INVEST SIMPLY THROUGH FOUR BASKETS APPROACH

It becomes very difficult for a non-financial background person to have a detailed financial plan and follow it systematically. So how can we make the investing things simple? In this post we will try to simplify the investment process in a lay man’s way.

Firstly we have to figure out our income, expenses and savings. We should also identify our primary and secondary goals which we want to achieve. We can divide our total income into four baskets based on the priorities of the need for the money.

The first part of the savings should go for immediate requirements and emergency purpose; like if we lose job how are we going to survive and meet our daily expenses. We can keep 3-6 months expenditure in this basket. The money saved for this purpose can be invested in liquid/ultra-short term mutual funds or may be in short maturity fixed Deposits. The main objective of this basket is to get the money as and when required therefore liquidity of this investment is of paramount importance. Now, many app-based systems for investing and redeeming money from liquid funds have been introduced which can move funds back and forth with ease and speed. They offer almost double the returns of savings accounts while being potentially much more tax-efficient.

The second basket of savings could be statutory or forced savings. Under Section 80C government gives us exemption for savings. Certain instruments are qualified for this savings which includes PPF, Insurance, ELSS, NSC etc. This type of savings helps us in two ways: first it reduces our income tax outflow as well as it forces us to save for a minimum period of 3-5 years. Some of these investment like PPF, ELLS are tax free at the time of maturity also hence gives full benefits of the savings. We can save upto Rs. 1.50 lakhs under 80C and additional Rs. 50,000 in NPS under section 80CCD. This saving can be used for short to medium purposes and can also be recycled for future tax saving purposes. Apart from this we should also have proper mediclaim polices which are also tax exempted for self, family and parents under section 80D.

The third basket of our savings could be based on our specific medium term goals. These goals/expenses can be figured out with more certainty as they are in near future say 3-5 years’ time. For example we would like to buy a house in next five years and need to put down an initial payment. Or we need a new car in three years, as the existing one will be pretty old by that time. We can separate these needs from the long term needs as they are more predictable and have shorter time period as compared to longer ones. This kind of savings can be put into balanced or hybrid mutual funds which are more tax efficient and have better returns comparatively. They are less volatile, and have a lower tax outgo than bank FDs.

The fourth and last basket is the one where we would be investing for a longer time horizon for example eight to ten years and more. These savings could be for our own old age requirements, or for kids education/ marriage etc. These investments would be based on our age and specific needs. Since these investments are for longer durations they can be kept in equity based investments options i.e. equity mutual funds. Even though equity funds can be volatile in the short term, they are the only asset class which can provide good enough returns in the long term to beat inflation and provide substantial returns. The income earned from equity mutual funds is fully tax free so gives us the maximum benefits without any cut.

To achieve anything we first need to know our goal, similarly to achieve a financial freedom we must know our specific goals and plan accordingly. For a starter, the four basket approach could be a good beginning in this path of financial freedom.

What to do when Market is continuously rising

This week BSE Sensex touched 30,000 mark, Nifty has already crossed 9000. As the stock market is touching new highs, many of us get jittery about what to do some also get over excited in this market. SO what should we do in this kind of situation and how to avoid temptation and errors while making most in this kind situation.

1.  Numbers are not just numbers look behind them

If we just look at a number in isolation it does not gives any clear information. Time value of money and the basics behind the numbers are more important to understand its significance.  Similarly the absolute number of the Nifty, BSE Sensex or any individual stock may not give a correct picture. We should look at Valuations based on earnings, growth and other factors to determine the actual value of that stock or group of stocks.

2.  Asset allocation is the Key

It is true that equity valuations are currently high as compared to historical averages. Hence expected returns are less. Still if we compare equities with other asset class i.e. bonds, gold, real estate it remains relatively attractive over the long term period of three years and more.

Another factor that determines market levels is Cashflow in the market of funds. Foreign Institutional Investors continuously buying Indian Stocks and Domes Institutional Investors like Mutual Funds are also buying. In this scenario when we do not have any other better asset available we can keep on investing in equity market,  We understand that equities may be volatile in the short term, but investors with a medium to long-term horizon should continue to invest in equities, preferably through SIPs. A staggered approach for investments through SIP or STPs could be better way in this scenario.

If we have a large sum to invest, it is best to park the funds in liquid or ultra short term bond funds and do a systematic transfer to equity funds over a period of time. This may help to average out the purchasing cost over a period of time.

Another strategy for investments in this scenario could be dynamic asset allocation or balanced funds. In Dynamic asset allocation funds mutual funds reduce equity exposure when the market valuations are high and increase it when the valuations are low. Some funds reduces the equity exposure below 65% required for getting equity tax benefits through derivatives.These funds can also be looked at to reduce equity exposure while getting the tax benefits in more efficient way.

Corporate Results, inflation behaviour and the interest rate movements, implementation of GST are major factors which should be looked at in near future to seek the direction of the market.

3.  Understand the actual risk

Normally, the large cap stocks are value higher as compared to mid and small cap stocks. However, currently it is the other way.  Mid & Small cap stocks are value much higher as compared to the large cap companies. This could get corrected to its normal levels in near future. In this scenario its better to be more careful while selecting stocks or mutual funds so as to avoid potential risks.  

4.  Nothing comes cheap so be careful

When markets are at very high levels people get tempted to buy penny stocks assuming they may multiply in future. Some people think that if stock price of a a company is very little it means the risk is also little but this is not true. Ultimately the return is calculated on percentage terms. If a stock priced at Rs. 4 falls to Rs. 2 or a stock of Rs. 1000 falls to Rs. 500 the loss will be same. As a basic we should always remember that any company’s stocks has to be valued on the fundamental factors like business growth, management, financial performance etc. and not on the absolute price.

Further little priced penny stocks could also be easily manipulated by operators and are best avoided.

5.  Trading has more excitement than actual gains

We keep on hearing various stories from friends & relatives that someone has made lot of money by day trading or playing in the futures and options (F&O) markets. It’s not so easy and may not be always true. We should understand that trading is a specialized activity and requires lot of expertise and knowledge of the market. Small investors should better to keep themselves away from these temptations.

6.  Insure the risk

The large investors who have significant equity exposure can take hedging positions to reduce their risks in equity market. investors can follow less aggressive hedging strategies like buying puts at higher levels and selling at lower levels to protect themselves from significant falls along with covering a steep rise in the markets. 

When something goes to a new and uncharted territory, proper prudence and maturity is required to see beyond the current hype so as to not get carried away with it and also to keep the eyes on reality. The Indian stock market may be like that at this juncture hence we should keep our eyes and ears open while taking any kind of decisions in this market.

Why should we SAVE MONEY ??

Everyone want to spend money so as to live comfortably and enjoy the life but in this article I want to discuss why should we save. Yes we can think that its very obvious why to save, but still lets find out more the reasons behind savings. Here while talking about saving means saving and investing both.

Normally we all feel that “saving money” is only related to securing your future. The equation for them is

Save money = Lead a better life tomorrow

However there are various other angles we need to think about, and that’s why we are going to discuss this in details. So lets understand it more in details:

1 – Securing our future

The most basic and core objective of saving money is to use it for our future requirements. We save or accumulate the money and use it for your future requirements.

We must know that “One day, our regular income which comes by name of salary will stop coming”

There will come a time when we will be left with 30-35 more years of our life and there won’t be a regular salary coming into your account like it happens today. We need to create a big enough corpus, which helps us to lead a life we desire for next few decades even when there is no regular inflow and which should last till our death.

Few people may think that they can avoid creating their wealth because their kids will take care of them. However it’s up to us to decide if that’s the right approach towards life or not.

Savings and Investing what does it means?

Saving: Saving money is very important. We should save money because if one day suddenly we need money we will have it with us. If we just keep on spending all the money that we get and one day we need money we will not know what to do

Investing: Investing makes our money grow. Just as a plant grows from a seed to a plant. When we keep our money in a savings bank we get interest but if we will invest our money in fixed deposits, shares, mutual funds, public provident funds, etc. our money will grow from a small amount to a big amount faster.

Start saving some money for future

To start with If  someone can’t manage to save enough money, at least he should start saving some money starting from TODAY itself . Let me share with you some numbers on this. If a 30 yrs old person invests Rs 5,000 per month for next 30 yrs consistently, then @13% average return over long term, a total of approx Rs 2.2 crore can be accumulated.

The amount of saving is something depends on person to person and even small amount can also make a big difference in a person’s life. We should remember that Anything is a good start! , may be upgrade later – but at least START RIGHT NOW.

2 – To allow us to do what we love to do

Let’s ask a basic question: Do you love what you do?

It is not just work we are talking here but about pursuing our passion for living or doing full time job in the area which we love to do. What we mean here is that do we have enough time and money to do things we love for few hours each week? Something which we truly want to do other than our regular job work?

·        Do you want to socialize more by throwing a party for your friends, but worried about the cost and affordability?

·        Do you love photography, but those costly lenses seem to be out of your current budget?

·        Do you love travelling to new places, but you are stuck because the home loan EMI needs to be paid first?

·        Are you afraid to tell your boss that you want to go on a month long road trip, with your best friend which was planned years back?

·        Want to go on a weekend trip with your friends, but seems it’s out of the budget!

Yes It’s going to be very tough to really achieve all the points mentioned above, if our bank balance is not sufficient. So what we understand here is that Less money means less power with you to do the things in your own way!

We basically need money or time to pursue our hobbies and both of these will come only when we focus on creating wealth.

There is a famous saying that “ Making Money is a hobby that will compliment any other hobbies we have, beautifully.”

If we are so much dependent on our monthly pay checks, it’s going to be very suffocating going forward. Enough wealth in a person’s kitty gives him that power to do things he loves.

3 – To enjoy and live a better lifestyle

There are many thing which don’t need money lie A great nap, a conversation with a good friend, a simple meal with your loved ones. However we should remember that this a materialistic world and we need money to do a lot of things in life.

Yes, I am talking about those materialistic things.

·        A beutifull house

·        A luxry Car

·        Dining in a famous restaurant

·        Partying with friends

·        Buying the I Phone

·        Going on an exotic trip

·        Redesigning your house

We need to spend money on various experience and possessions, only if we actually have the money at the first place (not always, but most of the times). We can be able to do it only if we have money saved at the first place.

While some one can argue that we can always take a personal loan and upgrade our car or go on that vacation etc. However we are talking about the way we do not increase our burden and tension but to enjoy without the tension which comes with the loans.

So lets understand first that What kind of life are we looking forward in coming times? Is our wealth enough to lead us there? Are we doing enough for that?

4 – To have financial independency

Financial independence means when we don’t need to work for earning money.

While retirement is linked to age (which is generally around 60) , the financial independence is a function of wealth and not our age. Financial independence can happen even at the age of 35 or some may be not even independent at the age of 60.

Financial Independence is also referred as financial freedom : Where our passive income equals our desired lifestyle expenses”

For a normal investor, financial independence can happen only when we start our wealth creation journey well in the start of working life and are disciplined enough not to disturb it for long time.

Millions of people go to their jobs in the morning with different moods depending on the day. They are happiest on Friday and very sad on Sunday night. We need to seriously start investing for the goal of financial independence if this is the case with us.

We should reduce our dependency on our active income (salary) as we move from age 30s to age 40s . We should have created enough wealth in the first 10-15 yrs of our working life that some part of our expenses can be met by passive income which our wealth can generate if things go wrong.

It does not mean that we should create wealth stop working and start living on the passive income right away, but we need to create that situation for so that It will bring peace of mind.

5 – To have tension free mind

Not have enough money brings a lot of tension. If we need peace of mind, we need enough wealth on our side which can give us comfort. If we do not have enough wealth we will keep worrying about future every now and then and every small financial problem will give a goose bump and force us to think about scary future.

If we don’t have enough money it  is bound to cause a lot of stress.

Various thoughts will cross the mind …

·        What will happen if I lose my job?

·        How will I meet my financial goals?

·        What if I suddenly need a lot of money for medical emergency?

·        What if I am not able to give my kids all the things they want?

It is possible that even a respectable amount of money saved at might not end our worries, but it will surely bring some peace of mind and lower the stress.

As a general rule of thumb, If a person has worked for X yrs in his life, he should at least have X/2 years worth of basic expenses saved at the end. This could be a general formula which one should aim for at the least.

6 – To pass on to our loved ones

We can see that a lot of families struggle for money generation after generations. The grandfather worked for money all their life, then father and then the son is also doing the same.

Many people who struggle financially set a goal in life that their kids should not face the same. They want to leave them a house and some wealth which makes their start a little easier in life. Although they also teach them money lessons and make them responsible.

If we create wealth in your life, we can leave some part of it for your kids so that they can pursue things they truly wanted to do and not work just for money to bring food on the table.

A lot of wonderful people are never able to do things in life which they truly want to do. They are not able to live their own life fully because of the money matters. If they already have some comfort on their kitty they can do much better in their life without fearing for just to meet the needs.

Finally

To conclude, there is a great possibility that one or more things mentioned below will happen to you if you do not get serious about saving money in your life going forward.

·        We will be spending a lot time worrying about future and how will your life end

·        We will depend too much on others (your kids may be) for money

·        We will have hard time maintaining a good standard of living

·      We will be too dependent on our active income and will be forced to keep working even when we don’t like it

·        We will find it tough to lead a better life compared to current lifestyle

·        It will be hard for us to focus on things we love to do, because we don’t have enough money or time

If we have still not crossed the age of 45, We still have a good chance to create a respectable corpus by the time we retire, even though we have lost a lot of time for compounding. This needs a proper planning and assistance through a good advisor.

Life Insurance as Investment is that makes sense??

Insurance is very important for every individual but is it right to mix it with investment products, different peoples will have different opinions lets understand the pros and cons of mixing insurance with investments.

1. TRADITIONAL POLICY GIVES LESS COVER

If we buy traditional investment policies the life cover offered by them is quite low as compared to buying a term insurance plan. Generally traditional plan offers 10 to 12 times life cover. So for example a person aged 30 years group wants one crore life cover, he may need to have policy of about Rs. 10 lakhs annual premium to cover that much insurance. Overall return of these products range between 4-6% P.a. Same person can get one crore insurance cover in Rs.12000-15000 by purchasing a term insurance cover. The remaining amount can be invested more smartly in other investment avenues where he can get 8-12% returns.

2. WE GET OBSSESSED WITH TAX SAVING

Another major reason for buying insurance is saving tax. Historically if we analyse the data, last quarter of the financial year gives as much business to insurance companies as the other three quarters together. In the last minute planning people buy insurance just to save tax; not for insuring themselves and without understanding the implications and future commitments, this results into lots of policy lapses later on.

If a person’s objective is to save tax then insurance may not be the best option for tax saving. There are various other instruments available which offer tax savings as well as better returns. PPF (8% tax free), NSC (8% but interest is taxable) and those with daughters below 10 year can even opt for the Sukanya Samriddhi Yojana (SSY) that offers 8.5% tax free.

NPS and ELSS can also be a good option for investors who are willing to take some risk. These two offers market-linked returns. In NPS the investment gets locked till retirement and only 40% of the corpus is tax free. In ELSS funds the investment is locked for three years and have the potential to give significantly higher returns, though the risk out there is also higher. For ELSS like PPF the amount received is also tax free

If we compare the returns of a traditional endowment plan with PPF and term plan combined or with ELSS funds and term plan combined we see the eye opening difference between their returns. If we assume a return of 8% for the PPF and 12% for the ELSS fund, both combinations would give far better returns and higher insurance cover to the buyer.

3. WHY PEOPLE STILL BUY IT

Although they do not offer very high returns but still people buy it mainly

•      High Commission to agents : As other products like term insurance and ULIPS offer very little commission compared to traditional products, agents always try to push traditional policies. Generally the agents are from some reference and people could not say no to them and buy these policies.
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•      They enforce a saving habit in the policyholder : These policies are generally for very long duration (20-30 years) and the agent keep on reminding (although more for their own commissions) to pay , Further people take it as a responsibility towards their families and afraid of losing money due to lapsation they keep it alive.
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•     Time value of money: Generally people don't realise that the huge maturity amount being projected may mean little after 25-30 years.  The Payouts in these polices are not given as lump sum but are spread across the years, which reduces the net return significantly.

4. SO WHAT SHOULD WE DO??

Well as mentioned above it is better to keep insurance and investments separately. Normally we should have insurance of ten times of our annual income (though it may vary based on future responsibilities and expenses). Term insurance can be a better option which gives a large coverage in small premium. The remaining amount can be invested base on a person’s risk appetite and requirements. For example if he needs to save more for tax saving under section 80C then for risk averse investors PPF, NSC or SSY are right options and for those who are willing to take risks NPS and ELSS are right products.

For general investments other than tax savings, mutual funds could be a good choice where a person can invest in Debt funds, Balanced funds and Equity based funds based on a persons need and risk appetite.

Every person should have insurance however the insurances should be brought for the main purpose of insuring the family towards some unexpected events not for tax savings or investment purposes.

Should we invest in Equity Mutual Funds or directly in equity shares?

There are two common ways, If we want to invest in equities. First option is we can open demat and trading accounts with a stock-broker to buy or sell equity shares in the stock market. Secondly, we can invest in equity mutual fund schemes.

Mutual fund is the instrument through which Mutual Fund companies pools the money of different people and invests them in different securities like stocks, bonds etc. Many retail investors think that, whether we are investing in mutual funds or through stock brokers, at the end of the day, we are investing in stock markets and therefore both types of investments are the same; hence the dilemma, whether to invest in mutual funds or directly in equity shares?

Here, we will try to understand the key differences of investing in mutual funds and investing directly in stocks.

1.   What is the Risk and Return?

As we all understand that Risk and Returns are the two most important aspects of investing. We invest our money to get returns. In certain investment products we can earn returns without taking any risk, e.g. bank fixed deposits, traditional life insurance plans, government bonds, etc. However, risk free return is the lowest expected return. Historically, risk free returns, on a post tax basis, has not been able to keep pace with inflation over a long time horizon. Hence, If we wish to beat inflation and want to earn higher returns, then we have to take some risks. Generally Higher the risk, higher the potential return, but is not always true. Higher risk and higher returns are fundamental attributes of both stocks and mutual funds, but from an investor’s perspective the question is, how much risk is the investor willing to take relative to returns he or she expects from his or her investments? A deeper understanding of risk is required.

There are two kinds of risk in equity investments, Systematic Risk and Unsystematic Risk. Let us understand both types of risks, with the help of an example.

Systematic Risk or Market Risk is a general market risk, like due to macro-economic factors, geo political reasons etc the market moves ups or down. For example when a single pro reforms political party gets majority in elections market takes it positively where as a hung parliament is taken as negative.

Unsystematic Risk is company or sector specific like Rupee exchange rate and US & European Country’s import policy could have direct impact on IT companies in India.

We don’t have any control over systematic risk and hence they are called uncontrollable risks. But we can reduce unsystematic risks to certain extent; It can be managed by understanding the characteristics of different companies, sectors and their business. how? This needs a detailed understanding and analysis of various sectors and companies. For an individual it may not be that easy however through mutual funds.

2.   Concentrated Portfolio or Diversification?

To reduce Unsystematic Risk, we should have a diversified portfolio, you need to invest in a sufficiently large number of stocks say 40 to 50 stocks to create to an adequately diversified portfolio. The share prices of the 50 stocks may range from Rs 50 to even Rs 25000 per share. As we know that we have to buy minimum one share and cannot buy fractional shares. Even if you buy just 1 share each of the 50 companies, assuming the share prices of the 50 stocks are uniformly distributed in the Rs 50 to Rs 25000 per share range, your minimum capital outlay can be more than Rs 100,000. And If we wish to buy more shares, our capital outlay will be higher. To achieve adequate diversification through direct equity shares, we will need a large capital investment.

Mutual funds, pool the money of different people and invest them in different stocks, in the right proportion, to create a diversified portfolio. The Assets under Management (AUM) of a mutual fund scheme is much larger ( few schemes have more than Rs. 10,000 crores in a single scheme) than the investible capital of an individual retail investor. Each investor in a mutual fund owns units of the fund, which represents a fraction of the holdings of the mutual fund. Therefore, by owning mutual fund units, the investors have the beneficial ownership of a diversified investment portfolio even investing, just Rs 5,000 in a diversified equity mutual fund. Hence we can get diversification benefits that would have required a few lakhs, if we had invested directly in equity shares.

Risk diversification should be an important consideration because it reduces the probability of losses. In terms of risk profile, for the same amount of investment, diversified equity mutual funds are less risky compared to investing directly in equity shares.

3.   Guesswork or Market expertise?

Generally the small and individual investors do not have the experience or expertise in understanding business of various sectors and companies which is required for right stock selections. Most of the retail investors in direct equity shares are speculative or based on guesswork or tips from friends, relatives or their brokers. If someone is investing in a stock, just because, the price has been rising for the last 3 weeks or a month or even a few months, it is still purely guesswork; just because a stock has been rising for the last few weeks or months does not mean it will continue to rise.

Mutual Fund managers have a team of analysts and fund managers who do fundamental analysis where they look at a variety of macro and micro economic factors, analysis of the companies balance sheets, income statements, cash-flow statements, management commentaries etc. Based on the forecast of these factors, employing a variety of methodologies, the fund managers and analysts forecast the future price of the asset. It needs certain set of skills and capabilities (which often includes speaking with the managements of the companies), which retail investors do not have.

A Mutual fund manager’s mandate is to outperform the relevant market benchmark returns. A good manager creates value for the investors through, what is known as, “Alpha”. Alpha is the excess return that the fund manager generates, over and above, the returns expected by the investor for taking a certain amount of risk.

4.   Trading or Systematic Investing?

Equity Share prices are very volatile it also affects the emotions of investors and thus can induce them to buy when market is going up and sell when it is falling sharply. This practise, normally, leads to losses for the investor. Historical data analysis suggests that, the effect of volatility reduces considerably, with increase in the investment horizon. Mutual funds, encourage investors to invest over a long time horizon to meet a variety of long term investment objectives like retirement planning, children’s education, wealth creation etc.

Systematic Investment Plans or SIP is a smart way to invest regularly. It helps investors to take advantage of short term volatility and invest in a disciplined manner by taking emotions out of the investment process which helps to meet their long term financial objectives. SIP also provides the advantage of Rupee Cost Averaging by investing regularly irrespective of ups and downs in the markets. This method helps us to buy units of a mutual fund scheme, both in rising and falling markets, which enables to average out the purchase price of units, resulting higher returns on the investments.

Historical data shows that, long term buy and hold is the best strategy to create wealth in the long term. Equity mutual funds provide solutions to investors to meet their long term financial goals through capital appreciation.

For someone who have lump sum funds to invest but is not sure about the market timing due to volatile conditions, he can invest in a low risk fund, such as liquid fund, and then purchase units of equity fund through a systematic transfer plan (STP). This help to average out the cost of purchase like in SIPs, along with that we also earn higher return on investment (liquid fund returns are usually much higher than savings bank interest). Such a facility is not available in direct equity investing.

Similarly, if we need regular Cashflow for regular expenses it can be done through mutual fund portfolio. Through systematic withdrawal plans (SWPs) an investor can draw a fixed or variable amount of funds from his portfolio. This way he can meet your regular income needs while, the balance invested will continue to earn returns. An investor can also opt for dividend options of mutual fund schemes to get tax free dividends.

And Finally

For small and normal investors who do not have expertise in equity markets, mutual funds are much better than direct equity investments. However If some one have the necessary stock selection and portfolio management skills, he can invest directly in shares through a stock broker. Investing in shares gives the freedom of selecting the shares and to decide when to buy or sell, while in mutual funds, investor will have to depend on the judgement of the portfolio manager. However, the knowledge, experience and judgement of a mutual fund who have team of analysts and fund manager, is likely to be much better than that of a typical retail investor. Henceforth mutual funds are more beneficial for normal retail investors, for meeting their long term financial goals.