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).
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?
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!
For the first time in my life I saw a financial plan without a single mention of the inflation and return assumed!!
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:
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.comand 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.
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 messagingAshal Jauharifor 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.
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.
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.
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:
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!
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.
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.
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.
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).
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.
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.
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: 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.
Do join me in thanking Mr. Roy for such an honest account of his journey to financial independence.
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
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!
“Dear Pattu Sir, I’m in DIY mode. Please tell me the BEST Term plan and the BEST Health Plan to purchase. Please suggest should I invest in HDFC Top 200 or not. How about keeping money in FDs under wife’s name? I want to crorepati in next 20Y………………..”
I don’t think, even after this open invitation from you (the above post) many ‘ll try to look into the deeper meaning of your post.
This is the sad reality of wannabe DIY investors. They either want the best solution or want ratification from a group of ‘experts’ for free.
Call it free lunch* and they are bound to get insulted.
free now. The ‘expert’ will not be held responsible for post-dated repercussions.
1)If a financial planner or IFA says DIY investing is time-consuming, it is quite understandable. You don’t expect barbers to admit that people can cut their own hair. It is sad to see that even neutrals in the financial services believe this nonsense.
Until a term life insurance, health insurance, goal planning and alignment of investments are in place, DIY investing will take no more than 2 hours a week.
Lost investors are those who take longer because they are busy seeking tertiary opinions.
Once the basics are in place, there is literally nothing to be done unless you are a direct equity investor. For the mutual fund investor, an annual review in the initial stages (would take about an hour) and a quarterly review after several years is all that one needs.
If that is time consuming, then I am lost for words … parliamentary ones that is.
Note: these are exaggerated figures. I take much less time than this. I get extremely irritated when people tell me that I am able to manage my finances on my own because I have time. Wrong!
I am able to write a blog, because I manage to make the time. DIY investing takes so little time that I don’t event account for it. It is part of normal routine like eating and sleeping.
2) DIY investing requires neither intelligence nor analytical skills All it requires is a maturity to focus on personal needs – one at a time. Sure, DIY investors pick up a bit of jargon and a bit of math down the line. This is incidental and not a requirement.
Lost investors are those who over-analyze a problem
Example: ‘Where do I invest my emergency fund?’!
3) DIY investors need not, rather should not, be personal finance enthusiasts.
This is utter nonsenses and often the root of all evil. All a DIY investor need to do is to take one step at a time. Identify one action item and work on it.
You don’t need to read books like inedible investor, rich step-mother, poor step-mother. You don’t need to read newspapers, TV, blogs, join forums etc. etc.
All this activity will only distract you from your goal: taking meaningful action
Lost investors are those who do not recognise the importance between knowledge and information.
4) I completely agree when someone from financial services says, most investors need hand-holding. These are the investors who get confused about product selection (among other things).
Thanks to the friendly neighbourhood insurance agent and the banks relationship manager, investors are wary of seeking professional help. Therefore, unfortunately for the IFA or financial planner, the investor needs hand-holding to seek professional help – they don’t know which hand to hold and when!
I can definitely afford to say that ‘I don’t trust anyone with my money’ provided I can trust myself with my money.
Lost investors are those who neither trust themselves nor professionals to get the job done.
Use this rolling returns calculator to compare the consistency in performance of one mutual fund with another. When you have shortlisted two funds and are not sure which one to choose, this tool along with the Fund A vs. Fund B Risk and Return Analyzer can be used to choose one fund.
For those who hold multiple funds in then same category, both these tools can be used to consolidate their portfolio.
This tool was suggested by certified financial planner Basavaraj Tonagatti, who runs Basunivesh.com
Here a few screenshots obtained for a comparison between ICICI Focussed Blue Chip and Franklin India Blue Chip
Normalized NAV movement
This is the 5 year rolling returns. In this case, the better performer is obvious. In general, a fund which has higher long-term rolling returns (more frequent) is better.
MF Utility, the web-based transaction portal through which direct mutual fund investors can invest in mutual funds offered by 26 (as of now) fund houses, is now online. It is not yet operational, however basic details of how it can be used are available and more information is likely to be added soon.
An extract from the MF Utility for Investors page:
MF Utility (MFU) is an innovative initiative from the Mutual Fund Industry which offers convenience and empowers the investors of Mutual Fund schemes. MFU facilitates the investors with a Common Account Number (CAN) which enables them to transact in multiple schemes of various Mutual Funds participating in MFU through a single transaction and consolidated payment.
MFU provides a 24×7 universal online access across Mutual Funds to investors to access NAV and Scheme related information and content. Through MFU, investors will be able to have a consolidated view of their holdings and transactions at industry level. MFU will also provide value added services like Common Account Statement (CAS), Alerts, Triggers, Reminders etc., to investors.
Thus, one will have to apply for a common account number once it is operational and hopefully this should enable us to map the existing holdings onto the portal for consolidation.
With a single account and a one-time KYC process, the investor will have access to the schemes of 26 (out of 42) fund houses from the same platform.
Hopefully, this should help existing direct mutual fund investors and encourage more investors to choose the direct route.
Here is a partial screenshot of the participating AMCs page
Buying a term life insurance policy based on an insurers claim settlement ratio (CSR) is a meaningless exercise. All it does is offer psychological comfort to the buyer who refuses to understand that each death, and therefore each claim settlement is unique. When a nominee applies for a claim, the insurers CSR is irrelevant.
That said, when a young earner wants to know, ‘which policy should I buy?”, or ‘how to choose a term policy?’, we typically say, ‘choose an insurer you are comfortable with, just be honest while applying’.
Unfortunately, I find that this is not of much use, as the person still needs a simple way to define a comfort zone and short-list insurers inside the zone. The honesty part is of course always relevant!
Therefore, in this post, much as I do not like it, I would like to propose a simple way, based on the CSR, to short-list insurers for purchasing a term plan.
The whole process should take you no more than 15-30 minutes.
One good thing that has come out of the CSR hype is that the insurers (incl LIC) have also fallen for it! Some make it a point to flaunt their CSR. This might be a good development from the (future) customers point of view. If the CSR drops, insurers have begun to realise that it could impact image and therefore sales.
Deconstructing IRDA’s Death Claim Settlement Table
First, let us touch upon aspects from IRDA’s death claim settlement table, obscured by the claim settlement ratio.
Let me start with an analogy between an insurer and a teacher evaluating answer scripts. As the teacher starts evaluating scripts, he/she gets a sense of what the average mark of the class would be. When a student scores little or no marks in the first few questions, the teacher realizes that the total mark would be much lower the class average. Therefore, the tendency would be to be a bit generous in the next few questions so that the total is bolstered a bit.
On the other hand, if the first few questions are well written, the tendency would be to scrutinize, the whole paper(!) a bit closer. This is normal human tendency and even a teacher with no pressure from the administration is likely to do this.
Why won’t an insurer who receives a big-ticket claim scrutinize it tougher? After all, there is much more at stake.
The point is, LIC or private players, no one is likely to offer term cover claim settlement on a platter. Of course, there is a due process clearly mandated by IRDA.
The following is a screenshot from the IRDA annual report 2010-11 (click to enlarge).
Trouble is, what a claimant considers a delay and what is legally allowed, are two different durations!
There is a crude way to point out that higher the claim amount, higher the scrutiny, resulting possibly in a repudiation or delay.
The claim settlement table published by IRDA has the total benefit amount along with the number of claims intimated, pending and repudiated.
This is a screenshot from the individual death claims table of the 2012-13 annual report. The entries have been merged with the column headings to aid reading.
The benefit amount per claim when compared over time can shed some light on the ‘average’ claim amount handled by the insurer. Of course, this ratio is not a sound way to make any solid inferences. Let us however run with it and see where it takes us. Before you pan me in the comments section, remember that I acknowledged this!
The claim amount (Lakhs) intimated per policy was 0.73 was LIC in 2006-07 and 1.58 for privates.
In 2012-13, this increased by 36% for LIC and nearly 33% for privates. It must be kept in mind that the number of private players increased by about 50% in this period.
Thus, there is a significant increase in the claim amount per policy handled by LIC.
Even more striking is the 78% increase in the benefit amount per repudiated claim (1.08 to 1.92) . How would you interpret that?
For the privates, the benefit amount per repudiated claim has increased by a whopping 95% (2.08 to 4.05) .
For LIC, the claim amount repudiated per claim can only increase from now (their e-term policy is only one reason). For the privates, I think it should come down in the future or at least not increase so dramatically.
One could argue that the new insurers would have processed early claims and hence would have scrutinized stringently. However, let us read too much into this.
Simply because it is clear enough (even without this data) that the privates are likely to scrutinize claims tougher than LIC.
This can also be seen by
1) comparing benefit amount per claim paid with benefit amount per claim intimated. These are comparable for LIC. For the privates, the benefit amount per claim paid is always lower than the benefit amount per claim intimated.
2) Privates have more claims pending at the end of the year than the start of the year (not shown). The converse is observed for LIC.
The number of pending claims at the start of the year decreased from 9574 in 2006-07 claims to 8856 claims in 2012-13 for LIC. While it nearly doubled for the privates, primarily because the number of such life insurers have increased.
Notice that the amount per claim pending at the start of the year has doubled for privates, from 2006-07 to 2012-13, even though the denominator (number of claims) has nearly doubled (from 1894 to 3467 in 2012-13).
When the denominator doubles, the ratio can double only if the numerator (benefit amount) quadruples!
This implies that the privates are handling much higher claim amounts than LIC (not much of a finding!). One could argue that this is the reason, their CSR is lower.
Even if you don’t wish to make much of these ratios, I hope that you agree with my contention that if the claim amount is big (as in a term insurance policy), LIC too would scrutinise it carefully. Simply because such an amount would be higher the average claim amounts they process.
Claim settlement ratio
Claim settlement ratio ignores the
1) nature of the policy. LIC typically has a higher number of small ticket claims. 2) the time it takes to settle. It can take up to six months or even more to settle a claim. As long as a claim is settled within the FY, it will be counted for computing CSR. From a nominees point of view, that is a ‘delay’.
Consider this: In 2012-13 LIC settled 7.33 lakh claims out of 7.51 lakh claims. A claim settlement ratio of 97.7% The privates settled 1.13 lakh claims out of 1.27 lakh claims. A claim settlement ratio of 88.6% (incidentally a significant improvement from 72.7% in 2006-07 despite a 50% increase in number of private pl.ayers)
Now, if the privates had a CSR equal to that of LIC, they should have settled 1.24 Lakh claims (instead of the actual 1.13 Lakh claims). This is less than 10% off. This is approximately the difference between the CSR’s, but when you look at it this way, I think it does not appear so bad!
If you are worried about this, then you should have enough money (including possible loading if any) to afford an LIC policy (offline or online).
If you don’t, why bother?!
I suggest you pick a private life insurer who has been around for at least 10 years (with no plans to leave – check recent news reports) with a CSR close to, or above the total private average.
Even better, if the insurer has a CSR history consistently higher than the current private average.
It will take you less than 30 minutes to access the IRDA reports, locate the “Individual death claims” table and scan the necessary numbers.
Once you can short-list 2-3 insurers, compare the price for a policy (without loading, but inclusive of service tax) using the premium calculator available at their websites.
Choose the cheaper among the two.
Apply immediately. Do not ask anyone else for an opinion.
R. Balakrishnan is a person of great renown in the banking and financial services space. He helped set up CRISIL and the Malaysian credit bureau, was head of equity research at DSP Merrill Lynch, executive vice president of Edelweiss, to name just a few. He is now an organic farmer, writes a blog and has a column at MoneyLife. More details about him can found at his farm website.
In an article titled, Investing in a concentrated ETF, he referred to the formation of an ETF with the stocks held by the Specified Undertaking of the Unit Trust of India (Suuti) such as ITC, Axis Bank and L&T. More on the ETF here.
He considered an ETF in which one unit would comprise of one share of ITC, Axis Bank and L&T, as an option for those who wanted to get into direct equity but did not have the time and effort to do so.
The SUUTI ETF will have more shares as these three shares only constitute 31% of the portfolio.
In this post, I present the backtesting results of such a three stock portfolio (not necessarily an ETF) from Jan 2000.
Get a list of common dates using a combination of Excels INDEX and MATCH functions.
The normalised movement of share prices. The y-axis is in log scale to show the evolution in the early stages clearly. L&T and ITC have moved up 15 times, while Axis bank, 75 times. ITCs movement is not well correlated to the other two shares.
We assume one share of the three stocks is purchased each month. The SIP states on 3rd Jan 2000 and ends on 7th Oct 2014.
So on 7th Oct. the investor would hold 177 shares of each company.
total investment: 1.47 L
portfolio value: 3.87 L
Brokerage charges, demat account charges have been neglected. If that bothers you too much, reduce the above return by say, about 1%.
Comparison with Franklin India Blue Chip
What if the investor had chosen a diversified large cap fund instead?
total investment: 1.47 L
portfolio value: 3.01 L
Normalized movement of FIBCFs NAV and the total price of the three stocks.
Notice how volatile the 3-stock portfolio is compared to the fund NAV.
The standard deviation in monthly returns for the 3-stock portfolio is 39%. A good 30% larger than the corresponding number for FIBCF.
That is the trade-off when it comes to direct equity vs. mutual fund investing.
Higher returns (potential) but higher volatility (guaranteed!) in direct equity.
While Mr. Balakrishan’s idea is certainly a sound one (with the caveat that the past performance means nothing!), should an investor use direct equity to create wealth or mutual funds?
Unfortunately, direct equity is seen by many as a route to create wealth quickly. Unfortunate because for most people the direct equity route is like walking the tightrope over a chasm that separates an investor from financial freedom.
The alternative is a wider plank laid out over the chasm . Walking the plank (!) would take longer but it is significantly safer.
Perhaps the tightrope would get thicker down the line, with experience. Perhaps not.
Now that is one risk that I am not willing to take. Simply because I don’t have to.
Investing for long-term goals is governed by the following tenets. 1) Beat inflation either by investing more and/or with adequate exposure to volatile but productive assets. Preferably ‘and’, not ‘or’. 2) Understand the importance of containing volatility and that trying to maximise returns by being more aggressive is like trying to run a marathon like Usain Bolt. 3) Knowing how to contain volatility. a) never ignoring debt. Not more than 50-60% equity exposure is needed for any long-term goal. b) having the maturity to diversify the folio among productive asset classes and within each asset class c) having the maturity to periodically shift gains from a performing asset class to a meek if not underperforming asset class. Also known as rebalancing.
I am convinced that investors, especially the young earners, must keep things as simple as possible and avoid portfolio clutter like the plague.
For most people, the best way to diversify a portfolio within an asset class is by not trying! If they don’t know what they are doing, this is what happens:
Here are a few long-term (15 Y plus) portfolio ideas that are minimalist in nature. All of them are likely to produce a real-return to the disciplined and un-wavering investor.
Be warned that, none of them will work
if you expect anything more than 12% CAGR (I prefer 10%) from the equity or equity-oriented component.
if you jump up and down each time other funds do better than yours.
if you think having more mid and small-cap funds will fetch you more returns because your goal is far away.
Minimalist Portfolio 1
Single Large Cap mutual fund (60%) + PPF (40% only!)
Core and satellite principle be damned. Solid large caps will be relatively less volatile. Size of the fund does not matter as large caps are liquid stocks.
Minimalist Portfolio 2
Single Equity-oriented balanced mutual fund
My favourite for the following reasons 1) Tax-free debt component. 2) Automatic rebalancing 3) Fund return = portfolio return. Goal tracking is the easiest. 4) Most liquid portfolio of them all. 5) The equity component could be diversified too
Minimalist Portfolio 3(a)
Single Large and Mid-cap fund (60%) +PPF (40% only!)
For those worried souls who long for mid-caps. Some have a touch of small-caps too!
Fund size could be an issue. Larger the fund, the more large cap it becomes in nature.
Minimalist Portfolio 3(b)
Single Large Cap mutual fund (60%) + PPF (40% only!)
Single Large and Mid-cap fund (60%) +PPF (40% only!)
The fund in this case has exposure to international stocks.
Robust diversification. Solid long-term returns but with the short-term impression of being a laggard (diversification requires maturity)
Down the line, a debt mutual fund can be added to the above portfolio to aid rebalancing. Initially, one-way rebalancing, that is shifting excess equity allocation (say 5% or more) to PPF is more than enough.
If you are starting to invest for all your long-term goals at the same time, a unified minimalist folio will do the trick. If there is a gap of a few years between the investment for each goals, you can construct separate minimalist portfolios for ease of tracking and rebalancing. A unified folio could also work, but tracking the corpus of each goal can be a pain.
Individual minimalist folios allow independent risk management. A 25 year goal is not the same as a 15 year goal. I would prefer to rebalance more often for a 15 year goal.
That is it. Don’t chase after that hot mid/small/micro cap fund.
In this post, let us compare two large cap funds from the same fund house. One a consistent performer with a terrific track record and the other a young superstar. The results will hopefully show how herd instincts among investors (and perhaps amcs and therefore(?) intermediaries too?) can obscure good funds from the same fund house.
Let us now list the salient features of both funds (Sources: VR online, thefundoo, fund SIDs, monthly reports)
ICICI Pru Focused Blue Chip Equity
Category: Large Cap
Benchmark: CNX Nifty
Inception Date: 23rd May 2008
AUM: 5879.7 Crores (30th June 2014)
Investment Objective: To generate long-term capital appreciation and income distribution to unit holders from a portfolio that is invested in equity and equity related securities of about 20 companies belonging to the large cap domain and the balance in debt securities and money market instruments. The Fund Manager will always select stocks for investment from among top 200 stocks in terms of market capitalization on the National Stock Exchange of India Ltd.
If the total assets under management under this scheme goes above Rs. 1,000 crores the Fund Manager reserves the right to increase the number of companies to more than 20.
Indicative asset allocation:
Equity: 70% or more. Rest in debt or money market instruments
Large cap: 88.5%
ICICI Pru Top 100
Category: Large Cap
Benchmark: CNX Nifty
Inception Date: 9th July 1998
AUM: 666.56 Crores (30th June 2014)
Investment Objective: To generate long-term capital appreciation from a portfolio that is invested predominantly in equity and equity related securities
(broader the mandate, the less verbose the objective!)
Indicative asset allocation:
Equity: 95% or more. Rest in debt or money market instruments
Large cap: 79%
Portfolio overlap: Out of the 80% folio listed at VR online, there is an overlap of 52%. Which is significant.
ICICI Top 100 has a current AUM of ~ 666 Crores. Lower than what focused blue chip had 5 years ago?
The reason I wrote up this analysis is to pose the question why is this so?
In terms of performance, that is bare returns, there is not much difference between the two funds. In fact, Top 100 has a longer track record of consistency.
So why has this been pushed to the background? Who is responsible for this?
The AMC? The distributors? The investors? My guess is everyone.
The only difference between the two funds:
Focused blue chip began operations at the start of the 2008 financial crisis. Therefore, I think it appeared as a saviour to many since the established funds (incl. top 100) were struggling to cope with the crash.
While existing mutual fund investors flocked to focused blue chip equity, new investors saw it as a safe bet. One person said, ‘the fund would never fail’.
It is heartening that MorningStar analysts have given a ‘silver’ rating to Top 100 and a ‘neutral’ rating to focused blue chip, while VR online rates them both as 5* funds.
Silver: Fund with advantages that outweigh the disadvantages across the five pillars and with sufficient level of analyst conviction to warrant a positive rating.
Neutral: Fund that isn’t likely to deliver standout returns but also isn’t likely to significantly underperform, according to the analysts.
Now a few definitions for your perusal. Hopefully, they would clarify the first word in the title of the post.
A group of animals fleeing from a predator shows the nature of herd behavior. In 1971, in the oft cited article “Geometry For The Selfish Herd,” evolutionary biologistW. D. Hamilton asserted that each individual group member reduces the danger to itself by moving as close as possible to the center of the fleeing group. Thus the herd appears as a unit in moving together, but its function emerges from the uncoordinated behavior of self-serving individuals. (wikipedia)
A mentality characterized by a lack of individual decision-making or thoughtfulness, causing people to think and act in the same way as the majority of those around them. In finance, a herd instinct would relate to instances in which individuals gravitate to the same or similar investments, based almost solely on the fact that many others are investing in those stocks. The fear of regret of missing out on a good investment is often a driving force behind herd instinct. (investopedia)
This occurs when a person observes the actions of others and then—despite possible contradictions in his/her own private information signals—engages in the same acts. A cascade develops, then, when people “abandon their own information in favor of inferences based on earlier people’s actions” (wikipedia).
Moral of the story: Never buy a fund because it is popular or even if a professional recommends it. Focus on your own portfolio. Do your own research. Ignore star ratings.
Note: Do not sell or stop investing in focused blue chip because of this post. Evaluate your needs and make informed choices. You know where to find the necessary tools
Many years ago, my wife and I took an evening stroll around a temple tank. The moon was full and beautiful. We stopped to stare at it for a few minutes and took some pictures. Before we stopped to look at the moon, no one around us cared about it in the busy street. When they saw two people looking at something, they became curious and joined in. Soon there was a chain reaction! I am pretty sure behavioral scientists have a word for this phenomenon. Do share, if you know what it is.
In the first parton why you should ignore mutual fund star ratings, I had stressed on the importance of focusing on our portfolio health and performance of the fund with its benchmarks.
In this post I would like to add a couple more reasons to strengthen the argument.
Let us assume that an investor named Tom has chosen to ignore my thoughts on this matter and decided to invest as per fund star ratings.
Which star ratings should he choose?
Value Research, Morning Star, Money Control, thefundoo, or others?
Not all star ratings are created equal. Each one differs in methodology. Even if the difference are small, the results can vary by a wide margin.
Take the case of ICICI Prudential Top 100 Fund, an excellent large-cap fund (analysis in a forthcoming post) with a consistent track record since 1998. It is managed by one of the best portfolio managers in the country: Sankaren Naren
Value Research rating: 5*
Morning Star: 4*
Moneycontrol: 4* (Crisil rating 2 in large cap category)
ICRA Online Rankings: 3*
Which rating system should Tom choose and why?
To answer this, the follow options present itself to Tom:
Read the methodology of each system. Assuming that he understands each of them, choose one that he is ‘comfortable with’!
Use what everyone is using. But how the hell will Tom know that in the first place?!
Pick one rating portal, write to them and find out which Tom should use?! Objective answers guaranteed!
Look at the website. If it looks impressive and easy to use, Tom can assume that the rankings are solid too!
As long as Tom wears horse blinders and sticks to one rating portal everything seems fine. The moment he compares ratings offered by different portals, he realizes (hopefully) that the guidelines for calling a fund as 5* or 3* are purely arbitrary. The guidelines are consistent and based on solid math, no doubt, but they are arbitrary nonetheless.
I say this because the criterion used each rating agency can differ. One fund portals risk-free rate could be different from another. The duration chosen to grade funds can vary. The way in which each metic is calculated can vary.
This is the primary reason why investors should avoid star ratings. Instead of these arbitrary guidelines, why not use some personalized, and therefore absolute ones likes our (reasonable) return expectation, net portfolio returns, position of the fund in the portfolio and consistency of performance wrt benchmark?
I would like to recommend the following simple way to evaluate a fund wrt its benchmark to the Toms of this world.
It compares the funds performance with that of its index for 1,2,3….8 year durations with 19 risk and return metrics and offers a simple score out of 100% for each year. A ‘good fund” is one which has consistently recorded a high score.
The user is free to set the risk-free rate and the minium acceptable return. It is open source so you can add or remove metrics as you please (removing is easier than adding though!).
It is an absolute measure of outperformance (or the lack thereof) in the sense that only funds benchmark is compared with the fund. You have about 35 equity benchmarks to choose from.
Both the long-term and short-term performance is taken into account unlike most star ratings.
Here is how ICICI Top 100 fared
It is a terrific fund. It has beat its benchmark on an absolute and risk adjusted basis consistently for the past 8 years. This is more important than the number of stars someone gives a fund.
Of course, this information is relevant to the investor only if he/she understands how to build a minimalist portfolio (coming soon!): one in which each fund has a specific role.
Not all funds rated 5* by the same agency are created equal.
Would you invest in this fund, rated 5* by VRonline? It is also benchmarked to the Nifty.
Use the data provided by the fund ratings portals and not the ratings themselves. Carpe Diem.
‘Should I choose only five star rated mutual funds?’, ‘Should I switch funds each time my funds rating is downgraded?’. These are extremely common questions among mutual fund investors. In this post, let us discuss how star fund ratings are irrelevant to the goal-based investor.
Any action, buy, sell, hold, switch etc. should be based on observations with respect to meaningful reference point.
Understanding this is key to successful investing, be it in stocks or mutual funds of fixed deposits.
However, it is important to recognise that we are investors and not analysts. An analyst has no choice but to relatively grade mutual funds and award them stars.
Only the listless investor would worry about the relative performance of his/her holding wrt to all the funds in that category.
Any investor should first have a clear idea of how much to expect from a particular fund category (and not from the fund). The expectation should be reasonable. They must understand what a standard deviation is and how much returns can typically deviate from the expected value for a given time period.
For example, no fund can satisfy an investor who wants 25% annual returns. A good 80% of funds in each category can satisfy investors if they only want average 10% return over the long-term – the recommended long-term return expectation from equity.
As long the as the CAGR of the holdings (not the recent CAGR of fund) is higher than the expectation, there is absolutely no reason to change funds.
Even if the CAGR of the holdings drop below expectations, one will need to qualitatively analyze the state of the market, the stance of the fund manager, when the money is needed, and then, and only then, take appropriate actions.
If the fund has a good track record, the fund manager has not changed, the content of its portfolio not deviated too much wrt its investment mandate, nine times out of ten, there is no need to immediately change the fund even if it returns lower than expectations, if the goal is far away (my HDFC Equity holdings CAGR was 4% last November. Today it is 32%. It is tagged to my retirement goal).
It may so happen that a fund which was returning 5% more than our expectation suddenly dropped to only 2% more. In such case, the consistency of the funds performance with respect to its benchmark should be evaluated.
As long the fund is out-performing the benchmark over 3 years or so, I see no reason to change the fund.
Therefore, a funds star rating is not relevant at all to the goal-based investor. Even those who mindlessly chase after returns, ‘just like that’, have a goal (of some sort!). So star ratings won’t help them either. That nothing would them help, is another matter altogether!
Bottom line: Learn about risk-adjusted return, how to evaluate consistency in funds performance or seek professional help … and pray that the professional does not rely on star ratings!!! Sadly too many of them do.
The sooner you retire, lower the retirement corpus necessary for financial freedom!* * terms and conditions apply! Let us consider this counterintuitive aspect of retirement calculators in this post, which stems from Sudhindra Aithal’s comment on this topic in response to the low-stress retirement calculator.
Used for illustrative purposes only. No copyright infringement intended.
Let us consider a 30 year old, Dagwood Bumstead who wishes to plan for retirement. For those who may not know, Dagwood is the husband of Blondie – a long running comic strip!
He wants to decide the age at which he could retire. Since there are (too) many parameters in a retirement calculator, Dagwood wishes to keep the following inputs fixed:
Inflation before and after retirement: 8.5%
Life Expectancy: 90
Return expected on retirement corpus: 9% A real return of 0.46% (not 0.5%!!)
If Dagwood wishes to retire at 65 (25 years in retirement), he would need a corpus of 14.8 Crores.
If he prepones his retirement to 60(30 years in retirement), he would only need 11.8 Crores.
If he wishes to retire even earlier at 50 (40 years in retirement), he would only 6.7 Crores. More than 50% reduction for 15 additional years in retirement!!!
At first sight this is astounding! The longer Dagwood needs to live in retirement, lower is the corpus he needs!
The reason for this is the interplay between negative and positive compounding.
Negative compounding refers to the effect of inflation and positive compounding refers to the grow rate of the retirement corpus.
The sooner Dagwood retires, lower would be the expenses at the start of retirement. If he retires at 50, his expenses would be about 30% lower than at 65 (the projected value). Meaning, he would withdraw less from his corpus. Therefore, more of the corpus can grow. Thus, he needs a lower corpus at 50 than he would at 65!
This bizarre but easy to understand idea is illustrated below.
The retirement corpus initially increases because the growth is higher than withdrawals. Soon due to inflation, the withdrawals exceed the growth. Therefore, the corpus peaks and then rapidly falls with each additional year in retirement to zero (at age 90 in each case).
Earlier the retirement or more the years in retirement, the longer it takes for the corpus to peak and then fall. That is the annual growth of the corpus is higher than the annual withdrawals for more number of years. This is why one can do with a relatively lower corpus (vertical dotted arrow).
This aspect can also be illustrated by compared the retirement corpus required for different retirement age and the expenses in the first year of retirement.
Higher the retirement age, higher the corpus because of higher the initial expenses.
Where is the catch?
This does not mean that one can retire early!! Although a lower corpus is required, the time needed to accumulate it is also lower.
That is, there is not enough time for Dagwoods monthly investment to grow! To offset this, Dagwood will need to increase his monthly investments. Lower the corpus required, higher the monthly investment! In fact, the investment rapidly increases with decrease in retirement age and soon become impractical. This is calculated assuming Dagwood has not made any investment so far.
Thus, if Dagwood wishes to retire at 50 rather than 65, his monthly investments should more than double (while his corpus is less than half!).
This post showcases a presentation by Aparna C K to her office colleagues on Sep. 19th 2014. I am delighted that she kindly consented to let me share this here. Regular readers maybe aware that Aparna has written two guest posts for freefincal which became instant hits:
I have chosen to post the PowerPoint slides as individual .jpeg figures with the authors notes (mildly edited for public consumption) and relevant hyperlinks.
Author Note:Personal finance is more to do with you as person than finance. It is not finance in the conventional sense. You must participate actively to get max return on your time invested. Let us find out what you guys expect from this.
Author Note:Not “making” money. What suits one person may not suit the other. Avoid copying others. Personal comes first rather than Finance, precisely because it is Personal.
Author Note: What if your vehicle meets with an accident and goes for repair, What if you die due to accident or illness? What happens if you lose jobs? Now you have income, but when it stops, how are you going to live How are you going to finance your dreams/goals which are a few years away Before really getting into deep waters, knowing one’s inclinations, attitudes is very important.
Author Note: When you already have so many genuine expenses, not spending on unnecessary things is very important. Not needed also applies to financial products.
Author Note: Once you start DIY, it is hard not to enjoy it. It is equally hard to trust someone else with our hard earned money. Only advantage with hiring someone to handle our finance is, they may help you to take balanced decision, but this may or may not happen. Many a times, they get interested only in their commission. Link in the slide:What does it take to do your own financial planning? Author Note: One may not realize the importance if staying in parents house, parents still working Check if you live within the budget. Don’t purchase anything on a whim, without understanding. In finance, this results in loss of investible surplus, which is formally termed as an opportunity cost. If you are already stuck with one, don’t try to avoid current loss, when you know further investments in bad products will only lead to more future losses. -Credit card is not bad if you exploit all its advantages and do not get spoilt
If you get tempted to spend, transfer it to another account. Best to keep one more account other than salary account. Let the salary account be expenses account and the other one savings. As soon as you receive salary, transfer the surplus to savings
When I say cutdown, I am not saying lead an ascetic life. As I said earlier, evaluate needs and wants. My own experience: I used to record my expenses right from my highschool days, as a result, once I started earning, I completely stopped it. I did it on and off after marriage, since December 2013, religiously doing it. Link in the slide:Budgeting Gets Your Financial Act in Place
Author Note: Touch it only for real emergencies-unforeseen events. Accident, house collapse, or forgetting wife’s birthday! Business people may keep more emergency fund, like 12 month expenses. On Life insurance: Go for it only if you have dependents/loans that too if your net worth is not sufficient to take care of them in your absence. Term + PPF/ELSS is superior to Endowment/ULIPs. Health insurance is a complicated product, be careful when you buy. Read exclusions, pre-existing illness cover, co-pay.
Author Note: An example. 1000 rupees invested today. After a year get back 1100. But what costed 1000 rupee today costs 1090 next year. Still net gain is 10 rupee, but this 10 rupee next year is not the same as this year’s 10 rupee. It is only 10/1.09 = 9.1 rupee. So your real return is 9.1 rupee for 1000 rupee invested.
CII Started in 1981-82, at 100. In 2014-15: 1024 => Over 33 years, 7.3% annualized inflation – At this rate, after 33 yrs, your 20k becomes 2L expenses. Collect actual data from your parents. My own experience: When I started in 2002, with rented home, my expenses were 10k per month, but now it is not comparable. Lifestyle itself has totally changed. FDs at 9%, after tax give 6.3%/7.2%/8.1% (Fixed Depreciation) So, don’t be fooled by how banks present their interest rates. Would you really love to save money in FDs if banks all over put banners saying, “we give -1% real returns”. It is just the way numbers are presented makes us not see the reality.
Author Note: If you are 60 today and your monthly expenses are 11900, you can retire with a corpus of 40Lakh, provided, the returns from corpus matches inflation. For 50 yr old, In 10 yr duration, due 40L gets inflated to 74L. For 22 yr old boy, in 38 yr duration, it gets inflated to 5.23Cr. This is the reason for the difference in the corpus needed. (Numbers entered in the fields of jagoinvestor calculator: 11900, years, 7,7,8.07,30,7,7)
Author Note: Set your personal priorities first. If you do not like grand weddings, do not have one, worse, do not take a loan for it. In general, do not plan for unnecessary expenses to please parents, relatives or friends. If your parents are ignorant and made mistakes, does not mean out of respect for them you must repeat them. Be logical. Another point. Do all these activities ASAP, before marriage, otherwise you need to please one more person. (At the same time, be flexible, and accept if the other person has better suggestions) If you are in single ready to mingle state, it makes sense to talk about finances at some stage while dating. It can start indirectly initially and go deeper with a few more meets. Converging on a common finance philosophy becomes very important in marriage. Do you want to be fighting about money every day? Own home in Bangalore, as of now does not make any financial sense. Renting is far sensible than buying. That is a different analysis by itself. We can take it up later. People are uncomfortable with huge cash, for the fear of spending them. Due to lack of familiarity with other avenues, they get into EMIs. This should be avoided.
Author Note: Short term : Buying a bike/car, house renovation, Big amounts of charity for a cause you believe in Medium term: Child education, downpayment for home/land for future home Long term: Retirement
Author Note: There are some more lesser known advantages of PPF apart from Govt backing It can be extended by 5 year blocks, after maturity, for n number of times. There are some fine rules to be adhered to. At any time after crossing 7 yrs, you can withdraw half the balance 4 yrs ago. But go for it only for matter of life and death PPF balance is safe, lenders can not claim it. Fact about PPF: Interest rates are volatile. Till 2002 it was around 11%!
On tax evasion TDS is not same as paying tax. Bank cuts at nominal rate of 10%, but you need to pay as per tax bracket. Also the 10k exemption is only on SB interest, not on FDs and RDs. To be paid on accrual basis If you do not pay tax and get caught, you may be fined 3 times the hidden income. Scrutiny is random. Author Note: Debt mutual funds: These could be superior to FDs especially for 20 and 30% bracket people, for short and medium term goals, due to indexation benefit after 3 years. Index funds: Do not choose blindly still. See AUM, expense ratio and tracking error. Buy it from reputed fund house.
Important point: SIP: Any time is a good time to start. Rupee cost averaging works independent of start and end points. Some numbers. Consider 1000 rupee SIP. Buy 100 units at 10 rupee Next month, say it falls to 9.5 rupee. Investment value has fallen to 950 rupees., But you get 105.26 units. Now your investment chart reads as 1950 Say next month it fell to 8 rupee. You get 125 units for 1000 rupees and your cost value 3000, investment value now reads as 2642. Do not panic. Wait patiently. Consider next month, increasing to 11 rupee, due to some factors. You get 90.9 units, your cost value is 4000, but the investment worth is 4631. You can either cry you got 90.9 units, or celebrate you gained 632 overall due to jump. Do not redeem. Let the SIPs continue.
Author Note: Once invested, focus on learning basics. Read books/blogs written by qualified people (not necessarily finance people). My list of Personal finance teachers (names not important): An old wise CA, Computer Sc Engineer turned financial planner, Physics Prof in IITM, Chemical Engineer, Doctor and all the active folks in an FB closed group called “Asan Ideas For Wealth” whom I’ve never met in my life and might not meet. For motivated people inspiration can come from anywhere, just have the willingness to learn. To be financially intelligent, you do not need to have a degree in finance. Do not listen to TV channels or read newspapers on market movements. Rebalance, not profit booking. Periodically move back and forth based on asset allocation ratio. With active funds, one needs to evaluate its performance wrt benchmark index, not as absolute performance. At least in the case of index funds, there is not even the need to check if the fund is performing poor, unless there’s a big change due to which the basic parameters started drifting.
It is found that if r is small enough, then any MF does a good job with SIP, but same cannot be said about lumpsum. Only in sideways markets SIPs wont work, but nor will the lumpsum.
Author Note: Do not link happiness and money. Also, frugal doesn’t mean miser. Clearly distinguish between needs and desires. Miser compromises on needs, frugal controls his desires, but spends on needs. When you do not know what it means to be in financial stress, it is hard to guess what will happen if you do not have enough in the retirement. This is just accumulation phase. During retirement, one can treat blocks of 5 yrs as a separate goal and keep aside money from the total corpus.
Story of a finance person, a CA getting into mess in her own personal finance, when her husband in early 30s dies. When there is a death (Unable to locate the original post. Pity that so many people have published this story but none of them seem to point to the original sour)
Please share your views on this presentation and any questions that you have in the comments section. If you found it useful, do share it with fellow young earners.