Why Should You Consider Inflation in Planning Your Long Term Goals?

Why Should You Consider Inflation in Planning Your Long Term Goals?
31/07/2019

Inflation is the rate at which prices go up annually. But, why is it so important? Inflation matters because over time it erodes value. Let us look at inflation from a different perspective. If the annual inflation is 5% then a product of Rs.100 will cost Rs.105 after 1 year. If you were to receive Rs.100 after 1 year then its value will be Rs.95.24. In other words, the value of Rs.100 today is not the same as the value of Rs.100 after one year. But why is that so important to financial planning and long term goals.

Just as returns compound, inflation also compounds

Have you heard your father or grandfather nostalgically recollect how they could buy all the joys of the earth for Rs.10 and how the world changed into a more materialistic place? What they are effectively talking about is inflation. Inflation erodes the value of money over time and your income needs to growth at a rate that is faster than the rate of inflation.

As the above equation depicts, what matters is the real return that you earn post inflation; and this is more critical when you are looking at longer periods of time. Let us assume equity returns at 14% per annum and inflation at 5%.

Actual Returns

Amount

Real Returns

Amount

Investment Amount

Rs.1,00,000

Investment Amount

Rs.1,00,000

Yield on Investment

14%

Inflation Rate

5%

Nominal Returns

14%

Real Returns

9%

Holding Period

15 years

Holding Period

15 years

Corpus after 15 years

Rs.7,13,794

Corpus after 15 years

Rs.3,64,248

Nominal Wealth Ratio

7.14 times

Nominal Wealth Ratio

3.64 times

Interestingly, you may be celebrating that you have multiplied your wealth 7 times over in 15 years. But if you remove the impact of inflation then the wealth nearly halves. That is why factoring inflation is the key to getting a proper picture of your future wealth.

Knowing the future value of your expenses

Financial planning is never about the next 2-3 years but about the next 20 years. You want to use the power of compounding to make money work harder. Let us look at the role of inflation in knowing the future value of your retirement needs and your insurance needs.

Case 1: How much should you save for retirement? Your starting point will be your monthly expenses. Let us say, your monthly expenses for your family of four is currently Rs.90,000 per month. Now what is the amount you should plan for? If you are planning to retire after 20 years then you can inflate at 5% annually for the next 20 years. That gives you a monthly expense of nearly Rs.2,40,000 per month after 20 years. Of course, there could be shifts in standard of living but your expenses will also come down due to lesser number of dependents. This inflation adjusted spending should be your base case.

Case 2: How much life insurance you need to buy? Of course, we are talking about a pure risk cover. Since you are looking at a 20 year horizon, consider expenses after 10 years as the benchmark. After 10 years your family will require at least Rs.1,47,000 per month to maintain the same standard of living. Now how do you plan the size of your insurance cover? Check the table below.

Particulars

Amount

Current Monthly Expenses

Rs.90,000

Monthly expenses after 10 years at 5% inflation

Rs.147,000

Annual income needed after 10 years

Rs.17,64,000

Where will the insurance corpus be invested?

5% liquid funds

Insurance corpus to earn above income (Rs.17.64 lakhs / 0.05)

Rs.3.53 crore

You can use the inflation approach to determine that you require a life risk cover of Rs.3.53 crore to take care of regular income needs in your absence. In the event of any exigency, this would take care of family running expenses for the next 10-15 years.

Need to tweak your plan with inflation shifts

This is an aspect of inflation, most of us tend to ignore. What happens if after 1 year you realize that the average inflation would be higher at 6% instead of 5%. Let us continue with the above case. At 6% inflation your monthly expenses after 10 years will be Rs.1,61,000. Your sum insured will also increase from Rs.3.53 crore to Rs.3.86 crore and your premium payout will go up proportionately.

Inflation remains one of the most important components of your financial plan. A reliable estimate of inflation is at the core of successful financial planning.

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5 Simple Ways to Invest with Little Money

5 Simple Ways to Invest with Little Money
05/08/2019

Quite often you hear the general excuse that one is not able to invest because they don’t have a large enough corpus. Actually, you don’t need a large corpus. You need to focus on maximizing savings and start regular investment immediately. Here are 5 things to do while investing with little money.

Start as early as possible

There is really no right age to start investing but the earlier you start the better it is. Over longer periods of time, even small contributions can grow to large sums of money. That is when the power of compounding really works in your favour. The longer you invest, the more your capital earns returns and the more your returns earn returns. Check this table below, where we have assumed a yield of 15%:

Monthly SIP

Invested in

Yield (%)

Tenure

Investment

Final Value

Rs. 3,000

Equity Funds

15%

30 years

Rs.10.80 lakhs

Rs.2.10 crore

Rs.10,000

Equity Funds

15%

20 years

Rs.24.00 lakhs

Rs.1.51 crore

Rs.20,000

Equity Funds

15%

10 years

Rs.24.00 lakhs

Rs.55.7 lakhs.

Interestingly, you create the maximum wealth with a monthly SIP of Rs3,000 just because you continue it for 30 years. In the other two cases, you end up with less wealth even through you contribute much more.

Adopt a SIP approach

Don’t try to time the market with lump sum investments. That is too much of strain on your finances. Instead opt for the comfort of a systematic investment plan. It synchronizes with your inflows and also gives you the added benefit of rupee cost averaging. As the table above captures, SIP instils the discipline and that matters more than the amount you invest.

Using diversified mutual funds

That brings us to the next question, if you have a small corpus to invest then where should you invest it. Obviously, if you put the money in a liquid fund earning 6% pre-tax or a debt fund giving 9% returns you cannot create meaningful wealth with a small investment. You need to take a long term view and stick to equities. Don’t fall for sectoral and thematic funds. They can be too risky and unproductive in down cycles. Rather stick to diversified equity funds and at best look at multi cap funds if you want to add the benefit of alpha from mid caps and small caps.

Buy quality stocks in small quantities

If you think that buying direct equities takes a lot of investment, just think again. When you buy shares in demat, you can even buy small quantity of a stock. A stock of Infosys costs you less than Rs.750 per or a share of SBI costs you around Rs.300. You can keep nibbling in small quantities. Remember this story from market folklore; an investment of Rs.10,000 in Wipro in 1980 would be worth Rs.600 crore today. Yes you did hear it right!

Keep a trading limit for options

Even with a small corpus you can always look to options. You can take a larger position in calls or puts where conviction is higher. Of course, keep the premium as your sunk cost and go ahead. Measure the risk you can afford, but this is a great way to play the market both ways.

Moral of the story is not to be intimidated because you have a small corpus to invest. In the final analysis discipline and diligence matters a lot more.
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The Difference Between Regular and Direct Mutual Fund

The Difference Between Regular and Direct Mutual Fund
01/09/2019

Browse through the NAVs of mutual funds either in the pink papers or the AMFI website and you will find that the same growth or dividend scheme of a mutual fund is subdivided into Regular plans and Direct Plans. Have you ever wondered what are these Direct Plans and Regular Plans? Let us check out a live NAV table first.

Date Source: AMFI

In the above table, you will find that the DSP Top 100 Equity Fund is subdivided into Direct Plan and Regular Plan. You will also find that the Direct Plan has a higher NAV compared to the Regular Plan. Before comparing Direct Plans and Regular Plans, let us briefly dwell on the brief history of Direct Plans.

A Brief History of Direct Plans

Prior to 2009, fund houses charged investors entry loads on mutual funds to cover selling and distribution costs. In August 2009, SEBI banned the collection of entry loads from mutual fund clients. However, the official model of Direct Plan came only from January 2013 when SEBI asked all fund schemes to classify into Direct Plans and Regular Plans.

Currently, funds are allowed to debit their annual expenses up to a ceiling of 2.25% of the AUM in case of equity funds to the fund NAV. This is called the Total Expense Ratio (TER). The fund does not bill the distribution and trail commission costs to Direct Plan investors. Hence, Direct Plans are subject to lower TERs and the NAV are higher. Here are three key points.

Direct Funds Have Lower Expense Ratio

The TER on Direct Plans is lower since the distribution and trail fees are not billed to them. However, there are other costs too in a mutual fund. Mutual funds have to incur operational costs, fund management fees, auditor fees, registrar charges, execution costs, statutory costs and brand expenses, among others. Even if you are holding a Direct Plan, these expenses will still be charged to you. It is only the distribution and trail commissions that are not billed to your NAV. In a typical equity fund the regular plans will have a TER of around 2.25% while the TER for a Direct Plan will be 60-70 bps lower. This cost saving each year enhances your return over the longer period of time.

Direct Plan Does Not Involve Any Intermediary

Direct Funds are simple in nature and the process of investing, especially through an online platform is easy as you do not deal with any intermediary. You can invest directly and make your own investment choice. Just ensure that the NAV in your statement actually reflects the Direct Plan NAV as available on the AMFI website.

Choose Direct Plans If You Can Make Financial Planning Decisions Independently

The common question is - who should opt for a Direct Plan. There are no hard and fast rules. If you are savvy enough to manage your financial planning and investments on your own, then you can consider Direct Plans. When you invest via Direct Plans you do not get the benefit of the advisory services of a broker or financial advisor. Hence, you need to make your choice of Direct Plan after due consideration. Ensure that you have the time and resources to make your financial planning decisions independently.

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How Can You Invest In Direct Mutual Funds?

How Can You Invest In Direct Mutual Funds?
01/09/2019

Direct plans of mutual funds enable the investor to save on costs. Direct Plan investors are not charged the distributor and trail commissions. For an average equity fund, this reduces the Total Expense Ratio by 60-70 basis points. This makes a big difference over longer periods.

The KYC process remains the same, irrespective of whether you opt for the Direct Plan or the Regular Plan. Also you have to register with the AMC or the aggregator once. The investor can either do a lump sum investment or follow SIP route through the Direct Plan. Once your SIP is registered as a Direct Plan, then it continues that way. You can convert a Regular Plan into a Direct Plan by writing to your fund. How do you invest in Direct Mutual Funds?

Direct Plan Investing Through AMCs

Walk into the nearest office or Investor Service Centre of the AMC of your choice. If you are a first time investor, then you will have to complete your KYC and you will be allotted a ‘Folio Number’. Once folio number is allotted, subsequent investments can be done online. Ensure that you specifically check the Direct Plan box in your application. The only challenge in this approach is that you will have to obtain a distinct folio number for each AMC.

Direct Plan Investing Through Fund Registrars

Registrars are the record keepers and folio managers of all mutual fund accounts. There are two key players viz. Karvy and CAMS. You can register with either registrar online to invest in Direct Plans. Of course, when you approach a registrar, you can only invest in funds for which they are the registrars. In fact, when you submit an application to your AMC, it is processed by the registrar only. So, this is an extension of the first method.

Leveraging MFUs and Fund Aggregators

Mutual Fund Utilities (MFU) or aggregators are an agnostic platform to invest in mutual funds. You will have to take a one-time registration and obtain a Common Account Number (CAN). Once the CAN is obtained, you can map all your existing folios to that particular CAN and they would be treated as Direct Funds. The advantage is that you don’t have to interface with multiple AMCs and the MFU aggregates and gives you requisite analytics for better decision making. The challenge is that you can only deal in the funds where the AMCs have tied up with the MFU. This platform is convenient and centralized.

Direct Plan Investing Through Investment Advisors, Online Direct Investment Portals

The challenge in the above 3 methods is that you still have to be self-driven. As an investor you need to take all the decisions including screening, selecting and ensuring that funds are in sync with your long term goals. One alternative is to go through on online platform of Registered Investment Advisor or through a Robo Advisor. These platforms provide investment recommendations to investors on the basis of certain details keyed in by the investor. 

Direct Plans Of Mutual Funds – How To Make The Choice?

Investing through Direct Plans requires that you are comfortable with a self-driven approach to investing in mutual funds. While mutual funds offer diversification and professional management, they are also exposed to the vagaries of the markets and macros. You must be confident to handle these gyrations. Ideally, Direct Plans are for investors who have the time, wherewithal and resources to spend in making investment decisions. Otherwise, you are better off opting for a Regular Plan and letting your broker advice you appropriately.
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Sensex Breaks Below 38,000. Is This Time To Be Cautious?

Sensex Breaks Below 38,000. Is This Time To Be Cautious?
05/09/2019

Between May 6 and May 8, 2019 the Sensex lost nearly 1,200 points in a vertical fall. It was triggered by an exasperated Donald Trump tweet on his intent to raise tariffs on Chinese imports from 10% to 25%. Global markets reacted in unison as nearly US$13 billion was wiped out for every word that Trump tweeted. India was not spared as the Sensex dipped below the psychological level of 38,000. What should investors really do?

Source: BSE (May 9, 2019)

The one-month chart of the Sensex is quite revealing. After crossing the 39,000 mark multiple times, the Sensex had faced tremendous pressure before it ascended further. Should traders and investors be cautious at this point?

A. There is a global angle to this correction

The big trigger for the correction was an escalation of the trade war. By now it is clear that this is not just a war over import duties, but a much bigger war of two of the largest economies trying to assert their economy supremacy. The US remains the market that every country looks up to and China is the only country that can absorb all the minerals and metals produced in the world. China is unwilling to commit anything on intellectual property rights and that is the bone of contention. A prolonged trade war will mean that there could be an impact on growth in US and Chinese GDP. That will surely rub off on global demand. Secondly, there is a limit to which China can retaliate because they run a trade surplus in the range of $400-500 billion with the US (as per US Census). The other option is to devalue the Yuan. That could have a weakening impact on currencies including the rupee. Hence the trade war will continue to be an overhang on the Sensex.

B. Domestic macros are a challenge too

There are a number of domestic challenges too. Despite two rounds of rate cuts, there has been little impact on lending rates. The rupee has been extremely volatile and the RBI has been using swaps to infuse domestic liquidity into markets. There is the more immediate challenge on top line growth in consumer sectors like FMCG and auto where the slowdown is obvious. Despite all the efforts of the government, farm incomes have not improved and weak rural demand is putting a limit on growth.

C. Banking holds the key for now

We have seen in the past that if the Sensex has to go up decisively, then banking stocks have to perform exceptionally well. That is hardly surprising considering that banking and financials account for 38% of the Nifty basket. Amidst this, PSU banks are struggling to recover from the NPA pile accumulated over the years. Then, there are the potential NPAs pertaining to IL&FS, ADAG group and sectors like power and telecom that are not yet accounted for. When you add these up, the question “where is the trigger for a market rise” continues to haunt.

D. You can sense the market risk in the VIX

The volatility index is also called the Fear Index as it is indicative of the caution in the markets. Historically, VIX and Sensex have had a negative correlation. This time around, the VIX has moved up from 14 levels to 26 levels over the last couple of months and shows no signs of abating. That is a clear indication of high levels of risk that markets are assigning at current levels. When the VIX is elevated at higher levels, each bounce is met with aggressive selling. VIX also reflects that the rupee is coming under pressure due to a consistently widening current account deficit.

What should investors really do at these levels?

While caution is warranted, the Sensex has shown a tendency to bounce each time the trade war has tampered. Once the rattling gets subdued, we could see the Sensex bouncing again. Other than the weakening consumer demand, all the other factors are temporary. Weak consumer demand appears to be the only structural issue and that may predicate on how the new government that assumes office deals with demand push. While traders can be choosy about timing, investors should stick to quality stocks and adopt a phased approach to investing. The more these things appear to change, the more they happen to remain the same!

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Top 6 Equity Investment Myths That You Must Overcome

Top 6 Equity Investment Myths That You Must Overcome
07/09/2019

In a way, investing myths are perpetuated over the years; partly by history and partly by your conditioning. There are some popular myths that almost all traders and investors appear to be victims of. Let us look at 6 such popular myths about investing that need to be debunked.

Myth 1: In long term investing, returns matter more than risk

Back in 2007, Nokia was a world leader in mobile phones and Forbes had even featured Nokia in a cover story calling them “invincible”. The same year, Apple launched its i-Phone and was followed by Samsung’s smart phone. In less than 4 years, Nokia was on the verge of bankruptcy. Imagine what would have happened to an investor who had ignored risk while investing in Nokia. The reality is that more investors made money in the equity markets by focusing on risk than purely on returns. Once you are able to measure and control risks, the returns will automatically follow. You invest with finite capital and that is why risk matters.

Myth 2: Equity investing is more risky than debt; so stick to bonds

This statement is technically correct because as an asset class equities are riskier than bonds. But there is a time definition that comes in here. In the short to medium term equities are definitely riskier than bonds because returns on equity can fluctuate. But let us talk about the longer term. In the long term both equity and debt carry risk. Look at the number of bond issuers who have defaulted in the last 1 year and you will understand the risk in debt. Secondly, when you are looking to create wealth in the long haul only equity investing can get you to your goals. In the long run, the risk of not taking any risk is much more for your portfolio. That is why equities automatically become low risk over the long term. Of course, you need to stick to quality equity stocks in this case.

Myth 3: I am a long term investor so charts are not for me

There is a general myth that fundamentals are for long term and technicals are for the short term. While that could be intuitively correct, it risks missing the wood for the trees. Charts are the key to any long term investor because it gives two very important signals. Firstly, even if you have identified a fundamentally strong stock, the timing of entry does make a difference to your returns and charts can help here. Also, charts can identify breakouts, which can be useful for long term investors.

Myth 4: Large caps are a better bet than mid caps

That is not necessarily true because some of the large caps of today were mid caps a few years back. There are examples like Lupin, Sun Pharma and Bajaj Finance. You can actually make big profits in equities if you identify a quality stock when it is still a small cap or a mid cap. Once it becomes a large cap there are scores of analysts and fund managers chasing the stock and it becomes overcrowded. Also, mid-caps create wealth because of more focused business models and lower levels of debt.

Myth 5: A great company can be bought at any price

That is not correct. A great company can be awesome at a certain price but can be expensive at a higher price. If you had bought L&T in 2011 or SBI in 2010 it would have taken you ages to recover your price. Both are outstanding companies! However good the company, if you are looking for stock market outperformance then the price of entry matters! That is why investing requires that you keep looking out for bargain sales in the stock market. Investors who bought quality stocks in 2009 or 2013 would have surely done a lot better than the others.

Myth 6: Investing is all about complex black box strategies

Black box strategies can give you better execution. You make big money by identifying a stock with great potential and holding on for a long time. Legendary investor Peter Lynch used to say, “A great idea should be so simple that you should be able to illustrate it with a piece of chalk”. Take Eicher Motors in 2009. A growing market, hardly crowded, low capital requirement and a high ROE was a classic combination to create wealth. That is how simple it is! Just keep your eyes and ears open.

Before you start investing, try to drive these myths out of your mind. It will make investing a lot simpler!