My 2011 predictions revisited

Who would have predicted the events of Q1 - As I sat and tried to predict the year ahead in early Jan 2011 – could I have predicted the blow out in Middle East? Could I have predicted the devastation caused in Japan? I am humbled by the fact that we can only predict so much – there are forces beyond us – however, it also means that we must constantly revisit our predictions and fine tune our strategy constantly.  Also as a risk mitigation strategy, we must be prepared for the worst and have an action plan for the worst case scenario.  

Having said that, when I see my predictions made for 2011 – I am not sure if I will change anything.

I truly did not predict the Indian stock market performance of Q1. I did expect a slowing down from the high PE levels of 2010 - but the markets went down faster than my estimates - it is now slowly inching up  - but I do believe that this year we will not see much gains in Indian stock markets.

Inflation is a major threat to all developing economies, including India and we will see a subdued GDP growth of around 8% due to rising input costs.  We have already had two rate hikes in Q1 and I am sure that the interest rates will keep going up as long as the inflation persists.

Further the US and European economies are not out of the woods yet – the US markets are being propped up by cheap money unleashed by Fed in the form of QE2 – Europe has it’s own problems in Portugal and Spain beside Ireland and Greece. 

In these circumstances, I do believe that Gold and Silver are safe investments at this point of time and will give a return of around 15% this year.

Real estate in India is also going through a small correction due to the 2G and LIC HFL scams -  the credit lines for real estate companies from the banks have almost dried up – further all the major real estate companies had announced many new projects last year and this drying up of credit has created cash flow problems for them – this would mean that the prices of projects may not rise as the companies would like to sell it and get cash flowing from customers – hence it is a good time to invest in real estate if you were planning for one in 2011 – look at premium projects and negotiate hard – there is a good chance you will get a reasonably good deal. In India, HNI’s have around 45-50% of their asset allocation in real estate and this is an area where I would recommend that we have at least 50% asset allocation. Last year Bangalore had witnessed around 15% appreciation in property prices and I believe that this year too we will see similar appreciation despite this credit crunch in India.

So as I write, I believe that real estate and Gold are the better avenues – each giving around 15% plus and beating the inflation by about 7-8% - Gold is more liquid but capital gains will be taxed – Real estate is less liquid and needs larger amounts. But as of now, I have moved most of my investments in these two areas.

In my next blog, I will share a real estate investment option where you can get about 20% returns per annum after having stayed invested for 3 years.

What to expect in 2011

As the New Year dawns all of us in India are optimistic – the mood is good, the future looks brighter –the MBA placements are doing well – the Engineering placements look still better –companies are hiring and there is a flurry of activity in almost every sphere of economy as we enter 2011.

Like any investor, my investments in 2011 would be based on my predictions and I thought I must share this with others – with a view to help and guide as many people as possible. I tend to be on the conservative side – hence if we do better than these predictions – I am happy. I am going to keep updating on these as we go through the year – and as all of us know, things can change.

So here are my predictions:

·      GDP growth would be slightly lower in 2011 than in 2010, and it would be around 8% - well known pundits are predicting 8.5-9% for India. However, I would base my decisions on a conservative 8% growth.

·      Interest rates in India are expected to rise in 2011 – Inflationary pressures in the economy due to demand pull and supply demand mismatch, increasing rise in commodity prices globally, increasingly competitive devaluations by developed countries through loose monetary policies will force RBI to hike interest rates and control liquidity in 2011. Hence if you are looking at Fixed Deposits to park your money – the rates should go up as the year progresses. If you are planning to take loans -that too will become dearer as the year progresses especially if it is a large loan like a home loan.

·      Indian stock markets –this is a difficult prediction – I believe that this year sensex will not show spectacular returns – in 2010, the sensex rose 17% (from 17460 to 20500) –I think we will not see a better performance in 2011. It could be lower than 17% growth in 2011. Our markets have a trailing PE multiple of around 23 and if it goes beyond this, I believe we are surely in bubble zone. If you want to invest in equities – look hard and look long term –do fundamental research  – look at industries like FMCG,  healthcare, infrastructure where India’s growth story will reside and in those industries, look at well managed companies and enter only when there is a reasonably low price. If you cannot do fundamental research – look at regular investments through SIP’s in MF’s investing in large caps or the above mentioned sectors.

·      Commodities – as per IMF, the world GDP grew at 4.8% last year and it is expected to grow at 4.2% in 2011. The commodity prices of crude, metals, gold are all expected to increase due to increasing consumption in growth economies like India, China, Indonesia and Brazil and due to increased investor appetite to counter weakening of currencies. In India, investment in Gold would not provide very great results due to strengthening of INR w.r.t USD – but it surely would be a good hedge against inflation. You may not get rich by investing in gold this year – but you will surely not get poorer –you will beat inflation by investing in gold. So I recommend that Gold be a part of your portfolio (about 20%) either through the SIP route in Gold ETF’s or through small purchases when the prices are going down.

·      Insurance – As my friends and colleagues know, I am not a fan of using insurance as an investment vehicle. However, I do believe in life cover and healthcare cover. With IRDA moving in and proactively regulating more and more, expect the cost of a term loan or a healthcare cover to go up in the years to come. However, I believe that there will be better customer service and better schemes in the years ahead.

·      Your savings bank – as of now, your bank gives you 3.5% interest on your money lying idle in the SB account – it is better than before – but it is much below inflation  -hence  keep as less money as possible in your SB account. Ideally, you must keep about one month’s cash requirement in the SB account – not more.

·         Real estate - with real estate markets picking up in 2010, there is currently an oversupply situation in property market in all major urban areas in the country. Hence this sector may not see massive appreciation in 2011 – however, the real estate sector, is a long term investment sector and in this sector, a three year timeline is considered short term – if you have investible surplus with a three year or more timeframe – this is still a good sector to invest – the appreciation can be at least 15% per annum as the India growth story and the massive urbanisation that we are witnessing in India will always push the prices up. However proper due diligence is a must.

Overall, I think 2011 will be an interesting year.

If you want advice on managing your wealth - I would be more than happy to help you out - and this service is absolutly free as I would like to share my learnings with as many people as possible.

Does financial literacy make you wealthy?

Not always. There are factors beyond just financial literacy. Let me explain.

There was a recent report of a study done at University of Pennsylvania that shows that there is a big downside in getting financially intelligent – as per this study, “financial intelligence increases the confidence levels of the investor and it leads to him making worse investing decisions.” In a 2005 survey, 65% Americans believed they were 'very' or 'highly' knowledgeable about personal finance, although they performed abysmally on objective questions about the subject.

I see the same attitude in India as well – most people think that they are financially literate. They confuse between savings and investment – they take investment decisions based on gut feel, optimism and unconfirmed data. They take risks that they are not aware of. With Indian economy growing at 8% for the past 10 years, these  people have had some successful investments – they attribute these successes to their financial intelligence – not knowing that when the times are good, you do not need too much expertise to make money. Warren Buffet opines that you do not need above average intelligence to be a successful investor – however one needs the right temperament – to control the urges that get people into trouble.  A good investor offcourse has financial intelligence – but beyond that, he has the right temperament to wait patiently for the right opportunity and not take undue risks.

As I said in my last blog (and this was popular with my MBA students) – “In the search for good investment opportunities, we must adopt the same attitude one might find appropriate looking for a spouse - it pays to be active, interested and open minded - but it does not pay to be in a hurry.”

When the student is ready, the teacher will appear

The content given here was was part of the last class that we had – where in I shared my views that Wealth is not really something physical – it is a way of life - a way of thinking – if you can understand this and then work towards thinking and operating the way the wealthy operate – in time, you will also become wealthy - as wealth will come to you.

People who have wealth use their time to create three things –

1.       A  network of acquaintances

2.       Financial fitness; and

3.       Clarity of their long term goals

As you can see, these three things can be created without having any wealth to start with. Hence anyone of us can become wealthy over time by following these three things – constantly build a network of acquaintances whom you can help grow, prosper; build a mindset wherein over time you end up collecting assets ( anything that increases you cash inflow) and not liabilities (anything that increases you cash outflow); and getting clarity through self education and introspection on your long term goals in each of the role that you play daily ( e.g. role of student, friend, classmate, son/ daughter, brother/ sister etc). As we get better and better in these three areas – we will see wealth coming to us.

Similarly, if one was wealthy and suddenly loses all their wealth due to reasons beyond his/her control, they would bounce back in life and become wealthy again as they still would have their acquaintances, financial fitness and goals.

Over time, I have collected quite a few quotes on wealth management that I shared with the class – I hope that you too enjoy reading these – please read it slowly and think about the message embedded in each quote:

1.       You can’t make a good deal with a bad person.

2.       It is easier to stay out of trouble than to get out of trouble –Warren Buffet

3.       It takes twenty years to build a reputation – and five minutes to lose it.
If you think about that – you will do things differently.

4.       Someone is sitting in the shade today because someone planted a tree a long time ago.

5.       You only have to do a very few things right in your life so long as you do not do too many things wrong.

6.       If you let yourself to be undisciplined on the small things, you will probably be undisciplined on the large things as well.

7.       In the search for good investment opportunities, we must adopt the same attitude one might find appropriate looking for a spouse - it pays to be active, interested and open minded - but it does not pay to be in a hurry.

8.       The most important thing to do if you find yourself in a hole is to stop digging.

9.       If at first you do succeed - quit trying.

10.   What we learn from history is that people do not learn from history.

11.   Saving is not investing

12.   Your work is to discover your work and then with all your heart to give yourself to it

13.   Wealth is far more about focus than talent.

14.   If it feels like hard work, you are already doing the wrong thing.

15.   The rich buy assets. The poor only have expenses. The middle class buys liabilities they think are assets –Robert Kiyosaki

16.   It is what you do with your money after you earn it that makes you rich or poor

17.   Success is not in what you have, but who you are

18.   Money won’t make you happy… but everybody wants to find out for themselves –Zig Ziglar

I have finished this course with this session.  However, I believe that wealth management is not a 30 hour course – it is a lifelong lesson and one needs to learn all the time –hence I intend to add to this blog regularly.

Real Estate investment in India

Currently we have about 300 million people residing in Urban India – appx 30% of our population – with increasing urbanisation, we will be having close to 550 - 600 million people in urban India by 2035 -  This massive wave of urbanisation in India means that our cities will grow to almost double the size in the next 25 years – we can see this happening all around us – if we compare a 1985 vintage map of any city in India  -we would realise that the city has truly expanded to almost double the size – the same thing will repeat –at a larger scale between 2010 and 2025.

Where is the opportunity hidden in this information – if you look at a 20 year horizon, invest in a plot of land (any size that you can afford) in an upcoming gated development that is 10-15 kms away from the current city limits –in 20-25 years, this locality would be part of the city and the value would have grown tremendously. Anyone who did this in 1985 knows the value of this smart investment and the same opportunity exists even today. The key issue here is that the land must be safe from encroachment for this period of 25 years - hence it must be a gated or walled development.

Real estate investment in India offers tremendous potential to get a 20% plus returns – it is quite difficult to make a mistake if one knows the basic rules of investing in real estate. Real estate investment is like a fixed deposit with near zero risk giving atleast 15% returns per annum. Once you have about 10-15 lacs worth of assets created – make your first real estate investment –- leverage your position by putting 20% of the investment from your savings and remaining 80% through a loan. Leveraging is a commonly used technique in this area as the investments are in large chunks and the appreciation of property is normally more (15-20%) than the interest costs (10%) of the loan. My class presentation is available for you in Slideshare.net and has some scenarios described on how leveraging works.

There are broadly five ways of investing in real estate:

·         Residential properties – flats and residences with land

·         Commercial properties – offices, shops, godowns etc

·         Urban Land – commercial, industrial, residential

·         Rural land – agricultural

·         Real Estate Investment Trusts ( REIT)

I consider the other way of investment in real estate sector through Real estate equities as not truly a real estate investment as this does not represent the true real estate risk/ reward scenario in India.

Let me elaborate on these five ways on investing:

Residential properties – contrary to popular opinion, this must ideally your second investment  -not the first investment – residential properties give you capital appreciation (10-25% pa)  and rental cash flow (2-5% pa) – the overall returns are 15% to 30% pa and I believe this will go on for at least another two decades in India due to urbanisation and economic growth. The land appreciates at a higher rate than building and hence the residences with land would show a higher appreciation than flats. However, due to good common amenities (like security and club house), the flats give a higher rental yield than residences with land. A good location, a good builder /architect, good landscaping, good common amenities will give higher ROI and hence one has to select properties based on these parameters. The minimum investment required (including loan) would be around Rs 50 lacs.

Commercial properties: This must be ideally your first investment – I have not seen too many people do this as their first investment – but those who have done it are more financially savvy. The reason for this is that, the commercial properties give the same capital appreciation of 10-25% pa as residential properties – however, they give a rental yield of 7-10% pa and that is double the rental yield of residential properties. Also the minimum investment required here is around Rs. 15-20 lacs as compared to Rs 50 lacs in residential properties. Early in life, when one wants to increase the cash flows from investment, higher rental helps – hence when compared to residential properties, we must look at investments in commercial properties early in life. Once we have become financially independent ( i.e. our cash flows from investments are more than our expenses), then we can look at residential and other investments. Go to any broker, look at the Sunday edition of Times of india and you would be surprised to see the kind of options that commercial real estate offers – however, surely do a legal check and also take advice from broker on the rental yields before investing.

Urban land – Once you have become financially independent, you must invest in urban land – land gives higher capital appreciation than buildings – my experience has been at least 20% pa – normally higher if the location is good. So after having a few rental yielding properties and after becoming financially independent – focus on urban land and keep a minimum of 5 year window for these investments – you will more than double your money.

Agricultural land – Investments in agricultural lands that are 10-15 kms from some urban area will give good appreciation over 15-20 years – however, lands that are truly rural and far away from urban areas – may not give good appreciation or rental. If you are investing in lands like these – do not expect a great appreciation unless there is some development in that area in the future.

REIT  - REIT is a good way to gain from real estate appreciation without getting into the legal and asset maintenance issues – REIT’s came in India as an investment structure in the last one decade and India REIT is the pioneer in our country. The company offering REIT takes commitments of Rs 25 lacs from investors over 2-3 years and they invest this money through well known real estate developers  in residential /commercial properties being built by them – as these properties get ready and are sold, the profits from this sale are given back to the investors  - this takes about 7-8 years to materialise – there was another flavour of this REIT before recession where the REIT company used to buy existing commercial spaces and the rental yields was given as quarterly yield, and after 5-7 years, they sold the commercial assets and returned the principle and profits from the investments. If you have 25 lacs to invest and do not want the hassles of legal work, property maintenance work, but still want the gains that one gets in real estate – REIT is highly recommended. These are closed funds and hence you will have to keep an eye for when these offers are available – ask your wealth manager and he will tell you when one comes up.

There are a few very logical, practical and doable tricks for real estate investment that I have shared in my class – these are in the ppt for you to see in slideshare.

As MBA’s starting your career, you must build your asset value of about 15 lacs in the first 3-5 years of work through equity route and then before marriage, invest in a property that yields rental plus capital appreciation – a commercial property is what I would recommend. Over the first 15 years of your career, you must own rental yielding properties worth 150 lacs  (in today’s value) – if you can do that, you will be financially independent by then– after that based on your savings, invest in land to get good appreciation.

But before all that, advice your parents to invest in an upcoming gated development that is 10-15 kms away from the current city limits in your city.

Insurance as an investment vehicle

After a break of one month, I would like to restart and share details on Insurance products available in India and what products you must use in your quest to create wealth. My presentation of this session can be downloaded from http://www.slideshare.net/sgrajasekharan/insurance-session

Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event.

In other words, Insurance is a promise made by the insurance company to pay a certain sum of money at some future date or on the happening of an unfortunate event.

The concept behind insurance is that a group of people exposed to similar risk come together and make contributions towards formation of a pool of funds. In case a person actually suffers a loss on account of such risk, he is compensated out of the same pool of funds. Contribution to the pool is made by a group of people sharing common risks and collected by the insurance companies in the form of premiums.
There are three broad categories of insurance –

1.       Non life or General insurance - that insures against the loss of assets like house, car, factory etc.

2.       Health insurance – that insures against loss of health.

3.       Life insurance – that insures against the loss of life.

As we discuss wealth management, the only area where insurance is relevant is

·         When we are insuring the assets that we have created; or

·         When we are insuring our family against loss of life or health; or

·         When we have a liability like a home loan or a car loan, then we need to insure against the risk of loss of life of the primary wage earner for the amount of loan taken.

·         Another relevant area where risk mitigation is necessary is when one lives longer than normal and needs to fund the old age.

However, no discussion in wealth management goes without discussing insurance as a wealth management tool – this is because there are various offerings by insurance companies that mix this risk mitigation strategy with investment strategy. As customers, we are not able to differentiate between the cost of risk mitigation and the investment returns that these insurance companies are committing. So let me describe the basic four types of insurance and share my views:

1.       Term insurance –in this type of policy, the policy holder pays a premium and get insured against death for a particular term – in case of the unfortunate event of his/her demise during that term, the insurance company would pay to his/her nominee the amount insured. If there is no demise, the policy holder does not get any returns. The annual premium for someone aged 25 years for a sum assured of Rs 100 lacs for 20 years term is only around Rs 10,000. This means, if you take this policy, you will need to pay Rs 10,000 per year for the next 20 years and during this period, if you lose your life, your nominee would get Rs 100 lacs. This is a pure risk mitigation policy that I recommend that each one of you take –the earlier the better.

2.       Whole life insurance – this policy runs as long as the policy holder is alive. The policy holder pays a premium every year for a period of 15 to 20 years and that will assure the nominee the insured amount plus bonuses on the death of the policy holder. In some cases, if the policy holder lives up to 85^th year, then the company would pay the insured amount plus bonus to the policy holder itself.  The premiums here are high and part of the premium is invested and another part goes towards risk mitigation from death. For example a well known insurance company offers for 25 year olds, a premium of 2.66 lacs per year to be paid for 20 years for a sum assured of Rs 100 lacs – which will be paid along with bonuses either on death of the policy holder or on his/her 85^th birthday. As you can see, 60 years is a long time and the returns are not good enough for a payment of 2.66 lacs per year for 20 years. Hence such policies are not recommended - instead take a pure term policy (which costs Rs 10000 per annum) and invest the remaining 2.56 lacs yourself – the returns will be better.

3.       Endowment policies – These policies are designed to provide a benefit to the policy holder at a stage of life when a lumpsum of money is required – like marriage of daughter or college education of kids or retirement time. Plus there is a benefit in case of death. For example a well known insurance company offers for 25 year olds, for a premium of Rs. 10.94 lacs per year, to be paid for 5 years, a sum assured of Rs 100 lacs for 30 years – this 100 lacs will be paid along with bonuses either on death of the policy holder or on his/her 55^th birthday (pre-retirement amount). As you can see, the policy holder is paying almost 55 lacs for the first 5 years and gets a term policy that he can get by paying 10,000 per year plus Rs 100 lacs plus bonuses after 30 years – it does not take too long to understand that this too is not an optimum investment strategy and we could do better by taking a term insurance and then investing the remaining amount directly. The endowment policies come in various forms and all of them have an investment /returns angle and an added death benefit. Unit linked insurance plans go further where they declare the value of units just like NAV’s in Mutual funds. Also in these policies, there are quite a few charges that the insurance companies charge – premium allocation charge, mortality charge, fund management fee, administration charge, surrender charge and fund switching charge. These charges are much more than what one would be charged by fund managers for managing your funds in wealth management companies. Hence it is far better to manage your own funds than use these endowment policies.

4.       Pension plans or Annuities – these policies cover the risk of living too long (unlike the risk of dying too early) – here you pay one single lumpsum or pay a premium for a few years now and in return get an assured pension after a particular age (normally retirement age). For example, a well known insurance company offers for people in their 50^th year, for a one time premium of 1000, a pension of Rs 42.79 per year for as long as he/she lives. As you can see, it comes to an ROI of 4.27%. We can do better than this simply by investing in a bank FD. Hence this too is not recommended.

As you can see, Insurance is a good wealth creation vehicle – not for you – but for the insurance company– hence it is better just to take pure term insurance and manage your investments directly or through a wealth manager.

Short note on Fixed Deposits

Fixed Deposits in India give returns of about 8-11% per annum. Inflation in India is around 8-9% and the interest from FD’s is taxable – hence FD’s cannot be used as a tool for wealth creation. However, FD is a good investment option for wealth preservation. Hence at the stage where you are, the wealth creation stage, FD’s are not the best option to invest.  And for people at the wealth preservation stage – the retirees for example, FD is a good option.

Having said that let me share with you few salient details on FD:

1. Traditionally, fixed deposits, as the name suggests, earned interest at fixed rates. However, recently this has changed. Now every bank has to declare a base rate every quarter (based on their cost of capital and other economic factors) – and the interest on all the existing FD’s would be linked to this base rate. Hence the FD is now technically a Floating rate deposit.
2. Each depositor in a bank is insured up to a maximum of Rs.1,00,000 for both principal and interest amount held by him. Hence there is safety till Rs 100,000 in the FD’s if the bank folds up.
3. Investments in fixed deposits up to a maximum of Rs.100,000 for 5 years are eligible for tax deductions under section 80 C of income tax act.
4. Fixed Deposit tenures can be as low as 7 days and the minimum amount can be as low as Rs 100.
5. For FD’s more than 15 lacs, the interest is decided daily by the banks.
6. While investing in FD’s one must look at the charges that will be levied in case of premature withdrawal.
7. Also we must appoint a nominee as a best practice when we invest in an FD.
8. Corporate deposits compete with bank FD’s and they tend to give a slightly higher rate of interest as there is a slightly higher risk in this case.
9. Then there are Mutual funds that invest in Debt instruments – these do not commit returns unlike FD’s but they are more liquid than FD’s