When 100% is less and 5% good4 min read . Updated: 05 Apr 2011, 08:54 PM IST
When 100% is less and 5% good
When 100% is less and 5% good
There is a hilarious mail exchange a friend forwarded me between him and his portfolio management scheme (PMS) “relationship manager". Friend invests money five years ago and forgets about it. 2011 tax time approaches and he pulls out the PMS to see how it did. Where did my ₹ 8 lakh reach after five years of cooking? ₹ 9 lakh? Shock and disbelief. It grew 0.87% a year! Does a quick check and finds that the Sensex grew 10% a year over that period. Asks PMS “relationship manager" what happened. PMS manager (I swear I am not making this up) says: look carefully, we actually gave a return of 4.62% per year. You get the figure of 0.87% because the difference is our charges. For managing your money, you see. I’ve advised friend to ride the bus called a mutual fund (buy out of the Mint50 list) and forget about these get-rich-quick PMS schemes. At least he got his money back. His other story… OK, OK, another time.
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But at least friend knew enough about evaluating return to make the quick comparison with a broad benchmark to figure out how his money was doing. Most people freeze when they hear the word “benchmark" or even “per cent". Unfortunately, the way returns are communicated is different across products, so I deal with mutual funds first. First, look at past performance over one, three, five and 10 years and ask the seller what the per annum return has been over these periods. Last year, an insurance company advertised a unit-linked plan that gave a 170% guaranteed return. Sounded good, till you found out that this was the total return over a 10-year period, your annual growth was just 5.45%, less than a Public Provident Fund!
Second, find out what a broad market index such as the Sensex or the Nifty returned. Just knowing the return of your fund is not good enough, that’s just half the story. We need to see this in relation to two other numbers. One, the broad market index and two, the performance of the rest of the funds in the category. When the market bounced back early 2010, some mutual fund houses advertised 100% returns on large hoardings. Hidden in small print was the benchmark (Sensex) return figure of 102%. The advertising fund house had actually underperformed the index! So even a 100% return may not be good enough because the market may have done better than that. A fund manager charges you to manage your money and the minimum requirement for him is to beat the broad market index by at least 4-5 percentage points since 2% is the fee he charges. The Sensex or the Nifty remains big benchmarks to use to see how your money would have done in a lower cost exchange-traded fund had you taken the passive investment route.
The next number to look at is the category average. Funds invest in many parts of the market—large-cap, mid-cap, small-cap, sector, multi-cap—and though a first comparison with a broad benchmark gives you some information about the performance, you need to see what the other funds in the same category of funds did over the past few years. A good place to get this information is www.valueresearchonline.com that in the bottom right hand corner of the home page gives the information in a manner that you can easily use. Your fund should be able to hold its head high in its peer group.
The investment products sold by life insurance companies are another animal altogether and deciphering returns needs a degree in finance. But we can try. Insurance embedded in investment has traditionally been sold in India by explaining how ₹ x contributed over 10-15 years will grow to ₹ y. Most investors get taken in by the large number that ₹ y looked like and forget to ask what the return was in percentage terms. Most traditional money back and endowment policies returned 4-5% a year. Carrying forward the same regressive return forecasting style, the market-linked products now showcase pages of numbers of what your money will grow to if it grew at 6% and 10%. These numbers are mostly misleading because nobody can forecast what the market will do in the future and the illustration figures do not take into account cost. Worse, you are open to being misled into buying a conservative fund but being pointed toward the 10% return illustration.
What you can do: ask the seller of any market-linked product what the product returned in the last one, three, five and 10 years? What was the Sensex or the Nifty return over these periods? What have other funds in the same category returned over these periods? Are these returns post-cost? Get the seller to sign off on this paper.
Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and can be reached at firstname.lastname@example.org