Zero Risk Investing and Tax Planning
Zero risk investing and capital guaranteed funds are a few of the buzz words in investment arena.
One way to avoid risk completely is to avoid any equities, any long term bonds or any thing that is related to market. The investment instruments like Bank Fixed Deposits, Post office investments, etc are really zero risk. But, as we all know, the returns are also very low with zero risk investments. Let us look at how to get a higher returns without taking any risk.
Let us define risk as 'the chance of losing the capital'. This is how most investors define risk, although in theory, the risk is defined by the standard deviation, or the chance of getting returns (positive or negative) above or below the expected returns.
Equities are the best way for higher returns (but, with higher risk), and the fixed return investments are the best way for zero risk (but, with low returns). We can use a combination for these two, to get a higher returns at zero risk. Let us look at various techniques of zero risk investing and also for zero risk tax planning.
Post Office Monthly Income Plan + SIP in Equity Fund
This article related to the zero risk investing -
How to invest in stocks WITHOUT any risk
Invest Rs 6 lakhs in the Post Office Monthly Income Scheme (POMIS). POMIS gives interest at the rate of 8% p.a., which means per year you would receive Rs 48,000. Since its a monthly income scheme, the interest per month works out to Rs 4,000. Now, this is fully taxable. Assuming you are in the 30% tax bracket, the net balance after tax left with you would be Rs. 2,800.
Now, enter into an SIP with this amount of Rs 2,800. POMIS is a six-year scheme. So basically, you would invest Rs 2,800 per month for six years. At the end of six years, you would receive the market value of your mutual fund investment and also the capital amount of Rs 6 lakhs invested in POMIS. Consequently, while you have kept your capital intact, you still have taken on equity with all its associated risk.
To see how this strategy can actually work out, we ran some numbers. Say, you started your POMIS account in September 2000. The monthly interest was invested in Franklin Templeton Prima Fund on an SIP basis.
By adopting this simple structure, at the end of six years, the investor would have received around Rs 9.45 lakh (Rs 945,000) just on account of the mutual fund investment. Add to it the capital amount of Rs 6 lakh of POMIS and the total investment would net a cool Rs 15 lakh (Rs 1.5 million). And this is after tax and without an iota of risk.
This is a nice and powerful technique. This assures capital guarantee. In the equity part, it also eliminates the timing risk by using SIP. But, there are a few drawbacks in this technique.
1. The amount invested in SIP is very less, because of the heavy tax on the income generated from POMIS.
2. The equity exposure is very less, as a major portion of the investment lies in low return investment, for most of the time period, there by reducing the returns.
3. It is difficult to extend the same technique for other time intervals, like 3 years, 5 years or 8 years, etc.
Fixed Deposits + Equity Fund
In this technique, we will invest in Fixed Term Deposits like Bank Deposits or Bonds like National Savings Scheme(NSC), or Kisan Vikas Patra(KVP), etc. Here, we will invest only the portion of the fund that is just sufficient to generate the total investment amount. That is, if the interest rate is 8% with a maturity period of 6 years, we will invest only Rs 3,80,000/ in this guaranteed, zero risk plan. The remaining amount can be invested in the equity funds. At the end of 6 years, the term deposit will mature with a amount of Rs 6,03,012.24/.
If we had invested the remaining amount (Rs 2,20,000/) in the same fund as in the previous example, the returns would have been Rs 27,57,804.73/ This is many times higher than the previous technique. This is because we have a higher equity exposure for a longer period of time. Here we didn't consider the tax. As the interest in most of the fixed maturity schemes are taxed at the same rate as that of the income tax rate, we shall assume the tax rate of 30% as in the previous example.
The interest generated is 223012.24, so, 30% tax = 66903.67, leaving a maturity value of Rs 536108.56/.
So, the investor should invest Rs 4,30,000/ in the Term Deposit. This will mature with Rs 6,82,355.95/. After tax, the net return will be Rs 6,06,649.165/. In the equity part, invest Rs 1,70,000/. This will return Rs 15,34,528.38/. This is far higher than the previous technique.
This techniques relies on two facts that helps achieve higher returns over the previous technique.
1. The returns in equity is directly proportion to the time period of the investment.
2. The tax paid today is higher than the equal value of the tax paid after 6 years.
A small variation can be done to this technique to avoid the timing risk. Instead of investing the entire amount at once, we can invest them as 6 months or 1 year SIP. Or, we can invest them in Liquid Funds and make a 6 months or 1 year STP to the equity fund. In this way, the timing risk can be eliminated. Also, the 1 year SIP is in many cases, more than sufficient to reduce the timing risk. But, since we have already made a capital guarantee, this risk can be ignored.
Advantages:
1. Higher returns.
2. Can be easily extended to various time periods. Now there are many banks that give a 8% return for a very short term of just 1 year in term deposit. For example, ICICI Bank gives 8% p.a. for a period of 395 days, Kotak Mahindra Bank gives an interest rate at 8% p.a. for just 290 days, HDFC bank gives an interest rate of 8% for 380 days and 8.25% for 745 days (2 years + 15 days)
Limitations:
1: The timing risk. But this can be reduced or ignored. As the time period is longer.
Zero Risk Tax Planning - NSC/Tax Saving Fixed Deposit + ELSS
The previous technique can be used in the same way for tax planning, by only changing the investment instruments.
Zero Risk investment:
National Savings Scheme for 6 years. (8% p.a)
Tax Saving Fixed Deposits for 5 years. (7-5-8% p.a.)
Infrastructure Bonds for 3 years. (4-5%p.a)(not recommended)
High Return investment:
Equity Linked Savings Scheme (ELSS)
Choose any of the good funds like HDFC Tax Saver, HDFC Long Term Advantage, Magnum Tax gain, or Prudential ICICI Tax Plan or Sundaram Tax Saver.
But, validating any such schemes, you must read this article from value research online about Zero Risk Investing.
[i]Assets like bank FDs and cash mutual funds are always zero risk, short-term income funds are zero risk after six months, and a good stock portfolio like a well-chosen set of diversified equity funds are close to zero risk after maybe seven years.[/i]
That is, the equity fund itself carries a very low risk after six years, hence it is not needed to allocate a high amount in the fixed deposits, instead we can invest as low as 10-20% in fixed deposits and remaining in diversified equity funds. Only thing is there is no word 'guarantee' in this way, but this is proved many times in the history, and so we can expect the same in the future. The returns may vary, but the chance of losing capital is very less in long term.
--
Happy Investing at Zero Risk.
One way to avoid risk completely is to avoid any equities, any long term bonds or any thing that is related to market. The investment instruments like Bank Fixed Deposits, Post office investments, etc are really zero risk. But, as we all know, the returns are also very low with zero risk investments. Let us look at how to get a higher returns without taking any risk.
Let us define risk as 'the chance of losing the capital'. This is how most investors define risk, although in theory, the risk is defined by the standard deviation, or the chance of getting returns (positive or negative) above or below the expected returns.
Equities are the best way for higher returns (but, with higher risk), and the fixed return investments are the best way for zero risk (but, with low returns). We can use a combination for these two, to get a higher returns at zero risk. Let us look at various techniques of zero risk investing and also for zero risk tax planning.
Post Office Monthly Income Plan + SIP in Equity Fund
This article related to the zero risk investing -
How to invest in stocks WITHOUT any risk
Invest Rs 6 lakhs in the Post Office Monthly Income Scheme (POMIS). POMIS gives interest at the rate of 8% p.a., which means per year you would receive Rs 48,000. Since its a monthly income scheme, the interest per month works out to Rs 4,000. Now, this is fully taxable. Assuming you are in the 30% tax bracket, the net balance after tax left with you would be Rs. 2,800.
Now, enter into an SIP with this amount of Rs 2,800. POMIS is a six-year scheme. So basically, you would invest Rs 2,800 per month for six years. At the end of six years, you would receive the market value of your mutual fund investment and also the capital amount of Rs 6 lakhs invested in POMIS. Consequently, while you have kept your capital intact, you still have taken on equity with all its associated risk.
To see how this strategy can actually work out, we ran some numbers. Say, you started your POMIS account in September 2000. The monthly interest was invested in Franklin Templeton Prima Fund on an SIP basis.
By adopting this simple structure, at the end of six years, the investor would have received around Rs 9.45 lakh (Rs 945,000) just on account of the mutual fund investment. Add to it the capital amount of Rs 6 lakh of POMIS and the total investment would net a cool Rs 15 lakh (Rs 1.5 million). And this is after tax and without an iota of risk.
This is a nice and powerful technique. This assures capital guarantee. In the equity part, it also eliminates the timing risk by using SIP. But, there are a few drawbacks in this technique.
1. The amount invested in SIP is very less, because of the heavy tax on the income generated from POMIS.
2. The equity exposure is very less, as a major portion of the investment lies in low return investment, for most of the time period, there by reducing the returns.
3. It is difficult to extend the same technique for other time intervals, like 3 years, 5 years or 8 years, etc.
Fixed Deposits + Equity Fund
In this technique, we will invest in Fixed Term Deposits like Bank Deposits or Bonds like National Savings Scheme(NSC), or Kisan Vikas Patra(KVP), etc. Here, we will invest only the portion of the fund that is just sufficient to generate the total investment amount. That is, if the interest rate is 8% with a maturity period of 6 years, we will invest only Rs 3,80,000/ in this guaranteed, zero risk plan. The remaining amount can be invested in the equity funds. At the end of 6 years, the term deposit will mature with a amount of Rs 6,03,012.24/.
If we had invested the remaining amount (Rs 2,20,000/) in the same fund as in the previous example, the returns would have been Rs 27,57,804.73/ This is many times higher than the previous technique. This is because we have a higher equity exposure for a longer period of time. Here we didn't consider the tax. As the interest in most of the fixed maturity schemes are taxed at the same rate as that of the income tax rate, we shall assume the tax rate of 30% as in the previous example.
The interest generated is 223012.24, so, 30% tax = 66903.67, leaving a maturity value of Rs 536108.56/.
So, the investor should invest Rs 4,30,000/ in the Term Deposit. This will mature with Rs 6,82,355.95/. After tax, the net return will be Rs 6,06,649.165/. In the equity part, invest Rs 1,70,000/. This will return Rs 15,34,528.38/. This is far higher than the previous technique.
This techniques relies on two facts that helps achieve higher returns over the previous technique.
1. The returns in equity is directly proportion to the time period of the investment.
2. The tax paid today is higher than the equal value of the tax paid after 6 years.
A small variation can be done to this technique to avoid the timing risk. Instead of investing the entire amount at once, we can invest them as 6 months or 1 year SIP. Or, we can invest them in Liquid Funds and make a 6 months or 1 year STP to the equity fund. In this way, the timing risk can be eliminated. Also, the 1 year SIP is in many cases, more than sufficient to reduce the timing risk. But, since we have already made a capital guarantee, this risk can be ignored.
Advantages:
1. Higher returns.
2. Can be easily extended to various time periods. Now there are many banks that give a 8% return for a very short term of just 1 year in term deposit. For example, ICICI Bank gives 8% p.a. for a period of 395 days, Kotak Mahindra Bank gives an interest rate at 8% p.a. for just 290 days, HDFC bank gives an interest rate of 8% for 380 days and 8.25% for 745 days (2 years + 15 days)
Limitations:
1: The timing risk. But this can be reduced or ignored. As the time period is longer.
Zero Risk Tax Planning - NSC/Tax Saving Fixed Deposit + ELSS
The previous technique can be used in the same way for tax planning, by only changing the investment instruments.
Zero Risk investment:
National Savings Scheme for 6 years. (8% p.a)
Tax Saving Fixed Deposits for 5 years. (7-5-8% p.a.)
Infrastructure Bonds for 3 years. (4-5%p.a)(not recommended)
High Return investment:
Equity Linked Savings Scheme (ELSS)
Choose any of the good funds like HDFC Tax Saver, HDFC Long Term Advantage, Magnum Tax gain, or Prudential ICICI Tax Plan or Sundaram Tax Saver.
But, validating any such schemes, you must read this article from value research online about Zero Risk Investing.
[i]Assets like bank FDs and cash mutual funds are always zero risk, short-term income funds are zero risk after six months, and a good stock portfolio like a well-chosen set of diversified equity funds are close to zero risk after maybe seven years.[/i]
That is, the equity fund itself carries a very low risk after six years, hence it is not needed to allocate a high amount in the fixed deposits, instead we can invest as low as 10-20% in fixed deposits and remaining in diversified equity funds. Only thing is there is no word 'guarantee' in this way, but this is proved many times in the history, and so we can expect the same in the future. The returns may vary, but the chance of losing capital is very less in long term.
--
Happy Investing at Zero Risk.
posted by Jayaprabhakar | 3:03 AM
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