Financial Questions I received from a friend

Publishing here if it helps other readers
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Question:

Needed a quick advice.

Ever since my EMI days, I have been slowly out of the market.

And now, I am so totally out of the market.

I just wanted to keep some money aside, and was wondering which was a better option.

Now that banks are giving a 9.5% interest rate, should I make an FD? Or should I invest in MF?

Even at 16K index, if you suggest an MF, then could you please suggest me funds and give me a breakup for investing 1L

I trust your market knowledge the best, and also got no time for any research, and hence would like to follow your advice.

Would really appreciate your time in suggesting.

Response:

this is so heartening to see young people investing for future.

The choice of investment instrument depends on your goals, risk tolerance

and risk capacity.

I read this in your email : "I just wanted to keep some money aside".

This begs the question - what for ?

I mean, what is the goal for this money ? Sounds like you would like to keep

some money as an emergency fund, which can be used in case you need money

urgently for some reason. This is a very good idea and experts say you should keep

about 6 months expenses (plus EMIs) as "emergency fund".

In case of a job loss or health problems (god forbid), this will help you.

So if that's what you have in mind, this fund should be kept in an instrument

where the risk of principal loss is minimum.

FD would be a good idea but for high tax brackets, the post-tax return sucks !

This doesn't even beat inflation. So 9.5% rate actually is not that attractive because

after tax, it is more like 6.5%.

I would consider Liquid mutual funds or variable interest rate debt funds.

They are tax efficient. The post-tax returns are better than FDs.

If you can block the fund for some period (a year or more), you can look at

FMPs. But then blocking funds earmarked for emergency doesn't make sense.

I would strongly suggest Liquid mutual funds. Opt for dividend reinvestment option.

But don't keep too much money in this emergency fund. Six months expenses plus EMIs.

Any more, and you are missing out on higher returns of other financial instruments.

Look up this site for more info on these funds.

Hope this helps.

"Even at 16K index, if you suggest an MF"

Choice of financial instruments has nothing to do with index levels.

It depends on your goals and your risk profile. I invest in equity MF every month for

my long term goals, irrespective of where index is.

Question:

Thank you for such a detailed mail.

My purpose was actually an emergency fund, which you figured so well.

Thank you for explaining how much an emergency fund should contain.

I really wasn't so sure.

I shall go over all the options that you have mentioned and then write back, for suggestions/clarifications.

"If you can block the fund for some period (a year or more), you can look at FMPs. But then blocking funds earmarked for emergency doesn't make sense."

What are FMPs?

Also If I want to start to invest monthly in MF, do you have any MF recommendations?

Response:

you are welcome !

FMPs are a special kind of bond funds.

Bond funds (also called "debt funds") are mutual funds that take money from investors like us

and lend to companies and government. Usually they don't lend directly. But they buy bond papers.

Usually debts are long term things - may be decades. To provide liquidity (so that investors can get

out if they wish to), debts are secuterized and sold in small pieces (called bond papers).

So these bonds are sold and bought in the market just like shares.

Bond funds trade in such papers and the value of these papers determines the NAV.

How FMPs are different is that they buy and hold papers for a Fixed Maturity Plan.

So they are not so volatile and the NAV doesn't swing when interest rates change.

So FMPs are safe investments in terms of volatility. They give around the same return as FDs do.

But they are much more tax efficient (for those in high tax brackets).

These should help you:

http://www.dnaindia.com/report.asp?NewsID=1001843

http://inhome.rediff.com/money/2006/dec/27spec.htm

http://www.themoneytimes.com/articles/20060715/fixed_maturity_plans_the_best_bet-id-10815.html

http://www.rediff.com/money/2006/jul/10perfin.htm

http://in.rediff.com/getahead/2005/may/16fund.htm

"Also If I want to start to invest monthly in MF, do you have any MF recommendations"

I would love to, but I have no data on your goals and risk profile to base my recommendations on.

Feel free to call me and discuss.