Planning for the year ahead

It was dark.  Bala got out of bed to go to the bathroom. On his way, he  saw light streaming out of the hall. How many times I have asked Pranay to switch off the TV before going to bed -  he was cursing under his breath. When he reached the hall, he was able to see that the TV was off and a blinding light was coming from the far-end, near the sofa. 

Bala was thoroughly perplexed. For a moment he thought something was afire. The light was however a powerful white light and there were no flames or smoke.

He was confused. He heard a voice call him. For a moment, fear paralysed him. The light was now subsiding and he was able to make out the silhouette of someone seated on the sofa. He panicked, thinking that it might be a burglar.

Sensing his panic, the figure addressed in a soothing voice, ”Don’t worry Bala. Don’t you recognize me? ”. Bala’s panic subsided; but he was questioning his sanity now. He slowly moved forward and found a  saintly figure seated on the sofa, with a flowing beard – much like Bhisma pithamaha.

Somehow the benign countenance comforted Bala.  He felt a surge of reverence well within him. “No Sir, I’m not able to recognize…”, he trailed. Then it dawned on him that this could be the Lord himself. He immediately fell to his feet and when he looked up, he saw the Lord, as he imagined him. Then he was back to being the Bishma pithamaha.

Words failed Bala. The great one gave tongue. “We are almost upon the new year.  You people make resolutions and then promptly break them. Why don’t you keep them for a change?”.

Bala’s tongue still was in knots. The Grand Sire intoned –“Let’s see what you can do in the next year – Finances is an area which you have mismanaged, all along. Why not take a few resolutions in that area and keep them?”

Bala’s heart was in his mouth. Finances were his nemesis. He could hardly manage two plus two – forget about managing finances. For a moment he was angry. Then he realized that he was dealing with The Almighty. Bala felt privileged, for God had chosen to talk to him, though it was on finances.

Invest before spending, said the Sire. Now this was a new paradigm for Bala. He normally spent almost everything and invested if he had anything left behind. The Lord knew what was going on in his mind. “You always have to think about the future. Future is not always as rosy as we think & hence the need to save”, cautioned the Lord. This got Bala a bit worried… was God hinting at an upcoming problem… a job loss perhaps?

“No, that is not what I’m getting at”, said the Sage, reading Bala’s mind. “I was just being cautionary and meant that one should put aside money to meet future goals. But many of you cash out your future income itself, by taking loans and buying what you cannot afford.  So, that’s the next one you should not do”, the Lord said.

Was he talking about him, wondered Bala again.  Bala had been in the habit of taking loans at the drop of the hat. He has a home loan, car loan, personal loan & a small loan for the washing machine.  Yes, he could have postponed some of it – like the washing machine. He had replaced a perfectly working washing machine with a new one, since he liked the technical wizardry,the bells and whistles the new machine had.

The-cashing-in-your-future-bit now hit him. He realized at once that he was recklessly spending his future earnings and is also jeopardizing achievement of major future goals, like retirement and education for his children, by throwing money on unnecessary thingies.

Bala resolved then and there that he will put a stop to such impulsive purchases and giving wing to flights of fancy.

The Sage was smiling. “That’s good”, he said.  That will ensure that you don’t have to keep looking for a new job, every couple of years. Bala was speechless. He had just that idea the previous evening, but he had dismissed it. He was doing well in his position. The thought had come in the first place, as he was struggling to make ends meet, inspite of his good income.

“Be realistic in your expectations. Be willing to take some risk. Give your investments time. Don’t worry too much after investing. You should have done that before”, the Lord said.

Sage counsel – Bala thought.  We all invest in something and start worrying. We pick up the paper and check the quotes and get palpitation. We don’t give the investments time. And in those cases where we cannot check, like property, we don’t worry, we retain it for long and tend to make money. Bala instantly understood that risk reduces with time – risk is inversely proportional.

“And finally, don’t chase fads. Don’t invest because everyone else is investing. Invest only if it makes sense in your portfolio. Invest as per the asset allocation required in your case for meeting the goals. What is good for one, need not be good for another”, held forth the Lord.

Bala was deep in thought. Yes. All these are good advice, which I should incorporate, he thought. There was a blinding light and the Lord was gone. Bala was in an uplifted mood now. He cannot go back to sleep now. He saw that the clock and it said it was five in the morning. He resolved to go for an early walk. The weather was great. When he hit the road, there was a cycle passing by with a man gaily pedaling and waving to him. “All will be well”, he said while he passed and then pedaled away in a jiffy. Bala saw the beard and he thought he caught a glimpse of the Bhisma pithamaha!

Article by Suresh Sadagopan ; Published in Moneycontrol.com on 29/12/2011     

Planning Holidays – How viable are club memberships?

Holidays for most people used to be a trip to hometown and back, twenty years back. But, that was then. These days, trips to hometown, do not count as holidays. Holidays are separately planned, often to far-off and exotic locations. That can cost quite a packet, as we can attest as Financial Planners, being privy to what our clients spend on their vacations.

The spends can range from Rs.25,000 to several lakhs of rupees. This means that, for some of them, this is a major expenditure item in a year and careful planning needs to be done. 

This is where time share resorts come in. RCI, Mahindra Holidays, Country Club, Sterling Holidays are some of the popular ones.  The concept in a timeshare is that one can avail of a holiday, for seven days in a year ( normal scenario ), in one of the many locations of the service provider, for a specified period, like, say, 25 years. For that, one needs to pay a certain sum of money in advance, say Rs.3.5 Lakhs. This money is either paid in a lump-sum or as part lump-sums & part EMIs. Apart from this, one also needs to pay an annual maintenance fee, which may be Rs.7,000 – Rs.20,000 pa. 

So, is that cost effective? The answer is not straight forward. These club memberships are not cheap, for sure.  The main reason why many want to go for such memberships is 1. Hassle free holidays – the rooms and the resort are good  2. Once there is a club membership, one may take a good holiday every year, instead of skipping it 3. Peer pressure & keeping up with the Sharmas. 

Now, everything depends on the kind of resort, facilities and services available.  Some of the resorts do have excellent facilities and the experience is entirely positive.  In some other cases, the experience is not so good and one feels cheated. Many of the resorts claim to offer five star quality rooms. My personal experience is that the rooms are pretty good, but the claim that they are five star quality, is a stretch. But, over all it had been good. Again my personal experience with another service provider was substandard. The room was OK; but the resort was like a housing colony in Mumbai. I definitely felt cheated. 

So, that’s the problem. The quality of the resorts & the rooms may not be uniform, especially for a provider like RCI, who depends on various resorts coming under it’s banner. Ofcourse, one can pick and choose and go to specific resorts, based on the feedback one has received from others who have used & hope for the best. But, that beats the purpose of choosing a club membership, which was for hassle-free holidays.

From a purely financial standpoint too, it is not a easy decision to make. Again, the cost is high or low depending on various factors – what kind of accommodation would you normally stay in and what you would pay, your willingness to evaluate various potential resort options each time you want to go for a holiday and other factors. If you want a uniformly good experience, you are better off with a good club / resorts chain, where you are confident of the resort and room quality and you would want a hassle free holiday. In this case, one would pay about Rs.44,000/- (Rs.35,000/- interest on the amount paid + about Rs.9,000/- as Annual maintenance charges , based on the example ), which works out to  Rs.6,285 per day for the people covered. That is not exactly cheap. Also, the amount paid does not come back to you, which adds to the cost too. 

There are alternatives available from various other travel agencies these days, which could give very competitive options. For those who do not commit for the very longterm, one can take advantage of the offers available. This ofcourse means more homework before zeroing on the holiday, but there is the benefit of not paying a huge sum upfront and the choice of going to any destination of one’s choice, over the years, instead of restricting to what the club/ resort chain has on offer.  It could also be cheaper.

On the whole, Club/ resort chain option would be a great idea for those who want to go on a holiday year-on-year, want hassle free holidays in quality resorts.  The downside is that the price can be  high, they get stuck to that chain, the holidays can be accumulated only till a point, after which it will lapse. Also, this is a very long term commitment that they are making and there is an inherent risk in it. In the other option, the advantage is that you don’t have to commit for the longterm, you are not chained to the resorts available with the club and your holidays may be of much lower cost. The downside here is that you may have to spend time & effort evaluating options for holidays each time, the experience will be good sometimes and not so at others.  

Choose the one that suits you best, based on what you are actually looking for.

Article by Suresh Sadagopan ; Published in Financial Chronicle on 17/11/2011

Small Saving schemes – Are they attractive in the new Avatar?

Small savings schemes used to be a major attraction, with investors. But, small savings schemes returns used to be static. With rising interest rates, other assets had adjusted their payouts – but that did not happen in the case of small savings. Due to this, small savings schemes lost out to Bank FDs, NCDs, Company FDs, FMPs and the like.

Now, that has been corrected to some extent. Is this going to excite people and make them go for these?

Unlikely, in most cases. The changes are there, but small. Time deposit in post office have gone up from the 6.25 – 7.5% range to 7.7 – 8.3% range. NSC has gone from 8% - 8.4%, but the 5% bonus at maturity has been discontinued. Hence, there is not much change in the returns. Now, NSC has a tenure of five years, down from six years. There is also a 10 year NSC which has been introduced now, offering a 8.7% return. All these instruments are currently offering returns lower than what a bank FD offers and may not sit well with most people. Those not in the tax bracket or in the 10% tax bracket and want government guarantees, may find these useful. An NSC offering 8.4% translates to a measly 5.8% post tax, for someone in the highest tax slab. That’s not much, isn’t it? Especially, when inflation is hovering between 9-10%.

The other change now is that, the rates have been linked to the government securities of similar maturities, with a 25 basis point spread ( 50 basis point spread in case of the 10 year NSC ). So, expect these rates to go up and down every year in line with the prevailing rates then. The rate for Senior Citizen Savings Scheme ( SCSS ), has been kept at the same level of 9%. The spread has been kept at 1% compared to the prevailing government security rates, keeping in mind the fact that Senior Citizens may depend on this income, for their sustenance.

However, the interest rate for PPF has gone up to 8.6%. This makes it attractive as this is a post-tax return. The post -tax return comes to 11.3% ( assuming Sec 80C benefit is being availed ), which is fantastic. An instrument yielding north of 16% pre-tax returns only, can give you such returns. Hence, this becomes a very good longterm wealth creation tool, in your hand. Also, the investment limit per year has been enhanced to Rs.1 Lakh. PPF comes under Sec 80C and helps you to save tax, in the year of investment where you can take advantage of the enhanced limits. All in all, PPF has become a very attractive long-term savings instrument. It always was a weapon of choice for meeting longterm goals, especially Retirement and Child Education. Now, that weapon has become far more potent!

Make the most of this new opportunity in PPF, that has come up. Otherwise, the other optione mentioned earlier – Bank & Company FDs, NCDs, Bonds, FMPs – score over other small savings instruments. Another one that could offer excellent return possibilities over the next 2 – 3 year period could be a debt MF scheme, especially with medium and long maturities.

Choose wisely, depending on your horizon and risk return expectations.  

Article authored by Suresh Sadagopan; Published in Moneycontrol on 16/11/2011

Financial Planning is not Investment Advisory

These are terms which are used synonymously – but they actually mean two different things. You might have heard of many. Sales & Marketing is one such pair. They are often used interchangeably. Sales is the art of persuading a client to buy a product or service. Whereas, Marketing is the sum-total of all activities from product conception, branding, retailing, communications and beyond, whose overall purpose is to ensure product sales. But these two areas are entirely different. There is another funny indian-ism which I have heard – I’m going to the bazaar for marketing ( which is their way of saying that they are going to the market to buy stuff !). A similar confusion surrounds Financial Planning & Investment Advisory. Financial Planning refers to drawing up a blueprint to achieve the goals one may have, through appropriate use of the finances at one’s disposal. Investment advisory however generally refers to understanding client requirements and advising appropriate products to invest in. An Investment Advisor ( as per Investment Advisors Act 1940 of US SEC ) is a person or a group that makes investment recommendations or conducts securities analysis for a fee. This clearly establishes the limited nature of engagement in case of an investment advisor as compared to a Financial Planner. A Financial Planner is like an Architect, in the sense that an FP draws up a blueprint of what needs to be done on various fronts like liquidity & cash management, goals feasibility & planning, Risk management, Long-term cashflow planning, estate planning… Investment advice comes at the end in a financial plan, after all aspects have been analysed. It is a by-product of comprehensive analysis of one’s situation. In that sense, the investment advice will simply flow out of the analysis done. For instance, if the risk assessment shows that Rs.1 Crore of insurance is required, then that will automatically come in the recommendation. Also, unlike in the case of an investment advisor, a financial planner will also look at past investments and offer advice on these, to dovetail with their overall plan. In a nutshell, a Financial Planner looks at one’s finances holistically, in the light of all the goals/ finances overtime. However, since almost everyone in the Financial Services space – from an insurance agent to a MF distributor to a stock broker – all use the term Financial Planning in a way that is convenient to them, there is lot of confusion in the minds of the public, at large. A chemist cannot call himself a Doctor. Similarly, agents/ distributors should not be allowed to call themselves Financial Planners. Such legislation is the need of the hour. However, SEBI through it’s Concept Paper on regulation of Investment Advisors is proposing to call an Investment Advisor, anyone who is offering Financial Advice, Financial Planning Services or any action that would influence an investment decision. This is extremely curious, as, financial advice, financial planning & something that influences an investment decision are three different things and cannot be clubbed under the single head of Investment Advice. Financial Planning is not Investment Advisory, though it is a small part of the overall plan. An Investment Advisor indicates a far more limited role than what a Financial Planner performs. More confusion will result if this concept paper sees the light of the day. Again, many use the appellation “Financial Planner” just because they have completed a Financial Planning course, but continue to be an insurance agent. This again confuses the normal investor as they see a person who is an agent, use the tag - Financial Planner. The need of the hour is for the investing public to know, who is a Financial Planner, who is an agent and who is an Investment Advisor. Only then they would know as to whom to contact for what. Simply calling a whole lot of people investment advisors would only confuse issues for the public and result in them approaching the wrong kind of advisors, which is precisely what SEBI may want to prevent. A simple rule applies as always for you – Keep your eyes and ears open. Understand what a particular person can do for you irrespective of what they call themselves. Check out past work they have done; talk to a few references; check whether they have appropriate qualifications, standing & experience in the field. Finally find out what they are charging and evaluate for yourself, if that offers a good value proposition or not. There is just no alternative for keeping one’s eyes open and ears to the ground. A healthy dose of common sense additionally helps! Authored by Suresh Sadagopan ; Published in The Economic Times on 17/11/2011

Understand the taxation on various products and benefit from them

There are advertisements these days for FDs, advertising 12-13% returns. But these are misleading as they just calculate the yield for the tenure of the investment and divide it by the tenure. For instance, if the yield is 10.75%pa for a five year deposit, the cumulative yield for the 5 year period is 66.62%. Dividing this by the tenure ( 5 years ) , one gets 13.32% as the annual return. But this is not correct and the annual return as we have seen in the beginning, is only 10.75%pa. But, people get misled by these numbers all the time. Also, these yields are just pre-tax returns. Now, if one calculates post tax returns, it will be even less impressive. For a person in the highest tax bracket ( 30.9% ), a 10.75% annual return turns out to be just 7.43%. That is not very impressive, is it? It obviously isn’t, with inflation itself hovering between 9-10%. One is actually getting a negative real return, this way. It would be better if this haircut called tax is not there, would’nt it? Unfortunately, it is going to be there. Is there a way out? There is, but not in FDs. In case of investments in Mutual Funds, the gains from the investment are taxed in a different manner. For investments upto 12 months, gains from them are treated Short-term and beyond that, gains made are treated as Long-term gains. In case of Equity oriented funds ( funds investing atleast 65% of the assets in indian equity ), the tax on short-term capital gains are at 15%. This is irrespective of one’s tax slab. Tax on long-term capital gains for Equity-oriented funds is nil, currently. For debt funds, the Short-term capital gains is taxed at one’s income tax slab and long-term capital gains are taxed at 10% without indexation and 20% with indexation. In case of dividends that are paid out, there is a dividend distribution tax, which is applicable. It is 13.51% for individuals, for most debt funds. This is paid by the fund house, but the investor is indirectly bearing the same. The amount coming into the hands of the investor is hence tax-free. This would be useful in cases where the investment is for less than 12 months and the investor is in the 20-30% tax slabs. The Long-term capital gains tax of 10% without indexation or 20% with indexation is applicable only for financial assets. For other assets, the gains are treated as long-term only after a period of 36 months. In case of property, gold or other assets, the tax on long-term gains are 20% with indexation. For this reason, Gold ETF would be a good bet ( instead of Gold ), as the capital gains are treated as long-term after 12 months. The tax treatment for long-term capital gains are like debt mutual funds. There are several other advantages of investing through ETFs like low transaction charges, no storage, no worry about purity etc. This has hence become very popular and Gold ETFs have been mopping very good sums in the recent months. It is important for an investor to hence understand where they are investing and the tax treatment for that instrument. This simple knowledge will assist them to maximize their post-tax returns and enable them not to fall for any advertising gimmicks offering 12 & 13% returns. Article by Suresh Sadagopan ; Published in moneycontrol.com on 30/11/2011

Advantage Customer!

RBI has done it at last… freeing up the interest rates on Savings accounts and allowing the market to determine the rates. This is a very welcome move. Also, this corrects a historical wrong. If RBI ( which is an entity with zero risk ) borrows at 7.5% currently, it stands to reason that other banks ( which carry more risk than investing with RBI ) should pay a premium to that, while borrowing from customers. Hence, Savings bank rate should actually be higher than the reverse repo rates. But bank SB customers were getting 3.5%pa as interest all these years and it became 4% pa very recently. Current account holders were and are still getting nil returns, which again is unfair as the banks get to use the money and it is essentially free money for them. They are firing from someone else’s shoulder! Now RBI has corrected the anomaly, at least regarding savings account interest rates. It has allowed the banks to offer a standard interest rate till Rs.1 Lakh in the Savings account and a differential rates above Rs.1 Lakh, for various slabs, as determined by the bank. Some banks, who have huge amount of CASA ( Current account Savings Accounts ) deposits are crying hoarse that this will impact their profitability and hence they may have to charge higher rates for loans. What they are crying about actually is about loss of easy money, which was a low hanging fruit for them. They justify the low rates saying that they give various services. These days every service is charged – be it a cheque book, a signature verification etc. So, that rings hollow. Now, competitive pressures will ensure that the interest rates for Savings accounts will go up. Yes Bank has already announced 6% interest in their SB account. This is probably the shape of things to come. Some of the banks may not increase it to that level, but will still have to take it up, if they want to ensure that money stays in Savings Bank accounts. Even 6% they are paying is very low. As seen earlier, it is much lower than the interest RBI pays banks! So, banks have no reason to complain. A specious logic I have seen in the paper says that the higher interest rate in savings account will result in a small increase in the interest rate, amounting to just hundreds of rupees. But that is the money which belongs to the customers – so it does not matter if it is hundreds of rupees or it is less than Rs.10. My experience with my clients shows that people do have substantial sums of money in their savings accounts. For them, the difference will be in thousands of rupees, not just loose change. Now the moot point – do you need to change your bank, if your bank is unwilling to hike the interest rates. It appears that banks will not have too many options in a competitive landscape. It is debatable whether they will go all the way to 6%. But 5% seems very much possible. Once many banks first come to this level, the ones who are sitting on the fence will have no other option but to follow suit. So, you are bound to benefit in any case and there is no need to change banks for now. But if your banks is playing truant, you could always close the account itself, if it suits you and open with a more customer friendly bank… or you could simply open a new account in the customer friendly bank and keep most of the deposits in it. The main point is that banks can no longer take you, their customer, for a ride. Authored by Suresh Sadagopan ; Published in Moneycontrol.com on 2/11/2011

Legislation is no replacement for Financial Literacy

Visiting parks and gardens has always been a pleasurable & soothing experience – not to relieve my straining bladder as my initial description might have indicated. It gives immense happiness just to be amidst the greenery and the sublime serenity that these havens seem to exude. So, I suppose it’s settled why I visit parks… While we take the whole thing for granted, it takes enormous effort to create one. There are all kinds of plants – some that grow without any support and others like vines, which require support. All these plants would ofcourse require optimal dose of nutrients, water, sunshine and tending so that they grow & flourish. Also, there are pests and animals to take care of. In effect, quite a handful needs to be done to ensure that what is planted, grows. Our government has given the framework in the Financial Sector by way of legislations – for Equity/ MFs, Insurance, Micro finance, Banks etc. There has been quite a burst of activism among the various regulators, in the recent years. They are striving to create an environment where the investor will not get misled and get a good deal. This is a laudable objective. In some senses, it is working too. But, legislation alone is not a panacea that will cure all ills that the common investor is afflicted with. The missing links today are that the investor is not fully aware of the financial landscape, the products & services, does not have the knowledge to interpret the information that is presented to him and is unwilling to allocate enough time to study the offerings and make informed choices. That ofcourse opens out the field for manipulation from unscrupulous elements, who will lead them up the garden path and sell them some apple-sauce, which is entirely unsuited to them. Result – an aggrieved customer, who thinks that the financial landscape is crawling with crooks. Turncoats there are, like in any profession. And like everywhere, the good ones far outnumber the black sheep. The problem in this case was both knowledge and willingness to spend time, understand the offering and take an informed decision, instead of blindly signing at every cross-mark that have been so thoughtfully pre-printed! This is an aspect that seems to have eluded the regulators. An informed and engaged customer is far more likely to take correct decisions; time and effort needs to be put in that direction too. Legislation is not a silver bullet that will cure the system of all it’s ills. Legislation is rather just one of the important components, not the only one. The regulators have been neglecting this aspect and it is showing up… instead they tend to bring in more regulation and end up over-regulating the industry under their charge, wringing out the life-force from them in the process. People are getting fooled by pyramid schemes, they get sold wrong insurance products, are holding unsuitable MF schemes, get into risky financial products, have wrong asset allocation… many investors just go by what their friend or colleague has done or recommends, without understanding the suitability. Lots of them chase fads – currently it is gold, silver & property investments. Some of these can be attributed to greed. But the significant other problem is the lack of financial literacy. Legislation cannot solve this. Concerted effort is required to address this. It is easy to bring a law – just a committee of a few people can bring in a well-meaning piece of legislation. But, education/literacy takes time to percolate. Putting up a few pages is not tantamount to educating people, as some regulators tend to believe. Ofcourse, that part is easy and that’s why they do it. Financial illiteracy costs everyone a lot. It hurts the investor, the distributors, the financial service companies & the economy at large, as an investor who has a bad experience does not go back to that asset class. For instance, many who had invested in company FDs in the past and lost money, are still wary even though the landscape has undergone a seachange now. It hurts the investors as they are not participating in good products available today and the companies who are unable to get much money from this route, due to investor indifference. Finally, investors themselves need to take up the onus of educating themselves, as that is in their best interest. If they are spending their whole lives to financially secure their family, why not spend some time to educate themselves on finances, so that they may secure their bases. Makes sense, doesn’t it? That willingness will mean all the difference between a financially secure future and another filled with worries. Just like the park that needs a fence to secure it from animals & pesticides to keep the worms at bay, ensuring adequate water & manure is the role of a regulator. Using the ambience provided and growing up in glorious profusion is what the plant will have to do – that’s the investor’s job too. Like they say, the horse has to still drink, even if it is taken to the water. That applies to investors too. Authored by Suresh Sadagopan ; Published in The Economic Times on 3/11/2011

Do you need to change Asset Allocation based on Market movements?

Investors have unrealistic expectations of themselves. They expect to accurately time the markets and weave in and out of various assets ontime, everytime. That is the stuff of dreams and mostly remains in the domain beyond our consciousness.
The rabbits of this world think that they can take advantage of every rise and fall and mostly fail. But, let us for a moment assume that they succeed, will it be very useful for them?

Maybe not. Let us examine.

We save money for a reason. Lots of people save money for their children’s education, their own retirement, for building/ acquiring a home etc. Each of these goals have specific timeframes. And each goal has a priority. Investments for these goals, hence needs to be done in a manner consistent with the priority and timeframe.

That is why Financial Planners usually come up with an appropriate asset allocation that will be suitable for a family, based on their goals. Once such asset allocation is decided and invested, it is a good idea to stay invested and not tinker the portfolio, too much. Financial Planners generally invest with a longterm focus , to meet such goals. It is ofcourse necessary to periodically review the portfolio and see if the investments areperforming, as per mandate. If there is a degradation in performance in an investment, generally, it is reallocated into another investment in the same asset class.

However, there can be changes in the situation of the investor or in the macro environment, due to which major changes in asset allocation may be required. At some point, one may for instance take a strategic call to increase equity allocation by 10%, in view of reducing interest rates and the possibility of low interest rates in future. This kind of a strategic change may be required when previous assumptions do not work any longer.

However, there could be cases where one may want to take advantage of the current market situation to an extent without deviating much, from the strategic mean. After, a point, when the situation returns back to the previous normal, the allocation also comes back to the strategic allocation. An example will help here. Let us say the asset allocation suggested for Rameshwar is, 60% in equities and 40% in debt. Due to the current market conditions, the planner may now suggest a tactical realignment of equity to the extent of say 15%, 10% towards debt and 5% towards gold. That may be suggested as both debt and gold are performing well now and the planner may want to allocate to these assets, temporarily. After a time, the allocation will come back, more or less, to 60% Equity and 40% debt. So, tactical allocation may have a role to play but it cannot be allowed to change the strategic allocation itself completely.

Like it was mentioned earlier, strategic allocation can change only if there are major changes in the client situation or in the environment.

Running after the asset classes which are doing well currently and trying to reallocate to a particular asset class, can be detrimental to one’s interest and that is why it is not recommended. For instance, let us say Girish had 50% in Equity and 50% in debt instruments. Due to the fact that equity had not been performing well, he pulled out the money in Equities in April 2011 and reallocated to debt. He is currently happy that his investment in debt is doing well. This is temporary relief and his happiness will be short lived if he does not reallocate to equity eventually. .. for debt investment returns hardly beat inflation and the corpus will infact de-grow in real terms, if he does not come back to equities later. Since there is the timing risk when one allocates in and out of an asset class, it is normally better to keep the allocations intact, apart from a bit of tactical allocation, from time to time.

That may look like a status quo strategy… but the tortoise won eventually in the race, in that tale from Aesop’s fables. The tortoises are the ones who have the faith and patience in their strategy and stick it out. These tortoises win too.

Risk Assessment

It’s funny how people respond to the same question, at different points. When things are going fine and optimism is reigning on the altar, people are buoyant and respond positively. The same question in more challenging times, evoke a far more gloomy, sometime diametrically opposite response!

But, many do risk assessment of their clients relying on responses of clients to basic questionnaires containing hypothetical questions. If the answers are going to vary so much based on environmental factors, like we saw earlier, how can this questionnaire be relied as a good indicator of the risk bearing capacity of a client? An example of a typical question in such a questionnaire is –“ What will you choose- a safe instrument giving 9%pa returns year-on-year or another that can give you 12% returns pa over long-term, but the returns every year can vary significantly, including being negative in some years?”. If you had asked this in year 2007, most respondents would have chosen the second option. If you were to pose the same question in 2008 or even now, most would look towards the safety of fixed income instruments!

If the answers vary so much based on the environment, how reliable are they? Clients have long-term goals and those need to be met. In fact this is the most important objective of a financial plan. From that perspective, a certain amount of risk may have to be taken regarding the investments to be done, in the interest of good returns. One cannot just stay invested in debt instruments alone like FDs, NSCs, PPF etc., as they give low real returns. Hence, a client is well advised to invest in Equity assets as well.

Now, if the risk profile shows up the risk bearing capacity of the client as very low, should a planner compromise on the goals and stick to the risk profiler? We have seen that the risk profiler itself could throw up different risk perceptions at different times.

A doctor does not ask the patient which medicine he would have. He simply prescribes them to him and the patient is to have them. The relationship that a financial planner shares with a client is similar. It is for the financial planner to understand the client situation, suggest appropriate instruments to invest in. It is his duty to also make the client understand why he has suggested that asset allocation and what the merits and drawbacks of such an asset allocation strategy are. The client will still have to take the call; but what the financial planner is suggesting is not based on the responses obtained in a simple questionnaire.

This kind of a questionnaire is arguably useful to someone who is just advising clients on investments and does not have complete information of the client and an understanding of his situation. But even then the limitations mentioned earlier, would very much be there. To circumvent this, a questionnaire has to be scientifically validated for consistency of outcomes, over a large sample and has to be standardized. This can help to an extent. It still leaves the other problem – if one were to strictly go by the risk profile, goals may not be met. Hence, there is no alternative to an informed diagnosis and a judgement from a Financial planner on this.

Financial Planning is not investment advisory

There are terms which are used synonymously – but they actually mean two different things. You might have heard of many. Sales & Marketing is one such pair. They are often used interchangeably. Sales is the art of persuading a client to buy a product or service. Whereas, Marketing is the sum-total of all activities from product conception, branding, retailing, communications and beyond, whose overall purpose is to ensure product sales. But these two areas are entirely different. There is another funny indian-ism which I have heard – I’m going to the bazaar for marketing! ( which is their way of saying that they are going to the market to buy stuff ).

A similar confusion surrounds Financial Planning & Investment Advisory. Financial Planning refers to drawing up a blueprint to achieve the goals one may have, through appropriate use of the finances at one’s disposal. Investment advisory however generally refers to understanding client requirements and advising appropriate products to invest in.

An Investment Advisor ( as per Investment Advisors Act 1940 of US SEC ) is a person or a group that makes investment recommendations or conducts securities analysis for a fee. This clearly establishes the limited nature of engagement in case of an investment advisor as compared to a Financial Planner.

A Financial Planner is like an Architect, in the sense that an FP draws up a blueprint of what needs to be done on various fronts like liquidity & cash management, goals feasibility & planning, Risk management, Long-term cashflow planning, estate planning… Investment advice comes at the end in a financial plan, after all aspects have been analysed. It is a by-product of comprehensive analysis of one’s situation. In that sense, the investment advice will simply flow out of the analysis done. For instance, if the risk assessment shows that Rs.1 Crore of insurance is required, then that will automatically come in the recommendation.
Also, unlike in the case of an investment advisor, a financial planner will also look at past investments and offer advice on these, to dovetail with their overall plan. In a nutshell, a Financial Planner looks at one’s finances holistically, in the light of all the goals/ finances overtime.

However, since almost everyone in the Financial Services space – from an insurance agent to a MF distributor to a stock broker – all use the term Financial Planning in a way that is convenient to them, there is lot of confusion in the minds of the public at large. A chemist cannot call himself a Doctor. Similarly, an agent/ distributor should not be allowed to call himself a Financial Planner. Such legislation is the need of the hour. However, SEBI through it’s Concept Paper on regulation of Investment Advisors is proposing to call an Investment Advisor anyone who is offering Financial Advice, Financial Planning Services or any action that would influence an investment decision. This is extremely curious as financial advice, financial planning & something that influences an investment decision are three different things and cannot be clubbed under the single head of Investment Advice. Financial Planning is not Investment Advisory, though it is a small part of the overall plan. An Investment Advisor indicates a far more limited role than what a Financial Planner performs. More confusion will result if this concept paper sees the light of the day.

Again, many use the appellation “Financial Planner” just because they have completed a Financial Planning course but continue to be an insurance agent. This again confuses the normal investor as they see a person who is an agent use the tag - Financial Planner.

The need of the hour is hence for the investing public to know, who is a Financial Planner, who is an agent and who is a Investment Advisor. Only then they would know as to whom to contact for what. Simply calling a whole lot of people investment advisors would only confuse issues for the public and result in them approaching the wrong kind of advisors, which is precisely what SEBI may want to avoid.
A simple rule applies as always for you – Keep your eyes and ears open. Understand what a particular person can do for you irrespective of what they call themselves. Check out past work they have done; talk to a few references; check whether they have appropriate qualifications, standing & experience in the field. Finally find out what they are charging and evaluate for yourself if that offers a good value proposition or not.

There is just no alternative for keeping one’s one’s eyes open and ears to the ground. A healthy dose of common sense additionally helps!

Changing jobs will not solve your money woes

There is enough depressing news in the papers these days – national & international. One persistent news that depresses me no end is how money is being wasted by our government. One of those was the hundreds of crores being spent in Mumbai on roads and yet the roads are filled with potholes. Hold your breath now… after being inundated with complaints about potholes, BMC awards contracts to the same contractors for makeover of those roads! Leakages abound in all government schemes like Public Distribution System, NREGS, government schools and most other public welfare schemes, where siphoning of funds even top 50%, in some cases. Is government plugging the holes? Nope, though it claims to do so. It just looks for sources to raise more revenue, when it first needs to plug the massive leakages. Coupled with it, government spends recklessly and runs deficits. This is the classic problem with most governments and the reason for the various crises across the world.

Reckless spending… profligacy, in a word. That’s the problem. Just like governments, we find the same problem with some of our clients. Thankfully, it is not as widespread as it is in the case of governments!

When some of these clients come for Financial Planning, we have problems. It surprises us that these people could have money problems at all, as most clients who come to us earn pretty well. In fact, in most cases, they are double income families. That’s why it surprised me when we found out that Raveena will not be able to meet some of her goals. Her husband Abhilash, again, earned a handsome packet. Still, it would be a challenge for them to buy a bigger home and ensure that they send their son abroad for education, like they wanted to.

At first, we thought we got some numbers wrong. We rechecked all the numbers and sought clarifications. The numbers we had taken in the plan were right, after all. What stood out like sore thumbs were the various expense heads – Rs.15,000 pm for fuel, Rs.26,000 pm for groceries/ provisions/ milk, Rs.10,000 pm for entertainment etc. The basic monthly expenses came to Rs.72,000. There was also a total EMI outgo of another Rs.63,000 pm. Apart from that they had other chunky annual expenses like Rs.3 Lakhs for Holidays & vacation, Rs.1 Lakhs towards Gifting etc. totaling Rs.5.9 Lakhs. They had committed expenses of Rs.95,000, towards insurance. All in all, they were spending with gay abandon with just Rs.1.6 Lakhs, as surplus in a year. That sounds like a positive story, while actually it is not.
Their burn rate is so vigourous that it leaves precious little for investments, to meet the future goals, including retirement funding. When I broke this news to them, their solution was simple. They almost nonchalantly said that they would change their jobs!

That was stunning news to me. What a solution! This is what every government does – increase the taxes. Has it ever helped? Nope. The problem is not income. It is expenses.

So I told them and an argument ensued. I argued that one should keep the expenses under wraps and be careful in upgrading the lifestyle, for it is easy to go up in life and very difficult to come down on it. They thought I’m too conservative and old fashioned.

They opined that they anyway change their jobs every 2-3 years and have no regrets about it. They also felt that if expenses go up, income can be made to go up too. So, if there is a need to save more, they can bring in more income. They were hence not able to understand, what I’m quibbling about.

I countered that though income can keep going up till a point, it cannot keep going up by huge margins, forever. If expenses keep spiraling, one will not be able to offset it by higher income. Also, higher expenses raises the bar forever. One will not be able to come down from that level. Moreover, more income will simply mean more expenses in their case, for that is how they have been living. I rested my case saying that more income will not solve any problems for them.

This was sobering for them and they wanted to think about it. Many in their situation are in denial about their spending and almost go into a depression if told to curtail expenses. But excessive spending is a disease and not being able to save enough for future is just the symptom. The pill that cures that is not more income. We need to attack the disease head-on, which is streamlining expenses. Only then the symptoms will vanish and the patient will recover. If continued for long enough, the situation will be like that of many governments today, where they spend much more than what they earn.

Income one earns is seldom the cause for concern. Excessive spends and lofty goals not aligned with income, are. Internalise this and your nest will be nicely feathered. Ignore it at your peril.

Authored by Suresh Sadagopan ; Published in Moneycontrol.com on 17/10/2011

Don't get carried away by one pet asset class

I have always been fascinated by Raju, our friendly neighbourhood shopkeeper, who defies any slotting – for he changes stripes with the season. His is a stationery cum general store, normally. But, now his shop would have morphed into a fireworks shop, during this time of the year. After Diwali, he will get back to being a stationery and general store and again by Christmas, he would again do his Houndini act and transform it into a Gifting cum sweets/ bakery shop. And so it keeps happening throughout the year.

There is nothing like a core competence for him, unlike Miteshbhai. Miteshbhai is into stationery business and he sticks to it, like a horse with blinkers. But, in this field, he is an ace. His range is wide & his stocking deep. Even if he does not have an item when a customer asks for it, he notes it down and ensures that he has it in his shop. Hence, he is well known in the entire locality for stationery and has a loyal clientele. Miteshbhai has done very well for himself, while Raju is still a struggler.

Raju’s tactics of taking advantage of every situation finds resonance with people in various walks of life. Infact, the Rajus are generally considered to be “street smart” & Savvy. Yet, in the final analysis, the opposite is true.

This Raju-like propensity is displayed by many with their investments too. The smart-alecs think that they can move in and out of various investment products, riding the crest of every wave and switching to the next rising wave, timing the whole thing to perfection. This is what is currently being played out, when it comes to Gold and property. Gold has been doing well throughout the year. It has also given excellent returns for the last 10 years. Hence, there is a buying frenzy in Gold today. The assumption is that Gold will continue to climb in times to come and will prove to be a fantastic investment. In fact this is assumed to be the case and people come to us seeking advice whether they could put all or most of their investments into Gold.

The frenzy about property is similar. There are many who have tasted success in property investments over the past 5-7 years. This has given them an aura of invincibility and many see themselves as someone endowed with a midas touch. But, all boats are lifted by the high tide. It is only when the tide turns, we will know who has been swimming naked, as Warren Buffett had once colourfully remarked.
Predicting the ups and downs of one asset class is one thing. This may help in making money. But predicting that to a nicety and doing it with different asset classes over and over again, is entirely another. Different asset classes have different dynamics. One needs to see the risk attached to the investment class, liquidity, tenure, taxation and other aspects before choosing the correct mix.
Choosing the correct mix of asset classes based on one’s goals, is of paramount importance. At different points, different asset classes will perform well. The assets one chooses should match the time frame when the proceeds are required, the risk one is willing to assume to get the returns, liquidity etc. Some asset classes like equities may perform well only in the long-term and one has to give it sufficient time to deliver results. In the short-term, the volatility in equities could be gut-wrenching. So if one has chosen equities as a part of the overall asset-allocation, short-term volatility will not cause any disruptions and heartburns.

The next on the totem pole is diversification. No matter how well an asset class is performing, it is always a better idea to spread one’s investments among the various asset classes – for overtime, one asset class can slacken and another will take the slack. Not for nothing do we have a wisecrack like “Do not put all your eggs in one basket”.

Choosing just Fixed Deposits or Gold or Property , just because they do well now, is hence not a great idea. Choosing the product which is currently doing well and cycling among those from time to time, will again not meet the longterm objectives. For one, in this process of choosing the current favourite, one may actually get trapped in the down cycle – like in properties ( which has long cycles ). The other is that, one will end up with the wrong set of products that do not meet one’s requirements overtime.

Jumping from one to the other product may look exciting. But sticking to a pre-meditated asset allocation strategy brings home the bacon. Miteshbhai can vouch for that. Due to his roving, free-wheeling ways, Raju ab tak nahi bana Gentleman!

Authored by Suresh Sadagopan ; Published in moneycontrol.com on 14/10/2011

Timing the market & investor psyche

With the mayhem unleashed due to the downgrade of US to AA+, markets across the world have experienced correction. In times like these, logical thinking is the first casualty. There are market observers who suggest that there is more pain and the market can trend down. There are those voices which are harping on the popular sound-bite that “Cash is King”. There are other more optimistic ones who suggest that markets have been anticipating this and are already factored into the fall. By implication, what they mean is that the downside is limited and the upside potential is higher.

Now such divergent voices are what cause confusion for the normal investor. As it is, they are scared as the markets are falling. Do they invest now, hold on to what they have or cash out?

Timing the markets has always been a subject of much debate. Paradoxically, retail investors tend to think that they can time the market well, based on what they read and hear. That is surprising as timing the market is virtually impossible, even for the most savvy investors, which includes fund managers.

Ironically, that is the advice investors want today from their advisors. So, what can the investor do…

First, they need not change their allocations now to accommodate the new kid on the block which is firing on all cylinders – Gold. Most people have long-term goals and meeting them would require a consistent strategy. One should not look at changing the strategy overnight, whenever there is some change in the environment. The strategy would have to be revisited only if the events have considerably changed the risk-return possibilities over the period, which calls for such a change. This is not one such event.

Indian stock markets have been considerably driven by FII money and when money moves back to western shores seeking “safe havens”, the markets fall. But, if one looks at the indebtedness of the various countries and the prognosis for their economies from here on, FII money will sooner than later come back to emerging economies with potential. India is one such economy, which has the potential to grow at 7%+ levels. Hence, it is a fact that though there are short-term problems, the medium to long-term outlook is good.

Hence, apart from changing some tactical allocation & tweaking the portfolio a bit, one should let the strategy remain intact. This means continuing SIPs/RDs which are going on, continuing with the investments done in the past to achieve long-term goals and not attempting a major change of the allocation just because Gold seems to be the star on the horizon. Gold continues to be a good hedge against inflation and due to it’s negative correlation with equities, it also reduces risk in the portfolio. The way Gold has run up does not bode well for this commodity and correction can happen in this, in times ahead. There seems to be a bubble building up in Gold but people don’t seem to be recognizing that. There are those who are going whole hog into Gold after liquidating investments from other assets, which is not a good strategy at all.

Since the markets are in correction mode, it may be a good time to invest in Equity and Equity oriented Mutual Fund schemes, for those with a long-term view. Such investors should split their investments and invest in small lots, over time. This will enable them to invest at low market levels and take care of volatility.
Investor psyche comes in the way here… there are those who want to shift their money away from equities and into FDs and other such debt instruments. That again is not a good strategy. Investing in equity at this point would give the best bang for the buck. Whether investors see it that way is another issue. Currently they are running scared – much against their best interests.

Authored by Suresh Sadagopan ; Article published in Moneycontrol.com on 18/8/2011

Assured return instruments, a must in all portfolios

Bhaskar was in a good mood. He was smiling presently and was in an elevated frame of mind. He was showing me his collection of Music & video CDS/DVDs and was explaining animatedly about some of his new acquisitions. I was happy for him. It was not always like this, though.

Bhaskar is one of those high-adrenaline types, who thrives on taking risks. In fact for Bhaskar, nothing look like a risk. For that reason, he has also been pretty successful in his entrepreneurial ventures where this risk taking ability nicely blended with his good eye for spotting opportunities and moving in decisively.
Bhaskar however was a miserable pulp 3 years before – in 2008. He had bet on Equities in a major way and had been doing very well. Like all those who taste huge success early on, he took too huge a risk by betting on various momentum players, with borrowed money. He lost crores of rupees in 2008.

That is when he had come to me. I had to calm him down and firstly make him see the sunny side of things. He was so dejected that he just saw gloom all around. I had to remind him that he had thriving businesses and he would be able to bounce back from the setback. I also told him that we will have to redo the portfolio and bring some sanity into it.

The first thing I had to do was to educate Bhaskar on the need for diversification, appropriate asset allocation, streamline investments in line with the goals, discipline & regularity in investments, investment horizon etc. It was not that Bhaskar was unaware of these… he just ignored all these due to his gun-slinging-cowboy like attitude towards investing.

When I had suggested that he rebalance the portfolio and have a decent allocation towards debt instruments, he had glared at me. He was incredulous that I was even suggesting this, I had to spend time…

Investing in instruments which give high returns were fine. But in one’s portfolio, there has to be a good mix of all kinds of assets from low risk-low return instruments to high risk-high return ones. The low risk instruments tend to be debt instruments, which are not very exciting for a person like Bhaskar. He infact made me say that the post-tax returns in debt instruments may not even beat inflation. But still, I insisted that these instruments will ensure that the capital is safe and some returns accrue from them. In fact these kind of instruments should form the bedrock on which one’s portfolio edifice needs to be built. These instruments are the ones that steady the portfolio.

Again there are different debt instruments and one needs to make appropriate choices. PPF will be a great choice for those with a long investment horizon. This will be suitable for accumulating one’s retirement corpus, children’s education / marriage requirements etc. Also PPF gives a decent 8% post-tax returns. PPF was started with the objective of giving access to a Provident Fund like account ( which is available to Organised sector employees ) to others who do not have access to PF. PPF was created with the mandate to assist individuals to build their corpus for their retirement needs.

Post office MIS helps those who want regular returns. Kisan Vikas Patra is another product with a 8 year 7 month duration, which doubles the money in this time frame. In the current regime, it is not all that attractive. Bank FDs themselves are offering 9.25-10% returns for 1-2 year tenures. There are Bonds & NCDs which are coming out with attractive rates too. Company Fixed deposits are offering between 9-11% pa. But in all these instruments mentioned, the interest income is taxable.
That however does not diminish the merit of having these in one’s portfolio as one requires stability too. The others which can potentially offer better post-tax returns are Fixed Maturity Plans from Mutual Funds. Apart from this there are several debt funds which could offer good post-tax return as the interest rate cycle is expected to turn sometime from now. Dynamically managed funds are best bets at this juncture. Apart from this, in times to come, Income funds with longer maturity papers and Gilt funds themselves would pose good opportunities.
The main point that I wanted Bhaskar to appreciate was that having these in the portfolio improves the chances of the goals being met, not the other way round. I had to hammer it across, that equities, though it offers good returns, carries high risk. He was not very convinced, though he reluctantly gave the go ahead to redo the portfolio. He did buy some equities after that too! And now they are trading at at a loss. But Bhaskar is not bothered. He has now understood the importance of his debt portfolio, secure in the knowledge that nothing can affect at least this portion. It helps that I had suggested 45% in debt instruments for him as he anyway takes high risk in his business. So you know why Bhaskar is atwitter now!

Authored by Suresh Sadagopan ; Published in The Financial Chronicle on 24/8/2011