Saturday, September 18, 2010

Are IT Industry stocks winning picks now?

The Indian IT Industry has been in the news for both good and bad reasons over the past few years. They put India as a force to reckon with in the IT field a few years back and are still doing it now, but at the same time they were in news for pink slipping employees during the recession. But all said and done, the Indian IT Industry is back on its feet after the long recession and people are speculating on these stocks like never before.

Anyone who has the habit of reading newspapers would have read two kinds of news. One from the Indian media about Indian IT cos riding high on profits and is poised on recruiting thousands of aspiring engineers in the forthcoming year and the other is from the president of the United States Mr. Obama about tighter offshoring norms and higher VISA fees. So as laymen investors many of us are confused about what is going on and are IT cos good bets now from the investment standpoint. The purpose of my article is to throw some light on this confusion.

Please note that – this by no means is a recommendation to buy IT Company stocks. This is purely my personal opinion about how IT cos may perform in the forthcoming years and is not a trading/buying suggestion.

First of all, I would like to apologize for a lengthy article and secondly, I firmly believe in the fact that, DO NOT Invest by hearsay. Get all your facts right before you invest your hard earned money in any company. That is why such a lengthy article. Please read on  ….

IT Cos – The Darlings of the Indian Stock market in the past Decade

The Indian IT Cos have been the darling picks of the Indian stock market over the past decade. Notably Infosys and TCS have been the flag bearers of the Indian IT Industry over the past decade (Of course I am proud to have worked for both these giants for nearly 3 years each) Not only have they grown from a few hundred people to over 1 lac employees, but also their share prices have sky rocketed in the past few years making a lot of millionaires in India. The price of Infosys stock at the time of writing this article is Rs. 2895/- and that of TCS is Rs. 873/-. Considering the fact that the stock market has just started recovering after languishing for months in 4 digit numbers, these numbers are pretty impressive. Even during such lean times, these cos weren’t the worst to be hit by the stock market collapse proving the fact that, these cos have been and most probably will be darling picks of the Indian stock market.

How does an IT company make money?

This is a simple question for a majority of us because we work in this industry but for the rest it’s still a puzzle. Let us take a simpler example which everyone can correlate. All of us hold bank accounts and invariably we would’ve tried the online banking facility. The website you login is an application which is developed by an IT software professional. Similarly there are millions and zillions of customers out there who need IT applications and our IT cos create them to help the customers carry out their business in a better/faster way. In return, the customers pay us for our service and this is how the IT cos make money.

The next question in your mind would be, how come these guys make such staggering profits? Read on for the answer…
IT cos charge its customers in US Dollars on a per hour basis and pays its employees in rupees. Let us take a look at a typical calculation. Lets assume company ABC Infosystems charges its clients USD 30 per hour of effort of its employees, net revenue per employee per month works out to USD 5280 per month (@ 8 hours per day and 22 days a month) This amount if calculated in Indian Rupees is more than 2 lacs.

You might be tempted to think that not all software engineers get paid 2 lacs per month and the cos should be making killer profits. Unfortunately employee salary is not the biggest contributor to the cos expenditures. Buildings, infrastructure, power, water and other logistics for running a company account for the major chunk of a cos budgeted expenditure. Of course salary is a significant contributor but definitely not the biggest.

This is why, even though a cos net revenue runs to a few thousand crores for a financial year, the profit runs to only a few hundred crores.

Why do companies outsource their IT operations?

The reasons are very simple and are as follows:
1. Cheaper workforce - We work for 1/4th or 1/3rd the price at which people from the local town would work for
2. Lack of skilled manpower – Not many countries has skilled manpower to contribute effectively to the IT operations for the cos growth.

The Boons and Banes of Outsourcing!!!

Outsourcing has been a boon for developing nations like India and China where skilled and cheap manpower has drawn thousands of jobs and millions of dollars in revenue but unfortunately it has been both a boon and bane for the country’s from which their local cos outsource jobs.

The Boon Part: A company from USA, by outsourcing 100 jobs to India would boost its profits significantly because the cost of employing 100 people in USA is nearly 4 or 5 times costlier than what it costs from India, plus the chances of getting 100 skilled IT professionals in the nearby locality to finish the job is also not 100% likely.

The Bane Part: 100 locals from USA would have to look somewhere else for their jobs

Can the US clients survive without the IT workforce from India?

The answer is an emphatic NO. (My personal Opinion)

There are thousands and thousands of Indian IT professionals who are working day and night for their customers in the United States. Finding an equal number of people in USA willing to do the same work and more importantly at the same wages is nearly impossible.

Most Importantly – If the US cos have to replace its entire outsourced workforce with locals, they will probably go bankrupt. I don’t think they will have any surplus left after paying employee wages to post any profits.

What are the difficulties IT Cos may face in the US market?

As of today, the United States accounts for 50% or more of the revenue earned by the Indian IT cos. With the economy in USA still struggling and with unemployment rates at new highs, the US government is urging businesses to recruit local talent for their human resource needs and avoid/reduce outsourcing. It is even promising benefits to companies that generate employment to Americans. This could partially motivate large corporations to hire locals in order to gain benefits like tax rebates or access to bailout funds etc. This would significantly affect the growth plans that IT cos would’ve planned for the next few quarters. They would have to aggressively market themselves in order to get new projects and fresh revenue.

Are IT Cos going to be hit by the new legislations/restrictions imposed by the US Government?

This is a very important question which will determine the future of these IT Cos. As of now, the restrictions are not very extensive and proper planning & due diligence on the part of IT cos can help them sail out of this storm. For Ex: IT cos may pass on the extra cost incurred due to higher VISA fees to their customers in order to retain their profit margins.

Considering the bigger picture, the answer is YES. IT Cos in India will be affected by newer legislations laid down by the US government in its attempt to reduce unemployment. But, it will not ruin the Indian IT cos.

IMHO, Dealing with the negative hype created by the news media would be much more of a challenge to the IT cos than dealing with such challenging business situation. The sales people for the leading IT cos have enough talent and skills to hunt for new business opportunities. This would be much easier than trying to minimize the damage that negative media hype can cause.

How will all this affect the Share Prices of IT Companies?

The stock market at times reacts in an impulse. If you see news that reads like below:

US President Obama, bans offshoring of jobs. Mandates companies to hire only locals

What would your instant reaction be if you hold stocks of IT cos? You’ll think, Oh my god, let me sell off my holdings at whatever profit I can make today. I don’t want to lose money. A classic example of “Panic Selling”

Am not blaming any of my dear Indian investors, I would’ve done the exact same thing if such a news had come up in my initial years of stock market investing. The problem is, we are all scared that we will lose our hard earned money and there is nothing wrong in thinking like that.

News like these, if they come up, they can badly affect the price of the IT cos stocks. But it will be short lived. The moment you see another news like below

IT Major Infosys signs multi billion dollar deal with ABC Ltd USA

Investors will start buying the stock and the price will rise again.

What will IT Cos do to handle the situation?

The IT giants in India have already weathered the recession and have proved that we are much more than what the world thinks we are. The upcoming few months are going to be difficult but not as bad as the recession. So below is what I feel will happen.
1. Cos will try to reduce their exposure to the US markets. As of now more than 50% of the revenues of Indian IT Cos is from the US markets. I even read an article on Infosys planning to reduce exposure to US markets to 40% from the present 65% over the next few years.
2. Cos will not hire every week. They will hire on a need basis maintaining a good bench strength to ensure that they do not run short of resources in case of huge deals coming through
3. Sales persons will be set stringent targets. They are the face and the voice of the IT Cos to their customers and a bulk or all of the load of gathering new business will be on their shoulders
4. Billing rates for workforce maybe reduced in order to boost customer chances of outsourcing because of cost benefits
5. Luxurious benefits to top managers may be cut in order to maintain cost effectiveness and profit margins
6. Exorbitant salary hikes to people while switching jobs may be reduced to an industry standard hike level
7. etc…

In short, IT Cos will try harder than ever to boost their revenue and reduce costs in order to grow their profit margins – which in turn would invite more investors to buy their shares.

In my personal opinion, this is not the end of the world for the Indian IT cos. They are backed by thousands of talented individuals and a strong management that has propelled them from a hundred employees to more than hundred thousand of them. We Indians are known to thrive under unforgiving situations and I am sure that our IT cos will come out as shining stars and two years down the lane, they’ll still be the market leaders as they are now.

Happy Investing!!!!

Friday, September 17, 2010

Good News for Salaried Employees

It always feels good to write something that is good news for my fellow citizens who toil hard everyday in their offices. This indeed is good news for all of us who get our monthly paychecks from our employers.

It has been announced by the EPF (Employee Provident Fund) Office in India that the rate of interest given on employee PF contributions has been increased from 8.5% to 9.5% for this year. This means that our PF contributions will be earning an increased rate of interest from now on. This 1% may look small now but in the long run, it is going to be very fruitful towards our aim of a bigger retirement corpus.

Let us try to figure out why…

Is this increase by 1% good?

Definitely YES. Without any doubts/questions. Provident Fund or PF is in many cases the only saving for the salaried middle class man who works hard, day and night for his monthly salary trying to manage his family with whatever meager income he makes. This increase of 1% is not only for fresh contributions to the PF corpus but also to the existing corpus that has been accumulated by the person. So, for people who are nearing their retirement, this is a bonanza.

Let us do some simple mathematics. Let us consider 2 people Mr. A & his boss Mr. B.

Mr. A has been employed for 5 years and has an existing PF corpus of Rs. 3 lacs and makes a monthly contribution of Rs. 2500/-

Mr. B has been employed for 25 years and has an existing PF corpus of Rs. 20 lacs and makes a monthly contribution of Rs. 7500/- every month.

Existing 8.5% Rate of Interest:

For Mr. A:

Initial Corpus: 3 lacs
Fresh Contribution this year: Rs. 27,500/- (@2500 every month)
Corpus Value at the end of the year: Rs. 3,55,214/-

Interest earned this year: Rs. 27,714/-

For Mr. B:

Initial Corpus: 20 lacs
Fresh Contribution this year: Rs. 82,500/- (@7500 every month)
Corpus Value at the end of the year: Rs. 22,62,872/-

Interest earned this year: Rs. 1,80,372/-

New 9.5% Rate of Interest:

For Mr. A:
Initial Corpus: 3 lacs
Fresh Contribution this year: Rs. 27,500/- (@2500 every month)
Corpus Value at the end of the year: Rs. 3,58,615/-

Interest earned this year: Rs. 31,115/-

For Mr. B:

Initial Corpus: 20 lacs
Fresh Contribution this year: Rs. 82,500/- (@7500 every month)
Corpus Value at the end of the year: Rs. 22,85,019/-

Interest earned this year: Rs. 2,02,519/-

Extra Interest Earned by Mr. A = Rs.3,401/-
Extra Interest Earned by Mr. B = Rs.22,147/-

What Should we do now?

This is a very interesting scenario. With the PF office giving us an extra 1% rate of interest, our tax saving options have just gotten better. I am sure many of us know what VPF is. VPF stands for Voluntary Provident Fund. This is an option that we have wherein we can make planned monthly contributions to our PF corpus that would earn the same interest as our PF and on top of that we will get tax benefits too.

So I would suggest that people who can spare some surplus every month, say Rs. 2000 or Rs. 3000 in a month, divert it to your VPF. This would earn you a handsome interest plus give you tax benefits. Two mangoes in one stone.

Happy Investing!!!

Sunday, September 12, 2010

Economic Crisis in Iceland

Iceland is a small country in Europe with a total population of around 300,000 people. A country that is smaller population wise to the city in which I was born and brought up (Chennai, India). Iceland was the first country to fall in the long list of countries that succumbed to the global crisis. The country and its economy is so small that a small sum of $20 or $25 billion could have seen it through the economic storm ($25 billion is small considering the trillions of dollars of economic relief that US is giving its economy) but unfortunately it did not have that money. Because of this it suffered a national crisis that has affected its citizens, financial institutions and everyone else. The prime minister of Iceland issued a press release in October 2008 that the country was bankrupt.

We have discussed in detail about the US and the world economic crisis but everyone forgot about this tiny arctic island that was one of the worst hit nations in the global crisis. Let us take a look at what exactly went wrong in the country.

What was Iceland a few years ago?

Iceland is a small arctic island whose main resources prior to their massive misadventure with globalization were thermal springs, fish and cattle. They are a closely knit community where people did not tolerate nonislanders much. To give a clearer example of how small the nation is, the country’s telephone directory lists the people by their first names. Globalization and Privatization were two terms that were not too familiar for this country until a few years ago.

What happened during globalization?

The privatization began in the year 2002 when the nation decided to allow private organizations to grow. The corporate taxes were reduced; incentives were given to people to grow their businesses. New hydro electric plants, aluminium smelting factories etc started sprouting throughout the country. The country decided that it had to grow beyond fishing and grow as a global financial player. With this aim the country privatized its banks. By 2003 there were 3 large private banks in Iceland that were extending easy credit to the islands inhabitants.

In a country with less than 200,000 wage earners, the banks soon ran out of prospective customers to whom they could lend and make money. Hence, they decided to venture outside. They were willing to lend to borrowers from neighbouring countries. To attract more investors from abroad, they were offering interest rates as high as 15% during peak times. This made the Iceland Krona the preferred destination for investors. People would borrow money at their native country at low rates and invest the money in Iceland at such exorbitant rates. Japan was one of the nations from which the country attracted huge sums of money.

By 2005 banks accounted for 95% of the country’s GDP. Borrowed money was the main propellant in this phenomenal growth but still the country ignore the situation and let it continue.

In 2003, Iceland’s government liberalized house-loan standards, in some cases lending purchasers up to 100% of value. Housing prices skyrocketed. Equity refinancing boomed, and people bought more cars, motorcycles and summer homes. Between 2003 and 2004, prices on Iceland’s stock market increased 900%. By 2006, the average Icelander was 300% wealthier than in 2003. As the bubble bulged, Iceland’s banks encouraged customers to buy bank stocks. Because of easy availability of credit, the islanders borrowed money and indulged in luxuries that they would not afford with their income.

By 2006 credit rating agencies around the globe sounded warnings with respect to the credit position of the island. People abroad were wary of the nations credibility and started looking at them watchfully. When the Bank of Japan raised interest rates in 2006, investors sold their positions in Iceland and brought money back to their country. This caused a massive outflow of funds from Iceland but still the country’s financial claimed to be in a sound position and appeased investors and citizens that there was no need to panic.

To repair their damaged credit ratings, some Icelandic financial institutions created online banks, attracting new retail customers, especially from Britain, Germany and the Netherlands.
They offered interest rates of more than 6%, drawing thousands of British and Dutch depositors. Many British institutions – including 116 local governments, plus Oxford and Cambridge Universities – invested in Icelandic banks.

What went wrong?

When the traces of economic troubles were sensed in economic powerhouses like the European union and USA, they tightened credit to countries like Iceland that were growing on borrowed money. They stopped cashflows to the island and asked them to repay. The nations banks were too much exposed to debt from abroad that they were unable to repay their debt obligations. It defaulted, destroying its credit rating and precipitating an economic tailspin. Iceland became linked to the subsequent decline in world financial markets. It suffered first and was deeply wounded, as were other small tax-haven countries, notably Estonia, Latvia and Lithuania.

The Aftermath!!!

In October 2008, the nations prime minister interrupted the TV broadcast and explained the nation of its grave financial adversities. The speech stunned the country. Citizens could not comprehend that their homeland could go bankrupt. One economist later estimated that the nation was €20 to €30 billion in debt. On the personal level, the average Icelander was $403,000 in debt and 25% of homeowners faced mortgage default.

It had tried to move too quickly from poverty to prosperity. As it staggered, aid came from a new source: Russia promised massive loans. Iceland was an ideal fit for its strategic plans to expand its military and commercial ventures in the Arctic.

As the crisis grew, the numbers became staggering: 85% of the banking system failed and more than 50,000 people lost their savings. Eventually more than 7,000 protestors filled the street outside parliament. In January 2009, early elections were announced and the current leaders said that they would not run. The commerce minister fired the head of the financial regulatory authority and then resigned. The Social Democrats and the Left Greens formed a new interim government led by J√≥hanna Sigurdard√≥ttir. She took office in January 2008. She called for joining the European Union, and stressed Iceland’s traditional virtues: modesty, hard work, respect and, in all things, moderation.

Now the country is slowly getting back on its feet just like every other nation that had suffered during the crisis. Because of its small size and population it was hit a bit harder than other countries and would take longer than other nations to recover.

Friday, September 10, 2010

Buying a Home

Buying a home is a dream for a majority of the salaried middle class people. It is something every dad tells his son when he goes to school to motivate him to study harder. Only if you study and get good grades, you’ll get a good job and only then you can buy a big house. The little boy nods his head and thinks of how big a house he wants to own and when the same boy lands in a job, his head starts working towards his goal of a dream home.

All of us have been through this phase of life and almost everyone owns a nice home or plans on owning one in the near future. That is why I thought lets write something on buying something as big and valuable as our home.

Things to do before buying a home:

1. Think long and hard. Include your life partner and maybe a close friend who you can trust with your life and have an open discussion. Buying a house is a long term financial commitment and should not be done in haste. (I am only talking about people who buy a home on bank loans)
2. Plan ahead – if you intend on buying a house in future, start saving for the initial down payment today. If you put aside a small amount let us say Rs. 10,000/- every month for 2 years you will have nearly 2.5 lacs at the end of 2 years and you can use it as the initial payment for your home. Remember – no bank is going to give you a loan for 100% of your home’s worth. They’ll give you only 85% or at max 90% of your property’s value. So you have to pay up the remaining and saving for that is a good idea.
3. Plan your finances – Check the probable EMI you may have to pay the bank once you get the loan, compare it with your net monthly expenditure, salary etc and make sure you can comfortably pay off your EMI. Ideally a person would require 60 - 70% of his salary to take care of his family and it is not a good idea to commit to an EMI that is more than 50% of your monthly salary.
4. Buy only what you need & can afford – many of us dream of a house with a huge garden, a nice car parking space, a road facing balcony etc etc but unfortunately in reality its something that remains a distant dream. We are forced to compromise on an apartment in most cases. I repeat - Buy only what you need and can afford. Do not give in to temptation and buy the apartment that would require you to pay the extra 5 or 10 thousand a month on EMI that you did not plan for. Settling for a smaller house is much better than not being able to pay the EMI or having to compromise on the standard of living.
5. Buy a house that you plan on living for at least the next decade. Do not buy a house thinking that, I will get a better one 4-5 years from now. Buying a house is a big decision and involves a lot of money (you’ll learn why in the later portion of this article) and its better done once or at most twice in a lifetime and it is not like buying a car every 3 or 4 years.
6. Do proper due diligence on the builder/real estate developer who is selling the properly. If the builders name is not very familiar inquire about them. In all probabilities someone in your own office may have had a good/bad experience with them. Either ways you get firsthand information reg. the builder before you sign the papers
7. Get quotations from 2 or 3 banks for home loan. Go with the bank that offers the best deal. Usually the cheapest interest rate bank isn’t always the best one to take the loan. Some banks offer much better service and lesser hidden costs at a fractionally higher rate of interest which is better than bad service and lots of hidden costs.

Is a house an asset?

For ages people are in a belief that a house is the best asset for any individual. Your dad and my dad would bet their heads off to make us believe so. Unfortunately I beg to differ slightly. Let us take a look at the below calculation before deciding.

Let us take myself as an example. I want to buy a Duplex house in a nice residential location in my hometown Chennai, which as per today’s market standards would cost me at least INR 50 to 60 lacs (2010 September) Assuming the house is 60 lacs and I put up 10 lacs from my pocket for the initial payment and get a home loan for the remaining 50 lacs below is how the math works out.

Loan Amount: INR 50,00,000/-
Approximate EMI per month: INR 50,000/-
Loan Tenure: 20 years

Total amount I will pay ABC Bank on my loan: INR 1,20,00,000 /-

If you see here, I am paying 1 crore and 20 lacs over a period of 20 years for a loan of 50 lacs that I got today for my house.

So, by 2030 if the cost of my property is not higher than 1.3 crores (remember I paid 10 lacs upfront for the house) by the end of 20 years, it would be the biggest blunder of my life. Paying 1.2 crores to the bank on a property that isn’t worth that much.

A further point to confuse everyone:

If I were to deposit this Rs. 50,000/- EMI I pay for the home loan every month in a bank deposit that pays me 7% per annum (Simple Interest), I will be left with more than Rs. 2.5 crores by the end of 20 years and if I were to put the same money in an equity oriented mutual fund that gives me 15% returns I will be left with a little over Rs. 7 crores by the end of 20 years

Will my house be worth more than 8 crores by the end of 20 years??? A serious point to ponder about!!!

Things to do after you buy a house?

There are a few things you can do to ease the burden of the home loan and to reap the full benefits of such a huge financial commitment.

1. Buy a pure term life insurance policy for the home loan amount – If I were to get a loan of Rs. 50 lacs I will definitely get a pure term life insurance policy for an equal amount and pledge it against the loan. So, in the unfortunate event of something happening to me, the bank won’t kick my family out of the house. Instead they will claim the balance amount from the insurance policy and pay the remaining to my wife and children. The last thing you want after our time is our family to be kicked out of our house. This is the MOST Important thing to do after or while you buy a house.
2. If you get surplus cash like an inheritance or a bonus from your company, use it to prepay your home loan. It will not only reduce your monthly EMI amount but also the loan tenure correspondingly.
3. Be on the watch out for great deals – once or twice a year banks usually advertise great home loan deals at throwaway interest rates. If you spot such a deal, do not hesitate; change your home loan providing bank. It involves a lot of paperwork and time but the rewards will be multifold. Let me explain with an example.

Assuming my existing loan with ABCD bank is @ 10% rate of interest and I see an advertisement from XYZ bank for a limited time offer 8.5% rate of interest, I rush to the bank and change the loan provider. This results in a saving of roughly Rs. 7000/- per month in EMI which if I put in a bank deposit earning me a 7% rate of interest would sum up to Rs. 35 lacs at the end of 20 years. Not small money my friends…

I am not saying that don’t buy a house. Everyone needs a house and we deserve to live in a place that we own. Just be careful not to overspend or hurry up on a bad deal. Plan nicely and live peacefully.

Happy home buying!!!

Thursday, September 9, 2010

Don't fall into the Credit Card Trap

A credit card is a small piece of plastic paper that fits exactly into your wallet and is an integral part of every man’s life (these days) my dad never knew what a credit card is or what it does when he was working for more than 25 years and earning for his family whereas I got my first credit card barely weeks into my first job. I dint know much about what a credit card is when I got it but I sure did learn about it the hard way. I have been wanting to write about credit cards and the way people use or rather misuse it and cause financial chaos to themselves for quite sometime. I guess its time to put my thought into action. Ok, let’s get started.

What is a Credit Card?

A Credit Card is an agreement between a lender (usually a bank or a financial institution) and a customer (you & me) wherein the lender issues you a card which has a specified limit upto which you can spend using the card. The lender will generate monthly bill statements and you pay him what you used the card for. It’s pretty straight forward.

Note: Credit Cards are a form of Revolving Credit which is used in Business/Industrial terms.

How does it work?

Let us explain with a simple example. Mr. X gets a credit card from ABCD Bank with a limit of Rs. 50,000/- (It means he can spend up to Rs. 50,000 using his card) In the joy of getting his card he takes his family out shopping. They get a new TV for Rs. 25,000/- and enjoy a nice family dinner at a restaurant for Rs. 2500/- and is back home. The next month ABCD Bank generates his bill statement which has the following information.

Statement Period – The dates for which the statement is generated. Ex: 01-July-2010 to 31-July-2010

Statement Date – The date on which the statement is generated. Ex: 01-Aug-2010

Due Date – The date before which we must make the payment to the bank. Ex: 08-Aug-2010

Total Amount Due – The total amount you owe the bank. Here it is Rs. 27500/-

Minimum Amount Due
– This is the minimum amount you need to pay the bank to avoid your card being blocked. Usually it is Rs.500/- or an equivalent amount based on the bank.

Now Mr. X sends a cheque for Rs. 27500/- on 4th August 2010 and there ends the matter.

How can Credit Card Company’s afford this?

You must be thinking by now, if it were as simple as I had explained in the first few paragraph’s people wouldn’t be burdened so much with their credit card debts. The second most important thing running in your mind is, why are banks running around in all cities selling credit cards like pastries? Why are there people standing outside every single company in India selling their bank’s credit cards? How do banks make money out of this?

Am I right? – I believe yes… read on for the answer.

Income for the Bank through Credit Cards is multifold.

1. Annual Membership Fees – most cards these days are free for life but certain high privilege cards like Platinum or Titanium cards come with an annual fee.
2. Merchant/Seller Commission – Every time you swipe your card at a store for Rs. 100/- the bank will credit only Rs. 98/- into the merchants account. They will keep Rs. 2/- as convenience fee which the merchant has to bear in order to have a credit card reading POS machine on his billing counter
3. Finance Charges paid by customers.

The third point needs to be looked in a bit more detail. Let us take the example of Mr.X and his shopping spree.

Mr. X received his bill that states minimum amount due as Rs. 500/- and total amount due as Rs. 27500/-. Let us say, due to cash shortage Mr. X opts to pay only Rs. 500/- he has successfully entered the credit card debt trap.

Credit cards usually charge customers an interest of 2.5% or more per month which annualized is more than 50% in a year.

Here Mr. X paid only Rs. 500/- So this is how the finance charges work out.

Interest on Rs. 26,500/- for one month: Rs.662.50/-

So essentially, the next months due amount for Mr.X would be Rs. 27162.50/- which is more than the money he used in his card. This is assuming he did not swipe his card for further purchases this month.

Assuming Mr.X bought some other stuff for Rs. 10,000/- this month then his finance charges would be

Interest on Rs. 36,500/- for one month: Rs. 912.50/- (If you have an existing balance on your credit card and still continue to use it, the bank will charge you an interest on the newly swiped amount too)

So essentially, the next months due will be Rs. 37412.50/-

This is something that not many people know. Now you know how banks can afford to spend so much money in marketing credit cards.

A Nail in the Coffin:

If you swipe Rs. 10,000/- on your credit card that charges you 2.5% interest per month and continue to pay your minimum payment due which is Rs. 500/- every month, you will be paying for the next 40 months and a total of Rs. 20,000/- before you finish repaying the debt of Rs. 10,000 you got from the bank.

Withdrawing Cash from a Credit Card:
This is yet another mistake the layman does. The card seller gives us a PIN number and tells us that we can withdraw cash from the card till a % of our credit limit for our urgent requirements. To hear it is good but once you withdraw cash your story is over. The bank will charge you a few hundred rupees for providing you with access to the ATM and instant cash plus you start paying interest on the amount withdrawn from the second you take it out of the machine.

If I withdraw cash Rs. 10,000/- from my credit card today morning at 9 AM and return it before 5 PM today I will pay at least Rs. 10,300/- or more. This extra money includes the charges to access the ATM and the interest. This again is a big NO NO for credit card users.

Should we use Credit Cards?

Am not advising against use of credit cards. Most credit cards come with great offers and benefits and it would be foolish on our part to miss out on them. For Ex: Indian Oil co-branded cards give you a 2% discount on fuel everytime you use it to pay your fuel bills. If you are someone who fills fuel for Rs. 10,000/- every month, you save Rs. 2400/- in a year. Which is a good saving.

So the point is – Use your credit card wisely and follow the below tips to stay away from credit card tips.

How to stay away from Credit Card Debt:

1. Repay your due amount in full every month. If you do not have enough to pay off your card bill in full, pay as much as you can. Don’t stick to the minimum amount due. Try to pay off your card due amount within 2-3 months to avoid paying too much interest to the bank
2. If you have not paid your card due in full this month, DO NOT use it for fresh purchases
3. Keep track of your spending. Saving the receipts of credit card swipes is a good way to start. You can reconcile your spending at the end of every month and check if it tallies with the card statement
4. DO NOT withdraw cash from your credit card
5. If you are not able to control your card usage, switch to using your Debit card. It is similar and much safer than credit cards because you cannot overspend.

Happy Spending!!!
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