Subramoney

This article first appeared on the utvi.com web site - written by the famous anchor, Mr. Vikram Oza. It kind of explains the relationship between risk and return.

The stock markets are risky business. At least that’s the line most people who didn’t park their money in Dalal Street have maintained. But on the flip side, the argument is ‘no pain, no gain’… ‘no risk, no returns’. It’s an age-old dilemma… Damned if you do and damned if you don’t.

Take the case of Nirav Kaku. He’s an IT professional. He, like millions, invested in the stock market consistently during the bull-run. Over the last two years, he parked Rs 24 lacs in it. Today his portfolio has lost half its value. And he’s cursing his luck.

Nirav took higher risks in the hope of higher returns. Was he wrong?

‘Quite’, says Financial Trainer P V Subramanyam. “You may expect higher risks for higher returns, but that’s not always true. To get better returns, sometimes you need to reduce risk – not increase it.”

How do you do that? Here’s an easy approach:

Keep the money you require in the short term (i.e. less than 3 years) in debt instruments.

And invest the money you require in the long term (i.e. like 7 years or more) in equity.

But resisting a ride on the crest of the stock market is tough. Especially when it soars. Blocking out exclamations of joy from those who see the value of their portfolios rise with the Sensex isn’t easy. The trouble only begins when markets do a U-turn and a tailspin all at once. Investors break into a frenzy, and ultimately, despair.

“If you have a long term view, why do you track the markets on an hourly basis?” asks Subramanyam. True. An exercise in futility for all you do is die a million deaths – without hope of nirvana.

Then again, from another perspective, the markets going down are good for young investors. After all you have the opportunity to invest for the long term, getting stocks that you wouldn’t get – at unimaginable prices.

Indeed, with a long term vision, investing in a bearish market isn’t a risk, it’s an opportunity.  Trading is risky, but not investing. As Warren Buffet says, “If you know what you are doing, there is no risk”.

Think about it this way. Not taking a risk is also a risk. For one, the money that you keep under your pillow would erode all its value with rising inflation.

The idea then is to manage risk. Here’s how:

Study your portfolio from time to time, say every six months. And then identify your risks. Your risks will typically change over a period of time with changes in interest rates and inflation. Your default risk also changes when the company you’ve invested money in, goes bankrupt.

Set your goals… the crucial ones like retirement and the not-so-crucial ones like that Tag Heur watch you wanted to indulge in. That way, you’ll see how you can best reduce your risk.

Keep a balanced portfolio. Spread your risks across different asset classes. You should have money in a savings bank account, PPF, Fixed Deposits, Gold, Real Estate and Equity. Ensure you’ve allocated 50-60% in equity with a long term vision and the rest in other asset classes.

Remember! You can’t avoid risk. At best, it can be managed

Continuing the debt class, have you ever wondered what assets can you invest in to meet your debt requirement? Well there are many – and most of them you know about. Let us just enumerate them. We will see them in detail in a later class. The list is as follows:

a. Savings Bank account

b. Bank Fixed deposits

c. Postal schemes / small savings as they call it includes Kisan Vikas Patra (KVP), Post Office Monthly Income Scheme (POMIS), National Savings Certificates (NSC), Post Office Time Deposit (POTD).

d. PPF (Public Provident fund)

e. Own Provident fund (Employee Provident fund) – not a rupee from here goes into the equity market

f. Endowment Plans from Life insurance companies (strictly speaking they do invest in a small amount of equities, but LIC’s return over the past 2-3 decades looks like there was almost no equities!

g. Mutual fund schemes – investing in debt only – like Liquid funds, Most of the fmps, floater funds, Income funds, Gilt funds.

h. The debt portion of balanced funds – the Hdfc prudence fund for example has invested – 25% of its corpus in debt.

We are in the midst of an economic slowdown for sure. The west is down to growth rates of 0 and 1% per annum. Dropping oil prices will mean Sovereign Funds will have lesser monies to spend, and IT companies will also bring in lesser revenues.

When the going gets tough, the tough go shopping! So you have Warren Buffet going shopping and picking up monies for buying options. Well you are not in that privileged class of investors, are you? Frankly I do not know of many such people even in the Indian scenario!

However this article is not about Ben Bernanke (who owns a printing press, so can make money) or Warren Buffet (He knows how to earn money with money as the raw material). This article is about every Joe, Harry, Smith or Radha, Shama, or Mridula.

In tough economic times, people are sometimes left scrambling for cash to meet everyday expenses and lifestyle demands. Salaries may be lowered or stopped or it may take some time to come. I just heard of a small shipping company which has not yet paid salaries for the month of August!

So what does the common man do? The normal tendency is to turn towards “assets” which were created just for such a day. Let us look at the tempting options which people look at:

1) Postpone paying the life insurance premium: You have just received a notice from your life insurance company, and you are tempted to ignore it. Do not do it. Revisit the reason for taking the policy. If you took it as a protection need, have the conditions changed? If not continue the policy. DO NOT LET IT LAPSE. However, if the policy is an old one, it would have acquired some “paid up” value, try making the policy “paid up” and stop paying further premia.

2) Stop the SIPs: If you have been investing for your children’s education, your own retirement, buying a house, etc. and this money is growing towards that goal, stopping it does not make sense. However, if you have to stop BECAUSE YOU HAVE a cash flow crisis, you should stop. However, you should not stop it because the markets are down.

3) Using your credit card and letting the debt run: This is another suicidal thing to do. Do not let your credit card bills run – at 42% per annum interest paying of your credit card in full should always be a top priority.

4) Borrowing from your PPF: is a good option because it comes at the least cost. It just your money which you are withdrawing, so if you MUST access money, let it be from your own PF, PPF or premature withdrawal of your national savings certificates.

5) Loan from your Life Insurance Policy: If you have old (classic) endowment or money back policies you will be able to get a loan against those policies. However, in such a case you need to remember to take a term life insurance policy to the amount of the loan. As an example let us say I have an endowment policy worth Rs. 30 lakhs. I think my family needs that much money if I drop dead. So if I do take a Rs. 20 lakh loan (for what ever purpose) I should IMMEDIATELY take a term life insurance for Rs. 20 lakhs.

However, what you must do are the following:

1) Check your credit card statements – look for life style expenses that can be cut down.

2) Check your investments – try getting rid of the duds – even it means taking the losses. You are only acknowledging what your heart already knows.

3) Downsize some non crucial goals – vacation locations and size of car can surely change.

4) If you have signed up for services that you are not using see if you can either cut it off or get some money for closing it.

5) Look around your house and list those things which you bought when you had the “feel good” factor because of you Rs. 20 million net worth! Keep the list for all to see! Next time you go shopping read the list and then make the trip – it will keep you frugal!

In every class on retirement planning one question which I always get a wrong answer is: “Will you buy big assets like house, car, etc. AFTER you retire?”

It is met with an “obviously no. why do you even ask”. Well the obviously no is said and ‘why do you even ask is in the body language.

I tell them, if you get used to using a car for, say 3 years, you have a problem, do you not?

Let us say you retire at the age of 55 (highly probable) and live up to the age of 90 (sad, but again possible). This means you have about 35 years in retirement. If you use a car for say 5 years (instead of 3 at present) you will need to buy at least 5 cars (assuming you drive till 80, then, start using a driver). Also buildings that are constructed today may not last 35 years. So if you have bought a house when you are 45 years of age, that may last say for 35 years. So at your age of 80, you will have to BUY a new house!

My father bought a house in Pune - Athashree (see www.paranjapebuilders.com) - which is a beautiful place for senior citizens to live. It has fantastic assisted living facilities. My mom’s brother bought a place for himself in Coimbatore. My Mom’s sister bought herself a nice house in Bangalore - where they liked the weather compared to their Chennai residence. All of them were above the age of 70 when this 2nd house purchase was made. The funding came from their mutual funds, ppf, sale of equity shares.

All of them had kept their primary residence - just in case they had to come back!

So in your post retirement age you will end up buying at least one house, a few cars, a few mobiles, a few white goods appliances, a few vacations (optional), medical care, assisted living, long term care, etc.

The question is no loans will be available for these purchases. You will pay cash - and the cash will come from redeeming your mutual funds, ppf, ulips, equity shares, etc. So apart from providing for your food, medicines, etc. provide for purchase of all these assets.

It is customary for people to give sane advice- if you have a kid, the kid should have a PPF account. This advice makes very little sense. First of all most of the people I meet today invest far, far more in a year than the max possible amount of Rs. 70,000 in a PPF account. So for most people I know PPF is insignificant.

Secondly in a growing economy inflation is a real danger - and most people do not understand this risk. Why people do not understand this risk is of course innumeracy. It takes a complicated mind to understand simple things like compounding (inflation is negative compounding).

Though strictly speaking there is not too much to worry about a soverign default, there is a serious risk that an ambitious finance minister will delay the return of your money. Let us say P Chidambaram decides to pay you in 10 instalments - yes alongwith interest, but…you know what I mean.

So sorry for being a party pooper. If you have a 16 year view (or 20) put your money in a plan with say 90% of the money in equities and 10% in debt. Rebalance every 3-4 years. Surely you will outperform a PPf.

Let me share what I did with my wife’s money. She changed jobs - and her earlier job started payin her a pension. I invested that in Templeton India Pension Plan. Over the last 4-5 years that has become a SIP - and the returns are in the region of 14-20% p.a. Surely if it does underperform over the next few years, it would surely have outperformed ppf. QED.

For many generations we have believed what we own (i.e. items on which we are allowed to put our names) are our assets, and monies that we owe are our liabilities. It took Robert Kiyosaki to tell us that assets that put money in our bank are our real assets – equity shares, rental property, mutual funds, unit-linked plans etc. I like to make the distinction a little differently – the “show off” assets – house, car, beach shack, and the boring assets – like mutual funds or unit linked policies – the former is loved, most people do the latter grudgingly. What you need to remember is that many artistes died broke and top of the mind recall are – Marilyn Monroe, and Marlon Brando. You keep hearing stories about how Michael Jackson has no money to pay his lawyers. The descendants of the last king of India – Bahadur Shah Zafar and the descendants of the last king of Bengal are not exactly middle class. Far from it. If you see the list of Indian film stars, who either died a pauper or have made a mess of their wealth by not leaving a clear will is quite shocking. The list could go on, naming big sports figures, entertainers, entrepreneurs and many folks who accumulated it a few rupees at a time by hard work and thrift. All of them had too many of the “show off” assets, but perhaps none of the “boring” assets. Too many people have learned that making a fortune is the easy part. The difficult part is in managing it. What all this means is how much money you have is a function of how well you managed your money, nor really how much you earned. If money management skills are, equal how is it that the Forbes list of the richest people keeps changing every year? If your money is not useful and available to you when you need it for yourself or your loved ones, money is useless. Your confidence to back answer your boss should come from your “net worth statement”, not your “next work” that you are able to get.Let us see what we can do to ensure that the money that we earn creates security for us.

· Too many people I meet are Income rich and balance sheet poor: If you earn Rs.1, 500,000 a year, but spend Rs.1.503, 000, you are broke, worse off than the person who earns Rs.500, 000 but spends only Rs.450, 000. You may be income-statement rich, but you are asset poor. Not enough people are able to realize that the amount of money in the retirement or pension kitty and the amount of life insurance is a function of your CURRENT life style, not the lifestyle you had 5 years back. Financial security comes from being able to live off your assets – and not need the job by the time you are 45.

· Start learning about money – it is not a difficult task. Start taking interest in how credit cards work, how to live within a budget, mutual funds, unit linked plans, financial goal setting, making a will, etc. Managing money is not in any academic syllabus at any academic institution, but you still need to know it. So go ahead, and learn. More importantly, for the women who are reading this article please ensure that you learn about money and encourage your friends, colleagues, daughters, daughters in law, etc. to learn about money. Money is not a “man” thing as much as “cooking” is not a “woman” thing.

· Don’t confuse debt with wealth. If you buy a Rs.8 million house with a Rs.7.75 million mortgage, you are not worth Rs.8 million. You are Rs.7.75 million in debt. Last week when my broker bought a car, he did not borrow any portion of the Rs. 14 lakhs that he needed to buy it. His logic was simple; many of the investments that he had made would yield him less than 15% p.a return – including his PPF. His logic was why should you borrow at a rate higher than the rate at which you lend? Most rich people do not borrow because they do not have money. They borrow because their assets are capable of earning much more than the rate at which they borrow. And as Robert Kiyosaki says in his book the rich buy the boring (my terminology) assets first and then use the income from these assets to buy the “luxuries” that we cannot live without.

· Get good advice: And then listen to them. A great portfolio manager manages my equity portfolio – and he keeps giving good results in all kinds of markets. My role in the good performance of my portfolio is simple – I let him be. Financial advisors like doctors are busy and they like involved and non-interfering clients. You may need a financial planner, a portfolio manager, and a banker. Or a simple mutual fund distributor. Once you have found a good advisor, trust her to perform.

· Retire gracefully: Plan for your retirement. Retirement is an amount of money, not an age. If you are a business owner, for instance, don’t assume you will be able to sell it for the “right” price when you are ready to retire. Keep shifting some money from “business” to the “personal” bucket of finances. Rather than put all your eggs in one basket, set aside a percentage of all earnings in conservative assets to help guarantee a secure retirement, no matter what happens to your other assets.

· Protect with life insurance. is the item that people pay attention to only when approached by an agent. Life insurance is a tremendous tool to help achieve distribution goals, all generally income-tax-free. It puts tremendous amount of liquidity and gives peace of mind. I know men who have constantly told their wives “use the life insurance money to pay off the mortgage if I were not around”. I would rather have guys telling their wives “I have a life insurance policy and Saki is our financial planner. I trust her, and so can you. Ask her how to collect the insurance money and consultatively chose an investment option. Use the notes we made at the financial planning seminar we attended”. Ha, that will be the day. If you do all this, will your wealth give you security? Well there are no “assured return” schemes any more. You need to keep learning and trying. However, by addressing the above issues, you can dramatically increase the potential for turning the wealth you’ve achieved into long-term financial security for yourself and for your loved ones.

Uma Kannan is a good friend and an ex- blue blooded MNC banker. Here she is taking potshots at her own ilk. She says when she was with the bank, she was a “rogue deal seeker” but she felt good in calling herself a relationship manager, investment adviser, associate director…and various other nice names which HR faithfully found her!

A small investor should never invest on her/his own. S/he should choose a mutual fund. But is it easy to