Finance for the Non-Finance People

From One Hundred to One Million

By Taher Shehabi

Do you hate hearing the words “financial markets” and “balance sheets” but feel its high time you understand something about it just to keep up? Well-read on and you will be taken care of.

 

No matter what background you come from – you can be a doctor, an engineer, a professor, a lawyer, an entrepreneur, a consultant, and the list can go on; one common thing across all these backgrounds is, money. You can be in any profession, your motive to pursue it, other than your passion for the work, is always to earn your basic living. In doing so, you will invariably land up with a little extra amount after your basic expenses, which you call your “savings”.

Now 8 out of 10 of you will bundle up those 500 rupee notes that you save, in a safe locker in your cupboard for a few months, until the time you have enough to buy something off your wish list, maybe a new pair of headphones, or a jean-jacket, or go for a fancy meal at an expensive restaurant. While all of this is the correct outlook to the “work hard party harder” saying, there is a slightly better way to handle it and reach your wish list items sooner.

A slightly witty person would take that bundle of 500-rupee notes and put it in a bank. The benefit of this is that the bank would yield him 

interest on that (yes, I realise I have used some finance jargon, but stay with me), this simply means that after 3 months, the 500 he puts in would now become 550, without him doing anything at all. Sounds lucrative right? But there is an even faster way to get there.

The wittiest of them all would take their savings and buy a few shares of Reliance Industries. It would be safe to say your wish list item could be bought in a matter of a few days if you would have done that.

Coming back to reality, all these situations are the “ideal” ones and are not always true. These examples were just to open your eyes to the different things you can do to your money. Some might feel this is pure gambling, and they would be correct, buying a share without any knowledge about it is, in fact, gambling. But the beauty of the real world is that it is not the same as a blackjack table. Imagine if you were allowed to walk into a casino and play blackjack along with counting cards, legally. That is what the real-world financial markets are like. Proper knowledge and a little bit financial literacy will take you a long way. Moving on, I will be talking about a few places where people like you and me, what the finance world calls, “retail investors”, can invest their money, in India.

But before jumping into it, some of you might still tell me that you are more than happy just stuffing your savings in your cupboard locker, and the fact that it’s completely safe sitting there. Well you are right 

about the “safe” part, but you will not be very happy after what I am about to tell you. The value of money over time goes down, now what does this really mean? Simplest example is the KitKat chocolate bar sticks. Remember a few years ago, you used to get the large 4 sticks KitKat for Rs. 10, then it became Rs. 15, well today I bought it for Rs. 25. This is a classic example of inflation on consumer products. Now nothing you did affected the price of the KitKat, but it still got more expensive. If you had stuffed Rs. 10 in your locker, today you would not be able to buy that KitKat. The value of your Rs. 10 savings have gone down, over time. This is why you need to worry a little about investing your money.

Let us now talk about different investment avenues that you could explore.

 

Stocks

 

The word stocks and shares are interchangeable.Before jumping into details, let me paint a picture for you, say you start a small pizza shop in Mumbai by borrowing some money from your parents. You rent a small place in your neighborhood, hire a chef and server, and specialize in making the best Margherita Pizzas in town. In a month’s time, your pizzas are amazing, and you become so famous that there is a long waiting line outside your restaurant every night. You decide that you need to open another branch and hire more people, well this is going to cost you some money. Your parents do not have that kind of amount to give you again, so you think of another solution. You go to 10 of your friends and tell them that you need Rs. 10 lakhs to begin a new branch and if each could just give you Rs. 1 lakh, you will give them back 1/10th of the profits you make.

This is exactly how the stocks work. When a company needs money to either expand their business or any other form of growth, they come to investors offering them a “share” in the company. If a company issues a total of 10 shares and you buy 1, that means you are entitled to 1/10th of the company’s profits

These shares get listed on a stock exchange where you can buy and sell these shares at any given point in time. Share prices move up and down basis the rules of demand and supply. You will earn when the company pays out their profits in the form of a dividend to its shareholders and when the share price moves up. There are many other factors too, but for a retail investor, you need to believe in what the company does and whether it will succeed conducting its work in the near future. 

Fixed Debt Instruments

The downside of owning a share is that the price of the share fluctuates a lot and it does pose as a risk for a lot of people. Some of us prefer that even if our savings do not double quickly, its fine, but we should not make a loss on it. For such people, there are instruments called “fixed deposits” which are also called “time/term deposits”. In this, you simply park your money for a given period of time and at the end of that 

period, you receive interest on the same. The large idea is that you are “lending” to an institution who will pay you back your money with some interest, thus the word “debt instruments”.

Bank Deposits

 

This is the most common one, where you can go to a bank and ask for a fixed deposit. In India, this is the most widely used investment instrument. Different banks will give you different rates of interest. These interest rates generally are a little above the government rates and lower than the rates at which they loan out money.

The interest you get can either be opted for at the end of the term or in regular intervals across the period of the term. The difference between the two is the compounding effect which is a topic for another discussion.

 

Corporate Deposits and Bonds

 

Corporate Deposits

Just like bank fixed deposits, you can deposit your money with a company too. The only difference is that companies can afford to provide you with a higher interest rate than what a bank could give you.

 

Corporate Bonds

The word bond is exactly what it sounds like, it is a commitment that a company gives you saying it will return your money after a given point in time. The main difference between a deposit and a bond is that a bond is tradable, meaning just like a share, you can buy and sell it during the life of the bond. Bond pricing is different from share pricing and we can leave that for another day.

Government Bonds

 

Also called GOIs (Govt. of India Bonds), these are absolutely similar to your bank or company deposits/bonds when it comes to how they work and are by far the safest form of investment in any country. You can opt for a central or a state

government bond, although central govt. bonds are more common. The interest rate they provide is the lowest but will exactly cover inflation, so the value of your money will remain the same over time, but you will not make a profit.

A GOI will never fail to pay you back, or as the finance world calls it, “they will never default”. And I can say this with confidence that if a GOI defaults, that means the country is failing economically and your money would be better off in that cupboard locker of yours.

Mutual Funds

 
The basic idea of a mutual fund is that an Asset Management Company or AMC (it’s just a company tag, like a software company, financial services company, etc.) will start something called a “Mutual Fund Scheme” where it will take 

money from multiple investors who are interested in that particular scheme and invest in the companies/instruments proposed by the scheme. Mutual Funds, just like share are tradable. The only reason it is called a “Mutual” fund is because a lot of people come together and ‘mutually’ invest in the scheme, seems like the founding fathers were not fans of creativity.

Anyway, Mutual Funds as a concept are amazing investments but you will encounter a lot of jargon when you go

ahead with it, so here is a simplified version of it. 

Scheme

 

A scheme gives the investor a general overview of what the fund will invest in. Generally, the name of the mutual fund is the scheme. This will indicate the different places where the fund will invest in. There is no rocket science behind this, for example, if I told you about the HDFC Corporate Bond Fund, you could understand that the AMC is HDFC and it will invest in different corporate bonds.

If you want further details about which bonds, they invest in, you can read a scheme document where they will elaborate on the same.

Categories

 

Mutual funds are entities that invest in other companies/instruments, and according to what they invest in, they are categorized into different segments. Mainly, there are three broad categories, Equity, Debt and Hybrid, each of these indicate what instruments they invest in. Hybrid is a mixture of equity and debt instruments.

The categories you will generally see are:

  •       Equity Schemes

o  Large/Medium/Small Cap

o  Multi cap – 65% holding in equity instruments across all caps

o  Sectoral/Thematic – invests in specific sectors, e.g. IT, Pharma, etc.

o  Focused – invests in not more than 30 companies 

  •       Debt Schemes

o  Corporate Bond

o Long/Medium/Short/Ultra Short/Overnight Duration

o  Dynamic Bond – across all durations

o  Gilt – invests in Government Securities

  •         Hybrid

o Balanced/Aggressive/Conservative – different proportions of equity and debt in its portfolio

o  Dynamic Asset Allocation – continuously changes the proportions depending on market movements

o  International – invests in foreign companies. These are generally equity based but can have debt instruments too.

o  Gold – invests in gold mining firms. In India, we do not have mining companies so these funds either track gold prices or invest in foreign gold mining companies

 

Net Asset Value (NAV)

Mutual Funds are tradable, meaning you can buy/sell them at market prices. The price of the mutual fund is called the Net Asset Value or the NAV.

Units

Your ownership in a Mutual Fund scheme is depicted by the units of the fund that you own. It is similar to how the quantity of shares that you own depict your ownership in the company. With mutual funds, you can own part units too, meaning you can own 50.8753 units of a scheme. You cannot do this in shares. 

SIP vs Lumpsums

Take for instance, you are doing an internship that pays you Rs. 5,000 a month. Now you know that every month you spend around Rs. 4,000 and you are willing to invest the 

balance Rs. 1,000 in a mutual fund scheme that you like. But every month it is a lot of work to do the application process for the fund again and again. You can avoid that by entering a SIP (Systematic Investment Plan) where you can tell the AMC to take Rs. 1,000 from your bank account and invest it in the scheme you select. You can modify this in many ways to make your investments more streamlined. 

Lumpsum is exactly what it sounds like, it is a one-time investment that you make and leave it. You can of course add more later on if you want to.

Dividend vs Growth

Majority of the times, every scheme will have two sub-options, a dividend, or a growth option.

A dividend option is where the firm is compelled to pay you dividends annually, semi-annually, quarterly, or monthly, whether the scheme makes a profit or not. Within dividends, there is a payout or reinvestment option. Payout is what it sounds like, where the dividend amount is transferred to your bank account. In  reinvestment, the AMC will buy 

additional units of the same scheme out of the dividend amount for you. Meaning, if the NAV on the date of dividend declaration is Rs. 10 and if you were entitled to a dividend amount of Rs. 500, the AMC will add 50 units to your account.

Growth on the other hand is a simple concept, the scheme never pays out any dividends, all the gains made by the investment are reinvested in further instruments, but your units do not increase. As an investor you can make sell your units and claim your profit.

 

 

Expense Ratio

It is a percentage that the AMC will charge you every year for handling your investment. This will be taken whether the scheme makes a profit or a loss. Generally, lies between 0-2%.

 

 

Exit Load

Any investment takes time to get you some return. You cannot expect extraordinary returns in a matter of a few days or weeks. Thus, if you pull out your money in a very short time, it will affect the scheme as a whole since their holding in instruments will have to also be pulled out to pay you.

 

Because this causes a negative effect on the overall scheme, you will be charged a small fine for exiting too soon. Generally, all schemes have an exit load of 1% if you redeem your units within 1 year. There are some schemes with no exit load too, these are called “Liquid Plans”.

Direct Plan vs Regular Plan

After every scheme, you will always see the words “Direct” or “Regular”. If nothing is written, the default is a “Regular” plan. Now what does this mean

You can invest in a Mutual Fund by either going to the AMC website and investing right there, or you could go to a professional who will advise you on what kind of fund suits your needs the best and she/he will take money from you and invest on your behalf.

In the first case, you would get a direct plan and, in the latter, a regular plan. Direct plans have a lower expense ratio as compared to regular plans. The difference in ratios is the commission that investment professional will be paid by the AMC for bringing you to them.

This was all when it comes to Mutual Funds. I know it is a lot but trust me you will encounter each of these words when you plan to invest.

 

Gold

 

It is very rightly said, “You can hate someone, but you will accept their gold”. Gold is perceived as an investment with no downside. Internationally, gold is one of the most secure investments. Gold will always cover inflation for you and also earn you a profit, unlike those GOI Bonds.

Now you must be wondering, how can a retail investor invest in something as expensive as gold, right? You will be surprised but the govt. of India has now enabled retail investors to buy gold online, where an institution will purchase it for you and store it in a digital locker. You could opt to get it delivered to your doorstep too. I have still not mentioned the best part, you can buy gold in denominations as low as Rs. 100. I think you can experiment by buying a few milligrams of gold now

I think that is all to get you started. I have used a lot of ‘finance’ words but if you got through this, you should be good to go. I have not spoken on analysis of these instruments, that is a little more advanced, so if this interested you, please go ahead and read up more on what I have mentioned. I hope now you can manage your money a little better than before. I would conclude by quoting Warren Buffet

“The best investment you can make, is an investment in yourself.

The more you learn, the more you’ll learn.”