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.

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.

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.

DO NOT PUT ALL YOUR EGGS IN ONE BASKET: DIVERSIFY

Introduction

➢ Diversification is a fundamental of investing. Oxford dictionary defines diversification (especially in business) as the act of developing a wider range of products, interests, skills, etc. in order to be more successful or reduce risk. Online portal Investopedia elaborates diversification as a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio constructed of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

➢ Why Diversify? Diversification will safeguard your portfolio against total loss, hedge your investments to cater for market volatility and accommodate your financial goals at varying timelines. Ipso facto, diversification of the portfolio must take place in the undermentioned varied asset classes.

Asset Classes

➢ Large numbers of asset classes, as follows, are available in the Indian market and it is important to understand their peculiarities before investing in them:-

Real Estate. Investment in real estate can be done by purchasing residential or commercial property (land, bungalows or flats), REIT (Real Estate Investment Trust) or REMF (Real Estate Mutual Fund). Investment in real estate is capital intensive and thus should be done early in life by availing home loan option to avail its tax saving advantage. Even so, one must avoid using entire savings towards payment of home loan EMI and concomitantly invest a portion of it, preferably through SIP, to ensure wealth creation. To avail maximum advantage, investment in this asset is for a long duration of at least a decade plus. The property market, which is fuelled by black money is on the decline due to Government instituted measures to restrict its use in the economy. Thereby, this asset may yield lesser returns in India in the coming decade. Retail investors should be wary of frauds and cheat galore in this sector and should carefully check the documents before striking a deal.

Equity (Stocks). Investing in the equity or stock market is a good option in the long run (minimum 7 to 10 years to ensure good returns). Investment in equity can be done directly by the investor through demat (dematerialization) account or through mutual funds (MFs) with high equity exposure. While the MFs are managed by professional fund managers, investments in the demat account will require the investor to manage them himself. For this, the investor should be abreast with the market trends and carefully select the stocks (large, mid or small cap) based on his risk profile. Since 1990 to date, the Indian stock market has returned about 17 percent to investors on an average in terms of increase in share prices or capital appreciation annually. Besides that on average, stocks have paid 1.5% dividend annually. A safe expectation would be 15 to 18 percent average return provided the investor stays invested for more than 5 to 7 years. It is felt that 100 minus your age is the percentage of your total net worth that should be invested in this asset class. E.g., if your age is 40 years then 100-40=60% of your portfolio must comprise of equity. Nevertheless, this is just a yardstick and one must seek his financial advisor’s advice before investing. The relationship between risk and returns in this asset class is directly proportional.

Fixed Income Instruments. Indians by nature, especially the burgeoning middle and salaried class, are moderate or conservative investors. Probably, this was one of the reasons that helped us tide over the economic meltdown of 2008 with relative ease. A wide array of fixed income instruments is available in India for a retail investor. To name a few – bank/post office fixed and recurring deposits/provident funds, Government/Corporate Bonds and a plethora of Debt MFs. These instruments give an effective post-tax yield of 6 to 8 percent per annum that barely beats the inflation. Moreover, the interest earned is also taxable in most cases that further compounds to the investor woes. However, these instruments are a good means of investment to give stability to your portfolio since the erosion of principal investment due to market volatility is nil to a bare minimum. As the investor’s age advances, these instruments become prudent investments for the elderly.

Cash/Liquid. This investment is suitable for investors to cater for short to ultra short-term financial goals. Investing in Liquid or money market/cash instruments is a good option since they have high credit quality and are highly liquid. Considering the low risk, the returns in these instruments vary from 6 to 8 percent per annum.
Bullion. Traditionally, Indian investors are crazy about investing in gold. The market now offers gold Exchange Traded Funds (ETFs) that rule out the physical holding of gold with freedom from ensuring its security. The latest Government launched Sovereign Gold Bonds is another good option since they carry a sovereign guarantee, on the interest, and an individual is exempted from Capital gain tax arising on their redemption. They are available demat and paper form with a minimum tenor of 8 years with an option to exit in 5th, 6th and 7th years. Another metal, silver is also a good option to invest. Bullion is good to hedge your portfolio against market volatility and about 5 to 10 of your net worth must comprise of this asset. Investing in jewelry is not a wise decision because you lose 15 to 20 percent of the asset value on each transaction due to nonrefundable labor charges. The best way for physical holding is buying coins & bars from reliable sources.
Arts and Antiques. This form of investment is gaining ground for high net worth individuals or genuine art and antique lovers. This form of investment is fraught with danger of fakes and swindling. However, a genuine masterpiece can fetch you your asking rate if the buyer needs it.

Conclusion
➢ Is it prudent to invest in all the above asset classes? The answer to this question will depend on the investor’s risk-taking ability based on his age, financial goals, and cash flow. Ideally, a twenty to thirty-year-old investor starting his career must invest 80% in equity, 10 to 15% in fixed income and bal in gold. During his middle age, he must invest in real estate to own shelter by the time he retires and avail tax benefit. However, he must continue his equity exposure after moderation to take care of his home loan. The Financial Goal Planner in Jaipur Helps you to During his sunset years, he must help you to reduce his equity exposure and enhance his fixed income exposure to safeguard his principal investment and also get assured monthly income from investments.

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 The 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 a quarterly compounding and a cumulative deposit.

ØDividend earned is on the face value of the shares.

The 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

The 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 your money. In the given example, the bank gives you an XIRR of 8% on your cumulative FD investment. In case, you require a business loan of the 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 a function of his age, risk appetite and liabilities. Normally you must invest 100 minuses 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.