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Mistakes I made trying to save tax

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When I started on my first job, I didn’t know much about income taxes and how to save money on paying it. So I let my Dad to handle all my tax savings. There were many mistakes that were made as a result of that.

Buying traditional LIC policies

Technically my dad can’t be blamed for taking these LIC policies. Because thats what he did when he started earning. During those times Life Insurance Corporation of India was the only company which provided life insurance and it was the only way to save a bulk on your income tax.

That is no longer true as there are numerous other companies which provide Term Life Insurance with quite a large amount of life cover at very low prices. Spending almost Rs.45,000 per year on LIC policies to get the 80C deductions is a complete waste of money.

At least my dad invested in 5 separate policies in a staggered manner (one every year) and they were money back policies. So every year one policy will return back a portion of the money invested. This reduced the amount of outgo every year, as the cheque I receive from LIC will pay a part of the premium every year. This is much better than the endowment policy which gives your money only at the end of the term.

Investing in ULIP

ULIPs are a very bad form of investment/insurance. It is evident with all the mis-selling that were done by the brokers and SEBI finally putting in more rules. Rs.5000 was put in a Unit Linked Insurance Policy by UTI because my dad’s friend suggested it. The amount I paid every year and the life cover & returns that I got wasn’t worth it.

Both the insurances I had bought returns less than what inflations eats from my savings. Must’ve opted for term insurance and skipped all the other forms of insurances.

Investing in ELSS funds in bulk at the same time

ELSS or Tax saving Mutual Funds allow you to invest in equity and also save tax. The only restriction is a lock-in period of 3 years. I invested in about 5 ELSS funds in the end of year 2007 for a huge amount.

While investing in equities is a good thing, I made three mistakes here:

  1. Invested just when the market was touching its all time highs.
  2. Putting all the money at the same time. The goal I had was to save taxes – not invest the money.
  3. Investing in 5 funds is a bit too much. Especially when all 5 were ELSS funds and almost had the same goals. I didn’t diversify in the right way.

Result? The returns I received was dismal. Even though NIFTY/Sensex is back to its highs, the funds haven’t reached the old NAVs. Meaning I am still in negative.

Tomorrow I will write how I could have done a better job in the Mutual Funds by using something called SIP (Systematic Investment Plan).

Nifty BeES – the only equity investment you would need

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Yesterday I explained enough about the equities market to help understand the basics. Now in this post I will tell about a single Scrip that you can invest which has low risk and can return gains equal market gains. Indian equities market has given an average annual growth of about 16% over the long term. Imagine a stock which will give you 16% annual returns if invested over 30 years.

If you don’t want to understand anything and don’t want to think about your equity investment, just remember this one sentence. It will work for 95% of people.

Buy N shares of NIFTYBEES every month.

Thats it. Simple right? For example, If you have a surplus of Rs.10,000 every month that you want to invest in equities – close your eyes and instruct your broker to buy Nifty BeES for the Rs.10,000. At today’s rate (Rs. 576) you would get about 17 shares of Nifty BeES. Investing every month, you would have a few hundred shares of it in a few years, which would continue to grow as long as you stay invested.

Now for the longer explanation.

What is Nifty BeES?

Nifty BeES is an ETF (Exchange Traded Fund) by Goldman Sachs, which tracks the Nifty Index. To explain in simpler terms, Goldman Sachs has a computer program which takes your money and uses it to buy the equivalent number of all 50 stocks that the component of Nifty Index. Each single share of Nifty BeES is priced at 1/10th of the Nifty Index.

If Nifty is at 5700, the price of Nifty BeES would be (about) Rs.570. So if you buy 1 stock of Nifty BeES, the ETF would have invested in all of the 50 shares in Nifty. But you can say one can’t buy all of the stocks with just Rs.570. Right, but when lakhs of people buy it, the fund can buy enough stocks and your returns will be weighted according to your investment.

Why not buy specific company’s stocks?

You might be very interested in investing in specific company’s stocks because thats what everyone does and the people on TV are so experienced and say that they have 100% strike rate in picking winning stocks.

Do they really? No. This is a common problem when it involved finance matter (just like in astrology). They don’t talk about predictions that failed. Instead they make you focus on how their choice of one particular stock earned them 60% returns. They don’t talk about the 10 other stocks which made investors lose more money than they earned in that 1 winning stock. People are easily affected by “confirmation bias” and it greatly affect their investments.

Remember no one can select winning stocks every time. And you won’t know in advance which prediction would work out and which wouldn’t. If you invest in all the predictions they make, you would end up making more loss than profits.

How about mutual funds?

Mutual funds are managed by humans who check the fundamentals of a company and try to guess when to invest in a company and when to exit it. But like I said they are no better than the financial experts you see on TV.

Add a small fee that you need to pay the fund manager to handle your money, called “Expense ratio”. You would end up losing money before even making a bit of profit. All this for just some mediocre stocks picked by some human.

How is Nifty BeES different?

Nifty BeES is an index fund – your value of the investment would increase if Nifty increases, and it would fall if Nifty decreases. The value of Nifty is closely tied to how the Indian economy performs. If all the industries are doing well, nifty would definitely increase.

Whenever a company is removed from the index and a new company is added to the index, the ETF automatically makes the adjustment in the investment. It is exactly as if you are investing in these 50 front line companies. When invested in the long term you would definitely have increased your investment multiple times.

How is it less risky than buying a company’s stocks?

It is definitely less risky than buying a separate company’s stocks. Because you are investing in 50 stocks spread over about 22 sectors. How much more diversification do you need? Even if one particular sector is not performing well, say metals/sugar, there would be other sectors which would be performing well, like IT industries because of higher dollar price. Your investment would grow even if a few sectors underperform. Incase of a total bear market, your investment wouldn’t fall as badly as investing in a few companies.

Why not buy these 50 companies individually?

You can buy all the 50 constituents of the Nifty Index individually and get the same effect. But the advantage of buying Nifty BeES instead is you can invest a very small amount every month and it would grow at the same rate as Nifty. To buy even a single share of all Nifty companies you would be needing a much higher investment.

Managing the weightage of the different companies and reshuffling the portfolio whenever a company is taken out of the index and a new one is inserted, would be a headache. Which is easier, tracking 50 companies in your portfolio daily or tracking a single ETF once a month, just for 5 minutes to see how much profit you earned? Thats why the ETF has computer programs which do this automatically. And since it doesn’t have any human to make any decisions, you are protected from someone’s mistakes.

How do you buy it?

Buying Nifty BeES is very similar to buying a company’s stocks. Ask your broker or goto your online trading website and search for the scrip “NIFTYBEES” and buy the required quantity. Some brokers even have an option to invest a fixed amount or buy a fixed number of shares every month, called Monthly SIP (Systematic Investment Plan).

If your broker has that option, choose that and automatically every month your money is invested in Nifty BeES and you don’t have to even think about it. When you retire 30 years later, you would be sitting on a nice, fat load of profits than any of your friends. And the best part is, you wouldn’t have to pay a single rupee as taxes for any of this profit you earn (after 1 year of investment).

Just trust me on this and invest in Nifty BeES regularly. This is more than enough for 95% of a common man’s investment needs. Especially for beginner, start with Nifty BeES for 3 years and see the difference it makes vs your friends who invested in some new company.

Everything about Equity markets

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For many, investing means buying shares in the Stock Markets. You should be knowing that it isn’t the only place to invest, equities are a very important piece for any serious investor who wants to grow his wealth.

Let me first explain a few basic terms that you might hear when asking to invest in equity market.

Shares/Stocks: This is the first word that you might have heard. This means a “share” of a company. If you own a “share/stock” of a company, you are a part owner of the company. You can own any number of shares of a company (willing to sell its shares) if you can pay the cost for it.

DeMat Account: Just like your savings account holds your cash, a DeMat account will hold all your shares. Long time back, companies issued share certificate which was a piece of paper saying the holder own N number of shares. There was a risk of theft and if the certificate was burnt or torn, very hard getting it back. But now everything is stored electronically in your DeMaterialized Account. Also you can do transactions ultra fast.

Dividends: Profits earned by Companies are split amongst its investors based on the number of shares they hold. Usually companies announce one or more dividends every year based on its performance.

Share market/Stock Exchange: These shares can’t be sold or bought in the nearby groceries shop. There is a special marketplace called stock exchange where buyers and sellers meet and do their transactions. In India, there are three such exchanges where you can buy/sell company’s shares – The Bombay Stock Exchange(BSE), National Stock Exchange(NSE) and Multi Commodity Exchange (MCX).

SEBI: Securities and Exchange Board of India, is a regulatory authority who monitors the exchanges, brokers and investors. They have a set of rules and guidelines, which everyone must adhere to. Any problem that the investor has with their brokers or the company, they can complain to SEBI and they would take immediate action to rectify it. SEBI’s primary duty is to protect the investors by making things as transparent as possible.

Nifty and Sensex: You must have heard these terms used pretty often in news, especially like “Nifty has gone up”, “sensex has fallen”, etc. These is just a number that shows how the overall market has performed over a time period. It is what is called an “index”. If the index has fallen, it means most of the stocks in the market has decreased in value. If the index has risen, it means most of the stocks in the market has increased in value.

The reason I say “most of the stocks” is these indices are composed of many shares from a wide range of sectors like banking, infrastructure, IT, capital goods, engineering, automobiles, etc. Nifty tracks the value of 50 such companies and Sensex tracks the value of 30 companies. It shows up as a number whose calculation is based on the weightages of particular companies in the index.

There are other popular indices like Bankex, Bank Nifty, CNX IT, etc., but these two are the most popularly discussed index.

Stock Broker: A Broker is a third party who acts as your representative in the market whenever you want to buy or sell a stock. He charges a very small percentage of the transaction you make. Eg: if you bought something for Rs. 1000, he would charge maybe Rs. 5 as brokerage (just an example).

Scrip: This is a short form for the stock you are looking at. Eg: the stock of Infosys would be under the scrip name “INFY” and of State Bank of India would be called “SBIN”. Mostly you wouldn’t need to remember this as lot of sites allow you to search using the company name. Note: Do note that it is SCRIP and NOT Script.

Bullish/Bearish: When people say the market or a stock is bullish, they mean it is rising. When they say its bearish, they mean it is decreasing in value. Sometimes the market or index or stock can be in a bullish/bearish phase for several months together. Investing in the beginning of a bullish phase and selling before the bearish phase is the wisest thing to do. But even the most experienced investors can’t predict it accurately. bull_and_bear

How does the price of a stock increase or decrease:

This is confusing to many of the first time investors. Who determines how much to pay for a stock? Answer: the people in the market. It is based on the basic law of demand vs supply. For a quick explanation: Lets say you want to buy a stock of some company. You ask goto the exchange and ask if someone is willing to sell you 1 stock at Rs. 100. If you find someone willing to sell at that rate, then great. You just pay him the money and you get your stock (not that simple as it involves brokerage, etc). If there isn’t anyone to sell at Rs.100, you can see at what rate everyone are quoting and you find that the minimum price they are willing to sell it is Rs. 110. Not you can choose to either take up the offer (by paying Rs.110) or wait a little longer for someone to come in and sell at Rs. 100.

You and the other participants in the market are actually deciding what price to buy or sell a particular stock. Usually the last traded price is quoted on the exchange websites or your trading site to give an idea of the current going rate of the scrip. That will save you from quoting Rs. 100 for a stock which averages around Rs. 2000.

How does one start to invest?

It is pretty easy for anyone to begin investing. All it requires is a PAN card and some address proof. There are many brokers who can help you buy and sell shares. Most banks also act as brokers. You need to ask your broker/bank to open a DeMat account and trading account. If you use a bank, they will link your savings account with the trading account (and would call it a 3-in-1 account). Else your broker would have ways to transfer money into and out of your trading account.

There is a small charge you need to pay every year for maintaining your Demat account. Also there is a very small percentage of all your transactions that the broker takes called as “brokerage”. Usually you can negotiate your brokerage to a lower one. But as you are an investor, it doesn’t matter as the number of transactions you would be making would be very small. It doesn’t matter if you pay a couple of rupees extra.

It would take about a week or so to open all these. You can choose to trade online or through phone. Online is pretty easy and you could call for a demo in the broker office. You would be given a user ID, password and a transaction password and you should enter these every time you need to login to the system. A bit tiring, but if you buy once a month or even less, shouldn’t be much of a problem.

How to buy a stock

Buying a stock is quite easy. Once you know what company you are going to invest in, you call your broker or goto the online trading site and say you want to buy N shares of the company X at the current market price or at some fixed limit price. Eg: Buy 10 shares of HDFC Bank at Rs. 650. Buy 100 shares of INFY at the market price (which means buy at whatever rate the sellers are selling).

However this is just the technicality. What is more important is the part you need to do before buying the stock: identifying the company, understanding its business, analyzing its financial status, calculating a value for it now and in the future, etc. A lot of things need to be considered before you even go to the broker to give your buy order.

I just bought a stock, it doesn’t show up in my Demat account yet

Even though all transactions are done electronically, it would take 2 more working days for you to see the stock you bought today. It is called T+2 days settlement (T is the transaction date). Similarly when you sell, you would get the money 2 days after you sold it.

How to sell a stock

Selling is also very similar to buying. Except you can only sell something you have bought earlier (Not entirely true, yes you can sell without owning a stock). But for an investor, selling means, selling your stocks which you have in your Demat account. Hopefully you would be making a profit by selling, by selling it at a much higher rate than you bought it for.

Selling can be done during the following three cases:

  1. You need back the money you put in and would like to get it back immediately. You don’t want it to grow to multi-millions and are contented with what you got now.
  2. You bought at a low price and now sitting at on a nice profit (paper profit, till you sell it and get the money in your bank account). You realise that the stock has reached a peak or plateau and there is nowhere else for it to go than down. There can be various reasons for it – maybe the technology is obsolete or the management has rotted the place.
    So you book your profits and get out before the others drag you down.
  3. You bought it at a high price and now the stock is selling at a much lower price. You want to get out of the stock trying to save as much as possible. You want to cut your losses (which is very important incase you chose the wrong company). This is called stop-loss and is very important for traders. Investors generally don’t have to worry about it as long as the company they chose is good.

This shows you how to make profit. “Buy low, sell high”. Simple. Thats it. You buy something for low and sell it for a higher price and pocket the difference. Eg: You bought State Bank of India for Rs. 1000, five years back. You sold it for Rs. 2000. Your profit: Rs.1000. See how I said 5 years and not 5 days.

Thats how it works. It takes a long time to earn significant profits. You can’t become a millionaire in a week. Don’t believe if someone says so.

What to buy/sell and when to buy/sell

Always remember this rule. “You need to decide what to buy/sell and when to buy/sell. Not someone else.”

Whatever decision you make in the stock market will affect you and your money. There will be many who will suggest you companies to buy because they heard some rumour. Or saying it looks cheap. Whatever you hear, remember the company you choose should be your decision. No one else will be affected if you lose your money.

Remember investing in equities is one of the most riskiest way you can put your money in some place. If you are willing to take the risk, you will be rewarded handsomely.

Tomorrow I will post on how to put your money in a scrip which has the least risk of erasing your wealth and at the same time returning returns which mimic the market’s returns.

How long is long term investment?

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In all the previous posts I have been saying to invest in the long-term for equity. Ask any good financial planner, they will also say you should invest in the long-term. So you can ask how long is long-term? 1 year? 5 years? 10 years? 30 years?

Actually, people have analysed past data from sensex from 33 years and have found out that holding your investment for 7 years yields the maximum return irrespective of the time you have started investing (in a bull/bear market).

They defined targets with 8% (average inflation rate), 10%, 12%, 15%, 16.2% (33 years market average return). Staying invested for minimum 7 years is all it takes to hit these targets.

Does this mean you take out all your money after 7 years? No. Of course not. The longer you stay invested, the better your returns are. The famous example always given is “if you bought 100 shares of Wipro for Rs. 100 each (Rs. 10,000 investment) in 1980s, it would’ve grown to more than Rs.535 crores by the year 2014.” Phenomenal growth by just staying invested for 34 years.

Remember that when you think you want to make money in short-term.

 

How to invest in gold the right way

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gold-coinIndians have an unexplainable love for gold. We can never have enough of gold. That is the reason jewellers go and announces various “auspicious day(s)” for buying gold. We also think that buying gold is a valid form of investment.

People always say that gold prices doesn’t always decrease (which isn’t exactly true if you look at historical prices). But Gold is an important asset class and everyone should have part of their investment made in gold.

Gold acts as a nice hedge against inflation as it increases along with inflation (mostly). So lets see what are the various forms one can buy gold in India.

Ornamental Gold

The truth is ornamental gold is never an investment. Because while we buy a gold jewellery, there are numerous extra charges which we have to pay for like making charges, wastage, etc. Sometimes, these all add up to even 30% more than the cost of the gold.

And when you go to the same shop to sell your jewels, they just give you money for the percentage of gold you have in the jewel. Thats right, all the making charges, wastage you paid is all your expenses and you don’t get it back.

Apart from that, most shops would want you to buy back some new jewels from them instead of giving you the cash. They would attract you with new designs and models and you would end up paying even more money from your pockets to get the new jewels.

Ornamental gold has an emotional value attached to it. People buy it for weddings or special occasions and wouldn’t want to sell it. The most that they can do is get loan by keeping the jewels as collateral and you would be paying extra money as interest. It isn’t that easy to convert gold jewels into money in an instant.

Gold Bars and coins

So how about buying gold as bars and coins. Most shops and banks/post offices sell 24 carat gold coins and bars starting right from 1 gram. They have a purity certificate and since it is in the form of bar/coins, they don’t have making charges/wastage. And they also assure you that, while selling back you would get the exact gold rate on that particular date.

So does that mean you can go ahead and buy it and store it in your safe and sell it when you need money? Not that easy. No bank or post office would buy back gold coins which they sold to you (even if it were just a few hours back). They just sell gold to you and their transaction is done. For selling, you would have to go to some gold shops and sell to them.

And what would these gold shops do? Right, ask you buy jewels from them instead of paying you by cash. Is there no way to get back money you “invested” in gold coins? You can, but you won’t get back that day’s gold rate. You would get only a discounted rate and so you are making a loss.

How else to “invest” in gold?

Now you are fed up and asking “How the hell am I supposed to invest in gold?”. There are two ways you can really invest in gold and get back money whenever you want to. Enter the world of Gold ETFs and E-Gold.

Gold ETF

ETF stands for Exchange Traded Funds which is a fancy way to saying “you give money to someone to help manage some security”. In the case of Gold ETFs, you pay money and buy N units (1 gram) of Gold. It is bought and sold like shares of a company in the stock market (NSE). Its all stored electronically in a special account of yours, called DeMat (Dematerialized) Account.

You pay the fund a small fees to manage your gold (though there isn’t much managing to be done). There is no problem of security, as all your gold stays in your account and cannot be opened/stolen by anyone else. The price of the gold ETF would track the price of a one gram 24 carat gold in the market.

There are many companies which sells Gold Fund and you can practically buy any one of them and you would have invested in gold. I would suggest the Gold BeES, because it is easy and can be bought directly from the NSE.

E-Gold

Then what is E-Gold? E-Gold is also an electronic way to buy and sell gold. Only difference is you would be buying Gold directly from the National Spot Exchange. You pay for whatever the price of 24 carat Gold was at the precise moment. No need for any fees to be paid to some fund house.

It is a good method of investing if you want to buy physical gold at a later stage. You can use the gold accumulated in your DeMat Account and buy jewels from the shop, without having to risk storing/safe guarding the gold in your safe.

Which form to buy?

For investing your money, always choose Gold ETFs or E-Gold. It doesn’t make a difference to both if you intend to stay invested in the long run. Both these are very liquid – meaning, if you suddenly want money you can tell your broker to sell X units of your gold and you would get back money immediately, without losing anything on wastage/impurity/etc.

But if you are buying gold for some wedding or as a gift to your wife so that she can wear gold to a function, you have no other option than to go and buy the gold jewels. But do remember that this money you spent to buy gold is an “expense” and not an “investment”.

Remember the difference between these and you would make sure you don’t “spend” more on gold and instead “invest” in it. Remember it is not advisable to invest all your money into gold too. There is the equity market where you would get much better returns if you are willing to stick around for the long term.

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