Khota Paisa

SIP – The Silver Bullet?

Posted in Investment by khotapaisa on January 25, 2010

Today I was watching a program on a leading financial news channel. A viewer called up and asked his investment query to the guest expert. The viewer had 5 lakhs (if remember correctly) for investment. He had a time horizon of 5 years after which he needed 15 lakhs towards his father’s medical needs. He wanted to take low risk so as to keep the principal investment amount safe. He wanted to know how to invest the money. The guest expert advised the viewer to start a SIP/STP in equity funds (I guess in HDFC Top 200, Reliance growth & SBI contra). He also suggested that at a reasonable 15%, he won’t have 15 lakhs after 5 years. So, either the viewer needed to increase time-horizon or take more risk.

This forced me to think about the common misuse of the systematic investment plan(SIP). Nowadays, SIP is being used as a silver bullet. No matter what your financial needs & profile, you will by default be suggested to invest in equity thru SIP. In reality, SIP has no magical properties. It doesn’t make your equity investment safe. In the example above, given the investor need and time horizon, equity is not exactly what the investor needs – SIP or no SIP. For a 5 year horizon, equity is avoidable for safety seeking investors. In this case, equity becomes less suitable given the purpose of investment. These days SIP is being offered as a equity-with-no-risk (what else would you ask for) investment option. This is another worrying trend like the ULIP trend. Remember, there is no one financial products that fits all. And this applies to SIP as well. The fact that you are going to invest thru SIP should not have any effect on your decision to invest in equity. You should first decide whether you can/want to invest in equity. Once you have decided to invest in equity then you decide whether to go SIP or no-SIP way.


ULIP – A 3 Year Love Story

Posted in Investment by khotapaisa on December 30, 2009

The single biggest reason for the extraordinary success of ULIP plans is the 3 year lock-in period. This feature of ULIP is disastrous as far as financial logic is concerned. But it is a masterstroke in terms of financial behaviour of humans. When a risky investment product like ULIP is presented to investors, you would expect the ever cautious investor to generally keep away from it. But the flexibility to stop paying premium after 3 years is what attracts the common investor. The common man actually sees the ULIP as a 3-premium-with-continued-benefit policy. And this explains the common practice of paying premiums only for three years.
The first three years are the costliest in terms of various charges that the investor pays. To cover this loss, the investor must remain invested for the full term of the ULIP. Calculations show that it is only after 10 years or so that this loss of income (by the way of high front end charges) is covered. The figure of 10 years also alignes well with the concept that any equity investment must be held for atleast a full equity cycle(typically 10 years). Another fine print that people fail to see is related to the idea that the benefits of ULIP (insurance or protection) continues even if you stop paying after first three premiums. It is actually not the case. All the protections that the ULIP offers, go away when your corpus falls below a certain value. So if market performs really bad during a certain period, you may stand to loose the insurance benefit from the ULIP if your corpus falls too low.

If you are one who is planning to take ULIP plan then make sure that –

1. Your premium paying term is more than 10 years.

2. You pay all the premiums.

3. You invest in all-equity fund option within the ULIP plan until you are 3-5 years away from maturity.

Gold ETF vs Coins?

Posted in Investment by khotapaisa on December 10, 2009

In a previous post, I talked about investing in physical gold (coins or bars). This resulted in few mails/comment(s) about the advantages of investing through Gold ETFs. It is common to see people advising in favour of Gold ETFs. ETFs seem to have all the advantages and hence appear to be the preferred choice of investment. I don’t necessarily see it that way. Though there might be some fundamental risks/costs associated with investment in physical gold, it still has it’s own set of advantages.
The following chart shows you the often quoted advantages of ETFs over physical gold.

Now lets try to see if the picture is really all that rosy for the Gold ETFs.

Now that we can see that ETFs are not the holy grail of gold investment, lets try to see the effective charges of ETF vs coins over a long period. When you invest in physical gold, you typically pay 1% VAT, ~4% overhead charges and some fixed charges, in all say 6% as charges. The same charge for ETFs is around 1% (or less) in terms of transaction charge. You will also pay a fixed fee (say 1000/- per year) for storing your gold coins/bars in the bank locker. For ETFs, you will pay ~1% of the total investment as expense. If you plot the cost of investing (and holding) in gold for long term (say 10-20 years), you will see ETFs are not that cheap. The following graph show that over 10-12 years, gold coins become cheaper investment option in comparison to ETFs. This may come as surprise, but the main reason for ETFs losing in long term is the expense ratio of 1-1.25%

Even with a 4% selling overhead (not always), investment in physical gold proves to be cheaper to ETF over long term (18-20 years). For a common investor, the relative lack of ease in selling gold coin may prove to be beneficial as it would resist the non-so-rare urge to sell to cover common expenses.
Keeping in mind that gold by nature is a long term investment, it may not be that bad to buy gold coins every year.

Note : If you have a demat account &  you use (and intend to use it for long) it, I would still suggest you to invest thru gold ETFs unless you prefer the good old way of buying gold.

Risk Profile & Asset Allocation

Posted in Investment by khotapaisa on November 27, 2009

For portfolio planning, the most important criteria is said to be asset allocation. The asset allocation is always done on the basis of the risk profile of the investor. This may seems pretty simple & logical but it is the most complex part of portfolio planning. By nature, risk profile is not a measurable entity. You can empirically judge it but that leaves it open to interpretation. And this makes the asset allocation difficult. Even though I agree with the concept of asset allocation based on risk profile, I could never use it in pratice (to my satisfaction). First of all, how do you judge risk profile? The simplest answer goes like this – How much loss in your portfolio will trigger your worry? Basically, how much loss before you start thinking of withdrawing your money? This might be an easy question but you are sure to get different answers from the same person at different times. Or you will get different asset allocations for an investor from different investment planners. This exactly is the art part of financial/investment planning. While asset allocation itself plays an important role in the performance of the portfolio, the basis of allocation is always questionable. This area is so fuzzy that I suggest you don’t worry about it much. Now, that doesn’t mean that you shouldn’t diversify. You must do it but without worrying about your risk profile. You can keep it easier by limiting your exposure to few asset classes like equity & debt (with little gold to add shine to it). You can allocate investments based on investment horizon. Anything for more than 10years goes fully into equity. Anything with less than 5 year horizon goes fully into debt. While this method can be questioned, it will allow you to keep your portfolio simple without hurting much on returns front. But then you shouldn’t invest to get the best returns. you should invest to achieve financial goal(s) assuming a decent(<15%) return on your portfolio. Any gain you have over and above the assumed return should be moved into debt instrument. This will allow you to increase your exposure to debt over time as well. You can try to do this exercise (rebalancing) once a year.

I think that the biggest enemy of an investor is greed. If we don’t run after higher returns, we will be cutting our risk considerably. As long as your investment is giving you a planned return, you should not even bother to look for other better performing instruments.

How To Invest In Gold?

Posted in Investment by khotapaisa on November 23, 2009

I have been planning to invest in gold for some time now. The cheapest way for me to invest in gold is thru gold ETFs. But I have not gone the ETF way as I don’t plan to keep my demat account. That brings the question of alternative ways to invest in gold. If you don’t/can’t invest in gold in demat form, the only other way to own gold is buy it in physical form. You can do it by buying it either in form of jewellery, coins or bars. But buying gold in physical form is a costly affair for the following reasons.

Premium : Whenever you buy any gold item, you pay the making charge, wastage and tax (as VAT) on it. This increases the cost of gold for you because when you sell gold, you will be paid only for the amount of gold. To minimize this cost, you should buy gold coin or bar as they have the least making/wastage charge.

Safety : This is the most important reason against owning gold in physical form. If you plan to invest in gold, you would typically be buying it regularly over a long period. Over a period of time, you will have enough gold with you to worry about it’s safety. So, if you own gold in physical form, you must have bank locker facility available to you.

Selling : Selling gold is as complicated as buying it. You would find it easy to exchange gold for jewellery but it’s not that easy to sell it for cash. On this front also, gold coins & bars provide better option. Some gold retailers like Tanishq buy gold coin (preferably of their own make) easily and pay in cash. But even when you get to sell it for cash, you will be paid thru cheque or DD. Though it may not be an issue, it certainly adds to your effort & time.

So if you are one of those who don’t/can’t buy gold in demat form, keep the following in mind while buying gold.

– Buy gold coins or bars.

– Find out the rate of gold coin/bar (22k or 24k) from different retailers.

– Avail bank locker facility for storage.

– Buy periodically in small amounts.

– Invest in gold over a long time and just hold it. Afterall, selling gold is not considered good (not without reasons).

– Let gold bring luck to you.

How to Select Funds?

Posted in Investment by khotapaisa on September 21, 2009

There are many ways to select mutual fund(s). No two advisors will give you the same answer. Some of the commonly accepted criteria for selection has been past performance, fund manager, size etc. I would try to list out some which I think are suitable to the common investor. Note that this fund selection criteria is applicable to investors who wish to invest for their financial goals, not just for wealth building. It means that for this type of investors, getting the maximum return may not be the best choice.

Old is Gold – Don’t select a fund which is less than 3 years old. The reason being, that the historical fund data is important for evaluation. It is not just the historical returns of the fund which is important but also the consistency of the fund.

Consistency Pays – There are two parameters which should be looked into. One is the historical return of the fund and the other is the volatility of the fund. If your goal is to build wealth, you should pay more attention to the historical returns. But if your plan is to achieve your financial goal (e.g. education, marriage, retirement etc), you should consider the volatility of the fund. This is measured by SD (standard deviation) of the fund. The lower the SD of a fund, the more stable/predictable it’s return. Once you have this information with you, shortlist funds which have the comparatively low SD with better than average return. It may not be one of the best funds in terms of return. But so be it. It’s better so invest in fund with average returns and low volatility than one with high return and high volatility.

Diversify – The meaning of diversification can be different for different people. There are a no. of attributes of a fund on which you can diversify. To make it simple, whenever you add a new fund to your portfolio, check out the top 5 holdings of the fund. If the existing funds in your portfolio give you enough exposure to these companies, you should not consider this fund. In addition, while selecting a fund you should make sure that the fund is not top heavy. Top heavy means that most of the fund investments are in its top 5 or 10 holdings.

Here are some sites which provide you with the necessary data on the mutual funds.

The Power of Staircase Investing

Posted in Investment by khotapaisa on September 3, 2009

Let me first tell you what staircase investing means? It simply means that every year or so, you increase your investment based on the increase in income. So what is new about it? When you plan your finance (say for the next 25 years), you basically try to forecast. And the forecast (as always) is based on certain assumptions. These assumptions may or may not hold good over the investment period. The most critical of these assumptions is the return on investment, typically equity. Some planners will use 15% for planning your finance while some will prefer to assume 12% as the return on equity over long term.  Very few try to assume that your income will increase at say 6% every year. Even if they do consider it, this assumption is never an integral part of the financial plan.

Which do you think is more probable to happen, say over 20 years – A 14% return on your equity investment OR a 7% average yearly increment in your salary? The fact is that the increment in your salary is way more likely to happen over long term than any return in equity. A back-of-the-envelope calculation shows that over the last 30 years, the average  yearly increment in goverment salary is around 11-14%. Difficult to believe, isn’t it? But look at it in a different way. Your salary has to increase to cover for inflation. And the increase is much more in private sector. So, it is much safer to assume that your salary will increase at a rate of say 7-8% (if you prefer to go with inflation) than assuming that you will get 12-15% return from equity over long term, say 20 years. And this is aplicable to government employees as well. Only that in this case the increase in salary will be every 6 years or so. But it will average out over long term.

Try it out youself – Ask you father what he earned when he started his job and what salary he drew last. Then try to calculate the average yearly increase in salary. I am sure you will get a double digit figure.

Why Rebalance Your Portfolio?

Posted in Investment by khotapaisa on July 30, 2009

Rebalancing is a widely descussed & debated topic. Generally, the investor fixes a equity:debt ratio for his/her portfolio. Whenever this ratio for his/her portfolio chages significantly, he/she rabalances it. So, if equity gives pretty high returns, some of it is sold and invested into debt instrument. This keeps the ratio fixed. Since I don’t follow the fixed ratio portfolio (for me >10 years is all equity, others all debt), I try to rebalance my portfolio in a different way. Since all my financial planning calculations are based on 12% return from equity, I book profit whenever the overall return(not just for the current year) on my portfolio exceeds 12%. The excess gain is then invested in safe investments. This helps in two ways 1) the debt exposure increases as I get closer to my financial goals, 2) it reduces the risk as I discourage my portfolio to give higher returns. To show the effect of this rebalancing, here is a table showing the comparative results against sensex. The investment here is a monthly SIP for 10 years.


The Simplest Portfolio Ever

Posted in General, Investment by khotapaisa on June 11, 2009

Some time back, I was watching an interview of an well known expert(perhaps the best in india) of equity investment. During the discussion, he sort of gave the broad details of his portfolio. In addition to being ultra simplistic, it is an interesting portfolio. His portfolio constitutes of just Equity Investment & PPF. That’s right, no other fancy stuff. In fact more than 90% of his portfolio is invested through equity. This may look like a funny portfolio but a second glance shows that it is indeed a very smart portfolio. The matter of fact is that there are only two types of investments, Equity & Debt. Everything else, we know of, is just a combination of these two. That’s what this portfolio is about. It consists of the most risk free investment available (i.e PPF) & pure equity.
It sure does look like an interesting portfolio. But does it suit all?  I guess not.