Saturday, June 28, 2014

Ain't I a Second grade sucker or what?

Just read this excerpt from the book 'Reminiscences of a Stock Operator' that I am currently reading. 

(Once I complete reading this book, I will post a review of the same in this blog, I promise)

"Suckers differ among themselves according to the degree of experience.
The tyro knows nothing, and everybody, including himself knows this. But the next, the second grade, thinks that he knows a great deal and makes others feel that way too. He is the experienced sucker, who has studied not the market itself, but a few remarks about the market made by a still higher grade of suckers. The second grade sucker knows how to keep from losing his money in some of the ways that gets a raw beginner. It is this semi-sucker rather than the 100 percent article that is the real all-the-year-round support of the commission houses. He lasts about three and a half years on the average, as compared with a single season of three to thirty weeks, which is the usual wall street life of a first offender. It is naturally the semisucker who is always quoting the famous trading aphorisms and the various rules of the game...."

And so on and on and on....

While I was reading it, I am like, this guy is talking about me. This book was written in early 1900s. I wasn't even born then. How the heck does this guy know so much about me? I am one of those half baked knowledge guys who thinks he knows all about Stock Market because he has dabbled in stocks a bit. 

"Buy and hold", I tell them earnestly. I have read in various investment books that it is the best strategy to make long-term wealth. I pride myself that I am an avid 'Buy and Hold-er' since I bought Reliance in the 'Muhurat Trading of 2010' when it was trading at 1195, a price the stock has avoided touching since then, as if the price were a leper or somethin'. Since I don't want to dispose off at a loss, the stock has become my example of the importance of 'Buy and Hold' strategy. God knows that if it were to just cross 1195 I would be exiting of that like a Pavlovian Rat in a electrified cage. (Inflation be damned, I just want my principal back). But  the real truth is that I have disposed off more stocks than a used diaper. For every stock of Reliance that I keep, I have sold off Kemrock (at a loss), Financial Technologies (at a loss), Bank of Baroda, Oriental Bank of Commerce, Canara Bank, ICICI Bank (all at minor profits).....

List goes on.

"If you buy a good stock, keep it", said someone. I took this advise to heart and purchased HUL in 2004 and kept it. Till 2012, the price of the share was wandering around my purchase price like some loafer in the Central Park.  I still have it (Though I must admit that the Share Price moved substantially upward in the last two years) 

"Keep a target return and sell off when you reach that return. That will take care of the two main enemies of a retail investor, vis. Greed and Fear", that is another mantra that CNBC taught me. I took to it like a fish to water. And that too at the very early stages of a Bull Market !!. I kept a profit target  of 30% and a loss target of 10%. I bought Oriental Bank of commerce at 60 and sold it off at 78, it went on to touch 800, I brought Financial Technologies, the stock went up to 90 and came down to 50, I followed my 10% loss rule and sold it at a loss, the stock went on to touch 2025...

Then there are advises that I have ignored. "Buy Praj Industries at 60. It has good long-term potential", said a finance magazine. Since CNBC told me to 'Ignore the noise', I ignored it. Praj went on to touch 1200, gave 1:1 Bonus and 1:5 Split and now it is trading at around 100.

"Let the winners run" said another expert on TV. I bought IDFC at 50, it touched 300 and it is back to 80 or so now. "Keep Trailing Stop Loss", said another expert and many of my stocks hit the stop loss before returning to their next bull market upward run. 

(Now I know one thing. I got the advises and the market trends mixed. 'Let the winners run' is a good advice in Bull Market. 'Keep 30% profit and 10% loss target' is a good advice in bear market)

"Understand and use the power of leverage", said another expert. I went and bought options. I purchased 'In the money' options, 'Out of the money' options, 'Far out of the money options', 'Calls', 'Puts', 'Straddles', 'Strangles'....

I lost money in all of them. 

I am one of those guys who expound on Stock Market like a passionate motivational speaker. I know all the theoretical concepts out there. I can keep them on thrall like I am Freud (Sigmund). I know about Stocks, Bonds (including James and Zero Coupon), Retirement Planning, Tax Planning....

You know, the works. And I don't hesitate to share my knowledge. 

I always used to wonder if there was something wrong with me. I wondered why, with all this knowledge, was I losing in Stock Market. Why the Stocks I keep tend to go down and stocks I sell tend to go up. 

Now I know.

When it comes to Finance and Investments, I am a second grade sucker. Thats why...

Friday, June 27, 2014

Book Review #4: Secrets of the Millionaire Mind: Author: T Harv Eker

This is the review of the book Secrets of the Millionaire Mind written by T Harv Eker

This book falls into the category of Inspirational Book. The full title of the book is 'Secrets of the millionaire mind - Mastering the inner game of wealth'. The key message in this book is that if you want to become rich, you have to think and act like rich.

I am structuring this book as a discussion between me and the book (SOTMM).

Me: So, SOTMM, tell me something about yourself?
SOTMM: As you read in the first paragraph, the focus in me is about thoughts and how they lead to actions. I am divided into two parts. The Part 1 focuses on how we are conditioned to think about being rich. Contrary to what we think, when it comes to riches, some of us are programmed to fail and remain poor. In this part,  I outline four strategies to change your thoughts to 'Wealth Accumulating' mode. Part 2 contains 17 'Wealth Files', each containing one difference in the way in which rich and poor think and act. At the end of each file, there are a set of declarations that you have to make loudly, and a set of actions that you have to follow. It is expected that by following these instructions, you will signal to the universe that you are ready to receive abundance of wealth. By the way, 'Ability to Receive Gracefully' is one of the traits that separate rich from the poor.

In addition, I am laced with nuggets of wisdom in the form of 'Wealth Principles'. Each principle is a gem on its own. Wealth Files together with Wealth Principles, if acted upon together can take you significant wealth in a short span of time. 

Me: You mention that when it comes to riches, some of us are conditioned to fail. Can you elaborate on that?

SOTMM: Let me give you an example. Suppose you are looking for a promotion. You go and tell your boss that you want that promotion. Then you add as an afterthought, 'But I am also a bit worried that this promotion will carry additional responsibility of people management. I have never done it in the past. I am worried if I will be able to handle that'. Do you think you are going to get that promotion. No. Here you are sending mixed signals to the boss. On the one hand you enthusiastically want that promotion, and other other hand, you are not sure if you can handle a key aspect of what that promotion entails.

Same is the case with most people when it comes to money. Sometime we say out aloud, 'I want to be rich'. Immediately universe hears it and gets ready to fill you with wealth and then you go, 'But will I be able to handle wealth? What if I am robbed? How will I handle taxmen? How will I handle people who come to me for charities? Will I be able to say no to them? What will I do if I get money? I don't have any clue of Investments?.....'

Now universe is confused. So it decide to wait giving you money to you are clear in your mind that you want money and wealth. The sad truth is that they maintain this ambivalence throughout their lives leaving their wealth generating potential untapped.

Me: Fascinating. How is this ambivalence generated?

SOTMM: Money is just an outer manifestation of your inner thought processes. Just as if you want get good fruits you have to nurture the roots, and if you want to remove the type, you have to updated the base document, if you want wealth, you have to work on the inner thought processes that generate wealth. The framework to get money is as follows.

P --> T --> F --> A-->R

P stands for mental Programming. The way you are conditioned to think. Programming leads to
T stands for Thoughts, which leads to
F stands for Feelings, which leads to
A stands for Actions, which ultimately leads to
R stands for Results, which in this case is more money, wealth and riches.

This means that the first step in your road to riches is to work on Programming. Most of the programming happens when you are at a young and impressionable age and you carry this into your adult life.

For most people, the above ambivalence is generated by three types of programming.
  1. Verbal programming: What you heard about money when you were young. For example, in your childhood  (in my childhood, SOTMM is talking to me, remember) you used to hear these two statements regularly. One, 'Government jobs provide job security and pension' and two, 'Business is risky. A job provides steady income'. Tell me if you are not conditioned by these two statements even now. Of course you are!. So you go about life not taking risks, not starting a business and not realizing your full money potential !
  2. Modelling: What you saw about money when you were young. For example, when you were young, you always saw your parents struggle with money. Money was always scarce and you were even afraid of asking your parents for simple things like Pencil and Stationery. How has it influenced you?
  3. Specific Experiences: Any specific experiences about money that you had when you were young.
Me: It is quite revealing. But still you did not answer my question. How can one come out of the ambivalence?

SOTMM: There are four steps that you need to take to change your 'Money Blueptint'. First is 
Awareness. You have to be aware that above conditioning exists and your Money Blueprint need review and revision. Second is Understanding the origins of your thought processes. Understand all the experiences that conditioned you to think the way you do. Third is Dissociation. You have to dissociate yourself from your thoughts. You have to realize that you have changed, the circumstances have changed and so you cannot afford to have these limiting thoughts anymore and you have to dissociate from them. Fourth and final step is Reconditioning. You have to regularly declare new positive thoughts into your mind to replace the ones from which you Dissociated. The Fourth step is what the rest of the book is about.

Me: I also see that author emphasizes 'The Power of Declaration'. Can you elaborate on this?

SOTMM: Sure. Declarations are powerful statements of intention that you speak out aloud to the universe. The energy generated by Declarations is transmitted to the universe thereby goading it to take action to fulfill the declaration. When making declaration, you should touch your heart so that you internalize your declarations. There is a lot of emphasis on declarations in this book. Author sincerely believes in their power to make change.

Me: Let us come to Part 2. Tell me something about Part 2.

SOTMM: Mr.Eker believes that the key to changing your 'Money Blueprint', your ability to attract Money and Wealth, is to replace the existing negative Wealth Files with new Wealth Files which are positive and supportive to meeting your financial potential. With this objective in mind, the author has identified the following 17 new Wealth Files. They are: 

  • Wealth File # 1: Rich people believe 'I create my life'. Poor people believe 'Life happens to me'
  • Wealth File # 2: Rich people play money game to win. Poor people play money game not to lose.
  • Wealth File # 3: Rich people are committed to become rich. Poor people want to be rich.
  • Wealth File # 4: Rich people think big. Poor people think small.
  • Wealth File # 5: Rich people focus on opportunities. Poor people focus on obstacles.
  • Wealth File # : Rich people admire other rich and successful people. Poor people resent other rich and successful people.
  • Wealth File # 7: Rich people associate with positive, successful people. Poor people associate with negative, unsuccessful people.
  • Wealth File # 8: Rich people are willing to promote themselves and their value. Poor people think negatively about selling and promotion.
  • Wealth File # 9: Rich people are bigger than their problems. Poor people are smaller than their problems.
  • Wealth File # 10: Rich people are excellent receivers. Poor people are poor receivers.
  • Wealth File # 11: Rich people choose to get paid based on their results. Poor people choose to get paid based on time.
  • Wealth File # 12: Rich people think 'Both'. Poor people think 'Either / Or'.
  • Wealth File # 13: Rich people focus on their net worth. Poor people focus on their working income.
  • Wealth File # 14: Rich people manage their money well. Poor people mismanage their money well.
  • Wealth File # 15: Rich people have their money work hard for them. Poor people work hard for their money.
  • Wealth File # 16: Rich people act in spite of their fear. Poor people let fear stop them.
  • Wealth File # 17: Rich people constantly learn and grow. Poor people think they already know. 
In addition to the 17 Wealth Files, the book is laced with 44 Wealth Principles. Wealth Principles acts as a peg around which you can consider your life experiences and make the necessary corrections and adjustments in your path to becoming rich. 

Now it was the turn of SOTMM to ask me some questions.

SOTMM: So Ram, now that you have read me and we had this discussion, what do you think of the points I mentioned? What did you like and What did you not like? Which are the points that are applicable to you and which you think are general?

I thought for a few moments before responding.

Me: There are a number of points that made me identify with the points in this book. Like most of the readers of this post, most of the people out there, I feel that I am yet to reach my full financial potential. While reading about my Financial Blueprint, I was thinking about some of the programming that has conditioned me  to think in a specific way. The most important I think is Fear. The fear of how I will handle being rich. How I will handle money, handle the responsibility that comes with it, handle the taxmen etc. Especially tax men. Since I am uncomfortable handling tax men, I tend to invest in Stocks and tax free bonds. In addition there is a lot of corruption in India. I have been told that you have to be corrupt in India to become rich. Since I don't want to be a part of Corruption, I take the way out by limiting myself to Tax free investment options. On further thoughts, I see that there are many people who has made money with out compromising their ethics. 

In addition, I belong to a community that prides itself on being very good government servants. Business is no-no for us. Right from childhood, I have been told that the best job is government job which comes with lifelong pension. Now I realize that the focus on 'Government Jobs' comes directly out of 'Paycheck Mentality'. It is very sad that many people know only 'Paycheck Mentality' and are not aware of 'Net worth Mentality'. Books like this will help people to understand that they have to think 'Net worth' if they hope to become rich. 

Also, I like some statements in the book. For example, 'You take yourself wherever you go'. So true. Our habits and attitudes stay with us wherever we go. We can't change ourselves by changing our physical location or our job. We have to change our thoughts and attitudes. Another point is that 'Not doing something also is a habit'. 

Another point mentioned is about the importance of learning. You can grow only by learning new stuff. Just as a tree starts to decay the moment it stops growing, people also start decaying the moment the stop learning and growing. Take an example of email. There are many people of older generation who, even now, do not know how to use email. Imagine how difficult it is for them in the current age when most of the communication happens through email !. As the book mentions, there is not age limit for learning and growing. I liked the idea. In fact I use it all the time. 

I also think that it is important to focus on 'Both'. That  is called 'Win-Win'. It is surprising to me the number of people who focus on 'I win, you lose' mindset. The entire blaming and criticism industry is based on 'I win, you lose' mindset. I think that whatever may be the conflict, you can find a Win-Win solution. 

SOTMM: So will you recommend this book?.

Me: Absolutely. I think that everyone should read this book. There are a lot of examples of people who learned the principles introduced in this book and were able to realize their money potential. .

If they can, So can you. 

Friday, June 20, 2014

Book Review #3:The Bogleheads' guide to investing: Authors: Taylor Larimore, Mel Lindauer, Michael Leboeuf

This is a review of the book 'Boogleheads' guide to Investing'

  Bogleheads are a group of enthusiasts of Vanguard Mutual Fund and its founder Mr.John Bogle.

Bogleheads' guide to investment is a book for those who are new to investing. Covering over 23 Chapters (written in small fonts !) this book acts as a full spectrum Investment Guide who has money to invest but don't know how or where (to invest).

When I first looked at this book as a part of my project on reviewing 50 Books on Finance, I decided against reviewing this. Yet another 'Dummies Guide' I thought. Even the reviews on the initial pages of the book confirmed my suspicion. 'Explains investing in mildly amusing tone', raved one reviewer. 'Explains the basics of investing, for both beginners and experts alike', said another.

A 'Dummies Guide' on investing which is 'Mildly Funny'? Not worth reviewing.

Fortunately I decided to borrow it, more so because I did not get any better books. I am lucky I borrowed it. This book as abundance of information and tonnes of wisdom. Even experts can learn new stuff from this book. Or they may come up with a different perspective on what they already know.

Both are good.

This book is divided into two parts. Part 1 spans from Chapter 1 to Chapter 16 and discusses 'Essentials of Investing'. Part 2 spanning Chapter 17 through Chapter 23 discusses 'Follow through strategies to keep you on target'. 

Like the other 'How to' books on making money and generating wealth, this book too starts with talking about your mind. If you want to become seriously rich, there are three behavioral traits that you must inculcate. They are:
  1. Graduate from paycheck mentality to net worth mentality
  2. Pay off credit card and high interest debts
  3. Establish an emergency fund.
The point about 'Net Worth' mentality require some elaboration. As you might have read in my review of the book 'Rich Dad Poor Dad', the rich work on the asset side of your financials while the middle class work on the Income side. The reason they (middle class) do that is because they are not financially literate. Working on building the asst side of your personal balance sheet is what is called 'Net Worth' mentality. Conversely, working on the Income side of your personal financial statement is called 'Paycheck' mentality.

One caveat against point 2. While no debt is better that most of the debts, if you get a loan at low interest, fixed rate terms you should go for it. Of course provided that you have your principal already invested in a high interest investment opportunity. 

So, ok, you have moved to the 'Net worth' mentality, now what? You know the difference between Assets and Liabilities, so how do you build your net worth. That is achieved by starting early and investing regularly. This chapter talks about the benefits of compounding and compound interest. If you invest 6000 rupees per month at 10%, you will have a Crore of rupees at the end of 30 years.

Over the next two chapters the Bogleheads go on to cover various investment options available to an average investor. The coverage spans Stocks, Bonds, Treasury issues, Government agency securities like GNMA,  Fanne Mae, Freddie Mac etc, Corporate Bonds, Municipal Bonds (Munis) etc. Chapter 3 focuses primarily on debt instruments. There is on section on the difference between Maturity and Duration (Read it, it is very important if you are a bond investor). Chapter 3 concludes by discussing three aspects relating to Bonds, vis, why should I invest in Bonds, How much should I invest (Thumb rule: A percentage equal to your age should be invested in debt and 100 minus your age should be in equity. For example, if you are 55 years old, 55% of your networth should be in Debt and 45% should be in equity. Of course this depends on your risk profile) and finally is is better to own an individual bond or a bond fund.

Chapter 4 continues the discussion into the realm of mutual funds. The book discusses 10 advantages of mutual funds, the difference between active management and indexing (latter is cheaper), and Fund of Funds. The third one is important. A fund of fund (FoF for short) is a fund that invests in other mutual funds. This way one FoF will give you the necessary allocation between Equity and Debt as you may wish. Life-cycle funds are a specific category of FoFs which become more conservative as years go by. This automatically does the Investment rebalancing as time progresses.

From mutual funds, the discussion moves on to Annuities - Fixed, Variable and Immediate, and finishes by a discussion on Exchange Traded Funds (ETFs). While discussing the various disadvantages of Annuities (ET Wealth had one full issue dedicated to this topic), authors point out that Annuities are 'normally sold not bought'. My advice, stay away from annuities (In India they are known as 'Pension Plans'). They are a very bad way to invest for future.

Discussion on Exchange Traded Funds (ETFs) clarified a long standing doubt in my mind about the difference between ETFs and FoFs. While NAV of FoFs are calculated on an end-of-the-day basis, the NAVs of the ETFs are calculated on a real time basis. One advantage of ETFs is that the fund expenses are relatively low compared to stand alone mutual funds.

Chapter 3 and 4 together gives a good summary of the investment options available to an investor.

Focus of Chapter 5 is on the 'Silent Thief', aka inflation. While compounding works in favour of an investor, inflation compounding works against her. The book discusses two investment options to protect against inflation. One is the Inflation Indexed Bonds (IIBs or I Bonds) and Treasury Inflation Protected Securities (TIPS). There is a lot of math in this chapter, the focus being on analysis of various Inflation, Tax Rate and Fixed Rate scenarios. 

There were two aspects in this chapter that were interesting to me. One was that the chapter destroyed the claims of many investment analysts that equities are best protection against inflation. The book points out different time periods when equities performed worse than inflation. The second aspect was that RBI has recently introduced IIBs in India. I need to look them up. Look to be an interesting investment option !.

Chapter 6 discusses the various aspects one should consider while deciding on how much amount one must save to plan for a smooth retirement without impacting ones quality of life. Various factors should be considered including current age, retirement age, expected no of years since retirement, expected rate of return, expected inflation rate, estate planning, inheritance and if one has other sources of income. Authors advice all to think thoroughly through all the details and plan for your savings.

I think this chapter is a misnomer. While the title is 'How much to save', the focus is on 'How much one will need' without any mention of how one will get there. There is some math given in the book that may be useful for people planning their investments.

Chapter 7 focuses on the best investment vehicle. The authors advise is to Keep it simple. There is no doubt in author's mind that Index Funds are the way to go. They convincingly prove (and if you need further proof, there are testimonials from some of the leading investment experts out there who also recommend index funds) that over the long term, index funds outperform more than 90 percent of the funds out there. The higher return of index funds come from the fact that their costs are very low.

So, why should you invest in index funds? Various reasons. Index funds have no sales commissions, low operating expenses (which means that more of your money stays invested), tax efficiency, no need to pay for expert advice, higher diversification and hence lower risk, there is no style drift and finally there is no tracking errors.

I have one question related to index funds. How come some funds perform better than others?

Chapter 8 on Asset Allocation is, in my opinion, is one of the most important chapters in this book. The authors site some very important theoretical concepts to bolster their case for asset allocation including Efficient Market Theory, Random Walk Theory and Modern Portfolio Theory. There are four question that one has to consider while deciding on asset allocation.
  1. Investment Goal
  2. Time Frame
  3. Risk Tolerance
  4. Current financial situation
Ideally one should allocate assets between different investment classes discussed earlier in Chapters 4 and 5. One should have investments in Stocks, Bonds, International Markets (and may be in Real Estate). It is surprising that Gold (a favorite asset class for Indians) do not even fare in this book !

The authors round off the chapter with a few sample portfolio for different age groups.

Chapter 9 is on costs. While reading this point, I was a bit surprised that I have not seen this point mentioned in any of the investment books that I have read previously. Costs are important. Your real returns will be equal to your actual returns less inflation less costs. As per this article while the long term return on US Stock Market is about 10.4 percent, the long  term costs are about 3.3 percent. This demonstrates the importance of keeping your costs down.

Is there any way to keep the costs down? Yes, we discussed this already. Invest in Index Funds. A part in Stock Index Funds, part in bond index funds and the rest in international index funds.

And remember, these costs do not even include taxes. Taxes further lower your return.

Next two chapters, Chapter 10 and Chapter 11 are on taxes. Authors give different examples of how taxes can significantly impact our returns from our investments. To effectively manage taxes, authors give the following suggestions.
  1. Invest in long-term tax deferred investment opportunities. That way, taxes are deferred to your post retirement years where you will fall into a lower tax bracket
  2. Buy low-cost, low turnover funds: Most of the taxes paid by the mutual funds are while buying and selling securities. A low turnover fund will ensure that the transaction taxes will be kept minimum. Why low cost? What is the relevance to taxes? Well, every time a Mutual Fund charges expenses on you, a part of it goes as taxes. So if the costs are low, the taxes are kept low. That is where Index Funds and ETFs come in. 
  3. Learn and understand the tax implications of your transactions. That will significantly alter the returns on your investments. 
Chapter 12 talks about diversifying your portfolio to lower the portfolio risk. While diversification will lower your risk, the authors also mention that diversification could increase your return. Details of how diversification could increase your return is not further considered in this Chapter. Diversification means buying different asset classes. The key is that for effective diversification, the return on these asset classes should have low or negative correlation. If the returns of two asset classes move totally against each other, when return on one is positive the return on other is equally negative, the returns on these asset classes are negatively correlated. (Time Spend on playing Computer games and Marks obtained in exam perfectly negatively correlated, for example. Let me sneak that one in least my son happens to read this review).

Another simple measure to evaluate the Correlation between two Investment classes is R-squared. Higher the R-squared between two investment classes, lower the Diversification effect of owing those investments.

Chapter 13 discusses whether one should chase performance or if one should time the market. Author's advise? Don't. Through convincing examples, authors point out the futility of both performance chasing and market timing. When it comes to market, or mutual funds for that matter, past performance is never an indicator of future performance. One cannot forecast even the direction of the market, let alone the future value of the market.

Authors advise the investors to cut out the external noise (Financial Channels, Pink Papers etc) and follow a well planned and consistent strategy through market ups and downs. No doubts for guessing that this strategy should consist of a liberal dose of Index Mutual Funds. Also bond funds and International Markets.

Chapter 14 discusses Savvy ways to invest for college while Chapter 15 talks about how to handle a windfall. Authors suggest the following four step process in case you are a recipient of a windfall.
  1. Deposit the money in a safe account for six months and leave it alone
  2. Create a realistic estimate of what the windfall can buy
  3. Make a wish list
  4. Get professional help.
My suggestion if you receive a windfall? Pay off your high cost debt including credit card debt.

You will notice that I did not speak anything about Chapter 14. That is because the chapter focuses on US. Being from India I did not understand most of it. But if you are a parent in US with kids to be sent to college in the near future, I recommend you to read this chapter. 

Chapter 16 recommends that as an investor, one should take the services of a Financial Advisor. It is very easy to become a Financial Advisor. What an investor should be looking for is a CFA (Chartered Financial Analyst) or a CFP (Certified Financial Planner). Find an advisor whose interests are aligned with yours. Authors strongly advice us to avoid financial advisors who are also Sales agents of financial products. 

And pay them.

Chapter 16 ends the Part 1 of this book

Chapter 17 starts the Part 2 of the book ('Follow through strategies to keep you on target') by discussing about Portfolio Rebalancing. They advice that at the beginning of your investments you should have a clear asset allocation plan. On a regular interval, you must review the performance of the portfolio and rebalance where required. The authors caution against the tendency to let the winners run pointing out that market has a tendency to 'Revert to mean (RTM)'. The significance of RTM is that over a period of time both winners and losers will revert to mean. This means that a misaligned portfolio when returns to mean will wipe out all the accumulated profits. 

In a counter-intuitive way, portfolio rebalancing can increase your portfolio returns by helping you to use MTM to your advantage. For instance, in the medium term, the chances are that today's winners will lose and today's losers will gain as they revert to the mean. Portfolio rebalancing will help us to keep our profit and invest it in potential gainers of tomorrow. 

There is a lot of noise out there in the form of Visual media, written media, advertisements trying to sway the investor in one direction or other. The noise out there that impacts an investor is the focus of Chapter 18. A savvy investor should learn to ignore and tune out the constant stream of information normally pointing out the next path-breaking opportunity. She should use the three guiding principles of Sticking to index funds, investing regularly and sticking to the investment strategy to win the investment game in the long-term.

Where are the emotions? I was wondering as I read all these chapters. Never have I espied an investment book that do not point out the behavioral impact on investment and returns. Greed and Fear have to be a staple component of the investment book. Without them the book is incomplete.

That is why was elated (relieved) when I read the title of Chapter 19. 'Mastering your investments means mastering your emotions', proclaimed the title. This is a very good chapter. My friends Greed and Fear were there of course. Also were other behavioral traps like Recency Bias (Giving more importance to recent events and ignoring earlier events), Overconfidence (I am unique, just like everyone else), Loss aversion (sticking with a loss making investment), Analysis paralysis (being paralyzed by information and noise and failing to take action), Endowment effect (one is more confident on things which are more familiar, like an employee investing his savings in the shares of the company that he works for), Mental accounting (giving different mental value to money based on the source. Money that you earned is worth more than the money that you received as a refund from IRS), Anchoring (not selling a losing investment till it touches your target price) and finally the worst of them all, Procrastination.

How do you overcome emotions? By following the three step mantra mentioned earlier. Invest in Index funds, Invest regularly and rebalance your portfolio on a regular basis.

How do you ensure that your investments lasts the entire duration of your retirement and then some? That is the focus of Chapter 20. Retired people face the spending dilemma of Overspending or Underspending. Best way to handle this dilemma is by taking the following steps. One, keep your fixed expenses as low as possible. Ensure that there are no loans remaining to be repaid and keep credit card debts as low as possible. Two, identify a viable way to earn some income. Internet has made it possible for one to sit at home and sell their knowledge and services. See if that is feasible for you. Three is to delay retirement as late as possible. Every year you delay the retirement is another year of income. Four, invest into an annuity (though this is a very bad way of ensuring income during retirement).

In my opinion, the most important investment planning as you approach retirement years is to transfer the equity portion of your investments into lower risk debt options. Coupon payments will ensure you regular income while your capital remains protected from the vagaries of stock market. Another option, a bit more riskier will be to purchase a dividend option of a conservative mutual fund. While not immune from Stock Market flucuations, some of these funds have a history of declaring regular dividends.

Chapter 21 touches another key subject, vis. Insurance. It is important to ensure that one has the following insurance.
  1. Life Insurance
  2. Medical / Health Insurance
  3. Disability Insurance
  4. Property Insurance against fire and flood
  5. Liability Insurance against expensive law suits
  6. Long-term care for older family members to prevent nest-egg erosion.
Three key insurance mistakes that people make are.
  1. Insuring the unimportant while ignoring the critical. Purchasing extended warranty on your car, TV etc without a liability cover to handle expensive law suits.
  2. Insuring based on the odds of misfortune. Not buying a flood insurance because you are living in a dry area.
  3. Insuring against specific, narrow circumstances.Buying a travel insurance prior to an air travel for example. 
There is one key aspect of buying a life insurance that this book covers and which I can't stress enough. It is the importance of Term Insurance. In Term Insurance, you are buying Insurance and nothing else. No endowment, no regular returns...Nada, Zilch. Just plain and pure Insurance cover. This works out to be the cheapest option for almost anybody at any age. The agent commissions on Term Insurance are measly and hence don't expect your agent to sell this to you.

(There are insurance companies offering term plans which you can buy on the internet. You should check it out.)

Chapter 22, the penultimate chapter in the book, talks about Estate Planning. The key points are about the documents required to be planned (A living will, a Living Trust, Powers of Attorney, Advance Healthcare Directive, Letter of Instruction etc). Other considerations include Gifting and the most important of them all, Taxes (How to reduce)

Chapter 23 winds off the book by telling you about the various ways in which Bogleheads' can help you as an investor. You can check out the details at

This completes my review of the book.

My thoughts after reading this book were as follows.

Through 23 chapters, the book covers the end to end information that an investor will need to start and maintain their investments. Part 1 covers the technical, data part of Investment and Part 2 covers the advisory aspect of Investments. As I mention below, this book adds value not only to novices, but also to Investors with a bit of knowledge like yours truly

Investment success calls for self discipline. Be it in shutting out the noise, investing regularly and consistently through market ups and downs, re-balancing your portfolio by selling off your winners and buying current losers....all these calls for dogged determination and exceptional self discipline. Even a regular portfolio review without blaming yourself for the losers and being detached about the winners takes tremendous amount of will power. Finally, you require self discipline to start a learning program and continue with it.

Even you need a lot of self-discipline to read this blog post !.

Importance of knowing Math cannot be overstated when it comes to investments. Investment is about analyzing numbers to find the underlying story or theme. The better you are at using Math, the better the insights the numbers provide and hence the better you will become as an investor. The area of finance and investing is based on a solid foundation of mathematical research. If you think you can't pick up math, find an adviser who can. It is worth it.

While I am knowledgeable when it comes to Finance and Investments, I learned a few new things after reading this book. One is the importance of investing in Index Funds. While I had previously invested regularly in Index funds, I found that my investments were going nowhere and I also found that managed funds were giving me better returns and hence I stuck with manged funds. After reading this book, I think I will take a re-look at Index Funds and ETFs.

I also realized the importance of considering taxes before making any investment decisions. Taxes, like inflation, is omnipresent and can significantly lower the return on your investment in the long-term. Most of us intuitively understand it and that is why tax-free bonds are so popular. But the point is this. There are tax-free options and then there are tax deferred options. We should also look into tax deferred options more closely. There may be bargains available there.

Another learning was about investing in Bond Index Funds and Inflation Indexed Bonds. I am not sure if any bond index fund exist in India and what are the taxation implications. I will need to check it out. In addition, IIBs have just been launched in India and they are yet to pick up. I will need to take a look.

I also learned about investing in ETFs. By the look of it, ETFs seem to be a better way to invest in mutual funds than the traditional MFs. Costs are apparently low, but I am not clear of the taxation implications.

Another point is that there is a need for such a book in the Indian Context. It may be there, I don't know, I have to check. I have included two books related to Indian Markets in my list of books to review. Hopefully I will be able to find more.

Thursday, June 19, 2014

How Sunder made a deal....

I was recently reading the book 'Rich Dad, Poor Dad' by Robert Kiyosaki. (My Review). In that book Mr.Kiyosaki posits that many rich people are deal makers.

What is a deal?

A deal is when you assemble multiples of investment options and sells the same as a deal where everyone involved gets a 'deal'. He shares the example of how he once made 40000 dollars in 5 hours by creating a deal. 

While reading this, I was reminded of my friend Sunder who made one such deal.

The year was 2000. The real estate market in Bangalore was slowly picking up. Mantri Group came up with an apartment complex named 'Mantri Paradise'. At that time a two bedroom apartment was being sold for about 13 lakhs. 

Sunder booked one apartment in the complex. He took a bank loan of about 11 lakhs. Mantri was ready to pay the 'Pre EMI' annuity payments to the bank. In fact Mantri facilitated the deal. 

By 2003 when the apartment was ready, the block which Sunder bought was being sold for about 25 lakhs. Sunder promptly sold off the house and paid off his bank loan and was left with a profit of about 12 lakhs. 

He did not rest with it. He used 3 Lakhs to buy a 3000 Square feet of land in Rajarajeswari Nagar, one the outskirts of Bangalore. He paid 100 per square feet. 

With the remaining 9 lakhs, he constructed 5 houses in the land. Fortuitously, Bangalore was starting to expand and Mind Tree set up their campus and office in Rajarajeswari Nagar, almost next door to Sunder's housing complex. 

Sunder saw an opportunity and promptly negotiated with Mindtree and leased out 5 apartments to the company at a tidy three year lease of about 10 Lakhs per house. 

Sunder's total out of pocket expense? About 2 lakhs

Sunder's cashflow from the 5 buildings? About 50 Lakhs

You do the math...

Tuesday, June 17, 2014

Book Review #2: Rich dad, poor dad: Author: Robert Kiyosaki and Sharon Lechter

"What the rich teach their kids about money - that the poor and middle class do not !"

The book 'Rich Dad, Poor Dad', that Mr.Kiyosaki has co-authored with Sharon Lechter, could have been one of those widely read and appreciated books on Financial Literacy and practical suggestions on how one can become rich. There is a need for such books.

If only Mr.Kiyosaki had not decided to embed his book with the Ayn Randian philosophy of 'Makers' vs 'Takers'. By incorporating his political philosophy on a book on Financial Literacy, Mr.Kiyosaki has diverted attention from the core ideas of the book. One can't just read the book without simultaneously thinking about the implicit political viewpoints being discussed in it.

The premise of this book is that for surviving in today's world, we need to be financially literate. Our educational system churns out people who are literate in Sciences, Art, Literature, History etc, but ignores the most important literacy of it all, the financial literacy. In her introduction to the book, Ms.Lechter argues that there is a need for imparting financial literacy in schools and that there is a need for books like these which focuses on the subject. Ms.Lechter, a certified accountant, working with a 'Big 8' firm feels that today's children are not educated on handling money. Like any typical parent she advises her children to 'study hard' so that they can get a 'good job'. To her consternation, her son informs her that most of the rich people like Steve Jobs and Bill Gates dropped out of collage and look where it took them to?

Concerned, Ms.Lechter carries on trying to educate her children on the importance of studying hard, all the while worrying that her kids are not getting the required Financial Literacy badly needed to survive in the future.

She and her husband sets up a meeting with Mr.Kiyosaki and his wife Kim. During discussions Mr.Kiyosaki impresses Ms.Lechter that the difference between wealthy and the others is that the wealthy think differently from others. As an example, when a company downsizes, the middle class people working in the company will feel sad and will protest about downsizing, while the rich people, who invested in the company, will become wealthier as the value of the investments in the company appreciates.

As per Mr.Kiyosaki, this approach of rich people is based on a thorough understanding of laws, concepts and principles of money and wealth.  All these concepts have theoretical and empirical underpinnings and everyone should have access to the concepts so that they can learn to think and act like rich people.

Mr.Kiyosaki argues that while every person will spend most of his life time with a primary objective of earning money and trying to accumulate wealth, most of them attempt to do this ignorant of the laws of wealth and having any kind of financial literacy. The author considers this a gap in the current education system that it does not teach the most important skill and knowledge that any person should possess.

While reading this book, I couldn't help comparing this book with the book 'The Millionaire Next Door' which I had reviewed here. While there are commonalities in the profile of the Rich Dad and of this book and a typical millionaire in TMND (Both have very little formal education, both owns businesses, both dress in working clothes most of the time etc) a significant difference between the two books is that RDPD focuses on CASHFLOW, which is considered as realized income as per TMND and which will be taxed as per the tax laws. The focus of TMND is on unrealized income in the form of value appreciation of the investments.

Back to Rich Dad, Poor Dad. The book is divided into 10 Chapters. The first chapter sets the tone of the book by comparing and contrasting the two dads. The next six chapters expounds on the six lessons that the Rich Dad taught the author. The last three chapters provides some suggestions and guidance on how a normal individual can earn money and become wealthy.

In Chapter 1,  'Rich Dad, Poor Dad', the author sets the tone of this book by comparing and contrasting the two dads. Both the dads were strong and successful. Both earned substantial incomes. However, what fascinates the reader is the contrast between the 'Rich Dad (RD) and the 'Poor Dad (PD)'.
  • While PD says 'I work for money', RD says 'I make money work for me'
  • While PD says 'Love of money is the root of all evil', RD says 'Lack of money is the root of all evil'
  • While PD says 'I can't afford it', RD asks 'How can I afford it?'
  • PD is highly educated but financially illeterate. RD dropped out of school at 13, but is highly literate financially
  • PD thought that rich should pay more in taxes to take care of the less fortunate. RD maintained that 'taxes reward those who do not produce and punish those who do'
  • RD encouraged talking about money and business at dinner table. PD forbade money being discussed over a meal.
  • PD says 'When it comes to money, don't take risks'. RD says 'Learn to manage risks'.
  • PD believed that home is the persons greatest asset. RD believed that having a home of ones own is a liability
  • Both paid their bills on time. PD paid the bills first and RD paid the bills last.
  • PD believed in the idea of company or government taking care of a person and her needs. RD believed in financial self reliance.
  • PD taught the author how to write and impressive resume so that he can get a good job. RD taught him how to write business and financial plans
  • PD always said 'I will never be rich'. RD always referred to himself as rich.
  • PD will say 'Money doesn't matter'. RD will say 'Money is power'
The chapter also outlines the two broad themes of the book. One is the need for Financial Literacy. Our education system teaches people everything except the laws and concepts of Finance and Wealth. However an average person spends his lifetime earning and spending money. It is a paradox that the education system doesn't teach a person on something as important as money since money is what  a person is going to spend a lifetime working for.

The other theme is the power of ideas and thoughts. For example, the PD always thought that 'I will never be rich' and that is what he ended up as (not rich). He made statements like 'I can't afford it' and those statements turned into reality. The emphasis of this book is on the power of thoughts and emotions and how one can handle the same to one's benefit.

The author rounds off the first chapter with the poem 'The Road Not Taken' by Robert Frost.

Chapters 2 through 7 discusses 6 money lessons that the RD taught the author. They are,

Lesson #1: Rich don't work for money
Lesson #2: Why teach financial literacy?
Lesson #3: Mind your own business
Lesson #4: History of taxes and the power of corporations
Lesson #5: The rich invent money
Lesson #6: Work to learn - Don't work for money

The final three chapters discusses the practical aspect of putting the above lessons in practice.

The primary focus of chapter 2, 'Rich don't work for money' is the difference in thinking between the rich and the poor when it comes to the idea of money. When thinking about money poor people fall pray to the emotions of fear and greed. They are fearful when they do not have money and when they have money, they are greedy for more. When faced with lack of money, rather than critically analyzing the situation that they are in, the poor people allow their emotions of fear to do the decision making. Due to the fear of not having the money, the poor people jump at the first opportunity of getting a job and getting paid. As per RD, a job is a short-term solution to a long-term problem.

Even rich people are not exempt from the above phenomena. The fear of losing all they have and going bankrupt motivates many rich people to work harder at accumulating more and more wealth. According to the Rich Dad, the rich people who allow fear to influence their behaviour is no different from an unemployed person standing in line to get that job.

Rich people think differently. They are also not immune to the emotion of fear. However, faced with a situation which induces fear, rich people ask the question 'What is the best way in which I can overcome this situation?'. A question put like that acts as a catalyst on the creative part of the brain and the brain will provide multiple options to handle that situation.

This chapter says that rather than working for money, we should make money work for us. The chapter is vague on how one can go about doing that and is left to the later chapters to elaborate. This chapter lays out the philosophical underpinnings for the remaining chapters. The chapter is filled with pearls of wisdom. RD points out that many a time life puts you through tests. That is life's way of teaching you lessons. Those who fail to recognize that life is doing the pushing will end up blaming themselves or blaming others for their misfortunes.

Having made the point that fear and greed makes people take wrong decisions in life, the natural question is how can you overcome the ill effects of these emotions. The answer to that is to gain knowledge. One need to learn how money works so as to realize how one can make money work for them. This is where Financial Literacy comes in. The best way to know about something is to learn about it. So is the case with money. The best way to understand money is to learn more about it. And that is what this book is about. It attempts to teach you how money flows in and out of your life and how you can change your attitude and approach to money so that it remains with you.

Chapter 3 is on Teaching Financial Literacy. This chapter outlines financial ideas that form core of this book. The chapter starts with a powerful story about 12 business leaders meeting in a hotel in 1923. 20 years later, most of those rich, powerful business leaders died broke and bankrupt. That story tells you about the importance of having financial literacy. Even though rich, many of the business leaders were not financially literate. 

So what is this financial literacy? Is there some simple but powerful rule that we can learn. As it happens, there is a simple rule. The rule is 'Know the difference between assets and liabilities and accumulate assets'.

As rules go this is very simple to understand but very difficult to implement. The key challenge is in understanding the difference between Assets and Liability. 

Many of us think of our house as an asset. But does a house, on which you are paying mortgage, count as an asset? 

As per the definition given in this book, Asset is something which gives you ongoing positive cash flows (Cash Inflows). Based on this definition, house does not count as an asset. Instead of giving Cash flows, a home is a net cash user. You have cash outflows in the form of Mortgage payment, property tax, maintenance charges etc. 

The biggest problem with taking a mortgage loan and keeping on the annuity payments is the opportunity loss that it entails. Annuity locks in significant amount of money that could have been used to buy assets that could provide cash flow in future. As I have written in another post in this blog, it makes a lot of sense to stay in the rented apartment and use the savings to accumulate assets.  

This chapter also shows through simple illustrations, the difference in the Cashflow habits of Rich people and middle class. Middle Class people has their job as their only source of income and pay off their liabilities first and then their expenses leaving them with minimal amount to buy assets. Rich people on the other hand buy assets first and use the cash flow provided by the assets to pay off the liabilities and spend on the expenses.

Chapter 4, Mind your own business, is a short and crisp chapter. The author points out that what you do may not be your business unless it is working in the asset column of your personal balance sheet. If your income is from your job and you do not have any assets, you are not minding your own business, you are minding someone else's business. Mr.Kiyosaki urges everyone to focus on building their asset column. He suggests multiple ways to do that including Starting your own company, buying stocks and bonds, IOUs, Real Estate etc. Only caveat is that you should enjoy doing that and once you put in money into your asset pool, you should not take it out under any circumstances.

Chapter 5, with a lengthy name The history of taxes and the power of corporations, makes the point that taxes are the biggest expenses for a middle class person. At 30% tax rate, it is like a common man is working for almost 4 months for the government, for free. The taxes of ordinary working people are taxed at source which means that only post tax earnings reach their hand. For them, the cycle of cash flow is Earning --> Taxes --> Spending. The rich works around the above problem through the use of personal corporations. The tax laws provide a lot of options for accounting for personal corporations. In case of corporations, Revenue net of expenses is taxed, which mean that the cycle of cash flow is Earning ---> Expenses --> Taxes, which can make a big difference to the overall cash flow position of an individual.

Mr.Kiyosaki talks of building Financial IQ which consist of knowledge of accounting, investing, market knowledge and law. Knowledge in these four areas is necessary for an individual if he or she is planning to become seriously rich !!

Chapter 6, The rich invent money, talks about how rich make money. They put together deals thereby appreciating the value of their investments sometimes exponentially. What do they need to do that? They need Financial literacy. Mr.Kiyosaki, convincingly explains that as the times and technology changes, only the knowledgeable people will stand to benefit. He gives one or two personal examples of how he converted 20000 Dollars into 1.2 million dollars through various legal deals. He emphasizes that he was able to do that only because he knew the law. As per Mr.Kiyosaki, there are two types of investors. One type put money into stocks and bonds and buys the same from the market. This is simple and quick way to build assets. The other type creates deals. They assemble various asset components and sells it to investors. To do this they require three main skills.

1. How to find opportunities that are financially lucrative
2. How to raise money
3. How to organize smart people

While reading this chapter, I realize that I am an investor of Type 1 above. I simply buy and keep stocks. I am not into bonds much. To illustrate the point about rich inventing money, Kiyosaki talks about how he made 40000 in about 5 hours through a real estate deal. While reading it, I was reminded of the story of my friend Sunder who did a similar deal. Here is the post.

Chapter 7 rounds off the set of lessons by asking everyone to Work to learn - Don't work to earn Mr.Kiyosaki postulates that most of the people are 'one skill away from great wealth'. Which means that most people can expand her wealth simply by learning new skills. Most of the people continue work in specialized area and end up limiting their wealth potential. As against being a specialist, the author recommends that we should try to learn 'a little about a lot'. By sating our need for learning different things, we are expanding our metier and that can help us increase our wealth.

If Financial Literacy is required for wealth creation, why are many financially literate people not successful? As per the book, there are four reasons why many financially literate people are not wealthy.

Reason 1 is Fear: They are afraid of failure and hence they do not take any risks. They keep avoiding what they fear do not move towards what they want in life. Fear clouds analysis. Many fearful people lose confidence in their knowledge and take decisions based on what they 'hear' outside.

Reading this I remembered another book that I had read named 'Five secrets you must learn before you die'. One of the secrets is 'Be true to yourself'. That book also make the same point that most people spend their entire lifetime running away from what they fear and not running towards what they want. When it comes to the above point about investments, this post and this post in my blog is an illustration.

In search for job security and job with government, many of us in India fall into the same trap of letting Fear overcome sensible decisions.

Reason 2 is Cynicism, which essentially displays as self doubt. Cynicism also clouds analysis. It is important to analyse any decisions that you make based on available data. Most people do not take good decisions because they do not take time to do thorough analysis.

Reason 3 is Laziness which includes both physical laziness and intellectual laziness. In my opinion, the second type of laziness is criminal. If you have the knowledge and intellect to do thorough analysis, why not put in the required hard work? Why become Mycroft Holmes when you can become Sherlock?

Reason 4, Bad Habits, is coupled with intellectual laziness. One bad habit that impact wealth creation is paying everyone else first before paying yourself. Rich people have developed a habit of 'Paying themselves first'. One could say that laziness is also a bad habit. Another bad habit is lack of decisiveness. When it comes to making investment decisions many of us vacillate and prevaricate.

Finally, is there something in this book that I do not agree with? Is there something that I did not like? Are there some scope for improvement?

I can think of three.

One, as I mentioned at the beginning of this review, this excellent book has been clouded a bit by author's political and philosophical view point about 'Rich' vs 'Poor', 'Makers Vs Takers' and 'Haves' Vs 'Havenots'. Considering that there are a number of rich people who do not share this contentious viewpoint and that this was not relevant to the main content of this book, Mr.Kiyosaki should have avoided this topic. And the world of Financial Literacy and literature would have been better for it.

Two, the authors focus is on Cash Flow. The book repeatedly exhorts the reader to buy assets that will provide positive cash flow. However as the authors of the book 'The millionaire next door' point out (My review), positive cashflow will fall into the category of 'Realized Income' and will be taxed at the prevailing tax rate. May be in an ideal world without taxes, positive cashflow may be an goal worth aspiring for, but in the mundane world of taxes, a cash flow will be taxed thereby lowering the return for the investor. It may be better for the investor to have an asset that appreciates in value rather than an asset that gives Cash Flow over a regular period.

Three, in some parts of the book, Mr.Kiyosaki points about how the rich people use the power of corporations to boost their wealth. He seem to imply that many of the day today expenses can be passed on as business expenses ('For example, by owning your corporation, Vacations are Board Meetings in Hawai'). One must be very careful of such advises least one falls on the wrong side of the Tax Authorities.

Have you ever experienced travelling in a train? It starts off slow from a station, picks up speed midway through the journey and again slows down as it approaches the next station. That is what reading this book feels like. It starts off by criticizing the current education system and lack of financial literacy, picks up steam with some wonderful chapters on purchasing assets and generating cash flow and meanders into generalities as it goes back to becoming philosophical and advisory.

But I also know that Mr.Kiyosaki filled some of the gaps in his next book 'Cash Flow Quadrant' which I will review some time soon. (Check out my review here)

Why in the world should Kambles buy a house in Mumbai?

I was talking to my friend Vinod Kamble today. Vinod and his wife Amrita (hereinafter called 'Kambles') recently signed on the mortgage deal to buy a house in Mumbai.

Vinod works in a multinational with an monthly salary of about one Lakhs on hand. Amrita works in an IT company at a monthly salary of Rs.50000 on hand. 

This is a house in the newly developing area near Mumbai. The cost of the house is about 1.5 Crores. The Kambles have taken a twenty year loan of about a Crore from a bank on which they pay an EMI of about a lakh per month.

I asked Vinod how they are managing to pay such high EMIs.

'My monthly salary goes directly to the Bank', he replied, 'we manage our monthly expenses through Amrita's salary'.

'What about savings? Any?', I queried

'No savings. We hardly are able to manage the monthly expenses', he replied.

'Why buy a costly house? Were there no better offers?', I asked.

'There was some available at a cheaper rate little farther away, but we wanted to live in this locality', he responded. 

'Have you taken possession of the house?'. I enquired

'No, currently I am living in a rented apartment in the same complex. We will get possession next year', came the reply

'How much are you paying as rent?', I asked

'Rs.25000 per month', he responded.

I did some math. Kambles are paying about 1.5 Crores for an apartment from which he can expect a rental income of about 3 Lakhs per year. That is a measly return of 2% per year. If they stay in a rented apartment and invest amount of 1.5 Crores in an FD paying about 9% (6.5% post tax), still he will be getting a post tax return of about 4.5% after paying rent on his house. 

Assume that Kambles want to have an investment that will pay their rent, at the above rate, they need to invest a principal amount of 47 Lakhs in an FD at 9% interest to get an annual income of 3 Lakhs which will pay off their house rent. It is still one third of the investment required to buy a house. 

In addition they will have a surplus income of almost 10 Lakhs in a year which they can invest in Wealth building investments. Rs.10 Lakhs a year at an interest of 10% will grow to about 1.75 Crores in 10 years. 

If you show the math to Vinod, he will tell me that the value of the house will appreciate in future and hence it is an investment worth making. But for people like Vinod, this is his home. He is buying this house to live there. This house is not an investment which he plans to sell off at a later point in time. Since he is planning to live here and is not planning to sell the house, any appreciation in value of the property is going to be only notional profit. 

But, does he see how this purchase is impacting his long term future? Currently he is left with no surplus investment income. Kambles have no savings. They are not planning for the long term. They don't even have sufficient contingency funds. How will they manage 10 years down the line when they have kids and expenses shoot up? 

So what is better? Is it better for Kambles to buy a house in a less expensive locality? Is it better for them to stay in a rented apartment and invest the surplus income in wealth growing investment opportunities? Anyway you look at it, staying in a rented apartment is better. You also get tax benefits if you stay in a rented apartment.  

Considering that a home purchase can wreck havoc with the finances, why in the world should Kambles buy a house in Mumbai?

Book Review #1: The Millionaire Next Door: Authors:Thomas J. Stanley & William D. Danko

Who do you think is richer? A neighbourhood garage owner who seem to be busy all the time, always in a Khaki pants and a Sweat shirt and drives a 4 year old Maruti Swift, or the neighbourhood doctor, who lives in a swanky apartment, has a six figure annual income, wears the latest Armani, sports the 50000 rupee mobile phone and drives around in an Audi...

Ok, I guess I gave away the surprise.

It is the doctor, right? 

Wrong. Chances are that your neighbourhood small business owner is richer than the doc who has substantially high income. 

That is the surprising conclusion that the book 'The millionaire next door' comes up with. As per the book, there are various reasons why a doctor is not as wealthy as he should be.

1. Doctors normally start earning late in their lives. The garage owner probably has a 10-12 year headstart over the doctor when comes to earning the income. This is applicable to many educated folks who spends a lot of time studying prior to entering the workforce.

2. Doctor has to live a 'high class' lifestyle. The profession of the doctor calls for a high class style of life. Since they are exposed to people all the time and are being judged regularly, the pressure to live up to your income is high in case of a doctor. They live in high end localities, wears expensive dresses, drives expensive cars all of which eats into their income leaving little as savings

3. Doctors have bad investment habits. They do not spend enough time on understanding wealth creation, do no learn about investing, are not consistent in investing and finally, tend to choose bad investment consultants and lawyers. 

The book is not about doctors, it is about millionaires. It is about how to become one. It is about the behavioural traits of wealthy people. The book is about what to do and what not to do to become wealthy. 

'Frugal' is a word that you see a lot in this book. The wealthy people are frugal. They live in inexpensive neighbourhood, stay in a 3 bedroom apartment for the last 20 years, most of them are self-employed (Two thirds of them), most have been married to and living with the same woman for over 20 years, they are very good at financial planning and their wives are better at financial management than they themselves are.

And they are frugal. They have conservative tastes, drives second hand cars and their spending on dress is only 33% of their more ostentatious neighbours.

The first question that the authors try to answer is 'What is Wealthy'? How do you define wealth?. The authors maintain that your wealth, which includes all your assets (House, Investments) less all your liabilities (Mortgage, Credit Card Debt) should be at least equal to your annual income multiplied by your age divided by 10. 

A person earning Rs.20 Lakhs per year and aged 40 years should have a wealth (also called 'Net Worth') of 20 Lakhs X 40 / 10 = 80 Lakhs. The authors call those who have wealth above this value as 'Prodigious Accumulators of Wealth (PAW) and those who have wealth below this as 'Under Accumulators of Wealth (UAW)'. What do you call those whose wealth is around this number? 

They are called 'Average Accumulators of Wealth (AAW)'

Authors argue that PAW share different behavioral traits from UAWs. We mentioned some of them above. In addition to the above, one fundamental difference between PAWs and UAWs lies in the nature of their income. Authors divide the income into two types. One is the unrealized income. These are incomes which keep accumulating but are not realized by the investor. These are in the nature of incomes which are due to appreciation in the value of their investments including investments in Stocks and Bonds. The characteristic of unrealized income is that since the income is not realized, you don't have to pay tax on the income. 

The other type of income is the realized income. This is the the income that you earn and which is credited in your bank account. Income from Salary is a good example. The moment the income is realized, it becomes eligible to be taxed at the personal income tax rate which in most countries is about 30%. 

Your total income is your realized income plus your unrealized income. 

Authors point out that PAWs usually pay between 2 to 3% of their wealth as income tax whereas a UAW will pay anywhere between 8-15% of their wealth as taxes in a year. That is because most of the income for a PAW is 'Unrealized' while that for a UAW is more 'Realized' in nature. 

Authors use an earthy Texan phrase for a person who looks and acts rich as 'All hat no cattle'. 

Other than being frugal, what else do PAWs do right? According to the authors these are the seven habits of wealthy individuals.

1. They live well below their means
2. They allocate their time, money and energy efficiently, in ways conducive to building wealth
3. They believe that financial independence is more important than displaying high social status
4. Their parents did not provide Economic Outpatient Care
5. Their adult children are economically self sufficient. 
6. They are proficient in targeting market opportunities
7. They choose the right occupation.

The wealthy people are very good at planning and budgeting. They have a clear idea of how much in a year they spent in Food, Clothing, entertainment etc. They also have clear financial goals and plans to meet those goals. 

In addition they spend a lot of time (Almost double that of the time spend by UAWs) in identifying the right professionals who can help them to generate unrealized income. They choose their lawyers and investment advisers very carefully. They own their investment decisions. They are consistent with their investments unlike the UAWs who are very inconsistent with their investment decisions. PAWs have investment plans and do not renege on their plans under any circumstance. UAWs invest in fits and starts. They are the targets of unscrupulous investment advisers. 

The average annual realized income of a wealthy person is about 6.7 percent of their wealth and they pay a tax of less than 2 percent of their wealth.

One interesting concept that the authors bring out is that of 'Economic Outpatient Care'. This is the phenomena where the adult children of UAWs are themselves UAWs and despite reaching their earning age, are still dependent on the support provided by their parents. Authors point out that since the behaviour of UAWs are responsible for their status as UAW, their children tend to inculcate their spending behaviour and themselves become UAWs.

Sometimes the opposite can happen. The book provides the example of a gentleman who grew up very poor. He was motivated to overcome his impoverished circumstances and studied very hard and reached a very successful position earning annual income in six figures. However, he was hellbent on trying to become 'Better Off' than when he was a child. He has a fleet of value depreciating assets. 

PAWs are also good at taking calculated risks. Where they see opportunities, they will invest in those opportunities. When it comes to UAWs they ignore opportunities. The authors discuss the case of multiple UAWs who despite working in blue chip companies like Microsoft or Walmart, do not own a single share of the company.

After reading this review you may wonder if you have it in you to become wealthy. The authors want you to answer the following four questions.

1. Does your household operate on an annual budget?
2. Do you know how much your family spends each year on food, clothing and shelter?
3. Do you have a clearly defined set of daily, weekly, monthly, yearly and long-term goals?
4. Do you spend a lot of time planning your financial future?

If your answer to the above questions is 'Yes' or 'Mostly Yes', then you are one of the lucky few to have what it takes to generate wealth.

Part of the book is tedious. For example, the authors spend considerable time on how much time UAWs spend on purchasing a car. Another complaint is that many of the points discussed in the book are not applicable to young people. Mind you, young people will benefit a lot by reading this book. The habits expostulated in this book are universal and are not age specific. But to expect a young person, barely into their working career to have a net worth calculated by the formula?

I mean, come on !

There is one area where I want to caution the readers. It is mentioned that wealthy takes calculated risks. This is an advice that I am very much worried about. The question is which came first, the wealth or the risk taking. One can say that wealthy can afford to take risks BECAUSE they are wealthy. In my opinion, by following a consistent savings and investment habit, one can build a very comfortable nest egg without taking too many risks. 

The authors have one advice for the youngsters who are at the beginning of their working life. "Start Investing Early". Perhaps, the same advice, removing the word 'Early' is applicable to all of us.