It’s about money, honey

So when I came back to India in late 2006, I had friends going, what the hell is wrong with you, you mean you have no investments? Not one? Not even now, when the stock market is booming and people are becoming mega-rich overnight?

My stock answer was, I don’t understand stocks and shares.

And the response invariably was, you don’t need to. Find a good advisor, tell him what you are looking to do and leave it to him to manage things for you. So I did all of that. Slept my way through several discussions, signed a lot of paper and a lot of checques, and began planning my rise to millionaire status, and my retirement, in quick succession.

And then the market tanked.

Two years and a bit later, it had still not reached the levels it was at when I invested in it. So, when I was planning to shift lock, stock and wife to Bangalore, I decided I might as well sell out and keep the money liquid, to fund house-renting and related expenses. Needless to say, the upshot of two years of investing is that I lost a few lakh of my hard-earned money.

And I still don’t understand how any of that happened.

Hopefully, enlightenment will come in carefully calibrated doses, going forward — today, Deepak Shenoy debuts his column on Yahoo.

It’s fascinating how the wizards of the financial world can take something simple and make it utterly confusing and intimidating. Take a simple loan: it used to be “I’ll give you money, you’ll pay me back more money”. Today there are processing fees, pre-closure charges and service taxes. Even the “more money”, traditionally known as “interest”, is now suitably prefixed with “flat-rate”, “monthly-reducing”, “floating rate”. They’ll even loan you money against deposits – the mouth-watering proposal of “Let me lend you your own money and charge you interest”. And finally, what you pay back is now an “Equated Monthly Installment”, a complicated mix of interest and principal, which has the magical effect that even after you make diligent payments for 10 years, you still owe the bank the same amount.

Exactly. That is precisely why I continue to live in a rented apartment, resisting all temptation to buy a swish place of my own.

There is a “huh” factor in everything financial. Shying away from it is ineffective, because our lives are intertwined with money more than ever before. We might have earlier trusted the industry to take care of our money; it no longer seems that’s a given. That just means we have to figure things for ourselves. Like a jigsaw puzzle, once you get the key pieces in place, it’s a lot more understandable.

Ah, okay. So I’ll wait for those missing pieces to surface in Deepak’s subsequent columns. And start investing again. And dream of being a millionaire in my own swish apartment.

Or maybe not.


31 thoughts on “It’s about money, honey

  1. I wonder how the extremely rich invest, and more so,the Indians -what do they do with the illgotten money?

  2. Arunaa: Er…Not always? Long term stock prices have gone up 12-18% in the last 18 years (depending on which day of the year you start) In the much longer term, the US has seen about 12% per year appreciation in stocks, though they’d prefer to forget the last decade.

    Counterexamples: Japan has seen -60% – a DROP in the markets – over the last twenty years. The US also saw a 16 year period of nothingness – 1966 to 1982 – when the index started at 1,000, went down to the 700 levels and came back up to 1000.

    Same with real estate. The Indian bust in the 96-99 time frame took about 3 to 5 years to recover. The US, UK and Spanish busts might never see prices at those inflated levels.

  3. In India The prices of land always go up. And many people make properties as an investment.
    I am told that if one does long term investment in stocks, it is always profitable. is that so?

  4. Mahesh, The premise that house prices only went up has been so ingrained that a certain software built to analyze mortgage risk (in the US) did not even allow negative values in an “estimate of house price change” input box.

    India has rental yields of 2-4%. That’s ridiculously low when you get 1 year FDs at 6%; a house is not a great cash flow asset. That’s why prices HAVE to go up for it to make mathematical sense, because then the appreciation makes up for lack of cash flow. Every once in a while the music stops – but since it hasn’t stopped for the last 10-12 years….

    Unfortunately that only works as long as it does. When prices stop appreciating, it starts to build panic and then you get pretty tough RE busts. It has happened even in India, but most of us won’t remember them.

  5. @Deepak in your colums”Buy a house, you might hear; why pay rent? Unless you consider that what you pay the bank as interest is just another form of rent, a much larger figure. The concept only makes mathematical sense if house prices only go up. And they only go up. Right?”
    Singapore and other places-House prices do come down often every few years,I have also seen cases on negative equity on property,In India yes the property prices seem to be shooting sky high all the time,but the cases of fraud and illegal occupancy are also very high.
    In India low rentals compensate for high property prices.In Singapore close to 7 years I enjoyed my owners negative equity,the market value had come down drastically while the rentals were low,and Owners EMi were high because they based on original value.

  6. Prem,

    What passive investors like you need is a no-load low cost mutual fund. I’m not sure what the options are in India but you should look for something that tracks an index (say the sensex).

    Just put away a something into it every month (automatically if possible) and forget about it. I have been doing that for the last 8 years now and I am way up. The power of compounding is really amazing. I’m not going to withdraw that money in the near future and let it lie for the next decade or so. Fire your advisor and just use the mutual fund. Don’t worry too much about dips in the market. I actually prefer to see dips which means I could potentially see larger gains in the future.

    • Heh! The best thing about Deepak’s debut column and my post on it is, I am getting tons of good advice, for free where I once paid for bad advice. 🙂

      Thanks, mate.

  7. So my father learnt about stocks and online trading at 72. Now his worry is that he does not understand options. His portfolio has doubled in 2 yrs. He does day trading and enjoys it. Listens to news, does not indulge in shop talk to gets tips and does his own research. Concept of my money being invested by others does not make sense. But one requires time, patience, conviction and most importantly drive. If he can do it at 72 I think you still have some years on hand.

  8. I believe Deepak went bit overboard with his views on finance especially when he is a finance guy himself. Complexity in finance has happened but that does not mean that the small guy has not benefited from the same.

    True, today we have more options than maybe even necessary, but invention is the mother of necessity. A decade or more back, the only persons who could even dream of owning their own house were some one with a good Govt job or one who had the kind of money that could be put up since loans were tough to get for most guys. Most people had neither and hence did not even dream of owning a house.

    Its now much easier to own (risk is always there, who says there is reward without risk) any thing one aspires. Financial Innovation happened because there seemed to be demand. If every person decides to stop using any financial product (Loans, Credit Card, etc) pushed by the banks, they just simply stop existing. The fact is that they know the human weakness and use it magnificently to enhance their business.

    CDO’s are blamed for much of the problem in the financial system in US, but until the government changed the rules of the game to allow for lending to strata of people (who are now called SubPrime borrowers), risk was very much within limits and the market had not taken off as it did later.

    People in my opinion always look for a scape goat, the complex the better. Hence we have Quants who end of the day (save for guys who are in Flash trading which I believe is wrong) are just traders being blamed for the rise in volatility, rise in commodity prices and anything and everything under the sun.

    • Prashant, thanks for that. My response: we haven’t benefited as much from the “complexity” in finance, more from the easy availability of money. What complexity has done is intimidate us, nothing more – people who understand can use the products better. Earlier a car was a covered private transport vehicle – the Amby was not much different from the Fiat. Today people argue about CRDi and MPFI, SOHC versus DOHC, climate control, ABS, Adjustable steering columns and all that jazz. It’s complex from the perspective of the Amby/Fiat owner; but we learnt and made our own set of informed decisions.

      The fact that we couldn’t get loans earlier – a by-product of bad regulation, high rates, and questionable creditworthiness – is not something that we can justify bad products with. That’s like saying, don’t complain about erratic power supply when in the old days we’d be lucky to get any power. No?

      Complexity is used as a weapon in a world of ultra-low interest rates – a complex brochure can bring the fees one wouldn’t quite dream of compared to other well understood products. I don’t grudge them the fees – but I do get concerned that the people who create the products are far more informed about them than they care to reveal. That information asymmetry – a dangerously long phrase – makes suckers out of intelligent people.

      CDOs aren’t a problem – if people who buy CDOs know what they’re buying and don’t go around trusting the intermediaries. The issue is in how CDOs are regulated – they aren’t, for the most part – and how current rules give a rosier picture of them than reality.

      Quants and traders – I think you have it right there. At least, before we vilify we can know WHY. And in doing so, probably realize they aren’t that big a deal? (Speaking of which, disclosure: I’m a trader. I’ve been a quant)

  9. “shift lock, stock and wife to Bangalore,”

    I hope your wife is not reading this “compliment”!!!

    • Oh, she reads. Very erudite, that woman. 🙂 Mercifully, she has a sense of humor — she had to have something, no, for us to have survived 20 years as a couple?!

  10. E= P x r x (1 + r)n / ((1+r)n -1)

    E= EMI
    P= Principal
    r = rate of interest (divided by 100)
    n = number of years (or months?)

    Am I right?

    • n= number of installments.

      There is an EMI function in MS Excel named PMT. Forget the formula, just use that function.

  11. bad luck Prem. I took each and every tanking of the stock market to buy. and all my investments have been courtesy my own research. thank god, my portfolio is still in the green 🙂

  12. Prem,
    You have got quite an eclectic assemble of columnists for the yahoo opinion makers. It covers a wide spectrum . Perhaps only thing lacking is a columnist on science and may be another one on environment.

  13. I do understand what Deepak is trying to say. That after paying Rs. 11,000 interest on Rs. 350 I actually owed on one credit card I had.

    I’ve washed my hands off everything that banks try to sell. Have been a fool and lost money in various schemes. Now its just a savings account and debit card for me. Wait, lost money once in that too when Bank raised the minimum balance required and “forgot” to inform me and then fined me for their incompetence.

  14. Prem, did you see that advisor again when the market tanked? I hope you did but most of them dont show up when the market goes against their so-called client’s investments.

    • Sure. Not much point, though, when he shrugs and points out that the entire market has crashed so it has nothing to do with his suggested investments. 🙂 It’s not like there is a clause that says he will give the money back, no?

      • No such clauses alright but the real pain point is – most of them don’t know details of the products they are selling AND secondly, they don’t make an effort to understand your goals. Two don’ts aren’t the best way to start off an investment plan 😀

  15. I came across this story of an IIM graduate asking a fisherman why he wasn’t trying to grow his business. The biz-wiz gave him a number of options which led to the fisherman living a happy life once he was old enough to retire, and the fisherman just said he was already living that life and had age on his side to make the most of what he had at his disposal.

  16. “”Equated Monthly Installment”, a complicated mix of interest and principal, which has the magical effect that even after you make diligent payments for 10 years, you still owe the bank the same amount.”
    Maybe Deepak’s column is just an introductory piece, but I would like him to explain the above statement in his forthcoming column. There is just no freakin’ way that after you pay 10 years of EMI you will still owe the bank the same amount.

      • I think Deepak went overboard with that sentence in the excitement to trash the bankers..-) To my eyes at least, EMI is a simple thing- you take the principal, apply the interest rate over the period of years and divide by number of months.

        But I agree to the larger idea of the column- people have complicated things so much that common man doesnt have a damn clue about what is going on. Oh wait- they complicated things so much in Wallstreet that even the executives in Lehman brothers and AIG didnt know what was going on. 🙂

        • Jazzy,
          I don’t think it is as simple as that. I don’t know the exact calculation. But, from the 2 loans that I have, I can guarantee it is much more complicated than that.

          • It is simple:

            E= P x r x (1 + r)n / ((1+r)n -1)

            What this formula does is: Suppose you take loan for 10L. If you pay only the interest each month, the principal amount never comes down, it remains in 10L. Hence, you pay some additional amount each month so that the entire principal amount reduces to zero at the end of the loan period. The formula calculates an amount (interest on the principal + payment towards principal) which will be equal for all the installments of the loan. Lets say that for the 10L loan, the EMI is 10K. This 10K may be 7K(interest) + 3K(principal). Once you pay EMI for the first month, your principal comes down to 10L-3K. The second month’s EMI of 10K will be a split like 6.9K + 3.1K. After paying the second month’s EMI, the principal comes down to 10L-3K-3.1K. This process continues till the principal becomes the big Zero.

          • Actually, the complication is not in the EMI, but the way it is implemented by the bankers. There is the concept of penalty for pre-closure. If I want to pay my loan before the timeperiod, the bank is telling me that “No boss, you cant do that, you keep on giving us the interest for the next 10 years, otherwise you give us some extra money.” WTF!

      • @IPLWatcher: It’s a bit exaggerated, but I think it is possible, that if all you do when you make payments is to eat into the interest, that you never get down to paying off the principal of the loan. What Deepak means when he says you owe the ‘same amount’ is the principal is left untouched.

    • That was intended to be an exaggeration 🙂 Still, it’s possible that you end up owing a lot more than you think you do. When you take on floating rate loans and interest rates go up, banks generally decide they’ll stretch the tenure of the loan to meet the higher interest payments. Meaning, most of your EMI is just interest. In some very strange cases – it’s happened in the US and called “negative amortization loans” – the EMI is not enough to even cover interest, and the principal actually goes UP every month. (But there’s usually increasing payments after a while, just to make up)

      Okay, 10 years was an exaggeration!

      EMI as JazzyB says below is fairly simple – there’s a complicated Math formula, but it really is like this: From your principal, I first calculate the interest amount you get to pay THIS month. Then anything paid above this reduces your principal. Work this formula for equal monthly amounts so that your principal becomes zero over the 20 year period (or whatever) you take the loan for.

      And yes, pre-closure penalties add to the cost – so one does get surprised when hit by this when trying to close a loan early.

      Prem, I hope you get that swanky house soon! I just hope I don’t sound too cynical – there is method in the madness, but there’s altogether too much madness.

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