Financial literacy series

Why?

I would like to start with a story that motivated me to write this blog post. I have a colleague who trades stocks and we had conversations about a share where he was making substantial losses. Based on that I presumed that he would be a financially literate person and at least he would know the basics of investing. Fair assumption, isn't it? However I was astonished when one day he mentioned that he doesn't know things as basic as SIPs into MFs. And guess what? He is not alone. I come across questions like following all the time:

• "I don't understand how should I fill up my tax declaration"
• "Should I opt for EPF, PPF or 5 years FD for tax saving?"
• "What is tax return? Why should I fill it up every year when my company already deduct taxes?"
• "Oh...I can file my tax returns in 10 minutes for free!!! Then why was I running around those help-desks and CA's all these years?"
• "This is tax proof submission time and I need to find some agent who can help me buy some LICs or ULIPs"
• "I don't have time to understand financial matters. The information available about this is too much (or too complex) and I have no time to get into any of it"
• "Finance is too complex for me to understand and I do whatever my father or a relatives or a friend or some adviser tells me to do" 

Do they sound familiar? Does it worth it to be financially literate  given that so much help is readily available from relative/friends/advisers? 

It does. Please read on to understand why.

Why does it matter?

Again let me take a very simple example. Two friends started their careers in 1998 and today they compared their tax saving portfolios. My friend A didn't know much about investing and his LIC agent uncle convinced him to buy a policy worth 15 lakh for 15 years with yearly premium of about Rs 25000/quarter for tax saving purpose. At the end of 15 years he got the sum assured 15 lakh along with a handsome bonus of worth about Rs 11 lakh. In addition, every year he saved tax of worth Rs 30000/-. Hence overall he received or saved Rs 31 lakh at the end of 15 years and he is very happy. That's why his father was trusting that LIC agent uncle for all these years and everybody is quite happy with this decision.

Now being financially literate B was far more careful, he chose to invest in tax saving equity mutual funds or ELSS through SIP (systematic investment plan, i.e. money is invested every month automatically). He chose a popular fund called "HDFC tax saver" and he started investing Rs 8300/- every month for all those same 15 years. Guess how much he had at the end of 15 years? A whopping sum of  about Rs 1.1 crore excluding Rs 30000/- that he saved on taxes every year. Do I have any proof about example of B? Yes, here you go: http://tinyurl.com/q748qqj

But wait a minute, isn't equity risky?

We hear all the time that "Mutual fund investments are subject to market risk. Read all scheme related documents carefully before investing". If things are that hunky-dory, why do they say that?

Yes, I admit equity investments are quite risky. In fact even in the same fund, if B had invested Rs 1 lakh when market was about to collapse in 2008-09 recession on January 1st 2008, he would had ended up with only Rs 40000 in March 2009 when market was at rock bottom!!

"What? Man, you give dangerous advice. Good that I read on so far. Now I understand what they mean when they say equity is risky".

But wait. Is the story really over? Or is there more? Please read on.

Being a sophisticated investor, why would B invest all that sum in one shot at the peak of market? Also why would he pull out all that sum within little more than a year when the market is at rock bottom?

If he decides to wait only for one more year and a half, he would have had about Rs 1.25 Lakh. By the way, tax saving mutual funds have lockin period of 3 years so he wouldn't be allowed to pull money out that early.

But B, being a financially literate, would choose the same strategy of doing SIP of 8300/- per month starting from same January 2008 when worst time started. He would not be deterred by ups and downs of the market and would continue investing no matter what. Let's see where would he be today. Keep in mind that when he started the market was collapsing and so far these have been one of the worst 5 years of Indian stock markets in terms of returns. Still my friend B would end up with Rs 8 lakh for the investment of about Rs 6 lakh in November 2013. Still impressive , isn't it? Adding Rs 1.5 lakh as saved tax over the same period makes it even better at about Rs 9.5 lakhs. 

The name of the game is long term and Rupee cost averaging my friend.   

Again, why this blog?

Though already there is a lot of information available and more & more is being generated every day, why am I still doing it?

Yes, true. There is indeed a lot of information available. Much of it is quite precise and helpful. But still, why do I encounter those above mentioned questions all the time?

In my opinion, like in case of A, every ULIP or LIC bought just for tax saving  is probably a big opportunity lost. May be my dear LIC agent uncle doesn't have any bad intentions but it's just that he is too old fashioned. Also our parents didn't have all these resources and internet at disposal hence they can't be blamed too. However school/college education is to be blamed as it fails to teach financial literacy to everybody. 

All of us work very hard to make money. But after working for those many years, how much wealth could you preserve? Are you satisfied with that amount? If no, then why not let's all become financially literate so that we are not at the mercy of others to preserve and grow that hard earned money.

I want everybody around me, even those who are far away but connected through my social network, to be financially literate. That's why I am writing it. Any takers?

Please stay tuned for more articles on tax planning, return filing, insurance , investment, financial planning & financial literacy in the weeks and months to come.  Needless to say, I would try to keep them short, sweet and simple to follow.