Investment School: 2008

Cash is King

When you take a look at the newspapers in the morning, you see more news on "DECLINE" in almost all asset classes and if not declining , they are volatile otherwise. So where can we put your money (if at all you are left with some money after being battered with losses in markets)

In these troubled times, "Cash is King" the best way to survive this downfall is just to keep accumulating your savings bank account with loads and loads of cash as and when you get them.

Reasons for being in Cash

1. The first and foremost reason to be in cash is that you have control over your money. In current scenario markets are driven by all kinds of external dependencies and is more sensitive to global economic condition.

2.Capital Protection is a must in these troubled times and one should minimize the risk of losing his/her money.


Where to park my cash

1. The best and most safe instrument is fixed deposit. Most banks offer 10+% interest on 1 year deposit. This is the safe heaven.

2.Investors with more risk appetite can go for liquid funds,FMP and other short term debt mutual funds.

Reiterating once more, "Cash is King" is the film Name and You are the real hero if you have cash right now.

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Sensex Long Term Outlook

I would like to introduce to Investment School Readers, a very good technical analyst -Mrs. Lokeshwari .For those who read Hindu Business Line, this name should be very familiar. She the technical analyst and writes technical analysis columns every sunday and she is associated with Business Line for past several years. Those who are curious to know the various resistance and supports of benchmark indices can definitely spare some time and read through her sunday columns in Business Line.

In her recent column , she had given the long term outlook of Sensex and i would like to quote her technical calculations to our readers,

In our review in July, we had stated that, “The decline below 13700 brings the next long-term supports for the Sensex at 11,900 (50 per cent retracement of the up-move from 2001) and then 9703 (61.8 per cent retracement) in to focus. We stay with our long-term count that the current down-move is the fourth part of the long-term cycle that began in 1980. The fifth leg (upward) would then take the index beyond 25,000 again. Caveat - decline below 9,703 would need recasting of the counts.

The more difficult question is, how long would this down-trend last? As per Elliott Wave theory, corrections can extend from anywhere between 0.33 to 1.618 times the time consumed by the previous up-move.

The previous up-move lasted four years. That gives us the range between 16 to 77 months. Since the previous long-term correction from 1994 to 2003 was a long-drawn one, applying rules of alteration, the correction this time can be a sharp and swift one that ends in one to one- and- a- half years.”

In her column, she has indicated the next major support levels at 9700,8800 and ofcourse 6800. So as per technical counts , Sensex can go to 6800 given the current situations.

Note: The counts are revisited if some major changes happens in the global financial arena.

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Should you buy real estate now?

Recently i read an article in Economic Times(not a opinion or sensex target kind of articles which is usually a trade mark of ET). This article was all about stats. The article was about the advance tax paid by the real estate companies.

What is Advance tax?

Advance tax is a tax paid by individuals who earn in addition to monthly income and corporates. These are paid in three installments,

1. Sep 15 - upto 30% of advance tax should be paid
2. Dec 15 - upto 60% of advance tax should be paid
3. March 15 - upto 100% of advance tax should be paid.

Take the following example:

Gross total income: Rs 160,500
Salary (Rs 100,000), income from house property (Rs 48,000), income from other sources (Rs 12,500)

Deductions: Rs 14,500
Section 80D (Rs 2,500), section 80L (Rs 12,000)

Net income: Rs 146,000

Total tax: Rs 15,970
Tax on net income (Rs 20,020) - section 88 rebate (Rs 5,500) + 10 per cent surcharge (Rs 1,452)

Net balance: Rs 10,000
Total tax (Rs 15,970) - TDS (Rs 5,972)

Taking the above example, Rs 3,000 by September 15; Rs 3,000 (60 per cent of Rs 10,000 - Rs 3,000) by December 15 and the balance Rs 4,000 by March 15.

So coming back to the article which i read, the following are the advance tax paid by some of the leading real estate companies and it gives useful insights on where the real estate market is heading towards.

1.DLF - NIL Vs 37 Crores paid on Sep 15 2007

2.Omaxe - NIL Vs 37.5 Crores paid on Sep 15 2007

3.HDIL - NIL Vs 30 Crores paid on Sep 15 2007

4.Unitech - 50 Crores Vs 100 Crores paid on Sep 15 2007

5.Ansal Properties - 5 Crores Vs 10 Crores paid on Sep 15 2007

What does this signify?

Real estate companies has paid NIL to fewer crores of advance tax because they expect far lesser revenue than the last year.

Why lower revenue expected?

Simple logical conclusion - They have sold lesser properties and many properties across the nation have no takers because of high interest rate and high cost of the property.

What can we expect out of lower revenue?

Builders build apartments by taking loan from banks at a much higher interest rate. At one point of time when there are no takers for the property, they will be forced to reduce the price of the property or even sell the properties at throw away prices like what is happening in US currently.

So real esate prices are in for a correction next to equities and think twice before you buy a property at this juncture.

Note : This is my personal assesment of the situation. You should take your decision after applying your thoughts and calculations.

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What is Balance Sheet?

As a continuation of Fundamental Analysis Series, let us learn about balance sheets of a company and how to interpret it and how to utilize a balance sheet of a company.

What is Balance Sheet?

Balance sheet of a company indicates how healthy is a company with respect to financial factors. It lists the assets and liabilities of a company and you should remember that assets and liabilities are not same as revenue and earnings. Broadly balance sheet has the following components

1. Assets
2. Liabilities
3. Equity

Asset:

There are two types of assets

Current Assets:

It includes assets that be converted into cash in a financial year.It includes ready cash,inventories and receivables. A company with high cash holding in its balance sheet is a good bet compared to a company with debt or less cash. Inventories are nothing but goods which are yet to be sold to consumers and receivables are bills which are pending payment to the company.

Non Current Assets:

These are assets which are not very liquid and can not be converted to cash quickly. These include Land,machinery etc.

Liabilities:

These are again classified into two types.

Current Liabilities:

These are debt which needs to be repaid within the current financial year.

Non-current Liabilities:

These are long term debt in the form of bank debt or bonds borrowed.

Equity or Shareholder's equity:

Shareholder's equity is nothing but

Equity = Total Assets - Total Liabilities

Paid Capital:

Amount of money the company collected during its IPO(Initial Public Offer).

Retained Earnings:

It is the amount of earnings that the company has reinvested in the business rather than paying it back as dividend to the share holders.


So these are the important components of a balance sheet though there may be few other. So as an investor one can derive very useful insight about the company financial health from its balance sheet and make a good decision on his investment.

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How to calculate HRA for Tax Exemption?

Most of us pay more tax by neglecting to know about House Rent Allowance(HRA) component in our payslip.

What is HRA?

HRA is house rent allowance offered by employers to all its employees. HRA is exempted from taxable income and hence reduces the tax paid by an employee.

How HRA is calculated?

The HRA calculated by the employer is the minimum of the following three amount.

1. Actual HRA given by the employer as mentioned in the payslip.
2. Acutal rent paid by employee minus(-) 10% of his/her basic salary
3. 50% of basic salary in metro cities(delhi,mumbai,chennai,calcutta) or 40% of basic salary in other cities.

Lets take an example.

Ram lives in a house in bangalore and pays a rent of 7,000. The HRA offered by his employee is 6000/month and his basic salary is 20,000/month. Let us calculate the three amount stated above

1. HRA offered = 6,000
2. Rent - 10% of basic = 7,000 - 10% of 20,000 = 5,000
3. 40% of basic salary = 40% of 20,000 = 8,000

Hence minimum of the three , 5,000 is taken as HRA and 12*5,000 = 60,000 is exempted from tax for the current financial year.

Note : You have to pay monthly rent receipts to your employer and you can not have short routes in stating wrong rents paid by you.

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What is Capital Gain tax?

Tax is one area where most of us have always loads n loads of questions. One major tax that is associated with any individual who owns an asset is Capital gains tax.

What is Capital Gains?

When a person sells an asset and makes profit out of it, the profit is called Capital Gains. The tax paid on profit of these asset sale is Capital Gains Tax. The asset may include
mutual funds, stocks, house, land,gold and few other. When a person makes a loss out of his asset sale, it is called Capital Loss.

What are 2 types of Capital Gains?

Depending on how long you hold on to your asset before selling, there are two types of capital gains.

Short Term Capital Gains

If a person sells an asset before 3 years from its purchase and if he makes a profit , it is called short term capital gains tax. For mutual funds and equities, it is 1 year.

Long Term Capital Gains

If a person sells an asset after 3 years from its purchase and makes a profit, it is called as a long term capital gains tax. For mutual funds and shares, it is 1 year.

Short Term Capital Gains Tax:

The short term capital gains is added to your taxable income for the financial year and taxed at your income tax slab rate.

Long Term Capital Gains Tax:

There are two ways for taxing long term gains.

1. 10% of your gains without indexation.
2. 20% of your gains with indexation.

 Lets take an example for case 2 (with indexation)

Let's say Mr Ram purchased a house of Rs 2,50,000 (Rs 250,000) on June 20, 1996. He sells it on January 20, 2005, for Rs 4,50,000 (Rs 450,000). Since the house was sold over 36 months after being bought, the capital gain will be long term.

First, you calculate the Cost Inflation Index. These indices are fixed and declared by the Central Government every year (see table below). This is called indexation.

Cost inflation index:

Index of the year it was sold / index of the year it was bought
2004-05 index / 1996-97 index
480/305 = 1.57377

Indexed cost of acquisition

= Buying cost x CII
= 250000 x 1.57377
= 3,93,443

Long term capital gain

= Selling price – Indexed cost
= 4,50,000 – 3,93,443
= Rs 56,547

Tax payable will be 20% of Rs 56,547 ie Rs 11,310. (Plus surcharge of 10% if applicable)

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Importance of Stop Loss

Sensex at 18 months low and global markets feeling the heat of us economic failure, and most of us have accumulated loss in our portfolio.We need to sit and analyse if we can digest the current loss and if we can digest more loss or should i cut back loss and move to fixed return investments.

This is required because each one of us have a certain level of risk appetite and we should ensure that our investments are bearing a risk which is affordable by us. All of us invest our hard earned income and hence we should have a comfort level with your investments.


Any investment made should have the following attributes associated with it.

1. Time period of investment.
2. Stop Loss.
3. Target Amount.

Lets take a usecase and analyse it. Ram makes an investment of 2 lacs in sensex(sensex taken for easy reference) on Oct 1st 2007.

Time period of investment = 3 years
Stop Loss = 10%
Target Amount = 3 lacs

Current Value of investment = 1.5 lacs

What is stop loss?

Stop loss is usually expressed as a %age of total investment. In this case it is 15%. So when your market value of investment reaches 90%(100-10) of your initial investment, you should book your losses and exit from that investment.In this example, Ram should have booked loss when it was 1.8 lacs (10% 2 lacs = 20,000) and exited his investment.

However he continues to hold his investment and his loss has increased from 20,000 to 50,000 now. There are so many Rams out there in the market who does not have a well defined stop loss planned for their investment and hence accumulate their losses.

How stop loss is useful?

Emotions should never play a part in one's investments. When you invest a certain amount and have your target set, you should exit when your target is achieved. In the same case, you should exit when your stop loss condition is also met.

Stock market is all about emotions but an intelligent investor should never get into that trap.

What is the common mistake committed?

Most of the investors, when experience a loss in their portfolio and if that loss is more than a specified stop loss, expect the market to recover and expect their investments to come back to profit at some point of time. But they never know "when will their investments be back in profit again". They live on hope of recovery.

Instead of living on hope of recovery, an investor should cut his losses and analyse the investment he had made and what are the areas that he can improve upon so that his upcoming investments are made properly.

Capital Protection Vs Hope of Profit

When an investor is in loss, he is expecting the market to recover and go back to highs but at the same time he has already lost his capital and he is bearing the risk of losing more of his capital. Capital protection should be given highest priority over expectation of recovery when an investor is experiencing a loss.

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What is super annuation?

As explained in the previous article, employees like you and me , make another hidden savings by means of super annuation. So what is super annuation and what are its benefits?

What is super annuation?
             Now a days, corporate have two sections in the compensation package. One of them is Gross Annual Income and the other is Cost To Company(CTC). Super Annuation is a fund maintained by the employer on behalf of all its employees. An employee needs to stay for more than 3 years in an organization to get the full benefit of super annuation fund.
  Amount invested in super annuation fund per year by employer for employee = 10% of basic sal.
   Duration of employment and super annuation benefits:
        IF employee stays in a company <  1 year,  he get no amount from super annuation.
        IF employee stays in a company  for 1 -2 years, he gets 50% of amount + interest earned on his super annuation contribution.
        IF employee stays in a company for 2-3 years, he gets 75% of amount invested + interes earned on his superannuation contribution.
         IF employee stays in a company for > 3 years, he gets full amount invested + interest earned.
         When an employee leaves a company to another one, he can get his super annuation fund balance transferred to the new company. The interest earned per year on super annuation fund varies from company to company. Each company can choose from a bunch of group super annuation policies offered by insurance companies to employers.
             When an individual stops working, he gets 33% of his super annuation fund in lumpsum and the rest of the amount will be given as monthly payments to the employee.
        So this explains the reason for being in a company for a longer period. In today's world, people shift companies very often which is not advisable from career perspective as well as monetary perspective.
              In the next article, lets see how gratuity also rewards long term employees.

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How to calculate your PF balance?

There are some savings that we make without our knowledge. Sounds surprising? but thats what is the reality. An employee in an organized sector have mandatory savings like PF,Employer Pension Scheme,Superannuation,Gratuity. From our monthly gross salary, we make a significant contribution to all four of these. Lets see how much we are saving each month unknowingly in a provident fund.

Provident Fund

For all employees who work in an organized sector, following is the PF contribution every month.

PF contribution by Employee = 12% of basic salary.

PF contribution by Employer = 12% of basic salary.

Employer Pension Scheme

Out of 12% contribution from employer, 8.33% of the contribution (subject to maximum of 541 rs/month) is invested in employer pension scheme.

Lets take an example and understand this.

Ram's basic salary per month = 15,000

Ram's contribution to PF = 12% of 15,000 = 1,800

Ram's Employer contribution = 12% of 15,000 = 1,800

Employer's contribution to EPS = 8.33% of 15,000 = 1250

This 1250 is higher than the max limit of Rs 541/month and hence

Employer's contribution to EPS = 541

Employer contribution to PF = 1800-541 = 1259

So Total PF contribution to Ram's PF account per month = 1800 + 1259
= 3059

How to calculate your PF balance?

Lets say Ram worked in a firm from April 2007 to March 2008.Let us find out what is his balance as on April 1st 2008.

Interest Rate on PF account = 8.5% (fixed by central govt)

So monthly contribution of 3059 for one year @ 8.5% =~ 40,000 (not exact figure)

So in this way you can calculate your return for 'n' number of years for your PF contribution, provided you know your monthly contribution.

I would insist on the readers to get to know their monthly contribution towards PF from your payslip and also collect your PF account statement every year.

Happy Investing!

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How double indexation increases return in FMP?

Finance minister Mr P.Chidambaram in one of the award function asked the recipient of the award "What is your wish list in this year's budget" and the recipient "he din want to pay more taxes" and the recipient is none other than India richest person Mr Mukesh Ambani. In return FM commented that "India is a country where a normal person as well as the richest person does not want to pay taxes".

If Mukesh Ambani himself is more conscious about paying taxes, aam aadmi like you and me should be trying to save taxes in a judicious manner. So lets see how we can reduce taxes on Fixed Maturity Plan by double indexation.

How is the profit taxed from debt mutual funds?

Debt mutual funds have a long term capital gain tax which is taxing the interest if the investment is held for more than a year. There are two methods of taxation.

1. 10% on the interest gained without indexation.

Taxable amount = Amount Returned - Amount Invested

2. 20% on the interest gained without indexation.

In the second gain, the taxable amount is calculated by

Taxable amount = Amount Returned – (Amount Invested * Inflation Index for Redemption financial Year/ Inflation Index for Investment financial Year)

Inflation index for every year is released by the govt.

Lets understand this concept with an example.

Assuming an FMP of 15 months returning 11% and Rs 10,000 is invested. Inflation index for 2006-2007 100 and inflation index for 2007-2008 is 105 and for 2008-2009 is 111. s Tax is calculated using indexation at the rate of 20%.

Scenario 1:

Amount invested in sep 2007.

Amount redeemed in Dec 2008 = Rs 11,000

Taxable Amount = 11000 - (10000 * (inflation index for 2008-2009 / inflation index for 2007-2008))

= 11000 - (10000 * 111/105)

= 11000 - 10571 = 430

Tax @ 20% = 20% of 430 = 86

Amount redeemed = 10914.

Scenario 2:

Amount invested in Mar 2007.

Amount redeemed in Dec 2008 = Rs 11,000

Taxable Amount = 11000 - (10000 * (inflation index for 2008-2009 / inflation index for 2006-2007))

= 11000 - (10000 * 111/100)

= 11000 - 11100 = -100

Net Loss = 100 and hence no tax.

Amount redeemed = 11000

So in this case we have totally avoided tax.


Hence while planning an FMP investment, we should plan it in such a way that it spans two financial years to get the advantage of double indexation.



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What is Fundamental Analysis?

When it comes investing in stocks, there are two schools of thoughts - Fundamental Analysis and Technical Analysis. Fundamental analysis focusses on company economic factors to make an investment decision whereas technical analysis focus on stock price movements to determine the investment. Let us get started with fundamental analysis and what are the various factors affecting fundamental analysis.

     Fundamental analysis of a stock should answer the following questions related to the stock.

1. How is the company growing in terms of revenues and earnings over the past?
2. Has the company been able to maintain healthy profit consistently over the past?
3. How good is the company placed with respect to its competitors?
4. How good is the management of the company?
5. How transparent are the company's operations and decisions?

      These are only few , more questions on the similar note needs to be answered to fulfill a fundamental analysis of the company.

Factors affecting Fundamental Analysis:

             Quantitative factors - The factors which can be measured in numeric terms like net profit growth,revenue growth, equity:debt ratio, EPS, P/E Ratio etc.
              Qualitative factors - Quality of management of the company, brand value of the company etc.

          Both these factors are equally important and should be considered in conjunction while choosing a stock. For eg, Coke has a good track record of financials and also a great brand value which also contributes to its sales. Some of Warren Buffet's(Richest person on earth) investment are shining examples of fundamental analysis. He invested in coke for a simple reason that people will not ditch coke no matter how many times they drink it, coz it has a brand value associated with it. 

          Fundamental analysis will help in identifying the "intrinsic value" of the company.  For eg a company trading at Rs 100 may have a intrinsic value of 200 rs which can be identified by fundamental analysis. In the long run stock markets will reflect the fundamentals of the company.
 
           Lets look into the factors affecting fundamental analysis in deep in the coming posts.
    

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How does inflation affect your invesment?

    
 Before going on with the topic, i would like to take some time and say a "big thanks" to all readers/subscribers of "Investment School" on the occasion of the 50th post of my blog. I am encouraged by your astounding response to my blog and consistent tracking of my blog.  Its your active reading that makes me to write more on investment and best practises. Thanks again!

Come every friday morning, you get to see inflation numbers in bold figures in the newspapers and television channels. So how does inflation affect a common man and its investments?So lets understand inflation and its impacts.

What is inflation?

To put it in simple terms, inflation is nothing but an increase in cost of living for a person on a yearly basis.

Eg. If inflation is 8%, then theortically a good which was sold for 100 rs an year back is now costing Rs 108. So inflation is not a very tricky and difficult to understand , it is as simple as the above example.

How does inflation affects investments?

Inflation reduces the purchasing power of money. 100 rupees can purchase you more last year than what it can purchase as per the last example.

Inflation also erodes investment. Lets see this with an example.

Eg. Ram invests Rs.1,00,000 in a bank FD fetching him 11% interest rate on yearly basis. Ram is in a income tax bracket of 20%.At the end of one year, he gets back Rs.1,11,000 and he pays 20% of 11,000 as tax.

Amount Invested = 1,00,000
Maturity Amount = 1,11,000
Interest Earned = 11,000
Tax on Interest @ 20% = 2,200
Amount in Hand = 1,08,800

Interest Earned = (8,800/1,00,000) * 100
= 8.8%

If the inflation prevailing is 7%, then

Real rate of return/Inflation adjusted return = 8.8% - 7%
= 1.8%

This implies value of money at your hand has increased only by 1.8% and not by 11% or 8.8%.

As we can see in the above example, inflation erodes the return from our investments significantly.

How to reduce the impact of inflation?

We should choose a mix of investment instruments, so that the collective return out of our investment should beat inflation by a good margin of (8-10%) so that real value of our money increases in a significant manner.

Lets rework the same example above by splitting across two investment instruments - debt and equity invested for 12 months or 1 year.

Amount to be invested = 1,00,000
Amount invested in equity = 50,000
Amount invested in debt = 50,000

Interest earned in debt = 11% (0r) 5,500
Tax on interest = 20% (or) 1100
Interest - tax = 4,400
Interest earned in equity = 20% (or) 10,000

Total Interest Earned = 14,400 (or) 14.4%

Inflation = 7%
Real rate of return = 14.4% - 7% = 7.4%

So the inflation adjusted return has increased from 1.8% to 7.4% by reallocating the amount in two different modes of investment. The returns mentioned are assumptions, you need to reallocate the %age of amount in each asset class based on interest available during your investment period.

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What is P/E Ratio?

"Company XYZ is available at a cheaper PE and is a good buy". You would have come across this phrase many a times in NDTV Profit or CNBC-TV18 or in the business newspapers. Most of us make an investment on recommendations from either friends/newspaper/TV channels and overlook technical parameters. Let us understand about these parameter and let me tell you it is not rocket science to learn these.

What is P/E Ratio?

P/E Ratio = Price of one share of a company/Earnings Per Share of the company.

Usually, EPS of the last four quarters is taken into consideration and the resultant P/E is called trailing P/E.If the expected EPS for the next few quarters is taken into account, we arrive at Forward P/E.

How to use P/E Ratio?

P/E Ratio can help investor take their decision to buy a stock. P/E indicates how much Rs is needed to generate a earning of Rs 1.

Eg. If P/E of company XYZ is 20, then it indicates, an investor is willing to pay Rs 20 to generate Rs 1 as earnings for the company.

P/E value varies across sectors. Banks have a lower P/E whereas the tail sector may have a higher P/E. Investors are willing to pay more for a retail company to generate earnings than they want to pay for Banks.

How to use P/E ratio along with other parameters?

As stated in one of the previous article, any technical parameter should not be considered alone to take a buy/sell decision. They should be analysed in conjunction with other parameters.

P/E ratio should be analyzed along with the growth rate of the company. If a company has a higher P/E ratio and but the future growth of the company is not very encouraging, then one should rethink on his decision to buy the stock. P/E of a company should be compared only with its peers. For eg, Infosys P/E should not be compared with SBI's P/E.

To reiterate, P/E should not be the only guiding factor to make your buy/sell decision. One should consider all factors affecting a stock's price before taking a call.

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What is short covering?

In the previous article, we have seen about short selling and what are the risks involved. As promised in the last article, let us see how to mitigate the risk associated with short selling. We shall look at this with an example.

Trader Ram, borrows 50 stock of company XYZ at Rs 100 and promises to give back the stocks to the lender in a months time. Ram anticipates that the stock price of the company would go down to 80 rs and he is planning to buy back the share at 80 rs. Unfortunately , due to external and market conditions, the stock price of the company XYZ rallies to Rs 120 and there is only 3 more days for the month end and Ram has to buy back the shares and deliver it to the lender.

So Ram is in a loss of 20 rs/share and he has only 3 days to go and the market sentiment is very bullish and the stock price of company XYZ can appreciate further. Hence Ram decides to trim his loss at 20 rs/share and buys the share at 120 rs. Share market is not a place with only Ram as a short seller. There are numerous short sellers in the market and say 500 people had short sold the stock of company XYZ. All of them would be trimming their losses and all of them would be buying at higher stock price of 120 rs.

When 500 people places buy order for company XYZ at 120 rs, the company's stock price will eventually go further up and this increases the stock price of the company. This entire process is called "Short Covering". Short covering will lead to a rally in the overall market and these are called short covering rallies. When most of the traders had predicted that the market will touch lower levels, due to some global cues or other factors if the market rises, we tend to see the short covering rally.

The practises of short selling and short covering only suits traders and investors should try to stay away from risky practises.

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What is short selling?

Most of us are taken back with the stock market crash of late eroding our investment value, but you would be surprised to know that you can make profits even in a crashing market. Want to know how is that possible at all? To know how to make money in a bear market, we need to understand the concept of short selling.

What is short selling?

Short selling is selling of a stock which is not owned by a seller. When a trader feels that the stock price of a particular company will fall in the near future, he indulges in short selling. Let us see how it works with a simple example.

Eg. Suppose say, trader Ram feels that stock price of company XYZ currently trading at 1000 rs will go down significantly in the near future due to market correction or any other reason. Ram borrows certain number of stocks,say 20, of company XYZ from his broker for 1000 rs/share.The commitment is that he will have to return back 20 shares to the broker on a specified date in the future say in one month's time.

After purchasing the stock at 1000 rs, Ram immediately sells the stock at 1000 rs and gets 20,000. As expected the stock price of the company XYZ falls by say 100 rs and is at 900 rs at the end of one month. So Ram buys back 20 shares of XYZ at 900/share thereby spending 18,000 and gives back the shares to the broker.

Hence Ram has gained 2,000 from short selling of company XYZ.

Risk Involved

Making money is not that easy. So once you buy the stocks assuming that it's price will go down, what if the price begins to rise due to the overall market sentiment and in these days, where the market volatility is very high the markets can go up and down in a days time and hence there is significant risk involved in short selling.

So should we not indulge in short selling at all? If involved how to trim our losses? The answer is short covering. Let us digg on that in the upcoming posts.

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Things to know about mutual funds

In a previous article , we have seen about famous investment myths about investments in general. There are also misconceptions about mutual funds prevailing among the investors. Let us dig through them and understand how they are misconceived.

1.Diversified funds invests across all sectors.
             Ideally an investor would expect the fund to be invested in all sectors . However the funds usually have a bias towards large cap or mid cap or small cap. They have significant exposures in one or two sectors as they take sectoral bets. So investor should not go by the label "diversified fund". One should look at the funds past track record and identify what are the funds major bets over the past. So long term funds are a better option than new funds.
2. Mutual fund dividends are same as stock dividends.
               Investors tend to believe that mutual fund's dividends are same as stock dividend. However it is not true. When a mutual fund declares dividend in a scheme, the dividend is deducted from the fund's NAV and it does not come free to investors.
            Eg. A fund with 40 rs nav, when declares a dividend of 3 rs , the nav of the fund reduces to 37.
               So an investor can opt for dividend-yield funds if he intends to generate minimum cash flow from his investment on a regular basis.
3.SIP always scores over lumpsum investing.
               Though it is true that SIP(Systematic Investment Planning) would bring in discipline in investment and would lead to regular contribution, SIP does not beat lumpsum investing in a rising market. The major benefit of SIP - cost averaging does not hold good in a long term rising market. SIP works best when market has upward and downward cycles alternatively.
4. Lower NAV is cheap to buy
          It is advisable to go for a old fund with a good track record rather than buying a new fund offer at a lower NAV. A detailed analysis of this given here.
5.FMP returns are fixed 
              Though the name Fixed Maturity Plan suggests fixed returns, in mutual funds, as per SEBI , no fund can assure the investor of fixed return. Hence even FMP's return can turn negative if the interest rate scenario changes during the tenure or inflation rises during the tenure.
          So as an investor you should know all features of asset class (pro's and cons) before making your investment. So i hope this series of information is educating you in your investment journey.

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What is Dividend Yield?

Continuing on the series of explanation of technical parameters of stock analysis, let us now get to know about one another important ratio known as "Dividend Yield".

Dividend yield of a company indicates the annual dividend paid by the company relative to its share price.

Dividend Yield % = (Annual Dividend Per Share / Price per share)*100

If a company A pays dividen of rs 10 and its stock price is 100 rs, then dividen yield is (10/100)*100 = 10%

Dividend yield indicates how much cash flow is generated for each rupee invested in the company by the investor.Dividend yield mutual funds are category which invests in stocks which has higher dividend yields.In general FMCG stocks have a higher dividend yield.

Who can invest in dividend yield stocks?

It is suitable for investors who wanted minimum cash payouts on a regular basis from their investment.

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What are Gold ETFs?

As a country, India is the largest consumer of gold and Indians value gold very high than anyone else in the world. In the past few years, apart from physical gold, other channels of gold investment have opened up. One of the most interesting option is Gold ETF. So what are GOLD ETF?

Gold ETFs are mutual funds which listed and traded in the stock market.All you need is a demat account to buy and sell Gold ETFs. The advantages of ETF as explained in the previous article holds good for Gold ETF too.

While investing in Gold ETF, take into account the following information.

1. Avoid buying Gold ETF funds during the NFO. The reason is during NFO Gold ETF charge 1.5-2.5% as entry load. However when these Gold ETFs are listed in the stock market, you can buy them without entry load but with a marginal brokerage of 0.2-0.5%.

2. Check the expense ratio of Gold ETFs. Currently they are in the range of around 1% for most Gold ETFs.

3. Gold ETFs cost includes cost of annual fees for demat account and online trading account. Remember you need demat and trading account to operate in Exchange Traded Funds.

What should investors do?

Though Gold ETFs reduces the risk of holding gold in physical format, you should take into account the cost(Expense ratio,brokerate,annual fees for trading and demat account) of holding a Gold ETF. After considering both scenarios, make your investment call.

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Famous Investment Myths

Though there is more participation from retail investors in Indian investments, but still most of us have not changed our perception on some investment myths although the awareness about investment has increased in the recent past. Let us go through some of the famous beliefs/myths that people still give importance.

1. I am very young to think about retirement

In today's world, a youth in early 20's having a good job at hand will most likely not even think about retirement planning. He is more inclined to spend on modern accessories. Nothing wrong in spending but it should not happen at the cost of "retirement planning". Its never early to start for retirement planning. Early planning will give the benefit of compounded annual return on your retirement investment.

2.Investment should be made only for 80(c) limit of 1 lac.

Most of us think about tax only in the month of march and collect funds upto 1 lac to be invested in tax instruments to save tax. People don plan tax early in the financial year. Investment should not be limited only to 1 lac of 80(c). If you have a positive net worth , you should consider investment with the positive net worth.

3.You can take higher risk in rising markets.

This is the most glaring mistake that investors commit in a bull market. When stocks are on the rise, they violate their asset allocation, invest more than needed in equities and when the market crashes they realize that they had invested more money in equities than actually required.If you are risk averse investor, you should be the same irrespective of market changes.

4.Invest only in equity since it gives higher returns.

One should not concentrate all his investments in a single asset class. It should be a diversified investment portfolio. Take the current situation, if you had invested all your money in equities, you would be suffering big loss now.

5. Invest once in a year and forget it

Investment is not a one time activity,it should be constantly tracked in a regular interval and evaluated once in a year. If your investment is not doing well over a prolonged period, you should consider exiting and moving to a different investment channel.

As a educated investor, try to avoid giving importance to these myths and also spread a word to your friends on the same.

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What are Exchange traded funds?

Of late ETF(Exchange traded fund) has gained more attention among the Indian investors. So what is all about ETF?

What is ETF?

ETFs are mutual fund schemes whose units can be sold or bought in the stock exchanges during the regular trading hours. They do not have cut off timings like other mutual funds for buying or selling units. You need a demat account to operate with ETF.

Types of ETF

Passive ETFs - These mutual funds mirror a index and invests in a same set of stocks which comprimises an index. It is similar to index funds.

Active ETFs - These funds invest in a set of stocks that pertain to the mandate of the fund.

How ETFs work?

1. ETF units have two prices - market price and NAV. So usually market price of ETF unit will be at discount or premium to underlying NAV.

2.Investor does not deal directly with mutual fund company for purchase of units, he purchases the units via stock exchange.

3. Direct purchase of units from mutual fund company is done by high net worth individuals or institutions, because the minimum number of units to be purchased will be very high and not affordable by retail investors.

4.By using arbitrage methods, mutual fund company tries to keep the difference between NAV and market price to minimum.

Advantages of ETF

1.ETFs are cheaper than index funds. They have a expense ratio of 0.5 to 1% compared 1.5% of index fund.

2.They can be bought or sold during any time of the trading hours unlike mutual funds where u can purchase only at a NAV which is calculated at end of day.

3. They mimic the performance of underlying index better than the index fund.

Disadvantages

1. You need to have a demat account and trading account to operate in ETF whereas in mutual funds you just need a pan card to invest.

2. You have to pay a brokerage of 0.5%-1% for trading via broker like icici direct,sharekhan etc.

Who can invest?

1. Investors who want to mirror the performance of benchmark indices.

2. Investors who want to invest in asset classes like gold.

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What to look for in a Fixed Deposit?

Fixed Deposit is considered as a safe haven for the investors, but there is some level of scrutiny to be done even in Fixed deposits. Fixed Deposits are not offered only by public sector banks, they are offered by large corporates, co operative banks and other financial institutions. So the FDs in non psu banks are not "totally" secure. They can technically default on payments if the financial institution is caught in a trouble.

Though the occurence of such an event is very minimal, lets look at some basic fundamentals to look at before putting your money in a FD.

Credit Profile

Check for the credit ratings of the instruments in which the bank FD is depositing the money.The rating of AAA is of higher quality. The higher the credit rating, the lower the return it delivers. Do not chase for a FD which gives 2% extra than the other prevailing FDs, because the risk exposure is higher in such a FD.

Rate of Return

Check the return on FDs prevailing in the market and choose an FD which is relatively equal or slightly higher than the rest of FDs in place.

Interest Payout

Check out the different interest payout options. Some banks provide monthly,quarterly interest payout. Suppose you want a steady monthly income, you can opt for monthly interest payout option. If you are growth investor, you can opt for the interest to be accrued to the prinicpal in the end of an year.

Duration

Find a FD which matches your requirement of fund down the line. If you want fund 3 years down the line, go for a FD with 3 years duration. You will get benefited from the compounded interest rate over 3 years.

Premature withdrawal penalty

People often quit an lower interest rate FD and go for a higher interest rate FD. In such a case, you need to pay a penalty for breaking the FD. So you need to take into account the expense of breaking the existing FD and opt for a new FD.

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Need for Health Insurance?

Insurance is all about tackling unseen risks that might affect an individual finance to a greater extent. In India, insurance is seen as a savings instrument and not as a risk mitigator. Moreover health insurance in india is less penetrated than life insurance.

So what is health insurance?

Health insurance reimburses the expenses of medical treatment,hospitalization and other expenses related to the treatment of your disease. There are various clauses with different health insurance policies which defines the expenses which it covers.

Why is health insurance needed?

As medical emergencies do not come well planned and these are completely unpredictable, when a person is diagnosed with a disease and requires treatment, the immediate requirement of fund for treatment takes a big toll on a person's finance and hence affects his planned investments.

With health insurance, you can be least affected with your finance, since the insurance companies takes care of all your expenses with respect to the treatment. There are even cashless claims that insurance companies offer when you get treatment from a network of hospitals that the insurance companies has tied up with.

How costly is health insurance?

To your surprise, health insurance is very cheap compared to life insurance. A health insurance policy of 5 lac in a public sector insurance company costs you roughly 6,000 per year which is 500 rs/month and very much affordable by most of us.

By spending 500 rs/month on health insurance, you are avoiding a risk of paying 1 or 2 lacs when you go undergo treatment in case of any medical emergency.

What is cashless claim?

If you are planning for surgery(bypass etc) and you are aware of the schedule, you can inform the insurance company of the same and the insurance will take care of all your expenses in the hospital and you need not spend a single paisa for your treatment. This cashless claim can be availed only at the network of hospitals that the insurance company has tied up with.

What if my employer gives me health insurance?

In today's world, most of the employers offer free health insurance to all its employees and their dependents. So people do not want to take a personal health insurance plan,but WAIT, think of the following scenario. When you have decided to leave your company and join the next company in 10 days time and what if you have met with a medical treatment during the span of those 10 days. In that case, you have to pay for your treatment since you are not under any employer's health insurance scheme during that span.

So don hesitate to take a health insurance plan, since you are avoiding a huge risk of payment by minimal contribution per month torwards health insurance.

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What are child insurance plans?

As most of us have plans on fulfilling our children's upcoming dreams on their career, we are more vigilant in planning for their future financial needs. As with any other financial needs, proper planning will ensure that your child's future financial needs are catered to.

          Most of you would have heard about "children's life insurance plan". The very common misconception is that it insures child's life, but it is not so. It is a policy which insures the parent only but the child get benefited out of it. Lets see how it works.


1. A children policy is taken by the parent as the policy holder.

2. The important feature of the policy is WOP(Waiver of Premium). In case if the parent dies during the term of the policy, all the future premiums are waived for the policy and the sum assured is paid immediately to the child of the parent.

Eg. For a 25 years old with a kid of 1 year old, the child insurance policy from hdfc for 20 years of sum assured of 1 lac have a premium of 4900/month. In case of eventuality to the parent 5 years down the line, the kid will get 1 lac immediately and all future premiums will be cancelled. On the other hand, if policy matures 20 years down the line, the kid will get 2.25 lacs when he/she turns 21.

3. There are quiet interesting child insurance policies. For eg LIC has a child insurance policy gives the option of giving 10 half-yearly installments on maturity instead of giving a bulk amount.

4. There are few insurance policies, which gives a assured amount to kid in various period of their life. (when kids turns 18, he/she receives certain %age of amount, when he/she turns 21, she gets certain %age and so on).

5. Child insurance policies comes in two flavours - ULIP and Endowment type. Endowment offers fixed rate of return while ULIP returns depends on the market. So you can make a decision after evaluating both the options.

     So as with any other investment products, there are variety of child insurance plans available in the market. Have a good analysis of the policies before buying it, BUT one should definitely give  a portion of insurance premium to child insurance policies.

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What is ELSS?

Most of us during the month of march rush up to our auditors or financial planners for tax planning to invest upto 1 lac which qualifies for tax exemption under section 80 (c) . Most of us end up in paying LIC premium,PPF,NSC,5 year bank FDs and other traditional tax savings instrument. Let us go through one another option available to us - ELSS

ELSS - Equity Linked Savings Scheme is a type of mutual fund which is qualified for tax exemption under section 80 c. Lets dig into more information on this scheme.

Features

1. It is a mutual fund with a lock in period of 3 years. The lock in period of 3 years is much lesser than lock in period of 15 years in PPF and 6 years in NSC or 5 years in bank FD.

2. It is a equity diversified fund and hence the returns over a longer period of time is higher than the fixed income instruments like PPF,NSC.

3. With high returns, comes high risk associated with the investment.Hence if you are an investor who does not want to take any risk with your investment, you can avoid ELSS.

4. You can invest upto 1,00,000 in ELSS for getting tax exemption.

5. You can invest periodically via SIP option and that brings in discipline and cost averaging in your investment.

6. You can opt for dividend option and get some money out of the scheme even during the lock in period. This is not possible in PPF or NSC in a duration of 3 years from investment.

So start exploring the various ELSS schemes in the market and choose a one with good track record and a good rating. You can refer http://valueresearchonline.com/ for fund ratings

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What are the benefits of mutual funds?

Of late there is an increase in awareness on various investment products among investors and it goes without saying that mutual funds have got its own share in 4% of Indian household savings.

So why is mutual fund preferred over direct investment in stocks?For a first time investor who doesnt have much knowledge on investments, mutual fund provides numerous advantages.

1. The most obvious reason in favour of Mutual Funds are that you can make an investment even at Rs 100 per month via SIP. You need not be blessed with huge sum of money to invest in mutual funds. Typical SIP amount per month is 1000-2000 in most cases.

2. Professional management of money put in by investors is an added advantage in mutual funds. Most of us do not have the time and bandwidth to place buy and sell orders in markets in a regular basis. It is always better to leave a job to professional fund managers than we breaking our heads.

3. Another advantage is that a mutual funds invests in a good set of stocks and it is not limited to 1 or 2 stocks. Typically a fund invests in 30-50 stocks and hence there is diversification in investment. It also reduces the risk associated with the failure of single stock.

4.Mutual funds (except for ELSS) have no lock in period. They provide ample liquidity to investors.

5.ELSS - a category of mutual funds which is eligible for tax benefits and at the same time can generate better returns than traditional tax saving instruments over a long period of time.

Keeping these in mind, for a beginner in investments, it is always advisable to opt for mutual funds than directly jumping into stocks.

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What is the right time to invest?

Most investors in their initial days asks the famous question - "What is the right time to invest (or) When can i start investing in markets?". A simple answer to this question is "Anytime is good time for investing provided you have a defined time frame of your investment".

The question should be rephrased as "How long should i be invested to attain my financial goals and How much should invest periodically(SIP) over a longer period of time". Investment over a longer period of time is always fruitful and facts supplement it. Sensex has come along all the way from 100 to 15,000. If you had invested 10,000 rs in infosys ipo in early nineties, you are crorepathi by now.

Follow the simple steps while making/tracking your investment.

1. Don't Waste time

The earlier you make investments, the better are your returns. The compounding rate of return increases with the number of years you are invested. Eg. 10,000 invested for 3 years at 15% return is worth 15000 whereas the same sum invested for 10 years at 15% return is worth 40,000. So do not time the markets to buy at lower levels. It is very difficult to find the bottom of the market.

2. When do you need money?

Decide on when you need the money down the line. For anything less than 5 years, do not go for stocks or equity mutual funds. Equity should be considered only for a longer period of greater than 5 years. For short to medium term investment , go for debt instruments

3. When to sell?

After you had made your investment, you should decide on when to cash out to meet your financial goals. There are two scenarios where in you can redeem your investments.

1. When your financial goals are met.
2. When the investment in stocks/mutual funds become overvalued.

4. Don listen to rumours

Do not redeem your investment going by the rumours in television and stock market of a correction or a crash. Take your decision on your own.

5. Consistent Review

The job is not done just by investing. One should always keep monitoring his/her investments in a regular basis and should take a decision based on the review.Do not churn the portfolio too often.

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what is return on equity?

Let us dig through yet another important technical criteria associate with a stock - Return on Equity(ROE). It is simple to calculate and helps in measuring the profitability and asset management of the company.

Return on Income = Net Income/Shareholder's equity

Net Income can be obtained from Profit and Loss statement and Shareholder's equity can be obtained from the balance sheet.

ROE indicates if a company is creating assets or eating up lot of cash in due course of doing its business.

If ROE is 15%, it means 15 rs of asset is created for every 100 rs invested in the stock.ROE also indicates if the additional cash investment made by the company is produced by the return on existing investment or out of fresh cash investment.

ROE can also be interpreted as

ROE = (one year's earnings / one year's sales) x (one year's sales / assets) x (assets / shareholder equity)

Lets see how ROE can give information on profit margin,asset management in the next articles.

Learn More : What is Earnings per share?

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How to analyze company's annual report?

Many of us are proud owners of shares of bluechip companies and we receive company's annual reports every year. Most of us do not give due importance to the annual reports. Many useful information can be obtained from the annual reports and those can help you decide on your future investment in the particular company.

Let us glance through some important information that needs to be looked at a company's annual report mailed to you.

1. Look out for the current state of the company and what are the changes which have evolved in the company over the past one year.Track the progress over the past few years.

2.Get information on new acquisitions or any major developments in the company.

3. Get to know about various offerings/products from the company.Learn what is unique about them and how are they different from the competitors.

4. Know what is the company's plan for the upcoming financial year.

5. Learn more about short term and long term goals from the annual report.

6. Go through the profit and loss account statement.

7. Analyse the sales growth and earnings growth over past 3-5 years which will be given in the annual report.

8. Go through the various assets,liabilities of the company from the balance sheet of the company.

In addition to these, many other useful information can be inferred from a company's annual report.Remember , every share holder has the right to know all details about his/her own company.

So , go and get the annual reports of your companies from your dusty shelves at home and go through them and get knowledgeable about your company.

Learn More : How to invest?

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How to minimize risk in investment?

In the previous article, we had seen the various risks involved in stock investing, let us now drill down on the steps needed to minize the risks involved.

Knowledge - Lack of knowledge is the greatest risk involved in investing.One should get familiar with the concepts and parameters in investing before investing. Knowledge will not only help reduce risk but also helps create wealth in a significant manner. Before investing in any stock, analyze the company thoroughly.

Don't Invest - This may sound strange but it makes sense to stay away from a stock or sector if you don't understand how the industry/company operates. It is always advisable to invest in stock/sector which you understand better than those which you don't understand. Try to read more about a stock/industry to gain more knowledge. Even after investing, you should always track the stock's behavior/reaction to various events in the market.

Get your financials right - Have your buffered cash(3-6 times * monthly expense) always ready before investing. Go for investing only if you have a positive net worth. Have adequate term insurance for your life.

Diversify your investments - Don invest all your money in a single stock/sector. Invest in different types of instruments like debt,equity(mutual funds,stocks). Don put more than 10% of your investment in any one stock. Invest across various sectors and don go for sectoral funds or stocks.

Learn More : How to calculate insurance cover?

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What are the risks involved in stock investing?

Everyone wanted to make quick money out of stock markets and very badly wanted good stock picks that would generate triple digit returns but WAIT,

1. Are you aware of risks involved in stock market investing?
2. Have you calculated the amount of risk that you can take?
3. Are u choosing the stocks that matches your scale of risk?

One should find answers to the above questions, before placing a buy order with his/her broker.Let us go through the various risks associated with stock market investing.

Financial Risk

The investor can lose his/her money when the financials of the company in which he has invested is not performing well. If an investor invests in a company and if the company's profit keep declining yoy, then investor is holding the risk of losing her money because the company's share price will keep moving downwards.

So before choosing a company to invest, do a thorough analysis of the financials of the company.

Interest Rate Risk

Lets assume an investors goes for fixed depost at the rate of 8%. When the interest rate scenario changes, the interest rate in the market can move to say 10%, then you stand to lose the extra 2% gained in new fresh deposits.

Interest rate also affects equity investment,how? . Companies borrow funds from banks, financial institutions for capital expansion. When the lending rate increases, companies bottom line(profit) is hit and hence it affects the share price of the company.

Market Risk

The investment can be influenced by market volatitlity in the short to medium term.The markets sentiment is driven by lots of factors - like global cues,economic data etc. When the entire market is moving down, your stock will also most likely move down and affect your return on investment.

Inflation Risk

In terms of investment, one should always look for inflation adjusted return for true evaluation. If your investment fetches you 10% per annum and the inflation is 12% per annum, then you are losing your money and your investment is giving negative returns.So inflation has a bigger impact in investments.

Poitical Risk

The market mood is influenced by the political climate in the country. When a govt changes,the market will be in a jittery mood to know if the new govt will be industry friendly or not.The major economic policy of a country is framed by the ruling government and hence it has a bigger say in market and hence your investments.

Emotional Risk

Investors usually get into the trap of three emotions while investing. Greed,Fear,Love.They have a greed to make most of the money in a short period of time. They fear to enter markets when market is in a deep bear run. They keep investing in a stock though it is moving down just because they have a mad love for that stock.

In investment, emotions should not rule over intelligence.

So, take into account all these risks before investing in stock markets.

Learn More : How to select a stock?

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What are different types of debt investments?

While searching for investment products which is aimed at capital protection and fixed returns, we turn our attention to various debt products available for investment. Let us go through some of them which is not very familiar with the normal investor community.You can see the following categories in the portfolio of almost all debt mutual funds.

1. Central Govt Securities - These are the most safest debt investment that one can make. They don have any default in payments.Even in case of bad situations, the government can print currency and payback the investment to the investors.

2. State Govt Securities - These are provided by respective state government and are less liquid compared to central govt securities. It has a higher yield than central govt securities and it may default on payment but in history it has never happened.

3. Public sector bonds - These are issued by public sector undertakings who borrow funds from the markets in terms of bonds.

4. Domestic Financial Institutaion bonds - These are provided by financial institutions like IDBI,ICICI and these are unsecured bonds.

5. Corporate Debentures - Private sector companies raise fund from investors through corporate debentures.

6. Commercial Paper - Private companies meet short term(1-6 months) fund requirements through commercial paper.

7. Certificates of Deposit - These are issued by banks and financial institutions.

Apart from these , there are other common products such as kisan vikas patra(money doubles in 8 years 7 months),NSC,Post office Deposits,Senior citizen scheme in post office,GOI bonds,PPF and Bank FDs.

Learn more about Debt investment

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How to create your cash flow statement?

In the previous article , we have seen how to calculate your net worth. Lets us now get to know how to improve your net worth. One of the tool that can be used to improve your net worth is your cash flow statement.

Cashflow statement is nothing but a measure of how much money is coming in and how much money is being spent by you.Lets start creating your cashflow statement by doing the following steps.

1. List down all your incomes. Identify all your source of incomes like monthly income,dividends,rental income and other sources.List down the monthly income and also list down the annual estimate of your income from each source.

2.List down all your expenses which may include credit card payments,rent/emi,grocery expenses,children's fees.

3. Calculate your cash flow by

Cashflow = Income - Expenses

After arriving at your cash flow, check if the cashflow is positive or negative. Lets see how to read/analyse cashflow statement.

4. Cashflow analysis

a) Look out ways to increase your income. Check if your hobby or your skill set can generate a significant income.

b) Check if you could reduce your expenses. Classify the expenses as necessary and unessential ones. Try to reduce the unessential expenses if possible.

c) Try to reduce your debt component and try to reduce taxes by investing in tax instruments.

Cashflow is directly proportional to the net worth and hence start creating your monthly cash flow statement and track them regularly to increase your net worth which would in term let you give you leeway for investments.

Learn More : What are Fixed Maturity Plans?

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What are the different types of stocks?

Many of us wanted to choose the right stock at the right time and make a good profitable investment,but this is easier said than done. Before picking up the right stock, you need to figure out what kind of stocks that you would like to invest.There are a wide variety of stocks.Let us go through them.

1. Growth Stocks - These are the companies whose earnings growth is much higher than the other peer companies in the stock market. The tag of "growth stocks" rotates among various sectoral stocks as time evolves and it is not a fixed one. In the last 3 years, capital goods,infrastructure,realty stocks were considered as growth stocks.

2. Income Stocks - These are stocks which have a good rate of dividend paid out to the shareholders consistently over time. Mostly these will be companies from a sector wherein after establishment of the business, there will be constant flow of income. For eg, power generation sector. While it takes more capital and time to build the power plant, but once its commissioned, there is a constant stream of revenue and hence these companies keep giving constant dividend to the share holders.

3. Value Stocks - These are stocks whose market value is much lower than the real value of the stock.These have a very low PE value and the marketmen have not yet identified the true potential of the stocks.

4. Defensive Stocks - These are stocks which are not affected by economical cycles of growth and slowdown. For eg, Pharma sector. People will not stop buying medicines if the economy is slowing down or growing fast. These companies will have moderate growth of income over a longer time of time and have stability in revenues.

5. Cyclical Stocks - These stocks are influenced by the current state of the economy. If the economy is growing , these stocks get benefited with the higher growth rate and if it slowsdown,these stocks also have the effect in them. Eg. Banking,Real Estate.

6.Momentum Stocks - These stocks are those which drive the market and influence the trend or mood of the market to a greater extent. Eg. Infosys,RIL.

So before you put your penny into stock market,figure out on which category of stocks are u gonna invest.

Learn More about Investment

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How to calculate your net worth?

Many of us have investment in stock market in our financial planning and all of us wanted to reap the benefits of booming stock markets across the world.

But WAIT, before start analysing the balance sheets of companies to invest in them, one should first analyse his/her own balance sheet and analyse if he/she has a NET WORTH that can be invested in stock markets.

To arrive at your net worth, carry out the following steps.

1. Keep an emergency fund to meet financial disruption or job loss or any other critical emergency.As a thumb rule one should always have 3-6 months expenses in the emergency fund.Do not take this emergency fund into account while calculating your net worth.

2. List all your assets. These can be stocks,savings deposit,fixed deposit,post office deposits,life insurance sum assured,mutual funds,gold,real estate. Classify the assets as liquid and illiquid assets.

What is Liquidity?

Liquidity is the ability to convert an asset into cash quickly. Stocks,savings deposit are highly liquid assets whereas real estate is a illiquid asset since it will take more time to convert the asset to cash.

3. List all your liabilities. These include credit education loan,card payments,personal loan,home loan and all other types of consumer loans.This can also include personal financial commitments like paying your parents monthly.

4. Net worth = Assets - Liablities.

If Net worth is positive, you have surplus and you can invest a portion of surplus or entire surplus in stocks from a longer term perspective.

If Net worth is negative, you have some homework to do in terms of bringing the net worth to the positive and then plan for your stock market investments.

Learn More - How to pick a stock

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What is Earnings per share?

We often come across the term EPS(Earnings per share) in the television channels when the companies report their quarterly/annual reports. Lets see whats exactly is EPS

Earnings per share = (Net Income - Dividend paid) / Outstanding shares

Where Outstanding shares = Total number of shares held by the investors. This is referred to as Capital stock in the company balance sheet.

EPS can be used as a comparison tool for evaluating companies. However we should compare EPS of companies in the same domain and not across various sectors.The decision to buy a company's share should not be totally dependent on one technical parameter. It should be based on collection of all technical parameters.

Instead of comparison of two companies by comparing their net income , comparing their EPS would give a more better comparison in terms of efficiency of the company to generate profit for each share that the investor holds.Two companies may have same net income,but one might have a higher EPS, because it has used less number of shares to generate that income.Given that net profit of two companies are same, the one with a higher EPS is better for investment.

There are three types of EPS reported.

Trailing EPS = Net profit for the last financial year/outstanding shares.

Current EPS = Estimated profit for the current financial year/outstanding shares.

Future EPS = Estimated profit for the upcoming financial year/outstanding shares.

When the company splits the stock bases, say from a face value of Rs 10 to face value to Rs 1,the EPS of the company would also get adjusted.

EPS is used in measuring PE ratio,which is again much discussed technical parameter.We shall see this in detail in the next blog entry.

Learn More....

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What is Liquid fund?

Liquid funds belong to the category of ultra short term debt funds. These can be used as alternative for short term bank deposits (deposits for less than a year).

1. They invest in debt instruments which have maturity of 1-2 months.

2. They have a lock in period of only few days unlike banks wherein you have to pay penalty if you preclose your FD.

3. They have a lower tax rate than a bank FD for a person in 30% tax bracket.The tax on dividend paid out is less than the income tax slab rate of a person in 30% tax bracket.

4.The interest rate varies with the market and it is a good option in a increasing interest rate scenario unlike bank FDs where interest rate is fixed.

5. They accept a minimum investment of 10,000.

6. These are suitable for investors who don want to lock in their money at banks for a shorter while but at the same time want to get interest on their amount.

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What is index fund?

There are two kinds of investing.

Active Investing

This involves active analysis of the company while investing. It involves answering the following questions

1. How is the company performing?
2. At what price should i buy?
3. What %age of my portfolio, should the stock occupy
and more questions.

Passive Investing

This involves creating a portfolio by simply replicating an already existing system witout any change at all.

Index Fund

Index funds are an example of Passive Investing where in the fund's portfolio is created completely by replicating an index.For eg, nifty index fund will constitute stocks present in nifty in the same ratio as it is in nifty

Advantages

1. The index fund has a lower cost attached to it. Since it has minimal transactions in terms of selling and buying stocks, it has a lower expense ratio. Lower expense ratio reflects in the NAV of the fund.

2. The investment objective is simple to understand and easy to track since its a mirror image of an index.

3. There will not be any change in fund's objective since it is based on index.Today lot of funds are churning their portfolio often.

Disadvantages

1. In the downward market, there will not be any cushion against the fall, since it does not have cash in its portfolio and is always fully invested.

2. When the tracking error(diff between fund's return n index return) is more than 2-3%

3. It can not outperform the benchmark index since it exactly replicates the index portfolio.

Target Investors

It is suitable for investors who are contempt with the broader market returns given by various indices.

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How to calculate your insurance cover?

There are well known methods to arrive at a ideal insurance cover for an indiviual.These further explains the significance of term insurance

Income Replacement Value

1. Age = 40

Annual Income = 5,00,000

Retirement Age = 60

Insurance Cover needed = (60-40) * 5,00,000 = 1 crore

Another variation, is to mutiply the income with a mutiplier to calculate your life cover.The multiplier differs across various age groups

20-30 years = 5-10 times annual income
30-40 years = 15-20 times annual income
40-50 years = 10-15 times annual income
50-60 years = 5-10 times annual income

So when you fit into any of this category and calculate your insurance cover it would be amounting to a significant sum.

When going for a typical endowment policy for such a insurance sum(eg 1 crore for 40 years old earning 5 lacs annually) , the premium would shoot to very high levels.

Term insurance 's cost benefit will be best exploited in these scenarios.

Always keep Insurance and Investment seperate.

Related Topics

What is term insurance?

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