Many people have been screaming about real estate as an investment. Well I have nothing against it, except that I do not understand it. Given limited brain power, I would rather not do it, instead of making a mess of the same

Let me share one real estate transaction that I saw from close quarters:

India Bulls has a property in Panvel (a suburb of a suburb of Mumbai!!).

Cost / buying price for the customer in Sep 2010        : Rs. 2200

brokerage                                                                                                       50

total cost say Rs          2250

the price at which one can be reasonably sure of selling : Rs. 4000 (the builder says 4400)

BUILDER’S transfer charges: Rs. 400

brokerage (assumed)               Rs.     80

Net cash that you will get (over a 16 month period) :              Rs. 3520

Capital Gains 3520-2250 = Rs. 1270

Cap gains tax @ 25% (short term cap gains, so you will pay at max marginal rate): 320 (rounded off)

so net gains: 3200 (cash) on an investment of Rs. 2250 over a 16 month period.

Net gains: 1270 – 320 = 950….

Not bad at all.

Right? Sure, you took the risk, made the investment and the broker still decides to take Rs. 400 – which is greater than the Capital Gains that the government of India charges…

So is realty a good investment…?

Well if you did invest cash, or if you leveraged (after all you did not have the money to do the deal)..and you made money…yes.

Did I do this transaction? NO.

I have done transactions where I have got about 10%p.a.  return over the past 3 years. Not cribbing.

I have seen / done a funding transaction with a builder @ 28% p.a. – secured.

I have seen / done a funding transaction with a builder @ 24%p.a. unsecured….

but my debt transactions are rarely worth talking about – I take too much risks.

Capital gains tax (short term cap gains so assuming 25% tax)

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A rich uncle – actually his dad’s younger brother (kids chacha) offered the loan at exactly the same terms as the bank – but without very complicated documentation.

The uncle asked me the following questions:

1. Can I afford the cash flow: the answer was a resounding yes.

2. Can I afford the loss: again this amount was about 1% of his net-worth, so was not an issue.

3. Is the interest fair on both the parties: My argument was yes.

I had some more questions like:

- how will you react if he does not repay?

- there is no tax exemption for him, find out how will he react if he knows that?

- after repaying a portion, IF HE WERE to drop dead, how will you react?

- if he stops paying after say 3 years, what will you do?

- if interest rate changes for companies, how will you react?

There are many such imponderables for which we do not have an answer, so what to do….?

Search me.

If you are doing private deals…inagine the risk that you are taking

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Brilliant advise. If you do not know what a portfolio manager does and what a financial planner does, you have right to talk like this. Also sit on panels to judge ‘who is the best aggregator for mutual funds’ and call him the best fund manager.

A good financial planner should:

- make you understand the importance of goals

- help you set them

-tell you what is practical and what is not

- help you create a portfolio

-ensure that your wife/dependents know and understand what you do

- help you make a will / nominate properly

For all this done well, HE SHOULD GET A FEE. To think he can create a portfolio that will beat the market is wrong. If you get good returns, it is because YOU TOOK THE RISK. If you do not get a good return, you do not get a good return.

Among the good financial planners that I have met – there are only 2 types- a) those who know that they are not portfolio managers and b) those who do not know.

Of course there are those who pretend that they are – and may even have a track record. As soon as they realise the role of luck, better for them.

If there are financial planners who agree to a profit sharing agreement, God bless the planner and the client.

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Let us see some comments:

1. At this point if you are afraid of the markets you should shift to a RISKLESS portfolio of debt funds, FMP and bank deposits.

Yuck, yuck, yuck.

If a 24 year old is saving for her retirement – or anything which is 5 years or more duration, this advice is cruelly inaccurate. I would have said laughable, but somebody may actually listen and shift to a debt portfolio.

2. People who do not want to take risks should shift to a riskless portfolio of debt funds, FMP, and bank deposits.

If the speaker/ anchor does not know / realise that getting NEGATIVE RETURNS (especially over long periods of time) is A HUGE RISK, he/she will make such comments. For a person investing for a 3-4 year horizon and the ability to weather storms in the interim period, this suggestion is stupid and obviously wrong.

3. As your age increases, you should invest more in debt funds rather than in equity funds.

My take: yuck again. This is only broadly true – while implementing the total amount available, the total expenses, how well the children are doing, whether there is an indexed pension, all these factors have to be considered. Do not use it like a truism!

All the three pieces of advise can be right for a few people and completely wrong for a lot of people. The way people say it it looks like a statement that is always true. Statements like ‘Sun rises in the East’ – is always true. However these statements are not ‘Always true’. At the time of retirement for example there is NO NEED TO SHIFT EVERY THING TO DEBT. You will need to tackle inflation, ability to withdraw during real bad times, ability to handle stress in a market going down for say 10 years etc….

Please understand the difference between ‘has not happened’ and ‘cannot happen’…- risks of watching the media, perhaps? LOL

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Well let us attempt an answer first…then decide whether the question is stupid….

The full repayment of principal and interest is guaranteed by the government, so there is no way how you will get less than what you paid for. So in a way it is safe.

However if you have a 8% bond maturing in 20 years…and you have bought it at Rs. 100 and redeem it at Rs. 100, and inflation in that period has been 8% p.a. YOUR REAL RETURNS ARE NEGATIVE (negative because of the post tax yield that you got!). Thus government securities will more or less give you a ZERO return, but it will surely repay the money that you had lent fully!

With foreign lenders there are 2 games that government can play…

1. Print as many notes as you can – inflation will ensure that the rates that the country is benefiting by the excessive printing. For those old enough to remember, the Yen was at 330 to the Dollar! Now it is 75 and falling. I think we will live to see a day when a Japanese says ‘here is a Yen, gimme a dollar’. The Japs may feel good, but what they are getting back is 20% of what they had lent. Risk? Totally.

2. Keep exchange rates under artificial control: again this will mean you will lose all the money that you have lent!

India has a lot of reserves – and too much of it is in US Dollars. We like to say ‘Our exports are….in US Dollars’. Remember if Ben Bernanke prints like there is no tomorrow…it may not be a far day when the dollar rupee rate may be Rs. 30 to the dollar. Currently all governments are printing notes – so that we can continue to ‘sell’ to US.

Well, let us continue to say ‘Government Securities are safe’ but at least not cheat our own selves….

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Investment in turbulent times!

The market has gone nowhere in the past 4 years. When your financial planner / relationship manager / advisor told you that equities are for the long run he/she also said ‘long run’ means more than one year, correct? Well you invested when the index was 20000 and after that the market has just gone down. First it went all the way to 9000 and then it came up to 20000, but now is at 17000.

Far more importantly the shares that you bought and the mutual funds in which you invested have fallen by almost 40%.

Your advisor has started some other business, and is now not taking your calls. Your wife is screaming at you for putting HER money into direct equity – and she is not able to withdraw it for her sister’s wedding. She had promised her dad she would pay Rs. 100,000 for the same, but the shares are worth only Rs. 62,000! You are at your wits end.

What is to be done?

Just go back in time. Rewind to Diwali 2005. All the bulls including die-hard bulls said the market would have done great if it ended Diwali of 2006 at the same index as Diwali 2005. No expert was willing to brave even a 9000 call.

What actually happened? Just go back to your older files, and refresh. The market made these bulls look ordinary. January, February, March…. the markets cross 11,000 then April sees 12,000. Then, we celebrated. We made 12,000 stickers and stuck it all over the place. We made T-shirts, mugs and celebrated 12,000.

We assumed that the market is a place where there is no downward risk!

Let us rewind even further, say 1993 to 1999. The year 1993 was perhaps the worst year in the equity market and was a virtual bloodbath. Markets lost 46% in the financial year ending March, 1993. The returns for the years from 1993 to 1999 are as follows:

-46, +65, -13, 3, 0, 15, and -3.

An arithmetic mean is 3 of these numbers is 3. So we assume that if you had put Rs 10,000 in 1993, you would have got back 10,300 in the year 1999, correct?

Well let us see what would have actually happened:
1993 you would have got  -46  and your corpus would have reached Rs. 5400.
1994  ——-do—————-65 —–do———————————–8910
1995 ———do——            -13 ———-do—————————-7751
1996 ————-do——–     3 —————-do——————— 7984
1997——————-d0 —- 0 % ———–do————————–7984
1998 ———-d0————–15%—-do———————————9181
1999   you would have got     -3% and your corpus would have reached     8906

Over the years this is what would have happened to your Rs. 10,000 – now include 2% amc charges…and that would be even worse

Well it would have been worth Rs. 8906, and not 10,300.

The year 2000 was a good year and gave a return of 33% – so yes you would have RECOVERED your capital. In the national savings certificate it would have doubled.

The key takeaway, ‘The market will do what the market will do. You have to do what you have to do’.
Markets will be volatile. You will see a sensex of 15,000, 18000, 20000 and even perhaps 25,000 in a 12-month period. As a rule everybody loves a bull market. So the FM, the SEBI Chairman and everyone else will look worried and will try to talk up the market.
Keep in mind – for 3 years we have believed that markets cannot come down, and interest rates cannot go up. That might be about to change. We believed that a 2-day fall would be followed by a rise. We believed that the market is fairly valued at 3000, 5000, 8000, 10000 and 12000. We may rethink. We believed that you could go to the terminal in the morning and come back richer at the end of the day with Rs 5,000 or Rs 50,000 simply by buying. The bigger you bet, the greater was the gain. We may rethink on that. We believed that we could build our own portfolio and save the asset management charges that mutual funds charged. We may rethink on that.

The lessons are very simple.
1.    Asset prices fluctuate and they are inversely related to the interest rates. Markets are but an asset class. If it goes up, it will come down.
2.    Individual investors will come, conquer, panic and leave. FIIs will do similar things. You need to act sane. Nothing changes in the economic situation. The solution lies in having an investor mindset rather than a trader mindset.
3.    If you have money for the long run (I mean 4-5 years at least) you should be in the market. If you need to pay your EMI by selling shares, you should be praying in a temple.
4.    If you have an advisor who says 1 year is long term, get another adviser. If your CA says 1 year is long term – he means the Income tax act, not the equity markets.
5.    If you think you understand arithmetic mean, please go back and learn geometric mean, harmonic mean, standard deviation, median and mode.
6.    Equity markets have returned about 22% over long periods of time – with reinvestment of dividend, but please note all calculations ignore taxes and fund management costs. If you include that the final result is not so rosy.
7.    It can take the market say 10 years to touch the previous high. In markets like Japan, it only made new lows!
8.    Be patient do a SIP in a good big fund from a good fund house. If you are worried about fund manager risk, just put it in an index.

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- What happens if the government withdraws medical cover for retirees of government organisations?

-What happens if PPF is frozen for 10 years for all of us?

- What happens if they introduce a withdrawal tax on PPF?

- What happens if your employer tells you that the Provident fund that he was managing has a hole -because the trust was defrauded, and so your assets (you thought it was Rs. 70 lakhs) is now worth NOTHING, and the employer does not have money to pay all of you?

You do not want to get more scared, do you?

Has something like this happened?

Well in the US the employee found a NEVER THOUGHT OF AS RISK – the employer who dipped into the pension fund, and well, killed it. The companies happily dipped into the pension fund….and some of the middle level managers are now working as guards.

So like Taleb says, if you know from where it will come, that is not risk.

The risk that you have to be prepared is the risk that can come from an unknown source. So a lion killing you in a forest is not a risk. However, if you see a deer and think it is a lion and die of a heart attack…then it is unknown risk! Or worse you trip on a vine, fall on a poisonous snake…Anyway read on..WSJ had this good story on pensions:

http://online.wsj.com/article/SB10001424053111903532804576566862041674794.html?mod=sf2tw

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He runs a big, huge 800-pound gorilla of an insurance company, where people like Mr. Jain can buy an risk -at the appropriate premium. In fact Mr. Buffet can buy a small stake in a company, can buy more stake, can merge it with Berkshire Hathway – things which a normal fund manager cannot even think of doing.

Berkshire Hathway is a fantastic company with a great 28 year track record. However over the past 2-3 years it has underperformed the index. Yes you read right, it has underperformed the index. How come it is not there in the index – well it is not traded enough, so perhaps the impact cost could be an issue.

So in my finance class if I ask you to name a great fund manager, you will get a zero if you said “Warren Buffet”. However if I asked you to name a great businessman, a great philanthropist, or a great business communicator and you said “WB” you would get a 10/10.

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Let me enumerate the ‘investment opportunities’ that I missed. Happily for me, I did not even waste an ounce of energy in considering these proposals except remembering the details enough for blogging about it .

Car loan scheme: One proposal was Mr. A wanted to buy a car. So I had to use my IT return (which means my creditworthiness) to borrow from Icici bank (that was chosen by the intermediary) and buy a car. Let us say the EMI was Rs. 18,000, then Mr. A would pay me Rs. 22,000 p.m. for FULL period of the loan and at the end of the period Mr. A would buy the car from me at Rs. X (pre-fixed). That amount would be equal to the down payment of the car (that I made today) + 15% (i.e. 5% simple interest for 3 years).

The person who brought the scheme to me of course told me this was a fantastic 30% return scheme WITH NO RISK at all, and beautifully with no MONEY at all also!

Well to me the risks were as follows:

1. The car HAD to be in my name for 3 – being the term of the loan. If during that period Mr. A decided to hit somebody, do some funny business called drugs, or use it for transporting prostitutes, – and got caught, I WOULD BE IN JAIL. Simple.

2. If ANY person was hurt / killed in an accident in this car, I WOULD BE IN JAIL.

3. If Mr. A ran away with the car, I WOULD BE STILL paying the EMI, AND not even have the asset .

4. Imagine complaining to the police that Mr. A stole my car. If arrested he could produce the papers showing he had the right to use the car. If not arrested I still pay the EMI. For recovering MY money I sue Mr. A. What a ride!

5. I should have played along and seen the agreement papers – would have been able to pick more holes in that perhaps.

more about such schemes….in later posts!

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Let me see:

1. He underestimates risk, and dramatically underestimates risk.

2. He takes one theory of investing in real estate and makes it look great.

3. He ridicules all other methods of earning money. This is ridiculous – the fact that everybody tries the same model will reduce the returns from that model . This is what Morgan Stanley calls ‘Convergence of Strategy’ in a well documented research paper.

4. He ridicules all people who are employees and use the 401(k).This is like criticizing about 99% of the people I know. I cannot AFFORD to take such a view. Sure employees do not become super rich. However to use money as a yardstick of success is a STUPID concept. I know of experts who know almost everything in their field – and get invited to Chief Minister’s and Prime Minister’s expert committees – and they earn salaries less than a million rupees.

5. His own strategy could have failed in various markets in India and succeeded in many markets. He does not accept the downside. This is funny I have seen people make big fortunes and make losses too in commodities, real estate, equities, debt, business, etc. Not many middle class people are ready for hardship. Dammit, they do not want it!! – who is RK to force it on ALL?

6. I have met many people who have read his book – only 2 concepts stick – real assets and liabilities and the cash quadrant. However I have not met anybody who has paid ’000 s of $ to attend his seminars.

7. His idea of ‘Cash flow investing’ is similar to ‘Dividend based investing’ which many people born in the decades of 50s, 60s and perhaps ’70s have done. Not sure people born in the ’80s have patience to do it. This is called ageism – like sexism and though I do not like ageism or sexism nor am I sure whether it is correct, I am still saying it….pardon me if it hurts.

more to follow…

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