25 Dec 2021

How to think about emergency fund

Every sane person I know agrees on this: you should not look for returns from your emergency corpus. “Keep the money in highly liquid forms, such as bank deposits or liquid debt funds; never buy volatile assets with that money,” they advise. I did not understand this advice. “What’s the harm in investing, say 10 to 25% of the corpus in equities?” I thought. The other 75 to 90% is not volatile, so you have access to cash when needed. The exposure to equities will keep your emergency corpus growing at a rapid rate (over a long duration such as 10 years).

This line of thinking led me to put most of my emergency corpus in a hybrid mutual fund. My new financial advisor said that this was a bad idea and asked me to move that money over to liquid funds and bank deposits. “Don’t look for returns from this money,” he said.

Since then, I have been thinking about this. It’s hard for me to do something because “the advisor says so.” I needed a convincing reason for why volatility is a strict no-no. After some thinking, I have come up with an analogy for explaining this.

If your wealth is kept inside a fort, the emergency fund is the wall of that fort and the moat around the wall. Anyone who has been to a fort will know: the walls of a fort are so wide that you can drive cars on them.

External wall of a fortress. Image credit: Dr D S Sinha, licensed under CC0

Imagine you are a king. Your fort also has such strong walls as protection. Maybe you have a moat around the walls too. These walls take up so much space! In all likelihood they also cost significant amount of money to keep in good repair. Now you think about it and say, “The walls and the moat take up a lot of space. What a waste of useful land! Wouldn’t it be better if we used this space for farming or housing?” How would your ministers and advisors respond?

This is exactly the reason for keeping the emergency fund liquid and without volatility. When there is an unforeseen need, you’d burn through your emergency corpus before you start to liquidate your long term assets. The wider the moat and the walls are, the safer your long term assets are. The wider the moat and walls are, the more farming land you give up for the sake of protection.

With this picture in mind, I don’t feel too bad keeping all of my emergency corpus in low-yield nonvolatile assets.

28 Nov 2021

Discipline determines the size of your retirement corpus

I am working with a financial planner, and they did some math to make sense of my current portfolio’s value. I knew how many rupees my portfolio was worth, but I didn’t know how many of my financial goals this money was good for. The planner’s way of looking at the corpus gave me a fresh look at the portfolio.

Let’s say the value of my current corpus is X. In about 21 years, I need a retirement corpus that’s at least as large as 3X. Assuming an average annual return of 10%, my existing corpus will double in about 7 years. If I left this corpus of X untouched for 21 years, I’ll have 8X by the time I retire! Such a corpus will be sufficiently large for the kind of retirement I want to have: the kind where I am free to travel, have sufficient buffer for unexpected emergencies, generously spend on life events of children and grandchildren, etc.

While this corpus grows in the background, I’ll also be making fresh investments in the next 21 years. All the new investments that I’ll be making towards retirement in the next 21 years will only grow to X. It’s almost unbelievable how little my new investments will amount to (X) vs how much the existing corpus will grow to (8X).

My main takeaway from this newly acquired knowledge is not that I’ll have an easy retirement. The main takeaway is that I should be financially disciplined enough that I am able to manage my day-to-day expenses and other financial goals without touching the current retirement corpus. The corpus will  have a chance to multiply manifold only if I leave it alone and let it grow.

The word 'discipline' with a man pointing his finger at it
‘Discipline’ by Nick Youngson • CC BY-SA 3.0 •  Pix4free.org

With this revelation, I am able to appreciate the truth behind the saying ‘a bird in the hand is worth two in the bush’. The corpus I already have is precious, and I must do what it takes to protect it. Staying disciplined for the next 21 years is far more important than asset selection or timing the market or chasing current trends. Even if I invest all the new money in an amazing product that gives higher return, it’s going to be incredibly hard to beat my existing corpus.

I always knew that investment duration was a critical factor. But seeing the math for my own corpus makes it all the more real. Discipline is hard when it’s a vague belief. Discipline becomes easier when you know it’ll enrich your life.

22 Nov 2021

Infographic of debt mutual fund durations

Whenever I want to see durations of debt mutual funds, I have to do a Google search, pick a result, and read through some text before I can understand how the debt fund durations stack up. I thought I’d make an infographic so it’s easy to see where each category falls on the spectrum. (I used Groww as the information source.)

The image is not to scale, though many of the boxes should be of a proportional height. Click on the image to magnify it.

Infographic showing durations of debt mutual funds
Infographic showing durations of debt mutual funds; click to make the image larger

When choosing a debt mutual fund, consider both credit risk and interest rate risk. A few previous posts on debt mutual funds:

10 Nov 2021

Some basic ideas of investing

  • Investing is just buying, holding, and selling assets.
  • Cash is a depreciating asset. Cash depreciates in value over time due to inflation. Other assets such as cars and buildings depreciate due to material depreciation.
  • Appreciating assets are a good investment. Depreciating assets are a bad investment.
    • Bank deposits are cash. They depreciate like cash, just as liquid as cash, and deposit interest is taxed like cash.
  • Price of your assets may change every day… or many times within a day. You don’t need to keep watching every price movement.
    • You don’t look at the current market value of your gold jewels or house every week. Treat your stock and mutual fund assets the same way.
  • Different assets have different behaviours. Understand your assets before buying them.
    • Will this asset appreciate over time, or will it depreciate?
    • How hard/easy will it be to sell this in the future, if/when I decide to sell?
      • Will I find buyers when I want to sell this in the future?
    • How will this asset make money?
      • For example, real estate assets provide rent, stocks pay dividends, etc.
    • How might this asset lose money?
      • For example, cars lose value to depreciation.
  • Diversification reduces risk. But it also reduces your maximum return. Another way to look at this is that diversification shields you from extremes, be it extreme loss or extreme profit.
    • It’s natural to want extreme profits while wanting to avoid extreme losses. Choose the right amount of diversification for your portfolio considering its benefits and risks.

16 Oct 2021

Should I invest in short term debt funds or long term debt funds?

I was listening to the Paisa Vaisa podcast on Trust AMC and got a better understanding of how mark-to-market pricing helps or hurts bond investors.

Mark-to-market pricing

Let’s imagine there are 2 mutual funds: 2YBF that invests in bonds that mature between 1 and 2 years and 1YBF that invests in bonds that mature in less than 1 year. Imagine a period of 1 or 2 years where the interest rate remains constant.

2YBF buys a 2-year bond that pays coupon (interest) of 4.5% per year. At the same time, 1YBF buys a 1-year bond that pays coupon of 4%. Remember these market rates; we’ll use these numbers later.

By the time the first year ends, the bond held by 1YBF would have matured and 1YBF will need to buy a new 1 year bond. The bond held by 2YBF is 1 year old and matures in a year from now. 2YBF cannot  invest in bonds maturing in a year or less, so this bond must be sold. 1YBF can buy this bond because 1 year maturity is what 1YBF wants.

If 1YBF buys 2YBF’s bond, it will have to pay more money than the principal + coupon that the bond will yield. The price will be set in such a way that 1YBF will get exactly 4% return, as that’s the market rate for a 1-year bond today. This is called mark-to-market pricing.

Interest rate movements and bond returns

From the above description, it might sound like buying longer duration bonds is better than buying shorter duration bonds. But it’s not that simple. Markets don’t give us more money without taking on more risk. In this specific case, 2YBF is taking on interest rate risk. If the market rate for 1 year bonds has gone up to 5% by the time 2YBF sells its 1 year bond, 2YBF will have to sell the bond at a loss.

This is how bond returns correlate with interest rate movements:

  • Holding longer maturity bonds is good in a market where the interest rate remains constant or keeps falling. You lock in a higher coupon rate and hold it for a long time.
  • In a market where the rate keeps rising, holding shorter maturity bonds is better. You can keep buying fresh bonds at higher and higher coupon rates.
  • In a dynamic market where the interest rate fluctuates up and down, you cannot stick to a specific duration. Something like a dynamic bond mutual fund will allow the fund manager to generate alpha by tactically buying and selling. In the scenario where 2YBF had to sell the 1 year bond at a loss, the fund manager may (or may not) choose to hold that bond till maturity to avoid selling at a loss.

Does this mean dynamic bond funds are a good investment?

It’s hard to generalise like that because higher return always means higher risk. I looked at 1 year and 3 year rolling returns of a constant maturity gilt fund (which holds bonds maturing in 10 years) and 2 dynamic maturity gilt funds. While minimum return is attractive for the 10 year gilt fund, average return looks better for the dynamic maturity funds.

These funds are also volatile, and an investor who wants predictable returns would want to stick to nonvolatile funds (usually ones with maturity less than a year) or target maturity funds.

Graph showing 1 year rolling returns of 2 dynamic gilt funds vs a 10-year constant duration gilt fund
1 year rolling returns of dynamic gilt vs 10-year gilt (source: pimeinvestor.in)

Graph showing 3 year rolling returns of 2 dynamic gilt funds vs a 10-year constant duration gilt fund
3 year rolling returns of dynamic gilt vs 10-year gilt (source: pimeinvestor.in)

29 Sept 2021

Career growth and inefficiency

When you start doing something new, you are usually pretty bad at it. Once you figure out how to do it right, you stop being bad. With practice, you’ll become good, and the work will become effortless. If you are rapidly growing to new heights, you won’t be spending a lot of time on such effortless tasks. You’ll keep on moving to newer problems and you will likely find yourself struggling again and again.

A woman covering her face, as if overwhelmed by challenges
Image source: pxfuel.com

It’s counterintuitive, but the faster you grow, the more time you spend being inefficient. If you’re too hard on yourself for being inefficient, your growth won’t be fast. Newer challenges will make you feel bad, and you’ll involuntarily resist growth.

If you want rapid growth, you need to change the way you assess yourself. Avoid thinking “It took me 2 full days to write a short business proposal.” Such a thought causes negativity. Instead, you may think “I have finished writing my first ever business proposal. Until today I was only an engineer, but now I am growing into also becoming a businessperson.” Feed on the positives rather than focusing on the negatives.

You need to consciously derive happiness and pride from the challenges that enable your growth. If you expect yourself to be flawless every time no matter what, your growth will be slow and painful.

PS: Implicit assumption here is that you can tell good results from bad: either you are capable of assessing it yourself or you have people who will give you reliable feedback. This post is not for people who declare victory too quickly even when the quality of their work is poor.

11 Sept 2021

Using credit card rewards to increase emergency corpus

I am scared of inflation. Not just ‘aware’ of inflation and plan with inflation in mind. I am really scared of purchasing power eroding due to inflation. This fear influences all my financial plans.

I have set aside some liquid investment as my emergency fund, to manage unexpected expenses. Because I am always afraid of inflation, I have set a goal of increasing the emergency corpus by 10% every year. While having a growing corpus is reassuring, it’s not easy to add to your corpus every year. I don’t have a plan for how to fund this increase.

I got an idea last week. I use cash back credit cards that give me some cash regularly. The reward shows up as credit on the card statement, but it’s cash nonetheless. From this month on, I am going to move that money into my emergency corpus. That will not be sufficient for the target increase of 10%, but every little bit helps.

In a way, credit card cash back rewards spending. The more we spend, the more the reward is. I am taking away this “free money” from my spending budget over to my emergency corpus. I somehow feel like this is a better habit than unconsciously spending the cash back rewards.

4 Sept 2021

Confused about investing in a bull market (or a bear market)?

Many years ago, I watched a video on riding motorbikes. That video said that a rider should always be willing to fall. They didn’t say the rider should want to fall, because no one wants to fall. Rather the rider should be willing to fall because falling off a motorcycle is a question of when, and not a question of if.

The same advice is appropriate for investing too.

If you’re investing in the share market, you should be willing to lose money. Notice that I am not saying you should want to lose money, because no one really wants to lose money. Rather, you should be willing to lose money. That means being prepared for when the investment does inevitably go down in value.
Image source: pixabay.com

Today we are in the middle of a raging bull market, and the price of equities is going up almost on a daily basis. What is the narrative that we hear in the media? “The market is overheated.” “The market is expensive.” “The valuations are too high.” We often hear advice to not invest large sums into equity now because the bull run can end any day. That sure sounds like sensible advice.

I haven’t witnessed a bear market yet, but I can imagine what the narrative will be in a bear market. “Don’t invest large sums into equity now because we don’t know how much further the market will fall.” “If you wait a few days/weeks/months, you can get more shares for the same money; why invest now?” Again the same advice despite the inverted market trend.

Thinking critically will reveal to us that waiting with liquid cash runs counter to the more fundamental investing advice: “don’t try to time the market, because it’s a very very hard thing to do.”

But what’s wrong with waiting? We all like a good deal, and why not wait for a bit if you can get the same asset for a better price tomorrow? Because we don’t know when we’ll get that better deal or if a better deal will ever come at all. Waiting for a better deal is actually predicting the future. Predicting the future can be a fun exercise, but do you want to bet your money on such predictions?

If you have the money today, invest it today; don’t wait for a better time that may or may not arrive. Rain or shine, continue your SIP, because the best time to invest is when you have the money to invest. Rather than trying to find the right time to enter or exit based on market conditions, spend your energy in finding the ideal asset allocation for you so that you are systemically buying low and selling high without taking too much (or too little) risk.

22 Aug 2021

Index vs value investing

I came across this tweet yesterday, and I think this highlights an advantage of index investing.

When seen with the context of inflation, NTPC is just losing money. Losing money through such a stock is a risk an index investor systemically avoids. A value investor might hold onto NTPC hoping that the price will eventually go up. It’ll be baffling to such an investor that you’d sell off a company just because it’s stopped satisfying an arbitrary requirement. (Other than whole market indices, everything else, including Nifty 50, Sensex, and S&P 500, pick an arbitrary number of companies.)

It’s possible that a company is kicked out of the Nifty 50 index today, but joins the index again a few years later at a higher valuation. A value investor that holds onto such a company throughout the journey will be satisfied at the end. But an index investor will be selling when the company leaves the index and buying again at a higher price when the same company rejoins the index. An index investor should be comfortable with such a turn of events.

Corollary: If you are an index investor but you cannot stomach buying expensive stocks, you should reconsider your investing style. Maybe you are a value investor in your heart, but you’re investing in indices because that’s more fashionable.

PS: Investing in whole market indices does not remove this risk. I am only considering indices that pick top N companies by market cap. Vast majority of index investors in India invest in such a “top N” indices.

PPS: To be 100% clear: I don’t know anything about NTPC; I don’t even know the full name of the company. I am not claiming that NTPC is a value stock. I am only talking about a hypothetical investor who thinks NTPC is a value pick.

2 Aug 2021

There’s an upside to online classes

One of the things that I learnt a long time ago was that positives and negatives are always mixed together. No such thing that’s entirely positive; no such that that’s entirely negative.

Children having to stay home and go to online classes is challenging for the most part. But it also has a benefit. Watching your children be part of a classroom is such a heart-melting experience. In a classroom setting, children act differently than they’d with their parents. Seeing this other side of their children, I think, would be a heart-melting experience to many parents.

Image source: PixaHive.com

25 Jul 2021

Can I keep some money aside to invest during market crashes?

I was having a chat with a friend about having some money set aside for “buying the dip” when there is a sudden market crash. This conversation allowed me to think deeper about this idea and made me realise that keeping such a corpus is nothing but FOMO (fear of missing out) pretending like a legitimate investment idea.

A dinosaur toy wearing suit like a human being
Image source: pxfuel.com

The downside to having an “opportunistic investment” corpus

  • It’s not clear what a “dip” even means, for someone to buy the dip. Let’s say you set aside some money in 2021 for “buying the dip”. In 2026, let’s say the market falls by 15%. Should you buy this dip? If you had invested this money in equity in 2021 itself, your corpus will likely be worth more even after a 15% fall! Should you buy this 15% dip or should you wait for a harder fall?
  • Inferring from the previous point, you are actually giving up real gains today for speculative gains in the future. You keep the money liquid and earn low returns with the hope that some day the market will fall very badly. Are you okay with this opportunity loss?
  • Let’s say you see the market fall drastically, say by 40%. You go all-in and deploy your entire opportunistic investment corpus in equity. Now, are you sure that the market won’t fall another 25% after you have invested? Opportunistic entry requires knowing where the bottom is (which is unknowable in advance).
  • How would you know how long you need to wait before your opportunistic investments give a big yield? When do you pull out and replenish your opportunistic investment corpus so you can be prepared for the next crash? Opportunistic exit requires knowing where the peak is (which is, again, unknowable in advance).

What can you do with excess cash then?

Let’s say you have fulfilled all your goal-based investment targets, but you still have some money left. What can you do with that money? Like everything in personal finance, there is no right or wrong answer here. I’ll go over what I’d personally do, and that might give you some ideas.

  1. To make the goal plans more robust, increase expected inflation. If I have assumed an inflation rate of 6%, maybe I can change it to 6.5% or 7%, just to be on the safer side.
  2. If it makes sense, increase the goal budget so we can afford a bigger car, a more expensive college education, or a more exotic vacation.
  3. If I still have money left over, I’d pick an asset allocation suitable for idle investments. This “idle corpus” is invested based on my risk appetite: a part of the corpus will be in stable investments so I can take the money out if needed; the rest will be in growth assets such as equity.

That’s my strategy. Does this mean I might never buy the dip when there is a crash? To the contrary, I’ll be better positioned to buy the dip than those who are waiting with liquid cash.

Whenever there is a dip or a rally, the asset allocation will get skewed. I’ll know exactly how much money to spend on buying the dips or exactly how much profit to book. If the market continues to fall for years, I’ll continue to buy the dips because the asset allocation keeps changing and more equity is needed to reset it. Likewise, if the market continues to rally for years, I can continue to book profits.

So the bottom line is that if you can pick a target asset allocation that you’re comfortable with, regular rebalancing is all you need to take advantage of market fluctuations. Just make a plan and stick to it.

Picking the right asset allocation is actually very hard. The right asset allocation should remove your worries about excessive loss. At the same time, it should also remove your worries about missing opportunities to buy the dips. Spend your time and energy in figuring out where your sweet spot is. That’ll make you richer and happier than most other investment tactics.

23 Jul 2021

Rebalancing requires conviction

When I started investing 1½ years ago, I was looking forward to rebalancing my portfolio. One asset class would have done better than the other and I’d either be safeguarding the excessive profit or buying the dip, I thought. I expected this to be a thrilling and pleasant experience.

When I did have to rebalance my portfolio earlier this year, however, it was not as pleasant as I had thought. I found myself hesitating to sell equity to buy debt. “The interest rates are so low, should I really invest in debt now?” “Maybe I can keep the higher equity allocation for some more time and make the most of this bull run?” These were some of my thoughts.

Image credit: QuoteInspector.com, licensed under CC BY-ND 4.0

When I sit down and think about this hesitation, I am realising that:

  • It’s easy to have conviction and discipline while discussing hypothetical scenarios. When it comes to actually following through with action, it can be hard.
  • Unless the investor emotionally prepares themselves, rebalancing will likely be an equally difficult experience every time. Because, we’ll always be dumping recent well-performers in favour of recent ill-performers.

My next task is to think about the whys of rebalancing and emotionally prepare myself. It will also help to do some backtest to see the performance difference between portfolios with and without regular rebalancing. Quantifying the difference is an easy way to get the conviction I’d need.

Maybe the real takeaway is that I am rebalancing the portfolio only because they say it’s necessary, and not because I know it’s necessary. “Because they say” is seldom a convincing reason.

15 Jul 2021

Ice creams are fun!

You like a certain pillow and a blanket in your house. They are your favourites. You bring them to the living room and put them on the floor when you watch TV. Because why not? They are your favourites after all.

You suddenly remember the 4 ice creams that are kept in the freezer. The freezer is a bit too high, but you can move your brother’s study desk and stand on it to reach the freezer; no big deal. You take the entire box with 4 ice creams and bring them to the living room. Did you close the freezer? Maybe you did, maybe you didn’t. But you’re too thrilled to worry about that now.

Kulfi ice creams in different colours with cashews and almonds scattered around

You take all 4 ice creams out and spread them on your favourite pillow. They are all different colours and you’re amused looking at them. But ice creams are tasty too. You eat them all in random order. Take one bite from this, and immediately get attracted by the other one, so one bite from that.

You don’t have the appetite to finish eating 1 ice cream, let alone 4. The ice creams are all meting. So you do the next best thing anyone can do: play with them. Spread the molten ice creams everywhere on the floor, on your favourite bedsheet, on your favourite pillow, on your clothes, everywhere on your body. It’s all super fun. The coldness and the gooey texture of the ice creams add to the fun.

When the ice creams are all fully molten and spread everywhere, not much is left to play with. You leave the place and go somewhere else and start a new game because you’re creative enough to invent a dozen new games everyday.

If you’re my daughter Anjana, this is something you’d casually do on a weekday afternoon. She’s probably thinking now, “Whether you eat them or play with them, ice creams are always fun!”

14 Jul 2021

Look before you leap: the temptation to invest in gold (again)

A new issue of Sovereign Gold Bond (SGB) is currently available for purchase, and that’s what I see everywhere I look. Everyone sells SGBs and everyone is advertising them big time. Understandably so, since gold is one of the most favourite investment vehicles of Indians.

decided to not invest in gold sometime back, but still, the temptation caused by these promotions made me consider buying maybe a few grams. Then I came across these 2 at the right time:

The highlight here is that neither of these is new to me. I knew I didn’t want to invest in gold; I knew I had to look at rolling returns before purchasing any new investment asset. Yet, I had the temptation to buy SGBs.

Moral of the story? It’s hard to keep your head steady when there’s so much noise around you. Remain focused, and remain with conviction whether you decide to invest in a certain asset or decide to not invest in a certain asset.

11 Jul 2021

If only I could fly…

Humans don’t have wings; we cannot fly. However we don’t sit down and worry about it. We don’t think to ourselves, “If only I was a bird, what all I could have done!” We don’t think that because we accept that we don’t have control over whether or not we can fly. In exactly the same way, you don’t have control over what happened in the past. Accept the past and focus on what you can do now. Think about the options available to you and choose the one you like the best. Keep moving forward.

Patience is essential for investing

Anyone who had an allocation to gold going into 2020 would be pleased now. Gold price has increased considerably since 2019.

Gold price in India over the past 24 months

Anyone who newly added gold to their portfolio after July 2020 may not have seen such a gain; they might have even lost money depending on when they bought their gold. An investor that bought gold in 2018 or 2019 benefitted in 2020. An investor that bought gold much later in 2020 needs to wait till the next gold rally, whenever that might be.

What does this mean?

You cannot add an asset to your portfolio today, and expect to reap the benefits immediately tomorrow. An investor needs to choose the right asset, invest, and then wait patiently. All 3 are necessary for success in investing.

20 Jun 2021

Stress is a response

I used to think that external factors caused stress in me. While that may not be entirely wrong, a more correct way to think about stress is that stress is a response.

Recently, I discovered that stress is my response to what happens externally. Stress doesn’t come from outside ready-made, but rather, I create the stress within me. Thinking this way puts me on the driver seat.

Various things happen beyond my control. Responding to many of them by getting stressed is unhealthy and unsustainable. Stress starts as a mental discomfort and quickly evolves into physical discomfort.

I have long believed that taking ownership of the problem is the first step towards finding a solution. I have spent a long time blaming my problems on stress, but I think the time has come to acknowledge that I have the power and responsibility to stop stress from entering my system.

17 Jun 2021

Asset allocation when you don’t have clear financial goals

I’m a big fan of goal-based investing and I’d recommend everyone to invest towards specific financial goals. But some of us cannot, or don’t want to, define goals. They just want to invest their money and get a good return. This post aims to give some guidance to such people.

• • •

Let’s time travel back a few centuries, and imagine that you are a king or a queen of a state.  You split your citizens into 2 groups: a group of warriors and a group of residents. The Warrior group is always on the march: they go far and wide looking for new land to invade. The Resident group stays where they are and spend their days productively by farming, trading, etc.

Venn diagram showing your subjects split into warriors and residents

The warriors are rapidly adding more new people to your realm by capturing new territory. (Realm, I have just learned, is the gender-neutral word for kingdom.) They are also taking a big risk: many warriors get killed in this dangerous endeavour. There is also the risk of the entire army getting decimated if they engage in a conflict with a much stronger opponent.

The residents are adding more new people to your realm too, but at a much slower pace. All the newborn babies automatically become your new subjects. Because the residents are keeping the land productive and full of opportunities, people from nearby states might also choose to immigrate into your state.

You could say that the warriors are using a High Risk High Reward strategy to expand your realm. The residents are using a Low Risk Low Reward strategy towards the same goal. As their ruler, you appreciate how each group is adding value to your realm, and understand that they are both necessary for different reasons.

• • •

Now let’s turn to investments. You split your investment assets into 2 buckets: a Growth Bucket that contains High Risk High Growth assets such as equity, gold, etc (disclaimer: I don’t invest in gold), and a Stability Bucket that contains Low Risk Slow Growth assets such as bonds, bank deposits, etc.

Let’s say you have a surplus of ₹10,00,000 that you want to invest. You can invest the whole sum in bank deposits, but the earnings will be low and taxes high. You want to invest this money in such a way that you get to make more returns without taking “too much” risk. The difficult part is determining how much risk is too much. When you follow goal-based investing, the asset allocation glide path tells you how much risk you can/should take at any given time. When you don’t have definite goals, you have to make do with guesswork or gut feel.

There are many ways to solve this, but here are some potential approaches.

Using a fixed ratio

Let’s say, for example, you’ll invest 30% of your corpus in growth assets and the remaining 70% will be in stable assets. Over time, based on how the investments appreciate, your asset allocation will regress from 70:30. You will periodically reset the asset allocation of the portfolio to control the amount of risk you take.

If the asset allocation has become 66:34, for example, meaning 34% of your corpus is now invested in growth assets, you’ll sell some of your growth assets and buy stable assets to bring the allocation back to 70:30. This is called rebalancing, and periodical rebalancing is crucial to keep the risk of a portfolio in check.

With a percentage based allocation, the amount of money you are risking increases as the investment corpus grows. Let’s say you start by investing ₹3,00,000 in equities and ₹7,00,000 in debt. After some time, your investment corpus has grown up to ₹12,00,000. 30% of this bigger corpus, ₹3,60,000, is now allocated to equity.

This method is analogous to having your army grow and shrink in proportion with the size of your realm. Over time, the investor might want to change their asset allocation based on their needs and preferences. A salaried person might be fine with 50% of their corpus in the growth bucket, but the same person might reduce it to 25 or 30% after they have retired.

Setting an upper limit on growth assets

You can say that you’ll invest a maximum of, say ₹5,00,000, in equity. That’s the amount of illiquidity you can afford. All your regular and unforeseen expenses will be met with the money you have in your stable portfolio. Periodically, say every 6 or 12 months, you’ll sell some of your growth assets to bring the Growth Bucket back to ₹5,00,000.

This method is analogous to saying that you don’t need more than a certain number of warriors irrespective of how big your realm is. You can say that a conservative investor will choose to do this. At any point, they know how much money they are willing to risk losing or locking up in potentially illiquid assets.

Setting an upper limit on stable assets

Now you are saying that you only need a maximum of, say ₹10,00,000, for any expenses you might come across. Everything else can be illiquid, and you invest them all in growth assets such as equity. Periodically, you’ll sell your growth assets to replenish your stable assets so you always have enough liquidity to manage expenses.

This method is analogous to saying that anyone who does not need to stay at home should become a warrior. You can say that an aggressive investor will choose to do this. You keep some money aside for your immediate (and near future) needs, and everything else is deployed as risky, potentially illiquid assets.

A combination of these

You can also combine the rules above to formulate a plan that’s very personalised to your needs and preferences. For example, 50% in growth assets until your corpus reaches a certain size. When your corpus gets larger, you’ll increase or reduce your equity exposure depending on whether you want to take more or less risk.

• • •

If you are looking to invest some money, but are not bought into the “goal based investing”, I hope this post gave you some guidance on how to think about your asset allocation.

26 Mar 2021

Open-ended target maturity debt funds are an excellent choice

A few months ago, I made a blog post arguing that you should avoid volatility in debt investments. To summarise, these were my arguments:

  1. When your financial goal is reached, all your money will be in debt investments. If there’s volatility in your debt portfolio, you might end up losing money. (Assumption here is that you don’t have flexibility around when you need to spend this money.)
  2. It’s fine to invest in volatile debt investments as long as you’re willing to manage the volatility. For example, gradually moving money from your volatile debt investments into more stable debt investments. While doable, this is more work because you’re now rebalancing between 3 asset classes (equity, high volatility debt, and low volatility debt) instead of 2.

As a follow-up to the 2nd point, I made another blog post where I compared the performance of a volatile debt fund with a liquid fund. While you do earn a little bit more on average — say 8% instead of 7% — the volatility can cause a loss if you don’t effectively manage the risk. I recommended avoiding volatility because that’s a good tradeoff for many people. Simple is better than complex.

Recently I learned that there are some open-ended target maturity debt funds in the market. To make sense of these funds, we must first understand what “open-ended” and “target maturity” mean.

“Target maturity” debt funds invest in bonds that mature at a predetermined time. As an example, you can invest in a fund that matures in June 2026 if your financial goal is within a few months from June 2026. This fund will be volatile in the early years, but you will not be affected if you stay invested till maturity. The fund’s volatility will keep on reducing as we approach the maturity date because interest rate risk keeps reducing until it becomes nil on the maturity date. (Remember that credit risk does not reduce, so this isn’t entirely risk free.)

Fixed maturity funds have usually been closed-ended, meaning you can only invest in them during their NFO period; you can exit only at maturity. (You can buy/sell in the secondary market, but that’s not always practical.) Closed-ended funds are too inflexible to use for goal-based investing because rebalancing between debt and equity will be very hard. You want to be able to buy and sell your assets freely. In other words, you want open-ended schemes that allow you to buy and sell whenever you like.

Now that we know what “open-ended” and “target maturity” mean, let’s look at why open-ended fixed maturity debt funds are perfect for goal-based investing.

  • Though the debt investment is volatile in the beginning, its volatility keeps reducing over time. This means that you don’t need to manage interest rate risk (which causes volatility), but the scheme automatically manages volatility. The only requirement is that you need to hold the investment till maturity.
  • Because high duration debt usually provides a little bit more return on average, you also end up making a little bit more return than investing in a liquid fund throughout the investment period. The difference is likely not huge, but this is free money since you’re getting this additional return without increasing risk or complexity.

Right now, there are open-ended fixed maturity funds that mature in 2023, 2025, 2026, 2027, 2028, 2030, and 2031! It’s possible that AMCs will launch similar funds that mature in other years as well. You may just have to wait for some time before an AMC introduces a fund that matures at a time suitable for you.

Choose a fund that matures very close to your goal

  • Do invest in a fund that matures no more than a few months before your goal date.
  • Do not invest in a fund that matures much before your goal date. You’ll pay taxes on the maturity proceeds and park the money in a safe place (say a bank deposit or a liquid debt fund). This parked money will have short term capital gain that’s taxed at a higher rate.
  • Do not invest in a fund that matures much after your goal. You will need to exit the investment before maturity. While open-ended schemes allow that, you’ll be exposed to volatility at the time of exit.

20 Mar 2021

Reasons why I exited my gold investments

There’s a phrase that’s commonly used: “the straw that broke the camel’s back”. You keep adding straws one by one on the back of a camel and the weight keeps increasing. At one point, you add a certain piece of straw and the load becomes too much for the camel to bear. That last straw is the “one that broke the camel’s back”. Anyone that blames just that one straw is obviously focusing too narrowly and missing the bigger picture.

When I made a blog post about exiting gold, I stated gold’s inconsistent appreciation as the reason. Truth to be told, that was not the only reason. There were other reasons that were already pushing me towards exiting gold. Inconsistent appreciation was the metaphorical last straw. Here is the list of all the reasons.

  • Gold is a passive asset (also known as store of value). Gold appreciates in value only when others are willing to pay us a higher price for the same gold. This is qualitatively different from equity and debt. Equity appreciates because businesses create wealth; debt appreciates because we lend capital and earn interest. The passiveness of gold made me uncomfortable.
  • This is probably leaning more towards paranoia than skepticism, but I am also afraid of some scientific breakthrough making mining/refining gold cheap. Say, for example, harvesting gold from asteroids. They say aluminium used to be expensive until technology made it super cheap. How can we be sure that something like that will not happen to gold?
  • Triggered by these concerns, I set out to see for myself what gold adds to a portfolio. 15% was the maximum I was willing to allocate to gold. At 15% allocation, I didn’t see that much of an improvement to the portfolio (analysis spreadsheet). There was perceptible difference for sure, but the difference wasn’t significant enough to overcome the other concerns.
  • Finally, the long periods of stagnation or depreciation that I highlighted in my previous blog post.

To be clear, my stance is not that gold is a bad investment. I am only saying that I personally am not comfortable investing in gold. If you like gold, go ahead and invest in it. But know beforehand why you are adding gold. If you want to reap the benefits when gold is outperforming, you need the conviction to stay invested when gold is underperforming. If you don’t know what gold is adding to your portfolio, it’s hard to remain calm when gold is having a few bad years.

16 Mar 2021

My DIY investment journey: an interim update

What does the journey of a typical DIY investor look like? (DIY is short for ‘do it yourself’ — rather than taking help from advisors or readymade tools.) I don’t know how much I can generalise, but my DIY journey has been filled with mistakes and revelations.

When I started goal based investing early in 2020, I used Kuvera’s goal planner. In fact, before Kuvera I hadn’t even heard of the phrase “goal based investing”. Within a few months, I decided to switch to DIY investing. I decided to take full control of the investments because I was just not comfortable investing without knowing the full glide path in advance. I drafted an elaborate plan using a spreadsheet with my own glide path for every financial goal I had.

Mistakes: an essential ingredient for progress?

It’s been around 8 months since then. In this short time, I have found and corrected an innumerable number of mistakes in my plan/spreadsheet. Mistakes such as not accounting for taxes. Or having too much exposure to equity. Or getting cell addresses wrong in spreadsheet formulas. Many, many such mistakes, big and small.

Some mistakes were annoying but harmless. Some were outright dangerous with a potential to cause capital loss. Despite the bumpy ride, I am pleased with my journey so far. If I had to start all over again, I’ll happily retrace the same path.

With months spent on tweaking and tuning, my investment planning spreadsheet has become sophisticated. Within the spreadsheet, I have a mini “dashboard” that shows informational and actionable data such as how much I am falling short compared expected corpus size, whether the asset allocation is out of whack, how much money to move to reset asset allocation, etc.

Asset allocation mistake

One big mistake I made was to allocate too much to equity in the initial year. Not because I wanted to, but because I made a mistake in the math. I have tweaked the plan to compensate for that mistake, but now I see that I’ll never have to buy more equity if everything goes according to plan.

The first column in the screenshot below is the year, and the second column shows the [truncated] amount I’ll be investing into equity. You’ll notice that for every year except 2020, the number is negative. This means I’ll keep selling some equity every year for 20+ years and might never have to buy more equity.

Screenshot of my spreadsheet showing that I only have outflows from equity investments throughout the rest of my investment horizon

Fixed income, not equity, is the bigger pie

Another interesting thing I noticed was how little I should allocate to equity. I am an irrationally greedy investor who wants to put as much money as possible in equity. But turns out, I should allocate less than 25% to equity in most of the years! To be honest, I am a little disappointed. I wanted to experience the violent volatility of equity, but my plan says I should invest most of the money in fixed income instead! 🙁

Screenshot of my spreadsheet showing target asset allocation. The first column is year, second column shows equity %, and the third column shows fixed income %. The big drop in equity allocation from 2020 to 2021 is not intentional. I overallocated to equities in 2020 by mistake.

This was an interesting revelation for me. This means a few things:

  • I didn’t know I wanted the thrill of equity investments. Without this exercise, I wouldn’t have known that about myself.
  • I pretty much don’t have to think about the choice of equity mutual funds to invest in. Redeeming equity and buying fixed income will be the usual thing I’ll be doing every year. (There will still be times when I have to buy equity for rebalancing. But I won’t have regular equity SIPs.)
  • Until now, I didn’t think much about my debt portfolio because debt was a “boring” investment. My debt portfolio is also very simple with just one ultra short term debt fund. But now, I think I should pay more attention and look for opportunities to optimise the debt portfolio.
  • A clarification on the previous point: complexity in a portfolio is not good, and I am well aware of that. However, I am not very comfortable leaving a big chunk of the money in one debt fund. This exposes me to fund manager/AMC risk, for example. Having more funds will help me sleep better, I think.
  • Investing in more debt categories than one is also an intriguing option. I’m thinking about the options. I’ll post my plans in future blog posts as the plan solidifies.

12 Mar 2021

Do longer duration debt funds give higher returns than liquid funds?

I started goal-based investing in 2020; a little more than a year ago. I invest in Kuvera’s recommended portfolio with some tweaks. One of the tweaks is to invest in an Ultra Short Term debt fund rather than a Liquid fund as recommended by Kuvera. In this post, I am going to describe how I made that decision and review whether that was a sensible decision.

Why I chose Ultra Short Term debt funds?

Back in early 2020, I was looking at many debt fund options. I was a naïve newbie investor back then, so I didn’t pay much attention to anything beyond returns. I noticed that Liquid funds were giving around 6% return while Ultra Short Term funds were giving around 8% return. Other categories had a longer duration, but the returns were around 8 or 9% only. I was told that longer duration means higher risk. I didn’t know why the risk was higher, but I avoided investing in any duration longer than Ultra Short because there was no reward (higher return) justifying the higher risk.

Basically, I chose Ultra Short over Liquid because Ultra Short gave better return than Liquid. (This was dumb; you please don’t make this mistake!)

Dabbling with different debt fund categories

Though I had decided to invest in Ultra Short Term debt, my search for an “optimal” debt fund never stopped. I kept looking at many options, including Credit Risk, Short Duration, Medium Duration, Equity Arbitrage, and even Conservative Hybrid. I started getting convincing answers only after I learned to look at rolling return graphs to get a summary view of historical returns over many years. (Huge Thanks to RupeeVest.com for making rolling return data available for free!)

With rolling return graphs, I am able to see fund behaviour more clearly than the NAV graphs that everyone shows. Let’s compare the historic returns (1 year rolling returns) of an average liquid fund (Edelweiss Liquid Fund) with a high-performing medium duration fund (SBI Magnum Medium Duration Fund).

Graph showing 1 year rolling returns of SBI Medium Duration fund vs Edelweiss Liquid fund
1 year rolling returns of SBI Medium Duration fund (green line) vs Edelweiss Liquid fund (purple line)

Two things stand out immediately:

  • The returns from the liquid fund is more predictable (less volatility)
  • While the medium duration fund has given higher returns at times, it has also given less returns than the liquid funds.

If (i) you’d be holding your debt investments for a few years, and (ii) you don’t intend to redeem and reinvest based on interest rate movement, the returns you’d get from a liquid fund is going to be similar to what you would get from the medium duration fund. In other words, the higher risk or higher volatility may not really translate into higher returns!

We observe the same pattern when comparing with another high performing medium duration fund. The HDFC medium duration fund has less volatility than the SBI one, but it’s still considerably more volatile than the liquid fund. The average returns are still not considerably better than the liquid fund.

Graph showing 1 year rolling returns of HDFC Medium Duration fund vs Edelweiss Liquid fund
1 year rolling returns of HDFC Medium Duration fund (blue line) vs Edelweiss Liquid fund (purple line)

So, what’s the takeaway here?

Longer duration debt definitely gives you more volatility, but the returns may not really justify the added volatility.

But what about Ultra Short Term?

After seeing this data, I had to know if I have made a mistake by choosing Ultra Short Term fund instead of Liquid. So I added my favourite Ultra Short Term fund to the graph:

Graph showing 1 year rolling returns of HDFC Medium Duration fund vs Edelweiss Liquid fund vs L&T Ultra Short Term fund
1 year rolling returns of HDFC Medium Duration fund (blue line) vs Edelweiss Liquid fund (purple line) vs L&T Ultra Short Term fund (teal line)

Graph showing 1 year rolling returns of Edelweiss Liquid fund vs L&T Ultra Short Term fund
1 year rolling returns of Edelweiss Liquid fund (purple line) vs L&T Ultra Short Term fund (teal line)

We see the same pattern again. The return lines are interwoven and the average is likely the same for both lines. My decision to invest in ultra short term funds is not particularly bad, since the volatility isn’t that high. But I may not really be getting higher returns as I had hoped.

Are longer duration debt funds useless then?

Of course not. They are useful if you know how to use them. Longer duration debt funds give opportunities to investors who are willing to buy and sell tactically to benefit from interest rate movements. You can earn a good return if you can sell your longer duration funds when the interest rate goes down. You need to watch the market and actively buy and sell.

But if you’re like me, and just want to hold the funds until your goal date, longer duration debt increases the likelihood of capital loss without increasing your returns by much.

28 Feb 2021

Save for everything all the time: an ‘EMI life’

I started goal-based investing only last year. A full 15 years after I started working full-time. This is a late start for sure, but better late than never.

I jotted down a total of 19 financial goals and made a plan for how much I’ll invest towards each goal. I was feeling proud about this for a while, but soon realised that this plan resulted in a bad liquidity crunch for me. I pretty much invested everything I was earning and I didn’t have much money left for even semi-essential day-to-day expenses. I tweaked the plan to improve the cash flow, but I was still falling short. Then I realised that big ticket short-term expenses were the biggest shock to the system, and I started saving for some of these expenses.

While I saved for some expenses, others were simply forgotten. I was saving for my 2 children’s school fees, but I had failed to save for the medical expenses for the birth of my 3rd child. Nor was I saving for the school admission fee for my 3rd child. My calculations show that I need to step up my savings significantly to meet these school expenses. I realised that the plans that I was so proud of were severely incomplete.

Saving for children’s school expenses significantly increased the amount of money I had to keep aside every month, but I was still able to remain afloat. Today I was thinking about our old car and it dawned on me that we’ll need to replace this car in a few years. I need to start yet another monthly saving to fund the car purchase when the time comes! 😟

Thinking more, I realised that I should be saving for everything all the time! When should I start saving for a new car? As soon as I have paid off the current car loan. When should I start saving for my child’s 2022-23 school fees? As soon as I have paid the 2021-22 school fees. Sort of like having to pay half a dozen EMIs indefinitely. If I don’t to do that, I am going to be unprepared when these big ticket expenses do inevitably come.


One of the simplest but very effective ideas for behaviour change is to start small. Just do one thing right, or change a tiny part of your day for the better. As time goes by, that change will spill over to other parts of your day and your life improves beyond the initial change that you made.

I am seeing such a change in the way I manage money. What started as a plan that covers my crucial long-term financial goals has spilled over to more and more of my less crucial but still important goals/expenses.

The revelation about having to buy a car in a few years came today. I have entered the goal into Kuvera without a plan for where the money will come from. This is definitely overwhelming and I am frustrated that expenses are piling up. At the same time, a part of me understands that uncovering such holes in my plan is a good thing. The more holes I uncover, the more holes I can plug. The more holes I plug, the fewer financial shocks our family will have to endure.

Like they say, the more you sweat in peace, the less you bleed in war. I intend to win the ‘personal finance’ war without bleeding (much).

26 Feb 2021

What companies are in Kuvera recommended portfolio?

What is a market-cap weighted index fund? Let’s say you are investing ₹1,000 in a typical Nifty 50 index fund. Where does your ₹1,000 go? It’s split between the shares of the 50 constituent companies in the index. But how much money is spent on each company? That’s determined by their market cap.

As I am writing this post, HDFC Bank takes up 10.29% of the index, Reliance Industries takes up 10.13%, and so on (source). In other words, ₹102.90 from your ₹1,000 is spent on HDFC Bank’s shares, ₹101.30 from your ₹1,000 is spent on buying Reliance Industries shares, and so on. Basically, you are buying 50 companies, but the larger each company is the more you spend on it.

Another way to think about this is to equally distribute the ₹1,000 to all 50 companies at ₹20 per company. Then, take a part of the money allocated to smaller companies and use it to buy more of the larger companies. This is a popular way of deciding how much money to put in each company. So popular, in fact, that this is the “default” way index funds allocate capital.

Mutual fund schemes recommended by Kuvera

I am a Kuvera customer, and I invest in the portfolio recommended by them. Kuvera recommends 3 funds for domestic equity and 1 fund for US equity. Let’s keep aside the US fund and focus on the 3 domestic funds. We have a market-cap weighted Nifty Next 50 index fund, an equal weight Nifty 50 index fund, and a focused fund. The focused fund states that it’ll allocate at least 65% of the money in companies chosen from the first 100 companies, i.e. constituents of the Nifty 50 and Nifty Next 50 indices (see screenshot below).

So, what does it mean to invest in the 3 funds recommended by Kuvera? It means you are mostly investing in the largest 100 companies in India.

  • You allocate more or less equal amount of money into each of the 50 companies in the Nifty 50 index (because this is an equal weight index fund).
  • You buy Nifty Next 50 companies according to their market cap, but the Next 50 index has a much less concentrated portfolio than the Nifty 50 index. The largest weight in this index is 4.45% (compared to 10.3% in the Nifty 50). So your money is a bit more evenly spread across the 50 constituents.
  • Now you add the focused fund. That increases your exposure to a subset of these 100 companies according to the fund managers’ judgement. It can also add exposure to companies beyond the first 100 companies, but that would be a maximum of 10% of your equity portfolio (28.5% is allocated to the focused fund; the focused fund can allocate up to 35% in companies outside the Nifty 100 index).

After having invested in this portfolio for a year, I think I understand what companies I am investing in. I still haven’t figured out the ratios: why 45.7% in Nifty Next 50, why 28.5% in the focused fund, etc. Hopefully I’ll understand that in some time.

20 Feb 2021

My portfolio does not have gold anymore

I am a new investor. I started goal-based investing only in Jan 2020. (Big thanks to Kuvera for introducing me to investing discipline!) I had bought into the idea that gold brings stability to the portfolio, so I had an allocation for gold.

The more I looked at gold, however, it became clearer that gold does not really add much to my portfolio. The gold price chart below was the ‘convincing evidence’ that I was looking for. It’s clear from the graph that for many years gold simply sits there without appreciating in value!

Gold price in INR in the past 10 years (click to enlarge)

That was bad enough for me, but it actually gets worse. Gold is bought and sold in the international market in USD. During this 10 year period, INR depreciated in value compared to USD. So gold must have lost value during most of the time represented in this graph. Looking at the price in USD confirms that from late 2012 to 2016, there has been a big fall. And then it sits idle for 3 years. (Both price graphs taken from goldprice.org.)

Gold price in USD in the past 10 years (click to enlarge)

It was an easy decision. I did not want to sell equity and buy gold when it was time to rebalance. I immediately stopped buying new gold, but I held on to the gold I had already bought. Let it sit idle for 3 years, I thought, so when I sell I’ll qualify for long-term capital gain. Yesterday, I realised that this was just Status Quo Bias (or maybe Sunk Cost Fallacy?). I would be better off if the same money was invested in assets that are better aligned with my preferences. So I sold all the gold.

Feeling good about having made the (apparently) tough call to let go of an asset, and also for having decluttered the portfolio by a little bit.

Update: I made a follow-up post going over more reasons behind my decision to exit gold.

19 Feb 2021

Visualising how interest rate movements affect debt fund yields

I have been thinking a lot about the debt part of my mutual fund portfolio. Because I follow Kuvera’s recommendations, I started off with a liquid fund as recommended by Kuvera. But I am always trying to find a debt fund that provides better returns without compromising too much on stability. I don’t want to invest in AA or lesser quality debt; I don’t want to invest in debts with longer durations such as 3 years or 5 years; I don’t want those risks. I want the volatility to be pretty much nonexistent while providing a better return than liquid funds. (Let’s keep aside the discussion of whether I should look beyond liquid funds at all.)

My natural first move was to look at Ultra Short Term (UST) debt funds. After looking at the portfolios and past performances of a few UST funds, I picked 2 funds for my portfolio. Though they have been my only debt instruments for many months, my fascination with debt funds is unceasing. I keep looking at other fund categories (such as Short Duration funds, Conservative Hybrid funds, etc) and considering if they are better than the UST category. It’s hard to tell just by looking at few months’ fact sheets and recent returns.

My confusion has increased due to the low bond yields for close to a year now. Liquid funds that used to give 6% returns are down to 3%; UST funds that used to give 8% are giving only around 4%. Other fund categories, such as corporate debt funds and short duration funds seem to be doing well even after the interest rate was reduced. Should I be switching to some other debt category? Maybe I should temporarily switch to a different category until the interest rates go up again? So many questions, but no easy answers anywhere. ValueResearch provides some insights into the risk and return characteristics of funds, but even that seems insufficient to tell whether it’s a good idea to move away from the UST category.

This is when I discovered the usefulness of historical rolling returns. The graph below is particularly insightful (graph screenshot taken from RupeeVest.com) and gave me the answer I was looking for.

Historical 1 year rolling returns of an Ultra Short Term debt fund and a Short Duration debt fund (click to enlarge)

The most interesting part for me from this graph is how the trajectory of the 2 lines are often in opposite directions. In 2009, the UST fund’s yield has started to go down and begins to go back up by late 2010 before getting back to older levels in 2012. How did the Short Term (ST) fund do during this time? The ST fund’s yield shot up when the UST fund’s yield went down; when the UST fund started recovering, the ST fund fell! Eventually, in 2012, both funds have caught up. The rise and fall of the UST fund is much smoother than the ST fund’s sharp rise and fall.

I think this is the key to understanding how these funds react to changing interest rates: UST yields go down quickly and recover quickly when the market interest rate changes. ST fund has a period where it enjoys higher yield when rates go down (due to the longer duration of the debts it holds), but suffers a fall on the other side when the market rates go up again (again, due to the longer duration of the underlying debts).

Look at the extreme right end of the graph: UST yield keeps on going down but the ST yield is staying above with 3+ percentage points better return. (In fact, this difference was the reason I even considered the ST category!) Eventually the interest rate will go up and when it does, the ST fund’s value will drop. The worst thing one can do is to buy an ST fund today because the returns are better: you’ll be paying more than the underlying debts’ actual yield (thanks to mark to market adjustment) and when the interest rate goes up, you will end up losing money.

If the debt fund that you chose for your portfolio is an ST fund, I guess you can continue to invest in it. Your existing portfolio would have gone up now. Your returns will average out when your ST fund’s value goes down later. But entering an ST fund today just to benefit from recent higher yields is a loss making move.

If you are willing to play tactically and buy/sell based on interest rate movements, you can very well do that and capitalise on the prices going up. But tactical play really is not my thing, so I should just stick to my UST funds.

I started this enquiry with the question of whether I can do something to increase the yield of my debt investments (without taking too much risk). The answer is clear: I just have to accept low yields for the time being. Looks like there is no prudent way to make my debt portfolio give a better yield.

15 Feb 2021

Can we use Conservative Hybrid funds as the debt part of our portfolio?

 Of late, I am fascinated by mutual fund schemes that have some equity exposure, but still maintain a conservative stance prioritising low volatility over high returns. In my previous post, I compared Quantum Multi-Asset fund with ICICI Regular Savings fund. Assessing just on volatility, there’s a better fund than the ICICI fund: it’s Baroda Conservative Hybrid Fund. The fund looked so attractive to me, I started wondering if I should use this fund for the debt part of my portfolio! Allowing equity into the debt portfolio is an unnecessary risk, but the 9% return is alluring (vs the 4% that we get from more stable debt funds).

Thankfully, I am not as impulsive and dumb as I used to be, so I started thinking of ways to accommodate this fund into my portfolio. To decide what value it can add to the portfolio, I decided to look at 1 year rolling returns of the fund. To qualify as a good debt fund, the variability should be within a reasonable range. (All rolling return graphs in this post are screenshots from RupeeVest.com.)

1 year rolling returns of Baroda Conservative Hybrid fund and Nifty Next 50 index plotted on the same graph

The blue line on the graph is the Baroda fund and the black line is Nifty Next 50 index. Compared to the index, the fund is essentially a flat line, making us think that it’s been very stable. While this graph looked great, I wanted to compare it with my primary debt instrument, the L&T Ultra Short Term Debt Fund. When plotted against the pure debt fund, the variability in the return of the hybrid fund stands out more clearly. The green line (debt fund) is fairly smooth while the blue line (hybrid fund) goes up and down.

1 year rolling returns of Baroda Conservative Hybrid fund and L&T Ultra Short Term fund plotted on the same graph

To get a better idea of the variability in these 2 funds, I also looked at them in isolation. While both funds have gone up and down in the yield curve, pay attention to the Y axis: the lowest 1 year return from the debt fund is around 4% while the lowest return from the hybrid fund is negative! The debt fund’s returns are in a range of 4 to 10% while the hybrid fund has a wider range of about -1 to almost 20%. The hybrid fund is also hovering below 5% yield far more frequently than the debt fund. Even with equity exposure, one might end up worse off than the pure debt investment.

Graph showing 1 year rolling returns of Baroda Conservative Hybrid Fund
1 year rolling returns of Baroda Conservative Hybrid Fund
Graph showing 1 year rolling returns of L&T Ultra Short Term Debt Fund
1 year rolling returns of L&T Ultra Short Term Debt Fund

Conservative Hybrid is a category that has lower volatility than other categories like pure equity, balanced advantage, etc. The Baroda fund has one of the lowest volatility numbers even within the Conservative Hybrid category. If this fund cannot add stability and predictability to a portfolio, I think no other fund in the category will. Nor any other fund category with a higher allocation to equity. 

Takeaways for me from this exercise:

  • Equity exposure, even when the allocation is less than 20%, adds variability to the amount of return you will get.
  • If you are just parking some money for a few years, an instrument with some equity exposure is probably okay. But don’t add these funds to the debt portion of your portfolio (why).
  • Current interest rates are not at all attractive, and the debt portion of my portfolio is not growing as quickly as I had expected. Simply accepting the low return is a more prudent option than investing in equities to make up for the lost interest. (In other words, don’t risk the capital in your search for more interest.)

6 Feb 2021

In search of a low volatility mutual fund

We own a house that we have rented out. The tenants pay a security deposit that we hold as long as the tenants live in our house; the deposit is returned when they move out. I was putting this money in an Ultra Short Term Debt fund thinking I’d need to take the money out any time. (Some context for the uninitiated: Ultra short term debt funds have negligible volatility, so you can redeem them pretty much any time without risking a capital loss. When you invest in more volatile instruments such as equity, you cannot simply take the money out as soon as you want.)

Later, I realised that our regular cash flow is often sufficient to return the deposit without needing to redeem the ultra short term debt investment. Armed with this new bit of information, I started looking for mutual fund schemes that have some equity exposure. I wanted the equity exposure to be low enough to keep the volatility low, even if it meant the returns are a few percentage points lower than an “optimum” investment scheme.

When it comes to mutual fund investments, I like Quantum as an AMC: they don’t take excessive risk chasing returns; they regularly conduct sessions to educate investors. I am also a big fan of Quantum Multi-Asset Fund of Funds. I recommend this fund to everyone who just wants to invest without making a list of goals as long as they can stay invested for a few years. My need aligns perfectly with this criteria: I just need a mutual fund that more or less acts like a bank FD, but gives better returns. (Yes, this is definitely not equivalent to an FD due to the inherent volatility. But I am okay if the fund value goes down a bit.)

But the trouble with choosing a mutual fund scheme is that there are so many of them to choose from! Conservative Hybrid funds seemed like a good fit for my need: they invest mere 10 to 25% in equity and invest the rest of the money in debt instruments. I looked at all available options sorting them by volatility. Of the top few options that had the least volatility, ICICI Prudential Regular Savings fund seemed like a good option. Looking at historical performance, the ICICI fund is actually better than Quantum Multi-Asset! It has given better return while remaining less volatile! This is like a dream combination.

Impressed by the ICICI fund’s historic performance, I moved on to the next step: I looked at the portfolio of the fund to see how it’s getting its returns. Before we get to the ICICI fund’s portfolio, let’s take a quick look at the Quantum fund’s portfolio:

The portfolio of the Mutli-Asset fund holds 42% in Quantum Liquid fund, and about 12% in Quantum Dynamic Bond fund. The rest is invested in equity and gold. I have seen the portfolios of the Quantum Liquid and Dynamic Bond funds; they hold mostly Sovereign debt and a small amount of AAA rated debt. This means the Quantum Multi-Asset fund is taking virtually no credit risk at all.

Now let’s look at the ICICI Regular Savings fund’s portfolio. On 31st December 2020, 82.39% of the portfolio had debt instruments. More than half of the debt portfolio, 57.8% to be precise, was debts rated AA or A! In other words, if you invest ₹1,000 in this fund, ₹476 of that money will be invested in debts rated AA and A. I was not expecting this at all.

So, ICICI Prudential Regular Savings fund is earning attractive return by taking credit risk. But you wouldn’t notice this if you just looked at past performance. The biggest dip you see in the NAV graph is in March 2020 when every fund in India lost value. (If the graph below looks too volatile to you, remember that this fund holds equity along with debt. For a fund with equity exposure, this volatility is incredibly low.)

Think about everything I have said so far. I am saying that this fund is taking a lot of credit risk. I am also saying this fund has very low volatility. How is that possible? Wouldn’t the fund see a credit event, a sharp dip in the NAV, whenever one of these risky debts default? But in the past 8 years, there’s hardly any sharp decline in NAV.

One theory I have is that ICICI is a very good lender: ICICI Bank, ICICI Home Finance, etc make all their money by lending money to customers. With their experience, maybe they have the ability to look beyond credit rating and they know how to identify quality borrowers even if they have a less than perfect credit rating. Maybe.

When it comes to investing my own money, I need to decide which one I trust more: credit ratings or ICICI’s ability to see beyond credit ratings. Neither option is risk free, so I need to choose which risk I am comfortable with. After some deliberation, I have decided that I’d stick with Quantum Multi-Asset Fund for my needs for the following reasons:

  • I am not comfortable taking credit risk. Not everyone agrees that credit ratings are accurate or useful, but that’s the best we have today.
  • The multi-asset fund is more diversified with some exposure to gold. I just like the idea of having some exposure to gold though I know that some people think gold doesn't add much to a portfolio.
  • Supporting responsible AMCs like Quantum is the right thing to do, even when they generate less returns.