Fixed deposits rates are on the rise. Though the investors living on interest income are happy about it, they are finding it difficult to catch the peak.
The biggest challenge an investor faces in a rising-rate scenario is to identify the peak and lock in the rates around that level. It is typical for an investor to put his money in a one-year fixed deposit (FD) a couple of months too soon and then repent at leisure when s/he finds one-year fixed deposit available at 75-200 basis points more than what s/he would earn from the old FD. Since FDs do not allow negotiating rates in future, the investors feel trapped in the old FD.
A better way to deal with a rising interest-rate scenario is to invest in floating-rate bond funds that invest in short-term instruments whose interest rates float in sync with benchmark rates. The other option is to invest in liquid-plus funds. Smart investors can start by putting in a good chunk of money in liquidplus funds.
As the rates rise, they keep locking in money in fixed maturity plans (FMPs) at regular intervals. This ensures that the money is deployed at attractive yields and saves you from the risk of missing the peak.
If the rates on the long-term fixed income instruments, such as bonds having a 5-10 year maturity , rise, then the prices of these bonds fall. As prices dip, investors lose money.
Hence, it is better to avoid mutual fund schemes that invest in long-term instruments. Of course, if you are of the opinion that the rates have already peaked on long-term instruments, you may consider investing in long-term funds to earn good returns over the next couple of years.
Equity investors are also not spared by interest rate movements. Interest is the price of one key raw material – money. Hence, when the interest rates rise, the profitability of companies with debt on books goes down.
Investors should avoid interest-rate sensitive sectors such as real estate, automobiles and consumer durables as a large chunk of demand for these goods is satisfied using borrowed funds.
http://www.cfpglobal.com/
Thursday, December 30, 2010
Why Fixed income will grow in 2011
2010 has been a tough time for those living on fixed income investments. Rising fuel and food prices have increased inflation and the middle class is struggling with its monthly finances. With inflation moving up due to rising commodity and oil prices, the central bank may be forced to increase rates in the near future despite already raising it six times in 2010. So, what should a fixed income investor do in such a situation?
Bank Fixed Deposits: Around 55% of Indian savings find their way to bank fixed deposits (FDs). The simplest of all investment products, a bank FD is easy to operate. All you have to do is walk in to your friendly neighbourhood bank and open an FD. In case of bank FDs, the Deposit Insurance and Credit Guarantee Corporation of India guarantees repayment of Rs 1 lakh in case of default. A point to be noted is that different banks offer different rates on FDs.
So, the rate offered by the State Bank of India (SBI) will be different from that offered by ICICI Bank or a foreign bank such as HSBC. “Most retired people find FDs easy to operate. The fact that they give an assured return is another positive,” says Harish Sabharwal, chief operating officer, Bajaj Capital. FDs are available across tenures ranging from seven days to 10 years. However, the interest rate on a seven-day deposit is merely 3% per annum, so choose your tenure accordingly.
With the recent revision in bank deposit rates, you could get as much as 8.5% per annum. If you are a senior citizen, you could earn 50 basis points extra on your FD. A 555-day SBI FD offers you an interest rate of 8.5% per annum. For a senior citizen, it goes up to 9% per annum. So, if you have not yet built your FD portfolio or are looking for higher interest from bank deposits, this could be the best time to get into it.
Post Office Schemes: The schemes offered by the post office give guaranteed returns and are attractive investment options. “These schemes find favour with investors who are looking for sovereign guarantee,” says Anil Chopra, Group CEO, Bajaj Capital. Interest rates here are fixed by the Government of India, and do not change often, unlike bank deposits. So, even though banks have revised deposit rates upwards, post offices are yet to follow suit.
Currently, National Savings Certificate and Post Office Monthly Scheme and Public Provident Fund offer you a return of 8% p. a. “NSC and PPF are eligible for deduction under Section 80C and, hence, find favour with some taxpayers,” says Anup Bhaiya, MD and CEO, Money Honey Financial . In addition, the Senior Citizens Savings Scheme offers you a 9% per annum rate of interest, but for that you need to be 60 years of age. “People generally flock to post office schemes when bank deposits pay lower than them,” adds Chopra. It would make more sense to invest in a PPF as interest income is tax-free.
Employee Provident Fund: EPF is a retirement benefit provided to the salaried class. Every month a small amount is deducted from your salary which is invested in the EPF account, with the employer also contributing a similar amount. On September 15, 2010, the Employees’ Provident Fund Organisation raised the interest rate by 1% for 2010-11 to 9.5%. This figure is the highest in the past five years. Liquidity is an issue in this and partial withdrawal is possible but only if you have completed five years of service.
Company Deposits: These are unsecured instruments. Their safety depends on the financial position of the company. Hence, investors have to be very careful while choosing a company. High returns come with higher risks. So, take the trouble of checking the company’s credit rating.
http://www.cfpglobal.com/
Bank Fixed Deposits: Around 55% of Indian savings find their way to bank fixed deposits (FDs). The simplest of all investment products, a bank FD is easy to operate. All you have to do is walk in to your friendly neighbourhood bank and open an FD. In case of bank FDs, the Deposit Insurance and Credit Guarantee Corporation of India guarantees repayment of Rs 1 lakh in case of default. A point to be noted is that different banks offer different rates on FDs.
So, the rate offered by the State Bank of India (SBI) will be different from that offered by ICICI Bank or a foreign bank such as HSBC. “Most retired people find FDs easy to operate. The fact that they give an assured return is another positive,” says Harish Sabharwal, chief operating officer, Bajaj Capital. FDs are available across tenures ranging from seven days to 10 years. However, the interest rate on a seven-day deposit is merely 3% per annum, so choose your tenure accordingly.
With the recent revision in bank deposit rates, you could get as much as 8.5% per annum. If you are a senior citizen, you could earn 50 basis points extra on your FD. A 555-day SBI FD offers you an interest rate of 8.5% per annum. For a senior citizen, it goes up to 9% per annum. So, if you have not yet built your FD portfolio or are looking for higher interest from bank deposits, this could be the best time to get into it.
Post Office Schemes: The schemes offered by the post office give guaranteed returns and are attractive investment options. “These schemes find favour with investors who are looking for sovereign guarantee,” says Anil Chopra, Group CEO, Bajaj Capital. Interest rates here are fixed by the Government of India, and do not change often, unlike bank deposits. So, even though banks have revised deposit rates upwards, post offices are yet to follow suit.
Currently, National Savings Certificate and Post Office Monthly Scheme and Public Provident Fund offer you a return of 8% p. a. “NSC and PPF are eligible for deduction under Section 80C and, hence, find favour with some taxpayers,” says Anup Bhaiya, MD and CEO, Money Honey Financial . In addition, the Senior Citizens Savings Scheme offers you a 9% per annum rate of interest, but for that you need to be 60 years of age. “People generally flock to post office schemes when bank deposits pay lower than them,” adds Chopra. It would make more sense to invest in a PPF as interest income is tax-free.
Employee Provident Fund: EPF is a retirement benefit provided to the salaried class. Every month a small amount is deducted from your salary which is invested in the EPF account, with the employer also contributing a similar amount. On September 15, 2010, the Employees’ Provident Fund Organisation raised the interest rate by 1% for 2010-11 to 9.5%. This figure is the highest in the past five years. Liquidity is an issue in this and partial withdrawal is possible but only if you have completed five years of service.
Company Deposits: These are unsecured instruments. Their safety depends on the financial position of the company. Hence, investors have to be very careful while choosing a company. High returns come with higher risks. So, take the trouble of checking the company’s credit rating.
http://www.cfpglobal.com/
Cover for some more swing in insurance
The insurance sector saw a series of changes in 2010, with the Insurance Regulatory and Development Authority (Irda) finally deciding to clamp down on mis-selling of Ulips (unit-linked insurance plans). Among the several steps that the regulator took included imposing ceiling on Ulip charges. Ironically, the changes can be attributed more to the much reported duel between capital market regulator Sebi and Irda rather than any consumer activism.
Whether the slew of Ulip-centric regulations, which came into effect from September 1, will make any noticeable difference to the way insurance products are bought and sold, remains to be seen.
In a separate development, public sector general insurers withdrew the cashless facility at several leading corporate (or five-star) hospitals starting July 1, citing exorbitant charges. Oddly enough, policyholders covered under corporate group mediclaim, which has been a loss-making portfolio for most insurers, were spared. Last heard, a large number of corporate hospitals had given in to the insurers’ demands to lower their charges, though many others in Mumbai continue to remain defiant.
Nevertheless, the impact of the changes, or the lack of it, will be clearer in 2011. The New Year is expected to herald several other changes, including guidelines on initial public offering (IPOs) as well as mergers and acquisitions (M&As) by insurance companies. On that count, at least, 2011 is likely to be a worthy successor to 2010.
Here are some likely trends and developments identified by industry experts and watchers that could affect you as a policyholder, next year:
http://www.cfpglobal.com/
Whether the slew of Ulip-centric regulations, which came into effect from September 1, will make any noticeable difference to the way insurance products are bought and sold, remains to be seen.
In a separate development, public sector general insurers withdrew the cashless facility at several leading corporate (or five-star) hospitals starting July 1, citing exorbitant charges. Oddly enough, policyholders covered under corporate group mediclaim, which has been a loss-making portfolio for most insurers, were spared. Last heard, a large number of corporate hospitals had given in to the insurers’ demands to lower their charges, though many others in Mumbai continue to remain defiant.
Nevertheless, the impact of the changes, or the lack of it, will be clearer in 2011. The New Year is expected to herald several other changes, including guidelines on initial public offering (IPOs) as well as mergers and acquisitions (M&As) by insurance companies. On that count, at least, 2011 is likely to be a worthy successor to 2010.
Here are some likely trends and developments identified by industry experts and watchers that could affect you as a policyholder, next year:
http://www.cfpglobal.com/
Thursday, December 23, 2010
Why using a credit card makes sense
No credit cards, please — we are young and credit-averse. It seems, a small bunch of youngsters will do anything to resist a credit card being pushed into their wallet. Nita, a young mediaperson, for example, cringes every time someone in her group flashes his or her card to take care of the bill at a restaurant. She just can’t understand why anyone would opt for a credit card — an easy way to fall into a credit trap, according to her — to pay bills. Why not opt for a debit card to settle the bill instead, she would often confront her friends, much to their amusement. Not in a mood to get into longdrawn boring conversations about the merits of using credit cards, her friends would mutter key phrases like convenience, free credit period and so on. To cut the story short, Nita is yet to figure out why people keep collecting credit cards as if they are life-saving masks.
Increasingly, a small number of youngsters are consciously resisting the desire to own a credit card. Of course, they are far outnumbered by the flashy crowd of youngsters working for BPOs and KPOs, who live by credit cards and swear by easy credit.
“I don’t have any figures to support the claim, but it is true that more and more people are aware of using credit cards in a reckless manner. Many people are content with their debit cards and they are not comfortable with the idea of using credit cards to pay up their bills,” says a financial advisor. According to him, the older people in the group may have had a bad experience dealing with credit cards and they consciously stay away from further trouble. Kids, who have grown up hearing stories about the perils of easy credit, seem to have learnt early lessons in life and keep away from free credit cards for the rest of their life.
Nita, however, hasn’t heard any horror stories about credit card traps. But she knows that it is an expensive form of credit available and many people tend to accumulate huge debt, thanks to easy availability of credit. “When someone is using a credit card, Istart thinking how much money that person would have to pay at the end the month. The way people use their credit card, I am sure they have a huge outstanding at the end of the month,” she says. “I somehow also start thinking about the interest rate they would be paying to clear off the debt. That is why I have decided that I will not get into the habit of accumulating debt,” she says. However, Rita stays away from the credit card because of the lessons learnt the hard way early in life. She used her credit card (an add-on card her father gave her) as if there was no tomorrow and in no time she was in trouble. “I maxed up my credit card and my father had to bail me out. That is why I have decided that I am not going to use credit cards all my life,” says Rita.
However, according to financial experts, every tool – including the much abused credit card – has its plus and minus sides. They don’t think people should develop an irrational fear about this piece of plastic unless they think that they are incapable of responsible behaviour. “Credit cards are a useful payment mechanism and people don’t have to avoid them unless they feel they would be irresponsible when it comes to using them,” says Gaurav Mahruwala.
Sajag Sangvi, a certified financial planner (CFP), says the best thing a person can do is to stay away from using the credit card if s/he cannot resist the temptation to shop and go on revolving credit. “If you don’t clear your outstanding amount on the due date, you are in for trouble. Credit card companies charge around 36% interest on the outstanding amount, which is the highest form of credit,” he says.
For the financially-savvy, the convenience and free credit periods are literally the rewards for using credit cards. For example, a credit card gives you around 50 days of free credit period. Some cards offer even more time. This is the feature that tempts the financial geek. Imagine, you earn interest rates on savings deposit on a daily basis and some other entity is giving you free credit for that period.
“Free credit is a very good feature. It allows you to shop without bothering about the money in your account. The only thing you have to be particular about is to make sure that you clear off your dues on the specified date on which you are supposed to make the payment,” says Mashruwala. He also underscores the convenient factor: you don’t have to carry a lot of cash around to shop. Sure, you can use your debit cards at most places now, but some people don’t like the idea of using debit cards for shopping as it may expose their entire savings account. Also, some travel sites insist on a credit card to make reservations.
In short, you don’t have to avoid credit cards like a plague. All you have to do is to clear off the outstanding on the due date. However, if you fall for the revolving credit facility (that is, pay up a small part of the outstanding immediately and pay the rest later), rest assured you will hurtle towards a debt trap. Because the standing joke is that you can go on paying the credit till you are alive if you are only paying the minimum amount due every month.
Get Credit-Savvy
Credit cards are a useful payment mechanism as you don’t have to carry around much cash for your purchases They are especially useful for people who travel frequently within the country and abroad Credit card bills give you an insight into your spending behaviour at the end of the month or quarter They provide you a free credit period of around 50 days, which is extremely attractive If you think you can go overboard with your shopping and may fail to make full payment on the due date, avoid using credit cards If you are using credit cards as a financing tool, do remember that it is one of the most expensive forms of credit
http://www.cfpglobal.com/
Increasingly, a small number of youngsters are consciously resisting the desire to own a credit card. Of course, they are far outnumbered by the flashy crowd of youngsters working for BPOs and KPOs, who live by credit cards and swear by easy credit.
“I don’t have any figures to support the claim, but it is true that more and more people are aware of using credit cards in a reckless manner. Many people are content with their debit cards and they are not comfortable with the idea of using credit cards to pay up their bills,” says a financial advisor. According to him, the older people in the group may have had a bad experience dealing with credit cards and they consciously stay away from further trouble. Kids, who have grown up hearing stories about the perils of easy credit, seem to have learnt early lessons in life and keep away from free credit cards for the rest of their life.
Nita, however, hasn’t heard any horror stories about credit card traps. But she knows that it is an expensive form of credit available and many people tend to accumulate huge debt, thanks to easy availability of credit. “When someone is using a credit card, Istart thinking how much money that person would have to pay at the end the month. The way people use their credit card, I am sure they have a huge outstanding at the end of the month,” she says. “I somehow also start thinking about the interest rate they would be paying to clear off the debt. That is why I have decided that I will not get into the habit of accumulating debt,” she says. However, Rita stays away from the credit card because of the lessons learnt the hard way early in life. She used her credit card (an add-on card her father gave her) as if there was no tomorrow and in no time she was in trouble. “I maxed up my credit card and my father had to bail me out. That is why I have decided that I am not going to use credit cards all my life,” says Rita.
However, according to financial experts, every tool – including the much abused credit card – has its plus and minus sides. They don’t think people should develop an irrational fear about this piece of plastic unless they think that they are incapable of responsible behaviour. “Credit cards are a useful payment mechanism and people don’t have to avoid them unless they feel they would be irresponsible when it comes to using them,” says Gaurav Mahruwala.
Sajag Sangvi, a certified financial planner (CFP), says the best thing a person can do is to stay away from using the credit card if s/he cannot resist the temptation to shop and go on revolving credit. “If you don’t clear your outstanding amount on the due date, you are in for trouble. Credit card companies charge around 36% interest on the outstanding amount, which is the highest form of credit,” he says.
For the financially-savvy, the convenience and free credit periods are literally the rewards for using credit cards. For example, a credit card gives you around 50 days of free credit period. Some cards offer even more time. This is the feature that tempts the financial geek. Imagine, you earn interest rates on savings deposit on a daily basis and some other entity is giving you free credit for that period.
“Free credit is a very good feature. It allows you to shop without bothering about the money in your account. The only thing you have to be particular about is to make sure that you clear off your dues on the specified date on which you are supposed to make the payment,” says Mashruwala. He also underscores the convenient factor: you don’t have to carry a lot of cash around to shop. Sure, you can use your debit cards at most places now, but some people don’t like the idea of using debit cards for shopping as it may expose their entire savings account. Also, some travel sites insist on a credit card to make reservations.
In short, you don’t have to avoid credit cards like a plague. All you have to do is to clear off the outstanding on the due date. However, if you fall for the revolving credit facility (that is, pay up a small part of the outstanding immediately and pay the rest later), rest assured you will hurtle towards a debt trap. Because the standing joke is that you can go on paying the credit till you are alive if you are only paying the minimum amount due every month.
Get Credit-Savvy
Credit cards are a useful payment mechanism as you don’t have to carry around much cash for your purchases They are especially useful for people who travel frequently within the country and abroad Credit card bills give you an insight into your spending behaviour at the end of the month or quarter They provide you a free credit period of around 50 days, which is extremely attractive If you think you can go overboard with your shopping and may fail to make full payment on the due date, avoid using credit cards If you are using credit cards as a financing tool, do remember that it is one of the most expensive forms of credit
http://www.cfpglobal.com/
Wednesday, December 22, 2010
Ulips in the name of mutual fund
ET went shopping for the right mutual fund(s). It caught up with a relationship manager of a leading private-sector bank. One look, a couple of background questions and the manager knew he had found his target clients.
The three musketeers — two of us along with our secret lethal weapon, the hidden camera — went shopping for the right mutual fund(s). We caught up with a relationship manager of a leading private-sector bank. One look, a couple of background questions and the manager knew he had found his target clients.
“So how much money are you looking to invest?” We thought for a few seconds and replied hesitantly, “About Rs 50,000-60,000.” He fired his next question, “So what have your earlier investments been?” We said we had some vague idea about a life insurance policy taken by our parents.
His targets had all that he wished for— wad of ready cash, eagerness to invest and had little clue about investment avenues.
We said we were looking to park our money in mutual funds. Did we say mutual funds? Well, we were presented with a fund, which, in every sense, was a “fund”. Our relationship manager-cum-investment-adviser-cum-financial planner started off the power-packed 20-minute conversation giving details of the fund and how it could weather all market conditions.
The fund he was selling was surely tempting enough. “Since inception it had given returns of 18%,” he said.
Fifteen minutes into the conversation and we were told everything the manager thought necessary for us to know. Rather, almost everything.
We thought we were finally lucky to get the right advice. Just as we were smiling at this thought, came his next statement: “You have to pay for only five years.” And this despite we clearly mentioning that we were looking to invest for only two to three years. A number of questions ran through our minds. No mutual fund had a five-year lock-in, after all!
What I was told What is wrong
Ulips are a type of mutual fund or just like a mutual fund Unit-linked insurance plans require a longer time horizon than MFs. The charges for investing in both are also different.
Invest in a mutual fund for a year and divert this money to pay the premium for Ulip Horizon for equity mutual funds should ideally be at least three years
Investing in MFs is not a great idea as markets are going down now It is an ideal time to start investing when markets are going down, as you get more units and there is scope for growth
You have to pay only for five years Five years is not the apt horizon for Ulips. It should be minimum of 10 years
In Ulips you are getting investment plus insurance Never mix investment and insurance
He comfortably borrowed words from the mutual fund glossary to explain the fund without naming it. Words like SIP, NAV, fund, etc were thrown into the conversation to camouflage the product in the name of an MF. And then came the final nail in the coffin. “It’s a type of mutual fund or you know just like a mutual fund,” he explained.
And to think that our insurance and market regulators Insurance Regulatory and Development Authority and Securities and Exchange Bureau of India were battlling all this while over the classification of this financial product!
But, since we were eager to find out the name of the product, we kept questioning as innocent investors. Which mutual fund was this, we finally asked, to which he reluctantly explained that the company had two businesses — one was the mutual fund and the other life insurance.
Everything possible was done to create chaos in the consumers’ minds. After 17 minutes the product was finally unveiled. And Ulip it was! No doubt he was hell bent on not using the dreaded four-letter word, until the very end of the conversation
http://www.cfpglobal.com/
The three musketeers — two of us along with our secret lethal weapon, the hidden camera — went shopping for the right mutual fund(s). We caught up with a relationship manager of a leading private-sector bank. One look, a couple of background questions and the manager knew he had found his target clients.
“So how much money are you looking to invest?” We thought for a few seconds and replied hesitantly, “About Rs 50,000-60,000.” He fired his next question, “So what have your earlier investments been?” We said we had some vague idea about a life insurance policy taken by our parents.
His targets had all that he wished for— wad of ready cash, eagerness to invest and had little clue about investment avenues.
We said we were looking to park our money in mutual funds. Did we say mutual funds? Well, we were presented with a fund, which, in every sense, was a “fund”. Our relationship manager-cum-investment-adviser-cum-financial planner started off the power-packed 20-minute conversation giving details of the fund and how it could weather all market conditions.
The fund he was selling was surely tempting enough. “Since inception it had given returns of 18%,” he said.
Fifteen minutes into the conversation and we were told everything the manager thought necessary for us to know. Rather, almost everything.
We thought we were finally lucky to get the right advice. Just as we were smiling at this thought, came his next statement: “You have to pay for only five years.” And this despite we clearly mentioning that we were looking to invest for only two to three years. A number of questions ran through our minds. No mutual fund had a five-year lock-in, after all!
What I was told What is wrong
Ulips are a type of mutual fund or just like a mutual fund Unit-linked insurance plans require a longer time horizon than MFs. The charges for investing in both are also different.
Invest in a mutual fund for a year and divert this money to pay the premium for Ulip Horizon for equity mutual funds should ideally be at least three years
Investing in MFs is not a great idea as markets are going down now It is an ideal time to start investing when markets are going down, as you get more units and there is scope for growth
You have to pay only for five years Five years is not the apt horizon for Ulips. It should be minimum of 10 years
In Ulips you are getting investment plus insurance Never mix investment and insurance
He comfortably borrowed words from the mutual fund glossary to explain the fund without naming it. Words like SIP, NAV, fund, etc were thrown into the conversation to camouflage the product in the name of an MF. And then came the final nail in the coffin. “It’s a type of mutual fund or you know just like a mutual fund,” he explained.
And to think that our insurance and market regulators Insurance Regulatory and Development Authority and Securities and Exchange Bureau of India were battlling all this while over the classification of this financial product!
But, since we were eager to find out the name of the product, we kept questioning as innocent investors. Which mutual fund was this, we finally asked, to which he reluctantly explained that the company had two businesses — one was the mutual fund and the other life insurance.
Everything possible was done to create chaos in the consumers’ minds. After 17 minutes the product was finally unveiled. And Ulip it was! No doubt he was hell bent on not using the dreaded four-letter word, until the very end of the conversation
http://www.cfpglobal.com/
Tuesday, December 21, 2010
ANALYZING FINANCIAL ADVICE
The possibility that financial advice can sometimes be worse than nothing needs no explanation these days. Think Bernie Madoff. That was extreme, of course, but how wary should investors be when it comes to more prosaic counsel from, say, the local financial planner? As with everything else in finance, the answer boils down to a gray area. In short, it depends.
It’s a given that in the grand scheme of financial advisory, most of it will end up as mediocre; a small slice of it will bring stellar gains; and a bit of it will be a disaster. That’s simply a twist on what Professor Bill Sharpe described as The Arithmetic of Active Management. Returns, in other words, are a zero sum game and the winning hands are financed by the losers. In the end, most invetsment decisions end up in the middle. That's not necessarily bad news. For most investors, sound advice that delivers reasonable if middling results will suffice. And compared with what happens with many portfolios, middling represents progress. But expectations are still important.
Sharpe's law of active investing has been demonstrated many times, and it has a habit of explaining the ebb and flow of performance in a single asset class as well as the rules for asset allocation. In a recent issue of The Beta Investment Report, for instance, I looked at how a passive mix of all major asset classes fared relative to 900-plus actively managed multi-asset class mutual funds over the past 10 years, courtesy of data crunching with Morningstar’s Principia software. The result wasn’t terribly surprising: the passive mix delivered a modestly above-average return.
Is it reasonable to expect something similar when it comes to hiring a financial advisor? Perhaps. Everyone can’t be above average. But can they at least do no harm? Not necessarily, or so a recent study of financial advisory suggests.
A paper penned by two researchers at Goethe University Frankfurt (“Financial Advice: An Improvement for Worse?) asks three key questions:
1. Does the consultation of financial advisors improve portfolio performance?
2. Do financial advisors ameliorate their clients investment mistakes?
3. Do advisor recommendations improve asset allocation?
The answers aren’t encouraging, according to the paper, which explains:
Firstly, involving financial advisors results in lower portfolio returns, higher risk, and thus, in lower risk-adjusted returns. Second, advisors correct for some but not all investment mistakes. Third, advisors do not generally improve the asset allocation in client portfolios. Overall, our analysis provides evidence that the advice offered by the sample bank lacks quality in some tangible dimensions. This implies that conventional types of financial advice may not be the best remedy for the widespread financial illiteracy of households.
Critics will rightly point out that the study examines one large German financial institution, and so it can be said that this unnamed “German universal bank” is the problem rather than financial advice per se. In addition, one could take issue with the paper’s methodology, which draws on the traditional mean-variance optimization process for reaching conclusions. There are other assumptions that could conceivably skew results, such as that deciding that all transactions take place in the middle of the month.
The study, which analyzes "10,434 randomly selected customers for the 34-month period from January 2003 to October 2005," is hardly definitive, and so reasonable minds can differ about its relevance. But at the very least this research is a timely reminder that investors who hire advisors to manage money and/or dispense financial recommendations need to have a clear idea of what they’re paying for and who they're dealing with.
Suffice to say, different advisors offer different services and come with different skills. When it comes to straight investment advisory, it’s crucial to develop reasonable expectations and decide if you’re paying a fair price. That’s a complicated subject, of course, although no investor can afford to dismiss the necessary work to gain a reaosnable comfort level with a hired financial gun. The details, in short, can get messy when it comes to weighing the pros and cons of advisors.
Meantime, some of the usual caveats still apply. That starts with the recognition that the odds that any one advisor is going to deliver stellar performance results is probably expecting too much. Of course, everyone likes to focus on the outliers. The difference between Bernie Madoff’s results vs. Warren Buffett’s are the proverbial night-and-day outcomes. But for most investors, the middle ground is probably destiny.
Impressive investment returns are still dependent on three factors: skill, luck and asset/factor allocation. Quite often, a mix of all three is often relevant when analyzing results. For obvious reasons, advisors and money managers prefer to emphasize one of these variables over the other two.
There are no short cuts for intelligently choosing a financial planner, but you can start by asking prudent questions. The Certified Financial Planner Board of Standards, for instance, recommends 10 Questions to Ask When Choosing a Financial Planner. The Financial Planning Association publishes useful resources on the topic as well, including this primer.
Ultimately, many of the hazards that infect investing choices apply to choosing an advisor. Indeed, the decision may be as much art as it is science.
Even if you do everything right and choose a great planner, you’ll still need to monitor and assess through time. Expecting to fully transfer responsibility to an advisor and assuming that everything he or she recommends is exactly correct is asking for trouble. Yes, minding assets is time consuming and requires hard work. But you’re going to be involved one way or another. After all, it’s still your money.
It’s a given that in the grand scheme of financial advisory, most of it will end up as mediocre; a small slice of it will bring stellar gains; and a bit of it will be a disaster. That’s simply a twist on what Professor Bill Sharpe described as The Arithmetic of Active Management. Returns, in other words, are a zero sum game and the winning hands are financed by the losers. In the end, most invetsment decisions end up in the middle. That's not necessarily bad news. For most investors, sound advice that delivers reasonable if middling results will suffice. And compared with what happens with many portfolios, middling represents progress. But expectations are still important.
Sharpe's law of active investing has been demonstrated many times, and it has a habit of explaining the ebb and flow of performance in a single asset class as well as the rules for asset allocation. In a recent issue of The Beta Investment Report, for instance, I looked at how a passive mix of all major asset classes fared relative to 900-plus actively managed multi-asset class mutual funds over the past 10 years, courtesy of data crunching with Morningstar’s Principia software. The result wasn’t terribly surprising: the passive mix delivered a modestly above-average return.
Is it reasonable to expect something similar when it comes to hiring a financial advisor? Perhaps. Everyone can’t be above average. But can they at least do no harm? Not necessarily, or so a recent study of financial advisory suggests.
A paper penned by two researchers at Goethe University Frankfurt (“Financial Advice: An Improvement for Worse?) asks three key questions:
1. Does the consultation of financial advisors improve portfolio performance?
2. Do financial advisors ameliorate their clients investment mistakes?
3. Do advisor recommendations improve asset allocation?
The answers aren’t encouraging, according to the paper, which explains:
Firstly, involving financial advisors results in lower portfolio returns, higher risk, and thus, in lower risk-adjusted returns. Second, advisors correct for some but not all investment mistakes. Third, advisors do not generally improve the asset allocation in client portfolios. Overall, our analysis provides evidence that the advice offered by the sample bank lacks quality in some tangible dimensions. This implies that conventional types of financial advice may not be the best remedy for the widespread financial illiteracy of households.
Critics will rightly point out that the study examines one large German financial institution, and so it can be said that this unnamed “German universal bank” is the problem rather than financial advice per se. In addition, one could take issue with the paper’s methodology, which draws on the traditional mean-variance optimization process for reaching conclusions. There are other assumptions that could conceivably skew results, such as that deciding that all transactions take place in the middle of the month.
The study, which analyzes "10,434 randomly selected customers for the 34-month period from January 2003 to October 2005," is hardly definitive, and so reasonable minds can differ about its relevance. But at the very least this research is a timely reminder that investors who hire advisors to manage money and/or dispense financial recommendations need to have a clear idea of what they’re paying for and who they're dealing with.
Suffice to say, different advisors offer different services and come with different skills. When it comes to straight investment advisory, it’s crucial to develop reasonable expectations and decide if you’re paying a fair price. That’s a complicated subject, of course, although no investor can afford to dismiss the necessary work to gain a reaosnable comfort level with a hired financial gun. The details, in short, can get messy when it comes to weighing the pros and cons of advisors.
Meantime, some of the usual caveats still apply. That starts with the recognition that the odds that any one advisor is going to deliver stellar performance results is probably expecting too much. Of course, everyone likes to focus on the outliers. The difference between Bernie Madoff’s results vs. Warren Buffett’s are the proverbial night-and-day outcomes. But for most investors, the middle ground is probably destiny.
Impressive investment returns are still dependent on three factors: skill, luck and asset/factor allocation. Quite often, a mix of all three is often relevant when analyzing results. For obvious reasons, advisors and money managers prefer to emphasize one of these variables over the other two.
There are no short cuts for intelligently choosing a financial planner, but you can start by asking prudent questions. The Certified Financial Planner Board of Standards, for instance, recommends 10 Questions to Ask When Choosing a Financial Planner. The Financial Planning Association publishes useful resources on the topic as well, including this primer.
Ultimately, many of the hazards that infect investing choices apply to choosing an advisor. Indeed, the decision may be as much art as it is science.
Even if you do everything right and choose a great planner, you’ll still need to monitor and assess through time. Expecting to fully transfer responsibility to an advisor and assuming that everything he or she recommends is exactly correct is asking for trouble. Yes, minding assets is time consuming and requires hard work. But you’re going to be involved one way or another. After all, it’s still your money.
Plan your goals well to secure happiness & money
The Dalai Lama once said: “Happiness is not something ready-made . It comes from your own actions.” When you look at the context of the same, we realise we are the sole creators of our happiness. And no one incident or person can change the course of this.
Happiness is the ultimate goal that everyone wants to achieve, it be in terms of health, wealth or social status. Bur rarely do we ask the question , what really makes us happy? For most of us, our happiness revolves around our goals and desires that we want to fulfill; it may be buying a house at 30 or planning a world tour with your spouse by 45. For us, our happiness is determined by the goals and dreams we plan to achieve.
Planning for your happiness is not as tough as it may sound. However, it is important to know what you’re planning for.
Know your dreams and how they make you happy. This is the first step towards understanding your goals. While you may have many wants and needs, it is important to segregate between the two and fulfill the ones that are more important to you and would make you happier. Once you have listed all the goals, discuss the same with your financial planner and explain to him the importance of a goal and how achieving that goal would make you happy.
Science of happiness helps:
Though you may have a tough time figuring out which of your needs are important enough to be fulfilled first, there is a simple process that we have come up with, called ‘the science of happiness test’ . Start this test by asking yourself this question: What do you want? Once you have answered the same, follow it up with a “why” . Each time you get an answer for the previous why, follow it up by another. By the end of five questions , you will realise how important that goal is and if it makes you happy. All our actions and goals are directed at helping us become happy, even if we are not aware about it consciously
http://www.cfpglobal.com/
Happiness is the ultimate goal that everyone wants to achieve, it be in terms of health, wealth or social status. Bur rarely do we ask the question , what really makes us happy? For most of us, our happiness revolves around our goals and desires that we want to fulfill; it may be buying a house at 30 or planning a world tour with your spouse by 45. For us, our happiness is determined by the goals and dreams we plan to achieve.
Planning for your happiness is not as tough as it may sound. However, it is important to know what you’re planning for.
Know your dreams and how they make you happy. This is the first step towards understanding your goals. While you may have many wants and needs, it is important to segregate between the two and fulfill the ones that are more important to you and would make you happier. Once you have listed all the goals, discuss the same with your financial planner and explain to him the importance of a goal and how achieving that goal would make you happy.
Science of happiness helps:
Though you may have a tough time figuring out which of your needs are important enough to be fulfilled first, there is a simple process that we have come up with, called ‘the science of happiness test’ . Start this test by asking yourself this question: What do you want? Once you have answered the same, follow it up with a “why” . Each time you get an answer for the previous why, follow it up by another. By the end of five questions , you will realise how important that goal is and if it makes you happy. All our actions and goals are directed at helping us become happy, even if we are not aware about it consciously
http://www.cfpglobal.com/
Higher CTC doesn't always mean higher pay
The truth is most professionals teach you strategies to employ during a job interview, not after. The result: unlike experienced hands, first-time job seekers fail to notice certain ruses companies employ to make an offer look "great".
Like many others, 23-year-old Ranbir Singh, too, realised his mistake late. He went for the highest cost-to-company (CTC) package. Singh, then a last-semester MBA student from a Hyderabad-based business school, had no choice but to rue his decision.
It is that time of the year again when corporates actively hunt for talent on campuses. So it is time to be on your guard. You had better scrutinise all offers before accepting the best one, and the bottom line is: higher CTC doesn't always mean higher pay.
Like many others, 23-year-old Ranbir Singh, too, realised his mistake late. He went for the highest cost-to-company (CTC) package. Singh, then a last-semester MBA student from a Hyderabad-based business school, had no choice but to rue his decision.
It is that time of the year again when corporates actively hunt for talent on campuses. So it is time to be on your guard. You had better scrutinise all offers before accepting the best one, and the bottom line is: higher CTC doesn't always mean higher pay.
EPF can make you a crorepati
Don't you hate it when you look at your salary slip and find that sundry deductions have pared it down. But believe us, you should actually feel happy about one of these deductions-the monthly contribution to the Employees' Provident Fund (EPF). The 12% of your basic salary that flows into the EPF every month has the potential to make you a crorepati when you retire.
Sounds unbelievable? After all, the investment seems too small and the interest rate offered doesn't seem too high. But don't forget that a matching contribution comes from your employer every month. Don't also underestimate the power of compounding and what it can do to your retirement savings over the long term. As the graphic above shows, the 8.5% interest earned on the EPF can help a person with a basic salary of Rs 25,000 a month accumulate a gargantuan Rs 1.65 crore in 35 years.
The Direct Taxes Code had initially proposed that new contributions to the EPF be taxed on withdrawal. However, the revised draft has once again made EPF fully exempt. This makes it the best debt option available in the market.
In fact, the EPF can single-handedly account for the debt portion of your financial portfolio. You need not invest in tax inefficient fixed deposits or worry about which debt fund to invest in. All you need to ensure is that you don't ever withdraw from your EPF account till you hang up your boots. If at any stage you find that your debt portion is lagging, you can add more through a voluntary increases in your contribution.
However, few people are able to reach even the Rs 1 crore milestone in their careers. EPF rules allow encashment of the accumulated corpus when a person quits a job and it's not uncommon for people to withdraw their PF at that stage.
This is despite the fact that the government discourages you from withdrawing the money. The withdrawals from the EPF within five years of joining are taxable. The tax will be minimal if the person is jobless and has no significant income from other sources but he won't completely escape the tax net. "When you withdraw you do not let the power of compounding to come into play," cautions Suresh Sadagopan, a Mumbai-based financial planner.
Transfer, don't withdraw: Instead of withdrawing money from the EPF on switching jobs, one should transfer the balance to the new account with the new employer. This does not happen automatically. You need to fill a ‘Form 13' and deposit it with the EPFO. Financial advisers recommend that you put this down among the list of priorities at the new workplace. "You should take up the matter with new organization as soon as you join. With passage of time you might get busy. Also, if your previous organization has lost the records, you could face a hard time looking for your PF details," adds Sadogapan.
In the form you are required to fill in details of your previous organisation including the previous EPF number and the regional provident fund office. The account number is basically a combination of your employee code, the PF regional office with which the account is maintained and your employer's PF code. Once the new organisation gets these details, it adds the new account number to it and submits the form to the regional office with which your previous organization had an account. In case your previous organisation had maintained a trust, the form has to be sent to the trust and a copy to the regional provident fund.
Though the process of transferring takes nearly a month, the good news is that the EPFO is developing a new software for enabling online transfer of money from the older accounts to the newer ones. This will not only reduce the paperwork but also the time taken for the transaction.
What if you don't transfer: Till now, there was no compelling reason to transfer the money from an old account to a new one. Even if you stopped putting money in your account, the balance kept earning interest till the time of withdrawal. This will stop from April 2011. After three years of inactivity, the balance will stop earning interest.
Even otherwise, multiple accounts can be a pain. They only add to your paperwork because you need to keep records of different accounts. Also, you will need to fill up separate forms to withdraw the money from the accounts. The process gets more cumbersome if accounts are located in different cities. "Transferring the balance not only makes it easy to transact, but also gives the subscriber a better idea of how much he has in his account," says Amit Gopal, senior vice-president, India Life Capital.
In future the social security number, which is in progress, would make EPF portable. "Once this number is allotted to members, they need not switch the funds. The new employer would make the contributions into that account. It will be completely independent of the workplace," he adds
Sounds unbelievable? After all, the investment seems too small and the interest rate offered doesn't seem too high. But don't forget that a matching contribution comes from your employer every month. Don't also underestimate the power of compounding and what it can do to your retirement savings over the long term. As the graphic above shows, the 8.5% interest earned on the EPF can help a person with a basic salary of Rs 25,000 a month accumulate a gargantuan Rs 1.65 crore in 35 years.
The Direct Taxes Code had initially proposed that new contributions to the EPF be taxed on withdrawal. However, the revised draft has once again made EPF fully exempt. This makes it the best debt option available in the market.
In fact, the EPF can single-handedly account for the debt portion of your financial portfolio. You need not invest in tax inefficient fixed deposits or worry about which debt fund to invest in. All you need to ensure is that you don't ever withdraw from your EPF account till you hang up your boots. If at any stage you find that your debt portion is lagging, you can add more through a voluntary increases in your contribution.
However, few people are able to reach even the Rs 1 crore milestone in their careers. EPF rules allow encashment of the accumulated corpus when a person quits a job and it's not uncommon for people to withdraw their PF at that stage.
This is despite the fact that the government discourages you from withdrawing the money. The withdrawals from the EPF within five years of joining are taxable. The tax will be minimal if the person is jobless and has no significant income from other sources but he won't completely escape the tax net. "When you withdraw you do not let the power of compounding to come into play," cautions Suresh Sadagopan, a Mumbai-based financial planner.
Transfer, don't withdraw: Instead of withdrawing money from the EPF on switching jobs, one should transfer the balance to the new account with the new employer. This does not happen automatically. You need to fill a ‘Form 13' and deposit it with the EPFO. Financial advisers recommend that you put this down among the list of priorities at the new workplace. "You should take up the matter with new organization as soon as you join. With passage of time you might get busy. Also, if your previous organization has lost the records, you could face a hard time looking for your PF details," adds Sadogapan.
In the form you are required to fill in details of your previous organisation including the previous EPF number and the regional provident fund office. The account number is basically a combination of your employee code, the PF regional office with which the account is maintained and your employer's PF code. Once the new organisation gets these details, it adds the new account number to it and submits the form to the regional office with which your previous organization had an account. In case your previous organisation had maintained a trust, the form has to be sent to the trust and a copy to the regional provident fund.
Though the process of transferring takes nearly a month, the good news is that the EPFO is developing a new software for enabling online transfer of money from the older accounts to the newer ones. This will not only reduce the paperwork but also the time taken for the transaction.
What if you don't transfer: Till now, there was no compelling reason to transfer the money from an old account to a new one. Even if you stopped putting money in your account, the balance kept earning interest till the time of withdrawal. This will stop from April 2011. After three years of inactivity, the balance will stop earning interest.
Even otherwise, multiple accounts can be a pain. They only add to your paperwork because you need to keep records of different accounts. Also, you will need to fill up separate forms to withdraw the money from the accounts. The process gets more cumbersome if accounts are located in different cities. "Transferring the balance not only makes it easy to transact, but also gives the subscriber a better idea of how much he has in his account," says Amit Gopal, senior vice-president, India Life Capital.
In future the social security number, which is in progress, would make EPF portable. "Once this number is allotted to members, they need not switch the funds. The new employer would make the contributions into that account. It will be completely independent of the workplace," he adds
2011 to welcome a new Finance inclusion plan
Bangalore: In order to aim at bringing unbanked area in to banking fold, the government is all set to launch a new nationwide campaign for financial inclusion, Swabhiman in the New Year wherein the key idea lies in transforming the programme into an extensively based political association. Sonia Gandhi, the Congress President would be bringing the campaign into public notice in New Delhi,as reported by Kumud Das, Sitanshu Swain.
The government is ambitiously seeking the banking services growth to spread into the selected 73,000 villages having population up to 2000, by March, 2012 with the assistance of the financial inclusion programme. The primary idea of the campaign is to spread financial literacy amongst the people.
In order to launch the nationwide campaign at the hands of Congress high command by speaking to FE, KV Eapen, the finance ministry is on red alert for the preparation of ground work. As the confirmation was received from the ministry of finance about the financial inclusion campaign, with the assistance of Indian Banks' Association (IBA), the other banks have been asked to come out with similar campaigns.
"Through the Swabhiman programme, we are not only concerned about opening of nearly 4 crore no-frills accounts in the country. We also want that there must be transactions through those accounts to make it a huge success," said Eapen. "The Centre wants banks to take the help of business correspondents (BCs) to reach masses in rural areas. Finally, we expect the banks to adopt the route to popularize the electronic benefit transfer (EBT) scheme too, through which the government makes payments to the workers involved in various government-run schemes by way of smart cards," he said.
18 state-owned banks which included Central Bank of India CMD S Sridhar, Indian Overseas Bank CMD M Narendra, Bank of Maharashtra CMD AS Bhattarcharya, and Indian Bank CMD TM Bhasin represented the banking industry and also concluded on a lot of strategies which can be helpful for the implementation of the government agenda.
In order to have a final review, another meeting in Mumbai will be organized by the finance ministry towards the February-end. Financial inclusion is a compulsion and not just an option according to Prime Minister's Economic Advisory Council chairman C Rangarajan. "Banks need to think on how to meet the challenge of meeting the credit demands of the marginalized," he had suggested. Bhaskar Sen, CMD, United Bank of India opined that the role of a bank has already been made clear which requires more aggression so that the financial inclusion target can be achieved
The government is ambitiously seeking the banking services growth to spread into the selected 73,000 villages having population up to 2000, by March, 2012 with the assistance of the financial inclusion programme. The primary idea of the campaign is to spread financial literacy amongst the people.
In order to launch the nationwide campaign at the hands of Congress high command by speaking to FE, KV Eapen, the finance ministry is on red alert for the preparation of ground work. As the confirmation was received from the ministry of finance about the financial inclusion campaign, with the assistance of Indian Banks' Association (IBA), the other banks have been asked to come out with similar campaigns.
"Through the Swabhiman programme, we are not only concerned about opening of nearly 4 crore no-frills accounts in the country. We also want that there must be transactions through those accounts to make it a huge success," said Eapen. "The Centre wants banks to take the help of business correspondents (BCs) to reach masses in rural areas. Finally, we expect the banks to adopt the route to popularize the electronic benefit transfer (EBT) scheme too, through which the government makes payments to the workers involved in various government-run schemes by way of smart cards," he said.
18 state-owned banks which included Central Bank of India CMD S Sridhar, Indian Overseas Bank CMD M Narendra, Bank of Maharashtra CMD AS Bhattarcharya, and Indian Bank CMD TM Bhasin represented the banking industry and also concluded on a lot of strategies which can be helpful for the implementation of the government agenda.
In order to have a final review, another meeting in Mumbai will be organized by the finance ministry towards the February-end. Financial inclusion is a compulsion and not just an option according to Prime Minister's Economic Advisory Council chairman C Rangarajan. "Banks need to think on how to meet the challenge of meeting the credit demands of the marginalized," he had suggested. Bhaskar Sen, CMD, United Bank of India opined that the role of a bank has already been made clear which requires more aggression so that the financial inclusion target can be achieved
Saturday, December 18, 2010
Warren Buffet's investing style?
If you want to emulate a classic value style, Warren Buffett is a great role model. Early in his career, Buffett said, "I'm 85% Benjamin Graham." Graham is the godfather of value investing, and introduced the idea of intrinsic value - the underlying fair value of a stock based on its future earnings power. But there are a few things worth noting about Buffett's interpretation of value investing that may surprise you. (For more on Warren Buffett and his current holdings, check out Coattail Investor.)
First, like many successful formulas, Buffett's looks simple. But simple does not mean easy. To guide him in his decisions, Buffett uses twelve investing tenets, or key considerations, which are categorized in the areas of business, management, financial measures and value. (See detailed explanations below.) Buffett's tenets may sound cliché and easy to understand, but they can be very difficult to execute. For example, one tenet asks if management is candid with shareholders. This is simple to ask and simple to understand, but it is not easy to answer. Conversely, there are interesting examples of the reverse: concepts that appear complex yet are easy to execute, such as economic value added (EVA). The full calculation of EVA is not easy to comprehend, and the explanation of EVA tends to be complex. But once you understand that EVA is a laundry list of adjustments - and once armed with the formula - it is fairly easy to calculate EVA for any company. (Interested in what companies Warren Buffett is buying and selling? Check out Coattail Investor, a subscription product tracking some of the best investors in the world.)
Second, the Buffett “way” can be viewed as a core, traditional style of investing that is open to adaptation. Even Hagstrom, who is a practicing Buffett disciple, or "Buffettologist", modified his own approach along the way to include technology stocks, a category Buffett conspicuously continues to avoid. One of the compelling aspects of Buffettology is its flexibility alongside its phenomenal success. If it were a religion, it would not be dogmatic but instead self-reflective and adaptive to the times. This is a good thing. Day traders may require rigid discipline and adherence to a formula (for example, as a means of controlling emotions), but it can be argued that successful investors ought to be willing to adapt their mental models to current environments.
Business
Buffett adamantly restricts himself to his "circle of competence" - businesses he can understand and analyze. As Hagstrom writes, investment success is not a matter of how much you know but rather how realistically you define what you don't know. Buffett considers this deep understanding of the operating business to be a prerequisite for a viable forecast of future business performance. After all, if you don't understand the business, how can you project performance? Buffett's business tenets each support the goal of producing a robust projection. First, analyze the business, not the market or the economy or investor sentiment. Next, look for a consistent operating history. Finally, use that data to ascertain whether the business has favorable long-term prospects.
Management Buffett's three management tenets help evaluate management quality. This is perhaps the most difficult analytical task for an investor. Buffett asks, "Is management rational?" Specifically, is management wise when it comes to reinvesting (retaining) earnings or returning profits to shareholders as dividends? This is a profound question, because most research suggests that historically, as a group and on average, management tends to be greedy and retain a bit too much (profits), as it is naturally inclined to build empires and seek scale rather than utilize cash flow in a manner that would maximize shareholder value. Another tenet examines management's honesty with shareholders. That is, does it admit mistakes? Lastly, does management resist the institutional imperative? This tenet seeks out management teams that resist a "lust for activity" and the lemming-like duplication of competitor strategies and tactics. It is particularly worth savoring because it requires you to draw a fine line between many parameters (for example, between blind duplication of competitor strategy and outmaneuvering a company that is first to market).
Financial Measures
Buffett focuses on return on equity (ROE) rather than on earnings per share. Most finance students understand that ROE can be distorted by leverage (a debt-to-equity ratio) and therefore is theoretically inferior to some degree to the return-on-capital metric. Here, return-on-capital is more like return on assets (ROA) or return on capital employed (ROCE), where the numerator equals earnings produced for all capital providers and the denominator includes debt and equity contributed to the business. Buffett understands this, of course, but instead examines leverage separately, preferring low-leverage companies. He also looks for high profit margins.
His final two financial tenets share a theoretical foundation with EVA. First, Buffett looks at what he calls "owner's earnings", which is essentially cash flow available to shareholders, or technically, free cash flow to equity (FCFE). Buffett defines it as net income plus depreciation and amortization (for example, adding back non-cash charges) minus capital expenditures (CAPX) minus additional working capital (W/C) needs. In summary, net income + D&A - CAPX - (change in W/C). Purists will argue the specific adjustments, but this equation is close enough to EVA before you deduct an equity charge for shareholders. Ultimately, with owners' earnings, Buffett looks at a company's ability to generate cash for shareholders, who are the residual owners.
Buffett also has a "one-dollar premise", which is based on the question: What is the market value of a dollar assigned to each dollar of retained earnings? This measure bears a strong resemblance to market value added (MVA), the ratio of market value to invested capital.
Value
Here, Buffett seeks to estimate a company's intrinsic value. A colleague summarized this well-regarded process as "bond math". Buffett projects the future owner's earnings, then discounts them back to the present. Keep in mind that if you've applied Buffett's other tenets, the projection of future earnings is, by definition, easier to do, because consistent historical earnings are easier to forecast.
Buffett also coined the term "moat", which has subsequently resurfaced in Morningstar's successful habit of favoring companies with a "wide economic moat". The moat is the "something that gives a company a clear advantage over others and protects it against incursions from the competition". In a bit of theoretical heresy perhaps available only to Buffett himself, he discounts projected earnings at the risk-free rate, claiming that the "margin of safety" in carefully applying his other tenets presupposes the minimization, if not the virtual elimination, of risk.
Summary
In essence, Buffett's tenets constitute a foundation in value investing, which may be open to adaptation and reinterpretation going forward. It is an open question as to the extent to which these tenets require modification in light of a future where consistent operating histories are harder to find, intangibles play a greater role in franchise value and the blurring of industries' boundaries makes deep business analysis more difficult.
The Most Important Day in America in 50 Years... Coming in 2011. This day will change everything about our nation and your day-to-day life. Watch the eye-opening video presentation here.
by David Harper,CFA, FRM (Contact Author
Biography)
In addition to writing for Investopedia, David Harper, CFA, FRM, is the founder of The Bionic Turtle, a site that trains professionals in advanced and career-related finance, including financial certification. David was a founding co-editor of the Investopedia Advisor, where his original portfolios (core, growth and technology value) led to superior outperformance (+35% in the first year) with minimal risk and helped to successfully launch Advisor.
He is the principal of Investor Alternatives, a firm that conducts quantitative research, consulting (derivatives valuation), litigation support and financial education.
First, like many successful formulas, Buffett's looks simple. But simple does not mean easy. To guide him in his decisions, Buffett uses twelve investing tenets, or key considerations, which are categorized in the areas of business, management, financial measures and value. (See detailed explanations below.) Buffett's tenets may sound cliché and easy to understand, but they can be very difficult to execute. For example, one tenet asks if management is candid with shareholders. This is simple to ask and simple to understand, but it is not easy to answer. Conversely, there are interesting examples of the reverse: concepts that appear complex yet are easy to execute, such as economic value added (EVA). The full calculation of EVA is not easy to comprehend, and the explanation of EVA tends to be complex. But once you understand that EVA is a laundry list of adjustments - and once armed with the formula - it is fairly easy to calculate EVA for any company. (Interested in what companies Warren Buffett is buying and selling? Check out Coattail Investor, a subscription product tracking some of the best investors in the world.)
Second, the Buffett “way” can be viewed as a core, traditional style of investing that is open to adaptation. Even Hagstrom, who is a practicing Buffett disciple, or "Buffettologist", modified his own approach along the way to include technology stocks, a category Buffett conspicuously continues to avoid. One of the compelling aspects of Buffettology is its flexibility alongside its phenomenal success. If it were a religion, it would not be dogmatic but instead self-reflective and adaptive to the times. This is a good thing. Day traders may require rigid discipline and adherence to a formula (for example, as a means of controlling emotions), but it can be argued that successful investors ought to be willing to adapt their mental models to current environments.
Business
Buffett adamantly restricts himself to his "circle of competence" - businesses he can understand and analyze. As Hagstrom writes, investment success is not a matter of how much you know but rather how realistically you define what you don't know. Buffett considers this deep understanding of the operating business to be a prerequisite for a viable forecast of future business performance. After all, if you don't understand the business, how can you project performance? Buffett's business tenets each support the goal of producing a robust projection. First, analyze the business, not the market or the economy or investor sentiment. Next, look for a consistent operating history. Finally, use that data to ascertain whether the business has favorable long-term prospects.
Management Buffett's three management tenets help evaluate management quality. This is perhaps the most difficult analytical task for an investor. Buffett asks, "Is management rational?" Specifically, is management wise when it comes to reinvesting (retaining) earnings or returning profits to shareholders as dividends? This is a profound question, because most research suggests that historically, as a group and on average, management tends to be greedy and retain a bit too much (profits), as it is naturally inclined to build empires and seek scale rather than utilize cash flow in a manner that would maximize shareholder value. Another tenet examines management's honesty with shareholders. That is, does it admit mistakes? Lastly, does management resist the institutional imperative? This tenet seeks out management teams that resist a "lust for activity" and the lemming-like duplication of competitor strategies and tactics. It is particularly worth savoring because it requires you to draw a fine line between many parameters (for example, between blind duplication of competitor strategy and outmaneuvering a company that is first to market).
Financial Measures
Buffett focuses on return on equity (ROE) rather than on earnings per share. Most finance students understand that ROE can be distorted by leverage (a debt-to-equity ratio) and therefore is theoretically inferior to some degree to the return-on-capital metric. Here, return-on-capital is more like return on assets (ROA) or return on capital employed (ROCE), where the numerator equals earnings produced for all capital providers and the denominator includes debt and equity contributed to the business. Buffett understands this, of course, but instead examines leverage separately, preferring low-leverage companies. He also looks for high profit margins.
His final two financial tenets share a theoretical foundation with EVA. First, Buffett looks at what he calls "owner's earnings", which is essentially cash flow available to shareholders, or technically, free cash flow to equity (FCFE). Buffett defines it as net income plus depreciation and amortization (for example, adding back non-cash charges) minus capital expenditures (CAPX) minus additional working capital (W/C) needs. In summary, net income + D&A - CAPX - (change in W/C). Purists will argue the specific adjustments, but this equation is close enough to EVA before you deduct an equity charge for shareholders. Ultimately, with owners' earnings, Buffett looks at a company's ability to generate cash for shareholders, who are the residual owners.
Buffett also has a "one-dollar premise", which is based on the question: What is the market value of a dollar assigned to each dollar of retained earnings? This measure bears a strong resemblance to market value added (MVA), the ratio of market value to invested capital.
Value
Here, Buffett seeks to estimate a company's intrinsic value. A colleague summarized this well-regarded process as "bond math". Buffett projects the future owner's earnings, then discounts them back to the present. Keep in mind that if you've applied Buffett's other tenets, the projection of future earnings is, by definition, easier to do, because consistent historical earnings are easier to forecast.
Buffett also coined the term "moat", which has subsequently resurfaced in Morningstar's successful habit of favoring companies with a "wide economic moat". The moat is the "something that gives a company a clear advantage over others and protects it against incursions from the competition". In a bit of theoretical heresy perhaps available only to Buffett himself, he discounts projected earnings at the risk-free rate, claiming that the "margin of safety" in carefully applying his other tenets presupposes the minimization, if not the virtual elimination, of risk.
Summary
In essence, Buffett's tenets constitute a foundation in value investing, which may be open to adaptation and reinterpretation going forward. It is an open question as to the extent to which these tenets require modification in light of a future where consistent operating histories are harder to find, intangibles play a greater role in franchise value and the blurring of industries' boundaries makes deep business analysis more difficult.
The Most Important Day in America in 50 Years... Coming in 2011. This day will change everything about our nation and your day-to-day life. Watch the eye-opening video presentation here.
by David Harper,CFA, FRM (Contact Author
Biography)
In addition to writing for Investopedia, David Harper, CFA, FRM, is the founder of The Bionic Turtle, a site that trains professionals in advanced and career-related finance, including financial certification. David was a founding co-editor of the Investopedia Advisor, where his original portfolios (core, growth and technology value) led to superior outperformance (+35% in the first year) with minimal risk and helped to successfully launch Advisor.
He is the principal of Investor Alternatives, a firm that conducts quantitative research, consulting (derivatives valuation), litigation support and financial education.
Senior Citizens: Three dividends a day
No less than 1,900 systematic investment plans (SIPs). Investments in 97% of all equity mutual funds, barring three asset management companies. Ninety dividends a month, averaging three a day. This is the investment strategy of 75-year-old Harubhai Sanghavi. Outrageous and contrary to all investment precepts? Yes. But the Mumbai-based septuagenarian thinks otherwise.
“It started with an investment in State Bank of India Magnum Multiplier in 1992-93. I was involved with my family business of seamless pipes and had no idea about mutual funds,” recalls Sanghavi. That was then. Today, he doesn't miss a single advertisement of a new fund offer (NFO) or the re-opening of a close-ended scheme. As soon as companies make an announcement, Sanghavi gets to work, deciding how to allocate dividends from previous NFOs in the dividend option of the new fund.
He never uses the dividends for personal use as his family meets his expenses. “I have created a chicken farm. The chickens lay eggs that hatch into chickens that lay more eggs. I am not interested in redemptions,” explains Sanghavi. Such rotational investments will soon force him to request for the 40th passbook from his bank.
In each NFO , he invests anywhere between Rs 500 and Rs 1,000 in the name of his children, their spouses
and grandchildren. What is the metric for evaluating a fund? Their net asset value (NAV). Financial advisers will immediately trash the idea, after all, NAVs have no impact on net returns. But Sanghavi is unfazed: “I choose NFOs because the unit value is Rs 10. If the NAV drops below `10 after the NFO, then I continue with the SIP for another six months,” he says.
Isn’t he concerned about investing in a fund with no performance history or deteriorating value? “Mutual fund offer documents state that past performance is no guarantee for the future. Moreover, I have not incurred any loss till now. I get units at Rs 10-10.50 and sometimes at Rs 7-8 during the initial months. Then I let investments grow,” he says.
Sanghavi proves his point with facts: “During the market crash in 2008, I purchased some schemes whose NAVs were as low as Rs 2-3 and about 25% lower. Today, they have grown by about four times.”
The humungous paperwork doesn’t deter him either. Initially, Sanghavi used a broker but since entry loads were scrapped, he deals with the fund houses directly. Helping him track his investments is a special spreadsheet prepared by his granddaughter.
“She has used icons of the 37 asset management companies. I click on them and all the SIPs open up on my computer screen,” he says. Wary of electronic records, he also keeps print outs of all investments since 2004-05 in a thick ledger.
Sanghavi has upturned the idea that age shrinks risk appetite. He is only focused on generating better returns than FDs, debt or liquid funds. The only thing about dividends that upsets him is the distribution of surplus. “Why do fund houses preserve maximum surplus and give out meager dividends. If the NAV rises from Rs 10 to Rs 23, they offer 1 paisa or 20 paise as dividends. Why not more? They must define the formula to calculate dividends,” he says. But that won't stop Sanghavi from collecting more of them
“It started with an investment in State Bank of India Magnum Multiplier in 1992-93. I was involved with my family business of seamless pipes and had no idea about mutual funds,” recalls Sanghavi. That was then. Today, he doesn't miss a single advertisement of a new fund offer (NFO) or the re-opening of a close-ended scheme. As soon as companies make an announcement, Sanghavi gets to work, deciding how to allocate dividends from previous NFOs in the dividend option of the new fund.
He never uses the dividends for personal use as his family meets his expenses. “I have created a chicken farm. The chickens lay eggs that hatch into chickens that lay more eggs. I am not interested in redemptions,” explains Sanghavi. Such rotational investments will soon force him to request for the 40th passbook from his bank.
In each NFO , he invests anywhere between Rs 500 and Rs 1,000 in the name of his children, their spouses
and grandchildren. What is the metric for evaluating a fund? Their net asset value (NAV). Financial advisers will immediately trash the idea, after all, NAVs have no impact on net returns. But Sanghavi is unfazed: “I choose NFOs because the unit value is Rs 10. If the NAV drops below `10 after the NFO, then I continue with the SIP for another six months,” he says.
Isn’t he concerned about investing in a fund with no performance history or deteriorating value? “Mutual fund offer documents state that past performance is no guarantee for the future. Moreover, I have not incurred any loss till now. I get units at Rs 10-10.50 and sometimes at Rs 7-8 during the initial months. Then I let investments grow,” he says.
Sanghavi proves his point with facts: “During the market crash in 2008, I purchased some schemes whose NAVs were as low as Rs 2-3 and about 25% lower. Today, they have grown by about four times.”
The humungous paperwork doesn’t deter him either. Initially, Sanghavi used a broker but since entry loads were scrapped, he deals with the fund houses directly. Helping him track his investments is a special spreadsheet prepared by his granddaughter.
“She has used icons of the 37 asset management companies. I click on them and all the SIPs open up on my computer screen,” he says. Wary of electronic records, he also keeps print outs of all investments since 2004-05 in a thick ledger.
Sanghavi has upturned the idea that age shrinks risk appetite. He is only focused on generating better returns than FDs, debt or liquid funds. The only thing about dividends that upsets him is the distribution of surplus. “Why do fund houses preserve maximum surplus and give out meager dividends. If the NAV rises from Rs 10 to Rs 23, they offer 1 paisa or 20 paise as dividends. Why not more? They must define the formula to calculate dividends,” he says. But that won't stop Sanghavi from collecting more of them
Is this the right time to buy a house?
This question perpetually haunts a home buyer, particularly when property prices are very high. The time is always right when you are buying a house for your own residential purpose.
So are you looking forward to buying your own dream home? You should take into account certain factors before concretising your purchase decision.
As a rule, no prospective home buyer can or should try to time the market and base his/her purchase decision on that. But there is a major exception to this rule.
You can take the first step by making a long-term commitment to a particular city, besides accumulating the necessary down payment amount (at least 20 -25 % of the home value) saved up as well as the earning necessary to pay the home loan EMIs.
The amount of down payment you have and the loan you are eligible for (which in turn is based on prevailing interest rates) will determine the value of the house that you can buy. Interest rates are on a floating basis (even in teaser rates they become floating after 1-5 years) and will go through many changes during a long-term loan product like home loans. Hence, while they can determine what house you can buy they definitely cannot determine the timing for such a purchase.
The Exception:
Those of our readers who have been following us will remember the exception that we publicly spoke about from the second half of 2007 till the Diwali of 2008 when property prices had climbed to stratospheric levels and sales had dropped to a trickle, making a price correction imminent
So are you looking forward to buying your own dream home? You should take into account certain factors before concretising your purchase decision.
As a rule, no prospective home buyer can or should try to time the market and base his/her purchase decision on that. But there is a major exception to this rule.
You can take the first step by making a long-term commitment to a particular city, besides accumulating the necessary down payment amount (at least 20 -25 % of the home value) saved up as well as the earning necessary to pay the home loan EMIs.
The amount of down payment you have and the loan you are eligible for (which in turn is based on prevailing interest rates) will determine the value of the house that you can buy. Interest rates are on a floating basis (even in teaser rates they become floating after 1-5 years) and will go through many changes during a long-term loan product like home loans. Hence, while they can determine what house you can buy they definitely cannot determine the timing for such a purchase.
The Exception:
Those of our readers who have been following us will remember the exception that we publicly spoke about from the second half of 2007 till the Diwali of 2008 when property prices had climbed to stratospheric levels and sales had dropped to a trickle, making a price correction imminent
Six tips to make the most of your PPF
The stock market, despite the probability of giddy returns, can give you the heebie-jeebies due to the wild swings in share prices. Fixed deposits can be a turnoff because the interest earned is taxable. For investors seeking the best of both worlds, there is the Public Provident Fund (PPF). Wrapped in safety and free of tax, the PPF is almost a godsend for risk-averse investors.
“PPF is an excellent tool for long-term investment. It is risk-free as it is backed by the government,” says Harsh Roongta, CEO of apnapaisa.com. It is especially suitable for self-employed professionals and small businessmen who are not covered by the Employees' Provident Fund . “Those who don't have access to an organised setup can realise long-term goals through the PPF,” says Surya Bhatia, a Delhi-based financial planner .
Don’t think of your PPF account as a stodgy investment option where you put away something once in a year. With a little planning, it can be an important part of your financial portfolio. Here are a few tips that will help you make the most of this option:
Maximise limit:
The 8% compounding interest you earn on the balance can work wonders for you, especially because a PPF account is a long-term investment. There is an annual limit of Rs 70,000 that one can invest in the PPF. You may feel it is a waste to be investing Rs 70,000 in this option when your Rs 1 lakh tax saving limit under Section 80C has already got exhausted. But don't let the tax savings alone guide your decision. Invest as much in PPF as you can afford to. If you contribute Rs 70,000 a year to your PPF for 15 years, your investment would grow to a gargantuan Rs 22.92 lakh on maturity.
And remember, this is tax-free money. In the 30% tax bracket, this is equivalent to receiving almost 11.5% interest on a bank fixed deposit. “The PPF offers the highest post-tax returns among all fixed income options since no tax is levied on the investment, income and withdrawals,” says Bhatia.
Distribute income:
There are benefits in store if you open a PPF account in the name of your spouse or child. Tax laws say that if any money gifted to a spouse is invested, the income from that investment is clubbed with the income of the giver. But since PPF income is tax free, it will not push up his tax liability. This way, you can invest more than Rs 70,000 a year in this tax-free haven and benefit from its various advantages.
This strategy does not work in case of minor children though. You can open a PPF account in the name of a minor child but the combined contribution to your and your child's account cannot exceed Rs 70,000 a year.
Invest for children:
However, if the child is over 18 years, up to Rs 70,000 a year can be invested in his name separately. The taxman insists on clubbing the income of minor children with that of the parent. But once they turn 18, they can have a separate income. “A PPF is an ideal way of building a fund for your child's educational needs instead of falling for all the ‘high-commission-paying’ child plans of insurers,” says Sandeep Shanbhag, director of Wonderland Consultants, a tax and financial planning firm. “In a child plan, you are not sure of the final returns.
“PPF is an excellent tool for long-term investment. It is risk-free as it is backed by the government,” says Harsh Roongta, CEO of apnapaisa.com. It is especially suitable for self-employed professionals and small businessmen who are not covered by the Employees' Provident Fund . “Those who don't have access to an organised setup can realise long-term goals through the PPF,” says Surya Bhatia, a Delhi-based financial planner .
Don’t think of your PPF account as a stodgy investment option where you put away something once in a year. With a little planning, it can be an important part of your financial portfolio. Here are a few tips that will help you make the most of this option:
Maximise limit:
The 8% compounding interest you earn on the balance can work wonders for you, especially because a PPF account is a long-term investment. There is an annual limit of Rs 70,000 that one can invest in the PPF. You may feel it is a waste to be investing Rs 70,000 in this option when your Rs 1 lakh tax saving limit under Section 80C has already got exhausted. But don't let the tax savings alone guide your decision. Invest as much in PPF as you can afford to. If you contribute Rs 70,000 a year to your PPF for 15 years, your investment would grow to a gargantuan Rs 22.92 lakh on maturity.
And remember, this is tax-free money. In the 30% tax bracket, this is equivalent to receiving almost 11.5% interest on a bank fixed deposit. “The PPF offers the highest post-tax returns among all fixed income options since no tax is levied on the investment, income and withdrawals,” says Bhatia.
Distribute income:
There are benefits in store if you open a PPF account in the name of your spouse or child. Tax laws say that if any money gifted to a spouse is invested, the income from that investment is clubbed with the income of the giver. But since PPF income is tax free, it will not push up his tax liability. This way, you can invest more than Rs 70,000 a year in this tax-free haven and benefit from its various advantages.
This strategy does not work in case of minor children though. You can open a PPF account in the name of a minor child but the combined contribution to your and your child's account cannot exceed Rs 70,000 a year.
Invest for children:
However, if the child is over 18 years, up to Rs 70,000 a year can be invested in his name separately. The taxman insists on clubbing the income of minor children with that of the parent. But once they turn 18, they can have a separate income. “A PPF is an ideal way of building a fund for your child's educational needs instead of falling for all the ‘high-commission-paying’ child plans of insurers,” says Sandeep Shanbhag, director of Wonderland Consultants, a tax and financial planning firm. “In a child plan, you are not sure of the final returns.
Wednesday, December 15, 2010
Livelihood and microfinance
We, as a country, have come a long way in meeting the financial needs of the poor. We are witnessing a transformation of micro-finance as a growth industry. More and more women are mobilized into SHGs all over the country. They are further mobilized into higher order federations. Bank linkages are growing rapidly. Some banks have started to offer cash credit lines of Rs.5 lakh per group. Credit Cards to farmers, weavers etc., are not uncommon now.
While a lot more poor still need to be reached out with access to microfinance services, and some more services can be loaded onto microfinance bandwagon, many a poor and their organizations are struggling to find ideas to invest the funds in remunerative activities. The problem moves from the lack of funds to the lack of ideas to invest the funds. The sector moves from the microfinance to microfinance plus all across. Each one is exploring the ‘plus’. The ‘plus’ may include insurance, loans and repayments in kind, food loans, businesses by the groups and federations themselves, public services for fee etc.
Most of us, who are and continue in the development sector, are essentially livelihoods workers and their intent is to ensure that everyone including the poor have a decent portfolio of livelihoods. The livelihoods are a play of six capitals – natural, physical, social, human, financial and spiritual, within the four contexts – ecological, techno-economic, patterns of distribution of capitals and patterns of investment and expenditure, resulting in four arrows – income, expenditure, employment and risks. The livelihoods interventions are at the level of one or more arrows, capitals, contexts and/or a combination thereof. Thus, the intervention resulting in enhancing livelihoods may happen with information, knowledge, skill development, infrastructure, access to finance, collectivization, access to storage, technology, value-addition processes, direct reach out to the market/consumer, risk diversification, minimum assured returns, etc. Therefore, the livelihoods interventions range from extremely simple actions to extremely complex sets of activities. Thus, microfinance activities are a small subset of the large livelihoods domain. Microfinance plus ways are expanding this subset to an extent.
Microfinance activities have become fairly systematic and the processes have become ‘standard’ for easy replication and scaling-up. The communities have responded well to these processes and are endorsing them with 99%+ repayment rates. The investors and the bankers are responding with increased investments for microfinance. It is able to attract a good number of human resources into it. The remunerations, it is able to pay, are comparable with the corporate sector. Bright and young minds are getting attracted to give a try.
Livelihoods activities are too large in number to attempt any standardization and/or systematization. For example, a small village of 100-200 families may have a number of crops, some once a year, some twice a year and sometimes thrice a year. It may have some plantation crops and some horticulture crops. It may have some trees and some fruit-bearing trees. It may have fisheries and produce a variety of fishes. It may have livestock including sheep and goats, cattle, buffaloes etc. It may have handlooms and handicrafts. It may have stone cutting, bidi rolling, and other miscellaneous activities. There may also be some support services like transport, trade, education etc. The people may be casual labour, skilled labour, self-employed, enterprise owners etc. Some may be full-timers and some part-timers. Some may not be engaged in direct income generation activities.
We have very few people who can appreciate and support these livelihoods in toto. In fact, there are very few who can appreciate and support a single value-chain in its entirety. The so-called experts master a bit of the value-chain. Yet, the poor and their collectives cannot afford them.
Some elements in the way forward for enhancing the livelihoods of the poor include organizing women and youth around savings, credit and micro-insurance into SHGs and their higher order federations; undertaking participatory livelihoods planning appreciating livelihoods current reality, gaps and opportunities; facilitating bank linkages and convergence with other programs to realize these plans; organizing people around livelihoods activities; organizing shops that sell essential items; building skills of the youth for meeting the services required; exploring employment opportunities outside and providing training; and building human resources for working in the people’s institutions.
The way forward gets further complicated when we contemplate about the people whose lives and livelihoods are threatened and affected by disasters. A variety of disasters and crises are looming large. This gets further amplified in many an ecologically fragile and marginalized zone. This further gets fuzzy for the poor with globalization, liberalization, privatization and climate changes.
In this dynamic context, we, the ‘blind’, should ensure that all the ‘blind’ come together and unravel the ‘elephant’ first, and explore the solutions. We need to reach the ‘ant’ when the ‘fish’ does not dry-up (as in the seven fish and the ant story). We need to recollect the sane advice of Seattle, the Red Indian Chief of conserving and living sustainable livelihoods.
As the pace of life is dramatically faster than what our grandfathers had, the most prominent issue is how we could offer ‘metafishing’ skills to the community, in addition to offering ‘fishing’ skills, in stead of offering fish. This is the need of the hour. The entire country and the world have to gear up for this effort. And I understand that this takes time, may be 10 years or 20 years. This can begin with appreciation of current reality and pooling up knowledge-skills-resources in people’s domain with K-S-R in our domain and outsiders’ domain. This in turn generates a variety of informed choices for the community to choose from. The community implements the plan so developed. In these iterative and repeated rounds, the community acquires metafishing skills and, I guess, learns to adapt to the changing needs and changing contexts.
Vast majority of the poor have to become partners in the high growth of the country. The issue is how we take some poor out of the existing traditional activities so that the remaining poor have better returns. What kind of vocations we can think of offering to them so that they come out and prosper? The situation at migration is not ‘great’. How do we address the plaguing issue of the equity in many parts of the country? How do we ensure that minimum wages come to workers? How do we address the issue of education and literacy on which the long-term solution to the poverty lies? How do we ensure that the poor have access to public services like health which form the most of the family’s expenditure? We still have lot of gender disparities to cope with and address. Civil Society efforts are, at best, weak.
MFIs are spreading across the country. SHG movement is growing rapidly. The proble of access to finance is being addressed. The need for the Governments and the Civil Society is to move into livelihoods domain. These efforts require large number of human resources at the community level, grassroots and at higher levels – paraprofessionals, professionals and volunteers, with passion, commitment and best brains. The poor need to have a hope for better life and this support can give that hope. Further policy support in terms of institutional framework like Mutually Aided Cooperative Societies’ Act, increased research into areas of livelihoods of the poor like dry land agriculture, minimum support prices for all products of the poor, ensuring minimum wages for all workers, risk covers for a wide variety of livelihoods of the poor etc., are important.
Finally, let us appreciate the reality – when in crisis, what matter the most are air, water and food. The rest is a matter of opinion really. Today the crisis is that the poor are struggling with lack of ideas for investing the funds they can access. It is time, we all jump in to help them out. Rest will be history made by us.
While a lot more poor still need to be reached out with access to microfinance services, and some more services can be loaded onto microfinance bandwagon, many a poor and their organizations are struggling to find ideas to invest the funds in remunerative activities. The problem moves from the lack of funds to the lack of ideas to invest the funds. The sector moves from the microfinance to microfinance plus all across. Each one is exploring the ‘plus’. The ‘plus’ may include insurance, loans and repayments in kind, food loans, businesses by the groups and federations themselves, public services for fee etc.
Most of us, who are and continue in the development sector, are essentially livelihoods workers and their intent is to ensure that everyone including the poor have a decent portfolio of livelihoods. The livelihoods are a play of six capitals – natural, physical, social, human, financial and spiritual, within the four contexts – ecological, techno-economic, patterns of distribution of capitals and patterns of investment and expenditure, resulting in four arrows – income, expenditure, employment and risks. The livelihoods interventions are at the level of one or more arrows, capitals, contexts and/or a combination thereof. Thus, the intervention resulting in enhancing livelihoods may happen with information, knowledge, skill development, infrastructure, access to finance, collectivization, access to storage, technology, value-addition processes, direct reach out to the market/consumer, risk diversification, minimum assured returns, etc. Therefore, the livelihoods interventions range from extremely simple actions to extremely complex sets of activities. Thus, microfinance activities are a small subset of the large livelihoods domain. Microfinance plus ways are expanding this subset to an extent.
Microfinance activities have become fairly systematic and the processes have become ‘standard’ for easy replication and scaling-up. The communities have responded well to these processes and are endorsing them with 99%+ repayment rates. The investors and the bankers are responding with increased investments for microfinance. It is able to attract a good number of human resources into it. The remunerations, it is able to pay, are comparable with the corporate sector. Bright and young minds are getting attracted to give a try.
Livelihoods activities are too large in number to attempt any standardization and/or systematization. For example, a small village of 100-200 families may have a number of crops, some once a year, some twice a year and sometimes thrice a year. It may have some plantation crops and some horticulture crops. It may have some trees and some fruit-bearing trees. It may have fisheries and produce a variety of fishes. It may have livestock including sheep and goats, cattle, buffaloes etc. It may have handlooms and handicrafts. It may have stone cutting, bidi rolling, and other miscellaneous activities. There may also be some support services like transport, trade, education etc. The people may be casual labour, skilled labour, self-employed, enterprise owners etc. Some may be full-timers and some part-timers. Some may not be engaged in direct income generation activities.
We have very few people who can appreciate and support these livelihoods in toto. In fact, there are very few who can appreciate and support a single value-chain in its entirety. The so-called experts master a bit of the value-chain. Yet, the poor and their collectives cannot afford them.
Some elements in the way forward for enhancing the livelihoods of the poor include organizing women and youth around savings, credit and micro-insurance into SHGs and their higher order federations; undertaking participatory livelihoods planning appreciating livelihoods current reality, gaps and opportunities; facilitating bank linkages and convergence with other programs to realize these plans; organizing people around livelihoods activities; organizing shops that sell essential items; building skills of the youth for meeting the services required; exploring employment opportunities outside and providing training; and building human resources for working in the people’s institutions.
The way forward gets further complicated when we contemplate about the people whose lives and livelihoods are threatened and affected by disasters. A variety of disasters and crises are looming large. This gets further amplified in many an ecologically fragile and marginalized zone. This further gets fuzzy for the poor with globalization, liberalization, privatization and climate changes.
In this dynamic context, we, the ‘blind’, should ensure that all the ‘blind’ come together and unravel the ‘elephant’ first, and explore the solutions. We need to reach the ‘ant’ when the ‘fish’ does not dry-up (as in the seven fish and the ant story). We need to recollect the sane advice of Seattle, the Red Indian Chief of conserving and living sustainable livelihoods.
As the pace of life is dramatically faster than what our grandfathers had, the most prominent issue is how we could offer ‘metafishing’ skills to the community, in addition to offering ‘fishing’ skills, in stead of offering fish. This is the need of the hour. The entire country and the world have to gear up for this effort. And I understand that this takes time, may be 10 years or 20 years. This can begin with appreciation of current reality and pooling up knowledge-skills-resources in people’s domain with K-S-R in our domain and outsiders’ domain. This in turn generates a variety of informed choices for the community to choose from. The community implements the plan so developed. In these iterative and repeated rounds, the community acquires metafishing skills and, I guess, learns to adapt to the changing needs and changing contexts.
Vast majority of the poor have to become partners in the high growth of the country. The issue is how we take some poor out of the existing traditional activities so that the remaining poor have better returns. What kind of vocations we can think of offering to them so that they come out and prosper? The situation at migration is not ‘great’. How do we address the plaguing issue of the equity in many parts of the country? How do we ensure that minimum wages come to workers? How do we address the issue of education and literacy on which the long-term solution to the poverty lies? How do we ensure that the poor have access to public services like health which form the most of the family’s expenditure? We still have lot of gender disparities to cope with and address. Civil Society efforts are, at best, weak.
MFIs are spreading across the country. SHG movement is growing rapidly. The proble of access to finance is being addressed. The need for the Governments and the Civil Society is to move into livelihoods domain. These efforts require large number of human resources at the community level, grassroots and at higher levels – paraprofessionals, professionals and volunteers, with passion, commitment and best brains. The poor need to have a hope for better life and this support can give that hope. Further policy support in terms of institutional framework like Mutually Aided Cooperative Societies’ Act, increased research into areas of livelihoods of the poor like dry land agriculture, minimum support prices for all products of the poor, ensuring minimum wages for all workers, risk covers for a wide variety of livelihoods of the poor etc., are important.
Finally, let us appreciate the reality – when in crisis, what matter the most are air, water and food. The rest is a matter of opinion really. Today the crisis is that the poor are struggling with lack of ideas for investing the funds they can access. It is time, we all jump in to help them out. Rest will be history made by us.
Financial inclusion is key to inclusive growth
Finance minister of India,Pranab Mukherjee urged private sector banks to build in financial inclusion plans in their respective business strategies.
Financial inclusion is integral to the inclusive growth process and sustainable development of the country. However, the financial inclusion models that banks come up with should be replicable and viable across the country. Stating this in his special address at the Financial Inclusion Summit, organised by Confederation of Indian Industry (CII) in New Delhi today, Mr Pranab Mukherjee, Minister of Finance, Government of India, said that although the banking network has rapidly expanded over the years, the key challenge would be to extend the banking coverage to include the large population living in 6 lakh villages in the country.
Expressing his immense confidence in the Indian banking system to deliver on the plan for financial inclusion, Mr Mukherjee said the system, which demonstrated its resilience in the face of the recent global financial crisis, should adopt strong and urgent measures to reach the unbanked segment of society and unlock their savings and investment potentials.
Pranab Mukherjee at the Financial Inclusion Summit organised by CII. Picture-credit:cii.in
Turning to the private sector banks, he urged the players to build in the financial inclusion plans in their respective business strategies. He added that while 80% of the public sector banks (PSBs) have already adopted the core banking solutions (CBS), steps are being taken to persuade the remaining 20% PSBs to adopt CBS.
The Finance Minister said that interventions and initiatives like the UID project will go a long way to ease the bank’s concerns pertaining to know your customer (KYC) criteria when dealing with a larger segment of potential and existing customers.
Mr Mukherjee laid particular emphasis on the adoption of new and appropriate technologies for promoting financial inclusion. He took the example of the Mahatma Gandhi National Rural Employment Guarantee Act Scheme to highlight how wage payments can be channeled through the banking system. This will lend new meaning to financial inclusion, he said, and added that banks need to come up with a definite financial inclusion plan.
To tap the fortune at the bottom of the pyramid, he recommended robust electronic transfers between bank branches located in the rural hinterland. This will facilitate the rural customers to transfer their income and conduct financial transactions seamlessly.
Talking about an enabling environment, Mr Mukherjee urged the private sector to support the designing of physical products including devices, software and financial services, training and capacity building so as to create a large manpower pool including business correspondents, and develop a business plan to tap the local talent that exists in the rural areas, on the lines of the e-choupal model.
Earlier, Dr Janmejaya Sinha, Chairman, CII Taskforce on Financial Inclusion & Chairman (Asia Pacific), The Boston Consulting Group, said in his address that 135 million of the 204 million households in the country face financial inclusion. Now, with 570 million people in the country being in the 0-25 age group, a very large segment would be entering the workforce in the coming years. Their financial inclusion at this stage would be of critical importance in the context of inclusive growth process and sustainable development.
Mr Sinha said that financial illiteracy is a key stumbling block in furthering financial inclusion. This has led to the financial illiterate segment making negative savings in many cases. He added that banks need to view the situation as not an obligation to be met but an opportunity that is to be weaved into their business strategies. He felt that a pro-active approach will see the banking network expanding in an all-inclusive manner like the telecom sector did.
Mr Sinha set a five-point agenda for financial inclusion, which called for:
(i) increasing overall consciousness of the need for financial inclusion;
(ii) increase in wireless and broadband connectivity in the rural areas to support rural banking;
(iii) spread of financial literacy programmes;
(iv) greater experimentation for financial inclusion through business correspondents, self-help groups, etc.
(v) greater collaboration between the key stakeholders in the banking system.
Ms Chanda Kochhar, Chairperson, CII National Committee on Banking and Managing Director & CEO, ICICI Bank, in her address said with a low ratio of 1 bank branch for 16,000 people, financial inclusion is far-fetched today. But, the idea of financial inclusion should be broad-based, such that people are able to not only access credit, but also fetch various financial services and products through the banking access point.
She said that at the micro-level, the financial services providers should aim for a holistic approach that meets the different financial needs of the target customers, address not just rural but also large urban excluded segments, reduce cost of transactions with proper technology adoption, and support the development of support infrastructure.
Ms Kochhar said that at the macro-level, there should be an eco-system that binds the different facets of banking and financial systems to deliver financial inclusion. She urged the banking and technology players to collaborate more firmly to strengthen financial inclusion, while adding that building financial habits among a large section of society will be just as important an objective to be focused upon.
Mr Hari S Bhartia, President, CII, in his opening remarks, said that CII’s theme of ‘Business for Livelihood’ is aligned to the objective of financial inclusion for sustainable high growth and development.
He said that financial inclusion will lead to the surplus rural income being converted into a pool of liquid funds for the economy. In this, the private sector has a key role cut out, by way of designing appropriate products and services, adoption of new and innovative technologies, and reduction of cost of banking and financial transactions.
Mr Chandrajit Banerjee, Director General, CII, in his closing remarks said that CII is bringing financial and technology players work closely to realise the goal of financial inclusion.
Financial inclusion is integral to the inclusive growth process and sustainable development of the country. However, the financial inclusion models that banks come up with should be replicable and viable across the country. Stating this in his special address at the Financial Inclusion Summit, organised by Confederation of Indian Industry (CII) in New Delhi today, Mr Pranab Mukherjee, Minister of Finance, Government of India, said that although the banking network has rapidly expanded over the years, the key challenge would be to extend the banking coverage to include the large population living in 6 lakh villages in the country.
Expressing his immense confidence in the Indian banking system to deliver on the plan for financial inclusion, Mr Mukherjee said the system, which demonstrated its resilience in the face of the recent global financial crisis, should adopt strong and urgent measures to reach the unbanked segment of society and unlock their savings and investment potentials.
Pranab Mukherjee at the Financial Inclusion Summit organised by CII. Picture-credit:cii.in
Turning to the private sector banks, he urged the players to build in the financial inclusion plans in their respective business strategies. He added that while 80% of the public sector banks (PSBs) have already adopted the core banking solutions (CBS), steps are being taken to persuade the remaining 20% PSBs to adopt CBS.
The Finance Minister said that interventions and initiatives like the UID project will go a long way to ease the bank’s concerns pertaining to know your customer (KYC) criteria when dealing with a larger segment of potential and existing customers.
Mr Mukherjee laid particular emphasis on the adoption of new and appropriate technologies for promoting financial inclusion. He took the example of the Mahatma Gandhi National Rural Employment Guarantee Act Scheme to highlight how wage payments can be channeled through the banking system. This will lend new meaning to financial inclusion, he said, and added that banks need to come up with a definite financial inclusion plan.
To tap the fortune at the bottom of the pyramid, he recommended robust electronic transfers between bank branches located in the rural hinterland. This will facilitate the rural customers to transfer their income and conduct financial transactions seamlessly.
Talking about an enabling environment, Mr Mukherjee urged the private sector to support the designing of physical products including devices, software and financial services, training and capacity building so as to create a large manpower pool including business correspondents, and develop a business plan to tap the local talent that exists in the rural areas, on the lines of the e-choupal model.
Earlier, Dr Janmejaya Sinha, Chairman, CII Taskforce on Financial Inclusion & Chairman (Asia Pacific), The Boston Consulting Group, said in his address that 135 million of the 204 million households in the country face financial inclusion. Now, with 570 million people in the country being in the 0-25 age group, a very large segment would be entering the workforce in the coming years. Their financial inclusion at this stage would be of critical importance in the context of inclusive growth process and sustainable development.
Mr Sinha said that financial illiteracy is a key stumbling block in furthering financial inclusion. This has led to the financial illiterate segment making negative savings in many cases. He added that banks need to view the situation as not an obligation to be met but an opportunity that is to be weaved into their business strategies. He felt that a pro-active approach will see the banking network expanding in an all-inclusive manner like the telecom sector did.
Mr Sinha set a five-point agenda for financial inclusion, which called for:
(i) increasing overall consciousness of the need for financial inclusion;
(ii) increase in wireless and broadband connectivity in the rural areas to support rural banking;
(iii) spread of financial literacy programmes;
(iv) greater experimentation for financial inclusion through business correspondents, self-help groups, etc.
(v) greater collaboration between the key stakeholders in the banking system.
Ms Chanda Kochhar, Chairperson, CII National Committee on Banking and Managing Director & CEO, ICICI Bank, in her address said with a low ratio of 1 bank branch for 16,000 people, financial inclusion is far-fetched today. But, the idea of financial inclusion should be broad-based, such that people are able to not only access credit, but also fetch various financial services and products through the banking access point.
She said that at the micro-level, the financial services providers should aim for a holistic approach that meets the different financial needs of the target customers, address not just rural but also large urban excluded segments, reduce cost of transactions with proper technology adoption, and support the development of support infrastructure.
Ms Kochhar said that at the macro-level, there should be an eco-system that binds the different facets of banking and financial systems to deliver financial inclusion. She urged the banking and technology players to collaborate more firmly to strengthen financial inclusion, while adding that building financial habits among a large section of society will be just as important an objective to be focused upon.
Mr Hari S Bhartia, President, CII, in his opening remarks, said that CII’s theme of ‘Business for Livelihood’ is aligned to the objective of financial inclusion for sustainable high growth and development.
He said that financial inclusion will lead to the surplus rural income being converted into a pool of liquid funds for the economy. In this, the private sector has a key role cut out, by way of designing appropriate products and services, adoption of new and innovative technologies, and reduction of cost of banking and financial transactions.
Mr Chandrajit Banerjee, Director General, CII, in his closing remarks said that CII is bringing financial and technology players work closely to realise the goal of financial inclusion.
FINANCIAL INCLUSION
Financial inclusion is the delivery of financial services at affordable costs to vast sections of disadvantaged and low income groups. Unrestrained access to public goods and services is the sine qua non of an open and efficient society. It is argued that as banking services are in the nature of public good, it is essential that availability of banking and payment services to the entire population without discrimination is the prime objective of public policy. The term "financial inclusion" has gained importance since the early 2000s, and is a result of findings about financial exclusion and its direct correlation to poverty. Financial inclusion is now a common objective for many central banks among the developing nations.
To just sum up " the process of ensuring access to financail services and timely and adequate credit where needed by vulnerable groups such as weaker section and low income groups at an affordable cost given by Rangarajan who headed com.on Financial Inclusion
On 29 December 2003,Former UN Secretary-General Kofi Annan said: ”The stark reality is that most poor
people in the world still lack access to sustainable financial services, whether it is savings, credit or insurance. The great challenge before us is to address the constraints that exclude people from full participation in the financial sector. Together, we can and must build inclusive financial sectors that help people improve their lives.”
According to the United Nations the main goals of Inclusive Finance are as follows:
Access at a reasonable cost of all households and enterprises to the range of financial services for which they are “bankable,” including savings, short and long-term credit, leasing and factoring, mortgages, insurance, pensions, payments, local money transfers and international remittances
Sound institutions, guided by appropriate internal management systems, industry performance standards, and performance monitoring by the market, as well as by sound prudential regulation where required
Financial and institutional sustainability as a means of providing access to financial services over time
Multiple providers of financial services, wherever feasible, so as to bring cost-effective and a wide variety of alternatives to customers (which could include any number of combinations of sound private, non-profit and public providers).
Financial Inclusion Taskforce, UK
The United Kingdom was one of the first countries to realize the importance of financial inclusion. It published its strategy of financial inclusion in its report Promoting Financial Inclusion which was published alongside the Pre-Budget Report of 2004. The UK government also set up the Financial Inclusion Fund of £120 m to help bring about Financial Inclusion. The Financial Inclusion Taskforce was formally launched on 21 February 2005 to monitor progress on financial inclusion and to make suitable recommendations.
Financial inclusion in India
This section may require cleanup to meet Wikipedia's quality standards. Please improve this section if you can. The talk page may contain suggestions. (May 2010)
The Reserve Bank of India has set up a commission (Khan Commission) in 2004 to look into financial inclusion and the recommendations of the commission were incorporated into the mid-term review of the policy (2005–06). In the report RBI exhorted the banks with a view of achieving greater financial inclusion to make available a basic "no-frills" banking account. In India, Financial Inclusion first featured in 2005, when it was introduced, that, too, from a pilot project in UT of Pondicherry, by K C Chakraborthy, the chairman of Indian Bank. Mangalam Village became the first village in India where all households were provided banking facilities. In addition to this KYC (Know your Customer) norms were relaxed for people intending to open accounts with annual deposits of less than Rs. 50,000. General Credit Cards (GCC) were issued to the poor and the disadvantaged with a view to help them access easy credit. In January 2006, the Reserve Bank permitted commercial banks to make use of the services of non-governmental organizations (NGOs/SHGs), micro-finance institutions and other civil society organizations as intermediaries for providing financial and banking services. These intermediaries could be used as business facilitators (BF) or business correspondents (BC) by commercial banks. The bank asked the commercial banks in different regions to start a 100% financial inclusion campaign on a pilot basis. As a result of the campaign states or U.T.s like Puducherry, Himachal Pradesh and Kerala have announced 100% financial inclusion in all their districts. Reserve Bank of India’s vision for 2020 is to open nearly 600 million new customers' accounts and service them through a variety of channels by leveraging on IT. However, illiteracy and the low income savings and lack of bank branches in rural areas continue to be a road block to financial inclusion in many states. Apart from this there are certain in Current model which is followed. There is inadequate legal and financial structure. India, being a mostly agrarian economy, hardly has schemes which lend for agriculture. Along with microfinance we need to focus on Microinsurance too.[citation needed]
In its platinum jubilee year, the Reserve Bank of India (RBI) wants to connect every Indian to the country s banking system.
RBI is currently working on a three-year financial inclusion plan and is discussing this with each bank to see how to take this forward, KC Chakrabarty, deputy governor, RBI said.
"Nearly forty years after nationalization of banks, 60% of the country's population does not have bank accounts and nearly 90% do not get loans," he pointed out .
Despite heightened focus on financial inclusion, Indian banks still somewhat failed to bring the under- and un-banked into the mainstream banking fold.
India has currently the second-highest number of financially excluded households in the world. Approximately, 40% of India s population have bank accounts, and only about 10% have any kind of life insurance cover, while a meager 0.6% have non-life insurance cover.
According to UNITED NATIONS, "A financial sector that provides 'access to credit for all "bankable " people and firms and to savings and payments services for everyone . Inclusive finance does not require that everyone who is eligible use each of the services , but they should be able to choose use them if desired.
REPORT OF THE COMMITTEE ON FINANCIAL INCLUSION IN INDIA (Chairperson : C. Rangarajan ) (2008) "The process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost."
As per " TREASURY COMMITTEE , HOUSE OF COMMONS , UK , (2005) " Ability of individuals to access appropriate financial products and services . "
'Major Three Aspects Of Financial Inclusion' Make people to
Access financial markets
Access credit markets
Learn financial matters (financial education )
Financial Inclusion Includes Accessing Of Financial Products And Services Like,
Savings facility
Credit and debit cards access
Electronic fund transfer
All kinds of commercial loans
Overdraft facility
Cheque facility
Payment and remittance services
Low cost financial services
Insurance (Medical insurance)
Financial advice
Pension for old age and investment schemes
Access to financial markets
Micro credit during emergency
Entrepreneurial credit
Financially Excluded People The financially excluded sections largely comprise :
Marginal farmers
Landless labourers
Oral lessees
Self employed and unorganised sector enterprises
Urban slum dwellers
Migrants
Ethnic minorities and socially excluded groups
Senior citizens
Women
The North East, Eastern and Central regions contain most of the financially excluded population.
Factors affecting access to financial services
Legal identity : Lack of legal identity like voter id , driving license , birth certificates ,employment identity card etc
Limited literacy : Particularly financial literacy and lack of basic education prevent people to have access from financial services .
Level of income : Level of income decides to have financial access . Low income people generally have the attitude of thinking that banks are only for rich.
'Terms and conditions : While getting loans or at the time of opening accounts banks places many conditions , so the uneducated and poor people find it very difficult to access financial services .
Complicated procedures : Due to lack of financial literacy and basic education , it is very difficult for those people who lack both to read terms and conditions and account filling forms .
Psychological and cultural barriers : Many people voluntarily excluded themselves due to psychological barriers and they think that they are excluded from accessing financial services .
Place of living : As the name suggests that commercial banks operate only in commercially profitable areas and they set up branches and main offices only in that areas .People who lived in under developed areas find it very difficult to go to areas in which banks are generally reside .
Lack of awareness : Finally , people who lack basic education do not know the importance of the financial products like Insurance , Finance , Bank Accounts , cheque facility ,etc.
Consequences Of Financial Exclusion Major Two Threats :
Losing opportunities to grow : In the absence of finance , people who are not connected with formal financial system lack opportunities to grow.
Country's growth will retard : Due to vast unutilized resources that is in the form of money in the hands of people who lack financial inclusive services.
Other Consequences :
Business loss to banks : Banks will loss business if this condition persists for ever due to lack of opening of bank accounts.
Exclusion from mainstream society : The people who lacks financial services , presumed that they are excluded from mainstream society .
All transactions cannot be made in cash : Some transactions can be made in cash . In this technological world everybody wants to have electronic cash system like debit and credit cards and also EFT .
Loss of opportunities to thrift and borrow : Financially excluded people , may lose chances to save their some part of livelihood earnings and also to borrow loans .
Employment barriers : Nowadays all salary and other financial benefits from various sources like Governments scholarships , any compensation , grants , reliefs , etc are paid through bank accounts.
Loss due to theft : Banks provide various schemes of safety locker facility . It mitigates the risk due to thefts .
Other allied financial services : People who do not have bank accounts may not go to bank as for as possible . So they lack basic financial auxiliary services like DD ,Insurance cover and other emergency need loans Etc .
Benefits Of Inclusive Financial Growth
Growth with equity : In the path of super power we the Indians will need to achieve the growth of our country with equality . It is provided by inclusive finance.
Get rid of poverty : To remove poverty from the Indian context all everybody will be given access to formal financial services . Because if they borrow loans for business or education or any other purpose they get the loan will pave way for their development .
Financial Transactions Made Easy : Inclusive finance will provide banking related financial transactions in an easy and speedy way .
Safe savings along with financial services : People will have safe savings along with other allied services like insurance cover , entrepreneurial loans , payment and settlement facility etc,
Inflating National Income : Boosting up business opportunities will definitely increase GDP and which will be reflected in our national income growth .
Becoming Global Player : Financial access will attract global market players to our country that will result in increasing employment and business opportunities .
Relationship between Financial Inclusion and Development Indicators
Economic growth follows financial inclusion. In order to achieve the objective of growth with equity, it is imperative that infrastructure is developed with financial inclusion.
savings and credit accounts - indicators of financial inclusion.
per capita income - indicator of economic development
Electricity consumption
and road length -indicators of infrastructure development.
All the above influence economic development which follows adequate financial and credit facilities
• Expectations of poor people from financial system Taking into account their
Seasonal Inflow Of Income from agricultural operations,
Migration from one place to another,
Seasonal And Irregular Work Availability And Income; the existing financial system needs to be designed to suit their requirements.
Security and safety of deposits
Low transaction cost
Convenient operating time
Minimum paper work
Frequent deposits
Quick and easy access
Product suitable to income and consumption
To just sum up " the process of ensuring access to financail services and timely and adequate credit where needed by vulnerable groups such as weaker section and low income groups at an affordable cost given by Rangarajan who headed com.on Financial Inclusion
On 29 December 2003,Former UN Secretary-General Kofi Annan said: ”The stark reality is that most poor
people in the world still lack access to sustainable financial services, whether it is savings, credit or insurance. The great challenge before us is to address the constraints that exclude people from full participation in the financial sector. Together, we can and must build inclusive financial sectors that help people improve their lives.”
According to the United Nations the main goals of Inclusive Finance are as follows:
Access at a reasonable cost of all households and enterprises to the range of financial services for which they are “bankable,” including savings, short and long-term credit, leasing and factoring, mortgages, insurance, pensions, payments, local money transfers and international remittances
Sound institutions, guided by appropriate internal management systems, industry performance standards, and performance monitoring by the market, as well as by sound prudential regulation where required
Financial and institutional sustainability as a means of providing access to financial services over time
Multiple providers of financial services, wherever feasible, so as to bring cost-effective and a wide variety of alternatives to customers (which could include any number of combinations of sound private, non-profit and public providers).
Financial Inclusion Taskforce, UK
The United Kingdom was one of the first countries to realize the importance of financial inclusion. It published its strategy of financial inclusion in its report Promoting Financial Inclusion which was published alongside the Pre-Budget Report of 2004. The UK government also set up the Financial Inclusion Fund of £120 m to help bring about Financial Inclusion. The Financial Inclusion Taskforce was formally launched on 21 February 2005 to monitor progress on financial inclusion and to make suitable recommendations.
Financial inclusion in India
This section may require cleanup to meet Wikipedia's quality standards. Please improve this section if you can. The talk page may contain suggestions. (May 2010)
The Reserve Bank of India has set up a commission (Khan Commission) in 2004 to look into financial inclusion and the recommendations of the commission were incorporated into the mid-term review of the policy (2005–06). In the report RBI exhorted the banks with a view of achieving greater financial inclusion to make available a basic "no-frills" banking account. In India, Financial Inclusion first featured in 2005, when it was introduced, that, too, from a pilot project in UT of Pondicherry, by K C Chakraborthy, the chairman of Indian Bank. Mangalam Village became the first village in India where all households were provided banking facilities. In addition to this KYC (Know your Customer) norms were relaxed for people intending to open accounts with annual deposits of less than Rs. 50,000. General Credit Cards (GCC) were issued to the poor and the disadvantaged with a view to help them access easy credit. In January 2006, the Reserve Bank permitted commercial banks to make use of the services of non-governmental organizations (NGOs/SHGs), micro-finance institutions and other civil society organizations as intermediaries for providing financial and banking services. These intermediaries could be used as business facilitators (BF) or business correspondents (BC) by commercial banks. The bank asked the commercial banks in different regions to start a 100% financial inclusion campaign on a pilot basis. As a result of the campaign states or U.T.s like Puducherry, Himachal Pradesh and Kerala have announced 100% financial inclusion in all their districts. Reserve Bank of India’s vision for 2020 is to open nearly 600 million new customers' accounts and service them through a variety of channels by leveraging on IT. However, illiteracy and the low income savings and lack of bank branches in rural areas continue to be a road block to financial inclusion in many states. Apart from this there are certain in Current model which is followed. There is inadequate legal and financial structure. India, being a mostly agrarian economy, hardly has schemes which lend for agriculture. Along with microfinance we need to focus on Microinsurance too.[citation needed]
In its platinum jubilee year, the Reserve Bank of India (RBI) wants to connect every Indian to the country s banking system.
RBI is currently working on a three-year financial inclusion plan and is discussing this with each bank to see how to take this forward, KC Chakrabarty, deputy governor, RBI said.
"Nearly forty years after nationalization of banks, 60% of the country's population does not have bank accounts and nearly 90% do not get loans," he pointed out .
Despite heightened focus on financial inclusion, Indian banks still somewhat failed to bring the under- and un-banked into the mainstream banking fold.
India has currently the second-highest number of financially excluded households in the world. Approximately, 40% of India s population have bank accounts, and only about 10% have any kind of life insurance cover, while a meager 0.6% have non-life insurance cover.
According to UNITED NATIONS, "A financial sector that provides 'access to credit for all "bankable " people and firms and to savings and payments services for everyone . Inclusive finance does not require that everyone who is eligible use each of the services , but they should be able to choose use them if desired.
REPORT OF THE COMMITTEE ON FINANCIAL INCLUSION IN INDIA (Chairperson : C. Rangarajan ) (2008) "The process of ensuring access to financial services and timely and adequate credit where needed by vulnerable groups such as weaker sections and low income groups at an affordable cost."
As per " TREASURY COMMITTEE , HOUSE OF COMMONS , UK , (2005) " Ability of individuals to access appropriate financial products and services . "
'Major Three Aspects Of Financial Inclusion' Make people to
Access financial markets
Access credit markets
Learn financial matters (financial education )
Financial Inclusion Includes Accessing Of Financial Products And Services Like,
Savings facility
Credit and debit cards access
Electronic fund transfer
All kinds of commercial loans
Overdraft facility
Cheque facility
Payment and remittance services
Low cost financial services
Insurance (Medical insurance)
Financial advice
Pension for old age and investment schemes
Access to financial markets
Micro credit during emergency
Entrepreneurial credit
Financially Excluded People The financially excluded sections largely comprise :
Marginal farmers
Landless labourers
Oral lessees
Self employed and unorganised sector enterprises
Urban slum dwellers
Migrants
Ethnic minorities and socially excluded groups
Senior citizens
Women
The North East, Eastern and Central regions contain most of the financially excluded population.
Factors affecting access to financial services
Legal identity : Lack of legal identity like voter id , driving license , birth certificates ,employment identity card etc
Limited literacy : Particularly financial literacy and lack of basic education prevent people to have access from financial services .
Level of income : Level of income decides to have financial access . Low income people generally have the attitude of thinking that banks are only for rich.
'Terms and conditions : While getting loans or at the time of opening accounts banks places many conditions , so the uneducated and poor people find it very difficult to access financial services .
Complicated procedures : Due to lack of financial literacy and basic education , it is very difficult for those people who lack both to read terms and conditions and account filling forms .
Psychological and cultural barriers : Many people voluntarily excluded themselves due to psychological barriers and they think that they are excluded from accessing financial services .
Place of living : As the name suggests that commercial banks operate only in commercially profitable areas and they set up branches and main offices only in that areas .People who lived in under developed areas find it very difficult to go to areas in which banks are generally reside .
Lack of awareness : Finally , people who lack basic education do not know the importance of the financial products like Insurance , Finance , Bank Accounts , cheque facility ,etc.
Consequences Of Financial Exclusion Major Two Threats :
Losing opportunities to grow : In the absence of finance , people who are not connected with formal financial system lack opportunities to grow.
Country's growth will retard : Due to vast unutilized resources that is in the form of money in the hands of people who lack financial inclusive services.
Other Consequences :
Business loss to banks : Banks will loss business if this condition persists for ever due to lack of opening of bank accounts.
Exclusion from mainstream society : The people who lacks financial services , presumed that they are excluded from mainstream society .
All transactions cannot be made in cash : Some transactions can be made in cash . In this technological world everybody wants to have electronic cash system like debit and credit cards and also EFT .
Loss of opportunities to thrift and borrow : Financially excluded people , may lose chances to save their some part of livelihood earnings and also to borrow loans .
Employment barriers : Nowadays all salary and other financial benefits from various sources like Governments scholarships , any compensation , grants , reliefs , etc are paid through bank accounts.
Loss due to theft : Banks provide various schemes of safety locker facility . It mitigates the risk due to thefts .
Other allied financial services : People who do not have bank accounts may not go to bank as for as possible . So they lack basic financial auxiliary services like DD ,Insurance cover and other emergency need loans Etc .
Benefits Of Inclusive Financial Growth
Growth with equity : In the path of super power we the Indians will need to achieve the growth of our country with equality . It is provided by inclusive finance.
Get rid of poverty : To remove poverty from the Indian context all everybody will be given access to formal financial services . Because if they borrow loans for business or education or any other purpose they get the loan will pave way for their development .
Financial Transactions Made Easy : Inclusive finance will provide banking related financial transactions in an easy and speedy way .
Safe savings along with financial services : People will have safe savings along with other allied services like insurance cover , entrepreneurial loans , payment and settlement facility etc,
Inflating National Income : Boosting up business opportunities will definitely increase GDP and which will be reflected in our national income growth .
Becoming Global Player : Financial access will attract global market players to our country that will result in increasing employment and business opportunities .
Relationship between Financial Inclusion and Development Indicators
Economic growth follows financial inclusion. In order to achieve the objective of growth with equity, it is imperative that infrastructure is developed with financial inclusion.
savings and credit accounts - indicators of financial inclusion.
per capita income - indicator of economic development
Electricity consumption
and road length -indicators of infrastructure development.
All the above influence economic development which follows adequate financial and credit facilities
• Expectations of poor people from financial system Taking into account their
Seasonal Inflow Of Income from agricultural operations,
Migration from one place to another,
Seasonal And Irregular Work Availability And Income; the existing financial system needs to be designed to suit their requirements.
Security and safety of deposits
Low transaction cost
Convenient operating time
Minimum paper work
Frequent deposits
Quick and easy access
Product suitable to income and consumption
Should you revive a lapsed policy?
It is that time of the year when money flows from your wallet like water. The reason could be last-minute investments to save on taxes just before the financial year ends or holidaying with the family during a Christmas break or a simple year-end gettogether.
Even as you are caught in the flurry of fast-paced events that ring in the excitement of the New Year , you suddenly remember an insurance policy that you bought a few years ago to claim tax breaks under Section 80C. Well, you are not alone. There are many who are stuck with bought-on-the-spur-of-the-moment policies.
“When a policyholder buys insurance just to save tax or under obligation, many times he or she doesn’t pay the subsequent premiums. Also, if the policy is mis-sold by an agent and the policyholder is not satisfied with the terms and conditions of the policy, he/she may call it quits,” says Pankaj Mathpal, managing director Optima Money Managers.
Sure, the policy could be a cause for regret and a financial burden, or just not worth it. But, the thousand-dollar question is: Should you pay the premium when the policy comes up for renewal by the end of the month?
The Doctrine Of Lapse:
There is no standard definition or time period within which the insurance policy lapses. It varies from company to company and from policy to policy. Moreover, there are various stages before the policy dies a natural death. Rahul Aggarwal, CEO, Optima Insurance Brokers & CEO, click2insure.in, says, “If a policy has a grace period of 40 days, you would still be covered under that policy up to 40 days provided you pay the premium within that period. After the grace period of 40 days, you can still pay the premium, but you are not covered by the policy anymore.
This number varies from policy to policy but the maximum time period within which you can revive the policy can extend up to one year.” But you have to pay a penalty interest and other fees to give new life to that policy.
Mathpal adds, “A policyholder can revive his lapsed policy by paying all arrears on the premium with interest within five years from the date of the first unpaid premium (FUP). The insurer may ask the policyholder to submit his health status in a prescribed form or may ask to undergo the medical tests to assess the risk.”
In fact, LIC has been organising policy-revival campaigns on a regular basis for years now. Any policyholder can revive his/her policy during the two weeks of the campaign without paying the revival fees.
Should You Let The Policy Go...:
The agent had been following up till you handed out the first premium cheque to him. Once he pocketed his handsome commission, you don’t require a Sherlock Holmes to discover the reason behind his absence. Now, it is your headache to remember the dates and pay the premiums on time to keep the policy alive. First things first — register for email and SMS alerts. Apart from the sheer convenience, constant SMS alerts and bombarding of email alerts will help you keep the premium date in sight. If it is just a temporary cashflow issue, link it to your credit card by opting for an auto-pay facility. The insurer will directly debit the premium amount from your credit card and add it to the next billing cycle.
... Or Should You Revive It?:
This solely depends upon the nature of the policy. But Aggarwal says it is always better to revive/renew the policy than buy a new one as the entire pricing of the policy is based on the age factor. “If you are buying an insurance policy now at the age of 35, the premiums would be higher. Also, you have to wait for a longer time to enjoy the benefits of the policy. In case of a Ulip, for instance, you have to pay premiums for another five years and then wait for another five years to be able to enjoy benefits.
Similarly, in case of endowment plans, you will realise the benefits much later than your earlier policy. Hence, it always makes sense to pay the penalty and renew the old policy.” However, it does not make sense to revive term insurance cover. “A term cover does not acquire any paid-up value or accumulate any re-turns as it is not investmentoriented in nature. It only makes sense to revive investment oriented policies after working out the cost benefit analysis,” says Harsh Roongta, CEO, ApnaPaisa.com. Similarly, there were some fixed return products, which offered tax free returns over a period of time to the policyholder. You should continue paying the premium on such products too, Roongta adds.
When To Hold On?:
“Even now the cost structure of a Ulip is such that it adds to your gains only from the ninth year. After paying a hefty premium year after year for five years, it does not make sense to quit at this stage. Even after nine years, if the policy does not generate good returns you can stop paying the premium and let the Ulip slip into the auto-recover mode,” Aggarwal adds. A Ulip has two buckets, namely, the risk and investment bucket. Once you stop paying the premium (allowed only after five years), the insurer shifts the money from investment bucket to risk bucket. This transfer of funds keeps happening till the investment component is siphoned off. But if you have another five years to go for the expiry of the policy, it is better to stay invested . Essentially, your policy will be growing well at this stage after factoring in all the costs and other deductions. Now, if you discontinue your policy, you will not be able to generate returns and make up for the losses by investing the balance premiums elsewhere.
The Tax Axe :
If you exit from your policy within three years from the effective date, then you will have to pay off the tax benefits that you enjoyed on previous premium payments. So, before deciding to call it quits, it is better you know how much you will lose monetarily . The simplest way to avoid all the hassle is just read the fine print. The next time your agent tells you to sign on the marked spots, resist from taking the easy way out. Read the document before you sign off a few thousands of rupees in favour of the insurer. Otherwise, you will have no one but yourself to blame since there is no recourse available after the free-look period, which spans in the range of 15-30 days. If you decide to quit half way, it may very well turn out to be an expensive affair
Even as you are caught in the flurry of fast-paced events that ring in the excitement of the New Year , you suddenly remember an insurance policy that you bought a few years ago to claim tax breaks under Section 80C. Well, you are not alone. There are many who are stuck with bought-on-the-spur-of-the-moment policies.
“When a policyholder buys insurance just to save tax or under obligation, many times he or she doesn’t pay the subsequent premiums. Also, if the policy is mis-sold by an agent and the policyholder is not satisfied with the terms and conditions of the policy, he/she may call it quits,” says Pankaj Mathpal, managing director Optima Money Managers.
Sure, the policy could be a cause for regret and a financial burden, or just not worth it. But, the thousand-dollar question is: Should you pay the premium when the policy comes up for renewal by the end of the month?
The Doctrine Of Lapse:
There is no standard definition or time period within which the insurance policy lapses. It varies from company to company and from policy to policy. Moreover, there are various stages before the policy dies a natural death. Rahul Aggarwal, CEO, Optima Insurance Brokers & CEO, click2insure.in, says, “If a policy has a grace period of 40 days, you would still be covered under that policy up to 40 days provided you pay the premium within that period. After the grace period of 40 days, you can still pay the premium, but you are not covered by the policy anymore.
This number varies from policy to policy but the maximum time period within which you can revive the policy can extend up to one year.” But you have to pay a penalty interest and other fees to give new life to that policy.
Mathpal adds, “A policyholder can revive his lapsed policy by paying all arrears on the premium with interest within five years from the date of the first unpaid premium (FUP). The insurer may ask the policyholder to submit his health status in a prescribed form or may ask to undergo the medical tests to assess the risk.”
In fact, LIC has been organising policy-revival campaigns on a regular basis for years now. Any policyholder can revive his/her policy during the two weeks of the campaign without paying the revival fees.
Should You Let The Policy Go...:
The agent had been following up till you handed out the first premium cheque to him. Once he pocketed his handsome commission, you don’t require a Sherlock Holmes to discover the reason behind his absence. Now, it is your headache to remember the dates and pay the premiums on time to keep the policy alive. First things first — register for email and SMS alerts. Apart from the sheer convenience, constant SMS alerts and bombarding of email alerts will help you keep the premium date in sight. If it is just a temporary cashflow issue, link it to your credit card by opting for an auto-pay facility. The insurer will directly debit the premium amount from your credit card and add it to the next billing cycle.
... Or Should You Revive It?:
This solely depends upon the nature of the policy. But Aggarwal says it is always better to revive/renew the policy than buy a new one as the entire pricing of the policy is based on the age factor. “If you are buying an insurance policy now at the age of 35, the premiums would be higher. Also, you have to wait for a longer time to enjoy the benefits of the policy. In case of a Ulip, for instance, you have to pay premiums for another five years and then wait for another five years to be able to enjoy benefits.
Similarly, in case of endowment plans, you will realise the benefits much later than your earlier policy. Hence, it always makes sense to pay the penalty and renew the old policy.” However, it does not make sense to revive term insurance cover. “A term cover does not acquire any paid-up value or accumulate any re-turns as it is not investmentoriented in nature. It only makes sense to revive investment oriented policies after working out the cost benefit analysis,” says Harsh Roongta, CEO, ApnaPaisa.com. Similarly, there were some fixed return products, which offered tax free returns over a period of time to the policyholder. You should continue paying the premium on such products too, Roongta adds.
When To Hold On?:
“Even now the cost structure of a Ulip is such that it adds to your gains only from the ninth year. After paying a hefty premium year after year for five years, it does not make sense to quit at this stage. Even after nine years, if the policy does not generate good returns you can stop paying the premium and let the Ulip slip into the auto-recover mode,” Aggarwal adds. A Ulip has two buckets, namely, the risk and investment bucket. Once you stop paying the premium (allowed only after five years), the insurer shifts the money from investment bucket to risk bucket. This transfer of funds keeps happening till the investment component is siphoned off. But if you have another five years to go for the expiry of the policy, it is better to stay invested . Essentially, your policy will be growing well at this stage after factoring in all the costs and other deductions. Now, if you discontinue your policy, you will not be able to generate returns and make up for the losses by investing the balance premiums elsewhere.
The Tax Axe :
If you exit from your policy within three years from the effective date, then you will have to pay off the tax benefits that you enjoyed on previous premium payments. So, before deciding to call it quits, it is better you know how much you will lose monetarily . The simplest way to avoid all the hassle is just read the fine print. The next time your agent tells you to sign on the marked spots, resist from taking the easy way out. Read the document before you sign off a few thousands of rupees in favour of the insurer. Otherwise, you will have no one but yourself to blame since there is no recourse available after the free-look period, which spans in the range of 15-30 days. If you decide to quit half way, it may very well turn out to be an expensive affair
Thursday, December 9, 2010
FD switch-over for better returns
Chennai: Fixed deposits have once again become an attractive option for investors with a large number of existing FD holders converting their old term deposits into new FDs at higher interest rates.
“Of the total approvals, 90% are new deposits while the rest are conversion of old deposits to new ones,” Govindan Bomba, general manager at Union Bank of India , said. With returns getting better as banks begin to hike rates, more customers are now breaking their existing FDs and are re-fixing them at higher rates. “When interest rates go up, some customers may find it beneficial to readjust their FDs to a higher interest rate,” S S Ranjan, chief financial officer at SBI , said. However , he said that such type of switching will be useful only for those customers who have opened FD accounts six months ago.
According to P Sitaram, CFO of IDBI Bank , the conversion of an old FD into a new one at a price. “For a fiveyear deposit, if a holder decides to break it after 3 years, he will have to settle down with interest rate for three years only. And in case interest rate on five-year deposit is more than three-year deposit, the interest rate differential will be deducted from the principal amount,” Sitaram said. “Thus, while changing an existing term into a new FD, one needs to bear in mind the interest rate one might have to forego in the process.”
When interest rates inch up, people tend to convert their deposits to higher rates, said S C Bansal, executive director at United Bank of India . However, it is senior citizens who are more sensitive to the changes in the deposit rates, as a quarter percentage change in the interest rates may make a lot of difference in their income, and they are the ones who shift their deposits from a lower rate to higher rates deposits
“Of the total approvals, 90% are new deposits while the rest are conversion of old deposits to new ones,” Govindan Bomba, general manager at Union Bank of India , said. With returns getting better as banks begin to hike rates, more customers are now breaking their existing FDs and are re-fixing them at higher rates. “When interest rates go up, some customers may find it beneficial to readjust their FDs to a higher interest rate,” S S Ranjan, chief financial officer at SBI , said. However , he said that such type of switching will be useful only for those customers who have opened FD accounts six months ago.
According to P Sitaram, CFO of IDBI Bank , the conversion of an old FD into a new one at a price. “For a fiveyear deposit, if a holder decides to break it after 3 years, he will have to settle down with interest rate for three years only. And in case interest rate on five-year deposit is more than three-year deposit, the interest rate differential will be deducted from the principal amount,” Sitaram said. “Thus, while changing an existing term into a new FD, one needs to bear in mind the interest rate one might have to forego in the process.”
When interest rates inch up, people tend to convert their deposits to higher rates, said S C Bansal, executive director at United Bank of India . However, it is senior citizens who are more sensitive to the changes in the deposit rates, as a quarter percentage change in the interest rates may make a lot of difference in their income, and they are the ones who shift their deposits from a lower rate to higher rates deposits
Wednesday, December 8, 2010
what is your risk tolerance?
Risk tolerance is a topic that is often discussed, but rarely defined. It is not unusual to read a trade recommendation discussing alternatives or options based on different risk tolerances. But how does an individual investor determine his or her risk tolerance? How can understanding this concept help investors in diversifying their portfolios? Read on as we delve into this concept. (To learn more, read Determining Risk And The Risk Pyramid.)
First, we need to consider investment. When will funds be needed? If the time horizon is relatively short, risk tolerance should shift to be more conservative. For long-term investments, there is room for more aggressive investing.
Be careful, however, about blindly following conventional wisdom. For example, don't think that just because you are 65 that you must shift everything to conservative investments, such as certificates of deposit or Treasury bills. While this may be appropriate for some, it may not be appropriate for all - such as for an individual who has enough to retire and live off of the interest of his or her investments without touching the principal. With today's growinglife expectancies and advancing medical science, the 65-year-old investor may still have a 20-year (or more) time horizon.
Risk CapitalNet worth and available risk capital should be important considerations when determining risk tolerance. Net worth is simply your assets minus your liabilities. Risk capital is money available to invest or trade that will not affect your lifestyle if lost. It should be defined asliquid capital, or capital that can easily be converted into cash.
Therefore, an investor or trader with a high net worth can assume more risk. The smaller the percentage of your overall net worth the investment or trade makes up, the more aggressive the risk tolerance can be.
Unfortunately, those with little to no net worth or with limited risk capital are often drawn to riskier investments like futures or options because of the lure of quick, easy and large profits. The problem with this is that when you are "trading with the rent" it is difficult to have your head in the game. Also, when too much risk is assumed with too little capital, a trader can be forced out of a position too early.
On the other hand, if an undercapitalized trader using limited or defined risk instruments (such as long options) "goes bust", it may not take that trader long to recover. Contrast this with the high-net-worth trader who puts everything into one risky trade and loses - it will take this trader much longer to recover.
Understand Your Investment ObjectivesYour investment objectives must also be considered when calculating how much risk can be assumed. If you are saving for a child's college education or your retirement, how much risk do you really want to take with those funds? Conversely, more risk could be taken if you are using true risk capital or disposable income to attempt to earn extra income.
Interestingly, some people seem quite alright with using retirement funds to trade higher-risk instruments. If you are doing this for the sole purpose of sheltering the trades from tax exposure, such as trading futures in an IRA, make sure you fully understand what you are doing. Such a strategy may be alright if you are experienced with trading futures, are using only a portion of your IRA funds for this purpose and are not risking your ability to retire on a single trade.
However, if you are applying your entire IRA to futures, have little or no net worth and are just trying to avoid tax exposure for that "sure thing" trade, you need to rethink the notion of taking on this much risk. Futures already receive favorable capital gains treatment (60% long term, 40% short term); capital gains rates are lower than for regular income, and 60% of your gains in futures will be charged the lower of the two capital gains rates. With this in mind, why would a low net worth individual need to take that much risk with retirement funds? In other words, just because you can do something doesn't always mean you should. (For related reading, see A Long-Term Mindset Meets Dreaded Capital Gains Tax.)
Investment ExperienceWhen it comes to determining your risk tolerance, your level of investing experience must also be considered. Are you new to investing and trading? Have you been doing this for some time but are branching into a new area, like selling options? It is prudent to begin new ventures with some degree of caution, and trading or investing is no different. Get some experience under your belt before committing too much capital. Always remember the old cliché and strive for "preservation of capital." It only makes sense to take on the appropriate risk for your situation if the worst-case scenario will leave you able to live to fight another day. (To learn more, see A Guide To Portfolio Construction.)
Careful Consideration of Risk ToleranceThere are many things to consider when determining the answer to a seemingly simple question, "What is my risk tolerance?" The answer will vary based on your age, experience, net worth, risk capital and the actual investment or trade being considered. Once you have thought this through, you will be able to apply this knowledge to a balanced and diversified program of investing and trading.
Spreading your risk around, even if it is all high risk, decreases your overall exposure to any single investment or trade. With appropriate diversification, the probability of total loss is greatly reduced. This comes back to preservation of capital.
Knowing your risk tolerance goes far beyond being able to sleep at night or stressing over your trades. It is a complex process of analyzing your personal financial situation and balancing it against your goals and objectives. Ultimately, knowing you risk tolerance - and keeping to investments that fit within it - should keep you from complete financial ruin.
(For related articles, visit How Risky Is You Portfolio? and Do You Understand Investment Risk?)
Risk Tolerance by Time frameAn often seen cliché is that of what we'll refer to as "age-based" risk tolerance. It is conventional wisdom that a younger investor has a long-term time horizon in terms of the need for investments and can take more risk. Following this logic, an older individual has a short investment horizon, especially once that individual is retired, and would have low risk tolerance. While this may be true in general, there are certainly a number of other considerations that come into play. (For related reading, see The Seasons Of An Investor's Life and Portfolio Management For The Under-30 Crowd.)
First, we need to consider investment. When will funds be needed? If the time horizon is relatively short, risk tolerance should shift to be more conservative. For long-term investments, there is room for more aggressive investing.
Be careful, however, about blindly following conventional wisdom. For example, don't think that just because you are 65 that you must shift everything to conservative investments, such as certificates of deposit or Treasury bills. While this may be appropriate for some, it may not be appropriate for all - such as for an individual who has enough to retire and live off of the interest of his or her investments without touching the principal. With today's growinglife expectancies and advancing medical science, the 65-year-old investor may still have a 20-year (or more) time horizon.
Risk CapitalNet worth and available risk capital should be important considerations when determining risk tolerance. Net worth is simply your assets minus your liabilities. Risk capital is money available to invest or trade that will not affect your lifestyle if lost. It should be defined asliquid capital, or capital that can easily be converted into cash.
Therefore, an investor or trader with a high net worth can assume more risk. The smaller the percentage of your overall net worth the investment or trade makes up, the more aggressive the risk tolerance can be.
Unfortunately, those with little to no net worth or with limited risk capital are often drawn to riskier investments like futures or options because of the lure of quick, easy and large profits. The problem with this is that when you are "trading with the rent" it is difficult to have your head in the game. Also, when too much risk is assumed with too little capital, a trader can be forced out of a position too early.
On the other hand, if an undercapitalized trader using limited or defined risk instruments (such as long options) "goes bust", it may not take that trader long to recover. Contrast this with the high-net-worth trader who puts everything into one risky trade and loses - it will take this trader much longer to recover.
Understand Your Investment ObjectivesYour investment objectives must also be considered when calculating how much risk can be assumed. If you are saving for a child's college education or your retirement, how much risk do you really want to take with those funds? Conversely, more risk could be taken if you are using true risk capital or disposable income to attempt to earn extra income.
Interestingly, some people seem quite alright with using retirement funds to trade higher-risk instruments. If you are doing this for the sole purpose of sheltering the trades from tax exposure, such as trading futures in an IRA, make sure you fully understand what you are doing. Such a strategy may be alright if you are experienced with trading futures, are using only a portion of your IRA funds for this purpose and are not risking your ability to retire on a single trade.
However, if you are applying your entire IRA to futures, have little or no net worth and are just trying to avoid tax exposure for that "sure thing" trade, you need to rethink the notion of taking on this much risk. Futures already receive favorable capital gains treatment (60% long term, 40% short term); capital gains rates are lower than for regular income, and 60% of your gains in futures will be charged the lower of the two capital gains rates. With this in mind, why would a low net worth individual need to take that much risk with retirement funds? In other words, just because you can do something doesn't always mean you should. (For related reading, see A Long-Term Mindset Meets Dreaded Capital Gains Tax.)
Investment ExperienceWhen it comes to determining your risk tolerance, your level of investing experience must also be considered. Are you new to investing and trading? Have you been doing this for some time but are branching into a new area, like selling options? It is prudent to begin new ventures with some degree of caution, and trading or investing is no different. Get some experience under your belt before committing too much capital. Always remember the old cliché and strive for "preservation of capital." It only makes sense to take on the appropriate risk for your situation if the worst-case scenario will leave you able to live to fight another day. (To learn more, see A Guide To Portfolio Construction.)
Careful Consideration of Risk ToleranceThere are many things to consider when determining the answer to a seemingly simple question, "What is my risk tolerance?" The answer will vary based on your age, experience, net worth, risk capital and the actual investment or trade being considered. Once you have thought this through, you will be able to apply this knowledge to a balanced and diversified program of investing and trading.
Spreading your risk around, even if it is all high risk, decreases your overall exposure to any single investment or trade. With appropriate diversification, the probability of total loss is greatly reduced. This comes back to preservation of capital.
Knowing your risk tolerance goes far beyond being able to sleep at night or stressing over your trades. It is a complex process of analyzing your personal financial situation and balancing it against your goals and objectives. Ultimately, knowing you risk tolerance - and keeping to investments that fit within it - should keep you from complete financial ruin.
(For related articles, visit How Risky Is You Portfolio? and Do You Understand Investment Risk?)
by Chad Butler,Senior Market Strategist, RJO Futures
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