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 Contents
1. Gettingstarted

2.PersonalFinanceSelfEvaluationChecklist

3.Howtofortifyyourfinancialcastle

4.HowtoBuyaTermLifeInsurancePolicy

5.HowtoBuyaHealthInsurancePolicy

6.SayNOtoPackagedFinancialProducts

7.RetirementPlanningASlideShow

8.UnderstandingHowRetirementCalculatorsWork

9.Generatinganinflationprotectedincomewithalumpsum

10.AStepByStepGuidetoLongTermGoalBasedInvesting1

11.LongTermGoalBasedInvestingPartII

12.Howtoselectmutualfundcategoriessuitableforyourfinancialgoals?

13.Howtoselectanequitymutualfundpreamble

14.HowtoselectanequitymutualfundCreatingashortlist

15.HowtoselectanequitymutualfundMakingaChoice!

16.HowtoSelectDebtMutualFundsSuitableForYourFinancialGoals?

17.HowtoConductaPersonalFinancialAudit

18.Howtoreviewyourmutualfundportfolio

19.ReviewYourRetirementPortfolioinSevenEasySteps

20.Assetallocationforlongtermgoals
 1.GettingStarted
1.Introduction
Howwouldyouliketochangethewayyourfamilyhasalwayslookedatmoney?Thatisthecentral
themeofthisebook.ThischapterisasynopsisofatalkIgavetoagroupofyoungresearchstudents.

2
.
Fortifications:Buildingbarriers
Ifachangehastomakeitsmark,ithastopermanent.Thusjustlikeanyconstruction,onehasto
beginwithfortifications.

LifeInsurance

Aresearchstudentdiedwhileonatrekrecently.Theirparentswereentirelydependentonhim.
Theyknewthis.Sonoeffortwasneededtoconvincethemabouttheneedforatermlifeinsurance
policy.

RelatedPost:
HowtoBuyaTermLifeInsurancePolicy

Healthinsurance

Samehere.Thesewerenotschoolkids.Theywerepostgraduates.Sotheyknewthevalueofhealth
insurance.

SubrasuggestedthatItalktothemabouttheimportanceofgettingtheirparentshealthcover.Done.

Relatedpost:
HowtoBuyaHealthInsurancePolicy

Accidentinsurance

ThiswassuggestedbyMr.R.BalakrishnanwhenIpostedaboutthistalkinthefacebookgroup,asan
ideasforwealth.

Emergencyfund

Seebelow

Relatedpost:
HowLongShouldIMaintainanEmergencyFund?
Will

Urgedthemtogettheirparentstowriteawill.AgainasuggestionbySubra.

3.
AnalysingCashFlow
Isuggestedthatthestudentsdothefollowingwiththeirmonthlyscholarship

Foratleast1year

i)30%
fees+food+needs

ii)30%
familyortothebank(sayaflexideposit)partlytobuildanemergencyfund

iii)30%
forlongterminvestment(moneyyouwillnottouchformany,manyyears)seebelow

iv)10%
bufferfor
wants
fromtimetotime

Afteraboutayearorwhenemergencyfundiscloseto1lakh:

i)30%
fees+food+needs

ii)30%
familyorpartlytowardslongterminvestment

iii)increaselongterminvestment(
moneyyouwillnottouchformany,manyyears)seebelow

iv)10%
bufferfor
wants
fromtimetotime

Therewasunanimousagreementthatthiswaspossible.

4.FrugalLiving
Donotconnectmoneyandhappiness.

Donottakeyourdegreeandfuturepositionstooseriouslyandbuystuffbecauseofsomestatus
nonsenseorbecauseofpeerpressure

5.Nevertakealoan
Exceptahomeloanandthattooonlyifnecessary.
6.Saynotocreditcards
Ifyouhaveacreditcard,youneedtopayitinfulleachmonth,anyway.Meaningyouneedtohave
themoneyready.Sowhyhaveoneatall?

Ignorealltheperksassociatedwithcreditcards.Theydonotaccountformuch.

Youdonotneedacreditcardtokeeptrackofyourexpenses

7.Saynotoanykindofinsuranceproducts
Exceptpuretermlifeinsurance.Enoughsaid

8.Donottalktoaninsuranceagentorbankrelationship
manager
tellthemwhatyouwant.
Ifyouneedsomethingfromthem, Nevereveraskanintermediary,
whatto
do

9.Donotbuylandasinvestment
Itisnotliquid,notwellregulated,demandisartificialetc.etc.

10.Donotbuygoldasinvestment

SinceIwastalkingtophysicistsIcouldaffordtosaythefollowing.

Goldglitterssimplybecausegoldisametal.Anelectricfieldcannotexistinsideametal.Otherwise,
theelectronsinsidewouldflow!

Whenlight(whichcontainsafluctuatingelectricfield)shinesonapieceofgold,orforthatmatter
anypieceofmetal,thenimbleelectronsmovearoundlikeagooeyfluidandreflectsmostofthe
light.Someofitgetsabsorbed.Sotheresultingcolourisgoldenyellow.Nobigdeal!

Ifoureyescouldsenseultravioletlightinsteadofthevisiblelight(VIBGYOR),goldwouldappearlike
aslabofglassbecausemetalsaretransparenttoultravioletlight.
11.Givemoneytocharity
Helpothersinneed.Whenyouareinneed,someonewouldturnuptohelpyou.Thatismy
strongestreligiousbelief.

12.Understandinglongterminvestments
thechaishop
analogy
Onlyonepersonsparent(outofnearly100)investedinstocks.NosurpriseshereIguess.

Tointroducethemtotheideaofstocksandbonds,Iusedthefollowinganalogy.

Imagineateastalloutsidethehostelgate.Youfrequentiteachday,youliketheownerandyoulike
theteaevenmore.Onedayhesayshehastoshutshopbecausehehashugedebt.

Youwanttobailhimout.

Youhavethefollowingchoices.

1)Lendhimsay50Kandaskfor8%interesteachyearfor1oyears.Thisiscalledabond.Sinceheisin
yourdebt,thisiscalledadebtinstrument.Ifthepersonistrustworthythereisnocreditrisk
involved.

Whetherhegetsaprofitornot,hehastogiveyouthe8%interest.Sothereisnoriskforyour
investmentinthesensethatpaymentswillberegular.

Youreinvestthepaymentsinthesameshopandgetthesameinterestorsay,putitinabankFD

2)Yougivehim50Kbuttellhimthatyouwantashareoftheprofits.Thatisyouownthecompany.
Thisiscalledequity.Ifthereisaloss,yougetaloss.Ifthereisagain,yougetagain.

Theremaybeintermittentlossesbutoveralongperiodoftime,youexpecttheannualgainsto
outnumbertheannuallosses.Youexpectthisbecause:

studentsneedaplacetohangoutoutsidethecampus.Sotheywouldfrequentteashops.
Iftheteaisgood(anditisinthiscase)thenmorestudentswouldcomeandmoreoften.
Thus,thereisachanceforconsistentprofit.
Afterseveralyears,theequityandbondinvestorsnetworthwouldlooksomethinglikethis(drew
thisontheboard).

IfIapply30%taxtobothequityanddebt,thevaluewillreduce.

NowImusttakeintoaccountthe
effectofinflation
.

Iaskedforthepriceofchaiwhentheyhaditforthefirsttimeeverintheirlives.

Rs.1,Rs.2.50weresomeanswers(notallarefrommetros!)

Thiswas10yearsago.

NowthepriceisaboutRs.7

Sothisisabout11%inflationwiththestartingpriceasRs.2.50

Soafterhavingdevaluedthecorpusduetotax,wemustdevalueitduetoinflation.

Nowwhodoyouthinkgotthebetterdeal?Thefellowwhohadthecouragetostomachannual
fluctuationsorthefellowwhowantedsteadygrowthwithpracticallynovolatility

Whichinvestorislikelytochangethewaytheirfamilyhandlesmoney?

Knowingwhichchaishoptobackmaybetoughastherearetoomanyofthemaroundthecampus.
Also,whyonlybackchaishops?ThereareseveralXeroxshops,suppliesshopsetc.
Whataboutourcampusbank(SBI)?Itmakesalotofmoneybyofferingattractivefixeddepositrates.
Itthenoffersdifferentkindsofloans(car,personal,house,forcompaniesetc.)atmuchhigherrates
andbagsaneatprofit.

Whynotbuythebanksstock?Whynotobservethespendinghabitsoftheundergraduatesandfind
outwhichbrandstheyprefer?Thosebrandscouldthenformashortlistforfurtherinvestigation.

Yes,knowingwheretoinvest(eitherequityorbond)istough.Itrequiresconfidence,disciplineand
thetimetoanalyzeandtrack.

Thereisamuchsimpleralternative:mutualfunds.Youpayasumtoafundmanagerwhopoolsinall
contributionsandinvestsinadiversifiedfolioofstocks,bondsorboth.

Iurgedthemtobuildfortificationsasap,learnthebasicsofequityandmutualfundsandbegin
investing.

Thereweresomeintelligentquestionslike:

Whydoyouexpectstockstoincreaseallthetime?
Whyisahomeloantheonlyloanthatoneshouldget?
WhichtermpolicyshouldIchoose?
CanIbuyrealestateifIwanttofarminit?
Ifonegetsrich,doesitmeansomeoneelsegetspoor?(Toughone!)

2.
PersonalFinanceSelfEvaluationChecklist
ActI:Preparation
1. Ismylifeinsuredadequately?Thatis,willmyfamilybeabletohandletheirimmediate,
shorttermandlongtermgoalsinmyabsence? Somepeopledismissthisasoveranalysis
andtakea1Croretermpolicy!Trustmethisanalysiswilltakeonly15minutes.Theparalysis
occurswhilechoosinganinsurernotwhiledecidingtheamount!
2. HaveIdiscussedwithmyspouseornomineehowtheterminsuranceamountshould
beutilizedinmyabsence? Youcanwriteadetailednoteaboutthisifyourspousefindsittoo
morbidtodiscussthis.Justbesuretoincludethedetailednotealongwiththepolicypapers.
Youcanalsoincludethecontactdetailsofafeeonlyfinancialplannerforguidance.
3. Aremeandmyfamilymembersinsuredadequatelywrtmedicalexpensesindependentof
myemployment? ThisseemslikeanobrainerbutIamappalledtoseethatpeopleconsider
mediclaimexpensesasawasteofmoneyiftheydontclaimandtakeemployeebenefitsand
theirownhealthforgranted.
4. HowreadyamItohandleemergencyexpenses? Youneedmorethan6monthsor12months
expenses.Rememberthatcashlesshospitalizationdoesnotmeancashfreehospitalization.
Youstillneedtopayfornonmedicalexpenses.
5. HowcapableamIofreplenishingmyemergencyfundifitgetsdepleted?! Dontlockallyour
monthlyinflowsintoEMIsandSIPs.Youneedasmallbuffertoreplenishtheemergency
fund.
6. DoIknowwhatmynetworthis? Theonlyreasonyouneedtodothisisforcesyoutolistall
yourinvestmentsandupdatetheirvalues.
7. HaveIlistedallmygoals:recurring,shortterm(lessthan5yearsaway),intermediateterm
(510Yaway)andlongterm(10Y+away)?
8. DoIknowtheapproximatebutrealisticcurrentcostassociatedwithmygoals?
9. HaveIdecidedtheassetallocationformyintermediateandlongtermgoals? Shorttermis
100%debt!
Theassetallocationgiveyouanet
portfolioreturnyouareaimingfor.For
exampleifyouexpect12%fromequityand7%(posttax)fromdebtandwouldliketohave
60%equityexposure,thenetportfolioreturnis(approximately):(12%x60%)+(7%x40%)
10. DoIknowhowmuchI needtosaveorinvest foreachofthem?Youneedtouseagoal
plannerwiththenetportfolioreturnandareasonableinflationestimate.Forretirement,
youneedtoassumeaninterestratepostretirement.Usesomethinglike7%orso,fornow.
11. DoIknowhowmuchI caninvestpermonth? Analyseyourcashinflowandoutflow.
Constructapiechartandstareatit.
12. IfthereisashortfallhowamIgoingtomanageit? Someoptions:postponegoals,reduce
targets,increaseinvestmentsdowntheline.Dontmakethemistakeofincreasingexposure
 tovolatileinstrumentsinthehopeofcompensatinglowerinvestmentswithhigherreturns.
Itcouldbackfireterribly.
13. HaveIdiscussedallthiswithmyspouseorpartner?
HaveIwrittendownaninvestmentplan?
Awritteninvestmentplanhelpseverybody,especiallythosewhocannotdiscussfinancial
matterswiththeirspouse.

ActII:Action
1. DoIknowwhatcategoryofinstruments(eg.whatkindofmutualfund)amIgoingtochoose
formygoals?
2. Ismyproposedportfoliodiversifiedwithineachassetclass?
3. HaveIbeguninvestmentsaspertheassetallocationdecided?Notallgoalscanbehandledat
thesametimebyeveryone.Retirementisprioritynumberone.
4. AmItrackingmyinvestments?AmIinvestingenoughandasperthescheduleassumedinthe
goalplanners?
5. HaveIwrittenawill?

ActIII:Review
1. DoIknowthenetreturn(XIRR)ofmydebtinvestmentsandequityinvestment? DoIknow
thenetXIRRoftheportfolio?Isthisaboveorbelowtheexpectedportfolioreturnusedinthe
goalplanners?
2. DoIknowwhatisthecurrentactualvalueofgoalportfolios?
DoIknowhowmucharethey
actuallyworth?IfIdontinvestanymoreforthesegoals,howmuchwouldthecurrentvalue
growtowhenIneedthemoney?
3. DoIknowforhowmanyyearsIcansurviveonaninflationindexedmonthlyincomewithmy
retirementcorpus,IfIretiretoday?
LetuscallthisXyears.
4. AmIincreasingthisXyearsbyatleastoneyearforeachyearthatIwork?
Thisisthetrue
measureofaretirementportfolio.

~~~~~~~~~~~~~

Endnote: Attheendofthedayhowsuccessfulwearewithourfinancesisdecidedbyhowmuch
moneywehavewhentheneedarisesatwhichpointXIRRorCAGRorIRRorwhateverwewishto
callitmatterslittle.Allwecandoismakereasonableassumptions,investinproductiveassetswhich
ispartofadiversifiedportfolioandhopeforthebest!

 3.Howtofortifyyourfinancialcastle
Lifeinsurance,healthinsurance,accidentinsuranceandcriticalillnessinsurancearetailormade
fortificationproductsthathelpafamilytackleunpleasantandunexpecteddevelopments.Beit
expensesduetohospitalization,orlossordecreaseinincomeduetodeath,accidentoracritical
illness.Irefertothemasfortificationproductsbecausetheyprotectthefamilieslongtermgoals
likeretirement,childrenseducation,marriageetc.Theyprotectbyminimizingthechanceof
redeemingthecorpusmeantforthesegoals.Theyprotectbyminimizingthechancesofinterrupting
thecompoundingofthecorpus.

Herearesomethoughtsonthefortificationprocess.

EmergencyFund
Aemergencyfundisalsoacrucialfortificationstepbutwedonothaveatailormadeproductforthis
andnorisitnecessary.Aslongaswecanfindawaytoreplenishtheemergencyfundwhenitis
used,whereweputthefundisprettymuchirrelevant.Ofcoursethechoseninstrumentmustbe
liquid.

Theproblemistheamount!(seebelow)

PureTermLifeInsurance
ThosewhorealizeatermplaniscrucialeitherchoosetoseekaoneCrorepolicyorworryabout
the
howmuchinsurancecoverisrequired .

Unfortunatelybothapproachesdonotcountformuchbecausetheinsurerhasanupperlimit
typicallybasedonanindividual'sincomeandriskprofile.

Therefore,Ithinkitwouldbebesttoidentify2/3insurersoneiscomfortablewith,writetothem
withbasicprofiledetailsanddeterminethemaximumcovertheyarewillingtooffer.

Thenwriteanactionplan:HowmuchshouldIallocatefor

1. squaringoffliabilities
2. inflationprotectedincomeandforhowmanyyears(perhapsuntilthekidsareoldenoughto
work
3. generatinganinflationprotectedsumforschoolfees(includingtrainingandcoaching
classes)
4. collegefees
 5. marriageexpenses(ifpossible)

UsetheComprehensiveChildplannertoworkthisout:
Howtoplanforyourchildseducationand
marriage

Remember:havingatermplanisgoodbutwhatifyournomineebuyswrongproducts?Sopreparean
actionplananddiscussitwithyournominee

Understandhowbestthemaximumeligiblesuminsuredshouldbedistributedamongthesebuckets,
writeitdownanddiscussandgivecopiestoyournomineeandsomeoneelseyoucantrust.Besure
toincludethenameofafeeonlyplanner(seelinkonthetopright).

Askyournomineetocontactthefeeonlyplanner,ifneeded,assoonasyouarereadytosubmitthe
claim.Theyshouldbeabletoguidethroughtheclaimsettlementprocess(forafeeofcourse)and
allocatethesumintodifferentbucketsasperyourplan.

Alsosee:
ThingstodoAFTERyoutakeaterminsurancepolicy!

HealthInsurance
Havingahealthcoverisindispensable.Howeveritisimportanttorecognizethatcashlessclaimis
moreofaprivilegethanaright.Reimbursementisaright.Sodonotbesurecashlesswillbe
approved.Meaningyouneedmoneymuchmorethan12timesmonthlyexpenses!

Emergencyfund
isalongtermgoal.Itisaninsatiablemonsterwhichneedstobefedconstantly.

Readmore:
HowLongShouldIMaintainanEmergencyFund?

Printthenecessarystepstobecompletedbeforeandafterhospitalizationandstoreitalongwith
theinsurancepolicyandcard.Itwouldbebetterifthespouseandothermembersreadit.

AccidentInsurance
Thisisamusthaveforprofessionalsandthoseinthecutthroatcorporateworld.

Theproductisrathercomplex.Theclaimwillbepaidinfullonlyforcertaintypesofaccident.All
otherswouldonlygetsomepercentageofthesuminsured.

Alsoonedoesnotneedtosufferanaccidenttoloseincome.Therearemanyotherailmentswhich
wouldrenderapersondisabled.
HowmuchaccidentinsuranceshouldIhave?IfIdie,familyexpensesmightdecreaseasIamno
longeraround.

IfIamrendereddisable,myfamilyexpensesarelikelytoincreaseandsharply.Soanaccidentcover
shouldbehigherthanatermcover.

Unfortunatelythisisrarelythecase.

Gettinganaccidentinsurancepolicyfor10,20,30Lisinadequate.

Noteveryonewillgethighcover.Itdependsontheincomeandthekindofjob

Thebiggerproblemisthatmanyinsurersofferquitelowcover.ThemaxcoverIhaveseenis1Crore
fromTataAIG.

Theonlyupsideisthatthepriceofsuminsuredoftensoflakhsisquiteinexpensive.

StayawayfromanygroupinsurancepolicyofferedbyBanks.

CriticalIllnessInsurance
Againacomplexproduct.Youneedtogetcriticallyill(andnotdiewithinamonth)
inacertainway.

Seemore:
CriticalIllnessInsurancePolicies:DoYouReallyNeedOne?

AgainthesuminsuredinmostCIproductsisnotaslargeasatermplan.Butthepolicyismuchmore
expensivethanatermplan.

IwouldprefertobuyaCIcoverifthereissomehistoryifCIinmyfamily.Butthenagain,doyoustop
withfirstcousinsorsecondcousins?SearchhardenoughandeveryfamilywillhaveCIcase!

Ifallourinvestiblesurplusgoestoinsurancepolicies(thatdonotofferbonuses!)wherewillwe
havemoneytoinvestforourfinancialgoals!

Soweeitherbuyalltypesofpoliciesforlowcoveroravoidcertaintypesofpolicies(CIoraccident
thatis.Restaremandatory).

Alaseitherwayitisnotaneasydecision.

Perhapsonecouldbuyabout30Lofaccidentcover,30LofCIcoverandgetashighatermcoverand
mediclaimaspossible,butthetotalpremiumwouldbecloseto1Lfora30something.
Ifwearelucky,dontgettousetheCIandaccidentpoliciesandthehealthcoverrarely,wecanfocus
oninvesting.

Ifweinvesttothebestofourabilityinproductiveassets,hopefullywewouldhavemorethan
enoughtohandle unexpectedbigticketexpenses acoupleofdecadeslater.Buildingarocksolid
fortificationtakestimeandluck.Lotsofboth

4.HowtoBuyaTermLifeInsurancePolicy
Buyingatermlifeinsurancepolicybasedonaninsurersclaimsettlementratio(CSR)isameaningless
exercise.Allitdoesisofferpsychologicalcomforttothebuyerwhorefusestounderstandthateach
death,andthereforeeachclaimsettlementisunique.Whenanomineeappliesforaclaim,the
insurersCSRisirrelevant.
Thatsaid,whenayoungearnerwantstoknow,whichpolicyshouldIbuy?,orhowtochoosea
termpolicy?,wetypicallysay,chooseaninsureryouarecomfortablewith,justbehonestwhile
applying.
Unfortunately,Ifindthatthisisnotofmuchuse,asthepersonstillneedsasimplewaytodefinea
comfortzoneandshortlistinsurersinsidethezone.Thehonestypartisofcoursealwaysrelevant!
Therefore,inthispost,muchasIdonotlikeit,Iwouldliketoproposeasimpleway,basedonthe
CSR,toshortlistinsurersforpurchasingatermplan.
Thewholeprocessshouldtakeyounomorethan1530minutes.
OnegoodthingthathascomeoutoftheCSRhypeisthattheinsurers(inclLIC)havealsofallenforit!
SomemakeitapointtoflaunttheirCSR.Thismightbeagooddevelopmentfromthe(future)
customerspointofview.IftheCSRdrops,insurershavebeguntorealisethatitcouldimpactimage
andthereforesales.

DeconstructingIRDAsDeathClaimSettlementTable
First,letustouchuponaspectsfromIRDAsdeathclaimsettlementtable,obscuredbytheclaim
settlementratio.
Letmestartwithananalogybetweenaninsurerandateacherevaluatinganswerscripts.Asthe
teacherstartsevaluatingscripts,he/shegetsasenseofwhattheaveragemarkoftheclasswouldbe.
Whenastudentscoreslittleornomarksinthefirstfewquestions,theteacherrealizesthatthetotal
markwouldbemuchlowertheclassaverage.Therefore,thetendencywouldbetobeabitgenerous
inthenextfewquestionssothatthetotalisbolsteredabit.
Ontheotherhand,ifthefirstfewquestionsarewellwritten,thetendencywouldbetoscrutinize,
thewholepaper(!)abitcloser.Thisisnormalhumantendencyandevenateacherwithnopressure
fromtheadministrationislikelytodothis.
Whywontaninsurerwhoreceivesabigticketclaimscrutinizeittougher?Afterall,thereismuch
moreatstake.
Thepointis,LICorprivateplayers,nooneislikelytooffertermcoverclaimsettlementonaplatter.
Ofcourse,thereisadueprocessclearlymandatedbyIRDA.
ThefollowingisascreenshotfromtheIRDAannualreport201011(clicktoenlarge).

Troubleis,whataclaimantconsidersadelayandwhatislegallyallowed,aretwodifferentdurations!
Thereisacrudewaytopointoutthathighertheclaimamount,higherthescrutiny,resultingpossibly
inarepudiationordelay.
TheclaimsettlementtablepublishedbyIRDAhasthetotalbenefitamountalongwiththenumberof
claimsintimated,pendingandrepudiated.
Thisisascreenshotfromtheindividualdeathclaimstableofthe201213annualreport.Theentries
havebeenmergedwiththecolumnheadingstoaidreading.

Thebenefitamountperclaimwhencomparedovertimecanshedsomelightontheaverageclaim
amounthandledbytheinsurer.Ofcourse,thisratioisnotasoundwaytomakeanysolidinferences.
Letushoweverrunwithitandseewhereittakesus.Beforeyoupanmeinthecomments
section,rememberthatIacknowledgedthis!

Theclaimamount(Lakhs)intimatedperpolicywas0.73wasLICin200607and1.58forprivates.
In201213,thisincreasedby36%forLICandnearly33%forprivates.Itmustbekeptinmindthatthe
numberofprivateplayersincreasedbyabout50%inthisperiod.
Thus,thereisasignificantincreaseintheclaimamountperpolicyhandledbyLIC.
Evenmorestrikingisthe78%increaseinthebenefitamountperrepudiatedclaim(1.08to1.92).
Howwouldyouinterpretthat?
Fortheprivates,thebenefitamountperrepudiatedclaimhasincreasedbyawhopping95%(2.08to
4.05).
ForLIC,theclaimamountrepudiatedperclaimcanonlyincreasefromnow(theiretermpolicyis
onlyonereason).Fortheprivates,Ithinkitshouldcomedowninthefutureoratleastnotincrease
sodramatically.
Onecouldarguethatthenewinsurerswouldhaveprocessedearlyclaimsandhencewouldhave
scrutinizedstringently.However,letusreadtoomuchintothis.
Simplybecauseitisclearenough(evenwithoutthisdata)thattheprivatesarelikelytoscrutinize
claimstougherthanLIC.
Thiscanalsobeseenby
1)comparingbenefitamountperclaimpaidwithbenefitamountperclaimintimated.Theseare
comparableforLIC.Fortheprivates,thebenefitamountperclaimpaidisalwayslowerthanthe
benefitamountperclaimintimated.
2)Privateshavemoreclaimspendingattheendoftheyearthanthestartoftheyear(notshown).
TheconverseisobservedforLIC.
Thenumberofpendingclaimsatthestartoftheyeardecreasedfrom9574in200607claimsto8856
claimsin201213forLIC.Whileitnearlydoubledfortheprivates,primarilybecausethenumberof
suchlifeinsurershaveincreased.
Noticethattheamountperclaimpendingatthestartoftheyearhasdoubledforprivates,from
200607to201213,eventhoughthedenominator(numberofclaims)hasnearlydoubled(from1894
to3467in201213).
Whenthedenominatordoubles,theratiocandoubleonlyifthenumerator(benefitamount)
quadruples!
ThisimpliesthattheprivatesarehandlingmuchhigherclaimamountsthanLIC(notmuchofa
finding!).Onecouldarguethatthisisthereason,theirCSRislower.
Evenifyoudontwishtomakemuchoftheseratios,Ihopethatyouagreewithmycontentionthatif
theclaimamountisbig(asinaterminsurancepolicy),LICtoowouldscrutiniseitcarefully.Simply
becausesuchanamountwouldbehighertheaverageclaimamountstheyprocess.

Claimsettlementratio
Claimsettlementratioignoresthe
1)natureofthepolicy.LICtypicallyhasahighernumberofsmallticketclaims.
2)thetimeittakestosettle.Itcantakeuptosixmonthsorevenmoretosettleaclaim.Aslongasa
claimissettledwithintheFY,itwillbecountedforcomputingCSR.Fromanomineespointofview,
thatisadelay.
Considerthis:
In201213
LICsettled7.33lakhclaimsoutof7.51lakhclaims.Aclaimsettlementratioof97.7%
Theprivatessettled1.13lakhclaimsoutof1.27lakhclaims.Aclaimsettlementratioof88.6%
(incidentallyasignificantimprovementfrom72.7%in200607 despite
a50%increaseinnumberof
privatepl.ayers)
Now,iftheprivateshadaCSRequaltothatofLIC,theyshouldhavesettled1.24Lakhclaims(instead
oftheactual1.13Lakhclaims).
Thisislessthan10%off.ThisisapproximatelythedifferencebetweentheCSRs,butwhenyoulook
atitthisway,Ithinkitdoesnotappearsobad!
Ifyouareworriedaboutthis,thenyoushouldhaveenoughmoney(includingpossibleloadingifany)
toaffordanLICpolicy(offlineoronline).
Ifyoudont,whybother?!
Isuggestyoupickaprivatelifeinsurerwhohasbeenaroundforatleast10years(withnoplans
toleavecheckrecentnewsreports)withaCSRcloseto,orabovethetotalprivateaverage.
Evenbetter,iftheinsurerhasaCSRhistoryconsistentlyhigherthanthe
current
privateaverage.
Itwilltakeyoulessthan30minutestoaccesstheIRDAreports,locatetheIndividualdeathclaims
tableandscanthenecessarynumbers.
Onceyoucanshortlist23insurers,comparethepriceforapolicy(withoutloading,butinclusiveof
servicetax)usingthepremiumcalculatoravailableattheirwebsites.
Choosethecheaperamongthetwo.
Applyimmediately.Donotaskanyoneelseforanopinion.

5.HowtoBuyaHealthInsurancePolicy
Itisfrustratingtoseeindividualshavingdifficultyinchoosinginsurancepoliciesbeitlife,healthor
accidentinsurance.Theirmindsareclutteredwithsomanyproductfeatures(somenecessaryand
othersnotso)thattheykeepdelayingthepurchase.

Hereisastepbystepguidetopurchasingahealthinsurancepolicy.Iamnoexpertonthesubject.I
amwritingthispartlyfromexperience(3claims+handlingmultiplehospitalizations)andpartlyfrom
onlineinformationaccruedoverthelastfewyears.

Iwroteaversionofthispostsomemonthsback,butdidnotfeelenthusedtopost.AfterJignesh
AcharyasuggestedIwriteaboutthisin,facebookAsanIdeasforWealth(AIFW),Iwouldliketogiveit
anothershot.

Firstletusdecideonthetypeofproduct.

Floaterorindividualplans?
Chooseindividualplansforallmembersifyoucanaffordit.Eachpersonsriskprofileisdifferentand
therecouldbemultiplehospitalizationsinayear.Mostinsurersfixthepremiumbasedontheoldest
personinthegroup.Steerclearofthisandgetindividualplans.

Forseniorcitizensindividualplanismandatory.Getthesameforyoungermembersifyoucanafford
it,afteralltherearetaxbenefits!

Nowletusask,

Whataretheessentialfeaturesofanidealhealthinsurance
policy?
1)NosublimitsonroomrentandICU.

Sublimitscanbeapainiftheroomrentisquitesteep(typicallyinNorthIndiaandnotinSouth
IndiaaslearntatAIFW).IftheroomrentevenforanonACsingleroomisquitehigh(arelative
notion),havingnosublimitsiscrucial.

Everythinginlifeisatradeoff.Nosublimitsimpliesahigherpremium.
Iftheroomrentsarenominal(severalhospitalsinChennai),Iwouldrecommendapolicywith
sublimits,typicallysoldbyPSUcompaniesUnitedIndia,NewIndiaandOrientalInsuranceCos.

Getapolicyforasuminsuredashighaspossibleinitially,andbesuretoincreasethesuminsuredas
muchaspossibleeachyearuponrenewal.Ihavebeendoingthisforthepast9years.Ihave
individualcoverforself,wife,sonandmotherfromUnitedIndia.

2)Noincreaseinpremiumifaclaimismade(akaloading).

ThankfullyIRDAhasmandatedthatthereshouldbenoclaimbasedloading.Seepage83(last
line)
here

(NikhilVermasharedthisatAIFW)

Theloadingonrenewalsshallbeintermsofincreaseordecreaseofpremiumsofferedforthe
entireportfolioandshallnotbebasedonanyindividualclaimexperience.

AccordingtoNikhil,portfolioherereferstotheentireclientbase.Twoindividualsofthesameage
cannothavedifferentpremiumsbasedontheirclaimexperience.

Tradeoff:Higherpremiumfromthestart!

PleasecitetheIRDArulingandconfirmwiththeinsurer,NOTtheagent.

NikhilVermasharedthefollowingpolicywordingsofL&Tinsurance

BasedontheexperienceoftheProduct,Premium,TermsandConditionsmayberevisedsubjectto
priorapprovalofInsuranceRegulatoryandDevelopmentAuthority.Suchrevisionshallbeintimatedto
you3monthsinadvancewithanoptionofrenewalunderanysimilarPolicybeingissuedbyus.
However,benefitspayableshallbesubjecttothetermscontainedinsuchother
Policy.IndividualClaimsexperienceloadingisnotapplicableunderthePolicy.

ICICILombardalsohasasimilarpolicyasconfirmedbyNikhil.

3)NoCopayment

Theinsurershouldnotshiftpartoftheclaimexpensestothepolicyholderbyprearrangement.
Sincenocopaymentimplieshigherpremium,itmightbeokaytoacceptcopaymentinthecaseof
veryseniorcitizens.

4)Minimumexclusionperiodforpreexistingdiseases
TheminimumtenurethatIhaveheardofis2years.Themaximumis4years.

Thisisimportantforeveryone,eventhosewhodonothaveanydiseasesatthestartofthepolicy.If
adiseaseisdiagnosedsay,after6policyyears,theadditionalsuminsured(ifany)willbeeligible
onlyaftertheexclusionperiod.

Tradeoff:againprice!

5)Lifelongrenewability

IRDAhasmandatedthatallinsurersshouldprovidelifelongrenewability(seepages78bottom
paraandpage79firstparaintheaboveattachment)

Sothisisnotanissue.Besttoconfirmwiththeinsurerthough.

6)MinimalExclusions

Againobviousbutdifficulttocompareoneinsurerwithanother.Readtheexclusionslistafter
makingashortlistandcheckifanyhereditaryorexistingconditionisexcluded.

Tradeoff:probablyagainprice.

~~~~~~~~~~~~~~~~~

Inmyopinion,ifapolicyissatisfactoryintheabovesixareas,itwillmakemyshortlist.

Nowthatwehavecoveredthecoreofthepolicy,letuslookatthewindowdressing.

WindowDressing
Insurersrewardpolicyholdersifnoclaimarisesbyeitherofferingadiscountonthepremiumorby
increasingthesuminsured.

Noclaimbonus:

Ifthesuminsuredincreaseseachyearby5%foreveryclaimfreeyear,itwillalsodecreasebythe
sameamountwhena
claimismade.Seepage80ofaboveattachment.Pleaseconfirmwiththetheinsurer.

Thepremiumwilltypicallyincreaseupto50%ofthesuminsuredandnofurther.
Noclaimdiscount:

Foreachclaimfreeyear,thereisadiscountinthepremiumwhenthepolicyisrenewed.

Whichisbetter?

Ipreferthenoclaimdiscount.Itissimpler.Ihaveseenmanypeoplewhodonotincreasethesum
insuredeachyearandrelyonlyonthebonusfromclaimfreeyears.

Itdoesnotmatterwhichyouchooseaslongasyouincreasethesuminsuredbyasmuchaspossible
eachyear.

RestoreBenefit

Whatabouttherestorebenefitthataninsureroffers?

Readthefineprintandwritedownatypicalsituationinwhichtherestorebenefitwillbeuseful.If
youthinkitisuseful,shellouttheextrapremium.Idontthinkmuchofitthough.

MaternityBenefit

Neverbuyapolicybecausepregnancyiscovered.Dumb!Payforhappy(Godwilling)nonrecurring
visitstothehospital.Rememberthetradeoffmentionedabove.

OutpatientCover,DentalCover,Spectaclesandothergoodies

Readthefineprint.Areyouwillingtochangedoctorsthatyouknewforagesjusttogetthisbenefit?

Sonowhowdoweshortlistpolicies?
1.
Checkouthospitalsnearyourneighbourhoodforroomrentratesandiftheyacceptcashless.This
willhelpyoudecidewhetheryouneedapolicywithnosublimitsornot.Whethertheyaccept
cashlessornot,startmobilizingfundsforamedicalemergencycorpus.Neverforgetthatcashlessisa
privilegethatneednotbegranted.

2.
Decideonyourbudgetandonwhetheryouaregoingtochooseafloaterpolicyorindividualpolicy.
Youcanusethepremiumcalculatorofanyinsurertogetanidea.

3.
Sublimitsandbudgetshouldhelpfilteroutmanypolicies.
4.

Chooseyourpoison.
IpreferPSUs.Nologicbehindthat.Justadeeprootedmistrustofprivates,
regulatorornoregulator.

Ifyoulikeprivates,findoutwhoownsthecompanyandhowoldtheyare.Isuggestchoosingaplayer
whoisatleast10yearsold.

5.
Afewyearsbackpolicycomparisonportalswereuserfriendly.Nowadaystheyareannoyingtouse
andsomedonotlistcertainpolicies.Bettertostayaway.

6.

Howaboutbuyingviaanintermediarylikemedimanage?IfIwanttobuyfruit,Iwouldliketopick
andchoosethefruitsIneed.Iwillnotleavethechoicetothefruitseller.

Whatabouttheirhelpduringclaimprocessing?

Overrated.Rulesaresimpleandlaidoutclearly.IfIdontorwontreadrules,Idontdeserve
insurance.

7.

Onceyousingleout23insurers,readtheirpolicydocumentsandcomparefeaturestosingleout
yourfutureinsurer.

8.
Nowyouwillneedtotakeacall.Insurancebuyingisallabouttakingarisk.Itishoweveramuch
lowerriskthannothavinganyinsurance.Youneedconfidencetochooseaninsurer.

9.
Neveraskothersabouttheirclaimexperienceoraskwhichisthebestpolicytobuy.Thatisa
onewaytickettodespair.

Allthisshouldbedoneoveroneweekend,withinabout23hours.Thelongerittakes,themore
confusingitbecomes.

6.SayNOtoPackagedFinancialProducts
Wealllikesolvedproblems.Rightfromschool,whenfacedwithaquestion,manyoftendtosearch
foranexampleproblem,sothatweknowhowtoproceed.Whenitcomestopersonalfinance,
solvedproblemsorreadymadefinancialproductspackagedforaspecificneedcanbedisastrous.

Someexamplesarethepensionplan childplan
and offeredbyinsurersandmutualfundhouses.
NowCafemutualreport
s
thatmanymoreretirementlinkedmutualfundsareontheanvil.During
thePPFASunitholdersmeet,RajeevThakkarmentionedthatsuchplansmightreplaceELSSSmutual
funds.

until
Ifthathappens,usesuchplansonly youneedtaxbreaks(Iamassumingthatreturnsfromsuch
fundswouldbeatPPFaftertax).Chooseonewiththelowestexpenseratiosincesomeofthese
fundscouldhaveaninsurancecomponentlinkedtothem.Sobesttochooseonewithoutaddons.

Wanttohearadumbquote?(fromaboveCafemutuallink)

Sharingtherationalebehindofferinganinsurancecoverwiththeretirementplan,(Dinesh)Khara(CEO
SBImutual)toldCafemutualthatitwillhelpinvestorstosaveforretirementalongwithprotectingtheir
life.Wewanttoprovideonestopsolutionthroughourretirementplan.Wehaveobservedthatmany
investorswanttosaveforretirementbutduetootherpreferenceslikelifeinsurancetheydelay
investingfortheretirement.

Duh!Mostpeopledontdelayinvestingforretirement.Theyjusttaketheeasyrouteandbuydud
pensionplansofferedbyinsurers(inclSBIlife!).

Butwhy?Whyshouldonesaynotopackagedfinancialproducts?

Thefirststeprequiredisachangeinmindset

ToquoteSubra,fromsavingforretirement,peopleshouldstartinvestingforretirement
Inflationshouldberecognisedastheenemybutalsothebenchmarkforalllongtermgoals
andnotjustretirement.
Theconceptofapensionoranannuityshouldbeeradicatedfromthemindsetsofyoung
investorsfarawayfromretirement.Sinceinflationistheenemy,aconstantincomein
retirementistheverylastthingyouneedinretirement

Nextaskthefollowingquestion:

WhatistheposttaxreturnIamlikelytogetfromthesepensionplans?FortheamountthatIcan
investeachmonthforretirement,isthatreturnenoughtogetmealargeenoughcorpus.Large
enoughcorpusheremeans,largeenoughtogenerateanincomethatcanbeincreasedatarateequal
totheprevailinginflation.

Noneofthepensionplansofferedbyinsurerscandothis.Dontexpectthemutualfundplanstobe
verydifferent.

Inanycase,youcannotcreatewealth(haveenoughforretirementplusalittleextra)withany
pensionplan.SEBIwillmostlikelylimittheexposureinthesefundsandmyguessisthattheywould
resembledebtorientedbalancedfunds.Dontthinkthegainswouldbetaxfreeliketheinsurance
product.Ithinktheyshouldbetaxedlikedebtfunds(goodnewsformeasmymandatoryNPScould
alsobetreatedsimilarly).

Apackageproductsoldasatailormadesolutionislikelytohavealockinandexitload.

Thequestiontoaskis,whybuysomethingofftheshelfwhenyoumakeabetterproductonyour
own.Subrahasawonderfulnameforit:
theretirementbasket.

Puttogetheranaggressivebasketthatisfilledwithaproductiveandliquidasset:equity.Youcan
usethecorpuswhenyouwant(earlyretirementoradireneed),andhowyouwant:generatean
inflationproofincomewithpartofit,whiletherestgrowsatadecentpace.

Thesameargumentsliquidityandflexibilityworkforlongtermgoalslikeourchildrens
education.Somepeopleinvestinplansinwhichthemoneyislockedinuntilthechildis18,
forgettingthattheirchildmightgraduatefromschoolatage17!

This
BuyNothingDay
*
,resolvetostayawayfromallpackagedfinancialproductsforever.

7.RetirementPlanningASlideShow
1.Imaginehowyourmonthlyincomewillevolveinthefuture

Theabruptstoppageinincomerepresentsretirement.

2.Nowimaginehowyourmonthlyexpenseswillevolveinthefuture

Obviouslyexpensesdonotstopwhenincomestops.Sothosewhodonothavethemeanstoaccount
forexpenseswhenincomestops,betterhopetheyaredeadonorbeforeretirement!
Theexpensesintheabovegraphseemtoheadfortheroof.Letusrescaleitoverourexpected
lifetime.

Inabout15yearsafterretirement,themonthlyexpenses,thankstoinflationishigherthelastdrawn
pay!
Meaning,ifIhadan(imaginary)monthlypensionthatequalsmylastdrawnpay,Iwillonlybe
financiallyindependentforabout15yearsafterretirement.Soweneedtodoalotbetter!

Thesadtruthisactualpensions(beitfromapensionplanoremployerprovidedannuity)aremuch,
muchlowerthanthelastdrawnpay.Somethinglikethis.

Therefore,foryourownsake,eradicatetheconceptofapensionfromyourminds.
Instead,think:

Inflationprotectedincome

(bluedotwithintheredcircles,below)

Togeneratethisinflationprotectedincome,youneedacorpusthatisabout300timesyourcurrent
annualexpenseorabout3538timesyourannualexpensesatthetimeofretirement(theearliest
greendot).Asyouwithdrawmoreandmorefromthecorpus,itdecreasesanddropstozero
hopefullywhenyoudie,andonlywhenyoudie.Ensuringthis,isthe
thirdstage
inretirement
planning.
Thesecondstageistoensureourinvestmentsgrowandhitsthefirstgreendot,whenweretire.

Weneedtodotwothingstogrowthecorpus.1.Chooseaproductive,butdiversifiedportfolio;2.
Invest

Onecannotchoosetoinvestaconstantsumbecause,themonthlyinvestmenttobemade
y
immediatelywillbemuchlargerthanmonthlyexpenses.Theabovegraphhasalogarithmicaxis
andhencethelinesappearlinear.
Toeaseourburden,wecaninsteadchoosetoincreaseoutinvestmenteachyearfromnowuntil
retirement.

Thiswouldimplywemuststrivetoinvestasmuchasspend.
Thisiseasiersaidthandone.Letushavealookatthesecondgraphagain

Inthispicture,thegapbetweenthemonthlysalaryandmonthlyexpensesincreasesasweapproach
retirement.Ifthisishowourlivespanout,thenwecanmangetoinvestasmuchaswespendwitha
littleeffortanddiscipline.
Unfortunately,

Ourexpensestendtogrowinstepsasshowningreenabove.Callitlifestylecreepifyoulike.Ifwe
embraceeverynewtechnologythatarrives,ifwecannotdistinguishbetweenourneedsandwants,
ifwesuccumbtopeerpressureandbuywhatothersbuy,wewillneverbeabletoinvestenough.
Meaning,wearesowingtheseedsforourfuturefinancialdoomtoday.
Lifestylecreep,thedesiretospendsfortodayandenjoywhenyoung,residesinallofus.Whatis
neededisadefiniteboundary:Wecanspendtheway,wewishaslongaswecanmanagetoinvestas
muchaswecanspend.
Safeguardingthatboundaryisthefirstandforemoststepofretirementplanning.

8.UnderstandingHowRetirementCalculatorsWork
Thefirstbrushwitharetirementcalculatoristypicallymemorable,ifnotunforgettable(!)forpretty
muchallinvestorsincludingoneswhodonottakethemseriously.

Thetypicalresponseswouldbe,

WhydoIneedsuchahugecorpusforretirement?
Howdoyouexpectmetoinvestthishighanamounteachmonth?

Hereishowretirementcalculatorsgoaboutcalculatingthecorpusandmonthlyinvestmentrequired.

Foreaseofunderstanding,Iwillconsiderthecaseofa55yearoldman,5yearsawayfrom
retirement.YoucaninputdesiredvaluesintheattachedExcelsheet.

Soheregoes,

Name:
CaptainHaddock

Age:
55

Yearstoretirement:
5(age60)

th
Yearinretirement:
5(Hedoesnotexpecttoseehis65 birthday,thankstoalivelongassociation
withthebottle!)

Currentannualexpenses:
Rs.5,00,000

Inflation:
10%

Netposttaxrateofreturn
fromtheCaptainsportfolio(equity+debt):10%

Annualincreaseinmonthlyinvestment:
10%

st
Expensesinthe1 yearofretirement:

Age60

Expenses:
E=Rs.8,05,255
1

Letustreatthisasanindependentgoal.

CaptainHaddockmustinvestanamount
XsoastohaveRs.8,05,255after5yearswithareturnof
1
10%andmonthlyinvestmentsincreasingeachyearby10%.

X=Rs.8,333(seeimage;ignorerightmostcolumn)
1

Expensesinthe2ndyearofretirement:

Age61

Expenses:
E=Rs.8,85,781
2

Treatingthisagainasanindependentgoal,wedeterminetheamountofinvestmentrequired,
X
2
(10%return,monthlyinvestmentincreasingeachyearby10%)7

X=Rs.9,167(seeimage;ignorerightmostcolumn)
2

Similarly,

E=9,74,359and
3 X=10,083(expensesfor3rdyearinretirement)
3

E=10,71,794and
4 X=11,092(expensesfor4thyearinretirement)
4
E=11,78,974and
5 X=12,201(expensesfor5thyearinretirement)
5

initial
Thetotal monthlyinvestmentrequiredis,

X+X
1 +X
2 +X
3 +X
4 =50,876(seeimage;tworedrectangles)
5

Thisinvestmentisassumedtoincreaseeachyearby10%.

Thetotalcorpusrequiresis,

E+E
1 +E
2 +E
3 +E
4 =49,16,162(seeimage;twobluerectangle)
5

if
Thisisthecorpusrequired
isnotinvestedanywhere.

Thusintheabovescenario,eachyearinretirementistreatedasanindependentgoal.

Obviously,wecandobetterthanthis.

netposttaxreturn
Thecorpusisinvestedsothatitearnsa of10%(forthesakeofillustration!),and
atthestartofeachyearinretirement,asumequaltotheexpectedmonthlyexpensesisredeemed.
Therestofthecorpusisallowedtogrow.

Forexample,atthestartofthefirstyear,asum,
E=Rs.8,05,255isredeemed.Atthestartofthe
1
secondyear,asum,
E=Rs.8,85,781isredeemedandsoon.
2

th
Attheendofthe5 yearinretirement(thedurationassumedintheexample),thecorpusisreduced
tozero(blackrectangleintheimage).

backcalculated
Usingtheseassumptions,thecorpusrequiredis tobeRs.40,26,275(orangerectangle
intheimage).

Noticethatthecorpus

Hasreducedfrom49,16,162to40,26,275.ObviouslybecauseCaptainHaddocknowchoosetoinvest
thecorpus!

9.Generatinganinflationprotectedincomewitha
lumpsum
Givenalumpsum,howdoweinvestitinordertocreateareliableincomestreamthatisriskfree
andhastheabilitytokeeppacewithinflation?

Thisisthemostcrucialquestionthatconcernseverypersonwhoisretired,nearingretirement,or
planningforsomeoneelsesretirement(aclientoraparentperhaps).Well,atleastitoughttobe!

Theanswerconcerns
everyone
sinceweallhavetoanswerthisquestionatsomepointinourlife.

ThispostisanoffshootofadiscussionwithVigneshBhaskarinAsanIdeasforWealth,FBgroup.Not
muchinformationisavailableoninflationproofpostretirementinvestmentstrategiesforthe
Indianscenario.Letustryanddiscussthisherefromtimetotime.

Mostquestionshavemorethanonesolution.Thisisnodifferent.Therearemanywaysofcreatinga
reliableinflationprotectedincomestream.Inthispost,Iwilldiscussonlyonesuchway.

Thebestwaytodothisisviaanillustration.

LetussaythatIamaretiree,aged60,withRs.30,000monthlyexpenses(involvingonlytheretiree
anddependents)orRs.3,60,000peryear.Perhapsatouchonthelowerside.

Imakethefollowingassumptions

Inflationthroughouttheretireelifetime:8%
Inflationprotectedincomerequiredfor:25yearsThatisupto85years.Perhaps30years
wouldhavebeenbetter,butletusworkwith25.
Mediclaim:Available.Premiumexpensesincludedintheannualexpenses.
Emergencyfund:Available.Asumequalto1yearsexpenses.Thisisnotpartofthe
retirementcorpus.

Nowwewillneedto
calculatethecorpusrequired

IhaveassumedthatIpayaflat10%taxonallinvestmentsthroughoutmylifetime.Thisisindeedan
oversimplification.Unfortunately,wewillneedtousethis,asitwillbeconfusingtoconsiderother
possibilities.
Aposttaxreturnof8%mayseemabitunrealistic.However,ifaretireeinthe10%taxslaboptsfor
fixeddepositsoffering9%forseniorcitizens(currentrates),theposttaxreturnisabout8%.

Usingthe
annuitycalculator
,wedeterminethecorpusrequired

Inputs

Payoutrequiredinthefirstyearofretirement:Rs.3,60,000

Inflation:8%

Posttaxreturn:8%

Duration:25years

Output

Corpusrequired:
Rs.90,00000orRs.90Lakhs

IfIhaveanamountclosetothisorhigherthanthis,Icanrelax.

WhatifIhaveacorpuslessthan90Lakhs?WhatshouldIdo?

Inordertoanswerthisandthequestionposedintheopeningsentence,letusfirsttryto
understand whyIneedRs.90Lakhs
giventheotherinputs.

IfIdividethis90Lakhsinto25parts,eachpartisequalto3.6Lakhs.ThisisjusttheamountIneedfor
meetingmyexpensesinthefirstyearofretirement.

Ikeepasideonepartformeetingthefirstyearsexpenses.
Ithenopen24fixeddeposits.Eachmaturingoneyearaftertheother.ThatisthefirstFDwill
matureafteroneyear,thesecondFDaftertwoyearsthelastFDafter24years.
Whenthe1stFD(investment=3.6L)matures,Iwillget3.88Lenoughtomeetexpensesinthe
nd
2 yearofretirement(hereexpenseshavebeeninflatedby8%)
nd
Whenthe2 FD(investment=3.6L)matures,Iwillget4.19Lenoughtomeetexpensesin
the3rdyearofretirement(hereexpenseshavebeeninflatedby8%)
..
..
Whenthe24thFD(investment=3.6L)matures,Iwillget22.8Lenoughtomeetexpensesin
th
the25 yearofretirement(hereexpenseshavebeeninflatedby8%)

HereisanillustrationwhichexplainswhyIneed90L

SupposeIdonothave90L.CanIworkwithalowercorpusandyetmangetogenerateinflation
protectedincome?

Toacertainextent,itispossible.Ofcourse,asmustbeobvious,onewillneedtogenerateahigher
rateofreturn.Thisimpliestakingonsomeriskwithapartofthecorpus.
Inordertounderstandthis,wewillneedtodiscussaboutthesocalled
bucketstrategy

Thebestwaytodothatistousetheabovenumbers.

Insteadofopening24FDs,Icanachievethesameresultinadifferent.

st
Ikeepaway3.6Lforthe1 year.
Iopen4FDfor3.6Lmaturingoneyearafteranotherasmentionedabove.
Thiswillgivemeinflationprotectedincomeforthefirst5yearsinretirement.
Thisiscalled
incomeladdering (alsooneformofFDladdering)

Iinvest18LinanFDthatmaturesin5years.Letuscallthis
bucketI

Iinvest18LinanFDthatmaturesin10years.Letuscallthis
bucketII

Iinvest18LinanFDthatmaturesin15years.Letuscallthis
bucketIII

Iinvest18LinanFDthatmaturesin20years.Letuscallthis
bucketIV

BucketIwillmatureto26.44L.Ithensplitthisupinto5parts,keeponeformanaging
th
expensesinthe6 yearofretirementandusetheremainingpartsformanagingexpensesin
years7to10byincomeladdering.
Similarly,
bucketIIwillmatureto38.86L.Ithensplitthisupinto5parts,keeponefor
th
managingexpensesinthe11 yearofretirementandusetheremainingpartsformanaging
expensesinyears12to15byincomeladdering.

andsoon.

Hereisanillustration


Inessence,insteadofcreatinganincomeladderfor25years,asmentionedinfirstscenario,we
createanincomeladderforthefirst5years,lettherestofthecorpuscompoundin
fourbuckets
,and
createnewincomeladdereveryfiveyears.
Ihaveassumedthatallthebucketscompoundwiththerateofreturn(8%).Sothereisnodifference
corpusneededisthesame
betweenthefirstandsecondscenarios.Ineffectthetotal .

Whatif,someofthebucketscompoundedwithahigherrateofreturn?

CanIthennotreducethetotalcorpusrequired?

Yes,thisisindeedpossible.Hereisalistofdifferentreturnscenarios.ThankstoCaptainAshok
KumarAnandforpointingoutanerrorinthistable.Ithasnowbeencorrected.

Noticethatthereturnsassociatedwithdifferentbucketshavebeenvaried.Thefirstscenario,of
coursecorrespondstotheonedetailedabove.

Noticethatasyouincreasethereturnindifferentbuckets,preferablytheoneswhichyouwillneed
10,15and20yearslater,thecorpusrequiredcomesdownquitesharplyfrom90Lto67.5L
HowcanIgoaboutachievingthis?

Herearesomeexamples

Lowrisk

Bucket1(5Yduration):FDs

Bucket2(10Y):Debtincomefunds

Bucket3(15Y):Balancedfunds(25%equity)

Bucket4(20Y):Balancedfunds(65%equity)

Mediumrisk

Bucket1(5Yduration):FDs

Bucket2(10Y):FDs

Bucket3(15Y):Balancedfunds(65%equity)

Bucket4(20Y):Diversifiedequity

Highrisk

Bucket1(5Yduration):FDs

Bucket2(10Y):Debtincomefunds

Bucket3(15Y):Diversifiedequity

Bucket4(20Y):Diversifiedequity

Howtodecidewhattodo?

Thisisatoughquestion!

norisk
IfIhave90L+Icanaffordtochoosethe option(allbucketsinFDs)
IfIhave~80LIwillneedtotakesomeriskandinvestbuckets3and4inhighreturn,
taxefficientinstruments
 IfIhave~7075LIwillneedtotakemuchmoreriskandinvestbuckets2,3and4inhigh
return,taxefficientinstruments.DoIhavethestomachforthis?IfIdont,Iwillhaveto
chooseaconstantannuityfromaninsurerandmyincomewillhavelittleorno
inflationprotection
Ifhavelessthan70L,itistooriskytousebuckets.Iwillhavetoresignmyselftothefateof
receivingconstantannuity
Note: Thisisaallinstrategy.Thatisonceyouchoosethebucketapproach,seekingannuity
laterinlifemaynot(ormay!)giveyouadecentpension.Soyouwilltoconsideryourhealth
intotheequation(thankstoSubraforpointingthisout).Areyoufitenoughtomanageyour
owncorpus?

10.AStepByStepGuidetoLongTermGoalBased
InvestingPartI
Hereisastepbysteptoguide,pluscalculator,tobeginandtracklongtermgoalbasedinvesting.
Thecalculatorwillperformthestepsdetailedbelow.Thesestepsareapplicableforall
except
goals retirement.

1. Identifythegoal,itstimeframeandfindoutasaccuratelyaspossiblehowmuchitwillcost
today(i.e.whenyoustartinvesting).
Ballparkestimatescanbedreadfullywrong.Ifyouaresavingforyourchildseducation,seek
outaparentwhosechildisstudyingadecentdegree(UG+PG)inadecentcollegeandget
theentire
feedetail.
2. Assumeareasonableinflationrate( notthehistoricalaverage).Thehigherthesafer.
3. Using1and2,determinehowmuchthegoalwouldcostatthetimeofneed.
4. Determinehowmuchyou caninvestaftertakingintoaccount:expenses,loans,investment
towardsretirement( always
theno.1goal).
5. Estimatehowmuchthisinvestmentamountwillincrease(ordecrease!)infuture.Ifaftera
loanpayout,youcaninvestmore,takethisintoaccount.
6. Youcannowdeterminethe averagerateofreturnrequired.Averageherereferstothe
weightedaverageofreturnsfromequityanddebtinstruments.Theequityanddebtreturns
themselvesrepresenttheexpectedcompoundedannualizedgrowthrate(CAGR:ageometric
average)
7. Dependingonthetimeframedecidethedebtinstrument.Ifyourgoalsif15financialyearsor
moreawaythenPPFisagoodtaxfreeinvestment.Youcouldalsochooseadebtfundlikean
incomefund.Estimatetheposttaxreturn(sayapprox.8%forPPFand6%foradebtfund).
8. Decideonappropriateequityexposure.ThisishowIwoulddoit.
o Forgoals15ormoreyearsaway:5070%
o Forgoals10ormore:about4050%
o Forgoals7yearsaway2030%

Thisisnotjustbasedonmyriskappetite.Itisbasedon
history
.

9. From6,7and8thereturnedfromequity needed canbeestimated.

o Anythingmorethan12%irrespectiveoftimeperiodisrisky.Unlessyouhaveagood
understandingofthemarketsuchreturnsitisbestnottoassumesuchhighreturns.
o 12%onlyfortimeperiodswellabove10years.
o Anythinglessthan10yearsexpectsomethinglike910%
10. Iftheequityreturnistoosmallandiftheinflationrateassumedisreasonableyoucanafford
todecreasethemonthlyinvestment.Ifequityreturnisanythingmorethan12%,itisbestto
 lowerit,irrespectiveofdurationandperhapsexpertise.Inthiscasetheinvestmenthastobe
increasedasmuchaspossible.
o Initialmonthlyinvestmentcouldbeincreasedand/or
o %bywhichinvestmentwillincreaseannually(fromyear2)canbeincreasedand/or
o Additionalinvestmentafewyearsdownthelinecanbeconsidered.
11. Ifyouhaveincreasedthemonthlyinvestmentasmuchasyoucanandstillfindtheequity
returnsstillunreasonablyhigh,then
o Considerpostponingthegoalifpossible
o Ifpostponementisnotpossiblethenthegoalcanonlybemetpartially
12. Ifgoalcanonlybepartiallymetestimate,withareasonableequityreturn,thecorpusthat
canbeobtained.Theshortfallwillhavetobemetwithexternalfunding.
13. Finallyyouarereadytostartinvesting!Spendnomorethanaweekstimetogetgoing.
Anythingmorewillimpactcompounding.Ifyouaresomeonewhocannotusecommonsense
unaidedthendoconsiderjoiningatutorial(likethe100moneyactionsbyJagoinvestor!)
14. Soyouareonyourway.Patyourselfonthebackandensuretheinvestingprocessis
automatedifyouareindisciplined(thatisstartaSIP).
15. Youcanaffordtorelaxforaboutayear.Attheendofeachyearthereturnshaveto
monitored,theportfoliorebalanced(ifnecessary)and mostcruciallysteps112havetobe
repeated (includingthepatontheback!).
o Whatisrebalancing?Whydoit?Whatarethedifferentwaysofdoingit?Whichis
preferredwhen?Thisisapostinitself(muchmore).Willwriteaboutthisinpart2.
o Assumereasonableratesofreturnforequityanddebt.The sooneryoustart
thelower
yourreturnexpectationfromequity.Themoreyoucaninvestthelower
yourreturnexpectationfromequity.
o Statutorywarning:Garbagein,garbageout!

11.LongTermGoalBasedInvestingPartII
stepbystepguidetolongtermgoalbasedinvesting
Thisisasequeltothe
andismeantforthose
whohavestartedinvestingfortheirlongtermgoalsafter,

1. understandinghowmuchtoinvest
2. understandinghowmuchtoexpectfromeachassetclassused
3. decidingonanassetallocation(howmuchinequity,howmuchindebtetc.)

Ifyouarenotclearabouttheabove,Isuggestyoustartwith
PartI

first,makenecessarychangeswith
theattachedcalculatorandthenreadthis:

Longtermgoalscanbedividedintotwocategories:

Retirement where(ideally)itshouldtaketherestofoneslifetime(couldbedecades)to
spendthecorpuswhilegeneratingan inflationprotectedincome
allothergoals!wheretheaccumulatedcorpusgetsspentfromanywherebetweenan
instant(!)tothecourseof(notmorethan)afewyears.WewillcallthiscategoryB
,justfor
reference.

Thisdistinctioniscrucialbecause,forsomeonewhohasstartedinvestingearlyforretirement(and
typicallyonlyforsuchpeople),thereisnoneedtosignificantlyreduceequityallocation
as
retirementapproaches(see
bucketstrategy

tolearnmore)

Forexample,someonewhousesanequity(60):debt(40)allocationcancontinuetousethesame
allocationallthroughtheirlife(managedeitherbythemselvesorbyatrustedprofessional).

Thesameisnottrueforallotherlongtermgoals.Asthegoalapproaches,theequityallocationmust
bereducedtozero.

Unfortunately,thereisnosetformulatodothis.Youcanfindanswerslike,wait3yearsbeforeyou
needthemoneyandpulloutcompletelyorsetupanSTPtoadebtfundamongothervariations.

Ithinksuchsetmethodscanbedangerous.Whatifthemarkettanks5yearsbeforeyouneedthe
moneyandyouarein6070%equity?Whatifittankstomorrow?

IthinkallcategoryBgoalsneedactivemanagementwrtassetallocation.HereIamnotreferringto
tacticalassetallocation,whereonechangesequityallocationsignificantlydependingonmarket
conditions.
WhileIaminterestedintacticalassetallocationstrategies(hencethe
marketvaluationcalculators!
),
IwouldthinktwicebeforeemployingitforcategoryBlongtermgoals.

Ithinkthisisagreyareaandtheinvestormustfirstidentifysomebenchmarksanddevelopa
techniquethatwouldsuitthem.Likemanyproblemsinlifeandinpersonalfinance,therearemany
solutionstotheproblem.

SoIwouldliketosharewithyouwhatIamdoing,andwhatIintendtodoformysonseducationgoal
inthehopethatitwouldserveassomefoodforthoughtforyou.Kindlydonotconfusemy
convictionwithexpertise.

Mysonisnearly5yearsold.Istartedinvestingforhiseducationgoalabout23monthsbeforehewas
born.IusePPF(inhisname)(40%)+mutualfunds(inmyname)forthegoal(60%).Ifyouare
interestedinknowingmoreaboutplanningforthisgoal,see: Howtoplanforyourchildseducation
andmarriage

Whenhejoinedschool,Irealisedthathewouldturn18about3monthsbeforehis12thstandard
boardexam.

SowhenIstartedIhadabout1718yearsforthegoalalongtermgoalbyanyyardstick.

Ihadneverrebalancedtheassetallocationandsimplyletitgrowupuntiltheelectionsthisyear.

WhenIndiaVIX:thestockmarketvolatilityindex

rosesharplyjustbeforetheelections,Irealised
howskewedmyassetallocationhadbecome(80%equity).SoIshiftedabigchunkintoPPF.
ThankfullythePPFlimitwasenhancedsoonsothatdidnotaffectmyinvestmentallocationtoo
much.

Regretisthenumberoneenemyforgoalbasedinvesting.Sothereispointingthinkingabout,
what
ifIhadnotrebalanced?Iwouldhavehadabiggercorpustoday
.

Thankfully,Iamnotworriedaboutthatatall.Isafeguardedmysonseducationcorpus
and
therefore
myretirementcorpus.

Evenafterrebalancing,IstillhaveenoughtoaffordaBE/BTechinathirdtierengineeringcollege
today.
(lowerthetier,higherthefee!!) Mybenchmarkforthisgoalis,
whatdegreecanIafford
today?

CAGRistertiary.
Todaythegoalisonlyabout13yearsaway.Thatis,longtermgoalsdonotremainlongtermgoals
forever.Soonitwouldbe8yearsoldandsoon.

Theriskprofileofa17yeargoalisdifferentfroma13yeargoal,whichisdifferentfroma8yeargoal.

MeaningIintendtogetconservativewrtmyequityholdingwithtime.

Oncethegoalbecomeslessthan10yearsaway,Iintendtoreduceequityexposurefrom60%to50%
andthento40%.SincethenextLokSabhaelectionwouldnearlycoincidewiththis,howthemarkets
behaveinthebuilduptotheelectionwilldecidetheequityallocation.

ThismeansIwillhavetoaddadebtmutualfundtotheportfolio.Ipreferoneswithlowaverage
portfoliomaturityperiodandlowmodifiedduration.Learnmoreaboutthis: HowtoSelectDebt
MutualFundsSuitableForYourFinancialGoals?

Oncethegoalbecomes5yearsorlessaway,Ihopetoreduceequityallocationtoabout2025%or
so.Ihopebythistime,thetotaldebtcorpusshouldbeenoughtopayforinitialcollegerelated
expensesandperhapseventheentireUGdegree.

Thecorpusforchildseducationgoaldoesnotgetspentinaninstant(unliketheirmarriagegoal!
).It
takesabout34yearstogetaUGdegreeandacoupleofmoretogetaPGdegree.Infactsome
readersprefertousea
staggeredgoalcalculator
toexplicitlytakethisintoaccount.

Soitisokaytohaveasmallequityexposureevenbythetimethechildenterscollege!

Whatmattersmosttomeis howmuchIinvestforthisgoaland
howmuchIincreaseinvestmentseach
yearforthisgoal
Itrackbothwiththis
monthlytracker.

WhereIinvestwillchangeasafunctionoftimeasmentionedabove.

AsIwritethis,Inoticethattheassetallocationisskewedonceagain,thankstothecontinuationof
therallyaftertheelections.NowIamintwominds.Onepartofmesays, rebalancenow ,andanother
waitfortheratecut,thatwayyoucaninvestanotherbigchunkinPPF,perhapsinApril
partsays, .

Suchconflictsarepartandparcelofthegoalplanningprocessandisquitehealthy.Theanswerlies
inintrospection.

ShouldIpostinFacebookgroupAsanIdeasforWealthtogetananswertothisdilemma?Hellno!I
simplycannotconveythesituationandlogisticsinvolved,bothofwhichareextremelypersonal.I
willendup1015differentpossibilitiesandmoreconfusedthanIstartedwith.Iambetteroff
thinkingthisoneout,takeacallandnotlookbackeitherinrelieforregret.
Whataboutprofessionalhelp?Hellno!Iamacontrolfreak.Iwouldlikethingsdoneinacertainway
andwilldrivethefinancialplannercrazy!

Well,whatdoyouknow!AsIwrotethis,Ihavedecided:

Areyouaskinganeither/orquestionaboutpersonalfinance?Trychangingitintoanandquestion.
Thesolutionwillpresentitself.Ithas,tome.IwillrebalanceabitnowandbitinApril.Peacereigns
intheGaulishvillage.fornow.

AtFBgroupAsanIdeasofWealththereisasaying:MyDullandBoringSipswillcontinue*.Hopefully
thispostclarifieswhatthe*standsfor!

12.Howtoselectmutualfundcategoriessuitable
foryourfinancialgoals?
Youmightbewonderingwhythetitlereferstomutualfundcategories.Woulditnotbemore
enticingandperhapsmoreusefulhaditread,howtoselectmutualfundssuitableforyourfinancial
goals?

Perhapsso.However,Ichoosetofocusonhowtoselectmutualfundcategoriesfirst,fortwo
reasons

Iampainedtoseeinvestorsselectmutualfundsutterlyunsuitablefortheirgoals.For
example,
o selectingdiversifiedequitymutualfundsorbalancedfundswithsignificantequity
componentforgoalsjustafewyearsaway.
o investinginvolatiledebtfundswithoutunderstandingtherisksinvolved.
Istronglybelievethatifaninvestorknowshowtopickthe
fundcategorysuitableforher
fromthat
needs,thetaskofselectingasuitablemutualfund categorybecomesutterly
simple,ifnotobvious.

Mutualfundreturns,andassociatedvolatility(fluctuatingreturns)canbeevaluatedinanumberof
ways.Troubleisveryfewamongustakethetroubletounderstandthesealthough theycouldbe
understoodquiteeasily.

WhenImadea stepbysteptoselectamutualfund
,Iused5oftheseriskreturnparameters.Iam
delightedtonotethatmanyinvestors,withanearzeroexperienceinmutualfundinvesting,have
startedusingtheseparametersinchoosingmutualfunds.

Inthispost,letusdiscusshowtoselectasuitablemutualfundcategoryusingjustone
parameter: thestandarddeviation .

Inordertounderstandwhatstandarddeviationis,Iwillborrowthis
wonderfulanalogy
bySubra.

Youaregivetwosetsofnumbers:

RunsscoredbyVirendraShewaginhislast25tests.
AsimilarsetforRahulDravid

Weallknowhowtodeterminetheaverage:addupallthescoresanddividebythenumberofsuch
scores.
Oncewegettheaverage,weimmediatelyrecognisethatsomescoresarehigherthantheaverage
andsomelowerthantheaverage.

Nowifwewishtoknow,betweenDravidandShewag,whosescores deviate more

fromtheaverage,
wewillneedtocalculatethedeviationofeachscorewrttheaverageandtakethe
averageofthe
deviations
.

Thisisthe
standarddeviation
.Itisdefinedsuchthatitisalwayspositivesothatwearenotconfused
(assumingwearenotthusfar!)

Evenwithoutanydata,wewillrecognisethatShewagisjustaboutiscapableofscoringanything
fromaducktoatriplehundred.Dravidontheotherhandisalotmoresedate,andwecantypically
expectatleast3040runsirrespectiveoftheconditions.

Therefore,DravidsscoresareexpectedtodeviateverylittlefromtheaveragewhileShewagsscores
areexpectedtodeviatesubstantially.

Sowesay,DravidsbattingaveragehaslowerstandarddeviationthanShewags.

Suchisthepowerofthisanalogythatitdriveshomethepointwithoutusinganydata!

Beforeweusethestandarddeviationtoselectasuitablefundcategory,letusrecognisethatmutual
fundscanbegroupedtogetherinseveralways.Thereisnorightorwrongwayandeachfundportal
(ValueResearch,MorningStar,MoneyControletc.)havetheirowncategorisationscheme.

Inthispost,IwillusetheschemecategorizationofVRonline.

Thecategorystandarddeviation,alongwiththetypicalassetallocationandmaturityofdebtpaper
(fordebtfunds)islistedbelowforsomeofthecategoriesdefinebyVRonline.

average
Categorystandarddeviationreferstothe standarddeviationinaparticularcategory.

Noticethat
returns
aremissingfromthistable.


Asyougodownthetable,theequitycomponentincreases.Obviously,ifafundhasmore
equityallocation,higherwouldbethefluctuationsinreturnandthereforehigherthe
categorystandarddeviation.
Thedebt income categoryhasdifferentkindofdebtfunds(dynamicbondfunds,diversified
debtfunds,thatisfundsthatinvestinpaperthatmaturesoverdifferentperiodsetc.).Soitis
notanexclusivegroup.Thisiswhythereisahugevariationinstandarddeviationand
averagematurity.
Theredarrowspointtotheevolutioninstandarddeviation.Theaveragestandarddeviation
ofonecategoryisclosetotheminimumstandarddeviationofthenextcategory.Forthe
abovementionedreason,thisdoesnotapplyto income
funds.
Ihavenotincludedgiltfundsastheyarespecialisedfundsthatresembleequitysectorfunds
notforeverybody.
Letusconsiderthefirstfourentriesthathavenoequity.Obviously,thesearepuredebt
funds.
Noticetheaverageageatwhichthecategorydebtholdingsmature.Adebtpaperisasimple
agreementbetweentwoparties: IwillpayanamountY.Youholditforndaysandpaymean
interestr.Ofcourse,thisisanoversimplificationbutshouldsufficeforourpurpose.
Liquiddebtfundsinvestinshorttermdebtpaperrangingoveracoupleofmonths
while income debtfundsinvestindebtpaperthatcanhaveanageofseveralyears.
Itisclearthat,highertheageofthematurity,higheristhestandarddeviationandtherefore
higherthefluctuationsinreturns. Ofcourse,thisalsomeanshigherreturns.typically!

Letusgettothebusinessathand,withafewexamples.

IhavealumpsumthatIwishtoinvestforafewmonths.WhichfundshouldIchoose?

Iunderstandthatequitywillbetooriskyforjustafewmonths.Soletmeeliminateallfund
categorieswithequity.
Thisleavesmewiththetopfourcategoriesinthetable.

IfIchooseadebtincomefundthatmatcheswiththecategoryaveragestandarddeviationof3.71%,

typically(
Myreturnswill 68%probability!!
)
rangefrom

X3.71%toX+3.71%
beforetaxes!

CanIaffordsuchaswinginreturns?

Iftheanswerisno,wecanmoveonandchoosesomethingwithlowerstandarddeviation.Whatif
theanswerisyes?!

WhatifIsay,Idontmindthisfluctuation?

ThenyouwillhavetoworryaboutwhatXis,orwhatitcanbe.

Letusnowintroduceasimplebutreliableruleofthumb.

corresponding
Ifthereturn(X)isgreaterthanthe standarddeviation(3.70%),thereislittleor
nochanceoflosingthecapitalinvested.
corresponding
Ifthereturnislesserthanthe standarddeviation,chancesoflosingthecapital
investedarehigh.

Ifweadoptthisthumbrule,thenextquestionis,whatisthekindofreturns(X)onecanexpectfrom
adebtincomefundoverafewmonths?

income
Well,foran fundXshould,undernormalcircumstances,behigherthanthestandard
deviation.

However,asmostofusrealisedinJulythisyear,
debtsmarketcancrashtoo
(hashappenedmanya
timebefore).ThatistheNAVofadebtfundcansharplydecreaseinadayoroverthecourseofafew
weeks.

all
Ifthisoccurs, debtsfundsarelikelytobeaffected.Somewillbouncebackafterafewdays,some
afterafewweeks,andsomeafterafewmonths.

income
IfIwanttoinvestforonlyafewmonthsinadebt fund,andifbondscrashintheperiod,will
myfundrecover?

Chancesare,itwillnot.
Iwouldliketousethefollowingruleofthumbwhenitcomestolossofcapitalriskassociatedwith
debtfunds.

Longertheaveragematurityperiod,higherthe correspondingstandarddeviation
andtherefore
longerthetimeitwouldtakeforthedebtfundtorecover.
IfDravidandShewagloseformatthesametime,whoislikelytospringbackfaster?The
batsmanwhocanscratcharoundatthecrease,orsomeonewhoseinstinctistowhackevery
ball?
Higherthestandarddeviation,biggerwouldbefallintheeventofacrashandtherefore
longeritwouldtakethedebtfundtorecover.

Fundswithtypicalmaturityperiodofmorethan1yeararelikelytotakeabout6monthstorecover
fromacrash.Ihavekepttrackofsomeincomefundsandmanyareyettorecover.Unfortunately,

thisincludesmy
NPSsubscriptionsaswell

Debtincomefundsarewellsuitedonlyforlongtermgoals(morethan5yearsat
least).
Longertheperiod,greateristhetaxadvantage.

Whatabouttheothercategories?Howsoonwouldtheyrecover?

Liquidfunds overafewdays
.Shorttermfundsoveracoupleofmonthsandultashorttermfundsa
littleearlierthatthat.

Therefore,forinvestmentdurationsofjust12yearsstickwith
Shortterm/Ultrashortterm/liquidfunds.Fixedmaturityplans(FMP)arealsoagoodoption
forsuchdurations.

Whataboutaninvestmentdurationof5years?

Iwillchoosedebtfundswithmaturityof1yearorless.

Why?Fordurationslessthanorequalto5years,thepowerofcompoundingisnotthat
Therefore
important. i nflationisnotthatimportant.SoIwillprefertosafeguardthecapital,choose
debtfundsoflowrisk.

Whynot RDsorBankFDs ?IfthegoaliscrucialandIknowexactlyhowmuchIneed,Iwillusethese

evenifIfallinthe30%slab.Ifthegoalislessimportant,thenlowriskdebtsofferataxadvantage.
Investdurationsbetween510years

Debtincomefundsthatinvestindebtpaperofshortdurationwithlowstandarddeviation.

DebtorientedHybridfundswithabout2030%equity.Debtportfolioshouldhavelowmaturity
duration.Equityfolioshouldhaveagoodamountoflargecapstocks.Again,bothfactorsleadtolow
standarddeviation(relatively!).

Investdurationsabove10years

Assetallocationshouldbedone
consideringtheriskprofileofthegoal
,
asbeatinginflationismajor
goal.

mustbehigh
Nowstandarddeviation !
Highvolatilityisimportantforbeatinginflation.

Toughtochoosejustonefund.Perhapsifsomeonemonitorsthefundregularly,theycanpullitoff
withafundlikeHDFCBalanced.However,evenfor10yeardurationIwouldbewaryofusing
balanced
a fundlikeHDFCPrudencethathasahighstandarddeviationcomparabletomany
largecapequityfunds!

ThepointofthispostistosharewithyouhowIusestandarddeviationtoselectfundcategoriesfor
myfinancialgoals.

AmIbeingtooconservative?AmIbeingtooriskaverseandmissingoutonreturns?

ThewayIseeit,forshorttermgoals,inflationisnotamajorissue.SoIwillnotrisklosingcapitalby
investinginafundwithlargestandarddeviation.

Iftheassetclasscrashes,therewillnotbeenoughtimetorecoverback
.

IS
Foralongtermgoal,inflation theissue.Soonemustembracehighstandarddeviation,bearwith
shorttermlossofcapitalandinvestinmutualfundswithhighstandarddeviation.Thatis,thosethat
hasagoodamountofequity.

Isay,standarddeviationiskeytoselectmutualfundcategoriessuitableforfinancialgoals.

Wouldyouagree?

13.Howtoselectanequitymutualfund
preamble
Overthenextfewdays,IwouldliketodoaseriesonHowtoselectanequitymutualfund.Thisis
thelongoverdueupdatetothe
stepbystepguide tomutualfundselection.

IwritethisprimarilybecausemyunderstandingaboutmutualfundshasgrownsignificantlysinceI
wrotethepdfguide.Ihavealreadysharedthiswithyouintheformofanalysisandcalculators.
Wouldliketoconsolidateitintermsofspecificsteps.

Inthispost,Iwouldliketostartwithapreamblewhichwilldefinetheobjectivesandtheframework
ofwhatwillfollow.

The
centralobjective
isquitesimple:Toenableanyonetoselectamutualfundinabout2030
minutes.Thistimewillreducesignificantlyoncetheinvestorgetsabettergriponthemethod.

Therearehoweverafewnecessaryprerequisitestomaketheselectionprocesseasier.

Thefollowingandensuingpostsarevalidonlyforlongtermgoalsthatis10yearsormoreaway.

1)
Afinancialgoalismandatory.
Questionslike,whyamIinvesting?andwhendoIneedthe
money?shouldbeanswered.

2)
Whatistheproposedassetallocation?Foragivengoalandduration,howmuchwilltheexposure
intheequityfundthatyouwouldliketoselectbe?Thisiscrucialbecausemanypeoplemakethe
mistakeofinvestingin100%equityforlongtermgoals.Theequity:debt(fixedincome)allocationis
mandatory.

3)Whatistheexpectedreturnfromtheequitymutualfundfortheinvestmentduration?PersonallyI
willuse10%forcalculatingtheinvestmentamountandexpectabout12%.Donotexpectmorethan
15%.

4)Expectedreturnfromtotalportfolio=(expectedreturnfromequity)x(equityallocation)+
(expectedposttaxreturnfromdebt)x(debtallocation)

5)Usetheexpectedportfolioreturninastandardgoalplannerwithabout10%inflationforallgoals
expectedretirement.Forretirementuseaminimumof8%inflation.Withotherinputsfoundinthe
goalplanner,youshouldbeabletodeterminethenecessarymonthlyinvestment.Evenifyouare
notabletoinvestasmuch,thisstepisnecessarytounderstandtherequirementsofthefinancial
objective.

6)Decideaboutthedebtportfolio.Forgoalswhichare15financialyearsaway,PPFisagoodchoice.
EPFormandatoryNPSwilldofineforretirement.Forothergoals,youcanconsidershorttermdebt
mutualfunds.

7)Decideabouttheequityportfolio.Therearemanywaystodothis.Iprefer
minimalistportfolios

Iprefer60%inlargecapand40%inmidandsmallcaps.Soonelargecapfundandonemidandsmall
capfundisallthatyouneed.Youcanalsooptforasinglelargeandmidcapfund.

Asingleequityorientedbalancedfundwillalsoworkfine.Inwhichcaseyouneedtotakecareof
overallequity:debtassetallocation.

Onceyouhavedecidedhowyouaregoingtoconstructyourportfolioandwhatmutual
categories
fund youaregoingtochoose,youareallsettopickafundtoinvestin.

Thosewhohavealreadystartedinvestingbuthavenotperformedanyoftheabovesteps,candoso
now.Betterlatethannever.

Therearemanywaystoselectamutualfund.Iwouldliketopresentthreewaystodoit.Idonot
qualitativelyanalyzeafundtoomuch.Ifthefundisgood,IbelieveitshouldshowupintheNAV
movement.SoforthemostpartItreatafundasablackbox.However,Iensurethatislabelonthe
boxistheoneIwant.

Herearethemethodstobediscussed.RegularreaderswillunderstandwhereIamgoingwiththis.

Method1:Thisisidenticalto
mutualfundguide
publishedearlier.Shortlistfundsbasedon
consistentperformanceandthenconsiderriskreturnmetricsforlast3years.

Method2:
Shortlistfundsbasedonconsistentperformanceandthenconsiderriskreturnmetricsfor
longerdurationseitherbasedoninvestmentdurationorforeachyear.

Method3:Shortlistfundsbasedonconsistentperformanceandthenconsiderdownsideprotection
andorconsistentlongtermrollingreturns.

Youcansavethispostasapdfdocumentwiththebuttonbelow.Tobecontinued..
14.HowtoselectanequitymutualfundCreating
ashortlist
Anyselectionprocessshouldhavethreecomponents:(a)anobjective;(b)amethodtocreatea
shortlistand(c)amethodtofinalizewiththeshortlist.

Yesterdaywediscussedtheobjective.Todayweshallconsiderhowtocreateashortlistfromwhich
anequitymutualfundcanbeselected.

Ifyouhavenotreadyesterdayspost,Istronglyurgeyoutodosobeforereadingthisanyfurther:

Howtoselectanequitymutualfundpreamble

Creatingashortlist
Note:
Thedescriptionoftheshortlistmayappearlong.Inpractice,youshouldbeabletocreateone
inunder150minutesonyourfirstattemptandinunder10minuteslater.Sopleasehangon.

Creatingashortlistisasimportantasitisdifficult.Thecriterionusedtocreateoneisarbitrarily
chosenandisbasedonpersonalcomfort.Itcanneitherbetoobroad(meaningtoomanyfundsto
analyzedeeper),nortoonarrow(ifonlyafewfundssatisfyus,thentheyarelikelytofalloutoffavor
soon).F0rexample,theratingofafivestarfundcanonlygodown!

Weneedtocastareasonablybroadnettocreatetheshortlist.Peercomparisonisanecessaryevilto
createtheshortlist.Iprefertoabandonallpeercomparisononcetheshortlistisprepared.

Theprimaryreasonforthatissimple:beforeselectingafund,weareanalysts.Afterselection,we
areinvestors.Analystandinvestorswillhaveverydifferentnumbers(returns/riskmetrics)tostare
atwhentheassetclassisvolatile.

OnceIinvest,Itakedecisionsbasedonthehealthofmyportfoliotaggedtoaspecificgoal.Many
makethemistakeofworryingaboutpeercomparison,viewtheirholdingslikeanalystsinsteadof
viewingitasinvestors.

Iwilldiscusstwomethodsofcreatingthisshortlist:withvalueresearchonlineandwithMorning
Star.Itiseasytoextendthismethodtootherportals.

ShortlistingwithValueResearchOnline
Thisisthemethoddiscussedinthepreviousversion:
StepbyStepGuidetoSelectingaMutualFund

Sincethetimeitwaswritten,VRonlinemadeacrucialchange:Itremovedthelastsevenyears
trailingreturnentryfromthecategorylisting.

TrailingreturnsimplyreferstotheCAGRforthelast1/3/5/7/10(etc.)yearsatanygivenpointin
time.IfIamnotwrong,VRupdatesthiseachmonth.

Removalofthe7Yreturnhasmadetheshortlistabitlonger.

Letusknowgothroughthisprocess,stepbystep.Clickontheimagestoenlargethemifyouwish.

1)Gotohttps://www.valueresearchonline.com/

Skiptheannoyingad,gotothemainpageandscrolldownuntilyousee
researchtools
.

WewillbeworkingwiththeFundselector

fundhouse
2)Leavethe entryalone.

Inthefundcategoryentry(leftimagebel0w),uncheckwhateverischeckedandcheckEquity:large
cap(weassumethatisthecategorywearelookingtoinvestin.Theprocessforotherequity
categoriesisthesame).

exclude
Inthe entry(rightimagebelow),

a)checkplanssuspendedforsales
b)checkdirectplans(addingthemwillonlycluttertheprocess.Thefoliosandrelativeperformance
forregularanddirectfundsisthesame).

c)checkclosedended

Scrolldownanduncheck3star,2star,1starandunrated(optional).

Whenready,clickGetData.

3)Youwillbetakentothissheet.Clickon
returns.
4)Youwillthenbetakenhere.

Wewillnowdiscusstwomethodsofshortlistingconsistentperformers.

A)Anchorthesearchwith5yearreturns.

Clickon5yearsreturns(redboxabove)onceortwiceuntil
thefundarearrangedinascendingorder.Thenyouneedtodecidethecutoffrank.Supposewe
selectfundswhichwererankedinthetop25overlast3years,5yearsand10years,wewillget
somethinglikethis(partiallist).


Invariablywehaveshortlistedmany(notall)5staror4starfundswhicharelessthan10yearsold.If
youarefinewiththis,thenyoucanproceed.

Byremovingthe7yearentry,VRforcesustorelyonitsstarratingmore.Whoaretheytotellus(at
leastme)thatitisenoughtoreviewonly5yearand3yearhistories?

Ipreferafundwhichhasconsistentlybeeninthetop25for3,5and10yearperiods.SoIwouldlike
toclickonthe10yearreturnsuntiltheyarearrangedinascendingorderandthencreatetheshort
list.

Top25mightsoundtoobroad.Narrowerthenet,highertheexpectationandsoonerthefundis
likelytodisappoint.

AsfarasIamconcerned,Iwillnotrepeatthisexerciseunlesstheselectedfundisalaggardinmy
aftergivingitatleast3yearstoperform
folio .Laggardsarenotidentifiedbypeercomparison(drop
instarratingetc.)butwithrespecttonetXIRRoftheequityportfolio.Seemorehere:
Howtoreview
amutualfundportfolio

B)Anchorthesearchwith10yearreturns. Clickon10yearsreturnsonceortwiceuntilthefundare
arrangedinascendingorder.Thenyouneedtodecidethecutoffrank.Supposeweselectfunds
whichwererankedinthetop25overlast3years,5yearsand10years,wewillgetsomethinglike
this(partiallist).Fundsmarkedinredhavedonewellinthepastbutnotintherecent
relatively
future .


Wenowhavemore10yearoldfundsandthedependenceonstarratingislower.Theshortlistalsois
abitsmaller.

Iammorecomfortablewiththis.Nowthatwehaveashortlist,wearereadytoanalyzefurther.
BeforethatAMCbiasmayshortenthelistfurther(wearehumans,notmachines).

ImaypreferaFranklin,HDFCorICCIoverKotak,TataorDWS.Imayalreadyhaveanaccountinoneof
theamcs!

Hadweshortlistedonly4and
5
starfunds,wewillendupwith19funds.Thisway(with5yearor
10yearanchoring
)
weonlyhave910tochoosefrom.

Wewilltakeupfurtheranalysisinthenextpostonthisseries.Iwouldnowliketodiscussafaster
waytoshortlistwithMorningStar.

ShortlistingwithMorningStarScreener
MorningStarIndiahasanicescreenerwhichcanautomatetheaboveshortlistingandreduceitdown
tominutes.
However,ithasonlylargecapandmid/smallcapcategories.UnlikeValueResearchwhich
distinguishesamonglargecap,largeandmidcap,midandsmallcapandmulticap.

Thiscanpresentaconsiderableproblemunlesswelookatthefoliocarefully.WhenItriedouta
largecapshortlistIendupwithmanylargeandmidcapfunds.Ifyoucanhandlethis,thisisasmart
waytocreateashortlist.

1)Goto

http://www.morningstar.in/tools/mutualfundscreener.aspx

totalresults
Firstmakethefollowingchoices.The willvaryaccordingtothechoices.Ifitiszero,it
meansyouwillhavetochangethechoices.

Inc Acc
standsfordividendoptionand standsfor
growth.

Scrolldowntofurthermakethefollowingchoices


Firstchoose3year,5yearand10yearreturnsabovethecategoryaverage.

Asyousettheoptionforeachyear,haveaneyeonthe totalresults
atthetop.Itshouldnotbecome
zero.Ifitdoes,youwillhavetochangeorrelaxyouroptions.

Withtheabovechoices,15fundstochoosefrom.

Playaroundwiththemorningstarriskrating(low,belowaverage,average,aboveaverage,high)
and

3yearstandarddeviationtoseeifyoucanreducetheshortlist.

Low>0results

Avg(belowaverage)>3results

Avg>6results

AvgandAvg9results(Ilikethis)

Youcanchoosewhatyoulike.

FurthermodificationscanbedonewiththesocalledMorningStarSyleBox.
Forlargecapfundschoose:

LargeandGrowth
(stockswithsubstantialearning,highPE,highPB)

Agood14outofthe15shortlistedfundsbelongtothiscategory.Onetolargeandablendofvalue
(underpricedstockswithlowPEandlowPB)andgrowth.

Ifyoudontunderstandthis,youcanignorethestyleboxforastartorreadmoreaboutthe
differencebetweengrowthandvaluestocksoraboutthemorningstarstylebox.

DontworryaboutAUMofalargecapfund.Foramidandsmallcapfund,itisnotaterribleideato
choosethefundwithsmallestAUMafterfurtheranalysis.

MidandsmallcapfundswithlargeAUM(saymorethan5000Crores)tendtohavemorelargecap
stocksforliquidity.

Reducingtheexpenseratioevenbyonestepmakesthetotalresultscountgotozero!

searchto
Finally,hit getthisshortlist.


Donotjumptoconclusionsthattheshortlisthasonly4/5starfundsandthatcouldhavebeenthe
lonecriterion.

Ifyoutriedthatyouwillhave43fundstocontendwithinsteadofjust14.

Outofthis14,youwillneedtoweedoutthelargeandmidcapfundsinconsultationwithValue
Researchifyouarenotlookingforone!

Wearenowreadytoanalyzefurther.Thisisequallysimple.Iwilltakethatupinadifferentpost.

Wasthisnoteasy?Anybodywithalittlecommonsensecandothis.

DIYandgodirect.Donottrustanyonewhosaysthatmutualfundselectionishard.Theysayso
becausetheyhaveabusinesstorun.

DIYimpliesdoingeverythingyourself.Notmakingashortlistingandaskingothers.Ifyoudonthave
confidence(timeisnottheissue),getyourselfafeeonlyfinancialplannerwhowillsuggestdirect
mutualfundplans.

15.HowtoselectanequitymutualfundMaking
aChoice!
Inthisthirdandfinalpartonhowtoselectanequitymutualfund,wewillconsiderdifferentways
inwhichonemakeachoicefromashortlist.

Yes,thereareseveralwaystochoosefromashortlist,justlikethereareseveralwaystomakea
shortlist.Youwillhavetotakeyourpick.Itiseasytodoso.Allyouneedtodoistotryandsellyour
picktoyourrationalside.Thatisyoumustbeabletojustifyyourmethodtoyourself.Forgetabout
whatothersthink.

Beforeweproceed,asuggestiontoreadthefirsttwostagesintheselectionprocess,ifyouhavenot
doneso:

(1)

Theobjectiveorthepreambleforfundselection

(2)

Howtocreateashortlist

Note:
Thetitleofthispostismakingachoiceandnotfindingthebestfundfromtheshortlist.This
meansthatnomatterhowhardyoutrytoshortenyourshortlist,youwillnotbeabletodoso(ifyou
objectivelygoaboutit).

Sofroma1015fundshortlist,youwillendwithmaybea25fundshortlist.Youwillhavetopickone
fromthis.Thereisnootherwayofdoingthis.

Thisisalongpost.Atotalof7methodsarelisted.Notallmethodsare(orcanbe)discussedindetail.
Pleaseconsultthelinksprovidedformoreinformation.

Method1:
Justpickonefromtheshortlist!

Method2:
Usingshorttermriskreturnmetrics

Method3:
Usinglongtermriskreturnmetrics

A.WithMorningstarIndia

B.Withthefreefincalriskreturnanalyzer

Method4:
Usingdownsidecaptureratios
A.WithMorningstarIndia

B.Withthefreefincalriskreturnanalyzer

Method5:
Withrollingreturns

Method6:
Withinformationratio

Method7:
WithUlcerindex

Iurgeyouread/considerallthemethods,anddevelopyourown.Acombinationofmethodscanalso
beconsidered.

Method1:Justpickonefromtheshortlist!
Bythetimeyouarefinishedwiththispost,chancesarethatyoumightagreethatdoingan
Eeny
meeny
, miny
, moe
, fromtheshortlistisaprettygoodmethod.Whynot?

Thinkaboutit,youhavemadeashortlistbasedonconsistentperformersbasedon3,5and10year
returns.Sowhynotpickonefromthislist?Theriskassociatedwiththereturnsobtainedwillbe
neglected,butthismethodisanydaybetterthanwhatmanypeopledo:askforbestfundnamesor
askotherpeopletopickfromtheirshortlist.

Ifthefollowingappearsabitcomplicatedtoyou,adoptmethod1,butdonotfailtolearn
howto
reviewyourmutualfundportfolio .

Ifso,whycantIusestarratingsasaguide?Frommyexperience,peoplewhostartusingstarratings
donotknowwhentostop.Theywouldcomparepeerswithoutcheckingthe actual
performanceof
theirportfolio.Icanneverfeelcomfortablewithsuchastrategy.Personalfinanceisanindividual
race.

Notconvinced?Tythis:
TheTroubleWithMutualFundStarRatings

Method2:Usingshorttermrisk
return
metrics
Thisisthemethodoutlinedinthe
stepbystepfundselectionguide

TherearetwoissuesthatIdidnotrealize/knowwhenIwrotetheabove.

A.TheriskreturnmetricslistedatValueresearchareoveronly3or5yearsonly.Theyhavenot
botheredtostatethis,norrepliedtomyquestionreg.this.Myguessafterhoursofstaringattheir
listingpagesisthatthemetricsareoverthelast3years.

B.Seebelow(perhapsnotimmediately!)

Whenwemakeashortlistconsidering3,5and10yearreturns,shouldweonlyconsider3years
riskreturnmetrics?

Perhapsnot.Itisnotaterriblechoice,butIthinkwecandobetter.

Fortherecord,letusgetthroughwithit.Itisanywayagoodstartingpointforgettingcomfortable
aboutthesemetrics.Tobefrank,Iamdelightedthatmanyreadershavedoneexactlythat.

Letuslookatsomedefinitionsfirst:

AlphaItisameasurehowmuchithasoutperformeditsbenchmarkindex.Higher(positive!)the
alphathebetter.BetaMeasureofvolatility.Betaof1.3meansfundis30%morevolatilethanthe
marketasawhole.Solowbetaisimportantfor
BetaMeasureofvolatility.Betaof1.3meansfundis30%morevolatilethanthemarketasawhole.
Solowbetaisimportantforriskaverseinvestors

StandardDeviation:
Higherthestd.dev.higherthefluctuationsinreturns.

SharpeRatio:Measureofreturnwrttorisk.Agoodfundgetsreturnswithouttoomuchriskandwill
havehigherSharperatioAriskaverseinvestorwilllookforreasonablereturnsandwithlow
fluctuationsinreturn.Sotheywilllookforreasonablyhighalpha,lowbeta,lowRsquared,lowstd.

Sortinoratio:
TheSharperatioconsidersbothpositiveandnegativeexcessreturns(wrtriskfree
rate).TheSortinoratioconsidersonlythenegativeexcessreturnswhilecalculatingthestandard
deviation.Higherthebetter.

Ifyouarelookingforaneasytounderstandvisualaidforunderstandingthesemetrics,try
this:
VisualizingMutualFundVolatilityMeasures

Whatnow?

Lookforfundswithreasonablyhighalpha,lowbeta,lowstddev,highSharperatioandhigh
Sortinoratio.

Hangon.

Higherthebeta,higherthestandarddeviation(typically!)

Higherthealpha,highertheSharperatio(typically!!)

HighertheSharperatio,highertheSortinoratio(typically!!!)

Soallweneedtodoistolookforfundwthreasonably

highalpha,andlowbeta

Iwouldprefertostatethistheotherway:

1)Lookforlowbeta

2)choosefundswithhighestalphaamongthelowbetagroup.

Pickoneofthosefunds.Youdone.
IhaveremovedameasurecalledRsquared(tellsyouhowcloselyperformanceisrelatedtothe
index.Higherthevaluecloserwilltheperformance.AlllargecapfundswillhavehighRsquare).I
feelthatthisistoouseful.

Soletusnowreturntotheshortlist.

RecalltheprocedureforgettingtheabovereturnscreenatValueResearch.Youwillfindthe
steps
here

Noneedtodothatrightnow.Followthislinkinanotherbrowsertabtogetthisscreen.

https://www.valueresearchonline.com/funds/fundSelector/default.asp?cat=8&exc=susp%2Cdir%2C
close%2CnotRated


Youhavealreadymadetheshortlist(fundscorrespondingtobluerectangles)

Nowclickon
Riskstats

Youwouldneedtopreparethiskindoftable.Youcandosomanually.Overtheyears,manyreaders
havesentmetheirexcelfilesinwhichtheyhavemadethisprocesssimpler.

YoucandownloadtheexcelfilefromVRandextractdataforthefundsinyourshortlist.

data
Ifyouknowabitofexcel,youcanselectthetabulatedshortlist,goto filiter.
andclickon That
willproducetheencircledsortingmenuasshownabove.Ifyoudontknowhowtodothisoruse
Excel,doitwithpenandpaper.Nobigdeal!

Youcanthensortthebetacolumnfromsmallesttolargest.Whathasbeendescribedabovewilltake
only10mins.
Nownoticetheyellowselection.Lowbetawithreasonablyhighalpha.

Wehaveourwinners!Pickonefundyouarecomfortablewith.Done!

Waitaminute!WhataboutFranklinBlueChipandHDFCTop200!Whydidtheynotmakethecut?

Simplybecausetheyhavenotdonewellinthelastthreeyearsandweareonlylookingatlast
threeyearmetrics!

Method3:Usinglongtermrisk
return
metrics
Whatifyouwantedtoconsiderriskreturnmetricsoverlongerdurations?Afterall,weconsidered
longtermreturnstomaketheshortlist.

Makessense.Therearetwowaystoaccomplish.

A.WithMorningstarIndia
Therearetwoissueshere.(1)thereisnoriskreturnlistingforallfundslikeVRonlineand(2)all
ratiosarecalculatedwithBSE100.Notabid

(1)thereisnoriskreturnlistingforallfundslikeVRonline.Soyouneedtogotoeachfundpage.

(2)allratiosarecalculatedwithBSE100.Perhapsnotaproblemforpurelargecapfunds.Willnotuse
forothercategories.

Seehereforasample.Thisisnotascreenshot.IhaveonlyincludedstuffthatIneed!


Noticethatthemetricsareavailablefordifferentdurations.

Troubleis,thefundsbenchmarkisBSE200andnotBSE100.

Youcanconsiderthemetricsprettymuchasmentionedbefore,makeatablefordifferentdurations
orvisuallyobserveforconsistencyandmakeachoice.Itwillnottakeaslongasitseems.Hey,whose
moneyisitanyway!

Thishasagotanewmetric:

TreynorRatioi sknownastherewardtovolatilityratio.WhiletheSharperatioistheexcessreturn
(wrtriskfreerate)dividedbystandarddeviation,Treynorratioistheexcessreturndividedbybeta.
Thisiscalculatedforboththefundandthebenchmarkforwhichbetaisassumedtobe1.
HighertheTreynorratio,betteristheperformance(higherreturns+lowvolatilitywrtbenchmark)

B.Withthefreefincalriskreturnanalyzer
Ifyoudonotlikethefactthatmorningstarusesthesamebenchmarkforallfunds,youcanconsider
myriskreturnanalyzer

YoucanthenchoosefromNifty,CNX100,CNXMidCap,CNX500,Sensex,BSESmallCap,MidCap,BSE
100,200,50.

Consider1to9yeardurations.CalculatelumpsumandSIPreturnsforeachduration

Evaluatetheriskreturnscorewith13metrics.

Youcanalsoconsiderthe
YearonYearMutualFundRiskReturnAnalyzer

forreviewingyearly
performance.

Method4:Usingdownsidecaptureratios
ThisisthemethodIadvocateintheinvestorworkshops.

Themainadvantageofthismodelisthatitdoesnotdependonmodernportfoliotheory(MPT)ratios
whichareapplicableonlyfornormalorGaussiandistributions.Itisquitepossible(infacteasyto
pve)thattheymaynotworkwithmutualfundsandstocks!Thismeansallstarratingsareonshaky
ground!!

PeopleuseMPTmetricsbecausealternativesaretoughtoevaluate(moreonthissoon).

Upsidecapture.

Foragivenperiod,howmuchofthebenchmarksgainshasthefundcaptured?Higherthebetter.

Downsidecapture.

Foragivenperiod,howmuchofthebenchmarkslosseshasthefundcaptured?Lowerthebetter.

FromwhatIhaveseen,
consistentdownsideprotectionisthesourceofalpha.

Ihavewrittenaboutthisindetailearlier:
UnderstandingUpsideandDownsideCaptureratios

SimplifyMutualFundAnalysiswithUpside/DownsideCaptureRatios

Againtwomethods

A.WithMorningstarIndia
MorningstaragainusesonlyBSE100forcalculation.However,thisiseasytouseandisperfectfor
largecapfundsandmaybeabittoostrictformidandsmallcapfunds.

B.Withthefreefincalriskreturnanalyzer
Againtroublewithmorningstarisitusesthesamebenchmarkforallfunds.Youcanuse
myriskreturnanalyzer

whichhasaseparateupsidedownsidepage.Theevaluationstrategyis
differentfromwhatmorningstarusesbuttheessenceisthesame.

Iwillpostanexclusivetooltocalculatethisbetter.Seesomescreenshotsofthisareavailable
here
Method5:Withfreefincalrollingreturnscalculator
Ro0llingreturnsofferasmartandeasytounderstandwaytoevaluateconsistencyinperformance.

SupposeyouwanttoevaluatefundperformancefromJan1st2000onwards.

Youcalculate3yearCAGR*from1sJan200toDec.31st2002.Thenyoushifttheperiodbyaday(roll
over)andcalculate3yearCAGR*from2nsJan200to1stJan.2003andsoon.Plotthemtogetherand
stareatit.

forbothfundanditsbenchmark

Thisideaistolookforconsistentlongtermoutperformance.

Seethispostformoredetails:

MutualFundRollingReturnsAnalysis:FranklinIndiaBlueChipFund

andusethisautomatedsheetforcalculations:

MutualFundRollingReturnsCalculator

Method6:Withinformationratio
Informationisdefinedastheaverageexcessreturnofthefundwrtbenchmarkforagivenperiod,
dividedbythestandarddeviationoftheexcessreturn.

Consistentlyhighinformationratioisagoodindicatorofperformance.Dr.UmaShashikantsays,

Informationratioismykeyquantitativeindicator.

Seethispostformoredetails(calculatorinthesamepost):

MutualFundAnalysiswiththeInformationRatio

Method7:WithUlcerindex
Ulcerindexisanotherdownsideprotectionindicator.Itpenalizesfundsmoreforlapsesindownside
protectionthanothermetrics.Thisismypersonalfavourite(thanksToRameshMangal)
Seethispostformoredetails:

MutualFundAnalysisWiththeUlcerIndex

andusethisforcalculations:

riskreturnanalyzer

whichhasaseparateulcerindexpage.

Eeny
WasInotright?Doesnt meeny
, miny
, moe
, fromtheshortlistseemlikeaprettygood
methodnow!!

Wouldyoulikeasuggestion?

Forlargecapfunds:

Use:
Method4A:Usingdownsidecaptureratioswithmorningstardata

Formidandsmallcapfunds

Use:

Method4B:Usingthenewdownsidecaptureratiocalculator
(releasinginacoupleofdays)

Alternatively

Use:
Method7:WithUlcerindex

oracombinationof

Method5:Withfreefincalrollingreturnscalculator
and

Method7:WithUlcerindex

16.HowtoSelectDebtMutualFundsSuitableFor
YourFinancialGoals?
Sincethetimemy
stepbystepguidetoselecting(Equity)mutualfundsbecomepopular,Ihave
beenreceivingrequeststopublishasimilarguidefordebtmutualfunds.

Wellbegunishalfdone.Ifaninvestorcanconfidentlyselectcategoriessuitablefortheirfinancial
goals,shortlistingasetoffundsfromthatcategoryisthatmucheasier.Thisisespeciallytruefor
debtfunds,sincechoosingoneistypicallytougherthanequityfunds.

AlthoughIintendedthisposttobeacompanionpiecetothemoregeneral, Howtoselectmutual
fundcategoriessuitableforyourfinancialgoals
,asIwroteit,enoughaspectshavebeenincludedto
considerthisasastepbystepselectionguidefordebtfunds.

Interestratesandbondpriceshaveafascinatingrelationship.Therefore,besidestheusual
riskreturnparametersofalpha,beta,standarddeviation,Sharperatio,Sortinoratioetcusedfor
equitymutualfunds,quantitieslikeyield,yieldtomaturity,averageportfolioduration,modified
durationetc.areinvolvedindebtfundselection/evaluation.

appear
Thismakestheselectionprocess complicated.However,thiscanbesimplifiedbyfocussing
on1/2parameterstofirstnarrowdownthedebtfundcategoryandthenshortlistfundsfromthat
category.

Thankstotherecentcrashinbondprices,avisualanalysisispossible.

th
OnJuly16 2013,the
1
0yearGsecrate
increasedby6.69%whilethe
1yearGsecrate
increasedby
awhopping14.8%.Source:www.investing.com

WhilethestepstakenbyRBItocurbrupeedepreciationwasthemainreasonforthis,otherevents
playedaparttoo.See
here
foradecentreport.

Thevalueofabondhasaninverserelationshipwithinterestrate.Ifinterestratesincrease,thevalue
hasto
ofabond fall
inordertomatchcurrentyields.Therefore,theNAVofabondfundholdingsuch
bondswilldecrease.

Sinceboththe1Yand10Yratejumpedupsharply,prettymuchbondsofalldurationswereaffected,
resultinginafallinNAVofalmostalltypesoffunds.
Evenliquidandultrashorttermfunds,withmaturitydurationsmuchlessthanayear,were
affected,becausebankspulledouthugeamountsofmoneystashedinsuchfunds.

performance
Sincethiseventoccurredlessthanayearago,thedefaultoption(1Y)inthe tabofeach
debtfundpageatValueResearchOnlineshowshowfundsbehavedduringthisperiod.

Thisoffersasimplewaytounderstandhowdifferenttypesofdebtfundsreacttointerestrate
movements,aka interestraterisk onetype
ofriskthatdebtfundsaresubjectto.

First,letmequotetwodefinitions:

ModifiedDuration:Measuredinyears,modifieddurationisameasurementofabondssensitivityto
movementsininterestrates.Forexample,abondwithamodifieddurationof5.2yearscanbe
expectedtoundergoa5.2%movementinpriceforeach1%movementininterestrates.Thelongerthe
modifiedduration(inyears),themoresensitiveabondspricetochangesininterest
rates.
Source:
InvescoPerpetual

AverageMaturity: Theaveragematurityoftheportfoliodeterminesthetimeinvolvedinmaturingof
allthedebtassetsintheportfolioofthedebtmutualfund.Highertheaveragematurityofthe
portfoliogreaterwouldbetheinterestrateriskontheportfolioofthedebtmutual
fund.
Source:
MoneyControl

Boththemodifieddurationandtheaveragematurityrepresentthesensitivityofthedebtfund
portfoliotointerestratemovements.

Whileaveragematurityisacrudemeasureofinterestratesensitivity,themodifieddurationisa
moresensitivemeasure.

Justbynotingthevaluesofthesetwoparameters,onecanunderstandhowinterestrateriskaffects
differentdebtfundcategories.

Hereisacompilationofaveragematurityandmodifieddurationfordifferentfundclasses.Ihave
deliberatelyavoideddefiningeachfundcategoryinthepost.Thosewhoarefamiliarwiththem
shouldnotworrytoomuch.Ifyouarenewtodebtfunds,thenIsuggestyoucomeupwithyourown
definitionoffundcategoriesbyobservingthemaximumvaluesoftheaveragematurityand
modifiedduration.

Source:ValueResearchOnline.Insomecases,theaveragematurityandmodifieddurationarenotforthesamefund.Thetypical
orderofthevaluesishowevercorrect.

Performanceinthepastyear

Debt:Liquid.
Letuslookatthefundwithhighestaveragematurity(AM)(0.2years)andhighest
modifiedduration(MD)(0.18years).


NoticethelittlebumpintheNSETreasuryBillalittleafterthebondcrash.Thefundhoweverwas
th
practicallyunharmed.IfyoupeeralittleyouwillnoticeasmalldiponJuly16 .Noticehowfastthe
fundbouncedbackinafewdays.

Debt:Income
Letuslookattwofunds.

ThefundwithlowestcategoryAM=0.44years,MD=0.37years


th
NoticehowthefundsufferedadiponJuly16 butrecoveredinacoupleofmonths.

NowletuslookatthefundwiththehighestcategoryAM=13.62years;MD=6.95years.


ThefundisyettoreachitsJuly16thNAV.

Similarplotscanbemadefortheshorttermgiltfunds.ImaginethefateoftheDebt:longtermfunds!

Therefore,ingeneral,highertheaveragematurityoftheportfolio,highertheinterestraterisk.

Highertheaveragematurity,higherthemodifiedduration.

interestraterisk
Higherthemodifiedduration,higherthe .Thevalueofthemodifieddurationgives
youamoreexactestimateofhowmuchtheNAVwillbeaffectedfor1%changeininterestrates.
TypicallyfundswithlowAMandMDwillfollowanaccrualstrategy.Thatistheywillbuyandhold
debtpaperuntilmaturity.Sointerestrateriskislowered.However,creditrisk
comesintoplay.Lower
the
qualityofthedebtpaper
,higherthecreditriskandhighertheinterestrate!

SEBIallowsfundhousesto
buycreditprotection
(sortofaninsurance)tohedgecreditriskon
corporatebonds.Sothatofferssomecomforttotheinvestors.

Howdoweusethisinformationtoselectmutualfunds?

Whenitcomestodebtfundinvestors,Icanthinkofthreetypes

1)Thosewhoarealwayschasinginterestrates,doubleindexationetc.

2)Thosewhoarelookingtoinvestforshorttermgoals,lessthan5yearsaway

3)Thosewhoarelookingtoinvestforlongtermgoals,aspartofdiversifiedfolio.

Wewillleavetype(1)alone.Obviouslytheyknowwhattheyaredoing.WewillleavethehighAM,
highMDfundstotheseguys.

Wherekindoffundsshouldtype(2)investorschoose?

Theyshouldchooseafundwithaveragematuritywellbelowthetenureofthefinancialgoal.

Fora5yeargoal,Iwouldchooseamodifieddurationandaveragematurityofnomorethan1year.

Whichkindoffundtoinvestin?
Nowwewillneedtolookintothe natureofthedebtholdings.Isit
corporatedebt?ItisBankpaper?Itisgovtdebt(gilt)?Whatistheratingofthedebtpaper?

Forimportantgoals,besttosticktohighqualitydebtissuedbybanksandPSU

ShorttermgiltfundswithlowerMDcanalsobeused,butthereturnswouldbeonthelowerside.

Forlessimportantgoals,youcanbealittlemoreadventurousandincludesomecorporatedebt.
HereagainsticktofundsthathavepredominantlyAAAsecuritiesintheirfolio.

interestrate.Therisk
Soinvestorsshouldfirstlookatlow (AM&MD)
,shortlistcoupleof
categories
fund andthenchoosefundswithlow creditrisk
(qualityofdebt).

HereisascreenshotfromtheValueResearch portfolio
pageshowingtheAM,MDandthe fundstyle
box.
Weshouldfundswithhigh low
creditqualityand i nterestratesensitivityforshorttermgoals.
Mostinvestorswithagoalinmind,shouldstaywithintheredcircle.

Oncethefundcategoryischosen,youcanshortlistfundsusingtheriskreturnparameters(alpha,
beta,standarddeviation,Rsquared,Sharperatio)usingthesamestrategyasoutlinedin
thestepbystepmutualfundselectionguide.Ifyouwouldliketounderstandriskreturnparameters
inasimplenonmathematicalway,clickhere

Thiswouldenableyoutoshortlistlowrisk,reasonablereturnfundsfromthecategoryofyour
choice.

Thenextstepwouldbetolookatthefundobjectiveandinvestmentstrategy.Somefundhouseslike
FranklinTempletonmentionthisclearlyoneachfundpage.Iftheinformationisnotclear,readthe
schemedocument.Donotaskanyoneelse!

Theobjectiveandinvestmentstrategymust
giveyoutheimpressionthatthecurrentAMandMDwill
moreorlessbethesamefortheinvestmenttenureyouhaveinmind.

Ifyes,goaheadandinvest!
NEVERinvestinadebtfundwithoutreadingtheinvestmentobjectiveandinvestmentstrategy.

Wherekindoffundsshouldtype(3)investorschoose?

Firstletusunderstandwhatweneeddebtfundsforlongtermgoalswhichwouldtypicallyhave
significantequity.

WhynotPPF?PPFisnotsuitableforgoalslessthan15financialyearsaway
PPFisgoodbutitdoesnotallowrebalancing.YoucanbookprofitsintoPPFbutnotviceversa
whenyouwantto.
Withadebtfundthereisachanceforhighreturnswhichcouldbetransferredtoequity
whenthemarketsfall.Sodebtfundsallowforrebalancingwhichifdonecleverlycancontain
portfoliovolatilitysignificantly.

Justlikeadiversifiedequityfund,awelldiversifieddebtfundlikeadynamicbondfundwith
modifieddurationandaveragematurityofnomorethan23yearswilldothework.TheNAVwill
fluctuateandthatisfine,sinceweneedfluctuationsforrebalancing!Youcanlearnmoreabout
rebalancinghere.Besuretoplaywiththesimulatortool.

Justastheconceptof
standarddeviationcanhelpanewbiemfinvestorunderstanddifferentfund
categories,theconceptsofaveragematurity,andmodifieddurationcanhelpthenewbiedebtfund
investortopickacategorysuitablefortheirneeds.

Debtfundsselectioncantypicallybemorecomplicatedthanequityfundselection.Itisuptothe
investortosimplifythisprocessbybeingclearon
whattheywant
.Theyshouldlearnnottochase
afterreturnsandkeepexpectationslow.

17.HowtoConductaPersonalFinancialAudit
IloveDecember.TheChennaiSummerisbusyrechargingitsbatteriesandthereforenotinfullforce.
TheCarnaticmusicseasonseemstobeginearliereachyear,thankstosomeprudentmarketing.The
semesterisover,andforme,goalbasedinvestingmonthstarts!

MostofwhatlittleIknowaboutpersonalfinanceandinvestingcomesfromtimespentstaringat
ExcelsheetsinDecember.Allmyretirementandgoalbasedinvestingcalculatorsweredonein
DecemberasIevaluatedmygoalsandfuturecashflow.

InDecember,Idoapersonalfinanceaudit.Detailsoflastyearauditcanbefound
here

(besureto
readcomments) .
Willpostthisyearsauditsoon.

ThemostimportantpartoftheauditistofindoutifIamontrackwithrespecttomylongterm
financialgoals.Muchofthisauditprocesshasbeencompletelyautomatedwiththesetools(andcan
bedoneanydayoftheyear):

1. Ikeeptrackofinvestmentswiththis
monthlytracker
2. Trackfundholdings,portfoliohealthandgoalprogresswith
AutomatedMutualFundand
GoalbasedInvestment
Tracker
3. PPFTracker
4. Getaperspectiveoffuturecashflowwiththeintegratedfinancialplanner

Ifyouhavenotdonethisexercise,dotryit.Itwillchangethewayyouthinkaboutmoney.Youcould
feelmoresecureandhopefullyincontrol.Itwoulddefinitelytellyouwhereyoustand
and
where
youneedtobe
(ifyouarenottherealready).

calltoaction
Atthecostofsoundingpresumptuous,mayIsuggestthatyoutreatthispostasa andtry
outtheabovetools?

Ifyouareinterested,hereiswhatyouwillneed:

60minutesofpeaceandquiet.
Anotebookandpenandofcourseacomputerhookeduptotheinternet.

Andthisiswhatyouwillneedtodo:

1. Inthenotebook,dateapageandlistallpossibleshorttermandlongtermgoals.
2. Entertheapproximatecurrentcostofeachgoal.Ifyoudontknowitoffhand,sourceitlater.
 3. Withthisinformation,playwiththe VisualGoalplanner
Hopefullyitwouldhelpyou
understandtheimportanceofinflationandhowtobeat:eitherby investingenoughorby
earninglargeenoughreturns .
4. Collection all
relevantinformationregardingyourinvestmentsandsavings:SBaccounts,FDs,
RDs,PPF,EPF,Gold,Stocks,mutualfundholdings,bonds,insurancepoliciesetc.
5. Youarenowreadytousethe integratedfinancialplanner
.
Asyouexploretheentries,ifyou
needhelpwithplanninglongtermgoals,youcanconsult: AStepByStepGuidetoLong
TermGoalBasedInvesting
6. Takeafewdaystostudyandunderstandtheresultsoftheintegratedfinancialplanner.That
howmuchyouneedtoinvest
willtellyou howmuchyoucaninvest.
and thisyearandinall
futureyearsuptoretirement.
7. Thisshouldgiveyousomeideaofachievableyourfinancialgoalsare.Youdontneedtotake
theresultsoftheplannerasGospel.Aslongasyoustrivetoinvestasmuchasyoucanand
keepexpensesatcheck,youwouldbefine.
8. Thenextstepistotagyourexistingandfutureinvestmentsorsavingswithlongtermor
shorttermgoalsandenterthatinthe monthlytracker
9. YoucanusetheabovementionedPPFandmutualfundtrackersifyouwish.
10. Writedownimportantconclusionsinthenotebook.
11. Repeatsteps110onceayear.
12. Stepslikechanginginvestments,rebalancingetchavenotbeendiscussedhere.Ifthese
stepsarefollowed,myguessisthatyouwouldknowwhattodowithyourinvestments
becauseyounowsetyoursightsontheonlybenchmarkthatcounts:yourfinancialhealth.
13. IwillprovidesomemoredetailsonthiswhenIpostmypersonalfinanceaudit.

Ifyouneedhelpwithanyoftheabovesteps,youcancontactmeandIwillbehappytoprovide
generichelp.

HappyAuditing!

18.Howtoreviewyourmutualfundportfolio?
Idiscusssimplewaysinwhichamutualfundportfolioassociatedwithalongtermgoalcanbe
reviewed.Thisisagreyareainpersonalfinanceandthereisnooptimalwaytodothis.Each
individualmustnecessarilydeveloptheirownstyleofreview.Somultiplesolutionsarethenorm
here.

howIdoit
Whatispresentedbelowaremythoughtsonthesubjectandisacombinationof and
howIwoulddoit
.Letusstartwithassumptions.

1. Thegoalisseveralyearsaway(shorttermgoalmanagementisadifferentballgame.Itthe
foliohasdebt,thenthereisnotmuchtodo.Ifithasalotofequity,oneshouldprayalot!)
2. Wehaveaclearexpectedreturnfromourtotalequityfolio(thisreviewisfortheequity
portionofthefolio.Wewillassumethedebtparthasminimalvolatilityanddoesnotneed
frequentreviews)
3. Wewillmonitorthefolio,sayeachmonthbutwillonlytakeactiononceayear.
4. Actionherereferstofundchangesonly.Otheractionslikerebalancingortacticalasset
allocationdependonequity:debtallocationoreconomicindicatorsandarenotconsidered.
5. Thefolioshouldatleastbe5Yold.Thereisnohurryfornewinvestorswithfoliosyounger
than5YtotakeanyactionandIstronglysuggesttheymonitortheirinvestmentpatternsand
notthefolioperformance.
6. Thereareseveraltypesoffolios(minimalist,mildlycluttered,severelycluttered).Socourse
ofactionwilldiffer.Wewillconsideraclutteredfolio.Itiseasytoextrapolatethegistofthe
argumenttoanyfolio.Ifyouhaveanyquestions,feelfreetoask.

Prettymucheveryactioninpersonalfinanceneedsabenchmark.Themorepersonaltheyare,the
easieritistodecide.

Sothefirstbenchmarkistohaveareturnexpectation.Thisexpectationshouldbereasonableand
mustkeepinmindassociatedvolatility.

Thesecondbenchmarkisthenetreturnfromtheportfolioatanygiventime.Thisiscalculatedusing
whatisknowastheXIRR(readmoreaboutthis
here
)

Howhasthefundperformed?
TheXIRRis,bydefinitionapersonalbenchmark. isnowquantifiedby,
WhatismyXIRRfromthefund?

ItisapersonalbenchmarkbecausenotwopeoplesXIRRwillbethesame,unlesstheyinveston
exactlythesamedates.
ThisiswhystarratingsareirrelevantonceIinvestinafund(theyareirrelevantevenbeforethat
because,imotheydonotreward/penalizelongtermconsistency/inconsistency.Aninvestoris
betteroffdoingtheirownanalysis).

OnceIinvestinafund,allthatmattertomeisitsimpactonmyfolioandnothowitcompareswithits
peers(starrating).

So,onceIhaveanexpectationfromequity,thenexttaskistofindoutthenetXIRR(thisistherateat
whichallyourinvestmentshavecompoundedonanaverage.ThisistheequivalentoftheCAGR
whenmultipleinvestmentsaremade).

YoucandothisbyenteringALLyourtransactionsinaportallikeValueResearchormymutualfund
trackerorMprofit.NotsureifPerfiosgivesthis.

Youshouldnowhaveatableofthecurrentvalueofallyourfunds,theirindividualXIRRsandthenet
XIRR.

Somethinglikethis(clicktoenlarge).Thisisafabrication.

NoprizesforguessingthatthefirstfundisPPFAS!!

Ifmyreturnexpectationis10%(lowerthebetter),IcanaffordtodonothingifmynetXIRRand
individualXIRRsareallabove10%.Thereisabsolutelynothingwrongwiththisstrategy.

IlikealargeXIRRasmuchasanyotherperson.Soasecondapproachistotry(andhope)tokeepthe
netXIRRwellabovethereturnexpectationandmake gradualchangestoincreasethedistance
betweenthetwobenchmarksasmuchaspossible.

Theabovepictureisanexampleofaclutteredfolio.Ithas3largecaps,onelargemidcapandtwo
midsmallcapfunds.Iamnotterriblybrightwhenitcomestogivinggoodexamples.Iamfairlysure
thatmanyreallifefoliosareworsethanthis!
Herewego,

Amongthethreelargecapfunds,twoare5Yoldinthefolioandone2Yold.

Isthe2Yoldinvestmentnecessary?Itisunlikelytodiversifythefolioastherearealreadytwolarge
capsanditsreturn,14.75%issignificantlylowerthantheNetXIRRof26%.Also,itconstitutesonly
1.23%oftheentirefolio.

SoIthinkthis(largecap1)canbegottenridof.

LargeCap2isnearlytwiceinvaluecomparedtolargecap1butitsreturnismuchlower.

Iflargecap2hasconsistentlyperformedthenitcanberetainedevenitsportfoliohassignificant
overlapwithlargecap3.

Samereasoningforlarge3.Ifithasbeenconsistent,leaveitalone.Ifithassuddenlyimprovedinthe
lastfewmonths,wewillhavetowaitandwatch.

Inthenameofconsolidation,oneshouldnothastilyshiftlargecap2holdingstolargecap3.Onecan
increaseinvestmentsinlargecap3anddecreaseinvestmentinlargecap2andseehowthatgoes.

Iflargecap3doesindeedcontinuetodowell(returnwellabovenetreturn)andlargecap2hasnot
pickedupitsact,onecanthengraduallyshiftunitsfromlargecap2to3.

TheaimhereistoslowlybutsteadilyincreasethenetXIRR(wellabovetheexpectedreturn,ifatall
possible).Onecannotaccomplishthiswithkneejerkchanges.Theideaistodoitwithamethodand
todoitgradually.

OnecanalsotrytoreducethevolatilityinthenetXIRR.Thismayneedtacticalcallsthough.

Thusisisimportanttotrackperformance.Otherwise,suchdecisionscannotbemade.

Thelargemidcapfundcanbeleftaloneevenifitholdsthesamelargecapstocksasthelargecap
funds2and3.Itsreturniswellabovethenetreturn.Whenitaintbrokedontfixit.

Therearetwosmallmidcapfunds.Oneofthemisquiterecent.Soleaveitbe.Theotherhasa
decentenoughreturn.Soleavethatbeaswell.

Again,ifthemidcap+internationalequityfundcontinuestodowell,investmentscanbeincreased
here.
IthinknothavingaSIPishelpfulinmakingtheseswitches.IthinkaSIPisbestdoneinthefirst5Yofa
longtermgoal.Afterthat,Ithinkactivemanagementwillhelp.

Allthisiswrittenwithoutanykindofqualitativeanalysisastowhycertainfundsdidnotdowell.
Diggingalittledeepermayormaynothelp.

Itisbesttonotgetemotionallyattachedtoafundandtoberuthless,butobjective.Thisis
somethingIamnotverygoodatbuthavechangedinthepastcoupleofyears.Ruthlessdoesnot
meanimmediate.Changecantakeafewmonthstohappen.Afterall,exitloadsandtaxationarealso
important.

Changescanhurt.Thefundweexitedcangoontodoquitewellandthenewfundplumbnew
depths.Whichiswhyitisimportanttonotmakeanysuddenchanges.

Oneshouldchaseafterreturnsliketheturtletryingtobeatthehare:slowandsteadydoesthetrick.

QuantumLongtermequitymaybeathreestarfundtoday(accordingtoVR)butinmyfolioitisafive
starfund.Chasingafterfivestarfundseveryyearortakingblogpostswhicharetitled,TopBestXX
fundsin2015(XX=number)seriouslycanbeinjurioustoyourfiscalhealth.Bloggerswritesuchcrap
togettrafficandmoreGoogleadsensemoney.

Understandinghowthesmallcapsandmidcapshavefaredagainstlargecapshelpinunderstanding
therecentreturnsofthefundinourportfolios.

Thisisjustonewayofdoingthings.Therecouldbesimplermethods.Personally,Iprefer
benchmarkingXIRRofeachfundwiththefoliosnetXIRR.

OnceIamunitholderinafund,itsperformanceagainstabenchmarkisnotallthatrelevanttome.
AMCschoosebenchmarksthatcanbeeasilybeat(ifyouranabusiness,wouldyousetyourselftough
targets?).Afundthathasconsistentlybeatitsbenchmarkcanstillnotevenmeetmyreturn
expectation,orcanbemuchlowerthanthenetXIRR.

Atsuchtimes,itmakessensetofindoutiftherearebetterperformingpeers takingintoaccount
consistencyindownsideprotection(seehowtodothishere
).Againstarratingsdontmeanmuchto
me.

Thismightwork,providedtheageoftheinvestmentandtheweightoftheinvestmentare
considered.TheideaistoidentifyfundsthatpulluporpulldownthenetXIRR.

Suchfundsneednotalwaysbeeliminated,butitdoesnothurttoreviewsuchfundsabitdeeper
andactaccordingly.
Allsaidanddone,historytellsusmostfunds(fromdecentfundhouses)tendtodowellifheldon
forlongenough.Soasimplebuyandholdstrategywilldefinitelywork.

Whatisproposedaboveisonlyoneofazillionpossibilities.Theideaofthisposttohighlightthe
personal
importanceof benchmarks.Therearemanysolutionstothisproblem.Feelfreetocritique
andproposealternativestrategies.

19.ReviewYourRetirementPortfolioinSeven
EasySteps
Alllongtermfinancialgoalsrequireperiodicreviewtoensurethattheyareontrackandinlinewith
expectationsandassumptionsmadewhile planningforthegoal
.

Retirementisauniquefinancialgoal
.Mostoftenonehasalargecorpustoutilizeoveraperiodof
severalyears.Hereareseveneasystepsbywhicharetirementportfoliocanbereviewed.

goalsanalysis
Youcanusethe sheetofthe
automatedmutualfundandfinancialgoaltracker
to
automatethisreviewprocess.

1. C
alculatethecurrentvalueoftheretirementcorpus .Determinecurrentvaluesofmutual
fund/stockholdings,PPF,EPF/ NPS,FDsetc.andaddthemallup.
2. Whatistheretirementcorpusworthtoday? Ifyouweretoretiretoday,whatnumberof
yearscanyoubefinanciallyindependent?Ifthisnumberisequaltothenumberofyearsyou
expecttobealivefromtoday,youarefinanciallyindependent!

Forexample,Icanbefinanciallyindependentwithoutworkingforjustaboutayearorso,
ifIretire
today!InordertoneverworkagainIwouldneedasumthatwouldsupportme,thatisprovidedme
an
inflationprotectedincomestream foratleast4045years!

3. Whatistheprojectedworthoftheretirementcorpus?Ifthepresentcorpuswasallowedto
growfromnowuntiltheexpectedageofretirementatareasonablerate(=returnon
investment),whatnumberofyearscanyoufinanciallyindependent?Ifthisnumberisequal
tothenumberofyearsyouexpecttoliveafterretirement,youcansafelyreducefurther
investmentsifnotstopthemaltogether.

Forexample,IfIdonotinvestmentforretirementanymoreandretireaspermyplansat65,Iwill
haveacorpusthatwillsupportforabout5years.WhereasIwouldneedacorpusthatshouldsupport
mefor2025years!

4. Whatisthecurrentmonthlyinvestmentrequired? Takingintoaccountthecurrentcorpus,
whatisthemonthlyinvestmentrequiredtoday,increasingeachyearatanassumed
(reasonable!)rate?Ifthemonthlyinvestmentrequiredislowerthanwhatyou actually
invest
,thenalliswell.Else,youwillneedtocutdownexpensesuntilyoucaninvestenough.

Iamnotdoingbadlyonthisaccount.Thankstoanaggressiveinvestmentstrategy,Ineedtoinvest
only65%ofwhatIcurrentlydo.ThatisIcanaffordtoreducemyinvestmentsbyagood35%
somethingIdonotintendtodoaslongasIcanmanagetokeep
unexpectedrecurringexpenses

at
bay.

MyAssumptions/Expectations

Equity:12%initially,gotitdownto10%(
thankstothis
)andnow9%

Debt:8%

Inflation:9%

Annualincreaseinmonthlyinvestment:10%

Posttaxreturnsafterretirement:7%

5. Whatisthegrowthrateoftheretirementportfolio? WhatistheCAGRofeachassetclass?
Thatis,theCAGRofequityholdings*,PPF,EPF, NPS,gold,FD,realestateetc.IftheCAGRof
thevolatileassetclassesismoreorlessclosetoyourexpectations,notmuchneedbedone.
Ifitmuchhigherthanexpectations,itmightbetimetorebalance .Ifitismuchlower,you
willneedtolookatthesourceofunderperformanceandtakeacallonit.

Thecurrentmonthlyinvestmentrequiredisalsoasignoftheportfoliogrowthrate.Ifitnottoo
initial
muchhigherthe monthlyinvestmentplanned,thingsarereasonablyfine.

th
MynetEquityCAGR:9.89%(asonMar.24 2014)

th
NPS:7.57%(ason14 Mar2014)

PPF:Sameasyours!IcontributeRs.500eachmonthtomywifesaccountandmine.

Gold:Notapplicable

RealEstate:Notapplicable

all
*take thetransactions(purchases,dividends,redemptions,switches,reinvestmentsetc.)made
forafinancialgoal,feedthemintoaXIRRcalculatorandcomputetheCAGR(the goaltracker
sheetof
theautomatedmutualfundandfinancialgoaltracker
doesthisatclickofabutton).

6. Isyourretirementinautopilotmode? Forthesalariedclass,someinvestmentslikeEPFare
mandatory.IfthecurrentmonthlyinvestmentrequiredislesserthanthemonthlyEPF
contribution,yourretirementisinautopilotmode, provided thereisnotsignificantbreakor
reductionincontributionsduetolayoffsorlesserpayingjobs.

Minehasbeeninautopilotmodeforquiteawhilenow.SinceIplantoretireearly,itdoesnot
mattermuchforme.

7. Areyouplanningtoretireearly? Ifso,thefirstrequirementistoinvestasmuchaspossible
andasearlyaspossible.Ifyouaredoingthisconsistentlyforatleastacoupleofyears,use
the
financialfreedomcalculator tofindouthowsoonyoucanretire.

Inmycase,financialfreedomisagood1820yearsaway(longerthanIoriginallythought

).Howeversincemyexpectedretirementislongerthanthis,Iamreasonablyhappy
withit.

Dobecarefulwhileinterpretingthesenumbersandbesureto
avoidthesecommonretirement
planningmistakes.

Ifyoucouldgothroughthesesevenstepsonceayear,youcanensurethatyourretirementplansare
ontrack.

goalsanalysis
The sheetofthe
automatedmutualfundandfinancialgoaltracker

automatesthis
reviewprocess.Justremembertoviewitoccasionallyandnoteveryday!

20.Assetallocationforlongtermgoals

Assetallocationreferstotheproportionofdifferentassetclassesinaportfolio.Forexample,
percentageallocationtoequityanddebt.Theallocationis(orrathershouldbe)decidedwithanaim
tobalanceriskandreward.Theadage,donotputallyoureggsinthesamebasketisusuallyused
toexplainthisstrategy.
Determiningtherightassetallocationforlongtermgoals(definedatleast10yearsplusaway)isa
toughtaskifwearelookingforamethodtodoit.Itisdifficult(ifnotimpossible)tofindthe
optimumassetallocationeitherwithariskprofileroraportfolioanalysistool.
Ideally,oneshouldchooseassetswhicharelittleorevenoppositecorrelationwitheachother(one
doeswellwhentheothertanks).Insuchacase,itiseasytouseaportfolioanalysistooltodetermine
therightassetallocation.
Equity,fixedincome(debt)andgoldisonestandardcombinationwhichcanbeusedforasset
allocation.
PersonallyIamnotafanofgoldandwillnotchooseit(toohighriskforthelongtermreward
offered).Sointhispost,Iwillsharesomeanalysiswithdifferentequity:debtratios.
AlokJhahasbeenaskingmeforananalysiswithallthreeassetsforalongtime.Sowilldothisinthe
nextpost.
IchooseFranklinIndianBlueChipasrepresentativeofequityandFranklinIndianIncomefundas
representativeasdebt.Theseareamongtheoldestequityanddebtfundsinthemarket.
WewillconsideraSIPfrom6thJuly1998to5thMay2014(thiswasdoneawhileback.Toolazyto
update)inbothfunds.
ThisishowtheXIRRwillvarymonthbymonth

CanwenowarguethatsincetheXIRRoftheequitySIPsettlesdownafterawhile,wecanhave100%
equityexposureforlongtermgoals?
Icertainlywouldnot.IfthereisabigcrashclosetowhenIneedthemoney,Iwouldbeintrouble.I
needthebedrockofdebt.HowmuchofitdoIneedisunfortunately,apersonalchoice.Hardto
provideaformulaforit.
Thisishowthestandarddeviation(ameasureofvolatility)ofthemonthlyXIRRlooksfordifferent
equityallocations.ThefinalXIRRisalsoplotted

Noticethebendinstandarddeviationat10%equityallocation.Itcanbeshownthatitcorrespondsto
theoptimumassetallocationintermsofriskvs.reward!
Heyweallwantbetterreturns,soletustakeonmorerisk.Buthowmuchmoreisthequestion?!
Hardtogiveamathematicalanswer.
Idonotlikeahighdoubledigitstandarddeviation.Ipersonallyuse60%equityformylongterm
goalsandsuggestnomorethan70%.Ithink50%equityisalsoaprettydecentallocation.
Recognisethatwehaveconsideredabluechipfund.Hadweincludedmidandsmallcaps,the
volatilitywouldhavebeenmuchhigher.
Ithinkanythingabout70%equityallocationwillrequirealotofmaintenance(monitoring,tactical
callsetc.)
Ihavebetterthingstodo.Iwantsomethingthatislowmaintenance,withreasonableriskand
reasonablereward.
Ifmynetequityportfoliogivesme1o12%after10Y+,Iwilldelighted.Iwouldhavemetallmy
financialgoalswithreasonablylowstresslevels.
LikeSubrasays,theassetallocationthatletsyousleeppeacefully,istherightallocation!
Whatdoyouthink?

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freefincal.com

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