30 December, 2010

Choose schemes correctly, and with a historical record. The rest is easy...

The term investment is used very loosely. People say they are investing in a house, even if they are going to live in the same house. You cannot really unlock the property’s real value unless it is sold. Similarly, most stock market investors gamble more than invest - buying huge quantities in the morning and selling them before afternoon. None of these are truly investments. There are many good investment options though, mutual funds (MFs) being one. Equity MF schemes have delivered a 20-plus per cent compounded annual growth rate (CAGR) over 10 years.

This may not look impressive but see the difference between Rs 1 lakh invested at eight per cent and 20 per cent. The former would grow to Rs 2.16 lakh or 2.15 times the amount invested. At 20 per cent, it becomes Rs 6.19 lakh in the same 10 years. This, when an investor needs to do nothing at all.


• Lower risks due to diversification
• Different funds to suit investors with varied risk appetite
• Professional advice at low cost
• Liquidity at redemption

The several regulatory changes, however, have led to distributors all but abandoning MFs. This has created a problem for investors as investing in MFs involves numerous rules even for a simple thing like a change of bank account.
Despite the troubles, one should do so since it is one of the best ways to participate in equities.


Mutual funds come with lower risks due to diversification. Equity MF schemes invest in different companies, sectors and even across market capitalisation levels. Even if one or two sectors don’t do well, others will compensate.
Take the case of DSP BR Equity Fund. Reliance Industries makes up 3.75 per cent of its portfolio. The top 10 holdings make up 28 per cent only. Energy is their top sector at 14 per cent The second largest is financial services at 12.5 per cent .It is invested across some 15 such sectors.

By investing in MFs, a normal investor gets access to a fund manager who is a specialist and professional in deciding which stocks to invest in or switch. And this comes at a small cost.It ensures you do not have to worry about the market movements, follow economic trends and data and other news that can affect the market.
Good fund managers generate that alpha, which makes his role (and the charges) worthwhile. Fund managers differ in style of functioning. Some churn the portfolios aggresively, while others may swear by a buy and hold strategy.

Liquidity is another plus point for MFs. There are many who have invested in one of the hugely hyped initial public offerings (IPOs) or much-talked about shares that are no longer trading now. When there are just no takers for these equity shares at any price, the investor faces a huge loss. That is where MFs score. If you want to sell, the fund will redeem the units for you. Illiquid shares or market conditions are their problem, not yours.

MFs schemes allow one to invest in amounts as low as Rs 5,000. Regular monthly investments can become a way of life if one adopts the systematic investment plans (SIP) that lets you invest as little as Rs 100 per month. Since they are invested every month on a given day, the market timing risk is taken out of investing – we tend to invest when the market is going up and tend to hold the purse when the market is down. With SIPs, since the same amount of money is getting invested every month, irrespective of market conditions, one averages out the buying price, over time. This is called the rupee cost averaging concept.

The array of products are suited for all kinds of investors. There are all kinds of funds, large-cap, small-cap, thematic, hybrid, sectoral and debt. In the latter, there are ultra short-term funds, money manager funds, bond funds monthly income plans(MIPS), income funds and others.


But investors need to be cautious about the kind of funds that they invest in since their returns depend on the scope of investments for a fund. For instance, investment by power sector specific funds may be restricted to the power sector which may or may not be doing too well at a particular time. One could invest in sector funds only if there is high conviction about it. For instance, energy sector companies like those in crude oil production and marketing have not done well. For instance, Sundaram Energy Opportunities Fund was a sector fund and has done badly, compared to broader market performance.

The icing on the cake is the tax benefit one can get. For equity MFs, the tax on short-term capital gains is 15 per cent. Short-term is defined as less than 12 months. Anything sold beyond 12 months is classified as long-term. No tax applies on long-term capital gains of equity funds. For debt funds, short term capital gains will be at one’s slab rate. Beyond a year, it is 10 per cent without indexation and 20 per cent with indexation. That makes the actual tax paid much less than comparable debt instruments.

Retail investors have yet to understand the benefits of investing through MFs. But given its unassailable relevance to investors, it is only a matter of time before they do.

Published in Business Standard on 26/12/2010

Got a medical cover? See if it is adequate

Life for Gopal was sipping tea in the mornings with his newspapers. His balcony, overlooking the park, was an ideal retreat to soothe frayed nerves, although Gopal seldom had those.

His office was nearby and being in a small town, he could reach either way in 20 minutes. A picture of contentment, if there was one.

But these days, Gopal has turned jumpy. He is irritable very often and gets into arguments with his colleagues. His bosses have noticed his change of demeanour and have mildly brought it to his notice too. But, Gopal can’t help it.
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It all started when his wife had a heart attack. Gopal refused to believe the news when his neighbour called around 3 pm that afternoon to say his wife has been admitted in the hospital and the doctors suspected a heart attack. Mohini and heart attack? After all, she was always so strict about her diet and had a lean frame, and there was no prior indication whatsoever of any malady.

But, it was. Gopal almost had an attack himself when the doctor said she might have had more than one attack in the past couple of days. It was diagnosed later through angiography that there was one severely blocked artery and one that was partially blocked. Angioplasty had to be done. Gopal consented, somewhat relieved that it would be a non-invasive procedure.

But a bolt from the blue came with the bill the hospital presented —- a whopping Rs4.15 lakh. And they hadn’t even conducted an operation (he learnt later that the cost was so high precisely because it was non-invasive)! The medicated stent cost Rs1 lakh; the doctors’ fees were Rs1 lakh more; there were so many other charges that brought in the rest.

Gopal’s medical insurance would pay him only Rs2 lakh. So he would have to bear the rest.

He rued ignoring his agent’s advice that the cover was very low and he should increase it. Given the cost of medical treatment these days, it helps to have a bigger medical cover —- typically, Rs5 lakh for adults and Rs3 lakh for children — Dinesh had said.

With all his family members in good health, why waste it on insurance, Gopal had asked himself then. Only if he had factored in an emergency of this order!

In fact, Dinesh had also suggested a critical illness cover, which he turned down. That would not have covered Mohini’s condition. But, it would have certainly come in handy if an open-heart surgery had become necessary.

Much as Gopal wishes Mohini would not require any further medical attention in future, he can’t help cursing himself for being under-insured. Not only did he have to shell out Rs2.15 lakh from his pocket, but has also got to continue spending on the medicines which she must continue to take.

Many came forward to help, though he quickly paid them back by taking a personal loan at an interest of 15% per annum. Now, the loan has become a burden. He has to pay Rs5,115 every month for 60 months.

Worse, Dinesh has told him it would not be possible to enhance the insurance cover immediately, though the existing cover has been renewed.

No wonder, Gopal has become irritable. The morning tea doesn’t taste as good any longer. The newspapers have failed to grip him. The park in the foreground, which he used to gaze at endlessly, has no appeal left.

In the mornings, he just paces up and down the hall, thinking how to make up the extra expenses of about Rs7,000 a month (towards EMI and medicines). He has started giving lectures after work, which saps him of whatever energy he has left. He hates the evenings.

And the last few days, he has started hating the hospital ceiling, for that is all he is able to see. He had passed out in the office and they admitted him here. The doctor fortunately diagnosed it as just stress and high blood pressure. He would be discharged this afternoon.

Published in DNA Money on 30/12/2010

Consider the total charges in ULIPs

It is an unnerving experience, getting admitted in the hospital. One is ofcourse, the fear of what tortures they will put you through… the other scare is entirely financial. When you get admitted in a hospital, you would not really be clear as to what all they will charge you for. You will not even know how much the bill will come to. In short, it is a huge amount of uncertainty & the consequent anxiety.

People investing in ULIPs are also finding themselves being subjected to anxieties, when they start getting to know the various charges. There are many charges in a ULIP, which an investor is supposed to know, before investing. But, many are not really aware. The most common charge that investors worry about is Premium Allocation Charge. But there are products which do not have any premium allocation charge, at all. It is not as if the milk of human kindness is being manifested through such a policy. There are other charges, which can compensate – like Policy Administration Charges. As the name suggests, it should be only to defray the expenses incurred to service a policy and should consequently not have anything to do with the amount of premium paid.

For instance, what will be the difference in servicing a policy where the annual premium is Rs.15,000/-, vis-à-vis another, where premium paid is Rs.30,000/-. Hence, as a rule, Policy admin charge is a fixed sum like Rs.40 Per month. What exactly they are doing on a monthly basis to warrant the charge, is ofcourse a mystery. But, the plot really thickens when the Policy Administration Charges are linked to the premium paid. Some policies link to the first annual premium, if the policy allows the premium to vary from year to year.

Now, there are two problems. Let us understand with an example. If the annual premium is Rs.15,000/- and if the Policy Administration Charge is 0.5% pm, the annual charges come to 6% pa. In this case, it will come to Rs.900/-pa. Now if the premium were Rs.30,000/-pa, then this charge would be Rs.1,800 pa. If the premium is much higher, like say Rs.3 Lakhs, the charges would be Rs.18,000/-pa. Now, you see the problem? Does the company really spend more for servicing a policy paying higher premium as opposed to another paying a much lower premium – enough to warrant Rs.900 pa charges in one policy and Rs.18,000 pa, in another? The problem is that most ULIP investors look only at the final figure that they may get after the tenure, as explained by the agent. The agent does tell in most cases that there are charges. The charges are spelt out in the brochures too. The client needs to ask the questions to understand what he would be paying in all, instead of being satisfied by “there are no Premium allocation charges” bit.

There is another problem with Policy Administration that is not apparent at first. This charge will continue even if you have stopped paying the premiums. In the example shared, if an investor has stopped paying the premium after three years, Policy Administration Charges would continue uninterrupted, maybe for the lifetime of the policy or for whatever time, the policy conditions envisage. This is particularly troubling… for this charge alone can become the hole in the vessel that holds their corpus.

Nor, are these the only charges. There can be a guarantee charge for highest NAV plans from 0.1% pa to 0.5% pa. Another charge is a Fund Management Charge. Depending on which fund one is putting the money into, there are charges. The charges would be about 1.3%pa today for Equity funds. In the past, it used to be upto 2.25%pa.

The other charge is the Mortality Charge. This is the risk premium that they are levying you to assume the risk. It is important to note what you are being charged here. Most ULIPs charge very competitive rates on this front. Though, you need to look into this too, as Mortality charges do not come under any overall cap. Creativity on the charges cannot be ruled out and it is a good idea to check the mortality rates and assure oneself that it is in line with their normal charges. Else, one would have a very costly insurance product, which may not even be a good investment product.

The other charge is the surrender charge. Surrender charge will be charged on the Fund value. The charges have come down dramatically from September 2010. It used to be extremely high in the first three to five years. In some cases, one could not even surrender in the first three years.

Insurance is a long-term product. Whether an ULIP or an Endowment product, it should be bought after careful thought. ULIPs are transparent and the charges revealed upfront, . Other products are opaque, which make them worse. Insurance should be bought for risk coverage. If ULIPs are looked at as investment vehicles, one should be willing to stay invested for 12-15 years or more. Only then it will make sense.

In summary, the following are what an investor needs to look at while going for a ULIP plan–

• What are all the charges that will be levied and for what period of time? Are these justified?
• What are other competitive products charging?
• On what will be the charges levied ( Surrender charge is on the fund value, Mortality charge is on Sum Assured and Premium Allocation Charge is on modal premium )?
• What is the tenure for which you would want to invest there?
• Performance of the funds under that company
• Would you be better served by some other option?

In the case of a hospital, you may go there based on references of the doctor or a friend. In case of ULIPs, your friends may not be able to guide you properly as they themselves may not be aware about the various charges. Do some homework yourself; or consult a proper advisor to assist you in this process. Else, it will be a costly decision, which you can repent at leisure!

Published in Business Standard on 19/12/2010

Successful Fee based practice is a reality

We see planes everyday. It is taken for granted. But for Wright brothers, it must have been a daunting task, then. Even they would not have imagined that their humble first flight in 1903, would kickstart an entire industry… that air travel would become commonplace… that a plane would one day be able to carry hundreds of people, across thousands of kilometers.

Pioneering is always difficult. Pioneers in any field are intrepid souls. They have to be more than entrepreneurs. They should have missionary zeal and almost a maniacal glint in their eyes. Such pioneers are successes. Like Edison, who famously said that he had found ten thousand ways in which a bulb will not work, a pioneer needs to persevere and make things work. Everything is possible.

It is always a question of our perception. Two sales people sent to a remote area in Africa had made the same observation – people there did not wear footwear. One sent a message to his company that no one wears footwear and it is a hopeless situation. The other person sent a message asking his company to dispatch a shipload of footwear as the market was virgin and wide open.

Pioneers get rewarded too, for their efforts. Gujarat has hard water and Nirma saw an opportunity in that. From pretty humble beginnings, Karsanbhai Patel rose up to form a mega empire. Mohammad Yunus ( Grameen Bank ) and Vikram Akula ( SKS Microfinance ) did the unthinkable. They lent to people who were considered unbankable – people who had no credit history, no collateral and from the lowest echelons of the society. The sums advanced were also pretty small - Rs.500 to Rs.5000. Yet the model was a success and benefitted millions who were outside the penumbra of organized finance. They did what the government should have done, but did not. SKS Microfinance did it at a profit. For both these institutions, the NPAs was less than 1%!

Opportunity inherent in any situation is not recognized most of the times, when it presents itself. Problems are seen in their place. But opportunities abound everywhere, if only one is willing to court them. What is required is the courage of conviction to make them work. The problem in most cases is unwillingness to change and lack of new ideas to solve a problem. We have heard of the epithet – Problems are opportunities in work clothes.

Currently, there is despondency among some CFP Certificants that the practice is not taking off. Some of them have suggested advertising on a big scale about CFP Certification and their benefits to make people aware of the certification and their benefits. There were many other ideas about what the board can do. Some of the ideas were indeed good and actionable. But the basic point is that one is talking of what someone else has to do rather than what they themselves can do and be a success.
Setting up a practice requires a certain mindset. There will be problems if our certificants ( most of them from insurance or other product sales background ) are not willing to abandon the typical sales approach, when they are approaching clients for practice. Clients look at CFP Certificants as their financial consultants & advisors. In consultancy, the overt sales technique seldom works. Clients are looking for competency, knowledge & skills, professionalism and trust worthiness in their Financial Planner. It really boils down to how a Planner is able to demonstrate this to clients. Being a CFP Certificant would help. Qualifications are good, to the extent that it endows the Certificant a certain level of knowledge & skills. But ultimately, the client is looking at the advisor who will be their confidant, their touchstone and guide.

So, the problem is really being a competent Financial Planner and in being able to demonstrate that to clients. All other attributes need to be developed to metamorphose into a consultant. That is what will help build a practice. Fee for services is incidental and will not pose a problem with a client, who is convinced.
What is the advice I would offer a CFP certificant, who wants to get into practice?
Firstly, they should be able to clearly differentiate the services offered by a sales person from what a planner like them, offers. It is a matter of communicating the value proposition clearly. The planner needs to lay before the client what exactly they would do for the client, the kind of information required, the actual intellectual inputs involved, the deliverables, the time they will spend on creating the plan, the process involved, who would be their contact point etc. The charges for the services also need to be clearly and unambiguously explained, right upfront, so that the client understands what he is getting into and there is complete transparency. Once these have been done, the client should be allowed to make up his/her mind. There is no need to hustle. Clients truly appreciate if we do not keep calling and pestering them. In fact, a planner would be shooting himself in the leg, if he were to do that. Consultancies do not work like that. Subtle reminders may be a good idea – like useful information relevant to them can be sent across or some relevant investment ideas could be forwarded. But don’t flood their inbox with spam! That’s an absolute put-off.

One of the most important attributes that needs to be internalized, is the ability to emphathise with the client and start thinking from their point of view. A good consultant will only think of what is best for the client and advice accordingly. It may seem on the surface to be a self-defeating proposition. Even the client may not be aware that you have done the best by them. But, it gives you the moral high-ground and confidence to talk to clients. Clients are adept at spotting a genuine one from another who is fibbing. Clients also understand that their advisor needs to be compensated. Today, many people who are contemplating engaging a planner are earning well and don’t mind paying for professional services.

Most people are running after new clients. Existing clients may feel neglected. It is a cliché to say that the cost of acquiring new clients is four times more than keeping existing clients. Yet, we all fall prey to the temptation to run after new ones, all the time. What keeps the clients with you is excellent, timely services. What you have promised, you need to deliver. If you are able to do this consistently, you are in business. Clients who have experienced great quality services, seldom abandon you. They are the insurance for any bad times, one may occasionally come upon.

Another persistent complaint is that clients don’t pay. I am yet to find a client who refuses to pay. Some may bargain. It is up to you to succumb to it, accept a lower fee or reject it. No one has flatly refused that they will not pay. If a prospect is refusing to pay then a) you may not have been able to communicate your value proposition properly ( assuming your value proposition is good, in the first place ) b) they just don’t believe that such services should be charged. If it is the former, we need to work on our communication – for the onus of communication is on the communicator. If it is the latter, it is a perception problem and a wrong type of client to have and hence should not be acquired in the first place.
How much to charge is a matter that is best left to a planner. The charges should be reasonable and commensurate with the services rendered. There is always the temptation to charge based on the capacity to pay. That will backfire, sooner than later. Integrity is one of the bedrock principles that a Financial Planner has to internalize. Working like opportunistic carpet baggers, will probably work for sometime – not for ever. Sooner or later, these things get around. Charging the same fee for same work rendered is ethical and the correct thing to do. The last thing you would want is a sullied reputation.

Scouting for clients is another area where planners face problems. In a virgin territory, it is the duty of every financial planner to articlulate what we stand for and shape opinions in favour of Financial Planning. Fortunately, this is the need of the hour. We need to meet people at every possible forum and communicate this. Regulatory activism has left advisors with no option but to embrace a consultancy practice. Change can be traumatic, like it was for the mouse who kept wondering who moved my cheese, in the book by that name. But change is constant. We can make it work for us by embracing change and be the first movers or be left out by others who were willing to do it. There is proof of concept now. There are many Financial Planners across the country, who run successful practices. And unlike the perception that it only works in Mumbai and Delhi, there are planners in Nagpur and Jaipur who are able to charge clients. There are planners in Mumbai and Delhi too, who complain that people are not willing to pay.

It is upto us to make it work. We are still at the pioneering stage. We need to go forward and acquire clients like the explorers of the past laid claim to new virgin land. Like Wright brothers, we may all be instrumental in starting off a gargantuan industry, that will look at this point as the inflexion point, when it all started. Let us lay the foundations for a successful fee based practice. It’s possible.

Published in Financial Planning Journal in the December 2010 edition

Setting up a FP Practice

Notes from a practitioner

I remember from longtime back, what my baby sister used to do. When she was but an infant, on the threshold of learning to standup and walk, she started walking early – but only on the bed! If she was put on the floor, she would promptly sit down. No amount of coaxing did the trick. It took another 6 months after she knew to walk, to actually walk!

A child does not know fear. My sister was somehow, different. At a tender age, she was able to assess that walking on the floor was not safe. May be she fell down a couple of times, trying to walk. That might have worked as a dampner in her case.
The fear of failure is a major deterrent to progress. A tortoise cannot move forward, till it sticks it’s neck out. Yet, it would feel secure inside it’s shell. The Financial Services industry is at crossroads now; there are a plethora of regulations, many of which have changed the way business is done in the industry. Change is always traumatic- at least initially. It is for us to figure out how to make the change work for us.

Financial Planning profession is still new. People still don’t know an insurance agent from a Financial Planner. Most still think that they are both the same – only that one actually talks about goals & cashflows and other talks about goals and products to fulfil them. This is the environment into which the newly minted CFPCM Certificants are stepping into. Naturally, there are butterflies in the stomach and a feeling of nausea. But, like my sister, they also have to learn to walk – on the floor!

So, what are those things that a new practitioner needs to know and understand? How can he/she start a successful practice? How does one talk to clients and ensure that they perceive the Financial Planner is a different animal?

Soaking time…
Spend a month in acquiring knowledge. This may sound out of place – now that you have the certification. But, my friend, studying to pass an exam and studying to gain knowledge are two different things. Go to the net and get updated on all the topics you had crammed for your exams. Get relevant updates on all topics that you will need to know in real life. Read up what is happening on financial Planning across the Globe, the various models, experiences of Financial Planners across the globe… This will give you some confidence to sally forth.

Dirty your hands… There is a saying which goes like - a gourd on paper cannot make your curry! Likewise, bookish knowledge on making a plan, cannot help you face a client. Clients would be comfortable with experienced planners. But, if all of them think like that, how will you get to do a plan? You need to learn from insurance agents. When they start-off they become a menace to their friends and relatives, who will receive a barrage of calls requesting/ coaxing/ cajoling, for insurance. Even this phase may not be all that easy. But these are a familiar set of faces who are sympathetic and help the agent to break the ice. Your friends/ relations may be your best bet to try your hand on planning. Once, you have created a few plans and have gained experience, you are ready for the world!

Accept your limitations –
There will be situations when a client may want to know about a subject you are not familiar with. You may not know everything, to start with. The best way out is - honesty. Tell the client that you do not know about the subject and will need to find out. Give the client a time & date by when you will clarify this and get back. Even experienced planners are at sea sometimes and will have to refer or consult with other professionals, before getting back to their clients. The only key thing is being upfront & honest about it and then come back later with the required answers. Ofcourse , if you say that in every case, you can only see the client’s door, not the client!

The bag of Gold –
Most people who come into this profession feel that they need to charge a hefty sum, to be counted as successful Financial Planners! Many have a ballpark figure of about Rs.20,000/- in mind! It is unreasonable to expect such astronomical sums at the start of one’s career. One has to be reasonable. It is more than a favour that a client is allowing you the privilege of making their plan. Be patient. Don’t worry about the charges. Focus on the plan. Money will flow eventually, if you have learnt the trade well.

How do I charge – Lots of aspiring financial planners are from Insurance/ MF industry. They come with their mental baggage. They can’t imagine someone paying for advice. In fact, they have been giving free advice and also a kickback, in many cases ( though, very few will admit to it ). So, firstly, it is a mindset change. Then, one has to apply the test of fairness – what is an amount I would pay for the kind of services that I can deliver today? That should be your charge. Which model you follow – Fee only or Fee & Commission, depends on your inclination.

Communication – Most times, we will be meeting new, unknown people. As planners, we will have to learn to inspire trust by our conduct & communication. Clients like people who a frank, honest and straight forward. Name dropping or bragging will turn off clients. The only way by which a client can be attracted is by communicating the value proposition effectively in a manner that inspires confidence to trust you to the extent of giving all financial data.

I have problems getting data – Obviously, the communication part has not been done well enough. Else, the client should not have a problem if he/she has understood that it is beneficial for them to share their details. The trust aspect is very important and the client has to be reassured that the data being shared is only for the purpose of creating the plan and that there is no other motive. Once the client understands that it is in his/her best interests, getting the data is a cinch.

How do I survive till my practice takes off? It would be a good idea to keep the cash registers ringing from you existing line of activity – be it insurance, MF distribution or anything else. Slowly, once the momentum builds, you could let go of the erstwhile activity and embrace Financial Planning, fulltime. There are those who would want to take a clean break and launch themselves into FP practice. That’s fine too – only that, they should be prepared for a bit of disruption in their cashflows.

Find a mentor – It would be a good idea to have someone experienced who can guide you & mentor you in the profession. Please understand that mentoring is not spoon feeding. The mentor will be the touchstone and guide who will be able to advice you on the way to go about your business. The mentor will be able to counsel you, give direction, suggest correction in your plans etc. They will not be able to come with you to meet clients or help you in making the plan. Make your expectations known and agree on what kind of assistance, you may seek. This will give confidence to the mentor about your seriousness, extent of intervention & commitment required from their side. You should be willing to put in efforts and act on advice given by the mentor. With a mentor, it will be far easier to succeed in the business.

The time is ripe now. There are few planners in practice now. The environment is conducive for Financial Planners to launch themselves– with the Financial Services space being as complex as it is and lots of people looking around for proper advice and hand-holding. Even the regulatory environment is goading the players to go the advisory way. What is required now is faith – Faith in oneself & faith that clients will come to you, if you have a good value proposition. What is also required is lots of patience. Rome was not built in a day , they say. Neither will your FP practice. There are rich pickings for those who are willing to take this career seriously. It is no longer in doubt if a Financial Planning Advisory is a serious career option…there are many of us for whom this is already our profession. Put your doubts behind you. Stop walking on the bed; step on the floor. That’s where you will have to walk. The time is now.

Published in Financial Planning Journal in Aug 2010

Financial Planning

We have all heard about the story of blind men describing an elephant… one describes it to resemble a pillar, another feels that it is more like a broom and yet another avers that it resembles a pipe. That would seem to be the situation on Financial Planning.

Confusion is being created and perpetrated by various product sellers about the true nature of Financial Planning. Every bank, Mutual Fund and Life Insurance Company is claiming to do Financial Planning. Insurance companies have retirement plans & children plans to take care of corpus building for retirement as well as for child’s education. A Mutual fund may similarly be promoting the concept of saving for a car, vacation, home – meeting a need through one of their plans. What actually they are doing is matching needs with products – there is a term for that – Need Satisfaction selling. This is an established method in sales and a useful one at that. But, this is not Financial Planning.

The primary area of difference is that Financial Planning is not just going to address different needs in exclusion. Rather, it is Complete 360 degree approach on everything to holistic and seeks to verify if the stated goals can be achieved within the time frames sought, given the individual’s financial situation. Financial Planning is a holistic process which facilitates goal achievement, through appropriate Financial Management. Financial Planning gives you a blueprint/ framework to achieving goals along with signposts and pathways to make the process reliable, foolproof & dependable.

Now it should be clear that, just matching the cash needed for child’s education itself is not sufficient. Or, for that matter, just matching all the goals with some plan/ scheme is not enough. That is a band-aid treatment – not a real solution. We need to see the whole - not just address the parts with patchwork solutions.

Financial Planning is like a wellness program – the ultimate aim is a healthy body. For that it is not just foods & vitamins which are essential… it is also exercises, proper sleep, rest & relaxation… Addressing the needs of the body with good food alone, may not be sufficient for ensuring wellness.

Many of the aspects and situations in one’s life and their financial impact Is something that a Financial Plan should incorporate. A financial plan has to be detailed and comprehensive.

In real life, we would need to consider the expenses, their ebb and flow over time, due to inflation and due to changing requirements in future; there could be changes in the income pattern. Inflation can play havoc, in many cases. We see that spouses sometimes stop working or even the salary income may stop as they are considering a venture on their own… there could also be unforeseen expenses due to contingencies. Value of investments could rise or fall, new goals can creep in, existing goals may get modified ( a 2BHK apartment may no longer be as attractive as it was 5 years ago and a 3 BHK may now be the cherished goal ). More often than not, changes will be there.

Interplay of these needs are to be understood properly to find out what the impact would be, financially. A robust plan will be able to show you the impact of one aspect on various other areas. For instance, changes in inflation can put paid to a cherished want – like a holiday... as other high priority needs have to be met first. A plan should have enough slack to adjust to changes and shifts, as is wont to happen in life. Such ability to handle all areas of one’s life and the ability to move forward after adjustments, should be embedded in the very heart of a good Financial Plan.

Published in DNA Money on 17/12/2010

What do you do to ensure peaceful retirement ?

Retirement is the time for enjoyment claimed one of the ads for Pension products. Yes it should be. But, whether it is actually that or it’s time to cut corners and count the coins, depends squarely on the actions prior to retirement of the individual concerned.

Most people are not that concerned about retirement… but they should be. Retirement period these days are two to three decades. The corpus accumulated needs to be able to sustain for such a long period. There are a whole lot of goals which take precedence as a rule – like a home, children’s education, vacation etc. These goals are important – but not nearly as important as planning for one’s retirement.

General perceptions about retirement :

• It’s so long into the future that we will look at it when the time comes. I want to enjoy life now.
• Retirement planning is taken care of by buying a few pension policies.
• I have pension and retirement benefits and that should take care of my retirement.
• I’m investing what I can. Is there anything more I could do?
• I have children on whom I’m investing. I’m sure they will take care of me after I retire.

While some of the above sentiments are even legitimate, it is not a good idea to give them as excuses for not planning for retirement. Like Warren Buffett famously said in another context, it will show who has been swimming naked, when the tide turns.

Starting off early - This is so often mentioned that it may be as interesting as watching a snail on trail – but bears repetition. A small amount saved every month for a longtime will create a sizable corpus, overtime. Rs.2,000/- pm invested in MF Schemes ( yielding 12% pa ) over the working years ( assumed as 30 ), will yield a princely sum of over Rs.70 Lakhs! That’s power of compounding at work – which Einstein called the eighth wonder of the world.

Investing sensibly - Invest in a good diversified basket of investments. There is a perception that retirement corpus needs to be invested in safe instruments only. That is wrong. For the retirement kitty to support decades of post-retirement period, it is necessary to have a portion invested in growth instruments ( like Equity / Equity oriented MF schemes ). Even in the run-up to retirement while one is building the required corpus, one needs to invest in growth assets to ensure that the corpus grows to the required level.

Look at taxation aspects while investing for retirement - Pension fund investments provide annuity after vesting. But, that is added along with the income and is taxable. Also, at vesting one can take out only upto 33% of the accumulated corpus, without tax. The rest if taken out is taxable. This is a major problem. Most people invest in Unit linked pension funds which are very similar to a typical ULIP. ULIPs & even Equity MF investments ( after 12 months ) are not taxable, but pension plans are. It is a sensible thing to invest for future in Mutual Funds or ULIPs ( the low cost ones ). The effect of tax works against pension plans currently.

Estimating the requirements in future - You would need to estimate the expenses at retirement. Let me suggest an easy way. Take your basic living expenses for a year and reduce it by 25%. Now, assuming 7% inflation over the years, multiply the figure arrived earlier by (1.07^(number of years left for retirement ). Now, that is probably what you may spend at the time of retirement. Multiply this by about 20. This will approximatel y give you a corpus required, inflation adjusted for future.

Let us do it with some numbers. Current expenses of Ravi’s family is Rs.2,40,000/-pa. Expenses at retirement is Rs.1,80,000 x ( 1.07^30), assuming 30 years of working life for Ravi. Rs.13.7 Lakhs pa would be the expenses when he retires. Multiply this by 20, which gives the corpus required as Rs.2.63 Crores. Incidentally, if someone has been investing Rs.7,500 pm ( instead of Rs.2000/-pm assumed above), the required corpus could be reached . Now, that does not sound like a big deal, does it.

I can always catch up later – That’s what the hare from Aesop’s fable thought. The tortoise was lumbering , slow and was a destined to lose. But, it won. Retirement planning is uninteresting, I concede. But, if you require your shot of adrenaline, it can be had through adventure sports – not necessarily through last minute legerdemain for accumulating the retirement stash.
Start early. Invest sensibly. Look at the tax aspects. That should see you through your Golden years in comfort – like they depict in those pension ads.

Published in Moneycontrol.com on 30/12/2010

06 December, 2010

Learning to live with inflation

The value of money will continue to be hit by inflation. The only way to counter it is by having investments that give better returns.

Life is like a treadmill, people complain. Once you get on it, you cannot easily jump off. Plus, the speed keeps increasing and you need to walk faster to just stay on it. It’s tiring.

Many feel the same with finances. The expenses are mounting and those items that have been there are becoming more expensive. The salaries seem to have increased; but that has not brought much cheer. That’s because inflation has bitten off more than the increase afforded by the income increase. Inflation is a big bugbear today. It is ironical when government publishes figures showing comparatively low numbers. But inflation is over the last period; if tomatoes have gone up to Rs 30 and has stayed the same over the period, it means zero per cent inflation. But, your cost has gone up for good. That is what has happened today on the entire range of food items.

Inflation affects everyone. The effect can be different on different classes of people. Food inflation has the highest impact on the lower sections of society. For instance, if a family earning Rs 10,000 per month is spending Rs 5,000 every month on food and the price of food articles goes up by 10 per cent, then their food expenses now occupy 55 per cent of their earnings. As opposed to that, another earning Rs 50,000 pm and spending Rs 15,000 every month (three times more than the other family) finds that with the 10 per cent increase, the food expenses will just increase from 30 to 33 per cent. Here, we find that though the higher income family spends more on food, as a percentage of income it is low and the impact of the price increase as a percentage of income is again low.

This impact is compounded by another fact. The low income earner may not be in a position to take advantage of bulk purchases in view of the lower availability of surpluses to fund such purchases. A high income earner can do so and lower his cost of commodities.

Varying impact
Inflation is not the same across the board. On some items, it is low or negligible. On telecom expenses, for instance, inflation tends to be low. On white goods and electronic items, there is negative inflation. Some 15 years earlier, a top-end, 21-inch TV set used to nudge Rs 20,000. Now, a good one can be had for around Rs 10,000. It feels great to know that some items like this have actually come down. But you don’t buy a TV or washing machine everyday.

Whereas, on medical, education and fuel charges it tends to be high, in the region of eight to 10 per cent yearly. One may be unaware of it till one receives a jolt. People do not realise the extent of inflation on medical expenses. Many do not see the need to have a health insurance policy. Medical expenses can clean-out one’s savings and are probably the biggest threat one faces in life. Similarly, education inflation is humongous. The fees have reached stratospheric levels for professional courses. It certainly appears on its way to the upper reaches in the years to come. Parents with children do not always realise the full magnitude of the cost increase in education. They also hope their child gets into a government-funded institution ( which today are inexpensive ) and make inadequate provisions. When they come to the point of higher education, they are forced to make a much higher allocation, many times what they’d envisaged, which compromises their interests in other areas.

Not realising the threat of inflation and not being prepared for it is a bigger threat than inflation itself. That is why in financial planning it is treated with a lot of respect! When we project expenses over time, inflation over the years will be the one that will determine whether goals are going to be met or not. Especially essential for retirement planning.

Wrong notions
When income stops and there are only expenses, inflation can be cruel. It is doubly cruel today, as the returns have come down. Since most investors do not take into account the inflation factor at all, they continue investing in debt instruments, that give moderate returns, not realising there is an actual erosion in the real value of their money.

It is an accepted fact that when a person retires, they should invest in debt instruments only. That is incorrect. These days, the retirement years can stretch up to three decades and their money-pile needs to last that long. Unless a person is supremely endowed and well-funded, investing only in debt funds is the sure route to end-up pan handling in the later years. It is always suggested that some portion of the investments be allocated to equity-oriented investments. These offer better returns and tax-free (after holding for 12 months).

So, inflation is bad, right? Not always. If inflation were not there, people would postpone purchases, as in future it may get cheaper. That cycle would cripple the economy and fold-up businesses. It will drive up unemployment, reduce purchasing power, which will drive prices even lower. That is a recipe for disaster. Ask the Japanese. They have seen that for the last couple of decades. It is better to be on the treadmill and complain of exhaustion than experience your world crumble before your eyes.

Published in Business Standard on 5/12/2010

Why investing in Balanced funds makes sense...

Librans are supposed to oscillate between one side and the other of any situation till they finally settle into an equilibrium, after taking both sides and clarifying for themselves. The balance symbol probably portrays the Libran psyche accurately. Not only librans, almost all of us want to achieve that fine balance in everything we do in life.

One of the most neglected areas for most people is their own finances. And again, most people do not diversify their investments. One would find concentrated investments in properties in some cases or equities in others. It is difficult for most people to dispassionately act on their investments. This is where balanced funds can help.

Balanced funds, as the name suggests, are hybrid funds which typically invest in equities and debt instruments. There are equity-oriented as well as debt-oriented hybrid plans.

The advantage of a balanced fund primarily is that it achieves a certain amount of diversification, in the investment made, automatically. The asset allocation is taken care of by the fund manager, as they typically rebalance the portfolio on a need basis. So, if a balanced fund typically has a 70:30 asset allocation towards equity and debt, the fund manager will typically maintain this, barring unusual circumstances. Unusual circumstances can be situations where there is too much market turbulence or the markets are headed one way and there is a chance of overheating.

The benefit of having a balanced fund became apparent when the markets plummeted in 2008 — balanced funds, due to their exposure to debt investments, suffered lesser losses compared to equity funds.

So, the most important benefit of investing in a balanced fund is to ensure a desirable asset allocation, which is insulated from the sudden euphoria or the depths of panic, which normal investors are typically prone to.

The other advantage is in terms of the risk-adjusted returns that a balance fund offers. There have been instances of equity-oriented balanced funds outperforming, even equity funds, which is very significant, considering that an equity-oriented balanced fund will maintain 30-35% allocation to debt investments. There can be some explanation for that. One of the reasons could be that the fund manager is aggressive on the equity portion and has a significant mid-cap and small-cap exposure. Also, it could be a measure of the stock picking and portfolio management capabilities of the fund manager.

HDFC Prudence Fund (a equity-oriented balanced fund) was able to outperform probably due to its midcap exposure, high conviction picks and buy and hold strategy. This fund has beaten the average performance of large cap (19%) & midcap-oriented schemes (10.25%), over a five-year period convincingly with a 23.25% CAGR. This is not the only balanced fund which has given a CAGR of over 20%.

Canara Robeco Balanced Fund, DSP BR Balanced fund, Birla Sunlife 95 and some others, have also given over 20% CAGR, over a five-year tenure. Some of the things that one should look at while investing in balanced funds are as follows: How has the long-term performance been; what’s the experience of the fund manager in the long term and keeping track of the risks taken by the fund manager – in terms of the aggression in the equity and debt components.

But, is there any downside to balanced fund investing? Yes, there is. Since there is both the equity and debt component in the portfolio, and their performance is not disclosed separately, one is not sure about the performance of the equity and debt portions. It can be that the equity portion is doing well but the debt portion may give a middling performance. One can never be sure of this. But still, this is a minor factor. There is enough persuasive evidence to finally settle for some well-chosen balanced funds. Even Librans would agree by now!

Published in The Economic Times on 30/11/2010

Don't ignore Expenses...

Unless watched, rising expenses could undermine your wealth creation

Income should not be confused with wealth. Whatever an individual’s income, if his expenses take up all or a larger portion of his income, there will be no surpluses left and as a result, no wealth creation. It is only when our surpluses are invested that wealth is generated.

Expenses are, hence, also critical. Two people, despite earning the same income can end up looking very different in a few years - the difference would be as a result of their expenses and their investment. Hence, having a laser-like focus on just the amount of income is misplaced.

Financial planners use various ratios to ascertain the health of their client's wealth. They consider the savings to income ratio, liquidity ratio and the debt to asset ratio of a person. However, intriguingly, even financial planners will leave expenses out of the calculus.

Savings to expenses ratio
This is a very important indicator of financial health. Let us say, Ram earns Rs 50,000 per month.He spends Rs 30,000 out of his earnings each month and saves the rest. His friend, Bharat, earns Rs 75,000 each month. His expenses add up to Rs 50,000 at the end of the month and he manages to save Rs 25,000 per month. Ideally on the face of it, Bharat saves Rs 5,000 more each month. This should add up to a good amount at the end of the year and so he is considered to be better off than Ram.

However, look closer. Ram's expenses are Rs 30,000 per month and he saves Rs 20,000 every month. His savings to expenses ratio is calculated at 0.66 (20,000/30,000). In practical terms, with the savings he manages every month, he will actually be able to pay for 20 days of his monthly expenses. Lets compare, the same ratio in Bharat’s case. His ratio works out to 0.5 (25,000/50,000). This means Bharat will be able to take care of only 15 days' expenses.

But the above observations could be debated by some who may conclude that Bharat may have a better standard of living than Ram, considering his expenses. Even that may not be true if Bharat is supporting a lavish or better lifestyle depending on loans. Servicing more loans does not mean a better lifestyle. One could be servicing more loans to support unwanted expenses.In any case, even if it were a better lifestyle that Bharat enjoys, he needs to save much more to enjoy the same staying power as Ram. With respect to this ratio, keeping the expenses within desirable limits is important, rather than focusing on income alone.

Debt servicing to total expenses
Even while considering one’s expenses, looking at the break-up of how much is being spent on which item will be significant. For instance, if out of your total expenses in a month, 40 per cent is spent on paying the equated monthly instalments (EMIs) for a home loan, it is fine. Spending another 20 per cent more to service other loans would also be fine. Assuming that the balance 40 per cent of your expenses gives sufficient leeway for all other expenses. And includes some savings too.

However, say the debt servicing to total expenses ratio is 0.6. In this case, if the instalment component of any loan goes beyond 60 per cent, it would be dangerous as EMIs are non-discretionary. You might end up paying a penalty if you miss paying those.

An ideal debt servicing to total expenses ratio would be 0.5 or lower. However, this works well for those in the higher income brackets (Rs 50,000 per month or more). For lower income brackets, the amount of loan that can be taken would be dictated by monthly or annual expenses, as loans' servicing can be done only after meeting the basic expenses.

For instance, for a person who is earning Rs 30,000 per month, if the monthly expenses are about Rs 20,000, then he can use a maximum of Rs 10,000 every month for servicing his loans. Here, the debt servicing to total expenses ratio is 0.33. The general logic of having a ratio of 0.5 atleast will not apply here. Similarly, for double income families with a high combined income, this ratio can go up, to even 0.7, as the balance available may still be big enough in absolute terms to meet the basic expenses and saving needs.

Expenses play an important role at the time of retirement and beyond. A muted spending style can stretch the corpus a long way. A flamboyant spender may see the same corpus deplete in no time. Expenses, hence, play a pivotal role through out life. Merely focusing on income and investments can be a mistake, a costly one.

The Delta factor
While calculating our future expense requirements, we merely consider our current expenses and inflation. However, another factor that would determine your future expenses is the aspiration factor-which we shall call the Delta factor. A hatchback might make one look self-assured today. But aspirations also keep galloping. In future, the same person may be aspiring for a car that is considered up-market.Once vacations meant going to hometown and back. Now, vacations take one to exotic locations in India and abroad.

The Delta factor is seldom considered while planning finances. It is true that this is difficult to estimate. Considering, it depends on societal and peer pressures, the future contours of which are difficult to define. It also depends on the strata of society they belong to. What may be "arrived" in one strata may be "passe" in another. How many people would have predicted that they would be sending their children abroad for education, if asked 15 years back? But then, that is what many are doing today.

Building a cushion to accommodate this delta factor, would be a capital idea. It may not be accurate. But then, estimating it and making at least a rough provision would solve the problem to an extent, instead of completely ignoring it.

Published in Business Standard on 28/11/2010

How thw capital market regulator paved the road to perdition for Mutual Funds

Data can be made to lie. The top brass at the Securities and Exchange Board of India (Sebi) has claimed an inflow of `65,000 crore to mutual funds during 2009.

The fact is, assets under management (AUM) of the mutual fund (MF) industry have been coming down since August 2009. From a high of Rs8.03 lakh crore, the average AUM declined to `7.13 lakh crore in September 2010.

The month-end figure for September 2010 was even lower, at Rs6.57 lakh crore.
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Meanwhile, equity MFs saw net redemptions of about Rs21,700+ crore from August 1, 2009 to September, 2010. In fact, in September alone, the folios dropped by 5.8 lakh.

All this in a period when the Sensex rose about 30%! The market has made a new peak, but mutual fund AUMs are down.

In any industry, for the product/ service to reach the end-user, there is a distribution system. There will be a cost attached to this distribution system, which needs to be commensurate with the value it delivers. The current distribution system is efficient and cost-effective as MFs do not have agents on their payrolls and pay them only for services rendered.

A distribution system will have its flaws. The mutual fund distribution has its —- pushing new fund offers (NFOs), undue churning of clients’ portfolios, etc.

These problems needed to be addressed and the perpetrators needed to be disciplined.

Sebi could have addressed the problems by putting a cap on how much can be given out as a distribution fee for NFOs, as also, approve meaningful NFOs only. Also, it could have put in place a metric, which measures the churn in a distributor’s portfolio and affords him lower fee for higher churn.

Doing away with the entry load and asking distributors to collect fees directly from the clients was unwarranted brinkmanship. It simply undid a distribution system that was built over the years.

Here is the full charge-sheet against the capital markets regulator:

Making business unviable

Asking distributors to collect fee directly from investors is one thing and actually collecting it from them is quite another, as distributors have found. Somewhat ironically, most investors expect the distributor to pay them for investing. The upshot? Most distributors have moved away from MFs and the AUMs are falling. We keep hearing justifications every month for falling assets such as advance tax, profit booking, etc. But the major reason is that the distribution system is a depleted force and is in disarray.

Destroying distribution

That distribution is an integral part and a vital link in the entire industry seems to have escaped Sebi. The regulator’s other moves betray this too. For instance, charging the same exit loads for retail and institutional investors does not make any business sense —- the cost of acquisition and servicing are different. Retail investors would be subsidised by institutional investors, which is an unhealthy development.

Another example —- assuming that all distributors are able to collect a fee for services rendered, the costs of billing, collecting the fee, accounting and compliance have ballooned so much that the fee charged will go up, not come down as intended.

As a corollary, distributors are unable to service small-ticket requests as the costs of servicing them is high, making such deals unviable. Hence, the real small investors are left to fend for themselves.

Justifying wrongs
It might be very nice of Sebi to say that investors have saved `1,300 crore (2% of the `65,000 crore inflows in 2009). But that calculation is wrong.
The 2% metric used was the fee for equity funds, not all funds. Secondly, it exposes a deeper malaise —- if Sebi seriously thought distributors would be able to collect fees from investors, the savings would not have happened —- investors would only have paid distributors directly, rather than via the fund house.

If Sebi knew distributors would not be able to collect any fees from investors, then the move shows the regulator’s moral bankruptcy, wherein it willfully misled distributors, fully knowing that they will not be able to collect any fees for services rendered.

The other statement —- about profits of mutual funds going up —- is again a convenient ploy to deflect criticism, for it does not address the flight of money from MFs, which will ultimately cripple the fund houses.

Unsettling legislations

There has been a continuous stream of legislation aimed at MFs and their distributors. This has not allowed the industry to find its equilibrium.

Some of the legislation does not even make sense —- such as not disclosing the indicative returns/ portfolios in fixed maturity plans (FMPs).

How would an investor invest without knowing what he might be getting from his investments and where it will be invested? It would have been more appropriate to make the funds comply with some broad parameters.
What has now happened is that informal information and guesswork has supplanted proper, direct communication.

Compliance requirements (and costs) have also gone up. Compulsory PAN and Know Your Customer compliance will ensure that mutual fund penetration will not go beyond a small sliver of the population. No wonder the number of unique investors in mutual funds number about 80 lakh, against India’s population of 110 crore.

Siding with stock brokers
There is a push to dematerialise (demat) all MF units and probably move everything to the online platform. It is common knowledge that MF schemes just issue statements and there is no certificate involved. Apart from probably viewing the holdings on a screen, demat serves no useful purpose. It also entails a cost to the investor in terms of maintaining holdings in demat form.
Sebi seems intent on pushing all investors to use the online stock-broking platform. Both the National Stock Exchange and the Bombay Stock Exchange have MF platforms, but both have been non-starters.

Also, stock brokers charge on both the buy and sell transaction. One does not understand how this is in investors’ interest. Also the brokers thrive on churning, and thus want clients who do day-trading. It is unfortunate that Sebi wants investors in mutual funds to go to stock brokers, fully knowing this.

There is no alternative low-cost online platform exclusively for MFs. This means that all MF distributors will have to become stock brokers or sub-brokers to invest a client’s money in MFs. Stock brokers will get a percentage share of all business without doing anything. It’s ironical that Sebi wants distributors to charge on buy/ sell transactions now and share the fee with stock brokers.

Anti-distributor moves
It is clear that Sebi has a pathological aversion to MF distributors. Know Your Distributor norms have been introduced now for MF distributors, which involves bionic identification. How will bionic identification help when the details of MF distributors, including their PAN, address, bank account details, etc, are already there? Distributors have been regularly harassed and their commissions withheld for documentation/ non-compliance reasons. Is it a surprise then that AUMs are falling?

By demonising only MF distributors, Sebi is causing major harm to investors. For investors, investments through MFs remain the best bet to participate in the stock market. It is wishful thinking that all investors will invest directly and no handholding is required.

The New Pension Scheme has turned out to be a non-starter because there is no one to promote it. That’s causing the pension funds regulator — the PFRDA — to rethink the involvement of distributors. Now, it is Sebi’s turn to wake up.

Cover Calculation

Take into account current and future family expenses, inflation, investments and sum assured of existing policies.

How much insurance is good enough is a question most people don’t ask themselves. Many don’t even realise that insurance is a security net, and not an investment vehicle. Most argue that they are paying tens of thousands as insurance premium and are reluctant to discuss additional insurance requirements.

Compounding this, people are not even aware that they require further insurance, over what they already have. Also, the most important benefit of having insurance, which is protection, is not fully appreciated.

Ironically, policy holders want to enjoy the benefits of insurance when they are alive (read investment), and opt for plans that give them some returns. That beats the entire purpose of an insurance policy, which is protection.

Insurance companies have, therefore, built in investment options. This also explains the popularity of unit-linked insurance products, which are essentially investment products, with lots of flexibility built in.

Tax savings is almost an article of faith for many of us. Since insurance comes under Section 80C, the premiums paid for insurance policies are eligible for deductions under this section. This has become one of the most important reasons for people buying insurance policies.

Going in for insurance primarily for tax savings is actually a sub-optimal way to go about tax savings. If one does not require insurance, the mortality charge being paid is actually money down the drain. Take the case of a 50-plus person, who may not have much insurance cover requirement. If he goes in for an insurance policy, the mortality charges he would pay for the cover would be a wasteful expense.

So, the first thing people need to appreciate is the requirement for adequate security cover. Then, they need to know how much cover they require. To find out this, we need to adopt the following method.

Take into account all monthly and annual expenses. About 90 per cent of that figure (it could actually be less) would be a fair estimate of expenses in the absence of the income earner. Subtract the insurance premium ( pertaining to the income earner) and personal expenses of the breadwinner.

Multiply the resulting figure by 23. This figure is about 50 per cent more than the corpus that may be required and is an approximation to account for inflation.

Add to this the specific, goal-related expenses such as education, marriage, and so on. Subtract from this the current investments, assets that can be liquidated (like a second home, land, etc) and insurance cover on the income earner. The resulting figure is the amount of insurance to be taken, additionally.

Let’s compute additional insurance requirement for Ramesh Jha using this method.

Jha and his family have a monthly and annual expense of Rs 4 lakh. Of this, 90 per cent is Rs 3.6 lakh. The insurance premium pertaining to Jha is Rs 40,000 a year and his personal expenses are about Rs 20,000 a year. After subtracting these two, the resultant figure is Rs 3 lakh. Multiplying this by 23 gives us Rs 69 lakh, which would be the corpus requirement to take care of the expenses in future. But then, there are other expenses like education and marriage. These are estimated to be Rs 20 lakh at today's cost. When that is added, the amount required comes to Rs 89 lakh.

From this, subtract current investments. These are Rs 11 lakh in this case. The sum assured of the policies on Jha is Rs 8 lakh. Subtracting these two, the corpus requirement comes down to Rs 70 lakh. He also has a second home, valued at Rs 40 lakh. That could, potentially, be liquidated, if there were a need. Hence, the net exposed amount is only Rs 30 lakh.

By this calculation, Jha would require an insurance of Rs 30 lakh additionally to cover the risk-exposure to his family. This can very easily be taken care of at low cost, by going in for a term insurance. It would cost him under Rs 10,000 each year. That is a pretty low cost to secure the family’s future.

Insurance is protection. All other benefits are incidental. It's time people get this right.

Published in Business Standard on 14/11/2010

The case for FMPs...

Look at the tax angle and the returns are often higher than the more popular debt options

Several Fixed Maturity Plans (FMPs) have been coming into the market for over three months. Let us examine what these are and why they may be useful.

FMPs typically are debt-oriented products, comprising bank certificate of deposits (CDs), commercial papers (CPs) issued by companies, structured obligations, debentures and bonds, pass-through certificates and so on. The duration can be a month to five years. As the name suggests, these are closed-ended products, comparable to bank fixed deposits (FDs) most retail investors opt for. They are sometimes called by slightly different names - Fixed Tenure Fund, Fixed Horizon Fund. The monthly and quarterly FMPs are also called interval funds.

FMPs are yet to become as popular as FDs with investors. However, there are some significant advantages of investing in these. Firstly, FMPs come in all kinds of tenures, from a month to five years. FDs can match this to a great extent, though the choice of tenures with FMPs is much more. Second, as opposed to FDs, the risk profile would be lower here. This is because FDs are with one institution and, so, pose a risk. If it is with a company instead of a bank, the risk is a bit higher. Instead, FMPs invest in a varied mix of CPs, CDs, debentures, which brings down the risk profile of the portfolio. Also, the fund manager ensures the maturity profile is more or less matched with the FMP's tenure and, hence, interest rate risk is almost eliminated. In most FMPs, a small proportion is invested in equity (for instance, Franklin Templeton Fixed Tenure Series). Clearly, the investor needs to understand what the FMP asset allocation would be and then invest.

Third and important, FMPs can offer a higher post-tax return as compared to FDs. For those in the highest tax bracket, FMPs will be very advantageous. In case of FMPs, the dividends distributed by the fund house are taxed in the latter's hands itself. Dividend Distribution Tax is 14.16 per cent now. The dividend received in the hands of the investor are not taxable. Hence, the investor effectively pays only 14.16 per cent tax, as opposed to the 31 per cent he would have paid for interest received from FDs, as they are treated as income and clubbed accordingly. Also, one could take advantage of indexation for FMPs of longer durations.

Indexation works like this: If one invests Rs100 today and takes it out after a year, getting Rs108, the profit is Rs 8. However, the value of Rs 100 last year is not the same today, as inflation has eroded the value. If inflation is at 7 per cent, then Rs 100 last year would be equivalent to Rs 107 today. Then, rightfully, only Rs 1 is the profit. The indexation principle takes this into account. The cost inflation index to be used for such calculations is published by the income tax department.

The tax on short-term capital gains (for investments of less than 12 months duration) for an individual is as in the applicable income tax slab rate. Long-term capital gains would be taxed at 10 per cent without indexation or 20 per cent with indexation. Hence, one can calculate and pay tax on whichever turns out to be less. In this example, a 20 per cent tax on a rupee is 20 paise; a 10 per cent tax without indexation on long-term capital gains works out to 80 paise. Hence, the 20 per cent with indexation is more beneficial for the investor. In this example, the net return for the investor is 7.8 per cent. Had the same investor invested in an FD yielding eight per cent and assuming he is in the highest tax slab, he would have to pay 31 per cent as tax.The return would then be only 5.52 per cent. A major difference, which is why FMP is a good investment option.

Coming to liquidity, previously fund houses used to accept premature redemptions, albeit with an exit load. Now, that has been stopped and FMPs are listed on the stock market. An investor who wants to redeem can directly sell on the stock market. However, this portion of the market is not liquid and may pose difficulty if a person requires money before maturity. Hence, invest money only when sure of staying invested till maturity.

It should also be clear to the investor that for tenures less than a year, a dividend distribution option may be better, as the tax incidence would be 14.16 per cent (paid by the MF), instead of their slab rate. The investor would be better off paying tax and be in the growth option, if their slab rate is the first slab, that is,10 per cent. For tenures more than a year, taking advantage of indexation would clearly be a better option, for most tax payers.

FMPs seem to be the best kept secret, with not too many knowing about the potential for much higher post-tax returns, without taking much higher risks. FMPs are a viable alternative to FDs and other debt investment options. Investors would do well to harness the potential for higher returns these offer.

Published in Business Standard on 7/11/2010

Chasing IPOs

Unless you have the means to analyse them, better opt for listed companies.

Chasing rainbows is a pleasure though there may be nothing at the journey’s end. The IPO (Initial Public Offering) game is similar. Investors chase the elusive rainbow and mistake all IPOs to be a pot of gold.

Somehow, IPOs, FPOs (Follow-on Public Offers) and rights issues have a draw with people that is beyond comprehension. The interest may not always merit the returns. Most people, for some reason, assume a public offer of shares has to be cheap and hence a good idea to participate. This is probably a hangover of the past, when the Controller of Capital Issues used to set the price for a public offer and getting an allotment was like winning a jackpot.

Today, IPOs are aggressively priced. For investors looking for listing gains, possibility of a loss is more or less 50 per cent (if you look at, say, the one-year history). In fact, a CARE Research study on the performance of 116 IPOs issued between August 2007 and 2010 indicates that in about 35 per cent of cases, the current traded price is above the upper band of the IPO price, while 62 per cent is below the IPO price. Investing in IPOs should not be the only strategy.

Investors may want to pick and choose between IPOs. But information about these companies may not be available freely, apart from their own prospectus. Not many investors can use information from this one source to establish if the IPO’s price is right, and can make an informed investment decision. If such were their prowess in identifying companies with underlying value, they would be milionaires many times over and need not resort to investing through IPOs anyway. A better strategy would be to choose from among the listed companies, whose performance is known and on whom even more data is available in the public domain.

If, on the other hand, they are relying on the analysis provided by various market mavens, the result can be confusing – for there are divergent and opposite recommendations. During an IPO, one can expect many planted good reviews too. Afterall, the company, their investment bankers, underwriters and the stock broking community are all direct and obvious beneficiaries. So, expect peans being sung in praise of the IPOs.

Most retail investors subscribe to various IPOs based on the ratings given by rating agencies. Incidentally, Reliance Power got rave reviews and even Crisil gave it a 4/5 rating. The stock listed below its issue price and is still quoting lower than its issue price. With the ratings going wrong, investors could end up owning a portfolio of companies without any underlying rationale. If this portfolio is not diversified across sectors, the risk profile increases.

Hope and greed
The other fallacy in investing in IPOs is looking for listing gains. That is gambling, not investing. Losses are as much a possibility as seen in the Reliance Power issue. One reasoning why IPOs seem attractive is because, choosing from among 3,000 companies that are already listed seems a herculean task. In the case of IPOs, the decision making process gets simplified, as there are just the IPO candidates to choose from. In addition, there is nothing to do except read some reviews and make up your mind. Some investors may not even do that – they just follow their friend or colleague who is applying for the IPO. They always find enough justifications for investing in IPOs – foreign institutional investors, (FIIs) are investing, there are enough favourable recommendations and brokers and other intermediaries are optimistic about IPOs.

It may be a far better idea to invest in the existing universe of stocks, about which performance history exists. Even if investors want to invest in stocks that came out with IPOs, they could wait until its listing, give it some time for price discovery and stabilisation. That way, they may even end up buying below IPO prices. Even if the price is up, one could check if the equity is good to invest at that price and then invest. lets remember, the IPO stock will be available even in future. Retail investors could even consider good mutual fund schemes to invest in if the IPO does not live up to its expectations.

Published in Business Standard on 31/11/2010

Should you pay for advice?

Should you pay for advice?

Suresh Sadagopan / Mumbai October 24, 2010, 0:45 IST

Yes, a good financial advisor costs money. But he takes the responsibility of ensuring your financial stability

The word ‘free’ has a soul-stirring universal ring. Something for nothing is music to the ears. Yet, there are no free lunches. So, the one-on-one free offer or buy-a-shampoo and get-a-soap free kind of offers have already been priced in the costs. Some of them may be genuine offers, where they may offer “something extra” by reducing their profit margins. But a promotional expense, not altruism.

It is, then, surprising that people are looking for ‘free’ advice, when they invest. Managing finances is a very important function. We all work to earn our money, to be able to meet goals. Then, why be callous about how to manage the money earned?

Question hour

* Does he/she understand your specific issues?
* Does he/she have knowledge about the product, its benefits and costs?
* Does he/she have the necessary experience. Has he/she invested in people, systems and processes?
* Does he/she answer tough questions such as – Will you be paid a commission for selling this product?
* Is he/she willing to provide references?

Either the person concerned should go through all the appropriate options, do a proper study of the products available and go for the one best suited for the goal in question. A lot of times, this is only on paper. Most investors are just not interested in doing this due-diligence. In fact, most do not have any specific plan to achieve goals.

Hence, in financial services, the various distributors play a role and decide what investors get to invest in. If it is an insurance agent who approaches and convinces a person, then it is an insurance product which gets sold. If it were a mutual fund advisor, the investor would have been convinced about the ability of one or the other scheme that will solve his problems. The point is, the investor is investing depending on who is approaching him and convincing him and not according to any well-thought strategy.

Most take it for granted that the financial advice and counselling is a “free” service from the advisor. But any advisor will have a vested interest in selling his product, as that is what is going to earn revenue, especially in a situation, where advisory fees are conspicuous by their absence. Hence, there will be an inherent bias in the recommendations. Also, many people buy from their friends and relatives. Here, even the rudimentary matching of client goals with appropriate options goes out of the window. Typically, in a meeting where a friend/relative is the advisor, most of the time is spent on extraneous matters and very little on discussing the product features and benefits. Even lesser time is spent on matching with goals. The client himself says in most cases - “You know about us and will know if this suits us. Just tell us where to sign and you handle the rest!” Proper advice can make a world of difference. But good advice may have to be paid for. Most people are unwilling to do so. They have never paid for financial advice. They have paid doctors, lawyers, architects, etc., but never a financial advisor. Without appropriate advice, one tends to make many mistakes, like getting into costly or patently inappropriate products. Such actions can really be costly for the investor - the price he would pay would most probably be far in excess of the fee which he would have paid to a advisor. Again, assuming you are willing to pay, you still need to choose a good one to advice you.

You should do due diligence before hiring one. Ask relevant questions, seek references, and importantly see if he/she is throwing numbers at you or genuinely understands your financial situation.

Published in Business Standard on 24/10/2010

Festive Binge can lead you to debt trap

Beware, impulse buying could spin your financial budgeting out of control.

Look around and you will find a million things you could spend on. The malls have a soothing effect for frayed nerves and people flock these places for entertainment and shopping. At times, we end up buying things even when we didn’t intend to. A simple session of window shopping could see us emptying our pockets and spin our monthly budget out of control. Lots of stuff bought on an impulse is never used and may not prove to be a prudent buy.

The easy availability of loans has made it easy for us to make purchases without planning for them. Almost everything is available on credit, from pizzas to overseas holidays, making enjoy now, pay later, a well-accepted motto today. But if you do not have enough cash flow to service the loans or if most of it is tied up in servicing of loans, managing finance can be difficult.

So, even while taking credit, one needs to be sure of the following aspects.

# Requirement: Whether the object or service in consideration is really required. And even if it is, should it be availed now or can be postponed for a later date.

# Loan warranted or not: A loan has to be paid off. So unless urgently required, there is no point in taking a loan for the object or service.

# Paying a reasonable rate: One needs to know, if the loan can be serviced easily or not. So check the outgoings per month besides having clarity on the loan repayment period. Many of us are unaware of the actual cost of the debts we have. For instance, loans which charge a flat 10 per cent may have other costs like the processing fees, late payment fees and so on. People are also ignorant of the interest they end up paying on revolving credit.

# Pre-payment options: Know the pre-payment options on the loan. If opting for a loan to tide over a temporary financial crisis, then a prepayment option with low penalties, is a good idea.

Planning ahead
If you really need to buying something, you could always put aside a small sum every month for a year before buying it. This way, the object of desire can be enjoyed sans any guilt.

But if you have taken a loan, consider converting it to a lower cost one. For instance, it may be a good idea to pay off credit card debts by taking a personal loan. There are loans that have a long tenure and are typically lower cost, like home loans. In the descending order of priority, if one wants to settle debts, credit card debt, personal loans, vehicle loans and home loans are the way to go.

However, not all loans need to be repaid in a rush. A loan availed at a cheaper rate can be retained.For instance, suppose a home loan interest rate is nine per cent. The actual interest incidence will be even less, due to the tax advantages. Hence, it may be a better idea to invest the money elsewhere, where the amount can earn a higher interest.

Facing financial crisis
One needs to explore ways to tide over a financial crisis without opting for a loan. If your bank gives an overdraft facility, it may be a good idea to use it. It will charge you only for the amount borrowed and for the number of days it is borrowed. Family and friends can also be a source of support. If you are confident of repaying in good time, by all means take the cash they are offering.

Stay away from unwanted debts. If taking loans is inevitable, look around for appropriate ones. This knowledge is worth its weight in gold.

Published in Business Standard on 17/10/2010

Helping friends doesn't add to your wealth

Seek professional help for investment advice

Money plays an important role in people’s lives. Yet, when one has it, it is seldom given the importance it deserves. People look forward to earning more money rather than managing the money that they already have. This is probably why, money in bank accounts, is not deployed for an extended period of time. People don’t realise they are missing an opportunity to earn profits on them.

The money lies around till they hear about some good investment or insurance ideas from friends and family. Many of us have friends and relatives working in the financial services sectors, who approach us for business. More often than not, they get both attention and business from us. While putting one’s money into any of the “amazing schemes” that one hears, most don’t really care to understand what the scheme means, what the risks involved are, how the scheme works and so on. The reason for this carefree attitude is the blind faith one has in their friends or relatives. Everyone likes to believe, our friends and relatives will do the best for us.

This is a classic problem that we all face today. Most times, our relative or friend has just joined the insurance or finance business. When a person is stepping into a new business, he or she is desperately looking for business. They have to sell the products they have taken up. They are looking for support from their friends and relatives. A newcomer typically spends the first six to twelve months, tapping this ready market of his close ones. Even companies hiring agents are betting on making initial business from the newbie’s inner circle.

As supportive relatives and friends, most people succumb to such proposals even though at a loss. A person may take an insurance policy with a premium of Rs 15,000 per annum, just to please their relative. Later, when they find the product unsuitable to their needs, they still stick to it. You cannot walk out on your relative or friend. If it is a traditional product, they had bought before the new insurance regime, they will have to pay the premium for three years before surrendering. After having spent Rs 45,000 for three years, all they may get is Rs 15,000. That's a lot of money to lose simply because you cannot say ‘no’ to your relative or friend. The money lost is with the insurance company. The relative has probably made Rs 4,000- 5,000 from what has been paid in three years.

Relatives and friends may not be selling what is good for the person - they may be pushing what they have to sell. A person from insurance will sell insurance policies to you, whether you require insurance or not. There are other problems too. When you invest in a financial product, you require proper servicing, over the tenure of the product. A newbie, especially those who plan to take up the job on a part time basis, may not be in the system after a year. In insurance, the drop-out rates are very high. Even when a person does not drop out, if he does not conduct his business seriously, it will impact the service levels. What’s worse, since this person is known, he cannot be taken to task.

When it comes to investing money, it makes sense to choose advisors who can help by giving out the right information and can be pulled up in case they don’t perform. One must have the freedom to change one’s advisor if need be. After all, it is a good amount of money at stake. Do give relatives and friends some business, but only if, they are able to stand scrutiny. Else, one should think of other ways to help them but it is best to keep one’s money with professionals. Mixing money and personal relationships can bring more problems than pleasure.

Published in Business Standard on 10/10/2010

Watch out before you cash in on your future income

Holidays and LCDs on EMIs and many other goodies on credit cards and a home bought with a huge dollop of loan, are all commonplace now. No one really worries about such things any longer. Being in debt is almost fashionable today. Also, in most cases, it is not possible to avoid it – like in the case of buying a home. Most people today want to buy a home early in their lives... that means, they may not have too much money to pay upfront and a bulk of it will have to come from a loan.

Everything done in right quantities is good. Brandy and wine, they say, have medicinal benefits, if had in the right quantities. But many people stretch the definition of “right quantity” and end up getting sozzled... and that is where the problem lies. Loans may be needed in certain situations. But, they need to be managed properly so that they don’t get the better of you.

When you take debt, you are essentially cashing in on future income. So, one needs to clearly weigh whether it is a good idea to draw on the future income. The most important thing then before assuming debt is to be clear about the pressing need for the object/service and the conviction that assuming debt is the best or the only option.

Today, loans are available quite easily. Hence, the temptation to just go around, get a loan and get your favourite toy or indulgence, is irresistible. That is why one needs to be careful. In the need to keep up with the Kapoors and Sharmas, one should not get sucked into the vortex of debt.

Again, there are benign loans like home loans, where an asset is created... there are others which can be worrisome – like credit card debt, personal loans etc. Going for a refrigerator on a loan may be justifiable – for it has become a necessity today. But assuming a loan for acquiring a huge LCD TV or a holiday abroad, falls under the “worrisome” category.

Easy serviceability of the loan is an important parameter. It is important to ensure that the EMIs can be paid without problems, from your income. Generally, around 40% of the net salary towards home loan servicing would be fine. For double income families, the portion of the income towards servicing home loans can go higher, as only a small fraction of their joint income may be needed for normal household expenses. However, in such cases, there will be a compulsion for both to work for extended periods of time and any break in one person’s earnings, can prove to be disastrous.

Other loans can be taken, based on cashflows. However, it is a better idea to start saving for it and then buying it. For instance, it is a good idea to save `3,000 per month for a year and then buy an LCD TV, instead of going for it with a loan. The end result is the same. But, in the second case, it is a more self-reliant and disciplined way of enjoying life.

If debt taken together is over 60% of one’s income, then it is a danger zone. Most look around for the cheapest debt. But the question to ask is, do I need to assume this debt. Anything done within limits, is good. Beyond limits, it becomes poison.

Published in The Economic Times, 7/10/2010

Hope after the nightmare

Investing in a stock like Mahindra Satyam requires a strong stomach. But there are long-term rewards.

When the Satyam scandal broke out in January, 2009, it stunned everyone. The scandal that was done with allegedly active collusion and participation from several senior functionaries, made investors quite jittery. Even external auditors were not able to find the frauds committed. This is a major problem for shareholders, who are not involved in the direct running of the company.

However, in every misfortune, some will always win. For instance, when there is an earthquake and houses are destroyed, builders and cement companies will benefit immensely. Similarly, when there is turmoil, there are those who would be willing to take the risk, for the chance of a windfall profit. But for that, they need to have a very high risk appetite.


* The impact of a scandal on the company’s financials
* The commitment of the management to turmoil resolution
* If the company is professionally managed and transparent
* If the company has opened up communication channels with employees, stockholders and customers
* Legal cases and the impact. Getting stuck in a financial suit has the capability to cripple the company

Warren Buffet, the legendary investor, poured in billions at the height of gloom in 2008. Earlier this year, he purchased 77 per cent of Burlington Northern railroad for about $26 billion, when the economy was not in a very good shape. That is a real long-term bet, in vintage Buffett style. He is willing to wait decades to get returns from his investment. It is all about value.

Similarly, when a company is in doldrums due to a scandal, the intrinsic value will typically fall below its fair value. There is bound to be bad press, which will depress the prices and create tremendous gloom around the company. This is fertile hunting ground for the intrepid investor. However, a savvy investor would invest after due diligence.

What does a savvy investor do? How does he assess whether a company in the midst of a scandal is worth investing in?

One of the prime things to evaluate is whether the scandal is so large as to destabilise the company itself. If it is, the risks are very high indeed. The second thing to look at is the response from the A-team in the company– they would be required to hold fort and steer the company clear from the storm. A committed A-team, is a positive aspect. Here, depth of management becomes critical. Owner-driven companies may have shallow structures and pose major questions about the recovery. There are even more questions if the main owner is implicated, as in the Satyam scandal.

The third thing to look for is the intention of the team to sort the problem and their resolve to come clean and tidy the situation. Here, communication plays a major role. A good team will open channels of communication with employees, shareholders, customers and other stakeholders and clearly inform them about the steps being taken to resolve the crisis. The fourth thing to look at is the nature of charges against the company or the management and the extent of monetary damage. In such situations, there is potential for a plethora of legal cases, which can cripple the company. This, by itself, is a major determinant of whether a company will be able to stand up ever again or not. This assessment could be tricky.

If a new management is brought in, which has credibility, it is to be seen as an extremely positive step. A credible management will re-infuse confidence all round and give the company the chance to stand up again. If there is a move to protect the brand by the new management, it is an entirely positive move. Towards this end, the management might delink the scandal and its perpetrators from the brand, through skillful communication. Ultimately, the brand persona is invaluable and is what enables sale of products and services.

Keeping the flock of clients intact is a challenge for battered firms. However, appropriate interventions and proper communication which isolate the criminal act and delinks it from what the company otherwise stands for, as also seeking their support and co-operation, will be positive for the company. This will help in retaining clients. Similarly, acquiring new clients could be a challenge and the management’s effectiveness in combating the problem will come to the fore in how well they do this.

Employees with deep understanding and experience are an asset for any organisation. It is important that the current employees are retained and their fears assuaged. If successful, this will be one of the greatest positives and give the company its best chance at revival.

An investor who wants to benefit from the huge plunge in share prices in a tainted company has to be hawk-eyed and needs to look at all these parameters before coming to a conclusion and then decide if the company is worth investing in. Admittedly, this is not everyone's cup of tea. There are huge risks involved. The potential for returns is also enormous, if the call turns out right. It could be a multi-bagger overtime, as such companies would be typically available at a deep discount to their intrinsic value.

Published in Business Standard on 3/10/2010