PERSONAL FINANCIAL PLANNING

Financial planning, which is infinitely more important than mere investment. Financial planning is like preventive medicine on the financial front. There are certain areas of your financial life that need to be addressed, where a few steps are to be taken, to ensure that you have a stress-free and comfortable financial existence.

1. Insurance 2. Emergency Fund 3. Retirement Planning 4. Housing 5. Extinguishment of Debt 6. Investment 7. Other objectives

INSURANCE
Insurance is the first area of financial planning. Generally, an individual requires three types of insurance health, life and property.

HEALTH INSURANCE
Health/Medical insurance is compulsory for all. Life and property insurance are optional, to be taken only if you need them and to the extent that you need them. This must be compulsorily taken for the whole family. It should be taken even if your employers provide you with a family cover. The reason for this is that you can have job losses, or one or both of you may resign from your jobs. You may also consider migration or relocation to a different place or country. During these vulnerable periods, if you are afflicted with serious illness, you can be exposed to considerable financial stress at a time when you have no medical cover. The advise you to take out a family floater health insurance policy in India. If by any chance you need to make a medical insurance claim when you are employed, ensure that the claim is made against your company insurance cover. However, have a 'private' family health cover to take care of situations when you may not have health insurance. Furthermore, once you retire, you will cease to have health insurance benefits from your employers. When you are aged 58 or 60, you will find it extremely difficult and prohibitively expensive to obtain health insurance. However, if you can show a long track record of paying premiums regularly on your 'private' health policy, there is no difficulty in renewing and even increasing your health cover later on in life. Lets understand the difference between stand alone health covers or individual health covers and floater health covers with an example. Let us assume you want to take individual health covers of Rs 1 lakh each for you, your wife and your child. Now, if only you have to make a claim for a medical problem of which the cost of treatment is Rs 3 lakhs, you will be reimbursed a maximum of just Rs 1 lakh, because only Rs 1 lakh has been taken on each individual. However, in a family floater policy, any one member can utilize the entire cover of Rs 3 lakhs. Such flexibility is better. Floaters are available from most banks in India. To conclude, it would be advisable to take such an insurance cover for you, your spouse and children and renew it every year, hiking the cover every block of 5 years or so. Floaters generally cover a total of 4 members of a family. Premiums are quite reasonable.

LIFE INSURANCE
No insurance in the world is more wrongly sold than life insurance. We will discuss about whether you require it or not, later. First, let us have some ideas on insurance which are based upon the advice of some of the world's best writers on financial planning, insurance and investment. Life insurance should be purchased only if required and to the extent required. A. N. Shanbhag is perhaps the best Indian writer on investment and financial planning. This is what he has to say about life insurance: "There is no substitute for life insurance. Life insurance is not an investment. It is a social and commercial instrument to provide financial security in the event of death of the insured. If dependents can look after themselves comfortably without the amount insured, life insurance is not needed. Life insurance is like a life saving drug. If you need it, you must have it irrespective of the cost. If you do not need it and you take it, it can have very bad side effects on your financial health." So the first question to be asked is: Do you need life insurance? The answer is simple. You need life insurance only if you have financial dependants. If no one is going to be financially affected by your absence, you do not need life insurance. The next question is: How much life insurance do you need? The answer is, enough to keep your financial dependants in the lifestyle they are used to, ensure that they are debt-free, and provide for their reasonably foreseeable future needs. In other words, enough to compensate your dependents for the adverse financial situation caused by your absence. Let us take a simple example for attempting to calculate how much life insurance a person needs. Suppose there is a family consisting of husband, wife and two very young children. Let us assume that the monthly normal expenditure of this family is Rs 25,000/-. That means a cash requirement of Rs 3 Lakhs per annum, to ensure that the family lives in the lifestyle it is accustomed to. Now supposing the husband is the sole bread winner of this family. His first concern will be that the family will not have the cash flow of Rs 3 Lakhs per annum, in case he should suddenly be removed from the scene. Therefore, he must calculate what size of corpus must be invested in a safe avenue of investment like a bank fixed deposit, to ensure that the family gets Rs 3 Lakhs per annum. If a corpus of Rs 43 Lakhs is invested in a safe avenue like a bank fixed deposit at an average rate of interest of say 7% p.a., it will provide the family with the required income stream. However, this does not mean that the husband must rush out and straightaway purchase Rs 43 Lakhs worth of insurance. There are some deductions to be made from this corpus. For example, he may already be having financial savings of say Rs 10 Lakhs. His wife may have financial resources of her own of another Rs 15 Lakhs. Let us say that the value of his retirement benefits, existing insurance policies and other cash flows that will accrue in case of his death amount to another Rs 5 Lakhs. This total of Rs 30 Lakhs must be deducted from the Rs 43 Lakhs corpus envisaged earlier, since it will be available to provide the necessary income stream. Therefore, there is an uninsured gap of Rs 13 Lakhs, that is 43 Lakhs minus Rs 30 Lakhs. This is the amount for which life insurance must be taken. We have of course given a very simple example, assuming that this family has already taken care of its housing requirements. You can discuss with your close family members and calculate your own insurance requirements. Going back to the example under consideration, if when doing your calculations, you find that your total liquid assets are say Rs 45 Lakhs, that is more than the corpus of Rs 43 Lakhs that would be required to provide income to take care of normal expenditure, then you do not have an uninsured gap and you certainly do not require life insurance. One final point. Do not be fooled by advisors who do complicated calculations to arrive at how much life insurance you need. They will add things like child education, marriage expenses, etc., to inflate the quantum of insurance to be taken. No one can predict the future, especially the distant future. The period of vulnerability is one, two, three or a maximum of five years after a death occurs in a family, especially of a breadwinner or important earning member. Human beings are very resilient by nature and are capable of adjusting to, and dealing with, new, adverse situations, in the medium to long term. It is in the short-term that they are vulnerable and need the protection of life insurance.

When we talk about expenses based on which to calculate life insurance needs, we generally talk about normal current monthly expenses. There is however definitely no harm in a slight increase in the estimate of these normal expenses. For example, if we are talking about Rs 25,000/-worth of normal monthly expenses, you certainly can provide for Rs 30,000/- normal expenses for the purpose of life insurance requirement calculations. However, there is no need to substantially inflate these figures or worry about providing for 10 or 20 years hence. No one can predict the future including what shape general circumstances or economic circumstances including inflation is going to take. The two simple examples are; Twelve years ago, the cost of a telephone call from Mangalore to Bombay was more than 26 rupees per minute. If anyone had predicted that the cost of this call would come down to less than Rs 1 per minute, he would have been laughed at and dismissed as a madman. Similarly, if someone had predicted that one day, you would have air tickets of Re 1/- (subject of course to conditions) available in India, no one would have believed the prediction. There is already a built-in safeguard in taking only normal monthly expenses for insurance calculations. In practical terms, we have observed that the expenses of a family tend to go down immediately after the death of one of its members. This is because expenses that used to be incurred on that particular person are no longer incurred. Further, as mentioned earlier, it is impossible to predict future inflation rates and future fund requirements. So long as the rest of the family is adequately insured for health, and to the extent required for life, the best you can do in life insurance is enable a corpus to take care of normal expenses for the next few years, say a maximum of 5 or 6 years. It is important and most people do not realise it when they buy insurance: Human beings are extremely resilient. They tend to adjust sooner rather than later to new situations, including existing, adverse situations. The greatest period of vulnerability is generally not more than, one, two or at the most three years from the date of death of the breadwinner. The final point for consideration is, what kind of life insurance to take? There is only one type of life insurance that is truly beneficial for the person buying it, and that is pure term insurance. This type of insurance is sometimes also called pure insurance or term insurance. Term insurance provides compensation in case the risk, against which protection is sought, actually occurs. There is no mixing up with investment. Term insurance is extremely economical. Going back to our example, in case there is an uninsured gap of Rs 13 Lakhs and you go to an advisor, he will actively discourage you from taking term insurance saying that you get nothing back for all the premiums you pay. He will not mention of course, that you will get protection from the perceived risk, which is the sole objective of term insurance. If you take a 10-year term policy for Rs 13 Lakhs, and if you are aged about 35 years, the term insurance premium may not be more than Rs 5,000/- per year. If you survive the term of the policy, you get nothing back. No problem. Be happy you survived! If something unfortunate happens, your nominees get Rs 13 Lakhs. Term insurance is that simple. If having taken a term policy, at sometime in the future, you decide that you no longer need insurance; all you have to do is stop paying the next premium. This brings another important point. Life insurance should be taken when there is a need for it and should be discontinued when the need for it disappears. So, life insurance requirements should be reviewed once in a while, at least once in five years. If you have taken a housing loan, then you must take adequate mortgage insurance, which is nothing but term life insurance, which will result in the insurance company paying off the entire housing loan in case of your untimely demise. Life insurance is too important a subject to deal with lightly.

PROPERTY INSURANCE
Property insurance too is not compulsory. insurance. If you have no meaningful property, you do not need property

A number of youngsters today well qualified, landing jobs in India at a salary of approximately Rs 3 Lakhs per annum. They may be working well away from their hometowns. Most reasonably good Indian companies provide them with comfortable accommodation. Such individuals have virtually no property and mostly live out of a suitcase. This is a classic case of not needing property insurance. Of course if they own a vehicle, insurance of that vehicle is compulsory under the motor vehicle laws.

On the other hand, take the case of a person who owns an apartment in India. There are two aspects to an apartment. First is the absolute right you acquire to the area situated within the four walls of your individual apartment. Second, there is the undivided right and interest that you acquire in the land on which the apartment is built and also in its common areas and facilities. This is a joint right you hold with the other apartment takers. Property insurance is relevant to both these aspects. You must insist that the association of apartment takers or co-operative society that runs the apartments, insures the entire structure of the building and also vitally important equipment such as transformers and electrical fittings, diesel generator, pump set and if possible, even the lifts. In case there is any structural or other damage to the building or its vital equipment, you are protected. Few people are aware of just how cheap such insurance is. Let me give you a practical example. An apartment complex having 29 apartments, the estimated value of the building and its essential equipment was Rs 3.25 crores, and taking out insurance for this sum, about three years ago. The premium worked out to be Rs 22,000/for the first year. Therefore, on the average, an apartment owner paid approximately Rs 759/- as premium per annum. There was no claim of any sort. The second and third year's premiums were drastically reduced by the insurance company, to approximately Rs 18,000/- and Rs 16,000/- respectively. Thus, it works out to just about Rs 552/- per apartment owner per year. In addition, if you happen to be living in the apartment and have furnished it reasonably well, and have expensive gadgets like a washing machine, fridge, TV, music system, microwave oven, etc., a basic householder's policy against fire, theft and breakdown should be useful. Do not take this insurance if you are renting out your flat, only if you are actually living in it. Such householder's insurance is once again quite cheap. I will be surprised if a basic policy costs more than Rs 1,300/- per annum.

EMERGENCY FUND
The financial plan of every individual and every family must be built upon a solid foundation of safety and security. Only after safety is ensured, do we venture out looking for higher returns. When the risks of death, disease and damage to property are taken care of through regulated institutions, it is called insurance. Apart from this institutionalized insurance, every individual and family must have their own 'private' insurance in the form of a reserve of money to meet emergencies. Such a reserve is called an emergency fund. The emergency fund must be deployed in highly liquid avenues of investment like savings accounts or money market mutual funds. Returns are not important here. Liquidity is. Only such avenues of investment must be chosen, which can be encashed within 24 hours. For your emergency fund, a separate investment account must be opened. Never should an emergency fund be confused with your normal bank or investment accounts. In India, the banks offer 'flexi deposits', which are well suited for emergency funding. A small portion of the flexi deposit is treated as balance in a savings account. The rest of it is treated as a fixed deposit. For example, if you have a Rs 1 Lakh flexi deposit, Rs 10,000/- out of this, may be considered being in the savings account at 3.5% for a resident Indian. The remaining Rs 90,000/- will be considered to be a fixed deposit at a rate of interest which may be twice the SB account interest. Now if you want to write a cheque for Rs 50,000/-, you can do so without going to the bank and prematurely redeeming the fixed deposit portion. Of the Rs 50,000/- that remains, Rs 5,000/- will now be in the savings account and Rs 45,000/- in the fixed deposit account. You can also add money to this account whenever you want, just like in a savings account. The important thing is that it should be a separate account and you and your wife should know that this has been set apart as an emergency fund. Furthermore, the emergency fund should perforce be in joint names, operable by any one of the joint holders. In case you have a minor mishap and cannot sign, the joint holder should be able to operate the account on his/her own. An emergency fund is sacred. It should never be touched unless there is an actual emergency to your family. The cumulative effect of interest being added back and compounded will help the fund keep pace with inflation. What should be the size of the emergency fund? There is no simple answer. A good thumb rule based upon common sense and our own experience is that at least 12 months of normal living expenses should be in the form of an emergency fund. You will by now be familiar with the concept of normal living expenses. For example of a family with expenses of Rs 25,000/- per month, we would be looking at an emergency fund of approximately Rs 3 Lakhs. Never think of an emergency fund as an unproductive waste of money. You will know the value of emergency funding only when calamity strikes. In these days of increased uncertainty and rapid changes, an emergency fund

has much more relevance and importance than say 30 years back. It is your first line of defence. Treat this as priority. RETIREMENT PLANNING When we talk to youngsters about retirement planning, very often the response we get is, "Oh, I have another 30 years to go for retirement." They do not realise that while retirement may be 30 years away, retirement planning should commence when an individual draws his or her first pay cheque. You are responsible for your financial comfortable retirement, not your employer or the government. Just as an emergency fund is a private insurance policy, you must also have a private retirement fund, independent of the one run by your employers. In fact, over two or three decades, your private retirement fund could very well dwarf your company retirement fund. In the Indian context, the two best possible avenues of retirement investments are the Public Provident Fund and Equity Linked Savings Schemes (ELSS) of mutual funds. The PPF gives tax-free returns of 8% per annum, compounded annually. ELSS investments give approximately 14% CAGR returns over a period of 10 years or so. Unfortunately, non-resident Indians cannot invest in the PPF. The best investment for retirement would be systematic investment into diversified equity funds. Nothing will give you better returns over the long run. The amount you invest need not be large. Investing regularly over several decades is important. You can start with even a very low amount of say Rs 1,000/- per month and then increase it gradually once your liquidity situation improves. There should be two separate retirement funds for husband and wife. You have to work out exactly how much each of you can save very comfortably per month for retirement. When you calculate the amounts to be invested for retirement, take a lower figure with which you are comfortable over a long period than a higher figure which you may not be able to sustain. Investments into retirement avenues are for the very long term. A period of ten years would be considered a short term for retirement investments. Like an emergency fund, a retirement fund is also sacred. Money in this fund should never be withdrawn until the actual date of retirement. The only exception to this rule is if there is a threat to the life of any family member and existing insurance and emergency funding prove themselves to be insufficient. With proper financial planning, the need for you to ever dip into retirement funds will almost definitely not arise. What we repeatedly see in investors who do proper financial planning is, that many of them do not touch their retirement corpuses even after retirement. These corpuses are left as inheritance for their successors. Their other investments or the income from their retirement corpuses generally see them through life comfortably.

HOUSING
Everyone should own a residence of their own. This is most applicable of course, to those who are not fortunate to have already taken steps in this direction, and/or those who are not fortunate enough to be sure of inheriting a house or apartment. So you can say, a house or apartment is an essential part of any financial plan. Now comes the question of further investments in real estate. We find that where real estate is concerned, normal people can be classified into two categories: 1. Those who have a genuine talent for and interest in real estate investments; and 2. Those that have neither the talent nor the interest in such investments. For people who fall in the second category, the advice given by some of the best real estate consultants that we have come across is: purchase real estate only if you have a use for it. Everyone has one basic use for real estate and that is the need for a dwelling place. So, everyone must own a house. Now, consider the case of a practicing physician. He will need a residence as well as an office. He must ideally try to own both, because he has a use for both. Let us take one more example, that of a person who manufactures and sells furniture. Such a person requires a residence, a workshop (which need not be in a centrally located area) to design and manufacture furniture, and finally, a showroom in an excellent location, to exhibit and sell the furniture. Such a person must try to own all three: his house, workshop and showroom. For a person who does not have a flair for real estate, additional investments in real estate are not advised. Undoubtedly, real estate is an excellent long-term, wealth enhancing avenue of investment. However, it suffers from certain drawbacks.

1.

2. 3. 4.

5. 6. 7. 8.

It has extremely poor liquidity. You can sell a stock on the stock market instantly and get your payment within 3 days. Similarly, you can encash a mutual fund investment within an outer limit of a week. But you cannot dispose of real estate quickly and easily, even in a boom. There are difficulties and dangers in verification of title when you purchase real estate. Large amounts of money are required even for a single purchase. Large amounts of money are required to make additional purchases, if you are willing to do so, when prices fall. For example. Let us say you have purchased stocks worth Rs 30 Lakhs and also real estate worth Rs 30 Lakhs. Both purchases have been made, when markets were high. Now the markets fall and both your stock market portfolio as well as real estate property are valued at Rs 20 Lakhs each. You want to make additional purchases. You can buy stocks even if you have just Rs 1, 2 or 3 Lakhs. But to make additional real estate purchases, you would need much more, perhaps even Rs 20 Lakhs. There is the presence of substantial black money components in real estate transactions. There are high stamp duties to be paid on purchases of real estate. Formalities pertaining to the purchase and sale of real estate are cumbersome. Once you have purchased real estate, there can be administrative problems. You need someone to look after it. There are many problems associated with absentee landlordism, such as encroachment, squatting, deterioration of houses / apartments because of keeping them locked up, etc.

All these matters must be carefully considered, before venturing into real estate investments, because real estate is easy to get into, but difficult to get out of, especially if you have made a mistake.

EXTINGUISHMENT OF DEBT
Extinguishment of debt means getting rid of debt, or not getting into debt in the first place. It is important to distinguish between acceptable and unacceptable debt, productive and unproductive debt. Any debt which is designed to automatically end itself is better than debt which remains open indefinitely. A housing loan or vehicle loan is debt which is repaid in instalments and extinguishes itself over the loan period. On the other hand, personal loans, personal overdrafts and credit card loans are examples of debt which remain open. The worst type of debt is credit card debt. In India the rates of interest on this type of debt presently vary between 24% & 48% per annum. Every individual must guard against ever getting into a debt trap. If an individual does not have a house, and does not have the resources to purchase a house right away, a housing loan could certainly be considered provided the loan instalments can be paid with a fair degree of comfort. All other types of undesirable loans should be extinguished before embarking upon investment.

INVESTMENT PLANNING
Some aspects of investment have already been touched upon. For example, an emergency fund is in some ways an investment. However, its objective is more insurance oriented, and we therefore do not consider an emergency fund to be part of our investment portfolio. Similarly, a retirement fund is certainly an investment. The time horizon of a retirement fund is extremely long, that is from the time you start it, right up to the date of retirement. In the case of a young person of less than 30 years, the time horizon of a retirement plan would probably run very close to 30 years. However, a retirement fund is not a general investment fund. Its purpose is specific. It is to take care of your needs during the period of your life after retirement, when your abilities to work and earn are either non-existent or vastly reduced. Finally, a house is also an investment. However, the objective here is to provide security and shelter to you and your family and not to treat your house as an investment, to be encashed when the price goes up. Therefore, the value of one residential house is also generally not included in the value of your investment portfolio. When we come to investment, we assume that you have taken out adequate insurance, established an emergency fund and started a retirement fund, no matter how small the monthly contributions to the retirement fund may be. If you have already purchased a house, there is nothing like it. If not, this aspect must also be attended to. Do not undertake general investment unless and until your emergency fund, insurance and the commencement of your private retirement fund have been undertaken. Also, ensure that you have no undesirable or excess debt. Only then, embark upon a general investment fund, regardless of whatever laudable objectives such as providing for your child's education and so on you may have. A financial plan cannot and should not be built without a sound foundation. Insurance, emergency funding, retirement funding and the acquisition of a residence constitute the foundation of a financial plan.

The foundation comes first. Then the superstructure. So, your general investment plan comes after a certain foundation is laid. Regardless of when you actually start your investment fund, it is vitally important to be acquainted with a few fundamentals of investment. From this point of view, we are giving you a brief introduction to investment. Investment is generally made for 3 purposes.

1.

Parking:

Parking has two aspects. One is emergency funding. The other is pure parking. You are already familiar with the concept of an emergency fund. An example to understand what is meant by pure parking. Suppose you have sold a real estate property for Rs 40 lakhs. With this money you want to buy another piece of real estate. You do not know whether you will be able to get a satisfactory unit of real estate in a week or a fortnight or a month or 6 months. But, the moment you identify a satisfactory real estate asset, if the price is right, you will want to conclude the deal immediately. So, the period of your investment is highly uncertain. The investment must therefore be very liquid and be readily available when you require it. Until the funds are required, they must be parked. The avenues for deploying emergency funds as well as the avenues for parking of funds are one and the same. These avenues are: 1. 2. 3. 4. 5. 6. 7. Current accounts. Savings accounts. Flexi-deposits with banks. Liquid mutual funds. Short-term mutual funds. Short-term floating rate mutual funds. Quarterly Interval Fixed Maturity Plans.

2. Earning Regular Returns:

The first purpose for which people may invest, is for emergency funding and/or the parking of funds. The second purpose for which people invest is to earn regular returns. When we talk of regular returns for resident Indians, we generally speak of avenues such as:

- Bank fixed deposits - Post Office Monthly Income Scheme - 8% taxable Government of India Savings Bonds - 9% Senior Citizens' Savings Scheme - Public Provident Fund - Post Office Time Deposits, - Intermediate-term fixed maturity plans of mutual funds; and - Arbitrage Funds. Future returns on debt investments are virtually impossible to predict, either in the short-run or the long-run. At certain times, certain regular returns avenues may appear attractive. At other times, there will be other avenues in this category that will come into the limelight

One must worry about regular returns avenues of investment only at the time the person requires to actually make investments for regular returns. It is no use trying to arrive at the best options in advance. The major mistake that investors make is that they invest in such regular returns avenues at a time when they are working and earning regular incomes from their employment or business or profession. When an investor is earning regular income because of his ability to work and earn such income, the last thing he should do is to invest current savings in further regular returns avenues of investment. All savings during an individual's productive years should go only into growth avenues of investment. This is because the earnings from your employment or business or profession are themselves regular earnings, so no purpose is served by investment in further regular returns avenues. When you are working, you must take adequate insurance, establish an emergency fund and start a retirement fund. Further savings should be mainly in growth avenues of investment. Simultaneously of course, steps should be taken to acquire a house if you have not done so already, or are not likely to inherit one. It is only when one is approaching the age of retirement that growth investments should be liquidated to the extent that they can be invested in regular returns avenues for providing a steady stream of regular return to take care of normal living expenses.

3. GROWTH INVESTMENT:
A study of the history of growth investments clearly reveals that there are only two avenues of these investments that have consistently beaten inflation over the long-term. These avenues are equity and real estate. 3.1. REAL ESTATE & BULLION: Here, we will deal mainly with real estate. But before we do so, we would like to briefly comment upon one more avenue namely gold or bullion, which most people think also increases wealth over the long-term. Timothy Green, a well known bullion expert, reminds us of a historical truth: "The great strength of gold throughout history has not been that you make money by holding it, but rather that you do not lose. That ought to remain its best credential." So gold can at the most preserve the value of your money over the long term. In other words, gold investments can grow at a rate approximately equal to inflation. Investing in gold does not beat inflation. Investors who had invested in a good piece of real estate 20 or 30 years back would certainly have increased their wealth considerably in this period, even after discounting for inflation. That brings us to the question of whether an ordinary investor should invest in real estate. Real estate suffers from certain drawbacks. One is poor liquidity. Even at the height of a real estate boom you cannot acquire or dispose of real estate as easily as you can buy or sell equity shares or mutual funds. Next, is the difficulty of averaging downwards or making use of a fall in real estate prices. For example, if you have bought real estate at the height of a boom and now prices fall by say 35 or 40%, you may be willing to buy more real estate, but may not have the money to do so, because each purchase involves a big outlay. On the other hand, in the stock market, you can add to your portfolio as the market goes down, with even small amounts. Next, there is a risk of imperfect title when you purchase real estate. Even a single purchase requires huge amounts of money. In equity on the other hand, you can start an investment in a mutual fund with Rs 500/- or less. Furthermore, when you purchase real estate, you pay an average stamp duty of 10 to 11 per cent. Whereas there is no stamp duty for purchases of equity shares. For people whose financial affairs are clean, there is also the tremendous problem of black money which is virtually an integral part of real estate transactions. Finally, by investing in a diversified portfolio of stocks, which includes stocks from the real estate sector, you can make real estate part of a diversified equity portfolio. But you cannot do the opposite - you cannot make equity part of a real estate portfolio, because it would then cease to be a real estate portfolio, unless you went in solely for real estate-oriented stocks!

One important question to answer is: Should a common investor go in for real estate in addition to one residential house (which is compulsory)? There is no easy and final answer. Let us give you our opinion, which is based upon the advice of some of the finest experts on real estate investment, at least in India. What these experts say, is that common investors can be divided into two broad categories where real estate investment is concerned. 3.1.1. The first category consists of people who appear to have a certain talent for real estate investments. They have an interest in real estate as well as a flair for real estate and before long they build a good and profitable track record of buying and selling various real estate properties. If you belong to this category, by all means press ahead with real estate. 3.1.2. If not, then the only advice given is, to buy real estate only if you have a use for it. Lets look at three examples: Example 1: Every one has one basic use for real estate and that is a residence, because everyone needs a roof over their heads. Therefore every individual must try to acquire and own one residential property. Example 2: Now, let us take the case of a doctor who needs an office where he sees patients. Such a person must aim to own his house as well as his office. Example 3: Finally, take the case of a person who manufactures and sells furniture. This person needs a house, a building and compound (not necessarily in a good area) in which his workmen can design, and manufacture the furniture, and finally a showroom in a prime location where he can exhibit and sell the manufactured furniture. Ideally, he must try to own his house, his workshop and his showroom, because he has a use for all three. The bottomline therefore is: If you belong to the category of people who do NOT have a flair for, and interest in real estate, it may not be advisable to acquire real estate in addition to your house, if you do not have a use for it.

3.2

EQUITY / STOCK MARKET INVESTMENT:

The world's best experts on investment are unanimous in their opinion that equity is the best avenue of investment ever invented for long-term growth. The problem is equity can also be used for speculation. When you see or hear of your friends, co-workers or acquaintances strenuously doing day trading, margin trading, etc., understand that these people are speculating and perverting this magnificent avenue of investment into an avenue of gambling. You can invest in the stock market in two ways.

3.2.1 DIRECT EQUITY / EQUITY INVESTMENT MODEL.

To invest in direct equity, you need to open a trading and demat account with a stock broker. The second way of investing in equity is through mutual funds. Our paper entitled "A Guide to Equity Investment" describes how a normal investor can invest effectively in the stock market by buying and holding a diversified portfolio of blue chip stocks over a minimum period of 5 years. If you have not done so already, it would be advisable to read these two papers before continuing. In 1988, we came out with a simple model for equity investment that any common investor could follow. It was based mainly on the classic "The Intelligent Investor" by Benjamin Graham, which is the only book on the stock market worth reading. Benjamin Graham was the teacher of Warren Buffett, who went on to become the world's most famous and successful stock market investor.

We attempt to give you a few other insights. These insights are worth having even if you do not immediately invest in either the stock market or equity mutual funds. Our model consists of six simple rules and one recommendation. Let us take the rules one by one. The first two rules speak about the most important investment technique ever invented, and that is diversification. We have tried to improve the quality of diversification by looking at it both from the point of view of industry sectors as well as companies. The stock market is not some magical place where stock prices keep fluctuating, often violently, of their own accord. The stock market is nothing but a reflection of the economy of a country. It factors in both current economic performance as well as future expectations of what is going to happen in the economy. That is why no one can call himself a stock market investor unless he invests in the economy of the country. That is why, the world's best investment advisers always recommend that you "buy the market." This is another way of saying "buy the economy," as the entire market consists of companies from almost all worthwhile sectors of the economy. In the US, there are total stock market index mutual funds which buy and hold all the stocks listed and traded on the stock market, in the ratio of their market capitalization. A low-cost, total stock market index fund would be the best way for a normal investor to invest in the stock market. In India however, such broad-based index funds do not exist. Therefore, we looked at the Indian economy and found that productive activity in the economy is generated by 3 major segments: agriculture, manufacturing industry and services. Today, services contribute approximately 55% to the GDP. Manufacturing contributes approximately 27%. Agriculture contributes approximately 18%. Translating this to stock market investment would mean that care should be taken to select stocks of companies present in all these 3 major segments. What we have attempted to do, is to take a sample of major companies from major sectors and build a portfolio spread across something like 60 to 70 companies and 20 to 25 sectors drawn from agriculture, manufacturing and services. We are also great believers in the concept of "economic impact". We will explain this concept with 3 examples. Example 1: Around the year 2000, there was an all-India craze for shrimp farming, which was also called aquaculture. A number of farmers converted their paddy fields into shallow lakes where they did prawn farming. The Supreme Court then passed a judgment that such farms had an adverse impact on the environment and should therefore be shut down. Overnight, the farms had to shut down. Thousands of entrepreneurs lost their money. Tens of thousands of workers lost their employment. There were hardly any protests, and aquaculture disappeared almost without a trace. Example 2: In 2001-2002, there were numerous leather tanning industries in and around Calcutta in West Bengal. In another judgment, the Supreme Court laid down that the chemicals from these leather tanneries were polluting certain rivers. The tanneries closed down, thousands of entrepreneurs lost their money, and tens of thousands of workers lost their jobs. Despite all this taking place in the Communist ruled state of West Bengal, this industry disappeared without a whimper. Example 3: At more or less the same time, the same Supreme Court of India passed another judgment sharply raising the vehicle emission control standards in India and giving manufacturers very little time to comply with the new requirements. The profits of all vehicle manufacturers were hit badly. The automobile companies could convince the finance minister just how much revenue in terms of excise duties, sales tax and corporate income-tax the government would lose, if major auto companies like Tata Motors, Mahindra & Mahindra, Maruti Udyog, Bajaj Auto and Hero Honda, ran into serious trouble. When the failure of a major company or industrial group can have an impact on the revenue generation by the government and when this impact will be felt in the GDP growth of the country, it is called economic impact. The

auto sector had economic impact. The prawn farmers and leather tanners did not have it. The government immediately amended certain laws, and gave more time for the Indian automobile sector to introduce emission controls in a phased manner, thereby circumventing the judgment of the Supreme Court. Once you have chosen the top sectors and the top companies, then as per the third rule of our model, spread your investments equally across companies arranged in these sectors, without attempting to predict which sectors and companies will do well and which won't, in the future. Such predictions have repeatedly proved themselves to be thoroughly useless. The fourth and fifth rules of our equity investment model do not need much explanation since they are very simple to understand. It is good to reinvest dividends. It is also good to review your investments once in a way. However, additional purchases need to be done only if there is a drop of 25% or more in the index from the day you started your initial investment, or from the last market peak. The portfolio need not be churned frequently and repeatedly. The sixth rule is extremely important. It speaks of the time horizon. A time horizon is a time element attached to each avenue of investment, which if adhered to, eliminates risks and delivers optimum returns. Time horizons are not dreamed up by us. They are based on the average time it takes for a boom and recession cycle to be completed in the stock market. Thus, time horizons are arrived at, by studying the time taken for boom-recession cycles throughout stock market history. The stock markets are slightly over 400 years old, having started in Amsterdam, Holland, in the very early 1600s. The remarkable thing is that across countries and centuries, the average time taken for a boom and recession in the stock market has been 5 years. True, there have been times when either a boom or recession may have lasted longer than the average of five years, but the average works most of the time. The concept of time horizons is not confined only to investments. To give you an example from agriculture, a farmer growing paddy can expect to harvest his crop after 6 to 7 months of sowing. However, if the same farmer plants mango saplings, he cannot argue that now also he must get yield in 6 to 7 months, just because paddy gave him yield in that period! Even the best varieties of mango saplings will give meaningful yields only after five years or so. Similarly, the best variety of coconut trees will give meaningful yield only in 8 to 10 years. In real estate

investments in India, the time horizon is 10 years. For equity, worldwide, the time horizon is 5 years. What this means is, money that I put into equity should be money I can afford to block for a minimum of 5 years. Similarly, money that I put into real estate should be money I can afford to block for at least 10 years. If not, I may be forced to sell in distress. A time horizon is however, not a jail sentence. If by some chance you make a lot of money in the stock market, in 2 or 3 years, and you are satisfied with the results, nothing prevents you from booking profits. If however, things go wrong, you can expect safety and returns over the time horizon. Finally, let us come to the one recommendation we always make for equity as well as equity mutual funds. That is, systematic investment. This simply consists of deciding about a fixed amount you are going to invest in the stock market every month and then sticking to your monthly investment programme, for a period of at least five years. The concept of systematic investment is very closely related to the risk management tool of diversification. Systematic or recurring investment is nothing but diversification across time. 3.2.1 MUTUAL FUND INVESTMENTS

Mutual funds are a hybrid way of investing in real estate, debt, commodity and equity markets. Instead of investing directly, you pool resources with other investors and invest. As in the case of stock market investments, a lot of wrong advice is given in mutual fund investments, too. Very often, terrible products like new fund offers (NFOs) are sold, not because they are good for investors, but because

mutual fund distributors earn maximum brokerage from them. and index funds.

Similarly, a lot of fads like sector funds are

recommended, whereas the only two types of equity mutual funds worth investing are well diversified equity funds

THE SIX AREAS WHERE WE SEE VALUE IN MUTUAL FUND INVESTMENTS 3.2.2.1:Emergency Funding and Short-term Parking of Funds: The four types of funds that I would choose for these purposes are liquid funds, short-term funds, short-term floating rate funds and quarterly interval fixed maturity plans. Liquid funds are chosen when an investor is not at all sure about the duration of investment. In other words, a liquid fund is used as a glorified savings account. It is generally recommended for investments of up to 3 months. A short-term fund is ideal for investment of between six months and a year. A short-term floating rate fund is good for any period of investment up to a year, especially when the investor is more or less sure that funds are not needed for the first month, but may be needed anytime thereafter. A quarterly interval fixed maturity plan (FMP) is ideal when an investor does not know when he requires the funds but is sure that he does not require them for at least the next 3 months. Liquid, short-term and short-term floating rate funds currently yield between 6.5% and 8% p.a. Quarterly interval funds yield approximately 7.5% p.a. Please note that these yields can change, depending upon the state of the debt market from time to time. None of the above funds have anything to do with the stock market. They invest in the inter-bank call money market, short-term government bonds, short-term corporate loans, short-term financial institution loans, etc. Non-resident Indians (NRIs) or Persons of Indian Origin (PIOs) can make investments in mutual funds funds from their NRE accounts. When they withdraw, the redemption proceeds get credited directly to the NRE accounts. Investments in mutual funds can also be made on a non-repatriable basis, by investment from the NRO account. 3.2.2.2 :Intermediate-term investment of between one and three years: The second area where we see value in mutual fund investments, is in intermediate-term investment of between one and three years. Undoubtedly, here there is nothing like FMPs of more than twelve months duration, especially on the tax-efficiency front for residents, and higher returns for NRIs. We need to dwell on this a little bit, because most non-residents are totally unaware of FMPs and keep their money in low-return NRE bank fixed deposits. Fixed maturity plans (FMPs) buy and hold a diversified portfolio of debt securities, all of which are designed to be redeemed in line with the term of the plan. There is no trading in the securities held by FMPs. The yield on each security is known in advance. The expenses of the plan are also known in advance. Therefore, mutual funds are able to indicate what the yield is likely to be just before each plan closes for subscription. We have found the indicated yields to be quite accurate. It does not mean however that the said indicative yields are exactly what you will get. If a bank deposit stipulates that you earn 9%, you earn 9%. If an FMP indicates that you earn 9%, you could earn 8.5% or 9.5%. Generally, the variations would not be more than 0.5% of the yield indicated on the last day the FMP is open for subscription.

If all this is confusing, think of mutual fund FMPs as the mutual fund equivalent of a cumulative bank deposit of more than 12 months' duration. FMPs have zero investments in the stock market. They invest in corporate and government bonds and other debt instruments. They therefore have a safety equal to bank fixed deposits. Now, let us assume a very low yield of just 8.25% per annum on FMPs of more than one year. Unlike NRE bank FDs, FMPs are not tax-free. They are subject to long-term capital gains tax deduction of 10.3%. So, net of tax, you get an yield of 7.4% p.a. after tax. This is appreciably higher than the tax-free yield of 4.85% or so that is being offered on NRE deposits. Where a resident Indian is concerned, bank FDs may be better for persons who are not paying tax, if at the time you are investing, the bank FD rates are higher than the FMP indicated rates. This is also more or less true for residential investors in the 10.3% income-tax slab. But for resident tax-payers in the 20.6, 30.9 and 33.99 brackets of tax, FMPs would be significantly better. For NRIs, they have to only compare the present NRE deposit rates with the indicative yield of intermediate-term FMPs, after deducting 10.3% from the indicative yield of FMPs. Understand one thing - both bank FD rates and FMP yields are dynamic and not static. They change and constantly compete with each other. However, the key factor in the investment decision is the post-tax rate at the time of investment. There are times when FMP rates were higher than domestic bank deposits. Right now, BFDs average 9.25%for residents, and FMP rates are in the range of 8.25 to 8.5%. But these rates are only the starting point of analysis. investments. A final example to illustrate the above. Let us say you are a resident Indian, in the 30.9% tax-bracket. You invest Rs 1 lakh in a 9% FMP of a year and a day. You earn Rs 9,000/- upon maturity. The long-term capital gains tax at 10.3% is Rs 927/-. So your net return is Rs 9,000/- minus Rs 927/- = Rs 8,073/-. Now let us assume you also invest another Rs 1 lakh on the same day in a bank fixed deposit yielding 10% p.a., a clear 1% more than the FMP. You earn Rs 10,000/- as interest. You pay Rs 3,090/- as tax, being in the 30.9% tax bracket. You are left with a net return of Rs 6,910/-, significantly lower than the Rs 8,073/- that you got as net return from the FMP. So it is this Rs 8,073/- versus Rs 6,910/- that is important, not the 10% BFD interest versus the 9% FMP yield. In financial jargon, this habit of always looking at the final yield, net of taxes and expenses, is called "LOOKING AT THE BOTTOMLINE". It is also called the post-tax rate. This is one of the best habits that an investor can cultivate. Now, we take an example of a non-resident investing in NRE Bank deposits. The NRI invests Rs 1 lakh in an NRE bank deposit giving 4.85%. There is no income-tax on interest earned on these deposits. So, he earns Rs 4,850/tax free. If he invests the same in a 8.25% FMP of one year, he earns Rs 8,250/- upon maturity. The long-term capital gains tax at 10.3% is Rs 850/-. So his net return is Rs 8,250/- minus Rs 850/- = Rs 7,400/-, appreciably higher than the Rs 4,850/- on the 'tax-free' NRE bank FD. There is one other class of safe mutual funds called arbitrage funds. These funds carry on a business of buying shares in one market and selling them in another market where the prices are higher. The deals are entered into in the two markets simultaneously and so there is no speculation or risk. For example, if a particular stock is traded at Rs 600/- in the Bombay Stock Exchange cash market and at Rs 606/in the National Stock Exchange 30-day futures market, the stock is bought on the BSE and sold on the NSE The deciding factor is the post-tax rate of FMPs vs the post-tax rate of other competing

simultaneously. If this position is settled after a month, the profits are Rs 6/- on Rs 600/- or about 1% per month or 12% per annum. There are mutual funds that specialise in such operations. When there are no such opportunities, the funds are kept in safe debt instruments. Returns on these funds have been between 7% and 9% per annum, for an investment horizon of a year or more. Now comes the important part. Because arbitrage funds are considered 'equity funds', there is no tax whatsoever on profits made, provided the investment is held for a year at least. A mix of FMPs and arbitrage funds is the best bet for intermediate-term, risk-free investments. We hope this has thrown some light on the subject of FMP investments in particular and debt investments in general. 3.2.2.3:Equity Linked Savings Schemes (ELSS) ELSS investments are more relevant to Indian residents. Section 80C of the Income-tax Act, enables an investor to get a tax exemption of Rs 1 lakh, in addition to the basic exemption of Rs 1.8 lakh given to all male assesees. For females, the basic exemption is Rs 1.9 Lakhs. For senior citizens (60 years and above), the basic exemption is Rs 2.5 Lakhs. What this means is, for example, if a non-senior citizen female earns Rs 15,000/- salary per month and has no other income, she does not have to worry about tax, because her total income is Rs 1.8 Lakhs, which is less than the basic exemption of Rs 1.9 Lakhs. Now, non-residents are not taxed in India on their foreign income. They are also not taxed on the interest they earn on NRE bank deposits. However, Indian income-tax laws assume very great importance when non-residents decide to return to India on permanent transfer of residence. At that time if proper tax planning is not done, it can result in non-residents having to pay unnecessarily high taxes, when they start filing income-tax returns as resident Indians. Therefore, what we advise NRI couples is that both husband and wife must have individual NRE and NRO accounts. The husband must have an NRE account and an NRO account in both of which he is the first holder, with his wife as second holder. The wife must in turn have an NRE account and an NRO account, in both of which she is first holder and the husband is second holder. This must be done even if only one of them is working and the other is not, although both are residing abroad. Before returning to India on permanent transfer of residence, the husband and wife must split their savings more or less equally between themselves and make two separate inward remittances to their respective NRE accounts, from abroad. Now let us see the implications of not doing this as well as of doing this, by taking 2 or 3 examples. Example 1:All investments are brought to India in the name of the husband only: Let us say the husband invests Rs 80 Lakhs in resident bank deposits at 9.5% interest per annum. He earns Rs 7.60 Lakhs of income. He will pay tax as follows: On the 1st Rs 1.8 lakh: On the next Rs 3.2 at 10.3%: On the next Rs 2.6 lakh, at 20.6%: Thus the total tax he will Nil Rs 32,960/Rs 53,560/pay on the income of Rs 7.6 lakhs is

Rs 86,520/Example 2: proportions: Husband and wife have split their savings and transferred them to India in equal

Each of them invests Rs 40 lakhs in 9.5% bank fixed deposits, each of them earns Rs 3,80,000/-. The total family income will be the same as in example 1, that is Rs 7,60,000 lakhs, except that it is now earned by two individual income-tax assessees equally. The tax paid by the husband will be: On the 1st Rs 1.8 lakh: On the next Rs 2,00,000/- at 10.3%: Nil Rs 20,600/-

The total tax payable by the husband amounts to Rs 20,600/-. The tax paid by the wife will be: On the 1st Rs 1.9 lakhs: On the next Rs 1,90,000/- @ 10.3%: Nil Rs 19,570/-

The total tax payable by the wife amounts to Rs 19,570/-. The total, tax payable by husband and wife will be Rs 40,170/-. Compare this to the tax figure of Rs 86,520/- that would have to be paid by the husband if the inward remittance of their savings had not been split between the two of them. Example 3: This is the same as example 2, but we now assume that from the earnings of Rs 3,80,000/of each of them, they also invest in instruments like ELSS which give them a further exemption of Rs 1 lakh each. In this case, the tax that each of them pays will be as follows: The tax paid by the husband will be: On the first Rs 2.8 lakhs: Nil

On the next Rs 1,00,000/- @ 10.3%: Rs 10,300/The total tax payable by the husband amounts to Rs 10,300/-. The tax paid by the wife will be: On the 1st Rs 2.9 lakhs: Nil

On the next Rs 90,000/- @ 10.3% : Rs. 9,270/The total tax payable by the wife amounts to Rs. 9,270/Therefore, on a total family income of Rs 7.60 lakhs, the total tax is only Rs 19,570/-.

Compare this to the tax figures of Rs 40,170/- and Rs 80,520/- in examples 2 & 3 respectively. Now you probably see the importance of good financial planning. Actually, what we have given above is an example of tax planning. Tax planning is one small part of financial planning. For eligibility under Section 80C, ELSS is not the only available avenue. There are numerous other avenues, of which the best two are the Public Provident Fund (PPF) and ELSS. Non-resident Indians cannot open PPF accounts. Anybody can invest in ELSS. Non-resident Indians may require tax saving under Section 80C, in case their Indian income exceeds the basic exemption limit prescribed from time to time. For example, if a non-resident Indian owns an apartment in Bangalore from which he earns rent of Rs 25,000/- per month, his total Indian income will be Rs 3 lakhs, far higher than the present basic exemption of Rs 1.8 lakhs. Such a person will definitely need tax saving avenues like ELSS. With its good long-term earnings potential, limited risk and tax saving features, ELSS schemes constitute the third area of mutual fund investment in which we see value. 3.2.2.4:Systematic Investment, especially into equity and balanced mutual funds If you have read and digested our paper on equity investment, you will appreciate that for a normal investor, to have a meaningful equity portfolio today, she/he will need to purchase Rs 20,000/- worth of each stock in at least the first 30 stocks in our recommended list. That would be a one-time outlay of Rs 6 lakhs. Actually, to totally take care of the unsystematic risk in the stock market, we recommend 60 stocks and not 30. This means an outlay of Rs 12 lakhs, at the minimum. Now if an investor wants to invest systematically in our model, he would have to purchase at least Rs 20,000/- worth of one stock per month. There are a number of small investors who will not be able to afford this amount of monthly investment. Thus, the fourth area where I see value in mutual fund investments is in systematic investments into non-ELSS equity and balanced funds, especially for small investors. For large investors, it can probably be argued that they can purchase one or two stocks or more, of Rs 10,000/- or Rs 20,000/- each per month directly in the stock market. For example, we have several clients from whom we have standing instructions to purchase Rs 10,000/- or Rs 20,000/- worth of stocks per week/fortnight/month from our list of about 60 recommended stocks. But what about a very small investor who can only afford to salt away Rs 500/-, Rs 1,000/- or Rs 2,000/- per month? For such persons, there is nothing like a sustained systematic investment into equity/balanced mutual funds. The value of systematic investment into a diversified equity fund is that with as little as Rs 500/- or Rs 1,000/-, you can purchase a diversified portfolio of stocks through the mutual fund route. It is time to understand the benefits of systematic investment, especially in a fluctuating avenue of investment such as the stock market. So, let me give you a primer on systematic investment. Systematic investment is a method by which fixed or varying sums of money are invested in one or more avenues of investment at regular intervals. If you examine this definition, you find that it is quite flexible on both the amounts to be invested, as well as the avenues of investment. The only area where there is rigidity and no compromise, is in the "at regular intervals" portion of the definition. This is because the objective of systematic investment is to make investing a habit. We are used to poor quality systematic investment plans such as recurring deposits into post office or bank recurring deposits. Actually, the greatest benefit of systematic investment is felt when it is made in investments whose values fluctuate. Let me give you an example of the difference between what a normal stock market investor does and how the same strategy would look in systematic investment.

Let us assume that there is a good stock market investor. He is not a speculator. He does the minimum amount of study required, invests in good stocks and does not panic when the stock markets falls. Let us assume he has identified a stock which is currently quoting at Rs 100/- per share in the market. He considers it a good buy and purchases 100 shares, paying Rs 10,000/- for them. Unfortunately, he has made his purchase at the market peak. The market now falls heavily and in 3 months' time, he finds the share quoting at Rs 70/- per share. This investor does not panic. He examines the new situation. His conclusion is simple. Three months back he found the share attractive at Rs 100/-. Now he finds it quite a bargain at Rs 70/-. So he buys another 100 shares, investing Rs 7,000/- this time. Unfortunately for him, the economy of the country is going into a 2 or 3 year recession. Three years later, he finds the same stock quoting at a miserable Rs 40/- per share. Once again he does not panic, nor does he buy again blindly. By now, he is a shareholder of the company for a little over 3 years and has been receiving the company's annual reports and financial statements. He concludes that even in a general recession, the company is making some profits and paying some dividends, although the profit and dividend levels are much lower than in the boom time. Now, our investor argues that if this company can keep its neck above the water in the bad times, it should certainly do very well when the next boom occurs. So he purchases a third lot of 100 shares, paying Rs 4,000/- for them. The summary of his investments is as follows: Purchased 100 shares at Rs 100/- per share, investing Rs 10,000/-; Purchased 100 shares at Rs 70/- per share, investing Rs 7,000/-; Purchased 100 shares at Rs 40/- per share, investing Rs 4,000/-; Therefore, purchased 300 shares totally, for a total consideration of Rs 21,000/-, or an average price of Rs 70/- per share. Now let us convert the above example into systematic investment. In normal stock market investment, the

investor's focus is generally on quantities or numbers of shares to be bought or sold. In systematic investment however, the focus is not on quantities, but on equal amounts at regular intervals. In the above example, Rs 21,000/- has been invested in 3 transactions. To convert that operation into systematic investment therefore, Rs 21,000/- should be divided into 3 equal portions of Rs 7,000/- each. The rest of the example is the same. You invest the first Rs 7,000/- when the price of the stock is Rs 100/-. You get 70 shares. You invest the next Rs 7,000/- when the price of the stock is Rs 70/-. You get 100 shares. You invest the final Rs 7,000/-, when the price of the stock is Rs 40/-. You get 175 shares. Now when you total this 70 + 100 + 175 shares, you get a total of 345 shares for the same Rs 21,000/- as opposed to 300 shares in the normal investment that you made in the earlier example. In the systematic investment, you end up holding 345 shares at an average price of approximately Rs 61/- per share, against 300 shares at Rs 70/- per share in lump sum investment. There is no magic in this. It is simple mathematics. By shifting your focus from a specified quantity of shares to be purchased per transaction, to investing equal amounts at regular intervals, you automatically tend to buy a lesser number of shares when the market is high and a greater number of shares when the market is low. This helps you obtain a favorable weighted average instead of a neutral simple average, as in the first example. When we buy the same stock or the same kind of investment (for example a particular diversified mutual fund, at different times, we will have a high price at which we purchase the stock or units and a low price. The median point

between the high price and the low price will be the simple average. For example, in the first case of normal stock market investment, the high price was Rs 100/-, the low price was Rs 40/- and therefore the mid-point between these two prices, or the simple average was Rs 70/-. Here prices changed, but our quantities remained the same. However, by using the superior technique of systematic investment, you end up with an actual price of Rs 61/-, which is below the simple average. In short, you have achieved better pricing, by an automatic process, without relying upon research and deep study. Systematic investment always and without exception enables you to get a final purchase price that is below the simple average price of the high and low rates during the period you made the investment. Here prices changed, and the quantities that we purchased also changed in response to the change in prices. Quantities purchased were greater when prices were down and lesser when prices were up. In real life also, wouldn't we tend to consume or use more of a product when its prices are down? The same common sense is automatically applied in a technique like systematic investment. To sum up, systematic investment plans (SIPs) in mutual funds are useful because: 1. They enable even a small investor with modest means to make systematic investments with amounts which can even be as low as Rs 500/- or Rs 1,000/- per month. 2. They afford convenience and ease of operation in making the investment. You can give standing instructions to your bank that a certain amount must be systematically invested every month into a certain mutual fund investment plan. 3. Even with very small amounts, you can achieve diversification across all major sectors and stocks. For example, three of the best diversified equity funds in India which invest in the main, large, blue chip companies are the Franklin India Bluechip Fund (from Franklin Templeton Mutual Fund), the HDFC Top 200 (from HDFC Mutual Fund), and the Fidelity Equity Fund (from Fidelity Mutual Fund). One of the best diversified mutual funds which invests in mid and small capital companies is the Sundaram Select Midcap Fund (from Sundaram Mutual Fund). At any given time, the above funds would be investing in something like 30, 50, 80, and 100 stocks respectively. Now, if a small investor is even putting Rs 500/- per month in the HDFC Top 200 through a systematic investment plan, each purchase of this Rs 500/- enables investment in the average of 50 companies that the fund is holding. Such a facility can be obtained only through mutual fund investment. 4. You have heard of diversification across sectors and companies. Systematic investment enables such diversification but also performs another very important function. It enables diversification to be complete. Systematic investment and diversification are very closely related. In fact, systematic investment is a part of diversification. Systematic investment is diversification across time. 5. Systematic investment automatically enables right pricing. 6. Systematic investment makes investment a habit. There is an old saying in investment: If you work on an investment, it will work for you. There is another old saying: A winner is not one who never fails, but one who never quits. Systematic investment in diversified equity funds, especially over the long term achieves and fulfills the spirit of these two sayings.

We conclude this note on systematic investment, by tackling the most important aspect of the risk involved in systematic investment into fluctuating avenues like index or diversified equity funds. Investment in diversified equity funds carries a risk in the short-term. Equity investment is however safe in the longrun. Systematic investment certainly does not eliminate risk. But it definitely reduces risk quite significantly. The maximum risks in equity indices almost never exceed 50%. In quality portfolios such as the ones recommended in our paper on equity investment, the risk is generally not more than 35%. But in systematic investment, the risk does not exceed 25%, 17%, and 10% in the first, second and third years. Lets look at an example. If you have a systematic investment of Rs 1,000/- per month into a diversified equity fund, and you have completed 12 months during which there has been a massive fall in the stock market, your maximum risk will not exceed 25% of the total of Rs 12,000/- that you have invested. 25% of Rs 12,000/- is Rs 3,000/-. This can be the maximum depletion in your investment. In 2 years, you would have invested Rs 24,000/-. Seventeen percent of this is approximately Rs 4,000/-. This can be your maximum risk in an SIP in two years time, in a worst case stock market scenario. In 3 years, you would have invested Rs 36,000/-. The maximum risk will not exceed 10% or Rs 4,000/approximately. Ever since the modern era of the Indian stock markets began in 1979, we have not seen any risk in SIPs of more than 3 years. Once you start, however, it is good to continue an SIP for at least the equity time horizon of 5 years. 3.2.2.5:SYSTEMATIC TRANSFER PLANS: This area involves an asset allocation strategy that has been described in Option 3 of our paper on good investment avenues in the Indian equity and debt markets. The strategy is called a 'ZERO RISK SYSTEMATIC TRANSFER PLAN.' It addresses a very important issue that most investors confront, and that is risk in equity investments. There are many investors who shy away from equity investments because of the risk involved. What they don't realize is that the stock markets have a history of slightly more than 400 years. During this period, not a single stock market system of any country has ever collapsed. On the other hand during the same period, countless banks, including some of the best banks in the world have gone under. When we talk about risk in the stock market, the so called risk is only in the short-term. History has shown repeatedly that there is absolutely no risk in equity investments in the long-term, especially in a well diversified portfolio of even reasonably good stocks. What if a stock market investor is given an opportunity to invest in equity without the accompanying risk? This was a question that fascinated us when we started our career sometime in 1985. We then came across many studies worldwide, which established that using an asset allocation strategy which combined both, debt and equity investments, risk could be fine tuned to the level desired by the investor. vYou will understand this better with a simple example. Assume that Rs 100,000/- is invested in a safe avenue of investment which gives a return of 5% p.a. Now, 1% of this principal that is Rs 1,000 /- per month is transferred to a reasonably well diversified bunch of stocks. If such a strategy is put in place, there will be no risk to the capital of the investor, regardless of the state of the stock market over any period of time. Using this strategy therefore, an investor can participate in the market without taking a risk to his capital. The systematic transfer plan (STP) combines all the benefits of systematic investment, and in addition makes use of the

asset class of debt, which is non-correlated to equity. Non-correlated means that equity and debt will generally not move together, where their returns are concerned. Short-term debt, which is the safest form of debt, will give low and steady returns. Equity can move up or down in the short-term, but gives higher returns in the long-term. To sum up, the rationale behind an STP can be explained in the following table: AssetClass ---------------------------Short-term Debt Diversified Equity Short-term(<5years) -----------------------------Safe Risky Long-term(>5years) -----------------------------Safe Safe

---------------------------------------------------------------------------------------------------------What you see above is that debt is safe whether in the short-term or the long-term. Equity is safe in the long-term, but can be quite risky in the short-term. Therefore, the table shows 3 areas of safety and one area of risk. The systematic transfer plan attempts to avoid this one area of risk by placing the corpus available (in our example Rs 100,000/-) in a short-term debt fund and systematically transferring 1% of this corpus per month to an avenue of investment that is safe in the long-term, namely equity. While debt is also safe in the long-term, it should be borne in mind that equity gives far higher returns than debt, in the longterm. Investing in an asset allocation strategy whereby a corpus is placed in a safe debt avenue of investment, and 1% of the corpus per month is transferred to a diversified equity avenue, is called a "zero risk systematic transfer plan." This discussion brings us to an interesting point. Risk can be of two types. You can have a risk to capital. You can have a risk to return. Let us assume you have invested Rs 1 lakh in equity. After one year, your investment is worth Rs 90,000/-. This is a risk to capital. Now, let us assume that you have invested Rs 1 lakh in a zero risk STP strategy and another Rs 1 lakh in a resident bank deposit. After one year, the stock market performs very badly. Your STP strategy is worth Rs 1.03 Lakhs. Your bank deposit has earned you 9% p.a. and is worth Rs 1.09 Lakhs. If you argue that you earned lesser returns of Rs 6,000/- in the STP strategy, the extent to which you earned lesser returns than a competing avenue of investment, is your risk to return. This example is given for illustrative purposes only, as an STP strategy involving debt and equity is totally different from a pure debt investment like a bank deposit. Over period of 5 years or more, STP strategies have repeatedly proved that they will give higher returns than most other avenues of investment, without taking a risk to capital. Hence to earn higher returns in a longer time frame, it is worth taking a risk to return. First time investors in the stock market would certainly do well to avoid a risk to capital at all costs. There are many risk-averse investors who do not mind a short-term risk to return, if they can be compensated by long-term returns which will beat almost all other avenues. Their main fear is of a risk to capital, not a risk to return. We fully support any investor who does not want to take a risk to capital. As Warren Buffett put it so beautifully: "The first rule of investing is: do not lose. And the second rule is: do not forget the first rule. And that's all the rules there are." The zero risk STP has one other outstanding feature. At any time during the period of your investment, if the stock market falls by more than 25% from its last peak and remains below this level for at least a month, then we advise you to double your monthly systematic transfer from Rs 1,000/- to Rs 2,000/-. Generally, you get a chance to do this at least once in a period of 5 years. If you do avail of this opportunity, it can substantially enhance your returns.

As things stand in India at present, zero risk systematic transfer strategies are designed to quadruple your money in a period of 10 years, even if you do not get an opportunity to double your systematic transfer when the markets fall by 25% from their peak. If you do, the returns will of course be higher. Viewed from any angle, the zero risk STP remains one of the best strategies in mutual fund investment. Its value lies in first, enabling a risk-averse investor to invest in the stock market without taking a risk to capital. Second, while capital is protected, returns are not compromised. Third, there will generally be an opportunity to substantially increase your returns when the markets descend 25% or more from their last peak. 3.2.2.6:INVESTMENTS: The definition of a mutual fund is that it is a common pool of money to which investors contribute, for investment in accordance with a stated objective. Therefore, mutual funds are not limited only to financial assets such as equity shares, government bonds, corporate bonds and other debt instruments. Mutual fund plans can also be formulated to invest in real estate, bullion, other precious metals, derivatives and so on. When we study the history of investments, we find that where long-term, investment-beating and wealth-enhancing returns are concerned, the only two worthwhile avenues of investment are equity and real estate. Since real estate requires a lot of capital and considerable expertise, real estate mutual funds can offer a good alternative for investment. Similarly, there are certain asset allocation funds which rebalance between various types of assets on a periodical basis. For example we can have a fund that follows Benjamin Graham's 50:50 rebalancing strategy. To understand this strategy, let us assume that the mutual fund has a corpus of Rs 2 Lakhs. Rs 1 lakh is invested in let us say the Nifty Index and the other Rs 1 lakh is invested in a liquid fund, thereby maintaining a 50:50 balance between debt and equity. Let us say 6 months down the line, the debt component has grown to Rs 1.04 lakhs and the equity component has grown to Rs 1.10 Lakhs. The total portfolio value is now Rs 2.14 lakhs. To maintain a 50:50 balance now, there should be Rs 1.07 Lakhs in debt and Rs 1.07 Lakhs in equity. So, the fund now shifts Rs 3,000/- from equity to debt, in order to realign itself to the 50:50 balance. Such a fund would certainly be worth investing in, especially if it has a regular programme for rebalancing its portfolios at fixed intervals of say 6 months or a year. Regular rebalancing is perhaps the finest way of investing. It takes care of all normal questions of an investor like when to invest, where to invest, when to book profits, what is the quantum of profits to be booked, etc. To conclude, real estate mutual funds and certain clear cut asset allocation and rebalancing funds are definitely to be considered in the overall investment portfolio of an investor.