Invest within your circle of competence

“I have never made money in stocks and never lost in real estate” – argued an investor  ...

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SIP - a simple way to wealth creation

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

http://epaper.gujaratimidday.com//epaperpdf/gmd/20102014/20102014-md-gm-23.pdf

The English translation is as under:

Convenience is the middle name of mutual funds – one may not be exaggerating by saying this. The convenience that mutual funds provide, has been highlighted in many discussions. This ensures that mutual funds become an integral part of any individual’s personal financial plan.

Let us look at the various conveniences. The first and foremost is the combination of very high transparency and easy liquidity – we had written about this in one of our earlier articles.

Another feature of mutual fund as a product is the unitisation of the investment. The money invested into a fund is converted into small units of the fund. In fact, an investor can also hold fractions of the unit. This allows an investor to invest (or withdraw) any amount of money – large or small (subject to a small minimum limit) depending on one’s needs. This facility makes investing in a mutual fund similar to operating a bank account.

Over the years, as the product has matured, the investment advisors have packaged some of these features and devised some excellent investment strategies. These packages then help an investor match the cash flow with the investment account. Let us look at one such strategy: systematic investment plan (SIP).

Systematic investing is a simple form of investing on a regular basis. For most investors the regular cash flows are on a monthly basis – be it salary or various household expenses. In that case, the net cash flow, or the difference between income and expenses, or the savings also happen on a monthly basis. Hence, there is a clear need to have a solution to park this monthly saving somewhere. This is where mutual funds offer a systematic investment plan. An investor has to fill up one form and submit the same with multiple payment instruments (or instruction to one’s bank for multiple investments). Then the mutual fund company takes over the entire administrative part of the process, i.e. handling the payment instruments, custody of the same, deposition in bank, sending information of transaction to the investor, etc. The investor has to only ensure sufficient balance in the bank account. While an SIP can be done in any mutual fund, it offers certain distinct advantages when done in an equity fund.

Equity as an asset class has two characteristics: one, in short periods of time, the prices of equity products fluctuate a lot; and two, over long periods of time, equity has the potential to create wealth by giving excess returns over inflation and taxes. SIP takes the advantage of both these characteristics of equity and works on two principles: the power of compounding and rupee cost averaging.

When one invests a fixed sum every month, one is able to turn the volatility of stock markets to one’s advantage. Let us see how it works. An investor is able to save a sum of Rs. 3,000 every month and decides to enter into a systematic investment plan in an equity fund (let us assume there are no loads – we will discuss about loads later). As equity prices fluctuate, the NAV of the units of the equity fund will also fluctuate. However, since the number of units purchased would be inversely proportional to the NAV (or the price of purchase), every time the NAV is high, the investor would buy fewer units and when the NAV is low, the investor would buy more units. This will lower the average cost of buying the units.

Thus, systematic investing offers a direct benefit of matching an investor’s requirement of managing monthly savings while also provides additional benefits of the power of compounding and rupee cost averaging. In this way, SIP works best to help an investor create wealth.

Many also do an SIP in liquid funds, which allows one to accumulate money in a slow and steady manner to build a reserve fund. While this does not offer the benefit of “Rupee cost averaging” discussed earlier, it serves a definite purpose of accumulation by saving small amounts regularly.

Amit Trivedi

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

My views on proposal to ban upfront commissions

The article carries my views on proposal to ban upfront commissions:
http://cafemutual.com/News/AMFI’s-proposal-to-ban-upfront-commissions-draws-flak-from-many-distributors~3401~New~Industry~21

Should one use bonuses to repay loan or invest in equity?

Recently in an interview, an expert recommended that the Diwali bonus should be invested in equity instead of repaying the home loan. 

Read on ...

Don't break down after a mid-career break

Taking a break or thinking of taking a break?

Differentiate between asset and liquidity: 'I have a house and a couple of properties as back-up' is a very common comfort for people who want to take a break. But, as Trivedi puts it, it is important to differentiate between asset and liquidity. If there is a problem, the back-up plan should not be to sell a property or jewellery to continue with the venture. Importantly, selling a property isn't quite easy. A property deal will take its own sweet time to go through. Also, if the buyers/brokers realise that the property is being sold by someone in desperation, you may not get the right price. It is important to ensure that you have money in the bank or liquid funds or other safe instruments that will provide you with liquidity during the emergency period.

http://www.business-standard.com/article/pf/don-t-break-down-after-a-mid-career-break-114092900040_1.html

Understanding close-ended mutual funds

My article published in Mid-day Gujarati, Mumbai edition today.

The English translation is as under:

“Should I invest in this new mutual fund scheme?” Someone asked me the other day. This person was referring to the launch of a New Fund Offer (NFO) of a close-ended mutual fund scheme. This is not unusual. So many investors worry about investment decisions and tend to check on the schemes being heavily advertised. This may result into them missing out on some good schemes only since these are not advertised enough and information may not be easily available.

Let us come back to the NFO of this scheme. We have dealt with NFOs in one of our earlier articles. However, this time we are looking at NFO of a particular category of mutual funds, the close-ended funds.

To make it simple to understand, let us start with the difference between the terms (tenure) of these two categories of funds – open-ended funds and close-ended funds. The open-ended funds do not have a specific date of maturity, whereas the close-ended funds have. This means, these funds are wound up after a particular date (the maturity date) and the money is returned to the fund’s investors. On the other hand, the open-ended funds continue to operate perpetually.

Close-ended funds differ from the open-ended funds in offering liquidity to the investor. In case of open-ended funds, an investor has the facility to get out of the scheme on any business day. This can be done through submission of a redemption request with the fund house. Close-ended fund do not offer such a redemption facility. However, SEBI has made it mandatory to offer an exit route for the investors through the stock exchanges. This means, the units of close-ended funds have to be compulsorily listed on a recognized stock exchange. At this stage, it must be clarified that listing on a stock exchange does not mean liquidity, which is a function of the trading activity in the units of a specific fund on the stock exchange. Experience suggests that there is hardly any liquidity in the units of close-ended funds.

Where do these funds invest? Well, the mutual fund companies have launched various kinds of close-ended funds – equity funds, debt funds and hybrid funds (those that invest in both equity and debt).

The close-ended funds investing in debt are popularly known as FMPs or Fixed Maturity Plans. These funds are often used in lieu of fixed deposits simply as the mutual fund schemes have a slight advantage over fixed deposits – the returns are more tax-efficient. Though the last budget reduced some of the tax advantages to these schemes, these are still better if the investment is for more than 3 years.

The hybrid funds come in mainly in the “capital protection oriented” structure. In such funds, the primary objective is to protect the investor’s capital over the term of the fund. The second objective is to generate returns higher than traditional fixed income products. However, since these are close-ended funds, the equity component must generate superior returns exactly matching the term of the scheme for the secondary objective to be fulfilled.

The equity funds need more attention. Many investors prefer to invest in these schemes with certain assumptions: (1) this is an NFO, and (2) a close-ended fund offers better flexibility to the fund manager since there would be no redemptions. Distributors prefer to sell these schemes due to high commission income. All these reasons may not be correct. An NFO does not mean better investment performance. History does not support the argument that close-ended funds are able to outperform their open-ended counter-parts.

On the whole, it is always advisable to avoid these schemes considering the lack of liquidity. The funds with equity exposure – equity funds or hybrid funds – suffer from the fact that one does not know exactly over what period the equity would generate good returns. Equity, as an asset class, is always unpredictable – this must never be forgotten.

- Amit Trivedi

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

Chat transcript - www.moneycontrol.com 16th September, 2014

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