Patience is a virtue
We quoted earlier that numbers look good when tabulated. However, transforming them into reality could be a Herculean task. Well, not quite. An investment of Rs 10,000 per month for a period of 10 years has yielded an average of 12 per cent on a year-on-year basis even after a huge market fall as the adjacent table illustrates.
Most of the magic of compounding happens only at the end. It's time you planned on how to be a millionaire and maybe not theSlumdog way!
Discipline & diversification
To achieve the best risk-adjusted returns, it becomes absolutely necessary not to put all your money in the same basket. Having a judicious mix of debt and equity is equally important whilst you embark on your journey to become a millionaire.
Ravi had a moderate risk appetite and was keen on buying stocks especially at current levels given the fact that they are available at discounts to their actual value. He had limited knowledge about equities hence I suggested that he start off with equity mutual funds, which is also an ideal way to begin investing into equities.
Often, one is unsure of how much exposure one can assume: a thumb rule is to have equity exposure at 100 less your age; for Ravi it translates into 75 per cent (100 less his age, that is, 25 years) into equities and 25 per cent parked in debt (say fixed deposits for safety). Diversification is what will determine what returns you achieve. In table 1, we have illustrated three scenarios on returns: 8 per cent, 10 per cent and 15 per cent. Although risk is directly proportional to returns, one should aim to achieve optimal returns at risk-adjusted levels.
Start early, save consistently
Often, it is seen that investments are generally the last thing on your mind in your early 20s. You probably didn't know a thing about investing during your college days. The pocket money went straight to splurging on shopping, gadgets, theatres etc. The earlier you realise the importance of investing, the more time you would have for your money to compound and build a huge corpus. The adjacent table shows a simple representation of the power of compounding.
The table shows that if you save Rs 10,000 per month for 10 years (that is Rs 12 lakh at the end of 10 years) and if it compounds every year at a rate of 8 per cent then at the end of the 10th year you will get a corpus of Rs 18, 29, 460. But if you continue investing Rs 10,000 per month for another 10 years (that is Rs 24 lakh at the end of 20th year) and if this money compounds itself at 8 per cent then you build a corpus of more than Rs 58 lakh. That is you double your invested amount in 20 years.
Doesn't sound very mouth-watering, does it? No. Well, the power of compounding works handsomely when you let your money grow for a longer period of time as the table and the two illustrations below highlight. Apart from the time factor the other assumption that changes is the rate at which your money grows.
Now, if the same Rs 10,000 per month grows at 10 per cent per annum then your Rs 24 lakh (at the end of 20th year) will get you an amount that is more than three times (Rs 75 lakh) your invested amount (Rs 24 lakh). Likewise, if the same amount of Rs 10,000 per month (Rs 24 lakh in 20 years) compounds at 15 per cent every year for 20 years then you end up becoming a crorepati: that is, your actual investment of Rs 24 lakh returns Rs 1crore and 49 lakh.
Numbers do look good when tabulated; however, it is indeed a Herculean task to translate them into reality! You may observe now that it is not just time and money that commands the direction in which your corpus grows; there is one more important parameter which determines the same: rate of returns. For nobody can give you an assurance that your corpus will grow every year at a given rate.
What is compounding?
We aren't defining the mathematical term, the achievement of academics is to apply them in daily life.
The wonder of compounding (in investing terms) is to make your money work, to transform it into a state-of-the-art, highly powerful income-generating tool. Compounding is the process of generating earnings on your asset's reinvested earnings. Compounding works on two basic premises: re-investment of earnings and time.
Simply put, the longer time you leave your money to compound, the higher is the wealth you generate.
One-time registration cost: Rs 100
Annual fees: Rs 350
Cost for every transaction: Rs 30
Fund management fee: 0.009 per cent per annum.
Annual asset servicing charges: Electronic (0.0075 per cent), physical (0.05 per cent) segment
All pension fund investments are tax free and fall under the Rs 1 lakh limit of Section 80C of the Income Tax Act. But withdrawals are fully taxed.
 Back | | | Next  |
For withdrawals before the age of 60, 80 per cent of the accumulated money must be invested in an annuity and the remaining can be withdrawn as a lump sum.
For withdrawals after the age of 60, you have to put at least 40 per cent into an annuity. The balance you can take as a lump sum or in a phased manner. If you opt for the latter, you can phase it out till you are 70, with a minimum 10 per cent to be withdrawn every year.
The annuity will have to be taken from any life insurance company regulated by the Insurance Regulatory and Development Authority (IRDA).
If you die before you withdraw the entire amount, then your nominee can receive the entire amount in a lump sum.It's up to you to choose from the various segments.
E (equity): The equity investment is capped at 50 per cent of the investor's money and will only constitute index funds that replicate the Sensex or Nifty.
C (credit risk bearing instruments): Liquid funds, corporate debt, which are fixed return instruments issued by companies, fixed deposits and bonds (public sector, municipal, infrastructure).
G (government securities): State and central government securities.
If you cannot decide, the 'Auto Choice' comes into effect whereby the investment is determined by a predefined portfolio. Depending on your age, an allocation is made between the three classes of investment mentioned. For instance, up to 35 years of age, 20 per cent of the portfolio will be in G. But by the time you are 55, it will stand at 80 per cent.Once you make your contribution with the PoP, it will be deposited with the CRA. The CRA will maintain all the accounts just like a depository maintains the dematerialised accounts for shares.
The CRA will then transfer the amount your money to the fund manger of your choice: ICICI Prudential, IDFC, Kotak Mahindra, Reliance Capital, SBI and UTI.Once you visit the PoP, you will have to fill in the prescribed form and submit the required documents. Your account will then be registered.
As of now, only Tier I accounts are available and these are non-withdrawal accounts.
Once registered, the Central Record-keeping Agency (CRA) will send you a Permanent Retirement Account Number (PRAN) along with telephone and Internet passwords.
The online site is: http://npscra.nsdl.co.inAny citizen of India can be part of the New Pension Scheme (NPS). The only criteria: you must be between 18 and 55 years of age. Even non-Resident Indians (NRIs) can apply. But they must have a local bank account and also be Know Your Customer (KYC) compliant.
In this feature, we answer the six most relevant questions concerning it.
Where do you go to open an account?
You will have to approach any of the Points of Presence (PoP) across the country.
These are run by Allahabad Bank, Axis Bank, Citibank, ICICI Bank, IDBI Bank, IL&FS, Kotak Mahindra Bank, Life Insurance Corporation (LIC), Oriental Bank of Commerce, Reliance Capital, South Indian Bank, State Bank of India (SBI) and its associates, Union Bank of India and UTI Asset Management.
You can locate them online at: http://npscra.nsdl.co.in/modules.php?name=Content&pa=showpage&pid=191
In the previous article we had seen how lack of knowledge prevents us from taking the best decision even in case of a simple bank fixed deposit.
We had also asked about the similarity between a bank FD and a bond paper? Let us take this discussion forward today.
A debt paper is a paper issued by the borrower to the lender when he takes a loan from the lender. The debt paper mentions the amount of money taken as loan (par value of the paper), the period for which the loan is taken (term to maturity) and the rate of interest which the borrower will pay to the lender (coupon).
A bank FD also has the same three features. The only difference in the two is that while a debt paper is traded in the market, a bank FD is not tradable. However, that does not prevent us from taking the analogy forward.
In the previous article we had seen that by investing in Rs 100 in a one-year bank FD at 12 per cent in 2000 and then rolling it over for another year in 2001 and 2002 at 10 per cent and 8 per cent respectively, we earned Rs 30 in three years on our investment of Rs 100.
Just imagine what would have happened if we would have invested Rs 100 at 12 per cent in 2000 for a three year period? At the end of 2002, we would be having Rs 36 as interest as against Rs 30! On an investment of Rs one lakh this would mean a difference of Rs 6,000. And we have not used the effect of compounding yet (see related link: The magical power of compounding)
Similarly, we saw that by investing Rs 130 at 6 per cent for 10 years, we had lost on the rising interest rates. Again our money was growing at a slower rate than the rest of the market.
The lesson to be learnt here is that even when investing in a bank FD, we must have an idea on where the interest rates are headed.
As interest were expected to head down in 2000 and 2008 (these are the indications which we had spoken about in the earlier articles. Please read the article on repo, revere repo, CRR (see related link: Understanding repo, reverse repo and CRR), etc to understand how to read these indications), we would have been better off by investing in bank FDs of longer duration.
Similarly, from 2003 till 2008, we would have been better off by investing in bank FD with shorter duration as we would have got our money back faster, and every time the rates went up, we could get the benefit of these high interest rates.
True no one can time the markets.
In 2000 no one knew that by 2003 rates would have bottomed (reached their lowest and once again begun their upward journey), but it is safe to assume that it will take around 5 to 10 years for the rate cycle to reach where it was. Say, if we had invested in 2000 at 12 per cent for 10 years, then even today our money had been growing at 12 per cent!
Similarly, for somebody who invested from 2003, s/he could have easily invested for 10 years in 2008 at 10 per cent. But banks were also advertising 10 per cent in 1,000 days. Any seemingly logical investor would ask the question: why should I invest for 10 years at 10 per cent, when I am getting 10 per cent for less than 3 years?
Another question that should have been asked is: why is the bank paying 10 per cent for 2.7 years (1,000 days)? Reasons were a plenty for that, but had anybody invested Rs 100 in such a scheme, then s/he will face the problem, which we discussed in the previous article.
After 1,000 days, when any investor gets Rs 27.5 on her/his Rs 100 investment, s/he cannot reinvest the same at 10 per cent. Interest rates on FDs have already come down and are set to come down even more, and it still far from 1,000 days!
Thus a simple rule in investing in any fixed income investing (be it bank FDs or bonds) is that if interest rates are expected to head down, increase the duration of your investment and if rates are expected to rise, reduce the duration of your investments.
So in a falling interest rate scenario, buy long-term bonds and in a rising interest rate scenario, buy short-term bonds. Since we cannot buy bonds directly (we can actually, but we do not get into that right now), this analogy should be used to buy long-term and short-term bond mutual funds.
Thus we have understood that interest rates are critical for investing in fixed income investments. Let us see how to apply this bit of knowledge and see whether it really works!
A look at the chart below highlights what we have said above. The chart below is drawn using data from the fund fact sheet of an Indian mutual fund for the period of January 2008 till May 2009.
As can be seen the period from January 2008 till July 2008 saw the fund manager reducing the maturity of his scheme. This was the time when a section of the markets were largely expecting that interest rates would increase due to high inflationary concerns. In January 2008, there was an expectation that Dr Yaga Venugopal Reddy (Governor of Reserve Bank of India [Get Quote] then) would cut repo rates, and that is what must have prompted the fund manager to increase the maturity of his portfolio in January. However, after January 2008, there was a sharp reduction in the average maturity on expectations of a rising interest rates.
After July 2008, the fund manager consciously raised the maturity of the scheme, as markets started anticipating an interest rate cut. This was also the time when the scheme's net asset value (LINK), NAV, shot up, as can be seen from the blue line in the chart.
Again from January 2009, the fund manager has actively reduced the average maturity of holdings, as by and large it was expected that rate cuts were done for and were expected to not fall much, hence there was no point in holding long-term bonds.
The NAV of the scheme has also started slipping from its highs since January 2009.
So, what we have said in the previous two articles about investing in fixed income instruments indeed holds true.
The irony is that while the fund manager was increasing maturity of his holdings from July 2008 onwards, we were actually withdrawing money from the scheme.
Please refer to the chart in the first article which shows how investors actually entered after the rally was over! It was not before October 2008 that money started coming into this scheme and the sad part was that when the rally was over in December 2008, maximum money entered at that point.
Mutual funds are products designed to help us make our money grow by taking professionals help. But that does not mean that just because professionals are managing our money, it will automatically grow!
In fact, the above chart shows how wonderfully the fund manager managed the interest rate movements and thereby generated such stellar returns and the chart in the first article shows how we as investors, due to lack of basic knowledge of investments, entered late!
At least now let us realise the importance of education and financial literacy. Remember: nobody loves your money more than you do.
In the next article we will look at the above chart in greater detail. We will also look at a frequently used term in this article 'average maturity'.
The first two points are explained in the first two articles (see related links) with examples and data whereas the last point was explained in the previous article using a simple hypothetical example.
Readers are requested to read all the three articles before proceeding because this article is a continuation of the previous three.
Let us try to understand basic bond market today before going into selection of debt schemes.
As mentioned in one of the previous articles, debt is nothing but a loan and any loan has the following three salient features:
Take the case of a bank fixed deposit. If we deposit Rs 100 in a bank for one year at 9 per cent, the bank is the borrower and we are the lender/ depositor. The FV of the FD is Rs 100, term is one year and coupon or rate of interest is 10 per cent
If we take a housing loan of Rs 20 lakh for 20 years at 10.75 per cent, it is still the same.
If I borrow Rs 100 from my friend for one day it is also a loan where the term to maturity is extremely small (24 hours) and the rate of interest is 0 per cent, as my friend will (hopefully) not ask for any interest.
So we have established that a loan will always have the above three features.
Borrowers may need money for any period of time. In some later articles we will focus on types of short-term and long-term instruments. For the time being let us assume that we are in the calendar year 2000 and we have Rs 100 to invest. We do not need the money immediately and hence we can afford to invest for a very long time. All the rates of interest used in the example are very close to real ones existing at that point of time. Some calculations have been ignored to make things simple.
Say we go to the bank and listen to the banker's suggestion that we invest the Rs 100 in a one year FD at 12 per cent. After one year, that is, in 2001, we get our Rs 112 and since we do not really need the money immediately, we again take the banker's suggestion.
The banker tells us to again reinvest Rs 112 in a year FD at 10 per cent. When we ask why 10 per cent this time around and not 12 per cent, the banker tells that interest rates have fallen. So we reinvest the Rs 112 at 10 per cent and after one year, that is, in 2002, we get slightly more than Rs 10 as interest. So, in 2002 we have Rs 122 with us, which we again reinvest at 8 per cent this time around for another year. By the time the FD matures, we get Rs 8 on our investment and thus after 3 years we have earned Rs 30 on our investment of Rs 100!
By the time 2003 is over, we have learnt one lesson that the banker who was suggesting us to invest for one year at a time was not giving the best advice, because every time we reinvested, the FD rates had come down as compared to the previous year; and we therefore choose to ignore him here onwards. We are so frustrated with these falling rates that we start fearing that the rate will continue to go down, and hence we invest our Rs 130 at 6 per cent for the next 10 years!
And what happens after that? As luck would have it, interest rates start moving up from 6 per cent in 2003 all the way to 10 per cent till 2008!
The familiar feeling of being the targeted one comes back to us. Why is it that this always happens with me? Why is it that when I invest for the long term the FD rates start moving up?
As mentioned in the previous articles, if only we devoted some of our time in understanding the language of money, we would be in a much better position. We will take this analogy of bank FD to debt markets in the next article, where we will again revisit the most important point in bond markets -- when rates go down, bond prices go up.
Till then think about this: is an FD in any way similar to a bond/ debt paper? Would you have liked it if you would have known earlier that interest rates would be going down from 2000 and would be rising from 2003 and again start falling from 2008? If you wanted to invest Rs 100 in a FD in 2000, what strategy would you have adopted?
Next article we will discuss these points. Do mail your answers. Remember if you love your money, you have to give it time, you have to understand it and you have to understand its language. Investing is not easy, but it is not so difficult either as it is made out to be!
In the previous two articles (see related articles) we had shown how bonds as an asset class have outperformed in the last few months of 2008. However, our objective never has been to give tips to investors; we instead believe in educating investors and making them self-reliant. Today we discuss some bond basics.
Let us say I approach you for a Rs 100 loan for one year period and I promise to pay you 8 per cent as interest on the same (ie I approach you with a debt paper which has face value of Rs 100, maturity of one year and it pays interest of 8 per cent). This means that if you invest Rs 100 today (and buy the paper), you will get Rs 108 after one year (as I will pay you Rs 8 interest as well as repay your principal of Rs 100).
Conversely it means, if you want Rs 108 after one year, then you need to invest Rs 100 today for one year, as your money will be growing at 8 per cent per annum.
In bond terminology, the Rs 100 which you give today is known as the present value of future cash flow which you will receive; ie Rs 108. You have learnt this in Class VIII; it's simple mathematics.
If this is clearly understood, then let us assume that interest rate falls to 7 per cent immediately after you give me Rs 100.
Now you have got an asset in your hand (the debt paper), which delivers higher returns (8 per cent) than the prevailing market rate (7 per cent). Obviously, if you wish to sell this paper now, you will not be selling that paper to anyone at Rs 100, but at a rate slightly higher than Rs 100. But why will this happen, you may ask?
As you have a paper, which delivers higher returns than comparable papers, you will charge a premium in case you want to sell this paper -- that's logical.
If anyone invests Rs 100 today in some paper, other than the one you have, he will get only Rs 7 after one year (as rates have now fallen to 7 per cent); so how can you sell your paper to him at Rs 100, when it will give him Rs 8 as interest after one year? You will obviously ask for some price higher than Rs 100! How much higher?
The paper will give you Rs 108 after one year. This has not changed -- we had mentioned in the previous article that the face value and the coupon of a bond paper does not change -- however the rate at which your money grows has changed.
Earlier you money was growing @ 8 per cent per annum, now it is growing at 7 per cent per annum. So, if an investor wants the same amount (Rs 108) after the same period of time (one year), then obviously s/he will have to invest more today to reach her/his target, as now her/his money will be growing at a slower pace.
If you do some quick calculations then you will have to invest Rs 100.93 today to get Rs 108 after one year, if interest rates were to fall to 7 per cent from 8 per cent. Thus you will sell the paper at Rs 100.93 and not Rs 100.
What does this mean? This means: when interest rates fall, bond prices move up.
This is a very important logic in bond markets. Markets were expecting in July 2008 that going forward interest rates were all set to fall in a big way. Bonds started rallying (prices increased) from July itself, although interest rate cuts started only from October 2008.
Not many people must have advised you about bond funds in July 2008. by the money flowing into gilt schemes in December 2008 proved this -- after the rally was over (refer to the chart in the first article for both these points)!
As mentioned earlier, we are not at all into giving advice. We want you to learn. We want you to ask the right question: why this will happen, how to benefit from this fact, how to choose a bond fund, which bond fund will perform and which one will not are some questions which we will answer in the next article.
Till then seek these answers, and invest with knowledge. A knowledgeable investor is an empowered investor who can take independent decisions in a wiser manner; because nobody loves your money more than you do!
Cash reserve ratio (CRR) is that slice of a bank's deposits, which the bank has to compulsorily deposit with RBI.
A CRR of five per cent means that out of every Rs 100 which the bank gets as deposit, Rs 5 have to be deposited with RBI. Interestingly, RBI does not pay any interest on this money to banks. When RBI wants to reduce liquidity from the system, like in times of high inflation, it increases the CRR.
While repo rate acts as an indirect measure to control liquidity, CRR is a blunt weapon, which directly sucks liquidity from the system.
Consequently, when RBI is adopting an expansionary monetary policy, that is, when reviving growth and reducing inflation is not the main agenda, the CRR is reduced. Again, this has a direct and immediate impact on the liquidity.
In times such as these, when banks have plenty of funds but not much demand for money, they buy G-Secs more than the stipulated 24 per cent with the excess cash. As seen in the previous article, when interest rates go down, bond prices go up. So banks make a lot of money by their treasury operations in a falling interest rate scenario.
In this quarter (a three-month period after which most companies announce their results) keep an eye on bank results, and you will see the 'other income'; that is, treasury income contributing to banks' profits.
As interest rates reach their lows and consequently bond prices reach their highs, banks sell G-Secs (that is also the time when bonds are making headlines and sadly average retail investors are entering then, as was shown in the previous article!) and keep money ready for lending. This is because low interest rates attract consumers and corporates and banks start advancing loans to these entities.
This is not something new. Banks make money when rates are high as well as when rates are low. This has been happening for years. And if banks can do this so can we. But how many of us do this?
It is only the lack of knowledge of this language of money that the average investor never makes big money out of this 'officially available insider information'. Retail investors invest on some silly 'tips' or 'inside information' from their brokers but conveniently ignore such big tips the biggest insider in the economy -- RBI -- gives.
In the next article we will focus on the mathematics of debt markets. We have been saying that bond prices are inversely proportional to interest rate movement. In the article next week we will see why this happens.
Reverse repo is that rate which RBI pays to banks.
When banks have surplus liquidity and there are not enough borrowings from banks by consumers (as is the condition now), banks park their surplus money with RBI and earn some minimum interest. The rate at which RBI pays interest is known as reverse repo rate.
It is only logical that repo rate will always be more than reverse repo rate.
When RBI wants the economy to grow, it will reduce reverse repo rate (as was seen recently in April). By doing so, it will give a signal to banks that instead of deploying surplus money with RBI for a low return they should deploy the same in projects in the economy, which will help to kickstart the economy.
In times of ample liquidity, repo rate is practically redundant. Hence you will observe RBI focusing more on cutting reverse repo rates in times of slowdown, as was seen in the recent past.
In bond markets, interest rates are the most important factor, and the RBI controls interest rates.
RBI uses various rates like repo, reverse repo and CRR to give direction to interest rates in the country. Lets us understand each one of these in detail.
Repo comes from the words 'repurchase obligation'. In case of tight liquidity conditions (as you saw in 2008), when banks need funding for the short term, they approach the RBI and ask for a temporary loan. RBI gives them a loan only after taking some collateral. This collateral is Government Securities (G-Secs). (What are G-Secs? Next article will focus on that!)
So banks give G-Secs to RBI and take money to meet their temporary requirements. The interest rate which RBI charges to banks for such short-term loan is known as the repo rate. After the short-term period is over, banks have the obligation to repay the money back to RBI, along with the interest and 'buys back' its G-Secs, hence the word repurchase obligation.
It must be understood that when RBI does not want more money to go into the economy, it will raise this rate. When repo rate increases, the cost of money for banks also increases. Banks in turn increase the interest rates for their borrowers (that is, people like you and me). This prevents borrowers from taking loans from banks and thus RBI's objective of controlling money supply is achieved.
The only fallout of this is that while inflation gets controlled growth slows down as people don't borrow.
Most of the times we remain from where we started. The rich get richer and the poor get poorer. Obviously the question that arises is what does it take to graduate from middle class to rich class? There are no simple answers here, but one of the first things that come to the mind is the language of money.
Till the time we don't understand money's language, we just cannot master the art of making and preserving money.
As mentioned in the previous article (http://getahead.rediff.com/slide-show/2009/may/15/slide-show-1-understanding-the-language-of-money.htm), we will focus on understanding market terminology, so that we will be able to analyse the developments ourselves and thereby reduce dependence on external assistance or advice.
Here are some basic terminologies used in debt markets.
Debt market is a place where debt paper, like say government bonds, is traded. It is no physical place; it is a platform, where buyers and sellers trade debt paper, something roughly similar to a stock market.
Debt paper is a paper, which is issued by a borrower when s/he takes a loan (debt). If a borrower takes a loan of Rs 100 for a period of 10 years @ 10 per cent, then the paper which he issues to the lender is the debt paper. The debt paper issued will have a face value of Rs 100 (as that is the loan given), maturity of 10 years (as that is the term of the loan) and Coupon (interest rate) of 10 per cent.
Coupon is the interest the borrower promises to pay to the lender. This never changes. In our example, the lender will continue to get Rs 10 as interest every year for the next 10 years.
It is important to note that neither the face value nor the coupon of a bond changes. What changes are the market value and the yield (in simple terms interest earned on investment). In the previous article we had seen, if interest rates go down the market price of the bond goes up and consequently its yield comes down.
Here, before going any further, I would like to focus on the importance of education and self-reliance. Many a times investors say: we don't understand even the basics of investments, forget the finer nuances; that's why we rely on external support of experts.
My point here is that if you do not understand, fair enough, but at least the so-called experts (on whom you rely) should have told you to enter gilt funds in July 2008 because they understand the dynamics of interest rates and rise in bond prices better than you do.
And more importantly, they should have warned you about not entering in December 2008! Reasons can be a plenty, but the bottom line is that nobody can ever (ever) love your money more than you do.
If you are not bothered about your money, do you really think somebody else will be?
And as I said earlier, forget what others say, tell or do if it's your money, you should take charge. Simple. Get up and get going!
The only way to do so is to understand the language of money. It's simple and once you understand it's addictive. Making money is a process not an event and the earlier we start learning the language the better it is for us.
In the next article we will focus on some important terms that we regularly hear and we will slowly build our foundation for understanding and interpreting financial jargon ourselves, including how we had the indications about this debt market rally and the subsequent fall as well.
Targeting inflation
In 2008 the focus was inflation targeting. We had to bring down inflation. Now things have changed. Inflation has cooled -- not necessarily as the result of RBI policies alone but due to a combination of local/ global factors. This has led to another problem that of lesser growth in the economy.
While high rates help to control inflation, they also stop companies and individuals from borrowing, and this in turn leads to reduced growth, which we are witnessing now.
So now the objective of RBI is to pump prime the economy and get growth back on track. This can be done if companies and consumers borrow from banks and spend. To make loans attractive, it is imperative for the cost of loans to be down. Interest rates are nothing but cost of loans and hence RBI is steadily reducing interest rates by reducing CRR and reverse repo rates. As mentioned earlier, our next article will focus on explaining these terms as well as how prices of bonds rise and fall taking cue from interest rates.
Looking at the chart on the first slide, we can infer that as interest rates came down (or more importantly as market expectations of rate cuts increased), gilt funds' performance started improving.
A conclusion here is that 'as interest rates go up, bond prices go down and bond prices move up as the last two are inversely related'.
In the coming few weeks, we will be focusing on these basic things such ascash reserve ratio (CRR), repo rate, reverse repo rate and how we can use all of these to make better investment decisions when investments in a debt mutual fund. Here we go...
RBI uses interest rates to keep economy on track, which means controlling inflation and at the same time ensuring growth. To keep inflation under check, it is important to control money supply. If money in the hands of people increases, people wouldn't mind paying more for things, for which otherwise they would not have paid so much.
Just because they have more money, they will be ready to pay/ spend more. This in turn stokes inflation, which is nothing but general rise in prices. When prices rise, we say inflation is rising.
So to control inflation, it is necessary that money supply in the economy should be controlled. Thus if inflation rises, RBI hikes key interest rates (CRR & repo) so that money supply in the system reduces. When inflation was raging for all of 2008, we saw RBI constantly hiking repo rate & CRR. While we will cover in detail how this affects inflation for the time being it is enough to understand that economic theory suggests that a hike in these rates leads to a fall in inflation.
It is a common thing that investors enter stocks only after the party is over. To tide over this problem, systematic investment plan, SIP, was made popular. But the equity crash of 2008 has shaken investor's confidence like never before. Time and again we have repeated that there is no shortcut to building wealth, except understanding investment basics.
Advice from professionals should only be considered for double-checking what you think is right, just like a second opinion.
At a more basic level should we not be more aware of our own money? Should we not have more control on our finances? If the answer you feel is yes, then obviously the next question you have is 'how do I take control of my finances, if I myself don't understand much about it'?
Obviously, it would have been so much better if we had known when the NAV would rise and fall.
Actually, there were fair indications to understand the rise and fall. But the problem is that investors didn't understand how to interpret these indications. Many times they don't even know what these indications are!
Simple: learn about it. Where is the doubt? If you want your money to grow; if you want to be in better control of your finances, there is only one way: learn how the game is played. Read on to find out what happens if you don't understand the language of money!
We now have enough data to prove that it is not only in stocks but also debt where investors like to lose money! Take a look at the adjacent chart. This is the data for a gilt (debt) fund, taken from the fact sheet.
Focus on the way the assets under management, AUM, (the blue vertical bars) came down till July 2008 after which there was neither any increase nor any decrease in the AUM for three months; and since October 2008 the AUM shot up each month.
While Rs 37 crore were added in October 2008, November 2008 and December 2008 saw an increase of Rs 200 crore and Rs 375 crore respectively.
What this means is that money went out of the scheme till July 2008 and again entered in big chunks in the last three months of 2008. After this too, money was coming in into this scheme, but at a lesser pace.
So, what's wrong with money coming in and going out of a scheme?
Look at the way the net asset value, NAV, has moved (the yellow line).
From January till July (when money was leaving the scheme) the NAV barely moved. It was Rs 25.38 in January 2008 and was at Rs 24.21 in July 2008. It was from July 2008 the NAV started moving up and reached its peak by December 2008!
What it means is that maximum money entered at the peak, and today all of these investors must be sitting on huge losses as the NAV has been going down since then!
Please look at the Image Attached with this Blog to understand clearly
Post the IPL matches, if there was one lesson the teams learned, it was to start scoring right from the beginning. The Deccan Chargers kept their scoreboards ticking and did not wait for miracles to occur. This is precisely what one should be doing with investments too. Disciplined investing habits, however hard to stick to, are one helluva hasslefree method to create wealth in the long term.
It is high time one stopped speculating on investments and worked towards employing ones where money in the right avenues produce the right results. To achieve the best risk-adjusted returns, it becomes absolutely necessary not to put all your eggs (money) in the same basket. Having a judicious mix of debt and equity is equally important while you embark on the journey to riches.
We leave you with a passing thought -- most of the systematic investment magic is seen only at the end, so it's time you gave the systematic route of investments a thought.
SIPs are especially useful when we are in a market situation like today. Most of us are bullish about the medium-long term growth story; however, the market has run up quite sharply. We are a little unsure whether to invest money now, lest we end up investing at a market peak. With a year of economic downturn behind us, a systematic invest is likely to yield good returns over the next 2-4 years -- so go ahead and start your long term SIP.
When all is well, there is absolutely no need to insulate oneself against a downtrend, given that the equity markets have scared us in the past and will continue to do so in the future as well. For an SIP to deliver the goods, it must witness a falling market. This way the investor can average out his cost of purchase. If the investor does not witness a downturn, ie he is only exposed to a market rally, the average purchase cost of his SIP will rise over a period of time.
The equity market cycle is normally between a 3-5 year horizon; there could be sharp intermediate glitches as well over such a period. Hence, looking at the mentioned horizon will ensure that we have had a rollercoaster ride over the market cycle and at the same time, continued to invest across all the slumps to average our cost effectively.
For one of the funds mentioned above -- Reliance Growth, we have the following data:
As one can evidently see, the highest number of units are bought at the highest point of NAV and vice versa. This grossly averages the cost. This principle is called Rupee Cost Averaging. While the popular belief is that SIPs are used to eliminate market-timing, investors must opt for a long-enough SIP tenure so as to 'time' the market downturn.
Often, systematic investment plans (SIPs) are criticised for the slow pace at which they add to one's wealth. SIPs are a 'slow and steady' story to win in the long term. When the markets slumped from 21K to 7.7K levels, the lumpsum investors pumped in at its peak saw a greater part of their investments in the red.
An investor who continued to invest undeterred even during such turbulent times is all smiles now, for investments made during the 7.7K-10K range are already yielding huge profits.
SIP-ing your way to wealth
SIPs are essentially a longterm story -- one should not be looking at equity if the investment time frame is less than 3-5 years. An SIP is often misunderstood as an investment avenue by itself. Actually, it is only a mode of investment, ideal to invest in equities given its inherent volatility.
An SIP is a replica of the cost averaging theory that we studied in high school. The objective of using SIPs is to buy less units at market peaks and lower at market troughs. Here is an example of how patience pays over a 5 year timeframe:
| Share Name | CMP | Target Price | Stop Loss | 26th May Price |
| Prakash Industries | 105 | 116 | 98 | |
| Bartronics | 134 | 144 | 131 | |
| Renuka Sugars | 133 | 146 | 127 | |
| BATA | 152 | 167 | 147 | |
| Glenmark | 252 | 314 | 225 | |
| HPCL | 339 | 372 | 322 | |
| Nucelus Software | 96 | 107 | 89 | |
| Oil Country Tub | 65 | 70 | 60 | |
| MRPL | 70 | 74 | 62 | |
| | | | | |
| Tanla Solutions | 72.5 | 86 | 72 | |
| SKumar | 37.5 | 44 | 37 | |
| Videocon Industries | 161.25 | 190 | 160 | |
| Micro Tecnology | 137 | 150 | 135.5 | |
| | 44.85 | 53 | 44 | |
| NOCIL | 27.70 | 33 | 27 | |
| HSIL | 47.75 | 57 | 47 | |
| Kajeria ceramic | 41 | 49 | 40 | |
| | | | | |
| IVRCL | 285 | 299 | 280 | |
| Financial technology | 1330 | 1400 | 1305 | |
| Subex | 51 | 54 | 49 | |
| ITC | 189 | 197 | 186 | |
| Torrent power | 140 | 148 | 139 | |
| Escorts | 63 | 67 | 61 | |
| Crompton Greaves | 260 | 275 | 254 | |
| Vakrangee Software | 45.75 | 48 | 44.6 | |
| Dolphin Offshore | 284 | 299 | 277 | |
| | 82 | 86 | 80 | |
| | | | | |
| | 147 | 160 | 145 | |
| NEYVELLI LIGNITE | 134 | 142 | 130 | |
| J P Associate | 185 | 195 | 182 | |
| GMR Infra | 164 | 175 | 162 | |
| FEDDERS LLYOD | 37 | 41 | 35 | |
| Videocon | 161 | 175 | 155 | |
| United Brew Hold | 233 | 245 | 230 | |
| Dabur | 114 | 125 | 111 | |
| Satyam | 54 | 60 | 53 | |
| | | | | |
