It is typical among new investors to find a surplus investible surplus after all expenses and look for a way to invest that. If this is āspare moneyā left after investing for other goals or a lump sum that is yet to be invested, we have discussed this in some detail here. However, if you have not invested before and have an amount to invest monthly, this post will tell you what to do.
We will use the concepts in this post on choosing suitable investments to ensure that we invest in only those products that allow us to fulfil the investment goals. All other considerations are secondary. For each goal, depending on the horizon, priority and risk profile applicable, we will choose those investments that are suitable for beating inflation (or not), have suitable taxation and liquidity.
We are covering a few typical investment options in this post but the list is not exhaustive.
Equity-linked savings scheme (ELSS) funds
ELSS funds are mutual funds with a mandatory 3-year lock-in for every purchase and offer a tax deduction under section 80C. If you are investing in SIP form, then keep in mind that every instalment is locked for three years from the date of purchase.
All ELSS funds are currently available only as active funds. Only having active funds leads to a āwhich is the best ELSS fundā confusion amongst investors. The thumb rule to choose active funds is
keep expense ratio as low as possible
past returns are good to know (to avoid the consistently worst funds) but unimportant as a predictor of future returns
stick to 1-2 ELSS funds in the whole portfolio
you should ignore star ratings shown in rating portals
Many investors use the 1-lakh equity LTCG tax exemption to roll their ELSS funds every year. This form of tax harvesting involves selling the oldest (>3y) ELSS units and reinvesting them immediately in the same or another fund.
Investments in ELSS funds should be only to fill any remaining 80C limit and should be as per the equity allocation of your goals. This post shows you how to select an ELSS fund: What are best tax-saving ELSS Mutual Funds?.
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National Pension Scheme (NPS)
NPS is a voluntary investment that works like more or less a mutual fund where the final corpus is
withdrawable only at 60 years age of which
60% can be withdrawn as a lump sum tax-free
the remaining 40% is compulsorily invested in an annuity to provide lifelong pension
NPS contributions are tax-deductible under 80C. There is an additional deduction under section 80CCD for an 50,000 i.e. tax payable reduces by 30% (slab rate) times ā¹50,000 or ā¹ 15,000 per year.
Who should invest in NPS
NPS may be a good option for those investors who
have stable jobs up to age 60
do not plan to retire early (due to 60 age lock-in)
want to save tax under section 80CCD (there is little benefit in doing that though if your retirement is far away)
have an employer match component in NPS
If your employer offers to pay 10% of your basic into NPS, match it via your contribution since it is a part of your CTC.
Who should not invest in NPS
If at least one or two of the above conditions are false makes NPS an unsuitable investment for investors who
do not mind the missed tax saving under 80CCD since, over time, this ā¹15,000 should grow a lot more in outside investments than in NPS
The fundamental critiques of NPS are
compulsory taxable annuity in a falling interest rate environment
lack of liquidity in accessing the corpus until age 60
Many proponents of NPS have the following opinion:
60y lock-in is good since the purpose is retirement. The investor needs to evaluate if they are disciplined enough not to touch the retirement corpus for non-retirement expenses. If they are not disciplined, locking their money in NPS will not save their retirement corpus since they have an option of spending money every month on other expenses and not contribute to NPS
ā¹15,000 80CCD tax saving has a compounding effect: this depends on the investorās perspective and ability of portfolio construction. The tax not saved by forgoing NPS can be considered a cost of liquidity on ā¹50,000 of corpus/year. Alternatively, many investors can be confident that they can make higher returns in the market by properly managing an equity portfolio with an equity proportion more than the 75% maximum equity limit in NPS funds
Bank deposits (FD/RD)
Fixed deposits offer a known interest and principal amount at the time of opening the FD. They are the only product that has this feature. All others are market linked and the return is unknown. There is a deposit guarantee insurance for money kept in banks up to ā¹5 lakhs per bank. However there is no timeline as to when the money the money will be received if a bank fails. If you need absolute safety, stick to RBIās list of Systematically Important banks which are currently SBI, HDFC and ICICI.
Bank deposits are taxed at your highest tax rate (say 30%) and post-tax the return is much lower than inflation. They should be avoided by most investors except in one special case as below.
Given how taxes work for debt mutual fund, if a goal is within three years, it should be saved in bank FD/RD solely because the final value of the FD is known and taxation will be same. This makes FD and RD good options for:
sinking fund: RD provides a way to save the amount regularly and makes the money available as per need
goals within three years: since taxes are same as debt funds but the return is known
Direct stocks
Buying individual shares requires considerable time and effort to analyse and pick stocks. If you have a full-time job, it may be challenging to devote the necessary amount of time to research and pick stocks. As we have argued before, if you invest in direct stocks, it is good to benchmark that frequently.
Mutual funds (MF)
Mutual funds give you the option to get your money managed by a professional asset manager without you having to track stocks markets, bonds markets and the overall economy. Once you start investing in mutuals funds, the only thing you need to do is a regular review of your funds.
This post will show how to choose suitable debt and equity MFs to create a portfolio.
Provident fund
These are government-backed debt instruments with known interest rates and usually long lock-in periods. However, these are very popular due to their tax benefits.
Public provident fund (PPF)
PPF allows you to invest ā¹1.5 lakhs/year in every family memberās PPF account (grandparents, parents, children) and allows ā¹1.5 lakhs exemption/year under 80C per investor who is investing. So a family with goals that are far away can invest 1.5 lakhs/year for multiple family members as long as their asset allocation allows it. The interest rate for PPF is 7.1% today and is expected to fall with time. The money is locked until maturity for 15 years.
Employee provident fund (EPF) / Voluntary provident Fund (VPF)
These are retirement schemes (currently offering 8.25%/year) with the following main differences
all salaried employees must invest in EPF while VPF is optional
EPF is locked in until retirement age, while VPF can be withdrawn after five years
VPF should be considered if the asset allocation allows it and not because of the interest rate.
SSY is allowed only for girl children and has a ā¹1.5 lakhs/year limit. It offers a deduction under 80C and has a 8.2% interest rate as of today. The amount is locked in until 21 years from account opening and allows partial withdrawal once the child is 18. It is recommended that SSY is used mainly for goals like post-graduation degree and marriage due to the lengthy lock-in if your asset allocation allows it. However, if your monthly investment amount is high enough, SSY can also be used for retirement planning.
It is expected that over time, as the economy matures, these debt instrument returns will go down. Invest in them only if
the product maturity aligns with the goal maturity (PPF is 15 years, EPF is up to retirement, and SSY is 21 years)
the motivation is not just to save tax under 80C. There are other alternatives to save tax
Investors may consider adding gold to their portfolio only if
they consider risk reduction the primary motivation knowing that the returns will be less
they have a view on how the rupee-dollar exchange rate will behave in the future
have the discipline and systems in place to perform a regular portfolio review and rebalance between stocks and gold
As a percentage of the total equity portfolio, investors should choose the proportion allocated to gold as per the desired amount of risk reduction in this chart.
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This post gives more details on how and where to invest in gold.
Putting it all together
Investing ā¹50,000/month in this example starts with goal-setting and asset allocation. This will throw up a split of equity and debt allocation for the portfolio based on your goals and risk profile. If you have not set goals, stop here and then go through this post on goal-setting first.
You can follow these thumb rules:
ELSS allocation under 80C
You should not invest in ELSS unless it is to save tax under 80C. If you target 80C allocation, fill that with EPF, life insurance (term plan preferred), housing loan principal and childrenās school fees as applicable. If you have not reached ā¹1.5 lakhs, fill that with ELSS up to the allowable limit of your equity asset allocation. If some amount is left in getting to ā¹1.5 lakhs, ignore that. It is better to have a correct asset allocation than to save tax.
Please note that we are not advocating PPF and Sukanya Samriddhi as a part of 80C investments. However, they will be a part of debt assets as per goals.
Equity allocation
Any part of the SIP that will not be a part of ELSS should be invested in a single index fund without complicating things. If desired, a small percentage of 5-15% of the equity allocation can be in gold.
Debt allocation
Debt allocation has three parts:
short term debt allocation for goals up to five years that has to be kept liquid in a bank account or suitable mutual funds
liquid debt allocation for rebalancing purpose
long term debt that is illiquid like provident funds and SSY
If the model says that you need to invest ā¹30,000 per month in debt funds and of which ā¹18,000 is for short term goals, you should split the remaining ā¹12,000 between liquid (like debt MF) and illiquid (PF, SSY). Do not divert the entire amount of ā¹12,000 to fill PF or SSY just because there is room in 80C.
A worked out example
Imagine a family with the following goals and ā¹50,000 of investible surplus, including ā¹5,000/month EPF contribution:
daughterās marriage that costs ten lakhs in todayās money and is targeted 27 years from now
30-years in retirement starting 22 years from now with a lifestyle equivalent to five lakhs/year today
ā¹30 lakhs down-payment for a new house eight years from now
a new car for five lakhs three years from now
We will assume the old tax regime is applicable and there is a single earning member (so 80C limit is ā¹1.5 lakhs)
The family has been investing for some time and has 35 lakhs of assets invested as:
10 lakhs in equity mutual funds (including three lakhs in ELSS)
10 lakhs in a provident fund (PPF and EPF)
2 lakhs in SSY
13 lakhs in bank account (savings and FD)
Currently, 80C is filled up to ā¹90,000 with EPF, childās school fees and insurance premium. However, a deduction is available for another ā¹60,000 in 80C and ā¹50,000 in 80CCD (NPS) for the whole year.
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As the goal-based investing planner shows, this family needs to invest ā¹70,000 per month for all goals and rebalance the existing corpus so that the equity component is ā¹15 lakhs. However, since the investible surplus (income minus expenditure) is ā¹50,000, we will prioritise the retirement, house and car goals. We will skip the college education goal until more surplus becomes available.
Model output
Goal
Equity
Debt
Total need
Retire
13898
9265
23163
College
10963
7950
18913
Marriage
1001
667
1668
Car
0
6043
6043
House
3670
16718
20388
Total
29531
40644
70175
SIP allocation
You can allocate the SIP amounts as below:
Goal
EPF
PPF
SSY
Debt MF
Equity MF
Total
Retire
5000
4265
0
0
13898
23163
College
0
0
0
0
0
0
Marriage
0
0
1000
0
0
1000
Car
0
0
0
6043
0
6043
House
0
0
0
16718
3670
20388
Total
5000
4265
1000
22761
17568
50594
Since we have a ā¹60,000 buffer left in 80C, we have room for ā¹5,000/month which will be allocated as ā¹4,265 in PPF (for retirement) and ā¹1,000/month in SSY (for marriage). It is recommended that instead of SSY, this ā¹1,000 goes into an equity MF for the college education goal. There is no need to invest in ELSS since the 80C limit is now reached.
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This post titled What should be my mix of MF, Stocks, Gold, NPS, FD, PPF and ELSS if I want to invest 50k per month? first appeared on 21 Sep 2021 at https://arthgyaan.com
