Investment School: 2008-08-31

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.

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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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