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Financial strategy for passive investors

Financial strategy for passive investors
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First Published: Sun, May 15 2011. 08 48 PM IST

Updated: Sun, May 15 2011. 08 48 PM IST
Do you remember your savings account balance? Do you track your investments—long-term and short-term—regularly and have time to change your allocation according to your life stage and requirements? If your answer to these questions is no, you can most likely be labelled a passive investor.
“About 90% of Indian investors would fall in the passive category,” says Madhur Todi, certified financial planner and managing director, Mera Money Advisors. But you can give your portfolio some direction with the help of some products and by refraining from dipping your feet into certain areas.
Sweep-in account: If you keep your liquid cash in your savings accounts because you don’t have the time or discipline to invest in a fixed deposit (FD), converting your account into a sweep-in would make sense.
In this account, as soon as your money crosses a predetermined limit, the surplus automatically gets swept into a term deposit and starts earning a higher rate of interest. At the same time, it remains liquid.
For example, if the limit is Rs5,000 and your balance goes up to Rs12,000, the surplus of Rs7,000 will start earning a higher rate of interest. However, you will be free to make withdrawals above Rs5,000. But you can do so only through a cheque.
The limit varies between banks, sometimes customers are allowed to fix the limit. Funds below the limit earn 4% returns, while any surplus would earn the fixed deposit rate of the bank. The rate would depend on the tenor.
Cumulative interest on FDs: If you do manage to open an FD or a company deposit on your own but don’t want to go and collect the interest it pays periodically, go for the cumulative rate of interest option. In this, the interest gets reinvested and you get the principal amount and the interest together at maturity. Alternatively, if you need a regular cash flow you can opt for the electronic clearing service and get the interest debited into your account directly.
Multi-asset funds: Following the saying that never place all your eggs in one basket, multi-asset products cater to the need of diversification. By investing across various assets such as equity, debt and in some case even gold, these funds absolve you of the headache of having to invest separately in equity, debt and gold. Some funds such as Sundaram Equity Plus, a new fund offer that closes on 16 May, invest only in equity and gold.
But you need to be careful. Most of these funds do not have a track record since multi-asset funds started entering the market only since the past year or so. Stick to fund houses that come with a good track across equities and debt, and chances are you won’t be disappointed.
Balanced funds: This is another category that aims to offer a ready solution. This one invests at least 65% in equities and the rest in debt.
Balanced funds come with a track record and some of them such as HDFC Prudence Fund have even outperformed diversified equity funds (that invest their entire corpus in equities). “Another advantage of a balanced fund is you get debt exposure without the tax implication of equity,” says Delhi-based financial planner Surya Bhatia.
Dynamic funds: It’s a close variation of a balanced fund. These schemes switch between equity and debt depending on a formula. Schemes such as Franklin Templeton India Dynamic PE Ratio FoF refer to Nifty’s price-earnings multiple (P-E). Higher the Nifty’s P-E, lower is its allocation to equity and vice-versa. For the two asset classes, it switches between Franklin India Bluechip Fund and Templeton India Income Fund. Others in this space such as ICICI Prudential Dynamic Plan do not switch entirely between equity and debt; the minimum equity exposure it takes is 65%.
Says Mukesh Gupta, director, Wealthcare Securities, a financial services provider, “In these funds, the debt-equity ratio keeps changing based on the parameters.”
But remember that dynamic funds that can invest up to 100% in equities can be risky as the fund manager has the freedom to decide the equity-debt split. Schemes that depend on a formula should come with a track record. “Asset allocation does help the investor in building a relatively less risky and stable portfolio. However, the investor should review and, if required, rebalance the asset allocation,” says Dhruva Chatterji, senior research analyst, Morningstar India, an MF data tracker.
Index funds: These are passively managed and mimic the returns of a particular index by purchasing all—or almost all—of the holdings in the index. Index funds offer the benefit of diversification and are also lower on cost.
“Nowadays you can buy the Index itself. The risk is very well spread and whenever the trading volumes come down for a particular stock, it goes out and another performing stock comes in,” says Vijay Kumar, investment strategist, Geojit BNP Paribas, a brokerage house.
Retirement planning
National Pension System (NPS): This product will specifically help you plan for your retirement. NPS invests across three fund options: equity, fixed-income instruments other than government securities and government securities. You can invest only up to 50% in equities and the rest in the other two options.
NPS offers two investment choices—active and auto. Under active choice, you can choose your allocation between the three asset classes. The auto choice facility does the job for you according to your age and risk profile. The auto facility starts with higher risk and moves to a less risky asset allocation as you approach retirement. For instance, if an 18-year-old enrols for auto choice, 50% of his money will be invested in equities till the age of 36 years; the equity exposure will keep going down as he progresses in age.
What passive investors shouldn’t do
Don’t buy stocks directly: Direct investment in stocks needs time and expertise; passive investors, in all probability, wouldn’t have either. In such a case, dabbling in stocks directly may be fraught with risk. “Many times investors invest based on hearsay or tips offered by brokers and friends. The risk goes up tremendously due to this,” says Suresh Sadagopan, certified financial planner, Ladder7 Financial Advisories.
Don’t chase new fund offers: When a new fund is launched, there is no performance history to fall back on. “It will be like shooting in the dark. It would hence be a better idea to invest in existing performing funds whose performance history and fund management philosophy are already known,” says Sadagopan.
Don’t churn your portfolio too much: Just because your agent advises you to do so, don’t blindly churn your portfolio, unless he has a convincing enough reason. “Churning would mean extra cost whenever you plan to exit from one fund and enter another and simultaneously it also increases your record-keeping job,” says Bhatia.
While these products may work for you, it’s important to review your portfolio regularly and assess whether it’s in sync with your goals.
Financial planners maintain that you must look at your portfolio every three-six months, or else they would categorize you as lazy and not a passive investor. “Just like you cannot be physically lazy if you want to stay fit you cannot create wealth if you are lazy. Review does not necessarily mean churning the portfolio,” says Mumbai-based certified financial planner Gaurav Mashruwala. Remember there is no short cut to wealth creation.
Illustration by Jayachandran/Mint
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First Published: Sun, May 15 2011. 08 48 PM IST