25 July, 2012

The Lord recommends Financial Planning!

Rajaram had been very tired that Saturday. He had brought some work to do but did not have the energy to even touch it.  He had just dozed off, with his laptop lying on bed and all his papers strewn about.

Aditi, his wife, had been urging him to look at their finances. She was the one handling the family finances. But, she was feeling overwhelmed. Rajaram was to assist her, but he had been keeping long hours and showed little interest.  Aditi wanted to take professional help.  Rajaram was not convinced. Aditi had enlisted the support of Srinivas, their friend. That is how I came into the picture. 

I was able to make out the desperate need for professional help, in their case. I had spent about an hour taking them through the process of financial planning and how it could bring clarity & peace of mind for them. The more Aditi heard about it, the more convinced she was.  Rajaram however, hemmed and hawed.  He was plainly bored.

I was surprised to get a call from him today, early in the morning. He wanted to meet me first thing in my office. “Would it be possible?”, he had inquired earnestly. I had agreed. When he came to my office, he had a determined look on his face. He wanted to sign up for a Comprehensive Financial Plan, right away.  This has happened with clients before. But still, I was surprised and wanted to know about his change of heart.
Rajaram looked at me piteously. Aditi however seemed to be enjoying it. “ You know something… I got a divine visitation today morning. I desperately need to  straighten out my finances”, he said with a zapped look on his face. He had a swig of water and continued. “I don’t know how you will take it. But I had seen God, face-to-face this morning and he exhorted me to straighten out my finances”. He looked at me. I had an earnest face and simply asked him lay it down straight for me.

He dived right in. He started narrating… I was in some forest and was walking down a path in the moonlight. Why was I here and what was I doing? I did not know. Not knowing that added to my already rising panic. It was as if someone was urging me on. I came to a clearing, which was actually the edge of the hill, I was standing on. The air was filled with a sweet aroma and a heavenly calm descended on me. I saw the silhouette of a figure at the other end. It was beckoning to me. I walked down and immediately knew that this was not just another man like me. The bliss I felt was indescribable. I knew this was my Lord Krishna. He was somewhat different from what I had imagined – but was magnetic in his appeal and supremely calming in influence.

The Lord enquired about me and the family. I was overwhelmed. He started advising me about life itself. At one point, it turned towards my finances. He was admonishing me for neglecting my finances.  “Do you know how worried Aditi is?”, he had remarked. “If you can’t devote time, why don’t you hire a professional to help you ”, he had said. I had resolved then and there to contact you. The Lord had added,”In one of my forms as Balaji, even I had to take a loan from Kubera to marry Padmavati!  Managing money is important.  I could have created gold and money. Your governments are doing it all the time – printing notes. But I wanted to show the world that even the Lord has to be disciplined with money.”

Next he was talking about my work, my responsibilities & duties… finally, he wanted me to go back home and act on all that he had enjoined me to do.  I prostrated before him. He gave me a flower and gave me my car key! Again I bent down to touch his feet and lo, he was not there.

He had told me that I would find the car by the road. I did find the car and drove down home. This place was just a couple of kilometers from my place. I did not even know that such a serene place existed.  Aditi was expecting me, which was a surprise. She had a dream and a visitation by the Lord himself, about how he has counseled me.  I had shared everything that happened with her. Aditi was pleased.

Here I am with you as per the Lord’s counsel. I did not want to waste any further time.

Seeing him in the right frame of mind, I quickly told him about financial planning… I told him that it was a blueprint for one to follow and achieve the goals one has in life.  A financial plan examines where one is, where one wants to go and how to get there.   A plan will also be able to clarify if the goals can be achieved or not, given the cash-flows and if so, what needs to be done.

I had to tell him too that this is not some investment advice that we are offering; but is far more overarching in scope.

I then told him of the very significant benefits of financial planning   1) a clear structure & path to walk down to achieve goals  2) specific actions to be taken for the purpose of straightening out the finances and moving towards the goals 3) discipline in money matters and regular investments 4) sorting out of one’s past investments & insurances, optimized investment portfolio with periodic reviews 5)  good risk management and security for the family 6) providing adequate liquidity, provisions & contingency funds, managing available finances well by fine-tuning the products to be invested in according to tenure, risk & return.    
Since it is a holistic exercise, it will offer tailor-made solutions for the family, to meet it’s specific objectives.
A financial plan will bring clarity and peace of mind. We will always be available for consultations on anything to do with your finances, I had told him.  The plan will also be revised every year to take into account all changes that have taken place in the intervening 12 months…

Rajaram seemed pleased – with himself. He seemed to know that this is going to work for him. He said,” I am fortunate to have a wife like Aditi. She is intelligent, disciplined and responsible. She will take this forward from now on”.  Aditi did not have a problem with this palm off. Only, I had to say that I would like to meet them both when the plan progresses. Rajaram was fine with that.

While leaving office, he was elated. He started humming a gay tune. He was himself again and Aditi was happy that finally, things have started moving in the right direction – God Speed.  

Article by Suresh Sadagopan ; published in Moneycontrol.com on 25/7/2012

24 July, 2012

Considerations for prepaying home loans

Having a roof above one’s head is a recurring dream among us. Most don’t find comfort and peace they seek, in a rental home, however good it may actually be. The primary reason cited is that we may be evicted from this home, anytime. That hangs like a Damocles sword over the head and many find this most disconcerting. The second is that the home may lack comprehensive facilities, which the landlord may not provide. Thirdly, there could be restrictions about the property usage, which can be stifling.

All these drive people to conclude that owning a home is the silver bullet to these problems. Since this belief is widespread, there is a huge demand countrywide for homes. With incomes surging & demand for homes robust, property prices have floated up, up and away. In many parts of the country, it has reached stratospheric proportions.

The upshot is that most people who buy properties take huge loans to give shape to their dreams. EMIs are hence an integral part of most people’s lives now. And these EMIs would go on for long – 20 years, on an average.

There is another quirk that afflicts our people. We have a tradition of eschewing loans. Virtually in every indian language there would be a wisecrack espousing the cause of living debt-free. Hence, being debt-free is an article of faith among most, due to which people are not comfortable having loans. They would like to prepay that as soon as feasible.

Should you prepay your home loan or is it advantageous to keep it? If you need to prepay, when and how much should you prepay? Let us discuss these.

The first aspect to consider is the stability of income of the loan taker. If that is in question, servicing an EMI over the years can pose serious problems. Self-employed can find the income varying a great deal – surging at certain points and dwindling at others. Even among those employed, some employments are more stable than others. In such situations, every endeavor should be made to reduce the loan amount, at every possible point, irrespective of the tax-savings or other considerations. Bonus/ Exgratia or any other inflow can be used to retire outstanding loans. This will bring down the exposed loans.

The second situation where it would be suggested to reduce the loan would be, when the home loan EMI as a percentage of take-home pay is beyond 40%. When the amount is higher than this, it exerts a lot of pressure on one’s cashflows, which is not healthy. Bringing the EMI amount to 40% of the take-home income or less is desirable. It is even more necessary if there are other EMIs for vehicle loans, personal loans to consider. If the EMI amount on the home loan comes below this 40% threshold and does not pose cashflow problems, it can be continued subject to effectively low interest rates, which is the next aspect to be considered.
The third aspect to consider is the effective interest rate that one is paying. In case of home loans, the principal portion comes under Sec 80C and the interest portion comes under Sec 24. After accounting for all the benefits, if one were to calculate the net cost of loan and that interest cost is above what one can earn by investments in a fixed income instrument, then pre-paying the loan is desirable. For instance, if the net interest cost amounts to 9.75% and the post-tax returns from any fixed income instrument is at best only 8.2%, then it is preferable to prepay any extra amount one has.  
The fourth aspect to consider is the tenure. If due to interest rate increase, the tenure extends beyond the superannuation age, it is a red flag. It is desirable to bring the tenure down so that a person can pay-off the loans before he retires. It is generally desirable to finish the loan several years prior to retirement, as a safe practice.

Home loan is a comparatively low-cost loan. If one wants to access loans for others, say a vehicle, it may make sense to instead keep the home loan intact instead of prepaying it and use the cash to reduce the loan to be taken for a vehicle. This will reduce the overall costs. For instance, if one wants to buy a Rs.4.5 Lakhs car in 2 years, and one also has a home loan of Rs.25 Lakhs with an effective interest rate of 9.75%, it may be a good idea to not prepay the home loans in the next two years. A better idea would be to invest the amount that could have been used for such pre-payments and reduce the vehicle loan to be taken. Vehicle loans would be between 2-4% more than the home loan rates and they offer no tax breaks for salaried individuals.

After these considerations, one could decide to keep the home loan or part-pay based on the various points discussed. One could also decide to tweak the EMI. One could keep the EMI high, even though prepayment has been done, to bring down the tenure. Or could allow the EMI to come down as the loan exposure amount goes down, if the tenure does not pose a problem.

The main aspect to keep in mind is that one cannot get obsessed with closing the home loan. Proper consideration needs to be given and one needs to act on the merits of the case.

Article by
Suresh Sadagopan, Founder, www.ladder7.co.in   Published in Business Standard on 22/7/2012

Is MF a good investment option?

This may sound like a question whose time is long past… most invest in Mutual fund schemes and it is known that, for the normal investor, this is definitely a very good investment option.

There are several things going for Mutual fund schemes. One of them is that you get professional oversight for a small fund management fee ( which is about 1%). You get unparalleled diversification, which is possible for as low an investment amount as Rs.5,000/-.  Thirdly, liquidity is assured as the counter party is the Mutual fund and they will redeem the unit at the prevailing NAV. You will not have a situation like in the case of some penny stock, where there is no one to buy the clutch of shares you own.   Fourthly, the investment amount is pretty low. There are different flavours of funds to suit every investment type and risk profile.  What’s more, the equity funds enjoy nil capital gains tax, after one year of investments and debt funds provide far more benign capital gains tax treatment as compared to other fixed income products. All in all, it seems like a winner.

Now, if you get all these served up in a Mutual Fund scheme, what are the costs?  In any product that we procure, including financial products, there are costs involved. If it is a soap, the costs involved are raw material, manufacturing & overhead costs, the company’s profit and the cost of sales, advertising, marketing and distribution. The cost of the raw material, overhead & manufacturing may just be 50% of the final price. All the rest of the costs come in later.

In case of farm products, it is worse. The final price the customer pays is  4-10 times the farm-gate prices! This is a well-documented fact and we pay these prices as there is no other alternative, for the moment.  So, in every industry, there would be costs involved in reaching the product to the end customer.

In case of Mutual funds, for all the convenience it confers, the costs are recovered by way of an expense that the fund charges. Currently, it is capped at a maximum of 2.5%pa of schemes net assets, for equity assets. This is the only revenue for a MF fund house, with which to run the show.  This is expected to go up now by 0.25%.

This means that out of your income, you would be forgoing 2.5%. Is it worth it? That is the debate. Let us examine.

Margin of outperformance - A good fund can outperform the index by a wide margin. As an example, the top 20 MF large-cap schemes have offered one year returns of between 1.28% and -3.99%. Whereas the corresponding indices have given one year performances of -6.5%  to -8.17%. In this case, there is a clear outperformance enough to justify the expenses. However, if one had invested in the next 20, their one year performance were between -4.2% to -7.07%, which do not fully cover the expenses paid.  Hence, to fully recover the expenses, one must invest in good, performing funds. But, performance keeps changing on a monthly, quarterly basis.

It’s not always about expenses, though -  We need to understand a key aspect. It is not always about expenses. In life too, we spend on petrol and car for convenience. Similarly, there are major advantages discussed earlier in a MF scheme, due to which the expenses are justified.  Out performance is one of them. There is just no point in obsessing over this alone, like a lot of people do.

Portfolio review - That does not mean that one should be oblivious to fund performance. Fund performance is very important indeed.  It is necessary to keep track of what is happening in the scheme one has invested.  A review from time to time is vital. Such a review & investigation will reveal,  if there are fundamental changes that  needs to be factored in. Fund manager change is a fundamental change, irrespective of what processes a fund house may have. When a fund is being revamped or repositioned, there can be sweeping changes. Changes can also be in terms of sectoral allocations, cash calls and moving substantially from the core objective of the scheme. In such cases, changes may be required. For this, one needs to keep track. If that is difficult, one needs to take help of an investment advisor.

Asset allocation – Each person’s need is different. The portfolio that works for one, need not be suitable for another.  Hence, don’t just look at five star funds and make the portfolio.  One might end up with a sectoral or small cap fund portfolio, which may not be what would be suitable. Having assets across categories brings down the risk, though it may be tempting to put everything in what seems to be performing today ( it was Gold sometime back !).

In conclusion, Mutual fund schemes offer a lot of advantages like assured liquidity, amazing diversification, professional expertise, ease of management etc.  There are expenses, but it confers several benefits we have discussed about.  Also, if the fund manager is able to beat the performance of the corresponding index and offer that monetary incentive to invest in a MF scheme, so much the better. Many of them do. One will need to do a bit of homework or take help. 

Lastly, MF is a longterm investment. Stay with it & it will be rewarding.

Article by
Suresh Sadagopan, Founder, www.ladder7.co.in  Published in Moneycontrol.com on 20/7/2012

21 July, 2012

What options are available before an individual to achieve child related goals

We are always running after something. As children, we run after grades, then college admission, then a suitable job, then after a suitable mate, then children and then their education… phew. Education of children is a pretty long-term affair, which these days require huge commitments, in terms of time and money.
Now, lot of us don’t have time as we are immersed in our careers, trying to make money. But, since we don’t have time and competition is intense these days, we put our children in tuitions. That takes a lot of money again! We all know time is money and it’s full meaning is evident more than ever, when we pay the tuition fees!

Children’s education has always been a cherished goal for most. We would be willing to go hungry than see children’s education suffer. Since we attach so much importance to it, it may be deduced that we would spend time and effort to invest for it, appropriately.

Alas, that is not true in most cases. Though they intend to do their best, they put their money away in nice sounding schemes. Insurance companies have come up with policies specifically for catering to this goal. People do fall for the emotional tugs & the happy situations that these policies tend to portray. They also tend to think that if they have taken a child insurance, their job is kind of over. Insurance policies for children may have a role for those who want their insurance and investments bundled. For this convenience, it comes at a price.

For all others, there are several instruments available to build a portfolio with which to achieve the child’s education goals. There are lots of advantages to investing in a good bouquet of instruments. They are –

1.    Choosing the instrument/tenure & type, according to when the payments are due.
2.    Option to choose from among the various instruments
3.    Diversification among various asset classes
4.    Lower cost to you, as an investor
5.    Ability to change the mix as we go

Estimating the amount required for education is a tricky job in itself. One needs to extrapolate it with the benefit of some hindsight and trends that are apparent. The first thing one needs to do is to take a term insurance for an appropriate amount, to cover the child education ( and other ) goals. This will address the uncertainty risk. Today, term insurances are available for a song and securing a good cover is not difficult. Also, one needs to take an appropriate medical insurance. In a medical emergency, a person without a medical cover could be forced to use money being accumulated for another goal.

After doing that, determine as to when one requires the payouts. Based on that and based on the risk-return possibility of the instruments, one could suggest from the rich profusion of instruments available. PPF can be chosen if the child is very young and the money is required for graduation/ post-graduation. Since this is a 15 year tenure instrument, it offers decent possibility of accumulating a good corpus, overtime. Also, this brings in a certain solidity to the portfolio as it is a government backed scheme, which offers tax-free returns.

For shorter tenures, there are bank and company FDs. Currently, their returns are between 9-10.5%, which make them attractive. But the returns from these are taxable, which diminishes their attractiveness, to an extent. But since these are for shorter tenures and the returns are certain, they bring in predictability of cashflows.

Debt funds are good to have in one’s portfolio as they are tax efficient. Their returns may not be much different from FDs; but their post-tax returns are much better considering they are subject to capital gains tax and not normal taxation. If the tenure is over a year, indexation applies. Long-term capital gains are at 10% without indexation or 20% with indexation. Fixed Maturity Plans ( FMPs) offer the comfort of better tax treatment, just like debt funds. It further has the advantage of having a portfolio which is held to maturity and hence no volatility in returns.

Equity & Mutual funds are other investment options which have the potential to offer good returns over time, but may not be suited if the time period is less. For beating inflation, equity and equity oriented MF schemes remain the best bets. This could be contested now as the past 4-5 year returns are poor. While that is true, it remains the best chance to beat inflation over time – history shows us that. There have been other periods when the stock markets have not performed… yet, over time ( over 30 years ), it has been able to deliver 17% pa compounded returns. What is required in this case is patience – loads of it… and iron conviction that history will repeat itself.

Gold and property have been other assets which are fancied today. Property has long cycles. It will work only if one has a long horizon. It can work in the short-term too, but you just cannot take that chance as that would put your child’s education on the line. Gold is doing well in the past 10 years. If you look at how it has performed in the last 30 years or more, it is a lot less flattering. Investing in gold for education may not be very suitable.

We see so many options, which can be chosen judiciously would help us put together a good portfolio, to achieve the child education goal comfortably. No need to fall for advertising legerdemain. Just a little bit of diligence will help one to put together a portfolio to achieve child education goals.  

Published in Financial Chronicle on 19/7/2012; Article by Suresh Sadagopan

Reviving the MF Industry

The entry load abolition was a watershed event for the MF industry. The industry has been sliding since and is now in a sorry mess.  The rapid-fire changes that were imposed on the industry added to the woes. Admittedly, many of the measures were good. But, they imposed a punishing load on the distributors, MFs and their R&Ts. This increased the costs when revenues had shrunk. To compound the problems, the stock market in this period had played truant. Result – an industry which is a spent force today and is a mere shadow of it’s former self.

Media bought the logic of investor friendliness, hook, line and sinker and went to town about how SEBI’s moves were – oh, so investor friendly. They depicted intermediaries as some rapacious plunderers and sullied the name of the entire community. It was true that some people did unethical acts. It was also true that it could have been handled by simply identifying and punishing the guilty, instead of tarring the entire distribution community and penalizing them with oppressive regulations.

Lot of water has flown under the bridge. Many distributors have found the profession to be all work and no pay and have hence since quit. They have sought other professions which allow them to earn a living, in a dignified manner. It is easy to mouth platitudes that the distributor can collect a fee, if their services are good. The fact is that most of the investors at large are not mature & professional enough, to pay for services. The problem in part was the making of the distributors themselves; they used to pass-back a portion of their commissions to the investors. How will they go to the same investors and now collect a fee? In a sense, they reaped the bitter harvest of their past karma.

SEBI & particularly it’s erstwhile chariman Mr.Bhave were not willing to give anytime before bringing in a game changing regulation.  It was a fait accompli that they foisted on the industry. The problem was that they also did not know what will be the effect on the industry, but still they persisted and look at the result!  SEBI should have first undertaken the task of communicating with the investing public and raised the level of public awareness on the sea change they were bringing about and what the investor was to expect and do.  Instead, they irresponsibly called distributors – courier boys. How do they expect self-respecting intermediaries to stay in the industry, which was anyway getting into the sunset mode? SEBI conveniently packaged the whole bitter sludge with a sugar coating called investor protection and got away. But the havoc it brought on the industry is there for all to see.

What can be done to get the industry back on the rails -

1.       Remuneration of intermediaries :   This is at the core of the matter.  The simple fact is that there should be a way for the intermediaries to earn respectably, instead of going to the investor and begging for a fee.  A standard percentage of the invested amount can be collected as a fee, along with the invested amount. For instance for an investment of Rs.10,000/-, an amount of Rs.100 ( let us say the fee is 1% ) is also collected in the same investment cheque as Rs.10,100/-. Rs.100/- is paid by the MF to the intermediary by the MF. This becomes transparent and will bring viability to the distribution community.

2.       Leave alone the industry :  We all understand that SEBI is very concerned about the investor. Now, thanks to their policies, there are legions of orphaned investors  who find that their distributor has moved on.  The industry has had it’s share of regulations. It is hightime that it is left alone to find it’s level, settle down and perform. The last thing the industry requires now is the regulator coming behind them and pulling them up for non-performing funds. The regulator should be more worried if there is non-performance due to non-compliance of regulations. The non-performers would anyway be taken care of by market forces and be driven out of business.

3.       Recognise the cost & time involved :   If the distributor has to maintain the rationale for recommendations, in every client case and needs to record every conversation, he has with the client ( which is at the proposal stage ), it will eat up on his time and would be costly to comply. If such regulations are brought in, the actual costs & time lost on such compliance needs to be recognized and should be built into the fee charged to the investor.  Similarly, sending reports to clients on a monthly basis is an investor friendly and welcome step. But, it costs money, which MFs have to bear. When regulations are brought in, the costs that it imposes should be recognized, and there should be a mechanism  for the MF / distributor to recover it.

4.       Be actually investor friendly : Asking even an investor who invests Rs.5,000/- for KYC, is taking matters too far.  If MF investments need to come from all across the country and not just Mumbai & Delhi, then a threshold to invest without KYC ( like upto Rs.50,000 ) should be brought in.  Processes have become complicated. For instance, a bonafide investor who has given one bank account and has now closed that account and wants to receive the amount in another bank account, has to go through a tortuous process where he gives proof of both accounts, before he gets the money. If the investor establishes his bonafides and is able to prove that the bank account is his, why haul him through coals. A lot of such rules exist today, which rattles the investor, instead of helping him.

SEBI needs to focus on bringing in an enabling environment where all stakeholders will benefit. Investors alone cannot benefit if MFs & their distributors are impaled.  It is not a question of entry loads. It is matter of change in attitude that will bring in the changes necessary to revive this industry.