Secure Your Retirement with NPS: Benefits, Tax Savings, and Investment Tips

Mohan N

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January 30, 2025

Introduction

Retirement is a stage of life that comes sooner or later. It is necessary to achieve financial freedom to live a worry-free lifestyle post-retirement. Few people have lifetime pensions guaranteed by the Government. But most of the people work in the private sector. There is widely used products of Employee Provident Fund (EPF) and Employee Pension Scheme (EPS), but this did not fill the gap. To address this need National Pension System (NPS) was launched by the Government. The National Pension System is a robust, government-backed scheme designed to provide long-term financial security among the various investment options available.

Understanding the National Pension System (NPS)

NPS is a voluntary, defined-contribution retirement savings plan. Voluntary, so that one can save any amount at their comfortable frequency. Defined contribution means, your final corpus will depend upon your contribution and returns over the years. The aims was to regularly contribute to a retirement corpus.

Key Features of NPS

Dual Account Structure: A tier-I account is a basic NPS account, which comes with specific rules of contributions, lock-in, and tax deductions. Withdrawal, etc. It is a mandatory account for NPS subscribers. Tier-II accounts is optional for NPS subscribers. It is a voluntary account that allows you to contribute and withdraw funds without restrictions.

Investment Flexibility: NPS offers a lot of flexibility regarding contributions, investments, and withdrawals. You can design your portfolio by allocating between equity (Class E), corporate debt (Class C), government securities (Class G), and alternative investment funds (Class A), depending upon your risk appetite and return expectations. 10 pension fund managers manage investments of NPS subscribers. These fund managers are Aditya Birla Sun Life, Axis, HDFC, ICICI, Kotak Mahindra, LIC, Max Life, SBI, Tata, and UTI Retirement. One can choose any of the fund managers. You can also change the fund manager if you find their performance not sufficient.

Regulated Framework: NPS works under a regulated framework. It is managed by the Pension Fund Regulatory and Development Authority (PFRDA).

How NPS Works

You need to contribute regularly till your retirement. During this period your funds grow depending upon your asset allocation. Upon retirement, 60% of the corpus is allowed to be withdrawn as a lumpsum amount, while 40% of the corpus will be compulsorily used to purchase an annuity for a pension amount.

Benefits of NPS for Retirement Planning

The NPS offers various of benefits and this makes it a top choice for investors. Let’s explore its advantages in detail.

Tax Benefits Under NPS

After the launch of the NPS scheme, it did not pick up initially. But once the Government added tax saving benefit with NPS, it took not much time to become popular. Now tax efficiency of NPS is one of the most attractive features. Contributions to NPS are eligible for tax deductions under:

Section 80CCD: You can claim up to ₹1.5 lakh per annum as part of the overall 80C limit.
Section 80CCD(1B): An additional deduction of ₹50,000 is exclusively available for NPS contributions. This is applicable for old tax regime only.
This means you can save up to ₹2 lakh annually, making it a tax-saving powerhouse for retirement planning.
Section 80CCD(2): Contribution made by employer towards NPS is tax deductible. This is applicable to both old and new tax regimes.

Flexible Investment Options

NPS offers two investment modes:

Active Choice: You can manually allocate a percentage of funds to be invested between equity, corporate bonds, and government securities. Once you set the allocation, your contribution will get automatically invested. You can also change the allocation.
Auto Choice: Your funds are allocated automatically based on your age, following a predefined lifecycle fund. In this more allocation is towards equity at young age, while the allocation towards equity is lesser when retirement comes to closure.

This flexibility helps investors tailor their portfolios based on their risk tolerance and financial goals.

Compounding Effect for Long-Term Growth

NPS leverages the power of compounding, as your funds are invested for long term at very low fee. Funds are allocated automatically. Any returns from dividends are reinvested to generate additional earnings. So dividends are also tax-free. If you can start early and contribute consistently, it will lead to substantial growth in your retirement corpus.

Portable and Inclusive Nature of NPS

Portability is one of the special features of NPS. You will have same NPS number, even if you change job or change place. NPS is also inclusive. Anybody can open NPS account, whether you are salaried, self-employed or a homemaker. Recently, the Government has launched NPS Vatsalya, wherein parents can open NPS for their kids, which can be handed over to kids, once they become adults.

What did I learn from Recent Stock Market Crash…

Mohan N

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January 20, 2025

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What did I learn from Recent Stock Market Crash…

The stock market has been on the roll since COVID-19. The winning spree is so long that everybody becomes a financial influencer. They thought that they had cracked the code. People started thinking that too much money could be made in the stock market in the short term. There has been a new breed of traders who have become social media stars. They show their trading P&L and entice people to join their course.

When there is too much exuberance, there is only one thing certain. Crash… The question is not, if a crash will happen. The question is when and how much?

Looking at my friends, who were making a killing in trading, I also got carried away. I started thinking, if these people with average intelligence can make good money by reading charts, why can’t I? So I tried my hands.

My earlier attempts at trading were pretty bad, so this time I was cautious. After watching several videos, I thought of trying hands in ETF trading first. Considering ETF as a zero risk option (as these YouTube influencers say…), I learned several strategies by watching YouTube videos. Then decided to use a rotation strategy. The strategy was pretty simple. Investing in top 10 ETFs. Book profit as soon as 3% gains are achieved. Then reinvest in another ETF. If ETF drops more than 3%, then invest again in the same ETF to average out.

For the initial few months, the strategy was profitable. Since I was putting smaller amounts, the profits were also smaller. My plan was to increase the bet size, once I achieved a certain degree of confidence.

Then came October 2024 and stock market started falling every day, like crazy. For the initial few days, I was ecstatic, as I was getting ETFs at cheaper value (as they say…). So I slowly invested to average out. But when the market kept on falling, I stopped investing. Needless to say, I was out of money.

In October month, the market fell by about 10%. My portfolio of ETFs fell even higher. Now I have the first-hand learning of investing in risky securities. I used to think I could bear a 10%-20% fall in the market without getting emotional. It is easier said than done. How can you keep calm when you see your portfolio falling every day? If you keep a daily watch on the stock market and your portfolio, you will be automatically pushed to take some action. This is called emotional instability.

One needs to have a sage-like mentality or mental conditioning of keeping calm and not reacting, even after seeing a bloodbath in the market every day.

Another issue was keeping a very low emergency fund. My take was to remain invested in equity so as to take benefit of rising market rather than keeping money in fixed deposit and earning below-inflation returns. So, I needed money immediately for some urgent work. And I had to sell a part of my investments at a loss. Though it was very small part of the investment. Still, it was quite painful to liquidate investments at a loss.

My learnings:

Trading is not for me. Stop trading in ETFs
Invest in mutual fund index funds. These vehicles avoid quick buying and selling. They keep your mind in check for emotional control.
Keep a good amount of emergency funds. The ideal recommendation is to keep a 6-month emergency fund. I will start from 2-3 months.
We always overestimate our ability to withstand notional losses.
Finally, do not sell. Remember, Stock market is voting machine in short term and weighing machine in long term.

Happy Investing.

Mutual Fund 101: Know Everything About Mutual Fund Investing

Investing

Mohan N

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December 1, 2024

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Mutual Fund 101: Know Everything About Mutual Fund Investing

Mutual funds are becoming increasingly popular as a starting point for investors. In addition, many people are familiar with mutual funds as a result of various campaigns and investor education initiatives.

According to a recent Computer Age Management Services (CAMS) report, young people increasingly choose to invest in mutual funds. So, if you’re a new investor looking to learn the fundamentals of mutual funds, this article will help.

What is a mutual fund?

Mutual funds are pools of investor money. Fund managers invest this money in various financial instruments, including stocks, bonds, gold, government securities, and other asset classes.

These are managed by experienced financial professionals known as fund managers, who allocate money to various asset classes based on the fund’s objectives. These fund managers are also responsible for making decisions about when and where to invest.

How do mutual funds work?

Before we get into the details of how a mutual fund works, you should first understand what NAV is. The NAV is the price at which you can buy or redeem your mutual fund investments.

Here is a quick example. Suppose you invest Rs 1,000 in a mutual fund scheme with a NAV of Rs 10. Then you will be allocated 100 units of the fund.

Remember that the NAV of a mutual fund fluctuates on a daily basis depending on the fund’s underlying assets. If a fund’s underlying asset performs well, the NAV will increase, and vice versa.

So, based on the preceding example, if your mutual fund’s NAV rises to Rs 20, your 100 units will be worth Rs 2,000 (100 units x Rs 20). If you redeem your units, you will receive Rs 2,000 in exchange for your initial investment of Rs 1000.

Historically, equity markets have provided a net positive return that outperformed inflation, resulting in true wealth compounding. Although fixed deposits (FDs) are still very popular, even the best FD cannot compete with mutual funds. Mutual funds have been able to generate returns ranging from 12 to 15% over the last 10-20 years.

So, if you invest in an equity mutual fund and stay invested for a long time, you can multiply your money several times and thus accumulate wealth.

What are the categories of mutual funds?

Mutual funds can be classified based on a variety of criteria. For example, depending on whether a fund is managed by a manager, it can be divided into two broad categories.

Actively managed funds

These funds are overseen by an experienced fund manager. These managers are experts in market analysis and research. They create a strategy for these funds that allows them to outperform the returns of a specific index.

Passively managed funds

These funds are not overseen by a fund manager. Instead, they are intended to follow an index. Sub-categories include Exchange Traded Funds (ETFs), Index Funds, and even Funds of Funds (FoFs).

Similarly, mutual funds can be classified into two types based on entry and exit restrictions.

These funds invest approximately 65% of their assets in various stocks. While these funds can provide higher returns, they also carry more risk. There are several types of equity mutual funds

Open-ended funds allow you to sell and buy units at any time.

Closed-ended funds allow for unit purchases only during their initial launch. When these mutual funds mature, you will be able to withdraw the amount invested.

Mutual funds can also be classified according to their investment objectives and underlying securities. Let’s look at each type of fund.

Equity mutual funds

1. Large-cap funds invest approximately 80% of their assets in large-cap stocks.

2. Mid-cap funds invest approximately 65% of their assets in mid-cap stocks.

3. Small-cap funds invest approximately 65% of their assets in small-cap stocks.

4. Equity Linked Saving Schemes (ELSS) are tax-saving equity mutual funds that invest approximately 80% of their assets in stocks. ELSS schemes have a three-year lock-in period from the date you invest. With your ELSS investments, you can enjoy tax benefits under Section 80C of the Income Tax Act.

5. Multi-cap funds have freedom in investment in different market cap companies. These invest at least 75% of their assets in stocks.

6. Index funds track a specific index and invest in companies within that index. For example, if you invest in an index fund that tracks the Sensex, your money will be allocated to the same companies as the Sensex, in the same proportion. These funds aim to closely replicate the returns of their underlying indices. Unlike other funds, these funds’ operating costs and portfolio turnover are relatively low.

7. International mutual funds invest in companies listed in other countries’ indices. It adds geographical diversity to your portfolio.

Debt mutual funds

Debt mutual funds are low risk funds. These are not affected by market ups and downs. Because these mutual funds invest in fixed income securities such as government bonds, debentures etc. Debt mutual funds can be categorised into several types:

1. Liquid funds invest in treasury bills, commercial papers and certificate of deposits with maturity less than 91 days. Thus, these funds invest in highly liquid securities. Liquid funds can be used for making your emergency funds. But sometimes these funds react sharply in response to changes in interest rates by US Federal Reserve or Reserve Bank of India or similar entities. Overall these are less riskier than equity funds.

2. Short-duration mutual funds invest in a mix of government and private corporate bonds.

3. Overnight funds invest in securities maturing within a day or assets that mature within a day.

4. Hybrid mutual funds invest in combination of debt and equity securities. These are good for investors, as these funds automatically take care of asset allocation between debt and equity. One can invest as per their risk profile in these funds. While equity component of fund provides capital appreciation. Debt component protect down side during bear market. There are various types of hybrid funds:

4.1 Aggressive hybrid funds invest more than 65% of their assets in equity and rest in debt.

4.2 Conservative hybrid funds invest more than 75% of their asset in debt securities and remaining in equity. These have low consistent returns.

4.3 Balanced advantage funds: These are best of both worlds. These keep a balance between equity and debt by adjusting asset allocation as per market situations, minimizing risk while maximising gains.

Commonly used mutual fund terms

Net Asset Value (NAV) is price of one unit of particular mutual fund. It is derived by dividing total fund’s portfolio value by total units.

Asset Management Company (AMC) receives investment from individual investors and invest them in variety of asset classes, depending upon type pf mutual fund.
Assets Under Management (AUM) is the total market value of all the assets, including bonds, securities, and stocks, managed by a fund house on behalf of its investors.

New Fund Offer (NFO) is a subscription offer made by AMC at the time of launching a new fund.
Exchange Traded Fund (ETF) are such mutual fund scheme that tracks the performance of its underlying index such as Nifty50, BSE30, NSE500 etc.
Registrar and Transfer Agents (RTA) helps mutual fund companies in maintaining their records. These also help investors for providing references of their investments.

Systematic Investment Plan (SIP) are such plans that allow investors to invest a fixed sum on a regular basis at a fixed period.
Systematic Transfer Plan (STP) are such plans that allow investors to transfer funds from one mutual fund scheme to another on a regular basis.

Systematic Withdrawal Plan (SWP) are such plans that allows investors to withdraw a fixed sum at regular intervals.

4 Step Framework to Calculate the Money You Need to Retire Today?

Mohan N

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November 2, 2024

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4 Step Framework to Calculate the Money You Need to Retire Today?

A friend (aged 44 years), was fed up with his job. During a discussion, he said that he would retire and never work for anybody if he had enough money to take care of life’s needs. Some discussion followed. But when he was asked, “How much money do you need to retire today?”, he had no specific answer. Because he never thought that way.

If you have also not thought about it, you are not alone. Most people are the same. Most people are aware of the criticality of retirement savings and have put some money away for those golden years. But will that money be enough? If you think of retiring today, like my friend, will the money saved with you be enough for the remaining years?

While it is very difficult to accurately forecast your future spending, a good estimate can be made. This estimate will help us in knowing, how much money would be required for retiring today.

Here is a Four- Step Framework to calculate your retirement fund:

STEP-1: Estimate Your Current Expenses

If you have never done this, it may feel daunting. But it is a simple process. First, gather all your financial statements, such as bank account statements, and credit card statements for last month. Here you can see, where money is going. Now, look for your recurring monthly expenses, like house rent, house mortgage, food (grocery, fruits and vegetables), utilities (electricity, cooking gas, mobile, broadband, etc.), transportation (petrol/ diesel, public transport), kid’s school fee, etc. Remember, these expenses are necessary and you do them every month. These are kind of fixed expenses. For example, say your fixed expenses are INR 70,000 per month.

Then look for discretionary expenses. These are such expenses, which are not necessary for living, but to enjoy life. Such as dining out, coffee shop, shopping, etc. We can say that you have more control over these expenses, in terms of timing and amount of spend. Say these are INR 30,000 per month. Adding fixed and discretionary expenses will give you monthly expenses. So, in our example, it is INR 1,00,000 per month or INR 12,00,000 per year.

Now think about such non-recurring expenses that you do annually or semi-annually. Such as Life Insurance premiums, health insurance premiums, Car insurance premiums, annual maintenance for car etc. Say these are 60,000 per year. Add these to fixed and discretionary expenses. So, your total annual expenses are now INR 12,60,000.

STEP-2: Estimate your Retirement Corpus

Once you have your annual expenses, multiply that by 25 to arrive at a ballpark retirement corpus. As per our example, it will be INR 12,60,000 X 25 = INR 3,15,00,000.

STEP-3: Estimate your Once-in-a-life expenses

Think about once-in-a-lifetime expenses. These can be funds for higher education and then the marriage of your kids. Say you have 2 kids aged 12 and 10 years. Say you estimate higher education expenses of 20,00,000 per kid and marriage expenses of 25,00,000 per kid. That makes your total expenses of 90,00,000. Add this to your retirement corpus. Now your total retirement corpus becomes INR 4,05,00,000 or say INR 4,00,00,000 approx.

STEP-4: Estimating post-retirement monthly income

So, you have INR 4,00,00,000 with you and you decide to retire. Now invest this retirement corpus in such a way that 75% be invested in equity and 25% in debt. For equity investment, you may choose index funds and for debt, you may choose a mix of liquid funds, bank fixed deposits, and balance advantage funds. Our goal is to achieve at least a 10-11% annual return.

You can start withdrawing 4% annually of STEP-2 corpus of INR 3,15,00,000 i.e. INR 12,60,000 annually i.e. INR 1,05,000 per month.

Every year increase your monthly withdrawal by 5%. So, year 2 monthly withdrawal would be INR 1,15,500 and so on. With 4% withdrawal, your corpus will last at least 25 years (assuming no investment). If you can earn 12% on your investment, while facing inflation of 5-6%, your corpus will last your lifetime.

Conclusion

Using the above four-step framework, you can determine your Retirement Corpus or Financial Independence Corpus. If you find that you are currently not at the stage of Financial Independence, means you are not saving enough money to secure your retirement. Do your best to increase your savings and invest with a target in mind.

Therefore, someone having INR 1,00,000 per month monthly expenses can retire, if he has INR 4,00,00,000 retirement corpus today.

Financial independence means you do not have to work long hours in a stressful job. You can work in less stressful jobs that you may enjoy, even if these may pay less. By doing this you won’t feel like you are working. You can slow down in life and do things, that you have missed such as traveling or just taking an afternoon nap.

The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.

How to Close Your Personal Loan Quickly?

Mohan N

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October 17, 2024

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How to Close Your Personal Loan Quickly?

A friend recently contacted me to help him get a personal loan from my bank. When I asked him, why he required a personal loan, he told me that he had a few personal loans on which the rate of interest is too high. He shared with me the list of personal loans taken by him. I noticed that he has taken 5-6 loans from different banks and NBFCs. We’ll return to his problem, but let’s first understand what a personal loan is. Then we will understand, how to close a personal loan quickly.

A personal loan is an unsecured loan. All bank and non-banking finance companies offer it to meet their customer’s wide-ranging short-term needs. Since the start of digital processing, the borrowings in the personal loan segment have been growing by leaps and bounds. Now few lenders claim to provide a personal loan, in which from application to disbursement of loan is done in few minutes. Due to easy availability and faster processing, many individuals take personal loans for quick financial assistance.

However, it is also important to pay off your personal loan quickly. This helps you save interest and reduce your overall debt so that you can manage your finances effectively. A personal loan is a high-interest loan due to its unsecured nature; therefore, it needs to be repaid faster.

Getting to know your repayment schedule

If you are taking a personal loan, you must have a clear understanding of the repayment schedule. A repayment schedule outlines, how much installment you need to pay monthly and for how long. It gives a clear roadmap, so that you have a clear understanding of, how much you owe.

Prepayment of an additional EMI

At the time of availing a personal loan, please enquire about prepayment terms. Prepayment is the repayment of a loan before it becomes due. As per Reserve Bank of India’s directive, no Bank can charge a prepayment penalty on personal loans and home loans. You must also know, how much minimum amount can be prepaid at once. For example, in ICICI Bank, a minimum prepayment is equivalent to one month’s EMI.

It is one effective way to pay off your personal loans faster. You can decide to prepay additional EMI in every quarter or every year, at your convenience. Prepaying an additional EMI will result in a significant reduction in both the principal and interest. That means you are closer to clearing your loan much ahead of schedule. If repaying an entire extra EMI feels burdensome at every 3 months, you can increase the frequency to every 6 months. For prepayment, plan ahead. Keep on accumulating excess cash. You can keep this excess cash aside to some other account, so it may not be used for regular expenses. You can also keep this additional money as a Fixed Deposit, till the time comes for extra EMI payment.

Take a smaller duration loan

Taking a personal loan of a smaller duration is another effective strategy for faster repayment. Although you have to pay higher EMIs, you will still save significant interest over the life of the debt. For instance, if you are taking a INR 10,00,000 loan at 12% interest, you will save INR 1,40,000 interest for 3-year tenure, as compared to 5-year tenure.

Consolidate multiple loans

If you have multiple personal loans from multiple lenders, it is advisable to consolidate all loans into a single personal loan. It will simplify repayment and you will be saved of missing any payment deadline. Multiple loans could have different interest rates. While consolidating, you can negotiate better terms with new lender. Better terms could be in the form of lower interest rates or longer tenure. Consolidating debt at lower rates or lower tenure will reduce your total debt burden and you can be debt free faster. I will give the same advice to my friend, who had multiple personal loans.

Refinancing at lower interest rates

Personal loans are generally provided at fixed interest rates. However, banks keep on changing interest rates depending on the conditions of the economy. If you find that market rates are significantly lower than your personal loan interest rate, you can negotiate with your bank to reduce interest rate. If the bank does not agree, you can explore refinancing from some other bank. Refinancing involves taking a new loan at better terms to payoff existing loan. By taking a loan at a lower interest rate, you can reduce your EMIs and repay your loan faster. You need to account for processing fees or prepayment penalties before deciding on refinance. Typically, 1% reduction in market interest rates is suitable to look for refinancing.

Avoid any default/ delays on EMIs

Missing an installment on loan repayment affects your credit score. Banks also add penal interest or penalty for defaults or delay in payment. Set up automatic EMI payment (auto debit) in your account for timely repayment. You need to be very careful, while selecting date of auto debit. It must be aligned with cash inflows in your account. Such as, if you are salaried and receive monthly salary on the last date of month, you can keep auto debit within 2-3 days of that, say second or third day of next month.

By paying timely, you can make yourself a good credit profile and avoid any money on penalty on late payments.

Keep a close watch

Keep reviewing personal loans regularly. Keep a track on principal and interest amount being paid. If you receive some unexpected money, use it for making prepayment of personal loan. Remember, even an extra EMI per year makes a lot of difference.

Conclusion

Remember, personal loans are great utility. You can get it faster, without any collateral. Processing is very fast. You can get it in few minutes of application from few lenders. But also note that a personal loan is high-cost and must be used only in exigency. In terms of peaking order, these are only better than credit card loans (Never take credit card loans). Given an option between credit card loan and personal loan, take personal loans. You can use the above-mentioned methods to repay your personal loans faster and save a substantial sum on interest payment. Just be more careful and be a disciplined borrower.

NPS Vatsalya: Low Cost Investing for Kids

Mohan N

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October 3, 2024

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NPS Vatsalya: Low Cost Investing for Kids

NPS Vatsalya is the central government’s new pension plan for children, which Finance Minister Nirmala Sitharaman recently launched. Finance Minister N. Sitharaman announced the Scheme in the Union Budget 2024-25. NPS Vatsalya is a plan for contribution by parents and guardians for minors. It is billed as the government’s “commitment to promote early start in securing children’s financial future”. The scheme will initiate minor subscribers into the scheme with Permanent Retirement Account Number (PRAN) cards.

NPS Vatsalya will allow parents to save for their children’s future by investing in a pension account and ensure long-term wealth with the power of compounding.

The Scheme offers flexible investment options, allowing parents and guardians to make contributions of ₹ 1,000 annually in the child’s name. This makes the scheme accessible to families from all economic backgrounds. When the child reaches age of majority, the plan can be converted seamlessly into a normal NPS account. This new initiative is designed to start early in securing children’s financial future, marking an important step in India’s pension system.

The NPS Vatsalya Scheme will be run under the Pension Fund Regulatory and Development Authority (PFRDA).

The scheme has already attracted significant interest, with 9,705 minor subscribers enrolling on launch day, according to a statement from the Pension Fund Regulatory and Development Authority (PFRDA).

Documentation required

To open an NPS Vatsalya account, the following documents are required:

PAN of the Guardian: The PAN of the parent or legal guardian is mandatory, while a PAN for the minor is not required.

Identity proof: Valid ID for the guardian.

Proof of age: Birth certificate or any government-issued document showing the child’s age.

Taxability

At present, there is no declaration from government to make it tax free. So no tax benefits available to parents. Tax benefits are generally available to a person, when investment is done in his/ her name. We need to wait till government comes up with another clarification. Once the child turns 18, the NPS Vatsalya account will be shifted to NPS Tier-I account. Once the child becomes tax payer, he/ she can avail tax benefits.

Transitioning to an adult account

When a minor turns 18, their NPS Vatsalya account will automatically convert into a regular NPS account. The subscriber will have to complete the KYC process for the same. This process can be completed online and the subscriber need not visit the points of presence (PoP). The schemes for NPS Vatsalya and regular NPS are the same. On shifting the account to regular NPS, the asset allocation will remain the same, and the subscriber will be able to change it, if required, under the norms of regular NPS.

At 18, investors can either withdraw a portion of their corpus or use it to purchase an annuity.

Currently, most of the parents buy Child Insurance plans. But these are low-return plans with bad insurance coverage. NPS Vatsalya will provide another avenue for parents who want to save money for their kids. Higher equity investment option will give market returns as the money will be locked for longer term.

However, only time will tell the acceptance of such a scheme among the masses.

Warren Buffett: Seven Rules for Successful Investing

Investing

Mohan N

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March 7, 2024

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Warren Buffett: Seven Rules for Successful Investing

Warren Buffett is known as a legendary investor. He is the greatest investor of all time. He earned consistent returns from his investment, which seems unrealistic, but true. Every investor wants to know, how did he do this. Warren himself explained that sticking to a few key principles over long term is key to successful investing. These rules can be implemented in everyday life. Here are seven rules of Warren Buffett, revealed by him during a lecture, which can make us better investors.

Intelligence, Initiative, and Integrity

Warren says – “We look for intelligence, initiative or energy, and integrity when hiring people. If somebody does not have integrity, then the first two will kill you. Because if you hire someone without integrity, you want them dumb and lazy. You don’t want them smart and energetic.”

Thus an investor must look to invest at those companies, that are run by people of integrity. Obviously, the first two are important, but integrity is a non-negotiable principle.

Always look at facts, not emotions

Warren says – “Investors behave in very human ways, which is they get very excited during bull markets and they look in the rearview mirror and they say, I made money last year, I want to make more money this year. So this time I will borrow. So when In view in the rearview mirror, a lot of money has been made in the last few years. They plow in and they just push and push up prices and when they look in the rearview mirror, and they see no money having been made, they just say, “ This is a lousy place to be”, So they don’t care what is going on in the underlying business. It is astounding but that makes for a huge opportunity.”

Typical investors get influenced by the bull run or bear phase. The correct ways to focus on the underlying business, irrespective of market sentiments.

Buy Wonderful Businesses at fair prices, not Cigar Butts

Warren says – “I have been taught by Ben Graham to buy things on a quantitative basis. Look around for things that are cheap. That was taught in 1940s or 1950s. It made a big impression on me. So I went around looking for what I call “Used Cigar Butt” of stocks. The Cigar Butt approach of buying stock is that you walk down the street and you are looking around for cigar butts and you find that on the street this terrible looking soggy, ugly looking cigar, one puff left in it. But you pick it up and you get one puff and throw it away. Disgusting, but it is free. I mean it is cheap. And then you look around for another soggy one puff cigarette. That’s what I did for years. But it is a mistake. Although you make money doing it but you can’t make it with big money. It is so much easier to buy wonderful businesses. So now I would rather buy a wonderful business at affair price than a fair business at wonderful price.”

Crappy businesses are unpredictable. There is a very low probability of making money by investing in such businesses. It is always better to invest in wonderful companies at a fair valuation.

Buy only those stocks, that you understand

Warren says – “I have an old-fashioned belief that I can only expect to make money on things that I understand and when I say understand, I do not mean to understand, what the product does or anything like that. I mean, I understand what the economics of the business look like 10 years from now or 20 years from now. I know in general what the economics will say, Wrigley’s chewing gum will look like 10 years from now. The internet is not going to change the the way, people chew gum. It is not going to change, which gum they chew. If you own the chewing gum market in a big way and if you have got Doublemint, Spearmint and Juicyfruit, those brand would be there 10 years from now on. I can’t pin point exactly, what the numbers going to be look like, but will not be way off, if I try to look forward on something like that. Evaluating that company is within what I call “ my circle of competence”. I understand what they do, I understand the economics of it, I understand the competitive aspects of business.”

Finding your circle of competence and investing around it will increase the probability of success in investing. One can understand the economics behind such businesses and can see 20 years from now in such businesses.

Avoid missing the opportunities

Warren says – “The biggest mistake we have made by far of mistakes of omission, not commission. It means, things, I knew enough to do. They were within my circle of competence. Still, I passed up the opportunity. I probably cost Berkshire at least USD 5 billion. For example 20 years ago, when Fannie Mae was having some troubles and we could have bought the whole company for practically nothing. I don’t worry about that if it is Microsoft, because Microsoft isn’t my circle of competence. But I did know enough to understand Fannie Mae and I blew it. Those were the big mistakes and I have got plenty of them. Big opportunities in life have to be seized. We do not do so many things, but when we get a chance to do something, that is right and big, we’ve got to do it. And even doing it a small scale is almost not doing it at all. You really got to grab them, when they come. Because you are not going to get 500 great opportunities. You would be better off, when you got out of school and you got a punch card with 20 punches on it and every big financial decision you made, you used up a punch, you’d get very rich because you’d think through very hard in making each decision. If you go to a cocktail party and someone talking about a company, he made money on that last week, you would not buy it, if you had only 20 punches on the card.”

Always think very hard before making an investing decision. Always look out for good investing opportunities.

When to sell?

Warren says – “We are not going to sell our wholly owned business, no matter how much somebody offers us. If somebody offers 3 times, what somebody is worth, we are not going to sell it. I may be wrong in having that approach. But selling one would be like selling one of my children, because somebody waived a big cheque. If we are short of funds and some opportunity comes, we might have a somewhat different approach. But our inclination is not to sell things unless we get really discouraged perhaps with management or we think that the economic characteristics of the business change in a big way. And that happens. So we are not going to sell simply because it looks too high, in all likelihood.”

Stay invested for long term. Sell only when business economics changes and does not support your long-term views.

How does Warren find intrinsic value in a company…

Warren says – “Intrinsic value is the number that if you were all knowing about the future and could predict all the cash that a business would give you between now and the judgment day, discounted at a proper discount rate, that number is what the intrinsic value of a business is. In other words the only reason for making an investment and laying out money now is to get more money later on, right? That’s what investing is all about. Now when you look at a stock, when you look at a bond, assuming it is a United States Government Bond, It is very easy to tell, what you are gonna get back. It says when you get the interest payments, it says when you get the principal. So it is very easy to figure out the value of a bond. It can change tomorrow if interest rates change. The cash flows are printed on the bond. But cash flows are not printed on stock certificate. That is the job of analyst to print out change that stock certificate , which represents an interest in the business and change that into a bond and say, this is what I think, it’s going to payout in future. If you buy Coca Cola today, the company is selling at $110-115 billion in the market. If you had $110-115 billion, the question is “ would you lay it out today, to get what the Coca Cola company is going to deliver to you over the next 200-300 years. The discount rate does make much difference after, as you get further out. And that is a question, how much cash they are going to give you. It is true if you are buying a farm or an apartment or oil in the ground, any financial asset. You are laying out cash now to get more cash back later on. And the question is how much you are going to get? When are you going to get it? And How sure are you? When I calculate intrinsic value of a business, whether we are buying all of a business or a little piece of a business, I always think, we are buying the whole business, because that’s may approach to it. I look at it and say, what will come out of this business and when? What you really like of course is then to be able to use the money, they earn and earn higher return on it, as you go along. I mean Berkshire has never distributed anything to its shareholders, but its ability to distribute goes up, as the value of business we own increases. We can compound it internally. So if you can’t answer this question, you can’t buy the stock.”

Intrinsic value is the present value of future cash flow, discounted at an appropriate discount rate. It is not very complex to estimate long-term cash flows of a simple and predictable business.

How to Create a Retirement Corpus, that last your Lifetime?

Retirement

Mohan N

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January 21, 2024

1

How to Create a Retirement Corpus, that last your Lifetime?

If you do not have a guaranteed pension for life, your biggest fear of retirement may be “What if the money does not last for life”. So, it is necessary to have a plan in advance for retirement years.

During a normal discussion on personal finances, Amit told Mohan that though he is saving for retirement, which is far away. Still, he does not know, how many years of retirement you should plan for. It is very difficult to look at 20-30 years of retirement. What if, saved money would not be sufficient for life, given the inflation?

This question is generally very difficult to answer because you do not know, how long you will live. Still, you can estimate the years of retirement and then you can chalk out a plan.

Estimating years of Retirement

Though it is not easy to accurately predict the number of years in retirement, still you can put in a rough estimate. This estimate could be based on general life expectancy, your present health, medical support systems in your neighborhood, and other factors. I know it is difficult to make such an estimate.

Recently, J. P. Morgan in a study showed that a person has about 83% chance of living till 75, about 50% chance of living till 85, 28% chance of living till 90, 11% chance of living till 95, and 2% chance of living till 100.

Assuming you do not have any life-threatening health issues, you can safely say that there are 25-28% chance of living till 90 years. Now you can plan around this estimated life.

You also need to decide about the age of retirement. Say, if you retire at the age of 55 years, you need to plan for 35 years of retirement (till the age of 90).

Estimating Retirement Corpus

You will need money to support you for about 35 years (a long time). You need to ensure that money does not run out. 35 years is a long time and inflation may have a critical impact on your plans. There have been several studies, that indicate that if you withdraw 3% to 4% annually from retirement corpus, adjusted for inflation, it will sustain you for your life. This is called the Safe Withdrawal Rate.

If you choose the 4% Safe Withdrawal rate, then you need to multiply your annual expenses by 25 to arrive at an estimated retirement corpus amount. For example, if you need 1 lakh for monthly expenses at retirement, then for 12 lakh annual expenses, 3 crores (12 lakh X 25) would be required in retirement corpus.

In the above example, monthly expenses of 1 lakh are estimated at retirement age. It also means that if you want to retire today with 1 lakh as monthly sustenance expenses, then you would require at least 3 Crores.

But only sustenance expenses are not enough. You also need to account for some big expenses that may fall after retirement, such as higher education of kids, marriage of kids, healthcare expenses, etc. The same needs to be added to arrive at the corpus needed at the time of retirement.

Keep an Eye on Inflation

To avoid the situation, where your corpus may run out, you need to keep a watch on inflation. You may need to adjust your expenses if the remaining corpus seems insufficient. If you are getting an average return of about 8% on your investments, while you withdraw 4% annually, you will have a surplus of 4%. This surplus can be used for additional expenses. If you are generating returns through equity, you need to decide surplus based on 3 years’ returns, because equity markets may also give negative returns in any year.

Keeping Things Simple

Once-a-year review is sufficient for this plan. You can do this on January 1^st or your birthday. Based on returns earned over investments and prevailing inflation, you can decide about the withdrawal amount for next year. You can withdraw the annual expenses and deposit them into a liquid fund. From liquid funds, a Systematic Withdrawal Plan (SWP) instructions will deposit the amount automatically in your bank account monthly.

With proper planning in advance, you can estimate the required corpus amount. The earlier you plan, you will have sufficient time to fund your corpus with savings and investments. Remember, you can not plan for retirement, if it is tomorrow.

Unlocking Wealth by Rs 10000 Monthly SIP for 10 Years

Mohan N

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December 31, 2023

8

Unlocking Wealth by Rs 10000 Monthly SIP for 10 Years

Simplification and ease of doing is the bedrock of financial planning. It is always helpful to get a perspective on investment returns. This article gives you scenarios of returns achieved if you invest Rs 10000 monthly SIP for 10 years.

SIP stands for Systematic Investment Plan. In SIP, an investor invests a fixed sum monthly on an asset class, irrespective of the condition of the economy or stock market. It is a technique of rupee cost averaging. A few mutual funds have also launched daily SIPs. But monthly SIP is sufficient for averaging and is more popular amongst investors. This study is based on monthly SIP. Before estimating returns on SIP, let us first decide on the asset class for investment.

Choosing Asset Class for Investment

There are plenty of options available to an investor for investment. One can invest directly in stocks or indirectly through equity mutual funds. You can also invest in much safer debt mutual funds. There are also Exchange Traded Funds (ETF). Equity mutual funds have a superior risk return profile. Also, you can get higher returns than debt mutual funds by investing in equity mutual funds. Selection of asset class to be done based on risk appetite of individual investors. But for this study, we will consider investing in equity mutual fund.

Selecting Equity Mutual Fund to Invest

Equity mutual funds are broadly of five types. Large Cap, Mid Cap, Small Cap, Flexi Cap, Thematic

Index have returned more than 12% in long term. We’ll avoid thematic and invest in a broad-based fund such as Nifty50 index or Nifty500 index fund.

Rs 10000 Monthly SIP for 10 Years

We’ll invest Rs 10,000 per month via the SIP route for 10 years. Given long-term track record, we assume a 12% annualized return on investment. At the end of ten years, the total value of investments would be Rs 22.42 lakhs, out of which Rs 10.42 lakhs were earned through returns, against a total investment of Rs 12.00 lakh. Please look at image below for year-on-year return.

You can notice that in the year 7 annual return Rs 1.32 lakh is more than the annual investment of Rs 1.20 lakh. By year 10, the annual return (Rs 2.34 lakh) would be around 2 times of annual investment.

Rs 10,000 monthly SIP for 15 years

If you invest Rs 10,000 via monthly SIP for 15 years. Assuming 12% annualized return on investment, at the end of 15 years, the total value of investments would be Rs 47.64 lakhs, out of which Rs 29.64 lakhs were earned through returns against total investment of Rs 18.00 lakh. Please look at yearly report below.

You can see that in the year 15, one year return is about Rs 5 lakh. This is power of compounding.

Returns for 20 and 30 Years Investment

If you can maintain the discipline of investing for 20 years without withdrawing any amount, your total maturity amount would be Rs 92.08 lakhs, against total investment of Rs 24 lakhs.

For 30 years investment, the total maturity amount would be Rs 3.08 crores against total investment of Rs 36 lakh. That is 8.5 times the invested amount.

Returns for 30 Years STEP-UP Investment

If you increase the SIP amount by Rs 1,000 every year and invest for 30 years in the same way, your maturity amount would be Rs 5.33 Crores against total investment of Rs 88.20 lakh.

Conclusion

This is a simple strategy to accumulate huge retirement sum, but it is very difficult to implement. It is simple because it is passive. It is difficult because, you will get into several situations, which may force you to withdraw from your investments. To make this strategy successful, you must have sufficient term insurance, health insurance and an appropriate emergency fund. Also, you need to create different funds for important life events such as an education fund, marriage fund, so that you need not dip into this corpus.

Please let me know, what do you think.

Budgeting Simplified: Some Tips on Sticking to Your Budget

Mohan N

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December 20, 2023

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Budgeting Simplified: Some Tips on Sticking to Your Budget

Creating a budget is the first step in your Financial Independence journey. Sticking to your budget is the next and most important step. If you are a free spender, then it could be very challenging for you. People usually tell me that they do not know, where the money is going. My answer is always like…” track it”. Usually, it does require big efforts to stick to your budget. You need to take the first step and continue for an entire month. Sticking to your budget for an entire month is like a tightrope walk for someone, who has never done this.

So let us assume that you have prepared your monthly budget. 20% of monthly take-home salary for investment/savings and 80% for current expenses. This 80% of current expenses would include Essential and Non-essential expenses. Try to limit your essential expenses to 50% of your take-home salary and 30% to non-essential expenses.

Here are some tips, which will help you to stay on track with your budget target.

Use Cash as far as Possible

Use cash for payments as far as possible for all your transactions. Cash means, you use real money in your account, not the credit card money. Seeing real cash getting deducted from your account or paying hard currency notes by hand has a profound impact on limiting overspending habits. For digital transactions, use UPI or Internet Banking. Since it requires that you can only use the amount available in your bank account, you can never spend more than you have.

Using this technique, you can stick to your budget and avoid overspending. You can also consider using hard cash for payment of non-essential things, such as eating out or entertainment.

Be a Responsible Credit Card User

When you pay for your expenses using Credit Cards, you will feel happier as compared to when you spend hard cash. Since you are not paying from your pocket, you feel like getting it for free. In reality, you have used the Credit Card Company’s money (money on credit), which you have to repay after a month. This is the reason, most of prudent financial planners advise staying away from Credit Cards.

I believe that it is not practical to not have Credit Cards. Credit Cards have their utility. In one place, they help us save substantial money through discounts on products, they also help to build good credit scores. Remember that Credit Cards Are Good Servant But Bad Master.

You have to be more responsible towards Credit Cards usage. You need to squeeze all discounts, cashback and benefits available from a credit card. If you get your salary on a “T” date, change your credit card payment date to a “T+5” date. As soon as you get your salary, pay off the entire credit card bill (without waiting till “T+5”). If a Credit Card is helping us to get a discount on flight tickets, restaurant bills, or e-commerce websites such as Amazon or Flipkart, etc, we must use that Credit Card to get the discount.

There is one Credit Card Trick, which can help you avoid overspending and keep a foolproof track on expenses. The trick is that If you want to spend “X” amount, first check, if you have that much amount in your bank account. If yes, only then use your Credit Card. After the transaction on your Credit Card, immediately transfer the same amount to your other bank account. This amount was saved for next month’s repayment of your credit card bill.

Let us understand this with an example. You have 2 bank accounts, say, one in ICICI Bank and the other in Axis Bank. You use ICICI Bank account as the primary account, where your salary gets credited. Suppose you need to buy a product from Amazon for 5,000. You found that Amazon is providing a 5% additional discount on Amazon Pay ICICI Bank Credit Card.

First check, if you have 5,000 in your ICICI Bank account.

Then decide, if this spend of 5,000 would fall under 50% (essential) or 30% (non-essential) and decide if you still want to make this purchase.

Then, use your credit card for a purchase of 4,750 (net of 5% discount).

After that, immediately transfer 4,750 from your ICICI Bank account to your Axis Bank account.

The amount transferred to Axis Bank will be used for payment of ICICI Credit Card bills.

Usually, people overspend, due to higher limits available on Credit Cards. They lose sense of control. But this overspending hits them at the time of payment of Credit Card bills. This technique of transferring equivalent cash to another bank account will ensure that you will never overspend.

Track Your Expenses

Tracking your expenses is extremely important for sticking to your budget. By tracking, you will always have a fair amount of idea, where your money is going. If you are going overboard, then you can adjust your spending to remain within your budget. Tracking will also help you in accurate planning for the next month. You can use a budgeting app or a spreadsheet to track your spending but I recommend old-fashioned, writing down your expenses in a notebook. You also need to review your budget regularly, so that you can stay on track.

Always Make a List Before Going for Shopping

Failing To Plan Is Planning To Fail. If you do not make a list of things to buy, before going shopping, you will do impulse buying and wreck your budget. First, make a list of things, you need and stick to it during shopping. Don’t buy things, that you don’t need.

Understand the difference between WANT (non-essential) and NEED (essential). If you see something and WANT to buy it, don’t buy it immediately. Wait for a few days before buying. By delaying tactics, you can avoid most of the non-essential expenses.

Plan for Your Food Ahead

If you can plan for your food, you can save substantial money on eating out and non-essential groceries. Some small steps such as buying groceries in bulk, having food at home before going out, and taking your water bottle with you whenever stepping out of home, are such small yet significant steps, that can help you save a substantial sum in the long run.

Cutting Non-Essential Expenses

Identify and cut non-essential expenses. You must regularly review your monthly expenses and decide if you can eliminate any expenses. Sometimes we enroll in magazine subscriptions and Gym memberships, which we do not use. You can cancel those, which you do not need.

Find Cheaper Options

Always try to find cheaper quality options for the product, you are buying. Rather than branded medicines, generic medicine can be used. Instead of costly branded clothing, quality clothes from discount stores may be purchased. Similarly, cheaper alternatives for transportation and entertainment can be explored.

Envelope System of budgeting

In this method of budgeting, we divide the entire available cash into different envelopes as per budget estimates, representing different categories such as grocery, transportation, entertainment, education, etc. As soon as you run out of cash from any envelope in a particular month, you stop spending cash in that category. This method will help you to avoid overspending and keep you within your budget.

Keep Your Morale High

Making a budget is the first step in financial freedom. Sticking to your budget is half the battle won. Stick to 50-30-20 which means not more than 50% of take-home on essential expenses, and not more than 30% on non-essential expenses. Essential + non-essential expenses must be less than 80% of your take-home pay. Try to increase your investment/ saving from the initial 20% target.

To keep yourself motivated, keep on indulging in some luxuries as a reward, while keeping in budget. Keep on reminding yourself that sticking to your budget will reward you with reduced debt and financial freedom over the long term.

Conclusion

Creating a budget and sticking to it, is essential for achieving your financial goals. If you implement the above tips, I am sure that you will not go over budget and have effective control over your finances. Your self-discipline and commitment towards sticking to a budget will lead you to the path of RICHNESS.