Have you ever bought a new pair of shoes that you’ve been planning to buy for a while, but started regretting the purchase as soon as you arrive home? Maybe it was the best deal in the last three months, and you got a discount of over 30% on the original price. Still, you can’t stop thinking that you might have overpaid for that shoe. Or you might start presuming that you didn’t need a new pair of shoes at all and you have wasted the money on it ‘unnecessarily’.
This regret after purchasing a product is called a buyer’s remorse. And don’t worry, you are not different. It happens to everyone.
Nevertheless, purchasing commodities are not the only thing where people feel “buyer’s remorse”. Stock investors are also like ordinary people, and they too feel the buyer’s remorse after purchasing equities. Anybody who has been in the market for a long time might have already experienced investor’s remorse.
In this post, we are going to discuss what actually is buyer’s/investor’s remorse and how one can deal with it.
Investors sometimes feel remorse when they make investment decisions that do not immediately produce results. The guilt is more prominent when the share price starts going down.
Here are a few general questions that come in the mind of every investor in such situations:
“Was buying this stock a mistake?”
“Was my timing right?”
“Did I just buy a lemon of a stock?”
“Is the market going to collapse?”
“What if I lose money?”
Moreover, the investor’s remorse become stronger when people watch the latest news. The TV analysts/anchors make the current facts (which were not available at the time of investment) look so obvious that people start regretting their decisions at once. However, it is always easier to see into the past than to estimate the future. As Warren Buffett used to say:
“In the business world, the rearview mirror is always clearer than the windshield,” -Warren Buffett
There’s a very fair chance that you might have taken the best decision based on all the available information at the time of your investment.
In general, there can be two effects of the buyer’s remorse.
Impulsive decision to return (or sell) the product which may be well reasoned and a smart idea in the first place.
Justifying the investment and refusing to accept the mistake.
Both these effects can be adverse for the investors.
Leaving your position in a well-researched stock just to get over the guilt is never a good idea. On the other hand, becoming adamant on your investment decisions may be damaging for your portfolio and will prevent you from learning a valuable lesson.
Ways to deal with Buyer’s Remorse:
The best way to deal with buyer’s/ investor’s remorse is to re-examine your purchase (both risks and opportunities).
Stand with your stock if the fundamentals are the same and the reasons for purchasing that share is still valid. On the other hand, if you made a mistake, then fix it.
Here are two additional ways which can help you to avoid buyer’s remorse:
Avoid impulsive buying or selling: It’s always a better approach to research intensely before buying or selling. Taking an informed decision will build confidence towards your investments, even if they do not show short-term results.
Final tip– Always remember that buyer’s remorse is natural and inbuilt human psychology. But acting or reacting to this guilt depends on the person. The ability to handle buyer’s remorse will make you a better investor.
We, at Trade Brains, happen to see a lot of these advertisements. In fact, we even love them because although comical and mere advertisements and these ads educate the public about mutual fund investments in a more touching way than what we could ever do.
But those of you who have seen these ads must have wondered for a long time about how these guys make money? Why give so much wealth away for free? After all, economics says that there are no free lunches, right?
Well, to be honest economics is right. There are no free lunches and mutual funds are not free. This post is aimed to provide a basic insight into answering the above questions. Here are the topics that we’ll cover in this post:
What are mutual funds?
What are the sources of revenue for a mutual fund?
The different costs involved in running a mutual fund.
Industry trends and closing thoughts
Overall, it’s going to be a very interesting post for the mutual fund enthusiasts. Therefore, let’s get started.
1. What are mutual funds?
Mutual funds are investment vehicles managed by professionals that seek to pool investments from many people together before investing them into markets within the financial ecosystem such as equity markets or debt market or a hybrid of both debt and equity. These vehicles are normally managed by professional fund managers or are programmed to follow certain broad indices pertaining to a certain industry or a country.
In general, mutual funds are thought to be best platforms for investors to get the benefits of capital appreciation from the equity markets even if they are not confident to manage their own money in the markets or if they are not able to dedicate time for their own research.
Some retail investors who invest on their own also happen to invest mutual to provide some diversification in their portfolio or reduce the volatility of returns since a lot of the times retail investors tend to have a concentrated portfolio of around 8-20 stocks.
2. How Do Mutual Funds Make Money? And what are the sources of revenue for a mutual fund?
The biggest source of revenue for mutual funds is usually the fees that they charge from their investors. This usually comes out in the range of 1.5%-3% of the assets under management. This is commonly known as the expense ratio. Here is the example of the expense ratio for a few popular funds:
However, as of September 2018, it has become legally binding for mutual funds to limit their total expense to 2.25% of the total assets under management.
3. What are the costs involved in running a mutual fund?
Since most funds hire analysts in research positions a good chunk of the revenues is spent as salary expense for most mutual funds. Other expenses include rent of office and facilities, administrative expenses, payments for research material from data sources etc.
The other major expenses include brokerage fees and transaction costs, costs, investment advisory fees, and marketing & distribution expenses.
4. Current Industry trends
Since this industry is very competitive it can be said that when it comes to profits being the industry tends to follow a bell curve with close to 50% of fund houses making a profit in a year. But lately, the trend has been that some firms also generate profits not from their core operations but also by providing research and analytics to clients based offshore.
Another interesting observation to be made is that fund houses which operate a number of mutual fund schemes tend to have higher profitability than their peers. This is due to the fact that a lot of the core setup required for research and administration is pretty much in place and doesn’t need to be set up from scratch each time a fund house launches a new scheme.
Investors in mutual funds could protect their investments if they were to invest in safe fund houses which can generate a decent return from the market even during the worse days. Since it is nearly impossible to get an idea of profitability among mutual fund players, investors could use the financials of the parent companies as a proxy.
Nevertheless, as always, mutual fund investments are subject to market risks. Please read all scheme-related documents carefully before investing.
New to mutual fund investing? Want to learn how to pick the best mutual funds? Then, check out our online course- Investing in Mutual Funds? A Beginner’s Course. Enroll now and start your journey in the exciting world of mutual fund investing today. #HappyInvesting.
Baron Rothschild, a British banker and politician from the wealthy international Rothschild family, once said that the best time to buy is “when there is blood in the streets.”
In simple words, when everyone else is selling, it’s a great time to purchase. However, this advise is far easier said than done. Although it seems logical advice, yet very few people follow it. (Btw, by streets we are referring wall street/ Dalal street or just the stock market.)
Why are people afraid to invest when the market is down?
Before diving more in-depth, let’s first understand why people are afraid to invest when the market is down.
For the beginners, they are simply scared that the market may go further down and hence, it might not be the right time to invest. Sounds legit, right?
However, here the problem is that even the most experienced investors can’t time the market correctly and repeatedly. If you are planning to invest in the stocks at the bottom most price, you would most probably fail. The better approach would be to buy when they are cheaper, not the cheapest.
On the other hand, the existing investors are afraid to invest further because they are already bathing in their blood. As many of the stocks in their portfolio may be in red, these investors might be scared to make further investments. However, this approach doesn’t sound correct, does it?
I mean, let’s assume that you bought some seeds to plant in your field which may produce big returns in the long-term. However, after a few months, the price of those seeds dropped significantly. What would you do? Would you buy more of those seeds so that you can enjoy a bigger discount and secure your future even further? Or will you just stay out of the market, even though you have a larger field left to sow?
In my opinion, it would be a better outlook to buy more seeds at a cheaper price which might produce a greater return in the future.
The Law of supply and demand
The laws of supply and demand say that whenever demand is lower, the price must come down.
Now, when there is blood in the streets, there is a panic selling and a majority of people tends to sell their stocks. In such scenarios, the demand of the stocks decreases a lot compared to the supply.
And obviously, when demand is less (and the supply is more), you can buy stuff at a better discount. (On the contrary, when the market is high — the demand goes higher and hence the buyers have to purchase the same stock at a premium).
That’s why bad times make for good buys. Invest in the market when there’s blood in the street and you can get great bargains.
The market always gives opportunities, but only a few are brave enough to take it.
If you look at the stock market history, you can find that the market always gives opportunities to purchase shares at a lower price. Whether it was correction during March 2018 (after the announcement of re-introduction of LTCG tax) or the demonetization, the market has always given amazing opportunities to the buyers.
However, most people miss out these opportunities as they are busy following the crowd. Nevertheless, buying when the market is high and trying to sell during the lows can never be profitable for the investors.
Moreover, making emotional decisions to sell stocks when the market is down is always a mistake.
The history says that market rebounds, and over the long term, it always gives decent returns (And this is a fact). Even during the worst economic crisis of 2008 (when the market fell around 60%), the market bounced back to the same points within two years. The biggest losers at that time were ‘not’ the ones who bought the stocks at the highs of 2008, but the ones who ‘bought at high’ and ‘sold at low’ (just because they didn’t have patience).
And if the market can survive such a big crisis, then it will definitely recover short-term corrections (or bears) and give good returns for the long-term investors. The intelligent investors should consider these times as opportunities, rather than threats.
The Time To Act is NOW!
In one of my previous post, I had suggested starting building your watchlist as the market was high then. And if you’ve followed my suggestion then, you might already have a list of a few amazing companies with terrific return potential in the future. (Btw, I believe everyone should keep a watchlist so that they do not miss out opportunities like these).
Next, look into your watchlist and find out the current valuation of those stocks. If any of them are currently undervalued or even trading at a decent valuation, then it is the right time to act.
Final tip: The best stocks to invest are the ones already existing in your portfolio.
I learned this lesson years back when I read ‘One up on wall street’ by Peter Lynch. And I believe it is a necessary lesson to share in this post.
The best stocks to invest are the ones already existing in your portfolio. Maybe they are trading at a lower valuation, and your portfolio is in red. However, they are still the best options available to you.
You have already researched those stocks, and they are still in your portfolio only because you’re confident that it will perform well in the future. Then, why not to invest more in such stocks when they are selling even at a better discount. Look into your portfolio and find out those stocks which are currently trading at a cheaper price.
Two friends- Rajesh and Suresh, were returning home after a long and tiring day at work.
Rajesh, who happened to be an active investor in the market, turned to Suresh and exclaimed “Avanti Feeds share price has fallen down so much in the last 6 months, it destroyed all the gains it has generated in the last one year. How could this happen?”.
Suresh, a calm and a seasoned investor, who has seen multiple market cycle– listened patiently to Rajesh’s rants but kept reading his novel.
Perplexed by Suresh’s lack of response to his situation Rajesh asked “How can you remain so calm in this market, Suresh? Hasn’t the contagion affected the stocks in your portfolio too?”.
Seeing that he could no longer escape the onslaught Suresh replied– “Yes Rajesh, stocks in my portfolio have also been affected by the ongoing contagion… But I don’t bother much about that because I stayed away from the markets when it was reaching premium valuations. The contagion effect has had only a mild effect on my portfolio.”
How many of us have been able to remain calm during the market volatility that we have witnessed in the last six months? Why is it so hard to remain stay put with our investments even when we had high conviction when we invested in them a couple of years ago?
In fact, what causes the price of a stock to change so drastically? And what can we, as investors, do to prepare ourselves for it? This is exactly what we seek to address in today’s post.
We shall try to understand the various components of stock returns. How each divergence between the components can be used to gain a broader understanding of the market as well as the expectations placed on the script by other investors.
The topics for this post are as below:
What are the components of stock returns?
How do the different components affect the share price?
Could the divergence be used to explain how the mood swings in the market?
What time period should be used for the divergence analysis?
This is going to a little longer post. But it will be worth reading. So, let’s get started.
Finding Stock Returns Using Divergence Analysis Toolkit:
1. What are the components of stock returns?
Everybody knows that the value of a company is driven by the underlying growth in its earnings.
But, the prices of a stock don’t just depend on the performance of the company. It also depends on the expectations of the investors and the underlying mood regarding the broader economy.
If we were to bring out an actual formula for stock price return for a company it would look something like this –>
Total Return = Fundamental Return + Speculative Return + Dividend Return + Inflation in the Country
2. How do the different components affect the share price?
The dividend returns are a small component of the overall return achieved from a stock. If the company gives a very little or no dividend, then this component is literally doled out by the company.
The inflation return, however, happens to the black box. But, for growing economy like India, it suffices to take the inflation returns close to 5%.
Now, this brings us to the remaining two components of the equation. The Fundamental Return and the Speculative Return. From empirical evidence, it is has been broadly understood that close to 80 percent of stock returns occur just from these two components.
In a bull market, the speculative return goes over and above the fundamental return. While in the bear market the speculative return goes well below the fundamental return.
Let’s understand this from the example of Avanti Feeds. It was a hot stock in 2017, which means that it was basically a recipe for portfolio disaster.
For simplicity of calculation let’s assume only the role played by fundamental and speculative return components in our equation.
Total Return = Fundamental Return + Speculative Return
This equation could also be represented as,
Speculative Return = Total Return – Fundamental Return
From financial and the stock price data we have created the following chart for our analysis:
Stock Price (Rs)
Stock return (%)
Fundamental Return (%)
Speculative Return (%)
*(Chart and table are scaled to show the returns starting from March 2014 and adjusted for stock splits and bonus issues. All financial data are shown on the preceding 12 months basis.)
From the above analysis, it becomes clear that whenever the overall stock returns exceed the fundamental returns produced by the company– the stock prices have seen a correction to the true levels denoted by the fundamentals.
3. Could the return divergence be used to explain how the mood swings in the market?
And is it really possible to time the market?
If the above analysis were to be repeated for every single company in the broader market indices, it could give a pretty good idea regarding the ebb and flow of investors’ money into and out of the market.
A possible combination of the PE multiples for the indices with the divergence analysis could be better used to indicate the overvalued/undervalued status of the market. And this may serve as a leading indicator for bull runs and market crashes.
4. What time period should be used for the divergence analysis?
Since most market cycles last around 5-7 years, we at tradebrains, believe that it suffices to use 5-7 years of data for performing the divergence analysis.
But since a lot of stock splits and bonus issues take place in the markets every year, investors should account for these events in their analysis and use only price data that has been adjusted for these special events.
The financial market, despite on a core level is powered by the fundamental returns generated by a company, it tends to fluctuate wildly from the fundamentals due to cycles of greed and fear that are chained to money investors put into the capital markets.
The divergence analysis can be used in this scenario to understand the cycles and be used as an indicator to make key capital allocation decisions on whether to keep away from the markets or build cash or sell your existing stock positions.
We hope you enjoyed this read, looking forward to your comments. Happy Investing.
What is the Internal Rate of Return (IRR)? And How Does it Works?
Hi readers. A lot has been covered in our blog since inception, we have written articles ranging from the basics of financial statements to concepts of valuation. A reader who has followed our blog from the beginning should now be able to perform a detailed analysis of a company and arrive at a valuation for investment.
To our ever growing list of posts, today we shall add one that seeks to provide a method for calculating the rate of return of a portfolio. This method is called as Internal Rate of Return (IRR).
The IRR method to measure the portfolio performance has become a lot popular in recent days because of its effectiveness over CAGR measurements. That’s why you need to get acquainted with what actually is IRR and how to quickly calculate it.
The topics we shall read about in today’s post are as follows.
What is the Internal Rate of Return (IRR)?
How is IRR different from CAGR and how is it more useful?
Application of IRR method of return calculation with an example.
It’s going to be a very informative post. So, let’s get started.
1. What is the Internal Rate of Return (IRR)?
Theoretically speaking, IRR is the rate at which the net cash flows (both inflow as well as outflow) from an investment would be equal to zero. Better said, it is the rate of return to be achieved by all the money invested to give back all the cash received.
2. How is IRR different from CAGR and how is it more useful for investors?
Although CAGR is a classic investment metric for calculating investment returns and makes a better representation of performance than average returns since it assumes the investment capital to be compounded over time.
But it makes a couple of assumptions which may hinder its practical use. Firstly, it assumes that the compounding process is a smooth one over time with steady returns being made every year. Secondly, it assumes that a portfolio incurs cashflow only two times during its lifetime. One at the very beginning when an investment is made and the second when the investment is sold and cash is returned to the investor.
In practice rarely do we come across such scenarios where an investment is made only once, most of us happen to make regular investments over time and hence the overall return may actually be different than what the CAGR method of calculation may usually project it to be.
In such cases of multiple or uneven investment periods and cash flows, the CAGR method of calculation becomes futile and using the Internal Rate of Return method would better serve the purpose. Mathematically, the IRR calculation is represented by the following expression.
Where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively; And, IRR equals the investment’s internal rate of return.
3. Application of IRR method of return calculation with an example.
Assume we bought a stock ₹3,00,000. Also, assume that we bought an additional ₹1,00,000 worth of stock one year later and another ₹50,000 in the two years later.
Let us make one more assumption that we hold the stock for 2 more years before selling the stock for a total cash return of ₹7,50,000 Here is how the IRR equation looks in this scenario:
Mathematically speaking IRR cannot be computed analytically, but thanks to calculators and spreadsheets today this task can be done fairly easily.
Using the XIRR function in an excel we get the IRR for this scenario as 11.80%, which is the rate that makes the present value of the investment’s cash flows equal to zero.
If we were to calculate the CAGR for the example for an initial investment of ₹4,50,000 and final cash return of ₹7,50,000 over a period of 5 years we would get a but the incorrect return of 10.8%.
Quick Note: If you want to learn how to perform fundamental analysis of stocks from scratch, feel free to check out this online course- HOW TO PICK WINNING STOCKS. Enroll now and start your journey is the Indian stock market today!!
Although initially, the IRR method found applications in the capital budgeting projects of companies, recently it has become a favored method among investors to calculate the capital allocation efficiency of their portfolio.
We advise our readers to add this to their ever-growing investing toolkit. Happy Investing.
Warren Buffett, also known as the ‘Oracle of Omaha’ is a popular name in the investing world.
He is an American business magnate, investor, speaker and philanthropist who serves as the chairman and CEO of Berkshire Hathaway. Warren Buffett is considered the greatest investor of all time. As of June 2018, he is the third richest person on the world with a net worth of over $88.5 billion.
Warren Buffett was born on 30th August 1920, in Omaha, Nebraska. He made his first stock investment as an age of eleven. Later, he attended Columbia Business School as a graduate where he learned the philosophies of Value Investing through his mentor- Benjamin Graham, the father of value investing. In 1959, Warren Buffett created his Buffett Partnership after meeting Charlie Munger.
In 1962, Warren Buffett started buying stocks in a textile manufacturing firm called Berkshire Hathaway On May 10, 1965 Warren Buffett, through his investment partnership, took over the management and control of Berkshire Hathaway. Buffett’s partnership firm had accumulated about 49% of the shares of Berkshire.
The Beginners Guide to Select Right Mutual Funds in 7 Easy Steps.
“But I don’t know anything regarding mutual funds…I’m interested to invest in mutual funds, but always confused where to begin?”, Rajat argued.
“That’s the beauty of investing in the mutual funds, Rajat. You do not need to be an expert or even a finance freak to start investing in mutual funds…
…there’s a professional fund manager who will manage your fund and will take all the critical decisions like which securities to buy or sell. Overall, your job as an investor is just to invest your money at the right fund. Rest everything will be taken care of by the fund manager and fund house.”, I explained to Rajat.
“Sounds good, so far? But how to find such funds which match my goals? There are hundreds of mutual fund in the Indian market…”, Rajat looked a little excited and cautious at the same time.
“Yes, there are hundreds of mutual funds in the market. However, there will only be a few good ones that will match your goals, risk appetite and has a good track record of consistent performance. Although it may take a little time to find such funds, once you find a good mutual fund, you can sit back and relax. Moreover, finding a winning mutual fund doesn’t take too long if you know the right approach…”, I was able to see a grin on Rajat’s face after listening to my answer.
Hi Readers. One of the most frequently asked question by our blog readers is how to select right mutual funds to invest in.
Although mutual funds are managed by professional managers, however, not all funds perform are equally well. There are many funds who are not even able to beat the index. That’s why it’s really important for you to select right mutual funds that will fulfill your investment goals.
While researching the best mutual funds to invest, most beginners just look at the past performance. However, two equally other important factors to be checked before selecting any fund is whether the objective of the fund matches your investment goals and what are the different risks associated with the fund.
Moreover, mutual fund investing is a long-term relationship. Unlike the direct investment in stocks, where the people can switch the stocks fast, mutual funds are a long time period commitment. Most people stick with their funds for over 8-10 years. Therefore, it’s important that you choose a right fund and not get stuck with lagging ones which might result in you to lose both time and money.
In this post, we are sharing a beginners guide to select right mutual funds in seven easy steps. This guide will help you to perform exact step-by-step research to find winning mutual funds. Let’s get started.
A Beginners Guide to Select Right Mutual Funds in 7 Easy Steps
Here are the seven essential steps to select right mutual funds that will help you to meet your investment goals.
1. Read the Offer Document Carefully
One of the most comprehensive documents that every mutual fund provides is its offer document (also known as the prospectus). The first and probably the biggest step while choosing a mutual fund is to read the offer document carefully.
The offer document contains all the important details regarding the mutual fund like its objective, scheme type, past performance, details about the asset management company, classes of the underlying assets etc. (Quick note: If you are not familiar with these terms, check out this post regarding the must-know mutual fund terms). There is a strict instruction by SEBI regarding the filling of offer letter offered by the mutual funds- which you can find here.
In short, begin your research by reading the offer document of the mutual fund. Moreover, it’s not really difficult to understand these documents.
2. Match the objective of the fund with that of yours.
Every mutual fund has a specific objective. And based on the objective, they decide different factors like asset allocation (equity to bond weight), risks, dividend payouts, tax benefits, theme/sector focus etc.
You need to read the offer document of the fund and attentively identify whether the fund objectives meets your investment needs in terms of the above-mentioned factors. If the objectives are not relevant to you, then it might not be a good option to invest in those funds w.r.t. your investment goals.
3. Check Fees and Exit Loads
Mutual fund charges a fee for offering services and to meet different expenses like manager’s fee, operational & administration costs, advertisement costs etc. Generally, this expense ratio for an active fund can be as high as 2-2.5%. Further, some mutual funds may also charge you a fee up front when you invest (entry load), or a deferred sales charge when you sell your shares (exit load).
These pieces of information are present in the offer letter of a mutual fund. As a value investor, you should try to stay away from mutual funds with high fees and loads to avoid unnecessary costs.
Although the past performance of a fund will not guarantee how well it will perform in the future, however, it will give you a rough idea about the returns and expectations. This is certainly an important factor which must be checked. Moreover, you should compare the funds’ past performance to the benchmark as it will give you a better idea of its actual performance.
You can easily find the information regarding the past performance of any fund vs the benchmark on the financial websites like ValueResearchOnline or moneycontrol. Further, focus on the long-term performance (3 years or greater) and compare it with its competitors and index.
5. Analyze portfolio and holdings
This may be a little tricky for those who have zero knowledge of investing. After all, even if you find out which companies that mutual fund is investing in, how will you understand whether the holdings are good or bad?
Nevertheless, analyzing the portfolio and holdings gives you a general idea about the securities in which the fund is investing. Here, the key point is to make sure that the fund is investing in the type of securities in which you are interested. For example- if you are optimistic about electric vehicles and want to invest a major proportion in the automobile sector, look for a mutual fund which has a high percentage of allocation in the automobile sector. Similarly, if you’re interested to invest in other sectors like energy, infrastructure, finance etc- then studying the portfolio will give you a good idea whether the fund is right for you or not.
Anyways, there is also another trouble in while analyzing the portfolio and holding. The portfolio/holdings can change from time to time as the manager may decide to buy or sell securities at their will. Therefore, if you are not regularly reviewing the fund, the current allocation might be a little different from the time when you invested in the fund. That’s why you should always review your fund every six months or a year after purchasing to confirm that your requirements are still met by the fund.
6. Check the Tenure of Fund Manager
The fund manager is probably the heart of the mutual fund. He/She is the one who will be making all the important buy/sell decisions on your behalf. Therefore, it’s important to find out more about the fund manager.
A manager with a long tenure may have done the job well and his/her credentials are tried out. On the other hand, the efficiency of a new manager might not have been tested yet. While researching mutual funds, check the tenure of the fund manager to find how long this fund manager is managing the fund.
Another important factor regarding the fund manager is to check which other funds he/she is managing. If the other funds are also doing equally good, then it is a good sign. On the other hand, if just one fund is performing well- while the other funds that he/she is managing are struggling, then it might be a fluff.
7. Check the size and credentials of the fund house
Although it’s not the biggest factor, however, as an intelligent investor- always invest in the fund which has already established a good track record. It’s important that the fund house has strong credentials because mutual funds investing is a prolonged relationship and you do not want to get involved with a troublesome fund house which might give you headaches in upcoming years.
Nevertheless, in a few scenarios, you may invest in comparatively newer plans or fund houses. For example, if there is an exciting new theme based fund house that meets your asset allocation plan, then feel free to invest a small amount in it and later increase the amount depending on the performance.
Quick Note: If you are new to investing and want to learn how to invest in mutual funds from scratch, check out this amazing online course: Investing in Mutual Funds- A Beginner’s course. Enroll in the course now to start your journey in the requisite world of investing today.
The procedure to select right mutual funds to invest requires a careful study of the fund. In this post, we have covered the seven critical factors that you need to check to select right mutual funds to invest.
Besides, you might have noticed that we didn’t talk about the ratings of the fund. This is because of the reason that the ratings vary from websites to the website. It’s quite rare that you’ll find the same fund listed in the top 10 suggested mutual funds on different financial websites. Which one to trust? Better make your own decisions. Anyways, if you’re really interested to check the ratings, then the CRISIL ratings may be a little helpful.
Here is the final tip- Do not rush with investing. There are hundreds of mutual funds in the Indian market. Take your time to analyze them and find out the one that best suits your goals.
That’s all for this post. I hope it was helpful to you. Happy Investing.
Hello readers. Many a time, you might have heard that you should keep a high credit score. You should not default that EMI or else it will hurt your credit score.
An obvious question that may come to your mind is what actually is a credit score? How are they measured? Moreover, why should you care whether your credit score is high?
Today, we shall be covering this hot topic in personal finance which we believe is central to addressing the financial health of any individual.
The topics we shall be covering are as follows:
What is a credit score?
Why is credit score important to you?
How is credit score measured?
Where can you get your credit report?
How can you improve your score and how long does it take?
This is going to be a very interesting post, especially for the youngsters. Therefore, let’s get started.
1. What is a credit score?
Credit score is a metric used by banks and lenders to provide a comprehensive risk profile of a borrower. It is provided by four companies in India namely TransUnion CIBIL, Equifax, Experian and Highmark. The most popular agency of this being TransUnion CIBIL which provides the fabled CIBIL score.
The score is basically a reflection of your monetary habits derived from your transaction history upto three years which banks give these agencies periodically.
Every time you approach a bank for a loan or credit card, the bank tries to gauge the risk that comes along with your loan application. Gone are the days when your branch manager used to engage you in a long and mundane conversation asking about everything from your family background to your parents’ monthly pension before sanctioning the loan you asked for. Nowadays, they just send a mail to the credit agencies asking them for your credit score.
Upon receiving this request, the credit agencies aggregate your transaction data from multiple banks to ratify your profile into a scale of 300-900 to give a simple quantified data point for banks to make a judgment. After analyzing your score, the banks decide whether to accept or reject the application for the new credit card or loan, period.
The score bands used by banks for making an inference about your risk profile are as below
Credit score band
You have done great work on your score, make sure it doesn’t dip.
You most likely a couple of hiccups in your payments but that shouldn’t stop banks from rejecting your applications. You could improve your score through minor improvements
Although you may not be able to get loans immediately. You could improve your score within a matter of 2-3 months through planned action.
You have several missed payments and defaults. Most banks would reject you right away.
Since a lot of things in life is unpredictable like the occurrence of disease or death of a family member, it would be beneficial to keep a healthy credit score so that one can always avail a line of credit when needed.
3. How is credit score measured?
The credit score may vary slightly due to the difference of calculation between each of the credit agencies but they more or less look at the same things to arrive at your score.
The following are the different parameters the credit agencies use to judge your score along with the weightage attributed to each of them.
Credit Mix and Duration
Credit History: This is the most important factor in determining one’s credit score. The agencies look at one’s loan repayment data provided by the banks complete with the loan schedules, EMIs, late payments, and outstanding loans.
Credit Utilisation: This basically the percentage of loan one has outstanding to the total loan amount that can be availed. Ideally lower the loan one has outstanding the higher one’s score.
Credit mix and duration: The type of loan you avail also has a bearing on this aspect of one’s credit score, a higher amount of unsecured loan could lower credit score faster than an equivalent amount of secured loans. The reason for this being that secured loans are backed by property or any other asset that the bank can claim in case of default making it less risky than an unsecured loan.
Other factors: These include miscellaneous activities such as the number of hard inquiries made at the bank for loans and credit card applications. The banks often construe this as a sign of a person being under financial stress. This may have a negative impact on the credit score.
4. How can you get your Credit Report?
As per the RBI directive in 2016, every customer is entitled to one free report from each of the credit agencies in a twelve month period. This means that you can get a total of four credit reports from all agencies together. We at Trade Brains advise that our readers avail this every quarter or at least semi-annually from different credit agencies.
Credit Score is the most important metrics banks and financial institutions use to gauge your risk profile. It would be beneficial for an individual to maintain a high credit score so that they can avail a line of credit in times of need.
Although not easy, a credit score can always be improved through planned and disciplined action on the side of an individual. We at Trade Brains hope our readers make the best efforts to maintain a high credit score.
Originally coined by Jim Cramer of MSNBC, ‘FANG’ is a group of high performing technology stocks that includes Facebook, Amazon, Netflix, and Google (Alphabet).
While all these companies started as tiny startups just a couple of decades ago, they have rapidly grown into innovation engines and in the process have delivered stellar returns to investors.
Just to put the size of the FANG companies into perspective, as of September 7, 2018, the combined market capitalization of the four companies was USD 2.4 Trillion. This is greater than the market capitalization of all the 30 companies in the SENSEX (USD 2.2 Trillion) put together!
Nowadays, the FANG acronym has multiple versions. Some investors added Apple to the list to coin the term FAANG. Meanwhile, Goldman Sachs created their own acronym, removing Netflix and adding Microsoft to the mix, to form FAAMG, signifying the top 5 tech companies that have been the primary drivers of growth in the US stock market.
Regardless of what you call them, these technology companies have displayed unprecedented growth and have become darlings of investors across the world. Some key facts about the companies:
Along with its own successful social media platform, Facebook owns Instagram, Whatsapp, and Facebook Messenger. All of these are globally recognized platforms with more than 1 billion users each.
Facebook makes the majority of its revenue from advertising. In fact, Facebook, along with Google, is a duopoly in digital advertising. Facebook captures almost 20% of the entire digital advertising spend in the US.
The Facebook stock recently lost USD 120 Billion in value primarily due to concerns over data privacy. Despite the stock price hit, Facebook continues to grow its revenue. At the end of 2Q 2018, the company’s revenue grew by 42% to USD 13.2 Billion.
A global e-commerce player, Amazon recently crossed the coveted USD 1 Trillion market cap mark for the first time.
The company has captured 49.1% of the online retail market in the US and is set to post USD 258 Billion in retail revenue in 2018.
One of Amazon’s growth drivers is its cloud computing service called Amazon Web Services (AWS). AWS revenues grew by 42% year on year in 2Q 2018 to reach a revenue of more than USD 4 Billion.
It also has an internet advertisement business, which is expected to drive significant future growth and achieve USD 16 Billion revenue by 2021.
Apple was the first company in the history of the stock market to hit a USD 1 Trillion market cap.
It has the market cornered for smartphones. Despite capturing only 18% of the smartphone volume, the iPhone captures about 87% of the profit margin of the entire smartphone industry. This is in stark contrast to Samsung, which captures only about 10% of the industry’s profit.
It also has a rapidly developing internet services business that grew at 31% year over year to deliver USD 9.5 Billion in revenue in Q2 2018. An incredible feat for a mature company.
The first global TV provider and pioneer of the subscription model, Netflix has more than 130 million subscribers worldwide. This large subscription base allows it to spread development cost across its users and thus gain a cost advantage over its competitors.
Recently, concerns have been raised over the high debt the company is raising to fuel content development, and also around the increasing number of streaming competitors.
In the past several years, Netflix has almost always beaten investors’ growth expectations. However, the next phase of its growth is going to be challenging, it missed growth targets for Q2 2018.
Satya Nadella, the CEO of Microsoft, has done a tremendous job in navigating Microsoft through a post-Windows world.
Led by its cloud and AI practice, the company’s revenue surpassed USD 100 Billion for the first time, in the fiscal year 2018.
In its last earnings release, the company announced that its three core business units reported double-digit revenue growth, with Azure Cloud (its cloud services arm) leading the charge by posting 89% year over year revenue growth.
Google (trades under the name of Alphabet)
The leader in digital advertising, Google has captured 90.5% of the search market. Despite its massive size, Google’s revenue continues to grow rapidly.
In Q2 2018, revenue was up 26% year on year to reach USD 32.6 Billion.
The company enjoys a leadership in AI technologies, largely due to its massive user base and superb ability to capture and utilize big data to train state of the art machine learning models.
Clearly, the FANG/FAANG/FAAMG companies are on their way to revolutionizing how the world interacts with and benefits from technology!
In order to become a part of this journey and to invest in these companies, visit Vested – It’s a platform that allows you to invest in US-listed companies like Facebook, Amazon, Google etc. in a cheap and simple way.
How to measure your investment performance? -The Right Way
Hello Readers. Honestly, we at Trade Brains love cricket!. We also happen to love following the latest records and comparing statistics of our favorite players. Which of our players are the most consistent? Who is more likely to score runs and how often? Who plays better against spinners? And who works best on a flat pitch?
Well, these are just some of the questions that we keep asking ourselves right?
This got us thinking, is there anyway, we as investors, could borrow from the sport and rate ourselves? And can we make ourselves as better investors through a defined process? After all, introspection is the best critic we have on our side right?
In this post, we will be covering the different metrics and techniques, we as investors, can use to measure our performance and hopefully identify and strengthen the weak spots in our investment process. An over the top view of the toolkit is as follows:
Performance relative to the benchmark
Overall, this post will give the best ever solution to measure your investment performance. So, without wasting any further time, let’s get started.
How to Measure Your Investment Performance?
Here are the four best and easy metrics that you can use to measure your investment performance over the years in a right way.
1. Hit Rate
Broadly defined, hit rate is the percentage of profitable investments to the total number of attempted investments.
The keyword in this metric is “attempted investments”. Many a time, retail investors do more harm than good to their portfolios by investing in stocks they do not understand in an attempt to diversify their portfolio. This approach could result in below market performance for the investors in the long run. A better approach would be to make infrequent but highly probably bets in the market.
This sentiment is also paraphrased by master investor Warren Buffett through one of his famous analogies comparing investment performance to playing baseball.
“What’s nice about investing is you don’t have to swing at pitches. You can watch pitches come in one inch above or one inch below your navel and you don’t have to swing. No umpire is going to call you out. You can wait for the pitch you want. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard. I’ve never swung at a ball while it’s still in the pitcher’s glove.” – Warren Buffett
Quite simply this is a measure of how much you profit when you win and how much loss you incur when you don’t.
Logically, any investor who wishes to make positive returns will have to ensure that their gains outdo their losses. The more the outperformance of the gains the better the returns will be for the overall portfolio.
Although most investors think they need not use this statistic to measure their performance, we at Trade Brains, believe otherwise.
Ideally, you as an investor would want to hold on to your winning picks and exit your losing stocks quickly. While, this doesn’t mean that you drop a stock just because it went down immediately after you bought the stock, a stock that drops 40-50% should be treated as a red flag and reviewed before taking a decision on whether to continue holding the stock or not.
4. Performance relative to the market benchmarks
Since most investors seek to beat the market over time, it would make sense to measure your portfolio’s performance against broader market indices such as NSE Nifty 50 or BSE Sensex.
The performance relative to the market indices can help you decide whether you need to increase your exposure to mutual funds or stop investing on your own entirely.
For a portfolio composed of predominantly large-cap stocks, it would make sense to compare the portfolio relative to large-cap indices (and similarly for mid-cap and small-caps).
But what if your portfolio had exposure to large, mid and small cap segments of the market?
Let us understand the method of evaluation through the following example.
Assume that an investor has 30% exposure to large-cap stocks, 30% to mid-cap and 40% to small-cap stocks.
The best method for evaluating such a scenario would be to take the weighted average returns of indices to measure one’s portfolio performance.
BSE Mid Cap
BSE Small Cap
The weighted average returns of the indices for a similar market exposure as the portfolio will be given by the following expression-
Weighted Average returns for 3 Years = [(large cap exposure x large-cap index return) + (mid-cap exposure x mid-cap return) + (small-cap exposure x small-cap return)] x100
= [(30.0% x 54.20%) + (30.0 %x 62.90%) + (40.0% x 62.2%)] x 100
= [0.1626 +0.1887+0.2488]x100
If the investor’s portfolio achieved returns greater than the 60.01% in three years (that would have been achieved by a similar exposure to the market benchmarks), then it is best for him to continue investing on his own. Otherwise, it would be better for the investor to allocate his capital to Index Funds with similar weighting or change his/her investing strategy.
The financial markets are fantastic yet dangerous places to grow your wealth over a lifetime. Any investor who wishes to play the game for the long term will have to continuously adapt their investing process to achieve the most optimum returns.
We hope our readers will add the above methods to their toolkit for measuring portfolio performance. Happy investing.
What is the Law of Small Numbers? Meaning, Examples & More:
Often we don’t realize but the game of investment can be closely connected with hardcore psychology. You must have heard many people say: research before you invest.
While that is absolutely true, you must also know what to research for. While being on a searching spree, generally, you find many online (or offline?!) resources which tend to favor a kind more than the other. Enter, The Law of Small Numbers.
A data has multiple dimensions and each one of them is responsible for inferring the data in a different context. Statisticians tend to choose the attributes (read dimensions) very carefully. The choice of attributes is not random, of course. A couple of data mining techniques such as “Decision Tree Induction” can carry out specific attribute selection methods to take exact inference.
Coming back to the real context, “The Law of Small Numbers” is actually a law confirming fallacy. It says that the length of data is an important consideration for a data as the probability of it being relatable is directly correlated to the length of the data. Read more of this article to get to know about “The Law of Small Numbers”.
The Loophole in the Probabilistic Inference:
Imagine our whole world running on the rules of probability! However fancy it might seem, it is not actually possible otherwise you would be having a fair chance to everything, wouldn’t you? The point is that probabilistic results are always relative. You can neither expect nor confirm the extent of its reality.
The source of the data that you are picking for your hypothesis and inference is of great importance here. Rather than completely shifting your focus to what does a data infer, you might want to shift your focus to where the data has been picked from (and possibly how).
Random Sampling is one of the famous probabilistic sampling techniques which goes with a very basic rule: Each element has an equal and a fair chance of getting picked. Now, nothing in this world is absolutely defined by itself and so the fair & equal chance is quite a hypothesis.
A Causal Narrative is something which is derived from general human behavior. You must have not realized but we humans have always indulged in pulling out inferences from the pieces of information that are provided to us. The data, however, is not always full-proof.
To put it in clearer words, the data can be churned out as a result of random sampling which makes it even more difficult to put a word to the analysis done through its inferences. You must note that Random Sampling inferences are sometimes misinterpreted as the whole account of the data is not clear and was in fact collected randomly. Similarly, a causal explanation of a data which has been collected or sampled randomly does not always pull out exact inferences.
Why? – Because we are trying to infer a cause for something which has no cause (by its nature).
Hence, equal attention must be paid to the method which has been used for collecting the data.
Sparse Population & an Example:
In a famous statistical puzzle related to kidney cancer among the 3143 counties in the US, the data had two interesting (& confusing) inferences at the same time.
Inference 1: US Counties with the lowest rates of Kidney Cancer have the following attributes:
Located in traditionally Republican states in the Midwest, the South, and the West.
Inference 2: US counties with the highest rates of Kidney Cancer have the following attributes:
Located in traditionally Republican states in the Midwest, the South, and the West.
Now, how two exactly opposite (in nature) inferences can have exactly the same attributes?
The key attribute or factor here in this example is the sparse population of the data collected in the first place. In fact, a misinterpretation of the data source has been done because of the sparsely populated data as a small population (generated with a random chance) is inclined to show greater extremes in terms of deviations.
Let’s understand this context better in terms of another famous example:
Take an example where a jar of equal red and green marbles is placed and you need to pick 4 marbles out of the jar randomly. The possible outcomes noted are:
2R/2G <- Actual Population Mean
3R/1G or 3G/1R
4G/4R <- extreme outcome (has 12.5% chance)
When the Sample sizes are increased and for example let’s say we’d be picking out 7 Marbles instead of 4 then the probability of extreme deviation (i.e. picking out 7 same colored marbles) is reduced to only 1.8%.
This result is in fact derived from the very famous law –“The Law of Small Numbers”.
The law of small numbers explains the Judgmental bias which occurs when it is assumed that the characteristics of a sample population can be estimated from a small number of observations or sample data.
Therefore, while studying any survey, the length of data should be given an important consideration as the probability of it being relatable is directly correlated to the length of the sample.
Hi Investors. The pledging of shares is one of the many important factors to check before investing- which many investors overlook. A high pledging of shares can be a point of concern for the shareholders.
In this post, we are going to discuss what exactly is pledging of shares and why it can be troublesome for investors. Here are the topics that we will discuss today:
What is pledging of shares?
Why promoters pledge their shares?
Why is pledging of shares risky for the shareholders?
How to find the pledging of shares for Indian companies?
This is going to be an interesting post and I’m confident that you’ll learn many new things concerning pledging of shares in this post. So, without wasting any further time, let’s get started.
1. What is Pledging of shares?
In simple words, pledging of shares means taking loans against the shares that one holds.
This is a way for the promoters of a company to get loans to meet their business or personal requirements by keeping their shares as collateral to lenders. Pledging of shares can be used to meet different needs like working capital requirements, funding other ventures, to carry out new acquisitions, personal obligations and more.
2. Why promoters pledge their shares?
As discussed above, the promoters can pledge their shares in order to meet various business or personal requirements.
Generally, pledging of shares is the last option for the promoters to raise fund. It is comparatively safer to raise fund through equity or debt for the promoter. However, if the promoters are looking forward to pledging their shares, then it means that all the other options of raising fund have been closed.
These situations occur during the economic slowdown. As shares are also considered as assets, hence it can be used as a security to take loans from the banks.
3. Why is pledging of shares risky for the shareholders?
While pledging of shares, the promoters use their stake as a collateral to get the secured loans.
During a bull market, pledging of shares may not create many issues as the market is moving upwards and the investors are optimistic. However, the problem arises in the bear market.
As the price of stocks keeps fluctuating, the value of the collateral (against the secured loan) also changes with the change in the share price. However, the promoters are required to maintain the value of that collateral.
If the price of the shares falls, the value of the collateral will also erode. In order to meet up the difference in the collateral value, the promoters have to cover the shortfall by either giving additional cash or pledging more shares to the lender.
Collateral Value (while taking the loan)
The collateral value after a 30% fall in share price
The collateral value after a 50% fall in share price
More pledging of shares to cover up the difference of the remaining 30 crores
Higher pledging of shares to cover up the difference of the remaining 50 crores
In the worst case, if the promoters fail to make up for the difference, the lender can sell the pledged shares in the open market to recover their money. This minimum collateral value is agreed in the contract between the lenders and the promoters. Hence, it gives the right to the lender to sell the pledged shares in the if the value falls below the minimum value.
What is the risk for the retail investors?
In general, the stock price can fall heavily on the news that lenders are selling shares in the open market that are pledged by the company’s promoters. This may result in a further decline in the collateral value because of the panic selling by the public.
In addition, selling of the pledged shares by the lenders may also result in the change of the shareholding pattern of the company. This may affect the voting power of the promoters as they are holding fewer shares now and their ability to make crucial decisions.
Moreover, pledging of shares can create a disaster if the share price continues to fall. This is because the promoters have to consistently pledge more shares to cover up the difference in the collateral value.
Quick Note: If you are new to stocks and confused where to begin… here’s an amazing online course for fundamental investment- HOW TO PICK WINNING STOCKS? The course is currently available at a discount.
4. How to find the pledging of shares for Indian companies?
You can find the pledged share as the percentage of total holding sharing shares on most of the major financial websites like moneycontrol, screener etc.
However, the best source to find the pledging of Indian shares would be the BSE or NSE website. Publically listed companies are obliged to submit their quarterly shareholding pattern to the stock exchanges. Hence you can find the latest (and correct) information regarding their shareholding pattern on the BSE/NSE website.
Here are the exact steps to find the pledging of shares for the Indian public companies.
Pledging of shares is generally seen in the companies where the shareholding of the promoters is high. As a thumb rule, pledging of shares above 50% can risky for the promoters. In short, ignore companies with high pledging of shares to avoid unnecessary troubles.
This is because pledging of shares is a sign of poor cash flow, low-creditability high-debt company and inability to meet the short-term requirements. (If the promoters have pledged a high percentage of shares, then it’s always worthwhile to find out the reason.) A decreasing pledging of shares over time is a good sign for the investors. On the other hand, an increasing pledging of shares can be dangerous for both promoters and shareholders. Even quality companies can become a victim if the pledging of shares is not reduced over time.
Nevertheless, pledging of shares is not always bad for the companies. You can understand this by relating with your personal loans. For example, taking an educational loan, car loan, house loan is not a big issue if you have a steady income or an amazing future earning prospects.
Similarly, if the company has an increasing operating cash flow and good future prospects, then pledging of shares is not a big concern for them. Many times, pledging of shares helps in the expansion of the company or to carry out new projects which result in increased revenue in the future. Moreover, 5-10% pledging of shares in fundamentally healthy companies should not be considered as a problem.
Anyways, the bottom line is to try avoiding to invest in companies with a high (or increasing) pledging of shares.
That’s all for this post. I hope it was helpful to you. Happy Investing!
“… Even Warren Buffett build most of his fortune after an age of 50. Admit it, Kritesh. Investing takes too long to make money.” Gaurav asked wickedly.
“I’m not denying the fact that investing requires time to build wealth. Yes, it does take time. However, it doesn’t mean that it takes too long time.” I defended my argument.
“But what’s the point of getting rich if you are too old to use that money?“, Gaurav replied.
“You do not need to be in your 50s or 60s to build a massive wealth by investing. There are many investors who are able to gain financial freedom in their late 30s or early 40s just by investing intelligently. Here, how much time it takes to build wealth depends on how early you started and how intelligently you’re investing.”, I added.
I could notice that Gaurav was still not convinced. Therefore, I continued.
“…Moreover, now that you have started the topic of Warren Buffett, I would like to add that he did become a millionaire by the age of 30. Obviously, it took some time for him for becoming a billionaire and the richest man on the earth… However, being a millionaire in the early 1960s was a big deal. Besides, its a lot of money for most people who aims for a financially independent life.” I summed up.
Gaurav seems to understand a little regarding what I’ve been trying to convey for the last fifteen minutes. However, our arguments generally never end within an hour. And hence, Gaurav was ready to fire his next question.
“…So you are saying that investing takes time to build wealth; but not too much time?” Gaurav asked with his witty sense of humor.
“All I’m saying is that for an intelligent investor- creating money doesn’t mean being wealthy in your 60s. One can achieve it a lot earlier. Obviously, value investing is not a get rich quick scheme. However, if you have made the right investments, you’ll start getting decent returns in next few years. Yes, it does take time, but the rewards are also great for those who are willing to be patient.”, finally, I had put my words to meaning.
Does Investing take too long to build wealth?
As a value investor, I understand the importance of investing for the long term. When you invest for a longer time horizon, the power of compounding works in your favor. Moreover, if you have invested in the right companies which and it is giving good returns, it does not makes much sense to sell that stock just to keep the money in the bank account. Keeping the stock for the long term in your portfolio is the key to build wealth. But how long is relative to your goals.
Nevertheless, one should always remember that successful investing is a tricky business. It takes years of time to learn to invest intelligently in the stock market. Most people should not expect to make money investing over the short term. Besides, the majority of the good stocks takes at least 2–4 years to give amazing returns to their investors. Investing for six months is only good for making small profits, not wealth.
Most stocks investors know this method to build wealth. Buy low and sell high. While investing in stocks, you can expect to make money through capital appreciation i.e capital gain when the share price rises. The profits can go as high as +1,000% (also known as ten-bagger stocks). However, even for the safest stock, there is no guarantee that the price will go higher in the short term.
Earning from dividends
Apart from capital appreciation, investors can also make income from the dividends. A healthy company distributes profits to its shareholders in the form of dividends. In most cases, the company partially distributes profits and keeps the rest for other purposes such as expansion, buying new assets, share buybacks etc. The dividends are distributed per share. If a company decides to give Rs 10 per share, and if the face value of the share is Rs 10, it is called a 100 percent dividend.
Anyways, an important point to learn here is that dividends grow over time for fundamentally strong companies. And if the dividends from the stocks are consistently increasing over the years, this means that the net income for the investors will also increase over time.
You might have heard the wealth creation stories of the common stocks like Wipro, Infosys, MRF etc. An investment of Rs 1,000 in these stocks in the early 1990s would have turned out to be worth over multiple crores in next 25–30 years.
Most people argue that no one can keep a stock for so long time frame. And I agree with their logic. Even, if I had invested in such stocks, there might be a few times in the time period of the last twenty-five years when I might have been tempted to sell those stocks and book profits. Overall, I agree with the logic that holding stocks for 25–30 years is a little difficult.
However, people ignore the second assumption that the investment in stocks was just Rs 1,000. This is something worthwhile discussing here. If I was an investor in those stocks, I would have definitely increased the investment amount with time. Investing just Rs 1,000 doesn’t make much sense if you already know its history of consistently making wealth over time. Any intelligent investor would have increased their investments in such stocks.
Therefore, while arguing the time period of investment for such wealth creators, also give a little attention to the investment amount. For simplicity, the analysts consider that people invested just Rs 1,000. However, as a matter of fact, most investors continuously increase their investment amount over time. And that’s why the total returns could be even higher than what mentioned. Even if you had not kept those stock for a long time frame, still the fact is that those stocks would have created a huge wealth for their investors.
Besides, you do not need to sell your stock to build wealth. As discussed above, you would have already made income from the dividends. And moreover, if the value of the stocks in your portfolio is increasing, your net worth will be increasing along with it.
While holding stocks for the long term is the key to build massive wealth, however, it would be wrong to say that investing takes too long to build wealth. Even if you are investing for a decent time frame like 8–10 years, still the returns can be amazing.
Besides, if you do not need the money, it would be worthwhile to remain invested in that stock. There are only three reasons when you should sell any stock- 1)If the fundamentals of the stock changes, 2) When you find a better opportunity to invest, 3) When you really need to money. In all other cases, you should remain invested in stocks.
As Warren Buffett used to say- “Our favorite holding period is forever”.
In the last few years, the financial market has noticed a strong rise in the robo advisors in India. As a matter of fact, these Robo advisors have broken down the traditional barrier between financial services and the average investors.
For a very long time, an average investor cannot afford the advisory facilities of the high-fee Dalal street advisors. However, with the rise of robo advisors in India, these investors have a new alternative now.
In this post, we are going to discuss robo advisors in India. Here are the topics that we will cover today:
What are Robo advisors?
Benefits of Robo advisors
Shortcomings of robo advisors
Are all robo advisors in India same?
Who should use a robo advisor?
In short, it’s going to be a very interesting post. Let’s get started.
1. What are Robo advisors?
In simple words, Robo advisors are online platforms that provide automated financial planning services based on the designed algorithms with minimum human interference. This is a method to automate asset allocation (and investments) of customers using computer algorithms.
Robo advisors are easy for goal setting and allocation for those who have no idea of where to begin.
Basically, robo advisors collect important pieces of information from clients like their financial situations, goals, preferences etc through a survey. And they use this data to offer financial advice or to automatically invest clients assets. (Please note that here the financial experts of the firm regularly monitor the market activity and underlying investment to keep the algorithm efficient.)
Robo advisors differ from the traditional financial advisors and do it yourself investors on various factors like cost, flexibility, time & research etc. Here is a simple comparison between traditional advisors, do it yourself investors and robo advisors.
Do it yourself Investors
Time & Research
From the above table, you can notice that the robo advisors can be a good alternative to the traditional advisors.
The biggest benefit of robo advisors is that they deliver services directly to the customers.
Compared to the traditional advisors, robo advisors offer a low-cost alternative because these digital platforms similar services with a fraction of cost charged earlier by eliminating the human labor. Moreover, robo advisors are easily available and can provide a 24×7 support.
In terms of initial investment, you need a very little capital to get started with robo advisors in India. Same is not true in case of traditional advisors. For an average investor, the fees of the traditional advisors can cost a lot. They can easily charge as much as 20-30k for providing the advisory services of a year. Nevertheless, if you are investing a small amount (say less than one lakh), then even if you make a good return of 15% on your investments, still this profit will be gone in the annual advisory fee only.
That’s why most of the clients of the traditional investors are the people who are investing lakhs of rupees. In general, the top human advisors won’t take clients with less than Rs 10-15 lakhs of annual investments.
The robo advisors in India are still in the evolutionary phase. And that’s why they still have a few shortcomings.
For example- Robo advisors lack emotions and empathy. As investments are also a subdomain of behavioral finance, there are still some doubts about the viability of Robo advisors.
Further, although they are good for beginners, still robo advisors are not effective for the advanced advisory services like complicated tax planning, real estate investment planning, multiple stage retirement planning etc.
And finally, Robo advisors are not trained/equipped to deal with an unexpected crisis or extraordinary situations like the economic crisis of 2008. Whether they can perform better or worse than the traditional advisors in such situations- is still not tested.
Now that you have learned about the basic meaning of the robo advisors, the next big question might be that- Are all these robo advisors the same.
The answer is ‘No’. All robo advisors are not the same in India. They have different algorithms and moreover, they differ in important factors like minimum investment, annual fees, asset allocation, account type, support, automation, tax planning etc.
If you are planning to use robo advisory, it’s important that you check these criteria and find out the best one that suits you.
Quick Note: If you are new to investing and want to learn how to invest in mutual funds, check out this amazing online course: Investing in Mutual Funds- A Beginner’s course. Enroll in the course now to start your journey in the requisite world of investing today.
5. Who should use a Robo Advisor in India?
The simple answer is that anyone can use Robo advisors in India.
However, the complicated question is whether they should or not? For the people who are investing lakhs of rupees, should they go with revolutionary robo advisors or choose the time-tested traditional advisors?
Although it might take years to find the right answer to the above question. However, there is no denying the fact that robo advisors in India are a good fit for people who are young, lacks investment experience and have a simple portfolio.
That’s all for this post. I hope it was helpful. Happy Investing.
Hi Investors. One of the most popular topics in company valuation is the Free cash flow. If you are involved in the fundamental analysis of stocks, you definitely have heard about this term.
Nevertheless, for beginners, free cash flow can be a mystery.
In this post, we are going to discuss what exactly is a free cash flow and why it is important to evaluate while researching a company. Here are the topics that we will cover in this post-
What is a free cash flow?
Why is free cash flow important?
How to calculate free cash flow of a company?
How to analyze the free cash flow?
This might be one of the most important articles for the people interested to learn stock valuations. Therefore, read this post completely. Let’s get started.
1. What is a Free Cash Flow (FCF)?
Free cash flow is the cash that is available for all the investors of the company. It represents the excess cash that a company is able to generate after spending the money required for its operation or to expand its asset base.
Now, you might be wondering what is so ‘FREE’ about this cash flow and how it is different from the earnings of the company?
Here you need to understand that not all income is equal to cash. If a company is making earnings, it doesn’t mean that it can spend all the income directly. The company can only spend the free cash. There is a crucial difference between ‘cash’ versus ‘cash that can be taken out of a business’, or in accounting terms: cash from operating activities and free cash flow (FCF).
The cash from operating activities is the amount of cash generated by the business operations of a company. However, not all of the cash from operating activities can be taken out of the business because some of it is required to keep the company operational. These expenses are called capital expenditures (CAPEX).
On the other hand, free cash flow is the cash that a company is able to generate after spending the money required to stay in business. This is the cash at the end of the year, after deducting all operating expenses, expenditures, investments etc and is available for distribution to all stakeholders of a company (Stakeholders include both equity and debt investors.)
It’s important for an investor to look into the free cash flow of a company carefully because it is a relatively more accurate method to find the profitability of a company than the company’s earnings.
This is because earnings show the current profitability of the company. On the other hand, the free cash flow signals the future growth prospects of the company as this is the cash that allows the company to pursue opportunities to enhance shareholder’s value. Free cash flow reflects the ease with which businesses can grow or pay dividends to the shareholder.
The excess cash can be utilized by the company in expanding their portfolio, developing new products, making useful acquisitions, paying dividends, reducing debt or to pursue any other growth opportunity.
Further, free cash flow is also used as the input while calculating the intrinsic value of a company using the popular valuation technique- Discounted cash flow (DCF) Model.
(Besides, as free cash flow is the additional money that can be taken out of the company without affecting the running of the business, it is also called the “Owner’s Earnings”.)
3. How to calculate free cash flow of a stock?
Companies in the stock market are not obliged to publish their free cash flow. That’s why you can’t find FCF directly in the financial statements of the companies. However, the good point is that it is easy to calculate them.
To calculate the free cash flow of a stock, you’ll require its financial statements i.e income statement, balance sheet, and cash flow statements. There are two calculation methods to find Free cash flow of a company.
Method 1: From the Income statement & Balance sheet
FCF = EBIT (1-tax rate) +(depreciation & amortisation) -(change in net working capital) – (capital expenditure)
Method 2: From the cash flow statement
Free cash flow is calculated as cash from operations minus capital expenditures.
FCF = Cash flow from operating activities – capital expenditures (from the cash flow from investing activities)
Quick Note: To make the things simpler, SCREENER.IN has already made the free cash flow of the stocks available on their website. Feel free to check it out. Nevertheless, we advise our readers to do the calculations themselves to avoid any algorithm miscalculations.
4. How to analyze the free cash flow of a company?
While studying the cash flow of a company, it is important to find out where the cash is coming from. The cash can be generated either from the earnings or debts. While an increase in cash flow because of the increase in earnings is a good sign. However, the same is not true with debts.
Moreover, if two companies have a same free cash flow, it doesn’t mean that they have a similar future prospect. Few industries have a higher capital expenditure compared to other industries. Further, if the Capex is high, you need to investigate whether the reason for the high capital expenditure is due to expenses in growth or expenditure. In order to learn these, you have to read the quarterly/annual reports of the companies carefully.
Negative FCF of a company.
A consistently declining or negative free cash flow of a can be a warning sign for the investors. Negative free cash flow is dangerous because it may lead to slow down in the business. Further, if the company didn’t improve its free cash flow, it might face insufficient liquidity to stay in the business.
Quick Note: If you want to learn free cash flow and discounted cash flow (DCF) model in depth, feel free to check out this online course: HOW TO PICK WINNING STOCKS? Enroll now and learn stock valuation techniques today.
In this post, we discussed the Free cash flow (FCF). It is a measure of a company’s financial performance. Free cash flow represents how much cash a company has left from its operations i.e. the cash that could be used to pursue opportunities that improve shareholder value.
However, the absolute value of the free cash value doesn’t tell you the whole story. You have to find out where this cash is coming from and how the company is using it. Whether they are spending this money effectively on operations like giving healthy dividends, buybacks, acquisitions etc- or not. And finally, a consistent negative free cash flow of a company might be a warning sign for the investors.
How to Check if a Moat Exist? Use the Moat Analysis Framework.
It is quite strange that a medieval defense strategy employed in the fortifications of forts in England has come to occupy such a central stage in value investing stock analysis.
Come to think of it, if you could picture England as a giant castle and The English Channel as the surrounding moat, you could quickly deduce that once England united the other nations on its island there would be few world powers who could launch massive territorial conquest on its shores especially since amphibious operations always tend to favour the defending side. (Perhaps this enabled them to expand their empire since not much needed to be done on homeland security front).
As explained in our posts before, Moats are long-lasting competitive advantages a company might have owing to its business model that enable it to resist the onslaught of competition for a great number of years.
In the period around 1950-1960, when great companies such as Walmart and Nike were still startups, the greatest struggle the entrepreneurs faced was the problem of securing a starting capital. Most of the times business in that time had to open a line of credit from banks but the problem was that the banks were highly regulated and only were willing to lend to those companies which had already established their operations and achieved some reasonable scale to their businesses. This gave an advantage to existing businesses since the system stifled the growth and emergence of new competitors.
Come the 70s, the world began to see the rise of venture capital and private equity firms namely Sequoia and Carlyle in the US. These companies were able to pool in money from investors and redirect them to fund the capital of emerging entrepreneurs of Silicon Valley and elsewhere.
In time (that is the last 4 decades), the high capital requirement as a barrier to entry has steadily eroded away and have enabled upstarts and disruptors to challenge incumbent businesses across different sectors.
The other trend (which will get even more relevant in the future) has been the evolution of technology at breakneck speed which has fundamentally brought down the cost of entry into many businesses at the cost of well-established firms.
Since companies face a greater risk to their business models now more than ever, it has become imperative for investors to select the companies with the most resilient business models for their portfolio. Only then it is possible for investors to generate steady returns without painful volatility.
The process of finding moats can be quite arduous and confusing for investors who are starting out, especially when a lot of companies seem to be running profitable operations for extended periods even without any apparent moat. Although moats often come in various forms and sizes, it may sometimes be very difficult to identify and to judge their quality for many companies. In such a scenario it helps to have a decision-making framework to act as a force multiplier in the investor’s toolkit.
The following moat analysis framework should provide a good starting point for our readers in their analysis. You may feel free to develop this into a more comprehensive and robust framework based on your experiences and understanding of different industrial sectors.
(Please note the framework was developed by Ensemble Capital, an asset management company in the US, it draws greatly from the experiences of the firm’s analysts and books including “The little book that builds wealth” by Pat Dorsey and The Investment Checklist by Michael Shearn)
Hi Investors. Have you recently checked the market price of MRF Share? It’s hovering at a whopping price of Rs 74,076 per share. The interesting question here is why the MRF’s management/promoters are not splitting its shares? After all, buying a stock at Rs 74,076 per share is not viable for most of the retail investors.
In this post, we are going to discuss why companies like MRF don’t split the stock. But before we discuss these expensive stocks, let’s first study why companies split their stocks?
In the last 25 years, Infosys has given multiple bonuses and stock splits to its shareholders. And, that’s why the share price of Infosys is still in the affordable purchase rate for the average investors. In fact, if Infosys has not given so many bonuses and splits, the price of one share of Infosys might have been over multiple lacks by now. Here is the bonus and split history of Infosys since 1993:
Besides, Wipro is another common stock with the similar story. Because of its consistent bonuses and splits, the Wipro share is still in the purchase range for the retail investors. Else, if the management had decided not to give any split or bonus, then the share of Wipro might also have been over multiple lakhs and maybe over crores by now.
Now, the big question is why do companies split share?
Here are four common reasons why companies split their shares-
Stock splits help to make the share price affordable for the retail investors. For example, if a company is trading at a share price of Rs 3000 and it offers a stock split of 10:1, then it means that its price will drop to Rs 300 per share after the split. Now, which price is more affordable to the public- Rs 3,000 or Rs 300? Obviously, Rs 300.
The stock split makes the stock more liquid and hence increases its trading volume. This is because the total number of outstanding shares increases after the stock split.
Splitting a stock does not affect the financials of a company. Although the outstanding shares of the company will increase after the split, however, the face value will decrease in the same proportion. Overall, stock splits don’t affect the financials and hence the companies are willing to go for it.
As small and retail investors are more interested in affordable shares, stock splits help in increasing their participation and overall helps the companies to build a broadly diversified investor base for their stock.
Overall, in terms of value, the stock split doesn’t matters much as the financials of the company remains the same. However, by splitting the shares- the company is able to keep the shares affordable to the public and hence maintains a wide ownership base.
Then, why few companies not split their shares?
The reasons to split shares might be clear by reading the above paragraph. However, the next big question is why few companies do not split their shares? Why the share price of many stocks in the share market is still in the 5 figures if they have an option to split their stocks.
If you check the current market price of the companies listed on the Indian stock exchange, you can find out that there are many companies whose share price is above Rs 10,000. Here are few of the top ones-
All these shares are not easily affordable for the average retail investor. Even the shares of Maruti is trading at a current price of above Rs 9,000.
Why Do Companies Like MRF Don’t Split the Stock?
Here are few common reasons why few companies do not split their shares-
1. They are already doing good. Why bother to split?
Many of these companies are already good. Then why should they bother to split the share and make it cheap?
For example- MRF was trading at a share price of Rs 12,800 in August 2013. Currently, it is trading at Rs 74,000. The people might have argued that the stock was expensive and not affordable even in 2013. However, it has done pretty well in the last 5 years and given a return of around 7 times to its shareholders.
In short, if a company is doing good, they why it should bother to go through the splitting process. It’s already making money for itself and its investor, even when the share price is expensive.
2. Fewer public shareholding
The high share price of a company results in low public shareholding. Retail investors and traders can’t easily enter such stocks. Sometimes, this also helps in decreasing the volatility in the share price. Moreover, by allowing the high share price, the promoters tend to keep the voting right in their hands. This helps in maintaining a static voting right which allows the owners to make key decisions without much interference.
Besides, fewer public shareholding also helps in avoiding the scenarios like creeping acquisition or in worst case hostile takeovers. Expensive stocks discourage acquisition.
3. No financial benefits:
There are no financial benefits while splitting the shares. The value of the stock remains the same after stock splitting (The financial statements and ratios don’t change). That’s why until and unless the promoters have any good enough reason, the share splitting does not appeal much to the management and promoters.
4. Keeps traders and speculators away:
The stock split increases the liquidity and makes the stock affordable. This results in an increase in the participation of the retail investors and traders. And with an increase in the participation, speculation also increases. On the other hand, a high share price helps to keep the traders and speculators away from the stock. Only serious investors are the ones who can find these companies appealing and might want to enter these stocks.
Another benefit of the high share price is that it keeps the newbie investors away from them. As the new investors are mostly attracted towards the affordable companies and are not willing to invest high amount, therefore their participation in quite low in these companies.
5. Symbol of Status and Uniqueness
Do you know that one share of Warren Buffett’s company- Berkshire Hathaway costs around Rs 2.05 crores? Yes, that’s true. The current share price of Berkshire Hathaway Inc. Class A is $3,16,200.00.
A high share price can be sometimes regarded as a symbol of status. Splitting that share means losing this exclusiveness.
There’s no specific guidelines or rules from SEBI or any stock exchange about a stock split. So, the prices of the shares can go as high as it can and the company is not obliged to offer any split.
As we studied in this post, there are both pros and cons of a high share price. The biggest advantage of a high share price is that it helps to keep the traders and speculators away for that share. Anyways, a company might choose whether it wants to split a share or not- depending on what suits the best for their interests.
That’s all for this post. I hope it was helpful to you. Happy Investing!
Enterprise Value and Equity Value are two terms that have confused investors and sometimes professionals alike through the years. In this post, I shall try to clear some air on both the terms and help our readers figure out the one they need to use during their analysis of companies.
Here are the topics that we will cover in this post:
Who are the different stakeholders in a firm?
What is the level of risk associated with the level of ownership?
What is Enterprise Value and Equity Value and how are they calculated?
Enterprise Value and Equity Value Multiples
Methods of analysis using Enterprise Value and Equity Value
On a broad level, this will be long, but an easy read and we would really appreciate that our readers leave comments in case of any doubts.
1. Who are the different stakeholders in a firm?
To understand the concept of Enterprise Value and Equity Value, it would first be necessary to understand the different players in the capital markets and their claims on a company’s capital and income.
To understand this, picture a company like a big country with different religious and social groups with each group seeking to pursue their own interest but somehow still manage to operate under the common banner of a company.
These interest groups from the perspective of a company include those who have contributed capital to the firm. Since a company can generate capital from debt and equity the top-level classification of the mentioned interest groups comprises of Debt Holders and Equity Holders
Note that the two groups can be further divided into subgroups depending on the priorities of each subgroup.
2. What is the level of risk and return associated with the level of ownership?
In corporate finance, when an asset is sold the debt holders get a priority to the funds generated from the sale and then the different classes of equity holders.
Since debt holders normally take fixed payments at the regular periods regardless of the profit-generating capacity of a company, their position tends to be the one of minimum risk in the company’s capital structure.
The equity holders, on the other hand, get dividends only when the company makes a profit (in most cases) and also happen to pledge their money as owners of the firm without the promise of returns. This makes their position the riskiest within the capital structure.
The below infographic should summarise the relationship between capital and relevant risk and payments for different equity and debt holders.
3. What is Enterprise Value and Equity Value and how are they calculated?
Now to address the crux of this post, assume that a big financial investor wants to buy a company. Let us say he wants to get 100% control of the firm and also 100% of the earnings generated by the firm.
To achieve the first goal, he would just have to buy the stakes of equity holders of the firm, these equity holders could include the Minority Interest, the Preferred Shareholders, and the Common Shareholders. The money the buyer would have to expend to acquire the complete equity of all the above-mentioned groups is what is known as the Equity Value.
Now since the equity holders are of the picture, the buyer now turns his eyes towards the debt holders. To make the debt holders give up claims to the company’s earnings (in the form of interest and principal payments), our buyer would have to pay them cash equivalent to the debt they hold in the company. A lot of the times, the buyers use the cash and cash equivalents of the company they bought to pay off the debt outstanding on the balance sheet. In finance, the term used for the is called the Net Debt.
Net Debt = Total Debt – Cash and Cash Equivalents
And further, the formula for Enterprise value becomes
Enterprise value = Equity Value + Net Debt
Assuming the company has also got minority interest, preferred shareholders and affiliates/associates the formula gets modified as
Enterprise Value = Equity Value + Preferred Shares + Minority Interests – Value of Associates + Net debt
4. What are the Enterprise Value and Equity Value multiples?
The key difference between Enterprise Value and Equity Value is the inclusion of the Net Debt figure in the calculation. So when we think of multiples only terms which have the payments related to debt (interest) should be included with Enterprise Value and the metrics devoid of debt payments (interest) should be included with Equity Value.
The following figure should give the summary of the financial statement components used with both Enterprise Value and Equity Value.
As mentioned earlier, please note in the income statement that all metrics which include interest is included with the Enterprise Value calculation.
The corresponding ratios are summarised in the following figure
5. Methods of analysis using Enterprise Value and Equity Value
The multiples of Enterprise Value and Equity Value can be used extensively in the valuation analysis of a company. The two methods of valuation that are commonly used are relative valuation and historical valuation.
The limitation of using the relative valuation method is that during the period of elevated valuations- during a bull market all our comparable companies may be trading at a premium, this may sometimes make our target company seem cheap when it is only less expensive.
Similarly, during periods of depressed valuations, our target company may look expensive compared to our comparables when it is actually only slightly less cheap.
Although a lot of retail investors do not use Enterprise Value multiples in their valuations to could be useful to do so since the resulting valuations are inclusive of the leverage the companies have employed in their business activities.
In case retail investors find the concept of Enterprise value confusing, it should not deter them from performing a good analysis of companies if they use other leverage evaluation methods in their research and analysis process.
We hope our readers continue to embrace an objective approach to their valuation processes while performing stringent quality checks on the stocks they invest in. Happy Investing.
What you earn, i.e. your income is centered, mostly, when it comes to “how much you actually need when you get retired”. But, are you really sure that the math used here is all correct? I am not.
Suppose if you draw a hefty sum from where you work (monthly) but barely manage to save a dime out of it; would you retire rich? I guess not.
On the other hand, if you get to save even a 30% (roughly) of whatever that you earn in a month, you’d definitely be at a much better place than the former you, right? So, the math here needs to be shifted to “savings and expenditure” and not on the overall income.
You’d be surprised to know that still many are sticking to the former notions of 70% of the income but yes, there are loopholes:
You wouldn’t want to get through an entirely miserable young age just to retire rich, would you? – That, sometimes, becomes the case when you try to save 70% of your income.
You are certainly not including the notion of current taxes and increasing health expenses as and when you grow up.
Strategically, therefore, the 70% rule is a decorated bubble. The question is how much do you actually need in order to retire rich? Let’s answer this question carefully in this article.
3 Simple Steps to Save for Your Retirement:
1. When Should You Start Saving?
The best answer to this question would be: “as soon as possible”. You are 21, well and good! 31? It is still not too late to start. You can always jump start your emergency funds whenever you want to. However, being consistent is the only key.
The best part about starting early is the “power of compound interest” even on low proportions of monthly savings. You can save as less as 5000 INR a month and see a huge difference years later.
However, if you are in your 30s or 40s, don’t worry; cutting back on a couple of things would work well for you to get you a feasible retirement fund. As we mentioned, the power of compound interest on your savings, you need to take your picks on where you should invest your money.
Fixed Deposits, Mutual Funds, or SIP? Different people have different priorities based on their own risk-taking capabilities. Choose your own option!
If you are confused what does it have to do with your retirement savings fund, wait up? We have an answer for you: The net sum of income you earn in your first decade of working makes much more impact on your net total of emergency or retirement fund.
Asking for a raise would balance out the money going directly from your bank account to your savings account. In the best scenarios, you could use the raised amount to go into your retirement fund (fully or partially) which would act as an extra cash for you in future.
Research says that about 37% of the employees who get a significant raise annually are those who ask for it. So, the next time, don’t wait up until the annual records of employees are checked but ask for the raise whenever you feel necessary.
When should you ask for a raise?
Honestly, there’s no strict rule for the same. But if you are asking for the possible options then it could be one of those times whenever you have successfully completed a project or have brought a fruitful result for the business you are working for.
3. Does Fixed Deposit always Work?
According to traditional sayings, you should focus more on keeping your savings in a fixed deposit. These days, it is quite controversial to choose where to put all your stakes on?
The greatest advantage that a fixed deposit offers is that it can be unsealed quite easily in case of an emergency. When you choose any other option to put your money into savings, you don’t actually get this leverage. Moreover, you might have to pay an extra unnecessary sum in order to unseal your deposit in case of emergency. True.
However, the rate of interest provided on a fixed deposit is very, very low. In fact, it is incomparable to other means such as mutual funds. Viewing the other side of the coin, mutual funds investments can be quite risky. They are subject to the market risks and what not.
Now, the correct way is to break your proportions into pieces and put them into different means such as fixed deposits, stocks, mutual funds, real estate etc. There is no compulsion or a set of predefined rules to govern the context of retirement savings.
The magic lies in the way how you balance your savings and lifestyle.
Our grandparents would like to reminisce about the days when they used to buy movie tickets for Rs 5-10. Nowadays it will cost you near Rs 200. In near future, it might be double. The simplest explanation for this increase in prices is- ‘Inflation’.
There have been a number of debates on the topic whether inflation is good or bad for an economy. However, before we discuss this complex question, first you need to understand what actually is inflation.
In this post, we are going to discuss what is inflation and why you should care about it. Here are the topics that we will cover today-
What is Inflation?
What causes Inflation?
Effects of Inflation.
An extreme case of Inflation
Inflation in India.
How is Inflation calculated?
Overall, it’s going to be a very interesting post. Without wasting any further time, let’s get started.
1. What is Inflation?
Inflation is nothing but an increase in the general price of goods and services. It is measured as an annual percentage increase. Inflation can also be defined as the decline in the purchasing power of the currency. In general, a two percent increase in inflation shows a healthy economy.
2. What Cause Inflation?
There are plenty of reasons which causes inflation, depending upon the location, type of economy, the status of government in terms of power and influence, and many other different factors. However, broadly here are the factors that are primarily responsible for causing inflation.
Problems with Supply
Inconsistency with growth in agriculture due to climate change or a natural disaster like flood, draught can hamper the supply to make the product. Inadequate growth of industry can also lead to less production of supply which ultimately leads to an increase in prices for manufacturing products. And hence price increases.
Problems with Demand
This is caused when an overall increase in demand for goods and services, which bids up their prices. It’s like too much money chasing too few goods. This usually occurs in rapidly growing economies. So, when there is more money circulation in the market that can cause inflation.
Problems with raw materials
Not all raw materials are produced in one country. In the era of globalization, we depend on many countries for the supply of raw material. So, if the prices of a commodity which we import from other parts of the world increases then it leads to an increase in the prices of the product that is made from it. For example- if the price of oil or corn increase that makes high prices of products that relies on that material.
In some case when central banks govern interest rates, then demand for services can either increase or decrease giving an invitation to Inflation.
3. What are the effects of Inflation?
Here are few of the major effects of Inflation in a country-
1. Cost-push inflation: High inflation can promote employees to demand rapid wage increases, to keep up with consumer prices. In this theory of inflation, rising wages fuel inflation. In a sense, inflation generates further inflationary expectations, which generate further inflation.
2. Hoarding: People buy durable and/or non-perishable commodities and other goods as stores of wealth, to avoid the losses expected from the declining purchasing power of money, creating shortages of the hoarded goods.
3. Social unrest and revolts: Inflation can lead to massive demonstrations and revolutions.
4. Hyperinflation: If inflation becomes too high, it can cause people to severely curtail their use of the currency, leading to an acceleration in the inflation rate. Hyperinflation can lead to the abandonment of the use of the country’s currency
5. Allocative efficiency: A change in the supply or demand for a goodwill normally cause its relative price to change, signaling the buyers and sellers that they should re-allocate resources in response to the new market conditions. But when prices are constantly changing due to inflation, some agents are slow to respond to them. This results in a loss of allocative efficiency.
6. Shoe leather cost: High inflation increases the opportunity cost of holding cash balances and can induce people to hold a greater portion of their assets in interest paying accounts. However, since cash is still needed to carry out transactions this means that more “trips to the bank” are necessary to make withdrawals, proverbially wearing out the “shoe leather” with each trip.
7. Menu costs: With high inflation, firms must change their prices often to keep up with economy-wide changes. Changing prices is itself a costly activity as it will lead to the need of printing new menus, or the extra time and effort needed to change prices constantly.
4. An Extreme case of Inflation-
In 2008, Zimbabwe had the second highest incidence of hyperinflation on record. The estimated inflation rate for Nov 2008 was 79,600,000,000%.
The daily inflation rate of 98.0%. Roughly every day, prices would double. It was also a time of real hardship and poverty, with an unemployment rate of close to 80%.
The situation in India has far been stable as far as the inflation rate is considered. Here is the inflation rate in India for the past few years:
Quick Note: The above statistic shows the inflation rate in India from 2012 to 2017, with projections up until 2022. The inflation rate is calculated using the price increase of a defined product basket. This product basket contains products and services, on which the average consumer spends money throughout the year. They include expenses for groceries, clothes, rent, power, telecommunications, recreational activities and raw materials (e.g. gas, oil), as well as federal fees and taxes. (Source: Statista)
6. How is Inflation calculated?
Part1: Finding Essential Inflation Information
1. Look up the average prices of the several products across a few years: – Inflation is calculated by comparing prices of standard goods across time.
2. Load the Consumer Price Index: – This is a breakdown, by month and year, of the changes in inflation based off of the averages mentioned in step 1. Any time the CPI is higher than the current month, it means there has been inflation. If it is lower, then there has been deflation. Inflation is calculated with the same formula in each country. Make sure the same currency is being used for all numbers in the calculation.
3. Choose the period of time for which inflation will be calculated: –Months, years, or decades can be used.
Part 2 Calculating Inflation
1. Learn the Inflation Rate Formula. This formula is simple. The “top” find the difference in the CPI (rate of inflation), the bottom finds out what ratio of the total inflation that difference represents.
2. Plug the data into the formula. For example, imagine that we are calculating the inflation based on the price of bread between 2010 and 2012. Assume the price of bread in 2012 is $3.67 and the price of bread in 2010 is $3.25.
3. Simplify the problem through an order of operations. Solve for the difference in price, then divide it. Multiply the outcome by 100 to get a percentage. Here, the inflation rate is 11.4%
4. Know how to read inflation. This percentage means that, in current time, your money is worth about 11.4% less in today’s dollars than they were in 2010. In other words, most products cost on average, 11.4% more than they did in 2010. If the answer is a negative number then it is deflation, where a scarcity of cash makes money more valuable, not less, over time. Use the formula just as in case of a positive figure.
Most people complain about the fact that prices of the day-to-day products are increasing too fast. However, they ignore the part that their salaries are also increasing at a similar pace.
Moreover, a little inflation can be sometimes as dangerous as a high inflation. In other words, a modest inflation is always a good sign as it reflects the growing economy of the country. However, the problem arises when the inflation is rising too fast when compared to your wages.