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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Archive for the ‘Basics’ Category

Barber and Odean

Posted by Muthu on January 26, 2018

Happy Republic Day.

Google for Barber and Odean, you’ll get articles and studies based on the work conducted by two Professors Brad M.Barber and Terrance Odean. They have studied in detail about the behaviour of individual investors in the market.

Their study has also been cited in the book ‘Simple but not easy’ by Richard Oldfield.

I’ve extracted the following details from the above book.

These professors studied in details performance of 78,000 individual investors for the period 1991 to 1996.

They classified people on the frequency of their trading. Higher the trading higher would be the turn over. A 100% turnover means a portfolio was completely changed every year. 50% turnover means half the portfolio was changed in a year and so on.

The most active (in term of trading) 15,000 investors had a turnover of more than 100% and made average annual return of 10%

The least active 15,000 investors had a turnover of just 1% and made average annual return of 17.5%

There is an excess annual return of 7.5% for buying right and staying the course patiently.

This is one more example to reinforce why we always insist staying the course not only during ups and downs of market but also during the periods of underperformance of funds.

We’ve explained to you in the past why our churn would be less and most of the time it would simply be staying the course. Chaser is a loser. Studies shows even the best of the investors or fund managers underperform 30% of the time.

As I’ve often repeated, our main job is to make you stay the course at all times.

You’re all similar to the above investors who got more returns because of a very less churn and being patient.

This is your strength. Always focus on the same.

Posted in Basics, Muthu's Musings, Stock Market, Wealth | 2 Comments »

How much you should save for retirement?

Posted by Muthu on September 5, 2016

I get many queries on how much to have as retirement corpus and what can be the withdrawal rate every year.

I come across instances where people are losing jobs in their mid forties and this is the question in top of their minds.

Let us say you are 50 years of age and need Rs.1 lakh every month for your expenses.

Having worked for 25 years, let us assume (hope!), you’ve repaid home loan and has made enough provision for your kids higher education and marriage. You also have sufficient medical cover and an emergency fund equivalent to 2 years of expenses.

The retirement corpus you aim for need to provide you an income of Rs.12 lakh per annum. What would be the corpus? I would suggest you need at least Rs.2 crores. Having a life expectancy of 80 years, for both you and your spouse, this corpus can be deployed in balanced funds (equity oriented hybrid funds, 65% in equity and 35% in debt). I assume balanced funds are capable of providing 12% returns over next one decade.

If we keep the withdrawal rate at 6%, you would get Rs.1 lakh per month. Why I’m keeping the withdrawal rate at 6%. The inflation is around 6%. So you get a real return of only 6%. If you withdraw more than the real rate, then your capital would start eroding. As capital erodes, your purchasing power would go down. This would affect your quality of living. So you should only withdraw the real rate of return. This would ensure that if both of you or one of you happen to live till 90 or more, still you’ve comfortable money.

If withdrawals include part of capital, at some point you may run out if it, especially if you live long. Not only that many want to leave some assets for the subsequent generations as well. Also it is difficult to even assume what return we would get beyond 10 years. There can be some major emergencies as well. Keeping all these in mind, it is never wise to withdraw part of capital. You should withdraw only real returns.

This also means that if you go for fixed deposits (other than for emergency fund and near term goals), your real returns would almost be zero. So to preserve your purchasing power, you cannot make any withdrawals! This is an impossible situation.So some amount of risk taking is essential unless you’ve tens of crores. Balanced funds are a better option as we are looking at the retirement life which can even be longer than our career span.

If we apply this strict yardstick, most of us are not ready to retire. So please try to develop your knowledge and skills and be employable till you achieve the goals. Early retirement is not easy. It may be possible if you drastically cut down your life style. Since most of us do not prefer this, the only way is to keep developing skills which can be monetised and thereby enhancing the means.

Early retirement is not easy. I’ll let you know when you’re ready.

Posted in Basics, Muthu's Musings, Wealth | 4 Comments »

Don’t look frequently

Posted by Muthu on July 18, 2016

I wrote the last piece immediately after Brexit. Like many, I was also expecting the market to correct in the near future. Markets, as always unpredictable, have been moving up after the event.

This shows the difficulty of forecasting and predictions. That’s why it’s always best to ignore them and stay the course. Though at times I do anticipate some market movements, I don’t change my investment plan accordingly. I simply stay the course with my portfolio. As you are all aware, I do the same for you as well. Brexit or no Brexit, the only sane option is to continue your SIPs.

Like I’ve mentioned many times before, we don’t try to sell our house or land based on constant news flows and macro events. In fact, we are not even aware of their exact market value. We intend to own those assets for decades. The same yard stick needs to be applied for equity funds as well. I would like to share what Buffett says in this regard.

“Those people who can sit quietly for decades when they own a farm or apartment house too often become frenetic when they are exposed to a stream of stock quotations and accompanying commentators delivering an implied message of ‘Don’t just sit there, do something.’ For these investors, liquidity is transformed from the unqualified benefit it should be to a curse.”

One way to increase the tenure of equity ownership is not to look at the value frequently. Many investors’ emotions get as volatile as markets when they keep looking at prices or NAVs regularly.

The less frequent you see, higher the probability of positive returns. The more positive returns are, higher the motivation to stay the course.

I want to share with you what personal finance expert Carl Richards has mentioned in this regard.

“Since many of us use the Standard & Poor’s 500-stock index as a proxy for the market, let’s take a look at the period from 1950 to 2012 to see how often we’re likely to feel positive, based on how often we check our investments:

  • If you checked daily, it would be positive 52.8 percent of the time.
  • If you checked monthly, it would be positive 63.1 percent of the time.
  • If you checked quarterly, it would be positive 68.7 percent of the time.
  • If you checked annually, it would be positive 77.8 percent of the time.

So here’s the thing to ask yourself. Other than upsetting yourself half of the time, what good is it doing you to look anyway? Maybe we should all invest as if we’re going on a 12-month trek in Nepal!

So along with your do-nothing streak, let’s see how long you can go without looking at your investments (assuming you’re in a low-cost, diversified portfolio, of course). I think you’ll discover that it makes you happier, keeps you from doing something stupid and helps you become a more successful investor.”

As we never get tired of repeating, please check your mutual fund portfolio only once a year. This increases the probability of seeing positive returns. Positive returns would lead to better emotions and self control.

Treat equity funds the same way you treat your house. Don’t look at the value frequently.

Posted in Basics, Mutual Funds, SIP, Stock Market | 2 Comments »

Understanding real returns

Posted by Muthu on January 17, 2016

Anand Radhakrishnan, CIO- Equities, Franklin Templeton mutual fund said the following in a panel discussion:

“Secondly, Sir John Templeton said focus on post-tax real returns. In India we focus a lot on nominal returns. If RBI is indeed successful in its inflation objective of 4%+ or -2% and the world is anyway reeling under zero inflation or a deflationary circumstance, it is quite alright to have lower expectations on nominal returns. If the economy is growing at 5%, 6% or 7% and then inflation is at 4% or even less, return expectations are still pretty high when investors walk into equity funds.

Focus on real post-tax returns, which is I think is going to be very different over the next five years than it was in the last five. Not in terms of real returns, but in terms of nominal returns.”

We’ve seen how Sensex has delivered around 17% over last 3.5 decades and CRISIL AMFI equity fund index delivering around 22% in last 18 years.

As you are aware, our long term nominal growth has been around 15%. This includes a real growth rate of 7% and an inflation rate of 8%.

In the long run, let us assume we would grow at 8%. Let us also assume the inflation would settle down at 4%. If this is the case, the nominal growth rate would settle around 12%.

When the nominal growth rate of the economy falls, the nominal growth rate of equity also falls. So instead of 18%, we may need to tone down our expectations to 15%.

But real growth rate, which is what relevant to us, would remain the same or marginally inch up higher; as real growth component increases and inflation reduces in the nominal growth.

If you notice, MIPs over the long run have delivered around 2% more than fixed deposits. As FD rates fall, the nominal returns from MIPs also would fall. But it would still deliver around 2% more than FDs due to active debt management and equity kicker.

So nominal growth rate is not static. It depends on real GDP growth rate and inflation. We may need to adjust our expectations in line with nominal growth rate. But the real growth rate would remain the same.

Nominal growth need not only go down. It can go up as well. It is a function of what is the real GDP growth rate and inflation.

Learn to accept the following returns from asset classes over long run:

Fixed Deposits: Inflation + 1%

Gold: Inflation + 1.5%

Real Estate: Inflation + 3% to 5%

Equity: Inflation + 7% to 9%

Actively managed fund would deliver couple of percentages more than index.

So if inflation is 4%, markets may deliver around 13% and equity funds would deliver around 15%.

Likewise, for an inflation of 4%, FDs may deliver around 5% and MIPs around 7%.

Please note that none of the above is guaranteed returns but only used as an illustration to explain the relationship between inflation, nominal growth rate and various asset class returns.

So start focusing on real returns, this is what matters to you as an investor.

Posted in Basics, Economy, Mutual Funds, Stock Market | 2 Comments »

Updated: Time or Timing

Posted by Muthu on December 18, 2015

After a long gap, I’ve updated the ‘Time or Timing’ page in our portal. I’m sharing the updated content below:

If you’ve invested Rs.1 lakh in Sensex on 1’st January 1990 and did not disturb it until 30th November 2015 (26 years, 25.91 to be precise) it would have multiplied 33 times and become Rs.33.38 lakhs. This works out to an annualized return of 14.49%.

We saw that over 26 years Sensex got multiplied by 33 times. Let us assume you missed the best 40 days spread over the above 26 year period. Then your money would have multiplied by mere 2 times instead of 33 times. 40 days over 26 year period is just 1.5 days per year! So hopping in and out of the market can dent your returns very significantly. Regular investing and staying for a long time (which would include the best days as well) is the way to build sustainable wealth.

Please see the complete data below:

Stayed invested for 26 years: 33 times, 14.49% per annum

Missed 10 best days: 12 times, 10.14% p.a

Missed 20 best days: 6 times, 7.22% p.a

Missed 30 best days: 3 times, 4.75% p.a

Missed 40 best days: 2 times, 2.54% p.a

It is clear that if you’ve even missed the 10 best days, instead of getting 33 times your wealth, you would have got only 12 times. Just missing 10 best days in nearly 3 decades costs you so much.

It is interesting to note that by just missing 10 or 20 best days over 26 year period; market gives you only fixed deposit kind of return.

For missing 30 or 40 best days; you just get savings bank account returns.

Markets tend to go up sharply on a few days, then consolidate for long periods and then go up sharply again over a few days. So just missing these days can bring down your returns drastically. It is impossible to predict the best days in advance and we would come to know of the same only in hindsight.

I also read somewhere that some of the best days of the markets come immediately after its worst days. It looks like many a time the worst and best days are lumped together in a short period of time.

There is no way to prevent worst days and time the best days.

Not many get rich from stock markets because they lack patience, hop in and out, losing many of the best days.

So don’t try to time your entry into the market. SIP is the way. What matters is how long you stay invested so that you catch as many best days as you can and maximize your returns.

Start early. Invest regularly. Stay the course. Get wealthy.

Staying the course without disturbing long term compounding is the key.

All the best.

(Data source: PPFAS mutual fund’s investor education material based on Value Research data).

Posted in Basics, General, Stock Market | 1 Comment »