CV1-I2-13- INVESTMENTS-Investors’ opportunities & threats in India

Clear policy vision of government, rising Indian equity markets, declining inflation and interest rates, tax reforms, black money crackdown, rising infrastructure budgets and lot many other factors are clearly sending one and the very strong message that India is passing through the strong economic growth phase.  The phase which once passed by Japan after second world war upto cold war era and China during post-cold war era to almost near present.  Discussing, reading and listening to news items and facts reflecting fast economic growth provides lots of positivity and confidence among citizens of country.  At investor level, understanding economic growth is much more than updating with economic news and beating drums of the same in social and corporate circles. Investors along with rising positivity and confidence levels, need to take more practical approach and understand the how economic growth would leave opportunities and threats for them.

Economic pattern shifts normally works like seesaw, when one side is up there being consequent downside impact on other side.  So, whether economic growth has some downside to it? Sounds weird? Isn’t it? But yes, it has some downside impact which investors, if they remain unprepared for this major economic shift in process, they may find themselves in unimaginable soup of struggling during their retired life in a developed country.  There is an imperative need to understand the impact on your investment pattern when economy is shifting from developing stage to developed stage.  Investors, sticking to old mindset towards investment may lose the fruits of economic growth.

Majority of Indian investors in rural areas still unable to disassociate their mind from cemented view of “double in 5 years”.   Completely cut off from the fact that money doubles in 5 years at compounded annual growth rate (CAGR) of 15.78%, an era Indian economy has left behind almost three decades before.   There is other set of investors in semi-urban or even urban areas, with cemented view of “guaranteed returns of 8-9% in PPF/small savings schemes”.   Again, not updated with the fact that Indian interest rates are now almost floating in case of PPF and even on small savings products, with government regularly revising the interest rates which is more aligned with G-Sec rate.  Indian economy is fast approaching towards low interest regime and faster development, the fact and its consequences are still undervalued by investor community.  Shift in economic pattern requires the requisite changes in investment pattern as well, to reap the fruits of economic development and upgrading standard of living with the pace with economic development.

To understand an impact of shift in interest rates during fast growth phases of other economies, let us see how interest rates have moved during the strong economic growth phase of various economies.  Post-world war II, US has emerged as the most powerful economy in the world, its interest rates has moved from 20% to 0% in a time span of 30 years (1980-2009).  Another powerful economy, which emerged post-world war II, is Japan.  Japan’s interest rate has witnessed journey from 9% to 0% during 1973-2000.  During the economic boom phase of China, which started in late seventies/early eighties, has witnessed fall in interest rate from 11% to 4% (1976-2016).  There is little doubt left even in the mind of poor economist that India is poised to huge economic growth and probably can play the role of engine for world economy in a time to come.  It is already a fastest growing economy in the world.  When it comes to interest rate movement, India has witnessed fall in the rate of interest from 19% in 1991 to 6-7% in 2017.

To understand how falling interest rates can create mess with your retirement goals, consider an example of a working executive, who has a plan to build retirement fund of Rs. 4.5 Crore.  Goal is based on expectation that corpus of Rs.4.5 Crores at the rate of 8% annual returns would provide monthly income of Rs.3 Lac (for upper middle-class family with present monthly expenses of Rs. 72,000/- with annual rise of 10% per annum due to inflation/enhanced standard of living, after 15 years).  Reduction in interest rate to say 3% in 10 years’ time, would result in his fund of Rs.4.5 Crore generating monthly income of

It is obvious from above that one need to build more retirement fund to generate the same required income at reduced interest rate.  Table II below shows the requirement of additional retirement fund for every fall in interest rate.

During high interest rate economy, taking risk was an option.   However, when economy is shifting towards low interest rate, taking risk is no more an option but probably a compulsion to achieve long term financial goals.  It is therefore necessary to shift investment pattern more towards equity or equity related instruments like equity oriented mutual funds.  Novice investors those who feel equity investment very risky need to understand that majority of the risk associated with equity gets reduced in booming economy itself.   Growth in economy results in higher corporate profits which in turn leads to higher stock market levels.  To begin with investors can chose regular investment through equity portfolio like mutual funds systematic investment plan (SIP).

SIP is probably the only investment tool which comes with maximum flexibility in its features and its benefits are enormous viz;

• Investors can decide their risk appetite and start SIP in appropriate fund with required level of risk like equity, debt or balanced funds.
• Investors reduce unsystematic risk through diversification, as mutual fund itself is a diversified portfolio
• Regular investment is not only a disciplined way to build net worth, it also helps investor to mitigate risk by entering in market at average rate in a long run
• SIP comes with in-build risk management system of rupee cost averaging.

Rupee Cost Averaging

For an example in the following table, an amount of Rs. 5,000 is invested through SIP in equity oriented mutual fund, for a period of just 8 months.   Units are allotted based on NAV (Net Asset Value) of the fund which keeps on changing based on market volatility.   It can be observed that from an investment of Rs. 40,000 (5000 X 8), the total number of units allotted are at various NAV levels ranging from high of Rs.13.20/Unit to the lowest of Rs.9/unit.  While the average of NAV for eight months stand at 11 at which investor should have got

Other way to look at this is to compute the average cost of units which as per NAV average works out at Rs.11/units, however based on actual allotment works out at Rs.10.79 (Rs.40000/3705.745 Units).

This happens as investor is buying more number of units when market is low and less number of units when market is high, which results in average cost of acquisition at lower levels all the time.  The more and more time SIP is on, investment cost will keep on going down as the process of accumulating more number of units at lower rate will go on.

In a nutshell, appropriate shift in investment pattern based on changing economic pattern can help investors not only to achieve their financial goals in appropriate manner but also helps them to enjoy the benefits of economic growth of nation.

Investors should always update themselves with latest SEBI guidelines before investment in securities and understand the risk associated with investment pattern.

Rajesh Ramchandani

Prof Rajesh Ramchandani is Cost Accountant, Investment & Tax Consultant and analyst in for Equity & Derivatives markets.  He is National Institute of Securities Markets (NISM) and NSE certified professional. His areas of interest and research are Mutual Funds, Capital Markets and Derivatives. Currently he is faculty at ITM-SIA Business School.