24 July 2015

My Wife – The Value Investor (of Precious Metals)?

If you are married, the news of gold and silver prices falling would not come as a surprise to you. Your wife would have already told you about it. And I am no different. I have least of interests in precious metals. But things are different when it comes to my wife.

"The gold prices are at multi-year lows!! So are the silver prices!!"

This is the first thing I got to hear when I came back home in evening today. And unsurprisingly, I knew what was coming after that statement…

“Shouldn’t we buy some gold and silver for future?”

Immediately, I was on the back foot. I was trying to duck a full-fledged bouncer hurled at me at 160 mph!

And the scorecard read:

Couple's Investing Scorecard

My response: “Gold neither gives any interest nor any dividends. And even Warren Buffett doesn’t like buying gold.”

Couple's Investing Scorecard

Wife’s response:So once again your Mr. Buffett enters our personal lives. Since when did you start listening to him in matters of gold and silver?”

Couple's Investing Scorecard

Dev: <Thinking what to reply>

Wife: “Now see, it has been years since gold and silver prices came down so low. Why can’t we buy some? After all, gold has a lot of value.”

Couple's Investing Scorecard

Dev: “But I still think its best not to buy these precious metals as investments. These are a type of insurances and not investments. We will anyways not sell it when it goes up in price. Isn’t it?”

Couple's Investing Scorecard
<Never give theoretical gyan to your wife. It is worth only half a point.>

Wife: “See? You haven’t even bought it and you want to sell it. You don’t like selling stocks even when they go up, do you? Then why should we sell gold when it goes up?”

Couple's Investing Scorecard

Dev: <Thinking what to reply>

Wife: “And will you sell my jewellery when prices of gold go up???”

Couple's Investing Scorecard
<that question is worth extra point. Married men know why>

Dev: “Not at all. All I meant was that we already have sufficient exposure to precious metals at the overall portfolio level. We don’t need to add more to it.”

Couple's Investing Scorecard
<Again giving theoretical gyan>

Wife: “Now I don’t know what you are talking about. But being from the jewellery industry, I know gold and silver are cheap right now! And we need to buy some now. Lets buy a little and I am sure it will not hurt your portfolio too much.”

Couple's Investing Scorecard

Dev: “But jewelry is not an investment. Can’t we buy coins instead of bangles, rings, etc.?”

Couple's Investing Scorecard

Wife: “What do you want me to wear in my ears – coins?”

Couple's Investing Scorecard

Dev: “Let's go. Let's buy some right now or prices might go up soon!”

Couple's Investing Scorecard

End of Story.

Disclosure: We bought some gold and silver today. Wife bought jewellery and I bought raw metal.

Final Scorecard? I guess you all know it. But in reality, I was more than happy that it was not a big innings defeat. ;-)

PS – Sometimes our investments (or expenditures) are more about the people who matter to us and less about returns we get from those investments. Coincidently, I had read this post by Rohit a few days back and never expected that something similar was to happen with me today.

20 July 2015

An Open Letter to my 18 Year old Self

Letter To Myself Investor

Hi Dev

Congratulations on officially becoming an adult now. I know how relieved you would be feeling having completed your school education – which in any case, you did not like very much.

Before you start wondering who I am, let me introduce myself. I am your future self – 12 years in the future to be exact. No don’t worry. I don’t have a terminator-like mission to protect you or something. And I am just future-you, writing this letter to you while sipping a hot cup of coffee at 12 midnight.

I don’t know what you will do in future – may be you will do your engineering, work for some energy company, do a MBA, then work for a bank, etc. – I don’t know. But to be honest, I actually know it. But let life surprise you. I am not telling you.

But one thing, which I do know is that you really like getting involved in managing money and helping others, do it. It sounds ridiculous to take advice and listen to an 18-year old. But I don’t know why my (our) parents and others do it.

I know you don’t want to listen to all this but there is one important thing which I want you to know. I am sure you know it theoretically – you were pretty good in mathematics. But what you do not know is how it can impact your future financial life. And I want to tell you all this because you have recently started dabbling in stock markets. Luckily our parents have been very supportive of you doing it. But there will be many others, who will tell you that it’s a place where you will only loose money. My advice: Ignore them. They are all full of noise Dev. Just ignore them.

Stock market is the place, where if you are diligent in your groundwork and have a sensible head that has the ability to cut down noise, then you can make truckloads of money. But when I say cut the noise, I also mean that you need to find sensible people to listen to. And you don’t necessarily need to meet those people. Many of them are already dead. But you can read what you they have already written. So get those books. Don’t wait too much. Read those books even if you don’t understand them completely. Because the next time you read it, you will understand it a little more.

But lets not waste more time. I know your friends are waiting for you to join them for a bike ride. :-)

So Dev, when I said that you know the mathematical concept, I was referring to the concept of compounding. I know you know it and how the calculations are done. But before you run away, listen to me.

Do you know how much returns can stock markets give? Great investors can manage above 20% for decades. But we are not great like them. So lets be sensible and pick a number that is much lower. Lets take 15%. Now the next two statements will tell you what I really wanted you to know.

If you can just invest Rs 5000 a month for next 12 years, then do you know how much you will have when you reach my age? More than Rs 20 lacs Dev!

You might say that Rs 20 lacs may not be a big amount after 12 years. But I know it Dev. It is a big amount. And it is still better than having nothing at all. Isn’t it?

And just think about it. Isn’t it a big number to achieve considering you only have to put aside a small amount of Rs 5000 every month? I know. Initially it might seem tough to find that amount of money. But as you age and start earning yourself, you will find that it is not tough.

And you know what? You can earn much more than 20 lacs if you can just increase your monthly investment amount every year!! You might even be able to save 35-40 lacs!! Sounds awesome. Great! It will feel much awesome(r) when you have that amount when you turn 30. I can swear that. I should have done it myself when I was at your age. But I had no one to tell me all this. But please don’t repeat my mistake of underestimating the power of investing small amounts. It can cost you a lot when you grow older.

You might feel that you can make a lot more money by investing directly in stocks. Yes you can. And I am not saying that you don’t invest in stocks. Do it. It’s a good learning exercise. But at the core of your investment philosophy (which you should have in place by the time you are 30), should be to invest as much as possible every month through mutual funds. And if you do recognize a good, sustainable, business that is selling at sensible valuations, go and buy truckloads of its shares? If you can’t buy truckloads of it, accumulate it slowly and steadily till the valuation remain reasonable and business remains attractive and growing.

I know I am using big words like ‘valuations’, ‘sustainable’, etc., which you might not understand completely at the age of 18.

But don’t worry.

Just focus on Compounding. And go and do a Google search for what Einstein (your childhood Physics hero) had to say about Compounding (link). Yes Dev. Even he knew what compounding could do.

But this is getting really long now. And I better get some sleep now. Have finished my coffee long time back. And my wife has already called me twice. Another advice Dev - Always respond to your wife before she needs to tell you something for the third time. :-)

But jokes apart, future is always bright. It is what we should atleast choose to believe. In life as well as in investing. You are just entering the most exciting phase of your life Dev. And remember that though its good to have money (which I am sure you will make using the concept of compounding), it is not the most important thing. I will not tell you what is the most important thing. You will figure it out yourself in next few years.

All I can tell you is that you will meet some amazing people in next 12 years. Some in person, and more of them in books you are going to read. So keep a sane head. Never let your ego do the thinking part for you. Brains have the responsibility of doing it. Stay calm and be stable. This reminds me of something Dev. The word ‘Stable’ will mean a lot to you in years to come. No. I can’t tell you anything more than that.

Now go and get hold of your friends for that bike ride.

Be original,

15 July 2015

Mutual Funds Vs ETFs in India - Which one to choose Today, And Which one in Future?

Note - This is a guest post by Girish Sidana, a reader and an accomplished professional working for a well-known name in Indian automobile industry. You can connect with him professional here.

So over to Girish... 

Most people reading Stable Investor would be fully convinced (even I am) that investing in well diversified Mutual Funds for a reasonably long period fetches the best possible returns. But what if I tell you that this may not remain true in future?

Yes. It may sound surprising.

But before I go into the details and tell you the reason for the above statement, let me try and explain the concept of another product, which is bound to play a big role in future. I am talking about Exchange Traded Funds or ETFs.

What are ETFs?

An ETF is very similar to mutual funds (MF) in a way, that it is also a fund of various stocks. It helps investors diversify their investment portfolio. But unlike actively managed mutual funds which charge around 2% as fund management fees, ETFs comes at a very low cost of about 0.5%

So how are ETFs able to charge so less?

Its because ETFs are not actively managed by fund managers. Rather these mimic the composition and returns provided by various indices. So you can invest in Nifty ETF which will track Nifty and will give returns commensurate to Nifty.

ETFs are also traded live on the exchanges. This is quite unlike MFs, which have a declared NAV for each day. Although ETFs have their own set of problems like tracking error, commission on each purchase or sale, liquidity etc., lets keep that discussion for some other day.

Here is what National Stock Exchange had to say about ETFs:

“In essence, ETFs trade like stocks and therefore offer a degree of flexibility unavailable with traditional mutual funds. Specifically, investors can trade ETFs throughout the trading day as in stocks. In comparison, in a traditional mutual fund, investors can purchase units only at the fund's NAV, which is published at the end of each trading day. In fact, investors cannot purchase ETFs at the closing NAV. This difference gives rise to an important advantage of ETFs over traditional funds: ETFs are immediately tradable and consequently, the risk of price differential between the time of investment and time of trade is substantially less in the case of ETFs.

ETFs are cheaper than traditional mutual funds and index funds in terms of fees. However, while investing in an ETF, an investor pays a commission to the broker. The tracking error of ETFs is generally lower than traditional index funds due to the "in-kind" creation / redemption facility and the low expense ratio. This "in-kind" creation / redemption facility ensures that long-term investors do not suffer at the cost of short-term investor activity.”

Note – To know more about ETFs and how they are structured, you can read comprehensive writeups available on NSE’s website (link).

Philosophy of Index Formation

It is also important to understand how an index is formed. Let us take the example of Nifty 50. It is made of top 50 companies of India. It is a dynamic index and keeps adding and dropping companies based on their market caps and various other factors. So, essentially, Nifty 50 is a good-enough barometer of the top Indian companies.

Thus an ETF taming Nifty 50 will give returns of these top 50 companies of India. Logically, this should be the best possible return one can think of. What better than top performing companies and that too tracking them almost on a real time basis?

But historical data shows otherwise. We all know (if not all then at least readers of this website) that lots of actively managed Mutual funds in our country have been giving better returns than Nifty (or Sensex for that matter).

And since actively managed funds are costlier than ETFs (or index funds), the higher expense will be justified as long as active funds, after accounting for expenses are able to beat the ETFs (and index funds) by a decent margin.

What Happens in Mature Markets like US?

The story in markets like US is very different from that of India. In those markets, most actively managed funds are not able to beat their benchmark indices. So purely from the returns perspective, ETFs make more sense there. 

An actively managed fund needs to return at least 2% more than the benchmark index to come at par with ETF. Now for all of you who have understood the power of compounding, appreciating a 2% increase per annum will be lot easier.

The reason which I have understood (by reading expert articles on this topic), and even though I don’t agree completely, is that Indian Mutual Fund managers are able to identify hidden stocks which may not be part of an index but are value stocks. Or, to put it differently, Indian stock markets still have nuggets of Gold hidden here and there - and that is because our markets have still not matured enough. And because of this, quite a few Indian mutual funds are able to give better returns than ETFs.

The Question / Deduction

Now the big question is that as the Indian economy grows and stock markets mature, the hidden value stocks may not remain as hidden as they are now. Also, there may be very few value stocks available over a period of time. This will make the task of Mutual Fund managers a lot more difficult.

Based on this logic, my understanding is that in times to come, the gap between returns from an ETF and return from a MF will reduce. And once this starts happening, it will be prudent to invest in ETFs rather than MFs. Or at least it will make sense to start allocating a decent part of your portfolio to a broader ETF like Nifty ETF.

Again, to take the example of developed market like USA, the debate of MF vs ETF is pretty hot. The data is very much in favour of ETF but there are equal proponents of both schemes. I remember reading one of the articles which compared this debate to vegetarian vs non vegetarian. Both advocate the merits of their school of thought.

Although history tells us that diversified MF are best investment vehicles, the future may be very different. So it might be wise to stay on the lookout for this development and remain cautious. 

MF may not be the cure-for-all as it is being told to all of us.

Personally, I have started allocating a part of my portfolio to ETFs (apart from the regular SIPs I do in MF). Whenever I see Nifty P/E going below 22, I invest some amount in Nifty ETF. I have started doing this very recently so have not got too many opportunities. My plan is to keep doing this regularly and may also reduce my SIP amount for a given month if I see Nifty P/E going below 20 and put this money in ETF. Or even skip my MF SIP in favour of ETF if it goes below 18.

What do you think? Do you think it makes sense to start looking at ETFs a little more seriously in near future?

11 July 2015

A Cheatsheet for Automatically accumulating Funds for Future Repeat Purchases

Note – This is a guest post by Ajay. He has already written quite a few thought-provoking articles like wealth accumulation through SIP, lumpsum investing in mutual funds. Sometime back, I collaborated with Ajay for doing a detailed comparative analysis about investing in Real Estate Vs. Mutual Funds. The post was well received and became widely shared over the social media.

So over to Ajay for another interesting analysis…

In last 15 - 20 years, our lifestyles have changed dramatically. I am sure that even 10 years back, no one would have imagined that our lives would become slaves to gadgets like mobiles phones, iPads, etc.

Whether this lifestyle is correct or not is a question best left for another day.

For a person who belongs to the previous generation and typical middle class family, important life targets were pretty well known:

- Complete your education
- Get a decent job (preferably government job)
- Have a regular monthly salary
- Live a contented life within the limited salary
- Bring up your kids nicely
- Before retirement, get yourself a house
- And live a retired life dependent either on your pension or on your kids

Plain and simple. Any deviation from this, and you could easily be termed as being the odd one out. :-)

Now during those good old days, the concept of credit cards, EMIs, Zero down-payments was not there at all. And that was because when we compare those times with current one, the desires and requirements of previous generation were very limited.

But today, the world is fueled by consumption and powered by availability of free and easy credit. Our needs and ambitions are growing day by day. We are becoming so used to the comforts and conveniences of new technologies, that in order to maintain (or improve) these comfort levels, we need to repeatedly change and upgrade the support equipments and products, which provide these comforts.

For a moment, imagine your life without the following:

- Smart Phones
- Computers / Laptops
- Tablets
- Smart LED TVs
- Music Systems
- Air Conditioners
- Refrigerators
- Kitchen Equipments
- Home furnishing
- Two Wheelers
- Four Wheelers
- Multiple Four Wheelers :-)

I know. Its tough to even think about a life without these. Life would be so difficult. Isn’t it?

Some of the these products have long lives and don’t need to be replaced frequently. But for others, regular replacement is advised (atleast by the manufacturers). For example, you might want to upgrade your smart phone every 3 years. On the other hand your desktop PC might need a replacement after about 7 years. Same for television and refrigerator.

Another reality is that once we get used to the comfort and convenience provided by these gadgets and their subsequent upgrades, it is not easy to simply go for a product that offers reduced comfort or features. And even if you do decide to do it, you might not feel very comfortable about it socially. For example, if you have been an iPhone or iPad user, it is highly unlikely that you will start using a basic smart phone.

Just to deviate a little, this shows the strength of the moat that Apple has been able to create over the years. The high social and emotional cost of switching to competitor products. And this indeed is the real reason that Apple is trading at a Market Cap of more than $700 Billion. You might like reading an article where Dev evaluates the biggest company of India and how small it actually is when compared to Global biggies.

Now here comes the important part.

Money For Future Repeat Purchases

If one observes carefully, it can be deduced that the prices of these products generally reduce over their lifetimes. But due to technological advancements, newly launched products offer additional comforts and features. And therefore, one is keener to buy an upgraded and superior product – which ofcourse comes at a higher price.

Now lets be honest…

We will always buy improved and upgraded products even though it might cost us more. Isn’t it? Under normal circumstances, our aspirations and needs are ever-increasing.

These days, the trend is too simply go and buy whatever you want.

How to pay for it? Use your credit card. Find it tough to pay your credit card bill? No worries. Convert it into EMI.

That’s it. Life is easy.

Credit is easily available for even very small purchases. And what is the justification for these increased credit-funded purchases? One is instantly able enjoy the benefits of product, without waiting for years. It is another matter that significant amounts are paid as interests, processing fees and insurance charges, even before you start using the product. Not to mention the continuous mental pressure of making the payment on time.

But if you are young, then you might not have many responsibilities and buying the product on credit may still not be a very big issue for you.

However when you have to repeat your purchases in future, say after 10-15 years, you would have additional responsibilities like higher family expenses, child education, medical expenses and so on. At that time, you might not be in a position to forego that comfort and may even have to pay much more to buy a superior product.

The question then is that how should one fund these repeated product purchases, without straining the regular cash flows?

I take television as an example for this study. This product is a perfect fit for the category that has undergone numerous technological advances.

So while the price of the old product has come down significantly (and some have become obsolete), there are other superior products available at much higher prices.

Also it is a kind of product you tend to replace after quite a long time, say 10 to 15 years (I used my last CRT TV for 15 years without any trouble before switching to a larger Smart LED TV).

In 1999, the cost of a 21-inch CRT television was approximately Rs 20,000.

In comparison, a full HD Smart 32-inch LED television costs Rs 44,000 today (in 2015).

As for the old tech 21-inch CRT television, it is still available at some places at a price as low as Rs 8500. But I am pretty sure that almost everyone these days will prefer buying a LED or LCD television and not the CRT one.

Now if given a choice, everyone would prefer to live a debt free life. But that is only possible if either you have loads of money; or if you can meticulously plan for most of your purchases in advance.

In my opinion, one should opt for loans and EMI only for buying the first house for self-occupancy - which also provides tax benefits. All other items bought for comfortable living and luxury, should be funded through savings and investments through proper planning.

In this case study of television, I have assume its useful life to be about 15 years. Lets see how we can fund the repeat purchase after 15 years.

Cost of CRT television in 1999 - Rs 20,000
Cost of LED Television in 2015 - Rs 44,000

Now here is the hypothesis. After buying the television in 1999, if a small percentage of the initial purchase value is invested in an investment option, whose ideal maturity period, matches that of the remaining time left for the repeat purchase, then it will automatically fund the future repeat purchase.

Sounds lovely? Automatically funding your repeat purchase? Read on…

Let’s say that 10% of the TV purchase amount (i.e. Rs 2000) was allocated for future repeat purchase. And this was invested in a financial product, which matched the expected duration of the repeat purchase.

In this case, the repeat purchase is expected after 15 years. Let’s see whether the purchase could have been funded automatically by this investment or not?

Since the investment duration is 15 years, the obvious choice of investment option is Equity Mutual Fund.

Let’s analyze by investing 10% amount (Rs.2000) in Franklin Prima Plus Fund on 01-Jan-1998. Rs 2000 Invested on that date, would have grown to Rs. 88,608 and would have easily funded your repeat purchases for not one but two televisions.

Lets pick another fund...

If Rs 2000 had been invested in Reliance Growth Fund, it would have grown to Rs 119,220 –good enough to fund almost 3 such televisions.

But for sake of being unbiased, lets choose another fund. And this time, lets pick up a fund that is not known to be a great one.

Lets take the worst performing fund of last 5 years in its category.

So now if the amount of Rs 2000 been invested in Sundaram Growth Fund, it would have grown to Rs 31,142. Agreed that it would not be good enough to fund a new 32-inch LED Smart TV. But it would still have been sufficient to buy a 32-inch regular LCD TV.

The point that I am trying to make here is that, by investing even a very small % of the actual amount spent on the initial purchase, you can more or less fund the repeat purchase of the item in future. And that too very easily.

For a moment lets assume that you are not able to contribute this 10% (for future repeat purchase fund) at the time of initial purchase.

No problem at all.

Divide the amount (Rs 2000) by 12 (~ Rs 200) and start a SIP for the divided amount for next 12 months.

Contributing Rs 200 monthly would not have been a problem for someone who is spending Rs 22,000 for buying a TV in 1998-99. Even this approach of breaking the amount into a small SIP would have yielded almost the same result.

Lets come back to 2015 now…

Now even today, if you are buying a LED TV for Rs 44,000, then contributing a small amount of Rs 600 per month for next 12 months should not be a very big issue.

But what if you don’t want to wait for 15 years to change your TV?

Suppose you want to change it every 7 to 10 years.

Even then, the suggestion would be to go for equity mutual funds. But since the expected duration is less (i.e. the time remaining in the next repeat purchase), your percentage contribution of the initial purchase value needs to be increased to say 20% to 25% as per the duration.

Lets take another example...

In year 2005, the cost of Honda Activa was Rs 44,000. And in 2015, the cost of same vehicle is Rs 58,000 approximately.

Now if one had invested Rs 16,000/- (in a fund for repeat purchase) in a diversified equity mutual fund in 2005, the money would have sufficiently grown to fully fund your new vehicle in 2015. And just to share some numbers, Rs 16,000 invested in Sundaram Growth Fund in July-2005 is now worth Rs 58,300. The same amount invested in Franklin Prima Plus Fund is now Rs 1,19,539.

Its quite understandable that as when you buy a vehicle for Rs 44,000, it is very quite tough find additional Rs 16,000 for something, which is to be bought 10 years later. But even if you cannot afford a one time investment, you can again divide this amount into small parts and do a SIP of 1 or 2 years.

But it is also possible that you don’t want to wait for 10 years. You want to buy another similar vehicle in 5 to 7 years. If that is the case, then it’s recommended to go for Recurring Deposits.

As a conclusion to this already long post, I would say that in order to maintain or improve one’s life style, one has to make some provisions for future. Proper, sensible planning….combined with investing a portion (10% to 20%) of the initial purchase value, will go a long way in giving you the financial comfort and also help you avoid getting trapped in loan-EMI cycle. In addition, it will not strain your regular cash flows during your middle ages, when there are other expenses that take precedence over these lifestyle related expenses.

Do let us know how you make provisions to fund future repeat purchases of necessary items.
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