Find the correct advisor and stick to their advice

I’m always amused by people who engage us for financial planning and then start giving us advice! These people try to convince us about why we should include real estate in our recommendations, send lots of inputs on why gold is going to reach USD 2000 per ounce in a matter of months or why their money should not be invested in equity assets …

It is indeed curious, as they come to us on their own accord for advice and start “moulding” our thoughts, even before we have fully understood the case and have offered our opinion. It is like going to a doctor and then telling him that you feel you have typhoid ( as many in your neighbourhood have it ) and pressurizing him to prescribe medicines for typhoid!

 It is best not to be opinionated and surrender one’s skepticism and instead trust the advisor. That is when one can get good advice. But the main task is to find the right advisor & trust them enough to do exactly what they ask you to.

How do you find the right advisor/ planner?

There are a few things that need to be done to get to the right advisor.

1.       Ask them – What business are they in? What are the type of clients, they advice? What are their services? Find out if they have experience in advising people who come from similar background & expectations?

2.       Find out if the person who claims to be an Advisor/ Financial planner is actually one. Or he is simply a product pusher, using a fancy name. It is fairly easy to find out. A seller of products would start talking about it in the first meeting itself. A proper advisor/ financial planner would be asking you about your goals, finances & situation. They would want detailed information and may involve many meetings. They would want to work on the data before they come up with any suggestions.

3.       Find out their story; when and how they came into this line. It will give you insights about them. You will also know about their expertise, experience & how they have progressed.

4.       Find out about their qualification, accreditions, professional activities, about what they do to stay current etc.  Would they be registering as Investment Advisors under SEBI regulations, which calls for stringent norms, compliance requirements, audits & record keeping?  

5.       Do they research/ write/ lecture on their professional  areas?  Are they part of professional groups/study circles to upgrade their knowledge / skills? What is their standing in their area of expertise? This will tell you whether they are qualified professionals to advice you or not.

6.       Ask them to show a sample of what they have done for a couple of clients and ask them to explain the same in detail. This will directly tell you what kind of work they do & the detailing they get into.

7.       Ask them about the process & flow they follow, once you engage them. Do they document the service engagement, it’s scope & time frame? Who are the people who will offer them the services? Is there a team that will assist you, or is it a one-man army?

8.       Is it a one-time advisory or is it an on-going engagement? If there is on-going involvement & engagement, ask them for details. Are all these documented?

9.       Find out the charges.  Find out what is the basis for their charge. Ask them to substantiate the value proposition they are offering. Ask them for a comprehensive quote in writing.

1.   How much time will it take to get the plan/ advice?  How is it delivered? What are the deliverables?

Once you have asked all these questions, only the true advisor/ financial planner will be left standing. The salesman will fall by the way side after just the first couple of questions. Once, you have satisfied yourself that the person you are dealing with is indeed a true professional, you need to trust the planner/ advisor completely.

Without trust, this relationship is bound to fail. You could always seek answers to all doubts and even seek clarifications/ justifications to any recommendations or suggestions advanced. But, once it has been convincingly handled, you would need to follow the advice. Trying to thrust your agenda into the plan is counterproductive and brings in friction in the relationship.

It is like following a guru. If you follow one guru /one path, you will get somewhere, even salvation. If you don’t trust your guru and do not do half the things he suggests, you will end up nowhere. The same is true here. So, choose your advisor/ financial planner with care; but after that, follow the advice to completely.

Hopefully, you will be on your way to financial nirvana! 

Published in Moneycontrol.com ; Author - Suresh Sadagopan  ;  www.ladder7.co.in

Inflation Indexed Bonds are not so hot after all

The inflation indexed bonds are linked to WPI, which is significantly lower than CPI. The retail investor is more interested in CPI and hence there is a fundamental disconnect. The eventual returns are not expected to be significantly better than existing options due to this - in fact it may be worse off. Hence, the inflation adjusted return is just on paper as this is not probably going to beat CPI even in future.

Also retail investors are put off when the interest rate is not a fixed amount they can expect ( the same problem with debt mutual funds due to which their participation here is low ).

Taxability aspect is not clear. If it is capital gains tax treatment, there is some benefit to be derived there. Should it be like interest income and taxed, it’s attraction diminishes further.

At best, it is meant for conservative investors.  Those who want to earn a bit more would not come here. There are many better options out there.

Published in Moneycontrol.com ; Author - Suresh Sadagopan

Do you know what you will be doing in retirement?

Retiring early and putting the leg up is an idea, which appeals to lots of people. As financial planners, we find that early retirement  to be one of the favoured goals, in atleast half our clients.  Why is it such a major draw? We find two reasons.

Reasons for early retirement -   One – they want to be financially self-sufficient by a much earlier date, so that they can disengage from the rate race. Then they want to work on, without any financial pressure on them. Some want to work part-time as consultants, which would leave enough time for relaxation or to pursue other interests.

Two – they just want time to relax & money enough to see the world;  do social work or pursue hobbies without worrying about money.

So, it’s essentially about two things. They are fed up with the rat race, want to accumulate money fast & opt out. The other is that they want to pursue some hobbies or other interests and need time for that.

It has almost become a fad now.  But, when we see if they will be financially secure by the time they want to retire, most times it does not work. In some cases we have found it to work. But we are never sure if they would actually stop working as per their original intent. We have seen that it did not happen in atleast one case, where he wanted to retire by 42. He was financially secure by 42, but did not want to retire. There was another reason… he had also added some aggressive goals, since we made the plan initially.

So, we find that people are never able to get off the tread mill, though they intend to. But it is a comforting feeling for them to know that they are financially secure and can live without worry.

Are they prepared?    The other reason why they leave – to pursue hobbies, do social work etc.  For most, it looks like the ideal thing to do.  But, when we dig deeper to see if they really mean it, we find that it is but a whimsical idea. Most have just not thought through it properly.

When we ask our clients to imagine what they will do 24 hours of the day in retirement, they get enthusiastic at first. But, when they start filling out what they will do 24 hours of the day, they start to realize how much time they would have and how bored they could get.

Many had said that they want to teach in villages / do social work. Lots of such people have never taught in their lives and do not know what it entails.  They don’t understand, for instance, that teaching is not for everyone.  Also, if they have expertise in a specialized area, will it not be more useful to assist / mentor people in those areas? This may result in more satisfaction as they would be passing on their expert domain knowledge to others, ensuring that their knowledge, experience & expertise is not lost forever.

Similarly – social work.  For most people, this again looks like the correct thing to do, as they feel that they have got so much from the society and would like to give back something. Again, the sentiment is fine & laudable. But lot of people find to their surprise that social work is not their cup of tea.

Even people who simply want to relax or pursue hobbies find that there is simply too much time on their hands. Retirement is seen as the time for enjoyment & rightly so, as one has worked the entire life and deserves a peaceful and relaxed life, after retirement. But boredom catches on… many find that after a few months, travel, hobbies, social activities etc. do not have the same attraction to them, as it initially did. 

Early retirees find that their contemporaries are still working and hence don’t have the time for them. At some point the early retirees start questioning their wisdom. And then when it appears to them that it is a mistake, they want to get back to work. Getting back is a lot more difficult. So, they start doing some assignments, where possible, or do work which is far lower than the one they were used to. All these are stress points for them.  

Preparing for retirement -  Whether It is early retirement or retirement at superannuation, one needs to prepare for the day of reckoning.

There are ways to be meaningfully involved in cultural, social, religious, personal work in retirement. One needs to be able to identify, what one wants to do in retirement.

For that, it is better to try them out and see if they really would be interesting. We suggest that people should start trying out things they want to do in retirement,  a couple of years before retirement .  They should play that round of golf a bit more frequently and see, if it grips them. For those who want to do social work, they should try their hand at teaching or doing other work in the weekends and find out if the attraction is for real. Lot of these things might look interesting initially. So we suggest that they try it out for atleast six months and then see, if the activity will be a good one to pursue in retirement. Lot of seemingly great pastimes, fall by the wayside, when subjected to this discipline.

Similarly, many would like to relocate to their villages after retirement. City dwellers find it very difficult to adjust to the perceived charm of the villages, which look alluring, when one goes on a short visit. Actually living there exposes one to the harsh realities – like lack of medical facilities, power cuts, voltage fluctuations, lack of entertainment avenues, disconnect with the people living there etc. So we recommend in such cases that one should try it out for about six months on rent, before making up their mind to shift lock, stock & barrel.

Ultimately, we all need to figure out some activities that will interest us and keep us engaged. Else, the retirees end up watching TV & spend the rest of the time in sheer boredom.  

Article by Suresh Sadagopan   Published in Business Standard 

For  Comprehensive Financial Planning come to the experts - Ladder7 Financial Advisories

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

A tactical allocation away from equities

“Why should I invest again in equity, when I have got just 5% annualized returns, over the last five years?”, asked my client, irritated. I told him that I’m not suggesting that he invest in equity now and that I’m actually suggesting that we should relook at the portfolio and do a bit of rebalancing. I told him that we will actually be moving away from equities.

Assuaged, he was willing to listen. I now told him that I have not lost faith in equities; in fact, it is quite the opposite. But then, I told him, I was willing to make a tactical call.  Equities keep going up and down. It may be due to the FM talking up the markets with possibilities of reform or based on the employment numbers in the US – but that is not something one needs to worry about.

We need to worry when the economy goes into a tailspin due to a combination of factors that would not get addressed in the near future. Interest rate being high is only part of the problem.  An adverse investment environment is hampering new investments coming in. Difficulties in getting environmental clearances, changing regulatory environment, uncertainty in policy framework, retrospective taxation evoked by income tax department and general bureaucratic problems abound, have started weighing on the economy. 

Industrialists are vocal about going abroad for investments. There have also been the usual, known problems of skills shortage, power woes across the country, coal & iron ore shortages and other such problems. 

Government has launched a lot of populist programs which completely plays havoc to the finances of the government. In a election year, it could get worse. Current account deficit is high too and we do not have much control over it. Add to this the continuing challenging environment abroad and an impending election.

All these point to the fact that things are not going to improve in a hurry. The FIIs have also started retreating in the recent past after investing continuously in the past year. Equities hence may not do well this year and hence the need to take a measured tactical call.

What are we suggesting ?

We are suggesting that those doing SIPs can continue with a longterm focus. However, if one is looking at needing money in 2-3 years and want to accumulate through monthly investments, we are suggesting investing through debt funds to do that . Short to medium term debt funds with upto three year maturities are suggested for those who need access to their funds, in less than three years.

We are suggesting a reallocation of equity assets to debt funds as required, in specific cases. This is a tactical call. We are suggesting between 10-20%  reallocation based on the specific requirements in client’s portfolios, in view of the conditions explained earlier.

Debt portion of Mutual funds are expected to have a good run in the months ahead. It is offering good returns now  and is expected to give decent returns going forward as well. It is also expected to benefit from a falling interest rate scenario that is expected to be there, for the next two years atleast. The weapon of choice would be actively managed debt funds or dynamic bond funds, which allows the fund manager to take the duration calls as well as managing the composition of the portfolio. For the normal investor, this seems like a good bet. The other investment which smells of roses is the Short term fund as the return potential is more visible here. 

Debt funds get better tax treatment. They can take advantage of indexation benefit and are subjected to capital gain treatment, which essentially ensures that one may pay an effective tax of just 5% overall. This is another reason why debt MFs are recommended. They would offer better post-tax returns than the traditional Bank FDs, Company EDs and Small savings instruments.

The dividend distribution tax hike in the budget from 12.5% to 25% has brought down the returns one can expect from Ultra short term funds. Hence, it’s attractiveness for liquidity purposes has diminished. Still, it is offering rates higher than bank FDs of short tenures and can still be used for parking short-term money. Since the returns they offer today are comparable to somewhat higher tenure debt funds, smart investors would want to invest in Ultra Short term funds and start withdrawing them for liquidity purposes, after a year only.

Contingency funds are also better kept in medium term funds, as they may not be required for long periods. Liquidity funds are best kept in a mix of ultra-short term and Short-term funds, to ensure that money can be accessed based on requirements, without exit loads. 

What is suggested here is what one could do in this financial year. Ofcourse each person’s financial situation is unique and they should look at what they should do with their portfolio. But a tactical allocation into debt investment options seems to be a good idea in the next one year atleast.

Article by Suresh Sadagopan   Published in Moneycontrol.com 

For  Comprehensive Financial Planning come to the experts - Ladder7 Financial Advisories

Get prepared for a good time in Retirement

Retiring early and putting the leg up is an idea, which appeals to lots of people. As financial planners, we find that early retirement  to be one of the favoured goals, in atleast half our clients.  Why is it such a major draw? We find two reasons.

Reasons for early retirement -   One – they want to be financially self-sufficient by a much earlier date, so that they can disengage from the rate race. Then they want to work on, without any financial pressure on them. Some want to work part-time as consultants, which would leave enough time for relaxation or to pursue other interests.

Two – they just want time to relax & money enough to see the world;  do social work or pursue hobbies without worrying about money.

So, it’s essentially about two things. They are fed up with the rat race, want to accumulate money fast & opt out. The other is that they want to pursue some hobbies or other interests and need time for that.

It has almost become a fad now.  But, when we see if they will be financially secure by the time they want to retire, most times it does not work. In some cases we have found it to work. But we are never sure if they would actually stop working as per their original intent. We have seen that it did not happen in atleast one case, where he wanted to retire by 42. He was financially secure by 42, but did not want to retire. There was another reason… he had also added some aggressive goals, since we made the plan initially.

So, we find that people are never able to get off the tread mill, though they intend to. But it is a comforting feeling for them to know that they are financially secure and can live without worry.

Are they prepared?    The other reason why they leave – to pursue hobbies, do social work etc.  For most, it looks like the ideal thing to do.  But, when we dig deeper to see if they really mean it, we find that it is but a whimsical idea. Most have just not thought through it properly.

When we ask our clients to imagine what they will do 24 hours of the day in retirement, they get enthusiastic at first. But, when they start filling out what they will do 24 hours of the day, they start to realize how much time they would have and how bored they could get.

Many had said that they want to teach in villages / do social work. Lots of such people have never taught in their lives and do not know what it entails.  They don’t understand, for instance, that teaching is not for everyone.  Also, if they have expertise in a specialized area, will it not be more useful to assist / mentor people in those areas? This may result in more satisfaction as they would be passing on their expert domain knowledge to others, ensuring that their knowledge, experience & expertise is not lost forever.

Similarly – social work.  For most people, this again looks like the correct thing to do, as they feel that they have got so much from the society and would like to give back something. Again, the sentiment is fine & laudable. But lot of people find to their surprise that social work is not their cup of tea.

Even people who simply want to relax or pursue hobbies find that there is simply too much time on their hands. Retirement is seen as the time for enjoyment & rightly so, as one has worked the entire life and deserves a peaceful and relaxed life, after retirement. But boredom catches on… many find that after a few months, travel, hobbies, social activities etc. do not have the same attraction to them, as it initially did. 

Early retirees find that their contemporaries are still working and hence don’t have the time for them. At some point the early retirees start questioning their wisdom. And then when it appears to them that it is a mistake, they want to get back to work. Getting back is a lot more difficult. So, they start doing some assignments, where possible, or do work which is far lower than the one they were used to. All these are stress points for them.  

Preparing for retirement -  Whether It is early retirement or retirement at superannuation, one needs to prepare for the day of reckoning.

There are ways to be meaningfully involved in cultural, social, religious, personal work in retirement. One needs to be able to identify, what one wants to do in retirement.

For that, it is better to try them out and see if they really would be interesting. We suggest that people should start trying out things they want to do in retirement,  a couple of years before retirement .  They should play that round of golf a bit more frequently and see, if it grips them. For those who want to do social work, they should try their hand at teaching or doing other work in the weekends and find out if the attraction is for real. Lot of these things might look interesting initially. So we suggest that they try it out for atleast six months and then see, if the activity will be a good one to pursue in retirement. Lot of seemingly great pastimes, fall by the wayside, when subjected to this discipline.

Similarly, many would like to relocate to their villages after retirement. City dwellers find it very difficult to adjust to the perceived charm of the villages, which look alluring, when one goes on a short visit. Actually living there exposes one to the harsh realities – like lack of medical facilities, power cuts, voltage fluctuations, lack of entertainment avenues, disconnect with the people living there etc. So we recommend in such cases that one should try it out for about six months on rent, before making up their mind to shift lock, stock & barrel.

Ultimately, we all need to figure out some activities that will interest us and keep us engaged. Else, the retirees end up watching TV & spend the rest of the time in sheer boredom.  

Article by Suresh Sadagopan   Published in Business Standard 

For  Comprehensive Financial Planning come to the experts - Ladder7 Financial Advisories

Using debt funds for financial planning

Debt funds are an area that most retail investors are not familiar with.  But investing in debt mutual fund schemes have benefits, that other  products in the debt space may not be able to offer.

It is important to consider aspects like liquidity, tenure, post-tax returns, risk associated with the product, amount to be invested and others before putting together the debt portion of the portfolio. Bank &  company FDs, PPF, small savings instruments etc. are normally the tools of choice for most investors. They use these as these options have existed for long and are easy to understand. All these instruments give fixed returns, which is a source of comfort. What they would be missing out is in terms of liquidity, taxation & rigidity in tenure.  

As financial planners, we find tremendous value in debt Mutual funds to tailor solutions to meet the needs of our clients.

Longterm investment needs :   Longterm corpus building is an important part of the planning process. This corpus is to take care of retirement as well as other longterm goals like Children’s education, marriage, retirement home among others. As part of the asset allocation some portion will be in debt instruments. Medium to longterm debt funds, including bond and gilt funds are good candidates, which have the potential to offer between 8-9% longterm. Currently, income funds are offering double digit returns, which may continue for some more time. The attraction here is that the tax treatment is benign, for investments over one year. Long term capital gains tax applies here, where indexation benefit can be taken advantage of. After this indexation, the actual tax incidence may be in the region of 4-6% ( assuming current levels of inflation ). Hence, there is little difference between gross and net returns as opposed to most other instruments where the gross returns would match a debt fund return, but the net returns don’t.

Liquidity & other shortterm needs :  Liquidity provisioning is to take care of sudden surges in expenses, which are not anticipated. By it’s very nature, these funds have to be available, at short notice. At the same time, the money should be deployed in a manner that it earns good returns. That is why liquid funds are a good option. Dividend Distribution option was the best option for this purpose. But, now things have changed after the current budget and the dividend distribution tax is at 28.3%. This tax is paid by the Mutual fund houses and hence indirectly the investor is paying for it. For a person in the highest tax bracket, this is definitely recommended. For those in the lower tax brackets, growth option would be a better choice, as the taxation is on their marginal tax rates, which is lower.

One more thing needs to be kept in mind. There are some who are far more prudent in managing their finances, than others. In such cases, we find that they do not access the liquidity margin for very long periods, stretching to years.  In such cases, Growth option can straight away be suggested, as beyond one year, one can apply indexation and the taxation incidence reduces.

The other thing that such investors could consider is shortterm or even medium term funds. These funds may have an exit load for a certain period. But, since these clients are disciplined, the chances of them cashing out in the initial exit load period is limited. Hence, these investors could enjoy potentially higher returns, even on the liquidity margin.

Contingency planning :  Contingency funds are created to take care of specific expenses that are anticipated, but their frequency or timing is not known. An example of this is a contingency fund for one’s parents. In this situation, it would be a better idea to invest in medium to longterm funds or in actively managed debt funds in the growth option, as the requirement may not be immediate. This way these funds can earn a higher return as compared to Ultra Short-term funds or Short-term funds.

Planning for upcoming goals/ payments in the near term :  Here, the goals or payments may be in the near term like three months to six months. It may be required for school fee payment In the next six months or to fund holiday expenses in the next six months or other such requirements. In this situation, an Ultra Short-term fund may be a good option. However, if the provision comes beyond six months the provisioning can be done through a Short term fund. Even a medium term fund can be considered if the tenure is beyond a year.  One can also consider Monthly / Quarterly Interval Plans for requirements whose time of need is fixed. But, in these cases, one needs to cash out in the window period available.

Investments & planning for upcoming goals :  Fixed Maturity Plans are a good option for those who want fairly stable returns, without market fluctuations and who strive for tax efficient returns as typically indexation benefit is sought in an FMP. Hence, this can be a good instrument for investment purposes. FMP investments are usually beyond one year duration, due to which single, double or triple indexation benefit can be availed of, as applicable and I hence tax efficient. FMPs can also be used for provisioning or meeting short term goals as it matures after a tenure and directly comes into one’s bank account.  

As we have discussed, debt funds can be used in one’s portfolio for a whole range of planning and can be the backbone of financial planning. As investors, one needs to understand and appreciate their place in the portfolio and the value they add in a planning exercise. It is not as arcane as it first sounds, does it?

Article by Suresh Sadagopan   Published in Business Standard 

For  Comprehensive Financial Planning come to the experts - Ladder7 Financial Advisories

Will the direct option introduced in Mutual Fund schemes live upto it’s promise?

SEBI has been a great votary of investor protection. There are many laws it had brought in specifically to help investors. Not all have been helpful for investors and some of them had unintended consequences for investors.

SEBI’s latest is the Direct option in Mutual fund schemes.  Let us understand what this is. Here, the expense ratio will be pegged at a lower level, as compared to the schemes distributed by intermediaries, as their commission can be saved.  This is akin to asking Godrej to sell a soap at their factory outlets at a lower price, though their retailers will be selling the same soap in their shops at a higher price! This would create a curious situation where the same product is available at two different prices and Godrej is in competition with it’s retailers! That would now happen with Mutual Fund houses and their distributors.

Will MFs benefit from this?   Savings for investors seems to be the motivation. But, will there be savings at all? If investors are motivated to invest in the direct mode, AMCs will have to augment their team for handling the volume.  The real retail crowd requires a lot of hand holding and these people will take up quite a bit of time and band-width, if they land up in the AMC’s points of presence. So truly, there may not really be any savings for the AMC. In fact, their costs may go up as their staffing is costlier, as compared to the staffing of distributors. It looks like SEBI feels that direct would entail lower costs. They may lean on the AMCs to artificially lower the expense ratios for the direct option. AMCs have to have another scheme called Direct apart from the regular one, for which they have to maintain a different NAV. All these increase their costing. This will affect the profitability of AMCs, where even in the current situation many AMCs are making losses.

Will clients benefit from this?  Now look at the clients. Are they going to benefit?  If clients want to bypass distributors and do things directly, they will have to fill out the forms and submit it at a POS.  Now, that seems easy. But, today that is easier said than done.  For instance, if a couple is investing in a MF scheme and the wife is the second applicant and she issues the cheque, the application will be rejected if the cheque does not bear her husband’s name! As a supporting document, a copy of the passbook will also have to be given, which shows both of them as account holders. So, that will entail a second visit.

Let’s take another example… suppose the wife invests in a scheme and the husband issues the cheque from his salary account, there is a third party declaration to be given. If his wife genuinely does not have a bank account or any other address proof, then the husband’s address proof and their marriage certificate would be required.

Assuming she has some address proof but does not have a bank account and gives her husband’s account no, at the time of cashing out she will have a problem as they will issue the cheque on her name though the account does not have her name. To take care of that, at the time of cashing out, she will have to give her old account details, including cheque and passbook and the new account details including cheque and passbook. Since old account is in the name of the husband, she will have to go to the branch and prove the relationship. If the old account is closed long back and one does not have any proof that they had that account, she had it. She will find it a herculean task to get her own money out.

So, it is not a painless process for the clients. In fact MF investments today have become quite cumbersome. They will have to go through the motions, bite their lip and keep reprocessing. In the process, lots of investors will give up, in between, in disgust. We are not done yet.  If the investments get done, there are invariably errors on the statement in lot many  cases. Now, further rounds will start to get that corrected.  This will become a full-time job rather than a diversion.

The investors would end up spending more time, effort & money in doing things themselves than they would save from the Direct mode, in terms of lower expenses. Only in case of those who invest in big chunks, like HNIs and corporates, Direct mode will be useful as they have the resources to invest directly, and handle any issues along the way. For all others, investing through their distributor would be the better choice.  There is lots of work to be done while doing MF investment today. As an investor, you need to decide if you want to do it or you want to get it done.  You cannot have the cake and eat it too, can you?

Article by Suresh Sadagopan   Published in Business Standard 

For  Comprehensive Financial Planning come to the experts - Ladder7 Financial Advisories

Don't reallocate to property just because it is doing well today

There is a worrisome trend today. The trend is to take loans to acquire properties – not just their residential home, but investment in home & land. The current thinking with people is that property is the only asset that will give good returns and hence investors it. One may wonder - what is so worrisome about this?  The point is that they are going in for multiple properties, in many cases liquidating most of what they have and taking a loan for the rest.

What we need to understand is that, it is not just property loans alone that people may have. Most people also have vehicle loans. Some have personal loans, credit card EMIs, consumer durable loans etc.  Property loans go on for long periods and hence has to be properly thought through, before taking it up. Also, in case of floating rate loans, the EMIs can go up.  So, we find many people with multiple loans – their overall loan servicing burden goes as  high as even 80% of their income, in some cases. When most of the income is going to service the EMIs, even a small increase can be very difficult to service.

The second important point that we need to realize is that no asset class, including properties will perform forever. There is a school of thought that property prices can never come down. Some argue that even if it comes down, it can come down by 20-30% and not like equity shares. It is true that property prices may not come down by a huge percentage; but properties can remain stagnant for long periods thereby depressing returns, like it happened between 1995-2003. So, there are up and down cycles in properties as much as there are cycles in every other asset class. Gold is another favourite. About two years back the gold fever was at it’s peak. Again, there are those who believe Gold cannot come down at all. Gold has performed well in the past 10 years; but if you look at the past 30 years, the annualized returns would be in high single digits.  That too is not due to gold returns ; it is due to rupee depreciation!

The other aspect to consider is the return on investment in properties, in the holding period. For land, there is no return. For residential  properties, the gross returns as a percentage of the property value would be 3-4%. For commercial properties it can be double that. If one calculates the various outgoes like society charges, property taxes, income tax on the rent received, brokerage etc., the net in hand would only be between 50-60% of the rental income.  So, every year one is earning only about 2% on residential property and may be twice that for commercial properties.  One is potentially losing 5-6% in terms of returns, every year.  The capital returns on the property has to make it up.

The other cost not factored are the registration, stamp duty, brokerage & other incidentals, which adds to the cost, but does not reflect in the value of property. Also, during the period when one is holding the property, the property has to be maintained, which is over and above the costs discussed earlier. At the time of liquidating the property, one also has to pay capital gains tax. Else, one needs to invest in Capital gain bonds ( yielding 6% taxable return ) or buy another residence to save tax!

However, most talk of creating an asset on borrowed capital and tax savings. One is creating an asset using  borrowed capital but is also paying interest. Only for residential property the interest rate is benign at about 10.5% and the real cost of borrowing can be low, if it is a second home.  In case of commercial property, the cost of capital will be atleast 3% more than the residential home rate.

The loans taken to create such assets are longterm loans which means the loan taker is assuming significant risk. One is making a commitment for a long period like 20 years to acquire a property, which itself is a huge risk. What is working for property investors are not what they think. What works is 1) people hold property for the longterm. They don’t look at the property prices every second day 2) consistent investments into it for years.

But, this kind of commitment would have worked well for other asset classes as well!

What people are afraid of is volatility. They do not realize that what they should ultimately be concerned about is returns over their holding period. Volatility is one of the accepted parameters of measuring risk. But given a long time horizon, volatility is less and less significant. That is, risk goes down as time increases, as one will be able to capture both up and down cycles that way. It will be even better, if one is investing regularly over time, as this will further ensure that the investor participates at all levels of the markets.  Long term investment horizon reduces risk. This is an important fact to bear in mind while investing in assets prone to volatility & cycles. Most investors dread volatility & end up cashing in or out at the wrong time.

A portfolio is created to offer diversification, deliver returns after taking into account risk, liquidity, maturity profile and other considerations.  No asset class will perform at all times. Only FDs or such fixed income products can always provide a stable & positive return.  But that return, especially post-tax, will be miniscule.

 A good asset allocation should have equity, debt, property and other assets in the required proportion, based on the investor’s needs. Moving from one to the other, just because one asset is performing well, will skew the portfolio as well as create liquidity issues, tenure mismatches, tax inefficiency & other problems. Also, timing error will come in as we may not always be able to time correctly in terms of moving back and forth. Also, there will be costs involved and there could be other issues like liquidity, taxation, tenure etc.  

In essence, it is better to stay true to the desired asset allocation, save for any tactical calls of a minor nature.

Article by Suresh Sadagopan   Published in Business Standard 

For  Comprehensive Financial Planning come to the experts - Ladder7 Financial Advisories