Khota Paisa

Guest Post @ InvestmentYogi

Posted in General by khotapaisa on August 30, 2009

My guest post was posted on InvestmentYogi earlier. You can read the post here (opens in a new window). It is not available on this blog. I will be ocassionally writing as guest at InvestmentYogi. They are one of the few startups working in the financial planning segment in India. I wish them all the best in their endevour to the educate and help the people manage their money.

Advertisements

Who Needs a 5% Return on Investment?

Posted in Insurance by khotapaisa on August 30, 2009

1. Recently IRDA made it mandatory to submit PAN details for insurance having more than 1 lacs premium. This happened after it was noticed that many people were buying insurance policies by paying huge amounts (guess it was crores) in premium (in cash).

2. I could never fully understand why would someone need an insurance policy (classic insurance) offering 4-5% return.

Combine the two and you get the answers. Who should buy classic insurance plan offering 4-5% return? Well, everyone who has bundles of money lying around unused. These insurance products offer (at least till now) a very good investment option (with no upper limit) which is mostly out of view of the banking system (and tax system). Add to this the tax exemption one gets on the maturity and the insurance, you get a perfect investment option.

But the problem is that most of these policies are bought by people who just don’t need it. People who earn hard money need to take the most out of money, instead they end up putting their money to idle at 4-5%.  The reason for this is mis-selling (as is in ULIPs) as well as low awareness. The best way to solve it is to remove the tax benefit on insurance premium partially. So, if you are paying a premium of 50,000/- and out of it 5,000/- goes toward mortality charges (i.e. towards pure protection), you should get tax exemption only for 5,000/-. This will also mean that only term insurance plans will get full tax exemption. Even otherwise, the common investor should be encouraged to buy insurance for protection not for saving.

How Much EMI Should You Afford?

Posted in General by khotapaisa on August 29, 2009

Not so long ago, a friend of mine bought a house. The EMI for his house comes to about 50% of his take-home salary. Now let us try to see how affordable this EMI is for him. Though I don’t have details of his expenses, I would try to list the mandatory monthly expenses conservatively.

EMI : 55000/-
Household expense : 25-30000/-
School : 3-5000/-
Saving for child education : 6-9000/-
Saving towards retirement : 25,000/- minimum

So he needs between 59,000 to 68,000/- every month towards his expenses. Remember that it doesn’t include other discretionary expenses, travel etc. It means that he is already falling short of money. So, how would he be managing it? Well, I can tell you that there are only two expenses he can cut corner into. One is the saving for child education and the other is the saving towards retirement. I can bet that the retirement quota is being used to manage the cash flow.
This situation is not uncommon now a days. Every other person (at least in my industry) has moderate to high levels of loans, sometimes more than one. They seem to afford it not because they are earning enough to afford it. They afford it because they compromise on one or more future goals (mostly retirement). Somehow people tend to think that over the next 20 or 30 years, they will earn/get a lot of money to fund their retirement. They might get it but not for sure. In fact retirement is the only financial goal that is non-negotiable. If you can’t save money for your kid’s education or marriage, you can still finance it by taking loan. Though this is not a good situation to be in, you at least have an option. But if you don’t save money towards your retirement, there is no option of loan. It might seem offending but your retirement is more important (or let’s say non-negotiable) that any other goal like house, higher education, marriage etc.

Making A Post-Retirement Portfolio

Posted in Retirement Planning by khotapaisa on August 23, 2009

Consider a person who has recently retired at the age of 60. All his savings, provident fund, gratuity etc put together provide him with a corpus of 45 lakhs. Staying in his own house, he has no dependent other than wife. The couple have the following expenses to cover.
Monthly Household Expense : 10,000/-
Yearly Travel Expense : 25,000/-
All the expenses total to 145,000/- per year.

Goals
 1. Medical Emergency – They should have a medical emergency cushion of 5-10 lacs. This can be provided by a combination of medical insurance & medical emergency fund. Even if they can afford a full 10 lacs S.A insurance, they must have their own medical fund. An insurance of 5 lacs with a 3 lacs medical fund would be a good starting point.
2. Emergency Fund – For retirees, the size of emergency fund should be 1-3 years worth of expenses. This would mean keeping aside around 2 lacs in this case covering 1+ years of expense.
3. Monthly Cash Flow – To cover the expenses, they need to keep money in combination of Post office MIS, Bonds, Senior citizen saving scheme etc.

Portfolio
Looking at the goals listed above, the portfolio may look like this.

Purpose : Medical Fund
Amount : 3 lacs (with 5 lacs insurance)
Invested in : A combination of long term debt fund & fixed deposits.

Purpose : Emergency Fund
Amount : 2 lacs
Invested in : A combination of long term debt fund & fixed deposits.

Purpose : Cash Flow
Amount : 1.5 Lacs/year
Invested in : Assuming a safe return of 6%, they need to invest atleast 25 lacs in safe instrument. They should start with putting 9 lacs in Post office MIS (joint account). They can then put next 15 lacs in senior citizen saving scheme. They can further put 6 lacs in debt funds. With the 30 lacs invested towards providing cash flow, the couple can decide to put the remaining 15 lacs in combination of long term funds, government bonds, fixed deposits etc. They may additionally invest (preferably less than one third of the remaining 15 lacs) in balanced fund/equity diversified fund depending on the comfort level.

Why Mutual Funds Are Not For Everyone?

Posted in General by khotapaisa on August 22, 2009

Mutual funds have come to form the core of any long term portfolio. Owing to the apparent simplicity, fund are now increasingly managing more of household savings. Even though investing in funds may seem to be very simple exercise (more so given the option of SIP route), there are some big practical issues with mutual funds. I would try to list a few.
1. Infrastructure – Unlike tier I & tier II cities, investor in smaller cities & towns don’t have the easy access to mutual fund agents. This situation is unlike the insurance space where agents are available in the neighborhood. Online trading is much less preferred because of reasons like awareness, computer-literacy, slow & unreliable net access.
2. Agent Reliability – Anyone who has regularly transacted in mutual funds will tell you that agents are not permanent. If you are looking over a few years, you might need to change your agent for various reason (bad service, agent stops offering service, relocates etc). In fact, in the last 3 years, I have changed my agent twice.
3. Continuous Paperwork – Even with SIP option, paper work is unavoidable when it comes to investing in funds. It is ok if you have to go through paper work to start your investment. But you need to sign forms every time you want to switch, sell, change SIP. And all this paper work becomes practically unbearable if you have to call your agent more than once to get it done. Consider it against the fact that all you need to do to sell/buy share is just a call to your broker.
4. Need For Monitoring – Investing in funds is not a one time process. The investor needs to actively monitor the investments. Though once-a-year assessment of funds is sufficient, a common investor is bound to do it more often. Assuming that every other assessment will result in transactions (buying, selling or switching), it will amount to a huge exercise over an year. The need to monitor fund investments also brings forth the issue of knowledge. A common investor is not qualified to assess or select funds. Most of the agent are not investment advisor but mere selling agents. And this inherently exposes the investor to higher risks like unsuitable fund selection, portfolio churning, unbalanced portfolio etc.
Given the issues, lets us try to consider ULIP. Before you react, let me state that I am no ULIP fan myself. Clearly ULIP doesn’t have the issues which confront mutual funds. They might give lower return on investment in comparison to mutual funds but they don’t need active monitoring. Infact, ULIP is a good alternative to MF for those who can’t invest in funds over long term for the above mentioned reasons. Remember that unlike aware & passionate investors, a common investor in a small city may not need/want to achieve high investment efficiency.
All said, imagine how good it would be if you just had to call you advisor to buy/sell/switch funds.

A Portfolio Without Equity

Posted in General by khotapaisa on August 21, 2009

Consider this –

Monthly Expense – 30,000/-
Net Monthly Saving – 45,000/-
Time to Retirement – 25 yrs
Post Retirement Period – 20 yrs
Employer Pension – None
Financial Goal – Retirement

What type of portfolio would you suggest? The most common (and generic) reply would be to invest in mutual funds and expect 12-15% return over long term.
Let me propose a radically different portfolio, one with no equity exposure. What if this person invest the full 25000/- every month in debt-based investments. Before analyzing the impact of this investment style, let me state the assumptions.

1. The monthly expenditure doesn’t include expenses like rent, school fee, premiums etc which will not be there after retirement.
2. The salary (and hence saving) rises enough to cover inflation. Af first it might look like a difficult assumption. But let me say that the chances of this assumption holding true over long term (25 years in our case) is way higher than getting 12-15% return over same period. And the data backs this every time. Even if you are in pulic sector job, your  salary rise over a long period will always( and has always) be more than inflation.
3. Investment in debt gives enough return to cover inflation

If your monthly saving (towards retirement) is not less than your expenses, every month you save today will fund one month after retirement. So, if you have more time left to retire than the post-retirement period (normally 20 years), you should be able to fund your retirement without taking any financial risk.

At the end, does it make sense? Given that all the three assumptions will hold true (practically always), I would say it is much less riskier than any other retirement alternative.

New Kid In The Town – Guaranteed NAV ULIP Plan

Posted in Reviews by khotapaisa on August 20, 2009

Welcome to the ULIP party. This is one area where products are increasingly becoming too complex for customers (even experts) to understand. Wasn’t ULIP already a complex product that we, the hard earning people, needed even more complex product like this? When I first read about this (in a newspaper), it sounded too good to be true. After all, why would someone offer me a product where I win all the times? I was sure that there was something more to it but it took me some time to figure it out. I don’t know if that’s the way the product is designed to work. In short, here is how I would do it if I were to offer this type of product to the world.
Say, at the end of every day, I would calculate the appreciation w.r.t the previous day. If there is any appreciation, I would move that into the debt bucket. I will keep it doing for next 7 years. So, what I end up doing is that I lock the gains in a debt fund (secure investment) and in turn reduce the equity exposure steadily over time. Anyways, based on this understanding, I did some number crunching and I came out with this –

“In the worst case, I will have to give <1% of the fund corpus (this is less than the fund management charge of 1.5% that I charge) out of my pocket”. – Based on my assumptions.

That means that in the worst case I, the insurer, will have to forgo fund management charge for just one year. That’s it!
So, what should you do? I suggest you follow the thumb rule –

Invest in the product which you understand.

How Good Is Gold As Investment?

Posted in General by khotapaisa on August 12, 2009

In an earlier post, I had analysed the performance of gold as in investment. The analysis was based on historical gold price in dollar terms. The analysis showed that gold has not been a consistant (low volatility) investment option as it is assumed to be.  When seen in rupee terms, gold has performed much better (atleast over last 10 years). I couldn’t get the necessary data for more than 10 years. But over the last 10 years, gold has given around 15% annual return. Does it mean that you should start investing more in gold? Well, I would say that irrespective of returns, you should typically have around 5-10% of your portfolio in gold. Any more exposure to gold will expose you to unnecessary volatility (as in all commodities).

Looking For A Financial Advisor?

Posted in General by khotapaisa on August 7, 2009

When I was looking for an advisor, I talked to many of them. After a long search, I got an honest advisor. Infact, the most difficult part of trying to fix your finance is actually getting a good financial advisor. Though there is no set of fixed rules, I would try to list down some filters you can use while selecting an advisor.
For all the questions listed below, you score one point if the answer is YES & zero if it’s NO.

Does your advisor
1. know your financial goals?
2. discourage you to buy NFOs?
3. discourage you to churn(buy/sell) your porfolio more than once every 6 months or an year?
4. ask you buy term insurance before any other insurance?
5. tell the risk associated with your various investments?

If your total score is 5, you are the lucky one. And if you scored less than 4, you may look for another advisor.

The (ill)Logic of Financial Experts

Posted in General by khotapaisa on August 6, 2009

Take 1 – Even if your wife is a house wife (non-earning member), you should insure her. The reason being, you will have to hire a cook and maybe a maid servant after her death. So, the amount you will spend on cook/maid, which you will need after wife’s death, should be the sum insured of your wife.

Take 2 – On valentine day, you should gift your fiancee with a demat account or fixed deposit or something on the same lines.
The first one is just out of this world. You can expect it only from a person who lives for money. The second one is more logical, but still i would rather not follow it. These are some of the advices right from the mouth of expert financial advisors. They regularly appear on TV, write in print media and give advice thru financial planning websites.
We must always remember that we make money to live. It is not the other way round. I would be happy to buy few grams of gold on my kid’s birthday every year. But I can’t be expected to pass it as “the birthday gift” to my kid. The kid expects something tangible as gift and that is natural. So it may be smart to buy gold on your kid’s birthday, but it will be equally dumb to gift the gold certificate to your kid as his/her birthday gift. And this is not all. As I read and see a lot on internet, TV etc, I come across many unjustifiable advices on financial planning.
Just the other day I was watching a program on insurance planning on a news channel. The expert was MD or some high level official from an insurance company. During the course of discussion, he said that you should take insurance in the tune 7-10 times your salary. This figure of 7-10 times is so commonly used that experts using this figure don’t even pause to think the rationale behind it. I have never come across the logic behind this assumption. I can, though tell you, that the 7-10 times rule will typically ensure that you are not underinsured. But this is just as a thumb rule which cannot (and should not) be followed in letters. Though there is nothing like over insurance, the insurance premium must be small enough to be affordable. And believe me, you will never find it affordable if you blindly follow the 7-10 times rule. So, the experts out there should keep in mind that they are not expected to give thumb rules to us. Many of us will blindly follow the thumb rules suggested by the experts. The experts ought to be specific in his/her advice. He/she should rather tell us that the insurance required by each individual depends on the debt, assets and many other variables. Similarly, another common advice which I have started seeing recently is about portfolio allocation. Experts are now suggesting keeping 10% your portfolio in cash. A few months back this 10% as cash would have been termed as idle money. So, what changed suddenly? Why do you need to keep 10% in cash? One possible reason given could be the economic downturn & the job insecurity. But then the job insecurity is only for private sector employees. And irrespective of the situation, one must have minimum 3 months equivalent of money in cash anyway. Experts are suggesting investing more in gold as it is expected to give more return. In reality, this whole concept of investing to get to get more and more return is the worst type of risk a common investor can take. The more you run after return, the more risky you investment becomes. Just continue with wherever you have invested. You need to reassess your investment periodically if your portfolio is not giving you the planned return. If it’s giving you the planned return, be happy and forget all the advices of the experts.

Take 2 – On valentine day, you should gift your fiancee with a demat account or fixed deposit or something on the same lines.
The first one is just out of this world. You can expect it only from a person who lives for money. The second one is more logical, but still i would rather not follow it. These are some of the advices right from the mouth of expert financial advisors. They regularly appear on TV, write in print media and give advice thru financial planning websites.
We must always remember that we make money to live. It is not the other way round. I would be happy to buy few grams of gold on my kid’s birthday every year. But I can’t be expected to pass it as “the birthday gift” to my kid. The kid expects something tangible as gift and that is natural. And this is not all. As I read and see a lot on internet, TV etc, I come across many unjustifiable advices on financial planning.
Just the other day I was watching a program on insurance planning on a news channel. The expert was MD or some high level official from an insurance company. During the course of discussion, he said that you should take insurance in the tune 7-10 times your salary. This figure of 7-10 times is so commonly used that experts using this figure don’t even pause to think the rationale behind it. I have never come across the logic behind this assumption. I can, though tell you, that the 7-10 times rule will typically ensure that you are not underinsured. But this is just as a thumb rule which cannot (and should not) be followed in letters. Though there is nothing like over insurance, the insurance premium must be small enough to be affordable. And believe me, you may not find it affordable if you blindly follow the 7-10 times rule. So, the experts out there should keep in mind that they are not expected to give thumb rules to us. He/she should rather tell us that the insurance required by each individual depends on the debt, assets and many other variables. Similarly, another common advice which I have started seeing recently is about portfolio allocation. Experts are now suggesting keeping 10% your portfolio in cash. A few months back this 10% as cash would have been termed as idle money. So, what changed suddenly? Why do you need to keep 10% in cash? One possible reason given could be the economic downturn & the job insecurity. But then the job insecurity is only for private sector employees. And irrespective of the situation, one must have minimum 3 months equivalent of money in cash anyway. In the same way, experts are suggesting investing more in gold as it is expected to give more return. In reality, this whole concept of investing to get to get more and more return is the worst type of risk a common investor can take. You need to reassess your investment periodically if your portfolio is not giving you the planned return. If it’s giving you the planned return, be happy and forget all the advices of the experts.