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SIP Plant

Mutual Funds have surely caught the fancy of the Indian Investor community with net flows crossing one lakh crores in 2017! Unlike in the past years, almost everyone we speak with has probably heard of mutual funds. The strong rise in awareness of this investment vehicle has even prompted the Association of Mutual Funds India (AMFI) to cash in on it, with their recent on going advertisement campaign, “Mutual Funds Sahi Hai”.

But what caused this sudden optimism and acceptance of mutual funds as an investment option? It clearly is not a “new trendy option”, for mutual funds have been around for over two decades. While a lot of its features and advantages may contribute to its overall success, one key factor that really has drawn the Indian investor to mutual funds is its ability to create long term wealth, not only for those who invest big lump sums in it, but more decisively, for the salaried class.

The most commonly availed route to invest in mutual funds for the a salaried investor has been Systematic Investment Plan (SIP). It has become synonymous with mutual fund investing. So how does an SIP work? And how does it help in long term wealth creation?

A SIP is simply an investment process to invest systematically every week or month or quarter into a mutual fund scheme at a periodic chosen date. The intent behind this process is that by investing small amounts over a medium or long term tenure, you are sidestepping the issue of market timing. Market timing being the decision to invest based on your view of market movement. As investments will be done over a period of time, such installments would get both the highs and lows of the underlying market, thereby averaging out the purchase cost. This concept is called Rupee Cost Averaging. But for the salaried class a SIP has been looked as a convenient method of investing, as investing monthly from the salary income is a easily achievable goal.

And what about the question of wealth creation? How can a SIP help with wealth creation?

A SIP is a great example of the Compounding Effect, referred to as the Eight Wonder of the World by Albert Einstein. Compounding, or Compound Interest, is the phenomenon where alongside the principal, the interest earned is also reinvested at the same rate of return. So if in Year 1 the principal invested was Rs, 10,000 at 10% rate of interest, the interest to be received at the end of the year would be Rs, 1000. Now because of compounding, the interest is added to the principal in the second year, making principal amount to Rs 11,000 on which 10% returns are gained, resulting in Rs 1,100 as interest in second year and so on so forth. This interest reinvestment is crucial because with passage of time, the increase in principal results in disproportional returns during the latter periods of the investment tenure.

The following table shows how certain equity mutual funds have grown a modest SIP amount of Rs 10,000 per month in the past 10 years:

Fund Name 10 year CAGR (rolling returns) Total SIP Amount Market Value
A diversified equity fund 24.72% Rs. 12 lakhs  Rs. 51 lakhs
A large cap fund 22.98% Rs. 12 lakhs  Rs 45 lakhs
A flexi cap fund 22.96% Rs. 12 lakhs  Rs 45 lakhs
A large cap fund 18.96% Rs. 12 lakhs  Rs 35 lakhs

(Source: Value Express as on 30th Sept 2017) (Note: All fund data taken for regular plans with growth option)

The following chart shows the value of the investment accelerate due to compounding over time.

compounding effects in SIP

(Note: Fund data used is of Diversified Equity Fund from the above table)

Another factor to consider when thinking of compounding is time. The longer you invest and hold the investment, the better results it will provide. The following table is a clear example of the same. Taking the same funds as in the above table, if an investor started late and had to invest for the second half i.e. 5 years and even if he invested at double the SIP amount i.e. Rs 20,000 per month, he/she would not achieve the same end result:

Fund Name 5 year CAGR (rolling returns) Total SIP Amount Market Value
A diversified equity fund 19.36% Rs. 12 lakhs Rs 36 lakhs
A large cap fund 16.07% Rs. 12 lakhs Rs 29 lakhs
A flexi cap fund 19.05% Rs. 12 lakhs Rs 35 lakhs
A large cap fund 18.92% Rs. 12 lakhs Rs 35 lakhs

(Source: Value Express as on 30th Sept 2017)

(Note: All fund data taken for regular plans with growth option)

As you may have noticed, barring the last large cap equity fund, all other funds performed significantly better over 10 year tenures, resulting in higher gains, even though in both cases the principal invested was the same.

As an investor you may have noticed various advertisements where mutual Funds are showcasing how much an SIP into their best performing star fund may have grown into, in a certain number of years. While the growth story in many such funds has been substantial, the key note all investors must keep in mind is that this is the result of staying invested into the fund for the long haul, including the times when the fund may have under performed. Compounding and a SIP will only go hand in hand when the investor has the horizon and patience to continue the SIP for a long tenure.

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Inflation concerns mean rates stay as is…

As was broadly expected, The Monetary Policy Committee (MPC) on Wednesday left the policy repo rate and reverse repo rate unchanged at 6 percent and 5.75 percent, respectively. Out of six members, five members voted for no rate cut and one member voted for 25 bps rate cut. RBI continued to maintain its view that the 4% target on inflation remains its focus. Retail inflation measured by year-on-year change in the consumer price index (CPI) had recorded a seven-month high in October, and with an indicated range of 4.3% to 4.7% for the next two quarters, along with higher inflationary expectations getting built in through the possibility of higher oil prices and some possible fiscal pressure, this was very much in line with expectations. Surplus liquidity in the system has also continued to decline, reducing chances of rate cuts going forward.

Focus on the real rate of return

With the RBI referring to possible green shoots on growth starting to appear in the economy, it does seem that whilst they will continue to track data closely, strategies that are focussed on interest rates getting reduced are likely to face pressure. However, considering that real rates of return (returns from fixed income investments less inflation) continue to be significantly positive, we continue to believe that investing in fixed income is attractive.

Your Investments

Considering positive real interest rates, and equities continuing to trade at significant premiums to long term price to earnings ratios,  it may be a good idea to continue to have fixed income exposure through a combination of largely accrual, short to medium term, and hold to maturity strategies. For investors willing to continue to look at interest rates heading downwards, dynamic bond funds that have flexibility to move across bond maturities, can be explored for a small portion of the fixed income portfolio.

Your Loans

The RBI’s decision to hold rate cuts could indicate that there is unlikely to be any impact on existing lending rates, especially home and car loans by banks. Whilst the transmission of the rate cuts for bank loans over the last couple of years has only been partial, we believe that interest rates may not head down much more going forward.

Way Forward

Considering that the next policy meeting on Feb 6 and 7 is likely to be post the Union Budget, one will need to track how the government manages its fiscal policy and its focus on growth going forward. Global interest rates headed upwards, will also continue to drive RBI’s decisions on interest rates.

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India is currently among the most watched Emerging Market nations. To top that, the Indian Equity Markets have witnessed unprecedented growth in the recent months. The YTD returns for Sensex alone has been 26% (data from BSE India). The euphoria and high confidence on the Indian Equities has continued to remain, especially from the institutional investors both foreign and domestic.

This is also leading to make many individual investors question whether they should invest in equities or sit on the sidelines. While individual risk appetite and time horizon would be some of the basic factors to understand before investing, there are many other fundamental factors to track. While the debate has been raging on as to which indicators should be looked at or ignored to make sense of the valuations of the Indian equity markets, the following factors can help bring some sense of clarity to the overall picture. Factors such as:

Current Price to Earnings Ratio (P/E Numbers): One of the most traditional tools used globally at gauging the valuations of an equity market of a country. In the last one year alone (based on data from Oct 16 to Oct 17), the P/E Ratio for S&P BSE Sensex has averaged close to 22 times in comparison to its historical average of approximately 17 on a trailing basis. For the BSE Mid Cap and Small Cap of the same period, the P/E valuations are at an average of 33.8 and 81.13 times.

Corporate Earnings: P/E Ratios are directly linked to the corporate earnings of the country. As per Kotak Institutional Equities Estimates, the Expected Earnings for companies representing the Nifty 50 Index are approximately 2% in FY 2018. A variety of reasons are attributed to these low earnings expectations, most famously discussed are the implementations and effects of Demonetization and Goods and Service Tax (GST).

Crude Oil Prices: Nearly 80% of India’s energy needs are import dependent. A direct consequence of this is the risk to the country’s inflation rate if the prices of crude oil are to rise. A rise in oil prices results in lower cashflows/profits for companies and higher prices for consumers. Brent crude oil prices are currently firming up at prices upwards of 60$ per barrel. This is a definite concern from an Indian economy perspective.

Exchange Rates: The Rupee is currently considered overvalued basis its 10 year average (Source: Kotak Research). This has a dual impact on the economy i.e. (A) it increases attractiveness of imported products, resulting in increased competition for domestic companies and lower profits; (B) it decreases the value of exported products and therefore hurts the margins of export based industries such as the IT sector. Both have resulted in muted growth prospects for these respective industries.

Bond Yields: In an growing economy like India, both equities and bonds compete for capital. In a equity bull rally, money is taken out from bond markets and pumped into equities, forgoing risk to capital for riskier investments. Currently bond yields are inching up to the mid 2017 high of 6.987% yield for the 10yr G-Sec. However there has only been net inflows into fixed income. Foreign Portfolio Investments into Government Securities have already reached 83.94% of their allotted limit (data dated as per 6th Nov NSDL)

Inflation Rate: Inflation brings about it own risks to the stock markets. In the last Monetary Policy Committee meeting, the RBI revised the inflation projections for the rest of FY 2018 upwards to 4% – 4.5%. This may indicate a stop to future rate cuts, freezing any possibilities of reduction in lending rates. Medium term consequences for companies could possibly mean dearer than expected debt to  service, resulting in subdued profits and revenue.

Role of FIIs: The way that Foreign Institutional Investors park monies in the market can give an indication to the current picture of that market. While FIIs were very bullish on Indian Equities for most part of the calendar year, starting June they slowly but surely tapered inflows in equity, finally resulting in net outflows in the month of September and October. (Source: moneycontrol)

Global Scenario: On a global scale, economies are starting to look up, with further growth expected. According to IMF Economic Outlook, average expected GDP growth for FY 2017 is 2.5%. Globally, equity markets have participated in this growth including India. What probably may need to be put in perspective is that the rally in Indian Equities may be partly due to the global rallies taking place. Therefore the Indian equities are associated with risks in terms of foreign external factors like outbreak of war in the Korean Peninsula. Such events are likely to have negative impacts on the domestic markets.

Keeping in mind the above mentioned factors, Plan Ahead Wealth Advisors has a definite view that current equity markets are over valued and investors should exercise caution. The not so positive indicators from these mentioned factors should mean a significant correction cannot be discounted, keeping us wary of diving too much into equities without first educating investors of the potential risks in the short to medium term horizon.

 

 

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Financial Welness image 1The traditional thoughts on wellness usually revolves around health and nutrition. However, in our current lifestyle, achieving a good health and having decent nutrition involves regular check ups and having healthy eating habits; which may be kind of difficult if we are stressed about our money. If you ask a group of working people who are having difficulties sleeping at night the reason for this, chances are high that a good number of them will cite financial stress as the cause. The impact of such stress is not unknown to us, with impact on health and loss of productivity just two of the effects.

Here are just a few reasons why Financial Wellness should be giving due consideration in today’s time:

Financial Concerns can be a major source of stress

According to the 2017 PWC Employee Wellness Survey (a survey done for employees in the United States), more than Fifty Percent of the employees surveyed are facing some sort of financial stress.

The Global Benefits Attitudes Survey conducted by Willis Tower Watson further showed that Fifty Three Percent of Indian Employee respondents claimed to have some sort of financial worry i.e. either long or short term, or maybe even both. Furthermore Seventy Three Percent of these respondents claimed that these worries have caused them above average stress. Following is a chart depicting the data collected by the Willis Tower Watson survey:

One in two survey participants have some kind of financial worry!

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It can be a major reason for loss of productivity

According to the PWC survey, distractions due to financial stress is a real thing and it can lead to wastage of working hours. The survey indicated that on average, financially stressed people spend up to 3 working hours per week on dealing with financial matters and they are also twice as likely to miss work due to personal financial matters

Improves Physical Well being

The American Psychological Association’s 2016 Stress in America report stated that Sixty Seven Percent of those surveyed revealed that money was a form of stress. And that rise in stress can lead to stress related health concerns.

While these are certain aspects that may be more applicable to an employee, employers should also look at this as a prime employee engagement tool for the following reasons:

Financial Planning take Time

As mentioned above, the stress caused by financial worries forces employees to bring these to the work place. As such they devote working hours to such matters and also altogether take leaves to attend to various financial concerns/emergencies. This only increases the burden of the employer ultimately.

Increases Employee Productivity and builds Loyalty

We have already read how financial worries leads to a loss of productivity in the office. An efficient manner in which employers can counter such trends is to increase financial awareness among its employees. Thus not only will employees worry less and reduce work hours wastage, they are also more likely to use their well deserved breaks better and therefore not be absent from work. Providing financial wellness initiatives can make them confident of planning better for major events like Retirement. This ultimately leads to trust between the organization and its employees, a great source of encouragement for all employers. 

Employees want Support and improve their Financial Literacy

Financially burdened employees would like their employers to help them in achieving wellness. Employees who stress from money issues are looking for help to improve their financial situation.

Financial Well Being is steadily gaining acceptance as an important factor of consideration for one’s overall well being. As such it it becomes critical for an individual to ensure that his/her’s financial situation does not lead to issues that has negative impacts on different aspects of life. And as an employer, Financial Wellness initiatives can be a source of efficient employee engagement and possible retention strategy.

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uncertain inflowsI have uncertain inflows – how should I invest?

Money may not be the end in itself, but for most, it is a means to achieve many necessities as well as aspirations. Therefore it becomes important how an individual plans to use his/her hard earned money. More so when the inflows are not necessarily streamlined and consistent like that of an employee. When your personal income is linked to the performance of your firm, a well thought out plan could be all the difference between financial stability or having to make huge compromises.

Being a HR firm owner can have its ups and downs. By following certain simple financial planning steps, you can have some peace of mind with regards to your personal financial situation even though you may not have a steady income:

  1. Contingency Fund: This is a basic yet most critical part of any financial planning for a self employed individual. You never know when your next pay check may come. So it pays to prepare for the worst. Thumb rule has always been 3-6 months worth of household expenses to be kept aside in highly liquid assets as an Emergency Fund. Yet we feel that when it comes to a owner/manager, it should be at least 6-9 months worth of basic expenses!  A handy tip, do not forget to count any committed payments such as EMIs and any insurance premiums when calculating the corpus. 
  1. Risk Planning: or in lay man terms, Insurance Planning. This could be a considered an extension of contingency planning, but for very specific events. Following are the types of insurance policies one must always have at all times: 
  • Term Life Insurance Plan: The plain vanilla term plan is exactly the only kind of life insurance anyone should purchase. Handy tip, to know the amount of cover you might need, start with at least 15 times your annual revenue/income. Don’t forget, insurance should never be mistaken for an investment!
  • Individual Health Insurance: If nothing else, an individual health cover to at least cover your own standard hospitalization expenses is a must. Financial independence means you should be able to fend for yourself at the very least, even if it paying for your own recovery. 
  • Critical Illness Policy: Contracting a serious illness or undergoing a major surgery would mean a drag on your finances as well as a dent on income. Such financial risks can be mitigated by procuring a critical illness policy. Such policies usually provide for a lump sum payment to tide over the finances needed, in case of being diagnosed with a critical illness.
  • Personal Accident Policy: Another source of financial risk associated with most professionals is loss of income/job due to an accident. Similar to a Critical Illness Policy, this policy provides a supplement alternative income for certain weeks of disability depending on the terms of the policy. This can be used to either pay off medical expenses or help in taking care of household expenses during the recovery period.

While more types of insurances are available, it is essential that this set is acquired first. Having your Contingency funds and Risk Planning in place makes a strong base for you to venture into the world of investments.

  1. Planning for Retirement: Retirement, or as financial advisors put it, Financial Freedom, is something we all aspire for. The dream of not working for the sake of survival is a goal we all work towards. Yet having an uncertain income can make such a dream feel a little distant more often than not. And while retirement always seem likes a far off goal in comparison to what seem like more pressing concerns, it should ALWAYS be top priority! Underestimating your retirement financial needs can be the one of the biggest mistakes you could make and more often than not, people realize it far too late to make any significant course corrections. Even if you have to start with small amounts, it is the consistency and discipline that will ultimately help you reach your goal.
  1. Financial Goal Planning: Only after the first three steps are in place, is when you should really consider planning for the rest of the commitments/aspirations that you might have. As with any goal planning, the two critical aspects to consider are time horizon and future value of the goal, not current value. If you get these two right, the rest becomes clear.

For any individual with uncertain income flows, planning can become easier if you can channelize your savings, prioritizing in the above order! It is essentially in this area where the difference between financial planning for an owner of a firm/business versus that for an employed individual lies.

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As was broadly expected, RBI cut policy rates by 0.25%, taking repo rates down to 6%. This was brought about largely due to the annual retail inflation in June to be the slowest for over five years and as expectations for inflation going forward remain at about 4%, a number that RBI seems to be comfortable with. In addition low core inflation, a good monsoon thus far and a reasonably decent GST roll out thus far. They also held the stance as neutral which was expected, considering that too many shifts in policy could impact long term credibility.

The good news is that the 6 member committee decision was not unanimous – four members voted for 25 bps cut, the fifth voted for a 50 bps cut and the last one voted to maintain status quo.  Hence repo rate got reduced from 6.25% to 6%, reverse repo rate from 6% to 5.75% and marginal standing facility (MSF) rate from 6.5% to 6.25%.

Big Image- What does the Monetary Policy mean for RBI monetary stance

Focus on the real rate of return

With interest rates remaining subdued, there is a tendency to want to take greater risk on the portfolio to achieve a higher absolute rate of return. We think that it is critical that investors focus on real rates of return ie the return after inflation on their portfolios. We believe RBI continues to keep its focus on real rates of return at 1.5% – 2%, which makes fixed income attractive at this stage. Avoid higher risk strategies in chasing a higher rate of return in the current environment, as the risk return trade off may not be favorable.

Your Investments

The decision of the MPC is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth. The neutral stance does not mean that there won’t be any future rate cuts, but it does seem like rate cuts going forward may be slow and investors expecting a repeat of the returns from bonds made over the last few years, are likely to be disappointed, if they have very high expectations.  The bond and equity markets had probably already priced in this 0.25% rate cut and thus they did not react  to this announcement. It may be a good idea to have bond fund exposure being weighted two thirds towards accrual/hold to maturity strategies and one third towards duration/dynamic strategies. With global bond yields in developed markets headed upwards, investors in equities may need to be careful, especially with equity markets priced to perfection.

Your Loans

The RBI decision to cut its policy repo rate to 6 per cent is likely to lead to a further cut in the lending rates, especially home and car loans by banks. New borrowers can expect EMIs to come down and which would also cut down interest outgo over the loan tenure. Banks may come also up with promotional offers till the festival season to attract more customers. Old borrowers under the MCLR would have to wait until the next reset period to get the rate reset as normally rates are reset once in a year. There is also an option for the old borrowers of switching the loan portfolio to another lender. The decision to examine how the shift to MCLR has worked, considering that most loans are still linked to the base rate, would be interesting to watch closely as RBI has set up an expert committee to look into how monetary transmission can be more effective.

Way Forward

With inflation being the focus of the RBI, the factors determining inflation as mentioned in the Monetary Policy include:

(a) The impact on CPI of the implementation of house rent allowances (HRA) under the 7th central pay commission (CPC); could be estimated to have a 1% impact on inflation over the next 12-24 months

(b) The impact of the price revisions withheld ahead of the GST; and

(c) The movement of food and fuel inflation.

Watch out for inflation, the movement of the Indian rupee and how the economic slowdown led by weak manufacturing and cape data, till the next RBI policy on 4th October 2017.

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The RBI has not changed the repo rates, maintained at 6.25% but has cut SLR rate by 50 bps.  RBI has indicated that it wait for more clarity on data on inflation going forward before taking any decision on monetary policy action. However with inflation in terms of CPI continuing to remain low, any rate hike action which the markets were fearing over the last few weeks seems less likely. Thus a rate cut which seemed off the table till a few weeks ago continues to be an alternative going forward, depending on multiple data points. GST rollout so far has been assumed to not affect inflation meaningfully, though it will need to be watched carefully.

Investments:

Investors having investments in dynamic or duration funds can benefit from falling interest rates if inflation continues to be low. Investors having long term goal durations of 5 plus years for their fixed income portfolio can continue to invest in the duration and dynamic funds, along with tax free bonds. For investments with 3 to 5 year horizons investors can consider investing in a mix of short term and duration funds. Investor having an investment horizon of 1 to 3 years could invest into ultra-short term and short term funds to avoid volatility in interest rates.

Loans:

As there is SLR rate cut by 50bps banks will have more liquidity for lending and to pursue credit growth opportunities. The bank lending rate may go down due to excess liquidity in the banks and to increase consumption. People having loans can look for refinancing opportunities as rates could continue to remain low going forward.

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