Money - A Friend in Need is a Friend Indeed (Part 2)

Okay.. It’s that time of the year when all salaried people rush to invest the money in order to save them from the Axe of Tax. In my earlier post, I tried to provide some pointers regarding investing in stock markets indirectly through Mutual Fund. One thing that I forgot to mention over there was that a person should ideally go with SIP as far as possible, so as to reap maximum benefits. Many people keep on waiting and analyzing as to when the NAV of any fund would reach low levels, so that they could invest the entire amount at that time in order to reap maximum benefits. However, they forget that if the market would have been that predictable, then there wouldn't have been any tension in life.. right.

Why do I need Insurance?

Let's now turn our attention to the second most sought after investment instrument - Insurance. First of all, let me clarify that insurance should not be treated as an investment instrument, as it defeats the very purpose of its existence. One needs insurance in order to protect his/her family in case the bread-earner dies, so that the regular family expenses are met, and the liabilities in form of loans etc could be easily taken care of. 

How much Insurance do I need?

The next obvious question that comes to our mind is how much insurance is enough for us. This is a kind of grey area that doesn't has any specific answer to it, because of the involvement of time factor. All the agents try to give you various perspectives on the insurance cover, and boom.. there comes the terms coined by the industry:

1.     Human Life Value (HLV)

2.     Underwriter's Thumb Rule

3.     Income Rule

4.     Income plus Expenses Rule

5.     Capital Fund Rule

6.     Family Needs Approach

Okay, please don't ask me about what all these things mean. If you want to get confused, please bug your agents and ask them to explain these concepts. All of them are quite fancy in nature. The purpose of my listing down so many approaches, to find out your insurance cover, is just to point out how much ambiguity is there for finding out the Sum Assured.

My Way

I believe that it's a very simple task. Just add on the transaction values for following Life Events:

1.     Car Loan

2.     Education Loan for Higher Education for self

3.     Home Loan

4.     Any other Personal Loans/Liabilities

5.     Amount for Healthcare

6.     Child's Education

7.     Child's Marriage

8.     Inflation adjusted monthly household expenses of your dependents

Which Type of Insurance Policy Should I Buy?

There is a lot of debate on this issue. I would like to dwell on two basic kinds of traditional policies available with the life insurers:

1.     Term Insurance: You need to pay a yearly premium for specified number of years, and upon your death the nominees would be given the Sum Assured. In case you are hale and hearty after the policy expires, you won't get anything in the end.

2.     Endowment Policy: You need to pay a yearly premium for specified number of years, and either upon your death or the expiration of the policy (whichever is earlier), a lump sum amount is paid to the nominees or the insured person respectively.

For the same value of Sum Assured, you need to pay significantly more amount of installment for Endowment Policy compared to Term Insurance. Hence, there is a classical debate on which type of policy is good.

My Verdict

It is generally advised by Financial Planners to go for a combination of PPF and Term Insurance, instead of going for Endowment Policy, as the returns offered in the former case is much more than the later. I believe that in order to fully secure the future of our family, we should go for a combination of PPF, Term Insurance and Equity Linked Financial Instrument (let's say, Mutual Fund). I have taken help of the following assumptions/ facts for my analysis:

1.     The Sum Assured in the case of Term policy as well as Endowment Plan is 50 lacs.

2.     The premium has been calculated for 20 years policy period; I have chosen Amulya Jeevan and Jeevan Anand policies of LIC for term and endowment policies respectively.

3.     The rate of interest on PPF is taken as 9% p.a

4.     The rate of interest on the Mutual Fund is taken as 10% p.a, considering the fact that the annualized rate of return of Benchmark Indices has been 15% for the last 5 years.

5.     The max amount that can be invested in PPF is 70,000 p.a

The premium for Jeevan Anand (267,133) is almost 12 times that of Amulya Jeevan (12,350).

In Scenario 1, suppose a person invests Rs 70,000 p.a in PPF and pays the premium for term insurance on yearly basis. In case the person dies after 20 years, the amount that nominee receives is 5.4 times the total investment. In case the person is alive, the person gets 2.4 times the total investment.

In Scenario 2, suppose a person invests into an endowment plan which offers the same insurance cover. Assuming that the person receives Rs 57 per thousand of sum insured, the total amount payable upon maturity after 20 years is only 2 times the total investment.

In Scenario 3, an assumption is made that a person has the capability to invest Rs 267,133 p.a (similar to the premium of the endowment plan). Here, the person invests Rs70, 000 in PPF, Rs12, 350 in term insurance and the rest in a Mutual Fund giving modest annualized returns of 10% p.a. In this case, if a person dies after 20 years, the nominees get an amount equal to 3.85 times the investment; else, in case the person is alive, the person gets 2.91 times the investment amount.

For more detailed calculations, please refer to the Insurance WorkSheet .

Conclusion

The major investments of an individual should be done in the following 3 instruments (in no particular order of preference):

1.     Term Insurance

2.     PPF

3.     Mutual Fund

In case a person is alive, the last 2 instruments would take care of the person and his/her family. In case of a misfortune that results in the death of the person, the 1st and 3rd instrument would take care of the person's family. In my next article, I would throw light on the remaining instruments – Health Insurance, Infrastructure Bonds and ULIPs. Happy Investing J

Can Money Buy Everything !!

There was a famous Mastercard Campaign that had been running for quite a few years. The punch line of their ads said –

 “Money can't buy everything; for everything else there is Mastercard".

The series of ads that ran during this campaign were very touching, and people used to emotionally connect with those ads. The ads usually focused on the emotional aspects of people that can't be bought. Now, to the list of things that one can buy using money, Mastercard can add - Environment Pollution. Oh yes, now one can pollute the environment at their own will and use money to buy CER (Certified Emission Reduction) certificates; which in turn helps in reducing their Carbon Footprint - notionally. Mastercard’s new punch line can be:

“Money can't buy everything; for everything else (even environment pollution) there is Mastercard”

Carbon Foot print

The concept around reducing the global carbon footprint goes like this:

1.     A company, X, uses fossil fuels/coal/natural gas for its production process, as it is cheaper compared to other "cleaner fuels" and other sources of "Renewable Energy" (e.g. - hydel power, solar power etc)

2.     Hence, X emits a lot of GHG (Green House Gases) such as CO2 in the atmosphere.

3.     These gases are harmful for the environment, especially the Ozone layer that protects our planet from the harmful effects of the UV rays.

4.     Imagine our planet surrounded by a kind of blanket (ozone layer) with lots of holes through which the UV rays are percolating.

5.     Now comes the catch. There is a UN body called UNFCCC, which says that the only parameter that it would use to gauge the Carbon Footprint of an organization is the no. of CERs it has.

6.     These CERs can easily be traded in the global market, in exchange for money, just like a regular financial instrument.

China Rules..

India is the 5th largest when it comes to the emission of CO2, after US, China, Russia and Japan. Just for comparison sake, India produces CO2 as much as just 18% and 30% to that of US and China respectively. What is noticeable about China is that in the past one year, it has started a lot of renewable energy projects, thus beginning to rely more on wind and hydel power. As of today, China houses as much as 50% of world's total no of hydel projects!! That is what determination (as well as Monarchy) can do for you. China is also thinking of imposing caps on industry-wise allowable limits for CO2 emissions, as well as putting an extra tax on companies that produce more than the specified limits of CO2. Hail China for these steps.

India – Again a Laggard

India has vowed to reduce its Carbon Footprint by as much as 25% by 2020. At the same time, India has also made its stand clear that it would not impose any binding emission cuts as suggested by UNFCCC, considering that the large part of the population lives below the Poverty Line - as the additional costs incurred by the company in using cleaner fuels would directly be passed on to the consumers. According to the Planning Commission of India, 27.5% of India's population lives below the poverty line, as of 2004-05. The BPL population has shown a constant decline over the years, and continuing the same trend, it's my rough estimate that the figure would now be at somewhere around 24%. So, what about the remaining 75% population?

The Govt. would never be able to pass on a bill regarding imposing industry-wise cuts in India, if the matter is left alone to the politicians and the big business houses of this country. Given the level of corruption in India (India ranks 87 in the World Corruption Index); such a bill would never see the light of the day. What is most amazing about Govt's statement is that they never tell when such a Legislative Bill would actually be introduced in India - what is their target level of population of BPL at which they would act. The most amazing part is that the BPL population didn't play any (or may be negligent) role in India's Growth Story - yet the Govt. is using it as its scapegoat. I believe it's not the Govt but the vested interests of the business houses of India that is speaking through Govt's mouth. The Govt is not concerned about the generations that are going to come - it's only concerned about the fact that again, after 5 years, they have to come to power - for which they would require the support of business groups, as well as their money for campaigning etc. It was shocking to me when I read in the newspaper last week that Mr. Sharad Pawar openly stated that the moves of the Govt is actually making the business houses the enemy of the ruling party. The business groups were feeling that the Govt was no more "business friendly" - and that they may move their support to the opposition party if this continues. Now what was that? There seems to be no space for justice for the common people in India!!

Developing Vs Developed Nations

What is the most surprising part in this issue of reducing the carbon footprint is that the developed nations, which are the biggest consumer of power, and hence have the highest carbon footprint, are so helpless at reducing their CO2 emissions. These people have so much money (as they are supposedly the biggest consumers of services in the world as well) - why can't they shell something extra to pay for renewable energy. Instead, they go on happily emitting CO2 without any checks and regulations, and then later use MONEY to buy the CERs, which is the metric used by the UN watchdog to infer about the carbon footprint of an industry. I believe that these UN bodies form the regulations keeping in mind the best interests of the Developed Nations; and try to impose all possible rules on the developing/under-developed nations. These UN bodies don't seem independent to me anymore - similar to the case when the UN bodies didn't (or may be couldn't) do anything when US attacked Iraq just because of assumptions that Iraq had WMD (Weapons of Mass Destruction). The only good thing that President Bush did was adding one more acronym to the ever-growing English dictionary - WMD. He would surely be remembered always for coining this word.

Methodology

In my opinion, taking the following course of action would be helpful in reducing the global carbon foot print and for the future generations as well:

1.     A global cap should be put on all economies so that the total emission of CO2 globally should be calculated and controlled.

2.     This should be then divided between the nations, factoring various things like population, kind of economy, production capacities, infrastructure etc. Each nation should be given a score on such parameters, and then a weighted average score should be calculated for all nations. The amount of CO2 emissions of each nation should be determined by this score. Higher the score, higher the allowable emission of CO2.

3.     The nations should then divide the allotted limit of CO2 emission industry-wise, and the national industry bodies should then divide this limit among the various players in that particular industry, depending on the production capacity or any such relevant metric for that industry.

4.     If a business group has multiple businesses across industrial sectors, those BUs (Business Units) should not be allowed to mutually share the target CO2 emission. For eg, say there is a business group ABC that has 2 business units in different sectors. The 1st BU had a limit of 5 units of CO2 emission, while the 2nd one had 8 units. So, if the 1st BU produces only 4 units, and the 2nd one 9 units, the extra 1 unit can't be transferred from 1st BU to 2nd BU.

5.     The trading of CERs should be completely banned. A company can't be allowed to reduce his carbon foot print by paying for it, though it is not taking any steps towards using clean fuels.

6.     The companies that produce more CO2, than what they are supposed to, should be taxed additionally - call it as "Carbon Tax"- over and above the regular corporate tax levied on the companies.

7.     The CERs should be mandatory criteria for credit rating agencies when they are rating a company. That is the additional incentive the companies should get for using clean fuel, and hence for getting the CERs.

Modify the Metrics Please!!

I guess it's high time to turn more attention to this issue, and give it more attention that it actually deserves. I believe putting a global cap on CO2 emissions is a mandatory step, so that all nations get aligned to a common goal. Also, instead of the nations claiming that they would reduce the CO2 emissions by x% by a certain period of time, they should state that they would make sure that y% of their total energy production would be done through use of clean fuel / renewable energy. This approach would be more effective because each country claims to reduce the current level of their CO2 emission by x%; but this is x% of the current level. 

Let us take an example. Say, a nation is producing 100 units of CO2 today, and they claim to reduce their emissions by 20% in 10 years. Hence, what they it is effectively saying is that it would reduce CO2 emissions by just 20 units in 10 years.

 But, let's say, its energy demand is increasing at a rate of 5% every year. So, the total no of CO2 units it would be producing after 10 years is 162 units approx. Even if one reduces 20 units from this (Say these units come from renewable energy sources), the total units of CO2 emitted would be 142 units.

Hence, we see that over 10 years, the CO2 emission has actually increased by 42 units.

If we take the other approach, and say that by 10 years, 20% of the nation's energy consumption would come from clean fuel. This simplifies to:

Total units produced after 10 years - 162 units

Power from clean fuel/renewable energy - 32 units

Power from regular sources - 130 units.

The increase happens in this case as well, but it is much less compared to the 1^st case. There is rather a higher increase in the use of renewable energy in the latter case.

Hence, we find that the second metric would be more suitable than the 1st one. Any one from the Govt listening? 

Money - A Friend in Need is a Friend Indeed (Part 1)

Oh No, Not Again

I know you would have read a lot of information about how to invest wisely - both offline and online; and that this topic might sound clichéd to many readers (I am feeling it while writing, so I am sure you would also harbour the same feelings as you read on). But trust me,a lot of information is available these days, and the trick lies in correct perception, understanding and application of relevant things which impact you. Having done my MBA in Finance, I have been tempted a lot of times to write something related to financial advisory. So, today goes my first post in this series. A lot from this article is derived from my own personal experiences. I have taken uninformed decisions in the past; I want others reading this blog to take better decisions than I did.

Needs Vary with Time

I believe that as we grow, get older and pass through different phases of life, our needs change with respect to the phase of life we are in. After passing out from college, having got the first job and experiencing financial independence for the first time in life, one hardly thinks about how much one is spending, where one is spending, how much should one save, how much and where should money be invested and the likes. This generally involves youngsters in age group of 21-26 years old, and this is the target segment for most of the businesses dealing with financial investments- be it mutual fund, insurance, ULIPS etc etc. The rationale for these companies is simple - youngsters generally don't have much experience with finance and have lots of money with them (especially during the months of November to February,w.r.t India especially, when we suddenly get a jolt from our fairy-tale lifestyle and think of our 1 lac of investment for tax saving purpose.)Hence, my article is especially dedicated to this segment.

Investopedia

One can have the following Investment Options (The list is not exhaustive):

1. Mutual Fund
2. Life Insurance
3. Health Insurance
4. Public Provident Fund (PPF)
5. ULIPS (I'll tell later why this is a bad option)
6. Infrastructure Bonds

Now, there is an obvious question: what amount should I be investing in which instrument? Many people are quite puzzled and confused with this question. I have seen people, after retirement, investing > 90% of their savings in Equity Linked Mutual Funds; while some stock broking houses target such people and invest their money directly into stock markets. I fail to understand the logic behind this, as retired people don’t even have a regular source of income. Hence, it would be difficult for them to absorb any losses that arise due to this decision.

The answer to the above question is very simple -> If your age is X, and your total investment amount is Y, then

• Investment in Equity = (100 - X)*Y/100
• Investment in Debt = X*100/Y

 Hence, suppose if one is 25 years old and has 1 lac to invest, that person should be investing 75,000 into Equity Instruments and 25,000 into Debt Instruments. The above equation helps you to decrease your exposure in Equity instruments, which have high risk and high return, as your age increases. Thus, as the risk bearing capacity of a person decreases with age (and hence, due to the different phases of life - marriage, kids, kids' education etc), his exposure to Debt instruments, also known as Fixed Income instruments, increases.

In this article, my focus would be on the Mutual Funds. In my subsequent articles, I'd throw more light on the other investment instruments listed above.

What’s in Here for Me??

Do these questions sound familiar?

Should I invest directly in Stock Market or in Mutual Funds?

In my opinion, and as suggested by the great Mr. Jhunjhunwalla, it is best to invest in Mutual Funds than in direct stock market, because of the following reasons:

1. The Mutual Fund houses have dedicated and qualified people who do the research about various companies, and then churn the portfolio accordingly, in order to keep in line with the investment focus of a particular mutual fund scheme, and give you the desired returns.
2. One doesn't have to glue himself to the stock broking websites all the time, and keep on looking for opportunities to buy/sell one's shared.
3. The portfolio maintained by the mutual fund houses are much more diversified than the portfolio of stocks that one holds. Many a times, due to inappropriate amount of diversification in the stock portfolio of individuals, they gain/lose more than the Sensex.

Should I invest in a New Fund Offer (NFO) or an Existing Scheme?

This is a very common misconception amongst the investors that they would be gaining more by investing in NFOs. This is because one thinks that one would be able to buy more units of the NFO, and more units translate to more profit, which is absolutely wrong. 

For eg, let's say one has 10,000 for investment. There is an NFO in which 1 unit is priced at 10/-. There is another scheme, say MF, that has been in market for 5 years now, and its 1 unit costs 100/-

No of units bought if invested in NFO - 1000

No of units if invested in MF - 100

Now, suppose after a year, the MF gives 15% returns, whereas the NFO gives 12% returns. Hence, a unit of NFO would now be valued at roughly 11.2/-, and that of MF would be valued at roughly 115. Hence, after a year

Value of Investment in NFO = 1000 * 11.2 = 11,200

Value of investment in MF = 100 * 115 = 11,500

Hence, the same amount of money (10,000/-) amounts more when invested in MF than in NFO. Of course, if you have reasons to believe that the portfolio of NFO is much stronger than that of MF, and has potential to generate more returns than NFO, one should go for the NFO. But, for taking this decision, one should have a good know how of finance.

Which Scheme should I invest in?

There are a plethora of schemes available in the market. The scheme in which you want to invest depends on your financial goal. If your goal is to save tax, then go for tax-saving schemes; if your objective is to generate wealth, then go for other schemes available in the market. In the tax saving ELSS schemes, there is a lock-in period of 3 years, whereas there is no such lock-in period in other schemes. Hence, once you have invested in a tax saving scheme and it’s not performing well, you can't do much about it for 3 years; the same is not true for other schemes though. Moreover, many of the non tax saving schemes in the market are giving much more returns as compared to the tax saving schemes. Hence, it's totally a call of an individual as to what one wants to do.

While selecting a scheme, keep in mind the following 2 points:

• The scheme that you select should be giving a consistent performance in the past 3-5 years. If a scheme is in top 5 schemes based on  5-yearly, 3-yearly and 2-yearly returns, short list that scheme.  
• This is one of the most important thing that people generally ignore. The returns of the scheme that you have shortlisted should also be greater than the returns of the Benchmark index that the scheme refers to, or at least the Nifty/Sensex. If you apply this criterion, you would be surprised that the short list that you arrived at in the first step would further get shortened. :)

The rationale behind the last point is that if the portfolio of shares maintained by the mutual fund scheme is not able to give more returns compared to the portfolio of shares used in calculation of Nifty/Sensex, then you are not gaining anything. You can easily get as much returns as the Nifty/Sensex, because their portfolio of shares is easily available to the general public. Hence, the logic.

The mutual funds that invest in large cap stocks are most secure, followed by mid-cap stocks, small cap stocks and sectoral stocks. Hence, the returns provided by these follows a reverse order,i.e, max in sectoral/small cap funds and min in large cap funds. This is because the small cap stocks are the most volatile and large cap stocks are least volatile. Thus, gains/losses in case of small cap stocks are much more than the large-cap stocks, when compared to the gains/losses in Sensex.

Conclusion

Watch out for the continuation of this series, for information on the other investment products. I hope the information in this article would help you in taking more informed decisions when it comes to choosing your Mutual Fund. All the Best!!

India's (UN)True Growth Story

What's This Blog About?

I recently conducted a poll on my blog, asking whether the Indian Govt. should start focusing on improving its UN Human Development Index rather than bettering its GDP year on year. I got a staggering response, with a total of 6 people stating their opinion!! I am really thankful to those 6 people from the bottom of my bottomless heart, really. Although the population size is not statistically significant to infer any results, yet I would say that 83% of the respondents were in favour of UN HDI over GDP. Well, I'd like to concur with the majority, and that is what this blog is all about!!

UN HDwhat??

Well, I wouldn't like to delve into the intricacies of how HDI is calculated. As they say, a picture speaks as much as 100 pages of writing (don’t scratch your heads; I just made it up!!). So I hope that by looking at the above graphics, one would be able to understand the basics of how HDI is calculated. For more details, (as if one needs to be told :)), please Google UN HDI or have a look at  UN HDI

India’s Growth True Story

Coming to India's stats: India - hailed as one of the most promising economies in times to come, the Great Investment Destination, blah blah blah (you can think of as many such accolades as you can, that keep coming in the business papers and business news). In 2010, India stands at a position of 119 out of 169 countries that were a part of the survey conducted by UN for their Human Development Report!! Can you beat that? One is forced to think how that could be possible. All the economies of the world go gaga over the "India Growth Story". At this time when even the IMF has made an upward revision of estimated growth of India's GDP YoY, does the common man also stand to gain from this growth? At this time when India is poised to grow at such enormous rates which even other economies of the world can only dream of, is this the "Inclusive Growth" that the politicians keep on talking about?

Consider this -

• % of Population without electricity (as of 2008) - 34.2
• Employment to population ratio - 55.6
• Employed people living on less than $ 1.25 a day - 51.4
• Overall Life satisfaction (on a scale of 0 to 10; 0 being the lowest) - 5.5

For more statistics, I have compiled a ppt taking excerpts from the UN HDR 2010 annual report. You can access the file here.

Do we need more Indices??

Recently, I read somewhere that a few countries want to create and adopt a new index- "Happiness Index"- and India wants to follow suit. My question is what would happen if the Govt goes ahead and adopts it. Isn't it shameful enough for us to be placed at 119 out of 169 countries? The actual image of India wouldn't change, no matter whether it’s UN HDI or any other index, unless it takes some drastic steps to improve on the other indicators included in calculating the HDI. Concentrating on just GDP is not going to help India in the long run. To me, this increase in GDP year on year just seems to be a kind of bubble that is bound to explode one day, shattering the hopes of millions of India's inhabitants as well as the foreign players/FDIs/FIIs. The Govt needs to focus on growing internally, and not just focus on making the face of India as a place where only businesses make profit. There is a need to strengthen India internally, and I am sure that the only way ahead is Public Private Partnerships. After all, whatever expenditure the Govt would make in improving the quality of life of fellow Indians will add to economic activities and increase the GDP finally.

To Sum it All…

The end goal remains the same (increase of GDP YoY); only the approach needs to change a bit. It's high time to introduce the new concept of GSR (Govt. Social Responsibility), and take a further leap from CSR (Corporate Social Responsibility). After all, People are the Real WEALTH of a Nation.

India is doing a good job by improving upon its HDI year on year, but it’s not a great job. The people here are hungry to see a phenomenal growth in its HDI, just like they are seeing in the GDP. After all, it’s a matter of our well being rather than that of self respect and pride. I believe the Govt should also incorporate seeing India in the top 80 nations out of the 169 nations, in the UN HDR, in its 5 Years plan. To add on, this objective should actually materialize in coming 5 years, unlike the status of previous 5 year plans. The Govt can do wonders if it improves on its efficiency and effectiveness of execution of its strategies that would help in the timely achievements of its goals. Let’s hope for the best. Amen!!