Discounts on Magazine Subscriptions – How do they work?

When I said yesterday that I subscribe to lot of magazines, there was a thought that crossed my mind. How do these magazines make a profit after giving such deep discounts when  you subscribe them? You must have seen them right? A copy which costs Rs.100 on the stands, you can subscribe to it for Rs.1080 for a year – or Rs.90 per copy. Subscribing to 3 or 5 years, further reduces the price. How are they able to give such discounts?

magazine subscription

To understand that, you would need to understand the time value of money. If I asked you “Do you want Rs.1000 today or Rs. 1000 a year from now?” What would your answer be? “Gimme the money today” right? Why? Because the money you get today is more valuable than the same money you will get in the future. Assuming a bank gives me 10% interest, you can take my money, put it in the bank and get back Rs.1100 in a year.

Now after understanding that, if the question was “Do you want Rs.1000 today or Rs.1100 a year from now?” Even if you invested in a bank you will get back Rs.1100 after a year. So there is no difference in getting the money today or a year from now – at least mathematically speaking.

But humans are not rational beings. Whenever I ask this question to my friends, I always get the answer “Better get it now. I am not sure what would happen in the future. What if you don’t give it to me?” The reason is: Certainty. What did we learn when we were kids? “A bird in hand is better than two in the bush”.

That is exactly what the magazine company also does. They give a reduced price for the same magazine, but your money is now in their bank. They can invest it or use it later and they are certain that you are locked into the subscription for the year. If you calculate the discount it would mostly match what a bank gives or even less than that. This same calculation holds true for the longer terms like 3 or 5 years. They may advertise it as 15% or 30%, but if you calculate the annual rate of interest it would be almost same as what you get in a bank.

So it doesn’t matter if you buy it every month from the stands or subscribe to it and get it for a year, you are not losing much. I would suggest subscribing – for the comfort of getting it delivered directly to your house.

So if you find a magazine that is not giving you any discounts for subscription, should you not subscribe? I would say “It depends, but I would subscribe even in that case.” If you look at it strictly on a mathematical sense, you are making a loss, but look at it from the comfort point of view. Not having to remember to walk down to the nearest newsstands every month, hoping they carry that magazine and instead if the company delivers it right down on my doorstep – I would pay for such a comfort. That is a fee that I am ready to pay.

Two things you should spend your money on

Read any personal finance site or expert’s opinions, you are sure to see the following:

you should save your money.
reduce your expenses.
make sure you spend less than you earn.

Well, I agree that this is good advice, but only if people follow it. Human brain is highly irrational, especially when it comes to money and you might want to buy certain things that make you happy. Your friends might call them as your weaknesses. These might be something as simple as lots of stickies or a nice pen or that expensive notebook that you never will use more than 2 or 3 times, etc. (btw, these are all my weaknesses).

It need not be so silly, it can be a weekend out-of-town with friends, nice candle light dinner with your significant other, a nice smart phone when your old one is broken, etc. These are things that are expensive, but gives you more happiness and joy than the money you spend. Just imagine going to a movie with your family/friends and then eating out – everyone enjoys the day and sleep happily. Sometimes such memories will stay with you for a long, long time.

Buy things that make you happy.

There are also other types of things which I would say are very important that you spend your money on – investing in yourself. No, this has got nothing with money, interest, inflation, etc. It is the things that you learn from others and which will make you better in your professional and/or personal life in general.

It could be books that you buy and read, the Yoga class you joined, Gym membership to keep yourself fit, even getting high quality dresses for your office, etc. If there was one thing that my dad didn’t think about buying for me was “books”. Whatever book I ask, he would get it for me – and the things I learnt from it surpass any returns that he would’ve gotten by putting that money somewhere else.

Other things that I have invested in is my health trying to get fit, books/magazines that I read and then online courses. I have joined a few online courses, about investing, self-improvement, entrepreneurship, etc. The few tens of thousands of rupees I spend today if it helps me in earning even a lakh in a year, is a great investment.

Invest in yourself.

There are other things doesn’t improve you personally, but are equally important. For example, if you are an entrepreneur, it could be a lawyer you hire to set up your company, the accountant who understands all the financial things better than you do, etc. All these are not expenses, but investments that you do for your business or yourself. If you are just another salaried person, one important investment you could make is getting the help of a good financial planner.

I know way too many people who were mis-sold investment products and who don’t know the difference between investment and savings. Even I was in a similar situation and decided to learn things from books and the internet – but if you are not interested in starting from the basics, you would do well by hiring a good financial planner. Remember your insurance agent isn’t a financial planner.

So remember these two things which you can and should spend your money on:

  • things which makes you/your close ones happy
  • things which will improve your personal/professional life in the long-term.

Diversification – How to do it and how not to do it

Lot of people don’t understand the need for diversification. If they did, they wouldn’t go and buy houses or land spending tens of lakhs of Rupees, being in debt for 25-30 years paying EMI. I am not against getting your own home to live in, but there are people who think real estate is the best investment and keep buying more houses, believing they can get rental income from it.

These are the people who have more than 80% of their net worth in real estate. If it is not real estate, it will be gold or fixed deposits. I don’t have a problem in investing in different asset classes, I even suggest that you should spread your money in different investments. That is what most of the financial planners also say.

How you split the investment should be based on your long-term goals and not how many apartments or gold jewellery your neighbour or relative has. If you are a young investor, you should have majority of your investments in equity and a very small amount in debt/gold. If you absolutely need to buy a house for living, remember to also invest a sizeable amount into equity, so that you begin saving enough for your retirement or your kid’s education.

Diversification in Stocks

The concept of diversification can be applied to individual stocks or sectors too. If you invest directly in equities and you keep buying just one specific share, you are putting all your eggs in that particular company. If that company faces a problem, no one can save you and all your capital can be erased within a few days.

But you may say that you invest only in large cap stocks and these are the companies that can never go down, right? Wrong. Have you heard of Satyam? Hindustan Motors? and literally hundreds of such big companies that tanked either in a few days or over the years. Anything can happen to any company at any time. In the case of Satyam, it was the problem with the Chairman and in case of Hindustan Motors they failed to innovate and it is almost wiped out.

Diversification in Sectors

So, now you may say, “Ok. Instead of buying just one company, let me buy all the companies in a particular sector.” That is also equally risky. Whenever bad luck comes, there is a high possibility it comes for the entire sector. Public sector companies, real estate, infrastructure, sugar are some of the examples that are down for many years now. If you invested in a single sector – say real estate, you would have gotten zero returns or even negative returns overall.

When a particular sector like real estate gives you negative returns, there will be other sectors, like Pharma or IT till 2013 which outperformed. Collectively all these sectors would save you from any adverse effects of a particular policy decision (or lack of) in a sector – like sugar or mining or power. That is why you should always spread your investments across sectors.

Diversification in Size

This is also important. You can play safe and invest in only large cap stocks. But large cap stocks can only grow unto a certain limit. If you need returns more than that, you would have to invest in mid-cap or small-cap stocks. While they are more risky and can be more volatile than large-cap stocks, in case of a bull market, they can give you much higher returns on your portfolio

Mutual Funds to the rescue

Now for a retail investor to analyse the thousands of stocks and the various sectors’ movements and market cap can be impossible. Also to track this every month and rebalance his portfolio is simple unthinkable. Now this is where mutual funds are going to help you. Investing in mutual funds gives you all the benefits of diversification and none of the headaches associated with analysing it.

Since Mutual Funds automatically invest in numerous stocks (typically 30-50 stocks) split across sectors and are also categorised based on the Market Cap of the companies it invests in – it is the easiest solution one could think of. All you need to do is pick the right mutual funds and you can just keep investing in SIP and just track the performance of the fund instead of individual stocks. Performance of individual stocks is something you leave the fund manager to worry about.

Diversification in Mutual Funds

Diversification is good right? So should you go invest in 10 or 15 mutual funds and enjoy the safety? There are people who do this too. I have seen people who are investing in 10-15 mutual funds – they feel happy that their investments are protected. This is the most dumb rookie mistake and if you think even a teeny-tiny bit what happens you would understand.

When you invest in a large-cap fund (A), what does the fund manager do?
He chooses the best 30-50 stocks from the universe of about 200 large-cap stocks and puts your money into them.

Now lets goto large-cap fund (B), what does the fund manager do?
He chooses the best 30-50 stocks from the universe of about 200 large-cap stocks and puts your money into them.

Now lets goto large-cap fund (C), what does the …… (you get the idea?)

If you are going to invest in N mutual funds which has the same objective, you are not really diversifying. You are in fact investing in the same stocks over and over again, because there is going to be a lot of overlap. You are going to have even more headache because you now have to track the performance of 15 funds.

So, what should you do?

Diversification is needed in mutual funds, but it does no good if done blindly. You should diversify only across market caps and not across the fund houses or fund managers. All you would be needing is invest in

  • one large-cap fund
  • one mid-cap fund
  • one small-cap fund

For 99.9% of the investors who want to invest in balanced equity funds, this combination should be more than enough. The percentage of the split would vary depending upon your risk tolerance and the market conditions. If you need to diversify across asset classes, there are funds for that too. which will solve most of your problems.

Remember, Mutual Funds are designed to make your life simpler. Once you begin to micro-manage stuff, all kinds of crazy stuff comes out. So investors need to first understand about diversification – why you need to do it and when you don’t need it, before going and picking numerous stocks or funds for their portfolio.

Dividend Distribution Tax in Mutual Funds

After reading about the dividends distribution tax that companies pay on dividends you get as a shareholder, you must be wondering if the same rules apply to even mutual funds. Mutual funds are a different beast altogether, but yes they too have Dividend Distribution Tax (DDT). There are some minor differences though.

Mutual funds can be broadly divided into Equity Funds and Non-Equity Funds (these include Debt, liquid, Gold funds or fund of funds, etc.). When you invest in any mutual fund, you have to option to choose either Growth Option or Dividend Option.

In the Growth Option, the fund doesn’t announce any dividends and instead it keeps all the money it earns (via capital appreciation or dividends from the companies) within the fund itself. Whereas choosing the Dividend Option, means the fund can announce dividends every year – remember “can” and not “must“. Whenever they announce dividends, they announces Rs. X per unit. You just have to multiply that amount with the number of units you hold. That would be the cheque or bank credit you would receive.

So lets now see how dividends are taxed depending upon the type of fund. Do remember that dividends are not taxed in the hands of the investor. It’s just the fund that needs to pay the DDT to the government. By the time it reaches your bank account, you can use it however you want.

Equity Mutual Funds

When an equity mutual fund (having minimum 65% exposure in equity) declares dividends, it needs to pay 0% taxes. Yes, there is no Dividend Distribution Tax at all on equity mutual funds. So any money you get out of equity funds, whether as dividends or as capital gains (after a year) is tax-free. This is a great benefit the government has given to improve more retail participation in equity markets.

Non-Equity Mutual Funds

When you invest in any fund which has less than 65% holding in domestic equity – be it pure debt funds, liquid funds, fund of funds, gold funds, or even funds which invest in international equity, there is a dividend distribution tax involved. If you are an individual investing in such funds, any dividend is taxes at 25% (previously it was 12.5% for debt funds, but recently increased). Add surcharge and education cess to it – you get a total tax rate of 28.325%.

The fund needs to pay this 28.325% as dividend distribution tax whenever it announces dividends. This is all paid for you by the fund house, so you don’t have to worry about it. But since this is a sizeable percentage from your investments, you need to keep this in mind when you choose the type of option when investing.

When the DDT was 12.5%, investors falling in the two highest income tax brackets (20 or 30%) chose to invest the dividend option – especially the dividend reinvestment option. But now that the DDT itself is 28.325%, it is not advisable to invest in dividend option. Now, it is more profitable to invest in the growth option, so that all the money is kept within the fund to grow its value.

Systematic Withdrawal Plan to the rescue

Incase you need a regular payout like a dividend, you can choose the Systematic Withdrawal Plan (SWP). Just like Systematic Investment Plan, where you invest a fixed amount every month or quarter, SWP allows you to withdraw a fixed amount every month or quarter or year. You get back this money just like a dividend, but without paying such high taxes. This is very helpful for people who are retired and want some regular income from their investments.

Summary

To sum it up, Equity Mutual Funds do not pay any Dividend Distribution Tax at all. All your money belongs to you. Non-Equity Funds needs to pay 28.325% as DDT. Remember that when you choose the investment option.

When does SIP give lower return than Lump Sum Investment

In many of the previous posts, I have talked a lot about the advantages of SIP(Systematic Investment Plan) and how averaging the cost of an asset helps hedge against volatility. But if something is so good, there must be some disadvantages. SIP too has disadvantages and doesn’t give you good returns in some cases.

In a bullish market, investing lump sum yields you much higher returns than investing in SIP. 

SIP vs Lump Sum
SIP vs Lump Sum

This is the only disadvantage when it comes to SIP. If you have a few lakhs or crores of rupees to invest in the market and you are currently in a bullish market, it makes sense to put all that money in one go. But there are a few problems here

  • It is very difficult to time the market and catch the lows. The years 2003 to 2008 was a good bull run and people who put in a lump sum money in 2003 and took it out by 2008 would’ve become super rich. But how many did it? No one we have heard of.
  • Even if you can time it, not everyone will have lakhs of rupees, ready to invest whenever the market is ready for the bull run. Most of the retail investors can spare a few tens of thousands maximum per month and it is easier to invest monthly.
  • Even if you can time the market and also have crores of surplus money to invest, your mind wouldn’t allow you to stay invested in the market for the long haul. It is basic psychology when fear kicks in as soon as you see unthinkable returns on your invested money. Imagine you investing Rs. 1 lakh and within a year it doubling to Rs. 2 lakhs. Your first thought would be to get out of the market with the profits, before everyone begins to sell. It will cause you to miss an even bigger bull run.
  • There is also another psychology that is the reverse of what you see in the above point. Most retail investors do not invest when the markets are at the lowest. Only after the markets have continuously made new highs, we begin to take notice and want to get in. This is totally opposite of what we should do. “Buy low, sell high”. Just like the current rally, it is the FII (Foreign Institutional Investors) who are putting in all the money and the retail investors and DII (Domestic Institutional Investors) who are selling.

Based on all these points – Yes! You can get better returns than SIP in some rare cases. But the risks associated with lump sum investing far outweighs the advantages in systematic investing.