Importance of Retirement Planning

Retirement planning is one of the most important part of total financial planning of an individual. Retirement years are the beautiful years of life. After taking his education when an individual starts his working life, he is burdened with lots of different responsibilities in his life. But retirement years are the years when one can live life that he wanted to live. At the same time, in retirement years when once physical and mental ability is continuously deteriorating, so in such times certain expenses like need for driver, servants to help increases so importance of having sufficient financial resources is very important. As a financial advisor I handle many clients and see that people don’t plan their retirement years seriously. So let us first see some aspects why retirement planning is must.

Changing Socio Economic Structure of Our Society: Socio economic structure of our society is continuously changing. We never saw our parents planning for their retirement years so precisely, because they believed that their kids are their retirement planning. Till now we have seen a joint family culture and the relationship between kids and parents in our country has been such that if you ask parents what corpus they have accumulated in their life they will say that their kids are their real wealth and they (kids) will take care of them and on the other side kids were also comfortable taking care of their parents in their retirement life but slowly and gradually we are adopting Western culture, joint family culture is ending so I believe that going forward this will change and parents will not be comfortable giving their financial burden to their children and kids may also not be comfortable taking this burden. So with this change our dependency to our next generation can lead us to miserable condition in retirement years.

Recent case of Mr. Vijay Pat Singhaniya (Chairman of Raymond group) who after his retirement handed over his wealth to his son is suffering from financial crisis in retirement years, is a live example for this.

Increasing life Expectancy: In 1947, when India became independent, it was said that life expectancy was around 49 years which kept increasing and current figures suggest that life expectancy is currently around 71 years due to better living conditions and advancement of medical facilities. But this figure of 71 years is an average which includes people from rural areas and people who live below poverty line and don’t have proper medical facilities, so actually for people like us who are health conscious and live in urban areas with good medical facilities; life expectancy is more than 80 years. So due to increasing life expectancy dependent years are becoming longer and we need to plan for that otherwise our old age can become miserable part of our life. Generally when we plan for Retirement, we take life expectancy at 90. If we consider our working life from 30 to 60 and our Retirement life from 60 to 90, during our working life every year we have to earn for almost two years, first for the year in which we are in working life and second for one year in retirement phase. For example, a person who is 35 he is also earning for his 35th year of life and also for one year of retirement phase which he has to fund and there will be no income. Following image gives more clarity about that. Generally investors don’t consider this fact.

Improving life style: Our life style has been continuously improving due to which our cost of living is increasing. Our earlier generations had a very contented and satisfied life style. Their cost of living during their working life was also not very high so needs in retirement life were also limited, against that we are increasing our life style very fast during working life itself so once the cost of living is increased during working life it has to be maintained for retirement life too. Famous Tennis player Boris Becker who lived a lavish life style and now suffers from the Bankruptcy post his retirement is one such real life examples of lavish life style and poor retirement planning which resulted in crisis during retirement years.

So the above aspects clearly show that to enjoy our retirement years we need to plan them properly. Now let us see some research and data about retirement planning

Research says that 47% of working population in India has either not started providing for their retirement years or due to some or other issue have stopped providing for retirement years ( according to report of HSBC). So Let me ask this question to all of you. Have you started providing for retirement years? Also have you actually prepared some written Retirement plan? Kindly check your financials and answer yourself for this.

Let me clarify that Retirement planning doesn’t mean that you will stop working at 60 years of age. You may continue to work for whole your life but if you have proper retirement plan in place you are not bound to work for your financial needs. You will work at your choice.

Here I would like to end this with conclusion that Retirement Planning is very important and one must have his written Retirement plan in place. In my next article I will be writing more on numbers and ways to Plan for Retirement..

Availability Bias in Investing : How it affects your Financial Decisions?

One of my friends is working in an engineering company at senior management level. 60% of his personal investment portfolio consists of his employer company shares. When, I ask him why he is buying so many shares of his employer’s company. He always gives me details of performance and future plans of his company. When I discuss about other good companies and their results he is not ready to believe and invest in them. This is availability bias. We believe in information which is easily and readily available to us.  This is a very common bias. In above case of my friend he trusts his company like anything because that information again and again comes in front of him but don’t look at information about other companies or don’t trust them.  But when the same information about his company comes to me, I don’t give much importance to it because I also have similar information about other companies too. So importance of information about any company is similar and I analyse all the companies with same importance.

We create the picture of the world based on the information available to us. Also we give more importance to information which is served to us more dramatically or loudly rather than considering quantitative factors. To prove this I will ask you one question. Tell me the name of bath soaps available in India?  Now observe yourself you will easily come up with 3 to 4 names that first come to your mind than you start struggling and still can come up with 1 or 2 more names.  Now think why the first three names came to your mind immediately. Some of them have given very good advertisements again and again which you have seen and have made place in your brains. So you first come up with these names. This is availability bias. The other brands of soaps may be better than these soaps but as you have not been given that information about these soaps you remember these three and believe they are better. The things which are made available to you more number of times come immediately in our mind and we believe them more. Further if the ads are more dramatic we believe them more. We don’t go into quantities analysis.

I remember last year when we were going for the vacation in the month of June by plane and just one week before that my son saw a Tv programme on plane crashes, he clearly refused to come with us because he believed that there are high chances that our plane may crash. So by watching that programme on plane crashes probability of plane crash in his mind went up and his decision to travel by plane was influenced heavily by that information. If he had not seen that programme he could have easily traveled to planes for his whole life.

Human brains give more importance to easily available and recent information while taking any decisions.  One of my clients is working in an infrastructure company, the company was not doing well for last few years, and so overall company had not given any salary rise to employees this year. Around a month back when I was discussing his portfolio with him, as a part of my investment recommendation I suggested him to invest some of his funds in few infrastructure equity funds. These funds were specific thematic funds and will invest in share of infrastructure companies but he was very pessimistic about the future of infrastructure companies and was reluctant to invest in infrastructure funds because of low performance of his own employer company. Two days before I was writing this article, I received a call from him asking me to invest his funds in infrastructure funds, when I went into details to find why his behaviour changed I found that his company got few orders one after another and this was sufficient to convert his pessimism to optimism. So the information which was available to him was very positive about infrastructure industry so future image he was making was very bright. On the other hand upto few days back it was reverse because information available to him easily was not speaking well about future of infrastructure companies in India. When I was arguing with him and giving him information that infrastructure companies will do well he was not  was not ready to listen & consider the information that I was sharing. So we believe in the information that is easily available to us and start making very important investment decisions or life decisions on those basis.

Many clients when first come to me have bought lots of life insurance policies for investment. When I analyze those policies and tell them that they are not worth investing and they should buy insurance only for life cover and not for investment purpose. Their answer is simple that at the beginning of my career I saw all my colleagues & friends investing in life insurance policies so I thought it is correct approach and did the same. So they believed what information was available to them.

When entire media speaks well about the economy and markets, you will see that inflows in equity market will generally increase and vice versa. So when positive information is shown to us again and again we start believing it otherwise not.

Impact of Availability Bias : Due to effect of availability bias our decisions are biased towards the recent and easily available information. Sometimes we prefer wrong information to no information. There are two aspects of this point explained below.

 a) We Don’t try to find the information: We generally use the information that is easily available to us and don’t try to get the correct information or other information that is not easily available to us. Due to this approach sometimes we prefer wrong information to no information. This means that if wrong information is easily available we believe that rather than finding correct information. Due to this we buy brands which give more advertisements. Investors buy financial products which are shown to them. Suppose you are in touch of a lic agent he will recommend you life insurance policies and you will buy life insurance policies.

b) We digest the information in the form it is provided to us: We don’t try to analyze the information and accept it in the form it is shown to us. Few years back LIC had launched a single premium policy where money was doubling after 10 years. Few clients came to me with marketing leaflets sent by few agents claiming that policy gives 10% returns. Clients were asking me that 10% returns are very good so let us invest in that plan. They never realized that this 10% is a simple rate of return and not a compounded return. Compounded rate of return is close to 7.15% p.a. So they never analyzed the information that was given to them. This leads to wrong decisions.

How to avoid Availability Bias:

1) Look at information that is not easily available : Try to find information that is not easily available, also try to find information about products which you are not buying. This will make you slightly uncomfortable but make it a habit.

2) Meet the people who look differently than you : Try to meet and understand views of the people who think differently from you. If you believe that markets are good for investment than try to listen and understand the people who believe that markets are not good for investment right now.  Think and analyze their view and then take important investment decisions.

3) Give your past mistakes a hard look : look at the mistakes you made in past and analyze why you made these mistakes. Was there lack of information analysis or you relied on the information easily available. Make the necessary changes in your approach of looking at the information.  

To conclude with availability bias is a very serious bias and has significant impact on our decisions so while making our important financial decisions we should try to dig more information and try to analyse it in more details before we make and decisions.

Nifty 50 @ 10000, what should investors do now?

On 8th of Nov. 2016, When Govt. Of India took a strong step to demonetize 500 & 1000 rupee currency notes, Nifty 50 which is one of the most important indices of National Stock Exchange and looked as a benchmark index to see markets of our country was trading at 8500. It was like an earthquake situation in the economy and from next day all media channels & everybody started predicting what will happen in markets. Almost everybody predicted that markets will fall sharply as economy will slow down because Indian economy is a cash economy and there will be heavy cash crises for next few months which will affect consumption badly and in turn markets will fall sharply. Initially markets crashed by around 5 to 6% but later on it started rising surprisingly with sharp speed and crossed 10K at the end of July-2017. So almost in the period of last six months Nifty 50 has gone up from 8k to 10k which is around 25%. Now the question arises that why markets went up by 25%? What will happen now from here? Whether it will go up or down? While reading the title of the article you must have thought that I have the answer of these questions but let me tell you that I don’t have answers for all these questions but yes I can definitely analyze the current situation and tell you what strategy you should adopt.

Overvalued Markets: Current rally of Nifty from 8k to 10K has made markets extremely overvalued and risky. Markets have gone up only based on future expectations.  But to understand this let us first understand EPS (Earnings per Share) & P E Ratio (Price to Earnings Ratio).

Earnings Per Share (EPS): First understand this by a simple example. For instance, there is a company which has issued 100 shares and has earned net profit of Rs. 1000. In this case Earning per share would be Rs. 10 (Earning per share= Net Profit/no. of shares issued)

Price to Earnings Ratio: Price to Earnings Ratio is the ratio which reflects relationship between market price of the share and Earning per share of the company. It is arrived at through following formula.

Price to Earnings Ratio is an indicator of valuation of the company. It gives you an idea whether company is available at cheaper valuations or costly valuations. Let me explain with an illustration.

There are two companies Company A and company B. Both are in the same industry and following is the chart of their data.

Looking at above table, at first instance it looks like company A is cheaper because its share is available at Rs. 100. And company B’s  share is available at Rs. 200 so a layman investor would jump up and buy the Shares of company A considering that he is buying a cheaper company. But look at EPS, company B’s EPS is Rs. 25 whereas company A’s EPS is Rs. 10 only so PE Ratio of company B is 8 times and it is lower than company A which is 10 times. This indicates that your return on investment is 12.5% (25/200= 12.5%) for company B and for company A it is 10% (10/100= 10%) so if other factors are same which company’s share would you like to buy now? Company A which is expected to give you 10% return on your investment or company B which is expected to give you 12.5% return on your investment. 

You can also look at PE Ratio like this, if you are buying company A with Rs. 10 EPS at Rs. 100 per share, this means you are paying price which is 10 years of profit of company A and if you are buying a company B with Rs. 25 EPS at Rs. 200 per share, you are paying price which is 8 years of profit of company B so which one you should buy now?  

Lower the PE Ratio Better it is: From above discussion one point you should understand clearly is lower the PE Ratio better it is and so you should buy stocks when they are available at lower PE Ratio and you should look at PE Ratio for comparison between two companies of same industry and not the price on standalone basis.

PE Ratio of Nifty and important lessons: while calculating PE Ratio for any index like Nifty we have to take value of Index and divide it by sum total of EPS of all the companies in that Index. Normally PE Ratio of Indices like Nifty is given on the website of NSE.

Now to understand current valuation of market let us see below table which gives some historical figures of Nifty 50, PE ratio and EPS to understand relationship between EPS and markets and analyze current situation.

Above table shows Nifty level at the end of every year from 1998 and at last I have taken recent level of Nifty on 31st July 2017. Logically there is direct relationship between markets and EPS (profits of the nifty companies) so Nifty should grow as much as EPS for Nifty companies taken together grows. But this is not true over short term because over short term participants(people who are trading ) in the market react to market events in more sentimental manner than logical manner so even though EPS has fallen markets may go up. To understand this you can see that in 1999 EPS has fallen by around 19% but still Nifty 50 has gone up by 67. Ideally Nifty 50 should have fallen but it has grown up so it shows that Nifty 50 has gone up due to sentiments by 87%. But when ever EPS has not grown and Nifty 50 has gone up than in next few years Nifty 50 has fallen even though earnings are positive, this can be seen in 2000, 2001 & 2002. In all three years EPS has grown positively but Nifty 50 has fallen because it had grown faster than EPS in 1999.

Similarly, in 2006 & 2007 EPS had grown by 13% & 19% but Nifty 50 had grown by 17% and 36% respectively so in next year 2008 it gave negative returns to the extent of 54%.

Lesson from the History: Above table shows that whenever market runs ahead of earnings growth it becomes overvalued and then either markets have to fall to match EPS or market may remain stable or range bound and EPS will grow to match market level. Similarly, if EPS is growing faster and markets are not growing than at some time in future markets will have to grow faster than EPS to match it.

Can we Predict Markets? : No, we cannot predict the markets, we can only understand whether markets are overvalued, undervalued or fairly valued. When the markets are undervalued investors can become aggressive and invest more in Equity, When markets are fairly valued investor’s should remain neutral and invest in equity as per their asset allocation requirement and when markets are overvalued investors can become conservative. In above table we can see that when EPS has grown faster, PE ratio has fallen and from there in next few years market has given good returns so lower the PE ratio better it is to invest in Equity.  Let us see below Table.


Every investor has his own Asset Allocation, suppose you have kept your asset allocation at  50% Equity and 50% Debt so that is your basic asset allocation. Now in case when markets are in undervalued zone (below 18 times PE ratio) you can think to increase your equity allocation from 50% to 60% or 70% and in times when markets are overvalued (above 22 times PE ration is ) you can slowly reduce your equity allocation from 50% to 40% or even less than that. In the times when markets are at fair value (between 18 to 22 times PE ratio) you should keep your equity allocation at 50%.Please remember that these levels of Equity allocation will differ for different investors based on their risk profile and asset allocation.

What to do in current situation where Nifty 50 is at 10000?

 In current situation when Nifty 50 has crossed 10K we have to see what has happen to EPS growth. Post demonetization say form Dec-2016 to July 2017 EPS of Nifty 50 companies has grown by around 5% where as Nifty 50 has grown by around 25% (from 8000 to 10000) and this has made PE ratio to reach at 25.69 times level which is highly overvalued. Historically, whenever PE ratio has reached these levels equity market has not given good returns for next few months or years. In current situation we cannot predict on which side markets will move but one thing that I can surely say is markets are in highly overvalued zone so when markets are overvalued we should become conservative and should reduce our equity allocation. But this doesn’t mean that we should totally exit from equity. If as an investor you are keeping your equity allocation at 50% equity now you should reduce it to 40% to 30%. So if markets fall sharply you will not be affected badly and will have liquidity to buy equity at cheaper prices.

For New Investors: For new investors, they should not make a mistake of waiting for correction to happen in the market. They should start investing through Systematic Transfer plan Mode. Suppose one has to invest Rs. 100 out of which 50 rupees will go in Equity then he can keep these 50 rupees in liquid funds and invest them slowly over next 12 to 18 months in equity so if markets fall sharply he is not affected badly and has some money in liquid to average out and if markets keep increasing he is not totally left out.

How Recency Bias affects your Portfolio performance? How to avoid Recency Bias?

If I ask you to recall name of 10 people you met this month, whom do you recall? Just observe, mostly you will recall name of 10 people whom you mate recently.  This is recency effect.  Similarly, if I ask you for opinion on behaviour or performance of any of your colleagues or employees kindly observe how you give your opinion and what affects your opinion maximum, Most of the time their recent behaviour or performance will influence your opinion. If one of your colleagues was very polite and humble since beginning of your relationship but has not behaved well recently, your opinion will move towards negative side or if any of your employees has not performed well recently then your opinion on his performance will not be good even though he has been performing well since beginning. So your recent experience affects your opinion the most. This is recency Bias. Events which occur recently have maximum impact on your mind.

 Recency Bias is one of the most common biases affecting our investment and other life decisions. Here we remember the events which happen recently or information which we received recently. Also the events which took place recently or information which came last affects our decisions maximum.

Let me give you one more example, Say if from tomorrow you have to go for some project or work to a city which is two hour from your city by train for next one month and I ask you that what are the chances that train comes by time in India? What will be your answer? When I ask this question in my seminars most of the people have answer in the range of 70% to 90%. So they believe that out of ten times 7 to 9 times train will be on time. Now if suppose your answer is 70% you believe that out of 10 times you travel, 7 times train will be on time. Suppose you have to travel from tomorrow and you have to catch a train that arrives at 7.30 a.m. and departs at 7.35 a.m. You reached station by 7.25 and announcement was made that train is late by 90 minutes. Second day again you reach station by time and train is late by 70 minutes, Third day again you reach by time but train is late by say 2 hrs. Now I meet you on platform you are very frustrated and angry and I ask you the same question that what are the chances that in India train comes by time? What will be your answer? Mostly the answer that comes is in the range of 0% to 30%. Now observe what happened here, earlier when you said 70% chances are there, it came from your subconscious mind and this registered slowly form your childhood when you started travelling but these last three days experiences changed your answer totally and dominated your decision making behaviour. This same thing happens in Investment decisions as well as other decisions of life.

When it comes to investing people invest in the instrument which have done excellent recently. Particularly if you will see in stock market maximum investment comes when markets are at peak.

Above chart gives data from Oct-99 to March-2017, red line shows Sensex levels where as black line indicates gross mutual fund investments. The chart clearly shows that whenever markets are doing very good and going high, investments in equity funds sharply rise and vice versa. So most of the times investors invest when equity market is very high and stay away from markets when markets have fallen sharply. This behaviour is seen universally. The reason behind this behaviour is recency effect. When markets goes up and up the returns of equity mutual funds are very good in recent past so investors look at recent past and start investing in equity. Here subconscious mind starts believing that this behaviour of markets will continue and they will make good returns so investment at these points increases. Similarly when markets fall they the recent past is not good so they start believing that markets will fall further so they avoid investing more money in equity.

How Recency effect creates illusion of Safety & illusion of Risk?

Actually recency effect creates illusion of safety & illusion of risk in the minds of investors. Let me show you with a historical example.

In January-2008, when Sensex first time touched 21000 levels it was all time high and in last one year ( from Jan-2007 ) to Jan 2008 Sensex had moved up from 14000 levels to 21000 levels so it was rise of around 50%. In this month (January -2008) equity mutual funds had highest net inflow from investors of Rs. 13678 crores in one month. Here at this point Sensex had gone up by around 50% in one year but economy (corporate profitability ) had not grown by even 20%  and no economy can grow by 50% in one year so at this point markets were extremely overvalued and risk reward ratio was unfavourable.  But due to recency effect investors start feeling very comfortable and forgot to consider risk of overvalued market on the contrary they start believing that this will continue so here there is illusion of safety. There was no safety at 21000 Sensex levels but there was illusion of safety. This behaviour of investing more money at higher market levels created a bubble in stock market and what happened next we all know.  On the other side when markets started falling immediately after this and saw the bottom Sensex levels in Mar-2008 ( when Satyam fraud came out) of around 8344 the net investment in equity mutual funds was around Rs. 544 crores only, which was not even 10% of what came in Jan-2008. Here markets had fallen by around 61% so ideally there was hardly any risk because economic activity in the country or corporate profitability had not fallen by even 5% which shows that markets were undervalued and risk reward ratio was favorable but unfortunately those investors who were ready to buy equity at 21000 Sensex levels were found equity markets costly at 8300 Sensex levels and were not ready to buy equity. Isn’t this a strange behaviour ? Yes but the reason is at 8300 Sensex levels actually there was not risk, whatever worst could happened had already happened but as the recent past was negative there was illusion of Risk. There was not actual risk but there was illusion of risk only.

Both these behaviours were irrational in nature those who invested more money at 21000 levels in Jan-2008 had increased their avg. Purchase price as a result of which they could not make money for next few years and saw negative returns in next one year. Similarly those who were not investing or redeeming their money from equity funds at 8300 level in Mar-2009 could not gain out of the rising market in 2009-10 because the fall was an opportunity to reduce their average purchase price in equity but they lost it and the opportunity was gone. Ideally they should have behaved exactly reverse of their actual behaviour. But recency effect did not allow this.

Recency Effect in Real Estate: Recency effect is not only seen in equity investing but also in real estate investing. From 2005 onwards real estate prices in India and particularly Gujarat started moving up, as a result we saw that those who invested in properties between 2005 to 2007 got good returns by 2009 and at this time equity market had fallen sharply so at this point of time real estate investment had given very good returns and equity investment had not given good returns in recent past. As a result investors started investing in real estate more and more money and this behaviour again repeated what had happened in stock market in 2007. By 2012 property prices went up sharply. Maximum investment happened in 2012 and after that property prices in most of the regions have fallen or art stagnant from last five years.  Those who bought properties in 2005 had multiplied their money by four to five times by 2012 so ideally they should have sold their properties and booked profit but they behaved exactly reverse and bought more properties in 2011 & 12. So this brought up their average purchase price up towards the prices of 2011-12 and lost the golden opportunity to book profits.

Recently, after demonetization markets have gone up by around 15% to 20% in just 5 months and as a result recent past is very positive and once again investors are investing in equity. So be careful while taking your investment decisions try to avoid impulsive investing.

To conclude with, recency bias is the most common and frequent bias affecting our Investment decisions. So to take rational decisions we have to learn how to keep our decisions free from recency effect. Following are few suggestions which I recommend you to adopt to keep yourself away from recency bias.

Read History:It is said that history repeats itself. So keep reading history of stock markets and investments. Every few years market cycles are repeated and investors make same type of mistakes. Every time when the market is high, the hopes are at peak and due to recency effect investors believe it will keep going high because this time it is different and markets will do very good. Sir John Templeton had said that “The four most dangerous words in investing are: ‘this time it’s different.'” My advice is whenever someone says this time is different, please run away from there. Don’t litsen him more. Reading history will help you to think from the other side and get away from current fancy market rises or falls and you will do rational things.

Delay your decisions by 2 to 3 days: Whenever recency effect is at peak you will feel tempted to take your investment decisions either buying at peak of market or selling at bottom of market after sharp falls. Try to avoid your decision for 3 days. Let 72 hours to pass and your emotions will calm down and you will be able to rationally.

Adopt process and strategies in Portfolio management: Your investment decisions (whether buying or selling) should not be based on current market events or news. It should be based on long term strategies like asset allocation and rebalancing.  Those who don’t adopt strategies are actually adopting tactical money managers. 

Is this Rational? : Whenever you find this type of situation where any asset class whether it is equity or real estate is performing on extreme sides (extremely good or extremely bad), before taking any buying or selling decisions just ask yourself “is this rational?” “Whether this continues rise in equity is rational?” Means is it supported by rise in profitability or when markets falls sharply try to find whether profitability of the companies have fallen that much or not? This is real logical thinking process and will lead you to rational and correct decisions.

How Sunk Cost Fallacy affects your financial Life?

Recently me & my wife were sitting idle at home so we planned to watch a movie. Bought the tickets online and went to watch the movie. In first 20 minutes we realized that the movie was boring and it was waste of time. I told my wife, let us move out and go for some shopping or anything else. At this point she had two options, option -1 to leave the movie and forget about Rs. 500 and time that we spent in the movie and enjoy something else which can increase our happiness level in remaining time and option-2 to continue watching a boring movie and waste the time. She selected Option-2 and immediately replied me that “we have already paid for tickets and how can we leave it now, we have to watch full movie”. Do you know why she did this? She felt that if we move out at this level we will lose Rs. 500. But actually Rs. 500 was a sunk cost. Whether we watch the movie or not had nothing to do with Rs. 500. But watching movie was going to waste further 2.5 hrs and also reduce our happiness level. Whereas if we move out from that movie and do something else we may do something fruit full in those 2.5 hours which can increase our happiness level. This approach of sticking to our initial decision to recover time and money already spend is called sunk cost fallacy. You are running behind the cost which is already incurred and should not be considered for future decisions. Decision of watching movie was not a rational decision it was not taken considering future cost benefit analysis it was taken to justify money and time already invested in initial decision of watching movie.

A sunk cost is a cost that has already been incurred and thus cannot be recovered now, in an effort to recover it we end up spending more money, time and energy. This behaviors of committing more money, time or effort to our earlier decisions is called sunk cost Fallacy. Sun cost fallacy is not only about money spent, it is also about time and effort spent on something. Let us see few more examples of Sunk cost.

Sunk Cost Fallacy in Corporate Decisions: Many times I have observed this in corporate world that company was conducting a marketing campaign or a product research and in the mid of that campaign or research they realize that this is not going to yield much benefit to the company but by that time they have invested a lot of time and money on the project. So ideally they should leave investing more time and money on that project but generally they will keep working on that with thought to recover the time and money already invested.                                                                         

Sunk Cost fallacy in Individual decisions: A study was conducted on few people; they were offered two picnics from two different agencies for two different places. One was costing them Rs. 3000 and another was costing them around Rs.2000. They subscribed both the picnics and paid the subscription money (subscription money was not refundable on cancellation) and then they were informed the dates of the picnics and purposefully dates were kept same. Now they had to select the one and on analysis it appeared that trip costing Rs. 2000 would be a better trip to enjoy. But most of the people selected to go for picnic for which they paid Rs. 3000. This happens because they believe that loss of Rs. 2000 is less than loss of Rs. 3000. Logically their decision should be based on the factor that which picnic will give them more happiness. But here the decision is taken based on loss incurred by not going in the picnic so the picnic which is more costly is preferred even though it will give less happiness.

  • Many times I see in hotels when we order something and after eating it we realize that the quality of food is not good or taste is worst but still we continue eating as we have to pay for that food. This is also clear example of sunk cost fallacy as eating a poor quality food can affect our health or if we don’t like the test then it is reducing our happiness but in order to recover the money that we have paid we eat that food. Is this a rational decision? No not at all. Here I am not saying that we should waste the food, we should order the food very carefully but if after that it is not of good quality or test there is no point in eating it to recover the money we have paid.
  • Last year me and two of my friends had subscribed for a workshop around 6 months in advance. We paid Rs. 5000 for the workshop. By the time that workshop actually came close we realized that due to some legal structural changes topic was not of much use to us. I decided not to go for workshop but both my friends attended the workshop by arguing the subscription was not refundable. They spend around Rs. 4500 more and one working day just to justify or recover Rs. 5000 which they had already paid and were a sunk cost.

– Sunk Cost Fallacy in Equity Investing: Sunk cost fallacy works very strongly in equity investment. When people buy shares of a company and suppose company starts doing bad and share price falls then either investor’s start buying more shares of that company with idea to recover earlier invested money or they don’t invest new funds but also don’t sell existing shares just with a mindset that already they have invested good amount of money and time in this company so will wait for the share price to reach to their purchase price. Here when company is really not doing good then there is no logic to buy more shares or to wait for share price to rise and reach their purchase price because money which is already invested is gone and whatever loss they are incurring now is a sunk cost. Logically if as an investor if you had not invested in this company earlier and you were analyzing it for the first time to invest then will you invest in it? The answer is NO. Then why you want to stick to this company just because of sunk cost fallacy. Ideally, if any other company is available with good future prospects then one should sell these share, book loses and move there. But more the share price will fall more the investors will stick to it. Both these decisions are not taken rationally but due to sunk cost fallacy. Also anchoring bias is working together here.

– Sunk Cost Fallacy in Life Insurance Policies: It is very common in India to purchase life insurance policies with investment or tax saving motive. Almost every month 4 to 5 clients come to us with a lot of life insurance policies which don’t suit their life insurance needs and have been sold to them as a investment instrument and when we analyse them, return on investment is sometimes hardly 6 or 6.5% p. a.. We prepare a sheet for every policy where we give calculation that if that policy is surrendered at this stage what will he or she get back and from here if that money along with future premiums is invested in another investment instrument it will give them 11 to 12% p.a. kind of returns and at the end of tenure there are very high chances that he or she will receive double the money that they were to receive from Life insurance policy. But to take this decision one has to book losses from current life insurance policy which most of the people are not able to do. The decision of surrendering existing policy and booking loss is psychologically a very difficult decision because of sunk cost fallacy. Even though most of clients agree with logic to surrender the policy, when it comes to surrender and book losses they cannot move ahead due to sunk cost fallacy.

Why we get stuck with Sunk Costs? & How to free your mind from Sunk Cost Fallacy?

In all above cases you will realize that sunk cost fallacy is most dangerous when we have invested lot of time, money, energy or love in something. This investment becomes a reason to carry on, even if we are dealing with a lost cause. The more we invest, the greater the sunk costs are and the greater the urge to continue becomes.  I found following few reasons for this human behavior.

  • First and most important we feel that whatever time, effort and money were invested till now will be wasted if we change our decision. This is fear of wasting. We don’t learn to accept losses(negative outcomes) of our actions. I always recommend my client to learn this and also teach this to their kids. One cannot go correct always.
  • Sometimes we don’t want to leave our ego of being wrong in our decision so we stick to our old decision. But being rational is about coming out of our emotions while decision making which includes our ego. I have seen many times that clients stick to their investment decisions to boost their ego they are not ready to admit their mistakes.
  • We have not anticipated better outcomes of other opportunities. Like in above case of movie, my wife had not though that we had other better options to spend our time which can give better outcome.
  • Sometimes we are afraid of what others will think if change our decision.

To conclude with, rational decision making requires you to forget about how much time, money and effort you have put on an investment or project and consider only future costs and benefits from the same. So while taking such decisions we should not be anchored to cost, effort or time that we have already put in, we should see whether it is beneficial to continue this or no.

How to avoid Anchoring Bias in Investment Decision?

In my last article I wrote about what is Anchoring Bias and we also saw few examples of anchoring Bias.  Now this month I would like to throw some light on how it affects our investment decisions and How to get out of Anchoring Bias?

How Anchoring Bias affects our investment decisions?

 Anchoring is basically a state of mind where we give more importance to first piece of information or some numbers or events while making our decisions. Here we get anchored to that information, number or event while taking any decisions. This happens very frequently in Investment decisions. Let me first discuss few real life examples of anchoring bias affecting our investment decisions and then we will see how to take investment decision without Anchoring effect.

  • Anchoring to purchase price of loss making company: Suppose you have bought shares of two companies, company A and company B.See following table and tell me if you are in need of money and you have to sell any one of these two companies, which one you will sell? Company A or B? Most of the investors will sell company A. Do you know the reason why? Because company B is below its purchase price so they are anchored to Rs. 60 the purchase price. Here decision of selling company A is result of company B operating below purchase price and anchoring effect to its purchase price.  Ideally speaking in this case it looks that company A is doing good and is a fundamentally strong company so one should hold it whereas it seems that company B is not a good company and one should sell it and book the loss. This type of cases regularly come to me where investors have bought some shares and they have gone below purchase price but when I tell them to sell it they tell me they will sell it when it reaches to their purchase price. So actually they are anchored to that purchase price which in this example in case of company B is Rs. 60. Here investors need to understand that  the price at which they bought this company is not at all important now , what is important is that fundamentally whether this company will do good in future or not? , is it at fair price currently or not?  But while taking decision of selling company B they are anchored to purchase price.

  • Share Purchase decisions based on higher share prices in Past: Recently I met with an investor who showed me his share portfolio. There were almost 56 company shares in that portfolio and most of them were in loss. When I started discussing about the reason for buying those company shares individually one by one, most of the times his answer was that “this company’s shares were quoting at Rs. 100 per share around a year back and then it has fallen to Rs. 50 so I thought it will come back to Rs. 100 and I will double my money. So I bought it.” So he was anchored to higher price which he saw. The buying decision was the result of anchoring effect to higher price and not the analysis of the company’s fundamental factors.
  • Anchoring to Past Returns experiences: Between 2003 to 2007 there was bull market in equity and sensex went up from 3000 to 21000 and if you look in to data of good equity mutual funds they were giving returns in the range of 25% to 30% p.a. after that markets collapsed in 2008 and started improving in 2009 and by 2012 investors were again getting around 15% p.a.. Returns of 15% p.a. are also good returns for an equity investment. But those investors who invested between 2003 to 2007 and earned high returns felt that these returns are very low and kept changing their funds and financial advisor believing that they are not doing good job and actually earned less returns due to changing funds and advisors. This happens because while analysing performance of their funds they were anchored to their higher returns experience and so believed that these funds are giving less returns. Due to anchoring bias they could not analyze the current situation of economy and see that overall returns in equity market have gone down. This resulted in wrong reactions of changing funds and advisors.
  • Anchoring to Events: Many times clients who had invested at the time Harshad Mehta Scam are reluctant in investing their money in equity by saying that I made losses in the times of Harshad Mehta scam- this scam took place in 1992 and that was the time many of the investors first time invested in stock market in India and were left out with huge losses which they could not forget. This is example of people getting anchored to events which occur in their investing life at initial stages. They are anchored to these bad experiences and not able to leave them behind and take their investment decisions by doing analysis of current economic fundamental in neutral and rational manner.
  • Anchoring to lower Indices Number: My father many times tells me that in my times Sensex was around 2000 and today it is 28000 so it is very costly. I try to explain him many times that over last 20-25 years economy, consumption, turnover and corporate profits have grown sharply and multiplied many times in India and so Sensex reaching 28k is justified but he is not able to digest this logic and make fresh investment in equity shares because he is anchored to 2000 level of Sensex. This is a very common argument that I receive from many senior clients.
  • Subscribing IPO based on belief that they are cheap: Most of equity market investors believe that IPOs (initial purchase offers of shares) are offered at cheap prices and will give more return. Here people get anchored to some of the past IPOs history where those companies turned to be very successful and investors multiplied their money very fast. But as a matter of fact IPOs are generally offered at significant premium and most of the IPOs don’t yield good returns. So due to anchoring to few past successful IPos  and mindset that IPos are cheaper investors buy IPO.
  • Anchoring to lower purchase price mindset of NFO : When it comes to mutual funds, many investors have tendency to purchase new funds which are launched at Rs. 10 because they believe that this is starting price so they feel it is relatively cheaper and will not fall below this price. So here they are anchored to lower price of the new fund and decision of investing in that fund was a result of that anchoring effect to lower price and not analysis of the characteristics of the fund. But actually when a new fund with Nav of Rs. 10 or an old fund with higher NAV invests in stock market they get shares at same price. Ideally old funds are better as they have more experience and have seen different market cycles.

How to get out of the anchoring affect?

If you will see in all above cases, decisions taken by investors are not based on fair and logical analysis but these decisions are result of anchoring to some numbers, past events or past experiences. While taking any decisions we should be rational and think on the reasoning of those decisions in a logical way and should not get anchored to some number, event or experience. As far as possible our decision should be based on predefined logical process, like in above case of buying shares, decision of buying shares should be based on process driven fundamental analysis of companies business and not based on their historical prices. So to conclude with be careful while taking decisions and try to be more logical and analytical.

How Anchoring Bias affects your Financial Decisions?

Anchoring Bias in Decision Making:

In my last article we saw that while taking our financial decisions mostly we react emotionally. We also discussed left brain: right brain theory as well as System 1 and system 2 theory given by Danial Kahneman. In this article I want to discuss Anchoring Bias which affects our decision making. Let us discuss Anchoring Bias in detail.

What is Anchoring Bias?

Anchoring is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered (the “anchor”) when making decisions. During decision making, anchoring occurs when individuals get anchored to initial piece of information or some number to make subsequent judgments. For example, if you want to take a cable connection at your house and have asked my opinion about ABC cable company and I gave you a bad review about that company and told you that there are lots of complaints against this company and you can check online. Now what will you search on Google, “complaints about ABC Cable company” so here you are anchored to first piece of information. Ideally you should search for “ABC cable company reviews”. There is common tendency in humans that they give more importance to first piece of information while making decisions.

Anchoring bias works more while we have to decide number. In 1974  Kahneman and Tversky two  psychologist conducted a study where a wheel containing the numbers 1 to 100 was there and participants in the study had to spin the wheel and see what number comes on the wheel. Once they spun the wheel and got one number they were asked that whether the percentage of U.N. membership accounted for by African countries was higher or lower than the number on the wheel. Afterwards, the participants were asked to give an estimate. Tversky and Kahneman found that the anchoring value of the number on the wheel had a pronounced effect on the answers given by individuals. When the wheel landed on 10, the average estimate given by the subjects was 25%. When the wheel landed on 60, the average estimate was 45%. The random number had an “anchoring” effect, pulling individual participants estimates closer to the number they were shown even though the number had zero correlation to the question.

One more aspect of anchoring is individuals try to find some anchor while giving answer of a question. For example, if I ask you in which year Gandhiji was born? Now observe how you think and answer my question. Immediately you go back to 1947 and then think that at that time Gandhiji looked around 65 to 70 years old and will answer somewhere near 1880 or 1885. So while thinking this you took 1947 as an anchor and then tried to find answer by deducting Gandhiji’s approximate age. So this is also anchoring effect.

Suppose you are in a market for shopping and you come across a jacket shown in picture which has a price tag of Rs. 1000. Now you like this jacket and want to purchase it so what price will you quote to negotiate? And if the same jacket had a price tag of Rs.1000 after deleting tag of Rs.1500 stating discount Rs. 500 as shown in second image what price will you quote now? In first case when price tag was directly Rs. 1000 most of us will negotiate and quote below Rs. 1000 as per our understanding of fair value but in second case most of us would not negotiate at all thinking that the jacket price is already Rs. 1500 and has offered a discount of Rs. 500 so this is the bottom price. Here in first case Rs. 1000 tag was there so that number became an anchor and in second case first number that was given was Rs. 1500 so that became anchor and we were ready to pay more easily even though in both cases jacket was same and it had not changed value offered in the form of jacket. Isn’t this very common in India? This is a very commonly used pricing policy.

One more example of this is property dealings. If you are negotiating for property with someone and when either buyer or seller speaks some figure then that figure becomes an anchor and negotiations happen around it. For example, if you are selling a house and discussing price with a prospective buyer and you have decided in your mind that you will not sell this house below Rs. 55 Lakhs. If while negotiating price you first put the figure of Rs. 55 Lakhs, then discussion will happen around it and the buyer will put some figure less than 55 Lakhs and matter will generally settle somewhere close to 50 to 55 lakhs. But if you first put figure of Rs. 60 Lakhs then discussion will happen around Rs. 60 lakhs and there are high chances that you will get around 55 lakhs. So in first case when you put 55 lakhs directly the anchor is 55 Lakhs but in second case when you put 60 lakhs you put a higher anchor. Let us take this example further suppose you are a buyer and someone puts a figure of 60 lakhs then both the parties will anchor to that figure but if you want to get out of that anchoring effect then immediately make a big loud dramatic voice and show him like you are shocked with that higher figure, this will help to erase the effect of that number and you will be able to move discussion to another number easily. Another way is to ask many small questions around that number, asking the other party to justify that number. Both these approaches will help you to erase anchoring effect of that first spoken number.

Now as this topic is very long we will continue in next month article with How anchoring affects our financial decisions? and How to get out of it while making financial decisions?

How Psychology plays an important Role in your Financial Decisions?

Till now I have written many articles on different topics of personal finance but this is my first article on “How Psychology plays an important role in your financial decisions?”

When I say Psychology plays important role in your financial decisions, it looks very odd at first instance. Apparently it looks that finance has nothing to do with psychology but let me tell you that your psychology plays a very important role in your success as an investor. Let us see this in detail.

How Investor Returns different from Investment Returns?

I have been in financial advisory practice since last twelve years now, and have observed that equity markets are giving good returns since long but investors are not able to earn that much returns. For example, Sensex which is index of 30 Large cap companies of India was started somewhere in April-1979 with a base of 100 and today it is more than 26000. So it shows that if someone had invested one lakh in Sensex in 1979 then his one lakh has become more than two crores and sixty lakhs in a period of around 37 years. Here returns are more than 15% compounded annualized. But when I look at investors I hardly find any investor who  could earn 15% p.a. kind of compounded returns in their portfolio over such long periods. So why investors are not able earn this kind of returns. Simple reason for this is our mistakes.

This picture shows this very clearly. Investment returns are much higher but investor returns are on lower side. So investments have given returns but investors have failed to gain those returns and this is due to behavioral gap. Investors behave in a manner that affects their returns negatively. In this regard conventional finance theory says that investors are rational and they act in a rational manner while taking their investment decision. Whereas Behavioral finance theory which has been developed off late in last two to three decades says that investors are emotional and they act in an emotional way while taking decisions related to their investments.

Left Brain v/s Right Brain Theory:

Now the question is why investors act emotionally and not rationally while making their investment decisions. There are different theories to this, one very famous and universally known theory is Right Brain : Left Brain theory which says that there are two sides of our brain, left and right. Left brain is more logical, rational, analytical brain which processes numbers, logic,etc., Whereas, Right brain is more emotional, subjective, creative and acts in an intuitive manner. People who are left brain oriented are logical and take rational decision where as people who are right brain oriented are emotional and behave emotionally. But my experience says that people generally use left brain in their own profession or business and use right brain in rest of the areas in life, Let me take an example of a doctor suppose a doctor gets a call from a patient says that his son his suffering from fever and has stomach pain and asks him to give some medicine then what would doctor do? Doctor will not prescribe a medicine on phone he will ask him to bring the patient to hospital and will recommend the medicine only after proper diagnosis. But suppose for the same doctor if one of his best friends, who is also a doctor but keeps reading magazines on finance suggest him to buy shares of a company very strongly what will he do. Mostly doctor will buy those shares. So when he had to take decision in his own profession where his core competence lies he prefers to do detailed analysis but in financial decisions he is ready to rely on a person who is not a professional and don’t want to even see whether he has done proper research or not. He is using left brain in his own profession and right brain in other areas of life. Same happens with everyone, we use left brain in our profession and right brain in other areas of life.

Fast Thinking v/s Slow Thinking System in our Brain:

The second theory is given by Daniel Kahneman, a psychologist and Noble price winner in Economics who said that our brain has two systems, first is system -1 Fast Thinking System  which thinks very fast, intuitive, emotional, subconscious and acts on a snap assessment of situation very quickly. Second is system-2 Slow Thinking System which is slow, rational, logical and reacts to situation slowly after detailed analysis of the situation. Let us see with illustration. If I ask you that 2+2 is how much you will immediately say 4. If I ask you 4+4 you will say 8. But if I ask you 6X9X7X18= then you will stop thinking and make calculations. So when you answered first two questions you used system 1 which is a fast thinking and answered the questions immediately but when the third question came your system 1 could not answer that and the question was sent to system 2 that is slow thinking system for calculation and detailed analysis. Let me ask you one more question here. There is one combo offer in a shop where one chocolate is available with a small candy in total of Rs. 11. There is no discount and price of chocolate is 10 Rs. more than price of candy. Now question is what is the price of Candy? Most of you will say that it is Rs. 1 but think quietly. If price of candy is Rs. 1 then and price of chocolate is Rs. 10 more than price of candy then price of chocolate will become Rs. 11 and total will become Rs.12. But total price is Rs. 11 only. So price of candy is Rs. 0.50. Now think why most of people at first instance give answer that candy’s price as Rs. 1? Because they use System -1 which is fast thinking system because question looks very simple so they don’t do detailed analysis and do snap assessment. This is what happens in real life while taking financial decisions because they look very simple but they are not so simple.

System 1 is the Fast thinking system of the brain which works on emotions, intuitions and snap assessment of the situation and answers questions very fast. System 1 has its uses in the daily life. Suppose you are driving a car and suddenly a truck comes on your way what will you do? Simply you will trigger the break and stop the car. So here you actually did not do any analysis it happens on it’s own. Here system 1 which is fast thinking part of the brain works and stops the car. So system 1 which is fast thinking is a survival system. It helps us to survive because if in above example you use system 2 and do detailed analysis then by that time you will meet an accident.

Both system 1- Fast thinking and system 2- Slow thinking are not opposite to each other, they are complementary to each other and both are important for us. But sometimes we use system 1 – Fast thinking system at places where we should use system 2, and that leads us to wrong conclusions.

While taking investment decisions we make the same mistake we do a basic, intuitive analysis and take decisions based on that analysis so questions which look very simple like above case of chocolate and candy are actually complex and need detailed analysis.

In my next article I will be discussing some psychological biases which affect our decision making process in investments.


Currency Demonetization & its Implications

3Currency demonetization, suddenly this word hits us on the evening of 8th of November, 2016 and we all were shocked with the demonetization measure of Prime Minister Shri Narendra Modi. This article is an effort to understand What Currency demonetization is actually and what will be its Short term & long term Economic implications.

To understand currency demonetization we first need to understand that any currency holds its value as a valid currency of that country due to two basic characteristics, which are as under.

  • Currency is a legal tender by the Govt. of that country to use it as a medium of exchange to fulfil your financial obligation.
  • Currency is a promissory note by Reserve Bank of India. It holds a promise to pay the equivalent amount by the RBI Governor.

In his speech of 8th Nov. 2016, our Prime Minister Shri Narendra Modi declared that from midnight of 8th Nov. 2016, all the currency notes of 500 & 1000 will not be a legal tender. So it lost its value as a medium of exchange in the country but RBI’s promise to pay the equivalent money remains intact till 30th Dec. 2016(after that it will remain valid a some places till 31st March 2017.), if you deposit that money in your bank account or get it exchanged in a bank.

Why demonetization of 500 & 1000 Currency notes was needed?

Total value of currency printed by RBI in India is around 16.4 Lakh Crores Rs. as mentioned with break up in table below. 500 & 1000 Rs. Currency notes in total comes to around 14.2 Lakhs crores which is around 86% of total Indian currency. So cancellation of 86% currency will definitely cause serious liquidity issue in the economy which is more cash driven.


Over last few years demand for currency (hard cash) was increasing in our country. Ideally in a country like India where economy is growing with a reasonably good pace, and banking system is also growing with good pace, demand for currency should reduce. Net fresh issuance of currency notes have increased by 34% in FY15 and 46% in FY16. This raises a possibility of large currency leakages – Money going out of the system (e.g. hoarding of black money or outside India, both are illegal.) It seems that due to tightening of KYC norms, tax laws and monitoring of other financial transaction in different investment avenues like post office, Mutual funds, banks and real estate etc., the black money which was invested earlier in these avenues was now preserved in the form of Cash in high denomination currency notes.

Currency is actually a medium of exchange but when it is preserved and kept in lockers it becomes a commodity to hold black money. This has a serious implication in the economy as this result to poor liquidity in the banking system.

So, Demonetization of 500 & 1000 currency notes is a step to curb black money.Now let us see how big this Black economy is in India?

There are no reliable estimates of black economy. A survey conducted by World Bank in 2007 says that around 23.2% of GDP is running as a black economy. So if we go with these numbers then our GDP is estimated to be 200 Lakhs crores this year and the 23.2 % of this would be around 46.4 Lakhs crores. Avg. Tax incidence in India is 16% so if we tax this 46.4 Lakh crores at 16% then the tax collection would be around 7.42 lakh crores. Our fiscal deficit for next year is estimated to be somewhere close to 7 lakh crores so if we convert this black economy to white we will have no fiscal deficit.

But the question is whether this step of demonetization will lead us to 100% conversion of black economy to white economy. The answer is certainly NO. But it can definitely push 30% to 40% conversion from black economy to white economy.

Consequences of Black Money:

Black money affects not only our economy but also our Social system. Social implications and economic implications of black money are interrelated and have cascading impact on each other. Let us see both the implications in detail.

  • Impact to Economy: When people start holding cash to preserve black money, the circulation of currency is affected very badly. When currency changes hands it turns to income and expense of many people which helps people to satisfy their needs and creates job opportunities for people. Since last few years increasing cash holding in the country resulted to poor liquidity in the banks which made our banking system weaker. Banking system is back born of an economy and a weak banking system with poor liquidity cannot support a fast economic growth.
  • Social implications: There are many social implications of black money. Increasing black money widens the gap between poor and rich which leads to social unrest. Black money also increases corruption and crime. Use of black money in elections by different parties is not anew thing in this country. Currently four state have their elections in March-2017. All these problems make our economy weak and it again creates social imbalance in the country so this is a vicious cycle and has a cascading effect.

How demonetization will help?

As discussed earlier 500 & 1000. Currency notes have lost their value as a legal tender from 8th Nov. 2016, midnight. But, RBI Governor’s promise to pay equivalent amount against these currency notes is still valid, but for that one has to deposit the currency notes to their bank account or get it exchanged from banks. So we are left out with two options as shown in below table.


Option 1: Deposit back the 500 & 1000 Currency notes with bank: People who have cash on hand in 500 & 1000 Currency notes which is accounted and tax paid money will deposit it back. A prediction says that around 10.62 lakh crores will come back with in the banking system. This will improve liquidity in our banking system which in turn will help us to strengthen our Economy.

Option 2: Don’t Deposit back in Bank: Those who have black money in the form of 500 & 1000. Currency notes will not be able to deposit it in the bank. A rough estimate says that around 4 Lakhs crores will not come back to banking system. So, on these currency notes, which will not return back to Reserve Bank of India, RBI’s liability to pay back will be over so this will result to profits to RBI and Govt. Now RBI can print new currency of equivalent amount and Govt. Can increase its expenditure towards infrastructure and other areas to spend this money. This will lead to increase in the income of people which ultimately will boost the economy.

Impact on different sectors: Different sectors will have different long term and short term impact of currency demonetization which is as under.

  • Interest Rates: Due to this action by Govt., Interest rates will fall sharply in short term and will also remain at low over medium to long term. This will bring down fixed deposit rates. Along with that loan interest rates will also fall sharply.
  • Inflation: over next 3 to 6 months demonetization will create deflationary pressure which will result to very low inflation in the country. Over medium to long term there will be neutral impact on inflation.
  • Real Estate: Over short term real estate prices can fall sharply. Real estate where there is no cash portion in the price will have relatively less impact. Over long term, if interest rates fall sharply and stay at low level this can have positive impact on real estate.
  • Equity Market: Due to currency crisis, consumption will fall and this will affect corporate results for next one or two quarters. So equity markets will also remain volatile till that time and are expected to fall sharply. But over long term it seems that we are entering in a new bull market cycle.
  • Gold Prices : Gold prices will not be affected much as they are internationally drive but demand for gold particularly against cash will fall sharply over short term.

To conclude with, this step will cause some pain over short term to common man but over a long term this may lead to a new beginning to the country and common man will be the beneficiary.

All about Section 80C of Income Tax Act.

pic2Sec 80C of income tax is most popular section for Small & middle tax payers. Deduction is available only to Individual tax payer and HUF. Deduction available u/s 80C is Rs. 1, 50,000/- from Financial year 2014-15 (before it was Rs. 1, 00,000/-) to all assessees, means if Assessee is in  30% tax bracket  than He/She can save Rs. 45000/- tax (30% of 1,50,000).

Let us discuss deductions in brief.


Life Insurance Premium

In case of Individual –

Individual can claim deduction for life insurance premium paid for himself, spouse and children (dependent or independent) but deduction not available for Premium paid for parent’s life insurance policy. If individual has more than one life insurance policy than deduction available to aggregate of all premium paid. It is not necessary to have the insurance policy from Life Insurance Corporation (LIC) – even insurance bought from private players can be considered here.

In case of HUF-

Individual can claim deduction for life insurance premium paid for members.

Provident Fund & Voluntary Provident Fund

Amount deducted from salary and deposited in Provident fund by employer (in case of salaried person) than it is considered to be investment and it is deductible u/s 80C .

Assessee has option to contribute additional amount through Voluntary provident fund and it is also considered as investment and deductible u/s 80C.

Public Provident Fund

In case of Individual-

Assessee can claim deduction of Amount deposited in PPF A/C of himself, wife and children’s (dependent &independent). PPF interest is exempt from tax and maturity amount is also exempt from tax so it is one of good investment scheme.

In case of HUF-

HUF can claim deduction of Amount deposited if PPF A/c of members.

5 Year Fixed Deposit & 5 Year Post office time deposit

Tax saving fixed deposit and post office time deposit of 5 year tenure is liable for deduction u/s 80C but interest earned on it is fully taxable. There are special fixed deposits in the bank which have maturity period of 5 years and are eligible for deduction under section 80C. Similarly Post offices also have a  5 year time deposit scheme which is also eligible for deduction under section 80C.

National Savings Certificate (NSC) (VIII Issue): 

NSC is a time-tested tax saving instrument with a maturity period of five Years. Presently, the interest is paid @ 8.10% p.a. on 5 year NSC.

Premature withdrawals are permitted only in specific circumstances such as death of the holder. Investments in NSC are eligible for a deduction of up to Rs 150,000 p.a. under Section 80C. Furthermore, the accrued interest which is deemed to be reinvested qualifies for deduction under Section 80C. However, the interest income is chargeable to tax in the year in which it accrues.

Stamp Duty and Registration Charges for a home:

This is not much known by the tax payers that the amount you pay as stamp duty when you buy a house and the amount you pay for the registration of the documents of the house can be claimed as deduction under section 80C in the year of purchase of the house.

Repayment of Housing loan Principal:

Deduction is available of Repayment of Principal Amount (not interest amount) of Home loan taken from specified financial institutions or entities like your employer a public limited company, central government or state government or board, corporation, university established by law. However in respect of loans taken from your relatives though you can claim deduction under Sec

tion 24b for interest, the deduction under Section 80 C for repayment is not available.

Deduction is available from Assesse has taken possession of property and if property sold within 5 year of possession than deduction claimed in earlier years is taxable in the year of property sold.

First time home buyers will get additional exemption of upto Rs. 50,000/- on interest paid for loans upto Rs. 35 lakhs with cost of home upto Rs. 50 lakhs but property should be purchased between 01/04/2016 to 31/03/2017 and loan to be sanctioned during this period only.

Infrastructure Bonds:

These are also popularly called Infra Bonds. These are issued by infrastructure companies, and not the government. The amount that you invest in these bonds can also be included in Sec 80C deductions.

Pension Funds – Section 80CCC :

This section – Sec 80CCC – stipulates that an investment in pension funds is eligible for deduction from your income. Section 80CCC investment limit is clubbed with the limit of Section 80C – it means that the total deduction available for 80CCC and 80C is Rs. 1.50 Lakh. This also means that your investment in pension funds up to Rs. 1.50 Lakh can be claimed as deduction u/s 80CCC. However, as mentioned earlier, the total deduction u/s 80C and 80CCC cannot exceed Rs. 1.50 Lakh.

Senior Citizen Savings Scheme 2004 (SCSS):

Amount deposited in SCSS is deductible u/s 80 C. The account may be opened by an individual, who has attained age of 60 years or above on the date of opening of the account. & who has attained the age 55 years or more but less than 60 years and has retired under a Voluntary Retirement Scheme or a Special Voluntary Retirement Scheme on the date of opening of the account within three months from the date of retirement. & No age limit for the retired personnel of Defense services provided they fulfill other specified conditions.

Education Expense:

Assessee can claim deduction of Tuition fees paid for Children’s education purpose (restricted to only 2 children’s) but educational institute must be in India and deduction is available for tuition fees only. So any amount paid as development charges, library charges are not deductible. Here tuition fees don’t mean that fees of private tuition classes.

Sukanya Samiriddhi Account:

Sukanya Samiriddhi Scheme Launched by Prime Minister Shri Narendra Modi on 22 January 2015 for a girl child. Any amount deposited in the Sukanya Samiriddhi Account is deductible u/s 80C. Interest earned on account is Tax free and Amount received at the time of maturity if also tax free. Interest rate is 9.1% for FY 2014-15 ,9.2% for FY 2015-16 and 8.6% for 2016-17. Minimum amount can be deposited in one year is Rs.1000/- and maximum amount can be deposited is Rs. 1,50,000/-.

Equity Linked Saving Scheme (ELSS):

ELSS of Mutual Funds are more popular since they are giving good returns in long run and lock in period is just 3 years which is shortest lock in period in saving based investment u/s 80C. In case of investment done by SIP than each SIP installment is treated as separate investment for lock in period purpose.

To conclude with section 80C is a very comprehensive section which offers deduction of Rs. 150000 in total for all above investments or expenses from income directly. Tax payers should understand all these investments and expenses and plan their finances accordingly to take full advantage of this section.