80/20 money makeover by Arun Kumar - illustrated book lessons

READING TIME - 5 MINUTES

BOOK - 46 0F 100 GREAT BOOKS ILLUSTRATED BOOK LESSONS

Hi friends,

We are back with a personal finance book this time. It is a book about managing personal finance which focuses specifically on stock and bond market from Indian perspective. It is basically a conservative policy to mange your money for long term gains.

Principles laid out are universal in their application and can be used by anyone in any country. So lets start.

Follow FISH technique for your funds.

FI is fixed expanses which should be below 50% of your income. Add 10% buffer to it.

S is for savings which should be around 30% of your income.

H is for spend happily on your interests. It should be around 10%. This can be spent on hobbies and personal development.

Shift from spending less to spending right.

Next make a safety net. It starts with emergency fund which should cover your 6 months expanses. Put it in fixed deposit or liquid fund of a reputed company.

Then take a good health insurance according to your city. You may refer to my book choosing health insurance which is available on Amazon.

Then take life insurance in form of a term plan which should be 15-20 times your annual income. Take it early and do not mix investments and insurance. Add your loans and close by big investments to the target amount of coverage.

Now after safety net lets come to our short term needs.

First is fixed deposit. Do not go to a small new private bank as banks go bust commonly and you are insured for only 5 lakhs of your deposit.

For any goal more than 2 years away - Debt mutual funds (Big AAA rating funds) are better than Fixed deposit as there is no penalty for early withdrawal, a better return rate and it is not taxed every year like a fixed deposit.

For shorter goals use money market funds.

Now comes the long term for which there are two tools. One is stocks or equity which has more risks and more returns. And other is debt or bond market where returns and risk are both low.

Foe equity one simple formula is 110 minus your age. This give the percentage of your total investment that should be used to buy stock or equity.

5-5-R rule- 5% income should go to emergency fund creation, 5% to short term goal and remaining to long term investment.

When you get bonus or lumpsum money apply 50-40-10 rule.

50% spend. 40% to long term investment and 10% in short term goals.

How you invest in equity and bond. Directly on online platforms in form of fixed monthly installments called SIP.

Continue it in spite of fall of market or rise so that you buy more units of stock during fall and less during rise. It creates discipline and stability.

After research of Indian market author concludes that if you continue your SIP for 7 years then chances of mediocre returns are 0%. Even if there is fall near the end of your SIP period you can negate it by extending SIP for 1-2 years. Start early and persist. You cannot time the market.

If you have lumpsum amount then decide like this. If it is less than 6 months SIP or less than 10% portfolio then invest immediately.

Options for equity funds.

50% in nifty 100 AND 50% IN NIFTY Midcap 150 fund. You can add 20% funds from midcap to US S and P 500 fund.

One more trick is to increase your SIP by 10% every year.

Now we come to wealth creation step. Here we need ABCDE.

A - Asset allocation

B- Bubble market plan

C - Crash plan (40-60% fall)

D - Deciding right product

E - Entry and exit plan

Asset allocation - Depends on time frame, risk tolerance and trade off in return.

If time frame is long increase equity portion. Maximum 70%

Tolerance - You should be able to tolerate temporary falls and declines.

Rebalance your portfolio once every year.

Bubble market prediction -

It means stocks are overpriced. It is predicted by few signs. Price to earning ratios, GDP, last five years earning, interest rate cycle, market sentiments, large number of IPO offerings, very high earnings and high demand in foreign investors. These all indicate that maintaining growth in time ahead will be difficult.

In bubble market reduce your equity to 60-80% of initial value.

Market crisis plan - Here question is if you should buy and become greedy how much is the amount. For this make a separate account from your funds in debt part of investment. It can be 20-30% of your portfolio.

Now pre decide what you will do during market fall so that you are not tormented by the emotions. If fall of 20% then shift 20% of this account funds to equity investments. This will give you chance to buy shares at low price and get benefit in coming time.

Now about choosing stocks. Better to go with index funds or ETF if you are not a professional stock picker with low expanse ratio and low tracking error. Tracking error means error in tracking the benchmark by an index fund.

One option is 80% funds in nifty 500 index fund and 20% in US S and P 500.

Factors to look in a fund are consistency, good management, less stocks turnover, avoid very large funds which cannot keep their pace up.

In case of debt funds choose AAA grade government bonds which are safest. Two risks are interest rate risk and default risk. Choose public sector banks and corporate bonds with AAA rating. Choose reputed AMC and low expanse ratio.

For short duration choose liquid fund from top 5 debt funds.

For duration above 2 years choose AAA debt fund of large company.

Now comes the entry and exit strategies.

When you get lumpsum money then invest it immediately. But if you cannot decide you can work with two rules.

First larger the amount then invest it slowly with SIP.

Higher the valuation of the market then invest it slowly so that it can correct.

Now the important exit plan. It depends on time left to your goal.

First see if market has fallen by more than 15% from peak during last 5 years

If it is low wait for 3 months for any correction.

Otherwise see time left to your goal and whether it is a flexible goal or a rigid goal that cannot be postponed.

For rigid goal if less than 3 years left then shift 85% OF GOAL VALUE IN A DEBT FUND. If goal is flexible then shift this 85% of goal value money in dynamic asset allocation fund.

Now when you have made a large fund in your stocks and bonds then you can start to think about financial freedom.

Put 3 years of annual spending fund in a separate peace of mind fund.

You can withdraw 4% of it per year in 12 installments.

Increase your monthly income from it by 5% to fight inflation.

That is stable when your portfolio grows at 5-6% per year. You can withdraw monthly by systematic withdrawal plan.

Finally few other lessons from the book.

Every fall in the stock market has false upside rallies.

The recoveries are fast. Temporary 10-20% happen every year and fall of 30-60% happen every 7-10 years.

So this a really important and practical book.