To unlock your freedom :      Visit Freedom Portal | Write to me
        No fees, no constraints..Ask for help !!



Sunday, September 30, 2012

Are you paying TAX on your FD interest

As you approach Financial Freedom, you would realize that the world of money brings its own challenges. Someone once asked me : "There are 2 different sets of money problems in the world - One set comes with having no money and the other set of problems come with having a lot of money. Which one do you prefer?". I chose the latter.

Most of us who are still stuck in our rat race may have never realized that we are earning interest through various bank Fixed Deposits and even if we are earning a single rupee of interest, we are liable to include that as our taxable income and pay tax on the same. This might not seem to be a big issue while we are in the rat race because the amount of interest is not significantly high and you may feel that your bank is anyway deducting tax at source, but once you start dealing with millions of rupees of interest, you got to take a re-look at your entire approach.

While you would see comprehensive details around Fixed Deposits in the upcoming book "From Rat Race to Financial Freedom", let me give you a quick summary.
Fixed Deposits (FDs) are one of the most popular and traditional debt instruments. They are much more popular than other debt saving instruments like Provident Fund, Post Office Deposits etc because of the high interest rate and liquidity that these deposits offer. But so often, we fail to realize the tax implications of the interest earned through such deposits. Whether you are financially free or not, it pays to understand the tax implications arising out of Fixed Deposits.

I would try to keep these tax rules as simple bullets so that it is easy to understand and follow. so, here we go...
1. Every rupee that you earn through Fixed Deposits is taxable. Yes, every single rupee. Do not get confused if you have heard something like a interest limit of Rs. 10,000.
2. The income through FD interest is added to your total income under the header "Income from other sources" and then taxed as per the income slab you are in, for that specific financial year.
3. The interest income from fixed deposits are taxed on "accrual basis" and not when actually received. This means that the tax on interest income earned at the end of financial year have to be paid even if the interest is credited at a later year. For e.g. if you are investing Rs 75000 in a  fixed deposit for five years, you will have to pay tax on liable interest for all financial years it spans, even though the interest will be credited at the end of fifth year.
4. Tax Deducted at Source (TDS) is deducted by the banks on your Fixed deposit interests if the interest amount exceeds Rs 10000 from one or through multiple investments put together.
5. If you think that your total income does not fall under the tax bracket, then you need to submit Form 15G (non senior citizens) and Form 15H (for senior citizens) which instructs the bank not to deduct any tax at source.
6. These forms (Form 15G and Form 15H) have to be submitted every year to avoid TDS, if applicable. The reason is that your tax bracket may have changed from one year to another.
7. Even FDs in name of the minor attract TDS, if the interest exceeds the limit of Rs. 10,000.

8. The TDS deducted by the bank would be at a fixed rate of 10% (if you have your PAN no. registered with the bank) or at 20% (if your PAN Number is not registered). At the end of the financial year, bank will also issue you a tax certificate mentioning the tax it has deducted at source(Form 16A).
9. If you fall in a different tax bracket - lets say 20% or 30%, you would have to incorporate that as a part of your income tax returns that you are filing for that financial year.
10. The NRI's, who earn interest on their NRO's account, are subject to 30% TDS
11. Since TDS threshold of Rs.10,000 interest is calculated at the branch level, you can avoid TDS by splitting your FDs across multiple bank branches OR by submitting Form 15G/15H OR by opening a FD in someone else's name, but all these techniques are just delaying the inevitable. You are liable to pay your tax on every single rupee you earned as interest on FD during the year. In all such cases, you will have to pay tax and show the same at the time of filing your income tax return.

I have tried to cover as much around Fixed Deposit taxation. Do feel free to leave a comment if you need any clarifications.


Manoj Arora

Friday, September 28, 2012

What is the purpose of your life?

Swami Vivekananda once said : "Take up one idea. Make that one idea your life - think of it, dream of it, live on that idea. Let the brain, muscles, nerves, every part of your body, be full of that idea, and just leave every other idea alone. This is the way to success."
If you think of any successful person (whosoever you consider as "successful"), you would realize that they all followed what Swami Vivekananda said, whether you talk of Mother Teresa, Mahatma Gandhi, Thomas Edison, Bill Gates, Michael Phelps, Michael Jackson or any one else. They all focused on one thing and devoted their entire life towards fulfilling that idea or dream or passion. They focused so much on that single objective that they forgot any other ideas in life and this focus helped them become the best in their own areas.
Most of us may not have even identified that dream of our life right now, which is completely fine. There is no need to worry or panic. There is no need to even get surprised that how could you live so many years of life without chasing any single goal or dream. It is never too late. You will be lucky if you get this realization that you must have one mission of your life, and you would be luckier if you are able to actually identify one and pursue the same. 
Trust me, and i am telling you by my own experience, that it is not easy to find your mission of life. It takes time. It takes enormous efforts in most cases. It takes lot of internal thinking, discussion and debate with your own self. It takes going wide, and trying multiple things quickly in life (and perhaps failing in most of them) until you can narrow down on one thing that brings happiness and cheer to your inner self. 
How would you know whether you have found your mission of life? It will always strike through your inner voice immediately. You will not have to think twice. You will know it immediately. You will get the feeling of bliss and the satisfaction of having found that idea that you have been looking for so many years, through your unconscious mind.
And once you have that idea or dream finalized and crystallized in your mind and heart, then you will start seeing the magic. You can, then, safely divide your entire life span into two parts: "Life before your dream" and "Life after your dream". These two lives are going to be absolutely different. While earlier you were driven by circumstances, you would now be driving the circumstances and situations. This one dream will change everything within you and around you. Your family and friends will see the difference in how you talk, work, walk and behave. You will see yourself as a more confident person in every aspect of life. You would start enjoying discussing your dream with others, and also wanting to know what other people are dreaming about. You will attract things and situations in your life that would help you chase your dream.
I was blessed to have realized my mission of life at the age of 32. It took a few months to crystallize the same  and i have been pursuing that for the last 8 years. Financial Freedom was my means to go and freely pursue the ultimate mission of my life. Having achieved that, i am now a "free man" - free to think, free to decide, free to work, free to do what i truly want to do in life, free to pursue my passion without worrying about the money.
So, here you are at the crossroad of your life. You may read this article, may be you would like it as well, and then you might flip over to see what is next on Facebook or what is the next blog you should read. Few lucky ones would halt here, take a deep breath and take a decision to find a mission for their life before they move ahead. They will start working on it everyday till they are able to find one. As with other good things in life, the choice will always be in "your hands".
So, If you still haven't got that mission of your life, it is still not too late !! Go and find it, and then forget everything else....& then go and chase your dream...
Every moment of your life would be worth living only after that !!
Manoj Arora

Wednesday, September 26, 2012

Preserve your Property Gains

Real Estate, as an investment tool, normally rewards you with enough annual returns, sometimes in line with what stocks can provide you. Though Stocks / Equity still remain the best choice considering relatively smaller investment, liquidity and extremely high return potential, Real Estate (in developing countries) remains the 2nd best option.

Though the upcoming book (From the Rat Race to Financial Freedom) would guide you on how to truly invest in real estate, there are a few tips you should keep in mind when you are selling your real estate investment to book profits or to subsequently invest your profits somewhere else. Knowledge of certain rules and laws would only help you to preserve your gains that you realize through this investment tool.

Short Term Capital Gains
If you sell your property within 3 years (36 months) of the date of acquisition, your property would qualify as a Sort Term Capital Asset (STCA) and the gains that you realize out of this sale would qualify as Short Term Capital Gains (STCG)

Here are the salient taxation laws for Short Term Capital Gains
1. Any STCG is considered as your taxable income for that year and should be included as your income when you file your income tax returns.
2. Since the profits are qualified as income, they are taxed as per the income tax slab applicable for you for that financial year.
3. This is the least efficient means of getting returns from real estate as an investment. One should consider this option only in case of emergency need of funds.

Long Term Capital Gains
If the holding period for your property exceeds 36 months,such property qualifies as a Long Term Capital Asset (LTCA) and the gains realized from its sale as Long Term Capital Gains (LTCG)

Here are the salient taxation laws for Long Term Capital Gains
1. LTCG is taxed at a flat rate of 20% after indexation of cost
2. Indexation of cost is very important and has a significant positive impact on you wrt the tax liability. 
3. Indexation of Cost typically means that for calculation of your gains, the cost of the house is uplifted by the inflation index for each year till the sale is made. So, your net indexed gain is less than the actual gain, resulting in reduced tax liability.

It makes lot of sense to wait for more than 3 years if you are selling your property for investment gains. Let us understand in some more detail through a simplified example.

Let us assume that you bought a house with the following details
Cost of Purchase : Rs. 20 Lacs
Expenses on improvement : Rs. 5 Lacs
Total Cost : Rs. 25 Lacs
Selling Price : Rs. 40 Lacs

Case 1 : House is sold within 3 years
Applicable Gain : STCG
STCG : Rs. 40 Lacs - Rs. 25 Lacs = Rs. 15Lacs
Taxable Income : Rs. 15 Lacs
If you are in the highest tax bracket (30%), your total tax : Rs. 5 Lacs.

Case 2 : House is old just after 3 years
Applicable Gain : LTCG
Indexation adjusted cost of purchase :  Rs. 33 Lacs (assuming approx 10% inflation every year for 3 years)
LTCG : Rs. 40 Lacs - Rs. 33 Lacs = Rs. 7 Lacs
Taxable Income : Rs. 7 Lacs
Your total tax (flat 20%) : Rs. 1.4 Lacs.

Summary : 
1) You saved Rs. 3.5 Lacs on taxes just by waiting for 3 years to pass by.
2) Education cess is applicable in both cases of LTCG and STCG, though not considered in the above example, just for the sake of simplicity.
3) Note that money spent on house improvement is also included in your cost, and helps you reduce your tax liability.
4) There are laws that help you save or re-invest the LTCG, thus avoiding any tax at all. That topic would in the scope of the next post.


Manoj Arora

Related Posts

Monday, September 24, 2012

5 reasons why everyone will never get rich

"Happiness is a state of mind, and my mind stays in a healthy state if there is enough money in my pocket :)"
Don't worry, i just made this up. But this remains a fact with so many of us, at least definitely with me.

Is there anyone reading this article who hates money? If that is the case, then this article is not the best one for money haters like you. This article is for those who truly wish to get rich in life. When i say rich, i mean really wealthy. What you do with the money after getting rich is totally up to you, and is not the point of discussion in this article.

Most of us want to get rich, with a few exceptions. But then why is that 99% of the worlds population is not rich. Why only 1% could get really rich? What stops us from achieving a real wealthy status? We want it, isn't it? We work hard for money, then what is missing?

While i was shooting for my promotional video for my upcoming book, i realized that there are few key traits that we lack, which results in most of us living a life of mediocrity. I analyzed and summarized 5 key reasons for most of us not being able to become rich

1. Wealthiness does not strike us
The fact that we have been born and brought up in an environment where we have hardly seen rich people around us, makes us believe that its a norm not to be extremely wealthy and wealth comes only as an exception to the fortunate few. We never had rich friends, rich neighbors, rich colleagues at office. So, how am i supposed to be different? I am normal. I am as most of us are. It never strikes us that we can be truly wealthy irrespective of what surrounds us. We can be that "exception". We deserve to be rich. 

2. We never "decide" to get wealthy
I love talking about this. Many of my friends come to me and ask me to list down the steps from 1 to 10 - whatever they need to follow so that they can get rich. Fine, i say, "Tell me your dream." They are confused with my response and re-iterate their wish to tell them the steps needed for achieving financial freedom. I have to keep reminding them that your dream is going to be your first step. If you have not yet identified a dream in your life, a single purpose in your life for which you are ready to sacrifice anything, you are not done with Step 1, and unless you are done with Step 1, all other steps are meaningless. In fact, all the subsequent steps after your dream are so common for everyone and available so easily in books and across multiple internet sites that anyone can learn from them and follow them. But your dream is something that will not be available anywhere else. It has to be searched and dug out from inside you. A dream would be something that excites you, that single purpose of your life that ignites you and makes you passionate about everything that you do. It took me 15 years to search for my own dream and purpose of life, but once i found it, financial freedom was a just a series of steps that took 7 years to execute. Most of us want to jump over the first step of identifying our true dream because identifying that takes time and effort. It takes a lot of time and lot of effort. Unfortunately, there is no short cut here.

3. We always have enough excuses
"I am too old to fight for my dream now", "I have a family to support and secure", "It is too early for me to talk about retirement or freedom", "I don't have time", "Money is not a very good thing to have", "Money cannot give you happiness", "I am busy", "Happiness is a state of mind",  etc etc etc....the list is endless. I only have one point to tell all my friends who have some "reason" for not getting wealthy - Either you can make excuses or you can make money, but not both. The choice is in your hands. the choices that you decide every day make your destiny.

4. We do not appreciate delayed gratification
Most of us understand the compound interest calculation but it is very rare for someone to truly appreciate the amazing power of compounding and delayed gratification, unless they have experienced it in life themselves. In this fast paced world, we are all looking for instant results, and if we do not see instant results, we want to change our goal itself. Well, nothing worthwhile in life can be achieved without spending enough time and effort. It takes time to get rich and the growth is exponential. You have to have patience in the first few years when it might seem that you would never reach the goal, and then suddenly you would start realizing the amazing exponential power of compounding. Do not quit your goal till the compounding power triggers off its magic.

5. We are all in our comfort zones
"Well, whats wrong with my life? It is going just fine...", said a fish to her peer, lying in the fish aquarium inside a house. Doesn't that sound familiar? Nothing wrong actually - they are being fed on time, they are being saved from their potential enemies, they are being taken care of with clean water - then why should they try anything different. Perhaps, they forgot the real meaning of life - to "live" and "experience" life and the situations it poses on you. It is a very similar story for most of us. We have got used so much to our comfort zones that it pains to make an extra effort to "live" life. Is it easy to come out of such a comfortable zone? No, not at all. Is it worthwhile? Definitely yes. what is "living" life unless you have your personal freedom in your hands.

So, while most of us want to get rich, only 1% of us who will learn the skill to manage the above 5 constraints, will actually get rich. It is a fact that not everyone can get rich...Rich would always be divided in the ratio of 1% to 99%. 

But you can definitely decide the category you want to be in. The choice is in your hands !!


Manoj Arora

Related Posts

What hell will break loose by the "Amazing Power of Compounding"

Come out of Comfort Zone : A Tale of 2 seeds

Dont be Frog in the Pan

Do I need Freedom when life is going on just fine?

Never Never Never Give Up

Go, Chase Your Dream !!

One person can make ALL the difference

Your Dream is your First Step

Have Hope.. and Dare to Dream !!

Thursday, September 20, 2012

Big things will happen by doing Little things right

Did you ever realize that your future results, and your destiny, could be determined by those little things that you do everyday. When i say "little" things, i have no intention to mean that they have "little" value. I only mean to say that these things seem to take relatively lesser time, and probably may not have an immediate major impact on the outwardly results that we see, or so we may feel.

These so called little things could be as simple as polishing your shoes, cutting your nails, keeping your house neat and tidy, making sure you keep the shoes and towel in its place after using them or even keeping a book back in its shelf after reading it. Well, you may wonder what impact these little things have to do with the outcome of your life. The fact is that the way you do little things says a lot about how you will handle the big things in life.

Resigning yourself to mediocrity around your minor pursuits clearly sets you up for mediocrity when it comes to the major ones. If your home and your office desk is well organized, i can almost bet that your life is also well organized. A well organized life would mean great relationships, happy family, and also sound financial planning, which ultimately leads to reduced stress levels and a happy existence, apart from the achievement of your dreams.

If you are paying attention to the birthdays and anniversaries of your friends and their families, i am sure you are paying equal attention to the larger projects and opportunities that come your way in your personal and professional life. If your office desk is tidy and spotless, i am also sure that this will reflect directly in the quality of deliveries that you make to your client.

The reason for this correlation is very logical and simple to understand. A tidy house or office directly means an organized mind. Have you ever felt that when your office is untidy, you are more ruffled in your approach to issues and situations that come your way? Did you ever notice that when things are untidy at home, you scold your child more often? 

If you have never tried this, you can try it any day. You can see the result the end of the same day. When you go to office tomorrow, just try this. Make a conscious effort to make your office desk and its surroundings more neat and tidy than what it normally is. Don't tell me that it is already neat and tidy and you cannot improve it further. When you go to office and see your desk and think about it, you would yourself realize what improvements are possible. Once you have done that, then only you start the work for the day. 

Do not let it become cluttered during the day as you proceed with your work. Keep arranging and organizing the things as and when you feel the need & recheck the status of your desk for a minute after every 1 hour. At the end of the day, you would realize that not only you could do more work that day (which means you became more efficient), but the quality of your work also goes up. You will be able to resolve issues with better solutions, be handle relationships with your peers and seniors much better than you normally do. It is because when your mind is focused only on one thing at a time, it can focus more and give you many alternative answers to the same problem than when it is focused on multiple things at the same time.

I have a peculiar habit of taking a fresh sheet of paper everyday morning as soon as i reach office. Before i open my emails,  I jot down what all i need to handle in the day, from what is there in the mind. I keep adding more things as they accumulate during the day. I also keep scratching out the action items that i complete (The very act of scratching completed items give lot of satisfaction !!). Of course, i cannot complete all tasks in the day. But, when i come back the next day, i never continue adding more action items on the same sheet of paper although that sounds a more logical approach. I take a fresh sheet of paper again and rewrite all pending items from the previous day and then add if there is anything new. What is the difference? Seems such a small thing, but a fresh and uncluttered paper keeps your thoughts aligned and uncluttered as well. I have seen the results over time. Whenever i use a fresh paper, i am much more efficient and am normally able to complete many more tasks than when i continue on an existing sheet of paper. It is such a small thing, but imagine what can be the cumulative result of making this small habit at the end of the year if my daily productivity goes up by 15-20%. Not only i can show better results at the end of the year, i have more time with me. I can use this time to spend with my family, or to pursue my other dreams and passions. 

You can bring this kind of efficiency in every so called "small thing" that you do in life. You would realize that your life is changing for the good in every sphere where you bring this change.

So, pay attention to the details. Focus on the small things in life. Keep yourself and your surroundings neat and tidy. These habits will bring a change in your thought process. Fresh thoughts would lead to a better action. Better action would yield great results. And consistently great results would ultimately define a powerful destiny for you.

So, the next time, when you see your cars key lying aimlessly around on the table rather than on the shelf where it is supposed to be, don't ignore it. Make a habit of correcting this untidiness there and then. Because, with every such change, you are tuning your mind to become more effecient in everything it does.


Manoj Arora

Sunday, September 16, 2012

What are Forwards and Futures

Fundamentally, forward and futures contracts have the same function that both these types of contracts allow people to buy or sell a specific type of asset at a specific time in future, at a previously agreed price. The contracts, however differ in specific details.

Forwards & Futures Contract Features
A forwards contract or simply a forward is a non-standardized private contract between two parties to buy or sell an asset at a specified future time at a price agreed upon today.
- As the name suggests, we look forward ahead of time to predict a price and decide the value of the Forward.
- Non standardized contract means that that the terms and conditions of the contract are not standard and would vary with each contract and the kind of asset being sold or bought.
- Future time means that the actual change of hands and payment of the asset would not happen now and would happen sometime in future.
- Price is agreed upon today between the seller and the buyer and is committed as a part of the contract

How a Forward / Futures contract works ?
Let us assume that you want to buy a house a year from now. At the same time, suppose that your friend, Ramesh currently owns a Rs. 50 Lacs house that he wishes to sell a year from now. Both parties could enter into a forward contract with each other. Suppose that they both agree on the sale price in one year's time of Rs.55 Lacs (a 10% appreciation assumed in one year). At this stage, both you and Ramesh have entered into a forward contract.

At the end of one year, suppose that the current market valuation of the house is Rs. 65 Lacs. Then, because Ramesh is obliged to sell this house to you for only Rs.55 Lacs,  you can easily make a profit of 10 Lacs. To see why this is so, one needs only to recognize that you can buy the house from Ramesh for Rs. 55 Lacs (as per the Forwards contract) and immediately sell to the market for Rs. 65 Lacs. In contrast, Ramesh has made a potential loss of Rs. 10 Lacs and an actual profit of Rs. 5 Lacs.

What is the purpose of Forwards / Futures contracts ?
Forward contracts offer users the ability to lock in a purchase or sale price without incurring any direct cost. This feature makes it attractive to many corporate treasurers, who can use forward contracts to lock in a profit margin, lock in an interest rate, assist in cash planning, or ensure supply of a scarce resources. 
Speculators also use forward contracts to make bets on price movements of the underlying asset. A very common example to hedge risks  is in cases like currency rate fluctuations. In currency forwards, one party opens a forward contract to buy or sell a currency to expire/settle at a future date, as they do not wish to be exposed to exchange rate/currency risk over a period of time. As the exchange rate fluctuates between the trade date and the earlier of the date at which the contract is closed or the expiration date, one party gains and the counter party loses as one currency strengthens against the other.

Comparison of Forwards Vs Futures
a) Futures contracts are exchange-traded and, therefore, are standardized contracts. Forward contracts, on the other hand, are private agreements between two parties and are not as rigid in their stated terms and conditions.
b) Because forward contracts are private agreements, there is always a chance that a party may default on its side of the agreement. Futures contracts have clearing houses that guarantee the transactions, which drastically lowers the probability of default to almost never.
c) For forward contracts, settlement of the contract occurs at the end of the contract. Futures contracts are marked-to-market daily, which means that daily changes are settled day by day until the end of the contract.
d) Settlement for futures contracts can occur over a range of dates. Forward contracts, on the other hand, only possess one settlement date.
e) Because futures contracts are quite frequently employed by speculators, who bet on the direction in which an asset's price will move, they are usually closed out prior to maturity and delivery usually never happens. On the other hand, forward contracts are mostly used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place. 
f) In contrast to forward contracts in which a bank or a brokerage is usually the counter party to the contract, there is a buyer and seller on each side of a futures trade.


Manoj Arora

Friday, September 14, 2012

Start organising your life

It is strange but true. In pursuit of achieving things in life, we sometimes forget to enjoy the results of what has been achieved.

When it comes to one's financial life, we truly work very hard to make sure that we earn more money, or we get the next progression or get the next client deal, or impress our boss, or at least make sure that we continue to earn what we are earning today. Well, all that is fine and it is always good to strive forward in life.

However, what startles me is the fact that hardly any of us have any time to manage the money that we have earned after sacrificing our health, family and peace ? Isn't that strange ? You might disagree with me and say that you manage it pretty well. You might also supplement this with the fact that you have invested in good fixed deposits, mutual funds, insurance policies, stocks etc. If you are doing it, then its fine. But i want to ask you some very fundamental and important questions and leave it to you to take a decision whether you and  your life is well organized or not.

- Do you have a documented plan for your life with clear goals / dreams with specific dates written on it ? The most common answer is that i have it in my mind. Well, yeah, that's good but that's not going to help you achieve anything as long as it stays in your mind and does not come down on paper. imagine a big 40 year project plan being executed through a plan which is just in some engineer's mind. alas, it does not work that way.
- How many of these goals ( i am assuming you know the number of goals - whether in mind or on paper) you have already achieved?  Let us assume that you have consumed 40% of your life span, so have you achieved at least 40% of your life goals ?
- Do you know exactly what are your total assets ? (Dont start calculating now. I am just poking.)
- Do you know how much is the exact total Return on investments you received last year on all your investments?, and a year before that? Please don't give me a rough figure or a figure that you "think" is the answer. Is this calculated anywhere?. I want this up to 2 decimal digits. Apologies for my swagger but thats critical to wake you up.
- Are you improving your return on investment each year (assuming you know the answer to the previous question) ? 
- Do you read enough to make sure that you learn new things and equip yourself to perform better financially every year ?
- Do you have a balanced life chart, which covers social, professional, spiritual and financial goals and targets ? Is your life truly balanced ? (or is this expecting too much from life?)
- Are you in pursuit of any one single BIG dream that is driving you crazy now a days ?
- Do you keep a track of your monthly income and expenses ? and then forecast it to plan your future income and expenses ?

Let me stop here. Don't curse me. The day you would stop ignoring these questions and start answering them, you would realise what was going wrong with your life. 
I know some of the thoughts that may already be percolating in your minds. Well, who has the time to do all this? You are right.  Who has the time to manage his or her own life when we are all so busy ? And that is exactly my point. We are so occupied earning money that we have no clue what do i do with the money that we have earned ? How can i make this money work more efficiently for me ? Forget about efficiencies, there are so many of us who do not even know how much money is locked up in which of our bank accounts, which credit card, and which mutual fund. 

I am not saying that you leave everything else and start talking about money or life, but what our life definitely deserves is to get more organised.

Ite reminds me of a short story of a small boy who goes to a garden to plant 2 trees. He has limited time, so he wants to finish this task quickly, but at the same time he also wants to make sure that he does a quality job. He decides to keep the trees aside and first dig the 2 holes needed to plant the trees. He is full of enthusiasm and energy, as each one of us are at the beginning of our money earning spree. With all the focus, excitement and energy, he digs one perfect hole in a garden. He is so happy to see the result of his hard work and immediately turns around to start and dig the next hole. As he turns around and starts digging the second hole, he does not realize that the mud coming out of the second hole is filling up the first hole itself. Well, he is short of time and can't care about every bout of mud that is getting pulled out from the second hole. There is no shortage of energy or enthusiasm as he continues to dig the second hole. The only unfortunate thing that happens is that by the time he has dug up the second hole, the first one is completely full with the mud that came out of the second hole. He turns around and realizes what mistake he has done.

We are just like that little boy, filled with energy and enthusiasm to earn money without realizing what we are doing with the money that we are digging out each month. Where is it going ? Is it efficiently returning me what it is expected to ? We don't know because we don't have time.Sad but true.

I just hope that we take out enough time in our lives to answer some of the questions above, so that we can get the reward for all the hard work that we have done till now. 
Take out time to organize your life. It will only pay you in the long run.

I want to end up with this famous quote from Tryon Edwards
Organize your life, and you will not only accomplish more, but have far more leisure than those who are always hurrying.

Happy organising


Manoj Arora

Wednesday, September 12, 2012

What are Debentures

Those of my investors who are close to the market may have recently heard of lot of noise around Non Convertible Debentures (NCDs) being issued by multiple corporates and open for general public. Before you invest, it is always advisable to get wise about Debentures in general, and Non Convertible Debentures (NCDs). So, i thought of writing this post on this important investment tool in your kitty. Here we go.

What are Debentures?
A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral. (For understanding Collateral, refer to the earlier post Understanding Mortgage).
In corporate finance, the term is used for a medium- to long-term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note, while in some other countries, bonds and debentures are separate instruments. (Refer to the section : "What is the difference between Bonds and Debentures" in the post below)
A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest.

What is the difference between Shares and Debentures?
Although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements.

What are the different types of debentures?
Debentures are divided into different categories on the basis of: 
(1) Convertibility of the instrument 
(2) Security

Debentures can be classified on the basis of convertibility into:
• Non Convertible Debentures (NCD): These instruments retain the debt character and can not be converted in to equity shares
• Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.
• Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company.
• Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.

On the basis of Security, debentures are classified into:
• Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of either the principal or interest amount, his assets can be sold to repay the liability to the investors
• Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.

Why Convertible or Non Convertible Debentures?
"Convertibility" is a feature that corporations may add to the bonds they issue to make them more attractive to buyers. In other words, it is a special feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert, convertible bonds or debentures typically have lower interest rates than non-convertible corporate bonds.
Non Convertible Debentures are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts.

Typical Features of Debentures
  • Debentures are listed on Stock Exchanges.
  • Issuance and Trading will be in De mat form only.
  • Interest will be paid through Direct Credit / ECS / RTGS / NEFT mode.
  • A good credit rating is required for the company to issue a Debenture.

Who Should Invest in Debentures?
  • Investors who expect a stable consistent return with least risk.
  • Investors who want to have consistent monthly returns. 
  • Fixed Deposit Investors can look at debentures to improvise their returns.
  • Investors looking at portfolio diversification with the Fixed Income security.
What is a difference between a bond and a debenture?
In many countries, Bonds and Debentures are separate instruments. Long‐term debt securities issued by the Government or any of the State Government’s or undertakings owned by them or by development financial institutions are called as Bonds
Instruments issued by other entities are called Debentures.

What is a Coupon rate?
The Coupon rate is simply the interest rate that every debenture/Bond carries on its face value and is fixed at the time of issuance.
For example, a 9% p.a coupon rate on a bond/debenture of  $ 100 implies that the investor will receive $ 9 p.a. as the interest. The coupon can be payable monthly, quarterly, half‐yearly, or annually or cumulative on redemption

What is Put and Call Options in Debentures?
Debentures can have put and / or call options.

• A “put” option means that you have an option to surrender the debenture if you want to, and get back your principal. A put option gives a lot of flexibility to you – if interest rates go up, and you can get better rates from the market, you can exercise the put option and get back your money. You can invest it elsewhere, and get better interest.

• A “call” option means that the company has an option to ask you to surrender the debenture, and pay back the principal to you. A call option gives flexibility to the company – if interest rates go down, and the company can get funds at lower rates from the market, it can exercise the call option and give your money back to you. It can then raise money from the market at lower rates.

Income Tax on Debentures / Bonds
For income tax purpose, the debentures are treated like debt instruments. Since debenture is a capital asset, no Income Tax is deductible at source.

If you sell the debenture on the stock exchange before holding it for a year, it would be a Short Term Capital Gain – it would be included in your income and would be tax as per prevailing IT slabs.
• If you sell it on an exchange after holding it for a year or more, the gain would be long term capital gain. This long term capital gain should be calculated without indexation, and would be taxed at 10% of the gain.

Benefits of investing in Debentures 
1) Better Returns: Debentures like NCD’s (Non Convertible Debentures) provide a higher rate of interest for their investors.
2) Good Liquidity: To sell NCDs, investor has two options.
    • Sell on the Stock Exchanges to anyone willing to buy
    • Exercise the Put /Call option and trade it back with the issuing corporate.

Related Links :
Understanding Mortgage

Monday, September 10, 2012

Identify your Dream Momento

It was exactly 1 year back on the same day when our family was visiting Disney World at Orlando, Florida, USA. That visit continues to stay as one of the most amazing, memorable and also one of the most inspiring trips i every had in my life till date (i am sure there are many more to come with we being financially free soon !!)

Well, it is so easy to get lost in the adventure, excitement, fun and frolic that these Disney parks have to offer you, that you could hardly think anything else happening in the outside world . We used to start right in the morning and go past mid night, and there was never a single moment where one can feel bored or short of adrenalin rush. The whole environment that gets created in the park with dance, music, fun and adventure all around, is overwhelming for anyone. This was our first trip to a Disney park and the excitement was overflowing.

Among all this fun and frolic that the park has to offer you, there is a subtle message that is delivered in the Magic Kingdom park of Disney World. This message is about the story of Mickey Mouse and how this entire kingdom of entertainment was created because of a dream of a single man, by the name of Walt Disney. While on the Magic Kingdom park, we saw a few movies that depicted the history of the origin of mickey mouse and realization of a dream. 

To me, these entire set of parks are the result of a dream of this one man, whose dream started with a mouse. He used his hand made drawings to sketch various moods of Mickey Mouse. While the world laughed at him for imagining a park just for entertainment at that time when making two ends met was the daily struggle of everyone's life. Over and above this, consider the fact that the foundation of this dream was a character none other than a mouse. Who would have imagined that dream would get converted into such sprawling park complexes across so many countries across the globe. There are so many such parks today around the world. The man, Walt Disney, was very sure of his dream and he had a particularly strong belief in the fact that "Dreams Do Come True".

While in the park, we also saw an amazing show in the evening lawns of the Cinderella Castle which reiterated this message that "Dreams Do Come True" if we follow them, chase them and go after it in spite of all obstacles.

I was overwhelmed and inspired, and kept thinking about the whole experience we had with our dreams. I did not ever wanted to forget this experience. While we were leaving the last park on the 3rd day after seeing Magic Kingdom, Animal Kingdom and Hollywood Studios, we were shopping for our own gifts and i wanted to buy a memento that can keep this overwhelming experience alive in my heart for ever. I got a hand sized Mickey Mouse memento which has his hands up in the air. I always keep this memento on my table at home. It gives me the required push whenever i am down and out. It reminds me of my dreams that i want to achieve once i am financially free. It tells me that nothing is impossible. I look at me the first thing in the morning to solidify my dream, and to keep moving ahead.

Here is a snap of the momento that serves as my "Dream Momento".

This memento always refreshes the memories of  Disney World and also reminds me that "Dreams Do Come True". I would urge you all to define a momento for your dreams, something which can remind you of your dreams every day. Seeing such a momento every morning will not only make you feel excited about your goals and dreams but also push you forward in the right direction

Happy Dreaming !!


Saturday, September 8, 2012

Understanding Mortgage

Understanding mortgage and few other key terms and concepts around it will help us understand more on this critical aspect of money management in our lives. So, lets go..

In layman's definition, a mortgage is a loan to finance the purchase of one's home. This is clearly the biggest debt that you would ever get into in your life.
Literally, The word mortgage is a French Law term meaning "death contract", meaning that the pledge ends (dies) when either the obligation is fulfilled or the property is taken through foreclosure.

Your home is a collateral for such a loan. Collateral means anything that you pledge as security for re-payment of your home loan. For mortgage, your home is the collateral. Remember that the collateral is subject to seizure on default. It is logical and very obvious that the bank would not give you a loan which is more than the value of the collateral.

To repay the debt (loan), you make monthly installments or payments that typically include the following:

(1) Principle: The principal is simply the sum of money you borrowed from the bank or financial institution to buy your home. Before the principal is financed you can give the lender a sum of cash called a down payment to reduce the amount of money that will be financed by the bank.

(2) Interest: Usually expressed as a percentage called the interest rate, interest is what the lender charges you to use the money you borrowed.

Principle and interest comprise the bulk of your monthly payments in a process called as amortization. Amortization is a process which reduces your debt (principle) over a fixed period of time. Over this period, which can be generally anywhere between 10 to 30 years, the principle component of the loan (the original loan) would be slowly paid through Equated Monthly Installments (EMIs). With amortization, your monthly payments are largely interest during the early years and principal later.

(3) Taxes: The taxes are the property taxes your community levies based on a percentage of the value of your home. The tax is generally used to help finance the cost of running your community, say to build schools, roads, infrastructure and other needs. You must pay property taxes even after your mortgage is paid off.

(4) Insurance : Though this is optional in some regions of the world, you might definitely want to consider one or both of the following insurances to safeguard your home:

a) Home insurance This covers your home and your personal property against losses from fire, theft, bad weather, natural calamities and other causes. Even if you pay cash for your home, you should buy home insurance unless you can afford to repair or rebuild your home if it's damaged or destroyed. 
b) Life Insurance - You should consider buying life insurance if you think that it would be financially challenging for someone in your family to continue to pay the EMIs for your home in case of your death. Typically, you should go for a term plan which gives you maximum returns with minimum investments.  

Foreclosure or Repossession 
The possibility that the lender has to foreclose, repossess or seize the property under certain circumstances is essential to a mortgage loan. Without this aspect, the loan is arguably no different from any other type of loan.

Types of Amortized loans 
Across the globe, there are two types of mortgage loans available:

1. Fixed rate mortgage (FRM)
The interest rate charged by the lender is fixed at the time of signing the mortgage contract and does not vary irrespective of prevailing market and economic conditions
2. Adjustable-rate mortgage (ARM) 
This is also known as a floating rate or variable rate mortgage. In some countries, such as the United States, fixed rate mortgages are the norm, but floating rate mortgages are relatively common in other countries like India.

Adjustable rates / Floating Rates transfer part of the interest rate risk from the lender to the borrower, and thus are widely used where fixed rate funding is difficult to obtain or prohibitively expensive. Since the risk is transferred to the borrower, the initial interest rate may be, for example, 0.5% to 2% lower than the average fixed rate.

Mortgage underwriting 
It is the process a lender uses to determine if the risk (especially the risk that the borrower will default) of offering a mortgage loan to a particular borrower is acceptable. Most of the risks and terms that underwriters consider fall under the three C’s of underwriting: credit, capacity and collateral (In the UK they are known as the three canons of credit - capacity, collateral and character).
To help the underwriter assess the quality of the loan, banks and lenders create guidelines and even computer models that analyze the various aspects of the mortgage and provide recommendations regarding the risks involved. However, it is always up to the underwriter to make the final decision on whether to approve or decline a loan.

Getting involved with real estate, and hence with mortgage loans, is a critical aspect of financial freedom, even after you are financially free.  In fact, my book "From Rat Race to Financial Freedom" will explain you how you can leverage the mortgage loans to maximize your annual returns.

Happy mortgaging till then !!


Manoj Arora

Related Articles

How to decide whether to Pre-Pay your Home Loan

Know more about Home Loans Pre-Payment