Unraveling the Magic Formula investing Strategy by Investing Ace Joel Greenblatt: Have you ever wondered if you would get an indestructible investment strategy if you combine the strategies of investment gurus in a perfect mix? The magic formula of Investing by Joel Greenblatt does exactly this. It combines the strategies of Warren Buffets value investing and Benjamin Grahams Deep value approach in order to create the winning ‘Magic Formula’.
In this article, we are going to cover this ‘The Magic Formula’ Investing Strategy by Joel Greenblatt. Here, we’ll discuss the exact magic formula approach and how it can be applied to your stock-picking technique and portfolios.
Who is Joel Greenblatt?
Joel Greenblatt is a hedge fund manager and professor at Columbia University. He runs Gotham Funds with his partner, Robert Goldstein. Joel is considered a genius by other fund managers at wall street. Such was his acumen, that post the release of his book ‘You Can Be A Stock Market Genius’, many hedge funds claimed they were following his approach.
The Magic Formula which we are about to discuss today is from his second book, ‘The Little Book That Beats the Market’. This book was specifically written by him in order to assist small investors with a simple strategy. According to Joel Greenblatt, The Magic Formula when tested by him offered 24% returns from 1988-2009.
What is Magic Formula Investing?
In the book “The Little Book that Still Beats The Market”, Joel Greenblatt focuses on his magic formula investing strategy that is based on two financial ratios- Return on capital and Earnings Yield. Let’s discuss each of these ratios.
1. Return on capital (ROC)
ROC is the ratio of the pre-tax operating earnings (EBIT) to tangible capital employed (Net working capital + Net fixed capital). It can be calculated by using the following formula: ROC = EBIT/ (Net working capital + Net Fixed capital).
Joel Greenblatt described why he used ROC in place of the commonly used financial ratios like ROE (Return on equity) or ROA (Return on assets). This is because, first of all, EBIT avoids the distortions arising from the differences in tax rates for different companies while comparing. Second, the net working capital plus net fixed capital is used in place of fixed assets as it actually tells how much capital is needed to conduct the working of the company’s business.
Overall, Return on capital tells how efficient the company is in turning your investments into profits.
2. Earnings Yield
Enterprise value is the market value of equity (including preferred shares) + net interest – bearing debt. Earning Yield can be calculated as: Earning yield = EBIT / Enterprise value.
This ratio tells how much money you can expect to make per year for each rupee you invest in the share.
In short, from the above two discussed financial rations, ROC tells how good is the company, and Earning yield tells how good is the price.
Next, here are the three steps suggested by the author Joel Greenblatt in his book ‘The little book that beats the market’ to find companies for investment:
Find the earning yields and return on capitals of the stock to evaluate stocks.
Rank the companies according to the above two factors and combine them to find the best companies for investment.
Have patience and remain invested for the long term. Lack of patience is why people fail to implement the magic formula.
How to use magic formula using the above ratios?
Find the Return on capital (ROC) and Earning yield (EY) for all the companies.
Sort all the companies in ranks by ROC.
Sort all the companies in ranks by EY.
Invest in the top 30 companies based on the combined factors.
Company Symbol
ROC Rank
EY Rank
Combined Rank
A
1
153
154
B
2
35
37
C
3
37
40
D
4
480
484
E
5
13
18
F
6
127
133
G
7
78
85
H
8
512
520
Now, we try to find the companies with the lowest combined factor rank.
For example, for company A, although it ranks 1 for the Return on capital. However, its earning yield rank is quite low and that’s why it’s combined rank is quite high. On the other hand, for company E, both ROC and EY rank are decent and hence its combined rank is good for investment.
How to use the Magic Formula Investing Strategy efficiently?
The Magic Formula is based on the simple principle that if you buy good companies at cheap prices you are going to do well. In a note of caution, Greenblatt emphasizes that for the formula to work its magic it must be applied for a period of 5 years. The following are the steps to be followed in order to implement this strategy.
1. The very first step involves deciding the total amount that you want to invest along with the number of stocks. Greenblatt suggests creating a portfolio of 20-30 stocks.
2. The next step includes setting up an investment pattern for the period when you would buy the stocks. Greenblatt expects the investments to be bought in batches spread out through the year. I.e. if you plan on investing in 20 stocks you can plan of buying stocks in batches of 5 every 3 months. Or if you plan on investing in 21 stocks you can plan of buying stocks in batches of 7 every 4 months.
3. The next step is to try and allocate the predetermined total investment amount equally among the number of stocks selected. This means that if you have decided to invest in 20 stocks with a capital of $200,000, then $10,000 must be spent on each stock.
4. Now we sort the companies in order to only include companies with a market capitalization of over $50 million, $100 million, or $200 million. This will depend on the risk an investor can stomach. On whether he would prefer to invest in stocks that have greater growth prospects in the lower Mcap or ones that are stable with higher Mcap.
5. Determine the company’s earnings yield, which is EBIT/EV.
6. Determine the company’s return on capital, which is EBIT/(net fixed assets + working capital).\
7. Based on the last two steps, rank the stocks according to earnings yield and return on capital. Once ranking them individually is on the 2 parameters is done, rank them based on the combined ranks of the two-parameter. This can be done by adding the ranks of stock in the 2 parameters.
8. Invest in the highest-ranked companies calculated whenever the predetermined dates to invest in the batches arrive.
9. Rebalance the portfolio once per year, selling losers 51 weeks after purchase and selling winners 53 weeks after purchase. This is for tax purposes, as losses can be considered for the same year, and stocks that gain are to be held for longer in order to benefit from the reduced Long term Capital Gain tax rate.
The two parameters used above i.e help us identify stocks that are of high value(earnings yield) and at the same time are below the average price(ROC).
Closing Thoughts
The Magic formula is a relatively simple investment strategy that is easy to understand. Its implementation, however, may take some toll. In order to ensure that it does not cause much of a hindrance, it is best that investors continuously keep recording.
This involves the plan and activity performed along with the appropriate dates. By doing so investors will avoid any confusion. These may arise regarding when they have to buy stocks and when they have to rebalance their portfolios. Happy Investing!
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Unwrapping Peter Lynch’s Investment Strategy: Peter Lynch was to the investing world what rockstars are to us. He is primarily known for his work at Fidelity Management and Research where he managed the Magellan Fund. This fund was launched in 1977 and ended when Mr. Lynch retired in 1990.
Even though 3 decades have passed since he retired, his work in Fidelity still astonishes investors as he grew the assets of the fund from $14 million in 1977 to $18 billion in 1990. With Lynch at its helm, the fund was among the highest-ranking stock funds throughout his 13 years tenure beating the S&P 500, its benchmark, in 11 of the 13 years.
Over the years there also have been debates on who was the ‘greatest investor of all time’ Buffet or Lynch? Clearly the 54 years Buffet spent at Berkshire Hathaway offering 20.9% annual return gives Buffet the greatest title. But Lynch achieving a 29% annual returns also provides solid arguments.
Just to put things in perspective a $10,000 investment that earned this return for 13 years would have grown to nearly $280,000. But it is not only this achievement that makes Lynch one of the greatest but also because he shares the strategy he used to achieve this in a simple manner gaining him considerable fame.
Peter Lynch’s Investment Strategy
Lynch was an institutional investor. Can his strategy be used for individual investors?
Lynch always believed that an average investor can generate better returns in comparison to professional or institutional investors like mutual fund managers, hedge funds, etc. This is because according to him individual investors hold a distinct advantage over Wall Street as they are not subject to the same bureaucratic rules.
Also, individual investors do not have to be bothered by short term performances. In comparison, professionals are answerable to their investors if a fund performs badly in a year. A justification saying “The assets are going through a phase and will perform better in the future” will not convince a fund’s clients.
Finally, individual investors also have the advantage of a smaller scale. It is easier to double $10,000 in the market than it is to double $10 billion.
Peter Lynch’s Investing philosophy
“Invest in what you know.” – Peter Lynch
Peter Lynch’s whole investing philosophy revolves around this. “Investing in what you already know about”. To support his argument he gives the example of a doctor. Say you are a cardiologist and are beginning your journey into the world of investing. Almost all of us have a fairly good idea of what companies like Mcdonalds and Nike do.
But would you have an edge by investing in these? Say, as required by your field you are made aware of a new heart pump being introduced. You being able to judge this will obviously be aware of the revolutionary effects the heart pump may have in saving human lives. Hence, in this case, your in-depth knowledge of the subject gives you an advantage while deciding if ever you could invest in the company or not.
Just like this, we may own experiences–for instance, within our own business or trade, or as consumers of products that provide us an edge to improve our investment judgment. Hence the quote “Buy what you know”. This is an advice that has also been advocated by Warren Buffet.
Sources that Peter Lynch Uses
The greatest stock research that we have at our disposal in order to identify superior stocks are our eyes, ears, and common sense. Also, Lynch does not believe that investors can predict actual growth rates, and he is skeptical of analysts’ earnings estimates.
Lynch was proud of the fact that many of his great stock ideas were discovered while walking through the grocery store or chatting casually with friends and family. Even when we are watching TV, reading the newspaper, driving down the street, or traveling on vacation just by noticing an investment opportunity we can do first-hand analysis over it.
Lynch is something of a ‘Story Investor’. Now that it is clear that Lynch advocates investing in what you know, and his initial research begins with his senses in the environment. The step that Lynch follows is that of finding a story behind the stock.
Often being engrossed in the investing world has led us to believe that stocks are nothing more than just a collection of blips on a screen or just numbers to be judged by ratios. But for Lynch, the stock is more than just that emphasis us to realize that behind the stock is a company with a story.
What is this ‘story’ Peter Lynch looked for?
According to Lynch a company’s plan to increase earnings and its ability to fulfill that plan is its “story,”. He lays down the 5 ways that a company can increase its earnings. Lynch points out five ways in which a company can increase earnings:
It can reduce costs.
Raise prices.
Expand into new markets.
Sell more in old markets.
Revitalize, close, or sell a losing operation.
Hence this is where is the advice of ‘Investing in what you know’ falls into place. The only way you can have a better edge to judge a company’s plans to increase earnings is if you are familiar with the company or industry. This will increase your chances of finding a good story.
For this reason, Lynch is a strong advocate of investing in companies with which one is familiar, or whose products or services are relatively easy to understand. Thus, Lynch says he would rather invest in “pantyhose rather than communications satellites,” and “motel chains rather than fiber optics.”.
How Peter Lynch Categorized Companies?
We may have come across several companies that may grab our interests after first-hand research. Peter Lynch suggests that in order to be able to judge their story potential better it is best that we categorize then by size. This will help us form reasonable expectations from the company.
This is because if the company is categorized by size we can then judge their ability to increase their value and hence their story. Large companies cannot be expected to grow as quickly as smaller companies. This will further help us decided if the expectations are what we would like to receive in our portfolio. According to him, the categorization can be done in the following 6 ways:
Slow Growers
Large and aging companies expected to grow only slightly faster than the economy as a whole. These generally make up for their growth by paying large regular dividends.
Stalwarts
These include large companies that are still able to grow, with annual earnings growth rates of around 10% to 12%. If purchased at a good price, Lynch says he expects good but not enormous returns–certainly no more than 50% in two years and possibly less.
Fast-Growers
Small, aggressive new firms with annual earnings growth of 20% to 25% a year. These do not have to be in fast-growing industries. Fast-growers are among Lynch’s favorites, and he says that an investor’s biggest gains will come from this type of stock. However, they also carry considerable risk.
Cyclicals
Companies in which sales and profits tend to rise and fall in somewhat predictable patterns based on the economic cycle; examples include companies in the auto industry, airlines, and steel. Lynch warns that these firms can be mistaken for stalwarts by inexperienced investors, but share prices of cyclical can drop dramatically during hard times. Thus, timing is crucial when investing in these firms, and Lynch says that investors must learn to detect the early signs that business is starting to turn down.
Turnarounds
Turnarounds are companies that were on the verge of bankruptcy but have been revived. This could be because the government bailed them out or another company made a strategic investment in them. Lynch calls these “no-growers”.The best example of such a company is Satyam. The stocks of successful turnarounds can move back up quickly, and Lynch points out that of all the categories, these upturns are least related to the general market.
Asset opportunities
Finding these hidden assets requires a real working knowledge of the company that owns the assets, and Lynch points out that within this category, the “local” edge–your own knowledge and experience–can be used to greatest advantage.
(Lynch would pick a David over Goliath company on any day)
The category an investor prefers for his/her portfolio may vary as per investor preference. But Lynch always preferred Fast Growers, this, however, came with considerable risk. To be more precise Fast Growers that are not from fast-growing industries.
This is because in contrast every stock in a fast-growing industry would be growing as well but not specifically because of the company. This growth is only because of investors Fear Of Missing Out due to a short hype in the industry. Over time, however, the high growth industry will also attract significant competitors. This will eventually lead to a drop in growth.
Lynch also coined in the term “Tenbagger” and these companies will clearly be found to be among the fast growers. Tenbaggers are stocks that go up in value tenfold or 1000%. These are the kind of stocks that Lynch looked out for when he was running the Magellan Fund.
The first rule that he set for the Magellan stock is that if one was identified to have the potential, then the investor must not sell the stock when it goes up 40% or 100%. Peter Lynch felt that this amounted to “pulling the flowers and watering the weeds.”
Evaluation and Selection of stocks
The simplicity of the strategy that we have gone through so far may lead us to believe that it is easy. But we are only halfway through the strategy. After classifying the stocks, we now come to its evaluation. Lynch was extremely dedicated when it came to researching. He always believed that the more he researched the greater were his odds of finding the best ones to invest in.
Peter Lynch follows what is called the ‘Bottoms-up’ approach. According to this every stock picked must be thoroughly investigated. Such analysis will expose any pitfalls in the story of the company. Also, it is important to note that if the stock was purchased at a too high of a price then the chances of making a profit will be reduced or wiped off. Hence it is important that the stocks are diligently researched and evaluated.
While looking at the company’s earning over the years one should try and assess if the earnings are stable and consistent. Ideally, the earnings should keep moving up consistently. Assessing the earnings over the years is important because this trend will eventually be reflected in the stock price revealing the stability and strength of the company.
— Earnings growth
It is also necessary that not only for the earnings to keep moving upwards consistently but also to match the company’s story. This means that if a company has the story of a fast grower its growth rate must be higher than those of slow growth rates. One must also keep an eye out for extremely high levels of earnings that are not consistent over the years.
This will also help us identify stocks that are overvalued as a result of attracting attention in that extremely high growth period. Investors here bid up the price. But if a continued growth rate is noticed then it may be factored into the price
— The price-earnings ratio
At times the market may get ahead of itself and overprice a stock even when there is no significant change in the earnings. The price-earnings ratio helps you keep your perspective, by comparing the current price to most recently reported earnings. Stocks with good prospects should sell with higher price-earnings ratios than stocks with poor prospects.
— The price-earnings ratio relative to its historical average
Studying the pattern of price-earnings ratios over a period of several years should reveal a level that is “normal” for the company. This should help you avoid buying into a stock if the price gets ahead of the earnings, or sends an early warning that it may be time to take some profits in a stock you own.
— The price-earnings ratio relative to the industry average
At this point, we may come across stocks that are undervalued in an industry. By comparing its P/E ratio with the rest of the industry we can figure out if it is because it is a bad performer or if the stock has simply been overlooked
— The price-earnings ratio relative to its earnings growth rate
Companies with better prospects should sell with higher price-earnings ratios, but the ratio between the two can reveal bargains or overvaluations. A price-earnings ratio of half the level of historical earnings growth is considered attractive, while relative ratios above 2.0 are unattractive.
For dividend-paying stocks, Lynch refines this measure by adding the dividend yield to the earnings growth [in other words, the price-earnings ratio divided by the sum of the earnings growth rate and dividend yield]. With this modified technique, ratios above 1.0 are considered poor, while ratios below 0.5 are considered attractive.
— The ratio of debt to equity
Lynch is especially wary of bank debt, which can usually be called in by the bank on demand. This is because a Balance sheet that does not have debt or minima debt will come in handy when the company chooses to expand or faces financial difficulty
— Net cash per share
Net cash per share is calculated by adding the level of cash and cash equivalents, subtracting long-term debt, and dividing the result by the number of shares outstanding. High levels provide support for the stock price and indicate financial strength.
— Dividends & payout ratio
Dividends are usually paid by larger companies, and Lynch tends to prefer smaller growth firms. However, Lynch suggests that investors who prefer dividend-paying firms should seek firms with the ability to pay during recessions (indicated by a low percentage of earnings paid out as dividends), and companies that have a 20-year or 30-year record of regularly providing dividends.
— Inventories
This is a particularly important figure for cyclical businesses. When it comes to manufacturers or retailers, an inventory buildup is a bad sign, and a red flag is waving when inventories grow faster than sales. On the other hand, if a company is depressed, the first evidence of a turnaround is when inventories start to be depleted.
Lynch keeps an eye out for ugly ducklings. These are companies that have a boring name or those that function in boring industries. He also considers companies that are in depressing and disagreeable industries. Examples being Funeral homes that are depressing or Waste Management which is disagreeable. Most investors invest in interesting companies like Tesla where cars are launched into space etc. But Lynch is aware that it is these ugly ducklings where their nature is reflected in the share price. This offers up good bargains
Spin-Offs. This is because investors are skeptical of spin-offs and hence receive lesser attention in comparison to the parent company.
Companies that operate in industries with multiple entry barriers. A niche firm controlling a market segment would be attractive
Companies that offer products that are a necessity. These companies provide stability as people tend to buy their products regardless. eg razor blades.
Companies that take advantage of technological advances in their industry but are not directly producing technology say like Google and Apple. This is because companies that produce technology are stock prices that are valued highly.
Companies with low analyst coverage as they are generally not priced too high.
The company is buying back shares. Buybacks are announced once companies start to mature and have cash flow that exceeds their capital needs. The buyback will help to support the stock price and is usually performed when management feels share price is favorable.
Characteristics Lynch finds unfavorable are:
“If I Could Avoid a Single Stock, It Would Be the Hottest Stock in the Hottest Industry.” Hot stocks in hot industries are those that attract a lot of attention in the initial stages due to its explosive growth. This growth, however, burns away as the growth achieved does not match the increase in price due to the added publicity. Over time it becomes clear that the company does not have the earnings, profits, or growth potential to back the buzz. Also as soon as a company with such hot stocks exist copy cats start to appear in the industry deflating the company’s stock value.
Companies that diversify into unrelated businesses. Lynch suggests staying away from such companies. Lynch calls this ‘Diworsefication’.
Companies in which one customer accounts for 25% to 50% of their sales.
Advice for new investors
Lynch suggests that for an investor who is just stepping into the stock market it is best that he starts off with a paper portfolio. And pick 5 companies to buy. Then he investor should ask himself why he is buying these stocks. Answers like “the sucker’s going up.” arent good enough of a reason.
And if the stock performs better for a period then he should again question himself. Why did it go up? Noticing the changes that occurred during this period is also what research is all about. One must also then notice what kind of stock is one good at picking. A person may have a better eye for cyclical while another may be good at selecting fast growers.
Lynch also lets us know that in the stock market it is not the brain that is the most important but the stomach. This is mainly because one must remain invested in stocks that are selected for the long term. There may be ups and downs on a daily basis and the waves of information made available to us do not help in this aspect. Hence being able to hear the news and still have faith in the stock for 10-30 years is necessary. Market falls occur regularly hence it one should have a significant tolerance for pain. Most people do really well because they just hang in there.
Even when it comes to professionals it is not necessary that those will grow multifold. Some may even make a loss.
“In this business, if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten.”
A stock may lose 100% of its value but even one great investment that grows at 1000% of its value will not only make up for the losses also change your life. This shows that you don’t have to be perfect as an investor as a handful of multi-baggers can help you create all the wealth you need.
According to the results of the study, the investor who invested on the absolute high day would have earned a compounded return of 10.6% for the 30-year period. The other investor who invests on the lowest day of the year would earn an 11.7% compounded return over the 30-year period. According to this study, the investor who invested in the worst market timings trailed only by 1.1% per year.
This led Lynch to believe that it wasn’t worth it to run around figuring the right time to invest. This time would be better invested in focussing on what was important i.e. finding great companies.
When to sell your investments?
Despite Lynch being an advocate of long term commitment and not favoring market timing, he does not believe that investors should hold one stock forever. According to Lynch investors should keep an eye on their investments and review their holdings once every 6 months. One may not expect it but just like the buys the sales also depend on the story on the company. An investor should sell his stock if he feels that the stock has played out according to the story and its performance is reflected in the price.
Another reason would be that the story itself is changed by the company or the stock fundamentally deteriorates. Or else as long as the story is as expected a price drop would only mean an opportunity to buy more. Therefore you have to define when a company is getting close to maturity, and that’s when you exit. Or the story deteriorates. If the story’s intact, you hold on.
“A good stock can take several years before it really pays off. Give your investment time to grow. No one can tell you when the right time is to sell a stock. You need to have patience. If you are averse to risk, the stock market is not for you,”
Lynch also advocates for rotation selling. According to him once a stock’s story is played and the expected returns achieved the investor should sell the shares and replace them with those of another company with similar prospects
Closing Thoughts
Peter Lynch’s performance and stock-picking ability have set him, leagues, apart from most of his peers at Wall Street. The strategies that he has provided us with not only provide us with a fresh perspective towards the investing world. One which is generally considered to be simply mundane snd a game of numbers.
His last lesson, however, can be noted in his walking away from the mutual fund industry at the pinnacle of his career. Where he chose to use his wealth to live life to the fullest instead of simply chasing money.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
After the gold prices crossed Rs. 50,000 for 10g after 9 years period since 2011 in India, there seems to be no stop to how high the prices can go. The gold prices touched Rs.58,100 for 10g in Bangalore as of 7th August. This shouldn’t have come as a surprise because commodities like gold have always had exceeding demand in India. Especially after considering that India is one of the world’s largest consumer second only to China.
However, the increase seems unrealistic in times of pandemic where every investment seems to have suffered, only gold seems to have found its biggest boom. In the three year period from September 2016 to October 2019, gold saw an increase of 25% in its value. But along with the increasing troubles of 2020 in the midst of a pandemic the value of gold has already shot up 37.8% or by Rs. 15,240 with 5 more months to go.
Today, we take a look at the scenario finding possible reasons for the boom and also discuss if investing now is a good idea.
The Indian Gold Market
It would be rare to find a market in India that has consistently been in demand such as that of Indian Gold. There have been many jokes that have passed on claiming that the gold available in households is more than sufficient to cover all the deficits and debt that our country faces. But when we look at the following figures these statements may not be exaggerated. Indian households have piled up as much as 25000 tonnes of gold. To put things in perspective that alone would amount to Rs. 145.25 lakh crores in today’s rates. India’s central bank the RBI, on the other hand, has a total holding of 653.01 tonnes of gold. That too after buying additional 40.45 tonnes of gold in the current year.
For many Indians, gold has always been the favorite investment instrument traditionally apart from the land. Despite this, a significant portion is still placed in liquid assets like cash, stocks, etc. In the times of a pandemic, individuals are seeking shelter for their savings in an investment that doesn’t necessarily provide great returns but at least maintains its value and provides liquidity. This has led to the demand for gold skyrocketing to new heights.
Now we take a look at some other factors that have lead to this increase in demand.
1. Scarcity
As you may already know that gold is scarce because all gold is mined. Over time however mining for more gold has become difficult and due to its characteristics, it is safe to say most of the gold is recycled and put back into circulation. But luckily enough this gold cannot be consumed like other commodities. Enabling it to keep its value since time immemorial keeping up with the rising population. Another factor that adds to its scarcity due to its lack of consumption is what happens after the commodity is bought.
Gold, after it is bought, is taken out of the market for long periods of time only to be kept in a drawer or bank locker taking it out of the market for years. But these factors like scarcity, inability to consume, etc, have always existed. Then why have the prices increased now?
These factors have always existed at lower prices only because the increasing demand has always been checked with adequate supply. In order to limit the spread of the virus most countries had to resort to a lockdown. This has had adverse effects on not only mining but also a lack of shipments. As per some estimates, the global demand for gold is 1000 tonnes more than the supply. This rise in demand as mentioned earlier has been due to people’s search for a secure asset.
2. Culture
The demand for gold also has its roots in humans’ desire for beauty. Demand for gold in India is interwoven with culture, tradition. This is primarily because of the dependence of marriages and other functions on gold. According to a study by the World Gold Council, Indian consumers view gold as both an investment and an adornment. When asked why they bought gold, almost 77 percent of respondents cited the safety of investment as a factor, while just over half cited adornment as a rationale behind their purchase of gold.
3. Geopolitical Factors.
People search for a safe haven like gold extends to periods of geopolitical tension like war. This is the reason why crisis situations like wars have a negative impact on almost all asset classes. But when it comes to gold it has a positive impact. This increase in the price of gold was earlier also noticed during the Korean nuclear crisis. Similar trends are noticed due to tensions between India-China and US-China.
4. Exchange Rates
It has been observed that a weakened US Dollar also leads to a rise in gold rates. The same is noticed in the current situation.
5. Limited Influence by Big Market Movers.
In stock markets, it is the FII and DII’s that are termed as market movers. This is because of their ability to influence market trends due to top huge capital in possession. In the Gold market, it is the central banks that have a significant influence. This is because almost every central bank keeps reserves in the form of investment in gold. When an economy is performing well and the RBI has sufficient foreign reserves it will want to get rid of gold.
Because gold does not generate any return and a booming market will provide a better return if the money is invested elsewhere. But in this scenario, the other investors as well will not want to invest in gold as they too would prefer to earn returns. Hence central banks are caught on the wrong side of the trade leading to a fall in the value of gold.
But however, the influence the central banks like RBI have is limited. This is because of the Washington Agreement. This agreement, however, is not binding and is more like a gentleman’s agreement. According to it, central banks will not sell more than 400 metric tons a year. Limiting the influence of central banks even if they want to benefit from high prices.
In Closing: Should you Invest in Gold now?
Predicting Investments is always tricky due to the uncertainties present. Most of us may have already noted the effects of economic turmoil on gold and decided to invest in the future if we are faced with a similar scenario. But that doesn’t help today, does it? In order to help you take better decisions, let us take a look at previous gold rate highs.
If you notice in the above chart you’ll be able to see that the Gold rates boomed in the 1980s as well. But a person investing in such a high would only reap the benefits almost 3 decades later post 2008. Similarly, a person who invested in 2011 is reaping some minimal positive benefits in 2020. Hence considering this if investments were made in gold say in early 2020 is a completely different story than investing now.
However, it is also best to take a look at the forecasts predicted by analysts. Analysts, however, have been bullish and have predicted that gold prices could go up to Rs. 65,000 for 10g in the next 18-24 months. But it is necessary to note that these estimates depend on a period that COVID-19 will take a while more to be controlled. Also, public vaccine availability is not anticipated for at least months to come.
From the above arguments, it shows that when the investment is made on a long term perspective there may be other alternatives that provide better results in the same time frame. However, investing for short periods completely depends on one’s estimates for COVID control or vaccine availability oy unavailability.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
Understanding corporate Spin-Offs and how they work: There are many corporate actions that act as a catalyst in the market and results in the prices of a share changing drastically within a short frame of time. A few common examples of such catalysts are mergers, acquisitions, bonus shares, buybacks, etc. The announcement of all these events results in rapidly increasing (and sometimes decreasing) of share prices in a short period. Therefore, share market investors and participants need to know what exactly these catalysts mean. One other typical example of such events are corporate spin-offs.
In this post, we are going to understand what are corporate spin-offs, how they work, their advantages, disadvantages and why does a company opt for spin-off. Let’s get started.
What are Corporate Spin-Offs?
A corporate spinoff is an operational strategy where an existing division of the parent company is dissolved and a new company is created in place of the division which is now independent of the parent company. Ownership in the newly formed independent company is given to the shareholders of the parent company on pro-rata based on the holdings in the parent company.
The new company resulting from this corporate action is known as the company spun-off. The company spun-off acquires its assets, employees, and other resources from the parent company.
A spin-off is a mandatory corporate action. In a mandatory corporate action, the board takes the decision and the shareholders are not permitted to vote.
To make the topic more comprehensible we shall be referring to the division of the company that is spun off and becomes independent as ‘Spinoff Ltd’. The portion of the company that remains with the existing company earlier will be referred to as ‘Parent Ltd’. The shares of the newly created Spinoff Ltd are distributed to the existing shareholders of Parent Ltd in the form of a stock dividend.
Why does a company opt for Spin-off?
There are a number of reasons why a company may opt for a spin-off. Here are the top grounds why a company may go for a spin-off:
1. Benefits of Focus
Companies that go for a spinoff generally have divisions that are least synergetic and have distinct core competencies from that of the Parent Ltd They find turning these divisions into independent companies i.e. into Spinoff Ltd would be most appropriate.
A spin-off would enable both the Parent Ltd and the Spinoff Ltd to sharpen focus on its resources and manage themselves better off independently.
Spinoff Ltd benefits from the spin-off the most because they get a new management that is focussed only on the goals of Spinoff Ltd. The newly assigned leaders present here would be experts in the field with focus only on the goals of the Spinoff Ltd. This would also help Spinoff Ltd override corporate bureaucracy that was impeding its growth in Parent Ltd.
2. Due to Failure to sell a division
At times Parent Ltd might have decided to sell off one of its divisions but does so unsuccessfully. In such cases, the company uses spin-off as a last resort to separate itself from the division.
3. Reduced agency costs
At times the parent company may enter sectors that are soo diverse from its core competencies that its investors may show no interest in the new division or may even oppose the new division. In these cases, the company incurs agency costs while resolving disagreements between the management and the shareholders.
If the new division is the cause of disagreement a spin-off will prove beneficial to Parent Ltd.
This will also result in satisfied shareholders.
4. Risk, Profitability, and Debt
If a division of a company increases its overall risk due to the sector it operates in the board may take a decision to spin-off that division.
A division may also have all the characteristics of growth in the future but its current performance or losses may be affecting the parent company. In such a situation the division may be spun off.
When a Spinoff Ltd is created it may take on the debt of the Parent Ltd. Or at times Parent Ltd. may give Spinoff Ltd a fresh start by not transferring any debt. This will depend on the strategic perspective of the board.
5. Reduced Overheads
Parent Ltd will benefit from the reduced overheads that pertain to the division which now becomes Spinoff Ltd. On the other hand, Spinoff Ltd will enjoy the freedom of taking care of its own overheads as required without any interference.
Although there are a number of reasons why a company may opt for a spin-off it is basically due to the fact that it feels that by doing so it would turn out to be beneficial to both Parent Ltd and Spinoff Ltd if they operated independently.
What is the Spin-off Process?
A spin-off may take anywhere from half a year up to over 2 years or even more to be executed. Once the board takes the decision there are multiple steps that follow. They include identifying well-suited leaders for Spinoff Ltd. Creating an operating model and financial plans to suit the business of Spinoff Ltd.
This is because the parent company is still responsible for its division. Proper communication about the terms of the spin-off to the shareholders is also necessary. This is followed by completing the legal requirements. The parent company also focuses and helps Spinoff Ltd to create a new distinct identity before the spin-off.
Types of Corporate Spin-offs
Here we classify spinoff on the basis of the ownership retained by the parent company.
– No ownership retained
In what is called a pure spin-off the parent company does not retain any ownership in Spinoff Ltd. 100% of the ownership in Spinoff Ltd is distributed among the existing shareholders of the company. Here Spinoff Ltd gets greater autonomy in its operations once the spin-off is complete.
– Minority Ownership Retained
Parent Ltd is also allowed to hold up to 20% of Spinoff Ltd. In such a case say if 20% is retained by Parent Ltd, the remaining 80% is distributed among the shareholders on a pro-rata basis. Here the parent company enjoys a greater focus on is operations and still retains some influence and decision making ability in the company spun-off.
There is also a possibility of a partial spin-off where the company may only spin-off a part of its division and retain minority or not retain ownership accordingly.
Effects of spin-off on price of securities of the company involved
Once a spin-off takes place the share prices of Parent Ltd will fall. This is because a spin-off involves the transfer of assets from Parent Ltd to Spinoff Ltd. This will result in reduced book value of Parent Ltd and hence its reduced price. However, the reduction in price is set-off by the share price of Spinoff Ltd. This is because Spinoff Ltd will receive the same assets transferred from Parent Ltd. Hence the investor will not face any immediate loss of value.
For eg. say the market cap of the company before the spin-off stands at Rs.10 crores and its current share price is Rs.100. Say the assets that will be transferred to Spinoff Ltd are worth Rs.2 crores. After the spin-off, the market cap of Parent Ltd will be worth 8 crores resulting in a post spinoff share price of Rs.80. The share price of Spinoff Ltd would be Rs.20 with a current market cap of Rs.2 crores.
Reduced demand from Funds
These prices will remain temporarily as the shares will be subject to market volatility. Spin-offs are said to cause sell-offs, particularly in the index-based funds. This is because an index shows the topmost companies in a market based on their market cap. The companies undergoing spin-off may no longer suit the requirements of the market index.
Parent Ltd too may lose its position among the top stocks due to the reduced market cap after the spin-off. This will cause funds that follow the indexes to sell the shares of Parent Ltd as well. Other funds may too sell the shares of Spinoff Ltd. This is because Spinoff Ltd may not suit their capital requirements, dividend requirements, etc. This will result in a reduced demand and fall in the price.
The cost of the spin-off will have to be borne by Parent Ltd. They will include legal duties and other costs of set-up.
2. Employee’s Discomfort
The employees in the division being spun may have joined the Parent Ltd owing to its reputation. They may be put in a situation where they will lose that identity and at the same time be confronted by the uncertainty of Spinoff Ltd.
Spin-offs as part of an Investing Strategy
The share price of Parent Ltd gets reduced after the spin-off. But this is made up for by the shares of Spinoff Ltd that the existing shareholders receive as a stock dividend. As discussed earlier due to market reactions the price may further fall.
After a spin-off takes place investors have the option to either hold onto both the shares of Parent Ltd and the shares of Spinoff Ltd. Or they have the option to sell both or either one. But before deciding which is better let us have a look at what historical studies have shown us about a spin-off.
— Parent company shares
According to a study by Patrick Cusatis, James Miles, and J. Randall Woolridge published in 1993 issue of The Journal of Financial Economics, it was observed that the parent companies beat the S&P 500 Index by 18% during the first 3 years. A study by JPMorgan showed the parent companies beating the market returns by 5% during the first 18 months.
A more recent study by the Lehman Brothers investigated by Chip Dickson between 2000 and 2005 showed that parent companies beat the market average by 40% during the first two years. Due to their strong market cap, holding onto shares of Parent Ltd will be well suited for those investors that look for stable and low-risk returns. This is because as we will observe ahead, the returns from Spinoff Ltd are higher in comparison. But the shares of Parent Ltd are observed to perform even in times of market downturn.
— Shares of the company spun off
According to the same study published in the 1993 issue of The Journal of Financial Economics, it was observed that the companies spun-off beat the S&P 500 Index by 30% during the first 3 years. The study by JPMorgan showed the companies spun-off beating the market returns by 20% during the first 18 months. The study by Lehman Brothers, investigated by Chip Dickson between 2000 and 2005 showed that parent companies beat the market average by 45% during the first two years.
All the studies show that the shares of Spinoff Ltd would not only beat the market but also would perform better than the shares of the Parent Ltd. It, however, should be noted that the share price of the spun-off companies is highly subjective to market volatility. They outperform in strong markets and underperform in weak markets. Hence they are much more suited for individuals with risk appetite.
Investors should also note that it is not the case that all spin-offs are successful. There have been situations where spinoffs have performed negatively. The best way to assess future performance is for the investor to find out why the company is attempting to have the division undergo spin-off. This is to assess if the company is using the corporate action to simply get rid of its debt or if the company is getting rid of a division in which they do not see much future prospect. In such situations, a study of debts and losses pertaining to the division in the companies books will help.
Aron, Bachelors in Commerce from Mangalore University, entered the world of Equity research to explore his interests in financial markets. Outside of work, you can catch him binging on a show, supporting RCB, and dreaming of visiting Kasol soon. He also believes that eating kid’s ice-cream is the best way to teach them taxes.
When the newbies enter the world of investing, one of the biggest questions that they may face is ‘how much’ and ‘how long’ should they invest? Enter the rule of 15*15*15.
In this post, we are going to discuss what is the rule of 15*15*15 (and the rule of 15*15*30) and how it can help you to make your investment decisions.
The rule of 15*15*15
The rule of 15*15*15 says that if you invest Rs 15,000 per month in an investment option which gives a return of 15% (CAGR), for a consistent period of 15 years, you will build a final corpus of Rs 1,00,00,000 (One crore).
Interestingly, your total invested amount is equal to just Rs 27 lakhs. However, over the time period of 15 years, you will build a total wealth of Rs 1 Crore.
Quick Note: In the scenarios discussed above, 15% is considered as the average compounded annual growth rate (CAGR) over the years. However, you must understand that it is just an average as no market can give consistent 15% returns. In the bull market, the returns can be as high as 30–40%. On the other hand, in the bear market, the performance can be as low as -10% to 5%. Here, the 15% is taken as the average of the returns over the 15 or 30 years.
Rule of 15*15*30
The rule of 15*15*15 gets even better when we double the ‘time horizon’ keeping all the other factors the same.
Here, you invest Rs 15,000 per month in an investment option which gives a return of 15% (CAGR), for a consistent period of 30 years.
Can you guess the final corpus build in this case?
The final corpus built after 30 years will be Rs 10,00,00,000 (Rs 10 Crores). And yes, that’s right — not a typo error…
Here your total invested amount is just Rs 54 lakhs. However, as the power of compounding is working in your favor, you will accumulate a final corpus of Rs 10 crores. Only by doubling the time horizon, you can get ten times the amount compared to the rule of 15*15*15.
And that’s why the power of compounding is considered the most substantial factor for wealth creation. Here’s a quote regarding the same by one of the greatest scientist of all time, Albert Einstein:
“Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.” -Albert Einstein
Warren Buffett Wealth Creation
The name ‘Warren Buffett’ needs no introduction, especially for the people involved in the world of investing. His wealth creation story is an interesting topic to discuss in this post.
Fascinatingly, unlike the young tech billionaires of this century like Mark Zuckerberg, Evan Spiegel, Bobby Murphy, John Collison, etc. Warren Buffett did not build his wealth by creating a super-tech company like FB, Snapchat, Google, etc.
Warren Buffett built most of his wealth over time through their investments (and acquisitions) by his company Berkshire Hathaway. You may get surprised to know the fact that the World’s third richest person become a billionaire only in his 50’s.
The biggest factor why Warren Buffett was able to build such a huge wealth was his amazing returns for a consistently longer period. His company, Berkshire Hathaway, gave an average yield of around 21.7% per year for over five decades. This return for such an extended time period is way-way better than what we discussed above. The power of compounding played an important role in Warren Buffett’s wealth creation story.
The time period is a significant factor when you are investing.
In this post, you can notice how by doubling the time horizon from 15 to 30 years; you can get ten times bigger final corpus. And that’s why it is recommended to start investing as soon as possible.
To end this post, here’s an amazing quote by Mr. Buffett: “Someone is sitting in the shade today because someone planted a tree a long time ago.” -Warren Buffett
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
Mutual Fund investment is the talk of the town. These days, many people who earlier used to invest in the traditional saving schemes like PPF and FD are showing more interest in investing in Mutual Fund.
Ideally, if you don’t have a good knowledge of analyzing the security market, instead of directly investing in stocks, buying through Mutual Funds is a lot safer and more convenient. For the middle-class Indians, Mutual Fund investing is a wonderful way of fulfilling their desired goals. You can even start investing with as low as Rs 500 per month.
Irrespective of these advantages, there are many people- especially novice investors, who make a plethora of mistakes investing in Mutual Funds. In this post, we are going to discuss ten of the most common mistakes while investing in mutual funds.
10 Common mistakes while investing in mutual funds
Here are some of the general mistakes which you should avoid while investing in Mutual Funds:
1. Not defining any goal
You should clearly define your financial goals before you jump into Mutual Funds. One requires specifying his/her short and long term goals before deciding over the investment portfolio. If you are planning to go for a tour abroad after a year from now, investing in a Debt Fund seems more appropriate. On the other hand, if you wish to retire after 30 years from today, you should set up your SIPs in an Equity Fund to have a large corpus in hand during your retirement.
2. Not researching the fund properly before investing
Investing in the financial market makes no sense if you haven’t done proper research. Before investing in a Mutual Fund scheme, you need to know its fund type, exit load, historical returns, asset size, expense ratio, etc. You need to have a clear idea about your own risk-return profile before you invest your savings in some scheme. This article can provide you with the necessary guidance regarding making the selection of the right Mutual Fund.
3. Reacting to short term market fluctuations
There are many investors who get scared when the market witnesses a bearish trend. You need to understand that Mutual Fund investing is basically meant for generating long term wealth. So, you should not react to any sharp correction in the market or short term volatility. Moreover, you should refrain from blindly following the stock market analysts and business channels on television. If you don’t keep yourself away from the noise, your chances of making larger returns from Mutual Funds will decrease.
4. Not having a long-term mindset
People generally invest in the Equity Funds to make huge money. Equity Funds can only generate long term wealth if you stay invested for a substantially long period of time. Many people sell their funds losing their enthusiasm and patience after suffering from short term losses. This doesn’t make any sense if you are aiming for quick money from an Equity Fund scheme.
5. Waiting for the perfect time to start investing
I have recently talked to some friends, to whom I had explained about Mutual Fund investing a year back. I was taken aback knowing that he is yet to start investing. He still couldn’t commence investing because he has been looking for the perfect time to invest. I must tell you that when it comes to investing, you should never think of timing the market. Timing the market is important only when you look to trade, and not invest. The market goes through several ups and down in order to reach to point B from point A over a significant period of time.
6. Not having an emergency fund
Many investors invest their entire savings in the Mutual Funds at one go. Therefore, it goes without saying that they don’t have sufficient money for meeting emergencies like medical expenses. So, for paying such expenses, they have no option but redeeming their units and end up paying exit load. Exit load is one type of charge which is levied by a Mutual Fund company if you redeem any units within a specific period of time from the date of investment.
7. Inadequate investment amount
In the case of Mutual Fund investing, you should increase your SIPs in accordance with the growth in your income. Many investors don’t understand the importance of this. Therefore, their SIPs remain the same over time and fail to generate their desired wealth in the long run. Moreover, the inflation rate goes up with time. So, this is also a reason that one should step up his/her SIPs with time to achieve the desired corpus.
8. The dilemma of dividend funds
You will find many people opting for Dividend based Mutual Funds. This is to be noted that the dividends from a Mutual Fund are paid to the investors out of that fund’s AUM. This results in decreasing the NAV of the units of such Mutual Fund. Mutual Funds work best only if you stay invested for a significant term and let the power of compounding play its role. So, if you invest in a growth plan instead of a dividend plan, the amount which you are not going to receive as the dividend is reinvested in the market. This results in creating more wealth in the future as compared to the earlier plan.
9. Not diversifying your mutual fund portfolio enough
When an investor invests in too many schemes of a particular type, he/she thinks that diversification is achieved. You should understand that each Mutual Fund scheme is a portfolio of diversified securities in itself. Therefore, investing in multiple schemes of a specific nature results in nothing but portfolio overlapping at a higher expense ratio. Instead of opting for it, investing in 2 or 3 schemes to the maximum helps in achieving the benefit of diversification.
10. Not monitoring your fund’s performances periodically
Among the investors who invest in the market regularly, only a few them track their investments periodically. If you review the performance of your portfolio timely, it would keep you aligned with your financial goals. Lack of periodic evaluation of funds results in keeping your portfolio filled with junk investments which keep pulling your mean portfolio returns down.
AMFI came out with the campaign “Mutual Funds Sahi Hai” two years back. This four words campaign means that Mutual Funds are good in all respects. The main objective of this campaign was to create awareness among the Indians regarding Mutual Funds and bring more investors in the stock market.
However, it doesn’t mean that you can invest in any Mutual Fund scheme blindly. You must have heard this famous dialogue, “Mutual fund investments are subject to market risks. Please read all scheme related documents carefully before investing.” Mutual Fund investments don’t guarantee a fixed return. You need to go through all relevant documents and analyze the key aspects of a scheme, before investing in the same.
In this post, we tried to cover some major mistakes that plenty of investors make while investing in Mutual Funds. If you prevent yourself from committing these mistakes, we hope that you would become a better investor in the long run. Happy Investing!
6 Best Investment Options for NRIs in India: Since the last two decades, India has been rapidly developing as an industrial hub. Day after day, our country is attracting more and more foreign direct investment (FDI). Moreover, these days we can see more and more investments coming from the NRIs to the Indian markets. And this is all happening because the Indian economy and government are offering adequate stability and flexibility to the investors. Not only India is conducive for business growth but our economy is also equipped with an extremely profitable financial market.
The year 2018 was not an immeasurable year for investing in the stocks as it witnessed significant bleeding throughout the year. Nonetheless, a similar situation was observed in any other country across the world. However, if you have a look at the year previous to that i.e. 2017, you would find that India’s stock market yielded around 29% return which was relatively higher than any other economy in the world.
Anyways, financial markets are subject to lots of ups and downs. It goes without saying that you need to undertake end-to-end research before you make your investment decision. Nevertheless, whatever investment option you opt for, it should always depend on your financial goals, liquidity requirement, risk appetite and expected returns.
In this post, we are going to discuss a few of the best investment options for NRIs in India which can provide them with adequate returns depending on their goals and needs.
6 Best Investment Options for NRIs in India.
Here are a few solid investment options in India where you can consider investing if you are an NRI.
— Fixed Deposit
Investing in Fixed Deposit is not only popular among the residents in India but also an attractive investment scheme for the NRIs. Being an NRI, you can open your FD with your NRE, NRO, or FCNR Account. All three of these are the types of bank accounts that an NRI can open in India.
Anyways, how much rate of interest will be applicable to your FD depends on the tenure of your deposit. In general, you can expect to earn interest between 6 to 7% on your account balance. Further, if you are a senior citizen, you would get the privilege of earning an extra interest of one percent. Moreover, this investment option is suitable for risk averse investors as FD is a comparatively safer form of investment.
Note: You can read more about the current Fixed Deposit rates in India here.
— Equity
In case you are an aggressive investor, you can consider investing in the equities listed in the Indian market. If you are an NRI, you can directly invest in the Indian stock market under the Portfolio Investment Scheme (PINS) of the RBI.
As an NRI, in order to invest in the stock market in India, you are required to have a bank account (NRE or NRO Account), a trading Account (with a SEBI registered Stock Broker), and a demat account. However, the maximum amount of your investment in the stocks of an Indian company cannot exceed 10% of its paid-up capital.
Further, this is to be noted that, as an NRI, you are not at all permitted to carry out intraday trading and short selling in India. This implies that you need to own the stocks before you can sell them.
— Mutual Fund
These days AMFI is working hard to promote Mutual Funds among the Indian population. Mutual Fund organizations pool money from their investors and then invest the same in the different financial assets. Mutual Funds have moderate risks as they are neither as risky as direct trading in stocks, nor they are as risk-candid as FDs. Further, mutual Fund investments can be highly profitable. There are a plethora of schemes available for Mutual Fund which can choose depending on your risk appetite and financial aspirations.
Anyways, if you are a person residing outside India, you would, unfortunately, face some limitations in mutual fund investing in India because of some rigid FATCA regulations. You are required to have an NRE or NRO Account for investing in the Indian Mutual Fund industry. Furthermore, you also have to invest in Indian rupees and not in any foreign currency.
Note: If you are new to mutual funds, check out our beginner’s resources for Mutual Fund Investing.
— Public Provident Fund (PPF)
A safer form of investment similar to FD is Public provident fund. PPF is an investment alternative which is backed by the Indian Government. Even if you are an NRI, you can invest in PPF. However, here the maximum limit is Rs 1.5 lakh in a financial year.
You can open your PPF account through a post office or through a branch of any nationalized bank in India. Although PPF comes with a lock-in period of 15 years it is definitely more tax efficient than FD. To know more about PPF, you can read this blog on our website.
— National Pension Scheme (NPS)
If you are looking for another tax-efficient investment option, you can even consider investing in NPS (National Pension Scheme). This is also cost-effective, easily accessible, and tax-efficient way to invest your money.
National Pension Scheme is an Indian Government sponsored pension system. If you invest in this instrument, your entire capital during maturity is treated as tax-free. Apart from that, you are not required to pay even a penny to the government as tax on the amount that you withdraw as pension. If you are an NRI aged between 18 and 60 years, you can open an NPS Account to start investing in this scheme. Click here to know more about NPS.
— Real Estate
It’s a fact that there are a lot of NRIs who stay abroad but look to buy their own house in India. Indian population is ever-growing and this is itself paving way for the advancement of Real Estate business in the nation. Being an NRI you can invest in a house property in India from where you can earn handsomely by letting it out to a third party.
However, this is to be noted that, you have to make any such purchases only in Indian rupee. Furthermore, you can’t buy agricultural lands, farmhouses, and plantations in India. Nonetheless, there is no restriction on you to inherit any such property or accepting them as gifts. Check out more on Real Estate investing in this article.
Closing thoughts
In this article, we tried to cover some of the best investment options for NRIs that they can consider if they are planning to invest their savings in India from abroad.
If you are a profit-loving investor and looking for a long term capital appreciation, you can choose to invest in the Indian stocks or mutual funds. In case you are having a huge corpus, high risk appetite, and high return expectation, you can invest in the real estate sector. Besides, you can invest in an FD if you have a short investment horizon and looking for a guaranteed return. Lastly, you can opt for investing in PPF or NPS if you are willing to earn tax efficient returns and at the same time not bothered to park your money for a longer period of time.
Overall, nn the basis of your priorities, budget and expected returns, you can make a choice of any investing scheme that suits you in the most effective manner. While making any investment in a financial instrument, ensure that you have gone through the relevant documents and understood the salient features of the same.
Our best wishes on your investment journey. Happy investing!
Making money from stocks is simple if you strictly follow the do’s and don’ts of stock market investing. However, because of the lack of financial education, the majority of the investing population do what they are not supposed to ‘do’ in the market and vice-versa.
For example, the first and foremost rule to invest intelligently in stocks is to ‘not speculate’, but invest only after proper research. However, most people speculate in stocks and bet that the share price will go high in the upcoming days without any significant analysis.
In this post, we are going to discuss the do’s and don’t of stock market investing for beginners. Let’s get started.
21 Do’s and Don’ts of Stock Market Investing for beginners.
Do’s of Stock Market Investing
Here are a few of the do’s of stock market investing that every investor should follow:
1. Get an education
This is probably the most relevant do’s of stock market investing. If you really want to become a successful stock investor, start learning the market.
It doesn’t mean that you should enroll in a college program/degree. Self-education is the best way to learn. There are tons of free information available on the internet which you access to learn the market. Moreover, if you want to get a head-start, you can also enroll in a few good online stock market investing courses. Let the learning begin.
2. Start small
If you are just starting to learn how to swim, you won’t jump in 8 ft deep water, right? Similarly, when beginning to start investing in the stock market, start small. Invest the lowest possible amount and gradually increase your investments as you get more knowledge and confidence.
3. Get started early
I cannot emphasize enough on the importance of getting started soon with your finances. Time is in your favor when you start investing early. Moreover, here you get enough time to recover even if you make some losses during the early time of your investment journey.
One of the key reasons why people do not make money from stocks is that they do not put the initial efforts before investing in the share. Every investor needs to research the company before investing. Here you need to learn the company’s fundamentals, financial statements, ratios, management and more. If you do not want to regret later, research the company first before investing.
The stock market gives an immense opportunity to invest in your favorite companies and make money. However, there are always a few risks involved in the market, and no returns are guaranteed. Moreover, many times a bad (or bear market) may even last for years. Therefore, you should only invest the surplus money which does not affect your lifestyle even if you can’t get it out.
6. Have an investment goal
It’s easier to plan your investments (and to monitor your progress) if you have an investment goal/plan. Your goal may be to build a corpus of Rs 10 Crores in the next ten years or to build a retirement fund. Having a goal will keep you motivated and on track.
7. Build a stock portfolio
For making good consistent money from the stock market, just having two or three stocks is not enough. You need to build a winning stock portfolio of 8–12 stocks which can give you reliable returns.
Although it’s very less likely that you can find all the fantastic stocks to invest at once. However, year-after-year you can keep adding/removing stocks to build a strong portfolio that can help you reach your goals.
8. Average out:
It’s challenging to time the market and almost impossible to buy the stock at the exact bottom and sell them at the highest point. If you’ve done it, you might be lucky. A better approach here is to Buy/Sell in ‘steps’ (unless you find an amazing opportunity which the market offer sometimes).
9. Diversify
“Do not put all your eggs in one basket!”. The risk involved while investing in just one stock is way higher compared to a portfolio of ten stocks. Even if one or two of your stock starts performing poorly in the later scenario, it may not affect the entire portfolio too much. Your stock portfolio should be sufficiently diversified.
10. Invest for the long-term
It’s a common fact that all the veterans of the stock market who made an incredible fortune from stocks are long term investors. But why do long-term investing helps to build wealth? Because of the power of compounding, the eighth wonder of the world. If you want to build massive wealth from the market, invest for the long-term.
11. Hold the winners, cut the losers
Cut you losing stocks if they underperform for a long time and hold your winning stocks longer to allow them to offer even better returns. This is the golden mantra of investing that you should strictly follow. Moreover, keeping your winners and cutting losers will also help in building your dream portfolio.
Most people get excited and enter the stock market when the market is doing well, and the indexes are touching new highs. However, if you only invest in a bull market and exit when the market is down i.e. when stocks are selling at discount, you will never find fantastic opportunities to pick cheap stocks.
Do not invest in the market just for a year. If you want to make good money from stocks, invest consistently and periodically increase your investment amount.
13. Have Patience
Most stocks take at least 1–2 years to give good returns to the investors. Moreover, the performances get better when you give more time. Have patience while investing in the share market and do not sell your stocks too soon for short term gratification.
Don’ts of Stock Market Investing:
14. Don’t take investing as gambling
Let me repeat this in simple words- “INVESTING IS NOT GAMBLING!”. Do not buy any random stock and expect it to give you two times return in a month.
15. Don’t invest blindly on free tips/recommendations
The moment you open your trading account, you’ll start getting free messages on your phone with BUY/SELL calls. But remember, there is no FREE lunch in this world. Why would anyone send a stranger free tips for multi-bagger stocks? Never invest blindly on free tips or recommendations that you receive, no matter how appealing they may sound.
16. Don’t have unrealistic expectations:
Yes, many lucky guys in the market have made 400–500% return on their single investment. However, the truth is that these kinds of news get quickly circulated (and inflated).
Have realistic expectations while investing in stocks. A return between 12–18% in a year is considered good in the market. Moreover, when you compound this return over multiple years, you will get way higher returns compared to 3.5% interest on your savings account.
Further, do not assume that you can get the same profits as others, who might be investing in stocks from many past years and may have acquired an amazing skill set. You can also get similar returns, but only after enough knowledge and practice.
17. Don’t over trade
When you are trading frequently, you are repeatedly paying for the brokerage and other charges. Don’t buy/sell the stocks too often. Take confident decisions and make transactions only when necessary.
18. Don’t follow the herd
Your colleague purchased a stock and made 67% returns from it within a year. Now, he’s boasting about it, and many of your office-mates are buying that stock. What would you do next? Should you buy the stock? Wrong!
No investor can get significant success from the market by following the herd. Do your own research, rather than following the crowd.
19. Avoid psychological biases/traps
There are a lot of physiological biases while investing that can adversely affect your investment decisions and your ability to make effective choices. For example- Confirmation Bias, Anchoring bias, Buyer’s Remorse, Superiority trap, etc.
Most of these biases are pre-programmed in human nature, and hence it might be a little difficult to notice them by the individuals. Anyways, knowing these biases can help you to avoid them causing any serious damage. Moreover, a good thing regarding these biases is that — like any habit, you can change or get over them by practice and efforts.
Investing all your money in a hot stock/industry to get a little higher return is never a wise move. Safeguarding your money is equally important than getting high returns. You should never take unnecessary risks while investing in stocks and your ‘risk-reward’ should always be balanced.
21. Don’t make emotional decisions
The human mind is very complex, and there are many factors both internal and external that can affect the choices we make. While investing in the stock market, do not take emotional decisions. No matter how much you like a company, if it is not profitable and doesn’t have a bright future potential, it may not be the right investment decision. Do not get emotional while making your investment decisions.
Bottom line
In this post, I tried to cover the do’s and don’ts of stock market investing for beginners. However, this is just a guide and not a manual. You will learn more do’s and don’t through your personal experiences when you start investing on your own.
I hope this article is useful to you. Have a great day and happy investing!
Hi, I am Kritesh (Tweet me here), an NSE Certified Equity Fundamental Analyst and an electrical engineer (NIT Warangal) by qualification. I have a passion for stocks and have spent my last 4+ years learning, investing and educating people about stock market investing. And so, I am delighted to share my learnings with you. #HappyInvesting
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.
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.
Renting vs buying a home has always been a big topic of discussion. Whenever we look for any long-term accommodation, we analyze deeply whether to buy a house property or take it on rent.
Some people say that staying in a rented home is better as we don’t have to spend a huge amount of money upfront. Moreover, when we opt for buying a residence, we mostly prefer raising a home loan which can again be a big commitment. On the other hand, those who advocate acquiring a residential property, state that it feels completely different to live in one’s own house and the house is their biggest asset.
We shall take an example to analyze the question of renting vs buying a home.
Renting vs buying a home
Let us consider two guys, Rohit and Sumit, who have got jobs as freshers in the IT sector in Kolkata. The former has decided to stay in rented accommodation while the latter has chosen to buy a flat on loan.
Let us see how the financial picture of Rohit looks like.
Renting a home
Rohit has decided to stay in a 3-BHK apartment on rent. Let us assume Rohit’s rent to be Rs 20k per month with an average annual appreciation of 5% per annum. This is to be noted that if you take accommodation on rent, your landlord may increase your rent with time so as to adjust inflation.
Coming back to our example, the expected rent of the apartment after 20 years can be assumed to be Rs 40k per month. The monthly rent after 20 further years (a total of 40 years from now) is expected to become Rs 80k per month. If we calculate, we will find that after 40 years, Rohit would have paid Rs 2.9 crores towards the rental of his home.
Pros and cons of staying in rented accommodation:
As Rohit has opted to stay in a rented apartment, he needs to consider a few key things. First, he can’t treat his house as his own home as the legal owner is his landlord. Next, Rohit is always exposed to the risk of losing his shelter as his landlord may ask him to leave anytime (by giving a notice period as per the rent agreement).
Generally, the landlords in the majority of the states in India impose restrictions on the number of years a tenant can stay in his house. This happens as the landlords are not adequately protected by the applicable Indian laws. There are certain restrictions that Rohit will have to face with regard to the renovation of his apartment and keeping pets. Moreover, he has no scope of enjoying complete privacy in rented accommodation.
There are a few advantages too that Rohit can enjoy while staying in his rented residence. He is not required to pay any house taxes. Next, Salaried individuals, who live in rented houses, can claim the House Rent Allowance (HRA) to lower their taxes – partially or wholly. Apart from paying a refundable security deposit and sometimes the maintenance charge, he is not required to pay any further lumpsum amount upfront.
If Rohit changes his job to another location or he is transferred to another location in his existing job, it won’t bother him financially. His contract with the existing landlord will be canceled and he will enter into a fresh contract with a new landlord.
So, far we have discussed only regarding Rohit. Let us now analyze the situation of Sumit.
Buying a home
It was stated earlier that Sumit has decided to buy a similar accommodation like Rohit by borrowing from a Bank. Let us assume the amount of his home loan is Rs 40 lakhs which he has to repay in 2 decades time. The applicable interest rate is 8.3% p.a and Sumit requires paying EMIs of Rs 34,200 for 20 years loan duration. So, if we calculate, the total amount that Sumit has to pay after 20 years, it will amount to Rs 82 lakhs.
After the loan is repaid, Sumit is not required to pay anything at all to the Banker. So, for staying in rented accommodation for 4 decades, Rohit has to pay Rs 2.08 crores more than Sumit. Although Sumit is required to pay Municipal Tax every year, it is a nominal amount and can be ignored in our analysis.
Sumit would get dual income tax benefits every year as long as he is repaying the loan on house property. On one side, his gross total income will get reduced by the Interest on Loans paid by him u/s 24(b) of the Income Tax Act, 1961. On the other side, he would get deduction u/s 80C of the said for the principal amount of loan paid by him. The maximum deduction allowed u/s 24(b) and 80C are Rs 2 lakhs and Rs 1.5 lakhs, respectively.
So, from the above discussion, Sumit’s decision of purchasing a house property seems to be financially more viable than that of Rohit’s choice of rental accommodation.
Pros and cons of staying in buying a home:
Let us discuss some major benefits that Sumit can enjoy by opting for buying an apartment.
It is needless to say that having one’s own house is a sign of pride, sense of achievement and source of privacy. If Sumit is transferred to a new location or takes up a job in another location, he can sublet his property to someone. Even if he doesn’t stay in his house, it doesn’t mean that he has to incur a loss if he has bought the apartment on loan.
Many people say that rentals are always cheaper than EMIs. But, the fact is that, as time passes, the rentals tend to get higher and higher while the amount of existing EMIs doesn’t.
As an owner of the house property, Sumit can obtain any personal loan keeping his apartment on collateral. Today, real estate is a growing industry where the price of properties is going up every single day. Therefore, as Sumit has chosen to buy a house property, he will be investing in a physical asset having huge potential to generate large returns in the days to come.
There are a few shortcomings of buying a house too. Although Sumit will get the house in his own name, he can only enjoy the ownership in a true sense after he has repaid the loan in full. Generally, a Bank charges a down payment while granting the home loan. This upfront payment could be as high as one-fifth of the price of the apartment bought. So, in the short term, Sumit has to incur a heavy payout to buy a house property on loan.
The decision of buying vs renting a home is not going to be the same for every individual. Whether you want to buy a house property or take it on rental, it totally depends on your financial situation. If buying accommodation suits my financial situation, it may not suit yours.
Moreover, both the options are having their own perks and shortcomings. In this article, we have evaluated both the options where buying accommodation sounds financially fitter than staying in a rented home.
A large proportion of the Indian population considers Gold as one of the best options to invest in India. Here, gold is not only treated as a satisfactory long term wealth creator but also auspicious and a symbol of social status. As per the World Gold Council, India ranks second in the globe in Gold consumption, after China. Up to 20-25% of the world’s Gold is consumed in India in the form of jewellery, bars, coins etc.
Ironically, a few years back, the fixed deposit was considered more promising investment options for the middle-class Indians. However, nowadays, the interest earned on FDs has gone substantially down, because of which FDs don’t seem to be as genuine potential wealth generating option like earlier. These days, people are again revealing a lot more inclination towards Gold investment.
Anyways, Gold is a long term investment option and not suitable for earning short term gains. Moreover, the prices of Gold fluctuate in a cyclical manner. Therefore, one cannot expect Gold to perform well all the time.
Why should you invest in Gold?
Indians have been investing in gold for thousands of years and it has so far proved to be a solid investment option. Here are a few best reasons why you should invest in gold:
— Gold acts as a hedge against inflation: History states that Gold has performed relatively better compared to equities or other investment options in the scenarios of high inflation. Stock prices do not have any functional relationship with inflation. However, as Gold belongs to the commodity market when the economy witnesses rising inflation, the Gold price goes up.
— Investing in gold won’t cost you a fortune: Unlike investing in real estate (which requires a bigger investment amount) or equities (which require paperwork to open your trading account), investing in gold is easier for most of the average Indians and does not require a big amount to get started.
— Investment in gold offers high liquidity: If you own a Gold coin or jewellery, you can easily liquidate it as you can sell your physical gold at a local jewellery shop anytime. Although stocks and mutual funds can also be converted into cash fast. However, such instruments do take a few days time to process the redemption and the selling amount to get credited in your bank. As compared to these securities, Gold offer higher liquidity.
— Gold investment can help you to balance the risk in your portfolio: In order to reduce the portfolio risk, it is important to diversify your investments. Gold, having a negative correlation with Equities, can help you in diversifying your portfolio in a convenient way. Whenever your equity portfolio is going through a bear phase, a notional loss on the same can be absorbed by your gold investments.
First of all, Gold investments do not only mean investing in physical Gold like gold coin or jewellery. There are various other ways available for investing in Gold in India.
Although investing in Gold via jewellery is decent in terms of generating long term wealth. However, keep in mind that when you purchase Gold jewellery, you have to pay the making charges too. Despite, when you sell that jewellery, you will only get the price for the Gold (and not the making charges that you paid earlier). Instead of investing in Gold jewellery, opting for Gold coins or bars seems a better choice. The latter is more profitable because here you do not need to pay the making charges.
Anyways, you can also invest in gold via Gold Mutual Funds. These funds invest in those companies which carry out extraction and mining of Gold or marketing of the same. The Gold Fund schemes are managed by skilled and experienced Fund Managers and are highly liquid. Therefore, investing in these Funds is a convenient option if you are looking to invest in gold. Nonetheless, the cons associated with the gold fund is that you might have to pay an exit load on your investments. Apart from that, you also have to pay an expense ratio which is deducted from your NAV every year for management and operational expenses.
Further, Gold ETF is another option while investing in gold. It works in a similar manner like Gold Mutual Funds but the same is traded on a stock exchange. However, you need to have your own Trading and Demat Account with a broker to invest in a Gold ETF. In addition, Gold ETF does not allow you to invest via SIP mode, unlike Gold Mutual Funds.
Lastly, if you want to invest in gold via the direct stock market, you can opt for investing in Gold mining companies. Investing in Gold mining stocks means investing in companies engaged in the mining and marketing of Gold. The performance of these stocks is not only related to the fundamental factors of the companies but is also dependent on the Gold rates.
Cons of investing in Gold
No investment option is perfect and gold investing also have some limitations. Here are a few key pointers which you should keep in mind while you invest in Gold:
— Gold does not generate sufficient returns like stocks or bonds: Gold is not a passive investment option. Investing in gold does not offer dividends or interests. Therefore, the only way to make a profit from Gold investment is by selling off.
–– Your Gold investment may demand safety against theft or robbery: Gold is a valuable asset. If you are planning to keep physical Gold, storing the same might be a matter of concern. Alternatively, you may store your physical gold in a bank ‘locker’ but this may cost you periodical maintenance charges.
— Investing in Gold is not tax-free: When you purchase physical Gold, you will be charged GST on the same. Moreover, Gold is treated as a capital asset. Therefore, whenever you sell Gold for profit, a tax on short term capital gain or long term capital gain is applicable. You can read this blog to know more about taxation of Gold in India.
— Gold investing is cyclical: As we discussed earlier, the prices of Equities and Gold usually move in the opposite direction. When the stock market witnesses a bearish (downward) trend, the Gold price goes up and investors find Gold an attractive investment option during these times. However, when the cycle changes and the stock market goes in a bull run, the gold price starts going downwards and gold investing may be ignored by the investors.
Conclusion
In this post, we covered the basics of investing in Gold. If you are seeking a regular source of income through your investments, Gold may never serve this purpose. However, if you want to hedge your existing investments in Equities and Bonds, you should consider investing in Gold. Further, if you are planning to invest in Gold for the very first time, it is recommended to start investing via Gold Mutual Funds or Gold ETF.
Apart from acting as a hedge against inflation, Gold comes in handy during the situation of financial crisis. Nevertheless, you should not treat Gold as your only choice, but consider it as one of the investment options in your portfolio. Ideally, you should allocate up to a maximum of 10% of your portfolio in Gold.
Whether you invest in Gold or not is solely your choice. However, what matters more is the clarity in your mind regarding why you are investing in the same.
