Equity for Dummies

Equity: the very sound of the word increases your heart beat with grand visions of wealth and fortune, because that's the easiest way to doing business on your own. Business??? Yes, if you come across the term 'holding equity' in a business, it suggests that you are taking some interest in a particular business and you are linking your fortune with that of the company.

So, what is EQUITY/STOCK/SHARE?

STOCK, as the name suggests, is a stock of something; in the case of investing, it's a stock of a particular business divided into smaller fragments so that a large number of limited income people ( like you and me ) can also buy ( part of ) a big business like Infosys or Zee or Reliance.

A SHARE is the smallest portion of stock, which gives you the right to a part of the company, without any liability.

And finally EQUITY; a term that has many hidden meanings. Let's first see what the Cambridge dictionary says : "equity: the value of a property after you have paid all charges associated with it". Now, that definition hides several meanings.

"The value of a property" : How does one identify it? In fact, this very act of "finding the value" drives the stock market. Every individual is trying to find his/her own value for a property(company) and that drives the price of the shares on the Market.

So broadly what EQUITY means is:

a: Equal parts of the company
b: Equal rights to the owner

In a nutshell, by holding a Equity in a company we are basically buying a small fragment of a company, in other words we are buying a BUSINESS with our money!

This concept of "owning" a company is very important for those who are SAVERS and INVESTORS,and those who think they fall under those categories should never forget that a particular share grants them the ownership of a company. So when we buy a share we should be extra careful about the nature of business and financial strengths/weaknesses of the company.

But there are some other important elements in the Market which have created a class of people called the SPECULATOR. These people really play a very important role in the functioning of the Market, they help the Market derive a fair ( usually??) value of the company. (The stock market is no different than a whole-sale market for vegetables, where traders decide the price based on demand and supply and we as individuals are conveyed those prices when we buy vegetables from the vendors).

Now, its really interesting to play the role of a SPECULATOR/TRADER (as against the INVESTOR) as you are in the driver's seat, actively participating in the pricing of the share through your trades, while an investor just takes the price and analyses it based on the company's value which sounds boring. But, the role that you should take depends on your psychology and appetite for risk. If you ask me, be a little bit of both. Use whatever money you do not want to lose for investing and use for speculations the amount whose loss won't bother you much (termed risk-capital). While INVESTING is anytime better than mere SPECULATION/TRADING, your gains could be higher and you can also live the feeling of being in the driver's seat if you do a little bit of trading.

A point to take home : A share gives you the ownership of a business.

Beginners' Problem

We had rules from the last three weeks, and we all must be having questions; well rules are fine, but now what ??? Where shall I put my money ? Which STOCKS ? and what are the other stuff, small savings, mutual funds, gold and what not ?

The major problem currently for those who are starting to SAVE and a little bit of investing is which STOCK to buy ? And very few are looking at other avenues of parking the money. ( Yes parking is the better word to use for certain investments as they will keep them safe) And that's why all Investment Planners talk about these jargons like asset classes, asset allocations.....yes all those things are very important once you have a lac or two in savings...but when you start off, at that time it's better to stick to vibeindia.com's 3 rules and follow KISS (Keep It Simple Stupid!) for rest of the matters.

Simplest thing to do with your Rs. 3000 a month i.e. 10% of your salary is, to find whether all your TAX Rebate avenues which give you 8% returns or more are exhausted or not ? Oops!!! These again are jargons as something related to TAX came... right ??? So first lets look what all these means.

The person who is earning Rs. 400,000 may have a TAX Liability of around Rs. 60,000, so in turn now your After Tax Salary (ATS) is 340,000 only. Its every individual's duty to reduce his/her payout to the Government...else government will take it from you before you see that amount.

We have a good government, which provides quite some rebates to us. And we must take benefit of them. How ? We must match the returns too. And that's the simplest thing we can do.

Easiest Way, if you want to save for your later life i.e. after 15 years, open a PPF account and start putting your Rs. 3000 every month and forget the rest. It will earn you 8% returns and all are TAX FREE plus you can claim 15% rebate ie for 36000 you will be saving in the year you will reduce your TAX Liability by 5400 and that can buy you a smart gadget...

A fancy way is to put 10000 into an ELSS(Equity Linked Saving Schemes) - they are equity mutual fund by way of investing Rs. 1000 for ten months and put the rest 26000 in the PPF. Really at least these savings must be done by someone who wants to keep life simple and sweet...

But new age professionals do not prefer this plain vanilla... so for them... I presume this TAX Rebate and so called SMALL SAVINGs are not that much exciting for them we will venture into a tora-tora ride... concentrating only on EQUITY and EQUITY related instruments...

But if you love KISS, then at least do either of the things mentioned above...

The tortoise wins the race!

Last October my parents became grandparents and their whole life seems to have changed. And yes, I too became "mama" (uncle) and my life too seems to have changed. During the course of last year I understood the meaning of "Muddal Karata Vyaj Vhaloo". Interest is lovelier than the Principal. And that's true for most of us.

I really bet, my parents will be happier after they become "grand"-grandparents; and so we arrive at the last basic LAW (after "Save 10% of what you earn" and "Ride on PoC") I would say is necessary for any person to do well in investing- Interest earns more Interest.

However, that wich matters more than the "laws" is Consistency...

Most of the times all of us start everything in a Big Bang style. Oops... for the last two weeks I have been reading articles on vibeindia and that guy(guess who? :-) ) who writes on investing says, "just save for FIVE years and in thirty-five years you will have a Crore Plus..."
Well, some of us may have already started saving something... That's great..... Now, what is important is to do the same for the next FIVE years!... or even more..., which will make you a crorepati, much earlier.... But remember its not just five years. It's SIXTY months! and even more.... To put aside 10% every month... there lies a real challenge... To be a millionaire we have to win this challenge....

I have a very recent example. Around June, one of my colleagues who is interested in Big Bang money asked me, "jigu bhai bataw main paisa kahan lagau? I have money and want to invest it in Mutual Funds; suggest some...". I said, if you want to invest money first tell me how much of the money you will need in Six Months, how much in Two Years and how much in Five Years. Based on that I adviced him to invest the amount in different CLASSes of mutual fund schemes. He expected his money to be in Five Figures.

Now, oops! Since then, he has not put "a single rupee" in the plan he had agreed upon! The reason- the job is tedious. Every month putting away FOUR Thousand bucks is a more difficult job than putting Rs. 48,000 in a single shot. If you see his investment, currently his equity fund investments are doing well but not the debt fund; they are negative( you can ask how a debt fund can give negative returns? those technicalities later on but they can give negative returns).

The point is he had a Plan, but he could not stick to it. Many reasons would be there and that will come to everyone who tries to follow the "consistent investment approach". It's difficult...it's boring...it doesn't have the charm of gambling...it's a slow process...but it's IMPERATIVE!

And that's why what matters is: Consistency.... Yes, Consistently save 10% of whatever you earn.... and that will bring you your first million.... Its a difficult job but that's why they say.. "To be a millionaire is not an easy task!"

If you really do something consistently then even mathematics supports you.... and here I will come to my favorite theory of STOCK markets....(Yeah!!! now its interesting stuff... STOCK Markets!) To succeed in STOCK Market, the best way for a lay man is to invest an equal sum "every month"... Forget about where the market is... forget what your uncle is saying... forget what your broker is saying.... Just follow this and I assure you.... in next five years or so you are a millionaire....(I will discuss the theory later, for now I just want to stress on Consistency!!!) Statistics call it.....the STRONG LAW OF LARGE NUMBERS.....

So, here we end with the last basic Law and that is: Consistency. No Matter what will happen, what I have kept aside as savings I will not use it... It is just for giving me my first Million.

Question:
In India, which money generating activity attracts nearly the same kind of Income Tax Rate as Farming ?
Check out the answer next week!

Who wants to be a Millionnaire!

I should start from where we ended, the statement : 10% of what you earn before Tax is yours to keep.

Rules apart, lets dive straight into some figures to stress the point. Assuming your annual salary before Tax is 4 lacs and that you will have a salary hike of 10% per annum on an average, what do you have at the end? Oops!!!

But first decide upon a return (from investments) that you expect from the amount before you begin your calculations. I consider a return, well CAGR-Compounded Annual Growth Rate(for details ask me) of 12% is great. "Just" 12% ? Yes, my dear. The reason is quiet simple. The investing genius Warren Buffet when he started off, had a goal of 15% CAGR and he ended up at 23% CAGR in the past 35 years. So, as first time investors, our target of 12% is quiet "high" really!.

Now having selected a rate of return, assuming you save 10% of your Base Salary of Rs. 4 lacs (which increases 10% annually) and a return (from investments) of 12% CAGR, What will I have at the end of 5 years, if I just keep 10% of what I earn every month aside ? Good CAT question. Feel lazy to solve it ? Well let me solve it for you.

First year you will have saved Rs. 40,000 from your pocket and will have a final sum of Rs. 42,151. Doesn't sound too good... :-(

Now your salary has increased to 4.4 lacs and you will save 44,000 the second year and at the end of the year you will have Rs. 93,584. Hey! That's close enough to a lakh!

Third year... your salary is 4.84 lacs and you will save 48,000 that year and at the end of the year you will have Rs. 1,55,400

Fourth Year... your salary is 5.3 lacs and you will save 53,000 that year and at the end of the year you will have :Rs. 2,29,908 !

Fifth Year... Your Salary is 5.83 lacs and you will save 58,000 that year and at the end of the year you will have Rs. 318617

So, finally you would have saved Rs. 2,43,000 and your investment reached at 3,18,617.

So are the returns worth the saving and investing stuff? Well at this point of time maybe it doesn't look that good ... you can't even buy a decent car with the money, but wait... yes, wait... so we will wait for another 10 years and see, what happens to your "save and invest" method.

First thing. From the 5th year onwards you do not "do" anything and let your money work for you .... riches gets you more riches!..

After 15 Years from now you will have : Rs. 9,87,712

After 25 Years from now you will have : Rs. 30,61,907

After 35 Years from now you will have : Rs. 94,91,912

Want to live more??....

After 50 years from now you will have : Rs. 5,22,49,238

Now does THAT sound like something!!! :-)

And all you have had to save (SACRIFICE really by foregoing that extra pizza/jeans/...) is a meagre Rs. 2,43,000!

Can you believe it ? Well perhaps that's why Einstein had said "The Greatest power on earth is Power of Compounding"(PoC).

So, the second thumb rule Ride on PoC !

Dust to Dust ... Riches to Riches!

Stocks!- sounds as lucrative as a Development Project does it?, Savings - thats as mundane as a maintenance Project(but as we all know it pays off well!). But as I have learned the hard way, you need to save some to gain some.

We software geeks were amused by a recent article posted on rediff.com citing that there are going to be around 30 overnight crorepatis among TCS employees through the recent IPO. But was that piece of news something to be laughed off? Look a bit more closely around you and you will find truth in the article.

There's your friend who,heeding his uncle's advice, invested in Divi's lab IPO in March 2003, the Ten Lakhs he had saved from his last trip to the US. Right now he must be having a cash holding of a crore rupees in his bank account(provided he had sold off the shares at their peak value)!

Take another example of my friend who had invested("speculated" really... you will get to know the difference as you follow this column) in a PSU named Indraprastha gas, last year. He was lucky enough to be alloted Rs. 1 lac worth of shares. And can you believe that a few DAYS after the listing of the shares on the market, he reaped in Rs. 5 lacs!!

Let me share MY story, and don't be jealous. My father being a banker, and expecting a above-average growth in the banking industry suggested in December of 2002 that I invest in banking stock. I followed;thought knowing zilch about either banking or stocks. Since I had an amount of Rs. 10,000 (too less really to seriously play the investing game!) I went ahead and invested in Bank of Baroda (the place where my dad works). You could have chosen any other PSU bank for that matter. And today that money has grown by four times! Joyous as I am, I also cant help regretting the puny amount I had invested. Only if I hadn't gone on a mindless shopping spree that month and had saved more! Moral of the story..... oops! no moral science lessons in my first article!

Enough of case studies (I am sure you would come up with more on your own). While you may not become a millionaire overnight, but given a few years of intelligent saving/investing you can get to your first million in 5 years and a first crore in 15 years!

So Whats the recipe? Nothing much; no on-site trips(well if it does come, you can reach your goal a year or two ahead of time!), no waiting for your rich uncle from Africa. Just forego that extra pair of jeans that you really don't need right now and invest the bucks saved!

Remember... 10% of what you earn before TAX is yours forever(minimum 5 years). Follow this space for more investment advice.