Posted in Financial Gyan

The Cobra Effect

The term Cobra Effect originated in an anecdote set at the time of British rule of colonial India. It is particularly important to know about it especially for the decision makers. If you are in a role which is responsible for making decisions which impact a large number of people, you must read it.

The Cobra Effect is a term in economics. It refers to a situation when an attempted solution to a problem makes the problem worse. And here is the anecdote from the British rule when the term is said to be coined.

For some reasons, there were too many venomous cobra snakes in Delhi. People were dying due to snake-bites and it became scary for almost everyone to step out of their houses. The government of the day had to get into action to stop this menace and it offered a silver coin for every dead cobra. The results were great, a large number of snakes were killed for the reward.

Eventually, however, it led to some serious unwanted consequences. After a short-term dip in cobra population, it started going up. This was because few people began to breed cobras for the income. When the news reached the government, the reward program was scrapped, causing the cobra breeders to set the now-worthless snakes free. As a result, the cobra population further increased. The solution for the problem made the situation even worse. The unintended consequence for a well-intentioned idea led to making the problem worst.

Trying a new solution?
Planning to tackle an existing problem with a new idea?

Well, it’s time to pause and think about how people would respond to the new idea that may sound great on paper! Specially the solutions that try to affect how people behave. There’s always a certain group of people who have a tendency to game the system -intentionally or otherwise.

They have a tendency to take short-term advantage of any situation though that may lead to harm to them & society-at-large only in the long run.

Every solution has consequences and those consequences may lead to certain situations where rather than solving a current problem, you may end up with more complex problems.

Few more examples: A similar type of incident like increasing cobra-population occurred in Vietnam. The rulers realised that there were too many rats in Hanoi and spread of plague was imminent They created a reward program that paid a prize for each rat killed. To obtain the bounty, people would provide the severed rat tail. After initial success, the officials, however, started noticing rats with no tails. The rat catchers would capture rats, cut off their tails, and then release them back into the sewers so that they could breed and produce more rats, thereby increasing the rat catchers’ profits.

As they say the road to hell is paved with good intentions, the similar mistakes are happening around us everyday when the decision-makers fail to take a 360 degree view of all the possible outcomes of an action before implementation.

Nearly 2 years ago, city of Philadelphia in USA passed a “soda tax” – a US $1 tax on a typical 2-liter bottle of soft-drink- as a “sin tax” in the national war on obesity. But the natives didn’t cut calories as a result of the tax on sweetened drinks, nor there was a shift towards any healthier option. Instead, most of them just drove outside the city to buy the same colas , from stores where they didn’t have to pay the tax. But the poorest paid more as they could not find it affordable to drive out of the city to buy their drinks. In the end , city suffered loss of revenue due to lower sales whereas the lower section society paid more .

The unintended consequence for a well-intentioned idea led to making the problem worst.

Even big & brilliant companies do the same mistake!

It is not that mistakes happen only with the government run programs, there’re n numbers of examples in great private companies too where the best & brilliant people lose sight of certain negative outcomes due to the initial magic of seemingly great looking ideas.

The Nano Car – a small car that could never it make it big !
The car once touted as the world’s cheapest, Tata Nano, ran into a dead end as sales and production went down to a trickle. The poor demand resulted in Tata Motors shutting down the plant.

A car considered as a brilliant product, launched in a segment having a billion dollar opportunity. Hope ran high , the company expected all present and potential two-wheeler owners would shift to Nano.

But they forgot to dwell deeper – a car marketed as ‘the cheapest car’, created huge initial interest. But it never took off. Later on, Ratan Tata admitted that the reason for failure of this idea was none other than the term which became synonymous with Nano – “The cheapest car”. Buying a car in India is associated with social status and prestige; if a person owns a car, he is assumed to be successful and settled. But the word ‘cheap’ in its marketing campaigns spoiled everything.

The company also failed to dwell upon the competition from used-cars. Used cars from other companies, which were much better in quality, space and mileage were available to the same customer-segment at the same or lesser price than Nano.

An intelligent team of people failed to think about the above likely outcomes because it became temporarily blinded by the brilliance of such a great idea, by the idea of tapping a billion-dollar opportunity.

Apple turning sour!
In 2017 Apple admitted that it was slowing down the speed of old iPhones as the batteries of those old phones were degrading with the passage of time. To make up on loss of brand image and to satisfy its erstwhile customers, it offered to cut its US $79 battery replacement feed down to US $29 as a way of apologising. This lower fee led to more people in 2018 ended up swapping their batteries — instead of upgrading to the latest iPhone models thus affecting new iPhone sales. As iPhone batteries became cheaper and easier to replace, fewer people are shelling out for new iPhones that can now cost up to US $1,449.

In January that year, Apple revealed that it was expecting a $9 billion loss in revenue due to weak iPhone demand that’s partly caused by more people replacing their batteries, according to a letter issued by CEO Tim Cook addressed to investors.
Slowing down of iPhones sales can be attributed to many external reasons too (better Chines phones, better Apps on Android phones etc ), but strategy of battery-replacement was an internal idea. It would have been handled better if people at top would have thought more about it , if they would have filtered this program from Cobra effect.

What’s in it for you ? Next time if you or your team has some brilliant idea , get your brilliant guys together in a room and think about the Cobra- effects before implementing that idea.

You can always fine-tune the idea to minimize the negative implications by spending few extra hours/days before rushing to announce it. Don’t rush to implement it while you’re under the awe of the brilliance of a never-tested, nice-looking solution or idea, think about the Cobra-effects first.

Posted in Financial Gyan

Easy Steps to Create a Goal Based Investing Portfolio

After having learned about “Goals Based Investing” and its benefits, today we are going to learn the simple steps to create a goals based portfolio. There are no pre-requisites to this exercise. All you need is willingness to explore this investment philosophy and evaluate the benefits vs your current approach and then decide for yourself.
Obviously, you will have a few questions around this concept and we will address them as we proceed. If you still have queries, please feel free to post it in the comments, I will try to address them. The first possible question that may come to your mind may be “What about my existing investments? Do I have to start afresh?” You do not have to start afresh. Once you are clear about your financial goals, you should be able to align the existing investments to some of your goals. So let’s get started by first taking a look at the many benefits of this approach –

  • Goal based investing is an investment framework which helps you align your existing as well as new investments to your financial or life goals.
  • It helps you diversify your investments as it helps you understand the right type of investment for each goal.
  • It ensures that you are aligning your investments as per your priority
  • It helps you avoid impulsive financial decisions so that you do not have to regret later

Let’s get started.

Step 1 : List Your Financial Goals

Create a list of all your financial / life goals such as buying a house, kids education, dream vacation etc etc. Against each financial goal mention the approximate amount you think you will need and the time period in which you want to accomplish them.

In the first pass don’t be bothered of being too accurate with the years or the amount required, ballpark numbers will do to get started. However it is important to capture all the goals.

For instance you may need INR 20 lakhs as down payment for buying your own home in the next two years. Or you may need 1 Crore for your retirement after 30 years. Or you may need 5 lakhs for your vacation abroad or or 3 lakhs for the downpayment of your new car next year. 

Financial GoalAmount RequiredBy When
Down payment for New House 20 Lakhs May 2021
Retirement Corpus1 Crore Dec 2049
Singapore Family Vacation5 Lakhs Jun 2020
Down payment for New Car3 Lakhs Jan 2020

Step 2 : Prioritize Your Goals

Once you have created the list, take a close and thoughtful look at it. Decide which financial goals are the most important. And which ones are more important than the others. Start numbering them in the order of priority. It is natural to have conflicting goals and you may have to make some uncomfortable choices. 

For example goals like your kids education or saving for your own retirement are non-negotiable. While there may be others which are essential for financial security like having an emergency fund equivalent to at least 6-9 months of your current monthly income. And then there are those discretionary ones like buying a new car or vacation abroad which you can prioritise depending on your flow of income.

Step 3 : Decide on the Investible Surplus

Now you know WHAT your financial goals are. Let’s look at HOW to achieve them.
Based on your current income and expense, think about an amount that you are willing to put aside each month towards these goals. This is the amount you have surplus after meeting your daily/weekly/monthly expenses. Do include the amount you are currently investing in SIPs or RDs. Let’s write it down as we are going to be using this in our next steps. In the first pass write down a number that you are comfortable with. In subsequent reviews you can revise this number depending on the availability of funds.

Step 4 : Map the Investible Surplus to the Goals

Let’s assume you have committed to invest INR 50k every month.  This amount needs to be divided among the various goals depending on their priority and time horizon. So first you have to calculate the monthly investment required to achieve each goal.

Financial GoalAmount
By WhenMonthsMonthly Investment
Required for Goal
Down payment for New House 20 Lakhs May 20212483333
Retirement Corpus1 Crore Dec 204936827174
Singapore Family Vacation5 Lakhs Jun 20201435714
Down payment for New Car3 Lakhs Jan 2020837500

Once you do this exercise it is quite possible that the investible surplus you have decided may not be enough to fund all your goals adequately. This means you will have to review your goals once again. By review I mean, you may have to either revise the amount required or the timeline of the goal or increase the monthly investment. Based on your priorities you may have to go through a few iterations to arrive at an acceptable balance.

Step 5 : Understand Your Risk Appetite

At this stage you are equipped with the knowledge of which goals are you chasing and how much you are willing to invest towards each of them. Now we need to decide WHERE are we going to invest this amount. For this we first need to evaluate your risk appetite for the short, medium and long term.

Simply put, risk appetite means how much money are you willing to lose on an investment. It can vary for different individuals based on their current financial situation, age and confidence level. Also there is no good or bad or one size fits all approach. Each person’s situation is unique. Look at the table below and calibrate your own risk appetite.

Sometimes your risk appetite may vary according to the time period. You may be willing to take higher risk in the short term and invest in stocks/equity directly where you feel more confident of being able to absorb the downside (if any). However you may want to stick to safer investment options for your long term goals or vice versa. 

Step 6 : Decide the Investment Type for Each Goal

There are a plethora of Investment Options available now-a-days but to keep this discussion meaningful I will restrict the discussion to the few tried and tested ones viz. Mutual Funds, ELSS, Stocks, NPS, PPF, NSC etc. One you understand your risk appetite and depending on the amount you have for investment you could try investing into Bitcoin, F & O, Commodities, Real Estate, Art and what not.

To start with, take a look at your existing investments and map them to some of your goals. For example if you have recently started a PPF account, you could map it to partially fund a goal which has a time horizon of 15 or more years. Similarly, you could map the corpus of your PF and the amount invested in NPS to your retirement goal and so on.

Now look at the goals that need to be funded. Depending on the time horizon, risk appetite and amount required you could invest in MF, Equity, ELSS or a Debt/Liquid fund. After deciding on the type of investment, note down the monthly amount you are committing to invest towards that goal. If you are investing in Mutual Funds, then SIP is the best way to fund your goals on a month-on-month basis without having to go thru the hassle of manual intervention.

Obviously, managing your wealth is not a one time activity. To ensure that your money continues to earn and grow, you will have to periodically review your portfolio and tweak it if required to meet the changing needs, disposable income and other factors. You may have to do a couple of iterations of your Goal Based Portfolio to make sure that you have reviewed it thoroughly and are ready to implement it. Feel free to share your comments and/or questions and I will try to answer them.

Posted in Financial Gyan

Timeless Wisdom of Warren Buffet

Never depend on single income. Make investment to create a second source

If you buy things you do not need, soon you will have to sell things you need

Do not save what is left after spending, but spend what is left after saving

Never test the depth of a river with both feet.

Do not put all eggs in one basket.

Honesty is a very expensive gift. Do not expect it from cheap people.

Posted in Financial Gyan

Million vs Billion

People don’t have a strong intuitive sense of how much bigger 1 Billion is than 1 Million. You may say 1 Billion is 1000 times 1 Million but even this does not really give you a real sense of the magnitude of difference between the two.
Here are 2 illustrations that may help you fathom this –

1 Million Seconds is 11.5 days…
1 Billion Seconds is 31.7 years.

Next let us compare the two in terms of $100 bills. How the two numbers stack against each other in physical terms. Here is a rather impressive presentation of one billion dollars in $100 bills.

one billion vs one million

Did you notice the the small bundle of notes in front of the ten big stacks – that bundle is one million dollars (in $100 bills).

Posted in Financial Gyan

Goals Based Investing

“Goal Based Investing” though a relatively new concept in the world of investing, is catching the fancy of many investors due to its various benefits. (And we are going to learn about them soon.) Once you learn more about this concept it seems more like common sense. (But common sense is quite uncommon) – so let’s learn a little bit more about this investing concept.

As the name says, in Goal based investing, you invest in specific goals such as your kids education, a vacation in Europe or saving for the dream house rather than generic investment and focusing on generating the highest possible return or beating the market. To start with you are required to list out your financial goals that you want to achieve. And then design an investment strategy that enables you to accomplish these goals in the best possible manner.

Most traditional investment frameworks start with assessing your risk taking ability  – Conservative, Moderate or Aggressive.  Then they use various indexes to show whether you will be able to beat the market but it does not specify whether you will be able to reach your financial goals.

Advantages of Goal based investing – 

  • Greater commitment of the investor as he is saving towards his own goals and he is able to track his progress 
  • Reduces chances of impulsive decision making due to sudden market fluctuations or availability of spare funds
  • Investor can relate to the entire process as it directly relates to a set of tangible goals 
  • Encourages a disciplined way of investing – whenever the person has some spare funds he is more likely to channel it to his current goals rather than get carried away by the sales pitch of some financial advisor
  • Helps have peace of mind w.r.t investing as he watches his investments grow

Also I have seen most investors struggle with the question of “When to book profits on investments?” In the absence of defined goals, it becomes very difficult to stay invested during market volatility or get carried away due to greed during a bull run. However when you are following a goal based investing approach, the process takes care of this dilemma. You book profit when a goal is attained. Period.