What to do when the stock market is bearish and volatile?

When stock markets are bearish and volatile, small investors feel anxious and unsure of what to do. Activity, innovation and endeavour are useful in business and employment – but they detract from wealth building. One has to be passive, dispassionate and patient to be able to make correct investment decisions when there is chaos and bad news flying around.

Having a financial plan with clear goals, and an asset allocation plan to meet those goals, helps investors to remain calm and resolute under adverse conditions. A proper asset allocation plan should include an equity component, a fixed income/debt component, a small allocation to gold and some cash. If you don’t have a plan yet, the time to start is now.

The equity component can comprise equity funds, balanced funds, index funds, sectoral funds, company stocks or any combination of these – depending on an investors risk tolerance and investing skills. The debt component can comprise PPF, Post Office MIS and other small savings schemes, bank fixed deposits, debt funds or any combination of these – depending on an investor’s risk tolerance and tax bracket.

The importance of the tax bracket should be remembered in choosing the constituents of the debt component. PPF (Public Provident Fund) scheme is available at post offices and banks. It allows an investment of a minimum of Rs 500 upto a maximum of Rs 1 Lakh per year. The entire investment is tax free under Section 80(C) of the Income Tax act. The dividends (around 8.5% per annum) are also tax free. For small investors, it makes sense to utilise the PPF avenue to the limit. The holding period is 15 years – which allows compound interest to work its miracle. Part withdrawals are permitted after 5 years. Investment can be extended beyond 15 years.

Interest on Post Office small savings schemes (7-8% per annum) and bank fixed deposits (8-9% per annum) are taxable. The tax will depend on an individual’s tax bracket. Rs 9000 earned on a Rs 1 Lakh bank fixed deposit will entail a tax of Rs 900/1800/2700 for tax bracket of 10/20/30%. So, the effective return will be 8.1/7.2/6.3% after tax instead of 9%.

For those in the highest tax bracket, and even for others, investment in debt funds – particularly gilt funds – is advisable. Gilt funds mainly invest in government securities, so there is negligible chance of shrinkage in the principle amount invested. Dividends are not taxable in the hands of investors, but the funds pay a dividend tax. Tax is payable at the time of withdrawal and is treated as short-term (for holdings of 1 year or less) or long-term (for holdings beyond 1 year) capital gains tax. Indexation is allowed for long-term capital gains, which can be a great advantage for long period of holding.

Another benefit of a gilt fund over a Post Office/bank fixed deposit is that you can add to or withdraw from your holdings at any time. A couple of gilt funds – IDFC GSF PF regular and Kotak Gilt Investment regular, which gave 12.5% and 14.2% returns over the past 12 months – beat fixed deposit returns comfortably. They may not do so in future, but the Kotak fund has given 10.35% returns since its launch in Dec 1998.

The importance of an asset allocation plan can’t be emphasised more. The most common query received from investors is: “Is this a good time to start buying?” The answer should be provided by the individual investor’s asset allocation plan – not by me!

Retirement planning with the Public Provident Fund (PPF)

With the 50 bps cut in the repo and reverse repo rates announced by the RBI, fixed deposit rates in banks are likely to get revised downwards soon. No one really looks at bank fixed deposits as part of retirement planning anyway, since there are no tax benefits on the principal or the accrued interest.

For those who have recently entered the work force – whether in a job or a business - retirement planning may not be the top priority right now. But it should be. That is the best way to let the magic of compound interest work in your favour. The sooner you start saving and the longer you stay invested, the more money you will accumulate.

In this month’s guest post, Nishit extols the virtues of investing regularly in the PPF scheme to help accumulate a tidy amount after retirement.

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Today we re-visit a very old, boring and vanilla investment instrument called the Public Provident Fund (PPF). PPF is a Government of India scheme which is deployed through PSU Banks, post offices and some of the Private Banks.

The money is safe as per the Sovereign guarantee and cannot be attached by anyone even if someone is declared bankrupt. The proceeds are tax free and the amount invested is also tax free.

The last year brought about two very important changes in the PPF scheme: (1) the investment limit was raised from Rs 70000 per year to Rs 1 lakh; (2) the rate of interest is floating linked to the 10 year Government bonds. PPF will carry about 0.25% more interest than the average yield of the G-Sec. G-Sec yield typically is in the range between 7.75 % and 9%. Accordingly the PF rates have gone up to 8.6% and 8.8% in the 2 years.

I have enclosed the chart of 10 year G-Sec over the past few years and for most of the times it is ruling around 8%. The government will be very careful in letting the interest rate of PPF drop below 8% since it is a very sensitive issue politically. Many of the middle class voting public of India invest in the PPF. For the sake of calculation I have taken the interest rate as 8.2%.

If one invests Rs 1 lakh (Rs 100,000) every year at the beginning of the year, after 20 years one will accumulate Rs 50 lakhs. Even if someone takes the interest rate as 8%, he will end up with Rs 49 lakhs.

PPF is definitely one of the pillars of investing for one’s retirement. The total amount becomes Rs 81 lakhs after 25 years. Now, taking into account inflation and the government dearness methodology Rs 100 after 25 years will be equivalent to Rs 500 today. So, you are left with a corpus equivalent to Rs 16 lakhs in today’s terms. That can provide a decent monthly income of Rs 12000 in today’s terms.

The other pillars of investment will be your equity portfolio and other savings. PPF is a simple, straightforward and tension-free way of preparing for one’s retirement.

The following table indicates the amounts accumulated after every five years:

Year	Amount invested at the beginning of the year (Rs)	Interest earned at the end of the year (Rs)	Total amount accumulated (Rs)
1	100,000	8,200	108,200
5	589,000	48,300	637,300
10	14,62,500	119,900	15,82,400
15	27,57,850	226,150	29,84,000
20	46,78,850	383,650	50,62,500
25	75,27,650	617,250	81,44,900

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Investment options in a bear market – a guest post

Both Sensex and Nifty indices have been sliding down in bear markets for the past 13 months. There doesn’t seem to be any signs of a recovery. In fact, the economic situation – both in India and abroad – seem to be heading from bad to worse. This is not the best time for investing in the stock market, because the market can fall much further.

What should investors do? Where can they park their savings and hope to get reasonable returns without undue risk? In this month’s guest post, Nishit discusses a few investment options that can provide decent returns without taking on too much risk.

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With the markets falling continuously, the question uppermost in people’s minds is where to invest their hard earned money? Let us explore a few options.

PPF investment limits have been increased from Rs 70,000 to Rs 1 lakh, and the interest rate has been increased to 8.6%. This is one of the safest options for investors and should be used first before looking at anything else. Next it is tax saving time and IDFC has come with Infrastructure bonds which provide tax saving on an additional Rs 20,000 over and above the 1 lakh cap under Section 80C. These bonds have an interest yield of 9%. If you are in the highest tax bracket you will save additional tax of Rs 6,000. Thus, in the month of December itself, additional avenues to invest Rs 50,000 are possible.

Gilt funds are a good place to be in. In the past 1 month, bond yields have fallen from 8.97% to 8.4%. Bond funds have given a return of 4.5%. Now, this performance will not be repeated every month but one may get an annualized return of about 15% in the next 2 years in gilt funds.

A slightly more sophisticated way of generating money in a falling market is writing call options of the Nifty against your portfolio. For example, Jan 5200 Nifty call is trading at Rs 32. The margin for writing 1 lot is around Rs 20,000. So, for 5 lots one would get an inflow of Rs 7,500 and the margin of 1 lakh would be blocked till Jan 25^th 2012. This is another safe way of generating steady returns in a bear market.

HDFC Top 200 is a very good equity fund where one can continue to do a SIP every month. This fund has yielded a return of 22% over the last 15 years. During this time, several bear and bull markets have come and gone.

The above mentioned are just a few avenues for putting in one’s money as per his or her risk appetite. Also, there is the safe bank fixed deposit giving very good returns for risk-averse investors. My advice for those not needing that cash in a hurry is to lock in the money for next 5 years for returns between 9-10%, depending on the bank.

Also, there is the L&T NCD trading on the NSE which has an expiry of about 7.5 years still and yield is about 10%. The benefit is one gets the interest credited twice to the bank account.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Investing strategies in inflationary times – a guest post

The business channels and pink papers have been obsessive about high inflation in the Indian economy and the consequent rise in interest rates – and well they should be. The government doesn’t seem too perturbed about the deleterious effect that high inflation causes – not just to GDP growth, but also to the wallets of common citizens.

During such times, savings and investments may be farthest from people’s minds as they struggle to make both ends meet. However, there are some comparatively less risky investment opportunities that smart investors can avail of – and Nishit discusses them in this month’s guest post.

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Inflation is rising, cost of loan repayments (EMIs) is going up and jobs are getting lost. How does a common man deal with such a situation?

Government bond yields have almost reached 9%. This means interest rates may rise further in the times to come. EMIs may go up if the RBI hikes the Repo rate, which is currently at 8.5%. In the case of loans, it is best to pre-pay some amount rather than letting the tenure increase. Many people will not get a tenure extension if their tenure has reached the maximum limit of about 25 years.

This is a good time to lock in your savings in high yield fixed investments. Non Convertible Debentures of L&T Finance gives an yield of about 10%. Other fixed income investments like Bank FDs should be utilized to avail of high interest rates. A SIP can be started in a Gilt fund. The interest rate cycle is about to peak soon and Gilt funds are likely to give good returns.

The recently increased limit in PPF investments from Rs 70,000 to Rs 1 lakh, and the higher rate of PPF return of 8.6% is a wonderful opportunity and should be made use of by small investors.

The markets are headed downwards. This scenario is likely to remain till interest rates start moving down. At every decline to key support levels, one can add blue chip shares to the portfolio keeping a 5 years horizon in mind. Supports for the Nifty are at 4700, 4300 and 3700.

Gold as an investment can be looked at only when the previous high of US $1900 per oz is taken out, or near the support level of US $1600 per oz.

For astute investors, cash is king. In a slow GDP growth environment, if one is willing to put down cash then real estate as well as automobiles may be available at good discounts. Plummeting car sales indicate that good cars may soon get sold at discounts just to clear off the inventory and keep the assembly lines working.

This is a great time for an investor to build an entire new portfolio. The portfolio should comprise of fixed income instruments, stocks, commodities and real estate. A proper balance of allocation to these assets will generate wealth going forward.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)