B. Venkatesh
Asset management firms continue to offer standard investment products such as fixed maturity plans, equity funds and, now, passive products on foreign indices. Investors do not always understand how to effectively utilize these products to create an optimal portfolio. Most do not seek professional investment advice either. The question is: Can asset management firms bridge the knowledge gap and channel investor resources optimally?
This article explains why asset management firms should offer investment solutions and not just products. It also explains how such solutions can be structured to improve investment experience for the end-users.
Asset management firms typically look to improving customer base through product offerings. This has resulted in most firms offering similar repertoire - equity funds, bond funds and gold ETFs. The value differentiator is generally the fund performance, though the statutory warning suggests that `past is not an indicator for the future.`
Yet, investors use past performance to choose a mutual fund. In the process, they do not actively choose alpha-generating funds and the alpha managers do not necessarily attract more investors.
Offering investment solutions could, perhaps, prove useful in several ways. For one, the differentiator would be the solutions offered, not the product. Though investment solutions can also be replicated, the offering need not be same.
Suppose an asset management firm were to offer a closed-end education fund that will enable investors pay for their child`s education at 18. The firm may decide to have 70% equity exposure, 20% bond exposure and 10% gold exposure with tactical range of 10%.
Another asset management firm may have a different asset allocation strategy for the same investment solution. An investor`s choice would depend on her preferred asset allocation, not just the fund performance.
For another, asset management firms may be able to attract even self-directed investors who may find such solutions useful. And for the investors who do not wish to pay for advisory services, such investment solutions could come cheap.
The question is: How should firms offer such investment solutions?
Portfolio structure
Consider the education portfolio. An asset management firm can offer such a solution either through direct asset exposure or through a fund-of-funds structure.
Direct exposure may be deviating from the traditional two asset-class (balanced) portfolio, as the fund will have to carry equity, bonds and, perhaps, gold. A fund-of-funds structure would be less complicated and more flexible- the fund will invest in equity funds, bond funds and Gold ETFs.
True, investors may have to incur additional costs for buying the investment solution - fund-of-funds fee of 50 basis points. But that would be a small price to pay for the manager selection skills of the fund-of-funds manager. This is, indeed, a valuable service for the investors who will otherwise find creating a portfolio of mutual funds a not-so-easy task.
There is a behavioral advantage too. The feeling of regret may be less when an investor buys mass investment solution from an asset management firm. Why?
A custom-tailored solution received from an investor advisor, though good, may sometimes not be enough. This is because the investor may feel that she could have done better by taking a more niche solution from another investment advisor. Choosing among several advisory service providers is not always easy. A mass investment solution helps, as the investor knows that her acquaintances also received the same solution as she did. Failing with the crowd, in the event the portfolio loses value, causes less regret.
Conclusion
There is a tremendous potential for asset management firms to offer mass investment solutions. Firms could use fund-of-funds route to offer solutions with even existing products.
Such offerings could provide cheaper solutions for retail investors and become a value differentiator for firms. Investment advisors could also use such products to custom-tailor portfolios for HNIs.
Friday, January 14, 2011
Placebo to drive away investment blues? Source: BUSINESS LINE (10-JAN-11)
B. Venkatesh
Consider this. You are running fever and your doctor recommends a medicine that is available only at select medical stores. You recover after a four-day dosage only to realize later that the pills were a mere placebo. Why do we fall for placebos and what are its linkages to investments?
Role of psychology
Placebo is Latin for ``I shall please``. Placebos have been documented to provide effective cure to patients, prompting pharma companies to research to find out why. Psychologists argue that it is our expectations that make the sugar pill work so well.
In one study, people were given light electric shocks on their wrists. They were then given a placebo. Half the people were given a brochure mentioning full cost of the pill while the other half were told that the price was marked down without providing a reason why. The researchers found that the people who were told the full price experienced less pain than the ones who were told that the price was marked down! This and similar experiments brings to the fore the role of psychology in placebo effect.
Why we diversify
How is this related to investments? Suppose we know that a particular stock is sure to move up, we would then use substantial part of our money, if not all, to buy the stock. The fact that we do not place all our money in one stock clearly shows that we are uncertain about asset price movements. We, hence, diversify.
Diversification in some ways is like a placebo. You feel good about diversifying, just like you feel better after swallowing the sugar pill. Why?
Suppose you have 15 stocks in your portfolio. Assume the market crashes and eight stocks in your portfolio fall 20 per cent and the rest fall by less than 10 per cent. You take relief from the fact that you did not lose 20 per cent in the other seven stocks as well! Diversification is the sugar pill that helps us typically drive away our investment blues!
Inflation: Go easy, big challenge ahead!
Author: Anil Rego
``Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.`` - Ronald Reagan
No better day to understand this! If there is one thing that has provided the maximum returns over the past year, then it has to be the humble onion and it`s red Indian cousin tomato. Food inflation is at 14.44%, the Y-o-Y increase in vegetable prices was 29.26%. Despite multiple attempts by the RBI to adjust the liquidity to in turn reduce inflation, they haven`t been able to tame inflation yet.
Understanding Inflation
Inflationary scenario, simply put would be when too many people chase too few goods and too few services, which automatically makes the prices of the goods and services high because of the high demand. At the same time, when inflation falls below the desired mark (in the negative territory); there are few people and abundant supply of goods and services, making the prices of the goods and services cheap. India`s vast population lives close to or below the poverty line, inflation acts as a `Poor Man`s Tax`. This effect is amplified when food prices rise, since food represents more than half of the expenditure of this population.
There are two measures for inflation, Wholesale Price Index and Consumer Price Index, the latter being more accurate in evaluating the change in value of money for the `Aam-Aadmi`. Here is a look at how inflation has fared over the past years -
Source of data: Ministry of finance
From the above graph, it is evident that inflation is definitely off the peaks, from a whopping 16.22% in Jan `10 to the current levels hovering around 10% - 11%, however, food items continue to suffer.
Impact of inflation on your budget
This is absolutely simple. Over the past year onion prices have risen ~35%, a kilo of onion, now costs a little higher than a liter of petrol, of course petrol itself was not spared either, the prices were revised recently and your outlay to fuel is definitely higher than what you did in the previous quarter.
When inflation is on the rise, it is amply clear that your outlay to the core ingredients of household expenses immediately increases by a similar % as your inflation. Further, inflation affects all without any discrimination, this simply means that your servant maid will demand a higher monthly salary than earlier, for she too has to face the brunt of increasing food items. There are indeed multiple factors which affect the household pattern, the rate hike by the RBI to curtail inflation, will in turn reflect in increased EMI outlay, thereby shrinking your investment / savings portion further.
Let`s assume that your due to the above factors, the core ingredients - food items, medical / clothing / entertainment expenses, ancillary expenses have risen by ~15%, fuel / vehicle maintenance outlay has increased by 10%, EMI outlay has increased by 8%, other expenses have moved up by a modest 8% (lesser than the inflation rate thru- the year) - here is how the pie of your net earnings / expenses / savings pattern would look at the begin of the year and at current times -
Savings / Investments have shrunk by a whopping 10%, atrocious as it may sound; this is clearly how things have panned out for the middle class over the past year. The big question is ``Can the `Aam Aadmi` control this?`` The answer is simply `No`, however, what is within his control is to keep tab on the expense pattern. 
There are various methods of reducing your expenses - some such examples are cutting on eat-outs, walking / jogging in open air instead of a gym subscription, car pooling, using your credit cards prudently etc.,
Your commitments
With the savings pie shrinking, it becomes increasingly tough for you to stay committed to your investments. This calls for prudently planning for contingencies, creating a buffer of 2% - 5% will help counter such adverse scenarios, this buffer can be kept in easily accessible avenues such as savings bank balance, flexi-fixed deposits or liquid plus / floating rate debt funds.
How much EMI you intend to lay out of your net earnings can determine your lifestyle, ensure that you conduct a financial feasibility before embarking on assuming loan liabilities, remember with liabilities comes great responsibilities! As a thumb rule, not more than 30% should be laid out towards EMI.
The movement of Inflation is inevitable, managing your household budget with acumen becomes vital to counter such adverse situations, there is definitely no set rule on how to counter these fluctuations, it is up to you to find your way, being watchful of small spending patterns and digging into detail can go a long way in helping you to fend these fluctuations.
The author is the founder and CEO of Right Horizons, an investment advisory and wealth management company.
``Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.`` - Ronald Reagan
No better day to understand this! If there is one thing that has provided the maximum returns over the past year, then it has to be the humble onion and it`s red Indian cousin tomato. Food inflation is at 14.44%, the Y-o-Y increase in vegetable prices was 29.26%. Despite multiple attempts by the RBI to adjust the liquidity to in turn reduce inflation, they haven`t been able to tame inflation yet.
Understanding Inflation
Inflationary scenario, simply put would be when too many people chase too few goods and too few services, which automatically makes the prices of the goods and services high because of the high demand. At the same time, when inflation falls below the desired mark (in the negative territory); there are few people and abundant supply of goods and services, making the prices of the goods and services cheap. India`s vast population lives close to or below the poverty line, inflation acts as a `Poor Man`s Tax`. This effect is amplified when food prices rise, since food represents more than half of the expenditure of this population.
There are two measures for inflation, Wholesale Price Index and Consumer Price Index, the latter being more accurate in evaluating the change in value of money for the `Aam-Aadmi`. Here is a look at how inflation has fared over the past years -
Source of data: Ministry of financeFrom the above graph, it is evident that inflation is definitely off the peaks, from a whopping 16.22% in Jan `10 to the current levels hovering around 10% - 11%, however, food items continue to suffer.
Impact of inflation on your budget
This is absolutely simple. Over the past year onion prices have risen ~35%, a kilo of onion, now costs a little higher than a liter of petrol, of course petrol itself was not spared either, the prices were revised recently and your outlay to fuel is definitely higher than what you did in the previous quarter.
When inflation is on the rise, it is amply clear that your outlay to the core ingredients of household expenses immediately increases by a similar % as your inflation. Further, inflation affects all without any discrimination, this simply means that your servant maid will demand a higher monthly salary than earlier, for she too has to face the brunt of increasing food items. There are indeed multiple factors which affect the household pattern, the rate hike by the RBI to curtail inflation, will in turn reflect in increased EMI outlay, thereby shrinking your investment / savings portion further.
Let`s assume that your due to the above factors, the core ingredients - food items, medical / clothing / entertainment expenses, ancillary expenses have risen by ~15%, fuel / vehicle maintenance outlay has increased by 10%, EMI outlay has increased by 8%, other expenses have moved up by a modest 8% (lesser than the inflation rate thru- the year) - here is how the pie of your net earnings / expenses / savings pattern would look at the begin of the year and at current times -
Savings / Investments have shrunk by a whopping 10%, atrocious as it may sound; this is clearly how things have panned out for the middle class over the past year. The big question is ``Can the `Aam Aadmi` control this?`` The answer is simply `No`, however, what is within his control is to keep tab on the expense pattern. There are various methods of reducing your expenses - some such examples are cutting on eat-outs, walking / jogging in open air instead of a gym subscription, car pooling, using your credit cards prudently etc.,
Your commitments
With the savings pie shrinking, it becomes increasingly tough for you to stay committed to your investments. This calls for prudently planning for contingencies, creating a buffer of 2% - 5% will help counter such adverse scenarios, this buffer can be kept in easily accessible avenues such as savings bank balance, flexi-fixed deposits or liquid plus / floating rate debt funds.
How much EMI you intend to lay out of your net earnings can determine your lifestyle, ensure that you conduct a financial feasibility before embarking on assuming loan liabilities, remember with liabilities comes great responsibilities! As a thumb rule, not more than 30% should be laid out towards EMI.
The movement of Inflation is inevitable, managing your household budget with acumen becomes vital to counter such adverse situations, there is definitely no set rule on how to counter these fluctuations, it is up to you to find your way, being watchful of small spending patterns and digging into detail can go a long way in helping you to fend these fluctuations.
The author is the founder and CEO of Right Horizons, an investment advisory and wealth management company.
Portfolio management scheme: A unique investment opportunity
Author: Ramalingam K
What is portfolio management scheme?
What is portfolio management scheme?
Portfolio management scheme popularly known as PMS are specialized investment vehicle for lump sum investments. The portfolio manager invests the money in shares and other securities and manages the portfolio on behalf of the client.
One can invest fresh money in portfolio management scheme and the portfolio manager will construct a portfolio by deploying that money. Also one can transfer his existing share portfolio to the portfolio management scheme provider. In that case, the portfolio manager will revamp the portfolio in sync with his investment philosophy and strategy.
Once the portfolio management scheme account is opened, the client will be given with a web access to his portfolio. The client can look at where the portfolio manager is investing client`s money. Also one will be able to generate reports like investment summary, portfolio transaction list, performance analysis, portfolio statement and quarterly capital gain report.
As a result, portfolio management scheme relieves investors from all the administrative hassles of investments.
Portfolio management scheme vs. direct stock market investment:
Portfolio management scheme vs. direct stock market investment:
One can directly invest in stock market. Then what is the advantage of investing in the stock market through a portfolio management scheme. Investing in share market demands knowledge, right mindset, time, and continuous monitoring. It is difficult for an individual investor to meet all these demands. But a portfolio management scheme meets these demands easily. The portfolio management scheme will be managed by an experienced professional. It saves the time and effort of the individual investors. Hence it is advisable to outsource the stock market investment to a sound portfolio management scheme operator instead of managing it on our own.
Portfolio management scheme vs. mutual funds:
Mutual fund is also a good investment vehicle. It should also form part of your total equity investment. But mutual funds are mass products. So they will be conservative by nature. As per SEBI regulation, mutual funds have some investment restrictions. There is a maximum limit on the percentage of amount invested in an individual stock. Also there is some maximum cap on the exposure in a particular sector.
Once the fund manager reaches the maximum limit prescribed by SEBI, he is forced to invest in some other stock or some other sector. That is why we see a large number of stocks in a mutual fund portfolio. Where as a Portfolio Management Scheme will invest in 15 to 20 stocks. This concentration makes it more attractive and aggressive. Managing Rs 25 lakhs portfolio management scheme portfolio will be more flexible when compared to managing Rs 20 billion mutual fund portfolio.
Portfolio management schemes relatively have more flexibility to move in and out of cash as and when required depending on the stock market outlook.
Basically the conservative portion of your equity investment can go into mutual funds. The aggressive portion can go into portfolio management scheme.
How to choose a best portfolio management scheme?
There are so many portfolio management schemes in the industry. So it is really very difficult to choose a good Portfolio Management Scheme provider. Here are some factors to be considered before choosing a portfolio management scheme.
1) Yardstick for Performance:
One should not just go by the past performance alone. Making an analysis on various Portfolio Management Schemes in the industry with their past performance along with the risk adjusted return and the consistency of performance will be useful in selecting the best Portfolio Management Scheme.
2) Minimum Investment Criteria:
Investors need to avoid Portfolio Management Schemes where the minimum investment is less than Rs 25 lacs. Even there are Portfolio Management Scheme operators who keep minimum investment for their schemes as low as Rs 5 lacs. But these kinds of Portfolio Management Scheme operators will have more number of PMS accounts. When the quantity (the number of PMS Acs) goes up the quality (the performance) may relatively come down.
Therefore it is better to choose a Portfolio Management Scheme where the minimum investment is Rs 25 lacs or more. So that our PMS Ac will be directly handled and managed by the top level portfolio manager and not managed by the juniors and analysts. If you are planning to invest less than Rs 25 lacs, then the ideal investment product for you would be mutual funds.
3) Conflict of interest:
Portfolio management schemes have been run by some stock broking companies as well as investment management companies. There is a conflict of interest in portfolio management schemes run by share broking companies. The main business of a share broking company is to earn commission income by facilitating the share market transactions.
Portfolio management scheme is an additional business for them. It is not their core business. Hence there may not be enough focus on the portfolio management scheme business. Also they may indulge in doing undue and unnecessary churning of the clients` portfolio to earn more commission income. This will cause additional expenses and short term capital gain tax to the client.
The core business of investment management companies is managing the investments of their clients to earn management fees. So, with the Portfolio Management Schemes run by investment management companies, there is no conflict of interest or vested interest. Therefore it is always advisable to choose a Portfolio Management Scheme offered by investment management companies.
4) Role of professional financial planners:
Portfolio management scheme is an additional business for them. It is not their core business. Hence there may not be enough focus on the portfolio management scheme business. Also they may indulge in doing undue and unnecessary churning of the clients` portfolio to earn more commission income. This will cause additional expenses and short term capital gain tax to the client.
The core business of investment management companies is managing the investments of their clients to earn management fees. So, with the Portfolio Management Schemes run by investment management companies, there is no conflict of interest or vested interest. Therefore it is always advisable to choose a Portfolio Management Scheme offered by investment management companies.
4) Role of professional financial planners:
A professional financial advisor or financial planner will study and analyze the portfolio management schemes run by various stock broking companies as well as investment management companies. If we approach them, they will guide us in choosing the right portfolio management scheme depending upon our requirements and other factors.
Also a professional financial advisor will continuously monitor the performance of various portfolio management schemes and advice the client on a regular basis on the performance of the Portfolio Management Scheme where the client has invested vis a vis the other PMS schemes in the industry. After a certain period, if necessary he may advice you to move from one portfolio management scheme operator to the other.
Also a professional financial advisor will continuously monitor the performance of various portfolio management schemes and advice the client on a regular basis on the performance of the Portfolio Management Scheme where the client has invested vis a vis the other PMS schemes in the industry. After a certain period, if necessary he may advice you to move from one portfolio management scheme operator to the other.
ESOPs and portfolio management scheme:
ESOPs are provided by the companies to its employees based on their service. Most of the employees are of the opinion of keeping the ESOPs as it is forever because it is their company shares. But logically it is too riskier to invest in a company to whom you work for. Because, your employment income as well as investment income will depend on the performance of a single company.
So it is not advisable to keep your investments in a company where you actually work. So it is at all times advisable to transfer your ESOPs to a portfolio management scheme. They will revamp it to construct a well diversified portfolio.
Portfolio management scheme is an aggressive investment product and really suitable for those investors:
> Who have a share portfolio and find it difficult to manage.
> Who have enough exposure in mutual funds and looking for a different and good investment option
> Who have sizable ESOPs.
The author is a founder and director of Holistic Investment Planners.
The author is a founder and director of Holistic Investment Planners.
Decoding mutual fund in Bollywood ishtyle!
What does mutual fund mean to common man?
`Mutual fund` seems synonym of `Bollywood` to me. Let`s find out here what`s the relation between two diverse worlds one in entertainment and other in investment has?
Back to past in 1980`s - 90`s era:
This was a time in Bollywood when producers used to bet on single hero projects and invest heavily in one particular movie. Audiences were getting excited to watch this movie if a hero is popular face such as Amitabh Bachchan, Dev Anand, Dilip Kumar, etc. But, if the script and direction is weak than such caliber actors of Bollywood also can`t help to make this movie perform and it gets bombed at box office. The situation discussed here is similar to investors of that period betting heavily on equities of single company. There were investors who use to have stocks of single company for example `Reliance Industries` or `Tata Motors` in their portfolio. Investors bet on company management, future prospects, profit numbers, etc. But, if this company underperforms due to lack of experience by core management than their stock prices had shed immediately on markets. This made the investors suffer heavy losses on their portfolio. Then time came investors started understanding need for diversified asset allocation…
Present Scenario:
Now, the time has changed and audience preferences. Producers have now started betting on multiple actor projects where they showcase the talent of each actor in strong character role. Audiences are also excited to watch their favorite stars perform to their best in a single movie. Recent example of a movie which was successful due to huge start cast and showcase of decent performance onscreen is `Rajneeti`. The movie had a strong storyline and director executed this movie exceptionally well. Similar, is the story for mutual fund the asset management company invests the pool of money collected from investors in diversified star performing / emerging companies. This makes their risk diversified among many company stocks. Every company is considered as an important character in their mutual fund scheme. So, if one company is underperforming and suffer losses than it gets adjusted with other company which is outperforming and making profits in that portfolio. Here, the fund manager is a director who takes care of asset allocation / returns from the mutual fund scheme and fund offer can be said as story line which gives general clue to investors where the amount will be utilized from their investments.
`Mutual fund` seems synonym of `Bollywood` to me. Let`s find out here what`s the relation between two diverse worlds one in entertainment and other in investment has?
Back to past in 1980`s - 90`s era:
This was a time in Bollywood when producers used to bet on single hero projects and invest heavily in one particular movie. Audiences were getting excited to watch this movie if a hero is popular face such as Amitabh Bachchan, Dev Anand, Dilip Kumar, etc. But, if the script and direction is weak than such caliber actors of Bollywood also can`t help to make this movie perform and it gets bombed at box office. The situation discussed here is similar to investors of that period betting heavily on equities of single company. There were investors who use to have stocks of single company for example `Reliance Industries` or `Tata Motors` in their portfolio. Investors bet on company management, future prospects, profit numbers, etc. But, if this company underperforms due to lack of experience by core management than their stock prices had shed immediately on markets. This made the investors suffer heavy losses on their portfolio. Then time came investors started understanding need for diversified asset allocation…
Present Scenario:
Now, the time has changed and audience preferences. Producers have now started betting on multiple actor projects where they showcase the talent of each actor in strong character role. Audiences are also excited to watch their favorite stars perform to their best in a single movie. Recent example of a movie which was successful due to huge start cast and showcase of decent performance onscreen is `Rajneeti`. The movie had a strong storyline and director executed this movie exceptionally well. Similar, is the story for mutual fund the asset management company invests the pool of money collected from investors in diversified star performing / emerging companies. This makes their risk diversified among many company stocks. Every company is considered as an important character in their mutual fund scheme. So, if one company is underperforming and suffer losses than it gets adjusted with other company which is outperforming and making profits in that portfolio. Here, the fund manager is a director who takes care of asset allocation / returns from the mutual fund scheme and fund offer can be said as story line which gives general clue to investors where the amount will be utilized from their investments.
Variety under mutual fund schemes:
As audiences prefer different genre of movies such as comedy, action, emotion, adventure, sci-fiction, etc. based on their interest. Similarly, asset management company has variety of schemes to offer for their investors based on their risk taking capacity and expected returns. There are index funds, sector oriented funds, global funds, balanced funds, etc.
Applicable charges:
To view movies audience has to bear the ticket charges or cost to buy DVD / VCD. Similarly, to get services of mutual fund investors have to bear annual charges for administration as well as pay exit load specified if applicable on offer document of scheme.
Advantages of investing in mutual fund:
> Professional management by Fund Manager
> Diversification of stocks
> Convenient Administration
> Return potential in schemes being offered
> Low costs to investors
> Liquidity to convert in cash
> Transparency and flexibility in operations
> Variety of schemes to select before investing
> Tax benefits products
> Well regulated by SEBI
As audiences prefer different genre of movies such as comedy, action, emotion, adventure, sci-fiction, etc. based on their interest. Similarly, asset management company has variety of schemes to offer for their investors based on their risk taking capacity and expected returns. There are index funds, sector oriented funds, global funds, balanced funds, etc.
Applicable charges:
To view movies audience has to bear the ticket charges or cost to buy DVD / VCD. Similarly, to get services of mutual fund investors have to bear annual charges for administration as well as pay exit load specified if applicable on offer document of scheme.
Advantages of investing in mutual fund:
> Professional management by Fund Manager
> Diversification of stocks
> Convenient Administration
> Return potential in schemes being offered
> Low costs to investors
> Liquidity to convert in cash
> Transparency and flexibility in operations
> Variety of schemes to select before investing
> Tax benefits products
> Well regulated by SEBI
Back to Future:
The future of mutual fund product seems bright. There are many investors who have entered into stock market thru this product because they lack the understanding of investing directly into equities and this number will keep on growing whenever there will be awareness among non-investing class of people. As, we are observing there are experimental movies such as `Phas Gaya re Obama` targeting multiplex going viewers as their audience. Similarly, asset management companies are also churning out new structured products whenever they find an opportunity to explore and target specific investors segment. This will keep on attracting investors towards their new offerings time to time and will see asset under management of mutual fund industry increasing year-on-year.
Monday, December 6, 2010
How index funds moderate investor biases
This article shows why index funds are behaviorally optimal. Specifically, it discusses how index funds moderate certain biases that investors suffer from. This and the cheap beta exposure offered by index funds make them an important part of the core portfolio.
Loss and regret biases
Psychology plays an important role in the investment process - during portfolio construction and at the time of rebalancing.
Consider this. Suppose an investor buys an active fund benchmarked to the Nifty Index. If the fund outperforms the index by 5 percentage points on a risk-adjusted basis, the investor would be happy with her choice. The investor would be, however, unhappy if the fund underperforms the index by 5 percentage points.
The fact is that the investor`s unhappiness from the five percentage point underperformance is likely to be more than her happiness from five percentage point outperformance. This is because the pain due to losses is more than the pleasure from gains. Exposure to index funds moderates this bias. How?
The pain of loss or pleasure of gain is typically relative. The investor will no doubt feel the pain if her portfolio losses 10 per cent in value.
But her pain will be even more if her portfolio underperforms the market by 5 percentage points. In other words, performance relative to the market benchmark is important. And index funds moderate this pain by mirroring the market return.
Loss and regret biases
Psychology plays an important role in the investment process - during portfolio construction and at the time of rebalancing.
Consider this. Suppose an investor buys an active fund benchmarked to the Nifty Index. If the fund outperforms the index by 5 percentage points on a risk-adjusted basis, the investor would be happy with her choice. The investor would be, however, unhappy if the fund underperforms the index by 5 percentage points.
The fact is that the investor`s unhappiness from the five percentage point underperformance is likely to be more than her happiness from five percentage point outperformance. This is because the pain due to losses is more than the pleasure from gains. Exposure to index funds moderates this bias. How?
The pain of loss or pleasure of gain is typically relative. The investor will no doubt feel the pain if her portfolio losses 10 per cent in value.
But her pain will be even more if her portfolio underperforms the market by 5 percentage points. In other words, performance relative to the market benchmark is important. And index funds moderate this pain by mirroring the market return.
This is not all. The feeling of regret of investing in equity is lower during market downturns if the investor has exposure to index funds than to active funds. The reason is that choosing an active fund requires an active decision by the investor. And with active decision comes the responsibility of choice. A bad choice leads to higher regret.
Risk psychology
Exposure to index funds also impacts risk psychology. Investors often tell us that active funds are better, as the market has managers with superior skills. We agree. What we wish to reiterate is that such superior managers are not easy to find.
The reason is that fund performance cannot be an indicator for a manager`s skill, as outperformance can be due to good luck and underperformance can be due to bad luck. And the problem is that good or back luck can persist for a longer time than investors can be solvent!
Suppose investors choose an active fund purely on past performance. The superior past performance could prompt the investor to undervalue the risks associated with the investment. This is because the fund manager`s past performance prompts the investor to make unrealistic expectations. But the fund could underperform the next year even if the fund manager possesses superior skills. And underperformance, in turn, leads to regret.
Investors` perception of risk is not so skewed when it comes to market expectations. That is, investors realize that markets cannot continually climb up. This translates into more realistic expectations from the market than from the active managers.
In other words, investors do expect asset prices to reverse direction, but do not expect outperforming managers to turn underperformers. And since index funds merely tail the market, the returns expectations from passive funds will be more measured. Realistic risk perception also helps in effective asset allocation.
ConclusionOur objective was to show why passive exposure is optimal. Readers may also recall from our earlier discussion that index funds also offer cheap market exposure, making it an important part of equity core portfolio. We wish to emphasize that an optimal portfolio should contain both active and passive exposure to the market. Index funds are important. So is alpha return.
Risk psychology
Exposure to index funds also impacts risk psychology. Investors often tell us that active funds are better, as the market has managers with superior skills. We agree. What we wish to reiterate is that such superior managers are not easy to find.
The reason is that fund performance cannot be an indicator for a manager`s skill, as outperformance can be due to good luck and underperformance can be due to bad luck. And the problem is that good or back luck can persist for a longer time than investors can be solvent!
Suppose investors choose an active fund purely on past performance. The superior past performance could prompt the investor to undervalue the risks associated with the investment. This is because the fund manager`s past performance prompts the investor to make unrealistic expectations. But the fund could underperform the next year even if the fund manager possesses superior skills. And underperformance, in turn, leads to regret.
Investors` perception of risk is not so skewed when it comes to market expectations. That is, investors realize that markets cannot continually climb up. This translates into more realistic expectations from the market than from the active managers.
In other words, investors do expect asset prices to reverse direction, but do not expect outperforming managers to turn underperformers. And since index funds merely tail the market, the returns expectations from passive funds will be more measured. Realistic risk perception also helps in effective asset allocation.
ConclusionOur objective was to show why passive exposure is optimal. Readers may also recall from our earlier discussion that index funds also offer cheap market exposure, making it an important part of equity core portfolio. We wish to emphasize that an optimal portfolio should contain both active and passive exposure to the market. Index funds are important. So is alpha return.
Choosing debt options is a balancing act Source: BUSINESS LINE (22-NOV-10)
Even as the equity market had a dream run over the past year, the dull debt market is in for interesting times too. Investors, who hitherto had to be content with traditional debt options such as fixed deposits and provident fund, now have a wider universe of investible options; thanks to the country`s slowly deepening debt market. Besides an array of debt products that mutual funds offer, zero-coupon bonds, non-convertible debentures, corporate bonds and infrastructure bonds - instruments that were often not accessible to retail investors - are the new debt options to hit the market since 2009.
What makes the recent set of options different from the traditional `deposits`? For one, most of the instruments are keenly watched by regulators, thanks to a good number of them being traded on the bourses. Two, being mostly tradable securities, they offer investors greater liquidity.
However, they are not free from the interest rate and credit risks typical of debt offers. For this reason investors may have to survey their options based on four key criteria - safety, liquidity, returns and taxation; the last two going hand-in-hand. Here`s a look at how to evaluate the universe of debt options against the above criteria.
Safety
Thanks to the liquidity crisis in 2008, companies and even financial institutions strapped for funding decided to tap retail investors more actively. For individual investors this means exercising more caution while investing in debt.
While small savings schemes come with a government guarantee and bank deposits are protected by insurance, the credit quality of the borrower may vary significantly in other debt options. Given that companies are from myriad backgrounds, it has become imperative for investors to know the business profile and financial soundness of the borrower.
High safety: On the safety parameter, therefore, the traditional government Post Office Schemes, PPF, NSC and even zero-coupon bonds offered by government-backed apex institutions such as the Nabard come with an almost nil credit risk and offer fixed returns. Bank fixed deposits too can be termed relatively safe, given the guarantee on deposits (including savings account) up to Rs 1 lakh.
Medium safety: Fixed Maturity Plans (FMPs) of mutual funds and secured non-convertible debentures come under the medium-safety category. While FMPs too are subject to credit and interest rate risk, with their close ended nature (locked for a fixed period) and portfolios that are held to maturity, investors can be reasonably sure of receiving the indicative yields of the instruments these schemes take exposure to.
However, investors have to understand the nature of instruments that these schemes invest in. While commercial paper or gilts may be less risky, higher exposure to corporate bonds may carry credit risk.
For instance, FMPs that invested in debt securities of real estate companies in 2007 had a tough time post the realty meltdown, restructuring the debt and getting back the money.
What makes the recent set of options different from the traditional `deposits`? For one, most of the instruments are keenly watched by regulators, thanks to a good number of them being traded on the bourses. Two, being mostly tradable securities, they offer investors greater liquidity.
However, they are not free from the interest rate and credit risks typical of debt offers. For this reason investors may have to survey their options based on four key criteria - safety, liquidity, returns and taxation; the last two going hand-in-hand. Here`s a look at how to evaluate the universe of debt options against the above criteria.
Safety
Thanks to the liquidity crisis in 2008, companies and even financial institutions strapped for funding decided to tap retail investors more actively. For individual investors this means exercising more caution while investing in debt.
While small savings schemes come with a government guarantee and bank deposits are protected by insurance, the credit quality of the borrower may vary significantly in other debt options. Given that companies are from myriad backgrounds, it has become imperative for investors to know the business profile and financial soundness of the borrower.
High safety: On the safety parameter, therefore, the traditional government Post Office Schemes, PPF, NSC and even zero-coupon bonds offered by government-backed apex institutions such as the Nabard come with an almost nil credit risk and offer fixed returns. Bank fixed deposits too can be termed relatively safe, given the guarantee on deposits (including savings account) up to Rs 1 lakh.
Medium safety: Fixed Maturity Plans (FMPs) of mutual funds and secured non-convertible debentures come under the medium-safety category. While FMPs too are subject to credit and interest rate risk, with their close ended nature (locked for a fixed period) and portfolios that are held to maturity, investors can be reasonably sure of receiving the indicative yields of the instruments these schemes take exposure to.
However, investors have to understand the nature of instruments that these schemes invest in. While commercial paper or gilts may be less risky, higher exposure to corporate bonds may carry credit risk.
For instance, FMPs that invested in debt securities of real estate companies in 2007 had a tough time post the realty meltdown, restructuring the debt and getting back the money.
Non-convertible debentures and infrastructure bonds that carry a fixed coupon rate and are secured by the assets of the issuer are also not too risky, provided investors attempt to understand their credit rating and hold them until maturity. However, for those who wish to sell the debentures in the market before their expiry, interest rate risk and liquidity risk are key factors to watch out for.
As bond prices will decline during periods of rising interest rates, a wrong decision to sell bonds in such a scenario may provide lower returns or sometimes even result in capital losses. Besides, given that the bond market in India lacks liquidity, it is possible that investors wanting to sell may be unable to find takers for the entire lot on the stock exchange.
Credit risks in debentures can, to some extent, be understood from reading credit rating reports. All debentures are rated by credit agencies (such as Crisil, ICRA) based on various criteria such as nature and track record of the business, debt-equity levels and capital adequacy. Higher the rating, lower the risk. Debentures of Tata Capital or L&T Finance issued last year are instruments with a high rating.
An instrument below investment grade (as defined by the rater) carries higher risk of default - a clear sign for investors to stay away. Investors holding long-term debentures must update themselves occasionally on the latest credit rating to know if the view on the issuer has changed.
Low safety: Corporate deposits of the high yielding variety are typical examples of high-risk, high-return instruments within the debt category. They often come last in terms of safety. While all corporate deposits are not equally risky, given that a number of deposit-takers do not disclose their credit rating in the application made available, investors are often lured by the high interest rate offered. While choosing from various corporate deposits, investors should do some homework in understanding the business risk of the borrower, track record of financial performance, the debt position and whether the company`s profit can comfortably service interest, besides any history of default. Looking out for deposit schemes of companies whose stocks are also listed may be less of a hassle, as the financial statements and filings pertaining to such companies are available in the public domain. Investors can also look out for companies with consistency in earnings rather than flashy performances.
LiquidityWhile the traditional options are high on the safety radar, it is the new-age options that often top the liquidity list. Open-end debt-oriented mutual funds are the most liquid options, given the ease with which these schemes can be redeemed, especially when there is an emergency. However, most of them have a short period of compulsory holding, any redemption within such period being charged an exit fee.
The holding period, though, is negligible for liquid and short-term funds. For this reason, these are most suited for any temporary parking of funds, at the same time earning more than savings bank interest rate.
Debentures: Some debentures and bonds are listed in the market as soon as they are issued and can be sold in the bourses provided one holds it in demat form. Shriram Transport Finance or Tata Capital NCDs are examples.
In fact, even if one missed the initial issue, they can be bought in the market, provided the investor is well-informed on debt markets and can time the call based on yield movements. Liquidity in these instruments is not uniform and some may be traded more frequently than others.
For investors wishing to hold these the debentures/bonds for a while but not until its maturity there are other options as well. Sometimes debentures/bond come with a lock-in period before they can be traded.
As bond prices will decline during periods of rising interest rates, a wrong decision to sell bonds in such a scenario may provide lower returns or sometimes even result in capital losses. Besides, given that the bond market in India lacks liquidity, it is possible that investors wanting to sell may be unable to find takers for the entire lot on the stock exchange.
Credit risks in debentures can, to some extent, be understood from reading credit rating reports. All debentures are rated by credit agencies (such as Crisil, ICRA) based on various criteria such as nature and track record of the business, debt-equity levels and capital adequacy. Higher the rating, lower the risk. Debentures of Tata Capital or L&T Finance issued last year are instruments with a high rating.
An instrument below investment grade (as defined by the rater) carries higher risk of default - a clear sign for investors to stay away. Investors holding long-term debentures must update themselves occasionally on the latest credit rating to know if the view on the issuer has changed.
Low safety: Corporate deposits of the high yielding variety are typical examples of high-risk, high-return instruments within the debt category. They often come last in terms of safety. While all corporate deposits are not equally risky, given that a number of deposit-takers do not disclose their credit rating in the application made available, investors are often lured by the high interest rate offered. While choosing from various corporate deposits, investors should do some homework in understanding the business risk of the borrower, track record of financial performance, the debt position and whether the company`s profit can comfortably service interest, besides any history of default. Looking out for deposit schemes of companies whose stocks are also listed may be less of a hassle, as the financial statements and filings pertaining to such companies are available in the public domain. Investors can also look out for companies with consistency in earnings rather than flashy performances.
LiquidityWhile the traditional options are high on the safety radar, it is the new-age options that often top the liquidity list. Open-end debt-oriented mutual funds are the most liquid options, given the ease with which these schemes can be redeemed, especially when there is an emergency. However, most of them have a short period of compulsory holding, any redemption within such period being charged an exit fee.
The holding period, though, is negligible for liquid and short-term funds. For this reason, these are most suited for any temporary parking of funds, at the same time earning more than savings bank interest rate.
Debentures: Some debentures and bonds are listed in the market as soon as they are issued and can be sold in the bourses provided one holds it in demat form. Shriram Transport Finance or Tata Capital NCDs are examples.
In fact, even if one missed the initial issue, they can be bought in the market, provided the investor is well-informed on debt markets and can time the call based on yield movements. Liquidity in these instruments is not uniform and some may be traded more frequently than others.
For investors wishing to hold these the debentures/bonds for a while but not until its maturity there are other options as well. Sometimes debentures/bond come with a lock-in period before they can be traded.
This is typically for almost half the tenure of the bond. Investors may either sell it post such lock-in or alternatively go for a call/put option if such an option is available at the time of applying for the bonds. The recent SBI Bond offered a call option, where it may choose to buy back the securities after five years. If it fails to do so, the bond promises an additional interest rate as compensation. A few other debentures also come with put options, where the investor has the option of redeeming the money.
While the traditional deposits are not very liquid, an exit from them is still possible. Most bank and corporate deposits allow premature withdrawal subject to a minimum lock-in period. Some even allow part withdrawal without affecting the interest earned on the rest of the capital.
Illiquid: Public provident funds can be termed illiquid as even a part withdrawal is possible only in the seventh financial year from the year of starting the account. The sum too is restricted.
Others, such as the Post Office Senior Citizens` Scheme and Post Office Monthly Income Scheme can be withdrawn after one year but are subject to penalty. However, loans can be taken against products such as PPF (from third year) and post-office time deposits, subject to certain conditions on the amount available as loan.
While the traditional deposits are not very liquid, an exit from them is still possible. Most bank and corporate deposits allow premature withdrawal subject to a minimum lock-in period. Some even allow part withdrawal without affecting the interest earned on the rest of the capital.
Illiquid: Public provident funds can be termed illiquid as even a part withdrawal is possible only in the seventh financial year from the year of starting the account. The sum too is restricted.
Others, such as the Post Office Senior Citizens` Scheme and Post Office Monthly Income Scheme can be withdrawn after one year but are subject to penalty. However, loans can be taken against products such as PPF (from third year) and post-office time deposits, subject to certain conditions on the amount available as loan.
5 ways to withstand inflation
A pretty humorous but powerful way of defining inflation is, ``it happens when everything gets more valuable, except money!``
Inflation or simply, the consistent increase in the prices of basic goods and essential services squeezes out every bit of penny from the hands of common man. Especially in a high growth and developing economy like ours, inflation would continue to remain a worry for all. In the past, we have had governments being given a pink slip owing to steep rise in onion prices and even a bandh this year to protest against inflation. While efforts are made by the central bank and government alike to keep the price rise under check, we need to safeguard ourselves against the demon of inflation which smartly keeps reducing the value of our savings.
It is never too early or too late to invest
Over a period of time, wealth creation is an eventuality and concern, not just to surpass the price effect but also to support your lifestyle needs particularly, post retirement. If one starts to invest early in life, the magic of power of compounding would help you grow your net worth sizably. Even if you haven`t started yet, a disciplined approach and regular investing would bring handsome gains.
I. Why not deposits
In order to restrain the inflationary pressures, the central bank hikes the interest rates. As a result, depositors enjoy higher interest rates on their fixed term deposits. But here lies a catch. Inflation reduces the real value of your money. For example, you bought a food item at Rs 100 in 2009. Assuming an average food price inflation of 10%, this food item will cost you Rs 110 today. Thus, though your expenses are still the same, you are spending more. The same principle applies to your deposits which should yield you more returns. In effect, your fixed deposit rate (x) should be more than inflation (y) to effectively beat the 10% price increase. Therefore, your real or actual return is (x-y) should match or exceed the `inflated` cost of living which is often not the case.
II. New pension system (NPS)
Today`s generation wants to retire early, has limited or no post employment pension and intends to live a hedonistic life. Building an adequate corpus to take care of expenses and a comfortable livelihood after retirement is important; moreover, because inflation erodes the corpus value. Therefore, an extremely cheap annuity plan like NPS is a viable option.
III. Diversify into equity asset class
As proven by the past market cycles, despite the fluctuations in the short-term, the returns generated from equities supersede other asset classes in the long term. Thus, the portfolio strategy to beat inflation is significantly aided by allocation to equities.
Plus, it is better to have a diversified portfolio of stocks or invest in a diversified equity fund without a sector or industry bias. Contrary to the depositors, higher borrowing rates by banks deeply impacts the credit requirements of corporate and individuals. So sectors such as real estate, infrastructure and power which require huge liquidity to supplement their long gestation plans are greatly affected. Despite this, there are sectors which source raw materials such as food grains and industrial metals, and offer essentials like utilities, health and personal care on which individual and industry depends on, would continue to function the same way. In fact, companies that produce these primary goods would benefit from the price rise.
IV. Alternate options: Commodity investing
Investing into agriculture-based funds is another option. There are also commodity funds which invest in companies related to precious metals (read gold), energy stocks, metal and mining industry. But commodities prices are highly cyclical and are subject to macro-economic policies, geo-political environment, and consumption demand. In case of global commodity based funds, currency risk is also applicable. However, aggressive investors can include these funds in their supplementary portfolio.
V. Gold - Traditional hedge
Indians are aware and have a significant allocation to gold albeit in jewelry form. With the emergence of ETFs and gold feeder funds, people are gradually looking at the yellow metal for investment. It also serves as a hedging tool during uncertain times. Presently, the steep rise in gold price is owing to the slow recovery in the developed markets. However, one has to bear in mind that gold does not generate interest income or pay dividends so it is more of the appreciation in value that would actually benefit your portfolio.
Inflation or simply, the consistent increase in the prices of basic goods and essential services squeezes out every bit of penny from the hands of common man. Especially in a high growth and developing economy like ours, inflation would continue to remain a worry for all. In the past, we have had governments being given a pink slip owing to steep rise in onion prices and even a bandh this year to protest against inflation. While efforts are made by the central bank and government alike to keep the price rise under check, we need to safeguard ourselves against the demon of inflation which smartly keeps reducing the value of our savings.
It is never too early or too late to invest
Over a period of time, wealth creation is an eventuality and concern, not just to surpass the price effect but also to support your lifestyle needs particularly, post retirement. If one starts to invest early in life, the magic of power of compounding would help you grow your net worth sizably. Even if you haven`t started yet, a disciplined approach and regular investing would bring handsome gains.
I. Why not deposits
In order to restrain the inflationary pressures, the central bank hikes the interest rates. As a result, depositors enjoy higher interest rates on their fixed term deposits. But here lies a catch. Inflation reduces the real value of your money. For example, you bought a food item at Rs 100 in 2009. Assuming an average food price inflation of 10%, this food item will cost you Rs 110 today. Thus, though your expenses are still the same, you are spending more. The same principle applies to your deposits which should yield you more returns. In effect, your fixed deposit rate (x) should be more than inflation (y) to effectively beat the 10% price increase. Therefore, your real or actual return is (x-y) should match or exceed the `inflated` cost of living which is often not the case.
II. New pension system (NPS)
Today`s generation wants to retire early, has limited or no post employment pension and intends to live a hedonistic life. Building an adequate corpus to take care of expenses and a comfortable livelihood after retirement is important; moreover, because inflation erodes the corpus value. Therefore, an extremely cheap annuity plan like NPS is a viable option.
III. Diversify into equity asset class
As proven by the past market cycles, despite the fluctuations in the short-term, the returns generated from equities supersede other asset classes in the long term. Thus, the portfolio strategy to beat inflation is significantly aided by allocation to equities.
Plus, it is better to have a diversified portfolio of stocks or invest in a diversified equity fund without a sector or industry bias. Contrary to the depositors, higher borrowing rates by banks deeply impacts the credit requirements of corporate and individuals. So sectors such as real estate, infrastructure and power which require huge liquidity to supplement their long gestation plans are greatly affected. Despite this, there are sectors which source raw materials such as food grains and industrial metals, and offer essentials like utilities, health and personal care on which individual and industry depends on, would continue to function the same way. In fact, companies that produce these primary goods would benefit from the price rise.
IV. Alternate options: Commodity investing
Investing into agriculture-based funds is another option. There are also commodity funds which invest in companies related to precious metals (read gold), energy stocks, metal and mining industry. But commodities prices are highly cyclical and are subject to macro-economic policies, geo-political environment, and consumption demand. In case of global commodity based funds, currency risk is also applicable. However, aggressive investors can include these funds in their supplementary portfolio.
V. Gold - Traditional hedge
Indians are aware and have a significant allocation to gold albeit in jewelry form. With the emergence of ETFs and gold feeder funds, people are gradually looking at the yellow metal for investment. It also serves as a hedging tool during uncertain times. Presently, the steep rise in gold price is owing to the slow recovery in the developed markets. However, one has to bear in mind that gold does not generate interest income or pay dividends so it is more of the appreciation in value that would actually benefit your portfolio.
Health is wealth: Put first thing first
It is rightly said, ``Health is Wealth``. But truly speaking how many of us are really serious about this. Today, when everything is uncertain, nobody can be sure what will happen tomorrow. We all are aware that medical bills are high and getting still higher. Still we do not buy health insurance plans. Health insurance is way of covering you and your family against any medical emergency arising out of any diseases or illness or accident. In India health insurance premium is considered as expense. This is because we do not give importance to eventualities. It is also true that, as the age of an individual increases, the medical bills are likely to increase and become a burden on the family. Some time entire family collapses because of this financial burden. We need to think seriously and act immediately upon it.
When we meet clients, usually we find one or two life insurance policy in each & every home, but the health cover is mostly missing there, not only because of lack of awareness but also because of unwillingness to pay the premium from customer side. At present less than 10% of total population have their health insurance plan. Data shows that 30% of people with heart problems are less than 40 years old. Diabetes, blood pressure and cholesterol are also very common in younger age. Stress level at work, habits and increasing life style illness also add to physical & mental pressure. Better we take early step to cover our self and our family before it`s too late.
A mediclaim policy covers hospitalization expenses for the treatment taken for disease or illness or accident. It also covers pre and post hospitalization expenses up to certain days and certain limit of sum assured. These limits differ from company to company depending upon the policy and sum assured.
In today`s scenario health plan of 50,000 or 1 lakh sum assured will not suffice. Individually we require minimum 3 to 5 lacs health cover. You can also buy a family floater with an extra top up plans, which will really help you in bad days. Now most of the companies also offer cash less facility if the patient is hospitalized in network hospital. Thus, we can concentrate only on illness of the patient and save time & energy from raising funds from friends and relatives.
Other benefits
> Cumulative bonus of 5% to your sum assured for every claims free year
> Family discount of 10% is applicable
> Health check-up in designated centers or reimbursement up to Rs 1000 at the end of continuous four claims free years.
> Income tax benefit on the premium paid up to Rs 15,000 as per section 80-D of the IT Act. You can also claim for the premium paid for your parents separately up to Rs 15,000 ( Rs 20,000 in case of senior citizens).
General exclusions
> All diseases/illness/injuries existing at the time of proposing this insurance
> Any disease contracted during the first 30 days of commencement of the policy
> Certain diseases such as hernia, piles, cataract, removal of gallstones or renal stones and sinusitis shall be covered after a waiting period of 2 years
> Non-allopathic medicine
> Congenital diseases
> All expenses arising from AIDS and related diseases
> Cosmetic, aesthetic or related treatment
> Use of intoxicating drugs, alcohol
> Joint replacement surgery (other than due to accidents shall have a waiting period of 4 years)
I also advise my clients to go through the exclusions and the limits of the cover, so that there should not be any problem in tough time. I personally believe that role of an agent/advisor is more important in claim settlement in health insurance compared to life insurance, because claim comes very frequently in health insurance. I also advice my clients to buy the health plans from general insurance or health insurance companies instead buying it from life insurance company. Today many life insurance companies also offers these plans, but you are advised to stay away from this.
A healthy life means many more working years and chance of wealth creation and financial freedom in your life.
> Cumulative bonus of 5% to your sum assured for every claims free year
> Family discount of 10% is applicable
> Health check-up in designated centers or reimbursement up to Rs 1000 at the end of continuous four claims free years.
> Income tax benefit on the premium paid up to Rs 15,000 as per section 80-D of the IT Act. You can also claim for the premium paid for your parents separately up to Rs 15,000 ( Rs 20,000 in case of senior citizens).
General exclusions
> All diseases/illness/injuries existing at the time of proposing this insurance
> Any disease contracted during the first 30 days of commencement of the policy
> Certain diseases such as hernia, piles, cataract, removal of gallstones or renal stones and sinusitis shall be covered after a waiting period of 2 years
> Non-allopathic medicine
> Congenital diseases
> All expenses arising from AIDS and related diseases
> Cosmetic, aesthetic or related treatment
> Use of intoxicating drugs, alcohol
> Joint replacement surgery (other than due to accidents shall have a waiting period of 4 years)
I also advise my clients to go through the exclusions and the limits of the cover, so that there should not be any problem in tough time. I personally believe that role of an agent/advisor is more important in claim settlement in health insurance compared to life insurance, because claim comes very frequently in health insurance. I also advice my clients to buy the health plans from general insurance or health insurance companies instead buying it from life insurance company. Today many life insurance companies also offers these plans, but you are advised to stay away from this.
A healthy life means many more working years and chance of wealth creation and financial freedom in your life.
Establish goals, don`t leave the future to chance Source: BUSINESS LINE (29-NOV-10)
I am 33 years old, married and have a five-year-old daughter. My wife is aged 30 and is employed. Together we have a take-home salary of Rs 1 lakh per month. I live in a joint family and my parents are independent.
My monthly expenses are Rs 15,000 and rest of our incomes is used to repay home loan, pay into investments, meet the annual insurance premiums and as savings for our international tour every year.
To meet my daughter`s education and marriage I have taken few insurance plans and the maturity proceeds of the plans would take care of both the goals. Recently I have availed a home loan for tenure of 10 years and our outstanding balance is Rs 25 lakh. To protect the home loan I have taken decreasing term insurance for the outstanding. Besides that I have taken a term insurance for Rs 70 lakh and my wife is covered for Rs 45 lakh.
As our parents are hale and healthy, I assume my life expectancy as 80 years. I wish to work till the age of 50 and at the time of retirement I wish to have a corpus of Rs 3 crore to manage the rest of my life.
For retirement, I am investing Rs 16,000 through SIPs in mutual funds such as HDFC Top 200, DSPBR Top 100, IDFC Premier Equity Plan, Reliance Opportunities, and Reliance Regular Savings. Apart from that, my portfolio has 12 schemes.
Beside mutual fund investments I have direct exposure to equity in blue-chip stocks and its current value is Rs 5.6 lakh. Based on the investment, please suggest if I am on track towards achieving my goal.
My current PF balance is Rs 5 lakh. We are covered by company group health insurance. But to be on the safer side I have taken a floater policy for a sum insured of Rs 5 lakh.
- Amit
Solution
A very small percentage of individuals in the age band of 30s plan well in advance towards goals such as education and marriage of their children. It`s nice to see your portfolio and you have attempted to reach the target not with risky equity assets, but through insurance.
But investors do need to understand that when your investment goals are long term in nature, instead of trying to reach your goals through debt it`s advisable to add equity component to keep cushion to meet unanticipated increase in the target amount.
Investors should keep in mind that debt investment through insurance should be a part of asset allocation and it should not be a primary source. The disadvantage with insurance investment is that to protect the life insured it needs to comprise on the return and it eventually increases your contribution towards the goals.
Retirement
It is true that without financial goals we would be leaving our future to chance. To tackle the ambiguities of future, establishing goal is mandatory.
My monthly expenses are Rs 15,000 and rest of our incomes is used to repay home loan, pay into investments, meet the annual insurance premiums and as savings for our international tour every year.
To meet my daughter`s education and marriage I have taken few insurance plans and the maturity proceeds of the plans would take care of both the goals. Recently I have availed a home loan for tenure of 10 years and our outstanding balance is Rs 25 lakh. To protect the home loan I have taken decreasing term insurance for the outstanding. Besides that I have taken a term insurance for Rs 70 lakh and my wife is covered for Rs 45 lakh.
As our parents are hale and healthy, I assume my life expectancy as 80 years. I wish to work till the age of 50 and at the time of retirement I wish to have a corpus of Rs 3 crore to manage the rest of my life.
For retirement, I am investing Rs 16,000 through SIPs in mutual funds such as HDFC Top 200, DSPBR Top 100, IDFC Premier Equity Plan, Reliance Opportunities, and Reliance Regular Savings. Apart from that, my portfolio has 12 schemes.
Beside mutual fund investments I have direct exposure to equity in blue-chip stocks and its current value is Rs 5.6 lakh. Based on the investment, please suggest if I am on track towards achieving my goal.
My current PF balance is Rs 5 lakh. We are covered by company group health insurance. But to be on the safer side I have taken a floater policy for a sum insured of Rs 5 lakh.
- Amit
Solution
A very small percentage of individuals in the age band of 30s plan well in advance towards goals such as education and marriage of their children. It`s nice to see your portfolio and you have attempted to reach the target not with risky equity assets, but through insurance.
But investors do need to understand that when your investment goals are long term in nature, instead of trying to reach your goals through debt it`s advisable to add equity component to keep cushion to meet unanticipated increase in the target amount.
Investors should keep in mind that debt investment through insurance should be a part of asset allocation and it should not be a primary source. The disadvantage with insurance investment is that to protect the life insured it needs to comprise on the return and it eventually increases your contribution towards the goals.
Retirement
It is true that without financial goals we would be leaving our future to chance. To tackle the ambiguities of future, establishing goal is mandatory.
If the monthly contribution required is higher than available surplus, investors might tend to take higher risk that eventually leads to more chaos. While calculating the future requirement it may be prudent to take long-term average inflation and provide for (any) increase in standard of living.
Take inflation at 7% and provide 2% for increase in standard of living. For instance, in your case, your current monthly expense of Rs 15,000 or Rs 1.8 lakh per annum if inflated at 9% (7% plus 2%) would make your annual requirement at the age of 50 to be Rs 7.8 lakh (corpus Rs 1.74 crore).
So your plan to build a retirement corpus of Rs 3 crore is on the higher side to meet this target you ought to save monthly a sum of Rs 56,600 at a return of 10%. Your current surplus would not permit you to do so.
If you want to build a corpus of Rs 1.74 crore you ought to save a sum of Rs 23,500 per month (inclusive of the existing SIPs) at a return of 10% after adjusting your current investment of Rs 10 lakh growing at same 10% for the next 17 years.
To meet your requirement, your retirement corpus should earn an interest of 2% above inflation.
For these calculations we have not taken your PF accumulation. That can be utilized to meet a shortfall in target.
Investment
Your current portfolio consists of 17 schemes and several of these schemes` investment objectives have overlaps.
It is generally advisable to restrict the number of schemes in the portfolio to 4-5. Your SIP investments are in the desired schemes and suggest that you continue with that.
Sell the remaining schemes and redeploy the proceeds in HDFC Top 200.
As you have taken adequate risk covers, don`t add term insurance to your portfolio.
Finally, it is advisable to review your portfolio at least once in six months to assess performance and to accommodate any change in lifestyle.
Take inflation at 7% and provide 2% for increase in standard of living. For instance, in your case, your current monthly expense of Rs 15,000 or Rs 1.8 lakh per annum if inflated at 9% (7% plus 2%) would make your annual requirement at the age of 50 to be Rs 7.8 lakh (corpus Rs 1.74 crore).
So your plan to build a retirement corpus of Rs 3 crore is on the higher side to meet this target you ought to save monthly a sum of Rs 56,600 at a return of 10%. Your current surplus would not permit you to do so.
If you want to build a corpus of Rs 1.74 crore you ought to save a sum of Rs 23,500 per month (inclusive of the existing SIPs) at a return of 10% after adjusting your current investment of Rs 10 lakh growing at same 10% for the next 17 years.
To meet your requirement, your retirement corpus should earn an interest of 2% above inflation.
For these calculations we have not taken your PF accumulation. That can be utilized to meet a shortfall in target.
Investment
Your current portfolio consists of 17 schemes and several of these schemes` investment objectives have overlaps.
It is generally advisable to restrict the number of schemes in the portfolio to 4-5. Your SIP investments are in the desired schemes and suggest that you continue with that.
Sell the remaining schemes and redeploy the proceeds in HDFC Top 200.
As you have taken adequate risk covers, don`t add term insurance to your portfolio.
Finally, it is advisable to review your portfolio at least once in six months to assess performance and to accommodate any change in lifestyle.
Portfolio ETFs for lifecycle investment Source: BUSINESS LINE (29-NOV-10)
Author: B. Venkatesh
It has been a while since ETFs were introduced in India. Its popularity is yet to grow, despite obvious benefits. Many look at ETFs as an alternative exposure to index funds. The question is: Can ETFs be used to generate cost-effective alpha and beta exposure for the investors?
This article discusses how ETFs can be used effectively in the core-satellite portfolio. It first explains the benefits of ETFs. It then discusses the process of using ETFs for beta and alpha generation. ETFs on asset classes such as bonds and commodities, which when introduced, could offer complete portfolio solutions for lifecycle investment.
Arbitrage and cash drag
ETFs moderate the cash drag and the price arbitrage problems faced by open-end and closed-end funds respectively. Consider the open-end fund. Cash drag refers to the lower returns that a portfolio may earn because it holds cash to meet daily redemption requirements of unit-holders. Closed-end funds, on the other hand, trade at a discount to the NAV.
ETFs sidestep the issue of cash drag by redeeming units in kind. That is, institutional investors do not get cash when they redeem units. They instead receive the underlying shares that constitute the benchmark (say Nifty Index) on which the ETF is based.
Likewise, ETFs reduce the NAV discount by allowing institutional investors to engage in arbitrage when the market price of the ETF is different from its NAV.
Besides, ETFs carry lower management fee compared with even passively-managed open-end funds. All these features make ETFs a desirable investment in any portfolio.
Beta ETF
ETFs are primarily passive structures, though some active ETFs do exist in the US. ETFs, therefore, logically form part of the passive equity core within a core-satellite portfolio.
The core-satellite framework separates the beta exposure from the alpha mandate.
That is, the core portfolio contains pure beta or market exposure while the satellite strives to generate alpha or risk-adjusted excess return over the benchmark index.
It has been a while since ETFs were introduced in India. Its popularity is yet to grow, despite obvious benefits. Many look at ETFs as an alternative exposure to index funds. The question is: Can ETFs be used to generate cost-effective alpha and beta exposure for the investors?
This article discusses how ETFs can be used effectively in the core-satellite portfolio. It first explains the benefits of ETFs. It then discusses the process of using ETFs for beta and alpha generation. ETFs on asset classes such as bonds and commodities, which when introduced, could offer complete portfolio solutions for lifecycle investment.
Arbitrage and cash drag
ETFs moderate the cash drag and the price arbitrage problems faced by open-end and closed-end funds respectively. Consider the open-end fund. Cash drag refers to the lower returns that a portfolio may earn because it holds cash to meet daily redemption requirements of unit-holders. Closed-end funds, on the other hand, trade at a discount to the NAV.
ETFs sidestep the issue of cash drag by redeeming units in kind. That is, institutional investors do not get cash when they redeem units. They instead receive the underlying shares that constitute the benchmark (say Nifty Index) on which the ETF is based.
Likewise, ETFs reduce the NAV discount by allowing institutional investors to engage in arbitrage when the market price of the ETF is different from its NAV.
Besides, ETFs carry lower management fee compared with even passively-managed open-end funds. All these features make ETFs a desirable investment in any portfolio.
Beta ETF
ETFs are primarily passive structures, though some active ETFs do exist in the US. ETFs, therefore, logically form part of the passive equity core within a core-satellite portfolio.
The core-satellite framework separates the beta exposure from the alpha mandate.
That is, the core portfolio contains pure beta or market exposure while the satellite strives to generate alpha or risk-adjusted excess return over the benchmark index.
We prefer ETFs on broad-cap indices such as the S&P CNX 500, as it helps investors get cheap market exposure to equity as an asset class. The Indian asset management industry does not yet offer such products. Investors have to therefore, settle for a passive exposure to a large-cap index such as the Nifty Index for their equity core.
Note that investors face a similar choice problem when they use open-end index funds.
We next discuss how ETFs can be used to generate excess returns over the benchmark index.
Alpha ETF
ETFs can be used to generate alpha in two ways. One, investors can buy-sell ETFs to generate excess returns. This is possible because ETFs are traded like stocks, unlike open-end funds that can be bought from a mutual fund complex only at the end of the day.
And two, ETFs can be used to back out the beta exposure in a fund. Suppose an investor buys a mid-cap fund.
Note that the mid-cap contains both alpha and beta exposure while the mid-cap ETF has only beta exposure. The investor has to first compute the relationship between the mid-cap fund and the mid-cap ETF.
Then, the investor has to use this relationship to short appropriate units of mid-cap ETF. Shorting beta-adjusted mid-cap ETF neutralizes the market exposure of the mid-cap fund.
And what remains is the alpha return! At present, investors can set-up such ETF alpha strategies in the banking sector and in large-cap stocks.
ConclusionThe use of ETFs in the satellite portfolio is only constrained by the availability of products in the market. While investors can now take exposure to gold ETFs, alternative and synthetic ETFs such as commodity ETFs (besides gold) hedge fund ETFs or Swap-based ETFs are yet to be introduced in the country.
Taken together, these products can help investors create a portfolio of ETFs to completely map their lifecycle needs.
Note that investors face a similar choice problem when they use open-end index funds.
We next discuss how ETFs can be used to generate excess returns over the benchmark index.
Alpha ETF
ETFs can be used to generate alpha in two ways. One, investors can buy-sell ETFs to generate excess returns. This is possible because ETFs are traded like stocks, unlike open-end funds that can be bought from a mutual fund complex only at the end of the day.
And two, ETFs can be used to back out the beta exposure in a fund. Suppose an investor buys a mid-cap fund.
Note that the mid-cap contains both alpha and beta exposure while the mid-cap ETF has only beta exposure. The investor has to first compute the relationship between the mid-cap fund and the mid-cap ETF.
Then, the investor has to use this relationship to short appropriate units of mid-cap ETF. Shorting beta-adjusted mid-cap ETF neutralizes the market exposure of the mid-cap fund.
And what remains is the alpha return! At present, investors can set-up such ETF alpha strategies in the banking sector and in large-cap stocks.
ConclusionThe use of ETFs in the satellite portfolio is only constrained by the availability of products in the market. While investors can now take exposure to gold ETFs, alternative and synthetic ETFs such as commodity ETFs (besides gold) hedge fund ETFs or Swap-based ETFs are yet to be introduced in the country.
Taken together, these products can help investors create a portfolio of ETFs to completely map their lifecycle needs.
Retirement planning: When`s the right time to start?
Author: Anil Rego
Of all the financial goals that we plan for in life - be it planning our children`s education, purchase of our house, a vacation, or buying a car - retirement remains a distant dream and also the one which occurs last on our priority list so we either avoid planning for it or push it to the next time. So people always wonder what would be a good time to start planning for it.
Only when we look at the numbers required in terms of money for retirement, one realizes that it could be a tad bit late or that it should have been done before. Sometimes people even drop the retirement planning by saying that they probably missed the train.
So what is the right time for retirement planning, we believe that any time between the ages of 25 to 35 is a good time to plan for retirement, but this does not mean that one should not plan for retirement after the age of 35. The sooner you start the better you can plan.
Let`s take an example of retirement planning at three different stage of life.
Chinmay is 25 year old professional. He works with an MNC for last 3 years. He decided to retire at the age of 60 years. Based on that, he calculated his monthly expenses and came up with a pension requirement of Rs 30,000 a month as of today. After doing analysis, he comes to know that inflation is a biggest enemy for his retirement; the expenses of Rs 30,000 today will certainly not remain the same after 35 years. Hence, it becomes pertinent to accommodate inflation as well to arrive at the corpus required for retirement, the investment pattern required to achieve the set corpus would entirely depend on when he chooses to start investing.
Below table shows the calculation for the retirement planning for different age group people.
House hold budget: - Rs 30000 a month
Year of retirement -60 years
Inflation Rate: - 6% p.a.
Expected Returns: - 12% p.a.
Considering, a large part of today`s expenses would not be there once one retires (EMIs, lifestyle expenses, hopefully even your investment commitments) and since most of the goals including owning a home, a car and children`s education would be taken care of; we assume that the only expenses that remain would be those pertaining to running household such as grocery, utility charges, adhoc expenses etc.,. Here`s a scenario analysis of impact of inflation, investment tenure and the resulting investment pattern.
Of all the financial goals that we plan for in life - be it planning our children`s education, purchase of our house, a vacation, or buying a car - retirement remains a distant dream and also the one which occurs last on our priority list so we either avoid planning for it or push it to the next time. So people always wonder what would be a good time to start planning for it.
Only when we look at the numbers required in terms of money for retirement, one realizes that it could be a tad bit late or that it should have been done before. Sometimes people even drop the retirement planning by saying that they probably missed the train.
So what is the right time for retirement planning, we believe that any time between the ages of 25 to 35 is a good time to plan for retirement, but this does not mean that one should not plan for retirement after the age of 35. The sooner you start the better you can plan.
Let`s take an example of retirement planning at three different stage of life.
Chinmay is 25 year old professional. He works with an MNC for last 3 years. He decided to retire at the age of 60 years. Based on that, he calculated his monthly expenses and came up with a pension requirement of Rs 30,000 a month as of today. After doing analysis, he comes to know that inflation is a biggest enemy for his retirement; the expenses of Rs 30,000 today will certainly not remain the same after 35 years. Hence, it becomes pertinent to accommodate inflation as well to arrive at the corpus required for retirement, the investment pattern required to achieve the set corpus would entirely depend on when he chooses to start investing.
Below table shows the calculation for the retirement planning for different age group people.
House hold budget: - Rs 30000 a month
Year of retirement -60 years
Inflation Rate: - 6% p.a.
Expected Returns: - 12% p.a.
Considering, a large part of today`s expenses would not be there once one retires (EMIs, lifestyle expenses, hopefully even your investment commitments) and since most of the goals including owning a home, a car and children`s education would be taken care of; we assume that the only expenses that remain would be those pertaining to running household such as grocery, utility charges, adhoc expenses etc.,. Here`s a scenario analysis of impact of inflation, investment tenure and the resulting investment pattern.
Age | Monthly Expenses @ Retirement | Corpus Needed @ Retirement | Lumpsum Investment | Monthly Investment |
25 | 230,583 | 41,291,957 | 782,050 | 7,971 |
30 | 172,305 | 41,291,957 | 1,378,240 | 14,258 |
35 | 128,756 | 41,291,957 | 2,428,929 | 25,807 |
40 | 96,214 | 41,291,957 | 4,280,604 | 47,757 |
A look at the table above suggests that the early you start the better you plan, you can build the corpus slowly and steadily. At the age of 25 or 30, you can easily manage to invest the amount and achieve the corpus.
The decision to retire is not an easy one, especially if you need to plan it before you reach your prime and even thought about other important priorities such as a home, a car or your children. However, it is a decision that we need to take because retirement is a certainty though it might be far out in the future.
Take aways…
> Recognize that retirement is as important a financial goal just like buying a home, a car or your children education
> It is extremely difficult to plan for retirement early since you are not sure about how to proceed since this goal is far out in the future - take professional help if required
> Starting early, with however little contribution, you could be on target to achieve your retirement goal since the power of compounding would work in your favor and you have greater chance to getting to the targeted corpus
> You just need to take care of your basic expenses post retirement since your profile would change meaningfully
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