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Contents
1. Gettingstarted
2.PersonalFinanceSelfEvaluationChecklist
3.Howtofortifyyourfinancialcastle
4.HowtoBuyaTermLifeInsurancePolicy
5.HowtoBuyaHealthInsurancePolicy
6.SayNOtoPackagedFinancialProducts
7.RetirementPlanningASlideShow
8.UnderstandingHowRetirementCalculatorsWork
9.Generatinganinflationprotectedincomewithalumpsum
10.AStepByStepGuidetoLongTermGoalBasedInvesting1
11.LongTermGoalBasedInvestingPartII
12.Howtoselectmutualfundcategoriessuitableforyourfinancialgoals?
13.Howtoselectanequitymutualfundpreamble
14.HowtoselectanequitymutualfundCreatingashortlist
15.HowtoselectanequitymutualfundMakingaChoice!
16.HowtoSelectDebtMutualFundsSuitableForYourFinancialGoals?
17.HowtoConductaPersonalFinancialAudit
18.Howtoreviewyourmutualfundportfolio
19.ReviewYourRetirementPortfolioinSevenEasySteps
20.Assetallocationforlongtermgoals

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

2
.
Fortifications:Buildingbarriers
Ifachangehastomakeitsmark,ithastopermanent.Thusjustlikeanyconstruction,onehasto
beginwithfortifications.
LifeInsurance
Aresearchstudentdiedwhileonatrekrecently.Theirparentswereentirelydependentonhim.
Theyknewthis.Sonoeffortwasneededtoconvincethemabouttheneedforatermlifeinsurance
policy.
RelatedPost:
HowtoBuyaTermLifeInsurancePolicy

Healthinsurance
Samehere.Thesewerenotschoolkids.Theywerepostgraduates.Sotheyknewthevalueofhealth
insurance.
SubrasuggestedthatItalktothemabouttheimportanceofgettingtheirparentshealthcover.Done.
Relatedpost:
HowtoBuyaHealthInsurancePolicy
Accidentinsurance
ThiswassuggestedbyMr.R.BalakrishnanwhenIpostedaboutthistalkinthefacebookgroup,asan
ideasforwealth.
Emergencyfund
Seebelow
Relatedpost:
HowLongShouldIMaintainanEmergencyFund?

Will
Urgedthemtogettheirparentstowriteawill.AgainasuggestionbySubra.

3.
AnalysingCashFlow
Isuggestedthatthestudentsdothefollowingwiththeirmonthlyscholarship
Foratleast1year
i)30%
fees+food+needs
ii)30%
familyortothebank(sayaflexideposit)partlytobuildanemergencyfund
iii)30%
forlongterminvestment(moneyyouwillnottouchformany,manyyears)seebelow
iv)10%
bufferfor
wants
fromtimetotime
Afteraboutayearorwhenemergencyfundiscloseto1lakh:
i)30%
fees+food+needs
ii)30%
familyorpartlytowardslongterminvestment
iii)increaselongterminvestment(
moneyyouwillnottouchformany,manyyears)seebelow
iv)10%
bufferfor
wants
fromtimetotime

Therewasunanimousagreementthatthiswaspossible.

4.FrugalLiving
Donotconnectmoneyandhappiness.
Donottakeyourdegreeandfuturepositionstooseriouslyandbuystuffbecauseofsomestatus
nonsenseorbecauseofpeerpressure

5.Nevertakealoan
Exceptahomeloanandthattooonlyifnecessary.

6.Saynotocreditcards
Ifyouhaveacreditcard,youneedtopayitinfulleachmonth,anyway.Meaningyouneedtohave
themoneyready.Sowhyhaveoneatall?
Ignorealltheperksassociatedwithcreditcards.Theydonotaccountformuch.
Youdonotneedacreditcardtokeeptrackofyourexpenses

7.Saynotoanykindofinsuranceproducts
Exceptpuretermlifeinsurance.Enoughsaid

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

9.Donotbuylandasinvestment
Itisnotliquid,notwellregulated,demandisartificialetc.etc.

10.Donotbuygoldasinvestment

SinceIwastalkingtophysicistsIcouldaffordtosaythefollowing.
Goldglitterssimplybecausegoldisametal.Anelectricfieldcannotexistinsideametal.Otherwise,
theelectronsinsidewouldflow!
Whenlight(whichcontainsafluctuatingelectricfield)shinesonapieceofgold,orforthatmatter
anypieceofmetal,thenimbleelectronsmovearoundlikeagooeyfluidandreflectsmostofthe
light.Someofitgetsabsorbed.Sotheresultingcolourisgoldenyellow.Nobigdeal!
Ifoureyescouldsenseultravioletlightinsteadofthevisiblelight(VIBGYOR),goldwouldappearlike
aslabofglassbecausemetalsaretransparenttoultravioletlight.

11.Givemoneytocharity
Helpothersinneed.Whenyouareinneed,someonewouldturnuptohelpyou.Thatismy
strongestreligiousbelief.

12.Understandinglongterminvestments
thechaishop
analogy
Onlyonepersonsparent(outofnearly100)investedinstocks.NosurpriseshereIguess.
Tointroducethemtotheideaofstocksandbonds,Iusedthefollowinganalogy.
Imagineateastalloutsidethehostelgate.Youfrequentiteachday,youliketheownerandyoulike
theteaevenmore.Onedayhesayshehastoshutshopbecausehehashugedebt.
Youwanttobailhimout.
Youhavethefollowingchoices.
1)Lendhimsay50Kandaskfor8%interesteachyearfor1oyears.Thisiscalledabond.Sinceheisin
yourdebt,thisiscalledadebtinstrument.Ifthepersonistrustworthythereisnocreditrisk
involved.
Whetherhegetsaprofitornot,hehastogiveyouthe8%interest.Sothereisnoriskforyour
investmentinthesensethatpaymentswillberegular.
Youreinvestthepaymentsinthesameshopandgetthesameinterestorsay,putitinabankFD
2)Yougivehim50Kbuttellhimthatyouwantashareoftheprofits.Thatisyouownthecompany.
Thisiscalledequity.Ifthereisaloss,yougetaloss.Ifthereisagain,yougetagain.
Theremaybeintermittentlossesbutoveralongperiodoftime,youexpecttheannualgainsto
outnumbertheannuallosses.Youexpectthisbecause:

studentsneedaplacetohangoutoutsidethecampus.Sotheywouldfrequentteashops.
Iftheteaisgood(anditisinthiscase)thenmorestudentswouldcomeandmoreoften.
Thus,thereisachanceforconsistentprofit.

Afterseveralyears,theequityandbondinvestorsnetworthwouldlooksomethinglikethis(drew
thisontheboard).

IfIapply30%taxtobothequityanddebt,thevaluewillreduce.
NowImusttakeintoaccountthe
effectofinflation
.
Iaskedforthepriceofchaiwhentheyhaditforthefirsttimeeverintheirlives.
Rs.1,Rs.2.50weresomeanswers(notallarefrommetros!)
Thiswas10yearsago.
NowthepriceisaboutRs.7
Sothisisabout11%inflationwiththestartingpriceasRs.2.50
Soafterhavingdevaluedthecorpusduetotax,wemustdevalueitduetoinflation.
Nowwhodoyouthinkgotthebetterdeal?Thefellowwhohadthecouragetostomachannual
fluctuationsorthefellowwhowantedsteadygrowthwithpracticallynovolatility
Whichinvestorislikelytochangethewaytheirfamilyhandlesmoney?
Knowingwhichchaishoptobackmaybetoughastherearetoomanyofthemaroundthecampus.
Also,whyonlybackchaishops?ThereareseveralXeroxshops,suppliesshopsetc.

Whataboutourcampusbank(SBI)?Itmakesalotofmoneybyofferingattractivefixeddepositrates.
Itthenoffersdifferentkindsofloans(car,personal,house,forcompaniesetc.)atmuchhigherrates
andbagsaneatprofit.
Whynotbuythebanksstock?Whynotobservethespendinghabitsoftheundergraduatesandfind
outwhichbrandstheyprefer?Thosebrandscouldthenformashortlistforfurtherinvestigation.
Yes,knowingwheretoinvest(eitherequityorbond)istough.Itrequiresconfidence,disciplineand
thetimetoanalyzeandtrack.
Thereisamuchsimpleralternative:mutualfunds.Youpayasumtoafundmanagerwhopoolsinall
contributionsandinvestsinadiversifiedfolioofstocks,bondsorboth.
Iurgedthemtobuildfortificationsasap,learnthebasicsofequityandmutualfundsandbegin
investing.
Thereweresomeintelligentquestionslike:

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

2.
PersonalFinanceSelfEvaluationChecklist
ActI:Preparation
1. Ismylifeinsuredadequately?Thatis,willmyfamilybeabletohandletheirimmediate,
shorttermandlongtermgoalsinmyabsence?
Somepeopledismissthisasoveranalysis
andtakea1Croretermpolicy!Trustmethisanalysiswilltakeonly15minutes.Theparalysis
occurswhilechoosinganinsurernotwhiledecidingtheamount!
2. HaveIdiscussedwithmyspouseornomineehowtheterminsuranceamountshould
be
utilized
inmyabsence?
Youcanwriteadetailednoteaboutthisifyourspousefindsittoo
morbidtodiscussthis.Justbesuretoincludethedetailednotealongwiththepolicypapers.
Youcanalsoincludethecontactdetailsofafeeonlyfinancialplannerforguidance.
3. Aremeandmyfamilymembersinsuredadequatelywrtmedicalexpensesindependentof
myemployment?
ThisseemslikeanobrainerbutIamappalledtoseethatpeopleconsider
mediclaimexpensesasawasteofmoneyiftheydontclaimandtakeemployeebenefitsand
theirownhealthforgranted.
4. HowreadyamItohandleemergencyexpenses?
Youneedmorethan6monthsor12months
expenses.Rememberthatcashlesshospitalizationdoesnotmeancashfreehospitalization.
Youstillneedtopayfornonmedicalexpenses.
5. HowcapableamIofreplenishingmyemergencyfundifitgetsdepleted?!
Dontlockallyour
monthlyinflowsintoEMIsandSIPs.Youneedasmallbuffertoreplenishtheemergency
fund.
6. DoIknowwhatmynetworthis?
Theonlyreasonyouneedtodothisisforcesyoutolistall
yourinvestmentsandupdatetheirvalues.
7. HaveIlistedallmygoals:recurring,shortterm(lessthan5yearsaway),intermediateterm
(510Yaway)andlongterm(10Y+away)?
8. DoIknowtheapproximatebutrealisticcurrentcostassociatedwithmygoals?
9. HaveIdecidedtheassetallocationformyintermediateandlongtermgoals?
Shorttermis
100%debt!

Theassetallocationgiveyoua
net
portfolioreturnyouareaimingfor.For
exampleifyouexpect12%fromequityand7%(posttax)fromdebtandwouldliketohave
60%equityexposure,thenetportfolioreturnis(approximately):(12%x60%)+(7%x40%)
10. DoIknowhowmuchI
needtosaveorinvest
foreachofthem?
Youneedtouseagoal
plannerwiththenetportfolioreturnandareasonableinflationestimate.Forretirement,
youneedtoassumeaninterestratepostretirement.Usesomethinglike7%orso,fornow.
11. DoIknowhowmuchI
caninvest
permonth?
Analyseyourcashinflowandoutflow.
Constructapiechartandstareatit.
12. IfthereisashortfallhowamIgoingtomanageit?
Someoptions:postponegoals,reduce
targets,increaseinvestmentsdowntheline.Dontmakethemistakeofincreasingexposure

tovolatileinstrumentsinthehopeofcompensatinglowerinvestmentswithhigherreturns.
Itcouldbackfireterribly.
13. HaveIdiscussedallthiswithmyspouseorpartner?
HaveIwrittendownaninvestmentplan?
Awritteninvestmentplanhelpseverybody,especiallythosewhocannotdiscussfinancial
matterswiththeirspouse.

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

ActIII:Review
1. DoIknowthenetreturn(XIRR)ofmydebtinvestmentsandequityinvestment?
DoIknow
thenetXIRRoftheportfolio?Isthisaboveorbelowtheexpectedportfolioreturnusedinthe
goalplanners?
2. DoIknowwhatisthecurrentactualvalueofgoalportfolios?
DoIknowhowmucharethey
actuallyworth?IfIdontinvestanymoreforthesegoals,howmuchwouldthecurrentvalue
growtowhenIneedthemoney?
3. DoIknowforhowmanyyearsIcansurviveonaninflationindexedmonthlyincomewithmy
retirementcorpus,IfIretiretoday?
LetuscallthisXyears.
4. AmIincreasingthisXyearsbyatleastoneyearforeachyearthatIwork?
Thisisthetrue
measureofaretirementportfolio.
~~~~~~~~~~~~~
Endnote:
Attheendofthedayhowsuccessfulwearewithourfinancesisdecidedbyhowmuch
moneywehavewhentheneedarisesatwhichpointXIRRorCAGRorIRRorwhateverwewishto
callitmatterslittle.Allwecandoismakereasonableassumptions,investinproductiveassetswhich
ispartofadiversifiedportfolioandhopeforthebest!

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

EmergencyFund
Aemergencyfundisalsoacrucialfortificationstepbutwedonothaveatailormadeproductforthis
andnorisitnecessary.Aslongaswecanfindawaytoreplenishtheemergencyfundwhenitis
used,whereweputthefundisprettymuchirrelevant.Ofcoursethechoseninstrumentmustbe
liquid.
Theproblemistheamount!(seebelow)

PureTermLifeInsurance
ThosewhorealizeatermplaniscrucialeitherchoosetoseekaoneCrorepolicyorworryabout
the
howmuchinsurancecoverisrequired
.
Unfortunatelybothapproachesdonotcountformuchbecausetheinsurerhasanupperlimit
typicallybasedonanindividual'sincomeandriskprofile.
Therefore,Ithinkitwouldbebesttoidentify2/3insurersoneiscomfortablewith,writetothem
withbasicprofiledetailsanddeterminethemaximumcovertheyarewillingtooffer.
Thenwriteanactionplan:HowmuchshouldIallocatefor
1. squaringoffliabilities
2. inflationprotectedincomeandforhowmanyyears(perhapsuntilthekidsareoldenoughto
work
3. generatinganinflationprotectedsumforschoolfees(includingtrainingandcoaching
classes)
4. collegefees

5. marriageexpenses(ifpossible)
UsetheComprehensiveChildplannertoworkthisout:
Howtoplanforyourchildseducationand
marriage
Remember:havingatermplanisgoodbutwhatifyournomineebuyswrongproducts?Sopreparean
actionplananddiscussitwithyournominee
Understandhowbestthemaximumeligiblesuminsuredshouldbedistributedamongthesebuckets,
writeitdownanddiscussandgivecopiestoyournomineeandsomeoneelseyoucantrust.Besure
toincludethenameofafeeonlyplanner(seelinkonthetopright).
Askyournomineetocontactthefeeonlyplanner,ifneeded,assoonasyouarereadytosubmitthe
claim.Theyshouldbeabletoguidethroughtheclaimsettlementprocess(forafeeofcourse)and
allocatethesumintodifferentbucketsasperyourplan.
Alsosee:
ThingstodoAFTERyoutakeaterminsurancepolicy!

HealthInsurance
Havingahealthcoverisindispensable.Howeveritisimportanttorecognizethatcashlessclaimis
moreofaprivilegethanaright.Reimbursementisaright.Sodonotbesurecashlesswillbe
approved.Meaningyouneedmoneymuchmorethan12timesmonthlyexpenses!
Emergencyfund
isalongtermgoal.Itisaninsatiablemonsterwhichneedstobefedconstantly.
Readmore:
HowLongShouldIMaintainanEmergencyFund?
Printthenecessarystepstobecompletedbeforeandafterhospitalizationandstoreitalongwith
theinsurancepolicyandcard.Itwouldbebetterifthespouseandothermembersreadit.

AccidentInsurance
Thisisamusthaveforprofessionalsandthoseinthecutthroatcorporateworld.
Theproductisrathercomplex.Theclaimwillbepaidinfullonlyforcertaintypesofaccident.All
otherswouldonlygetsomepercentageofthesuminsured.
Alsoonedoesnotneedtosufferanaccidenttoloseincome.Therearemanyotherailmentswhich
wouldrenderapersondisabled.

HowmuchaccidentinsuranceshouldIhave?IfIdie,familyexpensesmightdecreaseasIamno
longeraround.
IfIamrendereddisable,myfamilyexpensesarelikelytoincreaseandsharply.Soanaccidentcover
shouldbehigherthanatermcover.
Unfortunatelythisisrarelythecase.
Gettinganaccidentinsurancepolicyfor10,20,30Lisinadequate.
Noteveryonewillgethighcover.Itdependsontheincomeandthekindofjob
Thebiggerproblemisthatmanyinsurersofferquitelowcover.ThemaxcoverIhaveseenis1Crore
fromTataAIG.
Theonlyupsideisthatthepriceofsuminsuredoftensoflakhsisquiteinexpensive.
StayawayfromanygroupinsurancepolicyofferedbyBanks.

CriticalIllnessInsurance
Againacomplexproduct.Youneedtogetcriticallyill(andnotdiewithinamonth)
inacertainway.
Seemore:
CriticalIllnessInsurancePolicies:DoYouReallyNeedOne?
AgainthesuminsuredinmostCIproductsisnotaslargeasatermplan.Butthepolicyismuchmore
expensivethanatermplan.
IwouldprefertobuyaCIcoverifthereissomehistoryifCIinmyfamily.Butthenagain,doyoustop
withfirstcousinsorsecondcousins?SearchhardenoughandeveryfamilywillhaveCIcase!
Ifallourinvestiblesurplusgoestoinsurancepolicies(thatdonotofferbonuses!)wherewillwe
havemoneytoinvestforourfinancialgoals!
Soweeitherbuyalltypesofpoliciesforlowcoveroravoidcertaintypesofpolicies(CIoraccident
thatis.Restaremandatory).
Alaseitherwayitisnotaneasydecision.
Perhapsonecouldbuyabout30Lofaccidentcover,30LofCIcoverandgetashighatermcoverand
mediclaimaspossible,butthetotalpremiumwouldbecloseto1Lfora30something.

Ifwearelucky,dontgettousetheCIandaccidentpoliciesandthehealthcoverrarely,wecanfocus
oninvesting.
Ifweinvesttothebestofourabilityinproductiveassets,hopefullywewouldhavemorethan
enoughtohandle
unexpectedbigticketexpenses
acoupleofdecadeslater.Buildingarocksolid
fortificationtakestimeandluck.Lotsofboth

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

DeconstructingIRDAsDeathClaimSettlementTable
First,letustouchuponaspectsfromIRDAsdeathclaimsettlementtable,obscuredbytheclaim
settlementratio.
Letmestartwithananalogybetweenaninsurerandateacherevaluatinganswerscripts.Asthe
teacherstartsevaluatingscripts,he/shegetsasenseofwhattheaveragemarkoftheclasswouldbe.
Whenastudentscoreslittleornomarksinthefirstfewquestions,theteacherrealizesthatthetotal
markwouldbemuchlowertheclassaverage.Therefore,thetendencywouldbetobeabitgenerous
inthenextfewquestionssothatthetotalisbolsteredabit.
Ontheotherhand,ifthefirstfewquestionsarewellwritten,thetendencywouldbetoscrutinize,
thewholepaper(!)abitcloser.Thisisnormalhumantendencyandevenateacherwithnopressure
fromtheadministrationislikelytodothis.
Whywontaninsurerwhoreceivesabigticketclaimscrutinizeittougher?Afterall,thereismuch
moreatstake.
Thepointis,LICorprivateplayers,nooneislikelytooffertermcoverclaimsettlementonaplatter.
Ofcourse,thereisadueprocessclearlymandatedbyIRDA.
ThefollowingisascreenshotfromtheIRDAannualreport201011(clicktoenlarge).


Troubleis,whataclaimantconsidersadelayandwhatislegallyallowed,aretwodifferentdurations!
Thereisacrudewaytopointoutthathighertheclaimamount,higherthescrutiny,resultingpossibly
inarepudiationordelay.
TheclaimsettlementtablepublishedbyIRDAhasthetotalbenefitamountalongwiththenumberof
claimsintimated,pendingandrepudiated.
Thisisascreenshotfromtheindividualdeathclaimstableofthe201213annualreport.Theentries
havebeenmergedwiththecolumnheadingstoaidreading.

Thebenefitamountperclaimwhencomparedovertimecanshedsomelightontheaverageclaim
amounthandledbytheinsurer.Ofcourse,thisratioisnotasoundwaytomakeanysolidinferences.
Letushoweverrunwithitandseewhereittakesus.Beforeyoupanmeinthecomments
section,rememberthatIacknowledgedthis!


Theclaimamount(Lakhs)intimatedperpolicywas0.73wasLICin200607and1.58forprivates.
In201213,thisincreasedby36%forLICandnearly33%forprivates.Itmustbekeptinmindthatthe
numberofprivateplayersincreasedbyabout50%inthisperiod.
Thus,thereisasignificantincreaseintheclaimamountperpolicyhandledbyLIC.
Evenmorestrikingisthe78%increaseinthebenefitamountperrepudiatedclaim(1.08to1.92).
Howwouldyouinterpretthat?
Fortheprivates,thebenefitamountperrepudiatedclaimhasincreasedbyawhopping95%(2.08to
4.05).
ForLIC,theclaimamountrepudiatedperclaimcanonlyincreasefromnow(theiretermpolicyis
onlyonereason).Fortheprivates,Ithinkitshouldcomedowninthefutureoratleastnotincrease
sodramatically.
Onecouldarguethatthenewinsurerswouldhaveprocessedearlyclaimsandhencewouldhave
scrutinizedstringently.However,letusreadtoomuchintothis.
Simplybecauseitisclearenough(evenwithoutthisdata)thattheprivatesarelikelytoscrutinize
claimstougherthanLIC.
Thiscanalsobeseenby

1)comparingbenefitamountperclaimpaidwithbenefitamountperclaimintimated.Theseare
comparableforLIC.Fortheprivates,thebenefitamountperclaimpaidisalwayslowerthanthe
benefitamountperclaimintimated.
2)Privateshavemoreclaimspendingattheendoftheyearthanthestartoftheyear(notshown).
TheconverseisobservedforLIC.
Thenumberofpendingclaimsatthestartoftheyeardecreasedfrom9574in200607claimsto8856
claimsin201213forLIC.Whileitnearlydoubledfortheprivates,primarilybecausethenumberof
suchlifeinsurershaveincreased.
Noticethattheamountperclaimpendingatthestartoftheyearhasdoubledforprivates,from
200607to201213,eventhoughthedenominator(numberofclaims)hasnearlydoubled(from1894
to3467in201213).
Whenthedenominatordoubles,theratiocandoubleonlyifthenumerator(benefitamount)
quadruples!
ThisimpliesthattheprivatesarehandlingmuchhigherclaimamountsthanLIC(notmuchofa
finding!).Onecouldarguethatthisisthereason,theirCSRislower.
Evenifyoudontwishtomakemuchoftheseratios,Ihopethatyouagreewithmycontentionthatif
theclaimamountisbig(asinaterminsurancepolicy),LICtoowouldscrutiniseitcarefully.Simply
becausesuchanamountwouldbehighertheaverageclaimamountstheyprocess.

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

Itwilltakeyoulessthan30minutestoaccesstheIRDAreports,locatetheIndividualdeathclaims
tableandscanthenecessarynumbers.
Onceyoucanshortlist23insurers,comparethepriceforapolicy(withoutloading,butinclusiveof
servicetax)usingthepremiumcalculatoravailableattheirwebsites.
Choosethecheaperamongthetwo.
Applyimmediately.Donotaskanyoneelseforanopinion.

5.HowtoBuyaHealthInsurancePolicy
Itisfrustratingtoseeindividualshavingdifficultyinchoosinginsurancepoliciesbeitlife,healthor
accidentinsurance.Theirmindsareclutteredwithsomanyproductfeatures(somenecessaryand
othersnotso)thattheykeepdelayingthepurchase.
Hereisastepbystepguidetopurchasingahealthinsurancepolicy.Iamnoexpertonthesubject.I
amwritingthispartlyfromexperience(3claims+handlingmultiplehospitalizations)andpartlyfrom
onlineinformationaccruedoverthelastfewyears.
Iwroteaversionofthispostsomemonthsback,butdidnotfeelenthusedtopost.AfterJignesh
AcharyasuggestedIwriteaboutthisin,facebookAsanIdeasforWealth(AIFW),Iwouldliketogiveit
anothershot.
Firstletusdecideonthetypeofproduct.

Floaterorindividualplans?
Chooseindividualplansforallmembersifyoucanaffordit.Eachpersonsriskprofileisdifferentand
therecouldbemultiplehospitalizationsinayear.Mostinsurersfixthepremiumbasedontheoldest
personinthegroup.Steerclearofthisandgetindividualplans.
Forseniorcitizensindividualplanismandatory.Getthesameforyoungermembersifyoucanafford
it,afteralltherearetaxbenefits!
Nowletusask,

Whataretheessentialfeaturesofanidealhealthinsurance
policy?
1)NosublimitsonroomrentandICU.
Sublimitscanbeapainiftheroomrentisquitesteep(typicallyinNorthIndiaandnotinSouth
IndiaaslearntatAIFW).IftheroomrentevenforanonACsingleroomisquitehigh(arelative
notion),havingnosublimitsiscrucial.
Everythinginlifeisatradeoff.Nosublimitsimpliesahigherpremium.

Iftheroomrentsarenominal(severalhospitalsinChennai),Iwouldrecommendapolicywith
sublimits,typicallysoldbyPSUcompaniesUnitedIndia,NewIndiaandOrientalInsuranceCos.
Getapolicyforasuminsuredashighaspossibleinitially,andbesuretoincreasethesuminsuredas
muchaspossibleeachyearuponrenewal.Ihavebeendoingthisforthepast9years.Ihave
individualcoverforself,wife,sonandmotherfromUnitedIndia.
2)Noincreaseinpremiumifaclaimismade(akaloading).
ThankfullyIRDAhasmandatedthatthereshouldbenoclaimbasedloading.Seepage83(last
line)
here

(NikhilVermasharedthisatAIFW)

Theloadingonrenewalsshallbeintermsofincreaseordecreaseofpremiumsofferedforthe
entireportfolioandshallnotbebasedonanyindividualclaimexperience.
AccordingtoNikhil,portfolioherereferstotheentireclientbase.Twoindividualsofthesameage
cannothavedifferentpremiumsbasedontheirclaimexperience.
Tradeoff:Higherpremiumfromthestart!
PleasecitetheIRDArulingandconfirmwiththeinsurer,NOTtheagent.
NikhilVermasharedthefollowingpolicywordingsofL&Tinsurance
BasedontheexperienceoftheProduct,Premium,TermsandConditionsmayberevisedsubjectto
priorapprovalofInsuranceRegulatoryandDevelopmentAuthority.Suchrevisionshallbeintimatedto
you3monthsinadvancewithanoptionofrenewalunderanysimilarPolicybeingissuedbyus.
However,benefitspayableshallbesubjecttothetermscontainedinsuchother
Policy.IndividualClaimsexperienceloadingisnotapplicableunderthePolicy.

ICICILombardalsohasasimilarpolicyasconfirmedbyNikhil.
3)NoCopayment
Theinsurershouldnotshiftpartoftheclaimexpensestothepolicyholderbyprearrangement.
Sincenocopaymentimplieshigherpremium,itmightbeokaytoacceptcopaymentinthecaseof
veryseniorcitizens.
4)Minimumexclusionperiodforpreexistingdiseases

TheminimumtenurethatIhaveheardofis2years.Themaximumis4years.
Thisisimportantforeveryone,eventhosewhodonothaveanydiseasesatthestartofthepolicy.If
adiseaseisdiagnosedsay,after6policyyears,theadditionalsuminsured(ifany)willbeeligible
onlyaftertheexclusionperiod.
Tradeoff:againprice!
5)Lifelongrenewability
IRDAhasmandatedthatallinsurersshouldprovidelifelongrenewability(seepages78bottom
paraandpage79firstparaintheaboveattachment)
Sothisisnotanissue.Besttoconfirmwiththeinsurerthough.
6)MinimalExclusions
Againobviousbutdifficulttocompareoneinsurerwithanother.Readtheexclusionslistafter
makingashortlistandcheckifanyhereditaryorexistingconditionisexcluded.
Tradeoff:probablyagainprice.
~~~~~~~~~~~~~~~~~
Inmyopinion,ifapolicyissatisfactoryintheabovesixareas,itwillmakemyshortlist.
Nowthatwehavecoveredthecoreofthepolicy,letuslookatthewindowdressing.

WindowDressing
Insurersrewardpolicyholdersifnoclaimarisesbyeitherofferingadiscountonthepremiumorby
increasingthesuminsured.
Noclaimbonus:
Ifthesuminsuredincreaseseachyearby5%foreveryclaimfreeyear,itwillalsodecreasebythe
sameamountwhena
claimismade.Seepage80ofaboveattachment.Pleaseconfirmwiththetheinsurer.
Thepremiumwilltypicallyincreaseupto50%ofthesuminsuredandnofurther.

Noclaimdiscount:
Foreachclaimfreeyear,thereisadiscountinthepremiumwhenthepolicyisrenewed.
Whichisbetter?
Ipreferthenoclaimdiscount.Itissimpler.Ihaveseenmanypeoplewhodonotincreasethesum
insuredeachyearandrelyonlyonthebonusfromclaimfreeyears.
Itdoesnotmatterwhichyouchooseaslongasyouincreasethesuminsuredbyasmuchaspossible
eachyear.
RestoreBenefit
Whatabouttherestorebenefitthataninsureroffers?
Readthefineprintandwritedownatypicalsituationinwhichtherestorebenefitwillbeuseful.If
youthinkitisuseful,shellouttheextrapremium.Idontthinkmuchofitthough.
MaternityBenefit
Neverbuyapolicybecausepregnancyiscovered.Dumb!Payforhappy(Godwilling)nonrecurring
visitstothehospital.Rememberthetradeoffmentionedabove.
OutpatientCover,DentalCover,Spectaclesandothergoodies
Readthefineprint.Areyouwillingtochangedoctorsthatyouknewforagesjusttogetthisbenefit?

Sonowhowdoweshortlistpolicies?
1.
Checkouthospitalsnearyourneighbourhoodforroomrentratesandiftheyacceptcashless.This
willhelpyoudecidewhetheryouneedapolicywithnosublimitsornot.Whethertheyaccept
cashlessornot,startmobilizingfundsforamedicalemergencycorpus.Neverforgetthatcashlessisa
privilegethatneednotbegranted.
2.
Decideonyourbudgetandonwhetheryouaregoingtochooseafloaterpolicyorindividualpolicy.
Youcanusethepremiumcalculatorofanyinsurertogetanidea.
3.
Sublimitsandbudgetshouldhelpfilteroutmanypolicies.

4.

Chooseyourpoison.

IpreferPSUs.Nologicbehindthat.Justadeeprootedmistrustofprivates,
regulatorornoregulator.
Ifyoulikeprivates,findoutwhoownsthecompanyandhowoldtheyare.Isuggestchoosingaplayer
whoisatleast10yearsold.
5.
Afewyearsbackpolicycomparisonportalswereuserfriendly.Nowadaystheyareannoyingtouse
andsomedonotlistcertainpolicies.Bettertostayaway.
6.

Howaboutbuyingviaanintermediarylikemedimanage?IfIwanttobuyfruit,Iwouldliketopick
andchoosethefruitsIneed.Iwillnotleavethechoicetothefruitseller.
Whatabouttheirhelpduringclaimprocessing?
Overrated.Rulesaresimpleandlaidoutclearly.IfIdontorwontreadrules,Idontdeserve
insurance.
7.

Onceyousingleout23insurers,readtheirpolicydocumentsandcomparefeaturestosingleout
yourfutureinsurer.
8.
Nowyouwillneedtotakeacall.Insurancebuyingisallabouttakingarisk.Itishoweveramuch
lowerriskthannothavinganyinsurance.Youneedconfidencetochooseaninsurer.
9.
Neveraskothersabouttheirclaimexperienceoraskwhichisthebestpolicytobuy.Thatisa
onewaytickettodespair.
Allthisshouldbedoneoveroneweekend,withinabout23hours.Thelongerittakes,themore
confusingitbecomes.

6.SayNOtoPackagedFinancialProducts
Wealllikesolvedproblems.Rightfromschool,whenfacedwithaquestion,manyoftendtosearch
foranexampleproblem,sothatweknowhowtoproceed.Whenitcomestopersonalfinance,
solvedproblemsorreadymadefinancialproductspackagedforaspecificneedcanbedisastrous.
Someexamplesarethe
pensionplan
and
childplan
offeredbyinsurersandmutualfundhouses.
NowCafemutual
report
s
thatmanymoreretirementlinkedmutualfundsareontheanvil.During
thePPFASunitholdersmeet,RajeevThakkarmentionedthatsuchplansmightreplaceELSSSmutual
funds.
Ifthathappens,usesuchplansonly
until
youneedtaxbreaks(Iamassumingthatreturnsfromsuch
fundswouldbeatPPFaftertax).Chooseonewiththelowestexpenseratiosincesomeofthese
fundscouldhaveaninsurancecomponentlinkedtothem.Sobesttochooseonewithoutaddons.
Wanttohearadumbquote?(fromaboveCafemutuallink)
Sharingtherationalebehindofferinganinsurancecoverwiththeretirementplan,(Dinesh)Khara(CEO
SBImutual)toldCafemutualthatitwillhelpinvestorstosaveforretirementalongwithprotectingtheir
life.Wewanttoprovideonestopsolutionthroughourretirementplan.Wehaveobservedthatmany
investorswanttosaveforretirementbutduetootherpreferenceslikelifeinsurancetheydelay
investingfortheretirement.
Duh!Mostpeopledontdelayinvestingforretirement.Theyjusttaketheeasyrouteandbuydud
pensionplansofferedbyinsurers(inclSBIlife!).
Butwhy?Whyshouldonesaynotopackagedfinancialproducts?
Thefirststeprequiredisachangeinmindset

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

Nextaskthefollowingquestion:
WhatistheposttaxreturnIamlikelytogetfromthesepensionplans?FortheamountthatIcan
investeachmonthforretirement,isthatreturnenoughtogetmealargeenoughcorpus.Large

enoughcorpusheremeans,largeenoughtogenerateanincomethatcanbeincreasedatarateequal
totheprevailinginflation.
Noneofthepensionplansofferedbyinsurerscandothis.Dontexpectthemutualfundplanstobe
verydifferent.
Inanycase,youcannotcreatewealth(haveenoughforretirementplusalittleextra)withany
pensionplan.SEBIwillmostlikelylimittheexposureinthesefundsandmyguessisthattheywould
resembledebtorientedbalancedfunds.Dontthinkthegainswouldbetaxfreeliketheinsurance
product.Ithinktheyshouldbetaxedlikedebtfunds(goodnewsformeasmymandatoryNPScould
alsobetreatedsimilarly).
Apackageproductsoldasatailormadesolutionislikelytohavealockinandexitload.
Thequestiontoaskis,whybuysomethingofftheshelfwhenyoumakeabetterproductonyour
own.Subrahasawonderfulnameforit:
theretirementbasket
.
Puttogetheranaggressivebasketthatisfilledwithaproductiveandliquidasset:equity.Youcan
usethecorpuswhenyouwant(earlyretirementoradireneed),andhowyouwant:generatean
inflationproofincomewithpartofit,whiletherestgrowsatadecentpace.
Thesameargumentsliquidityandflexibilityworkforlongtermgoalslikeourchildrens
education.Somepeopleinvestinplansinwhichthemoneyislockedinuntilthechildis18,
forgettingthattheirchildmightgraduatefromschoolatage17!
This
BuyNothingDay
*
,resolvetostayawayfromallpackagedfinancialproductsforever.

7.RetirementPlanningASlideShow
1.Imaginehowyourmonthlyincomewillevolveinthefuture

Theabruptstoppageinincomerepresentsretirement.

2.Nowimaginehowyourmonthlyexpenseswillevolveinthefuture

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

Inabout15yearsafterretirement,themonthlyexpenses,thankstoinflationishigherthelastdrawn
pay!

Meaning,ifIhadan(imaginary)monthlypensionthatequalsmylastdrawnpay,Iwillonlybe
financiallyindependentforabout15yearsafterretirement.Soweneedtodoalotbetter!

Thesadtruthisactualpensions(beitfromapensionplanoremployerprovidedannuity)aremuch,
muchlowerthanthelastdrawnpay.Somethinglikethis.

Therefore,foryourownsake,eradicatetheconceptofapensionfromyourminds.
Instead,think:

Inflationprotectedincome

(bluedotwithintheredcircles,below)


Togeneratethisinflationprotectedincome,youneedacorpusthatisabout300timesyourcurrent
annualexpenseorabout3538timesyourannualexpensesatthetimeofretirement(theearliest
greendot).Asyouwithdrawmoreandmorefromthecorpus,itdecreasesanddropstozero
hopefullywhenyoudie,andonlywhenyoudie.Ensuringthis,isthe
thirdstage
inretirement
planning.
Thesecondstageistoensureourinvestmentsgrowandhitsthefirstgreendot,whenweretire.


Weneedtodotwothingstogrowthecorpus.1.Chooseaproductive,butdiversifiedportfolio;2.
Invest

Onecannotchoosetoinvestaconstantsumbecause,themonthlyinvestmenttobemade
immediatelywillbemuchlargerthanmonthlyexpenses.Theabovegraphhasalogarithmic
y
axis
andhencethelinesappearlinear.

Toeaseourburden,wecaninsteadchoosetoincreaseoutinvestmenteachyearfromnowuntil
retirement.

Thiswouldimplywemuststrivetoinvestasmuchasspend.

Thisiseasiersaidthandone.Letushavealookatthesecondgraphagain

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

Ourexpensestendtogrowinstepsasshowningreenabove.Callitlifestylecreepifyoulike.Ifwe
embraceeverynewtechnologythatarrives,ifwecannotdistinguishbetweenourneedsandwants,
ifwesuccumbtopeerpressureandbuywhatothersbuy,wewillneverbeabletoinvestenough.

Meaning,wearesowingtheseedsforourfuturefinancialdoomtoday.
Lifestylecreep,thedesiretospendsfortodayandenjoywhenyoung,residesinallofus.Whatis
neededisadefiniteboundary:Wecanspendtheway,wewishaslongaswecanmanagetoinvestas
muchaswecanspend.
Safeguardingthatboundaryisthefirstandforemoststepofretirementplanning.

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

WhydoIneedsuchahugecorpusforretirement?
Howdoyouexpectmetoinvestthishighanamounteachmonth?

Hereishowretirementcalculatorsgoaboutcalculatingthecorpusandmonthlyinvestmentrequired.
Foreaseofunderstanding,Iwillconsiderthecaseofa55yearoldman,5yearsawayfrom
retirement.YoucaninputdesiredvaluesintheattachedExcelsheet.
Soheregoes,
Name:
CaptainHaddock
Age:
55
Yearstoretirement:
5(age60)
th
Yearinretirement:
5(Hedoesnotexpecttoseehis65
birthday,thankstoalivelongassociation
withthebottle!)

Currentannualexpenses:
Rs.5,00,000
Inflation:
10%
Netposttaxrateofreturn
fromtheCaptainsportfolio(equity+debt):10%
Annualincreaseinmonthlyinvestment:
10%


st
Expensesinthe1
yearofretirement:

Age60
Expenses:
E
=Rs.8,05,255
1
Letustreatthisasanindependentgoal.
CaptainHaddockmustinvestanamount
X
soastohaveRs.8,05,255after5yearswithareturnof
1
10%andmonthlyinvestmentsincreasingeachyearby10%.
X
=Rs.8,333(seeimage;ignorerightmostcolumn)
1
Expensesinthe2ndyearofretirement:
Age61
Expenses:
E
=Rs.8,85,781
2
Treatingthisagainasanindependentgoal,wedeterminetheamountofinvestmentrequired,
X

2
(10%return,monthlyinvestmentincreasingeachyearby10%)7
X
=Rs.9,167(seeimage;ignorerightmostcolumn)
2
Similarly,
E
=9,74,359and
X
=10,083(expensesfor3rdyearinretirement)
3
3
E
=10,71,794and
X
=11,092(expensesfor4thyearinretirement)
4
4

E
=11,78,974and
X
=12,201(expensesfor5thyearinretirement)
5
5
Thetotal
initial
monthlyinvestmentrequiredis,
X
+X
+X
+X
+X
=50,876(seeimage;tworedrectangles)
1
2
3
4
5
Thisinvestmentisassumedtoincreaseeachyearby10%.
Thetotalcorpusrequiresis,
E
+E
+E
+E
+E
=49,16,162(seeimage;twobluerectangle)
1
2
3
4
5
Thisisthecorpusrequired
if

isnotinvestedanywhere.
Thusintheabovescenario,eachyearinretirementistreatedasanindependentgoal.
Obviously,wecandobetterthanthis.
Thecorpusisinvestedsothatitearnsa
netposttaxreturn
of10%(forthesakeofillustration!),and
atthestartofeachyearinretirement,asumequaltotheexpectedmonthlyexpensesisredeemed.
Therestofthecorpusisallowedtogrow.
Forexample,atthestartofthefirstyear,asum,
E
=Rs.8,05,255isredeemed.Atthestartofthe
1
secondyear,asum,
E
=Rs.8,85,781isredeemedandsoon.
2
th
Attheendofthe5
yearinretirement(thedurationassumedintheexample),thecorpusisreduced
tozero(blackrectangleintheimage).

Usingtheseassumptions,thecorpusrequiredis
backcalculated
tobeRs.40,26,275(orangerectangle
intheimage).
Noticethatthecorpus
Hasreducedfrom49,16,162to40,26,275.ObviouslybecauseCaptainHaddocknowchoosetoinvest
thecorpus!

9.Generatinganinflationprotectedincomewitha
lumpsum
Givenalumpsum,howdoweinvestitinordertocreateareliableincomestreamthatisriskfree
andhastheabilitytokeeppacewithinflation?
Thisisthemostcrucialquestionthatconcernseverypersonwhoisretired,nearingretirement,or
planningforsomeoneelsesretirement(aclientoraparentperhaps).Well,atleastitoughttobe!
Theanswerconcerns
everyone
sinceweallhavetoanswerthisquestionatsomepointinourlife.
ThispostisanoffshootofadiscussionwithVigneshBhaskarinAsanIdeasforWealth,FBgroup.Not
muchinformationisavailableoninflationproofpostretirementinvestmentstrategiesforthe
Indianscenario.Letustryanddiscussthisherefromtimetotime.
Mostquestionshavemorethanonesolution.Thisisnodifferent.Therearemanywaysofcreatinga
reliableinflationprotectedincomestream.Inthispost,Iwilldiscussonlyonesuchway.
Thebestwaytodothisisviaanillustration.
LetussaythatIamaretiree,aged60,withRs.30,000monthlyexpenses(involvingonlytheretiree
anddependents)orRs.3,60,000peryear.Perhapsatouchonthelowerside.
Imakethefollowingassumptions

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

Nowwewillneedto
calculatethecorpusrequired
IhaveassumedthatIpayaflat10%taxonallinvestmentsthroughoutmylifetime.Thisisindeedan
oversimplification.Unfortunately,wewillneedtousethis,asitwillbeconfusingtoconsiderother
possibilities.

Aposttaxreturnof8%mayseemabitunrealistic.However,ifaretireeinthe10%taxslaboptsfor
fixeddepositsoffering9%forseniorcitizens(currentrates),theposttaxreturnisabout8%.
Usingthe
annuitycalculator
,wedeterminethecorpusrequired
Inputs
Payoutrequiredinthefirstyearofretirement:Rs.3,60,000
Inflation:8%
Posttaxreturn:8%
Duration:25years
Output
Corpusrequired:
Rs.90,00000orRs.90Lakhs
IfIhaveanamountclosetothisorhigherthanthis,Icanrelax.
WhatifIhaveacorpuslessthan90Lakhs?WhatshouldIdo?
Inordertoanswerthisandthequestionposedintheopeningsentence,letusfirsttryto
understand
whyIneedRs.90Lakhs
giventheotherinputs.
IfIdividethis90Lakhsinto25parts,eachpartisequalto3.6Lakhs.ThisisjusttheamountIneedfor
meetingmyexpensesinthefirstyearofretirement.

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


HereisanillustrationwhichexplainswhyIneed90L

SupposeIdonothave90L.CanIworkwithalowercorpusandyetmangetogenerateinflation
protectedincome?
Toacertainextent,itispossible.Ofcourse,asmustbeobvious,onewillneedtogenerateahigher
rateofreturn.Thisimpliestakingonsomeriskwithapartofthecorpus.

Inordertounderstandthis,wewillneedtodiscussaboutthesocalled
bucketstrategy
Thebestwaytodothatistousetheabovenumbers.
Insteadofopening24FDs,Icanachievethesameresultinadifferent.

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

Iinvest18LinanFDthatmaturesin5years.Letuscallthis
bucketI
Iinvest18LinanFDthatmaturesin10years.Letuscallthis
bucketII
Iinvest18LinanFDthatmaturesin15years.Letuscallthis
bucketIII
Iinvest18LinanFDthatmaturesin20years.Letuscallthis
bucketIV

BucketI
willmatureto26.44L.Ithensplitthisupinto5parts,keeponeformanaging
th
expensesinthe6
yearofretirementandusetheremainingpartsformanagingexpensesin
years7to10byincomeladdering.
Similarly,
bucketII
willmatureto38.86L.Ithensplitthisupinto5parts,keeponefor
th
managingexpensesinthe11
yearofretirementandusetheremainingpartsformanaging
expensesinyears12to15byincomeladdering.

andsoon.

Hereisanillustration


Inessence,insteadofcreatinganincomeladderfor25years,asmentionedinfirstscenario,we
createanincomeladderforthefirst5years,lettherestofthecorpuscompoundin
fourbuckets
,and
createnewincomeladdereveryfiveyears.

Ihaveassumedthatallthebucketscompoundwiththerateofreturn(8%).Sothereisnodifference
betweenthefirstandsecondscenarios.Ineffectthetotal
corpusneededisthesame
.
Whatif,someofthebucketscompoundedwithahigherrateofreturn?
CanIthennotreducethetotalcorpusrequired?
Yes,thisisindeedpossible.Hereisalistofdifferentreturnscenarios.ThankstoCaptainAshok
KumarAnandforpointingoutanerrorinthistable.Ithasnowbeencorrected.

Noticethatthereturnsassociatedwithdifferentbucketshavebeenvaried.Thefirstscenario,of
coursecorrespondstotheonedetailedabove.
Noticethatasyouincreasethereturnindifferentbuckets,preferablytheoneswhichyouwillneed
10,15and20yearslater,thecorpusrequiredcomesdownquitesharplyfrom90Lto67.5L

HowcanIgoaboutachievingthis?
Herearesomeexamples
Lowrisk
Bucket1(5Yduration):FDs
Bucket2(10Y):Debtincomefunds
Bucket3(15Y):Balancedfunds(25%equity)
Bucket4(20Y):Balancedfunds(65%equity)
Mediumrisk
Bucket1(5Yduration):FDs
Bucket2(10Y):FDs
Bucket3(15Y):Balancedfunds(65%equity)
Bucket4(20Y):Diversifiedequity
Highrisk
Bucket1(5Yduration):FDs
Bucket2(10Y):Debtincomefunds
Bucket3(15Y):Diversifiedequity
Bucket4(20Y):Diversifiedequity
Howtodecidewhattodo?

Thisisatoughquestion!

IfIhave90L+Icanaffordtochoosethe
norisk
option(allbucketsinFDs)
IfIhave~80LIwillneedtotakesomeriskandinvestbuckets3and4inhighreturn,
taxefficientinstruments

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

10.AStepByStepGuidetoLongTermGoalBased
InvestingPartI
Hereisastepbysteptoguide,pluscalculator,tobeginandtracklongtermgoalbasedinvesting.
Thecalculatorwillperformthestepsdetailedbelow.Thesestepsareapplicableforall
goals
except
retirement.
1. Identifythegoal,itstimeframeandfindoutasaccuratelyaspossiblehowmuchitwillcost
today(i.e.whenyoustartinvesting).
Ballparkestimatescanbedreadfullywrong.Ifyouaresavingforyourchildseducation,seek
outaparentwhosechildisstudyingadecentdegree(UG+PG)inadecentcollegeandget
the
entire
feedetail.
2. Assumeareasonableinflationrate(
not
thehistoricalaverage).Thehigherthesafer.
3. Using1and2,determinehowmuchthegoalwouldcostatthetimeofneed.
4. Determinehowmuchyou
can
investaftertakingintoaccount:expenses,loans,investment
towardsretirement(
always
theno.1goal).
5. Estimatehowmuchthisinvestmentamountwillincrease(ordecrease!)infuture.Ifaftera
loanpayout,youcaninvestmore,takethisintoaccount.
6. Youcannowdeterminethe
average
rateofreturnrequired.Averageherereferstothe
weightedaverageofreturnsfromequityanddebtinstruments.Theequityanddebtreturns
themselvesrepresenttheexpectedcompoundedannualizedgrowthrate(CAGR:ageometric
average)
7. Dependingonthetimeframedecidethedebtinstrument.Ifyourgoalsif15financialyearsor
moreawaythenPPFisagoodtaxfreeinvestment.Youcouldalsochooseadebtfundlikean
incomefund.Estimatetheposttaxreturn(sayapprox.8%forPPFand6%foradebtfund).
8. Decideonappropriateequityexposure.ThisishowIwoulddoit.
o Forgoals15ormoreyearsaway:5070%
o Forgoals10ormore:about4050%
o Forgoals7yearsaway2030%
Thisisnotjustbasedonmyriskappetite.Itisbasedon
history
.
9. From6,7and8thereturnedfromequity
needed
canbeestimated.
o Anythingmorethan12%irrespectiveoftimeperiodisrisky.Unlessyouhaveagood
understandingofthemarketsuchreturnsitisbestnottoassumesuchhighreturns.
o 12%onlyfortimeperiodswellabove10years.
o Anythinglessthan10yearsexpectsomethinglike910%
10. Iftheequityreturnistoosmallandiftheinflationrateassumedisreasonableyoucanafford
todecreasethemonthlyinvestment.Ifequityreturnisanythingmorethan12%,itisbestto

11.

12.
13.

14.
15.

lowerit,irrespectiveofdurationandperhapsexpertise.Inthiscasetheinvestmenthastobe
increasedasmuchaspossible.
o Initialmonthlyinvestmentcouldbeincreasedand/or
o %bywhichinvestmentwillincreaseannually(fromyear2)canbeincreasedand/or
o Additionalinvestmentafewyearsdownthelinecanbeconsidered.
Ifyouhaveincreasedthemonthlyinvestmentasmuchasyoucanandstillfindtheequity
returnsstillunreasonablyhigh,then
o Considerpostponingthegoalifpossible
o Ifpostponementisnotpossiblethenthegoalcanonlybemetpartially
Ifgoalcanonlybepartiallymetestimate,withareasonableequityreturn,thecorpusthat
canbeobtained.Theshortfallwillhavetobemetwithexternalfunding.
Finallyyouarereadytostartinvesting!Spendnomorethanaweekstimetogetgoing.
Anythingmorewillimpactcompounding.Ifyouaresomeonewhocannotusecommonsense
unaidedthendoconsiderjoiningatutorial(likethe100moneyactionsbyJagoinvestor!)
Soyouareonyourway.Patyourselfonthebackandensuretheinvestingprocessis
automatedifyouareindisciplined(thatisstartaSIP).
Youcanaffordtorelaxforaboutayear.Attheendofeachyearthereturnshaveto
monitored,theportfoliorebalanced(ifnecessary)and
mostcruciallysteps112havetobe
repeated
(includingthepatontheback!).
o Whatisrebalancing?Whydoit?Whatarethedifferentwaysofdoingit?Whichis
preferredwhen?Thisisapostinitself(muchmore).Willwriteaboutthisinpart2.
o Assumereasonableratesofreturnforequityanddebt.The
sooner
youstart
the
lower
yourreturnexpectationfromequity.Themoreyoucaninvestthelower
yourreturnexpectationfromequity.
o Statutorywarning:Garbagein,garbageout!

11.LongTermGoalBasedInvestingPartII
Thisisasequeltothe
stepbystepguidetolongtermgoalbasedinvesting

andismeantforthose
whohavestartedinvestingfortheirlongtermgoalsafter,
1. understandinghowmuchtoinvest
2. understandinghowmuchtoexpectfromeachassetclassused
3. decidingonanassetallocation(howmuchinequity,howmuchindebtetc.)
Ifyouarenotclearabouttheabove,Isuggestyoustartwith
PartI

first,makenecessarychangeswith
theattachedcalculatorandthenreadthis:
Longtermgoalscanbedividedintotwocategories:

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

Thisdistinctioniscrucialbecause,forsomeonewhohasstartedinvestingearlyforretirement(and
typicallyonlyforsuchpeople),thereis
noneedtosignificantlyreduceequityallocation
as
retirementapproaches(see

bucketstrategy

tolearnmore)
Forexample,someonewhousesanequity(60):debt(40)allocationcancontinuetousethesame
allocationallthroughtheirlife(managedeitherbythemselvesorbyatrustedprofessional).
Thesameisnottrueforallotherlongtermgoals.Asthegoalapproaches,theequityallocationmust
bereducedtozero.
Unfortunately,thereisnosetformulatodothis.Youcanfindanswerslike,wait3yearsbeforeyou
needthemoneyandpulloutcompletelyorsetupanSTPtoadebtfundamongothervariations.
Ithinksuchsetmethodscanbedangerous.Whatifthemarkettanks5yearsbeforeyouneedthe
moneyandyouarein6070%equity?Whatifittankstomorrow?
IthinkallcategoryBgoalsneedactivemanagementwrtassetallocation.HereIamnotreferringto
tacticalassetallocation,whereonechangesequityallocationsignificantlydependingonmarket
conditions.

WhileIaminterestedintacticalassetallocationstrategies(hencethe
marketvaluationcalculators!
),
IwouldthinktwicebeforeemployingitforcategoryBlongtermgoals.
Ithinkthisisagreyareaandtheinvestormustfirstidentifysomebenchmarksanddevelopa
techniquethatwouldsuitthem.Likemanyproblemsinlifeandinpersonalfinance,therearemany
solutionstotheproblem.
SoIwouldliketosharewithyouwhatIamdoing,andwhatIintendtodoformysonseducationgoal
inthehopethatitwouldserveassomefoodforthoughtforyou.Kindlydonotconfusemy
convictionwithexpertise.
Mysonisnearly5yearsold.Istartedinvestingforhiseducationgoalabout23monthsbeforehewas
born.IusePPF(inhisname)(40%)+mutualfunds(inmyname)forthegoal(60%).Ifyouare
interestedinknowingmoreaboutplanningforthisgoal,see:
Howtoplanforyourchildseducation
andmarriage
Whenhejoinedschool,Irealisedthathewouldturn18about3monthsbeforehis12thstandard
boardexam.
SowhenIstartedIhadabout1718yearsforthegoalalongtermgoalbyanyyardstick.
Ihadneverrebalancedtheassetallocationandsimplyletitgrowupuntiltheelectionsthisyear.
When
IndiaVIX:thestockmarketvolatilityindex

rosesharplyjustbeforetheelections,Irealised
howskewedmyassetallocationhadbecome(80%equity).SoIshiftedabigchunkintoPPF.
ThankfullythePPFlimitwasenhancedsoonsothatdidnotaffectmyinvestmentallocationtoo
much.
Regretisthenumberoneenemyforgoalbasedinvesting.Sothereispointingthinkingabout,
what
ifIhadnotrebalanced?Iwouldhavehadabiggercorpustoday
.
Thankfully,Iamnotworriedaboutthatatall.Isafeguardedmysonseducationcorpus
and
therefore
myretirementcorpus.
Evenafterrebalancing,IstillhaveenoughtoaffordaBE/BTechinathirdtierengineeringcollege
(lowerthetier,higherthefee!!)
today.
Mybenchmarkforthisgoalis,
whatdegreecanIafford
today?
CAGRistertiary.

Todaythegoalisonlyabout13yearsaway.Thatis,longtermgoalsdonotremainlongtermgoals
forever.Soonitwouldbe8yearsoldandsoon.
Theriskprofileofa17yeargoalisdifferentfroma13yeargoal,whichisdifferentfroma8yeargoal.
MeaningIintendtogetconservativewrtmyequityholdingwithtime.
Oncethegoalbecomeslessthan10yearsaway,Iintendtoreduceequityexposurefrom60%to50%
andthento40%.SincethenextLokSabhaelectionwouldnearlycoincidewiththis,howthemarkets
behaveinthebuilduptotheelectionwilldecidetheequityallocation.
ThismeansIwillhavetoaddadebtmutualfundtotheportfolio.Ipreferoneswithlowaverage
portfoliomaturityperiodandlowmodifiedduration.Learnmoreaboutthis:
HowtoSelectDebt
MutualFundsSuitableForYourFinancialGoals?
Oncethegoalbecomes5yearsorlessaway,Ihopetoreduceequityallocationtoabout2025%or
so.Ihopebythistime,thetotaldebtcorpusshouldbeenoughtopayforinitialcollegerelated
expensesandperhapseventheentireUGdegree.
Thecorpusforchildseducationgoaldoesnotgetspentinaninstant(unliketheir
marriagegoal!
).It
takesabout34yearstogetaUGdegreeandacoupleofmoretogetaPGdegree.Infactsome
readersprefertousea
staggeredgoalcalculator
toexplicitlytakethisintoaccount.
Soitisokaytohaveasmallequityexposureevenbythetimethechildenterscollege!
Whatmattersmosttomeis
howmuchIinvestforthisgoal
and
howmuchIincreaseinvestmentseach
yearforthisgoal
Itrackbothwiththis
monthlytracker
.
WhereIinvestwillchangeasafunctionoftimeasmentionedabove.
AsIwritethis,Inoticethattheassetallocationisskewedonceagain,thankstothecontinuationof
therallyaftertheelections.NowIamintwominds.Onepartofmesays,
rebalancenow
,andanother
partsays,
waitfortheratecut,thatwayyoucaninvestanotherbigchunkinPPF,perhapsinApril
.
Suchconflictsarepartandparcelofthegoalplanningprocessandisquitehealthy.Theanswerlies
inintrospection.
ShouldIpostinFacebookgroupAsanIdeasforWealthtogetananswertothisdilemma?Hellno!I
simplycannotconveythesituationandlogisticsinvolved,bothofwhichareextremelypersonal.I
willendup1015differentpossibilitiesandmoreconfusedthanIstartedwith.Iambetteroff
thinkingthisoneout,takeacallandnotlookbackeitherinrelieforregret.

Whataboutprofessionalhelp?Hellno!Iamacontrolfreak.Iwouldlikethingsdoneinacertainway
andwilldrivethefinancialplannercrazy!
Well,whatdoyouknow!AsIwrotethis,Ihavedecided:
Areyouaskinganeither/orquestionaboutpersonalfinance?Trychangingitintoanandquestion.
Thesolutionwillpresentitself.Ithas,tome.IwillrebalanceabitnowandbitinApril.Peacereigns
intheGaulishvillage.fornow.
AtFBgroupAsanIdeasofWealththereisasaying:MyDullandBoringSipswillcontinue*.Hopefully
thispostclarifieswhatthe*standsfor!

12.Howtoselectmutualfundcategoriessuitable
foryourfinancialgoals?
Youmightbewonderingwhythetitlereferstomutualfundcategories.Woulditnotbemore
enticingandperhapsmoreusefulhaditread,howtoselectmutualfundssuitableforyourfinancial
goals?
Perhapsso.However,Ichoosetofocusonhowtoselectmutualfundcategoriesfirst,fortwo
reasons

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

Mutualfundreturns,andassociatedvolatility(fluctuatingreturns)canbeevaluatedinanumberof
ways.Troubleisveryfewamongustakethetroubletounderstandthesealthough
theycouldbe
understoodquiteeasily
.
WhenImadea
stepbysteptoselectamutualfund
,Iused5oftheseriskreturnparameters.Iam
delightedtonotethatmanyinvestors,withanearzeroexperienceinmutualfundinvesting,have
startedusingtheseparametersinchoosingmutualfunds.
Inthispost,letusdiscusshowtoselectasuitablemutualfundcategoryusingjustone
parameter:
thestandarddeviation
.
Inordertounderstandwhatstandarddeviationis,Iwillborrowthis
wonderfulanalogy
bySubra.
Youaregivetwosetsofnumbers:

RunsscoredbyVirendraShewaginhislast25tests.
AsimilarsetforRahulDravid

Weallknowhowtodeterminetheaverage:addupallthescoresanddividebythenumberofsuch
scores.

Oncewegettheaverage,weimmediatelyrecognisethatsomescoresarehigherthantheaverage
andsomelowerthantheaverage.
Nowifwewishtoknow,betweenDravidandShewag,whosescores
deviate

more
fromtheaverage,
wewillneedtocalculatethedeviationofeachscorewrttheaverageandtakethe
averageofthe
deviations
.
Thisisthe
standarddeviation
.Itisdefinedsuchthatitisalwayspositivesothatwearenotconfused
(assumingwearenotthusfar!)
Evenwithoutanydata,wewillrecognisethatShewagisjustaboutiscapableofscoringanything
fromaducktoatriplehundred.Dravidontheotherhandisalotmoresedate,andwecantypically
expectatleast3040runsirrespectiveoftheconditions.
Therefore,DravidsscoresareexpectedtodeviateverylittlefromtheaveragewhileShewagsscores
areexpectedtodeviatesubstantially.
Sowesay,DravidsbattingaveragehaslowerstandarddeviationthanShewags.
Suchisthepowerofthisanalogythatitdriveshomethepointwithoutusinganydata!
Beforeweusethestandarddeviationtoselectasuitablefundcategory,letusrecognisethatmutual
fundscanbegroupedtogetherinseveralways.Thereisnorightorwrongwayandeachfundportal
(ValueResearch,MorningStar,MoneyControletc.)havetheirowncategorisationscheme.
Inthispost,IwillusetheschemecategorizationofVRonline.
Thecategorystandarddeviation,alongwiththetypicalassetallocationandmaturityofdebtpaper
(fordebtfunds)islistedbelowforsomeofthecategoriesdefinebyVRonline.
Categorystandarddeviationreferstothe
average
standarddeviationinaparticularcategory.
Noticethat
returns
aremissingfromthistable.

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

Letusgettothebusinessathand,withafewexamples.

IhavealumpsumthatIwishtoinvestforafewmonths.WhichfundshouldIchoose?

Iunderstandthatequitywillbetooriskyforjustafewmonths.Soletmeeliminateallfund
categorieswithequity.

Thisleavesmewiththetopfourcategoriesinthetable.
IfIchooseadebtincomefundthatmatcheswiththecategoryaveragestandarddeviationof3.71%,
Myreturnswill
typically(
68%probability!!
)
rangefrom
X3.71%toX+3.71%
beforetaxes!

CanIaffordsuchaswinginreturns?
Iftheanswerisno,wecanmoveonandchoosesomethingwithlowerstandarddeviation.Whatif
theanswerisyes?!
WhatifIsay,Idontmindthisfluctuation?
ThenyouwillhavetoworryaboutwhatXis,orwhatitcanbe.
Letusnowintroduceasimplebutreliableruleofthumb.

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

Ifweadoptthisthumbrule,thenextquestionis,whatisthekindofreturns(X)onecanexpectfrom
adebtincomefundoverafewmonths?
Well,foran
income
fundXshould,undernormalcircumstances,behigherthanthestandard
deviation.
However,asmostofusrealisedinJulythisyear,
debtsmarketcancrashtoo
(hashappenedmanya
timebefore).ThatistheNAVofadebtfundcansharplydecreaseinadayoroverthecourseofafew
weeks.
Ifthisoccurs,
all
debtsfundsarelikelytobeaffected.Somewillbouncebackafterafewdays,some
afterafewweeks,andsomeafterafewmonths.
IfIwanttoinvestforonlyafewmonthsinadebt
income
fund,andifbondscrashintheperiod,will
myfundrecover?
Chancesare,itwillnot.

Iwouldliketousethefollowingruleofthumbwhenitcomestolossofcapitalriskassociatedwith
debtfunds.

Longertheaveragematurityperiod,higherthe
corresponding
standarddeviation
and
therefore
longerthetimeitwouldtakeforthedebtfundtorecover.
IfDravidandShewagloseformatthesametime,whoislikelytospringbackfaster?The
batsmanwhocanscratcharoundatthecrease,orsomeonewhoseinstinctistowhackevery
ball?
Higherthestandarddeviation,biggerwouldbefallintheeventofacrashandtherefore
longeritwouldtakethedebtfundtorecover.

Fundswithtypicalmaturityperiodofmorethan1yeararelikelytotakeabout6monthstorecover
fromacrash.Ihavekepttrackofsomeincomefundsandmanyareyettorecover.Unfortunately,

thisincludesmy
NPSsubscriptionsaswell

Debtincomefundsarewellsuitedonlyforlongtermgoals(morethan5yearsat
least).
Longertheperiod,greateristhetaxadvantage.

Whatabouttheothercategories?Howsoonwouldtheyrecover?
Liquidfunds
overafewdays
.Shorttermfundsoveracoupleofmonthsandultashorttermfundsa
littleearlierthatthat.

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

Whataboutaninvestmentdurationof5years?

Iwillchoosedebtfundswithmaturityof1yearorless.
Why?Fordurationslessthanorequalto5years,thepowerofcompoundingisnotthat
important.
Therefore
i nflationisnotthatimportant.SoIwillprefertosafeguardthecapital,choose
debtfundsoflowrisk.
Whynot
RDsorBankFDs
?IfthegoaliscrucialandIknowexactlyhowmuchIneed,Iwillusethese
evenifIfallinthe30%slab.Ifthegoalislessimportant,thenlowriskdebtsofferataxadvantage.

Investdurationsbetween510years
Debtincomefundsthatinvestindebtpaperofshortdurationwithlowstandarddeviation.
DebtorientedHybridfundswithabout2030%equity.Debtportfolioshouldhavelowmaturity
duration.Equityfolioshouldhaveagoodamountoflargecapstocks.Again,bothfactorsleadtolow
standarddeviation(relatively!).
Investdurationsabove10years
Assetallocationshouldbedone
consideringtheriskprofileofthegoal
,
asbeatinginflationismajor
goal.
Nowstandarddeviation
mustbehigh
!
Highvolatilityisimportantforbeatinginflation.
Toughtochoosejustonefund.Perhapsifsomeonemonitorsthefundregularly,theycanpullitoff
withafundlikeHDFCBalanced.However,evenfor10yeardurationIwouldbewaryofusing
a
balanced
fundlikeHDFCPrudencethathasahighstandarddeviationcomparabletomany
largecapequityfunds!
ThepointofthispostistosharewithyouhowIusestandarddeviationtoselectfundcategoriesfor
myfinancialgoals.
AmIbeingtooconservative?AmIbeingtooriskaverseandmissingoutonreturns?
ThewayIseeit,forshorttermgoals,inflationisnotamajorissue.SoIwillnotrisklosingcapitalby
investinginafundwithlargestandarddeviation.
Iftheassetclasscrashes,therewillnotbeenoughtimetorecoverback
.
Foralongtermgoal,inflation
IS
theissue.Soonemustembracehighstandarddeviation,bearwith
shorttermlossofcapitalandinvestinmutualfundswithhighstandarddeviation.Thatis,thosethat
hasagoodamountofequity.
Isay,standarddeviationiskeytoselectmutualfundcategoriessuitableforfinancialgoals.
Wouldyouagree?

13.Howtoselectanequitymutualfund
preamble
Overthenextfewdays,IwouldliketodoaseriesonHowtoselectanequitymutualfund.Thisis
thelongoverdueupdatetothe
stepbystepguide
tomutualfundselection.
IwritethisprimarilybecausemyunderstandingaboutmutualfundshasgrownsignificantlysinceI
wrotethepdfguide.Ihavealreadysharedthiswithyouintheformofanalysisandcalculators.
Wouldliketoconsolidateitintermsofspecificsteps.
Inthispost,Iwouldliketostartwithapreamblewhichwilldefinetheobjectivesandtheframework
ofwhatwillfollow.
The
centralobjective
isquitesimple:Toenableanyonetoselectamutualfundinabout2030
minutes.Thistimewillreducesignificantlyoncetheinvestorgetsabettergriponthemethod.
Therearehoweverafewnecessaryprerequisitestomaketheselectionprocesseasier.
Thefollowingandensuingpostsarevalidonlyforlongtermgoalsthatis10yearsormoreaway.
1)
Afinancialgoalismandatory.
Questionslike,whyamIinvesting?andwhendoIneedthe
money?shouldbeanswered.
2)
Whatistheproposedassetallocation?
Foragivengoalandduration,howmuchwilltheexposure
intheequityfundthatyouwouldliketoselectbe?Thisiscrucialbecausemanypeoplemakethe
mistakeofinvestingin100%equityforlongtermgoals.Theequity:debt(fixedincome)allocationis
mandatory.
3)Whatistheexpectedreturnfromtheequitymutualfundfortheinvestmentduration?PersonallyI
willuse10%forcalculatingtheinvestmentamountandexpectabout12%.Donotexpectmorethan
15%.
4)Expectedreturnfromtotalportfolio=(expectedreturnfromequity)x(equityallocation)+
(expectedposttaxreturnfromdebt)x(debtallocation)
5)Usetheexpectedportfolioreturninastandardgoalplannerwithabout10%inflationforallgoals
expectedretirement.Forretirementuseaminimumof8%inflation.Withotherinputsfoundinthe
goalplanner,youshouldbeabletodeterminethenecessarymonthlyinvestment.Evenifyouare

notabletoinvestasmuch,thisstepisnecessarytounderstandtherequirementsofthefinancial
objective.
6)Decideaboutthedebtportfolio.Forgoalswhichare15financialyearsaway,PPFisagoodchoice.
EPFormandatoryNPSwilldofineforretirement.Forothergoals,youcanconsidershorttermdebt
mutualfunds.
7)Decideabouttheequityportfolio.Therearemanywaystodothis.Iprefer
minimalistportfolios
Iprefer60%inlargecapand40%inmidandsmallcaps.Soonelargecapfundandonemidandsmall
capfundisallthatyouneed.Youcanalsooptforasinglelargeandmidcapfund.
Asingleequityorientedbalancedfundwillalsoworkfine.Inwhichcaseyouneedtotakecareof
overallequity:debtassetallocation.
Onceyouhavedecidedhowyouaregoingtoconstructyourportfolioandwhatmutual
fund
categories
youaregoingtochoose,youareallsettopickafundtoinvestin.
Thosewhohavealreadystartedinvestingbuthavenotperformedanyoftheabovesteps,candoso
now.Betterlatethannever.
Therearemanywaystoselectamutualfund.Iwouldliketopresentthreewaystodoit.Idonot
qualitativelyanalyzeafundtoomuch.Ifthefundisgood,IbelieveitshouldshowupintheNAV
movement.SoforthemostpartItreatafundasablackbox.However,Iensurethatislabelonthe
boxistheoneIwant.
Herearethemethodstobediscussed.RegularreaderswillunderstandwhereIamgoingwiththis.
Method1:
Thisisidenticalto
mutualfundguide
publishedearlier.Shortlistfundsbasedon
consistentperformanceandthenconsiderriskreturnmetricsforlast3years.
Method2:
Shortlistfundsbasedonconsistentperformanceandthenconsiderriskreturnmetricsfor
longerdurationseitherbasedoninvestmentdurationorforeachyear.
Method3:
Shortlistfundsbasedonconsistentperformanceandthenconsiderdownsideprotection
andorconsistentlongtermrollingreturns.
Youcansavethispostasapdfdocumentwiththebuttonbelow.Tobecontinued..

14.HowtoselectanequitymutualfundCreating
ashortlist
Anyselectionprocessshouldhavethreecomponents:(a)anobjective;(b)amethodtocreatea
shortlistand(c)amethodtofinalizewiththeshortlist.
Yesterdaywediscussedtheobjective.Todayweshallconsiderhowtocreateashortlistfromwhich
anequitymutualfundcanbeselected.
Ifyouhavenotreadyesterdayspost,Istronglyurgeyoutodosobeforereadingthisanyfurther:
Howtoselectanequitymutualfundpreamble

Creatingashortlist
Note:
Thedescriptionoftheshortlistmayappearlong.Inpractice,youshouldbeabletocreateone
inunder150minutesonyourfirstattemptandinunder10minuteslater.Sopleasehangon.
Creatingashortlistisasimportantasitisdifficult.Thecriterionusedtocreateoneisarbitrarily
chosenandisbasedonpersonalcomfort.Itcanneitherbetoobroad(meaningtoomanyfundsto
analyzedeeper),nortoonarrow(ifonlyafewfundssatisfyus,thentheyarelikelytofalloutoffavor
soon).F0rexample,theratingofafivestarfundcanonlygodown!
Weneedtocastareasonablybroadnettocreatetheshortlist.Peercomparisonisanecessaryevilto
createtheshortlist.Iprefertoabandonallpeercomparisononcetheshortlistisprepared.
Theprimaryreasonforthatissimple:beforeselectingafund,weareanalysts.Afterselection,we
areinvestors.Analystandinvestorswillhaveverydifferentnumbers(returns/riskmetrics)tostare
atwhentheassetclassisvolatile.
OnceIinvest,Itakedecisionsbasedonthehealthofmyportfoliotaggedtoaspecificgoal.Many
makethemistakeofworryingaboutpeercomparison,viewtheirholdingslikeanalystsinsteadof
viewingitasinvestors.
Iwilldiscusstwomethodsofcreatingthisshortlist:withvalueresearchonlineandwithMorning
Star.Itiseasytoextendthismethodtootherportals.

ShortlistingwithValueResearchOnline

Thisisthemethoddiscussedinthepreviousversion:
StepbyStepGuidetoSelectingaMutualFund
Sincethetimeitwaswritten,VRonlinemadeacrucialchange:Itremovedthelastsevenyears
trailingreturnentryfromthecategorylisting.
TrailingreturnsimplyreferstotheCAGRforthelast1/3/5/7/10(etc.)yearsatanygivenpointin
time.IfIamnotwrong,VRupdatesthiseachmonth.
Removalofthe7Yreturnhasmadetheshortlistabitlonger.
Letusknowgothroughthisprocess,stepbystep.Clickontheimagestoenlargethemifyouwish.
1)Gotohttps://www.valueresearchonline.com/
Skiptheannoyingad,gotothemainpageandscrolldownuntilyousee
researchtools
.
WewillbeworkingwiththeFundselector

2)Leavethe
fundhouse
entryalone.
Inthefundcategoryentry(leftimagebel0w),uncheckwhateverischeckedandcheckEquity:large
cap(weassumethatisthecategorywearelookingtoinvestin.Theprocessforotherequity
categoriesisthesame).
Inthe
exclude
entry(rightimagebelow),
a)checkplanssuspendedforsales

b)checkdirectplans(addingthemwillonlycluttertheprocess.Thefoliosandrelativeperformance
forregularanddirectfundsisthesame).
c)checkclosedended
Scrolldownanduncheck3star,2star,1starandunrated(optional).

Whenready,clickGetData.
3)Youwillbetakentothissheet.Clickon
returns.

4)Youwillthenbetakenhere.

Wewillnowdiscusstwomethodsofshortlistingconsistentperformers.
A)Anchorthesearchwith5yearreturns.

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


Invariablywehaveshortlistedmany(notall)5staror4starfundswhicharelessthan10yearsold.If
youarefinewiththis,thenyoucanproceed.
Byremovingthe7yearentry,VRforcesustorelyonitsstarratingmore.Whoaretheytotellus(at
leastme)thatitisenoughtoreviewonly5yearand3yearhistories?
Ipreferafundwhichhasconsistentlybeeninthetop25for3,5and10yearperiods.SoIwouldlike
toclickonthe10yearreturnsuntiltheyarearrangedinascendingorderandthencreatetheshort
list.
Top25mightsoundtoobroad.Narrowerthenet,highertheexpectationandsoonerthefundis
likelytodisappoint.
AsfarasIamconcerned,Iwillnotrepeatthisexerciseunlesstheselectedfundisalaggardinmy
folio
aftergivingitatleast3yearstoperform
.Laggardsarenotidentifiedbypeercomparison(drop
instarratingetc.)butwithrespecttonetXIRRoftheequityportfolio.Seemorehere:
Howtoreview
amutualfundportfolio
B)Anchorthesearchwith10yearreturns.
Clickon10yearsreturnsonceortwiceuntilthefundare
arrangedinascendingorder.Thenyouneedtodecidethecutoffrank.Supposeweselectfunds
whichwererankedinthetop25overlast3years,5yearsand10years,wewillgetsomethinglike
this(partiallist).Fundsmarkedinredhavedonewellinthepastbutnotintherecent
future
relatively
.


Wenowhavemore10yearoldfundsandthedependenceonstarratingislower.Theshortlistalsois
abitsmaller.
Iammorecomfortablewiththis.Nowthatwehaveashortlist,wearereadytoanalyzefurther.
BeforethatAMCbiasmayshortenthelistfurther(wearehumans,notmachines).
ImaypreferaFranklin,HDFCorICCIoverKotak,TataorDWS.Imayalreadyhaveanaccountinoneof
theamcs!
Hadweshortlistedonly4and
5
starfunds,wewillendupwith19funds.Thisway(with5yearor
10yearanchoring
)
weonlyhave910tochoosefrom.
Wewilltakeupfurtheranalysisinthenextpostonthisseries.Iwouldnowliketodiscussafaster
waytoshortlistwithMorningStar.

ShortlistingwithMorningStarScreener
MorningStarIndiahasanicescreenerwhichcanautomatetheaboveshortlistingandreduceitdown
tominutes.

However,ithasonlylargecapandmid/smallcapcategories.UnlikeValueResearchwhich
distinguishesamonglargecap,largeandmidcap,midandsmallcapandmulticap.
Thiscanpresentaconsiderableproblemunlesswelookatthefoliocarefully.WhenItriedouta
largecapshortlistIendupwithmanylargeandmidcapfunds.Ifyoucanhandlethis,thisisasmart
waytocreateashortlist.
1)Goto
http://www.morningstar.in/tools/mutualfundscreener.aspx
Firstmakethefollowingchoices.The
totalresults
willvaryaccordingtothechoices.Ifitiszero,it
meansyouwillhavetochangethechoices.

Inc
standsfordividendoptionand
Acc
standsfor
growth.
Scrolldowntofurthermakethefollowingchoices


Firstchoose3year,5yearand10yearreturnsabovethecategoryaverage.
Asyousettheoptionforeachyear,haveaneyeonthe
totalresults
atthetop.Itshouldnotbecome
zero.Ifitdoes,youwillhavetochangeorrelaxyouroptions.
Withtheabovechoices,15fundstochoosefrom.
Playaroundwiththemorningstarriskrating(low,belowaverage,average,aboveaverage,high)
and
3yearstandarddeviationtoseeifyoucanreducetheshortlist.
Low>0results

Avg(belowaverage)>3results

Avg>6results
AvgandAvg9results(Ilikethis)
Youcanchoosewhatyoulike.
FurthermodificationscanbedonewiththesocalledMorningStarSyleBox.

Forlargecapfundschoose:
LargeandGrowth
(stockswithsubstantialearning,highPE,highPB)

Agood14outofthe15shortlistedfundsbelongtothiscategory.Onetolargeandablendofvalue
(underpricedstockswithlowPEandlowPB)andgrowth.
Ifyoudontunderstandthis,youcanignorethestyleboxforastartorreadmoreaboutthe
differencebetweengrowthandvaluestocksoraboutthemorningstarstylebox.
DontworryaboutAUMofalargecapfund.Foramidandsmallcapfund,itisnotaterribleideato
choosethefundwithsmallestAUMafterfurtheranalysis.
MidandsmallcapfundswithlargeAUM(saymorethan5000Crores)tendtohavemorelargecap
stocksforliquidity.
Reducingtheexpenseratioevenbyonestepmakesthetotalresultscountgotozero!
Finally,hit
searchto
getthisshortlist.


Donotjumptoconclusionsthattheshortlisthasonly4/5starfundsandthatcouldhavebeenthe
lonecriterion.
Ifyoutriedthatyouwillhave43fundstocontendwithinsteadofjust14.
Outofthis14,youwillneedtoweedoutthelargeandmidcapfundsinconsultationwithValue
Research
ifyouarenotlookingforone!
Wearenowreadytoanalyzefurther.Thisisequallysimple.Iwilltakethatupinadifferentpost.
Wasthisnoteasy?Anybodywithalittlecommonsensecandothis.
DIYandgodirect.Donottrustanyonewhosaysthatmutualfundselectionishard.Theysayso
becausetheyhaveabusinesstorun.
DIYimpliesdoingeverythingyourself.Notmakingashortlistingandaskingothers.Ifyoudonthave
confidence(timeisnottheissue),getyourselfafeeonlyfinancialplannerwhowillsuggestdirect
mutualfundplans.

15.HowtoselectanequitymutualfundMaking
aChoice!
Inthisthirdandfinalpartonhowtoselectanequitymutualfund,wewillconsiderdifferentways
inwhichonemakeachoicefromashortlist.
Yes,thereareseveralwaystochoosefromashortlist,justlikethereareseveralwaystomakea
shortlist.Youwillhavetotakeyourpick.Itiseasytodoso.Allyouneedtodoistotryandsellyour
picktoyourrationalside.Thatisyoumustbeabletojustifyyourmethodtoyourself.Forgetabout
whatothersthink.
Beforeweproceed,asuggestiontoreadthefirsttwostagesintheselectionprocess,ifyouhavenot
doneso:
(1)

Theobjectiveorthepreambleforfundselection
(2)

Howtocreateashortlist
Note:
Thetitleofthispostismakingachoiceandnotfindingthebestfundfromtheshortlist.This
meansthatnomatterhowhardyoutrytoshortenyourshortlist,youwillnotbeabletodoso(ifyou
objectivelygoaboutit).
Sofroma1015fundshortlist,youwillendwithmaybea25fundshortlist.Youwillhavetopickone
fromthis.Thereisnootherwayofdoingthis.
Thisisalongpost.Atotalof7methodsarelisted.Notallmethodsare(orcanbe)discussedindetail.
Pleaseconsultthelinksprovidedformoreinformation.
Method1:
Justpickonefromtheshortlist!
Method2:
Usingshorttermriskreturnmetrics
Method3:
Usinglongtermriskreturnmetrics
A.WithMorningstarIndia
B.Withthefreefincalriskreturnanalyzer
Method4:
Usingdownsidecaptureratios

A.WithMorningstarIndia
B.Withthefreefincalriskreturnanalyzer
Method5:
Withrollingreturns
Method6:
Withinformationratio
Method7:
WithUlcerindex
Iurgeyouread/considerallthemethods,anddevelopyourown.Acombinationofmethodscanalso
beconsidered.

Method1:Justpickonefromtheshortlist!
Bythetimeyouarefinishedwiththispost,chancesarethatyoumightagreethatdoingan

Eeny
,
meeny
,
miny
,
moe
fromtheshortlistisaprettygoodmethod.Whynot?
Thinkaboutit,youhavemadeashortlistbasedonconsistentperformersbasedon3,5and10year
returns.Sowhynotpickonefromthislist?Theriskassociatedwiththereturnsobtainedwillbe
neglected,butthismethodisanydaybetterthanwhatmanypeopledo:askforbestfundnamesor
askotherpeopletopickfromtheirshortlist.
Ifthefollowingappearsabitcomplicatedtoyou,adoptmethod1,butdonotfailtolearn
howto
reviewyourmutualfundportfolio
.
Ifso,whycantIusestarratingsasaguide?Frommyexperience,peoplewhostartusingstarratings
donotknowwhentostop.Theywouldcomparepeerswithoutcheckingthe
actual
performanceof
theirportfolio.Icanneverfeelcomfortablewithsuchastrategy.Personalfinanceisanindividual
race.
Notconvinced?Tythis:
TheTroubleWithMutualFundStarRatings


Method2:Usingshorttermrisk
return
metrics
Thisisthemethodoutlinedinthe
stepbystepfundselectionguide
TherearetwoissuesthatIdidnotrealize/knowwhenIwrotetheabove.
A.TheriskreturnmetricslistedatValueresearchareoveronly3or5yearsonly.Theyhavenot
botheredtostatethis,norrepliedtomyquestionreg.this.Myguessafterhoursofstaringattheir
listingpagesisthatthemetricsareoverthelast3years.
B.Seebelow(perhapsnotimmediately!)
Whenwemakeashortlistconsidering3,5and10yearreturns,shouldweonlyconsider3years
riskreturnmetrics?
Perhapsnot.Itisnotaterriblechoice,butIthinkwecandobetter.
Fortherecord,letusgetthroughwithit.Itisanywayagoodstartingpointforgettingcomfortable
aboutthesemetrics.Tobefrank,Iamdelightedthatmanyreadershavedoneexactlythat.
Letuslookatsomedefinitionsfirst:
Alpha
Itisameasurehowmuchithasoutperformeditsbenchmarkindex.Higher(positive!)the
alphathebetter.BetaMeasureofvolatility.Betaof1.3meansfundis30%morevolatilethanthe
marketasawhole.Solowbetaisimportantfor

Beta
Measureofvolatility.Betaof1.3meansfundis30%morevolatilethanthemarketasawhole.
Solowbetaisimportantforriskaverseinvestors
StandardDeviation:
Higherthestd.dev.higherthefluctuationsinreturns.
SharpeRatio:
Measureofreturnwrttorisk.Agoodfundgetsreturnswithouttoomuchriskandwill
havehigherSharperatioAriskaverseinvestorwilllookforreasonablereturnsandwithlow
fluctuationsinreturn.Sotheywilllookforreasonablyhighalpha,lowbeta,lowRsquared,lowstd.
Sortinoratio:
TheSharperatioconsidersbothpositiveandnegativeexcessreturns(wrtriskfree
rate).TheSortinoratioconsidersonlythenegativeexcessreturnswhilecalculatingthestandard
deviation.Higherthebetter.
Ifyouarelookingforaneasytounderstandvisualaidforunderstandingthesemetrics,try
this:
VisualizingMutualFundVolatilityMeasures
Whatnow?
Lookforfundswithreasonablyhighalpha,lowbeta,lowstddev,highSharperatioandhigh
Sortinoratio.
Hangon.
Higherthebeta,higherthestandarddeviation(typically!)
Higherthealpha,highertheSharperatio(typically!!)
HighertheSharperatio,highertheSortinoratio(typically!!!)
Soallweneedtodoistolookforfundwthreasonably
highalpha,andlowbeta
Iwouldprefertostatethistheotherway:
1)Lookforlowbeta
2)choosefundswithhighestalphaamongthelowbetagroup.
Pickoneofthosefunds.Youdone.

IhaveremovedameasurecalledRsquared(tellsyouhowcloselyperformanceisrelatedtothe
index.Higherthevaluecloserwilltheperformance.AlllargecapfundswillhavehighRsquare).I
feelthatthisistoouseful.
Soletusnowreturntotheshortlist.

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


Youhavealreadymadetheshortlist(fundscorrespondingtobluerectangles)
Nowclickon
Riskstats
Youwouldneedtopreparethiskindoftable.Youcandosomanually.Overtheyears,manyreaders
havesentmetheirexcelfilesinwhichtheyhavemadethisprocesssimpler.
YoucandownloadtheexcelfilefromVRandextractdataforthefundsinyourshortlist.

Ifyouknowabitofexcel,youcanselectthetabulatedshortlist,goto
data
andclickon
filiter.
That
willproducetheencircledsortingmenuasshownabove.Ifyoudontknowhowtodothisoruse
Excel,doitwithpenandpaper.Nobigdeal!
Youcanthensortthebetacolumnfromsmallesttolargest.Whathasbeendescribedabovewilltake
only10mins.

Nownoticetheyellowselection.Lowbetawithreasonablyhighalpha.
Wehaveourwinners!Pickonefundyouarecomfortablewith.Done!
Waitaminute!WhataboutFranklinBlueChipandHDFCTop200!Whydidtheynotmakethecut?
Simplybecausetheyhavenotdonewellinthelastthreeyearsandweareonlylookingatlast
threeyearmetrics!

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

A.WithMorningstarIndia
Therearetwoissueshere.(1)thereisnoriskreturnlistingforallfundslikeVRonlineand(2)all
ratiosarecalculatedwithBSE100.Notabid
(1)thereisnoriskreturnlistingforallfundslikeVRonline.Soyouneedtogotoeachfundpage.
(2)allratiosarecalculatedwithBSE100.Perhapsnotaproblemforpurelargecapfunds.Willnotuse
forothercategories.
Seehereforasample.Thisisnotascreenshot.IhaveonlyincludedstuffthatIneed!


Noticethatthemetricsareavailablefordifferentdurations.
Troubleis,thefundsbenchmarkisBSE200andnotBSE100.
Youcanconsiderthemetricsprettymuchasmentionedbefore,makeatablefordifferentdurations
orvisuallyobserveforconsistencyandmakeachoice.Itwillnottakeaslongasitseems.Hey,whose
moneyisitanyway!
Thishasagotanewmetric:
TreynorRatio
i sknownastherewardtovolatilityratio.WhiletheSharperatioistheexcessreturn
(wrtriskfreerate)dividedbystandarddeviation,Treynorratioistheexcessreturndividedbybeta.
Thisiscalculatedforboththefundandthebenchmarkforwhichbetaisassumedtobe1.

HighertheTreynorratio,betteristheperformance(higherreturns+lowvolatilitywrtbenchmark)

B.Withthefreefincalriskreturnanalyzer
Ifyoudonotlikethefactthatmorningstarusesthesamebenchmarkforallfunds,youcanconsider
my
riskreturnanalyzer
YoucanthenchoosefromNifty,CNX100,CNXMidCap,CNX500,Sensex,BSESmallCap,MidCap,BSE
100,200,50.
Consider1to9yeardurations.CalculatelumpsumandSIPreturnsforeachduration
Evaluatetheriskreturnscorewith13metrics.
Youcanalsoconsiderthe
YearonYearMutualFundRiskReturnAnalyzer

forreviewingyearly
performance.

Method4:Usingdownsidecaptureratios
ThisisthemethodIadvocateintheinvestorworkshops.
Themainadvantageofthismodelisthatitdoesnotdependonmodernportfoliotheory(MPT)ratios
whichareapplicableonlyfornormalorGaussiandistributions.Itisquitepossible(infacteasyto
pve)thattheymaynotworkwithmutualfundsandstocks!Thismeansallstarratingsareonshaky
ground!!
PeopleuseMPTmetricsbecausealternativesaretoughtoevaluate(moreonthissoon).
Upsidecapture.
Foragivenperiod,howmuchofthebenchmarksgainshasthefundcaptured?Higherthebetter.
Downsidecapture.
Foragivenperiod,howmuchofthebenchmarkslosseshasthefundcaptured?Lowerthebetter.
FromwhatIhaveseen,
consistentdownsideprotectionisthesourceofalpha.
Ihavewrittenaboutthisindetailearlier:

UnderstandingUpsideandDownsideCaptureratios
SimplifyMutualFundAnalysiswithUpside/DownsideCaptureRatios

Againtwomethods

A.WithMorningstarIndia
MorningstaragainusesonlyBSE100forcalculation.However,thisiseasytouseandisperfectfor
largecapfundsandmaybeabittoostrictformidandsmallcapfunds.

B.Withthefreefincalriskreturnanalyzer
Againtroublewithmorningstarisitusesthesamebenchmarkforallfunds.Youcanuse
my
riskreturnanalyzer

whichhasaseparateupsidedownsidepage.Theevaluationstrategyis
differentfromwhatmorningstarusesbuttheessenceisthesame.
Iwillpostanexclusivetooltocalculatethisbetter.Seesomescreenshotsofthisareavailable
here

Method5:Withfreefincalrollingreturnscalculator
Ro0llingreturnsofferasmartandeasytounderstandwaytoevaluateconsistencyinperformance.
SupposeyouwanttoevaluatefundperformancefromJan1st2000onwards.
Youcalculate3yearCAGR*from1sJan200toDec.31st2002.Thenyoushifttheperiodbyaday(roll
over)andcalculate3yearCAGR*from2nsJan200to1stJan.2003andsoon.Plotthemtogetherand
stareatit.

forbothfundanditsbenchmark

Thisideaistolookforconsistentlongtermoutperformance.
Seethispostformoredetails:
MutualFundRollingReturnsAnalysis:FranklinIndiaBlueChipFund
andusethisautomatedsheetforcalculations:
MutualFundRollingReturnsCalculator

Method6:Withinformationratio
Informationisdefinedastheaverageexcessreturnofthefundwrtbenchmarkforagivenperiod,
dividedbythestandarddeviationoftheexcessreturn.
Consistentlyhighinformationratioisagoodindicatorofperformance.Dr.UmaShashikantsays,
Informationratioismykeyquantitativeindicator.
Seethispostformoredetails(calculatorinthesamepost):
MutualFundAnalysiswiththeInformationRatio

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

Seethispostformoredetails:
MutualFundAnalysisWiththeUlcerIndex
andusethisforcalculations:
riskreturnanalyzer

whichhasaseparateulcerindexpage.
WasInotright?Doesnt
Eeny
,
meeny
,
miny
,
moe
fromtheshortlistseemlikeaprettygood
methodnow!!
Wouldyoulikeasuggestion?
Forlargecapfunds:
Use:
Method4A:Usingdownsidecaptureratioswithmorningstardata
Formidandsmallcapfunds
Use:

Method4B:Usingthenewdownsidecaptureratiocalculator
(releasinginacoupleofdays)
Alternatively
Use:
Method7:WithUlcerindex
oracombinationof
Method5:Withfreefincalrollingreturnscalculator
and
Method7:WithUlcerindex

16.HowtoSelectDebtMutualFundsSuitableFor
YourFinancialGoals?
Sincethetimemy
stepbystepguidetoselecting(Equity)mutualfunds
becomepopular,Ihave
beenreceivingrequeststopublishasimilarguidefordebtmutualfunds.
Wellbegunishalfdone.Ifaninvestorcanconfidentlyselectcategoriessuitablefortheirfinancial
goals,shortlistingasetoffundsfromthatcategoryisthatmucheasier.Thisisespeciallytruefor
debtfunds,sincechoosingoneistypicallytougherthanequityfunds.
AlthoughIintendedthisposttobeacompanionpiecetothemoregeneral,
Howtoselectmutual
fundcategoriessuitableforyourfinancialgoals
,asIwroteit,enoughaspectshavebeenincludedto
considerthisasastepbystepselectionguidefordebtfunds.
Interestratesandbondpriceshaveafascinatingrelationship.Therefore,besidestheusual
riskreturnparametersofalpha,beta,standarddeviation,Sharperatio,Sortinoratioetcusedfor
equitymutualfunds,quantitieslikeyield,yieldtomaturity,averageportfolioduration,modified
durationetc.areinvolvedindebtfundselection/evaluation.
Thismakestheselectionprocess
appear
complicated.However,thiscanbesimplifiedbyfocussing
on1/2parameterstofirstnarrowdownthedebtfundcategoryandthenshortlistfundsfromthat
category.
Thankstotherecentcrashinbondprices,avisualanalysisispossible.
th
OnJuly16
2013,the
1
0yearGsecrate
increasedby6.69%whilethe
1yearGsecrate
increasedby
awhopping14.8%.Source:www.investing.com

WhilethestepstakenbyRBItocurbrupeedepreciationwasthemainreasonforthis,otherevents
playedaparttoo.See
here
foradecentreport.
Thevalueofabondhasaninverserelationshipwithinterestrate.Ifinterestratesincrease,thevalue
ofabond
hasto

fall
inordertomatchcurrentyields.Therefore,theNAVofabondfundholdingsuch
bondswilldecrease.
Sinceboththe1Yand10Yratejumpedupsharply,prettymuchbondsofalldurationswereaffected,
resultinginafallinNAVofalmostalltypesoffunds.

Evenliquidandultrashorttermfunds,withmaturitydurationsmuchlessthanayear,were
affected,becausebankspulledouthugeamountsofmoneystashedinsuchfunds.
Sincethiseventoccurredlessthanayearago,thedefaultoption(1Y)inthe
performance
tabofeach
debtfundpageatValueResearchOnlineshowshowfundsbehavedduringthisperiod.
Thisoffersasimplewaytounderstandhowdifferenttypesofdebtfundsreacttointerestrate
movements,aka
interestraterisk

onetype
ofriskthatdebtfundsaresubjectto.
First,letmequotetwodefinitions:
ModifiedDuration:
Measuredinyears,modifieddurationisameasurementofabondssensitivityto
movementsininterestrates.Forexample,abondwithamodifieddurationof5.2yearscanbe
expectedtoundergoa5.2%movementinpriceforeach1%movementininterestrates.Thelongerthe
modifiedduration(inyears),themoresensitiveabondspricetochangesininterest
rates.
Source:
InvescoPerpetual
AverageMaturity:
Theaveragematurityoftheportfoliodeterminesthetimeinvolvedinmaturingof
allthedebtassetsintheportfolioofthedebtmutualfund.Highertheaveragematurityofthe
portfoliogreaterwouldbetheinterestrateriskontheportfolioofthedebtmutual
fund.

Source:
MoneyControl
Boththemodifieddurationandtheaveragematurityrepresentthesensitivityofthedebtfund
portfoliotointerestratemovements.
Whileaveragematurityisacrudemeasureofinterestratesensitivity,themodifieddurationisa
moresensitivemeasure.
Justbynotingthevaluesofthesetwoparameters,onecanunderstandhowinterestrateriskaffects
differentdebtfundcategories.
Hereisacompilationofaveragematurityandmodifieddurationfordifferentfundclasses.Ihave
deliberatelyavoideddefiningeachfundcategoryinthepost.Thosewhoarefamiliarwiththem
shouldnotworrytoomuch.Ifyouarenewtodebtfunds,thenIsuggestyoucomeupwithyourown
definitionoffundcategoriesbyobservingthemaximumvaluesoftheaveragematurityand
modifiedduration.


Source:ValueResearchOnline.Insomecases,theaveragematurityandmodifieddurationarenotforthesamefund.Thetypical
orderofthevaluesishowevercorrect.

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

NoticethelittlebumpintheNSETreasuryBillalittleafterthebondcrash.Thefundhoweverwas
th
practicallyunharmed.IfyoupeeralittleyouwillnoticeasmalldiponJuly16
.Noticehowfastthe
fundbouncedbackinafewdays.
Debt:Income
Letuslookattwofunds.
ThefundwithlowestcategoryAM=0.44years,MD=0.37years

th
NoticehowthefundsufferedadiponJuly16
butrecoveredinacoupleofmonths.

NowletuslookatthefundwiththehighestcategoryAM=13.62years;MD=6.95years.


ThefundisyettoreachitsJuly16thNAV.
Similarplotscanbemadefortheshorttermgiltfunds.ImaginethefateoftheDebt:longtermfunds!
Therefore,ingeneral,highertheaveragematurityoftheportfolio,highertheinterestraterisk.
Highertheaveragematurity,higherthemodifiedduration.
Higherthemodifiedduration,higherthe
interestraterisk
.Thevalueofthemodifieddurationgives
youamoreexactestimateofhowmuchtheNAVwillbeaffectedfor1%changeininterestrates.

TypicallyfundswithlowAMandMDwillfollowanaccrualstrategy.Thatistheywillbuyandhold
debtpaperuntilmaturity.Sointerestrateriskislowered.However,
creditrisk
comesintoplay.Lower
the
qualityofthedebtpaper
,higherthecreditriskandhighertheinterestrate!
SEBIallowsfundhousesto
buycreditprotection
(sortofaninsurance)tohedgecreditriskon
corporatebonds.Sothatofferssomecomforttotheinvestors.
Howdoweusethisinformationtoselectmutualfunds?
Whenitcomestodebtfundinvestors,Icanthinkofthreetypes
1)Thosewhoarealwayschasinginterestrates,doubleindexationetc.
2)Thosewhoarelookingtoinvestforshorttermgoals,lessthan5yearsaway
3)Thosewhoarelookingtoinvestforlongtermgoals,aspartofdiversifiedfolio.
Wewillleavetype(1)alone.Obviouslytheyknowwhattheyaredoing.WewillleavethehighAM,
highMDfundstotheseguys.
Wherekindoffundsshouldtype(2)investorschoose?
Theyshouldchooseafundwithaveragematuritywellbelowthetenureofthefinancialgoal.
Fora5yeargoal,Iwouldchooseamodifieddurationandaveragematurityofnomorethan1year.
Whichkindoffundtoinvestin?
Nowwewillneedtolookintothe
nature
ofthedebtholdings.Isit
corporatedebt?ItisBankpaper?Itisgovtdebt(gilt)?Whatistheratingofthedebtpaper?
Forimportantgoals,besttosticktohighqualitydebtissuedbybanksandPSU
ShorttermgiltfundswithlowerMDcanalsobeused,butthereturnswouldbeonthelowerside.
Forlessimportantgoals,youcanbealittlemoreadventurousandincludesomecorporatedebt.
HereagainsticktofundsthathavepredominantlyAAAsecuritiesintheirfolio.
Soinvestorsshouldfirstlookatlow
interestrate.Therisk
(AM&MD)

,shortlistcoupleof
fund
categories
andthenchoosefundswithlow
creditrisk
(qualityofdebt).
HereisascreenshotfromtheValueResearch
portfolio
pageshowingtheAM,MDandthe
fundstyle
box.
Weshouldfundswith
high
creditqualityand
low
i nterestratesensitivityforshorttermgoals.

Mostinvestorswithagoalinmind,shouldstaywithintheredcircle.

Oncethefundcategoryischosen,youcanshortlistfundsusingtheriskreturnparameters(alpha,
beta,standarddeviation,Rsquared,Sharperatio)usingthesamestrategyasoutlinedin
the
stepbystepmutualfundselectionguide
.Ifyouwouldliketounderstandriskreturnparameters
inasimplenonmathematicalway,click
here
Thiswouldenableyoutoshortlistlowrisk,reasonablereturnfundsfromthecategoryofyour
choice.
Thenextstepwouldbetolookatthefundobjectiveandinvestmentstrategy.Somefundhouseslike
FranklinTempletonmentionthisclearlyoneachfundpage.Iftheinformationisnotclear,readthe
schemedocument.Donotaskanyoneelse!
Theobjectiveandinvestmentstrategy
must
giveyoutheimpressionthatthecurrentAMandMDwill
moreorlessbethesamefortheinvestmenttenureyouhaveinmind.
Ifyes,goaheadandinvest!

NEVERinvestinadebtfundwithoutreadingtheinvestmentobjectiveandinvestmentstrategy.
Wherekindoffundsshouldtype(3)investorschoose?
Firstletusunderstandwhatweneeddebtfundsforlongtermgoalswhichwouldtypicallyhave
significantequity.

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

Justlikeadiversifiedequityfund,awelldiversifieddebtfundlikeadynamicbondfundwith
modifieddurationandaveragematurityofnomorethan23yearswilldothework.TheNAVwill
fluctuateandthatisfine,sinceweneedfluctuationsforrebalancing!Youcanlearnmoreabout
rebalancinghere.Besuretoplaywiththesimulatortool.
Justastheconceptof
standarddeviationcanhelpanewbiemfinvestorunderstanddifferentfund
categories
,theconceptsofaveragematurity,andmodifieddurationcanhelpthenewbiedebtfund
investortopickacategorysuitablefortheirneeds.
Debtfundsselectioncantypicallybemorecomplicatedthanequityfundselection.Itisuptothe
investortosimplifythisprocessbybeingclearon
whattheywant
.Theyshouldlearnnottochase
afterreturnsandkeepexpectationslow.

17.HowtoConductaPersonalFinancialAudit
IloveDecember.TheChennaiSummerisbusyrechargingitsbatteriesandthereforenotinfullforce.
TheCarnaticmusicseasonseemstobeginearliereachyear,thankstosomeprudentmarketing.The
semesterisover,andforme,goalbasedinvestingmonthstarts!
MostofwhatlittleIknowaboutpersonalfinanceandinvestingcomesfromtimespentstaringat
ExcelsheetsinDecember.Allmyretirementandgoalbasedinvestingcalculatorsweredonein
DecemberasIevaluatedmygoalsandfuturecashflow.
InDecember,Idoapersonalfinanceaudit.Detailsoflastyearauditcanbefound
here

(besureto
readcomments)
.
Willpostthisyearsauditsoon.
ThemostimportantpartoftheauditistofindoutifIamontrackwithrespecttomylongterm
financialgoals.Muchofthisauditprocesshasbeencompletelyautomatedwiththesetools(andcan
bedoneanydayoftheyear):
1. Ikeeptrackofinvestmentswiththis
monthlytracker
2. Trackfundholdings,portfoliohealthandgoalprogresswith

AutomatedMutualFundand
GoalbasedInvestment

Tracker
3. PPFTracker
4. Getaperspectiveoffuturecashflowwiththe
integratedfinancialplanner
Ifyouhavenotdonethisexercise,dotryit.Itwillchangethewayyouthinkaboutmoney.Youcould
feelmoresecureandhopefullyincontrol.Itwoulddefinitelytellyou
whereyoustand
and
where
youneedtobe
(ifyouarenottherealready).
Atthecostofsoundingpresumptuous,mayIsuggestthatyoutreatthispostasa
calltoaction
andtry
outtheabovetools?
Ifyouareinterested,hereiswhatyouwillneed:

60minutesofpeaceandquiet.
Anotebookandpenandofcourseacomputerhookeduptotheinternet.

Andthisiswhatyouwillneedtodo:
1. Inthenotebook,dateapageandlistallpossibleshorttermandlongtermgoals.
2. Entertheapproximatecurrentcostofeachgoal.Ifyoudontknowitoffhand,sourceitlater.

3. Withthisinformation,playwiththe
VisualGoalplanner

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

18.Howtoreviewyourmutualfundportfolio?
Idiscusssimplewaysinwhichamutualfundportfolioassociatedwithalongtermgoalcanbe
reviewed.Thisisagreyareainpersonalfinanceandthereisnooptimalwaytodothis.Each
individualmustnecessarilydeveloptheirownstyleofreview.Somultiplesolutionsarethenorm
here.
Whatispresentedbelowaremythoughtsonthesubjectandisacombinationof
howIdoit
and

howIwoulddoit
.Letusstartwithassumptions.
1. Thegoalisseveralyearsaway(shorttermgoalmanagementisadifferentballgame.Itthe
foliohasdebt,thenthereisnotmuchtodo.Ifithasalotofequity,oneshouldprayalot!)
2. Wehaveaclearexpectedreturnfromourtotalequityfolio(thisreviewisfortheequity
portionofthefolio.Wewillassumethedebtparthasminimalvolatilityanddoesnotneed
frequentreviews)
3. Wewillmonitorthefolio,sayeachmonthbutwillonlytakeactiononceayear.
4. Actionherereferstofundchangesonly.Otheractionslikerebalancingortacticalasset
allocationdependonequity:debtallocationoreconomicindicatorsandarenotconsidered.
5. Thefolioshouldatleastbe5Yold.Thereisnohurryfornewinvestorswithfoliosyounger
than5YtotakeanyactionandIstronglysuggesttheymonitortheirinvestmentpatternsand
notthefolioperformance.
6. Thereareseveraltypesoffolios(
minimalist
,mildlycluttered,severelycluttered).Socourse
ofactionwilldiffer.Wewillconsideraclutteredfolio.Itiseasytoextrapolatethegistofthe
argumenttoanyfolio.Ifyouhaveanyquestions,feelfreetoask.
Prettymucheveryactioninpersonalfinanceneedsabenchmark.Themorepersonaltheyare,the
easieritistodecide.
Sothefirstbenchmarkistohaveareturnexpectation.Thisexpectationshouldbereasonableand
mustkeepinmindassociatedvolatility.
Thesecondbenchmarkisthenetreturnfromtheportfolioatanygiventime.Thisiscalculatedusing
whatisknowastheXIRR(readmoreaboutthis
here
)
TheXIRRis,bydefinitionapersonalbenchmark.
Howhasthefundperformed?
isnowquantifiedby,

WhatismyXIRRfromthefund?

ItisapersonalbenchmarkbecausenotwopeoplesXIRRwillbethesame,unlesstheyinveston
exactlythesamedates.

ThisiswhystarratingsareirrelevantonceIinvestinafund(theyareirrelevantevenbeforethat
because,imotheydonotreward/penalizelongtermconsistency/inconsistency.Aninvestoris
betteroffdoingtheirownanalysis).
OnceIinvestinafund,allthatmattertomeisitsimpactonmyfolioandnothowitcompareswithits
peers(starrating).
So,onceIhaveanexpectationfromequity,thenexttaskistofindoutthenetXIRR(thisistherateat
whichallyourinvestmentshavecompoundedonanaverage.ThisistheequivalentoftheCAGR
whenmultipleinvestmentsaremade).
YoucandothisbyenteringALLyourtransactionsinaportallikeValueResearchormymutualfund
trackerorMprofit.NotsureifPerfiosgivesthis.
Youshouldnowhaveatableofthecurrentvalueofallyourfunds,theirindividualXIRRsandthenet
XIRR.
Somethinglikethis(clicktoenlarge).Thisisafabrication.

NoprizesforguessingthatthefirstfundisPPFAS!!
Ifmyreturnexpectationis10%(lowerthebetter),IcanaffordtodonothingifmynetXIRRand
individualXIRRsareallabove10%.Thereisabsolutelynothingwrongwiththisstrategy.
IlikealargeXIRRasmuchasanyotherperson.Soasecondapproachistotry(andhope)tokeepthe
netXIRRwellabovethereturnexpectationandmake
gradualchanges
toincreasethedistance
betweenthetwobenchmarksasmuchaspossible.
Theabovepictureisanexampleofaclutteredfolio.Ithas3largecaps,onelargemidcapandtwo
midsmallcapfunds.Iamnotterriblybrightwhenitcomestogivinggoodexamples.Iamfairlysure
thatmanyreallifefoliosareworsethanthis!

Herewego,
Amongthethreelargecapfunds,twoare5Yoldinthefolioandone2Yold.
Isthe2Yoldinvestmentnecessary?Itisunlikelytodiversifythefolioastherearealreadytwolarge
capsanditsreturn,14.75%issignificantlylowerthantheNetXIRRof26%.Also,itconstitutesonly
1.23%oftheentirefolio.
SoIthinkthis(largecap1)canbegottenridof.
LargeCap2isnearlytwiceinvaluecomparedtolargecap1butitsreturnismuchlower.
Iflargecap2hasconsistentlyperformedthenitcanberetainedevenitsportfoliohassignificant
overlapwithlargecap3.
Samereasoningforlarge3.Ifithasbeenconsistent,leaveitalone.Ifithassuddenlyimprovedinthe
lastfewmonths,wewillhavetowaitandwatch.
Inthenameofconsolidation,oneshouldnothastilyshiftlargecap2holdingstolargecap3.Onecan
increaseinvestmentsinlargecap3anddecreaseinvestmentinlargecap2andseehowthatgoes.
Iflargecap3doesindeedcontinuetodowell(returnwellabovenetreturn)andlargecap2hasnot
pickedupitsact,onecanthengraduallyshiftunitsfromlargecap2to3.
TheaimhereistoslowlybutsteadilyincreasethenetXIRR(wellabovetheexpectedreturn,ifatall
possible).Onecannotaccomplishthiswithkneejerkchanges.Theideaistodoitwithamethodand
todoitgradually.
OnecanalsotrytoreducethevolatilityinthenetXIRR.Thismayneedtacticalcallsthough.
Thusisisimportanttotrackperformance.Otherwise,suchdecisionscannotbemade.
Thelargemidcapfundcanbeleftaloneevenifitholdsthesamelargecapstocksasthelargecap
funds2and3.Itsreturniswellabovethenetreturn.Whenitaintbrokedontfixit.
Therearetwosmallmidcapfunds.Oneofthemisquiterecent.Soleaveitbe.Theotherhasa
decentenoughreturn.Soleavethatbeaswell.
Again,ifthemidcap+internationalequityfundcontinuestodowell,investmentscanbeincreased
here.

IthinknothavingaSIPishelpfulinmakingtheseswitches.IthinkaSIPisbestdoneinthefirst5Yofa
longtermgoal.Afterthat,Ithinkactivemanagementwillhelp.
Allthisiswrittenwithoutanykindofqualitativeanalysisastowhycertainfundsdidnotdowell.
Diggingalittledeepermayormaynothelp.
Itisbesttonotgetemotionallyattachedtoafundandtoberuthless,butobjective.Thisis
somethingIamnotverygoodatbuthavechangedinthepastcoupleofyears.Ruthlessdoesnot
meanimmediate.Changecantakeafewmonthstohappen.Afterall,exitloadsandtaxationarealso
important.
Changescanhurt.Thefundweexitedcangoontodoquitewellandthenewfundplumbnew
depths.Whichiswhyitisimportanttonotmakeanysuddenchanges.
Oneshouldchaseafterreturnsliketheturtletryingtobeatthehare:slowandsteadydoesthetrick.
QuantumLongtermequitymaybeathreestarfundtoday(accordingtoVR)butinmyfolioitisafive
starfund.Chasingafterfivestarfundseveryyearortakingblogpostswhicharetitled,TopBestXX
fundsin2015(XX=number)seriouslycanbeinjurioustoyourfiscalhealth.Bloggerswritesuchcrap
togettrafficandmoreGoogleadsensemoney.
Understandinghowthesmallcapsandmidcapshavefaredagainstlargecapshelpinunderstanding
therecentreturnsofthefundinourportfolios.
Thisisjustonewayofdoingthings.Therecouldbesimplermethods.Personally,Iprefer
benchmarkingXIRRofeachfundwiththefoliosnetXIRR.
OnceIamunitholderinafund,itsperformanceagainstabenchmarkisnotallthatrelevanttome.
AMCschoosebenchmarksthatcanbeeasilybeat(ifyouranabusiness,wouldyousetyourselftough
targets?).Afundthathasconsistentlybeatitsbenchmarkcanstillnotevenmeetmyreturn
expectation,orcanbemuchlowerthanthenetXIRR.
Atsuchtimes,itmakessensetofindoutiftherearebetterperformingpeers
takingintoaccount
consistencyindownsideprotection
(seehowtodothis
here
).Againstarratingsdontmeanmuchto
me.
Thismightwork,providedtheageoftheinvestmentandtheweightoftheinvestmentare
considered.TheideaistoidentifyfundsthatpulluporpulldownthenetXIRR.
Suchfundsneednotalwaysbeeliminated,butitdoesnothurttoreviewsuchfundsabitdeeper
andactaccordingly.

Allsaidanddone,historytellsusmostfunds(fromdecentfundhouses)tendtodowellifheldon
forlongenough.Soasimplebuyandholdstrategywilldefinitelywork.
Whatisproposedaboveisonlyoneofazillionpossibilities.Theideaofthisposttohighlightthe
importanceof
personal
benchmarks.Therearemanysolutionstothisproblem.Feelfreetocritique
andproposealternativestrategies.

19.ReviewYourRetirementPortfolioinSeven
EasySteps
Alllongtermfinancialgoalsrequireperiodicreviewtoensurethattheyareontrackandinlinewith
expectationsandassumptionsmadewhile
planningforthegoal
.
Retirementis
auniquefinancialgoal
.Mostoftenonehasalargecorpustoutilizeoveraperiodof
severalyears.Hereareseveneasystepsbywhicharetirementportfoliocanbereviewed.
Youcanusethe
goalsanalysis
sheetofthe
automatedmutualfundandfinancialgoaltracker
to
automatethisreviewprocess.
1. C
alculatethecurrentvalueoftheretirementcorpus
.Determinecurrentvaluesofmutual
fund/stockholdings,PPF,EPF/
NPS
,FDsetc.andaddthemallup.
2. Whatistheretirementcorpusworthtoday?
Ifyouweretoretiretoday,whatnumberof
yearscanyoubefinanciallyindependent?Ifthisnumberisequaltothenumberofyearsyou
expecttobealivefromtoday,youare
financiallyindependent!
Forexample,Icanbefinanciallyindependentwithoutworkingforjustaboutayearorso,
ifIretire
today!
InordertoneverworkagainIwouldneedasumthatwouldsupportme,thatisprovidedme
an
inflationprotectedincomestream
foratleast4045years!
3. Whatistheprojectedworthoftheretirementcorpus?
Ifthepresentcorpuswasallowedto
growfromnowuntiltheexpectedageofretirementatareasonablerate(=returnon
investment),whatnumberofyearscanyoufinanciallyindependent?Ifthisnumberisequal
tothenumberofyearsyouexpecttoliveafterretirement,youcansafelyreducefurther
investmentsifnotstopthemaltogether.

Forexample,IfIdonotinvestmentforretirementanymoreandretireaspermyplansat65,Iwill
haveacorpusthatwillsupportforabout5years.WhereasIwouldneedacorpusthatshouldsupport
mefor2025years!
4. Whatisthecurrentmonthlyinvestmentrequired?
Takingintoaccountthecurrentcorpus,
whatisthemonthlyinvestmentrequiredtoday,increasingeachyearatanassumed
(reasonable!)rate?Ifthemonthlyinvestmentrequiredislowerthanwhatyou
actually
invest
,thenalliswell.Else,youwillneedtocutdownexpensesuntilyoucaninvestenough.
Iamnotdoingbadlyonthisaccount.Thankstoanaggressiveinvestmentstrategy,Ineedtoinvest
only65%ofwhatIcurrentlydo.ThatisIcanaffordtoreducemyinvestmentsbyagood35%

somethingIdonotintendtodoaslongasIcanmanagetokeep
unexpectedrecurringexpenses

at
bay.
MyAssumptions/Expectations
Equity:12%initially,gotitdownto10%(
thankstothis
)andnow9%
Debt:8%
Inflation:9%
Annualincreaseinmonthlyinvestment:10%
Posttaxreturnsafterretirement:7%
5. Whatisthegrowthrateoftheretirementportfolio?
WhatistheCAGRofeachassetclass?
Thatis,theCAGRofequityholdings*,PPF,EPF,
NPS
,gold,FD,realestateetc.IftheCAGRof
thevolatileassetclassesismoreorlessclosetoyourexpectations,notmuchneedbedone.
Ifitmuchhigherthanexpectations,itmightbetimeto
rebalance
.Ifitismuchlower,you
willneedtolookatthesourceofunderperformanceandtakeacallonit.

Thecurrentmonthlyinvestmentrequiredisalsoasignoftheportfoliogrowthrate.Ifitnottoo
muchhigherthe
initial
monthlyinvestmentplanned,thingsarereasonablyfine.
th
MynetEquityCAGR:9.89%(asonMar.24
2014)
th
NPS:7.57%(ason14
Mar2014)

PPF:Sameasyours!IcontributeRs.500eachmonthtomywifesaccountandmine.
Gold:Notapplicable
RealEstate:Notapplicable
*take
all
thetransactions(purchases,dividends,redemptions,switches,reinvestmentsetc.)made
forafinancialgoal,feedthemintoaXIRRcalculatorandcomputetheCAGR(the
goaltracker
sheetof
the
automatedmutualfundandfinancialgoaltracker

doesthisatclickofabutton).
6. Isyourretirementinautopilotmode?
Forthesalariedclass,someinvestmentslikeEPFare
mandatory.IfthecurrentmonthlyinvestmentrequiredislesserthanthemonthlyEPF
contribution,yourretirementisinautopilotmode,
provided
thereisnotsignificantbreakor
reductionincontributionsduetolayoffsorlesserpayingjobs.


Minehasbeeninautopilotmodeforquiteawhilenow.SinceIplantoretireearly,itdoesnot
mattermuchforme.
7. Areyouplanningtoretireearly?
Ifso,thefirstrequirementistoinvestasmuchaspossible
andasearlyaspossible.Ifyouaredoingthisconsistentlyforatleastacoupleofyears,use
the
financialfreedomcalculator
tofindouthowsoonyoucanretire.

Inmycase,financialfreedomisagood1820yearsaway(longerthanIoriginallythought

).Howeversincemyexpectedretirementislongerthanthis,Iamreasonablyhappy
withit.

Dobecarefulwhileinterpretingthesenumbersandbesureto
avoidthesecommonretirement
planningmistakes
.
Ifyoucouldgothroughthesesevenstepsonceayear,youcanensurethatyourretirementplansare
ontrack.
The
goalsanalysis
sheetofthe
automatedmutualfundandfinancialgoaltracker

automatesthis
reviewprocess.Justremembertoviewitoccasionallyandnoteveryday!

20.Assetallocationforlongtermgoals

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

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

Noticethebendinstandarddeviationat10%equityallocation.Itcanbeshownthatitcorrespondsto
theoptimumassetallocationintermsofriskvs.reward!
Heyweallwantbetterreturns,soletustakeonmorerisk.Buthowmuchmoreisthequestion?!
Hardtogiveamathematicalanswer.
Idonotlikeahighdoubledigitstandarddeviation.Ipersonallyuse60%equityformylongterm
goalsandsuggestnomorethan70%.Ithink50%equityisalsoaprettydecentallocation.
Recognisethatwehaveconsideredabluechipfund.Hadweincludedmidandsmallcaps,the
volatilitywouldhavebeenmuchhigher.
Ithinkanythingabout70%equityallocationwillrequirealotofmaintenance(monitoring,tactical
callsetc.)
Ihavebetterthingstodo.Iwantsomethingthatislowmaintenance,withreasonableriskand
reasonablereward.

Ifmynetequityportfoliogivesme1o12%after10Y+,Iwilldelighted.Iwouldhavemetallmy
financialgoalswithreasonablylowstresslevels.
LikeSubrasays,theassetallocationthatletsyousleeppeacefully,istherightallocation!
Whatdoyouthink?

Allcalculatorsreferencedinthetextareavailableforfreedownloadat
freefincal.com
Pleaseletmeknowyourfeedbackat
[email protected]

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