Wealth Management

WEALTH MANAGEMENT

FINANCE DOCTOR

Course objectives n n n n

What is wealth? Can everyone be wealthy? Identifying values and financial goals Inflation and Quantifying goals How can I achieve my goals? Ø Ø

Ø Ø

n

Knowing present state – organizing information Asset classes – stocks, debt, insurance, derivatives & real estate Putting it all together Implementation & Behavioural finance

Summary

FINANCE DOCTOR

WEALTH Passive income sufficient to sustain the desired lifestyle FINANCE DOCTOR

Identifying Values → Goals

n n n n

Retirement Education Housing Protection

FINANCE DOCTOR

Quantifying Needs RETIREMENT Visualize retirement expenses in relation to current expenses Monthly expenses Food Clothing Housing Children related Health & Insurance Transportation Appliances Discretionary any other

TOTAL EXPENSES

Current Retirement 7000 6000 4000 2500 3000 6000 8000 0 2000 5500 3000 4500 3000 2500 5000 3000 0 0

35000

FINANCE 30000 D O C T O R

Quantifying Needs TOTAL RETIREMENT MONTHLY EXPENSES TOTAL RETIREMENT ANNUAL EXPENSES Inflation rate assumption no of years inflation factor Taxation assumption Inflation adjusted retirement requirement Inflation & tax adjusted retirement requirement Return assumption on retirement Lump sum requirement at retirement

30,000 360000 6% 20 3.21 10% 1155600 1284000 8% 16050000 FINANCE DOCTOR

Quantifying Needs EDUCATION 1 2 3 4 5 6 7 8 9 10

children's names Kavi Deepika ages 10 7 no. of years until univ. 8 11 estimated no. of yrs in univ. 4 4 no. of years for infl. Adj. 10 13 estimated annual infl. Rate 6% 6% inflation factor 1.79 2.13 est. annual univ. cost today 200000 200000 est. annual costs adj. 358000 426000 estimated total costs adj. 1432000 1704000 money reqd.

2013

2016F I N A N C E DOCTOR

Quantifying Needs HOUSING 1 present value of the house 2 down payment 3 Soft loan from the company 4 Home loan reqd. 3 EMI 4 no. of years reqd. 5 House rent allowance and taxation benefit 6 Net monthly cash outflow

2500000 500000 1000000 1000000 Rs. 945 per lakh- approx. Rs. 9450 per month 20 years Rs. 4450 per month inflow Rs. 5000

assuming housing grows at 7% for the next 20 years money required to buy comparable house Rs. 97 lakhs FINANCE DOCTOR

Quantifying Needs TIMELINE

Need Money reqd. Year Education 14.32 lakhs Education 17.04 lakhs Housing 97 lakhs Retirement1.605 crores

2013 2016 2025 2025 FINANCE DOCTOR

Organizing InformationScore card

INCOME

ASSETS

EXPENSES

LIABILITIES FINANCE DOCTOR

Income INCOME Active sources employment salary professional income business income Passive sources rent from property investment income royalties any other COMBINED INCOME Deductions Taxation Pension Contribution any other

NET INCOME

FINANCE DOCTOR

Expenses – Latte factor EXPENSES Food Clothing Housing Children related Health & Insurance Transportation Appliances Discretionary any other

TOTAL EXPENSES FINANCE DOCTOR

Liabilities – Debt management LIABILITIES Short term credit card loan borrowings on life insurance personal loan installment accrued income taxes other obligations Long term home loan principal yet to be repayed loans to purchase investmnt assets loans to purchase personal assets

TOTAL LIABILITIES FINANCE DOCTOR

Assets –Most powerful ASSETS Liquidity

Safety

12 mths basic expense short term deposits liquid funds current income bonds saving schemes real estate on rent long term provident fund,pension plans rbi bonds real estate for own usage fixed term deposits gold, jewellery

Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

FINANCE DOCTOR

As Is

SCORE CARD INCOME Active sources employment salary professional income business income Passive sources rent from property investment income royalties any other Deductions Taxation COMBINED INCOME post taxn. Provident Fund Contribution

Monthly in Rs.

55000 15000

NET INCOME EXPENSES Food Clothing Housing Children related Health & Insurance Transportation Appliances Discretionary any other

40000

TOTAL EXPENSES

35000

7000 4000 3000 8000 2000 3000 3000 5000 0

ASSETS Liquidity 12 mths basic expense short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund,pension plans rbi bonds real estate for own usage fixed term deposits gold, jewellery Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS LIABILITIES Short term credit card loan borrowings on life insurance personal loan installment accrued income taxes other obligations Long term home loan principal yet to be repayed loans to purchase investmnt assets loans to purchase personal assets

TOTAL LIABILITIES

amount present return 50000 3% 0 0 150000 0 1250000 0 0 150000 300000 150000 0 0 0 0 0 0 100000 2150000

7%

8%

5% 3% 15%

6%

4%

0 0 0 0 0 0 0 0

FINANCE 0 DOCTOR

If ‘As Is’ continues 1 Education 2013 -----14.32 lakhs Saving scheme-1.5 lakhs at 7% Fixed`deposit-1.5 lakhs at 5% insurance inv. 1 lakh at 4 % for 8 years Total 2 Education 2016 ------17.04 lakhs stocks-1.5 lakhs at 15% 3 Retirement 2025----- 1.6 crores monthly savings Rs. 15000 in PF at 8% monthly savings 5000 in deposits at 5% Total 4 Housing 2025------97 lakhs provident fund 12.5 lakhs at 8 % 5 Protection----- 50 lakhs presently minimal cover

2.6 2.2 1.4 6.2

lakhs lakhs lakhs lakhs

6.98 lakhs 88.4 lakhs 23.1 lakhs 1.11 crores 58.2 lakhs

FINANCE DOCTOR

Things can be different n

Higher returns are possible at minimal risk and make significant difference

FINANCE DOCTOR

Power of Compounding n

For example, if 12 lakhs is required for children s education in 10 years: Rate of Return

Monthly saving

6%

Rs. 7322

15%

Rs. 4367

18%

Rs. 3622 FINANCE DOCTOR

Power of Compounding Time / Annualized returns 15 years

8%

20 years

49 lakhs

29 lakhs

15%

56 lakhs 1.25 crores

FINANCE DOCTOR

Inter Relationships INCOME Active sources employment salary professional income business income Passive sources rent from property investment income royalties any other Deductions Taxation COMBINED INCOME post taxn. Pension Contribution

NET INCOME EXPENSES Food Clothing Housing Children related Health & Insurance Transportation Appliances Discretionary any other

TOTAL EXPENSES

Monthly in Rs.

ASSETS Liquidity 12 mths basic expense short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund,pension plans rbi bonds real estate for own usage fixed term deposits gold, jewellery Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS LIABILITIES Short term credit card loan borrowings on life insurance personal loan installment accrued income taxes other obligations Long term home loan principal yet to be repayed loans to purchase investmnt assets loans to purchase personal assets

TOTAL LIABILITIES

amount

present return

FINANCE DOCTOR

Asset QuadrantAllocation is the key decision Maximizing wealth within business cycle & personal cycle constraints

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Personal Cycle

n n n

Accumulation stage Transition stage Reaping stage

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Personal Constraints

n n n

Liquidity Safety Current income

FINANCE DOCTOR

Assets –Most powerful ASSETS Liquidity

Safety

12 mths basic expense short term deposits liquid funds current income bonds saving schemes real estate on rent long term provident fund,pension plans rbi bonds real estate for own usage fixed term deposits gold, jewellery

Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

FINANCE DOCTOR

Business Cycle Consists of economic expansions followed by contractions and revivals which merge into the expansion stage of the next cycle

FINANCE DOCTOR

Business Cycle Stage & Asset Allocation n

n

n

Stocks will be the best assets in certain phases of business cycle Bonds will be the best assets in certain other phases Commodities might thrive in certain other conditions FINANCE DOCTOR

Asset classes n n n n n

Equity / Stocks Debt Insurance Derivatives Real estate

FINANCE DOCTOR

What is stock?

Two major types of financing n Debt – Borrowing & lending n Stocks – Ownership

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STOCKS Asset class with best returns and low risk – therefore most important for Wealth Creation

FINANCE DOCTOR

Total Nominal Return Indexes, 1801 – 2001

Stocks $8,800,000

Bonds $13,975

Gold

1801

$14.38

FINANCE 2001 DOCTOR

Comparative Indian Returns (As of 30-06-2005)

CATEGORY

COMPOUNDED ANNUALISED RETURN 1 YEAR

2 YEAR

3 YEAR

5YEAR

Stock Fund

74.83

72.83

61.64

40.57

Debt Fund

4.42

4.58

7.87

5.0

5.0

6.0

Fixed Deposits

6.0

FINANCE DOCTOR

Low Risk

Price

Time

FINANCE DOCTOR

International Experience for Stocks

n n n

USA Germany Japan

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What explains the consistency of worldwide stock returns?

n n

Related to economic activity Corporate sector is the engine of economic growth

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Risk Profiling

n

Can lead to erroneous allocation, to be used carefully

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Market Timing

Should we be always invested in stocks?

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Yes, except when stocks are severely over valued and when personal constraints are present

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Bluechip fund

Worst possible time to invest in stocks n n n

22nd February, 2000 – NAV 30.78 17th September, 2001 – NAV 15.02 10th June, 2005 – NAV 64.23

FINANCE DOCTOR

Returns

n n

Dividends Capital gains

FINANCE DOCTOR

Risks

n n n

Company specific Sector specific Market level risk

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Valuation

n n n n

P/E P/B Dividend Yield Market Value/GDP

FINANCE DOCTOR

Valuation Example

Date Sensex Level Historical range Feb 2000 6200 Dec 2002 3400 August 2004 5200

Price/EarningsPrice/Book Dividend Yield Verdict Subsequent Move 11-29 1.9-4.1 0.95-2.4 28 3.98 1 overvalued Big downward move for 3 years 14.37 2.24 2.18 undervalued 125 % returns in year 2003 15.38 2.88 2.24 undervalued Expected to move up significantly

FINANCE DOCTOR

Indian Equity Markets Strong long term potential

FINANCE DOCTOR

Advantage Asia Mixed economic data out of US, Europe and Japan. Concerns remain on structural imbalances, especially in a high oil price and inflation scenario US is unlikely to be the world s sole growth engine, given the gaping current account deficit and low savings rates. Multiple growth engines are likely to emerge with the Asian region in particular leading the way Changing demographical profile favors developing countries as developed countries are saddled with an ageing population Asia remains relatively insulated in an uncertain environment FINANCE DOCTOR

Global Scenario- Growth in Brics Goldman Sachs: Over the next 50 years, Brazil, Russia, India and China (BRICs) could together be larger than the G6 countries by 2039. UBS : By 2030, the combined purchasing power of China's and India's consumers will be five times greater than that of today's United States Growth economies driven by domestic demand offer superior investment opportunities and have a better chance of attracting new capital Global companies across sectors are looking to cut costs and improve efficiencies by outsourcing China and India offer an unique advantage of low cost outsourcing and a vast domestic market in a world of scarce growth FINANCE DOCTOR

2010 - 2030 : Favourable Demographic Bulge India Demographic Profile (2020)

China Demographic Profile (2020)

France Demographic Profile (2025)

Age group 80+

80+

80+

75-79

75-79

75-79

70-74

70-74

70-74

65-69

65-69

65-69

60-64

60-64

60-64

55-59

55-59

55-59

50-54

50-54

50-54

45-49

45-49

45-49

40-44

40-44

40-44

35-39

35-39

35-39

30-34

30-34

30-34

25-29

25-29

25-29

20-24

20-24

20-24

15-19

15-19

15-19

10-14

10-14

10-14

5-9

5-9

5-9

0-4

0-4

0-4

-60 60

-40 40

-20 20

0

20

40

60

-60 60

-40 40 40

-20 20

0

20

Mn people

40

60

-3 3

-2 2

1 -1

0

1

Mn people

2

3

Mn people

20 - 35 age group :

20 - 35 age group :

20 - 35 age group :

325 mn people ( ~ 25 %)

308 mn people ( ~ 21 %)

11 mn people ( ~ 17 %)

Female Male

Source: CII Conference 2002; CSFB Report; UN Population Division; BCG Analysis

Demand growth in consumer items over the next few years to remain strong

FINANCE DOCTOR

The growth surge 70

C onsumer loans to GDP 62

62

60

30

20

8

7

6

Phil.

10

India

15

Source: CLSA

Indonesia

Thailand

0 Taiwan

Increased consumption of services such as healthcare and tourism are also spin off benefits

40

Malaysia

Rising consumer aspirations reflected in high growth of cars, mobile subs

49

Singapore

Consumer credit is just starting to reach out to next tier of towns

52

50

HK

Job creation in services driving creation of +200m urban consumer base by FY07

53

Korea

Economic reform has raised product affordability through price stability

FINANCE DOCTOR

Services

India s strength 14

Indian IT Software & Services Exports (US$bn) 12.2

12

IT exports contributes to 3.5% of India s GDP and contributes to nearly 1% of the economy s growth Nearly 500,000 employees directly recruited by IT exports growing at a fast pace of over 30% ITES is emerging to be a larger employment generator than IT Services IT explosion creating traction in real estate of over 1 million square feet per quarter in main cities. Support facilities is an additional employment generator.

9.9

10

8

7.6

6.2 6

4.0

4 2.6 2

1.8

0 FY98

FY99

FY00

FY01

FY02

FY03

FY04

IT exports continues to push Indian economy into a higher growth orbit

FINANCE DOCTOR

Indian equities offer sustainable growth paradigm India An economic superpower in the making as demographics and consumerism play out Corporate India Gaining in strength and confidence after a period of restructuring

Indian Markets Closed 2004 a volatile year on a high note as FII inflows turned robust, reflecting the vote of confidence amongst global fund managers for India

FINANCE DOCTOR

24

Industry leaders are now value creators

(%)

22 Return on equity

20 18

Value created

16 14 12

Current c ost of Equity Cost of Equity

10 8 FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

05CL

06CL

Source: CLSA

Capex phase in the late nineties sets foundation for value creation

FINANCE DOCTOR

Favourable indicators for investment cycle 4500

Up tick in investment proposals, after 6 years of decline

Outstanding mfg. investments (Rsbn)

4000

Capex fuelled by need for new capacity with utilization c. 90% 3500

Cost competitiveness, strong balance sheets support growth with value creation 3000

Upside from step-up in spend on infrastructure led by power Concurrent investment, consumption cycle potential for +10% IIP growth

2500

Capacity Utilisation (%) FY02

FY03

FY04

FY05E

Refining

96

96

98

92

Cement

84

86

81

82

Steel

82

88

82

88

95

94

90

Aluminium Source: Cris Infac 88

2000 94

95

96

97

Source: CLSA, CMIE

98

99

00

01

02

03

04

FINANCE DOCTOR

25

Domestic equity ownership on the way up?

(%)

20 Equity savings as % of Financial Savings 15

10

5 Equity savings as % of Market C ap 0 80 81

82 83 84 85

86 87 88 89

90 91 92 93

94 95 96 97

98 99 00 01

02 03 04

Source: RBI, CLSA

Household savings into equities bottoming out

FINANCE DOCTOR

Tax changes support rise in equity ownership 120

Capital gains tax on listed equities cut;

Distribution of financial savings by households (%)

100

NIL for holdings > 12mths 80

10% (from 30%) for holding <12mths Dividends tax free since FY03

60

Friendly tax regime will remove a hurdle for 40 entry of many foreign funds

Currency Claims on Govt Providend and pension funds

FY04

FY03

FY02

FY01

FY00

FY99

FY98

FY97

FY96

0 FY95

Reduced yields on bank deposits (43% of savings), bonds also favor equities

20

FY94

Retail investors invest sub 1.5% of financial savings in equities

Deposits Insurance funds Shares and debentures FINAN

CE DOCTOR

India

The bottom line Economic future is bright

Per capita income expected to double by 2010 companies across sectors

will have cascading effect on

India could emerge as the third largest economy in world by 2050 India and China together expected to become a market 5 times the size of today s United States in purchasing power terms in 25 years Medium to long term story strong

Paradigm shift in exports Robust domestic demand Improved efficiencies leading to higher wealth creation by Corporate India Under ownership of equity assets will lead to higher allocation in future as risk FINANCE perceptions change DOCTOR

How to invest in stocks?

n n n n n

Current valuation Comparative yields Time horizon Diversification When to take profits? FINANCE DOCTOR

Mutual fund Vs Direct equity

n n

n

Debate redundant Personal choice of control vs convenience Basic principles of diversification and time horizon should be followed FINANCE DOCTOR

What is a mutual fund?

n

Collection of money from a large group of investors, pooling it and investing in various securities, in line with the fund’s specified objective FINANCE DOCTOR

Equity Fund Style

Growth

Blend

Value Large Mid Small

FINANCE DOCTOR

Types of Mutual Funds

n n n n

Diversified equity Index Tax planning Sectoral

FINANCE DOCTOR

RANKINGS Forward looking as compared to traditional rankings based only on past performance Criteria n Past performance n Resilience in the falling market n Risk n Stability of fund management n Investment style n Costs n Service levels FINANCE n MNC s Indian orientation DOCTOR

EQUITY DIVERSIFIED PERFORMANCE RETURN (As of 30-06-2005)

NAME

Index HDFC Equity Franklin India Blue Chip Magnum Contra Franklin Prima

3 MONTH

1 YEAR

2 YEAR

3 YEAR

5YEAR

9.09

47.49

39.93

28.04

8.58

10.37

61.68

56.91

49.61

27.63

7.04

42.86

53.72

45.20

22.22

10.51

98.87

88.77

59.08

38.88

8.15

74.83

72.83

61.64

40.57

FINANCE DOCTOR

Active Vs Passive

Active funds have outperformed passive funds by significant margin

FINANCE DOCTOR

Bluechip Composition Franklin India Bluechip fund jan 31, 2005 no. name 1 Grasim 2 Infosys 3 SBI 4 ITC 5 HPCL 6 Hindalco 7 Reliance 8 BPCL 9 Satyam 10 TISCO Weighted P/E

%

P/E 6.5 6.19 5.9 5.5 5.4 5.3 5.2 4.6 4.5 4.2

13 36 9.3 19 9 14 12.3 12 19.5 7.6 15.5 FINANCE DOCTOR

Prima Composition Franklin Prima jan 31,2005 no.

Weighted P/E

name 1 Indian rayon 2 LIC housing fin. 3 IPCA labs 4 eicher motors 5 MICO 6 goodlass nerolac 7 amtek auto 8 birla corp. 9 GE shipping 10 raymond

%

P/E 7.5 6.5 5.5 4.4 3.9 3.8 3.4 3.2 3.1 2.9

26 13.3 11.2 17 17.4 14 25 18.5 4.6 10 16.4 FINANCE DOCTOR

INVESTMENT TAXATION Equity / Equity Funds n Long term capital gains tax = 0 n Short term capital gains tax = 10% n Dividends exempt from dividend distribution tax Dividend reinvestment, FIFO n Section 80C, ELSS, SIP FINANCE DOCTOR

Allocation for Stocks 10 lakhs to be invested: Franklin Bluechip 2 lakhs Fidelity Fund 2 lakhs HDFC Equity 3 lakhs Franklin Prima 4 lakhs

FINANCE DOCTOR

Conclusion

n

n

Stocks are the best assets for wealth creation However these have to be utilized in a certain manner

FINANCE DOCTOR

Debt

FINANCE DOCTOR

Debt Two major sources of financing n Stocks – Ownership n Debt – Borrowing and lending FINANCE DOCTOR

Fixed Income Securities

n

n

Debt also known as fixed income Bond is the most familiar debt security

FINANCE DOCTOR

Bond

n

A long agreement between borrower & lender stating the terms of a loan n n n n

Principal Interest Maturity Face value

FINANCE DOCTOR

Characteristics

Steady instruments n Moderate returns n Providing stability under difficult conditions Bonds are wealth preservers while stocks are wealth builders n

FINANCE DOCTOR

Unique proposition

n

n

n

Low or inverse correlation with stocks Generally useful in business cycle stage where stocks are not favored Today’s example FINANCE DOCTOR

Types of bonds

Two most useful factors for categorization n Issuers and their credit worthiness n Maturity

FINANCE DOCTOR

Types of bonds

n n

Government bonds Corporate bonds

FINANCE DOCTOR

Yield to maturity

Yield on a bond, taking into consideration the price paid, interest to be received and the principal amount to be repaid at maturity

FINANCE DOCTOR

Price Yield Relationship

Inversely Related

FINANCE DOCTOR

Return

n n

Coupon payment Capital gain

FINANCE DOCTOR

Risk

Can fixed income securities be considered risk less?

FINANCE DOCTOR

Risk

n n n n

Credit Risk Interest Rate Risk Reinvestment Risk Liquidity Risk

FINANCE DOCTOR

What should be counted as Debt in portfolio? n n n n n

Debt Funds Bonds bought directly Bank deposits Small saving schemes Provident funds

FINANCE DOCTOR

Debt & Personal Cycle

Useful for every category within asset quadrant

FINANCE DOCTOR

Debt Fund Style Credit Quality Medium

Low High Medium Low

Interest rate sensitivity

High

FINANCE DOCTOR

Types of debt funds n

n n

n n n n

Gilt funds duration > 3 years, sovereign credit Gilt short term duration 1 3 years Debt medium term duration 3 6 years, both corporate & Govt. Debt short term Debt ultra short term (liquid funds) Floating rate fund Hybrid funds FINANCE DOCTOR

DEBT FUNDS PERFORMANCE (As of 30-06-2005) NAME

ANNUALISED RETURN (EXCEPT FOR 3 MONTHS) 3 MONTH

1 YEAR

2 YEAR

3 YEAR

HDFC Gilt

0.23

-0.40

2.30

8.27

Kotak Bond

1.53

4.42

4.58

7.87

Prudential ICICI short term

1.74

5.20

DSPML floating rate

1.32

5.02

0.10 (7days)

0.20 (14d)

0.41 (28d)

2.37

9.94

10.56

Can liquid Templeton MIP

10.83

FINANCE DOCTOR

INVESTMENT TAXATION Debt Funds n Long term capital gains tax = 10% n Short term capital gains tax = treated as normal income n Dividends tax free in hands of investors, 12.5% dividend distribution tax FINANCE DOCTOR

Insurance

FINANCE DOCTOR

Insurance n

n

n

Financial protection against unexpected event A risk management tool, a risk transferring product Similar to option

FINANCE DOCTOR

Low insurance penetration in India

Total insurance premium as a % of GDP is very low comparatively

FINANCE DOCTOR

Protection & Investment n

n

Insurance generally sold as a mixed productprotection+investment Main issue- how good is the comparative performance of insurance investment ?

FINANCE DOCTOR

Premium n

Dependent on probability distributions and individual factors (actuarial studies)

FINANCE DOCTOR

Types of Policies n n n n n n n n

Term insurance Endowment Money back Whole life Pension policies Unit linked Children s plans Riders FINANCE DOCTOR

Term insurance=pure protection All other policies=term insurance+investment

FINANCE DOCTOR

Calculation of ‘Rate of Return’ on ‘Insurance Investment” n

n

n

Reduce everything to actual cash flows Deduct term premium from actual premium paid Calculate rate of return

FINANCE DOCTOR

With Profit Endowment n n n n n n

Annual premium=Rs. 22,617 Payment period=20 years Expected payback=Rs. 9.4 lakhs Term premium=Rs. 1500 PMT= Rs. 21,117 Rate=7.75% FINANCE DOCTOR

Money Back n n n

n n n

Annual premium=Rs. 34,123 Payment period=20 years Expected payback=Rs. 1 lakh at 5,10,15 years and 6.4 lakhs at 20 years Term premium=Rs. 1500 PMT= Rs. 32,623 Rate=5.15% FINANCE DOCTOR

Calculation of Rate money back

year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

cash flows -34123 -34123 -34123 -34123 65877 -34123 -34123 -34123 -34123 65877 -34123 -34123 -34123 -34123 65877 -34123 -34123 -34123 -34123 605877

IRR calculation 5.15%

FINANCE DOCTOR

Whole Life n n n

n n n

Annual premium=Rs. 11,855 Payment period=35 years Expected payback=Rs. 8 lakhs at the age of 80 years Term premium=Rs. 1500 PMT= Rs. 10,355 Rate=less than 3 % FINANCE DOCTOR

Unit linked Insurance Plans (ULIPs) n

n

Returns are much less than comparable investment products Additionally, entry costs are very high

FINANCE DOCTOR

Pension Plans n n n

Accumulation phase Vesting Generation of annuity returns

FINANCE DOCTOR

Taxation n n n

Payment-exempt Accumulation-exempt Maturity-exempt

FINANCE DOCTOR

Taxation of ELSS n n n

Payment-exempt Accumulation-exempt Maturity-exempt

FINANCE DOCTOR

Overall Comparison n n n n n

Return-inferior Risk-same Costs-higher Taxation-same Liquidity-inferior

FINANCE DOCTOR

Conclusion n

n

n

Insurance is tremendously beneficial product for protection But investment performance and costs are inferior to those of mutual fund Conclusion only term insurance policy should be bought till the investment performance comes up FINANCE DOCTOR

Estimating Appropriate Cover n

n

n

Present income approach- a lump sum which can generate a return almost equivalent to the present income. Roughly 10 times the annual income is a good estimate In the case study, 50 lakhs will be the amount FINANCE DOCTOR

Derivatives & Structured Products

FINANCE DOCTOR

Derivatives n

n

A derivative security derives its value from an underlying Underlying can be stocks, commodities, bullion, currency & many others

FINANCE DOCTOR

Basic Types n n

Futures Options

FINANCE DOCTOR

Rationale n

n

n

Actual transaction not happening today Instead, there is an intent or commitment Origin lies in both buyers and sellers benefiting

FINANCE DOCTOR

Oil Prices An example of usefulness of derivatives

FINANCE DOCTOR

Futures n

n

Obligation to buy or sell an asset at a pre-specified price and at a pre-specified time Quantity is also determined before hand Note that this is an obligation

FINANCE DOCTOR

Terms n n n n

Expiration date Initial margin MTM margin Cash settled vs delivery settled

FINANCE DOCTOR

Options n

Options are deferred delivery contracts that give the buyers the right, but not the obligation, to buy or sell an asset at a prespecified price and on or before a specified date Note that this is a right FINANCE DOCTOR

Option Terminology n

Call Option n

n

Put Option n

n

Right to sell

Option Buyer n

n

Right to buy

has the right but not the obligation

Option Writer/Seller n

has the obligation but not the right FINANCE DOCTOR

Option Terminology n

Option Premium n

n

Strike Price OR Exercise Price n

n

Price at which the underlying may be purchased or sold

Expiration Date n

n

Price paid by the buyer to acquire the right

Last date for exercising the option

Exercise Date n

Date on which the option is actually exercised

FINANCE DOCTOR

Derivatives in Investment Management n n n

Hedging Portfolio rebalancing Capital protection

FINANCE DOCTOR

Taxation n

n

For an investor short term & long term capital gains taxation For a business loss can be set off against other business income

FINANCE DOCTOR

Real Estate

FINANCE DOCTOR

Real Estate Characteristics n n n

n

n

n

Dominant role in total wealth Housing one of the biggest expenses For most people, biggest & one of the best investment decisions Decision making not based on financial aspect alone Need for shelter & prestige also gets fulfilled Bungalow occupies an important place in an individual s psyche Deewar s FINANCE Maa comparison DOCTOR

Real Estate Characteristics n

n n n

n

n n

Fall back asset in unfavourable times like in rampant inflation Important role in multi asset portfolio Low correlation with bonds and stocks Versatile and multifaceted liquidity, safety & yield enhancing Holding a physically visible asset is good Financial leverage Taxation benefits FINANCE DOCTOR

Historical Return/ Risk Investment statistics from Real Estate and other categories of Assets 1973-1984 (USA statistics-but provide an indication about comparative return & risk) Investment Average rate of return Risk-Std. Deviation Residential Real estate 10.53% 4.44% Farmland 14.03 11.06 Business real estate 10.78 2.77 Common stocks 9.62 19.71 Corporate bonds 7.51 13.92 Small stocks 21.96 28.11 FINANCE DOCTOR

Risks n n

n n n

Market Risk Property destruction & cost of replacement Developer Risk, Title deeds Tenants refusing to vacate Structural flaws FINANCE DOCTOR

Risks n n n n n

Changes in neighborhood quality Liquidity risk High transaction costs Loan rate risk Landlord s duties onerous

FINANCE DOCTOR

Distinctiveness of Real Estate n n

n n

n n

Psychological value Concentration rather than diversification Each unit is distinct Liquidity less, transaction cost much higher Ideal time horizon longer than stocks There is no exchange for uniform price discovery FINANCE DOCTOR

Placing Real Estate in Portfolio NEEDS LIQUIDITY

SAFETY

PORTFOLIO INSTRUMENTS

PERCENTAGE

RETURN

Real Estate for self-occupation

YIELD ENHANCING Real estate as an investment

FINANCE DOCTOR

Valuation of Real Estate n

Physical n n n

Land Labor Material

Market sentiment n Demand & Supply When demand goes up supply might follow at a sluggish pace n

n n n

Zoning/ Planning Laws Controlled Release of Land Stock Limited supply of suitable land in a city, FINANCE area or a compound DOCTOR

Valuation of Real Estate n

n n

Like for any other asset, valuation determined by income stream its ability to generate rent is an important determinant Rental yield R/P Potential for capital gain

FINANCE DOCTOR

Financial Leverage Factor n

Buying cash outflows n

n n n n n

n n n

EMI as determined by house prices & interest rates Real Estate Taxes Utility Payments Home Insurance Repairs & Upkeep Savings by Tax Reduction

Net Buying Outflow E Net Rental Outflow R R/E Ratio also very useful for valuation FINANCE DOCTOR

Real Estate Cycle n

n

Superimposed on the main business cycle are demand supply curves of a city, sub-area and even going down to the unit itself While Real Estate in general might be depressed, one house might be fetching a very good price FINANCE DOCTOR

Gurgaon Example – Story of a Township First Phase 1988 to 1992 n n

n n

South of South Delhi Billed as IT Park, residential, commercial & self sufficient township Attractive prices Early adopters, investors & NRIs FINANCE DOCTOR

Gurgaon Example – Story of a Township Second Phase 1992 to 1996 n n n n

n n

Slow release of land stock Hype about investment potential Post reforms 1992 economy Powerful real estate cycle started kicking in Low occupancy, rents remained low R/P ratio very low FINANCE DOCTOR

Gurgaon Example – Story of a Township Third Phase 1996 to 2003 n

n

n

n n n

Investors taking profits by selling houses Developers increased the supply, looking at high prices Slow implementation of economic reforms People (end users) started moving in House prices crashed, rents went up FINANCE R/P ratio high DOCTOR

Gurgaon Example – Story of a Township Fourth Phase 2003 to to-date Economy growing at a healthy rate n Township living up to its initial potential n Multiplexes, malls, smart residential units, multinational companies, schools & hospitals coming up n Lower interest rates & booming housing loans n 8 lane highway from airport coming up Prices surging, moved by 250% in some FINANCE areas in 2004. DOCTOR n

Understanding Real Estate Cycle & Valuation is Beneficial n

n

In Gurgaon the cycle was giving strong signals in 2003 that the property was severely under valued Surprisingly the market stayed low for quiet some time, thus the opportunity was there for taking FINANCE DOCTOR

Understanding Real Estate Cycle & Valuation is Beneficial Other important factors are: n Motivated seller n Importance of negotiation n R/P & R/E ratios time series and comparative n Bid offer spreads very high to get information as buyer and seller n No price discovery mechanism n Multiple demand supply curves FINANCE DOCTOR

Beneficial Role of Real Estate in Portfolio n

n

n

Presently real estate positively correlated to stocks and negatively to bonds Flight to safety correlation with other asset classes can break easily Analytical studies show that addition of real estate to portfolio is very beneficial returns increase while risks go down FINANCE DOCTOR

Buying Vs Renting n n

Buying for own usage Buying for investment

FINANCE DOCTOR

Buying for own usage n n

n n

Forced saving Yields as compared to other safety instruments is much higher Reduces the portfolio risk Tremendous financial benefit with taxation and leverage

FINANCE DOCTOR

Buying for own usage n

Simulation example n

n

n

Buying entailed cash outflow of Rs. 9,450 There was an inflow in terms of HRA & Taxation benefit of Rs. 4,450 With the present value of 20 lakhs & a monthly outflow of Rs. 5,000 the effective interest on home loan is less than 2% FINANCE DOCTOR

Buying for Investment n n n n n n

Concentration Illiquid High transaction cost Disputed titles Weak tenancy agreements Returns can be higher in other asset classes FINANCE DOCTOR

General Principles n n n

n

n n

Long horizon Valuation R/P & R/E Intensive macro & localized research Comparison with other asset classes Developer s track record Legal details to be sorted out FINANCE DOCTOR

Taxation n

n

n

n

Interest on home loan up to Rs. 1,50,000 tax deductible Payment of Rs. 1,00,000 for returning home loan principal is also tax deductible Long term capital gain (> 3 yrs) taxed at 20% with inflation indexation This can be saved if gain invested in property or specified bonds FINANCE DOCTOR

Fixed Vs Floating n

n

n

n

Precise placing of interest rate cycle is difficult Estimate broadly whether we are at the bottom, middle or at the top of the cycle Presently we have just started moving up from lowest point of the cycle Locking in a fixed rate might be beneficial for a long term loan FINANCE DOCTOR

Fixed Vs Floating n n n

n

9.25% floating rate-- Rs. 916 EMI per lakh for 20 years 9.75% fixed rate -- Rs. 949 EMI per lakh for 20 years Even if the floating interest rate goes up to only 9.75% in next two years, EMI will go up to Rs. 944, because the loan amount has gone down only to Rs. 96,000 Overall in 20 years in floating, the borrower might end up paying a lot more FINANCE DOCTOR

Conclusion n n

n n

n

Versatile & favoured asset class For own usage, owning it under more circumstances is the correct decision Effective long term investment Increases the return while reducing the risk of the portfolio Does well under unfavourable circumstances FINANCE DOCTOR

Conclusion n

n n n n

However, when bought for enhancing yield, investor should be very careful Return could be less than other assets Illiquid with high transaction costs Concentrated Local factors need intensive research this prevents glaring mistakes while facilitating tremendous investment opportunities FINANCE DOCTOR

Behavioural Finance

FINANCE DOCTOR

Rationality and Emotion n

n

Every investment involves a financial commitment and an emotional commitment Rational advice, even if supported by lots of data, is much easier to take in theory than to put in practice FINANCE DOCTOR

Behavioural Finance Psychological Factors can thwart rational analysis and prevent investors from achieving the best results for their portfolios n Volatility of markets cannot be explained by earnings & growth Field of Behavioural Finance n

FINANCE DOCTOR

Nobel Prize for Behavioural Finance n

Daniel Kahneman n

n

Prospect theory, how individuals actually behave and make decisions when faced with uncertainty Replacing theories that assumed investors maximized their expected utility or well-being and always acted rationally FINANCE DOCTOR

Mismatch between great opportunities & actual results Date Dec. 93 Apr. 95 Feb. 97

NAV

Market View

4.69 Introduction of Fund 10.10 Reforms progressing well 5.00 Slow implementation of reforms

Feb. 00

30.78 Indian technology, internet, new millennium

Sep. 01

15.02 Global melt down

Dec. 02

23.31 Early signs of Indian corporate resurgence

Dec. 03

51.42 Second stage of reforms, good earnings growth

Apr 23. 04

56.75 India shining, NDA expected to win

May 17. 04

43.51 Surprising election results, Sonia as PM

Oct 4. 04

54.98 Reforms seen as irreversible FINANCE DOCTOR

Investor Psychology Date Dec. 93 Apr. 95 Feb. 97

N A V Investor Psychology 4.69 Memories of gold going out, 1992 scam 10.10 Investor confident and gets in 5.00 Investor sells at a loss, vows never to invest

Feb. 00

30.78 Draws up courage to get in at 25

Sep. 01

15.02 Extremely disillusioned, sells at a loss

Dec. 02

23.31 Remembers the past unfavorable experience

Dec. 03

51.42 Gets in at 42

Apr 23. 04

56.75 Period of happiness, expecting more gains

May 17. 04

43.51 Unnerved by rapid erosion

Oct 4. 04

54.98 Can t really understand, state of confusion FINANCE DOCTOR

The Emotions of Investing

FINANCE DOCTOR

Follow the Crowd & Asset Bubbles Herding instinct n Disbelief that a large group of people could be wrong n Hard to remain separate from a crowd n Social dynamics & facts n Information cascade Asset bubbles, prices overshooting what is determined by fundamentals n

FINANCE DOCTOR

Self Attribution Bias Taking credit for a favourable turn of events, when credit is not due n Over confidence An investor or a fund manager taking credit for high returns in the year 1999 & remaining over invested in technology stocks n

FINANCE DOCTOR

Representative Bias n

Too many parallels between events that seem the same but are remarkably different n

Example: Sensex at 6000 in year 2000 & at 6000 in year 2005

FINANCE DOCTOR

Reluctance to accept randomness n

Psychological need to know why something happens and forming a template for future events

FINANCE DOCTOR

Cognitive Dissonance n

n

Predisposition to disregard news that does not correspond to your view Shutting out bad news

FINANCE DOCTOR

Reference Point for Judging Performance n

n

n

Mental accounting with purchase price as the reference point Loss aversion, much more upset about losing from this reference point Holding on to losses

FINANCE DOCTOR

Anchoring Prospect theory predicts that investors rather than realize loss, will increase their position, since stock is now cheaper than their reference point n Anchoring in their mind more important than future prospects n Investors sell their stocks much more frequently for a gain rather than a loss They run their losses and take early profits rather than the other way round n

FINANCE DOCTOR

Myopic Loss Aversion & Portfolio Monitoring n

n

Tendency to base decisions on the short term fluctuations in the market Frequent portfolio changes

FINANCE DOCTOR

Applications n

n

n

n

Basic factors generating returns change far less than we think Asset allocation should be based on broad factors Investment discipline adhering to asset allocation based on long term factors Getting rid of temptation to trade stocks & other volatile assets in the short term FINANCE DOCTOR

Applications n n

n

n

n

Diversified portfolio Looking at future prospects rather than reference point/ anchoring Avoiding averaging if future prospects are dim Non-participation in asset bubbles (by curbing herding instinct) To buy in undervalued markets even if everybody else is selling FINANCE DOCTOR

Putting it all together

FINANCE DOCTOR

As Is

SCORE CARD INCOME Active sources employment salary professional income business income Passive sources rent from property investment income royalties any other Deductions Taxation COMBINED INCOME post taxn. Provident Fund Contribution

Monthly in Rs.

55000 15000

NET INCOME EXPENSES Food Clothing Housing Children related Health & Insurance Transportation Appliances Discretionary any other

40000

TOTAL EXPENSES

35000

7000 4000 3000 8000 2000 3000 3000 5000 0

ASSETS Liquidity 12 mths basic expense short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund,pension plans rbi bonds real estate for own usage fixed term deposits gold, jewellery Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS LIABILITIES Short term credit card loan borrowings on life insurance personal loan installment accrued income taxes other obligations Long term home loan principal yet to be repayed loans to purchase investmnt assets loans to purchase personal assets

TOTAL LIABILITIES

amount present return 50000 3% 0 0 150000 0 1250000 0 0 150000 300000 150000 0 0 0 0 0 0 100000 2150000

7%

8%

5% 3% 15%

6%

4%

0 0 0 0 0 0 0 0

FINANCE 0 DOCTOR

If ‘As Is’ continues 1 Education 2013 -----14.32 lakhs Saving scheme-1.5 lakhs at 7% Fixed`deposit-1.5 lakhs at 5% insurance inv. 1 lakh at 4 % for 8 years Total 2 Education 2016 ------17.04 lakhs stocks-1.5 lakhs at 15% 3 Retirement 2025----- 1.6 crores monthly savings Rs. 15000 in PF at 8% monthly savings 5000 in deposits at 5% Total 4 Housing 2025------97 lakhs provident fund 12.5 lakhs at 8 % 5 Protection----- 50 lakhs presently minimal cover

2.6 2.2 1.4 6.2

lakhs lakhs lakhs lakhs

6.98 lakhs 88.4 lakhs 23.1 lakhs 1.11 crores 58.2 lakhs

FINANCE DOCTOR

Should Be INCOME Active sources employment salary professional income business income Passive sources rent from property investment income royalties any other Deductions Taxation COMBINED INCOME post taxn. Provident Fund Contribution HRA & Taxation Benefit

Monthly in Rs.

55000 3000 4450

NET INCOME EXPENSES Food Clothing Housing Children related Health & Insurance Transportation Appliances Discretionary Housing Loan EMI Term Ins. premium(protection)

56500

TOTAL EXPENSES

46500

7000 4000 3000 8000 2000 3000 3000 5000 9450 2000

ASSETS Liquidity

6months basic expense amount present return short term deposits liquid funds 200000 3% Safety current income generating bonds 0 saving schemes 0 real estate on rent 0 long term provident fund,pension plans 220000 8% rbi bonds 0 real estate own usage(housing) 2500000 fixed term deposits 0 5% gold, jewellery 300000 3% Yield Enhancing stocks-direct equity 30000 15% stocks-mutual funds(Education) 900000 15% bonds 0 bond funds 0 6% real estate for investment 0 commodities 0 art,antique 0 investible part of insurance policy 0 4% TOTAL ASSETS 4150000 LIABILITIES Short term credit card loan 0 borrowings on life insurance 0 personal loan installment 0 accrued income taxes 0 other obligations 0 Long term home loan principal yet to be repayed 2000000 loans to purchase investmnt assets 0 loans to purchase personal assets 0

TOTAL LIABILITIES

FINANCE DOCTOR

2000000

‘Should Be’ Adjustments n

n

n

n

n

n

n

Home for own usage bought with 5 lakhs down payment, 10 lakhs soft loan from the company and 10 lakhs as home loan from the bank Term insurance of 50 lakhs cover bought with a premium of Rs. 2000 per month Monthly savings of Rs. 13,000 now being channelized into stock funds except for the mandatory requirement for Provident Fund, both for Retirement Investible money earmarked for children s education moved to stock mutual funds Minimal money in Existing Provident Fund Account, in keeping with whatever is required by rules Liquidity component now has amount equivalent to 6 months expenses FINANCE Gold & Jewellery totally as before for marital insurance DOCTOR

If ‘Should Be’ Implemented EDUCATION 1 Education 2013 -----14.32 lakhs 5 lakhs at 15% for 8 years 2 Education 2016 ------17.04 lakhs 4 lakhs at 15% for 11 years RETIREMENT 2025- 1.6 crores Rs. 10,000 every month at 15 % for 20 years Rs. 3000 every month at 8% for 20 years HOUSING 2025-----97 lakhs House worth 25 lakhs bought today 5 lakhs down payment Soft loan of 10 lakhs to be returned after 20 years, present lump sum in PF earmarked . Net outflow of Rs. 5000 every month PROTECTION insurance premium,monthly outflow of Rs. 2000

15.3 lakhs 18.60 lakhs 1.5 crores 17.6 lakhs

FINANCE DOCTOR

‘Should Be’ Asset Allocation ASSETS Liquidity

6months basic expense short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund,pension plans rbi bonds real estate own usage(housing) fixed term deposits gold, jewellery Yield Enhancing stocks-direct equity stocks-mutual funds(Education) bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS art,antique investible part of insurance policy TOTAL ASSETS

amount

allocation %

200000

5%

0 0 0 220000 0 2500000 0 300000 30000 900000 0 0 0 0 0 0 4150000 0 0 4150000

5% 60% 7%

22%

0%

100%

100%

FINANCE DOCTOR

After 5 Years ASSETS Liquidity

12 mths basic expense amount short term deposits liquid funds current income generating Safety bonds saving schemes real estate on rent long term provident fund pension plans with fixed return rbi bonds short term debt funds real estate for own usage-own equity fixed term deposits gold, jewellery TOTAL Safety Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

allocation % 10%

40%

30% 20%

100%F

INANCE DOCTOR

Asset Allocation 25 – 30 Years Old (Accumulator) ASSETS Liquidity

12 mths basic expense amount short term deposits liquid funds current income generating Safety bonds saving schemes real estate on rent long term provident fund pension plans with fixed return rbi bonds short term debt funds real estate for own usage-own equity fixed term deposits gold, jewellery TOTAL Safety Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

allocation % 10%

10%

75% 5%

FINANCE 100% D O C T O R

Asset Allocation 40 – 45 Years Old (Mid Life Accumulator/ Harvester) ASSETS Liquidity

12 mths basic expense amount short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund pension plans with fixed return rbi bonds short term debt funds real estate for own usage-own equity fixed term deposits gold, jewellery TOTAL Safety Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

allocation % 10%

30%

50% 10%

100%F

INANCE DOCTOR

Asset Allocation 40 – 45 Years Old (Mid Life Accumulator/ Harvester) Business Conditions Change – P/E at 24, Bond Yields at 10.5 ASSETS Liquidity

amount 12 mths basic expense short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund pension plans with fixed return rbi bonds short term debt funds real estate for own usage-own equity fixed term deposits gold, jewellery TOTAL Safety Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

allocation % 10%

35%

15% 40%

100%F

INANCE DOCTOR

Asset Allocation 55 – 60 Years Old (Harvester) ASSETS Liquidity

12 mths basic expense amount short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund pension plans with fixed return rbi bonds short term debt funds real estate for own usage-own equity fixed term deposits gold, jewellery TOTAL Safety Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

allocation % 10% 50%

20%

70%

10% 10%

100%F

INANCE DOCTOR

Asset Allocation Double Income High Liquidity ASSETS Liquidity

12 mths basic expense amount short term deposits liquid funds Safety current income generating bonds saving schemes real estate on rent long term provident fund pension plans with fixed return rbi bonds short term debt funds real estate for own usage-own equity fixed term deposits gold, jewellery TOTAL Safety Yield Enhancing stocks-direct equity stocks-mutual funds bonds bond funds real estate for investment commodities art,antique investible part of insurance policy TOTAL ASSETS

allocation % 10%

15%

60% 15%

100%F

INANCE DOCTOR

Implementation

n n

Pay yourself first Automate your plan

FINANCE DOCTOR

Summary n n

§ n n n

n

n

Everybody can be wealthy Achievable at minimal risk and with minimal adjustments Know values & specific goals Organize information & utilize score card Asset allocation is the key decision Know characteristics & general principles of various asset classes Put together a plan consistent with your objectives Automate your plan so that it gets FINANCE implemented DOCTOR