Personal Finance, Investments, and other things

Wednesday, February 17, 2010

On Technology

Technology is advancing at such a fast clip nowadays that it is impossible to keep up. And AAARAAA too – that’s short for “Acronyms Are Advancing Rapidly Across All Activities”. I’m sure you are not aware of some of the latest technical (and management) acronyms that are a result of the initiative undertaken by AEIUAA - Association for Enhancement and Integration Of Universal Animal Acronyms. If you haven’t heard of that organization, you should google.

The AGE Committee (Acronym Generation Evaluation Committee) is currently looking at including these acronyms into the DOTAGE – Dictionary of Technical Acronyms in
General English.

MULE: Multi User Limited Experience: Technical Enhancement to Massively Multi-user Online Games to Limit the experience of certain category of players based on age and other criteria.

DOG: Dedicated Optimized Gateway: The rapidly evolving science of Optimizing Dedicated Paths used by companies on Public Gateways to enable greater speeds while ensuring greater security of data.

CAT: Collaborative Application Terminal: Artificial Intelligence built into “dumb” terminals to enable collaboration across Applications. Also stands for the Common Admission tests of the Indian Institutes of Management which are currently struggling to go online.

COW: Co-located Online Workstation: The new feature offered by certain advanced call centers, where two associates who are remotely located can be co-located thorough on-line meshing of their workstations. A very advanced technology still under development.

PIG: Practical Implementation Guidelines: On the principle of KISS – Keep it Simple and Stupid comes this new SRS (Systems Requirement Specifications) development guideline – a new standard for Implementation Guidelines to be part of standard SRS documents in future.

EMU: Extended Management Unit: An extension of management cells into branch locations designed to replicate all decision-making functions – not just a branch office, but a head office in a branch. When applied to Chip Manufacture, refers to remote special-purpose chips being used as temporary EMU’s or extensions of the CPU to speed up processing.

HEN: Heuristic Engagement Networks: Optical Fiber Networks that figure out on their own how to re-route data packets based on statistical analysis of traffic density at various points of time during the day, and current and expected load of traffic. Uses extensive heuristic thumb-rules developed by the NSO – Network Statistical Organization.

ANT: Application Networking Terminal: A terminal that enables Applications to cross over on their own across various networks thus ensuring seamless connectivity and performance.

RAM: Rapid Application Management: Software techniques to enable quick development of enhanced versions of existing applications – popularized by the new book “Ram it through” by Ram Ramgopal.

BEES: Business Enhancement and Effectiveness Strategy: A new technique originating from Harvard. Means what it says. What it says can be learnt more in detail through a five-day seminar in Boston costing 100,000 dollars.

LIONS: Latency Inhibited Offline Network Server: A Server that acts as an Offline Inhibited Network Router – helping to cache data offline, for specified amounts to time depending on traffic density, and release it in tranches based on programmed latency models – the current servers that are being tested increase Total Network Throughput (TNT) by about 20% while the average increase in time delay is only 2 milliseconds.

MOOSE: Multi-User Online Oligopolistic Server Enhancement – an initiative by Microsoft and Intel to compete in the server market. They intend to combine their respective expertise in software and hardware to create special servers for massively multi-user online environments. It’s one of the initiatives under their Future Initiatives Baselining (FIB) project.

OX: Obsolescent Xtras: Useless resource-guzzling features that all application software developers are alleged to add to their products to ensure that current hardware configurations become obsolescent. It is suspected that this is a conspiracy between the major software and hardware companies to increase sales of their products. The allegations have not been proven. “When they want to retire their hardware early, they ask the software people to OX it.”

FOX: Freeflowing Online Xtensions: Extensions to open source online software.

TIGER: Time Induced Growth and Extinguishment Rationale: Modern theory of how to manage a Product Life Cycle – how to grow it, milk it, and kill it over time. Refer to the bestselling book “Evolution of the TIGER – Management Lessons from the Jungle” by Prof. Mule of Mumbai.

VIXEN: Vertically Integrated Xpanded Enhanced Networks: After the era of Networks expanding horizontally across the world – the coming era is expected to be one of vertically integrating all networks with the businesses and applications they serve to create a seamless global knowledge network. Research in this area is fast gathering momentum.

ZEBRA: Zero-based Estimation of Budgets, and Rational Allocations: A new advancement in Finance theory combining zero-based budgeting with “Theory of Rational Allocations based on Social Inequality – a new Paradigm for Justice” by Prof. OBC Iyer. This is expected to be the next big thing after Going Green.

Wednesday, February 3, 2010

Part 11A: It is time to take stock (answers)

1) If you estimate that your current monthly expenses (for your family of four) are in the region of Rs.20,000 per month, what is the corpus you would need today, in order to be able to retire? It’s a very open-ended question so let’s put in some more conditions. Use the method already explained in Part 1, and make a similar assumption for taxes. Assume that your corpus will yield 8% p.a. pre-tax. Since you still don’t own a house, you need to add Rs.25 lakhs to your final answer. I am looking for one number, in Rupees.

Ans: Rs.97 lakhs.

A corpus of Rs.30 lakhs yields Rs.20,000 p.m. as interest at 8% p.a. Doubling this gives Rs.60 lakhs. Adding 20% for taxes gives Rs.72 lakhs. Adding Rs.25 lakhs for the house gives Rs.97 lakhs.

2) Which of the following are assets in the sense that we have defined it? (a) Yacht (b) Motorbike (c) Cash (d) Equity Shares (e) Units in a Money Market Mutual Fund (f) RBI Bonds (g) Kisan Vikas Patra (h) 30% discount voucher of Shoppers’ Stop

Ans: The following are the assets as per our definition:

3) When interest rates go up, the NAV of your long-term GSec Fund (a) goes up (b) goes down (c) stays flat (d) fluctuates (e) can’t say

Ans: (b) – When the interest rate moves up, the NAV of a long-term GSec Fund goes down.

4) You invest Rs. One Lakh in your savings bank account. (A) What would it amount to at 3.5% per annum in 10 years? (B) What would be the Net Present Value of that amount today if you discount it at the expected inflation rate which is 7%? (2 points)

Ans: (a) Rs.1,41,060 (b) Rs.71,708

5) Your credit card company charges you 3.1% interest per month, compounded monthly. You have a credit card balance of Rs.50,000. How many months (rounded off to the nearest month) will it take to repay the whole balance assuming you repay 5% of the monthly outstanding every month? Assume the balance is repaid the moment the outstanding balance drops below Rs.100.

Ans: 300 months. That’s right - 25 years!

6) You take a personal loan of Rs.50,000 to repay the credit card balance. The loan is at 15% per annum (@ 1.25% p.m.), interest calculated monthly on the outstanding balances. You repay 5% of the outstanding balance every month. How long will it take you, in months (rounded off to the nearest month) to repay the entire loan? Assume the loan is repaid the moment the outstanding balance drops below Rs.100.

Ans: 160 months

7) Arrange the following in ascending order of liquidity (least liquid first, most liquid last). Land, Cash, Car, Equity stocks, US Dollar bills, Five-year Bank FD opened three years back, your Wedding Ring made of gold. Keep sentiments out of the picture.

Ans: Land, car, [wedding ring, five-year FD/equity stock (both are about equally liquid)], US Dollar bills, Cash

8) Arrange the following loans (assuming you are the one who is doing the borrowing) in order of most desirable to least desirable, in terms of interest rates (a) house loan (b) personal loan from a bank (c) credit card debt (d) overdraft against security of shares from a bank

Ans: House loan, overdraft against security of shares, personal loan, credit card debt

9) (A) How many companies is the BSE Sensex composed of? (B) What proportion of the Sensex is represented by the top 5 shares by market capitalization? Answers within +/- 2% will be taken as correct. (2 points)

Ans: a) 30 b) about one-third, as on Feb 26, 2010. See attached link for the details:

http://www.bseindia.com/mktlive/indiceswatch_scripweight.asp?iname=BSE30&sensid=30&type=sens&total=2460549.41&mktcapteck=1219463.52&dateheader=Tuesday%2C+February+02%2C+2010

10) Index Funds are usually (a) actively managed (b) passively managed (c) not managed

Ans: b) Passively managed

11) You are about to retire in five years’ time. Conventional financial wisdom indicates that you should currently have most of your money invested in (a) 100% Equity (b) 100% Debt (c) Predominantly Equity (d) Predominantly Debt. Assume Equity and Debt are the only two investment options available.

( d) Predominantly Debt

12) 916 Gold refers to how many carats?

Ans: 22 carats. 916/1000 = 22/24. 24 carats is pure gold.

13) If you want to retire, the following things are important to do: (1) Keep rigorous spending targets (2) Keep aside the balance by Paying Yourself First (3) Invest the balance to earn steady returns (4) Invest for the long term and allowing the money to compound (5) Have a judicious mix of less risky and more risky investments depending on life-stage and other factors (6) All the above

Ans: (6) All the above

14) You invest Rs. One Lakh in a five-year deposit with a finance company that promises to double your money every six months. At the end of five years, how much money are you likely to get back? Hint: Not everything in the world was achieved with Math.

Ans: Zero. You will not get any money back. At those interest rates, did you really think you would?

15) A Systematic Investment Plan is good because (a) it inculcates discipline in investing (b) of Dollar cost averaging (c) It takes away the hassle of thinking and analysis, while retaining good investment wisdom (d) of all the above

Ans: (d) All of the above

16) Diversified Equity Funds diversify by (a) investing in a broad range of Equities (b) investing in a mix of Equity, Corporate Debentures and Government Securities (c) buying and selling often (d) investing in only companies that sell a diverse range of products (e) investing in varied geographies (f) all the above

Ans: (a) Diversified Equity Funds diversify by investing in a broad range of Equities

17) Money Market Funds invest predominantly in securities with maturities exceeding one year – Yes/No

Ans: No. Money Market Funds invest in very short maturity securities, ranging from one day to a few months at most.

18) Fidelity believes ‘more’ (remember ‘more’ is only a matter of degree) in which of the following: (you can indicate one or more choices) (a) top-down stock picking (b) bottom-up stock picking (c) quick short-term returns (d) investing for the longer term

Ans: (b) and (d). Fidelity believes in “bottom-up stock picking” and “investing for the long term”

19) Peter Lynch managed which Fidelity Fund? Name one book that he has written?

Ans: Magellan Fund. He has written three books (with co-author John Rothchild) – One Up on Wall Street, Beating the Street, and Learn to Earn.

20) Who is known as the Sage of Omaha?

Ans: Warren Buffett (The last two were easy for those who know how to google!)

Part 11: It is time to take stock

Every person who sets out to train / explain / teach / pontificate sooner or later succumbs to the urge of running a quiz to see whether people have been reading his stuff all this while. And every person who takes such a quiz tries to get the answers without reading the stuff – what are friends for?

Who are we to resist these age-old temptations? Let’s try to do a recap-cum-quiz. The rules are that you can refer to the past issues (available in the Archives – go to the bottom of the home page); you can google for the answers if you don’t get them directly (not every question will be from the syllabus!); or you can phone a friend – this is however fraught with risk since he/she may know less than you do. Send in your answers by the time indicated to be eligible to win prizes – the kind of prize will be restricted by the budget available – you can thus pretty much guess what the prizes will be. Lots will be drawn from the correct entries to select the winners – who said investment is all about knowledge and ability only – you need luck as well. The decision of the judges will of course be final and they will be anonymous just so that you don’t try to bribe them. The first prize winner will get a chance to audition for the Fidelity Band.

1) If you estimate that your current monthly expenses (for you and your family of four) are in the region of Rs.70,000 per month, what is the corpus you would need today, in order to be able to retire? It’s a very open-ended question so let’s put in some more conditions. Use the method already explained, and make a similar assumption for taxes. Assume that your corpus will yield 7% p.a. Since you still don’t own a house, you need to add Rs.50 lakhs to your final answer. I am looking for one number, in Rupees.

2) Which of the following are assets in the sense that we have defined it? (a) Yacht (b) Motorbike (c) gold ornaments (d) Cash (e) Equity Shares (f) Units in a Money Market Mutual Fund (g) RBI Bonds (h) Kisan Vikas Patra (i) 30% discount voucher of Shoppers’ Stop

3) When interest rates go up, the NAV of your long-term GSec Fund (a) goes up (b) goes down (c) stays flat (d) fluctuates (e) can’t say

10) Index Funds are usually (a) actively managed (b) passively managed (c) not managed

12) 916 Gold refers to how many carats?

13) If you want to retire, the following things are important to do: (1) Keep rigorous spending targets (2) Keep aside the balance by Paying Yourself First (3) Investing the balance to earn steady returns (4) Investing for the long term and allowing the money to compound (5) Having a judicious mix of less risky and more risky investments depending on life-stage and other factors (6) All the above

17) Money Market Funds invest predominantly in securities with maturities exceeding one year – Yes/No

18) Fidelity believes ‘more’ in which (you can indicate one or more choices) of the following (remember ‘more’ is only a matter of degree): (a) top-down stock picking (b) bottom-up stock picking (c) quick short-term returns (d) investing for the longer term

19) Peter Lynch managed which Fidelity Fund? Name one book that he has written?

20) Who is known as the Sage of Omaha? Hint: It is not a-la-carte.

Send in your answers to ______ by _____. Winners will be announced and answers posted on the BitsnBytes website on ______.

All the Best!

(P.S. The fact that you manage to answer all the above questions correctly will not by itself make you a successful investor. If you manage to answer very few of them, it means you dislike reading, as do many rich people I know)

Wednesday, January 6, 2010

Part 10: Talking about Funds...

Any closed-ended Fund that trades on a stock exchange can be called an Exchange Traded Fund (ETF). However, ETF’s are more generally used to refer to closed-ended funds that track an underlying index or asset. For example, a Nifty ETF would invest in Nifty stocks in the same proportion as the Nifty. This ensures that the rise or fall in the NAV is in the same proportion or percentage as the rise or fall in the Nifty. A fund that follows such a strategy is said to be passively managed i.e., the fund manager does not have to do any work – his job is to buy or sell shares whenever there is an addition/redemption to the fund, or on the rare occasion when the composition of the Nifty changes, to achieve the required proportion once again. As you can see, that’s a job that can be done equally well by a computer. Which is why the management fees for such an ETF is supposed to be lesser.

The ETF of course does not track the underlying index (Nifty in this case) exactly. There is always a difference due to annual management fees; also due to the fact that the timing of the fund manager’s buy or sell can never exactly match the Nifty movements. This difference is called Tracking Error. The annual management fees for an actively managed equity fund are in the range of 2% whereas the management fees for an index fund of this kind is likely to be around 0.4% to 1%.

There are ETF’s for Gold as well. There are about half a dozen Gold ETF’s available in the Indian market. GoldBees, UTI Gold fund and Kotak are some of them. You buy and sell Gold ETF units just like buying or selling shares. The corpus of the fund is invested in Gold or Gold-backed securities in such a way that the price goes up or down with the price of Gold.

You pay brokerage and transaction charges just like you do for a share transaction on buying or selling ETF’s.

While investing in a fund, it is good to follow what is termed as a Systematic Investment Plan (SIP). You can give post-dated cheques to the Fund of the same amount every month, say, Rs. 1000 per month. The Fund would then systematically encash the cheque every month on the given date and credit units to you worth that amount at the NAV prevailing on that date. What are the benefits of such an approach?

To start with, it ensures discipline in investing. It eliminates the temptation to try to time the market, which is a job best left to experts who think they know what they are doing. It has another advantage that may not be so obvious at first glance. Let us say you have decided to buy Reliance Shares every month. For a moment assume you can buy fractional shares as well. You start an SIP with Rs.5000 a month. During the first month, Reliance is quoting at Rs.1000. You buy five shares. Next month the price is at 1200. You invest the same 5000, hence you buy 4.17 Reliance shares. The month after that it quotes at Rs.900, hence you buy 5.55 shares. In the fourth month, the price drops to 400 and you are able to buy 12.5 shares. In the fifth month it bounces up to Rs.2500, hence you buy only two shares.

What have you done in the process of investing in the above fashion? If you notice you bought more shares when the price was low, and you bought less shares when the price was high. What a brilliant strategy! Executed with a methodical precision, without the burden of having to think! This strategy is called dollar (or rupee) cost averaging, and it is an automatic benefit of investing using the SIP method. For those who are retired, and want to draw down, the same concept can be applied to a Systematic Withdrawal Plan (SWP) as well!

When it comes to Equity Investments, if you feel you will be able to able to do a better job than a fund manager, then by all means invest on your own. However, please do not venture into Equity investing without adequate preparation. You need to read up on the stock markets and do research on companies. You need to keep track of what’s happening in the economy and to the world in general. You need to be able to quantify the millions of inputs that you receive into a monetary value, and you must be able to ignore useless noise in the form of irrelevant data which is thrown at you from all directions. You must be prepared to stick to your convictions to get the returns you envisaged, and you must also be able to exit without emotion, taking a loss if required. You must be a combination of fortune teller and financial expert. You must have a finely-honed sixth sense which guides you on what to buy and when, and more important, when to sell. In short, you must be Superman. Or Warren Buffet. And you need to have a spouse who doesn’t insist on making joint investment decisions.

If that seems like a pretty daunting list of requirements, please don’t feel discouraged. We did say learning to invest is easy; but we did not mean investing on your own in the Equity Markets! In this series we will assume that you will stick to mutual funds when it comes to equity investing. Long experience over various equity markets have proven that fund managers don’t necessarily perform much better than the index; but your average John Doe who invests in the equity market does not do much better either. You might as well leave it to a Fund Manager and pay him to worry about it!

On the other hand, Warren Buffet or Rakesh Jhunjhunwala would never be where they are today if they had invested through funds. Think about it…

Wednesday, December 9, 2009

Part 9: More on Mutual Funds

You have an option to invest in either of two equity mutual funds. Both are diversified equity funds, with broadly similar portfolios. Let’s say Fund A has an AUM of Rs.100 crores and its NAV is Rs.20. Fund B has a corpus of Rs.500 crores and its NAV is Rs.200. If you invest Rupees one lakh you can buy 5000 units of Fund A, or 500 units of Fund B. Which fund would you invest in?

Actually, it makes no difference. Since their portfolios are broadly similar, your money would grow/shrink (depending on the market) in the same proportion once you are invested. Think about it.

Why then the ads that we see saying “Your only chance to invest at Rs.10! Subscribe to the IPO now!” It doesn’t make sense! Another gimmick is to advertise “dividends” from a fund. For a moment ignoring taxation aspects, what difference would that make? Would not the dividends come from your own corpus?

Continuing with our discussion on the different types of mutual funds, let’s talk about debt funds. These are also known as “income” funds. Money market or liquid funds are for investing short term surpluses. These funds invest in overnight call money markets (banks and institutions lending to each other for a day or very short periods) or in very short duration securities maturing in less than 90 days. Short term bond funds invest in short term bonds primarily with a duration of between 90 and 365 days. Gilt funds invest in Gilts which are Government Securities, of varying durations, which could extend to a few years.

There are funds which could invest in a mix of securities including Gilts, Certificates of Deposits, call money markets, etc. Certificates of Deposit are basically tradable debt of banks or companies which may differ in their maturities. In all these cases the investments carry a credit risk / counter-party risk viz., the risk that the borrower would default. The funds aim to minimize this risk through proper selection of the securities they buy. Bear in mind that to earn higher interest, the fund manager may invest in slightly lower rated securities as well. As we saw already, risk and return are inversely correlated. The risk is also minimized through diversification, i.e., putting the eggs in more than one basket.

There is another risk that we saw, which is the interest rate risk. We saw how as interest rates go up, bond prices could go down, and vice versa. This is especially true of longer duration securities, since the time period involved is larger. Gilt funds, especially, always carry an interest rate risk. If your money is invested in a long-duration gilt funds, and the interest rates in the economy go up, your NAV could see a drop.

I reproduce here the section from Part 4 that spoke about interest rate risk. “There is another kind of risk called ‘interest rate risk’. Let’s assume you lend someone one lakh rupees and he gives you a ten-year ten-percent bond (that means he will pay you ten thousand rupees a year for the next ten years and then repay your principal – if he is still alive). If you sell this bond to your friend after two years you expect him to give you one lakh rupees for it. He will, provided the interest rates in the market are ruling at 10% then. What if the new ten-year bonds in the market yield an interest of 12.5%, i.e., give an interest of rupees twelve thousand five hundred every year on one lakh of investment? He would then obviously pay you Rupees Eighty thousand for your bond – such that the rupees ten thousand interest on it works out to a yield of 12.5%. Thus, if interest rates go up, prices of existing bonds in the market go down; if interest rates go down, bond prices go up.”

Your best bet would be to invest in a large “income” fund which invests in a mix of all the above. It would be the fund manager’s call to manage the maturity profile and mix of his investments in order to optimize both the above risks. If, however, you have very short term funds which you may need soon and at short notice, you could look at investing in money market / liquid funds. These funds are supposed to be without any (or very little) credit risk since their lending is only to large and reputed institutions, and that too, for a few days at a time.

So far we have looked at funds that are “open ended” i.e., you can buy units or redeem units of the fund at any time based on the prevailing NAV. What if the same fund were to collect money which would be “locked in” for a specified number of years? The fund in this case would not allow you to buy fresh units or redeem them except during some pre-defined windows. This would give the fund manager more scope to invest for the long term without worrying about fluctuating inflows and outflows. Such a fund is called a “closed ended” fund. However, in such a fund how would you invest or divest in case you need to? This is done through listing. The fund is listed on a Stock Exchange and unitholders can buy or sell the units among themselves, just like they would buy or sell shares. The price at any point in time is expected to be very close to the underlying NAV of the units; however, in actual practice this may not happen. Several times, the prices are much below, or even slightly above the NAV’s. Since they are traded on the Exchange, they are also called Exchange Traded Funds.

However, the term Exchange Traded Funds is generally used to denote a specific type of fund that trades on the Exchange. We shall see more about that in the next issue.

And we of course have Fund of Funds. This would be a fund that invests in other funds. There could of course be some additional charges involved! In return, you get the benefit of additional diversification.

That covers quite a bit of ground on Mutual Funds. I’ll stop here – bye till next time!