The Palimpsest of Sawbones Surio

Pessimism of the Intellect, Optimism of the Will

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BRIC demographics: brief addendum to the PPF post

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ermine punctured my optimistic balloon in the PPF post with a good comment. I admit I was foolish in not catching the obvious regarding the passage of Father time, its effect on population age, and Government capriciousness in the face of it.
Especially, since I had written something on ageing myself, not so long ago! 😦

Well, never too late to make amends. I ran a small visual demographic trend of the “famous four” (the BRIC, that is). Here it is, in full glory. So, while I may not have the white pelt of an ermine (yet), things are not so rosy while my generation does get to middle age!

Population ageing for the BRIC

Population ageing for the BRIC (1997 — 2050)


Brazil


Russia
——————————————— ———————————————

India

China

Population ageing for the BRIC (1997 — 2050)

Contrast with few developed nations (and Mexico)

Population ageing in other nations (1997 — 2050)



UK

France

——————————————— ———————————————

Germany

Mexico

Population ageing in other nations (1997 — 2050)

Legend of the screencast:

    The red dot that you see is the country in question being tracked. The other dots around this are all other countries within the same continent — China, India graphs show all other Asian countries and the Brazil graph shows rest of South America, for instance.

  • The share of 60 year olds is doubling every decade. The graph is tracking to see on a YoY basis, how much of the population is being replaced by the younger workforce.
  • Already by 2005, the share of under 60 year olds had dropped to less than 80% in developed nations while it was over 90% in developing nations. This contrast is well captured in the graphs, where the dependencies are higher for developed nations than developing nations
  • Already by 2008 more than 20% of European population was over 60. Contrast this with Asia and LatAm with less than 10% of the population being over 60. This makes it good going for now, but wait a minute, I am part of that “young person” demographic, dammit! I will be part of that “old person” demographic by 2050, double dammit!
  • What the chart also captures (but not explicitly) is that the fertility rates across the spectrum are dropping. Pay attention to the number next to the population growth %. More eerie feeling followssssssss…..

Our economic model has created less and less jobs in response to the “creative destruction” of more traditional jobs around the globe. If this trend keeps up, this will lead to even more chaos in terms of the labour market, job rotations and ageing workforces around that time.

The real effects of peak oil is going to become apparent by the end of this decade and strongly manifest itself by 2030 for sure, so what might hit this young generation by then is going to be a different whammy. Well, ermine, thanks for jolting me with that point. Yes, things are not getting better for either of us, and it is better to bank on social capital, learning to mend and make do, and repackage our lifestyles drastically.

I think much of this juggernaut has to roll on, and there is nothing that the ermines or Surios can do to stop it, let alone stem it. But, I remembered this one from “Aw Shucks” Jimmy Stewart reading a homespun poem that he wrote about his dog, “Beau” (Bo).

A reminder, that time and tide waits for none, but it is for us to prepare with grace (and all by ourselves with the help of Social capital).

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Are PPFs really that risky?

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I started responding to some of the points raised by Mr. Burntout’s posts on PPF in India (equivalent of the state pension in other countries). Being a 4 part series, I was getting scattered all over the place. I have collected my thoughts here to burntout’s observations and placed them in a single place here.

However in the PPF scheme in India, even withdrawals are not taxed, making it unique and extremely attractive to investors. This is a tremendous gift form the government of India to the people, since in effect, it means that the money invested in PPF is never taxed!

Historically, Indian politics has transmogrified today from an anti-colonial freedom movement into a uni-party parlimentary democracy that has now fragmented to coalition based horse-tradery. And since we know that this form of politics purely sychronises with populism and vote banks, this EEE-PPF fund is one milch cow that no party will dare to touch (with barge pole).

table shows the PPF rates since the inception of the scheme

The above table is Mr. B’s PPF interest rates. I understand Mr. B’s point, but here’s a better table that compares PF returns against bank fixed deposit rates, to show how the PPF returns have matched, fared or trailed these cases (and it has done all three).

Now with the bank fixed deposit interest rates, it is easier to compare

  1. Notice from the table that over the years, the government has promised and delivered a rate of interest that is much higher than the prevailing market rate at that
    time. Ed’s note: Check! 
  2. Every time the market rates have gone up, the government has been forced to increase rates in the PPF scheme, to keep money flowing into the scheme.  Ed’s note: Not always true, look recent numbers. 
  3. Again this year, as the RBI has increased interest rates to keep inflation in check, the collections into the PPF scheme have dropped significantly.
  4. The government depends on having a strong cash flow every year into the PPF scheme, and it had to increase the interest rates for this year to keep the scheme viable. Ed’s
    note: : In the 80s, this seemed to be the case
     
  5. The government from this year, has pegged the PPF
    interest rate to the 10 year G-sec yield with a margin of 0.25%.  So if the G-sec yield is 10% for a given year, the PPF interest rate will be 10.25%  Ed’s note: Thank you for the info.

So, basically, we can see that B’s points bears out, but only obliquely. In the last few years, the PPF rates have actually been very steady when compared with the market — even during the bullish 2007-2008 phase. Yes, they did
increase their rate recently as B points out, but it is too early to draw any conclusions from any of that — definitely not enough data to be calling it a Ponzi yet. Just look at the pre-1992 numbers and compare to market rates, and you can take comfort that the numbers were more alarming then than now. After all, this is the first significant move in the last 10 years, and the average return for both banks and PPF is the same (8%).

For starters the PPF interest rate is pre-defined by the government at the beginning of every year, and for decades has had no correlation to market returns. The interest rate is in fact a political issue, and is decided by politicians, rather than economists. Typically the interest
rate is kept higher than prevailing market rates, ostensibly to encourage small savings, but also as a political ploy to please the voting populace.

This point connects to the first EEE point made at the beginning of the post. From sheer size of population that invests in PPF, the momentum is going to keep this scheme going. The same mindset of the population that continues to buy into bonds and treasury bills the world over, will also keep investing in ISAs, PPFs and 401ks. No doubts about it.

The PPF scheme is pretty opaque in terms of how the account is managed, where the money is invested and current status of the scheme. Asset Management Companies (AMCs) in India are regulated by SEBI and are required to publish a detailed list of their financials every quarter, that include their investment portfolio, balance sheet, expense ratio, rate of return etc. 

Well, Mr. B’s very harsh here. No amount of regulation prevents companies going belly-up though. However state pension schemes are like hornet’s nests. Disturb them at your own political peril. No Government worth its salt wants to be seen as defaulting on its assured payments either at home or abroad, no matter how hopeless the situation seems to be. I like to offer two case studies. In the first case, the Brazilian Real. This is a classic case of medium unrest locally, but in the end everyone weathered the storm with good results all round. Next up, the Argentinian crisis. Here, the Government defaulted rather than adopt the kind of thinking that Brazil displayed. Even India “opened itself up” when it faced imminent bankruptcy due to internal cronyism in the 90s (As much as I have mixed feelings about that move it seemed better than suicide — given the political leadership leading to that stage back then). Given an informed choice, most nations will choose to go the Brasilian way and bolster internal confidence, which will go a long way in keeping the nation solvent. As for the EU crisis, it is still being played out. Let us wait and watch.

The PPF scheme on the other hand is nowhere near as transparent. A recent audit of the EPF (Employee Provident Fund) scheme showed an excess of funds, that prompted the finance minister to increase the rate of return for the last financial year in the EPF scheme. The “finding” of these excess funds, in itself, was hotly debated for the correctness of the financial audit. Mr.Ponzi also did not maintain clear records, and it was impossible to fathom where the money deposited by his investors went.

Well, this is very true even for the large backbone institutions such as the LIC or even SBI. However, the LIC and SBI are exposed to the markets which bring in some kind of risk into the picture. The PPF on the other hand functions like sovereign debts by the public to the
Government of India. Therefore, failures of state pensions are treated in the same vein as sovereign defaults! So, B can be rest assured, the Government will resort of any trick in the book (going all the way to increasing retirement age!) to pay its obligations towards the citizens.

The PPF scheme depends on new investors coming in yearly with their fresh deposits to keep the scheme running. When the collection began to drop for this financial year, the government stepped in and increased the interest rates to make the scheme more attractive. This has been done in the past as well, to keep the inflow going.

While not mandated by law, most companies open for their employees an ipso defacto PF account and deposits the minimum required funds into it. Based on demographics and population size, this policy by companies will ensure that decent amount of funds will be making its way into the PPF coffers for some time.

The way B sees the EU crisis playing out and similarities with the PPF  is where I differ from him. Brasil and Argentina have had similar financial routs, but Brazil did manage to find its feet. And the EU crisis is still playing out and the end game is not in sight yet. Good luck to them all, and hopefully sanity will prevail.

We have demographics on our side in India. The population is *very* young when compared to the USA/Europe or even Japan and this might stagnate in a few decades, but not right now. Therefore, there is no danger of US level (pension) payouts like the one imagined in Ponzi schemes for the next generation (mine) at least.

There is one more idea that, while not popular, offers some peace of mind towards worries of these nature. The concept of “Ricardian equivalence“, while hotly contested, has been empirically observed and validated as true.

Ricardian equivalence suggests that it does not matter whether a government finances its spending with debt or a tax increase, because the effect on the total level of demand in the economy is the same. 

In other words,

present borrowing would be matched by increased bequest to future generations in order to pay future taxes expected to pay the debt on the government bonds.

So, because PPFs are effectively “sovereign debt”, there is no danger of this turning into an elaborate Ponzi scheme, ever.

Concluding Remarks:

I understand, and applaud burntout’s intent behind the  post. I was reminded of the mantra Diversify, diversify, diversify which cannot be understated! Thanks, burntout. I agree with him on that. Paradoxically and ironically however, if everyone abandons the financial instruments such as PPFs in droves and crowd the stock market (as people in the USA did in the 80s), the inevitable that B warns of — the failure of the PPF scheme — will actually happen, just like its is happening in the USA. It would be far more sensible to balance risk against something as tweed-like as the PPF, the ISA or the 401k and chiefly plan on rebalancing your lifestlye like some of these luminaries have. 😛

Alternatively, get yourself FI, and then you could even launch a second innings like Jacob has (YaY! Go Jacob, go!)

Mr. B, I am very glad to have come across your blog. May our tribe increase! 🙂

Written by Surio

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Retirement planning for “free”: A case study of a case study involving 1.2 crores

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Hello everyone! I am back! Inspired by Maus’ “internet fast”, I had undertaken a somewhat similar one myself. I would heartily recommend it to anyone. Regular transmission is back… until the next fast that is! 😛

Every week, The Hindu BusinessLine newspaper carries readers’ stories along with their financial data, their concerns and their enquiries regarding financial planning steps and their dreams about early retirement. Readers might recall that I had carried a one such story on the blog from the same newspaper on an earlier occasion.

Of some interest to me was today’s reader case study. Although not exactly about early retirement, the discussion that I had with DW on the case study as well as the points the study did not cover, opened more interesting questions and what-ifs, that we decided to share it with a wider audience. Here’s a brief breakup of the data of interest to us.

  • 32 yo, son aged 2, take-home salary is Rs 55,000 a month (SISK – Single Income Single Kid). Salary expected to grow at 10% pa
  • Home Loan monthly repayment is Rs 22,700 (loan amount: Rs 25,00,000 (25 lakhs), loan tenure 25 years)
  • monthly household expense is ~Rs 18,100 (15000+3083 insurance premium) leaving a surplus of ~Rs. 14,000 for his investments

Objectives for this person:

  1. to pre-pay the principal portion of the home loan and to close the loan in 10 years
  2. to save for my child’s higher education, I may require Rs 40 lakhs
  3. for my retirement at 58 years (26 years hence) with a corpus of Rs 1.2 crore.
  4. planning to take a foreign tour in the next four years for which I need to save Rs 10 lakh

BusinessLine, please advise?

(Un)Known-(Un)Knowns: Choose your title 😉

  • The man’s wife must be reeallly good at managing expenses. If I could contact them, I would definitely be asking them questions on how they manage with Rs. 15,000/month in Mumbai 😎
  • Household expenses will shoot up for certain once his son starts (pre-)school. See here and here
  • for a representative sample. In fact, I get such appalling numbers and stories about extortion development fund and daylight robberies fees these days, I am looking at homeschooling as a very serious option. With our own IIT/IISc National Programme on Technology Enhanced Learning (NPTEL), MIT OpenCourseWare and Khan academy it has become more and more possible and easier than most people think! And yes, it’s legal in India too!

  • “Higher education” from an Indian context starts by college (UK: after A-levels), i.e., only by the time boy turns 16 years of age. The 40 lakhs isn’t needed until that point.

Foreign trip

I am going to tackle objective no. 4, chiefly because it is something I personally do not empathise with. My own sentiments on international travel concides with Jacob Fisker’s experiences, but compounded by my AVML/JVML requirements. So, if the man needs to have 10 lakhs for a foreign tour four years hence, he needs to invest all of that Rs. 14,000 surplus in equities, earning 12% pa (as per the journo), starting this month. This investment will return roughly Rs. 11.5 lakhs by the end of five years. I have deliberately omitted in this calculation, the additional contributions per month of approximately Rs. 1300, Rs. 2000 and Rs. 3200 that will be added to the surplus amount by years 2, 3, and 4 respectively due to the increase in pay. If those are factored the trip is a reality by the fourth year (It would seem the man isn’t stupid, for he seems to have worked these things out already and had a year in mind in his query).

What the journo doesn’t discuss in the paper is the “true cost” of the trip from a retirement/FI perspective, which is not Rs. 10,00,000, but Rs. 33,333,333 (that’s 3.3 !crores!). But true cost aside, this actually leads us to the classic discussion of “opportunity cost”, i.e., take the trip and you’ve totally foregone both your retirement corpus *and* your son’s education corpus for the next five years! Personally, keeping in mind the coming turmoil with onset of peak oil and job stagnation/outsourcing to other parts of the flattened world, I would say “to hell with the trip” and focus on the other priorities.

Retirement/Education Corpus Fund

According to the newspaper, Rs. 8000 invested for 15 years in equities yielding 12% pa would cover the 40 lakh education corpus and ~Rs 5600 invested for 26 years as above would cover the 1.2 crores for his retirement. Two factors not discussed by the paper, are additional insurance that the man needs to take (1.1 crores!) and how Rs. 8000 of the son’s corpus would give the retirement corpus a bigger boost from the 16th year onwards.

Pre-closing the home loan

The newspaper has treaded the hackneyed line (CYA?) in this regard.

“As long as the current tax benefits are extended for home loan interest repayment, it is better to avoid pre-payment of the loan”.

Personal Context: Yours truly is one of the many that was conned advised along the same lines and in a misguided moment of sheer adrenaline induced frustration madness, signed on the dotted line only to repent it in leisure since. After a long hard look at the facts and figures of this big concocted lie called “home ownership”, I have taken a somewhat contrarian position towards homeownership. I am not alone in this and here’s a few Indian articles questioning the rationale, empirically and with numbers.

So, back to the story, the fact that the man is being asked to base a long term, financially draining commitment on the whims of “tax-savings” and not based on numbers is a poor piece of advice, IMO. One main gripe I have with such advice is the outright refusal to consider increasing one’s monthly payments towards the loan to one’s advantage.
For the loan amount of Rs. 25 lakhs, based on his EMI amount, he is being charged 10% pa interest. So, by the end of 25 years he would have paid out Rs. 68,15,043 (68 lakhs) to the bank of which the interest is Rs. 43,15,043 (43 lakhs)!

Annually, the man pays out Rs. 2,72,400 towards his home loan (10% interest rate, revised every 3 months — only going to go up under current inflation trends!). Of this, he claims 1.5 lakhs as tax exemption under the tax code. Based on this, he would save Rs. 30,000 – Rs. 40,000 in taxes paid annually. By contrast, he pays out Rs. 1,22,400 in excess to the bank towards the mortgage which is his own money that can be neither reclaimed nor saved/invested.

Back to the big picture: He intended to pay back the loan by 10 years. So, let’s look at his loan outstandings and tax savings side by side for the entire loan period with his liabilities at 10 years from now.

Amount paid out towards interest Amount saved in tax during that period
10 years

23,40,136 40,000 x 10 = 4,00, 000
15 years 19,74,907 40,000 x 15 = 6,00, 000
Total interest 4315043 (43 lakhs) 10,00,000 (10 lakhs)

There is no contest between the two. When compared to how much he is making the bank rich and what a paltry “tax savings” he is making, the man needs to pay off his home loan pronto and make better judicious use of his own money the way he feels fit.

To do this, he ought to increase his EMI payments by Rs. 12,000. By this he will close his home loan by 10 years(*). Classic opportunity cost scenario, for now he’s not able to save for his son’s education corpus fund! If on the other hand he sticks with the Rs. 8000 investment per month in equities towards son’s education corpus and moves Rs. 5000 into the EMI re-payments, the repayment window extends to 14½ years instead. He kills two birds in one stone. Son’s education as well as home loan: SORTED!

(*) Only if he had started paying 12,000 right at the beginning of the loan term. If he’s already into the loan by a few years, then it won’t be 10 years but somewhat different. I don’t know how far into the loan term he’s into now.

Going further

  • If he keeps up a 12,000 payment for his housing loan as discussed earlier, the loan amount might be closed by 10 years. That leaves Rs. 2000 per monthtowards his son’s fund
  • A 10% increase in salary every year is too optimistic IMO and his household expenses will be increasing as the members start ageing. So, I factored a 5% increase in salary and a 5% increase in expenses and re-worked the numbers.
  • From the increase in salary, the man can increase his monthly contribution to his son’s fund by 2000, 4000, 6000, 8000 and 9000 by years 2, 3, 4, 5 and 6 respectively, and hold it steady from then on.
  • He would have approximately, Rs. 2000, 4000, 7000, 10000, 13000 to invest into his pension from years 6, 7, 8, 9, 10 respectively. If he holds this payment steadily into equities, he will actually be able to reach his target of ~1.1 crores at the end of 58 years of age.

Conclusion

Since he has pre-paid the housing loan, from the 11th year onwards, he will have an additional surplus of nearly Rs. 50,000 per month (which excludes the payments mentioned above!). Even if his salary stagnates (a very likely possibility) and even if returns from the market is not exactly 12%, he will still be able to meet his financial commitments along with son’s education and retirement corpus. If he wishes to still undertake that ‘foreign trip’ of his, he could look at investing this Rs. 50,000 in equities for a period of 3 years at 12% pa, earning himself 20 lakhs and then take that trip. His son might also better remember the trip at this age.