The Best of it All: investing

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Monday, February 18, 2008

US NRI Investment Guide - Part 4 - Real estate

Disclaimer: I am not an expert or even a seasoned investor in the stock market – I am just an interested layman trying to apply some common sense to the market to sustain the value of my assets. Hence, none of this is intended to be investment advice and I do not take responsibility for any consequences that may arise by investing based on this post. Feel free to use or ignore any thoughts proposed here at your own discretion. Thanks.

An NRI can invest in homes or land in the USA, and also in the same in India. Investing in real estate in the USA is more transparent and secure, but is currently under what might be the beginning of a long downturn, where people may not be able to get mortgages approved for at least the next few years. However, once the real estate market bottoms out, it may make sense to buy into US real estate as well. The US also provides investment in real estate through REITs in the form of ETFs – these are simply traded on the exchange and avoid the logistical overhead of buying or selling land directly. Consider for instance, RWX (international REIT ETF) and VNQ (US REIT ETF). However, for the same reasons listed above, this may not be the best time to buy into real estate in any form.

Real estate in India, on the other hand, is a more complex beast, which we will discuss next.
First off, the real estate scenario in India is fraught with legal and bureaucratic risk. Many stories are told of lands that have been sold simultaneously to multiple parties. What documentation is needed for clear transfer of a piece of property to another person is not a universally accepted norm in, for instance, Bangalore, India. Some buyers are satisfied with just a GPA (general power of attorney) transfer, whereas others are particular about all the documents being clearly available. Some legal documents are not being released by the government due to various reasons, and hence the risk associated with purchase of land is higher today in many cases.

Clear land with clear title documents in a reasonably developed location is now exorbitantly overvalued, and the upside potential of such land in most tier I cities in India is suspect.
However, the rewards of buying land in India have been tremendous. Most people who bought land in a then suburban area of a major city in the 90s or early 2000s, and held onto it till date, are enjoying returns that can only be described as astronomical. For example, one piece of land close to the center of the city has grown around 8 to 9 times in a period of about 4 years.
Also note that an NRI is allowed to invest in most real estate, but not in some kinds such as farmlands. (See http://www.rbi.org.in/scripts/FAQView.aspx?Id=52 )

I have listed below a general process for benefiting from real estate investment in India (I have avoided discussion of commercial real estate since I do not know much about it – all these recommendations are related to residential real estate):

1. Focus on city suburbs (land sold in grounds – one ground is 2400 square feet) or rural land (land sold in acres – one acre is 43560 square feet).

2. While purchasing city suburbs, focus on buying land that is less than 500 rupees per square foot. This is because land in most cases plateaus out somewhere in the range of 5000 to 10000 rupees per sq ft. The lesser the price the higher the theoretical potential for growth. As long as the area is growing, or has a reason for growth, the percentage growth of a property worth 500 rupees per sq ft is likely to be higher than the percentage growth of a property worth 5000 rupees per sq ft.

3. An exception may be made to the last rule in case of unusual demand. For instance, you may buy land worth 1000 rupees per sq ft if available in, say, a distress sale, in a more central area of the city that has huge upside potential (which may be measured by close by properties being sold for say, five times that value).

4. While buying rural land, make sure that the land is already converted – conversion is a process where the government has converted formally agricultural land into land that can be used for residential purposes. Conversion is a process that has a lot of risks associated, so, avoid any land that has conversion under process.

5. Avoid agricultural land and farm houses. NRIs are not allowed to purchase such properties in most cases, and they need to be converted to be saleable as residential properties.

6. Avoid buying apartments as an investment – apartments, especially in tier one cities, cost way more than they can get in returns, and the upside potential is also stunted by the fact that the supply of apartments is, in general, increasing by the day. For every apartment complex that is completed, there are at least three or four new ones being built in the neighborhood (in most developing areas). Also, the growth in value of investment in an apartment is automatically slower than the growth of the investment in land – since the cost of construction material does not go up as rapidly as the underlying land.

7. Avoid buying homes as an investment – homes in most developing areas are likely, over time, to be replaced by apartments. Also, in most cases, the land is the appreciating part – the value of materials, etc. increases more gently than the value of the land.

8. Buy land that can be protected from encroachment – encroachment, or illegal occupation of land is a common problem in India – hence, if you are buying land, be sure to fence it, and if possible, have someone you trust watch over the land periodically.

9. Buy land that is recommended by someone you know and trust personally – this is critical for most land dealings in India, as there are several land based scams – people selling land that they do not own, people selling the same land to multiple people, people selling land that has a lien on it, people selling land that has a legal dispute over it, are all cases that have become commonplace.

10. Do not buy land that is too close to a developing government project such as a new highway, or a road widening project, etc. – recalculation of the dimensions could lead to your land being taken over by the government.

11. Preferably buy land (especially city land) that has some construction nearby – this reduces the chance of the land being grabbed by miscreants, or used by government or other projects.

12. Check the price of the land from neighboring sources – before buying any land, ask neighbors or people in the area, what the land in the area is worth – sometimes the easiest scams are where the land is worth a lot less than what you pay, since the prices change very frequently.

13. Always verify all documents associated with the land – have a lawyer, preferably from the same state or region (since laws vary by state in terms of what documentation is needed, etc.) look at the documents and certify that it is in order.

Disclaimer: I am not an expert or even a seasoned investor in the stock market – I am just an interested layman trying to apply some common sense to the market to sustain the value of my assets. Hence, none of this is intended to be investment advice and I do not take responsibility for any consequences that may arise by investing based on this post. Feel free to use or ignore any thoughts proposed here at your own discretion. Thanks.

US NRI Investment guide - part 3 - Debt

Debt is the safest form of investment short of securing your money as cash in an environment proof and heavily guarded fortress. The most secure form of debt instrument is in government backed instruments, such as treasury bonds in the US. However, the returns of such instruments is very low, and barely covers inflation in the US or in India. The minimum amount required to invest directly in such instruments is usually very high for an average retail investor, and so, most people invest in such instruments indirectly, through mutual funds.

Another similar debt investment is bank deposits, which provide similar yields. Such deposits are generally insured by the FDIC upto some limit in the US (usually 100000 USD), but arent generally insured in India. You can find options for bank deposits in the US at http://www.bankrate.com/brm/rate/deposits_home.asp and in India at http://www.ratekhoj.com/fixeddeposit/index.php . Note that the best NRI deposit rates in India are usually in the one year term.

Corporate deposits in India are riskier, but yield slightly higher returns. Again, speaking in general, the risk involved in corporate deposits is usually not worth the associate return potential. I would rather invest in equity if I want more returns, or in bank deposits if I want to minimize risk. Other instruments, such as income or debt based mutual funds are also available in both countries. The US also has exchange traded debt funds, such as BND.

Some guidelines for investing in debt instruments for a US NRI:

1. India provides better returns overall in debt instruments than the US – Indian returns are to the order of 9% per annum, which is much higher than the US returns (of 3.5%) at this time (Feb 2008).

2. Park US money in a money market fund in the US for the best returns: for instance, Fidelity municipal money market funds gave 1 year returns of 3.29% and lifetime annual returns of 3.76% (see http://content.members.fidelity.com/mfl/summary/0,,316048107,00.html ) – since this income is tax free, it beats most US bank deposits – which return about 3.5% (see http://www.bankrate.com/brm/rate/deposits_home.asp ). There are also savings deposits such as those from ING Direct and HSBC, but they also invite tax, and hence do not match the returns of the money market funds. They have an advantage of further liquidity, since money can be removed from it at any time, as opposed to a bank deposit, which has a term.

3. In India, divide the debt portion of your portfolio between NRI Fixed Deposits and fund based instruments - FMPs and quarterly debt interval funds.

a. NRI FDs yield much higher rates in non-repatriable FDs (NRO FDs) than repatriable FDs.

b. FMPs or Fixed Maturity Plans are like debt mutual funds, and they provide the benefit of not being taxable (if held for a minimum period of one year). However, FMPs have gone out of favor among asset management companies after the cost of starting an FMP was increased fourfold (see http://sify.com/finance/fullstory.php?id=14535046 ). A better choice today may be quarterly debt interval funds (QDEFs). Both FMPs and QDEFs have very low expenses as they invest in other debt instruments.

c. Quarterly debt interval funds are mutual funds that in general have a high exit load (i.e, the amount you have to pay if you withdraw), but every quarter, they give the choice to withdraw at no load. This provides a good degree of liquidity, and the benefits of mutual funds – no tax, etc.

The preferred mode for investing in India is in quarterly debt interval funds – though they are slightly riskier than bank NRI FDs (they do not guarantee a fixed return), they provide tax benefits, and also usually provide slightly better interest rates than a bank FD of the same term. In the US, park your debt portion of the portfolio in a money market fund, and maybe a portion in a high yield e-savings account for diversification. Another portion can be put into an inflation protection fund or ETF (such as TIP) which may protect against the event of hyperinflation in the case of a US recession.

Disclaimer: I am not an expert or even a seasoned investor in the stock market – I am just an interested layman trying to apply some common sense to the market to sustain the value of my assets. Hence, none of this is intended to be investment advice and I do not take responsibility for any consequences that may arise by investing based on this post. Feel free to use or ignore any thoughts proposed here at your own discretion. Thanks.

US NRI Investment Guide - Part 2 - Investment Avenues

There are several investment avenues available to the US NRI investor. The choice of which items to invest in, and in what proportion, is driven by a combination of the risk-reward nature of each security, the individual’s understanding of the security, and the risk profile of the individual. For instance, based on my understanding of investment options, the following securities are the only ones I am considering at the current time: debt, real estate, equity, gold and international currencies. Of these, debt, real estate and equity are the growth/sustenance portion, while gold and currency are used to hedge against inflation and currency devaluation risks.

There are other avenues such as commodities, art, franchises, etc. which we will not discuss here at this time.

In general, the safer (less riskier) the security, the lower the potential of returns, and the higher the predictability of returns. Hence, an ideal portfolio will ideally consist of a mix of low risk, low reward securities and higher risk, higher potential return securities. For example, a sample mix in today’s scenario could be 20-50% in debt, 20-50% in equity, 2-5% in gold, 20-50% in land in India and 2-5% in international currencies. What actual percentage you choose would be based on your appetite for risk, and the risk associated with each security.

Saturday, February 16, 2008

>13% of US households will owe more mortgage than their house is worth

"As for the sub-prime crisis, it is estimated that by the end of this year, 15 million U.S. households could be 'upside down' on their mortgages."

That's over 13% of all US households!

Read entire article here.

Tuesday, February 12, 2008

US NRI investment guide - part 1 - background

Monday, February 4, 2008

Seven principles - mostly about investment

The following 7 principles summarize my personal strategy to address a recent question that I came by: How do you keep a cool head in a hot market?

1. 1. Don’t panic

As stated on the cover of the Hitchhiker’s guide to the galaxy, don’t panic. If you see reason to panic at some point in the market, then your past investment strategies are more than likely flawed.

Another important aspect of this principle, is stated by several great investment gurus over the years (Sit tight and be right – principle of Jesse Livermore, a famous speculator from around 1900, to Bogle, Warren Buffett and other contemporary leaders – who prove that inaction is the best strategy to maximize the power of compounding).

2. 2. Be right, not successful

This is the essence of the bhagavad gita’s most famous quote(karmanyevaadhikaaraste…), and also the essence of many a strategy and investment article. Convince yourself of the right approach to tackle any problem, and follow it. Good results by bad strategy are just pure luck, and can be wiped out in your next attempt. Bad results by good strategy do not require a change of course. As long as your strategy is based on principles you have validated for yourself, you only need to test and see if the principles are changed by any of the new data you have in hand. If you are right, then success will eventually find you.

3. 3. Fish with a line and hook, not a net

When you fish with a line and hook, you know upfront exactly what you are looking for, and choose the precise spot, the precise kind of fish you want, and most importantly return with a few selective catches of your liking. On the other hand, fishing with a net, generally takes anything that falls into your net, and you land up taking a few good catches, along with a lot of mediocre and even outright bad catches.

Information today is like a sea – and unfortunately, most people fish with a net, in the form of surfing on the tv, or on the net, or listening to so called experts, or just plain chatting with people they know , hoping for the next big investment formula. The few anglers, who use the line and hook approach, ignore all the media buzz altogether. They start out with a specific question: what is the past performance of this stock? Who is the manager of this fund, and what is his past track record? And then they use the different media (and not the other way around) to find an answer. The media will sensationalize a soap bubble into the phenomenon of the century. Don’t let the media drive you – you go and pick what you want, and get out when you got what you were looking for.

4. 4. Squint hard

John Bogle, founder and ex-head of Vanguard, and a prominent investment thinker, shows, in his recent book – The little book of common sense investing, that if you look at the average annual stock market returns over the last century, you may land up noticing for instance the market crash of the 1930s. But if you hold the chart a distance away, and squint at it, you will see a more or less clear trend, upward, in this case. Squinting at the information from a distance is a good general strategy to follow. Anything that is a short term trend, or a short term activity will be evened out, and only the larger picture, which is what a good investor should focus on, will emerge. In current terms, all the panic, chaos and confusion around where each market, currency, etc. is headed will be something for us to laugh at twenty years from now.

5. 5. Do what you know

Invest in what you understand – be it the sector, the kind of security, the geography, or any other parameter. Do not invest in Timbuktoo just because 'they' say that it is booming. Some principles that relate to this include:

- Warren Buffett’s – invest as much as you can in a security you have identified. If you are not willing to invest all the money you have, then it only means that you do not understand the security well enough. Learn more about it.

- Bogle, Buffett and others – invest once and hold forever. Do not sell, unless data emerges that counters your premises.

- Lynch’s mall technique – walk around a shopping mall, and invest in the companies of products that you love to buy and people seem to be buying faster than they can be restocked – it means there is something in that business. Of course, learn about it before deciding, but that gives a good starting point.

- Fisher’s scuttlebutt - In ‘Common Stocks and Uncommon Profits’, Philip Fisher mentions a simple principle which he called ‘scuttlebutt’ – to analyze all you can about a security before investing in it.

6. If you love a rule, drop it

If you hear of a rule through the vine, that everyone says is guaranteed to give you millions, then in most cases, you can safely drop it. Unless you are an ‘insider’ with early access to such insights, chances are a lot of people have heard of it, and the market has already factored that formula in pricing the associated securities. This is also known as the efficient market hypothesis, which, in spite of all the controversy around it, makes sense. The only principles that are worth adopting are the ones that transcend any microlevel formula or strategy – (such as, Don’t panic.

7. Diversify

This is the most specific principle that I have and I will elaborate on it quite a bit. It means just that – diversify. Anything that tries to predict Mr Market is doomed to be speculative, and cannot return yields with any predictable certainty, over the long run.

As described in Ben Graham’s Intelligent Investor, how you build your investment strategy depends on how much time and effort you can invest in it. If you are a full time investor, then you would probably invest in good businesses as they become available at good discounts and hold them for life.

If you are a part time investor, then you need to set your portfolio on autopilot. The best way to do this, as per Graham’s ‘defensive investment’ extended by Bogle’s ideas, is to have a diversified portfolio, with minimum churn. Bogle however, is still for the most part biased in his views towards the US market. However, today’s global climate affords further opportunities for diversification.

There is a sum total of money in the market: People will move money between a set of things. When they are skeptical about the stock markets, they will put their money in gold. When they are skeptical about the US economy, they will invest in India, or Brazil, or China. And each of these classes tends to increase its intrinsic value over time.

So, the ideal safe strategy diversifies across all these instruments. Start with a distribution across all the asset classes that you can think of – stocks, bonds, gold, India, brazil, US, China, real estate. You could base the distribution on a simple equitable distribution, or a higher percentage in mature markets, or if you have a lesser appetite for risk, you may want to invest a higher percentage in stable income based securities.

Now apply small corrections to skew it in favor of your own speculative predictions. If you believe as I do, that there is a high chance of the US market going into recession, reduce the percentage in the US market. If you believe that gold is going to continue its upward spiral, then put a higher percentage in it. If you feel that the dollar will continue to drop relative to the Indian rupee, increase the percentage of investments in India to the percentage in the US. However, retain a lower threshold of investment in all the different asset classes, and make sure you never drop below that.

Once this is done, identify securities within those asset classes, and further diversify within those asset classes, but be sure to invest a good percentage in the asset class as a whole. By investing in the asset class as a whole, I mean to invest, ideally, in an index fund (or even better, an ETF) for the entire class, from a reputed fund company, with a low expense ratio. Unfortunately, index funds are not as available in India – in that case, invest in well managed funds with reputed managers with a good track record, in those sectors.

For instance, indian stocks can further be divided by sector – make sure to invest a significant portion in a Sensex and a Nifty index fund , and a smaller amount on each individual sector (after all, sector investment is, at the end of the day, speculative, and subject to market volatility more than the broad asset class as a whole).

Once you have identified the securities, and invested in them, track the news to see if there are any major influencing changes, especially in the more volatile and less understood aspects of your portfolio. For instance, I did not understand the Canadian market initially, but saw rapid gains in it when I initially invested there – I learnt by following the news how oil had a major influence on that growth. Readjust the percentages if (and only if) you learn anything that changes the fundamentals on which you based your initial asset allocations. After a month of initial investment, just leave the portfolio be, watch only the movie and music channels on tv and surf something more useful on the internet, like whether Britney Spears is in or out of rehab. (You may have set up SIPs as well, to invest periodically, but leave them be – don’t change the percentages based on sensational news). Set some alerts for when anything falls drastically, say, to half its value, and check back to see why it happened. More likely than not, it is some market craze doing it, but if you have some money lying around by then, then buy some more of that. Otherwise, just let your money grow. If you have extra money at any time, like an unexpected bonus, just check the percentages of things in your portfolio against your initial percentages, and buy back into those items whose percentages have dropped. For instance, if you had 10 percent in Brazil, and it has dropped to 8%, then buy enough to make it back up to 10%. Check back periodically: every year or so, and readjust the portfolio to the original percentages.

Monday, February 19, 2007

The right thing

Most people go about their lives doing their jobs, making money, somehow convincing themselves that they are doing the right thing. But look at a random sample of things being done by companies, individuals, etc. and within minutes you will see how meaningless their goals are. Whenever it comes time to evaluate oneself critically, people take solace in comparing themselves with someone more depraved than themselves, at least in the general public's eyes. I am much better than that evil suicide bomber that killed fifty people, they say to themselves, and feel strangely comforted by that thought. After all, if not for the existence of someone much 'worse' than themselves, wouldnt they be the ones at the receiving end of the criticism for their unjustified zombied walk through life? Maybe the question of the right thing to do has no answer. But then someone should prove that to be the case and document it for posterity, so we can all feel a little better doing what we do.

Let us consider the field of investment - the main purpose of this domain's existence is to answer the question: what is the ideal investment strategy for an investor or group of investors of a given investment mindset. Ideally, the industry should be converging towards solving that problem. There have been great contributors to the domain. Economics thinkers and writers like Adam Smith, John Stuart Mill, Marshall, Veblen, Galbraith, Milton Friedman and Todd Buccholz, Investment thinkers and writers such as Ben Graham, Warren Buffett, Charlie Munger, Philip Fisher, John Burr Williams, Burton Malkiel, Aswath Damodaran, Zvi Bodie, cross domain thinkers like Mauboussin, have all contributed greatly to approaching the problem. Even if we consider 1776, when Adam Smith wrote his famous 'wealth of nations', as the beginning of such thought, we have less than one person on average every 15 years, not a great number considering the amount that has been said about the subject. The larger danger lurks in the increase in flimsy opinion available in today's world. Today, with TV, the internet and other such space and time gap shortening technologies, almost anyone can publish anything. And success in the publishing industry is a measure of several things other than just plain quality of the content. So, a person with excellent articulation and writing skills and the wrong content can be very successful at spreading the wrong message. A person with the right message but poor communication skills will very likely go unheard. However, we cannot blame the perpetrator of wrong investment methodologies, as he may be successful at his goal of making money off of online advertisement or collecting money upfront for a get rich overnight scheme. In order to find an answer to the problem of investment, I would argue that more time is needed to sift out bad content than to find the good ones. In fact, the list of resources needed by a person with a rational and analytical mind is quite obvious. And yet people are all busy coming up with ways to make a quick buck, as opposed to solving the fundamental problem of investment.

Let us consider the question of technology - what problems must the software industry solve today to be most beneficial to each breed of customer? If you look at many of the software companies today, it does not seem like they accept this as the primary question - instead, like a group of ants collected from their ant hill and dropped off in the middle of a distant desert, they are scared, and do the only thing they know to do - scamper. Each ant scampers in his own direction, and then does what he has to do to continue scampering - justifies why that direction is better than the other, moves more firmly in that direction. We are in the umpteenth release of operating systems and web browsers, and we still havent solved fundamental problems of interoperability. When I plug my music player into my computer, every hour or so, I get the blue screen with a cryptic error, and after having judiciously bought each new release of operating systems, computers and software for the last decade and a half.

Similar questions can be asked about business - what is the right approach to a business model in a given domain? or employment - what is the right kind of work to do as a function of a person's characteristics? or buying - what product should I buy? or environment - what is the best approach to address global warming?

It is critical to answer these questions honestly before jumping ahead to do something based on the more common reasons - because others are doing it, because I said I'd do it this way, or because the media thinks its cool.

The Best of it All