Why is goal-based investing better?

There are two ways to invest money:

(a) simply investing whatever is left in your bank account after all the expenses have been taken care of, and
(b) investing with a goal of accumulating a specific amount by a specific date.

There’s a name for (b): it’s called Goal-Based Investing. Goal-based investing seems like more work in the beginning, but if you look at the big picture, it’s actually less work than investing without specific goals in mind.

Plans give us clarity

There’s a saying, “Plans are of little importance, but planning is essential.” The specifics of our plans change over time, and some plans simply become irrelevant. But having a plan gives us the confidence we would never get otherwise.

When we plan, we know in advance how much money we’re roughly going to need, and where that money will come from. Either we’ll know that our investments will give us what we need, and we can sleep peacefully. Or, we’ll know by how much we’ll fall short. This isn’t ideal, but it’s arguably better than falling short and not knowing it.

Asset classes

Financial assets can be divided into 2 categories: volatile and non-volatile. Value of volatile assets fluctuate badly making it hard for anyone to guess what the value of the asset would be on a certain date. Example: shares, gold, oil, etc. Non-volatile assets either retain their value or they almost always move in one direction – upwards. Example: cash in your locker, bank deposits, bonds, etc.

While volatility is annoying, volatile assets are the ones that can retain the money’s purchasing power over time. If you want your money to retain its purchasing power, investing them in something like equity is pretty much the only option you have. If you don’t have sufficient amount of volatile assets, your investment simply keeps losing its purchasing power, like a leaky bucket. If you hold too much of volatile assets, the price you get when you sell will be unpredictable, and that can very well be less than what you really need.

Asset allocation

Goals can help you decide on your desired asset allocation, meaning how much to invest in volatile assets and how much in non-volatile assets. Buying volatile assets such as equity or gold is fairly easy. But you need an exit plan for selling them if you want to avoid excessive capital loss. The exit plan usually is to gradually reduce your exposure to volatile assets until you bring it down to 0.

For a goal that’s 15 years away, I might start with investing 80% in equity and 20% in low volatility fixed income. For a goal that’s 8 years away, I’d probably start with 30 or 40% equity exposure. In both cases, I’d reduce equity exposure gradually over time. By the time I’m spending the money on whatever financial goal I had, my equity exposure would be zero, meaning almost zero volatility.

A framework for decision making

Mostly as a benefit of having a desired asset allocation, goal planning gives us a framework for investment decision making.

Equity investing can be confusing and stressful. If equity valuations suddenly fall, should you buy more equity or not? For how much should you buy equity during the fall? How long will you have to wait before you can see profits from this purchase? It’s not easy for anyone to answer these questions. Same confusion exists on the other side too: if there’s a stock market rally, should you sell some equity? When to sell and how much to sell? Nothing here is obvious or intuitive.

If you have a desired asset allocation that’s optimised for a specific goal date, your asset allocation will give you answers to every such question. Your desired exposure to equity is 40%; there’s a stock market rally, and now your equity is 46% of your portfolio. You sell 6% equity and invest that money in fixed income assets. There’s a stock market crash and your equity portfolio is worth only 32% of your entire portfolio. Sell 8% of fixed income and buy equity (at a lower price).

Stock market almost constantly feeds us fear and greed. In this dark alley, your asset allocation lights the path and gets you through safely. You just have to start with a reasonable plan and stick to it even when the going gets tough.

Nifty Next 50 returns — my ‘risk appreciation exercise’

It’s not hard to find historical annual returns of Nifty 50 (here’s a good one), but I couldn’t find a similar summary for Nifty Next 50. I care about the Next 50 index because Next 50 is the core component of Kuvera’s recommended portfolio, which I also invest in:

Nifty Next 50 is the base of our recommendation with 46% of our equity portfolio recommended to this index. Our diversification through Nifty index, one international fund and one focused fund significantly improve on the return and risk of Nifty Next 50.

Because the data wasn’t readily available, I ended up downloading the daily index data and calculating annual returns myself. 

While I was initially annoyed for having to do this myself, I think this was a good exercise. What Nifty Next 50 lost in 2000 and 2001, for example, it has recovered only by the end of 2004! I think creating this table was a good Risk Appreciation Exercise for me. I have a feeling I now have more understanding and respect for the risks involved in share market investing. 12 months ago, I would have simply repeated what I heard from others: if you stay invested in the share market for many years, you’ll be fine. Meaning, staying invested is the only risk mitigation you need.

But imagine investing a large sum in the Nifty Next 50 index by the end of 1999. Three preceding years — 1997, 1998, and 1999 — have given eye-popping returns. Novice investors may not think twice before investing if they see such numbers. The Next 50 index soared by 141% in 2003, and that still wasn’t enough to bring the index back to its 1999 level! Only by the end of 2004 did the index actually catch up. If you made a lump sum investment into Nifty Next 50 by the end of 1999 and wanted the money by the end of 2004, you made next to nothing from the share market. That’s still better than taking the money out before 2004 when you were clearly in the ‘capital loss’ territory.

It still might be possible that if you stay invested for 7 years, you’d end up making a good return. But looking at these scary scenarios help you appreciate the risk better and take risk mitigation strategies (such as having an asset allocation) more seriously.

Can you invest in sectoral funds?

What is a sectoral fund? Sectoral funds invest in equity of companies from a certain industry. For example, Tata Digital India fund invests 93% in the Technology sector; Nippon India Pharma fund invests over 96% in the Healthcare sector. (This is the weightage as on 31 Aug 2020, and can change over time.)

If you ask whether technology companies will continue to make money, the answer is Yes. If you ask whether healthcare companies will continue to make money, the answer is Yes. In fact, the answer would be Yes for most sectors. Does this mean you can invest in any sectoral fund?

The answer, as is often the case, depends on what your investment objectives are. If you are investing for the long-term, say for 10+ years, you are better off investing in funds that will consistently give you returns year after year. That usually means investing in a diversified set of companies across multiple sectors. Index funds are an excellent option; I also like the funds and allocation recommended by Kuvera.

If you know very well about a certain industry and you can reliably predict when an industry will do well, you can buy sectoral funds. But you will have to do active investing where you buy the right funds and the right time and sell them at the right time to hold on to the profits. If you have the skill, time, and interest to do this, sectoral funds are an option. If not, go with diversified funds.

Sectoral funds are, by definition, concentrated portfolios. In investing, concentration means high risk/high reward. You have the potential to make a lot of money, but at the same time you can lose a lot of money too. Understand what this means and decide for yourself if you want to take the risk.

But why is volatility in debt investment bad?

In an earlier blog post, I said this:

The way I invest—and most of us do—is to use the debt portion of the portfolio for stability while using the equity portion to bring in earnings/growth. Taking risks in debt funds for the sake of getting better returns is simply forgetting why you have an equity/debt split to begin with.

In this post, let us think about the rationale behind this principle. Before we start, let me expand on what I meant when I said “the way most of us invest”. The idea here is that:

1. As our financial goals are approaching, we’ll be moving money from volatile investments such as equity and gold over to debt investments.
2. By the time we want to spend the money on a financial goal, we’ll only be redeeming debt funds because 100% of the corpus for that goal should now be in debt.

My goal’s asset allocation glide path is designed in such a way that as the goal approaches, money is gradually moved from equity investments over to debt. I use my own asset allocation glide path, but if you use Kuvera’s goal planning, Kuvera will guide you through its own proprietary glide path. Follow the asset rebalancing advice that they regularly send, and your investments will follow their glide path. (Shameless plug: if you are new to Kuvera, sign up using my referral code JK1P3 to get Kuvera Coins worth ₹100.)

With these assumptions stated, let us look at an example. Let’s say I need 20 lakhs for my son’s college fees that’s due next month. I will have all of this 20 lakhs in debt funds, thanks to the glide path. Let’s say this is a volatile debt fund, and it loses 5% before the due date. Now the debt investment is worth only 19 lakhs! The fund might eventually recover if I stay invested for a few more months, but my son’s college will not wait. I’ll have to scramble to arrange the lost 1 lakh from some other source. This is essentially the reason for choosing a more stable debt investment over a more volatile one.

The natural question that follows is what if your goal is 10 or 15 years away and you’re not really going to spend the money any time soon? Can you invest in riskier debt funds and move them gradually to safer debt funds? You can. But then your glide path becomes complex; your portfolio will have more churn because you are not rebalancing between 2 buckets (equity+gold and debt) but 3 (equity+gold, high risk debt, and low risk debt). If you are okay with more risk, why not just invest in equity for a longer period? Your glide path remains simple and yet you take more risk in the initial days by having a larger allocation to equity+gold.

Investment is a very personal exercise. There are many “best practice” advices, but there is no single rule for how exactly to do it. Think about your desires and preferences and choose a path that’s just right for you.

Are debt mutual funds better than bank fixed deposits?

A friend of mine read my post on debt funds and asked me this question. “If you shouldn’t be optimising your debt portfolio for return, why not just put the money in bank fixed deposits (FDs)? Are there reasons to choose debt mutual funds over bank FDs?”

A very good question. Putting higher returns aside, are there reasons to invest in debt mutual funds rather than investing in FDs?

I can think of the following reasons:

• Diversification. With an FD, you trust that a certain bank (or a few banks) will be able to repay you. It’s arguably not a huge risk that a bank will go insolvent, but the risk is nonzero. With debt mutual funds, your money is invested in several bonds/CDs/CPs/etc so the risk of any one—or a few—institutions going insolvent is mitigated. You might lose, say 5% of your capital but not 50 or 70%.
• Convenience. If you were to invest in FDs, you need to decide which bank, for how long, etc at the time of investment. When you buy debt mutual funds, you don’t need to make those decisions. The fund manager makes those decisions for you. You pay the fund manager for this work, of course, through the fund’s expense ratio. But the convenience is worth the money in my view.
• Income tax. If you have an FD for 10 years, you’ll be paying taxes every year for the accrued interest. With debt funds, you don’t have to worry about taxes until the time you redeem the funds. Also, taxation of long term debt mutual funds is not at slab rate, which can be a big plus for people who are in the highest tax bracket; it’s less of an issue for people with low tax liability.
• Restrictions imposed by FDs. This is just a combination of convenience and rate of returns. Let’s say you have 10 lakh rupees in 10 FDs: 1 lakh each. You need to withdraw ₹70,000 for some expense. Now you can break one FD and re-deposit the balance ₹30,000, but you’ll lose any unpaid interest for the deposit, including for the ₹30,000 you will be re-depositing. You can maybe ignore the interest loss, but you really have to think and decide how to reinvest this ₹30,000. For example, how long to invest, should this be a single ₹30,000 deposit or a few deposits of lesser amounts, etc. If the same 10 lakhs was in a debt mutual fund, you simply redeem ₹70,000 and that’s the end of the story.

Which is better — gold mutual fund or digital gold?

Until I read this piece on Kuvera Blog, I was only mildly interested in gold. After reading that, I thought I’d invest in gold because it acts as a hedge against INR currency depreciation and inflation to some extent. I thought digital gold was the way to go because they are better than gold ETFs or gold mutual funds in these ways:

• no recurring expense though you pay 3% GST at the time of purchase, and
• the Kuvera blog post said digital gold tracks gold price more closely than other gold instruments.

I started a digital gold SIP and started buying gold every month. Only a few months later I realised that digital gold is a space that is not regulated by the government. This was concerning. From some online sources I found out that digital gold providers have set up regulatory processes by hiring third-party auditors, etc. That’s better than nothing, but that is still voluntary. If a vendor finds some process too inconvenient, they can decide to not do it; no one can question them.

•••

Quantum is an AMC that I am starting to like more and more for their conservative and responsible approach to handling investor’s money. Quantum has a gold mutual fund. They conducted an online session where they outlined their process for acquiring and storing the gold that their investors buy. I watched that live and from then on, I decided that I’d rather invest in gold through Quantum than anyone else. First of all, the mutual fund industry is regulated by SEBI, which is far better than self regulation. The next reason is very subjective: I happen to like and trust Quantum more than many other AMCs.

Thus, I switched my allegiance from Kuvera provided digital gold to Quantum gold mutual fund. I knew I was losing some money because the fund’s expense ratio pays for insurance, storage, AMC’s regular inspection and auditing, etc. But I convinced myself that the peace of mind I get is worth the money.

•••

Just today, I came across another reason that validates my decision to move away from digital gold. It’s an article on LiveMint, and it says:

Generally, these digital gold products have a maximum holding period after which the investor has to take delivery of gold or sell it back. For example, MMTC-PAMP investors will have to mandatorily take delivery or sell the gold purchased, unlike gold ETFs where there is no such limitation. After five years, the investor will have to pay extra charges decided by MMTC-PAMP, if the delivery is not taken. One can hold Gold ETF for as long as one wants to.

If you want to hold on to your gold for longer, you need to sell and repurchase the same gold at the 5 year mark. It sounds like a simple annoyance, but if you think a little bit more, you’d realise it’s more than an annoyance:

• If you’re selling and repurchasing, you will be paying the 3% GST again. The narrative that digital gold has an one-time overhead (GST) vs mutual funds having a recurring overhead (expense ratio) breaks down here. (The magnitude of the recurring cost can still be different.)
• Add to that the spread that exists between the selling price and buying price. Let’s say you need to sell 3 grams of gold because you have held them for the maximum holding period. Thanks to the bid-ask spread, the money you got from the purchase will get you less than 3 grams of gold. This is even before accounting for the 3% GST.
• Selling gold is a tax event. You need to determine whether it’s a capital gain or loss and include that in your tax returns. If there was capital appreciation, you’re also looking at a tax bill in addition to the aforementioned expenses.

This only strengthens my belief that picking the right investment instrument is really hard, but not for the lack of information. You can find any information you need on the web. Most vendors will also be happy to answer your questions if you just call them. But your needs and preferences are unique. Speak to knowledgeable people you know or a financial advisor, and find out what works best for your own unique needs.

PS: If you’re still not sure whether to invest in gold (more precisely, to have an allocation for gold in your portfolio) I would highly recommend reading Kuvera’s excellent advice on this. Gold has historically given less return than equity. If you have an allocation for gold, you should be prepared to sell some equity and put that money in gold. You should be willing to go through that unpleasant exercise.

The missing piece

When I moved to Bengaluru last year, I decided that I wouldn’t buy a car. When Uber and Ola taxis are available within a few minutes, having to pay for car maintenance seemed unnecessary to me. We got by without a car for the past year, and we were mostly fine. There were times when the need for an own car was felt more than other times, but I stood by my decision to not buy a car.

Last month Bengaluru went under a full lockdown for a week. There was an urgent need to see a doctor, but no taxis were available. Many auto drivers refused to take us too, fearing that they’ll be stopped by cops. After a bit of a hassle and a lot of stressful minutes, a kind person agreed to lend us his scooter. It wasn’t an ideal choice for that day, but it was far better than not making the appointment. It was then that I decided to buy a car.

I started enquiring as soon as the lockdown was lifted and got my car delivered yesterday. Since morning, I have been kinda looking for reasons to go out 😁. In the evening I decided that we’ll all go out to get some ice cream. I called Corner House, my favourite ice cream joint, and asked them if they allowed people to dine in. The answer was negative, but that wasn’t unexpected. We decided to drive down anyway and bring the ice cream home. Buying through Swiggy would have saved us time and money for sure. But the real goal was spending some quality time in the new car, so we went out.

After spending one and a half hour outside home, it was good to be back home. I felt refreshed. I think being stuck at home had made me unhappy and the little bit of “outside time” had made me happier. Spending time outside is likely the missing piece in my life in these “stay at home” days. With a car accessible 24×7, I think I’ll find ways to spend enough time outside and remain happy.

•••

This is also making me think about jail time as a punishment. Being locked up in a jail for even 6 months can be very painful. Spending years of your life in a jail is super sad. When I was younger, I used to think that punishing with 1 year or 2 years jail time was nothing. Anything less than 10 years seemed like an “easy punishment” to me. But now I see how even a few months can be really tough.

Choosing a debt mutual fund

When I subscribed to SIPs in Kuvera recommended funds, I had no idea what those funds were, or how to choose one. Kuvera recommends Nippon India Liquid Fund for the debt portion of one’s portfolio. After starting the SIP, I learned how to evaluate mutual funds. Soon I had the revelation that picking equity funds is much easier (big thanks to the existence of Index Funds) than picking the right debt fund(s).

I slowly learned how to find out how much risk a debt fund is taking. Chasing returns is generally a bad idea, but choosing debt funds based on returns is a particularly bad idea. The way I invest—and most of us do—is to use the debt portion of the portfolio for stability while using the equity portion to bring in earnings/growth. Taking risks in debt funds for the sake of getting better returns is simply forgetting why you have an equity/debt split to begin with. [See this blog post for the rationale.] Nevertheless, I decided to get better returns from my debt portfolio by selling off all my liquid fund holdings and invest in L&T Ultra Short Term Fund instead.

I chose the L&T fund because it has a high AUM; hasn’t had any significant credit incident; invests only in debts maturing in < 12 months, true to its label; and invests only in top-rated debts. I like PGIM India Ultra Short Term Fund too, but the PGIM fund’s low AUM (₹87 crores vs L&T’s ₹1,960 crores) scares me a bit. After choosing the L&T fund as the debt fund for my portfolio, I still had some discomfort… I was wondering if I should have chosen a different debt fund instead (to get better returns, of course!).

I read the definition of other debt fund categories, but that didn’t quite tell me whether they are better than ultra short term funds or not. Today, I downloaded the latest L&T fact sheets and looked at every debt fund they offer.

• Money Market Funds will invest only in money market instruments. They won’t invest in other debts such as non-convertible debentures or sovereign debt, etc. Although money market funds seem to get a better return, the debt is concentrated and hence the risk is higher. (Interest rate risk is comparable to ultra short term funds, though, given < 12 months maturity.)
• Banking and PSU Funds will only lend to banks and PSUs. The returns are quite attractive, but the maturity is much longer (about 5 years) and the one fund I looked at looks pretty volatile. Definitely not a great choice to bring in “stability” to your portfolio.
  
• Short Term Funds, Low Duration Funds, etc invest in debts with a longer maturity period, so they will be volatile too. Credit Risk Funds do not, as the name suggests, bring stability to one’s portfolio. (I wasn’t tempted to invest in these anyway.)

Overall, I think this was a good exercise. My debt fund isn’t earning eye-popping returns, but now I know why I don’t want to invest in other fund categories. They are just too risky. I still stand by my choice to switch from Liquid to Ultra Short Term, though. Liquid seems too conservative. I am okay to take a little bit of risk.

It must be clear by now: there’s no one fund that works for everyone. Understand the risks each fund is taking and consider if you’re comfortable with that risk. That’s the only way to choose a fund that’s just right for you.

Hacking Kuvera “family account” for goal separation

tl;dr: Create “fake” family member profiles to keep short-term and long-term goals separate or to keep your debt/equity investment ratio intact.

Let’s say you’re investing for some long-term goals (10 or more years away). Simultaneously, you also want to save for some short-term goals (1 or 2 years away). Or you just want to park some money in some debt funds (such as ultra short term funds). Kuvera’s default setup doesn’t support these needs very well. (Maybe for a good reason? They have SaveSmart which is probably what one should be using?)

Photo courtesy: PickPik.com

Mixing of short- and long-term goals
Kuvera uses unified goal planning, which takes advantage of the fact that as years pass, you’ll be earning more but your needs will reduce (because, say 2 of your 6 goals are already accomplished). But what it also means is that you cannot use Kuvera as a “recurring deposit” for saving (not investing) for a short-term goal. When you add a short-term goal, Kuvera will ask you to add just a tiny bit to your existing (long-term) SIPs because unified goal planning is inherently like that. If you kept adding many such short-term goals—I don’t pretend to know what really will happen—but intuitively it feels like you won’t have sufficient time for the money to grow for your long-term goals. It feels safer to keep the long-term SIPs and short-terms SIPs separate.

Parking surplus money for a few months/years
Let’s say you have some extra money lying around. You cannot quite invest it because you know you’ll have to spend that money in a few months. Or you may want to put a portion of your emergency funds in ultra short term debt funds that give higher return than liquid funds. (Also something wise people advise you to not do. Debt funds are for giving stability to your portfolio; don’t chase returns without understanding the risk.)

Basically, you want to park some money in debt funds. The moment you do that, your goal-based investments’ debt/equity ratio gets out of whack. This can be confusing and if you aren’t careful, would make your portfolio less than optimal.

In search of a solution…
Making Kuvera ignore your short-term or parked funds is easy: go to the folio management page and hide the folios that have the short-term funds. But now you cannot keep an eye on those funds.

I looked for alternate apps to track these funds. I tried ET Money and MoneyControl. They had the main feature that I wanted: I can enter when I bought what funds for how much; they’ll show me the current value, daily change in valuation, etc. But their user interfaces were a mess compared to Kuvera’s clean and beautiful UI. I tried Goalwise, but they only support defining and tracking goals, not the “I just want to track these external investments” use case. Their UI was so cluttered I didn’t even have the desire to learn if I can use their app somehow.

After struggling through this for a few weeks, I suddenly thought of a solution: just add a new “fake profile” to my account. I have enabled Family Account feature on my account so I can track my wife’s and brother’s investments. Now I have added a fake profile (i.e. a nonexistent family member) to the family for tracking short-term goals and parked funds. Now that I have learned this trick, all my recurring deposits will be going to Kuvera. I hope I’m not making a dumb mistake here 😬

Notes from ‘Happiness Unlimited’ #2

I have been watching 1 episode of Happiness Unlimited, a show where Mr Suresh Oberoi interviews Sister BK Shivani. Notes from the second episode ‘Stop Postponing Happiness’ that I watched today are here.

• We have 2 choices: I’ll be happy when I achieve this, and I’ll be happy while achieving this.
• We are not going to be able to lead our lives without goals, aims, and objectives. Because without goals, we’ll become very passive. I wouldn’t know where I’m heading.
• It’s not about what has happened. It’s about what I need to do now, how does my state of being have to be. I have to take care of that. Otherwise I’m in the vicious cycle of negativity.
• Whatever may be the situation, however challenging they may be, I am not going to get the solution unless I take care of myself.
• Let’s say I’m a family of 5 people. And 4 of them are not well. They are ill. I want to take the responsibility of taking care of them, of healing them. I’ll only be able to do it if I’m fine. This is about physical health, but now you take the same equation to emotional health.
• Happiness is an internal strength. Happiness doesn’t mean excitement. I’m not going to be jumping and dancing the whole day. I have lost my job; I am not excited about it.
• My child has got less marks. My responsibility at that time would be first to take charge of my mind... fine... first I have to remain stable so that I don’t react, I don’t shout at him. I don’t upset him. Then my responsibility is to take care of his state of mind. Then my third responsibility is to take care that he studies and gets good marks next time.
• The only reason a child commits suicide is because he is not able to face his parents after a failure. It’s not because he failed. It’s because he doesn’t want to see his parents unhappy. And he holds himself responsible for the parents’ unhappiness, because the parents conditioned him the whole year that we’ll be happy only when you do this.
• Every individual’s life is based on 4 aspects: physical, intellectual, emotional, and spiritual. Like the 4 legs of chair we are sitting on. If I want to be successful in life, all 4 should be equally balanced.
• It’s possible that a parent has not gone to school, but they send their child to the best school. It’s possible that a parent doesn’t eat, but gives food to the child. But it’s not possible for a parent to have his child happy without the parent being happy himself. You cannot make your child emotionally strong without being emotionally strong yourselves. That’s where the responsibility comes first on yourself.

Analysing the health of mutual funds

What should a mutual fund investor ideally do? Study mutual fund documents first and then invest. What did I do? Bought some funds without much analysis or reasoning and then, after a few months, I am looking at fund fact sheets and trying to understand how well they are managed. I am saying this upfront because I want to highlight that I am just doing things haphazardly, including the analysis itself. I don’t know what all information one should look at in a fact sheet, and how to determine if a fund is doing well. With that caveat out of the way, let me get into what I found from my analysis.

As a newbie investor, Franklin India’s decision to shut down 6 debt funds was bizarre to me. That news made me realise how some mutual funds can be bad. I had noticed this Reddit thread before, but couldn’t understand what they were talking about. I didn’t try to understand the discussion because I hadn’t invested in any of those funds. After the news, I reread that post and read some more on the web. I started to get some idea on what fund attributes I could look at.

If monitoring the health of mutual funds is an important thing investors should do, there must be dashboards on the Internet… or so I thought. After failing to find such a dashboard, I decided I had to make one myself. I downloaded March 2020 fact sheets of all my funds and I summarised some key stats (click on the image to magnify):

This was more confusing than useful to me: of the 12 funds I had data for, 6 had negative cash! Many debt funds, including liquid funds, had exposure to sub-top-grade debts. Is every debt fund taking risk in the market then?

After a few hours, I decided to add data from February so I can see how things have changed over the course of March. This turned out to be a good idea. Now I was able to see a clearer picture:

The market was less crazy in February, and that shows up in the numbers:

• Only 2 funds had negative cash. They also held a fairly low amount at -0.29% and -1.46% of respective AUM.
• Other than Kotak Savings, exposure to sub-top-grade debt was also minimal. Nippon Liquid fund had 0.35% lent to unrated borrowers.

In March, uncertainty rose sharply due to Covid-19 lockdown. That is also reflected in the numbers:

• Many investors have redeemed their debt funds: 30% reduction in AUM seems normal! (Remember, this was before the Franklin fiasco.)
• Quite a few funds now hold negative cash, probably to accommodate the high number of redemption requests.
• Risky debt has also increased across the board.
• PGIM is the only fund house to exclusively hold top-tier debts; they are also the only debt fund managers to hold some cash in hand.

(One surprising observation from the data is that people have bought equity mutual funds while they have exited debt funds. Maybe they were rebalancing because it was the end of quarter?)

What are my takeaways from this exercise? I was fond of Kotak Savings fund because it looked so nice. Kotak web sites are so good, I just loved looking at this fund’s official web page. PGIM UST fund’s site looks okay, but it’s hardly impressive. Logging into PGIM’s investor web site also doesn’t work most of the time. Due to all this, I didn’t really like PGIM funds. Dumb mistake, I know! I was judging both Kotak and PGIM ‘books’ by their ‘covers’. When I look at my spreadsheet, however, I see how disciplined PGIM’s fund managers are, and how risky Kotak Savings fund really is.

If I hadn’t gone through this exercise, I might have sold the PGIM units and bought Kotak units instead. I am so glad I sat down and looked at the numbers.

Legalese vs code

This morning, I had to read the text of one section of India’s Income Tax act. Unsurprisingly, reading the text and understanding it was not easy. The difficulty is so well known that there’s a name for the language used in such legal documents: legalese. As I was reading through the rather short document, I was reconstructing an internal version of the same document in my head. Only this internal version was easier for me to understand.

Suddenly I realised this practice of reading something complex and reconstructing it inside my head is something I had been doing for years. Reading legalese and making sense of it is not very different from reading legacy code and trying to understand what it does.

Understanding code is easier sometimes because experts have been steadily making progress in making code easier to understand. These include creating new languages that are easier to understand as well as coming up with ways to alter existing code to make it easier to understand (known as refactoring in the programming community).

Compared to lawmakers and lawyers, programmers are at a better place because programmers have the tools to help us simplify code. Less readable code is also culturally frowned upon.

Lawmakers, on the other hand, are stuck with imprecise human language to write precise laws. Inventing new languages for writing laws is not an option. Think of it as a surgeon using a kitchen knife to perform a surgery. It’s doable, but it’s very hard to be as precise as the surgeon would want to be. That’s probably why laws are so hard to read, understand, and interpret.

“Children are seriously children for a decade. But for five or more decades after that, they will be your friend—if you're fortunate to like each other.” — Elaine N Aron in The Highly Sensitive Child

How big a bag do you need for a 1kg gold bar?

I don’t often go to jewellery shops. The first time I was at a shop exchanging an old gold jewellery for a new one, I had a pretty novel experience. They took our old jewellery and melted it down to a small piece of gold. What was a relatively big piece of wearable shrank to a tiny piece of metal. I held it in my hand, and it was surprisingly heavy for its size! Of course it’s the same weight as the jewellery we gave them, but the smaller size made my brain expect something much lighter.

You can look up the density number on the web and see for yourself. However, I think the image below communicates gold’s density a lot more intuitively. (This is a screenshot from “Coins vs Bars“ video of Strategic Wealth Preservation YouTube channel.) The larger bar in the picture weighs 1kg despite being so small! This is so novel, I want to get a 1kg bar and just keep it with me, like a fancy toy. 😬

Capital gain tax and reinvestment (into residential property)

I just came across something interesting: apparently if you sell some long-term asset, such as shares/mutual funds or house, and put that money into buying a residential house property, you don’t have to pay capital gain taxes on the sale. Quoting ClearTax article on Capital Gains with some edits:

Exemption under Section 54F is available when there are capital gains from the sale of a long-term asset other than a house property. You must invest the entire sale [proceedings] to buy a new residential house property to claim this exemption.

Making it apply only to residential property is limiting: you’d still have to pay capital gain taxes when switching from one mutual fund scheme to another or while rebalancing your portfolio by selling equity/debt shares and buying the other. However, I think I should still be happy about this exemption for these reasons:

1. This is better than nothing. Governments usually subsidise only some kinds of investment; investing in residential properties is a popular one.
2. This can actually be useful to me. I have been toying with the idea of selling some equity shares and putting that money into buying a house. Saving some tax in the process only makes the idea more attractive.
3. While some of us might be unhappy that for some capital reinvestment there is no tax break, we should keep in mind what Aashish Somaiya of Motilal Oswal Asset Management Company said in a recent interview: “tax is a happy incidence; you have tax when you have a return”. Rather than fretting about the 20% tax, one should be happy that their investments have made them the remaining 80%.

PS: This is no tax advice. Neither am I qualified to provide tax advice. Even if I were to take advantage of this scheme, I’d consult a professional tax advisor before executing the plan.

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Update (1 May 2020): I was re-reading information on this topic and was dismayed to see mentions of “new residential house property” in ClearTax:

A new residential house property must be purchased or constructed to claim the exemption

This was a shock to me because the house we were considering to buy was not a new construction. Worried if I might not be able to take advantage of this tax exemption, I decided to read the actual text of the law itself, rather than interpretations of it, to see for myself what restrictions apply. Going through the text of Section 54F of the Income Tax Act, it’s clear that the exemption applies to both newly constructed and old houses. Phew!

How I blew an opportunity to buy equity funds for cheap

Equity investments are losing valuation due to the market crash. Depending on whom you ask, what to do in such a situation varies. The advice I took was to maintain asset allocation and rebalance when the allocation is off.

It’s not obvious how maintaining asset allocation can help during a market crash like this. But it’s not hard to understand if you think about it a little. Let’s say your desired asset allocation is 30% debt and 70% equity. When equity loses value and debt increases in value, your portfolio could get to something like 38% debt and 62% equity. The advice is to sell your (potentially overvalued) debt and buy undervalued equity at a cheaper price. As the equity market recovers, you would make some profit.

I did have a desired asset allocation before market rout, but due to some (self-induced) complexity, I had messed it up. I was over-invested in equity than I had thought. I discovered that mistake when I was taking a deeper look at my portfolio. I also found out that equity losing value had brought my portfolio down to the desired allocation. I don’t have to do anything for now; the market has rebalanced my assets. 🤦🏾‍♂️

But that also means that, because my asset allocation was off, I am not able to buy more equity at a cheaper price now. The equity I hold were bought at a higher price and I am holding onto the loss. It’s a lost opportunity.

While it’s true that nothing stops me from buying more equity now even if it means my asset allocation will be off for a while. I have decided to not do that because that’s essentially timing the market. There’s no guarantee that the market will recover after my equity purchase. Debt funds, at least in India, are not really going up in value either. Because many companies are at the risk of going bankrupt, investors are not keen to buy debt funds as well. Because demand is fairly flat, the value is also mostly flat. By selling my debt funds now, I may not be selling overvalued assets.

Moral of the story: asset allocation is actually important. Assets being off balance could lead to lost profits.

Choosing mutual funds to invest in

You want to invest in mutual funds, but you don’t know which of the thousands of available funds is right for you. The easiest thing to do is just look at historical returns and pick one that has performed well in the past. That’s pretty much what I did when I started investing in mutual funds a few years ago. Unsurprisingly, the returns weren’t as mind-blowing as I had expected.

Fast forward to 2020, I am now a Kuvera customer. (Plug: join using my referral code JK1P3 and get 100 Kuvera coins for free.) In addition to providing a well thought-out investment platform for free, Kuvera has written quite a bit about how to think about investing and wealth management. From the experience using Kuvera and reading about the thinking behind their decisions, I think I am starting to see some of the intricacies in choosing a good fund.

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In October 2018, Kuvera changed their recommended funds. In October 2018, they started recommending DSP Equal Nifty 50 instead of IDFC Nifty. I compared the facts and performance of these 2 funds, and it was surprising how unattractive the DSP fund looked to a novice investor like me.

In the past year, the IDFC fund has given an impressive 15.25% return while the DSP fund has given a mere 6.69%. The DSP fund’s return is below the benchmark return, actually!

The fact that the DSP fund is underperforming the benchmark is reflected in its “info” statistic. The IDFC fund has 0.8 for “info” while the DSP fund has -0.04! The IDFC fund wins in other attributes too: it has a cheaper expense ratio (0.24% vs 0.38%) as well as barely less volatility (14.14% vs 14.25%).

How then is the DSP fund better than the IDFC fund? They mention 3 reasons:

• Lower concentration of financials
• Historic EW premium
• Buy low–sell high in a systematic way

Of these, I don’t fully understand the “buy low–sell high” point, likely because I haven’t read the fund documents.

Lower concentration of financials
This becomes obvious if you look at the stocks held by these funds. The IDFC fund holds HDFC Bank shares for 10.6% of its value. In other words, you would be buying HDFC Bank shares roughly worth ₹10.60 if you were to buy the IDFC fund for ₹100. Intuitively, that is not something you’d want to do if you want to diversify your investments. But there’s more than just intuition.

Historic EW premium
I think the “EW” refers to “equal weight” here. The DSP fund distributes the money roughly equally between every share in the Nifty 50 basket. While intuitively this is a good diversification strategy, apparently this has yielded better returns historically. Gaurav Rastogi, CEO of Kuvera, states in a comment:

The reason we choose DSP Equal Weight Nifty fund instead of a plain vanilla Nifty index (IDFC) fund is because Equal Weight indices have outperformed their plain vanilla indices globally and in our back test in India as well on a risk adjusted basis.

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What are my takeaways from this?

• Past returns are useful data, but comparing the returns of 2 funds may not give us the full picture.
• Understanding how a fund is managed such as how they choose shares, the objective of the fund, etc are important. Investors should understand what the fund manager does with our money.
• Because most of us don't have the time or skill needed to study the mutual fund options, following the recommendations of good financial advisors is an easy shortcut to picking good investments. (How you tell if an advisor is good, I have no idea!)

Knowing where you’re headed

It’s far more productive to make tiny progress in solving the real problem than making huge progress in solving an irrelevant problem.

Fear of success

Just like how one fears failure, fear of success is also a real thing. Maybe it’s just the fear of unknown, and you haven’t seen success that often.

No matter what the cause is, fear of success can be terrifying!

Communication effort

If the sender of a message spends time crafting the message, making it easier to read, readers can understand it without much effort.

If the sender did not spend as much time in crafting the message, each reader would have to spend more time/energy in understanding the written message.

That should be obvious to everyone. Here’s my random thought: maybe, the effort it takes to communicate something is fairly constant. What varies is how much of that effort is contributed by the writer vs the reader.