See how easily you can create your own financial plan in 15 minutes

Do you have a financial plan??

Image result for funny quotes on future plans

Don’t worry if you don’t have one. Be with me for the next 15 minutes and we will get a simple yet effective financial plan done for you.

The backdrop..

All of us have dreams which are extremely close to our hearts. A happy family, our kids in the best colleges, memorable vacations, a nice cozy home, starting your own company, a comfortable retirement and so on…While as unromantic as it may sound, the hard truth is that most of them also need enough money to get fulfilled.

A financial plan for normal people like us, is a simple reality check of putting a cost to our dreams and figuring out ways to make them feasible.

So when I went about trying to find a simple planner online, one of the issues I faced was that, most of them were too complicated. The ones which were simple enough calculated a monthly required investment amount which was constant and did not increase. This meant, I got a horrendously large monthly required investment amount given my goals which also meant I was staring at a “put-your-entire-salary-into-investments” kind of a future. But its impractical to assume that my salary would remain the same for the next 10-20 years and it’s reasonable to assume that my investments will keep increasing let’s say conservatively by at least 5-10% every year. Since I couldn’t get my hands on a simple planner which let me do this, I have created my own basic planner which you can download from the below link.

Download the financial planner here: Link

How does it work..

Financial Planner

10 fairly simple steps:

  1. Enter your goal in column under the name “Goal”
  2. Enter the age of the person for whom the goal is planned
  3. Enter the age at which the money is required
  4. Enter the expected yearly increase in costs (i.e inflation) for the particular goal (In India Inflation historically is around 7-8%)
  5. Enter the goal’s current cost (i.e how much does it cost today)
  6. Enter the % by which you want to increase your yearly investments (approx should be equal to expected salary hike %)
  7. Enter existing overall investments value (if any)
  8. Enter the expected portfolio return from your investments
  9. Repeat the above steps for all your goals
  10. Press the “Calculate” button

Tips while filling the planner

  1. Don’t get too bogged on getting each and every assumption precisely right to the final decimal point. Honestly, no one knows what the future exactly looks like and so the basic idea is to get an approximate estimate of our future financial needs to help us plan
  2. Historically, inflation is around 7-8% in India.You can use that for most of the goals. Education and Housing might have higher inflation so I generally assume it to be around 10%.
  3. Play around with the portfolio returns – Get a sense of monthly investments required if you put your savings only in safe but lower return generating Fixed Deposits, volatile but higher return potential of equities etc. It lets you appreciate the importance of having a good investment process which can improve your returns.
  4. Retirement amount – Calculate it as 18-20x your annual requirement for getting inflation adjusted annual income for the next 30-40 years. I will do a separate post on the logic and mechanics behind creating an annual income flow.

Sample plan..

Lets take the case of someone who is around 30 years old, married and has a 1 year old kid. He wants to plan for his kid’s education (current cost of ~ Rs 8 lakhs for UG at 17 years + Rs 20 lakhs for PG at 21 years), kid’s marriage at 25 years (current cost of ~Rs 20 lakhs ), retirement at 60 years (current cost of ~ Rs 2cr) and purchase his own house after 15 years (current cost of ~ Rs 80 lakhs).

Given the above assumptions (you are free to use your own assumptions) as seen from the snapshot of the financial planner, he will need approximately around 1.02 cr currently for all his major future goals (adjusting the future costs for inflation). Now if he has it already, nothing like it. Else (which is most often the case), the next obvious alternative is to save and invest monthly. Normal SIP (systematic investment plan) means that you assume your investments to be constant every month which is impractical as discussed earlier (in this case he needs to invest approximately Rs 1.06 lakhs per month). Now the top up SIP is where he will increment his investments by 5% every year. Now the amount works to be around Rs 79,000 per month. If the amount is too high, given his salary, then he might need to take a hard look at his individual goals and prioritize on a few goals for the time being .

All of us have different priorities/needs and hence the above example is just to give you a sense of how someone can go about with it. So what are you waiting for. Go ahead and create your own financial plan.

Once you are done, our ability to fulfill our goals boils down to a combination of how much we can save and how well we can invest.

Obviously, the savings part will have to be figured by you.

On the investment part, don’t worry. I have got you covered. In my future posts, I will discuss on how we can go about putting a simple investment process in place.

P.S:
Just in case you find any difficulty in using the planner, kindly let me know via the comments so that I can help you out 🙂
By the way, my guess is, there should be far more comprehensive financial planners available on the net. While I find my own version sufficient for my personal use, you can consider this as a quick and effective starting point and can gradually explore the more comprehensive version of various planners available.
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Don’t even think about Real Estate without reading this !

What a fancy title. Well, that’s just about it. Fancy !! Please don’t take it too seriously. You have every right to think about real estate without reading this article. I am just dabbling around with some “how to make a sexy headline” articles and henceforth the dumb attempt. Please excuse me 🙂

Anyway, let me start this post with an honest confession. I am not an expert in real estate. Rather, I am your average 30 year old, just married, neighborhood guy who is currently going through the usual pressures of “Why haven’t you bought your own house yet?” from his lovable mom, grandpa, granny, aunties, uncles and every other human hierarchy in that order.

Since a real estate investment is generally one of the largest investments for most of us, a wrong decision can have a significant impact on our lives. Hence, it is extremely important to try and understand some underlying fundamentals of real estate investing. The article is my attempt at understanding real estate investing.

First things, first. Why do you want to buy real estate. Are you buying a home where you can live or are you investing for future returns and have no plans of staying at the place you are buying. Now if you are buying a home to stay, this article ends just here for all practical purposes. You cant put a price to the joy of owning an own house, the joy of watching your kid scribble across the walls..blah blah..and so on goes the argument. An own house is like an IPhone. While both definitely have some practical purpose, you never try justifying their price vis-a-vis the features !! An “own house” is not an investment , its a feeling 🙂

Now if you are not a part of the “it’s a feeling” gang, the rest of the article is for us.

Common belief : Real estate always provides you great returns. Prices never fall.

As always, we turn to evidence. Lets see how real estate prices across different cities have moved in the last 8 years.

Real Estate Price Trends.jpg

Source: http://www.nhb.org.in/Residex/Data&Graphs.php
NHB RESIDEX tracks the movement in prices of residential properties on a quarterly basis. This is being done since 2007

I have taken 2007 to be the starting date as NHB Residex data is only available from then and has been updated only till Mar-15 (courtesy, the lazy folks at NHB)

As seen above, Chennai has been the top performing Real state market with a whopping 17% annual returns. But if you look at other major cities, 7 out of 26 cities have had returns between 9 to 12% which while not very attractive has at least stayed ahead of Inflation (7-8%). But the shocker is that, 18 out of the 26 cities have had returns equal to or below 8% not even covering for inflation !!

Just to ensure, that the evidence is concrete, let’s confirm the pricing trend from another source  – Magic Bricks National Property Index which again confirms the subdued returns from real estate in the last few years.

Source: http://property.magicbricks.com/microsite/buy/propindex/index.html

So going back to our first statement – “Real estate always provides you great returns”.
The evidence doesn’t support this as most of the cities have had dismal price appreciation in the last 8 years (the above lines at this juncture apply only to chennai folks like me 🙂

Now addressing the second part – Do real estate prices fall?

Rewind to year 1997..

Read this India Today Article Real estate business in india faces unprecedented crisis as prices plummets

Real estate price crashes are pretty common across the world – Japan in 1990, US in 2007 etc. As seen in the above article even Indian real estate saw a sharp price decline during the 1996-2002 period.

“No asset class or investment has the birthright of a high return. An asset is only attractive if it’s priced right.”
― Howard Marks

So lets get our basics right,

Real Estate does not provide high returns at all points in time and can go through periods of decline or long periods of stagnant prices (time correction) !!

Real Estate prices just like any other asset goes through cycles (historically around 14 years with 7 years of high returns + 7 years of low returns according to JP Morgan Research) – there are periods of high returns inevitably followed by low returns.

Source: JP Morgan

The timing of exact turn in the cycle is extremely difficult. However an approximate evaluation of whether we are near the peak or the bottom of the cycle should be possible. Given the fact that real estate investing involves a large capital and significant loan component (at least for most of us), we need to be extremely careful and it is important to ensure that we are buying at the right price (read as valuation).

So, how do we go about evaluating if the prices are right ??

I will be using the Chennai market as an example. Given that Real estate markets are highly localized, you may apply the same framework for your respective location.

The first task is to make sure we are not caught near the peak of the cycle. But, how??

Test 1: Invert !!

The great 19th century mathematician Carl Jacobi was fond of saying that when you encounter a tough problem, “Invert, always invert.” So let us invert our problem and start with asking a simple question “What returns do we expect from our real estate investment?”

Going by the last 8 years, a lot of us would expect Chennai real estate to repeat the same 17% annualised returns. Let us invert this and see if this is possible.

A decent 2 BHK, 1200 sq ft apartment within the city would easily cost anywhere between 1 to 2 cr based on the locality. Hypothetically  assuming you get an 20 year EMI for the entire amount (generally loans are provided only for a portion – around 80% of the house cost), at the current rate of 9.6% (Source: Bank Bazaar Link) it works out to approximately 94,000 to 1,88,000 every month. Assuming you require a salary that is at least twice your EMI amount and thus you must be earning at least 1.8 lakhs to 3.7 lakhs per month to buy a decent house within the city !!

Now assuming we want our property to appreciate by 17% for the next 20 years, this implies the price should multiply by 23 times or in other words a house worth 1-2 cr should become 23-46 cr. And for someone to buy it after 20 years, the EMI at the current 9.6% would work out to be 21-43 lakhs per month. Thus the buyer’s salary must be around 43-86 lakhs per month after 20 years !!!

A similar calculation at:

  • 15% return expectation, works to a monthly salary requirement of Rs 30 to 61 lakhs
  • 12% return expectation, works to a monthly salary requirement of Rs 18 to 36 lakhs
  • 10% return expectation, works to a monthly salary requirement of Rs 12 to 25 lakhs
  • 8% return expectation, works to a  monthly salary requirement of Rs 8 to 17 lakhs

My head is already spinning.. Now don’t ask me what is the right price. But one thing clearly stares at our face. Real Estate prices in the long run must be a reflection of aggregate salary growth. The future salaries required to justify current chennai real estate prices look a little too unrealistic in my opinion. The past glory days of 15% plus returns in Chennai real estate look highly unlikely unless there is a new industry like IT which can manage to employ a lot of us and pay exorbitant salaries !!

Test 2: Rental Yields vs Home Loan Rates

One of the simple ways to evaluate if the property you are buying is reasonable or expensive is to compare the rental yields with home loan interest rates. Rental yield refers to the annual rent received from a property as a % of the total price of the property. Property price market is an illiquid market where generally the sellers in case of correction do not sell and mostly postpone their selling decision. Further even the real estate builders tend to not reduce prices even if demand is weak and try to wait out the period by getting support from banks who lend to them. Add to it the component of black money involved, the prices in real estate in India do not exactly respond to the economics of demand and supply as seen in other asset classes. However the rental market in comparison, is a lot more dynamic as tenants can easily shift between houses and hence responds to the demand scenario in a much better manner. Generally, in a fairly priced real estate market, the rental yield tends to be somewhere close to the cost of borrowing. Thus comparing the gap between the rental yield and home loan rates provides a good way to evaluate if real estate is cheap or expensive

 Chart1

Chart2

Source:
http://reports.ambitcapital.com/reports/Ambit_Economy_Thematic_RealEstate_14Jul2015.pdf
http://www.globalpropertyguide.com/Asia/rent-yields

Now the above data is from a Jul-2015 report. Applying current home loan rates of 9.6% and rental yields of around 2.5 % (I am taking my current rented place yield. Generally the range is between 2-4%) the gap works out to be ~7% which is pretty expensive compared to other global markets where the range is around 2-3%. So either rental yields should go up or home loan rates should come down or a combination of both should happen for real estate prices to become attractive.

In India, we also enjoy tax benefits* on home loans and hence adjusting for them, a simple rule of thumb can be:
Buy: when home loan interest rate – rental yield < 4 to 5%
Sell: when home loan interest rate – rental yield > 7%

Thus applying this metric, again the verdict is – Real Estate in Chennai is expensive

*To understand in detail the tax benefits in a home loan read the following article http://emicalculator.net/understanding-tax-benefits-on-home-loan-updated

Test 3: If last 7-8 year returns are damn good then be cautious 

Again, Chennai Real Estate has had phenomenal returns in the last 7-8 years . Caution !!

Test 4: If everyone says real estate will always go up and come up with their own stories of how they multiplied their money in the last few years – Your danger signalling siren should be at its loudest !!

In Chennai markets, the siren is still loud enough…

Phew a long post. But, nevertheless let me sum it up

  • Real Estate Investing Returns = Rental Yield + Price Appreciation
  • Real Estate Prices aren’t destined to go up always and can fall or go through long periods of time correction
  • Real Estate just like any other asset class goes through cycles – periods of high returns followed by low returns
  • When buying a property:
    • Evaluate future affordability by applying “inversion”
    • Evaluate “Rental Yield vs Home Loan Rates” – Buy when its less than 4-5% and sell when it is above 7%
    • If past 7-8Y returns are very high, then be cautious
    • Add to it, if everyone is gung ho on real estate, then be extra cautious
  • Verdict on Chennai Real Estate – looks damn expensive – need to be extremely cautious 

 

P.S:
Being from the financial industry, there is a natural bias built within me against real estate.While I have tried to be as rational as possible, I may have missed out on some perspectives given my biases. If you think I have missed out something or don’t agree with my thoughts, please feel free to share your thoughts in the comment section. I am consciously on the lookout for contradicting evidence and would love to be wrong !! Thanks for dropping by and happy investing 🙂

Why the odds are against you when it comes to good financial advice

All of us are regularly making decisions of varying degree of importance, for most part of our lives. This may include serious ones like how to improve sales in your company, buying a new house, evaluating a new job etc to day to day ones like which route to take, which restaurant for dinner etc. While simple decisions don’t require much of an effort as the stakes are pretty low, however in situations where the stakes are high, the decisions that we take, need to be taken after some reasonable analysis.

Though the situations and problems will be different, if we can develop a set of thinking tools which we can apply selectively to various problems, it would help us to improve our decisions dramatically. In essence, you don’t want to start a bike repair shop with only one spanner, you essentially want to have various tools which you can use based on the nature of problem in the bike.

So with the same premise, we are going to slowly build our own mental tool kit which will help us both in our day to day lives and investing. Our first tool that we will be adding to our mental tool kit is called “Incentives”

Most of economics can be summarized in four words: “People respond to incentives.”  The rest is commentary. – Steven E Landsburg

The basic idea is to ask the simple question “What’s in it for the fellow on the other side of the table”

Let’s apply this simple question to the financial industry and investing.

Most of us or someone in our family would definitely have an investment linked insurance product sold to us. But when it comes to mutual funds, most of us have hardly heard about them, leave alone buying them. Intuitively, our first line of reasoning goes – a better product gets more popular and hence insurance products must be better than mutual funds. But if you have held on to any investment linked insurance product (except for pure term insurance which in my honest opinion is the only decent product in the insurance industry) for more than 5 years and you do the calculation for returns, you realize the sad truth 😦

But what explains their popularity ??

You guessed it right. Incentives !!

When you are sold a mutual fund, the distributor commission is generally around 1% for equity mutual funds and around 0.5% for debt funds. So if you invest Rs 1 lakh in an equity mutual fund, your advisor will make just Rs 1,000 for the entire year.

But when you sell an investment linked insurance product, the first year commissions (including rewards) can be as high as 49% (see the below chart). So if your premium is Rs 1,00,000 then upto Rs 49,000 may go into the pockets of your agent or the bank. Then,the charges are capped at 7.5% of the premium till the 5th year and thereafter it is 5% of the premium. If you had a heart attack looking at this, hang on, these charges were even more exorbitant a few years back and the current rates are post the regulatory intervention putting a cap on the charges. You can imagine the “gala” times that your friendly insurance agent had those days.

You can see below the maximum commission charges for various plans and tenures. (Link)

Source: http://www.livemint.com/Money/AbOyobTzU0KrpbTSGEpysM/How-to-grab-70-of-a-premium.html

This has led to significant mis-selling in investment based insurance products. Since the incentives are front loaded the focus is on churning your insurance products given the high 1 st year commissions. This behavior is evident as seen from the low persistence of holding an insurance product beyond 5 years. Refer to this article for a detailed explanation  (Link)

Excerpts from the article,

“According to figures of financial year 2015, as reported by the insurance regulator in its handbook of statistics, the industry, on an average, reported a persistency of 59% in the 13th month, i.e., after a year of sale. In other words, out of 100, just 59 policies got renewed. In fact, the average persistency for the 61st month is about 22%, which means by the end of the fifth year, only 22 policies got renewed.

India compares badly with the rest of the world. The 13th month persistency in member countries of Organisation for Economic Co-operation and Development is above 90% and about 65% for the 61st month.”

Source: http://www.livemint.com/Money/wkeodGRDFxDjPYP3TtSWGJ/Life-insurers-selling-policies-that-die-early.html

This is a clear case of how incentives of our friendly insurance agent which are not aligned to our interests generally leads to a bad investing experience.

Quick take away:
At the current juncture, given the opaque cost structure, just-about-average investment managers who manage our money and not-in-our-favour commission structure avoid any insurance product which promises returns. Don’t confuse an insurance product with investments. If you need insurance, opt for pure term insurance which promise no investment returns but provide the insured value in case of your death within the term.

So, now let us assume you are just about 2-3 years into your career and you decide to save around 10,000 per month. Mutual funds are perhaps one of the best investment vehicle available for you (given their low costs, simple structure, high transparency, investor friendly regulator and the presence of seasoned fund managers). But you hardly have any knowledge on the markets and wish to work with an advisor. As you are relatively inexperienced, you also have a lot of queries and often get shit scared when markets go down. This means an advisor will also have to spend a lot of time hand holding you, meeting you, explaining to you about markets and stopping you from making hasty decisions. You would also like to meet your advisor regularly every month and discuss your various financial plans and queries. On top of it you are averse to paying your advisor. After all who pays for financial advice in India. We get it free of cost from our beloved news channels and friends 😦

So the advisor has to work on the wafer thin commissions that the mutual fund pays him which is approx 1% for distributing their funds. If your SIP is 100% equity, then the advisor gets around 1% of 1,20,000  (i.e 10,000 * 12) and it works out to Rs 1,200 !! Yup you read it right ..Lets assume the advisor remains patient and works with you for 5 years and your SIP of 10,000 each month has compounded at 15% and has increased to a value of Rs 9 lakhs. And how much does your advisor get paid for all this effort, honesty and persistence.. Rs 9000 !! Add to it the risk that the % of commission might further reduce after 5 years.

I hope you get the picture. Now you know why those lousy insurance products get sold to you (why in the world would anyone let go of an opportunity to make 30% plus 1st year commissions..to hell with long term client relationship). Did mutual funds not have a problem of incentives. Of course they did. The recent selling of closed ended funds (which had one time commissions which went as high as 7%) is a classic case. But the difference is you have an extremely investor friendly regulator by the name SEBI who regularly keeps a check on any possible investor unfriendly activities. While in insurance, the regulator IRDA continues to have its eyes closed on the high commission driven insurance sales.

For a good advisor, it generally makes sense to cater to larger clients where the efforts and time spent, while is the same as spent on a small client, provides him with a far better remuneration (a 1 cr client, with a 50% in equity and 50% in debt would provide an income of around Rs 75,000 per year)

So they key implication, is that if you are a small investor its extremely difficult to get decent and honest advice. 

Now given this practical reality, the safest choice for all of us is to educate ourselves on the bare minimal basics of investing. Sounds boring. But think about this, in a career spanning 38 years from the age of 22 to 60, you end up working approx 79,000 hours in exchange for all the money you make. Don’t you think should spend just about 2 hours a month, which works out to just 1% of your overall work hours, on making your money work equally hard as you.

“Give me six hours to chop down a tree and I will spend the first four sharpening the axe.”  – Abraham Lincoln

This blog is a small attempt from my part to ensure that all of us get good financial advice, and hopefully have a reasonably good investing experience. (intelligent folks should interpret these lines as shameless marketing 🙂 )

Now for those of us for whom investing sounds like greek and latin, and that’s the last thing on which you want to spend your well earned free time, don’t worry, all is not lost. To your rescue comes the new breed of online based advisors called robo advisors (Eg Scripbox, Arthayantra, Advicesure, Fundsindia etc) which are slowly gaining popularity. These guys provide advice through apps/websites with bare minimal human intervention and address the main issue of cost to service us, as most of the investment advice is standardized and can be easily scaled (think of uber, airbnb etc). While this is still at an initial stage and most of them are very basic, my sense is that in another 2-3 years we will have some really solid and evolved online advisory models for people like us. Till then let’s keep learning !!

Summary

  • Keep an eye on incentives – Always ask what’s in it for the guy on the other side
  • Investment-linked-Insurance products are injurious to your financial health
  • Tough to find good financial advice for small investors – the incentives for advisors are tilted towards the larger investors
  • Invest in improving your investing knowledge – no two ways about it !!
  • Robo-Advisors, while currently at a nascent stage, may be the solution to decent financial advice for small investors in the coming years

 

Equity Investing – Just 2 things to remember

In our previous two posts, we had covered in detail, the two key factors to evaluate when investing in equities. In case you haven’t read them, do take some time out to read them here – Link 1  Link 2

Now for those who don’t have the time and would like a “no-nonsense” summary of those posts, hang on, this post is just for you folks !!

Quick Summary

  1. Equity market returns are driven by
    • Earnings growth
    • Increase or decrease in Valuations
    • Dividends (In India, this component is not too significant and adds to around 1 to 1.5% additional returns for the Sensex annually)
  2. Earnings growth and Valuations are cyclical
  3. Earnings growth is the key determinant of long term equity returns
  4. So always evaluate which part of the cycle are we in terms of earnings growth
  5. Valuations = weighted average market opinion on the value of companies
  6. Valuations are a key contributor to the short term volatility seen in equity markets
  7. Evaluate if valuations are expensive, cheap or neutral (degree of difference with the long term average – ~15-16 times 1Y forward PE for Sensex)
  8. Do this evaluation once in 3 months
  9. Based on your evaluation, decide on whether you have to adjust your overall allocation to equities within your portfolio


Musing no 1: Stock prices are slaves of earnings growth in the long run !

Now to understand the role of earnings growth and stock prices better, lets take the help of investor Ralph Wanger who has come up with an interesting analogy between the stock market and a man walking a dog.

“There’s an excitable dog on a very long leash in New York City, darting randomly in every direction. The dog’s owner is walking from Columbus Circle, through Central Park, to the Metropolitan Museum. At any one moment, there is no predicting which way the pooch will lurch. But in the long run, you know he’s heading northeast at an average speed of three miles per hour. What is astonishing is that almost all of the dog watchers, big and small, seem to have their eye on the dog, and not the owner.”

The dog in our case is the stock price and the owners walking speed and direction is the earnings growth !!

Earnings vs Valuations

Musing no 2: Starting Valuations matter !

While earnings growth is the dominant driver of equity returns over a long investment horizon (let’s say >5 years), the starting valuations also play an important role as an increase in valuations can provide additional returns over and above earnings growth and vice versa. Generally valuations tend to revert to their long term averages . Think of valuations as tied to a pole called “long term average” with a rubber band. The farther away the current valuations of the market moves away from long term averages the higher is the force from the rubber band to bring them closer to the long term averages.The mean reversion effects of valuation have a significant impact on the overall returns in the near term and gets gradually evened out in the long term.

Starting Valuations = Low
Mean reversion in valuations will provide additional returns over and above earnings growth

Starting Valuations = High
Above normal earnings growth & Long investment time frame needed to nullify the impact of mean reversion in valuations

In order to appreciate the impact of starting valuations, I have calculated the annualized return impact over different time horizons due to valuations returning  to their average ( 16 times 1Y Fwd PE) assuming no contribution from earnings growth (i.e assuming it to be 0%)

Valuation Kicker

As seen above, higher starting valuations have a significant impact over returns in the short term if they were to mean revert (which is most often the case). For eg if you had invested at 24 times PE and it mean reverts to 16 times in 5 years it would have provided ~negative 8% annualised impact on the overall returns (read as earnings growth). Long investment time frames & above normal growth are required to subdue the impact of overvaluation.

Lower starting valuations, provide the potential for significant upside in case of mean reversion. For eg if you had invested at 12 times PE and it mean reverts to 16 times in 5 years it would have provided ~positive 6% annualised impact on the overall returns (read as earnings growth).

Thus summing it up..

  1. Stock prices are slaves of earnings growth in the long run !
  2. Starting Valuations matter !

PS:

For those who are still with me, check out how the actual 10 Year sensex returns have been impacted by earnings growth and valuations

Earnings growth + Valuation IMpact

Source: MOSL