I have been in the markets for more than 4 years. I use a fusion of – Fundamental & Technical Analysis in my trading. I am still in the process of figuring out what works in the markets but I am making good money consistently. In this blog, I thought I will write about my never ending search of holy grail. Also about the books / sources from where I learnt my skills and the strategies I use in my trades. Please treat this post as a course content book for, say, a diploma in stock market which will help you cut short your learning curve.
The line between investing and trading has eroded over time. Investing in the true sense is getting income through dividends paid by the company. To get regular income like dividends, I would rather invest in Government Securities which are risk free. In my methods, dividend is only a cushion for risk. Then came Ben Graham who bought stocks which were trading at a price less than their asset (book) value. His method worked when most of the companies listed in the exchange were old economy with asset heavy business models. Now, everyone is only interested in the price appreciation which makes everyone a trader. Per tax rules, if you buy and sell within an year, you are a trader. If you hold it for more than 12 months, you are an investor. Fundamental guys try to glorify their analysis but at the end of the day, price has to move higher than your purchase price for you to make money. My basic thought process, irrespective of timeframe, is:
Buy Low, Sell High or Buy High, Sell Higher
If you are a newbie and have never traded before or you don’t understand a company’s financial statements, please read the beautfiul primer by Zerodha.
I would definitely suggest you to explore the different types of trading / investing but once you are done exploring, try to find the ONE method that you identify the most with and build a plan around it. I have attended many webinars, workshops and talks related to stock markets in the last 3 years. In every event of those, I would pick up a new strategy. Try to apply it the markets immediately. After the initial luck, I started making losses. The reason for this is that they were not MY strategies and they did not suit MY style / mentality. Also, I was playing on borrowed conviction which never works in the long run. Hence, find out what kind of trader / investor you are and then build YOUR strategy. Psychology has to be in place before you even think about adding funds to your broking account. Psychology includes discipline as well. If you are not disciplined in personal life, it is very difficult to make money in the markets. Your habits will reflect in your trading, be it profits or losses. In fact, through trading you will learn new things about yourself which you never knew.
Remember – More knowledge is not more wisdom!
Fundamental analysis (FA) is a method of measuring a company’s intrinsic value by examining financial statements of the company and related economic factors. Fundamental analysts study anything that can affect the company’s value, from macroeconomic factors such as the state of the economy and industry conditions to microeconomic factors like the effectiveness of the company’s management and past financial performance. The end goal is to arrive at a number(fair value) that an investor can compare with a company’s current price in order to see whether the company is undervalued or overvalued.
Basics of Fundamental Analysis:
Five rules for successful stock investing – Pat Dorsey
Value Investing, From Graham to Buffett and beyond – Bruce Greenwald
Common Stocks and Uncommon profits – Philip Fisher
One up on wall street – Peter Lynch
Masterclass with super investors – India’s leading investors – Vishal Mittal
Cyclical Investing: (extension of Value investing)
My Investing Guru – Kenneth Andrade
Capital Returns – Edward Chancellor
Mastering the market cycle – Howard Marks
I identify my framework with that of Kenneth’s and I love his style of investing. Unfortunately, Kenneth hasn’t written any books but has done a lot of interviews. Links to them in my twitter thread:
I tried to apply the concepts in the book – Capital Retuns – in Indian markets. This helped me build a framework for cyclical companies.
Expectations Investing: Potential future value of a company based on growth and profitability (extension of Growth Investing)
Expectations Investing, Reading Stock Prices for Better Returns – Alfred Rappaport & Michael Mauboussin
Charlie Munger’s framework and adaptation by Professor Sanjay Bakshi for Indian markets – “Relaxo Lecture”
Valuation: Measuring and Managing the Value of Companies – Mckinsey
Warren Buffet’s letters to Berkshire Hathaway shareholders
Poor Charlie’s Almanack – Charlie Munger*
Note – These 2 guys (Warren & Charlie) are outliers and I don’t think anyone can repeat what they have done but they are the foundation for Value Investing. Also note that I say “Buy Low” and not “Buy Cheap”. Cheap is not necessarily Value.
To understand various aspects of a company, you should read the Annual Report and Conference Call transcripts. To anaylse companies and their financial performance, I use Screener website where you can find all the listed Indian companies’ data in one place:
Technical Analysis (TA) is to evaluate investments and identify trading opportunities in price trends and patterns seen on charts. Technical analysts believe past trading activity and price changes of a company’s share can be valuable indicators of the share’s future price movements. Technical analysis assumes that a company’s share price already reflects all publicly-available information and instead focuses on the market sentiment behind price trends by looking for patterns and trends rather than analyzing a security’s fundamental attributes.
You can learn basic TA and psychology from these books: Mark Douglas (must!)with either Martin Pring’s or John Murphy’s*
I buy when there is a high probability trading setup with low risk. Following are the high probability setups I use:
Darvas Box – All Time High, 52-week High, 6-month High –
Mark Minervini – Volatility Contraction Pattern –
Watch the following videos after you read these 2 books.
William O Neil – CANSLIM –
Value Zone – Market and Price move from one zone to another. Each zone is a Value Zone. Fight between supply and demand. Buyers and sellers. Whoever wins, pushes the price in their direction. This book was the game changer for me! (will write a blog soon about my trades using this setup)
Quantitative analysis (QA) is a technique that seeks to understand behavior by using mathematical and statistical modeling, measurement, and research. Quantitative analysts aim to represent a given reality in terms of a numerical value. I don’t understand mathematical or statistical modeling. You will need a PhD in Mathematics or Statistics to do data driven trading. I am only interested in the measurement aspect of QA. As in, quantifying Technical or Fundamental Analysis to build trading / investing systems with complete set of rules for buying and selling.
There are 2 broad categories where we can implement Measurement QA – Trend following / Momentum investing and Mean Reversion. I am not covering Mean Reversion in this blog because I don’t know that method / concept.
Trend following – a trading strategy based on the idea that markets move for long durations of time in a given direction, and one can quantitatively identify such a trend and ride it.
Momentum Investing – a trading strategy of buying financial assets that are showing strength and selling those which are showing weakness. This strategy is based on the age old tenet of cutting your losses and letting your winners ride.
“The key difference lies in the reference point used to identify a trend versus a momentum. For Momentum, we use the Performance of stocks as compared to other stocks in a given universe. In contrast, in Trend Following or Time Series momentum, we compare the current price of a stock/Index with its historical price.”
He recommended this book on how to apply math in trading. It involves a lot of Statistics and Data Analytics. Don’t waste time if you don’t know any of those.
Systematic Trading –
Phew, thats how much you will have to read to get a Diploma in stock market. But you promised us a holy grail? The sad truth – there is no holy grail! If there was one, everyone would be making money, right? Trading and Investing are marathons and they do not have any short cuts. No free lunches. You will have to grind it out and lose some money in the process. Consider it as tuition fee.
Fundamental Analysis – What to buy? Undervalued / Cyclical / Quality / Growth
Technical Analysis – When to buy? High probability setups with low risk
Quantitative Analysis – How much to buy? Who are the leaders in the sector? Trend strength / Relative momentum ranking / Maximum Drawdown / Position Sizing.
Load your account with few thousands. Trade, Invest. Lose money. Get a feel of the market. Decide if are you are capable of handling the emotions. You might feel that you are okay with 20% drawdowns but only when you experience a 20% drawdown in real life, you will know if you are okay with it or not.
Read again. THINK! INTROSPECT! Choose your style. Identify your psychology. You need not use all 3 sciences. If you are comfortable with Technical Analysis, then just stick to charts. Don’t look at fundamentals. Don’t run behind more information or knowldge. More knowledge is not more wisdom. Less is more!
Go through charts. A lot of charts. Study companies and their financial performance. Create a set of rules. Backtest those rules to see if they made money in the past. Finalise your strategy. I stress on backtesting because I have used almost every technical indicator available but I either lost money or couldn’t scale up because I hadn’t done the backtest. Only a back test will reveal if a certain indicator has an edge or not. (Personally, I do not use any indicator. My charts are clean and I use only price action with volume.)
Implement the strategy rules with Discipline and Money / Risk Management (read up about this as I am not an expert, in trading lingo its called Position Sizing). A system is nothing without discipline. If you can not control your emotions, forget stock market.
Start with small capital.
Trade short term to create capital
Invest long term to build wealth
Always have a stop loss!
If you are making less than 12% on an average every year, better to stick to Index funds. You will get the market returns with less effort.
“All you need is one trading pattern to make a living! Learn first to specialize in doing one thing well.”
Linda Bradford Raschke.
What not to do!
DO NOT START WITH FUTURES OR OPTIONS OR LEVERAGE. YOU WILL BLOW UP YOUR ACCOUNT. NOT JUST ONCE. YOU WILL LOSE EVERYTHING.
DO NOT BUY OR SELL BASED ON STOCK TIPS YOU RECEIVE ON SOCIAL MEDIA. DO YOUR RESEARCH. BUILD YOUR OWN CONVICTION.
DO NOT FOLLOW A LOT OF PEOPLE ON SOCIAL MEDIA. YOU WILL BECOME BETTER IF YOU STAY AWAY. INVESTING/TRADING IS BEST DONE ALONE.
The process –
You will lose big
You will lose small
You will breakeven
You will make small profits.
You will make money consistently. (It will take few years to get there)
“Patience and Discipline are the holy grails in the stock market!”
Will leave you with this
“A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts”
A life insurance policy is the cheapest and safest mode of making a certain provision for one’s family. Everyone in the family can sleep peacefully without having to worry about the future.
A person who dies without adequate life insurance should have to come back and see the mess he created.
So what is a Life Insurance policy?
Life Insurance is a contract between the policyholder and the insurance company. The policyholder pays a premium to the insurer for a certain time period or for life, and in return the insurer promises to pay the assured sum to the nominee upon the death of the policyholder. A life insurance cover is intended to ensure that, in the event of your death, folks who depend on your income are not left financially unsupported.
Who does not need a Life Insurance policy?
No income yet
No dependents yet (parents or children) or have partners who are self sufficient and can take care of their needs
People nearing their retirement and have sufficient savings and investments for retirement
Rich people with net assets in Crores of Rupees
What are the different kinds of Life Insurance?
Term Plan – Purest form of Life Insurance. You pay a premium for the specified number of years. Your nominee gets the benefit upon your death anytime during the term specified in the contract. Your nominee doesn’t have to pay the premiums after your death. On maturity of the plan (or expiry) and if you still alive, you don’t get any benefits.
Whole Life – Pay the premium as long as you are alive. It has some additional savings benefit.
Endowment Policy – Apart from covering the life of the insured, helps the policyholder save regularly over a specific period of time so that they are able to get a lump sum amount on the policy maturity in case they survive the policy term.
Unit Linked Insurance Plans (ULIPs) – The goal is to provide wealth creation along with life cover where the insurance company puts a portion of your investment towards life insurance and rest into a fund that is based on equity or debt or both and matches with your long-term goals.
The concept of Life Insurance is that – During your career, if something happens to you, your family should have a safe future and not struggle because of loss of the primary breadwinner. The insurance cover will replace your salary / income for the family. Ideally, your family will need the insurance cover only for the duration of your career – be it business or profession. Beyond that, your savings and investments should cater to your retirement needs. You shouldn’t rely on insurance for your retirement life. The best product for life insurance – Term Plan! Say you are 30 and you want to retire by 60, you should take a term plan for 30 years – till you retire and not for 40 years because your insurance agent says so. During the next 30 years or till you retire, split your income into 4 parts – Insurance Premium (both Life & Health, max 5%), Savings / Investments ( at least 35%), Daily Expenses (needs) and Luxury (wants). The last part should happen after the first 3 is taken care of. The insurance will provide cover to your family for the next 30 years. The savings / investments will provide for the retirement life. This is also the reason why I don’t recommend Whole Life policies where you pay a higher premium. Instead you could save that money and make better returns.
I am ignoring Endowment and ULIPs because these plans make more money for the insurance company than the policyholder. I have experienced them first hand and I have done enough research. The problem with these plans is that they try to combine insurance and investment into a single product which never achieves the purpose. Endowment combines insurance and savings. ULIPs combine insurance, investments and tax saving. The sum assured is very low. The returns are very poor, sometimes less than the savings account interest rate provided by the banks in case of Endowment and less than the market returns (mutual funds) in case of ULIPs. Instead, you can take a term plan for a significantly lower premiums and invest the excess in avenues which give you better control and returns. Never mix insurance, tax saving and investment. Keep it simple. My parents bought them without understanding the product and had paid premiums for few years. One had returns of 2.75% (SBI Savings Account was giving 3.5%) with a cover amount 10% of a Term Plan. I had to stop it and convert the policy to a paid up plan, i.e. stop the premiums immediately and just get the cover for an amount proportional to the premiums paid till date. If you have any endowment or ULIP policies running, I suggest you talk to the agents and check if you can convert it to a paid up plan. If yes, stop paying the premium. Take a Term Plan.
How much insurance cover do you need?
Amount equal to your family’s regular Annual Expenses till the end of Term Plan
Goals – Children’s Education and Marriage
Net Assets = Assets (Savings & Investments) – Liabilities (Liabilities are Home & vehicle EMIs or any personal loan)
Ideally, the cover amount should be the sum of these 3 components adjusted for inflation. Start with the following example and get into the nitty-gritties and other details.
Sit with your family and discuss. Involves serious decisions like number of children. If you feel that your children will fund their higher education by themselves through education loan or have a simple wedding, then make the necessary reductions. In any case, your family will need at least 2.5 Cr cover for basic expenses. The problem with this is that, insurers will give a maximum cover of 20 – 22x your annual income. Therefore, it’s not enough to buy a term insurance plan once in your life and pay premiums faithfully. You need to re-visit and add to your life insurance after significant life events, to ensure that you have enough cover to keep your family protected. Mind you, I have used a conservative inflation rate of 4%. Education and Health expenses are growing exponentially these days.
When should you take an insurance policy?
Fun is like Life Insurance; the older you get, the more it costs.
If you do not fall under any of the categories mentioned earlier, the best day to buy a term plan was before your last birthday. The 2nd best day to buy one is before your next birthday. Most insurers give 20 – 22x of your current annual income as cover. I don’t think that will be sufficient to meet your family expenses in future. So take a second term plan after maybe 10 or 15 years when you will have a better idea of your expenses. Go to each insurer’s website and keep track of premiums. Calculate how much you will end up paying extra if you take it a year or two later. Premiums are not likely to come down in future. In fact, they have gone up post Covid.
Until what age should you get cover?
Ideally, your retirement age!
Life Insurance is a product to secure a backup regular income for your family during your working years. IT IS NOT A RETIREMENT PLAN. For retirement, you have to save and invest regularly to build a huge corpus. Like I said before, your pension, PPF, FD, Gold and equity investments should provide for your family beyond your retirement.
The first problem with taking a policy for beyond the age of retirement is that premiums rise exponentially due to higher mortality risks. Instead, you could invest that excess amount in FD or an instrument of your choice which will grow into a corpus for your family.
Almost 10500 Rs. difference every year for 25 years which when invested at 7% will grow into a corpus of 20 Lakhs, whereas the cover itself is only 1 Crore. Yes, the differential is only for 25 years. After that, you wont’ add just the differential, you will have the entire premium of 80 year plan to invest. Which means, if you opt for a 80 year plan, you will have to pay premiums even after retirement when you won’t have any income. This is the second problem with a longer term plan. Why extend expenses beyond retirement? Expenses are gifts that keep on giving. If the excess premiums of the longer term plan are invested in gold or equity, you might end up getting the cover amount as your investment returns. Power of compounding. If you are an investor, then you can even take a term plan for the duration of your liability if any (like Home Loan) and invest the excess to get better returns.
So I wouldn’t recommend anything more than your retirement age. If you still feel it’s just few lakhs extra, then go ahead with a cover till 75. But make sure you find a source of income for paying the premium from your retirement age till you are 75. Even USA with the excellent health infrastructure has average life expectancy of 78.5 only.
What should be the type of premium payment?
Pay every month or year (small discounts if you pay annually). Do not opt for limited payment term. The insurer / agent will lie to you that you save money in limited payment term. Even in the ICICI screenshot below, you can see the “save up to 65%” trap. Why is it a trap?
They do not tell you about the time value of money.
In the above scenario, you pay Rs.16424 every year for 30 years which is equal to 30 * 16424 = 4,92,720 or Rs.36909 for 10 years which is 369090. They sell these plans by using this number that you are paying more in the regular payment term.
Time value of money = money in your hand today is worth more than money in your hand tomorrow. Due to inflation, money loses it’s value (purchasing power) every day. I use the example of coffee to explain this concept.
In 1970, you could have bought a cup of coffee for $0.25. For the same amount, you could have bought only a quarter cup of coffee in 2010 and approximately 1/7th of a cup today. Applying this concept to the insurance premiums you pay, the regular payment term is cheaper than the limited payment term. To know the present value of future cash outflows, I discounted the cash flows by 7% which is the prevailing FD rates. In simple terms, if you had to make one lump sum payment today for both these policies, you will have to pay 2.6 Lakhs for the limited term whereas you will only have to pay ~2 Lakhs for the regular term resulting in savings of 22%. I will post the link to the calculator and few links to read about this concept at the end of the post.
Also, 16424 Rs. every year now might be 1% of your annual income today but 20 years down the line it can be 0.1% of your annual income. It will be easier for you to pay in future than today.
Another important point – in the regular term, the premium payment is spread across the policy term. In limited payment, say you are 35 and have taken a policy for 30 years, you end up paying the entire premium amount in 10 years. So if you die when you are 50, you would have already paid all the premiums. Whereas, in regular payment you would have paid only half the premiums.
The same concept also applies to “Return of Premium (ROP)” policy. Since policy holders do not get any benefits on maturity of the policy (survival during the term of the policy), many do not opt for a Term Plan. Insurers wanted to make use of this and milk money. They started selling ROP policies by charging 75 to 100% higher premiums while guaranteeing the return of those premiums.
Consider the case of a Rs 1 crore term plan for a 45-year old man which covers him until age 75. In his case, a normal term cover would cost about Rs 35,000 a year in premiums for the next 30 years, while a ROP plan would cost about Rs 62,000 in premiums. Let’s assume he opts for the plain vanilla option and invests the Rs 27,000 thus saved in FD earning modest returns of 6%. Thirty years later he would be able to withdraw Rs 22.7 lakh from this, far more than the Rs 18.6 lakh he would have got back as return of premium on the ROP plan.
Remember – Insurance is not an investment. 5 Lakhs you pay over the term will give your family 1 Crore if you die during the term. What more returns do you want? If you do not die, you and your family would have slept peacefully during the term.
What additional benefits (also known as riders) should I opt for?
Premium waiver on Accidental disability or Terminal illness
In the first 2 options, you get a certain one-time additional amount on occurrence. In 3rd option, you get a one-time lump-sum amount as a proportion of your basic sum assured (cover), on your being diagnosed with a critical illness. 4th option allows the policyholder to stop premium payments upon disability or being diagnosed with a terminal illness.
The problem with these additional benefits is that the premium shoots up if you opt for any of these. There is no standard or rule to be followed by insurance companies to set these additional premiums. Hence, it varies a lot between various companies.
Also, the insurance companies have lots of terms and conditions for these. You will get to know only when you read the fine print. Know what you are paying for. I would recommend Critical Illness benefits if your family has a history of any of the listed illnesses. Like, ICICI provides cover for 34 and Tata for 59 illnesses. Within each illness category, the cover is only applicable for certain types. Like certain types of cancer are excluded. The use of words matter a lot in the policy. There is a huge difference between “Cancer” and “Cancer of specified severity”. Pre-existing conditions and diseases are excluded. If you don’t have family history, I would recommend a full fledged health insurance with a higher cover instead of this additional benefit. Accidental or disability benefits might apply only when death occurs within the specified number of days from the date of accident. So read the policy document carefully.
How should my family receive the benefits upon my death?
ICICI has 4 options to choose from and so do other insurers. I leave it up to you to decide. It depends on the financial literacy of your family. So educate them about the policy details and personal finance framework to help them make use of the funds they would receive.
Which insurance company should I choose?
There are 24 insurance companies in India. Choosing one is a headache. Worry not, as PrimeInvestor has done the basic filtering out process for us.
Assets Under Management (size of the investment book of the insurance company) > 10,000 Crores
Experience – Track record of atleast 10 years.
Solvency Ratio – The biggest risk to any insurer’s survival is that it will receive a flood of claims that it is unable to service with its available investments. The Solvency Margin is a metric designed to ensure that this doesn’t happen. It is the amount by which an insurer’s assets exceed its policy liabilities. Assets for an insurer usually consist of its investment book and fixed assets. Policy liabilities are the present value of future claims plus its own future expenses, minus the premiums it is likely to collect. Solvency Ratio is the insurer’s actual solvency margin measured against the required margin. Insurance Regulatory and Development Authority (IRDA) prescribes a minimum Solvency Ratio of 1.5 times for insurers in India.
Latest Market Share – The percentage of the premiums collected by an insurer during the latest quarter as against the total premiums collected in the entire sector. Market share confers disproportionate advantages in every financial business including the insurance space.
Persistency Ratio – A ratio that measures the proportion of customers who chose to renew their policies at the end of the year. This is a good proxy to measure an insurer’s service standards and selling practices as it shows how much confidence customers have with the insurer. It also indicates the stability and continuity of cash flows from existing customers of the insurer to pay the claims that will arise in future.
Claims Settlement Ratio – A measure of the percentage of claims settled by an insurer in a given financial year as opposed to the number of claims received. This is a key metric to gauge the ability and efficiency of an insurer to settle claims and is used as a primary decision-making guide to choose an insurer.
I considered AUM of 30000 Cr and 5 Yr Persistency ratio of at least 40%. I got 9 companies. I added a basic ranking for each of these parameters and then took an average to arrive at the final ranking. 1 being the best and 9 the worst. Premiums are based on a 35 year old Male, term plan for 40 years with a cover of 1 Crore. Age will affect the premium value but will not affect the ranking as the amount will be proportional.
There is no significant difference between the top 6. The top 3 ranked are part of the groups which own the largest private banks in India. LIC has the Sovereign (government) guarantee and SBI is a government bank but both have high premiums. Although I personally have ICICI Prudential policy, I would recommend Kotak’s e-term. It has the cheapest premium with the highest 5 year persistency ratio. It only lags behind in AUM and market share which I think will change in the coming years. The claim settlement ratios are taken from IRDA’s annual report for 2018 – 19. I looked up Kotak’s latest settlement ratio (FY20) and they have declared it to be 99%! I am also biased because I am a huge fan of Mr. Uday Kotak and his bank – Kotak Mahindra Bank.
Please make your decision based on your needs – term, payment structure, payout structure, government guarantee, insurance company management quality, total premiums including any accident or critical illness rider, free waiver of premium for disability or terminal illness. At the end of the day, you are responsible for your family. Not me.
It’s better to be 5 years too early, than be 5 minutes late.
Given that life insurance premiums increase with your age, please take one before your next birthday if you don’t have one already.
Answer all the questions in the application form and don’t let the agent fill it up. Read the documents thoroughly. After the Policy starts, if for some reason, you find that the details that you identified earlier is not covered in the policy or the response provided earlier by the agent when taking the policy was not correct, where by you took an unsuitable product or you were mis-sold, you must use this free look-up window and return your policy. It is usually 15 – 30 days after the policy term starts.
Give the truth. If you smoke or drink, mention it. Your premiums will increase. But it is better to pay now than regret later when the insurer rejects your claim stating smoking or drinking as a reason.
Insist on a medical test. One less reason for insurer to reject your claim.
If you already have a policy, check if the cover is adequate enough. If not, take additional policy. A policy without adequate cover does not serve the purpose.
Do not mix Insurance and Investment. Have separate plans for Life Insurance, Health Insurance and Investments. Death occurs once but accidents or different illness can occur more than once during a lifetime. If you opt for riders in a term plan, you will get paid only once on occurrence of accident or illness. Hence, the need for a separate Health Insurance. Will write a blog soon.
Of course, Premiums paid towards a term insurance plan qualify for a tax benefit under section 80C of the Income- tax Act. You can claim a deduction up to Rs 1.5 Lakh a financial year for the premium paid (premium should not exceed 10% of the sum assured) for yourself, your spouse, and your children. But do not buy a term plan for the sake of tax saving. Also, since the Government has come up with a new tax regime, we do not know for how long they will continue to provide tax benefits.
Life Insurance gives you the opportunity to be the Dark Knight. It’s not for you. It’s for your family.
I will leave you with this:
An ounce of prevention is worth a pound of cure.
Founding Father of America & Insurance – Benjamin Franklin
Disclaimer – I work for a consulting firm in their valuation team. I have an MBA in Finance. I am also an investor. Hence, you might see a certain bias in my post. Please do your own research before you buy a term plan. Read the terms and conditions of the policy. I am not registered with SEBI or IRDA. I am not responsible for your losses.
Excel sheet I used for the ranking and insurance cover calculation:
The old tax regime was introduced in the 1960s to incentivise savings and investment. As we progress as a matured economy and more people become aware of personal finance, it is natural and sensible to shift towards a flexible rate structure. It has to be simple and make the decisions related to tax incentives easier for the common man to understand. For the matured investors, it should allow them to choose between existing rates with incentives or a flat low rate without incentives. As a country, we need to evolve into investment mentality from the existing tax saving behaviour. The Govt. announced a new tax regime in the 2020 Budget on February 1st. Is it any good? Are we a matured economy yet?
An individual has 2 options now – Pay old tax rate with incentives or pay new lower tax rate without incentives.
Lower tax rate will put more money in the hands of the individual which will lead to increased spending. This will boost the economy.
People will not buy the shady ULIPs and insurance products anymore for the sake of tax planning (they might still buy Term Insurance).
Flexibility and ease of filing for the following people:
The ones who do not have or have finished their education / housing loan.
The ones who invest in the equity markets by themselves or through mutual funds and don’t want to go through the ELSS / PPF / NPS route.
I have made a basic calculator to check your tax and decide if one should stick to old regime or shift:
The ones who avail exemptions and deductions end up paying more tax if they move to the new regime.
People will now have to take the support of professionals to decide if they have to stay or switch because of the complex nature. It is definitely not simple.
An individual with a salary of 12.5 Lakhs will end up paying Rs. 30,500 more under the new rates. He will have to pay more if he has education or housing loans. They should stick to the old regime till they are done with their exemptions.
(Use the calculator above to play around)
Ms Sitharaman said while the intention this time was to “reduce rates and simplify structure”, the government “will be able to gradually remove all exemptions”.
So the Govt. will eventually force everyone to shift to the new tax regime where there is no incentive for savings at a time when savings as a % GDP is at rock bottom. We are actually spending from savings AND taking loans (vehicle, credit card, EMIs). And the new tax regime will only add fuel to the fire.
Why do I feel that people will spend more with the extra cash rather than saving it? Indians lack awareness, discipline and financial knowledge.
According to a survey by Standard & Poor, 76% of Indian adults are unable to understand key financial concepts
Only 3% of Indians have DEMAT account (3.65 crores). (The account in which one holds equity shares)
We are not a matured economy yet. Hence, although in the right direction, this new regime is a bit early for our country.
If Government is expecting people to be disciplined and take care of their own savings and investments, they should at least help the cause. They are destroying the financial product which will help us beat inflation – Equity Capital Market (Shares & Mutual Funds).
A company can raise capital needed for business in 2 different ways – Debt and Equity. Similar to individuals taking loan from banks, companies take loans from banks and investors. This is the debt part. The returns for them is the interest paid by the company on these loans. Or the company can issue shares (IPO, FPO) for a certain price (part ownership of business) to investors and offer them 3 types of returns:
Capital Gains – The company invests the money taken from the shareholders in the business and tries to increase the total value of the business by growing each year. The value of the shares also increases (sometimes disproportionately, both ways) in the long run. The shareholders can sell their shares in the secondary market (IPO is the primary market, after that the shares are traded in the secondary market) for a higher price than they initially paid.
Dividends – The company runs business and earns profits. After paying tax, the company can choose to invest these profits in the business for expansion. If they don’t have good opportunities to invest, they will pay some of the profits to the shareholders in the form of dividends (your share of profits) or do share buy backs.
Share Buy Back – ABC Ltd. issued 10 shares to me, 10 to you and the rest 80 is held by the owners of the company. We both own 10% of the company. Now if the company decides to buy back some shares, I return my shares since I am getting a higher price than I initially paid. These shares are put in the Treasury account of the company and no longer considered as ownership. Why do companies do this? We both owned 10% each when there were 100 shares. Now that there are only 90 shares, you own 11.11 % and the rest is for owners. The value per share of the company increases which might lead to increase in prices of these shares in the secondary market.
Guess what, the Govt. made a mess in all of these 3 options.
In the previous budget, they announced a long term capital gains tax of 10% for income of more than 1 Lakh from Equity shares or mutual funds.
Also in the previous budget, they announced taxation on buy backs, dividend distribution tax (DDT) on companies, dividend income tax on individuals who receive more than 10 Lakh in dividends.
In this year’s budget, they removed the DDT and transferred the tax burden to individuals. You have to pay tax on every rupee of dividends you receive. The 10 L limit is gone. Shareholder pays dividend tax as per his income slab and capital gains tax of 10%. The companies pay buy back tax. Tax tax tax.
Remember. The company pays tax to government before doing any of these. Hence, this is double taxation.
Now that the Govt. wants me to become an intelligent and matured investor, what do I do?
Invest in financial products which will help you beat the inflation and the government.
Why beat the government?
It is doing everything possible to make life worse for an investor. We need to up our game. We are on our own.
The returns of all the asset classes are linked to Government policies and performance of the economy as a whole.
What is Inflation and Why beat Inflation?
“Inflation is a quantitative measure of the rate at which the average price level of a basket of selected goods and services in an economy increases over a period of time. It is the constant rise in the general level of prices where a unit of currency buys less than it did in prior periods. As prices rise, a single unit of currency loses value as it buys fewer goods and services”
Your $0.75 in 1990 will only buy you half a cup of coffee today. Essentially, your money loses value because of inflation in prices. In finance, they call this the time value of money. To beat the inflation, you have to grow your money at a rate higher than the prevailing inflation rates. Yes, your income increases by the hike that your employer gives. But that is only for next year’s income and prices. What about the wealth that you have already generated? What about retirement where you don’t have income but there is inflation. You have to save today and grow your wealth for retirement and huge expenses like marriage, children’s education, house, car etc.
What is the current Inflation rate?
It ranges between 2.5% to 12%. RBI’s target is 4%.
If we drill down further, we can see that the education and health care expenses have gone up at much higher rates.
Personal example – I did my 12th grade for a fee of 18000 in 2010. One has to pay close to 75000 even for Kindergarten today. That’s 15% growth every year!!! Did your income AND wealth grow at 15% in the last 10 years? If not, you are lagging behind.
(Note – This rate might not sustain going forward. This is just to give you a perspective. Hope the government regulates both these primary sectors which are Govt’s responsibility but handed over to private players– Education and Health.)
What are the financial products available in India that will help me beat inflation?
We will start with the most common fixed income products.
SBI’s FD rate is 6.1%. Some private banks provide a bit higher rates. These rates keep changing based on REPO rate. The problem with FD is, the interests are taxable. Say your private bank gives you 7% and your effective tax rate is 20%, your net returns = 7% * 0.8 = 5.6%. Marginally above the average inflation of 4% and half of the education inflation.
Note – Do not deposit your money at random banks for 1 or 2% higher returns. The bank might get into issues like PMC did. Go for the bigger ones like SBI, HDFC, ICICI, Kotak if you still prefer FD.
The government allows you to deposit in the Public Provident Fund and gives you fixed returns. The current interest rate that you will get is 7.9%. Although, this return is tax free it has some disadvantages.
Lock in period of 15 years form the date of opening account
Limit on the maximum amount you can deposit every year – 1.5 Lakh
The government might withdraw the tax free status of NPS
Limitations in withdrawing the amount before 15 years
The interest rate has been on a decreasing trend since the 1990s. From 12% to 7.9%. It might go up in the short term but in the long run, it will go down like interest rates in developed economies.
I am ignoring government bonds as it is not easily available for everyone and are similar to FD rates.
We will look at the assets that give varying returns.
From 2000 to 2009, Gold CAGR was 12.67%
From 2010 to 2019, Gold CAGR was 8% only
If you look at the period between 2012 and 2018, you lost time value of money! Gold can give negative returns and is volatile too.
So learn more about Gold and how it performs or affects the economy before buying it.
Disadvantages of Gold:
We don’t know what makes the Gold prices move. People say, as long as humans exist the gold prices will go up. We do not know for sure. It depends on demand supply, macroeconomics, global sentiments and investor behaviour. Do millennials buy gold jewellery or even think of Gold as an investment? I don’t know.
There is no underlying in gold. Like, in equity the company is the underlying. Based on its performance, the share price moves.
Liquidity. If you have physical gold, it is very hard to immediately convert it to cash.
In case of a dollar or rupee, when the value depreciates, the corresponding Govt. or reserve bank steps in to avoid the depreciation of their currency. But Gold is not owned by any country or any standards or governing body.
Jewellery is not an investment. Liquidating gold jewellery incurs a significant loss. If you go to a bank with your gold, the bank wouldn’t pay 100% worth as the design will be outdated and redesign will result in some wastage.
Gold has given a CAGR of close to 10% since the 1980s! Is it better than Equity? I would have concluded it to be better if it had less volatility and less maximum drawdown (maximum loss from recent high). Data shows that Gold fell 20% from the highs in 2007, 2008 and every year from 2013 – 2017. So much for a safe bet, eh? If we look at the standard deviation, the long term average of yearly volatility is 25%. Which means, Gold prices can move 25% either side. Volatile! Can you bear this? Having given lesser returns with almost the same volatility and relatively less maximum drawdown, I don’t think Gold is better than Equity. Personally, I don’t prefer Gold because – no one knows why Gold moves. One advantage that Gold might(?) have is that – most of the world’s gold is in physical form and hence it is not easy to sell. So only the paper gold gets sold during market crashes which limits the downside.
There are some people who believe that Gold is a hedge (risk protection) to all other investments. I don’t think so. For an interesting comparison, look at 2008 (biggest market crash of our time), when Gold sold off along with most other assets from March through October. But it did bottom out and started rising much before Equity.
If one wants to buy paper/liquid Gold which can be considered as proper investment as you will get market price when you sell it, there are 2 options:
So Gold is neither a proper investment nor a hedge against Equity. It is a hedge against hyper-inflation.
The ultimate goal of all Indians? “Own a damn house”
Is it really an asset? It is, if the EMI you pay for the housing loan is less than the rent you receive. According to me, if the house is not in a growing city, it is a liability. What is a liability? Any depreciating property (real or personal) like car and electronics. I would only want to buy a house for me to stay and not as an investment. Use a calculator to decide if you want to buy or rent.
3 – 4%, which means you break even after 25 years!!! You might argue that one can sell the house for a higher price. Can you? Lets look at the housing prices in India.
The All India House Price Index has increased from 100 in 2010 to 250 in 2018. CAGR of 10.7%
The worrying factor is the decrease in the growth of the Index year on year. It was growing at 25% in 2010 but it was growing at a rate of only 5% in 2018.
The disadvantages of Gold are applicable to Real Estate too. You can’t sell your house or land immediately and convert to cash. We don’t know how the real estate market functions. There is the small problem of brokers, transaction and registration fees. Data reveals that Mumbai, Delhi and other metros have huge unsold inventory and the supply has dried up. It might take few years for the cycle to reverse. One can look at the property or land price movements in Hyderabad maybe or in growing Tier 2 cities. That again is difficult for an individual because how will you study the market of a different city without being there? So look at your local market. Talk to agents and try to judge the future growth and demand-supply of your city.
The major problem with gold and real estate it that there are no proven studies or strategies that will help you make informed buy or sell decisions in these assets. Let me know if you come across one. Also, capital needed for investment is huge if you want to buy a house or land.
There are new forms of Real Estate (commercial) investment:
I have not studied land prices and there is no data available for the same.
Final Asset Class. EQUITY!!!
Study this table and find out which gave the best returns.
The ones in double digit are all equity based products. Large Cap is the top 100 public companies in India by market capitalization. Mid Cap is the next set of 150 public companies in India. Small Cap is the rest of the Top 500 public companies in India. International is the top companies in developed markets like USA. We will ignore that in this blog. Amongst the varying return products, the price movement of gold and large cap is erratic but large cap beats gold by a margin of 1.6%. This is a huge number over a longer period. Real Estate didn’t give negative returns in any year but have been declining and the process of buying a land or property is very complicated with huge initial investment. Infact, the last few years have been very bad for Real Estate. They didn’t even beat FD returns. Who knows? The real estate cycle may turn and prices might start soaring in Tier 2 cities.
How do I buy equity?
Direct purchase of shares. You can buy the shares of the company through brokers like Zerodha. There are 2 sciences in this regard. Fundamental Analysis (based on the performance of the business), Technical Analysis (based on the price history of the shares). This will take years and some monetary losses to master these skills. Only individuals with the know-how and experience should indulge in the direct share purchases.
Mutual Funds. There are Asset Management companies like HDFC Mutual Fund and Parag Parikh which manage your money and invest in good companies on your behalf. They select companies based on Fundamental Analysis.
What is the problem with Mutual Funds?
Risk of Selection. There are close to 300 or so Mutual Funds in India under various categories. First, you have to select the category and then choose a fund within that category. You need some skill set to do this.
Skill Set of Manager who is handling the funds. The fund manager tries to beat a chosen benchmark like Nifty 50, Sensex 30, BSE 100, Nifty 500 etc. The manager tries to achieve this by actively picking stocks that can deliver the best growth.
Costs. You pay the fund house a fee to manage your funds. It is called the expense ratio or management fees. Even if you opt for Mutual Funds, select Direct funds. Do not opt for Regular funds where the cost is high.
An index is a representation of a part of a market. You might have heard of Nifty 50, which is one of the most widely used benchmarks. The Nifty 50 is a large-cap index that consists of the 50 biggest public companies in India. Similarly, there are various benchmarks which index various slices of the market.
Nifty 50 is a product based on certain rules and is rebalanced every 6 months.
Nifty 50 companies are listed in the National Stock Exchange whereas Sensex 30 is the top 30 companies listed in the Bombay Stock Exchange. A stock exchange is the market place for buyers and sellers of shares. You will find that the Sensex companies are a subset of Nifty since most companies list their shares in both the exchanges. Similar to Amazon and Flipkart
So do fund managers beat the Index?
Across almost all the categories, your odds of picking an outperforming fund are worse than a coin toss. It means, 6.4 out of 10 funds do not even given the same returns as the Index in a duration of 10 years.
If Index beats most of the Mutual Funds, can I buy the Index?
Of course! The very purpose of this blog. Index Funds!
Performance of Index:
Nifty gave 12% returns on average in the last 15 years.
Sensex gave 12.88% in 2000 decade and 9% in 2010 decade. This is just the Price Returns Index (PRI). The Total Returns Index (TRI) will be a bit higher by 1 – 2%. PRI is only the gain in the share price of the companies in the index. The TRI includes the dividends that the companies in the Index give to the shareholders.
The last decade returns in the Index were on the lower side due to various reasons. I am expecting the returns to be better if not same in the coming decade. Why? Usually, if a country’s real GDP grows at 6%, the nominal GDP growth is 10 – 12% (Real GDP + Inflation). The top 50 companies in India can grow at a rate similar to India’s nominal GDP growth(+- few points).
How long will India grow at high rates? Looking at South Korea for example, it grew at more than 5% for close to 4 decades.
So it is safe to assume India will be a high growth country in the next decade or two.
US markets, despite being developed and relatively low growth rates, gave 6% CAGR in the last 2 decades. Whereas, their bank interest rates and inflation are at 1 – 2%. Equity is always at a premium compared to fixed income products.
Higher the risk, Higher the returns. In Fixed income products like FD, PPF and Government bonds, your capital is safe but you get fixed returns. The upside is limited. In assets like equity or gold, your capital can lose value but your upside is open.
Look at Nifty chart in the last 2 decades. Nifty crashed 50% in 2008 and 25% in 2015but it has made up for all these losses and much more.
If the risk is high, why should one invest in Index funds? FD and PPF do not beat inflation significantly. Equity is your best bet. PPF has a lock in period of 15 years. Index funds do not have a lock in period but one should stay invested for at least 10 years to make up for any losses during the course. And equity is better than gold and real estate because of the fact that we do not understand the price movements in the latter. In Index funds like Nifty, we know it is the best 50 companies of India. It is dynamic and keeps changing every 6 months to accommodate the top 50. Why wouldn’t you want to invest in the best companies in India which is growing at 5 – 7%?
Hence, for investors who can digest such huge fall in prices and who are willing to take such risks, Equity should form a high % of your investments. For others, allocate at least 30 to 40%. Why?
Let us look at a fixed income portfolio and an equity portfolio performance for the same duration and amount invested.
Fixed Income / Debt Portfolio – Return on Investment of 5.84%
Blended Portfolio (45% Equity and 55% Debt) – ROI of 7.43% and a surplus of 10 Lakhs
I leave it to your math skills to figure out that you can double your money and hit the 1 Cr mark in 15 years by increasing your allocation / investment in Equity.
If you understood these tables, you will realize that there are 2 levers to returns:
Increase the monthly savings
Increase the returns by better asset allocation (more in equity)
The rule of thumb for equity allocation = 100 – your age. If you are 30 years old, you can invest 70% of your savings in equity. Decrease the allocation as you grow old. This will give you a solid 20 years in equity which might even help you retire early.
Note – These are only my suggestions. Please assess YOUR risk taking capacity and decide accordingly. On paper, you will feel you can sit through market crash. Only when you see your portfolio in red and falling like a knife, you will experience FEAR. For Liquid Funds, I would suggest – PPFAS or Quantum, the only two liquid funds that don’t have credit risks and invest mostly in Government securities.
Tactical allocation. Equity has cycles. When the stock markets are expensive, one can move their money to liquid funds and gold. When the stock market crashes like 2008, move major part of your money to shares as you will get quality companies at cheap prices.
Here is the Excel to calculate returns and allocation. Try to optimise your portfolio by changing the returns, monthly savings and allocation. For the sake of simplicity and the fact that we do not know what returns to expect, I have ignored Gold and Real Estate.
If you notice, the first 3 line items are Emergency Cash, Medical Insurance and Life Insurance (Term Plan). I will write another blog to cover these. Say NO to agents coming to you with ULIPs and other insurance related investment products. Ask them for the Internal Rate of Return (IRR) for their products. It is always below 7%. You would rather invest that money for a better return and buy a pure Term Insurance at lesser cost. Do not mix these 3 things – Tax, Insurance and Investment.
If you want a really comprehensive portfolio plan, Capitalmind has this beautiful wealth planner here –
Do check out their sample plans as well to get an idea.
How to buy Index Funds? The same way one buys other Mutual Funds. Through brokers or the Asset Management companies directly.
Choose any out of the 4. Remember to choose direct plans. TER is total expense ratio. Fee for managing your money. This is where Index Funds have an edge over active mutual funds. (Active funds are the ones managed by a fund manager who selects stocks. Passive funds like Index funds are the ones which do not need a manager as it simply copies the Index. Google AUM and NAV).
You can buy every month for as low as Rs. 500 using a feature called SIP – Systematic Investment Plan. You can apply for SIP in their website and set automatic debits from your account to the fund on a specific date. This will bring in the discipline that is needed to continue the investment for 10 years at least.
SIP reduces the risks involved in equity by letting you buy small quantity every month and not invest a lumpsum near the market peak. Staying invested for 10 years reduces the equity risk further.
Here is a real life story of how a guy turned 1.5 Cr into 4 Cr. Read to find out his experience of disciplined investing and sitting through market crashes.
Happy SIPping the top companies in India. Sita Ma has given you a wonderful opportunity to start as the markets crashed post the Budget.
While you are at it, please ask the government to remove the capital gains tac, dividend tax and buy back tax. This will unleash the animal spirits of the market.
Disclaimer – Mutual Funds and Index Funds investments are subject to market risk. It is your money and it is important that you understand the returns and risks of each of the asset class. Invest only if you can take the market risk. Past performance is not indicative of future returns. I am not a SEBI registered advisor.
If you have read till here, here are 2 special insights:
How to use Credit Cards? Can I save on my loan / EMI interest by using my existing investments? How? OVER DRAFT facility for both fixed income and equity products. Listen to this podcast to find out more.
Savings Account gives you a return of 3.5%. How to increase it to 6%?
Resources for individuals who want to get serious about equity investing and learn the 2 sciences, Fundamental and Technical Analysis: