22 August 2014

What Not To Do With Rs 10 Lacs

I have just come back from a trip to my hometown and this is the reason I could not update the site for last few days.

During my stay at home, something interesting happened when I had to accompany a family member to the Aadhar Card registration center. Registrations take place at many places like ones nominated as permanent centers by the government, ones which are temporary in nature and others which are set up in partnership with private companies operating in technology and financial domain and having existing branches at suitable locations.

The center which I visited was setup in partnership with a well known private company which is involved in share trading and financial services. One section of the office was dedicated for Aadhar registration and rest for normal trading and financial services related operations.

I was waiting for our turn when I heard 2 employees of this private company trying to convince a middle aged guy about the merits of investing for long term. Being a self-confessed long term investor, I was naturally attracted towards their discussion and decided to overhear them for a while.

The two salesmen were pitching a product to this guy with following simple claim:
Pay Rs 10 Lacs today (in 2014) and you will start receiving an assured income of Rs 1.5 Lacs every year from 2024 onwards till the time you die.

Simple and easy…

The potential customer seemed attracted to the simplicity of the statement and big numbers and claims of ‘assured income’ and started asking what(s), how(s) and when(s) about the scheme and the company which was managing the scheme.

Now both salesmen took this person away in one corner of the room (picture below) and (probably) started showing him vivid presentations about the potential riches which this 10 Lac – 1.5 Lac scheme had to offer.

Policy Agent Fool Investors
Salesmen Explaining the Benefits of Product/Scheme to the Customer

I am not sure what more these guys might have told him… but after about half an hour, I saw these men shaking hands with the customer and appreciating him for his wise and quick decision.

Now I don't know what this product (or scheme) was, nor did I make any effort to enquire about it. So, in case I get my assumptions and calculations wrong in rest of the post, please correct me by posting a comment. I will promptly correct the post to reflect changes.

So lets see…

Suppose you are the customer being persuaded by these salesmen...

But instead of buying this product, you decide to put Rs 10 Lacs in fixed deposits for 5 years. I checked a few bank websites and found that 5 year deposit rates are close to 9.00% per year.

Now the scheme/product offered by the people promises Rs 1.5 Lacs every year after 10th year.

So what would you get if you decided to put your money in Fixed Deposit for 10 years (two back-to-back 5 year terms)?

I did some basic calculations as depicted below:

10 Year Fixed Deposit Return

As evident from above calculations, using something as simple as 5-Year Fixed Bank Deposits, one can earn more ‘assured’ yearly income than that being promised by the scheme which these 2 salesmen were selling.

And I have not even considered the tax savings which you get from putting your money in 5-Year FDs. Assuming your only contribution to Section 80C is through these FDs, a sum of Rs 1.5 Lacs would be eligible for income tax exemption.

Now, a sum of Rs 40,000 yearly (difference in yearly incomes from above two scenarios) may not be much for a lot of people. And probably this difference would reduce further when we have more information about the product and are more realistic about our assumptions.

But the point which I am trying to drive home is that sometimes the facts are clearly in front of our eyes (in form of simple numbers) and we do not see them because of our ignorance.

But a little common sense and a sensible approach (which atleast questions the motives of people selling financial products, claiming ‘assured’ returns) can go a long way in creating long term wealth.

There may be other such assured returns kind of schemes which your so-called financial well-wishers might ask you to consider. But remember, its your hard earned money and not theirs. It is entirely upto you whether you really understand the scheme/product or are just blindly taking some action for sake of taking action (and showing off that you care and more importantly, understand about long term investing).

3 August 2014

Proof (Using 24+ Years Data) that Market Timing May Not Be Worth the Effort…Atleast for Us

I know people who have an uncanny knack of making correct calls (with almost perfect timings) in markets. And surprisingly, they are right more often than they are wrong. This surprises me as almost all wise investors are of view that average investors should not try to time the markets. Maybe I am wrong in putting these people in category of average investors. :-)

Jokes apart, I feel that making correct calls and making money in markets are two very different things. And as far as timing is concerned, I think that timing the markets is very tough, if not impossible. And as an extension to this thought, I feel that accepting one’s inability to time the markets can eventually help amass quite a lot of money in markets.

I keep looking for data which proves the futility of market timing, atleast for average investors. This post evaluates data set for last few decades to see whether it makes sense to try to time the markets or not.

Now someone has rightly said:

“The market timer’s Hall of Fame is an empty room.”

Even Peter Lynch, one of the greatest investors of his generation, who also popularized the concept of PEG Ratio once remarked:

 "I can't recall ever once having seen the name a market timer on Forbes' Annual List of Richest People."

Now to evaluate the usefulness (or uselessness) of market timing, lets pick 3 long term investors named A, B and C.

Investor Types

All three investors invest Rs 5,000 every month. Only difference is the timing of their investments.

Investor A invests on Monthly Highs (Perfect Mistiming)
Investor B invests on Monthly Lows (Perfect Timing)
Investor C invests on any one of the trading days of the month (Average Timing)

Now performance of these three investors has been evaluated over 5 different time periods (with amounts invested in brackets):

Starting 1990 – 24 Years Till Now (Rs 14.8 Lacs)
Starting 1995 – 19 Years Till Now (Rs 11.8 Lacs)
Starting 2000 – 14 Years till Now (Rs 8.8 Lacs)
Starting 2005 – 9 Years till Now (Rs 5.8 Lacs)
Starting 2010 – 4 Years Till Now (Rs 2.8 Lacs)

Results obtained by them over various time periods (upto 01 August 2014 - assuming complete month) are given in table below:

Market Timing Investor

Remember that Investor A is a Perfect Mis-timer and Investor B is a Perfect Timer. The calculations are based on actual Sensex figures between 1990 and 2014.

As you can see, the difference between a Perfect Timer (Investor B) and a Perfect Mis-timer (Investor A) is not as big as expected. For example, if both started out in 1995, their total investment of Rs 11.8 Lacs would have become Rs 54 Lacs and Rs 49 Lacs respectively.

A figure of Rs 49 Lacs is not bad for someone who got it wrong each month of the year since 1995!! He invested when index was at its highest point of the month. And he still fares decently when compared with Rs 54 Lacs achieved by a perfect timer (Investor B).

As an investor, I know I cannot time the markets perfectly, i.e. I am not Investor B. But since I invest regularly, I also know that by principle of averages, I cannot be Investor A, i.e. I cannot possibly pick the highest point every month to invest. This leaves me with just one option...that of being Investor C.

And I will be glad to be like Investor C.


Without the effort (like that required by perfect timer), I am able to earn returns which are respectable when compared to those earned by a perfect timer. And this is clearly visible in table below:

Market Timing Outperformance

There is no big outperformance achieved by the investor who times the market perfectly (atleast monthly). As an investor who strongly believes in Power of Doing Nothing in Stock Markets, this result should be acceptable to all average investors.

And this clearly (if not convincingly) shows that if someone is ready to invest periodically with discipline, then timing the markets may not be essential at all. I agree that I have made few assumptions in these calculations. And that these may not be a technically correct ones when trying to prove the uselessness of market timing. But for average investors like us, this analysis is a clear indicator that if one is not interested questions like how and which stocks to pick, then trying to time the markets may not only be futile but also a worthless exercise. 

Just keep investing regularly in well diversified equity funds or index funds. You will be better off than 99% of the investors.

Caution: The data used in above tables is only for one index (Sensex) and hence representative of performance of a weighted-combination of only 30 companies which constitute the index. And since index constituents change over time (existing companies are regularly replaced by other ones), its possible that numbers might differ if any other index is chosen. Also, as a reader has rightly pointed out in comments below,  if the same logic is used for a combination of companies which are not part of the index, chances are that you might lose some money! But this also does not mean that if you follow passive investing, then you will not lose money. In markets, no matter how careful we are, we can never eliminate the risk of being wrong. 


29 July 2014

One of the Biggest Reasons You should be Investing. Even if you can’t beat the Markets.


I am asking you to invest, knowing very well that most of you may not be capable of beating the markets regularly.

Let’s be honest here. Most investors haven’t been able to beat markets consistently over long periods. I am not talking about greats like Buffett. I am talking about common people like You and me. People who have an intention of making a killing in markets, but somehow or the other, end being killed by the markets.

But if you know that you cannot beat the market, then does it make any sense to be in market?

Yes it does.

But first and foremost, please understand that accepting and embracing the fact that you are incapable of beating markets is an achievement in itself. 95 out 100 people in markets do not know this or don't want to accept this. But it is the hard truth and tough to swallow.

But...if you are ready to accept this uncomfortable truth, then it can be one of your biggest strengths in stock markets. 

Market has an unbelievable potential of creating wealth. On an average, markets deliver annual returns of 12% to 15% over long term.

For someone who is capable of beating these numbers, returns would be in excess of 15%. But for those who are not in markets, all they can possibly earn is 7% to 9% depending on taxes applicable on the chosen asset class like banks deposits, etc. By not investing in markets, these people are missing out on extra 3% to 5% which can be earned by staying in markets.

Now these might look like small single-digit numbers. But you will be shocked to see the effect these numbers have on your wealth over a period of 10-20 years.

And the graph below clearly shows this. It’s a very simple depiction of what happens when an annual investment of Rs 60,000 (5K Per month) grows at 12%-15% (Equities); and what happens when the same money is parked in safer options at 7%-9% (FDs, PFs, etc).

Monthly Investment 20 Years
Returns on Rs 5000 per month investment in 20 years (At 7%, 9%, 12% and 15%)

Over a period of 20 years, you would have put in Rs 12 Lacs, i.e. Rs 5000 every month. Now this can either grow into Rs 26 to 34 Lacs if invested at 7% to 9% class of assets. Or into a much bigger amount of Rs 48 to 71 Lacs if invested at 12%-15% in stock markets.

Now wait…if you think that markets guarantee 12%-15% every year, then that is not the case. Returns in market are volatile. It can be 50% in one year and (-)30% in another. But over long periods spanning decades, the average returns are in line with these numbers.

And this clearly means one thing…

Even if you cannot beat the market, you should still not avoid investing in it.

Avoiding markets would prevent you from achieving higher long-term returns when compared with other options like bank deposits, PF, etc.

So is there a way to invest in markets, which is…

1) Simple
2) Sensible
3) In line with the thought that it is not easy to beat markets?

The answer is yes.

And the way to do it is Index Funds.

What is an Index Fund?

According to Investopedia, Index Fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index (such as Sensex or Nifty 50). An index fund is said to provide broad market exposure, low operating expenses and low portfolio turnover.

You might not know which individual stock or sector will outperform. But on an average, a carefully selected group of companies across sectors can do a decent job of maximizing diversification and minimizing exposure to few individual companies or sectors.

I am not saying that you should invest all your money in index funds. But if you think you want to save (invest) for long term, then atleast a part of your money should be parked in instruments linked to stock markets. And your safest bet can be Index funds. You can also choose well diversified large-cap or multi-cap funds which have proven track records. But that would mean that returns achieved by such funds would depend on fund manager’s ability to pick stocks. On the other hand, there is no active selection of stocks in index funds. Such funds simply replicate the composition of an index.

So if you feel that you have a knack of picking stocks which give market beating returns, then there is nothing like it and you should surely invest in stock markets directly.

But if not, then may be its time to think a little more seriously about Index Funds. And that is because if you are not in markets, then over long periods, you are missing out on some seriously big wealth creation opportunity.

Interesting Story:

When Google was about to launch it IPO in 2004, the company realized that this would create quite a few millionaires among its employees. The company therefore brought in a series of financial experts to teach them to make smart investment choices. A 1990 Economics Nobel Prize winner was also brought in. Even he advised Google employees “[not to] try to beat the markets” and to park their money in index funds.

Seems like Someone has rightly said - If you can’t beat them, join them. :-)


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