Year: 2017

The markets have been choppy lately for past four months and are reflecting the drunken movements of a ship in turbulent waters. As always happens in similar times, we have started fielding the familiar questions from worried customers – Is the India story dead? ; Should we get out of the mutual funds now? ; You said I’ll get good returns – see them now; I’m not even getting the FD returns on my investments; or worse – Get me out of these funds before its too late even if I have to pay tax and exit load on them!

This is the same story every time. A large number of investors get into equity mutual funds when the markets are doing well with the avowed aim of investing ‘for the long term’. But the moment there is some volatility, their ‘long term’ perspective becomes ‘short term’ in no time and they get out. Consequently, they get in at high rates, get out in panic at lower rates, and the cycle continues. They almost never get to see the returns that equity investments give in the long run, always maintain that equity should be avoided at all costs. Their long-term ‘real’ requirements suffer due to short-term ‘notional’ losses and they would revert to so-called safe investments of FDs, post-office products and insurance policies which would invariably give them negative post-tax-and-inflation returns, thus effectively eroding the purchasing power of their money.

The Business line newspaper column (Dated 14 June 2015) reproduced below gives out this same theme.

Don’t let market turbulence scare you. SIPs work well only because equity investing is a roller-coaster ride

‘Buy low, sell high’ — lesson 101 for success in investing is really a no-brainer. But for us emotion-driven humans, this cardinal principle is easier said than practised. When the market turns choppy, as it currently has, many of us panic and stop our systematic investment plans (SIPs) in mutual funds.

Don’t make this mistake. SIPs work great in the long run precisely because the equity investing is a roller-coaster ride.

In a SIP, you invest a fixed sum at regular intervals to buy units of mutual funds. The number of units you get depends on the prevailing net asset value (NAV) of the fund at the time of investment; the higher the NAV, lesser the number of units you get. And lower the NAV, higher the number of units in your kitty.

So, when the market and the NAV fall, you accumulate more units of the fund. This results in what is called ‘cost averaging’ — your average cost of acquiring the mutual fund units comes down.

In the long run, despite the volatility during interim periods, equity as an asset class and well-run equity mutual funds should see their values trend higher. Your return will be maximised when the average cost of investment is minimised.

This happens when you buy cheap, making a falling market the best time to invest in SIPs.

Whenever any retiring officer approaches us for advice, invariably the question of whether or not to commute the pension comes up. This article deals with this issue so that all officers, retired or retiring, would be able to make up their mind more knowledgeably.
Before we take a call on the same, a few connected issues need to be understood clearly:-

1. Basic Pension is exactly half of your last drawn Basic Salary. And Basic Salary for the purposes of pension calculations is Basic + Grade Pay + Rank Pay.

2. Whenever commutation is done, only the Basic Pension gets commuted, never the DA received. Thus, after commutation also, the DA is received on full value of Basic Pension.

3. Commutation can be done of any value from 0% to 50%. However, generally almost all the officers get 50% commutation done, if they go in for it.

4. Commutation is done based on a factor of commutation set by the Government which depends on the years of service that you’ve put in. To put it more simply, it is the time adjusted Present Value of your future pension.

5. Pension is restored exactly 15 years after first commuted pension is received by you.

6. Though not confirmed, probably commutation can still be done within one year of retirement, if the officer has not done commutation and wishes to change his decision.

Now, let us understand the difference between a commuted pension and an uncommuted pension. We’ll understand it by an example.

Does the title surprise you? Then it’s mainly because you have been using these three terms interchangeably, without knowing the actual difference between them. Hopefully, at the end of this article, you’ll realise how different these three animals are from each other.

To start with, let’s look at the following scenarios.
Scenario 1:

Nitesh is extremely happy. At the behest of his father, he ‘invested’ Rs. 30,000 in a life insurance policy. Apart from a coverage of Rs. 5 lakh, this policy also gave him tax benefits on the premiums that he was paying.

Now, what is wrong in the above scenario?

The answer is that we never invest in insurance. We always buy insurance.

The real purpose of life insurance is to help secure your dependents financially in case of your death. Theoretically, it has nothing to do with investing. Investing is done to achieve long term goals like a retirement corpus, your child’s higher education, and so on, that benefit both you and your family.

Now in India, there are many products which combine insurance with investments like an endowment policy, or money-back plans. Since such products are quite remunerative for agents, these are pushed aggressively and hence, they have become extremely popular.

Such products tend to be more expensive than simple term insurance plans, which provide higher coverage at cheaper prices. A major chunk of premiums in these products is used to build corpus, and this is given to the insured person at the end of the policy term (before death). This amount is only a fraction of what could have been accumulated had it been invested elsewhere (like in mutual funds). As for insurance, a cheaper term plan would have provided a larger cover.
Scenario 2:

In 2010, Chandan decided that he would buy a car in three years without taking a loan. At that time, the cost of the car was Rs. 7.5 lakh. So, taking inflation into account, he calculated that he would need Rs. 9 lakh in 2013 to buy the same car.

Now, a typical Recurring Deposit (RD) (paying 8.25 per cent) of Rs. 22,000 every month would have accumulated Rs. 9 lakh in three years. But on the advice of his stock-expert friend, he decided to invest in the stock markets through a Systematic Investment Plan (SIP) of Rs. 22,000. Chandan and his friend assumed that stocks always give better returns than RDs.

But unfortunately, due to the bearish markets in 2013, the value of Chandan’s investment became Rs. 6.9 lakh – even lesser than his total investment of Rs. 7.9 lakh (36 x Rs. 22,000)! As a result, he couldn’t afford to buy his dream car at the end of three years. What mistake did Chandan make? The answer lies in the philosophy: Savings is for the short term. Investing is for the long term.

The answer lies in the philosophy: Savings is for the short term. Investing is for the long term.

Chandan tried to invest for the short term, i.e. three years (anything less than five years is short term). So, with such a short-time horizon, the ideal choice would have been to save using safer options like RDs.

Now, saving and investing are two related but independent activities.

Savings are to be made for the short term because it is the process of putting aside money in extremely safe products which might offer very low returns, but seek to keep your capital intact.

Investing is for the long term as it is the process of putting away money in products which have the potential to earn more than what can be achieved through savings, but at higher risks. If invested properly with adequate diversification, even these risks can be greatly reduced.