Investment Archives - Page 4 of 7

How much taxes should you pay on dividends?

April 24, 2014 by Srinivasan Rangarajan 1 Comment

Dividends are a way to get easy profits, without even having to work in a company. But lot of people have the question of how much taxes does one owe to the government. Here is the easy answer:

ZERO TAXES

Yes, you read that right. Shareholders do NOT have to pay any taxes on dividends earned. That is great right? You get all the profits from the company and you also don’t have to give to the government any share.

But the government wouldn’t give up on such an easy money, right? True. That is why the government asks the company to pay something called a Dividend Distribution Tax (DDT). The company needs to pay a flat 15% DDT on all dividends that it wants to distribute to the shareholders, even before it pays out the dividend. On the 15% DDT, they also need to pay 10% surcharge and an education cess of 3% – leading to a total of 16.995% (FY 2013-14).

You as a shareholder do not have to worry about all this, as the DDT is paid for you by the company directly. So any money you get as dividend in your bank account is tax-free. You may think that it is great, right? Company handles all the taxation and you also get nice profit as an investor.

But remember you do lose 16.995% of your money to the government. Since dividend is calculated on after-tax profit of the company, DDT is an extra expense for your company. Remember, Income tax on profits is 30% (+surcharge +cess) and whenever the company declares dividends, an extra 15% (+ surcharge +cess) is paid.

Almost 50% of your money (earned in the business) is given away to the government whenever you get dividends. That is why there are two kinds of companies:

which gives regular dividends to the shareholders
which retain the maximum profits for developing more value out of the system (best example was Apple when Steve Jobs was alive)

Both of these companies are important and shareholders need to have both types of companies to get the best returns out of his investment. Since, India doesn’t tax dividends in the hands of shareholders, many experts will suggest investing in companies which give regular dividends with high dividend yield. At least you get back some money from your investment – almost like a FD in some cases.

Getting back a nice fat cheque (of Rs. 6 crores) tax-free every year is a good enough reason, if you ask me. And as long as the government uses all this money to improve the infrastructure and for the general public, it is a win-win situation for everyone.

Understanding Dividends and the various dividend dates

April 23, 2014 by Srinivasan Rangarajan 1 Comment

Dividends are payments that a company pays to its shareholder from the profits it had earned from running the business. When a company earns profits, they have the choice to either reinvest that money into the business for expansion, acquisition of other companies, hiring more employees, etc. There also can divide the profits and give it back to the investors, as a token of appreciation for believing in the company and investing in it.

Most companies retain a part of the profit for investing back into the business and pay the remaining profits as dividends. This is done so that there is enough cash for running the daily business and also helps earning the goodwill of the investors. Dividends are paid as cash and mostly credited into your bank account on a specific date (or they may mail a cheque if you are old-fashioned).

Companies declare dividend as an amount per share. Example, if you owned 1 share of SBI, and the company declares Rs.5 per share as dividend, you would get Rs.5 credited in your account. If you owned 100 shares, 100 shares * Rs.5 = Rs. 500 will be your dividend.

Now you may say “Neat. So if I know on which date a company is going to pay dividends, I can buy as much stocks as I can before that date and after I get the dividend, sell all the stocks. Easy way to make profits right?” Yeah right, thats how people earn money in stock markets. No you dumbo. If it were that easy why are we still going for jobs and running businesses. Everyone can buy and sell dividends before and after the dividends are paid.

To understand this, you need to understand a few “dates”:

Announcement date
Ex-dividend date
Record Date

Announcement Date

This is the date that the company board of directors announce that they want to declare a specific amount per share as dividend. The announcement is done to the exchanges and this date is simple to understand.

For example, lets assume a company announces dividends on 21 April, 2014. During the announcement, you need to find out two other information (other than the amount being paid) – Ex-Dividend Date and Record Date. In our example lets assume that the company announces Ex-Dividend Date as 1 May, 2014 and Record Date as 2 May, 2014.

T+2 Settlement

When you buy a stock on the exchange, it doesn’t immediately gets credited into you DeMat account the next second. It takes some time for the seller to give the stock to his broker and then to your broker and then to your DeMat account – this is called settlement. In India we follow what is called the T+2 settlement. Meaning: it takes 2 days from the date of the transaction for the stock to come to your account. Transaction Date + 2 days.

So if you bought a stock on 21^st of April, it would be credited to your DeMat account on 23^rd of April. After 23^rd of April, your name is now in the record books of the company and you are one of the proud shareholder.

Record Date

Now Record date is the date the company takes out it’s record book and makes a list of all it’s shareholders. Actually since everything is now in electronic format, it isn’t an actual book, the company asks the depository (who holds your DeMat Account) for a list of all shareholders on the Record Date. Now after it gets the record date, all it has to do is, distribute the dividend per share to all the shareholders and everyone will be happy. In our Example, 2^nd May is the record date – so if your name is in the records of the company on 2^nd May, you will get the dividend.

Ex-Dividend Date

Now you may ask, what is the Ex-Dividend Date. Lets say the stock is trading at Rs.100 per share and the company announces a dividend of Rs.5 per share. Now from where does the company pay the dividend? From the profits of the company. The stock price is a calculation of the companies assets, liabilities and also any profits it earned each quarter. So if part of the profit is taken out as dividend, the stock price also will be adjusted appropriately. So the stock price will become Rs.95 (actually even a bit less because of taxes, but we will see that later).

Now there must be a date when the stock price is adjusted from Rs.100 to Rs.95 – from cum-dividend to ex-dividend. Before the ex-dividend date, the stock price includes the entire profit and dividends. On the ex-dividend date, the dividend is taken out of the company accounts and the stock price also reflects this change. This is also announced by the company. See, your master plan of buying before dividend and selling after dividend to profit the money is gone.

Understanding Dividend Dates — Click to Enlarge

When should you buy to get dividends?

But you are not finished yet. You need to make sure you bought the stock on the correct date to get the dividend. If our example 1^st May is the Ex-Dividend date. So you much buy the stock before date (cum-dividend) to get your dividend. Lets say you bought the stock on 30 April and based on the T+2 settlement calculation, the stock would be in your DeMat account on 2^nd May. Your name would be listed as a shareholder on 2^nd May and you would get the dividend.

Lets imagine you missed the date and bought the stock on 1^st May. Your DeMat account would be credited on 3^rd May only and you are not eligible for dividends. Does that mean you lost money? No. Remember that 1^st May is Ex-Dividend date, so you bought the stock at Rs.95 instead of Rs.100. So you are paying less for the stock than what others paid on 30^th April. The dividend of Rs.5 is already in your account as you didn’t spend it at all.

Initially this concept is a bit tough to wrap your mind, but if you read it again, you can easily understand it.

As long as you buy the stock before the Ex-Dividend date, you are eligible for dividends. Anything on or after Ex-Dividend, you won’t get dividends.

Types of correction and understanding it

April 22, 2014 by Srinivasan Rangarajan Leave a Comment

Prices of any asset doesn’t always go up. Whenever the prices rally, there is bound to be a correction soon. A correction is when the prices stop going up and begin going down. It is usually a good thing as it helps adjust the price as the sudden increase has overvalued the stock. This holds true for any asset class you may choose – be it stocks, bonds, gold or even real estate. Lot of people think, well gold and real estate prices never go down, it always goes up. But, they were also affected badly when recently gold prices dropped last year.

It is the same case for real estate, as the prices have stagnated and have stopped going up and the inventories of various builders are growing. But you may ask, the prices haven’t gone down, right? Actually you may not realise it, but the prices have corrected – not in absolute value, but in terms of time value.

Assets can correct in two ways:

Price Correction
Time Correction

Price Correction

This is simple to understand. When the price of an asset rallies up a lot and then comes down by at least 10%, it’s value has gone down. Example, say a stock has grown from 100 to 200 in about 3 months, which is a 100% increase, and the prices correct back to a lower level (say Rs.170) before it can continue the rally.

This is what we call as price correction. This is important in any healthy stock or market. If the prices keeps on increasing without even a little correction, it is mostly manipulated by operators and is very risky, it might be leading to a bubble. Occasional corrections are OK and nothing to worry about. Lot of people panic when they see the prices correcting to even a very low 3%-5%. That is nothing to worry about as long as your view of the company hasn’t changed and you believe the stock will go back up.

Time Correction

This is a type of correction that many people wouldn’t think about. It is also popularly known as consolidation in technical analysis. Lets say a stock price increases from 100 to 200 in 3 months (same 100% increase), but for the next 3 months it doesn’t go anywhere and it just oscillates between 190-210, it is called time correction. Even though an investor who got in at Rs.100 is happy that he doubled his investment in 6 months, I would say he wasted 3 months.

He as a short-term trader, is losing money by holding on to this stock. This is what is called time correction. Many stocks consolidate after a huge rally to take a breather. After the consolidation, the prices can either continue the rally or can even go down. This is a risky time to enter into the stock.

Which type of correction is popular?

Both types are corrections are possible in all asset classes. Even high-quality blue-chip stocks like SBI, Reliance, HDFC, L&T, etc., correct or consolidate after a rally. So is gold, the price of gold kept rising for a long time and every one said, “No one can lose money investing in gold”. But the prices did fall and many investors in gold were hurt badly.

Real estates correction are much harder to see, because there is no officially published market price for a piece of land. But the prices can decrease, but realty is more prone to time correction. A price of a land which nearly doubled in 2 years would stay at the same rate for even more than 4 years. Since most home owners don’t sell their apartment within a few years, they don’t realise that the returns they got is almost the same as they getting from a FD.

Remember this next time you invest in an asset and the price has not moved at all for a very long time. You are losing money by holding it. Instead its best to book your profits and switch it over to an asset which has a much higher chance of a rally. Also just because an asset has corrected doesn’t mean it needs to be sold. Holding onto it may give you even better returns.

The mistake that cost me nearly Rs.100,000

April 21, 2014 by Srinivasan Rangarajan Leave a Comment

In the year 2007, lot of retail investors saw how the markets gave such phenomenal returns for their neighbours and began to invest most of their money into buying stocks. I too invested in many mutual funds & stocks in the last 3 months of 2007 – more than Rs. 100,000. January 2008 came and the markets saw the biggest fall and before the year ended, it hit the low of almost 2600.

Nifty daily chart from 2000 — Nifty Chart from 2000-14 (click to view large image)

Many retail investors lost money they had put in and the markets didn’t see the previous highs until the year 2010, but then again faced a correction. But it was just the index which had performed well and people who had invested in lot of individual stocks got their wealth eroded. Most mutual fund investments were also in the red and there was no other option than to wait or book losses.

I waited and it was only in end of 2013, that the markets attained new highs and now there is a pre-election rally that is going on hopes of a stable, business friendly government. So now that the markets are making new highs, what about the investments I made? How much profit I made?

In most mutual funds I had gotten back all the money I had invested with maybe 1% returns (mostly even less). Few stocks I made a profit and there are many other companies that have gotten so low that it costs more money to hold them in my DeMat account than if I sold it today.

What was the mistake I made?

All my investments during the 2007-2010 were all done in lump sum. One of the mutual fund agent (a friend’s father) had advised me to go for the SIP route as my cost would average out if any corrections happened. But me and my father decided against it and ended up putting all the money in lump sum.

That was a very costly mistake. You may ask “You got back your money in the funds you put in right? You didn’t lose anything.” No, remember the effect of inflation. Even though I got back all my money, I lost 6 years. And the Rs.1 Lakh I had in 2007 is worth much more than the Rs.1 Lakh I got back in 2014.

Imagine me investing the Rs.1 lakh in a bank fixed deposit and letting it grow for the 6 years. It would have nearly doubled in the 6 years. I lost the potential to grow that 1 Lakh to 2 Lakhs. This is the case for many such retail investors who got into the market at the near top, they are now only seeing absolute returns of about 6-7%, that too for 6 years.

What is the lesson?

It is common to make mistakes, but if one learns from it, it was worth it. My mistake cost me a possible return of nearly Rs.1 lakh and I learnt this valuable lesson. I am giving you this lesson for free, so that you don’t make the same mistake.

If you are investing in the markets via mutual funds or in the index via ETF, always use the systematic investment plan (SIP) option. It is easier on your pocket as only a part of your salary goes into the investment and you also get the benefit of Rupee Cost Averaging. You are protected against the market volatility and since no one can time the markets, it is best to let math decide your average cost. Remember this as a rule.

If I had used a monthly SIP for my investments, even starting in the highs of 2008 would only be profitable for me. With the bear market and various corrections again from 2010, I would be able to sit on a much bigger profit than what I would’ve gotten in bank FDs, not to mention what I earned in the lump sum investments.

Remember, you can’t make all the mistakes in the world. It is much easier (and cheaper) to learn from other’s mistakes.

5 reasons to start your tax planning today

April 20, 2014 by Srinivasan Rangarajan Leave a Comment

Many salaried employees suddenly wake up in January and begin investing in various assets for tax planning for the financial year (which in India is from April to March of next year). They rush to take numerous insurance policies (usually from some LIC agent in their office) and by March they are pretty pissed out.

Reason: Almost all their salary for the three months (Jan/Feb/Mar) has gone to these unwanted tax savings and this is one of the main reason they begin to hate Income Tax.

It need not be like that. There is a reason it is called “tax planning“. The best time to begin planning your tax savings is in April – the beginning of the new financial year. Here’s why:

Easy on your pocket

If you split your investments into 12 months instead of trying to cram it all up in 3 months, the total outgo on your salary becomes manageable. Lets say your salary is Rs.50,000 per month and you have to invest Rs.1,00,000 in 80C. Investing Rs. 1 Lakh in 3 months is more than Rs.33,000 per month. While spread in 12 months is slightly above Rs.8300.

Which is easy? Taking home Rs.41700 per month for the entire year? or Rs. 16000 per month in the last 3 months? What would you do if you need some money for an emergency in February?

Which would you like? The first image? Or the second image?

Last Minute Tax Saving — Salary affected maximum in last 3 months

Regular Tax Planning — Salary affected minimum per month

Easy on your mind

Last minute rush can be taxing on your brain and you don’t want to be running all around the place to get your finance right. Especially if your Annual Performance Review is around the corner, you better spend all your creative power on your work and get a better pay raise than fighting the tax headache. Getting that higher salary can be much easier and more beneficial to the growth of your investments than you trying to save few hundreds of rupees here and there.

Investing Early

There is a saying “The best time to invest was Yesterday (or last year or 34 years back). The second best time to invest in today.” I have already shown you examples of how starting your investments early can make a significant difference to your retirement corpus. By beginning to invest today, your investments would be growing at a much faster rate than 90% of others around you. Remember this site is about getting richer than what you were yesterday, also richer than your friends/colleagues around you.

Investing in the correct products

Investment decisions cannot and should not be taken in a split second. You need to spend lot of time thinking about the various investments products and assets before putting your hard-earned money. Whatever asset classes you invest in, there will be a lot of volatility in the price – be in stocks, bonds, gold, real estate. Even your bank FD interest rates can change any day. When you have the time to think, you can invest your money in the correct products at the right time.

Systematic Investment

If you are young, majority of your investments should be equities. And equities is one of the most volatile asset. So what is the best method to invest in such products? Systematically. That is why mutual funds have monthly mode as the most common SIP (Systematic Investment Plan) option. If you put in your money every month, you are going to get on average much higher number of units than doing a lump sum payment.

Also if the markets are at the peak like in January 2008 you made a lump sum investment you would have gotten back your money only recently (after this election rally). You would have lost 6 whole years and that is a risk no one should take.

Conclusion

Remember these reasons when you think about tax planning or any investment for that matter. It is not that difficult as you can set almost everything up as automatic investments and you wouldn’t even have to think about it at all for the rest of the year.