Whose Money is It Anyway?
Personal Finance Approaches• Tax-savings first
• Product-first
• Returns-first
• Needs first • Products-last• Tax-planning incidental
Goal-based investing
What is goal-based investing?
Permanent loss in capital
Permanent loss in capital
We cannot expect more because we cannot invest enough!
With 8% inflation• 12% return 5000 monthly investment• 6% return ~10,000 monthly investment• Takes 19 years to achieve goal
• What if I invest 10,000 pm in an instrument that offers a real chance to beat inflation?
• Can achieve goal 9 years earlier.
Inflation in India: Some Real Numbers
Jan 1995 to May 2014
kyunki saas kabhi bahu thi yojana
Your RetirementOther long-term goals
Accident insurance
Term Lifeinsurance
Emergencyinsurance
Health insurance
Inflation insurance
Returns do not matter!yearscorpus inv(1 return)
yearsinvcorpus (1 )return
returncorpus (1 )inv years
• Rs 1 grows at 8% for 20 Y ~ Rs. 4.7
• Rs. 1 grows at 12% for 20Y ~ Rs. 9.6
• Difference ~ 107%
• Rs 1 grows at 8% for 5 Y ~ Rs. 1.5
• Rs. 1 grows at 12% for 5Y ~ Rs. 1.8
• Difference ~ 20%
yearscorpus inv(1 return)
Power of non-compounding
Power of compounding does not matter for ~ 5Y or less
Saving vs. Investing
~ 5 years
Saving Investing
Choose not to Worry Inflation
Returns Choose not to worry
Importance of beating Inflation, grows with duration
Importance growsWith duration
Taxation Choose not to worry
Importance growsWith duration
Why not have some equity exposure?
Is not 5/7 years long-term?!
Year 1 Year 2 Year 3 Year 4 Year 5
10% 9% 8% 7% 6%
5
Investment = 100
After 5 years:
?
100× 1+10% 1+ 9% × 1+ 8% 1+7% 1+6%
100× 1+
5
After 5 years:
100× 1+10% 1+10% × 1+10% 1+10% 1+10%
100× 1+10%
Year 1 Year 2 Year 3 Year 4 Year 5
10% 10% 10% 10% 10%
5
Investment = 100
After 5 years:
100× 1+10% 1+ 9% × 1+ 8% 1+7% 1+6%
100× 1+CAGR
Year 1 Year 2 Year 3 Year 4 year 5 CAGR10% 10% 10% 10% 10% 10.00%
Year 1 Year 2 Year 3 Year 4 year 5 CAGR25% 7% 7% 7% 7% 10.05%
Year 1 Year 2 Year 3 Year 4 year 5 CAGR-25% 21% 9.96%
Year 1 Year 2 Year 3 Year 4 year 5 CAGR-25% 7% 7% 7% 7% -0.34%
Illustration: Volatile Compounding
Year 1 Year 2 Year 3 Year 4 year 5 CAGR25% -25% 7% 7% 7% 2.81%
Liquid Mutual Funds
• Savings bank account linked to bond market
• Invests in short-term bonds (4- 91 days)
• Sensitivity to interest rate change: low
• Risk of default: low
• Least volatile among volatile asset classes
HDFC Liquid Fund
Average
Arithmetic average ~ 7%Standard deviation ~ 2%CAGR ~ 7% (12 year)Difference ~ 0.02%
HDFC Liquid Fund
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
7.1 4.96 4.36 5.3 6.5 8.12 8.9 5.29 5.15 8.8 9.56 9.28
5.644
5.848
6.636
6.822
6.792
7.252
7.54
7.616
Discrete Rolling Return
Understand risks before investing
Continuous Rolling Return- 2Y
2048 Two year intervals betApril 3rd 2006 to Dec 4th 2014
April 3rd 2006 to April 2nd 2008April 4th 2006 to April 3rd 2008April 5th 2006 to April 4th 2008
Continuous Rolling Return- 2Y
Debt oriented balanced funds(<20% equity)
AMC suggested investment horizon 1-3 years
vs.
Equity oriented balanced funds(> 65% equity)
AMC suggested investment horizon 3-5 years
1 year rolling return
3 year rolling returns
5 year rolling returns
7 year rolling returns
Understanding the nature of stock market returns
Sensex Total Returns Index: 1979 to 2013
Sensex Total Returns Index: 1979 to 2013
Sensex Total Returns Index: 1979 to 2013
5%
S&P 500 Total Returns Index: 1871 to 2013
Source: http://www.moneychimp.com/features/market_cagr.htm
12%
Sensex Total Returns Index: 1979 to 2013
Normal Distribution
Source: http://www.mathsisfun.com/data/standard-normal-distribution.html
Mutual Fund Star Ratings
Source: MorningStar.com
Sensex 1979 to 201315 year CAGR
Transformed Distribution: Square Root
14% +/- 4%
Higher risk does not imply higher return!
Return
RiskStandard Deviation
Higher risk does not imply higher return!
Return
RiskStandard Deviation
FD
Debt mf Equity mf
Gold
How Important is
Mutual Fund Selection?
Large Cap funds• 10-year old funds: 34
• 13 index + LIC Nomura+ JM fund
• 10 year SIP XIRR
• Baroda Pioneer Growth: 14.45%
• UTI Equity: 17.68%
Mid and Small-cap funds• 10-year old funds: 20
• 17 + Sahara+Escorts+Taurus
• 10 year SIP XIRR
• ICICI Value Discover: 24.23%
• Kotak Mid-cap: 18.03%
Essentials of a good portfolio
• Minimalist : We must be able to justify the presence of each asset class or instrument.
• Minimum number of asset classes
• Minimum number of stocks, equity funds or debt products
• This will typically make the folio diversified among and within asset classes
Simple portfolio ideas
Equity (60%) 10% return
1. Single Large Cap fund
2. One large cap +one mid/small cap fund
3. Single Large and mid-cap fund
4. Single equity oriented balanced fund
Debt (40%) 8% return (pre-tax)PPF for 15+ Y goals for options 1,2 & 3 (do not max!)
Ultra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds
Long-term goals (10+ years)
Simple portfolio ideas
Equity (0-40%) 8% return
1. Single Large Cap fund
2. One large cap +one mid/small cap fund
3. Single Large and mid-cap fund
4. Single equity oriented balanced fund
5. Single debt oriented balanced fund
Debt (100-60%) 8% return (pre-tax)Ultra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds
Medium-term goals (5-10 years)
Simple portfolio ideas
Equity (0-10%) expect nothing!
1. Single Large Cap fund
2. One large cap +one mid/small cap fund
3. Single Large and mid-cap fund
4. Single oriented debt balanced fund (5Y)
Debt (100-90%) 6-7% return (pre-tax)FDs, RDsUltra-short-term liquid funds for less than 15Y goalsBanking debt mutual funds
Short-term goals (0-5 years)
Return expectation
• Equity allocation60%
• Debt allocation 40%
• Equity expectation 12% (after tax)
• Debt expectation 6-7% (after tax)
• Portfolio expectation
10%(60%) + 7%(40%) = 10% (approx.)
Investments are assumed to start simultaneously
Years to goalPresent costInflation Post-tax rate of return of portfolio 10%
Future CostAmt invested so farPost-tax rate of return on current investment
Future value of curr. Inv. Annual increase in monthly invest. %Initial monthly investment required
Annual increase in monthly invest. %Initial monthly investment required
Goal Planner
How many funds should I hold?
• Minimum:
2-3 funds! (all goals combined into one)
• Maximum:
No of long-term goals (10Y+) x (1 or 2)
How to select an equity mutual fund?
• Decide on the strategy.
(1)Why are you investing?
(2) What kind of portfolio will you be using?
Equity mutual funds: How to select/evaluate
Equity mutual funds: How to select/evaluate
Equity mutual funds: How to select/evaluate
Upside Capture ratio: When the benchmark has given a positive return (> 0), has the fund outperformed it?Higher (> 100%) the upside capture ratio, the better.
UPC = 120% => 20% out-performance during up-market
Downside Capture Ratio: When the benchmark recorded a loss, that is a negative return (< 0), did the fund record a lower or higher loss?Lower the downside ratio (<100%), the better.
DCP = 85% => 15% out-performance during down-market
Equity mutual funds: How to select/evaluate
Source: http://thefundoo.com/welcome/articlepage/44/Are+you+invested+in+the+Ideal+Outperforming+schemes%3F
Rolling returns analysis
3YFund (blue)
Vs benchmark
5Y
How to select a debt mutual fund?
Understand risks• interest rate risk capital gain/loss• credit risk accrual
How to select a debt mutual fund?
Interest rate risk
Creditrisk
How to select a debt mutual fund?
How to select a debt mutual fund?
How to select a debt mutual fund?
Portfolio with 50% equity and 50% debt
Asset Allocation
Maximum Loss: worst case scenario
Asset Allocation
Time Frame Conservative Moderate Risky Mad-Max
< 5 Years FD/RD ~ 10% Eq 30-40% Eq > 60% Eq
7 Years FD/RD 10-20% Eq 40-50% Eq >60% Eq
10 years FD/RD 40% Eq >60% Eq 100% Eq
10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq
>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq
Time Frame Conservative Moderate Risky Mad-Max
< 5 Years FD/RD/Debt ~ 10% Eq 30-40% Eq > 60% Eq
7 Years FD/RD/Debt 10-20% Eq 40-50% Eq >60% Eq
10 years FD/RD/Debt 40% Eq >60% Eq 100% Eq
10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq
>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq
Retirement Planning
Corpus ~ 300 times current annual expensesCorpus ~ 38 times annual expenses at retirement
Invest as much as you spend each month for retirement!
Financial Goal Tracking
• Be obsessed over goal planning entries not over mutual fund corpus