With waning interest in the US and Europe, pension funds in Japan and Australia are eyeing investments in India, say industry sources. Japanese funds like Japan Government Pension Investment and Pension fund Association, with an overexposure in China, would want to invest in growth-oriented sectors of the Indian economy. A possibility, according to experts, is that these funds would register as FIIs in India, or take the asset management route to enter the country. The $935.5-billion Japan Government Pension Investment is the world’s largest pension fund. “In Japan, the interest rate on savings in nil,” says Seiji Ota, a partner with BMR Associates. “Therefore, there is no point in keeping money with banks there. So pension funds have become attractive,” he says. He is quick to add that Japanese pension funds are generally conservative, unlike the sovereign funds of the Middle East. “If the Japanese pension funds do come in, then it demonstrates the conviction these funds have in the Indian growth story
. Of course, they have been attracted to China, but maybe they have sensed that it’s a bubble that could burst,” Ota adds. Agrees Rohit Kapur, head-corporate finance, KPMG India, “These funds could be looking at the Indian market as an alternative. The returns that these funds could get in Japan are quite small.” Same is the case with superannuation funds from Australia, including Westscheme, Statewide Superannuation Trust, SAS Trustee and Public Officers Superannuation Fund. In Australia, every employee puts 10% earnings into superannuation funds. A lot of that now gets captured by banks like Macquarie, which is a huge investor in infrastructure in various parts of the world. Most investments by such funds used to be in safe havens of Europe or US. With mortgage funds running into trouble, investors would now want to look at other alternatives.
Thursday, July 31, 2008
carbon credits of India to be rated
A month after IDEAcarbon launched the world's first carbon credit rating service in London, the firm plans to rate carbon credits generated from India's clean development mechanism (CDM) projects. A rating system, said experts, would be useful to both buyers and sellers of carbon credits, considering that carbon assets not only face the risk of normal project delivery, financial and performance uncertainties, but are also subject to a high degree of regulatory and measurement risk. Said Amul Gogna, managing director, The Carbon Rating Agency: ''IDEAcarbon views the Indian market as one of the most important markets that will play a key role in shaping the carbon markets in future. In light of that, IDEAcarbon has introduced ratings to key players in the Indian market and plans to escalate this in near future.'' IDEAcarbon has, on its own, rated projects of JSW and Malavalli Power under the Carbon Rating Agency's 'Market Initiated Ratings Initiative'. IDEAcarbon, which is an independent provider of ratings, research and strategic advice on carbon finance, has recently been engaged by Multi Commodity Exchange of India (MCX) as its global strategic adviser on carbon markets.
Gogna said that IDEAcarbon's association with MCX will assist in bringing ratings to the Indian market. IDEAcarbon with the assistance of MCX, will create instruments that MCX will make available for trading on its platforms, and this will require rating of certified emission reductions (CERs) originated by Indian developers. Since the carbon market in India is generating interest among investors across the board, credit rating would become an essential tool in the investment process. A rating is an independent opinion on the likely performance of an emission reduction project based on the information provided to the rating agency. Market research has shown that buyers of carbon credits are particularly interested in an independent view on likely delivery risk — a rating. Carbon ratings are expected to facilitate a disciplined and systematic development of the market that will lead to channelling of funds to more effective green projects. India has generated over 31 million CERs from registered projects which contribute around 14% to the average annual global total.
Gogna said that IDEAcarbon's association with MCX will assist in bringing ratings to the Indian market. IDEAcarbon with the assistance of MCX, will create instruments that MCX will make available for trading on its platforms, and this will require rating of certified emission reductions (CERs) originated by Indian developers. Since the carbon market in India is generating interest among investors across the board, credit rating would become an essential tool in the investment process. A rating is an independent opinion on the likely performance of an emission reduction project based on the information provided to the rating agency. Market research has shown that buyers of carbon credits are particularly interested in an independent view on likely delivery risk — a rating. Carbon ratings are expected to facilitate a disciplined and systematic development of the market that will lead to channelling of funds to more effective green projects. India has generated over 31 million CERs from registered projects which contribute around 14% to the average annual global total.
Tuesday, July 29, 2008
How to calculate your inflation
Rising prices take a heavy toll on the finances of families. And, while the declared rate of inflation may sound nominal (7.4 per cent), the real impact is different on individuals. So, it is important to get an idea of how inflation has impacted you in reality.
Of course, sitting with pen and paper to do this exercise yourself may not give you an exact figure, but it will definitely help to pin down items that have increased drastically and are hurting your budget.
Regular Expenses
Start with a list of the regular monthly expenses. These would include vegetables, fruits, milk, food items and other items, which make the consumption part of the household budget.
Then, there are regular expenses such as, newspapers, electricity, telephone bills, daily conveyance and salaries of maids and drivers.
Also, for a family with small children, there will be additional expenses on stationery, books, toys and other material that have to be bought at regular intervals.
There are other expenditures on eating out and entertainment activities. All these numbers, taken together, represent your monthly expenses.
Once you have a fix on these numbers, keep on monitoring them every month, or at least, quarterly. Accordingly, you will get an idea of the expenses you should cut down, if required.
Annual expenses
Every year, there would be certain expenses that would be a part of your regular outflow. In many cases, people forget to include these items in their calculations, but it's important to remember that they constitute a very important part of budgeting.
For instance, the tuition fees paid to the school or college or private teachers might be paid once or twice a year. However, if the cost of education is rising constantly, it also becomes a part of your inflation.
This annual number will vary from family to family, depending on their standard of living. For instance, a student who is going for a management degree at the Indian Institute of Management-Ahmedabad (IIM-A) will find that his tuition fees has shot up by 300 per cent. Other expenses that may vary include books, school and uniform.
Then, there are various festivals, where there would be purchases such as clothes and gold. Yes, it is a bit difficult to budget for them completely, but depending on your previous year's experiences, you will be able to put some numbers to them.
A point to note is that you will need to break the yearly expenses to expenses per month. Only then you will arrive at the actual expenditure per month. Now with these two sets of numbers, you can start doing the calculations.
Actual calculation
Now that there is an expense list, you can create a made-for-you index. While the Wholesale Price Index (WPI) gives weights to all the different kinds of items to come to a consolidated figure, you need to simply track the month-wise rise in prices.
However, though it's the simplest way, there could be some anomaly in it because in some months there is a tendency that prices might shoot up for some time.
For instance, during the months of April and May, you might see the electricity bill shooting up because of an extra levy in force. This might give the impression that the charges have increased. But in June, when this figure falls, it balances out the sudden rise.
A better way would be to compare year-on-year, so that the seasonal imbalances are wiped out. The change in the expense, overall, will give the real rate of inflation that is impacting your household.
Of course, sitting with pen and paper to do this exercise yourself may not give you an exact figure, but it will definitely help to pin down items that have increased drastically and are hurting your budget.
Regular Expenses
Start with a list of the regular monthly expenses. These would include vegetables, fruits, milk, food items and other items, which make the consumption part of the household budget.
Then, there are regular expenses such as, newspapers, electricity, telephone bills, daily conveyance and salaries of maids and drivers.
Also, for a family with small children, there will be additional expenses on stationery, books, toys and other material that have to be bought at regular intervals.
There are other expenditures on eating out and entertainment activities. All these numbers, taken together, represent your monthly expenses.
Once you have a fix on these numbers, keep on monitoring them every month, or at least, quarterly. Accordingly, you will get an idea of the expenses you should cut down, if required.
Annual expenses
Every year, there would be certain expenses that would be a part of your regular outflow. In many cases, people forget to include these items in their calculations, but it's important to remember that they constitute a very important part of budgeting.
For instance, the tuition fees paid to the school or college or private teachers might be paid once or twice a year. However, if the cost of education is rising constantly, it also becomes a part of your inflation.
This annual number will vary from family to family, depending on their standard of living. For instance, a student who is going for a management degree at the Indian Institute of Management-Ahmedabad (IIM-A) will find that his tuition fees has shot up by 300 per cent. Other expenses that may vary include books, school and uniform.
Then, there are various festivals, where there would be purchases such as clothes and gold. Yes, it is a bit difficult to budget for them completely, but depending on your previous year's experiences, you will be able to put some numbers to them.
A point to note is that you will need to break the yearly expenses to expenses per month. Only then you will arrive at the actual expenditure per month. Now with these two sets of numbers, you can start doing the calculations.
Actual calculation
Now that there is an expense list, you can create a made-for-you index. While the Wholesale Price Index (WPI) gives weights to all the different kinds of items to come to a consolidated figure, you need to simply track the month-wise rise in prices.
However, though it's the simplest way, there could be some anomaly in it because in some months there is a tendency that prices might shoot up for some time.
For instance, during the months of April and May, you might see the electricity bill shooting up because of an extra levy in force. This might give the impression that the charges have increased. But in June, when this figure falls, it balances out the sudden rise.
A better way would be to compare year-on-year, so that the seasonal imbalances are wiped out. The change in the expense, overall, will give the real rate of inflation that is impacting your household.
Inflation - who's to blame?
The graph of inflation and that of the blood pressure of the United Progressive Alliance ministers have become highly positively correlated, what with national election not very far away.
Not surprisingly, we are witness to a flurry of frantic actions and threat of even more frantic (read fanatic actions) to show to the whole world (nay the electorates) that the fight against inflation is very much on.
And, whenever that fails, one can always fall back on the tried and tested formula of blaming the global phenomenon having engendered the local problem.
Not that this attribution is baseless. There is indeed no gainsaying the fact that inflation has indeed taken a global hue with food and oil prices running amok all over the world. And, the rise in food and oil prices is more a reflection of runaway commodity prices.
Inflation, the silent killer
The fast growing developing economies, especially China and India, have been industrialising rapidly on the back of still energy intensive technologies while growing incomes of a greater part of the population is stimulating food demand. However, it does seem that price increases are not merely because of demand supply mismatch.
The fact that commodity prices are still rising despite perceived threat of global growth slowdown including that of Indian and China makes one believe that speculative activity is at play, especially in a commodity like oil which has seen substantial built-up in speculative demand.
This is not surprising. With a slowdown in equity markets, there seems to have been a shift in asset class in favour of commodities, leading to some speculative influence.
Question, however, is should global phenomenon be treated as a villain in the piece especially given the fact that galloping food prices is a nightmare for any government facing inflation?
I would say no. And, the sorry state of the Indian agricultural sector explains why.
The following graph probably explains it all.
Source: Handbook of statistics, RBI
Just look at the red line. This represents the share of agriculture in India's GDP and this has been on a secular downtrend. Falling share of agriculture is not necessarily bad as an economy progresses. However, for a sector that supports nearly 70 per cent of a country's population, a mere share of 18.46 per cent of GDP (at factor cost, at current prices) is disastrous.
The latest economic survey rightly talked about the lopsidedness of our economic growth. The manufacturing and the service sectors are doing relatively very well while the agricultural sector is lagging. Indeed, this lopsidedness is taking a toll on food price inflation in India.
Agricultural productivity for example, is quite deplorable. If we compare the productivity of Indian agriculture to that of the productivity in other countries, we will find that our's is way behind the leading nations. Take for instance China. With only 100 million hectare of agricultural land, China is producing 400 million tonnes of grain while India with its 146 million hectares of agricultural land produces on an average only 108 million tonnes of food.
If we take the production per hectare of individual crops too we will find that the country is way behind other countries. The average production of rice per hectare in India is around 1,756 kgs compared to 5,475 kgs of North Korea; we are harvesting only 2117 kgs of wheat per hectare compared to 7,716 kgs by the Netherlands. Similarly, India produces only 1606 kgs of corn per hectare compared to 9091 kgs of corn per hectare by Greece.
Inflation, the silent killer
It is the same story when it comes to soyabean and groundnut. The production of soyabean per hectare in India is 804 kgs compared to 3,453 kgs in Zimbabwe. As for groundnut, the country harvests only 929 kgs per hectare compared to 4,600 kgs per hectare harvested by Israel. In other words, Israel is getting five times the groundnut per hectare as against India. Similarly, India produces 15,817 kgs of potatoes per hectare compared to 45,349 kgs produced by Belgium. As for sugarcane we produce 65,382 kgs per hectare as against 135,448 kgs per hectare produced by Peru. [1]
With such low levels of productivity, foodgrain production is slowing at a pretty alarming pace. According to the latest economic survey, the rate of growth of foodgrain production has decelerated to 1.2 per cent during 1990-2007, which was lower than the annual growth of population at 1.9 per cent. This has resulted in a decline of per capita availability of foodgrain. The per capita consumption of cereals has fallen to 412 grams per day, indicating a decline of 13 per cent, while pulses consumption declined to 42 grams per day, a 33 per cent fall.
If that is not enough, more than 10 per cent of our foodgrain production gets wasted every year. As per the report of the 11th Planning Commission[2], preventable post-harvest losses of foodgrains are estimated at about 20 million tonnes a year, which is nearly 10.5 percent of the total production.
To put things in perspective, India wastes more than 50 per cent of Australia's annual foodgrain production (considering the latest available foodgrain production data provided by Food and Agricultural Organisation) every year due to improper storage and transportation facility. Can anything be more eye popping?
Infact, about 30 per cent of farm produce is stored under open condition, leading to wastage and distress sales. As per the Planning Commission estimate, if the domestic consumption level shoots up from current 100 gms of fruits and 200 gms of vegetables per capita per day to the recommended dietary level of 140 gms and 270 gms respectively by 2010, the domestic market for fresh fruits and vegetables could be as large as Rs 50,000 billion at present price structure.
This clearly requires substantial investment to build up commensurate supply chain infrastructure in terms of handling, storage, and transportation. Instead, we fritter away our precious resource in the name of populism. The latest Budget provision is a case in point, where we are allowing for Rs. 600 billion worth of farm loan waver, despite concerning level of deficit (refer to my article: The real dangers facing Indian economy). Who really cares for the rural infrastructural deficit? And many experts are now talking about food crisis being round the corner.
While these are supply side factors that result in elevated food price inflation, issues like marketing that encourages layers and layers of middlemen exacerbates the problem. Direct marketing encourages farmers to undertake marketing of farm produce at the farm gate and obviates the necessity to haul produce to regulated markets for sale.
Inflation, the silent killer
Direct marketing enables farmers and processors and other bulk buyers to economize on transportation costs and to considerably improve price realization. In South Korea, for instance, as a consequence of expansion of direct marketing of agricultural products, consumer prices declined by 20 to 30 per cent while the producers received 10 to 20 percent higher prices.
Direct marketing results in curtailing of middlemen and not only becomes more remunerative for farmers but also ensures that the economy benefits through lower prices. However, in the present marketing system, it is estimated that only 10 percent of the total produce is marketed through the above channel and the remaining is sold through other marketing channels. Marketing through other channels involve considerable amount of marketing cost.
Studies indicate (Acharya, 2003) that 77 percent of the marketing cost amounting to Rs 50,000 crore (Rs 500 billion) is estimated as avoidable loss. Even our policy of not allowing FDI in retail trade ensures that the middlemen thrive at the cost of the consumers.
Big retail companies could have brought in much more efficiency in the system through their superior supply chain management and, concomitantly, could have reduced the end price. Ironically, alarming food price inflation is only fostering a class of profiteering middlemen (aided in a great measure by our politician turned policy makers) but the actual producers (viz the farmers) barely see any improvement of their lot.
What is more galling is that these are not new problems. Yet, year after year, government after government, precious little gets done to reverse this trend. Agriculture continues to be a neglected sector and the devised policies hardly gets translated into meaningful actions.
A potential crisis is, therefore, always round the corner. And, as inflation reared its ugly head, the government gets into fire fighting mode like encouraging imports, banning exports etc. These, however, are proving to be less than successful attempts since the basic structural problems remain unaddressed.
Some politicians, with their half baked knowledge are even clamouring for a ban on future trading in agricultural commodities. Fact remains though, our previous such attempts have been futile. We banned futures trading in wheat, urad, tur and rice last year.
Prices of tur went up during the entire year due to a shortfall in production. Wheat prices are also rising, and now even rice prices have also gone up sharply. Also, prices of fruits, vegetables, milk, coarse cereals, pulses like urad, tur and masoor, which are not traded on the exchanges have registered very high increases. In almost all the cases it's a case of lower supply.
The other weapon at the hand of the government to flight inflation is to use monetary policy that aims to curtail demand through higher interest rates and lower liquidity. However, when the problem is not because of elevated level of demand but because of lower level of supply, monetary policy can hope to achieve precious little.
Time indeed it is to wake up and face the reality.
Not surprisingly, we are witness to a flurry of frantic actions and threat of even more frantic (read fanatic actions) to show to the whole world (nay the electorates) that the fight against inflation is very much on.
And, whenever that fails, one can always fall back on the tried and tested formula of blaming the global phenomenon having engendered the local problem.
Not that this attribution is baseless. There is indeed no gainsaying the fact that inflation has indeed taken a global hue with food and oil prices running amok all over the world. And, the rise in food and oil prices is more a reflection of runaway commodity prices.
Inflation, the silent killer
The fast growing developing economies, especially China and India, have been industrialising rapidly on the back of still energy intensive technologies while growing incomes of a greater part of the population is stimulating food demand. However, it does seem that price increases are not merely because of demand supply mismatch.
The fact that commodity prices are still rising despite perceived threat of global growth slowdown including that of Indian and China makes one believe that speculative activity is at play, especially in a commodity like oil which has seen substantial built-up in speculative demand.
This is not surprising. With a slowdown in equity markets, there seems to have been a shift in asset class in favour of commodities, leading to some speculative influence.
Question, however, is should global phenomenon be treated as a villain in the piece especially given the fact that galloping food prices is a nightmare for any government facing inflation?
I would say no. And, the sorry state of the Indian agricultural sector explains why.
The following graph probably explains it all.
Source: Handbook of statistics, RBI
Just look at the red line. This represents the share of agriculture in India's GDP and this has been on a secular downtrend. Falling share of agriculture is not necessarily bad as an economy progresses. However, for a sector that supports nearly 70 per cent of a country's population, a mere share of 18.46 per cent of GDP (at factor cost, at current prices) is disastrous.
The latest economic survey rightly talked about the lopsidedness of our economic growth. The manufacturing and the service sectors are doing relatively very well while the agricultural sector is lagging. Indeed, this lopsidedness is taking a toll on food price inflation in India.
Agricultural productivity for example, is quite deplorable. If we compare the productivity of Indian agriculture to that of the productivity in other countries, we will find that our's is way behind the leading nations. Take for instance China. With only 100 million hectare of agricultural land, China is producing 400 million tonnes of grain while India with its 146 million hectares of agricultural land produces on an average only 108 million tonnes of food.
If we take the production per hectare of individual crops too we will find that the country is way behind other countries. The average production of rice per hectare in India is around 1,756 kgs compared to 5,475 kgs of North Korea; we are harvesting only 2117 kgs of wheat per hectare compared to 7,716 kgs by the Netherlands. Similarly, India produces only 1606 kgs of corn per hectare compared to 9091 kgs of corn per hectare by Greece.
Inflation, the silent killer
It is the same story when it comes to soyabean and groundnut. The production of soyabean per hectare in India is 804 kgs compared to 3,453 kgs in Zimbabwe. As for groundnut, the country harvests only 929 kgs per hectare compared to 4,600 kgs per hectare harvested by Israel. In other words, Israel is getting five times the groundnut per hectare as against India. Similarly, India produces 15,817 kgs of potatoes per hectare compared to 45,349 kgs produced by Belgium. As for sugarcane we produce 65,382 kgs per hectare as against 135,448 kgs per hectare produced by Peru. [1]
With such low levels of productivity, foodgrain production is slowing at a pretty alarming pace. According to the latest economic survey, the rate of growth of foodgrain production has decelerated to 1.2 per cent during 1990-2007, which was lower than the annual growth of population at 1.9 per cent. This has resulted in a decline of per capita availability of foodgrain. The per capita consumption of cereals has fallen to 412 grams per day, indicating a decline of 13 per cent, while pulses consumption declined to 42 grams per day, a 33 per cent fall.
If that is not enough, more than 10 per cent of our foodgrain production gets wasted every year. As per the report of the 11th Planning Commission[2], preventable post-harvest losses of foodgrains are estimated at about 20 million tonnes a year, which is nearly 10.5 percent of the total production.
To put things in perspective, India wastes more than 50 per cent of Australia's annual foodgrain production (considering the latest available foodgrain production data provided by Food and Agricultural Organisation) every year due to improper storage and transportation facility. Can anything be more eye popping?
Infact, about 30 per cent of farm produce is stored under open condition, leading to wastage and distress sales. As per the Planning Commission estimate, if the domestic consumption level shoots up from current 100 gms of fruits and 200 gms of vegetables per capita per day to the recommended dietary level of 140 gms and 270 gms respectively by 2010, the domestic market for fresh fruits and vegetables could be as large as Rs 50,000 billion at present price structure.
This clearly requires substantial investment to build up commensurate supply chain infrastructure in terms of handling, storage, and transportation. Instead, we fritter away our precious resource in the name of populism. The latest Budget provision is a case in point, where we are allowing for Rs. 600 billion worth of farm loan waver, despite concerning level of deficit (refer to my article: The real dangers facing Indian economy). Who really cares for the rural infrastructural deficit? And many experts are now talking about food crisis being round the corner.
While these are supply side factors that result in elevated food price inflation, issues like marketing that encourages layers and layers of middlemen exacerbates the problem. Direct marketing encourages farmers to undertake marketing of farm produce at the farm gate and obviates the necessity to haul produce to regulated markets for sale.
Inflation, the silent killer
Direct marketing enables farmers and processors and other bulk buyers to economize on transportation costs and to considerably improve price realization. In South Korea, for instance, as a consequence of expansion of direct marketing of agricultural products, consumer prices declined by 20 to 30 per cent while the producers received 10 to 20 percent higher prices.
Direct marketing results in curtailing of middlemen and not only becomes more remunerative for farmers but also ensures that the economy benefits through lower prices. However, in the present marketing system, it is estimated that only 10 percent of the total produce is marketed through the above channel and the remaining is sold through other marketing channels. Marketing through other channels involve considerable amount of marketing cost.
Studies indicate (Acharya, 2003) that 77 percent of the marketing cost amounting to Rs 50,000 crore (Rs 500 billion) is estimated as avoidable loss. Even our policy of not allowing FDI in retail trade ensures that the middlemen thrive at the cost of the consumers.
Big retail companies could have brought in much more efficiency in the system through their superior supply chain management and, concomitantly, could have reduced the end price. Ironically, alarming food price inflation is only fostering a class of profiteering middlemen (aided in a great measure by our politician turned policy makers) but the actual producers (viz the farmers) barely see any improvement of their lot.
What is more galling is that these are not new problems. Yet, year after year, government after government, precious little gets done to reverse this trend. Agriculture continues to be a neglected sector and the devised policies hardly gets translated into meaningful actions.
A potential crisis is, therefore, always round the corner. And, as inflation reared its ugly head, the government gets into fire fighting mode like encouraging imports, banning exports etc. These, however, are proving to be less than successful attempts since the basic structural problems remain unaddressed.
Some politicians, with their half baked knowledge are even clamouring for a ban on future trading in agricultural commodities. Fact remains though, our previous such attempts have been futile. We banned futures trading in wheat, urad, tur and rice last year.
Prices of tur went up during the entire year due to a shortfall in production. Wheat prices are also rising, and now even rice prices have also gone up sharply. Also, prices of fruits, vegetables, milk, coarse cereals, pulses like urad, tur and masoor, which are not traded on the exchanges have registered very high increases. In almost all the cases it's a case of lower supply.
The other weapon at the hand of the government to flight inflation is to use monetary policy that aims to curtail demand through higher interest rates and lower liquidity. However, when the problem is not because of elevated level of demand but because of lower level of supply, monetary policy can hope to achieve precious little.
Time indeed it is to wake up and face the reality.
Kunal Kumar Kundu is the Head of Economic Research at Infosys [Get Quote] BPO. The views expressed are his own
[1] Strengthen Agricultural Sector, Where is the surplus foodgrain? By Dr. Vinod Mehta[2] Report of the working group on Agricultural marketing infrastructure and Policy required for internal and external trade for the XI Five Year Plan 2007-12
Thursday, July 17, 2008
How best to tackle inflation
The inflation fire is now an inferno. It singed wallets on its way from 4.7 per cent in July 2007 to 8.86 per cent in May 2008. It did not stop there, but shot up to a 13-year high of 11.42 per cent for the week ended 14 June. Much of this recent rise is being attributed to the pervasive impact of the increase in the state-administered prices of oil products on 5 June. That looked inevitable after international oil prices rose to an all-time high, up to $140 a barrel last fortnight. Worse, this inflation is not expected to go south anytime soon. Says Shuchita Mehta, senior economist, Standard Chartered Bank: "We expect inflation to remain high for some time and to average 8.72 per cent this fiscal year."
Why high inflation is here to stay
Oil aftershock. With little chance of increasing global supplies, higher extraction costs, production cuts and export taxes in some oil producing countries, and speculative investments in oil by large international investors has buttressed price pressures due to continuing high demand for oil.
Rising food prices.
A worldwide shortage is driving up food prices. In India, oil seed prices are 20 per cent higher than a year ago. While food supplies are expected to increase over 6-8 months, higher costs of inputs (diesel, fertilisers, and seeds, among others) would likely continue to keep prices high.
High commodity prices.
High prices of commodities such as iron and steel and edibles have been responsible for about a fifth of the spike in price rise. With stockmarkets worldwide falling, large international institutional investors are buying commodities, further pushing up their prices and inflation, a trend unlikely to change soon.
Expensive funds.
On 24 June, the Reserve Bank of India [Get Quote] hiked the cash-reserve ratio and the repo rate (rate at which it lends to banks) by 50 basis points each to reduce liquidity and weaken inflationary pressures. This has raised banks' cost of funds and, thus, making cost of production higher. With limited policy options, it could do so again.
Weaker rupee.
With a rapid price rise you need more rupees for the same amount of imports, making imported products or those with high import content such as edible oils, costlier. Expect more of the same.
Money shock
The immediate impact of high inflation will be pressure on household budgets, and lower savings, both for now and the future. Higher interest rates are pushing up EMIs. Inflation-adjusted returns from fixed income options, be it fixed deposits or pensions, have gone negative.
Five-year term deposits paying 8.5 per cent when inflation is 11.5 per cent are giving real returns of -2.69 per cent. So, the value of what you get back is lower than what you put in. The future's not rosy either. Higher costs due to high inflation is likely to dent corporate profitability, putting downward pressure on stock prices.
Some sectors, such as aviation, could see layoffs, while fewer people will be hired by IT, BPO, and banking and financial services companies. A recent services employment report for April-June 2008 by staffing company TeamLease said ITeS lost the most (-24 points) on its index of increasing employment.
Your action plan
As always, to tackle the situation, you will have to keep existing outflows down, skip new large expenses, bump up your savings, and invest in higher return options at, perhaps, marginally higher risk.
Enhance emergency funds, life and health covers.
The 3-6 months' worth of expenses that you keep aside in liquid assets such as fixed deposits for emergencies will need to be increased. Life and health covers may need to be augmented. Bridge the gap with low-cost term plans and family floaters.
Avoid large savings account balances.
Drain your bank account into short-term debt funds such as fixed maturity plans. Sanjay Prakash, CEO, HSBC Asset Management, says: "At 9-10 per cent returns, the real rate of return for FMPs may be negative in the short term. But, we expect inflation to lower by the last quarter of 2008 after which returns will turn positive."
Prepay your home loan.
As home finance rates are set to climb higher, prepay your floating rate loans. No investment option will currently give assured returns to match the higher interest outgo.
Opt for capital gains and dividend instead of interest
. Interest income is taxed at your income tax rate while capital gains taxes are lower or zero. Also, short-term capital gains are taxed at higher rates than long-term gains, which can even be zero. Dividends in your hands, whether from stocks, equity or debt mutual funds, is tax free.
Continue with equity investments.
"The only way to beat inflation is to keep investing in equity," says Rajen Shah, chief investment officer, Angel Broking. Carry on with your existing systematic investment plans in equity funds. For fresh investments, seek larger cap funds from OLM 50 - they are likely to rebound first, along with the blue-chips they primarily invest in.
If you want to pick up stocks, invest in stages and go for value buys. History is on your side. If you had invested in the Sensex after the markets recovered from the tech bust in 2004, you would be sitting on gains of about 150 per cent even now. Avoid interest rate-sensitive stocks such as real estate and auto. Go for large-cap pharma and FMCG stocks, which are more stable.
Diversify in international funds and gold.
Over the last six months, while the Indian market was falling by over 30 per cent, international funds fell by a little over 13 per cent. As before, we will yet again recommend that you invest 5-10 per cent of your portfolio in gold exchange-traded funds and gold mutual funds as periods of high inflation witness a surge in gold prices.
This will shore up the minimum long-term growth of your overall investments.
High inflation has terrible repercussions on the future of our money. Luckily, we have enough weapons in our arsenal to fight and win the war against it. Time's come to pull out all stops.
Prices on fire
Why inflation rose to a record high...
Rising oil prices. At an all-time high of $140 per barrel, oil prices have more than doubled from $64 a barrel in April 2007, fuelling inflation.
Rising food prices. A global shortage of foodgrains, such as wheat and rice, has made the food prices index shoot up by about 10 per cent, pushing up inflation.
High commodity prices. High prices of commodities such as steel and cement due to their less-than-adequate supply has made industrial production, housing, roads, airports and other crucial infrastructure more expensive.
High cost of funds. To combat inflation, the central bank is sucking out excess money from the economy by increasing cash-reserve ratio and increasing repo rates so that less money chases the limited supply of goods and services. This, however, is also driving up the cost of existing funds, that is interest rates, adding to inflation.
Rupee's eroding purchasing power. Rising prices are eroding the value of what the rupee can buy vis-a-vis other currencies such as the dollar. The rupee's fall of around 8 per cent in the last six months has made major imports like petroleum and edible oil costlier, fuelling inflation.
...and why it will continue to remain high
New era of high oil prices. With little prospect of increase in international oil supplies, production declines in some oil producing countries, increasing oil production costs, taxes on oil exports by producing countries and speculative investments in oil by large international investors, besides continuing high oil demand, oil prices are expected to remain high.
No respite from high food prices. While the situation of shortfall in supply is likely to improve in the next 6-8 months, higher input costs in the form of costlier diesel, seeds, fertilisers and the like will neutralise the impact of enhanced food supply.
Uninterrupted rise of commodity prices. As most stockmarkets across the world test lower levels, investments by institutional investors pouring into commodities is expected to keep commodity prices high. Also, with no sign of demand for commodities from high-growth countries like China tapering off, no relief seems to be in sight.
High interest rates to continue. As long as high prices remain, with limited fiscal policy options, the Reserve Bank of India will either make attempts to suck out money or ensure status quo. This will mean continuing high interest rates and inflation.
continued pressure on the rupee. Various domestic and international macroeconomic factors are expected to keep up the pressure on the rupee, which will make imports more expensive.
How high inflation will affect you
Higher Budgets. Get ready to pay more for vegetables, groceries, especially soaps, detergents, packaged food, personal and public transport, as well as for services such as couriers.
Costlier loans. You can expect costlier loans, especially car and personal loans. New home loan rates are likely to go up even as the tenure or EMIs of existing home loan rates go up.
More expensive recreation. Higher airfares along with lower purchasing power will make international travel more expensive even as domestic leisure becomes costlier.
Dent on returns. Fixed income options such as bank fixed deposits and monthly income options will give negative returns after adjusting for inflation, impacting senior citizens, single parents and risk-averse investors such as those with many dependents. Impact on corporate profitability via higher costs will bring down stock prices.
Higher taxes. To raise more money to cushion vulnerable parts of the population the government might impose higher taxes, cesses and surcharges on goods and services.
Lower infrastructure growth. Upcoming road, airport, power and port projects will witness cost escalations and might see slow downs.
Some layoffs and lower pay hikes. Hard hit sectors such as aviation could see some layoffs while most sectors are likely to witness lower pay hikes. This may be especially true in the IT and the BPO sectors.
More austere workplace. Expect fewer office parties and conferences, reduction in amenities, office travel and allowances as employers try to cut corners to save costs.
How you can fight back
Review your emergency fund requirement. Keep six months' expenses as emergency funds, mostly in short-term debt funds such as inflation- and tax-efficient FMPs.
Examine your health and life cover.
With costs going up, you need to bump up your life and health covers. Go for low-cost, high-cover term plans and floating health covers to bridge the gap. avoid large idle savings and bank balances. Invest in short-term debt funds like FMPs.
Defer large loan-based purchases.
Avoid large EMIs that will stretch your finances more. Go for your first home if you can afford the down payment and EMI.
Prepay high-cost loans.
Start with your floating rate home loan. Remember, no investment option will provide guaranteed returns that equal the higher interest payout.
Seek capital gains and dividend instead of interest.
Interest income gets taxed at your income tax rate. Long-term capital gains and dividends from equity and equity MFs are tax-free, but taxed at 10 per cent without indexation and 20 per cent with indexation if coming from debt funds. Dividends from debt funds are tax-free post dividend distribution tax.
Continue staggered investments in equity and equity MFs.
Carry on with your systematic investment plans (SIPs) in equity funds. For fresh investments, seek large-cap funds from OLM 50 that are likely to benefit from a rebound along with blue chips they predominantly invest in.
Diversify into international funds and gold.
Gain from the upsides in well-performing equity markets in other countries by investing in international funds. Investing in gold (up to 5-10 per cent of your corpus) will give your portfolio a stable growth.
Avoid interest rate-sensitive stocks.
This includes sectors such as real estate and auto. The best bets would be large-cap pharma and FMCG stocks currently available at attractive valuations.
Invest windfalls.
Why high inflation is here to stay
Oil aftershock. With little chance of increasing global supplies, higher extraction costs, production cuts and export taxes in some oil producing countries, and speculative investments in oil by large international investors has buttressed price pressures due to continuing high demand for oil.
Rising food prices.
A worldwide shortage is driving up food prices. In India, oil seed prices are 20 per cent higher than a year ago. While food supplies are expected to increase over 6-8 months, higher costs of inputs (diesel, fertilisers, and seeds, among others) would likely continue to keep prices high.
High commodity prices.
High prices of commodities such as iron and steel and edibles have been responsible for about a fifth of the spike in price rise. With stockmarkets worldwide falling, large international institutional investors are buying commodities, further pushing up their prices and inflation, a trend unlikely to change soon.
Expensive funds.
On 24 June, the Reserve Bank of India [Get Quote] hiked the cash-reserve ratio and the repo rate (rate at which it lends to banks) by 50 basis points each to reduce liquidity and weaken inflationary pressures. This has raised banks' cost of funds and, thus, making cost of production higher. With limited policy options, it could do so again.
Weaker rupee.
With a rapid price rise you need more rupees for the same amount of imports, making imported products or those with high import content such as edible oils, costlier. Expect more of the same.
Money shock
The immediate impact of high inflation will be pressure on household budgets, and lower savings, both for now and the future. Higher interest rates are pushing up EMIs. Inflation-adjusted returns from fixed income options, be it fixed deposits or pensions, have gone negative.
Five-year term deposits paying 8.5 per cent when inflation is 11.5 per cent are giving real returns of -2.69 per cent. So, the value of what you get back is lower than what you put in. The future's not rosy either. Higher costs due to high inflation is likely to dent corporate profitability, putting downward pressure on stock prices.
Some sectors, such as aviation, could see layoffs, while fewer people will be hired by IT, BPO, and banking and financial services companies. A recent services employment report for April-June 2008 by staffing company TeamLease said ITeS lost the most (-24 points) on its index of increasing employment.
Your action plan
As always, to tackle the situation, you will have to keep existing outflows down, skip new large expenses, bump up your savings, and invest in higher return options at, perhaps, marginally higher risk.
Enhance emergency funds, life and health covers.
The 3-6 months' worth of expenses that you keep aside in liquid assets such as fixed deposits for emergencies will need to be increased. Life and health covers may need to be augmented. Bridge the gap with low-cost term plans and family floaters.
Avoid large savings account balances.
Drain your bank account into short-term debt funds such as fixed maturity plans. Sanjay Prakash, CEO, HSBC Asset Management, says: "At 9-10 per cent returns, the real rate of return for FMPs may be negative in the short term. But, we expect inflation to lower by the last quarter of 2008 after which returns will turn positive."
Prepay your home loan.
As home finance rates are set to climb higher, prepay your floating rate loans. No investment option will currently give assured returns to match the higher interest outgo.
Opt for capital gains and dividend instead of interest
. Interest income is taxed at your income tax rate while capital gains taxes are lower or zero. Also, short-term capital gains are taxed at higher rates than long-term gains, which can even be zero. Dividends in your hands, whether from stocks, equity or debt mutual funds, is tax free.
Continue with equity investments.
"The only way to beat inflation is to keep investing in equity," says Rajen Shah, chief investment officer, Angel Broking. Carry on with your existing systematic investment plans in equity funds. For fresh investments, seek larger cap funds from OLM 50 - they are likely to rebound first, along with the blue-chips they primarily invest in.
If you want to pick up stocks, invest in stages and go for value buys. History is on your side. If you had invested in the Sensex after the markets recovered from the tech bust in 2004, you would be sitting on gains of about 150 per cent even now. Avoid interest rate-sensitive stocks such as real estate and auto. Go for large-cap pharma and FMCG stocks, which are more stable.
Diversify in international funds and gold.
Over the last six months, while the Indian market was falling by over 30 per cent, international funds fell by a little over 13 per cent. As before, we will yet again recommend that you invest 5-10 per cent of your portfolio in gold exchange-traded funds and gold mutual funds as periods of high inflation witness a surge in gold prices.
This will shore up the minimum long-term growth of your overall investments.
High inflation has terrible repercussions on the future of our money. Luckily, we have enough weapons in our arsenal to fight and win the war against it. Time's come to pull out all stops.
Prices on fire
Why inflation rose to a record high...
Rising oil prices. At an all-time high of $140 per barrel, oil prices have more than doubled from $64 a barrel in April 2007, fuelling inflation.
Rising food prices. A global shortage of foodgrains, such as wheat and rice, has made the food prices index shoot up by about 10 per cent, pushing up inflation.
High commodity prices. High prices of commodities such as steel and cement due to their less-than-adequate supply has made industrial production, housing, roads, airports and other crucial infrastructure more expensive.
High cost of funds. To combat inflation, the central bank is sucking out excess money from the economy by increasing cash-reserve ratio and increasing repo rates so that less money chases the limited supply of goods and services. This, however, is also driving up the cost of existing funds, that is interest rates, adding to inflation.
Rupee's eroding purchasing power. Rising prices are eroding the value of what the rupee can buy vis-a-vis other currencies such as the dollar. The rupee's fall of around 8 per cent in the last six months has made major imports like petroleum and edible oil costlier, fuelling inflation.
...and why it will continue to remain high
New era of high oil prices. With little prospect of increase in international oil supplies, production declines in some oil producing countries, increasing oil production costs, taxes on oil exports by producing countries and speculative investments in oil by large international investors, besides continuing high oil demand, oil prices are expected to remain high.
No respite from high food prices. While the situation of shortfall in supply is likely to improve in the next 6-8 months, higher input costs in the form of costlier diesel, seeds, fertilisers and the like will neutralise the impact of enhanced food supply.
Uninterrupted rise of commodity prices. As most stockmarkets across the world test lower levels, investments by institutional investors pouring into commodities is expected to keep commodity prices high. Also, with no sign of demand for commodities from high-growth countries like China tapering off, no relief seems to be in sight.
High interest rates to continue. As long as high prices remain, with limited fiscal policy options, the Reserve Bank of India will either make attempts to suck out money or ensure status quo. This will mean continuing high interest rates and inflation.
continued pressure on the rupee. Various domestic and international macroeconomic factors are expected to keep up the pressure on the rupee, which will make imports more expensive.
How high inflation will affect you
Higher Budgets. Get ready to pay more for vegetables, groceries, especially soaps, detergents, packaged food, personal and public transport, as well as for services such as couriers.
Costlier loans. You can expect costlier loans, especially car and personal loans. New home loan rates are likely to go up even as the tenure or EMIs of existing home loan rates go up.
More expensive recreation. Higher airfares along with lower purchasing power will make international travel more expensive even as domestic leisure becomes costlier.
Dent on returns. Fixed income options such as bank fixed deposits and monthly income options will give negative returns after adjusting for inflation, impacting senior citizens, single parents and risk-averse investors such as those with many dependents. Impact on corporate profitability via higher costs will bring down stock prices.
Higher taxes. To raise more money to cushion vulnerable parts of the population the government might impose higher taxes, cesses and surcharges on goods and services.
Lower infrastructure growth. Upcoming road, airport, power and port projects will witness cost escalations and might see slow downs.
Some layoffs and lower pay hikes. Hard hit sectors such as aviation could see some layoffs while most sectors are likely to witness lower pay hikes. This may be especially true in the IT and the BPO sectors.
More austere workplace. Expect fewer office parties and conferences, reduction in amenities, office travel and allowances as employers try to cut corners to save costs.
How you can fight back
Review your emergency fund requirement. Keep six months' expenses as emergency funds, mostly in short-term debt funds such as inflation- and tax-efficient FMPs.
Examine your health and life cover.
With costs going up, you need to bump up your life and health covers. Go for low-cost, high-cover term plans and floating health covers to bridge the gap. avoid large idle savings and bank balances. Invest in short-term debt funds like FMPs.
Defer large loan-based purchases.
Avoid large EMIs that will stretch your finances more. Go for your first home if you can afford the down payment and EMI.
Prepay high-cost loans.
Start with your floating rate home loan. Remember, no investment option will provide guaranteed returns that equal the higher interest payout.
Seek capital gains and dividend instead of interest.
Interest income gets taxed at your income tax rate. Long-term capital gains and dividends from equity and equity MFs are tax-free, but taxed at 10 per cent without indexation and 20 per cent with indexation if coming from debt funds. Dividends from debt funds are tax-free post dividend distribution tax.
Continue staggered investments in equity and equity MFs.
Carry on with your systematic investment plans (SIPs) in equity funds. For fresh investments, seek large-cap funds from OLM 50 that are likely to benefit from a rebound along with blue chips they predominantly invest in.
Diversify into international funds and gold.
Gain from the upsides in well-performing equity markets in other countries by investing in international funds. Investing in gold (up to 5-10 per cent of your corpus) will give your portfolio a stable growth.
Avoid interest rate-sensitive stocks.
This includes sectors such as real estate and auto. The best bets would be large-cap pharma and FMCG stocks currently available at attractive valuations.
Invest windfalls.
Wednesday, July 16, 2008
10 great investing rules to become RICH
An old saying goes, "You can't build wealth by buying things you don't need, with money you don't have, to impress people you don't like." So how do you build wealth? Read on...
There are basically only four roads to wealth:
You can marry it (don't laugh, some do);
You can inherit it (others do that);
You can get a windfall (from a lawsuit settlement, lottery, or some other unexpected good fortune); or
You can accumulate it.
Most of us are stuck with option #4 - accumulate it. To do so, you need to understand how to manage cash flow. First, look at your annual earnings and multiply that figure by your working years. Not counting inflation (that is, pay raises along the way), the result may total several million dollars.
Whether you will have that several million dollars by retirement, though, depends on how you manage your cash flow - and how you answer the following questions: What do you need now, what do you want now, and what can you save and invest for the future?
Here are ten time-tested rules that can weather the stormiest market cycles.
Rules #1: Live within your means
This includes managing debt and learning to budget. Such boring topics may not be the most exciting things about becoming wealthy, but they may be the most critical.
Consumer-driven economies relentlessly hammer away at why we must buy this item or that gadget so we can have the appearance of being successful, happy, and altogether "with it." So it takes financial discipline and sensible behavior to successfully accumulate money and grow wealthy.
Possibly the biggest trap out there is easy credit, which lets us buy numerous things we might not need. Comedians have pointed out the foolishness: "You buy something that's 10 per cent off and charge it on a 20 per cent interest credit card!" And US newspaper columnist Earl Wilson opined, "Nowadays there are three classes of people - the Haves, the Have-Nots, and the Have-Not-Paid-For-What-They-Haves."
Learning to live within your means leads to a freer life - debt can be a mean master instead of a worthy servant. Save first, spend second. If you do so, building wealth will be a lot easier for you.
Rule #2: Save aggressively
This does not mean "invest aggressively." Rather, it means making it an absolute priority to set aside 10 per cent of your income right off the top, and even more if your goals tell you to do that. The longer you wait to start saving, the larger the percentage of your current pay you will have to save to reach your goal.
If you can save aggressively, you will be surprised how that "nest egg" will start to compound. Look at any chart of compounding. It has been said that it's the last compounding that makes you wealthy.
In other words, $20,000 becoming $40,000 doesn't seem like a lot of headway, but when the $40,000 compounds to $80,000, and the $80,000 to $160,000, and finally the $160,000 to $320,000, we're now talking about some serious money. Two more "doublings" and this account will be worth over $1.2 million. Those who spend first and save later inevitably end up working for those who have learned to save first, spend second.
Rule #3: Dollar-cost average
When buying shares, remove emotions from your investing by automatically buying more shares or equity mutual fund units when they are cheap. Emotional investing gets too many people in trouble. Statistics continue to show that we tend to buy when things are going up and sell when they are going down - in other words, we tend to buy high and sell low. Dollar-cost averaging not only removes emotions from investing, but it helps you buy low. Here's how:
By putting a constant amount into the market, as the price slips, you buy more and more number of cheaper shares or fund units and thereby reduce your average cost.
For example, let's say you are investing $100 a month into a fund. In the first month, the price of the fund is $10 per share and you buy 10 shares. The next month, the price has dropped to $8 per share, so your $100 buys you 12.5 shares. The next month, the price has fallen again, to $5 a share, and you buy 20 shares. In the fourth month, the price ticks back up to $7 per share. Your total investment so far is $400.
If you're like most people, though, when you look at your statement and see that by the end of the third month the price has fallen to half, you would probably think you were losing money hand over fist. Especially after a fund continues to decline month after month, investors lose patience and start to bail. They're looking for "better returns," but they don't understand what's going on with the math.
At $5 a share, it feels as though you're down 50 per cent (because the price started at $10 per share). However, you own 42.5 shares, which, when multiplied by $5 a share, equals $212.50 - and you've invested $300. In the fourth month, the price gets back up to $7 per share. Although it might feel as though you're still down because the price started at $10 per share, you're actually within a couple of dollars of your break-even point. You own 56.79 shares, which when multiplied by $7 equals $397.53, on an investment of $400.
Of course, if the fund or market continues to go down and never comes back up, you can't be guaranteed a profit. But this would happen rarely, if ever. Dollar-cost averaging - by investing a fixed amount in regular intervals - is the best way to make money in a variable market over time.
The most difficult part is having the discipline to keep doing it. Investors should be willing to consider their ability to invest over an extended period of time. Remember, you need a longer time horizon when investing in the stock market.
Rule #4: Diversify
No investment is risk free; only a diversified portfolio can mitigate the risks of market cycles. We've all been warned against putting all our eggs in one basket; even Warren Buffett said, "It's better to be approximately right than definitely wrong." By "approximately right," he was referring to diversification.
If one piece of your portfolio is doing substantially better than other parts, the natural inclination is to load up on the part doing the best and forsake those not doing well. But the result will be an under-diversified portfolio that will probably be much more volatile - and the risks may be on the downward side.
Also, proper diversification does not mean any old bunch of mutual funds or stocks, but a proper allocation among stocks, bonds, real estate, fixed assets, and other investments. It also means diversifying within those investment categories.
For example, your stocks should include a mix of midcap, large-, and small-cap stocks as well as growth, blend, and value stocks. You should have bonds that are long, medium, and short term, as well as high grade, mid grade, and low grade.
A mutual fund may offer more diversification than you could afford by owning the same stocks individually. But owning a handful of mutual funds may not offer the diversification you seek unless you research the funds' holdings carefully. That's because many funds have substantial "overlap." In other words, fund A from mutual fund family X may have many of the same stocks as fund B from fund family Y.
Rule #5: Be patient
Warren Buffet says, "The market has a very efficient way of transferring wealth from the impatient to the patient."
But waiting is very hard to do. How long are you willing to hold an asset that is not performing well? One year? Two, three, or four? If you look at the history of asset classes over time, you will see that an asset can be "out of favor" for several years in a row.
You have to be prepared to wait. Don't think you can time when bonds will perform and stocks will get hot. If someone really could do that, he would own the world by now. So remember: Time in the market is more important than timing the market.
Rule #6: Understand volatility
Very few people truly understand the risk and volatility inevitably baked into every investment portfolio. Without getting into its complexity, every variable investment has produced a range of returns over its lifetime, and this range, or deviation, can be plotted on a chart.
So, it's important to understand what the investment category's "average" annual return means in order to prepare yourself for its volatility. For example, does a 10 per cent average mean the investment was up 73 per cent and down 30 per cent and happened to average 10 per cent? Or was it up 15 per cent, and then down 5 per cent to average 10 per cent?
Many investors are fooled by averages - they chase the 70 per cent return after it has happened, when the likelihood of a repeat performance is slim (which we'll discuss more in Rule #7). Yogi Berra is rumored to have said, "Averages don't mean nuthin". If they did, you could have one foot in the oven and the other in a bucket of ice and feel perfectly comfortable."
Over time, returns from investments regress to a mean. "Regression to the mean" simply means that highs and lows will average out so that your return regresses to a certain number or range. Understand an investment's range of returns so you know what to expect annually, and over time.
Markets move from fear to greed, and back to fear. So there are times when the market is "overvalued" and other times when it is "undervalued." Warren Buffett said of the stock buying and selling decisions made at his company, Berkshire Hathaway, "We strive to be fearful when others are greedy, and greedy only when others are fearful."
Rule #7: Don't chase returns
If we know from Rule #6 that a 10 per cent average annual return does not really mean a 10 per cent return each year, why do we still fall for an ad touting a fund that produces 20 per cent annually or some other phenomenal return?
Human nature. And maybe we even convince ourselves that for the chance to experience a year or two of 70 per cent gains, we're willing to stomach the years of 30 per cent losses that also fall within the fund's range of returns.
So, before chasing that incredible return, find out how the investment did during the last bad market for that asset class. Find out its risk, and ask yourself whether you can stomach a bumpy ride over the long term.
Another Buffettism: "The dumbest reason in the world to buy a stock is because it is going up." So before chasing a return, always consider how likely it is that the investment will continue to produce that return - and whether it's really worth the cost of cashing out of another, perhaps only temporarily depressed, investment to do so.
Rule #8: Periodically rebalance your portfolio
You may decide that your investment mix should be, for example, 50 per cent growth stocks, 20 per cent value stocks, and 30 per cent bonds. But asset classes vary in performance over time, so after a year or so, the portfolio balance will start to shift as one asset "overperforms" and another one "underperforms."
Emotions would tell you to sell the underperformers and buy the overachievers. If you want to remain adequately diversified, however, you would rebalance by selling some of the overperformers and buying some of the underachievers - probably just the opposite of what your emotions will tell you.
So, if you strive to put your portfolio back to its original allocations from time to time (annually, semi-annually, or possibly even quarterly), you will be taking gains from the best-performing assets (selling high) and buying those temporarily out of favor (buying low). But it takes discipline to keep your emotions in check.
Rule #9: Manage your taxes
Have you ever considered how taxes are your biggest expense in life - more than mortgage expense, education expense, or any other expense? So, you must take advantage of all tax breaks available - each and every single one of them.
Rule #10: Get advice
Never underestimate the value of good advice. Someone who manages investments full time certainly will find things you have overlooked or done wrong. A good financial adviser is like a personal trainer for your finances and can get you on track and keep you there until your goals are met.
And even more critical than getting the advice is being sure you consistently follow your game plan. The greatest problem for most people is procrastination and erratic investment behavior. So get started, get advice, and get going down the road to wealth - and steadfastly follow through.
(Excerpt from the book, Investing Under Fire)
There are basically only four roads to wealth:
You can marry it (don't laugh, some do);
You can inherit it (others do that);
You can get a windfall (from a lawsuit settlement, lottery, or some other unexpected good fortune); or
You can accumulate it.
Most of us are stuck with option #4 - accumulate it. To do so, you need to understand how to manage cash flow. First, look at your annual earnings and multiply that figure by your working years. Not counting inflation (that is, pay raises along the way), the result may total several million dollars.
Whether you will have that several million dollars by retirement, though, depends on how you manage your cash flow - and how you answer the following questions: What do you need now, what do you want now, and what can you save and invest for the future?
Here are ten time-tested rules that can weather the stormiest market cycles.
Rules #1: Live within your means
This includes managing debt and learning to budget. Such boring topics may not be the most exciting things about becoming wealthy, but they may be the most critical.
Consumer-driven economies relentlessly hammer away at why we must buy this item or that gadget so we can have the appearance of being successful, happy, and altogether "with it." So it takes financial discipline and sensible behavior to successfully accumulate money and grow wealthy.
Possibly the biggest trap out there is easy credit, which lets us buy numerous things we might not need. Comedians have pointed out the foolishness: "You buy something that's 10 per cent off and charge it on a 20 per cent interest credit card!" And US newspaper columnist Earl Wilson opined, "Nowadays there are three classes of people - the Haves, the Have-Nots, and the Have-Not-Paid-For-What-They-Haves."
Learning to live within your means leads to a freer life - debt can be a mean master instead of a worthy servant. Save first, spend second. If you do so, building wealth will be a lot easier for you.
Rule #2: Save aggressively
This does not mean "invest aggressively." Rather, it means making it an absolute priority to set aside 10 per cent of your income right off the top, and even more if your goals tell you to do that. The longer you wait to start saving, the larger the percentage of your current pay you will have to save to reach your goal.
If you can save aggressively, you will be surprised how that "nest egg" will start to compound. Look at any chart of compounding. It has been said that it's the last compounding that makes you wealthy.
In other words, $20,000 becoming $40,000 doesn't seem like a lot of headway, but when the $40,000 compounds to $80,000, and the $80,000 to $160,000, and finally the $160,000 to $320,000, we're now talking about some serious money. Two more "doublings" and this account will be worth over $1.2 million. Those who spend first and save later inevitably end up working for those who have learned to save first, spend second.
Rule #3: Dollar-cost average
When buying shares, remove emotions from your investing by automatically buying more shares or equity mutual fund units when they are cheap. Emotional investing gets too many people in trouble. Statistics continue to show that we tend to buy when things are going up and sell when they are going down - in other words, we tend to buy high and sell low. Dollar-cost averaging not only removes emotions from investing, but it helps you buy low. Here's how:
By putting a constant amount into the market, as the price slips, you buy more and more number of cheaper shares or fund units and thereby reduce your average cost.
For example, let's say you are investing $100 a month into a fund. In the first month, the price of the fund is $10 per share and you buy 10 shares. The next month, the price has dropped to $8 per share, so your $100 buys you 12.5 shares. The next month, the price has fallen again, to $5 a share, and you buy 20 shares. In the fourth month, the price ticks back up to $7 per share. Your total investment so far is $400.
If you're like most people, though, when you look at your statement and see that by the end of the third month the price has fallen to half, you would probably think you were losing money hand over fist. Especially after a fund continues to decline month after month, investors lose patience and start to bail. They're looking for "better returns," but they don't understand what's going on with the math.
At $5 a share, it feels as though you're down 50 per cent (because the price started at $10 per share). However, you own 42.5 shares, which, when multiplied by $5 a share, equals $212.50 - and you've invested $300. In the fourth month, the price gets back up to $7 per share. Although it might feel as though you're still down because the price started at $10 per share, you're actually within a couple of dollars of your break-even point. You own 56.79 shares, which when multiplied by $7 equals $397.53, on an investment of $400.
Of course, if the fund or market continues to go down and never comes back up, you can't be guaranteed a profit. But this would happen rarely, if ever. Dollar-cost averaging - by investing a fixed amount in regular intervals - is the best way to make money in a variable market over time.
The most difficult part is having the discipline to keep doing it. Investors should be willing to consider their ability to invest over an extended period of time. Remember, you need a longer time horizon when investing in the stock market.
Rule #4: Diversify
No investment is risk free; only a diversified portfolio can mitigate the risks of market cycles. We've all been warned against putting all our eggs in one basket; even Warren Buffett said, "It's better to be approximately right than definitely wrong." By "approximately right," he was referring to diversification.
If one piece of your portfolio is doing substantially better than other parts, the natural inclination is to load up on the part doing the best and forsake those not doing well. But the result will be an under-diversified portfolio that will probably be much more volatile - and the risks may be on the downward side.
Also, proper diversification does not mean any old bunch of mutual funds or stocks, but a proper allocation among stocks, bonds, real estate, fixed assets, and other investments. It also means diversifying within those investment categories.
For example, your stocks should include a mix of midcap, large-, and small-cap stocks as well as growth, blend, and value stocks. You should have bonds that are long, medium, and short term, as well as high grade, mid grade, and low grade.
A mutual fund may offer more diversification than you could afford by owning the same stocks individually. But owning a handful of mutual funds may not offer the diversification you seek unless you research the funds' holdings carefully. That's because many funds have substantial "overlap." In other words, fund A from mutual fund family X may have many of the same stocks as fund B from fund family Y.
Rule #5: Be patient
Warren Buffet says, "The market has a very efficient way of transferring wealth from the impatient to the patient."
But waiting is very hard to do. How long are you willing to hold an asset that is not performing well? One year? Two, three, or four? If you look at the history of asset classes over time, you will see that an asset can be "out of favor" for several years in a row.
You have to be prepared to wait. Don't think you can time when bonds will perform and stocks will get hot. If someone really could do that, he would own the world by now. So remember: Time in the market is more important than timing the market.
Rule #6: Understand volatility
Very few people truly understand the risk and volatility inevitably baked into every investment portfolio. Without getting into its complexity, every variable investment has produced a range of returns over its lifetime, and this range, or deviation, can be plotted on a chart.
So, it's important to understand what the investment category's "average" annual return means in order to prepare yourself for its volatility. For example, does a 10 per cent average mean the investment was up 73 per cent and down 30 per cent and happened to average 10 per cent? Or was it up 15 per cent, and then down 5 per cent to average 10 per cent?
Many investors are fooled by averages - they chase the 70 per cent return after it has happened, when the likelihood of a repeat performance is slim (which we'll discuss more in Rule #7). Yogi Berra is rumored to have said, "Averages don't mean nuthin". If they did, you could have one foot in the oven and the other in a bucket of ice and feel perfectly comfortable."
Over time, returns from investments regress to a mean. "Regression to the mean" simply means that highs and lows will average out so that your return regresses to a certain number or range. Understand an investment's range of returns so you know what to expect annually, and over time.
Markets move from fear to greed, and back to fear. So there are times when the market is "overvalued" and other times when it is "undervalued." Warren Buffett said of the stock buying and selling decisions made at his company, Berkshire Hathaway, "We strive to be fearful when others are greedy, and greedy only when others are fearful."
Rule #7: Don't chase returns
If we know from Rule #6 that a 10 per cent average annual return does not really mean a 10 per cent return each year, why do we still fall for an ad touting a fund that produces 20 per cent annually or some other phenomenal return?
Human nature. And maybe we even convince ourselves that for the chance to experience a year or two of 70 per cent gains, we're willing to stomach the years of 30 per cent losses that also fall within the fund's range of returns.
So, before chasing that incredible return, find out how the investment did during the last bad market for that asset class. Find out its risk, and ask yourself whether you can stomach a bumpy ride over the long term.
Another Buffettism: "The dumbest reason in the world to buy a stock is because it is going up." So before chasing a return, always consider how likely it is that the investment will continue to produce that return - and whether it's really worth the cost of cashing out of another, perhaps only temporarily depressed, investment to do so.
Rule #8: Periodically rebalance your portfolio
You may decide that your investment mix should be, for example, 50 per cent growth stocks, 20 per cent value stocks, and 30 per cent bonds. But asset classes vary in performance over time, so after a year or so, the portfolio balance will start to shift as one asset "overperforms" and another one "underperforms."
Emotions would tell you to sell the underperformers and buy the overachievers. If you want to remain adequately diversified, however, you would rebalance by selling some of the overperformers and buying some of the underachievers - probably just the opposite of what your emotions will tell you.
So, if you strive to put your portfolio back to its original allocations from time to time (annually, semi-annually, or possibly even quarterly), you will be taking gains from the best-performing assets (selling high) and buying those temporarily out of favor (buying low). But it takes discipline to keep your emotions in check.
Rule #9: Manage your taxes
Have you ever considered how taxes are your biggest expense in life - more than mortgage expense, education expense, or any other expense? So, you must take advantage of all tax breaks available - each and every single one of them.
Rule #10: Get advice
Never underestimate the value of good advice. Someone who manages investments full time certainly will find things you have overlooked or done wrong. A good financial adviser is like a personal trainer for your finances and can get you on track and keep you there until your goals are met.
And even more critical than getting the advice is being sure you consistently follow your game plan. The greatest problem for most people is procrastination and erratic investment behavior. So get started, get advice, and get going down the road to wealth - and steadfastly follow through.
(Excerpt from the book, Investing Under Fire)
Arresting Inflation
Nice Logic - It May Work !!
A man eats two eggs each morning for breakfast. When he goes to the Kirana store he pays Rs. 12 a dozen. Since a dozen eggs won't last a week he normally buys two dozens at a time. One day while buying eggs he notices that the price has risen to Rs. 16. The next time he buys groceries, eggs are Rs. 22 a dozen.
When asked to explain the price of eggs the store owner says, "The price has gone up and I have to raise my price accordingly". This store buys 100 dozen eggs a day. He checked around for a better price and all the distributors have raised their prices. The distributors have begun to buy from the huge egg farms. The small egg farms have been driven out of business. The huge egg farms sell 100,000 dozen eggs a day to distributors. With no competition, they can set the price as they see fit. The distributors then have to raise their prices to the grocery stores. And on and on and on.
As the man kept buying eggs the price kept going up. He saw the big egg trucks delivering 100 dozen eggs each day. Nothing changed there. He checked out the huge egg farms and found they were selling 100,000 dozen eggs to the distributors daily. Nothing had changed but the price of eggs.
Then week before Diwali the price of eggs shot up to Rs. 40 a dozen. Again he asked the grocery owner why and was told, "Cakes and baking for the holiday". The huge egg farmers know there will be a lot of baking going on and more eggs will be used. Hence, the price of eggs goes up. Expect the same thing at Christmas and other times when family cooking, baking, etc. happen.
This pattern continues until the price of eggs is Rs. 60 a dozen. The man says, " There must be something we can do about the price of eggs".
He starts talking to all the people in his town and they decide to stop buying eggs. This didn't work because everyone needed eggs.
Finally, the man suggested only buying what you need. He ate 2 eggs a day. On the way home from work he would stop at the grocery and buy two eggs. Everyone in town started buying 2 or 3 eggs a day.
The grocery store owner began complaining that he had too many eggs in his cooler. He told the distributor that he didn't need any eggs.
Maybe wouldn't need any all week.
The distributor had eggs piling up at his warehouse. He told the huge egg farms that he didn't have any room for eggs would not need any for at least two weeks.
At the egg farm, the chickens just kept on laying eggs. To relieve the pressure, the huge egg farm told the distributor that they could buy the eggs at a lower price.
The distributor said, " I don't have the room for the %$&^*&% eggs even if they were free". The distributor told the grocery store owner that he would lower the price of the eggs if the store would start buying
again.
The grocery store owner said, "I don't have room for more eggs. The customers are only buying 2 or 3 eggs at a time. Now if you were to drop the price of eggs back down to the original price, the customers
would start buying by the dozen again".
The distributors sent that proposal to the huge egg farmers but the egg farmers liked the price they were getting for their eggs but, those chickens just kept on laying. Finally, the egg farmers lowered the
price of their eggs. But only a few paisa.
The customers still bought 2 or 3 eggs at a time. They said, "when the price of eggs gets down to where it was before, we will start buying by the dozen."
Slowly the price of eggs started dropping. The distributors had to slash their prices to make room for the eggs coming from the egg farmers.
The egg farmers cut their prices because the distributors wouldn't buy at a higher price than they were selling eggs for. Anyway, they had full warehouses and wouldn't need eggs for quite a while.
And those chickens kept on laying.
Eventually, the egg farmers cut their prices because they were throwing away eggs they couldn't sell.
The distributors started buying again because the eggs were priced to where the stores could afford to sell them at the lower price.
And the customers starting buying by the dozen again.
Now, transpose this analogy to the gasoline industry.
What if everyone only bought Rs 200.00 worth of Petrol each time they pulled to the pump? The dealer's tanks would stay semi full all the time. The dealers wouldn't have room for the gas coming from the huge tanks. The tank farms wouldn't have room for the petrol coming from the refining plants. And the refining plants wouldn't have room for the oil being off loaded from the huge tankers coming from the oil fiends.
Just Rs 200.00 each time you buy gas. Don't fill up the tank of your car. You may have to stop for gas twice a week, but the price should come down.
Think about it.
Also, don't buy anything else at the fuel station; don't give them any more of your hard earned money than what you spend on gas, until the prices come down..."
...just think of this concept for a while.
A man eats two eggs each morning for breakfast. When he goes to the Kirana store he pays Rs. 12 a dozen. Since a dozen eggs won't last a week he normally buys two dozens at a time. One day while buying eggs he notices that the price has risen to Rs. 16. The next time he buys groceries, eggs are Rs. 22 a dozen.
When asked to explain the price of eggs the store owner says, "The price has gone up and I have to raise my price accordingly". This store buys 100 dozen eggs a day. He checked around for a better price and all the distributors have raised their prices. The distributors have begun to buy from the huge egg farms. The small egg farms have been driven out of business. The huge egg farms sell 100,000 dozen eggs a day to distributors. With no competition, they can set the price as they see fit. The distributors then have to raise their prices to the grocery stores. And on and on and on.
As the man kept buying eggs the price kept going up. He saw the big egg trucks delivering 100 dozen eggs each day. Nothing changed there. He checked out the huge egg farms and found they were selling 100,000 dozen eggs to the distributors daily. Nothing had changed but the price of eggs.
Then week before Diwali the price of eggs shot up to Rs. 40 a dozen. Again he asked the grocery owner why and was told, "Cakes and baking for the holiday". The huge egg farmers know there will be a lot of baking going on and more eggs will be used. Hence, the price of eggs goes up. Expect the same thing at Christmas and other times when family cooking, baking, etc. happen.
This pattern continues until the price of eggs is Rs. 60 a dozen. The man says, " There must be something we can do about the price of eggs".
He starts talking to all the people in his town and they decide to stop buying eggs. This didn't work because everyone needed eggs.
Finally, the man suggested only buying what you need. He ate 2 eggs a day. On the way home from work he would stop at the grocery and buy two eggs. Everyone in town started buying 2 or 3 eggs a day.
The grocery store owner began complaining that he had too many eggs in his cooler. He told the distributor that he didn't need any eggs.
Maybe wouldn't need any all week.
The distributor had eggs piling up at his warehouse. He told the huge egg farms that he didn't have any room for eggs would not need any for at least two weeks.
At the egg farm, the chickens just kept on laying eggs. To relieve the pressure, the huge egg farm told the distributor that they could buy the eggs at a lower price.
The distributor said, " I don't have the room for the %$&^*&% eggs even if they were free". The distributor told the grocery store owner that he would lower the price of the eggs if the store would start buying
again.
The grocery store owner said, "I don't have room for more eggs. The customers are only buying 2 or 3 eggs at a time. Now if you were to drop the price of eggs back down to the original price, the customers
would start buying by the dozen again".
The distributors sent that proposal to the huge egg farmers but the egg farmers liked the price they were getting for their eggs but, those chickens just kept on laying. Finally, the egg farmers lowered the
price of their eggs. But only a few paisa.
The customers still bought 2 or 3 eggs at a time. They said, "when the price of eggs gets down to where it was before, we will start buying by the dozen."
Slowly the price of eggs started dropping. The distributors had to slash their prices to make room for the eggs coming from the egg farmers.
The egg farmers cut their prices because the distributors wouldn't buy at a higher price than they were selling eggs for. Anyway, they had full warehouses and wouldn't need eggs for quite a while.
And those chickens kept on laying.
Eventually, the egg farmers cut their prices because they were throwing away eggs they couldn't sell.
The distributors started buying again because the eggs were priced to where the stores could afford to sell them at the lower price.
And the customers starting buying by the dozen again.
Now, transpose this analogy to the gasoline industry.
What if everyone only bought Rs 200.00 worth of Petrol each time they pulled to the pump? The dealer's tanks would stay semi full all the time. The dealers wouldn't have room for the gas coming from the huge tanks. The tank farms wouldn't have room for the petrol coming from the refining plants. And the refining plants wouldn't have room for the oil being off loaded from the huge tankers coming from the oil fiends.
Just Rs 200.00 each time you buy gas. Don't fill up the tank of your car. You may have to stop for gas twice a week, but the price should come down.
Think about it.
Also, don't buy anything else at the fuel station; don't give them any more of your hard earned money than what you spend on gas, until the prices come down..."
...just think of this concept for a while.
8 financial tips for young adults
Unfortunately, personal finance has not yet become a required subject in high school or college, so you might be fairly clueless about how to manage your money when you're out in the real world for the first time. If you think that understanding personal finance is way above your head, though, you're wrong.
Get emotional spending under control
How mutual funds differ around the globe
All it takes to get started on the right path is the willingness to do a little reading - you don't even need to be particularly good at math. To help you get started, we'll take a look at eight of the most important things to understand about money if you want to live a comfortable and prosperous life.
Learn self control now, not later.
If you're lucky, your parents taught you this skill when you were a kid. If not, keep in mind that the sooner you learn the fine art of delaying gratification, the sooner you'll find it easy to keep your finances in order. Although you can effortlessly purchase an item on credit the minute you want it, it's better to wait until you've actually saved up the money. Do you really want to pay interest on a pair of jeans or a box of cereal? (To learn more about credit, check out Understanding Credit Card Interest and our Debt Management feature.)
If you make a habit of putting all your purchases on credit cards, regardless of whether you can pay your bill in full at the end of the month, you might still be paying for those items in 10 years. If you want to keep your credit cards for the convenience factor or the rewards they offer, make sure to always pay your balance in full when the bill arrives, and don't carry more cards than you can keep track of.
Don't put your financial future in someone else's hands.
If you don't learn to manage your own money, other people will find ways to (mis)manage it for you. Some of these people may be ill-intentioned, like unscrupulous commission-based financial planners. Others may be well-meaning, but may not know what they're doing, like Grandma Betty who really wants you to buy a house even though you can only afford a treacherous adjustable-rate mortgage.
Instead of relying on others for advice, take charge and read a few basic books on personal finance. Once you're armed with personal finance knowledge, don't let anyone catch you off guard - whether it's a significant other that slowly siphons your bank account or friends who want you to go out and blow tons of money with them every weekend.
Trading's six biggest losers
Six biggest bond risks
Understanding how money works is the first step toward making your money work for you. (To find out how to have fun and still save money, see Budget Without Blowing Off Your Friends.)
Pay attention to where your money goes.
Once you've gone through a few personal finance books, you'll realize how important it is to make sure your expenses aren't exceeding your income. The best way to do this is by budgeting. Once you see how your morning java adds up over the course of a month, you'll realize that making small, manageable changes in your everyday expenses can have just as big of an impact on your financial situation as getting a raise.
In addition, keeping your recurring monthly expenses as low as possible will also save you big bucks over time. If you don't waste your money on a posh apartment now, you might be able to afford a nice condo or a house before you know it. (Read more on budgeting in our Budgeting 101 special feature.)
Start an emergency fund.
One of personal finance's oft-repeated mantras is "pay yourself first". No matter how much you owe in student loans or credit card debt and no matter how low your salary may seem, it's wise to find some amount - any amount - of money in your budget to save in an emergency fund every month.
Monopolies: Corporate triumph and treachery
Having money in savings to use for emergencies can really keep you out of trouble financially and help you sleep better at night. Also, if you get into the habit of saving money and treating it as a non-negotiable monthly "expense", pretty soon you'll have more than just emergency money saved up: you'll have retirement money, vacation money, and even money for a home down payment.Don't just sock away this money under your mattress; put it in a high-interest online savings account, a certificate of deposit, or a money market account. Otherwise, inflation will erode the value of your savings.
Start saving for retirement now.
Just as you headed off to kindergarten with your parents' hope to prepare you for success in a world that seemed eons away, you need to prepare for your retirement well in advance. Because of the way compound interest works, the sooner you start saving, the less principal you'll have to invest to end up with the amount you need to retire, and the sooner you'll be able to call working an "option" rather than a "necessity".
Company-sponsored retirement plans are a particularly great choice because you get to put in pretax dollars and the contribution limits tend to be high (much more than you can contribute to an individual retirement plan). Also, companies will often match part of your contribution, which is like getting free money. (To learn more, see Understanding The Time Value Of Money and Retirement Savings Tips For 18- To 24-Year-Olds.)
Get a grip on taxes.
It's important to understand how income taxes work even before you get your first paycheck. When a company offers you a starting salary, you need to know how to calculate whether that salary will give you enough money after taxes to meet your financial goals and obligations. Fortunately, there are plenty of online calculators that have taken the dirty work out of determining your own payroll taxes, such as Paycheck City. These calculators will show you your gross pay, how much goes to taxes and how much you'll be left with (also known as net, or take-home pay). For example, $35,000 a year in California will leave you with about $27,600 after taxes in 2008, or about $2,300 a month. By the same token, if you're considering leaving one job for another in search of a salary increase, you'll need to understand how your marginal tax rate will affect your raise and that a salary increase from $35,000 a year to $41,000 a year won't give you an extra $6,000, or $500 per month - it will only give you an extra $4,200, or $350 per month (again, the amount will vary depending on your state of residence). Also, you'll be better off in the long run if you learn to prepare your annual tax return yourself, as there is plenty of bad tax advice and misinformation floating around out there.
Guard your health.
If meeting monthly health insurance premiums seems impossible, what will you do if you have to go to the emergency room, where a single visit for a minor injury like a broken bone can cost thousands of dollars? If you're uninsured, don't wait another day to apply for health insurance: it's easier than you think to wind up in a car accident or trip down the stairs. You can save money by getting quotes from different insurance providers to find the lowest rates.
Also, by taking daily steps now to keep yourself healthy, like eating fruits and vegetables, maintaining a healthy weight, exercising, not smoking, not consuming alcohol in excess, and even driving defensively, you'll thank yourself down the road when you aren't paying exorbitant medical bills.
Guard your wealth.If you want to make sure all your hard-earned money doesn't vanish, you'll need to take steps to protect it. If you rent, get renter's insurance to protect the contents of your place from events like burglary or fire. Disability insurance protects your greatest asset: the ability to earn an income, by providing you with a steady income if you ever become unable to work for an extended period of time due to illness or injury.
If you want help managing your money, find a fee-only financial planner to provide unbiased advice that's in your best interest, rather than a commission-based financial advisor, who earns money when you sign up with the investments his or her company backs.
You'll also want to protect your money from taxes, which is easy to do with a retirement account, and inflation, which you can do by making sure that all of your money is earning interest through vehicles like high-interest savings accounts, money market funds, CDs, stocks, bonds, and mutual funds. (Find out all you need to know about insurance in Understand Your Insurance Contract, Five Insurance Policies Everyone Should Have and Insurance 101 For Renters.)
A financial basis for life
Remember, you don't need any fancy degrees or special background to become an expert at managing your finances. If you use these eight financial rules for your life, you can be as personally prosperous as the guy with the hard-won MBA.
Get emotional spending under control
How mutual funds differ around the globe
All it takes to get started on the right path is the willingness to do a little reading - you don't even need to be particularly good at math. To help you get started, we'll take a look at eight of the most important things to understand about money if you want to live a comfortable and prosperous life.
Learn self control now, not later.
If you're lucky, your parents taught you this skill when you were a kid. If not, keep in mind that the sooner you learn the fine art of delaying gratification, the sooner you'll find it easy to keep your finances in order. Although you can effortlessly purchase an item on credit the minute you want it, it's better to wait until you've actually saved up the money. Do you really want to pay interest on a pair of jeans or a box of cereal? (To learn more about credit, check out Understanding Credit Card Interest and our Debt Management feature.)
If you make a habit of putting all your purchases on credit cards, regardless of whether you can pay your bill in full at the end of the month, you might still be paying for those items in 10 years. If you want to keep your credit cards for the convenience factor or the rewards they offer, make sure to always pay your balance in full when the bill arrives, and don't carry more cards than you can keep track of.
Don't put your financial future in someone else's hands.
If you don't learn to manage your own money, other people will find ways to (mis)manage it for you. Some of these people may be ill-intentioned, like unscrupulous commission-based financial planners. Others may be well-meaning, but may not know what they're doing, like Grandma Betty who really wants you to buy a house even though you can only afford a treacherous adjustable-rate mortgage.
Instead of relying on others for advice, take charge and read a few basic books on personal finance. Once you're armed with personal finance knowledge, don't let anyone catch you off guard - whether it's a significant other that slowly siphons your bank account or friends who want you to go out and blow tons of money with them every weekend.
Trading's six biggest losers
Six biggest bond risks
Understanding how money works is the first step toward making your money work for you. (To find out how to have fun and still save money, see Budget Without Blowing Off Your Friends.)
Pay attention to where your money goes.
Once you've gone through a few personal finance books, you'll realize how important it is to make sure your expenses aren't exceeding your income. The best way to do this is by budgeting. Once you see how your morning java adds up over the course of a month, you'll realize that making small, manageable changes in your everyday expenses can have just as big of an impact on your financial situation as getting a raise.
In addition, keeping your recurring monthly expenses as low as possible will also save you big bucks over time. If you don't waste your money on a posh apartment now, you might be able to afford a nice condo or a house before you know it. (Read more on budgeting in our Budgeting 101 special feature.)
Start an emergency fund.
One of personal finance's oft-repeated mantras is "pay yourself first". No matter how much you owe in student loans or credit card debt and no matter how low your salary may seem, it's wise to find some amount - any amount - of money in your budget to save in an emergency fund every month.
Monopolies: Corporate triumph and treachery
Having money in savings to use for emergencies can really keep you out of trouble financially and help you sleep better at night. Also, if you get into the habit of saving money and treating it as a non-negotiable monthly "expense", pretty soon you'll have more than just emergency money saved up: you'll have retirement money, vacation money, and even money for a home down payment.Don't just sock away this money under your mattress; put it in a high-interest online savings account, a certificate of deposit, or a money market account. Otherwise, inflation will erode the value of your savings.
Start saving for retirement now.
Just as you headed off to kindergarten with your parents' hope to prepare you for success in a world that seemed eons away, you need to prepare for your retirement well in advance. Because of the way compound interest works, the sooner you start saving, the less principal you'll have to invest to end up with the amount you need to retire, and the sooner you'll be able to call working an "option" rather than a "necessity".
Company-sponsored retirement plans are a particularly great choice because you get to put in pretax dollars and the contribution limits tend to be high (much more than you can contribute to an individual retirement plan). Also, companies will often match part of your contribution, which is like getting free money. (To learn more, see Understanding The Time Value Of Money and Retirement Savings Tips For 18- To 24-Year-Olds.)
Get a grip on taxes.
It's important to understand how income taxes work even before you get your first paycheck. When a company offers you a starting salary, you need to know how to calculate whether that salary will give you enough money after taxes to meet your financial goals and obligations. Fortunately, there are plenty of online calculators that have taken the dirty work out of determining your own payroll taxes, such as Paycheck City. These calculators will show you your gross pay, how much goes to taxes and how much you'll be left with (also known as net, or take-home pay). For example, $35,000 a year in California will leave you with about $27,600 after taxes in 2008, or about $2,300 a month. By the same token, if you're considering leaving one job for another in search of a salary increase, you'll need to understand how your marginal tax rate will affect your raise and that a salary increase from $35,000 a year to $41,000 a year won't give you an extra $6,000, or $500 per month - it will only give you an extra $4,200, or $350 per month (again, the amount will vary depending on your state of residence). Also, you'll be better off in the long run if you learn to prepare your annual tax return yourself, as there is plenty of bad tax advice and misinformation floating around out there.
Guard your health.
If meeting monthly health insurance premiums seems impossible, what will you do if you have to go to the emergency room, where a single visit for a minor injury like a broken bone can cost thousands of dollars? If you're uninsured, don't wait another day to apply for health insurance: it's easier than you think to wind up in a car accident or trip down the stairs. You can save money by getting quotes from different insurance providers to find the lowest rates.
Also, by taking daily steps now to keep yourself healthy, like eating fruits and vegetables, maintaining a healthy weight, exercising, not smoking, not consuming alcohol in excess, and even driving defensively, you'll thank yourself down the road when you aren't paying exorbitant medical bills.
Guard your wealth.If you want to make sure all your hard-earned money doesn't vanish, you'll need to take steps to protect it. If you rent, get renter's insurance to protect the contents of your place from events like burglary or fire. Disability insurance protects your greatest asset: the ability to earn an income, by providing you with a steady income if you ever become unable to work for an extended period of time due to illness or injury.
If you want help managing your money, find a fee-only financial planner to provide unbiased advice that's in your best interest, rather than a commission-based financial advisor, who earns money when you sign up with the investments his or her company backs.
You'll also want to protect your money from taxes, which is easy to do with a retirement account, and inflation, which you can do by making sure that all of your money is earning interest through vehicles like high-interest savings accounts, money market funds, CDs, stocks, bonds, and mutual funds. (Find out all you need to know about insurance in Understand Your Insurance Contract, Five Insurance Policies Everyone Should Have and Insurance 101 For Renters.)
A financial basis for life
Remember, you don't need any fancy degrees or special background to become an expert at managing your finances. If you use these eight financial rules for your life, you can be as personally prosperous as the guy with the hard-won MBA.
How best to negotiate your salary
The celebratory mood in which you join a much-coveted job wanes off soon. What you see in the offer letter is not what you have got! The huge sign-on bonus, the stock option program to die for, the bonuses and the over-the-top benefits come with so many 'Ifs and Buts' and preconditions that you feel that you have been done in.
Do not blame the new company; it is their job to present their offer in the most attractive manner. It is your responsibility to decode the fine print in compensation by asking the right questions. Before you evaluate the offer, understand and monetise your current package or CTC (cost to company). List out all guaranteed elements that appear on your pay slip - the basic salary, housing, conveyance and other components.
Add up annual benefits like allowances for leave travel, education, medical treatment and car next. Then go to bonuses. Take the average of what you earned for the last two years. Last are deferred benefits like PF, gratuity and superannuation.
Then bells and whistles (Diwali gifts of silver from the chairman's office, spouse travel abroad ostensibly for team-building during conferences). You now have a complete picture of what you cost your company. Classify the components as fixed, 'Ifs and Buts' and deferred benefits. Calculate your current tax liability. Now you are ready to stack up the new offer against what you get currently.
When you get the new offer, ask questions. What are the fixed elements, perquisites, 'Ifs and Buts' and deferred benefits? Compare the guaranteed element of the current salary with that of the one offered. Is it higher? Then come to perquisites.
No point getting a petrol allowance of Rs 100,000 per year when you stay within walking distance from the office and would use only a tenth of it. Be practical with the LTA too - do you need to avail it or can you get cash value as taxable salary if not used? Clarify on medical programs and insurance covers. Is the coverage only for immediate family or for parents too?
The biggest culprits are sign-on and retention bonuses. Understand the strings attached to them. Is the sign-on bonus yours on joining or do you need to work for a defined period to get it? Ditto with the retention bonus. How does it play out? Will it be paid on a pro rata basis if you resign midway? Is the retention bonus tied to performance?
The performance bonus is the next big area. "This is a performance-driven company and bonuses are unlimited based on results" is what you hear during the interview. This is a manner of speaking and not to be taken literally. Ask how the bonus program works. Is there a cap on what you can earn? How much do 80 per cent of the employees at similar levels make?
How is performance measured? Is the bonus paid quarterly or annually? What happens if you leave mid-year? Will you be paid bonus for the period worked and results delivered?
Stock option programs can create grief if not comprehended fully. What is the basis of its allotment? Is it allotted on joining or is it linked to meeting some performance criteria? If the company is listed, check the vesting period and the percentage vesting per year. More questions if it is an MNC and the stock is listed abroad.
Pre-IPO options are the trickiest. When is it going to be listed? At what price do you get it and what is the basis for the strike price? What will be the fate of the options if the company gets acquired before the IPO, what happens if the listing is postponed?
New jobs often throw up of surprises in terms of things like role, culture and autonomy. Surprises on the compensation front can be avoided. It may be too late once you join. Too may queries on compensation immediately after joining also create a poor impression. Being forewarned is forearmed.
Do not blame the new company; it is their job to present their offer in the most attractive manner. It is your responsibility to decode the fine print in compensation by asking the right questions. Before you evaluate the offer, understand and monetise your current package or CTC (cost to company). List out all guaranteed elements that appear on your pay slip - the basic salary, housing, conveyance and other components.
Add up annual benefits like allowances for leave travel, education, medical treatment and car next. Then go to bonuses. Take the average of what you earned for the last two years. Last are deferred benefits like PF, gratuity and superannuation.
Then bells and whistles (Diwali gifts of silver from the chairman's office, spouse travel abroad ostensibly for team-building during conferences). You now have a complete picture of what you cost your company. Classify the components as fixed, 'Ifs and Buts' and deferred benefits. Calculate your current tax liability. Now you are ready to stack up the new offer against what you get currently.
When you get the new offer, ask questions. What are the fixed elements, perquisites, 'Ifs and Buts' and deferred benefits? Compare the guaranteed element of the current salary with that of the one offered. Is it higher? Then come to perquisites.
No point getting a petrol allowance of Rs 100,000 per year when you stay within walking distance from the office and would use only a tenth of it. Be practical with the LTA too - do you need to avail it or can you get cash value as taxable salary if not used? Clarify on medical programs and insurance covers. Is the coverage only for immediate family or for parents too?
The biggest culprits are sign-on and retention bonuses. Understand the strings attached to them. Is the sign-on bonus yours on joining or do you need to work for a defined period to get it? Ditto with the retention bonus. How does it play out? Will it be paid on a pro rata basis if you resign midway? Is the retention bonus tied to performance?
The performance bonus is the next big area. "This is a performance-driven company and bonuses are unlimited based on results" is what you hear during the interview. This is a manner of speaking and not to be taken literally. Ask how the bonus program works. Is there a cap on what you can earn? How much do 80 per cent of the employees at similar levels make?
How is performance measured? Is the bonus paid quarterly or annually? What happens if you leave mid-year? Will you be paid bonus for the period worked and results delivered?
Stock option programs can create grief if not comprehended fully. What is the basis of its allotment? Is it allotted on joining or is it linked to meeting some performance criteria? If the company is listed, check the vesting period and the percentage vesting per year. More questions if it is an MNC and the stock is listed abroad.
Pre-IPO options are the trickiest. When is it going to be listed? At what price do you get it and what is the basis for the strike price? What will be the fate of the options if the company gets acquired before the IPO, what happens if the listing is postponed?
New jobs often throw up of surprises in terms of things like role, culture and autonomy. Surprises on the compensation front can be avoided. It may be too late once you join. Too may queries on compensation immediately after joining also create a poor impression. Being forewarned is forearmed.
Filing tax returns? A step-by-step guide
It's that time of the year again. You knew all along that it would come, whether you ignored or waited for it. The pages of the calendar have turned and you can hear colleagues waking up to it.
And you know you can't run away from it any more. We are talking about 31 July, the day we are reminded of our bondage, the price we have to pay for many of the good things in our life.
This happens to be the last day for filing income tax returns for all salaried Indians, be they resident or non-resident. Of course, you must have done everything legally possible to maximise your freedom from this bondage called tax. But then, the law permits you only that much. The rest, as they say, is illegal.
You might also have wondered about the word return being used for an outgo. Maybe it's because governments always want citizens to see things from their point of view, perhaps for the larger good.
Filing of tax is compulsory for everyone whose gross total income - the income under the five heads (salary, business, capital gains, house property or other sources) before allowing for any deductions such as insurance premium - exceeds the basic exemption limit.
For financial year 2007-08 (assessment year 2008-09), this limit was Rs 145,000 for women below 65 years of age, Rs 195,000 for senior citizens (above age 65 years) and Rs 110,000 for any other individual. It is compulsory for every person exceeding these limits to file the return before the prescribed date, even if their employer has taken care of their tax liabilities by reducing their salaries by the necessary amounts before paying the rest to them. Paid this way, it is known as tax deducted at source or TDS.
Filing of the form
There are two income tax return forms, ITR-1 and ITR-2, for salaried individuals. Your sources of income (they will fall under one or more of the five sources mentioned earlier) will decide your form. You will have to submit the filled form to the tax authorities and get an acknowledgement from them.
Income source decides return form
ITR-1: Income from salary, pension and interest earned in a financial year
ITR-2: Capital gains, income/loss from house property and income from any other source
Use ITR-1 to file your tax return if your income is from salary, pension or interest. In case of any capital gains, income or loss from house property and income from any other source, you will have to use ITR-2. You can go to www.incometaxindia.gov.in/download_all.asp to download these forms.
You will find ITR-1 relatively simple to fill up. A prerequisite for the exercise is Form 16, the certificate that comes from the employer showing the TDS from the income chargeable under the head salary. ITR-1 is almost a replica of Form 16. All you have to do is pick the numbers from Form 16 and put them in the ITR form.
Apart from salary income, there is an important component of income that many taxpayers ignore while filing their returns. It is the interest income earned from the funds lying in savings accounts in banks. Disclosing that, however small it may be, is mandatory.
You just have to add the total interest credited to your bank account in the last financial year. Scrutinise your income tax return to ensure that no taxable income is undisclosed. After you file your return, the tax authorities will hand you an acknowledgment. That's it, you are through with the filing of returns.
You will need to fill up ITR-2 if you, as a salaried individual, have made any capital gains. This form is filled in the same way as ITR-1. In addition, you will have to fill in income, if any, from house property and other sources.
How to file
The actual filing of return can be done either by using the traditional paper form or electronically, over the Internet. The second, known as e-filing, is fast catching up. The digital method is compulsory for companies, but optional for salaried individuals still. However, it may well become compulsory for individuals with a certain level of income in times to come. So, it may not be a bad idea to familiarise yourself with this process.
Before you start filing the return, check if you would be getting a refund from the IT Department or have to pay tax. In case of the latter, even before starting the filing process, you should first get hold of Form 280, fill it up and deposit it any bank along with the tax payable in cash or cheque. You can also pay tax through Internet banking. In both cases, you will get a receipt number which has to be quoted in the ITR form.
Checklist
* Keep ITR-1, ITR-2 forms handy* Enter all the details in CAPITAL letters* Ensure that name, address and other personal details are entered correctly* Double-check PAN number, bank account details and the MICR code you write* Store the acknowledgement safely property and income from any other source
Doing it offline
There are two options - you may either submit the ITR form at the nearest income tax office after filling it up yourself, or you may get a chartered accountant or a tax return preparer to do it for you. Try to visit the ITO well before the last date for filing return as crowds increase as 31 July draws near.
You may also take help from the public relations officer of the ITO to fill the form. No documents or investment proofs need to be attached with the form, but remember to bring photocopies or originals with you to the ITO. These will come in handy if you are asked to authenticate the maths.
The fee of a CA would depend on your income slab and the number of income sources. Typically, it would range from Rs 300 to Rs 2,000, depending on the complexities involved. One good thing about filing through a CA is that it would bring down the margin of error to nil. Also, depending on the acumen of the CA, which often gets reflected in the quality of his practice, he would suggest some tax saving ways to you for the future.
Doing it online
E-filing is done through sites authorised by the IT Department to file taxes on your behalf. To e-file, you will have to input the details of Form 16 in the software of the website, which would automatically generate an electronic return in XML format.
This format helps in sharing of structured data across different information systems. A PDF file of the relevant ITR form is also created along with the XML format. You can download this ITR form, submit it at the ITO and get an acknowledgement.
Save the XML file to your desktop and then upload it on incometaxindiaefiling.gov.in - the IT Department site. Some sites also have provision for online payment of tax. Use of a digital signature will render the e-filing process complete without involving paperwork and visits to the ITO.
In case DS is used, the acknowledgement will be emailed to you. If you upload the file on the tax department's site without the DS, the acknowledgement, called ITR-V, emailed to you will have to be submitted at an ITO within 15 days of downloading it. A DS can be acquired from any of the agencies authorised by the government for the job, including the private and government websites meant for filing tax returns.
E-filing is not just convenient and saves time, it can also be done from anywhere. What is especially important is that the online method reduces or even eliminates the interface between the tax assessee and tax officials.
Online sites
Among the major sites offering e-filing facilities are Taxspanner, Taxsmile and Taxshax. You can either take printouts of the relevant ITRs from these three sites and physically submit them or upload your XML file on the IT Department's site.
Taxspanner uploads the taxpayer's file directly and emails ITR-V to him. With Taxsmile, you can submit the forms at any of its offices spread over the country. They will then forward it to the ITO.
All the three sites are secure and easy to navigate. The major difference among them is on two counts - the number of income sources covered and the process. Get clarity on the cost and features offered. The minimum cost package would normally be only for salary income. The advanced version might be required if you have income from other sources.
The tax sites also differ in the way they ask for information and allow you to input figures. Taxshax gets most of the figures filled up in a single page. Taxspanner has a step-by-step guide and takes one piece of information on one page. Taxsmile gives both these options.
Use of DS raises the cost of e-filing. The amount of this increase varies across tax sites. A DS can be obtained from Taxsmile for Rs 500. Apart from this, you will have to pay for the basic package. Your DS comes with a validity period, after which it has to be renewed.
A DS from Taxspanner, for example, is valid for two years. This site offers a deal in which you can file returns for three years at a cost of Rs 250 a year. To get your DS from a tax site, download the relevant form from it, attach the required documents, such as your identity and address proofs, and courier them to the address concerned. The entire process of acquiring a DS may take around 15 days.
A tax return can also be filed from the government site - incometaxindiaefiling.gov.in/portal/index.jsp - meant for it. Your PAN will work as the username for registering at this site.
Should you go online? Internet accessibility is growing, but it is still out of reach for many of the 40 million taxpayers. For those who have access to it and want to save time, the digital signature way looks ideal - you will be able to file the return in a few minutes from the comfort of your home or office. E-filing without the DS is almost the same as filing returns offline.
Tax laws can often seem like a cross between a Rubik's cube and Mutthiah Muralitharan's spin bowling. The three private tax sites get around this by making themselves friendly to taxpayers and not making filing of return dependent on an intricate understanding of the workings of tax laws. They empower with information and knowledge while taking the taxpayer step-by step through the entire process of tax filing. The details of the return filed get saved in the database of these sites and can be accessed anytime in the future.
If you have any specific doubts concerning the filing process, email the tax site to clear them. Getting clarity is important as some sites do not include things like income from business or profession, losses of earlier years brought forward or clubbed income. If tax is due, check if you can pay it through the site.
Stick to the deadline
Whether you are going offline or online, make sure your are on the right side of 31 July. If tax is due and return is not filed till 31 March of the following year, a penalty of Rs 5,000 is levied. Penalty may also have to be paid in the form of interest. Check out the answers on the next few pages to some frequently asked questions to get on top of tax returns. And then go ahead and file with a smile.
And you know you can't run away from it any more. We are talking about 31 July, the day we are reminded of our bondage, the price we have to pay for many of the good things in our life.
This happens to be the last day for filing income tax returns for all salaried Indians, be they resident or non-resident. Of course, you must have done everything legally possible to maximise your freedom from this bondage called tax. But then, the law permits you only that much. The rest, as they say, is illegal.
You might also have wondered about the word return being used for an outgo. Maybe it's because governments always want citizens to see things from their point of view, perhaps for the larger good.
Filing of tax is compulsory for everyone whose gross total income - the income under the five heads (salary, business, capital gains, house property or other sources) before allowing for any deductions such as insurance premium - exceeds the basic exemption limit.
For financial year 2007-08 (assessment year 2008-09), this limit was Rs 145,000 for women below 65 years of age, Rs 195,000 for senior citizens (above age 65 years) and Rs 110,000 for any other individual. It is compulsory for every person exceeding these limits to file the return before the prescribed date, even if their employer has taken care of their tax liabilities by reducing their salaries by the necessary amounts before paying the rest to them. Paid this way, it is known as tax deducted at source or TDS.
Filing of the form
There are two income tax return forms, ITR-1 and ITR-2, for salaried individuals. Your sources of income (they will fall under one or more of the five sources mentioned earlier) will decide your form. You will have to submit the filled form to the tax authorities and get an acknowledgement from them.
Income source decides return form
ITR-1: Income from salary, pension and interest earned in a financial year
ITR-2: Capital gains, income/loss from house property and income from any other source
Use ITR-1 to file your tax return if your income is from salary, pension or interest. In case of any capital gains, income or loss from house property and income from any other source, you will have to use ITR-2. You can go to www.incometaxindia.gov.in/download_all.asp to download these forms.
You will find ITR-1 relatively simple to fill up. A prerequisite for the exercise is Form 16, the certificate that comes from the employer showing the TDS from the income chargeable under the head salary. ITR-1 is almost a replica of Form 16. All you have to do is pick the numbers from Form 16 and put them in the ITR form.
Apart from salary income, there is an important component of income that many taxpayers ignore while filing their returns. It is the interest income earned from the funds lying in savings accounts in banks. Disclosing that, however small it may be, is mandatory.
You just have to add the total interest credited to your bank account in the last financial year. Scrutinise your income tax return to ensure that no taxable income is undisclosed. After you file your return, the tax authorities will hand you an acknowledgment. That's it, you are through with the filing of returns.
You will need to fill up ITR-2 if you, as a salaried individual, have made any capital gains. This form is filled in the same way as ITR-1. In addition, you will have to fill in income, if any, from house property and other sources.
How to file
The actual filing of return can be done either by using the traditional paper form or electronically, over the Internet. The second, known as e-filing, is fast catching up. The digital method is compulsory for companies, but optional for salaried individuals still. However, it may well become compulsory for individuals with a certain level of income in times to come. So, it may not be a bad idea to familiarise yourself with this process.
Before you start filing the return, check if you would be getting a refund from the IT Department or have to pay tax. In case of the latter, even before starting the filing process, you should first get hold of Form 280, fill it up and deposit it any bank along with the tax payable in cash or cheque. You can also pay tax through Internet banking. In both cases, you will get a receipt number which has to be quoted in the ITR form.
Checklist
* Keep ITR-1, ITR-2 forms handy* Enter all the details in CAPITAL letters* Ensure that name, address and other personal details are entered correctly* Double-check PAN number, bank account details and the MICR code you write* Store the acknowledgement safely property and income from any other source
Doing it offline
There are two options - you may either submit the ITR form at the nearest income tax office after filling it up yourself, or you may get a chartered accountant or a tax return preparer to do it for you. Try to visit the ITO well before the last date for filing return as crowds increase as 31 July draws near.
You may also take help from the public relations officer of the ITO to fill the form. No documents or investment proofs need to be attached with the form, but remember to bring photocopies or originals with you to the ITO. These will come in handy if you are asked to authenticate the maths.
The fee of a CA would depend on your income slab and the number of income sources. Typically, it would range from Rs 300 to Rs 2,000, depending on the complexities involved. One good thing about filing through a CA is that it would bring down the margin of error to nil. Also, depending on the acumen of the CA, which often gets reflected in the quality of his practice, he would suggest some tax saving ways to you for the future.
Doing it online
E-filing is done through sites authorised by the IT Department to file taxes on your behalf. To e-file, you will have to input the details of Form 16 in the software of the website, which would automatically generate an electronic return in XML format.
This format helps in sharing of structured data across different information systems. A PDF file of the relevant ITR form is also created along with the XML format. You can download this ITR form, submit it at the ITO and get an acknowledgement.
Save the XML file to your desktop and then upload it on incometaxindiaefiling.gov.in - the IT Department site. Some sites also have provision for online payment of tax. Use of a digital signature will render the e-filing process complete without involving paperwork and visits to the ITO.
In case DS is used, the acknowledgement will be emailed to you. If you upload the file on the tax department's site without the DS, the acknowledgement, called ITR-V, emailed to you will have to be submitted at an ITO within 15 days of downloading it. A DS can be acquired from any of the agencies authorised by the government for the job, including the private and government websites meant for filing tax returns.
E-filing is not just convenient and saves time, it can also be done from anywhere. What is especially important is that the online method reduces or even eliminates the interface between the tax assessee and tax officials.
Online sites
Among the major sites offering e-filing facilities are Taxspanner, Taxsmile and Taxshax. You can either take printouts of the relevant ITRs from these three sites and physically submit them or upload your XML file on the IT Department's site.
Taxspanner uploads the taxpayer's file directly and emails ITR-V to him. With Taxsmile, you can submit the forms at any of its offices spread over the country. They will then forward it to the ITO.
All the three sites are secure and easy to navigate. The major difference among them is on two counts - the number of income sources covered and the process. Get clarity on the cost and features offered. The minimum cost package would normally be only for salary income. The advanced version might be required if you have income from other sources.
The tax sites also differ in the way they ask for information and allow you to input figures. Taxshax gets most of the figures filled up in a single page. Taxspanner has a step-by-step guide and takes one piece of information on one page. Taxsmile gives both these options.
Use of DS raises the cost of e-filing. The amount of this increase varies across tax sites. A DS can be obtained from Taxsmile for Rs 500. Apart from this, you will have to pay for the basic package. Your DS comes with a validity period, after which it has to be renewed.
A DS from Taxspanner, for example, is valid for two years. This site offers a deal in which you can file returns for three years at a cost of Rs 250 a year. To get your DS from a tax site, download the relevant form from it, attach the required documents, such as your identity and address proofs, and courier them to the address concerned. The entire process of acquiring a DS may take around 15 days.
A tax return can also be filed from the government site - incometaxindiaefiling.gov.in/portal/index.jsp - meant for it. Your PAN will work as the username for registering at this site.
Should you go online? Internet accessibility is growing, but it is still out of reach for many of the 40 million taxpayers. For those who have access to it and want to save time, the digital signature way looks ideal - you will be able to file the return in a few minutes from the comfort of your home or office. E-filing without the DS is almost the same as filing returns offline.
Tax laws can often seem like a cross between a Rubik's cube and Mutthiah Muralitharan's spin bowling. The three private tax sites get around this by making themselves friendly to taxpayers and not making filing of return dependent on an intricate understanding of the workings of tax laws. They empower with information and knowledge while taking the taxpayer step-by step through the entire process of tax filing. The details of the return filed get saved in the database of these sites and can be accessed anytime in the future.
If you have any specific doubts concerning the filing process, email the tax site to clear them. Getting clarity is important as some sites do not include things like income from business or profession, losses of earlier years brought forward or clubbed income. If tax is due, check if you can pay it through the site.
Stick to the deadline
Whether you are going offline or online, make sure your are on the right side of 31 July. If tax is due and return is not filed till 31 March of the following year, a penalty of Rs 5,000 is levied. Penalty may also have to be paid in the form of interest. Check out the answers on the next few pages to some frequently asked questions to get on top of tax returns. And then go ahead and file with a smile.
key ratios for picking good stocks
The following 8 financial ratios offer terrific insights into the financial health of a company -- and the prospects for a rise in its share price.
1. Ploughback and reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book value per share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE), and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.
[Excerpt from Profitable Investment in Shares: A Beginner's Guide by S S Grewal and Navjot Grewal.]
1. Ploughback and reserves
After deduction of all expenses, including taxes, the net profits of a company are split into two parts -- dividends and ploughback.
Dividend is that portion of a company's profits which is distributed to its shareholders, whereas ploughback is the portion that the company retains and gets added to its reserves.
The figures for ploughback and reserves of any company can be obtained by a cursory glance at its balance sheet and profit and loss account.
Ploughback is important because it not only increases the reserves of a company but also provides the company with funds required for its growth and expansion. All growth companies maintain a high level of ploughback. So if you are looking for a growth company to invest in, you should examine its ploughback figures.
Companies that have no intention of expanding are unlikely to plough back a large portion of their profits.
Reserves constitute the accumulated retained profits of a company. It is important to compare the size of a company's reserves with the size of its equity capital. This will indicate whether the company is in a position to issue bonus shares.
As a rule-of-thumb, a company whose reserves are double that of its equity capital should be in a position to make a liberal bonus issue.
Retained profits also belong to the shareholders. This is why reserves are often referred to as shareholders' funds. Therefore, any addition to the reserves of a company will normally lead to a corresponding an increase in the price of your shares.
The higher the reserves, the greater will be the value of your shareholding. Retained profits (ploughback) may not come to you in the form of cash, but they benefit you by pushing up the price of your shares.
2. Book value per share
You will come across this term very often in investment discussions. Book value per share indicates what each share of a company is worth according to the company's books of accounts.
The company's books of account maintain a record of what the company owns (assets), and what it owes to its creditors (liabilities). If you subtract the total liabilities of a company from its total assets, then what is left belongs to the shareholders, called the shareholders' funds.
If you divide shareholders' funds by the total number of equity shares issued by the company, the figure that you get will be the book value per share.
Book Value per share = Shareholders' funds / Total number of equity shares issued
The figure for shareholders' funds can also be obtained by adding the equity capital and reserves of the company.
Book value is a historical record based on the original prices at which assets of the company were originally purchased. It doesn't reflect the current market value of the company's assets.
Therefore, book value per share has limited usage as a tool for evaluating the market value or price of a company's shares. It can, at best, give you a rough idea of what a company's shares should at least be worth.
The market prices of shares are generally much higher than what their book values indicate. Therefore, if you come across a share whose market price is around its book value, the chances are that it is under-priced. This is one way in which the book value per share ratio can prove useful to you while assessing whether a particular share is over- or under-priced.
3. Earnings per share (EPS)
EPS is a well-known and widely used investment ratio. It is calculated as:
Earnings Per Share (EPS) = Profit After Tax / Total number of equity shares issued
This ratio gives the earnings of a company on a per share basis. In order to get a clear idea of what this ratio signifies, let us assume that you possess 100 shares with a face value of Rs 10 each in XYZ Ltd. Suppose the earnings per share of XYZ Ltd. is Rs 6 per share and the dividend declared by it is 20 per cent, or Rs 2 per share. This means that each share of XYZ Ltd. earns Rs 6 every year, even though you receive only Rs 2 out of it as dividend.
The remaining amount, Rs 4 per share, constitutes the ploughback or retained earnings. If you had bought these shares at par, it would mean a 60 per cent return on your investment, out of which you would receive 20 per cent as dividend and 40 per cent would be the ploughback. This ploughback of 40 per cent would benefit you by pushing up the market price of your shares. Ideally speaking, your shares should appreciate by 40 per cent from Rs 10 to Rs 14 per share.
This illustration serves to drive home a basic investment lesson. You should evaluate your investment returns not on the basis of the dividend you receive, but on the basis of the earnings per share. Earnings per share is the true indicator of the returns on your share investments.
Suppose you had bought shares in XYZ Ltd at double their face value, i.e. at Rs 20 per share. Then an EPS of Rs 6 per share would mean a 30 per cent return on your investment, of which 10 per cent (Rs 2 per share) is dividend, and 20 per cent (Rs 4 per share) the ploughback.
Under ideal conditions, ploughback should push up the price of your shares by 20 per cent, i.e. from Rs 20 to 24 per share. Therefore, irrespective of what price you buy a particular company's shares at its EPS will provide you with an invaluable tool for calculating the returns on your investment.
4. Price earnings ratio (P/E)
The price earnings ratio (P/E) expresses the relationship between the market price of a company's share and its earnings per share:
Price/Earnings Ratio (P/E) = Price of the share / Earnings per share
This ratio indicates the extent to which earnings of a share are covered by its price. If P/E is 5, it means that the price of a share is 5 times its earnings. In other words, the company's EPS remaining constant, it will take you approximately five years through dividends plus capital appreciation to recover the cost of buying the share. The lower the P/E, lesser the time it will take for you to recover your investment.
P/E ratio is a reflection of the market's opinion of the earnings capacity and future business prospects of a company. Companies which enjoy the confidence of investors and have a higher market standing usually command high P/E ratios.
For example, blue chip companies often have P/E ratios that are as high as 20 to 60. However, most other companies in India have P/E ratios ranging between 5 and 20.
On the face of it, it would seem that companies with low P/E ratios would offer the most attractive investment opportunities. This is not always true. Companies with high current earnings but dim future prospects often have low P/E ratios.
Obviously such companies are not good investments, notwithstanding their P/E ratios. As an investor your primary concern is with the future prospects of a company and not so much with its present performance. This is the main reason why companies with low current earnings but bright future prospects usually command high P/E ratios.
To a great extent, the present price of a share, discounts, i.e. anticipates, its future earnings.
All this may seem very perplexing to you because it leaves the basic question unanswered: How does one use the P/E ratio for making sound investment decisions?
The answer lies in utilising the P/E ratio in conjunction with your assessment of the future earnings and growth prospects of a company. You have to judge the extent to which its P/E ratio reflects the company's future prospects.
If it is low compared to the future prospects of a company, then the company's shares are good for investment. Therefore, even if you come across a company with a high P/E ratio of 25 or 30 don't summarily reject it because even this level of P/E ratio may actually be low if the company is poised for meteoric future growth. On the other hand, a low P/E ratio of 4 or 5 may actually be high if your assessment of the company's future indicates sharply declining sales and large losses.
5. Dividend and yield
There are many investors who buy shares with the objective of earning a regular income from their investment. Their primary concern is with the amount that a company gives as dividends -- capital appreciation being only a secondary consideration. For such investors, dividends obviously play a crucial role in their investment calculations.
It is illogical to draw a distinction between capital appreciation and dividends. Money is money -- it doesn't really matter whether it comes from capital appreciation or from dividends.
A wise investor is primarily concerned with the total returns on his investment -- he doesn't really care whether these returns come from capital appreciation or dividends, or through varying combinations of both. In fact, investors in high tax brackets prefer to get most of their returns through long-term capital appreciation because of tax considerations.
Companies that give high dividends not only have a poor growth record but often also poor future growth prospects. If a company distributes the bulk of its earnings in the form of dividends, there will not be enough ploughback for financing future growth.
On the other hand, high growth companies generally have a poor dividend record. This is because such companies use only a relatively small proportion of their earnings to pay dividends. In the long run, however, high growth companies not only offer steep capital appreciation but also end up paying higher dividends.
On the whole, therefore, you are likely to get much higher total returns on your investment if you invest for capital appreciation rather than for dividends. In short, it all boils down to whether you are prepared to sacrifice a part of your immediate dividend income in the expectation of greater capital appreciation and higher dividends in the years to come and the whole issue is basically a trade-off between capital appreciation and income.
Investors are not really interested in dividends but in the relationship that dividends bear to the market price of the company's shares. This relationship is best expressed by the ratio called yield or dividend yield:
Yield = (Dividend per share / market price per share) x 100
Yield indicates the percentage of return that you can expect by way of dividends on your investment made at the prevailing market price. The concept of yield is best clarified by the following illustration.
Let us suppose you have invested Rs 2,000 in buying 100 shares of XYZ Ltd at Rs 20 per share with a face value of Rs 10 each.
If XYZ announces a dividend of 20 per cent (Rs 2 per share), then you stand to get a total dividend of Rs 200. Since you bought these shares at Rs 20 per share, the yield on your investment is 10 per cent (Yield = 2/20 x 100). Thus, while the dividend was 20 per cent; but your yield is actually 10 per cent.
The concept of yield is of far greater practical utility than dividends. It gives you an idea of what you are earning through dividends on the current market price of your shares.
Average yield figures in India usually vary around 2 per cent of the market value of the shares. If you have a share portfolio consisting of shares belonging to a large number of both high-growth and high-dividend companies, then on an average your dividend in-come is likely to be around 2 per cent of the total market value of your portfolio.
6. Return on Capital Employed (ROCE), and
7. Return on Net Worth (RONW)
While analysing a company, the most important thing you would like to know is whether the company is efficiently using the capital (shareholders' funds plus borrowed funds) entrusted to it.
While valuing the efficiency and worth of companies, we need to know the return that a company is able to earn on its capital, namely its equity plus debt. A company that earns a higher return on the capital it employs is more valuable than one which earns a lower return on its capital. The tools for measuring these returns are:
1. Return on Capital Employed (ROCE), and
2. Return on Net Worth (RONW).
Return on Capital Employed and Return on Net Worth (shareholders funds) are valuable financial ratios for evaluating a company's efficiency and the quality of its management. The figures for these ratios are commonly available in business magazines, annual reports and economic newspapers and financial Web sites.
Return on capital employed
Return on capital employed (ROCE) is best defined as operating profit divided by capital employed (net worth plus debt).
The figure for operating profit is arrived at after adding back taxes paid, depreciation, extraordinary one-time expenses, and deducting extraordinary one-time income and other income (income not earned through mainline operations), to the net profit figure.
The operating profit of a company is a better indicator of the profits earned by it than is the net profit.
ROCE thus reflects the overall earnings performance and operational efficiency of a company's business. It is an important basic ratio that permits an investor to make inter-company comparisons.
Return on net worth
Return on net worth (RONW) is defined as net profit divided by net worth. It is a basic ratio that tells a shareholder what he is getting out of his investment in the company.
ROCE is a better measure to get an idea of the overall profitability of the company's operations, while RONW is a better measure for judging the returns that a shareholder gets on his investment.
The use of both these ratios will give you a broad picture of a company's efficiency, financial viability and its ability to earn returns on shareholders' funds and capital employed.
8. PEG ratio
PEG is an important and widely used ratio for forming an estimate of the intrinsic value of a share. It tells you whether the share that you are interested in buying or selling is under-priced, fully priced or over-priced.
For this you need to link the P/E ratio discussed earlier to the future growth rate of the company. This is based on the assumption that the higher the expected growth rate of the company, the higher will be the P/E ratio that the company's share commands in the market.
The reverse is equally true. The P/E ratio cannot be viewed in isolation. It has to be viewed in the context of the company's future growth rate. The PEG is calculated by dividing the P/E by the forecasted growth rate in the EPS (earnings per share) of the company.
As a broad rule of the thumb, a PEG value below 0.5 indicates a very attractive buying opportunity, whereas a selling opportunity emerges when the PEG crosses 1.5, or even 2 for that matter.
The catch here is to accurately calculate the future growth rate of earnings (EPS) of the company. Wide and intensive reading of investment and business news and analysis, combined with experience will certainly help you to make more accurate forecasts of company earnings.
[Excerpt from Profitable Investment in Shares: A Beginner's Guide by S S Grewal and Navjot Grewal.]
Subscribe to:
Posts (Atom)