Mutual Funds Vs Real Estate – Which is better for Investing in India?

Real Estate or Mutual Funds? This might be one of the most controversial debates I am starting on Stable Investor. But I had to write about it someday. And by the number of mails I receive from readers asking me to answer this question, it seems that there is much more than just financial logic behind this question. Peer pressure, family pressure and just getting done with this big decision in life are some, which I can think of right now.

Note – This post is a combined effort by Ajay (who has previously authored interesting posts like how to invest your surplus money and how he created a corpus of Rs 3.7 Crores in just 10 years) and myself.

But if you expect us to give you a clear answer at the end of this post, then please tone down your expectations. We do not intend to provide a thumb rule or even a judgment for that matter.

This question of whether you should invest in Real Estate (for investment) or Mutual Funds, can only be answered by you and you alone. This article should ideally be read in that spirit.

Property Vs Mutual Funds

So lets go ahead…

In words of Ajay, a home is a place to live and it should not be linked to one’s investment strategy. There should not be any second thought given about buying your 1st property for self-occupancy whether with or without tax benefits.

My take on this question is not as strong as that of Ajay. But I do agree with him about the power of equities in the long run. As far as my real estate is concerned, I am still weighing my options and am yet to finalize my long-term real estate strategy. As of today, I don’t own any personal property but my family does have a house in our native city.

So why am I delaying this decision unlike many of my friends who are already paying hefty EMIs every month?

I know it might sound odd to those who believe that one should invest in property starting with the very first salary they get. But I am sorry… I don’t belong to that school of thought. I have full faith in power of compounding and investing in equities. And I will only buy my first piece of real estate when I am comfortable enough to service my EMIs. I don’t want to have myself stuck in years of paying EMIs where I feel burdened at the end of every month. I don’t want to be slave of my EMIs.

But that was about me and my philosophy…. 🙂 So you can ignore it…

And for those who think that instead of paying rent, its better to pay EMIs – I have an answer. Paying rent might seem like an expense. But EMI also has a significant component of interest, which even in accounting term is nothing, but Expense. So this argument does not stand completely true.

Once again I repeat that the objective of this article is to highlight the differences in returns earned by investing in mutual funds and those earned by investing in a home funded through a loan, in the name of investment and tax-saving.

We have tried comparing two cases:

One where investment is made in real estate and other where it is made in mutual funds.

So here it is…

Case 1: Real Estate Investment

Following is the data being used:

Value of Property = Rs 75 Lacs (1500 sq ft @ Rs 5000/sq ft)

Required Initial Down Payment (@20% of Property value) = Rs 15 Lacs

Loan Availed (for remaining 80%) = Rs 60 Lacs

Loan Tenure = 20 Years

Loan Interest Rate = 10.15%

Few more administrative costs are as follows:

Loan Processing Charges & Other Expenses (@2% of Property) = Rs 1.5 Lacs

Registration Fees (@10%) = Rs 7.5 Lacs

 

After doing some calculations which are depicted below, we arrived at quite interesting numbers.

India Real Estate Investing Analysis
Interest Paid over 20 Years = Rs 80.30 Lacs

And as you can see in the last column in table above, this property has also been able to generate post-tax and expense adjusted rental income. We used a few assumptions for rental income and expense which are as follows:

  • Rentals increase by 5% every year
  • Rental income from property is taxed at 20%
  • Maintenance expenses are recurring every 5 years: Rs 1 Lac (5th year), Rs 1.5 Lac (10th year), Rs 2 Lacs (15th year) and Rs 2 Lacs (20thyear)

All in all, these result in an amount of Rs 24.67 Lacs being generated from the property over a period of 20 years.

This means, that effectively the property costs about Rs 1.39 Crores as depicted in table below:

India Real Estate Profit 2015

Now as per general perception (at somewhat backed by data too), the properties are known to appreciate in price. But here, we are not talking about property prices doubling every 2-3 years. We are talking about much sensible returns ranging from 9% to 12%.

Lets see what this part of the calculation leads us to:

We will evaluate 3 scenarios where property appreciation is taken as 9%, 10% and 12% continuously for 20 years. And this evaluation is depicted in table below:

India Real Estate Investing
To summarize the above calculations, this property initially cost Rs 75 Lacs. But since loan was taken and it also generated rental income, the total landed cost was Rs 1.39 Crores.

Now when 3 different scenarios are considered where this property appreciates by 12%, 10% and 9%, the expected net gains are Rs 5.1 Cr, Rs 3.4 Cr and Rs 2.75 Cr respectively.

Agreed that these are some really big numbers.

But before you start putting your hands on your mouth after reading them, lets check out the second case where we evaluate similar investments in mutual funds.

Case 2: Mutual Fund Investment

We are using the following data for this case:

Initial lumpsum investment in MF schemes of Rs 24 Lacs. This amount is equal to the sum of Initial Property Down Payment (Rs 15 Lacs), Registration Charges (Rs 7.5 Lacs) and Loan Processing fees (Rs 1.5 Lacs).

Now the EMI amount in earlier case was Rs 58,459. This amount in this case can be used as monthly SIP. But we also need to consider the tax benefit of Rs 1 Lac availed on house loan investment – which is to be equated monthly. That amounts to Rs 8333 and resultant amount available for monthly SIP is Rs 50,126.

So here is the calculation sheet for two types of investment scenarios.

First one is where returns from MF move from initial 12% to 7% in later years. These are conservative numbers when compared to returns given by really good MFs.

Conservative Mutual Fund Investor

Second one is a slightly aggressive returns assumption based analysis. Here the returns move from 15% initially to 7% in later years. But even then the returns of 15% are not that rare and have been achieved by quite a few funds in India for decades.

Aggressive Mutual Fund Investor

Now what happens when these funds are sold after 20 years? There wont be any tax as long term capital gains is not taxed in India for stock market returns.

So for an investment of Rs 1.44 Crores (lump sum + SIP of 20 years), a corpus of Rs 10.28 Crs and Rs 7.06 Crs has been achieved. And mind you, this return has been achieved despite having paid the additional tax @ 8333/- per month for 20 years. And these numbers are substantially higher than the real estate investment even after tax saving.

This means a net expected gain ranging from Rs 5.61 Crs to Rs 8.84 Crs.

Compare these numbers with those of Real Estate case and you will understand what this article is trying to point you towards.

Why do People Invest in Real Estate?

We have tried to list down a few reasons which we though people have for investing in real estate. And here were are not talking about the 1st House but about the 2nd property, which is treated as an investment:

  1. There is mental comfort in buying a hard asset that you can see and feel (also applicable to gold).
  2. It is an asset that can be funded largely through long-term debt (75% Funded by banks). No other asset provides such a benefit.
  3. It is a big asset, which you can acquire and then comfortably pay back via monthly payments (EMIs) over a very long period of time. Once again, no other asset provides this benefit.
  4. The comfort we get by doing mental accounting about tax savings in real estate investments. One always feels happier when one is told that they don’t need to pay tax or no money would be deducted from salary, because of tax savings due to loan-funded real estate investment.
  5. Second income from spouse, which can be used to get additional tax benefits (by being a 1sthome loan for the spouse) by taking a home loan.
  6. Comfort of getting a stream of rental income. An income, which you get without working for – passive income. But most of the times, people forget about the linked expenses.
  7. General opinion that it is a hedge against inflation.
  8. Mental fix that there is Zero Risk in real estate purchases (in reality, there are more risk than most other investments like gold and mutual funds).
  9. Justification that it is an investment for the next generation(s).
  10. High return expectations due to the recent past records (say last 15 Years).
  11. Black money at work!!
  12. Pride of owning multiple real estate investment and being known as the ‘Landlord’.
  13. As there is no daily ticker, the daily mental valuation of the asset does not take place.
  14. Mental satisfaction and happiness when disclosing to others that you own multiple properties.
  15. The perception that since everyone is investing in real estate and profiting from it, even I should do the same and make easy money.
  16. You always hear story from neighbors that they bought a flat for Rs 900 / sq ft 15 years ago and now it is worth Rs 5000 / sq ft. Here mental maths comes into picture. Mentally you might think that this 900 to 5000 appreciation is more than 5 times and a very profitable one. But neighbors comfortably forget to tell you about the expenses they incurred in these 15 years or in repaying loans. Actual returns are always calculated net of expenses. Its neighbor’s envy and owner’s pride (copied from an old Onida TV advertisement). For those who want to turn Rs 900 to Rs 5000 in 15 years, it’s not that tough. You can do it at 12.1% per year.

Why Don’t People Invest in Mutual Funds?

Since you are reading Stable Investor, chances are high that you would be a mutual fund investor. But there are many who avoid mutual funds to invest in real estate. Lets see what are the possible reasons for them to do so:

  1. Lack of knowledge about mutual funds and equity markets.
  2. Lack of understanding about the power of compounding, the power of equity as an asset class and clear knowledge of wealth building via SIP.
  3. Lack of knowledge about asset allocation.
  4. Risk and loss aversion.
  5. Unable to determine financial goals and estimate the amount required.
  6. They have already utilized all the tax benefits available to them because of home loan. Now they have no tax-incentive to invest in mutual funds. And hence they don’t do it!
  7. Bad past experiences. And these are primarily due to wrong fund selection or wrong time horizon or wrong advice (like combining insurance and investment or wrong thinking that saving and investing are same).
  8. As daily price movement of MF through NAVs is available, the daily mental valuation of the asset, forces one to take frequent buy and sell related decisions. This is driven by general lack of patience in investors.
  9. Mutual Funds cannot be funded through Black Money.
  10. Unlike real estate, no long-term loans are available for investments in mutual funds.
  11. More people talk about losses made by investing in funds (for whatever reasons) and very few people talk about their success in meeting financial goals through funds.
  12. Mental fixation with recent huge loss events (like 2000, 2009, 2013 etc.)
  13. A major chunk of saved money has already gone into real estate, which leaves almost no money to invest in mutual funds.
  14. And as substantial money is not invested regularly in mutual funds, one does not feel that substantial money can be made through mutual funds.
  15. You don’t get to hear every day that a fund having a NAV of Rs 28 has grown after 15 years to Rs 805 – a return of 25% per year (Check Reliance Growth Fund). Such returns are very high ones and rare and cannot be matched by real estate investment or investments in other asset classes.

Now lets test your memory…

Do you remember how much did petrol cost in the year 2000?

It was around Rs 25. As of today, it is about Rs 66. Now suppose you had invested that Rs 25 in real estate, which grew at 12.1% as mentioned few paragraphs earlier. This would have grown to Rs 139. Enough to buy 2 liters of petrol today. Now if this was invested in a mutual fund, which somehow could manage 25% return, it would have grown to Rs 711. Enough to buy at least 11 liters of petrol.

That is how equities work. That is how compounding works. That is how value of your money is preserved and increased by investing in right asset class for long periods of time.

Concluding Thoughts

And this is a repetition of earlier statement. One should not give any second thought about buying your 1st property for self-occupancy, whether it is with or without tax benefits.

However, based on our comparative analysis above (and estimated returns), one should think twice (or even ten times…) before buying a second home for investment purpose. One should carefully weigh all the available data and then take a wise call. Just because your friend or family member is investing in real estate does not mean that you should also do it. You should evaluate your own financial goals and think about how you plan to achieve it, and then decide whether you want to ‘invest’ in real estate or not.

A hard and physical asset will always give a huge mental comfort and satisfaction over other financial assets like mutual funds. But it is also true that it may not always be the best available investment option. In fact, investing in house funded through loan, is a huge long-term liability – which chokes the ability of the person to save and invest in other right instruments for future.

In our opinion (and it is ours and you can ignore it), after purchase of the 1st property for self-use, if there is any surplus cash left to invest, you should invest it as per your asset allocation (which includes debt, equity, gold & real estate). If the asset allocation permits you to invest in real estate, you may very well do it. But if it doesn’t, then you should refrain from investing in it. Investing in real estate for the sake of saving tax may not be the best thing to do.

As stated at the beginning of this article, this is one hell of a controversial debate. And there is not straight-forward logical answer to it. There are no thumb rules or any other rules. The question of Real Estate Vs Mutual Funds can only be answered by you an you alone.

We have simply made an attempt to clear the myth that “Real estate investing is the only best Investment Option” available for everyone. We have done all the calculations by estimating the returns net off expenses. We cannot just ignore expenses like those who just tell you the number of times their property has appreciated in value.

Please note that this post may be biased towards Mutual Funds investments.

Do let us know about your thoughts on Real Estate vs. Mutual Fund debate.

Disclaimer:

Returns mentioned in this post are only assumptions and not guaranteed ones (for both Mutual Funds and Real Estate). While there is investment return record available for mutual funds, we could not get a credible investment return data for real state (we took NHB data as guideline). Moreover, the real estate returns vary vastly from location to location.

How to manage your finances when you get your first job?

Congratulations!! I just came to know that you got your first job. That too a well paying one. And that too at a young age of 21. There is no feeling which can be compared to the high one gets on getting your first paycheck. Not having to depend on your parents for pocket money….Brilliant! You earn and spend as you like. You are the king!
Seems familiar? Just like the feeling you had when you started your career?
This post is my feedback to one of the questions asked in the Personal Finances Survey conducted sometime back. The exact question of a regular reader Nupur, is as follows (edited for brevity):
I have just completed engineering and got a decent job – which pays about Rs 40,000 a month. I am young (21) and willing to invest for future. I read your post on huge cost of delaying investing and don’t want to end up not having anything later on in my life. I want to secure and solidify my finances as soon as possible.
Once again I am positively surprised with the clarity of thought, which the new people entering the workforce have about money. I personally was never so sure about financial solidification and was more fascinated about the stocks and investing in general.
Luckily, when I started my career, I was posted in a very remote location for more than 2.5 years, and which had almost no places or avenues where I could spend my money! And you will be surprised to know that there were many months, where I ended up spending less than 5% of my monthly salary. 🙂
But lets focus now on how Nupur can manage her new-found income source…
For this particular example, I prefer not projecting too long into the future. Its best to weigh the benefits of managing your money prudently in even the first 5 years of your career. And that is because if I can prove that a well-managed cashflow for first five years is a very big win for someone who wants to create long-term wealth, then there is no need to further convince this person…and that is because the reader is already very smart…well proven by the question asked. 🙂
From my personal experience, I have seen that a majority of young people realize about the importance of saving money (and investing) only after a few years of starting out. They don’t even realize and the first few years of their career just rush through in a jiffy. And when they look back and see how much they have saved, there is nothing to talk about. First few years are spent in buying things you always wanted to buy for yourself, but never had the money to do so. You also buy gifts for people you care about and travel and enjoy life. I am not against all this and even I have done this. And then there are those uncles and family friends who will sell you those high-premium insurance plans, which you don’t need. 🙂
Once again I am digressing from the real topic…so lets come back to the topic of how to manage money when starting out in your career…
Now lets see what we know here…
At the age of 21, Nupur starts earning Rs 40,000 after tax.
She would be making some mandatory PF contributions, which would be matched by her employer too. I am assuming this contribution to be 10% of her basic salary. This would have to be matched by her employer. Assuming basic is 50% of the take home salary, total PF contribution (Nupur’s + Employer’s) is Rs 4000 (Rs 2000 each).
Now for evaluating the scenario after 5 years, that is when Nupur turns around 26-27, I have assumed that her salary would rise by a nominal 10% every year.
Shown below is the table, which calculates the amount accumulated in her PF account after 5 years:
Monthly Income Provident Fund
A rough approximate, given the assumptions we have taken are valid, is around Rs 3.7 lacs. Not much considering that her starting annual income was more than that. But significant considering that this has been achieved by giving up just 5% of her monthly gross salary. Isn’t it?
Now this PF amount should not be considered as something that you can utilize in the short term. So it would be a mistake to depend on this if there is any emergency money requirement. And when Nupur switches her job after 5 years, she can get this corpus transferred to her new employer or she can withdraw it. But withdrawing PF is a big mistake, which results in significant damage to the process of wealth creation by compounding.
Now once she gets her salary every month after mandatory PF deductions, she has various expenses. Without getting into the details, I am assuming a decreasing component of expense as a percentage of annual income. Mind you, I am not saying that expenses are reducing. I am saying that as she grows older and her income increases, she will become more and more aware of benefits of reducing her expenses and increasing her savings. Atleast this is what the thought process should be.
So I have taken expenses as 50% of first year salary. Followed by two years of 40%. And remaining two years as 30% of the salary. All the while salary has been increasing at a fixed rate of 10% every year.
Table below details all the calculations about expenses and available surplus:
Monthly Expenses Savings Surplus
As you can see above, the monthly surplus is increasing every year. And this is achieved by a combination of rising income and decreasing percentage of expenses.
Now lets see how this monthly surplus can be managed effectively. I am assuming that Nupur is ready to put full surplus amount into savings and investments as all her expenses have already been taken care off.
Like most Indian parents, Nupur’s parents also (I assume) would be a little apprehensive about stock markets. They must have heard from many people that stock markets are risky and most of the time, people end up losing money. I am assuming this. And basis of my assumption is the general perception which most people of previous* generation have.
* If you are reading this website and are from the previous generation, then you don’t belong to this category and are financially smart and on your way to become rich. 🙂
So Nupur decides to save a small but significant portion (about 25%) of monthly surplus in bank Recurring Deposits. This augers well for her too as it can act as an emergency fund that she can use when required.
Monthly Savings Recurring Deposits
Assuming a nominal 7.5% rate and savings rate of 25% of monthly surplus, Nupur is on her way to amass about Rs 5.6 lacs by the time she has completed 5 years in job.
That was about safer investments (or rather savings). Now Nupur is smart. She knows the real power of investing in equities through regular small investments. So she decides to do a SIP of remaining 75% of monthly surplus in a few well-diversified and proven mutual fund schemes.
And as you can see in table below, her monthly SIP amount is increasing every year. And this is because her income has increased, her expenses as % of income have decreased, and consequently her monthly surplus has increased.
Monthly Investments Salaried Employee
I have assumed a SIP return rate of 11%. Please note that this is just used for calculations, and in reality SIP returns are not such straight-line. They are lumpy. They can be as high as 50% in a year to as low as (-)50%. But average returns for last about two decades in India have been around 15%. So 11% is a safe-enough assumption.
So as depicted in above table, Nupur is on her way to accumulate about Rs 18.4 lacs in her SIP portfolio. Now that is not a small amount for a 26-27 year old to have.
But aren’t we forgetting something else?
Nupur also has Rs 3.7 lacs in PF, Rs 5.6 lacs in bank deposits. Add to this the amount available in her SIP portfolio, she has a networth of Rs 26 lacs.
Even if we were to discount it by 15% for some wrong assumptions and other realities (and I call it Life-Discounting), she would still have about Rs 22 lacs.
And this is for someone who started her career at Rs 40,000 about 5 years back and still does not earn an eye-popping salary. She still earns a decent Rs 58,000.
This shows that if managed well, then it’s entirely possible to reach a decent networth position within a few years of starting your career. Just to give you a perspective, Nupur’s networth position at the end of 5 years is approximately 3-4 times of her then current annual income!! And that is commendable by any standards. And if she continues this approach, she is well on her way to become really – really rich and a Crorepati even before reaching the age of 40.
You would have noticed that in this example, there is not evenone statement that says that she needs to beat the stock markets or anything. And she is actually underperforming the markets when I assumed 11% as the return expected from MF. So even after a theoretically bad performance, Nupur is well positioned in financial terms than 95% of the people her age.
You might say that it would have been wiser for Nupur to purchase a house early on in her career. And you might be right. But I still believe that initial years should be devoted to fortifying one’s finances and accumulating for long term portfolio, than simply paying EMIs.
You might counter-argue that one still has to pay rent, which is an expense. And in case of an EMI, you are paying the money and getting an asset. But we are still paying interest on the loan taken. Right. And interest paid is always an expense. 🙂

But this post is not a discussion about the pros and cons of real estate investing.

The above scenario calculation is what I could think off in response to Nupur’s question. I hope if she reads this, she has some more clarity on what she can do now. As for other readers, feel free to share your own thoughts about the question posed by her.

Reader’s Story: How I Created a Corpus of Rs 3.7 Crores in 10 Years!! – Part 2

Note: This post is second part of this series about how a reader created a corpus of almost Rs 4 Crores in just 10 years. Like the first part, even this part is worded by Ajay Sreenivasan – a loyal reader of Stable Investor. And if you haven’t read the first part, please do so immediately (Part 1) before going ahead with this post. 

In this part (2nd), he reflects back on his experiences and shares his learnings…which can be used as broad guidelines by other mutual fund investors.

So over to Ajay, once again…


Self-Analysis of My 10+ Years of Investment Journey

Advantages I Had as an Investor
  1. I had a reasonably stable job and income.
  2. I had sufficient surplus to invest in markets & mutual funds.
  3. I had a habit of Saving. And it was not new and had its origin in times, much before I came to Gulf.
  4. Combined with this habit, I also had the Discipline to stick with it.
  5. Though I really started ‘planned process of investing’ quite late, I still had age on my side….and this always helps in allowing ‘Compounding’ to create its magic.
  6. Because of above point, I had a reasonable amount of time to achieve my targets.
  7. Since I had a decent regular income, I had a decent risk taking ability.
  8. I was lucky to be part of markets which became extremely volatile at times. I was lucky to witness quite a few market crashes. Why? Because SIP works best if the markets are volatile and present the investors with many opportunities to invest ‘more’ at lower levels.
  9. This was a big advantage. I had no personal loan or housing loan to worry about.
  10. Another big one. I had already bought a home prior to investing even a Rupee…and luckily, I did it much before the real estate boom started.

Things I did Wrong:

  1. I was late to start investing. And I have seen people repent…and I mean really repent…when they realise that just because they were late to start investing by a few year, their final corpus was nowhere near where it could actually have been.
  2. I put most of my early savings into products which actually reduced purchasing power (read Insurance products).
  3. I was very late in creating a plan for investing. I should have done it almost a decade earlier than when I actually did it.
  4. I invested randomly without any goals, during the early part of my career.
  5. I started getting into direct stock investing, without having the proper knowledge of stock markets or valuations.
  6. At times, I went over board with my direct stock investing.

Things I Did Right:
  1. I saved and invested as much as possible. And when markets were down, I invested more.
  2. Even though I questioned my own beliefs every now and then, I followed Systematic Investing diligently.
  3. I identified my mistakes pretty soon (in a few years!!) and started focusing on Mutual Fund investing…as this helped reduce chances of committing errors in direct stock investing.
  4. I got myself a financial plan and invested as per the plan (and with a purpose).
  5. I took adequate Term Insurance plan. And this in itself is a big factor, when you want to sleep peacefully at night, without having to worry about what will happen to your loved ones when you are not around.
  6. I realized and more importantly acted towards separating Insurance from Investment.
  7. I said no to ULIPs.
  8. I learnt the importance of Asset Allocation and acted upon it.
  9. Even though I had so many period where I could have panicked (and at times did) in last 8 years, I did not quit midway. I continued with my plans.
  10. I concentrated on investing the set investment amount (Monthly SIP x No of Months as per original plan)…sooner than bothering about the target amount.
  11. I cut my losses in direct stocks and re-invested the money in equity fund or debt as per the required asset allocation.
  12. I remained invested through out the period of 10 years.
  13. I invested only in well diversified Mutual Funds (max. 7) across fund houses.
  14. I chose Direct Plans as soon as it was introduced.
  15. I used Liquid Funds to park money when I had to transfer money to equity funds through STP (Systematic Transfer Plan).
  16. I made mistakes and learnt from those mistakes..and took the experience.
  17. I managed not to invest in real estate in the crazy boom of 2006 – 2009. But only time will tell whether I was correct or not.

Lessons To Be Learnt:

Lesson 1

Before Investing, ask yourself these questions:

– Why should I even invest?
– What am I investing in?
– How will I get my capital back?
– What return I will get back?
– Will the return match inflation?
– When do I need this money back?
– Is it the right investment option for me?
– What are the real possibilities of not receiving the capital or expected returns?
– Will my asset allocation allow me to invest in this option?
– And whether the current market valuations reasonable enough to invest in equity?

Lesson 2

Save as much as possible and start investing as soon as possible. And ideally, you should start investing from the very first day you get your first salary.

Lesson 3

If you are afraid of stocks and mutual funds, start by investing small amounts to gain practical experience of positive and negative portfolio returns. You might end up losing money, but experience gained will help you a lot when you plan for the big amount you want to end up with eventually.

Lesson 4

Have a plan. Even if you think it is difficult to achieve it. Having it is almost half the battle won. And if you cant make your own plan, get in touch with good financial planners. They will charge you money for their planning services. Don’t worry. You are ready to pay your doctors. Why not be ready to pay those who are looking after your financial health? Think about it.

Lesson 5

Invest whatever is possible towards your goals. And it seriously doesn’t matter initially whether its small or big amount. Just go and do it.

Lesson 6

Are you a regular person who goes to office and does not know much about stock markets? Stick to investing in mutual funds via SIP. End of Discussion.

Lesson 7

Inflation can kill you. Seriously. Always include a realistic inflation figure while making your financial plans. Its always safe to be on the higher side.

Lesson 8

High returns expectation can also kill you. And that is because you will start making buy/sell decisions in line with your expectations. Always keep reasonable returns expectations and accordingly, have your financial plans. Its always safe to be on the lower side.

Lesson 9

Have an asset allocation plan and follow it religiously. And unless the valuations become extremely compelling (like PE<14), keep 20% in debt.

Lesson 10

Any money which is not required for next 10 years or more, should be invested in well diversified equity or balanced fund. Remember this as this is very important.

Lesson 11

Any money which is required within next 5 years should be invested in debt instruments. If you have money which you need in next 5 years, please switch from equity to debt instruments as soon as possible.

Lesson 12

Always be ready to face short term notional losses. And remember that your returns could be Zero or Negative, even after 5 years (Remember 2009-2014). But over a period of more than 10 years, the general trend is Up. But even this is not guaranteed.

Lesson 13
Be happy and always welcome a market crash in the early stages of your investment journey. It will boost your return significantly in the long run.

Lesson 14

Invest some money whenever there is negative news all around and during panic selling to boost return.

Lesson 15

Always keep track of market valuations & your asset allocation. Set your own rules for asset allocation that suits you.

Lesson 16

Review performance of the mutual funds in your portfolio on an annual basis. And replace the under-performers after thorough analysis. Never replace a fund if it underperforms the benchmark for a quarter or two. You need more time (2+ years) to know whether its a good idea to move out of a fund or not.

Lesson 17

Avoid churning your funds frequently as it will not help you, but your broker or RM. And always choose funds with reasonable fees and direct plans.

Lesson 18

For choosing Mutual Fund schemes, always stick to reputed process oriented fund houses and evaluate funds based on all parameters.

Lesson 19

Watch business channels. But only for entertainment. Most advise being given, is for short term and not for you. Market experts are paid by channels for their opinions. Don’t invest your money to test their opinions. 🙂

Lesson 20

Don’t invest because your friend or relative is investing. Your risk and expectations will almost always be different.

Lesson 21

Mutual Funds are the best investment vehicle for retail investors. Only effort required is to choose a few good funds and invest in them regularly.

Lesson 22

Direct equity investing requires a lot of additional efforts. And these range from evaluating a company to regularly tracking it to finally, exiting it.

Lesson 23

In Mutual Funds, always invest in Growth options. If you require money, you can always withdraw. No point going for the Dividend option.

Lesson 24

Do not panic during bad times / bad news. And don’t get too excited in bull markets. Always stay calm.

Lesson 25

Make it a point to have adequate Term Insurance cover, from an early age. Also make it a point to have proper health cover and emergency fund to suit your needs.


Another Three Interesting Lessons (But With Proof This Time)…

Going forward, lets have a look at 3 (or rather 4) interesting lessons which I will try to make you understand using proofs:

Lesson:1

The following article was published in May 2006, in a online business news website:


This shows that the first hint of a coming market crash was published on 15th May 2006. But as highlighted above, the expert opinion was that there was ‘Nothing To Worry.’

A few days later, the markets crashed as depicted in the next image:


So what does it prove?

It only proves that there is no one who can predict what is going to happen in markets with 100% accuracy. So don’t waste your time in listening to these so called market experts who claim to have the power to predicts the market movements.

A good mutual fund scheme named HDFC Equity’s NAV fell from Rs 134 on 1st May 2006 to Rs 112 on 1st June 2006. A big fall at that time. But today, no one even remembers the crash in the long term chart. The NAV of the fund is more than Rs 480. In January 2005, it was just Rs 67. NAV today has multiplied almost 7.5 times.

There will be sudden market crashes in future as well. And fund NAVs will go down. And down to almost any level. Accept this fact and move on.

Lesson :2

Below is a broad compilation of the BIGGEST falls in the Indian stock market history (upto 2008)

October 24, 2008: Sensex falls 1070 points (10.96%)

March 17, 2008: Sensex falls 951 points.

March 3, 2008: Sensex falls 901 points.

January 21, 2008: Sensex falls 1408 points.

January 22, 2008: Sensex falls 875 points after intra-day fall of 2273 points.

February 11, 2008: Sensex falls 834 points

May 18, 2006: Sensex falls 826 points.

December 17, 2007
:  Sensex falls 769 points.

October 10, 2008: Sensex falls 801 points.

October 18, 2007: Sensex falls 717 points.

January 18, 2008: Sensex falls 687 points.

November 21, 2007: Sensex falls 678 points.

August 16, 2007: Sensex falls 643 points.

April 2, 2007: Sensex falls 617 points.

August 1, 2007: Sensex falls 615 points.

So…do you remember all these dates and falls today? And can you make out those big crashes in the NAV chart of a good well-diversified mutual fund like HDFC Equity fund?

Its tough I would say…

Over the long term, the graph generally tends to move up. It is the only prediction, of which one can be a little certain of…. 🙂


Lesson: 3

Index value on 1st Jan 2008 was 6144 – A peak value for the index at that point of time. At the same time, NAV of HDFC Equity fund was 224.

Lets fast forward to end of 2010…

Index value on 1st Oct 2010 was 6143 and NAV of HDFC Equity fund was 300.

So…after all the corrections in between 2008-2010, the markets recovered back to the same peak index level nearly after 2 years and 10 months. And even if you had invested at the peak valuations (of index) in HDFC Equity fund in Jan 2008 in lump sum mode, the fund would still have provided you with Rs 76 (300-224) gain per unit – and that is when index did not move anywhere at all.

So what does it prove?


It generally pays to stay invested in a good quality, actively managed equity fund.


Lesson: 4

Index value on 1st Oct 2010 was 6143. And NAV of HDFC Equity fund was 300. After all the corrections the market recovered back to the same peak index level nearly after 2 years 10 months.

Now after more than 3 years…

Index value on 1st Jan 2014  was 6301 and NAV of HDFC Equity fund was 304. Again after corrections, the market recovered back to the same peak index level after nearly 3 years and 2 months.

So after 4 years, the Index was up by 2.5% and NAV of the fund also gave similar returns of around 1%

So what does it prove?


Lesson 3 above was proven wrong. 🙂 Always remember, not all rules are applicable and proven, at all times.


Notes and Disclaimers:

  1. The above post and Part 1 of the same post-series should not be considered as any sort of recommendation or investment advise.
  2. These posts are not to be considered as advise to invest in HDFC Funds or any other funds named in both parts of these posts.
  3. HDFC equity fund was one of the core fund of my portfolio along with several other funds. However for simplicity of the post, all investments have been shown as invested in HDFC Equity. There were some funds performing better than HDFC Equity in my portfolio and some were lagging the performance also. The fund in general was used as an example.
  4. I thank Dev for guiding and encouraging me to write a post on Stable Investor.

Reader’s Story: How I Created a Corpus of Rs 3.7 Crores in 10 Years!! – Part 1

Note: This post has been written by Ajay Sreenivasan – a regular reader of Stable Investor. I have been interacting regularly with him after we got in touch regarding my SIP Case Study last month. Ajay made many useful suggestions, which I eventually used for the last part of the interesting analysis. In our email conversations, it became clear that he had a vast experience in Mutual Fund investing. So I requested him to share his experiences and learnings with all the readers of Stable Investor. And he gladly accepted the offer. 🙂
The first part of this story is about his actual experiences over the last 10 years. The second part of the series will be more about the learnings which can be used as guidelines by other mutual fund investors.
So over to Ajay, who shares his experience of mutual fund investing below:
__________________
Till 2004, I was of the opinion that stock market investing was not for ordinary people. And that the terms like ‘Saving’ and ‘Investing’ generally referred to depositing money in bank deposits. And this opinion is probably formed because I come from a middle class family and none of my family members have ever had to do anything with the stock markets. 
Also a few other people, whom we knew and who invested in stocks, were the ones who lost quite a lot of money in markets. This again kept me away from the markets.
All I knew was that bank deposits, postal deposits, chit funds and LIC were for Savings; and if there was a need to make an ‘investment’, I could buy land if I had sufficient money.
So this is my story…
I became a NRI in 1995 as I had come to Gulf for employment. In 1997, I bought a plot of land (because someone told me to buy it). Later on in 2001, I constructed a house for self-occupancy as my family wanted a place which we could call as a home. And luckily for me, the good part was that buying of plot as well as construction of house was all done with personal savings, without any loans or debt. 
I was lucky that I built my house much before the crazy real estate boom began. And I have no hesitation in saying that it was purely because of my need and partially because of luck that I was ahead of the boom.
In 1998, an American Insurance company agent promptly approached and duped me. He convinced me about how I should save for my future and almost forced me to buy a US Dollar endowment policy – it hardly gave 0% return, yes 0% after 10years of regular annual payment. And I realized this only after 2006. But once this realization occurred to me, I promptly chose to convert it into a term plan for next 10 years as there was an option to do it.
In 2003, when my first child was born, I promptly called a life insurance agent in Gulf and took a Child Marriage and Education policy. In this policy, I had to invest on a yearly basis for next 18 years. It was a US Dollar denominated LIC endowment policy – it hardly gave 2% bonus every year despite paying regular annual premium. My reason for buying this policy was to be a responsible father, who was saving for his child’s future. But to be honest, I was doing it without having any knowledge about what long term investment was all about, and more importantly, without having any set target in mind.
In 2003, banks deposit rates started coming down and dollar started becoming stronger. I felt that it was better to keep money in dollars, even if it fetches a lower rate. And that is because it will get compensated by the exchange rate – due to rupee depreciation over the holding period. With this thought in mind, I again bought a single payment US Dollar denominated endowment life insurance policy for a 5 year term. I was treating it more like a US Dollar fixed deposit. 🙂 Unfortunately, the returns were less than 4% per year as I did not get the exchange rate benefit. And reason for it was that even after 5 years, Dollar-INR rate remained more or less at same levels.
By 2003, I was in a good-to-be situation, where I was saving a considerable amount of cash. And more importantly, I was free from any kind of loans. At this juncture, I got fooled once again. A LIC agent in India fooled me into buying a so-called good a policy named Jeevan Anand. To cut the long story short, the policy is hardly earning 5% despite paying annual premiums regularly for last 10+ years. A good policy indeed!!
By 2003, stock markets had started gaining momentum and IPOs were all rage. Personally, I didn’t know anything about IPOs at all. All I was hearing on news channels and from friends, who had invested in IPOs, was that it was a way of making easy money….and that too quickly. Being attracted to the glamour of quick money, I approached a broker and promptly opened a demat/trading account. And I did this without even knowing what exactly a share was and how it worked, etc. The broker, being as helpful as an angel, promptly helped me apply for various IPOs. Luckily for me, I somehow got invested only in good, established companies without even knowing anything about them. Some of these were TCS, ONGC, PETLNG, etc. But without knowing the real potential of these companies, I sold them whenever I made a small profit.
Since I dealt a lot with my broker for IPO investing, these guys started recommending mutual funds to me too. They recommended many NFOs and sector funds to me. Not because these were good for me, but because these paid higher commissions to them. And they always recommended me to chose the dividend option, so that I could get back some of the money back in my hand. But as far as I understand now, the real reason for this was to give me a feeling that I was making money. And this in turn helped them, to easily convince me to re-invest with them in other NFOs and funds that they recommended. I became a cyclical commission-making machine for them. But I had no clue about it. All I knew was that I bought a fund and the fund was giving dividends. Broadly speaking, I had full faith on what my broker wanted me to do.
By 2005, I got more accustomed to the concepts of money management and mutual funds. I even started tracking my funds’ annualized returns on a 5 year basis. And at that time, it showed a healthy (rather, very healthy) 25% per year. At that time, my total investment in mutual funds was hardly anything to say about. Mostly, I was churning the funds as per my broker’s recommendations (which benefitted him the most).

With the kind of returns my fund’s portfolio was showing, and the dividend I was getting from these funds, I came to the conclusion that, making money in stock markets was very easy. Even at this juncture, I was completely unaware of the Dotcom crash or the No-Return periods after 1995 or the Asian crisis of 1998
The 5 years annualized return of mutual funds looked good, only because of the 2003-2004 Bull Run. However, because of my excitement at seeing the profits and because I was getting dividends, I had already invested close to Rs 3 Lacs in mutual funds.
As the bull market progressed through 2004-2005, and pulled many novices into the market, I started investing in secondary markets too. But it was purely based on business channel tips & newspaper recommendations. In my quest of making some quick money, I started putting money in companies that I had not even heard off!! You can imagine the risks I was taking when I tell you that I invested in shares of companies like GTC, Manugraph, Betala, Nocil, Kohinoor…only God knows what these companies did…

I simply thought that all stocks will make money for me. 

How foolish of me?

But due to losses in these unknown companies (although small), I realized that I should only buy shares of large companies. But I still didn’t know which stocks to buy and why to buy them. It was still very random for me, even though I was ready to hold for the long term. And the money I made in TCS, ONGC and ICICI gave me this foolish confidence, that I could not lose money if I stick with large caps.
It was during this time that I fortunately came across a financial guide on investing from PersonalFn. And as far as I am concerned, it was the turning point of my investment journey…or in fact, it was the starting point. I was not a voracious book reader (although I read a lot of blogs, articles and newspapers)…..however, this guide had me interested. And that was because it was short and simple, and more importantly, it spoke about all the foolish things I was doing in my investments. At that time, this guide was like Benjamin Graham’s Intelligent Investor to me. It taught me a lot about goal-based investing and how to use a range of mutual funds and direct stock investments to achieve my goals. Honestly, it was like a god sent material for me. 🙂

I realized that despite working for more than 15 years (with 10 spent in Gulf), and also being a good saver, I did not have any plan for the future and was goal-less. All I was doing was to buy some insurance products and some random Mutual Fund and stocks. 

I approached PersonalFN to prepare a financial plan and got in touch with a very capable and honest financial planner. During the planning part, I set my goals and the financial plan was ready for investment in line with my risk appetite and the asset allocation.

To cut the long story short, I set a goal of Rs 3 Crores by 2025 for retirement corpus and Rs 1 Crore by 2021 for my child’s education and marriage.

A monthly SIP target of Rs 60,000 was worked out for me. This amount had to be invested in Mutual Funds for my future goals. Though it’s true that 
I missed out on a good part of my younger age before I started proper investing, I would say that I was still lucky enough not to have any loans at that time when I eventually did start.
By April 2006, I consolidated all my existing funds to the chosen fund as per my financial plan and started SIP investing for the 1st time in a disciplined manner. I decided that no matter what happens, I will invest at least Rs 60,000 every month towards my goals. And I also intended to invest more to cover up for the lost time of 15 years. 
Just after a month (in May 2006), there was a significant fall in markets (it had something to do with the commodity price collapse on LME). And by June 2006, about 20% of my portfolio (Rs 1.1 Lacs from Rs 6.9 Lacs) had disappeared due to this market correction. But I told myself that I had to stick to my plans no matter what. Markets eventually recovered and went on to make some good gains over the next 6 months. By December 2006, my portfolio was sitting at 50% point-to-point return.(See entries for 1-Dec-2006 in the Table 1 below)


My investments in mutual funds continued from 2006 to 2008 and I remained loyal to my 60K SIP. Rest of the surplus money went into Fixed Deposits, Liquid Funds and Insurance premiums. I thus built the debt side of the portfolio too. But still I did not bother much about my asset allocation at that point of time.
While I could sense and for that matter, actually see the euphoria building up around me in November 2007, I didn’t do anything. The media propelled euphoria went over the roof around November 2007 as there was a general consensus that GDP will grow at 9+ percent for many years to come. I simply continued with my SIP. At one point, I even doubled my SIP investments as I got a substantial raise in my income. And this I did without any regard to market valuations at that time.
By Jan 2008, my portfolio had peaked with a point-to-point return (since 2006) of 79.27% (See entries for 1-Jan-2008 in Table 1).
An investment of 17 Lacs had turned into Rs 31 Lacs in just 18+ months. No one was bothered about market valuations and almost all market analysts were publishing much higher targets, and justifying them with the now (in)famous theory of disconnect between Indian economy and global market. At this point, Nifty PE Ratio was 27.64. But I only came to know about this in 2010.
And then came the Crash of 2008. Uptil then, I had never seen my portfolio getting slaughtered in a big way. After the crash, the markets started drifting downwards. By July 2008, while my investments went up from Rs 17 Lacs to Rs 29 Lacs (due to my increased SIP and additional purchase – seeing the market fall), the actual profits of my portfolio were completely wiped out and became negative for the first time (see the return figures of 01-July-2008).
Yes…from almost double (of my actual investments) in January 2008, the returns turned negative within just 6 months!! That is how ruthless the markets can be.
Actually in July 2008, the markets came to a reasonable level where Nifty PE was around 16.6. The media also started recommending that this steep correction presented one of the best opportunities that an investor can get (since 2004). I too decided to increase my SIP between April 2008 and August 2008. And I did this by breaking some of the fixed deposits. I also invested some additional money through direct stock investing. Frankly what I was doing was to average out my investments which had run into steep losses. Or you can say that I was trying to catch the falling knife. But as the knife continued to fall, I increased the additional purchases (See additional BUY transactions between August 2008 and March 2009).

By December 2008, the valuations had gone into a deep negative territory – a point to point return of (-) 28%, i.e. a steep loss of Rs 12.7 Lacs on a Rs 45 Lacs investment.  There was panic all around. And it was like there was no end to bad news – Dubai default, Sub Prime Crisis, UPA may not come back to power and no stability after upcoming elections etc.
By March 2009, investment showed a point to point return of (-) 28%, a Rs 52.5Lacs investment had become Rs 37.7 Lacs. And Nifty PE ratio had touched a once-in-a-lifetime low of PE 12.
The crash in the period of August 2008 to March 2009 made me read several prominent articles, blogs and most importantly, Benjamin Graham’s Intelligent Investor. Frankly, it was only then that I started understanding market valuations and the importance of asset allocation. It was here that I decided to consolidate all my investments to evaluate my asset allocation…and to bring it down to a comfortable equity and debt level.
For the first time in my life, I evaluated my complete portfolio of Fixed Deposits, Debt Funds, Equity Funds and individual stocks as one entity.
And based on my readings, I set following rules for myself:
Rule 1: Save as much money as possible for the purpose of investing.
Rule 2: Before investing (every time), look at your asset allocation and in general, market’s PE valuations.
Rule 3: Continue investing via SIP as per the original plan. Do not stop SIP midway for any reason till target investment value (not the target corpus value) is reached.
Rule 4: Broadly keep the asset allocation between 60% – 80% in favor of equity – for PE Ratio range of 18-24. And continue investing in SIPs as per investment plan.
Rule 5: If markets fall below 18PE, increase SIPs.
Rule 6: If markets fall further below 16PE, increase buyout, and
Rule 7: If markets fall below 14PE, invest maximum amount in equity in lumpsum.
Rule 8: If market crosses above 23PE, restrict investment amount in Equity.
Rule 9: Above 25PE, reset equity allocation to something in between 65% – 75%,
Rule 10: Above 27PE, do not invest further and reset the asset allocation to below 65%
Important Note: Equity allocation includes mutual funds and direct stock investments.
In my case, I didn’t sell any of the fund holdings till December 2014. But I did sell my direct equity holdings and invested additional money in debt portion (including gold) to manage my asset allocation.
It is very important to decide the investment period of the money being invested. If you don’t require the money for next 10 years, then it must go to equity mutual funds only (preferably via STP transfer from liquid funds). But if investment period is for less than 3 years, then it should be invested in debt.
Money required for other periods, i.e. between 3 and 10 years can be shuffled between equity and debt as per asset allocation.
So let’s go back to my story…
By May 2009, the election results were out and UPA 2 was forming the government. Markets took the news positively and the portfolio turned neutral i.e. 0% returns after 3 years of accelerated SIP investment. And within a month, i.e. by June 2009, it turned positive.
By this time, I went through a lot of dilemma about whether, what I was doing was correct or not. Honestly speaking, at times my portfolio looked scary to me and even disturbed my sleep. Almost all my friends were investing in real estate using cash and loans and enjoying rents & capital appreciation. As for me, I had almost ZERO returns to show after 3 years of investing. Even my family was not sure whether what I was doing was the right thing to do or not. After all I was going so aggressively with fund based investing, without any regard for what others were doing, i.e. investing in real estate.
And apart from the pain of 0% return of MF portfolio, there was added pain of direct stock portfolio being deep in red. This put further pressure on me. My thought process here was that after so many years of negative returns, even after investing in SIP mode and market touching all time low valuation levels, there is bound to be a point, where I will get decent returns. And backed by this thought and my understanding gained from reading various investment books, I decided to increase my SIP investment – but only using the money which would not be needed for next 10 years.
In any case, my original plan was to invest Rs 60,000 every month for 20 years to achieve my goals. This would amount to Rs 1.44 Crores (Rs 60,000 per month x 12 months x 20 years). By increasing my SIP now, I was only putting the money ahead of its planned schedule.
By Jan 2010, the market PE valuations touched 23. I brought down the equity asset allocation to 63% (see table) as the market at that point was nearly 100% up from March 2009 valuations.
As I had anticipated, markets did correct but recovered immediately. Throughout 2010, the market PE stayed above 21 and therefore I continued with my regular SIPs.
In October 2010, the market once again peaked out at 25PE. Yet, I continued with regular SIP and adjusted the asset allocation by investing equally in debt and also by selling the direct stocks. I had started looking at my whole portfolio in its entirety. So the bad quality stocks, which I held were sold….even if it meant that I had to sell them at a loss (for the sake of asset allocation).
Although, the market PE remained at 20+ till July 2011, the index itself corrected from 6200 to 5000 by September 2011. Witnessing this correction, I increased the additional purchases in this period and equity allocation touched almost 80% plus. Another reason for increasing the allocation was the availability of cheap USD-denominated loans in 2011 to invest in mutual funds. As of today, it seems to have turned out to be very successfully. The loans were paid off in 3 years from salary and the investment amount has nearly doubled.
As 2012 came, the valuations started moderating and PE came down to average levels of around 18 (probably this was due to lots of negative news about government, fiscal deficit, currency collapse, gold restrictions, high oil prices, etc). By this time, I had already become familiar with the volatility and bad news. Here, I decided to keep adding to my MF folio with an investment target of Rs 1.44 crores (and not the total end of 20 year target of Rs 4 crores). The Idea was that once I invest Rs 1.44 Crores, I could always give sufficient time to the markets to achieve my target. And I started increasing the investments whenever the PE came below 18. But I ensured that equity portion in portfolio did not exceed 85%.
As 2013 came, valuations stayed below 18PE and the gains were getting wiped off once again.  I was consciously raising the investments in MF and also allocating sufficient funds in debt side. By September 2013, the portfolio gains were nearly wiped off (just a point to point return of 28% was left out with just Rs 42 Lacs profit on a Rs 1.4 crore investment). It seemed that even after investing aggressively for 8+ years, there was no fruitful result. But this time, I got even bolder than ever and decided that even if markets were to correct 20% from here, the PE would only fall 20% from lows of 16 at that time. So downside was almost limited and upside was not. So I decided to continue doing my monthly SIP from there on.
Fortunately, BJP started winning state elections and the sentiment started to change from November 2013 onwards. And rising markets have started helping my portfolio too. By this time, my targeted investment of Rs 1.44 Crore has already been done. Yet I am continuing my minimum SIP investment of Rs 60K. From December 2013 onwards, the additional amounts were invested in the debt folio to increase the debt allocation and thereby bring down the equity allocation from 70% to 58%.
As of Dec 2014, the fund has reached a target of Rs 3.92 Crores versus the original target of Rs 4 crores. I still have another 6 years left to take this corpus out. Therefore except in case of nifty valuations going haywire, I don’t intend to take my profits out anytime soon. I expect this amount to become at least Rs 7-8 Crore by 2021 and serve my goals. Although my original goal was 4 crore, with increase in monthly expenses (retirement corpus), children education and marriage expenses, I may require around Rs 8 Crore. I expect the same to be comfortably met from the current mutual fund folio investment.
As of 1st Jan 2015, the returns on mutual fund portfolio stand at 19.80% per annum. A snapshot view from a portfolio manager tool is posted below:
The above summarize my investment journey till date.

If you want to have a look at the detailed transaction history over a 10 year period, please click on the image below:

——————–
The second part of the series will cover the learnings which can be used as bulleted list of guidelines by other mutual fund investors.

Mailbag: Should I take a Loan to Invest Now? (because Markets are making New Highs everyday)

This is going to be a short post. It’s more of a warning for those who have questions like one in title of this post….in their mind.

Yesterday, I received a mail from a reader asking me the following question:

My portfolio has moved up almost 50% in last 3 months. Some shares of small companies are up more than 100%. Do you think it is a good time to invest more? I don’t have lots of spare cash to put in markets but I am thinking of taking a personal loan to invest. A loan would cost me around 15% and that is much less than what can be easily made in these rising markets.



I replied to this reader’s mail instantly and without any hesitation.

But I felt that right now, there would many people thinking on similar lines. And that is because in recent times, markets have been moving in just one direction. And that is upwards. And this gives a perception that it is very easy to make money in stock markets.

My personal interaction with people tells that they have now started feeling that Fixed & Recurring Deposits offer just 8% in one year….whereas some stocks can give that kind of return in a day. True. It is possible. But can we be 100% sure about this? Can we be 100% sure that we will be making 5% to 8% every day kind-of-a-return on regular basis in stock markets?

The answer is no. I can’t do it. I am pretty sure nobody I know has done it. And neither have people like Warren Buffett done it. And since we are not sure about the returns, it would be a big mistake to borrow money for investing. 

It’s possible that when you take a loan and put that money in markets, your expectation is that markets will move up, like they have been doing for a while now. And probably in a year’s time, you will make much more from your investments than 15% interest that you need to pay on your personal loan.

But what if markets do not rise as expected?

What if returns are less than 15% in one year?

What if markets just stay at same levels after one year?

And what if markets fall…say by 15% in one year? What will you do then?

I hope you are getting what I mean here. 

Market returns are unpredictable. You can never be sure of returns or losses which come your way in markets. But if you take a loan, your EMIs would be predictable and fixed. You can be quite sure that you will have to pay around 15% every year for the loan.

I have seen people make this mistake in 2008 during Reliance Power’s IPO. People took loans, liquidated FDs to invest in the hottest IPO of that time. And what happened after that is known to everyone. Everyone lost money. Those who borrowed to invest lost much more than just money. They lost their sleep and faith in markets.

So, please understand that its not wise to borrow and invest in markets.

Even if you are 100% sure that markets will go up, please don’t borrow money to invest. If you do, I think it would be the biggest financial crime you can ever commit.

Note – Some months back, someone asked me just the very opposite question. I have a loan. Should I pay it back before investing? 

Seems like the question of this mailbag post is a side-effect of a bull market 😉

_______

I like You. Do you Like me?

Hi guys

I get a number of mails from you all every day. And this is in addition to numerous comments on all the blog posts. Mails range from ones asking for advice on specific stocks to ones asking about gifting foreign trips to wives!! 🙂

But unfortunately, I am unable to give timely replies to all your mails. Sometimes, the mails just get buried in ‘read mails folder’ of my inbox. There shouldn’t be any excuse for not giving timely replies but the fact is that I still have a day job and need to juggle between the job and this small adventure called Stable Investor. 🙂

I received a follow up mail from a lady reader (Sa####) about how I was trying to act pricey and not replying to her previous mail. First of all… my apologies to her. I understand that it is frustrating if one does not respond to one’s genuine concerns. But honestly, this and many such slip-ups are neither intentional nor an act of posing like a big gun. Its simply because of reasons given in previous paragraph. And I wanted the readers to know the truth.

I just want to finish by saying that I am just a regular guy like you all and am trying to act not only as a guide but also as a friend. I know what it means to be messed up with your finances, not being able to pay the bills, cutting down on expenditures, etc. I have gone through all that.

I would feel satisfied if Stable Investor is adding value (or rather bringing sanity) to your financial life.

And I would appreciate You if…

…you would join Stable Investor on Facebook by clicking the image below and LIKING the Facebook page:

Stable Investor Facebook


Its faster & easier for me to respond to your Facebook messages and comments. Also, you will get loads of interesting stock market and wealth building related updates on a daily basis.

I hope you understand

Regards
Dev
A Stable Investor

Mailbag: I have a loan. Should I Pay It Off Before Investing?

Note – I have written about Paying Off Loan Vs Investing for Future debate in detail recently. You might want to read that article – Pay Off Loan or Start Saving & Investing?

In this post, I am trying to give a suitable response to mail I received from a reader named Shivangi. A part of her mail is given below:

I have a loan with outstanding amount of Rs XX lacs. I want to save and invest for future also. But everyone in my family and  friends are telling me to clear off my loans before even thinking about saving or investing for future. Please advice if this is a prudent thing to do or whether one can clear loan and invest parallely?

To be honest to everyone, I may not be the best person to answer this question as I myself have not been in this kind of situation. But I will try to arrive at some conclusion using rational and common sense as my tool.

Readers are welcome to share their own suggestions for Shivangi in comments section.

Mailbag Readers Question Answered

Two Important Considerations

One thing which is not known here is the type of loan which Shivangi is referring to. This is important because different loans have different interest rates and different tenures. For example,

Home Loan : 12% : 20 Years

Personal Loan : 20% : 1 Year

Car Loan : 12% : 5 Years

Loan from Family : 0% : Flexible Tenure

And so on…

Another important thing which needs to be considered here is that when one is planning to invest or save, what is the expected rate of return?

This is because if you are paying 20% in interest for a personal loan, and you want to save your money in fixed deposits, which give an after tax return of 6%, then you are really not being financially intelligent.

Once you have knowledge of these two key important pieces of information, i.e. Interest Rate (&Tenure) of Loan and Expected Rate of return for investments, you need to do a little bit of prioritization…
Debt Prioritization

Now this is very important to understand. A loan taken to invest in a property, which brings monthly rent may not be a bad loan. It is creating an asset which in turn will become a cash-generating machine. But if you buy a car at same interest rates, it is a bad loan as the value of car would depreciate with time. And it will not earn you anything during the time you use it (unless it’s a commercial vehicle).

Please note that by using the word ‘BAD’, I do not mean the bad loans which are a major concern for PSU banks.

Then there is credit card (type-of) debt. Almost everyone will tell you that credit card debt is bad. And generally speaking, they are right. The effective annual interest rate of credit cards is close to 40%!! So in case you do have credit card debt, you should target to clear it off as soon as possible and with a priority greater than anything else.
5 Steps To Invest & Pay Off Loans Simultaneously

Pay Off Loan Or Invest & Save
The Decision

All in all, it is indeed difficult to create an investment or savings portfolio, if you have number of loans running. But it is not impossible. Read the steps below and then I will tell you the most important thing:
  • First of all, you need to recognize the high interest loans (credit cards, personal loans).
  • Get rid of them as soon as possible.
  • Now pay off loans taken to buy liabilities (cars, gadgets) which do not produce a stream of cash.
  • Initiate creation of an Emergency Fund which takes care of unforeseen money requirements.
  • Now if you have any long term, low cost loans (property loan) running, you can think of investing simultaneously as you go on paying off that loan.

And now for the most important and toughest part…

Before you even think of following the above steps, you need to be willing to change your lifestyle as well. And that is because you can only make sensible financial decisions when you are ready to temporarily change and cut down the discretionary expenditures. By discretionary expenditures, I mean buying of goods and services which can be postponed till the time you are financially secure. Just sometime back, I was shocked to know that people are buying wrist watches on monthly installments!! Now according to me that is heights of financial stupidity.

Anyways.. I hope that above information helps Shivangi in her efforts to pay off loan and simultaneously create a stable investment portfolio.

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Mailbag: I want to gift a Dubai trip to my wife. How do I fund it?

I think that after reading the title of this post, many of you would have become interested in knowing more about the person behind such a ‘noble’ thought. 😉 
 
Unfortunately, all I know is his name – Amir. Ever since I started a section to handle personal finance questions, this had to be the most interesting question and I decided to address it as fast as possible. For the benefit of readers, I would summarize Amir’s question below –
 
Amir’s 5thWedding Anniversary is due in 2015. He wants to take his wife to Dubai for 5-6 days to mark this special occasion. He also wants to make provision for shopping in Dubai. His question isn’t clear as to when exactly does he wants to go, but I would assume that it’s in second half of 2015. He also says that he can pre-pone his trip to take place in 2014. But that according to me might defeat the very purpose of 5th year celebrations. He wants to know whether he should fund this trip using credit cards or share market trading.
 
How To Fund My Dubai Trip?
 
I checked a number of flights, hotels and holiday packages for a 6 day trip to Dubai. And my preliminary research showed that it would cost around Rs 55,000 per person for a decent stay in Dubai for 6 days (including airfares). Additionally, one needs to pay another Rs 5200 per person for Visa. This brings the total for two persons to approximately Rs 1,21,000. Now the next figure which I would add to this amount can vary from person to person. It’s the shopping budget. And as far as ladies are concerned, any budget for shopping is less. So to keep matters simple, I assume that the couple would shop for around Rs 50,000 plus. This takes the total to Rs 1,71,000. 
 
And just to make provisions for contingencies, travel insurances and other unforeseen expenditures, I have decided to round off the estimate to Rs 2,00,000.
 
 
 
Now, Amir failed to provide the following important information(s):
 
– Monthly Surplus (Income from all sources – Investments – Expenditures)
 
– Exact time of travel
 
– Shopping Budget 🙂 (I have already played safe with my assumptions here).
 
Now to decide how to fund this trip, we need to know when Amir needs to travel. I will assume that he plans to travel between Sept – Dec 2015. This means that he needs to be ready with funds by August 2015. This leaves us with 21 months (starting December 2013). Now I still don’t know his monthly surplus. But what we do know is that Amir needs to arrange Rs 2,00,000 in 21 months.
 
Now a simple recurring deposit of Rs 8900 per month for next 21 months, earning a 7.5% interest per annum can do the job. It’s that simple. 
 
As far as taking a Credit Card debt is concerned, one must understand that it is the costliest form of debt and at times can cost you more than 35% per annum in interest costs. And you don’t want to pay 35% interest on Rs 2,00,000 for next few years, isn’t it? 🙂
 
Another option which Amir mentioned was stock markets. I would not suggest this option even though you have close to 2 years as your time horizon. I personally think that over a short term (less than 5-7 years) stock markets can be risky with high chances of capital erosion. You may be a good stock picker and may be able to make the required amount in less than 21 months. But I have no access to knowledge about your stock picking abilities. 🙂 And also, just imagine a situation that you decide to go ahead with your decision of making money in stock markets to fund this trip, and god forbid, markets take a dive in July 2015 and you are left with inadequate funds to pay for your trip. What will you do then? You may decide to take Credit Card debt and go ahead. But why would anyone want to take chances with such an important event of your life? It’s better to keep it simple and go for a simple recurring deposit.
 
Note – I have made assumptions regarding the trip and shopping expenditures. The real costs may be higher or lower, and consequently, your monthly RD contribution would also be higher or lower. Consider this to be disclaimer from my end. I don’t want your wife to come after me for miscalculating  her shopping budget. 🙂
 
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