28 Jun 2024

Some thoughts on SPIVA reports

SPIVA reports are a popular data point that proponents of index investing use to show how actively managed portfolios are doomed to underperform the broader market. Without going into the active vs passive debate, I want to put forth a few concerns I have about SPIVA reports.

  • Conflict of interest. SPIVA reports are published by S&P Global—a for-profit organisation that creates and maintains indices. When AMCs launch index funds tracking S&P indices, the AMCs pay S&P to get access to the index data.
        The more index investors are in the market, the more money S&P Global makes. Of course, S&P will show index funds in a positive light.
  • Factor indices are conveniently excluded. In addition to market-cap weighted indices, S&P (and other index curators) also publishes factor indices. You know, the likes of Low Volatility, Alpha, ESG, etc indices. While they are dressed up like passive indices, they have a lot of resemblance to active portfolio construction.
        These indices can and do underperform the broader market regularly. But funds tracking such factor indices are not evaluated by SPIVA reports.

I am not asking anyone to ignore SPIVA reports. Nor am I calling S&P’s intentions bad. All I am saying is that index funds don’t become great just because SPIVA reports praise them year after year.

If an electric car maker publishes a report of how petrol/diesel cars are bad for us, how much trust/skepticism would you have on that report? A similar level of trust/skepticism is warranted for SPIVA reports too.

27 Jun 2024

A fine line between acceptance and denial

I messed something up at work. This is a kind of mistake that I seem to keep repeating. It hasn’t been easy to forgive myself and move on. At one point, I started thinking if I should leave this job and move to a different team. “I am not anyway good at the skills needed for this role,” I thought, “so why not just find a different role?”

I have done this before—moving to a different role that aligns better with my existing skills. But in recent months, I have been thinking about the concept of “I”. In particular, the descriptions we give ourselves such as, “I am good at math,” “I am not very good with people,” etc. I have been trying to separate actions and behaviours from the person. Because of this, I almost immediately rejected my assumption/description that I was not great at my current job.

We change over time. I have gotten better at things that I was not very good at. I have started liking things that I used to dislike. It is only temporary that certain things are hard to do. I can get better if I tried. Understanding this has, thankfully, stopped the “I am bad at this” narrative in my own mind. However, now I am stuck at the next stop.

I agree this is just a skill. I agree I can get better at my current role. But why should I get better? Why not just take up tasks that don’t require so much effort?

What is preventing me from putting in the effort to get better? Hard to tell for sure, but 2 things come to my mind:

  1. Fear of failure. In the past, I have shied away from new things because (unconsciously) I was afraid to fail. If I never try something, I never fail at it, right?
  2. It feels futile. The “I don’t need to do this to prove my adequacy” narrative.

While reason #2 may sound like acceptance, it is, in fact, denial. Earnest attempts to improve requires accepting that there is room for improvement. Thinking “I am fine as I am” is denial. If I truly thought I was fine, I wouldn’t be brooding over the mistake I made at work.

Such denials are a hindrance for growth. But the good news is, awareness is (almost) all we need for shaking off such denials.

18 Jun 2024

Indexation can significantly reduce our tax liability

I invested in HSBC Ultra Short Duration debt fund while indexation benefit was still available to debt mutual funds. (Back then this fund was run by L&T. HSBC then merged this fund with their own Ultra Short Duration fund.)

As you can see from this screenshot, I have an unrealised gain of ₹3.12 lakhs.

Screenshot showing unrealised gain of ₹3,11,971

Kuvera has a premium feature called TradeSmart which shows estimated capital gain/loss before placing a redemption order. If I were to sell all my holdings of this fund, Kuvera tells me, I’ll have taxable long-term gain of ₹12,615.

Screenshot showing taxable gain of ₹12,614.83

How did the gain of ₹3,11,971 diminish to mere ₹12,615? Thanks to the magic of indexation.

Turns out, indexation substantially reduces tax liability of slow growth assets. Indexation is useful for fast growth assets too, but the impact is dramatic if the growth is slow.

In my case, if indexation benefit was not available, I would be liable to pay ₹93,591 (+ 4% cess) at 30% tax rate. But thanks to indexation and reduced 20% tax rate, my tax liability reduces to ₹2,523 (+ 4% cess).

Change in my attitude towards taxation

All this while, my stance was to pick the right asset without worrying about taxation. “Tax is inevitable, so just pay it,” I thought. But seeing these numbers has been a revelation. I had no idea indexation could make such a drastic difference.

I was dismissive of new “debt like” mutual funds that use fancy portfolio construction to qualify for indexation benefits. But I am not so sure anymore. I think I’ll give the Edelweiss Multi Asset Allocation fund a serious consideration. Even if this fund earns lower return than dynamic bond funds, I’ll likely end up with more after-tax corpus thanks to indexation.

5 Jun 2024

My experience ‘buying the dip’

Indian equity market fell hard on 4-Jun-2024 following the apprehension caused by the parliamentary election results. The Nifty 500 index fell by 6.71% in a single day.

My regular equity investment was due, but I was waiting to take care of some pending expenses. Seeing the index fall so much in a day, I decided act quickly. I pumped the money in to “buy the dip”.

Motilal Oswal Nifty 500’s NAV fell by 6.7% in a day. (Graph from ValueResearchOnline)

Investing as soon as I saw a big fall was a knee-jerk reaction. I hadn’t really thought through the impact of such an investment. During the whole day, I was consumed by thoughts about the election result and what it meant for the future of the country. Only much later, I looked at the NAV graph to see what this 6.71% discount meant.

To my surprise, this fall hadn’t even brought the fund to its 30-day low! The fund’s NAV on May 9th was ₹23.2971; the NAV after the June 4th’s fall is ₹23.3253.

Motilal Oswal Nifty 500’s NAV on 9th May was ₹23.2971. (Graph from ValueResearchOnline)

Expanding the horizon to 3 months, we see that the NAV on 19th March was ₹22.4901.

Motilal Oswal Nifty 500’s NAV on 19th March was ₹22.4901. (Graph from ValueResearchOnline)

Going back 6 months, the lowest NAV has been ₹21.3039 on 5th December 2023.

Motilal Oswal Nifty 500’s NAV on 5th December was ₹21.3039. (Graph from ValueResearchOnline)

If I had deployed my cash on 5-Dec-2023, my investment would have grown by 10.32% despite the fall on 4th June.

I already wrote about the futility of trying to buy the dip, and the current fall only reaffirms what I already knew. Sitting on cash is not a prudent way to buy equity at a cheap price.

Nevertheless, I do not regret making this investment. This was money I had anyway kept aside for buying Nifty 500, so I haven’t strayed away from the plan too much.

The price I got was lower than the previous day’s price, but the index can very well continue to fall until a stable government comes into place. If the index continues to fall, my haste would have resulted in the loss of a better opportunity.

But the reality is that, whatever price we buy at, the price will eventually fall below it. Whatever price we sell at, the price will eventually rise above it. Lamenting our buy/sell decisions can never be productive. If I stay invested for a decade+, all these falls and rises will eventually prove too small to matter anyway.

2 Jun 2024


Every human is biased. When we come across someone that has biases similar to our own, we call them unbiased.

18 May 2024

Will all Nifty 500 index funds have poor tracking differences?

I regularly review fact sheets of the mutual funds I invest in. I take note of some metrics to keep track of the funds’ health and performance. Starting this month, I have started noting down tracking differences of index funds.

3 years tracking difference of some popular index funds:

  • HDFC Nifty 50: 0.31 pp (percentage points)
  • UTI Nifty 50: 0.42 pp
  • Motilal Oswal Nifty 500: 1.36 pp

I was a little disappointed to see these numbers since Motilal Oswal Nifty 500 is the fund I have chosen for my portfolio. Looking at these numbers, predictions of the Motilal Oswal fund not being able to closely track its index seemed to have come true.

The linked article says that tracking 500 stocks will be more difficult than tracking 50 stocks due to impact cost and other overhead. It goes on to recommend that investors stick to Nifty 50 index funds.

If tracking 500 companies has such an impact, I wondered, what the story will be for funds that track thousands of companies? So I looked at 2 Vanguard ETFs tracking global indices. Despite holding thousands of stocks, these funds had incredibly low tracking differences.

Fund nameStocks held3 years tracking diff.
HDFC Nifty 50500.31 pp
UTI Nifty 50500.42 pp
Motilal Oswal Nifty 5005001.36 pp
Vanguard All-World (VWRA)3700+0.10 pp
Vanguard Total World Stock (VT)9800+0.52 pp

This busts the theory that tracking more companies will always lead to a higher tracking difference. A competent fund manager like Vanguard can replicate large indices without deviating too far away from the index.

This made me think of the Jio-BlackRock joint venture that is expected to launch mutual funds in the near future. BlackRock’s iShares MSCI World ETF had managed a 3-years tracking difference of -0.47 pp despite holding a large portfolio of stocks. A Nifty 500 fund run by BlackRock would likely have a low tracking difference, I thought. Then I discovered iShares MSCI India ETF, so I looked at this ETF’s tracking difference.

Recent cumulative returns of iShares MSCI India ETF
The tracking difference of the MSCI India ETF is more than 10 percentage points! This looks even worse when you consider that this ETF only holds 136 companies, possibly very liquid large- and mid-cap companies.

Takeaways for me:

  • While Motilal Oswal Nifty 500 has a mildly high tracking difference, it’s not that bad. There are worse options out there.
  • BlackRock coming to India need not be as amazing as some hype it up to be. We have to wait and see how they are able to perform.
  • Finally, some Nifty 50 index funds also have high tracking differences. NiftyBeES, India’s most popular Nifty 50 ETF, has a tracking difference of 0.98%. ABSL Nifty 50 and DSP Nifty 50 funds have tracking differences of 1.32 pp and 1.22 pp respectively. Compared to that, Motilal Oswal Nifty 500’s 1.36 pp is very respectable.

Index fund tracking error vs tracking difference

Tracking error and tracking difference are 2 metrics for assessing mutual funds that mirror an index. Let’s look at the difference between the 2 with an exaggerated hypothetical example.

Imagine there are 2 funds, Fund A and Fund B, both mirroring the same index. Let's pretend the index and the funds start at the value of 100 at time T0 and go through the following changes over time.

Absolute value of an index and 2 funds tracking it
TimestampIndexFund AFund B

Which fund do you think has a higher tracking error? Many investors would be surprised to hear that Fund A’s tracking error is 0.71% but Fund B’s tracking error is 2.95%.

Tracking difference vs tracking error?

Tracking difference is easy to understand and calculate. Take any time period. Find the difference between index return and fund return. That number is the tracking difference for that period. Tracking error, on the other hand, is a metric that tells us how consistent a fund’s tracking differences have been.

Let’s go back to our hypothetical example. The following table shows tracking difference for each time period.

Tracking differences of 2 hypothetical index funds
Time periodFund AFund B
T0T10.40 pp0.02 pp
T1T20.39 pp0.05 pp
T2T30.41 pp0.02 pp
T3T40.40 pp0.09 pp
T4T50.40 pp0.03 pp

As you can see, Fund A’s tracking differences have fallen in a narrow range of 0.39 percentage points to 0.41 percentage points. But Fund B’s tracking differences are spread across a wider range of 0.02 percentage points to 0.09 percentage points.

Tracking error is the standard deviation of all tracking differences of the fund. If the tracking differences are similar throughout the assessment period, that fund has a low tracking error. This is independent of the quantum of the tracking difference.

Index fund metrics for the time period T0T5
Fund AFund B
Tracking difference2.02 pp0.71 pp
Tracking error0.15 pp2.95 pp

What is important? Tracking error or tracking difference?

In a way, both are important. But tracking difference is a lot more important than tracking error.

  • A lower tracking difference over a long duration (such as 10 years) means that the return an investor earns is similar to the return the index earns. That is always a good thing.
  • A lower tracking error means that the process used by the fund management team can reliably replicate the index in all circumstances. Securities markets have good days and bad days. If a fund is able to replicate the index with a similar kind of tracking difference on all days, it means the fund follows a robust investment process.

How to choose an index fund?

  1. Choose the index that you want to invest in. My older posts Nifty 50 vs Nifty 500 or Not all index investing is passive may be of some help.
  2. If you have multiple funds mirroring your chosen index, then pick the one that has consistently low tracking difference over different time periods.
  3. If you still have multiple options to choose from, you can choose the fund with a lower tracking error.

But this is not foolproof. You should also appreciate and accept that we can only do Step 1 above reliably. The other 2 metrics—tracking difference and tracking error—are moving targets. A fund that has done well for many years may suddenly start to falter, or vice versa.

Do your best to choose a fund. But don’t panic or blame yourself if you make a judgement error. Just see how to course correct since that’s the only thing we can do after investing in a suboptimal fund.

Thanks to FreeFinCal for making me aware of the significance of tracking difference.

18 Apr 2024

The impact of “taxed at slab”

It’s often scary to hear the phrase “taxed at slab” because it means a relatively larger chunk of our profit is taken away by the government.

Many mutual fund categories are now taxed at slab. This has caused enough concern among investors to spur AMCs into creating weird mutual fund schemes. I know of at least Edelweiss Multi Asset and Parag Parikh Dynamic Asset Allocation funds. I am sure more such funds are coming from various AMCs.

But what is the impact of “at slab” taxation on long-term investments? We look at a few tax scenarios of a ₹50,000 per month SIP.

Estimated corpus @ 10% annualised return over 10 years

It should be no surprise, but a 30% tax bill is twice as large as a 15% tax bill and thrice as large as a 10% tax bill.

Screenshot from Groww SIP Calculator (click image to enlarge)
  • Pre-tax corpus: ₹1,03,27,601
  • Post-tax corpus with 30% tax and 4% cess: ₹89,77,389
    • Tax owed is ₹13,50,212.
    • 13.07% of the final corpus is owed as tax.
  • Post-tax corpus with 20% tax and 4% cess: ₹94,27,460
    • Tax owed is ₹9,00,141.
    • 8.72% of the final corpus is owed as tax.
  • Post-tax corpus with 15% tax and 4% cess: ₹96,52,495
    • Tax owed is ₹6,75,106.
    • 6.54% of the final corpus is owed as tax.
    • (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
  • Post-tax corpus with 10% tax and 4% cess: ₹98,77,530
    • Tax owed is ₹4,50,071.
    • 4.36% of the final corpus is owed as tax.

Estimated corpus @ 12% annualised return over 10 years

For the same investment duration, higher return rate results in higher tax owed (as a percentage of the corpus size).

Screenshot from Groww SIP Calculator (click image to enlarge)
  • Pre-tax corpus: ₹1,16,16,954
  • Post-tax corpus with 30% tax and 4% cess: ₹98,64,464
    • Tax owed is ₹17,52,490.
    • 15.09% of the final corpus is owed as tax.
  • Post-tax corpus with 20% tax and 4% cess: ₹1,04,48,628
    • Tax owed is ₹11,68,326.
    • 10.06% of the final corpus is owed as tax.
  • Post-tax corpus with 15% tax and 4% cess: ₹1,07,40,709.
    • Tax owed is ₹8,76,245.
    • 7.54% of the final corpus is owed as tax.
    • (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
  • Post-tax corpus with 10% tax and 4% cess: ₹1,10,32,791
    • Tax owed is ₹5,84,163.
    • 5.03% of the final corpus is owed as tax.

Estimated corpus @ 12% annualised return over 5 years

For the same 12% return, shorter investment duration results in lower tax owed (when looked at as a percentage of the corpus size).

Screenshot from Groww SIP Calculator (click image to enlarge)
  • Pre-tax corpus: ₹41,24,318
  • Post-tax corpus with 30% tax and 4% cess: ₹37,73,530.
    • Tax owed is ₹3,50,787.
    • 8.51% of the final corpus is owed as tax.
  • Post-tax corpus with 20% tax and 4% cess: ₹38,90,460.
    • Tax owed is ₹2,33,858.
    • 5.67% of the final corpus is owed as tax.
  • Post-tax corpus with 15% tax and 4% cess: ₹39,48,924.
    • Tax owed is ₹1,75,394.
    • 4.25% of the final corpus is owed as tax.
    • (Why 15% tax? Assuming indexation brings down the acquisition cost, the effective tax rate may be 15%. Just an unscientific estimate.)
  • Post-tax corpus with 10% tax and 4% cess: ₹40,07,389.
    • Tax owed is ₹1,16,929.
    • 2.84% of the final corpus is owed as tax.


To recap, these are the objective takeaways from the numbers.

  • Tax at 30% is significantly higher than 10% or 20%. (Of course!)
  • The higher the rate of return, the higher the taxes owed.
  • The higher the investment duration, the higher the taxes owed.

The more nuanced and subjective aspects are interesting to think about. For a 10 year debt SIP, if the tax difference is 8% of the corpus vs 13% of the corpus, the choice is easy for me: I’d pay the tax to keep my debt portfolio clean and simple. This is partly because I take barely any credit risk in my debt portfolio. High tax for a low-risk investment is fine.

Other asset classes are not so straightforward. Am I okay to invest in international equity and not be compensated for the risk (with a lower tax bill)? I don’t currently know what my stance is.

Hopefully, we can all think about these nuances and make the tradeoffs that we are comfortable living with.

9 Apr 2024

Random thoughts after our Bali visit

Some scattered thoughts from our recent visit to Bali, Indonesia:

Pura Tirta Empul in Bali
  • While I don’t hate my job, it probably is very stressful. I am not consciously aware of the stress, but my constant ailments pretty much disappeared during the trip, even when I had stopped taking the regular medicines.
  • One of the best things that happened during this trip was bonding with my (8 years old) son. I never thought I’d be able to connect with him at a different level, but this trip made that possible. This is itself reason enough to keep travelling with my children.
  • A day is 8 to 10 hours long. Be it work or leisure, it should be just that length. Adults in the party (my wife and I) were okay to stretch the days to 12 hours, but the children needed their “me” time. They had to put their feet up and watch their YouTube videos or run around playing in the hotel room before they’d go to bed. I need to remember this next time and limit the number of activities we pack into each day.
  • I have always found flight travel awful. Dragging 3 sleep deprived and dehydrated children through airport gates and immigration reaffirmed my dislike for flying.

25 Mar 2024

The sorry state of Indian banks

What do you expect a business to do? To add value to its customers’ lives and charge a fee for the value addition. A win-win arrangement where both the business and the customers voluntarily work together for their own benefit.

What do Indian bank employees do? They simply ask the customer for “favours” to benefit the business at the cost of the customer. (Just to be clear, I am talking in general about banks in India; not the entity named Indian Bank.)

This isn’t new; this has been happening for well over a decade now from what I have seen. Whenever I interact with bank employees, most of them push an insurance product. They don’t even pretend that they are helping me, the customer. They openly describe these as requests for favour.

My family members and I have received calls in the past few weeks from bank employees with requests to open fixed deposits so their branch’s balance sheet shows inflated numbers when the financial year ends. I opened a 10 days fixed deposit because I felt I could help a bank employee. That person knows that a 10 days fixed deposit doesn’t serve a meaningful benefit to anyone—neither to the bank nor to me. But still they were happy with my opening that deposit.

Our banks have been measuring the wrong things and incentivising the wrong things for a very long period. Until banks get serious about adding value to customers, our banks will stay as rotten as they are now.

Image credit: rawpixel.com

Until a meaningful positive change happens, I’d continue to repeat my advice: “Do not ever tell your bank that you have money to invest. They are uninterested in your desires and dreams. They only think about how they can transfer some of your money into their own coffers.”

9 Mar 2024

Can we use ULIPs as tax-free debt assets?

It was a shock to pretty much everyone when the government changed tax rules for debt mutual funds in the 2023 budget.

AMCs have since then been trying to adapt by shoehorning “debt-like” funds into unrelated categories. For example, Edelweiss has a multi-asset fund that is offered as a debt fund replacement (but with better taxation). Parag Parikh has launched a similar fund in the dynamic asset allocation category (the “balanced advantage” category).

I was wondering if ULIPs—the infamous Unit Linked Insurance Policies—can be used for debt investment. An investor can invest up to ₹2,50,000 every year into ULIPs and get tax free returns. There is a lock-in period of 5 years, but the funds become redeemable after 5 years irrespective of how long the policy term is. Since the returns are tax free, ULIP debt investments can be attractive even if they earn 1 or 2% less return than an average debt mutual fund.

That’s the theory. But we need to check if that theory holds any water.

The story of my ULIP investment

I started a ULIP 2 years ago to help a bank employee meet their sales target. I had been thinking of repurposing this ULIP as a pure debt investment. But I didn’t pull the trigger as I wasn’t 100% sure. Coincidentally, I received the annual statement for this policy last week, and it was eye opening.

2022 statement for my ULIP (click to enlarge)
2023 statement for my ULIP (click to enlarge)

If you can’t see the issue in these statements, you’re not alone. Most people can’t spot this.

There are 2 kinds of deduction in the statements.

  • “Mortality Charge” is what the insurer is charging for providing life cover. This is tiny because pure life insurance is very cheap. This charge can be ignored.
  • The other deduction, called “Allocation Charge”, is more sinister. This is for charges like policy administration, agent commission, etc. In 2022, when this policy started, they deducted 12% of the premium as the allocation charge. In 2023, this deduction was 8% of the premium.

Let’s look at the impact of allocation charges more carefully. I paid ₹60,000 as the premium in 2022. Of this, ₹7,200 was deducted upfront for fees and commissions, and only the remaining ₹52,800 was invested. To break even by the end of the first year—i.e. for the fund value to be ₹60,000 by the end of the first year—this investment needed to grow by 14%! Making such a return is no easy feat, so it is no surprise that the policy value never touched ₹60,000 throughout the first year.

I paid the next ₹60,000 premium by the end of the first year. Again, ₹4,800 was deducted from this money and only ₹55,200 was invested causing the investment to stay underwater for most of the second year too.

My ULIP’s fund value over the first 22 months

A policy that started in March 2022 has remained underwater till September 2023! This was the reality for a 70:30 portfolio. It took the 2023 equity rally and a big 70% equity exposure to get this investment to break even. Since debt returns are subdued, ULIPs with 100% debt portfolio may even stay underwater for 7+ years.

My hypothesis is still correct: if pure debt ULIPs make 2% less return than average debt mutual funds, ULIPs will be an attractive option. But my assumption that ULIP returns will fall short only by 2% is way off the mark.

Is there a way to salvage ULIPs that are already bought?

What follows is an untested idea. Say, I let my ULIP stay as a equity+debt blend for the first 7 years or so. Hopefully, the portfolio grows to a reasonable size. After this, I can switch the entire portfolio to debt. Given there is no allocation charge after the first 5 years, this can probably be considered a reasonable debt investment. Fresh investments won’t be possible, but partial and full withdrawals will be available.

If you already have a ULIP, this may be a way to salvage the situation. But don’t buy a new ULIP only to get tax-free debt return. ULIPs make a lot of money for insurance companies and agents. Investors have a slim chance of making money through ULIPs.

8 Feb 2024

Back to my roots

I grew up reading magazines at home. Political news commentary, children’s magazines, lifestyle magazines, science magazines, computer magazines, and whatnot.

Somehow the reading stopped once I moved out to live on my own. Now I am trying to go back to my roots.

One of the magazines in the picture is a brand new subscription; I have no idea how enjoyable and insightful it’s going to be. But I can’t know until I give it a try, can I?

3 magazines: Mutual Funds Insight, Wealth Insight, and Swarajya

20 Jan 2024

Temporal correction of market-linked securities

A “correction” in the securities market is when the price of assets fall.

The market often gets overenthusiastic about securities and the prices go up more rapidly than justified. Once the market participants realise this mistake, the prices come down. Sometimes prices come down sharply, within a few days. Sometimes prices stay more or less stable for many months: this is known as a temporal correction. Or a “sideways market” (vs bull market and bear market).

The chart below is an example of a temporal corrcetion.

You’ll notice that from about early 2020 through the end of 2021, the asset value (current balance in the chart, the blue region) has gone up rapidly. Since then, the balance has been falling and rising. By the end of December 2023, the balance is back to where it was in December 2021.

Essentially, 4 years worth of appreciation was realised in just 2 years, between January 2020 and December 2021. Instead of sharply correcting the price, the market has been tepid throughout 2022 and 2023. This temporal correction brings the asset prices back to a reasonable range.

It’s anyone’s guess where the prices will go from here. If 2024 also remains tepid, then we’d say the temporal correction continues. If the prices go up, then we can say that the correction is over.

15 Jan 2024

My progressive disillusionment about direct equity investing

My desire to dabble in direct equity investments is not new. I also know that direct equity investing is not a good fit for me. Despite knowing this, the desire for direct equity investment hasn’t fully vanished.

Rather than fighting the urge, I decided to give in. That’s usually how I roll. I just give in to the temptation and see for myself. Either I end up liking it or I come away with the understanding that it’s not as attractive or beneficial as it once looked.

If I am going to invest in direct equity, well, I might as well learn about it first. So I subscribed to Value Research’s Wealth Insight magazine. A part of me was afraid that I may end up risking too much of the family money in this direct equity experiment, but I marched on anyway. I have been reading the magazine for a few months now and learning.

Contraty to what I was expecting, I am picking up more and more signals and reasons for not investing in direct equity! Jan 2024 edition of the magazine has a story listing common mistakes investors tend to make. The following screenshot is one mistake from the list:

Screenshot from Wealth Insight magazine with this text: "This tree will grow to the sky: No trend can continue without a stoppage. Something or the other will always play spoilsport. It could be the entry of new competitors, a change in the economics of the product, changes in tastes and preferences, poor decisions by the management, etc."

The moment I read this, I remembered my bias towards holding on to my employer’s shares. I was (and still am to some extent) of the belief that holding on to my employer’s RSUs—which have grown much more rapidly than S&P 500—will make me rich. “No tree will grow to the sky” is the advice I had to see to remind myself that no one company is going to be infallible forever.

A few months of learning has not made me give up on direct equity, but I am not madly in love with that idea anymore. Learning about direct equity investing has made me more aware of the risks and nuances involved. I am in a better place than I was a year ago.

12 Jan 2024

A cluttered portfolio is not a problem—it’s a symptom

Let’s say you have bought a ticket for a 4pm movie show. When you arrive at the movie theatre, you notice that there is a 7:30pm show of a more interesting movie. If you had known about this screening earlier, you wouldn’t even have bought tickets to the 4pm movie—the 7:30pm movie is just better.

What do you do after your 4pm movie is over? Do you stay at the theatre and watch the 7:30pm show too? While some may do that, most people don’t. Despite the 7:30pm movie being good, most people don’t have an uncontrollable urge to watch it. Why? Because people know that it’s just another movie. Yes, every movie is unique, but that doesn’t mean you have to watch every movie out there to be entertained. You can afford to miss even really good movies.

Now replace movies with mutual funds. You have been investing in a flexi-cap fund for a few months. You see a media report that praises a certain mid-cap fund for its stellar performance. You fear you’re missing out, so you invest some money in that mid-cap fund. A few months later, maybe you invest in a thematic fund because the theme sounds so wonderful. Later you invest in a contra fund. If this goes on, you’ll soon be holding a dozen or more mutual funds in your portfolio.

Why does this happen? Why is it so easy to say No to a movie, but so very difficult to say No to a mutual fund? Not just mutual funds—accumulating clutter is true with pretty much any investment asset. People who invest in equity want to add gold to their portfolio. Then some REITs. Then some global equity. Then some InvITs. Then something fancy, say invoice discounting. When it comes to investment assets, many of us have a hard time saying No. Why?

I think I have an explanation.

We know that we don’t miss much by not watching a movie. We are able to control or ignore our desires and urges. Most of the time, it’s not even an issue because we know beyond doubt that it’s just a movie.

But we are not able to say No to investment assets because we lack that confidence. We have no confidence in our ability to make the right decisions. This lack of confidence makes us nervous every time we come across something new. Diversifying into different assets gives us a sense of safety. We hope that at least some assets will bring in profits. This lack of confidence inevitably leads to a messy and cluttered portfolio.

A cluttered portfolio is not a problem in itself, but it’s a symptom that tells us that the investor lacks confidence. The investor has no confidence in their ability to pick the right investment asstes. Nor do they have confidence in the assets they currently hold. They readily make room for new assets because they don’t know if their current assets are sufficient or whether they need the new asset. They err on the side of caution.

Conversely, a confident investor will have a simple, uncluttered portfolio. They are comfortable not having every interesting asset in their portfolio because they are confident about the prospects of the few assets they already hold. They don’t get FOMO (fear of missing out) because they know that it’s just another asset.

6 Jan 2024

How safe are “too big to fail” banks?

When conservative investors ask for “safest banks” to keep their money in, a popular answer they get is to stick to the D-SIBs—the list of banks that the RBI has declared as domestic systemically important banks. These banks are considered “too big to fail”. People assume that if such a bank were to fail, the government will intervene and save them. But is that really true?

What are “too big to fail” banks?

To understand this better, we need to start from the origins of the idea of systemically important banks. During the 2008 financial crisis, many governments had to bail out big banks in their respective countries. The governments were pretty much forced into this bailout since these banks were “too big to fail”. If such a bank was allowed to sink, the ripple effects would have been so severe that a significant chunk of the economy would have fallen with the bank! So the governments didn’t have much of a choice but to distribute cash to bail these banks out.

This is a moral hazard. A moral hazard is defined as a situation where one party takes excessive risk because they know that another party will rescue them if the risk were to realise. Big banks now know that they can lend recklessly in a pursuit to maximise their profits. If the low quality loans they give out are repaid, the banks get to keep the profit. If the lenders fail to pay, well, the government will bail the banks out anyway. So the big banks have no reason to be prudent about their lending. This is a problem.

To mitigate this moral hazard, a framework was brought up, called the G-SIB Framework. Essentially, banks that are too big to fail are identified and they are held to a higher bar than other banks. If a big loan they give out goes bad, the onus of recovering from that loss is placed on the bank itself.

The D-SIBs list, or the “domestic” systemically important banks is the same framework applied to Indian banks. The Reserve Bank of India (RBI) determines which Indian banks need to be held to a higher bar and sets them that bar.

What does it mean to be a D-SIB?

To understand D-SIBs, we need to first understand how the RBI prevents Indian banks from sinking. The RBI does this by prescribing a Capital Adequacy Ratio (CAR). Read this tweet thread by Kirtan A Shah to learn how CAR works, but in short, banks are required to have “risk capital” of at least 11.5% of their loan book. Risk capital is capital the bank can use to make up for any loss arising from bad loans.

An oversimplified example may help. A bank that has lent ₹10,000 crores needs to have risk capital of at least ₹1,150 crores. If the bank loses ₹200 crores to bad loans, the bank will dip into the risk capital to make up for the loss. Now the available risk capital is only ₹950 crores while the bank has active loans of ₹9,800 crores. The bank will need to raise additional ₹177 crores to bring the risk capital back to the required 11.5% level.

That 11.5% captial adequacy ratio is for “ordinary” banks. Since the nation cannot afford to have a D-SIB fail, the D-SIB banks have a higher CAR requirement. HDFC Bank and ICICI Bank need to maintain a CAR of 11.7% while SBI needs to maintain a CAR of 12.1%. That’s pretty much it.

In essence, neither the government nor the RBI is committing to bail out the big banks. These banks are classified as D-SIBs only to reduce the likelihood of them needing a bailout tomorrow. Assuming sovereign guarantee for these banks is a mistake.

Should we stick only to D-SIBs?

While any additional CAR doesn’t hurt, it is up to each investor to decide for themselves what protection an additional of 0.2% or 0.6% CAR is going to give them.

The RBI has been very proactive in regulating banks and preventing bank failures. Depositors have lost capital from the failures of PMC Bank and some small cooperative banks. But there has been no loss due to other bank failures. Yes Bank and Lakshmi Vilas Bank customers suffered some temporary liquidity issues, but no one lost their deposit.

I personally don’t consider a CAR of 12.1% to be significantly better than 11.5%, so I consider all domestic banks to have similar amount of risk. Choose any bank that you are comfortable with, but know that “too big to fail” is not a guarantee of bailouts.

What if I want more safety?

Some of us may find the banks’ capital protection measures unconvincing. The additional protection from the D-SIBs is not significantly better, either. If you seek even more safety for your capital, you have a few other options.

  • If you are okay with volatility, you can buy gilt mutual funds. The bonds are isssued by the government; the government can pay its loans off much more easily than any bank can.
    • What’s the downside? There will be volatility and the returns will be unpredictable.
  • Park your money in post office savings schemes. This money is essentially lent to the government, so it’s very safe.
    • What’s the downside? Working with the post office is not as convenient as working with a bank.
  • If you are savvy enough, find mutual funds that have less duration risk and invest predominantly in gilts. Quantum Liquid is one such fund, but there likely are other options too.
    • What’s the downside? You need to keep an eye on the mutual fund’s portfolio to make sure that the fund management team is not exposing your money to excessive risk.

1 Jan 2024

2023 yearly review: money management updates

My goal for 2022—sort of like a new year resolution—was to remove stress caused by money management. It’s been 2 full years, and I think I have accomplished that goal. This was accomplished by staying more organised, being aware of financial shocks and better planning to face them, and most of all becoming more willing to use the emergency fund.

A simpler holding plan for the emergency fund

I used to refuse to touch emergency fund most of the time because I’d tell myself that most of the situations were not a real emergency. This meant scrambling to gather cash to face the situation. All this while, I also wouldn’t want to stop my regular investment. This meant I was sacrificing the current needs only so I can stick to an ideal.

This reluctance to touch the emergency fund was also caused by my decision to use a hybrid mutual fund for holding my emergency fund. Selling equity for short-term needs never felt okay, so I kept trying to manage without touching the hybrid fund. Eventually, I took my financial advisor’s advice and split my emergency fund between 1 bank account (with auto sweeping fixed deposits) and 3 liquid funds. Living with this for about 2 years taught me that a bank account is a far better place to store cash than liquid funds. Now I have 77% of the emergency cash in a bank account; the remaining is still in a liquid fund (mostly because of inertia).

Having an emergency fund means more money for long-term investment

What I learnt after having a dedicated emergency corpus was that I was a lot more conservative than I thought. I tend to keep some excess cash everywhere just in case I needed it for something in the near future. If I have a surplus of, say 1½ lakhs, I’ll maybe invest 1 or 1.2 lakhs first and hold the surplus for a while. Now I want to change my behaviour to invest all 1½ lakhs in one go since I have an emergency fund to support me if/when a need arises.

It’s counterintuitive, but the presence of an emergency fund—a small corpus that is purposely kept in non-growth assets—enables us to invest more aggressively. I am yet to get comfortable with investing all the excess I have; I hope to get there in 2024.

Other tidbits

  • More diversification: My investment portfolio has a big concentration of my employer’s shares (which I receive as a part of compensation). I was ignorant and kept piling it up, but now, for the past 2 years, I have been working on reducing the concentration. In 2023 alone, I was able to reduce the number of shares by 15.6%. The concentration is still big, but looking at this reduction makes me happy.
  • More simplification: Back in 2021, my investment portolio had 6 equity mutual funds and 11 debt mutual funds. That has now reduced to 5 equity funds and 4 debt funds. In the next few years, I plan to bring it down even further to 2 equity funds and 3 debt funds.
  • Less anxiety: If I were a king, my spreadsheets would be my castle. I have been using tracker spreadsheets for pretty much everything. Spreadsheets + todo list + automated payments/money transfers have significantly reduced the amount of time I need to be thinking about money. Earlier, I’d check my bank account every few days and think if I had enough money to get through the month. These days I think about money a lot less because my trackers give me good visibility and I am starting to effectively take advantage of my emergency fund.

Overall, 2023 was a productive year. I am looking forward to continuing the trend into 2024 and beyond!