Recently one of my friends came to me for advise on how to invest the sudden fortune he had inherited. Please find the link below for basics of investments by David Swenson, the fund manager for Yale university:
http://oyc.yale.edu/transcript/1075/econ-252-11
As mentioned in the course, 90% of the variability of returns in institutional portfolios had to do with the asset allocation. So the first step is the most important step in the investment process, how much to invest in each asset category. Major asset classes, my recommended allocations and specific investments are:
Cash should be six times one's monthly salary to manage contingencies. It can be invested in either in a high interest rate savings account or a liquid debt fund. This should be one's first investment and till this is met, one should not invest anywhere else.
Bonds is the second most important investment. Bonds are a good hedge against any personal debt. They are also a good source of steady income and diversify risk from equities. It should form (age -10)% of total wealth plus personal debt. The bonds should be selected based on tax status and investment horizon. A "long term tax exempt in-state municipal bonds fund" is good for high salaried young individuals in high income tax states.
Real Estate should be lower of the two, "cost of your house" or "30% of the total wealth."
Equity is a great source of returns in the long run and should form the rest of the portfolio
Lets take an example of 30 year old Rick. He is a salaried individual earning $20K per month salary and has a house that costed him $500K. To finance his house, he took a $400K fixed rate home loan. More recently, he inherited $800K and is looking to invest.
His total wealth is $100K equity in the house and $800K cash. And he has a debt of $400K, he should either repay his debt with the extra cash or invest an equivalent amount in a debt fund to be able to repay his debt in all conditions. After this, he is left with $400K in cash.
6 times his salary $20Kx6 = $120K in cash in savings account. After this he is left with $280K
$280K*20% = $56K in Bonds
He already owns a house and thus further exposure to real estate is not needed
Remaining $280K-$56K = $224K in equities
Thus, as per my strategy, from $800K, he should invest $120K in cash, $456K in Bonds and $224K in equities.
While choosing funds keep in mind expense ratio, tax implications, bid ask spread, tracking errors and overall size of the fund.
Sunday, April 23, 2017
Wednesday, May 16, 2012
Trading strategy: 26% return from Nifty
Here is the strategy based on price/earnings ratio of Nifty:
1. Caculate average and standard deviation of Nifty P/E over last two year.
2. Buy one unit if current P/E is lower than average minus one standard deviation.
3. Sell one unit if current P/E is higher than average plus one standard deviation.
And thats it, I tested this strategy over last 10 years, the returns were 26% and the returns in no point in time fell below 20%.
Saturday, April 14, 2012
LIC's rate of return is 8.25% and is tax free
Today I had nice discussion on LIC policies with one of their agents. One policy seemed particularly good, Jeevan Mitra (table no. 133):
Premium: 1,19,000 per year
Term: 30 years
Insurance: 1.2 Cr for accidental death, 90 lacs for natural death, 30 lacs for disability
Sum at maturity: 1,08,00,000
Ignoring insurance, the rate of return is 6.75%.
However, if we include insurance and assume an equivalent term insurance would cost 28,000 per annum (high by any standard).
Net premium => 1,19,000 - 28,000 = 91,000.
The rate of return is 8.25% and is tax free. Pretty good except that the money gets locked up for 30 years. Alternatives can be PPF, higher returns and lesser locking 15 years.
Therefore, Term insurance + PPF is BETTER than LIC endowment policy.
Premium: 1,19,000 per year
Term: 30 years
Insurance: 1.2 Cr for accidental death, 90 lacs for natural death, 30 lacs for disability
Sum at maturity: 1,08,00,000
Ignoring insurance, the rate of return is 6.75%.
However, if we include insurance and assume an equivalent term insurance would cost 28,000 per annum (high by any standard).
Net premium => 1,19,000 - 28,000 = 91,000.
The rate of return is 8.25% and is tax free. Pretty good except that the money gets locked up for 30 years. Alternatives can be PPF, higher returns and lesser locking 15 years.
Therefore, Term insurance + PPF is BETTER than LIC endowment policy.
Tuesday, April 3, 2012
Is delay in construction helpful?
In an under construction property, is it favorable that construction of your flat is delayed?
From a pure investment point of view, assuming that one has taken a construction linked payment plan (CLPP),which is usually better than the upfront payment method, given unusual delays in India. For simplicity lets assume that CLPP is:
50% upfront
50% at possession
Costs of delay:
- Lost rental income from the constructed property
Benefits of delay:
- Lower interest rate expense on account of unpaid installment (50% in our case)
Rents in Indian metros are now hovering around 5% of property value, and the rental income is taxable. Thus, yield is:
5% * Property value * (1- tax rate) = 3.5%
Interest on home loans is around 11%, so interest expense saved on unpaid 50% installment is:
11% * 50% * Property value = 5.5%
As the interest expense on home loans is tax deductible, you lose out on this tax shield, thus net savings are:
5.5% * (1 - tax rate) = 3.85%
Thus, there only a marginal benefit of delay, accounting for psychological pain associated with delay, there are best avoided.
From a pure investment point of view, assuming that one has taken a construction linked payment plan (CLPP),which is usually better than the upfront payment method, given unusual delays in India. For simplicity lets assume that CLPP is:
50% upfront
50% at possession
Costs of delay:
- Lost rental income from the constructed property
Benefits of delay:
- Lower interest rate expense on account of unpaid installment (50% in our case)
Rents in Indian metros are now hovering around 5% of property value, and the rental income is taxable. Thus, yield is:
5% * Property value * (1- tax rate) = 3.5%
Interest on home loans is around 11%, so interest expense saved on unpaid 50% installment is:
11% * 50% * Property value = 5.5%
As the interest expense on home loans is tax deductible, you lose out on this tax shield, thus net savings are:
5.5% * (1 - tax rate) = 3.85%
Thus, there only a marginal benefit of delay, accounting for psychological pain associated with delay, there are best avoided.
FDs better than equities even over a long tenure
Please follow the link:
http://articles.economictimes.indiatimes.com/2012-04-02/news/31275335_1_sensex-returns-long-term-investors-nivesh-securities
I have been meaning to do this analysis for a long time. This might imply:
1. Indians are risk seekers and our equities were/are over-priced
2. Share markets are highly manipulated and long term investor is left holding the bag
It might mean that the long time adage of equities outperforming debt over a long period is a myth.
http://articles.economictimes.indiatimes.com/2012-04-02/news/31275335_1_sensex-returns-long-term-investors-nivesh-securities
I have been meaning to do this analysis for a long time. This might imply:
1. Indians are risk seekers and our equities were/are over-priced
2. Share markets are highly manipulated and long term investor is left holding the bag
It might mean that the long time adage of equities outperforming debt over a long period is a myth.
Why you should never prepay your education loan
1. Interest on education loan is tax free. For example, if you are paying 12% on your education loan, your effective interst rate is:
(12% * (1-30%(your marginal tax bracket)) = 8.4%).
This shows that your borrowing cost is just 8.4% and you can earn more than this on tax free bonds/FDs these days.
2. Cash in hand is always the best friend (liquidity).
3. It acts as a FREE insurance policy, if anything were to happen to you, your education loan will be written off. But, bank won't make a refund in case you had prepaid your loan.
(12% * (1-30%(your marginal tax bracket)) = 8.4%).
This shows that your borrowing cost is just 8.4% and you can earn more than this on tax free bonds/FDs these days.
2. Cash in hand is always the best friend (liquidity).
3. It acts as a FREE insurance policy, if anything were to happen to you, your education loan will be written off. But, bank won't make a refund in case you had prepaid your loan.
Beware of FDs/bonds of Gold NBFCs
Assume you have gold worth 1 lakh rupees.
1. Goto the NBFC ask for a loan of 95,000 rupees, they advertise 95% loan against gold.
2. Give fake details, 15 minutes processing will ensure you are not getting caught here.
3. A year later if gold prices rise, get your gold back by paying the NBFC. Else enjoy the rip off, complete protection against fall in gold prices.
And that is probably why you should be skeptic of bonds/FDs of these companies, when the gold prices fall, the defaults will rise exponentially.
1. Goto the NBFC ask for a loan of 95,000 rupees, they advertise 95% loan against gold.
2. Give fake details, 15 minutes processing will ensure you are not getting caught here.
3. A year later if gold prices rise, get your gold back by paying the NBFC. Else enjoy the rip off, complete protection against fall in gold prices.
And that is probably why you should be skeptic of bonds/FDs of these companies, when the gold prices fall, the defaults will rise exponentially.
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