Open Interest and how to benefit from F & O Cues

What Open Interest Tells Us
A contract has both a buyer and a seller, so the two market players combine to make one contract. The open-interest position that is reported each day represents the increase or decrease in the number of contracts for that day, and it is shown as a positive or negative number. An increase in open interest along with an increase in price is said to confirm an upward trend. Similarly, an increase in open interest along with a decrease in price confirms a downward trend. An increase or decrease in prices while open interest remains flat or declining may indicate a possible trend reversal

Recently www.moneycontrol.com has added F&O cues to the detailed view of all stocks which is very useful in predicting possible trends in stocks

The following table summarises the F&O Cues

Futures Price	OI Change	Trend
Up	Up	Confirms an upward trend
Up	Down	Weakening of Upward trend
Down	Up	Confirms a downward trend
Down	Down	Possible reversal of downward trend

The following points also help in understanding this(taken from investopedia.com)
If prices are declining and the open interest rises more than the seasonal average, this indicates that new short positions are being opened. As long as this process continues it is a bearish factor, but once the shorts begin to cover it turns bullish.

A decline in both price and open interest indicates liquidation by discouraged traders with long positions. As long as this trend continues, it is a bearish sign. Once open interest stabilizes at a low level, the liquidation is over and prices are then in a position to rally again.

If prices are rising and open interest is increasing at a rate faster than its five-year seasonal average, this is a bullish sign. More participants are entering the market, involving additional buying, and any purchases are generally aggressive in nature.
If the open-interest numbers flatten following a rising trend in both price and open interest, take this as a warning sign of an impending top.
High open interest at market tops is a bearish signal if the price drop is sudden, since this will force many 'weak' longs to liquidate. Occasionally, such conditions set off a self-feeding, downward spiral.
An unusually high or record open interest in a bull market is a danger signal. When a rising trend of open interest begins to reverse, expect a bear trend to get underway.
A breakout from a trading range will be much stronger if open interest rises during the consolidation. This is because many traders will be caught on the wrong side of the market when the breakout finally takes place. When the price moves out of the trading range, these traders are forced to abandon their positions. It is possible to take this rule one step further and say the greater the rise in open interest during the consolidation, the greater the potential for the subsequent move.
Rising prices and a decline in open interest at a rate greater than the seasonal norm is bearish. This market condition develops because short covering and not fundamental demand is fueling the rising price trend. In these circumstances money is flowing out of the market. Consequently, when the short covering has run its course, prices will decline.

Insurance Online

Want an insurance cover for your family, but don't have the time to run after the agents of various companies to decide on a product? Internet's the way to go for you. With policies and products available online, the cheapest deal could be just a click away.

Quick Facts

www.insurancemall.in is India's only insurance shopping website as of now
www.getmeinsure.com also deals with online insurance but is restricted to making comparisons among various plans
Only general insurance policies available online till now
Even among health plans, only those are available that don't require medical tests
Pension plans without life cover can also be accessed
Why online? At present, most people buy insurance products through an individual agent or a bank. However, these entities normally deal with products of only one company. So, you may not get the right deal at the right price from them.

The new insurance shopping websites act as online brokers and help you access and compare deals offered by various companies, and then pick the one best suited to you. Normal brokers, too, serve the same purpose, but their operations are largely restricted to high volumes and, hence, their main clients are corporate houses and big organizations.


Online bargains India's first insurance shopping website, www.insurancemall.in, through its associate firm, Bonsai America, has paved the way for the online insurance seeker. "We give customers the choice to buy any of the existing products," says Mahavir Chopra, chief financial officer (new businesses). Insurance Mall currently offers only general insurance products, but plans to start transactions in life insurance products by the end of July 2007.


Another entrant in the online insurance sector is www.getmeinsure.com. This site, however, is restricted to making comparisons among various plans. "As of now, we do not offer buying on our website but it will be introduced as and when the market is ripe," says Aditya Dwivedi, founder director and chief marketing officer.


General edge: For those looking for general insurance products, such as health, home, travel or car insurance, the online version can be a boon in the detariffed regime. Even pension plans provided by life insurers that come

without any life cover are ideal online plans to buy. In the detariffed regime, general insurance companies have been allowed to fix their own prices for products offered by them. Competition among insurers has led to falling prices. But, to zero down on the cheapest deal, one needs to know about other deals too. Buying insurance online makes the task easier.


"Post-detariffing, the premiums have fallen; they could fall further if online purchases pick up as the insurance companies would then pass on the agent commissions to their customers," says Dwivedi. Some past researches prove this. According to a study done in the US in 2004, the rise of buying on the Net reduced the cost of term life prices by as much as 10 to 15 per cent.

How to go about it: The process of online buying is as simple as it sounds. "Just a few clicks are all that is required," says Chopra. Once the applicant puts in the relevant information, the site lists the available options. The applicant then has to choose a suitable plan and purchase it online. Detailed brochures on each of the policies are also available.


Limitations. All life insurance products should not be bought over the Internet. Planning for retirement, or saving for children, needs focused attention of trained insurance professionals, which may not be available online.


Among the bouquet of health insurance products, only those are available that don't require medical tests. There are no life insurance products on offer yet. Also, the websites do not have all available offers from existing insurers as of now.


Words of caution: Always read the privacy policy carefully to make sure the site doesn't misuse the information you provide. Look for the little lock symbol at the bottom of your web browser screen to make sure that you are on a secure site.


Buying three policies-say a health plan, a car insurance and a term insurance-from three different insurers may make you end up running after three agents of various companies. A broker servicing all the three products and, that too, online, is the way to the future.

Five mutual funds that one can invest in

5 mutual funds that you must own
January 22, 2007 10:50 IST


It's the start of a new year and maybe its time for investors to take a re-look at their mutual fund portfolios to ensure that they are invested in the right schemes. We outline the most "invest-worthy" equity fund schemes that investors should consider owning.

Given Personalfn's mutual fund research processes, the best funds for 2007 are unlikely to be very different from those we recommended in 2006. Its because our view on a fund is crystallised after considerable deliberation that involves scrutinising the fund's performance over the long-term (minimum 3 years, although with some exceptions, many of our recommendations have established themselves over close to 10 years) and even then over several market cycles, particularly the downturns.

Performance of course is the concluding point for us. We begin with the sponsor, the credibility it commands, fund management philosophy of the fund house, its investment approach and processes, whether it promotes a steady, team-based approach as opposed to a volatile, fund manager-based approach. This forms the first line of evaluation for us; if a fund house redeems itself on these parameters then we migrate to performance.

At Personalfn, in a lot of instances we come across clients with a high risk appetite who believe that the best way to invest is to stack your portfolio with as many mutual funds (or stocks) as possible. The idea is that there is safety in numbers so by being 'well-diversified' you can cover all your bases.

To counter the diversification rational we have a quote from Warren Buffet, arguably the leading authority on investments � 'Diversification is a protection against ignorance. It makes very little sense for those who know what they are doing'. So rather than populate your portfolio with every second NFO (new fund offer), it makes imminent sense to invest some time researching mutual funds so as to pick the best funds. The Personalfn Research Team has selected the 5 diversified equity funds that investors with an appetite for risk must own.

Go for the tried and tested
Diversified Equity Funds NAV (Rs) 1-Yr (%) 3-Yr (%) 5-Yr (%) Since
Incep. (%) SD (%) SR (%) Launch Date
DSP ML Equity 45.29 51.6 47.2 46.7 28.9 8.35 0.41 Apr-97
DSP ML Opp. (G) 56.00 51.6 46.5 50.5 32.4 7.92 0.41 May-00
Franklin Flexi Cap (G) 20.95 48.0 - - 52.6 7.98 0.43 Mar-05
HDFC Top 200 (G) 109.47 43.8 45.3 49.9 35.8 7.28 0.43 Oct-96
Sundaram Select Midcap (G) 90.42 67.2 56.1 - 66.1 7.56 0.52 Jul-02
BSE Sensex 54.9 38.2 32.0

. DSP ML Opportunities Fund

DSP ML Opportunities Fund is an equity fund managed with a free flowing investment style, popularly known as an 'opportunities style' of investing. Launched in May 2000, it began poorly by making aggressive, ill-advised investments in technology stocks, but a change in the fund management team was just what the fund needed to effect a change in fortunes.

Although, an opportunities fund, DMLOF is probably one of the more conservatively managed, predominantly large cap diversified equity funds. It pursues a well-diversified investment strategy across stocks and sectors and is far from opportunistic given the consistency in its stock picks.

More than the fund, this is the mainstay of the well-defined investment processes and approach of the asset management company - DSP Merrill Lynch Fund Managers, a respectable name in the fund management business. The conservative fund management philosophy of the AMC is the reason we did not see any gimmicks being launched in the guise of NFOs when most other AMCs were gripped by the NFO frenzy.

In our view, investors with looking to invest in a well-managed, opportunities style, diversified equity fund with a large cap bias should invest in DMLOF.

2. DSP ML Equity Fund

Coming from the same pedigree as DSP ML Opportunities Fund explains DSP ML Equity Fund's (DMEF) steady track record as a well-managed value-style diversified equity fund.

The value style of investing, a popular investment approach in developed markets like the US, is lesser-known in the Indian context. This style involves investing in fundamentally strong companies that are trading at a discount to their fair values till such a time that their stock prices are fully valued. This is a departure from the growth style of investing, which involves investing in fairly valued companies in the hope that stock prices will rise even further.

DMEF scouts for value picks mainly among large cap companies. True to the investment approach of the fund house, it is well-diversified across stocks and sectors. Among its limited peer group, it has usually maintained an edge over competition by providing higher absolute and risk-adjusted returns.

In our view, DMEF is the first stop for investors looking for a well-managed value fund in the large cap segment.

3. Franklin India Flexicap Fund

An equity fund with as limited a tenure as Franklin India Flexicap Fund (launched in January 2005) would not usually have figured so high on our Research Team's list of recommendations. But FIFF is no ordinary fund; it is backed by a fund management team headed by K.N. Sivasubramanian and R. Sukumar, two very experienced fund managers who have given us Franklin India Bluechip and Franklin India Prima.

Both these funds, would normally have occupied the slot that FIFF now occupies, but as we mentioned right at the start, when we can do with one fund, we would not like to have two.

Franklin Flexicap was launched with a mandate to help it overcome the limitations of its illustrious predecessors (Franklin India Bluechip and Franklin India Prima). So unlike them, it can invest in companies regardless of the market capitalisation. So far, the fund has maintained a predominantly large cap portfolio recognising the risks of being over invested in mid caps.

In our view, investors looking for a fund that can invest freely across market capitalisation should invest in FIFF given the impressive track record of the fund management team that is managing it.

4. HDFC Top 200 Fund

Talk of well-managed diversified equity funds and HDFC Top 200 Fund emerges as an obvious option. The reasons are obvious - over the years HTF has established an impressive track record across time frames and parameters related to risk and return.

HTF has undergone a long journey from ITC Threadneedle to Zurich India Mutual Fund finally resting with HDFC Mutual Fund, one of the more respectable names in the AMC business. But a constant with the fund, for most of its existence, has been Mr. Prashant Jain, one of the more competent fund managers, who has directly or indirectly managed the fund. It was under him that HTF made the timely decision to exit technology stocks before the crash in March 2000.

HTF is one the earliest proponents of the index-plus investing style. It is mandated to invest at least 60% of its net assets in stocks drawn from the BSE 200. The fund is invested predominantly in large cap companies. It pursues a relatively well-diversified strategy as far as stocks are concerned but takes sectoral bets to score above-average returns.

In our view, investors looking for a fund that has consistently generated above-average returns at lower risk, must invest in HTF.

5. Sundaram BNP Paribas Select Midcap Fund

Having selected the regular large cap/flexi cap equity funds, it is time to move to a 'niche' fund that can give a boost to your portfolio. Look at Sundaram BNP Paribas Select Midcap for that edge.

Only 4 years in business and SSM has already assumed leadership position in this segment. Managed by Sundaram BNP Paribas Mutual Fund (a fund house known largely for its conservative investment style), SSM has adopted two measures to lower the risk in a relatively high risk segment.

For one, it diversifies its portfolio to include as many as 100 stocks. And two - it moves into cash (upto a maximum of 35 per cent of net assets) when it finds the market at uncomfortable levels. This particular feature held the fund in good stead during the crash in May 2006 when its fully invested peers witnessed significant erosion.

On the flipside, this has worked against SSM over the last few months when its peers have made the most of the rally from 9,000 points to 14,000 points, while it has been sitting on cash (31 per cent on October 31, 2006). However, over a market cycle, we believe SSM will still come out tops vis-a-vis its peers.

In our view, investors looking for a well-managed mid cap fund that has shown consistency in performance across parameters (related to risk and return) must invest in SSM.

Having selected the 5 funds is only one part of the investment process. The other and equally important step is to invest in the funds in the right allocation so as to make the most of what they have to offer investors. For instance, an investor with an appetite for risk who wants to avoid short-term volatility must consider investing a larger amount in HDFC Top 200 than Sundaram Select Midcap.

For the high risk investor, it could be the reverse. To add that element of customisation in your investment plan, you must get in touch with an experienced and competent financial planner

Commodity trading guide

Rajesh Kumar, Outlook Money January 05, 2007
You may have your debt and equity funds in place, but investing in commodities could just be the one element to improve your portfolio. Commodity trading provides an ideal asset allocation, also helps you hedge against inflation and buy a piece of global demand growth.
In 2003, the ban on commodity trading was lifted after 40 years in India. Now, more and more people are interested in investing in this new asset class. While price fluctuations in the sector could get rather volatile depending on the category, returns are relatively higher.
However, as this is not a primary area of investment for most, there is a lot of apprehension about when and how to invest. Outlook Money seeks to answer some of these questions and help you assess a whole new turf for making money.
Why invest in commodities?
Commodities allow a portfolio to improve overall return at the same level of risk. Ibbotson Associates, a leading US-based authority on asset allocation estimates that commodities increased returns between 133 and 188 basis points, at no extra risk.
Who should invest?
Any investor who wants to take advantage of price movements and wishes to diversify his portfolio can invest in commodities. However, retail and small investors should be careful while investing in commodities as the swings are volatile and lack of knowledge may result in loss of wealth.
Investors must understand the demand cycles that commodities go through and should have a view on what factors may affect this. Ideally, you should invest in select commodities that you can analyse rather than speculate across products you have no idea about.
Investing in commodities should be undertaken as a kicker in your portfolio and not as the first destination for your money.
What is commodity trading?
It's an age-old phenomenon. Modern markets came up in the late 18th century, when farming began to be modernised. Though the trade's mechanisms have changed, the basics are still the same.
In common parlance, commodities means all types of products. However, the Foreign Currency Regulation Act (FCRA) defines them as 'every kind of movable property other than actionable claims, money and securities.'
Commodity trading is nothing but trading in commodity spot and derivatives (futures). If you are keen on taking a buy or sell position based on the future performance of agricultural commodities or commodities like gold, silver, metals, or crude, then you could do so by trading in commodity derivatives.
Commodity derivatives are traded on the National Commodity and Derivative Exchange (NCDEX) and the Multi-Commodity Exchange (MCX). Gold, silver, agri-commodities including grains, pulses, spices, oils and oilseeds, mentha oil, metals and crude are some of the commodities that these exchanges deal in.
Trading in commodities futures is quite similar to equity futures trading. You could take a long position (where you buy a contract) or a short position (where you sell it). Simply speaking, like in equity and other markets, if you think prices are on their way up, you take a long position and when prices are headed south you opt for a short position.
How big is the Indian commodity trading market as compared to other Asian markets?
The commodity market in India clocks a daily average turnover of Rs 12,000-15,000 crore (Rs 120-150 billion). The accumulative commodities derivatives trade value is estimated to have reached the equivalent of 66 per cent of the gross domestic product and the future will only see the percentage rising, says ICICI direct.com vice-president Kedar Deshpande.
What do you need to start trading?
Like equity markets, you have to fulfil the 'know your customer' norms with a commodity broker. A photo identification, PAN and proof of address are essential for registration. You will also have to sign the necessary agreements with the broker.
Is there a regulator for the commodity trading market?
The Forward Markets Commission is the regulatory body for the commodity market in India. It is the equivalent of the Securities and Exchange Board of India (Sebi), which protects the interests of investors in securities.
What kind of products can be listed on the commodity market?
All commodities produced in the agriculture, mineral and fossil sectors have been sanctioned for futures trading. These include cereals, pulses, ginned cotton, un-ginned
cotton, oilseeds, oils, jute, jute products, sugar, gur, potatoes, onions, coffee, tea, petrochemicals, and bullion, among others.
What are the risk factors?
Commodity trading is done in the form of futures and that throws up a huge potential for profit and loss as it involves predictions of the future and hence uncertainty and risk. Risk factors in commodity trading are similar to futures trading in equity markets.
A major difference is that the information availability on supply and demand cycles in commodity markets is not as robust and controlled as the equity market.
What are the factors that influence the commodity prices in the market?
The commodity market is driven by demand and supply factors and inventory, when it comes to perishable commodities such as agricultural products and high demand products such as crude oil. Like any market, the demand-supply equation influences the prices.
Variables like weather, social changes, government policies and global factors influence the balance.
What is the difference between directional trading and day trading?
The key difference between commodity markets and stock markets is the nature of products traded. Agricultural produce is unpredictable and seasonal. During harvesting season, the prices of these commodities is low as supply goes up. There are traders who use these patterns to trade in the commodity market, and this is termed directional trading.
Day trading in commodity markets is no different from day trading in the equity market, where positions are bought in the morning and squared off by the end of the day.
Does commodity speculation affect agricultural income in India?
The vision for the commodity market in India is to reduce information asymmetry and make a robust market available to the end producer or farmer. It is also expected to balance out price information and give the producer a better price and a platform to hedge.
The futures market will allow the farmer to see the upside of the price over two to three months and help him decide where to sell.
How to keep updated?
Most commodity trading firms have a research team in place that prepares commodity charts and conducts detailed study on the trends of the commodity in question.
Investing strategies based on this research are usually provided to clients.
They usually provide daily market reports before the market opens and intra-day calls during trading hours, along with monthly and weekly research reports.

How and Why of Investing in GOLD

The street to wealth in 2007 is certainly paved with gold. While equity, debt and real estate may form the core of your portfolio, investing in the yellow metal is an ideal money move this year, say experts.
Investing in gold comes without the drama of the stock markets, you do not have to track minute by minute price movements or be wary of what news flows will send a stock up or down. It also does not have the staidness of parking your money in long-term debt products.
Gold prices have been volatile, but well within ranges and though the metal has had a strong run in 2006 and prices were fairly high, analysts expect there will be a further appreciation. Outlook Money takes you through the hows and whys of investing in gold.
Why is 2007 a good year to buy gold? Every year is a good year for buying gold. It is a "defensive" investment in your portfolio and every penny you put into it is, well, worth its weight in gold, to borrow a clich�. The year 2007, however, promises much excitement in the gold (usually referred to as 'bullion') commodity market.
The key driver for gold prices is the gross mismatch between demand and supply. Indians are the biggest buyers of gold in the world. However, buyers in other large economies like Russia and China have also fallen for its lustre. In the last few months, demand has been at least 15 per cent more than supply, say experts. This is one force that will keep prices on an upward trajectory, they say.
Gold prices are linked to the strength of the dollar. With the dollar weakening and expected to continue doing so, the demand and price of gold would only rise. Central banks of several countries have started adding to their gold reserves. While China is certainly going to increase its bullion reserves and match that of other Organisation for Economic Cooperation and Development (OECD) countries, Russia is seeking to double its reserves and has started buying.
Latin American countries have also been steadily buying gold in the last few months. India also might be mulling a similar move. Former deputy governor of Reserve Bank of India, S S Tarapore, has stated the need for RBI to increase its bullion reserves as the share of gold in our forex reserves is down to 3.16 per cent.
The price of gold is expected to rise also because the cost of production is rising, says a Multi-Commodity Exchange (MCX) official. Moreover, activities in many African mines have reduced due to strife, adding to the low supply situation.
Price movements: The price of gold has been rather volatile, especially in the last six months. It is currently trading at $644 per ounce. Prices are expected to remain between $725-735 in the first quarter of 2007. There might be corrections and dip in prices, but analysts do not expect a sustained trend of falling prices in the bullion market.
However, the price of gold and the movements of the bullion markets are heavily correlated to global macro-economics. Any attempt to rationalise major currencies could affect the price of gold. Devaluation of the dollar, for now, is not imminent but a strong possibility.
The good news here is that, even if all these factors do come into play, analysts say that the price of gold would move sideways rather than drastically downwards. That's more than what you can say of equities!
What kind of gold should you buy? Gold can be bought in various forms and the decision should be based on the reason you need gold. If you see this purely as an investment, you can either buy it in the form of physical gold -- bars, biscuits and or coins or even in a dematerialised form.
For most Indians, gold purchases usually mean buying jewellery. This makes it the rare asset class that you can wear. However, the disadvantage of buying gold in the form of jewellery is that its resale is not always a profitable proposition.
For one, the jeweller discounts what you paid as 'making charges' or 'design charges' from the value of your jewellery. This shaves off a significant part (up to 40 per cent) of your investment. Its second disadvantage is that most jewellers do not give you cash in lieu of your gold. Instead they allow you to exchange it for gold -- jewellery or in a bar or coin form.
However, if your reason for buying gold is enjoying it and wearing it, never mind the value loss; go ahead and buy that necklace that has been calling out to you. However, gold bars and biscuits are ideal ways of investing in physical gold. These are priced at market value and can easily be exchanged for cash.
Though experts say that retail investments in gold should be in the physical form, the modern way to invest is buying dematerialised gold from a commodity exchange as this has its own advantages. The National Commodity & Derivatives Exchange (NCDEX) introduced 100 gram gold futures in November. With this, investors can take positions in gold and will have to give or take physical delivery on the contract's expiry.
The exchange also provides an easy avenue to enter and exit the market as he can always square off his position before the contract closes. Dematerialisation of gold eliminates risks related to physical storage and theft, reducing paper work and facilitating easy transfer of holdings through the electronic mode.
Where should you buy it from? There have been serious debates about the ideal places to buy gold from. This is especially relevant now as banks have also started retailing gold bars and coins to customers.
Bullion experts recommend that it is best to buy gold from a reputed jeweller. Banks that sell gold bars charge a premium as high as 15 per cent for providing you with a 'certificate of purity', but you are assured that the gold is pure. Leading jewellers in all cities also sell pure gold bars, but most do not give a certificate with it.
However, when it's time to sell your gold, the bank does not buy it back and the jeweller that you sell it to has no use for your certificate. You end up paying a premium for no real value addition.
If you buy gold bars or coins from reputed jewellers, not only do they buy it back from you, they also give you the prevailing market rate for it. Jewellers like Tribhovandas Bhimji Zaveri have their own certificates of purity, just in case that piece of paper makes you feel more secure.
In the dematerialised form, gold can only be bought in the commodity exchanges. But make sure your payments are made by cheques and don't forget to take a receipt.
Gold as fund: Gold can be used for wedding expenses or as wedding gifts for your children. It is best to gift gold rather than trying to sell it to meet other expenses. But, do not forget that sale of gold jewellery or bullion is taxable. The short-term (less than three years) rate is your marginal income tax and long-term (over three years) is 20 per cent with indexation.
It is evident that gold is an asset class that you can rarely go wrong with. However you look at it, gold dust is the colour of the New Year.

One Way to Save Tax

Have you noticed ELSS (equity-linked savings scheme) funds are being launched left, right and centre? That insurance companies, not to be left behind, are busy with their single premium, multiple premium and premium back ULIP offerings? That financial dailies are awash with fixed deposit ads offering tax breaks?
Just like mangoes appear in summer, these products tend to emphasise their presence in and around December. For December is tax-planning season: a season when investors wake up to the rather unpleasant, but necessary, task of making investments to save tax.
But if you ask me, this is too much ado for a paltry Rs 30,000. And look at the number of products competing in the same space -- bank deposits, mutual funds, ULIPs (unit-linked insurance products), life insurance products, PPF, NSC and pension plans -- all vying for the aggregate limit of Rs 1 lakh (Rs 100,000) offered by Sec. 80C of the Income Tax Act. And this is not even considering mandatory cash flows like employees provident fund, home loan installments and children's tuition fees.
Which means that the maximum tax most people can save is Rs 30,000. Period.
If you happen to be in the highest tax bracket of 33 per cent, the amount is marginally higher at Rs 33,600. The lock-in period that the tax saving brings in its wake is another irritant. PPF (Public Provident Fund) or NSC (National Savings Certificate) means locking your money for six years. ELSS and ULIPs offer a marginally lower lock-in of 3 years, but you take equity risk with your hard earned money.
'No exit route' in an equity investment is not everyone's cup of tea. And most of all, the 30-odd thousand is hardly going to make a dent in the tax outgo for most investors.
So what's the solution? Does one be a mute spectator and accept the inevitable?
Well, perhaps not. In this article, we are going to discuss two tools that if used optimally can save you heavy taxes. Both when used simultaneously create such synergy in tax savings that it is really mind-boggling. Read on to know more.
The first tool is your basic tax threshold. Readers would know that the first Rs 1 lakh of income is exempt from tax. For non-senior ladies, the limit is Rs 135,000. And for senior citizens (65-plus) the limit is Rs 185,000.
So far, so good.
The second tool that works hand in hand with the first is known as Sec. 56 of the Income Tax Act.
Sec. 56 basically exempts cash gifts between relatives. Although there is a long list specified in the section of what constitutes 'relatives,' for our purposes, suffice it to know that as per the Income Tax Act, you, your parents, your brothers and sisters as well as your children are all relatives of each other.
Now in order to understand how these two tools can be used for some smart tax planning, let us take the example of one Mr Mehta who is 49 years of age.
He happens to be in a senior management job which puts him in the highest tax bracket. He has retired parents who live with him. His wife is a home maker. And he and his wife are also proud parents of an 18-year-old daughter and a 20-year-old son who are both studying in college.
Read Mr Mehta's profile once more if you must because it is important in our scheme of things. Also remember that some of the numbers that are going to be thrown up are astonishingly large. Don't get thrown off because of that.
This is just the power of these tools at work. You can use them at any income level to suit your particular situation. What is important is understanding the concept. . . individual numbers can always be plugged in.
Now Mr Mehta, like most of us, finds that all the tax saving investments in the world can help him save only Rs 33,600. That's not enough. His tax outgo is much more. Moreover, every rupee of post tax paid income that he invests in, say, RBI Bonds, Bank fixed deposits, Post Office MIS, et cetera, is subject to the highest rate of tax.
If he doesn't want to pay tax, he is forced to adopt market risk by investing in equity shares or mutual funds as long-term capital gains are tax-free. But this was hardly a solution.
He has found the stock market to be too whimsical for his liking -- while it gives a reasonably good return for a period of time, it also suddenly falls by around a 1,000 points in a couple of days. Already suffering from hypertension, no beta blocker in the world could prevent his pressure from outswinging the market.
It was at this delicate juncture that Mr Mehta was introduced to our tax planning tools by an old chartered accountant friend of his. This is what Mr Mehta did after his brief, but illuminating, chat with his friend.
He gifted Rs 21.25 lakh (Rs 2.125 million) to his father and a similar amount to his mother. Out of the gifted money, his father invested Rs 15 lakh (Rs 1.5 million) in the Senior Citizen Savings Scheme (SCSS). The balance Rs 6.25 lakh (Rs 625,000) was invested in RBI Savings Bonds.
His mother did the same.
Now what happened was the following. The SCSS yielded an interest of Rs 135,000 (9% of Rs 15 lakh). The RBI bonds yielded a return of Rs 50,000 (8% of Rs 6.25 lakh). The total interest earned by Mr Mehta's father was Rs 185,000. His mother too earned a similar amount.
However, not a penny of this was taxable as it is not beyond the initial tax slab available to senior citizens.
In one stroke, Mr Mehta, effectively made income from over Rs 42 lakh of capital tax-free in the family's hands. Realise that had Mr Mehta invested the funds himself, he would have paid full tax on it. However, since the gift was tax-free and the tax slab was available, this strategy could be put to work.
Now, Mr Mehta finds that his children have some time to go before they start earning. His daughter can earn up to Rs 135,000 without having to pay tax, while his son can earn Rs 100,000 without having to pay tax. But they aren't earning as of now, are they? They are studying and will continue to do so for the next five to seven years.
So what does he do? He gifts them around Rs 17 lakh (Rs 1.7 million) and Rs 12.50 lakh (Rs 1.25 million), respectively. This money in turn they invest in the 8% RBI Bonds. Rs 17 lakh earns Mr Mehta's daughter around Rs 135,000. Of course, as explained earlier, no tax would be payable. Now you can work out the math for yourself in case of Mr Mehta's son.
In effect, by using two simple tools that the Income Tax Act offers, Mr Mehta had managed to make almost Rs 6 lakh (Rs 600,000) of income tax-free for the family. Putting it differently, over Rs 71 lakh (Rs 7.1 million) of capital was deployed, however, the income therefrom was totally tax-free.
Now admittedly, Mr Mehta is an extremely rich man. He had Rs 70 lakh (Rs 7 million) to spare in the first place before trying to make it tax-free. Not everyone will have this kind of money.
However, the example given is an optimal one. You can use a similar strategy with the funds at your disposal and the benefit you derive will be proportional. In other words, it is not an all or none strategy. . . use it to the best of your ability.
Also note that Mr Mehta's profile was an ideal one. A man working in the highest tax bracket with retired parents having no income of their own and two major children who are still studying. Again, not every taxpayer will have a similar profile. You father may have income of his own, but your mom may not be working. Or your children may be earning already. However, the point is to use that particular element in the equation which applies in your case directly. The rest can't be helped.
Note that we have left Mr Mehta's home maker wife out of the picture. There are reasons for this -- the Act specifies that any income earned out of money gifted to spouse is added back to the donor's income for tax purposes. There are ways out of this too, but that is the topic for another column.
Last point
Beyond a point (barring ideas such as discussed above), tax saving is not possible. The worst mistake any investor could make is to invest with the primary objective of saving tax. The question to ask is would you have made the investment if it didn't offer tax saving? If the answer is no, don't touch the investment. It is better to try and optimise post-tax income instead of making a sub-optimal investment just to save on tax.
Or like Donald Trump says, some of your best investments are the ones that you don't make.
The writer is Director A N Shanbhag NR Group, a tax and investment advisory firm. He may be contacted at sandeep.shanbhag@gmail.com

Outlook money: Top 10 Mutual Funds with good growth potential in future

10 top mutual funds you MUST own

Throughout the year, on several occasions, Outlook Money tells you to invest in mutual funds. And now we come to you to say it one more time. Rational thinking says that the equity markets cannot go much higher than the current levels. Yet, who knows?
With each milestone that the Sensex crossed in the past year, experts claimed that a big correction was due. Even today, stockmarket experts do not see much steam in the markets for the next one year.
Yet, on November 22, the Sensex closed at another all-time high of 13,706.53. By the time you read this, don't be surprised if there has been another high. So, what do you do?
Multiple investment options are at your service, but none are as regulated or sharply focused on you, the small investor, as mutual funds.
10 Top Mutual Funds*
DSP ML Opportunities Fund
Franklin India Flexi Cap
HDFC Equity Fund
HDFC Top 200
Prudential ICICI Dynamic Fund
Reliance Vision
SBI Magnum Contra
SBI Magnum Global 94
Sundaram BNP Paribas Leadership
Sundaram BNP Paribas Select Midcap
Click on each fund to find out why you MUST buy it.
* The fund names are in alphabetical order and not in order of any ranking
Outlook Money gives you a list of 10 diversified equity schemes that must form a part of your core portfolio. Why 10? Because putting all your eggs in one basket is risky and it is necessary to diversify across schemes. Because 10 is an easy number of schemes to monitor; it is difficult to manage too many.
Because if Nobel laureate Harry Markowitz showed the risk reduction benefits of holding a diversified portfolio, academicians Evans and Archer, showed that most of the risk reduction due to diversification takes place with the aggregation of eight to 10 securities.
How we chose the 10: To come up with the 10, we considered diversified equity schemes with a two-year track record and crunched their risk-adjusted returns.
We took the one-year rolling returns (an average of one-year returns over the past two-year period) and divided it by their downside risk - the possibility of a scheme giving negative returns - to get their RAR.
We left out sectoral schemes, as these are the riskiest of all equity schemes and merit frequent churning depending on your sector view. We also left out thematic funds, as they are less diversified than plain-vanilla diversified equity schemes. They work best when part of your satellite portfolio.
Next, we looked at a set of qualitative parameters. For instance, our list of 10 schemes comes from fund houses with good pedigree and a long-term track record. Schemes that have witnessed frequent fund management changes were avoided. We also avoided excessive fund house concentration, though HDFC and Sundaram BNP Paribas Mutual Funds have two each of their schemes in our list.
Two schemes that have made it to our list are a slight deviation from the above. While one has a lower RAR, the other is a little less than two years old. Despite this, we feel you must own them; we'll tell you why once we get to them.
Our schemes are not necessarily the 10 best performing schemes in the past year. Our focus is to give you 10 schemes that we think will perform well in the next two to three years, using a healthy mix of numbers and qualitative parameters.
While it's good to own these schemes, you need not own all of them. Depending on the amount you want to invest, you may pick and choose from the list. Read more about each scheme to see which fits you the best.
Just holding is not enough: Your job is not done once you buy into a mutual fund. It's imperative that you consistently, not day-to-day, but, say, once in a month or two, monitor your scheme's performance.
Remember, you invest for the long term. So ignore short term blips. But if your scheme consistently underperforms its benchmark index, it's time for you to look around for better options.
Also, watch out for a change in fund management. The past two years has seen a lot of churn of fund managements. When fund managers change, styles and, at times, even fund strategies change. So watch out. You may want to give a year's time to the new fund manager to perform. If he does not match up to his predecessor, it is time for you to move out.
For now, it's time for you to move in. Over the next few pages, in no particular order, we present the 10 schemes we think you should own.