NPS- National Pension Scheme and The Marshmallow Experiment

It's been almost 72 years since India became independent and all the while the general public suffered from one basic aspect and that was The old age pension system and a social security system.

Traditionally up to 1991 the earning populace was so used to putting their money in FD and RD at 12% that it never really mattered for them to look anywhere beyond NSC or other post office schemes and of course the omnipresent LIC.

Last was the Ocean into which the public was throwing away its money which spoiled the investment culture so badly that people would rush to them for princely returns of 5% over 20 years and more.

Just like the story about frog who was put into a pot of water and slowly it was heated;  in a similar way the government kept reducing the interest rates on all small savings PPF and fds and to add insult to injury also introduced TDS on the fixed deposits.

Around this time something deceivingly spectacular made its way into the Indian market and it was called ULIP.

ULIP came riding piggyback on the mutual funds which had already made an entry about eight years  before.

Mutual Funds were not so aggressively sold so less than 1% of the investing public invested their hard earned money in them.But the ULIPs were being sold heavily at mind boggling commissions and hence were thrust down the throat of the higher income group.

Slowly few people caught on to the mutual funds and started making money with the return in excess of 15% on rolling basis.with this kind of return the people did not even mind losing the money to Ulips as they had tasted blood.

It seems very automatic to them that putting money in mutual funds was a sure shot way of gaining minimum 15% next year unless of course Y2K and 2008 happened.

The Dotcom bust in year 2000 and the global subprime crisis of 2008 pulled away a lot of people from the equity market.

Around the same time in 2009 NPS was introduced after being tried out for Govt employees in 2004.

It was supposed to be a path breaking plan backed by government of India and controlled by PFRDA.

NPS was supposed to be sold on the back of infinitesimally low expense charges , in fact fraction of what Mutual Funds were charging but having the same 8 fund houses as the fund managers.

The mechanics of NPS is a little complicated. You have 3 streams or asset classes to allocate your money to viz Equity, Government bonds and Corporate bonds. As a conservative gesture the government did not initially allow more than 50% allocation to equity (now it is max 75%). After a lock in upto the age person could take out 60% of the Corpus on his 60th birthday but 40% minimum would be allocated to buy annuity from insurance company . Annuity in simple language meant that 40% of the Corpus would be given to the insurance company of your choice who will continue to give you a monthly pension at a fixed rate which was not very high until subscriber’s death. At the time of death  the pension could be continued for the nominee or the annuity sum would be returned to the nominee.

What was important was that NPS was opened not only to the organised sector but a it also replaced the government pension scheme and was open to anyone who wished to open NPS account.

The next 10 years brought in a lot of changes and another asset class was added as Alternative Investments or AI. 40% of the Corpus which a person withdrew was made tax free and the lock in period or the period till which a person could defer its annuity was extended upto 70 years of age.

As things stand today there are 8-9 fund managers and NPS operates in Tier 1 and Tier 2 mode.

Tier 1 mode is compulsory with a minimum of 1000 rupees subscription and can be used for tax saving under 80C up to a sum of rupees 2 lacs. The lock in up to 60 years of age is in Tier 1 only.

Tier 2 also operates exactly like Tier 1 except that there is no lock-in and you can distribute your money into various asset classes.It is important to note that as soon as the funds appear in Tier 2 you can withdraw them anytime at a short notice.

The Unpopularity: the Indian middle class who had tasted the returns of mutual funds had become used to the instant liquidity nature of various types of funds.

Some of them preferred MFs over FDs also which is a very good thing.

The main thing which was pulling away the Indian public and even those who did not have any retiral benefits for gratuity and pension were not in a mood to keep their money locked in for such a long time till the age of 60.

This is precisely why I have written this article.

I am a self made mutual fund investor who started with the first mutual fund introduced in India. I have made my portfolio in due course of time but I would say one thing at this stage that, if something like NPS was available to me and everybody 30 years ago then probably Mutual Funds may not have been so popular.

In addition to the lock in the people refuse to believe in anything which is backed by the government or is sovereign in nature. This mistrust comes on the back of the famous US 64 debacle , through which the government royally cheated the investors.

Having considered both our aspect what I also feel is that with the popularity of the equity market and mutual funds people have lost the concept of pension.

It is a mindset which makes them feel that they can take care of their own Investments.

While this is a healthy thinking but if it is not backed by adequate qualification or determination and discipline it could actually prove to be undoing.

Most of the investors whom I know have invested or started investing in the last 10 to 15 years. In these years also they're on the constant look out for a good and a better fund hence exiting and entering various funds every year. This mindset does not give constancy and in certain cases people exit at a low and enter at a high. They confuse mutual fund investing with direct equity investing and carry the same mindset here.

This I refer to as the marshmallow syndrome.

Most of the investors are in such a bad habit of looking at the returns every week or every month that they cannot digest a little fluctuation in their NAVs.

If the downturn in the market continues for a few months in a year then they are quick to exit instead of investing more. NPS dissuades a person from this.

However much we talk about long term investing and compounding, the investor can never take a look beyond 5 years. The slow and boring process of compounding can produce spectacular returns is something that a person refuses to acknowledge or even consider.  

Considering the NPS as the investment and security avenues I feel that Tier1 should be made as an investment and also a tax saving Avenue and a small amount of money can also be deposited in the Tier 2. 

Tier 2 is exactly like normal Mutual Funds but at a much lower cost than the index funds or the ETFs. The taxation is also of the same level.

Due to low expenses The returns as seen in the last 5 years have been a little higher than the mutual funds in both equity and debt segment.

So what is keeping the Indian citizen away from an excellent pension scheme which has almost equivalent allocation as a equity hybrid fund.

As I have mentioned the first detractor is the lockin which  can be for almost 35 years for a youngster who is barely 25.

The second aspect is the annuity which is actually controlled by the insurance companies as PFRDA does not have a system of managing it on its own.

Strategy for the self-employed or those in the Merchant Navy: NPS provides a much simpler way of managing your savings and channeling them on a long term basis into a relatively secure system.

in my opinion one must open NPS account as soon as one starts working and should start investing smaller amounts equivalent to at least 15 days of salary. The option must be kept with maximum equity allocation which is 75% at present 15% Government bonds and 10% corporate bonds.

As one grows in age one will be able to see the consistent rise in the Corpus and if encouraged by that one can keep increasing the allocation to Tier 1. 

Along with this one can experiment by putting smaller amounts in Tier 2 which one will be able to withdraw as and when one needs it.

As one approaches the retirement age that is from 55 onwards one should increase the allocation into Tier 1.

5 years of increased allocation will boost the overall courses on the back of the returns that one sees over extended period of time.

In my opinion it is the very lock in nature of one's money which will give it the necessary boost even if it is against one's liking.

Since NPS also serves the central and State Government employees it is my feeling that it will never be allowed to be diluted and The returns that one sees will be greatly enhanced.

I cannot see for sure but as a speculation I feel that a part of the annuity could also be made tax free in future.

Hence as the government sector gains on the back of various improvements in NPS the common man should not be left behind.

2018 has seen the large cap return dwindle in the actively managed MF but higher in the index funds or ETFs.

By extrapolating this hypothesis I can say that in future the actively managed funds will continue to generate lower and lower Returns but before the exchange traded funds or index funds beat the actively managed funds , NPS would have beaten them fairly and squarely.

CONCLUSION: I am a fervent supporter of mutual funds and the basis of my propagation of Financial literacy rests on the versatility of Mutual Funds.
Mutual funds are beyond doubt very flexible when it comes to selection and allocation of funds. But one aspect that they severely suffer from is the ability to be purchased because of 47 Fund houses and each having at least 200 odd variety to pick from. Add to this the severe shortage of good advisors and distributors who can advise going beyond personal benefits.
NPS gives a secular platform to the Lowest Common Denominator to start investing his money in a fairly diversified manner, all the while knowing how much he is generating as returns from each asset class.
He has just 8 Fund Managers to chose from and hence choice is simpler even if he has to change the fund manager every year, which comes at a very small cost.
Apart from allocating funds to the NPS Tier 1 and 2, one can for comparison purposes invest in 1 Hybrid Equity fund and 1 Multi Cap fund.
After a few years of sustained investing, he will be able to decide for himself which is the best course for him.

How to build and maintain a Equity to Debt Allocation Ratio

Q.       Can u please suggest how One's portfolio should be allocated when investing both in equity and debt funds in mutual funds. Right now i am all in equity.

In theory everyone would suggest different figure to you but if we only talk about mutual funds and leave alone the FDs and various other schemes that you may be holding then for a youngster, equity to debt ratio of 80 :20 is sufficient.

But the question that arose was that how to arrive at this allocation ratio.

A better question  would be how to start building your portfolio.

The answer to this ;for those who work on shore and have a regular flow of income even if a little less would be to start a SIP in a few funds and keep building it.

Such people naturally have FDs and also invest in NPS,  PPF,  EPF and other avenues which makes up for the debt portion of the portfolio.

But for unfortunate people like us who just get a few lacs every month and 6 months of leave to do what we like there is a different strategy.

This strategy like most of my colleagues are aware is the header tank on expansion tank strategy.

And this is no different then a normal STP.

Select 5 to 7 good equity funds in different AMC s and start with putting 1 lakh each in liquid or Ultra short term funds with those AMCs.

Then simply set up a weekly STP from this liquid or Ultra short term fund in to those equity funds in such a way and with such a amount that the liquid fund or the Ultra short term fund ( which can be called the source fund) does not deplete during your leave and before going back to the ship.

This part... of the source fund not getting over is more important than choosing a higher value of STP. Because under all circumstances your STP must go uninterrupted for as many years as possible.

Once you have started moving your money from the liquid or Ultra short term funds to the equity funds your exposure to equity will keep on increasing and the debt portion will keep on reducing and in roughly 4-5 years the allocation ratio of 75 equity and 25 debt will be achieved automatically.

During these 5 years if you are lucky the share market will go down and your further investment will be able to buy more units in equity funds than in a bull run. Furthermore after this downturn in the stock market when the market will start looking up your allocation ratio will automatically start leaning towards equity.

At this stage you will be able to evaluate your risk appetite and will be able to decide exactly how much percent you want to have in equity.

This process will be a continuous one ... and whenever you find that your portfolio has skewed more than 5% on either side of Equity or Debt- you can make a corrective action of shifting it to the opposite  asset- Equity or Debt.

QED

What to do after I have set up my investment process.

 What to do after I have set up my investment process

A common question that I am often asked after one starts doing his customary as it is in STP into equity Mutual Funds is what do I do now?

Well !!! To start with, first accept my congratulations because you have done something which most of the country and even the world does not do.

As one moved from different type of political systems and economy  to the one of liberalization and privatization of high salaries and longer working hours, collecting millions - before one reached his 30s and getting that coveted house in the hills much much before the retirement. As We moved through all the above we forgot one thing that violent fires do not last long and heavy torrential rains come to abrupt stop and in the same way the highest salaries that we see in the beginning of a careers or towards the mid career and not forever.

The situation does not last long not because of many other reasons. But simply put, while running in that fast track race a person gets tired faster gets a lot of problems which add up to one’s adverse physical and mental condition much earlier. Hence  the very organisation which actually pushed you for all those mind-blowing achievements at a such a young age is further on the lookout of even younger blood all the time.

Hence right from day one when you enter the fast track career with higher compensations, it becomes imperative that you do not forget that's saving is important and putting that saving to work harder in form of investment is even more imperative.

It would not be an over statement if I say that you should have made your billion rupees much before your 40s.

…and now by the virtue of you having started on the road of investment in whatever small measure it may be… you need to understand a few things.

Firstly it should be remembered that what you have started investing in all probability is a small percentage of your salary and you need to step it up as soon as you have faith in the system and methodology of your investment.

Secondly you should remember to keep on the track without deviating much as different schemes which are both attractive and unbelievable comes along.

Just because you started 25000 SIP into equity mutual fund does not give you the right to start going for IPOs or NFOs or closed ended funds all get quick rich forest schemes, ulips, endowment plans money back plans of various insurance companies or some chit funds. Don't look at any of them just stick by your standard 7 golden rules and keep on your investment track.

Thirdly you have to remember that every year as your salary goes up by way of increment all the forex fluctuation you must try to divert the increased funds towards your Investments.

Fourth point, That I would like to stress is that somewhere in the middle do not start believing that real estate will give you a better return.this will not only take away and important portion of your savings but take it into an uncertain BLACKHOLE, out of which you will find it very difficult to come out as long as you invest and stay in India.

Fifth point that Comes along is most important of all and that is stop tracking the market everyday. Do not start subscribing to that pink newspaper start watching the CNBC channel everyday.

Just by investing a few lacs in mutual funds or direct stocks does not make you an expert on the Indian economy or give you the right to start discussing it at dinner parties. In fact it is definitely a good idea to start learning about your country in some small measure. Read newspapers to see how different projects are taking place across the countryand which companies are involved in it and what is the quantum of money being spent. You should try to read how different discoveries and inventions are coming up in the world and how they are expected to change your life.

The last. To be kept in mind is simply a extension of Fifth one and that is do not listen to the noise and cacophony that happens around you which tells that how the US economy is going down and further on the Indian economy will go down. Believe me at a lot of people … the leaders of the country, the governors of the central banks have lot more at stake than just a few lacs rupees and they will do something right to keep their own position intact even if not the economy at large.

What should be the ideal ratio for home loan EMI to yearly earnings as Seafarer

What should be the ideal ratio for home loan EMI to yearly earnings as Seafarer

Taking a home loan for a seafarer maybe a little different than that for a land based worker because he has a ability to pay it off earlier. We shall try to analyse and determine this on the basis of the following:

1. First determining factor I would say would be the rank of a person. For example the cash flow from salary would be quite different for the 4th engineer and a master. In case of the latter even if he takes the entire sum on loan he can easily pay off in a few years time. Whereas a junior officer might require many years which may extend to 10 or more than that.

2. Second determining factor would be the the cash available with the buyer.

If the amount in savings is substantial but parked in NRI or fcnr accounts then naturally a large portion of it can be used. However if the sum is properly invested over long periods of time then it would naturally be getting returns in the range of 12 to 15% over 5 to 10 years period in that case there should be no need to disturb that investment and go in for a loan of the amount desired.

3. Third determining factor would be the price of the property. If the price is prohibitively high then it would be prudent to go for at least 50 to 70% of the loan amount .

4. Next most important point is to maintain liquidity with oneself under all circumstances considering the unpredictability of life that we seafarers face. And with this I mean that take the loan, on as low rate of interest as possible with prepayment facility but secure it properly by taking good term plan and the insurance on the property as well.

So as you can see that the loan amount will depend upon some qualitative factors rather than the quantitative ones and a person should be careful enough to structure his finances properly after taking the loan.

In the view of the above. Up to a loan of 1.25 crore I can say that you can easily take UPTO 90 lacs or 1 crore secure it with very good insurances and try to pay off of repay the loan if the rate of interest is high by paying about 8 to 10% of the principal every year.

Having done this the next step become more important by which you should start investing your salary in a very disciplined way. Though the facility of the loan account of SBI and erstwhile HSBC seems very attractive but I am not a very big fan of it as it prevents you from investing your money as soon as it earned.

You must remember that loan is a liability and higher the amount means higher the liability and should be paid off as soon as possible unless the rate of interest is ridiculously low.

From the loan issuers point of view a home loan is the most secured loan which he can recover by taking control of the property at any given time.

a point that I would like to bring out in the circumstances is based upon two cases that came to my notice in last few years. It happens that somewhere in the mid career a person takes a exorbitant loan to buy home and very soon after he gets an opportunity to take up a shore job. Now these two offices workout between the devil and the deep sea because the house for which they had taken a huge loan prevented them from taking up the shore job abroad.

Now you can imagine why something as simple as a home loan can become tricky under circumstances.

A fleeting moment in a journey called Life

                              A fleeting moment in a journey called Life

Joginder uncle lost his life partner Toshi Auntie yesterday. I got 4 missed calls from him which I couldn't take as I was in a group Meditation. When I called him back he was talking in a matter of fact and balanced voice- बाकी सब ठीक है बेटा, तोशी कल चली गयी, आज उसे 11 बजे पहुंचाने जाएंगे।

When I met him a bit later, he must be the only person whom I met as always- hugging and laughing. Onlookers were horrified.

Why was that? Read on to find out...

We met first time exactly 25 years to the date when I bought my first house and he had also shifted to his new house just opposite mine after his retirement.

I wasn't even 30 and he was an experienced wise man, full of humility and life's philosophy, which I didn't understand at that stage.

In due course, he became a family member rather a family head and may be even more than that. 

During my absence from Dehradun and while I was on board the ship, he would stand like the rock of Gibraltar for my wife and daughter. I have never seen him complaining about his personal problems which were aplenty.

I came back once on leave, it was after Diwali only to discover that he had lost his younger son who was a full grown adult during the gallbladder operation at the hands of a local doctor.

His elder son was suffering from childhood hematological problem which he wasn't properly aware of. When I took both of them to a specialist, while taking out some papers from his pocket the receipt of the firewood which were purchased for cremating his younger son fell out.

Even the doctor was shaken and looked at me with questioning gaze.

Soon enough his elder son also passed away.

After both the losses he had very casually said that he looked after his sons as long as they were with him and now let almighty take care of them.

He never complaint about any God and nor did he become an atheist.

Then I bought another house and moved to a different locality but would meet uncle once in awhile. We would always hug each other like long-lost friends and chat away refusing to listen to each other and more interested in talking about ourselves.

5 years ago ,I had lost my mother and was quite in grief. A few days later Uncle came to see me and before he could utter a word , I jumped and hugged him laughingly. I did not need his sympathies and was instantly rejuvenated.

And since we both understood each other so perfectly, when I met him today I did not see any reason to put on artificially sad face and sympathize with him.

Uncle doesn't need it.

While leaving the cremation ground he told me that now he is free to come for Vipassana.

I told him , sorry we don't need a teacher right now.