Impact of budget on asset classes

Now that the dust has settled a bit on the budget front, it is a good time to look into the fine print to check how the different asset classes will be impacted with the budget plans. Since there hasn’t been much changes on the taxation front, all investors will be hoping that the budget proposals will have a positive impact on their asset classes.

Let us start with equity then. The following are the most notable:-

  • The FM did not touch LTCG exemption for this asset class and that in itself came as a huge relief to the markets. A lot of the up move was due to this factor.
  • Reduction of corporate taxes for companies having less than 50 crores turnover in 2015-2016 will definitely increase their profit margins and consequently contribute to the elusive earnings growth that all are seeking.
  • The monetary policy is definitely looking at reduction of rates and companies can look forward to cheaper credit. This will hopefully push up profit margins.
  • The infrastructure push will be positive news for many companies linked to this area of business. Easier credit will help consumer product companies.
  • Banking industry will get some much needed support for the NPA problem.

Based on the above, it will be logical to assume that the performance of our companies will start to get better over time, quite possibly from the next quarter. The discipline shown on the fiscal deficit front as well as the seemingly firm deadline on GST implementation should help our credit ratings. Over the past few months FII money has been going away from our markets to other developed and emerging markets. With the above changes and the rally which has been largely driven by domestic liquidity, it is conceivable that some FII buying may resume in our markets, at least in specific stocks. Equity therefore, seems to be the asset class of choice for investors this year. Our markets have not really gone anywhere in the last 2 years though several stocks have given good returns. This can be a year when the markets do well overall and this gets reflected in an up move of the indices.

What about Debt in that case? Some changes to note are as follows:-

  • As with equity the LTCG treatment has been kept unchanged.
  • Availability of huge amounts of cash with the banks may push interest rates further down. This may happen as early as the monetary policy of February 8th.
  • LIC scheme of 8 % returns for senior citizens is actually an indication that interest rates may well fall further.
  • The rate reduction will happen but the cycle is close to bottoming out too, maybe another 50 basis points overall will be there.

Based on these, I think Debt will not really be the asset class where investors should invest fresh in 2017. It makes sense to only look at mandatory debt such as PF and PPF. For the rest try to invest as much into equity as possible, both through MF and stocks. For any of your existing debt products that may get redeemed this year, look at equity again.

What about Real Estate? Well, that presents an interesting scenario. Look at the following:

  • Home loan rates are definitely going down and announcements of discounts on lower amount of loans will help the housing industry.
  • Demonetisation has definitely impacted the prices though Real Estate companies will fight hard to resist any downgrades of pricing.
  • Builders will be helped by the one year window to sell the property without getting into the Deemed income stiff.
  • 2 year duration for LTCG can make investment in homes easier.
  • Capping the interest deduction at 2 lacs for the second home makes sense but it is a blow for people who were looking to get a second home as an investment.

Based on the above, it does seem that buying the first home is a great idea now and doing so for a second investment property is a not so good idea. Unless you are really flush with funds, avoid the investment idea. You can easily get caught into an increasing cycle of interest rates 2-3 years down the line and the income from your investment may not be that great due to the generally low rental yields.

Conclusions then? Buy a first home if you are interested, keep debt only at PF / PPF level and put all the rest into equity. This is the year of equity, get started even if you feel hesitant. If you are already into it then go on to take a deeper plunge.

How will the asset classes fare in 2017?

Now that we are into 2017, it will be a good idea to look into the prospects of the different asset classes. As usual, I will deal with the 3 asset classes of Debt, Equity and Real Estate as I do not understand much about the others. Also, I will look at the fundamental context and avoid the clutter of any numeric analysis.

In all ways 2016 had a rather unexpected end, which was surprising as it was progressing rather well till we hit November. Despite Brexit and some other events, the overall scenario in the Indian economy was a positive. The monsoons had been good, GST seemed to be on track and it seemed that the corporate earning was on the way to recovery at long last. However, the demonetization move by the government has changed things rather dramatically and the impact of it will be felt hard at least in the short run. Firstly, the economy as a whole and some specific sectors in particular have been affected rather badly. There will be a likely impact on the GDP and corporate earning momentum, which was almost a given from this quarter, will probably be pushed back by a couple of quarters. The Fed rate hike in the US and the FII sell off associated with it in the Indian markets will also have a negative impact.

So how will Equity behave as an asset class in our markets in 2017? Well, right now it does seem that times will not be very good for equity in the first half of the year. There are far too many negatives in terms of the news flows and even if the budget happens to be a great one, it will probably only be able to pull the equity markets back marginally. In the second half though, there are great chances of a revival in the economy as well as the stock markets. GST rollout, the cash situation being better, impact of assembly elections being over and the effect of the budget being felt will all add up significantly to improve consumer confidence and therefore business volumes and subsequently corporate earning. It is very likely that the markets will follow suit. I see Nifty having a strong support at 7500 and also a possibility of reaching levels of 9000 towards end 2017.

So, in essence equity will very likely be a rewarding asset class in 2017. You will need guts to participate in it in the first half, but it is important that you do so in order to reap the probable benefits later on. Once markets start rising, the feeling you may get is one of being left out.

What about debt as an asset class in 2017? Well, with the rate cut cycle now being nearly over, debt investments are really not looking very bright in 2017. Unlike in equity, the turnaround of the rate cycle will probably happen only in 2019 or so. As a result any fresh investment in debt, except for the long term ones such as PF, PPF and SSY really make very little sense.

What about RE as an asset class in 2017? The banks have now finally reduced their rates based on a nudge from the PM. It is therefore easier to buy a home now and the home prices may also see a dip based on the demonetization effect. So, if you are buying a home for your own stay, it will be a good idea to seriously look at it in the latter half of 2017. However, as an investment do not look at RE in 2017 at all. There can be serious changes in the RE landscape soon and dealing with property may not be everyone’s cup of tea. Locking up a large chunk of money when you can invest it in favorable equity markets will be a really bad idea.

In summary bet on equity this year, almost completely. I will write some future posts on asset allocation as well as my own plans.

Where and how should you invest now?

We are living in very interesting times indeed and no one can really predict with a great deal of confidence as to how things will pan out for the economy or investors. However, some things are clear as far as trends are concerned and we can look at investment strategies based on these likely trends. In this post let me look at the most common asset classes and try to give a road map for the medium term which is till 2017 end.

As far as Debt asset class goes, it is fairly clear that will more cash being sucked out the system and inflation coming down the interest rates are going southwards. The government will also be under pressure now to show that some impact is there. In the RBI policy on 7th December I do expect some rate cuts. What will this translate into for the more popular debt investments and what should you be doing? In my opinion, here is what will happen in the next one year:-

  • Interest rates will go down by 1 – 1.5 % in the next few quarters. This will impact not only Debt instruments but also companies dependent on this factor.
  • Debt MF especially the short term variety will do well, so keep your investments in these and look at investing more in these.
  • You can lock in your interest rates wherever possible, as it seems very unlikely to me that there will be an upward trend in them for the next few years. Invest in long term FD and POMIS if you are comfortable with such products. 3 year FMP which are in the markets now may be a good option too.
  • For schemes such as SSY and PPF, the rates will definitely go down in the near future, most probably in January and again after the budget in April. While prediction on the rates is difficult, I think PPF will be at 7 % and SSY at 7.5 %.
  • Investors with investment in the above products should not panic and continue their investments as these are long term products and will tide over such issues.

What about equity markets then? Well, the current scenario is clearly bad for many companies and the economy overall in terms of these companies earnings. It is almost a given that the growth expected in Q3 and Q4 will really not happen now. The markets are very likely to suffer fairly deep cuts, especially if the budget also disappoints. I think Nifty will have strong support at 7000 levels and the lowest point will probably be around that. Beyond this point, a recovery both for our businesses as well as the economy is very likely and this may pull up the Nifty to 9000 or slightly more by the end of 2017. What should you then be doing with your stocks and MF portfolio now? Here is what I think :-

  • There are stocks in the IT, Pharma and Auto sector available at fairly inexpensive prices today. Start accumulating these and you can reap great rewards when the markets go back to the higher levels in about a year.
  • Rate sensitive sectors will do well. Look at Housing and related sectors which will get a fillip both from probable lower prices and lower interest rates. Housing Finance companies, Banks, Cement , Paint, Ceramics, Glass etc are all likely to benefit from this and so will stocks.
  • E-commerce companies, Banks will now benefit from the move towards cashless transactions and will do very well in the next year.
  • If your portfolio does not have such stocks, build it up with selective purchases over time. The next 6 months or so will be a great time for building a high quality direct stocks portfolio. Put as much money as you can in this.
  • As far as MF investments go, stop your SIP and look at making a few one time investments over the next 3-6 months. There is no point in buying with Nifty at 8700 when you can buy at 7500 or so. You have already seen this for your SIP in 2016, do not make the same mistake once again.

What about Real Estate then? While it is widely expected that prices will drop due to a lot of unsold inventory as well as the thrust against black money, I think it will take time for this correction to happen. End of 2017 may be a good time to buy the dream house you are looking at, you will get better prices and also good home loan rates. If you are trying to sell your house, do not do so now unless you really need the money.

The current crisis is also a time of great investing opportunities. If you take the right decisions over the next few months, the impact on your current portfolio as well as your future wealth will be hugely positive.

The real truth about asset ownership & loans

Since the time I have started writing this blog, I have interacted with many people who are very proud of the assets that they own. These can be financial assets such as Stocks, Bonds or MF units. These can also be real assets such as a car , a house, Land etc. The one thing which nearly always surprises me is that how many of them do not understand a fundamental point about owning an asset – you really own an asset only when you have paid up in full for it.

Now many of you think that I am nit-picking here. After all even if you have bought a home by taking a hefty loan, the home is in your name, right? You are staying in it and can rent it out tomorrow if you want to. So why do I say that you do not really own it? OK, let us take a simple example to illustrate my point. Let us say you have recently bought an apartment that is priced at 80 lacs. You funded it with your own resources to the extent of 30 lacs and the rest was taken as a loan from the bank. I hope most of you know that the house is now held by the bank as a collateral, till you are able to pay off the entire 50 lacs loan. In fact, should you fail to do so, the bank is well within it’s rights to sell off the house in an auction and claim the 50 lacs plus any due interest from the proceeds of the sale. Obviously, if you really owned the house this will never happen.

So in reality, if you own a house which has a bank loan funding it, what do you own? Well, you do own the house partly, to the tune of the amount of money you have contributed towards the cost. In the above example, you paid 30 lacs out of 80 lacs so you own 37.5 % of the house to begin with. Now as you keep paying your EMI every month, your ownership of the house will keep increasing. Keep in mind though, in the first few years the rate will be slow as much of the EMI amount goes towards the interest component. So if the house price remained constant and your loan tenure was 20 years, you would approximately be adding to your ownership by 3 % every year.

Now, the good thing in our country is that the prices of real estate generally go up over time. Thus when we are looking at house ownership, the right aspect to consider is the worth of your holding rather than your % holding of original price. Let me make this clear by using the same example:-

  • Let us say in 10 years the price of the house has gone up to 1.4 crores.
  • Total amount paid off till 10th year is 60 lacs (say)
  • Outstanding loan to the bank is still 60 lacs ( with interest )
  • So your equity in the house now is 80 lacs. In reality it is more as you can pre-pay.
  • So with an appreciating asset where the rate of appreciation is greater than the interest rate it will in general make sense to get the asset on loan, even though your ownership of the asset is limited.

So is the home loan a “good loan” then as many people say? Not really as you end up paying about 1.2 crores for 50 lac loan and get full ownership of your apartment when it is 20 years old !! Your family may have been pushing you for years by then to get a newer apartment. In reality all loans are avoidable – they are however imperative at times simply as you do not have adequate money to cover for the asset. In such an event, take the loan but pre-pay it as soon as you can.

Now look at a situation such as a car where the asset is a depreciating one. Here it makes very little sense to take a loan as you will probably be still paying your EMI by the time you start thinking of getting a new car. If you assume the life of a car to be 10 years then under no circumstances should you look at a loan tenure of more than 5 years. And if you are the kind of person who wants to change his car every 5 years, then forget about loans and think of buying a car only when you are able to pay it off in full. A direct follow up from this will be this – never take loans for anything whose life is less than 5 years.

Asset ownership makes us feel good but we need to be clear about the affordability of it. For long term assets we can look at our long term earning potential and take a long term loan, with the knowledge that our asset is quite likely to appreciate. However, for assets with short life such as a smartphone, we need to be able to afford it today.If you have to buy it on loan and know that you will need to replace it after 3 years, then you really cannot afford it.

Think about what you just read and look back on some of the last few asset purchases that you did. You cannot change those now but you can make sure that in future you are buying assets that you can truly afford.

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.

Building the Balance Sheet – My story

I said in the last post that I would write the next one on how I created my own Balance sheet. A disclaimer will be in order – while much of what I did in my life will be repeated even if I lived through it again, I did not necessarily do them for the same reasons that I am now having. However, when I look back, I feel quite surprised that most of the actions were fundamentally correct and that has stood me in good stead.

As we are talking of assets and liabilities here, I will restrict my experiences to those aspects only. I started work after passing out of IIM Calcutta in 1988. For about 5 years I really did not acquire any physical assets as I was living in shared apartment with friends and the apartment was furnished. I did not buy a Bike as for some strange reason I had always wanted my first vehicle to be a car. In this period I did buy some financial assets such as Debentures from L & T, Reliance and also had some FD in banks with the surplus money I had.

My need for purchasing assets started in 1993 when I rented a 3BHK apartment in Noida and had to furnish it for making it livable. The company I worked in then had a scheme of paying 12000 Rs for buying furniture, which took care of a lot of basic furniture. I had to put another 25000 or so to buy Fridge, TV and other appliances. I also got married in 1993 and most of the FD proceeds went to take care of the marriage expenses.

Between 1993 and 1998 we were a household with fairly high income and also high expenses. High income as both my wife and I worked and our salaries were fairly good for those times. Both our children were born in this period and this naturally resulted in high expenditure. Fortunately, my job change in 1994 meant that I had a car from the company and we did not have to worry about acquiring that asset. Financial assets were acquired in the form of starting PPF accounts, buying some shares from the companies I worked in and also a variety of debentures. In 1997 we also bought a Timeshare costing 1.1 lac, which we were able to pay off within 6 months.

When we shifted to Chennai in 1998, the need for asset creation assumed significance for us. Though the job in Chennai paid a fair amount, the company policy only allowed company cars of Vice Presidents and above. Unfortunately, I was not a VP yet, so I needed to buy a car. I wanted to buy a Maruti Zen costing 4 lacs plus. My wife had just given up her job and got her PF and Gratuity money which we used for down payment of the car. It still needed a loan of 1.5 lacs and I got one at a very decent rate. I remember the interest being only 6000 Rs for 1 year. This was a time of high expenses for us as we were settling down in Chennai and lower income as my wife had given up her job to take care of our 2 children. Our financial asset building was at a low key and was restricted to PPF and some FD with a view to purchasing a house later.

In many ways 2000 was a watershed year for our family. Professionally I became a CEO, which was great given I had worked for only 12 years by then. As my income more than doubled after the job change, we started looking actively for buying a home in Chennai. Our earlier FD as well as my wife’s PPF that matured in 2002 enabled us to make a reasonable down payment for a flat in a good locality of Chennai. We did have to take a loan from SBI of 20 lacs and I was already in thoughts as to how quickly we could possibly pay it back. Over the 2002 to 2005 period my main focus was on paying off the loan so as to get out of the liability. All surplus amounts including bonus and variable pay went towards pre-payment of the loan. By March 2005 we had managed to pay off the entire loan and saved a huge amount of interest in the bargain. We also bought our second car in 2002, a Hyundai Accent GTX costing about 8 lacs. We traded in the Maruti Zen for 2.25 lacs and managed to pay off the remainder in cash.

Post 2005 our main focus was on building up the equity asset base, both through direct stocks as well as MF. Apart from PF and PPF all other investments were in equity. Despite the crash in 2008, we started our regular SIP in 2008 and went ahead to buy more stocks in 2009. Over the last few years, this has continued in general terms. In 2009, we bought our third car a Toyota Corolla Altis costing about 14 lacs. Once again we paid for it in full through cash. In between we had shifted to Hyderabad in 2008, which considerably increased our expenses courtesy children’s schooling and other costs. At this stage except for the PF and PPF again, all other financial assets were being created in equity.

In 2011 I started to think seriously about giving up a regular corporate role and shifted to creation of financial assets with debt instruments. Over the next 3 years, bulk of my investments were in debt and a lot of it were in FMP and Tax free bonds. I continued the SIP in MF but toned down on buying stocks, though my wife started her own portfolio around this time. By end 2014 I had created a passive income stream to take care of my regular expenditure needs.

Today, I continue to create assets and they are mostly financial in nature, out of my Consultancy income. As you will see from here my secret to the strong balance sheet has been to create assets whenever possible, not taking loans unless it was absolutely needed and paying these off as quickly as possible. I have never really had any long term liability.

How to build a strong Balance sheet for yourself

Let us talk about how you should start building a strong Balance Sheet for your finances. As we saw in the last post, the two aspects of a Balance Sheet are assets and liabilities. Obviously any strong Balance Sheet will have strong assets and less of liabilities. The difference between the assets and liabilities is really the Net worth.

In essence a strong Balance Sheet for your finances will mean the following:-

  • Your assets are significant and hopefully growing over time.
  • Your liabilities are under control and are reducing as time goes by.
  • Your Net worth is having a positive trend and the rate of increase is faster as time goes on.

We will start with the assets part first. As we start our working life we begin acquiring assets in various shapes and forms. In the initial period most of these assets are for consumption such as household appliances when you set up a home, a two wheeler for getting to your place of work etc.As time goes by we graduate to purchasing more expensive assets such as a car and eventually a home. Apart from these physical and tangible assets we will also now start to acquire financial assets. These are essentially financial instruments which can be redeemed to realize monetary value. So any stock that you own is an asset, your units of equity or debt MF are assets and so is the FD that you have in your bank.

You have to spend money to build assets and the best way to do this is out of your income. However, many of us are not in a position to pay for a Bike out of the first couple of month’s salary. An option is to wait for a few months, accumulate the necessary amount and then buy it. As this takes more time than many are willing to give today, an easier way is seen to be to take a loan and pay EMI over the next few years. This simple example would have shown you how a liability is created. If you have bought a car for 6 lacs then it is an asset. However, if you took a loan of 5 lacs to buy the car then it is a liability. Both of these will come in your personal Balance Sheet.

We need to understand the liability of loans in a better manner. Any loan is a liability, even the credit card outstanding amount that you have is a liability. In simple terms you are enjoying the benefit of an asset that you really have not paid for. There are several ads nowadays telling you that you can buy an iPhone with paying a minimal amount and then getting into an EMI payment schedule. This is nothing but creating a liability which will remain in your personal Balance sheet till you pay it off in full. Every time you spend on your credit card you are creating a liability for yourself. If you are paying it off in full when the bill arrives at the end of month it is fine. However, if you are unable to do so this attracts a hefty interest and that increases your liability further. In general, I am in favor of minimizing loans and using them only when absolutely needed.

Why am I not in favor of loans? Well, you see most assets that we purchase reduce in value with time. Let us say you are buying a car today for 8 lacs and a helpful bank is willing to give you the entire loan. Now, the moment you drive the car out of the dealer show room the value has typically gone down by 20 %. In other words if you were to sell the car after just a week or so you will be very lucky to get even 7 lacs. As time goes by the value of this asset will keep depreciating. Your liability unfortunately remains the same. For a 8 lac loan your payment over the years may be 11 lacs and this is your total liability. So just after you own the car your asset value id 7 lacs and your liability is 11 lacs. Therefore on this transaction alone, your new worth takes a hit of 4 lacs on the down side.

Does this mean all loans are bad? In general, I am uncomfortable with taking loans for depreciating assets. Even if you do so, make sure there are no pre-payment penalties and try to pay it off as soon as you can. Also you must minimize your loan needs by being able to make a significant down payment yourself. For assets like home which appreciate in value, taking a loan can actually be a good strategy. However, even in this case the general principles of minimizing the loan amount needed and aggressive pre-payment will stand you in good stead.

I hope this has given all readers some good pointers on how they can start building a strong Balance sheet for their own finances. I did want to share my own experiences with you but as this post has already got long, I will do it tomorrow.

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