Dear Friends,
Hope you are safe and well. Our sincere condolences to the people affected by the rains in Chennai and other locations.
The impact of loss of property seem to be larger than the Tsunami that hit us in Dec 2004. Our office was inundated by water twice and damaged PC’s, UPS, furniture’s and racks. We are waiting to resume operations by this weekend as there is rumour that we might get hit again for the 3rd time. We don’t want to take chances as we replaced certain critical items after the first rains only to be hit back during the second spell destroying them.
I am sure each one of us can contribute in some way to provide relief to people. The impact would be high for the middle class as the poor might not have a lot of consumer durables (TV, Fridge, Inverter, Washing Machine, Grinder etc.) and the rich can afford to spend money in replacing them. Hence it’s the middle class which runs on tight monthly budgets that will face problems. As far as the relief is concerned, the Government would take care of the poor but not the middle class
Moving on to the subject matter of this blog, one of the fundamental principles of Wealth Management is to earn positive real returns. Let me explain this point with an example.
The Fixed deposit rate offered by State Bank of India for 1 year period now is 7.25% for a normal citizen (Senior Citizens get 0.25% extra). This 7.25% is not the real rate of interest that an investor earns as he/she needs to take into consideration the taxes that needs to be paid and the impact of inflation.
For a person having income of over 10 Lakhs, and RBI’s Inflation Guidance of 5.8% in Jan 2016, the actual return post taxes and Inflation works out to 5.8% (7.25% ) (100-30.9%). .i.e. the real rate of interest from a 1 year State Bank of India FD works out to meagre -0.79% (adjusted for taxes and inflation). This means Rs. 100 deposited for 1 year in FD will become Rs. 99.21 for a person in 30.9% tax bracket or income over 10L per annum. (Rs. 99.96 for a person with over 5 Lakhs income and Rs. 100.7 for a person between 2.5 to 5 Lakhs income). You can see that the returns are positive only for the person whose income is lower than 5 Lakhs.
Assets can be classified mainly into 2 Categories – Income Generation and Growth. I am sure that you would be able to classify the Assets:
Income Generation – Bank, Postal and Company Fixed Deposits, PO MIS, Senior Citizen Deposit, Short Term, Long Term and MIP Mutual Funds. Dividends yielded by Stocks and Mutual Funds also fall in this category
Growth – Real Estate – Land, Apartments, Individual house, Direct participation in Stock Markets and Equity Mutual Funds
If you observe the asset classes in the Income Generation Category, you can notice that the risks involved are comparatively lower than Growth Classes.
Does that mean our portfolio can comprise of only Income Generation Assets? The answer to that is “No” unless you have a huge networth which can yield post tax, inflation return of your needs (monthly/ yearly expenses)
The Income Generation Assets tend to give returns close to Inflation over long periods of time. So your portfolio has to have Growth assets which can yield 5% plus over Inflation in long term. Equity investments also have the added advantage of taxation when held for over a year.
So, when you construct portfolio for long term, ensure that it has an optimum ratio of Income Generation and Growth Assets. This will be relatively skewed towards Income Generating Assets in Short and Medium terms and towards Growth assets in long term.
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