Gaining Financial Independence
Investors – Aware and Beware
Umesh V. Kudalkar, CFA
16th August 2014
Pune
Disclosure & Disclaimer
• The Views and Opinions expressed in this
Presentation are in my personal capacity.
• This document does not constitute a personal
recommendation or take into account the
particular investment objectives, financial
situations, or needs of individual investors.
• Before acting on any recommendation in this
document, investors should consider whether it is
suitable for their particular circumstances and, if
necessary, seek professional advice.
Presentation Outline
Section I – Role of Investing & Financial Independence
Section II - Inflation and Asset Allocation Decision
Section III – Being a Successful Investor
Section IV - Best Offence: Awareness of Investing
Options so as to earn High Risk adjusted Return
Section V- Best Defense: Beware of Risks - Protection.
Section VI - Taking Care of yourself
Section I
Role of Investing and Financial
Independence
Target Audience
• This Presentation is not primarily targeted at:
– The Rich and the Wealthy
– DA Linked Pensioners
• Everybody else, I hope, will find actionable
concepts and ideas in this Presentation.
Why should you listen to me?
• I am an independent person.
• I am not here to earn any commissions out of
you.
• I am one amongst you and I share the same
concerns that you have.
• I am a CFA Charterholder – I hold Investment
related professional educational qualification.
Financial Independence (Wiki)
Financial independence is generally used
to describe the state of having sufficient
personal wealth to live, without having to
work actively for basic necessities.
Why Bother about FI?
• FI gives the freedom to live and work on one’s
own terms and pursue your dreams.
• Financial Independence allows you to protect
your pride through
– Loss of Job
– Accidents and Invalidity
– Old Age
Financial Independence and Role of
Investing
• Employees
• Self Employed Professionals – Doctor, Lawyer
• Businessmen
All the income streams arising out of the above need to be invested
wisely so as to speed up one’s journey towards financial
independence. Being a good ‘Investor’ is therefore an imperative
and a worthwhile professional pursuit.
• Being an ‘Investor’ can also be an
independent profession apart from the above
3 well known sources of livelihood.
Investing related terms
•
•
•
•
•
•
•
Return
Risk
Time Horizon
Liquidity
Taxation
Special Circumstances
Inflation
Section II
Inflation and Asset Allocation
Decision
Inflation
• Inflation is a tapeworm that can destroy one’s dreams.
• Although, the Government declared Rate of Inflation is 8%,
everyone MUST calculate his / her own inflation rate.
• Own Inflation Rate would be dependent on his / her
consumption basket and would vary depending on state of life
• How does one calculate inflation rate?
• It is increase in your annual expenses in the current year divided
by your previous year’s expenses assuming you didn’t have
change in lifestyle. Needless to say one has to beat one’s own
inflation %.
Example: Inflation and FD Return
If today you have money = to 20 years of
expenses:
At an inflation of 8%, if you invest all the
money in 9% Fixed Deposits and pay 30%
Tax, it will last only for 17 years.
Example: Inflation and FD Return
If today you have money = to 20 years of
expenses:
At an inflation of 12%, if you invest all the
money in 9% Fixed Deposits and pay 30%
Tax, it will last only for 13 years.
Theoretical Example: 50% Stocks
No guarantees but It shows potential
If today one has money = to 20 years of expenses
50% of money in Stocks (@16.5% Return) and holds for more than
1 year,
37% in Tax Free Bonds (@8.5% Return) &
13% in Fixed Deposits (@9.5%), then
Expected Post Tax Return could be 12% (i.e. ONLY 4% spread
over 8% inflation)
Effective Tax Rate would be 4% (no tax on gain on stocks).
The money would last for 37 years.
If today you have money = 30 years of expenses, then it will
last for infinite number of years. You won’t run out of money
Choices: FDs v/s Volatile Potential High
Return Stocks
• Increase in inflation rate can destroy us.
• One has to face 2 choices:
1. Hold all money in Bank Fixed Deposits and
progressively lose your purchasing power and run
out of money in retirement OR
2. Tolerate the volatility in high return asset classes
like Stocks and Equity Mutual Funds for the
possibility of money lasting through retirement.
• Choice 1 is riskier than Choice 2
• Primary Goal of Investing – Earn a Risk Adjusted
Return so as to beat Inflation
Section III
Being a Successful Investor
How can one become a successful
Investor?
• Using Cricketing Analogy for Scoring Runs:
– Employ Best Offence (Hit boundaries & Sixes) –
Aware – Earn High Risk adjusted Return through
awareness of various Investing Options
– Employ Best Defense (Protect your Wicket) –
Beware of all kinds of Investment Risks
Section IV
Best Offence:
Awareness of Investment Options so as
to Earn High Risk adjusted Return
It is better to be uncomfortable living in awareness
than to sleepwalk and stagnate.
Equity Mutual Funds & Stocks
Equity Mutual Funds over 6 years
January 2008 Peak to January 2014
Learning: Equity Mutual Funds
• Low Rtn: Some well known Equity Mutual Funds
returned only 3% return over 6 year holding
period beginning with 2008 SENSEX Bull Peak.
• This can test patience of an investor even though
over 30 year period beginning 01 April 1984
SENSEX returned 16.5%.
• If one was disciplined enough to invest in SIP the
return would have been higher @11%
• Constantly moving funds from Value Research’s 3
Star funds to Value Research’s 5 star funds is like
‘driving on the highway with rearview mirror’.
Few Stocks that beat the SENSEX
• Stock Allocation Category 1
Stocks: Awareness and Research is
worth one’s time
• There were at least 35 well known stocks that beat the
SENSEX by a wide margin over a 6 year period from 08
Jan 2008 (prior peak) to 08 Jan 2014.
• Equal Weighted Return was 23% while SENSEX gave
ZERO Return.
• Investor would have made 4 times in 6 years as
against ZERO Return for SENSEX.
• Awareness and Research is worth one’s time.
Example: One of the criteria to look for
such stocks for further research
Select Listed companies other than Banks
Find out a sub set / short list with following criteria:
• Companies that have had a total debt to Equity
Ratio less than 0.2 in each of the past 10 years.
• Companies that have paid equity dividend in
each of the past 10 years.
• Cumulative Dividend paid out divided by
cumulative Net Profit of the past 10 years is
greater than 25%.
• Market Cap > Rs.1,000 Crore
Section V
Best Defense: Beware of Risks
•
•
•
•
Develop Right Attitude
Beware of Risks and Mis-Sellers to protect yourself from loss
Diversify Assets and Income Streams
All about Risks so as protect yourself from Investment Loss:
–
–
–
–
–
–
–
–
–
Stocks and Mutual Funds
Derivatives – Futures and Options with Example
Fixed Income Mutual Funds
Be a Discerning Risk Evaluator
FDs: Bank, Company FDs, FDs v/s FMPs, Private FDs
Human Greed, NSEL Scam and Ponzi Schemes
Real Estate
IPOs: Prospectus
Password Security, Record Keeping and Nomination
Best Defense - Attitude
• Warren Buffett (a Legendary Investor and one of world’s
wealthiest):
– On Spending: If you buy things you do not need, soon you will have to
sell things you need.
– On Saving: Do not save what is left after spending but spend what is
left after saving.
• Well, you may have heard people saying “it’s never too late” but
Warren Buffett teaches us that it’s never to early. Warren bought
his first share at the age of 11. He also bought a small farm at the
age of 14. Still, he regrets that he should have started earlier.
• Albert Einstein: “Compound interest is the eighth wonder of the
world. He who understands it, earns it ... he who doesn't ... pays it.”
• Start saving more than 30%-50% of Income at an early age 20-22.
• Discipline – Almost Robotic
• Postponement of Gratification is the first sign of Emotional
intelligence.
Best Defense – Beware of Risks and
mis-sellers
• जो दस
ु ाला.
ु ऱ्यावरी ववश्वासला त्याचा काययभाग बड
• One who is not alert or vigilant or excessively trusts other people is
doomed for failure in life.
• Warren Buffett: “Honesty is an Expensive Gift. Do not expect it from
Cheap People.”
• Beware of aggressive or incompetent sales persons pampering your
ego. Understand what is in it for him. Learn to say ‘No’.
• जर तुमच्याकडे पैसे असतील तर निसगय नियमाप्रमाणे गुळाच्या
ढे पेला जशा मुुंग्या लागतात तशी लोकाुंची राुंग लागू शकते. परुं तु
त्यामळ
ु े 'मैं भी कुछ हु' असा दरु ाभभमाि बाळगि
ू स्वतःचे िक
ु साि
करूि घेऊ िये. Banks will call you ‘Privileged customer to boost
your ego.
• Warren Buffett: "Rule No.1: Never lose money. Rule No.2: Never
forget rule No.1"
Best Defense – Diversify Assets
Personal Balance Sheet
Debt MFs + FDs + [Savings Bank] = 15
Tax Free Bonds + PPF = 20
Estimated Annual Increase in NW = 12
Summary
A Equity & Balanced Funds and Direct Equity
Liquid 40
Stocks 040 AdjRtn
Eq MF 010 PostTax
AnnSav 02
12.4%
10.4%
Original Allocation Return %
50.0
50%
7.1%
7.0
7%
10.0%
3.0
3%
12.0%
40.0
40%
15.0%
6.0
6%
0.4%
1 Government Securities Funds (GSF)
0%
7.0%
2 Income Funds (Income F)
0%
7.0%
3 Fixed Maturity Plans (FMP)
0%
7.0%
6.0
6%
6.5%
34.2
34%
2.4%
2.0
2%
3.0%
7.0
7%
6.3%
4.0
4%
3.0%
5.0
5%
8.5%
15.0
15%
8.6%
1.0
1%
9.0%
0.2
0%
10.0
10%
0.2
0%
0.4
0%
1
2
3
Equity Funds - Large Cap
Equity Funds - Mid Cap
Equity - Stocks (Listed)
B Fixed Income Mutual Funds (Debt Funds)
4 Liquid and Short Term Funds (STF)
C Fixed Income Securities other than Debt MFs
Savings Bank
2 Bank Fixed Deposits and Company FDs
3 Cash and Gold
4 Public Provident Fund (PPF)
5 GOI Securities like NSC or NHAI, IRFC, NHB Tax Free Bonds
6 Superannuation, Pension
7 Illiquid Securities: Unlisted Equity
D Real Estate (Income Producing)
E Other Assets - Sundry Debtors and FX
F Less: Liabilities and Creditors
1 Loans taken from Banks etc and Creditors
1
G Gross NW (Rs. Lakhs)
0.4
100.0
100%
0.5%
Diversify Income Streams
• Do not put all your eggs in one basket.
• Multiple Employers: Consider these Asset Classes
as Multiple Employers paying you salary by way
of Dividends, Capital Gains, Interest. If any one of
them fails, still you will survive.
• Diversify within Equity Asset Class as well. At
least have 30 durable companies in the portfolio.
• Remember, In India: जजसके हाथ में लाठी उसकी
भैस. जजसके हाथ में चेक बक
उसकी कुंपिी.
ु
Never fully trust the financials of a company.
Stocks and Mutual Funds
Examples only – Not Recommendation
• Volatile Asset Class – Be ready to face quotational loss.
• Warren Buffett: “Investors should remember that excitement and
expenses are their enemies. And if they insist on trying to time their
participation in equities, they should try to be fearful when others are
greedy and greedy when others are fearful.” Never run after a ‘Missed
Bus’.
• Avoid Fads, fancy IPOs, Leveraged Cos. Avoid hope & event based
investing.
• Equity Mutual Fund NFOs offer units at Rs.10/- but remember that the
underlying will be stocks. Buying at Rs.10/- doesn’t make a NFO any safer.
• Buying Cheap / Penny Stocks and keep averaging at lower levels is likely
to wipe out your capital e.g. Kingfisher Airlines Stock. This is best avoided.
• Buy Durable Companies – Example: Nestle, Bosch have survived 2 world
wars and are 125 year old companies.
Stock Futures & Options Segment
Derivatives in Commodity & Currency
• Warren Buffett: Derivatives (Futures and
Options) are financial weapons of mass
destruction, carrying dangers that, while now
latent, are potentially lethal.
• If you are not a CFA Charterholder and if you
are not professionally trained, simply avoid
Derivatives Segment.
Example: Destruction caused by
Derivatives
Facts of a Pune Case in Derivatives Trading
• A lady in her 50s had a Demat Account with Broker for 10 years. Shares
bought on Delivery Basis.
• She never dealt in Futures & Options (F&O) Segment.
• She received a call by a sales person pursuant to which she got registered
for currency trading in 2012. Strict Instructions: 2 lots trading only.
• Shares were kept as collateral.
• Broker violated limits verbally imposed by her.
• Broker Relationship Manager used to call up the client in the evening and
confirm the trades but there was no proof of order placement by her.
• Total Loss in 6 months was over Rs.6 lacs.
• Reference to Sole Arbitrator was made under NSE Regulations. Award
granted in 6 months.
• Award: “I treat all trades as NULL and Void and direct the entire claim of
Rs.6,50,000/- be paid to the applicant.” 3 employees of Broker lost jobs.
Risks:
Fixed Income Mutual Funds (Debt)
• Credit Risk – Real Estate and Infrastructure
• Interest Rate Risk – Even if the fund holds 10
year maturity government securities of high
credit quality, increase in interest rate by 2%
can wipe of 20% of corpus.
• Liquid Funds are supposedly safer option to
park funds that may need to be accessed at
short notice. Having said this, there was 1
instance in 2008, when the NAV dropped.
Be mindful and discerning enough to
different subtle shades ‘Risk’
• One family will always have variations within:
Talkative, Quiet, Scholar, Tall, Short, Fair, Dark
• Asian Paints offers 60 shades of White. Other
Examples: Snow, Honeydew, Milky Way,
Crushed Ice ……….
Bank Fixed Deposits
• Deposit insurance and credit guarantee
corporation (DICGC) protects each depositor in a
bank up to a maximum of Rs.1 Lac.
• It would become unmanageable to open
accounts in multiple banks to get this protection.
• If we were to restrict ourselves to say 5 banks,
what are our options? We need to be discerning
and somehow be able to come up 5 options
within this category.
Types of Banks
• Nationalized Banks
• Private Banks
• Co-operative Banks
Criteria
• Too Big to Fail – RBI to start announcing toobig-to-fail banks in Aug 2015
• What is our guess? SBI, PNB, BoB, ICICI, HDFC
Bank
• Instances of Uncertainty / Failures in the past:
GTB, UWB, Sangli, Suvarna SB, Ganesh, Rupee
Bank FDs v/s FMP
Reading between the lines
• All articles in newspapers are in chorus: FMPs
are better than Bank FDs.
• Partly True: low taxation and high return
• But learn to ask the right questions through a
checklist provided earlier: Return, Risk, Time
Horizon,
Liquidity,
Taxation,
Special
Circumstances
• Is the Risk identical? – What if the FMP has a
Real Estate or Infrastructure Company Debt?
Company Fixed Deposits
• Some people work for 30-35 years in a
company and develop affection and
confidence.
• A retired employee of Mysore XXXX, kept all
his provident fund money as fixed deposit.
Money lost 15 years ago. Age 84. Miserable
Life.
• For getting 1% extra return, consider whether
you would lose 99% of principal amount.
Deposits given to Individuals v/s
Institutions
• Categories:
– Friends and Acquaintances
– Real Estate Builders
– Unlisted Companies
• Be realistic about your capability to recover. Assume total loss.
• Understand the difference between Banks v/s Individuals.
• Moreover, remember the In-Flight Safety Announcement: “In the
event of a sudden loss of cabin pressure, oxygen masks will
automatically descend from the ceiling. Grab the mask, and pull it
over your face. If you have children travelling with you, secure your
mask first before assisting your children”.
• Unless, you achieve your own Financial Security, be careful while
helping others – you may never recover your money – either willful
or otherwise due to unfortunate events.
Be Discerning w.r.t. Risk Return
#
Investment Features
Unsecured NBFC Debentures
Govt Tax Free Bonds
12%
NHB 13%
Unsecured AA-
Secured AAA
6 Years
20 Years
4 Liquidity
thin
Thin
5 Taxation
Taxable
Tax Free
Anagram, Alpic, CRB, Golden
Forest India and Golden
Project, Saradha
None
1 Pre-Tax Return @31% Tax
2 Risk
3 Time Horizon
6 Instances of uncertainty /
failure
Warren Buffett on Greed
• Warren Buffett:
– “If it seems too good to be true, it probably is.“
– “No matter how great the talent or efforts, some
things just take time. You can’t produce a baby in
one month by getting nine women pregnant.”
Example: NSEL Scam: 12-15%
Guaranteed Return Product mis-selling
• After National Spot Exchange defaulted in July 2013, it was
discovered that most of the underlying commodities did not exist
and the buying and the selling of commodities like steel, paddy,
sugar, ferrochrome etc. was being only conducted only on paper.
The pair trades in various commodities were offered in one-day
forward contracts of T+2 and T+25 payment terms (bought and sold
at the same time).
• Such pair trades offered an arbitrage opportunity of about 12-15%
return per annum. The investors, who honored the T+2 payment
obligation, found that the National Spot Exchange neither had the
money, nor the commodities, to honor their T+25 dues. Around 24
borrowers were given the funds by the NSEL, without any
underlying commodity deposited by those borrowers.
• An estimated number of 15,000 investors, along with public sector
units like MMTC and PEC, were victims of this NSEL scam.
Ponzi Schemes
It's a scheme in which investors are paid from money collected from
new investors instead of the scheme's earnings. It works as long as
new investors keep coming in.
Modus Operandi:
– Charlatans promise unbelievable guaranteed returns.
– Gullible and Greedy Investors part with their money – initially small
sums. The greed to make 'easy' money is so intense it overpowers
their financial wisdom.
– These early investors get the promised return.
– These early investors increase their contribution many fold
– By word of mouth publicity more investors get attracted.
– After accumulating sizable funds, the Charlatan disappears.
Examples: Blue Chip Hadapsar, Saradha;
Risks associated with Real Estate
•
•
•
•
•
•
•
•
Across the 92 micro markets that Crisil Research tracks, while the average
return over the past 8 years has been 11-12% (Pre-Tax).
Non Transparent compared to other Investment Options.
Can not be sliced or diced like stocks. Big chunk of money necessary.
Most people buy 1 home in their life. Property in litigation can wipe out one’s
life.
We buy noodles, biscuits, shirt, TV after carefully reviewing the product.
However, most Real Estate comes up with customers’ money. It is a free ride
for the builder.
Long gestation periods even up to 3-5 years. Wait can be stressful.
Umpteen examples of stuck projects due to untimely death of builder, Builder
unable to furnish bank guarantees for re-development projects, lack of
environmental clearance, defense lands, lack of basic amenities – roads, water.
Most Customers take disproportionate risk and are unaware of it.
Prospectus Risk Factors
• IPO Prospectus is too voluminous for investors to
read.
• Investor must read Internal ‘Risk Factors’.
• More particularly pay attention to:
– Promoter Specific Risks: Due Diligence – legal cases
– Company Specific Risks: legal, statutory dues, product,
market, event specific
• IPO: Many times, odds are stacked against the
investor.
Password Security and Record Keeping
• Read suggestions on internet about how to create a
password that is easy to remember & difficult to crack.
• Use incognito browsing.
• Sign out before closing the browser.
• Always have a nominee for everything that you invest
in.
• Make sure that there are absolutely no errors in
spelling anywhere – names, PAN Number
• One family member on monthly rotational basis should
take the responsibility of filing papers and record
keeping in a spreadsheet. This makes everyone aware.
Section VI
Taking Care of yourself
•
•
•
•
•
Scams: Capital Market and Retail
Take Care of Yourself
Problems in Investment Marketplace
Warren Buffett on IQ and Investing
Key Message in this Presentation
Capital Market Scams
Ref: Prime Database
Retail related Scams
Ref: Prime Database
Take Care of Yourself
• Just because there is Police Department, you
don’t keep your home door open at night and go
to sleep.
• Warning: Cigarette Smoking injurious to health.
• Apply the same logic for investments: Just
because SEBI exists, you can not rely on goodness
of strangers if you don’t wish to be cheated.
• Example: Investment in Kingfisher – No
Investment Protection SEBI Law can save you.
Problem with Investment Market
• Incentives:
Sales
Persons
suggesting
investment options earn huge incentives.
Hence, perpetually, you as an investor, are at
odds to begin with.
• Risks: Advisors who are professionally trained
in the investment discipline may have
knowledge but not the right attitude to give
sound advice. They don’t understand risks.
Warren Buffett on IQ and Investing
• IQ: Over and over Warren Buffett has emphasized that investing is
not an area where a person with a high IQ beats a person with a
lower IQ. He said "You don’t need to be a rocket scientist. Investing
is not a game where the guy with the 160 IQ beats the guy with the
130 IQ. Rationality is essential."
• Temperament जस्थतप्रज्ञ: He has also talked about the importance
of temperament as opposed to intellect. “The most important
quality for an investor is temperament, not intellect. You don’t need
tons of IQ in this business. You don’t have to be able to play threedimensional chess or duplicate bridge. You need a temperament
that neither derives great pleasure from being with the crowd or
against the crowd. You know you’re right, not because of the
position of others, because your facts and your reasoning are right.”
• Independent Thinking: Buffett also emphasizes the importance of
thinking for your self. “You have to think for yourself,” he said. “It
amazes me how high-IQ people mindlessly imitate.”
Summary (Key Message)
• Financial Independence is a worthwhile pursuit.
• FDs don’t protect you from Inflation. You will quickly run out of
money. Consider asset allocation to equity mutual funds and stocks.
• Quite a few stocks have beaten SENSEX by wide margin. Do own
Research.
• Don’t put all your eggs in one basket. Buy at least 30 durable
Stocks. Consider Equity MFs, Tax Free Bonds, FDs.
• SBI, PNB, BoB, ICICI, HDFC could possibly be ‘Too Big to Fail’ Banks
for your FDs.
• Be discerning for ‘Risk’ – 9% NHB Tax Free is better than 12% NBFC
NCD.
• Avoid Futures and Options, Commodities or Currency.
• FMP may have higher Credit Risk as compared to FD.
Summary (Key Message) continued….
–
–
–
•
•
•
•
•
Be careful with Company FDs. Be careful while lending to
Individuals.
One wrong Real Estate Investment can wipe out your life.
Protect your passwords. Every family member must know your
financials.
Warren Buffett: “A public-opinion poll is no substitute for
Independent Thought.”
जो दस
ु ाला.
ु ऱ्यावरी ववश्वासला त्याचा काययभाग बड
One who is not alert or vigilant or excessively trusts other people is
doomed for failure in life.
It is better to be uncomfortable living in awareness than to
sleepwalk and stagnate.
Investment Success is all about EQ and little about IQ.
Summary (Key Message) continued….
• If you don’t have investment knowledge, always invert
and ask simple commonsense questions.
• Beware of Salespersons. Incentives can corrupt their
minds. Never say ‘Yes’ till you fully understand what the
Broker communicating.
• One can’t avoid ‘Risk’ in life, learn to manage it. Develop
an insight in to what constitutes ‘Risk’.
• Warren Buffett: “If it seems too good to be true, it
probably is.“ Beware of Ponzi Schemes.
• Albert Einstein: “Two things are infinite: the universe and
human stupidity; and I’m not sure about the universe!”
Thank You