Risk profiling....Investing with a different perspective(Part II)

Continued from Part I

Coming back to the query:

"Could you please elaborate on how different assets come with varying combinations of return, risk, liquidity and throw light on the desired holding period of each asset class."

Once you have listed your financial goals and obtained the results of your psychometric test you are now set for product selection.

Let’s start with one of the more popular asset classes which is an important part of any portfolio - DEBT

Low Risk Low return:

This asset class includes investments like bonds, NSCs, Fixed Deposits, Corporate Deposits, PPF, EPF among others. All these products are essentially money given on loan to an entity like the government, govt backed organisations or others like a company and hence the term – debt.

Debt products are characterised by two things – safety of principal and fixed and regular income, hence this class of assets is also called fixed income investments. There is a guarantee to the return of principal –the level of guarantee would depend on the entity that you are giving the loan to – therefore if the debt product is a government bond then it will be more secure than say, a corporate bond. There is a return earned which is usually expressed as a percentage and given out as interest income at periodic intervals.

It forms the bedrock or foundation of any portfolio.

This safety comes at a price and that is mediocre return. While the returns are fixed and guaranteed, they are not high enough to give you the much required edge over inflation and taxation. In the long run to grow your wealth, you need the stimulus that comes through equity investing.

However, irrespective of your goals or your age, a certain portion of your portfolio needs to be in debt as a plausible alternative to volatile equity, forming the base of your portfolio – especially during times of high inflation and high interest rates.

Among debt products, bonds, fixed deposits, G-Secs, NSCs have been around for years and serve your needs of safety and regular income very well. 

What is lessor known are the various Advantages that DEBT MUTUAL FUNDS have to offer:

1. You can invest in any of the debt products with an added advantage of returns earned by way of dividends being tax free in your hands and the long term capital gains earned also being subject to indexation, resulting in lower tax outflow as opposed to interest earned on bonds and deposits which are taxable on  an accrual basis.

2. There is a wide range of debt funds available to meet different needs - liquid funds, as good alternative to savings bank accounts for short periods like 1 to 3 months; short term funds for 3-6 month time period; income funds and actively managed funds for a medium to long-term horizon i.e 6 months to 24 months.

3. An added advantage Mutual funds offer is also that you can easily switch to and from equity funds especially when you would like to re-balance or realign your investment portfolio.

Duration or holding period.

This will purely depend on your financial goal and/or the present/future market conditions. Some examples:

1.If you have a goal coming up in a year like a holiday, start an SIP in a liquid fund.

2. If you are retired or approaching retirement, a major portion of your portfolio should be in Debt assets.

3. PPF  is a superb debt instrument as you already know. Opening PPF accounts for your children will help in their long term financial Goals like Higher education.

If you don’t have an Employees' Provident Fund, then you must invest a good amount in PPF every year.

Important Tips:

Since the debt market in India does not have enough depth yet, it is important to invest in schemes that have larger assets under management (to avoid volatility on account of frequent entries/exits from such schemes by other larger investors) and AAA rated securities.

Stay tuned for more....

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source: livemint.com

With inputs from Novai Lovlakhi CFP

Risk profiling....Investing with a different perspective(Part I)

Writing on a blog every week is quite refreshing and tedious at the same time. At one point your are full of ideas(you want to write about) and the next moment you are caught up with office work and then desperately searching for time to write. Nevertheless its refreshing and I am enjoying it thoroughly. The reason I am sharing this with you(my readers) is because I was absolutely clueless about the response I would get for friday financials when I started writing. Mind you! I'm no professional writer hence crossing 1000 page views in 15 weeks for my blog (this week) is a great achievement for me.

THANK YOU for the over whelming response.

A couple of weeks back, in response to an earlier post on friday financials I had received a query from one of the readers. Instead of replying directly to the same I will try to answer it through this post(a lenghty answer).

Here is his query..

"Could you please elaborate on how different assets come with varying combinations of return, risk, liquidity and throw light on the desired holding period of each asset class."

Different assets have their own role to play in one's Financial Portfolio and various aspects like return, risk, liquidity come with it. So, for example, if you consider a product like PPF which falls in the debt asset class, it is a 15 yr investment with great(tax free) returns, low risk and limited liquidity. Although it might assure you of a certain future value, simply directing all your saving towards this product might help you in your long term goals but surely will not for goals having shorter time horizon. Hence you need to strike a balance between different asset classes to meet your short as well as long term financial goals.

I have already written about asset allocation in my earlier posts, so today its time to look at your investments with a different(psychological) perspective. This is where risk profiling comes in.

When you see your money increase or decrease it has direct relationship with your emotional state. If your money keeps increasing, you will feel excited, and on top of the world, and when you see it decrease or going down day by day you will feel anxious & despair on your investment decisions. Our emotions guide us in our day to day life, and they are very helpful in your financial life too.(to determine risk)

The biggest risk is not taking any risk... In a world that is changing really quickly, the only strategy that is guaranteed to fail is not taking risks.

Mark Zuckerberg

What is Risk Profiling?

Risk profiling is a process of finding the optimal level of investment risk for you considering the risk required, risk capacity and risk tolerance, where:

1. Risk required is the risk associated with the return required to achieve your goals from the financial resources available.

2. Risk capacity is the level of financial risk you can afford to take, and

3. Risk tolerance is the level of risk you are comfortable with.

If you are not willing to risk the unusual, you will have to settle for the ordinary.

Jim Rohn

The first two aspects of Risk profiling are addressed by financial planning whereas Risk tolerance is a psychological characteristic which is best determined by way of a psychometric test.

The way savings are accumulated can also provide clues as to what the risk tolerance level of an individual is. One way savings can be accumulated is through a passive means, like an inheritance or a lump sum payment from a lottery, litigation, bonus or unexpected dividend. Savings can also be accumulated using an active means, such as business which takes substantial risk taking and effort. Thus, the willingness to participate in risky activities is usually much higher for entrepreneurs and active capital accumulators.

For individuals who have accumulated wealth through passive means or saving (delayed consumption), investment risk may not be very appealing because they may not understand the concept of risk and commensurate return. Moreover, these individuals may not be confident that they can earn this wealth back if they experience steep losses.

Age is often used as a factor in determining one’s risk tolerance. More often than not, younger investors have longer to recover from temporary losses, so they can stomach higher market volatility. John Bogle, the founder of Vanguard, along with many other asset allocators, recommends(as a thumb rule) that one should equate the % of fixed income in a portfolio to one’s age, or equate the % of equity in a portfolio to one’s age.

Risk profiling consists of knowing one’s sources of income and capital, perception of wealth, and career stage or age. All of these factors can help one judge his or her risk tolerance.

Risk comes from not knowing what you're doing.

Warren Buffett

To be continued.....

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source: finametrica

This time be a Tax Planner (not a Tax Saver)....

March 2014 is upon us. Its tax saving season(for some). But why only march, why not April 2014? Just because the financial year is coming to an end?(its not the end of the world) A number of savers wake up from their 11 month slumber to the realisation that they have to save tax.

I have come across several investors who have bought insurance policies like Money-back, endowment plans and ULIPs or any other(unwanted) products to save taxes. This is a common mistake most of the investors do. They just don’t realize that they are trapped in these unwanted products because of their obsession with Tax saving. Most of them are today investing in products which do not suit them, which they don’t need, which they do not understand. All because of their idiotic decision of “Investing for Tax Saving!!”

This reminds me of ....

SANTA: Why are you throwing your money in the Pond? !!

BANTA: YOU KNOW WHAT!! Govt. Says that we can save up to Rs. 30 in Tax for every Rs. 100 we throw in this Pond!!

For some people the products they buy for Tax saving are like This Pond.

They are not sure what they will get from buying it, but they are happy about the fact that they are saving some money in tax!

But have you ever wondered whether it is a prudent way for tax savings?

ABSOLUTELY NOT!. Remember, merely buying products to save taxes will never drive it towards “Tax Planning”.

In my opinion, tax saving is a just another path towards the tax planning exercise.

75% of the people invest their money only for saving tax, 20% of them invest so that their Money can Grow and 5% of the people do proper Goal based investing.

Unlike “tax saving” which is generally done through investments in tax saving instruments/products, under “tax planning” you take into consideration one’s comprehensive financial plan after accounting for one’s age, financial goals, ability to take risk and investment horizon (including nearness to financial goals). And by adopting such a method of “tax planning”, you not only ensure long-term wealth creation but also protection of capital.

Other common Mistakes of a 11th hour tax saver:

1. Buying Unit Linked Insurance Plans

2. Ignoring power of compounding through PPF and or tax saving mutual funds.

3. Not optimizing all options for tax savings

4. Acting under Agent/ Distributor’s control

A Prudent exercise of tax planning extends to appropriate investment planning, which also takes into account your ideal asset allocation by considering the under-mentioned factors: (after you have utilized the tax provisions within each head / source of income)

Age  - For prudent tax planning, if you are young, you should allocate more towards market-linked tax saving instruments such as Equity Linked Saving Schemes (ELSS) and National Pension System (NPS), as at a young age, the willingness to take risk is high. One may also consider taking a home loan when you are young, as the number of years of repayment is more along with your willingness to take risks being high.

Income - Similarly, your risk taking capacity increases with higher income. This can work in your favour, as you have sufficient annual Gross Taxable Income (GTI ) which allows you to park more money towards market-linked tax saving investments, for generating higher returns and creating a good corpus for your financial goal(s). Also, on account of the higher GTI your eligibility to take a home loan increases, which can also help you to optimally reduce your tax liability. Make sure that you do not just take a Home loan for saving tax, that could actually spell a disaster for your long term goals like retirement.

Financial Goals - Financial goals which one sets in life, also influences the tax planning exercise. So, say for example your goal is retiring from work 5 years from now, then your tax saving investment portfolio will also be less skewed towards market-linked tax saving instruments, as you are quite near your goal and your regular income will stop.

Restructuring your Investment Plan:

Tax Saving is just a benefit provided when you invest your money. Don’t make it as a Primary objective to Invest. What you have to concentrate on is your Tax Planning. You have to restructure your Investment plan in such a way so as to get Tax Benefits from them. Tax Planning comes first and Tax saving second. If you are not able to save tax, it’s fine, PAY TAXES.

Hierarchy of products for tax saving:

1. Life insurance: Make sure you have adequate life insurance cover. If not, take a term insurance for amount of the cover you are short of. Protection is the first step of successful financial planning. Take a Term Plan from two Insurers.

2. Health Cover: The next thing you should target is Health Insurance. Better take a Family Floater Plan for your Family and the premium will be exempt under Sec 80D up to a maximum of Rs.15,000/- annually.

3. Planning for Long Term Goals: Make a list of goals for long term like Retirement, Child Education, Child Marriage etc (Anything with a target date of 7+ yrs). If the goal is extremely critical and you are not a risk taker then the best thing would be PPF. If you can take some amount of risk, you can invest in a combination of PPF and ELSS(Tax saving) Mutual funds.

 Conclusion

Tax planning should always be done at the beginning of the financial year. Always, so that you don’t take wrong decisions in a hurry. But if you are late, then you are better of saving tax by investing into low risk products like NSC/PPF or a 5yr Tax Saving Fixed Deposit for the time being.

Disclaimer : Funds are used for depicting long term performance and should not be construed as advice for investment.

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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Image source Valueresearch online 

Data Source: Financial Planners Guild of India

Empower yourself by transitioning...

Some days back I was privileged to attend a session on Mastering Asset Classes in investments which was presented to us by a very senior and highly knowledgeable trainer (Madam) Ms Uma Shashikant. Madam is a PhD in Finance(Goa University) and has been a trainer, researcher and consultant in the capital markets area since 1988. She is currently the Managing Director for Centre for Investment Education in India(which she was instrumental in setting up).

Madam is a noted and well respected personality(throughout India and also) in the Financial Advisor fraternity in Goa, not just because of her current post or position but more importantly because in the late 90's, when the regulator (SEBI) came up with a mandatory exam(AMFI) to qualify for the distribution of  Mutual fund products, madam travelled down from mumbai and trained most of the mutual financial advisors(including both my parents) in Goa for this exam which helped them in continuing/setting up their profession. We will be eternally grateful to her for this effort.

In this post I would like to share her views on Transitioning from Saving to Investing.

First, savers are hoarders. Storing money in some visible retrievable form appeals to them. They accumulate assets that make them feel they have something of lasting value. They fail to see that assets will need to have an economic value today or in the future.The transition to becoming investors requires the mindset to view assets for their economic value, and plan who will realise that value, how and when. Mere accumulation of something of value is not good enough.

Second, savers are focused on outcomes, not processes. They are keen to know what they will receive if they gave their money to someone. They are thus gullible to fraudulent packaging of financial products. Several gave their money to dubious schemes, plantation projects and unknown deposits. The motivation is the promise about what they would get. Their focus is on the return. Therefore, safety for them lies in the return of principal invested.

To transition from saving to investing, is to come to terms with risk and get armed to deal with it, rather than hope for risk to go away.

Third, savers fail to work out the math in finance. Since their focus is on preservation than growth, they are not sensitive to the fact that every rupee can earn interest every day. They do not seek the efficiency of putting their money to work, and abet lazy money lying unused. Allowing money to lie in bank accounts is quite common among savers. As long as they know the money is safe, not putting it to use does not bother them. To transition from saving to investing is to see the merits of asset allocation and diversification. To invest is to understand that it makes perfect sense to earn an average return at lower risk, by investing in a range of assets, rather than try and figure out the next best thing.

Fourth, savers are lured by bargains. They like the idea that a rupee saved is a rupee earned. They also feel a sense of importance and accomplishment when they have made financial decisions that result in immediate, visible savings. Buyers of insurance products do not see it as a decision that involves regular outgo of premium over years for risk protection and a poor rate of return. They only see the immediate tax saving that is possible. They also like the benevolent seller who compels them to save some money regularly. Young earners buying large homes so they compulsorily save and build an asset, which will grow in value, fall in the same category. They fail to see that they may need liquid assets in early stages of their lives. To transition from saving to investing, they need to see that assets come with varying combinations of return, risk, liquidity and desired holding period. There is no right combination that works for everyone. While choosing a product you need to consider immediate as well as future needs. After saving tax for three to five years, several default on insurance policies, unable to set aside the huge premium. Tax was saved, but an investment opportunity was lost.

Fifth, savers like icons and have a righteous view of things. They think there should be a prim and proper way of doing things and if they have to become investors: someone should lead them to making the right decisions so that they are protected and guided correctly. As it is in life, so it is in investing. There are no ideal marriages or ideal jobs. The shades of grey in investing are something they should learn to deal with. Savers 'kick and scream' about being led astray and their expectations from service providers tend to be unrealistic. Investors see that they have to make informed choices, and be responsible for their actions. They are prepared to do the hard work, when they make their investment choices.

It is important to save. This is what we were told when we began to earn money. We repeat the same lesson to our children. We then retire with the same attitude of wealth as a saved pile. We seek protection, assurance, promise, safety and all those comforting outcomes from the money we have saved, but we still fail to see ourselves as investors. 

So, what will it take for you to transit from being savers to becoming investors?

Ninad Kamat

CERTIFIED FINANCIAL PLANNER^CM

www.letsmakeaplan.in

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