Hierarchy of Financial Sufficiency

A noted American psychologist developed a hierarchy of needs based on human psychology- Abraham Maslow’s Hierarchy of Needs. The pyramid describes the level for the needs in human life cycle from basic to self-fulfillment needs. The bottom is physiological needs (What food I need to eat?) to the top of the triangle (What’s my purpose in life?), which can only fulfilled once basic needs are taken care of.

The same theory can be applied in money matters through financial priority triangle. We need to identify the first level towards meeting our financial milestone and keep moving ahead to reach the next level. Sounds simple? Sure, it is.

 

Cash flow management is the first step towards financial uplift. It is critical to understand that ideal scenario is income exceeds expenses. But, if that may not be the case, then our financial security is in jeopardy. As higher expenses not only increases debt but also reduce savings and future potential growth of capital. Hence, the focus needs to be either to increase income and/or reduce the expenses.

The equation needs to be:

Income- Expenses= Savings

The next step is to understand level of debt in personal balance sheet. It is essential to understand the type of debt held in terms on appreciating assets including education, property and precious metals and avoid holding debt on deprecating assets like car, travel, gadgets and vehicles. The idea behind is to understand that our liabilities should not eat away our saving opportunities.

As interest payment towards debt not only hampers current savings level, but also makes us lose opportunities to grow our savings through investments.

Understanding our cash flows, provides us an overview of the way the money is managed- in building assets or creating liabilities. It is essential to comprehend the budgeting and attain asset-liability management, as it impacts the savings rate and potential to achieve future financial goals.

It is important to achieve the discipline in savings for future financial aspirations, as saved money can be invested for tomorrow.  Furthermore, it is imperative to increase the net savings rate through minimizing financial leakages including taxes, interest payment, and credit card dues. The simple method is Know your goals. Invest your savings. Optimize portfolio performance.

But, investing the money is not where it ends all, it is equally significant to track the investment performance of the portfolio and at minimum match the performance to the benchmark index. The focus should be to align your goals, risk appetite and time horizon rather picking top performers or hot stocks. Nevertheless, portfolio performance is one of the important parameter to maximize the goals- but other parameters include knowing the sector allocation, risk allocation, distribution among risky and less risky assets. Thus, at the top of the pyramid is optimizing portfolio performance and employ strategy that maximizes goal achievement. As the objective, is to move up the ladder from financial security to sufficiency and wealth creation.         

    

Baby Steps for Indian Economy: One Budget at a time!

Less than 24 hours remaining for the most awaited day of the year- this time not longed for its weekend-but for the first full year budget, to be presented by NDA led BJP Prime Minister’s Narendra Modi’s government; after their historic win in May’14 elections. This year’s pre-budget rally is like silent reaction as against its extreme- as it was last year 2014 before the budget as well as elections.

Everyone marks their day for the last Saturday of the month- 28 February 2015; as many questions wait to be answered; many doubts wait to be cleared. Market stay cleared off the volatility this time, as investors wait to react to new happenings, as it seems to have absorbed the speeches and promises by our new government. Now, it is like they are asking for what more and better is there to digest around.

Investors have already reflected the optimism and confidence for the new government. Now, what they are aspiring is the delivery of their promises; now empty words won’t make any impact- but actions will. We are well aware of what you look forward to do but our main concern stays how shall you achieve what you have already said.

Today market is trading at 29,000+ points with valuations looking stretched at 18.09x 1-year forward. The market focuses on the action plan of the government as they remain the confident that government’s intent and purpose is clear, pure and goal-oriented.

Investors state their expectations for this year’s budget and request that actions say louder than words:

1.       Fiscal consolidation

Markets expects government to bring in quality in public finances and to keep the fiscal path intact with 4.1%, 3.6% and 3.0% target of the GDP in FY15,FY16 and FY17 respectively. Also, anticipates the reduction in subsidy spending by 0.4% and alternatively, increase the capital expenditure. (ING Vysya Bank, 2015). Given that the government is close to 90% fiscal target; the challenge remains how government shall focus on value-creating assets, decrease its interest outgo and improve its current tax-to-GDP ratio of 10.6%.

Its remains in critical factor for future monetary policy, equity markets and debt bond yields- as fiscal consolidation shall ‘make or break’ the future growth story of India. It is a key to macroeconomic stability and RBI has kept its eyes and ears glued to it.       

  

2.       Revival of investment cycle

Corporate continue to struggle with high interest rate, weak demand and low capital expenditure cycle. Hence, to ensure the economic revival it is critical for the government to increase savings and investment ratio from 30% to late-30% and rationalize the allocation of resources to important sectors including railways, defense, power, capital goods and manufacturing. The government should rightly focus on making India as investment-growth economy rather than being consumption-driven.

Ease of doing business, stable tax regime, managing inflation and routing financial savings to long-term infrastructure and economic developments plays a critical part in reviving both investment and consumption cycle.

3.       Simplified taxation regime

To boost the ease of doing business as well as stabilize the taxation system, it is critical for the government to focus on streamlining the tax structure and introduce a well-defined process for taxation. The workings and development of Goods & Services Tax (GST), Direct Tax Code (DTC) should be focused on. Clarity in Minimum Alternate Tax (MAT) framework, dispute settlement mechanism, Real Estate Investment Trusts (REITs) and Alternate Investment Funds (AIFs) should be presented.

Government also needs to focus on increasing its tax revenues and optimize on its tax administration; as government’s income-expenditure sheet should define India’s future growth story.

4.       Infrastructure development

Advancement of an economy is defined through its infrastructure, which not only includes roads, power, transport, and real estate but also quality of education and health services granted its citizens. As it not helps in improving the economic development but also ensures competiveness and healthy business climate. Hence, ‘Make in India’ is expected to not only focus on manufacturing but also transform India’s economic future as it shall lead to expansion in job market as well as skill development.

5.       Reform-focused

NDA led BJP government won May 2014 elections through its speeches as ‘pro-growth, pro-business and pro-reform’ government. It is time from them, to stick by their words and demonstrate an action plan. Government should focus on reforms including taxation, investments, infrastructure, policies and resources. It is critical for the government to ease its land acquisition, labor laws, acquisition and pricing of machinery and capital-raising for it to boost its agriculture, manufacturing and services industry.   

Economic inclusion, fiscal consolation and ‘Make in India’ remain defining parameters for Budget 2015 to be presented by Finance Minster Mr. Arun Jaitley.            

But on the darker side, analysts and India Inc expects market to react negatively, if budget fails to deliver its promises. A fall of 6-8% (Mint, 2014) is expected in equity markets if the government Additionally, rise by 25-30 bps in expected in the bond yields if fiscal consolidation roadmap is left un-adhered to. This sell-off may also lead currency plunging to 64-65/$. Thus, market looks around in observant manner, waiting to react to announcements to be led by our Honorable Finance Minister.

http://economictimes.indiatimes.com/opinion/interviews/markets-can-rally-20-30-if-budget-2015-meets-partial-expectations-jim-oneill/articleshow/46362167.cms

http://www.moneycontrol.com/budget-2015/?gclid=CJLcqIzC_MMCFUErjgodY5gAbA

http://articles.economictimes.indiatimes.com/2015-02-22/news/59386583_1_minimum-alternate-tax-tax-exemption-fm-arun-jaitley

http://www.moneycontrol.com/news/economy/will-budget-revive-investment-rate-experts-discuss_1313856.html

http://articles.economictimes.indiatimes.com/2015-02-21/news/59363094_1_swasthya-bima-yojna-helpage-india-pension-scheme

http://www.financialexpress.com/article/economy/expectations-from-budget-2015-indiamart/46507/

http://in.reuters.com/article/2015/01/15/india-rbi-idINKBN0KO07Z20150115

http://www.livemint.com/Opinion/G047pKZaxRkfmrCc0qTYcO/Union-Budget-2015--6-priorities-for-the-finance-minister.html

http://www.livemint.com/Money/tTzksHFPHnyubi2J1bWwWI/Indian-markets-riding-for-a-fall-unless-budget-delivers.html

http://www.livemint.com/Politics/J1nRGMHNzC7HvJQV1nVphP/Budget-2015-Does-the-Modi-govt-mean-business.html

http://www.livemint.com/Money/9vBSyTJuaaI7nSFQwi959L/Markets-no-room-for-disappointment-in-the-budget.html

http://www.mydigitalfc.com/stock-market/budget-must-revive-investment-cycle-754  

http://businesstoday.intoday.in/story/union-budget-2015-16-expectations-for-corporate-sector/1/215814.html

http://profit.ndtv.com/budget/fiscal-reforms-to-determine-indias-ratings-moodys-742226

Saving taxes through investments: The ELSS way

As the year-end proceeds, tax savers awaken- just like laggards during examination preparation. As a financial advisor, I would recommend not to, as tax planning should be considered as an annual practice rather than single quarter/ monthly process.

Nevertheless, hereby I present you with various financial savings/ investments instruments that are available u/s 80C including PPF, provident fund, life insurance premiums, NSC, ULIPs, 5-year locked-in bank FD, ELSS, Home loan re-payment, children’s tuition fees. Avenues like EPF are mandatory for salaried class, tuition fees and home loan are expenses, and insurance-related products are protection. Thus, among investments we have limited options with following characteristics:

In terms of long term returns and shortest investment period ELSS gains an edge over other investments as:

1. It is a well-diversified open-ended equity mutual fund investment with minimum of 80% assets invested in equities, qualifies u/s 80C of IT Act.

2. Both dividends and capital gains are tax-free as it has 3-year lock-in period.

3. Current limit u/s 80C is 1.5 lakh if invested in ELSS, can help you save Rs.20, 085, Rs. 35,535 and Rs. 50,985 with a tax effect of 13.39%, 23.69% and 33.99% respectively.

4. Moreover, you can churn the same investment after lock-in period to attain the tax benefit. Thus, ELSS forms as an appropriate tool for tax-savings, long-term wealth creation and investment product.

Following ELSS are recommended based on qualitative and quantitative analysis-

Quality ELSS funds has offered higher risk-adjusted returns over their comparative counterparts over long-term, mainly because of difference in asset allocation and distribution within market capitalization. Nevertheless, it is recommended to invest in both ELSS and diversified open-ended as latter has the flexibility built-in.

Wishing you all- Happy Tax Saving!

Life is full of choices these days; from your favorite toothpaste to your TV channel. But, sometimes choices = confusion. Things get little more complicated when it comes to finances and money management as choice of action today determines the future financial well-being and standard of living. That is why people generally rely on expert advice of their financial advisor. In the world of investing, where choice= chaos= confusion, expert opinion and information play a critical hand.

These days, equity mutual funds have garnered importance as equity markets have jumped 35% YTD and assets under management of the mutual funds has increased by 34% (September, 2014) as investors re-gain confidence in capital markets.

Different types of Equity Mutual Funds for different investing needs:

Mutual funds are professionally managed pool of money collected from large number of investors. They are utilized for wealth creation, tax savings, regular income and savings for future. There are various options in mutual funds.

a.      Generally for long-term wealth creation: Advisors recommend investors to invest in growth option as geometric returns helps investors make money on returns as well. In growth option the number of units allocated remains the same and the NAV keeps on growing as per the performance of the mutual fund.

b.      For regular Income:  Usually dividend option is recommended for income from mutual funds. Even though AMCs usually don’t declare dividends on regular and consistent manner, it also works as a strategy for timely profit booking. Within dividend option, there are sub-options including payout, reinvestment and sweep. In payout option, dividends are transferred to investor’s account directly; whereas in reinvestment option, declared dividend is transferred as units in existing investment and finally, in sweep option dividend amount is transferred as units in any other mutual funds, specified by investor beforehand

c.       Bonus Option:  Allocates bonus units to the investor, on any sustainable appreciation. This scheme comes in handy for HNI investors to reduce their taxation on capital gains.

Identify your needs before investing in any Equity Mutual Fund:

It is important to understand that choice of options in any mutual fund category can significantly impact the potential risk and return. The selection of option should be aligned to financial goal and to maximize the utility of investing.

Growth Option:

1.      Parking Any Surplus Funds like bonus for a long term (10-15 years).

2.      Small and regular savings per month for retirement, child education or marriage (SIP).

3.      Accumulating funds for pre-closure of loans in 5-10 years (SIP).

4.      Long term wealth creation.

Dividend Option and Bonus Option:

1.      Tax reduction in the short term.

2.      Income requirement from your portfolio.

3.      Automatic profit booking.

4.      Re-investment in different avenues for portfolio diversification and rebalancing

Investing in equity Mutual Fund is not an option but a necessity for average investor. It is the only investment avenue which has historically matched the returns of Real Estate but has very low threshold for investment (as low as 1000/- per month). Since the risk is spread over so many stocks, the liquidity is in 3 days and the entry price is so low, mutual fund becomes a must have investment avenue in every long term investor’s portfolio.

How many women it takes to give birth to a child in one month?

photo courtsey: flickr.com

The question is as simple as it seems. A woman takes nine months to give birth to a baby. So, can we say nine women can deliver a baby in a month! Ridiculous, right? How can nine women do it in a month? Because it’s a process that takes up to nine months, it’s not a mathematics problem that needs algebraic solution. It is an art and a science.

I would say, very logical. Now, what if I put the same logic in investing? On an average, a well-run equity mutual fund garners above-average returns in about 5-6 years.

A quality large-cap equity mutual fund garners an annualized return of 15-20 percent in about five years (on an average), would that also imply that 15-20 mutual funds can do the same magic in one year?

Confusing! Yes, just like my first example investing follow the same rules of art and science.

My case to you is that- long-term wealth creation is not myopic. It is a process of savings, accumulation, diversification, and active monitoring.

What hinders the process is investor’s myopia- an average investor fails to think beyond the period 2-3 years, when holding for long-term. But, how can we ignore the fact that our ancestors accumulated wealth over long-term through regular deposits and holding in avenues including Provident Fund, Fixed Deposits and Kisan Vikas Patra. It is no strange that long-term ‘buy and hold’ works in practice. Anyone invested Rs.1 lac in 1977 in Reliance IPO could have yielded Rs.11.98 crores by 2011 (The Economic Times, 2012), an XIRR of 30%.

Today, information access is no big concern as it was a generation ago. Today everything is available in a pocket (mobile); unlike the times where flow of information remained limited.

But, strangely enough dynamism within financial industry has dwindled the faith of common investor. Today, no one talks about holding a stock for 10 or 15 years. Trend-based investing seems to be the norm of the day. Globally the average stock holding period used to be around seven years in the 1940s; which has dropped to below six months today!

I believe we need to re-learn the practice of ‘buy and hold’. Even a small SIP of five thousand rupees has a potential to grow to twelve lakh in next ten years, sixty one lakh in twenty years and forty three crore in fifty years at the average rate of fifteen percent per annum.

I am not against tactical allocation as our financial needs change with time, age and goals. We need to balance our emotions and follow a discipline per se to attain the long-term goal of wealth building. The hypothesis to understand the investing is not a one-shot game. It is a strategy that needs patience, discipline and self-control. 

Apart from myopic view, over-diversified portfolio also leads to un-optimized returns. A lot of investors ask me, what do you think, how many mutual funds are adequate for my portfolio: ten, fifteen or twenty.  I generally recommend- for a neat equity mutual fund portfolio you need to have following funds:

I        a.  A good-rated large-cap fun

       b. A quality oriented mid-cap & small-cap fund

     c.   One/Two sector-oriented fund (depending on risk appetite and economy)

That’s all! A maximum of five mutual funds will not only garner handsome returns but also keep paperwork and book-keeping to the minimum.

Generally, people have a tendency to hold bouquet of outperforming large caps and aspire to create a large alpha and beat the market. But, at the end, fail to satisfy the urge to beat the markets. The real culprit is- what seems diversified, in real sense it is narrowly diversified. How?

BSE, Bombay Stock Exchange has about 7,000 listed companies. Astonishing, right? But, more surprising is 90% of mutual funds are invested in just about 500 companies (mind you, not in any particular order). Now you understand, the universe for any HDFC or ICICI or Birla Sun Life largely remain the same, which particularly holds true for large-cap because the rate of participation is high which reduces the return potential as mutual funds/ FIIs/ retail investors (like you, me and other individuals) readily invest in them. So, these large-cap stocks remain overpriced and overbought, hence garner average returns over medium term.

Here’s when, mid-cap, small-cap and sector-oriented pay for valuation, participation and earnings re-rating. Particularly, sector funds are direct beneficiaries of economic cycle like any banking-specific has earned 20% over and above any large-cap fund over the last one year (November, 2014).     

       

The call for over-diversification needs to be controlled and key focus should be to keep the core equity portfolio as per the economic cycle and your risk profile. Because, AMCs keep showering new schemes as per market condition to lure investors and the distributors will try to sell you the schemes in one form or the other. But, the idea should be to keep the allocation spread across equities, debt and international funds as per asset allocation.

I believe, a portfolio of total 8-10 mutual funds shall offer efficiency in holdings. Make sure your portfolio remains align to risk profile, financial goals and economy to reap in objective of long-term wealth maximization. Remain long-term focused on your portfolio because long-term benefits needs long time horizon as well.  

Indian engine gains momentum

We stand a 1.5 years ahead of the month when former Fed chairman-Ben Bernanke threatened to withdraw its QE3 program in May 2013, which caused chaos in the world markets. During all the hustle-bustle of the global markets, we witnessed the emergence of Fragile Five- Brazil, India, Indonesia, South Africa and Turkey.

But today India has walked a long way, from being a fragile economy to a strengthening economy.

India as a nation was struggling with its high inflation, wide current account deficit, low economic growth and high fiscal deficit; just then ‘Fed tapering announcement’ led to fall down in currency rates and capital inflows. INR rate plunged down to Rs.68.86/$*, at 3-year low. FIIs become net sellers, withdrawing more than 1,60,000cr from India within 3 months of the announcement- de-motivating India’s growth story.

Statistics projected a weak picture of Indian economy- inflation hovering around 10% (second highest in Asia), twin deficits weakening India- with trade deficit at 11.3% of the GDP in Q1- 2012-13 and fiscal deficit was as high as 4.9% in financial year 2013-14 all leading to weak investments and low capital formation within the country-plaguing the economic growth to less than 5%.

But, a strong change as early as in September 2013 swept in, when strong leader Dr. Raghuram Rajan became the captain of the sinking Indian economy. With all the tough decisions including monetary policy tightening, restricting the import of India’s favorite metal-Gold; trade deficit now stand at 1.7% of the GDP (The Hindu, May 2014).

In May 2014, strong leadership became even stronger when Mr. Narendra Modi took charge as India’s Prime Minister. Market sentiment turned overly optimistic from being pessimistic, FIIs pumped in money as new wave of growth was expected through governing leaders. Pro-investment growth in the nation led to regain in confidence for investors.

As we look today, fiscal deficit is expected to in control as government reduces its non-planned expenditure and improves tax revenues. Furthermore, as international commodities prices eases and demand-supply gap lowers, inflation eased at 6.46% with a downward trend. And 10-yr G-sec yields eased to 8.28% as on 30 October 2014 from a high of 9.24% in August 2013. Also, currency rate stabilities at Rs.60-61/$. Manufacturing sector expected to grow as interest rate cools off and ‘Make in India’ gains momentum; GDP is expected to 5.5-5.9% in current fiscal year (NDTV Profit, 2014).

Today Nifty is at all-time high of 8,330.75 from the lows of 5,118.85 as on 28 August 2013. Moreover, DIIs showed turnaround in confidence through injecting 4,000 cr in month of October (highest since August 2013). Corporate earnings expected to improve as economic recovery expected to gain pace and government policies take action.

We lay our hands for long bull markets; 1-yr Fwd P/E trading at 17.09 and expected EPS growth rate of 9.5% year ahead. Are you invested? Or did the pessimism of currency crisis led to bearish sentiment and you pulled out the money at 5,000 levels and booked deep losses? Nifty has garnered an annualized return of 48.39% from 28 August 2013 till date; did its unpredictability astonish you?

* value as on 28 August 2013

A Diwali of Hope!

Dear investors,

A very happy and prosperous Diwali to you and to your family!

With this Diwali, Imperial Regalia opens its eyes to the fifth month of its subsistence.

The stock market is hovering around 26,720 as I write this newsletter, jumping 25% from the figure of 21,321 as in last Diwali.

Apart from historical political changes like single government gaining majority after 25 years, a lot has changed; but, what has been the biggest change is intangible yet quite visible - the attitude of India as a nation.  

From a country, which was floundering in scams since the past 60 years; we now stand united against the soft yet greatly perceivable virtues of cleanliness and safety. The nationwide campaign of ‘Swachh Bharat Abhiyan’ and a very altruistic step of allocating 10,000-crore rupees towards the crash victims and improving ambulance system to ensure safety and care on roads for general public are the examples of changing India.

I always envy Warren Buffet when he proudly states, that he won the lottery of birth by being born in America which makes him among ‘lucky 1% of the entire population’. But the scenario can be different now. Despite all the gloomy news from around the world (except America, of course!), India as an emerging economy has shown a great resilience. The reason for this come-back and positivity for the future is our young population. We as a developing economy are strongly driven by internal consumption; if directed proportionately we can and must lead to a robust manufacturing-based economy. I believe that, if necessary steps are executed, we shall witness the results in 2-3 years.

Upbeat earnings are expected in the month of October as results open-up. Thus, hope of better economic performance gains strength. Yet ‘Caution’ remains the world of the day and as the past has taught us again and again, we need to stick to our risk profile and asset allocation for time in now.

I shall assert that every investment must be treated as a business with a sole, undeniable and indisputable aim of maximizing the profits. Hence, it becomes a matter of utmost necessity that one should be aware of the past as well as the factors that can affect the future course of investments.

Treading cautiously on the road of sectoral recommendations, I would emphasize on the following sectors:

1.      Economic cycle- Banking & Finance

2.      Consumption-based- Automobile & Engineering

3.      Infrastructure-based- Transport & Logistics

4.      Export-oriented- IT & Healthcare

Since last Diwali, investors invested in any of the above sector have witnessed a dramatic turnaround, earning anything between 40%-135%. I believe, we shall see a prolonged bullish momentum take force as and when the policy changes come true.

Wishing you again, a happy, joyous and prosperous Diwali!

Pallav Saraswat