|Name: Ramesh Babu G|
Age: 32 Years
Monthly income: Rs 45,000 (post tax)
Financial Dependents: Two (wife and child)
|Click here to see Ramesh Babu G's portfolio analysis|
He has made some excellent financial moves. And some disastrous investment decisions. For instance, Ramesh Babu G invests 59% of his take-home salary. Of this, nearly 44% is invested in mutual funds through systematic investment plans (SIPs). But the SIPs are in too many (11) funds. As a result of such mistakes and a dearth of rigour, a disciplined investor’s efforts are undone.
This flaw in strategy is common to many investors—they do not make an effort to understand a financial instrument thoroughly. Consequently, they either invest in a financial product unsuitable to their needs or are unable to fully benefit from it. Ramesh’s mutual fund binge, investment in Ulips for building an education corpus for his daughter, etc, are examples of this oversight.
Clearly, there are many lessons to be learnt from Ramesh’s investments. But first let’s make an inventory of his portfolio. Ramesh earns Rs 45,000 a month post tax. Routine expenses use up about Rs 15,000—33% of his income. Last year, he purchased a plot of land in the suburbs of Hyderabad along with his brother. To fund his contribution of Rs 3 lakh, he took a personal loan for the total amount at 11% interest. The EMI skims off another Rs 6,000 from his income.
Recognising his high risk appetite, Ramesh invests in equities heavily. He has committed Rs 11,500 to SIPs. In addition, he has made lump sum investments of approximately Rs 1.3 lakh in seven funds.
NOT REALLY DIVERSIFICATION
Ramesh has invested in 18 mutual funds. Here’s a look at the top 5 stocks of two funds to demonstrate that they are not very different:
|Magnum Tax gain||(%) holding|
|Larsen & Toubro||3.38|
|Welspun Gujarat Stahl Rohren||3.17|
|Infrastructure Dev Finance Company||2.98|
|Housing Development Finance Corporation||2.96|
|Sundaram BNP Taxsaver||(%) holding|
|Tata Power Company||5.2|
|Larsen & Toubro||4|
|Housing Development Finance Corporation||3.3|
|Percentage holding as on 30 April 2008|
About a year ago, Ramesh bought shares worth Rs 4 lakh of four companies. The collection includes Reliance Capital, Reliance Petroleum, Reliance infrastructure and Jai Corporation. These stocks have given him good returns. In fact, the value of his investment in Jai Corporation shares has gone up by Rs 4 lakh—equivalent to his total investment in direct equities.
Obviously, Ramesh is excited and keen to pump in more money in stocks. We want to sound an alarm. True, Ramesh has made stupendous profits, but this has nothing to do with strategy. He bought the shares on a friend’s advice—hardly any reason to believe that the good performance will be repeated.
Ramesh claims he does research on the Net about stocks. This “research” refers to reading up expert views on stocks and participating in online discussion forums. Talk of fundamental analysis and Ramesh is blank.
This is definitely not research. While exchanging ideas with fellow investors and reading articles by experts is helpful, research about stocks primarily refers to their fundamental and technical analysis. Ramesh must do a reality check. Is he willing to spend time and effort to understand the dynamics of the stock market? If no, it is best if he exits direct equities. But since he is very keen, we suggest he start doing real research.
Ramesh deliberately maintains a small debt portfolio of Rs 30,000 invested in Public Provident Fund and National Savings Certificates. He can continue with this strategy for a few more years. But with age, he must increase investments in fixed-income instruments.
For insurance, Ramesh has invested in three Ulips and three endowment policies. Collectively, they give him a cover of about Rs 14 lakh. Total annual premium is nearly Rs 1.1 lakh. All three Ulips have almost 100% equity exposure. Two of these are children’s plans.
We suggest Ramesh begin fine tuning his portfolio by prepaying his personal loan. If he is unwilling to withdraw money from his current investments, he should take a loan against his LIC policies at 9% to pay off the personal loan. This will reduce his EMI and add to his current monthly surplus of Rs 3,417.
STREAMLINING MUTUAL FUNDS
Iris recommends Ramesh consolidate mutual fund investments in few, mostly large-cap, funds
|Name of the fund||Amount (Rs)||Suggested action|
|SBI Magnum Umbrella||500||Stop|
|SBI Magnum Tax Gain||500||Continue|
|Sundaram Tax Saver||500||Stop|
|HDFC Prudence||1,000||Increase amount|
|HDFC Top 200||1,000||Continue|
|Sundaram Select Focus||1,000||Continue|
|Name of the fund||Amount (Rs)||Suggested action|
|HDFC Long Term Advantage||30,000||Stay invested|
|ICICI Pru Tax Plan||20,000||Stay invested|
|Fidelity Tax Plan||10,000||Stay invested|
|Reliance Tax Plan||25,000||Stay invested|
|SBI Magnum Tax Gain||15,000||Stay invested|
Next on the list is streamlining his mutual funds collection. There is a difference between diversification and variety. Too many funds do not necessarily diversify investments, especially if you focus on the same category of funds. These funds have almost similar portfolios. Thus they do not give significantly different equity exposure to a portfolio.
Does that mean you should invest in different fund types such as sectoral funds, quant funds, etc? The answer is yes and no. The safest category of funds is equity diversified since they spread investment across all sectors. Sector funds like infrastructure funds and technology funds are more risky since they invest in a smaller universe of companies. Hence, while they are not a complete no-no, investors must not make them the mainstay of their fund portfolio.
Following these principles, Iris has suggested how Ramesh should consolidate his mutual fund investments. It is best to concentrate on funds which invest in large-cap stocks as they are least risky.
Having built an emergency fund equivalent to three months’ expenses of his family, Ramesh should funnel his entire monthly surplus in one of the suggested funds.
Insurance is perhaps Ramesh’s biggest blunder since it may take time to correct. The reason— Ulips. Ramesh invests Rs 4,500 every month in two UIips which are children plans. In such plans, if the investor dies within the minimum premiumpaying period, the insurer pays the premium for the time left and gives the corpus at the end of the tenure to the nominee. In Ramesh’s case, this amount is Rs 6 lakh and the period is five years.
The sum assured is highly inadequate. Also, the plan is very expensive. If Ramesh buys a term plan of about Rs 60 lakh, annual premium will be about Rs 17,000. So, for nearly Rs 37,000 less, he gets a cover 10 times of what is provided by these Ulips.
Ramesh has invested in a third Ulip for which he pays an annual premium of Rs 30,000. This amount must be paid for a minimum of three years. The three years ends this December.
Most investors think that after this minimum premiumpaying term, the insurance cover lasts forever. This is a misconception. The premium for the insurance cover is deducted from the accumulated corpus. It is possible that the corpus reduces so much that the income generated from it cannot pay for the mortality charges of the insurance cover. In such a case, the investor will have to replenish the necessary amount.
Hence, for this Ulip, we suggest Ramesh continue paying the premium for 10 years. He can stop paying premiums for the other two plans after five years. Once the tenure for these plans are over, he should convert them into paid up. As for his endowment policies, since they are over three years old, he should convert them into paid up too and stop paying the premiums.
Financial Domain Trainer, Iris
Ramesh has invested heavily in stocks and earned phenomenal returns too. But investing in stocks requires a lot of expertise—usually unavailable to ordinary investors. Here’s a list of musthave knowledge before you decide to go on a stocks binge.
Asset allocation: Investor must be absolutely sure of how much to put in each asset class before he decides how much to allocate to stocks
Portfolio construction: The best portfolio is the index (Sensex or Nifty). So an investor must construct a portfolio that nearly copies the index. If not, he should clearly know why he is assigning more or less weight to a particular sector. For instance, if banking is 12% of the index, I should have a brilliant reason to give 8-14% weightage to banking.
Market timing: Investors must be disciplined about asset allocation despite temptations. If value of tech stocks zooms up and goes past the allocated proportion in my portfolio, I must sell despite rising stock prices.
Picking winners, consistently: Having chosen a particular sector, say banking, investors must know whether to buy SBI or HDFC Bank. This is a tough thing—you should understand PE, growth prospects, etc.
Time frame: Some shares are good in the short term, some in the long term. Investors must be able to classify their stocks investments according to the investment horizon.
Mis-pricing benefits: When Bharti Airtel was at Rs 80, my portfolio manager bought it for me. I smartly told him: “Ha! you missed it at 30, didn’t you?” He replied that it was the right time to enter since after the time lapse he had “execution proof” that it was a good buy. Markets capture all news and build it into the price—but ordinary investors should know how and when to react to them. Ramesh was plain lucky. If he holds this portfolio for five years, he may become a millionaire. But there are equal chances that he might underperform a savings bank account.