Penny-Wise: Investment tips to cut transaction costs

Here are a few tips on where you should invest in order to reduce your transaction costs.

Art: It’s a long-term and illiquid investment. You incur huge transaction costs both while buying and selling. We recommend that you take the direct route in this one. If you can buy straight from the artist, nothing like it. When you can’t, get yourself a curator to help you select the artist. Galleries typically charge a mark-up of 25-30% on each painting. Curators can bargain it down for you.

Skip art funds. The costs are much higher and you don’t know what you are paying for. You don’t know how they churn their portfolios either. There’s too much secrecy on that front. This is an asset class where you can get killed with one wrong move.

Property: Owning physical property is complicated and expensive. The registration fee and stamp duty can add about 10% to your purchase cost in most states and you cannot recover that when you sell.

Co-operative housing societies and builders also charge transfer fees when you sell a property, points out chartered accountant Gautam Nayak. The legal limit for transfer fees is Rs 25,000 but one of our friends just paid more than Rs 3 lakh for selling a one-bedroom house.

Keeping a property locked is a sure way to lose money. You lose the rent and pay for the maintenance. The best way to invest in this asset class is through real estate mutual funds. As of now, there are a few venture capital funds (ICICI and HDFC run a couple of them) but they are illiquid. When mutual funds make a big entry in India, don’t miss them.

Gold: Exchange traded funds are the way to go for the shiny metal. If you buy physical gold, you have to worry about the cost of storage, wealth tax, etc. If you have gold in hand then you can’t even trade it on a regular basis. With ETFs, fees are reasonable. They are liquid and backed by real gold.

Fixed Income: If you are the kind that wants to flip bonds within a year, then mutual funds are the way to go. Due to the favourable tax treatment given to MFs, they are a much cheaper route for the retail investor than buying bonds directly or investing in fixed deposits. If you are investing for less than a year you should go in for the dividend distribution scheme because dividends are taxed at 14 percent. If you sell bonds on the open market, the returns are taxed at 33 percent.

Commodities: Commodities involve more frequent transactions and hence higher costs. One way to play the commodities market is to buy shares in companies that will benefit from them. For instance, if you think the price of aluminium will rise, you can invest in Hindalco. But if you do want to invest
directly in commodities, make sure you get a discount in the brokerage depending on the volume of your trade. Financial planners can help you bargain down the rate.

Equity: Shop for the lowest brokerage costs. Big banks and well-known brokerages charge a premium for their brand. Leaders like ICICIDirect levy the highest brokerage for delivery trades ranging between 0.7% to 0.8%. A company like Motilal Oswal or Geojit, on the other hand, charges 0.3%
percent to 0.5% for the same. You can have multiple demat accounts. Use that leeway.

The Good Investor’s Checklist

Operating Cash Flow: A company can report a net profit without generating a net cash inflow. But cash is the oxygen of any business. Wide fluctuations or sustained negative cash flows are an indicator of trouble.

Dividends: A profit-making company must decide between funding its growth and rewarding its shareholders. The ability to pay dividends after spending for expansion marks a good company. Divide the payout by the share price to get the dividend yield.

Price to Earnings Ratio: P/E is the most popular ratio among investors. But use it only as one of many inputs. Compare the P/E of your company with that of its competitors.

Price-to-Book Value: It compares a company’s market price with the value of its tangible assets. Banks typically use this ratio. However, the ratio is not useful for companies with large intangible assets like patents and brands.

Debt-Equity Ratio: Each industry has its peculiar need for debt. A software firm can get along without borrowing, but an infrastructure company must borrow heavily. Understand the appropriate level for the industry.

Interest Coverage Ratio: The company’s ability to pay the interest on its borrowings is key to its solvency. Divide the Earnings Before Interest and Tax (EBIT) by the interest outgo (both the numbers are found in the profit & loss account) to get the ratio.

Return Ratios: A stock should earn you more than fixed deposit rates. Look for Return on Net Worth (earnings as a proportion of total shareholders’ funds) and Return of Capital Employed (earnings as a proportion of total capital including debt).