SAVINGS, INVESTMENT AND INFLATION
- Saving is the income left after meeting the expenses. Investments are savings used in an investment opportunity -whether physical or financial product.
- Inflation risk is the risk that the returns on the investment will be wiped away because of inflation.
- Returns on investment are expressed in nominal rate. When nominal rate is reduced by inflation, it is called real rate of return. The formula for calculation of real rate of return is –
- In Fixed Return instruments like FD, Bonds/Debentures, both interest rate and repayment of principal amount are fixed. If during the period of investment inflation is high, it will greatly reduce the returns.
- Inflation risk is highest for retirees whose income is fixed. Such an investor should consider investing part of his portfolio in short term debt securities or equity or commodity – which are capable of earning high returns to beat inflation.
PHYSICAL ASSETS Vs. FINANCIAL ASSETS
- Assets like land, building, jewellery, etc. are physical assets which can be touched and seen or can be actually used. Assets like shares, debentures, fixed deposit, mutual fund schemes are financial assets. Financial assets have value but they cannot be touched or seen. A physical asset is under direct possession and control of the investor and provides him psychological comfort.
- Indian investors have more than half of their wealth in physical assets mainly because of difference in comfort.
- Unforeseen events like fire, floods, earthquakes can destroy physical assets but have no impact on Financial Assets.
- Investment in physical assets like land, art, gold coin, etc. does not benefit the economy but investment in financial assets help the economy because the money mobilized by the investee organization is used for further economic activity.
- Though, there is cost of liquidating financial assets, such cost may be higher in physical asset. Further, the process of liquidating a financial asset is easier. Also, it is possible to sell only a part of financial asset.
- Unlike financial assets, physical assets take time, effort, Insurance, taxes etc.to maintain them.
INVESTING IN AND HOLDING GOLD
- If gold is held in physical form, there is a risk of loss by theft. If stored in bank locker, there is the cost of locker rent.
- Gold ETF–Gold ETFs are open-ended mutual fund schemes that invest in gold bullion and traded on stock exchange so an investor can buy and sell his units in gold ETF whenever he wants. They track price of gold closely.
- Gold Sector Fund–These invest in the shares of the companies involved in gold mining and processing. If gold prices increase, funds that have invested in companies holding reserves of gold will earn much higher returns than just increase in the value of gold and vice versa if value of gold falls.
- An investor can invest in Gold Futures Contract through National Commodity and Derivatives Exchange. Value of such contracts increases or decreases in line with increase or decrease in price of gold.
- In Gold deposit scheme –an investor deposits gold in the bank for a specified period, gets interest at regular intervals on the value of gold deposited and on maturity of the scheme, either the same quantity of gold or its equivalent value is paid back to the investor.
INVESTMENT AND HOLDING IN RAEL ESTATE
- Holding real estate in physical form gives rise to many risks like – Loss by Fire /Earthquake/Floods etc., High investment amount, High concentration risk, Encroachment Risk, Liquidity risk, High Transaction Cost etc.
- If the investment corpus of an investor is not very large, the investment option of Real Estate poses greatest concentration risk.
- Asset class of Real Estate has the least transparency and standardization when it comes to determining price.
- Real Estate Funds are financial assets that mitigate above mentioned risks to an extent. The ticket size to invest in such funds is smaller. These funds are managed by professional real estate managers who have better knowledge about the market. These managers can negotiate better prices, diversify investments and can take advantage of economies of scale.
INVESTOR’S GOAL AND MUTUAL FUNDSFixed Deposits Vs. Mutual Funds
- If a bank fails then deposit insurance scheme of the government will pay 1 Lakh to all the people who had fixed deposits. There is no such insurance scheme in mutual funds.
- Debt mutual fund schemes can be considered comparable to fixed deposits or saving bank accounts. Their advantages are Higher Returns, Different objectives for different schemes, Tax benefits, Choice of MF schemes etc.
- An investor looking for an alternative to Savings bank account should invest in Ultra Short-Term Debt Funds.
- An investor with a fixed horizon can invest in Fixed Maturity Plans (FMPs). Investor who can take higher risk can invest in Income Fund or Dynamic Bond Fund which invest in Corporate Fixed Deposit.
- A Monthly Income Plan (MIP) is Debt Oriented Hybrid kind of a Mutual Fund Scheme and is open ended. However, these schemes do not guarantee return.
- an investor should avoid the investment option of Dynamic Asset Allocation Fund If he wants to earn regular income.
- In Post Office Monthly Income Scheme (MIS) and Senior Citizen Savings Scheme (SCSS) there is an upper limit to the amount that can be invested and Income is taxable in the hands of investor
- A Fund Manager is responsible for selection of stocks and securities in a mutual fund scheme.
- Investing in equity through equity funds gives the benefit of an experienced fund manager who carries out research, analysis, monitoring and rebalancing to ensure investor earns good returns.
- Even a small investor can have a well-diversified portfolio which he could not have afforded if he was investing directly in equity because of insufficient corpus.
- Cost of investing directly in equity is more than the expense ratio of mutual fund scheme.
- Equity Linked Saving Schemes are equity mutual funds that are permitted under Section 80C of the Income Tax Act for exemptions.
- They also provide capital appreciation as they invest primarily in equity securities. Other investment options like PPF, NSC, Bank Deposits do not provide capital appreciation that can effectively beat inflation.
- The lock in period of ELSS is 3 years while that of PPF is 15 years, NSC is 5/10 years and Fixed Deposit is 5 years.
- Pension Funds Regulatory and Development Authority (PFRDA) regulates NPS.
- There are two types of pension accounts – Tier I – Pension account with limited withdrawal facility and Tier II–Savings account – withdrawable to meet financial contingencies. Active Tier I account needed for opening Tier II account.
- Investor can invest in –
- An investor can allocate his investment under National Pension Scheme in all asset classes of Equities, Debts and Government Securities subject to regulatory limits.
- Investment in Asset Class A can be only up to 5 percent.
- The securities under Asset class A comprise of
a. Commercial mortgage-based securities
b. Units issued by Real Estate Investment Trusts regulated by SEBI
c. Asset Backed Securities regulated by SEBI
d. Units issued by Infrastructure Investment Trust regulated by SEBI
e. Alternate Investment Funds (AIF Category I and II) regulated by SEBI
- Under Government model of NPS, only 15 percent of contributions are invested in equity-oriented investments and the rest in fixed income securities. Subscribers in Government model do not have a choice on how their contributions will be invested.
- Private sector NPS subscribers get two ways of investing – Auto Choice and Active Choice.
- In Auto choice, funds are allocated in different asset classes (E, C, G, A) based on a pre-determined ratio linked to the age of the subscriber.
- In Active choice, the subscriber can choose one of three life cycle funds –
a. Aggressive Life Cycle Fund (LC – 75) – equity investment restricted to 75 %
b. Moderate Life Cycle Fund (LC – 50) – equity investment restricted to 50 %
c. Conservative Life Cycle Fund (LC – 25) – equity investment restricted to 25 %
- After the age of 50, equity allocation is gradually reduced. If the allocation in equity becomes more than the maximum limit due to age of the subscriber, the excess portion is moved to G-Sec.
- Subscriber will continue to have a choice to allocate his non-equity portion between asset classes C, G & A.
PENSION FUND MANAGERS AND PRAN
- Pension funds are managed by Pension Fund managers (PFMs). The PFMs are authorized by PFRDA.
- Permanent Retirement Account Number (PRAN) is a unique ID number of a subscriber for his NPS investments.
- Same PRAN is applicable across all PFMs where subscriber’s money is invested.
- When an individual changes employer, his PRAN still remain associated with him.
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