For or Against NPS?

I had posted a few days ago, facts on NPS - it is available here.

Once in a few days, we would have got mail from NSDL saying to avail the additional tax benefit of Rs 50,000 per year under section 80CCD(1B).  So, if you are in 30% tax slab, it works out to a direct tax saving of Rs 15000 per year. So, it looks like Rs 15000 easy money.

But, just look at the the exit opportunity of Rs 50000 invested.

You can take out only after attaining age 60. And a mininum of 40% has to be invested in annuity. So, you can take out the lumpsum of a maximum of only 60%.  Out of 100%, 40% is tax free and the remaining is taxable at the appropriate income tax slab.

Let us say we take an annuity of only the minimum mandatory amount of 40%.

The split will be 40% taxfree lumpsum + 20% taxable lumpsum + 40% taxable annuity.

Two possible decisions:
1. Take the tax incentive and invest Rs 50000 in NPS
2. Do not take the tax incentive, pay Rs 15000 (@ 30% tax slab for the current year) and invest Rs 35000 in non NPS equity instruments (Long term capital gains being tax free).

For the ease of calculation, let us assume NPS and non-NPS investments generate the same CAGR over the years till the person reaches 60 years of age.  Assume the current investment becomes 10 times in about 30 years of time.

35,000 Non-NPS would have become 350,000 and this entire sum will be taxfree (assuming the current tax structure prevails after 30 years - big condition!)
50,000 NPS would have become 500,000
200,000 tax free
100,000 taxed at 30% = 70,000
200,000 annuity take which will generate just an inflation matching return beyond age 60

Current annuity table from LIC: https://www.licindia.in/Products/Pension-Plans/jeevan_akshay

@60 years of age, with return of capital, Rs 6600 is the annuity for Rs 1 Lakh purchase.  @15% service tax, for Rs 1.15 Lakh, annuity works out to be 5.74% - effectively just matching the inflation (and there is a possibility it might miss the inflation too in some years!)

And this will also be taxable.  Let us say, the annuity holder is still only at 10% tax bracket - then, net return is 5.74 * 0.9 = 5.17%  If the persion is in higher tax brackets beyond 60 years of age, the return further reduces.

@60 years of age:
Non-NPS is 350,000
NPS is 270,000 + 200,000 annuity

Effectively, the difference is :
Non-NPS is 80,000
NPS is 200,000 annuity with 5.17% return

Assume Non-NPS investment generates 3% higher CAGR - which is 8.74% and non-taxable.  At some point, the non-NPS will start accumulating more capital than the NPS one because of the higher compunding rate.
80000 * (1.0874) ^ (years) = 200000 * (1.0517) ^ (years)

It works out to be 27 years @ 3 percent better CAGR
It works out to be 18 years @ 5 percent better CAGR

NPS works out better if someone has an expectancy of around 80 years and do not foresee more than 5 percent better CAGR in non NPS investments (assuming LTCG in non NPS investments will be tax free)

All our analysis are based on our key assumption that till 60 years of age, NPS and non-NPS generate equal returns.  But, if the non NPS has compouneded at a better rate over the accumulation period till 60 years, then the scenario will be completely different with a tilt towards avoiding investing the tax incentivised NPS.

Mutual Fund Returns Calculator

I have published a SIP / SWP calculator, sometime back.  For now, it works with the Sensex data from Jan 1990.

The SIP calculator helps in calculating the CAGR / XIRR for
    1. Lumpsum Investments
    2. SIP Investments
    3. SWP Investments
   
SIP or SWP can be of daily / weekly / monthly / quarterly / yearly frequencies.

SWP is Systematic Withdrawal Plan where you have a corpus which is invested in an equity instrument (Sensex in this case) and from which a fixed amount is taken out at a regular frequency.

SIP - the assumption of calculating CAGR is that all the investments made at regular intervals compound at the same CAGR.

In SWP, if we have that assumption, then we also mean that the amounts taken out are reinvested at CAGR which may be an impractical assumption.  So, there is also an option given to modify the rate at which the withdrawals can be reinvested in.

Lumpsum / SIP / SWP calculator for Sensex

I am planning to update the calculator with the NAV values for Mutual Fund schemes - so it will be more useful.

MF Comparison Tools

Today, we shall see some tools which help in mutual funds comparison.

Morningstar's SIP Calculator - You can compare the SIP performance across three different funds.  But, it gives the performance review as on a particular date.  There are a few things that this comparator does not tell you:
1. How does a SIP perform across time periods, across different schemes?  This helps in selecting a scheme to invest in.
2. How will a daily or weekly SIP perform vs monthly or quarterly SIP?

FreeFincal (Dr Pattu) gives a rolling SIP returns calculator. He has a series of calculators on various components of personal finance!
https://freefincal.com/mutual-fund-sip-rolling-returns-calculator/
The way to interpret is this:  As on a point on X axis - say Aug 2013 (one of the lowest points of Sensex / Nifty), what would be my CAGR had I invested for the past 5 years (starting in 2008 Aug) and redeeming in Aug 2013?  It is 5% for rolling BSE Sensex.

Here, he compares the performance of several funds - HDFC Equity, HDFC Top200, Quantum LTE, IDFC Premier Equity against their benchmarks.  HDFC Equity and HDFC Top200 on the way to bottom, beats the benchmark - not good, losing more than the benchmark!  See Quantum LTE and IDFC Premier Equity - consistently beating benchmark and during the slide manages to lose less than the benchmark.

https://freefincal.com/nifty-200-dma-buying-high-vs-buying-low/
Here Dr Pattu analyzes whether there is an advantage doing SIP when the index (or the NAV) is less than the 200 day daily moving average vs index being greater than the 200 day daily moving average. The revealing and counter-intuitive observation is that the buying when the index is higher than the 200 DMA, the corpus is higher!

Systematic Investment Plan

SIP: Investing a certain quantum of money every month - in hope of accumulating a much higher sum in future.  An SIP is usually associated with the investment in mutual funds.  It is an MF version of erstwhile Recurring Deposit (RD).  Each investment in an RD can be treated as a monthly commitment towards a fixed deposit.  Let us say, an RD of 2 years, the first instalment stays for 24 months and the second for 23 months and so on - the last instalment stays for 1 month.  At the end of 24 months, the entire corpus collected along with accrued interest is returned to the investor.  The rate at which the interest will be accrued will be pre-fixed.  The first instalment generates interest for 24 months, while the last one generates interest for just 1 month.

A SIP in MF in that context is the same - you keep investing a fixed sum every month in a mutual fund scheme.  Except, there are a few caveats - which works well for investors with patience and may not work well for investors who are impatient.

There is no pre-fixed interest rate for SIP in MF.  By the way, there is no concept of interest rate at all, in mutual fund investments. If there is no interest at all, how does the corpus earns money?  On a daily basis, the mutual fund publishes Net Asset Value - NAV for all its schemes.  For an investment, units are allocated to investor based on NAV.  Let us say, the NAV of XYZ scheme is Rs 10.  An investor invests Rs 1000 today in the said scheme. 100 units are allotted to him.  Now, his money is converted into mutual fund units.  The next month, NAV falls to Rs 9.  Investor invests Rs 1000; 111.11 units will be allotted to him. Now after 2 months, his total units will be 211.11 and his Rs 2000 investment will be worth: 211.11 * 9 = Rs 1900.  So there is no guarantee that the investment will always travel upwards.  On the other hand if the NAV had risen to Rs 11, he would have got allotted 90.09 units and his total units of 190.09 will be worth 190.09 * 11 = Rs 2100

There might be very less chance of losing money in an RD in bank - though it might have lost the real value after accounting for inflation.  But there are good chances that a SIP, done for a shorter duration of time may end up less than the investment value.

At the end of RD, you need to mandatorily get back your amount - not necessarily the case in MF. You can keep the amount in MF to grow, even after the SIP period has ended.

Usually there is a penalty for premature withdrawal of RD.  Similarly, each investment of SIP has an associated exit load if withdrawn before certain period of time - the penalty percentage and the minimum commitment time differs from scheme to scheme.

By the way, RD is a product on its own; SIP is a way of investment.

CAGR - Compounded Annual Growth Rate is an important measure in determining how an investment performs over a given time period.  As on the day of evaluation, CAGR is the uniform rate which when applied for each instalment, accounting for the duration each instalment is invested for, would give the current amount - the total accumulated units valued at the current NAV. Sometimes, this CAGR is also called IRR or XIRR.

CAGR is one of the important benchmark in determining how the investment has fared over the years.  Though a point in time CAGR for evaluating mutual fund schemes is not so helpful.

Financial Calculator Suite

We earn and spend; Rinse - Repeat!  We really do not know how much it costs to earn and live, leave alone the needs for pursuing a passion!  As the income increases, the expenses catch up - unless planned.  Parkinson's law states "Work expands to fill the time available".  Similarly, the expenses increase to consume the income!  Planning is essential; setting aside an amount for future consumption is necessary.  People starting at age 25 and planning to retire at 55 have 30 years of work life and if they expect to live till 95 years, 40 years of retirement life. Assume there is no income in retirement, the 30 years of work life has to provide for 40 years of retirement!

It takes some math and compounding to estimate how much it is going to cost for expenses, when we retire.  To start with, one has to know what is the expense at the current level and how many years he has in his hands to retire and what is the contribution towards the retirement corpus that is going to be committed every year.

To help with such projections, I have created a simple application to help with the calculation.  This I call the "Calculator Suite for Retirement".  Consists of 3 parts:

1. Retirement Calculator: Projects the expenses and corpus and lets us know whether the current networth and the investment commitment till the retirment age will be able to provide for the entire life.

2. Annuity Calculator: Given a corpus and expected years for which the corpus is planned for, how much is the maximum annuity that can be withdrawn every year, assuming a given inflation

3. Corpus Calculator: Given a required annuity for a defined number of years at a set inflation level, how much is the corpus required?

Though I call it as a retirement calculator, this can be used for any defined goal - be it children's higher education, planning for a vacation, setting aside and building corpus for pursuing a passion, upgrading a house or a car - any such medium to long term goals.

Mohnish Pabrai TieCon Lecture

I watched another lecture by Mohnish Pabrai yesterday.

This was a talk on sales and marketing in TieCon Feb 2014.  The video was for one and half hours. Since it was a lecture, I did not watch it in full, but heard completely.  The full one and half hour was entertaining and captivating.  He started with how he initially thought of marketing was a jazzy or shiny or frivolous work and how his ideas changed after he read a few books by William Davido and Miller & Heiman in the late 1980s.  Those books are: Marketing High Technology, The New Strategic Selling, Successful Large Account Management and The New Conceptual Selling. Marketing is about the core value proposition that you put forth in what you believe.

The other books he mentions about are:
Power and Force - by Richard Dawkins - where he quoted on the idea of getting clues from sub conscious mind and keeping the communication channel (between the conscious and sub-conscious mind) free of clogging - so the message is sent across.

Origin and Evolution of New Businesses - by Amar Bhide - this is a research on the successful entrepreneurs and the best practices followed by them. Mohnish could relate to how he did his business with other people mentioned in the book - He gives his explanation of why he used the title "Vice President"

Tom Peters books: In Search of Excellence, A Passion for Excellence, Leadership

He has some very interesting anecdotes in the lecture.  His friend, then 19 years old, came up with the InstallShield software which was originally an after thought, non-buillt software listed as just a bullet point in a software exhibition at a conference.  A young person out from army, trained in making cables started a cable business, when he realised a demand, later went on to build a cable laying business.  These anecdotes he said on the necessity making things that customers want and of pursuing an idea wholeheartedly and changing it as per the needs of the customers and how the competitors evolve.

He says he is an expert cloner and never shies away in admitting the fact.  He shared his personal experiences of copying successful ideas (cloning) which he did in his business.  His experience in Mumbai with a jeweller who sent a greeting card every year - just to make himself remembered during a big wedding jewellery purchase - that made him to send cards to his customers.  A parcel he received from his law firm, where the organization name was written in extra large letters on the envelope - that made him to adopt a similar design for his business envelopes.  He says his Pabrai funds is a clone of Buffet partnership model which ran successfully for a decade till Buffet closed it in late 1960s.  He also says most of his stock ideas come from other investors.

Watch the video to experience!

Man's search for meaning

I have just started reading "Man's search for meaning" by Viktor Frankl, a psychiatrist and a II WW holocaust survivor. In the book, he writes about his experiences in the Auschwitz concentration camp and what made people to withstand and survive the terrible experiences - he says whoever had a "Why", a reason to survive had higher chances of survival than those who had lost hopes in between.  He willed himself of coming out and teaching psychiatry.  He chose to go to prison with his elderly parents, having his US visa lapsed.

He says: "Everything can be taken from a man but one thing: the last of the human freedoms; to choose one's own attitude in any given set of circumstances, to choose one's way".

There are multiple views of what makes a life: Life is a pursuit of happiness; Life is a pursuit of success.  In Viktor Frankl's view, life is a pursuit of meaning. And that meaning, the reason gives the life the support and balance to survive despite the circumstances.  If you have a "why", "how" does not really matter. He writes, "Life is never made unbearable by circumstances, but only by lack of meaning and purpose."

I have not completed the book in full. Will update more as I progress and finish.

My Financial Starter

I remember the first time when I got a job offer.  A software engineer job with a company based in Chennai with a good pay package. I felt it was a huge sum.  (It dawned on me later that it was not so big as I originally thought). My parents then, may not have been earning so much.  I was wondering what I would do with such a huge salary!  Once I joined the company, I wanted to plan my income tax and savings.  But, there was no body out in my circle of friends and relatives who could help with that. Adding to the complications, I changed my job in my first year itself.  I submitted all my investment proofs in the previous company.  The new company did not cut income tax for the few months when I worked. I was happy. Then, while filing the income tax, the auditors who came calculated a huge tax which I paid promptly - they were auditors right?  They must have calculated correctly!  The assumption was wrong.  The auditors added up the salaries at old and new companies and did not even take into account the investments I had made.  I realised it only later. I now consider that as a fee for learning how income tax filing works and a penalty for not doing my own tax returns filing.

There are some crazy things which I did in the first 2 years of my job.  Started a recurring deposit; bought some gold; bought a car in loan; opened a demat account and piled up around 30 different securities each for tiny sums; The craziest of all: Started a 6 month SIP! Adding to the list: 2 whole life LIC policies and another market linked one time premium ULIP from LIC apart from regular annual premium paying ULIP!

I was introduced to mutual funds by one of my colleagues.  He came with me to the nearest bank and helped me buy the first tax saving MF.  Later I opened a demat account and started trading in shares.  I bought mutual funds - so I know what shares to buy, right?  Again, wrong assumption!

It was not until after I finished my second tenure in college, I realised the importance of long term planning.

There are a lot of financial products available and not every thing is for everyone.  There are a few suited for some people which may be completely out of place for others.  And a few financial products are outright bad - helps the sales people and the product manufacturers at the expense of investors.  ULIP is the top name in that list.

As with the investment opportunities, are there the avenues and ways for expenditure.  Again, one needs to be watchful of mindless expenditure.  There are expenditure which people consider investments - this is a tricky trap.  If you expense on something considering it as investment, you are denying yourself an opportunity for learning as well.  Among these tricky traps are the expenses on car, car accessories, house purchase, house enhancements, mobile phones, laptops, bikes and many more!