Enrichmentors Wealth Builder Advisory

April-May 2013

The basics of building wealthHow to sell / exit right from an asset class?

Enrichmentors Wealth Builder Advisory April-May 2013

Building Businesses, People, Health & Wealth successfully over 30 years

What is in this IssueFrom The Editor’s Desk

What is in this IssueFrom The Editor’s Desk

Arun Singhal is the Founder and Principal Mentor & Managing Partner of Enrichmentors India. He founded Enrichmentors in 2007 to help individual investors build their wealth successfully in addition to providing business consultancy to Small and Medium Enterprises. He learned about building wealth successfully from his personal experiences in debt and equity markets in India over these years and now offers advisory services to individual investors about how to build their wealth by investing right in Debt and Equity markets in India now. He received his AMFI certification in 2011 and is an authorized mutual fund distributor for all the mutual funds. He also teaches Wealth Management at IIPM. He operates out of his office in Mumbai and can be contacted at arunsinghal@hotmail.com.

Dear Reader,

We talked about the basic principle of building wealth in the last issue- Buy low and sell high-

and I shared my learnings over the years about how to buy right the various asset classes.

All the wealth that you make by buying right or making the right investment is paper money till

either you encash it or ground it. You may be making a fabulous return on your investment in

equity or commodities like Gold etc. but if you do not exit or encash these returns in right way,

you may loose them for another period if not for all time!

Thus, exiting an investment class is as critical as entering it, probably more!

Certain asset classes are more volatile and certain are less but each has a time to exit like the

right time to enter. You need to know what is the right time to get out of an asset class that you

invested in earlier.

There is also a decision to be made about how much of that asset class should you exit. Should

you get out in one go or should you do in a staggered manner? If in staggered manner, how

should you stagger your exit?

Similar to while making an investment, the question is what is the best way to exit from that

asset class.

In this issue of Enrichmentors Wealth Builder Advisory, I will attempt to share my experiences in

gainfully exiting each of asset classes in terms of its timing, quantity and method.

Hope you find a way of gainfully exiting your well made investments so that you can

invest them again in another more suitable asset class. If you can do that, you can

build wealth!

Enrichmentors Wealth Builder Advisory April-May 2013The basics of building wealthHow to sell / exit right from an asset class?

This wealth builder advisory attempts to answer the following questions. How do you know if your investments are ripe for a sale or exit? What is the right time for each of the asset class to sell or exit? How much should you exit at a time in each asset class? How should you exit in each asset class?

How do you know your investments are ripe for sale or exit?

We talked about the following asset classesin the March Issue of the EnrichmentorsWealth Builder Advisory in increasing order of risk and return.

Fixed Income Assets• Savings Bank Accounts (SB)• Fixed Deposits (FD)• Government Bonds (GB)• Provident Fund (PF)• Debt Funds (DF)

Insurance Plans (IP) Commodities including (C) Property (P) Equity (E) Venture Funds (VF)

First thing, after making any investment, you need to do is to set a simple monitoring system and monitor all your investments systematically once a month.

A simple XL based monitoring system can be good enough. You can create your Monitoring System in the following format.

Every month end you need to update the original investments made till date, Cum investment days, dividends or interest received, and the current market value.

This will update the Total Gains and the Cum Avg Returns by setting up the following formulae in the XL sheet.

Total Gains= Dividends/interest received + Current Market Value-Original Investment

Cum Avg Return (CAR) = 100 x Total Gains X 365 / Cum Days Invested

You need to set a benchmark performance for each scheme based on the asset class and the scheme. With this your monitoring system in ready!

Now when your CAR is better than Benchmark Return your investment is ripe for an exit. But of course you need to consider other factors which we will talk in next pages.

Building Businesses, People, Health & Wealth successfully over 30 years

Scheme OriginalInvestment-(Rs)

Cum Days Invested

Dividend/interest received(Rs)

Current market Value(Rs)

Total Gains(Rs)

Cum Avg Return(%)

Benchmark Return(%)

Enrichmentors Wealth Builder Advisory April-May 2013When and How to exit Fixed Income Assets?Let us look at each fixed income asset and see when and how to exit from each of them.

Savings Bank Account

Fixed Deposits & Govt Bonds

You can consider totally exiting the FD as an asset class if the contingency for which it was set is no longer likely to incur and you feel you can make this money now available for more volatile investments. In such a situation, you can move out the unwanted FD amount immediately to a Liquid Debt Fund so that you start earning a better return while retaining the option to reinvest in another asset class at an appropriate time

PPF is a very good investment for your retirement needs and I have not yet found a good reason to exit as it still earns a 12% after tax return on the investment. The only case of exiting the PPF investment will be if and when the PPF interest rate and the after tax return drop sharply in future and other instruments like Debt Funds give a better return. Other times when you can take the money out from PPF account but in the form of a loan would be if you need the funds for buying a house.

Government Bonds mostly do not give you an option to exit earlier and you can exit only on their maturity. You need to get the cash in your bank for the matured Government Bonds as soon as they mature because you do not get any interest after the maturity. After the maturity, you need to decide afresh where to invest the funds encashed based on the new situation then.

Long term Debt Funds also normally carry an exit charge which requires you to weigh the pros and cons of exiting them. You need to consider exiting the Debt Funds for switching into higher return asset classes like Equities, Commodities, Property etc. The exit from Debt Funds is driven really by the need to invest in the more attractive categories. When the Equities, commodities and property prices are dropping, it will be good to exit from the Debt Funds in staggered manner based on the need to reinvest them.

Another time to exit the Debt Funds will be when the interest rates are rising.

Building Businesses, People, Health & Wealth successfully over 30 years

Savings Bank Account is one place where a lot of money keeps sitting idle making a return lower than inflation for most people and thus making you lose your wealth.

You need to review the amount of money lying in your savings bank account every month end and if you feel that it is more than your 6 months expenses requirements, you need to move out the excess amount to a liquid Debt fund immediately or make an FD depending on your investment requirements. This exit of excess money from your savings bank account will enable you to get better return on your money.

You need to very careful about exiting from the Fixed Deposits & Long Term Debt Fund because the premature withdrawal attracts a penalty of 1% at least.

I would suggest to exit from an FD made only if the prevailing interest rate is significantly higher than the interest your FD is earning. Please remember that you need to make FD only for your basic security against bad times and hence I suggest to keep the FDs once made and not shift them into other asset classes which are more volatile including Debt Funds. If the prevailing interest rate is far higher than your FD rate even after all the premature withdrawal charges, you need to exit from your low interest rate FD to new FD at higher rate.

Enrichmentors Wealth Builder Advisory April-May 2013When and How to exit Insurance Plans?Let us look at the different type of Insurance Plans and see when and how to exit of each of

them.There are broadly three categories of insurance plans we can look at.

1 Term & Whole life plans

2 Endowment Plans

3 Unit Linked Insurance Plans

Term & Whole life Plans

Endowment Plans

Unit Liked Plans (ULIP)

Thus a policy holder exiting even after competing 5 years is simultaneously suffering from having paid higher charges in first five years and not having received any bonuses in first 5 years. I would recommend not to even consider exiting a ULIP before 10 years. This will ensure that you recover the charges you have paid in first five years in the next five years by way of the bonuses and also get chance to switch funds and make some money

The best way to encash an insurance plan is to take a loan or make a partial withdrawal.

Building Businesses, People, Health & Wealth successfully over 30 years

Term Insurance Plans do not provide any returns while you live and their usefulness is in providing your family a sum of money on your death. You can consider exiting a Term Insurance Plan either when you have ended up buying a poor plan in terms of the benefits and its costs or not having any further need to cover your life! You can change or discontinue a plan with no loss other than the premiums paid which you can consider as having the cover for the period so far.

On the other side, Whole life Plan are to be exited only if your plan has a poor settlement rate and you are not sure on your family getting the money on your death

Endowment Plans offer you a Guaranteed sum on maturity in addition to the life cover. Most of these plans have very high exit barriers in terms of very low surrender value. You can at best hope to recover only 30% of the premiums paid. Given this you need to exit from a Endowment plan only under dire circumstances and that too after examining other options like taking a loan against the policy etc.

Given such high exit barriers and low returns on about 5.5% at best, Endowment Plans are best avoided and other options like a Term or Unit Linked Plan considered for life cover or fund growth along with life cover respectively

United linked Insurance Plans are more easy to exit relatively though not possible before 5 years now. All the new ULIPS now have a lock in period of 5 years and the policy holder can get his/her funds after 5 years only irrespective of when s/he discontinues.

While it is possible to exit a ULIP after 5 years, you would be very lucky if your funds show any respectable value. Most of the ULIPs are structured in such a way that insurance company charges the policy holders higher in initial year and provide the bonuses only after 5 years.

Enrichmentors Wealth Builder Advisory April-May 2013When and How to exit Commodities including Gold, Property and equities?Each of these asset classes have their peaking cycles primarily determined by the Demand

and Supply situation specific to each commodity, Gold, Property and equity. You need to assess if you are anywhere around that peak and that becomes the time to make an exit from that specific asset and reinvest in another place. That requires tracking that particular asset category and making a call to exit. Can you be certain that it is the peak? Mostly not. But you can be certain that you are in one of the peaks. And if you are making decent profit and feel more greedy, that is then the right time to exit from that asset or asset classes. Let us now look at some specific modalities of these.

Gold A look at the Gold prices since 1971 confirms the popular belief that Gold is good for long term, though there are times of drop and stagnation in gold prices.

Then, when to exit and how much of it?

I would say that you need to keep invested in Gold for long term for the fair share of your wealth between 20-25%. You can exit your Gold Holdings any time of major price increase when you are making a good profit. This will allow you to keep your part of Gold and also release cash for other asset classes.

Equity Equities on the other have been quite volatile over the same period.

Given its volatility, it would make sense ideally to totally exit from equity during a peak and re-enter when it reaches its low again. Unlike Gold, you have data on the valuations of Equity markets in terms of Price to Earning (P/E) ratios. You can consider exiting those stocks where the PE Ratios are more than 25 for sure and critically review between 17-25. When the previous highs are touched and you are making profits, it worth a partial exit if not full.

Building Businesses, People, Health & Wealth successfully over 30 years

Enrichmentors Wealth Builder Advisory April-May 2013When and How to exit Commodities including Gold, Property and equities?

P/E Ratio of the equity market is an important parameter to track. It not only tell you when you should be ready to exit equity but also that other large investors are also planning to get out of equity and look at other asset classes to invest. As you can see from the chart below that Gold rates have moved up due to switch from Equity after the Equity market PE reach a high. Gold appreciated between 2008 and 2011 when the equities PE went down and touched their bottom.

Thus there appears to be an inverse relationship between the equity market valuation and Gold price rise. You can use this insight also to decide when to exit from Gold. When the equity markets are undervalued and poised from rise, you can considering exiting Gold and investing in other asset classes including equity.

However, given the overall long term growth of Gold, I would again advise to exit only the extra gold investments- those that are more than fair share of 20-25%.

Property It is not easy to exit from property because the rate for your property falls when you want to exit! I would treat property holdings also like Gold. You need to consider exiting property only if it is more than the fair share (20-25%) of your wealth. I have also found that there is so much paucity of good property that once you buy it, you can not really sell. At the same time the property market from an investment point of view is still highly underdeveloped in India. Once we have Real Estate Investment Trusts very similar to Gold ETFs, we might have more liquidity and trading possibilities. Till then, Keep your Property with you, don’t sell, Your children will need them, if you don’t need them.

Building Businesses, People, Health & Wealth successfully over 30 years

Enrichmentors Wealth Builder Advisory April-May 2013What about Venture Funds?

You don’t need to worry about the exit from Venture Funds as that will be managed by the Fund itself. Let me explain how.

Any Venture Fund Management Company will invest your money into either the start up companies or high growth potential companies requiring fresh equity investment. Normally such companies are either a private limited companies or companies with large portion of private equity.

With the help of these fund, these companies realize with growth and profit potential, of course when managed well. But some company investments fail and some succeed. While you lose your capital partly or fully in the companies that fail, you can more than make up in the successful companies. The fund sells its stake in the companies to the public through an IPO or to a strategic investor who are willing to pay 10-20 times the Earning Per Share of the company. This exit creates multi bagger gains for you. Please see below an example of results of a Venture Funds portfolio. 9 out of 21 investments “failed” but the rest more than made up!

Let me summarize here now.

You need to focus your efforts on exiting from Equity, Debt and more than fair share of Gold. Property is worth keeping for next generations and Venture fund will exit on their own.

This further narrows down to Equity and Debt as most people are underinvested in Gold in spite of India being a big gold buyer. The most of Gold in the world today is held by the Governments, Central banks and investment funds, not you and me!

The key to exit from equity is to try a full exit when the markets move higher from a Price to Earnings ratio of 18 to 25.

The Debt Holding should be exit only as required to invest in other classes that can earn higher that your debt portfolio.

So the key is to keep watching the PE ratios of the equity market and decide your exits from the equity, debt and extra Gold. When equity PE are high, exit from Equity, when they are low, exit from Gold and Debt as required.

Building Businesses, People, Health & Wealth successfully over 30 years