Beware of Equity SIPs

SIP or Systematic Investment Plan is very well known for mutual fund investment. The advantages of investing through SIP mode that typically proclaimed are :

• Rupee cost averaging
• Disciplined mode of investment
• SIP methods works irrespective of the current market level

These are great advantages, especially for retail investors. So some brokerage companies have started providing facility to invest in the SIP route for individual stocks. This is “Equity SIP” which is the new buzzword. There are two types of SIP investment allowed:

• Amount based: Fix the amount to be invested at regular intervals
• Quantity based: Fix the quantity of shares to be invested at regular intervals.

This sounds like a great way of investment on the face of it, but is it really that good? Let us try to analyse whether a retail investor will get the same benefit of SIP investment as mutual funds:

1. Rupee cost averaging: The key advantage that is mentioned for SIP investment is that even in volatile markets this is a great tool due to rupee cost averaging. The key to cost averaging is that if market is down, you will get more units and if the market is up, you get a higher portfolio value. This sounds great and it definitely seem to work for individual stocks as well, but the rupee cost averaging can only average out a less volatile stock (which is mostly true for mutual fund due to inherent diversification). If a stock (& for that matter mutual fund) is extremely volatile, then this method may not be able to average out your losses. In essence you need to find a good stock with high growth potential and less volatility to use rupee cost averaging.
2. Disciplined mode of investment: Yes, this method definitely forces investors to shell out money at regular intervals, but it is useful only if over a long period you are increasing your wealth. If you invest regularly in a stock which is sliding down over a long period then definitely it is not a great investment even if you are putting money at regular intervals. In essence you need to find a good stock with high growth potential and less volatility to make disciplined mode of investment.
3. SIP works irrespective of market level: This is true because at lower levels you will get more units and the rupee cost averaging kicks in for mutual funds. This does not apply for individual shares though. Will it really makes sense to invest when you know that the particular share has just tanked to the bottom. Some of the stocks never recover and so will your SIP investments.

If I look carefully, Equity SIPs does not sound as attractive as it is made out to be by the brokerage houses. The brokerage charges for Equity SIPs are same as those for investing directly into shares and hence it does not offer any advantages. So does it mean that retail investor should never look at Equity SIPs? Well not actually, since I feel these are great tool of investment if :

• You invest in exchange traded funds (ETFs) which are passively managed and hence less volatile
• You invest in quality stocks which are strong in fundamentals and currently undervalued
• Brokerage houses start giving additional benefits like lower charges for this disciplined investing

I am using Equity SIPs for Gold ETFs as a long term investment.

How to choose Health Insurance?

When I wanted to buy a health insurance, I was completely baffled by the plethora of choices in the market offering different types of plans. It is an extremely difficult task to really select the medical insurance plan which will satisfy your needs.

There are two kinds of health insurance plans, the one is the traditional mediclaim policies (similar to the policies taken by companies for their employees) which does a reimbursement of any medical expenses incurred, the other way is the critical illness policies offered by life insurance companies which provide a lump sum for any critical illness. I will talk about how to choose the first kind of policy.

Some of the key questions to ask while selecting health insurance:

1) The Annual Limit: What is the annual limit of reimbursement per year. It is a good idea to choose around 3-5 lakhs since the medical costs are going up day by day.

2) Sub-limits : What are the various sub-limits in the policy? The most typically caps are on room-rent, ambulance services, doctor’s fees or diagnostics.

3) Co-payment Clause: Is there any clause of co-payment for certain cases? Some policies have co-payment clause either after certain age limit, some may have the clause of co-payment for kids, some may have this clause for specific treatments.

4) Pre-existing coverage: Does the policy cover the pre-existing illness? Some policies cover it from day one, some cover only after a specific time period (say 2 years).

5) Exclusions: Most policies will have some or the other exclusions. The exclusions come under permanent exclusions or time-period based exclusions. So for example, suicide related expenses are excluded permanently in every medical insurance. But for maternity benefits a policy may have a exclusion only for first 4 years.

It is very difficult to find a single policy which will have all the features and hence it might be a good idea to purchase 2-3 policies with different features to cover all medical possibilities.

Tax Saving Tips

Nothing is certain but death and taxes. The time of the year has come to think about your taxes for the last financial year. If you are a first timer in paying income tax, this guide might be helpful (may be out-dated a bit).

But do you really give a thought while investing for the purpose of tax-saving? The Income Tax law is complicated due to the variety of cases it needs to cover, but even for seasoned professionals certain aspects of Income tax laws are confusing or not knowledgeable. Here are some tips which might be helpful for some extra saving of tax:

1) Get insured but with a caveat: With the new DTC proposal, all life insurance policies whose sum assured is greater than 20 times the annual premium, the maturity proceeds are taxable as normal income. So if you are trying to buy any life insurance policies just to save tax, be aware to have annual premium less than 5% of sum assured. This does not apply to term insurance though, since there is no maturity proceeds.

2) Use losses in stocks to save tax: Short-term capital losses can be set off against both short-term as well as long-term capital gains. This is something most people often miss, especially for salaried employees who do not seem to account the stock losses in the IT-declaration proof submission to the employer.

3) Pay rent to your parents if you stay with them: If you stay in a house owned by your parents (or even spouse) and if their income is not significant (especially true to senior citizen parents), then you can pay them rent which can be used to save against HRA. The person receiving the rent has to pay taxes though if the income exceeds the stipulated amount.

4) Use alternate LTA claims: Typically LTA claims can be taken only once in two years. So if you & your spouse both are working, you can decide to alternately claim the LTA benefit with your respective employers.

5) Give loans to your children: If you give a lump-sum amount to your major children as loan (interest-free), you can avail of the tax-benefit since no income or gift tax is applicable on such a loan. This is similar as giving them a gift, the difference would be that when you gift the ownership of the money gets transferred to your children.

Inflation Index Funds

Inflation is definitely a cause of worry for every individual. If the purchasing power of money keeps getting reduced, then a person will not be able to sustain present living standard, unless his income is increasing proportionately.

Inflation is such a beast that it not only makes your present life difficult, but can ruin your savings/investments for the future. It is to be noted that before May 2005, SEBI prohibited any capital-protected products. But now SEBI, relaxed these rules, allowing issuers to offer funds that provide capital guarantee. Currently there are numerous fund houses marketing such capital guarantee funds, but inflation turns out to be a real beast.

It is no wonder that the “mehangai dayan” song is such a hit.

I am just waiting, when the government or financial institutions will start launching a inflation protection funds. Such inflation-indexed funds are not a novel idea and they definitely exists in other parts of the world. For e.g. Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation.

Reserve Bank of India published a paper on inflation-index funds [PDF] in December, indicating that these might become reality soon in India.

It is proposed that we may issue  IIBs wherein the principal is indexed and the coupon is calculated on the indexed principal, as set out in the discussion paper on Capital Indexed Bond issued by the Bank in 2005. 

In simple terms, here is how it works :

Assume the IIB are released with a 10-year bond with 2% interest to be paid semi-annually. It means every six months, interest at 2% will be calculated and paid to the investor. Assume you invested Rs 100 in January. So after six months, the interest needs to be paid. But before the interest is calculated, the principal is adjust to current inflation rate. In this case the principal (Rs 100) is first adjusted for inflation (assume 8%). So the inflation adjusted inflation will be Rs 108. The 2% interest will be calculated on this inflation adjusted  principal thus giving higher returns.

The key benefits of such a investment avenue is that it is risk-free way to beat inflation although the real returns are not very spectacular. It will be a great tool as a portfolio diversification method and specially useful for conservative investors or senior citizens.