Calculating Effective Annual Rate ( EAR ) and Compounded Annual Growth Rate ( CAGR )
Accurate estimation of the return on investment is important to an investor. It not only gives him a clear picture of how his investments have fared, but also enables him to compare the returns of fundamentally different investment options available in the market. The EAR and CAGR are two of the most important concepts/calculators, which cover the investments with a fixed rate of return and those which do not grow at a constant rate and fluctuate widely over the holding period.
Effective annual rate (EAR) Continue reading →
Maximizing your returns using the increased PPF limit
The finance minister increased the maximum investment ceiling in PPF (Public Provident Fund) from Rs 1 Lakh to Rs 1.5 Lakhs per financial year in the last budget. This makes the already popular PPF more attractive. The PPF is one of the very few investment avenues which still enjoys the EEE benefit – the investment is exempt from tax and eligible for tax rebate, the interest is tax free, and the maturity amount too is tax free.
How is an NCD different from a company FD?
Shriram Transport Finance is coming out with an NCD issue next week, which is the latest in the series of the many NCD issues it has launched till date. Now, the same company – Shriram Transport Finance Company Ltd also offers public fixed deposits for subscription with interest rates similar to those of the NCDs. This post is in response to a query by one of my clients who already has invested in the company’s FDs and wanted to know the basic difference between an NCD and an FD.
How much risk should you take on your investments?
If you approach any financial advisor/planner for advice on where to invest your money, one of the first questions posed by them would be if you are comfortable investing in riskier avenues for better appreciation of your wealth. Some of the well established financial planning outfits would also have you fill up a risk profiling questionnaire asking questions like how would you react if you lose money on your investments etc. to find out how much risk you would be willing to take in order to get better returns on your investments. In other words, they are trying to understand your risk appetite.
Understanding the ‘Rupee Cost Averaging’ concept
Rupee Cost averaging is a term often used by mutual fund agents and financial planners to explain the benefits of systematic investment plans of equity mutual funds or investing a small sum regularly in a disciplined manner.
Let us see how this actually works with a simple illustration.
| Month | Investment Amount | NAV | No. of Units |
|
1 |
2000 |
10 |
200.00 |
|
2 |
2000 |
9.95 |
201.01 |
|
3 |
2000 |
9.73 |
205.55 |
|
4 |
2000 |
9.65 |
207.25 |
|
5 |
2000 |
9.5 |
210.53 |
|
6 |
2000 |
9.47 |
211.19 |
|
7 |
2000 |
10.05 |
199.00 |
|
8 |
2000 |
10.53 |
189.93 |
|
9 |
2000 |
10.21 |
195.89 |
|
10 |
2000 |
10.73 |
186.39 |
|
11 |
2000 |
11.07 |
180.67 |
|
12 |
2000 |
11.66 |
171.53 |
|
TOTAL |
24000 |
|
2358.94 |
Mr. Gupta invests Rs 2000/- per month for a year in a systematic investment plan of a new equity mutual fund by a leading fund house. The NAV (Net Asset Value or price per unit) is Rs 10 at the time of entry.
During the year the markets fluctuate as a result of which the NAV falls a little below the entry price for the first 6 months and then recovers in the second half of the year. The NAV at the end of the one year period is 11.80.
Current value of Mr. Gupta’s investment = No. of units * current NAV = 2358.94*11.80 = Rs. 27835.50
Average NAV or sale price per unit over the 12 months = 10.21
Average cost per unit = 24000/2358.94 = Rs. 10.17
How this approach benefited Mr. Gupta –
Though the market fluctuated during the 12 month investment period, Mr. Gupta accumulated more units when the prices were low and less units when the prices were high due to which the average cost per unit is lesser than the sale price per unit resulting in a profit.
This is Rupee Cost Averaging. Mr. Gupta made the market fluctuation work for him by eliminating guesswork and the risk of timing the markets by following the disciplined approach of investing a fixed amount periodically.
Common mistakes people make while investing
Starting late
The earlier you start, the better off you are. The advantages of starting early have been discussed in an earlier article last week. ( See “importance of starting early” Dt. 19th March 2012)
Starting your investments when you have substantial outstanding loans to pay
We tend to hold on to home loans, educational loans etc. because of the tax rebates they offer, but the high interest charged on these more nullify the effect of these rebates . It is advisable to keep part paying your loans whenever you have any surplus money. I have also come across people who regularly invest their income surplus, yet never pay their credit card dues in full and always have a revolving credit.
Thinking “Short Term”
Most people are reluctant to lock-in their savings for a long term and prefer lesser yielding short term investment avenues where they have the flexibility of withdrawing their capital at will.
Stagger your investments- money which you are likely to require in the near future should go in short term fixed income or debt schemes. The rest of it which you probably do not require for the next 3-5 years or more should be invested in riskier avenues where the longer term mitigates the risk and enhances the returns.
Playing it too safe
Many of us are risk averse and are happy keeping all our money invested in Fixed Income and Govt. bonds where we are reassured that our principal is safe , even though the rate of return is not very attractive. The consequence- after accounting for the high inflation and income taxes, the real rate of return is actually close to NIL or even negative!!
Depending upon what your age is, take exposure to the stock markets-either directly or through the mutual fund route. The lesser your age, higher the exposure should be, since you have the time to face all the market fluctuations and get rewarded over the long term.
Not investing anywhere
There is a small segment of people who are happy letting their surpluses lying in savings or linked fixed deposits and do not believe in complicating their life by first investing and then tracking their investments. After all, why take unnecessary risks when the returns are not even guaranteed??
A piece of advice for them…
Yes, there is no guarantee that the investments will do as well as expected. But one thing is guaranteed. If you choose to do NOTHING, you are not going to achieve your financial goals for sure!
Investment Basics : Importance of starting early
” The early bird catches the worm”.
All of us would have heard this famous proverb.When it comes to our personal investments,it cannot be more relevant.Let us see with an example, how important it is to start saving early.
Ram and Shyam are childhood friends aged 25.They have just finished their studies and started working.
Ram is conservative,thoughtful and meticulous by nature.On being advised by a professional financial planner,he starts investing Rs 1000 per month in a recommended Systematic Investment Plan.
Shyam too is keen on saving,but he decides to enjoy his new found financial independence for now and like most of us tend to do,decides to postpone his savings plans for sometime, till he settles down in his job and gets some financial stability.
At age 35 , he is impressed with the steady growth in Ram’s portfolio and starts investing Rs 2000/- per month (to make up for the lost time) in the same plan.
Let us see where both of them are at age 55.
Ram has saved Rs 1000/- per month for 30 years.Total amount invested is Rs 3.6 Lakhs
Shyam starts 10 years later, and has invested Rs 2000/- for 20 years.Total amount invested is Rs 4.8 Lakhs.
Assuming a conservative growth rate of 8 % p.a , this is how they have fared:
Ram : Current Investment Value : Rs 15.03 Lakhs
Shyam : Current Investment Value : Rs 11.84 Lakhs
Even after starting with the double the amount per month and investing 33 % more over time, Shyam’s investments are still 27 % lesser in value !! This is the power of compounding,which Ram benefited from due to an early start.
Conclusion : Remember the three mantras of investing :
Start early
Save regularly
Invest wisely
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