29 July, 2011

How to determine the proper fee for a financial plan?

Let me start with a question… What would you say if you are offered a car for Rs.4 Lakhs? You would obviously want to know which car it is, whether it is new/ used, what are the features etc. and then you would use your judgement to conclude if the car is indeed worth the buy. What you have done just now is to evaluate the value embedded in the offer and then find out if indeed the asking price is at least equal to or higher than the value offered, in which case you will buy the car. Else, you will not.

In fact, this is precisely what we do before any decision.

If you get a novel at Rs.99/- it is seen as good value and you would buy it. If the same novel is Rs.750/-, you probably won’t buy. A movie ticket in a multiplex at Rs.100/-is seen as a value proposition, whereas you may not want to pay the same amount for a ticket in your neighbourhood theatre.

McDonalds is doing brisk business with their burgers priced at Rs.25/- and is seen as a value for money offering, whereas the vada pav which is also a burger, is available at Rs.7 at roadside stalls and at Rs.10 at Jumboking. All of them are seen as good value for money by different people and hence they all have a loyal clientele.

The thing to understand from this is the value proposition. For anyone, the cost alone is never the main or the only criteria. The value proposition comes from the entire set of benefits offered, not just price. Now, that is easy if there is a frame of reference. You could determine that Okra at Rs.30 a kilogram today is cheap, because it had been selling between Rs.40 – 60 a kilogram, for the past several months. A multiplex ticket at Rs.100 is seen as pretty good value, as it normally costs between Rs.175 to Rs.250 per ticket. Saw that?

Financial Planning is a new area. There is nothing to benchmark this with. So, how does one figure what is the right fee to pay?

Look at what you want. You probably want to hire a financial planner to get a blueprint for your life ahead and want to know as to how to achieve your goals. For creating a tailormade financial plan, our experience is that it takes 25-30 manhours, in all. Taking an average of Rs.500/-per hour for hiring the services of a qualified financial planner like a CFP(CM) certificant, the fee comes to Rs.12,500/- to Rs.15,000/-. But the per hour rate can be higher or lower depending on the process followed, experience & expertise of the planner etc. That’s about how planners arrive at their fee.

Now, is that value for money? For that you need to find out what benefits would derive by engaging them. The financial plan will give you clarity, direction & pathway to achieve your goals. That is important as you will know where you are, where you need to go and how to get there. The financial planner will also suggest if past investments and insurances are good to keep or are damaged goods and needs a rejig.

A good financial planner will also help a great deal in cash management – matching the right instrument for the end-use & tenure. We have found that the amount of extra money we could make for our clients by judicious investments, would more than pay our fees! Add to that, the fact that the Financial Planner would be the touchstone on anything to do with your finances – ensuring that you will not blunder while allocating between asset classes or the choice of products… you will also not be sweet talked into some card-castle-of-a-product, which makes sense only to the company & their agent.

You got the drift… there are various advantages you could derive from a financial planner. Find out from the planner, about the various services you can get. Find out how much money the planner can save/ make for you. Add to that the fact that you will have a clear blueprint which ensures peace of mind as you have an expert to guide you on finances all through the year.

The planner would also stanch leakages by stopping / reallocating resources into appropriate products, which improves returns and relevance. Find out how comprehensive the plan is… for the financial plan from different planners could be really different. Do a quick check about the integrity & dependability of the planner. Ask for references, if you feel the need for it.

Fees differ based on the experience & expertise of the planner, reputation, their processes, services offered, people strength ( is it a single person or is it a team ) etc. Now, after understanding the value offered, you can decide if the fee is appropriate. Now you can decide whose offering is good for you.

Authored by Suresh Sadagopan : Published in The Economic Times on 28/7/2011

18 July, 2011

Is NPS a good choice for retirement funding ?

“I want to enjoy life in Rishikesh, after I retire”, Mayank was telling me one of the evenings when we were discussing about work, life and everything in between. He has been saving for it too. He wants to take New Pension Scheme (NPS) as he has seen lots of favourable coverage about it. He in fact knew about CRIISP Report on reforms proposed for NPS. He was saying that the committee had found the structure of the product itself flawed in that it depended on buyer pull rather than being actively sold. The report was proposing to incentivize both Points of Presence ( POP) as well as allow fund managers to earn a remunerative fee to make it worthwhile. He was wondering still why it did not appeal to people.

Mayank knew that it has the lowest Fund management charges, that existed today. I agreed that it is low at 0.0009%pa. Mayank, in fact, knew a lot more… enough to write a product review!

Funds for Investment : There are three funds to choose from. A person can choose to invest in a Equity Fund (E ) , Fixed Income fund other than Government Securities ( C ) and a Government Securities Fund (G), according to the preference of how much risk a person wants to assume for returns. The Equity fund is an index fund that tracks NSE Nifty 50 or BSE Sensex. You can actively allocate the proceeds to the different funds, if you choose to. In the Equity Fund, you could place not more than 50%, in this case. However, you are at liberty to allocate upto 100% in any of the other two funds.

You also can choose the Auto choice for allocation of your investments. In this case, the allocations are made as per the age in the three different funds and they are rebalanced every year, automatically, in a predetermined way. Upto 35 years, there will be 50% in Equity & the balance will be in C & G. From the 36th year onwards, Equity allocation keeps coming down and more money gets allocated to the other two funds. This will be useful for those who do not want to manage their funds and the proportion for themselves.

There are 6 fund managers currently. The investor needs to choose the one of his/her choice necessarily. The returns generated by the fund managers ( for year ended March 31, 2011 ) are widely different in all the three funds. In the Equity fund, the returns of the various funds varied between 8.05% - 11.89% compared to Sensex and NIFT Y returns of 10.94% & 11.14% respectively. Similarly in the C fund, the returns varied between 6.26% – 12.66% and in the G Fund it was between 6.97% – 12.52%. It was found that the best performing fund in one category was not a best performer in other categories as well. One can invest in all three funds, but with one fund manager only. This means that if one invests with one fund manager and invests across funds, there will invariably be one or more funds that are not performing to potential.

Charges : There is a one-time account opening charge of Rs.50/-. Annual Maintenance Charges are Rs.280/-. There are charges per transaction of Rs.20/- at the Point of presence (POP )& another Rs.6 by the Central Record keeping Agency (CRA). The POP also charges Rs.40/-for intial subscriber registration and contribution upload. There are custodian charges of 0.0075% p.a for Electronic segment & 0.05% p.a. for Physical segment & the unbelievably low Fund Management Charges ( FMC ) of 0.0009% pa.

Types of accounts : There is a Tier 1 account, a non-withdrawable account, into which you contribute for building the retirement corpus till age 60. At, age 60, you would have to annuitise at least 40% and the remaining can be withdrawn at one stroke or in a phased manner. If you withdraw before age 60, you will have to compulsorily buy an annuity for 80% of the accumulated amount and could withdraw only 20%. One could also open a Tier 2 account, which is akin to a Savings account. One can put in and withdraw money anytime here. A person having Tier 1 account can open a tier 2 account, without any further charges.

Mayank seemed to know his stuff. He was able to rattle out so much information. He now wanted to know from me, if it is good to subscribe. I told him I see lot of positives and some negatives here and that he should decide after hearing me out.

Positives – A comprehensive, low-cost way of building one’s retirement corpus. Since it has a tier 1 & tier 2 accounts, it neatly addresses the long-term and short-term needs of an individual. In the Tier 2 account, since there are no exit loads on withdrawal anytime, it is like a savings account, which can potentially yield better returns. The charges being low, is a positive for the investor. Portability of the account across the country is a big positive.

The negatives – Since there is little incentive for the Points of Presence ( POP)to sell the product, Banks and other entities are just not interested in promoting it. In fact, in many banks they don’t have the forms. No one is selling it and awareness is still low, leading to very poor penetration of NPS among the public. The fund managers too have little incentive - for the fund management charge is 0.0009%pa! Anything that is win-lose proposition, won’t work. If they have to commit good people, they also need to earn something. For all three funds, there is one fund manager. This restricts choice for investors as they may want to keep the money in Equity fund with one & debt fund with another, much like in Mutual funds. Taxation as it stands today is against pension products. All annuities are currently taxable as income.

So. Mayank, it’s your call now, I had said. Consider all these aspects carefully and take your call. It is certainly not a bad product. It has it’s limitations, however. The other options which you could consider is to invest in a basket of securities from PPF, FDs, Bonds, Debentures, debt funds, Equity oriented products etc. and accumulate a corpus till retirement. At retirement, an immediate annuity can be taken , if required. This offers flexibility during the investment phase and a choice to choose the annuity provider at retirement.

Article by Suresh Sadagopan ; published in Business Standard on 17/7/2011

12 July, 2011

Four things you should not do if you have MF investments

When it is high tide, it lifts all boats. Irrespective of which fund one is investing in, an investor makes money. It is when the markets turn, that the investors find that some of the funds are found wanting and feel the pain. Warren Buffett, in his inimitable style had referred to the very same thing… When the tide turns, it will show who has been swimming naked!

That’s how many investors feel now – naked… exposed. That brings an irrational fear and many tend to take rash decisions at these points. But such decisions will only backfire on you. There are some things which an investor should not do now. Here they are –

1. Exit in a hurry – That would be one of the worst decisions. There are any number of people who had predicted in the recent past that the market will touch a sensex level of 15,000. But, it has gone up to 18,700 levels. Markets have a way of surprising even the most seasoned operator. Many think that they know enough to predict the market. The fact is that there are far too many variables for anyone to predict the market correctly. The most important thing to understand is that Equity markets perform, over time. Sensex has returned about 18% CAGR over the period from 1979. That should give you comfort. Though stocks go through their periods of gut-wrenching correction, they would perform over time. You could review your portfolio and remove deadwood and average performers. Other than that, just stay invested.

2. Stopping SIPs – This could be the second worst decision. SIPs essentially help you to invest without resorting to timing the market. In fact when the markets are doing badly, if you persist with your SIPs, it helps in purchasing at low prices, which will yield handsome returns when the market turns, as it eventually will.

3. Shifting from Equity to debt - If this is a part of the asset allocation strategy, it is fine. However, most times, it is not. When equity markets plunge, panic grips investors who just want to flee to the safety of debt funds. Debt instruments today are probably offering one of the best returns in a long time, what with interest rates at near peak levels. Keep the equity allocation intact. In fact, if you really want to play by the rules of asset allocation, you should increase equity allocation as they have lost in value and to restore the original allocation one needs to invest more in equity. But this is easier said than done.

4. Trying to time the market – Most people, including yours truly, have burned their fingers trying to time the markets. We all have that brimming self-confidence about our ability to get the timing perfect. But that works very well in fairy tales – not in real life. Yet, almost everyone is trying to do just that. I, for one, have realized that timing the market correctly is next to impossible. Simply stay invested for the longterm, instead of redeeming when you feel the market has reached it’s peak and trying to invest when the has reached it’s lows. Chances are, both times you might get it wrong.

Panic not. Continue your SIPs. Forget about shifting from Equity to debt to maximize returns – you might actually underperform when the markets start their phantom-rising act. Time in the market is more important than timing the market. I know it is a clichĂ©… but worth it’s weight in gold.

Article by Suresh Sadagopan; Published in Moneycontrol.com on 12/4/2011

The magic of FMPs

Hemant is down in spirit as his substantial stock investments have come down in value. He is cursing himself for investing so much in stocks, much against his native intelligence. He now wants to invest money in Fixed income instruments like FDs, NCDs, Bonds etc. His friend Manish counsels him not to panic about the Equity investments, and suggests that he even increase the holdings in Equities as the equities as percentage of his assets would have gone down. Hemant was looking at Manish, as if he were a gibbering baboon.

Manish understood and changed tack. Most investors including Manish, are wary of investing at this point, given the volatility. At an intuitive level, Manish understands that it would be a good idea to invest in Equity now. But, he just does not have the will to follow that through. Hemant wanted something safe.

Manish was now explaining to Hemant about FMPs. Debt instruments were offering good returns. But when he heard that the post-tax returns in a Fixed Maturity Plan (FMP) can be as high as 8.5- 9%, he was salivating. Bank FDs, were offering upto 10.5%pa interest. That looks impressive. But, for a person in the highest tax bracket, it translates to a post-tax return of just 7.25%. The difference between the returns offered by FMPs is between 17-24% more than FDs, on a post-tax basis.

Hemant was all ears… he wanted to know all about FMPs. Manish started to explain. FMPs are essentially debt Mutual Fund schemes with a tenure, which invest in a basket of securities like Certificate of Deposit (CD), Commercial Paper (CP), Structured Obligation, Bonds etc. There is no equity exposure in these. The tenures can typically range from 90 days to 3 years, though the most popular ones are those of one year plus duration. There is a reason to this. Hint – taxation.

The tax treatment in a debt Mutual Fund of which FMP is a part, is benign. It is subject to capital gains tax of the lesser of 10% without indexation and 20% with indexation. Assuming that the FMP gives a gross yield of 10.5%, the yield after tax comes to 9.45% & 9.8% respectively. The charges typically are about 0.2% - 0.4% in FMPs. Hence, the net return after charges in this example, would still be above 9%. One year CDs are yielding over 10% now, making FMPs an attractive proposition. Hemant was warming up to this subject.

Hemant wanted to know about the taxation treatment in case of investments of less than a year duration. For debt funds of less than one year duration, Capital gains are taxed at the applicable income-tax slab rate. That makes those FMPs below one year duration on par with a bank FD. However, if one goes for a dividend distribution option, the net return is still much higher than in an FD. Manish continued his illuminating exposition.

If one were in the Dividend distribution option, the Dividend distribution tax (DDT) is applicable. That tax is to be paid by the Mutual fund. The Mutual fund pays that tax and distributes the balance amount to the investor, which is tax free in the hands of the investor. The DDT is 13.519%. Hence, if a scheme is offering 10% returns, the post-tax returns in the hands of the investor is still a very healthy 8.65% annualized return. This makes FMPs a very good option for investors.
Manish concluded… for FMPs of less than one year duration, one should opt for the Dividend option & for those with over one year duration, Growth option is the best choice, especially if one is in the 20-30% tax bracket. Hemant was by now sold on FMPs.

Article by Suresh Sadagopan ; Published in Moneycontrol.com on 7/7/2011

09 July, 2011

Is Financial Planning akin to Wealth management?

When I was a boy I used to get confused between a tadpole and small fish. They looked alike, swam as effortlessly and looked so like each other. But they were different – I came to know later. One would eventually jump out of water and the other will stay in water, for life.

Financial Planning & Wealth Management are not so different from each other ( at least by definition ) and yet they are different in significant ways. But they are different actually in practice. The terms are confused and used interchangeably by lot of people… they are not the same.

Financial Plan is a blueprint to achieve client goals through appropriate financial management. The focus is always on the goals. A Financial Plan would be useful to a family that has various goals and wants to know whether they will be able to achieve them within the framework of their past investments & ongoing surpluses that will be available, over the years. Cashflows over the years will have to be worked out and it needs to be found out if the goals can be achieved within the timeframes specified or not. Once that is established planning for the near term needs to be done. Any deficits on a monthly basis or special needs that may be there needs to be addressed and provisioning needs to be done for that purpose. As part of the plan, advice is also offered on the right asset allocation for them. A proper risk assessment is also done and the correct amount of life insurance that may be needed is arrived at. It is after all these that specific recommendations are made.

How much liquidity may be needed, in what instruments to invest in, are specified. This amount would depend on the dependencies, the loans and other outflows that are there, stability of cash inflows and other factors. All past insurances would have been looked into and appropriate recommendations on whether to keep them or continue, is offered. New insurances on life, accident , medical, home etc. are suggested, after taking into account the present insurance they have, including what they have from their employer. Past investments are also looked into and reallocations are suggested based on their specific requirements and goals. After allocating for liquidity, the balance amount available in the bank needs to be deployed. Similarly, the surpluses coming out on a monthly basis would need to be deployed . Suggestions for all this would be there in the plan. The cash inflows over the period – especially over the next 12 months are looked into and specific recommendations are made for such amount coming in, in the future. Implementation is done once the client understands and agrees on the plan. Implementation can be done by the planner or any other third party.

Now coming to wealth management, it is typically for those who have already accumulated a fair amount of wealth. Ofcourse, even these people would have goals and allocations need to be made to achieve the goals. The primary point of difference here is that the planning done to achieve goals may not be required as most goals would have been achieved and the focus would be more on growing the wealth. So the focus here is different. Plus, the wealth here can be substantial and that has to be managed efficiently. Also, there would be opportunities available before such a client which may not be suitable for a normal investor. Investments in a serviced apartment, a Private Equity fund or special structured products is a case in the point. Investments in properties abroad, special asset classes like Art, collectibles, fine wines etc. would again be useful for them.
The product portfolio that a wealth manager deals would be far more varied and complex as compared to a Financial planner. The team of experts that would have to be available to a wealth management outfit would be of a higher order. A very important factor for a wealth management client is taxation. Also important would be proper estate planning. A person having substantial wealth would want to leave behind a legacy and would want it distributed as per his wishes. Wills and trusts become very important for such clients and needs to be an integral part of wealth management.

To sum it up, there are points of overlap between the two. But they are for two different audiences and hence their focus differs. To some extent, they are like that tadpole and fish!

Published in Financial Chronicle on 7/7/2011