Posted in Investing, Personal finance

Visualizing Indian Equity Mutual Funds

The human brain perceives better through images.

As they say – A picture is worth a thousand words.

I have been doing data driven personal finance decisions for some time now.

With a combination of Python libraries and data from aggregator websites like valueresearchonline.com (Indian Mutual Funds), I was able to create visuals that gave a new meaning to my decisions.

For example, in selection of mutual funds most people will just go with the ValueResearchOnline’s rating system and pick 4-star or 5-star funds. It is a system to rank the mutual funds based on risk adjusted returns.

Nothing wrong with that, but why not see the data for yourself?

With a bit of analysis, you can project the data yourself to understand long term trends.

Let’s pull the valueresearchonline.com equity funds’ data into a CSV file and load using Python.

VRO dataframe

Note: Some of the exotic fund categories (with fewer specialized funds) like EQ-BANK will be filtered out in below analysis.

For example, here is a box-plot showing 20 Year Returns per Category of Equity Mutual Funds.

20 Yr Returns per Category

It is easy to draw a few quick conclusions from this data for a time horizon of 20 years.

  • EQ-MC (Mid Cap Funds) fared the best with a mean return of 18%
    • 25% of the mid-cap funds returned less than 15%. 
    • 25% of the funds exceeded a return of 20%.
    • The Inter-Quartile Range (50%-75% of the EQ-MC funds) returns are 15-20% as depicted by the solid box.
  • The long tail in the bottom of EQ-MC shows that not all funds will get inter-quartile returns, hence there is a risk to invest only in Mid-cap funds. Many of them performed well below the mean.
  • EQ-THEMATIC funds did not fare that good in comparison to others, as themes are cyclical and it is never a good idea to time the market. We will see below in 10 and 15 years, they perform better in the short term validating their cyclical nature.
  • EQ-LC (Large Cap) and EQ-L&MC (Large & Mid Cap) funds have the least variations from their IQR (see the whiskers on top and bottom of the box), indicating investments in these funds are stable over long term.
  • For large caps, the variations are upward, which means more funds in this category surpass the average or IQR returns than other categories.

Let us now look at the short term of 3 years, to indicate the risk of equity in short term.

3 Yr Returns per Category

As you can see, if you draw a horizontal line on 0% returns :

  • Only EQ-INTL (International Funds) and EQ-LC (Large Cap) have their heads respectfully above the water. 
  • The International Funds are mainly invested in US stocks, and the US stock market has been bullish for few years since 2010.
  • The EQ-LC (Large cap) as we concluded earlier is stable and not so volatile as others, even in the shorter time frame. 
  • See the increased number of outliers (the dots beyond the whiskers) shows the unpredictability of equity fund performance in less than 3 years. 
  • In the 20 year’s plot, there were hardly any outliers seen which indicates that over the long term, the returns across various categories are range-bound and hence more predictable.

Comparatively here are similar plots for 10 Years and 15 Years.

10 Yr Retuns per Category

15 Yr Returns per Category

A few things to observe from the 10 and 15 year plots.

  • The number of outliers (variation in returns of funds) start reducing from 3 to 10 to 15 to 20 years, thus Equity funds should be considered only for a long term portfolio.
  • Different categories will perform differently over time horizons, hence a diversified portfolio should consider funds across categories without too many overlaps.
  • It is futile to chase the best performance, and for a personal portfolio it is good to choose funds within the IQR in each category.
  • If selected carefully, 4-5 funds across categories are enough to form a long term diversified portfolio.

Finally we come to the factor that I call the slow poison – Expense Ratio.

Expenses per category

Lets again draw some observations:

  • EQ-LC has the lowest expense ratio on an average.This is more dragged down due to the Nifty and Sensex Index funds.
  • The EQ-L&MC funds have the highest expenses (~ 2.0%) but in the 20 year range, performs close to EQ-LC (see the 20 year plot earlier). This category may then be best avoided depending on one’s personal time horizon and situation.
  • Same for EQ-THEMATIC with high expense ratios and not so good returns over long term, may be considered as cyclical fad only.
  • EQ-LC, EQ-MLC (multi-cap), EQ-MC and EQ-INTL are the ones worth considering for a diversified long term portfolio, with more allocation towards stable and low cost EQ-LC. 

Lastly let us see how the Expense ratio scatters with respect to the 20 year returns.

20Yr vs Expense

Again we can draw some pretty useful insights in selecting a fund portfolio.

  • If you are happy with 10-12% returns, then there are low cost funds with less than 0.5% expense ratio. These are Index funds and very popular in developed economies, but not yet so much popular in India. 
  • If you want to boast to your friends and family about spectacular returns, pick from the top quartile range of >15% returns but be ready to pay >1.8% expense ratio every year. 
  • There is little value in paying expense ratio over 2.0% as the returns normalize to same as low cost Index funds, as indicated by the density hues (black hexagons).
  • Just be aware that Expense Ratio is paid every year on your portfolio, whether the market goes up or down. That is, your beloved fund manager makes money off you every year, whether you make a profit or loss.
  • You can save around 1% by investing directly with the Mutual Fund house (called Direct option) than through regular channels like brokers, banks. 

This proves that like in US, slowly Index funds will start to make sense over long term in India too. This data corroborates my earlier posts on the same tenets of investing.

Active vs Passive Investing

The 3 dimensions of investment planning

Disclaimer

  • I am not a Financial Advisor by profession and the views expressed in this post are my own analysis of the data. 
  • Past performance is not a guarantee of the future. 
  • The data analysis does not take into account other factors like risk/return metrics of funds, and many other financial metrics. 
  • The data used here is confined to only Equity Mutual Funds and similar analysis can be done for Debt, Balanced and Specialty Fund categories too.
  • Readers are encouraged to do their own due diligence on similar lines. The data is sourced from www.valueresearchonline.com . The veracity of the data lies with the site.
  • There is no one-size-fits-all portfolio and this post is not an investment advice or recommendation. 
  • The data and analysis applies only to the Indian Mutual Fund data as downloaded from www.valueresearchonline.com . It should not be extrapolated to other countries and markets. 
  • For more detailed views and opinions, visit www.valueresearchonline.com . I am not an affiliate of the site and do not receive any remuneration or credit. 

 

 

 

Posted in Investing, Personal finance

Active vs Passive Investing

There is a continuous debate that goes on in the context of investing through mutual funds.

Should I choose funds which are actively managed or choose Index funds which simply mirrors an index?

Some experts are strongly opinionated in favor of Index funds, whereas investment firms will always tout active investing for obvious reasons.

So what should we as investors choose?

Let’s see the different reasons why Index Funds are better choice for most investors.

  • Index Funds simply cost much lesser yet gives you the returns of the market.
  • Index Funds provide instant diversification from flavors such as Total market Index to specific themes and international market indices.
  • Index Funds do not have the need to reward performance and compete with other funds.
  • Index Funds do not need to trade very often, thus saving unnecessary tax liability due to capital gains.
  • Index Funds are simple to understand and follow.

So in an efficient market like the US, where information about good companies is widely available, beating the benchmark indices is not easy for fund managers. There are star fund managers who may have done that, but the percentage is very less, typically < 5%.

The simplest and most convenient in the US is the proverbial Bogleheads’ Three fund portfolio. 

https://financinglife.org/best-books-on-investing/bogleheads-guide-three-fund-portfolio

However the story may be different in other parts of the world, for example, emerging markets like India.

There are evidences of active fund management overtaking Index returns and in the short to medium term, even with the high costs of management, beat the index fund often.

However this is slowly changing and in recent years, the Index Fund is tilting to be the better choice for long term investors.

With more institutional money flowing into Index Funds as well, Fund managers will find it difficult to beat the index returns and the market efficiency will move towards that of developed markets like the US. To quote an article, it clearly shows the trend.

Over the last couple of years, many investors have increased exposure to index funds as returns from several categories of actively-managed funds failed to beat the Nifty 50 returns. In the past one year, the Nifty 50 has returned 12.51%.

 

Thus no matter where you are investing, Index Funds are the simplest and the most efficient choice for a portfolio.

Index fund investing is like sticking to the basics, just invest for a very long term and you need not worry about the noise of the investment world.

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Posted in Budgeting, Investing, Personal finance, Savings

The Starter Kit

If you are just starting off with organizing your personal finance, or restarting from scratch, here is a step by step way to get started.

Most of the times, we get started haphazardly, the first account in the local bank or the ad-hoc insurance policy or even the next stock tip forces us to open a  brokerage account.

However there is a need to get started in a more planned way.

When I moved to the US couple of years back, the below is how I setup my money system. I had a similar one running in India for a long time and it has given me very good results.

Here is the starter kit that you need to get organized and get started. 

Since it is built in a systematic manner, it will help you automatically organize and keep your finances in order.

A checking account

This is the first step as you need a place to deposit your income, be it direct deposit from your employer or you get checks at the end of the month.

Get a simple checking account at a Credit Union which provides you with a basic ATM and Debit card. Try to find a credit union or bank which has very low fees. Obviously they will have some like overdraft fees that we will anyway avoid, but others like ATM access are something unavoidable, so shop around a little.

This is where all your income will come in and get deposited. 

A credit card

We are going to be responsible spenders, right? If not, do not get this and use your debit card from your checking account.

The key to being a responsible spender is to make a budget, stick to it and pay off the credit card bill in full every month. Lets just assume you agree to all of this. 

There are many credit cards in the market with various features like cash back, travel rewards etc.

As a starter kit, you will just get one from the same bank or credit union where you hold your checking account. The reason is ease of payments and setting up automatic transfers from your checking account to pay it off at end of month. 

The bonus will be of course if  the card also has generous cash back benefits or other similar perks. But get a free one and not one with annual fee loaded just for extra perks.

The credit card will be your main expense vehicle. It gives you automatic fraud protection, insurance and easier account tracking. 

Budgeting

If you do not do any further, you have setup the very basic system. You earn money which get deposited into the checking account, you spend with your credit card (on a budget!!) and your checking account pays it off every month.

But this sounds like living paycheck to paycheck or Living on the Edge, right?

We are going to do better – save and invest. 

First what we need is a planner. As the above system of checking account and credit card gets working in a flow, you will start getting an idea of how much you are spending every month.

For the next 2-3 months, track your spending to categorize your money into only 4 parts.

  • Food and Dining
  • Utilities and Transportation
  • Clothing and miscellaneous
  • Surplus

You will automatically get motivated to squeeze the first 3 categories and increase your surplus every month. 

Check out this post on how to budget: Budget – Grow the tree upside-down

The above technique will help you generate surplus for both savings and investment, make it your goal to only increase it and not fall back to paycheck to paycheck cycle.

Savings Account

There are unexpected events or expenses that will always come up. You need to be prepared for it and the only way is to build up a cash cushion.

One essential comfort zone

This is similar to Dave Ramsey’s first 3 baby steps, where you start with saving $1000, then get out of debt (hopefully you have none if you started with this) and finally build a cushion of 3-6 months of expenses.

I use an online savings account like CapitalOne 360, Ally Bank or Synchrony. There are many others, and online banks provide little more interest on your deposits than brick-and-mortar banks, or the one where you have your checking account.

Setup an automatic transfer of your Surplus from your checking account to this Savings account. Set this up for beginning of the month, so that your budget works with just the right amount needed (to pay off the credit card at end of month). 

Investment Account

Get to this step only when you have a running budget, able to generate surplus consistently and stacked up 3-6 months of expenses in your savings account.

From here on, you become a pro in personal finance as you are about to invest and grow your net worth. 

There are two main investment accounts, a retirement account and brokerage account.

Contact your employer for a 401k (Pretax or Roth) account and contribute to it, if there is a match. If this exhausts your projected surplus, no worries you have got started.

If there is still surplus, good news. Open a brokerage account in one of Schwab, Vanguard or Fidelity. Preferably open a Roth IRA account if your income is within eligible limits.

Roth IRA rules

Then invest in one or two broad index funds with very low expense ratio (< 0.05).

Here is a classic 3-fund portfolio from Vanguard index funds.

  • Vanguard Total Stock Market Index Fund (VTSAX)
  • Vanguard Total International Stock Index Fund (VTIAX)
  • Vanguard Total Bond Market Fund (VBTLX)

Similar portfolio can be constructed from Schwab Funds too.

https://www.wallstreetphysician.com/three-fund-portfolio-using-schwab-index-funds-etfs

Managing and growing the investments

You have done a great job in the above steps and at par with average disciplined investors.

In investment world, “average” is what wins. If you get average returns of 8-9% over a very long time (decades), there is nothing more you need to do. 

To know how to structure and maintain your investment accounts, read this blog post

Investing in the High Five portfolio

Conclusion

The above is a simple 5-step process to take you from a personal finance newbie to a disciplined investor and saver. Taking action in a systematic way is the key to financial bliss.

If you need motivation to get started, read this:

Shun that perfection

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Posted in Investing, Personal finance

Emotional Investing

How are emotions and investments linked? Or should they?

The two are actually intricately linked in our financial lives.

Emotions define investments, and investments define emotions. 

For example, most people who invest in stocks buy the next stock based on hot tips, be it from the last night party or the media channels doling out expert advice on stocks.

Or even the general euphoria about the economy and stock market makes us greedy and plunge into get-rich-quick behavior.

Thus an investment is made based on emotions for most people.

Now the same investments cause further emotions. The stock market is down, there is a trade war with China, the media is predicting a crash and so on.. We give in to the noise around us because we are now invested in the market, and it is our duty to become emotional with the world. Otherwise we are deemed too careless about the investments we made so emotionally.

Proven? – Emotions define investments, and investments define emotions. 

However the above linkage can be controlled and severed at the right place to make it advantageous to long term investments.

There are only 3 steps to build a successful investment strategy.

  1. Take your emotions into account in planning your investments and portfolio. See which areas of your financial life needs more focus, be it retirement, kids education, emergency fund or long term wealth. This is where most of the emotions should be used (as every one has different life goals and situation), but this is planning only – not yet buying any investment product. 
  2. Once you have decided what to invest in and how much, automate your plan. All banks and brokerage services provide automatic transfers and investments.
  3. Take rest of your emotions elsewhere. Just forget the investments as they build up. You just need to tweak it once a year. However this is where people pour in maximum emotions as the noise in the market and the economy rise and fall. Instead hold your investments for the long term as if the account is locked, and you forgot the password.

Note that after step 1, there is no more emotion.

Here are few previous posts on step 1.

Budget – Grow the tree upside-down

One essential comfort zone

Investing in the High Five portfolio

For step 2, where you take action.

Shun that perfection

Emotions are used to our advantage to plan the portfolio and then automation and ignorance (to the market) is the bliss. 

For step 3, the following quotes by Warren Buffet will help.

“If you cannot control your emotions, you cannot control your money”

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

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Posted in Investing

Investing in the High Five portfolio

What does investing mean to most people? Investing can be as complex or as simple as one wants to make it.

There are many theories for constructing a portfolio and it is not easy to ascertain which would work for one’s financial situation. Some common ones which are taught by most financial advisers are as follows.

  1. Risk/return trade-off achieved with diversification. 
  2. Goal based portfolio – retirement, education, short term, passive income. 
  3. Age based asset allocation. 
  4. Robo advisor created portfolio. 

The result is that one ends up creating multiple portfolios out of haphazard investments. The portfolios are also spread across multiple accounts as one’s financial life builds up.

As the accounts and portfolios spring up at different times, they lose the meaning of the overall asset allocation and financial goal of the person. There is no common theme or string to bind these accounts or portfolios together.

Here I present a 5 portfolio approach if you have multiple accounts and assign a meaning and goal to each. I have faced this dilemma and this solution/characterization comes from my own personal investment analysis.

This analysis assumes a person like me who is still 15-20 years from retirement, has children going to college in next 4-8 years and a starter in real estate and wealth building strategies.

The Portfolios

P1: 401k – The All Equity Portfolio

Term: 15-20 years

Most working people will have a 401-k or  IRA plan.

401-k has two very important kickers to deserve an All Equity portfolio.

  1. Long term – You cannot withdraw money before age 59.5 without penalty. This forces you to be committed for long term, which is good for holding equity. 
  2. Tax deferred – The contributions and earnings grow tax deferred, hence can compound tax free for a long time (till withdrawn).

Hence it makes sense to hold a predominantly equity portfolio, since equity investments are known to minimize loss and provide best returns over a very long term.

For example, one can be invested in just 3 index funds in a 401-k. You can find similar funds in your own 401-k plan.

  • Large Cap Blend (Growth and Value) Index Fund
  • Small Cap Blend (Growth and Value) Index Fund
  • International Index Fund

If you have Roth 401-k or Roth IRA, treat them as same although the restrictions of withdrawal are slightly more flexible in a Roth IRA. See the link below for a discussion on the topic.

Roth 401-k vs Roth IRA – which is better?

P2: Taxable account  – The Diversification Portfolio

Term: 7-10 years

The second portfolio is also long term but not restricted. It is created to accumulate wealth and then use it for any long term purpose.

This gives one the flexibility to withdraw it for early retirement, kids college, medical emergency or any other unforeseen circumstances. Or simply to buy a new house or invest further into real estate. 

This portfolio can be maintained in a taxable account with any brokerage firm. Although it is not tax deferred or tax shielded, it’s purpose is flexibility and use of the money in a medium to long term.

The characteristics of this portfolio is to hold a mix of different investments (low cost index funds or ETFs) which provide diversification across market caps, asset classes and risk/return profile.

It can also be optimized for tax savings if you design it that way, but then the goal is steady appreciation and not necessarily just tax savings.

This portfolio can be constructed using following types of index funds.

  • Total US Stock Market Fund (or S&P 500) 
  • Total US Bond Market Fund
  • Emerging Markets Fund
  • Global Real Estate Fund

One can add more mix and diversification to this portfolio, for example, International Developed Markets Fund or a Commodity Fund.

If the 401-k already has a sizable allocation to International Fund, this portfolio may not have one but gravitate towards more exotic ones like Emerging Markets, Global Real Estate etc.

P3: Special accounts – The Stable Portfolio

Term: 4-7 years (or custom)

This portfolio is for special purposes like kids college savings, medical savings and so on.

These are some important and unique goals, which needs both appreciation yet reasonable capital preservation. In this portfolio to gain steady returns, there can be a perfect balance between equity and bonds. 

For example, a 529 (kids college fund) and Health Savings Account portfolios can be simple:

  • Total Stock Market Fund 
  • US Treasury Bond Fund 

Typically a 50-50 allocation in two funds is good enough.

P4: The Daredevil – The Risky Portfolio

Term: 10+ years (longer the better)

This portfolio is not for everyone, but for people who are keen on more sophisticated investments in search of that extra kick (either the return or in your life).

This portfolio needs active monitoring and work to pick the investments. This portfolio has the potential for total loss, but at the same time may generate very high returns. 

For example, these two accounts below can form part of this portfolio.

  • Fundrise – Real estate crowdfunding 
  • Robinhood – Buy and hold individual stocks – dividend yielding and growth/value stocks at zero commission

However one can invest in a variety of similar high yield, high risk investments, for example, PeerStreet, YieldStreet etc.

P5: Cash Account – The Safety cushion

Term: 1-3 years

This is the most essential one to provide peace of mind. This account can be a high yield savings account or a FDIC insured money market account.

This portfolio serves two purposes.

  1. Emergency Fund – This is typically 3-6 months of expenses stashed away for a rainy day. 
  2. Cash for next opportunity – This is money you save for down payment on a house, or next investment like buying a rental or invest more in stocks when the market tanks. 

Any good online bank provides these savings account with reasonable yield.

Click here for a list of such savings options. 

Conclusion

The budgeting technique described in a previous post can help one allocate investments to all these portfolios.

So what do these P1 – P5 portfolios achieve?

  1. Purpose and time horizon
    • Assigns a purpose to each portfolio and defines its contents
    • Assigns different time horizons according to requirements/goals 
  2. Asset Allocation
    • Diversifies across different types of asset classes, yet keeps each one simple (2-4 funds) 
    • Right fund allocation according to risk appetite and age or financial situation. 
  3. Easier tracking 
    • Tracking and action is based on the particular portfolio, for example, when market goes up or down, not all portfolios need to react
    • Each portfolio can have a separate target growth number

Now give a High Five and start investing in the High Five Portfolio.

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