Recently I attended a corporate meet. The SPEAKER ask the audience about what is ASSET? Two people answered in Technical manner [commerce graduate] but audience could not understand.

Then the speaker raised another question: HOUSE is an ASSET or not?

Some said yes, some said no, Many were puzzled.

Then speaker explain by referring to Book “Rich Dad Poor Dad”. The book said – “Asset is that which put money into my pocket. Home we live in not an asset because we don’t earn anything [no cash flow]. But if we go for rental / reverse mortgage [bank product – pay the owner till s/he lives after their death Bank will sell the house to recover the money] then it is an asset. House can be both ASSET and LIABILITIES.”

What are the ASSET classes available in the Indian Market? They are

  1. Debt Instruments – Post Office, Bank FD, other FD, Bonds etc
  2. Equity Instruments / Business – Shares
  3. Real Estate
  4. Commodities – Agri, Ferrous, non-ferrous, precious metals
  5. Alternative Investments / Collectibles

Based on ASSET definition, many will agree that “Equity” is not an asset class as it is not putting money into pocket but draining it out of pocket.

Let’s think little bit more and we might conclude that all above are not asset class. I am not drunk. Let’s check HISTORY.

Say GOLD. Last 5 yrs it has given unbelievable return. But the same gold correct drastically in previous rally. Investor lost money and they have to wait for almost 2 decades to get their money back. Forget about return. Always GOLD don’t put money into the pocket. In India, we don’t buy Gold for return due to cultural/social reason. Gold market works little differently in India.

Now we come to Real Estate. Luckily we have not seen Sub-prime in India. It is difficult to observe the same here due to genuine buyer. But I remember buying Land in BOPAL [Near to Tata Nano project] in 1995. Till 2001 [Gujarat Earthquake] price did not move anywhere. But after that just rocketed. In last 5-6 years Farmer to under-privileged people who were having some land just became Crorepaties. Point is Sometime you need to wait for years to get your Return, and sometime within short span of time you earn hefty profit in real-estate. If you pick wrong area, then you might lose money or don’t find any buyer. There are issues.

Commodities – take any Agriculture/Metals/Crude – all have cycles of Up and Down. Crude is best example right now.

Collectibles – stamps/art etc – market is not developed in India. Illiquid market is very dangerous – see what happen to OSIAN Art Fund. First art fund in India could not find buyer to sell all the Art and return the money to investor. I met Stamp collector, he was also bullish about Postal stamps [old, printed very few], telling me the market of the STAMPS. You can earn good amount if you can find BUYER otherwise you as stuck with the COLLECTIBLES.

Only asset class we are left is DEBT instruments. Majority India believe that this is the only ASSET. So majority or should say all savings are invested in FD be in bank or Post Office or LIC or RBI bonds or PF/PPF etc. But if we consider the Inflation and/or TAX then reality is different. If I do FD, rate is 9-9.5% in banks and in Companies 12.5% with risk. Official figure of inflation is 7.5% – 8%. Actually real inflation figure is much more than that as we experience. [Return – Inflation] simple calculation will give me negative return.

Then I am left with no ASSET class!!!

More to come.

 

One day we get married or have a baby and suddenly we realize the importance of saving & investment. And want to start investment. But how to go about?

Biggest mistake we make is we never factored in WORST scenarios

  • Loss of Job – pink slip
  • Medical Emergency [parents or spouse or child]
  • Accident
  • Inflation –rising prices
  • Forget to pay Credit card Bill
  • Other emergencies

What we should do then?

In such scenario, we should be able to cut our Liabilities ASAP. Mean?

Say I bought HOME Loan/ PPF/ LIC/ Insurance Policy/ Recurring FD/ Systematic Investment Plan in Mutual Fund / OTHE LOAN etc.

Say I lost my job, can I stop paying for some time till I find another job or postpone the same? This is the reason why we should always make sure we don’t go beyond our means.

Secondly, We should build “WAR CHEST” to fight such scenarios. It means to keep 6-12 month DAY-to-DAY expense/liabilities [subject to one’s lifestyle] in SAVING Bank account or ULTRA SHORT TERM Scheme of Mutual Fund or Fixed deposit with Bank along with Over Draft – OD facility. I have done ALL three.

–          Kept 20,000 Ultra Short Term

–          20,000-25,000 saving bank account

–          2,00,000 Bank OD

Above amount one should decide.

 

One must/should buy INSURANCE also. MEDICAL insurance and PA-personal Accident along with LIFE insurance.[Which? How to choose? Write in future blog]

–          5,00,000 Family floater plan MEDICLAIM

–          20,00,000 Life Insurance

–          5,00,000 Personal Accident policy

 

NOW I have INSURANCE + “WAR CHEST”. Make sure you maintain above corpus based on yearly analysis of your changing day-to-day life style/living standard. And re-fill the same if used.

Above we called Contingency planning/Savings and Risk/Insurance Planning . Now the real investment [earn money out of money] starts or should say confusion starts. Firstly, there are so many options in terms of Products / Companies as well as WHITE-collar job Advisors/Agent/Relationship manager.

 

Secondly, we are also as confused. We hardly know what we want to do with the Surplus Money.

For example, I need 15%+ return but don’t want negative return and 15%+ return each year. I will invest for 2/3 yrs and then decide should I continue or switch. I want to save for retirement but after one year I need the money saved for my retirement due to personal reason. Will invest for 5 yrs but after 2/3 yrs bored by single digit return or negative return or same explanation/story.

 

We over-plan or never-plan or change-plan most of the time and lose hard-earned money. Always invest for Short-term [1-2-3 yrs] and Long term but decide the ratio.

Short term investment will go to Fixed return / Debt securities / Deposits etc. Long term investment will go to Equity/Shares or PPF or Gold/Silver or Real estate or other prevailing options [Bonds/debenture etc].

Asset allocation is the KEY. You never know which asset will perform in the future. It will be GOLD / Real Estate / Stocks / Deposits [Interest rate is also changing -increasing / decreasing]?

 

More on “Asset allocation” in future blog.

1)      Simple Return

A person invested amount 10,000 and after 2 yrs gets 12,000.

Simple return is 10% = { (12,000/10000) -1 } / 2 = 0.1

 

2)      Compounded Return

A person invested 10,000 and after 2 yrs get 12,000.

Compounded return is  9.5445% = {(12,000/10,000)^(1/2) -1

 

3)      Nominal Return

A person invested 10,000 and after 2 yrs get 12,000. Normally interest is paid quarterly.

Nominal return 9.2208% = { (1+Compounded return)^(1/4) – 1 } * 4

Nominal rate is used in advertisement / brochure etc. Reason being people normally takes out interest. Few opt for cumulative option.

 

4)      Effective Return

A person invested 10,000 and after 2 yrs get 12,000.

Compounded return is  9.5445% = {(12,000/10,000)^(1/2) -1

This return becomes important when one choose cumulative option.

I bought Jeevan Vriddhi. It is 10 yr plan. My age is 29. Premium is 1,00,000.

Based on Guarantee Table I will receive 1944.55 * 1.03 = 2002.8865 per 1000 at the end of 10 years. Guarantee amount will be 2,00,288.65. LIC will also give some Loyalty addition. How much? From 0 to ________ [fill the black].

 

Effective return [work like cumulative FD] = 7.1928.

{ ( [ 200288.65 + 0 ] / 100000) ^(1/10) -1 }

5)      Internal Rate of Return – IRR / XIRR

What about if I bought “Konal Jeevan” for a child age 0. As this is money back policy. Pays some % money at interval from age 18 to 26. Best to use IRR/XIRR in Excel to find the return. Premium paid for 18 yrs and Amount is 7,281. (http://www.licindia.in/children_need_002_illustration.htm)

 

Age

Scenario 1 Scenario 2

Age

Scenario 1 Scenario 2

0

-7281

-7281

14

-7281

-7281

1

-7281

-7281

15

-7281

-7281

2

-7281

-7281

16

-7281

-7281

3

-7281

-7281

17

-7281

-7281

4

-7281

-7281

18

20000

20000

5

-7281

-7281

19

0

0

6

-7281

-7281

20

20000

20000

7

-7281

-7281

21

0

0

8

-7281

-7281

22

30000

30000

9

-7281

-7281

23

0

0

10

-7281

-7281

24

30000

30000

11

-7281

-7281

25

0

0

12

-7281

-7281

26

195000

371000

13

-7281

-7281

IRR

5.0609%

7.6680%

 

6)      Compounded Annual Growth Rate – CAGR

CAGR isn’t the actual return in reality. It’s an imaginary number that describes the rate at which an investment would have grown if it grew at a steady rate. You can think of CAGR as a way to smooth out the returns.

Don’t worry if this concept is still fuzzy to you – CAGR is one of those terms best defined by example. Suppose you invested $10,000 in a portfolio on Jan 1, 2005. Let’s say by Jan 1, 2006, your portfolio had grown to $13,000, then $14,000 by 2007, and finally ended up at $19,500 by 2008.

Your CAGR would be the ratio of your ending value to beginning value ($19,500 / $10,000 = 1.95) raised to the power of 1/3 (since 1/# of years = 1/3), then subtracting 1 from the resulting number:

1.95 raised to 1/3 power = 1.2493. (This could be written as 1.95^0.3333).

1.2493 – 1 = 0.2493

Another way of writing 0.2493 is 24.93%. Thus, your CAGR for your three-year investment is equal to 24.93%, representing the smoothed annualized gain you earned over your investment time horizon.

Ref: http://www.investopedia.com/terms/c/cagr.asp#axzz1qZrxHoJ0

7)      Cost adjusted Return

We have take LIC Komal Jeevan Example. But at the time of calculation I have to consider the Service Tax Liabilities borne by me.

In case of Unit Linked product, there are many charges levied on the premium [Better check Unit Statement/Illustration to get an idea].

Say I invested 10,000 and return is 10% normal return compounding quarterly. But there is upfront charge of 10%.

I will get 10,965.63. HOW?

10% charge on 10,000 = 1,000.

Actual investment amount = 9,000.

10% is nominal interest rate and I opted for cumulative option. Effective return is = 10.3813%

9000 *(1+10.3813%)^2 = 10,965.63

 

8)      Tax adjusted Return

Imagine in the above example,  you have to pay 10% tax –  TDS !!!

One more input is required. Above charge is explicitly shown  in the statement?

If YES then profit = 10,965.63 – 9000 = 1965.626.

If NO then profit = 10,965.63 – 10000 = 965.63

Tax will be  196.5626 OR 96.563.

Return will be = 10,965.63 – { 196.5626 or 96.563 } = 7.69% OR 8.69%

Normally it is the “Second Case”.

 

9)      Inflation adjusted Return

Bigger problem. We can’t control it or should I say no one can control the Inflation. So TAX and Charges are under our control.

Say inflation is 7%.

I earn 10% on my investment [effective]. At the end of year my investment of 10,000 will be 11,000.

But at the same time the value of 10,000 will be increased to 10,700 at the end of the year. So return is (11000 / 10700) -1 = (1+10%)/(1+7%) – 1 = 2.8037%

 

Various method to calculate “RETURN”

Welcome to the financial world of jargon

1)      Simple Return 

2)      Compounded Return 

3)      Nominal Return 

4)      Effective Return 

5)      Internal Rate of Return – IRR / XIRR 

6)      Compounded Annual Growth Rate – CAGR 

7)      Cost adjusted Return 

8)      Tax adjusted Return 

9)      Inflation adjusted Return 

While evaluating Various option one should look at below return. Microsoft Excel can be very useful in calculating above returns.

i)Market Linked — CAGR / XIRR

  1. All Mutual Fund Schemes except FMP
  2. Unit Linked Plans – Insurance
  3. Stocks / Shares
  4. Listed Bond / Debenture

ii)Non Market Linked — Effective / Compounded Return

  1. Any Fixed Deposits – Banks / Company
  2. Bonds / Debentures
  3. FMP in Mutual Fund
  4. Post Office Schemes

iii)Insurance Product / Traditional Plans – IRR

  1. Jeevan Anand / Saral / Komal Jeevan – In short all LIC / Private Life Insurance Investment plans
  2. Guaranteed Plan offered

Last week, one of my father’s best friend son drop a mail. He showed eagerness to buy Term Plan.

In first mail, I responded by stating don’t buy Online Term plan and go for cover offered by private companies like ICICI or Kotak rather than LIC.

Reading my mail, he did Google and find premium for Kotak – e-preferred term plan and ICICI i-Care term plan. Replied me.

I told, ONLINE plan don’t involve any broker. As one is directly dealing with Company, Company is providing discount to you. Just like you do any booking (hotel/air/railway) with help of travel agent or directly.

There are many article also on the web – talking various benefits of such ONLINE term plan and what needs to be considered while going for such plan.

But I have very simple question – “Term plan benefits is given to Family member as insured person is dead! Who will make sure the benefits are paid? Normally agent/advisor make sure that. As there is no agent who will do it? Relatives! People are so busy with day-to-day life that they don’t have time to run from pillar-to-post.

Secondly, how much are you saving? No-one is calculating the same.

I calculated for above person born on 31-12-1981 for 50,00,000 insurance no rider for 30 yrs.

KOTAK e-preferred term – premium is = 6,500 approx

preferred-term – premium = 7,800 approx

Net savings = 1,300 * 30 yrs = 39,000

What to DO – Save 39,000 and leave claim settlement hassle for family or hire agent for the same!

Many people are going for lower premium as there is no return. But don’t forget to check death claim settlement ratio if the company in % term as well as in absolute term (total amount paid in INR). Why the company is offering such a cheap plan to get more business and later refuting the claim ?

Happy INSURING !!!!

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