Suppose a prudent investor has accumulated assets like a Rs 50-lakh flat, another Rs 30 lakh worth of land and a blue-chip stock portfolio worth some Rs 10 lakh as well as PPF and Ulips.
His net worth approaches a crore and he’s doing well. Now, assume this man has an emergency. How much can he raise in a hurry? Given a working day or two, he can get a loan to the value of about 50% against his share portfolio.
But it will take several days to process loans with property as collateral and maybe weeks to make a distress sale. And it may also be cumbersome and time-consuming to withdraw from a PPF account or a Ulip. Clearly, the man is high on networth but low on liquidity.
Financial planners say that there should be enough cash or near-cash assets in a portfolio to cover three to six months of expenses (rent, food, transport, EMIs and utilities).
You can use credit card(s) and empty your savings account. Other assets are “near-cash” or illiquid. Near-cash assets can be converted quickly but they tend to give lower returns than illiquid assets. “The objective of near-cash instruments is to provide liquidity on one hand and more returns than a normal savings account, on the other,” says Rahul Aggarwal, CEO, Optima Risk Management.
Investments in liquid funds, floating-rate funds, short-term fixed maturity plans (FMPs) and flexi bank accounts can all be redeemed within 48 hours—or less—thus offering easy liquidity and better returns than a savings account does.
Liquid funds or cash management funds are primarily investments for managing short-term cash.They offer optimal (about 6% post tax) returns with moderate risk and high liquidity. Unlike most mutual fund schemes, liquid funds do not levy loads on entry and exit. These fund schemes invest in financial instruments of less than one year maturity such as shortterm debt and money market instruments, certificate of deposits, shortterm debentures, fixed deposits and treasury bills.
Income from growth plans of liquid funds are taxed as capital gains and income from dividend plans are tax free in the hands of the investor. The fund pays dividend distribution tax at 22.44% for corporate investors and 14.03% for an individual, both of which are lower than the highest income tax rate (33%).
“My suggestion is to opt for liquid funds; especially the dividend option of liquid funds. They are tax efficient, and though they do not come with any guarantee they are virtually zero-risk product,” says Jayant Pai, Mumbai-based certified financial planner.
Short-term FMPs also invest in debt instruments and money market instruments. The instruments are held till maturity and give less volatile returns. FMPs are available with time horizons of 15 days, one month, three months, six months and one year. The minimum investment amount is usually Rs 5,000.
FMPs have low expense ratios (0.2-0.5%). Tax treatment of short-term FMPs is similar to that of liquid funds. They offered post-tax returns of 5-6% last year. These FMPs can be redeemed within 24 hours but there is an exit load in case of premature redemption.
Floating-rate funds generate stable returns by investing largely in floating-rate instruments and fixedrate corporate bonds. Floaters protect returns in a volatile interest rate environment. Investors can use floaters for very short investment horizons of 1-3 months. Fund expenses are minimal (0.5-1%) but there is an exit load of up to 0.5% if redeemed before 10-15 days. Dividends are taxed at a higher rate of 28%.
Most banks also offer flexiaccounts. If the balance in your savings account exceeds a certain limit, it is swept into a fixed deposit (FD) and earns higher interest. The money can be withdrawn just like from a savings account. This combines savings account liquidity with the higher returns of FDs.
Every bank has its own criteria for a flexi account. You can even avail an overdraft facility and pay back with interest (normally 2%) only on the withdrawn amount. The balance FD continues to earn interest at prevailing FD rates.
You can get an overdraft facility from a bank against the shares held by you. The overdraft is usually about 50% of the value of the holding. A current account is opened in your name and you are given a cheque book and an ATM card. You can withdraw cash or write cheques up to the limit given to you. However, banks lend only against a few select scrips. Interest of about 0.05% is charged per day on the amount withdrawn.
But there are a few caveats. If you withdraw up to the maximum limit and the stock markets crash, the value of your collateral will go down. You are then required to provide additional margin, failing which the bank can sell your shares to recover the loan. That’s why it’s advisable to keep some excess limit unutilised. Specified mutual funds, insurance policies, bonds, NSCs, gold certificates, even your car and house qualify as collateral for such a borrowing facility.
Since near-cash instruments are easily available, there is no point keeping large amounts of cash or hoarding gold as Indians did traditionally. In fact, if you have a cashless health insurance plan for your family, then liquidity requirements are further reduced. Like most assets, near-cash instruments carry some risks.
“Market risk is high in case of FMPs as they also invest some part in equities,” says Ashish Kapur, CEO, Invest Shoppe. There’s also interest rate risk—an upward movement in rates cause bond prices to decline. It’s up to you to ensure that your near-cash portfolio earns as much return as possible while offering adequate cover. That way, if there is a crisis, you possess a financial parachute.
