Sensible Measures without getting Too Ambitious

Sensible Investing
Sensible measures without getting too ambitious – these 6 words from an old RBI press release caught my attention.

RBI governor Raghuram Rajan’s recent announcement to not take up the second term, triggered a desire in me to read up whatever I could find about him. So I landed up on a press release (link), which had some key points in a speech made by him.

Talking of this announcement, the media is full of debates around the so-called Rexit (Raghuram Rajan’s Exit). I read up a lot and still have no answers to questions related to Rexit’s implications for the Indian economy.

But I am quite impressed with the PSU Bank cleanup that he initiated. There are few more initiatives that I think were in the right direction. To cut a long story short, I am of the opinion that having him around as the RBI chief would have been better for the economy than not having him.

But in life, we can have anything but not everything. So I guess, we will just have to do with a good Prime Minister for the time being. 🙂

Now getting back to the 6 words that caught my attention…

Sensible measures without getting too ambitious.

I feel these words can act as Level-1 Guidance for people looking to put their personal finances in order.

These words are neither as comprehensive nor as spectacular like these. But are still worth pondering over for few minutes (atleast in my opinion).

When we invest, its very natural to be influenced by the recent performance of the asset we are investing in. So when for example, stocks have given 15% plus annual returns in last 5 years, it becomes the new normal. People start believing that same (or higher) returns can be achieved ‘easily’ in future too. This is also known as the recency bias. People tend to believe that stocks will behave like bonds with guaranteed returns! Now is that sensible? Hell no!

We cannot take high-returns for granted. No matter how much we want something, we should be sensible about what we believe in.

Similarly, using a low inflation in your personal finance calculations can reduce the required monthly investments today.

But when the day of reckoning comes and if actual inflation is higher than your assumption, you will be short of the required funds for some very important goals of your life.

Ofcourse you can borrow and bridge the shortfall.

But why borrow when you can plan better today? Why not assume a higher inflation in your calculations and invest more from today itself? So that there are no rude shocks later on?

I am not advocating completely sacrificing the present in preparation for the future. But turning a blind eye to realities is something that is not acceptable.

Remember that returns given by any asset won’t necessarily match your expectations or those calculated returns that you need to achieve your goals. Markets and assets have no regard for your wishes. They take their own bloody path.

So lower your expectations. Don’t be too ambitious. If it means investing more today, so be it. Be sensible enough to do that.

As for RBI, it will be interesting to see who gets into Mr. Rajan’s shoes and continues the reforms he had initiated.


What are your Systemically Important Investments?

Just yesterday, RBI announced the names of Systemically Important Banks of India. To put it simply, these are those banks whose failure will lead to catastrophic consequences for the country and its people, that is, us.
This concept of Systemically Important Banks (or SIBs) gave me an interesting idea about our own personal finances. Now it may sound a little far fetched… but I request you to hear me out.

Important Investments

But before I move forward with my ideas, I guess there is a need to give a brief background about the concept of SIBs.
After the 2008 Credit Crisis, few smart* economists and financial wizards* decided to do something for the good of the global financial system. They announced a series of reformative measures, which were popularly referred to as the Basel III Norms, to improve the resilience of the banks and the banking systems.

* Sarcasm is intentional 🙂
However, it was felt that Basel III measures were not adequate to deal with the risks posed by systemically important banks. Therefore, it was decided that these SIBs should be governed by stricter norms.
Hence another committee of financial wizards, the Basel Committee on Banking Supervision (BCBS) came out with a framework for identifying the global Systemically Important Banks. This committee also recommended that all member countries (including India) should have additional loss absorbency requirements applicable to these SIBs.
Now I am not sure whether these norms are any good or not. Or whether adherence to these norms can prevent any future crisis or not. But nevertheless, these norms resulted in RBI coming out with its own list of ‘Systemically Important’ or ‘Too-Big-To-Fail’ Banks.
In yesterday’s announcement, RBI identified State Bank of India (SBI) and ICICI Bank as the 2 systemically important banks of India. According to RBI, the failure of these two banks has the potential to screw up the economy (something similar to what happened in US in 2008-2009).
So that was the short background about the Systemically Important Banks. Now lets come back from the world of big banks to the world of personal finance.
Once again, I ask you to hear me out completely and then throw bricks at me. 🙂
Now lets see how RBI defines these Systemically Important Banks:
A few banks assume systemic importance due to their size, cross-jurisdictional activities, complexity, lack of substitutability and interconnectedness. The disorderly failure of these banks has the propensity to cause significant disruption to the essential services provided by the banking system, and in turn, to the overall economic activity. These banks are considered Systemically Important Banks (SIBs) as their continued functioning is critical for the uninterrupted availability of essential banking services to the real economy.

Now I will adopt this statement to define something else.

In life, a few personal investments assume systemic importance due to their size, lack of substitutability and interconnectedness with other investments. The disorderly failure of these investments has the potential to cause significant disruption to the financial well-being of an individual, and in turn, to the overall well-being of his family. These investments should be considered as Systemically Important Investments as their continued growth is critical for the uninterrupted and timely availability of essential funds for the previously-identified goals of the individual.

I will suggest you read the above paragraph again.

I know you must be having some thoughts about what you just read. And I am sure that you already understand that few investments that you make, are more important than many others in your life.

So for someone who is around 30, a systemically important investment might be real estate (I am 30 and I am afraid that I don’t have much interest in real estate as investments).

On the other hand for someone who is around 45-50, retirement savings might be his systemically important investment.

For somebody else, it might be ensuring timely availability of funds for his child’s education.

Now just take a pause and think about your own Systemically Important Investments.A failure of these investments will lead to non-achievement of your goals – which in most cases, will be a big failure for an individual.

Just imagine what will happen if you retire with a retirement corpus which will only provide for your expenses for 5-10 years. After that you will have to depend on your children. Nothing bad about that. But even then, you will become dependent – a concept which I am personally not very comfortable with.

Now when you don’t have money to sustain yourself when you reach 70, then it also means that you will not have any financial legacy or portfolio for your children and grand-children. Doesn’t sound nice. Isn’t it?

For a moment, lets go back to the concept of Systematic Importance of Banks. So why is it that RBI wants to recognize these banks? It is to ensure that they can be further strengthened to make them more robust and less prone to failure. Right?

Same is my concept of Systemically Important Investments. We need to identify them to ensure that they are less prone to failure. And more importantly, help us achieve our goals.

Lets take retirement corpus as an important investment. Suppose for years, you have been investing diligently. But somewhere down the line, you had an emergency and you had to withdraw a part of your retirement corpus to pay for it. You did it because you did not have a sufficient emergency fund in place.

You might feel that it won’t matter much. But concept of compounding is not as forgiving as you or me. You have committed the biggest sin of personal finance. You have disturbed the process of compounding. Withdrawing a few lacs from the retirement corpus, mid way through your investment life (around 45), will result in you ending up with tens of lacs short of your target retirement corpus when you turn 60.

The above example clearly shows that your systemically important investment was not robust. You did not have a contingency plan to take care of unplanned expenditures. One small withdrawal from the retirement corpus resulted in shaving off a few years from your well-funded retired life.

Think of it. Have you stress tested your investments? How will you handle a sudden need of money when all of your money is invested in mutual funds or PPFs? Think about it when you are free and you will understand the importance of identifying important investments and stress testing them.

I have seen people withdrawing money from their Provident Funds to buy property or for other expenses. And many of these people don’t even have any other significant investments towards retirement. They might still lead a good life. But the keyword in previous statement is ‘might’.

That’s it for this post. I want to further explore this concept and see how it can be applied to personal finance and goal based investing. Do let me know about your thoughts on this one.
Suggested Reading:

Detailed write-up on Systematically Important Banks on RBI’s website (It is not as boring as it sounds. Believe me)

New Banking Licenses in India – The Winners

If everything goes according to RBI’s plan, then very soon we would have the names of new banks to bank with. Only hindrance to announcement of winners’ names could be Election Commission’s Model Code of Conduct for political parties. This code restricts existing government from making any announcements that can influence voters in coming elections, scheduled to take place between 7th April 2014 and 12th May 2014.

The committee under former RBI governor Bimal Jalan has already submitted its final recommendations and by now, (and most probably) RBI Governor would have clear knowledge about who is getting the banking license. But before public declaration of results, RBI is expected to take approvals from Election Commission to stay within the legal boundations of Model Code of Conduct.

So before RBI announces it, I am trying to make an educated guess about who all are going to get the banking licenses.

And my guesses are:

L&T Financial Holdings

Aditya Birla Nuvo

Muthoot Finance

Indian Post

I am not very sure about Indian Post getting the license. And that is even though I want it to get it. Reason for the same is that though everyone in this under-banked country is focusing on 150,000+ post offices which Indian Post has, the fact remains that most of these customer touch points are not in very usable condition. Another factor which might play against Indian Post is that this time, licenses were supposed to be granted to private players. And Indian Post is hardly private. 🙂

And if you do believe in concept of insider information then just have look at below graph. It shows share price movement of few of the above mentioned names in last one month. Do you feel that somebody, somewhere knows something? 🙂 🙂

New Banking License India Share Price
Banking Hopefuls : Share Price Movement in last One Month

So what do you think? Who will get the license this time?