Whose Money is It Anyway?

Winning in personal finance 1 2 3

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

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!

Your Retirement Other long-term goals Accident insurance Term Life insurance Emergency insurance 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 1Year 2Year 3Year 4Year 5 10%9%8%7%6% Year 1Year 2Year 3Year 4Year 5 10%

Year 1Year 2Year 3Year 4year 5CAGR 10% 10.00% Year 1Year 2Year 3Year 4year 5CAGR 25%7% 10.05% Year 1Year 2Year 3Year 4year 5CAGR -25%  21%  9.96% Year 1Year 2Year 3Year 4year 5CAGR -25%7% -0.34% Illustration: Volatile Compounding Year 1Year 2Year 3Year 4year 5CAGR 25%-25%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

Discrete Rolling Return Understand risks before investing

Continuous Rolling Return- 2Y 2048 Two year intervals bet April 3rd 2006 to Dec 4th 2014 April 3 rd 2006 to April 2 nd 2008 April 4 th 2006 to April 3 rd 2008 April 5 th 2006 to April 4 th 2008

Continuous Rolling Return- 2Y

Debt 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 FrameConservativeModerateRiskyMad-Max < 5 YearsFD/RD~ 10% Eq 30-40% Eq> 60% Eq 7 YearsFD/RD10-20% Eq40-50% Eq>60% Eq 10 yearsFD/RD40% Eq>60% Eq100% Eq Time FrameConservativeModerateRiskyMad-Max < 5 YearsFD/RD/Debt~ 10% Eq 30-40% Eq> 60% Eq 7 YearsFD/RD/Debt10-20% Eq40-50% Eq>60% Eq 10 yearsFD/RD/Debt30-40% Eq>60% Eq100% Eq

Understanding the nature of stock market returns

Sensex Total Returns Index: 1979 to 2013

5%

S&P 500 Total Returns Index: 1871 to 2013 Source: 12%

Sensex Total Returns Index: 1979 to 2013

Higher risk does not imply higher return! Return Risk Standard Deviation

Higher risk does not imply higher return! Return Risk Standard Deviation FD Debt mfEquity 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 or Banking 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 or Banking 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 or Short-term debt funds for less than 15Y goals or Banking debt mutual funds Short-term goals (0-5 years)

Return expectation Equity allocation  60% 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 goal Present cost Inflation Post-tax rate of return of portfolio8.8.00% Future Cost Amt invested so far Post-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

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:

Rolling returns analysis 3Y Fund (blue) Vs benchmark 5Y

Retirement Planning

Corpus ~ 300 times current annual expenses Corpus ~ 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 FrameConservativeModerateRiskyMad-Max < 5 YearsFD/RD~ 10% Eq 30-40% Eq> 60% Eq 7 YearsFD/RD10-20% Eq40-50% Eq>60% Eq 10 yearsFD/RD40% Eq>60% Eq100% Eq Years<40% Eq60% Eq80% Eq FD/RD 100% Eq >15 Years< 60% Eq60% Eq80% Eq FD/RD 100% Eq Time FrameConservativeModerateRiskyMad-Max < 5 YearsFD/RD/Debt~ 10% Eq 30-40% Eq> 60% Eq 7 YearsFD/RD/Debt10-20% Eq40-50% Eq>60% Eq 10 yearsFD/RD/Debt40% Eq>60% Eq100% Eq Years<40% Eq60% Eq80% Eq FD/RD 100% Eq >15 Years< 60% Eq60% Eq80% Eq FD/RD 100% 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 Credit risk Maturity period of bonds in portfolio

How to select a debt mutual fund?