Dear All,

Please find below a good article on issues faced with regard to P/E Ratio as appeared in Morning Star for your reading:

Issues with the P/E Ratio

The price earnings ratio, or the P/E ratio, is widely quoted by the investment community. It is also sometimes known as “earnings multiple” or “price multiple”.

Simplistically, it is arrived at by dividing the price of a share by the earnings per share, or EPS. For example, a Rs 200 share price divided by EPS of Rs 20 represents a PE ratio of 10. Theoretically, this means that if we were to buy this company today it would take 10 years to earn back our investment.

The P/E ratio tells us how much the market is willing to pay for a company’s earnings. A higher P/E ratio means that the market is more willing to pay for the earnings of the company and has high hopes for the future of the share. Conversely, a lower P/E ratio indicates that the market does not have much confidence in the future of the share.

There are plenty of issues with the PE ratio. One is that it does not account for any type of growth or the lack of it. Also, companies with major debt issues are obviously higher risk investments, but the P in the P/E ratio only considers the equity price and not the debt that the company has incurred.

Karl Siegling, portfolio manager at Cadence Capital, mentioned in Morningstar Australia some of the problems he associates with the P/E ratio. They are reproduced below.

1) The biggest and, by far, the most dangerous component of the P/E ratio is that the earnings are the accounting earnings as defined by the accounting standards for a particular country. These earnings are not the cash earnings of the business. In fact, many companies listed on the stock exchange earn no cash despite reporting profits.

2) A problem with the P/E assumption is that future earnings will be at least what they are currently. In the case of a company trading on a 10 times P/E ratio, we as investors are taking a chance that earnings will be at least what they are today for the next 10 years!

Working as an investor in the industry, it is quite clear that estimating the earnings of a company listed on the stock exchange for a year or two into the future is extremely difficult, let alone 10 years into the future.

3) Another problem with the P/E ratio is the idea that 10 times earnings is cheaper than 15 times earnings. The assumption that a company will earn its current earnings for the next 10 years and an investor will get their money back is, of course, theoretical.

A company's earnings may well go up significantly or down significantly over the next 10 years. It would follow that we as investors should prefer to own a company whose earnings go up significantly over the next 10 years rather down significantly. The P/E ratio has no way of telling us what will happen!

4) The P/E ratio tells the investor nothing about a company's balance sheet. It may be that a company trading on a 2 times P/E multiple is actually incredibly expensive since the company has a very large amount of current debt that it has no way of paying, and as a consequence, the company will be declared bankrupt in the current financial year.

We need only look back to the recent global financial crisis to find many examples of companies in exactly that situation.

5) The P/E ratio tells us nothing about the quality of a company's earnings. We may look at one company trading on 8 times earnings and declare it cheaper than a company trading on 16 times earnings.

We often hear conversations along these lines. However, upon closer inspection we discover that the company trading on 8 times earnings has just had a one-off profit never to be repeated and that the company on 16 times earnings has displayed 20% per annum earnings growth for the past 15 years.

It may well be that once these factors are taken into account, the company on a 16 times P/E multiple is actually a better investment than the company on 8 times.

The P/E ratio still has a place in valuing stocks, but investors need to use it in combination with other valuation methods, never as the sole reason for investing in a company.

http://www.morningstar.in/posts/24042/5-issues-with-the-pe-ratio.aspx?utm_campaign=just5&utm_medium=email&utm_source=morningstar

Here’s all you need to know about the trust and why it is important for you as an investor:

Dear All,

Please find below the basics of REIT's recently okayed by Sebi:

The market regulator, Securities and Exchange Board of India (SEBI), recently approved the setting up of real estate investment trusts (REITs). 

Here’s all you need to know about the trust and why it is important for you as an investor:

· What are REITs: REIT is an investment vehicle like a mutual fund, which invests in real estate. However, unlike a mutual fund which would invest in shares of realty companies, REITs would invest directly in real estate assets like office and apartment buildings, shopping centers, hotels and even warehouses. It could also invest in developers for building new projects. Thus, REITs engages in financing the real estate, helping people indirectly invest in commercial or large properties.

·  Why REITs are important to investors: Property or real estate is always an animated and exciting conversation. You often talk about property prices in various cities in the country with friends and wish you could benefit from the rise, without having to pump in the lakhs and crores of money required. This will now be possible through Real Estate Investment Trusts (REITs). REITs are also comparatively less risky in comparison with investments in under-construction properties. Investors will benefit from this. They could also help provide a regular secondary source of income, as 90% of the income earned from rent has to be distributed to investors. REITs also provide an avenue for investment in properties that are not easy for an ordinary investor. For example, REITs will allow you to invest in commercial estate like office complex, malls and hospitals etc. which is otherwise unaffordable.

· How they work: The idea of a REIT is to provide investors with an opportunity to invest in large-scale and diversified real estate that earns returns in the same way as an investment in other asset classes. A REIT works for an investor like a mutual fund. Just like when investing in mutual funds, you do not have to own stocks, similarly you do not need to own property when investing in REITs. A professional fund manager will pool money from investors and manage it by buying or selling properties on your behalf. You, thus, get the benefit of the market movement in prices through your unit holding. REITs will also be listed and traded on the stock exchange. This helps provide liquidity – something not easily available while investing directly in realty.

·  How developers benefit: For developers, REITs are positive as they could act as a private equity fund or a sponsor to a developer. SEBI has stipulated that investors must put in a minimum of Rs 2,00,000, while the trust should own assets worth at least Rs 500 crore. Assets under management of REITs are expected to touch $20 billion by 2020, according to a media report quoting real estate consultancy Cushman & Wakefield. Of this amount, as much as $12 billion could be raised in the first three to five years, the report added. This will act as an important source of liquidity for the cash-strapped realty sector, which is already teeming with high debt. With interest rates remaining elevated due to high inflation, REITs will be a welcome source of cheaper funding.

· Transparency and accountability: REITs are likely to bring in transparency and accountability in the real estate sector. In 2008, SEBI was hesitant to launch REITs. This was because there were inconsistencies in the valuation of properties in the country. This made it impossible to fairly price properties in which REITs can invest. Now, the regulator has said that an independent party will assess the property value every six months. This will be in addition to the yearly valuation check by two independent valuers. Also, the net asset value of REIT units will be declared at least twice a year. This will ensure transparency and correct valuation of the underlying assets of REITs.

Don't let your standard of living outrun your savings

Morningstar's editor of personal finance, Christine Benz, posed some interesting questions to US-based financial planning expert Michael Kitces. The discussion focused around Kitces blog post where he advises readers not to spend more than half their raise. Below is an excerpt.

Instead of investors saving 10% or 15% or 20% of their salaries, you think a better way to look at it is to focus on what you're consuming. Tell us about that thesis and how that requires a change in mindset.

The big challenge I have with these traditional rules of thumb--we're going to save 10% of our income, we're going to save 20% of our income--is when you look at that over a lifetime, there are really two faces to this. As I get raises and I increase my income over time, there's a percentage that I save and I keep saving that percentage as my income rises, and there's a percentage that I consume, because I'm also going to lift my consumption as my income rises.

The problem that occurs when you have a strategy like, I'm going to keep saving 10% of my income or 20% of my income, is that it basically says, I'm going to spend 80% or 90% of every raise. And what ends up happening when you go down that road is, your standard of living starts to rise so quickly that your savings actually lose pace, and you end up further and further behind on your retirement. Think of the logical extreme, by the time I'm in my 60s, I'm suddenly spending $150,000 a year and saving 10% of my income from when I was making $50,000 when I was 25; that isn't going to cut it.

The problem is, when I lift my standard of living, not only do I lift how much I'm spending, I'm generally lifting how much I'm going to be spending for the rest of my life, so that every increase in my spending is an increase I'm going to have to fund for 30 years of retirement. And so we see this outdistancing effect where, as my standard of living rises, it ends out rising so quickly and my early savings are so far behind that I basically never catch up, or I have to save something like 20% to 30% of my income throughout life just to get there.

Is there a prime time for people to get really busy in terms of saving and enlarging their nest egg? Such as the pre-retirement years when one is in their 40s and 50s.

We can come at this from two ends. For people who have gone down this road a little bit already, and maybe their standard of living did ramp up a little bit faster, we do have these natural life transitions that are catch-up points. The kids are done and they're out of college, and spending can decline since we don't have the actual cost of supporting children or college expenses. Some can even downsize their homes and free up some capital in the process. And so we see a pretty significant transition opportunity that happens there.

The problem that we see in a lot of situations is, once I'm used to that spending, however much it is-- Rs 20,000 a month or Rs 50,000 a month --whatever that amount is that we live on, however much that goes out of our checking account every month, tends to be the number that we're so used to spending. So when college and kids' expenses start to disappear, we just start substituting. So oh, I'm done with the mortgage, so I'll buy a second house. Oh, we're done with the college expenses, now we can take more vacations. And we start doing these trade-offs, which means we don't start playing catch-up.

One of the actual big warning points that we have for a lot of clients who are going into their 50s is to take a hard look at whether and how your spending behavior changes as you start getting to those transitions. These are the years you can do some really big saving and catching up, and that's normal. It's normal that you don't have a lot to save in your 30s and 40s. You're building a career and you're making a home and you're raising a family, and all of those pieces, but it does mean you have to be prepared to do a little bit of catch-up in later years as we hit some of those transition phases.

What are some concrete steps that individuals can take to ensure that their spending isn't getting out of control?

One of the rules of thumb that I've been experimenting with as an alternative to this idea of saving 10% or 20% of your income or 20%, is don't focus on how much of your income you save, focus on how much of your raises you spend. Give yourself permission to spend 50% of every raise that you get going forward. It's a pretty good number. You are going to feel like you are getting wealthier and you are spending more every year. So, you get all those enjoyment aspects of, I made more money, let's go spend more money.

But what actually happens over time is, if you merely spend 50% of every raise, you are implicitly saving 50% of every raise. And over the span of just a couple of years … if you are getting raises of maybe 10% or 12%, particularly when you are younger, you are often outpacing inflation--you get promotions, you have job changes, things that move up our income a little bit more quickly. We see scenarios where suddenly after 10 years of doing this, you've gone from saving absolutely nothing to saving 20% of your income, and it's painless.

You didn't have to give up anything. Technically, all you've given up was future increases you weren't spending yet anyway, so you never feel like you are going backward. And we see it as a path to get to absolutely extraordinary savings rates by basically committing to save a lot of our future spending increases and therefore making sure we don't spend our future income increases.

When we go down this road and we run the numbers out for a period of time, you get scenarios like, if you are 25 and you save 10% of your income very year, by the time you are actually ready to retire, you've only got about half of what you need to retire because your standard of living has gone up so much.

On the flipside, when you start saving 50% of every raise and your standard of living just rises more slowly, 30 or 40 years later, you're spending 30% to 40% less than the other scenario.

We're very cavalier about how quickly we raise our standard of living as we get a little bit more income, and then don't realize how hard that makes it to go backward. It's the way we're hardwired. We don't like to go backward. Once we get used to a certain standard of living, anything that goes backward is pretty traumatic. Maybe I can tighten my belt for a year or two, but I don't really like to go backward. If we're just a little bit more controlled about how much we move up our standard of living as we go, the whole path is much easier. You get an incredible ability to save, you get a much easier transition to retirement, because there's just not as much that you need to save, and it's just a much steadier path for people.

The paradigm shift is to back away from let's just figure out how to save a percentage of our income, which automatically means our standard of living rises quickly, and let's come up with a rule that actually focuses more directly on our standard of living itself, and try to control the pace of how quickly it rises. That's the key fundamental difference between saving 20% of your income, or whatever your number is, and spending 50% of your future raises.

I like to talk about the spending side because, we like to spend. The rule is, save 50% of every future raise, but it's more fun to talk about spending 50%. Look forward to every raise, because you're going to spend more. Just don't spend all of the raise and don't even spend 90% or 80% of the raise. Just spend 50% of the raise. You're still going to feel richer, but you're going to be on a much better path.

This discussion featured on Morningstar's U.S. website and has been edited for an Indian audience. 

Dear All,

Please find below a good article 'How Warren Buffett the Key to Happiness?' have a good reading:

How Warren Buffett Found the Key to Happiness

Money will not change how healthy you are or how many people love you. — Warren Buffett

So let’s start off with a tough reality: it’s unlikely that any of us will be as rich as Warren Buffett. In fact, he’s so rich that one-thousandth of a percent of his wealth is still about $6.5 million.

Before I get into why Buffett is winning at life, let me answer the question that’s probably roaming in the back of your mind: How could I possibly relate to someone so wealthy?

The answer is simple. Buffett was not always the mega-billionaire he is today. In fact, he had a rather humble upbringing. Yet he always had a clear vision of his future. In his high school yearbook, Buffett described himself as a “future stockbroker.” Either the man was highly driven to accomplish his goals, or he was clairvoyant.

What many do not know is that, despite his current wealth of billions, Buffett still lives in the home he purchased for $31,500 in 1958. (That would be about $250,000 in today’s market.) While the home has reportedly undergone renovations over the years, it is still not the mega-mansion most would expect America’s second-richest person to call home. So why does someone with more money than the entire economy of Uruguay choose to live in such a modest dwelling?

When asked this very question at a recent shareholder meeting, Buffett responded, “I don’t think standard of living equates with cost of living beyond a certain point. Good housing, good health, good food, good transport. There’s a point you start getting inverse correlation between wealth and quality of life. My life couldn’t be happier. In fact, it’d be worse if I had six or eight houses. So, I have everything I need to have, and I don’t need any more because it doesn’t make a difference after a point.”

What Buffett revealed in his response to the question was much more than a guide to financial responsibility. He shared his personal philosophy about happiness, and it’s very clear it doesn’t depend on overflowing bank accounts. Instead, Buffett says the two are inversely related; more wealth actually reduces quality of life.

In Buffett’s eyes, quality of life hinges upon having good health, housing, food, and transportation. These are fairly basic needs in life, ones that most of us likely already have. But, yet, we still search for more to make us happy. Bigger houses, flashier cars, more lavish meals. We derive happiness from the ever-fleeting joys of having more. But the problem is that no matter how new and shiny and expensive our iPhone is, we still run to line up every time a new one comes out.

How do we translate Buffett’s life insights into practical steps for ourselves? Well don’t worry, I already did that for you.

• Take an inventory of your life. This is probably the most important thing we can learn from Buffett. Despite having enough money to buy whatever he wants, Buffett views objects as merely hindrances to the true joys in life. “The asset I most value, aside from health, is interesting, diverse, and long-standing friends,” he said. The absolute first step to helping bring your important life assets into perspective is to acknowledge they exist. These are the things you cannot replace by going to the store: Your family, your significant other, your friends. This also includes your inherent assets, such as your personality, humor, strength, education, and so on. Write these down on a piece of paper and hold it sacred. They are the most important assets you’ll ever own.
• Embrace the simple pleasures of life. Buffett once said that a perfect day for him would be to have a whole day of peace and quiet just to read, without interruption. Figure out the simple pleasures in your life and find every opportunity to embrace them. Maybe it’s listening to your favorite radio station in the car, watching the news with a cup of hot tea, or literally stopping to smell the roses. Whatever these moments are, cherish them. Allow yourself to be fully present in the moments as they occur.
• Stay true to your core principles and values. Buffett invests in companies in which he believes, rather than in ones that can return the most profit. Buffett has been quoted as saying “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” The essence of this statement is that standing behind principle far outweighs the alternative. Now go back to the list you wrote of your assets. What does this list reveal about your values? What principles helped you achieve some of these assets in the first place? Take the time to answer these questions for yourself. You can write them down if you wish. Once you uncover these values and principles, you’ll reveal an important part of your own identity.

By sticking to these steps, I believe we can unlock the key to a much more gratifying life. These steps may not grant us the same financial achievements as Warren Buffett, but they just may help us better appreciate our most valuable assets.

Asset allocation for investing adults

Bill Bernstein's new book is an excellent read for investors and advisers.

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By Morningstar |  25-07-14 |  E-mail Article

 

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In 2000, Bill Bernstein published his first book, The Intelligent Asset Allocator. It yanked away the punch bowl from the New Era's party. While other investment publications  advocated euphoria and heavy doses of then-popular growth stocks, The Intelligent Asset Allocator preached the unfashionable virtues of diversification, caution, and contrarianism. Among its recommendations were REITs and gold stocks. It was, in short, a hopeless cause--the rare investment tome that sold what would succeed, rather than what had already thrived. Obscurity beckoned.

Then, however, the 2000-02 tech-stock crash made Bernstein a prophet. That his book was clearly written, laced with humor, and addressed evergreen topics ensured its ongoing success. Over the past decade, it has been widely read by both do-it-yourself investors and financial professionals.

This summer, Bernstein published a sequel: Rational Expectations: Asset Allocation for Investing Adults. Much of the material--the basics of Modern Portfolio Theory, asset allocation, and the efficient-market hypothesis--is familiar, although freshly presented. The changes interested me most, however. They addressed my favorite investment question (typically aimed at fund managers, but applicable to authors as well): What have you learned since you started in the business?

The biggest difference, perhaps, is that Bernstein has become much warier of investment science. Never a true believer in black boxes, he is now an outright skeptic. Complicated risk measures are rarely as instructive as the common standard-deviation statistic, he writes, and thinking of risk in purely verbal terms as being "bad returns in bad times" might be better still.

He is even less fond of quantitative asset-allocation schemes. Memorably, Bernstein wrote that rather than place return, risk, and correlation estimates into a mean-variance optimizer, and then following the programme's recommendations, readers should "stuff half [their] money in a mattress and lend the other half to [a] drug-addled nephew." (He may not have intended that literally.) This from a man who named his website efficientfrontier.com.

But that was back in the day. As with many serious self-taught investors, Bernstein has a quantitative background (Ph.D. chemistry, M.D.) and was initially attracted to investing because it had numbers. The field looked suitable for a man of his talents. As many other engineers and scientists have discovered, succeeding at investmentsisn't entirely the same as succeeding at science. Having a good feel for numbers is a necessary condition for investing well, but it is not sufficient.

Bernstein writes, "As Warren Buffett famously observed, investing is not a game in which the person with an IQ of 160 beats the person with an IQ of 130. Rather, it's a game best played by those with a broad set of skills that are rich not only in quantitative ability but also in deep historical knowledge, all deployed with Asperger's-like emotional detachment."

In fact, continues Bernstein, being extremely bright and technically accomplished can actually be detrimental to investment performance. As with prom queens, who overstate the importance of beauty, the quantitatively adept will sometimes overestimate the value of their own gifts. The geniuses at Long-Term Capital Management, for example, had rather too much faith in their ability to outsmart the marketplace and rather too little recognition of the possibility that they might be wrong. Bernstein suspects that many of his readers may fit a similar profile and pleads with them to "fill in what may be the shallow areas ... a working knowledge of financial history and a healthy dollop of self-awareness about [their] discipline under fire."

Put another way, a powerful mindset is at least as important for investing success as is a powerful mind. This realization did not come immediately to Bernstein because the mindset came naturally to him. He was willing to follow what the data suggested, regardless of how his actions looked to others, and regardless of whether the market seemed to agree--even if the market's disagreed for several years. (As with other contrarians, Bernstein spent much of the late 1990s doubling down on losing value stocks, and looking ever more foolish in doing so.)

Most people, however, are wired differently. In Rational Expectations, Bernstein painstakingly explains what was mostly implicit in his first book: Emotions destroy investment performance. Somehow, some way, investors must suppress them. The suppression might come from the blessing of nature; from ongoing investment education; through shielding mechanisms such as holding a blind trust; or, most commonly, by cutting back on stocks and holding a lower-volatility asset allocation. One way or another, though, it needs to happen.

Paradoxically, writes Bernstein, the task is hardest for people who are otherwise admirable. He states, "The most emotionally intelligent and empathetic people I know tend to be the worst investors. After all, the very definition of 'empathy' is to feel the emotions of others, which is deadly in investing." Bernstein relays the story of hospital patients who have brain lesions that disconnect their sense of fear; in investment simulations, those patients handily outperform the general population. For most people, investing successfully is a deeply unnatural act.

Aside from his two themes of using numbers carefully, and of mastering emotions, Bernstein adds several new topics. Among them are his definition of "real" risk (also known as "deep" risk), which concerns long-term damage to capital rather than short-term volatility measures; a lengthy discussion of the investment life cycle; strategic versus tactical asset allocation; and recommendations for when and when not to use exchange-traded funds. He also gives return forecasts for various asset classes.

Although I have spilled a couple of Rational Expectations' secrets, there's plenty of content remaining. As with its predecessor, this book figures to have a long shelf life.

This book review has been written by John Rekenthaler, Vice President of Research for Morningstar.

Dear All,

Please find below a good article as appeared in Advisor Khoj for your reading:

Living longer is the biggest risk

Biggest Risk in Life

When it comes to investment related risks or financial risks, we are aware of the risks like credit risk, currency risk, market risk, liquidity risk etc. But the bigger risk in today’s life which we all are facing is almost unknown to all of us. And that risk is the risk of living longer. Yes, you read it correctly. Let me again mention in BOLD letters - WE ALL ARE FACING A VERY BIG RISK OF LIVING A LONGER LIFE!

Average life expectancy of Indian is increased from 35 years to 67.8 years in 2014 since independence (Source: World Bank, World Development Indicators). And this number is increasing every year. Average Indian is expected to live longer and the life span is still expected to increase due to advancement in clinical research and medical field. The first thought which could occur in anyone’s mind after reading this number is, GREAT, IT'S A REASON TO CHEER! But the fact, which at first glance looks like a reason to cheer, is in fact a reason for a BIG WORRY. A longer life, if not coupled with financial independence is of no meaning.

Classic example is Japan. In Japan today the life expectancy is little more than 82 years. Look at the growth rate of economy. It’s almost NIL. As the life expectancy increases the number of more financially dependent people increases. The same could be the case with India in after 2 decades.

Three Phases of our life

In our life span we pass through 3 phases.

• Learning Phase


• Earning Phase


• Reaping Phase

In First phase i.e. learning phase which lasts for on an average 2 to 2.5 decades, one spends most of the time in getting education and acquiring the skills which he can use in future to earn money. In Earning Phase which lasts for approx 3 decades where one spends most of the time in earning money using the skill obtained during learning phase. And while earning one also tries and saves for the third phase i.e reaping phase which is also known as retirement. In this phase one is financially dependent on either one's own savings which is accumulated during second phase or their children.

Assume the situation in which you are solely dependent on your retirement kitty and your retirement account gets exhausted in 7 to 8 years after you attain the retirement and you still have a decade more to live. You might think that this situation could never occur to you, as you do lots of savings. But that's what our fathers and forefathers have done in past and still many of the aged people are dependent on their children for financial help even after working for 3 full decades and doing lots of savings.

Dependency is curse

Go and visit the nearest old age homes, you will realize that more and more number of people are getting added to these kind of old age homes and living their life on the support and pity of others. It’s not because, they didn't saved during their earning life, they surely would have. But it's because of lack of knowledge towards channelizing the savings into the right investments.

These people when they were young they never have thought that monthly grocery bill which was Rs. 1000 to 2000 per month at that time will rose to Rs. 20,000 to Rs. 25,000 per month when they retire. They never visualized that the medical expenses will increase many folds during the old age. They could never imagined that the cooking gas cylinder which was costing less than Rs. 100 at that time would cost them more than Rs. 650 at the time of retirement.

They kept on saving but never planned or never calculated the exact amount of money they would require for their retirement. This might happen to you as well. Have you ever planned your investment thinking that the petrol which is costing Rs. 75 today would be Rs. 500 per litre and the monthly expense to survive could increased to 1.5 Lacs rupees per month during your retirement.

Safety is illusive

Our forefathers have never thought that their capital being invested only into the FDs and Traditional Life insurance plans are not keeping their capital safe by giving 8% to 9% return but they are eating up the value of money every year. We need to look beyond the safety in nominal terms to the safety and growth in real terms.

The traditional investment which doubles our money in 8 to 9 years alone is not suitable in the current environment where our expenses get doubled in every 4 to 5 years. We must look at adding the equity investment into our retirement portfolio which has historically beaten the inflation.

Rs. 100 invested in some nationalised bank FD in 1979 would have grown to somewhere between Rs. 1500/- to Rs 1600/- which is hardly capable of fighting the inflation to save the purchasing power of your money. On the other hand, had the same amount of Rs. 100/- been invested into BSE Sensex, then today its worth would have been Rs. 26,000/- only due to price gain and ignoring dividends. If dividends are added this figure would even scale higher.

Case Study

I just came across one of the relatives of mine who was able to accumulate around Rs. 32 Lacs of money in his retirement kitty. And he is very happy saying that his house hold expense which is currently Rs. 25,000 approx per month is easy to earn just from the interest of the retirement kitty he has build up. But, he has never thought about the impact of devil called "Inflation"? Even if I assume conservatively 8% per annum inflation and risk free rate of return 9% post tax on the retirement funds, his retirement kitty would have zero balance before the completion of 7.5 years of retirement life.

Now what? If I assume the total 20 years of retirement life before he dies he requires roughly Rs. 55 Lacs for retirement kitty.

Goals come first

This happens with almost majority of the population due to lack of proper planning and knowledge. We always go and search in market for good investment product without knowing how much we would be wanting in future and weather the product in which we are investing will deliver the required rate of return to achieve our future goals. It’s like playing football without having goal posts.

If someone tells you that XYZ Pharma Company has come out with a very good medicine for heart diseases and you being impressed with the presentation of pharmacist, will you buy that medicine even if you don’t have a heart disease?

Will you ever buy any medicine if it doesn’t cure the diseases which you have but very good at curing the other diseases?

Will you ever buy a raincoat just because it looks very good if you are staying in a place which is deserted and never has a rainfall?

Will you ever catch the train going to Mumbai just because the berth is available and train looks good and safe, when your destination is New Delhi?

Think!

We invest to feel good

That's what we do most of the time when we buy the financial or investment product. We have bought the policy because we "FEEL" it’s good, we have bought Insurance Policies because we want to save the tax but never given a thought or never tried and calculated whether that plan had the ability to build up the required amount of retirement corpus which would be sufficient for our retirement.

Questions to be asked before Investing for retirement

So next time when you come across some very good financial product, ask yourself few questions like...

What am I saving for?

How much corpus is to be built with the help of savings?

Is this plan suitable for me in longer run?

Is this plan capable of protecting and growing my money against the effect of inflation?

How much return do I need to achieve my desired corpus based on time period and my saving capacity?

How much equity investments I need to add into portfolio to get comfortably accumulate my retirement corpus?

In Nutshell:

Take your retirement planning seriously at early age and make sure to channelize your saving into the right direction so as to beat the inflation and living a longer and financially free life. Take the help of some good financial advisor.

http://www.advisorkhoj.com/articles/Retirement-Planning/Living-longer-is-the-biggest-risk?utm_medium=email&utm_source=MailDirect&utm_campaign=Advisor_04_08_2014_1#.U-BJ1-OSxWg

RBI Governor Raghuram Rajan warns of global market 'crash'

Dear All,

Please find below an interview of RBI Governor Mr. Raghuram Rajan that appeared Central Banking Journal with regard to his view on the global markets. These comments were made by the Governor during an interview but some how only the negative portion of the interview has been highlighted:

RBI Governor Raghuram Rajan warns of global market 'crash'

The comments, carried in an interview with Central Banking Journal, reiterate Rajan's previous warnings that emerging markets were especially vulnerable to big shifts in capital flows brought on by the unprecedented monetary accommodation in rich nations.

Reserve Bank of India (RBI) governor Raghuram Rajan says global markets are at risk of a "crash" should investors start bailing out of risky assets created by the loose monetary policies of developed economies.

The comments, carried in an interview with Central Banking Journal, reiterate Rajan's previous warnings that emerging markets were especially vulnerable to big shifts in capital flows brought on by the unprecedented monetary accommodation in rich nations.

The former chief economist at the International Monetary Fund compared the current global markets to the 1930s - a period marked by the Great Depression.

Rajan said back then countries were engaged in a period of competitive devaluation, in a similar way to central banks now being engaged in ever more accommodative policies. 

"We are taking a greater chance of having another crash at a time when the world is less capable of bearing the cost," Rajan said in an interview on the journal's website dated Wednesday.

Rajan said he worried about the impact of investors exiting markets all at once after buying heavily into assets inflated by these loose central bank policies. 

"There will be major market volatility if that occurs. True, it may not happen if we can find a way to unwind everything steadily. But it is a big hope and a prayer," Rajan said.

Read more at: http://www.moneycontrol.com/news/economy/rbi-governor-raghuram-rajan-warnsglobal-market-39crash39_1148243.html?utm_source=ref_article

Dear All,

Please find below a good article as reproduced by Mr. Rajesh Krishnamoorthy, Ifast. The article is on the stock pick by fund managers and its performance, the comparison is on a international basis for your reading.

Your Mutual Fund May Be Too Lazy

It is well documented that on average active mutual fund tends to underperform the market. However, there is now a further issue with mutual funds according to the recent research of Antti Petajisto formerly of Yale University and now at Blackrock.

The problem is this. The point of owning a mutual fund is paying a team of analysts to pick stocks on your behalf, but according to this research, a significant group of mutual funds are no more than “closet indexers”, closer to following the market than trying to beat it. This matters because not only are you paying a high fee, you aren’t getting what you might expect. It’s a little like paying a premium for Gucci loafers and then discovering that the shoes you received are remarkably similar to a pair from Target.

Personal Finance (Photo credit: 401(K) 2013)

The average mutual fund in the study had a fee of 1.29% a year, whereas a passive ETF that tracks US stock can currently be held for as little as 0.05% a year. For example, the Vanguard S&P 500 tracker with ticker VOO costs 0.05%. So the average active fund costs 25 times more than the passive ETF (though costs have fallen in a few cases since the study). That’s a pretty steep price premium. To put that in perspective bear in mind that a Porsche 911 is ‘only’ 5 times the cost of a Toyota Camry, or flying first class is normally 3-6x the cost of an economy seat. However kicker here is that this, and other data, suggests that performance of passive ETFs is superior, precisely because of their lower fees. Unlike with cars, flights or shoes, in finance the fees you pay matter a great deal since they eat into your savings.

If you find that result surprising, take note that even Morningstar has come to the same conclusion, finding low fees to be a superior indicator of performance than their very own star rating system. Basically, even before this issue, active funds tend to underperform the index by -0.41% a year on average after costs, so you tend to end up behind with active funds based on the data, even before dealing with the potential risk and excessive fees of owning a closet tracker.

The active fund issue is this. For the 180 funds that are identified as closet indexers which is about 16% of all US equity funds studied , the active share is 59% and the average fee is 1.04%. This means that you are actually paying 1.76% for the proportion of the portfolio that is actively managed. This is because the remaining 41% of the fund is almost certainly no better than a tracker, and you could own a tracker for 0.05%. In essence many active funds aren’t picking enough stocks in large enough proportions to deviate from their benchmark in a meaningful way. As a result their performance is very likely to resemble that of the index, which is not the point of owning an active fund.

Lazy Afternoon Drifter (Photo credit: carterse)

So we now have two problems. Active funds underperform the index, and several of them appear to be expensive index trackers.  The Growth Fund of America AGTHX is one example according the research, it is an extremely large fund with over $140 billion in assets per recent reports. However it’s active share is relatively low at under 60% as of 2009, and hence the fees charged are relatively high given how much of the fund tracks the index based on Petajisto’s research. This is perhaps not surprising, as the fund with $140 billion in assets has such significant market impact that it is extremely challenging to be sufficiently agile to move into and out of stocks without adversely impacting their price. Nonetheless, it appears you save money and obtain a similar result with a passive ETF, or if you really want an active fund despite the prospect of underperformance, on average, then you should look elsewhere.

So we have one more problem for expensive active funds. Academics have found that performance has on average been poor in multiple prior studies, but now it appears a reasonable proportion of them have been investing as overpriced index trackers all along.

The views expressed represent the opinion of the author and are not intended to reflect those of FutureAdvisor or serve as a forecast, a guarantee of future results, investment recommendations or an offer to buy or sell securities.

regards

How to have a Recession proof home!

Couple of days back, my 10 year old son used the word ‘Recession’. When I asked him if he understands the meaning, he confidently explained ‘We know it is recession, when people start losing their jobs’!

Hearing this from a Vth grader was my moment of realization! It made me realize that the word ‘recession’ is no longer confined to the books on Economics or business news papers. In fact, in past few years this word has appeared and been used so often in our lives that even kids can explain it. No part of the world, be it Asia, Europe or America, seems to have remained untouched from the effects of ‘Recession’.

So, what is recession?

What is Recession and what’s our role in it as an individual?

Recession is known by many words, like, Downturn, Slump, Slowdown or Economic decline. It is generally identified by two or more consecutive quarters of negative GDP growth. In simple words, recession is temporary economic decline during which trade and industrial activities are reduced.  It is marked by declines in productivity and investment and high unemployment.

As an individual we have very limited role to play in the country’s economy. Economic cycles and fluctuations are beyond an individual’s control. We only get to face the consequences of these cycles. High unemployment means many people ‘losing their jobs’ and thereby losing their income. It is one extreme effect of recession and is quite capable of upsetting our lives. There by it is important that we know if we are hit by recession? And most importantly what can we do to safeguard ourselves against it?

Here are some indicators of recession and suggestions to prepare for the battle against being hit by the recession.

1. When your company stops hiring:

When HR says ‘Let’s put them on hold’ for the resumes you were planning to hire…it means they know something you still don’t know! It may mean Recession is here and your company is facing dwindling revenue and falling profits. Therefore it is not interested in expansion at the moment so you must brace up yourself for lesser than expected bonus and salary raise.

For the individuals whose house run on the salary they bring home, bonus is very coveted. Bonus is often used to plan some big annual/one time expenditure like vacations, down payment for a house purchase, prepayment of loans, marriage, college fees. Getting less than expected bonus may disrupt our entire planning. To avoid such situation, focus on Goal based Regular Savings!

If your goal is near, do not depend fully upon ‘mere expectations’ of getting good bonus! Rather liquidate and consolidate your prior investments and keep the cash ready.

2. When you see lesser footfall in malls and restaurants:

Lately you see No waiting lines to get the seats in your favorite restaurant and the amazing dress you saw last week in sale is still there…are you wondering where are all the people gone? The reason may not be the sudden reluctance to entertain themselves or buy new things but the reluctance to ‘part with the money’ in the Recession hit economy.

Before you are also forced to cut down your expenditure haphazardly it is better to categorize your discretionary and non discretionary expenses. ‘Prepare a budget’ and ask everyone in the family (including kids) to suggest cost cutting measures. It will keep everyone ready for hard time called recession.

3. When your boss become unreasonably demanding:

If your boss is suddenly asking you to take up more responsibilities without hinting any promotion or salary raise then it may be the time to become alert! It may mean that company is planning to squeeze more work out of lesser number of employees ie possibility of job cuts.

Even though you are not given the pink slip yet…it will be wise to prepare yourself for any such situation. It is advisable to ‘Create an emergency fund, buy more medical insurance besides the one from your company, get income protection insurance and also home loan insurance’. If you have any loan, you can increase the tenure and keep EMIs to the minimum; this will put lesser burden on your current finances. Also start looking for back-up job options or explore alternative career options before even before it becomes absolutely necessary.

4. When your investments give you negative surprises:

If you were planning to liquidate your investments and were surprised to find out that you cannot even get back what you have invested, Do not panic! Like others you may have hit by looming Recession among other reasons. One big challenge of a recessionary economy is the ‘fewer buyers’ in the market. And everyone wants to run away selling whatever is left of their investments. Hence you may be offered less money for your investments than expected.

The fear of losing money is ‘real’ at such a time provided you ‘really’ need to sell/ liquidate your investments. According to IMF (International Monetary Fund), "Global recessions seem to occur over a cycle lasting between eight and 10 years." And if you look at the data for last 50 years it is visible that at the maximum any Recessionary period has lasted for NOT more than 18-20 months, ie. Not even 2 years.

As an individual you need to understand these economic cycles before taking any hasty decision, particularly if you have NO immediate need of money and were originally planning to stay invested for 5-10 years. Hence ‘It is important to evaluate if you really need to liquidate your investments’? In case you are doing it because everyone else is doing it then it may be the time to recheck the fundamentals on which you initially invested your money. If there is no real need then perhaps you can bear this notional loss since almost always the economy goes back into the recovery mode.

Also while investing, instead of ‘waiting to get the best returns’ on your investment, you should pre-decide on how much money you need for your goals. This will help you calculate returns you should get from your investments. It is advisable to keep consolidating your investments whenever you reach the desired amount. Rest is the Bonus!!

Finally:

The needs and aspirations of your family are defined, derived and fulfilled by not only what do you earn but also by how much do you save and how do you spend it. You may love to plan about how to “earn’ more money but it is equally desirable to plan about ‘how to nurture and use this money’. And in recent times it also depends on ‘how you keep your home recession proof’!