art of investment
TRANSCRIPT
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The Art of Investment
A Guide to Manage Savings
Authored by: R. Ajay Vishwanath
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Investment. The term very often used by financial gurus,
which you hear almost every day. But what is Investment?
Or rather what is Investing? Or must the question be putas How to invest wisely?
To answer the last question, first you need to know what
Investment is. Investment is seen in everyday life. It is
something similar to use your resources wisely, with high
returns, low risk in the safest manner possible so that you
are prepared for any eventuality in future. Let me explain
this in the form of a story.
There was a boy called David, a shepherd. Daily he would
lead his sheep to the grasslands to graze and he would
watch over them. He would be sitting on top of a tree or a
small hill so that he can overlook them.
One day, he was so bored that he decided to play a prank
on the villagers nearby, and he began shouting suddenlyWOLF! WOLF! Somebody help me!! The wolf is eating
away my sheep!! The villagers came running with sticks
so that they can save his sheep only to find his sheep
intact and he laughing at them. The villagers warned David
not to do so again. David thought Man, they are boring
people, never laugh at jokes.
After a few days, David again shouted for help. Thevillagers came running, and he was laughing at them
again. The villagers gave him a last warning and went
away.
The very next day, a pack of wolves attacked his herd of
sheep and when he called for help no one turned up and
finally he lost all his sheep.
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The moral of the story is that he invested the trust the
villagers had on him on pranks that gave him fun in the
short term. But in the long run, he suffered losses.
The same way, you must spend your money in such a way
that it helps you when needed and keeps you going for a
very long time. Let me present another example, a boy is
given ten rupees, he has a choice to either buy ice cream
and enjoy it for the next five minutes, or he can purchase a
pen and use it for months or even years. In the former, he
is using money to blow up for temporary enjoyment whilst
in the case of the latter, the money used in obtaining
service for a long time.
According to www.investopedia.com , investment is An
asset or item that is purchased with the hope that it will
generate income or appreciate in the future. In an
economic sense, an investment is the purchase of goodsthat are not consumed today but are used in the future to
create wealth. In finance, an investment is a monetary
asset purchased with the idea that the asset will provide
income in the future or appreciate and be sold at a higher
price.
According to www.businessdictionary.com , Money
committed or property acquired for future income.
Thus summing it up, Investment is the art of savings that
gives you returns for a more comfortable future.
When invested wisely, you dont need to bother about
inflation hitting hard on your hard earned money. A wise
investment will take care of your future for the rest of your
life.
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Now that you know what investment is, let me tell you
about the most successful investor to date, Mr Warren
Edward Buffett, an American investor, born in 1930 in
Omaha, Nebraska state of the USA.
As a child, he showed interest in making and saving
money. So he began delivering newspapers, and purchased
his first shares in the stock market; three shares of Cities
Service for himself and three for his sister. He worked as a
financial analyst and stock broker initially and began tosave and invest in the stock markets gaining partnerships
in firms and gradually became a billionaire when the value
of his stocks & companies grew exponentially.
So the first step to start investing is saving.
The immediate question in your mind, how do I save? ormy finances are tight, how can I start saving? Savings
are closely related to purchase decisions one makes.
When you want to purchase anything, just answer the
following questions.
Do I need really it and now?; Is there another
alternative? Is it available at reduced cost?, can I
postpone buying?
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Once you answered the above questions, you will find that
you begin to save more than usual.
Next comes the question of diversification.
Diversification
Do not put all eggs
in one basket
Diversify your investments. It will minimize losses and
risks. Never invest all your money in one type of
investment. If the type of investment you make goes
wrong, you will have lost all your money. To safeguard
your investment, you diversify and invest in various options
so that even if one of the investment options fails, the
other investment options you invested in may offset the
loss.
Reliance Industries before Diversification:
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Source: http://www.ril.com/
In 1980 Reliance Industries had Rs.207.67 Cr. as sales and
Rs.11.2 cr. net profit.
The above data was prior to diversification where Reliance
was concentrating only on textile industries. Post 1980s, it
began to diversify.
Reliance Industries after Diversification:
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Source: http://www.ril.com/
RIL after diversification, in a span of 10 years from 1980,
its sales grew from Rs.207.67 cr. to a whopping Rs.2098.34
cr. (i.e. about 10 times). Net profit also grew similarly fromRs.11.2 cr. to Rs.125.55 cr. (about10 times) in the financial
year 1990-91.
Concluding what RIL did, initially they put all their
investment in one basket i.e. textile industries. Later they
diversified into other fields like petroleum, petrochemicals
etc. Seeing the benefits of diversification which also led to
substantial increase in volumes and sales, they furtherdiversified into other fields like retail, jewellery, telecom,
infrastructure, power etc. for more growth. It generally
becomes easy to manage risks when one sector incurs
losses, anothers profits covers the loss.
In much the same way, a normal investor must also
diversify his investment so as not to lose the entire
investment and ensure his investment grows at a balancedrate. Diversification does not guarantee returns but helps
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you to control extreme losses. It again depends on how you
diversify your investments.
Investment Choices for Diversification
You can diversify your investments under the following
heads:
Shares and Securities
The capital of a business is divided into multiple shares, thetotal of which must be stated at the time of businessformation. Given the total amount of money invested in thebusiness, a share has a certain declared face value,commonly known as the par value of a share. The par
value is the de minimis (minimum) amount of money that abusiness may issue and sell shares and it is the valuerepresented as capital in the accounting of the business.However, shares may not have an associated par value atall. Such stock is often called non-par stock, either issuedat premium (more than face value) or discount (less thanface value). Shares represent a fraction of ownership in abusiness. A business may declare different types of shares,each having distinctive ownership rules, privileges, or facevalues.
Ownership of shares is documented by issuance of a stockcertificate. A stock certificate is a legal document thatspecifies the amount of shares owned by the shareholder,and other specifics of the shares, such as the par value, ifany, or the class of the shares. But these days it iselectronic and shares are credited or debited into onesDemat account created before starting to trade or invest.
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(One of the earliest Share Certificates)Equity Investments
An equity investment generally refers to the buying and
holding of shares of stock on a stock market by individuals
and firms in anticipation of income from
dividends and capital gains, as the value of the stock rises.
Equity shares can be purchased in IPO (Initial Public Offer),FPO (Follow on Public Offer) or normally from other
investors in the open stock market.
An equity share holder will have voting rights and any
profits by the firm will be enjoyed by him in the form of
dividends or an increase in the value of the shares of the
firm, where dividends are not fixed and guaranteed. In case
of losses, he will lose his investment in the firm and theshare value of firm will fall. In case a firm is being
liquidated, the firm is not under the obligation to pay the
equity share holders their investment.
Debentures
A debenture is a document that either creates a debt or
acknowledges it. In corporate finance, the term is used for
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a medium to long-term debt instrument used by large
companies to borrow money. In some countries the term is
used interchangeably with bond, loan stock or note. A
debenture is thus like a certificate of loan or a loan bond
evidencing the fact that the company is liable to pay a
specified amount with interest and although the money
raised by the debentures becomes a part of the company's
capital structure, it does not become equity share capital.
Debentures are generally freely transferable by the
debenture holder. Debenture holders have no rights to vote
in the company's general meetings of shareholders, but
they may have separate meetings or votes e.g. on changes
to the rights attached to the debentures. The interest paid
to them is a charge against profit in the
company's financial statements.
They get a fixed rate of interest called dividend irrespective
of the firms financial position; the firm also at times gives
option to the debenture holders to convert their
debentures into equity shares.
The firm, when liquidated, must pay back the debenture
holders their investment.
Preference shares
Preference shares are legally shares, but they are very
different from ordinary shares. The economic effect of
preference share is more like that of bond.
Like convertibles, they are regarded as hybrids of debt and
equity:
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Dividends on preference shares have to be paid before
dividends on ordinary (equity) shares.
Dividends on ordinary shares will not be paid unless
the fixed rate of dividend for preference shares is paid
first.
Dividends are fixed like bond coupons, although there
are usually provisions to not pay, or delay payments.
In the case of cumulative preference shares, if the
dividend is not paid in full, the unpaid amount is
added to the next dividend due.
Preference dividends are fixed, so they do notparticipate in increases (or decreases) in profits as
ordinary shareholders do.
The firm also at times gives option to the preference
shareholders to convert their preference shares into
equity shares.
Preference shareholders have a higher priority if a
company is liquidated than ordinary shareholders,
although a lower priority than debt holders.
ETF
An exchange-traded fund (ETF) is an investment fund
traded on stock exchanges, much like stocks. An ETF holdsassets such as stocks, commodities, or bonds, and trades
close to its net asset value over the course of the trading
day. Most ETFs track an index, such as the S&P 500 or
MSCI EAFE.
So ETF is a security that tracks an index, commodity or a
basket of assets like an index fund. But trades like a stock
on an exchange. ETFs experience price changes
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throughout the day as they are bought and sold.
Because it trades like a stock, an ETF does not have its net
asset value (NAV) calculated every day like a mutual fund
does.
By owning an ETF, you get the diversification of an index
fund as well as the ability to sell short, buy on margin and
purchase as little as one share. Another advantage is that
the expense ratios for most ETFs are lower than those of
the average mutual fund. When buying and selling ETFs,you have to pay the same commission to your broker that
you'd pay on any regular order.
One of the most widely known ETFs is called the Spider
(SPDR), which tracks the S&P 500 index and trades under
the symbol SPY.
Real Estate
Real Estate is taken to mean "Property consisting of land
and the buildings on it, along with its natural resources
such as crops, minerals, or water; immovable property of
this nature; an interest vested in this; (also) an item of real
property; (more generally) buildings or housing in general.
Also: the business of real estate; the profession of buying,selling, or renting land, buildings, or housing."
Real Estate is the purchase and sale of, and investment in
properties like land and buildings. Investment in real estate
must be done with great care and timing. Wrong decisions
may lead you to debt trap or the property you purchase
may have no value.
The different investment areas in real estate are:-
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Land
Land is a good investment option when investing in longterm. Say for about ten to fifteen years. Its value can
multiply manifold. It is cheaply available on the outskirts of
the city, and when the town planning commission decides
to expand the city in the direction of your land, its value
increases manifold. This type of investment is generally
recommended to those who have spare cash to invest and
who do not expect any immediate returns.
Here a few precautions are imperative. One has to be
circumspect in selecting the location / ensuring its clear
title thru a legal opinion / pricing which are the most
important aspects. As a precaution, one can take the
local authoritys approval for building a small room, take
power and water connections, build a compound wall to
prevent unauthorised encroachments which are the bane
of such investments.
Commercial Properties
Commercial properties include shops and office spaces that
can either be used to setup shops by the owner or let outfor rent. Commercial properties cost more than residential
properties due to its location, size, availability and the type
of business determining the level of income earned from
the property.
Commercial properties can fetch returns in the region of 6
to 12 % p.a.
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Flats
Flats are residential properties that will give you returnsdepending on the location, demand and features.
Typically, one gets return between 3-5 % as rent.
Generally one gets lesser return on investment on new
properties as the costs of new flats are higher. On the
other hand second hand properties cost less and the rental
return will be higher. There is a possibility of substantially
increasing the return to 8 % (almost doubling the RoI) by
simply furnishing the property and letting out by spending
some additional money. This is an untapped market and
its potential is not known to many.
Deposits
There are many types of deposits where you can deposit
your savings and let it grow.
A simple savings account with a bank is a type of deposit. It
earns interest on your simple savings. The other types of
deposits are:
Fixed Deposit (FD)
In a fixed deposit, you deposit your savings in the bank for
a period of time and collect it with interest after maturity.
The duration of the deposit is as short as a year or even
lesser to as long as a decade. The rate of interest depends
on the duration you invest. The longer the period, higher
will be the rate of interest as a thumb rule. This is a very
safe option to invest. However, in the event of
unfortunate closure of the bank for any reason, only a
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maximum of Rs.100000/- will be paid to you as per RBI
rules.
Recurring Deposit (RD)
This is the type of fixed deposit where the investor must
keep depositing a fixed amount regularly every month into
the account.
Provident Fund
Provident fund is an avenue where an employee
contributes a part of his/her monthly salary (typically 8.33
% of his basic pay) to the fund which is paid at the time of
his retirement generally. This will come in handy for a
major expense like purchasing a house / clearing its
liability, childrens higher education / marriage / retirement
nest. Contributions are exempt from tax. In most cases
even the employer contributes a matching sum to the fund.
The employee can if he chooses can increase his own
contribution substantially which will yield a substantial
corpus at the time of his retirement. Presently, the
contributions attract 9.5 % interest p.a.
Mutual Fund
A totally market dependant fund where people with small
savings contribute to an Asset Management Company to
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invest in the stock market. Any profit or loss on the
investment will be shared proportionately by the investors.
The firm will charge a nominal amount for rendering itsservices and undertakes to invest the amount wisely. But
the risks and returns are totally market dependant. So
there is no guarantee of safety of the investment or its
return. But this will have lower risk as compared to
investing directly in the market. It is better to check the
tract record of the AMC and invest small amount in this
avenue.
Gold & Silver
The rate of increase in the value of gold and silver has
been phenomenal in recent times. One can invest in gold in
various means as follows:-
One can buy gold biscuits or jewellery from the openmarket. But it is risky due to vulnerability to theft,
purity issues, cost issues like making / wastage
charges and bulky nature. If keeping in bank locker,
its annual rental charges are to be considered.
One can purchase gold in Demat form online from
Exchange Traded Funds. There are quite a few ETFs in
the market like UTI Gold, Kotak Gold, Goldbees, SBIGold etc. who physically buy the metal and its value is
distributed to investors in proportion to their
investment. The product here is pure, safe,
transparent and risk free, but dependent on market
conditions. On the flip side, you will not get to see the
metal physically as it is in Demat form.
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However, if one analyses, silver has given far better returns
than gold in recent times. However, there are no ETFs
available to take the opportunity.
Worry not. One can invest in E-silver in 100 grams lots
which has recently been launched by National Spot
Exchange Limited. Rates are transparently available most
of the time and one can literally choose when to invest. E-
Gold is also available here. One can even invest in 1 gram
of gold!!! And seek physical delivery too. Here also one
can buy and sell the metals just like one does investments
in shares. One must have a Demat account for this type of
investment.
The Experience
My dad is a retired government employee and yet his
current income is more than his income when he was a
government employee.
How?
Because, he invested his savings wisely.