THE IDEAL INVESTMENT MIX – LIQUID? LOCKED IN? BOTH??

Last Updated : Nov. 8, 2019, 6:48 p.m.

by Dr. Sai Kulkarni, PhD

Say ‘investment’ and a series of questions come to mind. What is an investment? How does it work? Which type is the safest? Which type gives the maximum returns? Which one gives the fastest returns? So, here we throw light on the concept of investment and subsequently answer the above questions.

Economically speaking, investment is the purchase of goods that are not consumed today but are used in the future to create wealth. Financially speaking, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.

A lot of research goes in identifying the appropriate areas of investment. One needs to look at –

• Fund objectives
• Expected returns
• Cost
• Investment horizon
• Financial goals

Further, these funds can also be evaluated with the help of various formulae on

• Fund returns
• History
• Ratios and
• Expense ratio

Today, depending on my disposable income (money left with me after the tax deduction on my income), I am provided with a wide range of options under liquid or locked-in investment

Liquid investment like fixed deposit ; is which can be directly converted into cash without a significant impact on its value.

A Locked-in investment, like real estate, comes along with regulations or taxes or penalties which makes us unwilling to convert.

So, the question is, which type is right for you?

Let us say I have received ₹5,00,000/- as my annual bonus and need to invest it. But how do I diversify my risks? Equities are the most risky. Earlier fixed deposits (FDs) were considered the safest bet. But given the present banking situation, it is advisable to move to corporate FDs and mutual funds (MFs) with a view of short-term lock-in and Public Provident Fund (PPF) and National Pension Scheme (NPS) with a view of long term lock in.

I can park a maximum of ₹1,50,000/- in PPF while ₹2,00,000/- in the NPS Tier I account which will be tax exempted. But I should be in complete awareness that my money will be locked in under the PPF for 15 years, while under the NPS, till the age of 60 years. Also, the PPF maturity amount is tax free while in case of NPS 40% of the 60% which can be withdrawn at 60 years of age is tax free (the remaining 40% of the corpus would be given in the form of annuities). Moving on to FDs and MFs; both have a short-term lock-in ranging from 1 to 5 years with no upper limit on the sum to be invested. On maturity the gains from the MF are taxed while gains of more than ₹10,000/- on FDs are credited post TDS (Tax deducted at Source).

The annual returns on the above are varied; PPF and FDs have a fixed interest rate while NPS through a Pension Fund Manager (PFM) and MFs are to some extent market related. The tax-free dividends received from a MF equity investment with a dividend option while in case of the growth option the increase in value of the fund has to be also considered as an additional income becoming the silver lining. From this we can reaffirm that there exists a direct relation between risk and returns –  higher the risk, better the returns and lower the risk lower the returns. There is no specific formula that guides the diversification of risk. Proportion of the investments is all relative. Before suggesting the break-up of the bonus there are two important points that I would like to bring to everyone’s attention –

1. As we all are aware, under 80C we can avail tax exemption on ₹1,50,000/- under tax benefit investments. What fewer people are aware of is the additional tax exemption on ₹50,000/- that can be enjoyed if this sum of ₹50,000/- is invested in NPS.
2. When I recommend FDs I am considering the variety of options in corporate FDs and not the FDs offered by the banking system, considering the blanket of insecurity which has plagued the banking system as a whole.

Hence, coming to the break-up of the ₹5,00,000/- bonus –

Conservative Safe Investor:

PPF – ₹1,50,000/-

NPS – ₹2,00,000/-

FDs – ₹1,00,000/-

MFs – ₹50,000/-

Moderate Risk Investor:

PPF – ₹90,000/-

NPS – ₹60,000/-

FDs – ₹1,50,000/-

MFs – ₹2,25,000/-

Aggressive Risk Investor:

PPF – ₹50,000/-

NPS – ₹50,000/-

FDs – ₹1,00,000/-

MFs – ₹3,00,000/-

There will always be this aggressive hobby investor who says he would put the entire sum of ₹5,00,000/- in MF as the cumulative returns would be, if not higher, then equal to the outcome of diversification.

The investment profile you choose would depend on your responsibilities, age and capacity to take risk. A portion can also be put into the most volatile of the investment instruments; the equities. Now, you may make quick and relatively better profit, but it is important not to get carried away, no matter how tempting it is to continue toeing the risky line. Caution prescribes that you should increase the volume of money invested, instead keep the same sum floating and reinvest the profits earned on this sum in a MF. Finally, it is You who has to come to terms with not only your present and future earning, but also your lifestyle that you wish to be maintained vis-à-vis your capacity to earn. This will help you keep things realistic and  strike an appropriate investment balance between the liquid and locked-in investments.

Dr Sai Kulkarni is a PhD in Economics from University of Mumbai. She is a Guest Lecturer for MBA aspirants at The Rizvi College of Management, Mumbai. Dr Sai writes a Weekly Column in the Local Marathi Newpaper ‘Prahaar’ covering various socio economic topics.