Cutting Costs and Saving Money

“Cost Cutting” – This is a term that we are hearing day in and day out ever since the recession started. Though the economy seems to be stabilizing these days, the term cost cutting is still on the cards. Large organizations even conglomerates have introduced measures to cut their costs. They have cut jobs, reduced salaries, cut back on bonuses, avoided lavish spending on expansion plans etc. As employers they are taking steps to reduce their cost. As employees it is our duty to cut our costs too, to ensure that we do not end up spending more than what we earn.

A simple example. Let us say Mr. A, has an income of Rs. 50,000/- per month. He spends nearly 45,000/- of his salary every month on routine expenditure and saves the remaining 5,000. Assuming his employer introduced a 10% pay cut to cut costs, he would end up spending all his money and thereby his savings would turn out to be ‘0’ This is not an ideal scenario. If Mr. X follows some simple strategies, he may end up cutting his expenditure by Rs. 5,000/- thereby adjusting his spending with his income and at the same time continue to save money like he used to before.

The most important point to note here is the fact that, most of the essential commodity prices are on an upward movement always. So, if our salary is not rising the way these prices do, we may end up with not enough money to buy them. We would have to compromise on our living standard. This is not something that anyone would want to do.

All said and done, what are the things that we spend on every month? Food, groceries, clothes, etc etc. Let us have a look at some simple strategies that can help us achieve around 20% savings in our expenditure.

Where to cut costs?

Before deciding on how to cut costs, we must identify the areas where we can cut costs. We must identify the areas where we spend a lot of money every month.

1. Food & Groceries
2. Transportation & Communication
3. Education
4. Clothing & other accessories
5. Entertainment

Before going into the details, let me make one thing very clear. These are strategies that can help you cut costs by around 20% on your monthly total expenditure. The best thing we can do is, implement these steps, reduce our expenditure and “Save the surplus money for a rainy day”

1. Food & Groceries

Food & other grocery items for the house contribute to nearly 40% of our monthly expenditure.

a. Buy at discount stores. Large retail chains offer attractive discounts for people who buy stuff in bulk. Plan your grocery requirements before hand and buy them in bulk to take advantage of the discounts and offers available.
b. Reduce non-vegetarian food consumption. Switch to vegetarian items. It is healthy and at the same time cost effective too.
c. Cut out junk food

Target cost saving = 15%

2. Transportation & Communication

Transportation is an important area where we spend a bulk of our money. Nearly 10-15% of our monthly expenditure is spent on transportation & communication. This includes petrol bills, car/bike maintenance costs, telephone bills etc.

a. Do car pooling
b. Switch to a fuel efficient car. Forget those fuel guzzling SUVs and switch to sedans and smaller cars which offer us a better mileage.
c. Bundle land line, mobile and internet connection with one operator (If he is offering discounts for availing all services from him)
d. Change your tariff plans. Discontinue services that you do not utilize fully.
e. Switch to pre-paid if you do not keep a tap on your phone calls

Target cost saving = 10%

3. Education

Education is an area where scope of cost cutting is very difficult. It contributes to nearly 10% of our monthly expenditure. We cannot possibly try to shift our children to schools/colleges that ask for lesser fees, after all their education quality is extremely important and decides how successful they are in their career. But, here too we can squeeze in a bit of saving.

a. If you have multiple children, try to re-use the books used by the elder child
b. If you have a PC, check out options for online learning.
c. Do not buy everything for the schooling year every year. Try to re-use last years stuff like bags, shoes etc that can be used for a few more months.

Target cost saving = 5%

4. Clothing & other accessories

Clothes and apparels contribute to decent chunk of nearly 10% of our income. The kind of attire we wear, speaks volumes about ourselves wherever we go. But here too cost cutting can be done effectively.

a. Switch to private or in house brands instead of costlier brands
b. Buy at factory outlets. They are nearly 25% cheaper than showrooms.
c. Stock up during off season sale. Large brands offer up to 50% discounts during year end stock clearance sale. Use such opportunities.

Target cost saving = 25%

5. Entertainment

Everyone likes to spend time with friends and family away from home. Movies, multiplexes etc are the favorite hang out spots for people these days. We spend around 10% of our income in entertainment every month.

a. Avoid unnecessary eat outs. Eat at home, it is healthy and also cost effective
b. Explore your travel plans before going on a vacation. Book in advance. Most travel operators offer decent discounts for people who plan in advance
c. Switch to economy class from business class if you are paying the ticket charge. Your employer would have already done it, why don’t you. The air fares are comparatively lower.
d. Try downloading songs/movies instead of buying the CD/DVD.

Target cost saving = 30%

Cost Saving calculations:

Assuming Mr. X spends Rs. 50,000 every month. Which means he spends

1. Food & Groceries – 20,000
2. Transportation & communication – 7,500
3. Education – 5,000
4. Clothing & accessories – 5,000
5. Entertainment – 5,000

Total = 42,500/-

Expected Cost Savings:
1. Food & Groceries – 3,000
2. Transportation & Communication – 750
3. Education – 250
4. Clothing & accessories – 1,250
5. Entertainment – 1,500

Total = Rs. 6,750/-

If you invest this in an equity mutual fund that gives you a 15% returns per annum you would have saved up Rs. 93,150/- at the end of the year.

Doesn’t this sound nice?

Happy Spending!!!

Laddering

Laddering is an effective investment technique that is used by many intelligent investors who want to put their money to best possible use. You can do a Ladder using many investment options like Bank FD, NSC Certificates, Bonds etc.

Just like a normal ladder, our investment ladder also has a certain number of steps. This is determined by the initial number of investments that we would be ready to make. Let us take an example where a Bank FD ladder is formed by Mr. X.



Let us say Mr. X has idle cash of Rs. 3 lakhs and is willing to deposit it in a bank to ensure safety of the capital. Let us say the bank offers him an interest of 8% for one year and Mr. X invests it happily. At the end of the first year Mr. X would get Rs. 24,000/- as interest. Now if Mr. X wants to invest in the bank FD again, there is no guarantee that the bank would offer 8% or more. Based on the market interest rates, the bank may opt to reduce it. Let us say the bank reduces the rates to 6%, Mr. X has effectively lost Rs. 6,000/- that year as interest income. This is called Re-investment Risk.

Laddering is a technique that can help us reduce this risk to a great extent. You can limit reinvestment risk by laddering, since you'll only have to reinvest part of your total fixed-income assets at any one time.

A FD ladder is made up by purchasing several FD's at one time with different maturity dates. One example of a FD ladder is to have maturity dates of one year, two years and three years. These three investments make up the three rungs of your FD ladder with one certificate maturing every year for the next Three years.

Mr. X had Rs. 3 lakhs to invest. He would buy 3 FD's for Rs. 1 lakh each with each one invested for one year more than the first. So he would have a 1 lakh FD maturing in one year, another in two years, and so on up to the last one which matures in Three years. Every year for the next three years one of his FD matures and earns you interest on his principal of 1 lakh.

When the deposit matures, he would roll it over into another FD. The best strategy is to purchase a new CD at the longest term, which in our example above would be three years. This strategy allows you to take advantage of the higher rates normally associated with longer-term FDs while maintaining more frequent access to part of your funds.

Let us say Mr. X needs Rs. 50,000/- at the end of the 6 months and he has no other cash sources apart from his FD’s. In the normal scenario, he would have had to pre-close his FD (which would attract a penalty & he would not get the normal Interest) and then re-invest the remaining money in a different FD which may or may not earn as much as the interest rates may have changed. But in our scenario, all Mr. X would need to do is, take Rs. 50,000/- from one of his FD’s and let the remaining 2 FD’s go on as planned thereby reducing the penalty and interest lost because of the unexpected emergency.

Another advantage to laddering your FD's is that over time it evens out the high and low interest rate cycles. Some years interest rates will be high, other years the rates will be lower. Currently banks are paying some of the highest FD rates we've seen in the last decade.

Before deciding on laddering your FD's, make sure you can afford to do without that money for a period of time. You'll pay a penalty for withdrawing your funds before your FD reaches maturity.

Also, don't get stuck on the idea that you have to invest in a 3-year ladder. You may be more comfortable with a five year ladder based on your financial needs. Or you may want to try a ladder with a 3 month, a 6 month, a 12 month, and a 24 month maturity. You can try a NSC ladder with 6 steps where you begin by buying NSC certificates every year for the next 6 years and then continue to Ladder it during subsequent years.

The benefits of laddering your FD investment is that you lower your risk of losing money when rates are low, increase your returns when rates are high, and still have access to a portion of your money, should you need it for an emergency.

Happy Investing!!!

Tips to make your money work as hard as you do

During such times of recession, everyone is running away from equity investments and the stock market. People are talking about safety of the invested money as primary consideration. But, there are still people like me who have not yet lost faith in the equity markets. This article is going to be about, making your money work as hard as you do. People are doing double shifts, working extra hours etc. Why not, we make our hard earned money work that way.

Let us assume you have a cash of Rs. 10 lacs idle with you and want to invest it. You can use either of the below mentioned strategies to make your money work harder than what it would in a savings account.

Strategy 1:

Deposit the money in a Bank fixed deposit that would pay you interest on a monthly basis. Let us say the bank gives you an interest of 8% per annum you would get Rs. 6666.67/- per month as interest. Invest this money in an equity diversified mutual fund. By doing so, your 10 lacs remains intact (We have taken care of the safety part here) and the interest part that is invested in mutual funds would continue to earn returns that would help you beat inflation.

Let us say the mutual fund gives you a return of 20% this year your investment would be worth Rs. 96000/- which eventually makes your total investment to be worth Rs. 10,96,000/- which is very good considering the fact that your initial investment is still in tact.

Strategy 2:

Deposit the money in a Bank fixed deposit that would pay you interest on a monthly basis. Let us say the bank gives you an interest of 8% per annum you would get Rs. 6666.67/- per month as interest. Invest this money in a Bank Recurring Deposit. By doing so, your 10 lacs remains intact and the interest part is also invested in the bank and hence this is safe too.

Let us say the RD gives you a rate of interest of 7.5%, it means your RD would mature to Rs. 83,330/- at the end of the first year which eventually makes your total investment to be worth Rs. 10,83,330/- which is very good considering the fact that your investment is entirely intact.

Strategy 3:

Deposit the money in a Bank fixed deposit that would pay you interest on a monthly basis. Let us say the bank gives you an interest of 8% per annum you would get Rs. 6666.67/- per month as interest. Invest this money in a normal Bank Account. By doing so, your 10 lacs remains intact and the interest part is also invested in the bank and hence this is safe too.

Let us say the bank gives you a rate of interest of 3.5%, it means your RD would mature to Rs. 81,537/- at the end of the first year which eventually makes your total investment to be worth Rs. 10,81,537/- which is very good considering the fact that your investment is entirely intact.

Returns Comparison:

Strategy 1:
Net Returns: Rs. 96,000/-
Returns % = 9.6%

Strategy 2:
Net Returns: Rs. 83,330/-
Returns % = 8.33%

Strategy 3:
Net Returns = 81,537/-
Returns % = 8.15%

Using the above three scenarios we can make the interest portion on our investment earn an interest or earn us an income and at the same time keeping our initial investment safe and secure. The bank would give us only 8% as interest, by using either of the above mentioned strategies, we can make our money work harder and earn a better interest.

As always, equities is the best investment class and the returns is 9.6% which is much higher than the other strategies.

Happy Investing!!!

Safe Investment Havens

At troubled times like these, safety of the investment is of prime concern to most investors across the country. When we check safety as a primary criterion, we may have to compromise on the return on investment (ROI)
Safe investments (Like the ones we are going to see in this article) would give you returns of around 8% per annum with a full 100% guarantee on the invested amount.
Even in such difficult times, I would suggest equities for investment because they would outpace the returns of all other asset classes always, considering the interests of the conservative investor is also important. This article is for the conservative investor for whom the motto “Safety First” is etched on stone and they would never compromise on that.

Let us have a look at some of these investment options and their strengths which would tempt us to choose them to park our funds.

1. Bank Fixed Deposits
2. Post Office Time Deposits
3. Kisan Vikas Patra
4. National Savings Certificate
5. Post Office – Monthly Income Scheme (POMIS)
6. Post Office – Recurring Deposits (PORD)
7. Public Provident Fund (PPF)
8. Senior Citizen Savings Scheme

Bank Fixed Deposits:

Bank FDs have been one of the most prominent saving instruments for the average Indian citizen. If you happen to ask a person who is of our father’s age (Assuming you are in your 20’s or 30’s) one of the first choices for saving money would be a Bank Fixed Deposit. These are very safe investments where the bank is bound to repay our money along with interest at maturity or even before maturity if you wish to close the account.

Positives:

1. 100% safe
2. Tenure ranging from one month to 5 years is available
3. Rate of Interest ranging from 5% to 9% (An extra 0.5% for senior citizens)
4. Tax benefits on investment upto Rs. 1 lac for 5 year tax saving deposits
5. No upper limit on investment

Negatives:
1. Interest earned on the deposit is fully taxable
2. Penalty charges may be levied if you wish to close your deposit prematurely (i.e., before the scheduled maturity date)

Post Office Time Deposits:

Post office time deposits are similar to Bank fixed deposits with one major difference. You open the deposit account in a post office instead of a bank.

Positives:
1. 100% safe
2. Tenure ranging from 1 to 5 years is available
3. No upper limit on investment
4. Rate of interest ranging from 6.25% to 7.5% (Compounded Quarterly)

Negatives:
1. Interest earned on the deposit is fully taxable
2. No Income Tax benefits

Kisan Vikas Patra
KVP is similar to the Post office Time Deposits. These are close ended deposit products launched by Indian Post office where our money would double in 8 years and 7 months. Assuming you invest 1 lac today in KVP, your money would be worth 2 lacs at the end of 8 years and 7 months.

Positives:
1. 100% safe
2. No upper limit on investment
3. Rate of interest 8.41% (Accumulated Interest is compounded yearly and paid on maturity along with our principal)

Negatives:
1. Interest earned on the deposit is fully taxable
2. No Income Tax benefits

National Savings Certificate:

NSC certificates are certificates of deposits issued by the government of India. Any Indian can deposit cash in NSC. This money would be used by the government for its cash needs.

Positives:
1. 100% safe
2. No upper limit on investment
3. Rate of interest 8% (Compounded half yearly)
4. Tax benefits. Investments upto Rs. 1 lac are exempt from income tax under sec 80C
5. Investment tenure is 6 years

Negatives:
1. Interest earned on the deposit is fully taxable

Post Office Monthly Income Scheme (POMIS)

The POMIS is a scheme launched by the Indian post office where an investor can invest a lumpsum amount on which the interest would be paid out monthly. This is used as a regular source of income for many senior citizens.

Positives:
1. 100% safe
2. Rate of interest is 8% and is paid monthly
3. Investment tenure is 6 years

Negatives:
1. Interest earned is fully taxable
2. Upper limit on investment is Rs. 4.5 lacs for individual accounts and Rs. 9 lacs for joint accounts

Post Office Recurring Deposit (PORD)

The PORD is a recurring deposit scheme that is launched by the Indian post office. In this scheme, an investor can deposit a small sum of money on a monthly basis and the amount would be paid on maturity as a lump sum along with interest.

Positives:
1. 100% safe
2. Rate of interest is 7.5% (Compounded Quarterly)
3. No upper limit on investment
4. Tenure is 5 years

Negatives:
1. Interest earned is fully taxable

Public Provident Fund (PPF)

PPF is similar to the normal Provident Fund with the only difference being, anyone can open a PPF account by visiting the nearest State Bank of India branch. PPF is also managed by the government of India. Once we open a PPF account we can deposit cash in our PPF account anytime.

Positives:
1. 100% safe
2. Rate of Interest is 8% (Compounded yearly)
3. Investment tenure is 15 years
4. Tax benefits under sec 80C for investments upto Rs. 70,000/-
5. Returns on investment are tax free

Negatives:
1. One can invest only Rs. 70,000/- per year
2. Must invest atleast Rs. 500/- every year to keep the account active.

Senior Citizens Saving Scheme

Senior Citizens savings scheme is a special deposit scheme meant for senior citizens (Individuals who are over 60 years of age) You can invest in this scheme through either post offices or through nationalized banks like SBI.

Positives:
1. 100% safe
2. Rate of Interest is 9% per annum (compounded quarterly)
3. Tax benefits on investments upto Rs. 1 lac under sec 80C
4. Investment tenure is 5 years

Negatives:
1. Upper limit on investment is Rs. 15 lacs
2. Interest earned on investment is fully taxable.

Recommendation:
As the options discussed above are all 100% safe they are a must have in ones investment portfolio. Based on your age, the share of these investments in your portfolio would vary. As a rule of the thumb, you must have a % of your investments equaling your age in these instruments. Assuming you are 30 years old, 30% of your investments should be in such options and the remaining 70% in other options like equities, real estate, gold etc.

Happy Investing!!!

Debt Mutual Funds

A Debt Mutual fund is a type of mutual fund that is designed especially for the low risk investor whose main aim is capital preservation coupled with decent returns on investment. These are for investors who prefer funds with lesser volatility, who want a regular income and are willing to late little or very limited risk.

What are Debt Funds?

All mutual funds have some amount of risk, but debt mutual funds are less risky than equity oriented mutual funds. Debt funds usually invest in fixed income instruments that may also offer capital appreciation.

Debt funds can give you
1. Capital Appreciation and
2. Regular Income

Capital Appreciation:

Debt funds buy either listed or unlisted debt instruments at a certain price and then sell them. The difference between the cost and sale price accounts for the appreciation or depreciation in the funds value. A debt instruments market price depends on the interest rates of its underlying assets and also any up or downward movement in the credit ratings of its holdings.
Market prices of debt securities swing with movements in the prevailing interest rates. Let us say our debt fund owns a security that yields a 10% interest. If the market interest rates fall, new instruments that hit the market would reflect the changed interest rates and offer lower returns. This would result in an increase in our funds price as the higher yield would raise our instruments value. As a result the NAV of our fund would increase which provides us with the capital appreciation

Regular Income:

Similar to the interest that banks offer us on our deposits, debt funds also earn a regular interest from the fixed income securities they are invested in. This income gets added to the debt fund on a regular basis. This income would be shared with us, thereby providing us with regular income

Recommendation:

Debt funds are specifically designed for the investor who is not ready to take risks that come with equity mutual funds but at the same time wants a better return than bank deposits. You can have limited exposure to these funds to add a balance to your portfolio. An ideal investment portfolio would have around 10-15% exposure to these instruments.

Happy Investing!!!

Common Financial Terms - Part IV

Basis Trading

An arbitrage strategy usually consisting of the purchase of a particular security and the sale of a similar security (often the purchase of a security and the sale of a corresponding futures contract). Basis trading is done when the investor feels that the two securities are mispriced with respect to each other, and that the mispricing will correct itself such that the gain on one side of the trade will more than cancel out the loss on the other side of the trade. In the case of such a trade taking place on a security and the futures contract, the trade will be profitable if the purchase price plus the cost of carry is less than the futures price. also called cash and carry trade.

Net Proceeds

The amount of money received from a sale, after subtracting transaction costs. In the case of an investor selling securities, net proceeds is the total revenue from sales minus trading costs. In the case of an issuer of securities, net proceeds are the capital raised minus the costs of issuing the securities. For a property, net proceeds are the price of the house minus commissions, closing costs, costs of any repairs and inspections that may need to be undertaken, and realtor's charges.

Exercise Price

The specified price on an option contract at which the contract may be exercised, whereby a call option buyer can buy the underlier or a put option buyer can sell the underlier. The buyer's profit from exercising the option is the amount by which the spot price exceeds the exercise price (in the case of a call), or the amount by which the exercise price exceeds the spot price (in the case of a put). In general, the smaller the difference between spot and exercise price, the higher the option premium. also called strike price.

Net Capital Ratio

SEC requirement that all broker/dealers maintain a ratio of no more than 15:1 between indebtedness and liquid assets. Indebtedness includes money owed to the firm, margin loans, and commitments to purchase securities. Liquid assets include cash and assets which are easily converted to cash. The purpose of this rule is to make sure that the broker/dealer will be able to maintain its operations and not adversely affect the capital markets even if it suffers a large amount of bad debt. called net capital rule.

Credit Report

A report containing detailed information on a person's credit history, including identifying information, credit accounts and loans, bankruptcies and late payments, and recent inquiries. It can be obtained by prospective lenders with the borrower's permission, to determine his or her creditworthiness.

Knock-out Option

An option that becomes worthless in the event that the underlying commodity or currency crosses a certain price level.

Reload Option

An employee stock option granted upon the exercise of an option using shares already in the holder's possession. The reload option expires on the same date as the original option and its exercise price is equal to the price of the stock upon exercise of the original option.

Marketability

A measure of the ability of a security to be bought and sold. If there is an active marketplace for a security, it has good marketability. Marketability is similar to liquidity, except that liquidity implies that the value of the security is preserved, whereas marketability simply indicates that the security can be bought and sold easily.

Overnight Limit

The maximum amount of currency positions that can be carried over from one trading day to another. The overnight limit is set by the Central Bank regulation the financial institution where the positions are held.

Strike Price

The specified price on an option contract at which the contract may be exercised, whereby a call option buyer can buy the underlier or a put option buyer can sell the underlier. The buyer's profit from exercising the option is the amount by which the strike price exceeds the spot price (in the case of a put), or the amount by which the spot price exceeds the strike price (in the case of a call). In general, the smaller the difference between spot and strike price, the higher the option premium. also called exercise price.

Tax Straddle

An investing technique which is undergone for the purposes of creating tax benefits. To do this, it involves purchasing specific futures or options contracts where the loss of one contract will balance out the gain of another contract, and push back the tax impact until the next year. This technique is no longer practiced, as laws have been passed which require most gains and losses to be realized at the end of the calendar year.

Checking Account

An account which allows the holder to write checks against deposited funds. Checking accounts which pay interest are sometimes referred to as negotiable order of withdrawal (NOW) accounts. The interest rate often depends on how large the balance in the account is, and most charge a monthly service fee if the account balance falls below a preset level.

National Association of Securities Dealers Automated Quotations system - NASDAQ

A computerized system established by the NASD to facilitate trading by providing broker/dealers with current bid and ask price quotes on over-the-counter stocks and some listed stocks. Unlike the Amex and the NYSE, the Nasdaq (once an acronym for the National Association of securities Dealers Automated Quotation system) does not have a physical trading floor that brings together buyers and sellers. Instead, all trading on the Nasdaq exchange is done over a network of computers and telephones. Also, the Nasdaq does not employ market specialists to buy unfilled orders like the NYSE does. The Nasdaq began when brokers started informally trading via telephone; the network was later formalized and linked by computer in the early 1970s. In 1998 the parent company of the Nasdaq purchased the Amex, although the two continue to operate separately. Orders for stock are sent out electronically on the Nasdaq, where market makers list their buy and sell prices. Once a price is agreed upon, the transaction is executed electronically.

Economic Value Added - EVA

The monetary value of an entity at the end of an time period minus the monetary value of that same entity at the beginning of that time period.

For a company, after-tax earnings minus the opportunity cost of capital. As with any other entity, economic value added essentially measures how much more valuable a company has become during a given time period.




Financial Terms - Part I
Financial Terms - Part II
Financial Terms - Part III
Financial Terms - Part V
Financial Terms - Part VI