For A Few Rupees More: Planning Good & Avoiding Bad/Ugly Investment Decisions

 

When a cup of tasty coffee can be had from Rs. 5 to Rs. 500, we need to make sure that we pay for it knowing precisely what we are getting out of it. Our present is unlike our immediate past and each new investment opportunity is bringing with itself a huge amount of downside risk. Unless we know what these risks are and how they will change in the coming days, we should not be making any investment decision. Losing what we have already is much more catastrophic than not being able to make an additional dime! 

 

 

Context of the article

 

Increasingly, we observe that during debates on financial matters, folks with technical knowledge of the subject matter are able to emphasize the superiority of their logic, even though it does not jive with the common sense interpretation of the world of the other party.

 

This is the second article in the series of 2 articles I am writing to try and explain, with my limited knowledge,

Article 1: How the nature of money is itself going to change in the coming days?

Article 2 (this one): How one can avoid obvious mistakes while planning one’s investments?

 

This is meant for folks who would like to understand but are not too keen to look at hardcore business news for the same.

 

In this article, we are examining what are the obvious mistakes one can make today while investing money and how one can guard oneself against those. The topics below relate to the investments in Stocks/Gold/Bank FDs as I understand these better than other avenues.

 

 

What I mean by Savings and What I am excluding from the discussion

 

In the article below I repeatedly talk about the investments we are making from our own SAVINGS THAT WE HAVE GOT IN CASH/EQUIVALENTS OF CASH. By savings, I mean the amount of money we have kept for ourselves AFTER ALL OUR OBLIGATIONS ARE MET. It is important to emphasize such a mundane point because the discussion below is not geared to meeting the requirements of folks for whom investment is their primary source of income. Such folks will be served better by following the investment strategy that they have been following as they obviously know better than this writer. The discussion below is only for those who have managed to save money or their future and are desperately looking for ways to improve on their current cash/liquid holdings, but will be gutted if they lose what they have got.

 

Also, in the article below, I am excluding the topic of Real Estate altogether. The reasons are that a) the real estate market is very local and very speculative from my point of view and I profess no expertise on the same and b) most of us make the below investments on the savings we have got after meeting all obligations, including real estate.

 

 

Let’s Recall What We Discussed

 

In the previous article, I had concluded that we are going to see:

a)      Cheap money in the rest of the world,

b)     The currencies of the rest of the world are sure to lose their value

c)      A period of high inflation in India,

d)     Whether Indian rupee will gain as compared to others will depend on how better we can control our finances (very low chance) and how long can we prevent interest rates from going down (Hail our RBI governor for this!).

 

The above points bring a couple of very logical question to the fore: When cheap money is available, where does it go? What is the problem if nearly every currency is losing its value? Will the whole thing not average out for all cash that we hold and hence isn’t this an irrelevant point in the larger scheme of things?

 

 

Where Does the Cheap Money Go?

 

In the previous article we discussed that most of the governments in the developed/developing world are printing their own money in the hope that this will be made available to the citizens of their country and those citizens will spend it or will create businesses from it so that economic prosperity and financial security returns to all. Though this is a practical step, this does not solve the basic problem because of the whole mess was created.

 

Our financial systems started to face issues because the customers to which banks had lent their money to were not worthy of that money. By this I mean that the banks (which are backed by Governments) had only given loans on the basis of short term business prosperity and not on the basis of long-term credit worthiness of the customers. Either the customers were too weak financially to deserve large loans (USA) or were experiencing a temporary business boom that was not to be sustained (Spain) or were simply defrauding the banks by wrong reporting (Greece) or were dependent on health of the rest of the world  for their business (China/Brazil/Australia/Japan) or had a sustained period of economic boom and the business cycles were about to turn bad (UK) or were asking for loans on the basis of super rosy business projections (India) or were hoping to generate business returns by colluding with other industry partners (India, at least!).

 

Fundamentally, none of the above problems are solved yet. ANYWHERE!      However, because as humans we have repeatedly encountered and solved these problems in the past history we have started to believe that we can speed up the recovery process. That is where the governments are increasingly releasing larger and larger tranches of money believing that they can control each and every other variable of the recovery strategy (like policy/investments/trade restrictions etc) and so more money will simply help.

 

This is where, according to me, the governments are erring. As mentioned earlier, the governments are lending the money to banks assuming the banks will pass on that to the customers. But there are 2 reasons why that will not happen so easily: a) Banks know that the basic problems with the borrowers have not gone away and so there is no guarantee that old mistakes will not be repeated and b) The officers in these banks have seen VERY RECENTLY the after effects of their bad decisions and so will be doubly hesitant to lend money freely.

 

So net-net, cheap money will REACH BANKS BUT WILL NOT GO TO CITIZENS IMEDIATELY. It will go to citizens only after the banks have exhausted all the other possible investment options or if the government explicitly mandates these banks to do so.

 

So again… where are the other investment opportunities where everyone’s messing up to some degree? Let’s investigate!

 

 

What Happens When Each Currency Is Losing Its Value

 

Normally in an interconnected world where one country/geography is doing better than others, nearly everyone with money knows where to invest to get good returns. But our present is pretty peculiar. All the countries are tripping over to prove that they can do worse than others! In fact, if it were a race than anyone who simply stands his/her ground will win because everyone else is running backwards.

 

So if all currencies are losing their worth and nearly every government is messing up to some degree, does it mean that nobody loses relatively in the process? In short, NO.

 

Let us recall that all of us are humans. There are always some things that are more important to us than others. These are the things that we have been taught are more valuable than the rest and those who taught us themselves learnt so from their experiences or their elders! Some of these things are family, relationships, knowledge, values and GOLD.

 

When everything is losing value (i.e. running backwards) the one thing that is considered inherently valuable (standing his/her ground) becomes more expensive (wins the race). This is where Gold comes in.

 

All of us inherently know that even when one cannot buy anything from a piece of paper, one can buy the same thing using a piece of gold as gold has a) a ready cash equivalent and b) a market determined rate. This is the one aspect that makes sure that Gold retains its importance as its investment option.

 

When a country needs money from international market it can either a) sell its own gold holdings or b) print its own money. The first option reduces the general prices of gold in the world. But that is not happening as the countries know that all currencies are losing value and so there is no point selling Gold to get those external currencies. In other words, nearly everyone who is in a position to dictate the financial fortunes of economies knows that Gold is more valuable to hold than a currency (say Dollars/Euros/Rupees).

 

Same is the case with banks and other financial institutions. All of them know that the cheap money that they are getting from the governments cannot be kept idle (as it loses value) and cannot be given back to customers freely (as that restarts the whole money destruction cycle for the time being) and cannot be invested elsewhere on the planet (as everyone has the same problems in economic terms). SO ANY SPARE CHEAP MONEY IS INVESTED IN ASSETS THAT ARE CONSIDERED INVESTMENT WORTHY BECAUSE OF THEIR INHERENT PROPERTIES, AND GOLD FITS THE BILL PERFECTLY.

 

In short: WHEN EVERYTHING LOSES ITS VALUE THEN GOLD WINS IN RELATIVE TERMS.

 

 

If Gold, Then Why Not Silver, Oil, Copper, etc…

 

Recall why gold was gaining in the first place! It was gaining because none of the economies are certain of their inherent strengths over the medium to longer term. They are not sure that the business activity in their countries is going to pick up soon and so Gold is a SAFE OPTION.

 

Other commodities that have their inherent worth are Silver, Metals like Copper, Oil etc. All these commodities have one key difference with respect to gold. All of them are tied less to a human notion of importance and are tied more to their inherent use in industries/business activity. For e.g., you and I are not likely to hoard tankers of Oil in our homes in hope of gaining from price appreciation! Same is the case with Silver (though some of my fellow Indians will disagree!) Silver, has a much bigger usage in industries than in homes!

 

This difference is what separates Gold from all others. Since the industries that need these metals are not doing to demand these metals in the short term, the cost of these metals not likely to appreciate

 

Net –net, apart from Gold no other commodity (that we normally talk of) is as certain to retain its value because their value is more determined by how much it is wanted by industries and due to lesser economic activity happening they are not likely to appreciate.  

 

Before we proceed… One more question. If Gold, then why not Diamonds? Simple, it’s because Diamond is not a commodity. It cannot be exchanged over the counter for Cash and there is no easily accessible standard benchmark for its value upon conversion to cash. So it is considered valuable but is not an investment option and so banks are much less likely to buy diamonds from the cash they are getting from government because they do not know how much they will get back when they sell it.

 

 

Ok… So I should Start Hoarding Gold Right?

 

Yes, if you are American or European, but No if you are Indian. Let me explain! See, if you earn and spend in Dollars or Euros, then you already know that your currency will depreciate and gold will appreciate in comparison but there is another aspect that is to your advantage which you may not be appreciating. The countries with surplus money and the organizations/individuals with cheap money more often than not belong to US/Europe and so the inherent trades that dictate the price of Gold are all in these currencies. So basically you are risk free w.r.t. currency fluctuations.

 

However, if you are Indian then there is another aspect to the same story. The inherent trades deciding the value of gold will happen with cheap money as available with financial organizations/investors in the developed economies and those currencies are in US/Euros. But when you and I go out to buy gold, we pay in Rupees. So if you have a situation where gold prices are increasing in dollar terms but rupee is gaining with respect to dollar, then the overall price movement may not be beneficial.

 

For e.g., if today the price of Gold is 1 USD per 10 grams and the cost of dollar is 55 Rs per dollar, then the price of gold is 55 Rs per 10 grams. If in one year gold appreciates by 10% in dollar terms then it price will be 1.1 USD per to grams. So for an American investor there is a gain of 10%. But in the same year if your Rupee appreciates with respect to dollar (because say our finances become better in short term due to government selling stakes in government owned profitable enterprises) and becomes 50 Rs. per dollar then the cost of gold will be = 1.1*50 = 55 Rs. per 10 grams. So an Indian investor will not gain anything.

 

Above example is extremely dumbed down and simplified for the purpose of making a point. And that point is: to invest is Gold; we also need to see how our rupee is doing with respect to the global currencies.

 

Before going ahead I reiterate the question: Should we start hoarding Gold now? Hold on!

 

 

How Will Indian Rupee Fare W.R.T. Global Currencies?

 

There are 2 perspectives to this question: short term and long term perspectives. In a shorter term (say 6 months) the finances of the country are invariably going to be better because of recently announced ‘reforms’ as these ‘reforms’ have helped the corporate decision makers the most. And remember… these are the same folks who hold the most amount of spare money!

 

So with improved investments in India and by selling of government share in profitable companies our country’s finances are going to be better in the short term. This, combined with the fact that there will be unlimited Dollar/Euro in the market for some time to come, means that our Rupee will appreciate with respect to these currencies. Plainly this means that exchange rate will be closer to Rs. 50 per Dollar than to Rs. 55 – Rs. 60 per Dollar.

 

However, as the horizon expands we are going to see one of the 2 events in India. Either our government survives until 2014 or our government collapses in early 2013. If it’s the former, it is GOING TO ANNOUNCE a lot of welfare schemes for vote preservation for 2014 (I am not waging a bet here… This will happen given the historical trends!). If it’s the latter then budget in 2013 won’t matter as new government will present a new one and until then governance will drag on. If we agree that a new party will make the government then nearly all of them other than Congress are against retail FDI. No matter whether they agree or not with the present policies the investors are not going to like it and our financials will be in a mess for some time to come. Given this, either of these 2 variables is pointing to a longer term future (1-2 years) where the financials in India are not going to go bad and so Rupee will start its descent all over again.

 

So net-net, in the near term rupee is going to gain with respect to global currencies and in longer term it is going to lose.

 

 

So Again… What Should We Do About Gold?

 

I say… embrace it! From my point of view gold is going to appreciate with respect to global currencies and those currencies will depreciate with respect to Indian rupee. With these 2 combined we should have decent returns on gold in the coming year.

 

However, by above I do not mean that there won’t be days when the price won’t dip. See, it’s a trader’s marked and there are times/spots when prices go up or go down. However, the longer term indication for me for the next 18 months or so is positive and so I suggest each time one hears news of gold dropping in its value one should buy it.

 

Finally, one should remember than the same factors that are driving the price up will drag the price down. So when the global economy sees recovery and when Indian rupee gains its strength back we will see a reversal. But I do not see that happening for the next 18 months at least and so I think we will be covered until then.

 

 

Before We Proceed… Do You Know Where We Get The Cheapest Gold In India?

 

It is in our Post Offices! Private Banks sometimes give discounts on prices but when you compare you will find that the price even after discounts are more than some of the government banks and the Indian Post Office! So if you are like me who banks on his/her bank and is planning to do an auto-debit on the bank’s website for monthly gold purchase… DON’T! Please walk to the nearest post office and enquire about the price.

 

 

OK We Agree About Gold… Is There Anything Else Worth Considering?

 

Stocks! See, the reason why gold is going up is because there are not many good and reliable investment opportunities for those with money. But at the same time those investors are not going to invest 100% of their money in Gold! They will look at alternate investment opportunities. That is where stocks come in!

 

 

Er… Did I Just Not Say That Economy Is Not Picking Up?

 

Yes I did, but still I am advocating stocks. See… there are 2 reasons why stock prices go up. One reason is that the inherent economy does well and the other reason is that there is sufficient confidence that the inherent economy is going to do well in the near future. To the extent that one agrees that the recent wave of ‘reforms’ in India are targeting the investors, one will agree that the inherent stock market will do well as well because these investors  are not getting good news from many other sources.

 

In the absence of good news from elsewhere and of any other plausible investment opportunities, those with cheap money are going to the next place where one can invest and get out most easily and where news is good for the short term. That is our Indian Stock Market!

 

So net-net, I believe that our general Indian Stock Market is going to do better in the short term before the investors can take the money out to invest in other opportunities around the globe.

 

 

Say What Now! Should We Invest or Not Invest in Stocks?

 

We should, but with a caveat! See let’s ask ourselves how we understand the stock market. From my experience those with little interest in numbers invest in stocks by one of the following approaches:

  1. They listen to the experts in the market and pick stocks as suggested by those experts
  2. They choose an industry they know sufficiently about and then buy the stocks of the company that they believe is doing the best in that industry
  3. They go by their gut feeling about various companies and pick the ‘large’ or ‘famous’ companies that they have good feelings for!

 

Because of the inherent nature of the economy and the interest of global investors in making a quick buck, we are living in a time where the valuations of industries and companies within the same industry are varying a lot! Without a proper analysis it is extremely difficult to find out the good companies worth investing because one does not know: a) which company is extremely overvalued because it is in good news already or b) which company is overvalued today because it will be in a scam tomorrow.

 

So if you are an investor who approaches the stock market in any of the above methods then PLEASE DON’T! As of today, that is the worst decision you will be making!

 

For a lay investor like you and me, the best approach today is to try and invest in market as a whole and not in one/two selected companies. It is nearly certain that the overall BSE Sensex/NST Nifty is going to go up as the general interest of global money will be towards India.

 

So how does one invest in stock market as a whole but not in individual companies?

 

 

Index Based Mutual Funds

 

All the banks we talk to have mutual fund schemes for their customers. In these schemes they take the customer’s money and invest those in the stock market or government bonds or both. Normally they tell the customer at the time of taking money about the overall approach they will be following to manage the fund and what are the fees they will charge for the same.

 

One such scheme is the Index Funds. In these funds the mutual fund company simply takes the money from you and me and invests it into the same stocks that comprise the BSE Sensex or NSE Nifty and in the proportion in which those stocks appear there. So in basic terms, these funds are the closest proxy we have if we want to invest in Stocks as whole without investing in individual companies!

 

Another advantage of these funds is that in general their fee is the lowest because the people who manage these funds do not have to apply any logic from their own end while managing money. They simply have to buy and sell stocks that appear in the Sensex/Nifty and in the proportion they appear in those indices. So w.r.t. fees too, if we invest in these funds we get the maximum investment from the money we give to the mutual fund company.

 

So net-net, someone who does not want to lose money and is skeptical of buying mutual funds/stocks because he/she does not understand them well should be decently confident of getting decent returns with minimum losses by investing in an index fund right now. Any moment when the market dips will be a decent time to buy the fund.

 

 

Should We Invest In Futures and Options Market

 

Please don’t, unless you really know what is going on with the underlying business variables of the company. See in F&O segment, we get into an agreement to seal the deal (sale/purchase of a share at a pre-determined price) at a given time in the future. As I have mentioned above the overall broad economic environment in which companies operate are going to change a lot in the coming days and just like it is foolish to make long term commitments on investments, it is foolish (in my personal view) to commit to a sale/purchase at a predetermined price if one is really banking on one’s sixth sense.

 

So net-net, I would not personally invest into futures and options segments of the stock/commodities trading markets. Agents say that there is real money to be had in these markets, but I have observed entire Banks getting wiped out because of wrong deals and there is so much to lose here as it is most speculative.

 

 

My Banker Tells Me That a New Insurance Policy is such that Premium Can Be Invested and Returned in 5 Years… Should I?

 

For the love of God… DON’T! If you are buying an insurance policy then please buy a pure play policy with no funds attached to it. For e.g., if you are buying a Life Insurance policy then please buy a policy that pays your dependents money after your death and not the one that pays you money back after 5-20 years!

 

See, the basic point of right investing is that one should not mix 2 investment decisions together. There are too many variables that interplay and it is nearly impossible for a lay investor to take note/control of all of them at all points in time. Two of these variables are premium amount and lock-in period. If you are buying an insurance policy, please buy a policy that does ONLY THAT… which is providing you insurance. This ways your premium will be very less and the money you save can be invested elsewhere by your own choice. Also, an insurance policy clubbed with investment has its own locking period and my only contention throughout the article is that life will be different in long term than short term. There is no point giving money to someone for 5 years when you can a) not give that money and b) invest that money somewhere else and take it out at your own will.

 

So net-net… If you are planning insurance then please invest in a pure-play investment policy and not in a policy clubbed with investment option! Such policies are available in the market.

 

On a side note, there is a pretty neat article on Firstpost (here) on how the insurance companies in India are actually expensive mutual funds.

 

 

What about Bank Deposits/FDs?

 

We have just discussed that no matter what happens the economic variables are going to change a lot in a longer term. Also, the inflation in India is not going to come down any time soon and so it is basically a wasteful idea to invest in anything for a long time where we have no option to wait when everything else is getting so expensive! So if we need to make sure that we invest in an opportunity if it is very easy for us to take the money out on short notice. Hence, with this regards I suggest that we refrain from making any FDs for longer terms (say over a year). If we have decided to make a FD, please ensure that we do it for shorter terms and not for longer terms as it will be a bigger loss on longer term horizon due to inflation and misses in alternate investment opportunities.

 

In any case, this should be the last option for you when all the other options are explored. I am not saying this because of the returns but because we are not able to extract money out immediately in times of need.

 

 

What about Government Bonds?

 

Our government floats tax saving bonds where which we can buy from our regular salary. The basic idea is that when we pay for these bonds, the government will pay the whole amount back in some number of years and along with that it will pay a fixed additional amount. The rate at which it pays back is the similar in concept to interest rate that we get from any other money that we lend to someone else.

 

Should you and I do it? I think this is one way of getting assured returns from the government at confirmed and tax free rates.  It is directly in contrast with the FDs we talked about in Banks as then we only got fixed returns but we were not getting tax free returns and were not able to save taxes. Because of these added advantages, investing in tax free bonds is a decent option if we want to invest for longer term duration. However, I suggest that these should be the option only and only if we have decided that we have to have some long term investment of say more than 5 years. We need to understand that these bonds will surely cause us some losses (due to high inflation in India) but those losses will be much lesser if our money is going to be left altogether untouched in banks or is invested in a bank FD.

 

So net-net, only and only if we have decided that we need to invest somewhere and then forget about it for 5 years at least, we should  look at tax free government bonds. This is the only option of a long term investment of an investor who wants to minimize his/her losses.

 

 

Conclusion

 

From my point of view, the first instinct of a salaried struggling to enhance the savings should be to make sure that he/she does not lose what is earned already. We are sitting at a juncture where some of the broader economic trends are clear in short to medium term and there are many ways in which we can lose our money. Also, the messages that we are getting from the world are so many that sometimes it is not easy to differentiate between a good and a bad investment.

 

Below is what I am suggesting to myself because we are going to have a period of continued high inflation, low economic productivity, currency depreciation and FDI inflows into the country in short term.

  • Invest in gold each time you hear the price dipping
  • Invest in index based mutual funds instead of individual stocks
  • Avoid FDs
  • Buy pure play insurance policy, not insurance scheme bundled with mutual fund
  • Keep investing in avenues where it is easy to take the money out on a short notice
  • If a long term investment cannot be avoided, then government bonds are the most rewarding… relatively
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