Habits of successful financial advisors

Most financial advisors and mutual fund distributors recommend their clients to start investing once they identify their life’s goals. Why should it be any different for the financial advisors?...

Read my article entitled "Habits of successful financial advisors" on www.cafemutual.com 

Mutual funds sahi hai, but when?

The AMFI campaign "Mutual funds sahi hai" is making waves. Many investors are seriously looking at mutual funds. However, what is disturbing about this is that some investors may be coming in mutual funds with unreasonable expectations.

While mutual funds sahi hai, but it is important to understand when. Read my article published in Mid-day Gujarati edition today.

The English translation of the same is as under:

Interest rates have come down in the recent past. This has also impacted the fixed deposits in the banks. With such reduction in the interest rates, many are now looking for alternative investment avenues as their fixed deposits mature. In such a scenario, mutual fund has appealed to many such investors as the investment option of choice. As the industry advertisement goes, “Mutual funds sahi hai!”

However, what is disturbing about this is that some investors may be coming in mutual funds with unreasonable expectations.

There are still many out there, who do not understand what a mutual fund is. It just appears to be yet another investment option, and it can deliver high returns only because it has done so in the past. This is the problem. A lot of mutual fund schemes have, over the long term, delivered returns far in excess of what fixed deposits have done. It is important to understand the schemes before taking a decision solely based on historical returns.

As we have already mentioned earlier, mutual fund is a vehicle that helps you invest in various securities – these could be equity, fixed income, money market or even a commodity like gold. Mutual fund by itself is not an investment avenue, but it is an investment vehicle.

This background is important to understand as some of the investors mentioned earlier are unknowingly shifting their money from fixed deposits to equity mutual funds – thus taking risk they may not be in a position to handle.

Equity has the potential to deliver superior returns in comparison to fixed deposits. However, such returns have come with a lot of ups and downs along the way. Any investor must understand this. In case one needs money when the values are down, you may end up getting less than the amount invested. Even when you may not need money for a long period, seeing your investments losing value for extended periods of time could be hugely challenging.

While mutual funds are good investment vehicles, one must understand what one is getting into and only invest in schemes based on one’s own unique requirements. If you are unable to find the schemes suitable for you, take professional help.

Equity investments simplified - transcript of chat on www.moneycontrol.com on 11th December 2017

Click here to read the transcript of chat on www.moneycontrol.com on 11th December 2017

Diversification is not about investing in mutual fund schemes with different names

What exactly is diversification? Can I have a diversified portfolio by simply spreading my money across different mutual fund schemes?

Read my article on the above subject here ...

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The English translation is as under:

Diversification

“I diversify my investments across many mutual fund schemes. I have investments across different fund houses.” Mentioned an investor. Very often you come across investors, who use technical terms without understanding the real meaning of the term.

In this case, one needs to check whether the objective diversification was really achieved. For that purpose, let us look at what diversification means.

Diversification is a strategy to allocate the investments across investment options, which are inherently different from one another. This difference must be in the behavior of the investment option. Different investment options exhibit different behavior patterns due to the influence of various external factors. Let us understand this through some examples:

·      When the Indian Rupee appreciates against global currencies, import-oriented companies benefit, whereas export-oriented companies see reduction in their revenues per unit sold. When the Rupee depreciates, the export-oriented businesses do well, but costs of import-oriented businesses go up, thus reducing their margins.

·      When interest rates move up, short-maturity bonds lose less and start earning higher soon. During such a period, long-maturity bonds lose a lot of money. The long-maturity bonds gain a lot when interest rates move down.

·      When the economy is doing very well, stocks rise in price, whereas bonds suffer as interest rates start to move up. However, when the economy goes down, stocks plummet and the central banks get into action. They reduce interest rates, which push bond prices up.

As you can see in the above examples, there are different investment options that have opposing influence of the same external factors.

When you invest in such different alternatives, you are immune to changes in that particular factor. For example, if you invest in an import unit and an export unit, you are immune to changes in the exchange rate (assuming the foreign currency is same).

Since we are discussing investing through mutual funds, the investor need not get into the details of the business of each and every company; as that job is done by the fund management team. However, if one wishes to invest through mutual funds and ensure proper diversification, one may look at different types of mutual fund schemes, e.g. invest across market capitalization, viz. large-cap schemes, mid-cap schemes, etc. or invest across asset categories, viz. equity funds, debt funds, liquid funds, gold funds, or across geographies, viz. funds investing in Indian markets as well as fund investing in global markets, etc.

Simply diversifying across different schemes may not be a true diversification.

Transcript of chat about mutual funds

Equity investments simplified

How are equity savings funds different from monthly income plans?

In some of our earlier articles, we have covered various hybrid funds. One such category was the MIP or the Monthly Income Plan – a hybrid fund that invests predominantly in debt securities and marginally in equity. Such a combination offers stable, but potentially higher than debt fund returns over long periods.

In the last few years, a new variant has been introduced that works very similar to an MIP, but comes with a small difference. These products are known as the “equity savings funds”, popularly.

Click here to read more about these funds ...

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The English translation of the article is as under:

In some of our earlier articles, we have covered various hybrid funds. One such category was the MIP or the Monthly Income Plan – a hybrid fund that invests predominantly in debt securities and marginally in equity. Such a combination offers stable, but potentially higher than debt fund returns over long periods.

In the last few years, a new variant has been introduced that works very similar to an MIP, but comes with a small difference. These products are known as the “equity savings funds”, popularly.

These funds are a hybrid of three portfolios, instead of two in case of MIP. The three parts of an equity savings fund are: equity portion, debt portion and arbitrage portion. The exposure to the debt securities is kept below 35% in these cases, to ensure equity exposure (combined between pure equity and through arbitrage positions) at all times is above 65%. As we discussed in case of the arbitrage funds, keeping equity exposure above 65% gives these funds the status of equity-oriented funds for the purpose of income tax. Due to that, the dividends from these funds are tax-exempt in the hands of the investor as well as exempt from dividend distribution tax. The short term capital gains are taxable @ 15%, if the gains are booked within one year. If the holding period is longer than one year, the capital gains are qualified as long term and hence such capital gains are tax-exempt.

This offers a wonderful investment option for the conservative investor – stable portfolio returns with high tax-efficiency.

However, one must keep certain points in mind about this portfolio.

1.     This is not a debt fund, but a hybrid fund, having exposure to equity

2.     The fund has net positive exposure to equity, unlike arbitrage funds, where open equity exposure is covered by derivatives. Such a net positive equity exposure means the fund can exhibit higher volatility than arbitrage funds.

3.     The net equity exposure may be higher than in case of MIP, such schemes could deliver higher long term returns with high volatility in the short term. The risk is higher.

Given this, it is advisable to consider these funds only if you have money to be invested for medium to long term periods. These funds are not suitable for short term investments. Given the tax advantages, these funds could be a better option in comparison to MIPs.

- Amit Trivedi

Avoid falling prey to insurance mis-selling ...

While IRDAI can nudge the sector towards better practices, buyers need to view this as an instrument that provides risk cover, not as a tax saving or investment product

Read my article in today's Business Standard below ...

Avoid falling prey to mis-selling of insurance

Did the markets go up 21% due to demonetization?

Amit Trivedi examines if the Nifty rise of 21% for the one-year period since the announcement of demonetization is a coincidence, correlation or cause.

Click here to read the article ...

What is Bitcoin and How does it Work?

Is Bitcoin a good investment? Click here to read on ...

What are arbitrage funds? When are these funds appropriate for you?

In the last couple of years, one category among the mutual funds has gained popularity – the arbitrage funds. It is important to understand what these funds are, how they work and what purpose these serve. One must also understand the risks involved in these funds. Click here to read my article published in Mid-day Gujarati edition.

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The English translation of the article is as under:

What are arbitrage funds? When are these funds appropriate for you?

In the last couple of years, one category among the mutual funds has gained popularity – the arbitrage funds. It is important to understand what these funds are, how they work and what purpose these serve. One must also understand the risks involved in these funds.

We covered this category in our column on February 6, 2017 with proper example. However, we feel that there are a few misconceptions around this category that need to be clarified, especially looking at the amount of money getting parked in these funds. Many consider this as safe as liquid funds, with the benefit of lower (or zero) taxation.

Arbitrage is a strategy to generate returns due to the price difference between two different markets for the same (or similar) securities. This often happens between the cash segment and futures segment of the stock markets, on account of what is technically known as the “cost of carry”. This “cost of carry” is akin to interest charged for short term borrowing.

However, since the money is invested in stocks (at least 65% of the scheme’s corpus), the fund is treated as “equity oriented fund” according to the Income Tax Act. This means the dividend is tax exempt in the hands of the investor, as well as exempt from the dividend distribution tax. Capital gains are tax-exempt, if the holding period is more than one year. Even when the capital gains are booked for a holding period of less than a year, the same is taxed at a lower rate of 15% and not clubbed with the income.

This tax arbitrage is drawing a lot of money towards these funds. However, it is important to understand the investment before getting on to the discussion of taxation. The investment theory must precede considerations of tax and the investment theory would help one analyse the risk-reward trade-off.

First of all, let us make one point clear: as per the classification for purposes of income taxes, arbitrage funds may be classified as equity-oriented funds, but in terms of investment theory, these are alternatives of liquid funds. Hence, please do not expect returns in line with equity funds. These funds can generate investment returns very similar to those generated by liquid funds.

At the same time, while liquid funds invest in money markets and debt markets; arbitrage funds exploit arbitrage opportunities between two different segments within the equity markets.

Pure arbitrage is considered to be an almost zero risk strategy, since the prices converge on expiry of the futures contract. However, there is a possibility that the spreads widen before the contract expires. In such a case, there could be negative returns, temporarily. One must be aware of this.

Such short term negative returns may coincide with your parking horizon and thus, you may end up with very low or even negative returns, if you have parked money for very short periods of time. This only means that one should not treat arbitrage funds as a total replacement of liquid funds, but use these only when the time horizon is slightly long, say at least one month.

In spite of the risk highlighted, the arbitrage fund could be a good place to park your fund and enjoy the reduced taxation.

-       Amit Trivedi

Understanding exit loads in mutual funds

What is an exit load? How does it affect an investment's returns?

Click here to know the answers...

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The English translation of the article is as under:

Exit load

What is exit load?

Certain mutual fund schemes carry an exit load. This is the charge levied when an investor exits the fund scheme, or redeems the money. However, this charge is levied if the exit is made before a certain pre-defined time period. If the investor stays beyond this period, there is no exit load. Let us look at some examples. Various mutual fund schemes may have exit load structures like this:

(1) 1% exit load if redeemed before completing 1 year; Nil thereafter.

(2) 1% exit load if redeemed before completing 1 year; 0.5% exit load if redeemed after completing 1 year but before completing 2 years; Nil thereafter

(3) 0.5% exit load if redeemed before completing 6 months; Nil thereafter

(The above are only some examples. You may check the exit load applicable in the scheme of your choice.)

Which schemes have exit load?

Close-ended funds and ETFs do not have exit loads. Any open-ended mutual fund scheme can have an exit load. However, normally, liquid funds do not have it. Whereas all other schemes may have exit load, the same is not necessary. There are many equity and debt mutual funds that do not have any exit loads. It is also important to keep in mind that the same scheme may have different exit load structure at different points in time.

Though the exit load may be different at different times for the same scheme, in case of any investment the applicable exit load would be the one that was prevailing at the time of investment and not at the time of redemption.

In case of SIP too, the applicable exit load would be the one that were prevailing at the time of each of the SIP installments and thus, different installments may have different exit loads applicable.

How does this exit load work?

The exit load is charged by adjusting the redemption amount for the same. The amount payable to the investor would be less to the extent of the exit load. Let us see that with a calculation:

Let us assume that the exit load is 1%; NAV at the time of redemption is Rs. 20; the balance in the folio is 25,000 units and the investor has opted for redemption of all units..

In that case, the redemption price = NAV X (1 – exit load)

Redemption price = Rs. 20 X (1 – 1%) = Rs. 20 X (0.99) = Rs. 19.80

Amount received on redemption = no. of units X redemption price

= 25,000 X Rs. 19.80

= Rs. 4,95,000

Consider this amount in relation to the money that the investor would have got in the absence of exit load. (Rs. 20 X 25,000 units = Rs. 5,00,000).

Due to the exit load, the investor got Rs. 5,000 less than the value of investments on the day of redemption. This Rs. 5,000 is the exit load or the exit charge paid.

Then again, Rs. 5,000 is 1% of Rs. 5,00,000.

This is how exit load works.

-       Amit Trivedi

Wish you a Happy Diwali ...

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Diwali, the festival of light, is when Hindus perform a Laxmi pooja. What are we asking for when we pray to Goddess Laxmi? We ask for prosperity, not just money. There is a difference between the two. In order to understand the same, let us look at the photo of the goddess we use for the pooja.

One of my favourite Diwali posters is one that shows Goddesses Laxmi and Saraswati along with Lord Ganesh. It is not for no reason that these three are shown together.  
 

While we all need blessings of Goddess Laxmi to be successful in life and grow, she must come in our life flanked by Goddess Saraswati – the goddess of knowledge and Lord Ganesh – the god of wisdom. If Laxmi comes along with these two, it stays and brings bliss in life. And that is true wealth – not mere financial wealth.

Trying to earn more and more money without proper knowledge and wisdom can lead to ruins. Money may come but that would not bring bliss in life.

The difference between “knowledge” and “wisdom” also must be understood at this juncture. “Knowledge” is to know something – to be aware of something – to understand and being able to explain it. “Wisdom” is intelligence – it is about being able to judge – to use discretion – being able to separate the good from the bad – the right from the wrong.

First, let us address the knowledge part. It is critical to know what one is doing. “Look before you leap” is not just a proverb; it’s a great advice. Whether it is income, expenses, loans or investments, it is important to know.

Questions on income:

·       How sustainable is the income?

·       How stable is the source of income? This is especially critical for self-employed persons and small business owners. However, in the present times, even jobs are also not guaranteed.

·       Do you understand the taxes on the income?

Questions on expenses:

·       Know the monthly budget – the expenses you incur

·       How much of the monthly budget is spent on necessities and how much on luxuries? Which of the luxuries can you cut down?

·       Is it possible to reduce some expenses through finding alternatives?

·       Have you kept provision for these expenses in case there is an emergency, e.g. health issue or loss of job?

Questions on loan:

·       Have you understood the terms of the loan?

·       What is the interest rate on the loan? Is it too high or too low? If it is too low, is there a catch?

·       What are the various penalty clauses?

·       What are the flexibilities?

·       Can you terminate the loan earlier without any penalty, in case you get funds suddenly?

·       What is the security required by the lender?

Questions on investments:

·       Have you understood the terms of the investment?

·       What is the (expected) rate of return?

·       Is it too high or too low? If it is too high, is there a catch?

·       Is the risk too high? Understand the risk involved. If you do not understand the risk, please avoid the investment. Every investment carries some risk.

·       Is there a lock-in or is the investment liquid?

·       At what rate would the earning be taxed?

This is not an exhaustive list, but only an indicative one.

Discretion is required both while earning as well as spending. Is the money coming in through the right means or are you taking some actions, which may be incorrect ethically or morally? Are you spending too much money for luxuries than fulfilling your responsibilities?

Wisdom and discretion must be applied to the assets and liabilities, too. Are you borrowing wisely? Is it really required? Is it a good loan? Are you investing smart? Or are you acting on tips without understanding the risks? There have been many instances when one has asked “Is it safe?” or “I hope there are no risks” in stead of asking “Please tell me about the risks present. And how do we manage those”.

So, this Diwali, make sure to pray for Laxmi to arrive at your place – but the right type and through the correct means. Pray to Goddess Laxmi to stay in your life forever. Make sure your life is worth for her to stay forever.

-        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.