort of risk, the risk level varies based on the type of investment. Ideally speaking, all capital preserving investment ought to be very safe. The investment in which capital is not preserved during the tenure normally comes with higher risk with potentially higher returns probability.

Every person needs to quality his risk appetite before making any sort of investment. Sometimes the investor is not knowledgeable enough and unfamiliar with investing, in such cases it would be best to speak to someone trustworthy who could guide in the quantification process.

Risk Appetite normally depends on age of the investor, his dependents and his financial goals.

A good investment is one in which the real rate of return is positive, looking at the inflation figures this itself is a challenge of its own.

In some cases, investors give more priority to the liquid nature of the investment rather than the risk value of the investment. For such investors PPF and tax saving FD's are not good investments as these are not liquid in nature.

Needs, wants and investments

How often do you see items ubiquitously priced in retail outlets for Rs 199/-? Is Rs 199 so much better than Rs 200/- . Amazing on how such a psychology of pricing can attract more consumers to purchase the product. How often do you get an Éclair instead of the change of Rs 1/-?. Other tricks deployed by retail outlets are “Buy one get one free” and “Second half priced”. The perception of discounts is too tempting to resist for the consumers. It is not the “need” factor but the “save” or “affordability” factor which drives the purchasing of the new generation. New strategies are being deployed by retail outlets to sell mainly targeted for the new generation. A more recent one is to unbundle the items. e.g. get a mediclaim for as little as Rs 9.95 per day.

Unlike the old generation which were driven by the “need” factor, the new generation weighs all consumables by the “afford” factor. Credit cards have now-a-days become a necessary evil, elusively adding to the “affordability” power of the individual. While probably this new generation perception of consumerism is good for the global economy and employment growth, it also creates uncalled inflation and unsustainable bubbles.

Needs and wants are different for different people. It’s up-to us to decide what they are and zero down on the needs first. While we should budget for the needs in our everyday life, the wants should be chugged only if there is enough capital to spare.

It would be equivalent to a sin to dry out your liquid capital with some unnecessary wants.Remember, every rupee spend loses with it an opportunity to invest it.

Make budgeted expense and always try to spend only on what is needed rather than what you would want to have.

Setting Financial Goals

Financial education is never thought in school and like many, I started my job without any idea of what my financial goals should be. Like most of ab-initios, I also wanted to prosper fast and quick and have more money in my hands with every passing year. But how do I wisely invest this money was something I had no clue about. But fortunately I once got hold of a book titled Financial Planning for year 2001-02 and I read this book cover-to-cover in one weekend. I was so fascinated about the book that I read the book 5 times more. Felt great, it was like I know how to grow my money (of course after I have some as a capital).

Before going into any detail about investment, the first important step is to make financial goals. Financial goals are seen as mitigation to risky situations in your life and these will protect your dependent family and self against hard crunch financial situations. They are also used as a tool to keep focussed and draw your monthly spending limits. The best way to focus on your goals is write the financial goals on a piece of paper and visit this paper every few weeks.The financial goals can be abstractly stated with timeline like I want to buy a appartment or it can also be very microscopically detailed like I want to have Rs 500000 in my bank account. Normally speaking financial goals are set for the next few coming years, but it is up to you to draw your own time horizon. Here is an example:

1-Jan-2013: Accumulate 12 shares of L&T in my demat account.

1-Jan-2014: Have Rs 400000 in my PPF account.

1-Jan-2015: Reach a networth of Rs. 1000000

Once the financial goals are set, planning needs to be done to realise this into reality. Planning would verify if the goals are feasible or not. If a goal is seen to be infeasible then a correction needs to be applied as the time draws closer towards to goals.

Introduction

Good day all !! My introductory blog!! It probably would be right to begin with introducing myself . I am a Bachelor of Engineer from Mumbai University having achieved my honors in Computer Science field in May 1999. After a small sprint of working as a lecturer in a computer institute and a reputed management school, I joined as a Test Engineer in the software service industry in Dec 1999. Today, I am designated as a Project Manager in Larsen and Toubro Infotech.

Right from my schooling days I have been interested in numbers. I learnt tricks of Vedic Mathematics from my father and was fond in solving puzzles of the legendary Shakuntala Devi. In my junior college, I was awarded a silver medal in mathematics.

Since I started working some years back, I have put my free time in learning Indian income tax laws, later this blended into a formal financial planning.

I would like to use this blog to write about financial planning topics.

I shall keep the frequency to once a fortnight.