The Concept & Advice on Extinguishment of Debt

Mr. Gerard Colaco: Extinguishment of debt means getting rid of debt, or not getting into debt in the first place. It is important to distinguish between acceptable and unacceptable debt, productive and unproductive debt. Any debt which is designed to automatically end itself is better than debt which remains open indefinitely.

A housing loan or vehicle loan is debt which is repaid in instalments and extinguishes itself over the loan period. On the other hand, personal loans, personal overdrafts and credit card loans are examples of debt which remain open.

The worst type of debt is credit card debt. In India the rates of interest on this type of debt presently vary between 24% & 48% per annum. Every individual must guard against ever getting into a debt trap.

If an individual does not have a house, and does not have the resources to purchase a house right away, a housing loan could certainly be considered provided the loan instalments can be paid with a fair degree of comfort. All other types of undesirable loans should be extinguished before embarking upon investment.

 

The Concept & Advice on Housing

Mr. Gerard Colaco: Everyone should own a residence of their own. This is most applicable of course, to those who are not fortunate to have already taken steps in this direction, and/or those who are not fortunate enough to be sure of inheriting a house or apartment. So you can say, a house or apartment is an essential part of any financial plan.

Now comes the question of further investments in real estate. We find that where real estate is concerned, normal people can be classified into two categories:

1. Those who have a genuine talent for and interest in real estate investments; and

2. Those who have neither the talent nor the interest in such investments.

For people who fall in the second category, the advice given by some of the best real estate consultants that we have come across is: purchase real estate only if you have a use for it.

Everyone has one basic use for real estate and that is the need for a dwelling place. So, everyone must own a house. Now, consider the case of a practicing physician. He will need a residence as well as an office. He must ideally try to own both, because he has a use for both.

Let us take one more example, that of a person who manufactures and sells furniture. Such a person requires a residence, a workshop (which need not be in a centrally located area) to design and manufacture furniture, and finally, a showroom in an excellent location, to exhibit and sell the furniture. Such a person must try to own all three: his house, workshop and showroom.

For a person who does not have a flair for real estate, additional investments in real estate are not advised. Undoubtedly, real estate is an excellent long-term, wealth enhancing avenue of investment. However, it suffers from certain drawbacks.

·        It has extremely poor liquidity. You can sell a stock on the stock market instantly and get your payment within 3 days. Similarly, you can encash a mutual fund investment within an outer limit of a week. But you cannot dispose of real estate quickly and easily, even in a boom.

·      There are difficulties and dangers in verification of title when you purchase real estate.

·        Large amounts of money are required even for a single purchase.

·       Large amounts of money are required to make additional purchases, if you are willing to do so, when prices fall. For example. Let us say you have purchased stocks worth Rs 30 lakhs and also real estate worth Rs 30 lakhs. Both purchases have been made, when markets were high. Now the markets fall and both your stock market portfolio as well as real estate property are valued at Rs 20 lakhs each. You want to make additional purchases. You can buy stocks even if you have just Rs 1, 2 or 3 lakhs. But to make additional real estate purchases, you would need much more, perhaps even Rs 20 lakhs.

·       There is the presence of substantial black money components in real estate transactions.

·       There are high stamp duties to be paid on purchases of real estate.

·       Formalities pertaining to the purchase and sale of real estate are cumbersome.

·       Once you have purchased real estate, there can be administrative problems. You need someone to look after it. There are many problems associated with absentee landlordism, such as encroachment, squatting, deterioration of houses / apartments because of keeping them locked up, etc.

All these matters must be carefully considered, before venturing into real estate investments, because real estate is easy to get into, but difficult to get out of, especially if you have made a mistake.

 

The Concept & Advice on Retirement Planning

Mr. Gerard Colaco: When we talk to youngsters about retirement planning, very often the response we get is, "Oh, I have another 30 years to go for retirement." They do not realise that while retirement may be 30 years away, retirement planning should commence when an individual draws his or her first pay cheque.

You are responsible for your financial comfortable retirement, not your employer or the government. Just as an emergency fund is a private insurance policy, you must also have a private retirement fund, independent of the one run by your employers. In fact, over two or three decades, your private retirement fund could very well dwarf your company retirement fund.

In the Indian context, the two best possible avenues of retirement investments are the Public Provident Fund and Equity Linked Savings Schemes (ELSS) of mutual funds. The PPF gives tax-free returns of 8% per annum, compounded annually. ELSS investments give approximately 14% CAGR returns over a period of 10 years or so. Unfortunately, non-resident Indians cannot invest in the PPF.

The best investment for retirement would be systematic investment into diversified equity funds. Nothing will give you better returns over the long run. The amount you invest need not be large. Investing regularly over several decades is important. You can start with even a very low amount of say Rs 1,000/- per month and then increase it gradually once your liquidity situation improves. There should be two separate retirement funds for husband and wife. You have to work out exactly how much each of you can save very comfortably per month for retirement.

When you calculate the amounts to be invested for retirement, take a lower figure with which you are comfortable over a long period than a higher figure which you may not be able to sustain.

Investments into retirement avenues are for the very long term. A period of ten years would be considered a short term for retirement investments. Like an emergency fund, a retirement fund is also sacred. Money in this fund should never be withdrawn until the actual date of retirement. The only exception to this rule is if there is a threat to the life of any family member and existing insurance and emergency funding prove themselves to be insufficient. With proper financial planning, the need for you to ever dip into retirement funds will almost definitely not arise.

What we repeatedly see in investors who do proper financial planning is, that many of them do not touch their retirement corpuses even after retirement. These corpuses are left as inheritance for their successors. Their other investments or the income from their retirement corpuses generally see them through life comfortably.

The Concept & Advice on Emergency Fund

Mr. Gerard Colaco: The financial plan of every individual and every family must be built upon a solid foundation of safety and security. Only after safety is ensured, do we venture out looking for higher returns.

When the risks of death, disease and damage to property are taken care of through regulated institutions, it is called insurance. Apart from this institutionalized insurance, every individual and family must have their own 'private' insurance in the form of a reserve of money to meet emergencies. Such a reserve is called an emergency fund.

The emergency fund must be deployed in highly liquid avenues of investment like savings accounts or money market mutual funds. Returns are not important here. Liquidity is. Only such avenues of investment must be chosen, which can be encashed within 24 hours. For your emergency fund, a separate investment account must be opened. Never should an emergency fund be confused with your normal bank or investment accounts.

In India, the banks offer 'flexi deposits', which are well suited for emergency funding. A small portion of the flexi deposit is treated as balance in a savings account. The rest of it is treated as a fixed deposit. For example, if you have a Rs 1 lakh flexi deposit, Rs 10,000/- out of this, may be considered being in the savings account at 3.5% for a resident Indian. The remaining Rs 90,000/- will be considered to be a fixed deposit at a rate of interest which may be twice the SB account interest.

Now if you want to write a cheque for Rs 50,000/-, you can do so without going to the bank and prematurely redeeming the fixed deposit portion. Of the Rs 50,000/- that remains, Rs 5,000/- will now be in the savings account and Rs 45,000/- in the fixed deposit account. You can also add money to this account whenever you want, just like in a savings account.

The important thing is that it should be a separate account and you and your wife should know that this has been set apart as an emergency fund. Furthermore, the emergency fund should perforce be in joint names, operable by any one of the joint holders. In case you have a minor mishap and cannot sign, the joint holder should be able to operate the account on his/her own.

An emergency fund is sacred. It should never be touched unless there is an actual emergency to your family. The cumulative effect of interest being added back and compounded will help the fund keep pace with inflation.

What should be the size of the emergency fund? There is no simple answer. A good thumb rule based upon common sense and our own experience is that at least 12 months of normal living expenses should be in the form of an emergency fund. You will by now be familiar with the concept of normal living expenses. For example of a family with expenses of Rs 25,000/- per month, we would be looking at an emergency fund of approximately Rs 3 lakhs.

Never think of an emergency fund as an unproductive waste of money. You will know the value of emergency funding only when calamity strikes. In these days of increased uncertainty and rapid changes, an emergency fund has much more relevance and importance than say 30 years back. It is your first line of defence. Treat this as priority.

The Concept & Advice on Property Insurance

Mr. Gerard Colaco: Property insurance too is not compulsory. If you have no meaningful property, you do not need property insurance.

A number of youngsters today, well qualified, landing jobs in India at a salary of approximately Rs 3 lakhs per annum. They may be working well away from their hometowns. Most reasonably good Indian companies provide them with comfortable accommodation. Such individuals have virtually no property and mostly live out of a suitcase. This is a classic case of not needing property insurance. Of course if they own a vehicle, insurance of that vehicle is compulsory under the motor vehicle laws.

On the other hand, take the case of a person who owns an apartment in India. There are two aspects to an apartment. First is the absolute right you acquire to the area situated within the four walls of your individual apartment. Second, there is the undivided right and interest that you acquire in the land on which the apartment is built and also in its common areas and facilities. This is a joint right you hold with the other apartment takers.

Property insurance is relevant to both these aspects. You must insist that the association of apartment takers or co-operative society that runs the apartments, insures the entire structure of the building and also vitally important equipment such as transformers and electrical fittings, diesel generator, pump set and if possible, even the lifts. In case there is any structural or other damage to the building or its vital equipment, you are protected.

Few people are aware of just how cheap such insurance is. Let me give you a practical example. An apartment complex having 29 apartments, the estimated value of the building and its essential equipment was Rs 3.25 crores, and taking out insurance for this sum, about three years ago. The premium worked out to be Rs 22,000/- for the first year. Therefore, on the average, an apartment owner paid approximately Rs 759/- as premium per annum. There was no claim of any sort. The second and third year's premiums were drastically reduced by the insurance company, to approximately Rs 18,000/- and Rs 16,000/- respectively. Thus, it works out to just about Rs 552/- per apartment owner per year.

In addition, if you happen to be living in the apartment and have furnished it reasonably well, and have expensive gadgets like a washing machine, fridge, TV, music system, microwave oven, etc., a basic householder's policy against fire, theft and breakdown should be useful. Do not take this insurance if you are renting out your flat, only if you are actually living in it. Such householder's insurance is once again quite cheap. I will be surprised if a basic policy costs more than Rs 1,300/- per annum.

The Concept & Advice on Life Insurance

Mr. Gerard Colaco: No insurance in the world is more wrongly sold than life insurance. We will discuss about whether you require it or not, later. First, let us have some ideas on insurance which are based upon the advice of some of the world's best writers on financial planning, insurance and investment.

Life insurance should be purchased only if required and to the extent required.  A. N. Shanbhag is perhaps the best Indian writer on investment and financial planning. This is what he has to say about life insurance:

"There is no substitute for life insurance.
Life insurance is not an investment. 
It is a social and commercial instrument to provide financial security in the event of death of the insured.
If dependents can look after themselves comfortably without the amount insured, life insurance is not needed.

Life insurance is like a life saving drug. If you need it, you must have it irrespective of the cost.  If you do not need it and you take it, it can have very bad side effects on your financial health."

So the first question to be asked is: Do you need life insurance?

The answer is simple. You need life insurance only if you have financial dependants.  If no one is going to be financially affected by your absence, you do not need life insurance.

The next question is: How much life insurance do you need?

The answer is, enough to keep your financial dependants in the lifestyle they are used to, ensure that they are debt-free, and provide for their reasonably foreseeable future needs.  In other words, enough to compensate your dependents for the adverse financial situation caused by your absence.

Let us take a simple example for attempting to calculate how much life insurance a person needs. Suppose there is a family consisting of husband, wife and two very young children. Let us assume that the monthly normal expenditure of this family is Rs 25,000/-. That means a cash requirement of Rs. 3 lakhs per annum, to ensure that the family lives in the lifestyle it is accustomed to.

Now supposing the husband is the sole bread winner of this family. His first concern will be that the family will not have the cash flow of Rs 3 lakhs per annum, in case he should suddenly be removed from the scene. Therefore, he must calculate what size of corpus must be invested in a safe avenue of investment like a bank fixed deposit, to ensure that the family gets Rs 3 lakhs per annum. If a corpus of Rs 43 lakhs is invested in a safe avenue like a bank fixed deposit at an average rate of interest of say 7% p.a., it will provide the family with the required income stream.

However, this does not mean that the husband must rush out and straightaway purchase Rs 43 lakhs worth of insurance. There are some deductions to be made from this corpus. For example, he may already be having financial savings of say Rs 10 lakhs. His wife may have financial resources of her own of another Rs 15 lakhs. Let us say that the value of his retirement benefits, existing insurance policies and other cash flows that will accrue in case of his death amount to another Rs 5 lakhs. This total of Rs 30 lakhs must be deducted from the Rs 43 lakhs corpus envisaged earlier, since it will be available to provide the necessary income stream.

Therefore, there is an uninsured gap of Rs 13 lakhs, that is 43 lakhs minus Rs 30 lakhs.  This is the amount for which life insurance must be taken. We have of course given a very simple example, assuming that this family has already taken care of its housing requirements. You can discuss with your close family members and calculate your own insurance requirements.

Going back to the example under consideration, if when doing your calculations, you find that your total liquid assets are say Rs 45 lakhs, that is more than the corpus of Rs 43 lakhs that would be required to provide income to take care of normal expenditure, then you do not have an uninsured gap and you certainly do not require life insurance.

One final point.  Do not be fooled by advisors who do complicated calculations to arrive at how much life insurance you need.  They will add things like child education, marriage expenses, etc., to inflate the quantum of insurance to be taken.  No one can predict the future, especially the distant future.  The period of vulnerability is one, two, three or a maximum of five years after a death occurs in a family, especially of a breadwinner or important earning member.  Human beings are very resilient by nature and are capable of adjusting to, and dealing with, new, adverse situations, in the medium to long term.  It is in the short-term that they are vulnerable and need the protection of life insurance.

When we talk about expenses based on which to calculate life insurance needs, we generally talk about normal current monthly expenses. There is however definitely no harm in a slight increase in the estimate of these normal expenses. For example, if we are talking about Rs 25,000/-worth of normal monthly expenses, you certainly can provide for Rs 30,000/- normal expenses for the purpose of life insurance requirement calculations.

However, there is no need to substantially inflate these figures or worry about providing for 10 or 20 years hence. No one can predict the future including what shape general circumstances or economic circumstances including inflation is going to take.  The two simple examples are; Twelve years ago, the cost of a telephone call from Mangalore to Bombay was more than 26 rupees per minute.  If anyone had predicted that the cost of this call would come down to less than Rs 1 per minute, he would have been laughed at and dismissed as a madman.  Similarly, if someone had predicted that one day, you would have air tickets of Re 1/- (subject of course to conditions) available in India, no one would have believed the prediction.

There is already a built-in safeguard in taking only normal monthly expenses for insurance calculations.  In practical terms, we have observed that the expenses of a family tend to go down immediately after the death of one of its members. This is because expenses that used to be incurred on that particular person are no longer incurred.

Further, as mentioned earlier, it is impossible to predict future inflation rates and future fund requirements. So long as the rest of the family is adequately insured for health, and to the extent required for life, the best you can do in life insurance is enable a corpus to take care of normal expenses for the next few years, say a maximum of 5 or 6 years.

It is important and most people do not realise it when they buy insurance:  Human beings are extremely resilient. They tend to adjust sooner rather than later to new situations, including existing, adverse situations. The greatest period of vulnerability is generally not more than, one, two or at the most three years from the date of death of the breadwinner.

Foreign Banks & Financial Accounts (FBAR) – Filing Requirements

Query: I have received a query from one of my NRI clients In the U.S. regarding the above subject. He says, he would have to disclose /pay tax in the USA on investments made in India. Since you have a sizeable number of clients based in the USA, I wanted to know if you have any details on this.

The link below sheds more light on the subject
http://www.irs.gov/businesses/small/article/0,,id=210244,00.html

Mr. Gerard Colaco: I have since gone through the US IRS website pertaining to Foreign Bank and Financial Accounts Reporting Requirements (FBAR).

Individual investors who have investments in savings bank accounts, current accounts, bank fixed deposits, mutual funds, stocks, bonds or other financial assets would certainly be required to comply with reporting requirements under FBAR if the value of their accounts exceeds US $10,000/- at any point of time during a given financial year. Therefore, individuals resident in the US who have invested in Indian mutual funds would certainly be subject to FBAR reporting requirements.

Many individuals also confuse FBAR with the filing of tax returns in the US and the Double Taxation Avoidance Agreement (DTAA) between India and US. The right to tax generally vests with the country in which the taxpayer resides. This right is not at all affected by the DTAA between India and the US. Second, the right to tax can also vest with the country in which the income is earned. This right of the country which is the source of the income to tax that income, is also not affected by the DTAA between India and the US.

What then is the DTAA? As the very name suggests, it only seeks to avoid double taxation on the same income. The basis on which an individual is taxed is residence. If a person who is a US citizen is resident in India as defined by the Indian income-tax laws, he may have taxable income in India as well as in the US. Under Indian income-tax law, his citizenship has no relevance for purposes of taxation. It is whether he is resident in India for tax purposes and has taxable Indian income that is relevant. So a US citizen resident in India, who has both Indian income and US income, would be taxed in India on his global income.

Such an individual will be taxed in the US only in respect of his US income and not his global income, because he is a non-resident person in the US. Now, let's assume he is in the 20% tax bracket on his US income. But this US income has already been included in his Indian tax return and he has paid tax on it at the rate of 10%. The 10% tax paid by him on his US income in India will be available for set off against the tax payable by him in the US.

Similarly, if a person is resident in the US, he will be taxed on his global income in the US. He will be taxed in India on his taxable Indian income only. Let us say he pays tax at 30% in the US on his Indian income. But in India, he is liable for tax at only 10% on the Indian income. He will have to pay no tax in India, as he has paid tax at a much higher rate in the US. Double taxation is thus avoided.

Let us now take the case of dividends, short-term capital gains on shares or equity mutual funds and long-term capital gains on shares and equity mutual funds of an individual resident in the US.

Dividends on equity mutual funds are tax-free in the hands of the investor in India. Dividends on equity shares are also tax-free in the hands of the investor in India. In the case of equity dividends, there is a dividend distribution tax (DDT) paid by the companies to the government before dividends are distributed. This is not tax deducted at source against the individual investor. It is merely a tax on distribution of dividends. It is paid by the companies to the government. It is not paid on behalf of the investor who earns the dividends. Hence DDT is not available as tax credit to a US resident. Dividend on equity mutual funds and stocks will have to be added to his US income and applicable tax will have to be paid in the US on this Indian income.

Short-term capital gains on equity and equity mutual funds are taxed at a flat rate of 15.45%. Such STCG on Indian equities or equity MFs must be included in the US income of a person resident in the US. The STCG tax paid by him in India will be available as a tax credit in the US.

Long-term capital gains (LTCG) on equity and equity mutual funds are essentially tax-free in India. The Securities Transaction Tax (STT) cannot be claimed as a tax credit in the US, just as DDT cannot be claimed. STT is a tax on the transaction or purchase and sale of stocks or the redemption of mutual funds. It is not deducted against the individual investor. So although LTCG on equity and equity mutual funds is exempt from tax in India for all practical purposes, it is to be included in the global income of the US resident and he will be taxed at rates applicable to long-term capital gains tax in the US.

This is my understanding of the subject after discussing with my chartered accountant and also doing a little bit of reading. If subsequently I come across some knowledge that would need the above opinion to be altered, I will certainly let you know.

 

The Concept & Advice on Health Insurance

Mr. Gerard Colaco: Health/Medical insurance is compulsory for all. Life and property insurance are optional, to be taken only if you need them and to the extent that you need them.

This must be compulsorily taken for the whole family. It should be taken even if your employers provide you with a family cover. The reason for this is that you can have job losses, or one or both of you may resign from your jobs. You may also consider migration or relocation to a different place or country. During these vulnerable periods, if you are afflicted with serious illness, you can be exposed to considerable financial stress at a time when you have no medical cover.

The advise you to take out a family floater health insurance policy in India. If by any chance you need to make a medical insurance claim when you are employed, ensure that the claim is made against your company insurance cover. However, have a 'private' family health cover to take care of situations when you may not have health insurance.

Furthermore, once you retire, you will cease to have health insurance benefits from your employers. When you are aged 58 or 60, you will find it extremely difficult and prohibitively expensive to obtain health insurance. However, if you can show a long track record of paying premiums regularly on your 'private' health policy, there is no difficulty in renewing and even increasing your health cover later on in life.

Let’s understand the difference between stand alone health covers or individual health covers and floater health covers with an example. Let us assume you want to take individual health covers of Rs. 1,00,000/- each for you, your wife and your child. Now, if only you have to make a claim for a medical problem of which the cost of treatment is Rs. 3,00,000/-, you will be reimbursed a maximum of just Rs. 1,00,000/-, because only Rs. 1,00,000/- has been taken on each individual.

However, in a family floater policy, any one member can utilize the entire cover of Rs. 3,00,000/-. Such flexibility is better. Floaters are available from most banks in India. To conclude, it would be advisable to take such an insurance cover for you, your spouse and children and renew it every year, hiking the cover every block of 5 years or so. Floaters generally cover a total of 4 members of a family. Premiums are quite reasonable.

 

Investing in EPF for Retirement Corpus

Investor’s Query: I am contributing every month funds towards Employee Provident Fund (EPF) with my company. Can I account my monthly contribution towards EPF towards my Retirement Corpus?

Mr. Gerard Colaco: I never take Employee Provident Fund (EPF) into account when I prepare financial plans. For me, financial planning is what an individual can do with her / his NET surplus, that is income after all deductions and taxes, from which normal monthly expenditure is then further deducted.

EPF is not available to non-employees. Even where employees are concerned, not all employees are under EPF. So I treat EPF as a hidden reserve that should come as a pleasant surprise as an additional financial resource in retirement. Ditto for pensions.

Please note however that I do not consider EPF to be unimportant. My advice to all salaried people who are eligible for EPF is to max out on EPF contributions at least to the point where there is a matching contribution by the employer. If this is done, probably no investment including equity can match the returns on EPF.

For example if the EPF interest rate is 9% p.a. with a matching contribution by the employer, it is as if the employee is earning 18% p.a. This is higher than the average long-term equity returns in India. But I would certainly not depend upon EPF to ensure my comfortable retirement. It is my financial plan that should do so.

Like I said, the EPF must be a pleasant surprise and if it is large enough, it can contribute to either a higher standard of living in retirement and/or better legacies.

SEBI’s Concept Paper on Regulation on Investment Advisors

Query: Your feedback on SEBI’s Concept Paper on Regulation on Investment Advisors?

Mr. Gerard Colaco: My preliminary views are as follows. It was only a matter of time before investment advisers had to be regulated in India. There has been too much wrong advising and mis-selling. But what SEBI has not realised is that the main damage to investors is done by stock brokers and insurance agents, both of whom will escape the regulation on investment advisers.

No investor can lose more than her invested principal in a mutual fund. But they certainly can do so trading derivatives. Similarly, the most aggressively sold insurance products are the investment-linked insurance products, which are referred to by insurance people themselves as "poor-insurance, poor-investment products," thereby serving neither insurance nor investment needs.

I wonder why SEBI does not want stock brokers and sub-brokers to risk profile and maintain detailed records for five years of their tips, 'advice' and derivatives strategies for individual investors?! Is there some 'conflict of interest' here?

As mentioned earlier, from what I could see, both stock brokers (and sub-brokers) and insurance agents have been excluded from these regulations. So, there could be a greater shift to areas like insurance and the business of acting as sub-brokers to stock-brokers.

The category of persons who will be hardest hit by the proposed regulations will probably be the CFPs who wanted to establish fee-only practices. This is a concept that is alien to the Indian environment. Numerous workshops have been conducted by a variety of consultants on how mutual fund distributors must move from a commission-based system to a fee-based system. However, the only movement I have seen has been from areas of greater regulation and lower income to areas of lesser regulation and higher income.

Most mutual fund distributors may find it convenient to call themselves agents after this and abandon any pretence towards advisory services.

Where we are concerned, no client comes to us because of what we call ourselves. They come to us because of what we are. Also no one can prevent us from giving advice or opinions if we do not charge for them. We can easily restrict ourselves to giving advice only to such individuals who will route business through us. This is what we have been doing to a very great extent in any case and our revenues from such madness have been quite satisfactory.

Our elimination of conflicts of interest is based on our high standards of ethics, not on some regulatory clauses. I do not think I would like to function as an investment adviser when the term 'investment adviser' is defined by SEBI. I would not like to place myself in some investment advisory straightjacket, especially if it conflicts with the advice given by the world’s finest authorities on investment, none of whom will ever be found at NISM!

In fact you can be sure that most NISM-produced courses and material will originate from armchair academics and will be superficial, shallow and unrelated to life. I would be willing to bet my last devalued Indian rupee that none of these worthies have even five years of continuous experience in taking care of actual flesh-and-blood investors.

We will wait until the consultations are over and the regulations are out in their final form, before we fine-tune our business strategies if required and to the extent required. Right now, we remain alert but unworried, as usual. My co-conspirators at Colaco & Aranha and I believe in embracing change, not avoiding it. The days ahead should be entertaining!

 

Genuine Expertise

Query: Please find enclosed my article for the xyz souvenir. Please feel free to comment.

Mr. Gerard Colaco: Good article. Enjoyed reading it. I can readily identify with its content.

I have no reason to suggest alterations. I know you value confidence more than expertise. I don't, because I believe there can be no confidence without solid expertise which comes from a healthy mix of quality self-education and quality practice based on the quality self-education.

In the absence of genuine expertise, there may be overconfidence or misplaced confidence, which can lead to serious mistakes. I have seen this happen with depressing regularity.

Indian Economy

Investor’s Query: It seems a long time ago that I bought shares of Corporation Bank during their IPO. Not that I am complaining, but I wonder as to how people survive in India .I had a SB Account with the xxx branch. The then manager sent me some forms requesting I buy some shares. I made a very modest investment. Since then every year dividends are credited to my account. But the performance of the shares is somewhat disconcerting. Let me explain:

During those times a C$ was mostly worth around Rs. 8/-. I felt lucky when I got Rs. 8.72/- to a C$. After that the Rupee started sinking all the way down to Rs. 56/- to a C$. As of now the shares are Corporation Bank quoted at Rs. 382/-. Had I left the money in a SB Account at here, I would have received Rs. 56,000/- plus whatever the interest. I don't know what to say except the Indian Economy is somewhat in dire states.

Yes, the Real Estate prices have zoomed to kingdom come. Do you suppose they are sustainable, or are they headed to a head spinning sliding vortex?

Until 2007, you couldn't buy a 3BHK house in the US for less than $3,50,000. Now you are lucky if you can sell the same house for $1,50,000. Can this happen in India? I wouldn't bet against it.

During my visit in 2011, I had lots of opportunity to observe the Market Place. I felt everything was very expensive, especially transportation. I was spending anywhere from Rs. 250/- to Rs. 300/- on auto rickshaws alone. Food prices were the same as here. Actually it is much more expensive when you consider bones and fat. You can't buy pork, what you get is a slab of fat coloured red to make it look like meat. The same practice here would be considered as cheating. In India anything and everything is permitted. The more you can cheat and deceive the better off you are. Given this attitude, pray tell me who won't cheat?

As to accommodation, the less said the better. Beachfront Five Star hotels in Mexico with one week lodging and all you can eat and drink (alcohol), plus air fare cost only C$ 499 to 699. Can you do better in India? Please let me know.

Mr. Gerard Colaco: People do not seem to have much difficulty surviving in India. There are presently 1.26 billion of us who appear to be surviving. In fact, people here appear to be better equipped to survive and thrive than people in some of the 'advanced' countries. The reason is, we know that we are on our own and the government of India is not going to look after our welfare.

In many advanced countries, the population looks to the government for leadership, direction and economic well-being. In India, we are happy if the government mainly gets out of the way. That is why, when Indians are exposed to a different environment, they thrive, which perhaps explains why so many Indians do well abroad. They innately know how to succeed without depending upon state or other systems to help them.

I do not agree with your observations about the Indian economy either. We have xxx clients, of whom at least xxx are non-residents. A good deal of them are in the Gulf, but a significant number are also in the US, Canada and Australia. They have no complaints about their Indian investments, especially when they have constructed well diversified portfolios of blue chip stocks or well diversified mutual funds.

Purchasing some stocks of Corporation Bank at the request of a bank manager is not investment. It is merely obliging a bank manager.

I was born in 1963. I started business in 1985. I have seen the progress India has made from 1991 to 2012, when it abandoned socialism and liberalised its economy. More and more people have moved from poverty to the lower middle class and from the lower middle class to the middle class. A number of people in the middle class segment have gone on to become affluent. Currency fluctuations do not and should not concern the Indian government, whose duty is not to look after the economic well being of persons of Indian origin who are now foreign citizens.

Currency fluctuations between countries have their own dynamics, which need not be only economic. There are also a number of political factors that dictate currency levels. Pure economics would dictate that if there are two countries and the GDP of one is consistently higher than The GDP of the other, the currency of the country that has the higher GDP must appreciate against the currency of the other country.

However, India has consciously adopted a policy of major devaluation from time to time in order to make its products cheap internationally and thereby boost its exports. The whole Indian information technology and business process outsourcing boom was based on a policy of consistently devalued currency. A similar policy has been pursued by China, thereby allowing its goods to appear cheap and enabling it to flood the international markets with these cheap goods. The Chinese make their money on huge economies of scale that a disciplined workforce provides.

It is true that real estate prices have zoomed in India. On the average, they have gone up 9 times (900%) in the last 9 years. The real estate market is like any stock or commodity market where you can have booms and recessions, bubbles and their aftermath. We can argue that India’s steadily growing population and a rapidly growing middle class puts tremendous pressure on the demand for real estate. However, India too has had serious recessions in real estate, notably one that lasted from the latter half of 1995 to early 2003, when even prime real estate was difficult to sell.

As for cost of living, it depends entirely upon your knowledge of the local market and choice of what goods and services you want to buy and consume. If you think you can “observe” the local market conditions on a brief visit to India once every 5 or 10 years, you are fooling yourself. India is a much more complex country than that. When Catholics and Protestants have a problem co-existing in Great Britain, it is certainly commendable that Indians have somehow managed to pull together with diverse religions, ethnic groups and geography. India could easily be some 30 nations in one country.

Cheating happens everywhere. India has no monopoly over this. Have you forgotten Enron and WorldCom? Or Bernard Madoff? Or the information technology bubble of 1998-2000? Or the subprime mortgage crisis which ushered in a global financial crisis? Pray, which of these can you blame on India? What do you have to say about the Ivy League MBAs who are produced in needlessly large numbers by the “advanced" countries, whose main occupation appears to be creating a global financial crisis or two every decade or so?

Or let us take Mitt Romney who has pretensions to leading the world’s most powerful nation. I quote from the latest edition of The Economist: “When Mitt Romney was governor of liberal Massachusetts, he supported abortion, gun control, tackling climate change and a requirement that everyone should buy health insurance, backed up with generous subsidies for those who could not afford it. Now, as he prepares to fly to Tampa to accept the Republican Party’s vote for president on August 30^th, he opposes all those things. All politicians flip-flop from time to time; but Mr Romney could win an Olympic medal in it.”

I do not see much difference between Mr Romney and the thugs who pass for politicians in India. In fact, I would say Romney is worse. He appears to be a prize-winning hypocrite, despite the trappings of a good background, excellent education and all the advantages that a liberal environment and huge wealth can offer.

As for accommodation in Mexico versus India, I know of any number of discounted holiday packages offered in India which are extremely attractive. There are many travel websites besides various hotels, including five-star hotels offering attractive 3-day 5-day and a week-long package that would include accommodation and food and which should easily fall in the US$ 500 range. All you have to do to find them is use Google.

As for your comments about food, a brief visit to Mangalore cannot make you an expert on economic living or eating here. There is a superb vegetarian restaurant not far from our office called Hotel xxx, where a full vegetarian meal costs Rs 38/-. That's 70 US cents. Not far from there is another decent hotel with the unlikely name of xxx. A very good Chinese or Indian non-vegetarian 'thali' meal (a full meal, mind you) would cost Rs 80/-. That's US $ 1.45. Most people who come down from abroad, can't believe these prices.

Just as you have your prejudices against India, I know any number of Indians, including youngsters born and bred abroad, who love to visit India and even stay here for extended periods. Individual attitudes have a lot to do here. Right now in Mangalore, there is a group of about 30 Japanese who have taken up residence to launch an export business. Initially, just four of them came down. Now they have even created a website about Mangalore and share information about the best and most economical places to stay and eat out at.

I also know many Indians who have gone to places like the US and Canada on employment, disliked the environment there and returned to India. I have among our own clients, individuals who own investments and properties in Canada and India and divide their time between the two countries, and are happy for their experiences of both worlds.

All countries have their strong and weak points, their distinctive tastes and traditions. No country is absolutely perfect or imperfect. Neither is any economic, legal or other system or culture. What I find lacking in this world is an inability to focus on the good in a country or its people and attempts to emulate that good, while recognizing and attempting to reduce the bad in our own environment.

 

 

Of Mad Men & Markets!!!

 Query: I was wondering what you thought about the equity market - even though I know that you are not a market timer.

Obviously the global situation is very bad, and arguable things are reasonably bad here as well - be it the macro economic situation or the politics. However, over the past few years I have tended to be even more conservative than usual because of the unusual issues in the global environment (with parallels to the great depression etc).

In that context I wondered what your thoughts are - at least tactically. Do you feel that now is the time to be at weight or working towards getting more over weight in equities (for a long term investor). What do you feel about debt - I have a fear that we may be in for a period of reasonably high inflation and have therefore been more in fixed instruments with a shorter duration. Gold was also a good asset class to be in, but all this talk of it being a bubble is making me wary?

In fact the way assets are positioned anything that one invests in could go terribly wrong right now. And therefore interested in what you think?

Mr. Gerard Colaco: I do not think about the equity market in the sense of either discussing or reflecting endlessly over present political or economic situations or the course they will take in the short, intermediate or long term. This is because I know I can neither foresee these events nor exercise any control over them. I believe focusing on things I can control, not things I cannot control.

What I can control is my response to market fluctuations. If I have the depth, knowledge, expertise and stature, I can also control the response of my clients to the vagaries of the markets. When it comes to investment advising, the manner in which I exercise this control is very simple and would generally fit into one of the three situations mentioned below.

1. If I earn in the form of roughly regular monthly inflows, I would invest systematically whether in stocks or equity mutual funds or asset allocation funds, provided my investment programme is for a minimum of 5 years. I would ignore market fluctuations in between.

2. If I have a lump sum to invest and there is a margin of safety, that is if any popular diversified equity index is more than 25 percent below its last peak and the PE ratio of that index is less than 20, then I will invest in a well diversified portfolio of stocks, or an equity index fund or a diversified equity fund, after ensuring that the money I have invested can be locked away for at least 5 years.

3. If I have a lump sum to invest and there is no margin of safety, then I will invest in either a liquid or short-term floating rate mutual fund and transfer one percent of the principal amount per month to one or more diversified equity funds or index funds. I would double the systematic transfer when a margin of safety arose. I would transfer the entire balance from debt to equity if I were fortunate enough to encounter a drop of 50% in the index value from its last peak.

Beyond that, the global situation, politics, economics (whether micro or macro), bubbles in stock, real estate or commodity prices, fears of another great depression, and other such gibberish would entertain rather than bother me. In fact I do not like ordinary depressions. I would simply love another truly great depression and so would investors advised by my firm, since their assets lie in the kind of asset allocation strategies designed, as Benjamin Graham put it so well “to profit from other people’s folly, not participate in it.”

I wonder whether you have read Warren Buffett’s op-ed in the New York Times, written at the height of the Global Financial Crisis, in November 2008. I quote: “In the 20^th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.”

As regards the role of debt which you have mentioned in your mail below, the best advice ever given would come from John Bogle: “Irrespective of what the future holds, it seems to me that equities should remain the investment of choice for the long time investor - the dominant component of a well-balanced asset allocation programme. Bonds are best used as a source of regular income and as a moderating influence on a stock portfolio, not as an alternative to stocks."

As for gold, commodities, collectibles, and the much vaunted "alternative investments," my opinion is that these are not investments at all. The long term returns on gold, commodities and “things” are likely to equal the inflation rate not beat it. This is because virtually all their prices are included in the basket of commodities, goods and services based on which the consumer price index is calculated. So their prices ARE the inflation rate, to a large extent.

Timothy Green an internationally renowned bullion expert reminds us that “the great strength of gold throughout history has not been that you make money by holding it, but rather that you do not lose. That ought to remain its best credential.”

Genuine wealth-enhancing investments like equity and real estate have two attributes which most investors lose sight of. One, the principal invested increases in value over time. Two, they yield a stream of income which also grows over time. For example, real estate yields rent and rent increases over time. The value of real estate also increases over time. An equity portfolio yields dividends and these dividends increase as time passes. So does the value of the portfolio.

But precious metals and commodities can at best be described as sterile investments, yielding neither dividends nor rentals nor any income streams that grow over time. So, when an investment adviser like me is rooted deeply in the fundamental principles of investment and when the experience and expertise that a good investment adviser commands confers upon him/her a stature that makes most of his/her clients listen and implement plans suggested by the adviser, we reach the happy state that Warren Buffett described when he mentioned that “bad news is an investor’s best friend.”

As for the few clients who will not listen, we do not want them do we? They are eased out of our office with a speed that should surprise them, because it certainly surprises me!!

Since you are an investment adviser, let me end with a small piece of advice. I attribute two reasons for my success. The first way in which I built up my business was to listen to all other stock brokers and so-called investment advisers and then do exactly the opposite. I am gratified that this supremely arrogant strategy has paid rich dividends.

The second way in which I built up my business was to build up my own expertise. I therefore took the trouble of identifying the world's best knowledge, not the crappy, superficial and shallow academic knowledge found in such abundance today, and then mastering and implementing this truly great knowledge. When I look at stockbrokers, investment advisers, insurance agents, mutual fund distributors and other monkeys in the financial services industry today, I am impressed only by the remarkable consistency with which they choose to remain poor quality.

This wallowing in the cesspool of a dismally low quality makes them compete maniacally with each other, slash brokerages and income streams, constantly crib that they don't earn enough and then go out of business or fill their offices with new, exotic and alternative slot machines like commodities and derivatives terminals.

True knowledge opens up your mind, changes your personality for the better, and gives you the stature to lead, not to bleed. With this in mind, I am attaching to this mail our updated list of recommended reading. I guarantee you that if you take some time away from your work and go through the books and material recommended, you will never send me emails of the kind you have written below.

Query: Thanks for your candid views. Your confidence in the system you have for dealing with uncertainty is admirable.

Mr. Gerard Colaco: The confidence is borne out of 31 years of learning, which includes 26 years of practice. And it is backed by 400 years of stock market history, ever since shares of the Dutch East India Company were traded for the first time on the Amsterdam Stock Exchange.

As British PM and statesman Benjamin Disraeli put it so beautifully: "The lesson that we learn from history is that we do not learn from history."

One more reason for the confidence is that the system has never failed to deliver the goods whether in managing risk or delivering optimum returns over the last two-and-a-half decades.