Should a parent quit working after the birth of a child?

There are some grey areas in personal finance and there are some downright dark areas. One such dark area is how a couple should prepare for parenting duties once a child is on the way. Dark, because there are several possibilities and each would impact the present and the future in several ways.

Child birth will impact a families cash flow (salary, expenses  emi etc.) in several ways. One question that will influence cash flow, lifestyle and future goals is,

Should a parent quit working after the birth of a child?

More importantly, it would influence the way in which the child grows up.

My answer is yes, one parent should quit a full-time job, if this is possible. Not necessarily the mother (lest you call me a conservative caveman), but a parent (at least one!).

Some of my friends and relatives are shocked to find out that my wife did not resume work after she gave birth to our son. She is just as qualified as I am and more accomplished that me. It irritates and upsets us to hear them say, “why do you waste your education (Phd)? Please resume work. The child is big enough now”.

To be frank, I am relieved that my wife chose not to work after my son was born. Both my parents worked and I was raised by my aunts in a joint family. Although I was raised right (hopefully!), I longed for my mother. I did not want my son to go through what I went. So yes, I was relieved.

Relieved because it is not up to me to tell her what to do. She chose to put her parenting duties in front of her career.  Taking care of our son mattered more.

She is certainly not wasting her education. Her education is devoted to making my son a ‘civilized human being’ (as my nearly 5 year old son puts it!).

To think that education should only result in a fat pay cheque is not quite civilized.

The Thinker. Photo Credit: Brian Hillegas (Flickr)

The Thinker. Photo Credit: Brian Hillegas (Flickr)

I am also thankful because we had the luxury of choice. We could manage expenses and investments on my earnings and she could choose to stay at home at least for some years – until the child grows up (we just realized that it could a min of 18 years!)

Should only those couples who can manage on a single earning, have a child? I wish I could answer yes, but that would mean I was never born.

My parents did not have the luxury. Both had to work. Had they not, I could never have spent 10 years after school getting an education and two more to get a stable job. I would have been forced to take up a degree that I may not have liked. Forced to work instead of studying more.  Like I said, dark area!

If a couple can manage their long-term needs with a single earning after becoming parents, I think one parent should quit their full-time job and take care of the child. Careers be damned. Nurturing the child is of paramount importance.

Molding the child’s value system and encouraging the child’s curiosity are 24 x 7 tasks and  best done by a parent*

*there are two assumptions here. One, the assumption here is that the parents have some values in the first place! Otherwise it is best done by a grandparent (assuming they have some!). Two, see below.

Like they say in the movie ‘9 months’, you need a license for driving a car, hunt game, own a gun, get married, but you don’t need one to become a parent! (Unless you are in China)

Many thrust their child with the grandparents and go to work. Many invite their parents to the US only after they become parents! How justified is that? Dark area!

Look before you leap, they say. That applies to before and after marriage.

Before we get that joint home loan, before we procreate, I think the possibility of managing the family with one parent at home should be seriously considered.

Thankfully staying at home does not mean not earning an income. The stay-at-home parent can work part time (some choose work-from-home but not sure if that is smart) and engage themselves.

Yes, this will impact the possibility of a better lifestyle in future, but I think that is not as important as spending ‘quality time’ with the child, as they call it.  I don’t think this is possible if both parents have a full-time job.

Does the desire to create progeny imply we destroy the career aspirations of someone?

Perhaps yes, perhaps no. There is however no free lunch. The extra cash will have to come at the cost of something. Should that involve a child is up to individual couples to answer.

When I told my wife about this post, she said, ‘you are assuming all stay-at-home parents would actually spend time with their child!’ Dark area!

I am glad that  “she’s got brains enough for two, which is the exact quantity the girl who marries you will need.” (P.G. Wodehouse).

Have you registered for Workshop on Financial Planning and Goal-based Investing at Mumbai?

Register today and listen to Subra (retirement planning), Uma Shashikant (stock selection), Sharad Singh (investment analysis) and yours truly (goal-based investing).

You can also register via the DoAttend event page

Update: Mumbai Investing Workshop

I am delighted to announce that  P V Subramanyam (subramoney.com), or Subra as he is popularly known, will be speaking on retirement planning and incorrect perceptions about it, at the Workshop on financial planning and goal-based investing  to be held at Mumbai on Feb 1st 2015.

He will join,

Uma Shashikant – Director CIEL (Centre for Investment Education and Learning), who will speak on stock selection, and why it is a really tough job.

Sharad Singh – founder, thefundoo.com, who will speak on“True Lies: How analysis can help in investments?”

Mumbai investing workshop

created with wordle.net

and yours truly. I will speak on basic steps of financial planning,  aspects of volatile compounding, the nature of stock market returns, goal-based investing, mutual fund selection and analysis, asset allocation and basics of portfolio management.

The event is partly sponsored by thefundoo.com

Registration

This is a ‘not-for-profit’ event. All organization costs such as hall rent, breakfast, lunch, evening tea and audio visual arrangements and my travel will be shared equally by all participants. My sincere thanks to Mr.  Sundaram Ananthakrishnan who toiled hard to make all necessary arrangements.

Registration fee: Rs. 750 per person 

Please register via this link.  Spot-registration is not possible. Register Today!

You can also register via the DoAttend event page

Please do share this post ink with your social contacts and colleagues.

Financial Planning & Goal-Based Investing Workshop at Mumbai

This is a formal announcement and invitation to the workshop on financial planning and goal-based investing  to be held at Mumbai

Date: Feb 1st 2015

Time: 9 am to 4pm

Venue:  Hotel City Point, Khodadad Circle, Dadar T.T, Mumbai

Topics to be covered:

  • financial planning
  • goal-based investing
  • direct equity investing and ways of stock selection
  • mutual fund selection and analysis
  • goal tracking and portfolio management.

The event is partly sponsored by thefundoo.com

Speakers: 

1) Pattu – freefincal.com

2) Uma Shashikant – Director CIEL (Centre for Investment Education and Learning)

3) P V Subramanyam -subramoney.com

4) Sharad Singh – founder, thefundoo.com

A  Q&A session is also planned. Do Attend with your spouse if possible.

I would urge those in Pune to attend as well. The venue is easily accessible for those who are traveling from outside Mumbai.

Registration

This is a ‘not-for-profit’ event. All organization costs such as hall rent, breakfast, lunch, evening tea and audio visual arrangements and my travel will be shared equally by all participants. My sincere thanks to Mr. Sundaram Ananthakrishan who toiled hard to make all necessary arrangements.

Registration fee: Rs. 750 per person 

Please register via this link.  Spot-registration is not possible.

You can also register via the DoAttend event page

Please do share this post ink with your social contacts and colleagues.

Step-up SWP Calculator

A SWP or a systematic withdrawal plan is the lesser known cousin of the SIP. In a SWP, an investor would  receive  a specific sum at periodic intervals (monthly, quarterly etc.) from a lump sum invested in a mutual fund.

Although I am not a fan of the automated SWP option offered by AMCs (why do this, when you can manually redeem), I am a fan of taking money out of a lump sum to manage expenses after retirement provided,

1) the lump sum is only a part of the total corpus. Other parts of the corpus grow in instruments of  varying volatility (bucket method). See this for details: Generating an inflation-protected income with a lump sum

2) more importantly, the total corpus is large enough. This can be decided by dividing initial annual expenses by the total corpus. This is known as the initial withdrawal rate. If the initial withdrawal rate is about 1% more than the withdrawal rate calculated with an annuity calculator implies that the corpus is not big enough to be risked and the bucket method is not suitable. In other words, if the actual corpus is anything lower than 20-25%  compared to the coprus estimated with an annuity calculator, the bucket method and an SWP plan is not suitable.

Please tread with caution. Do not invest your corpus in a volatile instrument and attempt a SWP in the hope that the remaining sum will grow. If there is a crash, it will be disastrous to your financial independence in retirement.

Opt for a manual SWP from a low-volatile instrument like a liquid fund while the rest of your corpus grows elsewhere.

Remember: volatility is your best friend while accumulating a corpus, pre-retirement and your worst enemy while trying to generate an income from it, post-retirement.

Step-up SWP Calculator

This is a back-testing calculator in which you can evaluate a SWP in any mutual fund from April 3rd 2006. The monthly withdrawal can either be constant or can increase annually at some rate to keep pace with inflation.

A few screenshots

SWP Calculator-1

This is a SWP initiated with HDFC liquid.  The solid red line is the constant withdrawal or Rs. 5000 a month (right-axis). The dotted red line is the corresponding evolution of fund value. (left-axis).
The solid blue line (right axis) represents the increase in withdrawal (11% an year). The dotted blue line (left-axis), the corresponding fund value. Notice that by early 2013, the step-up method has drained the corpus.

SWP Calculator-4

This is for HDFC Equity (just fooling around. don’t attempt this at home!).

SWP Calculator-3

Download the Step-up SWP calculator

Are Debt Mutual Funds an Alternative to Fixed Deposits?

Debt mutual funds are advertised as tax-efficient alternatives to fixed deposits. There is more to investing than  tax-efficiency. Investors must be aware of the associated volatility and how it can impact returns depending on the duration.

Post-tax debt fund returns may or may not be higher than post-tax fixed deposit returns.

The answer to the titular question depends on when you need the money and how you need the money.

If you need the money less than 3 years from when you invest,

(a) do you need the money in one-shot? That is, will you redeem the amount all at once? If so stick to a plain fixed deposit.

If you want you can invest in say, a liquid fund with dividend reinvestment option to minimize capital gains, but why bother? Keep it simple. Pay a little tax. It will not affect your financial life.

One could argue that the TDS and tax payment each FY will reduce the gains of a FD when compared with a debt fund.

This will have an impact only for long durations. See Debt Fund vs FD calculators

All debt funds are volatile. That is, their returns are linked to the bond market and will vary. So before ‘expecting’ a return, from a debt fund (or for that matter any fund), one must be clear about how much the returns can vary and for how long (duration) would the variation be significant (see point (b)).

(b) will you  redeeem in parts? That is, take out money from time to time, depending on when you need it?

In this case, debt funds are tax efficient provided you have chosen the right category of funds.

I would like to the define the ‘right’ category in the following way: the average maturity period of the bonds in the folio should be much smaller than the investment duration.

You will find ‘experts’ who would tell you to ‘match’ your investment duration with the average maturity of the fund portfolio. If you did this,  you better not expect anything. Because your returns could swing by large extent. You may or may not be able to beat post-tax FD returns.

To illustrate this point, let us consider a few debt funds.

I like the way Franklin Templeton describes its products. You can get a clear snapshot of what the fund is all about. The bulleted fund features below are taken from the FT website.

Franklin India Ultra Short Bond Fund

  • An open ended income fund with an objective to provide a combination of regular income and high liquidity by investing primarily in a mix of short term debt and money market instruments
  • The fund manager strives to strike an optimum balance between regular income and high liquidity through a judicious mix of short term debt and money market instruments
  • The fund is suitable  for investors with an investment horizon of up to 3 months who prefer accrual based debt products

” investment horizon of up to 3 months” – that sounds like I can use it for any period up to 3 month.

Observed how the rolling returns evolve for different time periods.  A 30-day rolling return means every point in the graph is calculated for a 30-day period.

Notice that as the time period increases the sharp fluctuations in return reduces and the curve becomes smoother. How much would you expect from the fund if you invest f0r 3 months?

I would prefer to hold it for at least 1Y and expect about 7-8% return

Franklin Indian Short-term Income Plan

  • Open ended short term income fund whose investment objective is to provide stable returns by investing in fixed income instruments
  • Invests primarily in corporate bonds with a focus on higher accrual income
  • The fund focuses on investment opportunities at the short end of the yield curve by maintaining a low average maturity profile
  • The fund is positioned between a liquid fund and an income fund in terms of risk reward
  • This fund is suitable for investors with a time horizon of 9-15 months with moderate risk profile who prefer higher accrual and credit quality focused debt fund

In this case, I would prefer to hold it for at least 2-3Y and expect about 8% return.

For less than 3 year  durations, debt funds are taxed the same way as fixed deposits. So why should I take on more volatility? I might beat FDs, I might not. I would choose debt funds only if I don’t exactly know when I will need the money or if I need to redeem in parts.

For more than 3 years, the indexation benefit will make debt fund more attractive. However, choice of fund matters.

Consider:

Franklin India Income Builder Account

  • Open ended income fund that strives to deliver superior risk adjusted returns by actively managing a portfolio of high quality fixed income securities
  • The fund is positioned in the long term bond fund category that focuses investment in high quality fixed income instruments across segments ie G Secs, Corporate Bonds and Money Market instruments
  • The fund focuses on corporate bonds/ PSUs segment and has a high a moderate to high interest rate sensitivity
  • The fund is suitable for investors with a time horizon of 1-2 years with a moderate risk profile

Would you trust what the AMC says and buy income builder and hold for 3Y? Depending on when you purchased, the return can be higher or lower than FD return.

When it comes to short-term goals (anything less than 5Y), the very last thing that I want to do is monitor my portfolio and make course corrections. I would prefer to choose something that has low volatility so that I can be a buy and hold investor. I would prefer to focus on my long term goals.

Always account for the stress associated with holding a debt fund.

Choose short-duration funds. It is a low-stress option (relatively). Just don’t expect too much more than FDs.

Never speak ill of a fixed deposit. It is a wonderful product. Just don’t use it for long-term goals.

If the AMC recommends an investment duration, be sure to triple the estimate.  This applies to equity funds as well (PPFAS says min 5 years, meaning you should hold it for 15 year or more !!).

You can start with these links on how to choose debt mutual funds:
How to select mutual fund categories suitable for your financial goals

How to select debt mutual funds suitable for your financial goals

Excel Home Loan Amortization Schedule Template

Use this Excel-based template for creating an amortization schedule for your home loan. It allows you to visualize the monthly and yearly evolution of interest and principle components and the balance of the loan.

It can accommodate regular (monthly, quarterly, bi-annual and annual) and irregular (random months) pre-payment schedules.

It can also handle a loan disbursement schedule and allows variation of interest rate.

I think the sheet can handle a home-loan switch and extension of tenure if the existing balance is treated as a fresh loan. Can someone please confirm?

Here are some screenshots

Input page:

Excel-home-loan-amortization-schedule

EMI components

Excel-home-loan-amortization-schedule-2

Year-end Balance

Excel-home-loan-amortization-schedule-3

Download  the Home Loan Amortization Schedule Template

If you are wondering if you should pre-pay or invest use this calculator

Do let me know if any improvements can be made.

 

Calculator: Prepay Home Loan or Invest?

Use this calculator to  analyze if you should  pre-pay your home loan asap or invest instead.

I had posted an illustration of prepay vs invest in June  but did not post the associated sheet. I have now modified the sheet to include new tax rules. Future changes in rules can also be easily accommodated with user entry.

The money that is free for investments (inevstible surplus) is assumed to grow at some interest rate (can be modified). Whenever there is a need, withdrawals are made from the corpus.  This will work best if you use only long-term goals.

Inputs

1) Details about your home loan and the lump sum you have. An  amortization table will be created. Will post the amortization sheet separately.

2) Details about retirement and your other financial goals (preferably long-term, 7Y-plus)

The result would look something like this

pre-pay-vs-invest

Green line: This is how your investible surplus would have grown, had you not taken the loan.

The black dot represents the retirement corpus that you need (taking into account existing corpus)

Blue Line: Growth if you invest the lump sum (fully or partially)

Red line: Growth if you pre-paid the home loan with the lump sum (fully or partially)

The bumps in the lines represent withdrawals for different goals (coloured dots).

The sheet is rather complex. Therefore I request you to please play around with it and let me know if you spot anything funny.

My take: This is not an either-or question. Prep-pay in chunks without neglecting investments. Read more: Illustration: Pre-pay Home Loan or invest

Vinay: I will include your suggestions in the amortization sheet to be posted soon.

Download the prepay home loan vs. invest calculator

Thanks to Mohit Pandey for pointing out an error in the section 24 limit cell.

Thanks to Naveen for pointing out an error in the retirement planner sheet.

 

Notes on Financial Fortification

Life insurance, health insurance, accident insurance and critical illness insurance  are tailor-made fortification products that help a family tackle unpleasant and unexpected developments. Be it expenses due to hospitalization, or loss or decrease  in income due to death, accident or a critical illness.  I refer to them as fortification products because they protect the families long-term goals like retirement, children’s education, marriage etc. They protect by minimizing the chance of redeeming the corpus meant for these goals. They protect by minimizing the chances of interrupting the compounding of the corpus.

Here are some thoughts on the fortification process.

Emergency Fund

A emergency fund is also a crucial fortification step but we do not have a tailor-made product for this and nor is it necessary. As  long as we can find a way to replenish the emergency fund when it is used, where we put the fund is pretty much irrelevant. Of course the chosen instrument must be liquid.

The problem is the amount! (see below)

Pure Term Life Insurance

Those who realize a term plan is crucial either choose to seek a one Crore policy or worry about the how much insurance cover is required.

Unfortunately both approaches do not count for much because the insurer has an upper limit typically based on an individuals income and risk profile.

Therefore, I think it would be best to identify 2/3 insurers one is comfortable with, write to them with basic profile details and determine the maximum cover they are willing to offer.

Then write an action plan: How much should I allocate for

  1. squaring off liabilities
  2. inflation protected income and for how many years  (perhaps until the kids are old enough to work
  3. generating an inflation-protected sum for school fees (including training and coaching classes)
  4. college fees
  5. marriage expenses (if possible)

Use the Comprehensive Child planner to work this out: How to plan for your child’s education and marriage

Remember: having a term plan is good but what if your nominee buys wrong products? So prepare an action plan and discuss it with your nominee

Understand how best the maximum eligible sum insured should be distributed among these buckets, write it down and discuss and give copies to your nominee and someone else you can trust. Be sure to include the name of a fee-only planner (see link on the top right).

Ask your nominee to contact the fee-only planner, if needed, as soon as you are ready to submit the claim. They should be able to guide through the claim-settlement process (for a fee of course) and allocate the sum into different buckets as per your plan.

Also see: Things to do AFTER you take a term insurance policy!

Health Insurance

Having a health cover is indispensable. However it is important to recognize that cashless claim is more of a privilege than a right. Reimbursement is a right. So do not be sure cashless will be approved. Meaning you need money – much more than 12 times monthly expenses!

Emergency fund is a long-term goal. It is an insatiable monster which needs to be fed constantly.

Read more: How Long Should I Maintain an Emergency Fund?

Print the necessary steps  to be completed before and after hospitalization and store it along with the insurance policy and card. It would be better if the spouse and other members read it.

Accident Insurance

This is a must-have for professionals and those in the cut-throat corporate world.

The product is rather complex. The claim will be paid in full only for certain types of accident. All others would only get some percentage of the sum insured.

Also one does not need to suffer an accident to lose income.  There are many other ailments which would render a person disabled.

How much accident insurance should I have? If I die, family expenses might decrease as I am no longer around.

If I am rendered disable, my family expenses are likely to increase and sharply. So an accident cover should be higher than a term cover.

Unfortunately this is rarely the case.

Getting an accident insurance policy for 10,20,30L is inadequate.

Not everyone will get high cover. It depends on the income and the  kind of job

The bigger problem is that many insurers offer quite low cover. The max cover I have seen is 1 Crore from Tata AIG.

The only upside is that the price of  sum insured of tens of lakhs is quite inexpensive.

Stay away from any group insurance policy offered by Banks.

Critical Illness Insurance

Again a complex product. You need to get critically ill (and not die within a month) in a certain way.

See more: Critical Illness Insurance Policies: Do You Really Need One?

Again the sum insured in most CI products is not  as large as a term plan. But the policy is much more expensive than a term plan.

I would prefer to buy a CI cover if there is some history if CI in my family. But then again, do you stop with first cousins or second cousins? Search hard enough and every family will have CI case!

If all our investible surplus goes to insurance policies (that do not offer bonuses!) where will we have money to invest for our financial goals!

So we either buy all types of policies for low cover or avoid certain types of policies (CI or accident that is. Rest are mandatory).

Alas either way it is not an easy decision.

Perhaps one could buy about 30L of accident cover, 30L of CI cover and get as high a term cover and mediclaim as possible, but the total premium would be close to 1L for a 30-something.

If we are lucky, don’t get to use the CI and accident policies and the health cover rarely, we can focus on investing.

If we invest to the best of our ability in productive assets, hopefully we would have more than enough to handle unexpected big ticket expenses a couple of decades later. Building a rock-solid fortification takes time and luck. Lots of both

Pechersk Lavra fortification

Pechersk Lavra fortification a system of walls, towers and other constructions built for the protection of the Cave Monastery in Kiev, the capital of Ukraine

Interested in a workshop on financial planning and goal-based investing at Bangalore?

The first meet on Dec. 14th is sold out. Register here and I will plan for a second meet

Short Excerpts From a Talk by Parag Parikh

Listened to Parag Parikh speak on value investing on Nov. 7th in a meet organized by the Tamil Nadu Investors Association. Listened to him again on Nov. 8th in the PPFAS unit holders meet.

Some excerpts:

  • Equity has done well, but many (equity) investors have not.
  • There is nothing like a blue chip. Today’s blue chips may not be tomorrows blue chips (Krishnan instantly thought of you)
  •  A good stock is not equal to a good company
  • Do not buy ‘Gujarati’ stocks because of who is in power. Buy them if they are good businesses
  • Offering dividend option in mutual funds is cheating the public!  It is mental accounting. It is not ethical. Use growth option and redeem when you want and what you want.
  • No one knows what is going to happen in the future. So forget about macro factors and economic indicators
  • Ignore new fund offerings.
  • Delay Gratification. Redeem only if necessary
  • Movement in stock price is not relevant. A company can still be profitable and do good business when its stock price is falling
  • Judge a stock by its dividend. How do you think investors analyzed stocks in the pre-internet era?
  • Never forget the law of the farm. One cannot sow today and reap tomorrow. That is the law of nature.
  • A balanced fund is not one which invests in equity and debt. It is one which has geographic diversity. With geographic diversification, one can buy parent companies much cheaper than their Indian offsprings
  • The regulator (SEBI) is also on a learning curve.

He repeated much of this in the PPFAS unit holders meet held on 8th Nov.

  • Made an interesting observation. When the Sensex was 100, gold was Rs. 100 per gram. Check their prices now and you will notice that equity has beat gold by ten times.
  • Asked them about the 50 Cr net worth issue. From what Rajeev Thakkar, the fund manager replied, I understood that they would simply liquidate their ‘insider’ holdings in the fund and add it to the net worth of the company just before the SEBI deadline. As of now the sponsor company – PPFAS ltd and its directors holdings and PPFAS AMC and its directors holdings add up to 40 Cr worth.
  • Parag Parikh also said something striking: If you ask my fund manager for some ‘good stocks'”, he wouldn’t know. If you ask him for some ‘good business'”, he could tell you some.
  • Someone asked, why not start an ELSS fund. Rajeev replied that ELSS funds maybe replaced by long-term retirement funds (like Templeton India Pension plans).

Note: I am invested in PPFAS because I wanted the international equity exposure and do not hold any other mid/small-cap fund. For me, the funds diversification strategy will lend stability to my portfolio and offer good downside protection.  This means it will not be ‘best’ performer if you consider short durations.  This is not a ‘hot’ fund which will give you spectacular returns one year and remain a dud after that.  I expect it to remain a ‘true to logo’ (turtle) fund.
Please do not invest based on what I or other members in Asan Ideas of Wealth say about it. Buy it only if there is a vacancy in your folio and if you can justify its presence to yourself.

 

marshmallow test value investing

Can you guess the relevance of this picture?  Picture by Brian Fitzgerald (flickr)

 

Interested in a workshop on financial planning and goal-based investing at Bangalore?

The first meet on Dec. 14th is sold out. Register here and I will plan for a second meet

Bangalore Investor Workshop is a Sell Out!

The investor workshop on financial planning and goal-based investing on Dec. 14th is a sell out. We hoped 50 would attend but now we have 76 registered. We regret that we cannot take on anymore for this meet. If enough people show interest, a second meet can be organised early next year.

The Dec. 14th workshop is ably coordinated by:

Aaqil Mohammed, Vignesh Bhaskar, Prashant Kulkarni, V Muthu Krishnan (also a speaker), Krishna Kishore (also a speaker) and   Mohit Pandey.

Basavaraj of Basunivesh.com was kind enough to write a generous post about the workshop.

If you are from Bangalore,  could not register for the Dec. 14th meet, and would like to participate in this workshop in the future, please leave your name and email in this form.

Once we have enough people interested, we will organize a second meet.

Evaluating Volatility in Returns

Use this rolling standard deviation calculator to evaluate  the volatility in returns of  a mutual fund.   This is an idea that struck me during the Chennai investor meet in response to a question.

The sheet calculates the rolling return and rolling standard deviation for a specified interval. For equity funds, the rolling standard deviation of the fund can be compared with its benchmark.

One can also compare the rolling return of the fund with its rolling standard deviation.

The standard deviation is a measure of how much returns can deviate from the average return. In fact, the standard deviation is the average deviation.

Higher the standard deviation, higher the volatility in return.

The standard deviation is calculated from daily returns and then annualized by multiplying it with the square root of the number of trading days (250-252) in a year.

I have mentioned about the importance of the standard deviation in the following posts.  If you are not familiar with the term, please read these posts and then use this sheet:

Here are some screenshots.

7-year rolling return of equity fund return and standard deviation

rolling-std-3

Although the std-dev variation looks dramatic, compared to the variation in returns it is quite small. However, the standard deviation is a steady ~ 22-23% and always higher  than the return.

This means the investing in HDFC equity for 7 years is fraught with risk. The volatility in returns can result in a risk in this case since the duration is low.  Note that 7 year returns have been plotted from April 2006 only. Had it been since inception, the fluctuation in return would have been much more.

That said, the fund has a lower standard deviation that its benchmark.  Thus, the fee paid to the fund manager is justified.

rolling-std-4

This is the corresponding rolling return.

rolling-std-2

1-year rolling return of liquid fund return and standard deviation

rolling-std-5

The standard deviation of a liquid fund is 100 times lower than an equity fund!  However, due to debt market movement the spread in the returns in not proportionally lower and there is still significant volatility in returns.

That is, the actual return for a 1- year investment in a liquid fund will depend on when you started investing.  However,  it is safe to say that volatility will always be low.

For an equity fund, again the return will depend on when you start on investing. It is safe to say that, unless the duration is 15+ years, the standard deviation will be comparable to returns. That volatility will always be high.

The sharp vertical changes are due to discontinuity in dates and can be ignored. I do not know a way around this as of now.

Download the Rolling Returns + Rolling Standard Deviation Calculator

 

Workshop on financial planning and goal-based investing at Bangalore

Details here Register below (about 14-15 seats only left)

Financial Planning & Goal-Based Investing Workshop at Bangalore

Dear all,

This is a formal announcement and invitation to the workshop on financial planning and goal-based investing  to be held at Bangalore.

Date: Dec. 14th 2014

Time: 10 am to 3pm

Venue: Hotel Nandhana Palace , No. 280, next to DELL, Inner Ring Road, Amarjyothi Layout, Domlur

Objective: To present and discuss basic steps of financial planning, goal-based investing, mutual fund analysis, goal tracking and portfolio management.

Fellow DIY investors, V Muthu Krishnan, Krishna Kishore and Nitin Kumar  will share their experiences and approach to money management.

A  Q&A session is also planned.

Attend with your spouse if possible.

Registration

This is a ‘not-for-profit’ event. That is the cost of the hall rent, lunch and audio visual arrangements and my travel will be shared equally by all participants.

Registration fee: Rs. 500 per person 

Please register via this link.  Spot-registration is not possible.

Please share this link with your social contacts and colleagues. 

You can also register via the explara event page

There is more to investing than obtaining real returns

Here is a set of slides from the recently concluded Chennai investor meet that hopefully might convince you that a real return is only one side of the investing coin.

Consider some product or a service or a fee  that costs 10L today.  For an inflation rate as shown below (8%), the cost will increase with time as shown by the blue line.

real1

The green line represents the growth of the monthly investment amount at the average annual interest rate as shown above.

After 19 years the value of the investment will overtake the cost. Meaning we would have to wait 19 years to make the purchase.

The real return (approximately) in this scenario is 12% -8%  = 4%

Now, what if the inflation was 10% instead of 8%?

real2

 

When the inflation increases to 10%, it would take 30 years to make the purchase for the same investment.  The return is still above inflation, but the does not help much. The purchase is significantly delayed. Why?

Now consider this,

real3

More than double the investment, with less than half the return, a real return of about -2% produces the same result as a real return of +4%: purchase after 19 years.

What if we invest like we would expect a real return of -2% in an instrument that would give us a positive real return?

What if we invest 10200 each month in an instrument that has the potential to deliver double digit returns?

Unfortunately, many do the opposite. They invest less that the required amount (10,200) in instruments that offer negative real returns.

Loss of capital

Loss does not always mean a negative balance or an actual decrease in value.

real5

The result: permanent loss of capital (notice the gap between the curves at 19 years). I use the word permanent because these are the people who are scared of notional short-term losses.  They may never be able to make the purchase.

Not investing enough is an ailment that can affect those who hope to earn a real return too!

real6

A real return of +2% means nothing if one does not invest enough.

There is yet another side to this story.   Those who can only invest little (say 1500 pm) cannot take excessive risk in the hope of getting higher real return. This scenario,

real7

can be produced in an excel sheet but is unlikely in real life. At least it is quite uncommon.

What is the point of this post?

When an expense crops up (planned or unplanned) the only thing that matters is the money available us. At the point in time, the return we have got, and how much it is above or below existing inflation rates is irrelevant.

The goal behind investing is to obtain a big fat corpus.

The goal is not to beat inflation. The goal is not to obtain a real return.

The goal is to recognise the importance of inflation. Inflation can be overcome  in two ways:

1) investing in aggressive assets. That is in assets with potential to earn a positive real return (return higher then inflation)

2) investing enough capital. This could even be in assets with a guaranteed post-tax return lower than inflation.

You can beat inflation by investing in FD/RD or endowment policies by simply investing enough. See here for an example.

Don’t criticize the product or the agent who sold it to you. Nothing wrong with the product. Most people want guaranteed returns without understanding that the associated price is a huge increase in the necessary investment.

The second suggestion  may sound bizarre to you.  I am not suggesting you do that, for that would be an inefficient way to work your money.

I suggest that you combine the two ways:

Invest in an aggressive asset like equity, a sum that you will have to invest in a non-productive asset (like fixed deposits or endowment policies).

That way you can go beyond goal-based investing and create wealth. That is, have a surplus relative to your expenses at any point in life … after a certain age.

There is more to investing than real returns. You need to invest as much as possible and as often as possible. Otherwise high returns won’t amount to much.

Note:  I have received several requests to share the slides of the investor meet. My slides are not annotated and will be of little use to you in the present form. I intend to release them as a short booklet after the Bangalore Investor Meet to be announced shortly.

Chennai Investor Meet Photos

Here are some photographs from the Chennai investor meet on Nov. 1st, organised by Srinivasan Sundararaman of  MoneyKare, Wealth Managers, and myself .

The event was partially sponsored by Sundaram Mutual AMC.

What started out as a 1 to 1.5 hour meet in my mind was realised into a full-fledged one-day meet by Srini. If the participants found the meet useful, the credit is entirely Srini’s.

This was the agenda.

Final-agenda

Mr. Mohsin Bijepuri was kind to enough to introduce the speakers and keep time.

The following photos were taken by Ramakrishna Sripathy who was kind enough to bring his camera to the meet.

Registration

Registration

 

Srini on the left. Pattu sitting down.   On the right, in clock-wise direction, IFAs Sridevi Ganesh, Ganesh Ramamoorthy and Jayaraman Jeyakumar.

Srini-and-Pattu

 

Srini-2

 

Welcome address by Srini.

Pattu and Narendra

 

Was delighted that Narendra Kondajji one of the first CFPs in the country and one of the most erudite persons in the financial services community attended the meet.

Vignesh and Ramakrishna

Vignesh Bhaskar. He set up the FB event page, invited several of his friends and helped with the registration along with Ramakrishna.

The Hall

 

 

Mohsin and Srini

 

Mohsin Bijepuri and Srini

MuthuKrishnan

 

Muthu Krishnan (left). Dr. Sriraam Kalingarayar and tyroinvestor Krishna Kishore in the middle.

Krishna

 

Krisha Kishore (looking at the camera). Ayyub Mohammed to his right.  Guruprasad Bupathirajan to his left, Prasanth Prabhu and Prof. Subba Iyer. To the left of the video camera is Raj Kumar. Behind Ayyub is Nisith Baladevas.

Diagonally behind Krisna in the blue shirt is Balaji Swaminathan and his wife. To Balaji’s right are Muthu Krishnan and Dr. Sriraam.

In the front row,  Sridharan Venkatarajan (red shirt) is one of  the first patrons of freefincal. He urged me to do the retirement calculator for the middle-aged employee.

Srikanth

 

Srikanth Meenakshi, director FundsIndia, speaking about technology enabled investment solutions.

pattu-3

 

This was shot by Ashok Kumar.

pattu

 

By the grace of god I was able to speak for two sessions without any discomfort.

 

pattu-2

 

Srini

 

Srini with S R Chandrashekar who spoke on taxation and answered several queries. This was the last session. I was so tired that I could barely keep my eyes open. Even then I could sense that it was a fantastic talk.

group-photo

Can’t name everyone. A few I can recall:

Ladies first. Left extreme: Dipali Gupta. Right Extreme: Sridevi Ganesh.

Next to Dipali, Mohsin Bijepuri, Jeyaraman Jayakumar, Thennarasu Narayanaswamy, Subba Iyer (green shirt).

To my right Sarath Kumar.  To my left: Vignesh Bhaskar, Guruprasad Bupathirajan. Karan Kapasi is behind the two of them.

To the left of Guruprasad, Ayyub Mohammed. Prem Nath is behind the two of them.

To the left of Ayyb, my long-time friend Nirmal Thyagu, Krishna Kishore, Balaji Swaminathn (blue shirt).

Between (behind) Nirmal and krishna: Dr. Sriraam Kalingarayar

Between (behind) krishna and Balaji: Ramakrishan Sripathy.

Behind Balaji (right):  Sailesh Nagar and Nishith Baladevas

Behind me (right): Prasanth Prabhu

Behind me (left): V Shankar (presented me a book with a lovely note which I will cherish)

Sitting:

From left to right:

1st: Apologies. Forgot your name. Kindly let me know

2: Vasudevan Parthasarathy who busted our stress with a delightful presentation.

3: Srini

4: Ashok Kumar

5: Anandaraman

6: Muthu Krishnan (checked shirt)

7: S R Chandrashekar

8: Arvind Maharaj

9:  Senthil Nathan

10: Ganesh Ramamoorthy.

Friends who left early: Raj Kumar and his friend. Sridharan Venkatarajan, Srikanth Meenakshi, Vidya Bala and Narendra Kondajji.

Note: This is a not-for-profit event.  Srini presented the accounts at the end of the day.  Taking into account the sponsors contribution, the registration fee and the expenses (hall, food, video) we had a grand surplus of Rs. 1500. This will be donated to an orphanage.

Srini and I would like to thank all the participants, speakers and Sundaram Mutual for making the event a grand success.  Special thanks to those who travelled from Bangalore.

Investor meet in Bangalore:

Trying to put together a meet in Bangalore with the help of friends. Will keep you posted.

Random Musings on a Day Trip

A collection of thoughts and findings while on a day trip to Salem.

Claim Settlement Ratio (CSR)

I am a lot like Melvin Udall from the movie, ‘As good as it gets’. Before I travel, I make lists, set everything in order, list train stops etc.

I usually check the indiarailinfo.com to find out the average delay. This time it struck me that the average is meaningless.

The average would have been calculated with daily timings compiled over hundreds of days.   Knowing that the average delay was 8 minutes was not of much use to me because the actual delay in my case  was a good 30 minutes.

Although this individual value is much higher than the  average, it will not affect the newly computed average by much because hundreds of data points are used to compute it.

So for a traveller who takes the train the next day, the average delay will pretty much be the same.

The same logic applies to insurance claims. At least for a behemoth like LIC.   What matters it the claim settlement experience of your nominee. The claim settlement ratio will not change too much for LIC if a handful of claims are rejected. LIC’s reputation will remain unchanged with respect to a new buyer who takes the ratio too seriously.

What if you are one of those of those handful whose claim was rejected? Your own experience … that is all that matters.

This is what Subra means when he says do not compare  CSRs when the numerators and denominators are very different (as is  the case of LIC compared to privates).

Save/invest/Splurge

Yesterday (or the day before?!) was World Savings Day or World Thrift Day.  Saw an ad in the back of a newspaper released by the govt in this regard promoting post office schemes and PPF.

On the front page, amused to find a snippet about a couple who arrived by helicopter to their marriage reception!!

Later in the day I had a lot of time to kill before my train arrived so got hold of a copy of Outlook Money. Not a big fan of such magazines but I had to do something about my boredom.

Read a nice article by Aashish Somaiyaa, MD and CEO of Mostilal Oswal AMC.  It said, ‘you have voted for Modi, now make your vote count by investing in equity’. ‘put your money where your vote is’.

“We are very bad at participating. We love to enrich other (FIIs) from Indias growth but we do not want to be rich ourselves”.

Outlook Money on how to build a clutter-free portfolio!

In another article which urged readers to supplement EPF with equity, the magazine reporters state:

  •  Start with a SIP in an index fund
  • once you are in the groove, save more. Pick 3-4 large cap funds!!

In the same issue, in the article listing OLM rated mutual funds, they say, “Many equity schemes comprise of similar stocks; so just don’t buy them”!!

I suppose it is possible to pick 3-4 large cap funds without significant portfolio overlap!

How delightfully corroborative! Please be sure to subscribe or renew your subscription to such a wonderful magazine!

Blame thyself and not the LIC agent!!

In an interview, LIC chairman S K Roy was asked,

post new regulations, would there be less likelihood of mis-selling in ULIPS? Is LIC looking to add a ULIP?

His response:

A new Ulip is on the anvil.

Ulips have become more transparent. Whether new regulations would curb mis-selling or not is a separate question because, As a buyer I should also be making an informed choice that comes through disclosures.

Now how about that!

Finally,

For the first time in my life I saw a financial plan without a single mention of the inflation and return assumed!!

Young Earners Guide to Mutual Fund Investing

This post is meant for young earners who would like to begin mutual fund investments at the start of their career. I write this following a readers suggestion (unable to locate the comment -apologies).

The contents of this post is subject to the following assumptions:

  • The investment would be used for financial independence later in life and that no other goal is in the horizon.
  • Basic fortifications like emergency fund, life insurance (if there are dependents), health insurance (for parents and self) are in place.
  • The young earner understands the importance of equity exposure

There are several articles on what a mutual fund is, different types of mutual funds, how to invest in direct mutual funds etc. So I choose not to reinvent the wheel here.

Direct Equity vs. Equity Mutual Funds

I think there is absolutely no need for an individual ( young or old) to invest in direct equity. Equity mutual funds if held onto for a long enough period of time, is  more than likely to beat inflation and even give you a little extra after expenses.

Perhaps one can hasten financial independence with direct equity exposure but such a path is fraught with peril.

That said, in my uninformed opinion,  gradually accumulating and holding solid large cap companies instead of chasing multi-baggers is a decent way to ‘create wealth’. See this for more details:  Backtesting a three stock portfolio

Naturally one must learn how to choose a solid business before taking the plunge. Since this would take a while, I suggest the following:

1) Start a SIP in a single large and mid-cap fund (here is a simple guide to choosing funds. A simpler guide is coming soon).

2) If you need to save tax, use an ELSS fund. You don’t really need a PPF account. Just use ELSS + EPF + Term insurance premium (if applicable) for tax savings.

Personally I hate SIPs in ELSS funds (because getting rid of a poor performer would seem like forever). If you are okay with it, go for it. Just be sure to discontinue the SIP (and switch to another fund) after your EPF exceeds the 80C limit.

3) If you don’t care for direct equity, then that is all that you need to do!

  • As and when you get extra cash, buy more units Either in the ELSS fund (if you have not exhausted 80C limits) or in the large and mid-cap fund.
  • Do not monitor the value of your investment for 5 years! Monitor only how much you invest (try this monthly tracker).

4) If you wish to get into direct equity, then obviously you must learn. There are many useful resources. I prefer:
tyroinvestor.com and stableinvestor.com  and the resources mentioned in them.

These are written by passionate youngsters who are learning on the fly and do not hold anything back. I would prefer to learn from them any day compared to an ‘expert’ who runs a business.

We have a lifetime to learn and invest in equities. So there is no flaming hurry. Get the mutual fund investment going, learn in leisure and invest when you feel comfortable and ready.

Mr. Raghu Ramamurthy a patron of freefincal is 85 years young an active stock investor!

Stock investing requires capital. Perhaps a few years of mutual fund investing could provide the necessary seed capital for the stock investor …. perhaps. Do understand the risks in doing so.

DIY vs. Professional Help

While a young earner is best suited for DIY (do it yourself), taking professional help and then learning in one owns pace is also a fantastic idea.
Young earners are often under a lot of stress. So professional help could help calm nerves and enable them to focus on their career better.

I would recommend starting a relationship with a fee-only planner. If you can trust an IFA or web portal for investing, then that is fine too.

Either way the learning cannot be skipped!

Regular plans vs. Direct plans

If you employ the services of an IFA or use online distribution portals, think of the trail commission that you can save in direct plans as a fee for service or value adds.

If the features of an online portal are effectively used, then there is no need to lose sleep over being in regular plans.

DIY investing need not be 100% DIY.  Someone who uses an intermediary for investments but handles other aspects of goal-based investing on their own (monitoring, tracking investments, rebalancing  etc.) are also DIY investors.

Yes, direct plans would return more than regular plans in the long run. However, the gains made in a direct plan could be erased by seeking free lunch.

Using an IFA or a portal is better than going direct and asking portfolio suggestions at Asan Ideas for Wealth by providing (and therefore receiving) half-baked information.

Yes, I am an investor in direct plans and promote them every time I get an excuse. I also speak against free lunch every time I get an excuse.

More than time, effort etc. direct plan investing requires confidence. If you think you can confidently pick funds and manage your folio, go direct.
Else
1) either seek counsel from a fee-only planner and go direct or
2) go regular and be happy with your choice.

At the cost of repeating myself, either way the learning cannot be skipped!

Trust the planner or IFA. Do not post their recommendations in forums for ‘double-checking’. A second opinion with an individual is okay but do think twice before messaging  Ashal Jauhari for help!

Ashal: I think you should insist that people who ask your extensive help should donate to a charity and show you the receipt before you advice them.

Finally,

  • Never ever buy mutual funds from a bank.
  • Do not buy an NFO because  it is an NFO.
  • Do not buy/sell a fund because others are talking highly/lowly about it.
  • Do not clutter your portfolio. Choose a minimalist portfolio.

To sum it up, choose ONE fund, invest with discipline. Do not look the folio value for at least 5 years. In the meanwhile learn about stock investing, if you must. Seek professional advice and not free lunch if you lack confidence.
Tomorrow is too late, Start Now, Next28 Start, Start Now sign

The Not So Ugly Truth About Financial Independence

A little more than seven years ago, my expenses dropped to ‘normal’ levels after my father passed away (post a prolonged battle with cancer). I  had been in a regular position for less than two years then and was taking stock of my cash flow and investible surplus (money net of all expenses).

Immature me, I remember asking my mom a dumb question: “Why did you and appa not invest more when you were younger?”

She answered without batting an eyelid: “We (both worked) never earned enough”.

That felt like a slap to my face. I must have insulted her deeply.

I now realize that I was asking the wrong question.

The financial health of a family depends on its investible surplus at any point in time.

When the breadwinners work for a living, a good part of the surplus ought to be invested and not spent frivolously.

After retirement, the surplus could be invested or used in full to enjoy the finer pleasures of life.

Investible surplus is defined as

Surplus = Income – Expenses.

Interpreting this simple equation is a tricky and often a touchy subject.

You get a surplus if
1) you earn much more than you spend
or if
2) you spend much less than you earn

Unfortunately, there is a problem. The ugly truth is that these two conditions are not independent in practice.

You can spend much less than you earn only if you earn much more than you spend!

Distribution in income levels causes inequalities in society. However, all is not lost for those who earn less.

Consider a family (couple + 2 kids) whose sole breadwinner is in the 10% slab (or lower) and is likely to be in the same slab for the rest of
his/her life.

Can the couple expect to be financially independent after retirement?

Yes, if they expect to maintain their current lifestyle in retirement (and not dream of anything above that).
Yes, if they invest as much as they spend until the breadwinner retires.

But how practical is that?

The couple has two kids to parent. There is more to parenting than just taking care of the basic necessities of children. A parent will have to
indulge the children at least once in a while. They will have to support the kids dreams.

What if they decide to buy a small house? What if want to take a holiday? What if they want to spend a little extra during festivals?

Do we tell them that such things are luxuries and a strict no – no for them, because they are not earning enough?

Do we tell that the pleasures that rich and the affluent enjoy are beyond them even if they wish for it sporadically?

Financial advisory has to be clinical but who would have the heart to say such things to the family?

I don’t have an answer. However, I think there is one thing that MUST be said to such families:

Invest what you can, but invest it right, and as early as possible in productive assets. Never touch your investment unless absolutely necessary.

I write this post in the light of recent reactions to the post detailing the real-life experiences of two people who are financially independent:

Balaji Swaminathan and

Rajshekar Roy

I am miffed at comments which suggest that their financial independence is only because of their high income levels. Miffed because they could have been spendthrifts, locked their money in fixed deposits and still be chained to the desk.

The primary reason they are financially independent today is because of their disciplined investing in aggressive assets.

Had they earned less, they could not have retired early. No question about that. That, however is not the point.

A disciplined person, who understands the value of investing in aggressive assets to the best of their ability is more than likely to be financiallyindependent when they stop working. That is what counts.

That is all that we can expect a breadwinner and his family to do, irrespective of their income level.

During the recently concluded IFA Galaxy meet, I was delighted to spend most the day with Subra. He narrated how the peon in his office has a corpus of a few lakhs (thanks to Subra’s counsel). When the peon learnt about the value of his corpus, he could not believe it.

Disciplined investing matters. Investing right matters. Financial independence is not an impossible dream. It is a dream that is far away.

Yes, the investible surplus determines the distance to the dream. Why harp on that?

We can only control the controllables, but control them we must, to the best of our ability.

That is the mistake my parents made. They never invested in a productive asset like equity to the best of their ability. The comfort with which they met ends during their earning years gradually withered away, thanks to inflation.

Aiming for eventual financial independence backed with meaningful effort is something that we all should strive for. Regardless of ourincome levels.

Not all of us can achieve early financial independence.

Not all of us can enjoy the same level of financial independence. Subra’s office peon cannot go on a vacation abroad.

That goes against the nature of our existence. Every aspect of our lives follows a distribution – a spread. ‘True’ equality is defined but its absence!

All this reminds me of this quote.

An Evening with Young Earners

The physics PhD students of IIT, Madras invited me to speak on the rudiments of personal finance in their weekly meet on Oct. 24th.

Here is a transcript of the talk.  Since I spoke impromptu (following an outline!), I cannot reproduce everything that I said, but will try to list the important points covered.

Was delighted to note that the hall was packed. It is so refreshing to find youngsters interested in a talk on money management. I Am happy that this happened at a time when their scholarship has increased: 25K pm (from 16K pm)  for the first two years and then 28K (from 18K pm) for next three years.

1. Introduction

How would you like to change the way your family has always looked at money? That was the central theme of the talk.

 2. Fortifications: Building barriers

If a change has to make its mark, it has to permanent. Thus just like any construction, one has to begin with fortifications.

 Life Insurance

A research student died while on a trek recently. Their parents were entirely dependent  on him. They knew this. So no effort was needed to convince them about the need for a term life insurance policy.

Related Post:  How to Buy a Term Life Insurance Policy

 Health insurance

Same here. These were not school kids. They were postgraduates. So they knew the value of health insurance.

Subra suggested that I talk to them about the importance of getting their parents health cover. Done.

Related post: How to Buy a Health Insurance Policy

Accident insurance

This was suggested by Mr. R. Balakrishnan when I posted about this talk in the facebook group, asan ideas for wealth.

Emergency fund

See below

Related post: How Long Should I Maintain an Emergency Fund?

Will

Urged them to get their parents to write a will. Again a suggestion by Subra.

 3. Analysing Cash Flow

I suggested that the students do the following with their monthly scholarship

For at least 1 year

i) 30% fees + food + needs

ii) 30% family or to the bank (say a flexi-deposit) – partly to build an emergency fund

iii) 30% for long-term investment (money you will not touch for many, many years) – see below

iv) 10% buffer for wants … from time to time

After about an  year or when emergency fund is close to 1 lakh:

i) 30% fees + food + needs

ii) 30% family or  partly towards long-term investment

iii) increase long-term investment (money you will not touch for many, many years) – see below

iv) 10% buffer for wants … from time to time

 There was unanimous agreement that this was possible.

 4. Frugal Living

Do not connect money and happiness.

Do not take your degree and future positions too seriously and buy stuff because of some ‘status’ nonsense or because of peer pressure

5. Never take a loan

Except a home loan and that too only if necessary.

 6. Say no to credit cards

If you have a credit card, you need to pay it in full each month, anyway. Meaning you need to have the money ready. So why have one at all?

Ignore all the perks associated with credit cards. They do not account for much.

You do not need a credit card to keep track of your expenses

 7. Say no to any kind of insurance products

Except pure term life insurance. Enough said

8. Do not talk to an insurance agent or bank relationship manager

If you need something from them, tell them what you want. Never ever ask an intermediary, what to do

9. Do not buy land as investment

It is not liquid, not well regulated, demand is artificial etc. etc.

10. Do not buy gold as investment

 Since I was talking to physicists I could afford to say the following.

Gold glitters simply because gold is a metal. An electric field cannot exist inside a metal. Otherwise, the electrons inside would flow!

When light (which contains a fluctuating electric field) shines on a piece of gold, or for that matter any piece of metal, the nimble electrons move around like a gooey fluid and reflects most of the light. Some of it gets absorbed. So the resulting colour is golden-yellow. No big deal!

If our eyes could sense ultraviolet light instead of the visible light (VIBGYOR), gold would appear like a slab of glass because metals are transparent to ultraviolet light.

 11. Give money to charity

Help others in need.  When you are in need, someone would turn up to help you. That is my strongest religious belief.

 12.  Understanding long-term investments –  the chai shop analogy

Only one persons parent ( out of nearly 100)  invested in stocks. No surprises here I guess.

To introduce them to the idea of stocks and bonds, I used the following analogy.

Imagine a tea stall outside the hostel gate. You frequent it each day, you like the owner and you like the tea even more. One day he says he has to shut shop because he has huge debt.

You want to bail him out.

You have the following choices.

1)  Lend him say 50K and ask for 8% interest each year for 1o years. This is called a bond. Since he is in your debt, this is called a debt instrument.  If the person is trustworthy there is no credit risk involved.

Whether he gets a profit or not, he has to give you the 8% interest. So there is no ‘risk’ for your investment in the sense that payments will be regular.

You reinvest the payments in the same shop and get the same interest or say, put it in a bank FD

2) You give him 50K but tell him that you want a share of the profits. That is you own the company. This is called equity. If there is a loss, you get a loss. If there is a gain, you get a gain.

There maybe intermittent losses but over a long period of time, you expect the annual gains to outnumber the annual losses.  You expect this because:

  • students need a place to hangout outside the campus. So they would frequent tea shops.
  • If the tea is good (and it is in this case) then more students would come and more often.
  • Thus, there is a chance for consistent profit.

After several years, the equity and bond investors net worth would look something like this  (drew this on the board).

Equity-vs-debt

If I apply 30% tax to both equity and debt, the value will reduce.

Now I must take into account the effect of inflation.

I asked for the price of chai when they had it for the first time ever in their lives.

Rs. 1, Rs. 2.50 were some answers ( not all are from metros!)

This was 10 years ago.

Now the price is about Rs. 7

So this is about 11% inflation with the starting price as Rs. 2.50

So after having devalued the corpus due to tax, we must devalue it due to inflation.

Now who do you think got the better deal? The fellow who had the courage to stomach annual fluctuations or the fellow who wanted ‘steady’ growth with practically no volatility

Which investor is likely to change the way their family handles money?

Knowing which chai shop to back may be tough as there are too many of them around the campus.  Also, why only back chai shops? There are several Xerox shops, supplies shops  etc.

What about our campus bank (SBI)? It makes a lot of money by offering attractive fixed deposit rates. It then offers different kinds of loans (car, personal, house, for companies etc.) at much higher rates and bags a neat profit.

Why not buy the banks stock? Why not observe the spending habits of the undergraduates and find out which brands they prefer? Those brands could then form a shortlist for further investigation.

Yes, knowing where to invest (either equity or bond) is tough. It requires confidence, discipline and the time to analyze and track.

There is a much simpler alternative: mutual funds. You pay a sum to a fund manager who pools in all contributions and invests in a diversified folio of stocks, bonds or both.

I urged them to build fortifications asap, learn the basics of equity and mutual funds and begin investing.

There were some intelligent questions like:

  • Why do you expect stocks to increase all the time?
  • Why is a home loan the only loan that one should get?
  • Which term policy should I choose?
  • Can I buy real estate if I want to farm in it?
  • If one gets rich, does it mean someone else gets poor? (Tough one!)

 Ten commandments of investing

When I discussed about this talk at facebook group, Asan ideas for wealth, Prof. Parag Rijwanji, institute of management Nirma university laid down ten commandments a young earner should follow. This is a must-read.

To access it:

1)     Join Asan ideas for wealth (get on facebook if you are not there. Totally worth it)

2)     Search the group for ‘PhD’. You will find two threads started by an idiot.

You will find the commandments in the second thread.

Road to financial independence: A Forthright account

A few weeks back, Mr. Rajshekar Roy posted in the facebook group, Asan ideas for wealth. He wanted to know if his nest egg is big enough to quit a corporate job and start private consulting.  Many of us agreed that his fiscal health was sound enough to do so.

Since encountering such people is rare, the curiosity to know more about Mr. Roys journey increased. When I requested him to write an account, he readily agreed.

Regular readers may be aware that a couple of months ago, early retiree Mr. Balaji Swaminathan shared details about his journey towards financial independence in an interview.

Let us now learn from Mr. Roy.

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Of late, a number of people have expressed their interest in wanting to know about how I have dealt with my own financial planning. While it will be difficult to put all the thoughts in one article, I will try to outline my overall approach and the related successes and failures.

Let me start by giving an introduction. I was born and brought up in Durgapur, close to Kolkata. I did my BE in Computer Science from Jadavpur university and my MBA from IIM Calcutta. I started working in 1988 after IIMC and have been in the IT industry throughout, except for a brief period of 1 year where I worked as a consultant, again in the IT sector. From 2000 onwards I have held CEO level positions and am now planning to do other things. At present both my children are in college (BITS Hyderabad and BITS Goa) in the 3rd and 1st year respectively. My wife is an Economist and is currently working from home.

I have always felt that our attitude towards money is intimately linked to the value systems that we have in us. Some of the values that are deeply ingrained in me are as follows – I am not in favor of loans unless it is for creating assets, had initial reservations on equity markets, believe in spending based on affordability and understand that money is only a means to do things.

In the beginning of my career and till the time I got married in 1993, most of my savings were in Fixed deposits. In fact, I spent all my accumulated savings for the marriage and associated expenses. That did not matter too much as both my wife and I was working. In the initial period I continued investment in debt products like PPF for both of us. This was also the period when there were a slew of IPO s and I started investing in a few. L & T, Essar, HCL HP and Nucleus were a few stocks that I invested in. The last two were courtesy my being an employee there. Till 1998 when we were in Delhi, I did not give much thought to my financial planning. It was more of – I have a good job and will be able to earn more if needed etc.

We shifted to Chennai in 1998 and changes in my family situation resulted in my being more serious about financial planning. My wife gave up working after our second child was born, my daughter started attending school and we bought our first car (Maruti Zen VX). I had taken a loan of 1.5 lacs to buy the car but paid it back within a year. We had also bought a Timeshare unit from RGBC in 1997 which I managed to pay off in the same period. Though I was earning significantly more, our expenses were high and ability to save rather limited. I continued to invest in PPF and FD s as we wanted to build up an amount for the down-payment of a house.

The year 2000 was one of big change as I got a new job which more than doubled my compensation. Though our expenses also had an upward lift, this enabled us to start saving more rapidly towards the housing goal. The other thing was my getting introduced to a financial planner who sold us the first Mutual Funds – it was Franklin India Blue chip whose NAV was some 9 Rs then. Being from the IT industry I also bought Prudential ICICI Technology Fund, whose NAV due to the recession had come down to 3.27 Rs. The extra cash that we had enabled us to build up the down-payment for our home through FD s. I still remember our HDFC bank manager being quite sad when we liquidated these in 2002 for buying an apartment in Adyar. Side by side our equity portfolio was growing both in direct stocks as well as MFs. We initially bought only Blue chip companies but later on diversified into relatively lesser known companies. As far as MF went, we did not do SIP but bought into certain MF’s depending on our cash flows. By the year 2007 when we shifted to Hyderabad we had built up a significant portfolio in stocks and equity MF. At that point my goal was to have this value at 1 crore, which looked possible in the bull run of 2007.

Our portfolio did briefly exceed the above target, but the crash of 2008 depleted our net worth considerably. As I did not sell in the initial part of the fall, I just had to stay put and hope that there will be future recovery. I was in a stable job where I wanted to spend the next 3-4 years, so I was not really worried about needing money from my investments. In 2009 after the Satyam situation caused further bloodshed in the market, I actually took a contrarian step and started to add to my stocks. I still remember buying ICICI at 263 Rs and several others at great prices. We also started investing through SIP in MF from 2008, which still continues.

The last leg of my investment journey has been to focus on debt. I chose FMP s as the main instrument after trying out MIP s and not liking them much. Till the government changed the rules in this budget FMP was a great product. Most of the ones I had gave me double digit returns annually with hardly any tax liability. Today I have a substantial portfolio of FMP s and am exercising the rollover option as I do not need the money in the next 2 years. Tax Free bonds have been my other investments in the debt area. The main reason for this was to establish a regular income stream when I would not be working in a regular job. I do have a few regular debt funds, but the investment there is not significant. PPF has continued over the years and I do not intend to take money from it in the next 5 years, unless the rules change.

As far as insurance goes I have taken Life insurance early in my career and added more after marriage. Health insurance was always provided by the companies I worked in and last 2 years I have taken a Max Bupa policy.

I have had investment goals, but I have not separate investments for different goals. Children’s education was always funded through my salary and, except for the first car; my next 2 cars were bought outright. I had taken a 15 lacs housing loan but managed to pay it back in 3 years. I do not believe in taking loans for consumption. Our expenses have always been high, but fortunately the income had kept pace with it. Recently my wife and I went to Australia for 2 weeks and this too was funded by savings in the past year.

Breaking away from the herd

Breaking away from the herd: A solitary sheep breaking away from the herd accentuated by the disturbed dew on the grass.” – David Hannah (flickr)

Now that I am looking at getting out of the regular corporate grind to do some consultancy on my own, the present situation is this:-

  • Children’s graduation will be completed in a few years. I have provided for their fees based on the inflation levels that BITS has indicated. I do not consider this amount as part of my net worth.
  • I get some rent from my Chennai flat. This amount should suffice to rent a good apartment in another city. Will look at buying RE only if I sell the Chennai flat.
  • Medical insurance is taken care of. With my current resource base and reduced economic value of life, I do not think I need life insurance.
  • Regular expenses will be funded through dividends from stocks, interest from tax free bonds and dividends from MF.
  • For the next 5 years I do not anticipate touching the PPF money and hope not to deplete the Equity portfolio for 10 years.
  • My consultancy will probably generate a fairly good income, but I do not want to depend on it for my day-to-day expenses. This should be for some causes that are dear to me.

I think this has been a long article and hopefully it would have given some ideas to people as to how I went about constructing my financial independence. It has taken a lot of hard work and several twists and turns, but I do think of myself as financially independent today.

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Do join me in thanking Mr. Roy for such an honest account of his journey to financial independence.

The New Chinese Dosa: Equity Savings Fund

Human beings hate tax. They will do anything to reduce their tax outgo. Debt mutual fund investors received a jolt when the government erased the tax arbitrage that existed between bank fds/rds and non-equity funds (not just debt!).

Taking advantage of the fact that arbitrage mutual funds are (as of now!) taxed like equity mutual funds, fund houses are launching a new fund category: Equity Savings Funds.

This is sold as a low-risk, tax-free alternative to debt mutual funds.

Here are some examples:

1) JP Morgan India Equity Savings Fund
Under normal circumstances:
Equity 65-5% out of which 55-90% can be arbitrage.
Rest in debt
However the fund manager can decrease equity exposure to below 65% if debt instruments are attractive.

While JP Morgan does not highlight the investment duration, Kotak is promoting its equity savings fund as a tax-free option for 1-year duration

2) Kotak Equity Savings Fund
Direct Equity exposure: 15-25%
Arbitrage + Debt: 5-85%

3) Cafemutual reports that SBI, Birla Sun Life, ICICI Prudential and Reliance have such funds on the pipeline.

Should I invest?

Such funds are being projected as superior to arbitrage funds. Perhaps they maybe superior with respect to the quality of the arbitrage opportunities. However, the exposure to direct equity (recency bias?!), and debt would make the fund much more volatile than liquid-plus funds, and at least as volatile as a debt-oriented balanced funds (of which monthly income plans are the most popular).

Invest in these funds only if you have some cash lying around and do not know what to do with it! But first recognise that to have un-tagged cash lying around could be a sign of poor fiscal health.

Do not invest in these funds or for that matter any debt fund if you have a one-time expense less than or equal to 3 years away. Use bank deposits even if you are in the highest tax-slab.

If you have a staggered expense, use a liquid fund or liquid-plus (ultra short-term) fund.

The idea is to identify and understand the need and then locate a suitable instrument for it.

Remember that tax-free long-term capital gain is only one side of the coin. Never forget to take into account the associated volatility.
There is a pretty good chance that such funds could deliver returns comparable or even lower than post-tax bank deposits.
So when you are have an important goal in mind, why take a chance?

It is for the same reason (volatility) that I recommend bank deposits for those in the 30% slab even if the DDT rate ~28% for the dividend reinvestment option is lower.

Never focus on the return. Always evaluate the associated volatility (and therefore risk wrt your goal). For these funds the associated risk is pretty high for short durations. Never touch any fund which has got even a small amount of direct equity for 5 years or lesser durations.

About the title: A chinese dosa is a dosa stuffed with Chinese food (typically noodles)- an unnecessary culinary marriage.

‘The new chinese dosa’ because, this would not be the first time amc have come up with such unnecessary products – unnecessary for goal-based financial planning that it.

Seems to be reasonably productive move from an ‘asset gathering’ point of view: Cafemutual reports that the Jp Morgan fund collected about 160 Crores during the NFO period. Like I said, human beings hate tax!

Why not stick to plain dosas?      Happy Diwali.

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