For all central government employees and pensioners, the Cabinet has approved a pay bonanza. As per the recommendations of the Seventh Pay Commission, the pay and allowances would rise by an average 23.6%. States will also increase the salary and pension of their employees.
Kotak Research estimates that of the Rs 84,900-crore pay panel payout this fiscal by the Centre, about Rs 46,800 crore would be for private consumption, Rs 13,100 crore would be taxes paid to the government by the employees and pensioners on the additional income and Rs 25,000 crore would be saved.
As a first priority, the pay hike and the arrears received should be used to pay off expensive debt and rest invested in long-term products for higher post-tax returns.
Pay credit card outstanding, personal loan
Banks typically charge anywhere between 25% and 45% per annum for rolling over credit card outstanding. Clear off debts on the credit card that charges higher interest rate first. This will reduce your total interest outgo since unpaid dues with higher interest rates accumulate interest faster. Also, if you have a personal loan, pay if off with the arrears that you will receive.
Part payment of home loan
Monthly payout for home loan forms a big chunk of cash outflow for most home buyers. The arrears received could be used to prepay a part of the housing loan, if you have one. While this is a good option, it takes away all cash from your pocket. This has obvious repercussions in case of emergencies when you may need funds immediately. One can also look at increasing the EMI to prepay the loan before the tenure. Instead of discretionary spending on new clothes, vehicles, or gadgets, a wiser decision would be to increase the EMI and prepay the loan sooner.
In a home loan, the interest payout is higher in the beginning of the payment schedule. As you keep repaying, the interest component starts reducing while principal component increases. Hence, it makes sense to prepay in the beginning of the loan tenure than later in the payment schedule.
A part of the increment should be invested in equity mutual funds through systematic investment plans (SIPs). It helps an investor to create wealth, by investing small sums of money every month, over a period of time and investing at an early stage of life gives the twin benefits – rupee cost averaging and the power of compounding. The biggest advantage of SIPs is that the investor doesn’t have to time the market.
In fact, SIPs always make the volatility in the market work in favour of an investor and help in averaging out the cost, which is called rupee cost averaging. For instance, with R1,000 one can buy 50 units at R20 per unit or 100 units at R10 per unit depending on whether the market is up or down. If you are starting out young, equity funds should constitute around 80% of your portfolio as this asset class has been found to be the best bet for growing money over the long-term, especially if you start early.
For risk-averse individuals, Public Provident Fund (PPF) is the most preferred investment option as it is backed by the government, is tax-exempt at all stages and currently gives a return of 8.1% per annum, compounded yearly. Deposits made up to Rs 1.5 lakh under PPF qualify for deduction from income under Section 80C of I-T Act, and the PPF account matures after 15 years and can be renewed for every 5 years thereafter.
The government has recently allowed premature closure of PPF account after five financial years if the amount is required for treatment of serious ailments of the account holder, spouse or dependent children or if the amount is required for higher education of the account holder or children. An individual can do part withdrawal every year from seventh financial year from the year of opening account. So, look at all these options to make sure that the additional money that you get generates higher returns in the long run.