Category Archives: Personal Finance

Run and you will be safe

Consider that you are working in a multi-storeyed sophisticated building. Chances are high that you were taught by the fire squad team there, how to escape in case of fire. If you had ever attended that drill you will know that at the time of fire and asked to exit, you have to simply get up and start moving towards the exit (staircase) without any other thought. No saving your files, no shutting off your computer. No searching for valuables.
Now consider that as you are reading this a fire breaks out. Will any of you stop and try to figure out why? What caused the fire? That person will easily be termed as a stupid, foolish idiot and is most likely to lose a considerable portion of his body if not his life. How in the world would anyone be investigating the cause of the fire when all he has to do is run away from it.
Though so obvious, we all do the same when there is a fire in the stock market. Instead of running with whatever we have, we sit back and start analysing the reason for the same. How foolish!! And the fire slowly starts eating our profits (if any) and pushing us deeper into loss (read debt for most people). Still no reaction from the mass. But the funniest part is that those who run are termed as ‘Panic Sellers’. The stock market sometime falls further and touches a new 1 year low. Still people sit and watch without even reacting. “It will bounce’ they say and keep waiting. This foolishness may not be so obvious in the case of an index (say Sensex or Nasdaq) as probably (even this is not true) it will start moving back on the positive side.
But consider the case of individual stocks. The chances of a rebound are slim atleast in a definite time period considering that you could have earned a lot more booking profits and investing the amount elsewhere instead of waiting for the stock to come back to life. Let us say you buy stock XYZ for 500 Rs. It goes to 700 Rs., then something happens (the analysts in the TV show will tell you 1001 reasons why) and the stock starts falling to 600, 550 and then to 400. Ideally you must have had some stop loss below 700 booking you a decent profit. But people keep waiting even after it reaches 250. They say it will bounce back. But please note that the stock has fallen 50% from 500 to 250. But to even come back to 500 it has to rise 100%. That is maths for you and it will always work against you.
But this does not mean that stocks that fall to 50% below their value will never come up back to 100% or even move 1000% up. Many people investigate why the stock has fallen and somewhere (either in a TV show: CNBC or still worse in some blogs or messageboards) they get a valid reason for holding the stock. Chances are slim. It is like trying to find a reason not to run in case of a fire inside your building and still being alive at the end. Will you take that chance???

Hope for the best. Prepare for the worst

Thanks to Srini. Your comment got me in mood again to write on Personal Finance after quite some time.

‘Hope for the best’ – we all do it, almost without any effort. When we buy a stock, we expect it to sky rocket out of everybody’s expectation. When we plan to get a car we expect the prices to fall down and freebies added by the sellers. No one needs to tell us that. We will always hope for the very best to happen to us whatever be the case.

There is nothing wrong with that attitude, after all positive thinking can help your mind and will create an energy within you to work all the more harder towards your financial goal. No one expect the share price to fall down when they had bought it. Part of it has to do with the ego of doing things correctly. That is where the danger lies. We try to be correct rather than being reasonable. We just can’t stand to see our friends smiling at us for having to sell our shares at a loss after all the knowledgeable lectures we gave them during the lunch about how to make a killing in the stock market.

So while everyone is happy when things goes as planned, there is absolute chaos when things break loose like what happened today to sensex after it lost 1112 points in a single trading session. ‘Prepare for the worst’ is the key. Many feel that when you prepare for the worst like taking a life insurance you actually are negative in your thoughts and you invite bad luck. But contrary to the belief, you are brilliant and are prepared to accept the fact that life can be unpredictable. The same goes with financial planning. Prepare yourself for the worst situation that might arise. For example when you buy shares of a company, never ever forget to put a stop loss order in place however confident you are about your selection. Likewise when you put all your money in one area whatever it might be, just give a thought as to what might happen if that loses terribly. So diversify.

What preparing for the worst does is to keep you alive financially when the worst happens to the financial world. You will live to tell the tale. It is like having a working parachute in place before sky diving. Like having safety boats in a ship. Even a Titanic might sink. You never know.

So be prepared and when the worst strikes, you will be able to take it else you will be one among the many slaughtered on the way. Another aspect is to keep the preparation as automated as possible without you having to intervene. This is because you might not have enough time to react and also because your blood might just freeze and you will not make any move but just watch panic stricken.

Have stop losses, diversify, nominate, take insurance (life, vehicle, home, loan, medical) as per and to the extent you need. Above all, what matters is that you make money, not that your lunch friends call you a stock market wizard.

Stocks – Lesson 4

Stop the Losses (When to Sell – Part 1)

In lesson 3 we just learnt that the most important thing to do in investing in Stock Market is to take care of the losses. Make sure your losses are minimum and how do we do that. One technique that we learned was not to make big bets. The rule that you are going to learn is the most important and should be adhered with a lot of discipline.

Let us take the same example of the previous lesson. You got 1 lakh to invest in stocks and 5% of that you use to get 14 shares of Wipro at 371 Rs per share. So you have now invested 14 * 371 = 5194 Rs (i.e around 5% of 1 lakh). The next day you look at the price and Oh my God !! Wipro is quoted at 300 Rs, a fall of 71Rs per share taking your paper loss to 994 Rs. Not bad you think , after all it is WIPRO, it has posted great profits so it will come up. The week after that Wipro is at 200 Rs. Now your paper loss stands at (371-200) * 14 = 2394 Rs. What do you do? Many people hold on to their stock with the belief that it will come good one day. It might, but there is a possiblity that ‘THE DAY MIGHT NEVER COME’. So what is the best you can do?

Stop Loss Orders are the answer. When you buy Wipro or any Stock for that matter, make sure you place a stop loss order at some fixed % below the purchase price. The % depends on your choice but make sure that it is not more that 25%. (Ideally 10-15%). What will happen is that when Wipro’s share price falls below the indicated stop loss price, the stop loss order gets executed and your shares are sold ensuring minimum loss to you. Should I place the order for all the shares I bought? No.. Don’t do that too. Sell half or 2/3 of the shares (7 shares or 10 shares of Wipro in our example). Place another stop loss a bit further down from the earlier one where you will sell another % of shares. But the final level at which you sell all the shares should not be greater that 25% of the initial value. Too Confusing !! Right? Let me explain it in simple terms.

    * I go and buy 14 shares of Wipro at 371 Rs. Fine.
    * At the same time I place a stop loss order to sell 7 shares of Wipro if the price falls to/below 316 Rs.  [7 shares is 50% of 14 shares. Rs 316 is 15% less that Rs 371]
    * I place another stop loss order to sell 4 shares of Wipro if the price falls to/below 297 Rs [4 shares of Wipro is close to 25%. 297 Rs is 20% less than that of of Rs 371]
    * I place yet another stop loss order to sell the remaining 3 shares of Wipro if the price falls to/below Rs 278 [3 share of Wipro is close to 25% and 278 Rs is 25% lesser of Rs 371]

What I have done is ensured that my loss at the maximum will be 7*(371-316)+4*(371-297)+3 (371-278) = 960 Rs (i.e 7*55 + 4*74 + 3*93 = 385+296+279). Great. At the worst scenario our total loss in the trade would be 960 Rs + Agent’s comission. That is just fine. But how does the entire process of stop loss order takes place.
We place the stop loss order using our broker (person, by phone or through internet). Once the price of the stock for which we placed the stop loss order reaches or falls below the price that we indicated in the order then the order gets executed and the shares mentioned in the order or sold to the market at the current rate. This is known by the term that we have been stopped out. The same happens for the subsequent orders. It might also happen that Wipro might fall to 316, stopping us out of the first order and continue to fall till 300, but then it might climb back to 450 (who knows what might happen), in that case we would have sold 7 shares at 316 but we still have 7 more shares and with the price at 450 it means that we now have a profit of (450-371)*7 = 553, just with the 7 shares left. But we have incurred a loss of 385 already in selling the other 7 shares by way of stop loss. Net effect is that we have a 553-385 = 168 profit at hand. Not bad. But you might ask, if Wipro is capable of coming back then why sell the 7 shares at 316, why not wait. That is where the danger lies. You might Wait.. Wait and Wait for ever and Wipro might never come back or worse still it might continue to go down and bite the dust.
So stop loss is just that ‘Stop your loss – before it gets too bad’. The example we have taken is very trivial, but consider thousands of rupees at stake and you know its importance. To close this lesson let me tell you the funiest thing that people do when the price of their stock falls. Many people instead of stopping their loss, actually make it worse by buying more shares at the falling price. A few more think that long term investing means they can buy the shares and keep it with them without selling come what may. In the next lesson you will know why both of them are kicked out of the stock market as beggars.

Stocks – Lesson 3

Please go through Lesson 1 and Lesson 2 before reading this.

Why would you want to know all about the Stock market? Why the hell are people desperate to understand its functioning. There is just one answer “To make money”. You and I are here to get some profit from it. If anyone wants to know the market, because he thinks it is fun, Goodbye to him. You are better served at the Casino. Stock market and trading are serious business. They are not joke or fun or something like riding a roller coaster. We are putting our hard earned money (really!?!) into this. Fine, that said we will look into the basics of trading.

The first part is to ‘Buy’. We now have a few questions ‘Which Stock?’, ‘When’ and ‘How much’. Then we need to ‘Hold’ it for a certain period of time before we ‘Sell’ it for a profit/loss. We must also know ‘When’ and ‘How much’ to sell.

Most stock market experts are dumb asses. You can take that from me. Going through the entire ‘Hindu Business’ or ‘Financial Times’ will leave you nowhere. Some are still more humerous and they just sit and watch CNBC or NDTV Money for hours together. Still worse is talking about shares during the lunch and getting free tips from your closest friend. Believe me, when it comes to stock trading all of us are dumb – in fact we are equally dumb. If your friend suggest that you must buy ‘Infosys’ and he is proved right after some time, doesn’t mean that he was an expert but that he was lucky. Then is stock market is all about luck. Is it like a game of dice. No not exactly. There are some good steps that one can follow and ensure that they make some money. But forget the advice given by any expert wearing the best blazer, stating that the market is dangerous now or that it is the best time to enter the market, etc.

First and foremost, anyone who is financially unstable should not even think about ‘Stock Market’. Just because you have some spare cash does not mean that you must enter in. You are eligible only if you have the risk capital of atleast Rs. 50,000 – 1,00,000. ‘Risk Capital’ means losing which not have an effect in your lifestyle or break your heart. If you can just spare a few thousands, (or hundreds) you can think about mutual funds. The reason is very simple. There are times when you are required to make bold decisions, and you can’t do it with your lunch-money.
With atleast 1 Lakh in hand, you will be able to take a few blows, but live to tell the tale and enter again.

Before learning ‘What to buy’ we will first see ‘How to Buy’. ‘Asset Allocation’ is the most important and the most ignored part in trading. Asset allocation means how you are going to use your 1 Lakh to buy shares. The first rule is to put not more than 5% of your capital in one trade (read Stock). However promising it might look, never break this rule. Someone who puts 100% of his capital on a trade is expected to go to NIL very soon. (Even if his success rate is 9 out of 10 times, the 10th time he will be put to NIL as he is betting all his money in every trade). Let us say that we have 1 Lakh and somehow we are bullish on Wipro. Currently it is trading at Rs 371. 5% of 1 Lakh is Rs 5000 and so we should buy just 14 shares of Wipro initially. Nothing to worry. Suppose something goes wrong and the share price of Wipro falls to 300 our loss on paper would be (371-300)*14 = 994 Rs. Much better than the 18900 we would have lost had we put the entire 1 Lakh in Wipro. Things can still get worse and Wipro can slump to 200. you get the point right. When you begin a trade put only 5% in it. Not more!!  We will see about ‘Stop Loss’ and ‘Drawdown’ in the next lesson. But for now just remember this “In the stock market, concentrate on the loss and keep them low, the gains will take care of themselves”.

Stocks – Lesson 2

As we saw in Lesson No. 1, shares that are initially launched as IPOs eventually find their way to the secondary market (the BSE or the NSE). It is like an auction place for the shares, those who have the shares tell an ‘ask’ price at which they will sell the share and those who want it will have a ‘bid’ price at which they would like to buy the share.

If you had happened to see some news clips, you can find the BSE something like a local fish market with everyone yelling and running around. Why can’t they all sit in their places while the buy/sell takes place. It is because of the bid and ask differences. Why is there so much noise in a fish market? Because there is some bargaining and profits to be had. That is why the sellers shout their prices to attract the prospective buyers and the buyers bargain with more than one seller. Almost the same happens at the stock market. There are ‘ask’ers shouting their price and ‘bid’ders shouting theirs. For example a broker there might shout “I will sell 100 Infosys at Rs 1000” or something like that. Since huge money is involved you can see people running and shouting like maniacs in the BSE located at Dallal Street, Mumbai.

What would happen if we all were to go to BSE to shout our way to wealth. Not likely Right? and it would be a hell of a lot of work to do understanding a lot of rules and regulations along the way. So SEBI (Security and Exchange Board of India) have laid some rules governing all this and there are special tests to be passed to become a broker at BSE/NSE. These brokers will act on behalf of us and sell/buy whatever we tell them, Of course for a small comission. If you find this too a tedious process, you can go for an online broker like ICICIDirect, ShareKhan, Kotakstreet, Indiabulls etc. Then you can trade from the convenience of your home with a computer hooked to internet. We will see this in detail in later lessons.

Fine, so that is how there came to be so many shares of companies being traded everyday at both BSE and NSE. And you can buy any number of shares (on the bid price) of any company listed in the BSE or NSE, provided you have the money and the same holds for selling (on the ask price). Now let us come to a few terms that have pestered our minds for long.

‘Sensex’ – The whole concept lies behind the buy and sell in the BSE. Say we need to track whether there were more ‘buy’s or more ‘sells’ on a particular day. Again there might be 100 ‘buy’s of Rs 10 each and 1 buy of Rs 1000. So the point is to consider the actual price movement alone, i.e if ROHG was at 75 the previous day and is now at 78, it is +2 and the same goes for other companies. Finally Sum of all price action will give you a  +n (n points more) or a  -n (n points below) for the market as a whole on the day (compared to the previous day). But instead of considering all the companies whose shares make the BSE, SEBI considers only 30 stocks whose price action is alone considered in calculating sensex. So in rough terms Sensex = Previous day Sensex + Sum of the price difference of the 30 stocks compared to their previous day. But beware this is a very generic and simplified explanation. So when we say that Sensex is up 100 points, it means that there were more buys that day and that the stock prices have increased on a whole that day.

‘Nifty’ – A benchmark for NSE considering 50 stocks trading at NSE (Same function as that of Sensex for BSE).

‘Stocks and Shares’ – Stock usually refers to a collection of shares. So you can say “I was given a stock option of Infosys consisting of 100 shares”. My portfolio has stocks of IBM, Infosys and TCS.

‘Bull Market’ – When the Sensex (or Nifty) rises consistently for a prolonged period of time, the phase is said to be the ‘Bull Market’. There are huge ‘buy’s and people are happy with the prices raising. Bulls are those who expect the market to be bullish.

‘Bear Market’ – When the Sensex falls and stays at the same level for an extended period of time, the market is said to be bearish. Bears are those who are always negative about the market and expect it to fall down. Whenever there is an economic crisis (Political reasons too like NDA Govt’s failure), the market crashes (Sensex falls heavily) and it enters the bear market.

‘Correction’ – When the market is on a bull run, there is a phase when some of the traders (some of us), decide to sell our shares and make a profit. This causes a slight dent in the bull run and is known as the correction, but then usually the bull run continues again.

‘Porfolio’ – A collection of Stock (shares of many companies). For eg if I have 100 shares of Infosys, 50 shares of Wipro and 120 shares of ITC, then my portfolio would look like
Infosys – 100 shares – Net profit/loss at current price = 12000 Rs
Wipro – 50 shares –  Net profit/loss at current price = 5600 Rs
ITC – 120 shares –  Net profit/loss at current price = -7520 Rs

‘Paper Gain/Loss’ – The gain or loss of our stocks/portfolio if we sell the stock/entire portfolio at the current market price. It is the difference between the purchase and current market price. When we say that our paper gain in Infosys is 12000, it means that if we sell now we will gain 12000 from the trade (buy/sell) and the same is true when we say that we have a paper loss of 7520 in ITC.

‘Actual Gain/Loss’ – When we actually sell the shares/stocks in portfolio the loss or gain that we get is termed as actual loss/gain unlike the paper loss/gain which is just notianal. So if we have a paper gain and we don’t sell but keep it till the price falls below the purchase price, we have a paper loss and if we sell then we will get the actual loss.

Stocks – Lesson 1

hat better time to talk of shares than now with the Sensex hitting all time high and the bulls are having fun at the Dalal Street.
This is how most of the articles begin when they want to educate people on stocks and shares and eventually those who came to read will feel that it is not for them and flee from the place. So I thought I would do it a bit different and see if that helps. If you are one who had always wanted to know what stock market is and what they sell there or if you have as a kid (even as an adult) wondered what went high in Sensex and what the hell if it dropped few points, jump in. I will try to take you on a tour to the world of stocks and shares..
Mr. Rohit is a small textile owner. He gets the cloth materials and with the help of a few tailors working under him, he converts them to beautiful dresses and puts them up for sale. He has a good profit, enough to make a living in his rather small city. But he is not content with just being that. He wants to be a big business man. He dreams of it and one day decides to take the risk. So he approaches a bank and gets a loan of 1 Lakh and with some of his wife jewellery he opens a big shop at the heart of the town, employs 10 more tailors and gives his shop the name “Rohit Garments”. After two years, things are getting better, he settles his loan and still makes a profit of 2 Lakhs per year. People identify his brand and rush to his shop. Though the town is small, still many of his customers have to travel 20 kms to reach his shop. So he decides to open three more branches. But this time, he is not going for a loan in the bank. Instead he decides to make his company ‘Public’. This means instead of having 100% ownership on his firm he decides to share it with the public in return for some amount which he can use to open branches, buy tailoring machines and employ more tailors. He contacts a firm specialized in doing this and they sit and decide what is to be done.
They finally come up to a conclusion that Rohit will have 60% of ownership with him and the remaining 40% will go public. They put a valuation for the shop ‘Rohit Garments’ considering its machinery, furnitures, number of people employed, their abilities, the profit making capability etc. Let us say that they arrive at 5 Lakhs by valuation. Then they take 40% of that, which is (40 * 500000)/100 giving 2 Lakhs. Now this 2 Lakhs will be converted to units called shares. If they fix the face value of a share as Rs 10 then there will be 200000/10 = 20 thousand shares. If they fix the face value of the share as Rs 100 then there will be 200000/100 = 2 thousand shares. Let us say they decide that the face value will be Rs 10 (it really does not matter). Now we have 20 thousand shares of “Rohit Garments” ready to be sold to the public. But that is not all. The firm will further advice on the actual price for the Rs 10 unit (something like cost price and selling price). Let us say they decide it as Rs 25. This means the unit which is actually worth Rs 10 will be sold each for Rs 25 to the general public (whoever interested). And by this route, without any loan, Rohit can raise 20000 * 25 = 5 Lakhs for further expanding his business.
Now you might ask “Who the hell will give Rs 25 for something worth Rs 10?” But you will be surprised to know that many will and in fact that is how it works. People buy it hoping it will get better. Don’t confuse with it now, we will discuss that later. One fine day you will find in newspapers and in news (NDTV, CNBC, etc) that “Rohit Garments” have come up with an IPO (Initial Public Offering) of 20 thousand shares of face value Rs 10 at Rs 25 each. If you decide to buy say 100 shares of “Rohit Garments”, you can fill up a form and along with the required DD (100 * 25 = Rs 2500) send it. You will receive the certificate stating that you have been granted 100 shares at Rs 25 each (with face value Rs 10). What you have done unknowingly is to buy shares in the “Primary Stock Market” i.e IPOs.
Now what?? You can keep the shares with you. Whenever “Rohit Garments” did a great job, posted a very good profit and decide to give some to the shareholders they will announce “Dividend”. So if they decide to part with say 1 Lakh as dividend, it will be divided by 20 thousand (remember that initially there were 20 thousand shares issued) giving Rs 5 for each share held. And without doing any work you will get Rs 5 * 100 shares that you have = Rs 500. You will receive a cheque for the amount of Rs 500. Voila!! you made a profit in Stock Market. But that is not all.
Once the IPO is over the shares can get into the “Secondary Market” where they are bought and sold. Since “Rohit Garments” went public it will be given a symbol say “ROHG” and a place in the BSE (Bombay Stock Exchange). This means with the help of this symbol you can see what price it is being currently sold and bought in BSE. The BSE is a place (Secondary Market) to buy and sell shares. You happen to look into the daily newspaper and see that ROHG is now worth Rs 75. This means there are people out there that are willing to give Rs 75 for each share that you will sell them. Now you have 100 shares which you got for Rs 25 each. So if you sell them then 100 * (75-25) = 5000 Rs. Excellent!!! You get Rs 5000 for no work at all, just a buy and a sell. Wow!!!. But you need not sell it. It is upto you. You decide that you will see if the price goes above Rs 75 (So that your profit also becomes higher). After two months one day you check the prices, you find that the price of ROHG is now at Rs 150. You just can’t believe it. That means 100 * (150-25) = Rs12500. Your heart starts beating faster. I will wait you finally decide and then you forget all about it. After a few months one fine day, you check the prices. You are shocked?!? ROHG is quoted at Rs 4. “My God” You shout. That means 100 * (4 – 25) = Loss of Rs 2100. Though the profit and loss was in papers still it is the truth at the given time. So what does it take to get the profits only. Can I buy any other shares in Secondary market. To know the answers wait for Stocks – Lesson no 2.

Lesson 9: Property – A must for investors

As of this writing India is populated with 1533701675 individuals. Though India is quite a big country, the surging population will render the real estate costs on the higher side year after year. One often hears that a plot (site) purchased a few years back for say 65000 is now selling at 2.5 Lakhs and so on. In most cases property appreciation is in the order of 40-100%. That is enormous considering the fact that the very risky stock markets also cannot give such returns on a regular basis. The risk involved is very less as a carefully chosen property will rarely give negative returns. They can give additional income like rentals. They are a good hedge against inflation as rarely you will find a property costing less than what it was. Pride is attached with ownership of a property (especially in India).

Then why not everyone drop the idea of investing elsewhere and go for property alone. The chief blocking point is that investments in property are way too costly. You cannot go and invest a few thousands in it. Unless you have a few lakhs of disposable cash, you cannot think of investing in property. (Of course with the advent of real estate funds, this could be solved).  Also you have to be extra careful as there are many bogus operators and you could be easily cheated and the money involved is quite high as well. The liquidity part is also alarming as to dispose a house and book the profit, it might take anywhere between a few months to a year.

Having said all this, there are other advantages that outshine. You can opt for a home loan where-by you can avail of tax benefits (Principal in the 1 Lakh limit and the interest part of upto 1.5 Lakhs  can be exempt from tax). If a home is purchased for self-residential purpose then you have your own house to live in (no more rents) and the joy of which only people living in rental houses can realize. You can decorate it as you like, nail anywhere any number of times, and most important of them all, you need not change you address with a dozen people (banks, electricity board, telephone etc) as you will not be changing you house any more.

But if you insist on the property being only for an investment, then buy plots (sites) rather than houses as the appreciation in plots (sites) are far better than built houses. Of course there are exceptions here too, as for example in Bangalore there is not much difference between any type of real estate investments (sites, apartments, individual houses) as there are crazy beggers here who will happily buy an apartment (for resale) for Rs 38 Lakhs, which is located on block E in the 16th floor of some ‘Stupid Nests’ built by KirukuPaya Developers Pvt. Ltd.

Lesson 8: Investing in Gold

Gold is not new to us. Come marriage and there is the shameless talk of gold for dowry. We still have some auspicious day to buy gold. The shining yellow metal has attracted humans (especially indians) a lot and there are good reasons for that. Gold has always been equated to the status symbol. It does not get rusted or for that matter loses its shine. It is extremely ductile and can be easily converted to another form (jewellery).

Well we can go on like this and a chemist can give much more information like its symbol (Au) and what not. But let us focus our attention to its investment oriented features. Gold can be readily converted to money (sell/pawn). But the best feature is that it is a good hedge against inflation and it does not lose its value as the years go by, like an idle cash does. It is also accepted throughout the world. But it also does not generate returns (Two gold coins does not give birth to another one).

So what then. Diversification is the key. Have some amount of your money in gold. Of course if you are buying jewellery then your wife should be very happy about it. But we are not talking about jewellery. We are talking of pure gold coins . Jewellery gold may not be pure and also we need to face loss in the form of ‘Making charges’ and ‘Losses while the jewel is made’. When we resell, the person buying it may again ask for losses as he will have to recast the jewel to some new model. So it is loss all the way. Instead we need to buy gold from reputed sellers like ICICI bank, where you get a nicely packed gold coin along with its purity certificate. It is available in 5g / 8g / 10g. So next time, gift your wife with a beautiful gold coin.  And you can be happy that you have invested in gold too….

Lesson 7: PPF – Still a strong contender

We saw in the last lesson how ELSS can bring energetic returns. But we must keep in mind that Diversification is still the key. Also there are many out there who are apprehensive of investing in a Mutual Fund, especially the ones tied to Stock Market. What else? We cannot just pump in more money into LIC policies as we know how detrimental it can be. If you are ready to forgo liquidity you get another excellent investment vehicle – The Public Provident Fund, a Govt backed scheme. Please note that PPF is different from PF. To open a PPF account all you need is to go to a Nationalised bank and shell out Rs 500/- PPF is a 15 year time bound investment. It can be best used for long-range planning. Instead of describing PPF let me list out the key points alone.

    * The total tenure is 15 full financial years. Suppose you start today (June 15, 2005) your PPF account will mature on March 31, 2021.
    * You must invest min of Rs500 per year to keep the account active
    * The maximum limit is Rs 70000 per year
    * It hax Tax Exemption as per the section 80C (The 1 Lakh limit)
    * You can avail loan on your money(part of it) from the 3rd year onwards
    * You can withdraw money (part of it) from the 7th year onwards
    * The rate of return is 8% compounded (as of now. Please note that the rate is not fixed. It can go up or come down and Govt decides that)
    * The returns are also tax free (Unlike NSS/fixed deposits where the interest are taxed)
    * Every year you can pay the money in 1 to 12 installments, whichever suits you
    * It is an excellent choice for conservative investors to plan their retirement as it is a Government backed scheme
    * An example : Investing 17000 every year will give you 5 lakhs at the end of 15 years.

Lesson 5: Mutual Funds – An Intro

If you have come this far, I take it for granted that you are now aware of the basics and raring to go further. At this point, you must realize that you as a person are unique and there may be 1001 reasons why one investment vehicle won’t give you a pleasant ride, while the same may be the best for someone else. But there are a few well tested vehicles that I will review from now on. Still the decision is yours.

A Mutual Fund, as the name suggests, is a trust where many people put in money and this pool of money is managed by a  professional, who on behalf of the people invests the money and the profits/losses are shared (Of course we need to pay the professional too). Since there are many types of investment, there are even more types of Mutual Funds. There are many private players like HDFC-fund, Prudential ICICI, each with a long list of funds and to sort of these hundreds of funds and find the right one for you will take quite some time. Each fund has units that you can buy at a NAV (Net asset value). Say if the NAV is 100 Rs and you invest 2000 Rs in that fund, you will be alloted 20 units of that fund.

Let us see the major types alone. One way of classifying funds is based on where they invest.

   1. Equity – Invest in Shares of Companies in the Stock Market
          * Equity Diversified – Invest in a broad range of companies
          * Equite Sector – Invest only in one type of companies
   2. Debt – Invest in Bonds of Companies and Govt.
   3. Balanced – Midway of the above two

As you must have understood, Equity funds give the highest risk and highest return. Currently some funds are giving in the range of 40-60% per annum too. Debt funds are less riskier and lesser returns.

Another way to classify funds is by the way the profit is shared

   1. Growth Fund – Here the profits are used again for further investments (like compound interest) and so the NAV rises as profits grows.
   2. Dividend – The profit is given to the unit holders on a timely basis

Yet another way to classify funds would be on the basis of when one can invest in them.

   1. Open-ended funds – Open throughout the year. One can invest anytime.
   2. Closes-ended funds – Open only at specific intervals for investment

So if you happen to see details of a fund you can find that it could be “Equity Diversified Open Ended Growth” Scheme or “Balanced Dividend Closed” scheme or any other combination. There may be many gimmicks in the actual name, but you must take care to see the complete details.

Risk and Returns are the two things that you got to note down. For that you can see how the fund had performed in one year, three years, five years and since it was started. You must compare it with similar funds and with BSE/NSE. Also don’t get carried away by the fact that the fund has a great 3 year avg of 50%. It could be due to one 100% and two – 25%. That is not a good sign especially if the – 25 % is from the recent year. So check each year’s performance also separately.

Major Advantages of Mutual Fund

    * You get a professional to manage your fund
    * You can invest in Stock Market with just a few hundred rupees/month
    * You get instant diversification across shares of many companies

Major Disadvantages of Mutual Fund

    * Returns are market linked. So there is a possibility of losing your capital (negative returns)
    * All depends on that one professional. He may not be efficient enough.
    * Cost overhead
    * Sometimes too much diversification can dilute your profits

Situation in India – In India still, people are not very aware of this new type of investment. More are still bound with their love for recurring deposits, fixed deposits and savings account. But Mutual funds give a good method to invest some part of your money in stock markets and give yourself some chance of making greater returns.