The fundamentals of Asset Allocation

Doesn't Asset Allocation (AA) sound sophisticated? It assumes you have an asset to allocate and gives a boost to your ego. It's a smart and sexy word for something as drab and dreary as planning your personal finances. Asset allocation also gives you a feeling that you are holding some aces up in your sleeves. It specially applies to the Financial Planners or Advisors.
But seriously, asset allocation is a useful concept to know. And it's very simple too. Once you get your fundamentals clear about AA, you can use it to your advantage. It is the first step of adding value to your money or putting your money to good use.
Asset allocation is the percentage distribution of your money into equity, debt and liquid instruments. Equity, as you know, gives the highest growth but comes with the highest risk. Debt instruments are more or less guaranteed but give you a lesser return. Liquid money is your money in your savings account.
Let’s start with the thumb rule of AA. Your allocation to debt should be equal to your age. And as you age, the percentage in debt should increase too. In other words, your investments in equity should be (100 - your age).But AA should be much more dynamic than the above thumb rule. I feel that it should depend on your age and your risk appetite. Guys at 20-25 years of age may want to invest everything into equities and I think that is the right strategy.
And before you set off to do some AA for yourself, I would like you to ask the following questions to yourself:
What is your risk appetite? I mean if you are jittery with the slightest tremor in the stock market, you better be away from the stock market. Even though, stocks give the best returns on a longer run.
What are your financial goals? For example, if you believe in frugal approach to life and give a thumbs up to "Simple living, High thinking", you don't need to set very high goals with your money. In the other case, you may have to align the allocation to your goals.
When do you need the money? Is it for the car you want to buy in another 2-3 years? Or is it for the dream house 10 years from now? Ask yourself and then decide your asset allocation.
And if you love ready made formulas, here's some allocation strategies from John Bogle:Older investor in distribution phase: 50% equity; 50% debtYoung investor in distribution phase: 60% equity; 40% debtOlder investor in accumulation phase: 70% equity; 30% debtYoung investor in accumulation phase: 80% equity; 20% debt
The accumulation phase means the period when you have no use for the money and are focussed on building it on. In the distribution phase, you are also using your assets for your goals.
All said and done, AA can contribute to your financial prosperity in a big way. Studies have pointed out that the asset allocation decision is more important than the process of choosing the actual stocks, funds and even market timing. In other words, if you just replace active picks with simple asset allocation decisions, it will work just as well as, if not even better than, professional fund managers.
Do your allocations now.

Seven Deadly Sins of Financial Planning

Financial planning is a critical necessity for each one of us who seeks financial control of our affairs and wishes to create wealth. Then why is it that most of us do not have a Financial Plan or have not even given a thought to it? Why is it that we keep trudging along and feel that all will become right one day? Why is it that we always think of how to earn more but hardly give a thought to what our earned money is earning for us? Most of us have not even thought of having a dual income stream – one from our work and the other from our investments.Whether we accept or not, each day or each time we think about creating wealth we are imprisoned by what I call - the seven deadly sins.
Pride: Caused by excessive belief in one's own abilities, Pride happens because in school we were taught to believe in ourselves. But that belief was with knowledge. This sin is committed when we believe in ourselves and choose to act without adequate knowledge. All we want to have is only some idea of what is the best investment. And believing it to be the best for us, we commit that sin forever under the pretext of “I know how this works.”
Envy: You've just seen someone make a killing. And you think, that is reason enough for you to take the plunge as well! But then what if you have taken the plunge at the wrong time. We all know the old age wisdom, “Do not break your own hut by seeing someone else's palace.” Then why is it that we change our asset allocation and bet on something that has worked for another?
Gluttony: Have you incurred credit card debt? Well...in that case know for sure that you are committing a sin each day. Have you taken a loan for a depreciating asset? Now that’s an example of financial gluttony. But then, if you're able to manage the installments of that depreciating asset from your investment returns you're a smarty.
Lust: Whatever you do you are driven by money only. And if you're prepared to move from one job to another for a 20 per cent rise without considering the credentials of the company and the nature of job, you're far from being smart. What if you've just missed on the stock options there? Besides you could have always had the opportunity to create a niche for yourself no matter how large the organization.
Anger: This is widely seen when you are dealing with an agent to who comes to make a sales call and objects to your knowledge or when your broker did not sell when the markets were falling. In both the cases, you were to take the decision. You recall that with anger and/or arrogance you commanded that nothing be done without your consent. Know that in financial management there are two choices – either you take all decisions yourself or let your advisor take that for you. Of course given that you trust his skills and knowledge.
Greed: I hardly need to say anything here. Most people rush to invest in the stock markets when they touch an all time high. Others think markets will go up forever. Surely you cannot time the market but when the goal is achieved why not sell? After all, that's precisely the reason why you invested in the first place. Now if there is no goal and no plan to manage that goal, it is quite likely that this sin will keep revisiting you from time to time.
Sloth: This is the one that I love to talk about. The bible says, “Whatever we do in life requires effort” so if we wish to ask for tips and then act, it is a sure way to disaster. Either we must take effort to do all the hard work ourselves or take the effort to search for a trusted advisor and outsource our efforts. Finding a trusted, knowledgeable and skilled advisor is not a very easy task to do. Sins that were spoken of centuries ago are still so relevant. Needless to say, it is up to us how much we wish to cleanse

Do the high or low NAV really matter?

Nilanjan Dey writes on the perpetual argument on the low vs high NAVs in this Business Line column. He starts off with saying that waiting for corrections indefinitely may not be a good idea. Do not fret if some of your favourite equity funds have risen so much that their NAVs (net asset values) have reached stratospheric levels. That's the crux of an important message that fund houses try to convey every time you confront them with what is clearly a pet theory for some investors: sky-high NAVs are too unfriendly.
However, high NAVs are actually a matter of perception. They need not necessarily stop an investor from putting in fresh money. Instead, in a manner of speaking, they point to the way in which the funds concerned have done in recent times — a trend that is quite ably reflected in the kind of NAVs they have.
Never in the history of MFs in India was this dilemma more relevant as now. As pundits will no doubt tell you, NAVs of equity funds simply represent the state of the stock market. Lately, the latter has done superbly — mind you, it indeed has in the past few years — and NAVs have scaled new highs, crossing a number of psychological barriers in the process.Waiting for correction?
What could possibly prevent the average investor from entering at this stage, considering the sheer rise in NAVs? Well, the answer is obvious. He is waiting for the market to correct, for the NAVs to come down to what he thinks are more reasonable levels. A very astute decision, you may well think, right?
Not entirely. To put it bluntly, waiting for such corrections indefinitely may not be a good idea after all. Just in case the market goes up yet again, the investor may well lose out considerably by not joining forces. That's a very optimistic view, you will contend. There is the likelihood that sentiments may in fact turn bearish, forcing NAVs to slide. Should you then panic and start selling out? Some of us may be tempted to do just that — not paying heed to the argument that the bearishness may be transient.
Let us at this juncture quickly scan the NAV tables to find out how many funds have sailed to dizzying levels. Here goes: Birla Advantage Fund (Rs 150 or so, in the growth option), Franklin Prima (Rs 240), HDFC Prudence (Rs 135), Reliance Growth (Rs 350) and Sundaram Select Midcap (Rs 110). We have rounded the figures for convenience.The rising story
Of course, this list is not comprehensive and quite a few other funds have NAVs of, say, over Rs 100.
In fact, some of the country's older funds (we will include those with 10-year-plus track records) will easily find a place in this sub-set. And, if the longer-term India story retains its appeal, this sub-set will only grow in size. Fund managers will try to capitalise on the opportunities dished out to them by the market. And, as a result, NAVs will keep soaring.
The short point is, all this hype over high NAVs should not deter you from putting in fresh allocations.
If you are convinced about a fund's performance (and its potential), go ahead and write that cheque you have wanted to for a long time. NAVs, high or low, tell just one side of the story. What do you think?

Why you must NOT pay entry load on mutual funds

The market regulator Securities and Exchange Board of India, SEBI, in January 2008 abolished entry load on Indian equity funds if you're investing directly. However, it is mandatory to pay an entry load of 2.25 percent if you transact through intermediaries, also known as distributors by you and me. The distributors take this charge to service investors.

How is it levied on the investor?

Investor has to be careful and aware of how this charge is levied, since nobody asks you to pay this charge separately. Instead, it is deducted upfront from your investible money right at inception.

Suppose you are investing Rs 100 and the NAV (net asset value) of the scheme that you are buying is Rs 10. This NAV is multiplied by 1.0225 (2.25 percent of Rs 10) to factor in the entry load and operative NAV for you becomes Rs 10.225 (Rs 10 as the actual NAV and Rs 0.225 as the entry load).

This takes the number of units allocated to you to 9.78 and the money invested is Rs 97.8 instead of Rs 100. The remainder Rs 2.2 (100 less 97.8) goes to the distributor and to meet other administrative expenses incurred by the mutual fund company. However, if you invest directly through that mutual fund company's website then the whole Rs 100 is invested and you hold 10 units.

Cascading effect of this cost

While you lose this money upfront, this charge literally multiplies. For example, even on a conservative basis, Indian equities can double in the 5 years. Since 2.25 percent has been deducted upfront and not been invested, what you have lost is 4.5 percent (double of 2.25 percent) from your returns.

Consequently, it is a simple decision that you should invest directly and not pay this significant charge.

New favorable development

Abolition of this load is leading to the emergence of fee-based wealth management advisories in India. Just a fraction of the money that you save through direct investment can be utilised to buy the services of such an advisory.
Rajasthan Royals and the art of creating wealth

They will facilitate your direct transactions in addition to a host of other wealth management services.

Analysis of charges

On an average we are assuming that you are paying a rate of 0.4 percent of the assets under management (AUM) annual fee to your advisor. Since timing of cash outflows is different, we will have to take the time value of money into consideration.

Paying 2.25 percent of upfront commission is equivalent to paying 0.4 per cent of AUM every year for 13 years. In other words, what you are paying for 13 years you lose in one single shot when somebody charges you 2.25 percent upfront.


Additionally, a transaction-based company which has tasted blood by getting an upfront commission of 2.25 percent is likely to turn over your portfolio very soon and many times over, even when not required.
On the contrary, a fee-based advisor wins only when you win and his interests are totally aligned with yours. Even when he reallocates, it is at zero cost to yours and at no advantage to such an advisor and therefore it will be done only when really required.

Conclusion & recommendation

Consequently, my strong recommendation will be to take full advantage of this gift and investor-friendly move from SEBI, save lots of money and bolster your returns.

Value of NAV of a Mutual Fund

A number of people think that the unit price of a mutual fund matters when they purchase; i.e. that a cheaper unit price is better. Why? They say that they will get more units for the same money, and isn't that better? We shatters this myth in his blog.
The "Number of units" does not matter at all. It is all about gain percentages. The best funds have gained some 750% in five years. What does that mean? That means if you bought that fund at Rs. 10 in 2001 its NAV will now be Rs.75 .
If you bought it at Rs. 20, NAV will be Rs. 150. There are lots of such funds whose NAV is greater than 100 or 150 because they have performed very well. What's the NAV?
The total NAV, or "Net Asset Value" is a simple concept - First you get the "Net Assets", which is the sum total of all the assets minus any liabilities of the fund. Meaning, add the current market value of all the shares, minus any open redemption requests and any applicable charges (like Daily fund management fee etc.) and you get the Net Assets. Divide the Net Assets figure by the total number of outstanding units and you get the unit price (called the "NAV Unit Price" or simply, the NAV).
Most web sites and newspapers call the unit price "NAV". It's actually the NAV unit price, so the phrase is confusing. Let me not confuse you any further: I will call the total assets as the "Net Assets" and unit price as the "NAV".
Now you might think, if you have a 10,000 rupees, is it better to buy 1,000 units of one fund quoting at Rs. 10 NAV, or 100 or those quoting at hundred? Frankly it's dependent on how the fund performs. If the second fund grows at 20%, your units are worth Rs. 12,000 at an NAV of Rs. 120. If the first one grows at 10%, your units are worth Rs. 11,000 at Rs. 11 NAV.
What is better? Obviously the second one, but over here the NAVs are still Rs 11 vs. Rs. 120! Lesser number of units is like small change
But what if you have a 1000 Rs. NAV? That's a problem, you think; if you want 2,500 rupees, you have to sell three units! That means you take out more than you want, right? Also what if you have 1200 rupees to invest? You can only buy one unit, right?
Wrong. In Mutual funds you also get "fractional" units. So if you invest Rs. 1000 in HDFC Taxsaver, whose nav is Rs. 149.44, you will get 6.692 units. (Some funds even go to fourth decimal) You can then sell fractional units also, like 1.212 units etc! Growth is important, not unit price.
What you care about is how much your money grows, not the number of units you have. It is just as difficult for a Rs. 10 fund to move to Rs. 12, as it is for a Rs. 50 fund to move to Rs. 60.

Why should we invest in Mutual Funds?

Investing in the equity market directly is exciting and glamorous. You are in the thick of things and are able to take responsibility for yourself. Though the volatility and the information overload makes it a daunting task. The present subprime quagmire makes it even more daunting.

How about investing through Mutual finds? Doesn't it have its own loading and administrative charges and the fund managers making merry on your hard earned money? And can't we see the best performing mutual funds and follow their portfolio? The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes. NAV of mutual funds are required to be published in newspapers.

Here are some points to ponder:

• We should allocate our time to investment decisions in proportion to our income generation goals.
• Convenience and hassle free investing should be a major factor.
• Fund managers are into it full time. If we able to identify fund managers who have consistently performed over last 3-5 years, nothing like it.
• The fund manager also has the muscle power of crores of Rupees and is able to take entry and exit decisions impartially.
• MFs continuosly churn their portfolio. When MFs buy and sell stocks, they don't have to pay capital gains as you do when you churn.
• We are likely to panic over market crashes. MFs can take advantage of a crash!
• With Systematic Investment plans (SIP), you can start investing with as low as Rs 500 per month.

The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place.

The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes.

Investors can also look into other details like percentage of expenses of total assets as these have an affect on the yield and other useful information in the same half-yearly format. The mutual funds are also required to send annual report or abridged annual report to the unitholders at the end of the year.

Various studies on mutual fund schemes including yields of different schemes are being published by the financial newspapers on a weekly basis.

Apart from these, many research agencies also publish research reports on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves informed about the performance of various schemes of different mutual funds.

Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc. On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.

FII Activity on 19-06-2008 - June 20, 2008

The FIIs on Thursday stood as net seller in equity. The gross equity purchased was Rs2,469.90 Crore and the gross debt purchased was Rs0.00 Crore while the gross equity sold stood at Rs2,919.70 Crore and gross debt sold stood at Rs0.00 Crore. Therefore, the net investment of equity reported was (Rs449.80) Crore and net debt was Rs0.00 Crore.

FII Activity on 18-06-2008 - June 19 ,2008

The FIIs on Wednesday stood as net buyer in equity. The gross equity purchased was Rs2,546.20 Crore and the gross debt purchased was Rs0.00 Crore while the gross equity sold stood at Rs2,173.80 Crore and gross debt sold stood at Rs0.00 Crore. Therefore, the net investment of equity reported was Rs372.40 Crore and net debt was Rs0.00 Crore.