Plan to Bring Your Debt to Manageable Levels

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Series: Beginning Investing (6th post)
Section: Before You Invest
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So far you have accomplished two important things - you've set your goals and also determined the amount of money you can save / invest every month in order to achieve them.

It is time now to start doing the preparatory work towards creating a sound financial plan. This section, 'Before You Invest', will consist of three posts:

• Bringing your debt to manageable levels
• Insurance
• Setting aside a emergency cash

Today we'll be talking about the first of these.

Good and Bad Debt

Most of us have debt of some sort: car loans, personal loans, home loans / mortgages, credit card outstandings or just money we've borrowed from friends and family. This is in itself not such a bad thing. After all, loans serve the important pupose of letting us buy into things today that we could otherwise never afford.

The trick, however, is to distinguish 'good' debt from 'bad', a concept that I first read about years ago in the book 'Rich Dad, Poor Dad' and which has stuck with me ever since. Essentially, any debt you take on towards buying an appreciating asset (something that increases in value over time) is 'good' and any debt you take on to purchase depreciating assets (like cars, appliances etc.) or consumables is 'bad'. The idea here is to minimize bad debt and increase the amount of good debt in your portfolio.

Note that I am not talking about eliminating bad debt completely, which is probably impossible in real life. Everyone would like to buy a car or a nice TV or refrigerator and it's rather difficult to do these without taking a loan of some kind. Just understand bad debt for what it is - a drain on your savings - and work out ways to reduce this by postponing your purchase or perhaps settling for something a little less expensive.

The balance to strike here is between your current lifestyle and your future and it is up to you how much you sacrifice now so you can enjoy later. Just be aware that the more you live it up today, the less you will have for tomorrow.

'Good' debt, on the other hand, is a pretty neat thing to get into. You purchase an asset at a price locked in on the date of purchase and reap the benefits of all the profit the asset makes you over time.

How Much Debt Should You Have?

In general, most banks will not allow you to borrow any amount for which the total of your monthly instalments across all your loans will exceed more than half of your income. Most people stretch this even further by taking loans from different banks and not declaring their outstanding loans elsewhere. This is definitely too high for comfort and will leave you in a desperate position in case you were to lose your income for some reason.

I'd suggest perhaps 30% as the limit, and this includes all your debt, including any amount you are rolling over on your credit cards.

How Should You Reduce Your Debt?

Start by listing all your loans under the 'good' and 'bad' categories and, for each loan, list the annual interest rate you are paying. For credit cards, this would typically be about 40% (@ 3% per month interest), which makes it the most expensive loan you could take!

Based on the monthly savings you have already calculated, plan on pre-terminating the more expensive (higher interest) 'bad' loans. Focus on this first rather than on investing your money as this will also significantly increase your savings potential as your interest payments go down.

Further, explore the option of taking on lower cost loans to pay off higher cost loans e.g. taking a personal loan at 18-20% to pay off your card outstandings (which are at about 40%), transferring your card balance to another card to avail of balance transfer incentives, taking a top-up loan on your property (at about 9-11%) to pay off your car etc.

Especially on the subject of credit cards, if you have multiple cards with outstandings on each, plan on paying them off in the following manner:

• Pay the minimum due on all cards except the one where you have the highest interest. If all cards have equal interest, then choose the one which has the highest outstanding
• For this card, use your spare funds to pay off as much as you can
• Do this every month till you have paid off the first card. Then cancel the card
• Move your focus on the next highest interest or outstanding balance card, paying off as much as possible on this while maintaining the minimum due on the others
• Continue till you have paid off all cards. Retain only one or two cards at a maximum

Have a Plan and Stick to It

Based on the above, create a 'debt-reduction' plan and stick to it, trying to minimize or eliminate 'bad' debt over time, thereby creating a larger monthly savings base with which to start investing once your debt is down to manageable levels.

Next Post on Beginning Investing: Insure Yourself and Your Property

Realty Stocks Overvalued?

I've not really been tracking IPOs much of late. The main reason for ignoring these is the fact that there is almost nothing on the table for long-term investors in IPOs today.

The lack of sufficient historical information coupled with some really eye-popping valuations thanks to the bull market make me jittery, to be honest. Also, the mammoth oversubscriptions in most of these imply that the average investor gets a miniscule allocation that is simply not worth the effort. Even if you were to sell at a handsome profit on the first trading day, the absolute value of your returns doesn't make it really worthwhile.

Among IPOs, the ones I am most leery about are realty companies, which are blessed by being at the intersection of both a stock market boom as as well as a property boom and hence these companies are cashing in big time. This article illustrates the issue beautifully.

What Are Your Goals?

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Series: Beginning Investing (5th post)
Section: Setting Your Goals
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OK, so now you know how much you're worth, the amount you spend and the amount of money you can put away every month to meet your goals.

The question for this post is - what are your goals? And remember, these are goals you are defining, not dreams or visions like 'I want to retire rich on a little island in Spain'. They need to be tangible and down-to-earth.

There are three things you need to define for each of your financial goals: what you need money for, when you need it and how much you need. An example of a goal would be 'I need Rs. 5 lakhs to pay for my son's wedding 5 years from now'. Since it is tough to predict how much prices will rise over a long period of time, it would be easier if you just work out the funds you would need to fulfil the requirement in today's prices. You can work out the inflation-adjusted requirement later.

Sit down with your family and work your goals out in some level of detail. After you have these settled, re-order them in a chronological format, with the nearest goal first and moving down to the goals that are furthest out.

When planning your goals, do ensure you consider the following:

• Childrens' education: Lumpsum amount to pay for a good college / post-graduate education for your kids
• Weddings: Lumpsum amount to pay for your childrens' wedding(s)
• Home purchase: Lumpsum amount to pay for an outright purchase or down payment on your own home plus furnishings etc.
• Financial freedom: A point in time at which your average monthly spend should be accounted for purely out of passive income i.e. income from your investments. For more information on this, please read my earlier post on this subject
• Retirement: How much money you need to retire so that your retirement egg will sustain you for the rest of your days

This first draft of your goals might change a bit based on how much you can realistically invest and on the level of risk you are willing to take, but that is the subject of the next post. Also, do note that these goals will probably change from time to time, depending on your stage in life e.g. you might start planning for your childrens' education once you start a family, a requirement that may not have been in your plans earlier.

But, for now, give yourself a pat on the back for getting here. You now have the entire foundation laid for building your financial plan, not a mean achievement at all!

Till next time, happy investing!

Next Post on Beginning Investing: How Could You Achieve Your Goals?

Is the Indian Economy a Bubble?

Characteristics of a Bubble

A bubble is caused by extraordinary amounts of foreign capital coming into a country through the banking system, leading to excessive credit creation (lending) to consumers and businesses. This allows people to consume more and businesses to expand their manufacturing capacity to meet vastly increased demand. Thus, when the flow of foreign capital slows down, stops or reverses direction, businesses are left with over-capacity, forcing them to cut prices in order to survive, wages go down as jobs are cut and consumption reduces as a result, putting further pressure on prices. This is a downward spiral and governments usually try to rescue the economy by spending like crazy and reducing interest rates, trying to stimulate demand and revive businesses. The country has to take on a lot of debt in order to do this over a period of years and is left weak and financially exhausted.

Foreign capital can come into the economy either through trade surpluses (i.e. the country exports more than it imports), through foreign investments in the stock market or through foreign direct investment (FDI) and making its way into the banking system in the form of deposits, which are lent out to individuals and businesses. And as deposits continue to grow faster and faster, interest rates fall as banks try to lend what they have. This leads to over-investment (and hence over-capacity) and over-consumption.

Key symptoms to watch for are a massive buildup in forex reserves, very high credit growth, large-scale property development, unprecedented and sharp rises in asset prices (property, stocks, art...). However, once capacity reaches a stage when supply far outstrips demand, prices begin to fall and the downward spiral begins.

The Indian Economy Today

Based on the above discussion, let's examine the Indian economy today:

Forex reserves: $140 bn, as of 2005. Note that the article says the Reserve Bank has been trying to keep exchange rates in check. This is up from $3.96 bn, in 1990, with nearly 50% having been built up in the previous two years!

Credit Growth: A per a November article in the Financial Times, credit has grown by 30% overall last year, a rate that has the Reserve Bank of India rather concerned. Of this, retail loans have growth by an average of 47% as opposed to 27% and 37% for agriculture and business, respectively. Within retail loans, housing loans have grown by 54% and commercial real estate loans by a staggering 104%. It may be noted that Thailand's domestic credit growth in the years immediately preceding the crash were in the range of 15-35%. However, India's credit to GDP ratio stands at a fairly low 45%, as opposed to the almost 300% that Japan had before its crash in 1990

Growth in Property Prices and Development: The same article states that "analysts estimate India’s property industry will be worth $50bn in sales by 2010, from $12bn last year. Property companies are reported to have plans in the pipeline worth up to three times the value of all the projects they completed in the past five years". I think these statements pretty much sum up everything. Housing prices have risen by up to 60-100% in some parts of the country in the last year alone!

Growth in Stock Market: The Sensex has risen at a long term compounded rate of around 13% from 1,000 in 1990 to around 7,000 in 2005, but it has almost doubled since then to about 13,000 in a span of just about a year and a half!

Growth in Other Assets: I've already written about the phenomenal levels of appreciation in Indian art. Gold, too, has been on the rise, though this is of course a global trend

These statistics are disconcerting, to say the least, and there are two questions that need to be answered:

1. Is India a 'bubble economy' waiting to burst? This could be determined by comparing the amount of foreign inflows as a % of GDP vs what it was for the bubble economies before they burst
Foreign investment inflows have jumped sharply from $6 bn in 2003 to $ 20 bn in 2006, as per Reserve Bank statistics, and these are about 2.5% of India's $800 bn GDP. India is essentially a net importer, so that is a non-issue.

2. Is India so heavily dependent on exports to US that the economy would collapse on a reduction in trade deficit and / or a devaluation of the US dollar? Prima facie, it seems not because India runs only about a $10 bn trade surplus with the US, which is a small fraction of its $800 bn GDP, as per Reserve Bank statistics

Conclusion

We're not a bubble quite yet, and neither are we very heavily dependent on a strong US dollar, so you can probably stay invested still. However, the trends need to be analyzed further to get a better assessment of where we are heading...

The story is, however, not over for you dollar-earners, as the dollar exchange rate is probably an axe that is waiting to fall.... maybe you should start repatriating some funds to India?

Quote from 'Reminiscences of a Stock Market Operator'

The following is such a good quote that I couldn't but share it with all of you:

The training of a stock trader is like a medical education. The physician has to spend long years learning anatomy, physiology, materia medica and collateral subjects by the dozen. He learns the theory and then proceeds to devote his life to the practice. He observes and classifies all sorts of pathological phenomena. He learns to diagnose. If his diagnosis is correct, and that depends upon the accuracy of his observation, he ought to do pretty well in his prognosis, always keeping in mind, of course, that human fallibility and the utterly unforeseen will keep him from scoring 100 per cent of bull's-eyes.

And then, as he gains in experience, he learns not only to do the right thing but to do it instantly, so that many people will think he does it instinctively. It really isn't automatism. It is that he has diagnosed the case according to his observations of such cases during a period of many years; and, naturally, after he has diagnosed it, he can only treat it in the way that experience has taught him is the proper treatment.

You can transmit knowledge, that is, your particular collection of card-indexed facts but not your experience. A man may know what to do and lose money if he doesn't do it quickly enough.

You might want to read the book, but be warned that it was written about 75 years back so you could find it a bit old-fashioned.

The Dollar Crisis

I've been reading a book called 'The Dollar Crisis', which talks about how a rising US trade deficit is unsustainable and is sooner or later likely to be reduced through currency devaluation and general reduction in consumption and import. This will lead to severe repercussions for all export-oriented economies given that they basically survive on exports to the US (the Asian economies are the leaders in this respect, but India will also be affected) as well as other nations, since the world's reserve currency is the US dollar.

A slowdown in US imports will lead to a global slump and perhaps even a recession, creating worldwide stock and property market crashes, among other things. The good news is that prices of goods and services will most likely reduce, but if you're an investor that might not be much to cheer about! Further, if you are one of the many immigrants working in the US, I need not explain how a falling dollar will affect you. The book talks about currency devaluations of the order of 50% or more!!!

Reading all this has got me thinking about the general direction of the Indian economy, as the book provides multiple examples of 'bubble' economies, all of which showed similar trends in the years leading up to the inevitable crashes. We are all most familiar with the dot-com bust and perhaps the Asian crisis, but similar situations have been happening on a fairly regular basis e.g. Japan's bust in the early '90s, from which it is only now recovering...

The 'Crisis' In a Nutshell

Till early in the 20th century, the world followed what was called the 'gold standard', in which their money was backed by gold and, hence, redeemable as such. In such a system no country could afford to have a sustained net trade deficit as that would cause their gold reserves to deplete till it reached a stage when they no longer had enough gold to sustain their economy. Once this stage was reached, their economy would go into a recession and prices and wages would fall till they were low enough for their exports to become cheap so the rest of the world would start importing from them again, allowing their gold reserves to build up once more.

Today's system has no such checks and balances. The international standard is a set of currencies that float in value against each other, with the US dollar as the de facto reserve currency of the world. In such a situation, and with a strong dollar, there is nothing stopping the US from sustaining a large trade deficit (i.e. importing more than it exports). And since it is to the advantage of exporting nations like India, China and the Asian countries to keep their currency values low, they cannot take the US dollars they get from exports and convert them into their own currencies, as that would increase the value of their on currencies and hurt exports.

Therefore, these countries invest them back in the US and state them in the form of national reserves. Thus, the US gets goods and services and pays for them in dollars, which it then gets back in the form of investments. These investments are pumped into the US banking system, which it then lends out, thereby allowing businesses and consumers to buy more things, most of which are imported! This cycle allows the US to continue with a rising trade deficit. Thus, in effect, the US has been buying goods on credit!

This huge US trade deficit has been financing most of the economic growth in the Asian nations and other export-oriented economies, allowing for increased lending and creating jobs and wealth that are leading to economic booms and rising asset values (stocks, property etc). Therefore, a slowdown in US consumption will hurt these economies badly, leading to a very severe recession.

Since the US deficit is underpinned by the willingness of the rest of the world to continue to hold their reserves in dollar instruments, it is only a matter of time before it has to be curtailed as countries begin to get uneasy about the credit-worthiness of the US (after all, it cannot repay infinitely large sums of money) and either withdraw their funds or at least reduce their annual investments. The other possibility is that the US consumer, already neck-deep in debt thanks to all the low-cost credit they have had access to, is no longer able to service increasing debt repayments and chooses to cut back consumption, thereby reducing the extent of US imports.

Both of these scenarios spell doom for the rest of the world, as the net result will be for the US to have to sharply depreciate the dollar against countries with trade surpluses (China, India and the Asian economies) in order to reduce, and eventually reverse, the trade deficit.

The next post will focus on India

How Much Could You Save?

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Series: Beginning Investing (4th post)
Section: Setting Your Goals
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Now that you know how much you spend sit down with your family and work out where you could reduce your expenses. There are usually some useless expenses that you can cut without feeling the difference.

A good place to look for saves is in utility bills like electricity and telephone. It might also be possible to reduce in areas like credit card late payments and interest expenses (just pay before the due date, take an instalment loan scheme on the card or transfer your balances to another) and some entertainment expenses (no, I'm not asking you to sacrifice it all - maybe you could just reduce it by, say 10%?)

Once you have 'cut out the fat', you are now in a position to determine how much you could save every month - your monthly income less your monthly spend. This should, at the very least, be a positive figure otherwise you are definitely living beyond your means. Ideally it should be around perhaps 20% of your income or better. I think that's the average savings rate in India.

Your monthly savings are pretty much all you have to count on when you set your financial goals so the larger the figure you can mange, the better!

Next Post on Beginning Investing: What Are Your Goals?

How Much Do You Spend?

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Series: Beginning Investing (3rd post)
Section: Set Your Goals
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Ok, so now have taken the first step on your journey to wealth and financial freedom and you know what you're really worth. And you're ready to start working out your goals and figuring out your financial plan, right?

Wrong.

Before you move on to all the cool 'banker' stuff, it is important to figure out how much you spend. Without this information, all your goals and planning will just remain utopian dreams, your financial plan will not deliver the results you want and you'll eventually be discouraged into giving up the whole thing.

Keep an Expense Diary

The best way to work out your expenses is to maintain a log of your spending every day for at least two to three months, ideally a lot longer. If you're married, have a family or are living with a partner, do this at a household level i.e. maintain a diary of all personal as well as common expenses for the entire family.

Basically, at the end of every day write down your expenses in a little notebook. At the very least, the notebook should have columns for date, expense description and amount (ideally also add columns for expense category and person responsible for the expense) and you should add up the amounts spent every week. It takes 5 mins every day and is well worth the effort.

[When creating categories, make sure you have enough to cover the entire spectrum of expenses in a manner that will allow for meaningful analysis i.e. not too many or too few. I would suggest you set up 7-10 categories as a good number]

Remember to add in credit and debit card expenses as well as spends made through other non-cash means such as food coupons (like Sodexo, Ticket etc.)

For non-monthly outgo such as insurance premia or one-time purchases (like appliances etc) either maintain your diary for a long period and record these as you incur them or make a conservative (implies you should take a pessimistic / worst case) estimate of your annual spends, divide by 12 to reduce it to a monthly value and add it into your expense diary as a 'virtual' expense in an appropriate category.

Analyze Your Expenses

If you're somewhat comfortable with spreadsheets, create one or download the one shown here from the Journey to Wealth group to help you create cool graphs and charts that show you just how your expenses break up by category, when the peak spending times are every month, what your average monthly spend is and how your expenses change over time.




Believe me, if you haven't done this before, it's really fun - not to mention it gives a really professional feel to this entire personal finance thing and gives you the satisfaction of getting something done.

If you aren't great with spreadsheets, just manually calculate your average monthly expenses because this is the basic information you need for financial planning.

Testimonial

My wife and I kept such a diary for almost a year. We started because we really needed to find out where our money was going as somehow we never seemed to have any at the end of each month!

It gave us a wealth of information on our spending habits e.g. we discovered we were spending a lot on electricity (the AC was on all the time), telephone bills (we lived away from our parents) and pizzas (that was me) and were able to reduce the spend in those areas significantly. The money we saved went partly into investments and partly into living the good life (a regular Saturday night out). Everybody won!

It is possible you'll read this and think you can already estimate your spends, but that's usually not good enough because you'll invariably miss out some regular (not necessarily monthly) expenses. If you're very sure, keep the diary for a short while but don't skip this step. I can almost guarantee you will be surprised when you maintain this record for a while

***I would like to acknowledge Prasanth for providing some of the material for this post***

Next Post on Beginning Investing: How Much Could You Save?

Addendum Squared!

Sorry about these repeated post-scripts, but I've just figured out how to use Google Groups to upload templates and other tools that you can use to jump-start / accelerate your journey to wealth.

Here's the link to an Excel template you can use to calculate your net worth. All data are fictitious, and intended to illustrate how the sheet can be used.

If you are not familiar with pivot tables (used in the template), please just create standard charts for your analysis. I'd appreciate it if you could send me across a copy so everyone can benefit from your efforts.

Thanks and hope you like this new feature. I'm going to use it as often as I can!

How Much Are You Worth - Addendum

This is to acknowledge some excellent inputs provided by Prasanth in his comments on the previous post.

To summarize:

• Remember to include your Provident Fund (or 401k or equivalent) and surrender value of insurance policies in the assets column
• If you have reverse-mortgaged your property (taken a loan against your property or used your property as collateral for anything, including top-up loans, home improvement loans) include the amount of debt you have taken on as part of your liabilities.
• Prasanth prefers not to include his primary residence in the asset side at all since it is not, strictly speaking, an investment (after all you need a place to stay) but I'd prefer to include it anyway. Not many of us will own more than one property and, if you've had the sense to make a good investment, you've earned bragging (and 'asset-column') rights to it!
• Both Prasanth and I agree on not including inherited property because we tend to favour wealth creation over wealth inheritance, believing that you should add to what your forefathers left you, rather than living off it. But that's a matter of personal choice

I hope you have completed this exercise (or soon will) because I'll soon be back with the next post in the series and then there'll be more 'homework'!

How Much Are You Worth?

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Series: Beginning Investing (2nd post)
Section: Set Your Goals
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Now that you're sufficiently pumped up to start on your own journey to wealth, here's a fun task for you - calculating how much you are worth today!

In performing this calculation, we will use a very strict and narrow definition of assets, considering only those of your things that hold or appreciate in value over time rather than the accounting definition which assigns a value to everything you own. The reason for this is that we're trying to arrive at the most conservative and true assessment of your net worth rather than a value that will reduce over time due to depreciation.

[You could add in the value of your goods to make you feel better if you like, but do remember that these will reduce in value over time and will not contribute to your financial goals. After all your surround system will not really fetch much ten years from now if you want to sell it to meet your financial goals! And, what the heck, your net worth is for your eyes only so where's the point in inflating it?]

The calculation is fairly easy:

• First, work out the total value of your assets (things you own that meet the definition above). This would include cash in bank accounts, stocks, mutual funds, property, gold, fine art, jewellery, foreign exchange, antiques and other valuables (and even the spare change in your drawer if you're sufficiently desperate!). To be really conservative, take a reduced value for the more volatile assets like stocks and equity funds to account for a possible fall in value. You could discount them by, say, 20-30%.
• Then total up your liabilities (what you owe to others). This would essentially include all kinds of loans like your car loan, housing loan, personal loans, credit card outstandings etc. Be true to yourself and count everything you can think of.
• Subtract your liabilities from your assets to get your net worth

The above ignores the value of your car and other worldly goods and it paints a very stark, but true, picture of your financial health.

All too often, we feel well-off because we have nice things, a rockin' night-life and a cool car but in reality, we're just a mis-step away from trouble. And like the picture of Dorian Gray, this 'net worth' calculation presents us with what the ugly truth really is!!

If you find you have a healthy positive balance from the above calculation, pat yourself on the back. You're already well down the path to financial freedom.

And, if you find you're in the red, don't despair. A bit of discipline and you'll soon be in positive territory, after which it's just a matter of time before you're watching your moolah grow before your very eyes!

Next Post on Beginning Investing: How Much Do You Spend?

Ask Value Research (Only You Can't!)

This is just a quick post to update you about an excellent feature on Value Research Online, which, by the way, is probably the best Indian mutual funds site on the Internet. Check out their 'Ask!' feature wherein you could submit queries about mutual funds and get pretty insightful and well-researched answers from their experts.

Unfortunately they seem to have suspended fresh queries for lack of resources (I'm sure they must have been swamped by questions!), but a look at the answers they did post in the past would be extremely instructive for mutual funds investors. I hope they re-start the service soon but, till then, you could get your own answers by looking at the wealth of data and information available on the site itself.

You Need to Start Investing - Right NOW!

Welcome to the first of my posts on beginning investing. If you’re reading this with any degree of interest, it’s probably because:

1. You have a decent amount of money in your savings account and you know you need to do something with it but you’re just too busy and don’t have time for it just now. You’ll get to doing something next weekend. [You’ve been saying that for six years now]
2. You have a friend who gives you hot stock market tips, several of which have shot through the roof while you stood by and watched him laugh all the way to the bank. You’d like to take a punt on the stock market but you’re not sure whether to risk it.
   [The right, though fairly useless, answer at this point is – it depends. But you’ll be able to answer it before we’re through]
3. You have all the good things in life, but no savings to speak of even though you earn quite a decent sum (Come to think of it, you wonder where your salary goes every month…). But there’s that new surround system on the market you need to buy tomorrow, after which you’ll be pretty much broke so you’ll read this now and promise to get started next month
   [You’re in more trouble than you can imagine, my friend. Forget the surround system and start focusing on saving something RIGHT NOW]
4. You earn a reasonable, though not high, salary and you’re wondering whether it is even possible to get rich with what you get [Given time and patience, yes, you can become pretty well off]
5. You want to start out, but you don’t know enough and need some step-by-step directions. [Well, I’ll try my best and hope you can make use of what I have to say]

While the circumstances of each of the above types of people might be different, what is common to all is inertia and / or inactivity – and yes, a general interest in the subject. However, the only 'interest' of any importance in terms of money is the type you get from your investments. Plain enthusiasm and intellectual pontification will get you nowhere. You must get started – TODAY!

And here’s why:

• Bank savings accounts and fixed deposits earn between 3-6%, on an average, a rate that is, at best, keeping up with inflation (inflation is the rate at which prices in general are rising every year). This means that, over time, you are getting POORER. Not only are you not moving forward, you are actually moving BACKWARD and, when the time comes for you to retire, you will realize that you cannot. You will have to continue working your whole life to support yourself and your family
• Even if you are looking at the quantum of money you will have, rather than purchasing power (though that’s no use, really, due to the fact that prices are also rising due to inflation and a lakh ten years later will not be worth as much as a lakh today), please do note that 3% interest in savings accounts will imply your money will double in only about 24 years (I am not joking). Do you really want to wait that long to see the Rs. 20,000 you have in your savings account become Rs. 40,000? Especially when it will buy probably the equivalent of Rs. 10,000?
• Interest rates on government-backed investments like PF are falling and will continue to do so till they reach market rates of interest i.e. around the same levels as RBI bonds. This is because the government cannot continue to pay out artificially high rates of interest while earning less than it gives you. Such a system cannot be sustained indefinitely. If you doubt this, I’d like to draw your attention to National Savings Certificates and Kisan Vikas Patra that used to pay out around 14% in the ‘90s (doubling your money every five years) whereas they are now around 6.5% (doubling your money only in around 11 years). Even the PF rate has come down to around 8% and will continue to decline despite the opposition of various parties in the Indian government
• Prices of real estate are going up to stratospheric levels. Chennai, the city whose property prices I am most familiar with, has seen price rises of around 30-100% per year in the past 2-3 years, depending on the area. They have reached a level such that a budget of Rs. 20-25 lakhs would be about the minimum you need to get anything decent (good residential neighbourhood, 2 bedroom) in the city. Prices in the crores are now commonplace. Chances are, if you’re buying an apartment ten years from now with the money you have in savings accounts, you will need to move to towns that you haven’t even heard of today!

I'm sorry if the points above seem harsh, but those are the facts. And that's why you’ve really got to get started right away. There will always be excuses for putting off investing (let's face it, it's not exactly fun) but I can assure you that the hard work is only in the beginning. After that, for most of us, a disciplined approach to investing can run almost completely on auto-pilot.

Last (but this could have just as well been the first point) the magic of compound interest really kicks in when your investments have time to deliver returns. All else being equal (and sometimes even when things are not quite equal) the earlier you start, the richer you will be. Investing is one of the areas where the fable of the 'Hare and the Tortoise' really rings true.

Give your money time and, even at low rates of interest (yes, you do not need to invest in stocks if you don't want to), you will probably do better overall than many, many people who've made a quick buck in the current bull run, myself included.

Just get started! It’s that simple.

Next Post on Beginning Investing: How Much Are You Worth?

Current Trends in the Indian Residential Property Market

Found a few links to info I found interesting so I thought I'd share them with you. Enjoy!

Research Reports

1. Outlook for India's Real Estate Markets is a Deutsche Bank study that tries to arrive at a broad trend for the next few years based on demographic / lifestyle changes in India
2. A positive-sounding article talking about how Indian property prices will go up. Too generic in nature, though. Did not have the kind of facts and figures we'd all like to see
3. An exhaustive document on the prospects of the real estate market by Trammel Crow Meghraj, where I noted two main points, namely that real estate in India averages about a 12% return year on year (which is almost as good as equity) and that the Indian market has already been through a boom-bust cycle which ended in 1999. Since then prices have been on a steady upward trend, but that makes one wonder when the next 'bust' would be! The only good news here is that it looks like the downward trend generally bottoms off at a higher level than the previous downtrend, implying a general increase in prices in the long term...

Property Prices

• Market rates and prices for Bangalore, Delhi, Kochi, Mumbai and Pune
• Some really super, up-to-date info on prices in various areas of Chennai, Bangalore, Delhi and Mumbai. The prices in Delhi and Mumbai are truly eye-popping! This site seems to be worth a visit now and then...
• Some prices for Pune, but couldn't make out how recent this info is

I just realised that I've never found a site that can actually gives regularly updated info on residential property prices in a city or, even better, in a specific area in a city. Does anybody know of such a site or even a regular newsletter / report?

Series on Beginning Investing - Coming Soon!

Based on the poll results till date that indicate a demand for material on beginning investing, I will be devoting several posts to the subject in between my articles on other stuff.

I will be tackling the subject in five parts, based on the order in which you need to go through it:

1. You Need to Start Investing - Right Now!
2. Set Your Goals
3. Before You Invest Anywhere
4. Get Started
5. Manage Your Investments

Based on my experiences and those of many of my friends, I know the hardest part is getting over the initial intertia and our natural tendency to procrastinate on money matters. The solution is to just start doing it! And I hope the step-by-step approach I will be laying out will be making it easier for you to start off on your individual journeys to wealth.

If you are new to this and feel the need to make your money work for you, do bookmark this site and come back in a few days to check out the first of my posts. I will space out the material to let it sink in and allow you some time to work on what you learn before coming back to read the next instalment. The reason for doing this is so you get a chance to clarify your doubts before moving on. Please feel free to get in touch with me over email or leave me your comments so I can try to tailor the content to what you really want to know about.

I'm pretty excited about this series and I really hope it's of use to all of you out there.

Next Post on Beginning Investing: You Need To Start Investing - Right NOW!

I'm a Hedge Fund - and So Are You!

Few of us think of our investments outside the rather narrow context of fixed / time deposits, stocks, mutual funds, cash and government bonds, a mindset that is driven by the common financial planning approach used by banks.

However, this approach does not give us a true picture of how we are faring, as our investment assets generally include many more things that we don't take into account. What about property, jewellery, art, foreign curency, antiques (just check out the market price of that teak almirah and you'll know what I mean) etc? They should count for something, and it's quite likely a lot!

Most of these are potential investment areas as well. People make tons of money on art, for example. In that respect we are probably a lot like hedge funds, which are like mutual funds except they can invest in any asset class they need to in the search for higher returns or whatever the fund's mandate is.

[By the way, you and I could not afford to invest in hedge funds as these are generally rather exclusive and require gigantic investments to qualify]

As a hedge fund, we would be doing financial planning at a 'net worth' level rather than at the narrower level that we do today and managing our wealth as a whole, rather than as 'bank assets' and 'other assets'. We would be allocating a risk rating to our 'other assets' and treating them as part of one overall portfolio. For example, antiques should be fairly low risk but art would be in the high-risk category. Real estate risk rating would probably fall somewhere in between.

What's the Value in This?

Well, for one, you'd feel a LOT happier being that much closer to being a millionaire or whatever you want to be. It's like a free one-time bonus!

Further, you might even want to re-look your portfolio at the net-worth level based on the risk profiling your bank does for you rather than focusing only on the money you invest with them.

If, for example, you are supposed to have 25% of your money in equity (read 'high-risk assets') then see whether your stocks + equity funds + art + real estate + foreign currency add up to that. Same goes for the portion in low-risk assets: check whether your bonds + cash + antiques can make up that portion.

Hey, that's just what private banks do for their customers. And we all deserve that treatment, right?

If you can add up your household assets, then the exercise is even more meaningful because you can plan your finances at a household level rather than as two individuals, making for a more balanced portfolio. That's how my wife and I do it and it works well for us.

Indian Art Market - the Dark Side

This is an addendum to the post on Indian art as an investment. While I still believe there are genuine gains to be made, check out this link for some rather chilling information... Another great article along with some very insightful visitor comments may be found here.

Bear with me because I'm going to continue posting on Indian Art off and on. I have a feeling this is a market that is on the verge of something big (in general, not just for the top few artists) and it makes sense to keep an eye on it.

Please Vote!

By the way, I've set up a couple of polls where you can vote to give me a better idea of what you want to read and whether you use the info from this site for your personal investments.

Request you to take a few seconds to vote and help me improve on my efforts.

Thanks!

Indian Art as an Investment

I've flirted off and on with investing in Indian art, my interest having been piqued because my uncle, Tapan Ghosh, is a pretty well-known artist and also because of some of the rah-rah articles you get to read every so often about Indian art doing well at international auctions.

From my travels abroad, I've come to hold the opinion that Indian art is rather undervalued compared to other Asian art, which seems to bode well for the industry as a whole.

I firmly believe it is possible to make windfall gains on art. The only major hitch is that the market is non-transparent and there is no real objective way to measure the worth of an artist, especially an upcoming one whose works have not been publicly traded in major auctions. And yet, the upcoming artists' works are where the truly spectacular gains are likely to come from. Sounds familiar, right? It's just like the stock market.

It was therefore a rather pleasant surprise to find this (not very recent) document on 'Art as an Investment' that gives some stats about an otherwise closed, under-analysed market. Some of the juicy details:

• the Indian art market (represented by an index comprising of 24 of the top Indian artists) has outperformed the S&P 500 by two times over the past 3 years, the top 6 (Akbar Padamsee, FN Souza, MF Husain, Ram Kumar, SH Raza, Tyeb Mehta) having trounced the S&P 500 by several times and the rest having beaten it by a small margin
• the emerging artists (high-risk, high-return like the stock market small caps) recommended are Chanchal Mukherjee, Baiju Parthan, Sekhar Roy, Jayasri Burman, Vaikuntam and Ramananda Bandopadhyay. There are also some mid-cap equivalent artists named

The presentation also goes on to talk about the factors to consider when investing in art, but these are rather obvious.

Anyway, I'm pretty excited about this info. Will look up some of these artists and let you know what I can find out. I would love it if you could also do some research and let me know.

Not Convinced?

Check out these articles and you'll know what I'm excited about!

• Atul and Anju Dodia's prices have apparently been increasing at 20% month on month!
• Works by second-tier artists such as G R Santosh, Avinash Chandra and Sohan Qadri are buzzing in a market valued at around 1,100-1,200 crores per year!
• Prices for top-tier artists such as Tyeb Mehta and FN Souza have risen 20 times since 2000!
• Starting with $3.5 million in 2000, Osian's Indian art fund has grown by 10 times till date!

Still not convinced? Just search on Google! I mean, even Femina is advising readers to buy Indian art. (Yeah, that's right!)

And all you investors know that when everyone is talking about an investment, it's boom time!!

Odds of Making Money in the Stock Market

I was surfing through some blogs and came across Value Investor India, a real gem of a blog that is not updated frequently but has some really good posts. It is based on value investing concepts and has some really good posts on arbitrage and industry overviews. Rohit, the author, has obviously gone deep into the internet to dig out some really good stuff, such as this arbitrage returns evaluator, which seems to be based on what I read in Buffetology (or maybe that's just how all arbitrage stock opportunities are evaluated).

Anyways, one post caught my attention, as it seems to be a pretty interesting way to look at timing the market. Basically, the concept is that you should take the current PE and be able to judge the odds of making money in the market based on how often the PE has been higher than this in the past. If today's PE is towards the higher end, then chances are you will lose money in the medium term.

The NSE, and perhaps even the BSE, site allows visitors to download historical index data (open, high, low, close, PE etc) into excel sheets. Now, once you have downloaded the data, it is fairly easy to count the number of times the PE has been higher than the current PE and divide by the total number of days in the historical period considered in order to get an idea of the probability of it being higher than today in future.

Example:
If today's PE is 18 and you see that over the past 1000 days the PE has been >18 50 times and <=18 950 times, then chances of you making money in the future are 5% and chances of losing money are 95%. So you might want to keep your money in the bank for now.

The obvious flaw in this approach is that as markets in India mature and growth slows down, future PEs might be generally lower than past PEs, thereby throwing your calculations out of the window. Further, since you are looking at an index PE, it would be wise to invest in an index fund on this basis. It might even be better than a passive SIP and yield better returns...

Why would this not work for individual stocks? Because individual stock PEs should not be anallyzed statistically as they are completely dependent on management and factors affecting the individual company. For a basket of stocks such as the index, the approach does provide a good rule of thumb.

If you have bought stock funds in a period when the odds were good of PEs rising in future, you'd probably have really done well, benefiting from the increased PE as well as rising earnings, a double benefit!

The example given in the post was that of the stock market crash during the UPA elections when apparently the odds were 10:1 of PEs rising afterwards - and of course the market soared over the next couple of years!

Anyone want to try this out and let us know today's odds?

How Much is Enough?

--- continuing from the last post on Financial Freedom ---

Stage 2 is a tough nut to crack.

First, you need to know what you want out of life and how you expect to be spending your retirement. And this is a question that is really, really tough to answer for two reasons:

1. You've never thought about it
2. Can one really reliably predict what one will be doing 10, 15, 20 years ahead?

Yet this is important, because your entire well-being in retirement depends on it.

Your Provident Fund Alone Will Not Cut It

Till a few years back, it was OK to think that your Provident Fund would take care of your retirement. But things have changed dramatically of late and there is a pretty clear indication of how our retirement options will be a few years hence. In my opinion, the writing is on the wall:

• interest rates on capital protected investments like PF will continue to fall, eventually aligning themselves with market rates. This may not happen now or even in a few years, but definitely soon enough to demolish your PF strategy
• the responsibility for maintaining and managing retirement funds will move away from the government and into your hands
• inflation will eat away into your savings
• your kids may no longer be willing to take on responsibility for your well-being (God forbid, but one never knows)

Given this horror-story setting, it is definitely important for you to know how much money you need to set aside for a happy and fulfilling retirement.

So, How Much Is Enough?

To answer this, at least in a broad sense, try the following:

1. Figure out when you'd like to retire (Be realistic! Chances are, if you are reading this, you ain't gonna be quitting next year!!)
2. Write down your annual budget as determined from your Stage 1 analysis
3. Add in any additional regular payouts you think you might be incuring when you retire and increase the overall budget by, say, 20-30% since you'll probably want to live in better style than you are accustomed to right now. This is how much you would need if you were to retire today. This needs to be adjusted for increases due to inflation till your retirement date
4. Make a guesstimate on how inflation will remain till your retirement, it's better to aim high than low, so perhaps you could take a figure of 6%
5. Calculate the value of your annual payout at the time of retirement by multiplying your retirement payout (from step 3) with (100+inflation)% to the power 'n', where 'n' is the number of years left to retirement
6. This figure is the annual payout you need to keep you retired and happy and should be generated entirely out of investment income. Based on investment returns of, say, 5% you need to have saved about 20 times of your retirement annual payout (from step 5) in order to be comfortable

Example:

You want to retire 15 years from now and your current annual payout is, say, Rs. 200,000. You expect to be spending an additional Rs. 100,000 for annual vacations when you retire and you anticipate inflation to remain at a level of 6% from now till you retire.

Hence, your annual retirement payout in today's money would be about Rs. 390,000 (200,000 + 100,000 increased by 30%). Adjusting it to 15 years from now for 6% inflation would yield an anticipated annual payout of Rs. 934,657 at retirement. (390,000*1.06^15)

This needs to be generated entirely out of investment income and hence you need to save about Rs. 1.87 crores by the time you retire.

Further

Inflation will not end just because you have retired. Hence, the expenses will continue to rise even post-retirement. To account for that, you need to know how long you expect to live (!) post retirement and save even more to accommodate the increasing costs for that period.

But let's not get into that - it's too complicated!

The point of this entire article was that, while retirement planning is an inexact science, it is something you must do so prepare now rather than being taken by surprise when it's too late.

What is Financial Freedom?

I received a very kind comment the day before suggesting that I truly get what 'financial freedom' is about and I suddenly realised that I had never really talked about what that means to me. After all the very idea of this blog is to post about my journey to financial freedom - and yet that has got missed out on the way!

Different Interpretations

I guess there would be different interpretations for different people. Some might say financial freedom is when you have enough money to live off in the style you want and never have to work again. Others would tend to go with a more approachable definition of having enough money to ensure that living and other non-discretionary expenses are taken care of so one is then free to pursue other things free from the worry of paying the next bill. And for those among us who are saddled with uncomfortable amounts of debt, perhaps financial freedom is simply the ability to pay off the loans!

My Two-Stage Approach

I'm looking at financial freedom as a two-stage approach:

1. Lifestyle Maintenance: Save enough to ensure you can meet living expenses from the interest (if you live off the pricipal then of course you'll be back to square one in no time at all!)
2. Retirement: Then look at saving enough to retire and live a happy and comfortable life (again on the interest otherwise your kids might be a little unhappy at inheriting nothing from you, heh heh)

The first is rather easy to calculate - add up or estimate your living expenses per month, extrapolate that into an annual budget and add in any non-monthly expenses you regularly incur in order to determine your budget.

Examples of monthly expenses would be house rent, utility bills, food / groceries, entertainment, fuel, loan repayments, education-related expenses etc. Non-monthly regular payouts would include insurance payments (not an expense but a regular payout that must be accounted for nonetheless), annual vacations etc. Also factor in an anual lumpsum for large purchases that tend to come up every so often like purchasing appliances etc.

Since this will have to be met out of the interest on your savings, you can work out what the savings should be. I'd guess the interest would be about 5-6% on any capital-protected instrument (like perhaps govt bonds) so you need to have saved 17-20 times your annual budget in order to even get to Stage 1 of financial freedom.

It might be tough, but it is definitely possible for all of us. And this calculation will also give you excellent visibility on your spending habits. If you simply cannot figure out how to get to Stage 1 with your current lifestyle, perhaps it might be worth re-evaluating the necessity of some of your expenses.

Stage 2 is another story, though... will get to that in the next post! Till then, please give me your views on the subject.

ET Article Link

Thanks to.. err... 'Anonymous' for sending me the link to the Economic Times article. Was looking for it all over!

Thanks to the Economic Times

Hi everyone,

I've just learnt that this blog has got a mention in the Economic Times as one of a rising number of blogs on finance, investing and the stock market. Can't find the article online but will post a link once it is put up on the net.

[I, of course, look like a chump for having been a no-show on this blog for the past ten months. Oh, well, that's the price of celebrity... the intense media glare, the paparazzi, the complete lack of privacy...]

Thanks to all you readers who've followed my writing for the past couple of years and returned every so often only to read the same old stuff because I've been too lazy to add anything new. Will try to buck up now!

To the newcomers, please feel free to browse the archives. There's some stuff you might find useful. And do drop in from time to time to catch up on new articles as well.

Thanks for coming by!