Get rid of your bad investments now

Several investors believe that money can be made by buying the right investment at the right time. If they select a good investment and time their decisions well, they think it's enough. They never tire of ruing the investing opportunities they've missed. However, the same attention is not paid to the bad investments in their portfolios. In reality, an investor's portfolio suffers more due to the incorrect decisions that are not acknowledged and corrected. Holding bad investments may be worse than not selecting the right ones.

While the entire universe of investments is potentially available for buying, the decision to sell only involves what the investor already has. It is, therefore, pragmatic to focus on holding the best rather than wondering about what we may have missed.

According to behavioural economists, one of the main reasons for our refusal to sell an investment is our aversion to loss. If our investment turns out to be good, we are happy to sell and feel good about the gains. However, booking a loss is painful, so we tend to postpone the regret we feel at having made the wrong decision. We choose to wait out, ignore, or worse, add more to a poorly performing investment, hoping to average out the cost. Therefore, cleaning up a portfolio is a tough task and calls for rational decision-making. Here are three ways to discard the bad apples from your portfolio.

The rate of return of a portfolio is the weighted average of what we hold in it. If some of our money is stuck in bad investments that show a negative growth, or don't work as hard as the others, we are losing out on the overall gains. If the money from a bad investment is released and redeployed, it may end up doing better.

If we are reluctant to make the decision, it may help to begin with a partial liquidation of the investment that is performing poorly and comparing it over a period of time. When we see how the loss could have been arrested and funds redeployed, we may be able to rebalance the portfolio with greater confidence. For example, those who are still holding the JM Basic Fund bought in 2007 in the hope that they will recoup the loss, should liquidate the fund and pick an index fund to see the benefits of selling what is not working.

We also have to give up the urge to come out good even after we know that our investment decision was bad to begin with. Ignorance is not a pardonable error in investing and when time reveals our decision as a bad one, it is better to act than argue. An endowment policy that was bought to save taxes, a Ulip purchased assuming that it is an investment for a fixed period, low-priced stocks picked at market peaks when good stocks seemed expensive, NFOs bought on an erroneous understanding of the product are all bad investment decisions, ab initio. They will not become better with the passage of time.

However painful the decision, we may have to book the losses arising from the purchase of a bad product. The sooner it is done, the better it is for the investor. Many of us think we should recoup something from the investment. If the performance is poor because the market cycle turned down, it may be worthwhile waiting for an upturn. If the market improves and our investment fails to look up, it confirms the bad choice and the need to quit.

Several investors want to know when to sell and ask frequently about profit booking. The crux of good wealth management is in wisely booking the losses and having a strategy for weeding out bad investments. If such investments are recognised for their draining impact on the portfolio and are uprooted ruthlessly, the fruits of investing are bound to be sweeter.

5 Mutual Fund Myths

It is easy, even for an intelligent investor, to be taken in by the hype surrounding a mutual fund scheme. Such misconceptions can impact the investments, which is why they need to be debunked. Here are the five common myths:

1. A fund with a net asset value (NAV) of Rs 10 is cheaper than the one whose NAV is Rs 50: The NAV of a mutual fund represents the market value of all its investments. Any capital appreciation in the fund scheme will depend on the price movement of its underlying securities. Suppose you invest Rs 1,000 each in Fund A (a new scheme with an NAV of Rs 10) and Fund B (an older scheme with an NAV of Rs 50). You will get 100 units of Fund A and 20 units of Fund B. Let's assume that both the schemes invest in just one stock, quoting at Rs 100. If the stock appreciates by 10%, the NAVs of the two will rise by 10%, to Rs 11 and Rs 55, respectively. In both cases, the value of investment rises to Rs 1,100-an identical gain of 10%. Fund B's NAV is higher as it has been around for a longer time and had bought the scrip earlier, which appreciated. Any subsequent rise and fall in the funds' NAVs will depend on how the scrip moves.

2. A balanced fund will always have a 50:50 debt to equity ratio: Balanced funds aim to achieve a balance between equities and debt. But the balance can tip depending on the nature of the fund. The equity-oriented balanced funds usually invest at least 65% in equities and the rest in debt. The others do this in a 40:60 ratio.

3. Large corpus funds generate higher returns:  A fund with a very large corpus is prone to inefficiencies as rising assets become unmanageable after a point. Also, most fund managers are more dexterous managing mid-sized funds. A large fund forces them to broaden their stock universe. This can lead them to include less researched or low-potential stocks in the fund's portfolio or increase the stake in certain stocks, leading to a selection bias. HDFC Equity has a corpus of Rs 2,680 crore, but its three-year annualised return is -1.68%, whereas the best performer for the same period is Reliance Regular Savings Fund, with an annualised return of 7.71% and an AUM of Rs 618 crore. At one-fifth the assets, the Reliance fund has fared far better.

4. Funds that regularly declare dividends are good buys: Fund houses declare dividends when they have distributable surplus. However, there are times when fund managers declare dividends as they do not have adequate investment opportunities. In some circumstances, a fund manager may sell some quality stocks to generate surplus for dividend distribution to attract investors.

5. SIP always scores over lump-sum investing: A systematic investment plan (SIP) is the best way to invest during volatility as it lowers the average per unit cost. This is also termed as rupee cost averaging. However, investing systematically during a bull run results in lower returns. When markets are constantly rising, SIP fails to lower the average cost and so results in lower returns compared with a lumpsum investment.

How to earn higher returns than FDs?

Financial experts are known to repeat the axiom that death and taxes are inevitable in life. But they forget to add one more item to the list: contingency funds. Due to the uncertainties that govern our life, we don’t have an option but to maintain a corpus to meet emergencies. The golden rule, most wizards maintain, is to maintain emergency funds to match at least four months’ expenses.

Such money in most cases is kept in savings accounts or invested in liquid funds or fixed deposits of very short term, say 30-91 days. The idea here is to earn some returns without compromising liquidity.

What are bond funds?:

Short-term bond funds and ultra short-term funds (also known as liquid-plus funds) have emerged as preferred vehicles for investors to ride out rising interest rates. Short-term bond funds are mutual fund schemes that invest in bonds and other fixed-income instruments that have a tenure of around one year. The fund manager builds a diversified portfolio of fixed-income instruments with varying maturities. The portfolio comprises treasury bills, certificate of deposits, commercial papers, securitised debt and advances in the call money market.

The ultra short-term fund focuses on very short-term instruments in the fixed-income space. It invests most of the money in call money and other shortterm instruments, offering good liquidity (for a listing of these funds see table). The Reserve Bank of India (RBI) has increased the repo rate (the rate at which it lends to commercial banks) by 125 basis points in this financial year. This, in turn, pushes up the rate of interest on shortterm borrowings for corporate entities and commercial banks.

What do they do with your money?

These funds invest in financial securities that mature in three months which are currently offering an annualised return of 9%. They also invest in one-year tenure instruments that offer 9.25% returns . Of course, public sector banks have also been hiking interest rates on their fixed deposits. But the returns offered by short-term financial securities are higher than fixed deposits offered by large banks for a similar tenure, which makes the fund route rather attractive.

Let’s take the case of one-year fixed deposit . The interest rate being offered currently by most banks is in the range of 7.5-8 .5% whereas short-term financial securities offer higher returns. Shortterm funds invest in short-term financial securities. So in the days to come it is highly likely that that these funds may give higher returns than those given by fixed deposits.

Why should you invest?:

Also, once an investor invests in a fixed deposit he is locked into it. If the interest rate keeps rising, it will be difficult for him to capture the higher interest rate unless he breaks the current fixed deposit to get into a new fixed deposit. That, of course, has its own issues. But, if the investor invests in ultra short-term funds and short term bonds, he can hope to capture the higher interest rates that may be on offer. These funds invest in different kinds of financial securities which have varying maturity periods.

So, the money coming in from the financial securities that mature can be used to invest in the new financial securities offering a higher rate of interest.

In the recent monetary policy, RBI has left the key rates unaltered. Though the statutory liquidity ratio (SLR) has been reduced to 24% from 25% to accommodate liquidity along with bond buy back, there is no signal from RBI regarding lowering of short-term interest rates. The regulator has not taken any long-term measure to improve liquidity which may bring down the short-term rates.

This is also the season when companies pay advance tax to the government. This means all the idle money that companies have is going to disappear. This, in turn, would mean a further scarcity of money in the market, which would push up interest rates further.

Over and above this, till the end of this financial year — March 31, 2010 — there is a strong line of initial public offerings (IPOs) and follow-on public offerings (FPOs) that are expected to hit the stock market. This will further tighten the money situation, creating more demand than supply, and hence higher interest rates.

Also, to support the increased lending, banks will issue more certificates of deposits on higher interest rates. All these reasons make an even more strong case for investing in short-term and ultra short-term funds.

It makes sense to look at exit loads if any, especially in case of short term bond funds before investing. Funds with low expense ratio spell out better returns.

What about tax?:

An investor looking to invest in these funds with a less than oneyear time-frame in mind should ideally go for the dividend option to ensure better post-tax returns. The dividends declared by liquid-plus and short-term bond funds attract tax at 13.841%. If you opt for the growth option, your gains will be treated as short-term capital gains and taxed according to the income tax bracket you fall into.

So, if you fall in the top tax bracket, you will be taxed at the rate of 30.9%. Mutual funds typically keep declaring dividends on these schemes so as to ensure that investors’ gains are taxed at a lower rate of 13.841%, making the monthly dividend option more attractive for short-term investors.

Also, if you want to invest for a period that exceeds one year, and you happen to choose the growth option, your gains will be taxed at the rate of 10% without indexation or 20% with indexation, which ever is higher. If you invest in a fixed deposit and fall in the top tax bracket, the interest earned will be taxed at 30.9%.

What are the risks?:

But a point to note is that interest rates and prices of financial securities move in opposite directions. So, if interest rates keep going up, the prices of financial securities go down. This is because the newer financial securities offer a higher rate of interest. This, in turn, means that the net asset value of the scheme also goes down, leading to lower returns.

So, it is essential to enter these funds at the right time and stay invested throughout the up-cycle . In case of short-term bond funds, once you get your timing of investment right you should stay invested for at least a year’s time to ride out the investment cycle as well as ensure that your capital gains are taxed at lower tax rates.

Four financial thumb rules you can follow

Here are some time-tested financial thumb rules pertaining to borrowing and investing in fixed deposits

They say when your values are clear to you, making decisions becomes easier. The maxim also works when it comes to making financial decisions. Here are some time-tested financial thumb rules pertaining to borrowing and investing in fixed deposits. However, there are several other thumb rules for various financial decisions.

While borrowing, monthly rest is better than quarterly and quarterly is better than annual.

When you take a loan, the most important parameter to look into is the rate of interest. Then there are fees such as processing and pre-payment charges, loan tenor and the like. Let’s assume that you have an option to borrow from two different lenders and all the parameters are the same. How would you choose then?

The word “rest” is used in the milieu of a reducing balance loan. Rest describes the periodicity at which the principal amount is reduced as you repay the loan. Rests are usually monthly, quarterly and annual.

How it works:A monthly rest takes into account the reduced principal after each equated monthly instalment (EMI) and accordingly applies the interest rate on the reduced principal. If the rest is quarterly, the repaid principal amount is adjusted every quarter and so on.

It’s always best to go for monthly rest, loans with annual rest become expensive. For instance, if you borrow Rs. 5 lakh at 12% for 20 years, the total interest you pay on a monthly rest clause is Rs. 8.21 lakh. You pay Rs. 8.24 lakh on quarterly rest and Rs. 8.38 lakh on annual rest.

Not more than 30-35% of your income.

An average urban family today has two to three loans—such as loans for home, car and consumer durables—going at a given point of time. But while taking loans has become easier, repaying them could become a problem and you may not even realize when you slip in a debt trap.

So ensure your borrowing should never exceed 30-35% of your income. This means that if you earn Rs. 100 per month, your EMIs should not exceed Rs. 30-35 a month.

About 30% of monthly income as EMIs for all debt is ideal. Anything more than that could cause trouble. For instance, if the EMI on your home loan goes up due to rise in interest rates, there is a good chance of you getting trapped. If more than 45% of your income goes to service debt you are already heading into a debt trap.

Remember the ratio 20:4:10 when taking a car loan.

Most people buy a car on loan and this ratio would be useful in making a decision. In this ratio, 20 (or more) stands for down payment, ensuring that you have paid a substantial amount initially, which will decrease the overall cost of your loan.

Then, 4 stands for the tenor. While banks may offer you a car loan for up to seven years, it’s best to stick to a four-year tenor or less. Says Ranjit Dani, a Nagpur-based certified financial planner, “The longer the tenor of the loan, the higher is the total cost of the loan; the sooner you get rid of the loan, the better the deal.” That way not only does the total cost of the car goes down, you also get to own it sooner.

The last figure in the ratio, 10, stands for the percentage of your monthly income you should shell out for your car EMI. In other words, your car EMI should not exceed 10% of your monthly income.

Higher the compounding, more the amount of future value.

When you make an investment, the instrument quotes the nominal rate of interest. But that may not necessarily be the rate of interest which you would actually earn. Your earning depends on the type of compounding applied, so your effective rate is the annual rate of interest that accounts for the effect of compounding. A rate can compound monthly, quarterly, semi-annually or annually.

Let’s assume you invest Rs. 50,000 at 12% for a year. If the instrument compounds the interest on a monthly basis, your Rs. 50,000 will grow to Rs. 56,341.25; if the instrument is compounded quarterly, you will get Rs. 56,275.44; with semi-annual compounding, you will get Rs. 56,180; and with annual compounding, you will get Rs. 56,000. This clearly shows that the shorter the compounding frequency, higher would be the future value of your investment. In monthly compounding, you earn interest on interest compared with annual compounding. Higher the compounding, more is the incremental amount you earn.

Keep in mind that interest of fixed deposits can be compounded quarterly, half-yearly or annually and varies from bank to bank.

Following these general thumb rules will help you make informed decisions.

Small savings committee proposes to restructure agent commission

The report by finance ministry’s committee on small savings recommends either reducing or completely abolishing the commission paid to agents on various small savings schemes

The finance ministry’s committee on small savings chaired by Shyamala Gopinath, deputy governor, RBI, has recommended either reducing or completely abolishing the commission paid in the Standardised Agency System (SAS), Mahila Pradhan Kshetria Bachat Yojana (MPKBY) and Public Provident Fund Agents (PPFA). These recommendations were made in the report “The Committee on Comprehensive Review of National Small Savings Fund (NSSF)”.

The committee recommends that under PPF, the commission should be abolished, as 90% of the transactions are happening through banks and for banks commission is not payable for any other scheme. They feel that 4% commission under MPKBY is very high and is affecting the viability of NSSF.

The committee recognizes that the recurring deposit (RD) scheme requires considerable effort on part of agents in mobilizing monthly deposits. But calling the 4% commission distortionary and expensive, the committee recommends bringing down the commission to 1% in a phased manner in a period of three years with a 1% reduction every year.

In addition, under SAS, the committee recommends that commission of 0.5% should be abolished on Senior Citizen Saving Scheme whereas on other schemes, it should be brought down to 0.5% from 1%.

According to the report the 13th Finance Commission (FC) noted that, “Incentives such as cash awards to officials and other similar measures to promote subscription to small savings instruments either add to the cost of administration or affect normal market linked subscription. Hence, such incentives should be proactively withdrawn by the state government.”

Agreeing with 13th FC, the committee noted that agency charges distorts the investment pattern and increases the effective cost of borrowings for NSSF. Thus, in order to ensure that the state governments do not give any extra incentive to the agents, the committee has recommended that the incentive paid to the state government may be reduced from the incentive payable by the central government to the agents.

7 Most Common Myths About Fixed Deposits

Rising interest rates and volatile stock markets, it’s that time when banks and financial institutions are aggressively marketing the safe investment option – “Fixed Deposits”. However, very often we see that various misconceptions about Fixed Deposits prevail among investors. Here’s making you aware about some of the most common “Myths and Facts” that you may face while investing in one.

Myth 1: Only Banks Offer Fixed Deposits.

Fact 1: Fixed Deposits Are Offered By Companies Too.

If you thought you could only approach your bank to invest in a fixed deposit, well that’s not so. Various companies and financial institutions too offer fixed deposits for retail investors. Companies offering deposits are governed by proper guidelines under section 58A of the companies act. They generally offer a little higher interest rate than bank deposits.

However, when compared to bank deposits, company fixed deposits are considered as an unsecured option. This is because bank deposits come with insurance for up to a maximum of Rs. 1,00,000.

Myth 2: More Number Of Regular Interest Payments, More The Returns.

Fact 2: A Cumulative FD With Returns Only On Maturity Would Fetch You More.

Fixed deposits come with two options; of receiving interest payouts at regular intervals, or a cumulative deposit, where the whole amount (i.e. principal + interest) is received on maturity. Your annualised yield on your FD works out to be higher if you opt to receive the proceeds on maturity. This is due to the power of compounding. In cumulative deposits, the interest is compounded at regular frequencies, instead of it being paid out. Higher the frequency of compounding more is your yield on investment.

Myth 3: All 5 Year Deposits Fetch You A Tax Benefit.

Fact 3: Only Select 5 Year Fixed Deposits Fetch You a Tax Benefit.

Under Section 80C, investments in select fixed deposits of 5 year tenure, provide an exemption of up to Rs. 1 lakh. Such fixed deposits, must be essentially from a bank, and are locked for the tenure, during which time, they can not be pledged nor withdrawn. Also the fixed deposit certificate must mention the tax benefit under section 80C, on the face of the certificate.

  

Myth 4: TDS on FD Cannot Be Avoided, As It Has To Be Paid By All.

Fact 4: Providing Necessary Documents Could Help Avoid TDS.

Tax Deducted at Source on a fixed deposit is deducted once interest, in one single financial year, exceeds Rs. 10,000 for bank deposits and Rs. 5,000 for company deposits. Housewives, minors or senior citizens, who do not have any other source of income, or whose income is below the taxable limit, could avoid this TDS. All that needs to be done is to provide the bank, Form 15G, or Form 15H in case of senior citizens, well in advance in the financial year.

  

Myth 5: FD Interest Earned Need Not Be Declared In Your Tax Returns.

Fact 5: Income Earned on FD Should Be Included In Annual Tax Returns.

Well, if you are earning an income from your fixed deposits, you need to declare the same. Interest Earned from your FD must be included in your annual tax returns under the head “Income from other sources”.

Myth 6: Pre Mature Withdrawal Is The Only Way, If I Need Money Mid Way.

Fact 6: FD’s Have Other Options In Times Of Contingencies.

If at any time you require money from your FD, most banks offer part withdrawal of funds, so that you could withdraw the actual amount you require, and the balance would continue to earn interest. Some banks also offer flexi deposits, were the deposits are linked to a savings account. All excess amounts in the saving account are automatically swept into a deposit. If one requires money at any time, he could withdraw just as he would from a savings account. Automatically parts of the deposit are broken to cater to the withdrawal. Also, overdraft facilities are available of up to 80 to 90% of the FD amount. Please note: Tax saving FD’s do not have these options.

  

Myth 7: In the Long Term, Fixed Deposit Offers Better Returns Than The Stock Market.

Fact 7: The Effective Returns From an FD Are Lower Than Stock Market Returns

This is due to the fact that fixed deposits are unable to beat inflation. For example, if the deposit earns you 9% p.a. and the inflation is at 8%, the inflation adjusted returns works out to only 1% (9-8). A stock market portfolio may probably give you a much higher effective inflation adjusted returns in the longer run.

What’s coming in Direct Tax Code (DTC)

In his budget speech, Finance Minister Pranab Mukherjee said that the new Direct Taxes Code (DTC) would become effective from 1 April 2012. The revised version of the much-awaited legislation, which is being examined by a parliamentary committee, is nowhere close to the pathbreaking reform it was meant to be.

Insurance: Stiff conditions

The DTC is a game changer for insurance. Most Indians buy life insurance policies only to save tax. Under DTC, a policy should give a life cover of at least 20 times the annual premium to be eligible for tax deduction. If this condition is not met, you will not get any tax deduction on the premium and even the income from the policy will be taxable. Right now, the income received from insurance policies is tax-free.

The tax deduction limit for life insurance itself will get reduced from the present Rs 1 lakh a year to only Rs 50,000 a year. Besides, this annual limit of Rs 50,000 would include the amount paid for tuition fees of children as well as medical insurance for self and parents. So, an insurance policy with a very large premium of say, Rs 80,000-Rs 1 lakh will fetch a maximum tax deduction of Rs 50,000.

The DTC will also nudge policyholders to take a long-term view of their investments. Premature withdrawals from Ulips will be taxed, so think twice before you buy an insurance policy. Don't believe the agent when he tells you that surrender charges have been capped and you can withdraw after five years without paying a penny.

Though the revised draft had indicated that the tax exemption enjoyed by existing policies will continue till the term of the plan, this is a grey area and clarity will come when the DTC is passed.

Real estate: Mixed bag

The repayment of the principal of your home loan will not be eligible for tax deduction under the DTC. The people who are paying large home loan EMIs and claim benefits under Sec 80C may have to find the money for other tax-saving investments after the DTC comes into effect. But this setback is minor when compared with the gain from the removal of tax on notional rent.

Right now, people who own more than one house have to pay tax on notional rental income even if the second house is lying vacant. Paying tax on your earnings is bad enough, but having to pay tax on the income you haven't received is worse. The DTC will end this anomaly and make investments in second homes more tax-efficient. Another landlord friendly move is that advance rent received from a tenant will be taxed in the year to which it relates, not when it was received. In some cities, landlords take up to 6-12 months rent in advance, which pushes up their tax liability. The DTC has fixed this too.

Similarly, by retaining the tax benefits on the interest paid on a home loan the DTC has helped cushion some of the impact of rising interest rates. The tax benefits reduce the effective cost of the home loan, thus making it affordable for borrowers.

Debt: New rules for indexation

With earlier plans to tax withdrawals from the PPF junked, investors should continue investing in this tax-free haven. Of course they should take their overall asset allocation into account while gorging on debt. Suppose you have Rs 4 lakh to invest in a year and want to put 25% in debt. Invest Rs 70,000 in PPF and the remaining in fixed deposits. You can also consider debt funds but the change in the taxability of long-term and short-term gains will rob them of the tax efficiency they have enjoyed so far.

One significant change that will impact investments in debt funds is the new rule for calculating the indexation of capital gains. Indexation takes into account the inflation during the holding period and allows the investor to adjust his buying price. If you invested in a debt fund in March 2008 and redeem it in April 2011, your investment gets indexation benefits for four financial years-from 2007-8 to 2010-11.

The DTC has changed this and the asset will have to be held for more than 1 year from the end of the financial year in which it was bought to avail of the indexation benefit. This is a significant change and will impact the way investors in FMPs and debt funds use this benefit.

Pension funds: Major change

Under the DTC, most of the current tax saving investment will not be eligible for deduction. Instead, the focus has shifted to long-term options, with pension plans leading the way. An annuity is an investment that gives out a regular income to the investor. Pension plans require an investor to put at least 65% of the corpus received on maturity in an annuity, which then gives him a monthly pension.

Though details are still awaited, the DTC has proposed to make annuity income exempt from taxation, which makes them a good tax-saving investment. The New Pension Scheme is a low-cost pension fund but you must assess the track records of the six funds that are managing the scheme before entrusting your money to one of them.

Equities: Minor changes

Investors can continue investing in stocks and equity mutual funds because the exemption on long-term capital gains will continue. The most important advice for equity investors, however, has nothing to do with the DTC. In fact, it has nothing to do with tax at all. 

How much insurance do I need for my family?

A Sunday is a relaxing day. A late morning, sipping a cup of tea and reading the morning newspapers — especially the glossies. Love the advertisements in those — the latest gadgets, that fancy car.


Yes, the products are all very good, but we don’t end up buying most of them. Even if we are genuinely interested, we like to research, check around or talk to friends. We do not buy everything that is advertised repeatedly. But when it comes to insurance, we are pressurized by that persistent, glib-talking salesman, as we believe that the product on offer is the one made with only us in mind.


No wonder, I know more people who complain about their insurance than those who crib about their cars. Come to think of it, insurance will possibly last longer than their vehicle.


My family’s needs, not mine:
Insurance should be considered as a protection against risk, and you must focus on the sum assured of the policies you have. How much insurance do I really need? That’s an odd question to answer, as the benefits of life insurance accrue to my loved ones, and not me.


Don’t forget to rephrase the question to cover your family’s needs. If I have a home loan for the apartment I live in, I must buy term insurance for the outstanding amount of the loan right away, and, in addition, consider the regular expenses that my family is dependent upon me for.


Calculating expense & liability protection:
Let us consider a working example. You, aged 35 years, have a home loan of Rs 40 lakh with an EMI of Rs 40,000 per month for the next 18 years, and your family is dependent on you for living expenses of Rs 5 lakh annually.


The calculation of funds required by your family in the case of your demise will depend upon future rates of inflation and expected returns on the investments from the pool comprising insurance proceeds and other investments available. The assets required rapidly climb if inflation rates nudge up by 1% every year, and returns drop by an equal amount. If we were to consider requirements of the family to age 85 years in this example, the assets needed today spiral up dramatically.

Remember this does not cover other future goals (child’s education and the like) that may be aspirations of your family. Move on your life insurance right away.

Build portfolio through proper MF investment

There is always an inclination to look for good returns at the least possible risk. Many, in fact, say that they want to invest in instruments that give maximum returns at minimum risk. While that is utopian, we can strike a decent trade-off by assuming some amount of risk for good returns.

Mutual funds offer a comparatively lower risk profile compared to direct investment in equities. Funds from various investors are pooled and a fund manager manages the corpus. The corpus collected is invested in various companies, across sectors to mitigate the risk. Fund managers are specialists who are clued in on the market and also have access to information that the investor may find difficult to access – or he will get after a lag, by which time the market would have discounted the information.


Normally, equity investors go about investing based on tips, what their friend or broker advised, based on their general knowledge about some companies. This makes the portfolio a mish-mash of various stocks, which may not be diversified and may have poor fundamentals as well.


For most people who do not have a deep knowledge of finance, it would be a good idea investing through mutual funds. There are equity-oriented mutual funds, debt funds and hybrid funds, among others. But, within each of these categories there are several sub-categories, for instance, in equity mutual fund category there are large cap funds, mid cap funds, value funds, thematic fund and sectoral funds. A proper portfolio needs to be put together, taking into account the various categories and the individual schemes.


Mutual fund schemes allow one to invest even small amounts; for instance, even Rs 100 per month is possible in a scheme. Most companies permit a minimum of Rs 1,000 per month. Monthly investment through systematic investment plans is one of the best ways of investing, as many would find investing lump sums difficult. Also, since one gets income (in most cases) at the start of the month, it is easy to invest a portion of this every month.


Systematic investment plans also have the advantage of making timing the market redundant as the investor would be investing at all points in the market. This ensures that over time, the investor would get advantage of rupee cost averaging and would end up making money over time. Even if a person wants to invest one time, the money can be invested through the medium of systematic transfer from a debt fund to an equity fund over time. This will be very helpful, when markets are expected to be turbulent.


For any goal, savings in small lots is far easier than lump sums. Mutual fund investments in equity are popular vehicles to meet long-term goals as equities perform well over time. Sensex has returned about 18 per cent compound annual returns over its period of existence — 32 years.


Equity mutual funds too, have given sterling returns over their lifetime of over 10-15 years. There are many funds that have given even a 20 per cent plus returns over 10 year plus periods. For those who are a bit more conservative, hybrid funds with a preponderance of equity investments exist. The investment returns will be commensurately lower, but the risk assumed is also lower.


There are also hybrid funds that have a major portion in debt and some exposure to equity. This offers a good chance to participate in equity to some extent, to those who are averse to taking a lot of risk. Then there are full-fledged debt instruments too such as short, medium and long term funds, gilt funds and fixed maturity plans (FMPs).


Mutual funds hence, give an entire range of products to address the needs of every individual. Whatever the goals a person may have, a good portfolio can be put together for achieving them.


For instance, if a person has a short-term requirement of money say one year, an fixed maturity plan of that duration or a debt fund whose portfolio maturity coincides with the tenure, may be a good idea.


For comparatively longer periods, one could look at a mix of debt products, hybrid and equity-oriented products, to construct the portfolio. Since the mutual funds have assured liquidity and equity-oriented funds enjoy zero long-term capital gains, they are even more attractive.


In a nutshell, mutual funds lend themselves to investments for meeting the short, medium and long-term goals and that, too, at one’s pace and convenience. What is required is regularity in investments and reviews from time to time, to ensure that the funds ones have invested are still performing well.


Used well, mutual funds can work like a charm for investors seeking goal achievement.

Learn The Templeton Way

One man consistently searched for and bought neglected stocks and made a whole lot of money doing so over and over again in different markets — John Templeton. His name is now famously associated with Franklin Templeton Funds (John sold his funds to Franklin Resources in 1992). A hallmark of the Templeton way of investing was foraying into international markets at a time when doing so was not common. Constantly searching for markets that were depressed, and within them buying not the most popular stocks but those that were beaten down, was the secret of his outstanding track record spanning decades.

Point of maximum pessimism

Templeton executed his first trade in 1939 after the start of World War II. The markets had declined 39 per cent over the preceding 12 months and the outlook was gloomy. In this pessimistic environment, Templeton took a loan of $10,000 and bought as many stocks for less than $1 as he could lay his hands on. Why did he buy when the outlook was so depressing, and what was his fascination with the $1 mark?

Buying when the outlook was negative ensured that stocks were significantly undervalued. The outcome of the War, and a victory for the Allies, was by no means assured. Fear and uncertainty combined to produce an environment of “maximum pessimism”.

The market did not expect these below-$1 stocks to do well in the prevailing circumstances. Some even faced bankruptcy. Templeton recognised these problems. To counter the risk of some of his investments failing, he bought a large number of stocks: 104 in all.

Templeton was not speculating. His investment rationale was simple: during the War all companies would be expected to contribute to the “War effort”. Where others were pessimistic, Templeton realised that the War, and the massive expenditure it would entail, was just the kind of stimulus that the economy needed to pull it out of the Depression. He realised that the prospects and profitability of at least some of these beaten down stocks would improve and this would more than compensate for the losses that he would incur on stocks that failed to turn around. Templeton was proved right. Only four of the companies he invested in eventually folded up while his $10,000 investment multiplied four-fold to $40,000.

The concept of buying at maximum pessimism has been immortalised in Templeton’s own words: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.”

How to identify a good bargain

To identify stocks, Templeton looked at the price that he would have to pay for a dollar of future earnings today against the company’s long-term earnings growth rate. This concept is today more commonly known as the PEG ratio. A lower PEG ratio signifies a better bargain. However, don’t go buying any stock with a low PEG ratio. You need to watch out for a few things: check whether the P/E ratio itself is justified: a bull market inflates the P/E ratios of most stocks. Look up the stock’s historic trading range. Second, consider whether the company can sustain the growth rate of the last few years.

Take the example of Bata India. The stock is currently trading at a PEG ratio (calculated using a five-year EPS growth rate) of only 0.4. But is it necessarily a bargain? The five-year PEG ratio is based on an earnings growth rate of 62 per cent. But if you look at the three-year EPS growth rate, it dwindles to 21 per cent. As a result, Bata’s (three-year) PEG ratio jumps to 1.22. Not such a bargain anymore!

International foray

Templeton started looking for opportunities in international markets long before others. His rationale? “It is commonsense that if you are going to search for these unusually good bargains, you wouldn’t just search in Canada. If you search just in Canada, you will find some, or if you search just in the United States, you will find some. But why not search everywhere? That’s what we’ve been doing for 40 years; we search anywhere in the world,” he explained.

Templeton launched the Templeton Growth Fund in 1954 with the objective of searching for value stocks globally. To illustrate how successful the fund has been, take a look at these numbers: a $10,000 investment in the fund at its launch would be worth $74,61,144 today (as on January 31, 2011).

By looking beyond a single market, an investor can bypass overheated economies or those with poorer growth prospects in favour of markets that are attractively valued or offer better growth prospects. For example, global investors who invested in the Indian markets even as late as in 2006 would have made a 75 per cent return by now (BSE Sensex returns). On the other hand, those focusing on a single economy, say the US, would have made a trifling 10 per cent over the same period (Dow Jones returns).

Templeton’s yardstick for identifying attractive markets was primarily the P/E ratio. Using this measure, he would zero in on a country that offered the highest concentration of cheap stocks and start looking for potential investments. Using this method, he identified Japan as a good investment destination as early as in the 1960s — long before the Japanese markets saw the phenomenal bull run of the eighties. (Incidentally, Templeton exited the Japanese market with profits long before the bubble burst).

Investors wanting to emulate Templeton’s strategy of foraying abroad should, however, be forewarned. This is one arena where you must do your homework. While investors from better-developed markets could find the lack of information and poor disclosure standards (especially in developing markets) frustrating, for the diligent global investor this could be a source of advantage: these inimical conditions would drive the casual investor away, thereby presenting him with an opportunity to scoop up bargains before the crowds discovered them.

By incorporating these tenets of Templeton’s approach — investing at the point of maximum pessimism and foraying abroad in search of bargains — you too can improve your track record.

Rules for investing the Templeton way

Invest for maximum total return: Investors often make the mistake of investing too much in fixed-income securities. This is particularly true in today’s environment where many fixed-income securities offer negative returns to investor after factoring in inflation.

Invest - do not trade or speculate: Investors are people who buy for fundamental value. Speculators are those who buy in the hope of selling later to someone at high prices.

Remain flexible and open-minded about types of investments: Never adopt permanently any type of asset or selection method. Try to stay flexible, open minded and skeptical. When any method for selecting stocks becomes popular, then switch to unpopular methods.

Buy low: One of the great ironies of the stock market is that when stocks drop in price, or “go on sale”, they attract fewer buyers. Conversely, when stocks become more expensive, they attract increasing numbers of buyers because of their popularity. To get a bargain price, you’ve got to look for where the public is most frightened or pessimistic.

When buying stocks search for bargains among quality stocks: The best bargains are not stocks whose prices are simply down the most, but rather stocks having the lowest prices in relation to possible earning power of future years. Look for companies with high profit margins, high returns on capital, and a sustainable competitive advantage.

Buy value: Not market trends or economic outlook. Too many investors focus on the market trend or economic outlook. But individual stocks can rise in a bear market and fall in a bull market. Therefore, more profit is made by focusing on value.

Diversify: The only investors who shouldn’t diversify are those who are right 100 per cent of the time. If you are diversified among different forms of wealth, nations, industries and companies, you will be safer in the long run.

Do your homework or hire an expert to help you:There is no substitute for doing your own homework on a company. At the same time, it remains a tremendous undertaking both from a time and skill standpoint to successfully purchase individual stocks for one’s own brokerage account. For this reason, you may choose to hire an expert who has a similar investment philosophy to your own.

Don’t panic: During a market correction, DO NOT PANIC. Don’t rush to sell the next day. The time to sell is before the crash, not after. Instead, study your portfolio. If you didn’t own these stocks now, would you buy them at current prices? The only reason to sell stocks after a market sell off is to buy other more attractive stocks.

Invest for the long term: One of the most common errors in selecting stocks for purchase, or for sale, is the tendency to emphasise the temporary outlook for sales and profits for the company. Avoid this temptation and invest with a long-term perspective.

There is NO free lunch: Never invest on sentiment and never invest solely on a tip. Investing requires an open mind, continuous study, and most of all, critical judgment. There are no free lunches!

Do not be too negative: Although Sir John M. Templeton coined the phrase “maximum pessimism” to explain the best time to invest, he remains one of the world’s biggest optimists. Look for bargains and opportunities during times of market malaise. You will be rewarded in the long run for not following the crowd.

Risk-return: two sides of a coin

You can’t have one without the other. Hence, understand the risks involved in various investments to maximise returns.

People aren’t risk-averse; they're loss-averse. Usually, occurrence of loss is more painful than happiness from gain / profit. The pain on losing Rs 50,000 is much more than the happiness in gaining the same amount.

Similarly, when people say they want to take high risk, what is going on in their mind is ‘high risk, high return’. At that stage, the probability of a loss is almost absent in their mind. People tend to forget that loss (read: risk) is an integral part of any form of investment. An investor who understands different kinds of risk and their characteristics will have a much more stable portfolio than one who invests haphazardly.

There are mainly two kinds of risk for any form of investment anywhere in the world, systematic and unsystematic. This is what they mean:

Systematic risk exists in the economic system. For example, inflation, government policies, consumer confidence, and so on. These adversely impact all forms of investment. Inflation, for instance, will always reduce the real rate of return of all forms of investment. Unfortunately, we cannot diversify away from systematic risk. Whether we buy equity, debt or real estate or any other form of asset to diversify our portfolio, systematic risk will always impact the returns.

One strategy that can be adopted to tackle systematic risk is rupee cost averaging. If we keep investing a fixed amount at a fixed interval, over a period of time, our purchase value of investment will start averaging (unless it is a unidirectional falling market for a prolonged period.) This happens because the level and constituents of systematic risk keep varying. Many mutual funds offer systematic investment plans, the best way to invest in markets.

Unsystematic risk is associated with only a particular kind of investment vehicle or instrument. For instance, by investing only in Infosys, we get exposed to unsystematic risk. Any adverse outcome will impact the performance of the company. Similarly, if a majority of investment is in real estate and if the government’s policies on real estate change, there could be an adverse impact on the portfolio.

To reduce the impact of unsystematic risk, one should diversify the portfolio. Unfortunately, different people understand diversification differently. To some, investing in fixed deposits (FDs) of different banks is diversification. There are others who invest in similar styles of schemes of different mutual fund companies. Like a portfolio where an individual had invested in nine different gilt funds of different mutual fund houses. There are still others who will have eight to ten stocks of different pharmaceutical companies. None of these can be called diversification. If the government was to change the tax rate on FDs, for instance, it would universally impact all FD investments. Similarly, all pharmaceutical companies would get impacted due to a change of policy impinging on the sector.

Diversification means investing in those classes of assets which move in opposite directions. Statistically, it is called negative correlation. Usually (though, not always), debt and equity markets have negative correlation. In the year 2008 and 2009, equity markets performed poorly. In those years, debt markets (debt funds) gave exceptionally good returns. In the recent past, debt has been giving (lower) returns but equity has performed well. An individual with only equity in his portfolio would have had disastrous years in 2008 and 2009 but extremely good years in 2009 and 2010. His / her portfolio would have been extremely volatile. Compared to this, someone with a diversified portfolio consisting of both debt and equity would have had stable returns.

An expert investor is not one who generates a phenomenal return in a few years and poor returns in the other. What is needed is stable growth of the portfolio over a prolonged period of time. This can happen by generating optimal risk-adjusted returns. And by remembering at all times that risk is an integral part of all our investments.

The Illiterate HNIs

Financial commitments based on verbal assurances are a sure way of getting into trouble.

Indians are getting richer by the day. And, perhaps sillier. Imagine giving money to a wealth management firm, or signing contract documents on verbal assurances from relationship managers that they would earn one-two per cent returns each month on their investment. That’s nothing but a willing suspension of disbelief.

The Citibank scam, perpetrated by relationship manager Shiv Raj Puri, exposed this unwarranted faith of the Indian high net worth individual (HNI). Armed with a forged document from the Securities and Exchange Board of India (Sebi), he sold schemes to investors, including HNI and the co-founder of Helion Venture Partners, Sanjeev Aggarwal. Even the Hero Group wasn’t spared.

And, it is not an isolated case. There are a number of instances where investors have claimed they were given verbal assurances of high returns, and they ended up losing money. There are complaints galore from investors with the market regulator, but little action can be taken.

How does the regulator help investors who sign documents without reading these and who invest on verbal assurances? Brokerages or wealth management firms, on their part, will claim they have not given any written assurance. But something is wrong. And, all of us know this.

The method is simple. As a finance professional and active investor-friend explains, “The executive from the brokerage who came to my house with the promise of a high-return product insisted there was a specific ‘clause’ in the agreement that promised the return. However, when I called up her seniors in the organisation, I was told there was no clause or assurance, either in the document or verbally." There are umpteen stories like this.

Mis-selling is rampant in India. Whether it was unit-linked insurance plans or mutual funds, distributors have been known to sell products by promising high returns. Both the Insurance Regulatory and Development Authority and Sebi have managed to bring it down significantly by slashing commissions.

Companies in both the industries have been forced to look at client retention to ensure a steady flow of income. So, fund houses and distributors are pushing systematic investment plans more aggressively. Insurance companies are looking at pushing more traditional plans and asking distributors to work more on retaining their clients.

Both Sebi and the Reserve Bank of India need to come out with strict guidelines to handle the rampant mis-selling in brokerages and wealth management firms, as well.

However, the important point is that investors cannot always put the ball in the regulators’ court. Financial commitments, based on verbal assurances, are a sure way of getting into trouble. Importantly, during profitable times, all’s well.

But when things go wrong, they cry foul and try to garner media support or approach the regulators. Here’s an example. A former colleague opened a brokerage account and put Rs 25,000 in it. After a week, he came and said proudly, “These brokerage guys are amazing. My account balance has risen to Rs 30,000 because they invested in some good stock." Three months later, he was cribbing and abusing the brokerage for conning him. His balance: Rs 5,000.