Try this simpler & better alternative to standard SIP

The last two posts in the blog have really generated a lot of heat and dust in the form of comments and feedback, much of it supportive but some of it virulently critical. Many people have accepted that the standard way of doing SIP has serious flaws, but at the same time they found my method a bit too complex for their liking. I understand that it is not every person’s cup of tea to look at fixing the base level of Nifty or some other index every month. I have therefore come up with a far simpler plan that can be implemented by any investor, without any great effort or knowledge requirement.

Before I get to the plan let me state a few background assumptions that are important for it. As I will explain, most of these assumptions occur naturally for all investors, it is just that we need to be aware of it.

  1. An investor invests in both equity and debt every month. Equity is through the SIP route in an Equity MF portfolio, debt is in debt instruments. For simplicity let us assume PF and PPF are the only debt instruments that he has.
  2. Let us say PF is 12500 per month, PPF is 12500 per month and Equity MF through SIP is 25000 per month.
  3. SIP date is 7th of each month when 5000 is invested in the MF portfolio that has 5 funds.

Now let us see how the investor can have an alternative to his standard SIP. I will assume that he is looking at a 1 year investing period between October 2015 and September 2016. This is how it will work in practice:-

  • First of all stop the automated SIP on the 7th of each month.
  • In October, invest 12500 in PPF as usual. Starting from 1st October till 20th or so, look for any day when the Nifty falls to levels close to 7800. Trust me, there will be such days in all likelihood, especially with the quarterly results not likely to be great. Just in case there are no such days, then between 21st and 30th look for any day where the Nifty level is lower than what it was on 7th October. Invest in these days.
  • Assuming all of it does not happen at all then put your 25000 reserved for equity into PPF. Once your PPF allocation is over, you can use Liquid funds or just keep it in SB account.
  • Whatever level of Nifty you invest in a month, make that the base level for next month and try to buy at a lower level than that. Do not worry if you cannot buy for 2-3 months, over a year there are bound to be days and longer periods when the markets will correct heavily, either for fundamental reasons or on some negative news flow.
  • In this method you are buying MF at progressively lower NAV, which is basically the condition where SIP works best. Unfortunately, because we do SIP on a specific day, irrespective of the market levels we do not usually get this to our advantage, or even if we do it is only a matter of pure coincidence.
  • There is really no need to buy equity every month, though regular investment is a good practice in general. Returns from equity are dependent on what level you buy it at not on which date or month. I would rather buy an MF at an NAV of 20 in January, rather than buy it at 22 in November.
  • Debt on the other hand, is dependent on the time of investment. So by not investing in equity when markets are high and putting that money in debt you are creating two benefits for yourself. Firstly, you retain the chance of getting equity at lower prices, secondly your money in debt is earning returns for you.
  • I think you can work out the details now, you have got the basic principle.

The only scenario where this will not work is if the markets keep increasing every month and you are left in a situation where you are never in a position to buy MF according to the above process. But you will agree that it is almost an impossibility for this to happen. The market will always give you opportunities to invest, you just need to be patient and have a method that works.

Try it for a year and you’ll see you have done better than the standard SIP route.

What you must understand about equity returns

When I had written a post on Equities and compounding, one of the financial planners wrote to me and expressed his anxiety that my stating that equity returns were not time dependent like debt, may impact people investing in SIP etc. Note that he did not say I was wrong, as he obviously knew that I was not. Now, I have no problems if people want to invest in equities thinking that the amount invested will grow like it does for a standard debt product. However, as someone who runs this blog I will try my best to disseminate the right type of knowledge.

Let me take a simple example to demonstrate what I mean by equity returns not being time dependent. Many of you have bought MF through SIP over the last few years. Look at your purchases in the last 12 months and check the returns on those – it is a fair bet that you will find these to be in the negative zone. However, if you had invested in the same funds throughout 2013 and checked the returns one year later, it would have shown you returns of nearly 20 % or maybe more. Based on both of these can we say what will be the returns in 1 year for the investments we are making today? Unfortunately we cannot do so. Equities can work greatly in the short run or may not work at all. The same is unfortunately true for a longer time horizon, though the probability of negative returns does reduce significantly with increasing time period. You can look at the rolling returns on Sensex and Nifty to get a better understanding of this.

So if the returns on equity are so uncertain and you cannot depend on it at all then why should you be investing in equity. Well for most of us the answer is simple – with the kind of inflation we have in our country, equity is the only asset class that allows us a chance to meet our financial goals. If I had enough money to meet all my financial goals with 4 % return then I will keep all my money in a SB account. Unfortunately, most of us do not earn at that level and thereby need our investments to give us higher returns. If there are people who do not need this higher return my serious recommendation for them will be to stick to fixed income instruments and be peaceful.

In summary, irrespective of what people tell you remember these about the equity asset class returns:-

  1. The returns do not compound with time, like in debt instruments.
  2. The returns are non-linear in nature that is, you can have a high return year followed by several flat years or also exactly the opposite. 
  3. Secular bull and bear markets will really be rare in a market like India where issues are complex and there is a lot of dependence on FII money.
  4. Over the long term you will have good growth in equity but the duration is difficult to predict.
  5. Even when you have got good growth, there is no certainty it will stay that way. Think of how good your SIP investments looked in 2015 March and how they are looking today.
  6. Never depend on equity returns for a time bounded goal. If your son has to start college this year you cannot postpone it. Depending on equity to fund it in a poor market is going to hurt you financially.
  7. In case you are not OK with the above then equity is not for you.

There are a lot of other posts in the blog which will give you a great learning about equity as an asset class and how to invest in stocks and MF. Go through them and it will enrich your investment life significantly.

Why I will stop my standard SIP now

First an admission – like many other investors, I have also invested in MF through the SIP mode. When I started way back in 2001, my investments were all one time and they were few. After we paid off our home loan I started MF investments again and it was again one time investments. It was only in 2008, after the stock market crash that we started SIP and have been doing it in a regular manner till now. The results have been mixed, some funds have done rather well while others have been kind of mediocre performers. All my current SIP get over in October and I will not be renewing them.

Before I come to the why part, let me be clear on what I call as standard SIP. In simple terms it is a plan where you invest a fixed amount every month to buy units of a particular Mutual fund at the ongoing NAV prevalent on that day. Obviously, in some months you will get more units and in others you will get lesser depending o the NAV. The other feature of standard SIP is that you can automate the process. So the money directly goes from your bank account and once you set up the SIP, there is nothing you need to do, till the time comes to renew it after the duration you had originally specified.

My strongest objection to this model is this – it is completely logical for me to buy units at a lower NAV, in fact I would love to buy more BUT it makes no sense to spend the same money when the NAV is higher. Think about it through an analogy that will hopefully make it clearer. If you know that on certain days of the month, there are some good discounts in your Super Market, would you not plan to make most of your purchases on those days? Sure, you will not be able to stop all buying on other days as you need groceries round the month, but you will certainly make your bulk purchases on the days of the discounts. If you follow this for your groceries will it not make sense to do so for your investments, which are much higher?

I can see many of you jumping up to say, “but you are trying to time the market, and we know that does not work”. Really? Who told you so? Let me offer a counterpoint – the whole objective of all the continuous analysis that goes on in the world markets is precisely for the purpose of timing the markets. Yes, trying to time the markets by pure guesswork, without any knowledge or skills is obviously a non-starter. But thankfully, calling the trend of an MF NAV is  a lot easier as compared to an effort that involves predicting the pricing trend of a particular stock. So it is quite likely that if the Nifty and the Sensex is moving up, the Large cap oriented funds are likely to move up too – and vice e versa.

OK , so what should one do in practical terms. More importantly, assuming that I am still investing in the funds that I have a current SIP in, how do I want to invest in those? My broad plan is as follows:-

  • Take Nifty as the base index for ICICI Pru Focused Blue Chip fund that I want to continue investing in.
  • Decide on a base Nifty level for October. I think it will be 7800, that is the actual Nifty value will oscillate around this.
  • On any day, if the Nifty value goes 5 % below this level, I will invest the whole amount I wanted to invest in October.
  • If the market falls 2-3 % in a day, I will take a call based on what else is happening around the globe. If I think the fall is isolated then I will invest 50 % of my October investment. In case I feel it is a trend, I will wait for my 5 % drop.
  • Just in case the market keeps rising in October and ends at 8200 or so, I will simply not invest in the month. Remember, unlike debt, equity returns have nothing to do with the time you are invested in them. Most people sadly do not understand this but it is really important that you do.
  • If on the other hand, the Nifty falls to 7500 in October, I may invest my November allocation in October too.

Will this work? Well, as long as you are able to judge the base index correctly and have a rough idea about the spread on either side it is bound to work. The NAV of my MF will be far lower at Nifty levels of 7800 than it will be when Nifty is at 8200. So there is absolutely no way that this will ever do worse than a standard SIP, even with luck on it’s side.

Should you try this? That is clearly up to you. All I can say is that logging into the ICICI MF website and pressing a few keys on my laptop is well worth the effort if it helps me buy my MF units at a lower price every month. For me the decision is made and I am going to invest in this manner from November. Will share an update in the blog after 3-4 months.

SIP – Earlier fanatic support was wrong, so is present worry

A few months back I had written a post in one of the better known Facebook groups, suggesting that in certain market conditions SIP may not be the best mode of investment. I had fully expected some objections to my post, given that many members of that group were having long standing SIP in several funds. Even then, the vehemence of the reactions were surprising to me. The gist of it was this – SIP was the only way to invest, I was out of my mind to even question it, people who were there in the group for a long time had certified it as the way to go etc. One particular response was hilarious – the person stated that SIP was not volatile while stock investments were, obviously not understanding that equity MF also invested in stocks and hence the associated risks were not really fundamentally any different.

Last week, the same person wrote to me in a private message and asked if he should stop his SIP. I think in some way the wheel has now turned a full circle. We speak about the misleading sales of insurance policies, but really encouraging people to do SIP in equity MF has been no less misleading and in certain cases definitely worse. This is because unlike insurance sales, where the agent does it and the prospective customer is somewhat wary, SIP in equity MF was being promoted by Banks, MF distributors, a variety of websites catering to personal finance, bloggers of all ilk and a host of TV programs. It was almost impossible for the investor not to get caught up in this euphoria. The premise was simple – you keep investing a certain sum every month and over a period of 15 years or more you will end up with a financial bonanza. A few people put the returns at 18 – 20 %, some spoke about 15 % but everyone was clear about one thing – even if you were terribly unlucky, you would definitely get double digit CAGR with your SIP investments. Over 20 years that would be great !!

Obviously people making such predictions had no appreciation about the characteristics of equity as an asset class. It is said that over the long term equities have the best chance of giving good returns. While this is generally true, what people forget to realize is that the “long term” is undefined. It is quite possible for equity to give great returns in 2 years as well as not give any return over a much longer period. People who had started SIP in 2011 – 2013 period would have been elated when the market rose sharply in 2014. One of the people commenting on my SIP post asked me this – if the return can be 29 % in only 3 years then think of how much it can be in 15? Honestly, I do not know but his return today has gone to single digits and I hope he is not thinking that he should have opened a PPF account.

The way people were brainwashed into believing that SIP was almost like a Recurring Deposit, only with much higher returns was amazing. We are famous for the herd mentality and in this case push from the advisers and pull from the existing customers of SIP proved too much of a temptation for most people. The hype was so much that now, with only 12 % fall in the market from the peak levels, people are already wanting to stop SIP or reducing the amounts. This is sad as if anything really works for SIP, it is continued buying when markets are doing badly.

So what is the real story behind SIP, never mind what everyone purporting to be an expert has told you?

  1. Regular investment in equity MF is good, even if there are short term losses in portfolio.
  2. If volatility is something you cannot deal with, reconsider investment in equity as an asset class.
  3. Standard SIP makes little or no sense, except for the convenience factor which is really overrated.
  4. “Long term” equity story is true but understand that “long term” is really undefined.
  5. Anyone telling you that MF will be less volatile than stocks is either ignorant or trying to sell you MF for reasons of his own. There are also people who really think of SIP as something unique, which again makes no sense.

Three months of volatility has shaken the foundation of the edifice that has been built over the last 6-7 years. In case the volatility lasts another year or so, people will desperately seek other means of investment. That will be unfortunate as regular equity investment is really the way to go. SIP has been misleadingly sold to many people and it is time to make an honest assessment of it, not by hammering numbers on meaningless calculators, but by having an appreciation of how equity performs as an asset class.

In my next post I will outline how you can invest in MF regularly and what are the right expectations on time frame and returns. Equity is the way to go but we need to do it the right way and with understanding, not by the blind following of people having vested interest in selling their own products.

Financial advise for new earners

Most of my posts relate to my personal life, some more than others. This post however, is very specific and is directed towards my daughter who is in her BE final year in BITS Hyderabad now and will be starting her career next year. Of course, this can be equally for any person of her age or even in the first 2-3 years of their career.

To begin with I am very happy to see that there are excellent opportunities in the country today for bright people from good institutions. This goes, not only for Engineering education but for many other streams too. Any opportunity is however, only a launch pad and what is critical is how people use the opportunity to build their career and lives. Financial prudence in the right investments and handling money will be important but one must first maximize investment in one’s own ability first.

Let me make it simple – your ability to do well in your career and consequently earn money will really depend on what value you bring to the table that is useful to others. As long as you add value you will be relevant in the corporate or any other world and money will follow. The day you lose your value you will stagnate in your career or fall by the wayside. Therefore, invest in yourself by learning new things and applying them well. This can be a second degree like an MBA, a specific training in new and emerging area such as Business Analytic or a new business idea that you want to develop on your own.

That being said, how should you deal with money, now that you will be getting some of your own at long last? You must spend on what matters to you. Savings and investments will be there all your life and I am not asking any of you to be reckless in your spending, but go ahead and buy stuff for yourself and others that you have always wanted to but possibly did not have the money or the brazenness to ask your parents. After 20 or 22 years of education, very often in rather competitive circumstances to get where you have got to, you deserve this much. Once this initial charm of spending money on yourself and buying gifts for others get done, you can settle down to charting out your financial road map.

I will simply put some pointers here and let you work out the rest. You can go through the rest of this blog and all other resources available publicly to work out a plan of your own:-

  • Take a health and accident insurance, there are really no guarantees in life.
  • If you have dependents who need your income, take a term insurance. If you do not then there is no need to do so.
  • Do not worry yourself about goals etc for the long term now and definitely ignore anyone completely who wants you to invest for retirement. If you are looking at short term goals such as higher education, buying a car, down payment for an apartment etc, you will need to invest for it.
  • This will sound unexciting but you must open a PPF account and try to contribute the maximum to it every year. Debt instruments demonstrate the true power of compounding and PPF is the best long term instrument in many ways.
  • You must consider investment in Mutual Funds as these are great instruments run by professionals who are fairly good at what they do. At the same time, do not blindly go for an automated SIP that simply invests the same amount every month, irrespective of the state of the market. You are intelligent and will figure out a way to invest wisely.
  • Start building a stock portfolio for yourself as soon as you can. You can start small, gain knowledge and experience needed for building a good portfolio and do it over the long term. In a growth market like India, businesses will generate wealth and having a good diversified stock portfolio is your gateway to participating in this wealth.
  • Do not buy products you do not understand, never invest in a company whose business you are not clear about.
  • Contribute generously to good causes, there are many who are far less fortunate than you in having opportunities in life. Small contributions from each one of us can make a great deal of difference to their lives.
  • Finally do not get obsessed by finance or investment, unless you are doing that as a living !! Enjoy your profession and your life along with some sensible choices in investments and you will be fine.

I hope that was not too heavy, do not worry all of you will be fine as you go along. We had all started out in the same fashion ( with lot less opportunities ) and have not done too badly for ourselves.

Retirement calculators are part of the problem, not solution

If there is one phrase that dominates any discussion in the space of personal finance it is ” Retirement planning”. Children’s education comes close but cannot quite match up to it. A lot of discussions in all financial blogs center around this topic and there are a myriad of calculators that are a source of endless use and debate. I think most of the retirement calculators do not serve the purpose they are built for as they do not give you a real picture of how your finances will be in retirement.

Do not get me wrong here – a lot of people have put in a lot of man-hours in building these and as an academic exercise I do not have any quarrel with these. It is just that in computer terms the usage of these calculators can be characterized as GIGO – Garbage In Garbage Out. I will explain why I say so but before that let me explain briefly how most of the retirement calculators work, so that people not familiar with their operations will get an understanding of the same.

Most retirement calculators work in the below principle:-

  • They ask you to look at your current expenses and come up with an annual figure say X.
  • The next step is to ask you what % of this will you be expected to spend in retirement. Let us say you get Y.
  • Y will be projected into the first year of retirement with the current inflation rate to arrive at a figure Z.
  • You can now divide Z by a safe rate of return from debt instruments ( let us say 7 % ) to arrive at the corpus needed at retirement, say W.
  • To arrive at the corpus W, you may now use an SIP calculator which will give you the monthly SIP amount, say V.

I know that many of the financial planners, whether offering paid or voluntary services would have advised you in exactly the same fashion. You are also religiously investing the SIP amount every month, thinking that you have got all of your retirement worries dealt with. Sorry to spoil the party here, but you really have not. You may be way off the mark, either way, and even if the investment amount is correct it is purely fortuitous, not because of the calculations or approach.

Why do I say this? Let us start at the beginning. You simply cannot take a % of your current expenses, project it to your retirement year based on inflation and say that will be your expenses in retirement. In order to take away the subjectivity, let me discuss my specific situation with the approach of the financial planners and retirement calculators.

  • My current expenses in this FY will be X. Most advisers and calculators will say that I need to plan for at least 70-80 % of these expenses. 
  • Such generalizations unfortunately do not work. In my case about 50 % of my current expenses are due to my children. When I retire, let us say in next 8 years or so, these costs will definitely not be there.
  • I plan to shift to a lower cost city like Kolkata, from the current high cost city of Hyderabad.
  • I plan to travel more for the first 10 years of my retirement and take up some hobbies.
  • You will see from the above how hopelessly inadequate the retirement planning process and associated calculators are to deal with my situation, indeed to deal with any real life situation.

Obviously, in some cases you will be saving less and that is a problem as you will simply not have enough money in your retirement years. However, even if you are saving more than required, it may be a bad idea if it is preventing you from doing the things that you want to get done today.

Apart from estimating retirement expenses, the way most planners estimate the corpus is also wrong. It makes no sense to imagine that we will put all our money in a 7 % FD or similar instruments, There are far better ways of doing this and if your financial planner is unaware of those or lazy to do some real work, do not do business with him.

Now that we have understood the problem and what will not work, how can we get into a workable solution? I will address this in the next post.

My experiences of coping with 2008 downturn

Many readers of my blog and others who know me have always asked me to share how I dealt with the 2008 downturn in the equity markets and had the conviction to keep investing in the subsequent years. While I have never thought about it explicitly, being at a loose end in Kuwait at the start of a long Eid break gives me an opportunity to do so. A caveat – like all reminiscences, mine may also appear a tad self congratulatory so bear with me to that extent !!

Some background of my life and financial situation in 2007 end will be important to understand the events and my reactions to them. We had just shifted to Hyderabad in October 2007 and I had plans of working in Four Soft for about 4-5 years. Though I was not the CEO immediately, I knew that I would be made the CEO by April 2008. My daughter was in class 8 and my son was in class 6. We had got them admitted in middle of year in a very good public school ( it was tough but their earlier results and how they fared in the test ensured that ). So from a career viewpoint and family angle, I was in a reasonably good and stable situation where we could be in Hyderabad for the next few years, at least till the children went to college. 

From a financial standpoint, from 2005 onward the main focus of our investments was in equity. We had portfolios in both stocks and MF but the focus at that point was clearly on stocks. We had been aggressive in our pre-payment of home loan by 2005 and that left us in a situation of a fairly high monthly surplus. Except for investments in PPF and payment of insurance premiums, all other investments were in stocks. I must give due credit to my wife for building up the stock portfolio in these years. It was a good selection of industries and stocks, bought over a period of nearly 3 years at price points that made a lot of sense at that time.

By end 2007, the portfolio had grown to an impressive size. So much so that I could harbor thoughts of Four Soft being my last corporate role and being able to start my Consulting practice around 2012. I did realize from the rapid rise in the markets that a correction was going to come and the extent of the cut will be very significant. Yet, I must say when it happened the deep cut left me quite surprised. Over a few days the portfolio went down by more than 30 % and at a later point in 2008, I saw that the portfolio built with great care over the last 3 years had shrunk to 50 % of it’s peak value and was barely in the black. We were still lucky not to be in the red like many others, courtesy a few of our earlier stocks such as L & T, HCL Infosystems, RIL etc where the long term gains were still good, despite the brutal cuts. The MF portfolio that I had built up over 2 years by making selective one time purchases fared no better and was also into the red. The only good point there was I had sold off a few MF investments, seeing that they had run up a lot in December 2007. It was a pity I had not sold off the entire lot.

I wish I could tell the readers that we were not affected much by this but that will not be true. It seemed that our entire financial foundation had been totally shaken up and, for a few months, we were rather despondent about it. Two things helped – we were new to Hyderabad and were busy in settling down, also my job required extensive travel which helped me to think a fair deal and get matters into perspective. In the initial phase we had even bought more equity but as the market went into a tailspin, I had to give up that idea. The one thing we did do was to start an SIP in 4 funds as we realized the value of buying MF units in a declining market. All other surplus went into products like Debt funds, FD etc. We actually started spending more and took a vacation to Thailand as we had more money in hand.

When I looked at the situation objectively by September 2008 or so, life did not seem to be very bad. Yes, the portfolio had shrunk badly and not working in a regular job from 2012 was probably out. At the same time, I was the CEO in a public listed company and could be there pretty much for as long as I wanted. In any case, till our children went to college we did have plans to be in Hyderabad, so what I did was really not a huge issue if it shifted by a few years. I did think of going contrary to the crowd and start buying by end 2008 but the way the markets kept going down dampened my spirits. My wife, who had been the real force in building up the portfolio, simply wanted to stay away from the markets.

By the start of 2009, I realized that it would be a good idea to start investing. I had a fair amount of surplus every month and had reasonable conviction that good companies could not be at such beaten down prices forever. Over the next few months I bought into stocks selectively, despite every person including my family members telling me not to do so. My response was simple – I could not believe that  good Banks, good IT companies and companies in other sectors could do badly forever. Indian economy was not doing badly, it was the global turmoil and pulling out of the FII money that caused the crash in the markets. The markets went all over the place in the next 5 years but from an overall viewpoint the buying of selective stocks had a great positive impact on my portfolio.

From 2008 onward we also continued the SIP in MF regularly and this has helped to build up a substantial portfolio in this area. In fact, if the crash of 2008 had not happened I may not have gone to the SIP route. Obviously, it paid great dividends between 2008 and 2013 in building up the portfolio and 2014 was a great year to see the portfolio performing as though it were on steroids. However, 2015 has been a different story.

To conclude, while it will be tempting to say that I added stocks because of only my knowledge and skills in predicting the market, the reality is a little different. I knew I was in a stable job that paid well, I did not need to touch my portfolio for 15 years or more and so had time on my side and finally as I was investing into fundamentally good companies for the long term it was really not as risky a proposition as everyone was making it out to be. In the end the stock market is a place where the winner takes it all. There are many people who had money in 2008 and subsequently but chose to put it in FD or other similar avenues. Theirs is a case of lost opportunity.

In the next post, I will give some actual examples of stocks that I bought into prior to and after the crash.