Jagoinvestor

May 26, 2010

GFactor , A decision making tool for Financial products

How do you find out if a product suits your requirement ? What about a very simple calculation which can take into account most important requirements like lock in factor , complexity of a product , your requirement and its return and risk potential and tells you if it really suits your requirement. This Post will talk about a concept developed by me called GFactor , which is a score system for any Financial Product. You can input 4 factors and get a score for a product . So this GFactor score system will tell you about goodness/badness of a product.  Gfactor stands for Goodness Factor .

What is GFactor ?

GFactor is a very simple rating system for Financial products which gives a score on a scale of 0-1 . 1 represents excellent , 0 means worse . There are mainly 4 factors which we consider when we design this GFactor .

  • Trap Factor (Liquidity)
  • RR Factor (Risk/return Factor)
  • Complexity Factor
  • Need Factor

Trap Factor

Trap Factor is nothing but its score for the product on scale of 0 – 1 for the lock in period. The more trapped you have to be in product , the more will be the Trap factor score. One important point you should note here is that you should also consider how much loss you have to take even after you can freely come out of the product . For example : Endowment policies trap you for long periods like 15 to 20 yrs . Even though there is an option to close the policies you loose a lot of money. So the trap factor of Endowment Policies will be more like 0.9 or 1 , where as Mutual funds (non tax saving funds do not have any type of locking period) . So they can have trap factor of 0.1 or 0 . In ULIP you are stuck for at least 3-5 yrs , only after the 5th year. So it can have a trap factor of 0.6 or 0.7  you can get out without any penalties . For term insurance there is no trap factor , you can stop the policy any time .

Years of Trap

Trap Factor

No Trap 0
1-3 yrs 0.2
4-10 yrs 0.5
10-15 yrs 0.75
15+ yrs 1.0

 

 

Risk/Return Factor

Risk/Return Factor is a factor which will evaluate a single digit score for its risk/return potential . This score takes into consideration both risk and return . You can look it as risk adjusted return potential . so this factor will determine the return potential considering the risk potential. To calculate this you should know average return and average risk figures of a product in its total duration . Lets see the calculation first .

Risk Return Factor = (Average Return – Average Risk)/Average Return

Lets see an Example in case of ULIP : Robert wants to buy some mutual funds for next 5 yrs . In these 5 yrs , as per the historical data , we know that he can expect an absolute 100% return on average  (his money can double) , and if some thing bad has to happen hecan loose around 30% of value (the figures will differ for everybody) . So

Example for Mutual Funds (5 yrs)

  • Average Return = 100%
  • Average Risk = 30%

Risk Return Factor (Mutual funds) = (100 – 30)/100 = 0.7

Example for Fixed Deposits (2 yrs)

In this case suppose the returns from FD are @8% .

  • Average Return = 16%
  • Average Risk = 0%

Risk Return Factor (FD) = (16 – 0)/16 = 1.0

Note : For term insurance , the return will be the max amount you can get and Risk would be amount you can loose all , which is total premium over many years.

Complexity Factor

Complexity score is a number you assign to the product, depending on the how complex of easy it looks to you . For example Mutual funds can be easy to understand for me , so I can put 0.1% for it a complexity, whereas  NPS is more complicated to me , so I will put 0.5 . This means If it looks too complicated for you, then give a higher score, whereas if you understand it well, assign lower score .

For a normal person I would say ULIP is complicated , so we gave give a score of .7 or .8 or 1 ,depends on you, where as term insurance is extremely easy to understand, so it will get 0 or .1 , Mutual funds would be .2 or .3

Need Factor

Its a score given on the fact that how badly you need or require the product and will it be the best thing for you. One person may need it more than other, so the score will be different for different people. If you are not in a hurry, but your relative suggests you a policy , then it does not become a very high priority product for you, because you do not require it at that time, so you will assign a lower score to it .  For a person who is in his 26-27 age and just married and has some financial dependents , His score for term insurance will be around .9 or 1 because he badly needs it . Make sure you know difference between your needs and wants

A person who is 45 , for him/her NeedFactor for Health Insurance would be .8 or .9

A person who is Extremely High risk taker and understands equity investing well , his need factor for NSC or FD would be low , say a score of .2 or .3 because he really does not need it and it does not suit his requirement also .

Now Lets construct the formula

Variables are

TF : Trap Factor
RRF : Risk Return Factor
CF = Complexity Factor
NF = Need Factor

You should understand how the formula should be constructed. Out of the 4 variables, 2 scores shows strength of the product(Need Factor and Risk Return Factor), where as two scores are negative(Trap and Complexity Factor), so below formula should take care of this aspect .

GFactor Formula = (NF * RRF) – (CF*TF)

Lets take an example . Ajay is a 35 yrs old Indian working in a Software company, He has 2 kids and 1 wife 🙂 and 1 parent to support . His risk appetite is moderate and he cant take more than 20% downside in his investments at any given year . He has a home loan and a car loan at this moment and has just 10 lacs of overall savings . Below is the chart which calculates GFactor for some products considering Ajay’s situation. Understand that these numbers are for Ajay, it can change for you .

Products
Trap Factor
Return/Risk Factor
Complexity Factor
Need Factor
GFactor
 Term Insurance
0 0.95 0 1 0.95
 Health Insurance
0 0.85 0.3 0.8 0.68
 ELSS
.25 0.5 0.1 1 0.48
 ULIP
.25 0.5 0.4 0.4 0.1
 Tax Saving FD
.5 1 0 0.1 0.1
 Endowment Policy 1 1 0.5 0 -0.5

Rules

  • If GFactor value is more than .7 , you can consider that product as “Must buy. Go for it” .
  • If its more than .4 , you can consider it as “Average”
  • If its more than .2 , you can consider it as “Look for alternative product. Buy only if nothing else is available”
  • And if its less than .2 , then you must avoid it .

GFactor of a Portfolio

Just like we have Gfactor of a product , we can have GFactor of a Portfolio , which is average of GFactor’s of all the products in a Portfolio . Example

  • Term Insurance : 0.95
  • 4 ELSS : 0.43
  • 4-5 shares : 0.35
  • 10 gm of Gold ETF : .72
  • EPF contribution : 1
  • 3 months of Cash : 1

So average of all the GFactors = (.95 + .43 + .35 + .72 + 1 + 1)/6 = .742 . This  is a good Score for a Portfolio , But I can do better than this . Whats your Portfolio GFactor ?

 

Conclusion
There are 4 main factors which matter when taking the decision regarding a Financial product , The above concept is my own thinking and It may not fit everyone criteria , but I am sure it would be true for most of the people , If you have disagreements , its fine . We subconsciously understand how there 4 factors affects our decision making process , but the idea is to put it into formula and get a Score out of it , so that we can compare and know how good or bad a product can be for us .

Ques tion

  • Can you design a better formula for GFactor which makes more sense that what I have given .
  • Do you think GFactor can be useful to general investor to take decisions .
  • Please share with me GFactor of your overall Portfolio .

Note : This is an old post , I am republishing it with changes

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Humble Guy
Humble Guy
9 years ago

Dear Manish,
I have a LIC policy (Jeevan Anand – SA 10,00,000 – 16 Years – INR 75,752 PA)
i have already paid 7 installments without fail. I came to know that there are term policies which gives good cover like 1 Crore and premium is less like 20,000 PA
is this true?if yes, could you please advise do i need to surrener my Jeevan Anand policy? if so, how much would i get in return?if no, kindly let me know if i can take another term policy and continue with both?
I will be thankful if you educate me in this regard.

Neelkamal Agrawal
Neelkamal Agrawal
11 years ago

Agree with Akshay, yr Gfactor must be patented

Neelkamal Agrawal
Neelkamal Agrawal
11 years ago

Hi Manish,

Just read your articles on Real estate investment in India & GFactor, must say superb…..

Great Going

Shailendra
Shailendra
11 years ago

Hi Manish,
Your articles are always above comments and always attract compliments.I am thinking to contribute to your this effort of financial literacy mission which you are spreading across the investor community but I need some guidance and inputs from you so that I can make a start.

Thanks

Sid
Sid
12 years ago

Nice article dude…quite innovative.

Akshay Yelburgi
13 years ago

Manish,

True to your recort on Revert.

I had drafted a mail yesterday to the above revert- but due to your server problem it couldnt get uploaded and I hadnt saved any.

Nevertheless, Will try to communicated what I mean.

The discussion is never with regards to the tool GFactor, but the usage and applicability of it. This is because, the Gfactor is always depict what the prospect has decided earlier. His scoring is always baised to that extent. Thus I am suggesting, if the score is 1 – which means an absolute BUY. The prospect should challenge this decsion by asking reverse questions like do I really need it, is it totally risk free.. etc. This will help him evaluate the product/portfolio 360 degrees.

You must read How customer thinks by Gerald Zaltman.

Akshay Yelburgi

Akshay Yelburgi
Reply to  Jagoinvestor
13 years ago

Manish,

Absolutely Right.

You have got it largely. I will give an example.

I have already decided in getting into FD – or more importantly subconcisouly I favor FD. Hence my reactions will be attuned to favor it. Just like if I like someone, I will be in favor of him (conciously and subconcisouly). Thus the Gfactor will only throughput the same verdit – that is BUY FD. This can be very lethal – as your tool also validates his choice. Human always seek confirmation – Your tool makes them confident to take that call. But my point is at the base – that the decision you are making are could be emotional, could be irrational, preconceived, hardwired etc and needs to be reviewed in reverse.

Pls note subconciouly mind is very important parameter to be considered. They direct most of our decisions. Thus I emphasis on it so fervently. Since the call is coming from subconcious – becasue its subconcious we dont come to be in aware of it. GFactor will deduce what happening in your subconcious mind and help one to counter.

Akshay Yelburig

Akshay Yelburgi
Reply to  Jagoinvestor
13 years ago

One last point. get your Gfactor patented 🙂

Akshay Yelburgi
Reply to  Jagoinvestor
13 years ago

No Manish, probably you are undermining what you have created or not in insight of other things that could be created out of it. This is a compliment.

If you are in the age cohort of 27-30. I suggest you need to do a lot of diverse reading. Since you have an audiance, you have an responsibility.

All the best.
Akshay Yelburgi

Akshay Yelburgi
Reply to  Jagoinvestor
13 years ago

Hi Manish,

Can I invite you to my blog and share your feedback http://www.ayelburgi.wordpress.com

Very recently I have written an article on Checklist to evaluate an Relationship Manager/Investment Manager. There are others as well. Your feedback will help.

Cheers

Rgds
Akshay Yelburgi

Akshay Yelburgi
13 years ago

Hi Manish,

GFactor is a good indicator and I have read the cavet. But I was thinking why not invert it. For eg if its says 1 then I would consider the person might be taking an irrational decision while if its exterme at 0 – there are chances that he could be little more rational.

My point is the factor asked to be answered are all subjective. Research has proved that our congnition works in framing any answer or align it our already predecided result. This is not known to our concious mind as we have already taken decision through our subconcious mind. So its a case of, when you dont know about what you dont know – how can one reflect upon it.

Gfactor can be an alaram in this respect – when I encounter a ‘0’ – its speaking my rational mind. If I invert it – it gives me an option to review. Is it that complicated, shouldnt I lock in or is the return undermined or Do I really dont need it. Here you are challenging your deep routed animal brain wired cogniton. Then the prospect is complete in his decision making process as he has reflected 360 degrees.

I understand you have been a student of Behavioral Finance. Hence drafting this mail. You are doing a great service. Wishing you all the luck and god bless.

I am too a student of Behavioral finance. I invite you onto my blog (www.ayelburgi.wordpress.com) for your comments. I have lamblasted the abuse of Structured Products, The age old mindless categorisation of prospects like aggressive, moderate or conservative. It helps only analysts- they can afford to go more wrong with Aggressive clients than the moderate one’s – because, hey Sir – you are aggressive investor remember.

I have seen your track in replying quite promptly. Would be happy to receive your veiws.

saurabh aggarwal
saurabh aggarwal
13 years ago

hi Manish,
I have started visiting ur blog from the past 3 days and must say have spent most of my internet time on it.Loved the simplicity with which you explain all the content.Never thought that financial planning could be so much fun reading.I am just finished my studies and will join my job next month.Hope to apply all your knowledge there.

BIG FAN OF U AND UR BLOG

Meena Shivram
Meena Shivram
13 years ago

Manish,

The article on the GFactor is very interesting and I have applied the formula in my portfolio too. However I have a few doubts needing clarifications:
For Mutual Funds you assumed an RRF (Returns – 100%, Risk – 30%) of 0.7. While this may be true for Equity funds but for debt or balanced funds, it will be lower. How do we calculate the RRF if our MF portfolio has both Equity and Debt funds?
Also it will be interesting to apply this formula to self occupied home and the second house you may have purchased for investment purposes. My data will be:
Self occupied house – TF-0.9, RRF – 0.8, CF – 0.3, NF – 1.0
Second home – TF – 0.9, RRF – 0.8, CF – 0.4, NF – 0.6

Any thoughts/views on this?

Regards,
Meena

trackback
13 years ago

[…] , Investors forget the risk taken to get some return and only concentrate on Return part . See an Article on GFactor , A tool to find out if an investment suits you . What you have to see is how much return you got […]

trackback
13 years ago

[…] days back I had written about GFactor concept for choosing a Financial Product based on 4 factors and formulating it in mathematics , […]

Dinesh
Dinesh
13 years ago

Execellent thought for average investor. The “G-Factor” formulae only looks at narrow scope of investor requirements, there could tax complusion of an investor besides it is hard to quantify ranking of individual factors. A G-Factor score of over 0.7 may not guarantee returns that were expected or assumed while formulating strategy thus beating the entire process. More over Risk-Return factor gives me a feel of simplified Sharpe ratio explained to an investor, however Sharpe ratio would still do better job. The Tool also ignores long term perspective and invesment goals of investor.

NAVNEET DHAWAN
NAVNEET DHAWAN
13 years ago

This was a mistake from Business Bhaskar newspaper as there management trainee who translated the article was given the matter of my previous article to refer and the trainee translated this article coping the same sheet leaving some details left of the previous article. Editor of Business Bhaskar had a word with Shri Manish Chauhan and has communicated there mistake. They would come up with a clarification in the very next addition. I want to assure all our members that if I will sent any article which had even a small input from others views/thoughts then that article would clearly have the source information as I think that others people views/thoughts/articles can not be described in my name as my views. These views are solely from the origin point (in this case of Shri Manish) and should be shared strictly with the reference of there origin point. I have also asked Business Bhaskar to keep a throw check so that such blunder mistakes are not repeated in future and have been assured by them that necessary attention shall be paid hereafter. I once again repeat that I never had any intentions to publish manish ji articles with credits to me.

Ajay
Ajay
13 years ago

Manish,
I did not understand the Trap Factor properly.
Trap Factor will he higher if the lockin period is more – Is this correct ?
If so Endowment Plans should have Trap Factor of something close to 1 or 1

But the text above the table says
“Endowment policies trap you for long periods like 15 to 20 yrs . Even though there is an option to close the policies you loose a lot of money. So the trap factor of Endowment Policies will be very less like 0.1 , where as Mutual funds (non tax saving funds do not have any type of locking period) . So they can have trap factor of 0.9 or 1.0 .”

Shouldnt this be other way ?

trackback
Top Articles Around Money (Week Ending May 30, 2010) » Ranjan Varma's Blog
13 years ago

[…] Manish Chauhan has developed a score system for your financial products. He calls it the GFactor. […]

S S
S S
13 years ago

Good for beginners, actually can work for everyone if we know what we are putting there. But most of us don’t have good knowledge of the product. Too much of descretion is demanded on user’s part. Like, PPF provides loan facility which means easy liquidty how are we going to decide trap factor? People buy Emdowment/money back policies because they think they get sum assured in the end and some money at regular intervals for them these polocies are satisfactory product which may affect decision. May be I am confused, you can explain better.
Good example..2 kids 1 wife btw how many wives a normal person can afford otherwise?

dr kishan
dr kishan
13 years ago

MANISH
good effort from ur side towards mathematising human feelings like “complexity” and “need”. indeed if used properly this factor estimation shall help in assessing each product
one thing i wanted to mention regarding term insurance. u said it has a 100% return ability, but this means that the person is dead, right? then whats the use calculating return over it when the return is unutilisable since the investor is dead!! similarly if it has 100% risk (since all the premia may be completely lost ), it means that the investor is alive, whish of course is better than getting return after death. i think since term insurance return is related to the death of the investor it is better that the G factor of this product is better left uncalculated.
i dont mean to offend u. pardon me if i have.

dr kishan

Sunny Talreja
Sunny Talreja
13 years ago

Hi Manish,
This is really interesting, however, for newbie, it will better to make it more simpler (like the finance calculators in moneycontrol’s wealth sections). Here’s what u can do: Ask for exact trap period, person’s age and instrument type, I guess that will give you all the data to calculate your G-factor and then with the final g fctor, give an explaination like “The G-factor for your investment was 80%, which means, it is very attractive option for you”.
(i converted 0.8 to 80%, it can be shown as a green progress bar as well). Keep up this good work.

Jagbir Singh
13 years ago

Indeed very good work Manish. All I wish that JagoInvestor must reach to as many as people as possible to wide-spread the benefits of having financial knowledge.

I’m somewhat agree with Dr. S Ramakrishna that calculations of such sorts a bit cumbersome for ‘aam’ aadmi like me.. might be due to fact that I’m weak in numeric calculations 😛 .. still I will calculate G-Factor for my investments. btw, on other side… when I received this blog update in mail.. the ‘GF’ in GFactor put my interest on higher side to promptly check it out.. but alas! its all about calculations!! 😀

~ Jagbir

Dr. S Ramakrishna
Dr. S Ramakrishna
13 years ago

hi ! i feel it is a nice work indeed. but it is complex and not rememberable for long time. Not of much practical utility.