PPF vs ELSS – Which is better for Tax Saving investments?

Should I invest in PPF or ELSS to save taxes?

This is a common question that I am asked quite often, more so during the tax saving season.

Choosing between the ever so popular Public Provident Fund (PPF) and Equity-linked Saving Schemes (ELSS).

To be fair, comparing one to the other isn’t exactly correct. But I will get to that in a bit.

If you think about it, the main motive behind such PPF vs ELSS questions is fairly obvious – the more tax you pay, the less money remains in your hands. So you will naturally try to find ways to save more taxes. And if these tax saving efforts can help you earn good returns, then nothing like it. Isn’t it?

Unfortunately, people want a clear-cut, crisp, one-word answer to such ELSS vs PPF questions.

But that’s easier said than done. Things aren’t always black and white. There are hundreds of shades of greys in between.

Another question derived from the earlier one is whether doing SIP in ELSS funds is better than investing in PPF every month?

Those who are risk averse obviously feel PPF is a better savings option. While those who have got good returns from ELSS funds in the past (or know that equity is the best asset to create long-term wealth) advocate going for SIP in ELSS funds.

And here is an interesting fact: the number of such PPF vs tax saving ELSS debates rises during the tax saving season. J People are in a mad rush to do some glamorous, last-minute tax savings and portray themselves as financial superheroes!

But last-minute tax saving efforts near the end of the financial year is a recipe for disaster.

Many end up buying shi*** traditional insurance policies to save tax. That’s even worse than being wrong about choosing between ELSS and PPF.

But let’s not digress and instead focus on the main questions at hand:

  • Is ELSS mutual fund better tax-saving investment option than PPF (Public Provident Fund)? Or
  • Is PPF better tax-saving option than ELSS funds (Equity Linked Saving Schemes)?

No doubt both are very popular.

And when you ask people about the best tax saving investment options, chances are high that you will get either ELSS or PPF as the answer.

But as I said earlier, there is no perfect or one clearly defined right or wrong answer to this debate.

Ofcourse if you pick just one of the several parameters, you are bound to find one clear winner. But that is not the right approach.

But let’s begin the comparison anyway…

Most people prefer to compare returns.

Unfortunately, that is neither wise nor a fair comparison.

PPF as a product is extremely safe and gives assured returns whereas returns from ELSS depend on the performance of the stock markets. So the returns of ELSS can be very high or very low and fluctuate somewhere in between.

Both are completely different products and target different needs of a portfolio. So we shouldn’t even be comparing them!

But people do and will continue to compare.

And one very big reason why people compare them is that both have a good and instant side-effect of providing tax-saving… that too under the same Section 80C of the Income Tax Act. Hence people tend to compare.

I know what you are thinking.

Firstly, we are concerned about tax-saving. Right? That’s common between ELSS and PPF. So nothing much to compare.

Next obvious choice is to compare returns. What else could it have been?

You are right to an extent.

But I am of this view that all investments should be linked to financial goals. Tax saving should not be the prime motive for most investors (Talking of goals, if you still aren’t sure which goals you are or should be targeting, I strongly suggest you use this FREE Excel-based Financial Goal Planner to find out what your real personal financial goals are.)

Your goals and investment horizon play a major role in defining how you invest. If investing for long-term goals, the investment portfolio should ideally have a larger equity component. Whereas when saving for short-term goals, it should be a less volatile and debt-heavy portfolio. The asset allocation differs for different financial goals. That’s how it should be.

I will not delve into the full details of what PPF is or what tax-saving ELSS funds are. I am sure you already know most things about them. But just to recap a bit:

  • PPF (or Public Provident Fund) is a government-backed debt product that assures returns that are declared from time to time. How much to invest in PPF to save tax? A maximum of Rs 1.5 lakh can be invested in lump sum or installments in one financial year. The lock-in period is 15 years and the account can be extended in blocks of 5 years multiple times after the original 15-year maturity period is over. Tax benefits for investment in PPF under Section 80C are limited to upto Rs 1.5 lakh.
  • ELSS (or Equity Linked Savings Scheme) is a diversified mutual fund that invests in stocks and also offers benefits under Section 80C. There is no limit on maximum investment but tax benefit is available only on Rs 1.5 lakh. The lock-in period is 3 years. Returns are neither guaranteed nor assured. They are market linked and (average returns) tend to beat inflation in the long term.

Comparison of Returns – ELSS vs PPF

As I have already said, comparing returns of PPF with ELSS isn’t 100% correct.

Both have very different investment objectives.

PPF is a debt product whose returns are fixed but limited due to its very nature. There is no potential for positive or negative surprises. You get what you are promised by the authorities. ELSS, on the other hand, is an equity product that aims to maximize returns. To achieve this aim, it takes risks which can turn out well at times and not turn out well at other times.

To give you some idea about how returns in ELSS funds and PPF differ every year, I have tabulated the annual returns of some of the popular tax-saving ELSS mutual funds in the table below:

The data has been sourced from Value Research. This is not a perfect comparison but is still good enough to give you a comparative snapshot. You can compare the year-wise returns and average category-return of these ELSS funds with PPF annual interest rates. This table will give you some idea about how the returns vary in reality, so I suggest you spend some time on it.

And the funds above are one of the best ELSS funds that have been in existence for last several years now. But do not think of this as an advice of best-ELSS-funds-to-invest kind of list. The data is just for illustration purposes.

But nevertheless, read the observations below:

  • PPF returns have mostly ranged from 8.0% to 8.7% in the recent past. To know more about PPF account interest rate in different banks, check the updated latest PPF interest rates.
  • The years with green colored PPF-return grids indicate that the PPF was the better performing when compared with other ELSS funds in that year. Like in 2008, PPF delivered 8% whereas the chosen set of ELSS funds gave average returns of -54% with individual funds delivering anything between -48% to -63%. Similarly in 2011, PPF did better than ELSS schemes.
  • The years with red PPF return grids show that ELSS gave higher returns than PPF in those years. For example: in 2017, ELSS returns ranged from 26% to 46%. Obviously PPF couldn’t match that with its 8%.
  • The smaller grids (max/min) show the maximum and minimum annual return for different ELSS funds for that given year.

It’s clear from above that depending on the market conditions, the ELSS returns can have wild fluctuations. PPF returns on the other hand are more or less constant due to government’s blessings.

So where PPF returns average around 8%, tax saving ELSS mutual funds have the potential to deliver a much superior return – a 12% to 15% average returns is possible, but not guaranteed. And the top best ELSS funds have given much better returns than these average returns.

So does it mean that you should simply dump PPF and start investing everything in ELSS funds?

Ofcourse not! The average return comparison of ELSS and PPF does seem to show that ELSS offers superior returns in the long run. But basing your investment decisions only on one factor is very risky. Here’s why.

Let’s check another aspect before we get judgmental.

A lot of people don’t invest lumpsum and prefer SIP every month. So for them, it’s better to find out how SIP in ELSS funds Vs monthly PPF investment compares.

Let’s check that out too.

I have simulated Rs 10,000 monthly investment in Franklin India Tax Shield Fund* starting from January 2008 to December 2018. This is to be compared with Rs 10,000 per month savings in PPF for the same period.

*Chosen randomly from several ELSS funds. Don’t consider it as a recommendation.

The value of investment in Franklin’s ELSS fund at the end of 2018 would be about Rs 29-30 lakhs. On the other hand, the value of PPF corpus is 20-21 lakh.

Once again and maybe not surprisingly, it seems ELSS is the way to go.

You can also say that in the above case, the PPF-investor has actually lost out on more than 50% extra returns. (Rs 30 lakh – Rs 20 lakh)

Right?

But even if you see it highly possible that you will get more return on ELSS, you need to understand the short-term risks of investing in ELSS funds and how you react to such risks when you actually face them.

Here is why:

I have compared Rs 10,000 monthly SIP in Franklin Tax Shield vs monthly 10,000 savings in PPF starting from April 2007 (when the bull run was about to peak in coming months).

I chose that starting point because due to high returns from equity in recent past (2004-early-2007), many people would be attracted to stock markets and would be interested in ELSS – as it combined tax savings with much higher returns than PPF.

So here is a 2-year story – starting from April 2007 to March 2009:

In 2 years, the total contribution would have been Rs 2.4 lac in each.

And the value of ELSS investment would be Rs 1.6 lac and that of PPF would have been about Rs 2.6 lac (yellow cells in the bottom row).

Now think…

We know equity will do well in long term. That is what has been told and proven countless times

But how many people would remain convinced and loyal to that idea when their Rs 2.4 lakh investment goes down to Rs 1.6 lakh after 2 years?

They might be cursing themselves for ignoring PPF that would have saved them from such losses.

And this is what I wanted to highlight.

And no PPF vs ELSS calculator or SIP vs PPF calculator will tell you this. All such ELSS SIP investment calculators work on the principle of average returns which will not show the real picture.

Just looking at historical average returns, you might feel that investing 100% of the money in stock markets is the right way. But when markets correct, not many people have the ability to stay invested and accept the temporary losses, even though it is best for them.

Looking at the average long-term returns in isolation can give the wrong picture. Equity investing (directly or via mutual funds) does need a lot of will power to remain invested when markets are down. Not many people have it.

So is it better to invest in ELSS mutual funds SIP than in PPF?

It is true that investors of ELSS mutual funds are rewarded for accepting the short-term volatility. They are paid back handsomely as average return table above suggests. But when you invest in markets, you will face periods of stock market volatility every now and then. Like in 2008, the ELSS category fell by almost 50%. Again in 2011, the category average was about -24%.

Equity is perfectly fine for long-term investors and equity funds have given much better returns than PPF over long-term. But you just cannot ignore debt (like PPF) as the investors have different responses to volatility. Some might exit ELSS after 20-30% losses (which is normal in equities).

Another factor is that you don’t have to ‘choose’ anything in PPF. It’s simple.

But in ELSS funds, you have to choose the fund among many available ones. Is there any guarantee that you will be able to choose the right ELSS fund that will do well in future? Think about it. What if you picked the wrong funds?

That was about the comparison of investment returns of PPF vs ELSS mutual funds.

Let’s see other factors.

Tax Benefits on investments in ELSS Vs PPF

Both ELSS and PPF are quite tax efficient.

Under the Income Tax Act Section 80C, investment in ELSS mutual funds and PPF (Public Provident Fund) give you a full tax deduction upto Rs 1.5 lakh every financial year.

Under Section 80C, you cannot claim deduction of more than Rs 1.5 lac when investing in ELSS or/and PPF and/or other section-80 tax saving options.

Also, you cannot invest more than Rs 1.5 lakh in a PPF account in a year. But this restriction is not there in ELSS schemes. You can invest as much as you want, but the tax benefits available will be limited to Rs 1.5 lakh.

And let me answer two more questions that you might have:

  • Is maturity of PPF taxable or not?
  • Is maturity of ELSS taxable or not?

The answer is:

Lock In Period – PPF vs ELSS

A PPF account has a maturity period (lock-in) of 15 years. ELSS funds on the other hand have a lock in period of only 3 years. But wait. There is more to know than just that…

Assuming you make annual investments in PPF, only your first installment in locked-in for 15 years. The 2nd year installment is locked-in for 14 years. The 3rd year installment is locked-in for 13 years…and so on. Also, the PPF accounts that have completed 15-year lock-in and have been extended have a fresh lock-in of only 5-years.

In ELSS, each SIP installment has its own 3-year lock-in. many people get confused here. Do not think that lock in is valid on full amount that you have invested from the date of first investment in ELSS.

So first SIP in April 2017 will be locked in till April 2020. Second SIP in May 2017 will be locked-in till May 2020. And so on…

But let me remind you that equity is best suited for long-term. Like for periods exceeding 5 years. The money is locked for only 3 years in an ELSS fund. But even if the lock-in gets over after 3 years, you shouldn’t withdraw the funds and remain invested for as long as you don’t need the money.

As investors you need to be very clear that the asset that you are investing in is equity and thus you should be ready to stay invested for at least 5 to 7 years to get good returns.

What if you Invest 100% in PPF or 100% in ELSS?

These type of questions come from people who are unwilling to see the bigger picture and are only narrowly focusing and asking about PPF vs mutual funds which is better?

But neither approaches is advisable.

  • Is PPF a good option for investment?
  • Is ELSS a good option for investment?

Ofcourse yes.

But theoretically speaking, if you invest Rs 1.5 lakh in PPF every year for 15 years, your total corpus would be around Rs 43 lakh. You can use this Excel PPF Maturity Calculator to try out other scenarios (or find out how to save Rs 1 crore in PPF).

On the other hand, if you put in Rs 12,500 per month (= Rs 1.5 lakh per year) in ELSS funds, then your corpus after 15 years would be between Rs 60-82 lakh depending on assumed returns of 12-15%. Also check out How much to invest every month in ELSS funds for Rs 1 crore in 20 years.

Regular SIP in equity funds (both ELSS and non-ELSS) can create a lot of wealth in long run. Here is a good real-life success story of SIP-based Wealth Creation. To know how much wealth you can possibly create by investing small amounts every month, check out the following links:

Again, you might feel that why to use PPF when you can get more returns with ELSS.

But remember, PPF is a debt product and ELSS is an equity product. All goal-based investment portfolios are best constructed by diversifying across assets.

You should not be 100% in equities or 100% in debt.

It is not sensible either way.

For most people, the best approach is to invest in line with your goal requirements. Using the powerful concept of Goal based Investing, you find out how much you should be investing for each goal.

Let’s assume that the goal you have in mind is retirement planning – which is a nasty problem in itself.

It’s a big goal. And since for most people its decades away, its best served by an equity heavy portfolio.

For someone in 30s, it can be safely said that a portfolio with 70% equity and 30% debt is suitable.

And you also wish to save tax. Right?

So here is how to go about it:

  • You are investing for your financial goal of retirement planning.
  • After doing some calculations yourself (or taking help from an investment advisor), you have come to know that you need to invest Rs 20,000 every month in 70-30 Equity-Debt ratio.
  • That means investing Rs 14,000 in equity and Rs 6000 in debt every month.
  • But you are already making an EPF contribution of Rs 4000 every month. That also counts towards the 30% debt bucket.
  • EPF takes care of 48,000 under Section 80C tax saving options. Assuming you have a Rs 1 crore term insurance with Rs 12,000 annual premium, the total eligible deduction goes upto Rs 60,000 (48K+12K).
  • The remaining Rs 2000 per month (from debt) can be put in PPF. Or if you have the option of VPF, that’s better too. This totals to Rs 84,000.
  • And this increases eligible deductions to Rs 84,000 (48K+12K+24K). You need another Rs 66,000 for fully utilizing Section 80C limit.
  • You can now do a Rs 5500-6000 SIP in ELSS fund. That will take care of your tax-savings.
  • For the remaining Rs 8000-9000 (in equity bucket of Rs 14,000), you can choose other normal equity funds (non-ELSS). Or you can even do full Rs 14,000 SIP in ELSS funds.
  • All this is assuming that there aren’t any home loan tax benefits to accommodate.

The above approach is a very simple one.

And if you think like that, then you will easily get answers to questions like ‘how much should I invest in ELSS’ and ‘how much should I invest in PPF’?

But you don’t need to decide between PPF and ELSS because of just returns.

You instead simply need to focus on asset allocation (which is 70-30 in the above example). Therefore, the choice between doing SIP in ELSS funds and investing in PPF must also be seen in the context of overall portfolio asset allocation.

If there is room under the 30% debt bucket after deducting EPF contributions, you use PPF. For equity’s 70% bucket, you can use ELSS to the extent it is needed for tax saving.

And if your Section 80C limit of Rs 1.5 lac is fully utilized using EPF contributions, life insurance premiums and home loan principal repayment, there is no need for ELSS mutual funds investment. You can easily focus on non-tax saving equity funds instead.

But that doesn’t mean that you don’t invest for your goals. Tax-saving is not a financial goal. Just remember that.

The approach that I discussed above is in line with goal-based investment’s philosophy.

One simpler approach can be to take a middle path and do a 50-50 split between PPF and ELSS.

Another can be (for those who are interested in being more tactical about tax-saving) to use market valuations as an indicator to decide where to invest. If valuations are low, invest in ELSS. If valuations are very high, invest in PPF.

I am not suggesting that the tactical approach discussed above is a better way. Just highlighting that there can be multiple approaches. But most people are better off not trying to time the markets. 🙂

But the actual split between ELSS and PPF will depend on factors like your risk profile, existing assets, etc.

Just to reiterate, if you are young, keep a larger portion of your savings directed towards equity when investing for long term goals like retirement.

Both ELSS and PPF are suitable for retirement savings. But equity is better suited as long as you have several years left for the goal.

How to choose good Tax-Saving ELSS Mutual Funds?

Before even you consider ELSS as the choice for tax saving, do not forget that always invest in ELSS with a long-term perspective – something like 5+ years or even more.

Why?

Because ELSS is about equity investing. And equity as an asset class isn’t risk free. There is always a risk of loss of capital. But this risk is higher when you invest for short term. The longer your investment horizon, the lower is the risk of loss.

With that aside, how do we go about picking the best ELSS funds among all ELSS mutual fund schemes out there?

These days, the disclaimers about past performance not being necessarily sustained in the future fall on deaf ears.

So despite mutual fund companies highlighting great short term returns, you should focus on things that matter.

When looking for which ELSS funds to invest in for tax saving, keep the below discussed points in mind.

Depending solely on performance numbers from recent past can be misleading. Do not run after previous year’s best performing tax saving ELSS funds. Look for consistency in returns over several years. Has the fund been in the top quartile of its category for almost all the years? Has the fund protected the fall in poor markets? These are just some of the questions that should come to your mind when picking ELSS or building a proper mutual fund portfolio. You can even consult an investment advisor to find out these answers.

Also, all ELSS funds are not the same in terms of portfolio construction.

All ELSS funds are actively managed and its fund manager’s job to decide what to hold in fund’s portfolio. It can a portfolio with a bias towards large cap, midcaps, all caps or whatever.

What is worth remembering is that one ELSS fund’s investment mandate will not be the same as that of the ELSSs out there.

And there is absolutely no need to pick a new ELSS fund every year for your tax saving.

This often happens when you do last minute tax saving. You are in a hurry and want to find out the best performing ELSS fund on the basis of 1-year return. This is not advisable.

Over the years, investors end up with several ELSS schemes as they invest lump sums every year by picking one from the best performer of previous years. Like picking from Top ELSS Funds of 2018 or Top ELSS Funds of 2019.

But having more than 1 or 2 ELSS funds is useless. In any case, if you have other non-tax saving diversified mutual funds, having more ELSS funds will only lead to an overlap in your portfolio. Building a mutual fund portfolio isn’t tough but still people mess it up.

So don’t wait for January, February or March for planning your tax savings.

Do some homework earlier and find out how much is to be invested in ELSS in the year. And then begin investing in ELSS through SIP (systematic investment plans). This way, you would have time to pick good ELSS funds on the basis of long-term consistent performance. You will also benefit from averaging (and avoid timing the market through last minute lump sum investments).

We began this article with the question of whether to invest in PPF or ELSS to save taxes.

But as you have seen, both are completely different products. Both PPF and ELSS serve their own purposes when you combine goal-based investing with smart tax-saving strategies.

You should not decide randomly between ELSS or PPF. And there is no one-size-fits-all answer as both ELSS and PPF target different needs of the investment portfolio.

The decision should be made after you have a clear view of your financial goals and tax requirement.

But when it comes to combining equity investing with tax saving, there is no doubt that ELSS is good for long term investments. It scores well above several other tax saving products. And investing in ELSS through SIP (or systematic investment plans) over a long time horizon can help you do proper tax planning and financial goal planning.

If you have a well-thought out investment plan for your financial goals, you will not need to ask questions like which is a better investment option ELSS or PPF?

You don’t need to choose between the most suitable tax saver between ELSS vs PPF. That is because you will invest on basis of your goal-specific strategic allocation rather than randomly. And that is what goes a long way in sensible investment management and wealth creation. So taking sides on ELSS vs PPF is fine. But invest smartly and using correct goal-based approach.

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Is your Income Tax really Zero (Nil) for Rs 5 lakh income?

Budget 2019 initially proposed something that excited millions of Indians – No income tax on Rs 5 lakh income.

It seemed that the zero percent (0%) income tax slab was indeed increased to Rs 5 lakh in India.

But when actual details emerged, the reality was a little different.

If you still aren’t sure about this whole zero tax 5 lakh thing or are looking for answers, then this article might help.

What really happened is something like this:

Individuals with taxable income of up to Rs 5 lakh will get full tax rebate under section 87A. What this means is that if your net taxable income is up to Rs 5 lakh, then you don’t need to pay any taxes. However, if the net taxable income is above Rs 5 lakh, then the rebate under Section 87A cannot be availed.

But, there are no tax slab changes in the Budget 2019.

The only thing that has changed is the tax rebate under Section 87A – which has been revised; and it’s because of that alone, that there will be no tax liability for those whose taxable income is less than or equal to Rs 5 lakh (Rs 5,00,000) in India.

If this sounds a little confusing, then let’s go step-by-step and it will be crystal clear to you by the end.

Income Tax Slabs FY 2019-20 (AY 2020-21)

As I said, there hasn’t been any revision in the income tax slabs from the previous year. It remains the same the for Financial Year 2019-20 as follows (for individuals below 60):

This simply means that, currently:

  • Taxable income up to Rs 2.5 lakh has zero (nil) tax.
  • Taxable income between Rs 2,50,001 to Rs 5,00,000 taxed at 5%
  • Taxable income between Rs 5,00,001 to Rs 10,00,000 taxed at 20%
  • Taxable income above Rs 10,00,000 taxed at 30%
  • In addition to the above, following are also applicable: 10% surcharge on income tax if Rs 50 lakh < income < Rs 1 crore and 15% surcharge on if the total income > Rs 1 crore.
  • 4% Health & Education cess on income tax (including surcharge) to be added.

Remember, we are talking about the ‘Taxable Income’ here and not ther ‘Gross or Total Income’. The ‘net taxable income’ is the total income reduced by the amounts of permissible deductions under various sections (like Section 80C, etc.).

I know you might be thinking – if the tax exemption limit is still Rs 2.5 lakh, then how can there be zero tax on income of up to Rs 5 lakh?

Your curiousity is correct.

And the reason is hidden in the changes made in the Section 87A during the Budget 2019.

Revised Tax Rebate – Section 87A

What has happened is that the limits specified earlier in Section 87A have been revised. The changes are as follows:

Earlier: If the taxable income is less than Rs 3.5 lakh, then a rebate of Rs 2500 applies to the total tax payable (before cess). And if the tax payable is less than Rs 2500 then the entire tax amount is discounted.

Now (after Budget 2019): If the taxable income is less than Rs 5 lakh, then a rebate of Rs 12,500 applies to the total tax payable (before cess). And if the tax payable is less than Rs 12,500 then the entire tax amount is discounted.

So the earlier limit of Rs 3.5 lakh has been revised upwards to Rs 5 lakh. And the rebate available has been increased from Rs 2500 to Rs 12,500. Remember, that a rebate is the specified amount of tax that the taxpayer is not liable to pay.

Here is simple example to show the working

How Income Tax is Zero (nil) on Rs 5 lakh income?

Suppose, your net taxable income is Rs 5 lakh.

As per the tax slabs, calculated normal tax liability is as follows:

  • 0 to Rs 2.5 lakh – 0% – Nil
  • Rs 2.5 lakh to Rs 5.0 lakh – 5% of Rs 2.5 lakh – Rs 12,500
  • (ignoring cess, etc. for simplicity)

So the total tax = 0 + Rs 12,500 = Rs 12,500

But, the revised Section 87A limits offer a rebate of Rs 12,500 for taxable income of up to Rs 5 lakh.

Result

Tax of Rs 12,500 – Rebate of Rs 12,500 = Zero Tax.

That is, if the net taxable income is Rs 5 lakh or less, then the entire tax liability will be less than the rebate of Rs 12,500 – which means effectively no (zero) tax on income up to Rs 5 lakh.

So you can say that the so called zero tax is applicable only for those whose taxable income is Rs 5 lakhs or less.

But what happens in case taxable income is more than Rs 5 lakh?

Let’s see…

Income Tax on income above Rs 5 lakh

If you wish to calculate income tax on your net taxable income above Rs 5 lakh, then let’s take an example to understand it.

Suppose, your total income is Rs 7 lakh.

You do some smart tax saving (use PPF and/or use home loan tax benefits) and become eligible for deductions of full Rs 1.5 lakh under Section 80C.

Now your taxable income comes down to Rs 5.5 lakh (Rs 7 lakh – Rs 1.5 lakh).

Let’s calculate the taxes now…

  • Up to Rs 2.5 lakh – NIL
  • Rs 2.5 lakh to Rs 5.0 lakh – Rs.12,500 (i.e. 5% of Rs 2.5 lakh)
  • Rs 5.0 lakh to Rs 5.5 lakh – Rs 10,000 (i.e. 20% of Rs 0.5 lakh)

Total tax = Nil + Rs 12,500 + Rs 10,000 = Rs 22,500.

Since your taxable income is Rs 5.5 lakh, which is not less than Rs 5 lakh, you are not eligible for the rebate under Section 87A of the Income Tax Act.

So your tax liability remains as Rs 22,500 and you have to pay the full amount. Sorry! But you can still be wise about tax planning by giving priority to your investment planning.

It makes sense to repeat that the rebate is available only if taxable income is Rs 5 lakh or less. Not if it’s above it.

Had you by some means been able to further reduce your taxable income to less than Rs 5 lakh (in above example of Rs 7 lakh total income), you would have become eligible for the rebate of Rs 12,500.

So that’s it…

There has been no change in income slab or tax rates in Budget 2019. Only the limits in the Section 87A have been revised to benefit those whose taxable income is less than Rs 5 lakh.

Individuals with taxable income of up to Rs 5 lakh will get the full tax rebate under section 87A. This effectively means that they will not be required to pay any taxes. However, for those whose net taxable income is above Rs 5 lakh, there is not tax rebate that they can avail.

I hope this article clarifies your doubts about how income of Rs 5 lakh is tax free and what is the zero percent (0%) income tax slab in India.

SIP may not be perfect; but it’s Small Investor’s Best Bet

If you are a mutual fund SIP investor, you would already have been bombarded with thousands of articles about why mutual funds and more particularly mutual fund SIPs are great.

And that is true.

But I wanted to re-highlight this fact in a different light.

SIP is not perfect like the theoretical (but attractive) concept of Buying-Low-Selling-High. But still, it works best for small investors and is their best bet when it comes to equity investing.

I recently wrote an article for MoneyControl on this topic. If you wish to understand why SIP isn’t Perfect but still the small investor’s best bet, then please do read the article by clicking the link below:

[Click to read] – SIP isn’t Perfect; but it’s the Small Investor’s Best Bet

Hope you find the article useful.

How to use PPF to save Rs 1 Crore – Be PPF Crorepati

Rs 1 crore is still not a small amount. But whether it is sufficient or not depends on why you actually need it.

So for example, if you were to ask me whether Rs 1 crore is enough for retirement? In most cases, the answer would be a No. Retirement planning is a nasty problem and you can’t just ahead with random numbers for your retirement corpus.

But still, there is a psychological attraction to this figure of Rs 1 crore and becoming a crorepati that us Indians can relate to.

PPF is a beautiful debt product. I have already written about it earlier too (link).

And even though investing in equity is a necessity and highly advisable for the long term, a product like the PPF can still be a part of the overall portfolio. And I am sure the term PPF crorepati in the title would have already captured your interest by now. 🙂

However, PPF is not a short term investment option as it has a lock-in period of 15 years. But still, you can make partial withdrawal after few years. And You can even extend the maturity by a block of 5 years for multiple times. It currently falls under the ‘EEE’ category, which means that PPF contribution, interest earned on PPF and PPF maturity proceeds are exempted from tax.

Interestingly, a few days back I got a mail from a self-confessed conservative investor.

He said that he was slowly increasing his equity investments. But still he felt that he cannot part ways with something as sure-shot and as risk-free as a PPF account. And he wanted to know how long would it take to accumulate Rs 1 crore in PPF?

I felt that this question might interest others as well.

So this post is about finding out:

How to accumulate Rs 1 Crore in PPF (Public Provident Fund)?

And if you are low-risk conservative investor who wishes to accumulate Rs 1 Crore, then PPF is a decent option.

Let me try to answer this from various perspectives:

  • If you contribute Rs 1.5 lac every year for a period of 15 years, your PPF balance will be about Rs 43.9 lac at the end of 15 years (assuming a stable interest rate of 8.0% per annum).
  • If you contribute Rs 1.5 lac every year for a period of 15 years and then don’t liquidate your holding for another 15 years, then your PPF balance will be about Rs 1.39 crore at the end of 30 years (assuming a stable interest rate of 8.0% per annum). You will achieve the target of Rs 1 crore around the 27th year.
  • If you contribute Rs 1.5 lac every year for a period of 15+5+5+5=30 years, then your PPF balance will be about Rs 1.83 crore at the end of 30 years (assuming a stable PPF interest rate of 8.0% per annum). And you will reach Rs 1 crore during the 24th year itself.

But what if you are unable to invest Rs 1.5 lac every year (the full PPF annual limit), then obviously your target of reaching Rs 1 crore in PPF will be delayed accordingly.

Also, if the interest rates go down in years to come, then once again your target of reaching Rs 1 crore in PPF will be delayed to that extent.

So to sum it up, you can become a crorepati if you put Rs 1.5 lac every year in PPF then you can accumulate a corpus of Rs 1.08 crore by the end of the 24th year (assuming that 8% return)

But as you know, neither the PPF limit remains same nor PPF interest rates remain unchanged over the long term.

So let’s try a hypothetical scenario which might actually play out in the near future:

Suppose you begin saving full Rs 1.5 lac in PPF today. Government increases the annual PPF investment limit by Rs 50,000 every 5 years. It is assumed you will continue to invest as much as is needed to fully utilize the annual investment limit of PPF every year. The interest rates also reduce by an average 0.5% every 3 years or so.

What will be the result then?

At the end of 15th year, your total investment of Rs 30 lac would have become about Rs 49.4 lac.

If you continue investing (after extending your PPF account with contribution) for another 5+5+5=15 years, then at the end of 30th year, your total investment of Rs 82.5 lac would have become about Rs 2.02 crore.

Here is the tabular depiction of the excel:

As you might have observed by you, it is only after the initial few years that the actual compounding of the PPF investments becomes visible. And it is for this very reason that you should try not to disturb (withdraw from) your PPF account for as long as possible and try to extend its tenure after the first 15 years lock-in period.

Do you want to try some different scenarios of your own?

You can do so.

You can download this FREE Excel PPF Calculator and play around with inputs. If the previous link doesn’t work, use the link below:

Excel PPF Calculator (2019-20) Free Download

You can even check out historical PPF interest rate and how things have changed in the past when it comes to PPF.

Now, the current limit for PPF is Rs 1.5 lakh per year.

But what if you want to invest more?

Obviously, you need to respect the limit.

But if both husband and wife can contribute to PPF, then things can get fastened a bit.

Save Rs 1 crore Quickly using Husband PPF + Wife PPF

What needs to be done is that a PPF account needs to be opened for both you and your spouse.

Since both the husband and the wife can deposit Rs 1.5 lakh per annum, it means you can contribute Rs 3 lakh every year in PPF. And you will get interest in both these PPF accounts for the entire period of 15 years or more if extended.

So how much do you end up with if both you and spouse contribute Rs 1.5 lakh every year for 15 years?

The answer is Rs 43.9 lakh each, i.e. a total of Rs 87.8 lakh.

So if both of you save diligently, you can achieve Rs 1 Crore in about 17 years. Here is a sample depiction of PPF Husband Wife calculation:

So if you are a conservative investor, who isn’t much interested in volatile investment options, then PPF can be helpful. PPF can help you become a crorepati in a safe way.

  • If you put Rs 1.5 lakh every year in PPF, then you can accumulate a corpus of Rs 1 crore by the end of the 24th year.
  • If both you and your spouse put Rs 1.5 lakh each every year in individual PPFs, then you both accumulate a corpus of Rs 1 crore by the 17th year itself.

And if somehow you manage to continue investing for the 30 years (i.e. 15 years original and 3 extensions of 5 years each), then you will be able to accumulate a really big corpus.

So before I close, let me list down some facts about the PPF for your ready reference:

  • PPF Interest Rate – 8% (check PPF interest rate history)
  • PPF Duration – 15 years
  • Extension of PPF Account – After the maturity period of the original 15 years, it can be extended in blocks of 5 years each multiple times
  • Minimum deposit amount (per year):  Rs 500
  • Maximum deposit amount (per year) :  Rs 1,50,000
  • Number of installments every year: 1 (min) to 12 (max)
  • Number of accounts an individual can open: Only 1. If there is a 2nd PPF account, it is treated as invalid and doesn’t earn any interest.
  • Tax Savings – EEE status, i.e. the annual contribution (up to Rs 1.5 lakh) provides tax benefit under Section 80C. Interest earned and the maturity amount is fully exempted from taxes.
  • Interest on PPF is calculated on the minimum balance in the account between 5th and the last day of each month. So if you invest monthly, then it makes sense to do it before 5th every month.
  • You can further maximize your returns in PPF by investing the full amount at the beginning of the financial year itself. Ofcourse this is not easy for everyone. But if you do so, the full amount earns interest every month of the year.

Here is the link to download the free excel-based PPF Calculator again:

Excel PPF Calculator (2019-20) Free Download

Use the above excel with your own inputs and you can use it as a PPF crorepati calculator.

And before you accuse me of being too gung-ho about PPF, I repeat that equity is the best asset to create long-term wealth. You can become a crorepati by investing in mutual funds too. Here is How much to invest every month in mutual funds to get Rs 1 crore in 20 years.

Also, read how Rs 1 lakh invested every year for 20 years can create a Rs 90+ lakh portfolio without any problem

But let me tell you something.

Investing in equity does come with its own share of ups and downs in the near term. But if you look at the average annual returns of Indian Stock Market, then it will show how you can create some serious wealth from equity. The idea of this post was to tell how a comparatively safe and risk-free savings option like PPF can be used to accumulate a large corpus of PPF Rs 1 crore.

For most people, its advisable to have a balance between equity and debt when investing for long.

But if you aren’t sure whether you are saving and investing properly, do get in touch with an investment advisor soon (how?).


Confused with Different Types of Term Plans? Here is How to choose the Right Term Plan

When it comes to buying life insurance for yourself, the best option is to go for a simple term insurance policy. Period.

With that aside, your next question would be – which is the best term insurance plan to buy?

The answer isn’t simple anymore.

Earlier, term plans came in just one version, i.e. they paid lumpsum (sum assured) at the death of the insured person.

But now, the insurance companies have introduced many variations of these term life insurance plans.

Majorly, these variations give the policyholder different options to decide how the total sum assured is paid out to the nominee in case of policyholder’s death.

But think about it…

Why would you anyone even think about the other versions of the simple term plan?

It will become clear as I explain it in the next sections.

You will realize that just buying a Rs 1 crore term plan or some other plan is not enough. You really need to think hard about how the money will be handled after you and accordingly, choose the right version of the term plan.

So let’s move on…

Types of Term Insurance Policies in India

Let’s see how these term plan varieties differ from each other.

1 – Term Plan with Lumpsum Payout

This is the most basic version.

Let’s say you buy a term plan of Rs 1 crore. In case you die during the policy tenure, your nominee will be paid the full amount of Rs 1 crore in one go. Nothing more, nothing less.

There is nothing much to explain about this option.

The other remaining options of the term insurance plans in India take the staggered route to money payout.

2 – Term Plan with Fixed Monthly Payout

In this plan, there is no lumpsum payout. Instead, the sum assured is utilized to provide a regular monthly income to the nominee for a fixed number of years.

For example – You take Rs 1 Crore term plan. Now if you die within the policy tenure, then the sum assured is paid out as a monthly income of Rs 83,333 for next 10 years (i.e. Rs 83,333 x 12 x 10 = Rs 1 Cr).

This monthly income can either be fixed (as above) or can also be increasing one.

3 – Term Plan with Lumpsum + Fixed Monthly Payout

In this plan, a percentage of the sum assured is paid out at the time of death. The remaining amount is paid as a monthly income, which is a fixed percentage of the remaining sum assured for a fixed number of years.

For example – You take Rs 1 Crore term plan. Now if you die within the policy tenure, a percentage of the sum assured let’s say 40% (i.e. Rs 40 lac) is paid out immediately. The remaining 60% (or Rs 60 lac) is paid out as monthly income of Rs 50,000 for next 10 years (i.e. Rs 50,000 x 12 x 10).

4 – Term Plan with Lumpsum + Increasing Monthly Payout

In this plan, a percentage of the sum assured is paid out at the time of death. The remaining amount is paid as a monthly income, which increases at a pre-determined percentage on a simple interest basis on every policy/death anniversary for a fixed number of years.

For example – You take Rs 1 crore term plan. Now if you die within the policy tenure, a percentage of the sum assured let’s say 40% (i.e. Rs 40 lac) is paid out immediately. The remaining is paid out as a starting monthly income of Rs 50,000 which increases by let’s say 10% every year. So next year, the monthly payout will be Rs 55,000 and so on. Generally, the total payout in this version is more than the original sum assured.

In both the above options (lumpsum + fixed monthly payout and lumpsum + increasing monthly payout), the lumpsum % can be different as per insurer’s or policyholder’s choice. There are many plans that even pay 100% of the sum assured upfront and additionally pay a monthly income (fixed or increasing) to the nominee.

For example – You take Rs 1 crore term plan. Now if you die within the policy tenure, full Rs 1 crore is paid out to the nominee immediately. In addition, a monthly payout of Rs 50,000 is made for the next 10 years. The total payout in this version is more than the original sum assured. To be exact, it is Rs 1 crore + Rs 60 lac (Rs 50,000 x 12 x 10).

These are the major versions of the term plans that are available these days.

Now let me address the point that I raised earlier – Why would anyone even think about the other versions of the simple term plan where the payout is staggered?

Quite often, the nominees lack proper personal financial knowledge when it comes to handling large sums of money. So once they receive a large amount, they may be unable to properly manage the sudden increase in wealth and end up losing it by listening to the wrong people.

So in order to overcome this concern, many insurance companies came up with various other payout options.

This way, the nominees receive a part of the amount as lumpsum to take care of immediate concerns (like closing all loans, other big expenses in the near term). The remaining amount is paid as monthly payments over a pre-decided number of years, to replicate the regular income pattern and help smoothen the life of the nominees.

That is the major reason for the launch of these different versions.

So depending on the ability of your nominees to handle money, you should pick the adequate option:

  • If you are sure your nominee is well-versed in personal finance, then you can go for the full lumpsum payout term plan.
  • If you feel the nominee is better off not having a large amount suddenly (due to any reason you think), then you can go for the staggered-payout term plans.
  • If you feel that if your sudden death will result in financial chaos (due to outstanding loan or planned big expenses in the near term), then you can take the term plan that pays a % as lumpsum and remaining as monthly income (if you feel the nominee will be unable to handle money properly).

As you might be feeling right now, there are cases where opting for the staggered payout option actually makes sense.

Ofcourse from a purely financial perspective, it’s best to take the lumpsum and invest it efficiently and try to generate income from it for the nominees. But all decisions cannot be taken just from mathematical perspectives.

Do premiums vary for different Term Plans?

Yes of course.

Different versions of the term plan have different premiums.

To give you an idea, here is a snapshot of the various versions, with their benefits and approximate annual premiums for a 30-year old, non-smoking male living in a metro city and buying a 30-year term plan:

Types Term Insurance Plans India Premiums

The first one is the normal term plan that you know of – pays lumpsum amount (equal to the sum assured at the death of policyholder). Others are different plans paying different monthly incomes which is either fixed or increasing each year.

There are several term insurance premium calculator available online. It’s best to check out the premiums for different types of policies for yourself.

The actual premium that you will have to pay will depend on a variety of factors. If you take a policy for a longer tenure, then it will cost more. In general, shorter the policy term, lower will be the premiums. To choose the right policy term, do read what should be the ideal term insurance policy term?

And I almost forgot telling you about another variety of Term Plans that has been pitched by a lot of agents in recent times – Return of Premium Term Plan.

Is Return of Premium Term Plan Good?

A lot of people who wish to buy term plans have this feeling that since they will survive the policy period, the premium which they are paying will be wasted.

For these people, insurance companies have come up with a term plan where the premium paid over the course of policy tenure is returned back if the person survives.

At the face of it, this seems like a good idea. And this policy did address the concerns of people who thought that the term plans are a waste of money.

But if you deep dive a bit, things aren’t that great. Such policies have premiums much higher than the normal term plans.

If we were to compare a plain term plan (that only pays lumpsum amount) with a term plan (that also only pays lumpsum) with the return of premium option, then the premiums are Rs 9717 for a plain term plan and Rs 24,968 for return-of-premium term plan.

These premiums are for a 30-year old, non-smoking male buying a 30-year term plan living in a metro city.

Let’s compare these two plans a bit more.

The total premium paid is Rs 2.91 lac for plain term plan (Rs 9717 annually x 30 years) and Rs 7.49 lac for return-of-premium term plan (Rs 24,968 annually x 30 years).

In case of death during policy tenure, the nominee gets Rs 1 crore in both cases (as the sum assured is same).

But in case of survival, things change.

In case of plain term plan, you get back nothing – that is, you don’t get back Rs 2.91 lac. On the other hand in case of Return-of-Premium Term Plan, you get back your Rs 7.49 lac.

You may again feel that the return of premium plan is better. But remember that you are paying a high premium for that.

The difference between the annual premium of the two plans is a little more than Rs 15,000 (= Rs 24,968 – Rs 9717).

If you invest this difference amount of Rs 15,000 every year at just 8%, then at the end of 30 years you will have about Rs 18-19 lac. Compare this with the amount the return-of-premium offers you at the end, i.e. Rs 7.49 lac.

So the obvious conclusion is that it’s better to not purchase a return of premium term plan. You are better off with either a simple term plan (or some of its variants that offer monthly income).

Finally…

Term insurance is still the best insurance that you should be buying for covering your life. The traditional ones like endowment, moneyback insurance plans are best avoided.

But since term plans also come in various shapes in sizes, its natural to ask which is the best term insurance plan for you?

As mentioned earlier, the choice of the term plan variety is dependent a lot on how capable do you feel your nominees are in managing money. If they are financially aware, going for a lumpsum payout is best. If they aren’t and you want to provide them with a regular income for a few years after you die, then take the lumpsum + monthly income payout option. Or you can have the best of both worlds by taking two policies combining the two approaches.


Nifty P/E Ratio & Returns: Detailed Analysis of 20-years (1999-2019) Updated

Like previous years, I have once again revised the Nifty PE-Ratio & Return analysis to include fresh data (up to December 2018). Now, this analysis has data spanning from early-1999 to late-2018, i.e. full 20 years.

This analysis uses one simple valuation metric (P/E Ratio of Nifty50) and attempts to correlate it to the returns achieved across various time periods (rolling-periods ranging 3 to 10 years) when investments were made at different PE levels of the index.

The purpose of this analysis is simple.

To arrive at some sort of conclusion and see how well or not-so-well correlated are the two things – the market’s current valuation and its future returns.

This time, I have tried to make this analysis more comprehensive and have included a few additional updates that weren’t part of the previous years’ PE vs Return analysis. So even if you have read the earlier ones, I suggest you go through this one again. My guess is that you will find it incrementally useful.

But before we get to the findings, let me say this upfront that this is not a sure-shot method to make money.

Just because we can find some trends in past data doesn’t mean that the same trends will be replicated in future. Markets are dynamic and the history is no guarantee of the future. In markets, the history is known to rhyme but it is never exactly the same.

The sole purpose of this analysis is to highlight that there exists a relation between the broader market valuations and returns you can achieve.

If you buy low (valuation wise), chances of earning good returns increase and vice versa.

How to Analyse PE Vs. Returns?

What I have done is that I have calculated returns earned on investments made at all Nifty PE levels starting from the year 1999. The time periods of return calculations are 3-year, 5-year, 7-year and 10-years.

Let’s use a simple example to understand this.

Suppose you had invested money in the index Nifty50 on 24th-February-2004 when its PE was 19.97 (actual data).

Now in the next 3-year, 5-year, 7-year and 10-year period (starting from 24th February 2004), the CAGR returns would have been 29.3%, 8.5%, 17.0% and 13.0% respectively.

Using the above-described approach, I have done the return analysis for each and every trading day since 1st January 1999 (the day from which the Nifty PE data is available publically). Obviously, 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 the analysis of 3-year returns. Same is the case with 5, 7 and 10-year studies. For example, data for 15-July-2013 is used for calculating 3-year return (as data is available for July-2016) and 5-year return (as data is available for July-2018). But the same is not used for 7-year and 10-year returns as data is naturally not available for July-2020 or July 2023 (at the time of writing of this study).

To simplify the findings, I have been grouping Nifty PE into 5 groups earlier.

But to provide more granular data this time, I have decided to present my finding in a larger 7-grouping set.

Nifty-50 PE Ratio and Investment Returns

The findings are based on 4243 data points for 3-year analysis, 3751 data points for 5-year analysis, 3250 for 7-year analysis and 2509 for 10-year analysis.

And here is what has been found after updating the dataset:

Nifty PE Ratio 1999-2018 Detailed Grouping

Due to the choice of intervals in the PE range, the figures differ slightly if I revert back to the old PE-range choice. Here is the same summary on the basis of the old grouping:

Nifty PE Ratio 1999-2018 Grouping

Essentially, both tables tell you the same thing – when you invest at low PEs, your expected future returns are comparatively higher.

Remember, these figures are based on past data (of the last 20 years).

The trends no doubt are easily evident here. But they may or may not repeat in future. There are no guarantees that the future returns will follow similar patterns.

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.

But the above data set and relying on a common-sense based approach to investing tells that investing at low PEs is difficult but profitable.

So let’s say 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 18% respectively! Unfortunately, it’s very rare to find days where Nifty is trading at such low valuations.

On the other hand, if investments were made when Nifty50 was trading at PE ratios of above 24 and above 27 (which are the supposed overvalued territories), the chances of earning decent returns in (atleast) near term are pretty low. 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 (in times of crisis). This is what the 3 C’s of proper investing is all about too. 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.

Before we further slice and dice the dataset to find out more interesting things, let me highlight a few important points about using index data here:

  • The Nifty PE data is published by NSE (here) and is currently based on Standalone numbers. This means that actual earnings (that includes those from subsidiaries, etc.) in consolidated figures are higher than what the standalone numbers would suggest. And that also means that current actual PE may not be as high as that suggested by the standalone ones.
  • The constituents of Nifty50 keep changing. The index management committee that is responsible for maintenance of the index regularly brings in and moves out companies from the index. The Nifty composition of 2008 was quite different from that of 2018. Similarly, the index composition of 1999 might also be very different from that of 2008 and 2018. Try to understand it like this. If the index is made up primarily of companies that are low PE-types, then index at the overall level will tend to have low-PE. Whereas if the index is made up of high-PE companies, it will tend to have a high PE. So actual definition of high and low PE will be different for both type of companies, and so in turn for the index. A PE of 15 for a low-PE company might be very high whereas for a high-PE company might be very low. This is an important factor that should be kept in mind. I have addressed this to some extent in the latter part of this analysis by comparing returns while changing the periods under consideration from 20 years to 15 and 10 years.

Moving on, let’s address another important aspect here:

Risks when dealing with Average Returns

The table above gives a very clear relation 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, let’s 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.

That is how averages work. Isn’t it?

So this needs to be kept in mind…always.

To counter this, we need to analyze a few more things. So…

Adding More Data points to PE-Analysis

A better picture can be painted if in addition to the average returns, we also consider the following:

  1. Maximum returns during all the periods under evaluation
  2. Minimum returns
  3. Standard deviation
  4. Time spent in at a given valuation band

Have a look at the tables below now:

Nifty PE Ratio 3 Years Average

I want to spend some time here to highlight what all this means. I will also visually depict this using a small graph.

In the graph below, I have plotted PE ratios on X-axis and 3-year CAGR returns on Y-axis for all available data points in the last 20 years. As you can easily see, the trend is clear – returns are higher when investment happens towards lower PEs.

Nifty PE Return 3 Year Scatter

But you don’t always get the average returns that the preceding table shows. You can get anywhere between the MAX figure and MIN figure and the difference is huge.

Sounds confusing?

Let me try to segregate the above chart into PE-bands to highlight this:

Nifty PE Return 3 Year Detailed Scatter

As you can see, within each PE band, the actual returns are all over the place.

Focus on the first green block of PE12-15 band.

The red circle is the position of average return (38.7%).

But as the two text bubbles show, the Max and Min returns are very different from the average returns. Refer to the table above and you will find that max is about 58.1% and min is about 5.9%. And all this with a standard deviation of 14.6%.

What this means is that even though the average figure might tell you something, the actual returns can vary a lot.

I hope you get the drift of what I am trying to show you here…

Let’s now see the data for 5, 7 and 10-years:

Nifty PE Ratio 5 Years Average

Nifty PE Ratio 7 Years Average

Nifty PE Ratio 10 Years Average

Spend some time studying the above tables.

By now, you would be clearly noticing that there are big differences between the minimum and maximum returns for almost all periods.

So even though the average return figures will tell you one thing, the fact is that the actual returns that you get will depend a lot on when exactly you enter the markets and what happens afterwards.

Two different investors entering the markets at same valuation levels (let’s say PE=17.5) but at different times would have got 7-year returns ranging from 7.7% to 26.1%. Check the table for 7-year return above and you will know how.

For a lack of better word, the difference is shocking.

What this means is that even though the average return for 7-year period in the example taken above (PE17.5) is 16.2%, the actual returns have ranged from 7.7% to 26.1%.

This is equity investing for you. Welcome!

The statement that I made a couple of paragraphs before, ‘returns that you get will depend a lot on when exactly you enter the markets’, does sound like trying to time the markets. But this is a reality. I cannot deny it. For those who can, 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 analysis), 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 Avg. Returns. 🙂

This is another reason why I introduced the column for standard deviation in all tables above (see the last column of the table above).

Analyzing standard deviation tells you – how much the actual return can vary from the average returns. So higher the deviation, higher will be the variation in actual returns. For completing the scatter analysis, here are the 3 remaining scatter plots for 5, 7 and 10-year returns:

Nifty PE Return 5 Year Scatter

Can You Catch the Markets at Right Investible PE?

Ideally, and armed with the 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. It’s like a pendulum – it keeps oscillating between overvaluation and undervaluation. It is almost never perfectly valued.

So should you wait to only invest at low PEs? Though it might make theoretical sense to do so, it is still very difficult to wait for low PE markets. And extremely low PEs are extremely rare.

Just have a look at this 5-year table I shared earlier in this post:

Nifty Time Spent PE Levels

Look at the column ‘Time spent by the Nifty in PE band’ at Below-PE12 levels.

It is just about 1.5% of the time since 1999 that markets spent below PE12. This is extremely rare.

For common investors, it’s almost impossible to wait for such days. In fact, such days might be spaced several 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). It is not perfect (like buy low sell high) but it is your best bet given all the constraints. And once your portfolio grows in size, make sure you rebalance it periodically to adhere to proper asset allocation and manage risks appropriately.

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 OK-ish to good enough, even when one invests at high PEs.

Have a look:

Long Term Investing PE Returns High

So, even if an investor puts his money in the index at PE above 24, the historical average returns are more than 8 to 10%. That’s quite ok I guess. Atleast it’s much better than being in losses.

The longer you stay invested, higher are the chances of not losing money in stock markets…even if you have entered at comparatively higher levels.

Caution – I know that’s a dangerous statement to make but to keep things simple, please read it in the right spirit and get the drift.

Now let’s compare this with someone who is thinking to invest at high PEs (above 24) for less than 3 years. Have a look at the table below:

Short Term Investing PE Returns Low

There are un-ignorable chances that the person will not do well. Chances of losing money are fairly high if you see the average figures and Minimum returns for PE24-27 and PE>27 bands.

But let me touch upon an important point now.

Will this Result change if only the more Recent Data (and not last 20 years’) is considered?

That is no doubt an interesting and fairly valid point.

In last few years, it does seem (and I repeat ‘seem’ – may be due to our recency bias) that average PE levels are much higher than what they used to be in earlier years. The Reason for this may be many:

  • One of them can be that unlike earlier years, the constituents of Nifty50 are companies which in general have high PEs. So obviously there is a case for slightly higher average PE figures as the new normal.
  • The PE figures are based on standalone numbers of constituent companies of the index. If we consider the consolidated numbers, then chances are that the earning would be higher and lead to lower (calculated) PE figures. Earlier, the difference between standalone and consolidated figures wasn’t much as Indian companies did not have large subsidiaries that would distort the figures. But as Indian companies grow and so do their subsidiaries, the consolidated figures will be incrementally bigger than standalone ones.

To accommodate these facts, it makes sense to give more weight to consolidated figures. But NSE publishes data on the basis of standalone numbers till now. So we live with it for time being.

Another option is to reduce our period in consideration from 20 years to a more recent one – like last 10 or 15 years – where the comparative difference in the nature of index constituents in not as stark as what might be (like) 20 years ago.

Ofcourse the number of data points would reduce. But we can atleast have a slightly more relevant comparison if not a perfect one. So I wanted to try out the above analysis with different (but more recent time periods).

As a first case, let’s consider the last 10 years data, i.e. Jan-2009 to Dec-2018.

Do note that the beginning of this period coincides with the depth of the last severe bear market. So numbers will change. Let’s see:

Nifty PE Return Analysis 3 & 5 Year (10 Year)

You would agree that the trend remains the same. At higher valuations (PE), the future returns reduce.

I have not done the analysis for 7- and 10-year period as the period under consideration (i.e. 10 years) is too small to have any sufficient number of data points for the 7- and 10-year analysis.

But how does this compare with our previous analysis where period under consideration was 20 years? Let’s see:

Nifty PE Return Analysis 3 & 5 Year (10 20 Year)

Spend some time comparing the above 2 tables. The left one is based on the analysis of the last 10 years and the right one is based on the analysis of the last 20 years.

The basic conclusion once again is the same.

But the extent of these returns changes when we the period under consideration is changed.

How?

Focus on the red arrows for now. The returns for PE12 case moderate from 38.7% to 23.0% (for 3-year) and from 29.2% to 18.4% (for 5-year) when we change the analysis period from 20-year to 10-year.

Now focus on the green arrows. The returns for PE18 and above (i.e. PE18 to 21 to 24 to 27 and beyond) increase somewhat for both 3-year and 5-year analysis when we change the analysis period from 20-year to 10-year.

This might be getting slightly number heavy but what I want to highlight here is that depending on the data set I chose, the return figures change to some extent (increase and reduce for different PE bands).

The overall conclusion still remains the same. But the expectations need to be revised when we give more weight to the recent past (last 10 years) than what we gave to the full last 20-year period.

You might feel that by choosing the last 10-year period, I am missing out on the Bull Run between 2004 and 2007. And rightly so.

So let’s consider a different period now:

The last 15 years (from Jan 2004 to Dec-2018).

This period takes into account the great bull run of 2004-07, the big crash of 2008-09 and the upmove since then 2009-2018.

Let’s see what the data tells here:

Nifty PE Return Analysis 3 & 5 Year (15 Year)

I may sound repetitive here – but the overall trend is still the same.

But once again, what changes though is the extent of returns in each case.

Let’s now compare 3-year and 5-year investment returns for each of the PE bands when different analysis periods of 20, 15 and 10 years are considered:

Nifty PE Return Analysis 3 & 5 Year (10 15 20 Year)

As is clearly evident, the figures moderate if we reduce the analysis period to data of the last 10 years instead of 20 years.

To be fair, there is no perfect answer as to which one should be used or which shouldn’t be. But this moderation analysis proves that we should revise our expectations to more rational levels. Due to various factors (like increasing difference between standalone and consolidated earnings and PE figures, change in index constituents and their normal valuations), we may have to keep a range of outcomes in our mind when making investment decisions. It was never black and white. It was always grey. Now it has even more shades of grey!

For the sake of completeness, I am tabulating the full findings for everything below. This includes 3-year, 5-year, 7-year and 10-year Nifty return analysis compared across various PE levels and after considering data for different sample space of 10, 15 and 20 years:

Nifty PE Return Analysis 3 5 7 10 Year

Also, note one more thing – this analysis is based on one time investing at specified PE levels.

If you are a SIP investor, then returns will obviously vary as your investment would be spread out across time and PE ranges. You cannot and should not expect to receive lumpsum-like returns on your SIP investments. The mathematical concept of average doesn’t allow that to happen.

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 the overall markets. It tells you when the market is overheating and that you should take cover (reduce equity in line with asset allocation). This, in turn, helps 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 stories and need more in-depth analysis.

I have been doing this analysis now for several years. If you wish to access old ones done in the year 2017, 2016, 2015, 2014, 2013 and 2012, then please access the archives. But I think its best to stick with this current analysis as it’s the latest and most comprehensive one till date.

I regularly update PE and other ratios of Nifty50 and Nifty500 on State of the Indian Markets page.

What Should You Do as a Common Investor?

I am assuming that you are not Warren Buffett. 🙂 But jokes apart, the 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 a regular disciplined way of investing (easily achievable through MF SIPs). A proper way to do it is to first find your real life goals that require money (use this free excel) and then stick to Goal-based Investing. This is more than enough to begin with.

And once your corpus size grows, you should regularly rebalance your portfolio to de-risk it when needed and to position it for better risk-adjusted returns in future.

With that taken care off, you should try to invest more when market valuations are low. This will help increase your overall returns in the long term.

This is easier said than done but this is what really works in the market.

To sum it up…

There is a reasonable (but not guaranteed) correlation between the trailing PE and Nifty returns. And this study proves it and provides some useful insights. If we were to go by the historical data, the Nifty delivers higher return (in long-term) whenever investment is made at low PE ratios. On the other hand, it tends to deliver low to negative returns whenever investment is made at high PEs and when the investment horizon is short. You as an investor can use this insight as a backdrop to take your investments decisions.

 

I hope you found this detailed and comprehensive PE-Return analysis useful.

I will try to revise this study with new data points and other insights as and when practically feasible.


Answers to 20 Important Questions about Term Life Insurance

 

20 questions Term Life Insurance

Term life insurance is the most basic form of life insurance. And I can safely say that it’s the most effective and the best form of insurance.

Why?

Because it gives you a very high insurance coverage (sum assured) at a very low premium. It’s perfect!

Many of you know about the benefits of choosing a term plan when compared to the whole menu of the available life insurance varieties. But this post is for those who are still not sure whether buying term insurance makes sense or not.

So here are answers to a few common questions that people have about term insurance plans.

Q1: How does Term Plan work?

A1: The buyer buys a term plan for a specified tenure. Let’s say 30 years. Now if the premiums are being paid regularly, then if the insured person dies between today and the 30th year, the insurance company will pay the sum assured to the nominee. If the person does not die during the tenure of the policy, nothing will be paid to either the insured person or the nominee.

Q2: Most people won’t die. So money paid in term plan premiums will be lost?

A2: Wrong way to look at it. Term plans are incredibly cheap. You can get a term plan of Rs 1 crore for just Rs 10,000 or even lower. On the other hand, a traditional insurance plan (like moneyback and endowment plans) can cost about Rs 25,000 for just a Rs 5 lac cover. The first thing to note is that this doesn’t make sense when you compare it with term insurance premiums. Second is that if you die, a payout of Rs 1 crore is more useful for your family than a payout of Rs 5 lac. Agreed that you won’t get anything back in term plan if you live. But what if you want to buy a Rs 1 crore cover using a traditional plan? Try to find it out. The premium will be so huge that you might not even be capable of paying it. So term plan allows you to give bigger protection to your family at a much lower cost.

Q3: What if I am lucky and don’t die? In any case, the premiums would be lost right?

A3: Read the answer to the above question again. That should convince you. Remember, insurance is being bought to protect the financial well being of your family if you die. It is not for your well being. But if it could make you feel any better, what you can do is this – Instead of buying a Rs 5 lac endowment plan for Rs 25,000, you go ahead and buy Rs 1 crore term plan for Rs 10,000. The amount you saved this way is Rs 15,000. Right? Invest this amount every year in equity funds. Chances are high that the total value of your investment after several years (like 20-30 years assuming that is your insurance policy tenure) will be much higher than what your Rs 5 lac endowment plan would give on maturity. And what more, all this while you had a big cover of Rs 1 crore as you bought the term plan. You get the best of both the worlds.

Q4: How much term insurance cover should I take?

A4: It is quite popular to go by thumb rules and take a sum assured of 15-20 times your current annual income. So for example, if your annual income is Rs 10 lac, you can buy a cover of about Rs 1.5 crore. But it’s better to not go by thumb rules alone and instead calculate it correctly. You can refer to this detailed post that I have already written on this topic – How to calculate the right life insurance amount?

Q5: How to decide the Right tenure of the Term Plan?

A5: Under most circumstances, an insurance cover may not be required much beyond retirement. And that is simply because most of your financial goals will be over by then and you would also have accumulated enough money to take care of your dependents (mostly spouse) if you were to die. So if you are 25, then you can take a cover of 35-years which covers you till you turn 60. But if you are 38, then even a 22-year term plan will be sufficient. Shorter the tenure, lower the premium. But if you want to be conservative, you can opt for a slightly longer tenure than what is necessary and just stop paying the premium when the need for insurance is not there. You can refer to this detailed post that I have already written on this topic – How to find the right tenure for the term life insurance policy?

Q6: Term plans are cheap no doubt. But why are online term plans cheaper than offline ones?

A6: When a term plan is purchased online, the costs incurred by the company are less, as there is no middleman between you and the insurance company. This lowering of cost is passed on to you as lower premium as no commission has to be paid to any agent. Most companies offer online versions of their term plans. If you are looking to buy the best online term plan, be sure to do your research and compare across insurance providers and then make the final decision.

Q7: Is the premium of term plans same for everyone?

A7: No. It varies for everyone as it depends on the person’s age, chosen policy tenure, the sum assured, payout method opted for and other premium loadings (if any) due to medical or lifestyle reasons.

Q8: Does the premium of the term plan change during the policy tenure?

A8: No. It remains the same.

Q9: If I die, are there different options in which the sum assured gets paid out to my nominees?

A9: Yes. Insurance companies allow you to chose how the money is paid out to the nominee in case of your death. Suppose you take a term plan of Rs 1 crore. Now if you die, the money can be paid out as any of the following (depending on what you have chosen):

  1. Full Rs 1 crore paid at the time of death
  2. Rs 10 lac paid at the time of death. Remaining 90% (i.e. Rs 90 lac) paid out equally as Rs 50,000 monthly (0.5% of sum assured) for next 15 years
  3. Full Rs 1 crore paid at the time of death. Additionally, Rs 50,000 paid monthly (0.5% of sum assured) for the next 15 years
  4. Full Rs 1 crore paid at the time of death. Additionally, starting with Rs 50,000 monthly (0.5% of sum assured) and increasing by 10% every year paid out for the next 15 years
  5. And there can be many other options depending on what the insurance provider is offering at that time.

Obviously, the premiums charged in each variety would be different. Which one should you chose depends on your need. If your nominees know how to manage a large amount to generate regular income, you can go for simple 1st option. But if you feel they are better of receiving money regularly, then probably you can go for 2nd option (or even the 3rd or 4th option which will have higher premiums). You can even have 2 separate policies with different versions chosen for payout in case of death.

Q10: Should I opt regular premium or single premium?

A10: You can choose either. In regular, you pay premiums every year. In single premium, you premium once and never again. But let’s say you buy a 25-year term plan and die after 5th year. Now if you have taken the regular premium route, then you would only have paid 5 small premiums. But if you had opted for the single premium, then you would have paid in one go and that potentially means that the 20 premiums got paid extra as you died early. Nominee gets the same amount irrespective of what you chose. But I think that’s too small an issue to bother about. You can actually do whatever you feel comfortable with. Some people want to just tackle it upfront (via single premium) and be done with it. Others don’t have a lot of surplus money to do it so prefer regular route. Whatever works for the buyer.

Q11: Does it make sense to buy term plans early or I should wait for some time?

A11: The premium amount increases with age. So earlier you buy, better it is. Also, with passing age, it’s possible that you may unluckily develop some disease that might make it difficult to get a policy later on. So don’t wait too long to buy a term plan later on. Buy it as soon as possible even if it seems too early to do so.

Q12: Does the term plan pay out even if I die in an accident?

A12: Yes.

Q13: Wouldn’t a Rs 10-20 lac term plan cover be enough for me?

A13: No. Don’t be penny-wise pound-foolish. Simply answer this question – If you die today, will your family be able to maintain their lifestyle, pay for children’s higher education, pay off loans and live well for decades to come in just Rs 10-20 lac? The answer will be a big No. So take a plan that takes care of all the above things. You can refer to the earlier mentioned post (about the same question) – How to calculate the right life insurance amount?

Q14: Will Rs 1 crore insurance be sufficient?

A14: Maybe yes. Maybe no. It’s not necessary. Different people will have different optimal insurance coverage requirements. Read this – Is Rs 50 lakh to Rs 1 Crore term insurance enough?

Q15: I want to take a term plan of bigger amount, say Rs 2 crore. Should I split it?

A15: You can do it. But keep it limited to 2-3 policies max. Better limit it to just 2. If you die, your family will have to run around to get all the policies paid out. So think from that perspective.

Q16: What if I am outside India if I die? Will it still pay money to my nominees?

A16: Yes. In most cases. Unless you go and die in a country that is on the unsafe list of the insurance company. So check the list before choosing a country to go and die!

Q17: I want to buy a term plan. But I have a health condition (or family’s health history is odd). Should I hide this information?

A17: Please don’t hide any such information. Death claims can be rejected if the insurance company finds out that you had hidden any critical information. So don’t do it. This may result in slight loading of premiums (increase in premium) that you have to pay. I think that’s much better than having a hanging sword of the possibility of claim rejection in case of death. Be willing to accept the loading of the premiums and move on with it.

Q18: I have few existing insurance policies. Should I disclose them while buying term plans?

A18: Yes. Don’t hide these either. There is nothing bad in having previous insurance policies.

Q19: I have purchased the term insurance. Now what?

A19: Tell your nominees about it. They should be aware of the policy in case you die. Only then they can claim the amount. Isn’t it?

Q20: Anything else?

A20: Stay healthy and try not to die. Your family will get the money if you die. But that’s not an ideal scenario. Isn’t it?

I hope that if you or someone was looking to answer – How to buy the right term life insurance policy? – then they found this article useful.


My Interview Stable Investor

My Interview with Stock & Ladder

My Interview Stable Investor

Recently, I got interviewed by Ravichand of Stock & Ladder. The interview was originally published here (at Investing Chat with Dev Ashish).

It covers my background, investment philosophy (and how it has evolved over the years), how I invest and other related aspects. I thought it would be useful to publish it here as well, for the benefit of existing readers of Stable Investor.

This investing chat is a long one at about 6000 words and may require some time. But I hope you find it useful and worthy of your time.

So here it is…

_____________

Ravichand (S&L):  Hi Dev, Firstly a big thank you for sparing some time to share your thoughts with the readers of Stock and Ladder. First up, please tell us something about yourself especially the part about how you got into the world of investing and Personal finance.

Dev: Thanks Ravi, for considering me worth interviewing.

My story isn’t very inspirational or anything like that. I am just a regular person.

Being born in a family of lawyers and doctors, chances were high that I would take a similar path. But I have been the odd-man-out in my family. Maybe it was because of the powers above which had a very different plan for me and so, I began my journey in a completely different direction.

Currently, I am a practicing SEBI-registered Investment Advisor.

But even though I had a noticeable interest in finance since I can remember, I still went ahead and did my engineering. Later, I joined a government sector oil company and got posted in a remote location.

After working there for a few years, I made a conscious decision to gradually align my life and work towards my area of interest – which was investing in particular and finance in general.

This, however, was not going to be easy as for doing that, I would have to quit my safe government job. It was a tough decision but my family and then-friend-now-wife backed me fully for the decision.

So I quit, did my MBA and then joined a private bank. After a few years, I got a very good job offer from a startup. I was no doubt happy with the offer in my hand.

But I spent some time contemplating whether it was actually what I wanted to do. In the end, it didn’t seem like it. I realized that if I had to do something on my own, I had to take a call sooner or later.

So after having several rounds of discussion with wife, parents and a few people I consider to be my mentors, I quit my job and decided not to join the startup.

I decided to take a plunge into what I really wanted to do. I must mention here that I had sufficient savings by then to make this decision.

I took a license from SEBI to start my Investment Advisory practice and that’s what I am currently doing. After having worked in metros and other cities, I returned back to my hometown Lucknow, where I currently stay with my family.

Though my target eventually is to achieve financial independence, I think I can safely say that I will never actually retire, as is the norm in our family of doctors and lawyers.

As for my interest in investing, it got kindled when I was quite young. My father and grandfather had money invested in shares of a few MNCs. So every now and then, we used to get dividend cheques from these investments.

On enquiring, my father explained that these cheques were dividends – which he was being paid to hold pieces of paper (physical shares then).

This attracted me like anything. I just fell in love with the idea of getting a regular flow of passive income without going to work for somebody else! This was as clear a case of money working for you (rather than the other way around) that there could be.

So you can say that there wasn’t any one single moment when it happened for me. The seed was sown very early on and I tried to gradually align my life towards investing and working for my own self.

 

Ravichand (S&L):  That’s wonderful Dev. Not everyone can make their passion the means for their paycheck and many usually end up spending their lifetime helping someone else build their dreams.

Mark Twain’s golden words come to my mind “Twenty years from now you will be more disappointed by the things you didn’t do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover.”

Let’s get into investing proper. Tell us something about your investing philosophy and how it has evolved over the years?

Dev: I am 33 but have been investing in markets for about 15 years now. But initial few years are a grey area from investment philosophy perspective. Consciously or unconsciously, I was trying out several things then.

And to be honest, I did not even have a philosophy in those initial years. I simply went after ideas where I felt the probability of making money was reasonably high. Luckily, I have had this inherent bias of being a little conservative when it comes to stock picking. So more often than not, I gravitated towards good companies with proven businesses (this is an approach that I am still loyal to).

I am not exactly sure why I have had this conservative bias. Maybe it was due to my family’s history and me as a child having observed that most of the investments were in mature, dividend-paying safe stocks.

But whatever it was, I still made decent money. Maybe I got lucky in several cases. And I cannot ignore that I was amply helped by the rising tide of our great Indian bull run of 2004-07.

Thankfully, I have had an inquisitive mind that tries to look for answers to how things work. Not just in finance but everywhere. And one of the things that I really wanted to understand (after a good experience during the Bull Run) was what actually made the stock markets work and behave as they do.

So this pushed me into reading about markets and investors. Luckily, I got exposed to Warren Buffett and his philosophy at the start itself. And Mr. Buffett led me to Benjamin Graham.

The more I studied these value investors, the more I felt that value investing was best suited for me. Here I must say that I have nothing against other schools of investing. 3 plus 7 is 10 and so is 5 plus 5. So there are several ways of making money. It was just that value-conscious investing attracted me the most.

So from then on and for many years, most of my investments were based on valuation attractiveness. And I loved investing in dividend plays. Being valuation sensitive, my process was numbers driven.

But slowly I started realizing that just focusing on numbers wasn’t enough. Why? Because I was regularly missing out on other attractive opportunities that were not attractive valuation-wise.

So in due course of time and after having missed many good money making opportunities, I decided to gradually tweak my way of investing.

Valuations still mattered for me. But I was now willing to pay up (more than what I was earlier comfortable with) if I could find businesses that were of high quality, had good conservative (or let’s say non-adventurous) management, predictable growth runway and manageable debts which gave them some ability to suffer for extended periods of time.

So from a pure valuation’s guy, I became a valuation conscious investor who was willing to embrace growth. Not too much but still ready to pay up to an extent.

So instead of focusing on the cheapest stocks available, I was going after comparatively higher quality cos. which were not very cheap.

Along the way, I continued buying good companies when they faced temporary bad events. So in a way, I was and still operate as a virtual bad news investor.

This reminds me of a good analogy about why we should stick to good companies. Tennis balls are costlier than eggs. And both the egg and the tennis ball will fall occasionally. But only the tennis ball will bounce back. As for the egg, you know what fate does to a falling one. So when buying businesses, buy tennis balls. At least they will bounce back when they fall.

As of now, my approach is a little more structured than what it earlier was.

  • I run a core portfolio of about 20-25 stocks. But to ensure that I bet convincingly in my main picks, about 80-85% is allocated towards the top 12-15 stocks.
  • Remaining are ideas that I am either still working on and/or where I am yet to build full conviction about. I generally try to ensure that none of the stocks hold more than 12-15% of the overall portfolio.
  • A majority of the stocks in the core portfolio belong to the top-150 universe. So you can say that I am a conservative investor when it comes to stock picking.
  • Many people think that large caps cannot make money. I don’t agree but I don’t try to convince anyone now. Large caps have worked wonders for me over the years. So I stick with them.
  • I also run a smaller (call it satellite) portfolio where I enter into short-medium term bets. This is more to take advantage of temporary mispricing and other low hanging fruits.
  • Of course, it is easier said than done and chances of being wrong here are immense. But that’s fine. It’s my way to tackling my urge of doing something every now and then and trying to be the next Buffett.
  • And luckily, the results haven’t been bad and provide for more money to be pumped into the core portfolio.
  • I also maintain a watchlist of stocks where I keep an eye on businesses that I wish to buy but which still aren’t in my portfolio for some reason or the other.
  • Over the years I have realized the power and option that cash brings in times of distress. So I ensure that I regularly put aside some money in suitable debt instruments to act as a Market Crash Fund.
  • You never know when the market might throw up some interesting opportunity. So better to be prepared. This way, I will not miss having CASH, when there is a CRISIS and I have accumulated enough COURAGE to venture out in tough times.
  • The above point, as you might have guessed, refers basically to the idea of sitting on cash. And I swear it is extremely difficult to do. More so when I see people around me making easy money.
  • But in the long run, I think restricting the number of bets I make in most convincing ones (in my view) is how a larger part of the wealth will be created. So I try to sit on cash and do nothing if there is nothing to do.
  • Apart from direct stocks, I have a goal-specific investment portfolio that has equity funds, debt funds, PPFs, deposits, gold, etc. One of my major life goals is to become financially independent by 40. So these investments are aligned towards that goal.

There is one thing that I have learned over the years. And maybe this is because I still pay my respect to valuations.

A good investor knows that it is only occasionally that he has to do something. And when the time comes, he has to and should do that ‘something’. And then, there is no need to do anything else. Money will be made in most such cases.

 

Ravichand (S&L):  Dev, that was the most detailed way someone has ever shared their process. That’s a great blueprint on which we can build our own investing framework.

As regarding to the way you have gravitated towards value investing, I remembered what Seth Klarman said “It turns out that value investing is something that is in your blood. There are people who just don’t have the patience and discipline to do it, and there are people who do. So it leads me to think it’s genetic”

From philosophy let’s move on to putting the philosophy into action. Tell us, what are the criteria’s or characteristics you look for in a business for it to be considered investment worthy?

 

Dev: I don’t have a very long checklist.

But broadly, I check stocks around 3 things – quality of the actual business, quality of the management and price in relation to my view on valuation of the stock.

Obviously, there are several things to check within these 3 broad heads.

Quality of business is all about doing the typical number-oriented analysis like examining sales and profit growths, margins, etc. – for the company and the industry peers.

Analyzing how industry and economy-specific environmental variables have impacted company’s trajectory in the past. And that of its competitors. Cost and capital structures and power that suppliers and customers have on the company or vice versa.

Then a good return on equity and return on capital are no doubt important. A less leveraged balance sheet is preferable as it makes business more robust in trying times.

I prefer sticking with businesses that have some barrier to entry that is not evaporating at least in the medium term. These are just some of the factors that I try to assess the company on.

Then there is that grey area of having a view on future growth of the business and more importantly, longevity of this expected growth. There is a big possibility to get this wrong but you need to have an objective and unbiased view on this to make your bets.

I will be honest that the quality of management is a difficult one to judge. And quality not only means their business sense but also their integrity.

So no matter how deep I go with analyzing these factors (from various sources), there will always be a chance of being completely wrong. But that’s fine. Sticking to what information is available and what signs the management is sending via annual reports and other ways is what I stick to. I really cannot get it right every time.

Even after several years in the market, I regularly end up feeling like an amateur when it comes to picking stocks. I am improving but there is a lot to learn.

I do run excel models but none of them are extremely complex or fancy. That’s because I feel that if I need a very complex model to prove a stock as a worthy of investment, then maybe it’s not that good after all.

Also, businesses are run by people and not excel spreadsheets. An Excel model cannot be an alternative to thinking. And that is where our subjectivity and biases come.

I think that good investment ideas are very simple. And to be fair and acknowledging the limitations of my ability to analyze any and everything, I would say that a stock idea has to be so good on just a few parameters that it should just jump out and find me rather than me trying to find it out.

And last but not the least, and extremely important… there is valuation. It is very subjective and what is undervalued to me might look overvalued to someone else and vice versa. But that’s how it is.

The stock should be in a comfortable valuation range for me to buy it. I generally start buying in small lots and accumulate over a course of time. I am not very comfortable buying large quantities in one go.

Here I will say that I generally avoid talking about the stocks I own or am contemplating owning. It puts unnecessary pressure on me as an investor to defend my position every time there is a news (which may or may not be relevant for me as a long-term investor). The ability to ignore and filter out the short-termism is I think necessary to operate well as a long-term investor. And there is no competition. So I try to reduce the stress to the extent possible.

Generating alphas is in itself so difficult, so why take on additional stress to justify your picks to people who may have different investment horizons or risk taking capacity. Isn’t it?

Remaining silent is all the more important as a valuation-aware investment strategy does not work all the time. Markets don’t and won’t always agree with you.

So going through extended periods of under performance is necessary and fine with me. I am more than willing to have return-holidays if I can get better longer-term returns.  As they say that as a real investor, you should be willing to be misunderstood in short-term to be right in the long-term.

Talking of investment criteria’s I think I should also share my views on the somewhat related and important aspect of cycles.

Over the years, I have come to appreciate the importance of mean reversion. Or let’s say how cycles play out. I don’t have any expert advice to offer on this front as this topic tends to tread in the territory of market timing.

But I believe that we can improve our long-term investment returns by adjusting our portfolio in line with cycle requirements.

Talking of cycles, think of it like this – when recent market returns are high, the attitude of the masses towards risk changes. People forget what their real risk tolerance is and get comfortable taking more and more risk in search of better returns.

This is exactly what sows the seed for future declines. And when the time comes and the delicate balance is disturbed by some external event, it pushes the market off the cliff. That is where the cycle turns.  So if one learns from the past data, then there are indicators which highlight when people are getting irrational. The same case can be built around people’s unreasonable fear after the market falls.

It is at such junctures that some level of portfolio adjustment (by re-balancing or taking cash out or bringing it in the portfolio) can improve future returns.

This requires operating against the herd. This is about being contrarian in real sense and not just for the heck of it. Which is easier said than done but with each passing year, it becomes not too difficult.

 

Ravichand (S&L):  Completely agree on the point of simplicity and thinking of simplicity, Peter Lynch’s famous quote comes to my mind “Never invest in an idea you can’t illustrate with a crayon”.

You also brought up the important topic of market cycles which I believe to be a topic that every aspiring investor should be familiar with. Howard Marks book Mastering the Market Cycle: Getting the Odds on Your Side is an excellent read on market cycles.

From checklist let’s talk rules. If there were to be “Dev’s 5 rules for successful investing” then what would that be?

Dev: I feel there are no perfect rules out there for successful investing. Any day it is possible that the bets we make due to all our successful investing framework (that we are proud of) and where we have the maximum conviction, turns out to be super bad.

But if I had to list down few important realizations that I have had, then here are my rules:

  • Stick with good businesses run by capable and trustworthy management, which have the ability to survive bad years comfortably and operate in industries having clearly visible and reasonably long growth trajectory. As simple as it sounds, this I believe is the most effective filter to reduce the number of potential stock ideas.
  • Valuation should not be ignored at any cost. But be ready to pay a fair price for good businesses. Every now and then, the markets will surprise by offering unbelievable deals on a platter.
  • You may have the courage to go out, but if you don’t have the cash, forget about taking advantage of such few-in-a-lifetime events. So be prepared with surplus funds to the extent possible. It will test your patience. But that is the price that you should be willing to pay.
  • There is a time to be brave and there is a time to not be brave. Don’t try to be brave all the time. Protect and secure what you have earned. Remember Buffett’s 2 rules about losing money. Be willing to be laughed at for your investment ideas. But that is when it will work. In investing, you want others to agree with you…but later.

 

Ravichand (S&L): Great set of rules, Dev. The importance of protecting your investing capital cannot be emphasized enough. When you read the investing rules of super investors, the point that return of money is more important than return on money becomes obvious. 

Next let’s talk mistakes. Mistakes are sometimes referred to as “unexpected learning experiences”. Can you share any investing mistake(s) you have made and what were the learning?

Dev: Let me talk about my mistakes.

One of my major mistakes (and I repeat it) has been to not average up when I entered in a good stock early on. You can say that I got anchored to the price I got in first. The result is obvious. I could have made a lot more money in absolute terms than what I made when you look just at the CAGR figures.

Selling early is also one of the crimes I regularly commit. The reason might range from increasing overvaluation to change in unintended negative signals that the management might be sending. But selling early has cost me in past. It’s like waiting for that elusive 20- or 50-bagger. For that to happen, you need to stay put and go through 5x, 10x, 15x and so on sequentially. You cannot jump straight to the 50x. Isn’t it?

At times, I did not pay attention to valuation when deciding to buy a stock. Very often, it backfired. One thing that we should not forget is that it’s not just what you buy that makes for a good investment.

It is also about what you pay for it. Valuation is something that really cannot be ignored. At least not for me. And you know what the biggest problem apart from these mistakes is?

keep repeating these 3 all the time. The frequency is reducing. But maybe I can just never eliminate these fully.

 

Ravichand (S&L): To be honest, I believe that these mistakes you have mentioned would have been committed by every single investor. It’s only with experience and spending time in the market that we can avoid these potential investing landmines.

From Mistakes let’s talk on the skills required to succeed. What do you believe are the skills one need to hone for becoming a better investor?

Dev: I am not too sure about how to answer this question. But I feel that investing is unnecessarily made out to be too complex. It is in essence pretty simple. Some are born great investors. For others, I think they should do/have the following:

  • Basic understanding of how businesses work and make money. Before investing, think of how you would be running the business of which you are planning to buy the stock. Have an owner’s mindset.
  • fair idea of finance, accounting and what numbers are telling or what they are ‘forced’ to tell or what they are hiding.
  • A growing understanding of how the market works and more importantly, how market participants (and not just investors) behave under different market conditions. This isn’t exactly a skill but for this, there is a need to study market history.
  • Reading is essential. To learn about how others have successfully invested and also because you will need to read annual reports, etc. if you are serious about investing.
  • Now this isn’t exactly a skill but eventually, one needs to understand that just being right or wrong doesn’t mean anything. As they say, amateurs want to be right but professionals want to make money.
  • So allow me to invoke George Soros here who rightly said that it’s not whether you are right or wrong that’s important, but how much money you make when you are right and how much money you lose when you are wrong that’s important.
  • You may call it skill, insight or art… whatever. But this is required to grow the portfolio.

 

Ravichand (S&L): Cannot agree more on the importance of reading in the life of an investor. Munger famously quipped “In my whole life, I have known no wise people who didn’t read all the time- none, zero” From skills required we move onto lessons learnt.

What has been the most important investing lesson(s) you have learnt from your time in the market?

Dev: You ask tough questions Ravi!

There must have been several important things that I must have learnt along the way. And to be honest, I may be still too young and inexperienced to know which one is the most important one for me.

But in recent years and as the portfolio size grows, I have come to realize that it’s not just important to push portfolio to grow faster. It is also important to start protecting what one has.

This may sound like being conservative at times. But that is what is necessary. As I said earlier, there is a time to be brave and there is a time not to be brave.

Of course when one decides to become aggressive and when one switches over to being conservative is fairly subjective. Mean reversion and how cycles work in the market is something that should be respected here.

We may not feel any urgent need to accept the cyclicity in market behavior when we start investing. But I think cycles are inevitable and more importantly, are heightened by the investor’s inability to remember the past.

Investor’s attitude toward risk also goes through a cycle. Of course the speed and timing of the cycle matters, but I hope you get the drift of what I am trying to say.

You need to position yourself and your portfolio after giving a deep thought to the cycle. Cannot ignore it. And that’s because at the extremes of the cycle, things can get really strange and uncontrollable if you don’t know what hit you or you aren’t positioned correctly.

 

Ravichand (S&L):  Loved the lessons especially the one on the need to be brave and act decisively when needed. All the bookish knowledge like “Be greedy when other are fearful” or “Buy when there is blood on the streets” etc. are not useful if we are not going to act on this knowledge. Brian Tracy put this beautifully “Think before you act and then act decisively. Fortune favors the brave.”

From lessons let’s move on to advises. What has been the most important investing advice(s) you have received on investing? How has it influenced your investing process?

Dev: I admire a lot of famous investors as they have provided the intellectual base for my investing life. And I am grateful and lucky to be influenced by them early on.

But I think the most important investing advice I received was from someone whom I regularly interact to discuss ideas. He is a not-so-small investor but likes to remain in hiding.

What he told me (and keeps repeating) is that if I wanted to make good money in the long run, I needed to have a thick skin. And I needed to become deaf.

Why?

Because successful investing is all about being contrarian and making people agree with you…but later.

So in between, you will have to listen to all the reasons from others about why you are wrong and why they are right. But assuming you have done your homework before taking the position, you need to ignore all the pressure that is coming to you.

And for that, you need to have a thick skin and turn deaf. If you watch the movie ‘The Big Short’, this is exactly what Christian Bale playing Michael Burry is symbolic of.

Being contrarian isn’t easy. If I see some good opportunity to invest and the market seems to ignore it, then chances are that the particular opportunity exists because the conditions aren’t favorable for it yet. Or else price would have moved up already.

So if you have a thick skin and you are deaf, then you can be comfortable with people misunderstanding you in the short term. Eventually and in long term, you will be right and make money.

I know that there is always a risk of being arrogant if you do so. Who knows and it’s possible that you may be wrong in your judgment and others might actually be right. But that is fine. In investing, even if you are right 4-6 times out of 10, then you can make serious money (depending on your position sizing).

Other important advice is more on the personal finance front. My father has always been of the view that the allure for more wealth is an unhealthy obsession. It’s unnecessary and it’s not worth it.

He has time and again told me that we don’t need a lot of money to feel good. Having enough money and free time is more important. And as I age, I agree with him more and more.

 

Ravichand (S&L): John Neff described the essence of contrarian investing nicely “It’s not always easy to do what’s not popular, but that’s where you make your money. Buy stocks that look bad to less careful investors and hang on until their real value is recognized”. Indeed a contrarian strategy is highly rewarding as long as we take care of few key things about contrarian investing approach.

Next we move from advice to influencers. Is there any particular investor(s) or author(s) who have had a significant influence in your investment thinking?

Dev: I read a reasonable amount of text (and not just books). But as years pass, the incremental benefit I get from reading new books keeps getting smaller.

Nevertheless, the investors/authors that have had an impact on me are Benjamin Graham, Warren Buffett, Charlie Munger, Peter Lynch, Howard Marks, Seth Klarman, Nassim Taleb and Daniel Kahneman.

But I must say here that one should read a lot. We really don’t know which idea in which book might influence us in ways we can’t even imagine. And who knows what learning we get from any particular book might be used for our life decisions.

And we are always just one decision away from a completely different life. So keep reading. It’s your mind’s software update mechanism.

 

Ravichand (S&L):  Reading is a theme which gets emphasized by all the guests I chat with. Munger put it best “I don’t think you can get to be a really good investor over a broad range without doing a massive amount of reading.” Next up is one of my favorite question.

Let us say a bunch of enthusiastic beginners approached you for advice on how to be a better investor then what would your advice for them be?

Dev:

  • It is very important to study great investors and also about companies that survived and ones that did not survive.
  • The market does not reward activity. Others will tell and push you to do something or the other at all times. But money is made by not doing anything most of the times. So be ready to do nothing 95% of the time.
  • Since you will have a lot of time, be willing to read a lot. And I mean a lot. And use this time to upgrade yourself with core knowledge as well as practical insights about how various industries actually work and make money.
  • Market cycles and investment behavior influence each other. Spend time learning about this aspect. For this read up on market history across cycles.
  • As you keep investing and learning, slowly build up your checklist of factors that you should judge a business and its stock on. No book or no one can teach you what comes from putting your money on the line.
  • So begin investing and learn in parallel. Losing hard earned money on your bets is the best teacher. It gives you a perspective that nothing else can.
  • Luck plays a lot bigger role in investing than you may attribute it to. Be humble and grateful and more importantly, acknowledge (at least privately) if you made money due to luck and not skill.
  • Have a thick skin but don’t be arrogant. This won’t come easy. So give yourself time to go through the process of growing a thick skin. Jokes apart, what I am trying to say is that be ready to take a contrarian stand and be ready to take brickbats for it.
  • But also be willing to acknowledge and backtrack if you have made a mistake. You are here to make money and not prove whether you are right or wrong. Bury that ego in a flowerpot.
  • This is difficult – as the years pass, try to be unemotional about investing. I don’t know how as there is no perfect recipe. But you have to gradually and intentionally reduce the role of emotions in your investing life.
  • If you are a beginner then you will not understand the gravity of this advice. But it is far more important than what people will ever realize.
  • You will only appreciate a good market when you have been through a bad one. So be ready to face the bad one sooner or later. It will humble you and help later in life when your portfolio is larger.
  • On a personal front, realize that time and health matter more than your wealth. And please do remember that you always know how much money you have, but you never know how much time you have. So act accordingly.

 

Ravichand (S&L): I think that’s a great set of advice for beginners. On studying great investors, that is precisely what Stock and Ladder is focused on. I also think your point on time and health is very important but we rarely bother about it when we are beginners. On health, I like what Jim Rohn said “Take care of your body. It’s the only place you have to live” Next question is on my favorite activity – reading. If you have to recommend 5 books that every investor must read then which ones would that be?

Dev: To answer your question specifically, here are the 5 books:

Also, re-read these books (or ones you respect) every few years. You will gain new insights from the same books as by then, you would have gained more experience. Also because you could relate the information in these books to various other texts that you must have read elsewhere in between your re-readings. I must mention here that reading is fine. And necessary and there is no substitute for it.

But reading alone is not enough. Don’t expect to be rich and happy just by reading a lot of books. You need to read, adapt and use the understanding to invest and live well.

 

Ravichand (S&L): Wonderful reading list and a great point on applying the knowledge as Aristotle put it “The mind is not only knowledge but also the ability to apply that knowledge in practice”. Even good things need to come to an end like this wonderful conversation and here’s the last question: Outside your passion for stock market and investing, are there any other interests / activities which are close to your heart?

Dev: I like to travel. And I am lucky my wife shares this interest too. We try to visit a new place every 6 months or so.

Also, I believe that I am an ancient mountain soul! So every year, I just have to spend at least a couple of weeks in the hills or mountains. That you can say is my indulgence.

As you might have already guessed, I also like to read. Not just books on money but a lot of other stuff as well. My interests lie in space science, science fiction, aerodynamics, ancient civilizations, etc.

Walking is something that I do a lot. No particular reason for it. I just like it.

Formula 1 is my longtime favorite sports. So almost 20+ weekends a year (that’s the approx. number of races) are booked to watch it. My wife hates F1 as they take up the weekends at odd hours.

Other obvious sports interest is watching cricket. I don’t play but spend a lot of time reading up on cricket records now.  Socializing a lot is not my cup of tea. But I am lucky to have a few good friends and we meet often. That’s it.

Thanks Dev, it was a very enlightening, interesting and insightful conversation. Wishing you the very best in your career and life.