Topsy-turvy markets: Do I invest or do I exit?

Markets dancing up and down: do I invest now or do I exit? This question is in the minds of almost all investors small or big; short-term or long-term. This is a problem because nowadays the markets are fluctuating so much that a 1 per cent to 2 per cent change per day has become quite common.

If one thought the market was weak two weeks ago and going down, this week the markets are looking up. So where does a salaried individual put his/her bet on? This article is to give some ideas particularly for the small investors.

Market fluctuations

The stock market fluctuates, that too when the overall economy is not that stable, it fluctuates a lot. This is true not only for India [ Images ] but across the world.

Again this is true not only in our times, but in all known history. To fluctuate is one of the basic characteristics of the stock market.

However, research -- or for that matter any five-year chart of the indices (Sensex or Nifty) -- shows that there is always a significant gain. The same is the case even for the 5 years ending December 2008, when the market has fell almost 50 per cent during the year.

What are the implications of fluctuation?

There are a number of negative aspects/scenarios to the short-term fluctuations.

1. Investments are still in negative even after the markets have gained.

If an investor had invested his/her funds at the peak of the market and stayed there, the funds would not have still recovered from the losses that they suffered in 2008. Will the investment ever recover? Should I exit, taking the loss?

2. The planned financial goal is here. But the market is still low.

The planned financial goal could have been the daughter's marriage, retirement, a housing down payment. But if one had the misfortune of a fall in the market happening right when the withdrawal was planned, it is definitely a long postponement of the plan (if possible) or financial trouble (if it could not be postponed). A requirement like a daughter's marriage cannot be postponed for want of money.

3. I have got a one-time lump sum of money.

A loving relative's gift or an unexpected bonus or an arrear due for 2 years may suddenly land in an investor's hands. One can be sure that the same will not happen often.  So when does one invest this money in the market?

A better perspective

A better perspective to investments in the stock market is that the loss or gain is only on paper till the shares are sold. So the investment that has a lower value today as in scenario 1 has not lost its true value, unless one sells it. All that it needs is time to give a better value.

This perspective however does not solve the problem, when an investment is time bound as in scenario 2 or 3.

The question is thus not whether there will be returns or not but how does one time the market to get better returns?

Timing the market: Is it possible?

Is this the solution? Again the answer is 'NO'. Because we could find the right time to invest in the market only retrospectively. No one could guess to what extent the market would react to certain economical news.

So too no one could guess accurately in advance at what level and when a market would turn down or up.

So timing the market is not really possible. However, any five years' graph will show a steady gain as discussed earlier. So can we use time in the market to our advantage?

Time in the Market –The Solution

 By increasing the time in the market by being invested for a longer period and by investing in a higher frequency, we can overcome the problems related to the fluctuations in the market.

This is definitely a solution that can be used to tackle the problems faced by the small investors.

By increasing the time in the market (investment period), fluctuations are over come. This requires planning earlier and investing at least for a period of five years.

Even the one time lump sum of money, can be invested over a period of, say, five months in smaller chunks. This will take care of the market ups and downs during the investment period.

Those who have invested for their retirement and their daughter's (or son's) marriage can practice the same but in reverse order. Rather than wait till the date of retirement for the withdrawal from the market, they could withdraw over a period of 6 months before the marriage.

This will not only help them in the run up to the event but also prevent losses from any sudden fall in the market.

Fluctuations are a basic nature of the stock market. An investor cannot wish it away. Nor should one avoid the stock market because of the fluctuations.

Timing the market for its ups and downs for making investments is not possible as accurate prediction is in the realm of speculation.

The better option is to stay in the market. This is done by increasing the time period of investment and by increasing the frequency of investment and withdrawal.

Home loan: Benefit from prepayment !!

What is prepayment? Why and when do people opt for it?

It's just what the name implies: prepaying all or part of the loan amount before it is actually due. However, it is more complicated that it sounds! First, you will have to check your retail loan documents to find out if prepayment is allowed and the percentage of outstanding loan amount that you will paying towards prepayment penalty charges, if any.

You might want to prepay your home loan for two simple reasons. First, you could save on the net interest payable as longer loan tenure would mean more interest. The second reason is you can own the asset earlier than planned.

You could decide to prepay your loan if you have the capacity to make larger payment or if you have had a promotion or received a bonus.

Why do banks charge penalty for prepayment?

Well, banks and lenders lend money in the form of loans only to make money out of service fees and interest. And this requires the loan to be open for a fairly longer duration to give profits. They cannot stop your legal right from making a prepayment. But at the same time prepayment would mean upsetting their profit calculations from interests.

Hence, the banks and lenders impose a prepayment penalty to compensate a portion of the lost profit. Usually, your loan agreement would have a clause defining your obligations and interest in case of prepayment in part or in full.

RBI's current stand on this penalty

Recently, the Reserve Bank of India (RBI) hinted at drafting a policy to restrict banks from imposing prepayment penalty of retail loans.

The proposed move follows many such complaints from loan borrowers paying EMIs based on the floating rate of interest. They feel that they are missing out on the benefits of periodical rate cuts in interest.

The anti-monopoly body Competition Commission of India (CCI) is dealing with complaints from loan borrowers against collecting prepayment penalties on home loans from major lenders in the country.

Prepayment penalties by different banks in India

Public sector banks charge 1 to 1.5 percent as prepayment penalty on the outstanding loan amount and in the case of private banks it is between 2 and 4 percent.

Name of the bank	Prepayment penalty (in %)
Axis Bank	No prepayment penalties
ICICI Bank [ Get Quote ]	No penalty on part-prepayment 2% on foreclosure (+ applicable service tax) This will be calculated on the outstanding loan amount and amounts prepaid in the last one year, if any.
LIC Housing Finance [ Get Quote ]	2% on the principal amount prepaid
HDFC [ Get Quote ]	0 to 2% on loans If a prepayment is made within 3 years of the first disbursement subject to terms and conditions, 2% on the prepayment amount if the amount being repaid is more than 25% of the opening balance.
SBI [ Get Quote ] Home loans	No prepayment penalty if the loan is prepaid from own savings/windfall gains for which documentary evidence is produced by the customer.

How prepayment can benefit you?

Perhaps, the biggest benefit of prepaying loans is saving on the net interest payable. Usually you could find out how much you save on the interest based on the amortization chart provided by your bank.

Moreover you could own the asset bought on loan earlier than planned. Some banks also allow for part-prepayments say every quarter. This could effectively bring down the principle amount and the outstanding loan amount and subsequently the net interest.

Here's an example.

Ramesh took a home loan of Rs 20 lakh for 20 years as loan tenure and at an interest rate of 12 percent. At the end of 20 years the net interest would be Rs. 32.85 lakh. Instead Ramesh decided to pay two additional EMIs every year, which would mean he could close the loan in 13 years time.

His bank loan agreement had mentioned that there would be no prepayment penalty unless he paid off more than 25 percent of the principal in a year. The table below shows two scenarios and how opting to pay extra EMIs in a year actually helped Ramesh save on interest.

Details	Scenario 1 – 12 EMIs/year	Scenario 2 – Two additional EMIs every year
Interest rate per year	12%	12%
Tenure of loan	20 years	Since two additional EMIs are paid every year the loan tenure is reduced to 13 years
Amount of loan taken	Rs 20 lakh	Rs 20 lakh
Net interest paid	Rs 32.85 lakh	Rs 19.58 lakh

Prepayment can be made in part or in full. If you have plans to make a full repayment read carefully on prepayment penalty charges on your loan agreement. Some banks might allow you to prepay up to a certain period without any prepayment penalty. So you can garner enough funds to foreclose before the expiry date.

If your loan agreement allows you to make part prepayment, then you could do so every quarter. This way you can save some money, reduce the principal and the outstanding loan amount and the net interest rate.