What is Debt and Equity

Posted on March 6, 2011 by Ranjan

When we talk about asset allocation and selecting financial products, we also need to understand the difference between the two broad classification of financial products: Debt and Equity.

(Note: This is a very basic concept and I talk about this when I speak to students. It is a part of the Rupee101 series which is about first steps. So if you are an advanced user, please excuse!)

The basic difference between debt and equity would be the ownership level. Let’s take an example where you invest in me.

If you give out some money to me and expect that I return the money along with interest that I pre promise, that would be a debt investment. I’m indebted to you but since I have promised you a return with interest, you don’t actually own me.

In another case, you give me money at your own risk. But you trust me/hope that I’ll be a billionaire in the future and I’ll payback from my profits. The more profits I make, the more you do. If I am bankrupt, you don’t get anything back. And so you have invested in my equity. By trusting me, you own me in a way!

In other words, by investing in a debt instrument such as a bond, you are guaranteed the principal of the bond, plus any interest that is owing.

However, for equity investors, you become an owner. As such, you also take on the risk of the company not being a success. Just as a small business owner has no guarantee of success with each new venture, neither is a shareholder. As a shareholder, if the company is successful, you stand to make a lot of money. On the flipside, you stand to lose a lot of money if the company is less than successful.

Now debt and equity is just a classification of financial products and not a product by itself. So let me share the products available within the two classifications:

Equity: You can own any stock on the Stock Exchanges and you have invested in an equity product. If you invest through Mutual Funds who have schemes for equity. Even ULIPs invest in equity and so part of your Insurance buy goes to equity. The NPS also invests in equity.

Shares come in different sizes and categories. There are large, mid and small caps and there are penny stocks. As a beginner, you can invest in large and mid cap companies and only after you gain experience, you can consider investing a small portion in small caps and hot penny stocks. These are the riskiest but if handled adroitly, give the largest returns. However, it needs expertise and nerves of steel.

Debt: Mutual Funds also have debt funds where you can invest. Some people may find investing in bonds simpler than investing in stocks. Your friendly neighbourhood financial advisor can provide you with government bonds like NSC/KVP. Your banker provides you with Fixed Deposits and PPF accounts. You can also pick up some highly rated corporate bonds.

Then there are hybrid funds where the Mutual Funds invest a part in equity and a part in debt.

To compare debt and equity, you need to consider the risk and the reward tradeoff. But that I guess would be another post.

However, this understanding of debt and equity can help you understand the Hare and Tortoise story in a better way, where the debt products are tortoise and equity products are hares!

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The Magic of Compounding

Posted on December 20, 2010 by Ranjan

It is one thing to know theoretically about the difference between simple and compounding interest. It’s another thing to see an example.

I think it makes a much more impact to look at the following example instead of reading about the magic of compounding. Do you agree/disagree?

• Age 25, Invest Rs 2000 p.m. till age 60

• Asset @ 10% growth is Rs 65 lacs

• Age 30, Invest Rs 2000 p.m. till age 60

• Asset @ 10% growth is Rs 39.5 lacs

Difference: Rs 25.5 lacs

• Investment difference only Rs 1.2 lacs

Does it tell something about the power of compounding? How would you explain the magic of compounding?

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Investors Role in Building India

Posted on October 23, 2010 by Ranjan

Today, I spoke at the National Research Conference organized by Mumbai School of Business on the headline topic. I spoke on behalf of CGSI (Consumer Guidance Society of India).

The theme of the conference was “India Redined: Strategy for a Facelift” and had eminent speakers like Krishnan Khanna, Ravi Kumar (Director, KennisGroup), Amit Kapoor (SEBI).

I made the following points in my talk (Powerpoint free talk )

Started off with three questions 1. Do individual investors have a role? 2. What is the current situation and 3. How do we actually “Do It”?
While the Government and the business entities are “deficit economic units”, the individual is the surplus economic unit.
The surplus of the individual is channelised as savings and investment to the Government and business.
I interpreted Insurance as a protection against unemployment of the entire family. For example, if I die, the income of my dependents also stop and they become “Unemployed” which drags back the economy.
Investments in stocks and mutual funds channelize our savings into the business entities and thereby helping the economy.
Covering the present situation as part of question 2, I referred to the NCAER study which shows that:
- Even when 97% said that we must save, if chief earner expires, only 9% can survive more than 1 year upon the death of the chief earner.
- Even when 83% said that Health insurance is important, only 3% can manage as per their current planning.
- Even when 69% said pension planning is important, only 2% said they can manage as per their current planning.
- Even when 47% said growth is important, only 19% said that they are managing it well.
Coming to question 3 (how do we do it?), I outlined a 3 step action plan.
- Measure before you start managing it.
- Measure your assets and responsibilities.
- Measure your risk profile
- Measure your income and expenses and be aware of where’s it going.
- Search, Compare, Filter by using tools like the internet, consumer societies, forums.
- Take Action. Set Up Your Investments and Financial security.

I was the last speaker before lunch and we were running late. So I suspect that the applause was elaborate because I finished in 35 minutes and did not stand between my audience and their lunch!

Yes, I enjoyed giving the talk.

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How to set up your financial freedom?

Posted on August 11, 2010 by Ranjan

As we celebrate another Independence Day, let’s take a look at setting up your financial freedom. The following article was published in Jetlite’s in house magazine Flylite.

Freedom is being free of restraints and means having liberty from slavery, detention, or oppression. So, Financial Freedom would entail being free of money worries, to be free from working under oppression for money. Sounds interesting? Or does it look like too difficult thing to do? Does it look to be a utopian idea? The good news is that it can be achieved. Read on for the details.

It important to remember that freedom does not come for free and does not mean doing whatever we like. The fact is, Freedom is earned and freedom comes with responsibility.
Financial Freedom: Financial freedom comes when you’ve built a capital so that the interest earned from this capital takes care of your expenses when you decide to retire. We shall keep our discussions limited to managing our money. And managing money has three important components too.
1. Investing, to get more bang for your money.
2. Maximizing your income, to control the game of money.
3. Frugality, to save and not leak money.
So, personal finance is not just about investing. It’s also about optimizing your expenses as well as maximizing your income. In this article, we will focus on building the capital required for your financial freedom.

The situation: There are more than 300 life insurance schemes, numerous health insurance schemes, over 1000 Mutual Fund schemes, 2500+ stock scrips to choose from. Then there are 100+ deposit schemes with Banks, Corporates and the Government itself.
Wouldn’t it be a good idea to bring down the choice galore to a maximum of 20 products to choose from? Can’t this group of 20 products be the best in class and stands validated through a reasonable thought process?

Setting up your investments: The answer, to my mind, is yes! Read the following 7 points that gives you a set of 20 products to choose from for your investments.

Before we go on to investing our money, it’s a good idea to take a bit of cover. Let’s start with the emergency fund.

1. Emergency Fund: Keep an amount of three times your monthly expenses in your Bank in a Savings Account.

2. Insurance: Many of you who are just started having an income, are single wouldn’t really need insurance now. But some of you who have started a family need to get a cover. Trying to find how much insurance do you need from the internet will throw multiple calculations and options. Each one of them have their own logic. A simple thumb rule for me is to get insurance worth 60 times your monthly expenses. Not 60 times your gross monthly salary, mind you. Insurance is for taking cover, not profiting out of it.
You also need to get health insurance. A group health insurance privided by your company should be enough. If not, start with a mediclaim policy with one of the General Insurers.
To start investing, you need to first exhaust your tax planning options.

3. Tax Savers: Apart from the PF that might be deducted from your salary, getting a PPF account is a good idea. Plus you might go for equity linked tax saver Mutual Fund schemes. HDFC Tax Saver, SBI Magnum Taxgain, Sundaram BNP Paribas Tax Saver, Franklin India Tax shield and Sahara Tax Gain have given a return of 20%+ over the last 5 years.
From the money left after taking a cover and exhausting your tax planning options is available for investment.

4. New Pension Scheme (NPS): NPS is THE best & effective tool that covers capital protection and also provides growth for your retirement plans. With its lowest charges, it also is the cheapest way to get an exposure to the market. Despite being such a fabulous product, there’s not much sales to boast. This is because there’s no commission for an agent there. Infact getting a PRAN (Permanent Retirement Account Number) under NPS is not easy.

5. ETFs: This Pdf will tell you why ETFs are the best. Nifty Index ETFs which benchmark the Nifty that are available in India are NiftyBEES, KotakNifty, UTISunder, .QNifty

6. Equity Diversified/ Balanced Mutual Funds At a young age, you can take more risks and I will not ask you to invest in debt funds. A few Equity funds that I like are HDFC Top 200, Franklin India BlueChip, Sundaram Select and SBI Magnum Global fund. But to get a bit of diversification in your portfolio, I will recommend investing in a few balanced funds. Balanced funds have exposure to both equity and debt and their fund managers take a call on when to focus on equity or debt. HDFC Prudence, DSP Blackrock Balanced, Birla Sunlife 95, Tata Balanced are balanced funds which have done well. In fact some of them are at par with Equity Funds!

7. Gold ETF: Gold has been outperforming the equities for the last decade!. Looks like it’s on a dream run. For diversification purpose, investing 5-10% of your money in Gold ETF isn’t a bad idea. Gold ETF is seeing the highest turnover these days and there are a lot of players which are offering Gold ETF these days.
To set up your financial freedom, we have shortlisted a set of 20 odd products out of 5000+ financial products. Does it help you get started?

Advantages of the set up recommendations:

It tunes out the noise of the market place which is worse than the fish market.

It takes care of Diversification, Rupee Cost Averaging, Asset Allocation principles, Magic of Compounding and all principles and theory of investing.

It also gets you real bang for every Rupee at a very low cost.
Disadvantages: It’s boring and non-happening. More like a Cricket Test match when it’s the age of Twenty-20.
But the question is, do you need an audience for your finances? Or do you need to perform in front/for the benefit of others? Remember, it’s “personal” finance.

And once you set it up, you can forget about it and focus your life on more happening things! Yes, you have earned your financial freedom! And it is also the time when you become more responsible. And being responsible is easy. Just stick to the plan!

Yes, Freedom is earned and freedom comes with responsibility.

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Rupee101: Setting Financial Goals

Posted on October 10, 2009 by Ranjan

Setting a financial goal is the first step to achieving your financial objectives and creating a sustainable spending plan. That’s why, we are starting with this topic on our Rupee101 series.

Happy, Lucky and Chintamani (Who are they?) have come to Agra. It has been a long planned getaway for the three of them, along with Happy’s and Chintamani’s family.

During the journey, Happy told Chintamani that he wanted to start investing.

Chintamani: So, what are your goals?

Happy: Goals? I just want to invest my money, that’s all.

Chintamani: Let’s say you want to go to Agra. Like we are going. That’s like investing. But there are a whole lot of things that has to be done before you go to Agra.

Happy: Like?

Lucky: Arre, you need to decide you want to go to Agra first. And not to Timbucktoo!

Chintamani: Yes. And there are things like tickets, packing, arranging money for food, Booking hotels for stay, etc.

Happy: Ya, I got it. Okay, but how do I decide my financial goals?

$\Trip to Agra\$

SMART Goals

Goal setting is your map to reaching your financial dreams. Questions to ask yourself are:
Where do you want to go?
What is your vision for the future?
What would you do with your money if you didn’t have bills to pay or debt to extinguish?

Dreaming is a big part of goal setting. Let your imagination go wild: what would you like your financial future to look like?

But do remember to keep it SMART. SMART stands for Specific, Measurable, Attainable, Realistic, and Timeline

Needs and Wants

Before spending money on a goal, think about how important it is and whether it’s a want or a need. Ask yourself:

Why do I want this?
Do I really need this?
What is most important right now?

Taking Care of a Few Things

Having decided your financial goals is a very educative affair. It teaches you a lot about yourself and your own life. Having done that, a few things are worth taking note of. They are:

1. The time frame for your goals can be broadly classified into short term and long term goals. You may have a intermediate goal for say, 5-6 years, too.

2. If you find that after all of your planning and goal setting, your dream isn’t attainable as is? Does that mean you scrap the whole dream and move on to the next item on the list? Maybe! But there might also be another solution for you: consider “stepping down” your dream.

The Step-Down goal allows you to achieve a version of your dream. It may not be the exact goal you had in mind, but it will get you to the similar destination.

For example, if you want to go to Las Vegas, the step down goal would be to go to Goa and have fun.

Does this help you with setting your own financial goals? Let me know how I can improve this post and the series on Rupee101.

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Happy, Lucky & Chintamani And Rupee101

Posted on October 8, 2009 by Ranjan

Meet Happy, Lucky and Chintamani.

$\Happy_Lucky_Chintamani\$

Gururaj Singh (Happy), Sunil Pandey (Lucky) and Mani Iyer (ChintaMani) are unlikely of friends. The three of them were born decade/s after each other and have very different occupations and lifestyles. But still they are very good friends. How? We will tell you, but a bit of each one of them first.

Happy is 33 years old and runs a small business. Happy lives in a rented place with his vivacious wife and two small kids. This Sardar loves his Patiala peg and takes life as it comes. He has a gut instinct of managing his money and though he doesn’t understand the number crunching & jargons, he is fairly comfortable with his own money management skills. And he wants to take his business to the next level.

Lucky is just 24 and has joined a MBA course. His parents doubt that he will complete the two year course. Though he starts everything with a lot of enthusiasm, he gets bored with it very soon. He has dabbled with so many ideas and has left them midway all too soon. He has worked in Call Centers, started some trading activities, day traded stocks and commodities. Lucky thinks he’ll get lucky and gets restless at the waiting.

ChintaMani is 42. He is employed by a leading Bank and stays at their staff quarters along with his wife and two children, a 14 yr old daughter and a 10 year old son. Savings has been in his genes as his parents saved everything they could lay their hands on. From their salary to every nut & bolts used in the house. ChintaMani is progressive and wants to move ahead from just savings to a few investments. Right now, he is confused between two themes: One, “you can’t teach an old dog new tricks” and two, “learning never stops”.

Now you’re curious that how such different people can become friends. Neighbours? No, they were not even neighbours. There’s a clue above.

All of them wanted better control of their money. And they thought that some education was required. So they joined an Executive MBA course together. And they ended up being in the same class and group. Normally the group of students working on project assignments given by the Faculty keeps on changing. But the three guys begged, cajoled the Faculty to keep them in the same group.

And now they are buddy friends. We bring to you the uncensored version of the discussions between Happy, Lucky and ChintaMani. Some of it may be on Rupee101!

Rupee101 would be a series of posts on managing your rupee. It will cover the basics of setting financial goals, savings, tracking expenses, budgeting and ofcourse, investing.

Stay tuned. Do you have your own wish list for me? Tell me in the comments below.

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