Saturday, November 14, 2009

Risks Involved in Investing in Bonds

Bonds are one of the most preferred investment instruments for the risk averse investor who wants a decent return on investment (ROI) and capital preservation at the same time. Bonds are debt obligations which pay out a fixed interest on the invested sum and pay back the whole invested principal at maturity. Unfortunately, Bonds are not so straight forward as they might sound. There are many risks involved in investing in Bonds. These risks can cause losses to the investors bond portfolio and defeat the whole purpose of capital preservation.

Some of the risks involved in investing in Bonds are:

1. Interest Rate Risk
2. Re-investment Risk
3. Call Risk
4. Default Risk &
5. Inflation Risk

Interest Rate Risk:

This is the most or well known risk in the bond market. This refers to the risk that bond prices will fall as the interest rates in the market rise. Bond prices are inversely proportional to the prevailing interest rates in the market. By buying a bond, the bondholder has committed to receiving a fixed rate of return for a fixed period. If the market interest rate rises from the date of the bond's purchase, the bond's price will fall accordingly. The bond will then be trading at a discount to reflect the lower return that an investor will make on the bond. The investor would end up suffering losses if he wishes to liquidate his holdings at that point of time.

Market interest rates are a function of several factors such as the demand for, and supply of, money in the economy, the inflation rate, the stage that the business cycle is in as well as the government's monetary and fiscal policies.

Reinvestment Risk

This refers to the risk that the proceeds from a bond will be reinvested at a lower rate than the bond originally provided. For example, imagine that an investor bought a $1,000 bond that had an annual coupon of 12%. Each year the investor receives $120 (12%*$1,000), which can be reinvested back into another bond. But imagine that over time the market rate falls to 1%. Suddenly, that $120 received from the bond can only be reinvested at 1%, instead of the 12% rate of the original bond. If the investor has chosen reinvestment as an option, he would end up hurting his investment.

Call Risk

This refers to the risk that a bond will be called by its issuer. Callable bonds have call provisions, which allow the bond issuer to purchase the bond back from the bondholders and retire the issue. This is usually done when interest rates have fallen substantially since the issue date. Call provisions allow the issuer to retire the old, high-rate bonds and sell low-rate bonds in a bid to lower debt costs. If an investor has exposure to such callable bonds, the bond issuer can retire the bond and reissue fresh ones, reducing his debt cost, thereby damaging the return prospects for the investor

Default Risk

The risk that the bond's issuer will be unable to pay the contractual interest or principal on the bond in a timely manner, or at all. This is one of the serious risk factors that need to be considered before investing in a bond. The main aim behind investing in bonds is capital preservation and if you invest in a company that is on the verge of going bankrupt, the investment is as good as flushing it down the drain. To help investors who do not have the time or the means to research into such instruments, Credit ratings services such as Moody's, Standard & Poor's and Fitch give credit ratings to bond issues, which helps to give investors an idea of how likely it is that a payment default will occur. For example, most federal governments have very high credit ratings (AAA); they can raise taxes or print money to pay debts, making default unlikely. However, small, emerging companies have some of the worst credit (BB and lower). They are much more likely to default on their bond payments, in which case bondholders will likely lose all or most of their investment. Investing in high rating instruments is a wise choice rather than choosing ones with lower ratings. But, there is a catch here, lower rating bonds usually offer higher ROI when compared to the higher rating ones. The Risk-Return trade off comes into picture here. To attract more investors, companies with a lower credit rating usually offer higher interest rates which might tempt the high risk investor to give it a try.

Inflation Risk

The risk that the rate of price increases in the economy deteriorates the returns associated with the bond. This has the greatest effect on fixed bonds, which have a set interest rate from inception. For example, if an investor purchases a 5% fixed bond and then inflation rises to 10% a year, the bondholder will lose money on the investment because the purchasing power of the proceeds has been greatly diminished. The interest rates of floating-rate bonds (floaters) are adjusted periodically to match inflation rates, limiting investors' exposure to inflation risk.

Happy Investing!!!

Sunday, October 4, 2009

Common Investing Mistakes

Investment in the stock markets is something that many of us do very often and in many cases we end up suffering a loss. This is usually due to an error in judgement while choosing an investment instrument. This article is about the most common mistakes We as investors commonly make. Judging the market perfectly always is something nobody can do. Predicting market movement is a complex task and the chances of picking out a multibagger is the nearly the same as picking up a disaster of a stock. But, what we can do is, to be careful and take some precautions to ensure we dont lose our hard earned money.

The First Mistake: Going by word of mouth Tips

This is something we do all the time. A friend tells us a news about a stock that he heard from someone. The stock is expected to double or triple in a specific time and the friend went ahead and bought the stock. Most of us are tempted to go ahead and buy it ourselves. In all probabilities the stock could be a disaster and we can end up losing all our money. I did the same mistake when I started investing. A good friend of mine, who is a long term player suggested I buy stocks of a company that was expected to double up in the next 2 months. Believing my friend and his experience in the markets I went ahead and bought a decent number of shares of that company at Rs. 9.5/- each. The first week the stock reached a price of Rs. 10.5/- and I thought maybe my friend is right. But in the next few weeks the stock price started falling and currently the stock is trading at Rs. 0.75/- per share. I am glad that my exposure to this stock was less than 2% of my portfolio's worth and hence the profits I made out of the other stocks helped me recover the huge loss this stock brought to my portfolio.

The lesson is - Never rely on word of mouth tips. Do your own analysis. Find out more details about the company, its history, profit making capability etc before investing in it.

To learn some tips on how to pick a stock for your portfolio Click here

Mistake No 2: Not admitting making a mistake

People stubbornly hold on to stocks where they are making sizeable losses in the belief that they can exit when the price reaches their buying price. Most of the minds are not trained to acknowledge the fact that they have made a mistake and probably the best thing is to move on.

Mistake No 3: Buying on tips and emails from brokers and wanting to make a quick buck

Technology has made our lives much easier but at the same time has caused a lot of overload as well. We are subject to SMS's, emails and flyers with lucrative offers for “buy and sell tips” , commodities trading etc. that at the end of the day leave us confused. In this state only two things can happen, (a) One is that we procrastinate and not take any action with the fear of screwing it up or (b) Succumb to these offers for making us rich quickly.

Either ways the probability of facing a loss is pretty high. Never buy a stock until you have done your own analysis of the stock that you are going to buy.

Mistake No 4: Buying a disaster on its way down thinking you are averaging your costs

Mistake No 5: Ignoring Stock market Risks and looking only at the returns

Risk is an integral part of every equity investment and some equity investments are more risky than others. People however look at the returns without giving due importance to risk. Stock Futures can give you great returns but at the same time they can wipe out your capital as well. In the mutual fund context, people look at returns when investing in the fund, but do not consider the kind of risks the fund manager has taken whether it be concentration in stocks or sectors etc. At the same time betting heavily in Futures & Options, Commodities without understanding the nuances of the same is fraught with risk. Understand the risk i.e the downside inherent in every investment and volatility associated with it.

Mistake No 6: Buying penny stocks thinking they are cheaper and ignoring quality stocks, which are priced above a certain number like Rs. 1000/- or more thinking, they are expensive.

In most cases such blue chip stocks can give us better returns than a penny stock. For example the returns on one share of Reliance Industries stock bought at the beginning of the year 2009 when it was trading at around Rs. 1000/- on the current date could be more than the returns on 100 shares of stocks that are around the Rs. 10/- mark. The price of a stock must not determine our decision to buy it/

Mistake No 7: Exiting Winners early to make a small profit and sticking to Losers

Mistake No 8: Just thinking but not doing anything

This is probably the biggest mistake of all. Thinking about investing but doing nothing. Finally doing makes all the difference. There is no substitute for action. Just knowing that exercise is good will not keep you fit. In the same vein, just knowing this stock is good is of no use unless you buy it.

Some common statements from such people are:

“I knew this stock would do well, wish I had put in money here” or
“I missed a good time to enter this stock. It is too costly to invest now”

Whatever the reason be, in the end what matters is whether you did what you knew was right. A better option for people here is to put their investments on Autopilot - Choose quality mutual funds - investing fixed amounts every month in them.

To be a successful investor and create wealth through equities, you should shun & try to avoid the mistakes outlined above. And yes if you have made any one of the above mistakes, admit it and correct it. Mistakes are common. Even the best equity investor in the world would have made mistakes at some point of his time.

Happy Investing!!!

Saturday, August 22, 2009

How to Improve your Credit Score

Your credit score is one of the most important indicators of your financial strengh and profile. The better your credit score, the better would be the services offered to you by service providers.

There are some simple steps that we can take towards improving our credit score.

Lenders analyze your credit scores to determine whether or not to approve a home mortage, a car purchase and nearly all other types of loans.
Before lending you money, creditors want to determine how much of a risk you are in other words, how likely you are to repay the money they loan you. Credit scores help them do that, and the higher your score, the less risk they feel you'll be.

Most increases to your credit scores take place over time and require an ongoing effort from you. The only true credit score quick-fixes are to pay down debt and to successfully dispute negative information on a credit report.

Credit scoring software looks at five areas of your credit reports:
Your Payment History
Amounts You Owe
Length of Your Credit History
Types of Credit Used
Your New Credit

The article How Your Credit Score is Calculated explains what's included in each of the five categories. You can improve your credit scores by taking a close look at your credit reports and charting a plan of action to improve them.

Some main items you can focus and address are:

1. Improve your Payment History
2. Keep Debt to a Minimum
3. Length of Your Credit History
4. Manage New Credit Wisely
5. The Types of Credit You Use

Improve Your Payment History
1. Always pay your bills on time. Late payments play a major role in driving down your score.
2. Contact your creditors as soon as you know you will have a problem paying bills on time. Try to work out a payment arrangement and negotiate with them to keep at least a portion of the late notations off of your credit reports.
3. If your situation is serious, see a legitimate, non profit credit counselor. Avoid the scam artists who promise a quick reversal of your credit problems.

Keep Debt to a Minimum
1. Keep your credit card balances low. High debt-to-credit-limit ratios drive your scores down.
2. Pay off debt, don't move it around. Owing the same amounts, but having fewer open accounts, can lower your score if you max out the accounts involved.
3. Don't close unused accounts, because zero balance might help your score.
4. Don't open new accounts that you don't need as a quickie approach to altering your debt-to-credit-limit ratios. That can lower your score.

Length of Your Credit History
1. Time is the only thing that can improve this aspect of your scores, but you can manage it wisely
2. Don't open several new accounts in a short period, especially if your credit history is less than three years. Adding accounts too rapidly sends up a red flag that you might not be able to handle your credit responsibly.

Manage New Credit Wisely
1. Several credit inquiries during a short period means you are attempting to open multiple new accounts, and that lowers your credit scores.
2. Credit scoring software usually recognizes when you are shopping for a single loan within a short period of time, such as a home loan. If multiple inquiries are necessary, have them pulled as closely together as possible.
3. Do try to open a few new accounts if you've had credit problems in the past. Pay them on time and don't max out your credit limits.

The Types of Credit You Use
1. A mixture of credit cards and installment loans, loans with fixed payments, can help raise your score if you manage the credit cards responsibly.
2. Having many loans can lower your scores since payments remain the same until balances are paid in full.
3. Don't open new accounts just to have several accounts or to attempt a better mix of credit.
4. Closing an account doesn't remove it from your report. It may still be considered for scoring purposes.

All the very best!!!

Monday, July 20, 2009

Credit Score

A Credit Score is something we have been hearing or rather we hear all the time. In the US Banks talk about your credit score when you go to get a loan. Right from getting a loan to getting a job, your credit score is something that is checked. Even in India private banks and lending institutions have started checking the credit history of a customer before entering into a loan agreement with him. So, it is imperative that we learn what a credit score is and how we can build it.

What is a credit score?

A credit score is a number that lenders use to estimate risk. Experience has shown them that borrowers with higher credit scores are less likely to default on a loan. Usually banks and lending institutions would prefer somebody with a good credit score than someone who does not have such a strong credit score.

How are credit scores calculated?

Credit scores are generated by plugging the data from your credit report into software that analyzes it and cranks out a number. The three major credit reporting agencies don't necessarily use the same scoring software, so don't be surprised if you discover that the credit scores they generate for you are different. Generally lesser your outstanding debt and better the pay check you receive every month, it is better for your credit score. For ex: let us say A & B draw a salary of Rs. 50,000/- every month. A has a home loan for which he pays an EMI of Rs. 20,000/- every month whereas B does not have any such loans. So, obviosly the credit score of person A would be better than that of B and he would stand a better chance of striking a better deal or a loan from any bank or financial institutions.

Which parts of a credit history are most important?

There are many aspects of your credit history that affect your credit score.

35% - Your Payment History - Credit cards, Telephone bills and other utility bills
30% - Amounts You Owe - Outstanding credit amounts in loans and credit cards
15% - Length of Your Credit History
10% - Types of Credit Used
10% - New Credit

Why is your credit score important?

The credit score of an individual is an indicator of how worthy he is as a borrower to receive a financial product from a bank. A loan is a commitment on the part of the borrower or the customer to repay the loan. So, a bank would prefer a customer who has a better chance of repaying the loan than someone who has a past of being irregular or delinquent in his payments.

Most customers with decent credit scores manage to get a loan or any other service from a bank but at a price. Let us take the same example as above A & B. The rate of interest at which person B gets any new loan would be lesser than person A. This is because person A has a lesser credit score and hence the bank would want to collect as much money as possible from B before he stops making payments. If A manages to pay off his loan properly, this would eventually improve his credit score.

Credit scoring software only considers items on your credit report. Lenders typically look at other factors that aren't included in the report, such as income, employment history and the type of credit you are seeking.

What's a Good Credit Score?

Credit scores (usually) range from 340 to 850. The higher your score, the less risk a lender believes you will be. As your score climbs, the interest rate you are offered will probably decline.

Borrowers with a credit score over 700 are typically offered more financing options and better interest rates, but don't be discouraged if your scores are lower, because banks service nearly everyone.

It is believed that only around 10% of the population has a credit score of over 800. The bulk of the customers who receive services from banks and financial institutions are in the 550 - 700 score range. Anyone who has a score of over 700 can easily get services from banks without much of a hassle.

The next article would be on how to improve your credit score.

Sunday, July 12, 2009

Common Financial Terms - Part V

Broker recommendation

An opinion given by an analyst to his/her clients about whether a given stock is worth buying or not. Wall Street investment firms employ thousands of analysts whose job is to issue reports and broker recommendations on specific stocks. These analysts typically look at the company's fundamentals and then build financial models in order to project future trends, most notably future earnings. They then use these projections as a basis for issuing broker recommendations on whether or not they think the stock should be bought or sold. Each brokerage has its own terminology, which makes it difficult to compare broker recommendations between brokerages, but the most common ratings are (in descending order of quality) strong buy, buy, hold, and sell. also called recommendation.

Reverse split

A stock split which reduces the number of outstanding shares and increases the per-share price proportionately. This is usually an attempt by a company to disguise a falling stock price, since the actual market capitalization of the stock does not change at all. For example, if a company declares a one-for-ten reverese split, then a person who previously held 20 shares valued by the market at $1 each will then have 2 shares worth $10 each. Many stock exchanges in the U.S. do not allow companies with a stock price of less than $1 to remain listed, and many such companies then have to undertake reverse splits if they want to remain listed.

Gold standard

A monetary system that backs its currency with a reserve of gold, and allows currency holders to convert their currency into gold. The U.S. went off the gold standard in 1971.

Vertical spread

An option strategy involving the simultaneous purchase and sale of options of the same class and expiration date but different strike prices. also called price spread.

Permitted currency

A minor foreign currency that is allowed to be converted into a major currency, such the U.S. dollar.

Dollar drain

A situation in which a country's imports from the U.S. exceed their exports to the U.S., which results in a reduction in their dollar reserves. The idea can also be applied to currencies of other countries.

Municipal bond fund

A mutual fund which invests in municipal bonds. These bond funds are popular among investors in high income tax brackets because they are exempt from federal taxes and, in some cases, from state taxes as well. As with U.S. government bond funds, the underlying securities in municipal bond funds are backed by the government and thus are considered to have a high credit rating. However, municipalities have been known to declare bankruptcy on occasion, making these funds more risky than U.S. government bonds. also called muni fund.

Double taxation

Taxation of the same earnings at two levels. One common example is taxation of earnings at the corporate level and then again at the shareholder dividend level. Another example is taxation of foreign investments in the country of origin and then again upon repatriation, although many countries have signed agreements to prevent this latter type of double taxation.

Federal Reserve System

The central banking system of the U.S., comprised of the Federal Reserve Board, the 12 Federal Reserve Banks, and the national and state member banks. Its primary purpose is to regulate the flow of money and credit in the country. The Federal Reserve was established in 1913 to maintain a sound and stable banking system throughout the United States and to promote a strong economy. The Board of Governors is made up of 7 members that are appointed to 14-year terms by the President and approved by the Senate. Almost all U.S. banks are a part of the Federal Reserve System, which requires that those banks maintain a certain percentage of their assets deposited with the regional Federal Reserve Bank. These "reserve requirements" are set by the Board of Governors and by changing the requirements, the Federal Reserve System can greatly impact the amount of money supply in the economy. The Federal Reserve System has several functions. First, it serves as a bank for banks: many transactions between banks are processed through the Federal Reserve System. Financial institutions are also able to borrow money through the Federal Reserve, but only after attempting to find credit elsewhere; the Federal Reserve System provides credit only when it cannot be found in the markets or in cases of emergency. Second, the Federal Reserve System acts as the government's bank. The tax system processes incoming and outgoing payments through a Federal Reserve checking account. The Federal Reserve also buys and sells government securities. The Fed even issues the U.S. currency, although the actual production of the currency is handled elsewhere. Third, the Federal Reserve System acts as a regulatory agency. The Fed polices the banking industry to make sure that things run smoothly and that the rights of consumers are protected.

Interest rate cap

A provision of an adjustable rate mortgage limiting how much interest rates may increase in a single adjustment period.

An options contract which puts an upper limit on a floating exchange rate. The writer of the cap has to pay the holder of the cap the difference between the floating rate and the reference rate when that reference rate is breached. There is a premium to be paid by the buyer of such a contract in order to gain the certainty of a maximum payout.

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

Monday, May 25, 2009

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!!!

Saturday, May 23, 2009


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!!!

Wednesday, May 20, 2009

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!!!

Tuesday, May 19, 2009

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.


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

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.

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)

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.

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)

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.

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

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.

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

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.

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

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.

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

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.

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

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

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!!!

Saturday, May 16, 2009

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


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!!!

Saturday, May 9, 2009

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.


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

Wednesday, April 22, 2009

Common Financial Terms - Part III


A measurement of how closely a portfolio's performance correlates with the performance of a benchmark index, such as the S&P 500, and thus a measurement of what portion of its performance can be explained by the performance of the overall market or index. Values for r-squared range from 0 to 1, where 0 indicates no correlation and 1 indicates perfect correlation.

back-to-back loans

An arrangement in which two companies in different countries borrow each other's currency for a given period of time, in order reduce foreign exchange risk for both of them. also called parallel loans.

Authorized shares

The maximum number of shares of stock that a company can issue. This number is specified initially in the company's charter, but it can be changed with shareholder approval. Generally a much greater number of shares are authorized than required, to give the company flexibility to issue more stock as needed. also called authorized stock or shares authorized.

Swap spread

The difference between the swap rate on a contract and the yield on a government bond of the same maturity. It is used to represent the risk associated with the investment, since changes in interest rates will ultimately affect return. Swap spreads are based on LIBOR rates, the creditworthiness of the swap's parties, and other economic factors that could influence the terms of the investment's interest rates.

Variable rate

Any interest rate or dividend that changes on a periodic basis. Variable rates are often used for convertibles, mortgages, and certain other kinds of loans. The change is usually tied to movement of an outside indicator, such as the prime interest rate. Movement above or below certain levels is often prevented by a predetermined floor and ceiling for a given rate. also called adjustable rate.


A taxable payment declared by a company's board of directors and given to its shareholders out of the company's current or retained earnings, usually quarterly. Payouts are usually given as cash (cash dividend), but they can also take the form of stock (stock dividend) or other property. Payouts provide an incentive to own stock in stable companies even if they are not experiencing much growth. Companies are not required to pay payouts. The companies that offer payouts are most often companies that have progressed beyond the growth phase, and no longer benefit sufficiently by reinvesting their profits, so they usually choose to pay them out to their shareholders. also called dividend.

Employee Stock Ownership Plan

ESOP. A trust established by a corporate which acts as a tax-qualified, defined-contribution retirement plan by making the corporation's employees partial owners. contributions are made by the sponsoring employer, and can grow tax-deferred, just as with an IRA or 401(k) plan. But unlike other retirement plans, the contributions must be invested in the company's stock. The benefits for the company include increased cash flow, tax savings, and increased productivity from highly motivated workers. The main benefit for the employees is the ability to share in the company's success. Due to the tax benefits, the administration of ESOPs is regulated, and numerous restrictions apply. also called stock purchase plan.

Preferred shares

Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of a liquidation. Like common stock, preferred shares represent partial ownership in a company, although preferred stock shareholders do not enjoy any of the voting rights of common stockholders. Also unlike common stock, a preferred share pays a fixed dividend that does not fluctuate, although the company does not have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preferred share is that the investor has a greater claim on the company's assets than common stockholders. Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before common stockholders. In general, there are four different types of preferred stock: cumulative preferred, non-cumulative, participating, and convertible. also called preferred stock.


Global Depositary Receipt. A negotiable certificate held in the bank of one country representing a specific number of shares of a stock traded on an exchange of another country. American Depositary Receipts make it easier for individuals to invest in foreign companies, due to the widespread availability of price information, lower transaction costs, and timely dividend distributions. also called European Depositary Receipt.

Incentive stock option

ISO. A type of employee stock option which provides tax advantages for the employer that a non-qualified stock option does not, but which is subject to more stringent requirements. For ISOs, no income tax is due when the options are granted or when they're exercised. Instead, the tax is deferred until the holder sells the stock, at which time he/she is taxed for his/her entire gain. As long the sale is at least two years after the options were granted and at least one year after they were exercised, they'll be taxed at the lower, long-term capital gains rate; otherwise, the sale is considered a "disqualifying disposition", and they'll be taxed as if they were nonqualified options (the gain at exercise is taxed as ordinary income, and any subsequent appreciation is taxed as capital gains). ISOs may not be granted at a discount to the current stock price, and they are not transferable, except through a will. also called qualified stock option.

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

Tuesday, April 14, 2009

Post office Recurring Deposit

What is Post office Recurring Deposit Account (RDA)?

A Post-Office Recurring Deposit Account (RDA) is a banking service offered by Department of post, Government of India at all post office counters in the country. The scheme is meant for investors who want to deposit a fixed amount every month, in order to get a lump sum after five years. The scheme, a systematic way for long term savings, is one of the best investment option for the low income groups.


The minimum investment in a post-office RDA is Rs 10 and then in multiples of Rs. 5/- for a period of 5 years. There is no prescribed upper limit on your investment.

The deposit shall be paid as monthly installments and each subsequent monthly installment shall be made before the end of the calendar month and shall be equal to the first deposit. In case of default in payment, a default fee is chargeable for delayed deposit at 0.20 Paise per month of delay, for Rs.10 Denomination. After more than four defaults, the account shall be treated as discontinued in case the account is not revived within two months from the fifth default.

For Advance deposits for 6 months or 12 months, a rebate is allowed at the prescribed rate (For Rs 10 denomination:- Rs.1/- for 6 advance deposits, Rs.4/- for 12 advance deposits.

One withdrawal is allowed after one year of opening a post-office RDA on meeting certain conditions. You can withdraw up to half the balance lying to your credit at an interest charged at 15%. The withdrawal or the loan may be repaid in one lump or in equal monthly installments.

Premature closure is allowed on completion of three years from the date of opening and in such case, interest is payable as per the rate applicable for the Post Office Savings Bank Account.

After maturity of the account, it can be continued for a further period of 5 years with or without further deposits. During this extended period, the account can be closed at any time.

The post-office recurring deposits offers a fixed rate of interest, currently at 7.5 per cent per anum compounded quarterly.

Monthly Investment Total Investment(60months) Money returned on Maturity (after 60 months)
10 600 728.90
20 1200 1457.80
50 3000 3644.50
100 6000 7289
500 30000 36445
1000 60000 72890
1375 82500 100224
5000 300000 364450

The post office offers a fixed rate of interest unlike banks which constantly change their recurring deposit interest rates depending on their demand supply position. As the post office is a department of the government of India, it is a safe investment. The principal amount in the Recurring Deposit Account is assured. Moreover Interest earned on this account is exempted from tax as per Section 80L of Income Tax Act.

How to Start Post office RDA
A post-office RDA can be opened at any post office in the country by filling up the appropriate forms. The account can be opened by an individual adult as a single person account, two adults in a joint mode, or by a guardian on behalf of the minor who has attained the age of 10 years in his own name. A pass book is issued at the time of opening the account. If there is a loss, theft or the passbook is mutilated, a duplicate is issued on a charge. The deposit can be made personally at the particular post office every month or can be made through an appointed agent, who would collect the money from you and enter the same in your passbook.

Sunday, April 5, 2009

Types of Equity Mutual Funds

We all know what a mutual fund is. A Mutual fund is nothing but a common pool of money collected from investors and managed by a fund manager who would buy/sell stocks on our behalf and share the profit/loss with us. To know more about mutual funds click here

If somebody is talking about mutual funds, almost always they talk about equity mutual funds.

What is an Equity Mutual Fund?

A MF scheme that invests at least 65% of its fund corpus into equity and equity related instruments is called an equity mutual fund. Equity funds carry the most risk among all kinds of MFs because they invest in the stock market. This risk comes with the potential of high returns.

Types of Equity mutual funds:

Based on the investing style equity mutual funds are broadly classified into 4 categories:

  1. Equity Diversified funds
  2. Equity Linked Saving Schemes (ELSS)
  3. Index funds & ETFs
  4. Sectoral Funds

Equity Diversified Funds:

These are actively managed funds that invest across stocks and sectors. They do not concentrate on only a few sectors or scrips but focus on either large-caps or mid and small caps. They could also be thematic, for instance funds focusing on rural growth or infrastructure. These funds are riskier than index funds because their performance depends on the fund managers abilities to buy and sell the right stocks at the right time.

The top 3 Equity diversified funds are:

  1. ICICI Prudential Infrastructure fund
  2. Reliance RSF – Equity
  3. UTI dividend yield fund

ELSS funds:

ELSS are also diversified equity funds but offer income tax deduction under sec 80C up to a limit of Rs. 1 lakh. It also imposes a three year lock in period. You cannot redeem your units before the end of 3 years.

The top 3 ELSS funds are:

  1. Sundaram BNP Paribas tax saver
  2. SBI Magnum Tax gain
  3. Fidelity Tax Advantage

Index Funds:

These are the simplest and least risky of all equity funds. They invest in all the scrips and in exactly the same proportion as the scrips lie in their underlying benchmark indices. While an index fund buys and sells scrips on the stock exchanges, an ETF (Exchange Traded Fund) appoints market participants. They exchange a basket of securities (whose composition exactly matches that of the benchmark index) against an ETF unit. These ETF units are then traded on stock exchanges like stocks.

While index funds can be bought or sold from the MF or through an agent like any other ordinary scheme, ETFs can only be bought and sold on exchanges, therefore you need a DEMAT account to buy/sell them.

Sectoral Funds:

These are the riskiest of all funds. They invest in a single or at best two or three closely linked sectors. Their fortunes depend on these select sectors & its stocks only. As their name indicates, the fund house buys/sells stocks only in the sector on which it declared to invest while offering the fund. If the sector that the fund house invests performs well then our returns would be more than a equity diversified fund or an index fund but at the same time, if a sector underperforms our returns would get affected adversely. These funds are not for the normal investor. It is only for high risk and knowledgeable investors who can actively track their portfolio and exit a sector before it is adversely affected.

Note: This is not a recommendation to buy the mutual funds mentioned in their respective categories. This is just an illustration to point out the best funds in the categories as per my view as of today April 5th 2009. The funds performance may change its ranking over the next few weeks/months/years.

Happy Investing!!!

Saturday, April 4, 2009

Investing in Corporate Bonds

The bond market is currently abuzz with scores of investors investing money in millions in it. Before getting into the details let us first find out what a corporate bond is.

A corporate bond is something similar to a bank fixed deposit. The company issuing the bond accepts your deposit and issues you a certificate as proof of your deposit. During the deposit the company agrees to pay you an interest for your deposit. You can opt for periodic interest payments or one lumpsum payment at maturity. All said and done, there are a few major differences here.

1. The interest offered by corporate bonds are higher than that offered by banks
2. There is no guarantee that you would get your money back. The bond is issued on a best effort basis where the company would try its best to repay your money along with interest provided it is able to make sufficient profit.

Now you know why corporations offer a higher interest rate “To attract investors who are ready to take the risk by offering a higher Return on Investment (RoI)

Why are Corporate Bonds so attractive now?

With the ongoing financial crisis, the equity markets have slumped to nearly half of its peak value at the beginning of the year 2008. Most investors have lost interest/faith in the stock markets and are considering other avenues of investment which can provide them better returns. Currently bonds are one among the top investment options because they offer a better RoI than bank deposits. Though they come with an inherent risk, most corporations that issue bonds are in pretty sound financial status and the chances of losing our principal is comparatively low. Since bonds are like bank deposits your capital remains intact and hence bonds have become attractive now.

The bonds that are currently being issued offer us returns of around 11% which is nearly 2-3% more than what banks offer us.

Though the returns on corporate bonds are high, they come with their inherent risks. Below are some aspects that you need to check before investing your hard earned money in them.


Default in payment by the bond issuer is one f the major risks that we face while investing in bonds. The default could range from untimely payment of coupons to non payment of principal at maturity.

The chances of default can be found out by the rating assigned to the bond by authorized agencies on the basis of a rating scale. The higher end of the scale indicates better credit quality which means that the chances of default are lesser. Apart from the chances of default, such agencies also consider another risk before assigning a rating. That is the sector specific risk. If an industry is going through a rough patch due to the prevailing economic scenarios then the chances of the company performing well are lesser. Hence this would naturally affect the company’s finances and eventually affect the bond rating.

It is a general thumb rule to choose bonds with good credit ratings over the ones with not so good ratings.

Risk Return Balance

We should analyze our risk appetite before investing in certain bonds. Some company’s offer very high returns but their credit history wouldn’t be so great. Investing in such bonds should be done with caution.

We can compare the returns on existing bonds with a similar rating in the market to find out the kind of returns that we can expect in new issues. But the yield on a particular bond would also depend on the industry in which the bond issuing company operates. For example the yield on an ‘AAA’ bond in a finance industry would be higher than that of an ‘AAA’ bond in a manufacturing industry. But at the same time, investors would prefer manufacturing industry because of the safety of investment and would prefer them over finance bonds.

We must analyze the performance of the issuing company before making our investment.

Exit Options

One of the most important considerations before buying a bond is the liquidity offered. This is important because most bonds are long term investment options wherein your money would get locked in for 5 – 10 years.

Premature selling of bonds would expose us to interest rate risks. For example, when interest rates go up, new bonds start offering higher rates than that of existing bonds. So at such a situation if you want to sell your bond, you would have to sell it for a lower price than what is its current market value.

Also, some corporations may not be able to pay off the bonds if we plan to exit before maturity. Though these securities are listed in registered exchanges, they may not be liquid and you may not be able to sell them at the current market value. You may have to compromise on the selling price while selling such illiquid securities.

Other factors

Some other factors to be considered before buying such bonds are:

  • Do not invest in complex bonds. The simpler they are the better they are for you. For example some bonds give us the option of converting them to that company’s shares. This increases the volatility in price of the bond and it is better to stay away from them.
  • Industry situation: Always some industries would outperform its peers and some may underperform. Investing in bonds from industries that are struggling would adversely affect both liquidity and returns on our investments.
  • Credibility & Integrity of the Rating agency. Do not just go by the rating given by the rating agency. Analyze the credibility and past history of the agency before believing their rating. Also remember that these ratings are only speculations and do not guarantee the bond performance.

Happy Investing!!!

Tuesday, March 31, 2009

Bond Glossary

The Bond market is currently abuzz and is attracting heavy investments from investors because of the safety and capital preservation they offer. Bonds are similar to bank deposits with a few minor differences.

Let us have a look at some of the common terms used in the Bond Markets

Convertible Bonds:
These can be converted into the shares of the issuing company at a particular time.

Coupon Rate:
This is the interest received on the principal amount invested by us. It is generally paid half yearly or annually.

Current Yield:
It is the annual rate of return on the bond’s price

Face Value:
This is also called the Par value. This is the maturity amount that the bond issuer agrees to pay the investor

Default Rate:
It is the percentage of companies under a particular rating that have defaulted in making payments to its investors.

Interest Rate Risk:
This is the risk of change in price of the bond due to interest rate fluctuations in the market. Interest rates and bond prices are inversely related.

Yield to Maturity:
This is the rate of return that you get if you hold the bond till maturity. The return includes coupon payments as well as the maturity value. Change in yield reflects change in price of the bond and they are inversely related.

Yield Spread:
This is the difference between the yields of two bonds. Generally a bond’s yield spread is determined by calculating the difference between the bond’s yield and the yield on government securities.

Zero Coupon Bonds:
These are bonds that do not pay any interest. Instead, these bonds are issued at a discount and the difference between the face value and the issue price is the investors gain.

The next article would be on the aspects to be checked before investing in Corporate Bonds.

Happy Investing!!!!!

Sunday, March 29, 2009

Life Insurance Cover – Policy Lapse & Revival

Under the current economic scenario many of us are tightly placed when it comes to our finances. Many of us are in a worser situation that the others. Some of us are even unable to pay their life insurance policy dues. Under such testing times it is our prime responsibility to ensure that our insurance policies remain intact and do not get lapsed.

What is a Lapsed Policy?

The insuring company provides us the insurance policy based on the premium amount we pay them on a regular basis. This can be monthly or quarterly or half yearly or even annual.
A policy lapse means that the life insurance contract between the insurer and the insured (YOU) is terminated.

When does a policy lapse?

As long as we pay our dues on time the policy remains in force. The moment we stop paying our premiums the policy lapses and the insurance cover provided by the policy becomes nullified. A lapse occurs when premiums are not paid even during the grace period. The life cover continues during the grace period whose duration varies based on the type of policy and premium payment frequency.

What is the Grace Period offered by Insurance Companies?

The grace period offered to us differs on the policy type and the premium payment frequency. Let us take 3 major categories of policies and analyze the available grace time.

1. ULIPs that are 3 years old or less

For ULIPs that have been in effect for three or less years and that have a regular premium paying system, the grace period offered by the companies is usually one month. Once this period is over the policy lapses. But, during the grace period the cover continues. So if a claim is made during the grace period, the nominee would get the benefits.

2. ULIPS that are more than 3 years old

ULIPs that have been in effect for more than 3 years, assume a paid up value since an investment corpus is already accumulated from the premiums paid in the previous years. This means that even if further premiums are not paid, the policy continues so long as the fund value covers the expenses that the insurance company incurs in managing your fund.

3. Traditional Insurance Plans

In case of traditional policies like term plans, money back plans or endowment plans etc the insurers give a grace period of about a month or upto a maximum of 3 months. The cover continues during this period. If the premium is not paid by the end of this period, the policy lapses and the life cover ceases.

What can we do if a policy lapses?

Most insurance companies have an option wherein we can revive the policy by paying a small penalty amount. Even after the grace period is over, we can pay our premiums with a small penalty which the company takes as charges for not paying the premium on time and revives the policy.

Since insurance is an important aspect of our financial plans, it is very important that we do not delay our premium dues and pay them on time…

Thursday, March 26, 2009

Some Common Financial Terms - Part II

U.S. Treasury Bill

A negotiable debt obligation issued by the U.S. government and backed by its full faith and credit, having a maturity of one year or less. U.S. Treasury Bills are exempt from state and local taxes. These securities do not pay a coupon rate of interest, and the interest earned is estimated by taking the difference between the price paid and the par value of the bond, and calculating that rate of return on an annual basis. Treasury Bills are considered the safest securities available to the U.S. investor, and so the yield on these securities are considered the risk-free rate of return. also called Bill or T-Bill or Treasury Bill.


A physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts. The price of the commodity is subject to supply and demand. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be.
More generally, a product which trades on a commodity exchange; this would also include foreign currencies and financial instruments and indexes.


One who buys and sells securities for his/her personal account, not on behalf of clients.
An investor who holds stocks and securities for a short period of time (a few minutes, hours or days). The goal is to profit from short-term gains in the market. The stock selection is generally based on technical analysis or charting which relate only to the stock price rather than a fundamental evaluation of the company as a business. The IRS offers some tax benefits to traders: they can deduct their interest expense without itemizing, and seminar costs can be deducted as well as home office expenses in connection with investing.

Amortization of premium

Charges made against the interest received on a debt in order to offset a premium paid for the debt. Thus, with each periodic payment, a debtor is not only paying back interest, but also part of his or her premium. This leads to higher periodic payments than in the case when only interest is paid out. However, a payment schedule which includes premium amortization makes debt management easier, especially if the principal is large. While paying just the interest each period will lead to a low outflow of cash each month, the debtor might not save enough to pay the principal. Thus, amortizing the premium each period also reduces the credit risk of the debt, since the creditor gets some part of the principal each time period, as opposed to allowing a debtor to forfeit on all of it at the maturity of the loan. Amortization of premium is a common feature in cases when a person or company takes on a large amount of debt at one time, such as a mortgage.

Forward deal

A transaction consisting of a purchase or sale (often of foreign currency) with settlement to occur at a specified future date. Such a transaction will state the specific amount of the asset to be delivered at the specific time, as well as the unit price at which it will be delivered.

Secured bond

Bond backed by collateral, such as a mortgage or lien, the title to which would be transferred to the bondholders in the event of default. The most common form of secured bonds are mortgage bonds. These bonds are backed by real estate or physical equipment that can be liquidated. These are thought to be high-grade, safe investments. Other bonds are secured by the revenues created by projects. If an issuer in default has both secured and unsecured bonds outstanding, secured bondholders are paid off first, then unsecured bondholders. Naturally, because unsecured bonds carry greater risk than secured bonds, they usually pay higher yields.

Credit score

A measure of credit risk calculated from a credit report using a standardized formula. Factors that can damage a credit score include late payments, absence of credit references, and unfavorable credit card use. Lenders may use a credit score to determine whether to provide a loan and what rate to charge.

Cash pooling

A cash management technique employed by companies holding funds at financial institutions. Cash pooling allows companies to combine their credit and debit positions in various accounts into one account, and includes techniques like notional cash pooling and cash concentration. Notional cash pooling has the company combine the balances of several accounts in order to limit low balance or transaction fees. Cash concentration or zero balancing has the company physically combining various accounts into one single account.

Online banking

A system allowing individuals to perform banking activities at home, via the internet. Some online banks are traditional banks which also offer online banking, while others are online only and have no physical presence. Online banking through traditional banks enable customers to perform all routine transactions, such as account transfers, balance inquiries, bill payments, and stop-payment requests, and some even offer online loan and credit card applications. Account information can be accessed anytime, day or night, and can be done from anywhere. A few online banks update information in real-time, while others do it daily. Once information has been entered, it doesn't need to be re-entered for similar subsequent checks, and future payments can be scheduled to occur automatically. Many banks allow for file transfer between their program and popular accounting software packages, to simplify record keeping. Despite the advantages, there are a few drawbacks. It does take some time to set up and get used to an online account. Also, some banks only offer online banking in a limited area. In addition, when an account holder pays online, he/she may have to put in a check request as much as two weeks before the payment is due, but the bank may withdraw the money from the account the day that request is received, meaning the person has lost up to two weeks of interest on that payment. Online-only banks have a few additional drawbacks: an account holder has to mail in deposits (other than direct deposits), and some services that traditional banks offer are difficult or impossible for online-only banks to offer, such as traveler's checks and cashier's checks.

Index arbitrage

A strategy designed to profit from temporary discrepancies between the prices of the stocks comprising an index and the price of a futures contract on that index. By buying either the stocks or the futures contract and selling the other, an investor can sometimes exploit market inefficiency for a profit. Like all arbitrage opportunities, index arbitrage opportunities disappear rapidly once the opportunity becomes well-known and many investors act on it. Index arbitrage can involve large transaction costs because of the need to simultaneously buy and sell many different stocks and futures, and so only large money managers are usually able to profit from index arbitrage. In addition, sophisticated computer programs are needed to keep track of the large number of stocks and futures involved, which makes this a very difficult trading strategy for individuals.

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

Four Reasons to Buy Gold

For ages gold has been one of the most sought after investment option for people. Be it investors like us or women of the household, gold has been one of the top priorities. Gold analysts have been boasting of the potential returns gold can provide over the past few years. Gold prices have been in an upswing ever since the market started to go down. The price of gold was Rs. 9,000/- for 10 grams in 2007 and Jan 2008 it was more than Rs. 10,000/- Last month the price of gold was nearly Rs. 15,000/- for the same quantity 10 grams. This is the all time high the price of gold has touched. Even now our gold analysts are continuing with their buy advice.

Gold is the only asset class that has provided consistent positive returns over the years. Especially in such testing times it has outperformed all other asset classes including the stock markets and real estate. Analysts feel that the price of gold would touch Rs. 18,000/- for 10 grams by the end of this year 2009.

Below are 4 compelling reasons for us to consider gold as an investment option for this year.

The Global Economy would remain affected

The world economy is in serious trouble and is likely to remain the same in the forthcoming months. The global growth forecast for this year is less than 1%. This is slowest growth forecasted in the global economy. We expected the growth to be around 2% for this year last year but our forecast proved to be wrong. A realistic estimate would be around 0.5 to 1%

In such difficult times gold becomes an automatic choice for our investors. Investors are searching for safe havens for their investment and with the kind of capital preservation gold offers; it is the number one choice. Some top mutual fund managers are worried about the trend in the market. Investors are buying gold like there is no tomorrow. This has further impacted the slowing economy and stock markets.

Because of the activity in the Gold ETF markets and the commodity markets the price of gold is constantly going up and a price of around 17,500 – 18,000 seems to be very possible.

US Dollar may depreciate against global currencies

The price of gold and the value of the dollar have an inverse relationship. If the value of the dollar drops, more dollars would be required to buy the same quantity of gold. So the value of gold stays unchanged but the devaluation of the dollar pushes its price up. If the dollar declines against other currencies it would decline against gold as well. This negative correlation may not be so evident on a daily or weekly basis but this would be very significant when checked on the long run.

Some analyst’s world wide feel that the US government may resort to printing more money in the coming months to tide over the financial crisis. This may have a negative impact on the economy. This could push up inflation and cause the price of the dollar to slide further. This would naturally push the price of gold further upwards.

Crude oil prices could bounce back to $65 a barrel

Gold and crude oil prices always move hand in hand. At least that is the general trend over the years. When the price of oil goes up it leads to high inflation which in turn makes gold an attractive investment option.

In July 2008 we saw oil touch an all time high of $147 per barrel and then it started slipping. The fall in crude prices was because of heavy drop in demand in the second half of 2008. In spite of this correction and its price reaching around $40 per barrel now, gold is still going up.

Analyst’s world wide feel that the price of oil may bounce back and reach around $65 - 70 per barrel. This puts gold in a sweet spot. It will be a good hedge against deflation if the economy does not improve and at the same time, it would be a good investment option to counter inflation. Either ways the price of gold would go up.

Global Demand for Gold would Exceed its supply

The demand for gold is around 3500 tonnes in a year. This includes gold required for jewellery, the commodity markets etc. but the production of gold is only around 2500 tonnes which brings us to a situation where there is a straight excess demand of nearly 1000 tonnes. Also gold mining countries worldwide are cutting down on their production owing to fears of the global recession. This would further fuel the demand for gold and its price would continue the upward movement.

What should we do now?

Don’t buy gold right away. Experts are expecting a correction in gold prices due to profit booking. Also there is a certain seasonality in the price of gold. Usually gold prices tend to peak out in March and then fall a bit before resuming its upward journey. So buy only 10-15% of what you plan to invest in gold and then wait for the correction. Once the correction happens, buy more. Buy in a staggered manner and do not invest all your money in one shot.

Also remember the importance of asset allocation. No asset class should have an inordinately large part in your investment. Decide on proper asset allocation and make sure that the fluctuation in prices of one asset does not affect the value of your portfolio heavily. An ideal allocation for this precious yellow metal would around 15% of your portfolio’s worth.

Happy Investing!!!
© 2013 by All rights reserved. No part of this blog or its contents may be reproduced or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without prior written permission of the Author.


Popular Posts

Important Disclaimer

All the contents of this blog are the Authors personal opinion only and are not endorsed by any Company. This website or Author does not provide stock recommendations. The purpose of this blog is to educate people about the financial industry and to share my opinion about the day to day happenings in the Indian and world economy. Contents described here are not a recommendation to buy or sell any stock or investment product. The Author does not have any vested interest in recommending or reviewing any Investment Product discussed in this Blog. Readers are requested to perform their own analysis and make investment decisions at their own personal judgement and the site or the author cannot be claimed liable for any losses incurred out of the same.