Rs 50 lakh or Rs 1 crore – these don’t seem like small amounts.
But whether these amounts are enough (for life insurance) or not is another question.
Most people are unable to calculate the right insurance amount. To be honest, many people don’t even see the need to do it… as sadly, they buy insurance just for tax-saving!
There are quite a number of ways to calculate the right insurance amount. I have discussed one such approach earlier in an article titled How to Find the Right Insurance Amount. Another option is to go for thumb rules like ‘having a cover of 10-20 times your annual income’. But the first method is preferable.
But if you were to go by the thumb rule, then if you have an income of Rs 5 lakh, then maybe Rs 50 lakh to Rs 1 crore cover is fine. But if you have an income of Rs 15 lakh, then maybe it’s not enough. Ofcourse there are other factors too. But instead of lazily deciding that Rs 1 crore cover is fine for you, I would suggest you put some effort and find out the right life cover amount.
You might still feel that a Rs 1 Crore Term Life Insurance cover is big today. But remember that you are not going to die today. And when you do die, let’s say (and hope not) after 15 years, just think of the real value of that Rs 1 crore that your family will get? At 7% inflation, it might be worth just Rs 33 lakhs. That would surely not be enough for your family then – if the new breadwinner is still not up on his/her feet properly.
I am not saying that buying a Rs 50 lakh cover or Rs 1 crore insurance plan is wrong. I am just saying that it might not be enough for many people.
And don’t even think about buying such large covers using endowment or money back policies. You will be shocked to see the premiums.
Here is a sample:
Endowment Plans (LIC)
To get a life cover of Rs 1 crore for 30 years (when age of the insured person is 30), the total annual premium comes to around Rs. 3-4 lakhs
Moneyback Plans (LIC)
To get a life cover of Rs 1 crore for 25 years (when age of the insured person is 30), the total annual premium comes to around Rs. 4-5 lakhs
Term Plans (LIC)
To get a life cover of Rs 1 crore for 30 years (when the age of the insured person is 30), the total annual premium comes to around Rs. 20-30,000
Term Plans (Private Cos.)
To get a life cover of Rs 1 crore for 30 years (when the age of the insured person is 30), the total annual premium comes to around Rs. 10-15,000.
(I took these figures from various company websites)
I don’t have anything else to say. 🙂 The difference in premium says everything.
Term insurance is the cheapest way to buy a large and adequate life cover.
Many people don’t feel like buying term insurance, even when it’s so dirt cheap – just because they get nothing in return for the premiums they pay when they survive the policy term.
Since they are 100% sure that they would not die early, they want to invest in insurance 🙂 policies that offer something on maturity. I don’t know what to say. I have written about it already in detail here. Hopefully, such people would realize what is right before it’s too late.
Then there are many people who are actually surprised as to how and rather why the insurance companies pay Rs 1 crore when they are only giving Rs 10-15k as premium annually? They seriously feel that if such policies are being offered, then that means that insurance companies are fools.
But No… the companies are not fools. They are simply using the law of averages to run their insurance business. If 100 people take a term plan for 20 years and pay premiums regularly, not all will die in this 20-year period. Right? In fact, it’s possible that just 3-4 people would die. So the insurance amount (death benefit) is to be paid for just those few people, whereas the premiums are being paid by everyone! That’s how insurance works and that’s why it’s so profitable(ask Warren Buffett and you will know how he built his empire using insurance money.)
Coming back to premiums, there is a way to further reduce premiums.
By creating life insurance ladders – it’s a way of splitting insurance based on requirements like expenses, tenure of financial goals, outstanding loans, etc. But that’s not what I generally recommend. But still, it’s an interesting discussion. I will write about it some other time.
So that’s it from my side.
Do not hesitate in buying a Rs 50 lakh or Rs 1 crore insurance policy if you don’t have that kind of cover right now. Just ensure that it’s a term insurance policy. And better still, do use this method to find out your correct insurance requirement. After that, you can decide what you want to do.
This is a guest post by Shyam Shenoy. A software engineer who is passionate about value investing. He believes that one of the major reasons for the real estate prices reaching unrealistic levels is the Indian IT economy.
You may or may not agree to that, but he has an interesting story to tell you.
So over to Shyam…
There is absolutely no doubt that Housing is one of the 3 basic needs of life. You need a house. I need a house. And for all practical purposes, we all need a house.
Thousands of articles have already been written about why owning a house makes sense. And even if you don’t read such articles, people around you will try to ‘somehow’ convince you that it does make a lot of sense.
Now housing is a need. And every need… costs.
And for regular people like us, every cost… counts.
Having said that, the cost of a house is probably the single biggest expenditure that a person incurs in his lifetime.
Now Stable Investor is a site about investments. So here, I am talking from the perspective of prudent money utilization and not from house-is-a-basic-need-so-we-should-buy-it perspective.
In this post, I want to share a story with you. The standard disclaimers apply. 🙂
Disclaimer: Any Resemblance to Actual Persons, Living or Dead, is Purely Coincidental
The Story of 5 People
There were 5 people in a small town:
Ajay an IT engineer
Bob the builder
Charan a corrupt Government Employee
Daniel a banker
Edward who was engaged in small businesses
All of them had close to zero money to start with.
Now a businessman named Peter (who owns a big IT business) comes by and offers Ajay (the IT engineer), a job for Rs 15 Lac per annum.
Immediately, Ajay has levelled up and is going to be rich. And the other four people take notice.
Bob (the builder) now sees an opportunity here.
He approaches Ajay and lets him know that he could build a house for him for a price which he would let him know later. Ajay agrees to it in principle, as he is still not committing anything.
Bob gets down to work. As per his calculations, it would cost him about Rs 30 Lac to construct the house. If he adds his profit of Rs 10 Lac, he can sell this house to Ajay at Rs 40 Lac.
Charan (the corrupt government babu) has years of experience in dealing with approvals and permits. For lack of a better phrase, he can smell money in this transaction too. Being aware of Ajay’s new found income source and about Bob’s construction plans, he tells Bob that he will give approval for his construction project only if he gets his cut. A cut of Rs 20 lac in a suitcase so that he can ‘legalize’ and ‘approve’ this construction.
To sweeten the deal, he assures that he will also bring in Daniel (the banker) and influence him to grant loan for construction.
As you might have guessed, Bob is forced to add Rs 20 Lac more to the selling price. The house will now cost Rs 60 Lac. Adding more for registration costs, stamp duties and other miscellaneous items, the final price for Ajay comes to around Rs 70 Lac.
Bob lets Ajay know that the price of the house would be Rs 70 Lac – ofcourse in a combination of black and white 😉
Daniel (the banker) is ready to offer Home Loan to Ajay at 10% per annum.
Ajay feels that luck is favoring him again with these good deals. After all, it was him who found a job that pays an annual salary of Rs 15 lac whereas other four people still don’t get much.
He accepts Bob’s offer and takes a home loan from Daniel.
If you are aware of the home loan mathematics, then you would agree that for a long-term home loan of Rs 56 lac (assuming 20% downpayment by Ajay from some other source – maybe from his father’s retirement corpus), what Ajay is probably tying himself to is a loan repayment schedule where principal + interest would be around Rs 112 lacs or Rs 1.12 crore (approx.).
But that is Ajay’s headache. 🙂 Let’s move on.
Edward (the 5th person) sees all this and does his own biddings…. starts a school, hospital, shopping Mall and what not…
So what is the current situation?
Bob certainly makes a profit of Rs 10 Lac. Charan gets his ‘black’ Rs 20 lac. And banker Daniel gets his Rs 56 lac interest on home loan. There is no real estimate as to what Edward is making. No one except Charan is doing anything illegal (maybe Edward too is doing something as he got huge investments to build those hospitals and schools etc.)
However, Bob, Charan, Daniel and Edward have cleverly exploited the situation.
The money ‘traveled’ from Ajay’s hands to others and Ajay is at maximum risk.
Bob and Charan have already made the money and left. Edward obviously is stinking rich and can afford to sit and wait for things to work out.
Now comes the interesting part…
Try imagining thousands of Ajay(s) and other fours. This becomes the case of an exponentially growing city. Now imagine lacs of such people and it becomes the situation of the entire economy.
Now suppose that Ajay has four friends (colleagues) – Amit, Ashok, Ali and Antony.
They come to know that Ajay has bought a beautiful house. Now, these friends get into the herd mentality. They feel that since Ajay has bought it, it must be good. They too want to buy a house (obviously loan funded).
The opportunities for Bob’s construction business are plenty. So other builders, bankers and establishments also join the party. All are happy. Since people like Charan (the corrupt government official) have very few competitors, more and more people like Ajay and his friends make him richer and richer.
If you see the bigger picture, it’s a clear case of a mad rush to make money at the expense of people like Ajay and his friends.
As more builders enter the fray, Bob is facing stiff competition. He starts making houses out of substandard/inferior raw materials. He also engages real-estate agents and brokers to whom he pays a small cut – to bring more and more unsuspecting buyers to him. Some of the builders like Bob have already started absconding without even completing their projects.
Charan starts approving all the projects blindly. Lands near city dumps, toxic lakes, far away places, agricultural lands, lake beds, flood plains, encroached spaces and lands with no clear titles. Charan is busy signing approval papers and has no interest whatsoever in construction standards, roads or infrastructure.
Daniel is giving out loans like never before. All which can and might turn into NPAs. But he is too busy to see all that. He has undercover and shady links to loan recovery agents.
As for Edward, he starts raising prices of the services he is providing through his schools, hospitals and malls. Prices everywhere are going skywards.
Obviously, this cannot continue forever. The flip side starts showing up slowly but certainly.
Depleting land leads to land mafias. Depleting sand leads to sand mafias. Depleting ground water leads to water mafias. There are no proper waste management systems and nearby rivers are being filled with lakhs of litres of polluted water daily. There are laborers pouring in from all around the city and living in slums with a desire to get employed in this fast growing town.
Can the situation be reversed back?
Even if Charan suddenly decides to turn into a good man and stops accepting illegal money. Why would Bob reduce his price from Rs 70 lac to Rs 50 lac all of a sudden? His competitors will not be doing so. No one will quit as long as the party goes on. The houses already constructed cannot be demolished, given the scale of constructions that have taken place.
So that was the story.
But in spite of me claiming it to be an imaginary one, even you know that it’s not completely fictitious. 😉
Now I am not arguing in favor or against the idea of purchasing of real estate. It all depends and differs from one person to another.
Buying a first house (your primary residence) is sensible. But investing more money into real estate is another question (read this). And remember, you need to consider many other things:
Are you really getting your money’s worth when you are investing in property?
Is the quality of the house reasonably good? Do you know it or you are just assuming it?
Most of you will take a home loan to buy it. Are you fine being chained to the loan repayment cycle for life (ok not life but a decade or two) and thereby compromising other financial goals to a larger extent?
Have you considered how you would pay EMIs in situations like job loss, health deterioration, etc.?
If it’s an investment, do you feel you will really find a buyer at the price that you wish to dispose of your flat in case of an eventuality?
Now, this is not an easy one to digest. Aren’t you enriching other people with your money by buying houses at exorbitant prices? If so, don’t you think it makes sense to stay in a rental house?
This is the May 2017 update for the State of Indian Stock Markets.
As usual, this monthly update includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.
Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month.
Caution – Never make any investment decision based on just one or two ‘average’ indicators (Why?) At most, treat these heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.
Dividend Yield (on last day of May 2017): 1.19% Dividend Yield (on last day of April 2017): 1.23%
Now, to the historical analysis of Nifty500 companies…
As the name suggests, Nifty500 is made up of top 500 companies which represent about 95% of the free float market capitalization of the stocks listed on NSE (March 2017).
Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 63% of the free float market capitalization of the NSE listed stocks (March 2017).
So obviously, Nifty500 is comparatively a much broader index than Nifty50.
The two words ‘Financial Goals’ are fairly simple to understand.
It’s the ‘WHY’ of your investing(s) and saving(s). It’s the reason why you are ready to cut down your spendings today and put aside a part of your hard earned income for tomorrow. (Remember Save vs Spend debate?).
But… a lot of people invest without having a clear idea about what they are saving for.
They do have some idea about their major life goals but investments are mostly random. Or in many cases, driven by the need to save taxes (big mistake!).
But let me tell you one thing.
If you are aiming for beating the market or your friend’s portfolio returns, then you need to get a reality check. No doubt you will get emotional high and increased bank balance when you beat the market. But will that ‘beating’ be sufficient to help you achieve your goals?
Many people have no idea how to answer that question.
And this is one important reason why goal-based investing makes more sense for most people. I have already created a detailed guide on goal based investing. But I wanted to delve deeper into something that is at the core of goal-based investing.
You guessed it right, I am talking about…
And more specifically…
When it comes to planning your finances, one of the most critical things that you would be doing is identifying your financial goals.
This is ‘the’ first step.
If you have no specific goals that you are targeting, then you will be investing randomly in different financial products without knowing whether it is helping you get closer to your goals or not.
Its just like travelling without knowing your final destination or taking random paths. See below:
And this not advisable for most people.
But if you think that you are still ‘too young’ to bother about setting your goals or financial planning, then you are mistaken. Starting early on this path has eye-popping rewards. Don’t believe in the myth that goal setting is only for old people or for people in a certain age group or income bracket. It can be helpful for people at all stages of their lives. After all, everyone has financial dreams and needs.
So lets move on…
Life Goals –> Financial Goals
As humans, we are not born thinking about our financial goals.
As kids, we had various goals in life and we didn’t care what realities were and whether we were capable of achieving those goals or not. Its only when we grew up that reality sank in.
When I was a kid, I wanted to be an astronaut. That was the goal of life then. But as you might have guessed, that didn’t work out :-). And for me, it was like coming to terms with the reality that in life, we can have anything but not everything.
But lets leave my childhood and come back to the present.
We can have several goals in life. And sadly, many of these life goals require money – Yes…. can’t do away with that.
Goals like buying a house, children’s education, their higher education, their marriage, good retired life, early retirement, living a good life even before retirement, travelling, etc. — all require money.
And hence, these life goals are also your financial goals.
So when referring to financial goals, its mainly about the ‘significant goals’ of your life that require money. By significant, it is meant that these are important as well as cannot be met through regular income. So you need to save for these goals.
For example – Your kids’ school education is obviously important. But you can manage the monthly school fee through your salary. But when it comes to children’s higher education, you cannot meet the requirement from your regular income/salary. You need to save for it for years. So that is how we identify a significant financial goal – which in this case is your child’s higher education.
Goals must be S.M.A.R.T.
This is a very popular acronym used in context of goal-setting everywhere (including financial planning).
S = Specific
M = Measurable
A = Achievable
R = Relevant
T = Timely
Without using a lot of words to explain this theoretical concept, understand it like this – when these 5 requirements (i.e. S, M, A, R and T) are taken care off while setting your goals, it becomes a well-defined and strong target and not just a weak wish.
Here is the difference:
Wish – “I think I should have a big house in future”
Goal – “I have to buy a 3BHK in Mumbai for about Rs 40 lacs in next 3 years.”
The difference is clear.
Unlike a wish, a goal is:
Specific: Its clear what type of house is to be bought where
Measurable: Its not using general words like ‘big or small’. It’s a 3BHK.
Achievable: Ofcourse its achievable. We are not planning to buy a Taj Mahal here.
Relevant – Its relevant for the person who has this as goal. It is what he wants.
Timely – A clear deadline is set to achieve the goal
So…without doubt, your goals must be smart. Now lets move on and see how to go about setting your actual financial goals.
List down all Life Goals
Goals tell you where you want to go. And its only when you know where you are headed, you can decide what path to take. Isn’t it?
So when listing down your life goals, its imperative that you think hard. Take time to reflect on all the goals that come to your mind.
Ofcourse major ones are obvious, which include short as well as long-term financial goals – like buying a house, children’s education and marriage, retirement, etc.
But depending on your exact situation, you might have other goals that might be important for you. Like a good friend of mine is saving to gift his wife a big diamond ring on their 5th anniversary. 🙂 (I hope my wife doesn’t read this).
Please understand that as of now, you are just listing down all your goals. It doesn’t mean that all of them will be planned for and invested towards.
Having several goals doesn’t increase your chance of achieving them. Its better to focus on fewer goals instead to get the best result. Its also because your income is limited and you want to use it to save for the important and correct goals.
Also, some of the things that need to be done (like reducing your unmanageable credit card debt, paying off your brother’s small personal loan, etc.) might not be your life goals. But nevertheless, they are your financial goals.
So your list of life goals gets converted into list of financial goals. Here is a list of financial goals derived from life goals (with additions and deletions where necessary):
By the way, I have used a simple excel to list down these goals. You may call it setting financial goals with help of a Financial Goals Worksheet. Though I find it easier to do it in excel, if you want, you can use simple pen and paper to do it too.
Now once you have listed down all the goals, you need to identify which are worth planning for and which aren’t.
Tag all Goals as ‘Needs’ or ‘Desires’
Next step would be to tag each of your goals as either NEEDs or DESIREs. You can use other words too but idea is simply to differentiate between essential goals and non-essential (or lets say good-to-achieve) goals.
For example – Saving for your retirement is a NEED. You can’t do away with it. But saving for a foreign trip next year is a DESIRE. It can be postponed, have its budget reduced, etc.
Here is a sample tagging for goal list that was shown earlier:
Some goals might seem like both a need as well as desire. I can quote a personal goal of mine here – Travelling. Its a DESIRE for most people no doubt. But for me, Travelling is also a NEED. 🙂
If you too are facing such a dilemma, don’t worry. Its not a big problem. Just be reasonable in tagging. Don’t tag a goal like ‘Purchasing SUV’ as a need when you are unable to even pay your bills on time.
Ideally, the goals that are NEEDs (or Essential goals) should get priority over other ones. But that is easier said than done. We are humans and we need to simultaneously take care of multiple goals. You cannot keep saving for just one important goal (like retirement) and not do anything for others. You will screw up big time.
But tagging your goals like this can help clear your thoughts about what is important and what is not.
Categorize all Goals as Short, Mid and Long Term Goals
All goals are not similar and neither have to be achieved on the same day.
So now categorize all your goals (both NEEDs and DESIREs) according to their time horizon. One way to do it as follows:
Immediate Financial Goals (in next 1 year)
Short-term financial goals (1 to 5 years)
Medium term financial goal (5 to 10 years)
Long term financial goal (10+ years)
So this is how goals of previous points can be categorized as per time available:
This time period based categorization of your financial goals gives a lot of clarity when doing financial planning. That’s because a major factor that decides where you should be investing in (i.e. which assets and financial products), is time available for the goal.
Assign Priorities to Your Goals
Now you need to assign priority to your goals. It might look similar to the earlier differentiation of Needs Vs. Wants. But its not.
If it was possible to achieve all your life goals at once with the resources you had, then financial planning would be unnecessary. And it would be an ideal world where your needs as well as desires would be satisfied on demand. Instant gratification would rule. 🙂
But it’s the real world we live in. And we do not have unlimited supply of money.
We simply cannot have everything we want and whenever we want.
We need to accept tradeoffs, as the resource available (i.e. money to be invested) is limited. So you need to prioritize your goals.
It helps to identify important goals even within the categorization we made earlier (Needs and Desires). Once identified, resources will be allocated accordingly. This ensures that important goals are taken care off first. But this also means that money may not be left to satisfy all other less priority goals.
This is the tradeoff that prioritization of goals helps in dealing with.
You decide what goals will be satisfied first and which will be second, and which won’t be done until till very last.
Ultimately, the key may not merely be to give clients a comprehensive list of recommendations, or to tell them what steps they should take next, but instead to help them make the choice of what’s most important to them and then hold them accountable to follow through on it.
Here is a sample prioritization of the goals we are discussing as example:
The prioritization can be different for different people.
Some goals can have similar priority for some people while different for others. For example – many people are of view that children should take care of their marriage expenses. Some think otherwise. So priorities can be different.
Now what if your goal priorities change later on?
That will definitely happen in real life.
Nothing to worry. You will need to adjust your investments later on, so that they remain relevant as per your priorities then.
Now goals have been listed, categorized and prioritized. So are we done now?
Aren’t we missing something?
Yes we are.
What is the cost of each Goal Today?
You cannot move ahead without knowing the costs. Isn’t it?
What is the cost of these goals today? When you answer that question, only then you will be in a position to know the real cost of the goal in future (after adjusting for inflation).
A engineering degree that cost you Rs 5 lac about a decade ago can easily cost Rs 15 lac today. Fast forward another 15 years when your child might be starting his higher studies, the cost might have gone up to Rs 50 lacs or even more.
So knowing a goal is fine. But you also need to anticipate how much it will cost in future. And the only way to know it is to realistically assess two things:
Cost of Goal today
Inflation applicable to the goal’s cost in future
If you fail to account for inflation, you will end up saving woefully less than what is actually required in future. And that will be a sad as well as scary situation to be in.
So here is how one can assign costs to various goals. The figures are hypothetical:
Chose Your Final Goals Wisely
Now comes the tough part. Your income is limited and it might not be sufficient to fund all your goals.
So you will need to pick the goals you want to go after.
You might consider saving for some goals first as these are important. Other goals can be saved for (or postponed) later on. For example – You might want to postpone your plan to go for a foreign trip every 2-3 years till you have bought a house (and obviously cleared off the loan).
You might also consider reducing the targets for some goals. For example – In current example, instead of saving Rs 15 lac each for two children’s marriage, you can save Rs 20 lac combined for both of them.
Here is an example of rationalization:
But How much to Invest for my Financial Goals?
You have listed your goals. You have identified which are NEEDs and which are DESIREs. You have categorized them into short, mid and long-term buckets. You have prioritized them. You know their costs today. You have further rationalized them.
But now What?
The answer is that now you need to know 4 things:
Cost of goals in future?
How much you need to invest for these goals (monthly or lumpsum)?
Where to invest for these goals?
Whether any existing investments can be earmarked for these goals?
If you are good with numbers and understand how to read numbers from real-life perspective, then you can carry out goal based financial planning yourself. Or else, you can take help of trustworthy and competent financial advisors who can help you do just that (I can help).
So after going through all the steps, your financial goals worksheet will look something like this:
Or here is another sample of how you will get an action plan to achieve your financial goals:
Be Careful about Where you Invest for different Goals
I want to highlight this point, as this is what most people get wrong when trying to do things on their own.
Different goals require different investment plan and strategies.
Using single asset allocation and risk tolerance for all your goals in the investment plan can be a big mistake. Infact, it can be disastrous.
But question is how much should you invest and how should you distribute it across various assets? Goal-based financial planning helps people understand exactly how to invest and where to invest to achieve most (if not each) of their goals.
So lets see which assets are suitable for which types of goals:
Short-term goals (Upto 5 years)
Risky assets like equities are best avoided for such goals. More so if goals are high priority or critical. Some people might still be interested in investing a small part in equity for these goals. It might work for them. But everyone should understand that any losses that you incur on the way may not be easy to recover from in time, given the short-term horizon of these goals.
Medium-term goals (between 5 and 10 years)
Investments can be made in both risky as well as in safe assets in a balanced manner. The idea is to balance the safety of capital with the need for higher returns.
Long-term goals (more than 10 years away)
One can invest in assets that have a higher long-term return potential for the long-term goals. Best suited asset for this is equity. Even then, most people fail to realize the potential of equity and invest primarily in debt instruments like EPF / PPF / Pension etc. for their ultra long term goals like retirement planning.
It is important to understand here that a long term goal will not remain long term forever. As the goal date approaches, it will effectively become a short-term goal.
For example, when you are 35, your retirement is 25 years away, i.e. its a long term goal. But when you turn 55, it will only be 5 years away, i.e. its changed into a short term financial goal. When this transition begins, you should ideally start the process of slowly reducing the riskier equity component of your goal-specific portfolio. This will reduce the risk of large losses as you near goal completion.
Note – These are general and broad goal-specific asset allocation suggestions. The exact allocations will differ from one case to other depending on several other factors.
If you are reading this and already feeling a little overwhelmed with the big numbers being thrown around in name of these personal financial goals, then please relax.
Its true that financial planning is generally focused on dealing with larger financial goals. But I don’t want you to be overwhelmed and demotivated at the sight of these seemingly big numbers. They may seem distant or unachievable.
But this is where smart financial planning based on concept of goal based investing can help.
It can breakdown large financial goals into smaller and manageable pieces. So for example – you get a simple, easy to implement retirement plan that will tell you exactly how to go about building up (with small monthly investments) that multi-crore corpus you need for your retirement.
With Goals Clear, Start Working to achieve them
Its only logical to put your efforts in something that you really want to achieve.
Since now you already know what your goals are and how you need to invest for each one of them, there is only one thing left for you. And that is to take action.
You might have noticed that I have not mentioned much about saving taxes or chosing the right products (like specific mutual funds names, etc.). It is because things like tax saving are secondary. More important is ensuring that you are investing correctly for your goals. Tax saving should not come in way of proper investing plans.
Similarly, once you have finalized the goals, you can start putting in place separate investment portfolios for each of them (or group similar ones) with proper asset allocation. Goals come first and products come later.
Should I spend money today (to enjoy life) or save for the future?
This is a common dilemma faced by most people.
The amount of money you have is (sadly) limited. Naturally, you have to decide whether to use it to spend on things today or to save it for the future.
People have thousands of reasons for not saving for the future. Some will say that they don’t make enough money to save – which is acceptable if true. Others cant stop spending money as according to them, life is so uncertain and therefore its better to live for today and deal with future… in future.
On the other hand, there are many who save a lot. At times, they end up saving a little too much. Result? They have big bank balances or portfolios. But sadly, they are unable to enjoy their lives optimally.
So spending today vs. saving for tomorrow – What is right here? Or is it even worthwhile to contemplate about taking sides here?
How can one enjoy life today while saving for tomorrow?
But it is important to not shortchange your life today. What is the use of having saved up crores of rupees without any rhyme or reason?
A relative of mine has a young daughter (with no plan for more children). He went to the extent of saying that given his high income, he saves much less than what he can actually save.
That’s because at the end, his daughter will get married and he doesn’t want to be remembered as an ultra-rich father-in-law who saved a lot.
Interesting way of looking at things.
To put it simply (and as my wife once told me), we should not screw up a very long journey for the sake of a distant goal. It may really not be worth it.
Take for example a person who works very hard, sacrifices his family life, his passions, saves a lot of money and doesn’t spend much. At the end of the day, he will be very rich. And when he dies, even then too. But what is the point of being the richest person in graveyard?
It doesn’t feel good at first but its necessary. Just like exercising or going to the gym. It hurts at first but pays handsomely later on.
Saving is necessary because one day in future, you will stop earning (retirement). You will then have to have a big pool of saving from which you can withdraw money to survive in your retired life.
And mind you… most of you reading this won’t die early or the day after retirement. 🙂 Thanks to our doctor friends, most will live for atleast a couple of decades after retiring. So you do need a lot of money for your non-earning years. And you can’t depend on your children to be your retirement fund. Its that simple.
Children’s education, their marriage, your house purchase, car purchase, a foreign trip, etc. All these require money and most times, a lot of it.
You can’t fulfill the fund requirements for these goals from regular income alone. You need to save for these goals and allow your savings to grow on their own. That is how you will find the money you need to achieve these goals.
So saving today is necessary. Period.
But what if you feel like…
Let’s Spend Money Now. Will save MORE later. Does this work?
It might work. But here is the practical difficulty here.
Lets say that when you are young, you decide to spend money freely and save later. But since your parents were pushing you hard to save something, you decide to save 5-10% of your income to show respect to them.
But saving just 5-10% of your income also equates to the fact that you are permitting yourself to spend 90-95% of your income!
And so with each annual increase in your income, you are continuously raising your lifestyle costs too.
Now when you say that later on in life, you will start saving more (and it better be a lot more as this proof shows), it will be difficult for you to downgrade your lifestyle expenses.
And its quite possible that inspite of saving much more later on, your savings turn out to be woefully inadequate because spending and lifestyle costs have increased so much.
So if saving is so important…
Then why do Most People avoid saving for the Future?
Maybe its because of how we humans have evolved from the animals.
Animals will never turn down an instant reward in order to attain more in the future. You can train rats as much as you like; they’re never going to give up a piece of cheese today to get two pieces tomorrow.
As humans, we give more weightage to the present than to the future. At the cost of better options in future, most of us chose less better options today. That is a reality. And that is why people find it tough to save for future.
There was a famous experiment that was conducted to highlight people’s ability (or rather inability) to delay gratification. In this experiment, which was called the Marshmallow experiment, children were given a choice between:
A small prize (1 cookie) that they can have right now
A bigger prize (2 cookies) later on
And the results were interesting. Have a look at this video:
Being on the extremes can be glamorous. But its not sustainable.
You can’t just keep spending without going bankrupt sometime in future. And you also can’t keep saving everything without screwing up your normal life.
So as far as I think, balancing the two is what we should aim for.
How you will achieve that balance depends on your actual situation. There is no one fixed right answer here. In addition to saving and spending, there might also be a 3rd option in many people’s case – prepaying loans.
But somewhere between spending 100% and saving 100% (both theoretical), there is a sweet spot where you can live well today and also save reasonably well for tomorrow.
And the easiest way to do it is to…
Decide on your ‘YES’ to know when to say ‘NO’
Previous sentence highlights that if you are clear about what you really want in the short and long term (lets call them your real financial goals), it will be easier for you to stay focused and spend accordingly.
Take an example from your childhood. If you had an examination tomorrow, you will not spend your time fooling around today. You will sit and study. Or in many cases, you will be forced to study. 🙂
So in reference to spending vs. saving debate, if you know what you are saving for and how important it is for you achieve it, you will spend accordingly.
It will help you stay on track.
For example, you want to make a large down payment for your house after 3 years. Now if you are reasonable, you will do everything in your capacity to save as much money as possible in next 3 years for the downpayment. Most people in that situation will not go out every weekend for parties and spend thousands of rupees.
You need to decide on your ‘YES’ to know when to say ‘NO’
So once you know your Big YES (i.e. save for your dream home’s downpayment after 3 years), you will know when to Say NO (i.e. spending money recklessly on parties).
And by doing that, you are not depriving yourself if you don’t spend money on parties. On the contrary, you will be depriving yourself of what you really want (house), if you spend money on parties.
Delaying gratification is not a happy experience to start with. But the trick is to put in place strategies that can help you do that. Because doing that is the only option to achieve your goals by balancing today’s spending against saving for tomorrow.
I am not asking you to save everything.
I am also not asking you to not save anything.
But take some time out and have a hard look at your spending habits.
Certainly, there will some fixed expenses that you just can’t wish off. But apart from those, spend on things that are truly important. It might mean cutting back in other areas today to save for tomorrow. But there will always be better things in future that are worth that trade-off.
It is possible to save wisely and live a good life simultaneously. And even before you decide about taking sides on saving vs spending debate, sit down and think deeply about what you really value.
Edited: An updated and more detailed analysis is published in 2019 and is available here.
This is the detailed annual analysis – comparing Nifty P/E with Investment Returns.
It compares returns earned (during various periods ranging from 3 to 10 years) when investments have been made at various PE levels of the Nifty-50.
Before we get to the findings, lets try to understand the purpose of this analysis.
Purpose of comparing Nifty PE with Returns
First of all, this is not a sure-shot method to make money.
Just because we can find some clear trends from past data doesn’t mean that same will be replicated in future. Markets are dynamic and history is no guarantee of future. The sole purpose of this analysis is to realize that there is obvious relation between the market valuations and returns you will get. If you buy low (valuation wise), chances of earning good returns increase and vice versa.
This study tries to highlight the historical trends about possible returns one can get when the money is invested (in Nifty 50) at various PE levels. That’s it.
How to Analyse PE Vs. Returns?
What I have done here is that I have calculated returns earned on investments made at all Nifty PE levels. The time periods for return calculations are 3 year, 5 year, 7 year and 10 years.
Lets use a simple example to understand this.
Suppose you had invested money in Nifty on 24th-February-2004, when its PE was 19.97 (actual data).
Now I have calculated returns starting from 24th February 2004 for periods of 3, 5, 7 and 10 years. The CAGR returns have been 29.3%, 8.5%, 17.0% and 13.0% respectively.
This calculation has been done for each and every day since 1st January 1999 (day since when Nifty PE data is available). I had several thousand data points for each of these periods. The days that do not have forward returns for 3-years have not been considered in analysis of 3-year returns (likewise for 5, 7 and 10 year studies)
To simplify the findings, I have grouped Nifty PE into 5 groupings.
Nifty-50 PE Ratio and Investment Returns
So this is what I have found:
Clearly, the data shows that when you invest at low PEs, your expected future returns are high.
So if one had the courage to invest in Nifty when PE was less than 12, the average returns over the next 3, 5, 7 and 10 year periods would have been an astonishing 39%, 29%, 22% and 19% respectively! But sadly, its very rare to find days where Nifty is trading at such extremely low valuations.
On the other hand, if investments were made when PE ratios were above 24 (which is the overvalued territory), the chances of earning high returns in near future are pretty low. Infact, money invested at such inflated valuation levels, for the next 3, 5, 7 and 10-years have earned on an average are (-) 5%, 3.4%, 9.6% and 12% respectively.
At the time of writing on this post, the Nifty PE is about 23-24 (more details can be found here).
But it is important to note that these figures are based on historical data (of last 18+ years). The trends no doubt are easily evident here. But they may or may not be repeated in future. There are no guarantees in markets.
Markets won’t behave as you expect them to behave just because you have found its rhythm. You will not get returns just because you want them.
This shows that if you invest in high PE markets, your chances of low (and even negative) returns increase substantially. Investing at lower PEs can give bumper returns! But it is not easy. It takes a lot of courage, cash and common sense to invest when everybody else is selling. It is very easy to sound smart and quote things like ‘be greedy when others are fearful’. Unfortunately, very few are able to be actually greedy when others aren’t.
But lets focus on another important fact here.
Risk with dealing with Average Returns
The table above depicts a very clean and obvious relationship between P/E and Returns.
But the above numbers are just ‘averages’. And that can be risky if you solely invest on basis of averages.
To explain this more clearly, lets take an example. Imagine that your height is 6 feet. Now you don’t know swimming. But you want to cross a river, whose average depth is 5 feet. Will you cross it?
You shouldn’t – because it’s the average depth that is 5 feet. At some places, the river might be 3 feet deep. At others (and unfortunately for you), it might be 10 feet.
A better picture can be painted if in addition to average returns, we also find out:
Maximum returns during all the periods under evaluation
Have a look at tables below now:
If you have observed carefully, there are big differences between the minimum and maximum returns for almost all periods
So the returns that you will get will depend a lot on when exactly you enter the markets. Two people entering the markets at (lets say) PE=17.2 would have got 5-year returns ranging from 2.6% to 33.0%. Shocking! Isn’t it?
My previous statement ‘returns that you will get will depend a lot on when exactly you enter the markets’, does sound like timing the markets. But this is a reality. For those who can do it, timing the market works beautifully.
Hence even though the average returns give a good picture for long-term investors (look at the table for 10 year), its still possible that you end up getting returns that are closer to the ones that are shown in minimum (10Y Returns) column and not the Averge Returns. 😉
This is another reason why I introduced the column for standard deviation in all tables above (see last column).
Analyzing standard deviation tells you – how much the actual return will vary from the average returns. So higher the deviation, higher will be the variation in actual returns.
Can You Catch the Markets at Right PE Multiples?
Ideally and armed with above insights, it makes sense to buy more when valuations are low. Isn’t it? Buy Low. That is the whole idea of investing.
But real life is not that simple.
It is very difficult to catch markets on extremes. Its like a pendulum – keeps oscillating between overvaluation and undervaluation.
So should you wait to only invest at low PEs? Though it might make theoretical sense to do it, fact is that it is very difficult to wait for low PE markets.
Just have a look at this 5-year table I shared earlier in this post too:
Look at the time spent by the index at sub-PE12 levels.
It is just about 1.7% of the time since 1999 (Ref: Column name ‘Time Spent in PE Band’ in tables above).
Markets at below PE12 are extremely rare.
For common investors, it’s almost impossible to wait for such days. Infact, such days might be spaced years apart.
So the best bet for common people is to keep investing as much as possible, via disciplined investing (like SIP in equity mutual funds). Its not perfect (like buy low sell high) but it is your best bet given all the constraints.
Long-Term Investors have Better Chance of Doing Well
Another insight that this study gives is that as your investment horizon increases, the expected returns more or less are reasonably good enough, even when one invests at high PEs.
Have a look at 10-year returns table below:
Now 10-year is long term.
So, even if an investor puts his money in the index at PE24, the historical average returns are more than 12%. That’s pretty good. And what about the maximum and minimum returns achieved when investing around PE>24? At 13.8% and 10.5% respectively, these are not bad either. This is what really shows that if you are investing for long term, equity is your best bet for wealth creation.
The longer you stay invested, higher are the chances of making money in stock markets…even if you have entered at higher levels.
Caution – I know that’s a dangerous statement to make but to keep things simple, please read it in the right spirit.
On the contrary, if someone was thinking to invest at high PEs (above 24) for less than 3 years, then there are very high chances that the person will lose money:
Asking Again – Whether This Approach works in all kinds of investing?
My answer is that no one strategy can work in all conditions.
Knowing the broader market PE gives a fair idea about the valuations of overall markets. It tells you when the market is overheating and that you should take cover. This in turn can help reduce the chances of making mistakes when investing. Similarly, this knowledge of PE-Return Relationship also helps in identifying when markets are unnecessarily pessimist. If you are brave at such times, you can make some serious money.
And please don’t think about investing in individual stocks just because Nifty PE is low. Individual stocks have their own story and need more in-depth analysis.
What about Nifty changes? Does it not impact this analysis?
That’s a valid point.
The index management committee that is responsible for index (Nifty 50) maintenance regularly bring in and move out companies from the indexes. The Nifty composition of 2007 was quite different from that of 2017. Similarly, the index composition of 1999 might too be different from that of 2007 and 2017.
Try to understand it like this. If the index is made up primarily of companies that are low PE-types, then index at overall level will tend to have low-PE. Whereas if the index is made up of high-PE companies, it will tend to have high PE. So actual definition of high and low PE will be different for both type of companies, and so in turn for index. A PE of 15 for low-PE company might be very high whereas for high-PE company might be very low.
This is an important factor that should be kept in mind.
I am assuming that you are not Warren Buffett. 🙂 But jokes apart, fact is that most people do not have the skill or time to get into deep investing.
So what should such people do?
First thing is to simply stick with regular disciplined investing (easily achievable through MF SIPs).
With that taken care off, you should try to invest more when market valuations are low. This will help increase your overall returns in long term.
There is a strong (but not guaranteed) correlation between the trailing PE ratio and Nifty returns. And this small study proves the same and provides some useful insights. If we were to go by the historical data, the Nifty delivers higher return (in long term) whenever the PE ratio is low. On the other hand, it tends to deliver very low to negative returns, whenever the PE is very high and investment horizon is short.
You as an investor can use this insight as a backdrop to take your investments decisions.
There are very few things that an average investor can refer to as – timeless advice.
Know what goals you are saving for. Know how distant these goals are in future. Know how much these goals will cost you. Understand the asset allocation required to achieve these goals (it may be different from what your risk appetite might suggest). Keep your base SIPs running all the time irrespective of market conditions. Don’t mix investments and insurance. Don’t put money in something that you don’t understand. Say ‘No’ often. Reducing your expenses is fine but there is a limit to that – focus more on increasing your income (but don’t kill yourself doing that). If everyone is doing something, chances of making profits in that ‘something’ are low.
Its not tough to understand these things if you give them a deep thought. But it requires common sense to stay on course and benefit from these timeless principles.
Then there are things that have to be done in a timely manner. Or else, there are huge costs to be paid in case of being late.
Simple example can be that of buying a life insurance. If you are under-insured and you die without much savings for your family to depend on, you would have put your family’s future in jeopardy.
A simple way to assess whether you are under-insured or not is to calculate the money you family gets if you were to die today (= insurance money + savings + investments – outstanding loans). If this amount is sufficient for your family’s future needs and goals, then its fine. If its not, then you are gambling with important things (your family’s future) and which I think is unpardonable.
Timely purchase of insurances (all types – life, health, disability) and putting in place a solid emergency fund – can be the biggest building blocks of your financial life. Its like fortifying your personal finances before you actually start your wealth creation journey. And these require you to take Timely actions.
As for real timing of markets as we perceive it (getting in and out of the markets frequently), its best left to those who can do it.
If you don’t know whether you are good timer of markets or not, chances are high that you are not. 🙂
But if you think you are a good timer of market, then go ahead and do it. No one should stop you from making money if you can do it.
I don’t consider myself to be a good timer of markets. A large part of my portfolio is based on ‘Timeless’ principles whereas a small part is based on ‘Timing’ decisions. Also, I firmly believe in few things –
My family’s present or future should not be put in jeopardy because of my time / timing / timely / timeless decisions. Time in market is more important than timing. But there will be times when I can make money by simply participating (forget timing and not timing) in markets. And there will also be times when I will not be able to make money no matter how good I have been with my analysis or timing. So I need to be ready and mentally prepared for all such times.
This is the September 2016 update for the State of Indian Stock Markets.
But before I get to the regular analysis, I want to share my thoughts on the recent aggression at our borders.
On 29th Sept – as soon as the government announced that the Indian army had conducted “surgical strikes” on terrorist launchpads in Pakistan the previous night, the Indian markets reacted negatively. The strike was in response to the attack on Indian soldiers in Uri just 10 days back.
A fall in market is something I welcome. But this is not how I want markets to fall.
I am no expert on defence or geo-political matters. But as far as the economy is concerned, a war is not a good thing. Resources have to be diverted towards war and growth suffers. A friend sent me a message asking whether I was happy with the fall in markets?
The answer is that I am not happy. Even though current valuations make it very easy to predict a correction.
I want markets to fall but not for this reason.
Its easy for all of us sitting here to share our views about whether war is good or not. But it is fought there at the borders – not by us but by our defence forces. And we all know what happens when wars take place. People lose their lives.
I bring this up because I was disturbed after the attack on Indian forces in Uri (I have a few friends in army). And I was happy by the counter-measures taken by Indian forces later.
But we should be careful what we wish for.
War is the easiest solution that our mind throws up. But is it really? Think of those who actually will be fighting on ground. You answer might change…
Lets move on now…
As usual, this monthly update includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.
Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month.
Caution – Never make any investment decision based on just one or two ‘average’ indicators. At most, treat these Nifty heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.
Dividend Yield (on last day of September 2016): 1.29% Dividend Yield (on last day of August 2016): 1.22%
Now, to the historical analysis of Nifty500 companies…
As the name suggests, Nifty500 is made up of top 500 companies which represent about 94% of the free float market capitalization of the stocks listed on NSE (as on March 31, 2016).
Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 65% of the free float market capitalization of the NSE listed stocks. So obviously, Nifty500 is a comparatively broader index than Nifty50.
Dividend Yield (on last day of September 2016): 1.24% Dividend Yield (on last day of August 2016): 1.19%
You can read the last month’s update here. The State of Markets section has also been updated with new Nifty heat maps (link). For detailed analysis of how much returns you can expect depending on when the investments have been made (at various P/E, P/BV and Dividend Yield levels), please have a look at these 3 posts: