On the other hand, the value of investments gets eroded because the real rate of returns (returns after inflation) falls dramatically. Let's take an example to understand this.
Total sum invested: Rs 10, 000
Return on investment (a year): 8 per cent
End of year returns: Rs10, 800
Inflation: 7 per cent
Real rate of return: 1 per cent (Rs 10,100)
Tax: 33 per cent = Rs 264 (if you are in the highest income bracket)
Actual return: Rs 10,100 - 264 = Rs 9,936
In other words, you have actually lost money in the process. As the inflation crosses 7.5 per cent, investors would be wondering how to keep their money in instruments that give them some relief. Here's how to invest, well and wisely.
Fat fixed deposit: Is a fixed deposit of one-year maturing soon? You can re-invest in another short-term fixed deposit of one year, yielding 9.5 per cent returns, if unsure whether bank interest rates would go up or down.
Keep away from fixed deposits of 6 months, 30 days or even 359 days, because they offer 6 per cent - 7.50 per cent, which barely covers inflation. Unless a deposit is of one year or slightly more, you can't pocket 8 per cent or more return.
Also, settle for a bank where fixed deposit is compounded quarterly, instead of half-yearly. This can push up returns, at a faster rate. To get a whopping return of 10.25 per cent on your fixed deposit, open a joint account with someone in family, who is over 60. Gifting a child, say, an amount of Rs 5 lakh, can earn Rs 45,000 a year. And this amount is tax-free.
Perk up the provident fund: Put money in your provident fund (PF) account, before the fifth of every month. This is because the interest is calculated on the balance lying between the fifth and last day of the month. Paying early would mean more interest pay in.
Open a PF account in the name of the child in such a way that it matures when he is no longer a minor. That avoids clubbing of income, according to Sec-64 in your return.
Step up contribution to employee provident fund (EPF), amounting to 20 per cent of basic salary. The interest rate is an attractive 9.5 per cent. This fund always continues to give a higher amount than the rate of inflation.
Postal and NSC: Remember, a national savings certificate (NSC) allows income tax exemption till 5 years, because interest is deemed to be re-invested and can be claimed as tax deduction.
However, as soon as the scheme enters the sixth year, the tax element comes into the picture. Hence, it would be prudent to withdraw in the fifth year and invest in a fixed deposit.
The advantage of post office monthly income schemes is that money trickles in every month, at 8 per cent, with an initial investment of Rs 1,500.
Of course, an individual can contribute Rs 4.5 lakh and a couple Rs 9 lakh to increase the interest income. One can also re-invest interest flows into a post office recurring deposit, where money accumulates at 7.5 per cent interest. The sum is compounded quarterly.
While going for a post office term deposit, shun a 1-year one as it offers 6.25 per cent, while a 5-year investment throws in a 7.5 per cent return. Also, Kisan Vikas Patra's lure is high because the interest rate is at 8.41 per cent and there is the assurance that money doubles in eight years and seven months.
Twilight plan: Already invested in a Senior Citizens Savings Scheme? Take the option of extending it by another three years from the initial five year plan. The interest rate is high, at 9 per cent, and you can place Rs 15 lakh in account, locking in benefits for eight years. A plus point is, money is paid every quarter to account holder.
Don't enrol for pension plans that have additional benefits like insurance cover or critical illness riders. They turn out to be more costly. Also, you would not be able to claim insurance costs under tax exemptions.
Gold glitters, property pays: Because gold always keeps pace with inflation, one can allocate 15 per cent of the portfolio towards it, safely.
Real estate always gives real returns. If you have one house, a second one can be taken on a bank loan, rented out and proceeds used to clear the loan amount. Buying commercial property fetches more returns, like 12 per cent, while residential yields 6 per cent.
Of course, equities are always the best option for a person seeking higher returns, but remember that they give 15-20 per cent returns over time.
DEFT MOVES
There are investment rules, which must be practised when inflation is galloping:
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