News APP

NewsApp (Free)

Read news as it happens
Download NewsApp

Available on  gplay

This article was first published 16 years ago
Rediff.com  » Business » Get your numbers right

Get your numbers right

By Amar Pandit
Last updated on: August 21, 2007 08:45 IST
Get Rediff News in your Inbox:

"I have doubled my property investments in the last three years and tripled it in the last six years," claimed a proud Shashi Ranjan, a businessman in his late forties. "How many per cent per annum is that?" I asked.  "I don't know," he shrugged his shoulders, a very common response today.

It is almost fashionable to rattle out shocking numbers to gain respect from peers about your investment decisions. However, a reality check on them would bring down those absolute numbers by a few notches. Here is some food for thought to sober down the fashionistas of investment.

Cost to return

Shashi Ranjan's 'double' and 'triple' returns on the property investment comes from the fact that he paid Rs 20 lakh (Rs 2 million) in 2001 and sold it at Rs 60 lakh (Rs 6 million) in 2007.

Yes, it is three times the amount he paid for the property. But once he adds up the other costs, the picture is different. Stamp duty and brokerage paid for the purchase was 5 per cent and 2 per cent respectively. Registration charges were around Rs 30,000.

Annual maintenance charges were Rs 25,000 for six years plus there were property taxes paid for that period of holding the property. Now, finally when the sale is made, the broker is paid another 2 per cent, society transfer fees and finally there is capital gains of 20 per cent with indexation. So the actual returns would be quite different.

For a quick calculation use the rule 72 (for doubling) and rule 115 (for trebling). That is, divide 72 and 115 by the number of years get the returns per annum. In case of double returns (in three years for this case), the rule of 72 gives you 24 per cent returns per annum.

Add the capital gains tax of around 20 per cent on the transaction (selling) and brokerage, stamp duty and other and the returns would dip to 17 per cent per annum.

Similarly for trebling use the 115 rule and the returns would be 19.1 per cent returns per annum over six years. And after factoring in other costs, it comes to 12.8 per cent per annum. Obviously, there is a sharp fall when costs are taken into account.

Buying at Rs 10 NAV /Rs 1,000 NAV

Another big mistake people make is looking at the net asset value (NAV) while buying a mutual fund. There is a perception that a mutual fund with a Rs 10 NAV is cheaper than the one with a Rs 1,000 NAV.

Given a choice everyone would like to have Rs 1,000 note over a Rs 10 note but when you are buying an investment, you have to look at the percentage gain or loss. A Rs 100 fall in a Rs 1,000 investment is a 10 per cent loss.

Similarly, a Re 1 fall is also a 10 per cent loss in a Rs 10 investment. So if the underlying stocks in both the investments are similar, the investments will fall or rise by the same percentage. Nothing could be further from the truth that a Rs 10 NAV is cheaper than a Rs 1,000 investment. What matters in the end is the percentage appreciation or depreciation.

Insurance illustrations

Most people, after buying an insurance policy, just concentrate on the returns. I will receive Rs 20 lakh or Rs 50 lakh or maybe even Rs 1 crore (Rs 10 million) at the end of 30 years. This is at the cost of not knowing the sum assured or the surrender clauses of the policy, which are far more important issues of the policy.

It is human nature to ask the returns on the money that one is giving to the insurance company as premium.

So if the policy does not yield returns, it is construed to be a losing proposition. Therefore, in any insurance sale, the discussion centres around what the policy holder would get at the end of the term.

That is why there are so many versions of insurance plans right from endowment, money back, whole life, Ulips to goal-based investment such as children's plans and pension plans that provide you with expensive options.

Calculating the actual return on such policies would leave you crestfallen. Ask the insurance agent for the exact percentage and he would be quick to dole out the official illustration that gives you returns at the rate of 6 per cent or 10 per cent.

However, if you ask for the compounded annual return, you would be shocked to know that the returns drop to around 4 per cent to 5 per cent.

So the next time you see yourself making a financial decision on the basis of absolute numbers ask yourself what is the percentage return? This question might sound very basic but like Aristotle once said, "It is simplicity that makes the uneducated more effective than the educated when addressing popular audiences."

Points to ponder

  • Rule 72 (double) and 115 (triple) should be used when calculating the actual returns per annum
  • While calculating returns, you need to take the cost component into account
  • A 10 per cent  fall in a fund with Rs 10 NAV and 100 NAV mean the same
  • Look for fine print in an insurance policy rather than returns at the end of the period
  • The real rate of return on an endowment  policy is as low as 4 per cent to 5 per cent  per annum

The writer is director, My Financial Advisor

Get Rediff News in your Inbox:
Amar Pandit
Source: source
 

Moneywiz Live!