What did I learn from : "Let's Talk Mutual Funds" by Monika Halan

In my personal journey to become financially literate , my plan is to read many books on this subject and try to gain as much insights from them as possible. And in this journey today I came across "Let's Talk Mutual Funds" a book by Monika Halan.

Following are excerpts from this book which added value to my journey.

Money Insights :

One, stop thinking about money as a one-time decision. It is a recurring decision throughout your life. The earlier you have a first-principles–based mental roadmap, the better your money will serve you.

Two, investing long term is not your first goal at all. The goal is to have a financial plan that covers all the contours of an average money-life, such as having liquidity when you need it, having money when you want to buy a house, having buffer cash for when things go wrong. The larger plan includes a cash-flow system, an emergency fund and building life and medical insurances before we begin investing.

Three, you just have to stop killing your money in toxic insurance-plus-investment plans. These plans give neither a good life cover nor good returns.

Four, rethink the idea that real estate is your best long-term investment. This is an illiquid asset.

Five, you have no option but to give your money an equity exposure, or an allocation to stocks. Equity allocation must not be misunderstood to mean only buying shares yourself or trading them through the day. This means using mutual funds to invest into the Indian stock market for a lower risk way to create wealth.

Mutual Fund :

A mutual fund is simply an investment vehicle that you use to buy stocks, bonds, gold, real estate and combinations of these. Mutual funds are market-linked products and do not give a guaranteed return or interest and SIP is not a product, but a route.A mutual fund collects money from investors and deploys it in a bunch of listed securities. These securities are ‘listed’ or available for trade on a stock market.

Indian mutual fund has a three-tier structure—sponsor, trust and asset management company (AMC). India has chosen the trust structure so that neither the sponsor nor the AMC can divert the money and vanish. The investor money is held by a trustee company or a board of trustees. The trust rules in India are very strict—if found guilty of fraud or misuse of investor funds, the trustees stand to lose their personal assets and can be jailed. The business is set up by a sponsor who wants to earn a profit from running a mutual fund. the sponsor sets up the business, the AMC charges a fee for its services and the funds of the investor are held by the trustee company to be deployed in stocks, bonds, gold or any other securities and assets allowed by the regulator.

An investor seeks expert fund management and greater safety of diversification since each scheme holds between twenty-five and fifty stocks or bonds or both, rather than spend time trying to do this on his own.

Characteristics of Mutual fund:

1)    Higher returns

2)    Liquidity

3)    Ease of transaction,

4)    Comparison for investors.

5)    Costs are defined, standardized and have ceilings that cannot be breached.

6)    Automatic diversification

7)    Diversified portfolios across asset classes and within an asset class.

Market cap is just the number of stocks multiplied by the market price to give an indication of the size of the company rather than using turnover or profit.

The flexi-cap category allows the fund manager to invest anywhere in the market across market-caps, the only restriction is that 65 per cent of the assets must be in equity.

A multi-cap fund is more true to label as it has an investing floor built into the category mandate. The fund manager must invest at least 25 per cent of AUM in each of the three market caps. This typically works out to be 50 per cent in large-caps, 25 per cent in mid-caps and 25 per cent in small-caps.

ELSS or equity linked saving scheme - This is a scheme notified by the government to be eligible for the Section 80C benefit. (Read more on page 169 in Chapter 8 on taxes.) There is a three-year lock-in before you can redeem these funds. A small piece of statistics here—the average ten-year annual return for the ELSS category is almost 15 per cent. The worst fund gave 12 per cent and the best 21 per cent as on 6 April 2023.

From these eleven categories, six are useful for you: large-cap, mid-cap, small-cap, large-and mid-cap, ELSS and multi-cap funds.

Balanced advantage fund, also called the dynamic asset allocation fund. This is a go-anywhere fund where the fund manager can move between debt and equity without any limits on either. The idea is that the fund manager is better able to judge the potentially winning asset class and will move money ahead of a

A passive fund hopes to just give index returns. The two broad market indices in India—S&P BSE Sensex and Nifty 50—are the bellwether indices. The year-on-year return for the past thirty years on these indices has been around 14 per cent. If you just bought all the thirty stocks on the Sensex or the fifty in the Nifty and held them, not changing the stocks unless the composition of the index changed, you would have got the index return, which is not a bad return at all. All that a passive fund does is to give you a product that does the work for you and you do not need to manage the thirty or fifty stocks and their inclusion and exclusion from the index. Passive funds are great options for investors who are new to mutual funds in general, and are new to equity investing in particular.

Regular Plan VS Direct Plan:

A regular plan is one that is sold by an intermediary like a distributor, a bank or even a platform. A direct plan is one that is bought directly from the fund house. The difference between the two is the reduction in the cost of distribution—the agent commission. A direct plan is cheaper by the amount of the trail commission paid in the regular plan to the intermediary. It is like going to the factory outlet rather than a shop in the mall for the same branded pair of shoes—the factory outlet is cheaper because it removes the cost of distribution.

You invest Rs 5 lakh in both direct and regular plans of the same mutual fund scheme that grows at 7 per cent in the regular plan and 8 per cent in the direct plan (the 1 percentage point is the cost difference, and since they have the same portfolio, the returns are the same, just the cost is different). Thirty years later, the regular plan is now worth Rs 38 lakh and the direct plan is worth Rs 50 lakh. You are Rs 12 lakh richer in the direct plan. So, you should always only invest in the direct plan, right? Wrong. A good distributor will give many services starting from portfolio construction (a very complicated exercise for most people), maintaining the portfolio, updating you on changes in funds, managing the contact detail changes, the nominations, the tax work, the rebalancing and many other maintenance jobs that an active portfolio needs. For some super busy people or someone with no knowledge about funds, to go with a regular plan might be a better option than to struggle on your own using the direct option. Investing is not a one-time job, but an active portfolio needs to be looked after on a regular basis. The one situation in which a direct approach is always better is if you are only investing in a broad market index fund with a fill-it–shut-it–forget-it mindset. Then it makes no sense to pay commission to a seller. Or if the bank is doing nothing much in terms of all the services I had listed out, you are better off going direct. But there are distributors who add so much value that the higher expense ratio is fully worth it.

Lump Sum Vs SIP :

Lump-sum investments are not a good idea when investing in a short-term-volatile instrument such as equity.

SIP makes investing a habit. there are flexible SIPs, where you can increase or decrease the amount you want to invest each month. This is particularly useful for people with irregular income flows like consultants and gig workers. The top-up SIP that allows you to increase the money you are investing by a fixed amount or percentage every year.

It is not a good idea to put a large sum of money into the stock market on one day. Nobody can predict the short-term journey of a stock market, and a global event like a war, a pandemic or a financial crisis might take the market down by a large chunk over a very short period of time. It is very scary to see your Rs 7 lakh dissolve into nothing, and be left with Rs 4 or 5 lakh in just a few months. Of course, the money will recover if the fund choice is good, as markets eventually recover, but the mental agony of losing money can be managed by turning the lump sum into an SIP. This is done by using a systematic transfer plan (STP) that collects the lump sum in a low-risk debt scheme and at periodic intervals (decided by you) funds an equity scheme.

Your exit from a mutual fund is quite easy both in terms of cost and time taken. The SEBI rules gave mutual funds ten days to return your money on all the schemes, but in real life, the money comes back much faster. Liquid funds usually take just one working day to get your money back in your bank account. Other debt and equity funds take between three or four working days to get your money into your account. If you are working with a distributor, then the redemption request is processed through her; else you can do it yourself through your bank, digital platform or mobile app depending on who you are using to transact. There are two routes to exit—one is to redeem a lump sum and the second is to set up a systematic withdrawal plan (SWP).Very useful option is the SWP that allows you to set up a regular withdrawal amount. Typically used by the retired for their regular income needs, an SWP will redeem units to make available the money on a date chosen by you.

Mutual funds invest the entire amount without any commission. You do pay a tiny tax each time you invest in the form of a 0.005 per cent stamp duty that was introduced in Budget 2020. Of the Rs 1 lakh you invest, Rs 5 goes to the Union government and Rs 99,995 gets invested.

Exit loads are a cost you pay to the mutual fund at the point of redemption. Not all funds charge this and not all funds charge the same amount. An exit load of 1 per cent will reduce your redemption amount by that much. If you were redeeming Rs 5 lakh, you will get Rs 4.95 lakh in hand. These are imposed to nudge investors to stay invested and discourage churning.

Mutual funds make money even when you don’t. You pay an annual management fee to the AMC for managing your money. An expense ratio is a percentage of your assets under management that is deducted by the fund house towards its costs and profits.

Net asset value or NAV is the price per unit of a mutual fund scheme. How does the portfolio grow? Because the value of the stocks and bonds has increased, and this is called the undistributed profit. Undistributed because the fund has not released this money to the investor in the growth plan, though it might do so in the IDCW plan. The other ways the mutual fund earns is through interest on the bonds it holds, through dividend it receives on shares.

A return is earned in three ways—interest, dividend and profit. Interest on the bonds the portfolio holds. Dividend on the stocks it holds. Profit will come from the gains on prices on stocks, bonds and gold held in the portfolio.

Compounded annual growth rate or CAGR, is a much better measure for it considers the number of years it took your Rs 10 to turn to Rs 50. The CAGR for the endowment plan is just 8.4 per cent. Using point-to-point returns is also how we evaluate our real estate investments. I’ve heard this said so often: ‘My Rs 30 lakh property became worth Rs 2 crore—such a great return!’ What they do not say is that this journey happened over a thirty-year period, giving a CAGR of 6.5 per cent. Did you know that the CAGR on the Sensex over thirty years has been 14.5 per cent?

The rate of return after adjusting for the impact of inflation is called the real rate of return. Nominal return is what you get in rupees in your hand. Real return is what that money can actually buy after you take into account the price rise over the holding period. If the return is 5 per cent and inflation is at 6 per cent, you have lost around a percentage point of purchasing power. Add the tax on interest that you pay on slab level (more on this in Chapter 8) and you have a lower return number.

Provident fund and public provident fund in India -  Their annual returns have kept ahead of inflation. And since they are tax free, they make for a good core for the debt part of your portfolio.

Liquidity is defined as the ease (of time and money) with which an asset can be converted into cash, without affecting its market price. The risk arises when this takes too much time and costs the seller a lot.

Taxes : We go through various stages in our relationship with taxes that begin with ‘I don’t earn enough to care’ to ‘let’s get this over with’ each year and ‘rage rage rage’ at having to pay taxes. Governments need to spend on services such as defence, police, healthcare, education and so on. They need money for subsidies to sectors like agriculture and for the poor. And they need taxes to build infrastructure—both physical and digital. We can debate the quality of the services, but the fact that they are needed and therefore have to be funded is irrefutable.

Taxes take care of about 80 per cent of the total revenue of the government and the rest is the non-tax revenue. Non-tax revenue comes from dividends of public sector units, sale of government-owned businesses, sale of licenses like in telecom. Governments typically spend more than they get as revenue, and therefore need to borrow to fill the deficit. Total government expenditure is tax and non-tax revenue plus borrowing, also called deficit financing.

Direct taxes are levied on your income and profit and indirect taxes are levied on your spending. Any form of income—salary, fees, rent, interest, dividend, royalty—is a candidate for a direct income tax. Any form of profit—from real estate, stocks, bonds, trading, gold, mutual funds (that invest in stocks, bonds, gold and real estate)—is a candidate for a direct tax. Direct taxes are called fair because they are usually progressive, which means that you pay a higher rate as your income increases.

To ensure that the rich pay a higher tax, those who earn above Rs 50 lakh of income in a year pay an additional surcharge on the tax they pay. The surcharge rate begins at 10 per cent and goes up to a huge 37 per cent under the old tax regime for those who earn an annual income above Rs 5 crore making the effective rate 42.7 per cent of income tax.

Profits are called capital gain in tax language. Capital gain is the difference between your buying price and selling price. When the selling price is higher than the buying price, you have a capital gain. This can be short and long term, depending on the time difference between the buying and selling date. Short-term rates are usually higher than long-term rates, and in most cases treated like income. What is short and long term in the context of a holding period also differs across real estate, gold, stocks and bonds.

Indirect taxes are levied on goods and services that you buy and are said to be unfair because the impact is the same on anybody who buys a good or service. A very rich person buying a car and a middle-class person buying a car will have the same rate of goods and services tax (GST) they pay. The GST is the goods and service tax regime that has collapsed all the various indirect taxes into one system. To make GST fairer, the rates differ according to who consumes the good or service. For example, there is zero GST on fresh fruits and vegetables. Branded rice, spices and edible oil carry a GST rate of 5 per cent. Items like contact lenses and specs pay 12 per cent. Chocolates and ice cream have an 18 per cent rate. Luxury items such as ACs, cars, fizzy drinks pay a huge 28 per cent GST. 2 Alcohol and petroleum products are out of the purview of GST and are taxed separately.

Income Tax : income tax is calculated by incomes that arise under five heads. Income from salary, from house property, business and professional income, from other sources and from capital gain. agricultural income, gratuity and provident fund is exempt from income tax. On the indirect side, you can maximize your consumption of the zero or low GST items—home food over eating out. On the income side, you can earn as much exempt income as possible. Agricultural income is exempt and so is income from a United Nation entity. But not everybody can either be a farmer or a privileged UN employee.

Savings become investments when they pass through asset classes such as equity, debt, gold and real estate. These give income (rent, interest and dividend) and profit. We need to have a mix of assets that give us the required income and lump sums in the future when needed.

Real Estate :

Other than agricultural land, which under special circumstances has no capital gains tax, real estate rent and profits are taxed. Rent from real estate is added to your income and taxed at your highest slab rate. If your income was Rs 25 lakh a year and you added a rent of Rs 15 lakh to this, then your total income (ignoring all other deductions and expenses related issues), your taxable income becomes Rs 40 lakh. At Rs 25 lakh you were already in the 30 per cent tax bracket. The rent of Rs 15 lakh will also be taxed at the same rate. Should you breach the Rs 50 lakh taxable income limit, you will have to pay a surcharge as well.

Short term in real estate is defined as a holding period of two years. Real estate short-term profits are taxed at slab rate, like rent. These get added to your income and are taxed at your highest slab rate. For most readers of this book, you are looking in FY24 of slab rates between 31.2 per cent to 42.7 per cent. Long-term profits are taxed at 20 per cent of the profit with indexation.

You take the price of the past and make it up to date by using an inflation index published by the government. For example, Rs 50 lakh of 2002 becomes Rs 1.5 crore after indexation, giving a profit of Rs 49 lakh, on which the tax is Rs 9.8 lakh. The formula you need to use is this: Indexed purchase price = Price of buying × (Index in year of sale/ Index in year of purchase) 6 For this example, the values are: Indexed price purchase = 50,00,000 × (317/ 105) = 1,50,95,238

If you have sold your residential property, then buying another residential property with the profit will get you an exemption from the long-term capital gains tax. You must buy this new property either one year before the sale or within two years of the sale to get this benefit. Another route is to buy bonds that are described in Section 54EC of the act. These are now called Section 54EC bonds. Bonds issued by Rural Electrification Corporation Limited, National Highway Authority of India, Power Finance Corporation Limited and Indian Railway Finance Corporation Limited give you this benefit.

If you invest the profit (limited to Rs 50 lakh in a year) in any of these bonds within six months of the sale of the property, your profit is tax free. The lock-in is five years right now, but can change. These are low-interest-bearing bonds, and the interest you get is taxable at your slab rate. But when the principal returns to you, it is tax free.

PF and PPF are unique products in India that give an EEE tax benefit to you. These are exempt from tax on investment as they carry the Section 80C benefit. The interest they earn over the holding period is exempt from tax. At withdrawal, there is no tax either. So, PF and PPF are powerful products to build the core of the debt part of your portfolio.

Equity funds go long term at just one year. Short-term capital gains are taxed at 15 per cent and the long-term rate, after a profit of Rs 1 lakh a year has been taken, is 10 per cent. The long-term capital gains tax on equity

There are plenty of studies that show that passive investors on the whole do better than active fund investors.

Portfolio : The first decision you have to take when you think of building your portfolio is to solve for the allocation of money between debt and equity. I cannot stress how key this decision is for your entire financial life. The debt part of the portfolio is your life jacket whether in shallow waters or deep. This is always on. The debt part of the portfolio caters for short-term liquidity and long-term stability of the portfolio against the volatility of equity.

I have used the ‘100 minus your age’ idea to know your equity allocation according to age. At age eighty, you are still 20 per cent in equity. At age forty, you should be 60 per cent in equity.

How you missed out on some great return opportunity. Instead of letting it destabilize you, just ask one small question: what is your portfolio return? Across debt and equity and across all the products—what is that one number in CAGR? This is a simple but powerful way to get back to a balance when being told tall stories of return opportunities you might have missed.

The National Pension System is a great option but on retirement, 40 per cent of the corpus is forced to buy an annuity from an insurance company. The annuity market in India is not that great and that means you give up control over 40 per cent of your retirement money. This could change in the years ahead, but as in April 2023, I will still advise you to use an index fund on the Nifty 50 or Sensex to target your retirement corpus if it is more than ten years away.

For an investor who has never tasted mutual funds, an index fund is a great way to begin on the equity side. I cannot repeat this enough: equity investing through mutual funds is much easier than debt fund investing. Choose your index fund carefully and then just stay with it for your entire long-term investing journey. This is the easiest, safest, cheapest route to long-term wealth creation.

I like liquid funds for my short-term money needs, to park some funds before I deploy and to just hold money that I do not need immediately. The money is moved away from sitting in your savings deposit asking to be spent or lent away. The additional roadblock of having to redeem to use the money is like a cool-off period before spending.

When should you book profit?

When  there is change in your age, stage or needs. As you move towards a time period where your current spending needs are being partly or fully met from the income arising out of your assets, you will need to change your asset allocation to be heavier in debt than equity. When you have a long runway ahead of you of income through current work or a job, you can assign a higher allocation to equity, but that changes as you age. Be alert to changes in your personal situation and modify your portfolio accordingly. A way to do this, without having to book profits, is to funnel incremental investments into the asset class that needs to be enhanced. That way you do not have to pay capital gains tax just to rebalance.

What is the most important attribute of a driver or a cab? That he shows up on time. The car needs to be there when you have to leave for your meeting, airport or office. The money that you need in the next three years must be there when you need it. You cannot have a downturn in the stock market at a time when the fees for your course abroad need to be paid or when the down payment of the house is due. This money cannot be subject to the risk of the principal losing value (as is possible in real estate, gold, traded bonds and stocks). The money you need tomorrow needs to be in your bank account, ready for transfer. The other attribute is that the money should be liquid. You cannot go to market with a property and assume that the money will be with you in a month. Real estate is an illiquid asset. Similarly, if you have a long-term close-ended product such as an endowment policy or a pension product, you cannot bank on them to give you the money needed. It cannot be stocks since markets go up and down. Thus Mutual Funds are the route to take.

Remarks : For better appreciation, I would recommend to go through Monika Halan's "Let's Talk Money" before you turn to "Let's talk Mutual Funds" as many ideas which are mentioned in this book are very well covered in this first book. I would also recommend the readers to go through "Money Works" by Abhijeet Kolapkar which has become one of my personal favourites.