Does removing stress make you wealthy?

I spent a lot of time and energy in the last 3 years or so getting my money management story in order. What is the investment plan for long-term needs? What is the savings plan for short-term needs? How to tell if I am running a budget surplus or a budget deficit? How to protect family money from my whims?

It was stressing me out before. I kept working on solving one problem after another, and now everything is starting to fall in place. But that reveals another issue: I don’t know how to use the free time available now! So far, most of my free time went into making and tweaking my finance plan. Now that a mature plan is in place, I don’t really need to be actively thinking about those problems.

I have free time now. I need to figure out how to use that time. A good problem to have.

They say that “wealthy” means you have freedom over how you spend your time. Does that mean I have become relatively wealthier? 🤔

Jupiter Pots: a failed experiment?

I started using Jupiter a year and a half ago. The sole reason I signed up for Jupiter was their savings feature called “Pots”. I was already keeping money aside for different purposes; Jupiter Pots gave convenient tooling for what I was doing.

Jupiter Pots impressions

Pots were great when I started. I liked them so much that I wrote a blog post praising them. While the rest of Jupiter has continued to improve and evolve, the Pots feature has stagnated mostly. There have been some changes, but they fall short of being good.

For example, there is a Super Pots feature that lets you create fixed deposits using Pots. But on maturity, super pots will self-destruct, and the money will move to your saving account. That means Jupiter will put you at the risk of accidentally spending saved-up money on something unrelated! To me, that looks like a lazy implementation that doesn’t stop to consider why the customer created a pot in the first place.

Then they introduced Habits, which are essentially recurring deposits. Habits are buggy too; they move money from your saving account a day or two in advance. Reporting this issue to Jupiter hasn’t really accomplished anything. But maybe that isn’t surprising, given they don’t even support updating communication address of bank accounts. (Not allowing address updates is a KYC norms violation, one would think?)

Back to Pots being unloved. Even basic things like modifying pot names, rearranging pots in the UI, etc are not done even after so many months. Tells you how much they care about Pots.

Looking into the future

The thing with convenience is that we are impressed by simple convenience initially. But over time, we take things for granted, and our needs evolve. We want more convenience. We expect our tools to do more for us. Same for me with Pots. I was able to overlook their flaws before, but now they are glaring.

The Jupiter team not investing in Pots is understandable at the same time. Jupiter is a startup. Possibly a small team executing at their capacity to make their company a success by building features that people want to use. I strongly believe that no one outside a small niche of customers wants or uses Pots. If Pots aren’t bringing them customers or usage, the Jupiter team would be right to call Pots a failed experiment and go on to explore other ideas.

Back to my use of Pots. If Jupiter won’t continue to be relevant for my needs, I suppose I should take care of them on my own. I already track my mutual fund savings using a spreadsheet. Making a similar tracker for bank account will be straightforward.

Say, I close my Jupiter account and move all Pots to a tracker of my own. My primary bank provides auto-sweep fixed deposits, which means the money I hold as short term savings will earn a higher interest than the 3% Jupiter pays me.

On top of all this, I’ll be able to tweak the tooling as/when necessary. Such a flexibility is seldom available in a pre-packaged product. Looks like this is the end-of-the-road for Jupiter-and-me.

• • •

Finally, Thank You to the Jupiter team for making Pots in the first place. Their product helped me see the convenience of separately labelled short-term savings. I may sever all my ties with Jupiter, but they have changed my life for the better. They deserve credits for that!

Look at your portfolio everyday!

This is a popular investment advice: “Do not look at your portfolio often”. The underlying assumption is that you may panic and do something you regret later—such as panic-selling when the valuations have fallen badly.

In reality, however, the opposite has helped me.

I started investing in January 2020. For the first many months of my investment journey, I was stuck inside my house (due to Covid restrictions), so there was nothing much to do. Not only was I looking at my portfolio every day, but I was also looking at the broader market and comparing it to my portfolio.

Image by freeimageslive.co.uk - gratuit

Fast forward to 2023. Now I don’t really care as much to look at my portfolio. Nor do I care about how the Nifty index moved or how S&P 500 moved. Because I know—from the experience of watching my portfolio closely for months—that the changes are fairly inconsequential. I am not going to sell today or tomorrow. It matters little what the market did today. Inconsequential information becomes boring very soon.

If you are mature enough to not pull the trigger at a sign of a fall, watching the market or your portfolio every day can make you a better investor. It’ll help you focus on what matters while ignoring the noise.

PS: If it becomes very hard to resist the urge to do something, follow Gaurav Rastogi’s advice #5 from this article: just buy some asset for a tiny bit of money.

Using sovereign gold bonds for goal-based investing

I am not proud of this, but I have mostly been ignoring the advice to “look before you leap” when it comes to investing. My typical investment journey goes like this: I see some arguments for investing in some asset; I jump right into investing in it; a few months later I decide I don’t want that asset; then I figure out how to course correct. It happened with gold. It happened with Nifty 50. It may probably happen with active equity funds in the near future.

This blog post is about another such story.

Accumulating gold

When I decided to remove gold from my investment portfolio, I thought that investing in equity+debt was a good way to accumulate purchasing power to buy gold in future. If equity appreciates more rapidly than gold does, I thought, investing in equity was better than investing in gold.

But now I have a different point of view. If the end goal is to buy gold, accumulating gold slowly over time is likely a better approach than investing in equity.

The goal based investing framework recommends taking just enough risk to meet our financial goals. You don’t put all your money in fixed income because it’s going to be very difficult to retain your money’s purchasing power that way. You need to take more risk. So you add equity to your portfolio. But you don’t hold 100% or 80% equity for long since the added volatility can make it difficult to meet your financial goals. An investor following the goal based investing framework would start with relatively high equity exposure, but regularly keep reducing equity exposure to progressively reduce risk.

Investing to buy gold is tricky. Gold is just as volatile as equity is. But if equity prices fall, gold price may rise and vice versa. Gold’s price appreciation is also usually faster than fixed income’s growth. Given these, holding equity and/or fixed income assets to eventually buy gold sounds risky. it’s arguably less risky to just buy [investment] gold and hold it until we need to buy [consumption] gold. At the time of buying gold for consumption, we can sell the investment gold, and we’ll have just enough money. By holding gold as investment, we nullify the impact of gold’s price volatility.

Using sovereign gold bonds to accumulate gold

Sovereign gold bonds (SGBs) are issued by the Reserve Bank of India (RBI). These bonds have a fixed tenure of 8 years. A bond that was issued on 1-May-2021, for example, will mature on 30-April-2029. Each bond represents 1 gram of gold. On maturity, the current price of gold will be paid to the bondholder. If gold price had appreciated in these 8 years, the bondholder need not pay any tax on the capital gain, which is a good incentive for most people.

Indian weddings make use of gold. A nontrivial amount of gold is needed if you are the bride’s side. (The groom’s side usually doesn’t need as much gold.) I roughly know when our girl children will get married, so it’s easy to tell how much gold we’ll need when. In my investment tracker spreadsheet, I plot the maturity of our SGBs as a graph like this:

This graph tells me how many of our SGBs mature in a given year. This gives me clarity on exactly how much gold we can buy in that year. Accumulating SGBs is a convenient and less risky way to accumulate gold if the end goal is to buy consumption gold.

Don’t let attractive XIRR figures fool you!

Have you come across investment opportunities that quote very attractive XIRR numbers? Have you been tempted to invest in those just based on the XIRR? This blog post is for you—to discuss what XIRR means in a practical sense.

An example to understand XIRR

Let’s say I borrow ₹10,00,000 from my bank at 10% per year interest, which I promise to pay over the next 60 months. The bank will ask me to pay ₹21,247 every month. Assuming I pay exactly ₹21,247 every month from November 2023 through October 2028, I would have paid a total of ₹12,74,820. While quoted “interest rate” is 10.00%, the XIRR of this loan is 10.46%.

Let’s say I am able to pay this loan off more aggressively. If I pay ₹5,000 more every month—i.e. I pay ₹26,247 every month—how much will I save? Based on Fisdom’s calculator, I’ll be saving ₹66,689 in interest overall. The loan will be closed in 47 months instead of 60.

If I follow the original schedule, the bank receives repayments at the XIRR of 10.46%. Now that I am more aggressively repaying the debt, the total interest I pay goes down, but the XIRR increases to 11.31%!

What does this mean? A higher XIRR does not necessarily mean higher overall earnings.

How is this information practically useful?

Does this mean XIRR is a misleading metric that we should just ignore? Not really. XIRR takes into account the “time value” of money. A higher XIRR is useful to those who can optimally reinvest all the cash flow coming to them, as it is coming to them.

A higher XIRR is useful to a big bank since they can take this cash and lend to another borrower. A higher XIRR will mean the bank’s loan book can grow faster. However, if you, a retail investor, tend to simply accumulate the repayments in your savings bank account, the higher XIRR is often bad for you.

How to decide about high XIRR investments?

Some investment products show their high XIRR return prominently everywhere. If you calculate the CAGR return of the same investment, the rate may be low. But because the XIRR looks a lot more attractive, they promote the investment by quoting the XIRR number.

You can invest in such an investments if you have the ability to optimally reinvest all the repayments as they hit your bank account. If you cannot reinvest so quickly—most retail investors cannot—then you are better off ignoring the quoted XIRR and calculating the investment’s CAGR instead. Or, just calculate the corpus you’ll get from this investment and compare that with the other investment you may make instead (such as PPF or bank deposit or debt mutual fund).

Holding volatile assets can be frustrating

I was planning to sell some of my Google shares (GOOG) by the end of this month. Just a few more days to go for the end of the month, but all of a sudden, GOOG has fallen by about 7% in the last 5 days.

I already had to change my plans once because Google share prices fell badly right before I was going to sell them. Now this is the second time within a year where my plans are changing because of price movements.

Not everything is bad news, however. The way price moves up is also dramatic. See how rapidly the price has risen by the end of August only to fall again just as dramatically within a few weeks. (I also sold some shares at $138 when the going was good.)

The Motley Fool says this about growth stocks:

The price of a growth stock tends to be extremely sensitive to changes in future prospects for a company’s business. When things go better than expected, growth stocks can soar in price. When they disappoint, higher-priced growth stocks can fall back to Earth just as quickly.

GOOG being a growth stock means such high volatility is to be expected.

Not too long ago, I was afraid of losing the high growth that comes through Google shares. Now I am starting to appreciate the lower volatility that diversified stock portfolios (e.g. mutual funds) offer.

Takeaways for me

• Selling mutual fund units is far easier—emotionally speaking—than selling something as volatile as GOOG is.
• The more volatile an asset is, the harder it is to use it in financial plans.

Don’t sort debt funds by recent returns

I learnt about debt mutual funds before I learnt about equity mutual funds. I consider myself more knowledgeable in debt more than in equity. What follows is one of the first lessons I learnt about debt mutual funds.

When you come across a debt fund that has given incredibly high return than its peers, it’s usually a sign that this fund has had a troublesome past. In the screenshot below, we see that Bank of India AMC’s Short Duration debt fund is topping the charts with 14% and 12% returns while other funds have given merely 7.5% or 6% return.

It takes only a few seconds to see why the high returns.

This is ICICI’s short duration debt fund. Nothing stands out here: just some volatility over the past 5 years, and it’s given 8.2% annual return.

Now look at the Bank of India fund: it has seen about 3 credit events in the past 5 years! Thankfully, the fund has recovered from 2 of these credit events, it looks like. After all that drama, this fund has managed to earn at 4.1% per annum over the past 5 years.

That was interesting to see, but what’s the takeaway? If we cannot rely on recent return data, what data can we look at then? I am no expert, but the following is what I do.

• I like to look at past portfolios and fact sheets of the fund to see how much risk they take. I don’t like anything below AAA. So many funds invest in AA bonds since they are pretty safe on typical days, but I am too conservative for that.
• I especially like funds that choose PRC matrix positions of A-I, A-II, and A-III since they commit to not holding too much sub-AAA debt. Unfortunately, many funds that never/seldom hold sub-AAA debt choose the ‘B’ position just to have some extra wiggle room.

Can we “buy the dip”?

New investors cannot earn outsized return by investing in debt funds after they have seen credit events. If someone bought Bank of India Short Duration debt fund a year ago, what return they’ll be looking at? Definitely not 14% because they wouldn’t have gotten access to the troubled bonds. They will likely be getting around 7.5% which seems to be the typical return.

Once there is a credit event, the troubled debt assets are moved to an illiquid “segregated portfolio”. New subscriptions to the scheme only get access to the “core portfolio”, i.e. the debt assets that are not troubled. Existing investors who have a share in the segregated portfolio will have to live with the troubled bonds until either the bonds become good again or go completely to zero.

You seldom win by taking credit risk. It’s prudent to exhaust your risk appetite in “safer” assets like equity rather than betting on lower quality debt.

Uncharted territory

Every territory is an uncharted territory.

Maybe a thousand people have already done what you are about to do. But that doesn’t make a difference to you if this is the first time you are doing it. When you do it, you should do it your way. That means you learn, improvise, and improve as you go.

So what are the takeaways?

• Remember that you don’t have to copy others. Do it in your own way.
• You have learnt and done so many things in life. The challenge of this new thing is not going to define you. (You do not define yourself based on how you fare in this one challenge.)

Direct equity investing is a bumpy ride

We bought a house in February 2023. My original plan was to sell my Google shares to fund the house purchase. I have always had “too much” exposure to Google shares. Selling Google shares to buy the house was a way to reduce the concentration risk. But by the time we finalised a house, the price of Google shares had fallen pretty badly.

You can see the stark difference between the left half of the following price graph and the right half.

Google share price has appreciated by 21.42% in the last 12 months. But it was in the negative territory for the first 9 months.

Between August 2022 and February 2023, Google share price fell by 22.58%!

When we knew which house we were buying and how much money we needed, Google shares were trading for around $90. I felt it was too low a price to be selling at. I changed the plan and found a different way to raise funds. It felt unnerving when I did that because selling Google shares had always been the plan. Changing the plan in the final weeks is essentially dancing to the tune of the market — something I want to avoid.

$GOOG’s performance since then is nothing short of amazing: almost 50% growth in the last 6 months! It made up for the previous ~20% loss and appreciated further to post a +20% increase year-over-year!

Between March 2023 and September 2023, Google share price grew by 49.47%

Lessons learnt

• Price swings of 2% or 3% in a day is a regular event. 20% or 50% up/down in a year is also fairly common. Direct equity investors should accept this bumpy ride.
• What does that mean in practice? You may have heard people advising to not lose hope when the price falls. But the reverse is also true: we should not celebrate if there is a rally and the price is going up. The price can fall any day.
• Well-diversified mutual funds are a much better alternative for those who don’t like so much volatility. For example when investing towards a financial goal. Directly holding 20+ diversified stocks is not a comparable alternative because deciding how much of what to sell may not be straightforward.
• Direct equity investors need to be nimble-footed. They should be willing to change plans when needed. It would have been a bummer if I had sold off my Google shares for $90.
• In addition to having the willingness to alter the plan, a direct equity investor should also have the ability to alter the plan. My situation would have been rough if selling Google shares was the only option.
• This one I am not so sure about, but… maybe I am better at making investment decisions than I give myself credit for. (Or maybe I just got lucky. What if $GOOG had never recovered? What if $GOOG kept falling?)

Why direct equity investment is hard

Exhibit 1: A fairly well written analysis claims that Sundar Pichai is no visionary: Is there more to Alphabet than Google Search? Quoting from this article:

[Sundar Pichai] has played a significant role in building the core business, which he ran even before taking over as Alphabet’s CEO in 2019. But he is no visionary.

Google developed the Chrome browser, Chrome OS, and Chromebook laptops under Sundar’s leadership. Unless you knew this history — which goes back to late 2000s and early 2010s — it’s very hard to reject this article.

Exhibit 2: An opinion piece that narrates how Chromebooks stole iPad’s market share in a big way: I used to work for Apple and watched it lose the K-12 education market to Google. Now it could lose the next generation of fans. This article doesn’t mention Sundar’s name but it’d be a mistake to assume that Google may have done this all without Sundar’s leadership.

But Chrome is just 1 product line. We also have the benefit of hindsight to say that Chromebooks will continue to compete in the market for a while.

An investor backing Google in the recent past may have had to bet that Google Cloud would turn things around, when it was still making loss after loss every quarter. Investors today will have to believe that Waymo can actually make money when most other self-driving car projects are struggling or being shut down.

Irrespective of how much you know about a company or industry, you’re going to bet blindly at times. Bet blindly a nontrivial portion of your equity portfolio, because otherwise the investment returns don’t move the needle for your wealth. Anyone who cannot do that are better off staying away from direct equity investments.

Which index to invest in? Nifty 50 or Nifty 500?

A popular investment advice is to “invest in a low-cost mutual fund that tracks a diversified index”. There are two parts to this advice.

• Why index fund? The arithmetic of index investing explains why it makes sense to passively invest in an index rather than trying to take active positions to beat the index.
• Why low cost? From the point above, we accept that market return is the best we can do. Since mutual funds cost money to run, the lower the cost the higher the return investors can enjoy.

If I want to invest in the Indian share market, what are my options? There isn’t a mutual fund that tracks the entire Indian market. The most popular index is Nifty 50, while broadest investable index is Nifty 500. I am going to compare these 2 with the goal of finding out what we get from each index and what the tradeoffs are.

Diversification

Nifty 50 captures 66% of the Indian market cap, and only contains large cap companies. Nifty 500 captures more than 90% of the Indian market cap, and has large, mid, and small cap companies.

In general, the larger the index the more diversified it is. Any index that does not represent 100% of the market is taking an active position. (See Not all index investing is passive investing.) Nifty 500 is more passive and more diversified than Nifty 50.

Liquidity

While large cap Indian companies see high trading volumes, mid and small cap Indian companies are not traded as frequently. However, according to the NSE index construction methodology, every constituent of both indices must have traded on at least 90% of the days in the assessment period (past 6 months). In other words, both Nifty 50 and Nifty 500 have the same liquidity criteria.

There is no systemic advantage to Nifty 50 here, but in practice, large cap Nifty 50 companies see much greater trading volume than small cap companies. In comparison to Nifty 50, yes, Nifty 500 is at a disadvantage.

Impact cost

Impact cost is inversely proportional to trading volume. Low trading volume, or low liquidity, means that the impact cost is high.

Nifty 50 companies by definition have less impact cost than Nifty 500. According to the index methodologies used, a stock should have an impact cost of 0.5% or less to be included in the Nifty 50 index. Nifty 500 allows impact costs of up to 1%. So in reality and on paper, Nifty 500 has a higher impact cost.

Portfolio churn

Portfolio churn happens in index funds when new companies move into the index to replace an incumbent. When the index constituents change, index funds sell the companies that left the index and buy the ones that entered the index.

It doesn’t always need to happen this way, but the index changes often happen near the bottom of the index. New Nifty 50 companies come from the Nifty Next 50 index; companies that lose their spot in the Nifty 50 index move down to Nifty Next 50. Likewise, for the Nifty 500 index, the companies that enter and leave tend to be small cap companies that take up a small allocation in the index.

Intuitively, we can hypothesise that the impact of the churn can be large in a large cap index that holds only 50 companies compared to an index that holds 500 companies. The churn as a percentage of the market cap is going to be relatively low for the Nifty 500 index while it can be relatively much higher for the Nifty 50 index.

What about tracking error?

Tracking error is a measure of how much an index fund deviates from the index it tracks. It shouldn’t be a surprise that Nifty 50 index funds will have a lower tracking error than Nifty 500 index funds. Why? Because buying and selling 500 companies at the right weights is a lot harder than buying and selling 50 companies at the right weights. The increased impact cost of smaller size companies in the Nifty 500 index will also cause the tracking error to go up.

But tracking error should come into consideration only when there are multiple index funds tracking the same index. In other words, we first pick an index to invest in, and then choose a fund that has the least tracking error historically.

I have seen advice that recommends against investing in large indices like Nifty 500 because they tend to have high tracking errors. In my view, your portfolio companies and diversification are more important than technicalities such as tracking error. There is no need to sacrifice diversification only to get a lower tracking error.

Conclusion

So, what is the better index to invest in? Nifty 50, or Nifty 500? As with most things in finance, there is no one correct answer. Those who care more about cost and liquidity but are okay with a high portfolio churn and less diversification can choose Nifty 50. Those who are okay to pay more in terms of impact cost but prefer a more passive, more diversified portfolio can choose Nifty 500.

Life lesson from an economist

I have been reading The (Mis)Behaviour of Markets, a book that proposes a new way of looking at capital markets.

The author, Benoit B Mandelbrot, is essentially arguing why the older theories are wrong, and how his theories are better. But the amount of detail he has included in the book about how the older ideas were established is incredible.

On page 46, he says this:

“An interest in the history of ideas is good for the scientist’s soul.”

Mandelbrot has spent years working on his ideas and writing this book to replace older theories with his. Yet, he describes the scientists before him with utmost respect.

Isn’t that something we should all learn to do?

Am I coming of age w.r.t. investing?

I was perplexed as a child when I noticed people’s religious behaviours. Everyone around me seemed to believe in a god. They went to temples; they took part in elaborate prayers and rituals. At the same time, they also acted as if god won’t help them. They all acted as if they were on their own. I never understood why.

Photo credit: wallpaperflare.com

Fast forward to today. I know 3 people who are proponents of index investing. All 3 of them recommend against active investing such as investing in active mutual funds. However, every one of them is against investing in any NSE index other than Nifty 50!

A basic idea of passive investing is reducing the number of active choices we make. Our active choices don’t always work in our favour, so passive investors voluntarily give up control and let the market decide what they hold. In that view, investing in Nifty 50 is a more active choice than investing in a broader index like Nifty 500. (What do I mean by “active choice”? See Not all index investing is passive investing.) I believe that passive investors should prefer broader indices like Nifty 500.

But no. Contrary to my understanding, no one recommends going beyond the top 50. Take Pattu of freefincal.com for example. He is not enthusiastic about investing in the top 50 companies of the US market. But when it comes to the Indian market, he recommends just the opposite: “avoid going beyond the top 50” is his advice.

Nifty 50 investors lack exposure to more than 25% of the Indian market cap (image source)

Going back to my confusion about other people’s relationship with god: I eventually learnt to ignore other people’s beliefs and behaviours. These days I only care about my own relationship with god. I am comfortable holding opinions that are not commonly held or doing things that are not commonly done.

I am not as comfortable with investing. Not yet.

I want to invest in Nifty 500, but everyone says “beyond Nifty 50, there be dragons!” I think my hesitation is not about losing money. The 3 people whom I mentioned earlier — I respect these people. I trust their judgement. None of them is enthusiastic about anything beyond Nifty 50. Ignoring their advice and investing in Nifty 500 is a big leap. Big leaps are often scary. Maybe this is a rite of passage that I have to go through to become the independent investor that I want to be.

Update (6-Aug-2023): I wrote a follow-up blog post comparing Nifty 50 and Nifty 500.

Active equity investment without stock analysis

I have a desire to invest in “direct equity”. That is, buying stocks directly rather than through wrappers such as mutual funds. But I have neither the skills nor the time necessary to analyse companies. So I have been thinking about ways to invest in equity without doing analysis.

But why do I want to invest in direct equity? Like most people, I am inspired by anecdotal success stories.

I received Google shares as compensation. I left those shares idle in my brokerage account for years because I was ignorant about stocks, and I was not motivated enough to learn about them. This resulted in an unimaginable growth. Now that I know better about the danger of holding US stocks, I want to sell my Google shares and buy diversified assets instead. At the same time, I am afraid that I’ll lose the rapid growth I got through GOOG. I want to maintain a similar growth by holding some companies directly.

GOOG has grown significantly faster than S&P 500 (source)

There is also the lure of dividend income during retirement, but I recently decided that that’s not worth pursuing. (See Are equity dividends a good source of retirement income?)

I have so far thought about the following stock picking strategies.

Strategy 1: just buy popular stocks

Just buy the winners of the Indian share market. The likes of HDFC Bank, Asian Pains, Titan, etc. The risk is that you will not have any idea why you are buying a company, how much money you need to deploy in each of these companies, when to sell, how much to sell, etc.

This is possibly the worst option of all. You are essentially betting blindly, and hoping that it’ll all turn out fine. As Pattu of freefincal.com often says, our money deserves more respect than this.

Strategy 2: invest based on other people’s advice

Stock advisory services come in different shapes and forms. But essentially, the advisor tells you what to buy, what to sell, and what you can continue to hold. Different advisory services give you differing levels of detail on why they recommend what they recommend. Smallcase is a popular service in this category. You get advice that is integrated with your broker so that you can do the recommended trades with a click of a button.

While this sounds attractive on paper, you are essentially investing in a high cost mutual fund that lets you retain some control. You more or less blindly execute someone else’s decision. It is true that you can override the recommendation, but how many will do that in reality, with conviction (as opposed to simply rolling the dice)? If we are capable enough to override the recommendations, do we even need an advisory service?

Strategy 3: coffee can investing

You make a concentrated stock portfolio, and you just keep buying. You never sell. You don’t need to monitor your companies because you have already decided that you will never sell.

Coffee can investing is popular, so the idea must sound reasonable to many people. However, it sounds like a half-baked approach to me. We enter the equity market very much like how Abhimanyu entered the chakravyuha. If there is a Yes Bank in my portfolio, am I supposed to sit down patiently hoping that some day the share will make up for all the lost time?

My main concern with coffee can investing is that it’s built on the premise that we are infallible stock pickers. This strategy does not have a way to detect errors or course correct. Such a strategy fails to instill confidence in me, so this one gets a no-go from me.

My current stance

What is my goal? I want to invest in a concentrated stock portfolio to earn market-beating return. The simplest avenue for that is active mutual funds. Rather than paying for stock tips and advice, you pay for advice and management. Because the invested capital is usually thousands of crores, the fund managers can hire expensive advisors. Economies of scale reduce the trading costs. Rebalancing is a tax-free event (at least for now). You give up some control, but you get all these benefits for a fraction of the cost. This sounds to me like  a better way than trying to do it yourself.

Are equity dividends a good source of retirement income?

Receiving dividends brings a smile to direct equity investors. You are doing your own thing, and all of a sudden you get some money. Free money. What’s not to like about it?

People who aim to achieve financial independence through direct equity investments calculate how much of their annual expenses can be met through dividends alone. Living off of dividend income is like a dream. You still hold just as many shares as before, and yet you have more money to spend.

‘Dividends’ by Nick Youngson CC BY-SA 3.0 Pix4free.org

I wanted to build a direct equity portfolio too, to derive dividend income to cover my expenses after retirement. I haven’t acted on that desire, but I have been thinking about it. After thinking about it for a while, it does not sounds as appealing anymore.

• A company that pays dividends is essentially choosing not to use the cash for business growth or expansion. Doesn’t that mean that this business may potentially be at risk when its current source of revenue dries up? Do we really want such companies to be a big chunk of our corpus?
• Dividends are unpredictable. You may get ₹15 a share this year, and ₹2 a share next year. How do you even make a budget around such an unpredictable income source? You need a reliable source of income as the base. On top of that stable base, you can add equity dividends like a decoration.

What investments give you reliable income then? Those are bonds, for sure, since you know how much coupon they will pay. A little less predictable but still good are REITs and InvITs. REITs and InvITs don’t pay a predictable sum (such as ₹50 per share) regularly, but they are required to distribute 90% of their cash. While a company is free to not pay equity dividends for a few years, that flexibility is not available to REITs and InvITs. This means the investor can expect to see a reasonable inflow of cash.

My current stance

Given all this, I am not sure if building a direct equity portfolio for dividend income is a good move. Maybe it is better to invest in equity only for growth. Mutual funds that reinvest the equity dividends can be a good way to hold equity: you are not banking on dividends. Whatever dividend is earned will be efficiently and automatically reinvested by the fund management team, which optimises for rapid growth.

For retirement income, i.e. to pay for day-to-day expenses, we can use bonds, REITs, and InvITs. These assets do not grow rapidly, but that’s not a bad thing.

Not all index funds are created equal

The core of my equity portfolio is Vanguard FTSE All-World ETF (VWRA). I wanted to invest in the FTSE Global All-Cap Index through VT, but I had to avoid VT because it is US domiciled. (Reason: The case against investing in US assets.)

While VWRA is a pretty good substitute, at times it felt to me like a compromise. I really wanted to hold as many companies as I can.

A few days ago, I came across the IMID ETF that invests in the MSCI ACWI IMI index. This index is comparable to the FTSE All-Cap index with 9000+ companies from across the world. The ETF is Ireland domiciled. It even charges less expense ratio than VWRA (0.17% vs 0.22%)!

It was a dream come true. Or so it seemed.

I happily announced my discovery to Sayan Sircar, but I was surprised by his lack of enthusiasm. He told me about the “sampling” strategy that some ETFs and index funds use. This helped me dig more and see why IMID was not as amazing as I had thought.

What is “sampling” in ETFs?

The FTSE All-World index has 4163 companies. VWRA, the ETF that tracks this index, holds only 3691 companies. The remaining companies are not “in the sample” that the ETF uses.

VWRA’s portfolio as on 31 May 2023

My jaw dropped when I looked at the holdings of IMID. While the index has 9181 companies in it, the ETF is holding less than 2000 companies! I immediately understood why Sayan was not enthusiastic about this ETF.

Constituents of the MSCI ACWI IMI index

Holdings of the IMID ETF

I like index funds more because they are passive, and less because they track an index. (See: Not all index investing is passive investing.) An ETF that replicates an index’s performance while holding less than 25% of its constituents is anything but passive. I don’t want such a fund anywhere in my portfolio.

Takeaway

I have learnt this now: Not every index fund fully replicates its underlying index. When choosing an index fund, pay attention to how accurately the fund replicates the index. This is especially important if the index is large and diverse.

The case against investing in US assets

I am a big proponent of global investing, but Indian investors must avoid US assets as much as they can.

I am supportive of buying US stocks as investment assets. In fact, a big chunk of my investment portfolio is US companies. But I recommend against buying those shares directly. If you simply buy US stocks through a US broker (or their Indian partners such as Vested, IndMoney, etc), you’ll be acquiring US domiciled assets. US domiciled assets are bad because they attract US estate tax. ETFs such as VOO and BND are also US domiciled, and should be avoided.

The best way to buy US assets is through instruments that are domiciled in a country that does not collect unfair estate taxes. Any mutual fund sold by Indian AMCs, for example. Ireland domiciled ETFs are another option for those who are comfortable trading in markets outside India.

What is estate tax?

‘Estate tax’ by Nick Youngson CC BY-SA 3.0 Pix4free

Estate tax is the tax some countries collect when a deceased person’s assets are transferred to their legal heirs. If a US resident’s assets are passed to their heirs, assets worth up to 11 million US dollars are transferable without any tax. However, when transferring the assets of nonresident aliens, the US will start collecting taxes at mere 60,000 USD. The tax rate can go up to 40%. My estimation a few months ago was that there will be a tax liability of 3.4 crores INR while transferring a portfolio worth 10 crores INR. To be clear, this is not tax on the gains, but tax on the entire portfolio that is transferred!

But wait, the story gets worse. Even if you accept to pay this unfair tax, the transfer process won’t be quick. My employer has hired a firm to help with such transfers. (If I were to die tomorrow, my family can get assistance from this firm to transfer my assets to their names.) Even with this professional help, they are saying the transfer process can take up to 24 months. While this process is happening, all my US assets will be frozen. My family cannot sell these assets if there was an emergency. Nor can they maintain the portfolio by selling some shares to reduce risk.

My recommendation

Many investment platforms have made US investing extremely easy for Indian investors. While their offerings are great, it is prudent to stay away from them because the US is an unfair and unfriendly place for nonresident aliens like us.

FAQ: I am just 25 and single. Why should I worry about estate tax?

Whenever I talk about estate tax, someone young asks me this. “Why should I worry about estate tax?” The answer I give them is that, “I don’t plan on dying too, but death is inevitable and the time of death unpredictable.”

The main reason people ask this question is that they underestimate the longevity of their investment portfolio. If we are disciplined with investing, our retirement portfolio will last 50 to 80 years or even longer.

Our investment portfolios start small and humble. We don’t expect it to grow to 8 or 9 digit figures. But for most of us, the corpus will grow that big because we’ll be investing for 20, 30, or 40 years. And then we’ll retire and live off of that portfolio for the next 30 or 40 years. Do you want your spouse or your children to pay such a large sum to the US as tax? Especially when there are very good alternatives available, why should we make our families to go through this hassle?

A tracker for short-term mutual fund savings

Jupiter Pots is a service I use for my short-term savings. I also use mutual funds for short-term savings. I thought it’ll be nice if Jupiter Pots supported mutual funds too. Sayan Sircar of Arthgyaan is the kind of person who will inspire you to solve your problems yourself. He gave subtle hints while we were talking that it’s not hard to build something like Jupiter Pots if one wanted. That was enough motivation for me to try making a spreadsheet that does what Jupiter Pots does. Of course the spreadsheet gives a less polished UX (user experience), but it gives us much greater flexibility and control.

After I created the spreadsheet, I humble-bragged to Sayan that I had done it. Then the idea of sharing the spreadsheet to the world through Sayan’s website came. I wrote a blog post with Sayan’s help. He also recommended that we make a demo video, which I think was an excellent idea.

Please head over to Arthgyaan for an overview and demo of my short-term savings tracker.

Liquidity of insurance + investment products

Much before I knew what investing was, I “invested in” an LIC policy. I had the desire to save for the future, but I had no idea what I should be doing. I consulted a friendly LIC agent, and he advised me to get this policy. I bought the policy with my eyes closed. More than a decade later I understood what this policy was like. This is a participating policy, so the investment return is not predetermined.

When I had paid premium for 15 years, I asked an LIC branch to tell me the surrender value of this policy. The policy’s total value came to be over ₹6.46 lakhs. However, if I were to surrender the policy (i.e. abandon the investment), I’ll get just a little bit more than the premium I had paid.

For the corpus value of ₹6,46,875, the growth rate (XIRR) is an impressive 9.52%. But if I couldn’t continue the investment for any reason, I’ll only get ₹3,25,528. Growth rate for that is a measly 0.81%! A return of 0.81% after paying on time every single premium for 15 years straight.

To my surprise, most people seem fine with this. They only look at the 9.5% return, but ignore the lack of liquidity. When discussing liquidity, I ask people this question: “If I have ₹10,00,000 in my PPF account that matures in 5 years, and I need ₹6,00,000 today for a surgery, do I really have that ₹10,00,000?” The answer is No. If you cannot spend the money, you effectively don’t have it.

That’s my main problem with all these insurance + investment products. They give you a good or great return as long as everything goes perfectly as planned. The moment you have to deviate a bit from the original plan, you end up with a big loss. Imagine earning an annualised return of 0.81% on a 15-year investment. That’s as good as gifting money to the insurance company!

If you are considering buying one of these insurance plans with the focus of investing, here is my advice:

1. Don’t. Liquidity is just one problem. There are many other issues with these products: high cost, low return, insufficient insurance coverage, etc.
2. If you must buy one, choose a plan that has a short time horizon. A 5-year investment plan is easier to adhere to than a 25-year investment plan. The longer the time duration is, the more you need liquidity and flexibility.

Do TCS deductions reduce advance tax liability?

From 1-Jul-2023, 20% of the LRS amount will be deducted as Tax Collected at Source (TCS) by the bank, and only the remaining 80% will be transferred to the brokerage account. That means, if an investor sends ₹5,00,000 to their brokerage account, they will receive USD worth ₹4,00,000 only! The remaining ₹1,00,000 will be taken away as tax collected at source.

This is a big blow for Indian investors who invest outside India through the LRS scheme. Sure, this is not additional tax. Investors can claim this ₹1,00,000 as tax refund while filing tax return. But there is an opportunity cost as this ₹1,00,000 remains uninvested for up to 15 months (or sometimes even longer).

Can we adjust this TCS with advance tax?

I invest in a Vanguard ETF that is not traded in India. To make this investment, I send money out to a foreign brokerage account through the Liberalised Remittance Scheme (LRS). I was thinking about this new rule, and wondering if there was a way to reduce its impact on me.

I am liable to pay advance tax every quarter as I have regular rent income. I was wondering if the TCS collected at the time of LRS transfers can offset the advance tax I need to pay. Here is an illustration:

• I send ₹5,00,000 to my brokerage account on 12-Aug-2023. The bank takes out ₹1,00,000 from my remittance and deposits it as income tax into my account.
• On 15-Sep-2023, I have an advance tax liability of, let’s say, ₹54,000 from other incomes such as rent, capital gains, etc.
• The question I had was: Can I skip paying the advance tax because the TCS deduction was more than my advance tax liability?

The answer seems to be Yes!

Section 209 of the Income Tax Act, called “Computation of advance tax”, says this:

(1) The amount of advance tax payable by an assessee in the financial year shall […] be computed as follows:
[…]
  (d) the income-tax calculated […] shall […] be reduced by the amount of income-tax which would be deductible or collectible at source during the said financial year under any provision of this Act from any income […]; and the amount of income-tax as so reduced shall be the advance tax payable

It is not the easiest text to follow, but it seems to say that advance tax liability is computed as Advance Tax Payable = Total Tax Payable – (All TCS payments + All TDS payments).

I can skip or reduce my TDS payments based on how much TCS had been deducted in the quarter. That means I’ll have a little bit more capital left with me, which I can invest in India.

The new rule mandating 20% TCS on LRS payments is a big blow for many people. Having rent income has kind-of made it a little bit less severe a hassle for me.