Similarities In Your Investment And Car Journey

An investor embarks on his investment journey to attain his financial goals. Metaphorically, we can compare his journey with a car journey where he or his chauffeur drives the car to reach his desired destination (financial goals). It is imperative for a traveller to plan meticulously for a hassle free and smooth journey. Similarly, an investor must also plan his investment journey meticulously to avoid a bumpy financial ride.

Start Early – an early start in the morning helps to beat the rush and traffic on the way and helps you to reach the destination on time. If an investor starts investments early in his career, then he avoids the cost of delay. If Mr Early invests ₹10,000 per month from the age of 25, then he would have invested ₹36 lakh by the age of 55. However, Mr Late who starts at the age of 35, will have to invest ₹ 15,000 per month for a similar investment. However, the cost of delay is heavy for Mr Late whose wealth, till the age of 55, will grow to ₹ 2.27 crore at 15% assumed rate of return, whereas, Mr Early’s wealth would be ₹ 7.01 crore – a staggering difference of almost ₹ 5 crores. In case, Mr Late wants to catch up with Mr Early then he will have to make a monthly investment of ₹ 46,240.

Many Halts –if the traveller takes many halts during the journey then he will reach the desired destination late or must over speed to make up the lost time. Ideally, a halt every two to three hours is advisable to help the chauffeur and the passengers freshen up. Similarly, an investor who stops his SIP frequently will miss attaining his financial goals. We considered an example of a 10-year investment journey, wherein Mr Regular did not stop any of his monthly SIP instalments but Mr Halter took three halts wherein he stopped his SIP for 12 months each in between. Behaviourally, an investor normally does this due to a cognitive bias called regret/loss aversion. So, Mr Regular accumulated 6.401 units by investing ₹ 12 lakh through ₹ 10,000 monthly SIP and his corpus value was ₹22.78 lakh. On the other hand, Mr Halter could only accumulate 4102.628 units by investing ₹ 8.40 lakh through ₹ 10,000 monthly SIP and his corpus value was ₹ 14.60 lakh. Suppose, Mr Halter had taken only one considered halt of 12 months to watch the falling market and review/rebalance his portfolio then he would have accumulated 5775.831 units and his corpus value would have been ₹ 20.55 lakh.

Investor and Financial Advisor Relation – typically the driver controls the car with the accelerator, clutch, brake, and the steering. He decides when to drive fast or slow down, change gear or the turn the steering. In the same way, based on the market inputs, his experience and advice from his financial advisor the investor makes the final call regarding his investments. His financial advisor is his co-driver, cum navigator who guides him from time to time about what lies ahead in the driver’s blind spots, the turn ahead or the traffic jam conditions prevalent. A good financial advisor should not be commission driven and render dispassionate advice that has a financial rationale.

Equity the Accelerator – like the accelerator of a car through which the driver controls the speed, the investor controls his portfolio growth through its equity component. If he finds that the markets are falling, then he should top up or invest more to buy low akin to the driver pressing the accelerator to speed up when he finds that there is less traffic and roads are free. However, if he over speeds then it might lead to a crash and so should the investor beware of over-investment in equity, which is not commensurate to his risk profile. If the driver does not maintain adequate speed or goes very slow when he runs the risk of late arrival at his destination. Analogously, if the investor does maintain adequate resources in the equity component of his portfolio, proportionate to his risk profile, then he runs the risk of missing his long-term financial goals that are most achievable by wealth creation through equity.

Liquid Funds like Fuel Tanks – when you commence the car journey, you fill up adequate fuel depending on the distance of your journey. Likewise, before making a systematic investment the investor sets aside adequate cash in his bank account to start a SIP or invests it in liquid funds to start an STP. The main advantage of systematic investment is that it helps the investor to achieve rupee cost averaging as he buys more when the markets are low and vice versa. Parking the funds in liquid fund vis-à-vis leaving them in the bank accounts give the investor some additional advantages as follows: Firstly, their average annualised returns are 6 to 7.5%, unlike bank savings accounts that vary from 3.5 to 6%. Secondly, the total returns earned during the financial year through the bank interest are taxable as per the investor’s applicable IT slab rate within the same financial year; whereas, the short or long-term capital gains from the liquid fund are taxable only on redemption. Thirdly, there are no TDS applicable on liquid funds whereas banks deduct tax at source for interest earned in a financial year from savings and fixed deposits more than₹ 40,000.

Fixed Income Instruments Keeps the Portfolio Grounded – fixed income instruments pay investors fixed interest payments until its maturity date. At maturity, the concerned bank/corporation repays the principal amount invested. Bonds are the most common types of fixed-income products, which can be issued by governments and corporations. In the event of a company’s bankruptcy, it pays fixed-income investors before common stockholders. Therefore, these are safer investment options vis-à-vis equity and some even carry a sovereign guarantee. In other words, they keep the portfolio grounded and lend it safety, much like the four wheels of the car. The driver controls the drive to these tyres through the gearbox, which changes the ratio by enmeshing or delinking different sizes of gear wheels when the speed increases or decreases. Likewise, the investor also changes the cash flow into his fixed income instruments depending on his requirement of capital protection or wealth creation. Some of the commonly used financial instruments available in India in this category are the bank and post office deposits (Fixed deposits, Recurring deposits, Senior Citizen Savings Scheme, Provident Fund), government and corporate bonds and fixed deposits, mutual fund fixed maturity plan schemes, National Savings Certificate, Kisan Vikas Patra and-Convertible Debentures. Most of these instruments fall under the exempt-exempt-tax (EET) category, are liable for TDS and their returns taxed as per the applicable tax slab rate of the investor in his hands. Only the PF enjoys the exempt-exempt-exempt (EEE) status for taxation and its returns non-taxable in the hands of the investor.

Retirement Planningretirement planning is probably the best way to exemplify the above metaphors. Please see the first table below to understand that it is better to start the investment journey early to avoid paying a heavier SIP later. The second table exemplifies that to meet the desired financial goal, an investor must adopt an aggressive approach during his early years of career. This way he will invest smaller monthly SIP instalment or one-time lump sum amount. If he is overcautious and adopts a conservative approach then his lumpsum investment more than quadruples and his monthly SIP instalment more than triples. In the case of a moderate investor, the lump sum amount more than doubles and the monthly SIP instalment increases more than one-and-half times.

Live Life King Size By Planning Your Personal Finances

The other day, I had an animated discussion with a youngster who is in her final stages of completing her masters and is to commence her work life shortly. The discussion primarily focused on sharing my personal financial knowledge and experience with her, which she very grudgingly tried to accept. I could feel that she was not convinced with my various arguments for the simple reason that her zest to live and enjoy her life through parties, vacations and shopping had obfuscated her financial rationale. Her bewilderment at having to lock-in a sizeable amount of her salary to save taxes, naivety about the fact that wealth creation through compounding needs time and incomprehension that she must plan and start saving for her retirement from now on pushed me into penning down this article for the financial betterment of more youngsters like her.

To make the youngsters understand the financial nuances, I have assumed that they start work at age 24 years in the financial year 2018-19. They get a take-home salary of ₹ 5 Lakh (approximately ₹ 40,000 per month) along with a performance-based variable component of ₹ 1.5 Lakh per annum. Their monthly expense is roughly ₹ 25 to 30,000 that includes their daily necessities, boarding and lodging, and weekend parties. In accordance with these details, I assume that they save and invest the balance money either into high-risk diversified equity mutual fund or tax-saving ELSS mutual fund that generates a modest 10% annualized return over a long-term horizon. To exemplify my subsequent arguments and logic, I have used the undermentioned saving options:

Option 1 – the youngster saves ₹ 10,000 per month (₹ 1.2 Lakh annually) for 37 years till his retirement at the age of 60 years.

Option 2 – the youngster saves ₹ 12,500 per month (₹ 1.5 Lakh annually) for 37 years till his retirement at the age of 60 years.

Option 3 – the youngster saves ₹ 15,000 per month (₹ 1.8 Lakh annually) for 37 years till his retirement at the age of 60 years.

In all three options, the Corpus has grown sizeably after investing regularly for 37 years. As per the table and chart below, in options 1, 2 and 3, the total investment was ₹ 44.4, 55.5 and 66.6 Lakh, whereas, the corpus has grown to 4.18, 5.23 and 6.27 Crore respectively.

Details Option 1 Option 2 Option 3
Investment 44,40,000 55,50,000 66,60,000
Corpus 4,18,16,931 5,22,71,163 6,27,25,396
Growth 3,73,76,931 4,67,21,163 5,60,65,396
No of Years 37 37 37
Starting Age 24 24 24
Maturity Age 60 60 60
Start FY 2019 2019 2019
Maturity FY 2055 2055 2055

 

Mutual fund in jaipur

Planning and Spending: 

Whenever youngsters set out on their life’s journey, it is important for them to formulate their life’s goals in terms of their career, marriage, and children. Once they have clearly defined this, then they must break down their life’s journey through various stages to formulate their financial goals. These goals will pertain to their own marriage (if the parents are not financially well off), settling down into their post-marriage home to include buying a house and white goods, furniture and other furnishings that go along with it, children education especially higher education, children marriage, and finally their own retirement. These financial goals occur at different stages of life and saving for them is important. Thomas Jefferson had famously remarked, “Never spend your money before you have it.” Saving up to meet these major financial goals will help minimize debt while keeping a budget in line. People simply buy consumer goods on EMI and spend paying it off along with interest. However, if they can delay the purchase and save for it, they will both avoid debt and paying interest.

 

Save Pennies to Earn Pounds:

Warren Buffet had famously remarked, “Do not save what is left after spending, but spend what is left after saving.” A concerted and conscientious effort by an investor to make small sacrifices will lead to small savings, which over the period will accumulate large wealth and make a huge difference to his lifestyle. The table below exemplifies some common places where youngsters can make small savings

Cigarette Beer Movies & Restaurants
Skip 1 cigarette a day 1 beer over a weekend One movie & dinner in a month
Cost ₹ 15 per cigarette ₹ 200 per pint ₹ 1,500 per movie & dinner
Annual Saving Invested ₹ 5,475 ₹ 10,400 ₹ 18,000
Rate of Return 10% 10% 10%
Corpus after 37 Years ₹ 19.9 Lakh ₹ 37.8 Lakh ₹ 65.3 Lakh
Total Wealth Accumulated                                            ₹ 1.23 Crore

Starting Early:

The aptness of 17th Century adage that ‘the early bird catches the worm’ in financial management is unrivalled. Nevertheless, our youngsters are careless with their savings and investments during the first 8 to 10 years of their careers. It is only after about 30 or 35 years of age that they feel the need to save and invest for their financial goals. By then, it is too late and they have missed the investment bus that would have taken them to their identified financial goals. To explain the loss that one incurs by starting investments late in life, I have considered that an individual start investing ₹ 10,000 per month from the age of 24, 30, 35 and 40 years. The table and chart below clarify that the percentage growth loss is maximum when one starts investment at the age of 40 and reduces as one starts investing early.

Start at 24 Start at 30 Start at 35 Start at 40
Investment 44,40,000 37,20,000 31,20,000 25,20,000
Corpus at 60 years 4,18,16,931 2,54,84,721 1,53,43,703 90,46,929
Investment Loss 7,20,000 13,20,000 19,20,000
Growth Loss 1,63,32,210 2,64,73,228 3,27,70,002

mutual fund advisor

mutual fund advisor

POWER OF COMPOUNDING:

For wealth creation, you need to give time to the money to grow through compounding. Einstein, while describing compound interest as the eighth wonder of the world had said, “He who understands it, earns it. He who doesn’t pay it.” Financially, compounding is the process in which one reinvests an asset’s earnings, from either capital gains or interest, to generate additional earnings over time and this makes long-term investing rewarding. If one invested ₹ 10,000 per month in SIP then you will notice in the chart below that the power of compounding grows the wealth exponentially only after about 15 years of regular investment. Therefore, it is imperative to give enough time for wealth creation through compounding.

Maloo
Maloo

Save Regularly and Incrementally: A common mistake that people make is to stop the systematic investment in between for a few months or years due to psychological reasons attributable to falling markets or other frivolous reasons attributable to domestic compulsions. The losses incurred by stopping SIP midway and restarting later are dependent on the market situation. One must remember that by continuing the SIP in falling markets, the investor tends to gain due to the purchase of additional units as the NAV is also low. In fact, prudent investment philosophy suggests that the investor should increase his SIP annually to harvest better returns eventually (refer to the table below):

Normal SIP Incremental SIP
Monthly Investment ₹ 10,000 ₹ 10,000 plus an annual increment of 5%
Assumed Rate of Return 10% 10%
Investment Duration 37 years 37 years
Amount Invested ₹ 44,40,000 ₹ 84,36,000
Corpus after 37 Years ₹ 4,67,86,616 ₹ 6,71,84,005
Growth ₹ 4,25,46,616 ₹ 5,87,48,004

Inflation Reduces Purchasing Power: The youngster must understand that inflation eats into your returns and reduces the purchasing power. Therefore, today’s ₹ 100 will become ₹ 11.34 in 30 years at the inflation rate of 7 percent per annum and will not buy the same things tomorrow. The table below enumerates some examples to highlight inflationary pressure on necessities:

Price in 1947 in ₹ Price in 1997 in ₹ Current Price in ₹
Sugar (Kg) 0.4 16 40
Atta (Kg) 0.1 12 38
Rice (Kg) 0.12 20 52
Milk Full Cream (Ltr) 0.12 18 50

Real Rate of Returns: Connected with inflation is the real rate of return. It is important for an investor to understand this aspect of personal finance. Suppose a bank fixed deposit gives an interest of 7.5 percent on your investment. If the prevalent inflation is 4.5 percent and you are in a taxable bracket where you are liable to pay 2.55 percent tax on the interest earned, then the real rate of return on the investment is a meagre 0.45 percent. Therefore, for longer time horizon it is prudent to invest into equity either directly or through the mutual funds since they have the potential to beat inflation and deliver higher returns over long-term.

Taxation: An important aspect of financial planning is the taxation policy of the government. Simply put, an individual pays taxes on multiple counts. First is the GST on purchase of goods; second is the income tax on his total income; third is the tax (short-term and long-term based on the duration of financial instruments) on the capital gains from investments or real estate sale. Capital gains tax is chargeable only on the capital gains made during the financial year as per various capital gains tax rate including indexation benefit for long-term investments. Whereas, income from interest earned on fixed income financial instruments is taxable as per existing IT slab of the individual for the entire interest earned in the financial year. Moreover, there is no tax deduction at source (TDS) applicable to capital gains but the same is applicable to interest income from financial instruments. These tax rates are subject to change as per government decision from time to time. The reckoners below will help you understand the applicable rates for FY 2019-20.

       INCOME TAXABILITY AND COMMON DEDUCTIONS/EXEMPTIONS
Details Max Tax Relief Amount
Gross Salary ₹ 8.05 Lakh
Various instruments under Sec 80(C) ₹ 1.5 Lakh
Health insurance under Sec 80(D) if self, spouse, and children are less than 60 years and parents are above 60 years ₹ 55,000
NPS (Additional Relief) ₹ 50,000
Standard Deduction for salaried employees ₹ 50,000
Net Taxable Income ₹ 5 Lakh
(a-(b+c+d+e))

Note: An individual with taxable income up to ₹ 5 lakh will not pay any taxes. However, if the taxable income is above ₹ 5 Lakh then he will pay taxes as per slab rates are given below. He can avail additional tax benefit from home loans and charitable donations.

                                 INCOME TAX SLABS (including 4 percent cess)
Income Slab Individual < 60 years Senior Citizen > 60 years but < 80 years Very Senior Citizen > 80 years
Up to ₹ 2.5 Lakh NIL NIL NIL
₹ 2.5 to 3 Lakh 5.20% NIL NIL
₹ 3 to 5 Lakh 5.20% 5.20% NIL
₹ 5 to 10 Lakh 20.80% 20.80% 20.80%
Above ₹ 10 Lakh 31.20% 31.20% 31.20%
    CAPITAL GAINS TAX (excluding surcharge but including 4 percent cess)
Tax Other than Stocks and Equity Schemes Stocks and Equity MF Schemes
Long-Term Capital Gains (LTCG) 20.80% with indexation benefit if investment held for more than 36 months 10.40% on gains above ₹ 1 Lakh if investment held for more than 12 months
Short-Term Capital Gains (STCG) As per individual’s IT slab if investment held for less than 36 months 15.60% if investment held for less than 12 months

Retirement Goal: Most people do not realize the importance to save for their retirement from the word go and tend to delay this decision for the future. All the financial aspects that we have discussed so far come into play while planning for retirement. An individual must start early, invest regularly and adequately, and allow the power of compounding to grow his wealth to avoid impoverishment during his sunset years. The table below will help you to understand the dynamics of retirement planning:

                                               RETIREMENT PLANNER 
Current Age 24
Retirement Age 60
Life Expectancy 85
Current Monthly Expense ₹ 30,000
Monthly expense after 37 years at 60 years of age at 7% inflation ₹ 3,66,709
Corpus required at 60 years of age to last 25 years of retired life with assumed annual returns of 10 percent and inflation of 7% ₹ 7.32 Crore
Monthly SIP required to build a corpus of ₹ 7.32 Crore over 37 years at 10% annualized rate of return ₹ 15,580
financial advisor in jaipur
financial advisor in Jaipur

Rakesh Jhunjhunwala advised caution ahead of Lok-Sabha elections

Rakesh Kumar Radheyshyam Jhunjhunwala is an Indian Billionaire Investor and Trader. He is a Chartered Accountant. He manages his own portfolio as a partner in his asset management firm, Rare Enterprises. Jhunjhunwala has been described by India Today magazine as the “pin-up boy of the current bull run”[4] and by The Economic Times as “Pied Piper of Indian bourses”.  As per Forbes, he is the 54th richest person in India, with a net worth of USD 3 billion (as of June 1, 2018)

Source: https://en.wikipedia.org/wiki/Rakesh_Jhunjhunwala

mutual fund in jaipur
Dr. Ramesh Maloo With Mr. Rakesh Jhunjhunwala

 Rakesh Jhunjhunwala, one among India’s biggest securities market investors, suggested caution before Lok Sabha elections when he aforesaid that the ruling government is probably going to come back to power.

He was speaking on each day once the market hit new highs with a touch over a month to go before election results. He was a part of a word marking the launch of the most recent entrant within the mutual fund business — the Sun Pharmaceutical Industries co-promoter Sudhir Valia-backed ITI mutual fund. Others on the panel were Ramesh Damani, member, Bombay securities market (BSE); Nimesh monarch, administrator and chief officer at ICICI prudent quality Management Company; and martyr Heber Joseph, chief officer and chief investment officer at ITI mutual fund.

Both the benchmark indices closed at incomparable highs on Tuesday — the S&P BSE Sensex closed at 39,275.64 whereas the National Stock Exchange’s Nifty 50 terminated at eleven,787.15.

“Today may be a new high within the market however all the bars are empty!” said Jhunjhunwala, suggesting that the market has been driven higher by many stocks, instead of seeing a broad-based rally. However, he remained optimistic on expectations of a pickup within the capex cycle and aforesaid that the section of the dangerous loan crisis has passed.

Jhunjunwala aforesaid he expects the ruling National Democratic Alliance (NDA) to come back to power at the Centre. He adscititious that the Bharatiya Janata Party (BJP) may not win a single-party majority within the Lok Sabha. However, he expects the ruling party to be a dominant partner within the new government.

Ramesh Damani suggested investors against positioning themselves on the understanding of a specific party returning to power. He aforesaid markets have had a nasty record in predicting election outcomes, and investors ought to use caution of being too assured a few given outcome.

“I think the market is pricing another comfortable majority for the NDA, which may not happen,” he said.

Nimesh monarch aforesaid sure government-owned firms with smart returns on equity and banks with {a smart|an honest|a decent} liability franchise look good. He was additionally optimistic about pharmaceutical and care segments.

George Heber Joseph, chief officer and chief investment officer at ITI mutual fund, too was optimistic on the company and care phase, declaring that the share of the case for these segments is probably going to extend.

Jhunjhunwala additionally measured another note of caution on the character of the most recent bull-run. He aforesaid it’s didn’t profit the bulk of individuals, that may lead to the imposition of taxes for redistribution.

Source: https://www.business-standard.com/article/elections/rakesh-jhunjhunwala-still-sees-an-nda-government-but-advises-caution-119041700321_1.html

Team Maloo Investwise Met With Mr Prashant Jain

Team Maloo Investwise Dr Ramesh Maloo, CA Kamal Maloo and Kailash Maloo met with  Mr. Prashant Jain ED and CIO, HDFC AMC during a visit to Jaipur on 12 April 2019 at the Hotel Rambagh Palace.

Team Maloo With Mr Prashant Jain
Team Maloo With Mr Prashant Jain

Now you are thinking that who is Mr Prashant Jain, Here is basic information about him:


Mr Prashant Jain, CFA is the Chief Investment Officer, Executive Director, and Fund Manager at HDFC Asset Management Company Ltd. and previously, from June 20, 2003, to June 30, 2004, served as the Head of Equities. Mr Jain joined the firm on June 20, 2003. Prior to this, he was the Chief Investment Officer, Head of Funds Management, and Fund Manager at Zurich Asset Management Company (India) Private Limited from July 1993 till June 19, 2003. Before that, Mr Jain worked at SBI Mutual Fund as Fund In-Charge from 1991 to 1993. He is a Chartered Financial Analyst from AIMR. Mr Jain has extensive experience in fund management and research. He received a PGDM from the Indian Institute of Management Bangalore and a B. Tech degree from the Indian Institute of Technology, Kanpur.

Source: Bloomberg

Mr Prashant Jain who is managing 3 lakh crore has become the first Indian fund manager to complete 25 years managing a single fund.


Mr Prashant Jain has become the first Indian Fund manager who is completed 25 years to managing a single fund.  He achieved this in 2019 with balanced advantage fund of HDFC which has generated an alpha of 9.54 percent over the Sensex since 1994, Morningstar Direct data show.

HDFC Balanced Advantage Fund (the erstwhile HDFC Prudence Fund), launched in February 1994, is that the largest equity-oriented fund in India with assets of Rs 37,395 crore as of February 2019. The fund, now categorized as dynamic plus allocation (equity will be zero per cent to a hundred per cent), in its earlier avatar as HDFC Prudence Fund (a balanced fund). Information from Morningstar Direct show that when put next to alternative international funds managed by one fund manager for twenty-five years and higher than, Jain’s fund has generated an alpha of nine.54 per cent over the Sensex, second solely to legendary Peter kill who managed Fidelity Magellan until 1977, generating an alpha of 10.92 per cent.

Anthony Bolton managed Fidelity Special things from Dec 17, 1979, to December 31, 2007, and generated an alpha of 9.2 per cent. HDFC Balanced has come to an annualized 18.48 per cent since origination.

Financial planners suggest that one among the most reason for Jain’s success is his ability to spot market cycles before time and ride through cycles. as an example, he created the foremost of the IT-driven rally between 1995 and 2000 by shopping for Infosys NSE 0.68 you’re thinking that increased 113times. Between Dec 2000 and Dec 2017, religion was fast to identify the capex/banking and artefact stock rally distinguishing stocks like BHEL that rose 35x, L&T 33x, Reliance 19x and Tata Steel 16x and SBI 14x. within the next cycle between Dec 2007 and Dec 2017, wherever FMCG and pharmaceutical company stocks rallied he bought HUL that rose 8x, ITC 5x, ligneous plant 8x and HDFC Bank 6x.

“Jain has a sharp ability to spot cycles ahead of time. He adopts a long-term approach to stock picking, sticks to his investment mandate and is not worried about underperformance in the short term,” says Himanshu Srivastava, senior research analyst at Morningstar India.

While Jain’s strategy has worked in the long term, it has also tested investor patience in the short term. “The transition years, where he books profits and identifies stocks to ride the next cycle have been the most difficult for Jain, as returns lag those of peers in the short term. However, if you consider the block of 3 or 5 years the returns are good,” says Deepak Chhabria, CEO, Axiom Financial Services.

Source:
Economic Times at dated 14-March-2019

FINANCIAL BEHAVIOR OF A RETAIL INVESTOR

When we talk of an investor, we relate him to only money and finances and tend to overlook the fact that first, he is a human being and thereafter an investor. Investor behaviour is characterized by his feelings, moods and sentiments, personality traits, perception, attitude and emotions. Therefore, like all other humans, his actions and decisions are affected by various biases. Investor psychology (the science dealing with the mind and mental processes, especially in relation to investor behaviour) classifies these into heuristic biases and cognitive biases. Simply put, a heuristic is a ‘Rule of Thumb’ mental shortcut used to solve a problem. It is a quick, informal, and intuitive algorithm that the brain uses to generate an approximate answer to a reasoning question. When investor heuristics fail to produce a correct judgment, it can sometimes result in a cognitive bias, wherein the processes information by filtering it through his experience, thoughts, likes, and dislikes. Psychologically, these biases lead an investor to a judgmental error when it comes to investing, which includes both buying and selling of the financial instruments. In this article, we will explain how some of these or other biases play up to influence the investor’s decision making. Some of these biases are listed in the chart below, and explained and exemplified through Mr Anil, a retail investor residing in a Tier II city of India, in the succeeding paragraphs. He represents the common salaried man who has two children and strives to make his ends meet within his salary.

Present Bias:  This is the tendency to overvalue immediate rewards at the expense of long-term goals. This bias propels Anil to live in the present without thinking too much about how the future unfolds. This gives rise to the tendency of overspending or anticipating a future windfall, which creates barriers to current saving and hampers long-term investment. Therefore, he indulges in buying consumer durables and enjoying lavish vacations and parties and postpones saving for his retirement to a later date. This proves disastrous in the long run since Anil does not start investing early. Thereby, he loses the advantage of the exponential growth of his early investment into a sizeable retirement corpus achieved through the power of compounding, which requires time.

Representativeness: This refers to the tendency to form judgements based on stereotypes. For example, you may form an opinion that a person is rich if you see him alighting from a luxury car, even when he does not own it but has merely travelled in it as a guest of the owner. This results in investors labelling an investment as good or bad based on its recent performance. As per Chandra Prasanna (2016), Behavioral Finance, McGraw Hill Education, investors may be drawn to mutual funds with a good track record because such funds are believed to be representative of well-performing funds. They may forget that even unskilled managers can earn high returns by chance. Investors may become overly optimistic about past winners and overly pessimistic about past losers. Investors generally assume that good companies are good stocks, although the opposite holds true most of the time. Consequently, Anil may buy stocks after prices have risen expecting those increases to continue and ignore stocks when their prices are below their intrinsic values.

Availability Bias: It is a bias where most relevant, recent, or traumatic events strongly influence the perceptions of investors that may be far from economic reality. The danger of basing investment decisions on market perception, rather than facts, is that Anil may pull his money out at the wrong time and miss some of the best days as the market recovers. In the stock trading area, this bias manifests itself for Anil through his preference to invest in local companies, which he is familiar with or about which he can easily obtain information, rather than relying on deeper market research.

Anchoring: It is the tendency to hold on to a belief and then apply it as a subjective reference point for making future judgments. Anchoring occurs when an individual lets a specific piece of information control his cognitive decision-making process. As per Chandra Prasanna (2016), Behavioral Finance, McGraw Hill Education, there are two plausible explanations for anchoring. The first is based on uncertainty relating to true value. When there is uncertainty, the decision maker adjusts his answer away from anchoring value until he enters a plausible range. This explanation works best for relevant anchors.  The second explanation is based on cognitive laziness. Since it requires effort to move away from the anchor and people are cognitively lazy, they tend to stop too early. This explanation works best for irrelevant anchors. Therefore, anchoring will lead Anil to invest in the stocks of companies that have dropped considerably over a short span of time. He is likely anchoring on a recent high point for the stock’s value, likely believing in some way that the fall in price suggests that there is an opportunity to buy the stock at a discounted rate. As far as Anil is concerned, the overall market has caused some stocks to drop significantly in value, thereby allowing him to capitalize on short-term volatility. However, what is perhaps more likely is that a stock which has dropped in value in this way has seen a change in its underlying fundamentals.

Regret or Loss Aversion: This refers to an important concept encapsulated in the expression “losses loom larger than gains” as the pain of losing is psychologically about twice as powerful as the pleasure of gaining. Typically, this is noticeable in the game of golf where the golfer avoids a water hazard by going around it or taking a layup shot. In the bargain, he loses a stroke or is required to play an excellent shot thereafter to make up the loss. Similarly, Anil will prefer to avoid the loss because the associated pain is more intense than the reward that he will feel from a gain. To avoid this pain of loss, he will try to play safe and resultantly move his investments to a place he perceives as safe-haven i.e. cash, cash equivalents or fixed income instruments. Another step he may undertake is to discontinue his ongoing SIP/SEP. All this will cost him when the inflation eats into his savings and erodes his purchasing power. Regret aversion can explain investor reluctance to sell losing investments because it gives them feedback that they have made bad decisions. Anticipated regret influences Anil’s decision making to take less risk because this lessens the potential of poor outcomes.

Overconfidence: This bias leads to the false assumption that someone is better than others, due to their own false sense of skill, talent, or self-belief. Investors often exhibit overconfident behaviour resulting in severe consequences. Research documents that overconfident behaviour is connected to excessive trading and results in poor investment returns. It can also lead to investors failing to appropriately diversify their portfolios. Overconfidence plays out in the real world and creates biases, viz. over ranking, illusion of control, desirability effect and timing optimism. Therefore, Anil having performed well in recent past may conclude that he is truly skilled and take more risks and trade more. To him his overconfidence will make future trades look less risky, but, when things go wrong his potential losses will be higher as they are directly proportional to his degree of overconfidence. Barber and Odean (2001) studied the role of trading behaviour and gender bias for a sample of 35,000 individual accounts over a six-year period. Their findings reveal that males are not only more overconfident about their investing abilities but also trade more often than females. Compared to women, men also tend to sell their stocks at the incorrect time resulting in higher trading costs. Women generally trade less and apply a “buy and hold” approach resulting in lower trading costs. Other studies have found that the relatively young are more overconfident than the relatively old and that highly overconfident people tend to have a higher risk tolerance.

mutual funds in jaipur
mutual funds in jaipur

Herd Effect: It happens when people feel most comfortable following the crowd and tend to assume the consensus view to be the correct one. It is also referred to as the bandwagon effect where the phenomenon of a popular trend attracts even greater popularity. This is the single most important bias in financial markets that create economic bubbles, which burst later to erode capital of the investors. History is replete with example of such bubbles, where during the run-up, investors bid up the prices to unsustainable levels. Then, even more quickly than they expanded, these markets burst and contracted to leave the herd scrambling. It is because of this bias that Anil will invest into a scrip or financial instrument that forms part of the rising bubble without due diligence and personal research, only to lose his capital when the bubble bursts.

INVESTMENT NUANCES

An investor is someone who commits capital in order to gain financial returns. Warren Buffett, the investment legend, defines investing as “… the process of laying out money now to receive more money in the future.”  An investor differs from a trader. An investor puts capital to use for long-term gain, while a trader seeks to generate short-term profits by buying and selling securities repeatedly. Therefore, the frequently asked question is whether investment is an art or science? Investment is neither an art or nor science; instead it is common sense based on three important tenets – discipline, patience, and knowledge. An investor must be wary of the market cycle and understand that when he invests, for all the gains that he will make, he will also incur some losses. It is impossible to only gain from the markets and not undergo some loss. However, a seasoned investor will mitigate his losses and increase his gains to ultimately improve his financial position. In this article we discuss some important facets that an investor must consider while he undertakes his investment journey.

Know
Yourself

There are no set piece solutions for investing or template that fits many or
all investors. Each investor is different and before you embark on your
investment journey, make sure that you know and understand yourself as an
investor. There are some important financial aspects that you must understand
and then devise your investment strategy. If you are unable to do it yourself,
then seek help from a financial advisor who can help you to do it. First, is to
establish your cash flow. If you are a salaried person then financial planning
is relatively easier due to fixed cash flow. For a businessperson, it is
trickier due to cash flow and business cycle uncertainties. Second, is setting
your life’s financial goals that include children education and marriage, house
purchase, retirement, dream vacations, and consumer durable among others. In so
doing, also decide on the time horizon for each of these goals to then classify
them into short, medium, and long-term financial goals. Third, is the aspect of
your risk-taking ability that is function of your age, cash flow and liabilities?
This will help you to decide whether you are an aggressive, moderate, or
conservative investor. Fourth, beware of venturing into investment options that
you do not understand merely because your friend does it or your advisor has
asked your to do it for higher returns. Invest only in what you understand and
are comfortable to deal. Fifth, invest in yourself and purchase health/life
insurance early in life to keep the premiums low. Normally, one should consider
separate family floater policy for health and critical illness coverage and a
term insurance policy for life coverage. Ideally, your life coverage should be
10 times of your annual salary.

Compounding – Einstein called “compound interest is the eighth wonder of the world. He who understands it earns it. He who doesn’t pays it.” Compounding is the process of generating more return on an asset’s reinvested earnings. To work, it requires two things: the reinvestment of earnings and time. See the chart below where we have calculated the yearly compounding of rupees 1 lakh that earns 12 percent annual interest. In 30 years, it has grown to almost rupees 30 lakh. However, it has taken nearly 7 years to double and 21 years to grow 10 times. Thereafter, in the next 10 years it grew from 10 to nearly 30 times of the initial investment. As is evident, the exponential growth of the investment is only in the latter half of the investment period when the investment has grown from nearly 5 to 30 times. Therefore, the investor must start investing early to give himself adequate time for the compounding to work and minimise withdrawals or keep reinvesting the returns.

Real
Returns

understanding that real returns are the gains made after offsetting the
inflation and taxation will help an investor to consider and invest for maximum
total returns. Inflation erodes the purchasing power of money e.g. in 30 years,
real value of rupees 100 will become rupees 11.34 at 7 percent annual
inflation. The real rate of return is the return adjusted for inflation or
other factors. Adjusting the rate of return offers a better measure of
investment performance and allows for a more effective risk versus reward
measurement. Nominal rates are usually always higher than the real rate of
return. Even though fixed deposits guarantee returns, after tax and inflation
deduction, the real rate of returns in these varies between 0.45 to 0.75
percent. Investing in equities is one of the ways to beat inflation as they
generate positive real returns over long-term.

Flexibility – an investor must always remain
flexible in his investments by investing in different types of investments and
maintaining cash reserve to take care of emergencies (emergency fund) or take
advantage of investment opportunities. There are many types of investments like
mutual funds (open and close ended), ETFs, individual stocks and bonds, real estate,
and various alternative investments. An investor becomes a shareholder or part
owner by buying the company shares in dematerialized (Demat) form and thus
participates in the company’s growth/decline through rise/fall in share prices.
Besides, you also earn dividends that the company gives to its shareholders.
Before buying shares, the investor must use his power of observation, artful
questioning, and logical deduction to decide on the company. If the investor
buys company bonds, then he is loaning money to the company in exchange for
periodic interest payments plus the return of the bond’s face amount when the
bond matures. Both government and companies issue bonds. Several agencies issue
ratings to these bonds to evaluate the probability of whether a bond issuer
will default. Some of the important rating agencies are Standard and Poor
(S&P), Moody’s, CRISIL, ICRA and CARE. The investor should buy higher rated
bonds, which means the company has less chances of default. Government bonds
come with the sovereign guarantee and are relatively risk-free. Mutual fund
investment is best suited for passive investor who cannot actively track the
market or keep themselves abreast on a day to day basis. These are pooled
investments managed by professional fund managers that allow investors to
invest their money in stocks, bonds or other investment vehicles as stated in
the fund’s prospectus. Mutual funds use the end of trading day Net Asset Value
(NAV) for valuation and make distributions in the form of dividends and capital
gains based on this. They offer you the advantages of professional management,
high liquidity, and more tax efficient returns. Unlike mutual funds, ETFs
(although like mutual funds in many respects) trade constantly, like shares and
stocks, while the markets are open.

Diversification – to diversify means that the
investor must invest in various asset classes to manage his risk and earn
higher returns. This happens because the positive performance of some
investments neutralizes the negative performance of others. After, diversifying
his portfolio into various asset classes like equity, debt, gold, real estate
and fixed income instruments, the investor must also consider diversifying
within some of the these individually. He can consider buying securities of
large, mid, and small market cap companies or let us say mutual funds of
different asset management companies or different fixed income instruments like
PPF, FDs or SCSS and so on.

Keeping
Track
– after
investing, it is equally important to keep a track of your investments.
Ideally, you should review your portfolio on a half-yearly basis and if this is
asking too much then at least once a year is necessary. The portfolio review
will indicate the gainers and losers in the portfolio, the financial instrument’s
performance in relation to its financial goal and the overall growth of the
portfolio. Having reviewed the portfolio, the investor must then rebalance his
portfolio. In so doing, he must shed his losers, switch, or reinvest in other
asset classes to maximise gains and offset losses, and realign his portfolio
with his financial goals.

Technology – like all other facets of life,
technological advancement also has a significant impact on investors. The
digitization of the bourses and concomitant dematerialization of securities has
eased the investment avenues for investors. It has facilitated research and
analysis by investors by opening the plethora of information and tutorials on
the net, generated options for them to invest in various financial instruments
and significantly reduced paperwork by facilitating investment through the
click of a button. The next big change is the introduction of robo-advisory
services, which use technology for client portfolio management by using
algorithms. All these have eased out investor apprehensions and reduced tariffs
and fees.

Emotions – there is no place for emotions in
investments. An investor should be aware of the fear of loss or regret, greed,
risk aversion and bandwagon effect during his investment. An investor should
hold his stocks or other investments dispassionately and consider their
purchase or sale objectively. He should shed them when they have delivered the
result, stopped giving profit or outlived their utility. One cannot make an
investment for indefinite period; relate it to a financial goal or investment
horizon. Prudent investment is to the use financial assets that are suitable
for your financial goals and objectives by considering the risk/return profile
and the available time horizon. To do this, you must keep the fees and taxation
minimized, and rebalance the portfolio periodically.

Understanding
Markets
– know
that markets are volatile in the short-term. As the investment horizon
increases, probability of loss reduces. Sensex movement in the last 39 years
has proved that the likelihood of losing money for periods of 15 years or more
has been zero. Since 1979 till date, markets have given a CAGR of 17.1%. If
wealth compounds at this rate, then an investment in the stock market doubles
every 4.5 years. Robert Kiyosaki had suggested, “it is not how much money you
make, but how much money you keep, how hard it works for you, and how many
generations you keep it for.” If an investor stays fully invested in the market
then he will earn a lucrative CAGR that beats volatility and inflation.
However, if he tries to time the market, then he runs the risk of missing days
that registered some of the biggest gains and the CAGR will drop drastically.

Discipline – a disciplined approach in
investment by taking the SIP/SEP route help you to beat the market volatility,
achieve rupee cost average and reach your financial goal faster. Since the
early bird catches the worm, prudence lies in starting as early in life as
possible. Elders can inculcate the habit in their children by making them save
small amounts from their pocket money that they give them during school or
college days. Let us exemplify this with the case of two investors – Mr. Wise
and Mr. Unwise. Both investors invest rupees 36 lakh over different time spans
of their life. Mr. Wise invests rupees 10,000/- per month from the age of 25 to
55 years, whereas Mr. Unwise invests rupees 15,000 per month from 35 to 55
years. At the end of their investment period, Mr. Wise’s investment grows to
rupees 7.01 crore, but that of Mr. Unwise grows to only rupees 2.27 crore – a
shortfall of rupees 4.74 crore. There is no dearth of financial calculators or
ready reckoners, available on the internet, which show the exponential growth
of your wealth through the SIP route. Another aspect that an investor must
consider is to increase the SIP amount by 10 or 15 percent every year. Evident
from the table below is the fact that if an investor tops up or increases his
SIP of rupees 10,000 by 10 percent every year, then his corpus at the end of 30
years will be 150 percent more.

Details
SIP
without Annual Increase
SIP
with Annual Increase
Per
month SIP amount
Rupees 10
thousand
Rupees 10
thousand
Rate
of return
12% 12%
Investment
period
30 years 30 years
Total
amount invested
Rupees 36
lakh
Rupees
1.97 crore
Corpus
after 30 years
Rupees
3.53 crore
Rupees
8.83 crore

Taxation – since taxation is a dynamic
process and undergoes changes frequently an investor must keep himself abreast
with the taxation policy of his country. This will help him to invest in tax
efficient financial instruments that will also assist in simultaneous wealth
creation. In our country, government levies tax on your income through stipulated
income tax slabs. Government considers your annual interest income from various
fixed income instruments as part of your income and taxes them as per your IT
slab. Additionally, it also levies varying capital gains tax on your equity and
debt instruments and taxes them based on you holding duration (short-term if
you hold equity for less than one year and debt for less than 3 years, and
long-term if you hold both for periods more than their short-term duration
respectively). Capital gains harvesting or setting off capital losses are some
of the means to reduce taxation legally, provided you reinvest the capital to
maintain the corpus. Equity Linked Savings Scheme (ELSS) investment in mutual
funds with a 3-year lock-in period, provides lowest lock-in period and tax
efficient returns with tax savings under Sec 80C of the IT Act.

TROIKA TO MEET FINANCIAL GOALS

Start investing early and systematically to let the power of compounding work

During a lifetime, you undertake major life events at regular intervals viz. children higher education, their marriage, your own retirement. In addition, numerous minor events and purchases also come along. All these require the availability of lump sum cash at specific times, which become your financial goals. If you do not give adequate thought to meet these goals, then you may find yourself at your wit’s end at critical life junctures. Literally, the troika is a Russian carriage pulled by three horses abreast. Accordingly, the troika of starting early, investing systematically and using the power of compounding can pull your investment carriage to its various destinations (financial goals).

Start Early – If you start saving immediately after you start earning, then you can save a smaller amount over a longer duration to meet your financial goal with your financial goal planner. Relatively, earlier on in life, one has lesser domestic and social burdens, which lends itself to saving. As one gets older, the domestic necessities and social obligations increase. If you want to save a retirement corpus of Rs 5 Cr, then you require to invest Rs 5,400 per month over 40 years, Rs 17,200 per month over 30 years, Rs 57,500 per month over 20 years and Rs 2.35 Lakh per month over 10 years to achieve it @ standard 12% interest rate. It is evident that the financial burden is much lesser if one starts saving early to meet his financial goals.

Systematic Investment – Discipline in life is the single most important habit that holds you in good stead through life’s vicissitudes. Inculcating fiscal discipline helps you to meet your financial goals and relieves you of avoidable stress. Understandably, lump-sum investment is not always feasible nor is it advisable due to market fluctuations and difficulty of timing the market. Most open market investments now provide a Systematic Investment Plan (SIP) facility, which works on rupee cost averaging. To achieve rupee cost averaging you continue to invest a standard amount of money at a regular frequency (quarterly/monthly/weekly). Therefore, your cost of acquisition of the units/shares comes down to be much lower than what you would have otherwise paid. This is one of the best methods to inculcate financial discipline and takes the speculation and guesswork out from the investment. Over the last 10 years, monthly SIPs in equity mutual funds have provided 13.84% returns per annum. This means Rs 10,000 invested every month would return Rs 23.02 lakh tax-free on a principal investment of Rs 12 lakh. On the other hand, an 8% recurring deposit would mature to Rs 17.38 lakh and a 10% deposit would mature to Rs 19.12 lakh with taxes further reducing these returns.

Power of Compounding – Albert Einstein had famously quoted, “Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pay it.” One must also understand that shorter the compounding period better are the returns. If an investment house compounds 20% interest annually then at the end of one year he will return Rs 1,200 only over an initial investment of Rs 1,000. However, if the compounds it half-yearly (10% every six months), then after six months he will pay you Rs 1,110 and after a year he will pay Rs 1,210. Similarly, compounding it quarterly (5% every quarter) will get you Rs 1,215.51 after a year. This is Rs 15.51 more than the first instance where the investment house compounded the interest annually and Rs 5.51 more than half-yearly compounding interest. Therefore, start investing early and systematically, through SIP, and watch the power of compounding do the rest for you to meet your financial goals.

Let me explain this troika with the help of an Incremental SIP methodology. Factually, this investment technique takes into consideration that investor’s income increases over the years and so does his capacity to invest. Besides, this also hedges inflationary pressure on your accumulated wealth:

Stage I – If you start investing Rs 5,000 per month through SIP in an equity MF immediately after your child’s birth, then after 18 years (at the time of your child’s higher education) you would have invested Rs 10.8 Lakh. Assuming moderately, the MF returns a 12% interest on your investment during all stages, the fund value will be about Rs 33.44 Lakh. Either you may use this corpus partially or fully to meet your child’s higher education need for which a vast majority of Indian parents (up to 71% as per a recent survey by HSBC) are willing to take a loan. Suppose, you use only Rs 20 Lakh for this need and move onto the next stage.

Stage II – Now you increase your SIP investment to Rs 10,000 per month. After another 7 years or when your child attains 25 years of age, the aggregate fund value of your investment will be about Rs 41.84 Lakh. Supposing, this time you take a partial withdrawal of Rs 30 Lakh to cater for your child’s marriage and gift the balance of about Rs 11.84 Lakh to your child with a caveat that hereinafter he must continue the investment until his retirement to reap the benefits of compounding.

Stage III – Supposedly, during this stage, your child continues and increases the SIP investment to Rs 15,000 per month. Then, after another 20 years or when your child attains 45 years of age the aggregate fund value of his investment will be about Rs 2.43 Cr. This time your child may partially withdraw Rs 1 Cr to make a down payment for his new house. He makes the balance payment through home loan EMI to reduce his tax liability.

Stage IV – Your child now adopts a far-sighted financial strategy to continue his SIP along with his home loan EMI. Not only this, he prudently increases the SIP to Rs 20,000 per month. After another 15 years or on attaining 60 years of age (his retirement time), the aggregate fund value of the investment will be about Rs 8.77 Cr.

Addendum – Suppose, initially you and subsequently, your child decide to invest in an incremental SIP without making any withdrawals, then the fund value available to the child at the time of his retirement will be a whopping Rs 53.42 Cr.

INVEST THROUGH INCREMENTAL SIP TO MEET LIFETIME FINANCIAL GOALS
Age of Child in Years No of Years of Investment Incremental Investment (in Rs) Fund Value of Investment (in Rs) Fund Value of Previous Bal Left Aggregate Fund Value (in Rs) Partial Withdrawal (in Rs) to Meet Life Event Expenditure Bal Left After Partial Withdrawal Accumulated Fund Value Without Withdrawal
(a) (b) (c) (d) (e) (f)=(d)+(e) (g) (h) (i)
0 to 18 18 1,080,000 3,344,983 0 3,344,983 2,000,000 1,344,983 3,344,983
19 to 25 7 840,000 1,210,681 2,973,329 4,184,010 3,000,000 1,184,010 8,605,373
25 to 45 20 3,600,000 12,969,440 11,421,308 24,390,748 10,000,000 14,390,748 95,979,389
45 to 60 15 3,600,000 8,947,132 78,768,706 87,715,837 0 0 534,296,628
TOTAL 60 9,120,000 15,000,000

EVOLVE FINANCIALLY WITH AN ADVISOR

  According to the third CFA institute investor trust study survey covering 3,127 retail investors and 829 institutional investors worldwide, 70% of Indian investors work with professional advisers compared to 54% globally; 81% of these began work with advisers in the past six years. Of these Indian investors, 31% investors listen to primary advisers, 30% depend on online research and 19% take advice from friends and family. The investor looks for someone who will act in their best interest and can achieve high returns. In another survey, sixth-annual Legg Mason Global Investment Survey (LMGIS), 44% investors with financial advisors feel that volatility is “positive – if managed properly” as against 27% without advisors. This indicates that investors with advisors are more likely perceive volatility as an opportunity. The chart below is reproduced from a survey report of IIMS Data works Survey and shows with whom would Indians trust their money.

Benefits of Financial Advisers

  So, what do the
financial advisors bring to the table for you? According to Accenture
Consulting survey report. “a human advisor (even if advice is provided
virtually) is still seen by a slight majority (51 percent) as the most reliable
option for new investment ideas. 57 percent of investors felt human advisors
(virtual included) provided the best customized advice.”

Decision Making – Financial
advisors assist you in objective decision making. Generally, an investor tends
to get emotionally attached with his portfolio. When the markets undergo
upheaval, he is liable to get swayed by the volatility and take biased
decisions. A good professional advice from his financial advisor will assist
him to arrive at objective and well thought through decisions. Moreover,
financial advisors come to you with experience, intimate knowledge of financial
products and market research. By virtue of their work, the financial advisors
are in touch with numerous wealth managers, investment bankers, mutual fund
managers and most importantly the common man to know the market sentiment and
its buzz. This makes decision making more holistic by avoiding myopic and
blinkered market view.

Diversification – They help you to diversify your investments. The financial advisor understands the importance of diversification as a means to beat the market volatility and thus helps you to stay on course to meet the financial goals. Statistically, as per the LMGIS survey, advised investors are better informed and more confident to diversify their portfolio into asset classes other than equities.   

ASSET CLASS
% OF ADVISED INVESTOR
% OF DO IT YOURSELF (DIY) INVESTOR
Equities
44%

60%

Real Estate
31%

18%

Domestic Bonds
24%

13%

Alternatives
21%

12%

Golds/Metals
19%

11%

International Bonds
14%

1%

Taxation
– A common DIY investor may not understand the taxation intricacies of various
financial instruments. Furthermore, taxation is a dynamic process and staying
updated regarding various facets is also critical. To make maximum gains, the
investor must know how to work around the taxation labyrinth correctly to avoid
paying taxes unwisely and coming under the taxman’s scanner.

Risk Profiling and Goal Planning – A financial advisor will put you through the paces of risk profiling and financial goal planning before suggesting investment options. This is the correct and methodical way of going about investment.  A DIY investor at times overlooks these important aspects and gets carried away to invest in a financial instrument that is marketed better than others even though it may not suit his risk profile or meet his financial goals in the given time frame. Financial advisors tailor your portfolio from a plethora of financial instruments to suit your risk profile and help you meet your financial objectives within stipulate timeframe.

ProfessionalismFinancial advisors bring professionalism to your investment management. In accordance with your risk profile and financial goals, they carry out annual or half-yearly portfolio reviews and rebalancing to minimize losses and maximize gains. Next, they track the markets continuously and advice you at opportune times to book profits or cut out losses appropriately through redemptions, switches or purchases.

Better Returns – The use of a Financial advisor provides you the opportunity to generate better returns. The chart below is made from a sample survey carried out in the USA where it was deduced that advised individuals had a minimum of 25% and a maximum of up to 113% more assets than unadvised individuals. This was possible since advised individuals stayed invested for longer-term and had properly diversified their portfolios.

How to Select a Suitable Financial Advisor

Qualifications and Credentials – Dime a dozen financial advisors are available in the market. This makes it difficult for an investor to choose the right man for the right job. To choose a financial advisor wisely, an investor must look for a Securities and Exchange Board of India (SEBI) registered investment advisor (RIA) who preferably is a certified financial planner in jaipur (CFPCM ), which is mark of excellence granted to individuals who meet the stringent standards of education, examination, experience and ethics. Since the agents represent few companies, they can sell products of only those companies. Market Regulator SEBI feels the need of segregating distribution and advice and is moving in this direction. Stoppage of upfront commission for agents, fee-based Financial advisory services and trail commission-based distribution agents are some the regulatory norms being brought about by SEBI. This will protect the investors from commission-driven agents who tend to offer biased financial advice to secure a maximum commission.

Experience and Reputation
– A post graduate in finance related subjects or a graduate in any discipline
with five years’ experience in financial sector is eligible to apply to SEBI for registration as an
investment advisor. Therefore, the investor must look for an advisor with more
than five years’ experience with good market reputation.

Client Base and Assets Under Management (AUM) – Depending on his
financial net worth, the investor must choose the financial advisor based on
his client base. If the investor is a high net worth investor (HNI) then he should look for a
financial advisor who deals with HNIs and if the investor is
medium to low net worth investor then he should look for advisors whose
majority clients are of equal financial status. This will ensure desired client
relationship services and investment plans. It will be prudent for the client to
find out the AUM of the financial advisor
to gauge his overall market standing.

Referrals and Trust
– A referral from a friend or relative will go long way to shortlist the
correct financial advisor. A number of portals are available online to select,
however, it is difficult to gauge their integrity and service before putting
your money through them. The single most important aspect of the client
relationship is trust, which takes time to build up. It is only prudent to
initially invest small sum with the financial advisor and then take time to
gauge his returns, service and work ethics. If satisfied, your subsequent
investment could be a larger sum. It is advisable to give yourself two to three
years to correctly gauge the financial advisor before making more substantial
investment with him. Financial crisis tests the advisor-client trust. As per third
CFA institute investor study, 83% of Indian investors believe their advisers
are prepared to handle the next crisis, compared with 55% of investors
globally.

Watch Out Aspects

Vested Interests
– The financial advisors can be influenced by mutual fund houses or NBFCs to
sell their products because of additional gratifications that they offer to
them. Alternatively, he may be under pressure to meet their financial targets.
This results in a conflict of interest wherein the advisor tries to push
through financial products that do not suit the requirements of the investor.

Promise of Excessive Returns – The average equity returns vary between 12 to 15 percent.
All financial products investing in equity markets are subject to market risks
and an investor must understand that risk and returns are directly
proportional. Therefore, to invest on promise of absurdly higher returns of 25
to 35 percent is to take unnecessary risk.
DIY Investors – There are numerous pitfalls that a
DIY investor has to overcome. He must sift through labyrinth of information
available and then undertake correct documentation, have the courage to take
difficult financial decisions, beat the habit of chasing performance and
returns, keep a track of all investments and undertake periodic reviews
objectively.

MONEY LESSONS FROM GOLF

As a game, golf is slow and boring to watch; yet it is addictive to play. This is probably the reason for its limited fan following as compared to more adrenaline pumping games like football or basketball. Unlike other games, where you try to beat an opponent at every stage, in golf you play against yourself – in other words, concentrate on your own game. This is because there is no concept of defense against the shot of your opponent. Ultimately, what matters is how well and near perfectly (perfection being nearly impossible to achieve in golf) you hit your shots to win the game. However, quality and dispassionate coaching play a crucial role in success in competitive golf.

Lesson: Learn to read and understand the market yourself and do not try to copy other investors. A financial advisor’s truthful and unbiased advice is of the essence to make sound financial decisions. Nevertheless, remember that it is your money and you are the best judge to take the final call.

A round of golf consists of 18 holes and a tournament can run over three to five such rounds. The tournament result counts the cumulative performance of the player spread across all these rounds and an inconsistent player may have one or two fabulous rounds but is unlikely to maintain the tempo through all the rounds. Therefore, a consistent player normally emerges the winner.

Lesson: Consistency in investment pays in the end. Invest through systematic investment plan (SIP) in mutual funds, systematic equity plan (SEP) in direct equity or recurring deposits in fixed income instruments.

Most professional players start at an early age and build up their game over years of dedicated practice. Starting early in life affords them certain distinct advantages of suppleness of body to develop a correct swing, availability of long hours of practice due to lesser responsibilities in life, and longer time horizon to understand competitive golf, learn to tackle its stresses and absorb its ups and downs.

Lesson: Start investing early in life for wealth creation. It provides you with a longer period for investment and to understand the markets, which in turn helps you to offset the market volatility. By starting early, you learn to stay calm and invest during the intimidating falling markets and book profits during the rewarding rising markets.

Professional golfers play scratch or below par, i.e. complete a round of 18 holes in 72 strokes (Par 72) or less. In amateur golf, handicapping is a numerical measure that indicates the number of additional strokes, over and above par 72, which the player will take to complete the round. Therefore, a better player has a lower handicap number and the weaker player has a higher number, e.g. an 8-handicapper is better than a 14-handicapper. Therefore, handicap creates a level playing field for all participants by giving the advantage of additional strokes to weaker players. He applies the handicap while calculating the scores as per varying formats of the game, viz. Match play, stroke play or stable ford.

Lesson: Know your handicap in money matters and apply them as per the varying situations. A person acknowledging his handicap of poor knowledge of direct equity investments then adopts the mutual fund route.

The amazing aspect of golf is that a 300-yard drive or a one-foot putt equal as one stroke on the scorecard. In fact, the short game (played on or within 50 yards of the green) contributes more to your success than the long drives since it comprises more than 60 % of the game.

Lesson: You must understand the contribution of each of your asset towards meeting your financial goals. If equity giving 12 % return comprises only 20 % of your wealth, then fixed income instruments giving 8 % return but forming 60 % of your portfolio will contribute more towards your financial well-being. See the table below to understand this better.

Asset Proportion of Assets Amt Invested % Returns Contribution Future Value after 10 Years
Equity 20% 20,00,000 12% 2.40% 62,11,696
Debt 15% 15,00,000 9% 1.35% 35,51,046
Fixed Income 60% 60,00,000 8% 4.80% 1,29,53,550
Gold 5% 5,00,000 7% 0.35% 9,83,576
Total 100% 1,00,00,000 2,36,99,868

 

            When you play a par 5 hole, you try to cover the longer distance with a driver shot and as you come closer to the green, you use shorter irons for the approach shot or a chipper to chip onto the green and finally use the putter on the green. The driver is the least forgiving club and a mistimed or bad shot can land you in the rough or hazard. However, you have chances to recover with your second or third shot. The shorter irons are more accurate and help you to close in with the pin. Finally, to sink the putt in the hole, you require precision and accuracy in speed and line of the putt for which you use the putter.

Lesson: Equity investments are akin to playing the driver shot and used for longer time horizon. A bad investment can put you in a rough or tight spot from where you can recover in due course of time. Since the market volatility will not last, the probability of negative returns also reduces with time. As you approach your financial goals, you must switch your equity investment to debt or fixed income instruments for stability and capital protection guarantee.

A dilemma for a golfer while playing an approach shot (within 200 yards of the green) towards a green surrounded with sand bunkers or water bodies is whether to attack the pin or take a lay-by. In case he plays aggressively to attack the pin and miscues the shot, his ball will land in the bunker or water obstacle from which he will find it difficult to recover or incur a penalty. If he plays safe and takes a lay-by, then he uses an additional stroke but can pull through with a good chip and putt subsequently. Golf is a game of probability and the player plays based on his potential to play the shot consistently with reasonable accuracy.

Lesson: According to mutual fund advisor in Jaipur, When you approach your financial goals, you must secure the capital from the market risks and volatility by switching it from equity to safer financial instruments. An aggressive investor may continue his equity investment with the inherent risk of capital erosion due to falling markets at the time of meeting his financial goal. A modest or conservative investor who opts for switching may earn lesser returns but will ensure that the capital is available to him in full measure at the time of his choosing. A reasonable period to switch from equity to debt funds is 12 to 18 months prior to the date of the financial goal. However, to avail maximum tax benefits through indexation you must hold the capital in debt funds for a minimum of 36 months.

SIMPLIFICATION OF MUTUAL FUNDS

SEBI RE-CATEGORIZES AND RATIONALIZES MUTUAL FUNDS 

Ø  Background: There were 42 SEBI registered Asset Management Companies (AMC) in India with 2,043 Mutual Funds (MFs), which offered 9,680 possible choices to investors through their various plans and schemes. This confused the stakeholders and made it very difficult and cumbersome to choose the correct scheme. Therefore, the Securities and Exchange Board of India (SEBI) decided to classify and rationalize the plethora of MF schemes. In its circular SEBI/HO/IMD/DF3/CIR/P/2017/114 dated October 6, 2017, it reasoned that “it is desirable that different schemes launched by a mutual fund are clearly distinct in terms of asset allocation, investment strategy etc. Further, there is a need to bring in uniformity in the characteristics of the similar type of schemes launched by different MFs. This would ensure that an investor of MFs is able to evaluate the different options available, before taking an informed decision to invest in a scheme.” This circular was applicable to only open-ended schemes as follows: schemes in existence; schemes for which SEBI has issued final observations but have not yet been launched; schemes in respect of which draft scheme documents have been filed with SEBI as on date and schemes for which a mutual fund would file draft scheme document. After considering representations received from Association of Mutual Funds in India (AMFI), it issued some amendments to the ibid circular as per its circular SEBI/HO/IMD/DF3/CIR/P/2017/126 dated December 4, 2017.

Ø  New Categorization: These two circulars issued instructions to categorize existing schemes that permitted one scheme per category except these three: Index Funds/ETFs replicating/tracking different indices; the fund of funds having different underlying schemes and sectoral/thematic funds investing in different sectors/themes. MFs were to carry out the necessary changes in all respects within a maximum period of 3 months from the date of observations issued by SEBI on the analyzed and detailed proposals submitted by MFs. The aforesaid proposals of the MFs were to include the proposed course of action (viz., winding up, merger, fundamental attribute change etc.) in respect of the existing similar schemes as well as those that are not in alignment to the categories. SEBI classified the schemes broadly in the groups and subcategories as given in the table:

Main Category Number of Sub Categories Details of Sub Categories of Funds
Equity Schemes 10 Multi-Cap, Large Cap, Large and Mid Cap, Mid Cap, Small Cap, Dividend Yield, Value, Contra, Focused, Sectoral/Thematic and ELSS
Debt Schemes 16 Overnight, Liquid, Ultra Short Duration, Low Duration, Money Market, Short Duration, Medium Duration, Medium to Long Duration, Long Duration, Dynamic Bond, Corporate Bond, Credit Risk, Banking and PSU, Gilt, Gilt with 10 Year Constant Duration and Floater
Hybrid Schemes 6 Conservative Hybrid, Balanced Hybrid, Aggressive Hybrid, Dynamic Asset Allocation or Balanced Advantage, Multi-Asset Allocation, Arbitrage and Equity Savings
Solution Oriented Schemes 2 Retirement and Children
Others Schemes 2 Index/ETFs and Fund of Funds (Overseas and Domestic)

Ø  Market Capitalization Norms: Until now each fund had its own definition of large, mid and small cap stocks. Therefore, even in a large-cap category, the weighted average market capitalization of mutual funds ranged from Rs. 29 thousand crores to Rs. 1.9 lakh crore. Therefore, to ensure uniformity in respect of the investment universe for equity schemes, SEBI defined market capitalization norms for the listed companies. For its implementation and compliance, it asked MFs to adopt the list of stocks, to be prepared by AMFI and updated every six months. The defined market capitalization categorization is as follows:

v  Large Cap: 1st to 100th company in terms of full market capitalization

v  Mid Cap: 101st to 250th company in terms of full market capitalization

v  Small Cap: 251st company onwards in terms of full market capitalization

Implications for AMCs

Ø  Actions: The above circulars entailed that the MF houses undertake the following actions:

v  Change in scheme name

v  Change in investment objective

v  Fundamental change in investment strategy

v  Change in portfolio asset allocation

v  Change in category or investment theme

v  Change in fundamental attributes of a fund

v  Merger of schemes

Ø  Portfolio Management: Scheme merger will bring down the number of portfolios to be managed, thereby giving time to fund managers to focus their efforts on generating alpha. Fund managers may have to reshuffle scheme portfolios every six months based on AMFI revising the market cap list, which will increase their costs and impact their returns.

Ø  Trails and Commissions: Merging of various schemes might bring uniformity in commission paid by asset management companies (AMCs). However, the merger of schemes will result in the renegotiation of distributor commissions and the management of trails, thereby increasing transaction costs.

Ø  Equity Funds: Some of the large-cap funds will lose their sheen and returns since they will not have the flexibility to invest beyond the large-cap basket of 100 companies to generate alpha. There will be only 150 companies categorized under the mid-cap universe as compared to the current 400 stocks, as a result of which fund managers will have limited options to invest in the mid-cap category. This may force the investors to turn towards multi-cap funds that afford greater flexibility to the fund manager to generate a better alpha.

Investor Awareness:

Ø  Changes: The changes by SEBI create uniformity in the characteristics of similar types of schemes, enhance transparency and standardize disclosure requirements. It groups and names mutual fund schemes based on investors’ underlying investment objectives and offers flexibility to investors on the nature of investments and risk exposure. The new categorization will facilitate the investor to make an apple to apple comparison. Not only will this help him to choose the scheme, but it will also help him to know and understand the impact each scheme or fund will make in his portfolio.

Ø  Hurry Not, Worry Not: Almost all the fund houses have mentioned that these proposed changes are to be effective from 3rd or 4th week of May 2018. Investors need not to hurry or worry to exit and re-enter funds at this stage based on returns alone, without knowing whether the fund will fit you in its new category and attributes. Instead, they must wait for funds to settle into their new categories and then take considered decisions based on their risk profile. If there is a minor change in the fund mandate, then investors could ignore the past performance and wait for the fund to build a track record.

Ø  Debt Funds: The NAV of debt funds fall when the interest rates rise and vice versa. Therefore, SEBI has chosen the Macaulay duration (a measure of how much the NAV will vary when the interest rates change) to classify how volatile the debt fund NAV is to the interest rate movements. SEBI has also made an effort to segregate credit risk by differentiating corporate bond and credit risk funds. However, the gilt category does not have any restriction on duration and this can be painful for investors who wish to avoid credit risk completely and also minimize rate risk. The naming convention of debt schemes is as per the risk level of end investments. The nature of risk carried by debt schemes may still not be understood well by investors as simply changing the name might not highlight the quantum of risk element in these schemes.

Ø  Hybrid Schemes: Under the current categorization, these have been defined into three types: Conservative hybrid fund, balanced hybrid fund and aggressive hybrid fund. For an investor, the scheme differentiator will still remain a concern.

Ø  Portfolio Review: The new categorization necessitates a portfolio review by the investors based on their risk profile and financial goal planning. The problem is that investors who wish to exit or switch a scheme that has changed mandate or has merged will have to pay capital gains tax because of this SEBI ruling. In case they decide to continue with some of their ongoing schemes, then they must monitor the returns closely for the next 12 months and then take a call.

Ø  Financial Advisory Services: Last but not the least, it is better to check your choice of funds with your financial advisor in Jaipur to ensure you are not comparing funds whose past record is not comparable. Be wary of going merely by the ratings offered by various websites (unless they clearly state what their new methodology is), if the comparison is done with new peers based on past data. When it comes to reviewing your funds, stick to comparing the fund with its respective benchmark and check if the fund is able to deliver 2 to 3 percentage points more than the benchmark in the case of equity.

PS: Dhirendra Kumar, CEO Value Research, suggests “Practically speaking, if you are an individual investor whose financial goals are the normal ones that most people have, then you can easily ignore 32 of these 36 schemes. Here’s what remains: multi-cap for long-term investing, aggressive hybrid funds for medium-term savings, ELSS funds for tax saving combined with long-term savings, and short-term debt funds as a superior alternative for bank fixed deposits. That’s it.”