200,000 Hits & A new page for your Personal Finance Questions

Amid all bad news of falling stocks and rupee; and rising gold & oil prices, Stable Investor has something to cheer about. The site has received its 200,000thhit. In March this year, we celebrated 100,000th hit. Therefore, we are glad that though the first one lac hits took 16 months, the next one lac took just 5 months!!
Thanks.
To mark this small achievement, we have decided to add a new page to the site. It will be called Personal Finance Questions. You can post your personal finance related questions on this page in comments section. We will try to answer as many question as possible. Some by means of comment replies and other by individual blog posts (mailbags).

Please avoid posting questions related to individual stocks. We will not answer them.

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Mailbag: 22 years old & ready to invest for 25 years!!

A young reader (Dhruv) in his early 20s asked us a question. He has 25K to spare every month. He wants to know his options if he wants to invest this money (every month) for next 25 years. As we mentioned earlier also in our previous post, we are delighted to see that people ready to commit to long term wealth building for decades and not years. 🙂
So in this post, as we promised, we will try to address our young reader’s query.
 
 
But remember, there is no perfect way. People might take different roads to the same goal. So, go ahead and do let us know of your views in comments section.
Theoretically, putting aside 25K every month for next 25 years in a simple PPF account itself would create a corpus of 2.6+ Crore. And that is without even taking any risks. These are sure-shot returns. Unless the govt. and everything else comes crashing down.
But since you are young, it makes sense to take some risks. And with time horizon which you have, many (if not all) risks of so-called risky assets can be evened out.
We don’t know much about you, your family or your financial background. We only know two things. You are ready to invest 25K every month. You are ready to do this for next 25 years. Due to lack of important information, it is fundamentally not possible (and unethical) to suggest anything concrete here. Therefore, we will make certain assumptions and then give our thoughts.
Assumptions
  1. You are ready to invest 25K every month NOW.
  2. You don’t have any liabilities NOW.
  3. Your income (salary, etc) will increase every year for next 25 years.
  4. Your liabilities will increase in future (not uniformly though). i.e., you would need to fund your higher education, marriage, honeymoon, parent’s health, property purchases, etc.
  5. Hence we assume that though your income would increase, you will not be able to increase your contribution to investments. Your investment contribution would remain fixed at 25K per month.
  6. You and your family are adequately insured.
  7. You and your family have adequate health insurance.
  8. Though glamorous, we have chosen not to include individual stocks as an asset class for your wealth creation plan. It requires effort and passion. Since we don’t know much about you, it is best to avoid it. 🙂
 
What We Suggest
  1. Before even thinking of investing, keep aside 6 month’s expenses worth of money in some liquid asset classes. You can keep it in a savings account or an online fixed deposit. These days it’s easy to make (and break) online fixed deposits when required. So this should take care of your Emergency Fund.
  2. From the 25K, you should put in 10K (8.33K to be exact as there is a limit of 1 Lac on investing in PPF each year)* every month in a PPF account. This would turn into around 85 Lacs in 25 years. Now this is separate from your and your employer’s PF contribution. Remember, you cannot touch this money before 15 years (though you can withdraw some after 6 years, let’s not get into those details).
  3. For the remaining 15K, chose 4-5 good mutual funds. As one reader suggested in the previous post, it is better to stick with index funds when considering such long term horizons. That way, dependencies on fund managers and his team are reduced to almost nil.  So you can go ahead with 3 index funds (4k, 3K, 3K = 10K). But it is also advisable to pick two well established actively managed funds (2.5K each). These funds should have been in existence for more than 10 years and should have proven the mettle in multiple market cycles. For names of such funds, check out our last post and its comment section. This 15K every month for next 25 years would create a corpus of around 2.2 Crore.
Problems which you might face in future
Now suppose that you want to buy a property after say 5 years. You would definitely be tempted to take money from this corpus which you would have created in last 5 years. Now though this approach looks sane and full of common sense, the problem would be that this would break the COMPOUNDING. Once compounding breaks and you continue to invest for next 20 years (after 5 years from now), your PPF contribution would have become 52 Lacs & MF would have become 1.2 Crore (Down from 2.2 Crore in previous case). So, you should plan your big expenses in such a manner that you long term compounding is not interrupted.
 
So how can one do this? Though it may not seem like a good idea at first, what you can do is to reduce this 25K contribution in PPFs & MFs to around 15-20K. Park the remaining money every month in some recurring deposits or income funds. This way, you would have started preparing yourself for future expenses and would not be required to interrupt compounding of your investments.


Hope that helps. Others are welcome to pour in their thoughts.

* – Thanks our reader Hemant Bhatia for bringing this to our notice.

Mailbag: I want to invest Rs 10,000 every month

A friend recently asked me about how to invest in mutual funds.
He said that he was aware of the concept of mutual funds and was ready to invest Rs 10,000 every month for next decade or so.
 
Mailbag
As a friend, I was really happy that there are still people in my generation who are interested in investing for decades and not months. I decided that it would be interesting to share what I told him with my readers too.
Before, I gave him any advice, I confirmed the following –
– He is adequately insured.
– He has health insurance.
– He has money in liquid assets to act as emergency funds.
– He is already using his 1 lac limit for saving taxes. So, I didn’t check for tax saver funds.
– He contributes to his PPF account regularly.
– He would not require this money which goes into mutual funds for atleast next 5 years.
– He is not interested in investing directly in equities.
The last one was to ensure that he was not investing in long term assets with an assumption of making money in short term. Also, anything less than 5 years may not be a good idea when discussing instruments which depend on equity markets.
I advised him to divide his 10K into 3 parts – 4K, 3K & 3K. I think 3 funds would offer sufficient diversification. I suggested him the following 3 funds to start a Systematic Investment Plan:
  1. HDFC Top 200 (link)
  2. HDFC Prudence Fund (link)
  3. Franklin Templeton India BlueChip (link)
mutual fund SIP
How to divide 10K among 3 different Mutual Fund Schemes
I chose these funds because these have been in existence for atleast a decade. Hence they have proven themselves over multiple market cycles, i.e. ups and downs.
These funds may not give the best returns among the available universe of funds. But they have historically stayed in top 10% consistently. And that is no mean achievement considering the volatile nature of Indian stock markets.
Also, these funds don’t fall as much as the market does during correction.
I also suggested that he should go for GROWTH option and not DIVIDEND payout or reinvestment one. This choice is based on the principle of compounding.
Now this approach may not be the best one or the perfect one. But it is sane, simple and easy to implement.

Unique way of investing in NSC (National Savings Certificate)

If you belong to the same generation as me (born in mid-late 80s), then chances are that you would have heard about NSCs, but would not have invested in them. But if you are of a generation prior to me, then chances are high that some of your money might be invested in this instrument.

NSC stands for National Savings Certificates. These are reliable, tax efficient (tax exempt under section 80C) and guaranteed by the govt. You can read more about it here.

national savings certificate
National Savings Certificate
So why is it that my generation is neglecting this instrument? 
 
The main reason behind this is instrument’s so called ‘lower returns’. Lower when compared to more glamorous returns claimed by riskier ones like equities, mutual funds and ULIPs. Returns offered by NSC are between 8.5% and 8.8% depending on the flavour (5 year or 10 year) you chose. But since interest is calculated six monthly, the effective rate ranges between 8.78% and 9.00%. And that is not all. Investment in NSC can be claimed as a deduction under Section 80C. Also, the interest income is tax-exempted. So returns are much higher than what it seems at first glance. And these are assured returns with almost no risk, unless the govt. decides to default. 🙂

But there is another problem with NSCs. These instruments have a lock-in of 5 years and 10 years. Now this is an extremely long period for our impatient generation. But there is a way in which this lock-in can be managed in a way that an investor receives some money at the end of every year. The approach which I’ll discuss increases the liquidity of NSCs, with a little help from Fixed Deposits. This approach reduces the return a little. But that is a price we need to pay for increased liquidity. 🙂
I’ll refer to this approach as the NSC-LADDER. We use NSCs and Bank Fixed Deposits (for initial period of the strategy) in this approach. So here it goes…
Suppose at the start of time (Year 0), you have Rupees One Lac (Rs 1,00,000) to invest. Though you are ready to invest for long term, you are not very comfortable with the lock-in of 5 years (or 10 years) and want to invest (safely) in some (reliable) instruments which have some amount of liquidity. The interest rates on NSC & FDs of different tenures is as follows – 
 
Interest Rates NSC
Interest Rates – NSC & Fixed Deposits

 

You start by dividing this one lac into five parts of Rs 20,000 each. You invest first in a bank FD with maturity period of One Year. Invest the second in a FD of 2 Years, third for 3 years, fourth for 4 years and finally fifth for 5 years.
After this, what happens is that you receive maturity amounts from respective FDs at the end of first, second, third, fourth and fifth year. The maturity proceeds are in turn invested in 5 year NSCs starting from start of Year 2, 3, 4, 5 and 6.

NSC Ladder : Click to enlarge


This is what exactly happens –

  • 1st Tranche: Invested Rs 20,000 in FD for One Year – Received Rs 21,600 at end of Year 1 – This sum is invested in NSC for 5 Years – Received Rs 32,750 at end of Year 6.
  • 2nd Tranche: Invested Rs 20,000 in FD for Two Years – Received Rs 23,545 at end of Year 2 – This sum is invested in NSC for 5 Years – Received Rs 35,699 at end of Year 7.
  • 3rd Tranche: Invested Rs 20,000 in FD for Three Years – Received Rs 25,901 at end of Year 3 – This sum is invested in NSC for 5 Years – Received Rs 39,271 at end of Year 8.
  • 4th Tranche: Invested Rs 20,000 in FD for Four Years – Received Rs 28,232 at end of Year 4 – This sum is invested in NSC for 5 Years – Received Rs 42,805 at end of Year 9.
  • 5th Tranche: Invested Rs 20,000 in FD for Five Years – Received Rs 30,073 at end of Year 5 – This sum is invested in NSC for 5 Years – Received Rs 45,597 at end of Year 10.
As illustrated above, you keep receiving maturity proceeds at the end of year 6, 7, 8, 9 and 10. These proceeds in turn can be reinvested in further NSCs of five years, maturing at end of year 11, 12, 13, 14 and 15. This system creates a Ladder-like System, where every year there is a payout. Our initial concern was that NSCs have a long maturity period with long lock-ins. This results in money getting stuck and reduction in liquidity. But this LADDER approach addresses this concern and generates cash (maturity proceeds) at the end of each year.
Money available at end of each year : Click to enlarge
Now, you can continue this ladder for as long as you like and see the magic of compounding take shape. I know it is tough to plan for 10-15 years. But here, the best part is that once you have invested Rs 1,00,000 in first year, it keeps on rolling without any further investments. Also, interest earned by NSC in first 4 years is tax exempt as it is reinvested and paid out only once at maturity. So tax benefits are immense.
So, is this product for everyone?
No. It is for those who believe in long term wealth building using stable, reliable and risk free instruments. NSC can be one of the instruments if you want to diversify your portfolio.

Pay Yourself First: What does it mean and How to do it?

Pay Yourself First. This has often been referred to as the Golden Rule of Personal Finance. So what exactly does it mean and how can you do it?


Pay Yourself First: What does it mean?

Paying yourself first means to invest or save before making any expenditures. This is equivalent of saying that you save first and then spend, rather than spending first and saving later. So when you pay yourself first, you make saving a priority.
Pay Yourself First
Save & Invest before Spending

As soon as you receive your paycheck, you should pay yourself first, i.e. Save & Invest, and then move on to spend anything. But this is easier said than done. For many people, it just seems too hard to save their money first because they feel that they have too many loans, bills and other commitments.  So how do we do it?

Pay Yourself First: How to do it?

Once you have decided that from now on, you are going to pay yourself first, it is time to take some action. And the best way to do it is to AUTOMATE IT.

  • In case you are planning to save for your retirement, ask your employer to automate your PPF, EPF, VPF deductions. In this way, you would have saved for your retirement, before even getting any money in your wallet!! 🙂
  • If you are interested in stock markets, you should make regular monthly investments (SIP) in good mutual fund schemes. This can be automated via an ECS mandate to your bank.

So, now that you have understood the concept and importance of Paying Yourself First, what is the best thing you can do right now??

ppf vpf
You Action Plan to pay yourself first.
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How to calculate Compound Annual Growth Rate

When investing or saving (Yes, they are different), it is often useful to calculate your returns to measure how your investments (or savings) are doing. This can be easily done by calculating CAGR or the Compound Annual Growth Rate (CAGR) of your investments.

Always calculate the real growth rate of your investments

What is CAGR


Investopedia defines CAGR as –

“CAGR isn’t the actual return in reality. It’s an imaginary number that describes the rate at which an investment would have grown if it grew at a steady rate. You can think of CAGR as a way to smooth out the returns.”


Formula for calculating CAGR

A simple formula for calculating CAGR is,


Compound Annual Growth Rate

A simple tool to help you calculate CAGR

We have created a simple CAGR Calculator, which you can use to calculate real returns for your investments. To download this calculator, click on this link. You will be taken to a Google Spreadsheet. Go to the File Menu, and click Download. Once the spreadsheet is downloaded, you can fill up the required numbers and the CAGR or Final Amount or Years will be calculated accordingly.

Click on image to go to the CAGR Tool

In case you have any problems downloading the calculator, just leave a comment below (with email) and we will mail it to you. The instructions for using the calculator are given in the sheet itself.

Hope you find it useful.

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Starbucks in India: Choose between a Coffee for Rs 150 or Rs 1.65 Lacs from SIP?

Starbucks has finally opened its first store in India. Being in Mumbai, we got an opportunity to check out the store on very first day. Lucky us… 🙂

 
Starbucks in India
From Starbucks (India) website
 Checking the menu, we found that a cup of coffee could cost anywhere between Rs 100 to Rs 200, depending on the type of drink. Though this does not seem much at first, if it does become a part of the routine for the young generation, then it could eventually turn out to be a bit costly. Assuming one makes a visit every week and shells our Rs 150 (in between Rs 80 and Rs 200) for a coffee, one would end up spending about Rs 600 a month on coffees.

Now, if this amount was invested on monthly basis (SIP) in a good mutual fund scheme, then assuming 15% pa growth, the amount would have become Rs 1.65 Lacs in 10 years. You can calculate the same yourself by using a SIP Calculator.

 
A Snapshot from SIP Calculator (Source: HDFC MF)
Now don’t think that we are against coffee or enjoyment. Instead of coffee, you can choose expenditures made on more unhealthy habits like cigarettes. And the result would be more or less same. All we want to convey is that if you are ready to invest systematically for the long term, you are bound to earn handsome returns.

SIP on Steroids – How to give boost to your regular investments?

(Latest Update) – You can read an updated and more detailed analysis of the PE and other ratios here.

We decided to use this insight to boost our SIPs.

For our analysis, we started with SIP of Rs 5000 every month, from January 2000 and kept on investing till December 2011. A total of Rs 7.25 Lac was invested in 145 instalments. Now we add the Boost. Whenever markets PE fell below 15, an additional Rs 5000 was invested in that month i.e. a total of Rs 10,000 was invested in that particular month. This happened in 23 of the 145 months and an extra Rs 1.15 Lac boosted the normal investment of Rs 7.25 Lac. This took total investment to Rs 8.40 Lac.

So what is the current value of the investment? Did the boost help in earning higher returns? Read further. The investment of Rs 8.40 Lac stands at a Rs 23.8 Lac. And if SIP was not boosted by Rs 1.15 Lac, it would have stood at Rs 19 Lac.

In an earlier post about timing the markets, we saw that it doesn’t make sense in trying to time the markets. If earning a better-than-average return is the aim, it is enough to invest regularly in a disciplined manner rather than trying to time the markets.

Let’s suppose that you as have decided to invest at regular intervals. This type of investment can easily be executed by means of SIP or Systematic Investment Plans.

Systematic Investment Plan (SIP) allows investment in markets at regular intervals. A normal SIP invests once every month.
There are many online SIP Calculators available that can be used to calculate SIP amounts based on your financial goals.
 
SIP is fine…But how to put them on steroids?
Before we answer this question, we would quote an analysis from our previous post on Analysis of P/E Ratios of Indian Equity Markets. Our study suggested that whenever an investment is made with markets trading at a multiple of less than 15 (PE<15), returns over 3 and 5 years have been phenomenal.

Above data shows that on increasing our investment by 15.9% (Investing more when market is trading at lower valuations), our overall investment value increases by 25%.

So to summarize,

  • But even after discussing the benefits of regular investments in markets & redundancy trying to time the markets, if you want to time the markets by investing in direct stocks, you should stick to shares of large & stable companies (Read about how to find Large Caps selling at massive Discounts!)