What is a good or bad gearing ratio?

A gearing ratio is a general classification describing a financial ratio that compares some form of owner equity (or capital) to funds borrowed by the company. Gearing is a measurement of a company's financial leverage, and the gearing ratio is one of the most popular methods of evaluating a company's financial fitness.

Though there are several variations, the most common ratio measures how much a company is funded by debt versus how much is financed by equity, often called the net gearing ratio. A high gearing ratio means the company has a larger proportion of debt versus equity. Conversely, a low gearing ratio means the company has a small proportion of debt versus equity.

Read more at:
https://www.investopedia.com/ask/answers/121814/what-good-gearing-ratio.asp

5 Reasons why FIIs may continue to sell Indian equities

The Indian stock market topped out in early Sept '16, and was going through what looked like a routine bull market correction when the bottom seemed to fall out on Nov 9 '16.

A 'double whammy' of Modi's announcement of demonetisation of Rs 500 and Rs 1000 bank notes and Trump's unexpected victory in the US Presidential elections created major panic in the market.

Those were triggers for increased selling by FIIs. Here are 5 reasons why they may continue to sell Indian equities for some more time:

1. FIIs were net sellers of Indian equity worth Rs 57.7 Billion during Oct '16 as Nifty's TTM P/E was in a range between 22.98 and 23.80 - well above its average valuation.

During Nov '16, Nifty's TTM P/E range has been slightly lower so far - between 21.19 and 23.31 - but still well above its average valuation.

2. US bond yields have moved up above 2.3%, and are expected to move up further to 2.6% or so. Why? Because of rising inflation expectations on prospects of Trump's pro-growth policies.

FIIs prefer the safety of US bonds to riskier emerging market equities.

3. US Fed is likely to increase interest rates at its policy meeting in Dec '16. At least two more interest rate increases are expected during 2017. 

Since rising interest rates usually lead to lower bond prices, yields will get a further boost which can cause more FII outflows. 

4. China's economy is slowing down, which has triggered a slump in commodity prices because China is one of the biggest buyers of commodities. Since commodity prices and the US Dollar trend in opposite directions, the Dollar has been strengthening.

A strong Dollar usually leads to selling in all emerging markets. Currencies of Indonesia, Phillipines, Mexico, South Africa, Turkey have depreciated much more than the Indian Rupee.

5. As per nominal interest rate parity theory, lower interest rates lead to a stronger currency and higher interest rates lead to a weaker currency. This is a major reason why the Indian Rupee has been depreciating against the US Dollar for quite some time.

The recent FII selling in the Indian stock market has further depreciated the Rupee against the Dollar.

In a recent interview on a business TV channel, the global equity strategist of Citi Group said unequivocally: FIIs look at three things - US Dollar, US Treasury yield and China.

Rising US Dollar and rising US Treasury yields means selling in emerging market equities (and vice versa - i.e. falling Dollar and falling yields trigger buying in emerging market equities). 

A likely Trump policy against outsourcing of US manufacturing will further affect economic growth in export-oriented nations like China, Taiwan, South Korea, Malaysia.

A self-contained economy like India will be less affected by such a policy. So far, Trump has mentioned about restricting H1B and L1 visas but nothing against services outsourcing.

Demonetisation of bank notes has led to shorter-term ETF money outflows. Longer-term long-only funds may wait for Q3 and Q4 results of India Inc. before taking a call.

If the short-term damage to India's GDP growth is not 2% (as Dr Manmohan Singh mentioned in the Rajya Sabha) but 0.5% (as Mark Mobius of Templeton said in a TV interview), Indian economy should recover over the next 6 months.

A simple Strategy to achieve your Financial goals

(When Paul McCartney wrote the words "I don't care too much for money, 'cause money can't buy me love" he probably didn't have enough of it!)

There are three ways of making money:

1. Work hard
2. Own assets that earn money
3. Work hard and own assets that earn money

Unless you are born with a silver spoon in your mouth, you can't start adult life with option 2. So, you have no option but to work hard - whether at a job, or a business.

What you do with the money you earn by working hard will determine whether you will achieve your financial goals and will be able to retire later in life to benefit from option 2.

The simple strategy to achieve your financial goals? Save and invest. And the sooner you start, the better.

But you knew that already - right? 

Do you also know how much money you will need to save today, and what mix of assets you need to invest in so that when you eventually stop working you will be able to live comfortably on what your assets will earn?

Probably not - as per anecdotal evidence from a few young working people. 

One complained she hardly has any savings left after paying for rent, food and the daily commute. Another said he is putting some money into a mutual fund every month, but hasn't figured out how much he will need 30 years from now.

Would it be a surprise to know that both own high-end smartphones and laptops, commute only by app-cabs, wear designer clothes, eat out 2-3 times a week and rent apartments in posh localities?

Living the good life now may mean that you will neither be able to retire early to do the things you really love, nor will you be able to enjoy retired life without cutting corners. 

Is there a way to live reasonably well now - and in future when you will not be able (or willing) to work any more?

There is - but you will need to plan for it:

- Set financial goals - near-term, medium-term and long-term
- Figure out how much money you will need at each stage
- Save and invest accordingly

For longer term goals, you can and should invest in riskier assets like equity or equity funds for better returns. For nearer term goals, invest in less risky assets like bank fixed deposit or debt funds.

From your monthly/quarterly earnings, invest first (according to your financial plan) and then spend. 

Stay a bit farther away from town, commute by autorickshaw or train, eat out only once or twice a month, buy a cheaper phone and laptop, pay off your credit card dues in full every month. 

You will be amazed how much these small sacrifices now can lead to a more comfortable retired life. (Believe it or not, you will get old and retired life will be upon you sooner than you expect!)

Stock Buybacks: A Good Thing or Not?

There are many ways in which a company rewards its shareholders. The most common methods are bonus issues, rights issues, dividends, stock splits and share buybacks.

Bonus issues increase the equity capital. The market price of equity shares gets adjusted according to the issue ratio. So, in theory, there is no gain for shareholders. The company can benefit because the higher capital enables them to borrow more. 

In reality, share price often rises following a bonus issue - particularly for established and financially strong companies - as the lower bonus-adjusted price attracts buyers.

Rights issues increase the equity capital, and sometimes also the reserves if the rights issue is offered at a premium to face value. If the issue price is lower than the market price, shareholders benefit through capital appreciation, even though the market price gets adjusted in the same ratio as the rights issue.

Dividends benefit shareholders, because it is tax-free cash in their hands. For companies, the cash outgo indicates that the company does have sufficient resources to pay dividends. 

If the company has to resort to debt in order to pay dividend (or tax), then it is a 'red flag'. This is why studying the Cash Flow statement in Annual Reports is so important. It gives a clear view of a company's cash position.

Stock splits do not increase the share capital of a company. The face value of equity shares get reduced and the number of shares increase proportionately. Again, in theory, there is no benefit for shareholders.

However, the increased number of shares in demat accounts usually leads to near-term selling. Eventually the selling subsides. The lower market price of the split shares attracts buyers, pushing up the market price. 

Here is an example of how bonus and splits can enhance value for long-term shareholders.

Back in 2002, ITC shares of Rs 10 face value were trading at around Rs 600 or so. If someone had bought 100 shares, his investment would be worth Rs 60000 - not a small sum 14 years ago. 

If s/he had the foresight to hold on till today, the holding would have increased to 3000 shares of Rs 1 face value - thanks to two bonus issues (1:2 and 1:1) and a stock split (10:1).

At the current (corrected) market price of Rs 300, the shareholding would be worth Rs 9 Lakhs - a 15-fold increase, not counting the substantial dividends paid each year.

Share buybacks - sometimes at a premium to market price - reduce the equity capital to the extent of number of shares bought back. The bought-back shares are extinguished. Shareholders get an exit opportunity at a profit.

In case they hold on, the market price tends to rise after the buyback (due to higher EPS and lower P/E) - providing capital appreciation.

Read more about pros and cons of share buybacks in this article.

A re-look at Gilt funds – a guest post

Both WPI and CPI inflation rates have been moving down. However, there are questions whether inflation is low because of a higher base effect. As the base effect wears off from Jan ‘15 onwards, inflation may rise again.

Industrial growth continues to be tepid. India Inc. have been clamouring for an interest rate cut to spur growth. The RBI Governor has so far left rates unchanged till inflation gets firmly under control.

If inflation stays low during Jan-Feb ‘15, then a 25 or 50 bps rate cut in Feb ‘15 is a possibility. That should provide impetus to the stock market and gilt fund returns. In this month’s guest post, Nishit suggests a re-look at gilt funds as a safe diversification avenue for your investments.

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The 10 year Government Security yield has come down to 8.15% from a peak of about 9.10% in April. So, should one invest in Gilt funds now?

Gilt funds offer an interesting diversification from equity and Gold investments. They work best when interest rates are coming down and bond prices go up. For example, if a Rs 100 bond is yielding 9% interest and if the interest rate comes down to 8%, then the same Rs 100 bond will cost Rs 112.50 to yield 8% interest.

So, one stands to make a return of say about 12-13% if the interest rate comes down by 1% in about 6 months.

Inflation is going down and so are fuel prices. An interest rate cut by RBI is expected - if not in December ’14 then definitely in February ‘15.

The Government prefers low interest rates as industry can borrow at lower rates and make more investments leading to more employment and growth in the economy. The Finance Minister has already tried nudging the RBI Governor to reduce interest rates. The fear of inflation re-emerging is what is holding back the RBI from reducing interest rates in a hurry.

Interest rate is expected to come down to 7.75% in the next 4-6 months. Currently it is at 8%.

For those who have already invested in Gilt funds, now is the time to enjoy the profits. Those with a horizon of 6 months also can look at Gilt funds as a measure of diversification. Over the last 3 years, gilt funds have given an annual return of about 10%.

In a complete cycle of top to bottom when the interest rates start falling, they typically give about 25% returns out of which 10-12% have been realised already.

Interest rates usually bottom around 7%. Gilt funds can be used to optimise returns from fixed income instruments and one can invest about 5-10% of total allocated funds for investment.

The risk to Gilt funds arises from interest rates going up and at such times, the funds give very low returns.  For those who want to play the interest rate cycle, gilt funds offer the perfect medium.

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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. You can reach him at nish.stockid@gmail.com)

Why you should include gold in your investment portfolio – a guest post

For most Indians, buying gold is a no-brainer. Gold is bought for the family deity. It is bought for a daughter’s wedding and for the wife on a wedding anniversary. It is bought on Dhanteras, and on Diwali. Having significant amounts of gold in one’s possession is a sign of great wealth and status.

But is gold a good investment? Sure, the price of gold has appreciated over the years. But it doesn’t provide any regular returns. Equity shares provide dividends, rights and bonus shares. Plus, they can be redeemed quickly for cash. Redeeming gold for cash is cumbersome – though many NBFCs now offer easy gold loans.

The debate should not be about equity vs. gold. Logically, equity is far better as an inflation-beating investment. However, that does not mean one should not include gold as part of an asset allocation plan. In this month’s guest post, Nishit builds the case for including a small percentage allocation for gold as a hedge against inflation.

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Gold’s price is back where it was in July 2010 in US Dollar terms (at about 1200-1250). In July 2010, the Indian Rupee was about Rs 47 to the US Dollar and now it is around Rs 61.

While investment focus should be on equities, it is always better to have 5-10% in Gold as a hedge against inflation. People talk about Rupee going back to 47 levels but that will make exports uncompetitive and it remains to be seen if Rupee actually appreciates that much.

Historically, Rupee has always depreciated against the Dollar. With global markets showing signs of weakness, Gold can also be a hedge against equity weakness if any. While I do not believe that the Indian markets will have a drastic fall, it is always good to have a hedge.

Interest rates also show signs of weakening and Gilts are another good option at the current juncture. Gilt funds make money when interest rates drop. With weak diesel prices, inflationary pressure will lessen.

Investment in Gold can be in the form of Exchange Traded funds, physical gold or even jewellery (if one wishes to enjoy the gold while using it as a hedge). There are talks of import duty being cut on Gold in the forthcoming budget.

Asset allocation at the current juncture can be 90% Equity, 5% Gold and 5% Gilt funds. When gold was at its peak at almost US $1900, the risk-reward ratio was unfavourable for buying any gold. Now, it has corrected almost 33% from the top and almost 55% of the rise which started in 2008.

In US Dollar terms gold can correct another 10% or so. One cannot catch exact levels but it is safe to start accumulating gold.

The promise of “Acche Din” is here and I see no reason why India will not see glory days ahead, but it is always good to buy insurance for a rainy day.

If interest rates go up for some reason, or if the global economy weakens further for some reason, equity and Gilt funds will go for a toss. At least gold will cover up some of the losses.

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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. You can reach him at nish.stockid@gmail.com)

Has gold lost its lustre? – a guest post

We Indians tend to be conservative as far as investments are concerned. Why is that? Perhaps because several generations of Indians have faced hardship and deprivation due to exploitation by our ‘rulers’ – both overseas and Indian. Lack of education and infrastructure have contributed to the tendency to ‘hoard’ rather than ‘invest’.

For generations, two of the avenues for investing our little savings have been in land and gold ornaments. This is true even today in the hinterland – where infrastructure and banking services remain primitive or non-existent.

In larger towns and cities, infrastructure and services have improved to the extent that other avenues of investment – like post office and bank fixed deposits, mutual funds and equity are readily available. But our fascination for investing in real estate and gold has not dimmed.

In this month’s guest post, Nishit suggests that it may be time to reduce investment in gold. Debt and equity investments are likely to provide better returns in the foreseeable future.

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Indians are obsessed with Gold. The most common question which I am always asked is: “Should we buy Gold now or should we wait?” The Government has increased the price of Gold in India by increasing import duty - thereby reducing Gold imports and positively impacting the Current Account Deficit.

Gold by itself has no value in terms of utility and returns. Its status as a safe haven in times of uncertainty lends value to it. Gold’s price rises when uncertainty increases in the world. Earlier, the US dollar was linked to Gold’s price, but after it was delinked and the printing presses took over, the US dollar weakened. More dollars were required to buy the same amount of Gold.

Gold’s price had seen a parabolic rise in the past few years on the basis of fears of a worldwide economic collapse led by the US. Quantitative easing, the flooding of the markets with additionally printed dollars led to Gold’s price spurting up. It finally touched a peak of US $1920 in September 2011.

Gold’s price has been on a steady decline since then and has corrected to about US $1200 from $1920 - a decline of about 37.5% from its peak value. It had risen from a low of US $264 hit in 2001-2002 to $1920. The great Gold bull run may be over for now.

There are various reasons for this prognosis and they are:

1. The World economy seems to be recovering and the immediate crisis seems to over
2. US is reducing Quantitative easing; the easy money was one of the main reasons for Gold’s price to sky rocket

When Gold’s price hit a peak of $1920, the Rupee was at 46. Now, when Gold’s price has corrected 37.5% in Dollar terms, the Rupee has depreciated about 35%. Hence, in Rupee terms - thanks also to Government duties – Gold’s price has remained almost stagnant. The future movement in Gold’s price can come due to the Rupee weakening further, leading to appreciation in Gold’s price. The Rupee has been stable for the past few months.

Conclusion:

The value of Gold investing as a portfolio choice is no longer as significant as it was say about a couple of years back. Gold should still occupy maybe 5% of your portfolio instead of the earlier 10-20%. Thanks to the weakening rupee, there is still a chance to exit Gold at a very small loss or profit. Better options can be seen in debt or equity currently.

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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.)

Related Post

Gold and Silver charts: an update

Notes from the USA – a guest post

Of late, reports coming out of the USA point to a jobless economic growth rate that is lower than the rate of Quantitative Easing, low inflation, greater propensity to pay off debts and add to savings, a ‘sequestration’ that may cut government jobs and benefits. In other words, not a drift down into another recession, but certainly slower than healthy growth.

In this month’s guest post, KKP provides a ‘ground zero’ view of the state of the US economy from the point of view of a consumer and investor, and strategies that he is adopting to negotiate the likely pitfalls in the days to come.

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Macro Economics from the US

It’s time we look at the forest from the trees and evaluate where we are going….

From a bigger picture of our global economy, we heard a lot of buzz on the bearishness of Emerging Markets, which started with the corrections in China and Brazil, followed by India and other countries in the developing markets. Of course, one cannot avoid the negative buzz on gold also, where brokers and analysts are piling on with a feeling of relief that gold/silver/platinum are finally correcting after huge run-ups.

For equities and gold, the underlying theories that people talk about are based on lots of media and print accounts (whether true and not) that are driving part of market behavior.  Lots of those accounts cannot be proven, and there are often 'opposites written up' that counter those theories.  So, as investors, how do we decipher all of that stuff? The simple answer is: ‘charts’. Conspiracy theories have been going around for a long time, talking about what Obama is secretly doing and how the US Gold ETF vaults are filled with zinc bars coated with fine gold foil. Don’t believe any of it, and don’t even waste a lot of time investigating it, since price discounts almost 99.5% of those theories.

All of those stories are like the health care news that come out talking about "goodness or harm of caffeine", "goodness or harm of artificial sweeteners", "goodness or harm of weight loss with a protein filled diet" etc. I am a health-nut now, and read all of it. When you do, find out both sides of it, and there are usually caveats on BOTH sides of the equation, and without those caveats, it is “information out of context” (like you hear about what spouses do to their better halves!).

So is the case with Gold Bulls and Gold Bugs.  There are two sides of that gold coin! In a bull market forums print all of the positives and ride on the wave, and now that we have a correction (not a crash), we have the opposite side of the story being printed.  In BOTH cases mind you, we are trying to justify.  Why?  Because we are humans and like to justify the emotional behavior of the masses.

Best approach is to look at the macro element of gold and recall the folks talking about the extremes: gold is a useless investment instrument - all the way to gold being the currency of choice by 2020. The ride from $300 to $350 to $250 to $500 to $750 to $900 to $1100, back to $900 and then off to the races to $1900 (fast forwarding) proved this fact, and now it is the turn of the nay sayers to remind us that gold is a useless investment instrument. In Fibonacci terms, we are seeing the correction after the huge move from $750 to the $1900 levels, back down to one of the support levels. Being that gold holds a high beta, we might see a correction to $1000 (or the nearest support), to shake off the weak holders. Very simply, the correction that we need in any big move is now happening in gold, and we are justifying it with rationale that it is because we will not have inflation or hyper-inflation, or Obama is doing really well, or Central Banks are starting to unload, or the US Govt has started to sell gold in massive quantities.

Let’s get to US equities now. One needs to look at the USA as a “stock” and understand that this stock is generating Revenue, has Debt and Expenses, results in Net Income/Deficit and has issues related to Growth, Loss of Market-share and "Free Money" handouts.  Once we analyze this and realize that this is not a good “stock” to put money into, we get to understand that this is not a “stock” that one should count on long term unless it goes through a major restructuring of some kind. Put that into the perspective of lower job growth and early retirements, and you will start to understand the loss of Super-Power or  Monopolistic status of this “stock”. It is like GM or Chrysler from their hey-days. With Obama being the current CEO of this “company”, with responsibility for increasing the debt to the HIGHEST level ever relative to any other CEO in the history, one has to wonder what has he really accomplished with $6 Trillion in debt, or what is he going to realize from that debt in the next 3 years. $6 Trillion of additional debt can run entire economies of over 100 small countries.  Well, has he got the results to show in the USA? In my opinion, he let the US float and not sink, but the Titanic still has a crack in it and water is pouring into the bottom of the ship, albeit a bit slower than 2008-09-10.  With this being a known fact, how much of our portfolio do we want to ride on this optimism?

USD plays a very critical role in part of the sell-off in Gold.  The fact that shale oil might strengthen the USD in future is a potential strong variable that is predicting the upward move in USD and hence a downward push to the metals (inverse relationships). In fact, while all of that talk on oil is going on, we are paying above $4 per gallon of gas in the US (this week), which is higher than what it has been for months!

Gold is very widely considered as an inflation hedge, as well as a hedge against risk of the unknown. In reality, inflation is already here, although headlines in US newspapers will not agree.  We might not have hyper-inflation in the traditional sense of economic definition, but it is hard to understand why cost of grains, cereals, construction materials, tools, contractors, auto-parts, repairs, paint, utensils, electrical goods, decor, some clothing, furniture etc have all gone up every year for the last 5 years.  I measure these things by roaming around the stores quite a bit to get a first hand sense of it.   For example, I just bought a new property and got it fixed up (Jan 19^th to Apr 28^th).  I had to buy lots of materials, and I almost paid 2x of what I paid 3 years ago in the US.   And, for each property I buy (every 4-5 months), prices keep going up, and hence I now have a storage shed, where I buy and store materials when they come at a deep discount (dry wall, 2x4 wood, nails, screws, paint, doors, glass, screens, handles, shower-heads, faucets, glue, caulking etc).  I used to buy paint for $10 to $20 and now it is $30 to $40 per gallon, in just 3 years timeframe.  I have almost 34 gallons of paint sitting at home for the next job, and it will only last me one home, so I am still collecting and buying more.  Today, I bought 31 boxes of cereal based on an introductory price by a new chain of products introduced. These are prices that I used to pay in 1996-99 and I loaded up on it, and stored it in a well maintained temperature zone. How is this inflation going to play out in the next few years? And, what are you doing about it for your own personal situation?

Finally, EU and US still have 'structural issues'.  As soon as we get back to facing these head-on, we will once again have reasons to get out of Equities and back into Bonds, Cash, Gold, Silver and Platinum safe havens.   In the meantime, personally, I am going to continue to acquire of bit of gold and silver as “option” contracts as I have been doing, which allows me to invest small money with huge leverage (expiration 2015) in the US.  Risk of holding option contracts is limited to the premium paid, but the upside is huge, and can be converted into gold ETF shares at contract expiration. I still hold the view that we can see $1000 at the low in Gold (as I have for 3 years or so), but it is yet to be seen how gold reacts to its lower support levels based on the economic forecasts unfolding.  The possibility of it going to $1000 is less than 50% now (based on the recent correction), but I could be proven wrong, although I would be glad to double my position in gold at $1000, if it gets there.   In the meantime, equity markets in the US can go up temporarily, but with IBM and Caterpillar breaking some bad news and showing structural damage, Apple sinking to the $400 levels and the upcoming summer (“sell in May and go away”), the likelihood of Dow going to anything beyond 16000 is unlikely. A correction mode is around the corner (as seen in the RSI/STOC divergences and the Volume shrinking on up-days) in another 2 weeks to 2 months and it might affect the global markets in a similar manner (bearish). The ‘Sell in May’ theory is about to be proven right although the moving averages and price points have not shown clear signs of a break down as yet!

Bottom line, the macro picture shows that markets are climbing the proverbial wall of worry and has done a good job of doing that in Q1’13. Gold, which was overvalued, has done a good job in finally correcting (been expecting that correction for a while), and now, it will be the turn of equities to show its last hurrah by either going up to Dow 16000 or just going down from here into the summer. Hence, gold and equities might be good to buy in the correction mode this summer, and until then just trade in and out, or hold onto to your dry-powder until things settle down.

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KKP (Kiran Patel) is a long time investor in the US, investing in US, Indian and Chinese markets for the last 25 years. Investing is a passion, and most recently he has ventured into real estate in the US and also a bit in India. Running user groups, teaching kids at local high school, moderating a group in the US and running Investment Clubs are his current hobbies. He also works full time for a Fortune 100 corporation.

A re-look at Gilt funds – a guest post

After a decent rally during 2012, backed by strong FII inflows in 2012, the stock market touched 2 year highs. A correction has ensued since then. Slow down in economic growth has forced the RBI’s hand in lowering repo and reverse repo rates, though inflation remains high.

In this month’s guest post, Nishit argues in favour of an investment in Gilt funds – since repo and reverse repo rates have started on their way down.

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We had last reviewed Gilt funds in the month of August ‘11. A lot has changed since then. Let us take a look at where we stand now.

The 10 year bond was trading at 8.2% approx. In a period of 6 months, the rate has come down to 7.9% approx. A period of 6 moths and a rate drop of 0.3% - how does it translate into real returns for an investor?

The Birla Sun Life Government Securities fund, which is a blue chip fund with a 5 star rating from Valueresearcholine.com, has provided an absolute return of 6.61%. When annualized, it becomes 13.22%.

In the next 6 months, Interest Rates should fall by about another 0.5%. Typically in this Interest Rate cycle the peak and the bottom is usually 300 basis points minimum. The peak was about 9%, so the rates should bottom around 6 to 6.5% in the next 2 years.

Now is the time to invest in Government Securities funds, as the Interest rate cycle has clearly started its way down.

Government Securities are the highest rated securities. A default on them is almost impossible, as it would amount to a sovereign default of the Indian state.

If we look at other funds like Income funds, the rate of return has already declined. The trick to make profits from Gilt funds is to ride out the bottoming out of Interest Rate cycle and then move the money back to equity. Typically when the Interest Rate cycle bottoms, it is time to move back into equity.

This happened during October 2008 to March 2009. It happens because rate cuts stimulate the economy - which also means the economy is doing pretty badly. Stock markets are usually 6 months ahead of the economy. When the rate cuts stop and the yield bottoms out, it is also time to invest in equity.

The chart below illustrates how the cycle works. One can compare it with the equity cycle. The rate cuts bottomed out in Dec 2008 and equity markets bottomed in March 2009.

The idea of investing is to safely make a compounded return of around 15-16% every year. When the equity markets are headed downwards, it is time to make money in Gilts and when Gilts are headed down, it is time to make money in Equity Markets.

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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.)

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.)

Using Earnings Yield (E/P) to time your investments – a guest post

In last Thursday’s post, I had taken a look at the historical P/E ratios of the Nifty 50 index and suggested an investment strategy. In this month’s guest post, Nishit takes a slightly different view. He compares Nifty’s earnings yield with the 10 years G-Sec yield to time stock market investments.

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Subhankar had written about Nifty’s P/E multiple or Price to Earnings Multiple last week. Let us delve deeper into it. He had written “Nifty’s P/E ratio has varied between 11 and 27 during the past 12 years - with peaks of 27.35 on Mar 1, 2000 and 27.64 on Jan 1 2008, and troughs of 11.62 on Jan 1, 1999; 10.86 on May 2, 2003 and 11.76 on Dec 1, 2008. The average P/E ratio over the past 12 years is 18.24.”

Price/Earnings ratio is nothing but the Market Price divided by the Profits per share of a company in rupee terms. Assume the share price of a company is Rs 100 and it makes a profit of Rs 10. So its P/E ratio is 100/10 = 10. It is a very fundamental ratio of finding out the valuation of a stock (or index). Now, P/E by itself has no significance. How do we know if P/E of 10 is stretched or P/E of 50 is stretched?

We look at the growth prospects of a company and sector. The derived ratio is PEG Ratio (Price to Earnings Growth ratio). Now if the company is going to grow at an annualized growth rate of 100% for the next 3 years, a P/E of 100 may be acceptable. This is especially true of the IT companies in the glory days of 1998-2001 when Infosys used to come out with 100% growth figures every quarter.

The inverse of P/E (i.e. E/P) is the earnings yield. It is the amount per annum you are going to earn by investing in a company. This ratio is very important in the sense that you can use it to find if a stock (or the Nifty) is over-valued or not. What will we compare against? Let us take the 10 years Government Treasury Bill return. This is the safest investment in the country. Whenever 10 years G-Sec yield is more than equity earnings yield that is the time to go long big time.

Let us take an example. During Oct ’08 – Mar ’09, the Nifty P/E ratio dropped below 15; the earnings yield was 6.66% and below. The G-Sec Yield was 7.83% in Nov ’08.That was the time when the long term portfolio of stocks should have been built up.

For the past 1 year, the Earnings Yield of the Nifty has been around 5%. The G-Sec yield is around 8%. At such times, exposure to equity has to be limited. That is, keep trailing stop losses and don’t add fresh equities.

The Earnings Yield is a simple extension of the P/E concept and comparing it to the Bond Yield gives us a perspective on finding whether the equity markets are overvalued as compared to the Bonds Market or not.

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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.)

Planning for a hassle-free Retirement (a guest post)

Do you remember what you did with your first pay/payment cheque? (Haven’t received your first cheque yet? What are you doing on this page!) Did you blow it up having a good time with friends and family? Why not? You don’t remain young forever. There is a long and bright future ahead of you – and plenty of time to save and invest. Right?

Nishit doesn’t think so. He started planning for his retirement as soon as he received his first pay cheque. He wanted to use the leverage of compounding over his entire working life. In this month’s guest post, he explains why.

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Everyone invests money with the aim of having a comfortable nest egg at retirement. Most of us have not worked out how much money we need at retirement, and at what rate of return we will be comfortable. Most of us chase multibagger returns in the equity markets, burning our fingers in the process.

The magic of compounding is such that 1 lakh invested in the markets today turns into 19 lakhs after 20 years at a rate of 16% return every year. To make 16% every year your asset portfolio need not take undue risks. A Government securities fund over the past 10 years has given a compounded return of 9% on an annualized basis, and a good mutual fund like the HDFC Top 200 has given annualized return of 34% over the past 10 years.

Inflation is a monster which is like a silent killer. Now assuming an inflation rate of 8%, after 20 years, expenses of 1 lakh become 4.66 lakhs. Your assets of 1 lakh have transformed into 19 lakhs whereas the expenses have just gone up to 4.66 lakhs. You have a nice cushion of 14 lakhs.

Gold as an asset class has also yielded an annualized compounded return of 17% over the past 10 years. The trio of equity, gilt funds and gold should form the cornerstone of any investment portfolio. What I am trying to point out here is that investments need not be complex; any common person can invest making use of investment vehicles like Mutual Funds.

The above returns are through investments using the SIP (Systematic Investment Plan) method. One can invest a fixed amount every month, say Rs 5000 each, in a gold ETF, equity fund and a Debt fund. The idea of doing this is that you do not try and catch the bottom or top of any market. One need not invest in too many funds at one go.

India’s economy is growing and will continue to do so for the next 10 years at least. Anyone who is planning to retire with a comfortable income must start doing a SIP at the earliest. By doing this, one can ensure that one is financially independent after retirement. Add to this a Medical Insurance policy that will cover major health care expenses post retirement. The earlier one buys a Medical Insurance policy the fewer are the tests one has to undergo and easier it is to get one. Everyone should have a personal medical health insurance policy, as company policies expire when one leaves the company.

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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.)

Risk Management in Investing – a guest post

In last month’s guest post, Nishit had covered the important topic of asset allocation. Without a proper asset allocation plan, investing becomes a hit-and-miss affair. You never know how much of what asset to buy, when to buy and when to book some profit. Often, the end result is missed opportunities and losses.

In this month’s guest post, Nishit covers the related topic of Risk Management. Properly assessing and understanding the risks involved in one’s investment plan and taking appropriate steps to mitigate those risks helps in formulating a proper asset allocation plan to suit one’s individual investment style and risk tolerance level.

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One of the most important topics that every person who makes any investments should be aware of is Risk Management. A good investor who is poor at Risk Management can get wiped out. Let us try to define risk and risk management.

Any activity you perform in life has a best case scenario and a worst case scenario. The worst case scenario is the risk, and the steps you take to minimise it is Risk Management. In investing, the worst case scenario is loss of capital and returns. The steps for managing risk can be:

(1) avoiding it – e.g. not indulging in day trading

(2) reducing the negative effects - learning the art of setting stop-losses and selling when the stop-loss is hit

(3) accepting the consequences – realizing that to be successful in day trading, a lot of small losses will have to be absorbed

(4) transferring it – buying insurance against trading losses

Risk in investments should be linked to the reward it offers. Risk-reward ratio is the reward which is being offered for the risk you are willing to take. Equity as an investment is risky as compared to investment in government securities, but the rewards are much higher. A 10 year government security will give you a return of 8% whereas investing in blue chip equities may give you 20% annual returns. The G-Sec investment is risk free whereas you face the risk of capital erosion in equity investments.

Risk varies as per the age and the needs of an individual. A 30 year old with a secure job that gives him a steady cash flow can take a higher amount of risk, and a riskier asset class like equity can form a higher percentage of his portfolio. A 60 year old who has just retired may have a larger capital to play with but has no steady income coming from a job. He will need to invest a much higher proportion in debt, giving him a steady income. Also, he has to guard against capital erosion as he will not be in a position to earn back the lost capital from a full-time job.

The table below illustrates the risk-reward ratios of various asset classes:

Reward Risk	High	Medium	Low
High	Mid-cap Equities	Real Estate	Nil
Medium	Gold	‘A’ group Stocks in BSE	Nil
Low	Nil	Good Corporate Debt	Government Debt

Sunil Gavaskar has a favourite saying about percentage shots. He says the batsman has to consider what risk he takes of getting out when he plays a particular shot, and how many runs he scores. Sehwag plays in a very high risk-reward ratio style, whereas Sachin plays low risk shots. In IPL 3, he scored fast but scored mostly in boundaries. This is a classic example of a low risk and high reward strategy.

A good way of protecting your risks is by taking a term insurance cover which has a low insurance premium but high cover in case of your unfortunate demise. The first step of financial planning is to find out how much risk you can take. To play the game, you must remain in the game. In a game of poker, the poker player cannot afford to get wiped out. It is always better to get rich slowly rather than stake all. Twice the government yield of 10 yr paper (8% returns), which will give 16% annual returns when compounded over 10 years will turn Rs 1 lakh into 4.5 lakhs. That is the power of compound interest. Over 25 years, the same amount will turn into 40 lakhs!

Suggested Asset allocation for a 35 year old, considering the volatile state of the markets today:

Asset	% Allocation
Equity	20
Debt	40
Gold	30
Cash	10

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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.)