Divya Premkumar, Author at Trade Brains

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Socially Responsible Investing (SRI): Why it matters?

Introduction to Socially Responsible Investing (SRI): Deciding how you want to invest your money is often hard. You need to take many factors into consideration such as risk, returns, taxes, and inflation. It takes a lot of forethought and groundwork to figure out a way to get the best return on your investments.

Yet, there are some investors who choose to invest in companies that are not only financially stable but also make a positive impact on the environment. Socially Responsible Investing or SRI is choosing to invest in stocks that provide a financial gain as well as do social good.

The companies are evaluated based on the ESG index: environment, social justice, and corporate governance.

Although socially-responsible investing is still up and coming in India, it is expected to gain greater momentum in the next few years. Companies have become more aware of the ESG factors and are looking to incorporate more of it into their business practices.

Socially Responsible Investing History

Socially responsible investing began in the early 1700s when the Quakers refused to participate in the slave trade in the U.S. Pastor John Wesley, the leader of the Methodist church claimed it was a sin to make a profit at the cost of your neighbor’s well-being. He stated that it was unethical to gamble and invest in industries that used toxic chemicals.

For many decades after John Wesley’s speech, investors avoided industries such as tobacco and liquor referring to them as ‘sin industries’. This evolved in the 1960s when investors decided to invest their money in companies that promoted social causes such as women’s rights and civil liberty.

Socially responsible investing played a huge role in South Africa during the 1980s when investors began pulling out their money due to the apartheid or the segregation of races. SRI had a prominent role in helping bring an end to the apartheid in 1994.

Sustainability Indexes

If you look into the American and European nations, they already a family of indices evaluating the sustainability performance of thousands of companies trading publicly. The Dow Jones Sustainability Indices (DJSI) launched in 1999, are the longest-running global sustainability benchmarks worldwide. To be incorporated in the DJSI, companies are assessed and selected based on their long-term economic, social and environmental asset management plans.

For India, S&P BSE has three main indices that measure corporate sustainability: S&P BSE 100 ESG INDEX, S&P BSE GREENEX, and S&P BSE CARBONEX.

How to be a Socially Responsible Investor?

Here are a few points that can help you become a socially responsible investor:

— Know the difference

The first and foremost important step to becoming a socially responsible investor is to know the difference between traditional and responsible investing. The difference might be in returns that you get from your investments. The returns from socially responsible investing may differ a little from the traditional one as you might be leaving behind a lot of high return investment options. However, always remember the reason why you have opted for this way of investing.

— Do your research

This is where investors use negative and positive screening to shortlist investment options. In the negative screening, they avoid investing in companies that don’t relate to their social values. Many mutual funds that are socially responsible screen out tobacco and liquor companies. One type of negative screening is divestment, this is where investors take their money out of certain companies because they do not like their business practices or social values.

Along with screening out negative companies, it is also important for investors to choose companies that align with their values. These are companies that strive to bring change to a social aspect that the investor finds important along with their socially responsible business practices. This is also known as impact investing or incorporation of ESG.

— Use your influence as a shareholder

Shareholders not only invest in companies that align with their values but they also use their position to influence the actions of the company in which they own stock. Investors do this by filing a shareholder resolution. This is a document outlining the shareholder’s suggestions for management on how to run the company in a more socially responsible way.

— Invest in the community

This is where an investor invests in companies that have a positive impact on the community. This is usually done in low-income areas where the investment is used to provide loans to people and small-business owners who would otherwise have trouble getting approved for a loan. Community investments also support ‘green companies’ that have a large carbon footprint on the environment.

— Lead by examples

Socially responsible investing is still in the early adoption phase. By making the right investment choices, you can make a real positive impact on the community- along with building wealth. Moreover, sooner or later, social consciousness will become the selling point for global companies. And you, being a part of it, can lead the movement.

How to get started with Socially Responsible Investing?

1. Decide what your social principles are

Before you choose your stocks you need to decide what social goals you want to promote. You should focus on your values and what you want to achieve through your investments.

2. Decide what your financial goals are

The next step is to decide what financial goals you want to achieve through your investment just as you would with any other investment. You need to decide how much return you need to meet your goals as well as how much risk you are willing to handle. SRI has been shown to provide comparable returns as a traditional stock would.

3. Choose the fund that meets your needs and goals

Once you have decided what your social and financial goals are, the next step is to find the investment that’s right for you. The most common ESG funds in India include Tata Ethical Fund, Taurus Ethical Fund, and Reliance ETF Shariah BeES.

Social investing has also resulted in the success of micro-finance. This was created by social investors to create an impact on small businesses and has now become an industry worth over $8bn and is now a mainstream financial service.

Also read:

Conclusion

Socially Responsible investing is becoming increasingly popular in India and there has been a visible shift in the market strategy adopted by many participants as they incorporate social, economic and governance (ESG) factors into their investment process. Stakeholders realize the importance of their role in financial markets to influence sustainable growth.

According to the Indian Impact Investors council ‘more than 30 impact funds have invested in social enterprises in India’. There has been $2billion investment in over 300 companies in India.

While socially responsible investing is still not as big as traditional investing in India, it is still a rapidly growing market. Social investing in India has helped provide basic needs such as housing and education to the poor. Many investors have now realized the power and influence they have to make a positive impact on society.

April 18, 2020 Divya Premkumar Personal Finance No comments yet

What is Nifty and Sensex? Stock Market Basics (For Beginners) cover

How Does The Stock Market Affect The Economy?

The stock market and the economy are in a lot of talk in recent days. Seeing the market indexes declined by over 30% within a month, an obvious question among people is to understand how does the stock market affects the economy.

In this article, we are going to answer the same and discuss the effect of rising or falling stock market on the economy. In addition, we’ll also answer whether the stock market and the economy are the same or not. Let’s get started.

Why do we have a stock market?

A stock is a type of security that represents an individual’s ownership in a company and a stock market is a place where an investor can buy and sell ownership of such assets. Trading stock on a public exchange is essential for economic growth as it allows companies to raise capital through public funding, pay off debts or expand the business.

The stock market exists for two main reasons, the first is to provide a company with the opportunity to raise capital that can be used to expand and grow the business.

If a company issues one million shares that can sell at $4 a share, this allows them to raise $4 million for the business. Companies find it favorable to raise capital this way so they can avoid incurring debt and paying steep interest charges.

The stock market also provides investors with the opportunity to earn a share in the company’s profit.

One way to do this is to buy stocks and earn regular dividends on its value- that is the investor earns a certain amount of money for each stock they own.

Another way is to sell the stock to buyers for a profit when the price of the stock increases. If an investor buys a share for $20 and the price eventually increases to $25, the investor can sell the stock and realize a profit of 25%.

Also read: Why do Stock Markets Exist? And Why is it So Important?

How the Stock Market affects the Economy?

The increase and decrease in stock prices can influence numerous factors in the economy such as consumer and business confidence which can, in turn, have a positive or negative impact on the economy as a whole. Alternatively, different economic conditions can affect the stock market as well.

Here are a few ways the stock market can affect the economy of a country:

— Movements in the Stock Market

The movements in the individual prices of stocks give the stock market a volatile character. As stock prices move up or down, their volatility can have a positive or negative impact on consumers and businesses.

In the event of a bull market or a rise in the prices of stocks, the overall confidence in the economy increases. People’s spending also increases as they become more optimistic about the market. More investors also enter the market and this feeds into greater economic development in the nation.

When the prices of stock fall for a continuously longer period, also known as a bear market, it has a negative effect on the economy. People are pessimistic about the economic conditions and news reports on falling stock prices can often create a sense of panic. Fewer investors enter the market and people tend to invest in lower-risk assets which further depresses the state of the economy.

Also read: What is Bull and Bear market? Stock Market Basics

(Image credits: 5paisa.com)

— Consumption and the Wealth effect

When stock prices rise and there is a bull market, people are more confident in the market conditions, and their investment increases. They tend to spend more on expensive items such as houses and cars. This is also known as the wealth effect which is how a change in a person’s income affects their spending habits and eventually leads to growth in the economy.

In the case of a bear market or a fall in stock prices, there is a negative wealth effect. It creates an environment of uncertainty among consumers and a fall in the value of their investment portfolios decreases spending on goods and services. This affects economic growth as consumer spending is a major component of Gross Domestic Product.

A common situation of the wealth effect was during the US housing market crash of 2008, which had a large negative impact on consumers wealth.

(Image credits: Investopedia)

— Impact on Business Investment

Apart from consumer spending, business investment is also a key indicator of economic growth.

When stock prices are high, businesses are likely to make more capital investments due to high market values. Many companies issue an IPO during this time as market optimism is high and it is a good time to raise capital through the sale of shares. There is also more mergers and acquisitions during a bull market and firms can use the value of their stock to buy out other companies. This increased investment feeds into greater economic growth.

When the stock market is bearish, it has the opposite effect on investment. Confidence in the economy decreases and businesses are no longer eager to invest in the economy. The decrease in share price makes it harder for companies to raise funding in the stock market.

Other factors

The stock market also affects the bond market and pension funds. A large part of pension funds are invested in the stock market and a decrease in the price of shares will lower the value of the fund and affect future pension payments. This can lower economic growth as people who depend on pension income will tend to save more and this lowers spending and eventually the GDP.

While a fall in share prices has a negative impact on economic growth and GDP of a nation, it has a positive effect on the bond market. When there is a depression in the stock market, people look for other assets to invest their money in such as bonds or gold. They often provide a better return on investment than shares in the stock market.

Remember, it is always important to diversify your investment portfolio and spread your risk. Don’t throw all your eggs into one basket.

Final Thoughts: Stock market and Economy are not the same

Contrary to popular belief, the stock market and the economy are two different things. The GDP of an economy and the stock market gains are incompatible and, in fact, there is little comparison between the two. The major reason for this discrepancy is the difference in the size of the two markets. The economy depends on millions of factors that can have both a positive and negative impact, while the stock market is only affected by one factor, the supply and demand of stocks.

Also read:

The Stock Market and the Economy Are Two Different Things -The Balance

There’s Almost No Relationship Between The Magnitude Of GDP Growth And Stock Market Performance -Business Insider.

For investors in the stock market, it is better to err on the side of caution and focus on the fundamentals of each stock rather than on the economy as a whole. As the saying goes ‘an economist is a trained professional paid to guess wrong about the economy’.

March 20, 2020 Divya Premkumar Economics, Investment Basics 1 comment

6 things you should NOT do when the stock market is Volatile!

What ‘NOT’ do when the stock market is Volatile: Investing in the stock market is known to provide some of the highest long-term returns and can earn investors a profit in manifolds over the years.

People invest in stocks to reach their financial goals and earn a profit on their savings. It is a way to make money work for you rather than you working for the money.

What is stock market volatility?

Investing in stocks is a risky business. While investors can earn a high return on shares, we cannot overlook the volatility that comes with it.

Volatility can be described as the continuous change in the prices of stocks over a short period of time. Here, the price of stocks can rise on a certain day and can fall the very next day. For example, you may have seen situations where Sensex may have fallen over 400 points in a day and recovered on the very next. This can be considered as volatility.

High volatility also increases the VIX ratio (Volatility Index) also known as the Fear Index. It measures the amount of fear in the market as a result of the volatility.

The fear caused by a volatile market makes investors react in many different ways. Some start to panic as their investments get riskier and try to sell & exit the market. On the other hand, there are contrarian investors, who prefer investing only in situations when others are selling. Anyways, as shares start to lose value, investors often make hasty decisions that can result in terrible outcomes.

6 things you should NOT do when the stock market is volatile!

Here are six things investors should not do when the stock market is volatile:

1. Don’t Panic!

The number one reaction investors have when there is volatility in the market is to panic and make speculations. It is important not to be influenced by fear and do something irrational. Investors can consider buying a stock at a lower price but should not panic-sell. Instead, they should use this period of volatility to evaluate the stocks in their portfolio.

There are often many reasons why a person invests in a particular stock in the first place. If the fundamental values of why you invested in the stock are clear, then you should remain invested. However, if you are not sure of a particular investment, meet with your financial planner to decide a course of action to exit the market.

Remember, volatility in the market is only short-term, don’t panic-sell if your long-term objectives of investing in the market haven’t changed.

2. Don’t buy JUST BECAUSE prices are low!

When there is volatility in the stock market it is not advisable to invest in the market just because prices are low. This is because there is no guarantee that a stock with a low price today will increase in value in the future. In fact, the price may go even lower and you could end up in a value trap. (Also read- What are value traps?)

You need to analyze the stock’s fundamentals and track record. Look into factors like revenue growth, profit margin, price to earnings, debt-to-equity ratio etc as well as its future potential. If the stock shows a history of riskiness and volatility it would be best not to invest in them. Don’t be a bottom fisher!

3. Don’t believe everything you see on the news!

A sudden ‘breaking news’ segment on the stock market can cause people to make investment decisions that can prove to be disastrous in the future. News reports are not always authentic and often mislead or misguide the investor which can affect the sustainability of a stock.

News reports about the volatility of stock markets are usually short-lived and stock prices will bounce back like a ping-pong ball before you know it. This short-term volatility is often due to a current event in the economy. Once the event has passed, your stock price should be back to normal. As a serious investor, be aware of ‘breaking news’ but don’t follow it blindly.

4. Don’t make decisions based on international markets!

During certain periods, there can be a correlation between local and international stock markets. For example, a change in the leadership of a country could affect numerous economies around the world. But statistically speaking, such a correlation does not exist most of the time.

Volatility in the stock market is a reflection of individual events in an economy or movements in the economic cycle. The stock prices are a result of the anatomy of the local economy. For example, the Dow Jones in the US is completely independent of the stock prices in NSE’s NIFTY. Hence, investors should not be influenced by volatility in international markets, there may be various factors that could affect these stock prices.

5. Don’t rush to invest in volatile sectors!

An important rule for investors is to study trends in the market before investing. If there are particular stocks that drive bear markets- avoid these.

A stock that has a financial risk and a low standard of corporate regulations often leads to long-term problems and has a low chance of recovering. These stocks will have short bursts of upward movements but will have a long-term downward trend.

Do a market analysis of the sector you are investing in, if the industry shows a history of high volatility- you should remain cautious before you invest too much money into it.

6. Don’t put all your eggs in one basket- Diversify your portfolio!

One of the biggest mistakes an investor can make is not investing in a variety of stocks. If a certain industry shows potential for high returns, it is not a wise decision to invest all your money here. This is because if a certain economic event has a negative impact on the industry- it could result in a huge financial loss for the investor.

It is better to spread your risk and invest in different stocks that are stable, have a strong market presence and good growth potential. Here, even if you face volatility in one of your assets, you have a diverse portfolio of stocks to cover your losses.

An investor looking to reduce their risks and control losses should diversify their portfolio and not invest in too many volatile stocks. Greed can often take over fear and this can prove to be disastrous. Investors need to perform a thorough analysis of the stock market before picking stocks to invest in. If they do not have the bandwidth to do this, they can consult a financial advisor.

Also read:

When the stock market is volatile, follow the tips listed above to help you get through a period of high stock market volatility. While it is important to safeguard your portfolio from the effects of a volatile market, remember the biggest risk is not taking any risk at all.

March 16, 2020 Divya Premkumar Investment Basics 1 comment

Why do Stock Markets Exist? And Why is it so Important?

A stock market is a public market where people can buy and sell shares on the stock exchange. The stocks, also known as equities, represent ownership in the company.

Stock markets have existed for centuries. The oldest stock exchange was started in Belgium back in 1531. The brokers and moneylenders used to meet there to deal with the businesses. However, they never used actual stocks but traded in promissory notes and bonds. Later, the Amsterdam Stock Exchange was established in 1602 by the Dutch East India Company and regarded as the first real stock exchange.

Since its inception, stock markets have served many purposes, the most important being to provide companies with a source to raise capital for investment and expansion.

Why do stock markets exist?

Stock markets exist to serve the wider economy. It helps individuals earn a profit on their income when they invest in the stock market and allows firms to spread their risks and receive large rewards. It also enables the government to increase spending through the tax revenue they earn from corporations that trade on the stock exchange. The government uses the revenue to increase re-investment and employment capacity.

The stock market plays an important role in the economy of a country in terms of spending and investment. Without stock markets, many countries would not be as developed as they are. Alongside this, it has helped individuals become wealthy and increases the overall standard of living in many economies.

Following are some of the most important functions of a stock market in the economy:

— Stock market helps companies raise capital

If stock markets did not exist, companies would have to resort to borrowing from the bank to raise money for expansion. This would be a burden on the company as they would have to repay the loans with interest.

Fortunately, with stock markets, businesses have the ability to create an initial public offering and raise large amounts of cash without having to worry about repayment. Moreover, publicly traded companies have no obligation to pay dividends when they incur losses.

Capital raised this way can help companies expand operations and create jobs in the economy. From a greater economic perspective, consumer spending increases, governments can benefit from tax revenues and there will be lower levels of unemployment.

— Stock market helps create personal wealth

One of the most important benefits of the stock market is its ability to help generate personal wealth in the economy.

For the individual investor, the stock market provides a way to invest your income to earn a share of the companies’ profits. The revenue they earn can increase spending in the economy that can have a multiplier effect. The increased spending by individuals leads to increased investment and employment.

— It helps increase investment in the economy

One of the key drivers of Gross Domestic Product is the level of investment in the economy. Governments often create fiscal and monetary policies in the economy to promote greater investment. The stock market is considered to be one of the most prominent sources for people to invest money in.

Furthermore, investors are always looking to invest in companies with high growth potential. If the stock market is performing well, this not only increases investment from local investors but also attracts foreign direct investment as people abroad invest in the local stock exchange. For example, people in India can invest in the NYSE which helps increase GDP of the US economy or vice-versa.

— Market serves as an indicator of the state of the economy

(Sensex last +30 years graph)

The performance of the stock market is a rough indicator of how well the economy is performing. This often depends on speculators and perceptions of investors in the market. A rise or fall in the price of shares represents what cycle the economy is in such as a recession or a boom.

There is a symbiotic relationship between the state of the economy and the performance of the stock market. Economists use this as a way to analyze the past performance of investment and spending which helps them in the creation of new economic policies. The stock market serves as a barometer for the economy.

Also read:

— Stock Market also affects non-investors in the economy

All members of society are affected by the stock market performance regardless of whether or not they invest in stocks.

People with pension funds and retirement accounts are impacted by low stock prices as the value of their accounts is tied to the stock market. Companies can also reduce employee benefits (pensions) as they can no longer afford to spend money on this which can delay the retirement age. Furthermore, when a company’s share price goes down, it affects job security as firms cut back on spending and many people could end up losing their jobs.

The stock market also impacts the rate of taxes and interest rates set by the government. During the Great Depression, the US government lowered taxes to induce borrowing but once the economy was out of depression, the government increased interest rates to encourage investment. Interest rates can affect a non-investor because a person renting out a home does not have to pay interest on a home loan directly but the landlord is likely to increase the rent to cover the high-interest expense.

Closing Thoughts

The stock market gives opportunities to the businesses and the public to transfer capital and ownership in a controlled, secure and managed environment. In addition to providing a convenient way for companies to raise capital and for individuals to increase wealth, the stock market helps keep a check on corporate regulation and increases the economic growth and prosperity of the nation.

March 12, 2020 Divya Premkumar Investment Basics 1 comment

Cyclical and Non-cyclical stocks: How do they differ?

The best offense is a good defense. Just like in military combat or football, investors also need a good offense and defense strategy. In other words, you need to use more than one strategy in order to succeed. As a serious investor, there are many different ways you can do this. You can invest in a variety of stocks, cash, and other securities, you can also diversify your portfolio by investing in securities across various sectors and markets or you can invest in stocks that are at different growth and value levels.

Implementing the right strategy requires a good knowledge of the global economy and how the markets work- if you don’t have a good understanding of this, making decisions become incredibly difficult. As we all know, the economy goes through different business cycles and while we can’t predict the outcome of the cycles we can alter our decisions to keep up with the ever-changing landscape. This changing environment also provides a great way for investors to mix up their portfolio, namely with investing in cyclical and non-cyclical industries.

What are cyclical stocks?

As the name suggests, cyclical stocks are those that move in the direction of the market. That is when the economy is doing well, the stocks go up and when there is a downturn in the economy, the value of the stock goes down too. These stocks are more closely aligned with the broader economy and are more prone to economic activity.

Investors can use various indicators to tools to judge whether a stock is cyclical or not. One such popular indicator is Beta. In simple words, beta is a measure of a stock’s volatility in relation to the overall market. If a stock moves less than the market, the stock’s beta is less than 1.0. On the other hand, a beta of 1.5 means if the market falls 10 percent, the stock is likely to fall 15 percent. Cyclicals tend to have high beta values, which are usually higher than 1.

For many investors, the movement of stock in cyclical industries provides a great opportunity to earn revenue on the stock by buying when there is a downturn and selling when there is an upward trend. For a novice investor, this may seem like a fool-proof strategy but be cautious, as it is almost impossible to tell when there will be a downturn in the market.

Cyclical industries usually may include durable goods (that last for a long time into the future), non-durable goods (that have a short shelf life) and services like an automobile, construction, and travel.

When the economy is doing good and the people are earning well, they may spend a lot of money on buying a new car, constructing their new house or even plan fancy off-shore travels. However, when there is a downturn in the economy, people may prefer to hold these expenses for another year or two.

Around 75 percent of the stocks listed in the stock exchange are cyclical and follow the market trends. A few examples include Tata Motors, Honeywell Automation India Ltd, Shree Cement Ltd, SAIL, Hindalco etc.

What are non-cyclical stocks?

While cyclical industries may seem like a good investment, every good offense needs a defense, hence, it is important to balance out your portfolio with non-cyclical or defensive stocks. During a boom, people splurge on goods and services such as travel and cars. But during a slump, people stop spending on purchases that they don’t consider a basic necessity, instead they focus their spending money on food, water, and shelter.

During an economic recession or depression, the revenue and cash-flows and share price of non-cyclical companies continue to do well because they are industries that produce the basic needs of life that people will continue to consume.

In addition to basic needs, non-cyclical stocks also include those goods that are addictive such as tobacco or alcohol which can put ethical investors in a tricky situation as these industries do well even during a slump and reduces the number of industries that they can invest in.

Defensive stocks include goods and services in industries that are not affected by market fluctuations such as utilities, food, and medicines. It is basically any good or service that people will buy whether or not the economy is doing well. A few examples of defensive stock companies include Hindustan Unilever (HUL), Marico, HDFC Bank etc.

Bonus: The top-down strategy

There are two main investing strategies in the market, the top-down approach, and the bottom-up approach. The top-down approach involves looking at the economy as a whole and picking stocks that do well during certain economic conditions. This strategy requires the investor to have a good understanding of the macroeconomy along with its various sectors and industries to know what industry will perform well during the different business cycles. They also need to assess the inflexion points in the economy, that is when a certain stock price is expected to go up or down. For cyclical and non-cyclical stocks, top-down is the most commonly used strategy.

The bottom-up approach, on the other hand, involves looking at the stock individually and making investment decisions based on independent parameters.

When using the top-down approach, there are many indicators that investors can use to study the market. The first and most obvious metric is the GDP (Gross Domestic Product). This is the total value of all the goods and services produced in the economy and gives us a good understanding of the overall economic health.

Another great indicator is the ‘Purchasing Manager’s Index (PMI). This is a survey conducted among the purchasing managers in different sectors and industries in the economy. The PMI provides the investor with information on how the businesses are currently performing and which direction the economy is headed.

A third metric is the Consumer Price Index (CPI). This will give an investor insight into the changing price levels of goods and services in the economy and is a reflection of the state of the economy.

The top-down strategy is considered successful when the cyclical and defensive stocks are in perfect correlation with each other. A 100% correlation would mean that the stocks move in synch with each other while a -100% correlation means that the stocks are still in sync but move in the opposite direction.

During the 2008 recession, luxury goods such as Ford cars faced a huge decline in the value of their stock as people stopped spending on expensive items when the economy was down but at the same time, the stock for beverages such as Coco-Cola continued to do well as people spent money on this regardless of the business cycle.

Also read:

Conclusion

It is important for every investor to have a balanced and diversified portfolio with both cyclical and non-cyclical stocks.

Cyclical stocks include more luxury goods and hence a provide a higher return than non-cyclical stocks. However, the investor needs to study the market carefully and have a good tolerance for risk. Defensive stocks are safer investments but provide lower returns but are better for investors looking for safe investments Remember low risk, low return.

March 5, 2020 Divya Premkumar Economics, Stocks 2 comments

5 Psychology Traps that Investors Need to Avoid

5 Psychology Traps that Investors Need to Avoid: Benjamin Graham once said that “an investor’s chief problem and even his worst enemy- is likely to be himself.” It is a well-known fact that the human brain is a wonder that is capable of numerous mathematical, problem-solving and communication skills that is unparalleled with any other living species.

However, when it comes to investing, humans have been known to make terrible decisions and often fail to learn from their own mistakes. They go through a ‘roller-coaster of emotions’ as shown below.

(Image Source: Credit Suisse)

While the human mind is incredibly unique, people still fall victim to the investor traps that can have serious consequences in the financial markets. This has led to the emergence of behavioural finance, a new field that aims to shed light on investors’ behaviour in financial markets.

This post discusses the most common psychological traps investors need to overcome to increase their chances of earning high returns.

5 Psychology Traps that Investors Need to Avoid:

— Anchoring Bias

Anchoring Bias occurs when people rely too much on a reference point in the past when making decisions for the future- that is they are ‘anchored’ to the past. This bias can cause a lot of problems for investors and is an important concept in behavioural finance.

For example, if you had a favourable return on a stock when you first invested in it, your perception on the future returns of stock is positive even when there may be clear signs indicating that the stock might take a dive. It is important to remember that financial markets are very unpredictable so you need to remain flexible and seek professional advice when not-sure of making considerable investment decisions.

— Herding

Also known as the mob mentality, is a tactic that was passed on from our ancestors and believes that there is strength in numbers. Unfortunately, this is not always the best strategy in the financial market as following the crowd is not always the right move.

Ironically, this herding mentality among investors is the major reason for ‘bubbles’ in the financial markets. Investors often ‘herd’ to secure their reputation and base their decisions on past trends or on investors who have had success with the same stock in the past. However, people are quick to dump stock when a company receives bad press or go into a buying frenzy when the stock does well.

As an investor, you should perform your own analysis and research on every investment decision and avoid the temptation to follow the majority.

— Loss Aversion

Loss Aversion is when people go to great lengths to avoid losses because the pain of a loss is twice as impactful as the pleasure received from an investment gain. To put in simple terms, losing one dollar is twice as painful as earning one dollar.

As emotional beings, we often make decisions to avoid a loss, this could involve investors pulling their money out of the market when there is a dip which leads to a greater cash accumulation or to avoid losses after a market correction investors decide to hold their assets in the form of cash.

However, this perceived security of exiting the market when it is unstable only leads to a larger amount of cash circulated in the economy which results in the inflation. During the 2007 financial crisis, there was $943B worth of cash increases in the US economy.

Investors can avoid the loss aversion trap by speaking to a financial advisor to learn how to cut their losses and optimize their portfolio for higher returns.

— Superiority trap

Confidence is an asset when it comes to investing in the stock market, but over-confidence or narcissism can lead to an investor’s downfall. Many investors, especially those who are well educated and have a good understanding of finance and in the functioning of the stock market often believe they know more than an independent financial advisor.

It is important to remember that the financial market is a complex system made of many different elements and cannot be outwitted by a single person. Many investors in the past have lost large sums of money simply because they have fallen prey to the mentality of overconfidence and refused to heed anyone’s advice. Overconfidence is the most dangerous form of carelessness.

— Confirmation bias

Confirmation trap is when investors seek out information that validates their opinions and ignores any theories that refute it.

When investing in a particular stock that believe will result in favourable returns, an investor will filter out any information that goes against their belief. They will continue to seek the advice of people who gave them bad advice and make the same mistakes. This results in biased decision-making as investors tend to look at only one side of the coin.

For instance, an investor will continue to hold on to a stock that is decreasing in value simply because someone else is doing the same. The investors help validate each other’s reasons for holding on to the investment, -this, however, will not work in the long-term as both investors may end up in a loss. Investors should seek out new perspectives on a stock and conduct an unbiased analysis of their investment.

Also read:

How can an investor overcome these psychological traps?

The human mind is very complex and there are many factors both internal and external that can affect the decisions we make. The pressures we face in society make it easy to feed into temptation and fall prey to the psychological traps listed above. Being overconfident, seeking validation from others and finding comfort in other people who are in the same boat as you are just some of the reasons that can have an impact on the investment decisions we make.

Nobody is perfect and it is only human to fall into a psychological trap. The best way to mitigate these effects is to stay open to new information and think practically about how the investment will affect you as an individual. You should also seek the advice of industry experts to ensure that your investment decisions are based on well-researched information that can help you make unbiased decisions.

February 26, 2020 Divya Premkumar Investing Psychology 1 comment

What is Swing Trading? Definition, Pros, Cons & More!

Swing trading is when investors capitalize on swings in the market by holding on to a security for an extended period of time. Day trading positions last for less than a day while swing trading can last up to a week. It is used to trade numerous securities such as forex, futures, options, and stocks.

Swing trading is beneficial as it provides more opportunities for profits than day trading and quicker rewards than long-term investments. But on the downside, you need to constantly manage trades as you might miss out on opportunities to make a profit if you don’t act quick.

So what exactly is swing trading?

In its simplest form, traders hold on to securities for an extended period of time to earn a profit. This can range from overnight to several weeks. The objective of swing trading is to identify a trend and find swings within that trend to make a profit. Technical analysis can be used to identify these swings and act on them. Both day trading and swing trading have higher risks and costs than typical investments.

Swing trading is often undertaken by individuals and not large institutions as large institutions trade in large volumes, making it harder to enter and exit the market as required. It is a great option for beginner traders as it allows them to gain experience in trading. Losses can be kept minimal with stop-loss techniques and it provides perspective on both short and long-term trading.

(Video Credit: Elearnmarkets)

Benefits of swing trading

Swing trading is beneficial to beginner investors and for those who need more time to make trading decisions. It comes with several advantages such as:

— Versatility- Swing trading is a good option for people who can’t trade during market hours but still want to remain active traders. You can decide the price at which you want to enter and exit the market and place stops so they the stock value doesn’t go below a certain level- there are some trading softwares that even let you place multiple stop-orders in a day. Additionally, swing trading can be used for numerous securities such as bitcoin and standard options.

— Identify opportunities- Swing trading is generally not adopted by large firms as the trader constantly enters and exits the market but this comes with its own benefits. It allows the investor to identify new opportunities in the market. Looking at a financial chart shows you the long-term trend of stock but this is not always protected by support and resistance. By entering and exiting the market on a regular basis, you can identify opportunities in different markets with new trades. This not only allows you to spread your risk but you also have a lot less capital tied up in a single stock.

— Lower losses- Stop losses result in lower losses than long-term trades. A stop loss on a swing trade maybe 100 pips for a 5-hour chart but a stop loss on a chart over a week can be 400 pips or higher. This allows you to take larger positions on long-term trends. You can also place multiple stop losses in a day to protect your stocks against loss.

— You can have a better understanding of the trades- Swing traders are technical traders and have certain signs and signals to show them when a stock is/will not perform well. Therefore this makes it easier for a swing trader to limit the damages before they occur. Long-term traders cannot do this as trade based on the fundamentals of the stock. A swing trader, on the other hand, needs to be patient and take fewer trades.

Disadvantages of a swing trading

Although swing trading has its benefits, it comes with its own trade-offs. Here are a few challenges of swing trading:

— Unpredictable changes- Swing trades can change dramatically overnight, so if the market changes while you are sleeping, you could be up for a surprise the next morning. In certain cases, even a stop loss won’t be able to protect your trade. Trading is risky in itself and entering and exiting the market means that you are risking the money more often. You are likely to face losses every now and then due to this.

— Expert knowledge- While this might not necessarily be a disadvantage, swing trading requires a trader to be knowledgeable in technical analysis. Looking at a chart to find the high and low points is easy but as a swing trader, you need to identify the entry and exit points as well. Learning these skills takes time and effort and a trader would need to master this before they start swing trading.

— Psychology- You need to have a different mindset when it comes to swing trading. You need to be able to think on your feet and be sure of the decisions you make. As a swing trader is more aggressive than a regular trader who only studies the charts. Swing trading does not provide you with the same leverage as day trading.

Also read: What is Derivative Trading? Futures & Options Explained

Bullish and bearish swing tactics

Bullish traders

Stocks that are trending in the market rarely go in a straight line. A stock may go up for several days in a step formation and then gradually come back down. When the stock can be seen moving upward, it is said to be in an uptrend. Bullish traders look for the initial upward trend followed by the reversal of this, called the ‘counter-trend’. This is again followed by an upward trend. You should enter a trade only after the original upward trend has resumed.

Bearish traders

Like upward trends, downward trends also move in a step pattern. A stock could trend downward for a number of days, followed by a few days of upward movement and then back to the downward trend. Traders should enter a bearish swing trade when the stock resumes its downward trend. They can do this with a sell-stop limit order.

November 11, 2019 Divya Premkumar Market No comments yet

How to learn faster- The Feynman Technique!

As the world around us evolves, we seek to constantly learn and absorb new information every day. Learning new skills and concepts is exciting and can expand your views on the world as you know it, making you a better student and human being. As Benjamin Franklin said ‘An investment in knowledge pays the best interest’.

But there is no denying that learning all this new information can sometimes get tedious and monotonous, there’s only so much knowledge that your mind can take in at any given time. However, thanks to scientific research, there is a method you can use to make the process of studying easier and efficient while increasing your ability to learn- the Feynman Technique. But before we discuss this technique, let me first introduce Richard Feynman to you.

Who was Richard Feynman?

Theoretical physicist and Noble laureate Richard Feynman was born in 1918 in Queens, New York. From a very young age, Feynman quickly took to science and engineering and had a laboratory in his parent’s home where he built various electronic devices.

By a young age, he was self-taught in various subjects such as algebra, trigonometry, and integrals. Eventually, Feynman went on to study at MIT and later Princeton for his Ph.d, where he made numerous contributions in the field of Physics. Some of his accomplishments include:

He contributed research papers on the theory of light and matter which earned him a joint Noble Prize in 1965.
When the Space Shuttle Challenger disaster occurred, Feynman helped research scientists understand the cause for the crash and the risks involved in flying the shuttle
He made a major contribution to quantum physics through the Feynman Diagram. The diagram aimed to visualize the interactions between elementary particles such as electrons and photons.

In addition to the major contributions to Physics, Feynman had the ability to apply his learnings to other fields such as mathematics and biology. He has the ability to comprehend and explain information on a variety of subjects that earned him the title ‘The Great Explainer.’ His vast knowledge led him to give numerous guest lectures at universities such as Cal Tech and UCLA. Many people, including Bill Gates, enjoyed his lectures due to his ability to break down and simplify complex scientific principles.

The Feynman Technique

Say you want to have a good understanding of a really hard concept in a discipline of your choice. There’s a chance that you may find the theory hard to comprehend as the crux of the matter is lost in translation aka with all the business jargon. The ability to understand and communicate these complex ideas in a simple way is what the Feynman technique addresses.

This method was developed by Richard Feynman when he was a student at Princeton. He kept a notebook of concepts and theories that he did not understand and spent time breaking down each process and understanding its parts individually, while looking for contradictory details in the theory. The technique essentially comprises of four parts as follows:

1. Pick the concept or theory you wish to learn

The first step in the Feynman technique is to identify what concept or theory you want to learn and list out everything that you know about the topic in a notebook. This could be any concept, under any discipline.

For instance, if you want to learn more about the game theory, your first step would be to write down all the existing (even limited) information that you have on the topic. Any new information about the theory from various other sources can be added to the notebook. For the game theory, you can start by writing down the definition of the concept and any information about the theory that you may have come across (for example prisoner’s dilemma…).

2. Teach or explain the concept in your own words to someone else

As you approach the second step in the Feynman technique, you would have gathered plenty of information on the subject (in this case game theory). Read through the information you have written down and try to understand the concept as best you can because this step involves teaching it to someone else.

But before you explain the concept, analyze the information in parts, this can also mean re-writing some of the information in your own words to have a better understanding. When explaining the concept, think of it as explaining to a child who has no background in what the concept is about. Hence, you need to use simple words (no jargon) and keep the information concise and to the point- children have a low attention span.

3. Identify any areas in your explanation that you can improve on

Now that you’ve explained the concept to someone else, it is likely that you will find a few areas in the theory that you can learn and improve on. So it’s back to the books to do additional research on certain concepts and breaking the data down further until you understand them completely. The goal is to make the information as simple as possible because that’s what the Feynman technique is all about.

4. Restructure the information and use examples as needed

The information you collected from various sources in the first step of the Feynman technique is essentially a puzzle that you need to solve.

Once you have identified the gaps in your information in step 3, your next move is to fill in these gaps to complete the puzzle. Think of your concept as a story and pretend that you are narrating it to a friend or co-worker.

When you say the information out loud, it can help identify the missing pieces and form new thought processes. Alternatively, you can use examples to simplify your learnings and add an element of creativity.

(Image credits: Safal Niveshak)

Also read:

Conclusion

The Feynman technique aims to simplify complex learnings by breaking them down into smaller parts.

The technique can help you understand pretty much any concept or theory known to man and it helped Feynman amass large amounts of knowledge at a very young age. The trick is to break down any concept into a form so simple, that even a child would be able to comprehend the information. Albert Einstein famously said ‘if you can’t explain it simply, you don’t understand it well enough.’

August 4, 2019 Divya Premkumar Investing Psychology 1 comment

3 Uncommon Alternative Investments Option in 2019 cover

3 Uncommon Alternative Investment Options in 2020

It is no secret that diversifying is the key to success for investing and as humans we love our options! Many investors assume diversifying means investing in different types of securities like bonds, stocks, and options. However, the top investors take the term in their most exclusive form and invest in truly diversified assets. This brings us to alternative investments.

What are alternative investments?

Outside stocks and bonds, there is a world of investments that we can choose from. Alternative investments are those investments that vary from the traditional forms of investing in terms of liquidity, how they are regulated and the way they are managed. Having a mixed basket of investments is very beneficial for an investor especially during a downturn. People who have experienced a recession or inflation will tell you that investing in only one type of asset will result in great losses.

A few examples of alternative investments include venture capital, real estate investments and even gold efts. These assets are usually more illiquid than traditional investments and have little to no correlation with stocks and bonds. However, alternative investments are less regulated than traditional stocks which are under the control of organizations such as FINRA, SEC in the U.S or SEBI in India. On the flip side, although they are not controlled investments, the performance of alternative investments is difficult to measure. This is because, unlike stocks, there is limited information available on alternative investments, making them difficult to assess.

Types of alternative investments

Alternative investments is a mindset approach to investing rather than a specific investment. There are various alternative investments out there and investors can choose the ones that best suit their management style. A few investments include:

1. Private equity

Investing in the stock market is great but not all companies are listed on the exchange. There are more private companies than public companies and the companies often take on an investor to help fund their growth. Private equity is the broad term to describe the spectrum of investors in the private market. The funds raised by the private equity firms will be invested in private companies, many of which include promising startups. The capital raised is used for organic and inorganic growth of the company. The amount invested is then returned back to the investors during an exit event such as the private firm issuing an IPO to go public or an acquisition or merger.

To assess the performance of this alternative investment, many investors use the internal rate of return (IRR) however this does not take into consideration the interim or negative cash flows. In recent years, this formula evolved to the Modified IRR which is a more holistic approach to analyze the performance of a private equity investment.

2. Collectibles

Collectibles is the broad term used to describe items such as cars, antiques, paintings and various vintage items. In other words, they are items that have a low intrinsic value. Many people place a high value on these items, but unlike stock and bonds that can generate profits and income, the value of the collectibles is based on the speculations of buyers and sellers. An investment into collectibles can help diversify your portfolio but you need to have a good understanding of the items you are collecting to reduce risks.

One of the best ways to invest in collectibles is to have a personal interest in what you are collecting. This will help you develop an interest in the market and gain expertise on the items you are investing in. Items collected this way will give the collector personal satisfaction of the items they own whether or not they receive the expected return.

It is important for investors to remember that collectible items have a long holding period. While stocks and shares can be sold at a whim, depending on market conditions, collectibles, on the other hand, need to be ‘held’ by the owner for an extended period of time. This is because collectibles tend to gain value over time and selling them too quickly can only result in high transaction costs.

While collectibles can help diversify your portfolio, an investor requires extensive knowledge in the market to make the right decisions. But collectible investing is great because not only is it an alternative investment but it is also a hobby for many!

3. Hedge funds

A hedge fund isn’t a single investment but rather a pooled investment that is managed by an investment advisor. A hedge fund raises money from investors and uses the money to buy up entire businesses, either through a takeover or by investing in the business to improve operations. There are also hedge funds that specialize in real estate or other assets such as patents and trademarks.

Investing in hedge funds can help an investor diversify their portfolios because hedge fund managers used a variety of strategies when investing. This includes arbitrage, distressed assets, and macro-trends. They also take a Leveraged approach to investment which is using borrowed money for investment.

Hedge Funds vary from private equity investments because they invest in public companies, thereby providing more liquidity and making it easier for investors to take out their money if required. A report by the World Economic Forum states that in the U.S investments in hedge funds represent 40% of total alternative investments.

Also read: What is a Hedge Fund? And How do they operate?

Closing Thoughts

Diversification is the mantra when it comes to earning high returns on your investments. While the stock market allows investors to assess the performance of their stocks and provides liquidity, it is not always the safest investment as the markets are constantly volatile. This has led to an increase in the popularity of alternative investments in the last couple of years.

Historically, however, alternative investments are more popular among high net-worth individuals as they require a large initial investment and cannot be converted to cash quickly. Nevertheless, alternative investments have numerous advantages such as portfolio diversity and active management of funds.

Alternative investments are now an option for all classes of investors and not just the wealthy ones. But these investments requires a lot of research and study and investing in them without a thorough assessment can be incredibly risky.

May 18, 2019 Divya Premkumar Invest Intelligently, Personal Finance No comments yet

The Butterfly Effect: This Theory Can Change Your Life

It has been said that something as small as the flutter of a butterfly’s wing can cause a typhoon halfway around the world.

One of the greatest surprises in the scientific world is the chaos theory or butterfly effect which are events in our lives that are both non-linear and unpredictable. While science traditionally deals with outcomes that can be predicted and calculated to a certain extent like chemical reactions or the force of gravity, there are often many instances that are nearly impossible to predict like natural disasters, stock prices or the weather.

The first step to overcoming this unpredictability is to understand the chaotic nature of the world we live in. Identifying the elements that cause changes in stock price or the weather can help us steer our thinking in a certain direction. Finally, we need to remember that our eco, social and economic systems are all interconnected and taking negative actions on any of these systems can result in detrimental consequences.

The Butterfly Effect

The butterfly effect describes the phenomenon that a small event can have very large consequences.

This chain reaction is perfectly described in the movie ‘Pay it forward’ where a small boy, Trevor, creates a plan of kindness for a school project. A recipient of a kind favor carries forward this favor to three other people. As the movie goes on we see this circle of people who do favors become bigger and bigger and ultimately affects the lives of many people in the community. One random act kindness started by a small boy resulted in a very large impact, changing everyone’s lives for the better.

While the movie represents a glass half full situation, the butterfly effect can be negative as well. For example, as much as meteorologists try to predict natural disasters, there have been tsunamis and typhoons that are inexplicable.

It is important to remember that the butterfly effect is not a small event that can have a large impact which can eventually be driven to the desired end but it is in fact a small event in a complex universe that can either have a very large impact or no impact at all. It is virtually impossible for us to identify or predict which one will occur.

The invention of the butterfly effect

In popular culture, the butterfly effect is used to describe the explain the inexplicable. How one small event can have a magnanimous effect on a completely unrelated event. This theory was first discovered by an MIT meteorology professor, Edward Lorenz who came across the phenomenon while conducting some weather-related research.

In 1963, Lorenz was conducting research on weather patterns and entered numbers into a program that was based on 12 variables such as wind, speed, and temperature. These values would be depicted on a graph that would rise and fall depending on the weather pattern. Lorenz ran a stimulation similar to the one he ran previously and the results he saw surprised him.

The variables were drastically different from what he saw previously when he ran the same stimuli. This would forever change the way his program produced weather patterns. He said “the numbers I had typed into the computer were not exactly the original ones. They were rounded versions I had first given to the printer. The initial errors caused by rounding out the values were the cause: they constantly grew until they controlled the solution. Nowadays, we would call this chaos.”

This unexpected change in the value of the variables based on the same stimuli led Lorenz to the powerful insight that the smallest of changes could have large unpredictable effects. He later termed this the butterfly effect saying that a butterfly could flap its wings in one part of the world and it could cause a typhoon in a completely different place. This led him to the conclusion that even with knowledge of primary conditions, the future was virtually impossible to predict.

Lorenz presented his findings in a paper titled ‘Deterministic Nonperiodic Flow’ which is considered one of the greatest achievements of twentieth-century physics. He said that there are small variables that can have profound impacts on the same body or system in the future. The strength of the impact is however unpredictable. Weather is a variable that is often hard to predict.

How the butterfly effect has impacted reality?

There are many references in real life (also represented in popular culture) where a small event has resulted in a large consequence- the butterfly effect. Here are a few ways the butterfly effect has shaped modern history.

The bombing of Hiroshima and Nagasaki

The nuclear bombs dropped on Hiroshima and Nagasaki is remembered as one of the most significant events in the war that changed the course of history and won Korea their independence. A little research into the war will tell you that the U.S intended to bomb the Japanese city of Kuroko.

However, on the fateful day, bad weather conditions prevented the U.S from doing this. The fighter planes flew over the city three times and eventually gave up due to the lack of visibility. The military personnel then made the split second decision to bomb Nagasaki instead. This bombing, as has been documented in history, had a magnanimous effect on the war and changed the course of history. If the weather conditions in Kuroko had been better, it might have resulted in a completely different outcome.

The Chernobyl accident

In Soviet Ukraine, 1986, a catastrophic accident occurred at a Chernobyl nuclear plant. The disaster was a result of design flaws in the reactor and the arrangement of the nuclear core that was not in accordance with the manual. This nuclear accident is said to have released more radiation that the bombings of Hiroshima and Nagasaki. Numerous people were evacuated and it also resulted in deaths and birth defects.

However, the accident could have been much worse, after the initial release of radiation three workers volunteered to go turn off the underground valve which is said to have eventually killed them. This was a brave and heroic act because had they not turned off the valve when they did, more than half of Europe would have been destroyed and inhabitable (the butterfly effect). The Chernobyl accident has had numerous long-term effects and many believe it is the cause of global warming. Countries today are slow to adopt nuclear power as an energy source.

Closing Thoughts

While the human race thrives on control and predictability, the butterfly effect shows us that we, in fact, cannot predict the future. The complex universe around us is chaotic and vulnerable to even the smallest of changes. As humans, we can only identify catalysts that react to these conditions. However, if we try to control or predict outcomes, more often than not, it will result in failure.

Finally, always remember what the butterfly effect actually teaches us- “Everything that you do matters”.

May 13, 2019 Divya Premkumar Investing Psychology 1 comment

Minimalist lifestyle: Is it worth being a minimalist?

Being a minimalist is all about living with less and in recent years it’s become somewhat of a trend with shows such as Tidying up with Marie Condo and the Minimalism documentary (both on Netflix) taking the internet by storm. They say that minimalist lifestyle can change your life for the better and living with less equals more time to focus on the important things in life such as growing your personal relationships. But who is a minimalist and is it really worth being one?

Minimalist lifestyle: Is this for you?

While the word minimalism, these days, is synonymous with the clutter-free way people live their lives, it was traditionally a word used to describe art and design (such as the decorating your home with a minimalist concept). However, this word has become so much more today as we use it to define a certain lifestyle- less is more.

The idea behind this concept is that in today’s digital age we are often overwhelmed with materialistic things such as our iPhones and laptops. We forget to spend time with our loved ones and enjoy the simple things in life like cooking or creating art. Minimalism serves as an answer to these problems.

Minimalism is intentional living and involves getting rid of anything that takes up unnecessary space in your life like unwanted clothing, household items, bills, and fees. While living a clutter-free life sounds like a good idea, it may not be for everyone. Here are a few pros and cons to help you decide if the minimalist life is for you.

The PROS

Minimalism lets you focus on what matters the most and take out what you don’t need. Here are a few reasons why you should consider this lifestyle.

It helps you find the things you really need

Let’s be honest, you could honestly survive without a lot of things currently sitting in your house. The first step to being a minimalist is picking an area or room in your house and clean it out. You will find a bunch of things you no longer use or didn’t even know you owned.

Take this opportunity to either donate or sell these things. Not only does this leave you with the things that are important to you but you can also make a quick buck on the side. The rule of thumb is to take an item and see if you’ve used it in the last 90 days if the answer is no, will you use it in the next the 90 days? If the answer is still no, you no longer need it.

Having fewer things makes it easier to budget

When you know exactly what you have, it is easier to budget and make decisions. One of the main reasons many people find it hard to forecast expenses and prepare financially for the future is because they have too many unnecessary expenses to think about. This includes bills to apps like Hulu or Netflix or unwanted subscriptions. While these may not seem like too much money at first they can add up over time.

A few ways to overcome these unnecessary minor expenses is by having just one card to pay all your bills. You can even get a card with a good rewards program to rack up those points. This way you have all your major expenses on one statement which makes it easier to budget for the upcoming year.

Another option is to have a single checking account and a single emergency fund. This way you can maintain the minimal balance for the account and have a better idea of your daily expenses. An emergency fund is particularly useful during a period of a cash crunch. Getting your finances in order is a crucial element in living a stress-free and clutter-free life.

Also read: How Much Should You Save - 50/20/30 Rule!

You create room for the important things in life

Having too many things can create a sense of claustrophobia which often leads down a road of anxiety and unhappiness. So when we clear out unwanted items, it leaves more room for what truly brings happiness to our lives. Physical things tend to tie us down like an anchor and living a minimalist life can take that weight off your shoulders- freedom from greed and debt.

Happiness is subjective and can mean different things to each one of us. For some, it could mean spending time with your family, your puppy or even doing something you are passionate about. Many people find that living a minimalist life will get them closer to this goal.

The CONS

While living a minimalist life looks interesting, it is often easier said than done. Minimalism isn’t a personal project and tends to affect those around you as well. Here are a few cons of living a minimalist life.

The minimalist lifestyle is difficult to adopt

Living clutter-free sounds like paradise but many people find it incredibly challenging to trade in their material possessions for a more minimalist life. In today’s digital age, with new trends popping up on the internet every day, there is a lot of peer pressure to keep up with the latest styles. Living without material possessions (shoes, clothes and electronics) can seem unthinkable for many.

The process of de-cluttering your life is stressful and overwhelming and going through all your things can bring up a lot of memories (some good, some not so good). Moreover, minimalism has a different meaning for everyone so it can be hard to decide how much minimalism is right for you.

(Video Credits: Matt D’Avella)

Minimalism is not a one-stop solution to all your problems

Greed and debt are two evils that people want liberation from and many people see leading a minimalist lifestyle as the answer to all their problems. But this is not the case because if you wake up one day and decide to go cold-turkey and lead a completely minimalist life, you are more than likely to relapse and go right back to your old habits.

It is important to see minimalism as a gradual process rather than a quick fix to all your problems.

Also read: 7 Fun And Easy Tips to Save More Money

So, should you become a minimalist?

Well, that’s a question only you can answer. Leading a clutter-free life is a great feeling but it is not for everybody. Some people often find happiness amongst their chaos.

Choosing to live a minimal life depends on your mindset and what you hope to get out of it. If you do decide to become a minimalist, remember to take it one day at a time.

May 7, 2019 Divya Premkumar Personal Finance, Save money No comments yet

7 Incredible Side Hustle Ideas to Make an Extra Income

Thanks to the world wide web, earning a few extra bucks with a side-hustle is now easier than ever. But although there many different ways one can make money, you need to pick the side hustle ideas that matches your skills and needs.

Fortunately, there are many unique ways you can earn an income without an investment or a highly-specialized skill-set. While not all side-hustles may be the best fit for you, you need to pick the one that derives the most value- because at the end of the day, your job satisfaction is what mattes the most.

What are side hustles important?

Side hustles provide an outlet for you to pursue your passions outside your 9-5 job while giving you the opportunity to make an extra income. It is all about personal growth, discipline and can help you develop an entrepreneurial streak.

When choosing your side hustle, you may want to consider what you would want to supplement your current job with. This could be anything from blogging to selling your artwork online. Whatever your side hustle may be, it’s all about following your passions and seeing them through. Additionally, you can make some extra bucks and treat yourself.

Side hustle ideas

The idea of a side hustle can seem alluring but you are not sure what kind of job you want to do. Thanks to the developments in technology we have the world at our fingertips and a myriad of side hustles to choose from. A few of them include:

1. Sell your crafts online

If you have an artistic streak, you can use your talent to start a side hustle and earn some extra cash. They are many websites out there such as Etsy where you can list your crafts and other home-made items for others to buy.

Apps such as Instagram and Facebook are also great places to showcase your work. Many artists post pictures of their work on their Instagram or Facebook pages along with a link to their websites where customers can purchase the products. The rise in businesses born this way has led to a decrease in the number of brick and mortar stores worldwide.

2. Sell your stuff on e-bay or Amazon

A sure-fire way to make money online and have a lucrative side-business is to sell your items on websites such as e-bay, Amazon, or Olx. These items could include anything from household goods to furniture, books and even stamps. This is a great way to make use of things that you don’t really use or need. If you find that you have a knack for selling stuff online, you can do this professionally and earn a commission on every sale.

3. Drive for Uber or Ola

One of the best and most versatile ways to make money is to drive for Uber or Ola. Companies such as these have transformed the way we view transport in today’s sharing economy.

What makes these ride-share companies so great is that you get to decide when you want to work with just the click of a button. In metropolis cities such as Bangalore or Chennai, this is an easy and convenient way to make a side-income.

4. Start a blog

Starting a blog is not a quick money maker but it is a great way to create a platform for something you are passionate about while developing your skills.

What’s more? you can do it anywhere and from any part of the world. A blog is something you can create in your spare time and consistently working on it and posting great content can result in a high income eventually. You can even monetize your platform through sponsored posts, affiliate links or a shopping link to buy your products. Many people have created very lucrative businesses through their blogs.

5. Get a part-time job

If you want to trade in your time for money, you can get a part-time job. They are many options you can choose from to match your interests and skill-sets. A few ideas include babysitting, an administrative assistant or a barista.

If you are big on Instagram or Facebook, you can even take on a social media gig. The only downside to part-time jobs is that they often don’t pay as well as online businesses but they are still a great way to earn money while doing something you love.

6. Teaching

If you have the ability to teach other people skills, this opens up numerous side hustle possibilities. For example, if you are skilled in a particular academic field such as math or science, you could tutor students or even teach an online class. If your interests lie in other areas such as fitness or calligraphy, you can use your skills to teach a class in your free time. The great thing about teaching as a side hustle is that you get to do what you love while sharing your passion with others.

7. Freelance writing and editing

For those who possess the skill of putting words on paper, they are many side hustles that allow you to share your stories with others. Freelance writing and editing allows for flexibility and is quite enjoyable. You could write articles for magazines or journals on various genres (travel, fashion) and even edit student essays or websites online. You can develop your skills while expressing your creativity.

Also read: 11 Best Passive Ways to Make Money While You Sleep

Closing Thoughts

Tony Robbins famously said that’ if you do what you’ve always done, you’ll get what you’ve always gotten’ and this holds true for a lot of things in life.

Even if you love what you do for a full-time job, it is important to have an outlet where you can develop your passions and express free -thinking- this is where side-hustles play an important role in our lives.

While side-hustles can help you earn a supplemental income, they are important for many other reasons as it taches you to step out of your comfort zone and develop life-skills. While getting another job may be hard there are many ways you can earn an additional income as listed above.

So get a side-hustle and develop those skills!

May 4, 2019 Divya Premkumar Earn More, Personal Finance No comments yet

7 Fun And Easy Tips to Save More Money

We all want to save money and build a comfortable financial cushion to plan for our future. Many of us have milestones we want to reach like buying a house, a car, paying off debt or going on vacation. But although we may have good intentions, many of us don’t save money until much later in our lives because our current wants and needs seem much more important.

The trick to having enough money for a comfortable financial future is to start saving money as soon as you enter the workforce. Saving is not as overwhelming as it sounds and with a little prioritization and self-discipline, you can make it a life habit. Here are a few tips to help you get started:

7 fun and easy tips to save more money

1. Tackle your bigger debts

The first step to start saving money is to tackle your bigger debts, specifically the high-interest ones from any loans or credit cards you have taken out. This is because the fees on the loans add up quickly and can take up a significant portion of your income. Also once your debts are paid off, saving money in other areas of your life becomes much easier.

However, tackling the bigger debts can be intimidating so another effective way is to use the snowball method. This is when you start by paying off the small debts before you pay the larger ones. This method does not focus on the numbers in debt repayment but on behavior modification. When you pay the larger debts first, you will not see the numbers go down significantly and this can demotivate you. But paying off smaller debts is easier and you see the progress quickly which encourages you to stick it out until you’re debt free!

2. Cut down any unnecessary bills

When people budget out their expenses, they find many unnecessary leaks in their income. A major expense bracket is your grocery and entertainment bills.

For groceries, a great way to save money is by planning out your meals each week and taking account of what you have and what you need to buy. This will stop you from overspending on food and reducing any wastage. Managing your grocery expenses also reduces the money spent on restaurant meals as you can eat more home-cooked meals.

Brewing your own coffee at home is also very beneficial. Studies show that the average American spends $2,600 on Starbucks coffee every year which is a considerable amount of money to spend on coffee!

3. Reduce household expenses

In addition to food and entertainment, there are many ways you can reduce your household expenses as well. A quick way is to have an eye on the thermostat in your home, lowering the temperature by 10 degrees Fahrenheit can reduce energy costs by 3-5%. Other ways to reduce energy costs includes taking shorter showers, washing your clothes in cold water or switching to LED bulbs that have a lower energy consumption.

With OTT platforms such as Amazon Prime and Netflix, many people no longer find the need for cable television. Although your cable bill may not seem like much, it adds up over the course of the year. Cutting ties with cable and switching to streaming services can help you reduce your expenses in the long run.

Another expense you can reduce is your phone bill. You can either opt for a family plan to lower your overall costs or minimize your data plan by using apps such as WhatsApp, Skype or Facetime to make phone calls.

4. Use a zero-sum budget

Saving enough money always comes down to a well-structured budget. If your goal is to save money aggressively, a good method to utilize is the zero-sum budget.

The goal of this budget is to make your income minus the cash outflow equals zero. This is done by allocating every single dollar you make to a certain category. So for instance, you could allocate money to food, entertainment, bills, savings and paying off debt. A survey conducted showed that people were able to save 19% more of their income with this method.

Also read:

5. Automate your savings

A fool-proof way to save money is to automate your savings. When you ensure that a portion of your income goes into a savings account, you will be living on less money without even realizing it.

Creating a budget is easy but sticking to it is the challenging part. By automating your savings, you no longer have to worry about not meeting your budget goals. It is a good idea to have a separate checking and savings account or an emergency fund where the money from your income can be transferred every month.

(Image credits: Forbes)

6. Get a side hustle

In addition to cutting your costs, another great way to save more money is to diversify your income. You can do this by getting a side-hustle.

A side hustle is a part-time job or a passion project which provides an extra source of income. Many people do side-hustles as a hobby and use it as an outlet to express their creativity while earning an extra income. Very often, bloggers and Instagrammers turn their side-hustle into their full-time jobs if they find it to be a lucrative career. A few great side-hustle ideas include writing, coding or teaching a class.

Also read: 11 Best Passive Ways to Make Money While You Sleep.

7. Take a ‘staycation’

A staycation is an inexpensive alternative to an actual vacation and can be just as fun! While it is a trendy term used in social media, the reasoning behind it is pretty rational. If you are looking to have fun while saving some money, you can find some fun activities to do in the area you live in instead of dropping money on expensive airline tickets.

A staycation includes everything you would do on an actual vacation like taking time off work to relax and unwind and spending time with family and friends.

Closing Thoughts

Saving money can be intimidating at first but with a little perseverance and discipline, it can become a life habit. Each person has different goals when it comes to saving and it is up to you to decide where you can cut costs to make the most of your income.

While saving is important don’t forget to indulge in experiences once in a while because at the end of the day it is the experiences that you will remember not the materialistic comforts.

April 9, 2019 Divya Premkumar Personal Finance, Save money 2 comments

What is Private Equity? And how does it work?

Whether its buying ice-cream at Cold Stone or filling gas at a Shell petrol station, a large proportion of companies that we consume goods and services from is backed by a private-equity firm. This makes private equity a favorable investment option for many people. In this article, we will explore how private equities work and how they can benefit private companies.

What is a private equity firm?

To put it into simple terms, private equity is a part of the much larger finance sector known as private markets. It is a type of financing, whereby, capital is invested by the investor, usually into a large business in return for equity in the company. They are termed private because the stocks in the company are not traded in a public equity market (i.e. stock exchanges).

The private equity firm will then raise capital for the private companies they buy equity in, to fund the new projects, pay off existing private debt or raise capital for mergers and acquisitions. The funding for private equity firms comes from institutional investors such as large banks or insurance companies. For example, in 2017, during Lyft’s series G funding, they raised $600 million from private equity firms. This increased the company’s valuation from $5.5 billion to $7.5 billion.

Private equity firms are funded by pension funds, labor unions, foundations and many other powerful organizations who invest large sums of money in the hopes of receiving a large return on their big investment. Due to the hefty investments, private equities often have a large control over the industry of the companies they invest in. They invest in companies and manage and improve their operations and revenue over a period of time. Once the private equity has improved the investment value of the company, it can do one of two things. The company can issue an Initial Public Offering (IPO) to go public or it can be sold to a larger corporation at a profitable price.

Between 2000 and 2006, all private equity buyouts worth over $1 billion rose from $28 billion to $502 billion and has been at a steady upward growth since. There is no denying that is an incredibly prosperous business in the finance sector.

Here is the list of the largest private equity firms by PE capital raised:

(Source: Wikipedia)

What do private equity investors do?

Private equity investors have a versatile and powerful job and it is a profession that attracts the brightest and smartest people in the corporate world. The job of a private equity investor can be focused on three important tasks:

— Raise capital from large entities

Just as private companies raise money from private equity firms, private equity firms also go through rounds of funding to raise capital from large institutional investors. Sometimes, the owners of the private equity put in their own capital but this is no more than 1-5%. When raising capital, private equity firms prefer large companies that invest 10-100 million dollars each vs. many small companies that invest money in the thousands.

There are two time periods when a private equity raises funding. ‘First close’ means that the company has raised the required amount of money but new investors can still join the equity for a short period of time. The ‘Final close’ is when the private equity is done raising capital and no new investors can join.

— Buying out private companies

The main function of a private equity is to invest in private companies in both single or multiple sectors. Therefore, a large part of a private equity investor’s job is to source out potential companies, perform extensive research on why the company would be a good investment and finally implement a plan of action to acquire the company.

Prospective deals on companies usually come as a result of a partner’s reputation in the industry or from the in an auction conducted by investment banks where equity firms raise bids for a company and in each round of bidding, companies are rejected from the race. The bidding process happens for companies that have a very high potential for growth.

Once the potential companies are sourced, the private equity investor will perform the due diligence to acquire the company.

— Improve the investment value of the acquired company

Once equity in the company has been acquired, it is the duty of the private equity investors to improve operations and increase revenue in the company. The investors are not in charge of the day-to-day running of the company, rather, they take seats on the company’s board and provide advice and support on the strategies and operations management of the company.

The level of involvement by the investor can vary depending on how big their stake in the company is. If they own a large stake, they will have a significant influence on how the company is run and will be more involved in improving the workflow of the company.

The end goal of the investor is to exit the portfolio company once the investment value of the company has improved. This exit may happen 3-7 years after the company has been bought. The investors gain value in holding this investment through the revenue gained during the investment period, the reduction in costs as a result of streamlining the process and the revenue earned from selling the company which is used to pay off the debt incurred when the company was originally purchased.

Once the company’s revenue has been optimized the investors will either issue an IPO or sell it to a larger corporation.

Private Equity Strategies

Here are three commonly used private equity strategies:

— Growth capital

These are investments made in well-established companies who are looking for capital to expand their current operations or to expand their target markets. These investments are usually a minority investment by the private equity firm. The mature companies they invest in are looking to expand operations without affecting the ownership in the business.

— Leveraged buyouts

This is when a private equity firm borrows a large amount of capital to buyout other companies because they believe that they will get a significant return when they hold and eventually sell the company. Almost 90% of the LBO is financed through debt. Once the company is acquired, the private equity will either sell parts of the company or will improve the investment value of the company and exit at a profit.

— Fund of funds

A FOF strategy is when the private equity invests in various other funds and not directly into stocks and securities. Using this strategy provides a more diversified portfolio for the private equity and the ability to hedge the risk during the different stages of funding. On the downside, investing in funds of funds is expensive as there are additional fees involved such as the management fee and the performance fee.

Conclusion

A private equity investment is great for businesses that are looking to grow and expand their operations. The investors bring a lot of knowledge and experience to the table that can improve the company’s value and revenue and help leverage its position in both local or international markets.

March 26, 2019 Divya Premkumar Investment Basics 2 comments

Micro vs Macro Economics -What’s the Difference?

Economics is the study of how humans use limited resources (land, labor, capital and enterprise) to manufacture goods and services and satisfy their unlimited needs and distribute it among themselves. It is divided into two broad branches, microeconomics and macroeconomics.

Each branch has its own policies and regulations relating to different sectors such as agriculture, labor market and the government. Microeconomics is the study of the behavior of an individual, firm or household in the market while macroeconomics is the study of the economy as a whole- that is, the individuals, households and firms collectively.

What is Microeconomics?

Microeconomics was first introduced by the economist Adam Smith and is the study of the economy at a lower level, it is commonly termed the ‘bottom-up’ approach. This branch of economics focuses on how decisions made by people and organizations can affect the economy as a whole. As individuals, we make numerous decisions everyday from what clothes to wear to what food to eat. These decisions are made by the different agents in the economy and serve as the basis for microeconomists to study how they affect supply and demand and ultimately the economy as a whole.

Tools such as supply, demand, consumer behavior, spending and purchasing power of people are used by economists to build models that they base their learnings on, one such model is the supply and demand curve. By understanding the buying and spending habits of people, economists come up with various theories to understand relationships between different elements and how these small parts fit into the larger picture.

However, in the real world, things are different and cannot always be represented through a model. Hence some economists study subsets of microeconomics such as human behavior which is the actions taken by an individual when making a decision and the behavioral model which uses disciplines such as psychology and sociology to understand how people make decisions.

Since microeconomics is the study of the economy at a lower level, many people use it as a starting point for learning economics. The theories used in microeconomics are then used to study the economy at a larger scale- also known as macroeconomics.

Also read: What is Top Down and Bottom Up approach in stock investing?

What is Macroeconomics?

While microeconomics is a bottom-up approach, macroeconomics is considered a top-down approach as it is the study of the economy on a larger scale. Prior to 1929, many economists only studied microeconomics (people’s individual decisions) however after the crash of 1929 (aka the great depression), many economists were unable to explain its cause. They found that there were forces in the economy, which based on people’s decisions, could have a positive and negative impact. In addition to looking at individual decisions, it was also important to look at the big picture.

Macroeconomics is the study of larger issues affecting the economy such as economic growth, unemployment, trade, inflation, recessions and how decisions made by the government can affect the economy. For example, the Central Bank creates their interest rate policies based on the macroeconomic conditions in the country and around the world.

John Maynard Keynes is considered the founding father of Macroeconomics and his understanding of the subject was largely influenced by the Great Depression. During the 1930s Keynes wrote an essay titled The General Theory of Employment, Interest and Money where he outlined the broad principles of Macroeconomics that led to the development of Keynesian economics. Keynesian economics are macroeconomic theories about how during a recession, in the short run, the output is influenced by the aggregate demand in the economy. Milton Freidman another pioneer of macroeconomics used monetary policy to explain the reasons for the depression.

Micro vs Macro Economics -The key differences

As mentioned earlier, microeconomics is the study of individual and household decisions and the issues they face. This could be analyzing the demand for a certain good or service and how this affects the production levels of a company. It could also be the study of effects of certain regulations on a business.

While macroeconomics is the study of the economy as a whole. This involves looking at the gross domestic product (GDP) of the economy, the unemployment rates and the effects of inflation, deflation and monetary policy. For example, they may look at how an increase in taxes can affect the economy using the GDP, national income and inflation rate as a metric rather than individual factors.

Microeconomics is useful for determining the prices of goods and services in the economy along with the costs of the factors of production (land, labor, capital) while macroeconomics helps maintain price stability and creates policy to resolve problems dealing with unemployment, inflation and deflation.

However, both micro and macroeconomics come with their limitations. For example, the study of microeconomics assumes that there is full employment in the economy. This can lead to unrealistic theories as this is never true. In macroeconomics, there is a fallacy of composition where economists assume that what is true for an individual is true for the economy as a whole. However, in the real world, the aggregate factors may not be true for individuals too.

Micro and macroeconomics are interlinked

By definition, microeconomics and macroeconomics cover completely different aspects of the economy and while this is true, the two fields are similar and also interdependent on each other.

When dealing with inflation, many people think of it as a macroeconomic theory as it deals with interest rate and monetary policy. However, inflation is an important part of microeconomics because as inflation raises the prices of goods and services, it reduces the purchasing power that affects many individuals and businesses in the economy. Like inflation, government reforms such as minimum wage and tax rates have large implications in microeconomics.

Another similarity in microeconomics is the distribution of the limited resources. Microeconomics studies how the resources are distributed among individuals while macroeconomics studies how they are distributed among groups that consist of individuals.

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

Conclusion:

Although micro and macroeconomics affect different levels of the economy and cover different policies, they are in fact two sides of the same coin and often overlap each other. The most important distinction is their approach to the economy. Microeconomics is ‘bottom-up’ and macroeconomics is ‘top-down.’

March 14, 2019 Divya Premkumar Economics No comments yet

5 Mind Opening Advice From Successful Women in Finance cover 2

5 Incredibly Inspiring Tips From The Top Women in Finance

It is no secret that the finance sector is a fast-paced, competitive environment where it’s survival of the fittest. When you factor in gender dominance into the equation, there are often more hurdles that women need to overcome to find long-term success in the industry.

According to the World Economic Forum Gender Gap report in 2017, ‘female talent remains one of the most underutilized business resources’ and this is especially true in the finance sector where although 46 percent of the industry are women, they only represent 15 percent of executive level positions.

While this statistic is shocking, it’s true. There are many women in Finance who believe that the right personality traits, qualities and skills, regardless of gender, can get you to the top of your career. Here are a few career tips from the top successful women in Finance:

Network, Network, Network

As they say, ‘it’s about who you know, not what you know.’ Getting to the top of your game in the financial industry involves having a broad network of connections. According to Sally Krawcheck, CEO and Co-Founder of Ellevest, it is the number one rule for success in business- for both men and women.

Building a strong network requires time and patience and a lot of hard work on your part. Your professional network can include people from all walks of life, who share the same passions as you and can help you achieve all your career goals. But networking is a two-way street so while you reach out to others for help, you should develop a mutually beneficial relationship and aim to be their ‘go-to’ person at a time of need. You’ll find that your kindness will be repaid in multifold.

Find your passion and work towards it

Do what you love and you love and you’ll never have to work a day in your life. Before you take up a job, be it in finance or any other industry, you need to make sure you are passionate about what you are doing. This is exactly what Edie Hunt, the Chief Diversity Officer at Goldman Sachs, did. She always looked for opportunities that highlighted her passions and aligned with her personal and professional goals. Hunt believes that if you are passionate about your job, there’s a high chance that you will be good at it.

However, Wei Sun Christianson of Morgan Stanley says you should not fill your goals with only passions as you may hit a rough patch during your career and can get disheartened. When chasing your dreams it is important to be driven and develop a versatile skill set to get that job!

Never stop learning

The opportunity to learn new things every day is a driving factor for many in their career. Elle Kaplan, the CEO of LexION capital says that her ‘deep-seated intellectual curiosity’ is a motivating factor to learn new things every day. For her, the financial markets are always changing and they are constantly impacted by a variety of elements from politics, to current events and even climate change. Keeping up with the constant changes in the markets gives her the opportunity to soak up a wealth of knowledge every day.

The gender gap presents an opportunity

It comes as no surprise that the finance sector is a ‘boys club’ and women often find it a challenge break into the industry. Francesca Frederico of Twelve Point Wealth Management says that with the right outlook on life, you can turn a challenge into an opportunity. Instead of trying to fit into a male dominated environment, use your expertise and skills to do things your way. Women need to think outside the box, be more willing to take risks and follow their dreams. Not only is it an enlightening feeling to be yourself, but you will see that not doing things a certain way is not always the right way.

Take the risk

The greater the risk, the greater the reward. In order to find success in the finance world, women need to trust their gut and take the risks to get the most out of their career. Although you may face many trials and tribulations to the top, you need to follow your instincts and take the leap of faith to reap big rewards. At the end of the day, your journey of risk-taking should lead you to a job that you are passionate about.

Also read: 5 Psychology Traps that Investors Need to Avoid

Bonus: It’s not always about the money, focus on making a change

This does not just apply to jobs in the financial industry but to any job you have in your life. While paying your bills is important, you need to use your knowledge to make a difference in the lives of the people around you. Many financial leaders use their skills to educate people on wealth management and investing. This is a system that is a necessity for many people in world as nearly a majority of the population has a hard time saving money.

Although there is a gender gap, there are still many women blazing a trail in the finance industry, they took the risks and fought for what they believed in, ultimately making their mark. The future is bright for women in finance and it is up to us to find our passions and work diligently towards them. So this Women’s Day encourage the women around you and climb higher mountains and celebrate each other’s successes.

“Every great dream begins with a dreamer. Always remember, you have within you the strength, the patience, and the passion to reach for the stars to change the world.” —Harriet Tubman

March 9, 2019 Divya Premkumar Personal Finance No comments yet

Emergency fund: Why and How to build one?

Growing up, we’re often told to save for a rainy day. As kids, many of us didn’t heed this advice, choosing instead, to spend our money on the next best toy or video game. However, it is only when we grow older that we realize the importance of the values our parents instilled in us.

Learning how to save money from a young age is known to have numerous benefits. For one, it teaches you the value of money and motivates you to work towards your goal of buying a new book or a video game you really want. While kids put their money into a piggy bank for a rainy day, adults use the same principle to save their money in a bank account known as an Emergency Fund.

What is an Emergency Fund?

As the name suggests, an emergency fund is money that you put aside for emergencies. It is the money that you can reach out to during your hour of need and pay for those unforeseen and unexpected expenses such loss of a primary job (the main source of income), medical emergency, personal emergencies or even a car breakdown. You need to have a solid financial plan for the future and an emergency fund is an essential tool in helping you do just that.

Many people often find it hard to grasp the concept of saving for an unexpected circumstance as it is much easier to live in the movement and spend money on the things you love- money buys happiness, right? But an emergency fund can help you in darkest hour and statistics provide the proof. According to a report by the Federal Reserve on Economic Wellbeing in the U.S. Households in 2015 showed that when faced with an emergency of $400, 47% of Americans had a hard time coming up with the money without using their credit card or borrowing from family and friends. This shocking statistic is reason enough to start working on that emergency fund immediately.

The financial experts recommend that before you start making investments for your long-term goals, first you should build an emergency fund which should be greater than at least three times your monthly expenses. In other words, even if you lose your primary source of income, you should be able to survive at least three months through your emergency fund. For example, if your monthly expense is equal to $2,500, then you should have at least $7,500 in your emergency fund. It would be even better if you can build an emergency fund to cover six months of your expenses as it will reduce the need to draw from high-interest debt options, such as credit cards.

Moreover, this fund should be highly liquid i.e. readily accessible in case of emergency situation. A few good options to build your emergency fund is via savings account or money market funds. Additionally, avoid investing your emergency fund in instruments with lock-in periods or those which are subjected to penalties in case of early withdrawal.

How to build an emergency fund?

By now you understand why an emergency fund is so important and want to create one for yourself. Building an emergency fund is incredibly easy and only requires some discipline and resilience on your part.

So how do we do this? Like with all other things in life we need to start small. Here are a few ways to help you get started:

1. Big things have small beginnings

Saving is key to having a financially secure future and have an emergency fund is an important part of this. Saving a large amount of money for an expense that may or may not happen in the future is a hard thing to do. So take baby steps with your fund and start with saving small amounts of money. This could even be as low as $30-$50 dollars a month as long as you are actively putting away money for the future. Although you start out small, you need to have a goal as to how much money you would ultimately want to have in your emergency fund. Setting a fixed goal makes it easier to work towards it.

2. You don’t need all that coffee

Many people live paycheck to paycheck and often find it hard to put away money for the future. If you find yourself in such a situation, you need to look at your existing expenses and try to cut back on what is unnecessary. You can start by accounting for your expenses every day and putting them into different buckets. This can help you identify areas that you spend too much money on like all that expensive coffee or those frequent restaurant meals. If you are really trying to build that rainy day fun, try cooking all your meals at home for at least 5 days a week.

3. Automate it!

To successfully build an emergency fund you need to control your expenses and put away a certain amount of your paycheck every month. While this is easier said than done, one way to make the process simpler is by having an automatic transfer of a fixed amount from your bank account every month. This serves two purposes, one, the amount in your bank account will be lower meaning that your expenses will be in control and two, you won’t even have to think twice about putting away money since the process is now automated!

4. Get creative with saving

As you begin to get more serious about building your emergency fund, you can find new and creative ways to save money. When you begin to assess your income and spending, you may find some unnecessary leaks in your income. This could be canceling subscriptions that you no longer use for magazines or apps. These payments are automatically charged to your debit or credit card and can add up quickly. Additionally, with over the top (OTT) platforms like Netflix and Amazon Prime, the trend has shifted to online entertainment, making cable TV obsolete. So take a good look at your cable channel list and try to cut channels that you no longer watch or need. While these costs may not seem as much, they can amount to a lot of savings over time.

Alternatively, look for ways to increase your income stream. You can get a freelance job or have a side hustle like babysitting or dog-walking.

Also read:

5. Celebrate your accomplishments

While the goal of an emergency fund is to save money for a rainy day, it is also important to reward yourself once in a while. This doesn’t have to be a big splurge, it could even be a meal at your favorite restaurant or a new book. Rewarding yourself will motivate you to keep going and achieve all your saving goals!

An emergency fund can help you when you have a financial setback and is an essential tool for financial success. In addition to saving money, you will have the added advantage of earning a high-interest rate on the money. Once you’ve built up a system of saving money every month, you are well on your way to building that emergency fund but most importantly make sure to use your money wisely!

March 4, 2019 Divya Premkumar Personal Finance, Save money No comments yet

The Dogs of the Dow Strategy For Picking Stocks

The Dow Jones Industrial Average (DJIA) or the Dow is an index of 30 companies that many investors are confident about investing in. It shows the market valuation of companies such as General Electric, Exxon Mobil and Microsoft Corporation and is a good reflection of how the markets are performing. A common strategy used by traders when investing in the Dow is the ‘Dogs of the Dow’ strategy.

This strategy involves a trader buying the top 10 stocks with the highest yield from a bucket of 30 stocks in the Dow. The idea behind this strategy is that blue-chip stocks with a high dividend yield is a sign that these companies are currently facing a downturn in their business cycle and in the upcoming year these values are sure to increase as the company goes through its cycle.

What is the DJIA?

The DJIA or the Dow is one of the most famous and trusted indices in the world. Founded by Charles Dow during the 19^th century, the DJIA assesses the value of a basket of 30 blue chip companies based in the United States. Blue-chip stocks are shares of large, well-recognized companies that have a high valuation and a long history of trading on the stock market.

Here are the 30 stocks that make up the Dow Jones Industrial Average as of today.

Company	Price (USD)
MMM 3M	207.39
AXP American Express	107.74
AAPL Apple	173.15
BA Boeing	439.96
CAT Caterpillar	137.34
CVX Chevron	119.58
CSCO Cisco	51.77
KO Coca-Cola	45.34
DIS Disney	112.84
DWDP DowDuPont Inc	53.23
XOM Exxon Mobil	79.03
GS Goldman Sachs	196.7
HD Home Depot	185.14
IBM IBM	138.13
INTC Intel	52.96
JNJ Johnson & Johnson	136.64
JPM JPMorgan Chase	104.36
MCD McDonald’s	183.84
MRK Merck	81.29
MSFT Microsoft	112.03
NKE Nike	85.51
PFE Pfizer	43.35
PG Procter & Gamble	98.55
TRV Travelers Companies Inc	132.91
UTX United Technologies	125.67
UNH UnitedHealth	242.22
VZ Verizon	56.92
V Visa	148.12
WMT Wal-Mart	98.99
WBA Walgreen	71.19

Usually, when people say ‘the market is doing well’, they are most likely referring to the DJIA. The index also provides valuations for certain industries such as the Dow Jones Utility Average and the Dow Jones Transportation Average. Other famous indices like the DJIA include the S&P500 index which is an index that values 500 companies.

Also read: What are FANG stocks? And why are they so popular?

How is the DJIA calculated?

The DJIA calculates the value of 30 blue chip companies whose valuations have a large influence on the economy and are a good reflection of the current market conditions. The companies that are to be included in the DJIA are selected by editors of The Wall Street Journal.

When valuing the companies, the Dow only considers the average price of the stock and not the company’s market capitalization. Hence if both company A and B have a stock price of $40 but their market capitalizations are $30 million and $90 million respectively, as per the index calculation both companies will have the same impact on the market and the movement of the DJIA.

But the DJIA index differentiates between stock splits, spin-offs etc using a divisor. Before the divisor, the total value of the stock prices was divided by the total number of stocks. However, if there was a stock split in one of the shares, dividing it by the total number of shares will not provide an accurate value of the DJIA.

With the divisor, the value of the stock will be calculated as follows:

Say a stock has a share price of $50 that is split into two and the total sum of all the 30 stocks in the bucket is $1096. The first step will be to subtract the split stock from the total: 1096-25= $1,071.

To find the new divisor after the stock split you need the new sum by the index value before the split. Therefore: [1071/(1096/30)]= $29.32 (new divisor)

The new DJIA= 1071/29.32= $36.53

Why is the Dogs of the Dow strategy great for investors?

Using the calculation shown above the DJIA provides the valuation of 30 large companies that have a high market valuation and provide an accurate reflection of the market conditions. The Dogs of Dow strategy, introduced by Michael B. O’Higgins in his book Beating the Dow, picks the top 10 companies out of the 30 included in the index based on their dividend yield. The Dogs of the Dow are a list of the current 10 companies ranked by their yield in the prior year from highest to lowest. The dividend yield is the ratio of the total dividends paid out to shareholders to the market value of its shares. Therefore companies with a high dividend yield pay out a large amount of their revenue in the form of dividends.

The Dogs of Dow is an optimal strategy for many investors as it ensures that they receive a high return on their investments. Many investors usually pick stocks based on the number of dividends they receive and buying the stocks with the highest dividend yield (10 Dogs of the Dow) will ensure that the investor earns a good return.

Furthermore, as the dividend yield of a company increases, it signifies that a company is facing a downturn in their business cycle and as all cycles have their ups and downs, buying a Dogs of the Dow stock with a high dividend yield is a sign that the company will have an upward movement in the upcoming year. Stocks that are currently going through a slump tend to have a low share price that is attractive to many investors.

What companies are the Dogs of the Dow in 2019?

Historically, the Dogs of the Dow stocks have shown positive returns for investors. In 2015 and 2016 they had price gains that beat out the Dow but faced a low point in 2017 as they only had returns of 19% in comparison to the Dow’s 25%. In 2018 however, the current Dogs of the Dow faced losses of 4% that were still significantly lower than the losses faced by the Dow at 6%. While this strategy does not always promise returns, it is appealing to many investors as the high yielding stocks usually have a lower price and is a safer option to buying all 30 stocks in the Dow.

Here are the top 3 Dogs for 2019:

— Exxon Mobil: The price of oil per barrel has increased steadily during 2018 from $60 per barrel to $70 per barrel but ended the year at only $45 a barrel. This is a sign that Exxon Mobil may have an upward turn in its stock prices in 2019. Two factors that can lead to better market conditions for Exxon are the ongoing talks between the US and China along with a cut in oil production by OPEC nations. The second factor is Exxon’s aggressive growth plan that hopes to double their returns in the upstream and downstream business.

— Pfizer: Pfizer’s popular pharmaceutical drug Lyrica had a dip in sales in 2018 and lost a lot of market share in the U.S and Europe. However, with a change in management this year, Pfizer is more optimistic about 2019. Moreover, the company has more than 30 drugs in the pipeline that it hopes to receive approval for by 2022.

— Cisco Systems Although there has been an increase in Cisco’s dividend in the last few years, many investors are choosing to invest in younger tech companies, leaving older companies like Cisco behind. However, Cisco plans to rectify this issue in 2019 as they are turning all their subsidiary services into subscription models which they hope will help them leverage their position in global markets and increase revenue. They also have a 3% yield which is a high value in comparison to other DJIA companies.

Also read: Here Are the 2019 Dogs of the Dow

Closing Thoughts

The Dogs of the Dow strategy is great for investors to diversify their portfolio and receive above-average returns. While the current Dogs of the Dow stocks may not seem to be doing well in the market currently, they are sure to increase in value by the end of the year.

March 1, 2019 Divya Premkumar Investment Basics No comments yet

What is Sharpe Ratio? And how to calculate risk adjusted return using it?

The Sharpe ratio is an important metric used to determine the overall return an investor receives on his portfolio and measures the total amount of revenue earned for each unit of risk. The ratio shows the investor how their investment or fund is performing after being adjusted for risk and can help an investor understand how much their risk is worth. It is commonly used to compare the risks of two different investments against a benchmark number. The higher the Sharpe ratio, the better the risk-adjusted return on the investment.

The Sharpe ratio is often favored over a total returns ratio because it takes into account the investors risk when calculating the return. The return ratio, on the other hand, only lets the investor know the total amount of money they will earn on the investment. In certain cases, an investment that generates a high return can have high volatility and many investors find that the returns are not worth the risk. The Sharpe ratio is used to assess risky investments like equity funds where the extra return is seen as an excess risk.

Who invented the Sharpe Ratio?

The Sharpe Ratio was invented by William F. Sharpe, a Noble American Prize winner, in 1966. The Sharpe ratio is widely used today to calculate the risk-adjusted return on investments. In addition to inventing the ratio, Sharpe was also noted for his contributions in developing CAPM which assess’ the systematic risk relative to the return on a stock.

Although the ratio was named after him, Sharpe said that this was unintended. When he first developed the ratio it was called the Reward to Variability ratio but as it became increasingly popular among investors, it soon became synonymous with Sharpe’s name.

How is the Sharpe ratio calculated?

The Sharpe ratio is used to measure the risk-free return on your portfolio and helps an investor place a value on the level of risk undertaken. It can be calculated using the formula:

Sharpe Ratio = (Expected return – Risk-free return) / Standard deviation

The components of the formula:

Expected Return: This could be the expected return on the investment in days, months or years. To arrive at a standard value, the total return is annualized for uniformity. When there are extreme highs and lows, the data can often be skewed.

Risk-free Return: The rate of return is considered to ensure the investor is receiving a good return for the risk taken. This is often a benchmark that the level of risk is compared against. For example, government securities are known to have the lowest level of risk and the Sharpe ratio assumes that a similar security purchased for the same duration should carry identical risk.

Standard Deviation: this value indicates by how much individual elements in a group are away from the mean and is calculated as the square root of the variance. After subtracting the expected return from the risk-free return, it is divided by the standard deviation to show how far the asset is from the mean risk. The higher the Sharpe ratio, the greater the risk-adjusted return.

Numerical Example

Let’s say that an investor has a portfolio which consists of stocks and bonds. The current expected return on his portfolio is 13% with the market volatility of 4%. The risk-free rate for the securities is valued at 6%.

Now, he is planning to add another asset in his portfolio which may reduce the expected rate of return to 11%. However, the portfolio volatility will also reduce to 2.5% after adding the asset. What should he do? Is it wise to add this asset to his portfolio? Let’s find out the answer using the Sharpe Ratio.

Initially, the Sharpe ratio for his portfolio was:

= (0.13 – 0.06)/0.4 = 17.5%

Nonetheless, after adding the new asset, the expected rate of return and the portfolio volatility will reduce. Further, let’s assume the risk-free rate of return to be constant at 6%. The updated Sharpe ratio for his portfolio will become:

= (0.11- 0.06)/0.25 = 20%

Here you can notice that although the absolute return after adding the new asset is lower. However, there is an improved performance for his portfolio on the risk-adjusted basis which is reflected in the increased Sharpe ratio. Therefore, he should add this new asset to his portfolio.

What is the Sharpe Ratio used for?

The Sharpe ratio measures the total value of an investment, taking into account all the inherent risks involved in a certain asset. Investors use the Sharpe ratio in the following ways:

— To compare two investments- The ratio can be used to compare the risk-adjusted return for two investments and allows you to quantify the excess returns over the risk-free rate. This is useful information to an investor as an investment that has a high return may not always be worth a large amount of risk. It also standardizes different types of investments that allows for easy comparison.

— It helps you decide what to invest in next- The Sharpe ratio calculation can help you pick your next investment. If your existing ratio a lower Sharpe ratio, then ideally you should choose an investment that will increase your Sharpe ratio which would lower risk and increase return. Any investment that decreases the Sharpe ratio is a sign that the investment may not be the best addition to your portfolio.

— High return does not equal a good investment- the Sharpe ratio is a good measure for the risk to return value of an investment. An investment with a return of 9% and low volatility is better than an investment return of 11% with high volatility. The Sharpe ratio takes this volatility into consideration and provides a true return on investment.

Also read:

Warning: Sharpe ratio is not always a good indicator

The Sharpe ratio is used as a comparison between two investments and sometimes there is no indication as to whether all the stocks in the portfolio are concentrated in one sector. If this is the case, an industry that is doing well will result in a high Sharpe ratio but will also be a very risky investment for the trader.

Alternatively, finding the right valued for risk-free-return and the standard deviation is often a challenge for many investors. During unstable economic conditions, historical data may not provide a true reflection of the current market environment. In today’s everchanging market, history rarely repeats itself.

Hence, when using the Sharpe ratio to assess an investment, its value should be considered in addition to other qualitative factors and ratios to help you make informed decisions.

February 27, 2019 Divya Premkumar Investment Basics No comments yet

What is Goodwill in the Balance Sheet?

Goodwill is an intangible asset that represents the non-physical items of a company has that cannot be easily valued. It is the excess value of a business after subtracting the assets from the liabilities. This value can be generated from customer loyalty, the quality of the management, the brand image or even the location of the company. Anything that adds value to a company beyond its assets and liabilities is considered goodwill.

Why is goodwill important to a company?

The importance of goodwill comes into play during a merger or acquisition. A buyer who is looking to acquire the company can pay more than the market value due to the business’ intangible assets. When acquiring another business, companies often look beyond the physical assets that the company owns and consider the brand identity, customer satisfaction and efficiency of the staff to arrive at a fair price for the company. The total amount of money that the buyer pays for these intangible assets in excess of the company’s market value is considered goodwill.

Goodwill is subjective and can be a different value for each company. When Facebook acquired Instagram, many people believed that Instagram (a free app that allows you to share images at no cost) was not worth more than $500 million. But after valuing Instagram’s total assets, liabilities and goodwill, Facebook believed that Instagram was worth over $1 billion which is what they paid for it. It is often hard to put a specific value on a company.

What creates goodwill in a business?

There are three factors that makeup goodwill in a business. They include:

1. Going-concern

This includes the existing assets in the business such as the employees and equipment that can be used in the day to day operations of the business. When these assets are functional, they create intangible value for the business known as going-concern. The going concern of a company can be used in one of two ways.

It can either be shown as an individual intangible asset for specific valuation or tax reasons or as a component of the total goodwill in the company. This second method is in accordance with the Financial Accounting Standards Board (FASB) for deriving the fair value of a company.

Going-concern can increase the value of specific assets in the business. For example, the value of a machine will be greater when it is seen as being fully functional and adding value to the business every day versus being valued as a single entity in the company. Going concern can also add value to an intangible asset such as a trademark or copyright. These assets are usually worth more when there are seen as providing continuous value to the company.

2. Excess business income

When a company earns a rate of return that is greater than the fair value of the tangible and intangible assets combined, the excess income is considered goodwill for the company. This excess income cannot be assigned to any specific tangible or intangible asset and is hence included in the goodwill of the company. For example, any income earned by an actor or singer that is in excess of their direct return from their acting or singing abilities is considered goodwill.

3. The expectation of future events

Goodwill can also be created through any future events that are not directly related to the current operations of the business. This can include a merger or acquisition, expansion of the business or new clients. When valuing a company, financial advisors will use the current operations of the business (NPV) in relation to the future events assuming that it will have a positive impact on the company.

The different types of goodwill

There are three different types of goodwill:

— Institutional goodwill

This is the company’s reputation of the company in the market and their ability to serve customers. That is the goodwill created from the collective operations of the business through its assets.

— Professional goodwill

This is the goodwill in professions such as a doctor, lawyer or athlete. It consists of two types:

Practitioner goodwill- this is the goodwill created by the skills, talent, and reputation of the professional.
Practice goodwill- this is the goodwill created by the business the professional works and includes the location of the business, its reputation in the market and the efficiency of the operations.

— Goodwill as a result of fame

Famous people can also create goodwill through various factors. For an actor, their goodwill is attributable to their skill level while athletes create goodwill through their professional accomplishments and accolades. Top business executives and politicians create goodwill through their skill level and any professional accomplishments.

Also read:

Example

Company X purchased Company Y for $115,000. Business Y has assets worth $100,000 and liabilities worth $20,000. The value of goodwill is:

Goodwill = 115,000 – (100,000 – 20,000) = $35,000

The journal entry for Company X is:

Account	Debit	Credit
Total assets	100,000
Goodwill	35,000
Liabilities		20,000
Cash		115,000

Goodwill is shown separately in the assets of the buying company’s balance sheet but the treatment of goodwill can vary by the accounting standard followed by the company. Under the IFRS and US GAAP standards, goodwill should not be amortized on the balance sheet every year rather the goodwill should be monitored and only reported on the balance sheet when necessary i.e. during a merger or acquisition.

Under the UK GAAP, goodwill is seen as providing continuous value to the business and should be amortized every year. The intangible assets are included in the financial statements of the buyer at their fair value (the price at which the intangible assets could have been disposed of individually).

Sometimes, the goodwill of a company can be negative (the company is sold at a price lower than its market value). In this case, goodwill is shown as an income on the buyer’s balance sheet.

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

Conclusion:

Goodwill refers to the reputation of a business and is vital to any company in acquiring new customers and retaining existing ones. It also attracts new investors and keeps shareholders happy. Moreover, Goodwill represents the true value of a company, that is, its total worth over and above its market value. The goodwill of a company is often valued by financial advisors for the purpose of taxation, litigation or maintaining financial statements.

February 26, 2019 Divya Premkumar Investment Basics No comments yet