Diversified Protfolio

What is Portfolio ?
Your investments all together is your portfolio , as simple as that .

So , if i have
10,000 in shares
20,000 in real estate
30,000 in Fixed Deposits
1,000 cash

that's my portfolio


What is an Asset Class ?

An Asset class is something where we can invest and build assets. If i buy a Home or land, i build an asset in real estate category, if i buy anything in shares or mutual funds (equity), i create assets in Equity asset class. They are just categories.


Following are some asset classes:

Asset Class	Source	Return	Risk	Liquidity
Equity	Shares, Equity Mutual Funds, Derivatives	Very High Returns	Very Unsecure	Good
Debt	Fixed Deposits, PPF, NSC, FMP	Low Returns	Secure	Average
Real Estate	Land, Flat, Home, Commecial Plots	Good Returns	Stability	Very Low
Gold	Gold/Silver	Hedge against Inflation	Stability	Average
Cash	Cash	Negative due to Inflation	N/A	Excellent

Why Diversification ?

When you diversify you investments over different asset class, not only your money gets diversified, but also risk, so if some particular asset class is not performing well, it will affect only that part of your portfolio and not whole of it.

Obviously it also effects the returns, you returns are collection of returns from all the asset class, so even if some asset class did not perform over a period, it doesn't affect you hardly.


Lets see some examples :

1. Anyone who was heavily invested in "Debt" around 2003-2004 didn't get high returns
from the zooming stock markets (equity) for 4-5 yrs
2. Anyone who was heavily invested in Equity around start of 2008, saw his investments
go down by 40-60%
3. Anyone who is totally invested in Debt cant get instant money if required, either he has
to take some loan over those investments or break his PF or FD etc.


That does not mean, non-diversification always hits ...

1. Anyone heavily invested in Equities before the bull run of stock markets in 2003 onwards
made fortunes (but at their risk) .
2. And people who had most of there money in GOLD in 2007 got the highest returns
compared to any asset class.
3. It totally depends on person to person. Also inside every asset class, another level
of diversification is important. Like in Equity there are different categories like Large Cap,
Mid Cap, Small Cap

In Mutual funds there are sectoral funds, equity diversified, balanced funds, debt funds, liquid funds etc. Another level of diversification is also necessary to achieve high level of diversification .


Case study

Ajay a software engineer earning Rs 35,000 monthly (post tax) with a Family of 4 (1 wife and 2 kids) has following portfolio

Expenditure : 20,000 per month

Portfolio :

Tax savers Mutual funds : 1.25 lacs (locked for another 2 years)
Fixed Deposits (for 5 years) : 2 lacs
PPF : 1 lacs
Cash (in bank) : Rs 25,000
Insurance Payout : He pay 50,000 per year as life insurance premium for an endowment policy, for which he is insured for 12.5 lacs for 20 years. he started this policy before 4 years.


His Future plans

1. His goals are to buy a home in another 5 years for which he need down payment
of 3-4 lacs
2. Want to save 10 lacs for his each son's education in 10 years
3. He want to retire early with monthly income of 45,000 atleast


This Portfolio looks like diversified, and yes it is, but not in a well mannered way.
The asset wise allocation is

* Equity : 25%
* Debt : 70%
* Real Estate : 0%
* Cash : 5%


His overall Portfolio Shortcoming

- His exposure to different asset class is not well balanced
- His Life insurance is very less and and not at all enough.
For this he is paying a hefty amount every year which adds a lot to his burden.
- His Equity Allocation needs to go up
- His Debt allocation needs to go down
- His cash needs to go up for liquidity.
If he needs 1 lacs suddenly he can't get it, or will get it after breaking his FD.


Suggestions :

The first thing he must do is to restructure his portfolio.

* He shall surrender his existing Endowment policy and take a Term Insurance of 35-40 lacs for 20 years for which he will pay around 13000-14000 per annum. he will save surplus of 40,000 per year because of this. Also when he surrenders the policy he will get back around Rs. 2.4 lacs

* He must invest more in Shares and Mutual funds (as his risk taking capabilities is more because of his less age and less dependents). Now he got 2.4 lacs back after surrendering endowment policy

* He shall consider increasing his Cash to a level which can meet his contingent needs if any arised. He shall have atleast 2 to 3 times of his monthly expenses as contingency fund, which is totally liquid. Soo in this case it will be Rs 60,000.

* Also apart from Cash and investing in Tax saver mutual funds, he shall consider investing in some non-tax saver mutual funds which also gives him near liquidity. As per Govt laws you cannot break Tax Saver mutual fund investment before three years (lock in period)

* He may leave the debt investments as it is. If he wants he can break his FD incase he is going for the Home loan, he can increase the down payment part from this money.

* Incase he is going to take home loan after 1 year, he can also take some loan on his PPF, atleast for some part he will pay less interest than the home loan.

* Also he shall invest some money in GOLD, to give more stability and security to his portfolio.

* Atlast he shall consider taking a Family Floater Health Insurance plan , which helps him to secure his Family from and health problems or illness.


Recommended Portfolio

Apart from His Home (considering he takes Home soon)

* Equity 65% ( Direct shares 20%, Equity Funds 60%, Balanced Funds 20%)
* Debt 20%
* Gold (ETF) 10%
* Cash 5%

Diversification does not say that you have to invest in some money in every asset class for sure , the idea behind it is just that the risk is minimized by diversification and the portfolio is more stable.

How does inflation affect your investment

Come every friday morning, you get to see inflation numbers in bold figures in the newspapers and television channels. So how does inflation affect a common man and its investments? So lets understand inflation and its impacts.

What is inflation?

To put it in simple terms, inflation is nothing but an increase in cost of living for a person on a yearly basis.

Eg. If inflation is 8%, then theoretically a good which was sold for Rs 100 on the Same Week of a Last Year is now costing Rs 108. So inflation is not a very tricky and difficult to understand , it is as simple as the above example.
If the Inflation is 0 % it means that the good sold now are at the same price of last year. No marginal growth for retailers.

How does inflation affects investments?

Inflation reduces the purchasing power of money. 100 rupees can purchase you more last year than what it can purchase as per the last example (8% inflation).

Inflation also erodes investment. Lets see this with an example.

Eg. Robert invests Rs.1,00,000 in a bank FD fetching him 11% interest rate on yearly basis. Robert is in a income tax bracket of 20%.At the end of one year, he gets back Rs.1,11,000 and he pays 20% of 11,000 as tax.

Amount Invested = 1,00,000
Maturity Amount = 1,11,000
Interest Earned = 11,000
Tax on Interest @ 20% = 2,200
Amount in Hand = 1,08,800

Interest Earned = (8,800/1,00,000) * 100 = 8.8%

If the inflation prevailing is 7%, then

Real rate of return/Inflation adjusted return = 8.8% - 7% = 1.8%

This implies value of money at your hand has increased only by 1.8% and not by 11% or 8.8%.

As we can see in the above example, inflation erodes the return from our investments significantly.


How to reduce the impact of inflation?

We should choose a mix of investment instruments, so that the collective return out of our investment should beat inflation by a good margin of (8-10%) so that real value of our money increases in a significant manner.

Lets rework the same example above by splitting across two investment instruments - debt and equity invested for 12 months or 1 year.

Amount to be invested = 1,00,000
Amount invested in equity = 50,000
Amount invested in debt = 50,000

Interest earned in debt = 11% (or) 5,500
Tax on interest = 20% (or) 1100
Interest - tax = 4,400
Interest earned in equity = 20% (or) 10,000

Total Interest Earned = 14,400 (or) 14.4%

Inflation = 7%
Real rate of return = 14.4% - 7% = 7.4%

So the inflation adjusted return has increased from 1.8% to 7.4% by reallocating the amount in two different modes of investment. The returns mentioned are assumptions, you need to reallocate the %age of amount in each asset class based on interest available during your investment period.

How to calculate your PF balance

There are some savings that we make without our knowledge. Sounds surprising? but that's what is the reality. An employee in an organized sector have mandatory savings like PF,Employer Pension Scheme,Superannuation,Gratuity. From our monthly gross salary, we make a significant contribution to all four of these. Lets see how much we are saving each month unknowingly in a provident fund.


Provident Fund

For all employees who work in an organized sector, following is the PF contribution every month :-

PF contribution by Employee = 12% of basic salary.

PF contribution by Employer = 12% of basic salary.

Employer Pension Scheme

Out of 12% contribution from employer, 8.33% of the contribution (subject to maximum of 541 Rs/month) is invested in employer pension scheme.

Lets take an example and understand this.

Ram's basic salary per month = 15,000

Ram's contribution to PF = 12% of 15,000 = 1,800

Ram's Employer contribution = 12% of 15,000 = 1,800

Employer's contribution to EPS = 8.33% of 15,000 = 1250

This 1250 is higher than the max limit of Rs 541/month and hence

Employer's contribution to EPS = 541

Employer contribution to PF = 1800-541 = 1259

So Total PF contribution to Ram's PF account per month = 1800 + 1259 = 3059


How to calculate your PF balance?

Lets say Ram worked in a firm from April 2007 to March 2008.Let us find out what is his balance as on April 1st 2008.

Interest Rate on PF account = 8.5% (fixed by central govt)

So monthly contribution of 3059 for one year @ 8.5% = 39,828 /-

So in this way you can calculate your return for 'n' number of years for your PF contribution, provided you know your monthly contribution.

Happy Investing !!!

Revisit on National Pension Scheme (NPS)

What is NPS ?

You can regularly invest your money in this and get a lump sum at your retirement and a fixed monthly income for the lifetime . It will work almost the same way as Private Pension Schemes .


Features

- No upper limit of Investment
- Minimum limit of 6,000 per year (Rs 500 per month).
- Annual Fees of .00009% (90 paisa for Rs 10,000) for Manging the fund.
- Tax benefit under sec 80C .
- Any Indian citizen between 18 and 55 years can invest in NPS .


NPS Bodies

- Regulator : The one who will regulate the NPS System .
- Fund Managers : Who will invest the money
- Point of Presence : Responsible for Sales and Marketing .
- Central Record Keeping Agency : Responsible for all the document Keeping work (Record Keeper)


Who will Regulate NPS ?

PFRDA (Pension Fund Regulatory and Development Authority) will monitor and regulate all the activities under NPS . It checks how your money in invested and makes sure that the fund managers are following the rules and guidelines . Its just like "SEBI for Stock Market" .


Who are the Fund Managers ?
There will be 6 Fund houses appointed by Government to manage the funds under NPS . You can choose any one of them to be your Fund Managers . They are :

1. SBI Pension Funds Private Limited.
2. UTI Retirement Solutions Limited.
3. ICICI Prudential Pension Funds Management Company Limited.
4. Religare Pension Fund Limited.
5. IDFC Pension Funds Management Company Limited.
6. Kotak Mahindra Pension Fund Limited.

They will take all the decisions of where the money received under NPS should be invested in the best possible way considering all the rules and regulations set by PFRDA.


Who are Point of Presence ?

The following entities have been approved by PFRDA for appointment as Points of Presence (POPs) under the New Pension System for all citizens other than Government employees covered under NPS .

1. Allahabad Bank
2. Axis Bank Ltd
3. Bajaj Allianz General Insurance Co Ltd
4. Central Bank of India
5. Citibank N.A
6. Computer Age Management Services Private Limited
7. ICICI Bank Ltd
8. IDBI Bank Ltd
9. IL&FS Securities Services Ltd
10. Kotak Mahindra Bank Limited
11. LIC of India
12. Oriental Bank of Commerce
13. Reliance Capital Ltd
14. State Bank of Bikaner & Jaipur
15. State Bank of Hyderabad
16. State Bank of India
17. State Bank of Indore
18. State Bank of Mysore
19. State Bank of Patiala
20. State Bank of Travancore
21. The South Indian Bank Ltd
22. Union Bank of India
23. UTI Asset Management Company Ltd


Who will be the CRA ?

As per the website of PFRDA there is a Contact of negotiation is underway and NSDL/CSDL is expected to be appointed as the CRA.


Investment Options and Structure
- Risky option : The higher allocation in this option will be in Equity .
To decrease the risk , Equity Investment is allowed only to invest in Index funds which tracks Sensex or Nifty . Also the equity exposure is caped at 50% .

- Moderate : IN this options Main exposure would be Corporate debt and Fixed income securities with some exposure in Equity and Govt securities . It will be moderately risky and rewarding .

- Safe : In this option mainly the investment will be done in Govt securities , and very little will be invested in Equity .

There will be a Default option, under which the allocation will be decided as per your age, where Equity Allocation will be high in the start and then it will come down as your age increases . You can also decide your own asset allocation as per your Risk appetite


Cost

There are different kind of Costs in NPS .

- Fund management charges of .0009% per Annam , which is excellent if compared to ULPP's or Mutual funds charges .

- Annual Maintenance charges of Rs 350 and Rs 10 per transaction to CRA (soon , it will be Rs 280 per year , Rs 6 for per transaction) .

- Rs 40 for registration with PoP and Rs 20 per transaction with them .

- There are other small costs too , lets leave it for now .



Now we will see some NEGATIVE points about NPS

1) Taxation Issue
Sadly , As per the current law, the amount received at the end from NPS would be taxable , PFRDA is trying hard with govt to exempt the tax. You will get the 80C benefits on the amount invested in NPS .
Though I assume Govt will make the returns TAX FREE. But till that time we have to wait and watch.
You may have to pay the TAX on your monthly retirement income !!!

2) Not Fixed Income
Though this is called Pension scheme, It actually did not meant a fixed monthly income after retirement. The monthly income may vary from month to month. Or it may happen even for couple of months you may not get any income.
So don't think that you will get fixed monthly Income upon retirement !!!

3) NPS is not at all risk free
This is Defined Contribution scheme and NOT Defined Benefits scheme. So the Risk/Reward is totally bourned by Investor. Government is just to set the regulation on how to manage the funds.
NPS is not at all risk free !!!

4) Conscious decision while choosing FM
The income depends on the Fund Managers that one chooses. As investor has to choose one Fund Manager between 6 appointed Fund Managers. So returns will vary from one FM to other FM depending on how he generates the income for you.
Your returns depends on the Fund Manager that you chooses !!!

5) Not with drawable
Currently NPS is launched with Tier-I plan. In this you cannot withdraw your investment till retirement. After six months NPS Tier-II will be launched, In tier-II you can withdraw partial amount.
Wail till NPS Tier-II is launched !!!

6) Few questions still left unanswered
PFRDA site has given following information about death of PRAN holder.
The amount can be disbursed as pension to SPOUSE of PRAN holder. But what if Spouse also passes away. There is no clear answer for what will happen to the corpus amount left. Will that be given to family members especially children as lump sum or on a monthly pension format? No Idea !!!
Many questions still unclear !!!



If you want to have STRICTLY fixed monthly income after your retirement, This scheme is not for you. Better go for PPF. If you have surplus amount left after you invested in PPF, you can go for this NPS scheme.

I assume over a very longer term (20 years) you will get more profit in NPS compared to PPF.