AuthorRohit Chauhan

I recently conducted the following poll on the blog. The results of the poll for the 205 responses are given below

What do you expect to make from investing in stocks in a 3-5 yr time frame?
10-15% per annum – 16%
15-20% per annum – 33%
20-25% per annum – 25%
25-30% per annum – 9 %
30%+ per annum – 14%

What was the idea behind the poll?
I had the poll for two main reasons. The first reason was to gauge the return expectations of the readers from stock market investing. The second reason was to discuss what I think would be required to get these returns

Comparing against market returns
The above return expectations are for a portfolio and hence it makes sense to compare it with index returns which serves as a benchmark. Why consider index returns? Well, it’s a passive form of investing. You can invest in the index and go to sleep and still make these returns. So one can call the index returns as zero effort (not zero risk) returns.

So what can one expect from the index? One cannot predict where the index will be in 3-5 years (though there are more forecasters than we need), but one can try to make an intelligent guess. The index is currently at a PE of 23 which is fairly above average. The index EPS has grown at an average of 14% for the last 17 years with 20%+ growth in some years and negative in others.

For the sake of argument let’s assume that the EPS growth will be 14% for the next 3-5 years and lets also assume the PE will remain the same (though I will not really bet on it). If one makes these simplifying assumptions, then the index returns would be 14%. If the EPS growth is higher or PE increases further, then the returns could be higher. On the other hand if the EPS growth is slower or PE contracts, then the index returns will be less than 14%.

So in conclusion one can say that the index returns are likely to be in the first option of the poll. By the way, almost 86% of those who participated expect to beat the market by a decent amount :). High expectations indeed!!

First option: 10-15% per annum
This is an easy one to achieve as long one does not try to get too clever. One needs to create an SIP (systematic investment plan) in an index fund or ETF and put a fixed amount of money into the fund every month. The SIP should give a return of 1-2% in excess of the index (due to cost averaging). So if one were to follow this plan, these returns are quite achievable.

Second option: 15-20% per annum
This was my choice of expected returns . This choice means that index investing alone will not help. If the index were to return 14% or so (which is not destined to happen), then achieving these kind of returns would require a combination of the following
– An ability to pick high quality companies at slight undervaluation. These companies have to do well to give the 15-20% returns for the next 3-5 years
– An opportunistic pick of a few companies which are in temporary distress. If one is able to identify such companies and buy them before a turnaround, then you can add a few extra percentage point returns.
So this option looks doable, but would require more than average, but not extraordinary effort to achieve it. A reasonably diversified portfolio of 12-15 stocks should help one to achieve these kind of returns

Third option: 20-25% per annum
Now we are getting into an interesting area. A 20-25% return means one would be able to triple his or her money during this period. At the current PE levels and an optimistic expectation of 14% returns, getting 20-25% would require quite an effort. I can think of the following

– An ability to identify some out of favor stocks and being able to bet heavily in a few of these ideas. For example if you think that sugar stocks are going to do well and are able to pick some cheap stocks before the turnaround and sell after the turnaround happens, then the returns are likely to be good.
– A core portfolio (50-60%) of high quality companies which will give above average (more than 14%) returns
This option is not a low risk, low effort option. It would require a decent amount of work to research underpriced stocks and bet heavily on them. I don’t think you can make these kinds of returns unless you have a decent amount of experience in stocks and can devote ample time to investing. Almost 25% of the poll participants think they will fall in this category of real superior investors

Fourth option – 25-30%
As expected only 9% of the participants selected this option. A 25-30% return means making 3-4 times your capital. If you have not made these kind of returns in the past for a 3-5 year period, then expecting such returns would be risky. One can make these kind of returns only if
– One picks undervalued picks, holds till they hit fair value and then sells them. In addition one will have to find such ideas consistently
– One will also have to be a bit lucky to make these kind of returns. A mid size to large market crash would certainly help. If the market were to crash, an investor should be able to commit a lot of money.
– A focused portfolio (less than 10 stocks) would be required with a decent turnover in the stock holdings.
– A small amount of portfolio will have to dedicated to options or arbitrage kind of ideas where one should be able to make 30%+ returns
These kind of returns are not easy to get, especially if investing is not your full time work. A lot of guts, some amount of luck and sufficient investing experience would be required to make these returns.

Fifth option: 30%+ returns
This option was voted by 14% of the participants. I can think of some reasons behind these fairly high numbers. Some of the participants voted for the sake of it without giving much thought or are getting delusional about the returns. One can expect these returns only if one is very new to the market and has no clue of what to expect or has been around for quite some time and is a superior investor

I really don’t have specific ideas of how one can achieve these kind of returns at low to moderate risk. One can make these kind returns only by being aggressive in the market and through a decent amount of leverage via options or otherwise. A 30%+ returns for the future would mean beating the market by more than 16-20%. These kind of high returns are not achievable by buying index stocks. One can make these returns by having a highly focused portfolio (3-4 stocks at best) of great ideas or by investing in other kind of instruments such as options.

The problem with such expectations is that unless one has made these kind of returns for some time, it is likely that the investor would take on high risk and could thus get wiped out. I hope these investors know what they are doing.

By the way – if you expect to make 25% or above, please share your thoughts via email or comments as I would really be interested in knowing how you plan to achieve these kind of results.

Why no negative returns
Someone mentioned in the comments on the absence of an option for below 0% returns. I think that is quite possible, but would be an uninteresting option. If one believes below 0% returns, then it is an easy decision. Put all your funds in cash or FD and get on with other things. A 0% or less return would mean a PE drop of almost 50% in the next 3-5 years.

An optimistic bunch
I have to say the participants of the poll are a very optimistic and confident bunch. I personally think a 15-20% would be a very good return for me and more likely to be around the 15% level than the 20% mark.

Final point: If you were expecting me to provide an 8 point or 10 point plan to achieve 15%+ returns and have voted for option higher than 15%, please re-think your expectations. If you need someone else to show you how to beat the market, then you could be in for an unpleasant surprise over the next 3-5 years.

I have a lot of time on my hands these days ! With the market at the current levels, there is not much to buy. I am in the analysis/intellectual gymnastics mode these days, analyzing companies and thinking of odd ball stuff. In continuation of that spirit, I decided to write a post on the above topic. The advantage of a blog is that you can write anything you like. It’s a different issue if others would read it or just skip it.

This is a very contentious topic. I am not discussing about real estate as an investment. The post is only about a primary home – the home in which you are likely to stay.
I have also found myself in a minority of 1 when I discuss this topic with any friends or relatives. Lets try to look at the financial aspect of this topic first and then look at the non financial or emotional aspects of buying a house.

I can summarize a few ‘accepted’ financial truths in buying a house as follows
1. It is better to buy than rent. Money paid via rent is a sunk amount, whereas if one buys and pays an EMI, one is ‘investing’
2. A house always appreciates in the long term. As a result it is a smart decision to ‘invest’ in a house.
3. A house is a hard asset in comparison to financial assets which are just paper assets. So in the interest of diversification, one should buy a house.

Debunking some myths
The problem with accepted truths is that no one wants to think about them or question them. Everyone just accepts them as absolute truths such as ‘The sun rises in the east’. I have found it easier to discuss and argue about other topics about which people don’t think they know as much (such as stocks), in comparison to real estate, where everyone thinks they are a born guru just because they bought an apartment in the last 5 years which has appreciated by x%.

Let look at each point in detail now

Buy v/s rent
This is the most irritating argument I have heard on this topic. Everyone claims this as the truth, but I doubt if most would have actually done the calculations on a piece of paper ( I have !! yes, you cant get any more geeky than this :))

Let take an example and some cash flow numbers. Please don’t argue with me on exact numbers as they may vary a bit, but the overall conclusion will still hold. Let say you buy an apartment for 1000000 (10 lacs) for an easy round number.

A typical EMI for a 20 year loan @ 9-10%, would be in the range of 9000-10000 give or take. Additional costs of owning a house would be maintenance costs (repairs, painting etc), association fees and taxes. These are sunk cost which you need to spend to maintain the asset and no one will re-imburse you these cost when you sell the asset

EMI approximately = 11-12% of asset value. lets assume 5-6% of EMI is interest payment and rest goes to principal(varies during the tenure, but approximately 50% of the EMI is rent over the life of the loan)
Association Fees = 1% of value
Maintenance and upkeep = 1% or more
Taxes = 1% or more

Cost/ month of owning = EMI + maintenance cost + association fee + taxes
So total cash outflow = 5-6%+1+1+1= 8-9% of asset value (without tax benefit). If one consider 30% tax benefit then the number comes to 6-7% (you can do the math)

This component of your cash flow is not adding to the asset. Interest paid or association fees don’t add to the asset. Maintenance cost is equivalent to a depreciation expense. Only the principal paid adds to the equity.

If one rents a house, one would pay the rent (typically 5-6% of asset value) and association fees.
Rental cost/month = 5-6% +1% = 6-7% of asset value

Now you can play with the numbers as you like as I have not included some numbers such as utilities which are same whether you rent or buy. In addition we can get into all kinds of variations such as renting a room or doing something of such sort, but in the end if you buy a home just large enough to live, a lot of these variations may not be feasible.

The conclusion is this – The cash outflow on an owned asset which does not add to the asset (build equity by reducing the loan principal) is quite close the total rental and other associated cash flows of renting a house.

The difference in the numbers for rent v/s buy will vary by a bit if you modify some of the EMI and rental assumptions. However the real estate market is also reasonably efficient in the long run and these numbers tend to converge over a period of time (why ? ..thats a different post)

Real estate always appreciates in the long run
Says who ? can you claim it based on some data or are you just pulling that out of your ***** ? The long term (20-30yr) data for real estate across countries and time period has shown that real estate typically provides a 1-2% excess return over inflation.

Please don’t give me this type of example to prove your point
My ________ (fill uncle, nephew etc) bought this apartment/ land in a god forsaken place and then suddenly a new company came up and the real estate doubled overnight. It is the equivalent of saying that Infosys has gone up by 100 times in the last 20 years and hence all stocks should give that returns.

Finally long run does not mean, that if you buy an over priced asset, you will not lose money. If you don’t believe it please read about the investors in the US or in japan (in the 90s).

The key conclusion is this – If you overpay for an asset, you are toast !

House is a hard asset
That does not mean anything. If one can touch or feel a house, it does not mean that it is better than any other asset from a financial standpoint. An asset is attractive if it gives a high risk adjusted return, irrespective of its form.

For example – gold was always considered a hard asset and hence highly valued in India (not in other countries). In spite of this classification, gold returned close to nothing from 1970s till 2003. In the recent years, investors can now buy gold ETF and inspite of being a paper asset they have made good returns. The point is that the physical form of an asset does not change the characteristics of the investment. By the way, I am not justifying gold as an investment.

So should one not buy a house ?
No, the above analysis is not to arrive at that conclusion. On the contrary, one should buy a house, but for a very different set of reasons. I would say our parents got it right on this count. I would list the following reasons to buy a primary home

– Buying a home gives one peace of mind. It is a different feeling to live one’s own house and not in a rental one. It is a very satisfying experience. I cannot describe it, but those of you who own a house would know it.
– It is the smartest investment for a newly working professional. A lot of young people who starting working, get some cash in their bank accounts and get itchy with the cash. They go all around investing the cash in silly ways and end up losing money. In this respect, if they went and bought a house (within their means) it would be a sound investment and would also prevent them doing something foolish
– I now get into a slightly sensitive area – If the unfortunate occurs and the main earning member were to pass away, owning your own home makes a huge difference. I can tell that from my own experience.

Conclusion
I would say the primary reason for buying a home is that it provides a roof for your family and happiness and security. The accepted truths on financial aspects are delusions which people use to justify over spending on their house – buying more than they can afford.

Final question – have you heard of anyone who used to live in 3000 sqft house in a posh locality and when his house appreciated by 200%, decided to sell the house and went to live in a village in a 500 sqft hut ? Once you and your family gets used to a lifestyle, you will never want to downgrade it !!. So next time if you are getting giddy over the appreciation of your primary home, please think about what that means, if anything. (sorry for popping that bubble 🙂 ).

A reminder
I have the following poll on the side bar and would encourage you to vote !

What do you expect to make from investing in stocks in the next 3-5 years ?
10-15% per annum
15-20% per annum
20-25% per annum
25-30% per annum
30%+ per annum

Update on donations
I am extremely happy to announce that around 45000 rs has already been donated by the readers of this blog. All the donors (except 2-3 towards the end) were provided with an investment idea – ESAB india. The recent donors (last 2-3 weeks) have not been provided with same idea it has already appreciated by 25% since then and is no longer as undervalued.

I still intend to keep my promise to them and hope they will be patient.

My heartfelt thanks to all the donors.

Some links
If you are new to the blog, you can subscribe to rss using this link or get an email update of the posts by entering your email under the subscribe button. Dont worry, i wont spam you unless you think my posts are spam itself 🙂

I have uploaded a template i use to analyse each company and some examples of the analysis – NIIT, LMW, Gujarat gas and other files at this location. You can join the valueinvestorindia google group and download these files.

I have added a poll on the sidebar with the following question

What do you expect to make from investing in stocks in the next 3-5 years ?

10-15% per annum
15-20% per annum
20-25% per annum
25-30% per annum
30%+ per annum

The question is not what you wish, but what you think you will be able to make based on your past experience. The distinction is important as in my own case i would wish to make 100%+, have a private jet etc etc, but i will never make those kind of returns no matter how much i wish for it.

Why should i respond ?
Based on the survey i plan to publish a post with my personal views (who else’s ..its my blog 🙂 ) on what it would take to make the returns in each segment (10-15, 15-20% etc).

It should take not more than 10 sec to participate in the post and you can use the results to compare your expectations with others and see what it would take to get these returns.

The thing about a blog is that if you make an error in your analysis, especially a dumb one, it gets caught very quickly. I did not notice that HDFC floater LT has a 3% exit load. As a result, one of my conclusion in the previous post is invalid, if one is looking for parking short term funds. If however, the time horizon is more than 1.5 years, I think HDFC floater LT should turn out to be a decent option.

In addition to the options posted in my previous post, it was pointed out that flexible deposits and sweep-in are good options for short term funds. I agree with those comments completely. There may be a difference of +/- 1% point in terms of return between these various options, but unless you plan to invest 10 crores, I don’t think it will make a huge difference.

My personal preference when investing short term funds is for liquidity and safety of principal. Returns are important, but I will not compromise on the safety of my capital. A few percentage points is not worth the risk at all. I am a very conservative and risk averse investor in terms of debt and have always given high priority to the safety of principal.

Personal finance
This brings me to the next topic – personal finance. My own personal finance is split between equities, a little bit of debt instruments and cash. It is an idiosyncratic split reflecting my personal needs. I will definitely not recommend it to others who may have different goals than mine.

I don’t consider real estate (primary home) as an investment. I find it completely stupid to think of my primary home as an investment. If my home appreciates by 50%, what will do with it ? sell it and go live in a forest ? A home is an expense and responsibility. A second or third home or apartment can be called as an investment, but that’s a different story.

I consider insurance as simply that – insurance. So I have never bought a ULIP or a hybrid policy which are instruments of fleecing the common man. I have bought term insurance to cover my liabilities and to secure my family.

Keeping it simple
I prefer to keep my personal finance structure simple and manageable. I prefer to low to non-existent risk on my debt and other investments. The only risk I like to carry is the one for which I am paid – equity risk.

I wrote in my last post on my views on inflation and one venue of investing or hedging against it – floating rate funds. Two key points to keep in mind, when reading my views on inflation or any other macro fundamentals. They are views and guesses, nothing more and nothing less. Even paid economists get it wrong more than 50% of the time and it is their job to get it correct.

The second point – I look at floating rate funds as temporary place holders for cash. If I don’t find attractive ideas, I invest the surplus cash in a floating rate fund till I find something interesting. That way, the cash is earning more than the paltry 1% in a savings account and I can liquidate with complete ease and within 1-2 days if I want to move the cash to an attractive idea.

Due to the second point, I don’t agonize on finding the most attractive fund as the difference would at best 1-1.5% per annum which is not worth the effort for me.

A caveat – I am not a typical investor (that does not mean I am a super smart investor). I spend far more time looking for attractive ideas and as a result my focus and effort is directed towards higher return opportunities such as equities or arbitrage. If you do not fall in this category – investing being an area of extreme interest – then my suggestions on personal finance may not be entirely valid for you. If you really want to invest in a debt fund for the long turn, it makes sense to do more homework and invest intelligently

Floating rate funds are basically debt funds which invest in floating rate securities. So if the interest rates rise, the return on these securities and hence the fund rises and vice versa.

This is not the same in case of fixed rate funds. A fund which invests in fixed rate securities faces a different risk. When the interest rates rise, these debt instruments with fixed rates fall in value and so does the mutual fund. As a result these fixed rate funds show a higher return in falling rate scenario and poor returns in an increasing rate scenario

My views on mutual funds can be found here and on debt funds here.

Selection criteria

I had written the following in terms of debt funds

– Mutual funds – fixed income: This is my favored avenue during a falling rate scenario and I tend to invest with well know mutual fund houses such as franklin templeton, DSP etc. At the time of investing in a debt mutual fund, I tend to look at the following factors
o Asset under management – avoid investing in funds with low level of asset as the expense ratios could be high.
o Fund expense – lower the better. Although the indian mutual fund industry typically gouges its customers and charges too high compared to the returns.
o Duration of fund – This is the average duration of the fund. A fund with longer duration will rise or fall more when interest rates change
o Fund rating – 80-90% of the fund holding should be in p1+ or AAA / AA+ securities.
o Long term performance of the fund versus the benchmark

– Mutual funds – floating rate funds : This is my favored approach in a rising rate scenario. In addition to all the factors for the fixed income mutual funds, I also tend to favor floaters with shorter duration.

So based on the above criteria and in view of the possible rise in interest rates, I was able to find the following funds

Some selections

Templeton Floating rate retail growth – The fund has been around for 5+ years, has beaten the index by around .5% and has 425 crs under management. Majority of the fund holding is in AAA securities. The major downside is that it charges 1% as management fees.

Birla sunlife floating rate LT retail growth – This fund has been around for 6 odd years, beaten the index by around 1% and invests in AAA securities. An additional point is that the fund charges .44% as management fees which allows the fund to deliver better returns to the investor compared to other floating rate funds. The downside is that the fund does not have as much asset under management (around 150 crs)

HDFC floating rate income LT – This fund has been around for 7 years, has beaten the index by around 1%, and invests in AAA securities. In addition the fund charges only .25% as management fees and has fairly high asset under management (around 850 Crs). This fund clearly seems to be better among the lot.

ICICI prudential LT floating rate B – The fund has been around for 6 years, has barely beaten the index and charges 0.85%. In addition the fund is fairly small, less than 100 crs in asset.

Kotak Floater LT G – This is one of the largest funds with around 18000 crs in asset. The fund has beaten the index by around 0.6%. In spite of its large size, it charges around 0.5% as management fees.

The above list clearly shows that the variance in the performance between the funds is low as expected. As a result, it is critical to choose a low cost fund which is difficult as all the funds clearly charge too much compared to the value provided. If one nets out the cost, the return is almost same as the index for most of the funds.

Conclusion

The conclusions are obvious

• If you want flexibility and ease of transaction, select a low cost fund such as HDFC or kotak.
• If you have the time and can put the effort of going to a bank and don’t need the liquidity, then it makes sense to buy short duration fixed deposits with good banks and keep rolling them. As a result when the interest rates rise, you will be able to take advantage of the higher rates.

What am I doing ?

I am using option 1 for myself and option 2 for my parents.