What are Bonus, stock splits, rights issue and buybacks?

There are many corporate actions that a company takes that will affect the stock. Understanding the different corporate actions is important to help you determine whether to buy or sell the stock and how that action will affect you as a stock holder.

A corporate action is initiated by the board of directors, and approved by the company’s shareholders by voting on the issue.

Bonus Issue

bonus stocks giftWhen a company gives a bonus stock to it’s shareholders, it allots extra stocks to them. They are a gift to the shareholders for trusting and investing in the company. The bonus shares are issued out of the cash reserves of the company. You basically get free shares or equity against shares that you currently hold.

They are typically allotted in fixed ratios such as 1:1, 2:1, 10:2, etc. When a company allots bonus shares in the ratio of 2:1, for each 1 share you hold, you get back 2 additional shares at no extra cost. So if you hold 100 shares of a company (current price of Rs.60) and the company issues bonus at 2:1 ratio, you will get get an extra 200 shares and the total number of shares you hold will increase to 300 shares.

Remember its only the number of shares that increase. The overall value of the investment will remain the same. After the bonus is given the price of the each share will go down by the same ratio. So the price falls from Rs.60 to Rs.20.

Rs.60*100 = Rs.20*300

Your value is the same. But you have just received free shares of the same face value.

Lets see some more examples:

Bonus Ratios and Examples
Bonus Ratio No of shares before bonus Share price before bonus Value of investment No of shares after bonus Share price after bonus Value of investment
1:1 100 Rs.50 Rs.5000 200 Rs.25 Rs.5000
2:1 100 Rs.60 Rs.6000 300 Rs.20 Rs.6000
10:2 100 Rs.100 Rs.10000 500 Rs.20 Rs.10000

Stock Split

stock splitStock Split literally means what you think it means. The stock is actually split. When a stock split happens, the number of shares held increases, the value of your investment remains the same. The only thing that gets split is the face value.

If a stock’s face value is Rs.10 and there is a 1:1 stock split, then the face value is now split into 2 (Rs.5) and for every 1 stock you hold, you will get 1 more extra stock. Since the face value is now decreased by half, the current price of the stock also falls by half. If the price previously was Rs.60, now it will be at Rs.30. So the value of your investment remains the same.

Stock Split Ratios and Examples
Split Ratio Old FV No of shares before split Share Price before split Value of Investment before split New FV No of shares after split Share Price after split Value of Investment after split
1:1 Rs.10 100 Rs.50 Rs.5000 Rs.5 200 Rs.25 Rs.5000
5:1 Rs.10 100 Rs.100 Rs.10000 Rs.2 500 Rs.20 Rs.10000

Rights Issue

This is also frequently seen in markets. Companies announce a rights issue to their existing stock holder. This is just a way to way to raise fresh capital. Instead of issuing a fresh IPO to complete strangers, the company does a rights issue to it’s existing shareholders.

The shareholders can subscribe to the rights issue, if they wish depending upon the proportion of their share holding.

For example if a company does a 1:5 rights issue, it means for every 5 shares you hold, you can subscribe to 1 additional share. The advantage here is you will be able to subscribe to the new shares at a lower price than the current market price.

But remember subscribing to all rights issue isn’t advisable even though you get shares at a discount. You should always look at the fundamentals of the company and what the company’s future plans are before infusing fresh capital into it. And remember, if the rights issue price is almost equal to the current market price, there is no use in subscribing to it.

Since fresh money is brought into the company and new equity is given to the shareholders, the price of the existing shares doesn’t get directly affected by this.

Buyback of shares

Some companies announces a buyback of shares, if it has excess cash reserves and wants to reduce it’s outstanding shares in the market. It will given announce a fixed amount for each share and shareholders can choose to give off their shares back to the company at that price.

Shares BuybackUsually the price is slightly higher than the current market price so that it provides an incentive for the shareholders to use the buyback opportunity.

Companies does buybacks for one or more of the following reasons:

  • Consolidate the promoter’s stake in the company.
  • Increase the promoter holding percentage thereby showing confidence to the other shareholders.
  • Prevent competition from taking over the company.
  • Also maybe delist the company at a later stage.

Fundamentally, these reasons show that the company is confident about itself. And this decreases the liquidity of the share and thereby increases the stock price. Another reason for the stock price increase is the market is usually efficient in matching the current price with the buyback price. So the price oscillates around the buyback price till the event actually happens.

Dividends

dividendsThese are a portion of the profits that the company gives to it’s shareholders. Many companies typically give one or more dividends per year. They are announced as a percentage of the face value of each stock. So if a stock’s face value is Rs. 10 and the company announces a dividend of 100%, you will get Rs.10 as dividend for each stock you hold.

Rs.10 * 100% = Rs.10.

There are companies which doesn’t pay dividends too. That doesn’t mean they are not good companies. They just decided that instead of paying the shareholders the profits, they decided to reinvest the profits back into the business.

Also you should note that even if a company makes a loss for a year it can decide to give dividend from the excess cash reserves it has.

Since the company has given out money it has as dividends, the stock price would also reflect the new value of the company. So if a stock is at Rs.100 which announces a dividend of Rs.10, on the date the dividend is calculated (called ex-dividend date) the stock price will drop by Rs.10 (to Rs.90). So even if you buy a stock after the ex-dividend date, you get the share of the company based on what it was valid even after subtracting the dividend.

The only advantage of dividend is it is not taxable in the hands of the shareholder(up to a limit of Rs.10 lakh since 2016). So it was a good way to take some money out of the company for the promoters.

In the next article lets see what the different dates related to these corporate actions are and buying on what date lets you enjoy the benefits.

Last minute tax savings investments

Mar 31 CalendarIf you are a salaried employee the next 1 month is when your company’s HR/Payroll department keeps bugging you for your tax savings. And many employees haven’t done any investments for tax savings for this year or haven’t completely maxed out your 80C. If you also belong to that camp, there would be some colleague or friend who would try to sell you some LIC policy or a ULIP policy. But you know that you handling your insurance and investment yourself will lead to much better returns than buying an ULIP at the last moment.

If you checked my previous article comparing ULIP vs ELSS mutual funds you see that I suggest taking a term insurance and then doing a monthly SIP into a ELSS fund. Doing a monthly SIP would protect you against the ups and downs of the market. But since you missed your opportunity to start your SIP at the beginning of the financial year, you are now stuck with buying your fund at a lump sum amount. If the markets fall down after you just bought your fund, you will be at a significant loss. But there is a solution to that too.

I am assuming that you have not done any of your 80C investments and you have 1.5 lakhs ready to be invested. If you are contributing to an EPF (Employees Provident Fund) then subtract that total amount for this year from 1.5 lakhs and likewise subtract any life insurance premium you have paid.

Step 1: Get a Term Insurance first

If you don’t have a life insurance yet and you have others who are financially dependent on you, you need a term insurance first. There are numerous websites where you can search and compare different term insurances. Two of the popular ones are Policy Bazaar and the new CoverFox. First decide on a sum assured value which needs to be at least 10-12 times your current annual income. So if your annual salary is 10 lakh, your cover should be 1.2 to 1.5 crores.

Choose whichever policy is lowest price and has a decent claim settlement ratio. You won’t need any of the fancy riders or add-ons to your policy. Buy your policy online and you will be asked numerous questions. Please fill it in accurately. You would also be asked to do a health checkup (which is mostly to detect if you are a smoker or not). After all those are done, your policy document will be emailed and also sent by post to you. Now your insurance is done so you can subtract the amount you paid as premium from the 80C 1.5 lakhs limit.

Step 2: Put remaining money into ELSS

Next is investing into an ELSS fund. There are numerous ELSS funds and it is difficult to choose a good ELSS fund these days. You should get a professional financial advisors help if you can’t choose one yourself. But if you can spend a few hours you can identify good funds yourself. Goto websites like ValueResearchOnline and search for a section called ELSS. It would have different funds that are sorted by star rating. Just ignore the star rating.

Instead check for funds which has consistently performed well and given good returns even if the market is not doing good. Those fund managers know how to really pick the right stocks to invest in even if the market is on a downtrend. You can also check what kind of companies that fund invests in and how it has performed over the past 5 years. There are also neat graphs to show how an SIP in that fund would have performed.

Now we unfortunately can’t do an SIP today as we don’t have enough months remaining in the financial calendar. But we have enough weeks remaining – and as of Monday (Jan 30), exactly 9 weeks to March 31. Lets assume that you have to invest 1.4 lakhs into ELSS dividing it by 9 weeks, you have to invest Rs.15,555 per week into the fund.

Weekly SIP
Invest your weekly amounts on the dates marked in red

I can hear you asking that there is no SIP option for weekly period.
Yes there isn’t.
Does it mean you have to login to your mutual fund website and manually invest in the fund every week?
You can do that, but No. There is an easier way.

For this week, invest the first week’s amount manually. Then in the same fund house choose a Liquid fund. Make sure that the fund has no exit charges. Put your entire money into that Liquid Fund and search for an option called STP and set it up to transfer the weekly amount from the Liquid Fund into the ELSS fund on a specific day of the week.

STP to the Rescue

STP means Systematic Transfer Plan. It is an easy way to transfer money from one fund into a different fund within the same fund house. STP allows you to transfer money weekly, fortnightly, monthly or quarterly. Once you have set it up, transfers money from the Liquid Fund into the ELSS fund (just like you would have done a monthly SIP from your bank account to the ELSS fund).

And since you are doing a weekly transfer, even if the markets fall after week 1 or 2, you will be able to capture the fall over the next weeks. And the best part is once you have set it up, you wouldn’t have to lift a finger as everything is automated. End of the March you would have invested all your 80C money into an instrument which is both tax efficient and also have protected it against the market volatility.

Don’t forget to setup an SIP per month for the right amount from April 2017 to Mar 2018 (or till any year you want to).

Remember to use this STP only if you haven’t done your full 80C savings this year. Doing your regular 80C investment via STP instead of SIP would also work, but if you forgot to put in the money in your Liquid fund your STP would stop and you wouldn’t remember to check it. Instead go for a simpler SIP as the difference between a monthly vs weekly investment wouldn’t be too much over the long run.

At least from the next financial year onwards be more regular in your investments and make sure you don’t get stuck with a bad investment at the last minute. If you have any other ideas on savings tax better with only 2 months remaining, please comment below.

PS: This is just a simple idea for people to invest at the last minute. Each person’s financial situation might be different. Please get in touch with your financial advisor (you do have one right?) or email me at srini@getricher.in for help.

Common Misconceptions about Mutual Funds

Mutual Funds are an easy way to invest your money and let professional fund managers handle the hard part of choosing the right place to put your money in. But there are numerous confusions and misconceptions around mutual funds that I want to clear in this article.

Myth: Mutual Funds is just for equities

Fact: Mutual Funds are not only about investing in stocks or the equity market. There are different types of funds which are classified based on the underlying asset classes they invest in.

  • Equity Mutual Funds – invest mostly in equities (note mostly. SEBI says minimum it should have 65% in equity)
  • Debt Mutual Funds – invest mostly in debt or fixed income
  • Liquid Funds – invest in very short term (< 91 days) instruments like treasury bills.
  • Gold Funds – they invest in gold and track the price of gold.
  • International Funds – they invest in stocks of international companies and track foreign stock indices like Nasdaq.

People who want to invest in any kind of assets can invest using Mutual Funds and get the help of professional fund managers to handle their money.

Myth: A mutual fund with lower NAV (Net Asset Value) is cheaper and better

Fact: A fund’s NAV doesn’t matter because it represents the market value of all the fund’s investments and doesn’t depict the market price.

To understand it better: Lets say Fund A and B invests in the same portfolio of stocks. Only difference between then is the NAV of fund A is Rs.10 and fund B is Rs.100. After a year the stocks increase in value by 10%. So the NAV of fund A will be Rs.11 and of fund B will be Rs.110.

NAV of two funds

So your money grows by 10% and it doesn’t depend whether you invest in fund A or B.

Myth: Mutual funds are long term investments only

Fact: There are mutual funds which are suitable for short term investments too. They are funds which invest in bonds or even treasury bills which are protected for returns for a short duration. If you are in the highest tax bracket parking your excess money in Liquid funds or ultra short term funds are better and tax efficient than fixed deposits.

Myth: One needs lot of money to invest in Mutual Funds

Fact: No. You can invest in mutual funds even if you have just Rs.1000. And you can start an SIP even with Rs.500/month. Compared to investing in real estate or Gold, this is one of the best investments which doesn’t require lot of money.

Myth: Any investment in mutual funds enjoys tax benefits

Fact: Only ELSS (Equity Linked Savings Scheme) funds enjoy tax benefits under section 80C. And they too have a limit of Rs.1.5 lakhs per year. Remember any investment made in ELSS are locked in for 3 years.

Myth: Invest in lot of funds to properly diversify

Fact: Investing in lot of funds doesn’t help. Remember a fund just a collection of different stocks that a fund manager chose to invest in. Most of the funds would have a lot of overlap in the stocks. Also over diversification also hurts your returns. It is better to invest in only 1 good fund under each fund type.

Multiple funds

I personally am invested in 1 ELSS, 1 Large Cap, 1 Mid Cap and 1 Small Cap fund. There is no use in investing in 3 or 4 funds under each category.

I hope this has cleared some common myths surrounding mutual funds. Now the only problem is how to choose the right fund and how to invest in it the right way. Will cover it in future articles.

How to repay your credit cards instantly

In my last article I explained everything about credit cards and how easy it is to fall into the debt trap. If you haven’t read it, go and read it first. Two basic things should be obvious from that article:

  1. Interest Rates on credit card debt is one of the highest ever for an individual
  2. Paying just the minimum balance every month will take you years to clear off your debt and you lose a lot of money by paying interest.

We will take the same example of a credit card having an outstanding balance of Rs.1,00,000 and 3.25% interest rate per month. Lets also assume that your salary is not enough to repay the entire debt in a single month after all the expenses.

So you were paying only the minimum balance of Rs.5000 per month. But you saw that it will take 33 months to repay the entire debt. What if you wanted to repay it sooner? For that to happen there are two factors that play a role here:

  1. The bank should reduce your interest rate (Yah! like that is going to happen so easily)
  2. You pay slightly more than the minimum balance every month. With a little bit of proper budgeting, this is easier to manage and is within our control. Lets take 3 examples and see how each works out.

Lets take 4 possible scenarios:

  1. You are only able to pay the minimum balance of Rs.5000 per month.
  2. You are able to pay 10% more than the minimum balance. So instead of paying Rs.5000, you can pay Rs.5500 per month.
  3. You are able to control some of your expenses and can pay back Rs.10,000 per month. Double of your minimum balance.
  4. You got a raise and also cut down on your expenses. Now you are able to pay back Rs.20,000 per month.

You can plug in these numbers in one of the numerous calculators online or can check out this graph that I drew with the calculations already done.

Amount vs Time taken to pay
Monthly Amount vs Time taken to pay
Option Monthly Payment Num of Months Interest paid
A 5000 33 Rs.64,133
B 5500 28 Rs.53,711
C 10000 13 Rs.22,924
D 20000 6 Rs.10,972

This shows that even a small 10% increase in the monthly payments helps a lot by saving you 5 months and more than Rs.10000 as interest paid to the bank. If you have credit card debt make sure that you are putting in as much money as you can into your monthly payments.

What about very large outstanding balances?

There are numerous people who got too deep into the credit card debt trap, that it would take them many years to finish repaying their bill. What to do in those cases? Here are 7 ways that you can get out of your credit card debt almost instantly.

Credit Card Repayments

1) Break your savings/investments

If you have money lying around in your savings accounts or fixed deposits, break them and use that money to repay your credit card bill. Your fixed deposits might earn you 8% per annum. But remember your credit cards are making you lose 39-42% per annum. You will definitely be profitable by paying off your debt first than not breaking your fixed deposits.

Also remember it doesn’t have to be just FDs, but it could also be money that you have invested in mutual funds or bonds, etc. As long as you keep losing money servicing your debts, any investments would give you a net negative return on your networth.

2) Take a loan from friends/family

If you have a good relationship with friends or family, you can take a small loan from them to repay the bill first. Most friends/close family would give you money for zero or very low interest rates. Even if you agree to pay a bank FD rate to them, they would be profitable and you also would get a loan at much lower rates than banks.Win-Win situation to both parties. Also, it is easier to convince a close friend or family member.

3) Take a personal loan from your bank

Go to the bank with whom you have a good relationship and talk to the manager to get a personal loan for the amount you have to repay. The interest rates for personal loans are much higher than what you can get a friend to agree to, but it is definitely lower than a credit card debt. Personal loans are at a rate of about 16%-20% per annum and you end up paying half the interest rate than a credit card.

If your credit report is bad and your CIBIL score is too low, you can go for a secured loan. You have to give a collateral to the bank and get a loan. You can also try gold loans or top-up loans if you have a home loan already.

4) Convert Credit Card debt to EMI

Most banks gives you the option to convert Credit Card debt into EMIs which has a much lower rate than the APR – usually 13%-16%. You can also chose to convert it to an EMI immediately after purchase and you also get different repayment tenures like 3/6/9/12/24 months.

5) Balance Transfer to a different Card provider

Lot of banks provide a balance transfer facility to get new customers. All you have to do it become a new customer with a bank and the new bank will pay off your old credit card fees and will transfer the outstanding balance to your new card account. And as an incentive for you to join a new bank, they give interest free period of few months and very low interest rate for initial 6 months.
Eg: SBI offers a 0% interest for 2 months or a 1.7% interest/month for 6 months. Depending upon your balance to be paid and your repaying capacity you can choose whichever plan suits you.

6) Negotiate a lower interest rate

Remember I said lowering the interest rate means you get to pay back sooner? You can go to your bank and explain your financial situation to the manager and try to negotiate a lower interest rate. You have to convince them that you are willing to pay and intent to do it fully within a few months once your financial situation gets better, you can shave off a few percentage points off the interest rate. It is a long shot, but you can try it.

7) Credit Card Settlement

If all else fails and you think you can never completely pay off the entire balance, you can go in for a settlement. You have to go to your bank and negotiate a settlement amount (which is lesser than the outstanding amount). Once you pay off the settlement amount, your balances are cleared and you are free to go. Except this involves the bank reporting to CIBIL about the settlement and it will severely affect your credit score. Always use this as a last resort.

Be warned, all these are solutions only if you are unable to repay the balance easily. These solutions shouldn’t give you some sort of safety net to get into the debt trap.

3 Golden Rules to using a credit card

Always remember these 3 rules when using a credit card:

  1. Never spend more than you can afford.
  2. Pay your credit card bill at least 3 days before due date. Better enable auto debit facility from your savings account so you don’t have to remember it.
  3. Never lose money by paying unwanted interest rate to the bank. Remember no one has ever become rich by losing money.

Understanding Credit Cards and the debt trap

Credit cards! The smell of a freshly pressed plastic card is like a drug to many. Young people these days spend money using the credit card like it is real cash. They don’t realise that it is a loan that you take from your bank and you are supposed to pay it back with interest (a really high interest rate too).

As of October 2016, there were 2.73 crore credit card holders in India and with all the excess cash in banks due to demonetisation and cashless transaction drive by the Government, this number would increase a lot as banks will now try to give more credit to it’s customers and people get comfortable with online shopping.

credit cards

But first let us understand how credit cards work and the different terminology used.

Interest Free period

Credit cards are a great way to buy stuff without paying the entire amount on the day of purchase. The banks also give the customers a interest free period per month of upto 50 days. To understand that, lets say your credit card bill gets generated on the 5th of every month and your pay-by date is 25th of the same month.

You are buying a TV for Rs.1 lakh on the 6th of January. The seller has delivered the TV and the bank has also paid the seller the money. You haven’t paid the bank yet and your bill will be generated on the 5th of February at midnight. On 6th February morning you will get an Email and SMS about your bill amount of Rs. 1 lakh and that you need to pay it by 25th of February.

As long as you pay the entire amount of Rs.1 lakh on or before 25th February, you have practically gotten free money from the bank for 50 days. Neat right? This is a great way to handle urgent needs and cash flow crunches.

credit card statement
My own credit card statement

I have taken the example from my own credit card statement. The only difference is the amount payable.

Also what is the credit limit? This is the total amount that the bank allows you to spend. Do remember that this isn’t what your spending limit is. Your spending limit is based on how much you can repay and how much you really want to buy. And available cash limit is how much cash you can take out of the card from an ATM machine.

What happens if you keep paying only the minimum balance?

In your credit card statement you also notice in big bold letters that your minimum balance is just Rs. 5000 per month. So you bought something for Rs. 1 lakh and you just have to keep paying Rs. 5000 per month and you would have fully paid it off in 20 months right?

WRONG!

The bank gives you money as loan or credit and for that facility you have to pay the bank an interest. The bank calls that Revolving Credit Facility where as long as you pay the minimum balance for the month, you wouldn’t get into (too much) trouble. Problem is the interest rates these banks charge you.

Interest Rates

Credit cards have the highest interest rates of all the loans/credit that the banks give, because it is an unsecured loan, you don’t submit any collateral to the bank while applying for one. When the bank sales person comes and sells his credit card plans notice how he would say the interest rate is a very nominal (I hate that word) rate, typically something between 2.95% to 3.5%. What they wouldn’t clearly explain is that number is the interest rate you would pay monthly and the annual percentage rate (APR) is that number multiplied by 12. That translates to 35.4% to 42% per year.

APR vs APY

That interest rate x 12 months = APR is a nice and easy number to calculate and the banks usually mention that in their Schedule of Charges section of the brochure in a 10 pt font. But the people who run banks aren’t stupid. Unlike most of us, they know and understand compounding like the back of their hand. APR is just simple interest and doesn’t take it account the power of compounding.

Compounding is a way for the banks to earn more money from your spendthriftiness. To know how much you are really paying, you would have to understand something called the Annual Percentage Yield (APY), also known as Effective Annual Rate (EAR). So the APY will always be slightly higher than the APR.

To understand the difference between APR and APY, lets take a very nominal (there’s that word again) interest rate of 3.25% (which is the average you would be getting as a new customer).

APR: This is easy. 3.25×12 = 39%
APY: We have to use the Compound Interest formula for this.
= (1 + monthly interest rate) ^ number of months in a year – 1
= (1 + 0.0325) ^ 12 -1
= 1.0325 ^ 12 – 1
= 1.467846 – 1
= 0.467846
= 46.78 %

Wow. Look at that number. There is a world of a difference between the APR and the APY. No bank ever tells you this. Who in their right mind would say you would be paying nearly 50% as interest rate every year? Thats why banks stick to the monthly interest rate or the APR (which is a relatively smaller number).

It only gets worse when you have a balance to be paid on your card and are making more purchases. All purchases when you have a existing balance on your card doesn’t get to enjoy the interest free 50 day period. You have to pay interest the day you make the purchase.

Coming back to paying the minimum balance of Rs.5000 per month, can you guess how many months it will take to pay off all your credit card bill at a nominal 3.25% monthly rate?

Frickin’ 33 months.

And you would have paid Rs. 64,133.20 as interest to the bank along with the original principal of Rs. 1,00,000. You have paid Rs.1,64,113.20 for that TV by not properly using your credit card.

This is of course assuming you haven’t made any extra credit card purchases in that 2.8 years, which is very, very hard. If you add more purchases, your outstanding balance keeps increasing and you would be caught in a never ending debt trap.

This is what many people using credit cards don’t understand and end up losing a lot more than they can earn.

Always remember, the first rule to getting richer is to NOT LOSE MONEY. And misusing your credit cards is a really easy way to lose a significant chunk of your net-worth. In my next article I will be writing about how to get your credit card loans fixed and not lose any more money.

Update: Read the second part of this article – How to repay your Credit Card Debt instantly.