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A brief study of Petrol & Diesel price history in India

Crude Oil. You definitely have heard of this word, right? Crude oil is a naturally occurring unrefined petroleum product. It consists of organic materials and hydrocarbons. When the crude oil is refined, first it is heated until it starts boiling. Then, the boiling liquid is separated into various liquids and gases. These liquids are further utilized in making petrol, diesel, paraffin, and other petroleum products.

The products and by-products of crude oil are used in direct or indirect consumption by the end users. They are also used in manufacturing several commodities by a wide range of industries. Crude oil is also traded in the commodity market like gold, silver, etc. This results in the global price of crude oil to fluctuate. In India, only one-fifth of the crude oil requirements are met from domestic production. Therefore, we are heavily dependent on the US, African, and Middle East countries to support our nation’s demand for petrol and diesel.

How the prices of diesel and petrol are determined?

The Oil Marketing Companies or OMCs take crude oil to the refinery houses to generate petrol, diesel, kerosene and other products. After that, they dispose those products to the dealers of the same. In India, 90% of the share of oil marketing is owned by Indian oil corporation Ltd (IOCL), Bharat petroleum corporation ltd (BPCL) and Hindustan petroleum corporation ltd (HPCL).

Here is the exact process of how the price determination of diesel and petrol takes place in India.

First, an OMC imports crude oil from an oil producing nation like UAE. The cost and freight are the initial costs incurred on the same. Import charges (plus insurance charges, losses due to transportation and port fees) are further added to the same. Next, the Government of India adds Customs Duty on such crude oil, after which they are carried to the refinery houses.

The refineries charge Refinery Transfer Charge for their work. After that, such refined oil is sold to the dealers by the OMC at Depot Price after incurring inland freight on the same. So the total desired price is the result of all the Cost & Freight charges, Import charges, Refinery Transfer Price, Inland Freight, OMC’s Marketing costs, and Profit margin.

In addition, the Central Government of India adds Excise Duty on the Depot Price and the State Governments add State VAT on the same. Further, the dealers also add their commission which is calculated on the basis of per liter. So, after adding all the costs and taxes, we get the Retail Price that a consumer pays for buying a liter of petrol or diesel.

If you compare the prices of diesel and petrol in the South Asian nations, you would find that the prices in India are always the highest. This is because our Government regulates the prices by imposing taxes. Ironically, when you would see the prices of the crude oil dropping, Indian government increases the Excise Duty and State VAT to not let the retail prices of diesel and petrol fall. On the other hand, when the prices of crude oil rises, here the Government doesn’t reduce the said taxes so that the prices of the fuels in the nation don’t undergo fluctuations.

Besides, there is no doubt in stating that the prices of diesel and petrol would vary from one state to another in India due to differences in commission pattern of OMCs and transportation charges.

Petrol & Diesel price history in India

Now, let us have a look at the price history of diesel and petrol in India over the last few years. Given below is a table which shows the petrol prices per liter in the four metropolitan cities in India. 

Petrol Price history in India:

Date Chennai Mumbai Kolkata Delhi
05-11-2018 81.61 84.06 80.47 78.56
29-10-2018 82.86 85.24 81.63 79.75
29-09-2018 86.7 90.75 85.21 83.4
29-08-2018 81.22 85.6 81.11 78.18
29-07-2018 79.11 83.61 79.05 76.16
29-06-2018 78.4 83.06 78.23 75.55

As you can see from the above table, generally the petrol prices have been on the higher side in Mumbai. However, Delhi witnessed the most reasonable petrol prices in the last few months of 2018. 

Further, here is the historical petrol price movement in the big four metropolitan cities in India.

Date Chennai Mumbai Kolkata Delhi
29-05-2018 81.43 86.24 81.06 78.43
16-05-2017 68.26 76.55 68.21 65.32
17-05-2016 62.47 66.12 66.44 63.02
16-05-2015 69.45 74.12 73.76 66.29
07-06-2014 74.71 80.11 79.36 71.51
23-05-2013 65.9 71.13 70.35 63.09
24-05-2012 77.53 78.57 77.88 73.18
15-05-2011 67.22 68.33 67.71 63.37
01-04-2010 52.13 52.2 51.67 47.93
27-02-2010 51.59 51.68 51.15 47.43
02-07-2009 48.58 48.76 48.25 44.72
29-01-2009 44.24 44.55 44.05 40.62
24-05-2008 49.64 50.54 48.98 45.56
16-05-2007 47.44 48.38 46.86 42.85
10-06-2006 51.83 53.5 51.07 47.51
05-06-2006 51.83 53.5 51.07 47.51
20-06-2005 44.26 45.93 43.79 40.49
16-04-2003 35.48 37.25 34 32.49

When you look at the longer time period shown by the above table, the picture looks similar as well. Anyways, one comparable takeaway is that, in every metropolitan city, the petrol price has consistently gone up at the same rate in the last one and half decades. (Note: You can find the latest prices of petrol in India here).

crude oil price

Diesel Price history in India:

Now, let us talk about the historical prices of diesel per liter in India. Here is a short-term view of diesel prices in the four Indian metropolitan cities:

Date Chennai Mumbai Kolkata Delhi
05-11-2018 77.34 76.67 75.02 73.16
29-10-2018 78.08 77.4 75.7 73.85
29-09-2018 78.91 79.23 76.48 74.63
29-08-2018 73.69 74.05 72.6 69.75
29-07-2018 71.41 71.79 70.37 67.62
29-06-2018 71.12 71.49 69.93 67.38

The table given above shows that in the last few months of 2018, the diesel prices first have gone up and then they showed consolidation at the beginning of November.

Next, here is the long-term diesel price history in India. If you look at the table shared below, it is easily understood that the diesel prices in the said four Indian cities have actually witnessed consistently rising prices in the last fifteen years.

Date Chennai Mumbai Kolkata Delhi
29-05-2018 73.18 73.79 71.86 69.31
16-05-2017 58.07 60.47 57.23 54.9
17-05-2016 53.09 56.81 54.1 51.67
16-05-2015 55.74 59.86 56.85 52.28
07-06-2014 61.12 65.84 61.97 57.28
23-05-2013 52.92 57.17 53.97 49.69
24-05-2012 43.95 45.28 43.74 40.91
15-05-2011 43.8 45.84 43.57 41.12
01-04-2010 38.05 39.88 37.99 38.1
27-02-2010 37.78 39.6 37.73 35.47
02-07-2009 34.98 36.7 35.03 32.87
29-01-2009 32.82 34.45 33.21 30.86
24-05-2008 34.44 36.12 33.96 31.8
16-05-2007 33.3 34.94 32.87 30.25
10-06-2006 35.51 39.96 34.96 32.47
05-06-2006 35.95 39.96 34.96 32.47
20-06-2005 31.51 35.2 30.8 28.45
16-04-2003 23.55 26.7 23.51 21.12

Quick Note: You can find the latest price of diesel in India here.

diesel price

Difference between prices of Petrol & Diesel in India:

Below is a table shared for your reference which shows the price gap in diesel and petrol in the Indian metro cities during the mid of the year 2016.

City Diesel Price /Liter Petrol Price /Liter Price Gap
Chennai Rs 55.82 Rs 62 Rs 6.18 / Litre
Mumbai Rs 59.6 Rs 67.11 Rs 7.51 / Litre
Kolkata Rs 56.48 Rs 66.03 Rs 9.55 / Litre
New Delhi Rs 54.28 Rs 62.51 Rs 8.23 / Litre

Further, here is another table that would give you an idea of the price gap with regard to diesel and petrol during as of November 2018.

Date Diesel Price /Liter Petrol Price /Liter Price Gap
Chennai Rs 74.99 Rs 78.88 Rs 3.89 / Litre
Mumbai Rs 74.34 Rs 81.50 Rs 7.16 / Litre
Kolkata Rs 72.83 Rs 77.93 Rs 5.1 / Litre
New Delhi Rs 70.97 Rs 75.97 Rs 5 / Litre

From the above tables, it can be clearly noticed how substantially the price gap has been narrowed down within the period of around two years.

Consequences of petrol and diesel price hike

As you might have observed from the above tables, the fuel price in India has undergone a significant hike over the last multiple years. So, what does it imply? Does it mean that the overall cost of living in India has gone up too? If you look back in 2018, the rate of consumer inflation in India was around 4.75%

When the price of fuel increases, in general, it narrows down the gap between disposable income and expenditure of the consumers. It means that the consumers will try to reduce the consumption of luxury commodities like automobiles and electronic equipment in order to manage their necessities comfortably.

Hike in fuel price also has a direct adverse effect on the revenues of a few industries like tyres and fertilizers as the retail prices of their outputs shoot upwards. However, if you look at the financials of oil producing companies in India, there is no doubt in saying that they do enjoy a gala time during such period.

Further, you might think that only those companies which produce crude oil based products suffer during the fuel price bull run. But, the fact is that most of the companies in our nation (belonging to diverse industries) suffer as a result of the price hike. Even if you consider the FMCG industry, the cost of its products goes up considerably as a result of the upward movement in the prices of diesel and petrol. This happens because transportation costs go up significantly.

Now, what kind of impact can you expect to see in financial markets during fuel price hike? Well, when the price of diesel and petrol goes high, not only people will try to cut down their unnecessary expenses but they may even reduce financial investing. In order to finance their necessities, people would refrain from putting their money in the financial markets.

Therefore, will the banks have adequate funds to advance the businesses? Not really! Can the corporate organizations listed in NSE and BSE comfortably raise capital through IPO and FPO? Certainly not! Will the Asset Management Companies of Mutual Funds have an adequate corpus to pour into the market? No, my friend, they won’t have!

Also read: Rupee Depreciation: Is it a cause of concern?

Final thoughts

The hike in the global price of crude oil depends primarily on the demand-supply theory that we study in Economics. However, it also depends on other factors like the trade war, geopolitical tensions, and willingness of oil-producing countries to charge a higher price. As we had already seen earlier that hike in crude oil price results in inflation. So, to fight against the same, the Central Government charges more taxes and duties on diverse stuff. For a similar reason, the RBI also instructs the commercial banks to increase their interest rates on loans so as to squeeze money supply in the Indian economy.

Further, the price of petrol and diesel can be controlled if we lay emphasis on a few points. Firstly, price controlling mechanism has to be adopted either partially or fully. The half of Retail Prices of fuels in India consists of taxes and duties. The government (both central and state) does need to look into the matter. It would also be great if the OMCs can try to witness some of the price burdens that the ultimate consumers have to bear in our nation.

Finally, the consumption of petrol and diesel in India in terms of US Dollar is even higher than the GDPs of many small nations across the globe. And that’s why the government and the people need to consider petrol and diesel price hike in India seriously.

The 3 Words that may be holding you back from investing in stocks.

Fear of Losing!!

Since childhood, we are taught to save money. “A penny saved is a penny earned.” And the idea of losing money is something which we are not psychologically programmed to opt for.

When you invest in stocks, there is a probability that its value may decrease if you have made the wrong investment choice. Unlike most other investment options like Fixed deposits, Gold, Real estate, bonds etc, the stock market is a place where your invested amount can fluctuate a lot within hours. And these daily fluctuation of prices ignite the fear of losing. And trust me, no one likes losing, especially their hard-earned money.

Moreover, when you invest in stocks, there is no guarantee that it will give you good returns. Even the safest stocks may decline in value because of unforeseen reasons. And that’s why, a majority of the population tries to keep a safe distance from the stock market.

But, there’s one thing that most of these people forget.

You are already losing money!!!

When you are not investing, you are losing the value of your money. How?

The old common answer- “Inflation”

Inflation can be described as a continuous increase in the general level of prices. And when the price increases, obviously the purchasing power of your money will decrease. The money in hand that you have ‘today’ is not of the same worth in ‘future’. Therefore, no matter how much safer you are keeping it in a vault or bank account, you are losing your money.

Currently, the predicted inflation rate in India is +4.89%. Therefore, if you are not making interest on over 4.89% on savings, this means that you are not beating the inflation and in other words, losing money. Frankly speaking, most of the savings account in India do not offer such high-interest rate. And in the worst case, if you are keeping cash, you won’t getting any interest at all.

inflation in india

(Source: Statista)

Historically, stocks have out-performed all other investment options.

Traditionally, people in India used to invest in gold and property. The came savings, fixed deposits, bonds etc. And finally, since the stock exchanges became more active in India, the next investment options were stocks and mutual funds. Anyways, history says that the returns from the stock market has out-performed all the other investment options.

sensex last 30 years

Also read: 75x Returns by Sensex in last 30 Years of Performance.

You can reduce the risk while investing in stocks.

Although you cannot completely get rid of the risk, nonetheless, you can definitely reduce it by following a few simple rules. And when the risk reduces, it will also decrease your fear of losing money. Here are a few methods which can help you reduce the risks while investing in stocks:

Diversify your investment:

It’s true that no one cannot correctly and precisely predict the future returns from any stock. However, you can increase the chances of being correct by making multiple good bets in different companies.

Even if two out of ten doesn’t perform well or fails miserably due to whatever reason, if the other eight stocks are performing decently, you can get decent returns and minimize the harm done on your overall portfolio. Portfolio diversification is the easiest approach that investors can follow to reduce the risks while investing in stocks.

Also read: How to create your Stock Portfolio?

Invest in blue chips

Blue chip companies are large and well-established companies with a history of consistent performance. These companies are financially strong (usually debt-free or very low debts) and are capable to survive in the tough market situations.

Most of the blue-chip companies are the market leaders in their industry. A few common examples of blue chip companies in India are HDFC Bank, ITC, Asian Paints, Maruti Suzuki etc. These companies are comparatively safer to invest vs mid or small cap companies who are associated with high risks.

Also read: 10 Best Blue Chip Companies in India that You Should Know.

Get an investment advisor.

This is the easiest approach that people anyone can follow to minimize the risk without limiting the investment options. If you do not have time to study or research stocks or your own — hire a financial planner for making your investment decisions instead of you.

Now I understand that most people are reluctant to hire investment advisors or financial planners. But think of it in this way — If you can hire a doctor for taking care of your physical health, why cann’t you get the help of an investment advisor to take care of your financial health?

Ovearll, if you find investing by your own boring or do not give sufficient time to research in order to make the right investment decisions, then hire a professional.

Apart, a few other ways to reduce risk in your stock investments are rupee cost averaging, investing in index funds and having a big margin of safety.

Closing Thoughts

It’s a fact that the fear of losing cannot be completely detached when you are investing in stocks. However, the ability to overcome this fear to make wise decisions is necessary skill to learn for the individuals if they want to build good wealth. Therefore, mind these three words and make sure that ‘fear of losing’ is not the actual reason why you are losing money.

How to read stock charts for beginners?

For anyone looking to actively trade in the stock market, it is essential to know how to read stock charts. A stock chart is a chart that shows the price of a stock plotted on a time-frame that can range from minutes to many years. It serves as an important tool for picking the right stocks and easy to find on websites such as Yahoo Finance or Google Finance.

The ticker symbol of a company can help you find its stock chart. The ticker is a series of letters found in a company’s name (Apple= AAPL). Stock charts can help you identify stock price movements and make decisions on whether to enter, buy, sell or exit the trade.

When you first look at the chart

Stock charts come in various forms, they can be candle charts, bar charts or line charts.

In addition to the view of a stock chart, you also get to pick the time frame. The most commonly used ones are intraday, weekly, monthly, year-to-date (YTD), 5 years, 10 years or even a complete history of the stock.

how to read chart 1-min

(Stocktrader.com)

Once you have picked the chart view and time-frame, it is now time to understand the various features of a chart. For demonstration purposes, we can look at a candlestick chart.

On a candlestick chart, the red candles show downward price movement, while the white (or green) candles show an upward price movement. The chart has numerous technical indicators such as the moving average index (MA), the relative strength index (RSI) and the moving average convergence divergence index (MACD). These technical indicators are used to analyze future price movements.

Support and Resistance lines

how to read chart support and resistance

(Image credits: BabyPips)

The next step is to look for the support and resistance lines. As the name suggests, the resistance line indicates a point which resists the price from rising further. It shows the maximum supply for a stock where the level is always above the current market price. There is a great probability that the stock would rise up to the resistance level, absorb the supply and then decline. For traders, the resistance line is an indicator to sell.

Alternatively, the support line indicates a point that stops a price from falling lower. It shows the maximum demand for a stock in the market. There is a high chance that a stock price will reach the support line, absorb all the demand and then bounce back. The support line is a signal to buy stock.

Below the stock chart is a window that shows the trading volume of the stock. The volume shows how much of the stock has been traded over a period of time. The green bars show the greater buying volume days and the red bar shows the greater selling volume days.

how to read chart

(Image credits: Investors Underground)

Why is the volume important?

The volume of a stock is an important indicator of whether or not to invest in a stock. This is because the trading volume is influenced by the buying and selling of stocks done by big traders, large investment banks, mutual funds or exchange-traded funds (ETFs). It can be the high-value trading done by these large firms that causes the price of a stock to go up or down.

An individual investor can use the volume as an indicator of buying or selling stock, forecasting future price trends and identifying the support and resistance level. When there is a bullish market- that is investors are optimistic and expect the prices to rise- there is high volume trading on up days and low volume trading on low days. However, during a bear market- when investors are less optimistic- there is high volume trading on down days and low volume trading on up days.

how to read chart

(Investopedia)

Other technical indicators

In order to better understand the price movements and trends in a stock chart, investors use a variety of technical indicators. One such indicator is the 200-day moving average which is a stock’s average closing price in the last 200 days. A high 200-day average signifies a bullish market while a low 200-day average shows a bearish market. In reality, however, when the 200-day average is extremely high it is a sign that the market may soon go down and that investors are far too optimistic and when the 200-day average is low it signifies the reverse. The shorter the moving average, the greater the change in the market.

The 200-day average indicates whether a stock is healthy or not and is often compared to the 50-day moving average. When a stock in the 50 day moving average crosses the 200-day moving average, it achieves the ‘golden cross’ status. That is the stock may go up to a much higher price. On the flip-side, if a stock in 50-day moving average goes below the 200-day moving average, it is known as the ‘death cross’. This means there is a good chance the price of the stock will go down in the future. Technical indicators are used in conjunction with momentum indicators to analyze the direction and strength of a stock’s price movement.

Understand the overall trend of the stock

When looking at a stock chart it is important to understand the upward and downward trend of a stock but you also need to analyze the background of the stock as well. This involves understanding how a particular stock usually trends- does it have low price movements or is it constantly volatile?

Another factor to consider is the possibility of the trends reversing. Momentum indicators such as Relative Strength Index (RSI) or MACD can help identify if a stock has reached its peak giving investors the opportunity to exit the market. Understanding these trends can help you make better decisions about what stocks to purchase.

Also read: Fundamental vs Technical Analysis of Stocks

Conclusion

Knowing how to read stock charts is important for any trader. It provides perspective on the price movements of stocks and will help you make better decisions to improve profitability. Hopefully, this guide gives you a better understanding of how to read stock charts before you start trading. Always remember, by failing to prepare, you are preparing to fail.

How Does The Government Control Inflation?

We cannot minimize the explosive effects of inflation. High inflation has the ability to topple governments, ruin nations and reduce economic growth. It discourages savings and reduces the overall productivity in the country. In its creepiest form, inflation can reduce the purchasing power of people, this means the pensions and savings of people can now buy less than it did before.

In response to this, governments have many powerful tools they can use to control the rate of inflation in the economy. These policies have been discussed in detail in this article.

What is inflation?

Inflation can be described as a continuous increase in the general level of prices. In some cases, inflation can be used to encourage spending in the economy. However, this is not always the case as inflation can often get out of hand and the purchasing power of people drastically decreases. The government will then have to intervene to create balance in the economy.

Inflation can be measured using the Consumer Price Index (CPI). The bureau of labour statistics chooses close to 500,000 products from more than a 100 categories which are included into a ‘basket’. The prices of the goods are used to calculate the price index.

Effects of inflation

Inflation, depending on its severity, has the ability to disrupt economies. There is an uneven distribution of income that can affect many sectors in the economy. They are discussed as follows:  

— Effect on various economic groups- If there is low inflation in the economy, job seekers can benefit from this as increased demand will lead to a rise in employment. However, an unhealthy level of inflation can be disastrous for the economy as people pull their money out of financial institutions and their purchasing power reduces.

— Government spending- During inflation, the government, like individuals, have to pay more for wages and supplies. In order to raise more revenue the government can increase taxes but people will may have the ability to pay for them and some groups will be affected more than others.

— Savings and Investment- If inflation is on the rise, it is not a great time for savers as the decrease in the value of money reduces the value of savings. Many people move their investments to stocks and property during inflation. It is a favorable time for borrowers because the value of the money they owe reduces.

How Does The Government Control Inflation?

If the rate of inflation in the economy goes beyond a rate that is uncontrollable, the government has to intervene with policies to help stabilize the economy. Since inflation is the result of too much expenditure on the economy, the policies are created to restrict the growth of money. There are three ways the government can control the inflation- the monetary policy, the fiscal policy, and the exchange rate. They are discussed as follows.

— The Monetary Policy

Monetary policy is a tool used by the government to control the amount of money circulated in the economy. This includes paper money, coins and bank deposits held by businesses and individuals in the economy. Monetary policy uses interest rates to control the quantity of money in the economy.

— Open market operations

When there is high inflation in the economy, the amount of money created by financial institutions needs to be restricted. The Federal Reserve Bank lowers the supply of money by selling their large securities to the public, specifically to security dealers. The buyers pay for the securities by writing checks on the deposits they hold in the commercial banks. This is an effective way to control the supply of money as the deposits of the commercial banks at the Federal Reserve Bank are the legal reserve for the banks. With the sale of securities, the banks are forced to restrict their lending and security buying, therefore reducing the quantity of money in the economy.

— Increasing the reserve requirement

The reserve requirement refers to the amount of money that the commercial banks are required to have on deposit with the Federal Reserve Bank. A low reserve requirement means banks have more money to lend out which can increase the money supply. But when there is high inflation in the economy, the government increases the reserve requirement which restrains the growth of money and even reduces it.

— The rediscount rate

The rediscount rate is the rate of interest charged by the commercial banks. The commercial banks borrow from the Federal Reserve in exchange for a promissory note. In exchange, the Federal Bank increases the deposit of the bank. The rediscount rate controls the cost to banks for adding additional reserves. When inflation is high the bank increases the rediscount rate, which makes it more expensive for banks to buy reserves. This cost is usually translated to customers in the form of high interest rates on loans borrowed from commercial banks which ultimately reduces the supply of money in the economy. In order to control the supply of money in the economy with the monetary policy, the rediscount rate is used in conjunction with the reserve requirement and sale of securities.

— Fiscal policy

The Fiscal policy uses government spending and taxation to control the supply of money in the economy. The policy was designed by John Maynard Keynes who studied the relationship between aggregate spending and the amount of economic activity in society. He also claimed that government spending can be used to control aggregate demand.

— The decrease in government spending

Sending by the government constitutes a large part of the circular flow of income in the economy. During periods of high inflation, the government can reduce the spending to decrease the amount of money in circulation. In many instances, high government spending is the root cause of inflation. However, it is often hard for governments to differentiate between essential and non-essential expenditure so, the spending policy should be augmented by taxation.

— Increase in taxes

An increase in the level of taxes reduces the amount of money that people have to spend on good and services. The effect of the tax can vary with the kind of tax imposed, but any increase in tax would reduce spending in the economy. An increase in tax combined with a decrease in government spending can have a double-barrelled effect on the supply of money in the economy.

— Increase in savings

Another theory derived by Keynes was his belief in compulsory savings or deferred payments. In order to achieve this, the government should introduce public loans with a high rate of interest, attractive saving schemes and provident or pension funds. These measures lock people’s income into savings accounts for an extended period of time and are an effective way to control inflation.

Also read:

Conclusion

Inflation can have a major impact on the economy and can affect the government, investments and the purchasing power of people. A high rate of inflation for an extended period of time can lead an economy into a recession. Fortunately, the government has the ability to use the monetary and fiscal policies to help control the supply of money in the economy. When used in the conjunction, the policies can help achieve a lower rate of inflation and a more stabilized and balanced economy.

What is XIRR in mutual funds and how to calculate it?

Last weekend, one of my friends, Monika, came to my house to meet me. She is an old friend and we met after a long time that day. She told me that she is currently working in an Indian FMCG company after having completed her MBA in HR last year. We discussed a lot about general stuff, our school days and the extent to which our lives have undergone changes over the last few years.

As our conversation gradually progressed, I came to know that she has recently started investing in the Mutual Funds. I remember that a year back, we discussed on a call regarding the importance of investing in Mutual Funds for creating wealth in the future. Ever since she got her job, I have been telling her to invest in the Mutual Funds which would ultimately help her to achieve her financial goals. And that’s why I felt really pleased to know that she has finally started taking her personal finance seriously.

Anyways, I was just taking a sip of coffee when all of a sudden, she fired a wonderful question at me. She asked me how could she correctly calculate how much returns she is making from her Mutual Fund investments. I must tell that most of us focus on the absolute returns that we are generating. Only a minority of the investing population emphasizes on the underlying mechanism to compute our returns in relative terms. And therefore, I found her question truly charming.

How to measure returns on your Mutual fund portfolio?

If you have invested your money in a variety of securities, it is logical to say that the computation of portfolio returns is indispensable for evaluating the performance of your investments. This is because once you know the performance of your portfolio, you can decide whether you want to invest more, continue investing, or redeem your investments.

There are primarily two ways of computing your portfolio returns.

The first one is ‘Simple Return’ or ‘Point to Point return’ method. In this method, you consider the starting value of your investment and the ending value. However, here you do not consider when you made such investments and when did you withdraw.

The other method is by calculating XIRR (extended internal rate of return) of your investment portfolio. It takes into consideration multiple investments and withdrawals occurred at different time intervals– between the first investment and the last redemption.

The former method can be easily applied only if you are investing in Mutual Funds on a lump sum basis. On the other hand, the XIRR method can be applied for lump sum investing and it is also extremely suitable if you have opted for Systematic Investment Plan (SIP).

Also read: SIP or Lump sum – Which one is better?

Simple Return or Point to Point return

Simple Return method gives the absolute return on your investment portfolio. This method only requires your initial Net Asset Value (NAV) and the present NAV. It can be calculated as:

Simple return

Now, sometimes it might be possible that your holding period may not be in a complete number (i.e. not perfectly a year). In that case, you can compute returns using this formula:

Annualized return

Further, instead of using the Simple Return method, one can also opt for the CAGR (Compound Annual Growth Rate) method. The latter works in a similar way and the result is the same too. The only difference is that, even if your investment time period is not perfect one year, it will still calculate your returns in a one step. The formula for CAGR is:

CAGR

Let us take an example to understand how the Simple Return Method works.

Imagine you have invested Rs. 1 lakh in a Mutual Fund scheme on February 23, 2017, when its NAV was Rs. 10. As of March 20, 2018, its NAV has spiked to Rs. 35.

In this case, Simple Return = {(35-10)/10} x 100 = 250%.

On the other hand, Simple Annualized Return = [{(1+2.5) ^ (365/390)}-1] x 100 = 323%

I hope the above example is clear to you. As we already discussed earlier that if you’re simply going to follow ‘buy and hold’ investing strategy, then the Simple Return method would work well for you.

I also explained the same to Monika that evening. However, later what I came to know was that she invests a portion of her salary in Mutual Funds via SIP route i.e. periodic investments. Moreover, she also said that she doesn’t necessarily invest at regular intervals every month. So naturally, she can not even use IRR method for calculating her returns here.

Also read; What is Internal Rate of Return (IRR)? And How Does it Works?

So as discussed previously, the XIRR method can be useful to calculate returns in her case. This is a method that you can use to compute returns on your investments when you are carrying out multiple transactions at diverse points of time.

Calculating returns using XIRR in Mutual Funds

While investing in mutual funds via SIP, you can make multiple investments at different points of time. Further, it might also happen that you redeem some of your units if you required some cash at any particular time. And that’s why I guess by now you would have understood that it is going to be a little tricky to calculate your returns when you are investing via SIPs.

In these cases, the XIRR approach is the most appropriate measurement of the returns that you make on your Mutual Fund investments. Now, let’s understand how you can make use of MS Excel to calculate XIRR

How to use MS Excel to calculate XIRR?

Microsoft Excel provides a financial function called XIRR which you can use to calculate your Mutual Fund portfolio’s rate of return. The expanded formula of XIRR formula in MS Excel is: “= XIRR (value, dates, guess)”

Let us now discuss the step by step process that you can follow to compute XIRR in Excel:

Step 1: Open MS Excel and enter the dates of your transactions in a single column.

Step 2: Go to the next column. Here you have to mention the figures of your cash flows (investments made, dividends received and redemption proceeds).

Date Transaction (Rs)
01/01/19 -5,000

Step 3: Go to the first column and mention the current date (just below the last date mentioned by you) and put the figure of your present value of Mutual Fund in the adjacent column corresponding to the date mentioned by you in the earlier step.

Date Transaction (Rs)
01/01/19 -6,000
04/02/19 -6,000
31/07/19 13,000
XIRR (%)  ?

Now you have to use the XIRR function [“= XIRR (value, dates, guess)”] in MS Excel to find the XIRR for your investments.

To perform the calculation, you have to first select the values which are the series of cash inflows and outflows. Then, you have to select the dates from the dates column. Finally, in the ‘guess’ parameter you may not select anything for it. If you keep it blank, MS Excel is going to use the default value which is 0.1 (10%).

Example to demonstrate the use of XIRR function in MS Excel:

Let us assume that you are going to make seven monthly SIPs of Rs 6000 each. The SIP dates start on 01/01/2019 and it ends on 01/07/2019. Let the date of redemption be 31/07/2019 and the maturity amount is ₹ 43000

You can write the data set on MS Excel in the following manner:

XIRR in excel

As you can see, in the table given above, your cash flows are taking place at different intervals. So, here, we have to use XIRR function for computing the rate of return as a net result of these receipts and payments.

Quick Note: Do not forget to put the ‘minus’ sign before the figures which represent an investment of money.

Now, in the first column i.e. B, please enter dates of transactions. After that, go to the adjacent column, i.e. C. Here, you have to enter the SIP figures of -6,000. Next, again, go to column B and put the redemption date. Against that date, put the redemption figure of 43,000 in Column C.

Next, go to the cell below where you have put 43,000. For calculating the required XIRR, type “=XIRR(C3:C10, B3:B10)” and press ‘Enter’ key on your keyboard. You will get XIRR as 7.84% which will be displayed as a result of this operation.

I used the same example on my laptop to explain the process of XIRR computation to Monika. By this time, she had understood how she can apply this technique in calculating the returns on her Mutual Fund investments. I hope this is also clear to you guys now.

So, what are you waiting for? Open MS Excel and try this function with hypothetical figures to calculate IRR. In case you are an active Mutual Fund investor, try calculating the XIRR of your current portfolio.

Closing Thoughts

In case, if you choose growth scheme Mutual Funds and plan your SIPs at regular intervals, you can definitely opt for the IRR (Internal Rate of Return) method to evaluate your returns. However, in reality, this might be a little difficult to execute. We don’t always follow the ‘buy and hold strategy’ in Mutual Fund investments. As our savings witness debits and credits off and on with regard to our mutual fund transactions, we have no other way but to apply XIRR in computing our returns on investments.

Furthermore, you can, of course, give importance to CAGR as this parameter is useful for you in making a selection of your Mutual Fund scheme. However, when it comes to evaluating your personal investment portfolio, it is XIRR which is always more helpful.

So, if you have a series of cash inflows and outflows occurred over time (which includes withdrawals, dividends, investments, and transfers), the best way of computing the rate of returns is by using XIRR. Through this article, we have tried to make you understand how XIRR works far better for computing returns of your Mutual Fund portfolio in comparison with IRR and CAGR.

Best wishes for your mutual fund investment journey. And happy investing!

Is Negative Price To Earnings a Bad Sign for Investors?

Price to earnings ratio is definitely one of the most frequently used valuation ratio used by the investors to evaluate a company. Although I do not use this ratio too often, however, every now and then I check the PE of companies and industries to try to look them from a different angle.

Recently, I was going through the list of companies which are not making profits, in other words, losing money. Therefore, I run a simple query on stock screener to find the list of companies with negative earnings per share for the trailing twelve months.

Not surprisingly, I found the names of a lot of big companies in that list. A few of such companies with negative Earnings per share (EPS) for the trailing twelve months were State bank of India (SBI), Lupin, Adani Power, Tata Communication, Idea, Bank of Baroda, Future consumers etc. Here is a detailed list of such companies:

company with negative earnings

(Source: Trading View)

And obviously, when the earning of a company is negative, their Price to earnings will also be negative. Seeing so many big names in the list of companies with negative PE, it is easy to conclude that there will be thousands of people investing in companies that are losing money.

Therefore, in this post, I decided to discuss whether negative price to earnings of a company a bad sign for the investors. Let’s get started!

How Price to Earnings ratio is calculated?

As the name suggests, Price to earnings ratio is calculated by dividing the current market price per share by its earning per share.

PE ratio

For example, if the share price of a company is Rs 100 and the annual earning per share is Rs 20, then the Price to earnings ratio will be equal to 100/20 i.e. 5.

PE ratio of a company reflects how much people are willing to pay for that share compared to each Rs 1 in earnings. For example, for a company with a PE ratio, 5 means that the people are ready to pay a premium of 5 times for every Rs 1 of earnings. And obviously, the lower this premium, the better it is for the investors.

PE ratio is frequently used by the investors to find if a stock is undervalued or overvalued. Usually, a company with a lower PE ratio is a better valued. For example, a company with PE of 8 is comparatively undervalued against a company with a PE of 12.

Also read: No-Nonsense way to use PE Ratio.

Negative Price to Earnings

Basically, the share price of a company cannot go negative. Therefore, if the price to earnings is negative, it means that the company has negative earnings.

Although it is advisable to invest in companies with lower PE ratio, however, when this ratio becomes negative, it might not be favorable for the investors.

A negative price to earnings means that the company is not making profits and hence, why do you wanna invest in companies who are losing money? As a thumb rule, avoid investing in companies with negative price to earnings. If you want to live by a single rule for PE, then this might work perfectly well for you.

Moreover, a company with consistent negative PE means that it is not able to generate profits for a long period of time and therefore, it may fall into trouble while running its normal business operations and in the worst case, it may face the risk of bankruptcy.

Quick note: Most financial websites do not show the negative price to earnings for a company. In general, they will use the word ‘Not applicable’ or ‘ — ’ for the companies with a negative price to earnings.

When negative price to earnings might not be a bad sign.

A few industries like pharmaceutical or technology may have negative earnings if they are extensively spending in their research and development. Although it may be unfavorable for them in the short run, however, if they are able to spend their money in the right direction, it may be a good expenditure for the long term.

For example, if a pharmaceutical company is able to build a medicine for a rare disease and gets a patent for it, the company may generate a lot of profits through that research in the future.

Similarly, if a technology company is able to create a disruption through its research (a few of such trending technologies right now are artificial intelligence, deep learning or blockchain), they might be able to create a competitive advantage and generate profits in long run. And therefore, many investors are willing to invest in such industries even when they are not making money.

Note: Sometimes, a company may also have a negative PE because of the change in accounting norms or because of a few unexpected occurrences. In such scenario, you should not consider it as a bad sign and may wanna investigate further.

How to correctly analyze negative PE ratio?

While studying the price to earnings of a company, compare the PE with the competitors and historical performance. If the company’s PE is consistently falling for the last many years, it may be a warning sign. Further, if the PE of all the other competitors is positive and decently high, then the negative price to earnings for that company may be a caution sign.

Further, comparing the price to earnings of the company with the industry average can also give you a rough idea regarding the situation of that company.

Also read: #19 Most Important Financial Ratios for Investors

Closing Thoughts

In general, it is preferable for the investors to stay away from companies with a negative price to earnings. As an investor, you should find fundamentally strong companies to invest which are consistently making money.

If a company is consistently reporting a negative PE for a longer duration of time, then you should be concerned about it. Anyways, in a few industries, have a look at the company’s expenditure on Research and development by peeking in their income statement. This can give you an idea if the company is working on any cutting edge research or simply losing money in their operations.

Finally, never make your investment decision based on just one ratio. Price to earnings ratio is just a valuation tool. Apart from PE ratio, also look into other quantitative and qualitative aspects before making your choice.

Want to Retire Early? Now You Can!

Retire early, get financial freedom and travel the world!- It’s the common cubicle dream. But there are in fact many ways a person can make this a reality. Joining the FIRE movement which stands for ‘financially independent, retire early’ is not that hard provided you make the right financial moves while working a 9-5 job. FIRE has defined early retirement as not just leaving work but as gaining the financial freedom to pursue your passion projects and follow your dreams.

Retiring early, however, takes a lot of work and therefore many people find it challenging to achieve this. Contrary to popular belief, you don’t need to work in a certain high-salaried job or industry to retire early, anyone who has the long-term goal of retiring early can make it happen. With strong resolve and the right strategies, you can turn your dream into a reality. The key steps to early retirement are discussed below:

Track your expenses and make the necessary changes to your budget:

One of the most important things to do in order to meet all your financial goals, be it early retirement or buying a new home, is to analyze your current spending.

No matter how you look at it, you need to make changes to your current spending in order to achieve your dream of retiring early. This could even mean drastically reducing your spending. There are a slew of apps today that can help you track your expenses such as LearnVest or Penny. Most people with the goal of retiring early, aim to spend less than 50% of their income and put the rest into savings.

There are many ways you can work towards increasing your savings. If you are in debt, work towards aggressively paying off the loans so that any income you make in the future can be put directly towards savings. In addition to this, you can also cut back on unnecessary expenses such as that excessive coffee or those frequent restaurant dinners. You can also try and increase your income through side gigs or freelancing opportunities. If your goal is to retire early, frugal living should be your motto.

Also check: 10 best Android budget apps for money management

Make your money work for you:

In other words, invest aggressively! The longer the amount of time, you allow your money to grow, the greater the rewards. Hence, it only makes sense that you start investing at the start of your career. Early retirement essentially means that you have a shorter amount of time to save money but a longer amount of time that the money has to last you so make investment your best friend.

Design your portfolio in a way that will generate long-term returns. While stocks can be a risky investment, in the long-term they produce very high returns. If you look at the historic analysis of the Indian stock market, taking into consideration its various downturns, the market barometer NIFTY 50 has averaged a little higher than 10.84% annually since inception. This means if you put a majority of your savings into an index fund, there is a good chance you’ll receive an annual return of 10.5%.

Many people assume you should look for low-risk investments options when investing for the retirement fund. But this is an inaccurate assumption. Investing in low-cost investment funds is recommended when you are near the retirement age, as you need to move some of your money into more liquid investments so that you don’t have to worry about the investments selling options when you need it.

Calculate how much money you need for retirement:

Planning for the future is the most important strategy when it comes to retirement. That is you need to estimate what your retirement spending will look like. To do this, you should analyze your current spending and look at what expenses will go up, down, added, subtracted or eliminated completely.

A few things to consider are your health insurance and rent. Many companies offer health insurance as part of the employment package, but for retirement, you need to make sure to factor in this expense. Another large expense is your monthly rent. If you hope to own a home before retirement, this should not be a problem but if you plan to rent, you need to make sure to include this in your retirement expense.

Also read: 6 Reasons Why You Should Get Health Insurance

financial freedom

Start saving as early as possible:

The earlier you start saving money, the more you would have accumulated when you decide to retire. Hence, if you start putting money away from the start of your career, there is a higher chance you can exit the workforce earlier. There is a rule of 25 that states that you need to have 25 times your planned annual spending when you retire. That is if you plan to spend $35,000 during the first year of retirement, you need to have a total of $875,000 when you retire.

The second rule of saving is the 4% rule which states that you can take out 4% of your invested savings during your first year of retirement and continue to draw out that same amount adjusted for inflation for the following years. This strategy was developed in the 1990s and was based on historical market conditions.

While neither of these strategies is fool-proof, they are considered reasonable when it comes to saving. Moreover, it is imperative to remain conservative with your savings when it comes to retirement.

Conclusion

The FIRE (financially independent, retire early) dream may seem a distant reality for many but with a little planning and smart financial moves, it can become a reality. But it also helps to rethink what early retirement means, it’s not always fancy cruises and dinners. For some, it could mean spending more time with your grandchildren or significant others.

Whatever it may be, as long as it is important to you to live by your own schedule and not that of the employers, you should diligently work towards getting out of the workforce early using the strategies listed above. Remember to start saving early because running out of money means running back to work.

What is Deep Value Investing?

Deep value investing is an intense version of value investing which focuses on buying stocks at a much higher discount to intrinsic value in comparison to value investing. This results in an increase in the potential reward and risk of the investment.

Background

Traditional value investors have the belief that the market will misjudge stock prices in the short-term and hence they prefer to conduct their own fundamental analysis on stocks that they feel may be undervalued. They first determine the intrinsic value of these stocks and compare it with their current market value. Value investors usually invest in stocks where the market value is below its intrinsic value.

Nonetheless, value investors don’t invest in every undervalued stock they come across as each investor has a different level of margin of safety with regards to the market price and intrinsic value. The major difference between value and deep value investing is that deep value investors require a higher margin of safety.

This high margin of safety means that the return potential of the stock will be high but the risk associated with the stock increases as well. Hence deep value investing is usually followed by those investors who understand their strategies and can fully trust their investment decisions.

Benjamin’s Graham’s deep value investment philosophy

Benjamin Graham defined intrinsic value as the value that a businessman places on a business. He believed it was more important to assess the true value of a company based on the numbers present on financial statements such as the assets, earnings, and dividends. He would use these figures to come up with the fair value of the stock. (Also read: How to Find Intrinsic Value of Stocks Using Graham Formula?)

However, Graham would only buy the stock if it was discounted at 1/3rd (or more) of its intrinsic value. For example, if the intrinsic value of a stock calculated by Benjamin Graham turns out to be at $162, then he would only consider purchasing that stock if it is trading at $108 or less.

Anyways, there are multiple calculation methods that investors can use when valuing stocks such as Discounted cash flow (DCF) analysis, dividend discount model (DDM) and relative valuation tools like the price to earnings, price to book value or price to sales.

How do deep value investors assess the fair value of the stock?

Deep value investors usually buy stock in companies that trade below their liquidation value-although finding such companies is rare. In assessing the fair value of the stock, deep value investors use valuation methods that range in their level of conservativeness. Following are the ways, deep value investors assess the fair value of a company’s stock:

  • Most of the low conservative deep investors look at the future earnings of a company ignoring the fact whether the company has a competitive advantage or not. However, there are also a few investors in this group who look at the firm’s competitive advantage which can be used in the future to earn much higher returns.
  • Slightly conservative deep investors look at the firm’s ability to produce a profit. The earning power of the company is mostly determined based on past earnings with reference to price to earnings (PE) ratio.
  • Highly conservative deep investors look at the book value which involves looking at all the assets held by the company to determine its fair value. They also check Net current asset value, Networking capital and dividends.

Deep value investors use highly conservative strategies the most when looking for stocks that are traded at very low prices.

Deep value Returns

If you are a new investor, you need to use simple strategies that yield the highest return. In other words- deep value is the way to go. Deep value investing in coherence with traditional investing can help an investor earn very high returns. When conducting a conservative assessment of stock value, those stocks with a low price relative to book and current asset value generate very high returns. But remember with higher reward come higher risk.

Deep value Risk

The major risk involved in deep value investing is ending up in a value trap. This is where a stock may seem to be a good investment based on a quantitative analysis with financial ratios like low PE, low price to book value. However, the investor may overlook the ‘qualitative’ factors associated with the stock.

There is often an underlying reason why such stocks trade at a low price. It could be the result of problems with the management of the company or the lack of growth potential. There can be a fundamental problem in the company that is not reflected in its finances. Whatever it may be, an investor needs to be able to spot the reason for the low stock price. If they fail to do so, they end up in a value trap.

Also read:

Conclusion

Deep value investing can reap high rewards if you are willing to take the risk. A deep value stock usually exists when the company is in a difficult situation. It may take time for the company to recover and eventually generate returns. However, as with any investment, you need to be patient.

How to Evaluate Inventory on Balance Sheet?

In the past two decades, we have seen countless companies which turned from zero to over billion rupees in market value with very limited inventories. It’s true that companies in the information sector (which only require a laptop and internet connection) doesn’t need a lot of inventories. After all, if the sole purpose of a company is running their mobile app (Android/iOS) and offering services through them, then what physical inventories they actually need apart from hosting, customer support and a few other development tools.

On the other hand, if you look into manufacturing companies which offer goods to the people/organization, inventory analysis plays a crucial role. The inventories of those companies are their most valuable current assets as they contribute directly to the source of revenue.

In this post, we’ll discuss what is an inventory and how to evaluate inventory on balance sheet.

What is an inventory?

inventory-control

Integratory can be defined as the goods available for sale and raw materials used to produce those goods. In other words, these can be the raw materials, goods in process and the finished goods.

There are a number of advantages of keeping sufficient inventories for a company. For example, if the company has the necessary inventories, it can quickly meet the customer orders. Stock in hand improves customer experiences. Moreover, in a few sectors, high inventories may make an attractive display and increase conversions.

On the other hand, delays in fulfilling orders, empty shelves and products out of stocks might drive away customers to the competitors. And therefore, inventory control is a key area for the company’s management to focus.

Excess Inventory

inventoryIn case the company has excess inventories, it may be a little troublesome for them.

Too much inventories involve a higher cost of storage, damage issues, and insurance costs. It may also lead to increased wastage of goods if the inventories are perishable or the threat of obsolescence in case the products changes fast.

Moreover, if the company is spending a lot of money on excessive inventories, it is fixing that money which they could have used in other potentially rewarding opportunities. And that’s why excessive inventories should be controlled by the company.

How to Evaluate Inventory on Balance Sheet?

The Inventory level of a company can be evaluated by using the inventory to current asset ratio. This ratio reflects how much percentage of the current asset is kept as inventory.

Inventory to current asset=Inventory/(Current assets)  ∗100

Although the ideal inventory to current asset ratio varies industry-to-industry as a few industries may require more inventories in their shelves for timely operations compared to other. However, as a thumb rule, this ratio should be less than 40%.

Moreover, try avoiding to invest in companies with inventory to current asset ratio greater than 60% as this might reflect too much inventories and the management’s inefficiency in inventory control.

For example, here is the balance sheet of Hindustan Unilever (HUL). Let’s calculate its inventory to current assets ratio.

inventories hulBalance sheet HUL

For Hindustan Unilever, if you calculate the inventory to current assets ratio, you can find it equal to 30.75% for the year ending March 2018.

In the last 5 years, this ratio has been continuously increasing- 21.55% (2014), 24.87%(2015), 26.87%(2016), 28.54%(2017), which means that HUL is spending more on their inventories. As the inventory to current assets ratio is still under satisfactory level, this can be considered healthy for the company.

However, to get a better idea, you need to compare the inventory to current assets ratio of HUL with its competitors in the consumer goods segment.

Note: If you are new to the financial world and want to learn how to effectively read the financial statements of companiesfeel free to check out this awesome online course on Introduction to Financial Statements & Ratio Analysis.

Summary

Although inventories are often ignored while evaluating companies in many industries, however, they are still one of the most crucial assets of a company. And that’s why inventory control is an important area to focus.

A low inventory level may lead to delays in completing orders, empty shelves and out of stocks which are not a good experience for the customers. On the flip side, excess inventory might lead to higher cost of storage, damage issues, insurance costs, spoilage costs or the threat of obsolescence. In order for a company to work effectively, its necessary to have sufficient (but not excess) inventories.

Also read:

Monte Carlo Simulation -How can it help investors?

We face an element of risk in almost every decision we make which often leaves us feeling uncertain and ambiguous. Although we have unparalleled access to information, we can never predict the future. A method that can help ease this risk is the Monte Carlo simulation that allows you to see all the possible outcomes of a decision and its associated risk. It can help you, as an investor, to make better decisions at uncertain times.

Background

The Monte Carlo simulation was developed in the 1940s by Stanislaw Ullam, a brilliant Polish-American mathematician who was in charge of the Manhattan Project (R&D for WWII nuclear weapons). While recovering from a brain surgery Stanislaw spent many hours playing solitaire. He was soon drawn to trying to devise the game through the distribution of cards and predict the probability of winning.

Stanislaw’s analysis of trying to predict the outcomes led him to develop the Monte Carlo simulation. It was named after the glamorous gambling casinos of Monaco, France.

What is the Monte Carlo Simulation?

The Monte Carlo approach is a computer-based method that uses statistical sampling to build a model of a possible range of results (a probability distribution) for those factors that have an element of uncertainty.

The results for the uncertain elements are calculated over and over using a set of random values at each time. The values entered as samples into the simulation as input ate chosen at random from the probability of income distribution. These sample sets are called iterations. The simulation produces a distribution of possible outcomes and these outcomes are recorded.

The Monte Carlo simulation is used by many different sectors and industries from project management to energy and engineering. But it is especially applicable to the finance and business sectors due to its emphasis on random variables. The simulation can be used to calculate the probability that the costs of a certain project will exceed its budget and the probability that the price of an asset will go up or down.

In addition to this, the model can be used to determine the investment default risk and assess the performance of derivatives such as options.

Why should we use the Monte Carlo Simulation?

Simply put, the Monte Carlo simulation helps you make better decisions. It helps predict future outcomes based on different scenarios. The technique used in the simulation allows us to measure the risk in quantitative analysis. In addition to providing the outcomes in a given scenario, it lets us know the likelihood of each outcome occurring.

In terms of investing, the Monte Carlo simulation lets us identify all the risks associated with a particular investment. It gives us a range of outcomes so it can show you outcomes for conservative investments and incredibly risky ones. There is also a middle ground for the portfolio which is the outcome of a neutral investment and is particularly useful to investors who want to assess the risk of options.

How is the Monte Carlo Simulation useful to investors?

The Monte Carlo simulation helps investors assess their portfolios and make investment decisions. Modern technology has now made it easy to perform a Monte Carlo simulation with the just a few clicks. The investor needs to enter a relevant time period between 1-25 years along with a downside floor constraint or an upper target value.

The simulator then generates 10,000 possible outcomes by playing out each simulated version in the future from the lowest to the highest risk based on values entered. However, it is important to remember that the simulator does not take into consideration real-world events such as crashes or unexpected events. Reality can differ from the simulator but it is still a powerful tool in understanding the trade-off between risk and the upside.

There are many websites that can help you perform a Monte Carlo simulation such as Vanguard that offers a ‘Retirement Nest Egg Calculator’. Vanguard uses the Monte Carlo simulation to provide the possible outcomes of a retirement portfolio. It takes into account your balance sheet, spending, and asset allocation and tries to determine the probability that your investment revenue will last the duration of your retirement.

Vanguard Monte Carlo Simulation Retirement Nest Egg Calculator

(Image Credits: Vanguard)

Another great website is Personal Capital that also uses the Monte Carlo simulation to assess portfolios. The tool calculates the standard deviation and annual returns on the portfolio based on set targets. The result provides you with three market scenarios, the best possible case, the worst possible case and midpoint between the two. The tool aims to show how a diversified portfolio can be catastrophic when there is a bad market.

Disadvantages of the Monte Carlo simulation

Like all things, the Monte Carlo simulation has its shortcomings as well because no one can predict the future. The simulations are particularly disadvantageous during a bear market. This is because the outcomes are based on constant volatility and can create a false sense of security for the investors. In reality, however, stock markets are very unpredictable and the Monte Carlo simulation does not hold good for these scenarios.

Moreover, the simulation is unable to factor in the behavioral aspect of the stock market. The Monte Carlo simulation could not predict accurate outcomes during the volatile stock markets of 2008. Therefore the simulations only show an approximation of the true value and can sometimes show very large variances.

Also read: The Ultimate Guide to Walter Schloss Investing

Conclusion

The Monte Carlo simulation is used by many investors to gauge the performance of their investments so they can make more informed decisions.

While you cannot trust the outcomes of the simulation with complete certainty, they do provide a viable way to understand the trade-off between risk and investment. It is a great tool for advisors when assessing the potential risks associated with the client’s portfolio. By changing the investment horizon and the upper and lower targets of the simulation, you can have a better understanding of how you can affect and change the outcome of your future investments.

A Beginner’s Guide to Debt Mutual Funds

Debt investment- this topic has been into a lot of contest since people started investing in the financial world, especially when people compare it with other investment options like equities or real estate. Although equity investments are known for their higher returns, however, investing in debt investments have their own benefits.

In general, if you have some idle funds and looking to invest in the financial market, you have two broad options. The first is to purchase something for a specific value and hope to dispose of at higher returns in the future. Such investment options include Stocks, Mutual Funds, Real Estates, Commodities, and Derivatives.

The other choice could be to lend your savings to some other person (or organization) and keep earning interests until you get your corpus back. This includes Bank Savings Account, Bank Fixed Deposit Account, Corporate Bonds, Government Bonds, and Debt Mutual Funds.

In this post, we will discuss what exactly are Debt Investments (focusing on debt mutual funds), types of debt funds, their benefits and more. However, before getting into that, let us first understand the basics of lending.

Basics of Lending:

basics of lending

The process of lending involves two parties. The borrower borrows the money from the lender as the former is in need of that. The former pays a specific regular payment known as “interest” to the latter for using the funds.

The loan is closed when the borrower repays the entire amount due to the lender. Here, ‘loan’ is also referred to as ‘credit’, ‘debt’ or ‘bond.’

Such instruments are called ‘fixed income securities’ because everything here is predetermined like the interest rate, maturity period, debtor and creditor.

How do Debt Mutual Funds work?

If you invest in a Debt Mutual Fund, you are simply giving loans to the issuing entity. Through Debt Fund investing, you can earn income in the form of interest and capital appreciation. You earn a pre-decided interest on Debt securities for a particular duration after the end of which such debt instrument will mature. Debt securities are also known as ‘fixed-income’ instruments as you are aware of what you will be getting.

In the case of Debt funds, the Fund Managers make investments across diversified securities. This gives ample scope for the Debt Funds for earning decent returns. Although no one can guarantee the returns for the same, however, debt fund yields return to fall in a predictable range. This makes the conservative investors interested in Debt Mutual Fund Investing.

The underlying assets of a Debt Fund usually consist of financial securities having a higher credit rating. The Debt Funds investing in higher-rated financial products will tend to be less volatile in comparison to low-rated securities.

An important thing to note here is that the duration (maturity) of the underlying depends on the Fund Manager’s investment strategy and the rate of interest prevailing in the economy. If the interest rate in the market falls, the Fund Manager may shift the underlying investments from short-term securities to the long-term ones and vice versa. The key differentiating factor among the varieties of Debt Funds is nothing but the maturity period of the underlying investments.

Types of Debt Funds

 debt instruments

    – Dynamic Bond Funds: In these funds, the Fund Managers keep altering the portfolio composition in accordance with the changing rate of interest in the economy. This fund’s average maturity period keeps fluctuating as the underlying portfolio is churned according to the rise and fall in the interest rates in the economy.

    – Income Funds: These funds are similar to Dynamic Bond Funds but on most of the occasions, the underlying portfolio of Income Funds consists of securities having long-term maturity period. This gives more stability to the Income Funds as compared to Dynamic Bond Funds.

    – Short-Term & Ultra Short-Term Debt Funds: These funds invest in the instruments having shorter maturity periods. Owing to their short-term nature, they are likely to be less affected by movements of interest rates.

    – Liquid Funds: These funds invest in the fixed income securities which come with a maturity period of not exceeding 91 days. These funds seem to be a better option than keeping one’s liquidity in a savings bank account. This is because the former provides similar liquidity but at higher returns.

    – Gilt Funds: These funds invest in only government instruments. The Government instruments are having high credit rating thereby come with low credit risk. Therefore, Gilt Funds are ideal investment products for the risk-averse investors who also prefer investing in the debt instruments.

    – Credit Opportunities Funds: These funds aim in earning higher returns by taking a call on credit risks. These funds aim in holding lower-rated bonds that come with higher interest rates. The Credit Opportunities Funds can be riskier than any Debt Mutual Funds.

    – Fixed Maturity Plans: These are closed-end Mutual Funds, which come with a lock-in period and invest in the debt securities. You can invest in Investments FMPs during the time of the initial offer period. An FMP is very similar to a fixed deposit, which yields excellent tax-efficient returns but it does not provide any guarantee for the same.

Who should invest in Debt Mutual Funds?

If you are a conservative investor, Debt Funds are an ideal investment option for you. You can even invest for a short-term period ranging from 3 months to 1 year. Debt Fund investing can also be of a medium-term which can range from 3 years to 5 years.

If you want to invest for a short-term where liquidity is your concern, then investing in the Liquid Funds could be more profitable than parking your money in a Savings Bank Account. Investing in the former would give you almost double the returns that you Bank Savings Account can yield for you.

For medium-term investing, you can go for Dynamic Bond Funds. Investing in such type of Debt Fund will fetch you more returns than a Bank FD of 5 years. For earning a regular income, you can look to opt for Monthly Income Plans (MIP).

What are the benefits of investing in Debt Funds?

    – A perfect starter: During the early stage of your career, your income might be low and so be your savings. You might be unsure of where to invest your meager savings. Investing in debt fund would be a good starter to your investment journey. Gradually, you would learn more about investing, risk-reward relationship, financial planning and can diversify your portfolio with time.

    – Adding stability to your investment portfolio: Debt Mutual Funds usually invest in the debt instruments. Therefore, they are comparatively more stable financial product than the equity investments. Debt Funds can provide some stability to your equity portfolio by diversifying the risk associated with your current investment portfolio.

    – Long term growth: Through a Debt Fund investment, you would earn a return of around 8% without taking any significant risk. Further, if you hold your investment for more than three years, your investment would attract the benefit of indexation. Here, indexation allows you to inflate the purchase price using cost Inflation Index. In indexation, the purchase price is increased (adjusted for inflation) and deducted from the sale price to calculate long term capital gain. And obviously, this will reduce your taxable capital gains.  In short, if you redeem your investments (partly or wholly) after three years, your returns in the form of capital gain would be more tax efficient as compared to keeping your money in a Fixed Deposit Account.

    – Helpful in meeting emergency expenses: You should always have a fund for supporting yourself in unforeseen circumstances. Creating an emergency fund can help you a lot in tough situations. Here, investing in debt funds offer a great alternative to keeping your emergency money in the savings account as it offers similar liquidity, very low risk, and comparatively higher turns.

    – Providing you liquidity: Debt Funds give you easy liquidity. You can keep investing your salaries in a Debt Mutual Fund and withdraw your money from such fund anytime. You can park your money in a Debt Funds and liquidate the same if you want to meet any of your needs.

 debt instruments 3

Things to consider before you invest in a Debt Funds.

    – Debt Funds are not entirely risk-free: Debt Funds are comparatively riskier than the Fixed Deposits as they are associated with both credit risk and interest rate risk. The Fund Manager might choose low-credit rated instruments for the underlying portfolio which gives rise to credit risk. Further, interest rate risk can be witnessed where the prices of the bonds may go down due to a rise in the interest rates.

    – Cost: Debt Funds do charge you for managing your investment. Such fee is called an expense ratio. As per SEBI, the cap with respect to the expense ratio is 2.25%. Although the upper limit of expense ratio might look a little adverse, but over the long-term investment horizon, this would definitely help you in generating even higher money which you have paid in the expense ratio.

    – There is no guarantee for returns: The underlying portfolio of a Debt Fund consists of fixed-income securities, but they don’t guarantee you any returns. The Net Asset Value (NAV) of your Debt Fund will fall if the interest rates in the economy shoot up as a whole. So, you would find Debt Mutual Funds attractive to be invested during the condition of falling interest rates in the market.

    – Higher the holding period, better are the returns: You can consider investing in Debt Funds for any investment horizon as per your needs. However, this is to be noted that, the longer the investment horizon, the higher is the probability of gaining attractive returns.

    – Achieving your long-term goals: Through Debt Fund investing, you can fulfill a plethora of your financial goals. You can make use of Debt Mutual Funds as a passive source of earning for supplementing your monthly salary. Furthermore, if you are a budding investor, you may invest some savings of yours in Debt Funds for meeting liquidity requirements. On the other hand, when you retire after around three decades, you may consider investing the lion’s share of your retirement benefits in some Debt Mutual Fund for receiving a regular pension.

    – Don’t forget taxation on capital gains: When you redeem your units of a Debt Fund, you would earn income which is called capital gain. The capital gain is taxable. The rate of taxation of capital gains is dependent on the holding period of your units in such a fund.

The capital gain which is earned by you over an investment horizon of lower than three years is referred to as a Short-term Capital Gain (STCG). On the other hand, the capital gain of yours made by you on redeeming your units after holding them for 3 years or more is termed as Long-term Capital Gains (LTCG).

STCG earned by you is added to your net income which is thus going to be taxed as per your income slab. The LTCG earned by you will be taxed @ 20% after considering the effect of indexation.

Also read: Mutual Fund Taxation – How Mutual Fund Returns Are Taxed in India?

Conclusion

Debt Mutual Funds are a wonderful investment option if you are a novice in financial market investing with low-risk tolerance.

As you gradually grow in your career, your earning increases and so does your risk appetite. Your investment keeps increasing and the proportion of Debt Fund in your investment portfolio keeps getting lower. However, when you retire, you would look for a stable source of income and again your financial assets will seem to be debt-heavy. So, your investment journey starts with Debt Fund and ends with the same. Therefore, you can’t really ignore the importance of the same in your professional career.

So, are you a fresher in the financial world and want to invest in low-risk investment options? Have you started investing for your future? If not, then what are you waiting for? Start your investment journey today with investing in the Debt Mutual Funds. Happy investing!

More resources to check:

Three Words That Matters: Margin of Safety

When I worked as a Trainee at Tata Motors, I got to know about the term payload. In easy words, it is simply the load carried by a vehicle. The payload helps the owner to determ­ine how much they can fit in their vehicle and moreover how many trips they have to take to carry a specific load.

During that time, once I was walking with my manager and we were discussing a light truck – Tata 407, which could carry 2.25 tonnes of payload. And we started talking about its payload. My manager told me that most of the commercial vehicles in India are almost always overloaded and easily crosses the prescribed payload. I asked him why do the Tata trucks perform so well then and why it doesn’t break? Obviously, if you overload the truck with twice its capacity, it should snap. And his answer was Margin of safety!!

Before developing any new vehicle, there’s a comprehensive study done on consumer behavior. And the R&D team of Tata knew this Indian behavior of overloading the truck in order to reduce the total number of trips to carry out the goods. And that’s why the load capacity of the Tata trucks are always more than what specified in the manual.

Moreover, here having a safety is a must for Tata trucks as they are known for their strength and the brand image matters a lot while selling vehicles in the automobile segment. They couldn’t afford to get their brand image ruined by not having a margin on their vehicle’s load capacity.

A similar concept of safety is used in the investing world to reduce the risk and maximize the profit. In fact, it is the central concept of value investing.

What is the Margin of Safety?

The margin of safety means purchasing the stock when the market price of the company is significantly below its intrinsic value. Here, the difference in the intrinsic value and your purchase price is called the d Margin of Safety (MOS).

The fundamental analysts believe that there is a true (intrinsic) value for all the company which can be found by reading financials of the company. Moreover, they also believe that the stocks do not trade at their true intrinsic value at most of the time because of speculations and other short term market behavior. A stock can be overvalued or undervalued at any moment of time. And that’s why Investors can make good profits by purchasing stocks when they are trading at a discount i.e. below their true value.

The margin of safety helps to safeguard the investments against calculation error, human error, judgment errors or any other unexpected occurrences concerning the market or stocks.

margin of safety chart

The margin of safety plays a significant role while purchasing stocks.

For example, if you think a stock is valued at Rs 100 per share (fairly). Then, there is no harm in giving yourself some benefit of the doubt that you may be wrong with your judgment and calculation. And hence, you should buy that stocks at Rs 70 or Rs 80 instead of Rs 100. Here, the difference in the calculated intrinsic amount and your final purchase price is your margin of safety.

The ideal margin of safety depends on the risk tolerance of an investor. The strict value investors may have a MOS of over 50% to minimize the downside risk. On the other hand, aggressive investors may choose a comfortable MOS of 10–15%. As a rule of thumb, always have a margin of safety of between 10–30% on the intrinsic value of the stock while making your investment decisions.

Moreover, apart from the risk tolerance of the investor, this margin of safety percentage also depends on how risky the investment is. If you are investing in a safe blue chip stock, this margin of safety can be comparatively lower than the MOS on high-growth riskier small-cap stocks.

Methods to find Intrinsic value:

The concept of Margin of safety was poularized by the legendary investor, Benjamin Graham (also known as the father of value investing). He used his ‘Graham formula’ to find the true value of companies, and if the stock was trading way below the intrinsic value, only then he would purchase them. This concept of MOS was later inherited by Warren Buffett, a student of Ben Graham.

There are different tools to find the intrinsic value of a company. While many prefer using PE or Book value to find if the stock is undervalued, one of the most popular method to find the true value of a company is the discounted cash flow. DCF analysis is a method of valuing a company using the concepts of the time value of money. Here, all future cash flows of a company are estimated and discounted by using the cost of capital to find their present values. (Read more here: How to value stocks using DCF Analysis?)

A few other methods to find the intrinsic value of a company is the dividend discount model (DDM), EPS valuation, relative valuation etc.

Also check: Intrinsic value calculators

Closing Thoughts

Having a margin of safety in the investments helps the investors to minimize the downside risk. However, an important point to highlight here is that having a MOS does not guarantee that the investment will always be profitable. Finding the intrinsic value of the company correctly also plays a crucial role here. And therefore, you should spend a significant amount of time valuing the stocks suitably.

Nevertheless, a meaningful discount on the purchase price compared to the intrinsic value can limit your losses and maximize the profits on your investments.

6 Reasons Why You Should Get Health Insurance

When people are in the best of their physical health, the obvious question among them is why should they invest in health insurance? Especially for the people in their early career when they find themselves physically fit and miles away from any health issues, paying a premium plan for ensuring health may seem an unnecessary expenditure.

Now, there is no denying the fact that investing in the long term wealth generating investment options during your earning career is inevitable. This will definitely help you to achieve your goals and maintain the expected standard of living of yours and your dependents even after your retirement.

However, when you retire, you also become old.  It is a fact that old age brings health issues along with it. And hence, it is highly necessary for you to incorporate healthcare planning within the budget of your family financial planning.

What is health insurance?

If you search the meaning of the word ‘health insurance’ on Google, you will get the result as “Insurance taken out to cover the cost of medical care.”

In simple words, health insurance is a contract between you (policyholder) and the insurance company, where you pay a regular premium against which the latter assumes the responsibility in meeting your medical expenses. With increasing medical costs, having a medical insurance policy has become highly important for every family in India.

Although increasing access to advanced electronic media has created awareness among the people in India towards the importance of buying health insurance plans. Nonetheless, the majority of the population in India still fails to understand the importance of getting medical coverage for themselves.

If you have already realized the significance of having mediclaim for yourself and your family members, you are a step ahead from the majority. However, In case you don’t, let us help you explain why you should consider health insurance as an investment and not an expense.

6 Reasons Why You Should Get Health Insurance

1. Being Medically insured can help you avoid facing financial instability in future:

Medical expenses are going up day by day. Moreover, you may need to incur any emergency medical expense at any point in time. If you have not made separate provision for the same, you have to dig into your savings or sell off your assets to meet the medical needs of yours or your family. Buying a health insurance policy gives you the assurance of financial stability during any medical urgency.

2. Medical insurance enables you to get the best health treatment

Shortage of funds could make you opt for a reasonable medical treatment instead of choosing the best of the lot. Having a good mediclaim can assure you the best treatment for overcoming toughest of health conditions.

3. You can get the coverage of hospitalization charges 

In the last few years, not only the medical costs, but even the expenses of the out-patient department and diagnostic tests have also gone up a lot. This has further increased the importance to buy a medical insurance policy. The health insurance policies not only provide adequate coverage of the hospitalization expenses but also enable meeting the costs incurred in diagnostic and OPD tests, earlier and later of a specific time period as mentioned by the policy.

4. The modern dynamic lifestyle demands medical insurance

Over the past few decades, our lifestyle has undergone a plethora of changes. Frequent traveling, busy work schedules, unhealthy eating habits and a rise in the level of pollution in big cities have exposed us to the risk of new health issues. And that’s why medical insurance has become a necessary part of our life.

5. Opting for medical insurance will help in your retirement planning

During the old age, your income may decrease but your medical expenses will be high. However, here if you already know that your health is insured, you can spend on different options of your choice after retirement.

Health insurance plans also come with lifelong renewability features. You can renew your health plans until your death and there is no such age limit for it. This is going to be of immense help in the later stage of your life. Having medical insurance will offer you a lot of flexibility and will also reduce the burden on your kids to take care of your medical expenses.

6. You can enjoy the benefit of tax deductions on your health insurance plan

The health insurance premiums that you pay for yourself, spouse and dependent children are eligible to get tax exemption under Section 80D of the Income Tax Act, 1961 up to Rs 25,000. Moreover, if you or your spouse is a senior citizen (60 years or more), the limit will go up to Rs 30,000. By opting for health insurance plans, you can enjoy these tax deductions benefits. Check out this blog to study further regarding the tax benefit on health insurance as per Union Budget 2018.

health insurance 2

Is there any right age to buy a health insurance policy?

Frankly speaking, there is no appropriate age to buy a medical insurance policy.

However, if you buy a health plan in your early age, you need to pay quite less for opting most policies. As you grow old, the premiums which you require to pay for your health insurance policy increase will also gradually increase. The reason being that the associated health issues and risk goes up with time. Medical insurance premiums are dependent on the age of the policyholder, his/her medical history, where he/she lives, etc.

Further, an important option that you need to consider while purchasing a health insurance policy is selecting critical illness medical insurance policy. The critical illness policy offers to pay a fixed amount if you are diagnosed with any critical illness which is under the coverage of that policy. You can either buy only the critical illness insurance policy or you can also opt for purchasing it as an add-on when you buy your regular health insurance. In case you are diagnosed with a critical disease, this critical illness policy does act as a great support to your mainstream health insurance plan. Besides, here are five must know things regarding critical illness insurance plan.

Why is opting for a health insurance plan important in a country like India?

Today, we live in a dynamic India where many of us don’t even follow a healthy lifestyle. It is resulting in a number of health conditions which require a lot of medical attention. A plethora of people in India are suffering from heart diseases and diabetes at an early age due to work stress and unhealthy lifestyle. In addition to that, respiratory issues, infectious diseases, and birth complications are also highly popular in India. Degrading health in India has really heightened the need for health insurance in the country.

So what do you think? Have you given a thought to protect yourself and your near and dear ones from health ailments? The way healthcare expenses are going up, it is getting more and more difficult with time for people to manage such costs. A wonderful way of protecting yourself from such a financial crisis is to opt for health insurance policies. So, why are you still waiting? Go on and get a medical plan for yourself and your dependents today!

Resources to check:

The Ultimate Guide to Walter Schloss Investing

When you think of investing, the first name that comes to your mind is Warren Buffet- and with good reason. Buffet has a legendary track record and has generated very high returns for his investors since the ’60s. But a lesser-known investor who was just as good and referred to as ‘Big Walt’ by Buffet is Walter Schloss, one of the most legendary investors in the investment world.

Background

Walter Schloss’ investment theories are most applicable to small value investors and were based on the teachings of Benjamin Graham (another icon in the investing world and also known as the father of the value investing).

Schloss’s studies helped gain an insight into how to perform deep value investing that is still relevant in today’s market. While the basis of Walter Schloss’s principles were based on Graham, he developed his own strategies while staying close to the fundamentals. His theories earned him the title ‘Superinvestor’ in 1984.

The Investing Playbook

Walter Schloss’ investment strategies involved a more ‘play by the book’ approach of investing in undervalued stocks. He focused on the quantitative factor and instead of following every stock he owned, Schloss decided to follow stocks based on valuation and buying at a discount to the intrinsic value. In 1994 Schloss listed the factors he believed were required to make money on the stock market. I have discussed the most important factors below:

1. Price is the most important thing when it comes to buying stocks

Walter Schloss’ believed Ben Graham’s philosophy that ‘a stock well bought is half sold’. He felt that every stock will become an attractive buy at a certain point as long as the price dropped low enough to provide a safety margin.

2. The price of a stock in relation to its book value is the most important factor in valuing stocks

Walter Schloss never bought stocks that had a premium to book value ratio. Instead, he bought it at a discount to book value as it provided a margin of safety. The investors who remained patient in the short run would be rewarded in the long run if they systematically bought discounted stocks.

3. Buy stock in companies that have been in business for a while

Schloss preferred to invest in stocks of companies that have a long history of being in business. The fact that these businesses have been in operation for so long gives the investor the confidence that the company will continue to operate long into the future as well. It can also help identify their business cycle and compare the book value earnings. Walter Schloss’s also invested in companies that were going through a downturn in their business cycle if he believed that the asset portfolio was strong and the chances of the company performing well in the long-term seemed favorable.

4. Maintain a diverse asset portfolio and stay fully invested

Walter Schloss usually traded a 100 different stocks at any given time and he was a 100% invested. During a high market valuation, he would adjust his price to book value upward if the company was paying a good dividend. But he relied on dividends rather than earnings as an indicator of a company’s profitability.

When analyzing the quality of the management in the company you choose to invest in, Walter Schloss believed that being ethical was more important than just being smart. In an interview, he said: “In a choice between a smart guy with a bad reputation and a dumb guy, I think I’d go with the dumb guy who’s honest. Of course, you can’t always protect yourself there, either. I guess the choices we’ve made are probably in those areas.”

The ‘rules of investing’ were written by Walter Schloss many years ago but they still remain relevant today. If an investor learns to stick to a small value approach, it will benefit them in the long run. Keep it simple.

Also read: Why Warren Buffet Suggests- ‘Price Is What You Pay, Value Is What You Get’?

Walter Schloss and Portfolio Management

Walter Schloss did not invest too much time assessing the details of a particular stock to the very last detail rather he studied the company financials and did not overanalyze each investment opportunity. He spread his risks evenly and sometimes invested just $10,000 in a stock. His portfolio consisted of a hundred stocks.

In the initial investment, Schloss would take a small position and eventually buy more if the difference between the trading price and intrinsic value continued to widen. In particular, he preferred to invest in companies with a higher margin of safety and focused on stocks with low leverage.

Walter Schloss’s deep value investing

As a small value investor, the strategies used by Walter Schloss are extremely relevant. Walter Schloss’s investment strategy was incredibly old-school, he was a simple man and operated more like a small-time investor rather than a professional financial advisor. Schloss never aimed to reach new heights as an investor and continued to use and search for new deep value investing ideas till the very end.

Value investing are stocks that trade lower than their book value and while it is hard to find these stocks in today’s market where ‘money never sleeps’, this old school strategy developed by Walter Schloss is still important. Here are the key takeaways of this investing style:

  • The main criteria of the investor should be to discount your stock to a tangible book value
  • The quality of the management is also important, if the company is not confident in their management, then neither should you
  • Having a diversified portfolio is incredibly important. In the long term, it is the valuation of your portfolio that helps you earn large gains in the stock market.

Also read: #5 Things Warren Buffett looks for before investing.

BONUS: 16 Investing Rules from Walter Schloss

(FROM A 1994 LECTURE)

  1. Price is the most important factor to use in relation to value.
  2. Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.
  3. Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).
  4. Have patience. Stocks don’t go up immediately.
  5. Don’t buy on tips or for a quick move. Let the professionals do that if they can. Don’t sell on bad news.
  6. Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for the weaknesses in your thinking. Buy on a scale down and sell on a scale up.
  7. Have the courage of your convictions once you have made a decision.
  8. Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.
  9. Don’t be in too much of a hurry to see. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to re-evaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E ratios high? If the stock market historically high. Are people very optimistic etc?
  10. When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 years before the stock sold at 20 which shows that there is some vulnerability in it.
  11. Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually, assets change slowly. One has to know much more about a company if one buys earnings.
  12. Listen to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally, it is harder to keep money than to make it. Once you lose a lot of money, it is hard to make it back.
  13. Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.
  14. Remember the work compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.
  15. Prefer stock over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
  16. Be careful of leverage. It can go against you.

Conclusion

The Walter Schloss investing style is great for anyone looking to invest in small companies. The strategies help reduce risk with the promise of high returns.

Unlike Warren Buffet’s investing style which requires the ability to identify a competitive advantage and do thorough research into a company’s financial statements that most people don’t have the know-how to do. Schloss provides a great alternative to this- focus on assets rather than earnings.

Many small investors are in the habit of solely investing in a company based on its annual earnings but they are more likely to succeed if they focus on the assets in the balance sheet. Walter Schloss investing is a time-tested lesson that still holds true today.

The Stock Market Cycle: 4 Stages That Every Trader Should Know!

From the changing seasons to the different stages of our lives, cycles exist all around us. These cycles are often influenced by numerous factors at each stage. Likewise, cycles also affect the movements of stocks in the market. Understanding how these movements work can help a trader identify new trading opportunities and lower their risk.

In this post, we are going to discuss the four stock market cycle stages that every trader should know. Let’s get started.

Stages in the Stock Market Cycle

The movement of prices in the stock market can often seem random and hard to follow. Prices may go up on certain days, and down on others. To an average person, these shifts are often confusing and the prices can resemble a casino game.

The reality, however, is that the stock market cycles move in similar ways and go through the same phases. Once an investor understands the phases, the markets will not seem so random anymore. The trader can recognize each phase and change their style of trading accordingly. There are four phases in the stock market cycle as follows:

four stages of stock market cycle

(Image Credits: Investopedia)

1. The Accumulation Phase

accumulation phase

(Image credits: Investopedia)

This phase of the stock market can apply to an individual stock or the market as a whole. As the name suggests this phase does not have a clear trend and is a period of agglomeration. The stock tends to trends at a range as traders accumulate their shares before the market ‘breaks out’. It is also known as the basing period because the accumulation phase comes after a downward trend but precedes an uptrend.

The moving average does not provide a clear indicator at this point as the market is not following a particular trend. The longer the accumulation phase the stronger the break out in the market when the stocks start to trend.

How to trade:

The accumulation phase may last a few weeks or a few months. So use this time to study the market and anticipate the right time to enter. The price range during this period is small and not particularly advantageous for day traders. It is advisable not to make large trades at this time until a market trend is confirmed. A current event in the economy can take stock out of this phase as you begin to see an uptrend. Once this accumulation phase is broken, you begin to see highs and lows in the market as we move on to the run-up phase of the market.

2. The Run-Up Phase

Just as the accumulation phase is defined by its resistance to the changes in stock prices, the run-up phase is defined by the price going above this resistance level. The breakout of the accumulation phase results in a high volume of shares as the traders who remained silent during the accumulation phase aggressively purchase stocks. As this period progresses we begin to see a trend in the prices. The highs and lows in the market attract more traders as they begin investing. This result in an upward trend as the market becomes stronger and moves on to the next phase.

How to trade:

This is the best time for a trader to make money. There is a lot of upward movement of prices which is great for momentum traders. Any downward trend during this period is not viewed as a bad thing but rather an opportunity to buy shares. When the market goes down, the shares will get bought up as the market begins to trend again. The run-up phase is best for swing or short-term traders. As this phase progresses, the volatility in the market decreases as prices move slowly every day.

3. Distribution Phase

distribution phase

(Image Credits: Investopedia)

This phase, also known as the reversal stage, is when traders who purchased stocks during the accumulation phase begin to exit the market. A prominent feature of this phase is an increase in the volume of shares but not in its price. The market is usually bullish but the demand does not exceed the supply of shares enough for the prices to increase. There are usually hard sell-offs but not enough to make the market trend downward.

How to trade:

There is a lot of volatility in the early stages as investors begin to pull out of the market which presents a good shorting opportunity as the market reaches the bottom it will bounce back with velocity. The distribution phase is identified through certain chart patterns like the head-and-shoulders top or bottom top. As the phase progresses the market starts to lose its volatility as a range begins to form. This is not the best situation for momentum traders.

4. Decline or Run-down Phasemark down cycle

(Image Credits: Investopedia)

This is the last stage of the stock market cycle and is not a favorable time for most investors. Those traders who bought stocks during the distribution phase hastily try to sell as they are underwater on their positions. However, there are few buyers to meet the sale of shares. This lack of demand drives down the prices of stocks. If there are higher lows in the market for a long period of time, it signifies that the market is headed towards the accumulation stage.

How to trade:

During this phase prices of stocks fall lower than expected so ‘don’t try to catch the falling knife’. A bear marker provides a good opportunity for long trades if the right strategies are used. It is important not to panic and sell during this period because these phases don’t last forever.

Also read:

Conclusion:

Understanding each of the phases in the stock market cycle is essential to making the right decisions when it comes to buying and selling stock. A good way to study these phases it to study the past chart trends of particular stocks. You can identify certain indicators at each phase. Finally, always remember this quote by Yvan Byeajee- “Trading effectively is about assessing probabilities, not certainties.”

A quick guide to Public Provident Fund (PPF)

In the last few years, Mutual Fund investing has gained immense popularity among the people in India. All thanks to AMFI and their tagline “Mutual Fund Sahi Hai”. However, a significant population in India are still more inclined towards Public provident fund (PPF) compared to any other investment option.

In this post, we are going to discuss what exactly is Public provident fund and why a majority of Indian families has so much faith in it. Let’s get started.

What is a Public Provident Fund (PPF)?

Public Provident Fund or PPF is an investment product which is tax-free in nature and comes with a maturity period of 15 years. PPF yields return similar to the government securities or G-secs. The returns are declared every month. Currently, PPF offers a return rate of around 8% per annum.

Your contributions in your PPF account up to Rs 1.5 lakh is eligible for tax benefit u/s 80C of Income Tax Act, 1961. On top of that, Interest earned is exempt from income tax and maturity proceeds are also exempt from tax.

Interest rates of ppf

Image: Interest rates of PPF (Source: Cleartax)

By now, you have understood the basics of Public Provident Fund. Next, let us discuss some key features of PPF.

Opening your PPF account is hassle-free.

If you are an Indian citizen, you can easily open a PPF account (but not more than one). You can open the PPF account in your name or on behalf of your minor children, being a parent or a legal guardian.

A PPF account can be opened in the post offices or any designated bank branches like SBI and its subsidiaries, ICICI Bank, Axis Bank, HDFC Bank, Central Bank of India, IDBI, Central bank of India, Punjab National Bank, Indian Overseas Bank, Bank of India (BOI), and few others. You can even transfer a PPF account from a Post Office to a Bank account and vice versa.

However, if you are an NRI, you would be sad to know that you are NOT eligible to open a PPF account in India. Anyways, if you have already opened a PPF account in India while you were a resident, then you are allowed to operate your existing PPF account until 15 years with no option for extension.

You can take a loan from your PPF account:

If you are a PPF account holder, then you can take a loan from your PPF account, but only from the third year of investing. This loan facility would be available to you till the sixth year-end as afterward, your account will be eligible for withdrawal.

An important thing to note here is that you can only raise loan up to one-quarter of your corpus generated in your PPF account as per the previous year ending. The principal portion of your borrowing has to be repaid by you within the next three years time span. Further, the loan provided to you will be rated two percent high than the interest offered to you on the balance in your PPF account.

Your PPF account is safe:

The balance in your PPF account is completely yours and no one can take it away from you. Your PPF account is not attached for paying off any of your liability. However, please note that there is an exception to this. The Income Tax authority of India is free to attach your PPF account for recovering their Income Tax dues.

Don’t forget your investment limit:

You can invest in your PPF account either through lump-sum mode or via twelve monthly installments. You need to deposit a bare minimum of Rs 500 in a Financial Year to keep your account active. The maximum amount that is allowed to be deposited in a Financial Year is Rs 1.5 lakhs.

Please note that if you deposit any amount exceeding Rs 1.5 lakh in a Financial Year, such an excess amount will be considered as an irregular investment and the same will not attract any interest.

You can make nominee to your PPF account:

You are allowed to nominate a person to your PPF account. The nominee gets the authority of collecting the money in your PPF account occasion of your death. Being a PPF account holder, you are required to mention the percentage of your share in case there is more than one nominee.

The nomination is disallowed to a PPF account if the same is opened on behalf of a minor. You can alter the nomination to your PPF account at any point of time throughout its maturity period.

Don’t keep any misconception regarding lock-in period: 

According to the PPF scheme rules, the maturity period starts from the END of the Financial Year in which you have made a deposit. It is not calculated from the date of the opening of the account. For example- Suppose you have made your first contribution on August 10, 2018. Then, the 15 years lock-in period will be computed from the 31st March of the next year. In this case, the maturity period will be 1st April 2034 (technically 16 years).

Making withdrawals from your PPF account:

withdrawl of ppf

(Source: Bankbazaar)

You can start partially withdrawing your balance from your PPF account at the commencement of the 7th year, i.e. after completing six years. However, you can withdraw only up to 50% of the available balance at the 4th yearend to the year when the money is being withdrawn or 50% of the closing balance of the previous year, whichever is lower.

After the end of the 15 years maturity period, you will become eligible for complete withdrawal. If you still wish to extend your investment intact, you can wait for a further period of five years before making a complete withdrawal.

Read more here: Public Provident Fund -PPF Withdrawal Rules & Process

PPF account discontinuation:

If you fail in keeping a minimum deposit of Rs 500 in a year, it can lead to discontinuation of your PPF account. During the occasion of discontinuation of your PPF account, you would get the invested amount along with corresponding interest, but only after the expiry of the lock-in period. The discontinued account will generate interest in every year until maturity.

Facility of withdrawal borrowing is not allowed to you if your PPF account is a discontinued one. For availing such facilities, you would require to continue your account by paying the stated penalty and minimum subscription for such discontinued period. So, please make sure that you are investing the minimum amount in your PPF account every year to keep it in an operational mode. 

Also read: How to revive a dormant PPF Account?

Should you invest in PPF?

Indian is an FD centric country and PPF is still a favorite among most of the retail investors of middle-class background.

Moreover, PPF is a safe financial product as it is backed by the Government of India. The underlying portfolio of PPF consists of fixed income securities where no exposure to equities is involved. Therefore, the Public Provident Fund is highly suitable for those investors who are highly risk-averse but at the same time looking for an inflation-adjusted return on a regular basis.

Although these days, Indian youth is getting inclined more towards Stock Market trading and Mutual Fund investing, still they are unable to move their eyes from the luster of PPF. By offering a regular and guaranteed return, support from the Government and reasonably hassle-free investment process, PPF continues to meet the long term financial needs of millions of people in India.

Overall, if you are you a risk-averse individual and want to avail tax benefit on your gross income along with building wealth, then PPF is an astounding option for you!!

Also read:

What is the difference between Face Value, Market Value & Book Value?

Recently when I was navigating my Quora profile, I got an answer request for the question what is the difference between face value and market value of a company. Although both these are elementary terms related to stocks, however, they may be a little confusing for the beginners. Therefore, I decided to write a simple blog explaining the difference.

In this post, we are going to discuss the difference between Face Value, Market Value, and Book Value of a stock. Let’s start with the easiest.

Market Value

Market value per share is the current value of the stock. This is the price at which market values the stock. For example, if a stock is trading at a share price of Rs 100, then this is the market value per share of that company. The market value per share of a company fluctuates continuously throughout the trading time period.

Further, the total market value of a company, also referred as the market capitalization of the public company, is calculated by multiplying the current share price of the company by its total outstanding shares. 

face value and book value-minFace Value

Face value (also known as par value) is the value of a company listed in its books and share certificate. The company decides the face value when it offers shares at the time of issuance. The face value of a share is fixed (until the company decides to split or reverse-split the shares).

For example, during the IPO of Avenue Supermart (Parent company of D’mart Supermarkets), the management decided the face value per share to be Rs 10. Here is the details:

D mart IPO-min

(Source: Avenue supermart IPO details- Chittorgarh)

In general, the face value of a company is lower than its market value. For example, when a company goes public, it can have a face value of Rs 10. And it may trade at a market price of Rs 500.

However, this case is not always true. For example, in the case of penny stocks, the face value of the company may be higher than its market value. Penny stocks are those companies which trade at a share price less than Rs 10. Therefore, here the market price may be Rs 5 and the face value of the company may be Rs 10.

Further, the face value of a company is not affected by whether the market price goes up or down. However, the face value of a company will reduce in the case of a stock split. For example, if the current face value of a company is Rs 10 and it announces a stock split in the ratio of 1:1. Then, the face value of that company will split in the same proportion. Here, the face value will change to Rs 5 as the total number of share doubles after the stock split.

Also read: Stock split vs bonus share – Basics of stock market

Book Value

In simple words, the book value of a company theoretically means the total value of the company’s assets that shareholders will receive in case the company gets liquidated i.e. when all company’s assets get sold and all the liabilities are paid back to all the debt-holders. Therefore, book value can be considered as the net value of the company reflected in its books.

The book value is calculated as total assets minus intangible assets (patents, goodwill) and liabilities. When you divide the book value of a company by it the total number of outstanding shares, you arrive at the book value per share.

You can compare the book value per share of a company with its market price to find whether the company is under or overvalued. Further, its always advisable to invest in companies with growing book value over time.

For example- here is the book value of ASIAN PAINTS:

face value and book value-min

(Source: Moneycontrol)

Where to find the face value, book value and market value of a company?

The face value, book value and market value of a company can be found on almost all financial websites.

Whenever you open the company page on any financial websites, the first thing that you’ll notice is its market value per share. However, just by cruising a little, you can easily find face value and book value per share of the company. For example, here is the face value, market value and book value per share for Asian Paints. (Source- Screener).

screener face value market value and book value-min

(Source- Screener)

You can also find this information on other popular financial websites like Yahoo Finance, Marketsmojo, Equitymaster etc.

Also read:

Bottom line

By now, the meaning of face value, market value, and book value should be clear to you. All these three terms are different and one should not get confused among them while studying any company.

Market value per share is the current value at which the stock is trading in the market. Face value is the value of a company listed in its books of the company and share certificate. And finally, the book value of a company is the total value of the company’s assets that shareholders will receive in case the company gets liquidated.

That’s all for this post. I hope it was useful to you. Happy Investing!!

Rupee Depreciation: Is it a cause of concern?

Rupee depreciation and its impact on the economy, market and people have been in a lot of debate lately.

Last year, the exchange rate of Indian rupee to US Dollar made an all-time of Rs 74.34 on October 9, 2018. Although the currency has recovered a little since making its high and currently hovering at Rs 70.52 (as of January 9, 2019), however, people are still wondering how rupee depreciation can impact their lives.

In this post, we will understand what exactly is rupee depreciation and also analyze the impact of rupee depreciation on different industries, imports, exports, and the stock markets.

How the Rupee value is determined?

In simple words, the rupee value is determined by the forces of supply and demand in the currency market.

If the demand for Indian currency is high, Indian rupee will appreciate. This is called rupee appreciation. For example, if $1 = Rs 70 previously and later it moves to 1$ = Rs 67, then the rupee is said to be appreciating. This also means that our currency is gaining strength against the dollar.

On the other hand, if the demand is low, the currency value will depreciate. For example, if $1 =Rs 70 previously and later it moves to $1 = Rs 73, then it means that the rupee is depreciating. Here, our currency is losing strength against the dollar.

Quick Note: Although it’s easier to say that the price of a currency is determined by the forces of supply and demand, what actually drives an increase in demand or supply is a little complex and depends on multiple factors.

Some of the key determinants are inflation in the country, growth rate, interest rates, imports and exports, General macroeconomic conditions of the country, Economic Policies of a government (Fiscal Policy, Budget, Investment policy, and Foreign Trade Policies), political stability, banking capital, commodity prices etc.

Floating vs Fixed Vs Managed Rate System:

Another important concept to understand while studying the currency of a country is its rate system. It can be either fixed, floating or managed float regime.

The floating rate system is a situation in which the value of the currency is freely determined by the market through supply and demand forces and it generally fluctuates constantly.

On the other hand, if the government or RBI exercise controls and fix the exchange rate of a currency (and disallow any fluctuations according to demand and supply forces in the market), such a system is called the Fixed Rate system. It is also called the Bretton Woods system or Pegged Currency System.

However, since this mechanism does not depict the real currency strength (or weakness), most of the countries including India changed to Managed Floating Rate System where currency value is determined by competitive market forces, with intervention by the Central Govt by purchasing rupee in exchange for the foreign currency to increase money supply in the economy which leads to home currency depreciation. Vice versa, it buys foreign currency in exchange for the rupee to reduce the money supply in the economy leading to home currency appreciation.

History of Indian Rupee: A comparison of Indian Rupee Value vs US dollar 

Since October 2008, the exchange rate of INR per USD has depreciated from Rs 48.88 to Rs 70.52 – as of 9th January 2019. Here is a historical data of the exchange rate of Indian rupee per US Dollar.

Year Exchange rate
(INR per USD)
1947 3.30
1949 4.76
1966 7.50
1975 8.39
1980 7.86
1985 12.38
1990 17.01
1995 32.427
2000 43.50
2005 (Jan) 43.47
2007 (Jan) 39.42
2008 (October) 48.88
2010 (22 January) 46.21
2012 (22 June) 57.15
2014 (12 Sep) 60.95
2016(20 Jan) 68.01
2017 (28 Mar) 65.04
2018 (9 May) 64.80
2018 (Oct) 74.00

Source: Wikipedia

Exchange rate inr per dollar

(Source: Tradingeconomics.com)

What TRIGGERS the increase in demand of currency?

Rupee’s appreciation or depreciation against the dollar depends on the dynamics of demand and supply for the currencies. Besides global factors, the following factors also are instrumental in creating the demand:

  • Interest Rate: The interest rate of a country influences the demand for the currency. India with an interest rate of 6-7% would attract greater capital inflow as investors get a higher return than their earnings in the US. (with Interest rates of 2-3%). This results in rupee appreciation.
  • Inflation Rate: A country with lower inflation would have increased demand for its products by foreign buyers. Higher demand for goods & services would translate into higher demand for that currency resulting in currency appreciation.
  • Export-Import: A country exporting more than importing from other countries, would result in higher demand for that currency, causing currency appreciation.

Current Scenario of Currency in India

The Rupee is currently sharply depreciating against the dollar having breached the Rs 70 per dollar mark by the end of 2018. As per a report dated 8 Jan 2019 by Livemint –Analysts say fundamentals will aid the rupee this year.

  “Attractive real yields (net of inflation), growth momentum and robust FX reserves of $394 billion and dollar stabilization are likely to be positive for the rupee, while lower global growth and trade will eventually impact the US economy and asset markets, causing the US Federal Reserve to slow the pace of rate hikes”, -Standard Chartered Bank. (Source: Livemint)

The dollar is expected to stabilize as interest rate differentials between the US and the rest of the world peak.

how the rupee fared last year-min

(Source: Bloomberg)

What are the different impacts?

Industry impact:

Rupee Appreciation means imports turn cheaper and exports become expensive. So, it means good news for companies who are dependent on imported inputs like Petro Products and Engineering Goods as their outflows would decline.

Rupee depreciation means exports earn more. Indian IT sector is dependent on US export revenues.  The contracts with US clients are usually quoted in dollars term. Hence their inflows would increase.

rupee appreciation and depreciation impact-min

Source: Moneyworks4me.com

Stock Market impact:

Foreign investors (FIIs) stand to benefit from a rupee appreciation. Subsequently increased FII inflows could fuel a bull run in the stock market.

To explain with an example: Suppose an FII Invests Rs. 1lakh in the Indian stock market and at an exchange rate of $1 = Rs. 50. So, the amount invested is (1,00,000/50) $2000. Suppose, after 1 year, hypothetical, even if the value of the investment doesn’t appreciate or depreciate, the foreign investor will be in a position to book a profit if the exchange rate has appreciated to $1 = Rs. 40

If the investor sells his investment at the prevailing currency conversion rate, he would get (1,00,000/40)  $ 2500. So, he would book profits of $ 500 due to the rupee appreciation.

Also read: How Does The Stock Market Affect The Economy?

Fuel Shock:

In the case of a Rupee depreciation, the biggest blow to the Indian economy would be the higher outflows due to fuel becoming expensive. India imports most of its fuel requirements from the OPEC countries. This increased fuel costs would result in food inflation as transportation costs become higher. In a developing country like India, this would have disastrous consequences on the vast population.

Summary

In this post, we studied the broad framework of how the exchange rate is decided by the currency market and the factors that influence the Rupee appreciation or depreciation. We also discussed the outlook as per analyst expectations and the impact of the exchange rate fluctuation on the real economy and the stock market.

Although the impact of rupee appreciation or depreciation on individuals and industry depends on which side of the fence they are. However, broadly speaking, rupee appreciation against US dollar is an indicator of a strong, robust Indian economy.

ULIP vs Mutual Fund -Which one should you opt for?

ULIP or Unit Linked Insurance Plan is a financial instrument which is a fusion of insurance and investment. Therefore, if you are a ULIP holder, you are going to enjoy the benefits of both insurance and investment at the same time.

Being a ULIP holder, you are required to pay a regular premium for the insurance part. A part of such premium paid by you would get invested in financial instruments (combination of debt and equity) as per your choice of weightage. It is solely your discretion what your investment is going to be consisted of. Your choice is should match with your risk appetite, liquidity requirement, and financial goal.

On the other hand, a Mutual Fund is purely an investment product. The AMC or Asset Management Company pools the money from the investors (also called unit holders) for investing in financial instruments like shares, derivatives, and bonds. Such investments are professionally managed by the AMC through its experienced and knowledgeable fund managers. (Read more about Mutual Funds here.)

After the re-introduction of long-term capital gain (LTCG) tax on equity and equity oriented Mutual Funds in the Union Budget of 2018, people in India have started to discuss whether ULIPs have become more rewarding than Mutual Funds. In fact, many experts have stated that ULIPs have become more profitable than equity oriented Mutual Funds after LTCG tax has come into effect. ULIPs are not subjected to any capital gains tax.

However, it has to be stated here that taxation is not the only parameter that you should consider for selecting an investment product. There are many other key factors which you should keep in mind before selecting any investment product.

ULIP vs Mutual Fund

Here are some parameters that you should consider before selecting one investment product between Mutual Fund and ULIP.

What is your purpose of investing?

Before getting started, you should clearly define your purpose for investing. Having no clarity in purpose or creating vague goals in mind would never help you meet your financial needs in the future.

Suppose, you have set a goal to accumulate Rs. 2 crores in 30 years, you should go for investing. If your objective is to have your life insured, you should think of going for a term insurance plan.

ULIP is not a financial product which can provide you with an adequate insurance cover. If you already have got an insurance policy in your name, then you can consider investing in ULIP additionallyULIP has an insurance element in it which Mutual Fund lacks.

In short, a ULIP plan is a combo of insurance and investment product at the same time. The premium that you pay on your ULIP plan, a part of the same is meant for providing you with an insurance cover. The rest of your payment is invested in a combo of debt and equity which is as per your discretion.

Further, it is a fact that a mutual fund does not offer any insurance component. But if you’ve planned properly, it is may not be a huge issue. You can start a mutual fund SIP and simultaneously take a term insurance plan alongside. It is going to help you artificially create a ULIP for yourself.

Who is more transparent between Mutual Fund and ULIP?

The disclosures of the underlying portfolio of a ULIP are not as transparent as that of a Mutual Fund because it is not mandatory for the ULIPs to disclose their NAVs on an everyday basis. In addition to that, the exact break-up of load on a ULIP plan is not available, unlike a Mutual Fund scheme.

Apart from the loading, expense ratio which in regard to a Mutual Fund plan is also mandatorily required to be stated clearly in the mutual fund fact sheet.

The Mutual Fund industry in India definitely comes in the list of the most regulated and transparent industries across the globe. From returns to underlying portfolios to sector allocation of investments, one can clearly find all the information in the online platform of an AMC and various other websites.

Furthermore, many analysts track Mutual Funds and publish their analysis time to time. It is not that ULIPs don’t disclose the information on analysis. But, they are not tracked by the analysts in a detailed manner like Mutual Funds.

Which is more tax efficient? ULIP or Mutual Fund?

tax ulip vs mutual fund

If you invest in a ULIP plan, the premium that you will pay is eligible for tax deduction u/s 80C of the Income Tax Act, 1961 up to Rs.1.50 lakhs.

However, you won’t be getting this benefit if you invest lump sum or SIP in any equity or debt fund. Only if you invest (whether lump sum or SIP) in an ELSS Mutual Fund (an equity fund), then you can avail the income tax benefit under the said section.

Again, the capital gain from redeeming your investment in ULIP is fully tax-free in your hands, irrespective of whether the investment is in the nature of equity or debt.

However, this is to be noted that you are required to pay 15.6% effective tax on short-term capital gains in case of Mutual Fund redemption. And also, 10.6% tax has been introduced on long-term capital gains with effect from April 1, 2018, from equity mutual funds, in case the aggregate gains cross Rs.1 lakh.

Taxation rate on short-term gains from the redemption of debt funds is per one’s income tax slab, while the long-term capital gains are subject to tax @20% (excluding Cess) after indexation. From the angle of taxability, ULIP definitely seems to be a better choice, provided it yields higher after-tax returns than Mutual Fund.

Note: If you want to learn more about taxation of ULIPs, you can read this article. For studying more on taxation of Mutual Funds, you check out this post.

ULIP vs Mutual fund Comparison on the basis of costs.

costs ulip vs mutual funds

If you decide to invest in a ULIP through online mode, you would save incurring significant expenses which are not only limited to administrative expenses and fund allocation charges. On the other hand, the expense ratios of Mutual Fund schemes are a little high, especially for the active funds. Furthermore, you can reduce the expense ratios if you invest in the direct plans.

Both these financial products have their own pros and cons. But, it can still be said that if you compare Direct Mutual Funds with ULIP, the former seems more cost effective.

Mutual Funds are more liquid than ULIP.

One of the most important parameters to look into any investment product is its liquidity.

An investment option should be preferred if you are able to liquidate your investments when you are in need of doing so. Mutual Funds are highly liquid in nature. You can redeem your units at any time and would get the proceeds straight into your bank account at most by 3days.

But, you can’t withdraw your investments from ULIPs unless the minimum lock-in period of 5 years gets over.

For mutual funds, it is only the tax saving ELSS funds where your investments get locked-in for 3 years. Rest other funds can be bought/sold/increased/decreased at any time. But, in case of ULIPs, the lock-in periods is an additional two years compared to even tax saving ELSS’s locking period.

Even after the lock-in period of ULIP ends, if you redeem your investments, it will around a week for your money to get credited in your bank account.

In terms of profitability, who is the winner?

In the case of ULIPS, a significant portion of your premium is actually spent towards costs, in the initial five years. The same gradually gets lower over time. So, even in an excellent bullish market, it will take you around half a decade to break even. Hence, if you look to earn returns which would beat the market in the long run, you require staying invested in ULIPs for at least one to decades.

However, the financial situation is not so complicated in the case of Mutual Funds. Many active mutual funds continuously beat the market and give superior returns to their shareholders since their origin. Furthermore, if you are investing in equity funds via the SIP route, you also be gaining the advantages of rupee cost averaging.

Note: To know more about profitability, check out this blog by Economic Times.

Flexibility – Do you know Mutual Funds offer more flexibility than ULIPs?

Investing in Mutual funds is of more flexibility than ULIPs. You can make a move from one scheme to another within the same fund house or another one. But, ULIPs allow you only to switch your investments from equity to debt or debt to equity but only within the same insurance house.

So, if the fund manager of your ULIP plan is underperforming or resigns from the company, it is going to be a matter of concern for you. You simply cannot move in such an adverse situation to a new insurance company without redeeming your existing investments before the end of its maturity period. A similar situation does not arise in the case of a Mutual Fund.

Summary

In this post, we have tried to highlight the features of Mutual Fund and ULIP. We have tried to draw a line by line comparison between these two investment products to help you understand how they both work in real.

Now, let us quickly summarize what we have discussed in this article.

  • ULIP neither gives an adequate life cover nor offers a great investment opportunity.
  • A Mutual Fund plus a Term Insurance Plan can comfortably compensate a ULIP.
  • Mutual Funds are more transparent than ULIPs and also provide more comprehensive disclosures.
  • ULIP is more tax efficient than Mutual Fund, given the former’s after-tax returns are higher.
  • Both Mutual Funds and ULIPS investing are associated with several charges.
  • Mutual Funds are more liquid, profitable and flexible than ULIPs.

From the above summary, it is clearly understood that the Mutual Fund seems to be a better financial product as compared to ULIP.

Generally speaking, the concept of combining insurance and mutual funds into one specific product is against the essence of financial planning. Financial planning means you will buy term policies for covering life risk followed by SIPs on equity funds to grow long-term wealth. ULIPs combine insurance and investment into one financial product thereby making ULIPs prone to mis-selling. This is because it is highly probable that many investors would fail to understand where insurance actually begins and where investing ends.

Anyways, ULIPs have always been more tax friendly as compared to Mutual Funds. On top of that, the introduction of income tax @ 10% on LTCG tax from equity investments, by the Union Budget 2018 has given ULIP more boosts. But, as discussed, you don’t choose an investment product on the basis of one parameter, do you? Mutual Funds do outweigh ULIPs on several grounds like profitability, transparency, flexibility, and liquidity.

ulip vs mutual funds summary

Anyways, if you are sloping towards ULIPs, let us first discuss when you should consider opting for ULIPs.

  • Do you want to have a life insurance cover which comes with an investment opportunity? Are you comfortable with moderate returns? If both of your answers are a yes, then ULIP is suitable for you.
  • Further, can opt for ULIPs if your risk appetite is low or on the medium side.
  • Apart from that, if you are looking for a tax saving financial instrument where liquidity is not of much importance to you, then also ULIP would not be an appropriate choice.

Now, let us discuss when you should give a thought to start Mutual Fund Investing.

  • In case you have a risk appetite of a medium or higher side, then Mutual Fund is going to suit you.
  • In case you are seeking a pure investment product with high returns, then Mutual Fund is the answer.
  • And finally, if you are okay with paying a little additional tax on capital gains, but you want your investment to be liquid (Except ELSS), then you can go for Mutual Funds.

That’s all. We hope this article of ours will add to your knowledge and enable you to take a more rational decision with respect to your investments in the future. Happy investing!

How do oil prices affect the stock market?

Crude oil is considered to be one of the most important commodities in the global economy. It is versatile in its uses and helps industrialize economies. A variety of things from plastics to rubber and machinery uses crude oil or its byproduct, making it a crucial element in the raw materials for many businesses in the economy.

Hence it is no surprise that the stock market is often influenced by the price of oil. It can affect an individual investor or have a domino effect on the stock market. Here are some of the ways oil prices affect the stock market:

How do oil prices affect the stock market?

– Profitability of oil companies

The oil business has two main components to it, the upstream and downstream business.

The upstream business is involved in the drilling of oil wells and the manufacture of crude oil in industries. Examples of such businesses include Oil India and Shell.  When these companies are profitable it usually results in high stock market prices because the crude oil manufactured by these companies is the raw material for many businesses.

If upstream companies find it hard to drill for oil and face an increase in research and development costs, it could have an adverse effect on the value of the oil company’s stock.

The second type of oil business is the downstream business. These are corporations involved in the distribution and retail function of crude oil. They are in control of your local gas stations such as Indian Oil and Bharat Petroleum. These companies find low crude oil prices beneficial as they can now purchase crude oil at a low price from upstream companies.

– Consumer Demand

Almost everything that a person consumes is tied to oil such as electricity or fuel for their cars.

An increase in the price of oil can raise the daily living costs for people, reducing the amount of money they have available to spend on other goods and services such as electronics or clothing. The revenue of these companies decreases as consumer demand for their goods and services falls. The negative effect on the earning of firms lowers the value of their stock.

Alternatively, a decrease in oil prices has the opposite effect. When consumers spend less on fuel, it gives them more money for other goods and services. The increase in demand raises earnings and has a positive impact on the stock market.

How do oil prices affect the stock market cover

– Profitability of other industries

Since all businesses use a byproduct of oil, an increase or decrease in the price of oil can indirectly affect them as well.

If the price of oil increases, a delivery services company will face higher fuel costs. These costs will be translated to consumers as high prices for their services. The low earnings of the company will result in low stock prices for the industry.

Likewise, if oil prices decrease, the companies can charge lower prices to consumers and have high profitability and higher share prices. In reality, however, companies rarely lower the prices of goods and services if the price of raw materials has decreased.

– Impact on Inflation

The price of oil can directly or indirectly increase or decrease costs of goods and services in the economy and can result in inflation. In the United States, the price of oil is not considered a factor when the inflationary rate is calculated but its price can cause a ripple effect in the economy through industries that use crude oil as a raw material.

If oil prices rise, it can increase the cost of living for individuals, putting a pressure on wage rates to make up for this. The high labor costs increase the costs of goods and services and increase the rate of inflation in the economy as each dollar can now buy fewer goods and services. When inflation rises the stock prices of the industry decline.

Also read:

– Effect on Imports

For countries such as India that import almost 80 percent of its crude oil, a decrease in the price of oil is beneficial because it decreases imports expenditure and stabilizes the exchange rate of the currency.

However, a reduction in oil prices isn’t always great for the stock market. There is a positive relationship between the Foreign Direct Investment and the price of oil. When the price of oil goes up, oil-rich countries invest in emerging oil markets like India. However, when prices go down, they withdraw their investments.

Hence with a fall in oil prices, few foreign investors will invest their money in the Indian stock markets resulting in a negative impact on stock prices.

Conclusion

The versatility of the crude oil has made it an influential factor in the increase and decrease of stock prices. The price of oil not only affects the stock of oil companies but also the stocks of industries that use it a byproduct of it.

While the exact amount of influence it has on stock prices cannot be calculated, the price of this commodity can increase or decrease the total costs of production of many goods and services. This can affect the amount of goods people consume to exchange rate and the level of foreign direct investment which collectively affect the stock prices in an economy.

Needless to say, the price of crude oil has the ability to affect the level of investment in the economy and influence stock prices.