Undone by excesses

Pune-based Shailesh Phule must bring order to his finances and reassess the balance between risk and returns as per his profile, says Kamya Jaiswal.

Kamya Jaiswal | Print Edition: February 19, 2009

Selection is a woefully underrated financial skill. Strategy has been given its due and calculations have their moments of glory. Even boring theories are treated with respect. But when it comes to selection, investors assume that it follows naturally from the above three.

If this were true, Shailesh Anant Phule would not have piled up a mind-boggling 31 mutual funds in his portfolio. As if this collection is not big enough, he has also bought 25 stocks. You could dismiss this as overzealousness. Or it could be considered a camouflage for his inability to select the right funds and stocks. This 40-year-old franchisee of a confectionery chain is no newbie investor and claims to be reasonably dextrous with equity analysis tools.

Yet, Phule has gone on a shopping spree for funds and stocks, which if bought with a credit card, would have resulted in lakhs of reward points. Unfortunately, this strategy has no rewards and only spawns inefficiency. Betting across the table ensures that you always win some, but the winnings are never large because the invest-ments are spread too thinly. Worse, this strategy is not as safe as it is thought to be. This is partly because of the tendency to duplicate fund types which means that all the chips go down together. Most importantly, the overall risk is a function of the proportion of other asset classes in the portfolio.

Portfolio analysis of Shailesh Anant Phule

So our challenge is to prune Phule's finances. This is the easier part of the reconstruction of his plan. Phule has a differently-abled brother, who is financially dependent on him. Therefore, Phule must build a corpus large enough to take care of his brother's needs too. With an income of Rs 50,000 from his store and Rs 17,500 as rent from two shops and two one-bedroom apartments, it's not going to be easy. Phule's monthly expenses are close to Rs 35,000-52% of his income. After deducting the investment of Rs 16,000 in SIPs, a car loan EMI of Rs 8,000 and the average insurance premium of Rs 2,143, his monthly surplus is Rs 6,357. Even after including this amount, Phule's total monthly investments will be painfully short of the Rs 74,092 required to meet all his goals.

There is some respite though. Of this amount, Rs 32,659 is for building Phule's nest egg in the next 20 years. However, a retirement corpus is redundant for most businessmen because they tend to work for as long as they enjoy good health. By this logic, Phule's earning capacity should extend beyond the usual retirement age of 60.

A Special Plan
Here are some ways to protect the financial interests of a differently-abled dependant like Phule's younger brother
Account for the extra expenses: These include the medical outlay, cost of special equipment and pay of care-givers, among others.
Aim for a bigger nest egg: The corpus should be able to meet not only your expenses, but also those of the dependant for life.
Build an income-generating asset: The easiest way to do this is to acquire property in the name of the dependant and rent it out.
Appoint a guardian: Someone should be responsible for the emotional and financial needs of the dependant after your death.
Create a trust: It is an inexpensive way to ensure the financial independence of the dependant and to reduce the chances of misuse of the assets left to him.

So we suggest that Phule replace the goal of a nest egg with a corpus for his brother. The annual medical expenses for his brother are about Rs 25,000. At an inflation of 8%, Phule must accumulate Rs 22 lakh in 10 years to meet these expenses through his brother's life. Phule can claim an exemption of up to Rs 50,000 for the expenses incurred on his brother's care under Section 80DD of the IT Act.

Unlike any other dependant, his brother may not be able to assert his rights when Phule is no longer around to take care of him. So it is a good idea to build a trust for his brother (see A Special Plan).

After the change in goals, the target monthly investment is down to Rs 50,280, but it is still beyond Phule's means. What can help are the properties that Phule has inherited. The shops and apartments are collectively valued at about Rs 1.25 crore. Some of these can be sold to meet the deficit in the corpus for goals like the education of his children. Another option is to downsize some of the objectives to more realistic levels.

Now, for his investments. Iris suggests that Phule focus entirely on equities. He has a sizeable debt cushion of Rs 6.5 lakh through investments in the Public Provident Fund, National Savings Certificates, bonds and fixed deposits. Gold jewellery worth about Rs 4 lakh gives additional support to his finances.

Within equities, investment in stocks is avoidable. Phule's basket of 25 stocks has many blue chips but they were not bought cheap. Moreover, the number of stocks for each company is very small. So the transaction cost is a high proportion of the investment. We suggest that Phule slowly exit direct equity. He usually books profit when the stocks appreciate by 30-35%. This time, he should tame his expectations and sell them at the earliest.

So the ideal investment vehicle for Phule is mutual funds. But suggesting funds to Phule is fraught with danger. He is likely to commit the SIPs to new funds and make his unwieldy portfolio completely unmanageable. So Iris has suggested a massive consolidation drive for Phule's fund collection (see Balancing Act).

Birla Sun Life International Fund Plan A and B and ICICI Prudential Indo Asia Equity have been shown the door because they offer a high level of diversification that Phule's portfolio does not require. As the name suggests, ICICI Prudential Equity and Derivative Wealth Optimiser invests in derivatives. To understand them requires specialised knowledge. So this fund is best avoided. Some midcap funds like Sundaram BNP Mid Cap and Sundaram BNP Capex Opportunity have also been booted out as their high risk is unsuitable for Phule.

Similarly, Magnum Contra, Magnum Global and Magnum Multiplier Plus are out because they invest in a very narrow range of stocks, which makes them more risky. Reliance Diversified Power, Tata Infrastructure and Tata Indo Global Infrastructure are sector funds and require an insight into the respective industries. Phule does not have the acumen to analyse these sectors and should, therefore, exit these funds too.

By now it is clear that the basis of selection of funds is consistent performance and low risk. Equity diversified and balanced funds fit this description to the T. But Phule must not invest in the same set of stocks through different funds. Hence Fidelity Equity and Franklin India Bluechip have been struck off the list. Some of their better performing peers like DSP Black Rock T.I.G.E.R have been retained. Iris has also suggested that Phule choose from HDFC Top 200, HDFC Equity and DSP Black Rock Top 100 for SIPs. The funds from the Principal fund house have been ousted because the company is exiting the fund management business.

Buying health insurance policies for his family is one of Phule's smartest moves. He believes that insurance and investment are best kept separate. So he has bought a term plan of Rs 10 lakh. We endorse his view but the value of the policy is ridiculously small for someone with five dependants. He should buy a term plan of at least Rs 50 lakh, which will cost about Rs 25,000 annually. Phule is keen on investing in a pension plan, but it is unnecessary if he follows our strategy.

Anand Paladhi

Revisiting past patients

Anand Paladhi, 33 years | Financial dependants: Two

Old asset allocation

  1. Cash: 63%
  2. Debt: 6%
  3. Equities: 31%

What we diagnosed

  1. Very low investing rate.
  2. Very high risk appetite.
  3. Inadequate insurance cover.

What we prescribed

  1. Invest in a Ulip as it is cheaper than a mutual fund over a 10-year horizon.
  2. Increase investment in SIPs.
  3. Invest in HDFC Prudence, HDFC Equity and Reliance Vision funds.
  4. Buy a term plan of Rs 25 lakh.

What he did

  1. Bought a term policy of Rs 10 lakh. Plans to increase insurance cover to Rs 30 lakh.
  2. Increased SIP investment in HDFC Prudence. Total investments through SIPs have also increased to Rs 15,000 a month.

What he did not do

  1. Invest in a Ulip as he is not sure whether he will hold his investments for the long term when it becomes more beneficial.
  2. Paladhi’s choice of a combination of term plans and mutual funds is fine as long as he continues to increase investments in SIPs.

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