Notes from the USA (Apr 2012) - a guest post

If you are like most small investors who have been in the investing game for some time, you probably have an unplanned and unwieldy portfolio of funds/stocks with a lot of losers and a few winners. Loss aversion may motivate you to hang on to the losers with the hope that they will somehow by some miracle turn into winners – or, at the very least, allow you to break even. The few winners are quickly disposed off at small profits lest they turn into losers as well.

How does one break out of this losing cycle of ‘cutting the flowers and watering the weeds’? Learning the rules of the game before playing it is a necessary pre-condition – but it isn’t sufficient. Not knowing the rules is courting disaster, but just knowing the rules won’t turn you into a good player. For success in your investments, you must be dispassionate and learn to be patient and disciplined. Easier said than done?

In this month’s guest post, KKP suggests how you can generate better returns by actively managing your investments with an asset allocation plan that takes some of the emotion and guesswork out of your investment decisions.

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Active Management of Investments

Everyone knows that managing investments can be a complicated and overwhelming affair, and for many investors, entrusting the management of their portfolio to a broker or an advisor may seem like the smart thing to do. In the end, very few investors have found that to be as successful as per expectations. So, is it an issue with our expectations, or are these brokers and advisors in that position where they need to make money from doing a ‘job’, as opposed to generating high returns of the invested cash? I think that with the help of powerful new tools commonly available over the net (for free and fee), self-directed investors like you and me can invest more confidently and be better informed about actively managing our investments and can greatly improve our long-term financial well-being.

Entrusting portfolios to mutual funds might be the right thing to do for some investors, but even that route has not proven to be as good. Hence the invention of passive indexed portfolios which has commonly turned into ETFs (Exchange Traded Funds). This simply means that they are like mutual funds, but are traded all day, with total transparency to the investor. Transparency comes from the fact that they are following a predetermined mix of stocks or bonds created by one of the brokerage houses under the name of one of thousands of indices. Besides ETFs provide this simplicity generally at a lower cost of operation than Mutual Funds, hence the popularity.

When we become more informed, we get deeper into being an active investor. As we become more active, we can get deeper into picking a basket of stocks, a few ETFs, and finally some other asset classes. So, the more knowledge about investing and the financial markets that we gain (and it comes over time), the better it serves us and our families. Best part of all is that this passion will last a lifetime, and especially serve us well at a time in our lives when our kids have grown, and we have more time on our hands.

Every investor whether young or mature, rich or middle class, needs to have an investment plan that is documented to lead to financial success. Defining life’s goals, financial needs, current disposable assets, risk tolerances and knowing the benchmarks that we wish to beat is the key to going ‘independent’. This 360 degree plan is needed to determine which investments are best for us, and of course, the plan changes over time. After all, how can we accomplish our goals, if we don’t know what they are or how to get there?

Asset Allocation: Spreading investments across a variety of asset types that react differently (and this is critical) from each other in both bull and bear markets can give you good overall returns, year after year, while reducing the overall risk. Young investors miss out on this, as I missed out also, in my younger naïve days. Once ours goals, risk tolerance, and benchmarks (that we want to beat) are documented, it is time to decide/develop a portfolio with weights. The most important step then is to rebalance with ‘new’ ideas, but essentially keep the asset allocation percentage constant from year to year (apart from making overall changes every 5 years – more to come on this). Annual rebalancing works for most, but if you want to be active, then quarterly rebalancing is also OK. This will allow you to keep your overall portfolio oriented towards the long-term goals with which the asset weightings are aligned to your thinking. Also, it will avoid the emotional mood swings that we all go through when the markets are too far up or too far down.

Allocation changes every five years are necessary by taking your laptop / iPad / Tablet to a coffee shop and thinking this through with a ‘strategic mind-set’. Look at my previous post on ‘strategic thinking’. Once you get good at both strategic thinking, and evaluations of everything every 5 years, the Asset Allocations should match your age, need for funds, and also re-alignment with the then-current-goals. What if you were planning to do a huge upgrade on the housing front? What if the kids are now talking about going to a Private University instead of a Public University (delta between these in the US is approx $30,000 per year). Or what if the wedding of your son/daughter is coming up earlier than you planned. All of these are big events that don’t have a fixed date or expense amount. In addition, we are all aging. So, these changes need to be incorporated into your Asset Allocation, over time.

In summary, allocate your assets, keep some assets aside for ‘playing with the market’, and keep the discipline and faith in the longer term performance of the markets. Also, do not forget to have bonds, real estate, gold/silver/diamonds, rental-real-estate, FMP/FDs etc in your portfolio as a permanent aspect of your assets (change allocations only). For those who do not believe in investing in gold/silver/diamond, these assets can be worn to make you feel good. An FMP feels good inside the heart, but a gold pendant with a 1 carat diamond looks good right outside the heart on your wife!

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

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Notes from the USA (Nov 2011) - a guest post

The US economy is slowly recovering from a massive downturn. To boost growth, interest rates have been maintained at near zero levels. Despite two rounds of Quantitative Easing, growth hasn’t picked up as expected. So, inflation has also remained low.

India has the opposite problem. High inflation has been fuelled by strong growth. To contain inflation, interest rates have been increased. But the inflation adjusted fixed income returns are negligible in both countries. In this month’s guest post, KKP gives his views on how to truly get rich by boosting your inflation-adjusted returns.

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Feel Rich Only with ‘Real’ Inflation-Adjusted Net-Worth-Growth

The 8^th wonder of the world is ‘% rate compounding’. In simple terms it means that growth in money based on money-making-money. In the US schools, I have taught kids how to become a millionaire by starting a part-time job at age 16 and putting $100 per month into an interest bearing account that multiplies money over the next 20-40 years of their life. On a side note, it is very interesting how many millionaires there are in the US, and in general, their profiles/habits/investment-styles (Google search for this info).

Well, the same effect of compounding works against us when it comes to inflation. In mainstream economics, the word ‘inflation’ refers to a general rise in prices measured against a standard level of purchasing power. Previously the term was used to refer to an increase in the money supply, which is now referred to as expansionary monetary policy or monetary inflation. Inflation is measured by comparing two sets of goods/services at two different points in time, and computing the increase in cost not reflected by an increase/decrease in quality. This is something that emerging economies grapple with during their entire growth phase, and we call that ‘growth pains’.

The inflation rate in India was last reported at 10.1% in Sep 2011. From 1969 until 2011, the average inflation rate in India was 7.99% reaching an historical high of 34.68% in Sep 1974 and a record low of -11.31% in May 1976 (strange but reported as negative). Many banks in India are offering 9% to 10% FD rates today, with corporate FDs getting much higher rates (at higher risk levels). Well, that is just a net 1% to 2% rate of return (after inflation). The chart below shows fluctuations in inflation within our Indian (a.k.a emerging) economy over the past three years. So, money is growing at a net-rate of only 1% to 2% in FDs or FMPs.

The US is about to move from a highly controlled non-inflationary environment into a high-inflation environment due to the non-stop printing of treasury bonds (no gold collateral is needed as everyone knows). Inflation basically makes you shell out more dollars to buy the same product (same quality and quantity assumed). So, one needs to earn more as a result - just to keep up with the inflation. Now, what really happens with inflation is a reduction in the value of the currency. So, as an example, one needs more dollars to buy an asset like a home, a gold coin or gallon of milk. See the chart below and study it for a couple minutes. Has the S&P500 really grown even though our Mutual Fund account might be showing net-growth-in-value? Maybe, slightly!

On the other hand, companies pay employees more every year to keep up with the inflationary environment, and over a period of time everyone feels good that they were earning $24,000 per year in 1996 or 2001, and now, they are earning $50,000 per year. But, when you measure it in terms of the depreciation in the dollar (caused by inflation), are they really better off with the higher salary? Or, would they rather have a no-inflation environment and get paid slightly more for their growth in experience and skills?

So, compounding effects of inflation in every economy around the world is really killing the value of the underlying savings that we hold, unless we keep growing that money ABOVE the inflation rate on a consistent basis. So, in India, if one had Rs 10 Lakhs in 2001, and now has Rs 21.58 Lakhs, then at the average inflation rate of 8% per year, their net-growth in wealth is a BIG ZERO. Same zero growth applies if one had Rs 1 Crore in 2001 and now has Rs 2.158 Crores. Yet, all of us feel good about the growth in the ‘total raw value of our accounts’.

Emerging economies give a lot of people a false sense of security that they have grown their income or assets by a huge amount over time, but one needs to beware of the 8^th wonder of the world working in ‘reverse’. India is going to generate the largest population of ‘middle income earners’, but one has to consider what a ‘real middle income level’ is, as inflation rate is eating away a lot of the increased income. As a result of the growth in the underlying Indian economy, a lot of low income earners will start feeling like middle-income-families, but for many it is a false sense of hope and feeling. Beware and generate a Return on Investment (ROI) way above inflation through a mixture of Stocks, Bonds, Real Estate, Commodities, FMPs and FDs.……That is the only way to feel rich and get truly rich!

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

Start your own risk free FMP

We have now spent 9 months in a bear market. For investors who had entered the markets in the last 5 years, this is the first experience of how a bear market can destroy wealth.

What we saw in 2004 and 2006 were just bear phases in a bull market, which provided opportunities to buy.  Many small investors jumped in to buy in March and July this year - only to see that there was no real recovery in the markets.

Experts have now started talking about a 4-digit Sensex, and investors who have been in denial for the past 9 months are now thinking and talking about how to protect capital and reduce losses.

The mutual fund industry has been promoting Fixed Maturity Plans (FMPs) of 12 months+ duration and trying to explain the benefits of lower tax against a bank fixed deposit. Of late, they have even started offering 1 month FMPs - and are not mentioning anything about tax benefits!

A small investor trying to protect his capital should start his own FMP and make it completely risk free. How? It is so simple, that it is almost a no-brainer.

Let us say you have some investable cash of Rs 2 lakhs. What are your options?

a) You can buy shares at low prices and watch them go lower;

b) You can buy MF units and watch their NAV drop

c) You can park it in a bank FD for 2 years and earn 10% interest

d) Start your own FMP - start with Option (c) above, but take monthly or quarterly simple interest. Depending on your risk tolerance, set up a recurring deposit (RD) account with 20% or 50% of your monthly/quarterly interest. The balance interest should stay parked in your savings account for periodic purchases of shares and/or MF units. 

After 2 years, when your FD matures your entire capital will be intact, the RD account would be intact as well, and the shares or MF units that you purchase should start showing some real gains, as this bear market should be history by then.

Simple, isn't it? But exciting? No. But who said building wealth is exciting? It is a slow and steady and disciplined process to be carried through for many years.

(I try to preach what I practice. In Oct '07, I had sold a percentage of my holdings in shares and MF units when the market looked overbought. With the proceeds, I opened a 3 years FD with a leading private bank. 20% of the quarterly interest earned is reinvested in a RD. The balance interest is accumulating in a savings account. I have slowly started to reinvest in shares and MF units.)