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Gaining Financial Independence Investors – Aware and Beware Umesh V. Kudalkar, CFA 16 th August 2014 Pune.

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Presentation on theme: "Gaining Financial Independence Investors – Aware and Beware Umesh V. Kudalkar, CFA 16 th August 2014 Pune."— Presentation transcript:

1 Gaining Financial Independence Investors – Aware and Beware Umesh V. Kudalkar, CFA 16 th August 2014 Pune

2 Disclosure & Disclaimer The Views and Opinions expressed in this Presentation are in my personal capacity. This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Before acting on any recommendation in this document, investors should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice.

3 Presentation Outline Section I – Role of Investing & Financial Independence Section II - Inflation and Asset Allocation Decision Section III – Being a Successful Investor Section IV - Best Offence: Awareness of Investing Options so as to earn High Risk adjusted Return Section V- Best Defense: Beware of Risks - Protection. Section VI - Taking Care of yourself

4 Section I Role of Investing and Financial Independence

5 Target Audience This Presentation is not primarily targeted at: – The Rich and the Wealthy – DA Linked Pensioners Everybody else, I hope, will find actionable concepts and ideas in this Presentation.

6 Why should you listen to me? I am an independent person. I am not here to earn any commissions out of you. I am one amongst you and I share the same concerns that you have. I am a CFA Charterholder – I hold Investment related professional educational qualification.

7 Financial Independence (Wiki) Financial independence is generally used to describe the state of having sufficient personal wealth to live, without having to work actively for basic necessities.

8 Why Bother about FI? FI gives the freedom to live and work on one’s own terms and pursue your dreams. Financial Independence allows you to protect your pride through – Loss of Job – Accidents and Invalidity – Old Age

9 Financial Independence and Role of Investing Employees Self Employed Professionals – Doctor, Lawyer Businessmen All the income streams arising out of the above need to be invested wisely so as to speed up one’s journey towards financial independence. Being a good ‘Investor’ is therefore an imperative and a worthwhile professional pursuit. Being an ‘Investor’ can also be an independent profession apart from the above 3 well known sources of livelihood.

10 Investing related terms Return Risk Time Horizon Liquidity Taxation Special Circumstances Inflation

11 Section II Inflation and Asset Allocation Decision

12 Inflation Inflation is a tapeworm that can destroy one’s dreams. Although, the Government declared Rate of Inflation is 8%, everyone MUST calculate his / her own inflation rate. Own Inflation Rate would be dependent on his / her consumption basket and would vary depending on state of life How does one calculate inflation rate? It is increase in your annual expenses in the current year divided by your previous year’s expenses assuming you didn’t have change in lifestyle. Needless to say one has to beat one’s own inflation %.

13 Example: Inflation and FD Return If today you have money = to 20 years of expenses: At an inflation of 8%, if you invest all the money in 9% Fixed Deposits and pay 30% Tax, it will last only for 17 years.

14 Example: Inflation and FD Return If today you have money = to 20 years of expenses: At an inflation of 12%, if you invest all the money in 9% Fixed Deposits and pay 30% Tax, it will last only for 13 years.

15 Theoretical Example: 50% Stocks No guarantees but It shows potential If today one has money = to 20 years of expenses 50% of money in Stocks (@16.5% Return) and holds for more than 1 year, 37% in Tax Free Bonds (@8.5% Return) & 13% in Fixed Deposits (@9.5%), then Expected Post Tax Return could be 12% (i.e. ONLY 4% spread over 8% inflation) Effective Tax Rate would be 4% ( no tax on gain on stocks ). The money would last for 37 years. If today you have money = 30 years of expenses, then it will last for infinite number of years. You won’t run out of money

16 Choices: FDs v/s Volatile Potential High Return Stocks Increase in inflation rate can destroy us. One has to face 2 choices: 1.Hold all money in Bank Fixed Deposits and progressively lose your purchasing power and run out of money in retirement OR 2.Tolerate the volatility in high return asset classes like Stocks and Equity Mutual Funds for the possibility of money lasting through retirement. Choice 1 is riskier than Choice 2 Primary Goal of Investing – Earn a Risk Adjusted Return so as to beat Inflation

17 Section III Being a Successful Investor

18 How can one become a successful Investor? Using Cricketing Analogy for Scoring Runs: – Employ Best Offence (Hit boundaries & Sixes) – Aware – Earn High Risk adjusted Return through awareness of various Investing Options – Employ Best Defense (Protect your Wicket) – Beware of all kinds of Investment Risks

19 Section IV Best Offence: Awareness of Investment Options so as to Earn High Risk adjusted Return It is better to be uncomfortable living in awareness than to sleepwalk and stagnate. Equity Mutual Funds & Stocks

20 Equity Mutual Funds over 6 years January 2008 Peak to January 2014

21 Learning: Equity Mutual Funds Low Rtn: Some well known Equity Mutual Funds returned only 3% return over 6 year holding period beginning with 2008 SENSEX Bull Peak. This can test patience of an investor even though over 30 year period beginning 01 April 1984 SENSEX returned 16.5%. If one was disciplined enough to invest in SIP the return would have been higher @11% Constantly moving funds from Value Research’s 3 Star funds to Value Research’s 5 star funds is like ‘driving on the highway with rearview mirror’.

22 Few Stocks that beat the SENSEX Stock Allocation Category 1

23 Stocks: Awareness and Research is worth one’s time There were at least 35 well known stocks that beat the SENSEX by a wide margin over a 6 year period from 08 Jan 2008 (prior peak) to 08 Jan 2014. Equal Weighted Return was 23% while SENSEX gave ZERO Return. Investor would have made 4 times in 6 years as against ZERO Return for SENSEX. Awareness and Research is worth one’s time.

24 Example: One of the criteria to look for such stocks for further research Select Listed companies other than Banks Find out a sub set / short list with following criteria: Companies that have had a total debt to Equity Ratio less than 0.2 in each of the past 10 years. Companies that have paid equity dividend in each of the past 10 years. Cumulative Dividend paid out divided by cumulative Net Profit of the past 10 years is greater than 25%. Market Cap > Rs.1,000 Crore

25 Section V Best Defense: Beware of Risks Develop Right Attitude Beware of Risks and Mis-Sellers to protect yourself from loss Diversify Assets and Income Streams All about Risks so as protect yourself from Investment Loss: – Stocks and Mutual Funds – Derivatives – Futures and Options with Example – Fixed Income Mutual Funds – Be a Discerning Risk Evaluator – FDs: Bank, Company FDs, FDs v/s FMPs, Private FDs – Human Greed, NSEL Scam and Ponzi Schemes – Real Estate – IPOs: Prospectus – Password Security, Record Keeping and Nomination

26 Best Defense - Attitude Warren Buffett (a Legendary Investor and one of world’s wealthiest): – On Spending: If you buy things you do not need, soon you will have to sell things you need. – On Saving: Do not save what is left after spending but spend what is left after saving. Well, you may have heard people saying “it’s never too late” but Warren Buffett teaches us that it’s never to early. Warren bought his first share at the age of 11. He also bought a small farm at the age of 14. Still, he regrets that he should have started earlier. Albert Einstein: “Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it.” Start saving more than 30%-50% of Income at an early age 20-22. Discipline – Almost Robotic Postponement of Gratification is the first sign of Emotional intelligence.

27 Best Defense – Beware of Risks and mis-sellers जो दुसऱ्यावरी विश्वासला त्याचा कार्यभाग बुडाला. One who is not alert or vigilant or excessively trusts other people is doomed for failure in life. Warren Buffett: “Honesty is an Expensive Gift. Do not expect it from Cheap People.” Beware of aggressive or incompetent sales persons pampering your ego. Understand what is in it for him. Learn to say ‘No’. जर तुमच्याकडे पैसे असतील तर निसर्ग नियमाप्रमाणे गुळाच्या ढेपेला जशा मुंग्या लागतात तशी लोकांची रांग लागू शकते. परंतु त्यामुळे ' मैं भी कुछ हु ' असा दुराभिमान बाळगून स्वतःचे नुकसान करून घेऊ नये. Banks will call you ‘Privileged customer to boost your ego. Warren Buffett: "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1"

28 Best Defense – Diversify Assets Personal Balance Sheet

29 Diversify Income Streams Do not put all your eggs in one basket. Multiple Employers: Consider these Asset Classes as Multiple Employers paying you salary by way of Dividends, Capital Gains, Interest. If any one of them fails, still you will survive. Diversify within Equity Asset Class as well. At least have 30 durable companies in the portfolio. Remember, In India: जिसके हाथ में लाठी उसकी भैस. जिसके हाथ में चेक बुक उसकी कंपनी. Never fully trust the financials of a company.

30 Stocks and Mutual Funds Examples only – Not Recommendation Volatile Asset Class – Be ready to face quotational loss. Warren Buffett: “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.” Never run after a ‘Missed Bus’. Avoid Fads, fancy IPOs, Leveraged Cos. Avoid hope & event based investing. Equity Mutual Fund NFOs offer units at Rs.10/- but remember that the underlying will be stocks. Buying at Rs.10/- doesn’t make a NFO any safer. Buying Cheap / Penny Stocks and keep averaging at lower levels is likely to wipe out your capital e.g. Kingfisher Airlines Stock. This is best avoided. Buy Durable Companies – Example: Nestle, Bosch have survived 2 world wars and are 125 year old companies.

31 Stock Futures & Options Segment Derivatives in Commodity & Currency Warren Buffett: Derivatives (Futures and Options) are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal. If you are not a CFA Charterholder and if you are not professionally trained, simply avoid Derivatives Segment.

32 Example: Destruction caused by Derivatives Facts of a Pune Case in Derivatives Trading A lady in her 50s had a Demat Account with Broker for 10 years. Shares bought on Delivery Basis. She never dealt in Futures & Options (F&O) Segment. She received a call by a sales person pursuant to which she got registered for currency trading in 2012. Strict Instructions: 2 lots trading only. Shares were kept as collateral. Broker violated limits verbally imposed by her. Broker Relationship Manager used to call up the client in the evening and confirm the trades but there was no proof of order placement by her. Total Loss in 6 months was over Rs.6 lacs. Reference to Sole Arbitrator was made under NSE Regulations. Award granted in 6 months. Award: “I treat all trades as NULL and Void and direct the entire claim of Rs.6,50,000/- be paid to the applicant.” 3 employees of Broker lost jobs.

33 Risks: Fixed Income Mutual Funds (Debt) Credit Risk – Real Estate and Infrastructure Interest Rate Risk – Even if the fund holds 10 year maturity government securities of high credit quality, increase in interest rate by 2% can wipe of 20% of corpus. Liquid Funds are supposedly safer option to park funds that may need to be accessed at short notice. Having said this, there was 1 instance in 2008, when the NAV dropped.

34 Be mindful and discerning enough to different subtle shades ‘Risk’ One family will always have variations within: Talkative, Quiet, Scholar, Tall, Short, Fair, Dark Asian Paints offers 60 shades of White. Other Examples: Snow, Honeydew, Milky Way, Crushed Ice ……….

35 Bank Fixed Deposits Deposit insurance and credit guarantee corporation (DICGC) protects each depositor in a bank up to a maximum of Rs.1 Lac. It would become unmanageable to open accounts in multiple banks to get this protection. If we were to restrict ourselves to say 5 banks, what are our options? We need to be discerning and somehow be able to come up 5 options within this category.

36 Types of Banks Nationalized Banks Private Banks Co-operative Banks

37 Criteria Too Big to Fail – RBI to start announcing too- big-to-fail banks in Aug 2015 What is our guess? SBI, PNB, BoB, ICICI, HDFC Bank Instances of Uncertainty / Failures in the past: GTB, UWB, Sangli, Suvarna SB, Ganesh, Rupee

38 Bank FDs v/s FMP Reading between the lines All articles in newspapers are in chorus: FMPs are better than Bank FDs. Partly True: low taxation and high return But learn to ask the right questions through a checklist provided earlier: Return, Risk, Time Horizon, Liquidity, Taxation, Special Circumstances Is the Risk identical? – What if the FMP has a Real Estate or Infrastructure Company Debt?

39 Company Fixed Deposits Some people work for 30-35 years in a company and develop affection and confidence. A retired employee of Mysore XXXX, kept all his provident fund money as fixed deposit. Money lost 15 years ago. Age 84. Miserable Life. For getting 1% extra return, consider whether you would lose 99% of principal amount.

40 Deposits given to Individuals v/s Institutions Categories: – Friends and Acquaintances – Real Estate Builders – Unlisted Companies Be realistic about your capability to recover. Assume total loss. Understand the difference between Banks v/s Individuals. Moreover, remember the In-Flight Safety Announcement: “In the event of a sudden loss of cabin pressure, oxygen masks will automatically descend from the ceiling. Grab the mask, and pull it over your face. If you have children travelling with you, secure your mask first before assisting your children”. Unless, you achieve your own Financial Security, be careful while helping others – you may never recover your money – either willful or otherwise due to unfortunate events.

41 Be Discerning w.r.t. Risk Return #Investment FeaturesUnsecured NBFC DebenturesGovt Tax Free Bonds 1Pre-Tax Return @31% Tax12%NHB 13% 2RiskUnsecured AA-Secured AAA 3Time Horizon6 Years20 Years 4LiquiditythinThin 5TaxationTaxableTax Free 6Instances of uncertainty / failure Anagram, Alpic, CRB, Golden Forest India and Golden Project, Saradha None

42 Warren Buffett on Greed Warren Buffett: – “If it seems too good to be true, it probably is.“ – “No matter how great the talent or efforts, some things just take time. You can’t produce a baby in one month by getting nine women pregnant.”

43 Example: NSEL Scam: 12-15% Guaranteed Return Product mis-selling After National Spot Exchange defaulted in July 2013, it was discovered that most of the underlying commodities did not exist and the buying and the selling of commodities like steel, paddy, sugar, ferrochrome etc. was being only conducted only on paper. The pair trades in various commodities were offered in one-day forward contracts of T+2 and T+25 payment terms (bought and sold at the same time). Such pair trades offered an arbitrage opportunity of about 12-15% return per annum. The investors, who honored the T+2 payment obligation, found that the National Spot Exchange neither had the money, nor the commodities, to honor their T+25 dues. Around 24 borrowers were given the funds by the NSEL, without any underlying commodity deposited by those borrowers. An estimated number of 15,000 investors, along with public sector units like MMTC and PEC, were victims of this NSEL scam.MMTC

44 Ponzi Schemes It's a scheme in which investors are paid from money collected from new investors instead of the scheme's earnings. It works as long as new investors keep coming in. Modus Operandi: – Charlatans promise unbelievable guaranteed returns. – Gullible and Greedy Investors part with their money – initially small sums. The greed to make 'easy' money is so intense it overpowers their financial wisdom. – These early investors get the promised return. – These early investors increase their contribution many fold – By word of mouth publicity more investors get attracted. – After accumulating sizable funds, the Charlatan disappears. Examples: Blue Chip Hadapsar, Saradha;

45 Risks associated with Real Estate Across the 92 micro markets that Crisil Research tracks, while the average return over the past 8 years has been 11-12% (Pre-Tax). Non Transparent compared to other Investment Options. Can not be sliced or diced like stocks. Big chunk of money necessary. Most people buy 1 home in their life. Property in litigation can wipe out one’s life. We buy noodles, biscuits, shirt, TV after carefully reviewing the product. However, most Real Estate comes up with customers’ money. It is a free ride for the builder. Long gestation periods even up to 3-5 years. Wait can be stressful. Umpteen examples of stuck projects due to untimely death of builder, Builder unable to furnish bank guarantees for re-development projects, lack of environmental clearance, defense lands, lack of basic amenities – roads, water. Most Customers take disproportionate risk and are unaware of it.

46 Prospectus Risk Factors IPO Prospectus is too voluminous for investors to read. Investor must read Internal ‘Risk Factors’. More particularly pay attention to: – Promoter Specific Risks: Due Diligence – legal cases – Company Specific Risks: legal, statutory dues, product, market, event specific IPO: Many times, odds are stacked against the investor.

47 Password Security and Record Keeping Read suggestions on internet about how to create a password that is easy to remember & difficult to crack. Use incognito browsing. Sign out before closing the browser. Always have a nominee for everything that you invest in. Make sure that there are absolutely no errors in spelling anywhere – names, PAN Number One family member on monthly rotational basis should take the responsibility of filing papers and record keeping in a spreadsheet. This makes everyone aware.

48 Section VI Taking Care of yourself Scams: Capital Market and Retail Take Care of Yourself Problems in Investment Marketplace Warren Buffett on IQ and Investing Key Message in this Presentation

49 Capital Market Scams Ref: Prime Database

50 Retail related Scams Ref: Prime Database

51 Take Care of Yourself Just because there is Police Department, you don’t keep your home door open at night and go to sleep. Warning: Cigarette Smoking injurious to health. Apply the same logic for investments: Just because SEBI exists, you can not rely on goodness of strangers if you don’t wish to be cheated. Example: Investment in Kingfisher – No Investment Protection SEBI Law can save you.

52 Problem with Investment Market Incentives: Sales Persons suggesting investment options earn huge incentives. Hence, perpetually, you as an investor, are at odds to begin with. Risks: Advisors who are professionally trained in the investment discipline may have knowledge but not the right attitude to give sound advice. They don’t understand risks.

53 Warren Buffett on IQ and Investing IQ: Over and over Warren Buffett has emphasized that investing is not an area where a person with a high IQ beats a person with a lower IQ. He said "You don’t need to be a rocket scientist. Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Rationality is essential." Temperament स्थितप्रज्ञ : He has also talked about the importance of temperament as opposed to intellect. “The most important quality for an investor is temperament, not intellect. You don’t need tons of IQ in this business. You don’t have to be able to play three- dimensional chess or duplicate bridge. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd. You know you’re right, not because of the position of others, because your facts and your reasoning are right.” Independent Thinking: Buffett also emphasizes the importance of thinking for your self. “You have to think for yourself,” he said. “It amazes me how high-IQ people mindlessly imitate.”

54 Summary (Key Message) Financial Independence is a worthwhile pursuit. FDs don’t protect you from Inflation. You will quickly run out of money. Consider asset allocation to equity mutual funds and stocks. Quite a few stocks have beaten SENSEX by wide margin. Do own Research. Don’t put all your eggs in one basket. Buy at least 30 durable Stocks. Consider Equity MFs, Tax Free Bonds, FDs. SBI, PNB, BoB, ICICI, HDFC could possibly be ‘Too Big to Fail’ Banks for your FDs. Be discerning for ‘Risk’ – 9% NHB Tax Free is better than 12% NBFC NCD. Avoid Futures and Options, Commodities or Currency. FMP may have higher Credit Risk as compared to FD.

55 Summary (Key Message) continued…. – Be careful with Company FDs. Be careful while lending to Individuals. – One wrong Real Estate Investment can wipe out your life. – Protect your passwords. Every family member must know your financials. Warren Buffett: “A public-opinion poll is no substitute for Independent Thought.” जो दुसऱ्यावरी विश्वासला त्याचा कार्यभाग बुडाला. One who is not alert or vigilant or excessively trusts other people is doomed for failure in life. It is better to be uncomfortable living in awareness than to sleepwalk and stagnate. Investment Success is all about EQ and little about IQ.

56 Summary (Key Message) continued…. If you don’t have investment knowledge, always invert and ask simple commonsense questions. Beware of Salespersons. Incentives can corrupt their minds. Never say ‘Yes’ till you fully understand what the Broker communicating. One can’t avoid ‘Risk’ in life, learn to manage it. Develop an insight in to what constitutes ‘Risk’. Warren Buffett: “If it seems too good to be true, it probably is.“ Beware of Ponzi Schemes. Albert Einstein: “Two things are infinite: the universe and human stupidity; and I’m not sure about the universe!”

57 Thank You


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