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Freefincal Q & A: Too many funds; Surviving Crashes; Indexed Capital Gains

Each week I answer generic questions on personal finance & investing from readers.  Here is this weeks edition. You can use the form below to enter your question.

Announcement: Venkatesh Jambulingam has been kind enough to translate few of my posts in Tamil. Please support his work by sharing it. Latest posts:

How to review a mutual fund portfolio (Tamil) (English version is here)

Minimalist portfolio ideas for young earners (Tamil) (English version is here)

Sandeep Rao:
 I'm a 26-year-old who holds way too many mutual fund schemes (36 at last count) owing to my father signed me up for all the schemes his advisor suggested. Now that I have read up more on personal finance, I have worked out a retirement portfolio (with ~9 schemes, way more sane!) using your MF screener(was a great help). The dilemma I face now is whether to redeem the schemes I hold presently (which a more of a random mix of good and bad funds) when they are out of exit load period (in about 3 months time) and put the proceeds into my target folio as a lump sum or put them in a liquid fund and do an STP. The previous funds I held were mostly built by SIPs, so rupee-cost averaging is already built-in, yet with the current high market levels, I wonder if I should hold off on a lump sum investment. I had found your SI-PE concept quite intriguing, also since I'm looking at retirement (another 34 yrs away), the returns probably wouldn't be very susceptible to timing. Thoughts?

Pattu: Keep it simple. Redeem and once money hits your bank, invest in the selected fund. Trim without fear and mercy! As regards, SI-PE, the reward (for the nos shown) was not commensurate with the effort. So I won't take it too seriously.

P R RAVINDRAN: I was looking for a Rent vs Buy calculator which can be used by anyone with his own set of figures. After going thru' a lot of articles I found this one ( link given ) very useful. But there is no calculator - I need Pattu Sirs help in creating on these lines and with any other improvements.The article is dated in 2010.

Pattu: Sir, as mentioned before, The trouble with rent vs. buy calculations, I am not a fan of such calculations because we are considering two situations which can never be identical (unless we wish to buy the house that we live in rent). I have an old buy vs rent calculator by ex-blogger of thewealthwisher, Radhey Sharma. I can dig that up and send it to you.

Narasimmamurthy: My adoring thanks for the thoughtful article on Standard deviation for the choice of Mutual fund category. May I know the investment duration suitable for pure equity funds; since Equity oriented hybrid funds suggested for duration more than 10 years

Pattu: What matters is the asset allocation. For important goals within 5 years, I will not recommend any equity. Within 5-10 years, a 10% -30% exposure for a few years may work for those who have an appetite for it. Above 10 years, at least 40% equity can be used. How a plan to change asset allocation as the goal nears is mandatory. This can be factored in  using this tool: Financial Goal Planner with Flexible Asset Allocation

Mayur Shah: Hi Pattu Does AUM size and Expense Ratio play any role whilst selecting the mutual fund? For example, AUM size of as high as Rs. 10k+cr and as low as Rs. 100cr would have any impact during high volatility period? Similarly, high expense ratio of 1.5% and above and low expense ratio of 0.7% and below (for Direct Plans) would have any say on the returns? If the answer is No, is it advisable that we can choose a fund with the expense ratio of 1.5-2.0% if the fund is meeting other criteria? Many thanks Mayur

Pattu: I am not a fan of harping on expense ratios. However, a fund with a higher ER should provide the necessary risk protection and reward to the investor. As long as this is happening, a higher ER is justified imo, unless a similar fund with lower ER can be found.

Unless the AUM is dramatically low, I don't think it matters much.

R Ramanathan: ITR 2 AY 2017-2018 seems to be having a glitch in Schedule AL. I am required to file ITR 2 for reasons like income from shares ST and LT but total taxable income very much below 50 lakhs (mandatory under Schedule AL. I tried to drop this schedule as not applicable. Unfortunately, the system forces me to fill in the columns. An error message comes and I am not able to proceed with validation. I have failed to get an answer from anyone including the different tax helpline and sites. Can u help? Please

Pattu: Use the Java utility and exclude the AL schedule. This works fine.

Ramakrishna: How to survive during a crash? Particularly invested in equity MF

Pattu: What does "survive" mean? Emotionally or financially? The latter is easy to answer: one should not commit to any risk security, money that is required in the next few years. As far as emotions are concerned, we will know only when the event is upon us. In his new study, Taleb shows that investors are not irrational (as sales guys claims) when reacting to extreme market events!


venkat: If a senior citizen does NOT have a pension but have some money for investing how to get funds for his living?

Pattu: I have covered this in detail in the free e-book: Post-retirement income generation strategies. The first step is to find out if the senior citizen has to buy an annuity (pension plan) or has enough corpus to take some risk. For someone who can take some risk, a bucket strategy can be adopted. See: Generating an inflation-protected income with a lump sum

Shabbar: For taxation purpose, how can one calculate tax liability of a debt Mutual fund after inflation? For example, I bought 10,000 units at NAV 10 rs. of a debt fund in 2008. Now if I want to redeem all of it and now NAV is 20 rs. then what is going to be tax on it? I assume I don't have to pay tax on whole 1 Lac profit and can reduce it by taking inflation as allowed per law and then pay 20% irrespective of my own tax slab. Generically, How can i calculate it for any time period?

Pattu: You will have to calculate the indexed capital gain in the following way.

Suppose you purchase it in April 2008, find out the cost inflation index for FY 2008-09. Say this is 1000 (not the exact no)

You wish to redeem in July 2017. The current cost inflation index is, say 1500 (again only for illustration, I am too lazy to look up exact values).

The purchase price is 10,000 x 10 = 1,00,000 in 2008.
Inflate this purchase price to 2017 values.

1,00,000 x (1500/1000) = 1,50,000 (indexed purchase price)

Now the amount redeemed = 10,000 x 20  = 2,00,000

Tax has to be paid on the indexed capital gain.

Indexed capital gain = (Redemption amount) - (indexed purchase price)

= 2,00,000 - 1,50,000 = 50,000.

A tax of 20% with all applicable cesses will have to be paid on this 50,000

Mayur1: Dear Sir, I have been a reader of your blog and many others for years now. Also been a direct equity investor for almost 30 years now, and am uniquely qualified for the 'Excess Financial Literacy Syndrome'. This leads me to ask you the following question. Inspired by your bucket retirement strategy, it struck me that one could probably make use of it backwards for equity investing. It is well understood that returns from the Nifty and good mutual funds average 12-14 % over the long term and mean revert. Assume I have a portfolio of 30 stocks and a few of them have given from 3x to 15x returns over the last 4 years while a few are biding time. Does it make sense to cash out from the multi baggers and invest the proceeds in (for sake of simplicity ) an arbitrage fund giving a tax-free return of 6%. The math works as follows. A stock which has given 3x can be invested in a risk-free instrument giving 6% for upto 10 - 12 years and one would still average a return of 14 %. Similarly, if your stock has given you returns of 2x you are good with investing in a risk-free instrument for 8-10 years. ( Calculations are a little approximate). Suppose I treat any stock which gives quick gains in the same way and then wait for the markets to give a sane buying opportunity without sacrificing the mean return of 12-14%? Is my logic correct ? Ignore my asset allocation, look at this only as being part of my equity allocation, also ignore my stock picking ability, risk taking ability and any forward looking assumptions. Thanks & regards, Mayur

Pattu: What you are referring to is a form a tactical asset allocation ( arbitrage fund = debt from the pov of risk). The logic is sound and will most definitely reduce risk significantly. Whether there will be an accompanying reward or not, is something unpredictable. See: Is it possible to time the market?

Mean reversion is an incorrect idea. For reversion, there has to be a mean and if there is a mean, it means we can predict market movements. Price going up and them down is not mean reversion.

Mayur2: Dear Sir, Although I have been investing in the markets directly , through MF's and PMS since a number of years now, there is a something which bothers me in a very commonsensical way. If you were to hire a market expert and ask him to invest some money for you today, how would he go about it ? He would find some stocks for you to buy which he feels are worth buying today. Suppose you went to him after 6 months with the same query - he would recommend stocks which are worth buying at that particular time. These stocks may or may not be the same as the ones he recommended 6 months back. And so on whenever you went to him. However when you invest in a MF what happens is that you buy into a portfolio which has been in existence for years. If the MF is a good one you are probably buying into those shares at very high valuations. The advantage of the fund managers stock picking will only accrue to you for the shares which have been bought after you have invested. If you consider the fact that most MF's have about 30 -40 scrips with a weightage of 0.5 - 10% in their portfolio it's going to be a long time before one really gets the full advantage of a fund managers stock picking ability. And this is probably the reason why picking the best performing MF's over a 1-3 year period doesn't always work ! The value unlocking would have probably happened in most of the shares in their portfolio leaving very little on the table. In order to get around this problem I thought that the answer lay in PMS schemes. But I find that the PMS schemes also operate in more or less the same way investing around a core portfolio. PMS are a bit better since they do time purchases and sales a little more individually and can theoretically go all to cash and do not have shares mirroring the benchmark. However, I found the same story repeating in a PMS scheme where a few of us invested at different times over the last 18 months. Therefore the best time to invest in such schemes would be around their inception would it not ? Else you would run the risk of buying into scrips where substantial value unlocking would already have happened. Taking as read all the advantages of investing in MF's over a sustained period of time and their track records, as also the fact that most MF's are launched whenever a sector or theme is in favour - is my logic correct or am I missing something ? Thanks & regards Mayur

Pattu: 1) you are assuming all stock picks will pay off, 2) you are comparing a diversified porfolio (mf) with a concentrated/personalised portfolio (PMS)

3) You have no knowledge about when and why a fund manager chooses or sells stocks. In an open ended mutual fund, percentage exposure to stocks depends on aum inflows and outflows. And cannot be simplified the way you have described it.

I recently showed rolling returns data for Franklin Prima for 15 years. Does this show that returns for the first 15Y (for NFO investor) to be the highest and lower for all those who entered later?

Sunny: Hi Pattu, I have 2 questions 1. Is there any mf whose benchmark is nifty next 50 ? What are your views on this index 2. Can a mf portfolio comprising of just a single balanced fund can provide a good diversification? If not then what else can be added. Thanks

Pattu: As far as I know Nifty Next 50 is not used by any fund. This is an extremely volatile index and I would recommend it only for those who have the risk appetite or are quite young.
I would strongly recommend an equity portfolio with core holding as a balanced fund (and this is how mine is). The other funds can be mid cap/small cap as per risk appetite.

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