Another year has just commenced. Dilip Maitra recommends some fundamental principles of investing in a year which is likely to see a stronger economic performance.
Another year has just commenced. Dilip Maitra recommends some fundamental principles of investing in a year which is likely to see a stronger economic performance.Indians are lucky, our banks offer one of the highest interests in the world. And there are many other options to earn a good return on investments. The year 2010 was fairly good in terms of return to investors as major stock indices like BSE Sensex and NSE Nifty both were up 17 per cent at the end of the year. Though interest rates were low most of the year, they started rising towards the last quarter. Investors in gold of course minted money as the price of the yellow metal jumped 15 per cent during the year. Even the property prices increased slowly but steadily.
Will 2011 be as good or better for the investors? Where should we invest our money and how much? While we do not have precise answers for everything, through this article we shall present various investment options for the common man.
We know that life is full of uncertainties and no one can predict how the stock markets will behave, interest rates will move and rate of inflation will climb. But amidst the uncertainty, we must plan for an investments strategy that is likely to be effective in providing a reasonable return on our money and, more importantly, protect us from losing money.
Different needs
Before we begin, it is important to understand a very basic fact: In the world of investments, there is no “one size fits all”. Investors have different goals, needs, risk appetite and time horizons. Ideal investment strategy should be worked out in line with the investor’s risk profile and time horizon. In every investment, options discussed below risk and time span for investment will vary from person to person.
Once you are clear about your risk-taking ability, it is time to choose from various available options. Someone, who wants to play absolutely safe, for example, should stick to fixed deposits in banks or keep money in post offices. If the time horizon is long, investing in endowment life insurance policies can also be considered as another safe option. Mutual funds can be considered for relatively higher return by those who are ready to take slightly more risk. Buying equity shares of companies and properties can give very high returns but they also carry the highest amount of risk.
To balance between risk and return, one can also think of a mixture of the above three. A prudent asset allocation strategy will help you decide how much money should be invested where. A low risk option, for example, can be an allocation of funds in 50:25:25 proportions for bank deposits, mutual funds and shares.
Don’t be passive
Another very important need is to remain active. Unfortunately, most people in the salaried class/ fixed income earners are passive investors. Our salary gets deposited in the bank each month, we withdraw money or issue cheques for expenses and whatever is left in the savings account earns a paltry interest of 3.5 per cent. Very few realise the fact that by leaving money in savings account we are actually getting a negative return (losing money) because inflation is always higher than savings interest.
As the current rate of inflation is around 8 per cent, to make sure that the return is positive (or we do not lose money) the minimum return must be higher than the rate of inflation.
Playing safe
For those who do not want any risk, the best option is to go for fixed return schemes or term deposits in reputed banks or invest in various instruments offered by post offices.
Thanks to the tight money policy followed by the Reserve Bank of India in recent months, all banks have significantly raised interest rates. For a two to three years fixed deposit, it is now possible to earn 8.55 per cent interest (0.50 per cent more for senior citizens), giving a cumulative yield of around 9 per cent, from government-owned banks. Fixed deposits in some private banks, non-banking financial institutions and private companies will earn higher returns — it can even go up to 12.50 per cent for a 3 year period (yield 14.90 per cent), but the risk is also greater.
At present, post office deposits are less attractive as schemes like NSC, PPF, monthly income schemes now earn interest at around 8 per cent or less. Of course, the Senior Citizen Savings Scheme earns 9 per cent for a five-year deposit, but it is available to people above 60 years of age.
Another interesting fixed income instrument is the Long Term Infrastructure Bond introduced in the current financial year by some of the infrastructure financing companies.
Under this scheme, one can buy infrastructure bonds for 10 years to earn interest at 8.25 per cent. Investment in this bond is locked in for 5 years, with buyback at the end of 5th, 6th, 7th, 8th, and 9th year. These bonds are listed and traded on stock exchanges and can be sold and purchased like shares. The more interesting feature is that on an investment of Rs 20,000 an investor can save tax up to Rs 6,000 under the section 80CCF of the IT Act, giving an effective yield of 11.01 per cent at the highest tax slab.
Remember that term deposits will levy penalty in case of premature withdrawal. If you are forced to keep large sums of money in savings account for unplanned emergency withdrawals, there is a better option. Many banks now offer automatic transfer (called sweeping) of surplus fund (above a specified amount) from savings to fixed deposits. In case of withdrawals above the available amount, fixed deposits are broken to the extent needed and money gets swept back to savings. Such schemes provide the flexibility of savings account but earn higher interest. In 2011, fixed deposit will be a good bet as the interest rates are expected to rule high in the first four to five months of the year.
Silver out-shined gold
Indians are obsessed about gold and our country is the largest purchaser of gold in the world. Why? We Indians buy gold jewellery not only for gifting or wearing, but also for investment. Most gold jewellery buyers think that acquiring the yellow metal is one of the safest investment options because the gold prices always go up.
But in 2010, silver, the poor cousin of gold, performed much better as an investment option than gold. At the current price of around Rs 47,000 a kg, silver price is 74 per cent higher than Rs 27,000 in the beginning of 2010. On the contrary, at the current price of 19,500 per ten gram, gold has appreciated around 15 per cent on a 12 months horizon.
Silver prices have reached the record peak mainly because of a worldwide shortage of the metal in comparison to its demand.
Though gold has appreciated slower than silver, it is still a good bet to invest in gold. As two of the world’s strongest currencies - the US dollar and Euro Zones Euro have remained relatively unstable in the last six months or so, many large investors are buying gold as a safe investment option and hedge against currency depreciation. Bullion experts believe that gold and silver prices will continue to remain bullish in the long term though there could be corrections in the short term.
But investment in gold and silver should ideally be in the form of coins and bars. Most Indians buy gold in the form of jewellery whose price includes between 10 to 15 per cent of the value as making charge, wastage, etc. When the same jewellery is sold, one is paid only for the gold, minus the making charges and impurities. Moreover, in the short term, one can also lose money in gold or silver if the prices -which depend on market forces, decline. On the other hand, a fixed income instrument over a period of three to five years can get a decent guaranteed return.
The growth story
If you do not mind taking some risk in life and want to get rich quickly, then investing in equity shares of companies is the option. The year 2010 was a revival year for stocks in the country after a bad 2008 and 2009 when the global financial crisis battered prices down for most shares. In 2010, the BSE Sensex, one of the two most important indicators of stock prices, gained 16 per cent to 20,390 at the end of the year from 17,558 in the beginning. Another important indicator, NSE Nifty also gained 17 per cent to 6,012 from 5,232.
There were several factors pushing the stock prices up. Finding India an attractive investment destination, global investors, known as foreign institutional investors (FIIs), pumped in a massive $28.60 billion in 2010 (till December 23, 2010) or Rs 1,29,857 crore in Indian stocks, 64 per cent more that $17.45 in 2009. FIIs had good company with the large domestic financial players like Life Insurance Corporation, public and private banks and high networth individuals. Another indicator of the boom in the stock market is that Indian companies, public and private, raised a record Rs 71,114 crore from 70 public issue of shares in 2010. The earlier best was Rs 45,000 crore in 2007.
Will the honeymoon continue? Most market experts think that share markets in 2011 will continue to do well if there are no major disturbances in the developed countries.
Investors poured in money because they were won over on Indian growth story despite the minor hiccups of some scams. India is the second fastest growing economy in the world (after China) with an expected GDP growth of around 9 per cent to make.
All other major indicators also tell positive stories: Industrial production is growing at a healthy rate of 10 per cent, exports up 27 per cent, capital formation jumped nearly 25 per cent, our savings rate is high at around 35 per cent and employment outlook is better than the previous year. In short, the Indian economy will support rising stock markets if there are no unusual developments.
But stocks are risky
Despite all these positive factors will dream run continue? No one knows. As share prices go up and down, and many a times for reasons totally unrelated to a company, investing in stocks is the riskiest. Sometime you can make a windfall gain and sometime you may lose the entire money. While both is possible, if you must invest in stocks follow the following basic rules;
Do not speculate: If earning a good return is the objective, invest for long term - three to five years. Do not speculate based on so called “Buy Tips”. More often than not the tips are engineered to serve a purpose of interest parties.
Do not try to time the market: Many say that it is wrong to buy stocks in a rising market and sell in a falling market. The question is how long will the bull or bear phase run? The wild and prolonged fluctuations in stock indices over a long period have proved that it is difficult to time ‘buy’ or ‘sell’ decisions. Since you can not predict the market, you can’t time it.
Do a lot of home work: On the face of it, making money in stocks looks easy. But for a serious player it involves a lot of research and applying common sense. One not only needs to study the company but also the industry it belongs to, check the future trends in market and technology, the government’s policies and the overall status of the economy. If, for example, the banking sector looks exciting for the next five years one can buy shares of the most profitable banks in the industry even if its pricing looks high.
Go for growth: Pick up stocks of companies that have good growth potential due to its own strengths and also because the industry it belongs will do well. Infosys, Wipro, TCS in software, HLL in FMCG, Reliance in oil refining and petrochemicals, Maruti in cars are some of the good examples of growth stocks. If they are too expensive, go for small and medium size companies with good growth potential.
De-risking strategy: Even after you have done an extensive research, finished all your calculations, factored in all possible scenarios before investing in stocks, everything can come to naught all of a sudden for reasons totally unpredictable and unexplainable. So the most important golden rule: do not put all your eggs in one basket. Diversify and well diversify your portfolio among industries and companies. If one wants to play somewhat safe in stock investing one should fix a limit for ‘profit’ and ‘stop loss’. This means that one should sell shares once their value has appreciated to a self-determined level or sell them if they have depreciated up to point. Such acts will limit the downside risk and upside gain.
Mutual funds
Mutual Funds (MF) collect money from large number of investors buying units of a scheme and invest the fund according to the pre-stated plan. Since the asset management company of a MF has a team of experts to decide where and when to invest, it is right to assume that a MF is a safer option than an individual investing directly. There are different types of funds roughly classified as gilt fund, debt fund, balanced fund and equity fund. While the first two are safer options but provide low return. Balanced funds invest both in debt and equity shares while equity funds focuses only on equity shares of listed companies.
Over the years Indian mutual fund has matured with many fund houses and investment options. Though there is a wide choice, selecting a fund for investment will again depend on your risk appetite. A thorough research, with time series data, on the performance of the fund is a must to get an idea how a scheme has done in relation to the overall market and competition. Though past performance cannot guarantee a good return in the future, research is always better than blind play.
MFs also often come up with new schemes and investors are made to believe that buying into a new fund at par of Rs 10 is cheaper than an existing scheme. But this is a fallacy as the price of a unit in a scheme is based on the net asset value (NAV) which is simply representative of the assets backed by each unit of the mutual fund.
Source: http://www.deccanherald.com/content/125685/where-invest-2011.html
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