Tuesday, March 20, 2007

How to Add Value To Your Money

Some readers are asking me about where to invest. I have been guarded with my answers and try to evade with the observation that since everyone has different financial goals and risk appetite and so my recommendations may not work for him/her.

But when my elder brother asked me the question, I did not have an escape route. And a responsibility too. After all I can't vanish from him after a year or so!! ;)

Btw, it's also important to note that this elder brother is an IIT(D)/IIM(A) guy and can't be taken for a ride! And also that the IIT/IIM guys also need proper financial advice!!

Let's take a look at some of the popular options available which are Bonds, Stocks, Real Estate, Mutual Funds, Unit Linked Insurance Policy (ULIP) and Exchange Traded Funds (ETF). Now I'll try to rate them on four parameters of investing. i.e. 1. Growth, 2. Liquidity , 3. Security and 4. Expenses

  1. Growth: Stocks MFs and ETFs top the rankings here. Over a period of over 5 years, the CAGR is above 15% in comparison to 8% in Bonds. ULIPs begin to give a good growth only after 5 years or so because initially they are very expensive. Real estate is on a fairy run these days too.
  2. Liquidity: Again, Stocks, MFs and ETFs score heavily while Bonds and ULIPs have a lock in period or have substantial surrender charges. Real estate scores low here (u have to be lucky to get good buyers at the right time)
  3. Security: I would rate all of them at par over a long term of over 5 years. But you may get into a bad stock or real estate which are totally unsecured. Otherwise too, stocks and real estate are very volatile and can affect your blood pressure too!!
  4. Expenses: ETF is the least expensive with charges of around 0.5% compared to 2% from MFs and much more in ULIPs (especially in the initial years). Stocks too are the least expensive provided you get into the right stocks at the right time.

Based on this short analysis, I would recommend ETFs. Read more about ETFs here. But as I said earlier too, one man's meat could be another man's poison. Moreover the diversification rule says that one should not keep all your eggs/ apples (for the veggy!!) in one basket. So let us take a look at the investment options, one at a time.

  • Shares: Investing in the equity market directly is exciting and sexy. You are in the thick of things and learn many things in the process. Though the volatility and the information overload makes it a daunting task, investing in stocks is not rocket science. You can start with identifying a list of 10-15 companies out of 3-5 sectors which you know or which interests you. You can keep a tab on their management team, financials and future outlook and over a period of time, you will be able to take a call on them.
  • Real Estate: I feel that one has to be plain lucky to get into a good deal and be able to get the right buyer at the right price and time. I can't think of any other factor other than luck. So if you feel , you are blessed and have the right tip, go for it. Otherwise, it's a no no.
  • Mutual Funds: One should allocate time to investment decisions in proportion to our income generation goals. Also convenience and hassle free investing should be a major factor. Mutual Funds fit the bill where Fund Managers are into it full time. If you are able to identify fund managers who have consistently performed over last 3-5 years, nothing like it. The fund manager also has the muscle power of crores of Rupees and is able to take entry and exit decisions impartially. MFs continuously churn their portfolio. When MFs buy and sell stocks, they don't have to pay capital gains as you do when you churn. With Systematic Investment plans (SIP), you can start investing with as low as Rs 500 per month. But MFs have its own loading and administrative charges and the fund managers make merry on your hard earned money.
  • Exchange Traded Funds: While the index fund has given a one-year return of 42%, diversified equity schemes (MF) could only come up with 34% returns. Diversified equity funds usually have large expense ratios compared to index funds. For example, the expense ratio of Banking BeES, an index fund, is only 0.45, while it is anywhere between 2-2.50% for diversified equity schemes. That's why I recommend ETFs.
  • ULIPs: Unit linked insurance policies combine two products, i.e. Insurance and Mutual Funds. In the initial few years, ULIPs are damn expensive. But in case you don't want any hassles of investing, you have a tried and tested Insurance agent who is almost part of your family then ULIPs are for you.
  • Bonds: For those of you who are risk averse.

U can also read more on Mutual Fund, Equities, ULIPs.

Your comments help me in arranging my thoughts in a better way. I would like to post more detailed analysis on each of these and also spell out the steps to be taken.

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