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.