30 Jul 2023

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.

woman wearing white scoop-neck long-sleeved top over green trees during daytime, photo of people praying
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.

According to SEBI's market cap definitions, 75.5% of the Indian equity market cap is large-cap, 15.7% mid-cap, and 8.8% small-cap.
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.

16 Jul 2023

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.

14 Jul 2023

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.

13 Jul 2023

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.


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.

11 Jul 2023

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?