The 5 most useful points in my articles about Personal Finance

These are the 5 most useful points from my various articles in Mint, Business Standard, The Ken etc starting with the relatively most original points:

1. How much you should save for retirement:

“Real returns, (after inflation and tax), across one’s entire portfolio and across one’s lifetime, will be in the ballpark of zero per cent. This dramatically changes how one should invest and save…

If you and your spouse are 60 years old, you should have savings equal to 30 years of current expenses to be able to retire and survive retirement till the age of 90…

You should save half of your lifetime salary.”

(This article provides a layman explanation in the Indian context while this article provides a finance theory explanation which applies across countries and this video also covers how much one can spend during retirement)

2. Why Active Mutual Fund managers are unable to beat the Index in India:

“Intuitively, stock-selection net-alpha (i.e. net of costs) is so difficult because firstly, competent investors are competing not just against laymen. They are also competing against promoters [Indian term which is something like ‘founders’] of companies who will also try to personally benefit from their company’s stock being temporarily undervalued or else, talk it up to prevent it from being undervalued. Secondly, in financial markets, the crowd as a whole is, more often than not, smarter than even the smartest member of the crowd. This is because members of the crowd typically err on either side and the errors cancel each other out. Finally, costs are a critical aspect in the intuition. On this aspect of costs, an interested reader can simply read William Sharpe’s brilliantly elegant and concise logical proof of this which cannot be made any more concise (‘The Arithmetic of Active Management’ is a 2-page article which was published in 1991)" (Article)

"Nobel prize winner William Sharpe proved mathematically that the average active investor is (a) before costs, guaranteed to match the performance of the index and (b) net of costs, guaranteed to underperform the index.” (Article)

3. It’s a myth that equity is safe in the long term - Often, people take too much risk believing the myth that equity is safe in the long term:

"Almost everyone believes that equity is safe in the long term… The data, theory and principles of finance all disagree with this myth. And, sometime over the next decade or so, believing in this myth may have devastating consequences…

Believing the myth that equity is safe in the long term is one of the key reasons that people take too much equity risk. The reality is that over a 5-10-year horizon, there is a higher probability that equity will at least match inflation but there is also a material probability that it will generate returns that are lower than inflation…

Inflation indexed bonds (or inflation-protected bonds) largely do not exist in India. So Indian residents are almost forced to invest in equity and real estate (i.e. risky investments) to protect against the rare risk of very high inflation. But too high an allocation to risky investments could lead to permanently losing half of that investment (in real value of money). So, one must find some middle ground and lean towards taking less risk. The recent high returns from equity has led many people to do the opposite.” (Article)

"Do not believe the myth that equity is safe in the long term and do not put more than 50% of your net worth in equity. Some experts suggest a more aggressive allocation depending on risk appetite and time horizon, but my experience with clients time and again has confirmed an inability of people to handle an equity allocation beyond 50% when there are market crashes, regardless of the time horizon and risk appetite." (Article)

4. The battle for 1% p.a. will determine whether you will survive retirement:

"The financial services industry / Dalal Street’s primary focus is to transfer wealth from the client to Dalal Street. Dalal Street knows that clients will not hand over all their net worth at one go. So instead, Dalal Street uses a very effective technique called ‘salami-slicing’. In this context it means, Dalal Street fights a battle to get 1% of the client’s net worth each year.” (Article)

“Minimize investment costs to maximize returns: Let’s assume that a financial product such as a mutual fund has fees of 1% per annum. The fee appears to be small but, in reality, it isn’t. It’s the mind playing games with us. Giving up 1% per annum over 30 years means giving up a total of 26% of the investment. It requires a pocket calculator to arrive at that 26%.

You can instead use a short-cut to arrive at a rough estimate: 1% per annum lost over 30 years is approximately equal to 1% multiplied by 30 (years) which is equal to losing a total of 30% of the investment. So, the next time, multiply the fee by 30 (years) to understand how much it will cost you in the long term.” (Article)

“Fees Kill: Even if one uses Direct Plans (i.e. Zero Commission Plans), all else being equal, focus on mutual fund fees and try to minimize them as much as possible. A good way to condition your mind to do this is to think of commissions/costs/ fees not in percentage points but in basis points (a basis point is one-hundredth of a percentage point).” (An article that was mentioned earlier , an article that is behind a paywall and another article that was mentioned earlier)

5. It is rational to use Passive Index Funds and irrational to use Active Mutual Funds:

"The S&P Indices Versus Active funds (SPIVA) India report is the only one [report] that uses correct statistics. It shows that the average active MF does not beat the index…

Let’s understand why almost no one recommends index funds. Only a trivially small number of all other commentators about funds understand the SPIVA India report. This is primarily because it requires a deep understanding of statistics to correctly understand the SPIVA India report which is prepared over three months. Also, as Upton Sinclair said, ‘It is difficult to get a man to understand something, when his salary depends on his not understanding it’ ” (A simple article , a data oriented article and an article which explains the SPIVA India report in detail)

"Don’t use smart-beta or factor funds that pretend to be ‘passive’ but are actually ‘active’, e.g. momentum and low-volatility funds. They do not work and neither does market-timing/technical analysis." (An article that was mentioned earlier and a TV discussion with Active Mutual Fund managers)

Postscript: A full list of articles in Mint, Business Standard, The Ken etc is available here