Archives April 2020

Where to invest excess money?

Knowledge, Discipline & Time are the 3 vertices of an investment triangle. Once an investor gains understanding of these key areas, investing excess money becomes an enjoyable process.

Knowledge is foremost

As investors, we need to be aware of the various financial products available in the market. Without first hand knowledge of various products, it is easy to fall prey to quick sales tricks and part our money to unsuitable products. Let us take the case of Anand, a manager in a private sector firm. In 2017, when he received his bonus, his relationship manager called him and recommended him to invest in Arbitrage funds (AF).

The primary reason cited to him being good returns and no long term tax since arbitrage fund is treated at par with equity funds. It was further explained to him that a portion of the arbitrage funds would be invested in derivatives to cover any fall in stocks held by the fund. Anand was convinced and invested his entire bonus in one such arbitrage fund. However, Anand is very disappointed that his 6.7% returns from the fund has been lower than liquid funds (7.2%).

Seek knowledge..

When treading in unknown waters, it is better to familiarize with the new product by reading or seeking expert opinion. Had Anand sought help from experts or advisors on arbitrage funds, he would have come to understand that Arbitrage Funds (AF) is a type of mutual fund that uses the price differential in the cash and derivatives market to generate returns. The returns are dependent on the volatility of the asset. AFs buys stocks in the equity market and simultaneously sells it in the derivatives market. The price differential between equity market & derivatives market is used to generate returns for the fund.

Many funds in this category were launched in 2014 when the bull market in sensex had just began, which is a ripe platform for AFs to perform. It was also in the same year that the holding period for FMPs (Fixed Maturity Plans) to qualify as long term was revised from 12 to 36 months. This led investors to search for tax free avenues with a maximum of 12 month holding period, resulting in a shift from debt to equity oriented Arbitrage funds.

Is a product suited to retail investors?

AFs seems to be designed for businesses to park their idle cash and enjoy tax-free returns in a short time (1 year). It is also suitable to stock traders familiar with derivatives. Inflows into AFs have particularly spiked post-demonetization. And its story sold well with a retail investor who is obsessed with tax savings.

Gaining knowledge on Afs reveals that there are three main issues with AFs.

  1. From a risk profile perspective, under the premise of tax savings, this fund shifts an investor from low risk to high risk (debt to equity).
  2. From a product perspective, if an investor is ready to take on equities, better alternatives are available in large-cap & multi-cap equity funds.
  3. From arbitrage perspective, when more money chases fewer arbitrage opportunities, returns will be zero.

Also, the risk of the tax benefit of AFs being taken away became real in 2018 budget. Overall, AFs are not a good fit for retail investors who have custom-built their portfolio to align with their financial goals. A well-planned portfolio worth Rs.30 Lacs or even higher would be very tax efficient with proper asset allocation, eliminating the need for a retail investor to chase unsuitable tax saving funds such as Arbitrage funds.

How knowledge helps an investor?

Knowledge helps dispel myth & fear and helps in understanding a product. Without this understanding, if you chase returns, you will end up with a portfolio full of irrelevant products which may not grow adequately to fund your financial goals. Once you acquire knowledge, you may or may not become comfortable with a product – but you would be in a much better position to make an informed decision, which is key to an investor.

Discipline is easy when imposed

Discipline in investing is an essential ingredient to successful investing. When we stay invested in a right asset over a longer duration, it certainly pays off. Let us take Suresh, a teacher, who has a home loan EMI to pay for 15 years. Only if he pays his monthly EMIs regularly without fail, he could own the property at the end of the loan tenure. Paying a monthly EMI is a huge commitment and requires discipline on part of the investor.

Similarly, take Sara, a lawyer, who pays the premium for her parent’s health insurance policy. Only if she pays the annual premium in a disciplined manner, her parents would be able to avail the hospitalization benefits. Most of us diligently pay our periodic payments in a disciplined way, like Suresh & Sara, so as to enjoy the asset(s) or facilities as required.

In both these cases, discipline is imposed on them by a third party (Bank or Insurance company) to make payments on a regular basis.

And discipline is hard when voluntary

Now, take Kathir, an accountant, who invests Rs.25,000 per month in mutual funds via SIPs. Due to a recent market correction, his existing portfolio is down by 12% and so he is considering stopping his SIP. If he indeed stops his SIP, he has nothing to lose immediately, although he may hinder his own long term wealth building.

In comparison, if Suresh or Sara stop their periodic payments, they stand to lose their house & hospitalization benefit right away. However, this is not the case with Kathir, why? Because SIP is voluntary, no one is imposing this periodic payment on him. This makes it all the more challenging for him to stay invested in a disciplined way with his SIPs.

How discipline helps an investor?

At this juncture, it is important for Kathir to keep his focus on his long-term goals. If he wants to fulfill his financial goals in future, he must continue with his SIPs regardless of market movements. If he lets short-term market volatility dictate his investing approach, he may not have sufficient money to fulfill his future liabilities.

Time is money

To understand the power of time, let us consider an important life goal of Sara (age 25) & Kathir (age 35). They both have a goal to retire at 55 years of age and would like to get a retirement income of Rs.50,000 per month in today’s terms (present value). To attain their respective retirement goals, Sara needs to save Rs.16000 p.m while Kathir will have to save Rs.30000 p.m. This is because Sara being 10 years younger to Kathir, she has 30 years left to retire.m while Kathir has only 20 years to retire. Even though the time difference is only 10 years, the amount required of Kathir to save doubles, as he has lesser time to put his money to work.

Young people like Sara may not have Rs16000 disposable income at age 25, an alternate would be to start even with a smaller amount such as Rs.8000 and increase it by 10-15% every year to attain the same goal.

Similarly, if Kathir wants to fund his daughter’s higher education expense of say Rs.10 Lacs (in today’s cost), he needs to start investing when his daughter is 10 years old. In this case, he might have to save only Rs.15000 p.m. If he postpones saving for this goal until she is in class 9 or 10, then he might have to shell out Rs.35000 p.m or higher because he does not have the time to let his money work & multiply for him.

How Time helps an investor?

In essence, time is money. You do not need to hit a jackpot or become a millionaire to achieve your financial goals. The secret is, even with little money, you may be able to fulfill all your life goals, provided you have the knowledge, discipline and time on your side!

How to save taxes outside 80c?

While we always tend to focus on maximizing our tax savings using 80c, this section of the Income Tax Act helps us save taxes on 1 year’s income only. What about saving your tax outgo on savings from your hard work over multiple years? The answer lies in mutual funds.

Fixed Deposit (vs) Debt Funds

Let us say our investment horizon is 7 years. Rs.10 Lacs in FD at 8.5% interest p.a would fetch a post-tax return of 5.87% (considering the highest tax bracket of 30.9%). Crunching the numbers, your FD would earn Rs.7.1 Lacs interest in total, on which you would pay Rs.2.19 Lacs tax and be left with an accumulated sum of Rs.14.9 Lacs at the end of 7 years.

If you had invested the same Rs.10 Lacs in a debt fund with similar returns as an FD at 8.5% p.a, you would pay a tax of only Rs.1680 in all (0.22% tax against 30.9% in the case of FDs) and be left with Rs.17.78 Lacs at the end of 7 years. The significantly lower tax outgo is due to the indexation provisions available to capital assets, providing you with the twin benefits of incurring lower tax and growing your wealth by 20% or more when compared to a FD.

Fixed Deposit (vs) Equity Funds

If you had invested the same Rs.10 Lacs in an equity fund with returns of say 15% p.a and had remained invested for the same 7 year period, you would pay ZERO tax and be left with Rs.26.6 Lacs at the end of 7 years. Even if the fund had returned a lower 12% return, your returns at the end of 7 years would be Rs.22 Lacs, a whopping 47% more than your FD returns and 28% more than your debt fund returns. Of course, the higher returns comes with higher level of risk to be undertaken.

Fund selection

The above *illustrative* scenarios are presented for one to comprehend the tax advantages of investing in a suitable mutual fund. Do not use it blindly – as to what funds to invest in, when to invest, how long to stay invested, whether to go for lump-sum or SIP and all other questions that you may have, it is best to perform a detailed investment planning with your financial planner.

Although mutual funds comes with its own risks, there is a suitable fund to cater to everyone’s risk appetite and propensity. Perform a careful fund selection with your financial planner, get your tax savings worked out and make a sound investment decision – you are in to reap good returns in the long run.

Are you asset rich and cash poor?

To know if you are asset and/or cash rich, it is vital to understand a unique money trait called “liquidity” – whether your asset could be quickly converted to cash. Assets that can be easily converted to cash form Movables and the rest form immovable assets.

Movable Assets

Most of the cash assets such as bank FD, RD & Post office schemes and capital market instruments such as open-ended mutual funds & stocks are liquid and form part of movable assets. There are 2 stages in one’s life when most people desire to have a higher percentage of the movable assets in their portfolio. They are buying a dream home & children’s Education/Marriage expenses.

Lets take Robin who is building his dream home. Due to an unexpected rise in the cost of certain raw materials, say his budget overshoots by 20%. He now needs extra cash to meet this shortfall. Even if he has other properties, they may not be readily convertible to cash to finish constructing his dream home.

This is where capital market instruments scores over physical assets. They could be sold anytime as there is always a buyer to bid your sale. And cash proceeds from the transaction gets deposited in your bank account in 2days.

Lets consider Priya, a salaried mother, who invests Rs.12000 p.m in equity funds for 5 years from 2013 towards her daughter’s college education. At the end of 5 years, in 2018, her investment grows to Rs.10Lacs (15% p.a return) & meets the education expense. At the same time, Anu, Priya’s friend, invests Rs.5L in a plot of land. As most of the real estate growth had stopped in 2013, her plot did not appreciate much and she is also unable to find a buyer for her plot when she needs it in 2018.

This is a critical time for Anu as she wishes to have a movable asset to support her daughter’s education, but she’s left with no choice except to go for a loan. So, it is important to align major financial liabilities in one’s life with movable assets or at least convert some of the immovable assets to movables, 1-2 years before the actual liabilities arise.

Immovable Assets

Immovables are just that – they cannot be quickly converted to cash & they include a variety of assets such as property, land, agricultural properties, art, a business (shop, school, franchisee or showroom) etc. These assets could be tended to only during one’s active life stages. Once a person retires, age-related ailments or living abroad with children makes the management of immovable assets a big burden to shoulder. It gets difficult to run around the various government agencies & keep up with the ever changing procedures & digitization efforts.

Take the case of Sundar Sir, a retired banker, whose son is settled abroad. He owns 1 tenanted property and he manages another tenanted property for his son. Every two years, the tenants change, so he needs to work with contractors to ready up the place & with the broker to fix up a tenant. In case he is traveling abroad or on a pilgrimage, it gets difficult for him to manage the properties.

And most seniors are taken for a ride when they decide to sell their properties, right from having to produce non-existent documents to a beaten down sale price, not to mention the challenges in handling the black money one is forced to accept in these transactions.

In other cases, when both parents passes away, the transfer and sale procedures get very complex in case all children have settled abroad. Not only it is time consuming for them, but the lack of correct guidance on legal practices, tax compliance and repatriation of funds poses a much bigger challenge for them to dispose of the immovable assets.

When to move to movables?

During your income earning years, it is key to plan a portion of your movable investments to align with your personal financial goals & liabilities. This way, you will never have to face cash crunch and be “Asset Rich, Cash Poor”.

And during retirement, it would be a good idea to consider liquidating your excess immovable assets at the earliest. When children settle abroad, they have their own properties to manage overseas. They are no longer interested in managing your plots of land in an undeveloped suburb. So, when it comes to bequeathing your excess assets, leave it to them in liquid form, which is hassle-free for both the giver & the receiver.

How to time the entry/exit of investments?

Even the most successful investors are a little lost when it comes to timing the entry/exit of any asset – be it real estate, gold, mutual funds or stocks. Let us take the case of Ajay, who invests in stocks with an aim of making a quick profit of 10-12% in the short term by timing his entry and exit based on news & stock movements.

Ajay had invested Rs.5Lacs in the stock market in Oct’16 in a few counters. By Sep’17, his stock portfolio jumped 40%, so he sold his stocks & cashed in gains of Rs.2Lac. He re-entered the market in Mar’18, but due to the recent correction, his stock portfolio is down 10%. So, his portfolio went up from Rs.5L to Rs.7L and is now down to Rs.6.3L over a 2 year period – this translates to 12.25% in annualized returns, matching nifty returns of 12% in the same period.

Note that although Ajay cashed in 40% gains, he was not invested in the market at all times. He was entering and exiting the market at different times. So, his money was idling some times & hence his annualized returns is 12.25%.

This is an episode of a very successful investor as the rally from Jan’17 helped boost his returns. However, it is not possible to replicate this kind of success at all times because it requires the investor to monitor the stock market on a daily basis and take action. Also, the stock market does not rally all the times, it falls or stagnates at other times. Many investors who got into the market in 2010 in certain sectors such as infrastructure & realty lost up to 60-80% of their invested amount. But that does not mean one cannot take advantage of the equity markets.

How to handle the timing risk?

You could turn the timing challenge to your advantage by building a portfolio of equity funds using SIPs (Systematic Investment Plan), based on your risk taking capacity. The secret here is to understand that there is an “appreciation time line” associated with every asset class. And the appreciation time line for equity mutual funds is 5-7 years.

If you expect reasonable double digit returns (12-15% p.a) from equity mutual funds, you need to stay invested for 5-7 years to allow it to multiply. If your personal financial goal of say funding your son’s education, is only 2-3 years away, then equity funds may not provide you with the kind of returns you expect, because equity returns are volatile in the short term.

Do SIPs really work?

To answer this question, let us analyze Ajay’s SIPs. Ajay also invests Rs.10,000/- per month via SIPs in a mix of 3 large cap funds since 2007. If you look at the 3 year periods 2007-10 & 2010-13 in the below table, his returns from SIPs in largecap mutual funds is 10-11% p.a, compared to 6-8% Nifty annualized returns. Similarly, for a tenure of 5 or more years, his returns are 15-17% p.a, compared to 6-10% nifty annualized returns.

Between 2008-2018, the markets peaked 4 times and fell 6 times. It also had a long stagnation period from 2010 to 2013, when nifty returned 6% (vs) 10% from fixed deposits. Despite all this, his steady monthly SIP of Rs.10,000, totaling Rs.12Lacs over 10 years, had grown to Rs.28 Lacs in his portfolio today.

If Ajay had invested the same Rs.10,000 in a 10 year recurring deposit, his maturity amount would be Rs.18Lacs (vs) Rs.28Lacs from his largecap mutual funds portfolio. SIPs have generated the additional Rs.10L return for him. Again, not all 100% of your money should be put into equity funds, it is important to allocate a portion of your total investments in equity funds to reap higher market returns.

Still puzzled?

As each investor is unique, the risk and return preferences of each investor too varies significantly. Spend quality time to understand the financial products or consult experts / advisors to determine the suitability of various financial products based on your risk taking ability. You could then align your investments with each of your expenditures in future so as to meet all your financial needs comfortably. A simple portfolio with 4-6 funds & a disciplined approach to investing is all that is required to beat the timing risk.

How to compare financial products?

One of the Top-3 issues faced by investors is how to compare financial products. The previous article discussed the first issue of how to choose a financial product. In this article, lets explore the second issue of comparing products in detail.

Understanding all available choices

Hema, a designer, pays Rs.25k premium p.a for an endownment policy that offers her a life cover of Rs.6L. Now, lets see what other comparable choices she has got – For the same cost of premium, she could either obtain a higher pure term cover for Rs.3 crores (and still claim the 80c deduction) for 25 years or she could invest the sum in another product to grow her money. One question was key for Hema to make a decision – what is her actual objective or intent in buying those 3 insurance policies? She said she would like a life cover. This helped bring clarity and made her chose a Rs.3 Cr pure life term cover.

But lets assume Hema already had a term cover, then where would she invest her Rs.25k annually? She has many products to choose from both fixed income as well as from capital market baskets. There is PPF, NSC, NPS (National Pension Scheme), Tax saving ELSS (Equity Linked Savings Scheme) Mutual funds, Stocks, Company FDs, NCD (Non-Convertible Debt), Gold ETF (Exchange traded funds), Jewels and many more. Note that some of these products may offer her tax rebate while others may not. While tax saving is desired, it should not be the sole reason why you choose a product. Just like Hema, you need to choose a product by not only understanding its merits and demerits, but more so, its suitability to you as an investor.

Metrics for comparison

When a product is evaluated on say 5-6 chosen metrics, some metrics such as investment tenure and annualized returns could stand out independently and convince us to make a decision. Say, “I am happy with a 12% return from an ELSS mutual fund” or “I am good with receiving Rs.1.5Lacs after 5 years on Rs.1L investment in NSC”. However some other metrics such as cost and risk(s) may not tell us anything standalone. Such metrics gain relevance only when compared against other financial products.

For example, it is easier to compare the performance of two large cap equity mutual funds. You could compare their returns over 1-yr, 3-yr or 5-yr periods, their expense ratios, their portfolio holdings or even by how much value they lost during a correction or crisis. Most of this information is available on many websites today. But how would you compare this mutual fund against another financial product – say an endowment policy, ULIP, NPS, PPF or an NCD and make an investment decision?

Seek Help

The answer to this question does not lie in those metrics alone. It lies in YOU, the investor’s preference for asset mix, risk-to-reward expectations and most importantly it is dependent on your personal financial goals. The nature of these financial products is so diverse that a simple return comparison does not make any meaningful sense to an investor. And in many cases, it is almost impossible for an investor to understand the hidden risks – for example, how could an investor tell whether a balanced fund is of lower or higher risk than a balanced advantage fund or a ULIP (Unit linked Insurance Plan)?

Ask the right questions or seek help from experts/advisors.

Most investors are good with decision making, where they need help is getting the right set of metrics to bring forth a product’s credentials. By consulting an expert, it is possible to understand the metrics and make an informed investment decision.

In the next article, we are going to look at some of the challenges investors face in timing the entry/exit of the invested products to maximize returns!

How to choose a financial product?

  1. How to choose a Financial Product?
  2. How to compare Financial Products?
  3. Could I time the entry/exit of my investments?

Let us understand each of these issues that investors face in a 3-part series..

Choosing a Financial Product

Today there are hundreds of financial products to choose from the market. They range from simple fixed deposits to complicated ULIPs. Then we have health insurance plans with all kinds of riders (flexible or restrictive), loan products (home, vehicle, personal) & lastly, the Capital market products – Mutual Funds, Equities & Derivatives.

Hema, a 23 year old designer, has been working only for 2 years. However, she seems to have already bought 3 endowment policies with a total premium of Rs.25,000 p.a. She neither has any idea on the life cover received nor on the adequacy of cover. She was told she would get Rs.10-12Lacs after 25 years (this is called the future value), so she thought it is not a bad idea to take up the policy.

Even before she realized what she had bought, her family’s well-wisher was selling her more policies each year. When the premium burden increased, she started asking some questions such as what are the returns from the policy and whether she could exit half way. But the only answers Hema received were the policies would help her save tax and give her good returns after 25 years.

Understand by reviewing your Insurance Policies

Upon reviewing her policies, I noticed that Hema’s life cover was barely Rs.6L (all 3 plans combined) and the illustrated approximate returns were only Rs.2.5L, inflation-adjusted in today’s money value, giving her 3-5% p.a returns. Also there is a bonus part in every policy which is subject to market conditions, it is variable and not guaranteed – it is only illustrative, putting it in the same league as mutual funds.

When she was shown the math behind her plans, she was shocked and confused as to whether to continue with the policies for the remaining 23 years. But the review helped her understand that insurance is not investment. She made a prudent choice to discontinue her endowment policies and bought other pure term plans that offered her higher life cover for Rs.1 crore at a much lower premium. This move also allowed her to invest the Rs.25,000 in PPF (an alternate) and reap additional returns.

So, why do we buy insurance?

There is widespread belief among us that the sum assured in a policy means “premiums paid are returned with assurance“. In a way it is ingrained in our minds that insurance is some form of a “capital-protected” investment compared to other financial products such as mutual funds or equities, which come with a tag-line “Mutual Funds are subject to Market Risks”. But the fact is both insurance companies & fund houses invest in the same bonds & stocks of the Indian capital market and hence they both face the same risks.

What should an investor do?

Investors need to ask certain basic questions prior to parting their money and assess the suitability of the product, its risk, the time horizon of investment & returns.

Ask these questions and seek to understand the financial instruments. Invest your money only if you receive simple, straight forward and reasonable answers for the above questions. If you exit an insurance policy, you get only 30% of all premiums paid, compared to losing 30% in a financial crisis in an equity mutual fund. So, like Hema, seek to understand the financial products before parting your hard earned money.

In the next article, we shall examine the next challenge that investors face – how to compare different financial products?

What are real returns?

In the previous article, we sought to explore if there is any magical number to measure good return. And yes, that magical number is based on your real return. To understand real returns, it would be good to begin understanding inflation. There are two types of inflation, wholesale and retail. The retail inflation (a.k.a CPI) measures the price rise of a common basket of 460 commodities primarily used by indian households. Wholsesale inflation is used for national GDP accounting, while retail inflation is adopted by RBI for determining interest rates in the country. It also forms the basis for wage rise.

Inflation-adjusted Income to meet Cost of Living

Senthil, a professional is 43 years of age. Let us say 20 years ago, in 1998, Senthil earned Rs.8000/- and at that time, his family’s expenses were about Rs.5000/- p.m. At an average wage rise of 12% p.a and an inflation rate of 6.5% p.a, today his income rises to Rs.77k p.m and basic expenses rises to Rs.17k. However, due to higher spending on lifestyle expenses such as consumer goods, gadgets and travel, his present monthly expenses have risen to Rs.50k p.m.

If his income was not adjusted to the rate of inflation, he could not afford his daily basket of goods. This is why it is important that wages be adjusted to inflation annually. On the other hand, it is important to note here that his savings rate has remained the same, at an average of 33% through out the 20 years.

What are nominal & real returns?

We invest today to get a certain return in future. As inflation keeps rising year-over-year, we would like our returns to be higher than the inflation, so that we could afford to buy the same basket of goods & services in future, with the returns from investments made today. Investment returns stated plainly are called nominal returns (7%). When nominal returns are adjusted by inflation rate (6.5%), we get real returns 0.5% (7% – 6.5%).

Why Real Returns matter?

A higher real return is important to make your retirement worry-free. It also determines whether you could retire early or you have will sufficient corpus to sail through your retirement life.

Senthil has 15 more years to retire. If Senthil had used only fixed income instruments like fixed deposits, despite saving 33% of his salary, he would have accumulated only Rs.44L at the end of 20 years. His Rs.44L corpus could provide him with only the basic cost of living expenses of Rs.17k, during his retirement. He would not be able to afford the additional lifestyle expenses (gadgets & travel) with his savings, even if he works for the next 15 years. This is because in the case of saving via FDs, real returns are only 0.5% = 7% FD – 6.5% inflation rate.

Fortunately, Senthil had invested a good part of his savings in market-linked products, which have accumulated to Rs.62Lacs in 20 years, 40% more than the FD route, so not only he could comfortably afford his current lifestyle of Rs.50k at the time he retires, he could also retire 5 years early, if he wishes to. This is because real returns from his market-linked portfolio is higher at 4% = 10.5% Portfolio returns – 6.5% inflation rate.

Why only 10%, couldn’t Senthil get a 20% return on his portfolio?

If Senthil owns a 1000 sq.ft house that he bought 10 years ago for Rs.20L and he expects a return of 20% p.a on it today, he needs a buyer to pay him at least Rs.1.2Cr for his property. Would you be Senthil’s buyer? Most of us would not be willing to pay this price especially when similar sized units are available at a much lower price in the market, at Rs.75L, which translates to a 14% rate of return for Senthil.

As a seller, it would be unreasonable on Senthil’s part to expect a buyer to pay a price that he himself would not pay for a similar property. And this return is from only one asset in Senthil’s portfolio. The combined returns of his entire portfolio would be lower due to varied returns of different asset types. Return on investment also depends on the economic state of a nation. If a nation’s GDP grows at 8% p.a, it is only reasonable to expect a nominal return of 12% p.a = 8% GDP + 4% real return.

How could I attain a realistic real return of 4% consistently?

Saving via bank FD or other fixed income instruments alone is not sufficient to attain a real return of 4%. It is also important to not be overweight on gold or property as they are not liquid assets. Investing a certain portion of your assets in market-linked products would enhance your real returns from 0.5% to 4% in the long term and help to meet your retirement income needs. In order to build a right asset mix, we need to understand the various assets, their inherent risks & the nature of their returns. We shall continue in the next session..

What makes a good return?

We know that when we invest our money, we get returns, measured either in absolute amounts or as a percentage of our investment. But what exactly is a return? We part/lend our savings to someone, who borrows it and pays us a small sum until they return our entire money back. This small sum is called return, which could be periodic or single lumpsum repayment.

How do we decide if a return is good?

Before we attempt to answer this question, lets look at some returns that we’re familiar with.

  • Kala lends her savings to a bank as Fixed Deposit & the bank returns her 7%
  • Ram invest in stocks & the company pays him a dividend of 1.5%
  • Mangai buys gold & gets no return till she sells it
  • Siva rents his Rs.60 Lacs apartment/house and gets Rs.15,000/- p.m, i.e, rental yield of 3%
  • Arul buys a plot of land & gets no return till he sells it

If we compare the percentage returns of the above people, we would be inclined to conclude that Kala’s FD is the best investment & Mangai’s gold and Arul’s plot as the worst. But somehow we know this is not the case, why?

Cash (vs) Capital Asset

The answer lies in the nature of the asset – FD is a cash asset, while the rest are capital assets. We believe that capital assets appreciates in value over time and hence choose to accept a relatively smaller return (dividend or rent) or even 0% return (gold) from these assets. On the other hand, FD being a cash asset, it does not appreciate in value and hence we expect a higher return.

Even amongst the capital assets not all returns are alike. Capital assets appreciate based on demand-supply dynamics and hence the rate of appreciation is not predictable – in certain years they return 50% and in others they return only 3%.

Ram may be lucky to generate a 30% return from stocks in a rally year like 2018, but he may not be able to repeat it consistently year after year. Similarly, Arul may have sold his Rs.5L plot of land for Rs.30L in 10 years, but he may not be able to sell that Rs.30L plot for Rs.2 Cr in the next 10 years.

How do I measure my returns?

Lets say your total asset holding is Rs.1 crore – Rs.60L house on rent, Rs.5L plot, Rs.5L in stocks and Rs.30L in FD/EPF/PPF). Your total returns per annum would be Rs.5.13L, at 5.13%.

Asset DescriptionAsset Purchase ValueAsset WeightAsset Returns p.aAsset Return Absolute AmountWeighted Asset Return
1. Rental Property₹6,000,00060.00%3.00%₹180,0001.80%
2. Plot of Land₹500,0005.00%20.00%₹100,0001.00%
3. Stocks₹500,0005.00%1.50%₹7,5000.08%
4. Fixed Deposit/EPF/PPF₹3,000,00030.00%7.50%₹225,0002.25%
Total Portfolio Value₹10,000,000₹512,5005.13%

Although you generated 20% returns by sale of the plot of land, it forms only 5% of your assets. Now, if you would like to generate 20% return on your entire portfolio of assets, it requires you to invest the entire Rs.1Cr in just one asset class – in plots of land, which is not preferred as you would like to diversify your risk. Similarly you may not invest all of Rs.1Cr in gold nor stocks for the same reason. So, it is important to understand total returns of all your money and not be carried away by a single asset’s high return.

So, What makes a good return?

A good return is not about making windfall gains in one transaction. It is about making each drop count. Jerky returns are like flash floods, they come & go, but they do not fill your wells. Consistent and steady returns over many years is the secret to building long term wealth. A good return is one that gives us inflation-adjusted income + a reasonable appreciation over a long term. Is there a magical number to measure good return? We shall explore in the next issue..