Whose Money is It Anyway?

2. Whose Money is It Anyway?

3. Introduction to Personal Finance When does the typical, average, salaried individual start thinking about money, investing, personal finance? • Tax-saving; Email from F/A! • Circumstances • Employee Chit-chat • Call from relationship Manager • Friendly neighbourhood insurance agent

4. Personal Finance Approaches • Tax-savings first Buy products or make investments in haste at the end of each FY • Product-first Seek out a product for a need without understanding/analyzing the need • Returns-first Maniacal obsession over returns without paying heed to long-term and short-term risks

5. Personal Finance Approaches • Needs first Thorough evaluation of needs … and wants! • Product-last We do not search for products. We narrow down a type of product and then select one from that type • Tax-planning incidental Select a product from the chosen category that saves tax.

6. Personal Finance Approaches • Tax-savings first • Product-first • Returns-first • Needs first • Products-last • Tax-planning incidental Goal-based investing

7. Goal-based investing • List all known ‘needs’ and ‘wants’ • Classify them in order of importance • Classify them as per duration • Analyze each need/want. Determine how much we need to invest • Determine how much we can invest(!) • Decide on an approach • Find suitable investments • Invest • Monitor; Manage – A life long exercise!

8. First, we need to build a moat! Caerlaverock  Castle, Scotland. Source: Wikipedia Random Ramblings

9. 1. Protection against …. • Death of breadwinner(s) Solution:Life Insurance • Inflation-proof income to manage monthly expenses at least until kids go to a job • School fees • College fees • Marriage expenses • Other liabilities Product:Pure Term Life Insurance until retirement

10. 2. Protection against …. • Hospitalization of family members Solution:Medical Insurance • History of illness • Age of dependents • Typical room rents in neighboring hospitals • Exclusions • Pre-existing disease clause • Co-payment Note:Enhance sum insured annually

11. 3. Protection against …. • Emergency expenditures Solution:Rainy day fund • Monthly expenses x 12 • Medical emergencies • Liabilities Products:SB account; Online FDs, Liquid funds. No credit cards! Key:Returns are irrelevant; Taxation is secondary; Ability to replenish

12. 4. Protection against …. • Disability Solution:Accident Insurance • Must if job is not permanent • Must for professionals and businessmen Products:Get from general insurer not from bank! Key:Read policy document before buying

13. 5. Protection against …. • Critical illness? Solution:CI insurance • Complex products • Better off starting a corpus for medical expenses – treat as a long term goal

14. 6. Protection against …. • Misuse (intentional or otherwise) • An action plan and & a Will • More to a will than, ‘who gets what?!’ • It is a set of broad guidelines instructing a spouse or guardian about how to use the corpus accumulated for each long-term goal • Best to identify a trustworthy professional

15. 7. Protection against …. • Interrupted compounding Danger: Lifestyle change during retirement Solution: Efficient goal planning

16. Financial Goals Life, health, accident insurance etc Emergency fund

17. Cash Flow Analysis: Creating a Zero-based budget • Zero-based budget: “One in which every dollar is assigned a role” – Dave Ramsey • No money left at the end of the month! • Live ‘hand to mouth’ because of investing! • No lump sums allowed!

18. Zero-based budget • Step 1: List all sources of income • Step 2: List all monthly expenses • Step 3: List all annual/recurring expenses • Step 4: Listpresent and future liabilities • Step 5: List all present investments (incl EPF etc.) • Step 6: Determine amount available for investment (incl EPF)

21. Recurring Expenses • Insurance premium, school fee, AMC fee etc. • Returns: irrelevant • Taxation: Irrelevant • Instruments: SB acct; RDs; Liquid funds; Arbitrage fund(?!) …

22. Future Expenses: aka financial goals! • List all expected expenses in future Expenses after regular income stops aka ‘Retirement’ Expenses before income stops

23. Dividing the goal timeline ~ 5 years Save Invest

24. Power of non-compounding Power of compounding does not matter for ~ 5Y or less

25. Saving vs. Investing ~ 5 years Saving Investing Importance grows With duration Choose not to Worry Inflation Importance of beating Inflation, grows with duration Choose not to worry Returns Importance grows With duration Choose not to worry Taxation

26. Short-term Goals: determining how much to invest • What is the current Cost ? • Take all expenses into account • As accurately as possible Use an inflation of 8-10% (more for a safety margin) Return = post-tax interest rate of FD or RD Most people can pull this off

28. Short-term Goals: selecting instruments Nature of taxation: • Tax upon maturity/redemption (mutual funds) • Tax each financial year (RD/FD) • As per slab; with indexation; flat rate;

29. Why not have some equity exposure? Is not 5 years long-term?! A primer on volatility Annual Returns

30. Compounded Annual Growth Rate Geometric Average

31. Illustration: Volatile Compounding

32. XXXX Liquid Fund Arithmetic average ~ 7% CAGR ~ 7% (12 year) Difference ~ 0.02%

33. Average Arithmetic average ~ 7% Standard deviation ~ 2%

34. XXXX Liquid Fund Expected return ~ average +/- stdev ~ 7% +/- 2% Value Research online: Standard deviation: 0.21%

35. Rolling average Understand risks before investing

36. Monthly Income Plan Fund -1 Equity Exposure: 11.5% to 15.1% Cash-equivalent Exposure: 41% to 85% Rest Bonds

37. Monthly Income Plan Fund -1 Arithmetic average ~ 5.68% CAGR ~ 5.50% (10 year) Difference ~ 0.18% Standard deviation: 6.25%

38. Monthly Income fund -2 Equity ~ 25% Debt = long-term bonds Arithmetic average ~ 11.7% CAGR ~ 11.24% (12 year) Difference ~ 0.47% Standard deviation: 10.4%

39. Rolling average Monthly Income fund -2

40. There is more to investing than returns! Standard deviation is the simplest measure that an investor can use to select investment categories. Standard deviation listed in fund portals like VR online, Money Control, Morning Star are of limited use Investors will have to calculate the stdev. for the investment duration in mind from annual returns Whose money is it anyway? There is more to investing than standard deviation too!

41. Intermediate-term financial goals5-10 years Saving/Investing? Important Inflation Important because inflation is important Returns Important because inflation is important Taxation

42. Equity oriented balanced funds(> 65% equity)vs. Debt oriented balanced funds(<25% equity)

47. I can only invest 6000 a month. What should I do?

48. Asset Allocation