Where does this road lead to? - My article on www.moneycontrol.com

Where does this road lead to? Asking the right question can put you on the right path. It holds good in the world of personal finance too.

Read more at: http://www.moneycontrol.com/news/planning/where-does-this-road-lead-to_5859581.html?utm_source=ref_article

Invest your irregular income systematically

How do you take the advantage of SIP if your income is irregular? Read on ... (My article is at the bottom of the page)

http://epaper.gujaratimidday.com//epaperpdf/gmd/19102015/19102015-md-gm-19.pdf

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The English translation is as under:

“You had written about SIP some time ago. I think that is a good idea, but I do not have monthly income. I get some money every once in a while. Is there a way that I can benefit from the features of an SIP in that case?”

A reader asked the above question.

He was considering investing on a regular basis in equity mutual funds with an objective of creating wealth over a long period of time. At the same time, he was uncomfortable investing lump sum. He also seemed to have understood the power of compounding as well as the concept of Rupee cost averaging.

While the power of compounding helps one create wealth over long holding periods, the Rupee cost averaging brings the average purchase price down. We have already discussed these in our earlier articles.

SIP or Systematic Investment Plan allows one to invest money saved on a regular basis. This is ideal for people who get monthly salary or such regular income.  The reader, who asked the question above, seemed to have an irregular income or no income. What is the alternative for such investors?

Mutual funds offer another convenience and flexibility here. Investors having irregular income, but who want to benefit out of SIP can invest their money in liquid funds, as and when they have surplus. They can then give a standing instruction to the fund house to transfer a fixed sum of money at regular interval into an equity fund. What this does is that it helps the investor park the surplus in such a way that the money earns some returns. At the same time, since the lump sum is to be invested in a liquid fund, there is no worry about the price fluctuations. Many investors are not comfortable with the wild swings in the value of their investments, especially in the beginning.

Since the money is transferred regularly into an equity fund, this is like an SIP. The only difference between this strategy and SIP is that, in case of an SIP, the money is invested in an equity fund from a bank account. In the proposed case, the same happens from a liquid fund. The liquid fund replaces the bank account in this case for the stated purpose.

Now let us look at someone who has irregular income. Some months, there is high inflow, whereas there are some lean months. Whenever this investor has high income, he can keep investing this into a liquid fund. On a regular basis, some money is getting transferred into an equity fund, systematically.

Thus, the investment in equity fund gets the benefits of SIP, though the investor does not have regular income.

Such a strategy is known as Systematic Transfer Plan or STP.

Someone planning to opt for this strategy should first choose the equity fund into which one wants to do an SIP. The next step is to select the liquid fund from the same fund house and invest lump sum money into this liquid fund. Then, one can give a standing instruction to the fund house for the said systematic, regular transfer. You have set up your systematic transfer plan.

Yet another benefit of the great flexible and investor-friendly mutual funds.

Happy investing.

-        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.

Diversification helps - especially during downturns

My article in Mid-day Gujarati, Mumbai edition today:

http://epaper.gujaratimidday.com//epaperpdf/gmd/16022015/16022015-md-gm-11.pdf

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English translation is as under:

In almost all discussions, diversification is highlighted as one of the major benefits offered by mutual funds. It is worth spending some time on this subject. We will look at some questions: What is diversification? How does it help an investor? What is the role of mutual funds in providing this benefit to the investors?

We have heard the popular English proverb: “Do not put all eggs in one basket”. This proverb suggests diversifying across various baskets, so that if something goes wrong with one basket, all your eggs are not spoiled. Understanding this principal is critical to the success of any investment strategy.

Let us look at one critical factor impacting the earnings of various companies: price of petroleum oil. As we read in the news, the price of oil in the international markets has been falling for some time now. The fall has been quite steep and has taken most people – common men as well as experts by surprise. What would happen to portfolio positioned with an assumption of stable oil prices?

There are various businesses that may be positively impacted by the fall in petroleum prices; some may be negatively impacted; whereas some others may be neutral.

Even when the impact of drop in oil price may be negative for some business, many businesses are resilient to recover after the initial setback only to resume long-term growth after some time. However, one may not be too sure in the short term.

In such a case, if someone has spread the investments across all the three types of businesses – those that may be positively impacted, those that may be negatively impacted and those that may be neutral to oil price changes – the short-term impact may be quite low. This is a huge benefit of diversification.

Another major advantage flows from the above. What if some companies are unable to recover from the short-term impact and eventually go out of business? Well, is it possible to identify such companies in advance so that one can avoid these completely? The fund managers and analysts try to do exactly the same. However, with so many factors involved, there is a possibility that their judgment may be wrong sometimes. Here again, a diversified portfolio is able to withstand the vagaries of short-term changes.

The above discussion could be true for individual companies as also for an entire industry.

At some time, euphoria may set in the market taking stock prices to sky-high levels. We have often seen that such a rally primarily driven by one or two sectors that take the lead. Given below is a chart showing market price movements during the technology boom of 1998-2000.

In the above chart, the blue line shows the movement of technology sector funds, whereas the red line represents that of diversified equity funds. One can easily see that the technology sector prices move much more than the diversified sector – in both directions – up as well as down.

Point to point, the technology sector ends higher after a three year period than the diversified funds. While an investment of Rs. 1 lac in the diversified funds would be worth Rs. 1.07 lacs; that in technology sector funds would be worth Rs. 1.75 lacs. However, the bigger question is: how many investors entered the funds around September-1998 (the start of the period in the above chart) and how many entered around February-2000 (when the prices reached the peak levels)?

Experience and data suggest that majority of people entered closed to the peak than the bottom. This resulted in regret. Between February-2000 and September-2001, while diversified funds lost by 51%; the technology funds lost a whopping 86%. Recovering from such a loss would take a while.

Putting the above numbers in perspective:

Let us say, someone invested Rs. 10,000 at the peak of the market in February-2000 in a diversified fund. The value of the investments would be around Rs. 49,000 since the prices fell by 51%. Now, to recover the losses and to break-even, the fund vale has to rise by Rs. 51,000. This means the fund price has to more than double (return on investment of roughly 104%).

On the other hand, an investment of Rs. 1 lac in technology sector would have been down to Rs. 14,000 by Spetember-2001. To recover the losses and to breakeven, the value has to rise by Rs. 86,000. This is a growth by more than 6 times (Rs. 86,000 on a base value of Rs. 14,000 or 614% return on investment).

Which do you think is possible? Which can happen faster? A concentrated portfolio is likely to see more volatility than a diversified portfolio.

There is a story about a man who had four sons. All four were almost always fighting among themselves. The father wanted to teach them a lesson. He gave each one a twig and asked to break. All could do it very easily. Then the father collected a number of twigs and tied these with a rope and then asked his sons to break the bundle of twigs. They failed. As kids, we were taught, “there is strength in unity”. This was nothing but a diversified portfolio that could withstand the external force better than individual twigs could.

Happy diversifying and happy investing to all.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

ELSS - benefit of equity investing along with tax saving

My article on ELSS in Mid-day Gujarati edition today.

Here is the link



Below please find the English translation

Mutual funds were not invented in India. However, we have some variants that one won’t find anywhere else in the world. These funds came into existence with an objective of promoting investments by retail investors into equity markets. We will talk about the two variations available only in the Indian market, viz., Equity Linked Savings Scheme (ELSS) and Rajiv Gandhi Equity Savings Scheme (RGESS).

While ELSS category has been in existence for many years, RGESS is a new entrant. Both are essentially equity mutual funds, but come with certain restrictions. Today, we will discuss about the merits and demerits of investing in ELSS.

Equity Linked Savings Scheme is a type of mutual fund that invests in equity shares and equity related instruments. An investor can invest upto Rs. 1,50,000 per year (As per the Union Budget 2014) to avail benefit of Section 80C of the Income Tax Act. The taxable income is reduced to the extent of amount invested (subject to the limit mentioned earlier) in ELSS. There is also a lock-in for a period of three years.

Since ELSS is a equity-oriented as defined by the income Tax Act, the dividends received from the scheme as well as long term capital are exempt from income tax as per the current provisions. Thus, apart from the reduction in tax, the investor also enjoys tax-exempt returns from the scheme. However, care must be taken to understand that these are equity funds and hence are subject to the volatility in the stock markets.

Does it make sense to invest in this scheme in spite of the price fluctuations?

First of all, the scheme comes with a lock-in of three years and hence the price appreciation, if any, would be considered long-term capital gain. As per the current laws, such long-term capital gain is tax exempt.

Second, due to the lock-in, an investor cannot exit the scheme before completion of three years. This means, there is no liquidity to the investor for a period of the lock-in. at the same time, this is not a close-ended fund and hence one can continue to stay invested in the scheme beyond the lock-in period. Since financial advisors recommend investment in equity mutual funds for long periods, the lock-in automatically makes the investor wait for at least three years before taking the money out of the scheme. A disciplined approach to using ELSS for tax saving can go a long way in helping the investor create wealth through the power of equity investing.

Third, since ELSS is an open-ended mutual fund scheme, one can start saving tax from April, the first month of the accounting year, instead of waiting for the last moment. SIP in ELSS ensures that the investor does not get burdened by tax planning in the last months of the year. It also ensures that the investor gets the benefit of Rupee cost averaging. (We discussed the benefits of SIP in one of our earlier articles).

At the same time, if an investor has already planned for saving tax through other means, viz. EPF, PPF, insurance premium, home loan EMI, etc., one may avoid ELSS and invest the money in an open-ended equity mutual fund without lock-in.

As a word of caution, ELSS is an equity linked investment and hence one must plan carefully before investing in this scheme.

Happy tax planning.

-       Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal views. He can be reached at amit@karmayog-knowledge.com.

Seven point prescription for investors in 2015 - my article on www.moneycontrol.com

This is again that time of the year when the business and investment world considers doing the following:
1. Looking back at the year gone by 
2. Preparing a list of resolutions for the coming year
3. Predicting what lies in store in the coming year

Let us also indulge into the same exercise.

Read on ...

SWP in a mutual fund - a better option for regular income

My article in Mumbai Mid-day Gujarati edition today:

http://epaper.gujaratimidday.com//epaperpdf/gmd/17112014/17112014-md-gm-11.pdf


English translation of the same is as under:

In the last two columns, we have highlighted some points about how mutual funds make it convenient to attain some of our objectives. First we talked about someone who has a regular savings that one needs to invest to achieve long term goals – mutual funds offer a facility called SIP for this. Then we looked at how convenient mutual funds make to buy gold. Let us now look at another category of investors, who need regular income from the investment portfolio.

Such an investor typically looks at certain traditional instruments that offer regular interest income – Post Office Monthly Income Scheme (MIS), Senior Citizens’ Savings Scheme, Fixed deposits, Debentures are some of the options that come to mind. All these are good investment options, but each has certain limitations. Due to these limitations, these instruments may be suitable to only certain investors and only in certain situations.

Let us spend some time in these instruments. All the abovementioned instruments give a feel of safety. However, the level of safety could be very different among all these. The Post Office MIS and Senior Citizens’ Savings Scheme are much safer than debentures issued by companies. Fixed deposits issued by banks are much safer than those issued by Non-Banking Finance Companies (NBFCs). An investor must keep this in mind.

Two features of these instruments must be understood properly. These are: term and interest rate. All the traditional instruments listed above have a fixed term and a fixed interest rate. That gives a good feeling of safety and regularity. However, if we consider the needs of a typical investor and compare the same with the features of these instruments, we start seeing a gap.

·      First of all, the investor may need regular income for a period that is different from the term of these instruments. We may have a five-year debenture available in the market. What if the investor needs regular income for seven years or three years? What about a retired investor, who would need regular income till one is alive and that period is unknown.

·      Secondly, all these instruments have a fixed interest rate. If we consider a retired investor, the income from investments is required to fund regular household expenses. These household expenses do not remain constant – they go up over a period due to the rise in prices of essential items like food or medicines.

Given these two gaps, the traditional instruments, though safe and predictable, may not be suitable to all in all situations.

Hence, there is a need to look at alternatives, if available. One such alternative is offered by the mutual funds. This comes in form of Systematic Withdrawal Plans (SWPs).

How does SWP work?

All mutual funds offer facilities for systematic transactions. An investor is required to give standing instructions to the fund house and they take care of completing the transaction based on the instructions given. SIP is one example of such standing instruction or systematic transaction.

Any investor can invest a lump sum amount in a mutual fund scheme and give standing instruction to the fund house for regular withdrawal of a fixed amount. Let us say, one needs regular income of Rs. 5,000 per month and has a sum of Rs. 5,00,000 that can be invested. After investing the amount in a particular mutual fund scheme, the investor needs to fill up a form for SWP. Every month on the stipulated date, the money would be taken out of the scheme and paid out to the investor.

This small amount withdrawal can be set up irrespective of the gains generated by the scheme. This is possible due to the divisibility of the investment. Though one can withdraw any amount (as long as it is less than the balance in the account), one would recommend keeping the withdrawal rate closer to (preferably lower than) the expected rate of investment growth. If you are expecting the fund to grow at 10@ p.a., keep the withdrawal rate at less than 10% p.a.

At the same time, if one has a need for regular income only for a stipulated period, say 5 years, one can draw the full amount over these 5 years.

SWP is much more tax-efficient than earning interest income from fixed income investments, if the withdrawal is done for a very long period. As compared to traditional instruments, this does not need the full amount to be blocked for the entire period, which means, one can keep withdrawing regularly and keep funding the account whenever other investments mature or when other lump sum amount is available.

A word of caution: please consider this discussion only in the context of liquid and short-term debt funds and no other categories.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.