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.

MYTHS ABOUT FINANCIAL PLANNING

You've earned hard, now let money do the same for you

THEY say that money is on the top of everyone’s mind. That’s really true. The fact is that it stays right there, and it requires a big trigger to get moving on it. We then rationalize, and justify our inertia. While my personal view is that financial planning is a universal requirement, there are some show-stoppers which we must recognize. If these thoughts are there in your mind, banish them and achieve financial freedom. The top reasons for procrastination are:

I have too little money
Financial planning is required when the goals you have are more than the funds that you possess. Waiting for the great day when we have accumulated a sizeable corpus to start planning is like living for today, without any plans for tomorrow.

I don’t have enough to spend
Even if you are thinking this, you need a plan, manage credit (or debt) judiciously. Invest the money you receive in a liquid fund and keep a minimum amount in the bank. Prepare a budget and stick to it, you may be surprised with how much you can save.

After I complete my house
I have come across clients who have used marble-tops in their kitchen and granite on their floors as they had funds in their bank account. Only later they realized that their sons education was of greater priority.

I can’t afford planning
Its the same as refusing to consult a specialist doctor even when you are seriously ill and advised to do so. Constructing a financial plan is as important as getting the blueprints to build your home. Paying for these services also makes your advisor accountable to you, so don’t hesitate on this count.

I can do it myself
Some people have an inborn flair for numbers and are organized enough to keep regular track of all their investments. Now the question is: are they emotionally cut off from their investments enough to take the right decisions. A financial advisor has the requisite qualifications and training that a layman can only master to a small extent.

I only invest in FDs
Most of India’s domestic savings are heading to bank deposits. However, with inflation soaring and interest being taxable, you need an avenue which enhances the value of your investments, after inflation and tax.

I don’t need advisers

There is an information overload: the media and the internet make investing look like child’s play. There are many factors to consider: financial goals, cash flow, risk taking ability. If this seems overwhelming, take the help of an advisor, who can recommend changes not for the entire mass, but specifically for you.

I don’t trust advisers
If you lack trust, because of an awful experience previously, the mistake was probably made while hiring the advisor. Make sure you do your homework before choosing your advisor. Remember, you need to exercise the same care as you would while selecting your life partner.

I don’t have the time
This is the most popular reason that people give for procrastinating. Take one step at a time. Talk to people you know and trust, and ask them who manages their finances. Talk to a few advisers; look for the 3 Es empathy, ethics, and education. Invest some time to know your advisor and you can save yourself a lot of time, effort and money! But do it today.

Replace EPFO With NPS??

Suddenly, there’s seems to be an abundance of people who are eager to mark the New Pension System (NPS) as a failure. Everyone’s favourite statistic is the laughably small number of people (2,500 or so) who have actually, of their own free will, enrolled in the NPS. However, this number is completely irrelevant. It doesn’t tell you anything about the NPS. What it does tell you is that the NPS today is like a product that has been designed, but exists only in the design labs. It hasn’t yet been launched in the market.

Moreover, the 2,500 members that the NPS has got is a miracle because, out of the various entities who are supposed to be selling it, some are ignoring it completely, while others are actively de-selling it. If you walk into a bank that’s supposed to be an NPS agent, chances are that no one in the branch would have heard of the NPS and they will actively try to sell you an unit-linked insurance policy (ULIP) or a mutual fund as an alternative to the NPS. This is a product without a seller, and the way the world works, for all practical purposes, such a product doesn’t really exist.

I’ve read that the pension authority (PFRDA) is about to launch an advertising campaign to promote the product. That’s great and will surely result in more people hearing about the NPS. However, people who have first hand experience of marketing financial products would still doubt whether it would be enough to actually create participation without a structure that creates more profit for the seller than competing products do. It’s possible that the NPS’s future lies in being a mandatory saving, just like practically every retirement savings solution around the world.

Under the circumstances, the most significant step would the replacement of the Employees’ Provident Fund Organisation (EPFO) with the NPS for the private sector. It’s a puzzle that, as things stand today, the government’s pension money is being managed by the private sector (the NPS’s fund managers) and the private sector’s provident funds are being managed (though managed is not the right word) by the EPFO. Moving the private sector to the NPS is an urgent need. Not only would this free employee from struggling with the phenomenally hostile service quality of the EPFO, it could encourage many more businesses to come into the pension fold.

This is such an obvious step that it’s a puzzle that it wasn’t done right away with the launch of the NPS. In any case, if the NPS is ever to move beyond being just a solution to the government’s financial problem of financing pensions and fulfill its real potential, then it has to become an automatic and unavoidable option for every employee in the country.