Sandeep Bhuwania's Blogs: Innovative Ways to Mis-sell A Low-Returns Product

Sandeep Bhuwania's Blogs: Innovative Ways to Mis-sell A Low-Returns Product: How your Banker is taking you for a ride! In the past few weeks, at least 3 clients have sought my opinion on a 'Lucrative' inves...

Innovative Ways to Mis-sell A Low-Returns Product

How your Banker is taking you for a ride!

In the past few weeks, at least 3 clients have sought my opinion on a 'Lucrative' investment scheme from Birla Sun Life Insurance being aggressively pitched to them by their bankers.

Here is the extract of the brochure

You can notice how Birla Sun Life Insurance is promising 100% to 600% Fully Guaranteed payouts after completion of policy term.

Such seemingly high Guaranteed Payout figures are used by the agents & bankers to mis-sell the policies.

A simple 2-minute calculation using IRR Function in Excel shows that the annualised return of such a 'Guaranteed' plan is less than 5.2% p.a.

Beware!!

Learn to use IRR & XIRR function in MS Excel for your own benefit.

Do Not Pay Attention To All The Noise About Demonitisation

 Ever since PM Modi announced #Demonitisation on Nov. 8, 2016 the media is abuzz about potential impact - both short term & long-term; Good & bad.

The extent of negativity an individual is associating with #Demonitisation# is directly proportional to one or both the following factors combined:

1. The inability to accept Modi as the Prime Minister of India, and
2. The mental agony & financial loss borne to 'adjust' the banned Rs. 1,000 & Rs. 500 cash notes lying with the individual

This negative reaction to #Demonitisation is then getting rationalised by highlighting the hardship to the common man or fretting about the long-term negative impact on the economy, and so on.

Here is how to deal with all the noise surrounding #Demonitisation...

1. Realize that this is an unprecedented event: Never in the history of mankind, an economy growing at 7% has sucked out 86% of cash available. With due respect to all the qualified & unqualified economists out there, one cannot fathom fully all the positive & negative long-term impact of this event.
2. Be aware that there are too many moving parts: One never knows what further actions the Government will announce. Therefore, one's view on the positive/negative impacts can change suddenly.
3. Learn from experience - Like always, actual impact will be in shades of grey: Long-term impact will have both positives & negatives for the economy. Only time can tell how far will one outweigh the other.
4. Remain focused on YOUR own goals & objectives: Cut out the noise, focus on your own goals.

A Tale of Two Events

What a week this has been - Two events that shook 2 of the world's largest democracies and the Indian Stock Market!!

Here are my views on the events....

TRUMP TRUMPS

Against all predictions, Donald Trump wins the Presidential election riding on the anger of America's poor & less privileged. Over the last 8 years, US has been trying to revive their economy by keeping the interest rates near zero - hoping that cheap money would encourage businesses to invest & individuals to spend - with unsatisfactory results. This was the 'Monetary Policy' method of reviving the economy through increased Consumption.

What Trump advocates is increasing Government spending on various projects which will have a ripple effect through businesses/individuals getting contracts for supplying goods & services. In other words, increasing the 'Fiscal Deficit' to revive the economy. 

The Impact

The interest rate in US has risen and FIIs are, therefore, moving way their investments from Emerging Markets like India back to US.

INDIA DEMONITISES

To curb Black Money & to check Terror Financing, the Indian Government banned use of Rs. 500 & Rs. 1,000 currency notes - effectively making 86% of currency in circulation illegal.

The Impact

Besides a temporary inconvenience to the general public, there will be huge long-term impact of this bold step.

1. The currency notes of Rs. 500 & Rs. 1,000 in circulation approximately add up to a staggering Rs. 14 Lakh Crore. Out of this approx. 30% (i.e. Rs. 4 Lakh Crore) will never come back into circulation because the hoarders would not risk identification. Since currency notes are in effect RBI liability (Govt. debt), this would mean a write-off of Rs. 4 Lakh Crore debt, thereby, improving the Govt. Fiscal position
2. Interest rates would come down sharply in near term
3. Big ticket consumption would suffer and therefore, Corporate profits may be down for at least next 4-6 months. This would lead to weakness in stock market over next 6 months

What Investors Can Do

1. Risk-averse investors should park their maturing Fixed Deposits in Ultra-Short Term Debt Schemes of Mutual Funds. The returns would be better than bank FDs over 1 & 2 years.
2. Those thinking of investing in 3 years Fixed Deposits would be better off by investing in Dynamic Bond Funds for 3 years for far better post-tax returns than a Fixed Deposit.
3. Those with 5-year horizon should invest in a staggered manner in Equity or Equity Funds over next 6 months
4. Those with 10-15 years horizon should not even bother. This will pass - just like World Trade Centre attack (9/11), Lehman Crisis, BrExit and countless others which you may not even remember!!

Investment Expertise is Over-Rated & Discipline is Under-Rated

There is a classic story about how a stock portfolio built by having a blindfolded monkey throwing darts at the financial pages of a newspaper does better than a portfolio constructed by experts!! 

Sounds unbelievable?

You must then read “A Random Walk Down Wall Street”, a 1973 bestseller by Burton Malkiel.

It is quite common for investors to seek 'Expert' advice on stock market direction or on the prospects of a company's share price.

The reason for such behavior is the belief that there are 'Investment Experts' who can provide 'Investment Tips' to help one earn superior returns on their money.

Such belief often leads to grossly sub-optimal returns on investment for a retail, individual investor who ideally wants to build substantial capital over his/her working life (20-30 years or more).

So, what should a common individual investor do?

First of all, remember this:

It is NOT so much the SMARTNESS, but better DISCIPLINE which creates Higher Wealth

Here are the simple habits that one can develop to be a Disciplined Investor:

1. Understand that someone promising a High Return is only trying to attract your attention. Be extremely wary of such promises
2. Focus on your GOALS rather than trying to generate abnormal returns
3. Start investing at the earliest possible - No matter howsoever small the amount may be. This way you allow Compounding to work for your benefit
4. Remember George Soros ' words: "If investing is entertaining, if you’re having fun, you’re probably not making any money. Good investing is boring.”

Flawed Thinking That is Disastrous For Your Wealth

Quite often we come across investors who display the following mindset relating to their investment planning:

This is the classic case of flawed thinking that is disastrous to one's wealth!!

Investors make wrong choices when they confuse volatility with Risk. Stock markets are volatile but not risky if one has an investment horizon of 15-20 or 30 years. In fact, it is the most suitable vehicle to create huge wealth over such time horizons.

On the other hand, 'Safe' instruments like bank deposits & debt funds are the best choice for wealth preservation over 1-3 years horizon but extremely unsuitable for wealth creation due to taxation & inflation.

The correct plan for the above investor is:

Wealth Creation Lesson From the Sun

The Sun is the source of all life on the planet. It dutifully rises everyday, without fail to break the night into dawn. Fog. haze, or cloud cover may subdue its light and energy on some days. Yet, it rises with the same intensity and persists in its endeavors. Eventually the clouds clear out, the fog subsides and the haze gives way for its light to shine brighter than ever.

But, what would happen if the Sun were to lose hope due to these 'disturbances' and decide to stop rising?

Creating wealth through Systematic Investment Plan (SIP) requires persistence like the sun to push beyond the haze, clouds and fog!! There would be days, weeks or at times even months of "thick cloud cover" when the markets are in panic mode, owing to whatsoever reason.

Yet, if one fearlessly endures the days of "Thick cloud cover" and continues with the SIP month on month for years continuously, their wealth grows beyond imagination.

Let's rewind and go back 20 years to January 1996 and relive the experience of an investor who would have started their SIP in a diversified Mutual Fund in that month.

Since then, the stock markets have seen some major prolonged 'cloud covers' which must have tempted the investors to  discontinue their SIP in a Mutual Fund.

• Year 1997-98: Asian Financial crisis - Starting from Thailand and spreading soon to Malaysia, Phillipines, Indonesia, South Korea, Hong Kong, China and many others. 
• The BSE Sensex fell 33% - from 4,320 in Aug. 1997 to 2,860 in Sept. 1998
• Year 2000-2001: Dotcom bubble crash; Ketan Parekh Scam, Twin Tower Attack
• BSE Sensex crashes 48% - from 5,465 in March 2000 to 2,820 in Oct. 2001
• Year 2008-09: Global Financial Crisis
• BSE Sensex crashes 62% - From 21,200 in Jan. 2008 to 8,050 in March 2009

And then there is that short-term fog which hits the markets from time to time:

• Kargill war
• Russia attacking Ukraine
• Indian Current Account Crisis of 2013
• North Korea Hydrogen Bomb
• Chinese slowdown

What would be the result of persisting through these long term cloud covers and short term foggy days?

Look at the results below: (Assuming a monthly SIP of Rs. 5,000 started on 1-Jan-1996 for 20 years)

Total Amount Invested over 20 years: Rs. 12,00,000

SCHEME NAME	Approx. accumulated Value as on 1-Jan-2016	Compounded Annual Return (CAGR)
Birla SL Balanced 95 Fund	Rs. 1.40 Crores	20.9% p.a.
HDFC Equity Fund	Rs. 2.06 Crores	24.0% p.a.
Reliance Growth Fund	Rs. 2.47 Crores	25.5% p.a.

For more on Wealth Creation fundamentals, please visit www.deepamfinvest.com

Where should you FOCUS?

Where should YOU Focus?

• Dow, S&P off to worst 4-day Jan start ever as China fears grow
• Soros sees 2008-like crisis 

China on boil: Should India be worried?

The above is just a sample of ever so pervasive news headlines which shout for your attention everytime there is a 'significant' event. 

But should you - as a long-term investor - pay attention? 

Should you rather not be paying more attention on how to ensure that your children get the best education or how your retirement can be planned?

This is where FOCUS comes in.

Consider this:

Exactly this day seven years ago,  that is on 7th Jan 2009, Satyam Computer Services scandal was revealed by its chairman. 

The new York Stock exchange halted the trading of Satyam Computer shares.

Satyam shares crashed from 544 and fell to 11.5 per share.

Indian stock market fell by 749 points on 7th March 2009.

Sensex on 7th Jan 09=9587 points 

Sensex today, 7th Jan 2016=24851.

Returns delivered = 14.58% every year.

Moral of the story.

Do not concentrate on the noise happening in the market.
Instead focus on your financial goals. Noise will continue everyday.

Personal Finance Lesson from Hare & Tortoise story

We have all understood from the traditional Hare & Tortoise Story how 'Slow & Steady Wins the Race'!!

Well, this is true even for personal finance.

How may times you have heard a colleague or a friend or a relative boast of making 50-100% returns on a stock in 4 months? Now, the same friend or relative or colleague would not tell you what he lost on his other bets in his quest to earn some quick money. And, if you happen to speak to him a few months later about the experiences from his stock picking, he would definitely be far less enthusiastic.

This happens because the stock markets are the worst place to consistently make a quick buck.  (Notice the emphasis on 'Consistently') In fact, almost everyone trying to get rich quick in the stock market ultimately comes out brutally scratched & injured - and then blames the stock market!!

He is the proverbial Hare in the story - Excited & Active, Misplaced confidence in his abilities to beat the system consistently.

Compare the above behaviour with someone who follows the most boring & unimaginative but consistent strategy of investing regularly through a Systematic Investment Plan (SIP) over 10 - 15 or 20 years. Look at the following chart (Assumption: Rs. 3,000 invested per month):

This is the result achieved by the proverbial 'Tortoise' in the traditional story!!

Moral: The longer the race, the more startling the margin of victory for the Tortoise.

For useful insights into Personal Finance, visit the Learning Centre at www.deepamfinvest.com

Learning this tool alone can save investors Lakhs!

A major reason that investors get misled into putting their hard earned money into wrong types of plans is their quest for:

High Returns - GUARANTEED

Big financial institutions - (Namely Banks & Insurance Companies) know this mindset of the average investor. They collude & offer you Guaranteed plans weaving such dreams in their sales pitch that it is easy for a gullible investor to fall prey to them.

Recently, a 41 year old businessman friend of mine was approached by his banker with following scheme from a large insurance company claiming a Return on Investment of 8% p.a. GUARANTEED, Tax-Free and FREE Insurance:

• Invest Rs. 10 lakh per year for 10 years in a Guaranteed Insurance Plan.
• You will get a Life Cover of Rs. 1 crore.
• From Year 21 to Year 34, you will get a Guaranteed Payout of Rs. 5,06,380
• At end of year 34, you will get a Guaranteed maturity of Rs. 3,94,62,300

As an incentive to buy this scheme, the banker also offered to reduce the interest rates on my friend's CC Limits!!

This friend, who is a successful business person & brilliant in his work, could not understand what the plan meant but was suspicious of the fact that if the plan was actually so good, why would the banker offer incentives for investing in the plan! He sought my advice.

The best approach in such cases it to use the XIRR calculation in MS Excel. XIRR gives the return % p.a, for a series of known cash flows.

Using the XIRR calculation in MS Excel, one can easily see that the actual return being guaranteed is only 5.47% p.a. (The actual yearly investment would be Rs. 10,30,900 for 1st year & Rs. 10,15,450 for year 2 to year 10)

On careful reading of the brochure given by the banker,it was clear that even this 5.47% p.a. was not guaranteed!!

It is strongly recommended to be familiar with XIRR Function to ward off such fraudulent bankers who are chasing their own bonuses rather than their clients' interest!

For a demo, click http://www.deepamfinvest.com/deepam-learning-centre/irr

Absolute amounts can be misleading

A few years back, my client (around 51 years age) walked into my office along with his 26 year old daughter who had recently secured a job at a prestigious MNC. Both father & daughter were understandably very happy.

However, I learnt that there was another reason for their happiness! My client excitedly informed me that he has just finalised a long-term investment for his daughter which is probably the best investment he has ever come across. Before I could congratulate him, he pulled out a sheet of paper with the following matter hand-written on it:

• Age: 26 years
• Payment Term: 35 years
• Annual Premium: Rs. 13,225
• Life Insurance: Rs. 5,00,000
• Cumulative amount at end of payment term: Rs. 23,45,000
• Annual Pension: Rs. 1,77,165

His excitement about the plan came from the fact that an yearly investment of only Rs. 13,225 would give his daughter an assured pension of Rs. 1,77,000 throughout her life after she crosses 60 years age.

Seems lucrative right? 

An yearly investment of only Rs. 13,225 leading to an assured pension of Rs. 1,77,000 throughout life after crossing 60 years of age!!

If you should use the IRR calculation demonstrated in the video below for any such guaranteed returns proposal, you might be surprised to find that the annualised return of this “lucrative” plan is a measly 7.8% p.a.!

Often, the investors get swayed by the absolute amounts without understanding the time value of money. It is always advisable to use the IRR calculation for any such Guaranteed returns plan.

What can 14% p.a. returns do!!

What can 14% returns do? 

Let us see...

In 1971, Govt’s Enemy Property Office had shares worth Rs. 29 Crores value, mostly belonging to people who left India during Indo Pak war of 1965. In the year 2015 i.e. 44 years later, the shares were valued at 10,000 Cr. 

That is approximately 345 times in 45 years!

Can you imagine what return per year it must have taken to grow by 345 times? 

Approximately 14%, that is all.  

Over 44 years that 14% made 29 Crs turn into 10,000 Crores !!  This was a static investment on which nothing was done,  This 14% p.a. returns is not counting the Dividends that would have been paid out on these shares. 

This is what equities can do over long periods of time, create real wealth. !! Holding for 20 or 30 years can create wealth; buying and selling every 1- 2 years will create lots of paper work and not wealth !!

Moral of the story: 

Invest for really long periods to create wealth

Source for the news on Enemy Property:

http://www.business-standard.com/article/markets/enemy-shares-to-be-dematerialised-115041700037_1.html

Simplest Way to Create Wealth

To build wealth, most people try to take short-cuts and end up wasting their time or squandering what little wealth they have. Make no mistake, there are no real short-cuts unless you get lucky and win the lottery.

The foundation of building wealth starts with establishing the right mindset and following through on a few basic principles.

The first & most basic principle that anyone who wants to succeed in investing should understand is the Concept of Compounding..​​

Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.”

Compounding of returns happens when both your initial investment amount and the accumulated returns grow together!! Therefore, Compound interest can be thought of as “interest on interest,” and will make a deposit or loan grow at a faster rate than simple interest, which is interest calculated only on the principal amount. 

Thanks to compounding interest, it doesn’t really take much to build your wealth over time. The key to amassing a fortune is by constantly contributing to the overall pot as often as possible and allowing the money to work for you and grow itself. Remember that it doesn’t take much additional money to have a profound effect on one's wealth. Covet your cash and don’t let go it too easily. Before you make a frivolous purchase, consider the ramifications on your overall future wealth.

Look at the Compounded Returns Formula below:

If one looks at the equation carefully, one can observe that 'Time in Years' has the most impact on the accumulated amount. Yet, so many individuals focus on 'Principal' & 'Rate of Interest'.