EPFO insists on Guarantee

According to a news report in one of the pink dailies, labour ministry has requested the finance ministry to provide a guarantee for investing EPFO money (that too only up to 15% as proposed by Finance ministry) in stock market. As of date there has been no news of finance ministry acceding to the request of labour ministry.

Why this clamour for guarantee by EPFO trustees? This is, we feel, because the labour ministry and the EPFO are still living in an era when government used to guarantee returns and it feels the latter should continue to guarantee returns for equity investments also! Moreover, the insistence on guarantee by labour ministry can be explained by the fact that since the Board of Trustees and the babudom of labour ministry may not have any involvement/exposure in the stock markets and hence sees only one side of the coin. Hence, they are willing to forgo the chance of workers getting a higher return in lieu of saving their skin!

What they fail to comprehend is that in their zeal to appear as sole protector of worker’s money, they are eroding the value of accumulated savings systematically—by insisting on investment of corpus in fixed income investments.

Most equity investors—that we've interacted with—are willing to forgo guarantee owing to the following reasons:-

• History has shown that investors relying on debt alone and thereby shunning equity totally---eventually run into the risk of effectively becoming poorer and poorer as retirement draws nearer.
• It’s positively dangerous to rely on debt alone to preserve the value of their money—dawns on to the investor only when it’s too late.
• Equities pay in the long term and pays handsomely.

While equities tend to be volatile in the short term, it gives superb returns over the long term. Hence, we've always maintained that conservative investors would be better off by having a small percentage of their savings in equities. Even a 10-15% exposure to equities would generate return which at least equals inflation.

For service class, by having a small exposure to equities and ignoring the short term volatility can be beneficial in the form of accumulating a bigger retirement corpus. Equities offers a chance of looking at the other side of the coin also—a fact conveniently overlooked by EPFO trustees

Patience thy name is SIP!!!

One of the less foreseeable results of last two years' turmoil on the stock markets has been that many investors are loudly questioning the efficacy of SIPs. One such person I met (a typical case) started off by claiming that SIPs were no good and that he had barely broken even on SIPs in a number of funds over the last four years. This seemed odd because the funds he named had done quite well. I quizzed him further and it turned out that back in 2008, when the markets had crashed, he had immediately stopped all his SIPs. However, he had restarted all the SIPs in August 2009.

Observant readers would have realised that this investor had basically done it to himself. He had invested in a manner that was guaranteed to shield him from any possibility of making money. Unfortunately, this mistake is way too common. The underlying problem is the increasing belief among people who skim the financial media that SIPs are a magical device, akin to the blessings of a god man, and are thus guaranteed to produce profits no matter when. They can stop whenever they feel like and start whenever they feel like and the God of SIPs will protect them.

The basic idea behind SIP, what the Americans would call SIP 101, is that while the general direction of an investment (a fund or even a stock) is upwards, it is not possible to reliably predict the actual fluctuations that it may undergo as part of its general trend.

Instead of trying to time one's investments, one should regularly invest a constant amount. As time goes by and the investment's NAV or market price fluctuates, this will automatically ensure that when the price was low, you ended up purchasing a larger number of shares or units. Eventually, when you want to redeem your investment, all the units are worth the same price. However, because your SIP meant that you bought a larger number of units whenever the price was low; your returns are higher than they would have been otherwise.

That's the way it works. Usually! However, you have to allow it to work by going on investing when the market is low. That's the most important part. At one level, SIPs are nothing more than a psychological trick to make you invest when the market is low. The whole point of investing is to buy low and sell high. If you stop your SIPs when the markets are low and then restart them when they have risen, then you have done the exact opposite of what SIPs are supposed to achieve, and you will get the exact opposite of good returns. Apparently, during the last two years, a lot of people actually did this.

Of course, there are circumstances in which a lump sum investment can (in hindsight) prove to be better. This happens when during a given period; the equity markets keep rising and never fall below the level they were at the beginning of that period. In such a case, a lump sum investment made at the beginning of that period will turn out to have the maximum gains because the buying price was the lowest at that point. The last one year (March 2009 to March 2010) happens to be one such period. However, over any longer period, such cases are rare. Generally, over a long period of time, the ups and downs of the market will ensure that SIP has the better returns. At the end, it is "time in the market and NOT timing the market that make or break your returns."

LIC--notional gains & Losses

25/11/2010

It’s the decade of black holes!

Another black hole was discovered in LIC a couple of days back after one was discovered in Employees Pension Fund scheme, 1995.

It was admitted by officials of LIC that 3 of its guaranteed returns schemes were facing a shortfall of about Rs. 14000 CRORES. These schemes –assures a guaranteed return of 12%---were launched in the hey days of high interest rate regimes.

However, with interest rates plummeting to single digits, the gap --between what the assets of the schemes expected to realize at maturity and what they actually realize-- is a big one and growing daily. Every fall in the interest rates will only widen this gap.

Rather than take corrective measures (which are extremely remotely possible) LIC has like the CWG officials keeps chanting aal is well. The reasoning it has put forth is unexpected from an organization of the likes of LIC. It has said that:-

• The losses are notional; and
• The losses will be made good by surplus of some other plans.

It is rather strange that even the financial crisis of 2008 has not taught any lessons to the LIC top brass or our watch dogs when they dismiss the so called “notional losses” as not so important! Why don’t they ignore the gains of other schemes in the same manner as they are also notional? That notional gains should be enjoyed as the EPF board trustees showed us when they declared a higher interest rate of 9.50% --just because they discovered Rs.1700 odd crores of notional gains tucked away somewhere in their books.

The existence of this gap—albeit notional at present—is not something to be wished away. It is like a time bomb ticking away….it is only a matter of time before it explodes.

A gap between the realizable returns and guaranteed returns is very much real and will in all likelihood expected to grow at an exponential rate. The simple reason being that fixed income returns in India are likely to remain below 12% --as is promised by the schemes---for the foreseeable future.

The gap will most likely be around 3% if not more. With the schemes having still got a few decades to run, this 3% gap will grow to about 80% in nearly 20 years. However, a lic policy holder need not worry as long as they have the following support base:-

• Holders of those policies which are in surplus (so what if you have to subsidize the loss making policy with your surplus)
• Government of India

No matter how much LIC mis-manages its investments or policies, at the end of the day it can always run to its big daddy—Government of India—for a bail out. And the best way for the government to make good its losses---impose a cess/tax. Taxpayers are meant to be milked!

CRASH IS WELCOME!!

If there is one question that everyone wants answered, it is regarding the plan of action in such market turmoil. How does one get through this crisis?

Actually, there are just two avenues to explore.

First, you can sell your investments and sit on cash or channelize the money into fixed return instruments. Not only is this not very tax efficient (the returns from fixed income instruments are taxed) but you also lose capital since you are selling at very low rates.

Cashing out closer to the bottom is disaster from an investment point of view. Even if you go ahead, you will not know when to begin reinvesting down the road. The odds are against you when you attempt market timing.

Your second option, and definitely the most preferable route, is to stick with your long term plan since this crash will actually benefit you. Because in the equity market, you make money not despite the crashes but because of the crashes.

Let’s look at the tech boom. The Sensex touched around 5900 in February 2000 before sinking to 2600 in September 2001. It touched 6000 only in January 2004.

Now let’s assume that the crash never happened. The Sensex reached 5600 in March 2000 and stayed at that level till October 2004.

If you had started investing Rs 20,000/month in a Sensex-based index fund in early 1997 and continued all through, your investments would have been worth Rs 55 lakh (without the crash) instead of Rs 66 lakh (with the crash). The reason? The crash enabled the investor to buy cheap and thus eventually raise total returns.

If you are investing steadily for the long term, then intermittent crashes help you make more money, not less. Because when bubbles correct, they usually overcorrect so that the market is selling well below fair value. So that’s the time to go buying, not selling.

Discipline--Key to Equity Investments

We at AIMS have always believed that equity is the best asset class in the long run. History is replete with numbers/figures to support our belief, as after all history does not lie.

Over the last decade, Sensex has given an annualized return of about 18%. The numbers of equity funds that have been around for that kind of time period have done even better. To give you a brief idea of the wealth generated by Mutual Funds since 01/11/2000 till 31/10/2010:-

Fund Name		Returns CAGR (from 1/11/2000)
DSP BR Opportunities Fund	:-	27.73%
DSP BR Equity	:-	27.68%
HDFC Top 200 Equity Fund	:-	32.12%
HDFC Equity Fund	:-	32.10%
HDFC Growth Fund	:-	25.46%
Reliance Growth Fund	:-	36.13%
Reliance Vision Fund	:-	32.60%

These kinds of returns can generate serious wealth without much of an effort.

Over the past 10 years, a saving of Rs 20,000 a month at typical fixed income interest rates would have left you with just Rs 36 lakh while a SIP in a typical equity fund would have left you with around Rs 1.20 crore. That’s the kind of differential that can change someone’s life for better.

However, you will hardly come across anybody who has realized/generated this kind of wealth by just being a passive investor! We get so worked up trying to predict the sensex level and try to ride every peak and bottom that we more than often forget the basic purpose of investing; whether it is to fund our children education, marriage, our retirement etc.

Rather it is an irony that we have come across far more people who have managed to either lose money or gain very little while investing in equity. Why is this so? If equity investing is such a wonderful thing, why aren’t the streets full of ordinary investors singing virtues of the stock market? We believe that the answer lies in the large gulf between the theory and practice of equity investing.

The returns as shown above can be yours if the investors follow but a simple rule, viz;

· stick to the straight and narrow.

· Invest in a mix of stable large to large-mid stocks;

· invest regularly to average your cost and keep investing for years and years, and

· most importantly, don’t stop investing when the market is down and don’t invest more when the market is up.

Most likely we just end up doing whatever our instinct tells us to do and that the theory remains without practice. We still get queries for SIP like:-“I’ve been investing in SIPs for more than a year, should I book profits now?”

Queries like these arise since investors still equate SIP investing in particular and equity in general with short term betting and thinking that 1 year is long term!

The fruits of equity investing are available to everyone, but we’ll have to figure out how to peel that fruit.

EPFO goof up --boon or bane??

It’s official now—EPFO –which manages a corpus of Rs. 1,30,000 crores –is facing a shortfall of Rs. 54,000 crores.!! (According to the Central Provident Fund Commissioner).If this piece of news item is indeed true then this black hole is 10 times bigger (or deeper, shall we say) then the one created by the erstwhile UTI!

Wait! The story is not over yet. Quite unlike a prudent person, instead of taking urgent steps to set the house in order, EPFO has announced an increase of 1% in interest pay out for 2010-2011(only) to 9.50% (since it found about Rs. 1700 crore probably tucked away on top of their cup board.)It seems rather strange that while on one hand the organization meets its liabilities out of a subsidy of Rs.1100 crores annually from the government, it is handing out largesse to its members to the tune of 1700 crores.

The writing was all over the wall for the Board of trustees to see. Falling interest rates and an archaic investment pattern have resulted in a deficit in actuarial valuation to the tune of Rs.54,000 crores.

That the organization is facing this huge shortfall is not too difficult to understand! Typically a pension fund/scheme lays down either the contributions to be made into a worker’s account, or fixes the pension amount to be paid to him at the time of his retirement. However, the EPFO spells out both the contributions as well as the benefits—which is unsustainable.

EPFO must be really lucky to be able to find out Rs. 1,700 crores (wonder why such hidden treasures do not come my way) and that too distributing amongst those who may not be even entitled to it (this surplus belongs in part to those workers who may not be working any more as it was earned over last 2 decades or so).

What however this revelation by the Central PF Commissioner’s observation highlights is that EPFO’s operations are in shambles! However more alarming is the casual acceptance of what is to be done with the re-discovered money! If today they have found a surplus due to a calculation error, they may again re-discover a shortfall tomorrow due to a calculation error. Will the Board be able to re-cover the largesse from the workers citing calculation error?? The one fact that hits the eye is that the EPFO’s operations are in shambles!! The pertinent point to ask is whether is it safe to continue to park the funds with EPFO?

There’s no way but to turn the EPFO into a collective investment scheme where each member get what his money has earned. But then that what’s what NPS is supposed to be. Could EPFO be merged into NPS? (possibly an out of the box solution).

I guess the day’s not too far away when the EPFO will have to go back to its mummy & daddy for a careful re-calculation of its financial position. But may be it would be too late by than….but that’s exactly what mom and dad are there for isn’t it—with deep pockets (hopefully)

Highest NAV guarantee Insurance plans-- Fact or fiction

Today presentation or packaging plays a very important role in success or failure of a product. People are willing to pay the cost even if it exorbitantly priced. For example cost of a mineral water bottle is more than the water inside. The only reason people buy packaged water is because it is very convenient.

This concept was applicable in the investment field in general till now has now been seen playing out in the insurance arena in the form of Highest NAV Guarantee ULIP plan.

Such plans quite contrary to common belief do not guarantee highest returns but guarantee only highest NAV (as highest NAV does not necessarily mean highest return). For example if your NAV was Rs.10/- at the time of initial purchase and it’s value grows to Rs.20/- over a period of time and then falls; you will receive at least Rs.20/- on maturity. Subsequently even if the stock market goes up, your ULIP may not move in tandem.

However, there are a few important points about these types of plan which we believe should be highlighted. They are:-

• The guarantee is valid only if you hold the policy till maturity. Premature withdrawal may prevent you from enjoying this guarantee were you to withdraw such a plan pre-maturely.
• Guarantee is that of the highest NAV and not of the returns on the premium (net of charges) invested on your behalf. Guarantee comes into play after accounting all the charges.

Many investors have wondered how is it that a ULIP fund manager able to guarantee highest NAV and not the Mutual fund manager while both invest in equity market. The answer lies in the manner such plan works. The modus operandi adopted is quite similar to the one followed in case of the Capital protection oriented funds. The fund manager –depending upon the prevailing interest rates and the given time horizon—invests a portion of the inflows in fixed interest bearing securities. For example Rs.100 can be generated and returned back as capital to the investors by investing Rs.46.31 into fixed interest bearing secuties. It will grow to Rs.100/- after 8 years.

The fund manager draws an imaginary safety line—or laxman rekha—below which the portfolio value should not go. As soon as the NAV of the investment breaches this imaginary safety line, he would exit all equity investments and re-invests into debt securities. This amount would then grow to the desired amount at the time of maturity.

A simple advice to the investor with investment horizon as long as that of the ULIP:-

• Avoid such guarantee plans how so ever lucrative it may sound to be.
• Instead start an SIP in a scheme of a diversified mutual fund immediately
• Start shifting from equity to debt as retirement draws nearer.
• The charges that you save by not buying ULIP by investing in a diversified mutual fund will also act as another earning member of the family.

Managing personal finance is for long term…..

The whole thing is that ke bhaiya sabse bada rupaiya!!

Money goes round the world and the world goes round the money! In spite of its importance, it is on top of our mind, managing it is not! The fact that managing money requires more skill than making it seldom dawns on us—since we always pride in ourselves thinking that we know all that we need to know about money!

Your money is as important as someone else’s money!!

It is strange but true that many a finance professionals are not able to show the same level of performance in managing own money vis-à-vis client’s money! A sales manager at a prominent MF was more comfortable investing own funds in bank FDs. Why? It is possibly easier to handle client’s money as there are no attachments or far less compared to that in case of own funds.

Get professional help!!

Sure you do and we are glad about it!! There several terabytes of information available on the internet for you to access and utilize. There are websites that offer free analysis of MF schemes. But it is not the only input you need to home in to an investible fund/scheme.

Do the so called free on line fund analysis work out your risk profile before throwing up a scheme onto the screen? How do you decide the right asset allocation or allocation between say large caps/mid cap/small cap oriented funds? Sure you can download the best performing schemes---but who’ll tell you that it is the history that you are looking at….and history may not be repeated always—howsoever we may want it. Fee based advise is far better than free advice--let us all accept it for our own and our money's good.

You may not always get No.1 fund

If you have invested in 5 schemes, then one of the schemes has to be placed at No. 5. All the schemes you have invested in will not be at No.1. This wish to invest in No.1 scheme may lead you to divest a potentially good scheme. Do not fall for neighbour’s envy owner’s pride.

Let us engrave the statement “Managing personal finances is for long term”. You will have a peaceful night’s sleep once you start believing in it. Your long term financial goals will be met if you let your money work for itself with minimal of interference from you.

Are Mutual Fund advisors not honest???

Local newspaper "The Telegraph" in it's editorial on 12/07/2010, carried an article which to us seemed to come out from a person who is either too short sighted in his view about the Mutual funds or is a die-hard anti MF person.

We had written to the editor trying to make a case for MF advisors. Reproduced here below is the letter:-

Sir,

This letter is in response to your editorial in The Telegraph of Monday 12^th. July 2010. In the said article you have stated—amongst other things--that:-

1. MF agents do not render any essential services.
2. Hence there is no logic in paying them any remuneration; and that
3. They are robbers.

It seems that the Mutual Fund advisors have become the popular whipping boys of all and sundry. Everything that is wrong, not investor friendly, or unethical is in MF industry only; while everything in every other industry including media and journalism is respectable ethical & acceptable. Sir, you seem to have breached all norms of etiquette, and reasonableness expected of an editor of an “unputdownable” paper!!

In writing “(SEBI’s probable action of rescinding its ban on entry load) will return the investors to the situation where they would have to shell out money to agents for no essential service” you have conveniently overlooked or ignored the fact that it is this supposedly redundant set of MF advisors—who have taken the MF to Tier II & Tier III cities of India. In a recent study (conducted jointly by Boston Consultancy Group and CAMS) published in www.wealthforumezine.com it has been shown that over a period between 2003 and 2010, share of Mumbai, New Delhi and next Top 8 cities in Mutual Fund holdings have gone down from 90%(47%+14%+29%) to 75%(32%+12%+31%) respectively. Simultaneously, the share of next 90 cities+others has gone up from about 9% to 25% during this same period. Certainly, this shift would not have been possible without the MF agents/advisors!

You further go on to say that an investor does not need an agent to buy MF! Agreed, that today internet has facilitated online transactions and thus by-pass an intermediary! There is nothing wrong in it also. There are many financial magazines that dole out so called “best buys” every week or fortnight! However, the underlying point to be considered is whether the average retail investor equipped enough to identify the scheme that suits his risk profile? More importantly how does an investor ascertain the neutrality of the recommendation(s)? Can the investor be assured that the journalist’s recommendations of MF schemes are not the result of their collusion with MF houses? Is there a Regulator who will ensure that schemes are not recommended based on ad revenue generated by magazines out of MF house?

Nowhere in the world is a salesman expected to work in an environment of falling and uncertain revenues! It happens only in India! Let us be honest enough to accept the fact that the MF agent is here to do business and as is normal bottom-line of a business is “bottom-line”. However, events of the recent past and the article in question seem to suggest that sky would fall down if a MF agent speaks of remuneration! No body questions the legitimacy of the reimbursement earned by the Small savings agent or the insurance advisor from their respective institutions! Then why this step motherly treatment to MF agents?

Sir, you have only showed your ignorance by equating the MF agents’ remuneration with robbery—and by logical extension of the phrase---MF agents are robbers—since only robbers rob! If you so believe, than why don’t you-- through your newspaper-- or anybody petition the courts/government to ban Mutual Fund industry! Let investors buy only ULIPs—where upfront charges are acceptable and the company paying its agents is not robbery but proper! This will ensure that there will be no mis-selling in insurance in times to come.

In conclusion, I—being a part of the MF industry will be honest enough to accept that there have been some excesses in the past—which industry has not had its share of excesses? However, in view of such excesses to paint the entire breed of the MF agents & advisors as corrupt is not proper. There were and are honest advisors in the industry who keep their client’s interest first. I AM PROUD TO BE A MF AGENT/ADVISOR.

At the end, I would only like to request you to be neutral in the article that you write and not be a judge your self. Your job is to place the facts of the matter before your reader. Let the reader/investor judge for himself what he wants and at what price.

Yours truly,

A MF advisor

Profit from the Great Panic

Now is possibly the most stressful situation that Indian equity investors have ever faced.

Let's take a look at what we've said in the past, and how the Great Panic of 2008 reinforces the principles behind our advice. Here's a summary of those unchanging principles.

- Investors should not need to time the market. Therefore, the only valid investing approach is one that is always the same, regardless of market conditions.

- At any point of time, all the money that you need within three to five years should be in fixed income assets.

- Long-term money should be allocated between fixed income and equity depending on your ability to take temporary losses.

- Whenever the balance of this allocation changes because one asset type has earned more than the other sell one and buy the other to restore the balance.

- Never invest large lumps of money in equity. Do it gradually, SIP style.

Any investor who has followed this advice is sitting pretty today, largely unaffected by the Great Panic. The market value of your investments may be down today, but since you don't need any of it for many years to come, that doesn't matter. Long before you'll need the money; it would have had a chance to start growing again.

Today, the natural response of many investors to what we're saying is that right now, they've lost money. They say, “The returns may come back in the future, but what about the losses that I've made today". Those who say this are right in their arithmetic, but completely wrong in their assumptions. The only way to avoid the occasional crash is to be able to see the future, and if you could see into the future then you wouldn't be reading this any way. The whole point of investment approach that we are advocating is that it eliminates the need to see into the future.

The Past Proves the Point

The actual track record of the past decade shows that this approach works quite well. If you had started investing Rs 20,000 a month in a Sensex-based index fund in early 1997 and had continued to do so without regard to the ups and downs of the market, then today your rate of return would have stood at 14 per cent per annum. In all, you would have gradually put in Rs 28.6 lakh and these investments would have stood at Rs 66 lakh today, after the crash.

During this period, many mutual funds have comfortably beaten the Sensex so the Rs 66 lakh is a rather conservative figure. In a median fund, the 10 years would have seen your nest egg reach about Rs 1.04 crore. And this, during a decade which has witnessed two huge market crashes!

That's after absorbing the hit of the worst panic that anyone has ever seen, when the market is at a long-term low point. Once any kind of recovery commences, the value is very likely to shoot up. If this isn't a perfect demonstration for the value of our slow-and steady way, then nothing can be.

Over such a long period, the so-called 'safe' fixed-income avenues do so much worse than supposedly 'unsafe' equity, that the there's no contest at all. Over this same period, you could have earned an average of no more than around 8 per cent per annum in fixed income investments. The same inputs would leave you with just about Rs 44 lakh, which doesn't cover even the inflation rate adequately.

The moral of the story: Despite the crashes, equity is the far safer option over the long run.

The real danger to your financial well-being is not market crashes, but from the insidious affect of inflation.

Crashes are Your Friends

In the equity markets, you make more money not despite the crashes, but because of the crashes. Let's modify the above story with the assumption that the post-tech crash of 2000-2001 never happened. The way that crash actually happened, the Sensex reached a peak of about 5,900 in February 2000. It then crashed and went as low as about 2,600 in September 2001. It then started rising and reached the previous peak of ~6,190 again only in January 2004.

Let's assume that the crash never happened. The Sensex reached 5,600 in March 2000 and then stayed at that level till October 2004. If that had happened, then your Rs 20,000 a month would be worth Rs 55 lakh instead of Rs 66 lakh! That's right. For the long term investor, the crash of 2000 was worth a lot of money.

How did you make more money because the crash? The answer is obvious to anyone who understands the basic arithmetic of what's happening here. The crash enabled you to buy cheap and thus eventually raised your total returns. If you are investing steadily for the long-term, then intermittent crashes help you make more money, not less.

And that is how you will eventually profit from the Great Panic of 2008. Stocks are now cheap, and are probably going to get cheaper. The longer and deeper this crash, the more money you will eventually make. If you know what's good for you, you should be praying that the Sensex falls to maybe 6000 or 7000 and then stays there for a few months or years before coming to life again.

And that's the secret of equity investing, the real moral of the story: For the long-term investor, equity is not good despite the occasional crash. It's good precisely because it crashes.

Volatility is your friend. Volatility is what will make you rich.

Why Investors must look beyond returns??

Ask an investor, which investment avenue he wants to invest in and there’s more than a fair chance that he will say – the best performing one i.e. one that can deliver the highest returns. Sounds reasonable, doesn't it? Why would an investor like to settle for anything less than the best, right? The trouble with such an approach is that it oversimplifies the investment process. As a result, emphasis is laid only on the returns aspect; vital factors like risk and suitability are ignored.

Far too often, investors and advisers alike are guilty of falling prey to the allure of high returns. The rationale being, investing is all about clocking the highest return, hence any avenue that can deliver on this front gets the thumbs up. Don’t get us wrong. We are not suggesting that returns aren't important or that there is necessarily something wrong with an avenue simply because it can deliver a better showing on the returns front vis-à-vis other avenues. However, selecting an investment avenue based solely on its performance is certainly a flawed approach.

In the first place, such an approach erroneously assumes that the investment avenue (say a mutual fund for instance) is an end, rather than a means to achieve an end. While investing, the end should be a tangible goal like providing for one’s retirement, buying a car or simply wealth accumulation, expressed in monetary terms. And once the target sum has been established, appropriate avenues to achieve that end should be chosen. Conversely, if the investment process begins with the selection of the investment avenue, the investor ends up investing in an aimless manner and may never achieve his goals.

Second, by investing in an avenue based solely on returns, the investor runs the risk of getting invested in an avenue that might be unsuitable for him in terms of the risk involved. For instance in the equity funds segment, by and large one would expect a diversified equity fund (which invests its entire corpus in equities) to outperform a balanced fund (which invests around 65%-75% of its corpus in equities and the balance in debt instruments) in times when equity markets are rising. But from an investor’s perspective, the key lies in determining what’s right for him.

For example, assume that a balanced fund can deliver a 12% CAGR over a 5-Yr period; conversely, a diversified equity fund is equipped to deliver a 15% CAGR over the same time-frame. Say an investor wishes to accumulate Rs 500,000 for a holiday 5 years down the line. Now the investor has to choose between investing in a balanced fund or in a diversified equity fund. Should the investor decide to build a corpus using a balanced fund, he will have to invest around Rs 6,223 per month or Rs 78,705 pa. Conversely, opting for an equity fund will necessitate a lower investment i.e. Rs 5,792 per month or Rs 74,158 pa.

Most investors might instinctively opt for the equity fund option on account of the higher return (i.e. a lower investment amount). However, while making the choice, the risk factor has been ignored. On account of the debt holdings in the portfolio, the balanced fund is invested across asset classes i.e. equity and debt. Over the 5-Yr investment horizon, should equity markets witness a rough patch, the balanced fund will be better equipped to protect the investor’s corpus. In effect, the trade-off for the higher investment amount is the proposition of delivering during a downturn in markets. Before making a choice, the investor should first evaluate his risk appetite and then choose between the balanced fund and the equity fund.

Another reason investors opt for the best performing avenues is excitement. Yes, you read that right. There is a section of investors, which believes that the investment activity should be exciting; hence selecting investment avenues offering the highest returns is justified. For the record, investing has nothing to do with excitement; on the contrary, investing is serious business and is all about achieving one’s predetermined financial goals. Seeking excitement from the investment activity amounts to trivializing it.

In conclusion, investors would do well to look beyond just returns while making an investment decision. Sure, returns are important, but certainly not a parameter to be considered in isolation. The key lies in looking at the investment activity in totality and then making a decision. If not, investors run the risk of missing the wood for the trees.

Are Equity Markets that risky??

There was an American comedian who, whenever someone would ask him, "How's your wife?" would reply, "Compared to what"? The answer to today's big question is the same. Is equity investing too risky for the retail investors? Well, compared to what? The crucial issue is not whether the investor is retail or wholesale, but whether the investments are for the long- or the short-term and what kind of skills and presence of mind does he or she brings to the actual choice of investments.

Practically speaking, risk in the stock markets is a function of time. The longer the time frame over which you invest, the lower the risk. Today, all this talk of the 'retail investors' losing money in the markets appears to be about individuals who normally do not invest in the markets but have perhaps come into the markets in recent months hoping for some quick gains. There are many such investors and it's possible that they will lose money. Nothing should be done about this. Such 'investors', retail or not, should not be surprised by their losses.

But there are long-term investors too who are feeling nervous at the volatility in the markets. Here, I think people need to define what is meant by risk and what is meant by loss. Most of us feel cheated whenever the market value of any investment declines. We invest Rs 1 lakh and in just a few months it becomes Rs 2 lakh. Then, when it comes down to Rs 1.6 lakh, we start crying about risk because we've lost Rs 40,000. This is not a loss. Such volatility is part of the same deal that gives us the high returns in the first place.

If you define risk as volatility (which most people do), then the stock markets are indeed very risky. But if you define risk as the probability of suffering a loss over a long-term (which is how I think individual investors should define it), then the risk is entirely manageable and largely dependent on the quality of your investment decisions. So how can you make sure that you make good investment decisions? That's simple--take the mutual fund route and leave it to someone with a public track-record of being a good investor.

Think about it for a moment. When someone gets a serious disease, should they go to a doctor? Or should they declare themselves to be 'retail doctors' and start treating themselves? Just because you have money to invest doesn't mean that you have the skill to invest any more that than having a disease means that you have the skill to cure yourself.

I believe equity investing is a highly specialized task that needs skills and judgement that only a few people have. I'm not saying that this is a skill that only professional fund managers have. There are many individual investors who are good at it and there are many professional fund managers who are lousy. However, it's easy-and dangerous-to convince yourself that you have what it takes to make good investments when the markets are booming.

The daily, hyperventilative tracking of the BSE Sensex in the media creates the impression that the stock markets are a high-risk casino where the one must stake all at unknown odds to stand a chance of making money. And actually, if you are a short-term punter that may well be true. However, for someone who has, over the years, invested steadily in mutual funds with good track records, the markets are an almost sure shot way of getting far better returns than any other investment can provide.

SIPs reward only the faithful!!

One of the less foreseeable results of last two years' turmoil on the stock markets has been that many investors are loudly questioning the efficacy of SIPs. One such person I met (a typical case) started off by claiming that SIPs were no good and that he had barely broken even on SIPs in a number of funds over the last four years. This seemed odd because the funds he named had done quite well. I quizzed him further and it turned out that back in 2008, when the markets had crashed, he had immediately stopped all his SIPs. However, he had restarted all the SIPs in August 2009.

Observant readers would have realised that this investor had basically done it to himself. He had invested in a manner that was guaranteed to shield him from any possibility of making money. Unfortunately, this mistake is way too common. The underlying problem is the increasing belief among people who skim the financial media that SIPs are a magical device, akin to the blessings of a god man, and are thus guaranteed to produce profits no matter when. They can stop whenever they feel like and start whenever they feel like and the God of SIPs will protect them.

The basic idea behind SIP, what the Americans would call SIP 101, is that while the general direction of an investment (a fund or even a stock) is upwards, it is not possible to reliably predict the actual fluctuations that it may undergo as part of its general trend.

Instead of trying to time one's investments, one should regularly invest a constant amount. As time goes by and the investment's NAV or market price fluctuates, this will automatically ensure that when the price was low, you ended up purchasing a larger number of shares or units. Eventually, when you want to redeem your investment, all the units are worth the same price. However, because your SIP meant that you bought a larger number of units whenever the price was low; your returns are higher than they would have been otherwise.

That's the way it works. Usually! However, you have to allow it to work by going on investing when the market is low. That's the most important part. At one level, SIPs are nothing more than a psychological trick to make you invest when the market is low. The whole point of investing is to buy low and sell high. If you stop your SIPs when the markets are low and then restart them when they have risen, then you have done the exact opposite of what SIPs are supposed to achieve, and you will get the exact opposite of good returns. Apparently, during the last two years, a lot of people actually did this.

Of course, there are circumstances in which a lump sum investment can (in hindsight) prove to be better. This happens when during a given period; the equity markets keep rising and never fall below the level they were at the beginning of that period. In such a case, a lump sum investment made at the beginning of that period will turn out to have the maximum gains because the buying price was the lowest at that point. The last one year (March 2009 to March 2010) happens to be one such period. However, over any longer period, such cases are rare. Generally, over a long period of time, the ups and downs of the market will ensure that SIP has the better returns.

Truth about Highest Guarantee NAV policies

Over the last few months, one after another, a number of insurance companies have launched ULIPs which promise to repay the investor on the basis of the highest NAV that the fund has achieved. The pitch is that these funds' NAV effectively does not drop. Once a level is achieved, then the investor is assured of getting at least as much, no matter what happens to the market. It's certainly a very attractive idea. From the way insurance companies are stampeding into launching such products, I'm sure investors must be putting down their money in good numbers-in just a couple of months, six insurance companies have launched such products. Any investor who is told of this concept will immediately start salivating at the thought. Imagine how rich you could have been had you been invested over the last ten years and had been able to lock your investments at the magical value that the markets achieved on the day when the Sensex touched 20,873!

Any investor thinking about this product would say, "What a wonderful idea!" Why don't all investment schemes-whether mutual funds or ULIPs or even portfolio management schemes offer this kind of a protection on all their products anyway. The answer to this obvious question is simple. There is no free lunch. These products don't actually offer what you think they are offering. That is, they do not offer equity returns that never fall.

Instead, they offer an investment system with a very long lock-in (seven to ten years) in which protection is achieved by progressively putting your gains in a fixed income assets which will give returns far more slowly than a pure equity option. The lock-in and the non-equity assets make this a very different kind of investment than the equity-gains-without losses dream that these funds' advertising seems to imply.

However, even that's not the real reason that these funds are useless. The real reason is that if you are willing to lock-in for seven to ten years, then practically any equity mutual fund would deliver this dream of equity-gains-without-losses. Seven years is a very long time. Over such a period practically any equity portfolio into which any kind of thought has gone would capture substantial gains. This is not mere conjecture. Since at least 1997 the minimum total return that the Sensex has generated over its worst seven is 12 per cent, which was over the seven year period from 6th July 1997 to 5th July 2004. The truth is that in a growing economy like India's it's extremely hard to lose money over a long period like seven years. If you are willing to lock in your money for seven years, then for all practical purposes, you have a guarantee of making a profit.

Of course, this is not a guarantee that is signed in a contract and legally enforceable, but it's the kind of guarantee that any thoughtful investor would be willing to believe in. Mind you, this is also not a guarantee that you will get the highest NAV achieved but again, that's the kind of thing that can't be attained if you want the gains of pure equity anyway.

The most instructive thing in this whole business of guaranteed highest NAV products is the contrast between the illusions spun by those peddling complex financial products and the reality of simple, straightforward investing. It just reinforces one's belief that financial products are being designed whose goal is nothing more than to create a marketing hype which can manipulate the psychology of the ordinary saver.

Is free financial advice costing you?

Everyone loves financial advice – if it’s free. A tip from a colleague, broker, or any other joker who knows little more than what the SENSEX is, is welcome, and actually sought after. But the minute a fee is quoted, even if the individual is a genuinely smart person with valuable advice, we roll our eyes and say, you must be crazy if you think I will PAY for financial advice.

It’s especially amazing because we will, gladly or grudgingly, write a check to a doctor, lawyer or even CA, and for the most part, listen to what they have to say. When we are so kind to our medical, legal and tax advisors, what about a little charity for our financial advisors?

The blame is not entirely on the investor, because while it is pretty clear what your doctor or lawyer is supposed to do, most of us aren’t even sure what a financial advisor is or does. I’ll start by saying a financial advisor is NOT a broker. A broker’s job is purely transactional – execute the trades you want to do. A financial advisor is also NOT an agent. An insurance or mutual fund agent’s job is to sell you a financial product and help you with the paperwork required to purchase the product. It’s a different matter that many so-called financial advisors are mutual fund agents in disguise. Finally, a financial advisor is NOT a mutual fund manager. A fund manager’s job is to manage a specified portfolio of assets given to them, not to give individuals financial advice.

So, what is this eponymous advisor? For starters, a financial advisor is someone who has your interests in mind – not that of a particular AMC, broker, or insurance company. He or she is someone who will take the time to sit down with you and understand your goals and tailor a unique investment portfolio for your needs.This is more than buying equity funds and holding fixed deposits, but understanding the entire range of investment classes available to you and knowing specific products within each asset class. Gold funds, commodities, PPFs, post-office schemes, art investments, real estate, private equity – this is the tip of the iceberg of a good advisor’s knowledge. Financial products, like the human body and the Indian legal system, are complex and financial advisors should be professionally qualified – you don’t go to a doctor without a MBBS right? Finally, a good financial advisor will be your financial companion and that means having more than one meeting with you. A financial advisor’s relationship with you should be open, honest, and ongoing – one that evolves with your changing financial situation.

Now, the critical question – even if I find this wonderful advisor, why should I pay him, because I get plenty of free advice. Free advice is the bane of financial services and has cost many investors more than they budgeted.While very few people think they can be doctors, everyone thinks they are a closet fund manager or financial planner and everyone is happy to dole out free advice. The problem with free advice is that it has no quality, guarantee or liability. When a website gives you a free tip, you cannot blame them if anything goes wrong.

However, when you have paid for financial advice, you will definitely come back and blame the financial advisor – his business and reputation are both at stake. Free financial advice from professionals – brokers and wealth managers – is even more dangerous. Brokers give you free advice so that you will trade, and indirectly fill their pockets with brokerage. After all, who can ignore a well-sold tip? Wealth managers, who are supposed to look out for your interests, will charge you nothing for advice, but get compensated when you buy a product.Different products lure wealth managers with different commissions twisting their incentives from giving you the best advice to earning the highest commission. And at some level, wealth managers are not entirely at fault – they have to earn revenue, and because our mindset is so opposed to paying for advice itself, they have little choice but to make the advice free and benefit from the product sales instead.

Paying for financial advice feels painful but it is an inevitable part of India becoming a more transparent and conflict of interest free wealth management market. So, the time a smart capable financial advisor comes to you and wins over your trust, don’t balk when the word FEE comes up. A capable advisor can earn you multiples of the few percent he charges.

In the long run, free advice may cost you more than you think, and paid advice may quickly pay for itself – a quirky case where FEES are better than FREE.