Wednesday, July 23, 2014

Basics of investing

I am an amateur value investor. I am, and have always been, interested in business, finance and economics. Recently a few friends and team mates have asked me about how they can get started investing in stocks. I have few thoughts about the goals and process of investing that are relevant and important but unknown to most folks. I hope to shed some light on them in this post.

Investing is unique to every individual

This is one of the most important points to remember when you wish to start investing. Investing, to define simply, means growing your savings at a certain rate of return. This definition implies that you don't lose money when investing. Most people save for a future event like paying for a wedding, buying a house, kid's college education, retirement, etc. These events are unique for every individual based on their desire, ambition and life style. Investing is tool to achieve one's unique goals and thus it has to be tailored to their needs.

For example, a recent college grad (Bob) has different goals than some one who is about to retire in a few years (Alice). Bob wants to save for a wedding and a house while Alice needs to save for retirement and medical costs. The difference is that Bob has decades of work life ahead of him and has plenty of opportunity to earn money. Alice doesn't have a salary, so she needs safety of fixed income. Both have different goals and will need different investing tools.

Stocks and Bonds

There are various instruments for investing like stocks, bonds, real-estate, commodities, futures, etc.
Broadly, stocks and bonds are the two main investing tools in the financial markets and others should be left for an advanced investor or a professional.

Stock of a company represents a unit of ownership in that company/business. When business profits are increasing, you as a owner get to enjoy those profits in terms of dividends. On the flip side, if the business suffers a loss, you may lose money. The key point to remember is that increasing profits mean your stock is more valuable. As the earnings grow year over year, so does the value of your stock. While earnings of a business might fluctuate for a few quarters/years, stocks are a great tool to grow your savings over the long term.

Bond is an obligation of a company/business to pay back the money borrowed along with interest. A bond is similar to an interest bearing bank deposit where you give your money to a company and they repay you the sum after a defined period of time along with interest. The key point to remember is that you always get your money paid back in full along with the interest, irrespective of the earnings of the business. So, if the company's earnings are poor for a period of time, you are not affected by that. On the flip side, if the company does really well, you have no claim to the extra earnings. Bonds are a great tool to protect your savings and grow them at a small rate of return.


A well rounded personal portfolio contains a mix of stocks and bonds. Based on your goals, the ratio of stocks to bonds will vary. Bob from our previous example will have a larger percentage of his savings in stocks to make them grow aggressively. Alice on the other hand will have most of her savings in bonds to protect the wealth she has.

A general rule of thumb for determining the ratio of stocks in your portfolio is to subtract your age from 100. For Bob who is 25 years of age, 75% (100 - 25) of his retirement savings should be in invested in stocks and 25% in bonds. Remember that this only applies to goals that are years away. If Bob is saving to buy a house next year, he should keep that money in a bank deposit.

Can we pick stocks already?

Now that we have determined how one's savings should be divided between stocks and bonds, the next step is to go buy them. You have two options here:
1. Buy individual stocks in businesses
2. Buy mutual funds

Buying stocks in the companies you know and love is a good way to invest in stocks. But it also requires a lot of effort on your part to do it right. You must know how to read financial statements and make sense, follow up with the company and sector related news, and keep with the local, country and world economy. This sounds like a lot of hard work and it is. You might not have the time to put in the effort or simply might be not inclined to do so. If that is the case, you are better off buying mutual funds rather than individual stocks. 

When faced with ignorance in investing, diversification is your friend.

Mutual funds are a great way to invest in stocks. You pay a professional to invest the money for you for a fee. You might not have the bragging rights of investing in the latest "hot" company but you will have a better overall rate of return than most people. You can increase your returns further by investing in a index mutual fund that buys a broad set of stocks instead of an active mutual fund where the fund manager chooses which stocks to invest in.

Active mutual funds are generally a loser's bet. While the fund manager might generate a great rate of return on your money (and that's a big assumption) compared to an benchmark index, he will also charge you a large fee to manage your money. After all the fees and taxes, you actually end up under performing the index mutual fund. To be fair, there are some skilled mutual fund managers who have consistently beaten the benchmark index. But it is near impossible to separate the wheat from the chaff. You are almost always better off buying an index mutual fund

Which funds to buy? Where to buy them?

For stock portion of your portfolio, you should buy the mutual funds that track S&P 500 index or the total stock market index. S&P 500 index is a collection of top 500 companies in America and is published and maintained by Standards and Poors. It is the world's most widely tracked index. The total stock market index consists of all stocks in the US. For the bond portion of your portfolio, you should buy a total bond market mutual fund. 

You can buy these mutual funds directly from the company that manages them or from your broker. Having decided on the index that you want to track, the golden rule of buying mutual funds is to buy the ones with the lowest expense ratio, not the past performance. 

I recommend buying the mutual funds from Vanguard as they are usually the funds with the cheapest ratio. In addition to that, Vanguard is owned by the investors that put money in its mutual funds. This aligns the incentives of the company and management with its investors. This is not true of other fund companies like Fidelity, BlackRock, etc. which exist to enrich their shareholders, not its investors (which is YOU).

Your retirement savings are most likely in a workplace 401K plan. This is the money that is deducted from your paycheck before any taxes and invested for your retirement. Ideally, you would withdraw this money on your retirement at age of 60, giving it at least 35 years to grow. Your choice of funds in the 401K plan is determined by your company and is usually limited. Given a choice, always choose a Vanguard fund.

Next steps

By this point, I hope you have a basic understanding of how to think about investing. The topic of investing is too big to cover all the details in a few blogs posts. There are numerous books that go into all aspects of investing in detail. I recommend "The Four Pillars of Investing" as a great beginner's book. Remember, investing is always for the long haul and requires a lot of patience. If you were planning to double your money in the next few weeks, you will have better luck in a casino than in the stock market.

Market, like the Lord, helps those who help themselves. Unlike the Lord, it doesn't forgive those who know not what they do. -Warren Buffett

If you have more questions, post them in the comments or email me. I ll try my best to help you.

Sunday, December 8, 2013

Giving

Life, with all it's ups and downs, has been good to me. I come from a small town in India. Growing up as a child, I have seen my parents help people in whatever way they could. This instilled in me an appreciation for always (despite the circumstances) sharing and giving to those in need.

Over the years, I have always wondered about impactful and sustaining ways to do this and enable the masses to alleviate their suffering. Through various discussions with folks, and a lot of reading, it was clear to me that education was this enabler. I think education (however you define it) is the most meaningful way to help the people help themselves. A well rounded education, while not sufficient, is necessary to successfully navigate and grow in today's world. Something about "teaching a man to fish rather than feeding him a fish" always felt true. :)

I have been fortunate enough to have an opportunity to receive education (if you are reading this, you have been too) and enjoy the subsequent benefits it brings. But there are hundreds of millions of people in this world that don't have access to basic education, leaving them and their children at an inherent disadvantage. Hence, I decided to focus on education and educational charities.

I have recently started volunteering for the seattle chapter of Asha for Education. They focus on funding charities related to education and social welfare in India. It is a volunteer driven organization with zero overhead, which made it attractive to me. It means every dollar donated to Asha goes to the people in need. It has been exciting so far and I hope to write more about my experience soon. 

I encourage you to start giving in whichever way you can. The joy and fulfillment it brings is difficult to put in words. Also, don't forget to get a corporate match for your donations.

Microsoft, where I work, has a long and illustrious tradition of employee giving to various charities. And Microsoft matches various employee donations like cash, securities and products/things dollar-for-dollar up to a generous limit. It also matches the number of hours that employees volunteer at charities. This is a fantastic program at Microsoft and part of the credit goes to Bill Gates for encouraging it over the years. In fact in 2012, Microsoft employees had cumulatively raised an unprecedented $1 billion dollars for various charities. 

If your company/workplace doesn't have a matching program for employee donations, why not? Start a conversation with your fellow employees to get it going and how your company can have a more meaningful impact on the society. 

Saturday, November 9, 2013

A word about processes and implementations

Yesterday evening, Mrs and I had an interesting argument about functioning of a democracy and it's effectiveness in bringing about change. It started with a news article on her Facebook feed about corruption in India. 

She lamented that democracy as a system was inadequate to handle corruption that manifests in every sphere of life. And that India should consider switching to a "benevolent" dictatorship (if such a thing exists). Her reasoning was that people in power (politicians, bureaucrats and crony capitalists) were too entrenched in corruption and "some third person/entity" needed to cleanup the system as the people of country could not. She thought that the only power people have is to vote out the incumbent government and replace it with a new one. And with almost every candidate being similarly inclined in terms of political cleanup (that being, why ruin a good thing?), people really don't have a choice. 

There were a few factual and conceptual gaps in her argument. I pointed out that democracy is a system "by the people, of the people, for the people", with special emphasis on the phrase "by the people". This implies that people hold the power in a representative democracy. A quick recap of the middle school civics lesson is in order before we proceed.

A democracy consists of the Parliament (legislative branch), Government (executive branch) and Judiciary (judicial branch). Parliament is comprised of representatives of the people and are responsible for making the laws of the country. For example, parliament would be the body that creates a law saying, "Every citizen should receive an apple daily". Government can be comprised of elected representatives (as is the case in India) or domain experts (as is the case in US). Government is responsible for implementing and enforcing the laws made by the parliament. So in our example, the government is responsible for sourcing and distributing an apple to every citizen daily. Now, some citizens might not get any apples at all. This is where Judiciary comes in. Judiciary is comprised of law experts (judges) and is responsible to interpret the laws. In our example, the citizens not getting their share of apples can file a case in court against the government. The court will interpret the laws and pass a judgement based on the facts. 

Democracy is a system of checks and balances. The three branches of democracy have rights and duties that enable them to keep the excesses of other branches in check. The constitution of India grants people the power to influence the laws and their implementation by influencing their representative. Coming back to our discussion, I said, "If people are not happy with the laws their representative is supporting, they should call/email/write to him/her and voice their concerns. Human beings respond to incentives and if a politician recognizes that his constituents want him to vote a certain way, you can be sure he will follow the will of the people. If he doesn't, he knows he will lose his seat in the next election". This is the democratic process to effect a change. 

And the Mrs replied that, "surely all those people shouting on the road, liking & sharing on Facebook, tweeting about corruption on Twitter might have done this and obviously it didn't work". And therein lies the problem. She just assumed that the implementation was done, even though there is no data to support/refute it. And given that, inferred that the process doesn't work, without even considering that implementation might have been flawed. 

She continued, "Lakhs of protestors supported Anna Hazare who wanted the Lokpal Bill passed and implemented. This bill would help the country tremendously." But the constitution provides a way for the people to effect change via their elected representatives, not a random person (however popular and honest he may be). And that's why I appreciate Arvind Kejriwal, who recognized this fact and formed the Aam Aadmi Party with like-minded people. The system can only be changed from within. 

To illustrate my point further, I gave her the example of Stop Online Piracy Act (SOPA) that was being consider by the US Congress. This bill would have threatened the free and open principles of the web and was rightly opposed by a lot of people and companies. These people and companies started a grass roots movement and rallied the people to call their representatives to protest against the bill. Millions of US citizens expressed their opinion about the bill to their representatives. And in response, members of US Congress dropped their support to the bill according to the will of the people. This is a fantastic example of democracy in action. 

In the end, we agreed that democracy (process) empowers people with rights to change their fate. For India, it will take a lot of effort and hard work to effect the change (implementation). But as a wise man said, 
"Nothing worth having comes easy".

Friday, August 16, 2013

Filing FBAR online

Individuals can file the FBAR form online for FREE at the US treasury's website. There are private companies like Fbaronline.com and Fbartax.com that greatly simplify the FBAR filing process for laymen for a small fee.

Sunday, April 7, 2013

US taxes and reporting for foreign income

US tax season is at its peak and I just finished filing my taxes for 2012. There are two requirements on an US tax resident if he/she has foreign income:
  1. Paying US taxes on the foreign income
  2. Reporting foreign financial assets to the IRS (FATCA) as well as Dept of Treasury (FBAR)
US taxes on the foreign income
 
Unlike many countries, a tax resident in US is required to pay taxes on his/her global income. It means if you have any income in a foreign country, you have to pay taxes on that foreign income in US as well as in the foreign country (if applicable). Interest from the foreign bank deposits, dividends from foreign stocks held in a foreign institution, sale of foreign real estate, foreign wages or salary, etc. are a few examples where taxes are due in US. 

If you think this is double taxation, you are right; paying taxes on a stream of income where it was earned as well as in US is double taxation. To solve this issue, IRS allows you take tax credits for the taxes paid in other countries. These credits are called the Foreign Earned Income Credits (Form 2555). You are allowed to reduce your US taxes by an amount equal to the dollar equivalent of the taxes paid in a foreign country by filling the Form 2555.

Here is what I had to do for 2012 tax season. I have a few investments back in India that generate interest income for me. I reported the following foreign income to IRS on form Schedule B
  • Interest income from investments that are taxable in India. 
    • This is interest income from fixed deposits and bank savings accounts.
    • It also includes interest income from any loans that you gave in a foreign country. For example, if I gave a loan to a person or a company in India, I need to report the interest income from that income in India as well as US.
  • Interest income from investments that are tax-free in India
    • This is interest income from tax-free investments like PPF, infrastructure bonds and other government securities.
Note that any income generated in India, be it from a taxable or tax-free investment, is taxable in US. You are required to report it and you can claim tax credits if you paid any taxes in India. As for me, my income in India was in the tax-free slab so I didn't pay any taxes in India (Read: couldn't claim foreign earned income credits) but had to pay substantial taxes in US on that income. :(

There are other sources of foreign income like dividends from foreign stocks, capital gains from sale of stocks, mutual funds, real estate etc, gifts from relatives and income from foreign trust or an estate. They don't apply to me (yet), but if you have questions regarding their tax treatment, leave a comment and I will be happy to help.

 
Reporting foreign financial assets to the IRS (FATCA) as well as Dept of Treasury (FBAR)
 
Up until a few years ago, US residents (Read: rich people) could evade US taxes by moving their assets to tax havens or countries with less taxes. This allowed one to hide their financial assets from the IRS and in turn, evade US taxes on income generated from these assets. Also, one could simply renounce US citizenship after having made billions of dollars and move to a country with a more favorable tax treament. Link.

In an effort to prevent these instances of tax evasion, US Congress passed Foreign Account Tax Compliance Act, known as FATCA, that required tax residents to report their foreign financial assets to IRS with stiff penalties for non-compliance.

As if one overly broad and complex law (FATCA) was not enough, US Congress also passed Bank Secrecy Act to prevent money laundering, tax evasion, financing of terror groups, etc . Under this law, Dept of Treasury was authorized to collect even more information about foreign assets of US residents via Report of Foreign Bank and Financial Accounts, known as FBAR. This is over and above the FATCA reporting requirements.

To summarize, if you are a US person (definitions are so broad, practically everyone living in US is included), you are required to file Form 8938 for FATCA compliance while filing your taxes (due in April every year) and FBAR forms (due on 30th June every year).

The eligibility requirements for FATCA and FBAR are slightly different. 
  • Go here to check if you need to file form 8938 for FATCA compliance: Link
  • Go here to check if you need to file FBAR forms: Link
This is a handy comparison table from IRS to determine if you need to file any or both of FATCA and FBAR forms. 

Once you determined which forms you need to file, you need to start collecting information about the foreign financial assets. This includes
  • Names of the Financial Institutions, their address and phone numbers
  • Your account numbers
  • Amount/Value of the assets in these accounts
Populating the FATCA and FBAR forms is straight forward once you have all the above information. 

If you are still with me, I applaud you. This is a lot of information to digest. Now, go get started on your taxes, FATCA and FBAR forms. I am planning to write follow up posts about FATCA and FBAR, going into details about filing requirements. In the meantime, if you have any questions, leave a comment below and I will be happy to help.

Sunday, February 24, 2013

Safe and secure web browsing

I was recently walking my wife through all the tips and tricks for secure web browsing that I accumulated over the years. I consider this knowledge essential for anyone browsing the internet. Share it with all your non-technical (and technical) friends and spread awareness about secure web browsing.
  • Always check for https:// in the address bar when visiting a website with sensitive data like financial websites, email providers, etc. HTTPS is a secure protocol for communication over the internet. You should use the https://  version of a web page whenever possible. I use the HTTPS Everywhere extension in Firefox to force my web traffic over HTTPS.
    Check the if the website supports HTTPS
  •  Always hover over a link in your web browser to see what website it would open. NEVER trust the name of the link. See the picture below:

Hover over a link with mouse to see where it points
  • Avoid clicking anywhere when visiting an unknown website. 
  • This is common knowledge nowadays but bears repeating. Don't open email attachments from people you don't know. I am skeptical about email attachments even from people I know. Always ask others to share files with you via one of the various cloud storage services like DropBox, SkyDrive, Google Drive, etc.
  • Never download and install software from websites if you are uncertain about it's authenticity.
  • Never download anything (music, videos, software) via BitTorrent. This is a major source of malware.
  • Avoid visiting web sites that provide free music, movies, sports downloads or streaming. 
  • Always use strong passwords that contain numbers, capital letters and symbols. This post from LifeHacker has a nice infographic on how to create a strong password. 
  • Use a whitelist of contacts, instead of a blacklist, for your incoming email to avoid phishing emails in your inbox.
  • When emailing a large group of people, use BCC instead of TO or CC
  • Use NoScript and Adblock Plus on unknown websites.
  • Always keep your OS, browser and anti-virus up-to-date.
  • Enable safe search for your favorite search engine.
  • Enable Windows Firewall 
  • Read more about online safety at the US CERT website

Wednesday, February 6, 2013

Surface RT unboxing

I recently collected my Surface RT that was distributed to all Microsoft employees. Here are the unboxing pictures:







The box, the Surface, the package design are all very slick. My initial impressions are positive, though to be fair, I have mostly been using my Surface for playing games and web browsing. There is a decent collection of apps in the Windows Store and that number increases every time I visit it. I am very excited about the product and the progress it is making. Do you plan on getting a surface? Let me know.