Friday, December 30, 2011

4 Investment Tips Best Not Followed

As this year draws to a close, a lot of traders and brokers are saying that they are really glad that 2011 is finally over. The stock markets around the world have lost billions of dollars worth of wealth this year & the world is still looking at the Euro zone and the US nervously hoping that the debt crises in these mammoth economies would somehow miraculously pass. The emerging economies are also facing slowing growth, high inflation and rapid depreciation of their currencies. I am writing this article from the Kingdom of Saudi Arabia, which is enjoying a period of great prosperity and the largest budget surplus they ever had till date due to firm oil prices.

In the last 3 yrs several myths were debunked and the perils of the US credit expansion programme which started in the 70's was finally revealed early this year when there was a deadlock in the senate over increasing their credit limit. Through this article, I would like to list a few investment myths which Mark Mobius spoke about a decade ago. I find it makes even more sense in the present context.

Sunday, November 27, 2011

4 Things Not to Do in Bear Markets

"It is only when the tide goes out that you know who was swimming naked" - Warren Buffet

About a year back investors were euphoric when the Sensex hit 21,000 and when I look at the bloodbath the markets have witnessed in the last month, it's hard to believe that it is the very same market and the very same TV anchors & investors talking all about gloom and doom! In my article a few weeks ago, I had  taken the risk of making a forecast - that the markets would fall further (Click here to read the article). And I am glad that I am vindicated but what next? Will the markets fall further?

Sunday, November 13, 2011

Corporate Fixed Deposits: An Attractive Investment Option

The volatility in the Stock Markets have driven several people away from Equities into Fixed Deposits (Term Deposits). While Bank Fixed Deposits (Term Deposits) have been a favorite, Corporate Fixed Deposits are attracting more investors, who are attracted by the higher interest rates and wider options. Corporate Fixed Deposits  are exactly like fixed deposits offered by banks where you get a specified interest for a specified term. 

However, if you think Corporate Deposits are as your Bank Deposit, there is some bad news -

Saturday, November 12, 2011

Saving Schemes to Give Higher Returns Now

A few months back ,I had written an article on why investing in the Public Provident Fund (PPF) is lucrative (Click here to Read). In the article I had also brought about the differences in Employer's Provident Fund (which you may be enrolled in from your work place) and PPF. However yesterday the Government accepted the recommendations from an expert panel, headed by former RBI deputy governor Shyamala Gopinath, which would result in the following advantages for Investors.

Sunday, November 6, 2011

Should I invest in the Stock Market now?

"Mr. Market suffers from some rather incurable emotional problems; you see, he is very temperamental. When Mr. Market is overcome by boundless optimism or bottomless pessimism, he will quote you a price that seems to you a little short of silly. As an intelligent investor, you should not fall under Mr. Market's influence, but rather you should learn to take advantage of him." - Benjamin Graham

Stock Markets around the world kept plummeting the past few months, wiping away a large amount of investor wealth. However the month of October saw a smart recovery in the markets. During a time when an annual return of 10% is considered fantastic, the markets gained 10% just in the month of October! The rise in markets during October was largely due to perceptions that the Greek crisis would be contained, and perhaps even solved. As European politicians negotiated with one another, the stock markets continued to gain momentum.

However, there is a possibility that the deal reached the previous week will not be honored. There is also the possibility that the current government will not survive. The stock market expectation that this would be solved has clearly not materialized. So why are the markets not reflecting this? Is there something the stock markets know which others don't?

Tuesday, November 1, 2011

Tips to Reduce your Auto Insurance Premium (USA)

This article comes as a result of the readers of my blog in USA & focusses on some methods to reduce Car Insurance premiums. I have compiled most of these tips by looking at the data supplied by the American Institue for Chartered Property Underwriters.

Remove towing coverage: Towing — or “emergency roadside service”, as it’s sometimes called — is an easy cost to self-insure (paying for the cost yourself). (You likely pay $10 to $30 a year for towing insurance, and one tow costs about $100, which you can save quickly by not paying for towing insurance.) Sometimes your car will break down, but

Sunday, October 30, 2011

Top 10 Tax Saving Mutual Funds

This is a list of top 10 Tax Saving Equity Mutual Funds which you can invest in. This year hasn't been particularly good for the Equity Markets and hence you will find most Equity Mutual Funds gave a negative return if you look at their 12 month return. However if you consider a 3 year return (Tax saving funds have a 3 year lock in), the top 10 funds have given an Annual Compounded Return of over 30%.

Thursday, October 27, 2011

CTC! What happened to my Salary?

Scene: The day of placements at your b-school and there is palpable tension in the air and you finally hear the news – the XYZ Company has offered you a job and you have been offered an annual package of Rs 11,00,000 ! You blink for a moment and realize that you earn 1.1 million rupees annually! Not bad considering the situation the economy is in! And you slowly start putting on the airs of a new Rupee Millionaire till you receive your first pay check in hand. You see that you have got only Rs 60,000. Doesn’t that mean you are just receiving 7.2 Lakhs? Or considering Tax deductions, where did my 2.8 - 3 lakhs go? You start cursing the HR and the inefficient payroll department of your company and decide to give a earful to your payroll department, when they explain the situation in one word – ‘CTC’! CTC? It is not even a proper word, it’s an abbreviation! And yet it is supposed to explain where fantastic sums of money from your salary have disappeared!

Wednesday, October 26, 2011

Pre-pay my Housing & Education Loan?

My friend Sandeep and I were having lunch today when the news flashed across the screen – ‘RBI has hiked interest rates again by 25bps’. With the central bank hiking the interest rates every few months, loans were getting costlier and our salaries were not increasing at that rate! After seeing this news we got into a discussion as to whether it made sense to pre-close the education loan that he had or should he not pre-close it since he was receiving tax benefits. This is a question a lot of people ask, especially among those who have a housing loan since housing loans give higher tax breaks. This article seeks to demystify this confusion among several people as to whether it makes sense to pre-close a loan if they come into some additional money.

Sunday, October 23, 2011

No more Penalty for Home Loan Pre-Payment in India

The Reserve Bank of India (RBI) is in the process of directing banks to stop charging penalties for repayment of home loans ahead of schedule to ensure a level-playing field between banks and housing finance companies (HFCs). RBI’s move follows a similar directive to Housing Finance Companies (HFCs) by their regulator, the National Housing Bank (NHB), earlier this week. The NHB notification asked HFCs not to charge pre- payment levy or penalty for pre-closure of housing loans under two situations — pre-closed through any source, where the housing loan is on floating interest rate basis; and loans pre-closed by the borrowers out of their own sources of funds, where the housing loan is on fixed interest rate basis.

Friday, October 21, 2011

Life Insurance and why You should buy one

Several investors especially those who are young, do not see the need to purchase life insurance. They consider it a waste of money since they do not get any ‘returns’ from the money they spend in buying insurance. Before a person starts investing any money, he/she should first look at protecting their current assets. Insurance is an instrument which saves you & your family from a catastrophic financial loss. Unless you consider yourself immortal and are sure that no accident or fatality would occur to you, you should consider buying insurance. On the other hand if your family is dependent on your income or if you have any debts/loans that you need to pay off, Life Insurance is no longer an option but becomes mandatory.

Monday, October 17, 2011

Joke:How the Stock Markets work

A really funny illustration that I saw on Facebook but market sentiments function something like this!

Saturday, October 15, 2011

Should I buy Gold at these high prices?

“After almost a dream run of gold prices, does it make sense to invest in Gold now? Will the prices of gold rise even higher or is this a bubble just waiting to explode?” – this is a small snippet from a conversation I had with a friend who recently came into some money and was looking at parking it somewhere. He was scared of equities and most of his money was in Fixed Deposits. Investing in gold was something which had caught his fancy but he was unsure, especially after gold corrected about 18% from the highs it set.

Friday, October 7, 2011

How to time the markets right?

This article, contrary to its title will NOT teach you to time the market. And why is that? Simply because, you cannot learn to time the markets perfectly! Warren Buffet the world’s most successful investor famously said – “I know what events will unfold in the markets but I do not know when those events will unfold”. Switch on your television and check to see what each expert thinks the Stock Market would close at. Each self-proclaimed expert has a different view and when you have a 100 views, one of them is bound to be correct!

“Sir, this is a good time to enter the market. The market has almost bottomed out!” - Sound familiar?

Friday, September 30, 2011

The Magic Word to Riches!

Now what would you give to know this one word that could radically transform your fortunes and could make you rich! And just saying this word could take you a really long way in achieving your financial goals! It isn't a magical word but nevertheless a word which we do not use sufficiently enough when it comes to investing. The word is – ‘NO’. I saw an article on Newsweek and Yahoo finance which spoke about the power of the word NO but in a different context, however it makes a lot of sense in the context of financial planning also!

In India, with so many financial planners, quasi financial planners, quacks, banks, life and general insurance companies, mutual funds, portfolio advisors, portfolio managers, Relationship managers, wealth advisers etc. obviously somebody would have got you! It is also so difficult NOT TO SEE THE ADVANTAGES when confronted by a good salesman who probably is dressed better than you and is showing you a laptop with an excel sheet with fancy graphs, charts and ‘potential return’ tables! They talk about the need for focus, asset allocation, pension plan, child plan, neighbour's wife plan, aunty in hospital plan, funeral plan, broken dentures plan, cancer plan, kidney failure plan, tiger eating you on the highway plan, - given the right name, selling it to the retail 'prospect' seems like selling toothpaste.

Friday, September 16, 2011

IRDA plans to scrap Highest Guarantee Plans

In order to keep the equity markets away from any systemic risks, the Insurance Regulatory and Development Authority (IRDA) is planning to scrap the highest Net Asset Value (NAV) guarantee products. This could further dent the sales of the Unit Linked Insurance Plans (ULIPs) as the highest NAV guarantee products account for 20% of ULIP sales.

Under the highest NAV guarantee products, customers are guaranteed returns based on the highest NAV a policy has achieved during the entire term of the insurance plan. However, IRDA is weary of the fact the insurers protect the guarantee by appropriately apportioning money in debt instruments. When the market falls the exposure in debt instruments increases and insurers try to sell equities at marginal profits. If there is too much concentration of such products in the market, a large number of insurers might sell equities at the same time to protect the guarantee, leading to a further market fall which leads to systemic risks.

In my opinion the IRDA has done the right thing by putting a stop gap on the so-called 'highest NAV guarantee plans'. Many investors have been lured to buy such ULIP plans by their agents / distributors / relationship managers in the name of providing huge returns based on the highest NAV achieved by the plan in its tenure.

Policyholders should keep in mind that insurance is for indemnifying your risk, and thus insurance and investment needs should be dealt separately. For insuring yourself only pure term insurance plans are appropriate, and while investing you should give due attention to your investment objectives, goals, age, income, no. of dependents amongst others; which is a holistic investment planning process rather than an ad-hoc activity.

Also read the article posted previously on Highest NAV Guarantee Plans -

Sunday, September 11, 2011

What does rising Gold prices mean?

Gold has been one of the best performing assets over the last year, as prices have skyrocketed to record levels. It seems as though a new record in prices is set nearly every week, and the trend appears set to continue going forward.

So how can we interpret the rise in gold prices? There are two issues to discuss here. The first is, why is it that investors want to buy gold, and the second is, what is the impact of rising gold prices on the rest of the economy.

Saturday, September 10, 2011

Deciding between Fixed Deposits and Fixed Maturity Plans

There is a lot of news, information and advertisements about Fixed Maturity Plans offered by Mutual Fund companies. As an investor you must have come across this dilemma as to what to choose from – a Fixed Maturity Plan (FMP) offered by a mutual fund house, or a Fixed Deposit (FD). Well it’s confusing for an investor because both of them start with the word ‘Fixed’. So, now let us understand what exactly a FMP is and how it is different from a FD.

Sunday, August 14, 2011

Investing in Equity in these times

" Be fearful when others are greedy and be greedy when others are fearful" - Warren Buffet

There is actually just one simple rule to investing in equities ‘Buy low and sell high!’. However for the majority of the investors in the stock market, it is this same rule which is the most difficult to follow. When the going is good everyone wants to seem to want a slice of the cake and when the flow of news starts becoming negative, investors flee the markets in droves.

To be successful in investing one should focus more on the underlying value of the sticks and less on news plan. Do not get me wrong, I am not asking you to totally disregard the news on the world economy. If you look at an investor in India, the moment he/she switches on the news channel – he only gets to hear negative news – US downgrade, slow growth in the west despite low interest rates, countries on the verge of default, rising interest rates in India with persistent inflation and all those massive corruption scandals. And all these news items are truly causes for concern. However in the midst of all these negativity we tend to overlook the positive impact of falling crude prices which could actually negate a lot of the above negative factors. And how is that? Here is how:

India is a developing country which is a net importer of crude oil and commodities. What a lot of people tend to overlook is the fact that every $20 drop in the price of crude, the country saves $18 billion per annum viz. equivalent to 1.1 percent of GDP. Lower oil prices means lower fiscal deficit, lower inflation and lower interest rates over time.

Indian exports to the US and Europe are only 6 percent of the GDP. And if you carefully look at the kind of exports we have, it is not materially linked to rate of growth of the western economies. Indian exports have captured market share from the existing players in those markets since they were cheaper (the IT industry and generic drugs industry are prime examples). However about 25% of the growth in exports are linked to the growth in the western economies. I would like to quote Mr. Prakash Jain in his article in Business Line – “Exports were materially impacted in 2009 after the Lehman bankruptcy as the crisis was unanticipated, due to a paralysis in bank lending and a consequent sharp inventory destocking.” This is clearly not the case today.

Scandals were already there, that was the bad news. The good news is that they have now come out to the open. In India major change has always taken place in a crisis. Right from the opening up of the economy in 1992 driven by a balance of payment crisis to increasing diesel prices when the subsidy burden was unbearable!

I would like to conclude this article with this chart which shows major debacles/crisis and the kind of returns investors got when they invested in equities during the time others were fleeing the markets.

There are several reasons to be optimistic about the growth prospects and about improvement in governance and infrastructure in India. If growth persists and if PEs (denoting valuations) are low, then equity returns can’t be too far away!

Friday, August 5, 2011

Public Provident Fund: A Tax Effective and Safe Investment

PPF or Public Provident Fund is one of the most popular fixed income schemes in India and a scheme which investors who are risk averse and who have a high risk appetite – equally make full use of. In spite of being a very popular scheme and information being available on the PPF website, young investors are not fully aware of this investment option since there is very little advertisement and almost no ‘selling’ of this scheme by wealth advisors and retail banks (simply because they have no incentive to do so). This article seeks to comprehensively cover the salient features of a PPF scheme.

Where can you open a Public Provident Fund - PPF account?

Make a trip to your local post office. You can open it at any head post office or selection grade sub post offices. Visit the nationalized bank in your neighborhood. Selected branches of nationalized banks can also open accounts. Drop by a State Bank of India branch. SBI and its subsidiary banks also open accounts. I have heard that banks are sometimes reluctant to open PPF accounts because they get no additional money to handle these accounts and the money is credited to the RBI the same day. However I have not faced this problem.

Who can open a Public Provident Fund PPF account?

Anyone can open a PPF account, either on his/her own behalf or on behalf of a minor. Being part of a General Provident Fund or Employees’ Provident Fund scheme does not disqualify you from subscribing to the PPF, but at no point are you allowed to have two PPF accounts in your own name at the same time. Doing so will invite a penalty: if the issuing authority (bank or post office) detects two accounts during the tenure of the scheme, you will get only your principal back. Also, two adults cannot open a joint PPF account -- an account has to be opened singly, but can have one or more nominations.It's a good practice to open a separate account in the name of your spouse (or your minor children) and keep contributing to it -- you can even claim the tax benefit from the contribution made to accounts in your spouse's or minor children's names. In this way you could save tax-free funds even for your children and spouse. Consider opening a PPF account even if you are not a taxpayer, and keep it active. When you do become a taxpayer, you will have an account that will mature early. Remember, however, that any change in the interest rate will apply to you too, even if you've been maintaining an old account.

NRIs who wish to avail of rebate on their income in India are also eligible to open a PPF account. Subscriptions, however, will have to made from their NRO account on a non-repatriable basis.
When you open an account, you will be given a passbook in which all subscriptions, interest accrued, withdrawals and loans are recorded.

Term, Minimum Amount and Frequency of Installments to a PPF Account:

The term of a PPF account is 15 years. Even so, the effective period works out to 16 years because you are allowed to make your last contribution in the 16th financial year. Why should this interest you? - Because even if you make a contribution on the last day, you still get the tax rebate, although you won’t earn any interest on the amount.
During a financial year, you can contribute a minimum of Rs 500 and a maximum of Rs 70,000. If you are putting in money in installments, remember that you can't make more than 12 installments a year. There's more flexibility in the scheme: unlike a bank recurring deposit, you don't have to deposit the same amount every month.
Yes. Your account will become defunct if you don't deposit the required minimum of Rs 500 a year. The amounts already deposited will continue to earn interest, which will be paid to you at the end of the term (15 years), but you can't take loans or make withdrawals. You can revive your account by paying a fee of Rs 50 for each year that you default, along with subscription arrears of Rs 500 for each such year. And don't worry if your account is discontinued -- you will not be debarred from opening a new one.

Withdrawals and Loans from your Public Provident Fund - PPF account:

The entire credit balance in your PPF account is yours to withdraw when it matures -- at the end of 15 years. Meanwhile, you can make withdrawals within specified limits. The first withdrawal can be made from the seventh year. Subsequently, you can make one withdrawal every year. You can withdraw up to 50 per cent of the balance at the end of the fourth year or the year immediately preceding the withdrawal, whichever is lower.
You don't have to wait to withdraw from your PPF account to get some money from it -- you can get a loan on your PPF from the third year. You can get a loan equal to not more than 25 per cent of the balance in your PPF account. You can repay the loan in a maximum of 36 installments.
The interest on the loan amount is 1 per cent a year, but will be hiked to 6 per cent a year if the loan, or a part of it, remains unpaid even after 36 months. New loans are disbursed only after you pay up earlier loans. If you do decide to withdraw money -- after the seventh year, of course -- remember that you cannot take a loan in addition.

TAX Benefit s and other details:

The interest credited to your account, as well as withdrawals from it, are exempt from income tax. The balance held is fully exempt from wealth tax, without any limit. The balance in a PPF account cannot be attached under an order or decree of a court. What that means: if you're involved in a legal dispute, a court cannot attach or question the money in your PPF account -- as it can with your other personal property.

The money that you deposit in the Fund earns interest at a rate that the government fixes periodically. The interest rate is 8 per cent (currently), compounded annually. Interest is calculated for a calendar month on the lowest balance in your account between the close of the fifth day and the end of the month, and is credited to your account at the end of each year. So, to derive the maximum from your investment, put in your deposit in the first few days of a month. The monthly contributions will earn simple interest till the end of the financial year.

As a PPF account holder, you can nominate one or more persons. In the event of your death, the amount in your account will be paid to your nominee or legal heir even before the end of 15 years. However, if the balance is not withdrawn, it will continue to earn tax-free returns. It is advisable to open a savings account of the nominee or nominees in the same bank and mention this number in the PPF account opening form. Also, since a single cheque is issued in favor of all the nominees, it would be prudent for the nominees (in case of more than 1 nominee) to open a joint bank account. The account can be transferred to any scheduled bank or post office in India.

Monday, July 25, 2011

Gold ETFs or Physical Gold or Gold Funds?: The Gold Investor's Quandary

In my last article, I made a case for investment in Gold. The thing about gold is that there is no true way to determine its exact value. You can determine the value of bonds by their coupon rate & nature of the issuer and also stocks by looking at the underlying company and its earnings & management. Gold on the other hand responds to investor sentiment and demand. As mentioned in my last article, the huge deficits in Japan, USA and some Euro-zone countries have created an environment, where gold seems to be the safe haven investors seek in these turbbulent times. This article seeks to address the quandary investors face in relation to how to invest in Gold and of the different instruments available in the market, which one would be the best.

There are three common methods for Gold investment –

1. Buy Gold ETFs (Exchange Traded Funds)
2. Buy Physical Gold in terms of gold bars and coins
3. Invest in Gold funds

Gold ETFs:

Gold ETFs (Exchange Traded Funds) are open-ended funds which track prices of gold. They are listed and traded on a stock exchange; hence, they can be bought and sold like stocks on a real-time basis. These funds are passively managed and they mirror domestic gold prices. By enabling investors to invest in gold without holding it in physical form, Gold ETFs offer a rather unique investment opportunity to investors. You need to have a demat account if you want to buy a Gold ETF.


Gold ETFs are convenient since there is no physical delivery of gold involved. Since the SEBI mandates that the purity of underlying gold be 99.5% and above, the investors do not have to worry about the quality of the gold. Gold ETFs offer convenience in terms of transparent pricing and selling of the ETF units. And most importantly you do not have the hassle of storing physical gold (no locker charges or mental tension if stored at home). ETFs are tax efficient - ETFs sold after a year of purchase are not taxable.


ETFs need to remain liquid and so they cannot invest everything into gold and so you are actually not investing in 100% gold. ETFs maintain certain amount of cash as part of their assets along with physical gold. Gold ETFs may have an annual expense of 1% charges depending on the fund house which issued the ETF.

Physical Gold:

Physical Gold can be purchased from a bank or a trusted jeweler in the form of gold bars or coins.


In September 2008, shareholders in ETF securities were left high and dry - unable to trade popular commodity securities, due to concerns over the future of their backer, insurance giant AIG. Overnight, banks and brokerages stopped making markets in the Exchange Traded Commodities (ETCs) backed by the troubled insurer. In the event of your ETF fund house going bust, you would be left holding illiquid units whilst its value keeps falling.
Physical gold can be converted into cash by taking it to any jeweler. Banks however will not buy the gold bars they sold to you. Physical gold is the safest form of investing in gold.


Banks and jewelers charge a premium when they sell you gold (premium could be anywhere between 2-10%). And if you sell your gold in less than 3 years, you would be taxed. Again, your local goldsmith may not give you the correct value or the spot price of gold.

Gold Funds:

A gold fund comes in two variants – they either invest in gold or they are a fund of funds wherein they buy various ETFs.


By investing a fixed sum of money every month, you get the benefit of rupee cost averaging. Gold funds provide you this benefit, where you can invest a fixed sum of money in units of gold fund sailing through the highs and lows of gold. Currently, there are around a dozen gold ETFs listed on the stock exchanges. But barring the gold ETF of Benchmark Fund, known as Gold BeES, and the gold ETF of Reliance, their traded volumes on the stock exchanges are not significant. This raises an issue of liquidity of the investment. In case you invest in gold through gold funds, you can surrender the units to the mutual fund at any time and based on the payment cycle, you will get your money. This ensures that you are able to get your money back whenever you want.


Gold funds charge you a 1.5% annual fee which is higher than the amount charged by ETFs.


Gold funds are typically attractive for those who want to take the benefit of rupee cost averaging principle through a systematic investment plan. However, if you are looking to opt for short term trade based on Gold pricing you should opt for ETFS. Gold ETFs provide an opportunity to benefit from sudden price movements of gold as the prices of gold ETF reflect the value of the underlying gold on a real time basis. If you are a long term investor and would hold your investment for more than 3 years, go with physical gold. As the saying goes, one size cannot fit all. You have to decide what fits you and what your needs are.

Friday, July 22, 2011

Investing in Gold: The glitter of the yellow metal

I have received a few emails from the readers of my blog asking me questions with regards to investment in Gold. I shall henceforth write a series of articles on investment in Gold and why does gold investment make sense in these times.

Yesterday during a discussion, my friend told me that Gold has run up to a very high level and people who invest now are never going to make any reasonable profit. It is true that Gold has rallied significantly from the levels it was at since 2000. However, in spite of its spectacular rally, I do not think that the rally of Gold is over or that an investor would face crippling losses if they buy gold at these levels. And it is simply because the reasons that caused gold to rally are still there. Those reasons are:

1. There's no magic to money. It works as a medium of exchange and a store of value when and only when its quantity is strictly controlled. With the burgeoning budget deficits in countries around the world and most notably with USA’s 12 trillion dollar deficit, the Federal Reserve will have to end up printing more money (if the government has to honor its commitments to pay interest on the treasury bonds). Reckless printing of money would destroy its value and you would see a much devalued currency. That's what's nice about gold. Its quantity is controlled by nature herself. People have been trying to get around it for centuries. Alchemists labored long and hard to turn base metal into gold. None succeeded. The only way you can increase the supply of gold is by mining it - which is expensive and time consuming.

In the 19th century, paper money was backed by gold. People had learned their lessons in the panics and bubbles of the 18th century. They didn't trust pure paper currencies. Lincoln fiddled the dollar during the War Between the States - inflating the currency to pay for the wars, but it was put right soon after. Apart from that, for the whole period - from the beginning of the 19th century to the creation of the Federal Reserve in 1913, the dollar was stable and reliable; people trusted it because there was real money - gold - standing behind it.

But now, the chief of America's central bank (Ben Bernanke) says that gold is not the best form of money; the dollar is supposed to be money now! His desperation is obvious considering the situation USA is going through now. If dollar loses its status as the preffered currency - its going to be all gloom & doom for USA. And now, the feds don't worry too much about how many dollars they issue. Their primary goal is no longer preserving the purchasing power of the dollar - it's lost 95% of its value since the Fed was set up. Now, they're more concerned with the stock market, with the housing market, with consumer spending, and with the next election!

2. The second reason as to why I feel Gold would continue to rise is due to factors local to the world’s largest importer and domestic consumer of Gold – INDIA. Gold – since time immemorial has been hoarded by Indians. During marriages, the bride is adorned in gold and gold is gifted to the new couple. Gold consumption in India goes up significantly during the marriage season. With more than 50% of Indians below the age of 25, the next decade would be a real boom period for wedding planners & of course gold merchants in India.

3. Chinese citizens had been forbidden from hoarding or saving in gold beyond a certain limit till a few years back. With these restrictions lifted, the world’s most populous country is also going on a gold buying spree.

In spite of these factors in favor of gold, like any other commodity, gold prices could dip and rise because prices depend largely on consumer sentiment. However the long term prospects of gold seem bright and the glitter of the yellow metal would continue to attract investors looking for a safe haven for investment for a long time to come.

Thursday, June 30, 2011

Education Loan Interest Waiver

With the cost of education rising every year, students are increasingly looking towards financial institutions for education loans to support their higher education studies. And once a candidate has availed of an education loan, the banker would have told him/her that they would have to either pay the interest during the moratorium period or that the interest would accumulate leading to a higher principal amount when they start paying the EMIs.

What a lot of people still are not aware of, is that the government of India has brought out a scheme where there will be full interest subsidy on educational loans to certain eligible applicants during the moratorium period, which usually extends throughout the course of study and a short grace period allowing the student to get gainful employment. The scheme is effective from the year 2009-10. So if you have paid the interest on the period, it will be returned to your bank account.

The eligibility to avail of this subsidy is that the family income of the candidate should be below 4.5 lakhs/annum. The interest subsidy is only for a loan amount of a maximum of Rs 10 lakhs.

There will be a full interest subsidy provided during the period of moratorium on loans for students. Here the moratorium means the time till the students completing the course and 6 months after completing the course. The proof of income is to be certified by authorities to be designated by the State governments.

Eligible students can approach the respective bank branch from where they have availed the loan and complete the formalities so that the individual accounts could be credited with the interest due on the loan from the academic year 2009-10 onwards.

The interest subsidy under the Scheme shall be available to the eligible students only once, either for the first undergraduate degree course or the post graduate degrees/diplomas. Interest subsidy shall, however, be admissible for combined undergraduate and post graduate courses.
Interest subsidy under this scheme shall not be available for those students who either discontinue the course midstream, due to any reason except on medical grounds, or for those who are expelled from the Institutions.

Sunday, June 26, 2011

Financial Planning 101 - 6 simple steps

"Would you tell me which way I ought to go from here?" asked Alice.

"That depends a good deal on where you want to get," said the Cat.

"I really don't care where I get" replied Alice.

"Then it doesn't much matter which way you go," said the Cat.

-Lewis Carroll, Alice's Adventures in Wonderland

Financial Planning doesn't require a jargon spewing financial adviser but is essentially a simple 6 step process.

1. Identify and list down your future needs/ objectives

The very first step as you begin to plan on how to save/invest your surplus money is to - take a sheet of paper and write down your future and immediate plans/goals. Different people have different goals in life, some may want to buy a house, a car, save for children’s education and marriage, retire early to pursue a hobby or to do social service and many other long term and short term goals. Once you have listed your goals you should assign them a certain priority depending on how fast you want to achieve these goals and how crucial these goals are for you. Clarity in this respect would be the starting point to help an individual work out the journey on the financial road which needs to be followed.

You have to physically list down your goals and not just run them through your head. Seeing it in physical form on paper or on your computer screen actually helps you think clearer about your goals.

2. Convert your personal goals into financial goals

It is very important to convert each of your personal goals to financial goals. Two components go into converting the needs into financial goals. First is to evaluate and find out when you need to make withdrawals from your investments for each of your objectives. Then you should estimate the amount of money (how much) needed in current value to meet the objective today. Once you have estimated the amount needed today, then you should apply an inflation factor to project how much would you need in the future.

For eg. If you want to purchase a house 5-6 years from now and if an apartment costs Rs. 30 lakhs in the locality you are looking at and if the cost of housing is rising at about 10% annually, the total amount required at the end of 6 years would be Rs 48.32 lakhs.

3. Get clarity on your current financial stage

The next step to financial planning is to list down your income and monthly expenditures. This enables you to get an idea of the pattern of cash outflows (expenses) during the year. Accordingly you can plan to keep adequate money liquid for the necessary expenses during the course of the year. All Loan EMIs (equated monthly installments) paid should be kept separate under the monthly expenses head, as after a finite number of years they will no longer be part of your regular living expenses.

The most important information that you get from the above study is your current annual cost of living (that part of expenses which supports your current lifestyle). An analysis of the above figures would enable you to understand the amount of savings (income less expenses) that you are left with on an average. This in turn will give you an idea of surplus regular money available for investment. This is the savings that will take care of you and your family when income from your work stops.

4. Risk Planning:

Before you start thinking of various instruments where you could invest your money to achieve your financial goals, you need to focus on the oft neglected area of risk planning. India is a severely under-insured country. Most people have not fully grasped the full impact of improper risk planning and the most people consider insurance as a ‘waste of money’. An insurance product aims at financial protection from risk of death or illness (the two major risks). A suitable health insurance cover is worked out after taking into account the situation of the family and information about the availability of any cover from the employer. The next step is to estimate the amount of life insurance cover required. Loss of income in case of death of an earning member may put the rest of the family into financial discomfort (especially where he/ she may be the primary bread winner). The role of insurance is to take care of this financial discomfort. The most suitable life Insurance cover for this is a term cover. To read more about insurance, please visit the Insurance section on this blog.

5. Determining allocation of your surplus among different assets for investment

Different assets classes like debt, equity, real estate, etc. grow at certain natural growth rates over the long term. You have to work out an investment strategy to invest the saving across various asset classes in a suitable ratio so that you meet the targeted return as per the financial plan. If a higher return is needed then accordingly a higher exposure to higher growth assets like equities is needed. Discipline in maintaining the asset allocation is the key to achieving success in the long term.

A lot of individuals invest into an investment option without understanding its overall long term impact on their lives. Due to this reason they may find out that they are left with inadequate financial resources during their later years.

To read about the popular common investment options, please visit the different sections in this blog.

6. Monitoring and evaluating your investments and your financial plan

Financial planning does not end as soon as investments are made. It is a continuous process where regular monitoring and periodic evaluation is necessary to ensure that things are happening as per the plan. It is essential to ensure that planned contributions from your savings are happening towards your investments. In addition to this the returns being generated, the investments should be monitored and rebalancing of investments should be made as per the asset allocation strategy. Based on the above evaluation the financial plan should be fine tuned if necessary.

Wednesday, June 22, 2011

Highest NAV Guarantee Plans - The complete story

I was introduced to an interesting product by my friend the last day – the ‘Highest NAV Guarantee’ Plan. These funds are currently pretty popular and most major ULIP providers have a product which offers the ‘Highest NAV Guarantee’. The name sounded so appealing and the fact that the fund house will guarantee me the highest NAV seemed too good to be true. But the real crux of the plan lay in the fine print. And going through the details of the plan, I must say that the Highest NAV Plan is just another marketing gimmick of selling a mediocre product to gullible customers.

To start with, it is a known fact that stock markets and ‘guaranteed returns’ do not go hand in hand, yet the fund managers of such plans claim to have found some magical formula through which they could perform this impossible task. However Highest NAV guarantee plan is based on the constant proportion portfolio insurance (CPPI) model. Though it is a fancy name, according to this model, the fund would invest in fixed-income type of securities in order to maintain a certain minimum unit value. When the fund value exceeds this floor value, the surplus is placed into stocks. With constant rebalancing of the portfolio, the aim of the fund manager is to not let the unit value fall below a certain base value.

Similarly, the proceeds in highest NAV guarantee plans would be invested in equity, fixed income and money markets instruments. However, in such plans, there is no specific asset allocation that the fund manager has to adhere to, unlike a mutual fund or ULIP. Since such plans are a new product, there is no historical data to evaluate the performance of the said funds.
As the policy guarantees you the highest NAV, a fund manager may follow a conservative approach and allocate the money into money market and fixed income instruments and ensure that you get the highest NAV without much trouble. Also you don’t get the highest returns from the stock markets but rather the highest NAV reached by the fund. Besides the returns from these funds lie between 9-10%, viz. slightly higher than the 100% debt funds. Again, if you decide to surrender the policy after 3 years or you die within a couple of years of starting the policy, you don’t get the highest NAV but the current value of your investment.

The insurance component in highest NAV guarantee works merely as a supplementary portion to the entire plan as these plans provide limited cover (normally 10 times the annual premium viz. pretty low compared to a term plan). Secondly, the highest NAV guarantee terminates past the grace period when you stop paying your premiums (got this info from the net). The exit from the plan or partial withdrawals is possible only after 3-5 years. Also, there are no options for partial withdrawals or surrenders (which attract a high exit charge).

As with any other ULIP, highest NAV guarantee funds have the following charges:
1. Premium allocation charge
2. Mortality charges
3. Policy administration charges
4. Fund management charges

Having said all this, my advice to an investor is to avoid these funds. Paying high charges for modest returns doesn’t make any sound investment sense to me! And remember that guarantees and stock markets do not work together. So view any plan which promises you guaranteed returns from stocks with scepticism.

Tuesday, June 14, 2011

Easy steps to selecting a mutual fund

For a new investor, the selection of a mutual fund could seem particularly daunting. However behind all the jargon and complexity, lies a series of simple steps, which if followed with some common sense and research could lead to long term wealth creation.

1. Identify funds whose investment objectives match your asset allocation needs:

Just as you would buy a car or a laptop that fits your needs and budget, you should choose a mutual fund that meets your risk tolerance (need) and your risk capacity (budget) levels (i.e. has similar investment objectives as your own). Typical investment objectives of mutual funds include fixed income or equity, general equity or sector-focused, high risk or low risk, blue-chips or turnarounds, long-term or short-term liquidity focus. (Check the mutual funds tab for a quick overview on these different types)

2. Evaluate past performance, look for consistency:

Although, past performance is no guarantee for the future, it is a useful way of assessing how well or badly a fund has performed in comparison to its stated objectives and peer group. A good way to do this would be to identify the five best performing funds (within your selected investment objectives) over various long term periods, say 1 year, 3 years and 5 years. Shortlist funds that appear in the top 5 in each of these time horizons as they have thus demonstrated their ability to be not only good but also, consistent performers.

3. Diversify but don’t Over-diversify:

Don't just zero in on one mutual fund especially if it is a thematic fund (to avoid the risk of being overly dependent on any one fund). Pick two ideally and pick two diversified funds. Picking two diversified funds from two different fund houses would give you all the diversification that you need. But remember that if you start thinking that you need to diversify further and start shopping for more funds, you would end up diminishing your returns. Check out the article – ‘The Problem with (too much) Diversification’ to know about the problems with too much diversification.

4. Consider Fund Costs:

The cost of investing through a mutual fund is not insignificant and is important especially when it comes to fixed income funds. Management fees, annual expenses of the fund and sales loads can take away a significant portion of your returns. As a general rule, 1% towards management fees and 0.6% towards other annual expenses should be acceptable. Carefully examine load the fee a fund charges for getting in and out of the fund.

5. Invest, monitor and review:

Having made an investment in a mutual fund, you should monitor it to see whether its management and performance is in line with stated objectives and also whether its performance exceeds or lags your expectations. Unlike individual stocks and bonds, mutual fund reviews are required less frequently, once in a quarter should be sufficient. A review of the fund’s performance should be carried out with the objective of holding or selling your investment in the mutual fund. The article on the blog on ‘When should you redeem your Fund’ discusses this in more detail.
Investing in mutual funds is not just a decision but is more a process. It requires more of discipline in adhering to the process and a certain amount of simple research.

Thursday, June 9, 2011

Housing Loan: Important steps to keep in mind to ensure you get the best deal

There is a lot of news about the state of several real estate companies in India. Some are embroiled in telecom scams whilst some have huge debts on their books & projects which have not kept their schedules. All these notwithstanding there is no doubt that at the time of writing this blog, there was definitely a lot of construction going on in India and in spite of rising interest rates, residential demand was still strong. This article is the first of a series on Home Loans and on investing in ‘homes’. This article specifically tries to highlight the key steps a potential home loan candidate should keep in mind while taking a home loan.

There are various lenders for housing loans and to get the best deal and to have a smooth process, one should spend time and put effort into researching to arrive at the right lender. To have a hassle free housing loan process, look into the following details:

1. Check the Lenders Reputation:

Housing loans are a long process and finding the right lender could make the process easier. Loan seekers should check for the reputation of the lenders in order to finalise on the source for borrowing. A lender with a good reputation is sure to make the loan process a pleasant one.

2. The Experience of the Lender:

Following the construction boom in India, several lenders have sprung up all over the country. Numerous NBFCs (Non banking Financial Companies) have started offering housing loan products. It would be prudent to go with a lender who has been operating the housing loan markets for at least 5 years. A lender with more experience could also help in solving problems that arise easily.

3. Features of a Loan:

The features of a loan are an important factor in choosing a lender. There are numerous lenders offering various features on a loan. An individual needs to figure out his/ her wants from a loan in order choose the right kind of loan. The features of a loan that are to sought for are the structure of the loan, interest calculation, provision for pre-closure and other benefits that arise from a loan.

4. Rate of Interest:

Different financial institutions provide different rates of interest. People always go in for lower rate of interest that is beneficial. But a proper analysis needs to be made while distinguishing the rates of interest offered by the various lenders. Some financial companies which may offer an initial lower rate may have several clauses in the fine print which may finally make the loan pretty expensive.

5. Rests in the Rate of Interest:

The rate of interest is the factor that determines the cost of a loan. There are annual rests and monthly rests in the calculation of interest. The annual rest brings about a change in the interest rate on an annual basis. With the payment for the loan being made on a monthly basis, it will be beneficial for the borrower if the rests are calculated on a monthly basis as it will bring down the interest on a reducing capital and one can enjoy the immediate benefits.

6. Options in Repayment:

The repayment option provided by the lender is a crucial factor in clearing off the loan. If there is an option for pre-closure or premature clearance of the loan, it will benefit the borrower in terms of paying at his or her convenience. In most cases there is a penalty in the form of pre-closure charges to be paid mostly in the case of fixed rate loans because of the mismatch of asset liability for the lender.

Sunday, May 29, 2011

When should I redeem my mutual fund?

For most people the decision of the redemption of a mutual fund is as daunting as that of picking the right mutual fund. Again if you try to run a google search on ‘when to redeem your mutual fund’ it returns a lot less relevant results than when you search for ‘how to select a mutual fund’! And I have heard an investment manager once remark on TV that it takes a certain degree of expertise and proficiency to redeem your mutual fund investment at the right time. However, it is not all rocket science and all it takes is just basic common sense decisions. This article is not on learning how to ‘time’ the market and redeem your mutual fund but on when to redeem it since it is no longer prudent to hold your mutual fund. There are several reasons as to why you should redeem your mutual fund but the most common and top reasons for the same are as follows:

1. You have achieved your investment objective: Every investment is made with some specific objective like paying for your child’s education, marriage, purchasing a house or any other objective. If your fund is performing more or less on expected lines and you haven’t met your investment objective then it makes no sense to redeem your fund. However if you have achieved your investment objective or are close to achieving your investment objective, then you should slowly start redeeming your fund, so that you are completely liquid in cash by the time you would need to pay for your goal (like purchasing a house).

2. The Star Mutual Fund Manager has quit: The performance of your mutual fund is inextricably tied to the capability and investment acumen of the fund manager. A lot of investors check the track record of the mutual fund manager and not just the performance of the fund which is indeed a wise decision. However, in the mutual fund industry, you would see a lot of churn amongst fund managers and trying to follow a star fund manager may result in you having to switch among fund managers quite a bit. Unless you are sure that the fund manager can give really significant results with respect to others, it makes sense to invest in process-driven fund house since this is a more reliable way of investing.

3. Your mutual fund is not performing: I have heard several people complaining about the performance of their mutual fund. However most people tend to look at the performance of their fund in the short term. Evaluating a mutual fund in the short term would give you an erroneous view of the performance depending on the state of the markets. To correctly understand the performance of a mutual fund, you should consider its performance over a period of at least 3 -5 years. However, even after all this you are convinced that your mutual fund’s performance is below par, then it’s best you redeem it.

4. You have invested in a thematic fund: In one of my earlier articles, I had mentioned the dangers of investing in a thematic fund. The problem of investing in thematic or sectoral funds is that if the whole sector is hit by some macro economical or regulatory factors, your mutual fund performance would dip significantly. You should not invest in a thematic fund unless you have sufficient knowledge about the particular sector and you have good reasons to believe that the particular sector is poised for considerable growth. Most investors do not have the necessary skills and resources to track the underlying sector/theme. They only got invested in them either because everyone they knew was investing in them or their agent made a compelling marketing pitch for the fund. Either ways they are invested in the fund and want to know when they can redeem. If you are one of them, then the right time to redeem your thematic fund is when the stock markets give you the opportunity. A market rally is an opportunity for you to sell that thematic/sector fund that you always wanted to redeem but could not because of unsuitable market conditions.

For example: Several people had invested in Telecom Sectoral funds 3-5 years back when the telecom sector was booming but currently due to the intense competition and a price war in the sector, the companies and the funds in that sector aren’t doing too well.

5. Your mutual fund has revised its investment process/mandate: Mutual fund managers have certain guidelines’ about how they should manage their funds which is commonly known as the fund mandate. A mandate has been formally stated and hence a lot of investors choose funds based on this mandate. Sometimes mutual funds revise their mandate, if they believe that they can perform better following another investment process. In the event of a revision in the mandate, regulations require that investors be given the option to redeem the mutual fund without an exit load, so you can redeem the investment without worrying about the exit load (if any). So if you had invested in a fund because of a certain mandate and if the revised mandate does not interest you, then you should redeem your fund.

Saving vs Investing

I had lunch with an old friend of mine last week whom I was meeting after a couple of years. My friend, a young hardworking guy, had recently made a smart career move and was now thinking of settling down and during my discussion with him, we were reviewing some investment decisions he had made a few years back and he was telling me about how he felt that his ‘savings’ weren’t satisfactory enough. However I noticed throughout my discussion that my friend was using the words ‘investments’ and ‘savings’ interchangeably. However I discovered that a lot of people confuse between the two and there are some similarities between the two, however they are two very different entities with different objectives and characteristics.

Savings is defined in the dictionary as ‘The accumulation of money for future use’ while an Investment is defined as ‘the laying out of money or capital in an enterprise with the expectation of profit’. Dictionary definitions aside, an investment is where you can grow your money at a significant rate after taxes. The current inflation in India is at about 8-9% which is pretty high. There are a lot of people who say that this is an aberration and in the long term inflation would settle down at about 5%. I do not know what the future holds or when the inflation would settle down at a more reasonable rate but what I do know is that if you keep your money in your savings bank account, you are losing the purchase value of your hard earned money which is akin to losing money. If you have put in your money in some financial instrument which earns you a ‘real’ return which exceeds the inflation rate, I would say that it has the characteristics of an investment.

A ‘saving’ is basically the accumulation of a certain amount of money in your ordinary savings account or even debt funds or in your piggy bank to fund some big ticket purchase like a swanky vacation, a car, a higher education degree, an iPod or that new plasma TV! (Cars, LCD TVs etc are not investments since they start depreciating in value the moment you step out of the showroom!).Your savings rarely return more than inflation after accounting for taxes.

Investments usually employ two methods through which they grow the invested money

1) By giving a regular cash flow like rent from real estate, royalty from books or art etc.

2) Value appreciation of the assets purchased (eg. Value appreciation of stocks, real estate, gold and other commodities)

Most investments are based on value appreciation, since the opportunities for cash flow are limited. Investments which give a high return in the long term (like shares or equity mutual funds) usually carry a certain amount of risk. However it has been historically proved that no investment can beat the returns that equity can give in the long term.

Investments are for your future while savings are for your present needs. It would be prudent to keep at least 40% of your surplus cash in investments which by their very nature are for a long term holding. Keep some amount as savings also to meet your planned purchases and any unexpected expenses (like hospitalization or an unforeseen expense). The more you are able to invest, the more corpus would you have in your future. The more you have in your long term fund, the more stable our future is financially.

Sunday, May 22, 2011

The problem with (too much) Diversification

Diversification (n) - The act of introducing variety (especially in investments or in the variety of goods and services offered). Diversification is something all financial planners suggest sticking to the adage – ‘Not putting all the eggs in one basket’. Though this strategy makes a lot of sense, I have rarely seen people follow this strategy in its right sense. People other over-diversify or diversify within a sector (like buying a lot of funds all which invest in real estate stocks), both of which defeats the purpose of the strategy of diversifying. The real purpose of diversification is to minimize risk by spreading your investments across different stocks or assets, so that in case one of them does badly, the performance of the other assets or stocks would ensure that the average performance of your investments are good.
I was prompted to write this article when a friend of mine recently showed me his portfolio of funds. He owned a total of 23 funds! And his reason for investing in so many funds was because he thought that was ‘diversifying’ and by doing so he would get good returns at a lower risk! The result

Monday, May 16, 2011

Fixed Deposits: To Switch or not to Switch?

Fixed Deposit rates have in the recent 2 weeks gone up significantly. If you remember the rate offered by banks last year (May 2010) for a 2 - 3 year Fixed Deposit, it was around 7 – 7.5%. The current rates offered are significantly higher at almost 9% with some banks offering even up to 9.5% for a 3 year fixed deposit (check the section on Fixed Deposits to see the table with details of bank Fixed Deposit rates). So the question now is – ‘Do I switch my fixed deposit by foreclosing my Fixed Deposit and re-investing it at the higher rates?’ This question may seem a no-brainer and may seem ridiculous because you can see that you can clearly earn a higher return! However before you take the plunge you must look closely at your current Fixed Deposit and ask yourself the following questions:

1. What is the pre-closure penalty that I will be charged?

      2.   When will my original fixed deposit mature (check the tenure)?

1. Pre-closure penalty: When you put your money in a Fixed Deposit after listening to your friendly manager, you probably did not ask about and neither were you told much about the pre-closure rate, in case you closed your Fixed Deposit before the term ended. The pre-closure rate varies from bank to bank and also may vary depending on how much of the term has passed. This pre-closure penalty is charged irrespective of whether you reinvest in the same bank. Therefore as a depositor it is paramount that you assess whether the new rates that you will receive will cover the penalty that may be charged to you when you pre-close your Fixed Deposit.

2. Tenure of the Fixed Deposit: If your Fixed Deposit term is just about to end, then it may not make sense to pre-close your Fixed Deposit. Also the current 1 year deposit rate available in the market is a maximum of 9.25%. But with pre-closure charges of 0.5%-1%, it doesn’t make sense to break an FD if you are going to reinvest it for less than 2 years, since you wouldn’t be able to get any advantage of a higher return after the pre-closure penalty.

A switching strategy is advantageous if a depositor wants to re-invest for a period of more than 2 years and a depositor should look out for the best deposit rates available and invest accordingly. For a list of deposit rates, check the section on Fixed Deposits.

Monday, May 9, 2011

Endowment Policies - Are they really good products?

Endowment policies are a very popular asset class in India and are promoted by most insurance companies and insurance agents. Life Insurance Corporation of India (LIC) has a lot of products which are endowment insurance products and these are one of the most popular products in its kitty. This is another product which tries to combine insurance and investment. I have seen a lot of people buy this product without properly understanding what an endowment policy is and simply buy it because it is being sold by a ‘known’ agent from LIC. In this article, I shall explore the merits and demerit of an endowment plan and shall let the reader decide for himself/herself if it makes sense for them to take an endowment plan.

Firstly, an endowment policy is like I have mentioned before, tries to combine insurance and investment. The life of the individual is insured for a certain amount (referred to as sum assured in an endowment policy), So the amount you pay every year or quarter (known as ‘premiums’ in insurance parlance), is allocated towards the sum assured, administrative charges and what remains is then invested.

An endowment policy rewards its investors by means of a ‘bonus’ every year. The amount of bonus declared every year, differs from company to company and on fund performance. The bonus declared is declared in the form of a proportion of the sum assured. For example if the sum assured is Rs 5 lakhs (Rs 500,000), and the company declares a bonus of Rs 50 per Rs 1000 of the sum assured, then the bonus works out to be Rs 25,000. However, unlike stock dividends or mutual funds, the company does not pay out the bonus immediately. It is paid only when the policy matures or the policy owner passes away. The bonus does not compound but only accumulates (unlike your Bank Fixed Deposits where your interest compounds). To explain how this works, I shall illustrate using an example: Take the case of a 35 year old person who takes a policy with an assured sum of Rs 5 lakhs with a term of 20 years. The premium for this would be roughly around Rs 25,000. If at the end of the first year, the insurance company declares a dividend of Rs 50 per thousand or 5% of the sum assured which works out to be Rs 25,000. Since this bonus does not compound, this amount stays the same till the end of the remaining 19 years and this is the same for all the further bonuses being declared. However I must point out that it is not very likely that an insurance company would declare a 5% bonus every year. There could be years where the bonus payments could be lower.

Why is compounding important?

To answer this question, let us continue with our above example. If the insurance company continues to pay you 5% bonus every year, you would have accumulated Rs 5 lakhs of bonus by the end of the 20 year period. Hence you get Rs 5 lakh of assured sum and Rs 5 lakh of your bonus at the end of 20 years. You have achieved this by paying Rs 25,000 per year for 20 years. This is NOT an impressive return at all! This actually amounts to a return of just 6.39% per annum!
Had an individual taken a term insurance which covered the person for Rs 5 lakhs and invested in Provident Fund his returns would have been much higher. For example, a term insurance covering a person for Rs 5 lakhs for a period of 20 years would amount to an annual premium of about Rs 2,500. Subtract this amount from the Rs 25,000 premium you are paying for the endowment policy and it comes to Rs 22,500. Invest this amount in a provident fund for 20 years (at the rate of 8.5%). At the end of 20 years you receive 10.88 lakhs viz. Rs 88,000 more! The other point to be noted is that the return from a Provident fund is non-taxable and guaranteed while you can never be sure of the amount of bonus being paid out by an insurance company!

Conclusion: I would advise risk averse investors who do not want to invest in mutual funds or equity products to take a term insurance and invest in Provident Fund Account instead of buying an endowment plan. Once again I would like to re-iterate that insurance and investment are two important albeit different goals. Do not try to mix up both and be very careful about products which try to mix both!

Tuesday, May 3, 2011

The Quandary of Investing

Have you ever had a relative or family friend call you up and tell you - “Now that you are earning, have you thought about your future and investments to save tax?” And you are surprised and start thinking as to why your relative/family friend suddenly was interested in you saving tax and making investments, till they drop in their next line – “ I am an ‘investment advisor’ and I have this product wherein you have to make yearly payments and you see an overwhelming return on your investment.” You now really don’t know what to say and then he/she starts off with the story of how Mr. Ravi – another relative/family friend that both of you are acquainted with, doubled his money in 2-3 years by investing in this particular fund/instrument. If you are somebody who earns more than Rs 50,000 per month (varies from bank to bank), you may even have ‘wealth advisors’ call you from your bank who would want to advise you on investments! A few of my classmates from my MBA class are wealth advisors with certain banks and from what they have told me, you really wouldn’t want to take your wealth advisor’s call seriously especially if the advice comes ‘free since you are a premium client’. Wealth advisors in most banks are given a target of the number of products to sell and these poor souls call up their clients and try to pitch in as many products as possible! So much for wealth management!