How much Housing Loan should you take?

How much Housing Loan should you take_

Most people need a housing loan to purchase their first house. And I know what you might be thinking when you saw the title of the post ‘how much home loan should you take’.

As much as possible or as much as I can afford. Isn’t it?

But before we talk about in detail as to how much home loan should you take, let’s give some thought to the on-going but growing debate between buying vs renting a house.

I will try not to take sides but it is difficult.

A house in spite of being the biggest expense of most people’s lives is also an emotional decision. And no number can be attached to this emotion. No matter what the online buy vs rent calculators might be telling, I believe that most people would want to buy a house eventually. That’s what makes us human. 🙂 Ofcourse there will be some who feel that staying on rent forever is the way to go. But such people are still in a minority.

Now I am not a very big fan of real estate as an investment. I prefer equity. But I also feel that having one house somewhere is a good idea. Whether you decide to buy a house early in your career or later is a personal decision. Since I mentioned the word ‘investment’, here is an old but detailed analysis of investing in Equity Mutual Funds vs investing in Real Estate. You might find it interesting.

So let’s come back to the agenda for this post

How Much Housing Loan Can You Take?

This is not an easy question for most people but it also has a mathematical approach to help you decide.

Let’s look at it from the lender’s perspective. What does a bank/organization giving home loan wants to know?

  • Do you earn enough to be able to service the home loan EMIs?
  • Will you continue to earn enough to repay the home loan fully in future?
  • How has your past loan repayment behaviour been? Did you miss paying EMIs occasionally or regularly?
  • Do you have other loans (like a car loan, personal loan, education loan, etc.) where you are already servicing the EMIs?
  • Do you have some other financial assets as well?
  • Can you bring in some money (about 20% downpayment) from your own pocket to make the house purchase?

These are some of the major factors that lenders consider among many others.

Now generally, lenders have this rule that says that you should only be using about 30-40% of your income for loan repayments. Let us assume 40% for simplicity.

So if you earn Rs 1 lac per month, lenders will give you a loan that has a maximum EMI of about Rs 40,000 (i.e. 40% of Rs 1 lac).

If now you do some reverse calculations, you will know what home loan amounts are available for the EMI of Rs 40,000 per month. Ofcourse the loan amounts will vary for different combinations of loan tenures and interest rates.

So from the lenders perspective, we have answered the question – What percentage of monthly income should my home loan EMI be?

But let’s be practical, I am pretty sure that most people would be willing to stretch this ‘40% of monthly income as EMI’ to even ‘50% or even more of monthly income as EMI’ if the right property comes along. Isn’t it?

But should you do this?

Because this will obviously impact your ability to manage your personal finances, savings for other financial goals and your lifestyle. And everybody has a different expense pattern so it is difficult to say anything in general. So some people will find it comfortable even if they have to pay more than 50% of their income as EMI. Others will find it difficult to pay even 30% of their income as EMI due to higher expenses.

Also, what if you are taking a loan with your spouse and eventually the plan is for your spouse to quit working? Will you still be able to foot the entire EMI bill from single income?

Some feel that renting for some more years is better than choosing a small house just to keep your loan EMIs down. Then there are others who feel that it’s better to buy a house (even if small) soon and then, later on, when income is higher, they can buy a bigger house by selling the first one.

Both seem to be practical approaches. To be honest, it’s difficult to judge anyone here.

Buying a house as soon as possible gives you the satisfaction of having arrived in life. You own a house dammit! 🙂 You are also protected from the future increase in property prices as you have already made your purchase. You can then use fresh enthusiasm and free surplus income to pursue other financial goals (free excel download).

Buying a house later when you are more settled and have a higher income is also one common approach. Since income is high, you can even go for a bigger and better house (assuming you need it) as you can service a bigger loan and EMIs as your EMI/Income Ratio (40% max) has a bigger denominator.

As I said earlier, both approaches are right for different types of people. It’s a personal choice.

You already know that your credit history plays a major role in the lenders deciding whether to lend to you or not. Your cibil report tells the lender how you have been repaying your past loans. Have you been a good borrower who repays each EMI on time? Or you have been a not-so-good borrower who misses his EMI every now and then and finds it difficult to close his loans cleanly.

And did you know that in some cases, your score also decides what loan interest rate will be offered to you? If your score is high, you might get the loan at a lower rate! And that can save you tons of money in the long run. So it would be a good idea to check your credit score before you apply for a home loan. Atleast you will know whether the score is good or bad and accordingly, you can negotiate with your lender for better loan rates.

Some More Thoughts

Real estate juggernaut went on for more than a decade till it eventually slowed down in last few years. Earlier, people used to keep taking loans to buy houses and sold them a few years down the line because prices were rising enough to prepay the home loan and still make a huge profit. And this was being repeated. An entire ecosystem got built around people’s interest in this asset as an investment (Read more about the reality of Indian real estate).

But people still need houses and will buy them. If not as an investment (thankfully) then as something for personal use. I offer some thoughts here about making the house purchase:

  • Buying one house is enough for you. And unless you are really getting a good deal in properties, there are other reasonably good investment options to consider.
  • If you want to buy a house in the early part of your life, then so be it. But still don’t be in a hurry. It’s a big decision. Take your time to decide it correctly.
  • Banks and other lenders want you to take a huge loan so that they can earn interest on higher loan amounts. But it’s in your best interest to not stretch yourself too much. They say 40% of your income can be used for EMI payment. But if you can bring in higher downpayment (i.e. take a smaller home loan), then it is not a bad idea to have a lower EMI component.
  • It’s a good idea to wait for a few years and save up a sufficiently large amount (preferably larger than 20% of house cost) as the downpayment. Depending on your saving capability, eagerness to buy, available time (years) at hand and market conditions, you can even consider having some equity component in your savings for this downpayment.
  • Understand this concept fully – shorter the loan duration, lower will be the interest component, but higher will be loan EMIs.
  • Depending on how much home loan EMI you can comfortably service with your current income, keep the loan tenure as about 15 or 20 years.
  • Do make up your mind that you will clear this loan earlier than the originally stipulated tenure. But making mind is not enough. You will have to do something about it too.
  • One way is to try and pay one extra EMI every year (atleast).
  • Another way is to use your annual bonuses to prepay part of the loan.
  • Then there is a case for going for a longer than usual loan tenure of let’s say 30 years. Why and when? This approach uses a combination of home loan EMI and mutual fund SIP. A longer tenure means lower EMIs. The savings made on lower EMIs can then be invested every month in something like equity mutual funds SIP– which is expected to do well over long periods. Assuming equity does deliver decent returns, this approach of selecting a longer loan tenure and doing the SIP can help you repay your loan earlier. This approach might suit some people but is not for everyone. I will write about this approach in detail sometime later.
  • There are many who want to do keep it simple and be done with their loans as soon as possible (and live a loan free life) without any financial jugglery. They will aggressively repay their home loans. But if done too aggressively, this approach can compromise savings for other financial goals. And that is not advisable – more so because home loan rates are fairly low if you consider tax breaks on offer.
  • Ensure that you have an adequate life insurance that can be used to pay off the loan if you were to die tomorrow.

Loan Free Life – Possible and Worth the Effort!

Loan debt Free Life

Who wouldn’t want to live a debt-free life?

This image below aptly depicts what I would need thousands of words to explain 🙂

But let us be fair – at times, loans are unavoidable.

You just have to take some external help to manage your personal finances and expenses.

These days, very few people would be capable of purchasing houses without taking home loans – reason being the sky-high property prices and the sad reality of the Indian property market. Then there are personal loans for people who need money for various other reasons. And credit cards – remember them too!

It is easy for us to say that loans should be avoided. But without knowing the borrower’s background and personal situation, we really cannot judge whether they are taking loans unnecessarily or whether they are doing the right thing.

Historically, we have been a society of savers.

But things are changing now. There is a generational shift in how the newer generation views debt. I read an interesting article recently on this issue (link). India’s household debt to GDP has moved up from 11.2% in FY12 to 15.7% in FY18. And this trend is expected to continue as there is an attitudinal shift towards loans among the younger lots. And here is another interesting fact, current Household Debt to GDP of 15.7% is way below the emerging market average of 39%.

So atleast theoretically, we may continue to see this ratio inch upwards as we transition from being a hard-core savers’ society to one which is more comfortable saving a little less and taking loans for preponing their expenses.

Will this transition lead to an eventual crisis like the over-leveraged societies of developed nations?

Maybe yes. But that is something which you or I cannot predict in the near term. So no point deliberating on it. Let’s cross the bridge when it comes.

Earlier, loans were treated like a disease. But now, they are being perceived as nutritional supplements. 😉

I remember that when one of my young clients approached me for financial planning and investment advisory, I was shocked to see how he was treating debt like the working capital of his personal finance!!

At times, I am surprised to see how many young people (including some of my friends) are trying to tackle huge credit card bills, personal loan EMIs, car loan EMIs and yes…. Home loan EMIs.

Some feel ok living like that. But others repent their choices day in and out as they end up arm-twisting themselves into a debt filled life. Its like they are earning money just to pay their EMIs and bills.

But let’s move on…

How to close your Loans and Live Debt Free?

Now we are talking. 🙂

You have credit card bills, personal loan EMI, car loan EMI and a home loan EMI. Did I miss anything? Maybe an Education Loan EMI as well.

How are you feeling?

No need to answer. I know it. You know it. And worse, your family members can sense how you feel about it.

See the basic principles of how to close all your loans is no secret. You know it too. But most people end up taking a lot more loan than what they should be doing. Home loan (and even a car loan) I understand can be justified. But others are more about spending problems – not being able to stop yourself from spending beyond your means.

And I hope you realize what happens when a major chunk of your income goes towards loan EMIs. You already have non-negotiable household expenses to tackle. This leaves very little or no surplus that can go towards savings and investments for your financial goals.

God bless the government that forces people to save via EPF, etc. Had it not been for them, many young people would literally have no savings at all! These people are most vulnerable to ‘being just one unplanned expense away from financial disasters’.

Now make 2 lists.

First one listing down all your loan details as given below:

Loan EMI Monthly Obligations

* The figures used above are random.

This list will clearly show you where you are in relation to your debt.

Now make another list as given below:

Monthly Cashflows Personal Income

This list tells you how your income comes and goes out. In the above particular situation, the person is basically broke at month end and is living paycheck to paycheck.

And if you still haven’t noticed, then let me highlight that there is no row for savings in the 2nd table. That is because the person has put himself in this situation of not being able to save for his real financial goals. He (it seems) is planning to take one side of the payoff loans or invest for future kind of debates.

The sad result of this inability to save is the dramatic loss of compounding which comes with delay in investing.

But that’s how it is for many people – Earning well. High expenses and EMIs. Almost no savings!

So with data in front of you (in two tables), what should you do?

For practical reasons, try to pay off the smallest loan first. In this particular scenario, it is also the highest-interest bearing loan (i.e. credit card), so this makes all the more sense.

Now you will ask, how should you prepay it when there is no surplus left at the end of the month?

The answer to this question is to figure out a way to generate that surplus from somewhere.

How do you do it?

If you can increase your income quickly, then that’s great. Else – Reduce your expenses somewhat My Lord! 🙂 That’s how elementary it is!

I know it is difficult for you to do and easy for me to say.

But you have to do it Sir!

More so, if you can spare some money from your existing assets (let’s say money in fixed deposits or savings account), then use it too. But do keep some money for emergencies as well.

So that takes care of your one EMI.

One loan closed!

And since the loan is closed, you have more surplus money as the EMI for that particular loan is not needed to be paid.

Now what to do?

Take the next smallest loan or higher-interest cost loan and begin prepaying it.

Repeat this again and again. That’s how you do it. After each loan closure, your monthly surplus will increase (due to EMI elimination).

I don’t think most people are comfortable taking money from friends and relatives. But if it works for you, then you can take some and pre-close a small loan. Up to you.

Remember that you should first try to get yourself free of at least credit card debt and personal loan debt. Once these two are tackled, you should think about clearing your car loan and then the home loan (that you took to purchase your properties). But whatever you do, please do not default on your EMI payments of any of your loans. It will hurt your credit score and your ability to get loans in the future.

I am repeating this but when you begin this exercise, reducing your expenses is very important.

Just for some months, give up on your worldly pleasures and tackle the loan problem. Once you have closed one of your loans, automatically your surplus would increase and I would not pester you to reduce your expenses 🙂 You can begin living in ‘today’ again.

Ultimately, this combination of controlled expenses, reducing EMI outgo leading to higher surplus and income hikes will allow you to be in a comfortable situation.

This would then allow you to invest and save properly in a structured manner – goal based investing. And believe me, this approach will make you feel in total control of your finances.

So that’s how you can begin your journey of a debt-free life. Simple but maybe not so easy. But do it nevertheless. It will be worth it.

Now let’s discuss briefly some points that should have been tackled earlier itself.

How much loan EMI can you afford?

This is the question that should be asked before you start applying for your multiple loans. 🙂

Ofcourse there is no perfect answer.

But your income is limited and with regular expenses to take care off, there is a limit to how big EMI(s) you can afford.

Different people having different loans will ask a different version of this question. Like:

  • How much Home Loan EMI can I afford?
  • How much Personal Loan EMI can I afford?
  • How much Car Loan EMI can I afford?
  • I already have a car loan. Now how much Home Loan EMI can I afford?
  • I already have a home loan. Now how much Car Loan EMI can I afford?
  • I already have a home loan and a car loan. Sh**! But I also need some more money urgently due to an emergency. So how much Personal Loan EMI can I afford now?

See?

Different situations, same concern – Due to limited income and growing expenses, what is your loan EMI affordability?

The lenders (banks, NBFCs in collaboration with credit rating agencies) help you in this regard somewhat.

These lenders ensure that EMIs for all your loans combined do not exceed 40-45% of your take home salary.

But problem is that they don’t know about your expenses and other off-book financial commitments.

So if your non-EMI based expenses are too high (like 70%) and bank doesn’t know that, then even if bank is willing to give you a loan of EMI equal to 40% of your income, you yourself will be stupid to take such a loan as your EMI+Expenses would far exceed your Income. That would be a financial disaster unless you can cut down your expenses drastically.

And ideally, you also need to save for the future too. And saving a very small amount – like saving 10% of your income might not be enough.

So you need to be prudent about how many and how much loan you take.

There is a limit to what you earn. There is a limit to how much you can reduce your current expenses to accommodate the loan EMIs. And there is a limit to how much you should compromise your savings and investments to repay the loan.

So do not get attracted unnecessarily towards easy availability of loans to spend on discretionary material possessions.

Taking loans is inevitable for most people.

But remember that no matter how easily you get a loan, the fact is that you and no one else has to pay it back. So gradually, make a conscious decision and work towards a debt-free life to build your case of achieving financial freedom at the earliest.

Should you use ‘100 minus age’ rule to decide Portfolio Asset Allocation?

100 minus age rule Asset Allocation

The rule of ‘100 minus age’ to decide investment portfolio asset allocation is a popular and one of the oldest rules for retirement planning.

But unfortunately, it’s a highly misused one too.

And the reason is simple.

The investment world can be quite complex at times and people are constantly on a lookout for shortcuts or thumb rules. And one such thumb rule that is born out of the search for such shortcuts is the much-abused thumb rule of ‘100 minus age’ to get your ideal portfolio asset allocation.

So…

What is the ‘100 Minus Age’ rule of Investing?

It is simple.

If your age is 30, then you invest 100 minus 30 = 70% of your portfolio in equity. Remaining 30% goes to debt.

It basically answers the question about what proportion of your portfolio should be in equity investments.

More examples according to the rule:

  • Age 35 means 65% can be in equity and 35% in debt
  • Age 40 means 60% can be in equity and 40% in debt
  • Age 45 means 55% can be in equity and 45% in debt
  • Age 50 means 50% can be in equity and 50% in debt
  • Age 60 means 40% can be in equity and 60% in debt
  • Age 70 means 30% can be in equity and 70% in debt
  • Age 80 means 20% can be in equity and 80% in debt

At the face of it, it seems like a reasonable rule to adhere to. But the reality is very different.

This thumb-rule of 100 minus age doesn’t take into account other important factors to arrive at the right equity-debt allocation in a portfolio. And that is why one needs to be careful while using it.

The 100 minus Age rule doesn’t always make sense

The very first thing to note is that the idea is too simplistic.

I am a firm believer of simplicity when it comes to investing. But this rule takes it a bit too far and makes it far simpler than is actually needed.

And that is where it fails.

It simplistically assumes that age is the only factor that should decide the asset allocation and investor’s risk appetite and return needs.

And this assumption is wrong.

Broadly, the rule tries to say that older investors should have a lower allocation to equity. That’s it. This is the broad message. But beyond that, using this formula that is a very big generalization can turn out to be disastrous if followed blindly.

It cannot and should not be applied in all scenarios.

Let us take a few examples to understand why:

Suppose two investors A and B aged 40 are planning their asset allocation. If the rule of 100 minus age is used, then both should have 60% in equity and 40% in debt.

But let’s see what is the real situation of these investors A and B.

Investor A has many dependents – housewife, two school going kids, old retired parents one of whom is scheduled to have a big surgery in coming months, a sister ready to get married in next few years. He also has a running home loan.

Investor B has a working wife, one school going kid and his father runs a successful business. He stays in a home which is fully paid for.

As is easily evident, there is a vast difference between the profiles of both investor A and B even though both are aged 40.

So should they have the same asset allocation?

The answer is no.

Investor A needs a lot of money in the near future (due to parent’s operation and sister’s wedding) and hence, cannot take a lot of equity. He is also constrained by the fact that he is the sole earning member and also has home loan EMIs to pay every month (in addition to school fees of kids). So overall, a very tight situation with a lot of near-term liabilities and scheduled cash outflows. Investing a large proportion of savings in equity can be disastrous for him if markets take a wrong turn.

Investor B on the other hand, is part of a dual income family, with just one school going kid as a dependent. No loan EMIs too. So naturally, he can have a more aggressive asset allocation.

And this is what the problem of 100 minus Age rule has.

It does not give any weightage to the investor’s unique situation.

Robotically reducing your equity allocation just because you’re getting older?

Not the most prudent strategy as people are living longer now and if they have less than adequate amount of equity in their portfolio, they are not going to get the much-needed growth that is imperative to ensure that their portfolio lasts longer than themselves.

The actual asset allocation should also consider factors like the total corpus, its relative size with respect to regular expenses, any scheduled cash outflows for short-term goals. And let us not forget the willingness to take risk as well as the ability to take risk.

Another problem I see in this is that it doesn’t consider the size of investor’s portfolio relative to the regular living expenses.

A 65-year financially independent investor who has a retirement corpus of 45x his annual living expenses and another 5x for regular expenses / liquidity can take a lot more risk than what the formula might tell him.

Isn’t it?

The 100 minus age rule will tell that this investor should have 35% in equity. But I think that if the investor is willing to take the risk, then 35% is too less for such a scenario. The retirement corpus, which is equal to about 45 times his annual expenses, is not needed for his regular expenses (which are handled via the other corpus of 5x). So here equity can be much higher. So in an undervalued market, it can even be as high as 60-70% equity or even more if the investor is comfortable.

What To Do Then?

The “100 minus age” rule is a very general thumb rule. And as highlighted previously, it may not be suitable for everybody of a particular age.

The biggest flaw with the thumb rule is that it puts every individual in an age group in the same box. And that is stupid!

Instead if you are a common investor, then you are better off sticking to the goal-based approach to investing.

Goal-based investing is more scientific, situation-aware and works best when combined with dynamic portfolio strategy to maintain asset allocation.

I have already covered various aspects of it in detail earlier. Some of the links that you may find useful are:

The best part of this strategy is its simplicity. Depending on your risk profile and goal investment horizon, this strategy tells you how much to invest and in what asset allocation for all of your financial goals.

Finally…

As you have seen, the thumb rule of 100 minus age isn’t applicable in all scenarios.

The general idea of the rule is that older you get, will have to depend more and more on your investments for your living expenses and hence you should reduce your equity exposure. But that’s it.

There is no use of this thumb rule beyond that.

Rules of thumb in any case are mere approximations and one should not rely on these rules blindly.

So should you use the 100 minus age rule to decide your portfolio asset allocation?

To cut a long story short, if you’re planning out your asset allocation, then its best to forget this rule.

Find out your financial goals and take the goal-based investing approach.

If you have trouble figuring things out, you can even consult an investment advisor to create a goal based financial plan for you.

It works much better and helps you achieve your financial goals. To be fair, it may not be as simple as these thumb rules but it is far more accurate and increases the probability of goal achievement. And that is something that we all want.

Are you making the most of your money in Savings Account?

Making most Savings account

For most people, a savings bank account is the default choice when it comes to the options to park their money for the short term. Other popular one being short-term fixed deposits.

But many times, savers end up leaving excess amounts in their bank accounts for various reasons or the other.

I understand that if it’s for some short-term goal or expense, then it makes sense. But given that the interest rates on most banks’ savings account are nothing to write off, it’s a no brainer that this type of account is unsuitable for parking money for long term.

As the name suggests, it’s a savings account and not an investment account. That should be remembered.

Read that again.

If you do a saving bank interest rates comparison, you will find that the savings account interest rates are mostly 3.5% to 4% but can go up to 7%. The actual rate you are offered depends on the bank you are dealing with and the amount you wish to park.

Presently, if you were to search for which bank gives the highest interest rate on the saving account, then chances are that the rates on offer would be about 7.5% (for amounts exceeding some threshold).

As for historical savings account interest rates – till 2010, the interest rate on savings accounts was 3.5%. But in 2011, the Reserve Bank of India or RBI deregulated the interest rate on savings accounts. Banks could then set their own interest rates. But the general trend has been to offer about 3.5% to 4% by most major banks. Some newer and aggressive banks offer higher interest rates of 6-7%.

How much money should you keep in Savings Account? 

Good question. 🙂

But there is no standard formula for this.

A reasonable amount should be kept. If you were to ask me what exactly do I mean by ‘reasonable’, I would say that an amount equal to 1 to 3 month’s worth of expenses should be fine. Whatever gives you reasonable levels of peace of mind.

Ofcourse if some near term expenses are approaching, then the amount in savings account can be much higher.

But there is no reason to keep a high savings account balance on a regular basis. More so in the era of zero balance account and unless you are an ultra-conservative investor, it will mean you will lose out on higher returns that could have been generated by parking your money elsewhere.

For the sake of completeness and because many are unaware, let me tell in brief how the interest on Saving Bank account is calculated?

The interest is calculated on the daily balance in your account. But the total interest is credited to the account only quarterly.

Taxation of Interest from Savings Account

Since you are parking money with the bank, it will pay you interest. This interest is an income for you and hence, should be taxed.

But our respected Income Tax Department gives a deduction of up to Rs 10,000 under the Section 80TTA on interest earned from all your saving bank accounts in a financial year.

What about interest exceeding Rs 10,000 per financial year?

It will be taxed.

So, if your interest income from the savings accounts is Rs 7000, you don’t have to pay any tax on it. But if it is Rs.14,000, you need to pay income tax on Rs 4,000 according to your tax slab.

Remember, the deduction available under section 80TTA is only applicable to interest earned from Savings Account and not on interest earned from fixed deposits or term deposits.

Also, this deduction is available on interest income from ALL savings bank accounts. So you cannot have Rs 10,000 deduction for interest from each of your saving accounts.

So how much money should be kept in your savings account(s) to earn Rs 10,000 in tax-free interest?

It will depend on the interest rate on offer like this:

  • At 4% interest, amount to be kept in savings account is Rs 2.5 lac
  • At 5% interest, amount to be kept in savings account is Rs 2.0 lac
  • At 6% interest, amount to be kept in savings account is Rs 1.66 lac

So if you are keeping a few month’s worth of expenses in Savings Account, then the amount will generally be tax-free. This is assuming your expenses are not extremely high. 😉

And since we are talking about taxes, let me tell you that Tax Saving should not be your blind priority.

Your life is about your real financial goals and money should help you achieve them. And efficient tax saving is a positive side effect of a Smart Goal-based Financial Plan that helps you achieve your life goals.

Good alternatives to Savings Account?

 Is the there a better option to earn somewhat higher returns than keeping money in savings account?

One decent option is Liquid Fund – a type of low-risk debt fund (read more about Mutual Fund category changes).

These are open-ended mutual fund debt schemes which have a very short-term investment horizon. These invest in money market instruments like the certificate of deposit, treasury bills and commercial papers of up to 91 days.

Infact, these days you will see a lot of promotion around Liquid Funds vs Savings Account kind of theme.

Let’s try to briefly understand whether Liquid Fund is really a good alternative to Savings Account or not.

In 2017, the returns delivered by Liquid funds were about 6.5%. But in years preceding 2017, the returns ranged from 7.5% to 9% for good liquid funds. So by putting money in Liquid funds, you are more likely to get returns higher than the basic savings account. Even the post-tax returns are likely to be more than that of savings accounts.

But remember that unlike savings account, the returns of Liquid Funds are not guaranteed. They fluctuate. Not much but still they do. These are low-risk products and not zero-risk products.

And there have been cases where poorly managed liquid funds saw their NAV crash by more than 7% in a day! Search google and you will find this incident.

So I repeat – Returns from liquid funds are expected to be higher than the savings account but are not guaranteed.

But that’s how it should be – Isn’t it?

In your search for higher returns (than savings account), you are taking higher risk. So the risk of being wrong will always be there. It’s a fair deal.

That was about the returns.

What about liquidity?

Since we are comparing with savings account, liquidity should be discussed.

Liquid funds are fairly liquid(!) but you will usually get your money in T+1 days. So in a situation where you need the money ‘right now’, you will remember the liquidity offered by the savings account – and which is one of the reasons why people park money in those accounts.

So if you understand the above basic points about the liquid funds and are willing to accept the small risks, then liquid fund can be a good alternative for the savings account. But even then, having some money in savings bank account makes sense for immediate liquidity (emergency) and simplicity needs.

But if you are not comfortable with these, then stick with savings account or short term FDs. In any case, you should not be parking a vary large amount in it for long time. So chances of big interest loss are low.

Infact to keep things simple, you can even opt for your bank’s Sweep-In FD facility. It works like this that you can set a threshold limit for your savings account, above which any amount deposited will automatically be moved into a fixed deposit to earn higher interest. Plain and simple.

But you have to pay income tax on interest income from FD every year. Compare this with money kept in savings account where interest of Rs 10,000 per year is not taxable as per Section 80TTA of the Income Tax Act. Also compare this with debt funds, where you will pay tax only when you sell your MF units. So if you end up holding your units for 3+ years, then your gains will be taxed at 20% after indexation – which most often works out much better than pure savings account returns.

Using Savings Account for Emergency Fund?

Yes, atleast a part of it.

It makes sense to have atleast 6 month’s worth of basic expenses in your emergency fund. You already know what emergency funds are for.

Now the first thing to remember about an emergency fund is that it is to tackle emergencies and not to earn high returns (by taking higher risks). Read that again.

From liquidity perspective, there can be a case for putting all of the Emergency fund in savings account. But if your emergency fund size is big enough (like equal to 6 months worth of expense), then you can have a tiered structure in place. for example:

  • Savings Account
  • Fixed Deposits with instant liquidation facility
  • Liquid funds

This way, you will earn much higher than a pure savings account and have enough liquidity at hand from a practical perspective. The exact allocation between these 3 tiers can vary and depend on person’s comfort level and individual situation.

But have atleast 1-1.5 month’s worth in savings account. The remaining fund can be divided into the other two. And if you are beginning to build your emergency fund, it makes sense to keep it simple and have higher initial allocation towards savings account + FD. Later on, even a not-so-evil credit card can help you smoothen out your cash flows.

Finally…

To be honest, there is not much to write about savings account. People use it as it is their default choice to park/receive money, is easy, offers ‘some’ interest and lots of liquidity to them.

Is there a perfect formula about how much money to keep in savings account?

Yes.

You should keep as much in savings account as you are reasonably comfortable with but not too comfortable with. 🙂

Sorry… there is no formula. Though you can take your hints from the section above where we discussed how savings account can be a part of the emergency fund.

Getting Rich without Going Into Unsafe Territories

Getting Rich without Going Into Unsafe Territories

Let’s get straight to the point.

You want to become rich and you want to become rich FAST!

That’s what we all want right?

Thankfully, most of us understand that it’s easier said than done. But unfortunately, far too many don’t get it and end up losing tons of money instead of making it.

And the internet does what it does best – adds to the noise – and is overcrowded with a lot of misleading information on how to become wealthy. To be fair, it’s quite possible to get rich quickly, more often than you’d think.

However, it comes with a high probability of losing whatever you put into such get-rich-quick ventures. And it involves taking high-risks, putting in hard work and ofcourse a lot of luck – or let’s say a ‘lucky’ combination of all the three.

Stock market investors who get greedy after noticing a good run in certain stocks for a couple of years start believing the stock market is a sneaky way to get rich very fast.

Sometimes this is true for the short run. But mostly it’s not. After a good run, mean reversions reframe the game and markets go down. And people aren’t ready for it.

As a result, people end up losing whole life investments or at best end up with a very bad experience with equities – and that can haunt them for years, make them stay away from equities (and it just translates into a big loss of wealth creation opportunities).

Another example can be the almost vertical rise in value of cryptocurrencies like Bitcoin in the very recent past.

Again what happened there was that people believed that this is a way to get rich overnight and so hoards of investors started joining the party. But the crash that happened after the all-time highs has left most people with a bad taste for currency investments. To be honest, cryptocurrency isn’t my field of expertise, but I have close friends in Silicon Valley who have actually got rich taking a cut of this modern-day currency market.

And I mean they became filthy rich way too fast. Some were lucky to cash out before the big fall and have literally achieved financial independence. Others weren’t so lucky. I would say that in the case of crypto-riches, luck played a really big part for many people’s good fortune – there can be no denying that.

Also, there is the foreign exchange or currency market also known as forex – which I’m not sure most people know is the biggest market in the world!

If you surf around enough online financial and trading sites, chances are that soon enough, our Lord Google will contextually throw in alluring Forex Trading advertisements which highlight the magical capabilities of currency trading offers.

I personally know someone abroad who does quite well dealing in forex trading. And he has been doing it for years so he knows his trade. If you were to ask him whether it’s possible to get rich in forex trading he’d say ‘Hell yes!’. But if you were to ask him whether it’s easy to get rich trading in the forex market, he would say right off the bat ‘No way!’.

In fact, he very clearly told me that Forex Trading is not a get-rich-quick method as many online advertisements make it out to be. That doesn’t happen. It’s a skill and takes time to learn and profit from. Being properly equipped with certain tools to trade in forex and having timely funds along with proper non-impulsive risk management skills are valuable assets when going the forex way.

I, being a participant in Indian stock markets for several years, could clearly see the similarities with it.

The insights about what works and what doesn’t work in stock markets come after years of trying out various strategies, taking hits on your portfolio and your ego and what not.

It might seem that it’s easy but I can vouch that there is no easy money-making here. It is simple but not easy.

Another close acquaintance of mine got really lucky sometime back. He piggybacked another friend’s VC and Angel around bets without any clue about what the startups were exactly doing. Lady luck shined and he made a killing with a couple of super bets.

You see the pattern?

Some people ‘get rich quick’ here and there. But they are the exception to the rule, not the norm.

You need to realize that for most people, the way to wealth is typically on the slow lane. It’s good to take your chance, but more often than not, what happens is that your capital gets lost and you need to start fresh. Which is hard stuff. After a while it adds up, less money is available for compounding and naturally, the amount of money you end up making is much lesser than what would have been possible if you’d have not run greedily towards a quick highly risky scheme.

Believe me, you can wait for years to accept the perennial truth that slow and steady wins the race and compounding is indeed the 8th wonder of the world. Or you can start with time-tested wealth creation strategies and begin your journey of being really wealthy.

It might not seem as glamorous as the get-rich-quick schemes but it works.

By starting early, you can be rich enough much before you retire – something that is desirable as you don’t want to be the richest man in the graveyard! Right?

Frequently, getting rich quickly is either due to pure coincidence or extreme risk. But even hard work and willingness to take tons of risks cannot guarantee overnight riches.

So do yourself and your family a favor and assume calculated risk, invest in testing out the best strategies and work only with the best ones. Don’t ever take luck or hope into account! Both hope and luck are not strategies. 🙂

May the odds be in your favor!

State of Indian Stock Markets – June 2018

This is the June 2018 update for the State of Indian Stock Markets and includes historical analysis and Heat Maps of Nifty50 as well as Nifty500‘s key ratios, namely P/E, P/BV ratios and Dividend Yield.

Please remember that these numbers are averages of P/E, P/BV and Dividend Yield in each month. Neither Nifty50 heat maps nor Nifty500 heat maps show the maximum or the minimum values for each month. Also, note that NSE publishes PE ratios based on standalone numbers and not consolidated numbers (Read why this may matter too).

Caution – Never make any investment decision based on just one or two ‘average’ indicators (Why?) At most, treat these heat maps as broad indicators of market sentiments and a reference of market’s historical mood swings.

So here are the Nifty 50 Heat Maps…

Historical P/E Ratios – Nifty 50 (Monthly Average)

Historical Nifty PE 2018 June

P/E Ratio (on last day of June 2018): 25.90
P/E Ratio (on last day of May 2018): 27.19

The 12-month trend of P/E has been as follows:

Nifty 12 Month PE Trend June 2018

And here are the average figures of Nifty50’s PE for some recent periods:

Nifty Average PE Trends June 2018

Historical P/BV Ratios – Nifty 50 (Monthly Average)

Historical Nifty Book Value 2018 June

P/BV Ratio (on last day of June 2018): 3.61
P/BV Ratio (on last day of May 2018): 3.69

Historical Dividend Yield – Nifty 50 (Monthly Average)

Historical Nifty Dividend Yield 2018 June

Dividend Yield (on last day of June 2018): 1.22%
Dividend Yield (on last day of May 2018): 1.23%

Now, to the historical analysis of Nifty500 companies…

As the name suggests, Nifty500 is made up of top 500 companies which represent about 95% of the free float market capitalization of the stocks listed on NSE (March 2017).

Nifty50 on other hand is an index of 50 of the largest and most frequently traded stocks on NSE. These represent about 63% of the free float market capitalization of the NSE listed stocks (March 2017).

So obviously, Nifty500 is comparatively a much broader index than Nifty50.

Historical P/E Ratios – Nifty 500 (Monthly Average)

Historical Nifty 500 PE 2018 June

P/E Ratio (on last day of June 2018): 30.47
P/E Ratio (on last day of May 2018): 31.59

Historical P/BV Ratios – Nifty 500 (Monthly Average)

Historical Nifty 500 Book Value 2018 June

P/BV Ratio (on last day of June 2018): 3.37
P/BV Ratio (on last day of May 2018): 3.49

Historical Dividend Yield – Nifty 500 (Monthly Average)

Historical Nifty 500 Dividend Yield 2018 June

Dividend Yield (on last day of June 2018): 1.09%
Dividend Yield (on last day of May 2018): 1.08%

You can read the previous update here. The State of Markets section has also been updated with new Nifty heat maps (link).

For a detailed analysis of how much returns you can expect depending on when the investments have been made (at various P/E, P/BV and Dividend Yield levels), please have a look at these 3 posts:

Do you even have the ‘Right Mutual Funds’ in your portfolio?

 

Best Mutual Fund Portfolio

You have been investing in mutual funds for some time now.

But in last few months, 3 big changes took place. And all those changes can and will impact all mutual fund investors in big ways.

You remember the 3 changes…don’t you?

  • Introduction of Long-Term Capital Gains Tax on equity
  • Changes in existing Mutual Funds attributes due to SEBI’s categorization and rationalization push
  • Shift to TRI for performance benchmarking, which will reduce the so-called over-performance of the funds

I repeat. These are big changes.

Why?

I have already explained it in detail in the post titled MF Investors and 3 Big Changes that will Impact their Portfolio and Returns and here and here. So won’t repeat it here. But if you haven’t read these posts, please do so for your own good.

I am writing this post to bring in front some questions that need to be asked by all mutual fund investors NOW!

This ofcourse is not a comprehensive list.

But it will help you get started in the right direction. So here it is:

  • All future profits from the sale of mutual funds will attract LTCG tax. This means that you need to be careful so as to reduce the impact of this tax and allow more money to remain invested for longer (for compounding). This also means that you should be investing in funds, in which you can ‘ideally’ remain invested for long without much need of selling. So do you have such funds in your portfolio?
  • Have you been investing in flavor-of-the-season funds (or last year’s top equity fund) till now which required you to enter and exit every 1-2 years? If yes, then do you realize that this strategy may not work very well in future due to the impact of LTCG tax on each reshuffling of funds?
  • Do you understand that due to the two above-mentioned points, your portfolio should now be curated strategically to have funds that need comparatively less maintenance and can survive various market scenarios?
  • Do you know how to find such funds that fit into the above criteria (which have become more relevant now than ever before)?
  • After SEBI’s recent categorization & rationalization exercise, several funds have changed their mandates, categories, etc. This means that these funds will not be doing what they were doing till now (atleast to an extent). This also means that the returns delivered by these funds till now may not be possible in future. Do you know if these are the very funds that are still part of your portfolio?
  • Do you understand that not all funds have changed their mandates and categories in the SEBI-pushed rejig? So even though some funds may have to be kicked out of your portfolio, it is possible that many are still good enough to remain invested in. Do you know which funds?
  • Do you understand that some of the funds that you are holding may not remain in line with the asset allocation that you had initially bought them for? For example: Suppose you bought a fund that earlier was a multi-cap fund. But after the re-categorization, it has become a mid-cap fund. So going forward, about 60% of your money would be invested in mid-caps. This is not exactly what you bought the fund for. Isn’t it? Remember you bought it for its multi-cap(ness). So there will be a need to change the funds. Do you know which all of your existing funds have changed so much that they should be exited from?
  • Some of the funds, despite changing name and attributes and categories, may still be inherently doing what they were doing earlier. Therefore, no point exiting such funds. This is all the more important as exiting also means paying exit loads and additional taxes. So do you know which funds you hold are still the same even after getting their new clothes?
  • Do you know that after the change in benchmarking for mutual funds, it will be more difficult for the funds to beat their benchmarks like earlier? Fund managers will now have to work extra hard to deliver benchmark-beating returns. This will be difficult for them to manage on a consistent basis. So do you have funds that have been able to beat new TRI-based benchmarks in past? Do you even understand what I am talking about??
  • Do you understand that the two changes in combination, namely i) using TRI for benchmarking and, ii) limited universe of stocks available for fund managers to invest as per SEBI’s new guidelines, hints to the fact that more and more large-cap funds will find it difficult to beat their benchmarks? This also means that there is a case for investing in index funds for a subset of investors now. Do you realize why this might make sense for you too?

Thought provoking… Isn’t it?

Even I have reviewed my personal mutual fund portfolio in last few months and made changes where necessary.

It goes without saying that proper review of your existing mutual fund portfolio is now more necessary than ever before.

Chances are high that you may want (or have) to weed out unwanted schemes from your mutual fund portfolio as soon as possible.

I understand that you might be worried about exit loads and taxes. But these are short-term pains and frictional costs that must be borne for long-term course correction.

In fact, take it as a forced blessing-in-disguise. You are being forced to think properly about how to build a robust, all-weather mutual fund portfolio that is worth remaining invested in for several years.

So go on… identify funds that should be exited from your portfolio. Find out funds that are worth bringing in to your portfolio based on proper fund selection and above discussed questions.

Also ensure that your final fund portfolio (after all the changes) – maintains proper asset allocation, is reasonably diversified among various caps and fund houses, has funds that can be held for several years, doesn’t have adventurous funds which may cause regret in future, and most importantly is built on common-sense.

This is an opportune time for you to build a mutual fund portfolio wisely and safely and that is well-positioned to create wealth and achieve your financial goals.

Featured in Times of India (for Early Retirement)

My wife and I got some coverage in Times of India a few weeks back.

The coverage was mainly about how some Indians are working towards their Financial Independence (or let’s say Early Retirement).

Here is the article:

Dev Ashish Stable Investor Times of India

After the article was published, I was amazed by the number of emails I received from people telling me how they too wished to achieve financial freedom. It made me happy that people are giving importance to this idea – irrespective of the reason that’s driving them.

Most readers would know that achieving financial independence is one of my major financial goals.

By when – Let’s see… I am planning to do it by 40. Fingers crossed! 🙂

But let me clarify one thing here… as many people get it wrong.

Becoming financial independent or achieving early retirement doesn’t mean that I would not be doing anything after I turn 40. It only means that I would have accumulated enough money to take care of my expenses for the rest of my life.

I will (no doubt) continue to do what I am doing right now – investment advisory.

Here, I must thank my wife Aditi who is my partner in crime in working towards this goal. Without her support, I could not have imagined aiming for such a goal. 🙂

If you are new to this idea of Financial Freedom or FIRE (Financial Independence & Retiring Early), then I have already written about it a few times:

Will try to write more about various aspects of Financial Freedom in near future – as I can clearly see that there are many people out there who wish to make Early Retirement as their biggest financial goal.