Money Market Instruments – Portfolio Management for Armed Forces Officers

SECTION I : STOCKS

The aim of this Section is not to teach the mechanics of stock market, or its virtues or otherwise. Suffice it to say that if played properly, stocks have the potential to give year-after-year returns much in excess of any other investment avenue. However, an undeniable fact remains that, apart from the beginner’s luck, the risk in stocks is probably the highest of any asset class. On the other hand, one would be lucky to come out unscathed if any stock investment is made without due diligence and the market turns volatile. Some people, out of plain ignorance, tend to equate stock market to a gambling den – it can only be said that they are depriving themselves of a great investment class due to their lack of knowledge.

Fundamental Guidelines of ‘The Market’

While it is true that, in the stock market, there is no rule without an exception, there are some principles which are tough to dispute:-

Sell the losers and let the winners ride! Time and time again, investors take profits by selling their appreciated investments, but they hold onto stocks that have declined, in hopes of a rebound. Just remember not to let your fears limit your returns or inflate your losses. The following information might help:-

  • Riding a Winner – No one in the history of investing with a ” I’ll-sell-after-I-have-tripled-my-money” mentality has ever had a ten-bagger.
  • Selling a Loser – Don’t be afraid to swallow your pride and move on before your losses become even greater!

Don’t chase the “hot tip”. When you make an investment, it’s important you know the reasons for doing so: do your own research and analysis of any company before you even consider investing your hard earned money.

Don’t sweat the small stuff. As a long-term investor, you shouldn’t panic when your investments experience short-term movements.

Do not overemphasise the P/E ratio. Investors often place too much importance on the Price-to-Earning ratio. The P/E ratio must be interpreted within a context, and it should be used in conjunction with other analytical processes.

Resist the lure of penny stocks. A common misconception is that there is less to lose in buying a low-priced stock. In fact, a penny stock is probably riskier than a company with a higher share price, which would have more regulations placed on it.

Focus on the future. It’s important to keep in mind that, even though we use past data as an indication of things to come, it’s what happens in the future that matters most.

Borrow Expertise and Knowledge to Win. As smaller retail investors, we are constrained by large number of limitations on our knowledge. It is better to invest in the stock market using the expertise of good brokerage houses (or of Mutual Fund managers) so that our long and short term goals are fulfilled through this powerful investment vehicle.

Common Pitfalls to be Avoided

  • Not being disciplined and failing to cut losses at 8% below the purchase price. But do not to sell a winning stock just because it pulls back a little bit.
  • Do not purchase low-priced, low quality stocks.
  • Do not let emotions or ego get in the way of a sound investing strategy.
  • Invest in equities for long term and not short term.
  • Not keeping an eye on what the big players / mutual funds buy & sell is a pitfall and an opportunity lost to pick the right stocks
  • Patience is a virtue in investing. Do not panic on your existing stocks.
  • Do not be unaware of what is happening around in the market. Dig for more information other than just the top stories that are flashed in media.
  • Do not put all your money on the same horse. Diversify your portfolio ideally into five industries and ten stocks.
  • Greed is dangerous. Once a reasonable profit is made, the investor should get out of the market quickly.

SECTION II : MUTUAL FUNDS

Put simply, a mutual fund is an investment vehicle that pools in the monies of several investors, and collectively invests this amount in either the equity market or the debt market, or both, depending upon the fund’s objective.

This is one investment vehicle that has truly come of age in India in the past decade. The mutual fund industry’s Assets Under Management (AUM) was Rs 6,21,946 crore as on 31 Dec 2011, a large part of which comes from retail investors. Mutual funds have emerged as a proxy for investing in avenues that are out of reach of most retail investors, particularly government securities and money market instruments.

Mutual funds: The Advantages…

Here are some compelling arguments in following the mutual fund route:-
Professional management. Most of us have neither the skill to find good stocks that suit our risk and returns profile nor the time to track them.

Small investments. Investment in mutual funds can be made for as small an amount as Rs 500 while utilising the investment knowledge of experts.

Diversified portfolio. For a small amount, investors get a hugely diversified portfolio, one of the oft-mentioned basic tenets of portfolio management.

Liquidity. You are free to take your money out of open-ended mutual funds whenever you want, no questions asked.

Tax breaks. Last but not the least, mutual funds offer significant tax advantages like tax-free dividends, capital gains taxation and benefits under Section 88 through tax-saving schemes and pension.

And disadvantages

Mutual funds carry risk and offer no assured returns or protection of capital. They do not offer assured returns, nor are insured or guaranteed by any government body.

Types of Mutual Funds

Many people tend to wrongly equate mutual fund investing with equity investing only. In-fact, equity is just one of the various asset classes mutual funds invest in. They also invest in debt instruments such as bonds, debentures, commercial paper and government securities as also in Gold.Equity funds. The highest rung on the mutual fund risk ladder, such funds invest only in stocks. At present, there are four types of equity funds available in the market. In the increasing order of risk, these are:-

  • Index funds which track a key stock market index, like the BSE Sensex or the NSE Nifty.
  • Diversified funds which have the mandate to invest in the entire universe of stocks.
  • Tax-saving funds which offer benefits under Section 88 of the Income-Tax Act but you are locked into the scheme for three years.
  • Sector funds, the riskiest among equity funds which invest only in stocks of a specific industry or a particular theme.

Debt funds which invest exclusively in fixed-income instruments securities like bonds, debentures, Government securities, and money market instruments such as certificates of deposit (CD), commercial paper (CP) and call money. There are basically of three types:-

  • Income funds They park a major part of their corpus in corporate bonds and debentures.
  • Gilt funds They invest only in government securities and T-bills.
  • Liquid funds which invest in money market instruments (duration of up to one year) such as treasury bills, call money, etc.

Balanced funds invest in a pre-determined proportion in equity and debt – like, 60:40 in favour of equity. Therefore, they are a good option for investors who would like greater returns than from pure debt, and are willing to take on a little more risk in the process.

Six Rules to Intelligent Investing in Mutual Funds

Know your risk profile: Ask yourself – Can you live with volatility? Or are you a low-risk investor? Would you be satisfied if your fund invests in fixed-income securities, and yields low but sure-shot returns?

Identify your investment horizon: Invest in an equity fund only if you are willing to stay on for at least two years. For income and gilt funds, have a one-year perspective at least. Anything less than one year, the only option among mutual funds is liquid funds.

Read the offer document carefully
Go through the fund fact sheet
Diversify across fund houses

Track your investments through websites like valueresearchonline.com, mutualfundsindia.com and moneycontrol.com, which are complied on a quarterly basis.

And the caveat …

Mutual funds are not immune to risk: risk is inherent to their operation. Different plans have differing degrees of risk, depending upon the fund’s management style and its objective; it is important that you know the risk involved in your fund(s).

SECTION III : REAL ESTATE

As far as statistics are concerned, real estate/property investment is, and always has been, the most powerful type of investment for building wealth. It has been said that over 90% of the world’s millionaires got there by owning property. Investing in property offers two major benefits: capital growth and tax advantages.

In the early stages of property investment, rental incomes often don’t exceed your outgoings on a property – particularly the costs of servicing the loan. But as the property increases in value, rents tend to rise faster than costs and the property generates net income. However, it would not be correct to recommend property to the exclusion of other investments. A strong portfolio is a diversified one, with investments spread across different asset classes.

Advantages of Investing in Property

  • No investment today offers the stability, simplicity and excellent returns offered by property investment.
  • While the Stock Market offers high returns, many investors have found it to be a volatile and dangerous place.
  • No other investment allows you to purchase with other peoples’ money (Bank’s) and pay this back with other peoples’ money (rental income from tenants)!
  • Although there is no law stating that your property will increase in value each year, it is a well documented fact that, on average, the value of a property doubles at least every seven years provided the property has been carefully selected.

To make property investing even more attractive, there may soon be Real Estate mutual funds in the Indian markets. Real Estate Investment Trusts (REITs) are companies that buy, sell, manage and develop real estate assets using money much like mutual funds. So if you want a piece of the action in the real estate market, all you have to do is buy shares of a REIT. REIT makes its money in several ways:-

  • Buying and selling property
  • Developing commercial space
  • Renting and leasing commercial space
  • Financing mortgages and loans on property

How much can you afford?

What kind of property you can afford is basically a function of how much you can borrow. The monthly home loan instalment has two distinct parts: the interest (calculated at the loan interest rate on the principal outstanding for that month) and the principal balance.

Tax advantages of taking a housing loan. A housing loan comes with two tax benefits which further reduces the cost of your borrowing. One is an exemption for interest paid on a housing loan, currently up to an interest paid of Rs 1.5 lakh per year on a self-occupied house and UNLIMITED on a rented out house. The other is a tax break on principal repaid in the year under IT section 80C subject to the current maximum overall limit of Rs 1,00,000 under this section.

How does indexation work?

Let’s take an example. If you had bought an asset during financial year 1981-82 for Rs 3 lakh, and sold it in 1993-94 for Rs 8 lakhs, your capital gains will be less than the apparent Rs 5 lakh, due to indexation as below:-

Cost in 1981-82 (base year, when cost inflation index is 100) Rs 3 lakhs

Cost inflation index in 1993-94 when the asset was sold. 244

Therefore, cost after factoring in the cost inflation index. (Rs 3 lakh x 244/100)Rs 7.32 lakhs

Net capital gain (8 lakhs ‘minus’ 7.32 lakh) Rs 68,000 Only

The benefit of the cost of inflation index is also available in the case of cost of improvement from the year in which the improvement is effected.

SECTION IV : GOLD

Gold has worked down from Alexander’s time. When something holds good for two thousand years, I do not believe it can be so because of prejudice or mistaken theory.

– Bernard Baruch (1870-1965), American millionaire

Over the ages, Gold has worked as an investment, especially during times of economic crisis, political strife and wars. It has also been used to back currencies. In the year 2011, almost 980 tonnes of gold were bought in India, the world’s largest market for gold, a 40% jump over the corresponding period last year. Such is the demand for gold in India that prices have increased in the long term, even in the last decade, when many central banks sold their gold holdings. The compounded annual growth rate (CAGR) of gold prices over the last 10 years stand at 19.6 per cent. The price of gold is expected to rise also because Central banks of several countries have been adding to their gold reserves and the cost of production is rising. Moreover, activities in many African mines have reduced due to strife, adding to the low supply situation.

What kind of gold should you buy? If you see this purely as an investment, you can either buy it in the form of physical gold-bars, biscuits or coins or even in a dematerialised form. The disadvantage of buying gold in the form of jewellery is that its resale is not always a profitable proposition, one cannot be sure of the purity, and handling and storing remains an issue. Bars and biscuits are better as they can easily be exchanged for cash even though while purchasing these may be priced up to 8-20% above the market value of Gold. The modern way to invest is buying dematerialised gold from a commodity exchange – it eliminates risks related to physical storage and theft, reducing paper work and facilitating easy transfer of holdings through the electronic mode. However, a very good option that has emerged now is buying the Gold Exchange Traded Funds (Gold ETFs) on stock exchanges. These are typically in denomination of single units, generally representing one gram of gold each. Many companies, like Reliance, Kotak, Quantum, Benchmark and UTI, are offering the same on NSE (National Stock Exchange) and they are bought and sold exactly like stocks. In case you wish to buy in small quantities regularly so as to build up a good gold portfolio over a period of time, Gold Mutual Funds is the best option. Here you buy Gold units exactly like you buy any other units – in small nibbling through Systematic Investment Plans (SIP) and/or in bulk.

Where should you buy Physical gold from? Bullion experts recommend that it is best to buy gold from a reputed jeweller. Banks that sell gold bars charge a premium as high as 8-20% for providing you with a ‘certificate of purity’, but they are not allowed to buy it back and the jeweller that you sell it to has no use for that certificate. You end up paying a premium for no real value addition. If you buy from reputed jewellers, not only do they buy it back from you, they also give you the prevailing market rate for it.

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