Let's Talk Money: You've Worked Hard for It, Now Make It Work for You

by Monika Halan

Why do we buy active funds when passive is cheaper and less risky? Because the Indian market still has alpha left in it. What’s this alpha? Alpha is the extra return that the fund manager can generate over the index. Active fund managers have done very well in India and the higher cost of active management has been more than compensated by the higher returns these have earned.

two kinds of passive funds – an index fund and an exchange-traded fund.

An ETF also tracks an index like the Sensex but lists its units on a stock exchange, unlike a mutual fund. To buy and sell mutual funds you don’t need to have a demat account. But to invest in an ETF, you need a demat account.

The other difference in index funds and ETFs is that you can buy an index fund at a price at the end of the day, but you can buy an ETF at any point in the day. This difference in price is not relevant to retail investors like us.

ETFs come with tiny costs compared to the index funds. The average index fund costs between ten basis points to 1 per cent, or ten paise to Rs 10 on every Rs 1,000 invested. ETF costs have hit rock bottom and you ...

Small- and mid-cap stocks are the engines of growth in a portfolio.

These are usually aggressive high-growth firms. The returns from small- and mid-cap firms are much higher than those from large-cap ones, but this possible higher return comes with higher risk. When markets fall, it is the small- and mid-cap stocks that fall harder than the large-cap stocks.

An open-ended fund is open for investors buying and selling it forever. A closed-end fund comes to the market with a fixed time frame. Closed-end equity funds come with a three- or five-year investing horizon. I like open-ended funds that have been in the market for at least five years.

The growth option works especially well for equity funds as it allows you to keep the money invested in the market.

The full form is net asset value. It is not ‘gross’, because the costs have been removed from the price, and you get the net value in your hand.

In its simplest form, a market-linked investment product carries three kinds of costs. One, the cost to enter the product, also called a front load. If you invest Rs 100, and Rs 2 from that is cut out so that Rs 98 is invested, the Rs 2 is called a load. A load is part of the price of the product, or is embedded in the price – it is an invisible charge because it is not usually disclosed. Mutual funds have zero loads and are an extremely investor-friendly product.

Two, an ongoing cost or the annual fees that you need to pay to have experts manage your money. To take care of the running costs and profits of investment managers each year, some fees are deducted from your money. The cost to you of handing over your money to professionals is captured in a number called the ‘expense ratio’. This is the fees that a mutual fund charges investors for its costs and the profits it makes.

Three, an exit cost, or the cost of selling the product. To take care of expenses of selling the investment you made or to act as a deterrent to frequent churning of money, funds levy exit charges. This is a percentage of your corpus and usually falls off to zero after about one or two years. Ask this question: What does it cost to redeem this product after one, two, three years and so on over the life of the product?

Do you know that people like us are pumping over Rs 6,500 crores a month (that’s Rs 78,000 crores a year!) into the equity market through SIPs? And do you know that people like us are the reason Indian markets don’t fall when foreign hot money flows out? But remember that SIP is a vehicle and not the goal. You use an SIP to make investments in a mutual fund.

What if you suddenly got a big bonus or some arrears, or inherited a bunch of money? Instead of investing it all in one go, you can put the money in a liquid fund and set up a monthly (or weekly or fortnightly) transfer into an equity scheme. Remember that you have to choose a liquid fund of the same fund house whose equity fund you want to buy through an STP.

First, there is a cost to buy the product. Look at this as an entry ticket, a ticket that allows you to board the bus. Different products, even if they do the same thing, have different entry costs, also called loads. These are commissions that the person selling collects from the manufacturer of the financial product. Understand that in certain kinds of life insurance products, like endowment and money-back plans, the cost of buying the product can be as high as 42 per cent. If your premium is Rs 1 lakh, Rs 42,000 goes straight to the agent selling it to you. In addition, they charge ‘policy administration charges’ or the cost to the insurance company to make that sale.

In a ULIP the front load is about 8–9 per cent. In a mutual fund, there is no cost of entry. The front load was brought to zero in 2009. In a bank FD, PPF and PF there is no front load. The National Pension Scheme (NPS) has a front load of 0.25 per cent

Second, there is an ongoing cost. This is the money you need to pay each year for you to stay in the product. Also called expense ratio, this is usually a percentage of the money in the investment. If you invested Rs 1 lakh and the money is now worth Rs 2 lakhs, you will pay the expense ratio on Rs 2 lakhs. The expense ratios differ according to type of product you buy.

Inflation is a serious risk for you if all your assets are sitting in FDs.

depends on your risk appetite and capacity. The thumb rule is this: the closer you are to the goal, the lesser should be the equity part of your portfolio.

The government’s sovereign bond issue is very good and if you don’t need the money for the next seven years, you can begin to build a gold laddering system.

Real estate has its own cell, but the only product I have in that cell is the house I own and live in. You know that I’m not a big fan of real estate. I find it really messy.

Use the Rule of 72 again to do the maths. This time you divide 72 by the inflation you are projecting into the future. For example, if we think inflation will be 6 per cent in the future, divide 72 by 6. This means you will spend twice of today’s expenditure in twelve years. If you spend Rs 1 lakh a month, in twelve years you will spend Rs 2 lakhs a month. In another twelve years, you will be spending Rs 4 lakhs a month; in another twelve years, you will be spending Rs 8 lakhs a month. Remember: Divide 72 with your inflation number to get the number of years it will take to double your current expenses.

At age sixty, you need between eighteen to thirty-five times your annual expenses at retirement to retire with the lifestyle you are used to.

Fidelity Investments has a retirement guideline out that maps the journey of the retirement corpus over the years. At age forty, you should have three times your annual income as your retirement corpus already. If you earn Rs 15 lakhs a year at age forty, you should have Rs 45 lakhs in your retirement corpus. At fifty, you should have six times your annual income. If you have an annual income of Rs 40 lakhs at age fifty, you should already have Rs 2.4 crores in your corpus. At age sixty, or at retirement, you should have eight times your annual salary. Earning a crore at sixty, you must have Rs 8 crores as corpus.

But the decade of the fifties is one of high income and much lower expenditure. You are at the peak of your earning cycle. Your home EMIs are paid off (if they are not, know that they should be). Your kids are financially independent. This is the decade when you can save at least half your income. I know people who save almost 70 per cent of their income at this age.

at age thirty, if you have zero retirement money, you start saving 30 per cent of your post-tax income; at age forty 40 per cent; and at age fifty 80 per cent of your income;

you are targeting a retirement kitty that is between eighteen and thirty-five times your annual spending at age sixty;

by age forty you have three times your annual income as a retirement kitty, by age fifty six times your annual income and by age sixty-eight times yo...

The ‘fill it, shut it, forget it’ approach needs a once-in-a-year audit.

the government’s sovereign gold bond issues are the best way to hold gold today.

There is a rule of thumb on how much equity you should hold: 100 minus your age. At age thirty, you should have 70 per cent of your holdings in equity and at age seventy, you should have 30 per cent of your holdings in equity. It is a good idea to do an annual audit of your money box to see if you are on track.

Complete your money box with a will in the final cell of the box. Hope that it is opened only after you die of old age and not before.

I don’t invest in things I do not understand. I don’t