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

The biggest enemy of your investments

Its not the fees.

Its not even the portfolio churning manager.

Its not the financial adviser.

The biggest enemy of your investments is YOU. 

I realized this with my own behavior. With more passion to manage investments and as I learn more, I started to tinker my portfolio almost every month, if possible every week coming up with a new plan.

Selling stocks and bonds, reallocating in the name of asset allocation, refinancing mortgages, buying exotic investments – all are detrimental to peace of mind, and moreover to the productivity of those little bundles of money sent to work for you.

Each investment needs time to grow. Except for hard cash, when you invest in something it needs to stay there to do its job. Equities and Real Estate are long term investments and bond and bond funds are medium term. But none is a short term get rich scheme.

So what makes us do this damaging exercise? The economy around us is constantly changing and producing a lot of noise. We dance to its tune and the sense of a smart ME, does not let us ignore the noise of the experts.

  • For example, the last few months the mortgage interest rate went down and down, and there was huge rush for refinancing mortgages. Hopefully all the refinancing makes sense in terms of cost and long term goals. It is perfectly fine to just not do anything if your mortgage is already in the low 4% or even lower.
  • Similarly, the news and predictions about an impending stock market crash is making a lot of investors shaky and market pundits elated at the same time. Equities are long term investments and there is no need of any action for a crash. The markets are cyclical and any equity investment should be part of a long term (> 15 years) portfolio.
  • Real Estate similarly is at an all time high, with REIT returns touching new highs and homes selling for record prices. This may well be time to be cautious and investors should not change anything in their Real Estate allocation, but just wait out the present jubilation. Or simply continue buying REITs at regular intervals like equity with a longer time (20 years) horizon.
  • I have also seen people switching their cash from one bank to another just to capture the extra 0.2% interest rate, or get that $300 bonus for opening a new account. A $300 free money does sound alluring, but read the fine prints of the terms and conditions. You have to setup a direct deposit and also deposit a lump sum of new money into the account and hold it for 90 days to get that $300.  All this will cause huge changes in your financial plan and system. And then once you get the $300, what next? Another bank may offer $400, but are you going to change your direct deposits again, and move the surplus money which could have been invested?
  • Simply for changing your asset allocation, selling stocks and funds can incur a huge tax bill, if the capital gains and taxation are not taken into account. For example, short term capital gains are taxed as ordinary income than long term. So even though the asset allocation looks skewed than what you want, it is better to tweak your monthly investments to slowly adjust the portfolio towards desired asset allocation.

As an illustration, below is my asset allocation now and what I want it 5-7 years later.

Note that since I moved from India, a major allocation is still Emerging Market stocks, mostly in Indian stock market. I am also holding about 18% in cash, which needs to be redeployed.

Asset allocation JPG

The simple way to achieve this is to freeze the Emerging Markets and Cash allocation, and for next few years my investments will be heavily tilted towards US and International (developed market) stocks and bonds.

As I reflect on the 2019 year to date, I have been victim to this behavior of myself. Following are some of the tinkering I did, which left me with little tangible benefits but probably valuable lessons.

  1. I refinanced a 3.625% mortgage (7-1 ARM going into 8.6% on 8th year) into a 4.125% fixed rate mortgage. The rationale was that a fixed rate mortgage will make cash flow predictable. Hence if I rent out my house few years from now, I will not be hit by increasing interest rate scenario. However with recent low in interest rate, I lost an opportunity to refinance at a fixed rate even lower than the ARM.
  2. I hired a financial adviser to suggest mutual funds across all my portfolios (401k, taxable etc.) and paid him $500 for two sessions. At the end, as I learnt more I ended up choosing my own investments, although a part still came from his recommendation.
  3. I bought a 5 year locked home warranty, possibly not so useful in the long run. I have used them only once in last year, and most of the expensive repairs they don’t cover anyways. I could have done better to save the money instead.
  4. I accumulated a decent amount of cash and procrastinated to invest it. In fact it was a decision on which I vacillated between buying real estate or investing in equities. I did nothing and it just sat there in a savings account, earning less than 2%. At the end of the year, now I have the urge (or somewhat a need) to buy a second car. This money had it been invested earlier, would have forced me to think more creatively on how to acquire the second car. I don’t like car loans, so probably I will now use this cash to buy the second car, a depreciating asset.

So sometimes action is good and inaction is bad.

At other times, too much action should be avoided since long term investments need the long (really long) term to perform. Here inaction is the best way forward. 

action activity adult attack
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Posted in Personal finance

Five FAQs of personal finance

Throughout my journey with personal finance, and through the mistakes and learning, I compiled a list of Top 5 questions that come to my mind, time and again. 

So I decided to compile these as a FAQ and try to answer them to the best of my knowledge and experience. 

  • Buy vs. Rent
  • How many accounts to have
  • How and where to invest
  • How to save more money
  • How to manage my portfolio

Buy vs. Rent?

Photo by Trygve Finkelsen on Pexels.com

One of the biggest financial decisions in everyone’s life is to buy a house. However there are pros and cons that need to be weighed against renting similar or better homes. There are lots of views and articles on Internet which give both a logical as well as emotional opinion to this question. In my opinion (just another), only You know better whether you are ready to buy a home.

To put it logically from what I know, there are few costs and factors that need to be considered.

  • Save up for a down payment of at least 20%.
  • Consider closing costs, it can easily be in the range of $4000-$5000.
  • Consider any rehab budget if you are not buying a recently updated home. You will pay for it either way. 
  • Aggregate of all monthly expenses of home ownership should be less than the current rent paid. These expenses are: 
    • Mortgage payment
    • Taxes
    • Insurance
    • Maintenance (1% of home value per year)
    • HoA fees
    • Lawn care and utilities
      • if you had paid these apart from rent, you need to make sure the costs are almost identical

Only after you have made the calculation above, and convinced yourself that total monthly housing expenses will be less than the rent, you can consider buying provided there is the cash cushion of down payment and closing costs.

One argument which is floated in favor of ownership is that rents are going to increase per year, whereas the mortgage will remain constant. However please consider that Taxes, Insurance and Maintenance will go up too year after year.

On the other hand, the mortgage will get paid down giving a little more advantage to the ownership since you are building equity and hence net worth.

The other factor is how long you are going to stay in the home to recoup the costs of mortgage interest, taxes, insurance, upgrades, maintenance etc. 

One day (in a few years), you may want to move out and convert this house into a rental.

Will the rental numbers in the area completely cover all the expenses? You certainly don’t want to pay for new house as well part of the expenses for your tenant.

All of these factors should be taken into calculation before making the big decision. 

The following post may help in setting up the calculation, but I suggest do your own homework too. 

How to decide on a purchase – the P.V.T formula

If you are interested in scenarios of managing a mortgage or multiple properties, here are couple of previous posts on the subject. 

The Paid Piper of Hamelin

Don’t twist your ARM, fix it !!!

How many accounts should I have?

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There are many banks and financial institutions who are vying to keep your money, earn fees and lure you into a long term relationship. These marketing flyers and lure of higher interest rates or credit offers make us open many bank accounts indiscriminately.

The more you spread out without a purpose to each account, it will become unmanageable and have overlapping features. There are many cases where people (or spouses after the death of one) forgot about their accounts, and the money lies there idle never to be claimed again.

So bank and brokerage accounts all should be tied to specific goals and purpose in your regular financial picture. Typically the following should suffice:

  • A checking account and a debit/credit card
  • A savings account, if more than one, each should be for a specific saving goal
  • A retirement account (typically 401k or IRA)
  • An investment account (outside the 401k/IRA for medium term investments)
  • A special purpose account depending on needs
    • 529 – Kids’ education
    • HSA – Health Savings Account if you have high deductible insurance

Beyond this, it becomes fancy and unmanageable.

The following post shows a step by step guide to open and manage these accounts.

The Starter Kit

How and where do I invest?

One of the main hurdles of personal finance is to find out how and where to invest. There are many risk-return trade-offs from cash savings to mutual funds to real estate, and even exotic investments like art and commodities.

The simplest investment however is a balanced indexed fund, where there is an automatic asset allocation of stocks and bonds and which can vary according to your age and risk tolerance. These are also called Target date funds. Being an index fund, the costs are extremely low (0.0x%) and you get instant diversification.

Most portfolio should not need more that this. However if you are a little bit more knowledgeable, then you can create your own basket of index funds. For example, the three fund portfolio is very popular. Here is a good link: Three-Fund Portfolio

One of my previous posts mentions the various investment accounts that you can setup. 

Investing in the High Five portfolio

Know yourself and your investments

How do I save more?

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This is one of the questions which has many different ways of asking.

  1. How do I spend less?
  2. How do I pay myself first?
  3. How do I increase my income?

The answer lies in all of the above questions. You have to do all to be able to save for emergency, goals, vacations and fun.

The topic on how many bank accounts to have, takes into account this aspect. It is very important to build a cash cushion along with your investments and lifestyle.

See below posts on why and how to do this effectively.

One essential comfort zone

Budget – Grow the tree upside-down

How do I manage my portfolio and reach my goals?

black mazda steering wheel
Photo by KML on Pexels.com

Managing your investments and financial system may not be a complex or time consuming task. It needs essentially three things. 

  1. Automation 
  2. Tracking 
  3. Learning

The following post describes a step by step process for managing and growing your personal finance system. 

Five components of a personal finance system

All it takes is to first setup the automatic payments and investments, then a weekly tracking mechanism and weekly reading and exploring more.

With time, you will start flowing like a pro. 

Shun that perfection

Conclusion

While the list of FAQs above is not exhaustive, these are questions that I have seen people struggle with or make irrational decisions on. Or to put it another way, I have done same mistakes and learnt that if you manage these aspects well, you don’t need to worry any more. 

beard cafe coffee shop connection
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Posted in Investing, Liabilities and Debt, Personal finance

The Net worth vs. Cash flow debate

What is your net worth? Let me see, probably close to a million. So what? Are you financially independent? No. Why? ’cause I don’t have enough cash flow to replace my W2 income. Ok then, net worth is a worthless metric. But it projects my comfort into the future.

And so it goes on and on…

Does it sound familiar? There are two schools of thought. One says be conservative, save, invest for growth, have little to no debt and build your net worth slowly. The other school scoffs at this conservative approach, and instead propounds building wealth and cash flow through acquiring assets, leverage and working out deals.

None of them are wrong. However what is right for you (and me) is important. For that, it is extremely important to understand the benefits and risks attached with each approach.

In more practical sense, you will do both in the right proportions that you are comfortable with.

The Net worth approach: 

Here your main cash flow is your W2 income. Your ability to live below your means gives you the leverage to save and invest the rest.

Budget – Grow the tree upside-down

As you invest your money into stock mutual funds, CD, money market, bonds and a house of your own to live in, you are increasing your net worth slowly.  This is how most people start and someone starting off should. The difference between income and expenses, is the main contributor to your net worth. Additional is the appreciation and growth that your investments achieve. You also pay down mortgage of your house which builds equity, adding to your net worth.

In my opinion, this is a perfect approach to build wealth as long as you enjoy what you do in your W2 job and have a good work-life balance.

This is also the simplest since there is no extra debt burden (except probably your house, which you can pay down if you want). Your investments are also passive and takes hardly any time from your schedule, except occasional re-balancing and tracking.

Investing in the High Five portfolio

With a spreadsheet like Excel, you can easily calculate your projected net worth in “t” years in the future, assuming a “r” rate of interest (or growth).

cp_formula

However this approach takes a lot of time and patience, disciplined living on a budget and regular investments. You will not have something to brag about in a few years, but you will sleep in peace as you have liquidity, less or no debt and enjoy your work.

The risk of this approach is if you retire early and do not have enough corpus to live off for the rest of your retired life.

The Cash Flow approach:

The cash flow approach on the other hand, only focuses on generating cash flow. It means you have enough assets or mechanism (businesses, activities) which generate cash month after month, in a predicable fashion.

This can be achieved with several avenues for example:

  1. Rental property investing
  2. Commercial property
  3. Dividend paying stocks
  4. Passive income from books, royalty of other IP, YouTube videos etc.

There are many resources on Internet to give a list of passive income ideas.

However in the cash flow investing approach, I wish to draw attention to the big ones like Rental Property Investing and Dividend Stocks.

These are two ways which makes a very predictable cash flow stream if done right.

However to get this predictable cash flow, one has to do the investment right. For example, real estate has many hidden costs and running expenses, which if not taken into account will quickly convert an on-paper cash flow asset into a black hole for your money.

Similarly dividend stock investing, if not researched correctly can cause the principal investment value to go down. Same for income producing corporate bonds, where the ability of the company to make the regular payouts needs to be researched.

Last but not the least, income producing real estate is typically obtained through leverage, which means steadily increasing debt.

For example, if you want to generate $5000/mo in cash flow from real estate, you need to buy as many houses that will in total produce that much positive cash flow. Lets say each house produces $200/mo in positive cash flow after mortgage, taxes, insurance and expenses. Now you will need to manage at least 25 such properties to generate the requisite cash flow. Self managing 25+ properties is more than a full time job, and if you hire a property manager you will have to part with the cash flow (fees), and hence no. of houses under management will need to increase. This is all not to mention that now you have 25+ mortgages in your name. The risk – 10 out of 25 properties suddenly loses the tenants and remains vacant for 3 months. Now you have to be able to make 10 mortgage payments every month from other sources of income for an extended period of time. 

I am not saying Real Estate Investing is bad, lots of millionaires and billionaires have achieved their wealth creation through this. However you need to know yourself and act accordingly after you understand all the risks involved.

A combined approach:

 Is it possible to have best of both worlds? Sure there is, if you are not in a hurry to get out of your job and have the patience to slowly build both your net worth and cash flow. 

A few simple ideas which comes to my mind are below. I have done some myself and plan to do the rest.

  1. Increase your income and live below your means. This is very obvious, yet the most difficult to do consistently.
  2. Invest consistently 15-20% of your income into stocks, bonds and cash. See post: Emotional Investing
  3. Live in and then rent – Convert your existing house to a rental once you move out to another one. Or just rent out a portion of your house. This has the advantage that the mortgage you have is an owner occupied one (less interest rates typically), also it is paid up consistently as you spend more years and gets factored in your regular budget. See post: Don’t twist your ARM, fix it !!!
  4. Pay off your old houses completely but do not sell. Convert your equity play into a rental now. The paid off house will generate much better cash flow with substantially less risk, as there is no mortgage payments to worry about. See post: The Paid Piper of Hamelin
  5. Find sources of passive income which you can buy with your accumulated savings, like investing in a profitable business, crowd funded real estate etc. These have much less risk if you do your homework, at least there is no risk of foreclosure etc.
  6. Write a book or start an online course about your area of expertise.

In short, increase your net worth and cash flowing assets in a sensible fashion, with less to no debt and consistent action. 

Here are some of my previous posts which may inspire the above principles.

Know yourself and your investments

Shun that perfection

How a cassette player caused debt aversion

Enjoy the journey and the destination will follow. 

lake-balaton-sunset-lake-landscape-158045.jpeg
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Posted in Personal finance

Take off to the aerial view

Today I am flying to India. I am very excited and looking forward to visiting what is my second home now.

As the long flight from US started very early this morning, a few thoughts on personal finance hovered around my mind.

Before the flight takes off, there are a number of events that take place more like items in a checklist. As the plane’s technicians go through their routine yet stricter checks, as a passenger we too go through some disciplined steps like reaching the airport on time, checking in, clearing though security and finally boarding in a queue. All of these steps are important and must be done in sequence.

Then as I put on the seat belt and the plane takes off, the mind switches off from the low level sequence to a higher level composure. The plane rises above the clouds and I can see the world top down.

Personal finance is also the same. As you go through the low level details of controlling your expenditures, paying your credit card on time, automating a few bills on the way, you slowly but steadily reach the state of composure as if your financial life has taken off the grounds.

You no longer worry about petty coupons and discounts, or avoiding the crave for that latte, or even recording each transaction in your budget app.

Instead, now your systems are automated and you have a pretty good idea of how much is spent every month and how much you can invest.

Now your focus shifts to the clouds and you need to only take a top down view of the financial landscape. You start learning more about various investments, real estate, taxes and start strategizing on how to grow all areas of your personal and financial life.

You can now see personal finance is not just about money but when managed well, can allow you to cruise in other areas of your life as an aircraft in a turbulence free sky.

For example, this holiday is completely planned and paid for and I do not need to stress about credit card balance to afford the cost of the trip.

Complete the ground steps in a defined sequence as the suggested posts below, and then focus on the bigger clouds.

Budget – Grow the tree upside-down

One essential comfort zone

Investing in the High Five portfolio

The clouds that you can focus on once done with above are:

  • Taxes and how to find tax efficient investments
  • Insurance
  • Estate planning and wills
  • Passive income generation
  • Career goals
  • Your potential for earning more
  • Having fun

From time to time you do need to come down and go through the low level steps again, as I am in transit now in JFK airport.

I will be flying to my destination in a couple of hours again.

At the end the sequence matters. You can imagine how chaotic it would be to rush through security without checking in your bags first.

The cruise comes later when you are a disciplined traveler and follow the steps.

Posted in Personal finance

Beware of ripoffs

Everyone does financial mistakes, some large some small.

The personal finance industry is designed to chase you for your money, for obvious reasons. The people working in this industry has to make a living and profit. Nothing wrong with it, however there are some unscrupulous greedy professionals and companies who will siphon off your money before you realize what happened.

I too have been a victim of such tactics, where that sinking feeling is unavoidable once you realize you have been swindled. You vacillate between blaming yourself for being careless to simply justifying as how would I know.

I have made other stupid mistakes many times, thankfully most of them were small.

Here are 2 big ones which I will remember throughout my life, and hopefully draw some lessons not to repeat the same.

Insurance masquerading as investment

In 2005, when I started my journey of personal finance (I was earning for 8 years with no savings/investment), I decided to open an investment account with one of the big international banks in India. They had what was called a “Wealth Management” division that would help me all the way in opening an account to choosing my investments. What a convenience! I just had to commit a specific amount to be invested by a certain time, either through a lump sum or regular investment.

So I met with what they call a Relationship Manager. The lady came to my home to advise me, suggested some good mutual funds (I later researched they were decent performing ones) and setup an investment account. I was thrilled and excited to start my first investment, and then came the unsuspecting pitch.

She told me investments in mutual funds are risky, so alongside I should also invest in something very stable with tax-free and better returns than a CD. Diversification, Tax-free and stability all sounded perfect music to my ears, and I resonated to her plan. What followed next was I signed up for a so called U.L.I.P (Unit Linked Insurance Plan or Cash value life insurance).

So far so good, only couple of years later I inquired about the fund value or the surrender charges. By this time, I started reading about charges and commissions on financial products. To my utter disbelief, the product I signed up for (which seemed perfect then) had a special charge of 60% of my first year’s premium. They called it the Premium Allocation Charge. Wow!! Why would you charge to allocate my money? and 60%?

Even robbery at gunpoint would have sounded harmless in comparison. 🙂

That was my first big ripoff, I eventually bailed out of it few years later by minimizing my loss. In the subsequent years, the I.R.D.A (Insurance Regulatory and Development Authority of India) realized this dishonest practice by insurance companies and their agents, and reduced the charges to more like 4-6% and now it is clearly documented in brochures and illustrations.

Lesson: Do not mix investments with insurance. Insurance companies have no edge over low cost mutual funds. If there is a guarantee of principal, the returns are paltry and most of the profits are distributed to their agents. For insurance, term plan has no better substitute.

Fact check: In later years, I came across a relative who was selling such products. He told me agents who perform well are rewarded with paid for vacations to destinations in Europe. No wonder where 60% of my first premium went. 

Real estate bought wrong

Real estate is a high return, high risk product. Even when you are buying a home, you have to be knowledgeable in every step of the process, guard yourself against potential rip-offs. Everyone you come into contact is trying to make big bucks (and very quickly) in that industry.

My share of stupidity in this area is huge.

I bought my second home (condo) in India from a new builder, but who was also very well known to me. His claim to fame was honest communication, promised execution, good discounted price and quality of construction. The deal was really a good one, from both price and quality.

As things progressed (the development cycle was for 3 years), I became confident and  upgraded to a bigger sized condo. As the earlier one was not delivered, it was an arrangement to switch the contract to the new one and I would be paying the difference.

It was like upgrading to business class from the economy class, by paying the fare difference. Except that it was not such a smooth ride. 

The blunder I did was not to insist in a new contract being signed immediately and the title of holding the new condo to be defined. Since the builder was known to me personally, I somehow gave the benefit of trust and waited patiently for him to switch the contract. Meanwhile as the payment system demanded from his office, I continued making the scheduled payments up to almost 90% of all dues.

A year down the line, things went south for this builder and I realized that something is wrong. On digging further, it came out that the new condo was not approved in the building plan and cannot have a regular title yet. Just to clarify, there is no Title insurance or Title company in India. Usually the transactions are directly between buyer and seller (or builder) with an optional broker mediating in between.

It took me the next couple of years to untangle the mess, and I lost a huge amount of money and mental peace in getting the title legitimized.

Lesson: Know the process and only thing you trust is the paperwork. Do not take any verbal assurances. In the above incident, I had only myself to blame for the stupidity. 

Fact check: I later came to know it was a deliberate lie (while selling the unit to me and in my follow-ups) by the person (builder) I knew very closely for years. Trust no one. 

So those are the two biggest financial suicides I signed up for.

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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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