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.”

MARKETS BULLISH BUT PORTFOLIOS REMAIN BEARISH

Ø  Investor Concern: Investors are concerned these days that although the markets are rising and touching new highs frequently, their investments in mutual funds (MFs) are not rising proportionately. In the last six to seven months, the SENSEX 30 navigated between a high of 36,283 on 29 Jan 18 to an all-time high of 37,606 on 31 Jul 18. The ebb came when it touched 32,596 to hit its low point on 23 Mar 18. Similarly, the NIFTY 50 traversed between its record high of 11,171 on 29 Jan 18 to an all-time high of 11,360 on 03 Aug 18 with the low point on 23 Mar of 9,998. The reasons are explained in the subsequent paragraphs.

  •  Average Returns: As on 20 Jul 18, equity large cap had generated a negative average return during the last six months of -1.85%. The multi cap generated -4.96%, whereas the mid-cap generated -10.65% and a small cap of -17.44%. Equity sector (technology) generated the best returns at 13.48% followed by debt funds at about 3 to 3.5%. The worst performer was the equity sector (infrastructure) that generated negative returns of -18.71%. Given below is the chart indicating the six months (Jan to Jun 18) returns of various fund categories as per Value Research.
  •  Market Performance: In the last three months, 26 out of 30 large cap MF schemes underperformed their benchmark. In fact, only 3 to 7 big companies are driving the market and their market caps are zooming to new highs. About 60% of the NIFTY 50 constituent stocks are in the red. Only 19 stocks in the Nifty outperformed the index with positive returns. 31 stocks, comprising more than 50 percent of the Nifty, underperformed the index. The poor conditions of the banking sector due to their large NPAs and unbelievable frauds have dipped their stocks to the bottom 10 of the list. The mid and small cap stocks dropped between 20 to 50 percent with some companies going down by almost 80 to 90 percent. Corrections in the mid and small cap space are primarily attributable to the mismatch between earnings and valuations. The stocks in the mid and small cap section had premium valuations that their earnings could not support. So their dream run of last two years started crashing after the Budget 2018. In the Nifty, only 27 percent of mid-cap and 19 percent of small-cap stocks delivered positive returns.
  • Advance Decline Ratio: The advance-decline ratio is a popular market-breadth indicator used in technical analysis. It compares the number of stocks that closed higher against the number of stocks that closed lower. If we compare the total stocks that advanced or declined at the two bourses over the last six months, we realize that the ratio has crossed 1 only in April. This indicates that in the other five months, more stocks have declined at these bourses than advanced. 
  •  Tightening of Regulatory Process: The other major contributory reason to the poor performance is the recently implemented SEBI guideline to re-categorize and rationalize the MFs into five broad categories, viz. equity schemes, debt schemes, hybrid schemes, solution-oriented schemes, and other schemes. Along with this, SEBI also redefined the market capitalization norms for the large, mid and small cap companies resulting in the eligibility of the first 100 companies only for large cap. Although this will help the investors in the long term, it has severely constrained the fund managers in the near and short term by reducing their flexibility to decide the market cap norms and switch funds to generate better alpha. Besides, SEBI has mandated all equity schemes to benchmark their performance against a total returns index (TRI), which are calculated after adding the dividends of the underlying companies. Effectively, these results in raising the hurdle for fund managers as the return of TRI indices are typically 1.5-2.5 percent higher than regular indices. Moreover, SEBI has also cracked down on MF Houses who were breaking the norms by investing outside the scheme’s mandate to generate higher returns.
  • Other Reasons: The other reason is the global headwinds generated by the likelihood of trade wars and Fed tightening. The market outflows by FIIs due to falling rupee have adversely impacted the sentiments, which the domestic investors mitigated to a large extent through their sizable inflows. At the national level, FY 2018-19 is governed by eight assembly polls followed by general elections in 2019.

Ø  Investor Advisory:

  •  The investors are advised to maintain their calm and should not prematurely churn their portfolios or exit from underperforming schemes. The market cycle auto corrected such dichotomous market situations on its own.
  • Stay invested in equity MFs while maintaining a long term investment horizon and continuing the existing SIP. The market cycle will auto correct after the political and global headwinds.
  • Watch the performance of hybrid funds over the next two quarters since they may stabilize after the turmoil created by the new SEBI regulatory order forcing mergers and fundamental change of attributes. Park your funds in short duration debt funds or FMPs to negate the market volatility and generate better returns than fixed return instruments.

PERSONAL FINANCIAL MANAGEMENT FOR THE ELDERLY RETIREES

Adopt a balanced approach to avoid impoverishment during sunset years

According to Population Census 2011, there are nearly 104 million elderly persons (aged 60 years or above) in India and their share and size is increasing. It was 5.6 percent of the population in 1961 and increased to 8.6 percent in 2011. By 2050, the population of Indians above 65 years will increase almost three times (predicted by US-based Population Reference Bureau). The growth in the elderly population is due to the longevity of life achieved because of economic well-being, better medicines and medical facilities, and reduction in fertility rates. In the urban areas, only 56 percent of male and 17 percent of the female population is financially independent while the others are partially or fully dependent. Most elderly people become penurious by falling into the financial trap due to their overcautious approach to investment. They do not realize that given the longevity, their retired life may extend for 30 or 40 years, which is as long a period as their working life or even more. When a retiree sees a large corpus available to him at the time of his retirement, he may tend to splurge by undertaking leisure vacations, gifting to his near and dear ones or even investing in some fraud schemes to get unrealistically higher returns. Alternately, he becomes a conservatively timid investor who deposits everything in safe and fixed income instruments that give lower returns. Our endeavor in this article is to look at the criticalities of financial planning and systematically explain the adoption of a balanced approach to leading a financially stable retired life.

There are two types of retirees, viz. Pensioner and non-pensioner. While the former has regular financial backing through his pension, the latter has no such guarantee. This implies that the non-pensioner will have to start with a larger corpus to sustain his monthly expenses, while a pensioner may start his retired life with relatively smaller corpus and sustain through regular pension income. Let us assume that the current monthly expense for both is rupees one Lakh, which will rise @6% per annum due to inflation. If they both live up to the age of 90 years, then their monthly expense during their 90th year will be rupees 6.02 Lakh per month. To sustain his regulated monthly expenses through 30 years of retirement, the non-pensioner requires to start with a corpus of rupees 274.74 Lakh at the real rate of return @1.89% (annual percentage return realized on the investment of 274.74 Lakh @8% and adjusted for changes in prices due to inflation @6%). Hypothetically, if the pensioner starts his retirement with a monthly pension of rupees 0.75 Lakh, he has to cater for a monthly shortfall of 0.25 Lakh and for that, he requires a corpus of rupees 68.68 Lakh.

Given this longevity of life, a question that haunts every elderly person is as to how long will he live and how much money will he require to take care of his old age? We can broadly divide 30 to 40 years of post-retirement life into 3 or 4 decades. The first decade of the sixties that holds 5.3 percent of Indian population is one of reconciliation and acceptance of the retired life and then adjusting into it. The next decade of the seventies, which is of prime concern for 2.4 percent of the Indian population, is of consolidation of assets and health. Thereafter, the decade eighties is of fragile health and growing dependence on children/domestic help for 0.9 percent of the Indian population, whose old-age dependency proportion has climbed from 10.9 percent in 1961 to 14.2 percent in 2011. Finally, only a minuscule percentage attain the extraordinaire decade of the nineties.

When a retiree invests, he is cautious, risk-averse, and puts everything in safe income instruments; so, he will not beat the inflation. Although this is sensible and apt for capital protection, it does not help to overcome the inflationary pressures. The primary inflationary pressure is from rising medical and hospitalization costs, which is about 15 percent as compared to the average consumer price index inflation rates of 6.27 percent (average monthly of a calendar year taken over past 20 years). The real rate of return of fixed income instruments is much lower than their indicative interest rate due to the taxability of the interest earned and the inflation cost. We have exemplified this point for better understanding of the readers. Rupees one Lakh invested @ 8% gives a retiree rupees 8,000 as interest in one year. If he pays 20.8 percent tax (inclusive of 4 percent cess) on it, then interest left in hand is rupees 6,336 only, which is effectively 6.34 percent. Further, 5 percent inflation eats into this 6.34 percent interest to give a meager 1.28 percent real rate of return. Since 1972, even gold has only given average 7.4 percent returns. Therefore, he must invest some percentage of his cash asset in the equity market, directly in stocks, if he has market experience and confidence, or through mutual funds, since they have given an average return of 14.3 percent in past 10 years.

The question that arises in the mind is about the asset allocation percentage. As a guideline, he must keep 50 to 60 percent in fixed income instruments to ensure capital protection, about 20 to 30 percent in equity, 10 to 15 percent in debt mutual funds and 5 to 10 percent in gold. The elderly will do well to understand the decision dilemma created due to the risky inverse relationship between the size of corpus and percentage of equity investment. If the retiree has a large corpus, then he can afford to invest a smaller percentage (up to 20 percent) in equity since his investment in other assets will take care of his financial needs. However, if his corpus is small, then he should invest a larger percentage (maximum up to 40 percent) into equity to generate better returns to meet his financial needs. Initially, the retiree may invest the retirement corpus as per this guideline through a systematic transfer plan (STP) in equity and a lump sum in other assets.

Asset Diversification Percentage Amt Invested@ Expected Returns Real Rate of Return* Inflation-Adjusted Value after 10 Yrs Inflation Adjusted Value in 30 Yrs
Equity 20% 20,00,000 15% 8.49% 45,18,037      2,30,56,281
Debt 15% 15,00,000 9% 2.83% 19,82,885        34,65,056
Fixed Income# 60% 60,00,000 8% 1.89% 72,33,195      1,05,12,063
Gold 5% 5,00,000 7% 0.94% 5,49,224          6,62,685
TOTAL 1,00,00,000 1,42,83,340      3,76,96,085
@ Assuming the retiree has a corpus of rupees 1 Crore to invest

* Assuming CPI Inflation Rate as 6%

# Includes contingency fund (equal to six months expenses) to cater for emergencies invested in Sweep FD for better liquidity.

Thereafter, he should invest to save about 15 to 20 percent of his gross monthly income in equity mutual funds through systematic investment plan (SIP) or directly in stocks. This investment will give a fillip to his savings in his eighties or nineties as their holding period would have exceeded 15 to 20 years. To illustrate and emphasize my point: A retiree investing rupees 10,000 per month in an equity mutual fund over 20 years, generating 12 percent return, will accumulate rupees 99.91 Lakh with a growth of 76 percent in his investment of rupees 24 Lakh.

He must diversify to hedge, which is a technique designed to reduce or eliminate financial risk; for example, gold and equity will offset each other if markets change. As the time goes by, the investment returns from equity start performing better than the benchmark indices since volatility decreases and so does the probability of loss, which is only 3.7 percent after 10 years and becomes zero after 15 years. If required, the retiree must make withdrawals from his fixed income instruments. The usual dilemma is how much to withdraw in a year from the fixed income corpus. Suppose a retiree invests rupees 60 Lakh in fixed income instruments @8% return in an economic environment of 6 percent annual inflation and annually withdraws 5 percent from the corpus. Then, the value of his investment after 10 years, as per the real rate of return, will reduce to rupees 43.32 Lakh. If he desires to protect his capital, then he can annually withdraw a maximum 2 percent from his corpus, to match the real rate of return @1.89%. The retiree should hold his equity investment preferably for minimum 5 years so that it can generate returns and then withdraw from it to meet financial goals or augment his sustenance income.

The retiree must also correctly comprehend the tax structure of all these assets to derive maximum advantage. Government levies tax on interest earned in most fixed income instruments, and short and long-term capital gains (STCG and LTCG) tax on equity and debt schemes at varying rates. The point to understand is that government levies tax on entire interest earned during the financial year through fixed income instruments, immaterial of the fact whether the retiree withdraws it or not for his use. However, it levies capital gains tax only on the actual gains made by the retiree during redemption or switching done in the financial year. Government adds short-term debt fund (less than 3 years) gains to the retiree’s income and taxes it at his applicable tax slab rate, whereas, it taxes long-term gains at 20 percent after the indexation benefits. This aspect and the applicable tax rates make an investment in debt mutual funds more attractive than fixed income instruments. If the retiree is in the higher tax slab with income more than rupees five Lakh, then financial wisdom dictates that his debt fund investment should be more than his fixed income investment.

Particulars Debt Funds Fixed Deposits
Investment 10,00,000 10,00,000
Return Rate 8% 8%
Lock-in period 3 3
Amount after 3 Years 12,59,712 12,59,712
Effective Return Rate 8.66% 8.66%
Inflation 6% 6%
Indexed Cost of Purchase 11,91,016
Gains (Taxed Amount) 68,696 2,59,712
Tax Paid* 13,739 80,251
Net Gain 2,45,973 1,79,461
Returns after tax 8.20% 5.98%
*LTCG Tax after indexation benefit @20% on for debt fund and Income Tax @30.9% for FD including Health and Education cess @4%

A lot is also made of investment in property for financial security and independence. In old age, the property becomes a liability due to its regular maintenance and encroachment issues. Therefore, financial prudence lies in staying cash rich and asset meager. Feel blessed to have one residential property that the retiree occupies and invests his cash assets to provide regular cash flows. The retiree must guard against holding a lot of liquid cash that he can withdraw easily or his children may coerce him to withdraw. To obviate this, he should consider making a lump sum deposit in the following instruments as they restrict liquidity and give decent returns. One, Pradhan Mantri Vyaya Vanden Yojana (PMVVY) that provides an assured monthly pension of rupees 10,000/- on maximum permissible investment of rupees 15 Lakh @8% per annum for ten years, with an option to also opt for a pension on a quarterly, half-yearly or annual basis. Two, Senior Citizen Savings Scheme (SCSS) that provides risk-free quarterly returns @8.3% (revised on a quarterly basis), on maximum permissible investment of rupees 15 Lakh for five years, which is extendable by another 3 years. Three, Government of India Savings (Taxable) Bonds, which give 7.75 percent assured returns, have 7 years tenure and no maximum investment limit. Four, Public Provident Fund (PPF) that gives 7.8 percent returns (revised on a quarterly basis) on maximum permissible investment of rupees 1.5 Lakh per year for fifteen years, which is then extendable by another 5 years. All these enjoy tax benefit under sec 80C of the IT Act, but their returns are taxable as per the retiree’s applicable tax slab except PPF, which enjoys tax exemption.

OWNERSHIP Vs FIXED INCOME INVESTMENT

Initial Investment: Back in 2000, four friends made a New Year resolution to invest their savings of about Rs. 50,000/- each with the intention to ‘invest and forget’. Accordingly, on 01 Apr 2000, in the new financial year, friend A bought 7093 shares of AXIS Bank @ purchase value of Rs. 50,006/-, B bought 1015 shares of HDFC Bank @ purchase value of Rs. 50,029/- and C bought 2571 shares of SBI @ purchase value of Rs. 50,006/-. However, their fourth friend, being conservative, invested his savings in the cumulative FD of SBI @ 9.5% initial interest rate. Now in 2018, they decided to see their investment values and compare their returns. Thus, what they saw of their returns astonished them and we have summarized it below for your better understanding:

Investment Type Amount Invested on  01 Apr 2000 Value on 01 Feb 2018 Growth of Corpus XIRR Dividend
AXIS Bank (Friend A) Shares (Ownership) 50,006 38,14,261 7528% 27% 1880%
HDFC Bank (Friend B) Shares (Ownership) 50,029 19,07,946 3714% 23% 3008%
SBI (Friend C) Shares (Ownership) 50,006 6,98,669 1297% 16% 3750%
SBI (Friend D) FD (Investment) 50,000 1,96,315 293% 8% 0%
Notes:

ØThe holding period of the securities is 6515 days or 17 years and 10 months.

ØThe FD is quarterly compounding and a cumulative deposit.

ØDividend earned is on the face value of the shares .

Concept of Ownership: This concept entails that you buy shares of the bank or company that you want to take ownership. Buying some shares of the bank/company makes you a shareholder and provides your part ownership. However, prudence demands that before buying these shares you must check the fundamentals of the company to be sure that you put your money on a winner. The other point to be borne in mind is that you should undertake ownership for a long duration to cater for adverse market cycles and give time for the bank/company to grow adequately. Nevertheless, a word of caution that ownership is subject to market risks and subject

Concept of Fixed Investment: In this concept, you give your money to a bank/company for investment in a fixed deposit. By this, you ensure capital protection of your money but the returns are far lower than ownership. In fact, at times these returns cannot even beat the inflationary costs and gradually erodes the time value of you money. In the given example, the bank gives you a XIRR of 8% on your cumulative FD investment. In case, you require a business loan of larger amount then the same bank will provide a loan at 12%. Now, if you have to repay this loan, then your investments must fetch you a minimum of 18% return to repay and beat the inflation.

Taxation: As per the taxation policy in vogue, the capital gains (difference of sale value from cost value) from shares is taxable only in the short term (less than one year holding) @15%. No tax is applicable in the long term (more than one year holding). However, the income (interest) from FD is taxable at the applicable tax slab rate of the investor, irrespective of its holding period. The 2018 budgetary proposal has introduced long-term capital gains tax @10% (without indexation) on gains more than Rs 1 Lakh with effect from 01 Apr 18, but left short-term gains and interest income taxation unchanged.

Asset Allocation: An investor must remember that he must not risk everything in one type of investment. He must follow the cardinal principle of diversification of asset allocation and invest in equity as per his risk return profile, which is function of his age, risk appetite and liabilities. Normally you must invest 100 minus your age percentage in equity. Therefore, if your age is 60 then you may allocate up to 40% of your investments towards equity or if your age is 30 then the equity exposure can go up to 70%.

Lessons: Owning shares is ownership of the bank/company and is beneficial in the long-term than merely investing in FDs. Firstly, shares give much higher returns than fixed income instruments. Secondly, shares additionally earn dividend income that does not come with fixed income instruments. Thirdly, shares have lesser tax liability than fixed income instruments. However, while investment in fixed income instruments ensures capital protection, investment in shares is subject to market risk. Therefore, have faith in ownership of shares with a long-term investment horizon of more than 7 years.

Disclaimer: We have obtained the data for the above chart and graphs from Moneycontrol.com and RBI site. This example is to highlight that ownership is better than investment but equity investments are subject to market risks.