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The Art of Investment

Authored by: R. Ajay Vishwanath

A Guide to Manage Savings

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 put as 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 suddenly WOLF! 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. The villagers 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.

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 goods that 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.

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 to save 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? or my 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?

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:

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:

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 from Rs.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 further diversified 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 balanced rate. Diversification does not guarantee returns but helps

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, the total of which must be stated at the time of business formation. Given the total amount of money invested in the business, 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 a business may issue and sell shares and it is the value represented as capital in the accounting of the business. However, shares may not have an associated par value at all. Such stock is often called non-par stock, either issued at premium (more than face value) or discount (less than face value). Shares represent a fraction of ownership in a business. A business may declare different types of shares, each having distinctive ownership rules, privileges, or face values. Ownership of shares is documented by issuance of a stock certificate. A stock certificate is a legal document that specifies the amount of shares owned by the shareholder, and other specifics of the shares, such as the par value, if any, or the class of the shares. But these days it is electronic and shares are credited or debited into ones Demat account created before starting to trade or invest.

(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 the share 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

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:

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 not participate 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 holds assets 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

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:-

Land Land is a good investment option when investing in long term. 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 out for 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.

Flats Flats are residential properties that will give you returns depending 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

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

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 its services 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 open market. 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, SBI Gold 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.

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. EGold 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.