What to do in a Volatile market

In the first week of March a retired gentleman called me asked what should I do with my investments in mutual funds as the market has crashed? I just asked one question, do you need the money? He said no. My advice was then just hold on. A few days later he again called, saying my debt funds have also fallen and again I asked him the same question and our replies were the same. This gentleman now was very frustrated as he was losing money and did not know what to do. The thing is, was he really losing money or that losing money was just in his mind. More often than not, it is usually in our mind. The market is an unknown beast and we are trying to tame unknown and milk it. This is our problem.

Why do we want to go into unchartered waters without even learning the basics? My advice to such persons is, just do regular asset allocation. If we have decided to keep 50% of our financial assets in equity and the balance in debt, then on a regular basis just ensure that you are maintaining that balance. This will help in lowering the risk of your portfolio. Asset Allocation is the most boring job. We want excitement, but this most boring job helps keep our portfolio safe. This is what most of us want. We are ready to keep our money in fixed deposits in the name of safety, which is also boring, then why not asset allocation with higher returns and a little higher risk compared to Fixed Deposits.

Over a log period studies have shown that regular rebalancing even once a year has given better returns than doing nothing. Rebalancing is necessary because different asset classes give varying returns over different periods of time. Because of these varying returns, the asset allocation changes over a period of time. Regular rebalancing helps in restoring the asset allocation and also reducing the risk. In the bargain, you tend to book profits from the asset class which has grown and purchase at a lower price the asset which has not grown to the same extend. Mind you, we are not timing the market, but we are still booking profits on a regular basis.

So do not let your emotions drive your decisions, just do regular rebalancing. If you find it difficult, just go for professional advice.

Success and Finances

What is success? For different people, success means different things. But we usually see similar traits or measurement of success in a particular age group. What I have seen, is for people in their 40’s success means having a good position in his/her job and earning is good. So here the focus in mostly on making money. Taking the current working environment, earnings growth peaks in your mid 40’s (this is average). This is the time to invest so that your wealth also grows aggressively.

Most of the couples, I have met (who are in their 40’s) have very good income streams, but their finances are in shambles. The reason is simple, they have been totally concentrating on their earnings, then add to it, home and car loans, Children’s education and holidays to beat the pressure and the worst peer pressure. In all this they did not get time to look at their investments. Most of them are professionals, but have not even thought of employing a professional to look after their investments, even when they do not have the time. Some are so burnt out by the time they reach 50, they just give up, if they do not reach the board room.

One of the things they could do is start investing wisely with the help of a professional, so that even if they plan to quit, they do not have to worry. As your earnings increase, increase your savings percentage. Most of them have savings, but in Fixed Deposits and PPF. This is good, but this investment will not beat inflation and your rising lifestyle expenses. When I talk about SIP’s they say let’s start with Rs.5000/-, it’s like only 1% of your regular expense is lifestyle expense. Rs.5000/- is small at the age of 40, it should be a minimum of Rs.40000/- pm. After 10 years when you look back and see the corpus, this Rs. 40000/- will look like a small amount.

The other think I have seen most of them do is go for a second house as investment. Do not do this till your goals are met. If you need a bigger house depending on your status, go for it. As with most capital intensive purchases, all you will do is build up your liabilities and your savings will come down. As this is the time to let your money grow. This is the time to work on your dreams and let a professional work on your finances to help you reach your long term dreams. It should not happen that you meet your current dreams and then when you reach your sunset years, you will spend your time dreaming, instead of living your dreams.

Arbitrage Funds

Arbitrage is a term used to describe the purchase of a product which is then immediately sold to make a profit. Arbitrage is popular in the stock market or as a means to make profit from goods being sold at differing prices in varying markets.

Let’s take an example of arbitrage. Suppose a tailor sells a shirt for Rs. 400/- the cost for him is Rs. 300/- He makes a profit of Rs. 100. One day when he at the cloth manufacturer, he meets another tailor who also makes shirts and sells. The cloth and accessories are the same, his fitting is also more or less similar, but he sells his shirts for Rs.250/- So our tailor to increase his profits, buys from the other tailor at Rs. 250/- and sells for Rs. 400, increasing his profit to Rs. 150/- per shirt. This is arbitrage, basically taking advantage of the price difference in the other market for the same product.

The above type of arbitrage is available in the financial markets as well. In the financial markets there are 2 types of markets, one is cash and the other is derivative. There is always a price difference in both these markets. So if one buys in the cash market and sells in the derivatives market it will be called an arbitrage trade.

Now if it was so easy everyone would have been doing it. But here is the catch. In the cash market you can buy today and sell tomorrow. But in the derivatives market it is a contract which is valid for a fixed period. One just pays a premium initially and at the end of the contract period, s/he has to settle it by paying the difference between the then prevailing price and the contract price. So if your bet goes wrong, you could lose big. But since you have done the opposite in the cash market, the loss will be minimal.

Arbitrage funds returns are very similar to debt fund or fixed deposits, but this product is treated as an equity product. The reason is tax.

Therefore it is very important that you know about the tax treatment and investment options before making any investment decisions.

For income tax purpose, as mentioned above arbitrage mutual funds are classified as Equity oriented funds.

·         Long Term Capital Gains on Arbitrage Fund

      o   If you make a gain / profit on your investment in an Arbitrage Mutual Fund scheme that you have held for over 1 year, it will be classified as Long Term Capital Gain.

      o   The long term capital gains on Equity oriented funds will be taxed at 10% if the total Long Term Capital gains is more than Rs. 1 Lakh in a year. It is tax free till March 31, 2018.

·         Short Term Capital Gains

   o   If your holdings of an Arbitrage Equity mutual fund scheme are less than 1 year old i.e. if you withdraw your mutual fund units before 1 year, after making a profit, then the profit will be considered as Short Term Capital Gain.

      o   The capital gain tax rate of 15% is applicable on Short Term Capital Gains of Arbitrage Fund.

   o   Kindly note that interest income on Fixed Deposits will be charged at as per your income tax slab rate.

   o   The Short term Capital gains on Debt mutual funds too are taxed at as per your income tax slab rate if the holding period is less than 3 years.

So, as per the current tax laws, the Arbitrage Funds have clear tax advantage over Fixed Deposits or Debt Mutual Funds.