How to invest in 2010 for better Profits?

This articles explores different investment avenues to invest in year 2010. Here are some excerpts from an article published in Sify.com.

Equities - Consolidation time

Making good money in Equities is going to be tough in 2010 when compared to the phenominal profits it gave in 2009. Year 2010 will be a consolidation year for equities and investors should do good research and home work before investion and should invest in specific stocks that focus on domestic consumptions (that too urban consumption) and have less exposure to global markets.

Direct equity investors would have to follow a bottom-up approach. Selection of stocks will be an important. Stocks with low price-earning ratio and good business models are likely to do much better.

Investors in mutual fund schemes through systematic investment plans (SIPs) should continue their investments. Some of them can book profits from their large-cap schemes (if they have invested for more than a year, they can avoid the short-term capital gains tax as well) and shift the money to mid-cap schemes. But one should look at the track record of the various schemes before doing so.

Debt – Improved returns

Returns from debt instruments in 2010 will be much more attractive than they were in 2009. The RBI has already signalled a higher interest rate regime because of inflationary pressures. “Interest rates are likely to go up. RBI may take the initial steps in January itself and continue the tightening process during the year,” said Murthy Nagarajan, head, fixed income, Mirae Asset (India). As a result, returns from liquid, ultra short-term and short-term debt funds could increase to 6 per cent compared with the current range of 4.5-5 per cent.

Gold: Continues to shine

In the last two years, the yellow metal has given 24.19 per cent annual returns. In comparison, returns from the Sensex and the Nifty have been in the negative territory —7.20 per cent and 7.62 per cent, respectively.

A known hedge against inflation, gold is expected to remain stable in the coming year. Deutsche Bank and Birla Sun Life Distribution Company expect the price at around $1,200 an ounce, or Rs 56,112 (exchange rate of $1 = Rs 46.76), by the end of 2010. “We believe that gold will be reasonably stable through the year. Our 12-month target is $1,200 an ounce,” said Pankaj Narain, director and head, private clients, banking and investments, India at Deutsche Bank. It is currently trading around $1,093 (or Rs 51,108.68) an ounce.

Property: Wait and watch

Experts said the next few months could be crucial. “Things will change around February when buying from NRIs stop. One could get good deals then,” said Pranay Vakil, chairman, Knight Frank (India).

Investors in commercial property would do well to wait for a longer period. In many cities, oversupply is leading to depressed prices. Also, industries like information technology and business process outsourcing (BPO), which drive the demand for commercial property, are under pressure because of the hardening rupee.

A better proposition would be invest in a property that is already earning some rent. This would give an idea about the expected returns.

Source: http://sify.com/finance/adrenaline-rush-is-over-cheers-to-consolidation-news-default-jm5aOBcgfge.html

Keep The Faith: Time to Invest Again

Companies are poised to do better, bankers are opening the money spigot, consumer wallets are opening up. It’s time to invest again

im Rogers, “investment biker” and fund manager, still prefers China over India. But wait. India has just wrested a star defector from the Chinese camp. Stephen Roach, one of the few guys who still retain a job and a reputation on Wall Street, believes that “for the first time, India looks [to be] ahead of China as the investment destination in Asia.”

He is in growing company. When Roach said this in the first week of June in Mumbai at a Morgan Stanley conference, there were 150 fund managers and stock brokers from across the world listening to him. Just a month earlier, the same conference had found it hard to get 75 people to attend. The rise in attendance was symbolic of the optimism pervading the investment community. It is due in no small measure to the decisive mandate returned by the Lok Sabha elections. A strong government in India and a robust rally across all emerging markets, particularly in Asia, over the previous 10 weeks brought the masters of the Universe sweeping in from over the Himalayas.

What they heard was sweet. Ridham Desai, Morgan Stanley India’s head of investment, said at the conference that the 30-share BSE Sensex could rise to 19,000 by the end of 2009, provided there were no rude policy shocks. All the fund managers wanted to know just one — actually three — things. Haven’t stock prices risen sharply in the last few months making them look expensive already? Can the Indian economy absorb any relapse, if attempts by the US Fed to revive its economy fail? What if domestic demand flags and oil prices shoot up increasing input costs again?
Those are vexing questions and market analysts are divided on the answers. Not good enough. A careful reading of company balance sheets and conversations with company executives are quite in order.

INPUT COSTS HEADED SOUTH, PROFITS RISE

Falling commodity prices have brought down input costs of companies by 37 percent. This helped a 60 percent rise in their net profits. Sales had been flat between December 2008 and March 2009, but now demand is picking up

And here’s the upshot. For the first time, operating margins are creeping up after five straight quarters of decline. Global commodity prices have fallen and working capital has become cheaper. That has helped companies shave off a hefty chunk of their costs. So far, sales have remained stagnant. And indications suggest that the demand for core sectors like steel, cement and even commercial vehicles has already begun to pick up, signalling a broader economic recovery.
Smart money is already moving in. After a lull of nearly six months, foreign investors are pumping money into Indian stocks. As much as $3.5 billion came in the three months to May 16, the day election results were announced. During this period, the Sensex had risen 34 percent compared with a 42 percent rise in all the emerging markets put together. After the results, India forged ahead, becoming the best performing market in Asia.

It doesn’t end here. The market has risen on the back of higher expectations of both corporate performance and a stable, growth-oriented policy of the government. Much will now depend on whether demand conditions continue to improve and that translates into higher sales growth for companies. Their earnings per share is also set to rise. The EPS for Sensex-30 companies could grow from Rs. 820 now to Rs. 950 in the year ending March 2010, Rajeev Thakkar, CEO and director of Parag Parikh Financial Advisory Services (PPFAS), says.

Then there’s one more crucial factor: Will Asia eventually decouple from the rest of the world? When the economic collapse blew a hole in the theory that Asian growth markets would stay insulated from the turmoil. Now, as the crisis abates, will a resurgent Asia pull away from the rest of the world?

COMPANIES BOOST ABILITY TO SERVICE DEBT

Interest cover- the ability of companies to pay their interests costs from their profits- is improving after five quarters of a free fall. The operating and net profit margins are also coming back to December 2007 levels

Siting on a large exercise ball inside his small office on Lan Kwai Fong, a popular locality dotted with pubs in Hong Kong, Robert Howe is clear that Asia is out of the crisis. Howe, a former chief investment officer at AIG, started Akamai Asia Pacific fund, a hedge fund that invests in India, Australia and South Korea. “Asia will have nothing to do with what happens in the US henceforth,” says Howe. Last week, after India’s statistical office reported better-than-anticipated economic growth numbers, analysts have begun changing their outlook for the country and the stock market. A Citigroup Global Markets report on June 10 raised India’s GDP growth estimates to 6.8 percent for financial year 2009-10 and 7.8 percent for financial year 2010-11.

Clearly, this isn’t the time for any recklessness. The worst is not yet over. And the risks need to be carefully gauged. But the big monkey — declining consumer demand — seems to be coming off the economy’s back.

Hitting the Road
Ask P.M. Telang, the newly appointed managing director of Tata Motors about his business prospects. “It is not the lack of demand, but the sudden dearth of vehicle financing since October 2008 that affected our sales. The fact that liquidity situation has eased, has corrected that situation.” From the middle of last year, leading banks like ICICI Bank and HDFC Bank pulled the plug on vehicle financing because they felt the interest rate hikes by the Reserve Bank of India would make it tough for the truckers to pay on time.

For the past six months, Tata Motors cut back production by nearly 40 percent largely to bring down its inventory. Sales, too, had flagged. Today, the demand for its large trucks and tractor trailers that carry heavy engineering goods and export consignments to ports still hasn’t picked up — a clear reflection of India Inc’s self-imposed cap on any further capital expansion. However, Tata Motors is selling more and more of light commercial vehicles and buses — typically bought by state transport agencies and small and medium sized enterprises intent on modernising their fleet. “This year’s sales of LCVs and buses are actually more than last year,” says Ravi Pisharody, head of sales for commercial vehicles at Tata Motors.

TRUCK SALES, A STOCK MARKET BAROMETER
There is a 95 percent correlation between commercial vehicle scales and the movement of Nifty. When CV sales fell in 2007-08, this was very much reflected in the index. After March 2009, CV sales have risen and so has Nifty

It’s the same story for other sectors like cement and steel. Despatches have held up and prices have actually increased month-on-month. Even in real estate, where accurate data is always hard to come by, demand hasn’t evaporated. Buyers are now coming back to the market at the right price. In Thane, a leading builder sold 60 flats within a fortnight in March priced at Rs. 45 lakh each, after he brought down prices from Rs. 6,000 per square feet to Rs. 4,100. Thirty kilometres away in Mahalaxmi in mid-town Mumbai, Lodha Group’s director Abhishek Lodha says the demand for his premium, upscale apartments has shown a big jump since February. He claims to have sold a dozen apartments each priced at about Rs. 2 crore.

It is these signals on the ground that are helping build investor confidence. Retail brokerage Sharekhan spent the past one year closing down several offices it had opened across the country, particularly in small towns like Nashik and Salem. Today, day traders are slowly coming back every day to use their terminals in their offices across Mumbai. At the Morgan Stanley conference, the organisers claim that investors held 1,200 one-to-one meetings with executives of 55 companies to examine investment opportunities.

Even cash-strapped companies are now tapping into this new-found investor confidence. There has been a spree of qualified institutional placements. Firms like Unitech, Indiabulls Real Estate and Power Trading Corporation of India raised money without a sweat through QID. For Unitech, the timing couldn’t have been better. Its debt-to-equity ratio is expected to come down from 3.55 in 2007-08 to 1.9 in 2008-09.

NIFTY DECOUPLES FROM DOW ON THE UPMOVE
When the Dow index falls, it drags global markets down. But in the absence of very bad news, from the US all the other markets are on their own. This shows Asia is "decoupling" from the US on the upmove

Last time the financial markets went into a tailspin in India in the mid Nineties, the economy almost ground to a halt. The lack of demand, the high cost of money and inefficient operations, for instance, pushed Tata Motors into India Inc’s biggest corporate loss. Several companies had to clean up the mess inside, wait long for cheaper finances and pray for demand to pick up. For Tata Motors, which entered the car segment during this period, the recovery came only in 2003.

This time, however, investors won’t have to wait that long. Costs have come down and profit margins have already improved. So far, consumer demand is holding steady. Indians have bought more TVs, bikes and cars this year than they did last year. And for sectors like steel and cement, pricing power has already improved. Says Tata Motors Pisharody: “Economic activity in some sectors will eventually drag the inactive ones like manufacturing to move. Then surely the situation will appear more normal.”

Step Out, With Care
There’s, of course, a school of thought that believes the run-up has been far too swift. Though stock markets around the world have risen, global investors are still wary of the speed at which the Sensex have risen in comparison. Sanjeev Prasad, head of equity research at Kotak Securities, belongs to that school. Prasad, rated by Asiamoney as the third best analyst for predicting the Indian market, says that based on the current earnings of companies the Sensex would find it tough to go beyond 15,000. He said that the index may fall to as low as 11,000 over the next 12 months, if there are any policy surprises. Read that as creeping inflation and a possible rate increase by the central bank in the third or fourth quarter.

So what’s the best time to step in? For investors, that has always been a complex question. When the markets had bottomed out in December last year, the thinly traded volumes on the stock exchanges were evidence of the lack of investor interest. When the market suddenly spurted, most investors were caught off guard. Brokers say that initially retail investors sold stocks before the election, clearly expecting a patch-work government to create a big policy muddle. Inflows into mutual funds also showed no significant increase.

For people like Rajeev Thakkar of PPFAS, these tricky situations present the best buying opportunities. As a fund manager for wealthy individuals, Thakkar bought shares of financial software company Oracle Financial at Rs. 900, when the market was still falling. At that time, he found the stock was reasonably valued and argued that the turmoil in global banking would increase the demand for automation and controls. Despite murmurs from some of his clients, Thakkar continued to buy the stock even as it continued to fall to below Rs. 500. Today, the stock trades at Rs. 1,200 and Thakkar has made a neat packet for his clients. But more importantly, he continues to hold the stock betting on its future potential. Says Thakkar, “You got to make your pick and take the plunge.”

Image: Pravin Palande
Robert Howe, founder of Akami Asia Pacific Fund, expressing his belief that Asia has come out of the crisis

But before taking the plunge, you’ve got to believe in two critical assumptions: that the Indian economy will continue to grow in the near term and that the growth will present smart companies an opportunity to make money and grow. If you buy into these two assumptions, it’s time to do a bit of homework and do a careful round of smart stock picking. If the market continues its bull run, you’ll be in the money. If it faces any interim hiccups, there’ll be better opportunities to buy your picks at even lower prices. You can average your cost of acquisition downwards like Thakkar did.
Savvy investors need a brand new investing playbook for these uncertain times. Now, turn the page to choose from among the best investment themes that this market has to offer.

Jim Rogers
The Skeptic



Now, if you haven’t heard of Jim Rogers, you haven’t heard of nothing. The co-founder of the Quantum Fund (along with billionaire George Soros), hit the headlines in the Seventies when his portfolio gained 4,200 percent while the S&P 500 index had advanced just 47 percent. He moved to Singapore in 1997. “If you were smart in 1807, you moved to London, if you were smart in 1907, you moved to New York, and if you’re smart in 2007, you move to Asia,” he reportedly said.

World View

• The world consumes more than it produces. So, agriculture is a good bet in the long run.

• There’s a currency crisis waiting to happen — not sure which one though — but most probably European or American.

• Invest in Sri Lanka. A 30-year war is just over. The country needs to be rebuilt. That spells opportunity.
  

India View

• Bullish on the country’s tourism, infrastructure and defence.
• Uncomfortable with the government. The Congress has always over promised and under delivered. If it does keep its promise this time around, India could be the greatest development story for the next 20 years
  
  Stephen Roach The Convert

One of the most influential economists on Wall Street, Roach is MD and chief economist of Morgan Stanley. His gloomy predictions earned him the sobriquet “Perennial Bear”. In 2004, he predicted an Economic Armageddon. His outlook stemmed from the fact that debt in the US was more than 50 percent of its GDP; it continues to remain there till date.

World View

• The US is dead as a consumer nation. No country can take its place — not even India or China.
• 75 percent of the world’s economies are contracting and will limit global growth rates.
• Therefore, the current equity rally across the world isn’t justified.

India View

• For the first time, Roach says he likes India over China because India isn’t as dependent on exports as China is.
• Domestic savings as a percentage of GDP is at 37 percent. This is among the highest in the world and makes the average Indian consumer a formidable creature.
• There is enough evidence to indicate FDI into the country will accelerate.
• Likes the fact that the Congress is in power. He believes it gives India the stability it needs.

LIC to invest Rs 1,75,000cr

Life Insurance Corporation (LIC) on Wednesday said it would invest Rs 1,75,000 crore, including Rs 50,000 crore in the equity market, during the current fiscal.

"We are planning to invest a total of Rs 1,75,000 crore against Rs 1,62,000 crore last year," the LIC managing director, Mr Thomas Mathew T., told reporters on the sideline of the LIC roundtable here.

Of the total, Rs 50,000 crore would be invested in the equities and similar amo-unt would go towards the corporate debt, he said. The largest player with a market share of 61 per cent in the life insurance sector has pumped in Rs 8,000 crore in equity markets so far in this fiscal.

On the debt side, he said, the investment was in the the range of Rs 6,000 crore to Rs 7,000 crore in the past two and a half months of the fiscal.

The company had invested Rs 40,800 crore in equities and Rs 40,000 crore in debt instruments in 2008-09. The insurer plans to invest about Rs 65,000 crore into government securities, Mr Mathew said, adding that the remaining Rs 10,000 crore would go towards term loans, mutual funds and venture capital.

Asked about the investment preference, he said, "This year particularly with the government focus on infrastructure, infrastructure-related sectors should be doing well."

On the new premium collection, he said that LIC expects a growth of 35 per cent this fiscal.

In 2008-09, the company earned new premium of Rs 52,000 crore, 10 per cent lower than the previous fiscal.

"New premium plus first year renewal plus group business would all add up to Rs 70,000 crore," he said. — PTI

Why You Should Invest In Stocks And How To Start Investing

You get more return for the money invested in a stock over a period of time. Usually, a fixed deposit account in India may not yield more than 10% returns in a year but in stock market, it can happen in a single trading day. Reverse is also true, it can wipe out 10% of the investment in a single day.

For example, Infosys Technologies Limited has appreciated nearly 330 times since 1994. This is just impossible with any other type of business.

Having said that, stock prices simply do not always go upwards. They do fall. Sometimes the fall can be so heavy that it erodes investor wealth by more than 5 or 10% in a session.

Investors will ideally want to buy a stock when demand is about to pick up for the stock and sell when it slowly disappears. But that has to be estimated using some analytical techniques. These are called fundamental analysis and technical analysis. Fundamental analysis focuses on company’s business model, earnings forecast, demand and supply scenario for the company’s products and services and so on. Technical analysis uses price and volume analysis for predicting future price movements.

Procedures for investing in India:

An Indian resident, a non-resident Indian or person of Indian origin (PIO) can invest or trade in Indian stock markets. The rules are slightly different for NRI’s and PIO’s.

Prior to 2001, securities were being traded in physical form i.e. paper certificates were in use. This resulted in delays, loss in transit, signature mismatch, theft etc. With the online trading system, shares are held in electronic form very much like money is held in a bank. This is called a ‘demat’ account. (Demat stands for dematerialization.) It is now compulsory for all securities to be traded under demat segment only. The IPO’s or the initial public offerings insist that the applicant needs to have a demat account.

There are two depositories in India, National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL). They hold the equity shares for a fee.

All transactions in the stock exchanges are through brokerage houses only. Some of them offer internet trading facility too.

Demat Account:

This accounts holds the shares in electronic form. Sold shares will be debited by the Depository Participant (DP). Similarly, bought / bonus shares will be credited to this account.

To open an Indian resident demat account, one has to approach a brokerage house. The person(s) will have to:

Fill out demat account opening form
.

Fill out demat account opening form
Provide PAN (Permanent Account Number) card issued by Income Tax department
Provide proof of identity (such as passport, driving license etc.)
Provide proof of residence (such as passport, telephone bill, etc.)
Provide a working savings bank account number for credit of dividends

It may take approximately 2 to 5 working days for opening a demat account. The broker may also issue depository instruction slips which should be filled when stocks are bought or sold. Both client and broker need to have account with the same DP in order to transact. In case of online trading, no such slips are needed; in some cases, depository participant and trading member (broker) may be the same.

Trading Account:

A trading account monitors the cash transactions of the client. Based on his delivery/intraday transactions, the broker will debit/credit the amount due in his trading account. If a client wants to purchase stocks for which he needs funding from broker (also known as margin) he needs to enter a margin trading agreement with broker. The broker may allow purchase of securities depending upon the market value of clients’ holding and cash balance. In case of delivery (i.e. buying from the market and holding it for sale later) the broker needs to be paid within settlement date i.e. two working days from trade date. However, some brokers may allow a day or two extra.

The procedure for opening a trading account is similar to opening a demat account. A POA (Power of Attorney) agreement needs to be signed by the client and broker. In case the client fails to pay the margin, the broker at his descretion, may square off the transaction.

Where to Invest?

Where to Invest decisions and how you allocate your portfolio among the 3 main asset categories - stocks, bonds, or cash (money market funds and short-term FDs) has a great impact on your investment portfolio's long-term performance. Infact my seniors tell me, this impact over the long-term is far greater than any specific investment decision (like investing in XYZ stock) you might ever make.

Where to Invest: Asset allocation is important because it has a major impact on whether you will meet your financial goal. If you don't include enough risk in your portfolio, your investments may not earn a large enough return to meet your goal. For example, if you are saving for a long-term goal, such as buying your dream house, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio.

On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it. A portfolio heavily weighted in stock or stock mutual funds, for instance, would be inappropriate for a short-term goal, such as saving for the family's Europe trip, next summer.

Now look at this in another way. Let's say you have followed basic investing principles well, and in particular are well-diversified within each asset category, you would have eliminated most risks associated with any single investment. However, you could still end up not meeting your financial goals if you got your where to invest: asset allocation wrong.

For example, let's say you have a nice diversified portfolio of 20 stocks. Your decision, several years ago, to invest in Wipro rather than Infosys may have caused you to kick yourself once or twice, but this would have cost you far less than a decision several years ago to invest only 20% of your total portfolio in the stock market, and the rest in cash investments.

So, we are clear now how important it is to get your Where to Invest decisions, or your asset allocation right. Great! But how do you go on to make the right where to invest: asset allocation decisions for yourself? There are two components that can help you in this decision making process.
1. Historical returns/risks associated with the 3 major asset categories, and
2. Your own Investment profile

Balancing these risks and potential returns based on your investment profile, will lead us to the right where to invest decisions.

Historical Returns

We never know what the future will hold. But we do know the past. We sure can use historical data from the past to serve as a guide for our where to invest decisions, provided we remain aware of the limitations.

Fistly, the past may not be repeated, we should be fully aware of that! Second, it is important to look over enough of the past to cover various economic and market conditions. Yet avoid extending so far back that we view conditions that may no longer be applicable due to structural changes in the economy.

I couldn't get data for the Indian stock market extending so far back, so I have used S&P 500 index data from 1946-2004, as presented below. As I looked at this data and tried to interpret, it's clear to me that similar where to invest conclusions will hold for the Indian markets as well.

So what are these where to invest conclusions?

I thought it best to include the following data, analysis & interpretation based entirely on an American Association of Individual Investors (AAII) article.

The where to invest stock data presented here covers the Standard & Poor’s 500 index, which consists of larger, established companies. The bond data is for intermediate-term government bonds, with a maturity of about five years. Cash is represented by Treasury bills, the most conservative segment of the cash investment market. This where to invest data represents the core areas in which most investors will concentrate, but there are more volatile segments of each category - small stocks and longer-term bonds, for instance.

The where to invest data includes annual returns for the overall period, as well as annual returns based on 1, 5, 10, and 20 year holding periods, to indicate how the risk/return equation can change with time. (These holding period returns encompass all the years using rolling holding periods. For instance, five-year periods include 1946 through 1950; 1947 through 1951, etc.). The data also indicates the percentage of holding period returns that were losses, and the percentage of holding period returns that were below the rate of inflation.

Using the where to invest historical data, you can start to get an idea concerning the risks and potential returns of the three major asset categories.

Market risks

Both stocks and bonds face substantial market risk - a rise or fall in the value of the investment due to market conditions. A good indication of market risk is to simply examine the best and worst returns over one-year holding periods. Those returns were the kinds of variations that may occur within that category.

Stock market risk is due to the volatility of the overall market, which can cause even reputed stocks to drop in price. For one-year holding periods, stock returns were extremely volatile (and therefore uncertain)- ranging from a high of 52.6% to a low of –26.5%, a substantial loss. In addition, 24% of the one-year holding periods’ returns have been losses. Stock market risk for stocks does decrease with longer holding periods, as the longterm growth benefits kick in. Check out the 10 & 20 yr holding periods.

Bonds also face substantial market risk due to fluctuating interest rates; this risk is referred to as interest rate risk. Rising interest rates cause existing bonds to drop in value, while falling interest rates cause existing bonds to rise in value; the effect is greater the longer the maturity of the bond. Interest rate risk has caused intermediate-term bond returns to range between 29.1% and –5.1% for one-year holding periods, and suffer losses 12% of the time for one-year holding periods. Interest rate risk decreases only slightly as the holding period increases.

Cash investments face no market risk because their return is solely based on their current yield.

Inflation risk

All investments face inflation risk - the risk that inflation will erode the real value of the investment. There are two good indications of inflation risk: an investment’s real return (its return after inflation) and the percentage of holding period returns that are below inflation.

Stocks face the least inflation risk. Over the entire period, they have produced an annual real return of 7.5%. In contrast, bonds have outpaced inflation by only 1.8% annually, and cash by only 0.5%. Individual holding period returns also indicate the substantial inflation risk facing bond investments. For one-year holding periods, bond returns were below inflation fully 44% of the time; for longer holding periods, inflation risk was similar for bonds and cash; stocks suffered the least.

Please spend some time over the table above. It summarises quite well the where to invest risk/return characteristics of the 3 major asset categories, and thus what you can or should do, about them. I am re-emphasising these where to invest characteristics for better effect!

1. To beat inflation risk over the long term, there is no alternative but stocks.
So if you are investing for a future event that's 10 or 20 years away (buying a house, child's marriage/education, retirement) - you gotta be invested in stocks or stock mutual funds. So you need to take higher risks with some part of your portfolio for these kind of requirements. Else, inflation would have eaten away all your returns!

2. To reduce liquidity risk, some portion of one's portfolio has to be in Cash,
cash equivalents (money market funds, short-term, medium-term FDs). This would mean if you need cash urgently, you might not need to sell out of stocks or stock mutual funds at inopportune moments at a loss.

3. To reduce business risk, one's stock or stock mutual fund investment portfolio needs to be well-diversified.

4. To reduce stock market risk one should invest in schemes like the Public Provident Fund and other such government-backed investment schemes in India, like NSC and KVP schemes.

But all these, are on an individual asset category basis. A more efficient approach is to weigh the risks and return potential of your overall portfolio, not just the individual parts. Diversifying among the asset categories reduces the individual category risks and allows you to build a portfolio that matches your investment profile.

Your Investment Profile

As discussed at length before, your investment profile includes your tolerance for risk, your return requirments, your time horizon, and your tax exposure.

So let's see how can we go about using the data above to build a where to invest portfolio - allocate your assets with the right balance - that can meet your return requirements without exceeding your tolerance for risk.

Risk Tolerance
We can use the worst-case scenario - the maximum loss for all categories - as a guide to how much of a loss you can stomach. In the examples below, I have used the worst one-year holding period returns.

Return Requirments
We can use the average annual returns for the entire period, average annual growth and the average income figures to help put a perspective on what you can expect on your growth and annual income requirments, but keep in mind these are long-term figures; variations year-to-year can be significant.

With the background set, we can now examine various possible asset category combinations to see how they might fit your personal investment profile. We will use the
risk and return characteristics of the individual categories to help you decide what to emphasize. Then we will examine the risk and return characteristics of the total portfolio.

Portfolio 1 is heavily invested in stocks, which indicates that this is for a long-term investor with a primary need for long-term growth that outweighs the short-term stock market risk considerations. The overall characteristics of the portfolio reflect the investor’s profile: a high tolerance for risk (the downside risk is –21.2%); less emphasis on annual income; and a higher requirement for growth return. This portfolio tends to match an aggressive investor, or the characteristics of many individuals in their early, or mid-career stages of the investing life cycle.

Portfolio 2 is suited for a more moderate risk taker, with a downside risk of –16.9%. The trade-off is ofcourse lower growth.

Portfolio 3 stresses a higher annual income and lower downside risk. The trade-off again, is considerably lower growth. This portfolio tends to match the characteristics of a defensive investor, say someone in early retirement.

And, there are some investors with a portfolio completely devoid of stocks - only bonds and cash. These are the ultra conservative investors for whom capital protection is a must. This kind of portfolio matches the characteristics of someone in late retirement.

As is evident, you could use several combinations to match your specific individual profile - your unique risk tolerance and return requirments. Each individual is unique and one's asset allocation could potentially use any combination to achieve the needed balance between return requirements and risk tolerance.

If you want to play around with other combinations, you can use the formulas as mentioned above. Have fun!

You now probably have a rough idea of your overall where to invest: asset allocation decisions. Equipped with this, you can now go on to make selections within each asset category - while maintaining this broad allocation across asset categories.

How to Invest? - Part II

How to Invest: Your Investment Profile

Now that you have an understanding of the how to invest: basic investing principles, its time to determine your investment style, or investmentment profile. The investment profile plays a crucial role in devising an investment strategy that can help you meet your investment goals without exceeding your tolerance for risk.

Your investing decisions are heavily influenced by your financial circumstances and your personality. No two individuals are alike in terms of their financial situation, their requirements from an investing plan, or in their ability to handle or tolerate risks. Infact each individual needs to tailor the investment strategy, or how to invest, based on his/her investment profile. Thus crafting your own investment strategy would require an understanding of how various aspects of your investment profile affect your investment decisions.

Your Investment Profile

We have seen in the first article in this series - how to invest: basic investing principles - how investment decisions are based on the risk/return trade-offs and the ways you can mitigate the risks. You will now see how your investment profile affects the risk/return trade-offs you may be willing to make and thus your ability to reduce the risks. Your investment profile decides how to invest, depending on your financial circumstances and personality traits, as below:

- your return requirements; whether you need current income or future growth
- your tolerance for risk
- your time horizon, that you can stay invested
- your tax exposure

Let's examine these aspects individually and their impact on investment decisions, now in more detail.

Return Requirements

Our return requirements are often dictated by our financial situation.

Some will be looking at how to invest strategies to save for a future event such as buying a house, a child's higher education or marriage. These circumstances would require that the investments are aimed at generating higher returns for healthy growth. Since the investment is meant for meeting a future financial goal, you will be willing to stay invested for a longer term.

There will be some who want how to invest strategies that make annualised (or even monthly) returns every year to augment their current income. These circumstances dictate that the investments generate consistent annual payouts and that the capital is protected. You will probably be looking to remain invested for the medium to long term in such investments.

There will also be some who want some current income as well as future growth. Let's see how the how to invest - common investment options stack up on these risk/return trade-offs.

The how to invest risk/return trade-offs become apparent here isnt it. If principal protection is important, you will have to settle for lower return instruments such as bank FDs or Bonds. This is because the more certain the annual payments, the less risky the investment, and therefore lower the potential return in the form of growth.

On the other hand if you are looking for growth strategies, you will need to settle for less certain principal protection and thus take on more risks by investing in high-quality Stocks or reputed Mutual Funds.

Looking at the above table and the examples of how to invest options with return characteristics may help you identify your return requirements. One may invest in other investment options (Equity Diversified Mutual Funds, Balanced Mutual Funds, or Gold for instance) with their attendant return characteristics. It is certainly possible to meet your return requirments by diversifying across different how to invest options in proper proportion, as long as you have identified them properly along the lines, as exemplified above.

Risk Tolerance

Now we have come to a crucial aspect of your investment profile - your tolerance for risk. How much risk are you willing and able to take on is extremely important for defining your how to invest profile. We all know the consequences of taking on too much risk.

We have seen/read about how many investors panicked during the recent stock market crash of 2008 and withdrew their investments at inopportune times suffering heavy losses. Had they stayed on for the whole of 2008 and continued till now (May 2009) they would have recovered most of these losses and possibly made some gains.

Properly assessing your tolerance for risk is designed to prevent you from making panic decisions and abandoning your how to invest plan mid-stream at the worst possible times. So how do we measure risk tolerance?

Looking at the table it might be possible for you to identify what kind of risk you may be willing and able to take on.

There is another way to approach this. We have seen the how to invest risk/return trade-offs for some investment options earlier. So if you are drawn towards a particular type of investment, you probably have a tolerance for risk approaching that type of investment option. For example, if you are drawn only to FDs and bonds, you risk tolerance is probably the conservative type.

If you drawn to high-quality dividend paying stocks, your risk tolerance probably is moderate. On the other hand, if you are drawn to aggressive growth and momentum stocks, or quality small and mid-cap stock portfolios, your risk tolerance is certainly the aggressive type.

Its important to note that an investor with a "defensive" risk-tolerance can diversify into riskier investments with a portion (say 20%) of the portfolio for better returns, while still maintaining a low-risk profile.

What this boils down to then, is that your risk tolerance profile indicates where the bulk of your portfolio investment could be. However proper diversification across investment categories is essential to ensure a balance between capital safety and growth.

Time Horizon

Now we come to another important how to invest aspect - Time Horizon - or the time you can or will remain invested.

We have discussed in the first article in this series - how to invest: basic investing principles - how Time Diversification, or remaining invested through various market cycles, helps reduce risk. Time diversification is especially useful for highly volatile investment categories such as stocks, where prices can fluctuate over the short term. Staying invested over longer term smoothes these fluctuations.

Because you can reduce some of the risks through time diversification, a longer time horizon allows you to take on greater risks, for a higher return potential. Naturally, with a shorter time horizon you cannot effectively diversify across market or economic cycles, and thus will need to settle for lower-risk, low-return investments.

So, how do we decide on our time horizon -short, long or medium?
Your time horizon is effectively dictated by when you need to take out the money. So if you are investing for a future event such as buying a house, a child's education or marriage - 10 years away - the time horizon, is simply 10 years - the time when you need the cash.

However if you are investing for your retirement requirements - say, 20 years away - when you will need money for periodic withdrawls - the time horizon is simple, till retirement. But when the withdrawls begin, you may need to take out only part of your investment portfolio. Here, the time horizon becomes a blend - short-term, as well as medium to long-term.

And, how do we decide what is long term?
To make the most of time diversification, we have learnt we must remain invested over one complete economic cycle, at the least. In general an economic cycle lasts about 5 years. So a time horizon over 5 years can be considered long term. And longer time horizons over 10 or 20 years works best as they would see through multiple economic cycles. As we have mentioned before, Stocks are a good bet for longer term horizons.

And short and medium term horizons? Well if you need the money within a year or two, you are obviously restricted to the money market funds, short-term fixed deposits and bonds. A medium term horizon of 2-5 years implies you could go in for a mix of medium term bonds and/or high-quality dividend paying stocks. And you will be well-advised to stay out of growth stocks.

Tax exposure

Fortunately in India, there are several tax incentives for investing in stocks and mutual funds (MF). However fixed deposits and bonds are subject to tax, as usual.

Dividends from both stocks and mutual funds are tax-exempt in the hands of the investor. The corporate distributing the dividends needs to incur the dividend tax, of course.

And on Capital Gains, there is even better news. Currently, capital gains from any stock/MF investment held for more than a year (12 months) from date of purchase, is completely tax-exempt again. Capital gains from anything sold within a year is subject to a short-term capital gains tax of 15%.

So the tax structure in India, incentivises you to invest in stocks and mutual funds for the medium to long term and avoid the very short-term.

Life Cycle Investing

As you progress from early career to mid career and acquire more assets and become more financially secure, your risk tolerance may undergo changes. Form a purely growth and capital building requirement, your needs may change to capital preservation. For some part (or a major part) of your investment portfolio you may turn "defensive" and may want to preserve capital first?

Similarly as you grow older and approach retirement your time horizon may shift - you may opt for a mix of short, medium and long term horizon instruments.

We have tried to show an instance of how your investing profile may undergo changes as you go through different life cycle stages. Investment profiles are highly individual. Your own individual profile may be very different from this at any stage. Or, your investment profile may match one of the stages shown here - early retirement for example - but you may be at a different life cycle stage yourself, such as early career.

You need to achive a balance between the risks you are willing to take and the returns you require to achive your financial goals. If you have understood the different aspects of your individual profile well, then you are in a position to assess that proper balance, and create an effective investment portfolio.

Well there, if you are done with your investment profile, get ready to move on to the next step - Where to Invest: Asset allocation - maximising return and minimising risk, by matching your investment profile with the characteristics of individual asset categories.

How to Invest? - Part I

How to invest: the basic principles

Now that you have figured out why investing is a smart thing to do,
let's move on to – how to invest.

For a beginner investor its tough not to get overwhelmed -
market publications and websites are full of 5-star rated Mutual Funds, ULIPs that promise the best of insurance and investment (but actually isn't), the lure of momentum stocks that everyone at office seems to be making a quick buck on - hell, just how and where does one start?

Relax. This 2 part series, on how to invest, will make life simpler.

First you will need to understand the relationship between risk and return, and the associated trade-offs between the two. Next you will learn established ways of mitigating such risks.

Equally important is to understand how your individual circumstances affect your investment decisions. Your tolerance for risk (can you stomach a 10% temporary loss), your return requirements (are you investing towards buying a house, or you need some regular monthly income), your investment horizon (the time you can remain invested), as also your tax status will impact decisions on what kinds of investments to go for, and what to avoid.

The 2nd part of this series - how to invest: Your individual investment profile, will address that.

So much for an overall picture on the how to invest decision making process. Let's get started on the details.

First things first

Before we get going on return and risk principles and how to invest, we will first need to talk a little bit on how to structure your financial life to make it possible to invest.

When you start investing you must do so with a clean slate. There's no point in trying to save while you have high-interest credit card or personal loan debts accumulating by the day. Sure, some kind of debts can be low-interest or useful for tax-saving purposes such as your housing-loan. But you will be well-advised to get ready to close off your high interest debts, before you start thinking on how to invest.

Next get into the habit of forced saving. You pay bills every month - electricity, to mobile to cable bills, right. Just add yourself at the top of the list. Every month as you get your salary credited to you account, set aside a sum to save or invest. Start with a minimum of 20%. The more you save, the more wealth you can create. Even a few rupees saved now will do more than lots of rupees saved later!

Understanding Return and Risk

At the core, understanding how to invest is all about returns and risk. Return is measured by how much one's money has grown over the investment period. Returns are not known in advance. Instead, you can only make an educated guess as to what kind of return to expect.

Expecting a return of 25% just because your stock-investing friend say's that's what you will make may be unreasonable. Most expectations are based on what's happened in the past. Unfortunately history doesnt always repeat itself! We have all seen the highs of 2007, followed by the lows in 2008, haven't we?

However we can draw reasonable conclusions about future returns by looking at longer-term data - 5yr and 10yr records - ofcourse with the express understanding that these returns are not guaranteed.

Even if your return expectations are reasonable, there is the possibility that your actual returns turn out different than expected. You run the risk of losing some or all of your original investment.

Why is that? Because of an uncertain future ( e.g. global economic environment), uncertainity over the quality and stability of investment, and some other uncertainities. In general, greater the uncertainity, greater the risk. Some common sources of uncertainity or risks that we must absorb, while we learn how to invest, are:

Business and Industry Risk
There might be a industry-wide slowdown, or even a global economic recession as we are experiencing now. That presents an uncertain future for any business, isn't it. Or the business might see its earnings dropping significantly say, due to management ineptitude/wrong decisions. The lower earnings (due to any of the above) may cause the companys stock to fall.

Inflation Risk
The money you earn today is always worth more than the same amount of money at a future date. This is because goods and services usually cost more in the future, due to inflation. So its important that your investment return beats the inflation rate. If it merely keeps pace with inflation then your investment return is not worth much. We have seen inflation soaring upto 11% in 2008, now in 2009 its at 1 or 2% levels. Perhaps an average inflation rate over next 10 years may work out at 5-6%. Who knows, there's enough uncertainity here too.

Market Risk
Market Risk is about the uncertainity faced in the stock market. Several macro and micro economic details singularly or plurally can spook the market. We have seen how the massive mandate in elections 2009 has re-invigorated the market. On the other hand, A fragmented hung parliament may have caused the market to nosedive? Even for a well-managed business growing profitably, its stock may drop in value simply because the overall stock market has fallen.

Liquidity Risk
Sometimes you are not able to get out of your investment conveniently, and at a reasonable price. For example in 2008, you may have found it tough to sell your house at a price you wanted. In 2007 however you could have gone laughing to the bank. The market may simply be inactive or it may be just volatile - and that means you cant sell your investment or get the price you want, if you needed to sell immediately.

Now here comes an important takeway in learning how to invest - understanding the risks associated with different asset classes.

The degree of risk varies widely between asset classes and even among investment options in a asset class. We all appreciate that a govt-backed bond like a NSC or PPF scheme is safer than that offered by a reputed corporate. Next consider inflation risk - stocks face far lesser inflation risk than bonds. While bonds have managed to just keep pace with inflation, stocks have historically outpaced inflation, by some 10% annually on an average in India. However short-term bonds and money market investments face very little liquidity risk, while stocks face relatively greater liquidity risk.

The risk return trade-off

The next important takeaway in learning how to invest, is understanding risk/return analysis or trade-offs. Every investor would want the highest possible return for the level of risk (uncertainity) that he is willing to accept. In a competitive marketplace, this results in a trade-off. Low-risk investments naturally are associated with low potential returns and high-risk investments with high potential returns.

If we look at long term returns, stocks in India have historically produced returns that average 15% annually, while bonds have averaged 6-9% annually. This reflects the risk/return trade-off.

Its important to remember that this is on an average for the asset class. Specific investment options may produce far higher or lower returns. For example an investment in ITC for the last 15 years has provided returns in excess of 30% annually. It's useful to remember that the risk is in the uncertainity. If you can evaluate a stock investment and weigh the potential returns with the uncertainities (or, relative lack of uncertainity) vis-a-vis another stock investment, you stand to gain tremendously from these trade-offs too!

There's another useful service these risk/return trade-offs serve. They flag off highly risky investments. Any scheme advertising high potential returns usually flags high risk, even though the risks may not be apparent at first glance. For example, quite often we see Corporate Bonds offering far higher yields than usual (usually, from unknown companies), don't we - now that you know how to invest basics and the risk/return trade-offs, I am sure you will treat these with caution and a healthy dose of skepticism!

Diversification: Mitigating Risks

Diversification is a strategy that can be neatly summed up by the timeless adage "Don't put all your eggs in one basket." We have learnt how to invest, is all about returns and risk principles. You will now probably look to invest in a stock only after analysing that you will be compensated well (for the risk you are taking by investing in the stock), from the stock's returns.

Now consider the scenario that you are invested in a single stock ABC Ltd. What happens if ABC Ltd. performs badly. You will not be compensated for the risk you have taken with the stock. Now consider the other scenario when you are invested in a portfolio of 10 stocks - ABC Ltd. and 9 other unrelated stocks. What happens again if ABC Ltd. performs badly? Your total returns are not hurt as badly, right. You have mitigated the business risk substantially by diversifying your investment among 10 different stocks!

The return of ABC Ltd. remains the same, please note. Also note that, each stock's return is affected by different factors (say the stocks belonged to different sectors -telecom, Banking, Steel,etc.) and they face different risks. So its important to invest across different categories or stocks - to diversify and reduce risks substantially.

We have seen before that different asset categories - stocks, fixed-income and money market investments -face varying degree of risks w.r.t. liquidity, inflation and market risks. So it makes sense that you should diversify across these major investment categories. Diversification within an asset category such as stocks (across sectors and large-cap, mid-cap, blue-chip stocks) and even fixed-income products (long term bonds, money market funds) will further reduce market and inflation risks. And we have already seen business risk can be mitigated by diversifying across a portfolio of unrelated stocks.

Now don't go overboard and over-diversify (say across 100 stocks). You run the over-diversification risk then! There are bound to be pockets of similarity, the incremental risk mitigation will be minimal. And you lose the benefits of stock concentration (as opposed to diversification) - but that's another discussion and let's leave it for another article.

As a senior investor once put to me: Invert the logic. If you do not diversify, you are putting all your eggs in one basket, and are taking on too much of a risk; it's likely you will not get compensated for it, by your returns.

Time Diversification

There is another important how to invest mechanism through which we can mitigate risks substantially - remain invested for a longer time and across different market cycles. Let's say you invested in 2006 and 2007 in the Indian stock market. If you had to withdraw money anytime in 2008, you would have incurred substantial losses. However if you remained invested through 2008 till now you would have pared your losses significantly and even made gains in some. This works even better across longer time-periods of 5 years to 10 years.

This is diversification over time and it ensures that you avoid the worst periods of economic cycles. Time diversification is especially useful for highly volatile investment categories such as stocks, where prices can fluctuate over the short term. Staying invested over longer term smoothes these fluctuations.

Which brings us to another important how to invest takeway. If you cannot remain invested in (volatile) stock investments for relatively long time periods, you should avoid such investments. Obviously time diversification is less important for relatively stable investments such as bonds, Money market investments and fixed deposits.

Another senior investor time diversification tip: It is always better to invest or withdraw large sums of money gradually over time, instead of bulk investment or withdrawl. Use time diversification to average out costs/gains and reduce risks.

How to invest: is the foundation strong?

Let's try and ensure that you truly absorb the how to invest principles of return and risk. Your investing success depends on how strong this foundation is.

1. Returns are not known in advance. So, you must make your investment decision using return expectations that are reasonable and mesh with reality

2. Your actual return may not meet your expectations. Be aware of that possibility while making all investments

3. Risk comes from the uncertainty surrounding the actual outcome of your investment; greater the uncertainty, greater the risk

4. Business or industry risk, inflation risk, liquidity risk, and market risk - these are the major sources of risk. All investments face each of these risks, but to varying degrees

5. There is a trade-off between risk and potential return: higher the potential returns, greater the risk; lower the potential returns, lower the risks. Be wary of claims of high returns, there may be hidden risks

6. These risks can be reduced significantly through diversification. Always diversify across asset categories (stocks, bonds,money market instruments), within asset categories, and across individual securities

7. Diversification is also important across market environments — the longer your holding period, the better. Do not invest in volatile investments like stocks if you cannot remain invested for atleast three to five years

Why Invest at all?

Why invest? This came to me sometime in late 2004/early 2005 as I strongly felt the need for making my money work better for me. We were blessed with twin daughters, and full of hopes and dreams.

I was transforming to become more financially responsible and aware. No one needed to educate me on why invest, as I suddenly realised that to achieve these dreams, I needed to shed a bit of my happy-go-lucky attitude and set longer term financial goals. And to achieve these financial goals, I needed to invest!

Investing to me, is focused primarily on making my own money (work harder, and) make more money for me. It is clearly about long term financial goals. As I started reading up and thinking more about building long-term capital, certain simple why invest basics became very very clear to me.

Time Value of Money

Like most things in life, the early bird catches the worm! I understood I was already late into the game. Realised I could never play catch up - even if I doubled the stakes - compared to having started just 10 years earlier.

Consider the graphic below. Suppose you start early at age 20, invest Rs.20,000 yearly for 10 years in a safe government-backed instrument like PPF (Public Provident Fund) and forget about it-just let it lie in the bank till retirement. And somone who wakes up somewhat later in life, at age 31, and starts investing double that amount Rs.40,000 every year for 30 years, till he reaches the age of 60.

At age 60 You, the Early Starter would have invested just Rs. 200,000 and seen your investment grow to ~Rs. 3.4 million, and seen a return of 16x. Someone like me who woke up later, will have invested a not inconsiderable Rs. 1.2 miliion, but seen only a 3x return!

Wished I could start the game all over again? You bet, I did! Understood perfectly this aspect of time value of money or what is also called the power of compounding. The longer your money remains invested, the better it works for You! Why Invest, became a no-brainer.

By now my mind had started ticking! Hey wait, what if I could make my money work just a bit faster?

Compounding at different rates

It appeared to me now hey, there are other financial instruments too. If I can make my own money work just a bit harder and faster, perhaps I could play catch up? Lets see how the figures stack up.



Now this was getting interesting. Compounding at just 2 percent more per year every year for next 20 years made for a sizeable 44 percent difference in overall returns. And over 40 years the 2 percent difference more than doubled the returns! Why Invest, indeed!

Now I had learnt my math in school, and knew this is due to the power of compounding! But had I ever worked figures through like this? The miracle of the power of compounding ensures that our investment makes money and the return on that investment makes some more money - keep it that way for a number of years and our investment quickly starts exploding. The more the time our money remains invested and/or earns a higher return, the higher the trajectory of our returns graph.

The Thumb Rule of 72

How long will it take to double my money? From a why invest novice, someone was getting greedier here!

The Thumb rule of 72 comes in handy here. Just divide 72 by the interest rate and you have the number of years it takes to double your money, roughly. So if we are getting a 8% interest rate, it will take 9 years. And at a 15% rate, your money doubles in roughly 5 years. Use a calculator, or an excel worksheet to Test this! Its an amazing thumb rule to keep in your head.

So the next time an agent comes to you, preaches why invest, and talks about doubling your money in 10 years, you know that it means compunding at a rate of 7.2% only. And that you have better options. On the other hand if he is promising the moon, you know how to bring him down to earth with some quick incisive queries.

There are a few other considerations too. Many instruments are subject to tax, while some are not. You might be getting a nice 9% annual return on say your fixed deposit, but what is your effective post-tax return? And there is the bigger factor of inflation -none of us could have missed the high inflation figures cited by the government in 2008 - so what happens to your real rate of return? Post-tax return minus inflation? You don't need more pointers on why invest, do you?

Different Investment Options

Now that I was better informed on the why invest proposition, I decided to find out more about the common investment options available to us in India, the pros and cons, taxability, risk and typical return levels associated with each instrument.

Certificates of Deposits

These are short-to-medium-term interest bearing, debt instruments offered by banks. And are low-risk, low-return instruments. There is usually an early withdrawal penalty. Fixed deposits, recurring deposits etc. are some of these.

Average rate of return is usually between 5-9%, depending on duration/instrument. Returns are taxable.

Bonds

These are fixed income (debt) instruments issued for a period of more than one year with the purpose of raising capital. The central or state government, corporations and similar institutions sell bonds. A bond is generally a promise to repay the principal along with fixed rate of interest on a specified maturity date.

The average rate of return on bonds and securities in India has been around 10-12% p.a. Returns are taxable.

Public Provident Fund (PPF)

One of the best instruments available. Must have in your investment portfolio. Scheme can be opened with SBI, leading Pvt. Banks, and Post offices. This is a long term investment vehicle with a term 15 years. Max deposit in a year Rs. 70,000 with the current rate of return fixed at 8%. It's a good idea to first max this Rs. 70,000 limit every year before putting surplus money into other investments.

Why? For one, because of the longer term you can unleash the miracle power of compunding to good effect here. Besides its a tax saving instrument, completely safe, risk-free government guaranteed instrument. Returns too are currently, tax free.

Stocks

Investment in shares of companies, is investing in Stocks. Stocks can be bought/sold from the exchanges (secondary market) or via IPOs – Initial Public Offerings (primary market).

However unlike Bonds or Certificate of Deposits, investing in stocks isn't risk free. The market returns over the long term is dependent on the company's business performance - after all buying a share is a part ownership in the company! If you are going to trust your investment with a company for the longer term, you need to be reasonably sure the company will stay in business for next 10-15 years, and profitably! Investing in shares is not for everyone, requires hard work, a lot of discipline and patience to make a success of it. Else all the analysts would be sitting at home and rolling in the moolah, right!

Having said that, history shows us that investment in quality stocks have proven to be the ideal long term investment. On an average an investment in stocks in India has provided returns of 15-25% p.a. over the medium to long term. Dividend Income and Long Term Capital gains (>1 year) in India are currently, tax free.

Mutual Funds

These are open and close ended funds operated by an investment company which raises money from the public and invests in a group of assets, based on a published set of objectives.

Investing in Mutual Funds provide benefits of diversification (investments spread over a larger number of stocks and thus lesser risk)and professional money management -they have the team of researchers and analysts to pick the best stocks for you.

The rate of return again is market-performance related; generally substantially more than what is earned in fixed deposits. Each mutual fund has a rate of return dependent on how well its stock-picks have performed in the market.

Good Mutual funds in India have given a return of 15–20% p.a. over the long term. Dividend Income and Long Term Capital gains (>1 year) in India are currently, tax free.

Others

There are also other savings and investment vehicles such as gold, real estate, commodities, art and crafts, antiques, foreign currency etc., which too can be considered.

Wealth Creation studies in India

Finally as I dug in more on the why invest case, I was lucky to come across the extensive
Wealth Creation studies conducted and documented by Motilal Oswal on the most consistent wealth creators in India.

That was an eye opener for me as I learnt how some of the best and trusted names in India have delivered more than 30% compounded returns annually (with all dividends re-invested), over the last 15 years and more. Names like HDFC, Infosys, ITC figure here - but more on that, later.

Using the thumb rule, I knew a 30% compounding rate means doubling the money in 2.4 years. Amazing. I was even more astounded when I used the excel sheet to work out that with 30% compounding, an investment of Rs. 20,000 in ITC 15 years back and left untouched, would have grown to Rs. 1.02 million, or grown over 51 times! Why Invest I asked no more, I became a convert.

As I digested this better, I resolved to gift my wife 100 ITC shares, for her next birthday. To her credit, she didn't quiz me on why invest! But you are, I know, I know ...there are no gurantees, but what the heck, that smokers will keep smoking is a good enough bet, or what?

Well that's the run-down on some important basic why invest realisations that convinced me why I should invest and made me a committed long-term investor. Hope, it is equally convincing for you too.