Whose Money is It Anyway? Winning in personal finance 1 2 3

Whose Money is It Anyway?

Winning in personal finance

123

Personal Finance Approaches• Tax-savings first

• Product-first

• Returns-first

• Needs first • Products-last• Tax-planning incidental

Goal-based investing

What is goal-based investing?

Permanent loss in capital

Permanent loss in capital

We cannot expect more because we cannot invest enough!

With 8% inflation

• 12% return 5000 monthly investment

• 6% return ~10,000 monthly investment

• What if I invest 10,000 pm in an instrument that offers a real chance to beat inflation?

Returns do not matter!yearscorpus inv(1 return)

yearsinvcorpus (1 )return

returncorpus (1 )inv years

Your RetirementOther long-term goals

Accident insurance

Term Lifeinsurance

Emergencyinsurance

Health insurance

Inflation insurance

Cash Flow Analysis: Creating a Zero-based budget

• Zero-based budget: “One in which every dollar is assigned a role” – Dave Ramsey

• No money left at the end of the month!

• Live ‘hand to mouth’ because of investing!

• No lump sums allowed!

Zero-based budget

• Step 1: List all sources of income

• Step 2: List all monthly expenses

• Step 3: List all annual/recurring expenses

• Step 4: List present and future liabilities

• Step 5: List present investments (incl EPF)

• Step 6: Determine amount available for investment (incl EPF)

Power of non-compounding

Power of compounding does not matter for ~ 5Y or less

Inflation in India: Some Real Numbers

Jan 1995 to May 2014

Why not have some equity exposure?

Is not 5/7 years long-term?!

Year 1 Year 2 Year 3 Year 4 Year 5

10% 9% 8% 7% 6%

5

Investment = 100

After 5 years:

?

100× 1+10% 1+ 9% × 1+ 8% 1+7% 1+6%

100× 1+

5

After 5 years:

100× 1+10% 1+10% × 1+10% 1+10% 1+10%

100× 1+10%

Year 1 Year 2 Year 3 Year 4 Year 5

10% 10% 10% 10% 10%

5

Investment = 100

After 5 years:

100× 1+10% 1+ 9% × 1+ 8% 1+7% 1+6%

100× 1+CAGR

Year 1 Year 2 Year 3 Year 4 year 5 CAGR10% 10% 10% 10% 10% 10.00%

Year 1 Year 2 Year 3 Year 4 year 5 CAGR25% 7% 7% 7% 7% 10.05%

Year 1 Year 2 Year 3 Year 4 year 5 CAGR-25% 21% 9.96%

Year 1 Year 2 Year 3 Year 4 year 5 CAGR-25% 7% 7% 7% 7% -0.34%

Illustration: Volatile Compounding

Year 1 Year 2 Year 3 Year 4 year 5 CAGR25% -25% 7% 7% 7% 2.81%

Liquid Mutual Funds

• Savings bank account linked to bond market

• Invests in short-term bonds (4- 91 days)

• Sensitivity to interest rate change: low

• Risk of default: low

• Least volatile among volatile asset classes

xxxx Liquid Fund

Average

Arithmetic average ~ 7%Standard deviation ~ 2%CAGR ~ 7% (12 year)Difference ~ 0.02%

xxxx Liquid Fund

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

7.1 4.96 4.36 5.3 6.5 8.12 8.9 5.29 5.15 8.8 9.56 9.28

5.644

5.848

6.636

6.822

6.792

7.252

7.54

7.616

Discrete Rolling Return

Understand risks before investing

Continuous Rolling Return- 2Y

2048 Two year intervals betApril 3rd 2006 to Dec 4th 2014

April 3rd 2006 to April 2nd 2008April 4th 2006 to April 3rd 2008April 5th 2006 to April 4th 2008

Continuous Rolling Return- 2Y

Debt oriented balanced funds(<20% equity)

AMC suggests investment horizon 1-3 years

vs.

Equity oriented balanced funds(> 65% equity)

AMC suggests investment horizon 3-5 years

1 year rolling returns

3 year rolling returns

5 year rolling returns

7 year rolling returns

10 year rolling returns

Asset Allocation

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD 40% Eq >60% Eq 100% Eq

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD/Debt ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD/Debt 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD/Debt 30-40% Eq >60% Eq 100% Eq

Understanding the nature of stock market returns

Sensex Total Returns Index: 1979 to 2013

Sensex Total Returns Index: 1979 to 2013

Sensex Total Returns Index: 1979 to 2013

5%

S&P 500 Total Returns Index: 1871 to 2013

Source: http://www.moneychimp.com/features/market_cagr.htm

12%

Sensex Total Returns Index: 1979 to 2013

Higher risk does not imply higher return!

Return

RiskStandard Deviation

Higher risk does not imply higher return!

Return

RiskStandard Deviation

FD

Debt mf Equity mf

Gold

How Important is

Mutual Fund Selection?

Large Cap Funds

Computed with SIP calculator, thefundoo.com

Large Cap & Large/Mid-Cap Funds

Computed with SIP calculator, thefundoo.com

Large Cap, Large/Mid-Cap & Mid/Small-Cap Funds

Computed with SIP calculator, thefundoo.com

Lump sum returns

Essentials of a good portfolio

• Minimalist : We must be able to justify the presence of each asset class or instrument.

• Minimum number of asset classes

• Minimum number of stocks, equity funds or debt products

• This will typically make the folio diversified among and within asset classes

Simple portfolio ideas

Equity (60%) 10% return

1. Single Large Cap fund or

2. One large cap +one mid/small cap fund or

3. Single Large and mid-cap fund or

4. Single equity oriented balanced fund

Debt (40%) 8% return (pre-tax)PPF for 15+ Y goals for options 1,2 & 3 (do not max!)

Short-term debt funds for less than 15Y goals orBanking debt mutual funds

Long-term goals (10+ years)

Simple portfolio ideas

Equity (0-40%) 8% return

1. Single Large Cap fund or

2. One large cap +one mid/small cap fund or

3. Single Large and mid-cap fund or

4. Single equity oriented balanced fund or

5. Single debt oriented balanced fund

Debt (100-60%) 8% return (pre-tax)Short-term debt funds for less than 15Y goals orBanking debt mutual funds

Medium-term goals (5-10 years)

Simple portfolio ideas

Equity (0-10%) expect nothing!

1. Single Large Cap fund or

2. One large cap +one mid/small cap fund or

3. Single Large and mid-cap fund or

4. Single oriented debt balanced fund (5Y)

Debt (100-90%) 6-7% return (pre-tax)FDs, RDs orShort-term debt funds for less than 15Y goals orBanking debt mutual funds

Short-term goals (0-5 years)

Return expectation

• Equity allocation60%

• Debt allocation 40%

• Equity expectation 10% (after tax)

• Debt expectation 6-7% (after tax)

• Portfolio expectation

10%(60%) + 7%(40%) = 8.8% (approx.)

Investments are assumed to start simultaneously

Years to goalPresent costInflation Post-tax rate of return of portfolio 8.8.00%

Future CostAmt invested so farPost-tax rate of return on current investment

Future value of curr. Inv. Annual increase in monthly invest. %Initial monthly investment required

Annual increase in monthly invest. %Initial monthly investment required

Goal Planner

How many funds should I hold?

• Minimum:

1 fund! (all goals combined into one)

• Maximum:

No of long-term goals (10Y+) x (1 or 2)

How to select an equity mutual fund?

• Decide on the strategy.

(1)Why are you investing?

(2) What kind of portfolio will you be using?

Equity mutual funds: How to select/evaluate

Equity mutual funds: How to select/evaluate

Equity mutual funds: How to select/evaluate

Upside Capture ratio: When the benchmark has given a positive return (> 0), has the fund outperformed it?Higher (> 100%)  the upside capture ratio, the better. 

UPC = 120% => 20% out-performance during up-market

Downside Capture Ratio: When the benchmark recorded a loss, that is a negative return (< 0), did the fund record a lower or higher loss?Lower the downside ratio (<100%), the better. 

DCP = 85% => 15% out-performance during down-market

Equity mutual funds: How to select/evaluate

Source: http://thefundoo.com/welcome/articlepage/44/Are+you+invested+in+the+Ideal+Outperforming+schemes%3F

Rolling returns analysis

3YFund (blue)

Vs benchmark

5Y

Retirement Planning

Corpus ~ 300 times current annual expensesCorpus ~ 38 times annual expenses at retirement

Invest as much as you spend each month for retirement!

Financial Goal Tracking

• Be obsessed over goal planning entries not over mutual fund corpus

Asset Allocation

Portfolio with 50% equity and 50% debt

Asset Allocation

Maximum Loss: worst case scenario

Asset Allocation

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD 40% Eq >60% Eq 100% Eq

10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq

>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq

Time Frame Conservative Moderate Risky Mad-Max

< 5 Years FD/RD/Debt ~ 10% Eq 30-40% Eq > 60% Eq

7 Years FD/RD/Debt 10-20% Eq 40-50% Eq >60% Eq

10 years FD/RD/Debt 40% Eq >60% Eq 100% Eq

10-15 Years <40% Eq 60% Eq 80% EqFD/RD100% Eq

>15 Years < 60% Eq 60% Eq 80% EqFD/RD100% Eq

How to select a debt mutual fund?

Understand risks• interest rate risk capital gain/loss •credit risk risk of default

How to select a debt mutual fund?

Interest rate risk

Creditrisk

Maturity period of bonds in portfolio

How to select a debt mutual fund?

How to select a debt mutual fund?

How to select a debt mutual fund?