This is how CY2016 will pan out

Many experts attempt to predict future course of action in financial markets. However, seldom one gets most of this predictions right. It makes more sense to position yourself to benefit from various developments in the financial markets than trying to predict the financial markets.

To read more click here

Trust, but verify

In financial transactions, the mantra is: "trust, but verify".

Read my article here



The English translation is as under:

The other day, I was talking to an investment advisor. He was very excited about the trust he has won from his clients. He claimed that he was so much trusted by his clients that they give him signed demat account slips and mutual fund transaction forms.

I asked if the client would ever give blank signed cheques to the same advisor. He laughed it off. Nobody in one’s right mind would ever give blank cheques.

So often, people consider this argument of comparing blank cheques with signed demat slips as ridiculous and laugh it off. While giving someone a blank cheque is accepted as a huge risk, giving a blank signed demat slip is not.

So let us understand what all can happen if you give signed blank demat slip to someone. You are letting the person fill in the details without your knowledge, yet legally you have approved whatever he writes on the slip. This “whatever” means that he can transfer the securities from your demat account to his personal account or anybody else’s account. If it comes to your notice, one can argue that it was just a mistake and he can return the securities in your account.

One has also come across cases where the investor lets the securities remain in the broker’s pool account. When the investor was suggested not to do so, he came up with arguments: (i) it is convenient; (ii) he wanted to avoid the transfer charges. The convenience argument also appeared in case of giving signed but blank demat transaction slips.

So often, we seek to avoid minor inconveniences and fall in a major trap.

In both the above cases, one is offering an opportunity to someone to defraud. Are we suggesting that you should not trust anyone? Well, we cannot. It is one’s choice to decide whom to trust and whom not to. However, we would only like to ask one question, “What is the priority – safety or convenience?” And then to what extent do we want to compromise one for the other?

This is not just about demat accounts. There have been many instances of defrauding innocent investors by conmen. Some have collected cash from investors for depositing in the post office schemes. The amount never reached the post office.

Majority of the frauds have this pattern in common. It all starts with convenience and the same is given the name of trust. Convenience is the primary objective. The conman pretends to be trustworthy and sells the convenience part. He keeps both the decisions and custody of assets with him. The custody is kept in form of the transaction slips in the above example. If someone has the authority to take decisions and also controls the transaction related documents, it becomes easy to commit fraud.

Trusting someone is not bad, as we have already mentioned earlier. However, once convenience becomes a habit, it takes a painful experience to once again get trust on priority.

Mutual funds are a bit different. When redemption is filed in a mutual fund scheme, the proceeds would only go to the investor’s bank account registered with the mutual fund folio. Mutual funds have built this safety mechanism in place and hence they do not issue cheques to third party.

For all other investment avenues, please insist on transfer of all the money only through the banking channel. Else deal through mutual funds, which do not accept cash beyond Rs. 20,000 and always pay the redemption proceeds and dividends in the registered bank accounts.

An investor would be better off being objective in deciding the trust v/s convenience equation. It is better to decide whom to trust and why. Even after that, it is good to take stock of the situation once in a while. Blind trust may not always be desirable. The mantra to remember should be, “Trust, but verify”.

Wish you a very happy 2016!

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

Chat transcript - 14th Dec, 2015

Below please find link to the transcript of my chat session on www.moneycontrol.com on 14th Dec, 2015

Equity investments simplified

Value averaging can add value to your investments

In our article published in Mid-day Gujarati edition on 30-Nov-15, we discussed some limitations of SIP. This time, we offer an alternative to SIP. Value averaging can add value to your investments and take care of some limitations of SIPs. Click here to read further ...


The English translation of the two articles combined is as under:

Very often people ask this question, “So many financial advisors keep talking so many good things about SIP. Is there anything negative about it?” Come to think of it. Can there be something that is only good and without any limitation?

Well, SIP is not without any limitations. It has two serious limitations.

(1) That the asset prices have to go up in the long term, and

(2) During the investment period, even when the market is at a high level the investor keeps investing (though one buys fewer units)

Well, some may argue that these limitations are not very serious or that these are no limitations at all. Even if someone believes so, let us look at the word “limitation” with an objective to explore if there could be something better.

Incidentally, there is, at least in theory.

Let us look at the second of the limitations we have highlighted, that in SIP, we keep investing even when the markets are at high levels. The advocates of SIP would argue: Is it possible to know in advance if the markets are high or low? And since we do not know in advance, we keep investing and the principle of “Rupee Cost Averaging” takes over.

This principle of Rupee Cost Averaging helps us reduce the cost of purchase. When we invest a fixed sum of money in equity mutual funds, which have volatile NAVs, we buy more units when the NAV is low and fewer when the NAV is high. This happens automatically since the units allotted are a function of the amount invested divided by the prevailing NAV. This, by itself, turns the stock market’s inherent volatility do work for the investor.

However the fact remains, even though one buys fewer units, one does buy something even at market peaks. Let us see if at market peaks we can stop our investments or even take some money out of the investments.

Michael Edleson, a former professor at Harvard Business School promoted an approach that can improve upon the SIP. This approach does not keep the investment amount constant, but changes it – either the amount is increased or decreased. Incidentally, the investment amount is increased when the markets are low and vice versa. This approach is popularly known as “Value averaging”.

While in case of SIP, the regular investment is kept constant, in value averaging, the attempt is to keep the monthly (or whatever period one has chosen) value constant. As we all know, the value of investments (NAV of an equity mutual fund) would regularly change in line with the movement in the market prices. When this happens, the fresh investment amount would be adjusted such that the value is restored to a predecided level. Let us understand this with an example.

Assume that we have decided to invest ₹ 10,000 (or close to that amount) monthly. We also expect the market to go up @ 12% per year over the long term. However, this upward movement is not expected to be smooth and there would be periods when the market moves up much more or even goes down a lot.

Under value averaging, the investment would be varied as under (the price changes are assumed and only for the purpose of illustration):

Column 1	Column 2	Column 3	Column 4	Column 5	Column 6	Column 7
Month	Investment	Value at the beginning of the month	Value at the end of the month	Target value	% Change in market price	Change in investment amount
1	₹ 10,000.00	₹ 10,000.00	₹ 10,500.00	₹ 10,100.00	5.00%
2	₹ 9,600.00	₹ 20,100.00	₹ 19,954.00	₹ 20,301.00	-0.73%	- ₹ 400.00
3	₹ 10,347.00	₹ 30,301.00	₹ 29,984.00	₹ 30,604.01	-1.05%	₹ 347.00
4	₹ 10,620.01	₹ 40,604.01	₹ 40,992.00	₹ 41,010.05	0.96%	₹ 620.01
5	₹ 10,018.05	₹ 51,010.05	₹ 51,197.00	₹ 51,520.15	0.37%	₹ 18.05
6	₹ 10,323.15	₹ 61,520.15	₹ 62,150.00	₹ 62,135.35	1.02%	₹ 323.15
7	₹ 9,985.35	₹ 72,135.35	₹ 72,849.00	₹ 72,856.71	0.99%	- ₹14.65
8	₹ 10,007.71	₹ 82,856.71	₹ 81,645.00	₹ 83,685.27	-1.46%	₹ 7.71
9	₹ 12,040.27	₹ 93,685.27	₹ 95,329.00	₹ 94,622.13	1.75%	₹ 2,040.27
10	₹ 9,293.13	₹ 1,04,622.13	₹ 1,05,504.00	₹ 1,05,668.35	0.84%	- ₹ 706.87

The first column indicates the month number. The second is how much fresh money one has to invest. The third shows the value of portfolio at the beginning of the month, that is why in the first month both the amount to be invested and the start value are the same. The fifth column is the expected value, if the portfolio grows @ 1% during the month. This value is arrived at by adding 1% appreciation to the value at the beginning of the month in the column 3 for the respective month. However, as we discussed earlier, this does not happen in real life. In reality, the amount would go up in some months and down in some. This value (randomly arrived at) is captured in column 4.

If the value in column 4 is higher than that column 5, it means the market went up more than the expected 1% per month. In such a case, the next month’s investment is to be adjusted down from the original ₹ 10,000 per month.

The big advantage of value averaging is that one can plan to reach a target portfolio value – could be the expected value of the financial goal. Whenever there is a shortfall on account of adverse market movement, there would be small adjustments through increased investments and vice versa. This would ensure one reaches the financial goals comfortably and more assuredly.

Columns 6 and 7 capture the relation between market movement in the previous month with the subsequent month’s investment. As can be seen in the graph below, the amount to be invested changes in opposite direction to the previous month’s market movement.

This adjustment is an improvement over SIP.

Also please notice that the swings in investment amounts are quite large as time goes by. The value of the portfolio is such that after a while small movements in market value of portfolio would lead to major changes in the amount to be invested. This means, after few more months or may be a few years, we are likely to see some money being taken out of the fund. This is exactly what some investors may prefer to do – taking money out when the markets are high.

Sounds good. However, this is not so easy to implement.

How do you adjust your cash flows in line with the changing investment amount month after month? As seen above, as the time passes, the changes could be too large. In fact, in the 10^th month, the investment required is 20% more than what one started with. How can one suddenly save so much more?

Some mutual fund companies have innovated to take care of this issue. They have introduced systematic transfer plans that work on the principle of value averaging. This means, instead of transferring money from the bank to an equity fund, the investor puts lump sum amount in a debt (or liquid) fund and then transfers to equity fund. This takes care of the cash flow issue, too.

The salaried individuals can invest in a debt (or liquid) fund through SIP and then after building some corpus start value averaging through systematic transfer into an equity fund of one’s choice.

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.