Protect your investments. Here's how !!

Anything done without proper planning will turn out to be a dud! This holds good for almost everything in life, from marriages to managing finances to running businesses.

Today, one of the most important things is managing finances. Going by recent trends almost everything else in your life hinges more on one huge binding factor called money!

Believe it or not, making money is no big deal, neither saving it nor cutting down on your expenditure for that matter. These are all important but above everything is mastering the art called investment!

It is the only sure way you could build on your wealth and protect it. Investment is a science. And a wise investment is about choosing the right scheme based on certain underlying principles and algorithms.

And unless we do our home work right even the effective steps of the regulators will not help us. So, let us see what it takes to turn into a smart and wise investor that will help you protect and multiply your investment!

To begin with, know your goal

Perhaps the first point to consider before investing in a financial product is to understand your goal! Are you looking at the investment for the long term or short term?

For instance, never invest in a product like Unit Linked Insurance Policy (ULIP), a long term product, if you have plans to surrender it after paying the premium for the mandatory first 3 years called the lock-in period in industry parlance!

When you finally decide on the nature of the investment scheme it is better to do a comparison of the similar products available in the market. Do not give in to selling pressure. After all, it is your money and investment.

Be disciplined

Don't try to do things that are really outside your purview, portfolio management for instance. Approach your financial consultant or a fund manager for expert guidance on these issues.

These areas and things like timing the market are expert zones that requires years of experience to understand and practice and not like simple investment methods like the public provident fund.

Also, misunderstanding does as good as not knowing a product at all and probably even worse! Just one ore two instances of making accidental profits don't put one anywhere in the vicinity of financial disciplines.

Proper asset allocation is important

Allocation of assets in a portfolio is very, very important. Simply put, it is deciding about the mixture of stocks, bonds, real estate, derivates and mutual funds you want to hold in your portfolio.

The fact is that most asset allocation is ad hoc but aims to minimize risk. Asset allocation begins with considering your objectives. This is perhaps one area where even the most seasoned investor might go wrong. Though there is no select formula for a perfect asset allocation, you can still try to do a few things that could help you build a safe portfolio.

Firstly, weigh the difference between risk and returns. For example, investors willing to take a higher risk should allocate more money into stocks. Do not fully rely on planner sheets.

Find out the real cost of your investment from the company. Timing is also important, the earlier you start the better but do consult an expert before you implement it.

Watch out for costs

The one area which many investors fail to decode is the breakup of the costs involved in an investment. Failing to see the hidden costs such as the brokerage costs particularly in a mutual fund or a life insurance company could actually hurt you real hard.

Mutual fund companies often subtract fees from your portfolio known as fund's expense ratio before their annual results are announced. These are expenses paid to the advisor as fees, marketing efforts, legal expenses and accounting and auditing costs.

According to statistics, every year on an average, the expense ratio for a U.S stock fund is roughly between 1 and 1.5 per cent. Apart from this there are other hidden costs like trading costs involved. Learn about the impact of this break up on your investment.

Fund managers often churn their portfolios to whopping per centages thus putting your investment at a higher risk by making your yield fall far below the index return.

Hence, as an investor it is very important for you to keep a watch on all costs, including the fund manager cost, churning cost and other associated costs.

The Ideal P/E Multiple For A Stock Is...

Warren Buffett’s fortune is enough to stupefy anyone. Starting from scratch, he has amassed a fortune of billions and billions of dollars. And the most amazing part of that feat is not even that – it is the fact that he has achieved so much wealth in his lifetime purely by investing in the stocks and bonds of companies.

As he has mentioned a number of times, he credits much of the framework with which he invests to Benjamin Graham, his mentor and teacher from whom he learned how to invest. Thus, it should be of immense interest to anyone who wants to invest wisely, to hear what Graham has to say on the subject of the maximum price one should pay for buying a stock. After all, this is a perennial question that comes to the mind of investors – What is the right price to pay?

For the purchase of a stock to be successful, every investor relies on future earnings of the company and not its past earnings. But at the same time, Graham was of the firm opinion that when evaluating a stock and its future earnings, one can be conservative only by basing this opinion on company’s actual performance over a period of time in the past. Thus, in most cases, the investment (and not speculative) value of stock can be arrived at by taking into consideration the company’s average earnings over a period of five to ten years.

The company’s profit in the most recent year may be taken as the base for arriving at the value in some cases, but only if it meets the following criteria –

(1) general business conditions in that year were not exceptionally good

(2) the company has shown an upward trend of earnings for some years past

(3) the investor’s study of the industry gives him confidence in its continued growth

And only in the extremely rare and exceptional case should one rely on the assumption of a company achieving higher earnings in the future while calculating the price one pays. Higher future earnings should be taken into consideration only if it is a 100% sure thing, which is very rarely the case.

The above was a discussion of Graham’s suggestion of which earnings should one take as the base when valuing a company by using a P/E ratio. Now for the second part – what would be the right multiple one should give those earnings to arrive at the price one should pay for the stock?

A conservative investor may rightfully give a very attractive company a higher multiple. This may be a company whose latest earnings are above its past average, which has extremely promising future prospects, or has an inherently stable earnings power. However, at the very heart of Graham’s argument was his opinion that there must always, in every case, be some upper limit of this multiple that is assigned to the stock in order to stay conservative in one’s valuation. He suggested that about 20 times average earnings is the highest price that can be paid buying a stock from an investment perspective. While this is the maximum one should pay for a company considered to have very good prospects, about 12 or 12.5 times average earnings would be suitable for the typical company with average prospects. This is because investment, as opposed to speculation, necessarily requires demonstrated value, which can be verified only by way of average earning power in the past. A P/E multiple of 20 in effect means an earnings yield of 5% (1 divided by 20).

It would indeed be very hard to conservatively justify average earnings of less than 5% of the market price of a stock without betting your money on an increase in earnings of the company in the future. Thus, according to Graham, a price to earnings ratio of higher than 20 times average earnings cannot by any means provide the margin of safety that an investor should have. It might be accepted by an investor in expectation that future earnings will be larger than in the past. But such a basis of valuation would then have to be termed “speculative”. That is because speculation derives its basis and justification from potential developments that differ from past performance.

By the above thumb rule of not paying more than 20 times average earnings, Graham did not imply that it would be mistake to do so. He suggested instead that such a price would be speculative. Further, it should also be noted that such a purchase can easily turn out to be highly profitable, but in that case it will have proved to be a merely fortunate speculation. And very few people are consistently fortunate in their speculation.

Hence people who habitually purchase stocks at more than about 20 times their average earnings “are likely to lose considerable money in the long run” according to Graham. This is all the more likely because if such a mechanical check were not enforced, investors have the tendency to time and again give in to the temptation and lure of bull markets, which always find some or the other deceptively pleasing argument to justify paying extravagant prices for stocks.

Do you know where to invest your money ??

 How many of you can confidently say that you are well aware of all the investment avenues available? Not all. There is a plethora of investment options available in the market today. But then the options must be selected based on the goals you want to achieve in life and the time frame in which you want to achieve it.

Let us take a trip down the different paths of investment world.

This is the first part where in we will explore different options available under equities:

Equity

I guess one of the most talked about asset class in recent years. So what is equity investment? It refers to buying and holding of shares or stocks in a stock market by an individual and funds in anticipation of income by way of dividend and capital gain as the value of the stock rises. Equity investment is a good form of long-term investments. There are various ways of investing in equity:

Direct investment: Refers to buying and selling (trading) in the stocks or shares on the exchange. In order to trade you need to have a demat account. As for trading you need to register with a broker or you can have an online trading account which is linked to your demat account and your bank account through which you can trade.

This form of investment in equities is for investors who regularly follow the stock market. Investors who are looking for developing long-term wealth should not indulge in speculative trading (buying and selling within a short span of time). Also investments in stocks or scripts should not be done based on tips that you have received from your friendly neighbor or relatives.

Investment should be done after a thorough analysis of the company, sector, and industry on the whole. We have heard many stories where people have lost their entire wealth by investing based on tips. Also do remember, one can never time the market. So be careful when you are investing directly.

Portfolio management services (PMS): In return for a fee, trained professional portfolio managers allocate your assets in various asset classes depending upon your personal investment goals and risk preferences. PMS is not restricted to only investing in equity and equity mutual funds. They also include investment in bonds. The advantage of this form of investment: professional expertise for your hard earned money, transparency and flexibility. You do not have to overlook in the day-to-day management. You are given an online user name and password that grants you an online access to your portfolio that keeps you up to date. The fee structure can also be selected either on performance or on a fixed basis.

The disadvantages: the minimum requirement for PMS is generally very high, that is., most of the PMS are offered where the portfolio offered to manage is at least Rs 25 lakh. The fee charged is also high. Generally losses are not shared when you opt for performance-based fees. This form of investment is especially good for high net worth individuals who have money but no time to monitor them.

Equity mutual fund: Mutual fund is the latest buzzword. After the debacle of US 64, the mutual fund industry took many years to get their act together. But now with stricter norms set by SEBI and more transparency mutual fund industry has developed in a big way. With more than 500 funds there are options available for each and every investor. Also, with investment of as low as Rs 1,000 (for systematic investment plan) and Rs 5,000 (lump sum investment) this form of investment attracts one and all.

So what is a mutual fund? A mutual fund is professionally managed collective investment scheme that pools money from many investors and invest it in stocks, bonds and various others securities and instruments. Mutual funds are divided into open ended and closed ended mutual fund.

Open-ended fund: Are funds in which you can buy or sell on any business working day. Just like shares value, mutual funds have net asset value on which you buy or sell your units. Unlike shares in mutual funds, units are allocated to an investor for the amount invested.

Closed-ended fund: Is a collective investment scheme where limited a number of units are allocated. New units are not allocated on a day-to-day basis. Generally closed-ended funds are traded on the exchange and one can trade their units on the exchange.

In this section, we will have a look at various forms of open-ended equity mutual funds. Equity mutual funds are sub-divided into:

Diversified equity mutual fund: A kind of mutual fund which invests in stocks of various companies of various sectors. Best bet to park your funds in.

Sector funds: Mutual fund whose investment objective is to invest stocks of companies of a particular sector like automobiles, pharma, banking, infrastructure and others. This type of fund can be risky if the sector does not perform well. So limit your exposure to sector funds.

Index fund: A type of mutual fund with a portfolio constructed to match or track the market index. It is relatively passive fund with broad market exposure and low operating cost.

Tax savers or equity linked saving schemes (ELSS): They are same like diversified mutual fund. The difference is investment in these funds have tax benefit up to Rs 1 lakh as it is exempted under section 80C. Also, ELSS has a three year lock-in period. Any withdrawal before this period means that you will not get the tax benefit under section 80C. Do keep in mind the risk factor while opting to invest in ELSS. Also, select growth or dividend payout option but not dividend reinvestment as dividend reinvestments go into the lock in period loop.

Why select mutual fund? Here's why. Low minimum investment amount, low management cost, low investment, professional management, diversification, liquidity and with entry load removed from August 1, 2009 make them all the more attractive.

Disadvantage of mutual fund: Backend load or exit load if investment redeemed within six months to one year. Many funds have high operating charges, decision-making is in someone else's hands and no tailor made portfolio.

The pros outweigh the cons and hence equity mutual funds form a very attractive form of investments. Mutual funds are especially for investors who do not have the time to follow the market and also who cannot shell out huge amounts. It is advisable to do a SIP in mutual funds as power of compounding and cost averaging works wonders to your hard earned money.

Derivative refers to a variable that has been derived from another variable. They have no value of their own. They derive their value from some underlying asset. For example a derivative of a share of Reliance Industries will derive its value from the share price of Reliance. Derivatives are specialised contracts wherein an agreement or an option to buy or sell the underlying asset of the derivate up to a certain time in the future at a pre-arranged price which is known as exercise price. The contract has a fixed expiry period between 3 to 12 months.

The value of the contract depends on the expiry period and on the price of the underlying asset. The underlying asset in derivative trading can be financial assets like shares, index, currency or can be commodities like soyabean, oil and others. We will right now be looking only at financial derivative trading whose underlying asset is equities.

The different forms of derivative contracts are:

Futures and forwards: Futures contract give the holder the opportunity to buy or sell the underlying asset at a pre-specified price some time in future. These contracts come in standardised format with fixed expiry date, time contract size and price. Forwards are similar contracts like future but the size, expiry date and price are customised as per the needs of the user.

Options: It is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset (it maybe an index or a stock) at a specific price on or before a certain date. The right to buy an underlying asset is known as call option. The right to sell the underlying asset is known as put option.

Financial derivative contract can be bought or sold by paying a premium. The upside in a derivative contract is unlimited. But again if you are a buyer of an option, your downside is limited up to the extent of the premium amount paid (Note: The seller of an option has an unlimited loss potential).

Futures and forwards too have an unlimited loss potential.

The advantages are you need to pay only 20 to 30 per cent of the contract price. You also have the option to first sell the lot of stocks and then buy them within the stipulated time. This is only possible in normal equity trading if you are an intra-day trader.

The disadvantage is there is a time frame to the contract. Not all the stocks are available in derivatives trading. Finally they are complicated and extremely risky.

Only investors who have a thorough knowledge of derivative trading and who can regularly follow the stock market should trade in them. It is not for investors who are looking to develop long-term wealth.

Who should be investing in equities?

Investors whose goals are long term, that is, more than seven years can invest comfortably in equities. As aptly said by Warren Buffet: If, when making a stock investment, you're not considering holding it at least ten years, don't waste more than ten minutes considering it.

If you want to achieve any of your goals in less than this time frame then equity is not the vehicle for you. Remember that emotions like greed and fear should have no place when investing in equities. Otherwise debt is the avenue for risk-averse safe fixed income generation.

Which IT form is right for U ??

We are all aware that filing of tax returns is our moral duty. Whether you are an individual, hindu undivided family or a company, filing tax returns is a must. However, with the plethora of tax return forms available with the income tax, the question that arises is which form is meant for whom? Remember, different forms have different purposes and meant for different categories of tax payers. Here are the income tax forms meant for the respective taxpayers. Let us divide the tax payers into two categories: corporate and individuals as well as HUFs.

Individuals and HUFs

This category has four different types of forms.

ITR 1: If you are an individual whose main source of income is salary, then this is the form for you. There are two versions of the form available on the income tax site, the first one having 2 pages and second one with 3 pages. Don't worry, there is no difference between the two except for the size of the font. But don't use this form if you have income from other sources like rental income, capital gains, business income, dividends received from investment in shares of overseas companies, lottery or any other prizes.

ITR 2: This form is meant for people and HUFs whose income sources don't include business and profession. Besides salary, if your income sources include rent from property, capital gains and other earnings excluding those from business and profession, you should fill this form. This form is 12 pages long, of which 6 pages are simply explanatory notes.

ITR 3: Persons and HUFs who are partners in a partnership companies will have to submit this form. It is 14 pages long, of which 7 are simply explanatory notes.

ITR 4: Persons and HUFs who are in business or profession should fill out this form. It is 30 pages long, of which 10 pages comprise of explanatory notes.

For companies

ITR 5: This form contains 22 pages and 30 schedules where you must give details about your income, tax details and fringe benefit tax. It is meant for companies, association of persons and body of individuals. There are 10 pages containing explanatory notes.

ITR 6: Meant for companies, this form has 24 pages, and 34 schedules. It is used in lieu of older Form 1. It contains 9 pages of explanatory notes. Here also you must include your fringe benefit tax.

For charitable trusts and political organizations

ITR 7: Designed for the charitable trusts and political organizations, this form has 17 pages and 17 schedules. There are 8 pages of explanatory notes and you must also list fringe benefit tax information.

ITR 8: For those who must file returns for fringe benefit tax but not income tax, this form is a must. It has 4 pages with 3 extra pages listing explanatory notes.

When filing your tax returns, it is important to submit the correct form. Use the proper form listed above to save yourself of the trouble later on.

How to find the real value of property !!

Any investor (buyer or seller) can optimize his taxable profits from real estate transactions with proper tax management. What one needs to do is work out the cost of purchase, the sales consideration and consequently the taxable profits.

The first thing to work out is the difference in tax treatment for long-term and short-term capital gains (profits).

If the asset has been held for more than 36 months before sale, the profit is considered as long-term. Short-term profits are added to the individual's other income and taxed at appropriate rates. While computing long-term profits, indexation is allowed on the cost of acquisition.

Typically, capital gains are computed as under:

1. For net sale proceed deduct some costs from sale value. Sale value: Rs 50,00,000. Other charges: sale brokerage (Rs 1,00,000), incidental costs (say, lawyers' fees, Rs 10,000), transfer fees paid to society (Rs 10,000) and donation to society for transfer of flat (provided it can be shown that the society charges this donation as a matter of policy). Total: Rs 1,20,000. So, net sale would be Rs 48,80,000.

2. Deduct the following from the net sale proceed: cost of acquisition and improvement (for short-term profits) / indexed cost of acquisition and improvement (for long-term profits) = Rs 19,60,000 (assumed purchase price after indexation).

Add all the charges listed in the point above paid at the time of acquisition, for example brokerage paid then of, say, Rs 20,000. So, the capital gains would be Rs 30 lakh (48,80,000-19,80,000) 'Cost of improvement' would include major alterations carried out subsequent to the year of buying but not routine repairs and maintenance.

All the above deductions need proof so keep all bills or vouchers safely even if the purchase was made years back.

There is a perception that, in real estate transactions, some payment may be paid or received as unaccounted money and, hence, not recorded in the agreement. This reduces the real value and thus, the related stamp duty and income tax.

To curb this, many state governments have introduced the Ready Reckoner Index Value for calculating stamp duty. Under this, an RRIV is prescribed locality wise and is revised periodically.

The stamp duty is levied based on the RRIV, irrespective of the value mentioned in the sale agreement, which may be higher or lower than the RRIV.

At times, this can create tremendous hardships. In practice, the RRIV may not reflect the actual market rates in the locality or even of different locations in the locality. This became obvious in the recent past, when the RRIVs were not revised downwards though property prices were depressed.

In case the RRIV is higher, paying the additional stamp duty won't end the matter as the Income Tax Law (Section 50C) also adopts a similar concept. In other words, tax would have to be paid on sale profit based on the RRIV and not the actual profit. This means the seller pays tax on profits or income he hasn't earned.

Therefore, where the actual transaction value is below the RRIV, the parties should apply to the stamp act authorities for adjudication of the property's value giving full explanation.

In case you haven't got the value adjudicated and have paid the stamp duty as per the RRIV, the seller can still avoid Section 50C by requesting the tax officer to refer the matter to the valuation officer (VO).

When the VO visits, the reasons for the lesser consideration can be explained. If the fair market value (FMV) determined by the VO is lesser than the RRIV, the tax officer has to take the FMV as the correct figure. But, if the FMV is more, the RRIV stands.

How well do you know your Mutual Fund Basics ??

A mutual fund (MF) is a professionally managed type of collective investment scheme that pools money from many investors, that is, your money and invests it in stocks, bonds, short-term money market instruments, and/or other securities to yield returns. If you are apprehensive of investing in the stock market because of its unpredictability, play relatively safe with MFs.

You will receive units of the MFs in proportion to the money put in. The value of each unit is also impacted when management fees and other expenses are deducted from the overall pool of funds.

The value of a unit is called the Net Asset Value (NAV) of the MF which changes on a daily basis.

Investors who wish to purchase or sell units of a mutual fund after the scheme is fully functional must do so at a price that is linked to the NAV or the Net Asset Value.

Here are 12 important facts you should know about MFs.

1. How is the Net Asset Value calculated?

The Net Asset value (NAV) = (Market value of the fund's investments + Receivables + Accrued income Liabilities - Accrued expenses)/Number of outstanding units.

2. What is a Systematic Investment Plan?

A systematic Investment Plan or SIP is an investment strategy wherein you can invest into a mutual fund at specific intervals over a defined time frame. You can select the investment frequency for your chosen SIP, either monthly or quarterly.

Since a fixed amount is invested on a regular basis, you get more number of units in a falling market and fewer units when the market is on the rise.

This will also help you to smoothen out the market fluctuations and the investment will be low cost investment over a period of time. This strategy of investing is also called Rupee Cost Averaging.

3. What is Systematic Withdrawal Plan (SWP)?

The systematic Withdrawal Plan (SWP) is a facility available to the investor to withdraw funds at regular intervals.

4. Are there any sector-specific funds or schemes?

There are some sector specific schemes. Some funds/schemes invest in the securities of only those sectors or industries as specified in the offer documents. It could any sector such as pharmaceuticals, software, fast moving consumer goods (FMCG), petroleum stocks, etc. In such schemes, the returns are dependent on the performance of the respective sectors/industries.

These sector-specific schemes may give higher returns, but the investment in such schemes is riskier compared to diversified funds. As an investor, you need to be vigilant and keep an eye on the performance of the specific sectors/industries. In such schemes, it becomes extremely important for you to exit at an appropriate time. You may also need to consult an expert regarding these investments.

5. Are investments in mutual fund units safe?

Any stock market investment is inherently risky. Different funds have different risk profiles that are clearly specified in their objectives. Funds that are low risk invest generally in debt, which is safer than equity investments. Mutual funds have access to services of expert fund managers another assurance to the investor that your money is in good hands.

6. How much should I invest in debt or equity-oriented schemes?

As an investor, you should take into account your risk-taking capacity, age, financial position, etc. Schemes invest in different type of securities as disclosed in the offer documents and offer different returns and risks. You may also consult financial experts before taking decisions. Agents and distributors may also help in this regard.

7. How do I fill up an application form of a mutual fund scheme?

You are required to mention clearly your name, address, number of units applied for and other relevant information as required in the application form. Also provide a bank account number to avoid any fraudulent encashment of any cheque/draft issued by the MF at a later date for dividend or repurchase. It is important to make sure that the MF company is apprised of any change in your address, bank account number, etc.

8. Can mutual fund units be purchased after the cut-off time?

To be able to get the NAV of the same day, you must purchase the MF units inside the cut-off time of that scheme. Delay on this part will mean that you will only get the next day's NAV. Also, if the next day happens to be a holiday, the NAV of the next working day will be applicable.

9. Under which sections of the Income Tax Act can tax benefits for investing in mutual fund units be claimed?

Dividend income from MF units is exempt from income tax with effect from July 1, 1999. Investors can claim tax rebate under section 88 of Income Tax Act, 1961 with investments in Equity Linked Saving Schemes (ELSS). Tax benefits will also be available under section 54EA and 54EB with regard to relief from long-term capital gains (LTCG) tax in specific schemes.

10. When does an investor get a certificate or statement of account after investing in a MF?

Mutual funds are required to send out certificates or statements of accounts within six weeks from the date of closure of the initial subscription of the scheme.

In case of close-ended schemes, the investors can get a demat account statement or unit certificates as these are traded in the stock exchanges. In case of open-ended schemes, a statement of account is issued by the mutual fund within 30 days from the date of closure of initial public offer of the scheme. The procedure of repurchase is mentioned in the offer document.

11. How long does it take for transfer of units after purchase from stock markets in case of close-ended schemes?

Securities and Exchange Board India (SEBI) regulations require that transfer of units be done within thirty days from the date of lodgment of certificates with the mutual fund.

12. Is there a body that handles investor complaints redressal?

The name of contact person to approach for queries, complaints, or grievances is mentioned in the offer document. Trustees of a mutual fund also monitor the activities of the mutual fund. The names of the directors of asset management companies and trustees are also given in the offer documents.Investors can also approach SEBI for redressal of their complaints. Once the complaints are received, SEBI takes up the matter with the concerned mutual fund and follows up with them till the matter is resolved.

HAPPY INVESTING !!