ULIP’s

Now a day’s, I should not be saying now a day’s but some months back, many insurance agents used to keep saying buy ULIP’s as an investment cum insurance. While the market was going up it made a lots of sense investing in ULIP’s. Definitely they were better than endowment or moneyback policies, which gave very low returns. In endowment or moneyback policies you do not have an option as to where your money would be invested.

The returns in ULIP’s are market driven and you have a choice of deciding where you would like your money to be invested, depending upon your risk appetite. Having said market driven, we need to understand how they work. Remember ULIP’s are long term investments.

In most of the ULIP’s you need to pay premium only for the first 3 years after that you can withdraw the money. But it is usually after 3 years that the real returns start coming.

One of the main drawback is in the initial 3 years the initial charges are very high, after 3 years the charges come down. So if you go by what the insurance agent has told you and invest only for 3 years and after that withdraw, you would not have got much benefit. If your plan was only 3 years, then mutual fund would have been better.

The advantage of ULIP’s is long term investment. Though in the initial years the administrative charges are high almost 25 to 40%, they start going down after the 3rd year. Here the administrative charges are even below those of mutual funds, which keep charging 2 to 2.5% every year. In the long term, these small charges make a big difference.

Another huge advantage with ULIP is most of the companies offer 2 or 3 free switchs per year between plans. Also you need to check if they have a feature like top up. In case you get a raise or bonus, and would like to invest the money, check if the company has a topup facility.

So seeing the advantages, what age bracket should go for ULIP’s? As we have seen, you need to look at it as a long term investment. Therefore assuming a retirement age of 60, the persons who should go for ULIP’s are persons upto the age of 40.
Remember the premium amounts for ULIP’s are quite high, so only if you are sure of being able to keep investing for 20 years, go for it.

Note that the charges I have written above are just examples. Check with the insurance company, before investing. In case the charges excluding mortality charges after the 3rd year are above 2 to 2.5% do not invest in it. In that case it would be better to go in for a pure term plan and invest the balance in a good mutual fund.

Insurance

While doing financial planning we always talk about taking an insurance policy. Usually financial advisors would ask you to take the types of policies

1) Life
2) Health
3) Home

I am not talking about car, is because the law forces you to have one anyway.

Now let’s look at Life. The insurance agents usually will show you a range of policies, from wholelife, moneyback, etc. and they talk of riders, to take care of health, accident, etc. But what is best for you? First let us try and understand what is life insurance? Life Insurance is usually to take care of your loved ones incase something happened to you. So it would be best to take a policy, which would take care of the financial needs of you and your family in case something happens to you. You should not look at insurance as an investment.

Before we go into anything lets see how insurance works. Insurance does not protect you against something happening to you, it covers the consequence of an event. So if that is the case, why should we look at is an investment to get something in return. You should buy an insurance hoping the event does not happen, but if does happen. The reason for which you have taken the insurance will be taken care of. The premium you pay, is an expense to buy Peace of mind.

Basically what happens when you buy an insurance policy with a return of money? The insurance company breaks up the premium into 2 parts. One risk premium and another investment. The risk premium goes as expense to buy you peace of mind. Then investment premium is invested and what you get is return of your investment premium. So why should you ask an insurance company to do investment for you?

The core competency of an insurance company is not investment. You have scores of investment companies. Also check the historical returns of the same amount of investments with an insurance company vis-à-vis an investment company. The returns you get from an insurance company have always been less. So the best thing to do is go in for term insurance only.
Term insurance provides insurance for a specific period of time, or “term”. Term insurance provides only “pure” insurance protection and does not have the savings or investment feature. This type of insurance offers the users a choice of terms from 1 year renewable up to 30 year terms. The premium for the term remains the same throughout the term; the most popular nowadays is the 20 year term. In certain cases you can also opt for a term to a specified age, usually 65.

Budgeting for Financial Planning

We always speak of Financial Planning and try to make plans. One of the most important parts of Financial Planning is Budgeting. It is one of the things we don’t like to do. It’s only when we start writing down our incomes and expenses and put a budget for our expenses, we would go one step ahead in Financial Planning.

It is very important to be as detailed as possible. Only then you would know where your money is coming from and where it is going. How much time do you think it would take you to write a monthly financial budget? 30 minutes to 1 hour. That’s all. First time you might take a bit longer, but after that it is easy.

How do we go about? First collect all your financial statements, just as you do for the purposes of your income tax. Some of the examples are Bank Statements, salary slips, investment documents, insurance, etc.

Open an excel sheet and make 12 monthly columns.

Next start making a note of all your incomes and the months in which you would got it and how much. Put the gross amount in the incomes write each category of income separately. Put the deductions in the expenses or investments.

Now start noting down all your monthly expenses; Fixed and variable. Fixed expenses are those which would be the same every month. Eg. Rent or maintenance charges, EMI’s, Insurance premiums, etc. Variable would be those which would change on monthly basis. Eg. Groceries, travelling expenses, gifts etc.

Take into account special occasions and budget for them. Eg. Birthdays, holidays, festivals, etc.

Now total up your incomes and expenses and presto you have your budget ready. Our first step is done. You would have some months where expenses would be more than income or the other way around.

If you have excess income, you can plan your investments or keep the money aside for months where expenses would be more. Also in case expenses would be more in a particular month, you could readjust your expenses.

Now review your budget with actual on a monthly basis and adjust your budget accordingly. Do this regularly.

Hedging to make money

Hedging is an investment in order to reduce or nullify a risk taken. It is a strategy to reduce risk.

Let’s take an example I have to receive US$ 100, 3 months from today, the current exchange rate is US$ 1 = Rs. 47. So if the exchange rate remains steady I would receive Rs.4700. But I am not sure what would happen with the exchange rate, so I can sell a 3 month future contract at US$ 1 = Rs. 47. In this way I am assured of Rs. 4700, when I get my US$. In reality what happens, say after 3 months the exchange rate is US$ 1 = Rs. 45. I will receive Rs. 4500 only from the bank, but I will gain Rs. 200 from my future contract.

So is hedging normal, YES. We do it in our day to day life.

By the way, even buying a health insurance is a Hedge. We hedge our risk of an uncertain future event of falling sick and being hospitalized. What we are basically doing is making an investment to reduce or nullify our risk to bankruptcy.

How can we use this to increase our profits? Let us say I feel that there would be an announcement today that will benefit the Telecom Industry and I feel Tata Tele is better than Reliance Communication. But I am not a risk taker, so what can I do?

Let’s say the current price of Tata Tele is Rs. 16 and Reliance Communication is Rs. 216.
So what I will do is buy 63 shares of Tata Tele that will be Rs. 1008 (63 X 16) and short sell 5 shares of Reliance Communication that will be Rs. 1080 (216 X 5)

Now if there is an announcement, since Tata Tele is a better company the price of its share would definitely grow at a faster rate than the price of Reliance Communication. Let us assume the price Tata Tele became Rs.18 and Reliance Communication becomes Rs. 238. What happens? If you sell Tata Tele you will get Rs. 1197 (63 X 19) and you will have to pay for Reliance Communication Rs. 1190 (238 X 5).
Net amount you would have made is
Tata Tele – Profit Rs 189 (1197 – 1008) and Reliance Communication – Loss Rs. 110 (1190 – 1080)
Net Profit Rs. 79 (189 – 110)

But what would happen if the announcement is unfavorable. The prices of both the shares would fall, but Reliance communication would fall at a faster rate than Tata Tele. Let us assume at the end of the day the price of Tata tele became Rs. 14 and Reliance Communication become 173.
Net amount you would have made would be
Tata Tele – Loss Rs. 126 (63 X (16 – 14)) and Reliance Communication – Profit Rs. 215 (5 X (216 – 173))
Net Profit Rs. 89 (215 – 126).

So whatever the news you would make money. But the key would be to know which is a better company.

Long Term Financial Planning

We looked at short term needs, but are those enough? We also need to look at our long term needs. We would not be working through out our life’s, so we would need to make money work for us. This I picked up from the book “Rich Dad Poor Dad”. It’s a beautiful book, it really wakes you up.

What are the long term needs we should take care of?

• Health care
• Care of our near and dear ones
• Retirement care
• Luxuries

Health care: Life expectancy is growing and the longer you live the more it becomes necessary to take care of your health or medical costs. This is most important. Medical costs are going up and will keep going up. You would not want all your savings going off in case you fall sick. So it’s best to have a health insurance in place. At a younger age we may feel it’s not important, but as we grow older it becomes very important. It becomes difficult getting an insurance policy after the age of 40. It’s better to get one before that. Now the question comes as to what should be the amount of health insurance. It would differ from person to person. The points to be considered are how long do you expect to live, Marital status, Gender, Lifestyle and Family health history.

Care of near and dear ones: Here we need to see how many dependents we have and for how long they would depend on us. Some points to be considered are Spouse, Children (include education and marriage expenses), Parents and others.

Retirement care: Here we should take into account the cost of living. Note our costs usually go up as we age. It might sound funny, but it’s true. Also is boring to just sit in the house and be idle. It is best to work on what you would do once you retire. Lot’s of people just spent their entire life working for money and not doing what they longed to do. Take up such tasks, they will keep you occupied. Find out what you would be able to do when you retire and start planning for the same when you can. Saving for retirement is not very complicated. It’s easy. Remember the power of compounding (when you start investing early, you would need to invest less to reach the same target on retirement), Pension plans, tax benefits (the government gives you tax benefits for investing, invest it for your retirement), Employer contribution (This is one of the best, it is not part of your taxable income e.g. PF). Even if you do this little bit it goes into making a big corpus for your retirement

Luxuries: Don’t forget to pamper yourself on retirement. You need to enjoy your life as well. Why did you work for so many years? Plan a separate corpus for planned holidays after retirement on a regular basis.

Plan and Enjoy life Longer.

Short term financial planning

So we decided that we need to invest and invest is such a way that we do not lose our capital. What are the options we have? When it comes to savings, it depends on your needs. Let’s look at the options available for our short term needs.

Savings Accounts

All of us have a savings account, it is a safe investment or should we say savings. How much do we earn? Currently we get 3.5% per annum. Yes, that is income, but the inflation is much above that. Your money does not work for you here. After taking into account inflation, you would actually be losing money. This account is only meant to keep you liquid. Therefore here money should be kept only to meet our average monthly expenses.

Term Deposits (Fixed Deposits)

This gives us a return from 8 to 10% per annum depending on the bank and tenure. The return on this is slightly better than savings Account and closer to the inflation rate. Indirectly our money would be growing at approximately the same rate of inflation. Taking into account some emergency situation, about 3 months current average expenses should be kept in fixed deposits. If you withdraw your money before maturity, the bank imposes a penalty, which could wipe off the interest earned. That should not matter since this money was kept for emergency use. If you are looking for a large investment in a few months down the line and the money is lying in your Savings account it would make more sense to put the money in Term Deposits for a few months. Banks give you such flexibility. You could also go for Money Market Mutual funds or Fixed maturity plans.

Money Market Mutual Funds

These funds usually give you returns in line with the market and just above inflation rate. This would be more like the Term Deposits but better returns. But this comes with more restrictions, especially on withdrawals. Though there is insurance on Savings accounts and Term Deposits to the tune of Rs. 1 Lakh, there is no such insurance on most of the instruments we would speak about from here onwards.

RBI Bonds, NSC’s and other instruments through post office

All of these are more or less like the Term Deposits offered by Banks. The main problem is liquidity. They are not as liquid as Term Deposits. These deposits are assured by the government of India. You could also get loans against these instruments.

Depending on your needs you can look at these different options. Please note the above options are only for your short term needs.

financial Goal setting

In the earlier article we had just seen an overview on Financial Planning; now let’s go a little deeper.

What was the first step we had to do? Find out your financial situation. You would know exactly how much money you have and how much you owe. In short you would know your net asset value.

The next step was goal setting. I had mentioned that it should be specific and measurable in terms of money. What did I mean by specific? The goal should be clear like I would like to have a car, home or would like to plan for retirement. Now if the goals are specific, they can be measured. i.e. it would be possible to tell which car you want, how big a house you would like to have or how much money you would like to have in case you retire.

Once this step is done, we need to see how much time we have to reach this goal. We need to say I would like to have a car in 2 years, a home in 5 years and retire at the age of 40. Be realistic. Don’t say you want it today, since if that was true, you would not have been sitting here making a plan. You would have already purchased the car, house or retired.

When you put a time frame it gives us an idea as to how much time I have to meet my target.

Once we have these factors in place, we need to check what are the investment avenues you have to achieve the goals? Or how do we go about earning that money.

What is investment? Investment is a method of using your savings to earn an income. Now investing is not the same as saving. When we keep our money aside in a safe place without spending means saving. When we buy something or lend out money in the hope of receiving a higher amount after a certain period of time, its called investing.

Taking your money and putting it into fixed deposit is saving. But putting the same into Equity mutual funds is investing. Now some might say I can do that by buying and selling shares on the stock exchange. Yes you can, but that is not investing its trading. If you buy a particular share and only sell when you would require it, is investing.

Remember we have to invest or earn in such a way that we should not lose our capital.

If we do not do the above exercise we do not give ourselves a chance. Give yourself a chance. Go ahead and plan, at least you would be happy that you tried and you would get a better idea as to your chances.

Financial Planning

With Financial markets in doldrums, I think this is the best time to do your financial planning. What needs to be done?

First find out your financial situation. Make a list of all your investments, your insurance policies, your loans or financial commitments.

Now that you know what your current financial situation is, make a list of your goals and objectives in life. You need to be specific, at what age what would you like to have or what commitments you might expect. You should be able to measure the same in terms of amount of money, its OK if you measure using today’s rates. Ensure that the goals are realistic and attainable.

Now that we have the goals, let’s make a list of unexpected problems. Basically we need to do a what-if analysis. This is required to counter any untoward incident, which could hamper or be a clog in the wheel to achieve the goals. There are no solutions if there are no problems.

We have most of the things in place, using the data gathered, prepare a plan.

Now follow the plan.

Do a periodic review, basically do all the steps given above, suggested review once a year.

What does the plan usually contain, it usually will tell you invest, invest and invest. So now you understand why I started with this is the best time to financial planning. This is the most pessimistic scenario. Markets are down, there is also a fear of recession or should I say we are already in recession. But the prices are still high (except stock prices).

So this is the best time to make the most. What is your take? How long will the markets take to return to normal? Most of the economists say max 2 years and then they will bounce back. You will never get such good valuations. Don’t try to time the market. Make your plan and follow it. I’m sure your goals are long term, by which I mean more than 5 years. In that time you would definitely benefit.

So what are you waiting for? Take a paper and pen and start. Let me assure you once you start, it won’t take much time to write. It will take a long time to gather data. So better start and if you are lucky you might just time the market.

All the best.

Inflation

Hi Everyone,

I actually got bored writing, also did not know what to write on. While sitting over a drink with some of my friends, I mentioned that I have started writing my own blog. I explained that I would be writing on some finance topics. And when it comes to finance everyone wants to know more. This is where the money is. Then one of them started asking what Inflation is. That is when I thought this is a good topic to write on.

We keep reading everyday that inflation is gone up, it has reached 12.65% etc. So one of them mentioned that for me everything is the same. Even when inflation was down prices were going up, so how does this 12.65% make a difference and how is it affecting our lives, or should we say prices.

Let’s check what Wikipedia says about Inflation. As per Wikipedia, in economics, inflation or price inflation refers to a general rise in the level of prices of goods and services over a period of time. That means it is nothing but a comparison of prices from one period with another. So this brings us to another conclusion, if the price rises there is inflation.

If there is a rise in prices there is inflation. With our income remaining constant, if the prices go up, it affects our saving potential or our life style. So the value of our money is gone done. What I mean is Rs.10 will be Rs.10 but what I can get in Rs.10 will be less i.e. the real value of money has reduced or our purchasing power has reduced.

So what happens when Inflation goes up? As explained earlier our savings potential is reduced. This affects investments, since we invest our savings. And those with money or in business might go into the mode of hoarding, to generate more income. Because the cost of production or purchase also goes up. If there is less stock in the market, the prices will rise.
When we say comparison of prices, the question is prices of which items. Usually the prices of a number of items of common use as a basket are compared. A series is made of all these items on a weekly basis and this series is compared to find out if the price is going up or down.
Usually the series that is used is Consumer price Index. Consumer Price Index typically contains items which are generally used by normal consumers. In India the Consumer Price Index is calculated by the Central Statistical Organisation. They first collect the average prices by cities and then tabulate the all India figures.

The main Categories
1) Food, beverages, tobacco
2) Fuel and light
3) Housing
4) Cloth., bedding and footwear
5) Miscellaneous

To Conclude, as my friend had mentioned earlier prices were always rising, then why the noise now. The reason is simple, earlier the rate of rise was small, not it has gone up. Prices are going up rapidly or at a higher rate.

Gold

These days everyone says buy gold or better buy gold based mutual funds. But is it actually what they claim it to be?

First of all why gold and not any other metal. This is only because gold is the most sought after metal and was used as monetary exchange. Though we only look at gold being used as Jewellery, it is also used in Industry like Electronics. In the international market gold is priced in Troy ounce, which is equivalent to 480 grams.

Gold prices have kept fluctuating from time to time from a low of $252 in 1999 to a high of $850 in 1980. The 1980 high was never overtaken till 2008. From 1999 to 2008 the price has gone up almost 4 times i.e. 400%. The major reason for the rise in gold prices is said to be because of increase in money supply in the market, inflation and high fiscal deficit of US.

But like all investments the price of gold also depends on demand and supply. But unlike other investments the biggest problem with gold is hoarding. Since there is always a steady demand for gold, but because of hoarding the supply gets limited and this raises the price.

Major part of gold mined goes into production and only around 15 to 20 % goes in Jewelley and Exchange traded funds.

As per the world gold council, the annual production of gold is around 2500 tonnes whereas the demand is around 3500 tonnes making the demand over supply to be around 1000 tonnes.

When it comes to investing in gold, it is always compared to stocks. The major difference between buying gold directly and stocks is holding cost of gold. You have to store gold and sell to get returns, but in case of stocks other than selling, you also get dividends. Gold will always have a demand, but the demand of a stock keeps fluctuating depending on a number of circumstances.

So the risk factor is low in case of gold. The only other risk in case of gold is holding risk. In that case ETF become a better option.

Technical Analysis

Somebody asked me what Technical Analysis is. Actually I had learnt it a long time back, and frankly do not remember any definitions. I can look at a chart and tell, OK it is about time to buy or sell. But even that I am not sure if it’s right. So actually I look at the chart and still follow my gut feel.

This article on Technical Analysis I picked from the net just gives an overview of what it means.

Technical analysis is a technique that claims the ability to forecast the future direction of stock prices through the study of past market data, primarily price and volume. Technical analysis considers only the actual price behavior of the stock, on the assumption that price reflects all relevant factors before an investor becomes aware of them through other channels.

In simple terms Technical analysts believe that the historical performance of stocks and markets are indications of future performance. A fundamental analyst would study the fundamentals of each stock and then decide whether to buy it or not. By contrast, a technical analyst would sit in his office and make a list of trades on the stock. Disregarding the intrinsic value of the stock, his or her decision would be based on the patterns or activity of people doing trade.

In reality even the analyst won’t know what would happen, he too is just speculating. For that matter all of us are. That is why we have a stock market. Everyone wants to make money and nobody wants to fail. So we rely on analysts. That is how everyone makes money.

So it’s up to you to decide if you want to believe someone or some sort of analyst. It’s your money. We are very busy people, who do not have time to study stocks. There are lots of people who do study of stocks and these guys are employed by Magazines, newspapers, TV channels, Stock brokers, Mutual funds, etc.

We read their articles, listen to the radio or listen to our friends and relatives, and reach a decision on what to buy or sell. But remember one thing, whatever anyone says follow your instincts. Ultimately it’s your money. Technical Analysis is good, it gives you a fair indication, but this indication is just based on past data.

So we should always combine this data with other analysis, data or information.

Midcap and Bluechips

The other day I was having lunch with a friend and he asked me a question, which we keep talking about all the time when it comes to stock. This was a very basic question “What are Mid Cap Stocks” It really caught me unawares. This is what I found out on surfing the net.

The term ‘mid-cap’ originates from the term medium capitalized.
Market capitalization is calculated by multiplying the current stock price with the number of shares outstanding or issued by the company. The definition of mid-cap shares can vary from market to market and from country to country. In case of India, the National Stock Exchange (NSE) defines the mid-cap stocks as stocks whose average six months’ market capitalization is between Rs 75 crore and Rs 750 crore. Thus, classification of shares into large-cap, mid-cap, small-cap is made on the basis of the relative size of the market in the country.
Mid-cap shares are considered as attractive investment avenues since their growth rate would be faster. However on the flip side, mid-cap shares are of small companies where revenue and profits could be more volatile than large companies. The availability of mid-cap shares in the secondary market is also limited. The promoter holding in these companies is high and there is very little public shareholding. Thus a volatile financial performance and the limited number of shares in the market make investing in mid -cap shares more risky. The other question that popped up was “What are Blue Chips”

The top stocks of the stock market are usually referred to as Blue Chips, the question that would pop up now is which are the top stocks. The general way would be, those stocks which are included in the index of the exchange are Blue Chips.
Generally, a blue chip has a history of solid earnings, regular and increasing dividends, and an impeccable balance sheet.

To summarize Mid-caps have the potential to be tomorrow's blue chips.
But, then again, they may not. Hence, mid-caps carry a higher risk than blue chips. Also, their earnings are much more volatile and neither are they as liquid. If you want to invest in shares but are not too savvy with the market, then blue chips are your best bet. Even if you want to invest in mid-caps, ensure that you have a few blue chips too to balance your risk.