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Important Ratios To Evaluate a Banking Company

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The financial statements of banks are typically much more complicated than those of companies engaged in virtually any other type of business. While investors considering bank stocks look at such traditional equity evaluation measures as price-to-book (P/B) ratio or price-to-earnings (P/E) ratio, they also examine industry-specific metrics to more accurately evaluate the investment potential of individual banks.

1. Non-Performing Assets (NPAs)

What are NON PERFORMING ASSETS? NPAs are of Two Types

1. GNPA:- Loans where interest is not received for a period of 3 months, a loan turns into NPA. GNPA tells us about the financial condition of the bank. High GNPA tells us that the asset quality of the bank is in bad shape.
Lower the better.


2. NET NPA:- Banks provide for some loans going bad. The net NPA is that portion of bad loans which has not been provided for in the books.
Net NPA gives us a better view of the financial health of the Bank as by this ratio we get to know about the ability of the bank to provide for Non-Performing Assets.
Lower the better.

2. Capital Adequacy Ratio(CAR)

It is the ratio of a bank’s capital in relation to its risk-weighted assets and current liabilities. This is a measure of a bank’s ability to meet its obligations. A high CAR means the bank can absorb losses without diluting capital.
Higher the Better.

3. Current Account, Savings Account Ratio (CASA Ratio)

It is the proportion of current account and savings account deposits in the total deposits of the bank. Lower CASA Ratio means the bank relies on costlier wholesale funding which may hurt the margin of the bank. As we know that no interest is given by banks on Current Account deposits & an interest rate of as low as 3.5% is given on Saving Account Deposits, these are relatively very cheap source of financing for banks as compared to other sources.
Higher the Better.

4. Provisioning Coverage Ratio

Provisioning means to set aside or provide some funds to cover up losses if things go wrong and some of their loans turn into bad assets. A high PCR ratio (ideally above 70%) means most asset quality issues have been taken care of and the bank is not vulnerable.
Higher the Better.

5. Net-Interest Margin

The difference between interest earned by a bank on loans and the interest it pays on deposits is called Net-Interest Margin. Net-Interest Margin will be high for banks with higher low-cost deposits or high lending rates. In particular, for a bank, if the bank has a significant amount of non-performing assets (such as loans where full repayment is in doubt). NIM will generally decrease because interest earned on non-performing assets is treated, for accounting purposes, as repayment of principal and not payment of interest due to the uncertainty that the loan will be fully repaid.
Higher the Better.

6. Credit-Deposit Ratio

This shows how much a bank lends out of its deposits.  A high credit-deposit ratio suggests an overstretched balance sheet, and may also hint at capital adequacy issues. Credit-Deposit Ratio helps in assessing a bank’s liquidity and indicates its health.
If the ratio is too low, banks may not be earning as much as they could be.
If the ratio is too high, banks might not have enough liquidity to cover any unforeseen fund requirements which may affect capital adequacy.

7. Return On Assets(ROA)

It shows how profitable a bank’s assets are in generating revenue. A lower RoA means that the bank is not able to utilize assets efficiently. Negative ROA implies the bank’s assets are yielding a negative return. The term return in the ROA ratio or Net Profit to Total Assets customarily refers to net profit or net income, the number of earnings from sales after all costs, expenses, and taxes. The more assets a company has amassed, the more sales and potentially more profits the company may generate. As economies of scale help lower costs and improve margins, the return may grow at a faster rate than assets, ultimately increasing return on assets.
Higher the better.

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Options Trading Strategies for Consistent Monthly Income

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I bet most of you when introduced to Options trading, imagined of creating a fortune through it in no time. You would have heard stories where people doubled their investment or even made it 4 times in no time by trading Options. But how many of you were lucky enough to turn this dream into reality. I guess a very small percentage, and that too because they were extremely fortunate. But in actuality, you cannot just depend on luck to become an extremely successful trader. It’s better to have a regular cash flow than a one time fortune. In this post, we would discuss some of the popular options trading strategies for consistent monthly income. I have personally traded on these strategies and they are profitable most of the time without any adjustments.

Iron Condor Strategy

This is one of the most popular Options Trading strategies for consistent monthly income. This is a non-directional strategy consisting of 4 legs. That means you need to trade 4 option positions simultaneously to execute this strategy. Due to this reason, the margin required for this strategy is a little higher. Iron Condor is a combination of Bull put spread and Bear Call spread.

Here is how Iron Condor is constructed:

Sell 1 OTM Put: B
Buy 1 OTM Put (Lower Strike): A
Sell 1 OTM Call: C
Buy 1 OTM Call (Higher Strike): D

Below are some of the characteristic features of Iron Condor:

Profit Potential: Limited to the net credit received. Max Profit is achieved when the price of underlying is in between strike prices of the Short Put and the Short Call

Maximum Loss: Strike Price of Long Call – Strike Price of Short Call-Net credit received

Breakeven Point:

  • Upper Breakeven Point = Strike Price of Short Call + Net credit received
  • Lower Breakeven Point = Strike Price of Short Put – Net credit received

When to execute this strategy: This strategy should be executed when you are expecting a minimum movement in stock or consolidation phase.

Payoff Graph: Below is the payoff graph of this strategy

Iron Butterfly Strategy

Iron Butterfly is similar to Iron Condor except for the fact that At the money (ATM) options are sold in this strategy. It is suitable for more aggressive traders, but still the risk is limited.

Here is how Iron Butterfly is constructed:

Sell 1 ATM Put: B
Buy 1 OTM Put (Lower Strike): A
Sell 1 ATM Call: B
Buy 1 OTM Call (Higher Strike): C

Below are some of the characteristic features of Iron Condor:

Profit Potential: Limited to the net credit received. Max Profit is achieved when the price of the underlying expires exactly at the strike price where Call and Put options are sold.

Maximum Loss: Strike Price of Long Call – Strike Price of Short Call-Net credit received

Breakeven Point:

  • Upper Breakeven Point = Strike Price of Short Call + Net credit received
  • Lower Breakeven Point = Strike Price of Short Put – Net credit received

When to execute this strategy: This strategy should be executed when you are expecting a minimum movement in stock or consolidation phase.

Payoff Graph: Below is the payoff graph of this strategy

Iron Condor vs Iron Butterfly

As you would have noticed, both these strategies are very similar both in terms of execution as well as the breakeven point. There is no straightforward way to select one of them. While Iron Condor is more popular among traders, the Iron butterfly also does have its own advantages. Iron butterfly has higher profit potential among the two as you would receive more premium by selling ATM options. Iron Condor is better in terms of probability of winning as it has a wider profitable range.

What are Futures Contracts?

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FUTURES CONTRACT: A futures contract is the obligation to sell or buy an asset at a later date at an agreed-upon price & are traded on the stock exchange for different asset classes such as currency, equity, index & commodities.

Example

Let’s demonstrate with an example.
Assume two traders (A & B)  agree to a Rs 880 per share price of HDFC bank on an HDFC Bank futures contract.
A” believes that the HDFC BANK stock price will go up while “B” is betting that HDFCBANK stock will go down.

If the price of HDFC BANK moves up to Rs 990, the buyer of the contract makes Rs 110 Profit.
The seller, on the other hand, loses out Rs 110.

NOTE – It’s not mandatory to have the buy-side futures contract or the underlying shares with you at the time of selling a futures contract & vice versa. When you sell a futures contract you are betting that the stock will go down. While an equity short position has to be squared off the same day, a sell position in a futures contract can be held till the expiry of the contract.

Stock futures can be purchased on individual stocks or on an index like the Nifty 50. The buyer of a futures contract is not required to pay the full amount of the contract up front. A percentage of the price called an initial margin is paid.

Futures contracts tend to be for large amounts of money. The obligation to sell or buy at a given price makes futures riskier by their nature.

IMPORTANT FEATURES OF A FUTURES CONTRACT

TRADED IN LOTS – Lot size specifies the minimum quantity that you will have to transact in a futures contract. Lot size varies from one asset to another.

CONTRACT VALUE – The contract value is the quantity times the price of the asset. We know the futures agreement has a standard pre-determined minimum quantity (lot size). Going by this, the contract value of a futures agreement can be generalized to “Lot size x Price”.

MARGIN – However, in a futures agreement the moment a transaction takes place, both the parties involved will have to deposit some money. Consider this as the token advance required for entering into an agreement. The money has to be deposited with the broker. Usually, the money that needs to be deposited is calculated as a % of the contract value. This is called the ‘margin amount’. Margins play a very pivotal role in futures trading; we will understand this in greater detail at a later stage. For now, just remember that to enter into a futures agreement a margin amount is required, which is a certain percentage of the contract value.

EXPIRY – As we know, all futures contracts are time-bound. The expiry or the expiry date of the futures contract is the date up to which the agreement is valid. Beyond the valid date, the contract ceases to exist. Also be aware that the day a contract expires, new contracts are introduced by the exchanges.



SBI Card’s 10 financial highlights to look at before bidding for the IPO

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Most analysts and market experts are positive on the forthcoming Rs 10,000 crore initial public offering of SBI Card, which is going to hit the market on March 2.

The company has set the price band for the share sale at Rs 750-755. Promoters SBINSE -1.90 % will offload 3.73 crore shares and Carlyle Group 9.32 shares. SBI Card’s market share in terms of the number of credit cards outstanding stands at 18 per cent. While these recommendations are good to refer to, investors should also do their own homework before investing in the public issue. Here are 10 key financial parameters of the company that may influence your investment decision.

Bottomline
Net profit of SBI Card for FY19 increased 43.52 per cent year-on-year to Rs 862.70 crore from Rs 601.10 crore reported for the year-ago period. The figure stood at Rs 372.80 crore in FY17.

Net interest income
This figure increased by nearly 25 per cent year-on-year to Rs 2,558.50 in FY19. NII stood at Rs 1,359.70 crore as of March 31, 2017.

Return on equity (RoE)
The company has been maintaining an RoE of over 25 per cent. This figure stood at 30 per cent in FY19, 32.40 per cent in FY18 and 28.60 per cent in FY17.

Return on assets (RoA)
The company reported a return on assets of 4.80 per cent in FY19 against 4.50 per cent in FY18. The figure stood at 4 per cent in FY17.

Total assets
Total assets of SBI Card stood at Rs 24,459.20 crore for the half-year ended September 2019 against Rs 20,239.60 crore as of March 31, 2018. The figure stood at Rs 15,686 crore and Rs 10,765 crore for the year ended March 31, 2018 and 2017, respectively.

Net worth
Net worth of the company jumped 147 per cent to Rs 3,581.70 crore in FY19 over Rs 1,448.80 crore in FY17.

Non-performing assets
Percentage of gross non-performing assets (NPA) of SBI Card stood at 2.30 per cent as of September 30. The figure stood at 2.40 per cent and 2.80 per cent in FY19 and FY18, respectively.

Earnings per share (EPS)
The figure jumped to Rs 16.40 during the first half of FY20 against Rs 10.60 in FY19 and Rs 7.70 in FY18.

Impairment losses and bad debts
The figure stood at Rs 1,102.10 crore as of September 30 against Rs 1,147.70 crore as of March 31, 2019. Impairment losses and bad debt stood at Rs 800.10 crore and Rs 532 crore in FY18 and FY17, respectively.

Operating profit (pre-provision)
Pre-provision operating profit of SBI Card increased 9.74 per cent to Rs 2,720.70 crore for the nine-month ended December 2019. The figure stood at Rs 2,479.30 crore and Rs 1,719.40 crore in FY19 and FY18, respectively.

Source – Economic Times

15 Financial Ratios Every Investor Should Use

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Financial ratios can help to make sense of the overwhelming amount of information that can be found in a company’s financial statements. 

Knowing how to pick out small bits of important information, combine them with other small bits of information and interpret the resulting number is more of an art than a science. But it’s undoubtedly one of the most important arts that an investor should practice. To start your journey into ratio analysis, you’ll need a company’s consolidated financial statements, found in a company’s 10-K and available for free on the Moneycontrol and screener.in website. The three most important financial statements are the income statement, balance sheet and cash flow statement. Track these down before proceeding further. 

While there are quite a few financial ratios, investors use a handful of them over and over again. These 15 ratios are indispensable tools that should be a part of every investor’s research process. 

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Price Ratios

Price ratios are used to get an idea of whether a stock’s price is reasonable or not. They are easy to use and generally pretty intuitive, but do not forget this major caveat: Price ratios are “relative” metrics, meaning they are useful only when comparing one company’s ratio to another company’s ratio, a company’s ratio to itself over time, or a company’s ratio to a benchmark. 

1) Price-to-Earnings Ratio (P/E) 

What you need:     Income Statement, Most Recent Stock Price

The formula:         P/E Ratio = Price per Share / Earnings Per Share

What it means:     Think of the price-to-earnings ratio as the price you’ll pay for ₹1 of earnings. A very, very general rule of thumb is that shares trading at a “low” P/E are a value, though the definition of “low” varies from industry to industry. 

2) PEG Ratio

What you need:     Income Statement, Most Recent Stock Price

The formula:         PEG Ratio = (P/E Ratio) / Projected Annual Growth in Earnings per Share 

What it means:      The PEG ratio uses the basic format of the P/E ratio for a numerator and then divides by the potential growth for EPS, which you’ll have to estimate. The two ratios may seem to be very similar but the PEG ratio is able to take into account future earnings growth. A very general rule of thumb is that any PEG ratio below 1.0 is considered to be a good value.

3) Price-to-Sales Ratio

What you need:     Income Statement, Most Recent Stock Price

The formula:         Price-to-Sales Ratio = Price per Share / Annual Sales Per Share

What it means:      Much like P/E or P/B, think of P/S as the price you’ll pay for ₹ 1 of sales. If you are comparing two different firms and you see that one firm’s P/S ratio is 2x and the other is 4x, it makes sense to figure out why investors are willing to pay more for the company with a P/S of 4x. The P/S ratio is a great tool because sales figures are considered to be relatively reliable while other income statement items, like earnings, can be easily manipulated by using different accounting rules. 

4) Price-to-Book Ratio (P/B) 

What you need:     Balance Sheet, Most Recent Stock Price

The formula:          P/B Ratio = Price per Share / Book Value per Share    

What it means:      Book value (BV) is already listed on the balance sheet, it’s just under a different name: shareholder equity. Equity is the portion of the company that owners (i.e. shareholders) own free and clear. Dividing book value by the number of shares outstanding gives you book value per share.

Like P/E, the P/B ratio is essentially the number of dollars you’ll have to pay for ₹ 1 of equity. And like P/E, there are different criteria for what makes a P/B ratio “high” or “low.” 

5) Dividend Yield

What you need:     Income Statement, Most Recent Stock Price

The formula:          Dividend Yield = Dividend per Share / Price per Share

What it means:      Dividends are the main way companies return money to their shareholders. If a firm pays a dividend, it will be listed on the balance sheet, right above the bottom line. Dividend yield is used to compare different dividend-paying stocks. Some people prefer to invest in companies with a steady dividend, even if the dividend yield is low, while others prefer to invest in stocks with a high dividend yield.

6) Dividend Payout Ratio

What you need:     Income Statement

The formula:          Dividend Payout Ratio = Dividend / Net Income

What it means:      The percentage of profits distributed as a dividend is called the dividend payout ratio. Some companies maintain a steady payout ratio, while other try to maintain a steady number of dollars paid out each year (which means the payout ratio will fluctuate). Each company sets its own dividend policy according to what it thinks is in the best interest of its shareholders. Income investors should keep an especially close eye on changes in dividend policy. 

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Profitability Ratios

Profitability ratios tell you how good a company is at converting business operations into profits. Profit is a key driver of stock price, and it is undoubtedly one of the most closely followed metrics in business, finance and investing. 

7) Return on Assets (ROA)

What you need:     Income Statement, Balance Sheet

The formula:         Return on Assets =  Net Income / Average Total Assets

What it means:      A company buys assets (factories, equipment, etc.) in order to conduct its business. ROA tells you how good the company is at using its assets to make money. For example, if Company A reported ₹10,000 of net income and owns ₹ 100,000 in assets, its ROA is 10%. For ever ₹ 1 of assets it owns, it can generate ₹ 0.10 in profits each year. With ROA, higher is better.

8) Return on Equity (ROE)

What you need: Income Statement, Balance Sheet

The formula: Return on Equity = Net Income / Average Stockholder Equity        

What it means: Equity is another word for ownership. ROE tells you how good a company is at rewarding its shareholders for their investment. For example, if Company B reported ₹ 10,000 of net income and its shareholders have ₹ 200,000 in equity, its ROE is 5%. For every ₹ 1 of equity shareholders own, the company generates ₹ 0.05 in profits each year. As with ROA, higher is better.

9) Profit Margin

What you need: Income Statement

The formula: Profit Margin = Net Income / Sales        

What it means: Profit margin calculates how much of a company’s total sales flow through to the bottom line. As you can probably tell, higher profits are better for shareholders, as is a high (and/or increasing) profit margin.   

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Liquidity Ratios

Liquidity ratios indicate how capable a business is of meeting its short-term obligations. Liquidity is important to a company because when times are tough, a company without enough liquidity to pay its short-term debts could be forced to make unfavourable decisions in order to raise money (sell assets at a low price, borrow at high-interest rates, sell part of the company to a vulture investor, etc.). 

10) Current Ratio

What you need: Balance Sheet

The formula: Current Ratio = Current Assets / Current Liabilities        

What it means: The current ratio measures a company’s ability to pay its short-term liabilities with its short-term assets. If the ratio is over 1.0, the firm has more short-term assets than short-term debts. But if the current ratio is less than 1.0, the opposite is true and the company could be vulnerable to unexpected bumps in the economy or business climate. 

11) Quick Ratio 

What you need: Balance Sheet

The formula: Quick Ratio = (Current Assets – Inventory) / Current Liabilities        

What it means: The quick ratio (also known as the acid-test ratio) is similar to the quick ratio in that it’s a measure of how well a company can meet its short-term financial liabilities. However, it takes the concept one step further. The quick ratio backs out inventory because it assumes that selling inventory would take several weeks or months. The quick ratio only takes into account those assets that could be used to pay short-term debts today. 

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Debt RatiosThese ratios concentrate on the long-term health of a business, particularly the effect of the capital and finance structure on the business: 

12) Debt to Equity Ratio What you need: Balance Sheet The formula:  Debt-to-Equity Ratio = Total Liabilities / Total Shareholder Equity

 What it means: Total liabilities and total shareholder equity are both found on the balance sheet. The debt-to-equity ratio measures the relationship between the amount of capital that has been borrowed (i.e. debt) and the amount of capital contributed by shareholders (i.e. equity). Generally speaking, as a firm’s debt-to-equity ratio increases, it becomes riskier because if it becomes unable to meet its debt obligations, it will be forced into bankruptcy.  

13) Interest Coverage Ratio

What you need: Income Statement 

The formula:  Interest Coverage Ratio = EBIT / Interest Expense 

What it means: Both EBIT (aka, operating income) and interest expense are found on the income statement. The interest coverage ratio, also known as times interest earned (TIE), is a measure of how well a company can meet its interest payment obligations. If a company can’t make enough to make interest payments, it will be forced into bankruptcy. Anything lower than 1.0 is usually a sign of trouble. 

Efficiency Ratios These ratios give investors insight into how efficiently a business is employing resources invested in fixed assets and working capital. It’s can also be a reflection of how effective a company’s management is.  

14) Asset Turnover Ratio

What you need: Income Statement, Balance Sheet The formula: Asset Turnover Ratio = Sales / Average Total Assets 

What it means: Like return on assets (ROA), the asset turnover ratio tells you how good the company is at using its assets to make products to sell. For example, if Company A reported ₹ 100,000 of sales and owns ₹ 50,000 in assets, its asset turnover ratio is 2x. For ever ₹ 1 of assets it owns, it can generate ₹ 2 in sales each year.

  15) Inventory Turnover Ratio What you need: Income Statement, Balance Sheet 

The formula: Inventory Turnover Ratio = Costs of Goods Sold / Average Inventory

 What it means: If the company you’re analyzing holds has inventory, you want that company to be selling it as fast as possible, not stockpiling it. The inventory turnover ratio measures this efficiency in cycling inventory. By dividing costs of goods sold (COGS) by the average amount of inventory the company held during the period, you can discern how fast the company has to replenish its shelves. Generally, a high inventory turnover ratio indicates that the firm is selling inventory (thereby having to spend money to make new inventory) relatively quickly.

The 9 Best Personal Finance Books of 2020

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Some people manage their money like they were born with calculators in their hands. Others…not so much. Maybe they fall prey to their own instincts to spend more than they should. Maybe math just isn’t their strong suit or they find it unbearably tedious to keep track of pennies and dimes, let alone dollars.

If this sounds like you, you’re not alone. Just look at the statistics. The American Psychological Association does a survey every year in an attempt to pin down where folks think they stand financially. The most recent survey indicated that a walloping 70 percent of us believe we’re on shaky financial ground. Even more — 75 percent — are of the firm belief that we’d be a whole lot happier if we just had more money.

So what can you do to get a grip on your finances and make your money grow? Learn. Educate yourself. That’s how Elon Musk and Warren Buffett started out, and they haven’t stopped reading now that they’re at the top of their respective games. These books should give you a great start.

RICH DAD POOR DAD

Rich Dad Poor Dad is Robert’s story of growing up with two dads — his real father and the father of his best friend, his rich dad — and the ways in which both men shaped his thoughts about money and investing. The book explodes the myth that you need to earn a high income to be rich and explains the difference between working for money and having your money work for you.

Rich Dad Poor Dad

•Explodes the myth that you need to earn a high income to become rich
• Challenges the belief that your house is an asset
• Shows parents why they can’t rely on the school system to teach their kids about money
• Defines once and for all an asset and a liability
• Teaches you what to teach your kids about money for their future financial success

How SIPs Can Help You Maintain Stable Financial Health?

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Many of us get a health check-up done at regular intervals. We recognise the importance of being in pink of our health to make our dreams come true and provide the best to our family. However, what most of us often forget is that ‘financial health’ also plays a critical role to meet many aspirations of life –that’s the bitter truth!

Hence, as much as regular medical health, a Financial Health Check-up, too, is essential for your wellbeing at every phase of life. It is irrespective of how much you earn per month and who you are.

Your financial security lies in being completely in control of your personal finances. Therefore, focus on your budgets, lower your expenses; so that you save more and accomplish the envisioned financial goals. Ideally, as Warren Buffett says, “Don’t save what is left after spending, but spend what is left after savings”.

Further, your savings need to be parked in investment avenues that are productive, whereby you benefit from the power of compounding, grow your wealth and counter the inflation bug better, as it otherwise erodes the purchasing power of your hard-earned money.

Investing in mutual funds is a promising avenue for wealth creation. The top-6 benefits of investing in mutual funds are:

  • Diversification;
  • Professional management;
  • Lower entry-level (you can start with as little as Rs 500);
  • Economies of scale;
  • Liquidity; and
  • Innovative plans/services for investors (SIP/STP/SWP)

But selecting the best mutual fund schemes in accordance with your risk profile, investment objectives, and investment horizon, is a critical task.

There are various categories of mutual funds — broadly equity, debt, hybrid, gold, and so on. Plus, a galore of sub-categories, each having their own investment mandate to achieve the stated investment objectives. Strategizing the investment portfolio by recognising your financial needs/objectives, which could be the following, is essential:

  • Growth
  • Income
  • Inflation protection
  • Peace of mind
  • Preservation of capital and
  • Tax saving

Subscribing to the investment approach and portfolios of friends and relatives may not always reap the best results. This is because every individual’s risk appetite, investment objectives, financial goals, circumstances, investment horizon, and other circumstances are different.

Thus, take extra time and care to align your portfolio prudently!

SIP for wealth creation

For systematic wealth creation over the long-term, Systematic Investment Plans (or SIPs) offered by mutual funds are a good mode. SIPs, like a bank recurring deposit, works on the simple principle of investing regularly. Plus, it enforces discipline as your hard-earned money gets parked (debited from the bank account) either daily, monthly, quarterly in a respective mutual fund scheme.

Here are 5 benefits of SIPs:

  • SIPs are lighter on the wallet
    • SIPs facilitate you to invest in smaller amounts at regular intervals (daily, monthly or quarterly). This, in turn, reduces your burden of defraying a lump-sum – at one go – from your bank account. If you cannot invest Rs 50,000 in one shot, that’s not a huge stumbling block. The SIP route enables investments as low as Rs 500 per month.
  • SIPs make market timing irrelevant
    • Timing in the market can be hazardous to your wealth and health. Instead, focus on ‘time in the market’ in the endeavour to create wealth by selecting the best mutual fund schemes with a dependable track record through SIPs and staying invested for the long-term. And if market volatility worries you, SIPs, in fact, can aid in managing (even-out) that volatility and prove effective, particularly when markets are at high.
  • Enables rupee-cost averaging
    • Many a time, a SIP works better as opposed to investing a lump sum one-time. This is because of rupee cost averaging. Under rupee-cost averaging, you typically buy more units of a mutual fund scheme when prices are low, and buy fewer mutual units when prices are high. This infuses good discipline because it forces you to commit cash at market lows when other investors around you are wary and exiting the market. It also enables you to lower the average cost of your investments.
  • Offers the benefit of the power of compounding
    • For example, a monthly SIP of Rs 1,000, in a mutual fund scheme with an appealing track record following robust investment processes & systems, can aid you to build a corpus of approximately Rs 9.99 lakh over a 20 years investment horizon with a modest 12% annualized growth rate in equities.
    • And if the equity market performs better, the corpus can be even greater provided the fund selection is apt.
    • So, over the long-term, SIPs can compound wealth productively and systematically.
  • SIPs are an effective medium of goal planning
    • Buying a dream home, a car, providing good education to children, travelling abroad for leisure, and retirement are some of the vital financial goals of life. Once you have realistically identified the corpus needed to fulfil such goals, SIP-ping regularly in deserving mutual fund schemes can help in effectively achieving the financial goals.
    • Notwithstanding the above, even to tide over contingencies, viz. loss of a job, loss due to natural calamity, medical emergency and so on, SIPs in appropriate mutual fund schemes—can come to your rescue.

Are there any best SIPs?

Well, by now you know that SIPs are a medium to invest in mutual funds. Hence, there’s nothing like ‘best SIPs’.

You need to select mutual fund schemes in congruence to your needs to accomplish the envisioned financial goals and in the interest of long-term financial wellbeing.

Some guidance to select winning mutual fund schemes for your portfolio

  • Performance: The past performance of a fund is important in analysing a mutual fund. But, remember that past performance is not everything, as it may or may not be sustained in future. Therefore, it should not be used as a basis for comparison with other investments.It just indicates the fund’s ability to clock returns across market conditions. And, if the fund has a well-established track record, there is a higher likelihood of it performing well in the future than a fund which has not performed well. Under the performance criteria, you must make a note of the following:
    • Comparison:
      • A fund’s performance in isolation does not indicate anything. Hence, it becomes crucial to compare the fund with its benchmark index and its peers, so as to deduce a meaningful inference. Again, one must be careful while selecting peers for comparison. For instance, it doesn’t make sense comparing the performance of a mid-cap fund to that of a large-cap. Remember: Don’t compare apples with oranges.
    • Time period:
      • It is very important that you as an investor have a long-term horizon (of at least 3-5 years) if you wish to invest in equity-oriented funds. So, it becomes crucial to evaluate the long-term performance of the funds. However, this does not imply that the short term performance should be ignored. Besides, it is equally important to evaluate how a fund has performed over different market cycles (especially during the downturn). During a rally it is easy for a fund to deliver above-average returns, but the true measure of its performance is when it posts higher returns than its benchmark and peers during the downturn.
    • Returns:
      • Returns are obviously one of the important parameters that one must look at while evaluating a fund. But remember, it is not the only parameter. Many investors simply invest in a fund because it has given higher returns. Such an approach when making investments is incomplete. In addition to the returns, one also needs to look at the risk parameters, which explains how much risk the fund has undertaken to clock higher returns.
      • Risk: To put it simply, the risk is a result or outcome which is other than what is/was expected. The outcome, when different from the expected outcome is referred to as a deviation. When we talk about the expected outcome, we are referring to the average; or what is technically called the mean of the multiple outcomes. Filtering it further, the term risk simply means deviation from average or mean return.
        Risk is normally measured by Standard Deviation (SD or STDEV) and signifies the degree of risk the fund has exposed its investors to. From an investor’s perspective, evaluating a fund on risk parameters is important because it will help you check whether the fund’s risk profile is in line with your risk profile or not. For example, if two funds have delivered similar returns, then as a prudent investor, invest in the fund which has taken less risk, i.e. the fund that has a lower SD.
    • Risk-adjusted return:
      • This is normally measured by the Sharpe Ratio (SR). It signifies how much return a fund has delivered vis-à-vis the risk taken. Higher the Sharpe Ratio better is the fund’s performance. As an investor, it is important to be cognizant of this because you should choose a fund which has delivered higher risk-adjusted returns. In fact, this ratio tells whether the high returns of a fund are attributed to good investment decisions, or to higher risk.
    • Portfolio Concentration:
      • Funds that have a high concentration in particular stocks or sectors tend to be very risky and volatile. Hence, you should invest in these funds only if you have a high-risk appetite. Ideally, a well-diversified fund should hold no more than 50% of its assets in its top-10 stock holdings. Remember: Make sure your fund does not put all its eggs in one basket.
    • Portfolio Turnover:
      • The portfolio turnover rate refers to the frequency with which stocks are bought and sold in a fund’s portfolio. Higher the turnover rate, higher the volatility. The fund might not always be able to adequately compensate you for the higher risk taken. So, if you want lower volatility, invest in funds with a low portfolio turnover rate.
  • Costs:
    If two funds are similar in most contexts, it might not be worth buying a mutual fund scheme that has high costs associated with it, only for a marginally better performance than the other. Simply put, there is no reason for a mutual fund house to incur higher costs, other than its desire to have higher margins. The two main costs incurred are:
    • Expense Ratio:
      • Annual expenses involved in running the mutual fund include administrative costs, management salary, overheads, etc. Expense Ratio is the percentage of assets that go towards these expenses. Every time the fund manager churns his portfolio, he pays a brokerage fee, which is ultimately borne by you, the investor, in the form of an expense ratio.
    • Exit Load:
      • After SEBI’s ban on entry loads in 2009, as an investor, you now have only exit loads to worry about. An exit load is charged when you sell your units of a mutual fund scheme within a particular tenure. Most funds charge if the units are sold within a year from date of purchase. As the exit load is a fraction of the NAV, it eats into your investment value.

“Becoming wealthy is not a matter of how much you earn, who your parents are, or what you do… it is a matter of managing your money properly.” – Noel Whittaker

Happy Investing!

What is Compounding? How to Benefit From It?

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Compound return is earned when the interest earned in one period is added back to the principal amount to generate a new principal on which interest is computed for the next period. As a result, interest is reinvested in the asset so that interest is earned on interest.

This picture below compares the value of a rupee when it grows at a simple interest of 10%, as against a compounded annual rate of 10%.At the end of the first year, the rupee would have grown to Rs.1.01, which forms the new principal for the second year if compound interest is calculated, and so on for each following year. Note that with time, the difference between the two options grows, as the power of compound interest kicks in.

The formula for compounding is
FV = PV (1+r)^n
Where
FV= Future Value PV= Present Value r = rate of return for each compounding period n = number of compounding periods

Note that the rate of return for each compounding period has to be adjusted for the frequency of compounding. For example, if an investment pays 8% interest p.a compounded quarterly, then the applicable rate of return for each compounding period is 8%/4, or 2%. The number of compounding periods (n) refers to the periodicity with which interest is paid on the investment during the year. For example, the Post Office Monthly Income Scheme (MIS) pays interest every month, while the Senior Citizens Scheme pays every quarter. The greater the frequency of compounding, the more often interest is paid on interest, and the greater are returns earned through compounding.

Consider the following example. Krishna invests Rs.5 lakhs in a bank deposit that pays 8% interest compounded annually. What is the interest he earns from the investment if
1. The interest is used to pay the college fees of his daughter
2. The cumulative option is chosen and the interest is paid at maturity
3. If the interest is instead compounded quarterly and he chooses the cumulative option

Under Scenario 1
The interest income earned is: Rs.5 lakhs x 8% x 5=Rs.200000 There is no compounding benefit since the interest is taken out and used and not re-invested.

Under scenario 2
The maturity value will be= 500000 x (1+8%)^5 = Rs.734664 Interest income earned over 5 years = Rs.734664- Rs.500000= Rs.23664
The interest income is higher because the interest earned each year is re-invested and earns interest too. This is the compounding benefit.

Under scenario 3
The maturity value will be= 500000 x (1+(8%/4)^20) = 500000 x (1+2%)^20= Rs.742974 Interest income earned over 5 years = Rs.743974- Rs.500000= Rs.242974 The interest income is higher than scenario 2 because the frequency of compounding is higher. The interest is paid each quarter and this earns interest for the remaining period.

To understand more about compound interest, consider the example of Mr. and Mrs. Mony, both aged 30, who are making their respective retirement plans.
Mr Mony plans to invest Rs. 100,000 every year starting from age 45 for 15 years (i.e. he will withdraw the money at the age of 60) and he is expecting a return of about 12%.
Mrs. Mony invests Rs. 100,000 every year starting from age 30 for 30 years (i.e. she will withdraw the money at the age of 60) with a similar return expectation.
Note that both are planning to invest the same amount and expect the same rate of return, but Mrs Mony plans to keep her funds invested for double the time (30 years versus 15 years). The retirement corpus of both can be calculated as follows.

In Plan 1, Mrs Mony’s corpus has grown by more than 6.5 times than of Mr. Mony, due to the longer compounding period. In fact, even if she reduces her annual investment to one-third of the original, say Rs.30,000, her corpus is double that of Mr Mony (Plan 2).
For Mr. Mony to grow his corpus at the same compound rate, given his shorter investment horizon, he needs to double his investment (Plan 3). The power of compounding allows Mrs Mony’s corpus to grow more rapidly.

What are Debentures?

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A debenture is a type of debt instrument unsecured or secured by collateral. Debentures rely on the creditworthiness and reputation of the issuer for support. Both corporations and governments frequently issue debentures to raise capital or funds. Debentures may be interest-paying or cumulative where the principal invested and interest over it is paid by the issuer at the end of the tenor of the debentures.

Debentures can Convertable or Non-Convertible
Convertable Debetures gives the right to the debenture holder the right to convert the debt into equity shares of the company. Where in case of Non- convertible debentures no such right is vested with the debenture holder.

Features of a Debenture

Interest Rate – That a issuer promises to pay on its debentures.
Credit Rating – A company’s credit rating impacts the rate of interest at which it can raise funds through the means of debentures.
Maturity Date – Date at which the company much payback the money to the debenture holders the principal along with any interest accrued.



Debentures, bonds and other debt instruments of various issuers can be used to generate a portion of the periodic income that will form part of the retiral income. The choice of the bonds should be made with care to reduce the risk of default by the issuer. The interest earned will depend upon the market rates at the time of issue and the default risk associated with the borrower. The interest is typically paid annually or semi-annually and is taxed in the hands of the investor.

What is a Health Insurance Policy?

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Health insurance policies reimburse the medical expenses incurred for the policyholder and identified family members who are covered under the policy. This policy provides for reimbursement of hospitalization or domiciliary treatment expenses for illness or accidental injury up to the sum insured under the policy. The expenses that can be claimed, such as consultation fees, medicine and treatment costs, room costs, are specified in the policy and sub-limits may be fixed for each head. Claim is typically allowed only for “In-patient” (patients who are admitted in a hospital for treatment that requires at least overnight or 24 hours of stay in hospital) treatments and domiciliary treatments (patients can be treated at home when they are not in a condition to be moved to the hospital), according to the terms of the policy. Pre-existing illnesses may be excluded from cover for a fixed period when insurance is being taken for the first time or if it is being renewed after a lapse. Health policies provide cashless facility too where the bills are directly settled with the hospital and the insured is not required to pay upfront up to the sum approved for this facility. There is also the option to take a family floater policy that will cover multiple family members under the same policy up to the sum insured. The premium payable on the policy is a function of the sum insured, age and medical history of the insured, among others. Premiums may be adjusted for continued health cover and record of no-claim. Portability of health policies has been introduced under which the benefits of no-claim, bonus and time-bound exclusions for existing conditions can be transferred if the insured chooses to switch the insurance company. To benefit from portability, the previous policy should have been maintained without a break.

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