Tag: simply put

Why no-cost EMI is no free lunch

Personal Finance

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A coffee time chat between two colleagues leads to an interesting explainer on an emerging loan product.

Vina: Hi Tina, did you check out the ongoing festive sales online? I have shortlisted a few items to buy.

Tina: No big ticket purchases this year, Vina. Spent a lot last month. It’s time I tighten my purse strings.

Vina: Why don’t you try the no-cost EMI options offered by many sellers, including e-comm websites?

Tina: No, Vina. No-cost EMI is a misnomer.

Vina: Why do you say that? The EMI instalments include no interest or any other additional charges. Plus, you get to defer the payment on your purchases by 3 to 12 months. What more could you ask for?

Tina: That’s not entirely true. Many banks, NBFCs (Bajaj FinServ) and other financial institutions (such as ZestMoney) with whom e-commerce websites have lending tie-ups, charge a processing fee on such no-cost EMI options. Starting from ₹99, the processing fee can go up to 1 per cent of the order value. Besides, a few also levy additional charges on pre-closure of loans, which may apply even if you return the product or cancel purchase.

And like any other loan, the instalments in no-cost EMIs also include an interest component, which however is offered as an upfront discount, hence the term ‘no-cost’. This interest ranges from 12 to 15 per cent per annum.

Vina: Yeah, isn’t that good saving on the interest front? Imagine how many people could benefit.

Tina: There is another catch here. The no-cost EMIs are only available for existing customers (debit or credit card holders) of the bank with whom the e-commerce site has partnered. These customers must have an existing pre-approved credit or overdraft limit with the bank. Moreover, this option is available only on purchases over a certain limit, ₹5,000 in most cases. Besides, part payment is also not an option. You need to either make full payment or avail a no-cost EMI option in full. But the advantage is that one can avail the loan online and almost instantly, without visiting the branch and submitting numerous documents.

Vina: Oh, these are part of pre-approved loans? Clearly those who have already exhausted such limits with their bankers, or have low or no credit score cannot avail no-cost EMI options.

Tina: Right. However, there are new fintech players such as ZestMoney, that provide such no-cost EMI options online to even those with no cards, credit score or such pre-approved limits. One has to just register their Aadhaar-linked mobile number on the platform and complete basic KYC for onboarding. Post this, the website approves a certain credit limit based on your transaction history and the customer can avail the no- cost EMI option on its partnered websites. These come with varying terms and conditions.

Vina: But then again, I need to verify if such players have partnered with the store where I want to make a purchase, or if the product of my choice is entitled for such an option from the fintech players.

Tina: Right! Net-net while no-cost EMIs do sound exciting, remember that there is no free lunch, ever.

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Is earnings yield a good valuation metric?

Personal Finance

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Two friends caught up for a movie at a multiplex. They had lots to discuss as they came out after watching the movie.

Ram: I really liked the scene where the world was turned upside down and Topsy sung ’when you change the view from where you stood, the things you view will change for good.’ It reminded me of looking at the PE ratio upside down as some analysts do these days, although I don’t fully understand it.

Veena: Hey, that’s the earnings yield. It is 1/PE expressed as a percentage. For example, if the PE of a stock is 25 times, then it means its earnings yield is 1/25 = 4 per cent.

Ram: OK, I now get it! Why is it being used?

Veena: Expressing equity valuations in terms of earnings yield makes it easy to compare it as an asset class versus other alternatives you have such as real estate, bonds etc.

Ram: How? I don’t understand?

Veena: Well, when you want to buy a bond you look at bond yields, when you want to buy a real estate property for investment you look at rental yields, so similarly when you are looking at buying equities you must look at earnings yield to see how much your equity investment is going to yield. Amongst other factors, this will help you in understanding whether or not you are over paying for a stock based on fundamental valuation. Ultimately the valuation of any asset has to be based on what income it can generate, and evaluating it based on yields helps.

Ram: OK, so does it mean if the earnings yield is lower than bond yields then one must be cautious?

Veena: It depends. For example, growth stocks may have a low earnings yield as investors expect their earnings to be much higher in future years. However if an equity investment is yielding lower than risk-free government bonds – say the 10 year bond, you must be clear why you are buying a company stock which is yielding lower and be convinced about its growth prospects.

For example, in India, the 10-year government bond has a yield of around 6.2 per cent, while the benchmark Nifty 50 index based on its current price and expected earnings for FY21 has a lower earnings yield of around 4 per cent. On the other hand, in many developed countries such as the US, the UK and Japan, the earnings yield for benchmark index is higher than the government bond yield!

Ram: Interesting. Never realised…

Veena: By the way, there is one more interesting thing here. Investors usually look at the ROE (return on equity) as a metric when they buy shares, but fail to realise that looking at the ROE without considering the P/B (price/book value) may be misleading sometimes. ROE is earnings/book value; so if the ROE is high, but at the same time, the P/B is also high, it means the stock has already priced in the high returns on the book value. So..

Ram: I get it now! So, earnings yield helps cut through this by knocking off the book value component. That is ROE/(P/B) = earnings yield?

Veena: Bingo!

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How EPF interest income is taxed

Personal Finance

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A phone call between two friends leads to a conversation on how interest on the popular retirement product for the salaried, the Employee Provident Fund (EPF) is calculated.

Akhila: Hi Karthik.

Karthik: Hi Akhila. Wassup?

Akhila: I am planning to increase my contribution towards the EPF voluntarily since it offers a good interest rate and has taxation benefits too. I saw your recent tweet that the EPF account will be split into two separate accounts. What is it all about?

Karthik: First things first. Did you know that the interest on PF contributions beyond a point is taxable now?

Akhila: Oops.. No! My eye have been on the high interest rate that the scheme has been offering – 8.5 per cent for FY21 – and the belief that it continues to be one of the last bastions of high fixed returns.

Karthik: You didn’t know?!

Earlier this year on budget day, the government announced that the interest earned on an employees’ PF contribution of over ₹2.5 lakh a year would be taxable. This threshold also includes contributions to the Voluntary Provident Fund (VPF), which you can make at your own will beyond your usual 12 per cent contribution

Akhila: Oh!! Good you told me. So, investing in VPF will not be as attractive as it used to be earlier, right?

Karthik: Yeah. The EEE (exempt-exempt-exempt) status will no longer be applicable on contributions exceeding the threshold.

Akhila: Uh oh! So, from when is this new rule applicable?

Karthik: The new rule will be applicable on all such contributions starting from the current financial year (2021-22).

Akhila: Oh! Is this why the government wants separate accounts within the provident fund account?

Karthik: Bang on! The balance as on March 31, 2021 and the contributions made thereafter upto the threshold, will not be impacted by this new rule. This will be put into the non-taxable contribution account.

The taxable contribution account will comprise employee contributions in excess of ₹2.5 lakh every year.

Akhila: I understand. Now, that interest on both EPF and VPF contribution beyond a certain limit is taxable, what do you think is the next best safe and tax-free fixed income avenue to build my retirement corpus?

Karthik: You can consider the public provident fund (PPF), given its attractive return. The scheme has a 15-year maturity. Investment in PPF is eligible for tax deduction under Section 80C of the Income Tax Act. Interest earned and the maturity amount are also tax-exempt.

Akhila: What is the rate of interest on the PPF?

Karthik: The PPF currently offers 7.1 per cent per annum. The interest payable is revised quarterly by the Centre, but usually the rates have been at a premium to bank deposit rates, for instance.

Akhila: This looks like a good deal.

Karthik: You can probably contribute to the VPF until the ₹2.5 lakh limit is breached and put the balance amout into the PPF.

Akhila: Ok. Any limits on PPF investments?

Karthik: Good question. You can invest only upto ₹1.5 lakh per annum in PPF.

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All you wanted to know about bumper-to-bumper insurance

Personal Finance

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Shyam, who is on the verge of buying a car, finds himself discussing more about car insurance than the car itself.

Manohar: So Shyam have you finalised the car you want to buy?

Shyam: Yes, but that seems far easier than deciding on an insurance plan to go with it. The dealer informs me that something called ‘third party’ insurance is mandatory and now a new bumper-to-bumper cover is all over the news.

Manohar: Yes, the Madras High Court has issued an order mandating bumper-to-bumper insurance cover every year, apart from providing cover for the driver, the passengers and the owners of the vehicle for five years. These are to be purchased over and above the third party insurance.

Shyam: How are they different from each other?

Manohar: Well first, you must be aware of mandatory third party insurance which provides cover against liability from damage to third parties. Most motor insurance policies have add-ons available to insure the driver, the owner and the passengers in line with the court order.

Specifically, personal accident policy covers the owner-driver, the paid driver and the passengers.

Shyam: Then, what is bumper-to-bumper cover?

Manohar: In the current parlance, bumper-to-bumper cover is also known as zero depreciation cover. This add-on allows you to cover the parts of a car, except tyres and batteries, against damage. And as the name suggests, no depreciation will be charged onthe value of the car while deciding on the claim amounts.

Any claim without a zero depreciation add-on is settled by adjusting for the wear and tear of the part captured by the depreciation charge. This makes the cost of replacing that part higher. Bumper-to-bumper insurance can land a claim amount closer to the actual value without depreciation. However, this policy does not cover engine damage caused by water ingress and oil leakage.

Shyam: So, what should one expect?

Manohar: Well since the order has been passed only recently, there is not much clarity on how it will be implemented.

The court itself has placed the order on hold as insurers asked for time to design an appropriate product. For one, the issue of buying the cover upfront for five years has to be clarified. The pricing and the availability of such a comprehensive product too will be something to watch out for.

Shyam: Seems like we have to wait and watch for more clarity on this.

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Know the difference between exemption and deduction

Personal Finance

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A coffee time conversation between two colleagues leads to an interesting explainer on tax jargon.

Tina: Problems with the new IT website seem to be never ending. Have you filed your tax returns?

Vina: No Tina. I seem to have missed the receipt for my insurance premium payment. That could help me with some exemption in income.

Tina: Er.. exemption? You mean deduction?

Vina: Yeah potato, po-tah-toh! Aren’t they the same thing said differently?

Tina: No. Even though both the terms do ultimately mean a lower tax outgo for you, they are different.

Vina: Why? What is the difference?

Tina: Exemptions deal with incomes or rather sources of incomes that are not required to be considered while calculating your taxable income. These excluded incomes may be exempt either entirely or partially depending upon the provisions in the Income Tax Act.

For instance, agricultural income and sums received under a life insurance policy (subject to some conditions) are examples of incomes that are completely exempt from income tax. On the other hand, exemption of long-term capital gains on listed equity shares for an amount of up to ₹1 lakh a year is an example of partially exempt income. Section 10 of the Income Tax Act specifies many other exempt incomes.

Vina: What are deductions then?

Tina: Deductions, as the name suggests, are amounts that are allowed to be deducted or reduced from your gross taxable income. Well-known examples of these are the deductions laid out in Chapter VI A of the Income Tax Act. These deductions generally aim to promote the habit of saving and investment in people. Take for instance, deductions under Section 80 C of up to ₹1.5 lakh a year. One can claim them on making investments in various instruments such as Equity Linked Savings Schemes (ELSS), Public Provident Fund and NPS, or through expenses such as repayment of home loan principal. Also, deduction is allowed for health insurance premium payment under Section 80D.

There are certain other deductions too. Take, for instance, the 30 per cent deduction on income from house property, or the standard deduction of ₹50,000 a year from your salary income. Donations to certain specified funds, interest on home and education loans etc. can also be claimed as deductions from your taxable income.

Vina: Okay, I get it now. So, the difference between exemptions and deductions is that the Income tax Act exempts certain incomes- either entirely or partially – from the calculation of total income to be considered for taxation. Hence, one need not include them in the gross taxable income. On the other hand, deductions must be claimed against (or deducted from) your total taxable income.

Tina: Yes. That’s simply put!

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Explaining core and satellite portfolio strategy

Personal Finance

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A coffee time conversation between two colleagues leads to an interesting explainer on a portfolio construction strategy.

Vina: Did you hear about Meena making windfall gains through her smallcase investments? Makes me want to try my hand at it too. I felt exactly the same way when cryptos rallied last year. I think it is some kind of FOMO playing out!

Tina: Relax Vina. It is not like she has got the Midas touch when it comes to investing. You can also up your game by venturing into other asset classes. But be mindful of the risk you undertake. I hope you know that every asset class that promises you superior returns comes attached with equally superior risks too.

Vina: Agreed! But isn’t there a way out. I mean, what is one to do if one wants to generate better than market returns, and at the same time contain the risks.

Tina: Have you heard of the Core – Satellite portfolio strategy? It is a strategy that aims to optimise costs, taxes and risks in the overall portfolio while aiming to maximize returns. May be this approach could help you address your FOMO.

Vina: I assume, the core is the main portfolio. But, what is the satellite portfolio? Does it keep revolving around the core? Like the Moon around planet Earth?

Tina: No Vina. This strategy works as follows. The core portfolio is made up of funds or other investments that aim at acheiving one’s financial goals — be it through debt instruments (sovereign or otherwise), funds (ETFs or index funds) and other assets that essentially help cut down on costs and volatility in the long run. For longer tenure portfolios, gold can also form part of the core portfolio. The smaller satellite portfolio is one where you can try your hand at actively-managed riskier assets for alpha generation. One can also use his / her satellite portfolio for saving taxes by investing in equity-linked savings schemes or ELSS. Depending upon one’s goals and the risk associated with the stock picks, direct equity investments can either be part of your core or satellite portfolio.

Vina: Why two portfolios? How does that help?

Tina: While the core helps in generating the minimumreturn required to meet one’s goals according to one’s risk appetite, the satellite portfolio adds extra spice to these returns. This is definitely better than burning one’s fingers by investing the entire corpus in risky assets, all in the name of seeking alpha.

Vina: Fair point. What is the ratio in which I should split my portfolio into core and satellite, then?

Tina: While there is no one size fits all approach, most experts advise a 70-80 per cent allocation to the core portfolio. The ideal ratio depends on the type of assets added to your satellite portfolio and the amount of risk they would add to your overall portfolio. The idea is to earn the minimum return to meet your financial goals through your core portfolio investments. One’s satellite investments can range from credit risk funds to thematic or international mutual funds to direct investments in equity. Some also prefer to add alternate investments such as REITs/InvITs, PMS, private equity (including pre-IPOs) and even cryptos to their satellite portfolio. Whatever the asset class(/es) you choose, the losses if any, should not eat away too much into your overall portfolio return.

Vina: Right. Simply put, this strategy seems like a fair way in which one can try to get the best of both worlds, superior returns with a cap on the downside risk.

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Do shareholders gain from Britannia’s bonus debentures?

Personal Finance

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Sujoy and Minnie, two working professionals met up over Teams, to share notes on their investments.

Sujoy: Hi Minnie! How are you spending your time?

Minnie: Mostly on the Cowin app, trying to get a slot. And, there’s my first love – playing the markets.

Sujoy: Nowadays it’s easier to make money on the markets than book vaccine slots, I must say. I called for a very specific thing, Minnie. I read somewhere that Britannia, the cake and biscuit company is issuing bonus debentures. I know it’s a solid company, so how do I invest in them?

Minnie: A bonus debenture issue, unlike a normal one from a company, isn’t open to the public. Britannia is issuing these debentures to its existing shareholders only. For every Britannia share, they’ll get one free bonus debenture.

Sujoy: Oh, the free part sounds good, but how is this different from dividends or bonus shares?

Minnie: When a company pays out a dividend, it simply distributes a part of its retained profits to its shareholders. In bonus issues, it issues free shares against equity already held. In the case of bonus debentures, the company issues free bonds to its shareholders. It promises to pay regular interest and the principal at maturity. In Britannia’s case, if you held 10 shares, you will get 10 debentures of face value of ₹29 each. You will get interest at 5.5 per cent (of ₹29). At the end of 3 years, you will get ₹290.

Sujoy: But in a normal bonus issue, I would get Britannia shares which add to my long-term portfolio and returns!

Minnie: When you get bonus shares, their value may go up or down over the years. But here, you are getting an assured return. I agree that the benefit however, is much smaller. Against a Britannia share of over ₹3400 apiece, you are getting a bonus debenture worth ₹29 and an even smaller interest on it.

Sujoy: Why do companies do this?

Minnie: Britannia’s intent is to reward shareholders. Instead of paying dividend at one go, it now gets to retain the money for a few years and use it for expansion or to repay debt. In a normal debenture, Britannia would pay interest to outsiders. Here, it converts part of its retained profits into debt and pay interest to its own shareholders. Plus, interest is tax deductible.

Sujoy: Then why don’t more companies do it?

Minnie: Well, a few have – HUL, NTPC and Britannia. But the issue of bonus debentures is complicated requiring a scheme of arrangement, NCLT approval etc.

Sujoy: So net-net I can’t buy these debentures?

Minnie: These will be listed on the bourses. If some shareholder sells, you can grab them!

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