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Friday, September 02, 2011

Money Rules It Pays to Break

It was the depths of the recession in mid-2009. My life savings in stocks, built up over a quarter century, had been decimated to a fifth of its value in months. That’s when my bank’s relationship manager, a sweet young thing assigned to take care of my account, kept calling me persistently. “Sir, we have checked your demat account,” she told me, spelling out its exact value. “Let us manage your savings for you. There are other ways of investing for better returns.”
“No, thank you,” I told her, “I’m not selling any shares. Not now!”
Are you wondering why anybody in their right mind would say no to people like her? I had “lost” so much that a banker coming to my rescue should have been the silver lining.
Another day recently, another relationship manager: “Sir, I have a new investment product for you,” the young man told me. “We’re offering it only to select clients and it comes with a guaranteed return…”
“Is it insurance or mutual fund?” I interrupted.
“It incorporates both.”
“ULIPs? I’m not interested,” I said.
We live in times of financial information overload, with too many experts, too many promises, and too many cold-callers trying to make profits with our hard-earned money.
We also have to contend with too many so-called rules, like the ten described here. If you haven’t heard them, you haven’t been following the business pages. If you have, it’s high time you questioned them.

“Invest only through mutual funds.”
Verdict: Thumbs down.
You see or hear this every day, from the experts who are often mutual fund managers. They invest your money in shares, bonds or other securities for you, but that does not mean they will always bring you a profit, although you are unlikely to lose all your money either (as with a bankrupt company FD).
Mutual fund schemes are usually compared to “benchmarks,” like the Sensex, to gauge their performance. Stock-based equity schemes that do well outperform the Sensex. But how many really do so? The sorry truth is that the large majority of mutual fund schemes have underperformed their benchmarks! “Very few mutual fund schemes could manage to give better returns than banks between January 15, 2008, when the Sensex was at 20,000 level and Tuesday [September 21, 2010], when it again regained the same level,” maintains theJournal of Finance. “Out of 30 highly-rated schemes, 20 gave less than 5% return,” which is less than a bank FD.
Innumerable individual stocks have given immensely better returns than the best mutual funds. Picking stocks yourself is not as hard as mutual fund managers make it out to be, because if you learnt to do so, you’d be doing their job much better than many of them. But you must read the business papers daily to learn about the markets as if it were a lucrative hobby. If you do, you’ll also know about the best mutual fund schemes to invest in and when.
Incidentally, the investment research firm Morningstar recently reported that eight Indian equity mutual fund schemes were among the world’s 25 best for the returns they gave in a decade. So mutual funds can be good—but only if you picked the best ones from among hundreds of schemes available.

“Fixed deposits are safe and sound.”
Verdict: Thumbs down.
Some are indeed safe, but few make sound investment sense because of inflation.
Not all company FDs are safe—many investors lured by their high interest rates have lost it all. In general, the higher the interest rates offered, the riskier an FD is, because those who offer unusually high rates are not doing it for love, but for the money they can’t borrow at cheaper rates from financial institutions that won’t trust them!
Fixed deposits offered by the Post Office are safe, and so are those from government-owned banks like SBI and some of the larger private banks.
Instead of FDs, consider investing in a mutual fund’s monthly income plan (MIP). Some, like those from HDFC Mutual Fund and Reliance Mutual Fund, have given much higher returns than the best FDs and the earnings are tax-free in your hands. The value of an FD erodes over time due to our high inflation. MIPs can overcome that because they invest about 15 to 20 percent of your money in stocks, which are a good bet against inflation. Again, you need to pick a good scheme from among many MIPs.

“Don’t hold large amounts in your savings account.”
Verdict: Thumbs up.
Leaving a large amount of money idle in your saving bank account for months is a silly idea, because all it will earn is 3.5%. If you’re not sure about what to do with the money, it’s best to hold it there while you decide, because as the saying goes, “sometimes your best investments are the ones you don’t make.” But even for short periods, some banks now offer facilities like “sweep-in” or “flexi” accounts where anything in excess of an amount you decide automatically gets FD interest rates, with the option to withdraw it anytime with no penalty.

“Invest only in blue-chip shares.”
Verdict: Thumbs down.
Blue chips, as the casino metaphor suggests, are strong, highly valued shares. Some people swear by them and will not invest in the weaker “mid-” or “small-caps” that are usually much cheaper.
Blue chips are backed by businesses that are huge and rock-solid. But if you look back, they were small once and grew to that size. So those who invested in them long before they were blue chips are the smartest people—their investments may have grown a thousand-fold.
There are hundreds of cheap stocks today that have potential, so avoiding anything but blue chips means you’ll be missing big opportunities. It’s hard to identify a potential blue-chip share, but you increase the possibility of owning a few of them in your portfolio in 10 years’ time if you are invested in about 20 growing mid-sized companies today that are in profitable businesses with a future. In 2001, watchmaker Titan Industries was no blue chip. But had you bought the shares for about `40 then, you’d now own blue chips worth Rs3650 each. So with, for instance, Blue Star
Limited, which sold for around Rs7* in 2001, when it was clear that they were in a business with a future: air-conditioning a growing number of malls, BPOs and skyscrapers. Today that Rs7 has become Rs430—a 6043% gain—more than gold, property or any mutual fund. There are scores of other such stories.
Blue chips are great to hold, but if you’re a smart investor, you’ll need to research and invest in potential blue chips as well.
[*Price adjusted for a 5:1 stock split in 2006. All early-January 2011 prices.]

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