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Late start, slow growth

Late start, slow growth

This Visakhapatnam-based couple must try to increase surplus money and invest it in equity diversified funds to accelerate the growth of their portfolio.

Name: Srinivasan Donthineni (left) and T. Saroja

Age: 39 years (both)

Monthly income: Rs 48,157 (post tax)

Financial dependants: Three (children and Saroja’s mother)

Most investors have portfolios that are good and bad in parts. While a very few of our patients are in perfect financial health, the percentage of singularly bad investors is also very low. Usually, even the most dismal of cases have redeeming factors that can be used as anchors for suggesting a financial plan.

So we were surprised when we scanned the finances of Srinivasan Donthineni and T. Saroja because, at first glance, there appeared to be no redeeming factor. They have an ultra-slim portfolio: financial assets worth Rs 2.3 lakh and a plot of land currently valued at only Rs 20,000. This is because though they started working 10 years ago, they have been investing only for the past two years. Age is definitely not on their side; both are 39 years old, well past the golden years when the power of compounding would have beefed up their finances.

They are inadequately insured—Donthineni has a cover of Rs 11 lakh and Saroja of Rs 5 lakh— as the couple have used insurance policies to save tax, another no-no for prudent planning. A newbie equity investor, Donthineni has invested Rs 2.1 lakh in 11 mutual funds, of which nine funds are either inappropriate for his risk profile or duplicate his stock exposure.

If the couple continues with this approach, the future is definitely not bright. The silver lining is that both are government employees. This means they need not invest for a retirement corpus, the financial goal that devours the highest portion of savings. So our job becomes less difficult, but not easy.

Donthineni and Saroja did not want to list their financial goals. Their logic was that they only want to optimise their investments; how much they eventually spend will depend on how much they can save. It is a naive philosophy that will not erase their worries, only postpone them till a time when nothing can be done about it. Moreover, how can one build a plan when one doesn’t know what one is planning for? So, after much persuasion, they shared their goals with us.

The numbers are daunting. The couple requires a monthly investment of Rs 91,179. Donthineni brings home Rs 23,861 a month and Saroja earns Rs 24,296. After deducting their regular expenses of Rs 25,000 (52% of income), EMIs and average insurance premium, they have an investible surplus of Rs 12,198. The shortfall of Rs 78,981 cannot be met with salary increments in the short term. So they must follow an aggressive investment strategy and prioritise their goals.

CASH ON DEMAND

Donthineni had a sudden requirement of Rs 1.2 lakh for his mother’s operation*. Here are some ways that can help you source money at short notice:

Withdraw from existing investments: It works best if investments earn a lower interest than loan rate. After withdrawal, the debt cushion should be reasonable.

Take a loan against securities: It has a lower interest rate than a personal loan, but there are complications if equity investments are used as collateral.

Personal loan: This is probably one of the costliest options, but it is easy to get this loan if you have a good credit history.

Credit card: If the amount needed is within the credit limit, it is the most convenient option. For repayment, you can convert it to EMIs, but the interest is high.

* Ideally, Donthineni should have taken a family floater health insurance to cover the cost

Equities is the elixir for their ailing finances. Iris suggests that they invest the entire surplus in equity diversified funds. Perhaps Donthineni realises the urgency of his situation. This is the reason he has invested in stocks—Reliance Power and Tata Motors. But this hasty decision might prove counterproductive. Donthineni has very little knowledge of the markets and has no fundamental analysis skills. Therefore, instead of accelerating the growth of his portfolio, chances are that this move will result in losses. Hence, we suggest that he exit these stocks and reinvest the amount in mutual funds.

Of his current fund investments, Iris suggests retaining only Reliance Growth and HDFC Top 200, which are mid-cap and large-cap funds, respectively. The distribution of their surplus in these funds can either be in the ratio of 50:50 or 30:70, depending on how much aggression is palatable to the couple.

Why has Iris rejected the other funds? Primarily because the collection has a majority of sector funds like Tata Indo Global Infrastructure and ICICI Pru Indo Asia Equity. Such funds are meant for investors who can time the entry and exit from a sector according to the rise and fall of the industry’s fortunes. Funds like Magnum COMMA invest in a very select group of stocks that make the fund riskier than its equity diversified counterparts. Also, each fund accounts for a very tiny portion of the mutual fund portfolio, indicating inefficient management.

Donthineni has a penchant for lump-sum investments. He believes that when the markets are down, lump-sum investments maximise the benefit of a future upturn and that systematic investment plans (SIPs) are more suited to a bullish phase.

If only markets had a linear trajectory, things would have been as easy as Donthineni thinks. In reality, market curves resemble doodles, going in haphazard directions. So a market that moves up one day can nosedive in the next trading session. An SIP helps to average out the cost of investing. As it is a regular investment, you are sure to gain every time the market moves down. There are times when lump-sum investments score over SIPs. If the market zooms right after a big investment, the gains would be much more than those from an SIP. But it is impossible for ordinary investors to do this all the time. So a mix of SIPs and large investments is ideal.

LESS IS EFFICIENT

Donthineni has invested in mutual funds randomly. Iris suggests that he consolidate investments in equity diversified funds.

Fund% of portfolioRecommended action1-year returns (%)
HDFC Top 2006.4Continue-45.6
ICICI Pru Indo Asia4Exit-54.2
Magnum COMMA5.3Exit-57.9
Magnum Contra9.4Exit-51.6
Magnum Multiplier8.7Exit-54.9
Magnum Taxgain27Exit-54.7
Principal Tax Savings10.8Exit-63.4
Reliance Growth9.2Continue-52
Tata Indo Global Infrastructure3.9Exit-56.9
UTI India Lifestyle10.5Exit-46.1
UTI Infrastructure Advantage4.9Exitn.a.
The funds that Donthineni has been advised to exit either have a concentrated portfolio, are sector funds or have a very small amount invested in them.

 

Most investors have portfolios that are good and bad in parts. While a very few of our patients are in perfect financial health, the percentage of singularly bad investors is also very low. Usually, even the most dismal of cases have redeeming factors that can be used as anchors for suggesting a financial plan.

So we were surprised when we scanned the finances of Srinivasan Donthineni and T. Saroja because, at first glance, there appeared to be no redeeming factor. They have an ultra-slim portfolio: financial assets worth Rs 2.3 lakh and a plot of land currently valued at only Rs 20,000. This is because though they started working 10 years ago, they have been investing only for the past two years. Age is definitely not on their side; both are 39 years old, well past the golden years when the power of compounding would have beefed up their finances.

They are inadequately insured—Donthineni has a cover of Rs 11 lakh and Saroja of Rs 5 lakh— as the couple have used insurance policies to save tax, another no-no for prudent planning. A newbie equity investor, Donthineni has invested Rs 2.1 lakh in 11 mutual funds, of which nine funds are either inappropriate for his risk profile or duplicate his stock exposure.

If the couple continues with this approach, the future is definitely not bright. The silver lining is that both are government employees. This means they need not invest for a retirement corpus, the financial goal that devours the highest portion of savings. So our job becomes less difficult, but not easy.

CASH ON DEMAND

Donthineni had a sudden requirement of Rs 1.2 lakh for his mother’s operation*. Here are some ways that can help you source money at short notice:

Withdraw from existing investments: It works best if investments earn a lower interest than loan rate. After withdrawal, the debt cushion should be reasonable.

Take a loan against securities: It has a lower interest rate than a personal loan, but there are complications if equity investments are used as collateral.

Personal loan: This is probably one of the costliest options, but it is easy to get this loan if you have a good credit history.

Credit card: If the amount needed is within the credit limit, it is the most convenient option. For repayment, you can convert it to EMIs, but the interest is high.

* Ideally, Donthineni should have taken a family floater health insurance to cover the cost

Donthineni and Saroja did not want to list their financial goals. Their logic was that they only want to optimise their investments; how much they eventually spend will depend on how much they can save. It is a naive philosophy that will not erase their worries, only postpone them till a time when nothing can be done about it. Moreover, how can one build a plan when one doesn’t know what one is planning for? So, after much persuasion, they shared their goals with us.

The numbers are daunting. The couple requires a monthly investment of Rs 91,179. Donthineni brings home Rs 23,861 a month and Saroja earns Rs 24,296. After deducting their regular expenses of Rs 25,000 (52% of income), EMIs and average insurance premium, they have an investible surplus of Rs 12,198. The shortfall of Rs 78,981 cannot be met with salary increments in the short term. So they must follow an aggressive investment strategy and prioritise their goals.

Equities is the elixir for their ailing finances. Iris suggests that they invest the entire surplus in equity diversified funds. Perhaps Donthineni realises the urgency of his situation. This is the reason he has invested in stocks—Reliance Power and Tata Motors. But this hasty decision might prove counterproductive. Donthineni has very little knowledge of the markets and has no fundamental analysis skills. Therefore, instead of accelerating the growth of his portfolio, chances are that this move will result in losses. Hence, we suggest that he exit these stocks and reinvest the amount in mutual funds.

Of his current fund investments, Iris suggests retaining only Reliance Growth and HDFC Top 200, which are mid-cap and large-cap funds, respectively. The distribution of their surplus in these funds can either be in the ratio of 50:50 or 30:70, depending on how much aggression is palatable to the couple.

Why has Iris rejected the other funds? Primarily because the collection has a majority of sector funds like Tata Indo Global Infrastructure and ICICI Pru Indo Asia Equity. Such funds are meant for investors who can time the entry and exit from a sector according to the rise and fall of the industry’s fortunes. Funds like Magnum COMMA invest in a very select group of stocks that make the fund riskier than its equity diversified counterparts. Also, each fund accounts for a very tiny portion of the mutual fund portfolio, indicating inefficient management.

Donthineni has a penchant for lump-sum investments. He believes that when the markets are down, lump-sum investments maximise the benefit of a future upturn and that systematic investment plans (SIPs) are more suited to a bullish phase.

If only markets had a linear trajectory, things would have been as easy as Donthineni thinks. In reality, market curves resemble doodles, going in haphazard directions. So a market that moves up one day can nosedive in the next trading session. An SIP helps to average out the cost of investing. As it is a regular investment, you are sure to gain every time the market moves down. There are times when lump-sum investments score over SIPs. If the market zooms right after a big investment, the gains would be much more than those from an SIP. But it is impossible for ordinary investors to do this all the time. So a mix of SIPs and large investments is ideal.

Real estate has been on the couple’s radar for some time. Last year, they bought a plot of land at Chirala, Donthineni’s home town, for Rs 1.4 lakh. But the government has decided to use the area as a special economic zone, and as compensation, the couple will receive only Rs 20,000. To compound the problem, they have taken a loan against an insurance policy as well as committed to regular withdrawals from their provident fund to pay for the land. The loan EMI is Rs 8,359 every six months.

There is little that the couple can do to reduce the losses. Iris suggests that they convert the wife’s insurance policy, Jeevan Shri, to a fully paid-up plan as it very expensive; it provides a cover of Rs 5 lakh to Saroja at an annual premium of Rs 25,272. As the policy is 10 years old, there will be enough corpus to automatically foreclose the loan.

Donthineni has also bought a Jeevan Shri policy for himself with the same cover and premium. So the advice is the same for him—convert it to a fully paid-up plan. He has also picked up a postal life insurance policy that covers him for Rs 5 lakh. As the premium is low, Rs 1,275 a month, he can retain the policy and consider it a debt investment. He should also continue the moneyback policy as it will mature soon. This will increase the couple’s investible surplus to Rs 17,803. To make up for the shortfall in their life cover, they should buy a term plan of Rs 20 lakh each, the annual premium for which will be about Rs 9,000. About a year ago, Donthineni had to withdraw nearly Rs 1 lakh to meet the medical expenses for his mother. Taking a cue from this, he should buy a family floater health plan of about Rs 5 lakh so that he does not have to dip into his savings to meet such exigencies.

As we had said earlier, it will be difficult to meet all the goals of the couple. We suggest that they downsize some, like settling for a smaller and cheaper apartment.

ON THE FUND HUNT
P.V. SUBRAMANYAM,
Financial Trainer

If past records were enough to predict the future, the result of every match would be known even before it started. Similarly, if the past performance of mutual funds was the only barometer, no fund investor would ever lose money. In reality, this is never the case. So all investors should take mutual fund ratings and recommendations with a pinch of salt. To identify whether a fund works for you, look for the following:

Risk taken by a fund manager: Base your decisions on “risk-adjusted returns”. Risk is measured using standard deviation or beta.

Processes of fund houses: If it is a good fund house, it will have a seamless operation with a definite investing philosophy. This means that if a key person in the organisation leaves, it will not affect the fund’s performance. Also, consider the track record of the manager.

Nomenclature: If a fund says it is a large-cap fund, it must buy only large-cap shares. Also, check the amount of cash that the fund sits on. If you have invested Rs 5,000 in a large-cap fund, you want the fund manager to buy shares worth Rs 5,000, not to sit on Rs 3,000.

Returns in the very long term: Pick a period that covers both bull and bear markets. This reveals whether the fund has been able to weather all business cycles. If you are number savvy, use the monthly moving average and compare it with the risk-adjusted return, that is the return divided by standard deviation. You will be able to compare the performance of funds better.

Where it fits in your portfolio: Sometimes, a second-best fund could work because its risk profile suits you more than the top fund. So don’t be hassled by tiny differences in returns between funds.