What can you hope to get out of a financial plan?

Let me rephrase the question – What can a financial plan do for you?  You need to know the answer to this, if you are engaging a financial planner.

Firstly, a financial plan is not an exercise to assist you in getting amazing returns. It is a blueprint created for you to follow to achieve your goals, with the available finances.  The challenge for the planner is to find out if multiple goals, which you may have mentioned, are possible to be achieved or not.  If one had been wildly throwing around fancy dreams as one’s goals, the planner would come to know, when he crunches the numbers.  The planner will be able to find if the goal can be achieved or not. This also puts to rest,  the tussles that go on in a family about whether a specific goal is desirable to have or not.

A goal need not be thrown out altogether too. In some cases, due to multiple goals running concurrently, some goals may have to be postponed rather than dropped.  For instance, if there are two goals – a foreign jaunt after 2 years costing Rs.5 Lakhs and a car in three years costing Rs.7 Lakhs, calculations could show that one of them, say, the car, has to be postponed.  Sometimes the goals may also have to be scaled down.  For instance, if the client is willing to go for a Rs.4 Lakh car after three years, the goal can be achieved after three years, in the scaled down version.

A good financial plan can hence tell you if you are on course to reaching your goals, as well as how to achieve them.

The next important thing a financial plan does is to assess your risk and find out how much you and your family are exposed.  The planner should be able to calculate & tell you how much insurance you may require. Today, term insurance is available at very low cost.  Covering the loan exposures, goal expenses as well as the cover required to take care of future expenses, is essential.  Replacing the income may be an ideal goal, but is difficult to achieve, while providing life cover.

Medical cover is even more essential.  Based on the coverage from the employer ( if in service ), the planner would suggest a suitable plan with appropriate cover.  Various factors like waiting period for pre-existing conditions, domiciliary hospitalization, day care procedure coverage etc. will have to be properly weighed in before the planner will decide a suitable plan for you. Premium is just one of the considerations.  Atleast Rs.5 Lakhs is required for an adult and Rs.3 Lakhs is required for a child. Further cover can be provided through top-up insurance, to minimise premium outgo and maximize benefits.

The third important aspect would be asset allocation. Based on the cash-flow requirements, number of years of working life, savings potential and other factors, a correct asset-allocation will have to be decided keeping in view the risk that can be assumed in the portfolio. Existing investments have to be reviewed and appropriate cleanup & reallocation, needs to be done.  To build the portfolio, regularly available products themselves would be able to round-up the portfolio. 

The fourth vital aspect would be cash-flow management. Proper provisioning for liquidity, contingency and building up the corpus for the upcoming & long-term goals, needs to be planned. A good financial planner would be able to manage the available cash-flows and deploy in a manner so as to maximize the returns till the funds are needed, by choosing the right instruments to invest into. Matching the cash-flow requirements over the period requires one to consider the time when money would be required for the goals and accordingly choose the investment vehicle considering liquidity, returns, risk inherent in it, tenure, tax-efficiency and other considerations.    

Finally, a good financial plan would offer actionable recommendations. The recommendations need to be clear & specific. Also, you would need to know why you are asked to do what you are asked to do. Easy to understand & actionable recommendations, along with a lucid explanation about the suggestions,  give clarity on the course of action to be taken and peace of mind that comes with knowing what you are doing.

That is a good financial plan in a nutshell and it can offer you the structure around which you can build your future. A good plan is tailor-made for the family and will offer you clarity & peace of mind. Once there is a proper plan in place, all you need to do is follow it diligently. That should end in financial nirvana, god willing! 

Authored by Suresh Sadagopan  www.ladder7.co.in and published in Moneycontrol.com

The impact of new changes by SEBI on MF industry

The new regulations for the MF industry are out. As usual, there are the routine platitudes on the fine job SEBI has done. Even three years back when they banned entry load, there was all-round jubilation that SEBI has done something revolutionary and path-breaking. It brought the industry to it's knees.

The changes suggested this time too cannot energize the industry as they are hoping to.

What have the investors got?

Investors have got a direct route to investments, where they can save on expense loads. It will be lower, but by how much is not clear. But that means these people are assumed to be savvy investors, who do not need any guidance from intermediaries. Elsewhere, the expenses have gone up for them. They will have to bear the Service tax for the Investment Management Fee, which was earlier a part of the overall expenses.

The exit loads will be credited back to the schemes, which is a positive for investors.  The expense ratio will go up by 20 basis points (one basis point is one hundredth of a percent). But the 20 bps increase and the crediting back of exit loads are expected to more or less be neutral, in terms of implication for the investor.

Investors will now be paying 30 basis points if the AMCs are able to source 30% of the business beyond top 15 cities. If their mobilization from other than the top 15 cities is less than 30%, they can charge on a pro-rata basis. From an investor perspective, this is an unnecessary expense.

Investor protection: To avoid churn, the exit loads are being credited to the scheme. This could have been done in 2009, instead of accusing the entire distribution community of churning. To tackle mis-selling, SEBI is now suggesting a system of identifying sales personnel of distributors, evolve a system of product labeling and inclusion of misspelling as a fraudulent and unfair trade practice. These are good moves though coming in very late, which have put the black sheep among distributors on notice. These could have been done earlier and they could have spared the industry it's black eye.

Simple products: SEBI has proposed introduction of simple products, a tiered distribution system including different levels of certification & registration depending on the products & services offered. This a certainly a positive move as there would be many who want simple products, where the distributor may not have a real role to play. Also, this can increase the feet on the street for these plain vanilla products and increase MF penetration.

PAN India foot-print for MFs: The other aspect covered is to take the Mutual Funds beyond the top 15 cities. That is a laudable objective.

So is eradicating chronic-persistent  hunger, access to potable water and a roof above the heads.  But, how do we get there?

What is proposed is to allow AMCs to charge upto 30 basis points more, if their assets mobilized are 30% or more beyond top 15 cities. Tell me something... if 0.3% is going to entice AMCs to go to the hinterland, why was the penetration so poor before the entry load ban, when AMCs had collected entry loads of about 2.25% & distributors were getting about 2% upfront commission? If it was not possible then, why is it going to work now?

The awareness has gone up in the interim, I agree. The penetration which is evidenced today,  is due to the education by the media and inspite of the crippling blows to the industry. But this will be a slow process. What is required is proper investor education.  For that, SEBI has asked the industry to set aside a portion of the asset management fees. Fine. But, what is now going to be different, that had not been tried in the past and has spectacularly failed, so much so that, 83% of the entire Mutual fund assets are from just 15 cities?

Cash transactions... Allowing cash transactions ( even upto Rs.20,000/- ) is a retrograde step. In fact, everywhere, it is moving towards transactions through banking channels. This smacks of desperation to somehow prop-up the industry and does not come across as a well though-out step. Also, how this is going to be implemented is to be seen. Sometime back, there was another news that for upto Rs.50,000/-, PAN card is not required. If true, this is a retrograde step as Government of India is trying to bring all financial transactions into the mainstream and is trying to monitor financial transactions and bring more and more people under the tax regime.

AMCs &Distributors: Now, coming to the AMCs and distributors, there is nothing much for them. For AMCs, service tax has been taken out of the ambit of their expenses. Also, there are internal caps on using the Expenses collected. They get to charge 20 basis points more, if the investor exits within a year. But, they cannot use Exit loads any longer, which will be credited back to the scheme. If they are able to get more than 30% from beyond the top 15 cities, they get 30 basis points more.

Doing business across the country imposes huge costs. They will have to offer higher remuneration to the distributors working there, as it is much more difficult to mobilise business in those areas. They will need to set up offices across the country with their personnel, which is a costly affair. This means, the 30 basis points which they earn will hardly compensate their efforts. In fact, it may prove to be far more costly. Hence, this may not be incentive enough for them to spread out.

Now coming to the distributors, there is nothing much coming out of this regulation. Infact, for them, no major negative by itself, is positive. Many distributors have by now evolved a model to survive in the difficult times after the entry load ban. Direct investment route is a dampener for them.  They may get 0.1-0.2% more from the AMC. But, that is not going to bring in the distributors who have left the system and it is not enough incentive for new distributors to enroll.

Life will go on. Expecting to energise the distribution network with these regulations is an illusion. With markets tanking, unenthusiastic distribution force, higher expenses to be paid by investors, it will be more of sideways movement for the MF industry.

Authored by Suresh Sadagopan  www.ladder7.co.in  Published in Moneycontrol.com on

Is Financial planning only for the rich?

I don’t have money, what planning can I do? This is a common refrain I get to hear. These same people often tell me that financial planning is for the rich, the fat cats. Let us examine.

A person has low or no savings :  Every single individual has goals and aspirations irrespective of whether they have money in the bank or, are living from paycheck to paycheck.  How are they going to meet their goals? Not by continually saying that they don’t have money. They may require help, if they have been here long. They don’t have money probably because they accord more priority to living well today, than saving for tomorrow.  Then, there is frustration awaiting them in future. Correcting this is critical, as only that will result in putting aside something to meet the goals.

No margin for errors :  People with comparatively low incomes do not have a margin for error. If they get their investments/ insurance wrong, it would have a significant negative effect on them. A wrong  insurance policy, especially can bog one down for years, sucking up liquidity & locking them in an unsuitable product.  Also, traditional insurance products offer typically between 4-7% tax-free returns. ULIP returns can vary. But, in case of ULIPs, since the premium is going into the same funds or set of funds, there is a concentration risk. Any error on investments/ insurance made especially by a low income earner, would be far more detrimental as compared to another, who is a high income earner.

The rich get richer due to better investments :  The well-endowed choose their investments well. They get their asset allocation right. They invest in a manner that they earn better returns on their funds. For instance, even funds that may be needed anytime can be kept in a liquid fund, instead of in the Savings Bank account.   Liquid fund offers better gross returns and better tax treatment, leading to better post-tax returns. Similarly, FDs may not be the best product in fixed income. A better product would be a FMP or a debt fund, in terms of post-tax returns.  The rich have advisors who would take care of this. Others have to get it right themselves or take professional help. Quite some money can be earned if invested in the right avenues.

Can you achieve this goal?   Almost everyone, irrespective of their income level, have this question. Will I be able to buy a home in 3 years? Will I be able to educate my son/ daughter till post-graduation? Will I have sufficient money when I retire? Proceeding with life without knowing this is dangerous, for you know not, where it is leading you.  But to understand this you may require to do your math. Hence, this is needed irrespective of income level. Whether you are going to do it yourself or you will be taking professional help is the question.

Prioritisation of goals & right sizing them :   Ideally, we all want to achieve all goals. Sometimes, that may not be possible. We will need to prioritise and keep goals that are really important and scale down or eliminate other goals.  For example, it may be that education of children & retirement funding goals are possible, but not buying a bigger home. This, we will come to know, if we do the calculations. Getting this right is important so that the client knows fully well, what he is saving for and has no unrealistic expectations. Some of the goals may not be dropped, but will have to be scaled down, or pushed back.  To what extent these have to be done, needs to be seen.

Implementation & Management :  Once decisions have been taken about what needs to be done, they need to be done. Financial Planning is only the beginning. Only if it is implemented, it would yield results. Lots of people do not implement or end up implementing partially. This produces less than desirable results. After implementation, people forget all about it.  Periodic reviews are not done. Sometimes, the proceeds of past investments themselves are not claimed. Reinvestment of the proceeds is not done in reasonable time. And for everything, they just rely on what their friends/ colleagues tell them.  All these would mean that one would get poorer results than what could have been.

It is important to take finances seriously. If one is unable to do it, one should engage someone who can do it for them. It is a fallacy to think that professional financial planning services can be afforded by the rich. If one were to total up all the potential losses and the cost of wrong decisions, the fee would be paid for. Plus, one gets the assurance & peaceof mind that a well-crafted plan brings in.

It is nothing to do with being rich or poor. It all boils down to how seriously one takes one’s own future.

Author : Suresh Sadagopan, Ladder7 Financial Advisories ; Published in Moneycontrol. com on 9/8/2012

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!

Article by Suresh Sadagopan, Ladder7 Financial Advisories

Tenets for Financial Solvency & Wellness

Who would not want a comfortable life? We all aspire for it. But some of us are able to make things happen. Others, inspite of being good income earners, falter along the way and end up with sub-optimal results. Such people often wonder about those “others” who have almost magically stolen a march over them, even though they stood no chance to start with.

Parth was one such person. His good friend Amar, who was not exactly a high flier, had ended up with an enviable corpus at the portals of retirement. Parth just did not get it. Amar did not seem to have done anything spectacular and yet this ugly duckling had transformed into a swan.

Parth wanted to know the secret and Amar was willing to oblige. Amar shared with Parth,

  five tenets he followed for financial solvency and wellness. Here they are –

Invest first, then spend – Amar had been doing this almost from the start of his career. He had always earmarked a portion of his income for investment. Initially since the income was low, it was 10%. Later on, he had increased it to 15% and then 20%. He had accelerated to 30, then 35 and eventually 40%. He did not leave this investment to chance. He put that money aside first and only then spent the rest. That way there was no guilt feeling when he spent and there was no compromise about his future.

Discipline in investments – While putting aside some money every month is important, it needs to be invested in appropriate vehicles diligently. The easiest way is to invest every month, as soon as the salary came in. Amar used to do precisely that. He had setup Systematic Investment Plans ( SIPs) with MFs and was also investing in Recurring deposits ( RDs ). This way he did not get to see that money and was “not even aware that this money was there”. This money which he had started off with a modest Rs.1,000/-pm at the start of the career, ended with Rs.48,000/-pm, in the last year of his contribution.

Also, he had earmarked some of the investments for really long-term goals like retirement. He had invested in PPF & EPF for that and did not once dip into this kitty. For his other goals, he had invested in various instruments, which he had used for those goals. He always was willing to invest for the long-term. Amar had even some investments in equity, some of which were positively good for him. He had held on some shares for over 25 years in which he had received bonus and rights shares and the number of shares had multiplied like rabbits.  The dividends from these shares themselves had become significant source of income for him.

Don’t chase fads – Every once in a while, there are pet assets, which catch the fancy of the public. At one time, it was teak plantations & goat farms, at other times, it was farm land and of late - Gold. Amar was in fact quite vocal about this. He was telling Parth about the need to invest across asset classes and believe in their power to deliver results. Each asset class will perform at some point. One needs to wait for it. The temptation would be great to cash out from one asset class and put everything in another. Lots of people have cashed out from equity and put their money into gold. In 2007, people were transferring all their assets to equity. Some even borrowed to invest in equity! A proper asset allocation, periodic review and rebalancing & tweaking the asset allocation itself, to reflect the changes in one’s situation, are necessary.

Keeping expenses in check – Amar had one golden rule. Keep your lifestyle a couple of notches below what you can afford. His favourite rule was if you can afford a Honda City, stay with i20. This way, one will be able to comfortably afford it and the running expenses as well as other expenses would not pose problems. He had been practising this in all facets of life. Most people do precisely the opposite. They buy a 3BHK home, when all they can comfortably afford is a 1 BHK home. These things that put pressure on one’s finances and compromises the future.

Keeping a budget and recording his expenses was the other important activity, which Amar practised to keep his expenses in check. Estimating the expenses correctly is the first step. For that, one needs to record the actual expenses incurred for a few months to get a hang of the pattern. Making the family members to adhere to the expense budget, is an important step in keeping the expenses in check. Amar used to reward them if they used to stick to their budgets. For his wife, he used to buy some jewellery and for his children, it used to be a trip to an amusement park.

Liquidity & contingency – Amar always used to keep sufficient liquidity. He used to maintain about two months expenses in his bank account for liquidity. Another two months liquidity was parked in liquid funds for getting somewhat better returns. He also used to maintain a contingency fund of Rs.2.5 Lakhs to take care of any unforeseen emergency.

Also, he had sufficient medical cover for the family, which is very important today. Without it, one’s savings can get depleted and expose one to an uncertain financial future. This can put various goals that one has planned for, in jeopardy. Since Amar had realised this early on, his family was adequately covered and he never had to pay for the medical emergencies in his family. This he had parked in bank FDs.

On hearing Amar spout such wisdom, Parth was floored. Parth ruefully thought that it might have been so useful had he asked the same questions two decades back. Now Amar had raced past Parth, inspite of Parth’s higher earnings and is looking forward to a peaceful and contented retirement. Parth had adopted a fancy lifestyle, overstretched himself in his home and his children’s education and is now looking to work for another five years. Two very different outcomes, just due to the way they handled their money.

The simple principles adopted by Amar had proved to be a major factor in his being financially solvent and achieve all his goals without compromises. 

Article by Suresh Sadagopan, Ladder7 Financial Advisories; Published in Business Standard on 5/7/2012

Clear Expectations lead to longer lasting relationships

Believe it or not – we are constantly trying to sell, convince or persuade people to agree with our way of thinking. This is irrespective of what we do in life.

A mother needs to coax and persuade her children to brush their teeth well, eat healthy food, study their lessons properly and keep good company.  A teacher needs to instill the love of the subject in the students and needs to impress upon them the need to study their lessons regularly and do well in their examinations. A supervisor needs their subordinates to trust them, make them do the work they are entrusted with and carry the mandate of the department/unit forward.

We are all in the business of persuasion, all the time. In our case, financial planners, have lots of work to do before a client completely trusts us. Getting the clients to trust us is the foundation of a long-term relationship.

After being in the business for a while, new clients may come from referrals and therefore have preconceived opinions and expectations about us.

There is a lot of work that goes into building solid foundational relationships with clients that eventually flourish.

Setting CLEAR Expectations

The first step in building a relationship is identifying the client’s expectations, validating the expectations if they are right or correcting them if they are wrong. This is a very important step if you are trying to achieve long-lasting relationships. Lots of times, clients may come in with unrealistic expectations of what a planner may do for them.  For instance, I have found that some clients come in thinking that we will be able to grow their current income by 2-3%. This is one expectation I have had to do away with.

While setting expectations, it is important for the client to understand what they will get out of the engagement with their financial planner. This is a very important step as it will become touchstone against which the future performance will be measured. It is a very good idea to specify in writing what the client should and should not expect from the relationship.

Once the expectations are set, the engagement will run much more smoothly.

Professionalism in ALL Interactions

There are going to be some expectations which are essential for a financial planner to fulfill. We cannot wriggle out of these and still have a satisfying client relationship.

For example, almost all clients want their financial planner to have a deep knowledge in the planning area, as well as appropriate experience to handle the relationship. They want their planner to be a professional. The planner should exude professionalism in every interaction – from the communications being sent, promptness in responses, returning calls etc. As their consultants, we need to inspire confidence, as clients share their aspirations, fears and secrets with us. One expectation we can be sure of is that clients expect us to be deeply interested in their well-being.

Clients NEED to Trust You

After setting the expectations and fulfilling all the things that clients take for granted, the planner needs to build trust.

Simply delivering on the expectations that were set in the beginning of the relationship is at the heart of building a trusting relationship. This might seem simple but it is not. These expectations need to be met relentlessly, week-after-week, month-after-month, for years, which is difficult to maintain.

There can be upheavals in the client’s life, in the market or economic conditions, changes in income/ expenses or other aspects of finances. The financial planner who is continuously by the client’s side, through it all, is the one who will have the client for life.

Trust builds over time and there is no alternative to building this trust other than being there for the client consistently.

Existing Clients Give Referrals for FREE

It is this trusting relationship that ensures longevity of the relationship and also results in referrals. For financial planners, both of these are critical. Existing clients are the bedrock for a practice. New client acquisition is best done in our business through referrals. There is no cost associated with these two. Anyone who has ever spent time acquiring new clients would know the large amount of time, effort and money involved in that process.

While a good first impression will help with acquiring new client, it is the continuous client engagement and relentless pursuit of professional duties that is going to ensure that the client sticks around. However, the planner’s persuasive skills will be on full display throughout the engagement with the client. At various points, the client will have to be coaxed into giving up unrealistic goals, pointless investments or unwanted expenses. At other points, clients will have to be guided down the path of fiscal prudence, regular investments and reasonable targets.

The persuasive skills of the planner will especially be tested when the markets sky-dive or when there is a huge run-up in an asset class. For example, when there is a market crash, clients will want to exit, whatever the costs and in the latter they have to be held with a leash to save them from themselves! Keeping the client on the straight and narrow path is a full time challenge for financial planners like us. Done well, it turns out to be a rewarding career option!

Article by Suresh Sadagopan ; Published in financialplanet.org

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

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

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.

Chasing hot products will get you nowhere...

We are a cinema crazy country. What our heroes & heroines wear & flaunt, become a craze overnight.  You can get your “Aamir cap”, “Shahrukh coat” or “Kareena  salwar suit” which was featured in a recent movie, in shops across town. You will find half the town wearing the latest hot fashion, though!

Chasing the latest fads does not end with our sartorial sense alone. Even in one’s finances, we tend to choose the latest, hottest product.  So, if all in office are procuring a particular insurance policy or are going for some investment plan, it becomes the basis of investment itself, without any further thought. Thought is not given as to whether the product is suitable for them in terms of the asset class, duration, liquidity, risk profile of the product, end use and other factors.

The other fundamental problem is that different products perform at different times.  Fixed income securities give good returns when the interest rates peak. But logically, when interest rates peak, economy and it’s constituents – the businesses, tend to underperform due to the higher cost of capital.

The right time to invest in an asset class which displays up and down cycles is when it is down, not when it is at it’s peak.  Investors tend to invest when the market is in the middle of a bull frenzy, which is like sowing seeds in the middle of the rainy season.  The crops grow properly only if the fields are prepared and seeds sown well before the rains so that the saplings are ready to receive the bountiful rains and grow in lush profusion.

In case of products which are prone to cycles like equity, real estate, property etc., it is very difficult to divine the bottom point, at which to invest. The psychological aspect comes into play here. When the markets are bottoming out, the investor expects it to go down even further. But contrary to expectations when it starts rising, they expect a dip again as the lowest level is their anchor now and anything above that seems expensive. When the price has moved up and away, the investor realizes that they have missed the boat. They wait even more. When the markets move further and there is a frenzy, they come in. Soon after, the markets tumble as they have come in at the height of a bull cycle. They retreat into a shell and want to invest only in fixed income products from then on. Investments done at the height of the markets take very longtime to recover. This happens as we want to time the investments and want to chase only those that are giving good returns, at that point. Paradoxically, we end up getting poor returns when we are gunning for products that give good returns all the time!

Chasing returns like this will ensure that one ends up buying equities, real estate, gold etc. at inflated prices, as investors tend to buy when they are performing. Pulling money out from “non-performing assets” like equities now and channeling them into “performing” assets like FD, Gold, Real Estate looks like the path to nirvana. Actually, they are setting themselves up for future failure.

Investing too much into fixed income securities alone also exposes an investor to undue risks. Fixed income products mostly do not give positive inflation adjusted positive returns. This means that the corpus that one needs for any future goals will have to be accumulated with higher savings contribution, to reach the same goal. Also, retreating into the shell and not willing to commit resources to cyclical assets at the bottom of the market ensures that they do not reap the rewards of the upcycle.

Equity markets, especially, are driven by fear and greed.   Investing only when it is rising is a sure recipe for poor performance of one’s portfolio.

Investing in products which are doing well at that moment also does not address several other aspects that need to be taken into account while investing.

The first is that one needs to know why they are investing in a product – what is the end use for it. Without a proper goal, an investment tends to be fuzzy.  A product invested without much thought, may be a long-term one like property, but the requirement may come for it after a year. In such a situation, there is a huge mismatch between the product characteristics and it’s end use. Hence, one should at least classify whether a product is for short-term needs or for the long-term goals. That way, one would invest in an appropriately oriented product.

Secondly, one needs to invest for an appropriate tenure. Some products offer good returns only over time. Correct tenure for an equity product may be five years. Now, if it is invested for a couple of years and redeemed, it may give poor returns.

The other aspect is liquidity. Investing in PPF may be a very good idea for someone who is accumulating a corpus for retirement.  However, it may not be suited if the amount may be required for daughter’s admission, two years hence.

This is the classic problem. The product may be good in a lot of cases but may not be useful if it is not properly matched. It is like mating a low powered engine to a sports car. It is just the wrong kind of engine for a sports car though there is nothing wrong with the engine itself.  It would be perfectly at home in a small car.

The simple solution is to diversify one’s investment basket. That way, one will not end up with one kind of product alone and lose out on the potential that other products have. The other solution is not timing the investment and investing across cycles and time horizons. If one also rebalances assets and sticks to a predetermined asset allocation, it will work wonders. 

It requires guts to put in more money into equities at the bottom of the market, like what Warren Buffett did in 2008 & 2009. But, he is no ordinary investor. He does not chase fads. He is after good investment propositions – which he got at the market bottom. Time for us to learn from the master – that buying in times of distress is the correct investment strategy and investing while there is a frenzy is a slippery, glacial slope to nowhere.

Article published in Business Standard on 17/6/2012 by Suresh Sadagopan