Thursday, November 27, 2014

Are your assets earning enough?

I invited 2 of my clients —let’s call them Sanjay and Vijay-- over for dinner once.  After dinner, we sat down for a chat and the conversation turned to property, equity market, retirement and lifestyle. Who is more likely to have a more secure retirement and why? I just listened to their respective points of views without agreeing or disagreeing to their points of view/


Sanjay is a top marketing executive—based out of Mumbai-- in an Indian company having operations all over the globe—drawing an enviable eight figure package. He owns a flat in Salt Lake City, Kolkata where his family lives. He has also invested in a flat in Rajarhat. He strongly believes in safety of capital and so has invested a bulk of his savings in bank fixed deposits. He has a small investment in mutual funds also (small compared to his total investments/savings). He has at most 5-6 years for his retirement. Having been a busy professional, he does not have much interest in managing money. He firmly thought that with bank fixed deposits and a flat in Salt Lake his retirement was secured.

Vijay—a first generation entrepreneur —had far more calculated approach towards his finances. He was very clear about creating a 2nd. earning member for his family when he retired. He started to set aside a fixed sum every month towards SIPs in equity mutual funds knowing that he is not going to need the money for at least twenty years till his only daughter was ready to pursue higher education. He also had a small portfolio invested in equity shares.

So now the question was who is doing better? Sanjay or Vijay?

Despite Sanjay’s confidence of a secured retirement, Vijay was far better placed in terms of a secured retirement owing to following points:-

Firstly, Sanjay failed to realize that retirement requires a regular cash flow. His investments in Salt Lake flat in and fixed deposits will not be able to generate the monthly cash flows needed to sustain the lifestyle that he was used to all these years. Moreover, being a private sector employee, he does not have the security of post retirement income viz pension which can augment his monthly cash requirement.

Secondly, Vijay understood equity better. He knew that only equity as an asset class can deliver returns in excess of inflation but only over long term. He was also very clear that he was not going to need the money for next 20 years or so. So he ignored the short term market fluctuations—fully confident that the long term trend of the market was up. He started SIPs in equity funds to run for 20 years—coinciding with the time his daughter was ready for higher education. He will have a corpus ready for it and will not have to dip into his retirement corpus.

Thirdly, Vijay operated from a point of expertise. While Sanjay failed to realize or overlooked the fact that his core assets—Rajarhat flat and bank deposits were not generating regular income in excess of inflation. They were on the other hand losing money—deposits by earning less than inflation and the flat by way of maintenance charges and taxes. Vijay’s portfolio on the other hand was earning positive returns. He focused –and rightly so-- on annualized returns rather than annual returns.

Sanjay was convinced that he was better off compared to Vijay. Many of us live under the same illusion. We overlook the wisdom of people like Vijay, who align their life, expertise, income and future to their assets. Such an approach helps in managing risks better. Instead, we approach life like Sanjay. We are happy with scattered residential property that earns too little income; we focus too much on the current job and resultant cash flows; we do not explore the need for additional income to protect us during bad times or retirement.

How we work with our assets and the incomes they generate critically determine how secure our financial lives will be. What are the lessons? 

  1. Owning assets means little if they are not made to work hard to generate income. In other words your investments have to work harder than you do. 
  2. The assets that are core, huge, and not intended to be sold, should be in prime shape and not remain idle. 
  3. Investing in expertise in managing assets is important to make the most out of them after all it is said that managing money requires more skill than making it. 
  4. Assets should be diverse in terms of their nature, location, and productivity, so that the risks are lower. 
  5. One is not wealthy based on the asset one owns, but on the basis of how he manages them. Before blindly accumulating assets, pause to consider: how you will get them to work for you and your future?