Money management

Srikumar Bondyopadhyay tells investors how to rejig assets for higher returns Small investors have been the biggest losers in the recent market mayhem. Experts say small investors follow a herd mentality, which means they buy in hordes when stock prices are high, but when the markets come crashing, they either get stuck or sell investments at a loss.

Profit is the ultimate goal of any investment planning. If an investment does not yield the desired result, book profits may turn into book losses when the markets plunge.

So, what should small investors do to beat the market blues?

Asset watch

First, as an investor, you need to set an investment goal for yourself and chalk out an asset allocation strategy that will help you achieve this target. You should regularly review the relative balance of your asset allocations. If there is any imbalance in excess of 10 per cent in a particular asset category, use this as a trigger to sell part of your investment in that asset class that has seen an appreciation to restore the balance.

It will also help you correct the timing of your entry into and exit from the markets.

Let us explain this with the help of an exercise (see chart). The table tells you how much money you need to invest now to help you become a crorepati after a given period of time.

It is clear from the chart that longer the period of your investment, lesser will be the capital required to be invested.

The illustration, however, considers only a one-time investment and no interim contributions after the initial endowment. So, if you have the required initial capital and are willing to make additional investments on a regular basis, you can become a crorepati quicker.

It also can be seen from the table that higher the rate of return, the lower is the initial capital requirement.

Risk-return nexus

However, it is the “rate of return” on the investment that throws up a tricky situation as different asset classes have different risk-return profile.

For example, you can get an 8 per cent rate of return for the next 5-10 years by stashing away your money in bank fixed deposits or any one (or a combination) of the state-run small savings schemes, such as NSC, PPF, Post Office Monthly Income Scheme. For such schemes, there is no fear of any capital loss.

You can spice up your returns a bit more by including debt mutual funds in your portfolio without significantly increasing the risk factor.

However, if you are looking at more than 10 per cent rate of return over the long term, you’ll have to invest at least part of your capital in equities, either directly through stock exchanges or through equity mutual funds.

Though equities generate higher return, they carry risk. So, you need to be judicious about asset allocation.

The rule book

There is a thumb rule for asset allocation. According to the rule, an investor’s equity allocation (as a percentage of total investment) should be equivalent to 100 minus the age of the individual. If you are 40-years-old, you should allocate 60 (= 100 - 40) per cent of your total in investment in equities or equity-linked instruments. The remaining 40 per cent should be invested in fixed income or debt instruments.

But if you are 60-years-old, you would rather need a steady flow of income from your investments. Hence, your equity exposure at the age of 60 should be much less (at 40 per cent) than when you were 40-years-old.

Hence, this asset allocation strategy follows the formula of lowering one’s investment risk with the growing age of the investor.

Market mood

Now, let us see how you can brave the market highs and lows using this strategy. Let us

consider a 40-year-old investor who has an initial capital of Rs 1 lakh. According to the asset allocation strategy, the investor will invest Rs 60,000 in equities and equity-linked instruments and Rs 40,000 in fixed income schemes and debt instruments.

Suppose, the fixed income plan fetches an annual rate of interest of 8 per cent. If equity prices go up 50 per cent in the next six months, the value of equity investment will be Rs 90,000 and the value of his fixed income investment will be Rs 41,600 at the end of the period.

A review of the investment portfolio after six months will reveal the following:

• The total investment has gone up to Rs 1,31,600, a gain of 31.6 per cent.
• Value of equity investment at Rs 90,000 constitutes 68.39 per cent of the total investment.
• Value of fixed income at Rs 41,600 comprises 31.61 per cent of total investment.

Here, we seen that an imbalance has cropped up following a 50 per cent rise in equity prices. The investor should restore the balance by bringing down the equity component of the portfolio to 60 per cent from 68.39 per cent and reinvesting the proceeds in fixed income instruments.

This means the investor should sell equities worth Rs 11,040 and reinvest the amount in fixed income instruments. Thus, after the rebalancing act, the revised portfolio will be:

• Total investment: Rs 1,31,600
• Equity investment: Rs 78,960, or 60 per cent of the total portfolio.
• Fixed income investment: Rs 52,640, or 40 per cent of total investment.

Now, if stock prices fall by 50 per cent in the next six months, the value of the equity portfolio will be Rs 39,480 and that of the fixed income investment will be Rs 54,745.60.

Total investment at the end of 12 months will, thus, stand at Rs 94,225.60. Equity and fixed-income assets comprise 41.9 per cent and 58.1 per cent, respectively, of the investment portfolio. This is again an instance of imbalance that can be restored by switching fixed income investments worth Rs 17,055 to equities.

After rebalancing, your equity investment will be Rs 56,535 (39,480 + 17,055).

If you had not gone for the rebalancing, then your initial equity investment of Rs 60000 would have come down to Rs 45,000 at the end of one year.

Thus, by adopting this asset allocation strategy, one can significantly reduce the investment loss if there is a steep decline in equity prices.

This was so because the investor was able to book profits from his equity investment when the market was up. On an overall portfolio basis, the loss is only Rs 5,774.40.

Ten hot money-spinners in India

Chicago, New York, London and Shanghai bourses may be rocketing. But for making money, one needs to catch the action in desi markets. So I did a quick reccy and guess what I found. There is plenty happening right here under our noses.

Here’s my list (in no particular order) of the top 10 commodities on the upswing. Keep an eye on them.

Gold and Silver: Gold is inversely linked to the dollar. So when dollar weakens, investors switch from currency to a hard asset like gold. Gold is attractive to everyone: those who believe the economy will recover and customers will start buying again; and those pessimistic ones who believe the worst is still ahead. For the latter, gold becomes a safe shelter for impending bad times. That is why pure gold crossed Rs 15,000 on Monday. Silver, the poor man’s gold, has tracked gold and risen to a 10-month high. They will continue to remain firmly bullish.

Tea and Coffee: Tea production in India, the world’s largest producer, is down 15%, affected by very poor rains in Assam and West Bengal. That comes when there is a global shortage of 45 mn kg, pushing Indian tea prices to an unprecedented Rs 98/kg. Exports have dropped by 12 million kg between January and March 2009, compared to last year. As consumption both locally and across the world continues to rise, this bodes well for tea companies, traders and exporters.

Coffee has been hit by disease and poor rains, too. Berry borer pest has hit 13,000 ha robusta coffee crop in the main growing districts of Chikmagalur, Coorg and Hassan in Karnataka. Last year too the crop was hit, albeit by heavy unseasonal rains. Currently, coffee prices are so high in the domestic market that traders are making more money selling locally than exporting overseas.

Gur and sugar: Sugar is hot because India produced only 14.5 million t in 2008-09 while it consumed 21 million t. This deficit has to be filled by imports. But if sufficient sugar is not imported, prices will remain at Rs 26/kg ex-factory. In 2009-10, India is expected to produce 21 million t sugar, going by current sugar cane planting reports from Maharashtra and UP. But all depends on the rains, which could change yields. Even if India does produce 21 mn t in 2009-10, the supply pipeline will still be badly stretched. Traders are already licking their chops.

If sugar is hot, gur is even hotter. Gur is now more expensive than sugar and no one has seen these prices of Rs 28/kg in a long, long time. There is tremendous demand for gur because it can replace molasses and be brewed to make country liquor. Right now, molasses are so expensive, that all desi vends have switched to gur. So gur can say hic, hic, hurray.

Pulses: Pulses are actually a no-brainer. India is perennially short of pulses. And with green vegetables so expensive, old staple dal is the only affordable source of protein for most families in India.

Spices: Cardamom, pepper, cloves are all looking good because the festival season is expected to make wholesalers finish their stocking by August itself. In cardamom, for instance, the local crop is down. The areas that grow cardamom have not yet started getting southwest monsoon showers. So if rains are poor, it will affect the Indian cardamom crop next season too. Meanwhile, the lone other producer in the world is Guatemala, where the quality is not too hot either this season. No wonder then the average price in May this year has been Rs 530/kg. Last year, it was Rs 500/kg.

Rubber: Rubber June futures have topped Rs 100/kg on NMCE and spot market rates are very close behind. Indian rubber prices move mainly in line with Tokyo’s TOCOM, so a jump there gets reflected in local futures. Natural rubber moves in tandem with crude oil because when crude oil becomes expensive, petrochemical-based artificial rubber also becomes expensive. That makes natural rubber a more affordable option for tyre companies and thus increases its demand. So if crude oil continues to rise, natural rubber will rise too, though only up to the point where tyre companies shout “enough” and stop buying.

Soya bean oil: It’s rising in India because of the push up from palm oil, the world’s cheapest oil. Palm oil touched a two-week high in Malaysia yesterday after the jump in crude oil prices made it again a viable option for using in biodiesel. There is bullishness in groundnut oil too because arrivals are slowing down from Gujarat and Maharashtra.

Rice: India produced 98.9 mn t of rice this year and will consume 92 mn t. That means we have a surplus of 5 mn t. Usually, this should be sufficient to keep prices steady in the market. But that hasn’t happened this year, chiefly because the government has bought such a large quantity of rice this season that the distribution pipeline is feeling tight. Don’t forget that the bulk of the rice grown in India is actually not sold in the market and usually saved for self-consumption and use as seed by millions of small farmers. Added to this feeling of tightness is the constant threat that the government will allow non-basmati exports. Already it has permitted export of 2 mn t to Africa as aid to poor countries. If exports begin, then the tightness could translate into tremendous momentum in the market.

Cotton: New York cotton futures have spurted sharply in April and May due to the general upswing in commodities and a fear that dry weather in key cotton growing state Texas could affect the crop. In India, price of good quality cotton is rising smartly. There was initially too much cotton this year in India because exports have been poor, and textile mills too did not have sufficient demand. But that could be changing. The rise in international prices means that expensive Indian cotton is again competitive in the world market. The recovery in textile demand means that yarn mills are back to work. Over all, cotton is looking good.

Potatoes: The potato crop was lower this year because of disease in West Bengal, hotter winters in the North, and poor rains in Maharashtra and Gujarat. That has pushed up mandi prices across the country to Rs 8-9/kg, up from Rs 3-5/kg last year. In the coming weeks, all eyes are on arrivals from Maharashtra. If they are poor, then prices could really shoot during the festival season. Going further, prices in November will depend on the early crop from Hoshiarpur and Una. If that crop is down, potato prices could hit new highs.

20 Rules To Stop Losing Money

1. Don't trust others opinions -
It's your money at stake, not theirs. Do your own analysis, regardless of the information source.

2. Don't believe in a company -
Trading is not investment. Remember the numbers and forget the press releases. Leave the American Dream to Peter Lynch.

3. Don't break your rules -
You made them for tough situations, just like the one you're probably in right now.

4. Don't try to get even -
Trading is never a game of catch-up. Every position must stand on its merits. Take your loss with composure, and take the next trade with absolute discipline.

5. Don't trade over your head -
If your last name isn't Buffett or Cramer, don't trade like them. Concentrate on playing the game well, and don't worry about making money.

6. Don't seek the Holy Grail -
There is no secret trading formula, other than solid risk management. So stop looking for it.

7. Don't forget your discipline -
Learning the basics is easy. Most traders fail due to a lack of discipline, not a lack of knowledge.

8. Don't chase the crowd -
Listen to the beat of your own drummer. By the time the crowd acts, you're probably too late…or too early.

9. Don't trade the obvious -
The prettiest patterns set up the most painful losses. If it looks too good to be true, it probably is.

10. Don't ignore the warning signs -
Big losses rarely come without warning. Don't wait for a lifeboat to abandon a sinking ship.

11. Don't count your chickens -
Profits aren't booked until the trade is closed. The market gives and the market takes away with great fury.

12. Don't forget the plan -
Remember the reasons you took the trade in the first place, and don't get blinded by volatility.

13. Don't have a paycheck mentality -
You don't deserve anything for all of your hard work. The market only pays off when you're right, and your timing is really, really good.

14. Don't join a group -
Trading is not a team sport. Avoid stock boards, chatrooms and financial TV. You want the truth, not blind support from others with your point of view.

15. Don't ignore your intuition -
Respect the little voice that tells you what to do, and what to avoid. That's the voice of the winner trying to get into your thick head.

16. Don't hate losing -
Expect to win and lose with great regularity. Expect the losing to teach you more about winning, than the winning itself.

17. Don't fall into the complexity trap -
A well-trained eye is more effective than a stack of indicators. Common sense is more valuable than a backtested system.

18. Don't confuse execution with opportunity -
Overpriced software won't help you trade like a pro. Pretty colors and flashing lights make you a faster trader, not a better one.

19. Don't project your personal life -
Trading gives you the perfect opportunity to discover just how screwed up your life really is. Get your own house in order before playing the markets.

20. Don't think its entertainment -
Trading should be boring most of the time, just like the real job you have right now.

How to make money in shares

Everyone wants a piece of the stock market. And why not?

But do you know how shares reward an investor?

If you are a shareholder, there are two ways you can benefit from the profits of a company: capital appreciation or dividend. Read on to understand how shares reward you.

Dividends, dividends!

Usually, a company distributes part of the profit it earns as dividend.

Say a company earned a profit of Rs 1 crore (Rs 10 million) in 2004-05.

It keeps half that amount within the company. This is used for a variety of purposes -- buying more machinery, land or raw materials, building a new factory or setting up a new office. It could even be used to repay loans.

The other half is to be distributed as dividend.

Assume the company has 10,000 shares. This would mean half the profit -- ie Rs 50 lakh (Rs 5 million) -- would be divided by 10,000 shares.

So each share would earn Rs 500. The dividend would then be Rs 500 per share.

If you own 100 shares of the company, you get a cheque of Rs 50,000 (100 shares x Rs 500) from the company.

I have never got such a high dividend!

Let's retract a bit. When the company issues shares, it gives a basic value to each share -- say Rs 10. This is called the face value of the share.

When the share is traded at the stock market, however, this value may go up or down, depending on the supply and demand for the stock.

The value of a share in the market at any point of time is called the price of the share or the market value of a stock.

A share with a face value of Rs 10, may be quoted at Rs 55 (higher than the face value), or even Rs 9 (lower than the face value).

Companies often decide to give the dividend as a percentage. So the company can declare a dividend of 50%. This dividend is a percentage of the share's face value.

This means if the face value of your share is Rs 10, a 50% dividend would mean a dividend of Rs 5 per share.

But chances are you would not have paid Rs 10 (the face value) for the share.

Let's say you paid Rs 100 (the then market value). But you will only get Rs 5 as your dividend for every share you own.

That, in percentage terms, means you got just 5% percent as your dividend and not the 50% the company announced.

Let's say you paid Rs 9 (the then market value). You will still get Rs 5 per share as dividend. That means, in percentage terms, you got 55.55% as dividend yield and not the 50% the company announced.

It all depends on how much you paid for the shares.

There is money in holding and selling

When you buy the shares of a company, you invest in its business. As the company expands and grows and profits increase, its value increases.

This, in turn, drives up the value of the stock. So when you sell, you will receive a premium over (more than) what you paid.

It is not as easy as it sounds. A stock's price is always on the move. It could either appreciate (increase in value) or depreciate (decrease in value) with respect to the price at which you purchased it.

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, your return from that stock is Rs 10, or 100%.

Or if you buy a stock for Rs 10 and sell it for Rs 9, you lose Re 1, or your loss is 10%.

You have to look at both

If you buy a stock for Rs 10 and sell it for Rs 20 after a year, your return from that stock is Rs 10 or 100%.

Now add the Rs 5 per share you have received as dividend.

Your total return will be Rs 15 (Rs 10 + Rs 5) or 150% (Rs 15 / by Rs 10 x 100).

If you buy a stock for Rs 10 and sell it for Rs 9 after a year, you would lose Re 1 per share.

However, you would have got Rs 5 as dividend. So you would net Rs 4 as earnings from the company.

In percentage terms, your return would be 40% (Rs 4 / Rs 10 x 100).

The tax factor

There is no tax on dividend.

When you sell any asset you own (house, land, shares, mutual fund units, gold, debentures, bonds), and you make a profit on the sale, it is known as capital gain.

If you sell your shares after a year, the profit you make is referred to as long-term capital gain. There is no tax on long-term capital gain.

If you sell it within a year of buying, it is referred to as short-term capital gain and taxed at 10%.

On a closing note

It is purely up to the company's discretion whether or not to declare a dividend and how much it should be. Normally, the dividend earnings do not amount to much.

People make their money in shares via capital appreciation. This means the share value rises over time and can be sold at a profit.

That is why shares are a long-term investment of at least a few years. From the tax angle, too, it pays to invest for the long-term.

Do remember that you are investing in a business. And businesses do fail. Shares are a risky investment!