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Sunday, March 19, 2006

Tax saving investments explained

Look at the options available

Following are exempt from tax
The payment towards the principal amount (not interest payment) is eligible for a deduction under Section 80C.
Payments towards the education fees for your children.
If above expenses sum upto 1,00,000, there is no point in invest to save tax.
Once you are done with these expenses, look at the Employee Provident Fund (if you are a salaried individual). 12% percentage of your salary is deducted by your employer towards the EPF. Check your salary slips to find out the amount.
Once you calculate this, see if you still need to invest to touch the Rs 1,00,000 limit under Section 80C.
If you have already taken a life insurance policy or a pension plan, add to the above the premium you have paid this year.
If the above totals to Rs 1,00,000, you do not need to do any more tax investing. But if you have a PPF account, deposit at least Rs 500 in it to keep it going.

Look at the lock-in period
All tax saving investments have a minimum lock-in period. They are not like shares or mutual funds which you can buy/sell anytime.
The National Savings Certificate has a lock-in period of six years. The Public Provident Fund has a lock-in of 15 years.
Even Equity Linked Saving Schemes have a lock-in period. These are mutual funds with a tax benefit. Unlike other mutual funds which you can sell whenever you want, you have to keep your investments in these tax saving funds for at least three years.
And, of course, in insurance and pension plans, the money is only available many years down the road.

Is it right for you
Just because an instrument is available for tax saving, it does not mean you should invest in it.
Always look at it in relation to the rest of your other investments. Don't view your tax saving investments in isolation.
For instance, if you have already invested a fair portion of your money in equity (shares and mutual funds that invest in shares), avoid an ELSS. Opting for an ELSS means a huge portion of your investments will be in equity and that may not be what you want.
Or, on the other hand, if you have invested huge portions in debt funds (funds that invest in fixed return instruments), post office saving schemes, bank fixed deposits and NSC and PPF, you could look at putting some amount in ELSS.

It may be a total rip-off
Let's say you are working on a contract or as a consultant and do not have an EPF. Neither do you have and children to claim education fees nor are you servicing a home loan. This means you have to invest the entire Rs 1,00,000 to get the tax break.
In such a situation, you may get conned by an insurance agent into buying a policy that does not suit you at all.
You may take a policy that will require you to pay a premium every single year for the next 30 years. Is that what you want? Even if it is, be careful. To reach your Rs 1,00,000 target, you may opt for a policy that requires you to pay a hefty premium. You will have to pay this year after year, even when your other monetary commitments begin to increase.
It may turn out to be the worst investment decision you ever make.
If you do not have the time to sit and think about your goals, how much it is you really need to invest in insurance or a pension scheme and how this fits your overall financial situation now and later, avoid investing insurance right now.
Instead, stick to PPF and NSC.

Friday, February 17, 2006

Beginners guide to Mutual Funds

1. Mutual funds are simply vehicles of investments

Your real investments are the securities these mutual funds finally invest in. The final securities can be, for simplicity's sake, divided into equity (shares), debt (fixed return) and real estate (property).

Your returns will be generated by the fund's investments. For instance, the returns on an equity fund will be determined by the stocks your fund manager invests in and the state of the stock market.

2. Be practical and realistic

As a simple principle for a beginner, it would help you if you choose where to invest. In other words, how much should you invest in debt, equity and real estate.

Make this decision on the assumption that you will get the normal returns expected from such instruments. Don't invest on the assumption that you will beat the market. Don't invest with the assumption that you will get 40% returns from equity or 18% from debt.

Be realistic. Here's a rough estimate of the returns you will get depending on the kind of investment you choose (remember to factor in inflation, which will be around 5.5%), debt -- 6%, equity -- 16%, real estate -- 8%.

3. Invest according to your time horizon

Money that can be put away for 7-10 years can be invested in equity. Property might be okay for a slightly shorter time horizon, say 7-10 years. The rest must be invested in debt.

4. Do not jump in and out of your investments

Your investment returns are substantially determined by your behaviour. If you get in and get out at the wrong times, a good investment will be no good for you.

Start by educating yourself about mutual funds. Invest in a floating rate income fund. These funds invest in fixed return investments that have a floating rate of interest, as against a fixed rate of interest.

Once you are comfortable with and understand the concept of mutual funds, you could start participating in equity.

Diversified equity funds are a lower risk than sectoral funds. Diversified equity funds invest in shares of various companies of various sectors. Sector funds invest only in stocks of a particular sector.

If you decide to take financial advice, which I know at some point you will consider, please consider fee-only planners. Going to a planner who gets commissions on what he sells will result in him trying to convince you to buy products he is selling and making money on.

Mutual funds with a twist

Contra Funds

Diversified equity funds are mutual funds that invest in the shares of various companies in different sectors.

It parts company with other diversified equity funds in the types of stocks it chooses to invest in. As the name suggests, it follows a contrarian view to investing. This means the fund manager will deliberately bypass the popular stocks that everyone else is chasing. Instead, he will invest in companies that are not in fashion.

Why? Because these out-of-fashion stocks would currently be available at a cheap price since they are undervalued.

Contra funds do not invest in just about any stock. The stocks that are selected will be strong on fundamentals but their value is not yet recognised by other investors. They must have the potential to rise substantially over time.

To spot such stocks requires a lot of research and understanding of the industry in question. That is why, if you want to be a contrarian investor, you should consider a contra fund. On your own, you may not be in a position to decide which stocks to go for.

To be a contrarian investor, you must be convinced the stock you choose to invest in has the potential to make it big. You must also have the courage to invest in it when everyone else is ignoring it.

Should you be a contra fund investor?

That depends on where you stand as an investor.

If you have not invested either in stocks or in diversified equity funds, then you should ignore this avenue of investment.

Investing in a contra fund makes sense only if you have already invested in a diversified equity fund and would like to experiment with an alternative investment style.

Secondly, are you willing to take a risk with your investment?

Don't forget, investments in a contra fund are more risky than those in a diversified equity fund.
All said and done, the fund manager is making a call on a company that may or may not eventually do that well and give a phenomenal return. He is taking a substantial risk.

Thirdly, are you willing to ignore this investment for a number of years?

It may take a fair amount of time for the company to start making huge profits and get noticed by other investors. Only when others see its potential and start buying the shares will the price begin to climb upward.

Tuesday, February 14, 2006

So how does the Sensex Rise ?

The Sensex likes to climb uphill like those nursery rhyme characters, Jack and Jill. And then, just like them, it comes tumbling down causing many heartbroken Jack and Jills to lose their wallets in the bargain).

The Sensex comprises of 30 stocks. When the prices of these stocks increase, the Sensex goes up. When the prices decrease, the Sensex falls.

The BSE Sensex was last updated on June 6, 2005:It sounds simple but it still does not answer the 'how' question.

Well, there is the market cap method

Each of the 30 stocks in the Sensex has a weight attached to it. This weight depends on the market capitalisation of the stock.

Market capitalisation refers to the number of shares of a company multiplied by its market value (the price of each share). For instance, if a company has 10 million shares whose value is Rs 30 per share on November 1, 2004, it will have a market cap of Rs 300 million on November 1, 2004.

If the market cap of the 30 Sensex stocks is Rs 3,00,000 crore and the market cap of ITC (which is one of the 30 shares that make up the Sensex) is Rs 20,000 crore, then ITC's weight in the Sensex is 6.66 percent.

The rise or fall in the price of ITC's shares will impact the Sensex to that extent.

This is referred to as the full market capitalisation methodology.

Now, let's check free-float weightage

The Sensex shifted to the free-float weightage method on September 1, 2003.

Here, a company's entire lot of shares are not taken into account (which means we are not looking at the entire market capitalisation). Only the shares readily available for trading are considered.

In every company, a certain amount of shares are not available for trading on the stock exchange. These shares could be held by the government or the promoters of the company. Under the free-float weightage method, they are not taken into account.

How does the stock exchange arrive at this weightage?

In this case, the market cap is multiplied by the free float factor (which is the proportion of a company's shares that can be readily bought and sold).

The Sensex's free float market cap at close of business on December 3 was Rs 3,66,124 crore.

Unlike the Sensex, the 50 stocks in Nifty -- the index of the National Stock Exchange -- is based on the market cap method and not the free-float method.

Sounds scary, does it not? Just 30 stocks can send the Sensex soaring or plummeting. What makes the difference is the fact that these are the most actively traded stocks in the market.

In fact, they account for half the BSE's market capitalisation. They also represent 13 sectors of the economy and are leaders in their respective industries. Which means they are fairly representative of the stock market.

Now, that doesn't sound too bad -- does it?

More indepth FAQ's

Things parents wont tell you about money

1. Sometimes debt is good

"Never borrow!" These words were drummed into me since I was little. Debt was always a four-letter word with my folks.

But now I realise that at times, debt makes perfect sense. The key words: at times. Not always.

One instance where borrowing makes sense is Home Loan. This one is a dire necessity.

And, you get tax benefits on the principal repayment and interest payment.

2. The stock market is not only for gamblers

Horror stories of naive investors losing their shirts (and a whole lot more) in the market are a dime a dozen.

And, so are those of savvy millionaires.

You could lose all your money in the stock market. Or, you could make a fortune.

Equity may be intimidating. But over time, it offers THEE highest return compared to all other investment assets.

When you invest in shares, you do not invest in the market. You invest in the equity shares of a company. That makes you a shareholder or part owner in the company.

Since you own part of the assets of the company, you are entitled to the profits those assets generate. Or bear the loss.

Owning shares, therefore, means having a share of a business without the headache of managing it.

As the business does well and profits increase, the value of your stock goes up. Hence, you can make phenomenal profits and tremendous losses too. After all, businesses are risky.

The trick is not to get greedy and to be prepared to stay in for the long haul. You lose out when your sole intention is to make a fast buck.

3. Credit cards can actually work for you

Yes. Credit cards does not necessarily be an evil thing.

One can get great insights into one's spending habits by scrutinising their monthly statements. It promptly tells if you are spending too much on eating out or shopping.

Also, it helps one access interest-free credit. You don't have to pay for anything right away. You pay your bill when you get it at the end of the month. And the time frame from the repayment of one bill to the next is around 45 days.

This is great if I have to make a heavy purchase. I make it at the start of the billing cycle and repay it later when my salary gets credited to my account.

The trick, of course, is never to spend so much that you owe your bank money. That is when they begin to benefit from the card.

How do credit cards work

4. Jewellery is a lousy investment!

When you regard something as an investment, it should fetch you a higher amount when you sell. Unfortunately, jewellery does not always do that.

There is always a great amount of sentimental value attached to a piece of jewellery that makes selling difficult.

Even if you overcome that hurdle, you will face another. This time, with the jeweller.

He will talk about the design being old fashioned and outdated and nobody wanting to own such piece. That means a drop in resale value. Then he will check the purity of gold.

Don't be too sure that the jeweller from whom you purchased it has not cheated you. He may have stated the purity as 18kt while in reality it may be much less.

In India, it is safe to assume that most of jewellers sell jewellery with lower karatage than stated. Would you be any wiser?

Only when you go to sell it will you find out that you were cheated.

A jeweller buying a piece from you will not take your word for its purity. Even if the purity is mentioned, he will not go by it. He will test the piece himself.

And, if it is below the karatage you state, then you can be sure you got ripped off when buying it.

Jewellery is an accessory. A great accessory! But, a BAD investment.

5. The bank is not the best place for your money

Granted. Some amount of money should be kept in a bank for liquidity and safety.

Instead of keeping all of it in a savings account, put some in a fixed deposit. Some banks offer deposits that are linked to the savings account. Which means that the money earns a higher rate of interest and when you can withdraw it when needed.

Check out fixed deposits and bonds of other corporates and financial institutions. You also have post office saving schemes and the Public Provident Fund to consider. Liquidity may be a problem, but safety should not.

For liquidity and safety you can even look at cash funds.

Cash funds are mutual funds that invest in money market instruments such as treasury bills, commercial paper, call money and short-term bank deposits.

These are very safe (issued by government agencies, banks or reputed corporates) and have very short maturity periods (unlike those of PPF and post office schemes).

While the returns are much lower than equity and debt mutual funds, it is higher than a savings account and as safe.


Monday, February 13, 2006

All you want to know about Shares

You must have heard stories of the fabulous returns made in the stock markets in recent months. And you longed wishfully for a piece of the action.

But you could also have heard horror stories of how a friend lost his shirt in the stock market.

And were promptly thankful that you didn't lose yours.

Let's set the record straight.

Wisely chosen (those are the key words), stocks are a must for any serious investor.

They add that extra zing to your collection of investments.

Study after study has revealed that over the long term, stocks outperform all other assets. That means you can expect to earn more from shares than from bonds, fixed deposits or gold.

No doubt the risk is higher with shares. But if you are in for the long haul, so are the potential returns.

But before you take the plunge and invest in the stock market, get your basics right.

This series will tell you about the basics of investing in stocks.

1. Stocks are not only for the brilliant

Stocks are far from being rocket science.

The strategies you need to know to maximise your wealth and the pitfalls you need to avoid are not beyond comprehension.

Even if you feel that you don't have the time, and prefer to entrust your money to a portfolio manager or mutual fund, the least you need to know is which funds are better, how to choose your fund manager, and keep a tab on his performance.

2. So what is a share?

Any business has a lot of assets: The machinery, buildings, furniture, stock-in-trade, cash, etc.

It will also have liabilities. This is what the company owes to other people. Bank loans, money owed to people from whom things have been bought on credit, are examples of liabilities.

Take away the liabilities from the total assets, and you are left with the capital.

Assets - Liabilities = Capital.

Capital is the amount that the owner has in the business. As the business grows and makes profits, it adds to its capital.

This capital is subdivided into shares (or stocks).

So if a company's capital is Rs 10 crore (Rs 100 million), that could be divided into 1 crore (10 million) shares of Rs 10 each.

Part of this capital, or some of the shares, is held by the people who started the business, called the promoters.

The other shares are held by investors. These investors could be people like you and me or mutual funds and other institutional investors.

3. What does this mean for me?

When you invest in stocks, you do not invest in the market. You invest in the equity shares in a company. That makes you a shareholder or part owner in the company.

Since you own part of the assets of the company, you are entitled to the profits those assets generate. Or bear the loss.

So, if you own 100 shares of Gujarat Ambuja Cement, for example, you own a very small part -- since Gujarat Ambuja has millions of shares -- of the company. You own a share of its assets, its liabilities, its profits, its losses, and so on.

Owning shares, therefore, means having a share of a business without the headache of managing it.

Your Gujarat Ambuja shares, for instance, will rise in value if the company makes good profits, or may do badly if people stop building houses and demand for cement falls.

4. What do mean by rise in value?

If the company has divided its capital into shares of Rs 10 each, then Rs 10 is called the face value of the share.

When the share is traded in the stock market, however, this value may go up or down depending on supply and demand for the stock.

If everyone wants to buy the shares, the price will go up. If nobody wants to buy them, and many want to sell the shares, the price will fall.

The value of a share in the market at any point of time is called the price of the share or the market value of a stock. So the share with a face value of Rs 10, may be quoted at Rs 55 (higher than the face value), or even Rs 9 (lower than the face value).

If the number of shares in a company is multiplied by its market value, the result is market capitalisation.

For instance, a company having 10 million shares of a face value Rs 10 and a market value of Rs 30 as on November 1, 2004, will have a market capitalisation of Rs 300 million as on November 1, 2004.

5. So how does one buy shares?

Shares are bought and sold on the stock exchanges -- the two main ones in India are the National Stock Exchange (NSE), and the Bombay Stock Exchange (BSE).

You can use three different routes to buy shares: Through your broker, trade directly online, or buy shares when a company comes out with a fresh issue of shares. This is called an Initial Public Offering (IPO).

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Usually, a company distributes a part of the profit it earns as dividend.

For example: A company may have earned a profit of Rs 1 crore in 2003-04. It keeps half that amount within the company. This will be utilised on buying new machinery or more raw materials or even to reduce its borrowing from the bank. It distributes the other half as dividend.

Assume that the capital of this company is divided into 10,000 shares. That would mean half the profit -- ie Rs 50 lakh (Rs 5 million) -- would be divided by 10,000 shares; each share would earn Rs 500. The dividend would then be Rs 500 per share. If you own 100 shares of the company, you will get a cheque of Rs 50,000 (100 shares x Rs 500) from the company.

Sometimes, the dividend is given as a percentage -- i e the company says it has declared a dividend of 50 percent. It's important to remember that this dividend is a percentage of the share's face value. This means, if the face value of your share is Rs 10, a 50 percent dividend will mean a dividend of Rs 5 per share (See What's in a share? Money!).

However, chances are you would not have paid Rs 10 (the face value) for the share.

Let's say you paid Rs 100 (the then market value). Yet, you will only get Rs 5 as your dividend for every share you own. That, in percentage terms, means you got just five percent as your dividend and not the 50 percent the company announced.

Or, let's say, you paid Rs 9 (the then market value). You will still get Rs 5 per share as dividend. That means, in percentage terms, you got just 55.55 percent as dividend yield and not the 50 percent the company announced.

Capital Gain

As the company expands and grows, acquires more assets and makes more profit, the value of its business increases. This, in turn, drives up the value of the stock. So, when you sell, you will receive a premium over (more than) what you paid.

This is known as capital gain and this is the main reason why people invest in stocks. They want to make money by selling the stock at a profit.

It is not as easy as it sounds. A stock's price is always on the move. It could either appreciate (increase in value) or depreciate (decrease in value) with respect to the price at which you purchased it.

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, then your return from that stock is Rs 10, or 100 percent.

Or, if you buy a stock for Rs 10 and sell it for Rs 9, you lose Rs 1, or your loss is 10 percent.

Now look at both: Dividend and Capital Gain

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, then your return from that stock is Rs 10, or 100 percent.

Add the Rs 5 per share you have received as dividend, and your total return will be Rs 10 plus Rs 5 = Rs 15 or 150 percent (Rs 15 divided by Rs 10 multiplied by 100).

If you buy a stock for Rs 10 and sell it for Rs 9 after a year, you would lose Rs 1 per share.

However, you would have got Rs 5 as dividend. So you would net Rs 4 as earnings from the company.

In percentage terms, your return would be 40 percent (Rs 4 divided by Rs 10 multiplied by 100).


One last point.

If you are a tax payer, the finance minister has made it very easy for you to invest in the stock market. There is no tax on dividend. Neither will you be taxed on long-term capital gains. This means, if you buy a share, hold it for at least a year and sell it at a profit, you don't have to pay any tax on the profit your make. If you sell it within a year, the short-term capital gains tax is only 10 percent.

Contrast this with fixed deposits, where you have to pay tax on the interest at your marginal tax rate. This means that, if you are in the 30 percent tax bracket and your interest income exceeds Rs 12,000 in a year, you'll have to pay tax on your interest income at that rate (including the surcharge, the cess, etc, the rate works out to almost 35 percent).

Investing in stocks may be more risky, but it is more tax-friendly. Besides, there is the potential to get a higher return on your investment.

Sensex? What's that?

What's so hot about the Sensex?

It is the benchmark index for the Indian stock market. It is the most frequently used indictor while reporting on the state of the market.

The index has just one job: To capture the price movement. So a stock index will reflect the price movements of shares while a bond index captures the manner in which bond prices go up or down.

If the Sensex rises, it indicates the market is doing well. Since stocks are supposed to reflect what companies expect to earn in the future, a rising index indicates investors expect better earnings from companies.

It is, therefore, also a measure of the state of the Indian economy. If Indian companies are expected to do well, obviously the economy should do well too.

In case you are wondering why a stock market index has a provocative term like Sensex, let me tell you it stands for something quite mundane -- The Bombay Stock Exchange Sensitive Index.

What is the Sensex made of?

Thirty stocks. That's right. Just 30 stocks tell you how the market is faring.

Before you throw up your hands in protest, there is something you should know about these 30 stocks.

For one, they are the most actively traded stocks in the market. In fact, they account for half the BSE's market capitalisation

Besides, they represent 13 sectors of the economy and are leaders in their respective industries. Now that sounds fair, doesn't it?

Who selects these 30 stocks?

They are selected by the Index Committee.

This committee consists of all sorts of individuals including academicians, mutual fund managers, finance journalists, independent governing board members and other participants in the financial markets.

How do they select these 30 stocks?

Well, they definitely don't do it on the basis of their individual whims and fancies. Some of the criteria they follow include:

~ The stock should have been traded on each and every trading day (the days on which the stock market works) for the past one year.

~ It should be among the top 150 companies listed by average number of trades (buying or selling of shares) and the average value of the trades (in actual rupee terms) per day over the past one year.

~ The stock must have been listed on the BSE for at least one year.

Does the Sensex have any contemporaries?

In terms of age? No.

The Sensex is the oldest index in the country. It was born in 1986.

In terms of popularity, the Nifty follows close.

The Nifty? What's that?

Well, the National Stock Exchange has an index called the Nifty (officially called S&P CNX Nifty). This name can be credited to the 50 stocks that comprise its index.
Isn't that a broader representation than the Sensex?

You're right. The Nifty has 50 stocks covering 24 sectors, as against 30 stocks and 13 sectors for the Sensex.

In case you are shaking your head about 50 also being too small a number, let me remind you these 50 stocks account for around 60 percent of the market capitalisation.

If these indices tell us about the market, why do people talk about sectoral indices?

The price of every stock price increases or decreases for two possible reasons:

~ News about the company, like a product launch, closure of a factory, the government providing tax or duty exemptions to the sector so more profits expected, a feud among the company's top bosses, etc. This will be stock specific news.

~ News about the country, like testing a nuclear bomb, a terrorist attack, a budget announcement, etc. This will be called index news.

The job of an index is mainly to capture the news about the country. This will reflect the movement of the stock market as a whole.

A good index will only capture news that is common to all stocks in India. This is what the Sensex and the Nifty do.
What about stock specific news then?

This is where the sector-specific indices come into the picture. They reflect the performance of the stocks in a particular sector only

For example, the BSE's IT Index captures the price movements of information technology stocks while its Bankex represents the change in the prices of bank stocks.

So a look at the specific sector index will tell you about that particular sector. For instance, bank stocks may not be performing and that will be reflected in the Bankex falling or remaining stagnant even though the Sensex might have gone up.

Did you know the NSE has a mid-cap index that is made up of mid-sized companies?

This index has run up smartly in recent months, rising even more than the Nifty, which shows that people have been investing more in smaller companies. This could be because the price for the stocks of bigger companies has increased recently.

Now, let's see how globally savvy you are.

Guess the Indices of these countries: The US, the UK and Japan.

Dow Jones Industrial Average, the FTSE (Footsie) and the Nikkei?