Predicting The Future: Two Perspectives

Posted on July 22, 2010 by Ranjan

There are always two perspectives on one topic. But what happens if a single source has two-in-one perspective?
From The 5 Minute Wrapup:

A financial portal has put the fair value of gold at, hold your breath, US$ 52, 381 an ounce! This is a whopping 43 times more than the current price. For an Indian buyer, this is equivalent to nearly Rs 8,00,000 per 10 Gms of gold.

However at the end of the newsletter is another “Investing Mantra”:

“Those who have knowledge don’t predict. Those who predict don’t have knowledge.”

- Lao Tzu, sixth-century B.C. Chinese poet

Okay, good to get both type of intelligence reports. But how do I integrate that into my intellect?

Can you help?

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Expert Equity Analysts Rarely Get It Right

Posted on July 20, 2010 by Ranjan

McKinsey research shows that equity analysts have been overoptimistic for the past quarter century.

On average, their earnings-growth estimates—ranging from 10 to 12 percent annually, compared with actual growth of 6 percent—were almost 100 percent too high.

Only in years of strong growth, such as 2003 to 2006, when actual earnings caught up with earlier predictions, do these forecasts hit the mark.

You can read the entire Mckinsey report here. You need to register.

And here’s another study that I wrote about sometime back:

Further, DALBAR’s update of its Quantitative Analysis of Investor Behavior (QAIB) study found that for the 20-year period, equity fund investors averaged 3.17% compared to 8.20% for buy-and-hold stock investors (S&P 500)

How about taking a look at the 88% solution!

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Play Soccer & Become A Personal Finance Champion

Posted on July 13, 2010 by Ranjan

Spain is Soccer World Cup 2010 Champion. Analysts say that is because of their mental strength, their wily forwards, a strong defence and the hardworking midfield.

Imp: Do remember that what the analyst say is on the basis of hindsight of course. Spain was pilloried for losing their first match by the same analysts!

Apart from the mental strength, which is invisible, what’s visible on the field are three important components.
1. Forwards, to score the goals.
2. Midfielders, to control the game.
3. Defenders, to save, not leak goals.

I know you have this idea that I would be comparing soccer with Personal Finance. Here it is.

Personal Finance has three important components too.
1. Investing, to get more bang on your money.
2. Maximizing your income, to control the game of money.
3. Frugality, to save and not leak money .

And yes, you also need to have that mental strength not to be dragged down by “fear and greed“. And keep coming back even after failure.

In any case, personal finance is not just about investing. It’s also about optimizing your expenses as well as maximizing your income.

I talk to a lot of people on managing money and I can classify them in three categories.

1. I know how to manage money. I save a lot. I have kept it safe and have put all my money with Bank FDs.

2. I know how to manage my money. It’s all about making more and more money. If I have a good income, everything else will be okay.

3. I know how to manage my money. I focus on investing my money in equity which is the best asset class. I focus on maximizing my money.

All of them know that they are managing it well. Infact, they are. But doing one component of it very well does not complete the entire task of managing your money.

Coming back to soccer, a team may say that they have excellent forwards. Like Lionel Messi. But their defenders leak goals. Or the midfield isn’t able to control the game. That’s what happened to Argentina, I guess.

As an aside, when I tell my son (who plays as a forward) that I played as a defender in school, he frowns. He says, “What does the defender do? The real work is done by the forwards”.

My son is less than 16 years old and can be excused. But what about us grown ups? Who think investing is personal finance. Or saving money is personal finance. Or, increasing our income (legally) is personal finance.

Defending, controlling the midfield and attacking relentlessly is what makes a Soccer Champion. So if you want to be a Personal Finance champion, you need to take care of your investing, savings as well as maximize your income.

What do you say? Do share your own perspectives. Thanks.

I edit Personal Finance Online Resources, nurture Financial Literacy Foundation, deliver Financial Awareness Workshops and have built a desktop RupeeManager.

Invite me for a talk. Email me on ranjan@ranjanvarma.com or Call me on +919867755615

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Benjamin Graham on Stock Market Predictions

Posted on July 9, 2010 by Ranjan

I would like to point out that the last time I made any stock market predictions was in the year 1914, when my firm judged me qualified to write their daily market letter, based on the fact that I had one month’s experience in Wall Street. Since then I have given up making predictions.

– Benjamin Graham (in 1963)

From The 5 minute wrapup email.

I edit Personal Finance Online Resources, nurture Financial Literacy Foundation, deliver Financial Awareness Workshops and have built a desktop RupeeManager.

Invite me for a talk. Email me on ranjan@ranjanvarma.com or Call me on +919867755615

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Don’t Trust Me For Financial Advice

Posted on July 8, 2010 by Ranjan

It feels good when people ask for advice and thank me for what they have learned from the blog. But I wonder if it’s right.

The right advice: A good advice means a total understanding of your situation, your risk profile, your spending profile and your income. For example your present spending spree can be a result of giving yourself some shopping therapy for the current stress levels. So, does telling you to minimize your spending help? Maybe yes, maybe no!

Beware of confidence tricksters: When you are stressed to make financial decisions, any guy who gives you advice seems to be an expert. The more confident the advisor, the more trust you have on him.

Finance is Personal: Even with the same age and income profile, a financial decision by a Gujarati and a Bihari would be different. Even between two Gujaratis/Biharis and with the same age/income, the situation could be different. I guess, finance is as personal as the genes we have.

NYT has an article, Ignore Generic Financial Advice: Excerpts:

The financial press, personal finance bloggers and best-selling authors are all sources of information. But don’t confuse information with the real work of figuring out how it applies to your very unique situation. I know many of the best personal finance bloggers. As good as many of them are at providing a filter for information, and even providing general rules of thumb, you are the only one who can figure out how it applies to your life.

And this comment was scathing!

So am I advising that you shouldn’t depend on my advice? (Btw, your head spinning is another side effect!)

I edit Personal Finance Online Resources, nurture Financial Literacy Foundation, deliver Financial Awareness Workshops and have built a desktop RupeeManager.

Invite me for a talk. Email me on ranjan@ranjanvarma.com or Call me on +919867755615

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Doing Your Homework Before Investing In Stocks

Posted on July 7, 2010 by Ranjan

I wrote the following article for FlyLite magazine, which is the in-flight magazine of JetLite. The post takes it’s motivation from Deepak Shenoy’s post on shares, IPOs and stock markets. The proceeds from Flylite would go to a non religous charity as soon as I get it.

Investing in stocks is very rewarding but comes with a caveat. It is not for the faint hearted and you need to have a disciplined and informed approach to stock investing.

A friend was boasting about his Stock picks and how he has discovered a whole lot of money making stocks. To be fair to him, he had a good sense of stocks which were selling below their value in the crashes. And he helped himself with those stocks “On Sale”. But (being a friend), he also admitted that some of his stocks happened to be the “falling knife”. (Falling knife stocks look like undervalued stocks, but continue to go downhill)

The point I want to make is not to laugh at my friend but realize that becoming a self proclaimed stock guru can be easy but dangerous! And we need to beware of a lot of “noise” in the media giving out “hot tips” and “get rich quick” schemes.

That’s why learning all about shares is a good idea before you begin.

Let us take a journey around shares and understand the jargons like Earning per share (EPS), Price Earning Ratio (P/E) as we go along.

Let’s say you start a company named “ChangeTheWorld Pvt. Ltd.”. You and a friend invest Rs 500000/- each to start the company. What you can do is to issue 50000 shares to your friend and yourself and it will have a face value of Rs 10/-. Totally the company has “issued” 100,000 shares of face value of Rs. 10.

Now the company grows. You earn Rs. 1 crore in profits because of a great marketing strategy. The total number of shares remains the same at 100,000. So what is your share of face value of Rs 10/- worth now?

Common sense tells me that the profits divided by the number of shares will give me the answer. This is commonly known as Earning Per Share. For your company it will be Rs 100/-

The exact price of your share is a matter of “valuation”. Typically this is a function of how well you can grow your company in the future, a factor called the P/E ratio which is a multiple of your net profits.

The P/E Ratio that is considered to value your company takes into account the P/E Ratio of your competitors. The average P/E of the industry indicates the growth prospects in the future for that industry.
So let us say that you expect a Price to Earnings ratio (P/E) of 15 on last twelve month earnings, a conservative value that you believe we can get. You can value the company at Rs. 15 crores (1 cr. profit x 15 P/E ratio).

Then suddenly you decide that you need to expand, and need 15 crores more money to allow us to expand faster. We can do two things – go to a bank to borrow or ask for other people to invest in the business. We decide to do the latter.

But who will have 15 crores? We can choose to find a big rich individual or company, or choose to “go public” meaning we ask a LOT of small shareholders to invest whatever they want to, and in return we will issue them shares of the company. Let’s again go with the latter option.

Now you have grown the company and you have built assets for the company, so the value of the company is much higher than the face value of Rs 10/- per share. Obviously I would like to invest in your business and pay much more for the shares. How much should I pay for a share? Read on.

Right now 100,000 shares are valued at Rs. 15 crore as we saw by taking a P/E of 15. That’s a value of Rs. 1500 per share.

Now as the company grows, the profits are accumulated in the reserves in your balance sheet. And your company has 2 cr. reserves but only 10 lakhs as capital. So you can issue more shares as “bonus shares”, reducing the reserves and increasing the capital. This increases the total number of current shares from 100,000 to 1 crore shares, again at a “face value” of Rs. 10. So now you are owners of 50 lakh shares each. And each share is worth Rs. 15 (15 crore total value divided by one crore shares)

To get Rs. 15 crores, we have to issue 1 crore more shares (at a price of Rs. 15). For this you go for an IPO, which will ask for money from anyone who wants to own a share of our business. Post IPO, you will have a total of 2.0 crore shares (1 crore earlier and 1 crore freshly issued shares) and you will be listed in a stock market for anyone to buy and sell your shares. The shares list at Rs. 15, but because the company is expected to grow even more, the price goes up to Rs. 20 per share.

Let’s say another person wants to buy a share of this business but the company has got all the money it needs from the IPO. So there will no further shares issued, but anyone can buy shares from the stock exchange. He will buy shares at Rs. 20. So he will own a share of the company, but he’s willing to pay more than the IPO price because he thinks the company will do well.

The person who sold the share got it in the IPO – at Rs. 15. Now he makes a profit of Rs. 5. Later the other person who bought at Rs 20/- can sell it to someone else at even higher values like 25 etc. The company doesn’t really get affected because it isn’t seeing the money, but the share price goes up as the company starts doing better, and as more people begin to want the shares.

Why does the share price go up? The answer is: Perceived value. I may think the company is worth 15 crore, but someone else might think it’s worth 20 crores. When my shares reach my valuation I sell, but someone else will think it’s a good deal and buy.

To organize such buying and selling, there are commercial “stock exchanges”. BSE and NSE are some of them, though there are a number of other, smaller exchanges in India. An exchange provides a common place for people to buy or sell shares, with sales happening on an auction basis – buyers bid for shares at a price they are willing to pay, and sellers “ask” for a price from buyers. Exchanges match these prices and share exchanges happen along with payments. “Brokers” facilitate these exchanges, and you pay them a fee as brokerage, part of which goes to the stock exchange as well.

I edit Personal Finance Online Resources, nurture Financial Literacy Foundation, deliver Financial Awareness Workshops and have built a desktop RupeeManager.

Invite me for a talk. Email me on ranjan@ranjanvarma.com or Call me on +919867755615

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What Is The 88% Solution?

Posted on June 7, 2010 by Ranjan

This post is about a simple solution to setup your investments. I call it “The 88% Solution”. Why 88%? Because it works for 88% people. It works 88% of the time! This is the third and the final part.

Part 1: The Background & Part 2: The thought process.

There are more than 300 life insurance schemes, numerous health insurance schemes, over 1000 Mutual Fund schemes, 2500+ stock scrips to choose from. Then there are 100+ deposit schemes with Banks, Corporates and the Government itself.

Wouldn’t it be a good idea to bring down the choice galore to a maximum of 20 products to choose from? Can’t this group of 20 products be the best in class and stands validated through a reasonable thought process?

The answer, to my mind, is yes! Read the following 7 points that gives you the a set of 20 products to choose from for your investments.

Before we go on to investing our money, it’s a good idea to take a bit of cover. Let’s start with the emergency fund.

1. Emergency Fund: Keep an amount of three times your monthly expenses in your Bank in a Savings Account.

2. Insurance: Many of you who are just started having an income, are single wouldn’t really need insurance now. But some of you who have started a family need to get a cover. Trying to find how much insurance do you need from the internet will throw multiple calculations and options. Each one of them have their own logic. A simple thumb rule for me is to get insurance worth 60 times your monthly expenses. Not 60 times your gross monthly salary, mind you. Insurance is for taking cover, not profiting out of it. Two products that I would recommend choosing from is LIC’s Anmol Jeevan and Religare’s iTerm. The first one a trusted name in Insurance and the other one is the cheapest one available.

You also need to get health insurance. A group health insurance privided by your company should be enough. If not, start with a mediclaim policy with one of the General Insurers.

To start investing, you need to first exhaust your tax planning options.

3. Tax Savers: Apart from the PF that might be deducted from your salary, getting a PPF account is a good idea. Plus you might go for equity linked tax saver Mutual Fund schemes. HDFC Tax Saver, SBI Magnum Taxgain, Sundaram BNP Paribas Tax Saver, Franklin India Tax shield and Sahara Tax Gain have given a return of 20%+ over the last 5 years.

From the money left after taking a cover and exhausting your tax planning options is available for investment.

4. New Pension Scheme (NPS): NPS is THE best & effective tool that covers capital protection and also provides growth for your retirement plans. With its lowest charges, it also is the cheapest way to get an exposure to the market. Despite being such a fabulous product, there’s not much sales to boast. This is because there’s no commission for an agent there.

Infact getting a PRAN (Permanent Retirement Account Number) under NPS is not easy. I’ll do a detailed post later.

5. ETFs: This Pdf will tell you why ETFs are the best. Nifty Index ETFs which benchmark the Nifty that are available in India are NiftyBEES, KotakNifty, UTISunder, .QNifty

6. Debt Index/ Balanced Mutual Funds At a young age, you can take more risks and I will not ask you to invest in debt funds. But to get a bit of diversification in your portfolio, I will recommend investing in a few balanced funds. Balanced funds have exposure to both equity and debt and their fund managers take a call on when to focus on equity or debt. HDFC Prudence, DSP Blackrock Balanced, Birla Sunlife 95, Tata Balanced are balanced funds which have done well. In fact some of them are at par with Equity Funds!

7. Gold ETF: Gold has been outperforming the equities for the last decade!. Looks like it’s on a dream run. For diversification purpose, investing 5-10% of your money in Gold ETF isn’t a bad idea. Gold ETF is seeing the highest turnover these days and there are a lot of players which are offering Gold ETF these days.

So the 88% solution has shortlisted a set of 20 odd products out of 5000+ financial products. Does it help you get started?

Advantages of the 88% solution:
It tunes out the noise of the market place which is worse than the fish market.

It takes care of Diversification, Rupee Cost Averaging, Asset Allocation principles, Magic of Compounding and all principles and theory of investing.

It also gets you real bang for every Rupee at a very low cost.

And once you set it up, you can forget about it and focus your life on more happening things!

Disadvantages: It’s boring and non-happening. More like a Cricket Test match when it’s the age of Twenty-20.

But the question is, do you need an audience for your finances? Or do you need to perform infront/for the benefit of others? Remember, it’s “personal” finance.

I’ll wait for your questions and your views on the 88% solution. Thanks.

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