Confused about NAV?

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When I started reading about Mutual Funds, I use to read about NAV as a measure of fund performace and I always got confused as to what exactly is this parameter. Then someone simplistically told me "It is the value of one unit of fund". That made sense since it gave me info about how rich I am with respect to my investment. For example if I have 400 units of a mutual fund and the NAV for that fund is 12 Rs, essentially at this point I have 4800 Rs (minus the administrative charges of the fund). But then how is the NAV calculated from the fund's perspective.

Here is a simple example :

Assume that the mutual fund has an initial investment of 100 units with each unit is worth Rs 10. Hence, the total amount with the fund is Rs 10,00. Let us now say that this amount is invested in one share of Reliance (say Rs 5,20) and one share of Sify (Rs 4,40) and the balance Rs 40 is held in cash

Let's assume that after some time, the value of the shares goes up to Rs 780 (Reliance), Rs 520 (Sify) and expenses incurred by the fund amount to Rs 50. The NAV will be:

(780+520+40-50) / 100 units = Rs 12.90

Thus the fund have achieved an absolute return of 29 per cent during the period. Pretty neat ..uh !!

Why debt funds are not same as FDs

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Harsha commented in one of my previous posts about not mentioning debt funds. I do not consider debt funds as a good investment option since there are lot of negatives attached to it then the gains. As mentioned by The Hindu a debt and gilt funds usually invest in long-term borrowings of the government or corporate issuers at fixed rates of interest. These funds earn their return from two avenues — the interest payments that they receive from bonds/gilts and the fluctuations in the market price of their holdings.

The most negative aspect of debt fund compared to FD is that the returns are not assured due to linking with markets. Even after taking this risk, there are no tax breaks. A flat divident distribution tax (around 14%) is applicable to the mutual fund house which obviously cuts it out of the investor money. The returns are also not spectacular and hovers around 6-7 % which post distribution tax comes out to be 5.9%.

Compare this with a bank FD say for a yearly tenure. The interest rate is 7-8%, which comes out to be 5.1% post tax for the highest tax bracet. It goes higher(even about 6.5%) for people in lower tax bracket. Thus the biggest dis-advantage is that despite the risky nature the returns are more or less same, then why an investor should take the additional risk. The only advantage is the liquidity since there are no entry or exit loads (the charge applied by fund house on pulling out the money).

Is financial planning funny?

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Have you ever imagined that even a serious subject like financial planning can tickle your funny bones. For example, when I read about Life Insurance it seem to be kind of funny. If you purchase a life insurance product, you are paying money for something you will never use !! Life insurance implies the money that goes to your nominee when you die. So obviously you cannt make use of your life insurance. The worst part is that the agents use your "guiltiness" to sell their product. They will pitch the product saying "Have you ever thought of what will happen to your dear ones if you suddenly die?" "What your wife will do?" And this set the ball rolling in your mind, you feel guilty and buy the product.

Take another example, my parents are living a retired life. They get a meagre pension of 5000 Rs per month after serving the government for their entire life. If I try to analyse their situation, they put their majority of saving into buying a house. Now thats funny since today they are large asset-owner but cash-deprived. All their sons are well-setteled (enough to take care of their own families), so what is the use of such a huge house sitting out there while my parents struggle for cash. And they wont accept money from any of their sons.

There should be some scheme reverse of home-loans. I mean when you want to buy a house, you go to a bank, take a loan and give back money in the form of EMI. The idea is that the house is a mortgage with the bank until you repay the entire loan. Wouldnt a reverse scheme be nice. For example, the bank might have a contract with the elderly people who are house owners. Once the person retires and wishes to enroll in the scheme, he will sign a contract with the bank. As per the estimated price of the house, the bank will pay a monthly EMI to the customer (say 10,000 Rs per month) till the customer is alive (which could be say 20-25 years after retiring at the age of 60 years). After his death, the house ownership instead of going to the legal heirs will go to the bank. The bank can then do whatever it wants. Isnt that a win-win situation for everyone.

Negligence leading to fraud

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I was just reading the Outlook Money and came across a customer complaining. Here is what happened to him:

He had a HSBC account in Delhi which was designated to receive his investment income. So when he shifted to south india, he didnt closed the account. He started using a new saving account there and occassonaly would use the Delhi account using an ATM card. Some two years ago his ATM card became inactive and hence he stopped using the account. Now when he checked, he realised that someone has fradulantly withdrawn 29,000 Rs using an ATM card. He was shocked.

This is purely a case of negligence on his part. He should have changed the address of communication, since the bank might have issued another ATM card on his old address along with sending him a PIN number. Someone must have used this ATM card and pin code to access his funds.

As soon as you shift your location, you immediately have to inform all the banks you deal with about the change of address. But there are banks like SBI, where change of address is a tedious process. I once went to the SBI to change my address from delhi to hyderabad branch and what they told me shocked me. They told me that I first have to submit my pass-book/cheque book and all other bank account details in the hyderabad branch, then they will send a request of cancellation of my account in the delhi branch and create a new account in this branch. This entire process might take 2-3 months.

Questions to ask your financial advisor

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In my previous post I talked about being alert despite using the services of a financial advisor. I feel that there are certain questions to be put forward to any financial advisor to know what he/she is worth of. Although you might find it embarrasing to ask these questions, but keep in mind that what you are doing is entrusting your hard-earned money to him and as with any service you should be fully satisfied before you use it. In India people from banks and distribution houses, insurance agents, mutual fund distributors and chartered accountants etc all call themselves wealth manager or a financial advisor which makes it totally confusing.

In a purely technical sense certified financial planners (CFPs) are those who have been certified by the Financial Planning Standards Board (FPSB), India. But even if the concerend person is not a CFP, make sure that he understands your financial goals and uses the financial planning process to help you figure out how to meet your life goals through the proper management of your financial resources.

What you should look out for in a good financial advisor is :

-- His qualification
-- His experience
-- Does he provides any value-added services and covers an entire range of financial planning
products including equity investment, debt, commodities, art, insurance, international investment,
which home loans to take and why, tax planning, estate planning, filing tax returns,
superannuation, real estate, and do a cash-flow analysis.
-- Does he understands your goals or he pushes his own products
-- What are the charges he puts on any product. what is his cut? This will give you an idea of
whether he is pushing a product just to make a higher cut.
-- Diversification is the key for proper financial planning, what is his financial planning philosophy
-- Does he provide any references of other people subscribing to his services
-- What about the exit route in case you want to discontinue his services

A satisfactory answer to each and every question above should be obtained before you trust him with all your moolah !!

10 most common financial queries

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When I started earning, I was not very clear of how to manage my finance (by the way even today I am not very sure) but I have learned few things along the way. The first and the most common questions relating to personal finance that people ask are mentioned below. I will try to put my views on them.

1) Is financial planning for me?

Yes, whoever you are, unless ofcourse you have unlimited access to unlimited money anywhere, anytime. I term financial planning as nothing but a way to optimise the usage of your money to help you lead a comfortable and unworrying life. So anyone who have limited sources of income and have certain ambitions or goals to achieve, should get involved in planning their finances.

A most common complaint is that an individual would like to invest and build a corpus but they dont have enough money saved to invest. A proper financial planning can help them alleviate these problems. There is no age limit or any income limit for getting yourself involved in financial planning. So dont have the mis-conception that only HNWI (High Net Worth Individual) should do the financial planning or only young people who are into their first job should think about it. Anyone including house wives, retired persons should think about planning the finances. And trust me it is not that complicated as it sounds. It is more of a mental game than anything else.

2) I save a lot of money and put it in bank, isnt that enough?

Take note of the inflation. India's one of the biggest banking player, SBI, provides a saving account interest rate of 3.5 % annually.

A simple example will illustrate why money put in savings account is eroding slowly. A person with Rs 10,000 in a savings account earning 3% interest each year would have Rs 18,061 in 20 years time. That's a return of just over 80% of original amount. But if inflation is about 7%, that Rs 18,061 would only be worth Rs 4,668 in today's terms!

3) When should I start managing my finance?

A usual answer to this question is "as early as possible". But I feel that this does not apply equally to everyone. If financial goals of each individual is not same then why the answer to this question should be same. A young graduate who has lived all his student life borrowing money from everyone, when he starts earning why the hell he should put away part of his income worrying about future problems. I personally believe that for the initial two years the youngsters should have all the fun the can sustain spending on whatever they feel on. Once the charm of earning wears off and then they think about future, then only they should start the financial planning. Why to waste today in the fear of a worse tommorow? The answer to the question usually lies with the individual, the higher the financial goals, the better it is to start early.

4) I invest money for tax saving, isnt that same?

No, it is not same. The idea of financial planning stems from the various needs of a person. For example, a person might want to buy a house not less than 20 lakhs and also wants his children to study in US along with a decent 7-8 lakh car and an yearly trip abroad. He also wants to keep aside some money for emergency cases like sever illness. There can be hundreds of things a person might wish for in his lifetime, which in financial field is termed as 'goals'. Ofcourse the goals have to be realistic in terms of his own earning power. A person earning 60 K Rs per year cannt expect to buy a huge mansion in New York. So the goals are the first thing to keep in mind before you start planning.

The 'income tax' is the charge levied by government on all the income earned by an employer. This is essential for the government to provide various public facilities like roads, transport etc. This is similar in principle to maintenance charges in your own apartments for common facilities. The provisions made by government to save money to earn income tax rebate is just a small measure to ensure the saving habits of individual so that any individual should not become liability to the society once he stops earning. But this saving is not enough to achieve the desired financial goals. The investment limits put by government is just enough to make an individual able to survive in his retirement days. (With inflation even this seems to be not enough).

Hence saving for tax should be treated just a part of financial planning but there are lot of other things to be kept in mind (which is what this blog is all about)

5) It is very tough & I could never understand the terms, so I dont care?

It seems tough since you are not able to understand it and that is so because you never tried to learn it. The best way to distill through financial jargons is to discuss it with your friends. Everyone has to manage their own funds and hence a discussion would bring out innovative ideas from different corners. Otherwise check the loads of information on various websites, else put your queries in the comment section here, I might be of some help !!

6) Which schemes are best and where should I invest?

There is no single answer to this question. There are hundreds of good and bad schemes lurking in the markets. So the answer is "it depends". It depends on your financial goals, your risk ability, your initial capital and loads of other things. Keep watching this space for hints and suggesstion.

7) I am too old for all this, now there should not be any need for it?

I mentioned earlier, there is no age limit of planning. If you are nearing retirement, then you need to have more urgency to manage your funds to live a comfortable life ahead. If you are already retired, again you need to take a look at your finances to ensure stability of income and enough funds during contingencies like illness. So whatever your age is, take a stock of your fortune once again.

8) How can I quickly make millions? Should I start investing in shares?

There are people who have this financial goal of making millions. My suggesstion is to think realistically. Is just having say one million in your pockets going to make you happy? It is more about living comforably and enjoying life than keeping loads and loads of moolah in your pockets. There are hundreds of legal and illegal ways of making millions, and investing in shares is just one of them. Take your own pick and stick to it. But beware the road ahead is not rosy !!

9) My expenses are always higher than my salary, so where is the question of saving?

Assuming that you are like most normal people and hence you have a job. Every month you get a pay check for some amount. Lets take an example of a fictitious person named Sachin, a 24 year old computer programmer out of college. He is paid 30,000 Rs each month.

He has taxes. The government, in an effort to make the life easier, politely using TDS (Tax deducted at Source) pockets out something like probably a third of his pay. Poof, it's gone - he never even get to touch it. Sachin's 30,000 paycheck therefore diminishes to perhaps 22,000 by the time he sees it !!

He has expenses. Livng costs money. A normal person in India has some expenses like
-- Rent: 3000
-- Bike maintenance (petrol, repairs, etc.): 2000
-- Power: 500
-- Phone and Long distance: 1000 (if girlfriend then more !!)
-- Cable TV: 250
-- Groceries: 3000
-- Entertainment, eating out, etc.: 2000

He has problems. For example, He blows the bike silencer and it costs 1000 to repair. Or he meets a "special friend" and feel compelled to take him or her out to an expensive dinner. Or he loses job.

Then he has desires. He might desire new living room furniture, a new TV or stereo, a nice gift for mother or spouse, a special piece of jewelry, new clothes…. Whatever.

Therefore he has debt. Debt makes up the difference between income and expense. For most people day-to-day debt goes on a credit card, and large items like cars and houses are handled with more formal loans. Debt itself is not bad. The problem arises when debt accumulates for no apparent reason.
Let's say Sachin's salary got doubled magically. It would be perfect to meet all his expenses, except that he would feel an irresistible urge to double his expenses at the same time. Clearly, making more money is not going to solve all the problem, because we seem to have a natural tendency to spend proportionally to what we earn. It is normal

So is there a solution to this problem? The answer is, it requires a big mental shift. If you are willing to make the mental shift the answer is "yes." It turns out there is a different way to live life. This way of life involves figuring out what you really want to do, and what is really important to you as an individual, and then working toward those goals rather than proceeding randomly. What you gain in the process is a sense of control and satisfaction, and a sense of achievement, that is difficult to beat.

10) I already have hired a professional financial planner, so why should I bother now?

A professional financial planner can really tell you loads of inside info about various schemes and ways of managing your finances, but at the end, he is doing his job. He is not you and his motive would be make you subscribe to scheme in which he would get a fair enough cut. Your money is your money and so are your losses. Also you will be more passionate towards your financial goals than he will ever be, so although it is good to get advise and support functionality of doing the paperwork, but the ultimate decision of managing your money should be yours. For all the schemes mentioned by your planner, you should read about it and cross-check the details. Its your money at stake.

Inflation revisited

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I talked about a common man's definition of inflation. Alex talks about a more technical definition. I agree with him that one of the major reason for increasing inflation is due to increase in fuel prices. But he forgot to mention the increasing prices of Basic Metal Alloys and Metal Products. So the inflation is mainly due to international reasons.

I am not sure that the government has reduced import duties in wake of inflationary pressure. The increase in repo rates has been the primary technique used by government to reduce the inflation impact. I also dis-agree with Alex that there is no overheated demand. The disposable income of a common man has certainly increased and so are the ambitions. So increasing the interest rates is just a way to choke the rising demand, which I am not sure whether is a perfect way of taming the inflation beast.

FDs are back

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An interesting comparision done by Sowmya Sundar regarding the attractiveness of Fixed Deposits.

This mode of investment has been popular amongst the retail investors, but recently due to taxable nature of the interest earned and lower interest rates by banks, FDs had lost the sheen. With the finance minister announcing (PDF File) in 06 budget that

Last year, I recast the provisions relating to savings. Fixed deposits were not included. There is a demand that fixed deposits of certain tenure should qualify for tax exemption. I propose to include investments in fixed deposits in scheduled banks for a term of not less than five years in section 80C of the Income Tax Act.

the FDs will again be gaining popularities. Also with the RBI increasing the repo rates, the interest rates given by banks on FDs is on rise. This is a good news for retail investor, who does not want to risk his capital in the equity based markets. As per my knowledge, the banks are increasing the interest rates on FDs even more than what is depicted in the above picture...yoohoo... more the merrier !!