Financial Plan @ First Salary

Advent of IT and BPO companies in India has resulted into a scenario where youngsters as young as 22 years old start earning a respectable amount. Many a times - if not most of the times - this financial independence fails to result into financial discipline or a proper financial plan and by the time youngsters wake up they only regret for starting too late. Below is the framework which I had implemented for myself and which has brought substantial stability to my finances. Implementing such discipline resulted in very satisfying results which can be read about by clicking here. 

Major steps of a holistic financial framework are as below - 

1. Tax Planning - I firmly believe that "tax saved is money earned". Hence a proper tax plan has the potential to implicitly increase your earnings by way of saving money spent on paying taxes. Learn how to save tax by following below article 
• Debt Funds - The Tax Warrior against FDs 
• Income Tax Savings - A Checklist 
• ELSS - An expensive neglect 
• National Pension Scheme : A Tax Exemption or tax deferment  
2. Contingency Planning - contingency can come in two variants - professional i.e. job loss and personal i.e. loss of life or medical exigency. For facing job loss scenario one should ensure proper liquidity like e.g. three month expenses should always be in liquid assets like bank account balances or fixed deposits or liquid funds. For medical and life loss issues, one should have adequate life cover and medical cover. For understanding liquidity and Life Insurance you can go through below articles - 
• Life Insurance- Your commitment to your loved ones
• Life Insurance : A new perspective.
• Liquidity: The Oxygen equivalent of money
3. Target Planning - Identify your financial targets like Retirement , Kids' Education and Wedding. They should form the pillars of a holistic financial plan. One should take into view factors like current expenses, inflation, time horizon etc to figure out how much saving is required for ensuring achievement of these critical goals. (Drop an email on healthynivesh@gmail.com if you want us to plan your lifestage goal planning)
4. Diversification and Asset Allocation - Absence of professional investment advisors in India ensures that our approach towards investment is more of a product oriented than being individual oriented. Product oriented approach means that we buy any product which is supposed to be a good investment product without caring about its suitability to us. While investment oriented approach means that any investment decision is taken after taking in view guiding principals of a diversified asset allocation. If you put all your money into FDs or in LIC or in Equity , it means you are product oriented. If you invest across asset classes then it means you are diversified. Learn about diversification and asset allocation in below article
• 97% Annual Returns : My Learning and Practices
5. Avoiding financial mistakes - Guided by vested interests , many of us do commit financial mistakes ignorant of their consequences to our finances. Some of them are explained in below articles - 
• How to avoid "Greece Crisis" with your personal money
• 9 Money Mistakes to Avoid in Your 20's

Just like in life, no article no matter how large and holistic can cover everything and anything that should be part of a good financial plan , but everybody can make a good start based on above steps. I will love to hear your views and experiences about money management. You can drop me mail on healthynivesh@gmail.com with your views, experiences and queries of course. 

Customized Financial Planning

97% Annual Returns : Mutual Funds Selection - Statistical Analysis beyond Historical Returns

Below article is the 3rd in my series of articles on how I built up a portfolio giving 97% compounded annual returns (in stocks portfolio) and 37% annual returns in MFs. You can read first article by clicking on 97% Annual Returns : My Learning and Practices and second article can be accessed by clicking on 97% Annual Returns : Implementation.  

One of the most sure-shot method of convincing clients about investing in Mutual Funds (MF) employed by Wealth Managers in India is showing them Historical Returns. Typically clients are aware of 6-8% returns of Fixed Deposits, while Mutual Funds historically have returns of more than 12% and hence looks tempting. Being a Wealth Manager myself I can swear on the fact that its the most effective tool of closing the deal positively. 

I myself have been using the same methodology for selecting which MFs to invest into. It is the easiest way to select MF, just download historical data , have it in ascending order and select the top ones in the list.  

But the real change came when I started revising my concepts of Statistical Analysis learnt during my Portfolio Analysis course at IIT Delhi. Going through standard deviation , mean , Sharpe Ratio etc., I realized that same can be used to select MFs whose historical returns are not only a function of market returns and fluke but because of good investment strategy of the Fund Manager. It also makes future performance of the MFs more predictable. 

These ratios can not only be used for MF selection, but for overall portfolio as well. So before going further into the Ratios, I will dwell into some basics of the statistics beforehand.

• Standard Deviation - It is the parameter by which you can measure the propensity of any data to 'deviate' from the 'mean' i.e. average value. Hence , you can say it is a measure of 'Risk' of the MF or portfolio. 
• Correlation - It is a measure of how much two parameters are 'linked' to each other. Simply put how would movement in one parameter effect values of other parameter.  

Now lets explore the ratios one by one - 

1. Alpha - It is the difference between the returns of the portfolio or MF and the respective benchmark. E.g. If 3 years returns of Reliance Small Cap Fund is 23% and 3 years returns of its respective benchmark (i.e. S&P BSE Small Cap Index) is 15%, Alpha will be 23%-15% = 8%.
2. Beta - It is a measure of 'correlation' between a MF and its respective benchmark. In layman terms,
• A Beta value of '1' signifies that MF will move perfectly in tandem with the benchmark. So if benchmark moves up by 15%, MF will also move up by 15%.
• Similarly a Beta value of less than '1' means that MF is less volatile than the benchmark. So MF will move less 'up' and 'down' than the benchmark. 
• A Beta value of more than '1' means that MF will move more 'up' and 'down' than the benchmark. 
3. Sharpe Ratio - Sharpe Ratio is a measure of 'Returns' and 'Risk'. Numerator is the difference between expected returns of the MF and Risk Free returns like returns of US treasury bonds, while denominator is a measure of Risk i.e. 'overall' standard deviation of the MF. As anybody will tell, we will like 'Risk' to be as less as possible and Returns to be maximum, hence a higher value of Sharpe Ratio is always desirable. 
   
4. Sortino Ratio - It is a better version of Sharpe Ratio, while Sharpe Ratio takes into account  'overall' part of standard deviation, Sortino takes into account only 'negative' part of standard deviation. A parameter (in this case Returns) can 'deviate' in both 'positive' (i.e. higher returns than the 'mean' value) and 'negative' (i.e. lower returns than the 'mean' value) direction. While negative deviation is harmful to the investor, positive deviation only increases investor returns. So Sortino takes into account only standard deviation of 'negative' returns in the denominator. 
5. Expense Ratio -  It is the %age of the fund value charged by the Fund Manager as his expenses. In India it is capped at 2.5% per year by the market regulator SEBI. Needless to say lower is the expense ratio, better the MF is. 

Stay tuned to learn about stock selection in my next article. Till then you can read about my multibagger which gave me more than 300% annual returns Avanti Feeds : A Comprehensive Stock Analysis.