bonds cd bank deposits build first wealth part 4

8/14/2019 Bonds CD Bank Deposits Build First Wealth Part 4

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Ref: 0908-031A of 21-08-2009

In the days of Kings, Queens, Sultans, Moguls and Rajahs, there were only two currencydenominator with reference to which a persons wealth was measured. - Gold and Silver. Otherunits used were the number of sheeps, goats, horses, cows and buffaloes.

However, these objects were relatively scarce, and hindrance to trade development. When paperwas invented, especially Security paper, the concept of bank notes was introduced. Itrevolutionized the coming century. A time came when Alan Greenspan was spoken of more thanthe Jesus Christ.

Having seen the investment medium of Gold (Silver and Palladium will be discussed later), let ussee how a person should build wealth that is liquid, earning and transferable. East and Westfollowed different philosophy, thanks to numbers of Nobel Laureate Economists who inventednumber of theories understood either by them only or some small fraction of so calledprofessionals who brought the financial ruin as you witness today.

WEST followed the policy of Spend first, Save later and used plastic money (credit or debitcards) with gay abandon. Paper and Plastic were the two numerators of proof of wealth. When Iwent to USA a few years ago, I tried to pay them with greenback, that is, $ 100 green dollar bills somuch loved by the Asians over here. They love dollar more than their wives and children. Thecounter clerk asked me Sir, dont you have credit card? We can not accept this note I asked himfor reasons to which he replied, we do not know whether it is genuine or fake. WOW, we Asians gomad after dollars, and these Americans do not trust their own currency!

EAST followed the policy of Save first, Spend later, diametrically opposite of western philosophy.

This is why Asians prospered, and West was brought down to knees. After contracting debt viacredit card, if the consumer can not pay, the remedy was easy go bankrupt!

Look at the following table, how much consumers gain or lose in following West and East policy.

We compare two countries USA and INDIA for simplicity.

Let us say, an American bought a few items for US$ 10,000 via Credit Card, paying interest @ 12%on average (it varies between 7% earlier to 16% to 24% now) for say, 3 years. An Indian saved themoney for 3 years earning 9% interest and then decided to spend it. The cost of the items isworked out as under:


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Description An American An Indian (not Red Indian)Period of Comparison 36 months 36 mts

Item Cost 10,000.00 10,000.00Immediate Spend 10,000.00 0.00

Paid by Credit card 10,000.00 0.00Interest paid for CreditCard or Received onsavings (Debit/Credit)using reducing balance

@12%Paid for 3years EMI 332.14

1,957.04 @9%Receivedfor 3 yearssaving277.78/mth

1,517.14

Net Item Cost Cost + Int 11,957.04 Cost - Int 8,482.86

Relative Cost Difference LOSS 3,474.18 GAIN 3,474.18MORALE:1. If Debt via credit card is used for consumer item, it is irrecoverable expense. The item also

depreciates over 3 years, so that realizable value also diminishes.2. If no debt is used for consumer items, but savings resources were used instead, the cost of the

item is reduced by interest income on savings.3. Debt is useful for a businessman because he employs the amount for earning. Though he pays

interest, he also earns income or profits. His loss or gain is the difference between the two. Itistwo way traffic for him.4. For an employee, having no other income than salary, he loses on contracting debt, because no

income is created out of debt. It is a One way street for him loss only.

This is why the East is asserting on West now. America is technically bankrupt with years ofconsumer spending financed by Credit cards. Eastern countries like China, India and other Asiannations have acquired wealth due to their reliance on savings rather than debt.

Make your First Million by Savings (very difficult), Subsequent millions are easy. Making first million in any currency anywhere in the world is extremely difficult. One makes or

loses continuously, learning all the time. The balance so accumulates make the million after longtime, may be 3 to 8 years.

Once one has made real one million in the currency of his country, he has sufficiently learnt the artof making a million. If he is able to hold on that million for at least 3 months, making of furthermillions become relatively easy process. There is a saying that Money attracts More Money. Itworks both ways once one begins to lose, the lost money attracts more money from the holder,compounding the losses. Similarly, when one has made a million, the chances are the money thathe holds will attract more money inward to make him rich.

So let us make our first million in the currency of your country. A million is a million, regardless of

any currency. The PPP or Purchasing Power Parity operates silently in every currency to make theabove idiom true.

Bank Deposits vs. Bonds; Currency Risks, Capital Risk and Exchange RiskEach country has its own products for savings. For instance, it is easy to buy Treasury bonds inUSA, howsoever small amount may be. In a country like India or Hong Kong, the availability ofTreasury bond is limited to large amount, often 250,000 minimum. An ordinary saver can nothandle such amount. He is not millionaire yet. Now again, I remind you of the difference betweenSavings and Investment.


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When one makes a deposit in the currency of his country with assurance to return the samecurrency in same principal amount (plus interest), it is called Savings. Example, one takesout bank deposits for say 100,000 in currency X with interest @ n%, with assurance toreturn the money on maturity in same currency with interest, it is Savings. (He getsX100,000 + n% interest)

Where one makes deposit in the currency of his or other country if his local currency isconvertible), with no assurance that same amount will be returned to him later onmaturity, it is called pseudo Savings cum Investment.

o He is assured here the same amount of foreign currency on maturity + Interest, buthe is not assured the same amount in his local currency. He takes exchange risk thatmay give him increased or reduced return. This is the first level of risk heundertakes.

If one buys the Treasury Bond, in his currency or foreign currency, he takes on one morerisk the interest rate risk. If the interest rates go higher/lower, the capital value of thebond reduces/increases during transit time (until it matures). On maturity, he gets thesame capital value in respective currency.

If one buys corporate, municipal bond or state government bond, then he takes one morerisk the credit risk of respective corporation, municipality and state government.

oFor instance, in USA, many of the Municipalities or state governments face severeliquidity strains or nearly bankrupt.

The federal government in USA is not kind enough to guarantee the bonds ofstate government or municipalities (FED would stupidly guarantee $306billions of Citibank bonds, but not even $ 25 billions of the State of California)

A country like India is more responsible. The Central government alwayscomes to the rescue of the state governments or local semi governmentauthorities

Having seen the difference between Savings and Investment, let us dwell on the specific productsand their variations.

BEFORE that, please note that if you do not understand any investment products, simply say NO.In investment world, there are many conmen or crooks that are out to reach your pockets withinnovating scheme or theme. They get paid liberal commission by the issuers. You must thereforebe prepared to say firm NO. These two letters will save your lifes savings.

Also, when you are talking of the savings, do not include investment or credit risk profile.Savings must be Savings totally risk free returnable to you intact on maturity with interest onmaturity. Here are some principles of how to save in bank deposits:

Fixed Deposits: (with Banks)

In centers like USA, Japan, Hong Kong and other dollar block countries, the interest rates are nearzero. It would be stupid to invest in such deposits on long term basis. Use the following guide:

If interest rates are very low, follow the table as under:If Interest rates/year are =


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By rule of thumb if the interest is over 10%, one may lock in yield for 12 months to 36months. Make it cumulative, so that you earn interest on interest. That is, your effectiveinterest rate is 11% (10% regular + 1% (10% of 10%) = 11%)

DO NOT make single large deposit. Make 3 to 5 units minimum. The reason is if you needthe money for any emergency, you can break the deposit (withdraw before maturity,paying some penalty).

If you are making deposits for 3 years or more, do as under to maintain continuous cashflow. Say you have X 500,000 to keep as bank deposits, keep 100,000 each maturing onexpiry of 36 months, 38 months, 40 months, 42 months and 44 months.

o This will ensure that after the expiry of 3 years, you have cash flow of 100,000 everytwo months.

o Further, if you need some amount earlier, you need to break or withdraw prematureonly one unit without disturbing others.

CHECK the maturity value before leaving the counter. Most people presume that banks arealways correct. It is not so. The clerk who is servicing you may make clerical error andwrite wrong amount.

USE the following Interest calculator one of the best tools around. It is free softwarewhich works out interest and cumulative amount on loans, deposits, recurring deposits etc.

oIt has small limitation. It uses 360 days per year which is international standard forBond market, not Fixed Income market like Deposits where they use 365 days peryear as standard. (In India and Hong Kong, for instance)

o This tool is very useful in planning your savings. Fixed, Savings, Recurring Deposit(very powerful concept discussed later)


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While opening Fixed Deposit account, please ensure that 1. You are opening jointly with some member of your immediate family, say spouse, if your own

age is 55 or more. Make it Either or Survivor (E or S) if you trust your named partner.2. In some countries like India, nomination facility is available where you can nominate non-

depositor but your immediate family members like son or daughter, should anything happento you or your spouse. This will avoid all legal formalities like will, probate, letter ofadministration etc.

3. One may avoid nomination by including one more name after his name, say of Son or Daughter,but limiting operation in account as Former or Survivor which means that one will get thepayment on maturity, not other beneficiaries. Former means you. If one makes a mistake inwriting his Childrens name ahead of his own, then they will get the money on maturity, not he.Other beneficiaries will get if only the original depositor dies.

4. If you are 55 years or older, NEVER EVER give away your entire wealth to your children,. Theywill take care of you only when they know that money will be theirs when you are no longeraround. Otherwise, you may have to wash dishes in their homes and reduce your status to thatof a house servant or even worse. Money always talks, remember that always.

5. In liberal countries like USA, where marriages often do not last long enough, it will beadvisable to keep deposit in your own name without the knowledge of spouse. Suchconfidentiality will avoid substantial payment or alimony in divorce proceedings.

6. Many frauds have been reported in India, when a Non Resident Indian (known as NRI) remitslarge amount without taking adequate precaution. Note the following example (Illustrative)

a. A NRI remitted US$ 100,000 by wire or TT to a small town branch of a nationalizedbank with request to open the Cumulative Fixed Deposit (CFD) for 3 years in favor ofthe depositor and his wife. Since the online account opening facility was not available,he requested the Branch to send him the Account opening form for his signature anddocumentation. This was perfectly normal.

b. The Branch Manager was not honest. He sent the FD Acct. form to the depositor withspecimen signature card. At the same time, he issued the FD in the name of samedepositors and attached the signature card with fictitious signature.

c. On very next day, he created a loan in favor of third party and pledged the FD dulydischarged by him and also signing necessary loan documentation forms.

d. Meanwhile, the depositor sent him the Account form. The Branch Manager sent himanother FD with similar particulars. Since the FD was for 3 years, and interest beingcumulative, he did not know of this fraud for 3 years until his FD came for maturity andhe wanted to cash it out.

e. The Branch Manager was changed. He informed the depositor that third party haddefaulted on loan, so the deposit was adjusted against the loan. No further amount waspayable.

f. The depositor then complained to his Regional Office, who instead of investigatingrehearsed what the branch said. When he approached its HO, the Inspection

department conducted the investigation and the entire fraud came to light. Meanwhilethe original Branch Manager had taken voluntary retirement and absconded from town.g. It took for more than 6 months for the depositor to get his claim settled, and that too,

without additional interest for extended period from maturity.h. If the FD was non cumulative, the depositor would have known non payment of

quarterly interest into his Savings account, and the fraud detected early. Alternatively,the depositor may ask for Certificate of Non Encumbrances from the Regional Officesending them a copy of your FD received.

i. The best course is to maintain account only with large branches or Main Branch wherethe chances of such irregularities are almost non existent.


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SAVINGS ACCOUNT:Same as above. However make sure that you know the banks Minimum Balance requirements,Otherwise they go on debiting your account every quarter with Rs 750/quarter. I have badexperience with Axis Bank in Mumbai, India. I opened NRI-PIS account with them with oneordinary NRE where I was maintaining decent 6 figure balance and another sub account for stockpurchases. They disabled my Internet access on some fictitious ground. After a year and half, Irealized that my account was debited 6 times with the bank charges of Rs 750/Qtr or Rs 4500 over18 months. I tried to close my account, and lodged a strong complaint, that my relationshipbalance was 20 times their minimum balance required. But no one listens you have to press 1, 24 5 6 and what not and finally told that it was a call center.

A new Manager assured me proper service again and refunded Rs 1500 only. Again, for lastquarter, I was debited with Rs 750 again. I am going to close down my all accounts with suchglossy electronic banks who do not know the basics of banking. (I was a banker for 19 years, so Iknow what is called Banking!)

The purpose of referring above episode is to help you understand that banking is not what it usedto be 10 years ago. Modern day MBA bankers are too procedural to meet the requirement ofordinary depositor. Make it a habit to check your bank account regularly so that no charges areimproperly levied.

CURRENT ACCOUNTS:Same as above. This is non interest bearing account, so avoid keeping large balances. Instead,keep major portion of your balances in Savings account so that your deposit earns some interest.

MANDATE FORMSSome banks, especially in India, have a facility of Mandate Form under which you may authorizesigning powers to known third person (mostly in your family) without executing complicatedPower of Attorney document.

As far as possible, try to avoid joint bank accounts with some third person with only intent toauthorize him to operate your account for sundry purposes. Use Mandate form instead, which canbe cancelled at any time, if you find inconvenient or your account is not properly administered.

There is a legal risk too in opening Joint account with third person for only operational purpose.By opening joint account, he earns the status of being joint owner or co owner of the funds. If heruns into financial problem, your account could be subject to court seizure or attachment. If heholds mandate power nothing happens or could happen to your account. He is merelyauthorized signatory, not co-owner of the account.

RECURRING DEPOSIT ACCOUNT Sure way to build wealth:This kind of facility is only available in India, not in advanced countries (they are not thatadvanced). This account is the most important savings instrument available to individualinvestors on long term basis. This is like an Imprest system under which you contribute someamount every month and receive lump sum at the end of contracted period.

This account helps you manage the following:1. One can lock in higher interest rate for 5 to 10 years with meager sum.

a. Example: Supposing one is in era of high interest rates, say 15% on long term deposits.The rates have stopped rising and may fall. One wants to lock in such rate with


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minimum cash outlay. He can open 5 different RD account with maturity of 5,6,7,8,9 or10 years contributing say, 1000 per month. He has to pay just Rs 5000 every month forwhich he can give standing instructions to debit his Savings account monthly. Now lookat the maturity scenario:

Installment Amt Period Interest % Maturity Amt Total Investment Simple Yield1000 60M 10% 77,911 60,000 11.94%

1000 72M 10% 98,664 72,000 12.34%1000 84M 10% 121,572 84,000 12.77%

1000 96M 10% 146,858 96,000 13.24%1000 108M 10% 174,769 108,000 13.74%1000 120M 10% 205,577 120,000 14.26%

Simple Yield = {Interest Gain / (Average Investment) %} divided by No. of years(Average Investment = Initial Investment (=0) + Final Investment /2)

b. It will be observed that current yield of 10% become compounded yield of 12% to 14%c. Above method ensures steady cash flow after 5 years in greater proportion every yeard. If you plan from the age of 51, to retire after the age of 60, you will have steady cash

flow every year from 77000 to 205000 per year, enough to pull on without muchexternal support. This is your self made Provident Fund on which you have total control

e.

You can vary the amount in multiples of 5 or 10 to make larger sum available to you atlater age.f. You can also open separate RD account for each activity, Childrens college education,

wedding or purchase of property. Say in above case, you contributed Rs 10000 for 10years for your childrens education, you will get Rs Rs 20 lakhs after 10 years, whenthey are about to get into higher education. No more educational loans at that timewhich will reduce your net worth. This will enhance your net worth...

g. In 1992 to 1994 FOREX crises in India, one bank offered very long period RD (for 20years). By depositing Rs 5000 per month for 20 years @ 13% interest rate, one wouldget 5,619,929 against total investment of 1,200,000 (240 x 5,000) netting simple yieldof 36%. Longer the period, higher the simple yield. The average investment is worked

out on this basis: Initial Investment is ZERO, Final Investment = Installment x no. ofMonths in a period. Divide it by 2 to have average investment over the period.

h. In short, if you plan your cash flow from early age, you will have worry less future, be iteducation for your children, their wedding, purchase of property or own retirement.

How to use Recurring Deposit (or Remittance) to avoid Exchange fluctuation?While living in Hong Kong, I came across hundreds of instances from local people who alwayscomplained about exchange loss due to currency devaluation against USD. They also tried to timethe remittance, and always failed. I used to tell them to send the remittance periodically taking outadvantage of weaker destination currency. See the following example (we used Indian Rupees forillustration purpose. You can replace it with your national currency.)

Say, you remitted USD 10,000 @ Rs 50, 46, 44, 39, 43, 48, and 49 on seven occasions. The averageworks out to Rs 45.57, marginally lower by 7% over 7 years or just 1% per year.

The people always average down, never up. This is where they lose profitable opportunity.

USING RECURRING DEPOSIT TO PLAN UNIFORM CASH FLOW IN FUTURE:In middle age, from 36 to 50, a persons earning and savings power is higher than later years,when increasing expenses take toll on his savings. The reason is that his children have grown into


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adult; they need cars, increased monthly allowances, higher tuition fees and more entertainingexpenses to go out with their girl/boy friend to enjoy the innocent young adult life.

One may therefore employ savings at reducing rate, that is, save higher or pay higher RDInstallment when his propensity to save is higher, and then go on reducing it so that he can meetmore expenses at home.

He may open the Recurring Deposit accounts spread over 3 to 10 years with higher EMI (Equated

Monthly Installments) for first 3 to 5 years, and then go on reducing them progressively so that histake home pay or income remain same.

Say, he has capacity to pay 10,000 (you can take any amount and divide proportionately in India,the amount is less, but in US it may appear very high) every month. He may open 5 accounts asunder:

EMI 4,000 for 3 yearsEMI 3,000 for 5 yearsEMI 1,500 for 7 yearsEMI 900 for 9 yearsEMI 600 for 10 yearsTOTAL10, 000

Now look at the following. We open all accounts with different maturities. We presume currentrate of 9% (say, in India)

Now, start the Interest Calculator and open its RD Section. Enter the installment amount, period inmonths, compounding quarterly (as applicable in India use your countrys practice) and thenpress Maturity value. You get the following maturity amount:

Maturity

Period

Monthly

EMI

Amount

Invested

Interest

@%

Maturity

Amt

Interest

Earned

Simple Rate %

(1) (2) (3=1*2) (4) (5) (6=5-3) (6/Avg Inv=%)

36M 4,000 144,000 9% 165,675 21,675 10.03%60M 3,000 180,000 9% 227,567 47,567 10.57%

84M 1,500 126,000 9% 175,502 49,502 11.22%108M 900 97,200 9% 149,548 52,348 11.96%

120M 600 72,000 9% 116,537 44,537 12.37%It may be noted that after 5 years, the monthly installment gets reduced to Rs 3000 only so that apersons take home pay or income is increased by 7,000, and he still gets sizable amount onmaturity. If his position to save is intact or his income has increased, he can open more RD account

after the end of 5 years. Each year, he is going to reap the amount in excess of 100,000 which isgood sum to own at later age.

One can use the Interest Calculator according to his savings needs, in multiples or divisible of EMI.Each country has different needs, but the above example was taken with reference to India.

Anil Selarka, Hong Kong, 21stAugust, 2009, Ref: 0908-031ADocument Statistics: (8 Pages + Cover Image = 9 pages)Pages 8; Words 4,043; Characters (no spaces) 19,161;Characters (with spaces) 23,040; Paragraphs 244; Lines 491

(Revised on 24-Aug-09)

bonds cd bank deposits build first wealth part 4

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