RISK Profile

 Risk profile is generally asked by any financial advisor. What does Risk Profile mean? In simple terms it is your capacity to take risks. You may want to take a 100% risk with your capital, but the questions they ask before slotting you in a particular risk profile is the real risk YOU can take. I may have 10 Lakhs and may want to invest it in a 100% risky investment. It can fetch you good returns after a few years or it may not. But till such time how are you going to survive. So, the risk profile takes your income, expenses, emergency fund etc and your age (key) to determine the risk profile.

Risk Profiling is important and I have categorised as follows: 

a) 20 years to 35 years (assuming you start earning) - High Risk (Equity/Ipos/crypto/nft) - Risk (Equity/Mutual fund) - Safety (some long term debt funds)

b) 36 years to 45 years (assuming you have invested above and have some capital)- Risk (Primarily Equity, Index funds and some IPO's)- Risk (Mutual fund -aggressive ones/sectoral)-Safety (some medium term debt funds)

c) 46-59 (assuming you have made a neat pile by now)- Risk (Mutual fund- Multi asset/Multicap/some sectoral, Equity large caps/index)- Safety (More medium and short term debt fund)- Income (funds/equity that generate dividends or deferred annuity plans)

d)60 and above - Safety (liquid funds, short term funds)- Income ( funds that get you regular income). By this time, your investment should focus on Safety and getting regular income for living a normal life. If over and above that you have funds, you can risk by trading/playing the market for time pass.

The above may or may not be applicable to all as each one may have some other commitments in terms of debt of house/family commitments/health issues etc. But investments like above sample is required for ensuring a financial freedom, at the age of 60

Spend or Save

 It is always a conundrum for young earners who are told to save, but they have their own aspirations/desires and FOMO and to be seen as part of the young up swinging crowd.

While it may stem from pent up desires to spend on things you want, UNLESS you are earning a phenomenal amount of money, SAVING is a key ingredient for life long success.

Going out, travelling, buying things for short term use etc. should be done if at least 30% of your salary saving is done apart from your day to day expenses. If money is still left over after that, think of spending. Till such time, belt tightening or holding on to your gratification is key for a financially peaceful old age.

In older generation, investment in the house was key  and once that was done, pension used to take care or expenses were kept to minimal in terms of food/health.

Expectations from children were very high to take them through old age. Saving and Investment was not possible given the frugal income, large family of own and taking care of their parents.

But today's world is changing. The children have their own life and parents should have saved. The children also should start saving as they will be left in a no man's land with parents not leaving much and having spent their money in their youth, find themselves in a difficult situation.

Most of the realizations come when someone is in their 40's when they start to panic as they feel that in next 10-15 years they will retire and do not have the CASH or financial comfort to manage their old age.

40's also brings in panic investment and Banks usually bank on this insecurity and provide products which are more to get commissions than a safety net for the investor.

Believe it or not, a comfortable financial security at the time of retirement will bring far more happiness than the spends done at young age and in particular taking Debts or EMIs. If gratification can be postponed, and savings encouraged when young could lead to a peaceful retirement without the need to worry about the next meal. 

Read an interesting post and thought I will update this post on saving.

Method 1

Suppose you earn 100 - You will spend ,say, 60 on Needs like food/shelter/basics etc., you will spend 40 on Wants - like buying a new phone, new clothes, eating out, entertainment etc. You will end up saving Zero, which will impact you going forward.

Take the other saving scenario. 

Method 2

Suppose you earn 100- you save 20. You will spend 60 on Needs like food/shelter/basics etc. Now you are left with only 20 for your Wants and that will decide which of the want is critical and will buy or wait till you have enough money.

This will ensure you save going by the 2nd method.

The thumb rule for spending money wisely is

50% on Needs - housing, food, transportation, utilities, insurance etc.

30% on Savings -investments, emergency funds

20% on Wants - Travel, entertainment, clothes, electronic purchase etc.

1 and 2 can vary, but ensure the 2nd is maintained as closely as possible to the %age to avoid retirement worries.

 

 

 

THE DEBT TRAP

 Debt - such a simple word, but that is one which puts people into so much trouble.

It is primarily using tomorrow's income today. Debt is such a compounding quicksand that once you fall into it, it is near impossible to retrieve yourself.

When you are borrowing, you are not doing a simple debt, but you are borrowing your future. Living within your means is a universal truth for peace and harmony, but the moment you step into debt, your life is marooned and some at end feel giving away life as the only solution.

Why is DEBT such a bad word. It is because of poor management and thinking. A person in dire strait thinks he can quickly repay the debt, not understanding the interest, the penal interest etc and the pressure to meet the deadline.

Eg. You take 10,000 Rs for 1 year at an interest rate of 8% (which is normally 2-3% higher than fixed deposit interest in normal circumstances, but depending on whom you go to and your credibility and collateral can be 10% or more too).

Thus 10,000 @8% is 800 rs interest. So, you assume you pay 10,800 Rs at end of year. But the loan giver generally deducts interest upfront. So you are given 9,200 only. This makes the rate go to 8.7%. A subtle nuance but significant change.

You default in the first year, saying you will pay in 2nd year as you have used that money and income is not supporting the repayment.

Now it jumps to 10,000*8%=800 or you have to pay overall 10800 when you got only 9200. That is 10800/9200= 17.4%. This quickly jumps if there is a penal interest or you have hoodlums coming and knocking your door.

So many farmers commit suicide in India, till a bit of micro finance came. The local lenders used to charge 50-60% interest and take the children from the parents to work for them. The farmers take small loans thinking their crop will be good their prices will be good and can pay 50-60% interest and return their loan. But unfortunately, they are bonded and whole life they work for these money lenders who exploit them and also take away their lands.

Thus DEBT IS ONE OF THE DEADLIEST MEDICINE TO TAKE AND I AM TELLING ABOUT PERSONAL DEBT.

Companies taking debt, is though equally bad, however has a logic as they expand their business (i.e for revenue generation) by building more capital items. Thus if demand exists, say a cola company, as predicted by a hot summer and company puts manufacturing plant to make extra bottles of cola and sells it, it can recover its money and pay off the loans. Where instead of a hot summer, it is a cool weather, the Company can get into a debt trap.

Reason why the Companies take Debt is something called Debt Leveraging. For a company to get equity funds (no expectation of return, but take the risk that company will pay you good dividends if it makes profit) is difficult as equity holders give out at say Risk free govt bond rate (say 7%) PLUS Risk premium (which can be say, 4%). That is equity holders expect a 11% return. If company can get from Bank @ 8%, and generates income, it effectively saves 3% (11%-8%).

Investors when investing thus look at financials and see if the Debt is reasonable for a company- what is called the Debt/Equity ratio, which is a standard 2:1. You are taking Debt at max of 2 times your equity. Normally, business without hiccups can manage this and still pay a good dividend and helps in expansion in a growth economy. Investors will not touch a Company with Debt in declining growth company as they know that the Company will not be able to service their Debt. This is calculated in another ration called Debt Servicing Ratio (EBIT/Interest). This shows how many times you interest is covered by Profit. Higher the ratio, better is the Company.

On a personal Debt, 

1) Never borrow, unless you have sufficient Assets that can pay off the loans if required. (If you have gold or other FD amount invested and for short term you need Debt, you may take a chance as when time comes to pay Debt, you can sell gold or liquidate FD)

2) Never borrow on the assumption that your income in future will be sufficient to pay off the installments. If income stops for any reason, a huge burden will fall.

3) Never borrow, if you are not 500% sure that it can be repaid in your life time. You may die, but your children, wife carry that burden through generations.

4) Always maximize down payment, in case of large purchase like house, which will keep Debt at a Sane level as well as save on interest to avoid falling into a Debt trap.

5) The Debt trap is sometimes so bad that you get BP, Diabetes (all stress related) and on top of Debt you are burdened with medical expenses and repayment becomes near impossible.

6) Like someone said, Debt is like modern day slavery. Be free.

7) Debt induces Ostrich effect - Bury the head in Sand thinking Danger will be over.

Marriage and Expectation

 Charlie Munger's take on lowering expectations: “That's how I got married. My wife lowered her expectations.”

This got me thinking on Women getting married. Their initial expectation of a six pack, understanding, Shahrukh features etc. But as they grow older and don't find their expectation starts to go a notch lower. Investments are also like that. People start thinking of greats like Buffet worth in billions and soon realize that it is a long term plan and not an overnight success. Slowly, their expectations get lowered and invest slowly over  a period of time or some take huge risks and think they can easily earn money and put in investments which may turn out to be duds.

This interestingly brings a statistic test called Chi Square Test - an expectation test.

A chi-square test is a statistical test used to compare observed results with expected results. The purpose of this test is to determine if a difference between observed data and expected data is due to chance, or if it is due to a relationship between the variables you are studying.

Rich Charlie Munger died yesterday -28th Nov 2023 and remembering his famous quote on expectations.

Many people take trophy wife, more to show off, than having a real partnership. Both lead their own lives and come together for parties or for the paparazzi photo ops.

Like I mentioned in other blog that wife should be a person you grow old with and would greatly help if there is a common thread between them- either music, reading, watching movies or such other common hobbies that hold them together in old age. Young and high end hormones help for a short time, but what afterwards. That is the question on expectations and reality. Both have to be balanced. 

 

 

 

 

 

Diversify or Concentrate

 One of the biggest hurdle which a young investor faces is whether to concentrate or diversify your investment.

This persists over your life time of investment and in particular when you read one story that small and midcap has done 40-50% return or sometimes you see that small and midcap has collapsed. Thus at times, in particularly hindsight, you feel you should diversify or concentrate.

My personal take is as follows, Though I respect each individuals risk taking and risk losing ability.

If you are a person looking for a steady growth over a period of time and not bothered about 40-50% some one made or is making, then go for DIVERSIFICATION. That is out of 100 Rs, you put some in index fund, some in large cap, some in midcap, some in small cap and some in gold.

On the other hand if you are a person who likes to take risk and does not mind losing a large chunk of money (like a lottery), you may go the risky funds way. Like if you have 100 Rs, invest 50 in small cap and 50 in mid caps. It may or may not give you the returns you want.

Finally, if you have reached your goals of having sufficient money by following diversification at a certain point of life, you can take a chance and risk some in IPOs, small caps or midcaps or direct equity.

Thus Diversification on Concentration is a state of mind play as well as the backup funds you have. 

As a note of caution, while diversification is good, too much diversification will also not help. Thus 100 rs is invested in 50 stocks. A gain of 1 re in some will not generate wealth. Maximum recommended is 10-15 stocks or 5-6 mutual funds. This helps you to concentrate your understanding on these rather than getting lost in too many stocks.

Lemmings

 Lemmings are small rodents and not fish as some wrongly assume. Lemmings term is used when a crowd blindly follows something which it does not know. Just because some one is running on a fear or rumour, it also runs.

Investments are also something like Lemming. People flock to that particular investment just because returns are higher and the fear of FOMO is there and just flock to it. This can have negative effect and investment should not be on the basis of Lemmings.

To generate wealth over long term, requires steady, constant investment that grows 10-15 or even 20% beating the inflation. It's not like a dip into the sea when tide is low and come out when tide is high. It may work once or twice, but invariably people get caught in high tide and when low tide comes they are left without any clothes.

There are many examples in the last few years like the Real Estate, Sectors like Chemicals, Pharma, Banks, FMCG where people have put in investments at PE of as high as 50 and above and suddenly get disheartened when the stock crashes. This creates a negative mindset on investment and poor returns over long term.

Many people when they see some investors (over a long term) has made money in stock market, think that is the best place to invest and jump into it, losing a lot of wealth. People should realize that wealth is created over a long period of time layer by layer and not a quick dip.

Earn-Keep aside for investment-Spend should be the mantra for youngsters just about tipping their toes in the field of investment. This will help in generating long term wealth. As nations people become rich, investments will generate more companies to innovate and bring products creating a market and this cycle goes on.

Begin early investment to have a wealthy portfolio at the end of the twilight years.

 

Health Insurance

 While we are young, we eat all the junk foods as it is tasty and full of high sodium by way of salt and high fat by way of oil.

While some do exercise and eat moderately, for most of us it becomes difficult to burn off the excesses and over a period of time it leads to an unhealthy body.

Most of us are covered by medical insurance by the company when young (at least partly), but once a serious issue comes it can lead to a financial disaster.

As a prudent practice, it is always wiser to have a medical insurance apart from the Company provided to a) build a history of no claims and b) to gain confidence of the insurance company that you are taking care of health and easier to cover up pre existing as well as insurance above 60 years which are difficult to come by.

So, what are the medical insurance policies key things to be kept in mind

First, is one should take a Base policy. This can be, say, (in year 2023) INR 10 lakhs

Second one should take a TOP UP or SUPER TOP UP policy of , say,  INR 90 lakhs.

The second one is to cover any unforseen exigencies and is generally much cheaper than 1st one.

Other key points to note when taking Medical Insurance

a) Buy a Comprehensive Medical policy

b) ENSURE No Room Limit (This is critical as your claim is based on that)

c) No Sub limit on various disease (The ins. cpy puts a max on certain claims like diabetes etc.

d) Unlimited No of restore (This is to ensure if you, by chance, get hospitalized again to cover it)

e) MOST CRITICAL Life long renew-ability (Some ins. companies after 70 years do not renew the policy and you could be stuck) 

f) Maximum 2 years for pre-existing disease (DISCLOSE ALL YOUR DISEASE FULLY-EVEN IF AGENT SAYS NO. One of the reason claim gets rejected)

g) Buy the policy at the earliest ( 30 years to 50 years maximum). The older you get fresh policy comes at a higher cost

h) Senior Citizen policy is after 60 years.

Cost for Husband Wife less than 65 is around 30-50K /year

Cost for Husband Wife > 65 is around 50 K plus

For family (till kid is 18 years) buy a floater policy

Contact ditto - a company that helps with insurance without commissions.

As Rajaji said to R.Venkatraman, ex president when he went for condolences of one of the son in law, that it  was not a great thing to live a great age, "One has to bear the sorrows of the next generation".