Thursday, June 30, 2011

Education Loan Interest Waiver

With the cost of education rising every year, students are increasingly looking towards financial institutions for education loans to support their higher education studies. And once a candidate has availed of an education loan, the banker would have told him/her that they would have to either pay the interest during the moratorium period or that the interest would accumulate leading to a higher principal amount when they start paying the EMIs.

What a lot of people still are not aware of, is that the government of India has brought out a scheme where there will be full interest subsidy on educational loans to certain eligible applicants during the moratorium period, which usually extends throughout the course of study and a short grace period allowing the student to get gainful employment. The scheme is effective from the year 2009-10. So if you have paid the interest on the period, it will be returned to your bank account.

The eligibility to avail of this subsidy is that the family income of the candidate should be below 4.5 lakhs/annum. The interest subsidy is only for a loan amount of a maximum of Rs 10 lakhs.

There will be a full interest subsidy provided during the period of moratorium on loans for students. Here the moratorium means the time till the students completing the course and 6 months after completing the course. The proof of income is to be certified by authorities to be designated by the State governments.

Eligible students can approach the respective bank branch from where they have availed the loan and complete the formalities so that the individual accounts could be credited with the interest due on the loan from the academic year 2009-10 onwards.

The interest subsidy under the Scheme shall be available to the eligible students only once, either for the first undergraduate degree course or the post graduate degrees/diplomas. Interest subsidy shall, however, be admissible for combined undergraduate and post graduate courses.
Interest subsidy under this scheme shall not be available for those students who either discontinue the course midstream, due to any reason except on medical grounds, or for those who are expelled from the Institutions.

Sunday, June 26, 2011

Financial Planning 101 - 6 simple steps

"Would you tell me which way I ought to go from here?" asked Alice.

"That depends a good deal on where you want to get," said the Cat.

"I really don't care where I get" replied Alice.

"Then it doesn't much matter which way you go," said the Cat.

-Lewis Carroll, Alice's Adventures in Wonderland

Financial Planning doesn't require a jargon spewing financial adviser but is essentially a simple 6 step process.

1. Identify and list down your future needs/ objectives

The very first step as you begin to plan on how to save/invest your surplus money is to - take a sheet of paper and write down your future and immediate plans/goals. Different people have different goals in life, some may want to buy a house, a car, save for children’s education and marriage, retire early to pursue a hobby or to do social service and many other long term and short term goals. Once you have listed your goals you should assign them a certain priority depending on how fast you want to achieve these goals and how crucial these goals are for you. Clarity in this respect would be the starting point to help an individual work out the journey on the financial road which needs to be followed.

You have to physically list down your goals and not just run them through your head. Seeing it in physical form on paper or on your computer screen actually helps you think clearer about your goals.

2. Convert your personal goals into financial goals

It is very important to convert each of your personal goals to financial goals. Two components go into converting the needs into financial goals. First is to evaluate and find out when you need to make withdrawals from your investments for each of your objectives. Then you should estimate the amount of money (how much) needed in current value to meet the objective today. Once you have estimated the amount needed today, then you should apply an inflation factor to project how much would you need in the future.

For eg. If you want to purchase a house 5-6 years from now and if an apartment costs Rs. 30 lakhs in the locality you are looking at and if the cost of housing is rising at about 10% annually, the total amount required at the end of 6 years would be Rs 48.32 lakhs.

3. Get clarity on your current financial stage

The next step to financial planning is to list down your income and monthly expenditures. This enables you to get an idea of the pattern of cash outflows (expenses) during the year. Accordingly you can plan to keep adequate money liquid for the necessary expenses during the course of the year. All Loan EMIs (equated monthly installments) paid should be kept separate under the monthly expenses head, as after a finite number of years they will no longer be part of your regular living expenses.

The most important information that you get from the above study is your current annual cost of living (that part of expenses which supports your current lifestyle). An analysis of the above figures would enable you to understand the amount of savings (income less expenses) that you are left with on an average. This in turn will give you an idea of surplus regular money available for investment. This is the savings that will take care of you and your family when income from your work stops.

4. Risk Planning:

Before you start thinking of various instruments where you could invest your money to achieve your financial goals, you need to focus on the oft neglected area of risk planning. India is a severely under-insured country. Most people have not fully grasped the full impact of improper risk planning and the most people consider insurance as a ‘waste of money’. An insurance product aims at financial protection from risk of death or illness (the two major risks). A suitable health insurance cover is worked out after taking into account the situation of the family and information about the availability of any cover from the employer. The next step is to estimate the amount of life insurance cover required. Loss of income in case of death of an earning member may put the rest of the family into financial discomfort (especially where he/ she may be the primary bread winner). The role of insurance is to take care of this financial discomfort. The most suitable life Insurance cover for this is a term cover. To read more about insurance, please visit the Insurance section on this blog.

5. Determining allocation of your surplus among different assets for investment

Different assets classes like debt, equity, real estate, etc. grow at certain natural growth rates over the long term. You have to work out an investment strategy to invest the saving across various asset classes in a suitable ratio so that you meet the targeted return as per the financial plan. If a higher return is needed then accordingly a higher exposure to higher growth assets like equities is needed. Discipline in maintaining the asset allocation is the key to achieving success in the long term.

A lot of individuals invest into an investment option without understanding its overall long term impact on their lives. Due to this reason they may find out that they are left with inadequate financial resources during their later years.

To read about the popular common investment options, please visit the different sections in this blog.

6. Monitoring and evaluating your investments and your financial plan

Financial planning does not end as soon as investments are made. It is a continuous process where regular monitoring and periodic evaluation is necessary to ensure that things are happening as per the plan. It is essential to ensure that planned contributions from your savings are happening towards your investments. In addition to this the returns being generated, the investments should be monitored and rebalancing of investments should be made as per the asset allocation strategy. Based on the above evaluation the financial plan should be fine tuned if necessary.

Wednesday, June 22, 2011

Highest NAV Guarantee Plans - The complete story

I was introduced to an interesting product by my friend the last day – the ‘Highest NAV Guarantee’ Plan. These funds are currently pretty popular and most major ULIP providers have a product which offers the ‘Highest NAV Guarantee’. The name sounded so appealing and the fact that the fund house will guarantee me the highest NAV seemed too good to be true. But the real crux of the plan lay in the fine print. And going through the details of the plan, I must say that the Highest NAV Plan is just another marketing gimmick of selling a mediocre product to gullible customers.

To start with, it is a known fact that stock markets and ‘guaranteed returns’ do not go hand in hand, yet the fund managers of such plans claim to have found some magical formula through which they could perform this impossible task. However Highest NAV guarantee plan is based on the constant proportion portfolio insurance (CPPI) model. Though it is a fancy name, according to this model, the fund would invest in fixed-income type of securities in order to maintain a certain minimum unit value. When the fund value exceeds this floor value, the surplus is placed into stocks. With constant rebalancing of the portfolio, the aim of the fund manager is to not let the unit value fall below a certain base value.

Similarly, the proceeds in highest NAV guarantee plans would be invested in equity, fixed income and money markets instruments. However, in such plans, there is no specific asset allocation that the fund manager has to adhere to, unlike a mutual fund or ULIP. Since such plans are a new product, there is no historical data to evaluate the performance of the said funds.
As the policy guarantees you the highest NAV, a fund manager may follow a conservative approach and allocate the money into money market and fixed income instruments and ensure that you get the highest NAV without much trouble. Also you don’t get the highest returns from the stock markets but rather the highest NAV reached by the fund. Besides the returns from these funds lie between 9-10%, viz. slightly higher than the 100% debt funds. Again, if you decide to surrender the policy after 3 years or you die within a couple of years of starting the policy, you don’t get the highest NAV but the current value of your investment.

The insurance component in highest NAV guarantee works merely as a supplementary portion to the entire plan as these plans provide limited cover (normally 10 times the annual premium viz. pretty low compared to a term plan). Secondly, the highest NAV guarantee terminates past the grace period when you stop paying your premiums (got this info from the net). The exit from the plan or partial withdrawals is possible only after 3-5 years. Also, there are no options for partial withdrawals or surrenders (which attract a high exit charge).

As with any other ULIP, highest NAV guarantee funds have the following charges:
1. Premium allocation charge
2. Mortality charges
3. Policy administration charges
4. Fund management charges

Having said all this, my advice to an investor is to avoid these funds. Paying high charges for modest returns doesn’t make any sound investment sense to me! And remember that guarantees and stock markets do not work together. So view any plan which promises you guaranteed returns from stocks with scepticism.

Tuesday, June 14, 2011

Easy steps to selecting a mutual fund

For a new investor, the selection of a mutual fund could seem particularly daunting. However behind all the jargon and complexity, lies a series of simple steps, which if followed with some common sense and research could lead to long term wealth creation.

1. Identify funds whose investment objectives match your asset allocation needs:

Just as you would buy a car or a laptop that fits your needs and budget, you should choose a mutual fund that meets your risk tolerance (need) and your risk capacity (budget) levels (i.e. has similar investment objectives as your own). Typical investment objectives of mutual funds include fixed income or equity, general equity or sector-focused, high risk or low risk, blue-chips or turnarounds, long-term or short-term liquidity focus. (Check the mutual funds tab for a quick overview on these different types)

2. Evaluate past performance, look for consistency:

Although, past performance is no guarantee for the future, it is a useful way of assessing how well or badly a fund has performed in comparison to its stated objectives and peer group. A good way to do this would be to identify the five best performing funds (within your selected investment objectives) over various long term periods, say 1 year, 3 years and 5 years. Shortlist funds that appear in the top 5 in each of these time horizons as they have thus demonstrated their ability to be not only good but also, consistent performers.

3. Diversify but don’t Over-diversify:

Don't just zero in on one mutual fund especially if it is a thematic fund (to avoid the risk of being overly dependent on any one fund). Pick two ideally and pick two diversified funds. Picking two diversified funds from two different fund houses would give you all the diversification that you need. But remember that if you start thinking that you need to diversify further and start shopping for more funds, you would end up diminishing your returns. Check out the article – ‘The Problem with (too much) Diversification’ to know about the problems with too much diversification.

4. Consider Fund Costs:

The cost of investing through a mutual fund is not insignificant and is important especially when it comes to fixed income funds. Management fees, annual expenses of the fund and sales loads can take away a significant portion of your returns. As a general rule, 1% towards management fees and 0.6% towards other annual expenses should be acceptable. Carefully examine load the fee a fund charges for getting in and out of the fund.

5. Invest, monitor and review:

Having made an investment in a mutual fund, you should monitor it to see whether its management and performance is in line with stated objectives and also whether its performance exceeds or lags your expectations. Unlike individual stocks and bonds, mutual fund reviews are required less frequently, once in a quarter should be sufficient. A review of the fund’s performance should be carried out with the objective of holding or selling your investment in the mutual fund. The article on the blog on ‘When should you redeem your Fund’ discusses this in more detail.
Investing in mutual funds is not just a decision but is more a process. It requires more of discipline in adhering to the process and a certain amount of simple research.

Thursday, June 9, 2011

Housing Loan: Important steps to keep in mind to ensure you get the best deal

There is a lot of news about the state of several real estate companies in India. Some are embroiled in telecom scams whilst some have huge debts on their books & projects which have not kept their schedules. All these notwithstanding there is no doubt that at the time of writing this blog, there was definitely a lot of construction going on in India and in spite of rising interest rates, residential demand was still strong. This article is the first of a series on Home Loans and on investing in ‘homes’. This article specifically tries to highlight the key steps a potential home loan candidate should keep in mind while taking a home loan.

There are various lenders for housing loans and to get the best deal and to have a smooth process, one should spend time and put effort into researching to arrive at the right lender. To have a hassle free housing loan process, look into the following details:

1. Check the Lenders Reputation:

Housing loans are a long process and finding the right lender could make the process easier. Loan seekers should check for the reputation of the lenders in order to finalise on the source for borrowing. A lender with a good reputation is sure to make the loan process a pleasant one.

2. The Experience of the Lender:

Following the construction boom in India, several lenders have sprung up all over the country. Numerous NBFCs (Non banking Financial Companies) have started offering housing loan products. It would be prudent to go with a lender who has been operating the housing loan markets for at least 5 years. A lender with more experience could also help in solving problems that arise easily.

3. Features of a Loan:

The features of a loan are an important factor in choosing a lender. There are numerous lenders offering various features on a loan. An individual needs to figure out his/ her wants from a loan in order choose the right kind of loan. The features of a loan that are to sought for are the structure of the loan, interest calculation, provision for pre-closure and other benefits that arise from a loan.

4. Rate of Interest:

Different financial institutions provide different rates of interest. People always go in for lower rate of interest that is beneficial. But a proper analysis needs to be made while distinguishing the rates of interest offered by the various lenders. Some financial companies which may offer an initial lower rate may have several clauses in the fine print which may finally make the loan pretty expensive.

5. Rests in the Rate of Interest:

The rate of interest is the factor that determines the cost of a loan. There are annual rests and monthly rests in the calculation of interest. The annual rest brings about a change in the interest rate on an annual basis. With the payment for the loan being made on a monthly basis, it will be beneficial for the borrower if the rests are calculated on a monthly basis as it will bring down the interest on a reducing capital and one can enjoy the immediate benefits.

6. Options in Repayment:

The repayment option provided by the lender is a crucial factor in clearing off the loan. If there is an option for pre-closure or premature clearance of the loan, it will benefit the borrower in terms of paying at his or her convenience. In most cases there is a penalty in the form of pre-closure charges to be paid mostly in the case of fixed rate loans because of the mismatch of asset liability for the lender.