Monthly Archives: April, 2012

Why Some Investors Fail When They Use Mutual Funds

Mutual funds are good instruments to put your money in.  Many investors know this and use it to their advantage.  Some investors, however, consistently do not succeed when they use mutual funds as financial instruments.  Out of my experience, I can list few important reasons why some people fail when they use mutual funds. If you are the one who has lost money consistently in mutual funds, take heed of the following

Not Knowing The Difference Between Saving And Investing 

Both these financial activities are different from one another in their intent and purpose, time horizon, choice of instruments and risk and reward equation.  If you confuse one to another, you end up with wrong instruments and consequently lose money.  Talk to your financial planner to understand whether your goal is a savings goal or investment goal and choose the funds accordingly.

Not Understanding The Nature Of Underlying Assets 

Can you compare oranges and apples?  Only to the extent that they both are fruits.  Both fruits are vastly different genetically.  Orange is citrus and Apple is a rose fruit. Similarly, not all mutual funds are same.  They differ from one another in their investment objectives.  Since you are putting your hard earned money in to a mutual fund, take some time to talk to your financial planner and understand the objectives of the funds.  It would be good for you if you spend at least as much time in knowing the fund you are going to put your hard earned money in as you spend on let us say selecting vegetables in the supermarket.

Looking Through The Tax Exemption Prism

Tax exemption is good to get but it should not be the sole purpose of your investment objective.   Tax exemption comes with the constraint of lock-in.  This means, tax planning schemes of mutual funds, popularly known as ELSS, are inflexible till they are locked-in. If you chose to invest through Systematic Investment Plan (SIP) in such schemes, the period of inflexibility increases because each instalment of SIP would have 3-year lock in.  During the lock-in period, you will be just staring at the valuation, either negative or positive, with no option to take any action.  If you are investing in tax exemption schemes, adjust your time horizon suitably and have good patience.  Stock market is neither in your control and nor at the control of your financial planner.  Only way to beat the stock market is to have patience in abundance.

Driving Looking At Rear View Mirror

Past performance is a good indicator but not the sole indicator.  Don’t override the choice of your financial planner because you track the fund rankings through free websites or bloggers’ dens.  Please remember the publicly available information about a fund is stale and expired. One of the most important value your financial planner can add is the information culled during the interaction she has with the fund house/fund manager regularly.  No blogger or ranking website can provide you this.  Most of the good financial planners and investment advisors can pick up the phone and talk to the fund managers directly.

Mutual Funds Are Not Shares

It is not an amusement to a financial planner, in spite of spending enough time with the planned, the fact that she is unable to germinate the thought that mutual funds are specialised instruments designed to invest in various types of assets including shares and stocks and are not in themselves that.   Mutual Funds are not the instruments to trade but to save or invest.  Mutual funds are driven by investment objectives as stated in offer documents and not meant for maximising the profits to promoters or shareholders of the companies in which they invest.

Oranges And Apples Are Fruits But All Fruits Are Not Apples And Oranges

Mutual funds are not ‘only’ about shares and stocks.  They are also about cash and other types of assets/financial instruments.   You can create a vast array of choices using various combinations of different types of funds to meet your goals and needs.  For this to happen, you have to spend enough time and energy either yourself or with your financial planner.  Your goals and needs should drive the choice of funds and not the other way round.  Chase four or five stars blindly and when the day dawns there are none left except the only one.

Choosing The Wrong Time

You can call this as the curse on individual investors, especially the unguided.  Money is highly emotional subject and your basic emotions sway your decision making process.  You invest at market highs and exit at lows.  Fear and Greed rule the roost.  If you are of this mindset, my dear friend, mutual funds are not the best choice for you.

Visit us at: http://www.procyonfp.com/

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What You Should Not Be Doing in The Transition Phase in Retirement Planning

Whether you are salaried person, employed by a Government or private entity, a professional, a business person or anyone who have indulged in active pursuit of goals, take care not to fall in to the trap of adventure seeking.

a)      Do not take an about turn in your career.  If you had been an office goer for the last three decades, it would be necessary for the right combination of luck and hard work to become a successful farmer after you retire.

b)      Do not take any aggressive stance on your investment portfolio for reasons such as starting late or mid-way losses.  Economic environment may not favour your thoughts and you will not have any time left to recover from the losses.

c)      Do not get in to the itch of ‘one last time before I retire’ syndrome, especially in relation to risky options in the areas of investments or adventurous activities.

d)     Do not under-estimate your life expectancy.  Disciplined way of living clubbed with improvement in health sciences would increase your longevity.

e)      Do not give away your wealth and assets to your heirs sooner than necessary.

f)       Do not ignore taxes and inflation

g)      Do not ignore health insurance.  You need it most when you retire if you have not created a separate health care management fund.

h)      Do not ignore your exercise or yoga routine.  Prevention is better than cure.

i)        Do not forget to remember that when you retire you do not work for others.  You never retire from what you do for yourself and your love ones.

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The Transition Phase in Retirement Planning

It used to be the common refrain in the last decade that people wanted to retire early.  How early?  ‘May be after 45 years’ used to be the common answer.  Somehow, such thinking has diminished in the new decade.  Reasons could be many. Stagnation of salaries could be one of the reasons for loss of bullishness to retire early.  Economic environment could also be a dampner. Whether you wish to retire early or at the legal superannuation age, you need to know and define your transition phase.

So what is transition phase and how long it should be?  Transition phase is defined usually as the time period before the actual change happens and the next phase begins,  from active regular employment to part time employment or transition to profession or business or complete cessation of activities related to job, such activities constitute the transition phase.  The length of transition phase would depend on your approach to retirement planning.  It could be just one day as in most of the cases or it could be long drawn.

What is the importance of transition phase and what actually happens in the transition phase?

Transition phase is important in the following ways:

a)      You will soak in the reality that your life would alter, may be even drastically, when you retire.

b)      You will start developing your hobby or passion in to useful economic activity that can sustain you emotionally and/or financially during your retirement.

c)      You will cut down on your activities related to your profession or business, create backup plan and set in motion activities to handover your jobs and responsibilities to your heir-apparent.

d)      You will start counting the beans and re-align your investment goals.  You will also start establishing passive sources of income.

e)     If you are relocating to another place or city or country you will begin the process of acclimatisation.

A financial planner would use the transition phase to re-jig the portfolio which is currently oriented towards growth to a portfolio oriented towards safety and income generation.  Usually the financial planner would use a 3-year period to perform transition activities.

Visit us at: http://www.procyonfp.com/

Retirement Planning – Accumulation and Growth Phase

The general connotation of retirement planning actually is “Accumulation and Growth Phase” and other phases are conveniently ignored but not by a professional.

This phase of retirement planning is most exciting for you and host of other solution providers especially product manufacturers whereas you must give equal importance to all the phases of retirement planning.

What makes Accumulation and Growth Phase more exciting than others?  Firstly, it is the first in the order.  Secondly, it is easy to visualise.  Thirdly, it could be the longest phase and comparatively easier to manage than other three phases.  For do-it-yourselfers it is a veritable buffet lunch of assorted financial products and solutions.  For product manufacturers it is most rewarding phase by the type of products they can manufacture.  In actuality, it is the easiest phase to traverse and for a financial planner it may amount to managing the risk-reward expectation of the client unless she enters in to the nexus with the client to make it more complicated than necessary.

Why many fail in this phase?  I can list some of the common pitfalls you may come across in this phase:

a)      Procrastination and lack of future orientation

b)      Mis-understanding your ability to take risk and not giving enough time and effort to understand the activities you need to perform during this phase

c)      Over-dependence on products than on solutions

d)     Failing to prioritise what is most important – current consumption or future wellbeing?

The accumulation and growth phase of retirement planning can be traversed very easily provided you:

a)      start early

b)      talk to your financial planner and understand your money-personality and the needs

c)      keep the choices simple, easily comprehensible for you and your spouse and most importantly flexible

d)     have future orientation

Best wishes for a successful Phase 1 of your retirement planning.

Planning For Your Retirement

Your retirement planning time horizon can be divided in to four major stages or phases:

a)      Accumulation and Growth Phase

b)      Transition Phase

c)      Consumption phase

d)     Transmission or ‘giving away’ phase

One fundamental question you will face is when to start ‘investing’ for your retirement.  Logical answer is soon after you receive your first ‘income’ or ‘salary’.  Provident fund contribution is a statutory contribution mechanism for organised work force.  From your very first salary, you and your employer would start contributing in to this account.  For the present, it is a tax free accumulation and growth enabling system.  What about unorganised sector of employment?  If you belong to this category, or otherwise also, you can open ‘Public Provident Fund’ Account and begin your contribution.  This also is a tax free account to help you in the first phase retirement planning. Those of you who wish to take exposure to equities in your primary retirement account, you can look at NPS.  Importantaly, before opening the account, make it a point to understand clearly how the account works and its limitations.

When you should start contributing additional amount for retirement planning?  Well, the answer again is immediate, generally.  There would be certain situation in your life and career when you will be unable to do this.  If you want to pursue higher education or if you are a business person or a professional starting your own practice, you will be cash strapped and would be unable to commit additional resources.  Work with your financial planner to chalk out an action plan to fund your retirement account optimally.

Time Perspective

Are you past or present or future oriented?  Your time perspective has a major bearing on your ability to create wealth.

According to the research done by psychologists, if you have future time perspective, you will be more successful.  People with future time perspective (futures) get more education and they earn more money.  Also, they spend less and save more.

Psychologist Prof. Philip Zimbardo identified several personality types in relation to time orientation. People can live in different time zones

  • Past positive: you are nostalgic and think of good old days gone by
  • Past negative: you are regretful about the past and think of failure, all the things that went wrong
  • Present hedonistic: you live for today and seek pleasure and sensation
  • Present fatalism: your life is governed by external forces and you abhor planning.
  • Future: your focus is on learning rather than play.  You are goal orientend and amenable for planning
  • Transcendental Future: you believe life begins after the death of the mortal body

It should be no surprise to find that future oriented people tend to be wealthy because to become wealthy you can’t spend more money than you earn.  In fact, you should save and invest wisely.

Here are Prof. Zimbardo’s recommended five steps toward achieving financial freedom:

(1) The present is the best time to start investing.

(2) Time in the market is more important than timing the market.

(3) Know when your time will be up; those with a long time ahead of them can afford more risky investments.

(4) You can’t time the markets.

(5) A pleasure-seeking time perspective is an expensive habit few can afford.

Simple, aren’t they?

Link to Prof. Zimbardo’s video “The Secret Power of Time.

Souring Dreams of Indian Middle Class

Two headlines in today’s Economic times attracted my attention and also caused a bit of turmoil.

LIC’s Large Exposure to PSUs Raises Fears on Returns Front

Fees at Some IIMs Triple in 5 Yrs; up 15% at IIM-B This Yr

First one was about Govt.’s dictate to the state run life insurance company to buy public sector undertakings’ stocks and consequently them losing in value.  This incident brings back the memories of UTI fiasco in 2001.  Barely a decade later, it appears that Govt.’s short-sightedness and financial exigencies are pushing the insurance behemoth in to the same road.  The insurer may be too big to fail but loss of confidence would hurt the organisation and the economy greatly.  With court dismissing PIL on LIC’s investment practices, you and me, either as policy holders or as advisors can do little about such decisions other than feeling the despair.  People who think of ‘investing’ in such schemes because of Govt. guarantee (in spite the returns being low) should pause and ponder.

Another headline is about fee of some IIMs tripling in 5 years (from Rs.4 Lakhs to Rs.1.5 Lakhs).  Another Indian Middle Class dream is biting the dust!  If this can happen in the case of an institution set up by Govt. of India, there will be no control over other institutions offering similar courses and education.  The report says around 25% of students would get fee waiver?  The rest have to bear the burden.  If you are a parent aspiring that your children should aim for IIMs please take note of these numbers.  Inflation is real and it can hurt you.

Imagination

Following paragraphs are extracted from Napoleon Hill’s 1938 classic “Think and Grow Rich”

The imagination is literally the workshop wherein are fashioned all plans created by man. The impulse, the desire, is given shape, form, and action through the aid of the imaginative faculty of the mind.

It has been said that man can create anything which he can imagine.

Of all the ages of civilization, this is the most favorable for the development of the imagination, because it is an age of rapid change. On every hand one may contact stimuli which develop the imagination.

Through the aid of his imaginative faculty, man has discovered, and harnessed, more of Nature’s forces during the past fifty years than during the entire history of the human race, previous to that time. He has conquered the air so completely, that the birds are a poor match for him in flying. He has harnessed the ether, and made it serve as a means of instantaneous communication with any part of the world. He has analyzed, and weighed the sun at a distance of millions of miles, and has determined, through the aid of imagination, the elements of which it consists. He has discovered that his own brain is both a broadcasting, and a receiving station for the vibration of thought, and he is beginning now to learn how to make practical use of this discovery. He has increased the speed of locomotion, until he may now travel at a speed of more than three hundred miles an hour. The time will soon come when a man may breakfast in New York, and lunch in San Francisco.

Man’s only limitation, within reason, lies in his development and use of his imagination. He has not yet reached the apex of development in the use of his imaginative faculty. He has merely discovered that he has an imagination, and has commenced to use it in a very elementary way.

What he said is very much true even today.  I recommend this book for all to read.  You can download a free copy at http://manybooks.net/

Are Your Finances Under Stress?

If yes, how will you know about it before you run out of time?  Similar to economic indicators of a country that can tell if economy is doing well or not, you can draw up these four financial statements to know about your finances.

a)      Income & Expenses Statement
b)      Cash Flow Statement
c)      Family Budget
d)     Net Worth Statement

(In later write-ups I will explain each one of them in detail.  Advanced Financial Planning also employs ratio analysis techniques to monitor financial health.)

Income and Expense Statement, prepared usually for a period of one financial year or plan year, can tell you whether your income is sufficient to meet your expenses.  If you end up with surplus, it indicates that you are on the right track.

Sometimes, Income & Expense Statement can be deceiving because it does not measure the cash flow.  A cash flow statement measures the actual cash you receive and give away during the same financial year.

Just to highlight few differences between Income & Expense Statement and Cash Flow Statement, your income and expense statement may include performance bonus that you may not actually receive.  It may also include accrued interest on which tax needs to be paid. Your cash flow statement may show the amount returned by your friend who had borrowed at some immemorial time.  It may also include the mutual fund redemptions you are likely to make in the financial year.

Family Budget will tell you if you have enough rupees to spend each month of the financial year.

Net Worth Statement (or Balance Sheet) provides pointers to the long term health of your finances. It shows how much you own and how much you owe.

Some of the financial stress indicators are:

  • You have more than one credit card and each has some unpaid balances.
  • You use credit card more often than debit card.
  • You are spending all your earnings or more than your earnings.
  • You use credit card borrowings to balance your family budget.
  • You are often in the habit of borrowing from your parents and friends with reasons such as “I am running short of cash” or “I will square up in my next month’s salary”.
  • You are using ‘revolving credit facility’ or ‘convert to easy EMI facility’ in your credit cards.
  • You have more than one personal loan borrowed for purchase of things that lose value once you buy them.

Following situation may indicate that you are under severe financial stress and may need immediate attention and help:

  • You are defaulting on your minimum payments of your credit cards or EMIs, for several months in a row now.
  • Banking and Financial institutions are unwilling to lend you anymore.
  • You are borrowing at very high costs just to repay either the old loans or the minimum payments or just the interest.
  • You are stopping your on-going saving and investment plans and/or also redeeming the investments beforehand.
  • You are pledging your existing financial assets such as fixed deposits or cash value insurance policies to pay interests.
  • You have unpaid term and health insurance premiums.

Surprisingly (or unsurprisingly), financial stress has nothing to do with your personal status.  If you are a bad money manager, it can affect you even if you are responsible for millions of rupees of revenue for your employer and you head a large team of people.  It can affect you whether you are a business person or professional or salaried employee. It can affect you at any stage of your life if you have not learnt the lessons and haven’t inculcated prudent financial habits.  It can affect your household even if both spouses are drawing million rupee salaries each.

Prevention is better than cure.  If your doctor says that you must walk every day for at least 30 minutes, do not ignore the advice. It may save you from lot of troubles in future. Similarly, if you are under financial stress, mildly or especially severely, do not hesitate to talk to your elders and/or professional advisers and listen carefully to what they have to say.  You should also speak to your spouse openly and honestly because he or she has to stand by you in the difficult times.  You can also talk to your tweens truthfully and involve them in the recovery plan. Talk to your friends only if they are dependable.  It may not help you much if they have also played a role in the first instance or if they are in bad shape themselves.

It may surprise you, but just the same, the old adage of stretching your legs to the length of your bed is the advice you will receive from all your well-wishers including your financial planner.

Have The Cake and Eat It Too

It is important that you make money when you invest.  For the sake of simplicity, let us remove theone off investments such as purchasing or constructing a house property or buying a farm house from the scope of discussion and consider only the regular investments you make every day such as bank deposits, bonds and securities, shares and stock and so on. Especially when it comes to investing in financial instruments, it is important that you consider the role of asset allocation.  If you think investing in a volatile asset is riskier, the only way you can have the cake and eat it too is by doing asset allocation.

If you consider the returns you can get by investing in bank may not fetch you higher returns after adjusting for tax, you have to consider adding other assets such as equity and gold to your portfolio.  Similarly, if you consider investing in shares and stocks is a very risky thing to do, you must add investments such as bonds and fixed deposits to your investment portfolio.