Should you invest in Gold

 


Gold can play a very valuable role in equity and bond portfolios, doing well when both equities and bonds are under-performing. Hence long-term investors should definitely consider investing 5-20% of their portfolios in gold even though the recent price action has not been very encouraging.

What does the gold price even mean?

This question may seem strange. Of course gold price is the amount of rupees I need to spend to buy a certain amount of gold. But while it may be natural for us in India to think of the gold price in Indian rupees, this rupee price of gold is actually a derived price with two different components:

What is happening to the gold price in dollars: This portion is affected by various international developments; the effect of India-specific factors is actually quite minimal.

What is happening to the price of Indian rupee in dollars: This is the interesting part. When people own gold, they are also implicitly holding a position in USDINR. This position will do well every time the rupee weakens and do badly when rupee strengthens – so a very clear India-specific angle.

(In practice, the relationship between these 3 may not be exact because there is friction due to government restrictions on gold imports etc which gives rise to the “Mumbai premium”. But that part is small and can be ignored for this discussion.)

USDINR component of gold makes it useful in reducing equity downside

USDINR is strongly correlated with Indian equities. The relationship is negative, i.e. (usually) when Indian equities go up (down) then the rupee is also strengthening (weakening) at the same time. Very intuitively this is because all factors that are big negatives for Indian equities (growth crises in the world and/or India and high inflation in India) are all also big negatives for INR. 

Gold in INR is useful for protecting against the downside in Indian equities because of this USD INR component. Basically gold in INR does well when equities go down not because gold (as measured in USD) is necessarily doing well but because INR is doing poorly and getting weaker.

This explanation is also borne by data. The chart below shows the performance of USDINR and Gold in INR when equities have been down by more than 20%.

USDINR and Gold have been up in recent episodes when equities were down by >20%
 

Also in the long run, the correlation between the monthly returns of gold and Nifty in the 15 year period from 2002-2016 has been -7% highlighting that these are two positive return asset classes which behave differently from each other – pure gold (pun intended) from a portfolio construction perspective!

Gold can also give returns when bonds are falling

Many people think of debt as adding stability to their portfolio. While this is mostly true, bonds themselves (esp. those with long maturity) can do extremely badly during periods of high inflation because the central bank is expected to increase rates to fight inflation.

However, high inflation periods are also when INR depreciates or in other word gold in INR is likely to do well. This explanation is again supported by data. The correlation between the monthly returns of gold and a 10-year government bond index between 2002-17 has been -12%.

Who is gold not for?

So far we have shown that gold can be a valuable third asset component in equity-bond portfolios. However there are at least 2 portfolios/requirements for which gold may not be very useful.

First, is for investors who are investing money for regular income or other short-term objectives such as emergency funds. Gold does not generate regular interest or dividends. Further short-term investors are mostly invested in short-duration debt instruments which provide low but steady returns and do not need diversification.

Second, is for investors at the opposite end of the spectrum who want to invest for the long term and are not concerned about (even significant) volatility in the meantime. In such cases, investors have low need for diversification and would rather put all their money in the highest returning asset namely equities. However, in my experience, such investors are very rare in real life.

The Final word

Both data and intuitive explanation show that gold can be extremely useful in most portfolios due to its ability to give positive returns when both equities and bonds are giving negative returns. Our analysis shows that a 5-20% allocation to gold is desirable with the exact percentage depending on an investor’s goal and risk appetite.


This article was first published on IIFL website on May 18, 2017.

At ORO's goal advisory, we offer truely diversified portfolios with 6 different kinds of mutual funds including gold funds.  Invest with ORO goal advisory services to experience the difference that scientifically-constructed diversified portfolios can make to your returns. As an additional benefit all of these funds are direct i.e. have 0% commissions. Login to preview ORO goal advisory for FREE

20 types of mutual funds in India that you need to know about - Part 4



In this 4-part article series, we discuss the 20 main types of mutual funds available in India and whether you should be investing in them. The main classification of mutual funds is by asset class ( i.e. what assets they are investing in). In part 1 of the series we focused on the different types of equity mutual funds, in part 2 of the series we discussed the different types of debt funds and finally in part 3 of the series we discussed hybrid funds, which invest in a mixture of debt and equity. In part 4, the final part of this series we discuss the remaining funds which do not fall into these neat categories.

Read: 20 types of mutual funds in India that you need to know about - Part 1
Read: 20 types of mutual funds in India that you need to know about - Part 2
Read: 20 types of mutual funds in India that you need to know about - Part3



17. Equity Arbitrage Funds:

What they invest in:Equity arbitrage funds invest in equities and equity futures to generate liquid fund like returns. Confused? Specifically equity arbitrage funds follow a strategy of buying the cash equities and selling equity futures. An equity future is a contract to buy the underlying share in the future at a price set today but paid in the future. According to futures pricing theory, futures are priced such that it does not make  a difference whether you buy a stock today and pay its price now or purchase a future on that stock and pay the price later. This is only possible if the futures price today is higher by the amount of interest that you can earn on the stock price. Hence if you buy the equity and sell the future (at higher price) you will get an amount equal to the interest rate - very similar to a liquid fund.

Should you be investing in them: If equity arbitrage funds are just like liquid funds, then why go through the bother? Simply because of the taxation regime. Because arbitrage funds invest only in equity instruments therefore they are taxed like equity-oriented funds even though they give debt like returns. The taxation for equity funds is more favourable than debt funds giving arbitrage funds an edge over liquid funds. However do note that the pre-tax returns of arbitrage funds are slightly lower so whether post-tax returns work out to be higher than liquid funds depends on your tax bracket. Liquid fund investors for whom the tax advantage exists should definitely consider arbitrage funds.


18. Fixed Monthly Plans (FMPs):

What they invest in: FMPs are close-ended debt mutual funds. They are different from the open-ended debt mutual funds that we discussed in part 2 of this series in that with open-ended funds you can buy/sell units any time directly with the AMC and the assets under management of the mutual fund rise and fall as a result. However with close-ended funds, you can buy/sell with the AMC only during specified intervals of time. Apart from these periods the assets of the close-ended mutual fund are fixed and investors can buy/sell units among themselves in the secondary market. However usually the secondary market in closed ended mutual funds is not very liquid so investors in closed-ended funds should be prepared to hold them till the maturity date of the fund.

FMPS invest in debt securities with maturities that match the term of the scheme. The debt securities are redeemed on maturity and paid to investors. FMPs are issued for various maturity periods ranging from 3 months to 5 years.

Should you be investing in them: In general we do not recommend investing in close-ended funds. There is no history to evaluate the performance of these funds when you are putting your money in plus you money is locked-in  for the term of the fund. And the usual reason for preferring close-ended funds over open-ended funds - that because the manager does not face pressure of redemption he/she can follow long-term and hence more profitable strategies - does not hold if you look at performance data. It would not be wrong to say that one of the major reasons that closed-ended funds get sold is because of the high upfront commissions on offer to distributors since your money is locked in.

With this said about close-ended funds, lets evaluate the FMPs on their own merit. An FMP is structured very much like an FD. Because you are holding all the instruments till maturity (or the manager is holding them on your behalf), there is no interest rate risk unlike open-ended debt funds. You will only earn the rate of interest which can be estimated to some extent in advance. The reason I say "to some extent" is because you will not earn this interest if there is a default which makes FMPs more risky than FDs. On the plus side, FMPs, if held for more than 3 years, offer a much better taxation regime than FDs (taxed at 20% after indexation vs. at income tax rate for FDs). The important thing then with FMPs is to closely go through their portfolio especially as no history is available. So FMPs are best suited for investors in higher tax brackets who are looking for FD-like returns provided they are comfortable with locking in their money for the said period.


19. Gold Funds:

What they invest in: As the name suggests these funds invest in gold and gold-related instruments. The objective of gold funds is to closely replicate the price of physical gold.

Should you be investing in them: Gold can play a valuable role in your investment portfolio giving good performance when equities and debt are under-performing. As we discuss in detail in another blog post, gold has a limited role to play in very short-term portfolios or if your objective is to generate regular income since gold does not do that. Also a long-term investor who is comfortable  with the volatility in equities may not see too much of a role for gold for diversifying downside. They may choose to only invest in equities for higher returns. The true value-add for gold comes in the medium term portfolios, say for a 3-8 year horizon and/or if you would like to avoid significant volatility in portfolio returns. In such portfolios, gold can provide returns when equities and bonds are not doing well, increasing your probability of ending up with good positive returns.
Read more: Why you should invest in gold

 

20. Fund of Funds:

What they invest in: As the name suggests, these are funds which invest in other mutual funds. Usually these funds set a specific objective such as conservative/moderate/aggressive allocation or investment for a certain age group and so on.

Should you be investing in them: The biggest problem with funds of funds, in India and elsewhere is the high expense ratio. When you buy a fund of funds, not only do you pay the expense ratio of the bought fund but also the expense ratio of all the underlying funds. As you can imagine paying two layers of expenses can be a big drag on returns.  Hence investors may be better off using ordinary mutual funds together with the help of a financial advisor to create a customised portfolio for their requirements.

 

Also read

Part 1
Part 2
Part3

Should you invest in ELSS funds beyond the 80C limit?




ELSS funds are special equity funds which enjoy tax exemption on the investment amount, gains and final amount (so EEE regime) up to a limit of 1.5 lakhs under section 80C of the income tax act.

However ELSS is not the only investment eligible for Section 80C deduction. Other common eligible investments/expenditures include EPF, home loan repayment (principal only), child education expenses, life insurance premium and PPF. Faced with all these competing investments, people often face the question that whether they should still be investing in ELSS funds even if they have exhausted their 80C limit of 1.5 lakhs.

The question is directly related to the performance of ELSS funds relative to other equity funds. If we find evidence that the performance of ELSS funds is better than other equity funds then it makes sense to invest in them even beyond 80C. However if the performance of ELSS is just in line with other equity funds, then investors should only invest up till they have exhausted their 1.5 lakh limit and then if needed they  should invest in other equity funds. This is because ELSS funds impose a 3-year lock-in restriction on investors which are not present with other equity funds.

Understanding the cap exposure of ELSS funds to evaluate performance

To assess the performance of ELSS funds, it is first important to understand their cap exposure. This is because we know that smaller-cap equities have a beta of > 1 to larger-cap equities. What that means is that if large cap equities move by a certain % say x, then smaller-cap equities move by more than x. This is true both when returns are positive and when they are negative. 

As a result equity funds can outperform their peers during good times (and underperform during bad times) by simply holding smaller cap companies. So true performance can only be measured once we control for the cap exposure.

ELSS funds are multi-cap funds with greater large cap exposure

The most straightforward way to find out how ELSS funds figure in the spectrum of large-cap, mid-cap and small-cap funds is to look at their stated investment objective. This objective is summarised in the benchmark the fund chooses for itself.

So as a first step we looked at what percentage of ELSS funds are benchmarked to a certain equity index vs. what percentage of large cap funds are benchmarked to that index. The data is in the chart below.



Indices are arranged from narrow indices such as Sensex and Nifty 50 which only have the largest companies to progressively broader indices which have more and more small companies. For large- cap funds, as expected, ~50% of funds are benchmarked to Nifty 50 and Sensex and then a decreasing percentage is benchmarked to broader indices Comparing this this with  ELSS funds, more % of ELSS funds are benchmarked to broader indices and less to Sensex/Nifty 50. So clearly ELSS funds as a group hold more shares of smaller companies compared to large cap funds.

Based on this finding, we compared the benchmarks distribution of ELSS funds with multi-cap funds. Here the results are opposite. More ELSS (Multi-cap) funds are benchmarked to narrow (broad) indices.



This comparison of benchmarks leads us to conclude, that based on their own stated objectives, ELSS are like multicap funds with a stronger tilt towards holding large cap stocks than the average non-ELSS mutual fund.

Performance of ELSS funds is in line with their cap exposure

Having thus classified ELSS funds as multi-cap funds with a strong large cap tilt, the next question that arises is whether ELSS funds have provided returns which are commensurate with this classification. The answer appears to be yes.

Given our discussion about ELSS funds, we should expect their category returns to be higher than that of large cap funds but lower than that of non-ELSS multi-cap funds since the latter have more small stocks. The table below shows that that has indeed been the case. Performance of ELSS funds over different historical time periods has been between that of large cap and non-ELSS multi-cap funds like one should expect from the analysis of benchmarks.


Source: ORO Wealth, Morningstar category returns (average)

Conclusion: Invest in ELSS funds only till 80C limit

Our analysis shows that performance of ELSS funds is in line with other equity funds and commensurate with their cap exposure. Hence investors, who have limit left under Section 80C and who want to invest in equity funds, should definitely go ahead and invest in ELSS.

However if you have already exhausted your 1.5l limit, then there is no reason for investing in ELSS. Investors are better-off investing in other equity funds where they can avoid the 3-year lock-in period. They can generate a similar kind of exposure as ELSS funds through a combination of large-cap and mid/multi-cap funds. These funds have a typical exit load period of 1-1.5 years and investors can enjoy long-term capital gains tax of 0 after 1 year of investment.

This article was first published on IIFL website on May 9, 2017.

You can buy direct (0-commission) plans of ELSS mutual funds though ORO Wealth. Paying 0-commissions directly translates into higher returns every year on the same mutual funds. Further with ORO advice, you can be rest assured that we are working only for you and not for commissions. Login to invest in direct mutual funds through ORO

Financial planning Essentials: How to build your financial plan in 5 simple steps

financial planning

A lot of us have the tendency to think that financial planning is something only for high-networth individuals, or those with complex financial situations or worse those with messy financial situations. However nothing can be further from the truth.

According to Investopedia, A financial plan is “a comprehensive evaluation of an investor's current and future financial state … to determine if a person's financial goals can be met in the future, or what steps need to be taken to ensure that they are.”

By giving a direction to your financial life, financial planning can not only help you secure your future but also make you more comfortable with what you are spending today.

In this article, we detail 5 simple steps to making your very own financial plan. You can also check out our infographic for a short summary

financial planning infographics

 

1. Assess your current situation

The first step of financial planning is to find out where you stand today with respect to you income, expenses, assets and any outstanding liabilities. You can think of this exercise as making your personal balance sheet.

A professional financial planner will next proceed to analyse your balance sheet through multiple standard ratios. However as a DIY financial planner, you can work with less formalisation and focus on three main aspects of your balance sheet ( which is what the ratios measure in any case):

a. Savings: What are your annual savings and also your accumulated savings relative to your annual income
b. Debt position
: How does your debt stand relative to your assets and how  do the interest payments stack up against your income
c. Liquidity: What is the composition of your assets, liquid vs. illiquid, financial (typically more liquid) vs real assets

It is always important to evaluate your balance sheet relative to your age (as a proxy for your current stage in life). When you are young, in your 20s and early 30s it is natural to have higher expenses relative to income and low accumulated savings.

Also a significant portion of income is likely going towards servicing  a home loan on a house which is a significant percentage of your assets. However the ratios should improve as you get older.

2. Pay off outstanding debt now (well mostly):  

Once you have analysed your balance sheet, and in case you find that the debt situation is precarious ( if you are spending greater than 40% of your monthly income in debt repayments then that is a good indicator) then that should be you first and foremost area of action. 

I have often come across one question from investors: if they have a surplus, should they use it to pay off their outstanding debt or make investments. And the answer in 90% of the cases (I will come to the exceptions later) is to pay off debt. The choice really is between the post-tax cost of having debt vs. the post-tax returns that your investments can generate. 

If you look at almost all the consumer-oriented debt out there such as credit card debt, EMIs on car, durables etc. then usually the rate of interest charged is so high that no reasonable investment can beat that.  So if your debt-income ratio is >40% then you should first of all pay off debt to lower this ratio. This could be through cutting down on expenditure and even selling of assets if need be.

The only “good loan” , that one can think of is the home loan – the rate of interest is reasonable and both the principal and interest payments are tax deductible which further bring down post-tax cost.

A long-term portfolio in equities can likely earn you more than the cost of home debt. Hence that is one debt that can stay in your books. However even mortgage payments should be no more than 30% of your income.

3. Buy insurance:

With a clean (low-debt) balance sheet as the starting point, the next area to focus on is insurance. The number 1 ground rule here is that insurance is not investment. While many insurance-investment products are available (some even marketed as the right investment for specific goals such as child education) usually the returns on these “investments” work out to be quite low. Investors are almost always better-off buying pure protection plans and handling investments separately. 

At minimum, you should consider buying the following two kinds of Life insurance and Medical insurance.

a. Life insurance:  The first thing to know about life insurance is that you only need it if you have dependants. The second thing is that the amount of life insurance you buy should be directly related to the needs of your dependants rather than any arbitrary number.

A simple rule of thumb is that the sum insured should be sufficient to pay any outstanding loans that you have plus once it is invested it should be sufficient to provide for any goals that you have and generate a desired regular income scheme for your dependants.

b. Medical insurance: This is more straightforward. Many salaried employees already have an health insurance plan provided by their employer. They should go through the terms and conditions carefully especially the sub-limits and apply for an appropriate top up plan in case required. For those who have to buy medical insurance themselves, they need to choose between family floater plan and individual medical insurance. 

The premium for a family floater plan is generally determined by the oldest insured member and hence these plans are best suited for young families. For families with senior citizens, it may be better to buy individual policies for the older members and buy a family floater for the younger members. 

4. Set goals and asset allocation: 

With insurance and debt payments taken care of, what you have left is your investible surplus. This is the total of your assets (minus debt and minus the house you are living in) plus your surplus savings every month. This is the amount that you can invest to achieve your financial goals. 

However before you achieve your financial goals the first step is to define them and define them clearly. For instance, saying “I want to be wealthy” does not help. Instead something specific and measurable like “ I want to be a millionaire by the time I am 40” is more likely to be achieved.

The next step is to then determine an asset allocation for each of your goals. The general rule here is that you can invest in more risky assets like equities for goals which are further away because these assets also have higher expected returns even if there may be ups and downs in any single year.

Similarly for goals which are more near terms it is better to invest in safer assets such as debt because that you gives you a higher probability of getting positive returns over the period.

While goals are personal to an individual, there are two goals which are near universal which you should think about. 
  
a. First is Emergency funds. While we have already talked about insurance, but there can also be other unforeseen emergencies for which you need to be prepared. The usually suggested size for an emergency fund is about 3-6months of your monthly income. 

Further because the emergency funds can be needed anytime it is a good idea to keep them invested in extremely safe assets which give just about enough returns to beat inflation.

b. The second near universal goal is Retirement Planning. The first crucial question here is to determine the retirement corpus that you want to achieve. Like determining the corpus for life insurance, this problem is one of estimating the kind of income that you would like to have during retirement, seeing how that would increase with inflation and then figuring out an amount which when invested in safe assets can generate that income stream. 

The second crucial question is to determining an asset allocation depending on how far you are from retirement. Do remember to update this asset allocation as you approach retirement to move to safer portfolios. Based on the corpus that you want to reach and returns you expect to generate (given asset allocation) you can determine the amount you need to invest today and/or every month. 

5. Tax Planning:

Many people may be surprised to see tax planning as the last item in this list since saving taxes often gets top most priority in our financial lives. However in reality you should never invest just to save taxes. Instead once you have an asset allocation in place ( i.e. you know how much you want to invest in equities, debt gold etc.), then you should look for tax saving alternatives in these categories.

For instance, if we look at the tax deduction available under Section 80C, then there are perfectly good investments available in both the equities (ELSS funds) and debt categories (PPF). Whether you should invest your 80C limit in one or the other and by how much depends on the asset allocation that you arrive at based on your goals.

And..

With these 5 simple steps your financial plan is ready. Just remember that financial planning is not a one-time exercise. You need to revisit your financial plan every time there is a major change in your life such as marriage, birth of a child etc. Apart from that the second condition for getting your financial plan to work is to stick to it. This may seem obvious but is easier said than done.
Make a financial plan, stick to it, keep revisiting it periodically and see your goals turning into reality! Happy Planning.

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While having a financial plan is a great idea, in our busy lives we often do not have the time to sit down and make a plan ourselves, let alone revisiting it periodically. A financial planner can take away this headache, not only making a plan but making sure that you stick to it. At ORO, we offer comprehensive financial planning services. We are a fee-only advisor and only offer you 0-commission investments so that you can be rest assured that we are only working for you and not for commissions. Contact us to know more.

 

 

7 investment ideas to beat low FD rates




With the RBI in the rate-cutting mode over the last 2 years, currently we are at a low in the interest rate cycle. FDs are perhaps the most popular investment avenue in India and <7% FD rates definitely hurt retail investors. So we have compiled a list of top 7 investment ideas which can help you protect your returns:

1. Small savings schemes such as PPF, NSC, Post Office accounts etc:  Currently interest rates on all such schemes (but one) are still >7%. These schemes are a good option for risk-averse investors who are ok to lock-in your funds for the required period of time.  While technically interest rates on these investments are now market-linked and reset quarterly, what we have noticed in the last 2-3 quarters is that the government has been reluctant to cut rates on these schemes even as market rates have come down making them less volatile interest rate investments.

2. Liquid Funds: Liquid funds invest in short-dated instruments (>90 days to maturity), provide the same liquidity as current account but interest rates are closer to FDs since there is no bank in the middle. For instance, according to RBI data in the last 10 years, savings accounts have returned c. 3.8% p.a., FDs have returned c. 8.25% p.a. and liquid funds have returned 7.84% (category average, Morningstar). Now that FD rates are in 6.5-7% range, we should expect liquid funds to return around 6-6.5%. However 6-6.5% is still significantly more than the bank savings account interest rate.

3. Arbitrage funds: These mutual funds use equities and equity futures contracts to give returns which are extremely similar to liquid mutual funds. So over the last 10 years, the average arbitrage fund (category average, Morningstar) has returned 7.74% p.a.  But because arbitrage funds are invested in equity instruments, they are taxed like equity mutual funds. So for somebody in the 30% tax bracket, if they hold an arbitrage fund for 12 months then a 7.74% return is like earning 11% on your bank deposit. Do note that like liquid funds, returns on arbitrage funds will be lower going forward around 6 – 6.5% post tax or 8.5-9% pre tax (30% bracket).

4. Convertible Debentures/Corporate Fixed Deposits: With an FD, you are lending money to your bank. With NCDs and Corporate FDs you lend money to a company. Because lending to companies is considered to be more risky than banks, therefore such instruments are paying higher interest rates than bank FDs of similar maturity. However there is a very real default risk which exists with lending to companies and which does not exist with bank FDs. As a result while investing in such instruments, investors need to either do adequate research or they can consider investing in mutual funds which invest in such instruments (See #6)

5. Tax-free Government bonds: These bonds are issued by government-backed entities on which the interest is tax-free. Because of the tax-free status, interest rates on these bonds are slightly lower but typically for people in the 30% tax bracket the post tax returns still work out to be higher than FDs. Due to an economy-wide lowering of interest rates, yields on tax-free bonds have already come down, but they may still give slightly higher returns than FDs for those in the higher tax brackets. If investing in tax-free bonds, do note that the liquidity in these bonds is quite low, so you should be prepared to hold them to maturity. Alternatively investors can also consider long-term gilt funds (See #6).

6. Debt mutual funds: Investors can hold corporate debt or long-dated government of India debt on their own or through debt mutual funds. Debt mutual funds are of two kinds.
First are the income funds/accrual funds/credit opportunities funds. These hold corporate paper which pays more interest than FD of similar maturity due to higher credit risk. They will give good returns (and do better than FDs) as long as the underlying companies whose bonds they hold do ok and do not default.
The second kind of debt funds are Long-term Gilt funds which hold longer-dated government debt. These funds have 0 credit risk because the borrower is the government. However they pay more interest because money is being lent for a longer period of time. Also price of the debt goes up (giving you capital gains) if interest rates come down.  As long as your expect interest rates to continue falling or at least not rise substantially, you can consider investing in these funds.

7. Equity Mutual Funds: Investors willing to take more risk can invest in equity mutual funds. Typically when interest rates come down, equity markets do well as both consumers and businesses are able to borrow on more favourable terms. For investors used to FDs, investing in equity fund may seem very risky but most retail investors will be surprised by how safe they invest. Perhaps the current low in interest rates can be a good opportunity to start investing an amount (howsoever small) in equity mutual funds.  First time investors can look at large cap diversified funds which invest in the biggest companies on the stock exchange and are hence considered to be the safest among equity funds.

This article was first published on IIFL website on May 2, 2017.

You can buy direct (0-commission) plans of mutual funds though ORO Wealth. Paying 0-commissions directly translates into higher returns every year on the same mutual funds. Further with ORO advice, you can be rest assured that we are working only for you and not for commissions. Login to invest in direct mutual funds through ORO

5 things you must do to achieve financial success



Personal finance can be intimidating especially if you are a first time investor. But you can now stay on top of your personal finances by following this 5-point checklist.

1. List down your personal finance goals: 

The first step to achieve financial success is to define what exactly financial success means to you. What are the 5 (or even 10, 15, 20) monetary things that you would like to achieve in your lifetime. However, be careful; do not just specify vague goals like “I want to be wealthy”. Go for something specific and measurable like “I want to be a millionaire when I am 40”. The latter are easier to track and achieve.

2. Have a specific portfolio for each goal:

A lot of investors often “just invest” their money in the hope that it will grow enough to meet their future needs. This approach is exactly what it sounds like - shooting arrows in the dark. Instead, investments should be geared toward specific goals. Think of your investment portfolio as a collection of multiple goal portfolios. A goal-based approach to investing is superior because each goal needs a different kind of investment mix based on the nature of the goal and the time available for investment. You need to invest in a safer mix of investments for a “must-achieve” goal such as retirement planning compared to a “nice-to-have” goal like owning an SUV. Similarly, you can hold a more risky mix of investments if your goal is further way, since risky investment generally also give higher returns over the long-term even if there are ups and downs in the short-term.

3. Hold a diversified mix of investments:

Many times we make the mistake of equating risky investments with equities and safe investments with debt. But do you know that you can add a little bit of equities to a predominantly debt portfolio to give a return-kicker without compromising on safety? Or that you can add a little bit of debt to equities to reduce some losses without giving up on overall returns? This happens because different investments such as equities and debt are complementary to each other i.e. they do well at different times in the economic cycle. And hence a correctly constructed mix of different investments can do much better than any single investment. As smart investors, we need to take to take advantage of this fact and hold diversified portfolios.

4. Spend what is left after investing: 

A good thing about the goal-based approach to investing is that it allows you to earmark exactly how much you need to save every month for each goal. Once you take out these savings from your income, you know how much you have left to spend every month. Don’t worry, if this calculation leaves you with a below poverty line spending limit. All that means is that you either need to be more realistic about the goals that you have set for yourself or you need to work on increasing the income side of the equation, (maybe with a side gig). In either case, knowing that your financial life is not on-track to meet your goals is the first step towards taking any corrective actions.

5. Stay away from biased investment advice: 

This point cannot be stressed enough. Professional financial advice can definitely increase your investment returns while leaving you time to do other things. However, all financial advice is not created equal. Unfortunately, the financial advice industry in India is dominated by distributors who provide “free advice” but whose real business is to earn commissions on the financial products that they sell. The problem with this model is immediately clear if we transport it to the health industry for a second. Would you ever consider visiting a “free” doctor who gets paid by the companies whose medicines he/she prescribes? Most people would immediately reach the (correct?) conclusion that such a doctor would prescribe expensive and often unnecessary medicines. The same problems plague financial advice in India. Fortunately, the regulator is taking steps to rectify the situation by separating financial product distribution (which will be commission-based) from financial advice (which will be fee-only). Investors, who think they would like to have professional financial advice, can do themselves a big favour by opting for fee-only advisors who do not have any conflict of interest.

This article was first published on IIFL website on April 24, 2017.

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20 types of mutual funds in India that you need to know about - Part 3



In this 4-part article series, we discuss the 20 main types of mutual funds available in India and whether you should be investing in them. The main classification of mutual funds is by asset class ( i.e. what assets they are investing in). In part 1 of the series we focused on the different types of equity mutual funds and in part 2 of the series we discussed the different types of debt funds. In part 3 of the series, we discuss hybrid funds, which investment in a mixture of debt and equity.

Read: 20 types of mutual funds in India that you need to know about - Part 1
Read:  20 types of mutual funds in India that you need to know about - Part 2



Hybrid mutual funds - an introduction

So far in this series we have discussed equity and debt funds. Most investors would do well by holding a mixture of these two asset classes. One option is to hold a bunch of individual funds, but the other is just to opt for a hybrid fund. Here the fund manager holds both equity and debt instruments. He/she can change the allocation between debt and equity while staying within the mandate of the fund. So with hybrids funds, you not only outsource the job of instrument selection but also that of asset allocation (choosing between asset classes).

The main classification of hybrid funds is based on whether they are equity-oriented (% of equity > 65%) or not since this has important implications for whether the hybrid fund is taxed as equity or debt funds. Another classification is whether the fund is a generic hybrid fund or has a specific objective.

14. Balanced Funds:

What they invest in:As the name suggests, balanced funds invest in a balance of equity and debt instruments. However in India, balanced funds typically refer to equity-oriented hybrid funds i.e. they invest greater than 65% in equities.

Should you be investing in them: There are two angles to consider while investing in balanced funds: 1) the investment angle and 2) the tax angle. First, the investment angle. As a mixture of equities and debt, balanced funds are most suited for investors who have a intermediate investment horizon (3-5 years).  You can consider balanced funds even  if you have a longer investment horizon but not enough risk appetite to go for an equities-only fund. Since it if often thought that first-time equity investors are quick to sell their equity portfolios if they coincidentally end up experiencing big losses before they see any big gains, hence balanced funds are the recommended choice for first-time investors with long investment horizons. The second angle for investing in balanced  funds is the tax angle, more specifically the favourable taxation of the debt part of the investment. Currently for debt funds, short-term capital gain tax (STCG) equal to marginal tax rate is applicable if investment is held for less than 3 years. If a debt investment is held for more than 3 years than a long-term capital gain tax (LTCG) of 20% (after indexation) is applicable. However in the balanced fund, the debt components gets taxed like equities - STCG  of 15% till 1 year and LTCG of 0 after that.

15. Monthly Income Plans (MIPs):

What they invest in: MIPs also invest in a balance of equity and debt instruments, however these are debt-oriented hybrid funds i.e. they invest less than 65% in equities typically between 5% and 30%. MIPs may be further sub-classified as conservative or aggressive with c. 20% equity exposure being a good dividing point.

Should you be investing in them: The obvious thing to say would be that MIPs are best suited for debt investors who are willing or able to take slightly more risk. However things are not so simple. The big problem with MIPs is the expense ratio (i.e. the fees that you pay to the fund every year to manage your investments). Typically the expense ratio of debt funds is lower than that of equity funds because of their lower expected return. However the problem with MIPs as they currently exist in India is that while the expected return is closer to debt funds (since that is the predominant investment), expense ratios are close to that of equity funds. Another issue is that the taxation angle works the other way compared to balanced funds - so you end up incurring debt-like taxation even on the equity component. As a result, we feel that instead of investing in MIPs, potential investors would be much better-off investing in debt and equity funds separately. This way they would pay lower expense ratio and incur favourable taxation on at least the equity component. A MIP-like mix of equities and debt is most suited for conservative investors with a 3-5 year investment horizon.

16. Speciality Funds:

What they invest in: These hybrid funds invest in equity and debt instruments but with a specific purpose which is usually clear from the name of the fund. The two kinds of speciality funds most common in India are retirement funds and child education plans.

Should you be investing in them: While speciality funds are supposed to help you invest for a specific purpose, currently the speciality funds in India do not have much to distinguish themselves from other hybrid funds. For instance there are no target dated funds for retirement. Also the expense ratio of speciality funds is usually on the the higher side (>2%). Hence investors may be better off using ordinary mutual funds together with the help of a financial advisor to plan for their goals.

Also read

Part 1
Part 2

20 types of mutual funds in India that you need to know about - Part 2



In this 4-part article series, we discuss the 20 main types of mutual funds available in India and whether you should be investing in them. The main classification of mutual funds is by asset class ( i.e. what assets they are investing in). In part 1 of the series we focused on the different types of equity mutual funds and in part 2 we discuss the different types of debt funds.

Read: 20 types of mutual funds in India that you need to know about - Part 1


Debt mutual funds - an introduction

Many retail investors tend to equate mutual funds with equity mutual funds. However did you know that  it is Debt mutual funds which account for nearly two-thirds of the industry AUM? (Source: AMFI).

Debt mutual funds invest in various fixed-income instruments. At the risk of broad generalization, one could define fixed-income instruments as those which pay a fixed rate of interest for the life of the instrument and then return the principal amount back at maturity. Now all of us are already aware of one major instrument that fulfills this criteria - the ubiquitous bank fixed deposit or FD.

However what distinguishes the fixed-income instruments that debt funds invest in from your typical FD is that these instruments have a secondary market where they can be bought and sold. Prices of fixed-income instruments can fluctuate a lot. Because of this even though the rate of interest on these instruments is fixed, the returns that can be earned are not.

To understand, how the prices of fixed-income instruments fluctuate, read: Understanding bonds and debt funds through a simple comparison with FDs 
Also read:  How is it possible for debt funds to give double digit returns when they are holding bonds which give them fixed returns

Debt mutual funds can be classified according to the type of fixed-income instruments that they hold.

8. Liquid funds:

What they invest in: These funds invest in debt instruments with very little time to maturity left (less than 91 days). These instruments can be issued by different kinds of issuers such as government, corporate etc.

Should you be investing in them: Liquid funds are considered extremely safe. There are two kinds of risk in any debt instrument. First, the risk of default by the issuer of the instrument and Second, is the interest rate risk or the risk that interest rates in the market will go up compared to what is paid by the instrument because of which price of the instrument will come down. For liquid funds, since instruments have very little time left for expiry, therefore the risk of default is quite small. Also the interest rate risk also depends on the maturity because the maturity determines that for how long you are locked in the lower rate of interest. Hence the interest rate risk in liquid funds is also negligible. As a result, liquid funds are safe. However for these very reasons the upside in liquid funds is also limited. Investors can think of liquid funds as an alternative to bank deposits/FDs. They give returns similar to FDs/slightly higher than bank deposits, have a more favorable tax treatment and are nearly as liquid as your current accounts.

Read more: Why Liquid funds are like bank deposits or even better.

Liquid funds are best suited for investors who are looking for stable returns even if they are a bit low. This kind of return profile is best suitable for someone who has a short (less than 1 year) investment horizon or someone who wants to park funds which can be needed at any time such as emergency funds.

9. Ultra Short-term Funds:

What they invest in: These funds invest in debt instruments with slightly longer time to maturity ( 91 days to  1 year). These instruments can be issued by different kinds of issuers such as government, corporate etc.

Should you be investing in them: Since the maturity of instruments is higher than liquid funds, therefore the risk (both default risk and interest rate risk) is slightly higher but so in the potential for returns. Ultra short-term funds are suited for those investors who are willing to take slightly higher risk for more returns and have a time horizon of 1-2 years.

10. Floater Funds:

What they invest in: These funds invest in special kind of debt instrument where the interest is reset regularly (typically one a quarter or once in 6 months), based on the market interest rate. These instruments can be issued by different kinds of issuers such as government, corporate etc.

Should you be investing in them: Floating-rate instruments and hence floater funds have very little interest rate risk because the interest keeps getting reset regularly. Rather than being suited for a particular type of investor, these funds are suited for particular times. Floater funds make sense if you expect interest rates to go up and hence do not want to lock today's low interest rate.

11. Short-term Income Funds:

What they invest in: These funds invest in debt instruments with maturity of up to 3 years though there is some scope for flexibility in the time period which separates short term income funds from regular income funds. Short-term income funds also invest in paper issued by various entities such as government, corporate etc. 

Should you be investing in them: Due to the longer maturity of short-term income funds (compared to liquid and ultra short-term funds), they have more credit risk or risk of default and also more interest rate risk. As a result if interest rates in the market go down, the returns of short-term funds will increase and can even be in double digits. There is commensurate risk if interest rates go up. These funds are most suited for investors with a 1-3 year investment horizon.
 

12. Income Funds:

What they invest in: These funds invest in debt instruments from different issuers with an average maturity of greater than 3 years.

Should you be investing in them: The longer maturity of income funds means they have significant interest rate risk. As a result if interest rates in the market go down, income funds generate double digit returns due a significant increase in prices of the underlying instruments. If interest rates go up then  investors will see losses. The interest rate cycle (central bank going through a complete of hiking interest rates and then cutting them or cutting and then hiking) is typically of 3-5 years. Hence an investor with 3-5 year horizon can invest in income funds. Over this horizon, they should expect to see positive returns which are higher than that of liquid funds due to the fact that the investor took more credit and interest rate risk.

13. Gilt Funds:

What they invest in: Gilt funds can be thought of as a special kind of Income funds that only invest in instruments issued by the government. These funds can either be short-term or long-term based on the maturity of instruments that they invest in. The average maturity of a long-term gilt fund is usually more than that of income funds. This is  because of the easier availability of government paper at longer maturities.  

Should you be investing in them: Since the government is considered to be an extremely safe borrower (they can always print money in case they run out of it!), so gilt funds do not take credit risk. They only take interest rate risk. However the interest rate risk in gilt funds is typically more because of higher average maturity since the government typically issues more longer-dated paper  than corporate.Conservative investors with a 1-3 year investment horizon can consider short-term gilt funds. More risk-oriented investors with 3-5 year horizon can consider long-term gilt funds.


Additional points to note about debt mutual funds

While investing in debt funds, it is important to be careful about "Plus" or "Enhanced" funds. Such suffixes usually denote that the fund is investing a small percentage of its portfolio in some higher return (and higher risk) financial instruments. These could either be equities or more risky interest rate instruments than in the main portfolio. For instance a "Liquid Plus" fund could be investing in some longer maturity debt instruments. Hence it is important to carefully go through the fund factsheet when investing in such funds to make sure there are no unpleasant surprises.

While all fund managers have some amount of discretion on what to hold in their portfolio, they are still bound by the objective or mandate of the fund in terms of maturity and credit quality. However there is a special category of funds called "Dynamic Bond Funds" where the manager has the explicit mandate that they can pick debt instruments of any maturity. In theory, such a manager will invest in longer maturity instruments when interest rates are expected to come down and will invest in shorter maturity/floating rate instruments when interest rates are expected to go up, thereby giving consistent returns. In practice, interest rate timing is not that easy and evidence of dynamic bond funds outperforming their more passive counterparts is unclear. Hence investors may be better-off creating their own portfolio of liquid, short-term and long-term debt funds based on their investment horizon and risk appetite.

Also read

Part 1


ORO Weekend Reads: 20 - 25 Mar 2017




This week in ORO Weekend Reads: We go back to the basics with the different ways to invest in mutual funds. Plus how you can avoid the higher charges being levied by your bank and what google search trends can mean for your investments.

Staying on top of your personal finances was never this easy. So sit back and enjoy reading.


ORO Wealth Exclusives

Back to the basics What are the different ways in which you can invest in mutual funds



From the News

Topical, How to avoid the higher charges levied by your bank

Nearly 5 months post-demonetisation, How sticky have been the cash deposits in banks?

Look  out for these 10 most important income-tax changes that will apply from April 1

How are stocks included/excluded in the Nifty (Hint: It is not just the market cap)

Very important for financial planning in India 7 smart ways to cut down wedding costs



Around the Web

Some interesting data on  What google search trends can mean for investments

An interesting discussion on Why real estate prices have not fallen post-demonetisation

An infographic of the spectrum of financial service providers

NY Times article on How you can improve your productivity at work


Hope you enjoyed reading! Subscribe to our newsletter to receive it directly in your inbox every week.

ORO Weekend Reads: 13 - 18 Mar 2017




This week in ORO Weekend Reads: Top 6 things to look for in your financial advisor, how to deal with changes in EPF and find out the winners of Morningstar Fund Awards.

Staying on top of your personal finances was never this easy. So sit back and enjoy reading.


ORO Wealth Exclusives

Revisiting an oldie but goldie Looking for a financial advisor? Make sure they are offering these 6 things



From the News 

You can now transfer your EPF money to NPS but some legal hurdles remain. But should you transfer? See some viewpoints  here and here.

More changes for the EPF as you now withdraw funds to buy a house. Key points that you need to know but again exercise this option with caution.

Do donations through mutual funds work?

How to complete your tax-related issues before March 31. A  useful read for this year and the next.

Morningstar Fund Awards 2016: The nominations and the eventual winners

Move your accounts from the post-office to your bank for convenient online access


Around the Web

A good analysis of the Distinction between good (bad) companies and good (bad) investments from the blog of Aswath Damodaran

Three good articles which do a deep-dive into the nitty gritties of mutual fund investments: Are mid-cap funds using the right benchmark indices, What to do when your fund manager quits and How did mutual funds handle (Ballarpur) debt default



Hope you enjoyed reading! Subscribe to our newsletter to receive it directly in your inbox every week.

ORO Weekend Reads: 6 - 11 Feb 2017



This week in ORO Weekend Reads: A handy infographic on the 7 types of equity mutual funds in India. Plus are you aware of these 7 things in your payslip and all you need to know about Central KYC.

Staying on top of your personal finances was never this easy. So sit back and enjoy reading.


ORO Wealth Exclusives

This infographic is an easy way to find out about the 7 different types of equity mutual funds in India

For a more detailed discussion, read the first part of our 4-part article series on the 20 types of mutual funds in India and should you invest in them




From the News 

RBI leaves rates unchanged. What does the RBI decision mean for investors and borrowers?

Understand the 7 key points in your payslip for effective money management with this handy article

The focus is usually on returns, however risk is equally important. Read 3 things to keep in mind about fund volatility for a  good discussion

Use this Simple yet Powerful Mutual Fund Pre-investment checklist if you are a DIY investor or better still come to ORO!



Around the Web

Central KYC becomes the norm after Feb 1. Here is All that you need to know about Central KYC, cKYC or One KYC

Check out where India figures in this list of  The countries most and least optimistic about 2017

Less can be more when it comes to Health Insurance. Here are  2 Health Insurance Plan features that you should avoid.

Are you making use of these 12 ways to lower taxes on your salary



Hope you enjoyed reading! Subscribe to our newsletter to receive it directly in your inbox every week.

7 types of equity mutal funds in India explained through an infographic




Find out about the 7 different types of equity mutual funds in India through this easy to read infographic.

For more details read the full blog.




20 types of mutual funds in India that you need to know about - Part 1




In this 4-part article series, we discuss the 20 main types of mutual funds available in India and whether you should be investing in them. The main classification of mutual funds is by asset class ( i.e. what assets they are investing in) and in part 1 of the series we discuss the different types of equity mutual funds.



Equity mutual funds - an introduction

Funds that invest in shares of different companies and other equity related instruments such as derivatives, warrants etc.. Equity fund can be further classified according to market cap, active/passive, by sectors/themes and by geography.  Also tax treatment has created another class of equity funds called ELSS (Equity-linked Savings Scheme).

You can also read about the 7 different types of equity mutual funds in India in this infographic. Click for an enlarged version.

http://blog.orowealth.com/2017/02/7-types-of-equity-mutal-funds-in-india.html

1. Large-Cap funds:

What they invest in: Invest in shares of the largest companies on the stock exchange. Usually the top 50 stocks by market cap (shares outstanding*price) are considered large cap.

Should you be investing in them: Equities are expected to give high (double-digit) returns but can show significant ups and downs in any single year. Hence they are recommended for investors who can stay invested for an extended period of time (5+ years) and have the risk appetite to stay invested through the interim ups and downs. Among all equity funds, large cap funds are considered to be among the safest and suitable for beginner investors in equity mutual funds because (1) they are diversified so risk is spread across different industries and (2) they invest in large companies with established businesses.

2. Mid and Small-cap funds: 

What they invest in: Invest in shares of smaller companies listed on the stock exchange. Usually the next 200 stocks after large cap are considered as mid cap and the next 500 stocks are considered as small cap.

Should you be investing in them: Similar to large cap funds, these funds are recommended for investors who have high risk appetite and can stay invested for 5+ years. However Mid and small-cap funds have both higher risk and higher expected returns than Large cap funds because they invest in small companies with high growth potential. Technical way of saying this is that mid cap and small cap equities have a beta of greater than 1 to large cap equities.

Read: The different types of mutual funds in equities by capitalization for more on how large, mid and small cap funds are related to each other

3. Multi cap/Flexi cap funds:

What they invest in: Invest in shares from different cap segments. Exact proportion of investment in large cap vs mid cap vs small cap stocks in different mid cap funds should be looked up in their respective factsheets.

Should you be investing in them: Like large and small and mid cap  equity funds, these funds are also recommended for investors who have high risk appetite and can stay invested for 5+ years. Risk and expected returns lie between that of large cap and mid and small cap funds, depending on the market cap composition as mentioned in the fact sheet. While comparing multi-cap funds, it is extremely investors should not look at the returns alone but see returns in context of the cap composition that they hold.

 4. Index Funds:

What they invest in: Usually Index funds are mutual funds which passively track a benchmark index unlike active mutual funds which try to beat a benchmark by applying a strategy (Source: Investopedia). Index funds can exist in any asset class, however in India Index mutual funds are only found in the equities tracking either the large cap or mid and small cap index . You can find the exact benchmark that a particular fund is tracking by looking at its fact sheet.

Should you be investing in them: Since index funds are just passive versions of the largecap, multi cap and mid and small cap funds discussed earlier, they are also suitable for a similar kind of investor profile: high risk appetite and investment horizon of 5+ years. The big advantage of going with index funds is that they have lower costs. So if you do not believe that active mangers will outperform their benchmark (most US studies show this, though data is less clear for India), then you can opt for this low cost alternative to gain exposure to equities.

5. Sector/Thematic Funds:

What the invest in: Invest only in shares from a particular sector or theme. Some common sectors for which mutual funds are available in India include: Financial services, FMCG, Energy, Healthcare etc. Similarly common themes include PSU/MNC etc.

Should you be investing in them: As sector/thematic funds have more concentrated exposure, they are suited for investors who are bullish on that sector/theme. However sector performance is also linked to economic cycle. For instance sectors such as FMCG, Healthcare and Utilities are considered defensive because their sales react less to what is happening in the economy. On the other hand there are cyclical sectors such as Auto, Banking etc which are very tightly linked to economic conditions. So investors can also hold a bunch of sector funds (defensive or cyclical) to express their view on the economy in general rather than just a particular sector. Having said that in general these fund are not that suitable for an average retail investor who wants to get an exposure to equities. Such investors are better of with the diversified funds that we discussed earlier.

6. International Funds

What they invest in: Invest in equities of other countries. Because the fund manager has to buy the  equities of these other countries in their local currency, they need to convert INR to local currency. Hence these funds are also effectively holding the foreign currency vs. INR and will do well if the foreign currency strengthen/INR weakens.
 
Should you be investing in them: The requirements for buying equities anywhere remains the same: high risk appetite and long time horizon. However investors need to beware of the high expense ratios (annual % costs) of holding a mutual fund. As such investors should only look at international funds, if they already have a sufficient amount already invested in domestic equity funds. Also in such case it makes sense to opt for globally diversified international funds rather than those pertaining to  a specific country unless and untill the investor is suitably knowledgeable about individual markets.


7. ELSS (Equity-linked Savings Scheme)

What they invest in: ELSS funds are a special kind of equity fund which enjoy tax exemption under Section 80C of the Income Tax Act. Any investment in ELSS funds is tax-exempt up to a limit of 1.5 lakhs (limit is subject to other 80C investments that you already have). Further gains and maturity amount are also tax free. However unlike other equity funds, ELSS funds have a lock-in period of 3 years during which investors cannot withdraw their money.  From an investment point of view, ELSS funds are also multi-cap equity funds with a larger bias towards large-cap equities.

Read: How do ELSS funds compare with other equity funds

Should you be investing in them: You should invest in ELSS funds if you would consider investing in multicap/largecap funds. Many investors are often encouraged to invest in ELSS funds to "save taxes". However investors should remember that they have both Equity options (ELSS) and fixed return options(such as PPF) when it comes to saving taxes under 80C. And they should make the choice between them depending on the overall asset allocation they decide. ELSS/Equities have the promise of higher returns but also come with higher risk. Further even though the lock-in of ELSS funds is just 3 years as we discuss above, investors should be prepared to remain invested for at least 5 years to expect good returns.

Read: Answer these 3 questions to know whether you should be investing in ELSS