FirstStep

An experiential exercise to initiate children to the world of Personal Finance

Once upon a time, a child was born in a lovely home with the quintessential hard-working disciplined father, the over-protective mother and the obnoxious sibling; and as the child grows up, s/he realizes quite early and unknowingly in their subconscious mind that it’s not all hunky-dory, and that everyone has to do one seemingly useless activity called ‘work’, for it pays for all of those things that one wants.

We, as parents try to do the same as well; we all want our children to do better than us and get more than what we got. And as our parents, we too have goals, dreams and aspirations and some of us have achieved them, and many of us are working towards achieving the same.


That’s pretty much the story for most of us.

As children, we were always told to evaluate between ‘needs’ and ‘wants’; and that is the understanding with which we all grew up. Some of us were fortunate and some not so fortunate. Nevertheless, our parents made all the efforts to ensure that we get all that we need and want.


Having said that many of us may benefit from a higher understanding of finance. Infact, you would agree that as we grew up, we were exposed to various subjects that enabled us to become professionals and earn money. However, personal finance was not a subject that we got adequate exposure to. And we would have benefitted had we got the correct set of inputs at the right age.

Keeping the same thought in mind, we went ahead and created FirstStep. The design of the program is such that the learning happens on the fly, as the exercise proceeds. Having said that the program has a formal debrief as well. The exercise aims at giving students an exposure in taking decisions about their expenses around their needs & wants, and bank deposits & investments which would fetch them a return. The game expects them to manage all of this for a period of one year (June - May).

The program is divided into four parts.
a. Briefing
b. The Game
c. The Score Card
d. Debriefing

a. Briefing

This section is the most crucial one, as we had to be extremely cautious about the fact that we are dealing with children. While children are quick at grasping, but because it is not a subject that they usually deal with, it takes them that much extra time to get a hang of it. However, thereafter, it is a smooth sail. The biggest challenge is to organise the students into teams of 5 and to get them seated without creating too much of confusion. Each team is to appoint an accountant in the team who interact with the Provisioner. 5 such teams are mapped to 1 provisioner. The provisioner is the person with whom the teams interact throughout the exercise. During the briefing, the children are exposed to 3 critical aspects of the game:

i) Understanding Income, Goals & Expenses, and the rules around them.

Income: The teams start with savings from last year, and they are told that they shall get a fixed monthly pocket money every month.

Goals: Teams have to decide upon two goals that they will have to achieve through the year. They are given a fixed choice of goals to choose from. These goals are things that they may want. However, in all cases the choice are such that the variants of the same products may fall in the realm of 'needs' and 'wants'. For example, in the entire list one could find a low-end mobile phone and a blackberry. The students are supposed to choose a minimum of 2 goals from the list.

Expenses: Students are explained that they will come across some mandated expenses such as canteen expenses &entertainment expenses, and some optional expenses. They have to manage within the budget available. They are also expected to buy two pairs of shoes and the goals have to be purchased within the year as well. For some purchases, there may be bonus points available, and they are a reflection of prudent decisions made.

ii) The activities to be done

To begin with, the students are given an accounting pack which contains the previous year's savings, an blank account book (two pages), pens, goal/expense cards etc.

The steps of the activity per se are fairly simple, however, the managing accounts is seemingly tough because most (~99%) aren't used to and they probably have never seen their parents managing their accounts as well.

Every month is for five minutes. During this time, the students will be shown the monthly expenses (regular / optional)

Step 1: Collect pocket money from the provisioner

Step 2: The participants need to fill up the monthly account statement (Expense, Saving, Banking, Investment).

Step 3: Rush to their Provisioner, pay for their expenses (regular/optional) and close the monthly account statement. Incase they decide to deposit money in the bank or invest their money, they need to collect bank / investment certificates. Incase they buy any of their goals or the two shoes, they need to collect cards against them.

iii) Money Management

This is section which decided whether they make the money or not. Participants have 3 choices for keeping their money. All the modes are completely liquid in nature; that is money can be withdrawn from the bank or one's investments whenever they need. However, interest is applicable monthly and on the money available in the instrument.

i) Cash-in-Hand: Doesn't give any returns

ii) Cash-in-Bank: Gives a return of 0.5% per month, however minimum deposit at one given time is of Rs. 200, and thereafter in multiples of 200.

iii) Cash Invested: Gives a return of 2.0% per month, however minimum deposit at one given time is of Rs. 500, and thereafter in multiples of 500. Investments, in our game, are not subject to market risk!!!

b) The Game

The game is simple to execute. There are 12 months on 12 slides that give them regular & optional expenses. The months are supposed to run for 5 minutes, however, the first three months take about 25-30 minutes, as children need to get used to the idea of filling up their account statement. The image is just an example of how a typical month looks like. The activity to be done is explained in point a (ii).

c) The ScoreCard

This is an important step. While designing we kept two things in mind in so far as the output is concerned; we wanted the children to feel proud of their accomplishments and at the same time get their minds of 'how much money they made'. The scorecard is complicated, however, it is effective in meeting our thought behind the output. The calculations are done manually. At this stage the bonus and interest accrued as a result of deposits in the bank and the investment vehicle are taken into account. Finally the Goal Card is filled up which factors in not only the accruals, but also rewards their work by increasing their asset value and further more uses a coefficient factor to turn the asset value into points. These points help decide as to which team has made more money out of the available resources.

d) Debriefing

The debriefing is important, and the learning needs to be drawn out from what happens in the session, although using the basic framework of questions mentioned below:

i) What was our objective?

ii) Why does the Goal Card give different weightage to goal achievement vis-à-vis cash-in-hand or why is there a different weightage for cash-in-bank vis-à-vis money invested?

iii) How could we play better next time?

iv) How do we differentiate between ‘needs’ and ‘wants’?

v) How is money earned?

vi) What are the avenues of saving?

a) Do you have savings goal?
b) What are the ideas on how to save more?

vii) Do you have your own savings account?

=> What about an Investment Account?

viii) Should we take loans?

ix) What are fixed deposits or Systematic Investment Plans?

=> How can they help you achieve your goals?
=> What do you know about the power of compunding?

At the final stage, we have reiterated that 'Habit comes from Practice', and that the children should discuss their goals with their parents or someone who can & will help them.

As a follow-up of this session, a special initiative for the parents is planned out. Under the aegis of various regulatory bodies of the Financial Services Industry, our organisation, Reliance Mutual Fund has planned an Investor Awareness Program which is essentially a Personal Finance Workshop designed especially for the parents, aimed at

a) exposing parents to the learning that have been shared with thier child, and
b) share inputs with them to establish and manage their personal goals such as children’s education & marriage, their retirement, their home etc by making simple systematic investment plans involving mutual funds.

As a parent myself, I truly believe that this two-hour workshop will help the parents, as a family. Their actions will become a model for their children.

Please send in your feedback & suggestions which will help improve this effort. The pilot program was conducted for 275 students of Ryan International School, Kharghar, Navi Mumbai.

A special thanks to Sumit Kati, Shyamac Jal, Maadhavi Samant and Jayant M Parneria for being part of the team which created the program, and to same set of people and Mihir Shah, Vikram Masand, Gaurav Warman and Krupali Jhaveri for helping execute the program.

Portfolio Construct

How Many Mutual Funds Should You Have in Your Investment Portfolio?


This is a trick-question as how many and which type depends upon a host of factors such as my risk appetite, financial goals etc.

Time to take an inventory of your mutual funds. How many are there? What are their investment styles? Is your portfolio of mutual funds cluttered just like your closet? Have you owned some mutual funds so long that you have forgotten why you bought them? Are there some mutual funds on the top shelf, way in the back of your financial closet you haven't even looked at in a while?

Adding new mutual funds to your portfolio is far easier than reorganizing your fund portfolio and discarding inappropriate, redundant, or simply poor-performing mutual funds. The answer to the question of how many mutual funds you should have in your portfolio is not just a number. But if you have many more than eight mutual funds in your closet, chances are you need to do some serious portfolio cleaning; and here's why.

First, in order to be well-diversified, your mutual fund portfolio should be invested in stock mutual funds and in fixed-income mutual funds or income fund equivalents. Within the stock mutual funds, your mutual funds should cover large-cap stocks, small-cap stocks, and mid-cap stocks.

In case you are making investments across the shores, one should cover established firms in industrialized countries and stocks of countries that would be considered emerging markets. While geographic diversification domestically is relatively unimportant, diversification by region for foreign investments is. Representation in Europe for large stock international mutual funds is important, and investments in Latin America and the Pacific Rim are crucial when considering emerging stock mutual funds. Global mutual funds that invest domestically and abroad sound like a one-fund answer, but it is too much geography for one portfolio manager to cover and global funds tend to change domestic/foreign portfolio weights as world conditions change, neutralizing some diversification benefits.


Counting the Mutual Funds
Let's stop and take a count: one large-cap fund, one small-cap fund, one emerging sector fund—so far, three mutual funds. Have we missed the mid-cap stocks? Well, check your large-cap fund and your small-cap fund to see what they include. Usually, large-cap funds leak down into the mid-cap range and small-cap funds push up into the mid-cap range. If not, add a mid-cap mutual fund to avoid any portfolio gaps. Now we may be up to four, all of which are stock mutual funds at this point.

If you want income and the diversification benefit of a fixed-income fund, then a simple choice would be to consider Debt mutual funds with a decent focus towards Government Bonds. These funds on a 3 to 10 year weighted average maturity deliver stability in the portfolio and captures most of the yield of longer-term mutual funds when interest rates change. If you are in a high tax bracket, a stable tax-saving fund might be a better choice. Aggressive investors can reach to high-yield corporate bond funds and while these funds invest in lower-quality corporate debt that pays high income, the individual default risk of the bonds in the portfolio is softened through diversification and the high income dampens portfolio volatility. Furthermore, high-yield bonds tend to be sensitive to the economic cycle, acting more like stocks than government bonds.

So, if we add one to our fund count for a fixed-income fund we have a total of five mutual funds; and another in GILT securities fund would push the kitty to six.


Other Categories of Mutual Funds
What about all those other categories of mutual funds? Do you need a gold fund, sector fund, index fund?

Let's take them one at a time...

Gold mutual funds are concentrated sector funds holding gold mining stocks primarily in North America, South Africa, and Australia. They are extremely volatile, as gold price changes are magnified by the operating cost break-even points of gold mining firms. Do you need a gold fund in your portfolio? No. Most investors use gold funds as a store of value, a hedge against inflation. Over the last decade, however, they have been neither. When stocks are roaring up, you would like your gold fund to behave like a stock, but it tends to act like gold bullion. When the stock market collapses, you hope your gold fund behaves like gold bullion, but unfortunately, it tends to act more like a stock. Hence, I would then rather take a Gold Exchange Traded Fund which is Gold Bullion in that case and would actually provide the hedge the portfolio needs especially given the volatile times we are in.

Sector mutual funds concentrate on one industry or a few closely related industries. Because they are concentrated in an industry, they are not well diversified. Beyond the additional risk, the trick to master is just which sector funds to invest in. At the top of most "best-performing mutual funds" lists will be some sector funds, but they'll also appear on the "worst-performing mutual funds" lists—it's just a question of when. Most aggressively managed stock mutual funds concentrate in some industries and might be viewed as a combination of sector funds. Few investors are willing and able to place sector bets unless they have particular experience in a sector through their education, work experience or vocation, and if they do have expertise, selecting individual stocks may be more rewarding. So, unless there are strong convictions on a sector and one doesn't really have the time to pick up stocks

Do index mutual funds have a place in your portfolio? Yes, but they don't add to the number of funds. They simply are another way of managing your assets in one of the fund categories necessary for a rational, well-diversified, non-redundant mutual fund portfolio. Index mutual funds should be employed in a situation where even the brightest and best of portfolio managers using superior timing and stock selection decisions would have difficulty overcoming the cost advantage of an index fund. Areas of the markets that are efficient, have readily available information, are well-researched and followed closely by the investment community, or are simply not susceptible to very profitable analysis are candidates for indexing. These markets have attributes that make intelligent, thorough analysis more likely to contribute returns that can overcome the cost of active fund management.


Style Diversification in a Portfolio of Mutual Funds
An added classification for domestic funds is investment style—mutual funds can be categorized as growth or value, or both. Growth mutual funds would typically invest in stocks with high earnings growth expectations; value mutual funds would invest in stocks with low prices relative to earnings and net asset values. The style label should be based not on what the fund says it is or what it says it will do, but on what it does. Investment style classification should serve to help investors avoid redundancies and coverage gaps. But they also beg the question, "Should a portfolio of stock mutual funds be diversified by style as well as size of stocks?" Size, yes. Style, perhaps.

Many mutual funds operate in more than one stock size range and many use approaches that are classified as both growth and value. Do you need a value and growth fund in each stock size category? No. One value fund, and it might be the large-cap fund, and one growth fund covering the mid-sized and small stock area provide coverage of size and style. An index fund can be both growth and value, and more extensive indexes will cover value and growth for more stocks and stock size ranges.


Eight Is Enough…
Understanding the style and stock size characteristics of mutual funds will help prevent duplication and unnecessary run-up in the number of mutual funds in your portfolio. Now, back to our count of mutual funds: We left off at six with one fixed-income fund, or seven funds with a fixed-income fund and GILT fund. Add a money market fund and the counter clicks to eight. Be sure you can justify adding mutual funds to your portfolio beyond eight. Make certain you need them, that they truly cover new ground in asset type, geography, or investment style, and that the addition is meaningful.

Taking the time to create an organized, understandable, appropriate and efficient portfolio of mutual funds may be your most important investment.


But, What if one doesn't have time...
Off late, funds with hybrid asset allocation have become popular. These funds invest in different assets (debt & equity) on the basis of predefined asset allocation (moderate / low / aggressive). Also, there are funds with dynamic asset allocation on the basis of statistical models (quant models). Investing in these funds would enable you to have the same exposure to asset classes and reduce the number of overall investments. This is best suited for a person who doesn't take active calls between equity & debt.



The response is inspired by John Markese's response to a similar question put up to him in the AAII Journal, and adapted to the Indian context. John is the President of AAII, the American Association for Individual Investors. I also thank Rajnish Girdhar, Anamika Mattey and Manish Rangwani for their inputs.