The unknown risk in fixed deposits!

Investing Strategies
1

Fixed deposits are considered one of the safest heavens to keep hard earned money. Are they really safe?

Let us go back to 1980. If someone had one lakh rupees in 1980, and had kept it at a fixed deposit till now, today, he/she would have Rs. 20 lakhs (at average annual post tax interest rate of 10%) or Rs. 33 lakhs (average post tax interest rate of 12%).

In 1980 Indian sensex was around 130, today it is 19,500, up 155 times. If that guy had invested one lakh in Wipro in 1980, and held till date, the value of those shares would be Rs. 4000 crores or four thousand crores.

If one lakh had been invested in real estate in Delhi (12 plots of 100 squaremeterin North Delhi), the value of investment would be around Rs. 40 crores today.

So we have the following case scenarios for aninvestment of Rs. one lakh in 1980 in India, and its value today-

1.Fixed deposits)- Rs. 20-35 lakhs

2.**Index (Sensex)**investing a Rs.1.5 crore

3.Wipro)- Rs.4000 crores

4.Real estatein Delhi- Rs.40 crores

5). Investment in agood portfolio of sharesby a good portfolio manager would have generated returns more than index, but less than Wipro a somewherebetween Rs. 20-100 crores.

Would you still say money kept in fixed deposits is safe?Where should youkeepyourmoneythen**? This link will help you**understand the same-http://goo.gl/WbLm4

Inflation, opportunity costs,andinterest ratesareeating your moneykept in fixed deposits. Go and help!

2

Hi Vijay,

What about the known risk of equity investing? One fine day, due to some crazy reason, the sensex starts falling and within a week, it is down 25% in a week; and because of small-cap oriented portfolio, your equity portfolio is down 60% odd. If you have put all your fruits in one basket, you are as good as dead in such situation.

FD, which might give you a slight negative return post inflation, at least assures your capital preservation.

Real estate usually gives inflation beating return; and with leverage due to 20yr loan scheme, you might get as good return as equity at least in initial few years (where your leverage will be 4:1 to 2:1).

So being blinded by pure expected return maximization, is a sure shot way of financial suicide. One must suitably mix and match amongst various asset class (equity, MF, FD, gold, real estate) so as to satisfy these criteria

1> Short term liquidity

2> Capital preservation during arbit fall of equity market

3> Capital to invest in golden period of post-fall equity market

We had a valuepickr meet in Delhi and have heard fearful story of having 75% networth in equity market during market fall. Those folks have 50-60% cagr return for last 2-3 year, and all their profit wiped out in a short span of time.

And I know folks who have increased their networth by huge multiple just by investing in real estate at right time, and right place. Also there was a time when gold was giving excellent return as compared to equity.

I feel a dynamic asset allocation strategy with sufficient assurance of capital preservation is a must for most of us, even at the cost of lower return on networth.

Also what about return-per-unit-of-stress.

Also what about rear-view mirror effect. What happened in last 20 odd years not going to be valid in next 20 years, that is for sure. So old strategies are unlikely to work in future.

3

So let me give my crazy mental model from teaching of Mahatma Gandhi. He has famously told to see the world as if you are going to die tomorrow, and plan your action suitably.

I think we can extend this in personal finance. So have a strategy ready, which has inbuilt assumption of crazy things happening to part of your asset at any time in future. When you start felling this end-of-world moment, you will start appreciating return-per-unit-of-stress, less return more security, diversified asset allocation model.

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The investor has to be an optimist and never do his planning based on as if he is going to die tomorrow. He should plant the tree and wait for the tree to bear fruit and enjoy the fruit.

5

Hi Vijay,

You have nicely put how useless it is to put money in FDs. Basically once you keep your money if FD, you are telling the banks…please use my hard earned money to make yourself bigger and better. Nobody has ever become rich by keeping money in FDs and nobody will ever become.

The so called security simply reflects the middle class mindset(I belong to the same group), since we are taught from day one to avoid risks and play safe.

I personally feel that one should keep some liquid funds to meet emergency needs(medical needs, job loss etc…) probably worth one year of expenses. Beyond that anything in FD is waste. Though my family members do not agree with me and keep their 95% locked in FDs and Real Estate. I am able to convince them somehow to put at least 5% in stocks.

I found your writings style very interesting and to the point. Please do keep writing. By the way it you wish to share, please share your personal portfolio. It would be interesting to know your picks.

Regards,

Raj

6

I will share Gaurav Sud told us during the Delhi ValuePickr meet.

Have as much assets in equity that tomorrow if the market closes down for some years, that doesnot hamper your normal life style and standard of living.

%age allocation etc. is all meaningless. A guy like Buffet may have 99% of his net worth in equities, as the 1% may see him through for 50 years of normal lifestyle with inflation.

On the other hand, for a normal guy, even a 75% exposure to equities may harm him with a job loss, high EMIs to care, family and maintaining a healthy lifestyle.

So if you are sure, that your lifestyle and expenses are taken care of, and would not be impacted (inflation adjusted) go and invest that amount in equities.

7

Here is my answer for a black swan event-

How to manage a black swan event or a market crash, and make profit fromit?

JANUARY 1, 2013LEAVE A COMMENT(EDIT)

A Black swan event is a rare, hard to predict, low probability event-http://en.wikipedia.org/wiki/Black_swan_theory

A massive earth quake in Delhi, a major war between India and one of the neighbors, a terrorist nuclear attack in Delhi/Mumbai, a sudden significant contraction of the Indian/world economy, and a major war between any two of the top five economies in the world, are a few examples of the black swan events.

These black swan events are capable of not only killing us but also destroying our networth and leaving us unemployed. Assuming that we would not get killed in such a event, we need to understand how do we deal with them financially? Can we predict them? Can we make profit from them?

We can not predict these events, yet a black swan event may occur in our life time, and we will have to deal with it. Here is a simple strategy not only to deal with the event, but also make huge profits from it.

Let us first understand the series of events (financial) that would take place in a case of black swan event. Let us take two black swan events.

1). A massive earthquake in Delhi

  • A lot of people would be unemployed, may be including you
  • Real estate would crash
  • People who had taken loans to buy real estate may default. Many of them would go bankrupt
  • Banks would be reluctant to give loans, specially to buy real estate
  • Real estate developers would also default

2). A sudden, significant contraction/recession in the Indian/world economy

  • Stock market and real estate would crash
  • A lot of people would be unemployed, may be including you
  • Banks will be reluctant to give loans, specially to buy real estate
  • Real estate developers would also default
  • Both stock market and real estate would be available at cheap prices, specially stocks
  • Crash in stock market likely to be a lot more than real estate

We can hedge against such events, and even make profit by following a few rules and implementing the strategy outlined below-

**Rule#1:**Never leverage more than yournet-worthto buy either stocks or real estate. For example, if your current networth is 50 lakhs, do not take a loan of 60 lakhs to invest in a flat in Gurgaon.

**Rule#2:**Always have 20% of your total networth in gold/cash/international currency etc. You should always keep 20% of your networth in safe heavens. Even a bank deposit may not be a safe heaven in case of a black swan event. Gold may crash. Rupee may lose itas value. Only way is to keep a mix of gold, cash, international currencies like dollars, swiss francs etc. This money should be separate from your investment portfolio, or anyfinancialgoal like marriage etc.

Assume you have followed the rules above, what would you do in case of a black swan event.

**Strategy:**Wait and watch the black swan event to completely unfold and impact the markets. As the stock market starts crashing, some investors still buy hoping to average out. The price keeps falling for a long period of time. Eventually, the investors stop averaging, and the market comes to a stand still. Let the asset prices touch the bottom. You can identify the bottom of any asset by very low volumes, and complete dis-interest in the asset (Stage-1 of an asset cycle-http://goo.gl/oEujd). Once you feel the bottom has reached, invest half of the funds in the stocks/asset. Wait for some time, as you may have missed the bottom. If the prices remain stagnant for some more time, with low volumes, invest the other half of funds as well.

You can apply the same strategy to real estate.

**Outcome:**Once the world around you starts normalizing, the asset value will start moving up. You need to hold your assets (stocks/real estate) at this stage (Stage 2 of an asset cycle). Wait for the environment to be completely normal, and for asset prices to shoot up before you sell them to make huge profits. (Stage-3)

Happy Investing!

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And, here is the answer for index levels and correlation with your returns or loss-

Sensex at 21000 in 2013! Making sense of thesensex!

JANUARY 2, 2013LEAVE A COMMENT(EDIT)

Businesschannelson TV (CNBC, Moneycontrol etc.) and paid analysts are creating a lot of hype of BSE index reaching 21,000 level in 2013.

How does this affect us? Does this mean it is a time to sell or to buy? Does this mean our portfolio should be in profit?

We should be worried about how the businesses of stocks we own are performing. Whether, the promoters of stocks we own are honest? Do they share profit with minorityshareholders? Do we own excellent, sustainable businesses? Do these businesses have barrier to entry, pricing power and competitive advantage? Are the valuations of the stocks we own in a sane range? Is our portfolio allocation right for long term wealth creation- http://goo.gl/4Z494? If the answers to all these questions is positive, we should not at all be bothered where the sensex is headed.

Let us look at the performance of sensex vs a few stocks in the last five years.

Five year return - sensex vs select stocks

Five year return a Sensex vs select stocks

Rs. 20 lakh portfolio of Hawkins, ITC, Titan, and HDFC Bankwould havegrown to almost a croreby now. While thesame 20 laks investedin Reliance comm, Reliance cap, DLF, HDIL and GMR infra**would have shrunk to only Rs. 3 lakh as of date.**The index has returned -6% in the same time, so have many mutual funds.

Do you still think that sensex level has any relation to your portfolio return? Are you still listening to the analyst who is predicting sensex level of 21,000 in 2013?

Happy investing!

9

**
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**This is a statement from Peter Lynch and I totally agree with it. **This is the key. One should not put any money in equity which he can’t afford to loose(theoretically), as market can go down and remain dormant for years together.

I personally never took out a single penny from my portfolio money even during 2008 crash and have no intention to take it out. My day job takes care of my day-to-day need and I generally keep enough cash for one year of expenses. Rest all in equities as I haven’t found any other way(ethical and legal) to grow my money at a faster pace.

10

Great post subhash a joyful day spent with family a good dinner followed by sound and peaceful sleep cannot be valued at all and is priceless.

Ability to appreciate and enjoy small things in life and live a meaningful life is lost somewhere in the quest for super-duper returns and safer retired life.

And I have seen when age ultimately catches on,one actually realises,these lost moments were actually more valuable than all those worthless crores.

Having said this,strategy of diversified asset allocation should fetch you a balance between two. Hence three cheers from my side for this strategy.

Only thing so far I have not understood from your posts that you are considering your home loan as a positive leverage on credit side of your personal acounting I am not sure how right you are here.If you were staying on rent and had borrowed money and invested in stocks that would have been considered as leverage.Home loan however cheap (interest outgo cannot be less than rentals you pay to occupy similar property)is always on liability side in personal acounting. Here again if you are referring return-unit-of rental mental stress vs ownership comfort then again I think you are right.

11

The risk on FDs is a real risk. That is by investing in them, one is surely loosing money. One gets a negative return for keeping money safe.

In equities the risk is there but the same can be mitigated by following good strategies - like value investing, diversification etc. One needs to go through a cpl of bull and bear market cycle to get a comfort and understanding of the markets. Once that is done, I’m sure, equities won’t look that risky.

Ayush

12

Hi Aysuh,

What to said might be valid for folks like you and other valuepickr seniors who have honed their equity investing skill to a level to understand the market top-to-down. My question is “is it valid for a new learners?”. As I know one need to spend minimum 10K hrs of effort to qualify for the title of expert, and I doubt there will be more than 10% of folks here who qualify for the same.

With each passing day, the world is getting more globalized, economies are getting much more inter-mixed. This is resulting in spilling of issue of one country to rest of the world (tiny greece’s default almost rocking the entire europe, and world’s exchanges). Think of 1trillion $ US deficit, slowing down china, the financial alchemy of wall street, and you start feeling that there are more ways a negative black swan can come and engulf the market.

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Subhash,

If you want to become an analyst then all the points you mentioned are fine, else investing is not that complicated unless you want to maximize your return to the max. Just focus on the companies you have faith in. If the management is good, they will take care and adjust to changing macros.

The above is my belief. I may be thinking differently than you and may go wrong.

Regards,

Raj

14

It is a certainity that the post tax FD will fail to beat inflation in the Indian context.

A certainity implies that there is no risk as the outcome is known before hand. A risk in an event exists where the outcome is unknown and one tries to manage that risk by assigning probability to the possible outcomes and then choosing a particular option.

Despite knowing before hand , that the outcome will not favour you and if one still contines on that known path, is a sure and risk less way of eroding your wealth.

15

One thing, all agree on is, Putting money is a sure shot way of losing money as the purchasing power of money couple of years down the line will no where be near to what it was when invested in FD.

As mentioned by Peter Lynch and pointed out by Rudra and furtheremphasizedby Raj, that put only as much money in the equities that you don’t need for your day-to-day living.Point well taken.

Kudos to Raj for his conviction for keeping through 2008, that really requires tough mentalmusclesand strongconviction.

So

FD is ruled out and also the option of parking money in equities needed for day-to-day life.

But there are people who are earning their bread & butter from investing only…how is that possible…how do full time investors are managing their day -to- day expenses ?

Looks like, it should definitely be possible to juggle money for investment and for day-to-day use. Just that the rules of the game are different and need to be understood frompeople are Full time in investment and already doing this…

16

Equities is a long term investment avenue (mostly) and debt is a short term investment avenue. Unfortunately, most people do the opposite - invest in a 5 year FD, but invest in equities for 5 days/ weeks/ months.

Look at HDFC Bank. Its depositers earn 7% post tax, while shareholders earn 20-30%. Even from Jan 2008 top, over 5 years, its has doubled i.e. 15-16% CAGR. This is lower than earning growth due to initial high valuations, but still far better than FD.

17

Hi,

The biggest consideration is how you take starting points !!

1980 - New issues were under control by CCI which would decide prices. Assets were illiquid leading to longer holding periods.

Have a look at 2006-2012 for a normal investor who knows nothing and buys into Index funds or mutual funds. Every asset class has beaten the equity segment ( not talking valuepickr stocks)

Meanwhile WIPRO CIPLA INFOSYS etc are the best examples used by AMCs and should not be used by Value Investors. Wipro was into vanaspati ghee and i doubt even Mr Premji knew that he would be what he is today.

I remain a firm believer to buy in Equities but one should also know the risks.

18

To earn your bread and butter from investing, the first thing is, corpus size should be big enough. At least 50 times of annual expense. With that, the portfolio can produce at least a 2% dividend yield for bread & butter without having to compromise too much on quality of stocks (read not having to choose only high dividend yield stock instead of growth,deep value stocks) and hopefully the growing corpus and dividend yield can take care of inflation adjusted expense of future years.

This is something i had read on a TED thread and made sense to me. 50 times annual expense corpus is stiff target though for salaried ppl who don’t have much financialinheritance!

19

The logic of black swan events affecting equity investments is flawed in my point of view. They may in the short term no doubt but arent we looking at our investments from more long term view. Looking at the history of equities, there have been events like that and events like US Fiscal cliff, European sovereign issue etc are similar to Vietnam war, US inflation in 70’s (around 15-18%), 22% fall in DOW in 1987etc.

The fall in equities can give great opportunites to pick companies with competitive advantage/economic moat ( HDFC bank, Titan, asian paints ,hawkinsetc) and a value investor should perhaps welcome that. Warren Buffett bought American express when it was clouded due to Salad oil scandal and Washington Post when it was selling at a huge discount to its intrinsic value - in 1974. Perhaps those two were his best bets.Till the time we are buying companies with great competitive advantage at reasonable prices, we should not worry. The problem is when we pick low quality securities- darlings of the market :)which are rising in a rising market and we never get back those prices. ( Reliance com, DLF, GMR, Suzlon , Educomp etc). The major risk ( permanent loss) to an investor is when he/she buys low quality securities.

20

True, That is a huge- huge target. There should be alternatives. There are always more than one solution to a problem.

financialinheritance!

But there are people who are earning their bread & butter from investing only…how is that possible…how do full time investors are managing their day -to- day expenses ?