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Bank FD vs Bank Stocks – not the same

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A week back a caller to a Stock Market program in a local news channel asked the following question:

Instead of putting my money in Bank Fixed Deposits, isn’t it better to invest all my money buying bank stocks? After all stock markets give better returns right?

Hearing that made me go

There are three things wrong in that guy’s thought process. Lets see that in the reverse.

Stock Markets give better returns

Yes. It is true that Equity is the best form of investment which can beat inflation. But you need to remember that it works that way only in the long term. If you are thinking of putting in money and taking it out for some urgent personal expense within a year – please run away from equities. Anything less than 7 years isn’t long term enough. For some sectors or stocks even that isn’t a good enough time period. Short term volatility will give you heart aches.

Usually people investing in fixed deposits look at a time horizon of 1-2 or maximum 3 years. Of course you can invest for a maximum of 10 years in FDs, but normally people don’t do that.

You need to also remember that, even though stocks give higher returns, FDs have fixed returns. Whatever happens to the stock price, you will get assured returns of around 8-9%.

Invest all my money

This is classic mistake that people do when they hear of the phenomenal returns given by a few stocks. They put in all their money into equities. Even worse they put all their money in a specific sector or even a single stock.

I have heard of people saying “Banks are very important to an economy and its not like they will shut shop. Let me put in all my life savings in buying bank stocks”. Lot of investors have their own favourite stocks/sectors and its driven by nothing logical/fundamental other than hearing their friend or neighbour talk about it.

Remember the saying “Never put all your eggs in one basket”. Putting all your hard earned money in a single instrument is dangerous. A single bad news and your favourite company’s stock might never recover back to its highs. The same rule applies to equities/debt/gold/real estate.

You should learn to diversify your investment across different asset classes based on your financial goals, age, retirement year, etc.

Stocks instead of Bank Deposits

First understand the basic difference between a Fixed deposit and buying a stock. When you deposit money in a bank FD account, you are giving permission to the bank to lend it to other borrowers. You are loaning the money to someone else through your bank. The borrower pays an interest for the money borrowed to the bank, the bank takes a percentage as its profit and pays the remainder as interest to you at the end of the term.

When you buy a stock of a company (a bank in this case), you own a part of that company/business (that’s why it’s called a share). The money you put in has now become the actual company itself. The only way you will make a profit out of your investment is when the company’s performance is good.

If the company runs into a rough patch and is making losses and finally shuts down, your investment is all gone (at least mostly gone). But if you had a FD in that bank, the bank tries to  makes sure that your money is returned back to you before it can pay back its investors.

Also RBI (Reserve Bank of India) makes sure that all depositors are protected by an insurance up to a maximum of Rs. 1,00,000. So even if the bank shuts down without recovering its loans, Rs. 1 lakh of your deposit & interest is safe. Such insurance isn’t available in the stock market, thus making it a riskier mode of investment for your money. But remember with higher risks you also get the benefit of higher rewards.

So, next time you hear someone asking if putting their money in FD or equity is safer, you know what to reply to them.

 

How does Systematic Investment Plan work?

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Everyone knows that equity markets are quite volatile in nature. There are wide swings in the stock prices or the index values over a period of time.

From my previous post you should’ve known that I invested in various mutual funds when the market was peaking out in the end of 2007. After January 2008, the markets crashed and I didn’t invest even a single rupee.

Instead if I had put in all my money in October 2008, I would be sitting on a nice profit. Unfortunately, hindsight is always 20/20. No one could’ve known that the market was going to crash in January and it reached the bottom in October. Contrary to what anyone may say, no one can time the market.

What else can you do instead of trying to time the markets? Everyone wants to buy at the lows and sell at the highs, right?

Rupee Cost Averaging

In simple terms, you invest a fixed amount and buy stocks or a mutual fund for that amount every month. The number of stocks or the units of the fund will vary every month due to the volatility in the market. But over the longer time period, things will average out and you will end up with higher profits than investing in lump sum. This is called as Systematic Investment Plan or SIP for short.

Lets see an illustration with some sample numbers. You are willing to invest Rs. 10000 per month in a mutual fund scheme (for a year). The NAV of the mutual fund will vary over the period of time. Lets see how many units of the fund you get every month.

Month Investment NAV Units Allocated
January 10000 10.2 980.39
February 10000 12.4 806.45
March 10000 12.2 819.67
April 10000 11.9 840.33
May 10000 11.6 862.06
June 10000 10.5 952.38
July 10000 11.3 884.95
August 10000 10.9 917.43
September 10000 11.5 869.56
October 10000 11.1 900.90
November 10000 12.0 833.33
December 10000 13.2 757.57
Total 120000 10425.02

By investing a small amount every month, you would’ve around 10425 units of the fund invested at an average rate of NAV of 11.57.

Lets assume you instead put in the entire Rs.1,20,000 at the average NAV 11.57, your account would have only 10371.65 units. You got 53.36 units for free by spreading out your investment. This is free money with no work done on your part. Who doesn’t want this? This will be even more when invested in the longer time frame.

This number would’ve been even higher if it was a bear market and every month you keep getting more units than the previous month. Of course, this means in a bull market you lose out on the opportunity of investing in bulk at the beginning. But no one knows if we are currently in a bull market or a bear market, as its all in retrospective.

Here is a nice graph of a real world fund which shows how SIP gives you a better return. Investing Rs.10000 every month for a year from Jan 2013 to Jan 2014 (13 months), we have made a decent profit. Part of the profit is due to the fund’s performance and NAV increase and part of the profit is also from the SIP.

sip-returns

SIP works out as a nice hedge against wide fluctuations in the market and also makes sure you keep investing in the market whatever happens – as in equity only long term counts.

So, if you are salaried and has even a little bit of surplus cash, go start an SIP on a good mutual fund and invest every month. It doesn’t matter what happens to the market every day, you will be profitable in the longer term. Even if you aren’t salaried, invest regularly instead of trying to time the markets.

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.

 

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