"My relationship manager has shared with me the details of a financial product denominated in dollars. This will assure me a lump sum in dollars after 20 years. I am very attracted by this offer, as I intend to send my son for higher education after 20 years and this investment can protect me from the depreciation in the Indian rupee over the next 20 years. Should I buy this instrument? "
This question was posed to me by Mritunjay, an upwardly mobile professional. I was intrigued and asked him to tell me his rationale for being attracted to this product. Here is how he explained it to me:
"I can remit (and invest) up to $1 million (he had four family members) every year but have consciously decided to stay away from any foreign investment, as I am not comfortable and do not understand the foreign markets. But my son will definitely do his post graduation in the US. The course currently costs around $75,000 (approx Rs 48 lakh). If I invest in this dollar-denominated instrument it assures me a lump sum of $90,000 and if the performance is good it can be as much as $135,000. Although the return is low, I will be getting the money in dollars, so I won't be affected even if the rupee depreciates considerably in the next 20 years. What should I do? "
I took some time to respond. A little bit of goggling helped me find out the average inflation in college education expenses in the US is around seven per cent per annum. This effectively meant that his investment value even at $135,000 would meet less than 50 per cent of his requirement of $290,000 at the assumed rate of inflation of seven per cent. Clearly if he wanted to protect himself fully he would need an investment in dollars that has a reasonable certainty of coming close to seven per cent and that too after he had paid taxes due in both the US (did not know how much) and India (definitely payable at the highest rate here). His US investment would need to earn 10 per cent in dollar terms to give him a corpus sufficient to meet his son's education expense requirements.
The average rate of rupee depreciation vis-à-vis the dollar over the last 20 years is around 3.50 per cent per annum (the dollar was around Rs 32 in 1995 and is currently around Rs 64). Assuming the same rate of depreciation for 20 years, the rupee would be quoting at around Rs 130 at that time. If he invested Rs 48 lakh in rupee-instruments and if that earned 11 per cent post tax, it would amount to Rs 375 lakh in 20 years, which would give him the required amount of $290,000 at that time.
I asked him "You tell me what is easier: trying to earn 11 per cent per annum post tax in a known market like India or earning 10 per cent in dollar terms and would the risks you take even be comparable assuming you can understand them? "
The point I made to him is that rupee depreciation risk vis-à-vis the dollar is built into the inflation assumption that we do on the goal and we can take it a little more aggressively to provide for it even through rupee investments. You do not need to invest in dollar instruments just because you need dollars at the end of 20 years. The size of Mritunjay's portfolio just did not justify the complications that would necessarily entail from making direct investments in foreign instruments. I told him to remember the double tax issues and more importantly the unwelcome attention he is likely to attract from the tax department when he discloses these foreign assets in his tax returns.
At the same time a certain amount of portfolio diversification into foreign markets is a must even for those with no need for any dollar amounts in the future, But this exposure could be more easily taken by investing in the international fund offerings of several Indian mutual fund houses who have the wherewithal to research those markets (or invest passively in those markets through index funds) which avoids compliance issues and are also tax-friendly and easy to handle for clients like him.
Mritunjay ultimately decided to defer the idea of investing in foreign assets altogether (whether directly or through international funds from Indian mutual funds) but that is not necessarily the best way forward.
What do you think?
This question was posed to me by Mritunjay, an upwardly mobile professional. I was intrigued and asked him to tell me his rationale for being attracted to this product. Here is how he explained it to me:
"I can remit (and invest) up to $1 million (he had four family members) every year but have consciously decided to stay away from any foreign investment, as I am not comfortable and do not understand the foreign markets. But my son will definitely do his post graduation in the US. The course currently costs around $75,000 (approx Rs 48 lakh). If I invest in this dollar-denominated instrument it assures me a lump sum of $90,000 and if the performance is good it can be as much as $135,000. Although the return is low, I will be getting the money in dollars, so I won't be affected even if the rupee depreciates considerably in the next 20 years. What should I do? "
I took some time to respond. A little bit of goggling helped me find out the average inflation in college education expenses in the US is around seven per cent per annum. This effectively meant that his investment value even at $135,000 would meet less than 50 per cent of his requirement of $290,000 at the assumed rate of inflation of seven per cent. Clearly if he wanted to protect himself fully he would need an investment in dollars that has a reasonable certainty of coming close to seven per cent and that too after he had paid taxes due in both the US (did not know how much) and India (definitely payable at the highest rate here). His US investment would need to earn 10 per cent in dollar terms to give him a corpus sufficient to meet his son's education expense requirements.
The average rate of rupee depreciation vis-à-vis the dollar over the last 20 years is around 3.50 per cent per annum (the dollar was around Rs 32 in 1995 and is currently around Rs 64). Assuming the same rate of depreciation for 20 years, the rupee would be quoting at around Rs 130 at that time. If he invested Rs 48 lakh in rupee-instruments and if that earned 11 per cent post tax, it would amount to Rs 375 lakh in 20 years, which would give him the required amount of $290,000 at that time.
I asked him "You tell me what is easier: trying to earn 11 per cent per annum post tax in a known market like India or earning 10 per cent in dollar terms and would the risks you take even be comparable assuming you can understand them? "
The point I made to him is that rupee depreciation risk vis-à-vis the dollar is built into the inflation assumption that we do on the goal and we can take it a little more aggressively to provide for it even through rupee investments. You do not need to invest in dollar instruments just because you need dollars at the end of 20 years. The size of Mritunjay's portfolio just did not justify the complications that would necessarily entail from making direct investments in foreign instruments. I told him to remember the double tax issues and more importantly the unwelcome attention he is likely to attract from the tax department when he discloses these foreign assets in his tax returns.
At the same time a certain amount of portfolio diversification into foreign markets is a must even for those with no need for any dollar amounts in the future, But this exposure could be more easily taken by investing in the international fund offerings of several Indian mutual fund houses who have the wherewithal to research those markets (or invest passively in those markets through index funds) which avoids compliance issues and are also tax-friendly and easy to handle for clients like him.
Mritunjay ultimately decided to defer the idea of investing in foreign assets altogether (whether directly or through international funds from Indian mutual funds) but that is not necessarily the best way forward.
What do you think?
The writer is a Sebi-registered investment adviser