Prajna Capital

Make sector rotation investing work for you
Switching from a dividend plan to growth options of Mutual funds
Know Your Risk Appetite Before Making Investments
What you must know when Buying gold in physical form?

Make sector rotation investing work for you

Posted: 13 Oct 2011 06:27 AM PDT

With some indications of interest rates peaking, it is time to review your investment strategy

There is a heated debate among analysts going on about peaking of interest rates here. Looking at the moderating growth numbers and the length of the rate hike cycle, some analysts are of the opinion that interest rates are peaking, and they will slow down in the coming months. They feel the Reserve Bank of India (RBI) has already achieved what it set out to do - moderate growth and inflation.

On the other hand, those analysts focusing on the inflation numbers are doubtful about this. They are of the opinion that there may be some steam left in the rate hike cycle, and they may peak at the end of this year or even a little later. However, there is a broad consensus among analysts that the rate hike cycle is closer to its peak. This information is important to investors as the higher interest rates seen at the peak of the interest rate cycle signal a shift in investing - away from stocks and into fixed income securities.

Since fixed income securities' prices move contrary to interest rates, the best time to invest in these securities is at the peak of an inflation cycle, when interest rates are high and fixed income securities trade at low prices. Such opportunities are likely to occur periodically every few years, due to the limitations that central banks face when trying to curb inflation with a tight monetary policy. India is facing such a situation now as the country has undergone a series of rate hikes in an effort to curb inflation. Today, a fixed income investor is probably getting more returns risk free than a stocks investor who has undertaken more risk and is getting lower returns.

This is due to the fact that interest rates play an important role in the performance of the stock markets. Higher interest rates imply that companies must pay more on their borrowings for capital investments. This naturally impacts their margins negatively, thereby bringing down stock prices. At the peak of an inflation cycle, stock prices are high compared to their forward earnings. Their returns and yields compare unfavourably with the high yields at virtually no risk available from fixed income securities.

In a rising inflation period, a typical interest rate cycle consists of two stages - a series of rate hikes, followed by a period of stabilisation. When the inflation rate rises due to demand pull pressures, the RBI will hike the interest rates to fight off inflation and cool down the economy. As the effect starts, with the economy slowing down, the interest rates will be held steady for a while. However, if the inflation rate is more due to a cost push effect, resulting from sharp increases in the fuel prices for example, rather than demand pull pressures, the rate hike cycle can continue for a longer duration.

Investment strategy

By understanding how an interest rate cycle works, an investor can put in place an investment strategy that works differently at each stage of the interest rate cycle. As the interest rate cycle nears its peak, a risk averse investor can allocate a larger part of his portfolio to long-term fixed income funds, which will benefit from the stabilisation and subsequent fall in interest rates.

But, till the peak is reached, he must invest in shorter duration bonds and fixed deposits to take advantage of the rising interest rates. That said, just how an investor will determine when the peak in the cycle occurs is a question that does not have an easy answer.

For a stock only, risk-embracing investor, tagging the investment style to interest rates basically means investing in different industries at different stages of the cycle. Foreseeing that interest rate is going to increase, an investor will tend to shy away from interest rate-sensitive sectors such as banking and auto, knowing that these industries will be hit during rate hikes. As the rate hike peaks, the sectors that come back into focus are cyclicals, materials and basic industries.

Hence, investors with a high risk appetite, at the current juncture, should look for signs of peaking in the interest rates and get ready for some sector rotation.

Switching from a dividend plan to growth options of Mutual funds

Posted: 13 Oct 2011 05:19 AM PDT

Switching from a dividend plan to growth amounts to a financial transaction. Meaning, your existing investment will be redeemed and invested in the growth plan. This can have tax implication. For this we suggest, discontinue fresh investment in the dividend plan, don't redeem your existing accumulation and request a change from dividend to dividend reinvestment plan which is possible. Start investing your money from now on in the growth plan.

-----------------------------------------------------------------

Also, know how to buy mutual funds online:

Invest in DSP BlackRock Mutual Funds Online

Invest in Reliance Mutual Funds Online

Invest in HDFC Mutual Funds Online

Invest in Sundaram Mutual Funds Online

Invest in Birla Sunlife Mutual Funds Online

Invest in UTI Mutual Funds Online

Invest in SBI Mutual Funds Online

Invest in Edelweiss Mutual Funds Online

Invest in IDFC Mutual Funds Online

Know Your Risk Appetite Before Making Investments

Posted: 12 Oct 2011 08:25 PM PDT

On a routine walk last week, the light drizzle was a welcome relief for me from the heat and humidity that was building up. As the drizzle increased, I could see concerned parents fish out large umbrellas to protect their children from the raindrops, old men make valiant run for shelter to save themselves from getting wet and the newspaper vendor take a huge sheet to cover his wares and not himself. While I was happily humming one of my favourite rain songs, I observed that everyone had a different method to address the risk of getting wet.

For much of human history, risk and survival have gone hand in hand. Right from the moment we get up in the morning, drive or take public transportation to work, till we get back into our beds, we are exposed to risks of different degrees. While we may not have much of a control on some risks, we seek out some risks on our own (speeding on the expressways or betting over a cricket match, for instance) and enjoy them. Some of these risks may seem trivial, others make a significant difference to the way we live our lives, especially the risks we take with our finances. We all know or have heard that investing is a powerful tool to increase one's wealth, and many of us blindly get into investing for one reason or the other. However, at the time of investing, we do not ask ourselves: What is this investment for? What are the products I need to consider?

Getting into investing without a clear understanding of the process involved is like setting off on a treasure hunt without a map and clues. It is not difficult to understand why and what investing is, and once you understand these two aspects, choosing the right financial product to meet your needs will be easy.

The first step to investing is to understand the purpose of the investment, to determine your risk tolerance and the kind of products that would suit your risk profile. For instance, at 40, when I am planning for my retirement at 60, I don't need the money for another 20 years. Hence, the kind of risk I can take will be higher as I can withstand the ups and downs of the stock markets and stay invested. On the other hand, if the money that I have is meant for rainy days, then my purpose is to protect my savings so that in case of unfortunate events, there is cash available to help me tide through the problems. Therefore, the risk tolerance will be very low for this money and the type of products I choose will have to meet this need.

While your age and your time frame for meeting specific financial goals play a role in determining your risk tolerance, there are also other factors that affect your tolerance for investment risk. Your personality, personal experiences, and current financial circumstances also come into play. For instance, if you're the sole breadwinner responsible for the care of a sick or an elderly relative, or have lived through a period of economic downturn, you may be a more risk-averse, or conservative, investor. On the other hand, if you have a promising career, a generous salary, and little in the way of financial responsibilities, you may be more comfortable in taking greater investment risk.

A simple way to check your risk tolerance is to ask yourself how comfortable you are in taking risks. For instance, if changes in the value of your savings and investments keep you fidgeting and worried, or your instinct is to sell your investments every time the market drops, then you may want to consider shifting to a more moderate investment mix, with greater emphasis on predictable, income-producing investments such as fixed deposits or traditional life insurance.

If you're a risk-taker by nature and have at least 15 years to meet your goals, then you may be comfortable allocating most of your assets to a diversified portfolio of stock, equity funds, and unitlinked insurance plans, along with certain fixed-income investments that have the potential to provide the strongest returns over the long run.

The decisions on how much risk to take and what type of risks to take are critical to the success of your investments. You can get a clear view of your risk-taking ability with professional help and a scientific risk profiler.

Life insurance forms the bedrock of all financial planning and the best way to begin one's financial journey. The needs and goals in a person's life keep changing and a periodic re-evaluation of your mix of asset allocation, time horizons, liquidity and risk-return equation is necessary to optimise the desired outcomes.

Keeping this mantra in mind, make the right choices of financial products and your invested money can go up in value. But with the wrong choices, you may end up losing it all.

What you must know when Buying gold in physical form?

Posted: 12 Oct 2011 08:51 AM PDT

Today you can buy gold either in paper form, like through an ETF. Or, you can buy gold the old-fashioned way and hold it in physical form like coins, bars or jewellery. Here we shed some light on things you must know if you are looking at owning gold in physical form.

How to buy gold in physical form?

You can buy physical gold through a jeweller or a bank. Jewellers are the traditional channel for purchasing gold, typically in jewellery form. But more recently banks have also started offering gold bars and biscuits for sale. Wherever you buy it from, make sure its a trusted source jeweller or a bank that will provide you a certificate.

If you buy gold coins or bars worth more than Rs 50,000, then you will need to show your PAN card and an ID proof. If you buy gold from a jeweller, then you don't have to produce any documents.

What are the advantages of owning gold in physical form?

1. Tangible: Some of us want to be able to touch, feel and hold things that we own. Clearly owning gold in metal form like a coin or jewellery offer this. Additionally, this gold can be used for consumption purposes in that one can wear it for ornamentation, or use it during religious occasions. By accumulating jewellery early, one can start building a pool of assets that one can gift to immediate family members at the time of their respective weddings. Clearly this is a benefit and satisfaction that you will not get if you hold a gold ETF.

2. Store of value: Gold coins and bars are a good form in which to hold some of our wealth. At any time one wishes to convert them into cash, all one has to do is to go to the local jeweller and receive the then prevailing price in return for our gold. Of course the price can fluctuate, but given that gold is a scarce resource in the world, one can be sure that one will get some value for this at all times. Compare this to say other assets such as art or some antiques where people's tastes might vary across time and geographies and one might not be able to realize the full value of that asset. As long as the gold is pure, gold ought to have the same value globally, any where you wish you encash your gold.

What are the disadvantages of buying in physical gold?

1. Purity: Unless you are buying a gold coin or bar from a bank where it comes with a certificate of purity, you might run the risk of buying gold that is not of a very high purity. This is especially true if you are shopping at a jeweller where you are not sure of their credibility and quality. Only buy from trusted sources.

2. Storage costs: Physical gold needs to be stored in a safe place as there is a threat of it being stolen. So, you need to protect it by keeping it in a bank locker or a commercial vault. This however comes at a cost as you will have to pay a charge to safely store your gold in either of these places. You might also need to spend money on gold insurance.

3. Lack of interest income: Holding gold, especially when it sits idle in a locker or at home, earns the owner zero interest income. Unlike financial instruments such as FDs, bonds and stocks, that can earn interest or dividend income, gold does not provide a recurring income.

Purity and storage costs are not issues you need to worry about if you buy an gold ETF. However, even if you hold ETFs you will not get any interest income on your holding.

What are the tax implications of buying and selling in physical gold?

The tax treatment to the profits booked on selling physical gold is similar to that of any capital asset. If you invest in physical gold in the long-term, i.e., more than 3 years, then the tax deducted will be 20% of the gains. On the other hand, if you sell it before 3 years, the tax treatment will be according to the tax slab you fall in depending upon your income bracket.

Any gold you hold in physical form will be liable for wealth tax.

Is it easy to sell physical gold?

Selling your gold depends upon where you and your prevailing circumstances. If you are selling coins or bars and the purity is not in doubt, you can get the current available market price. However, recognize that banks will not buy your gold back from you. Chances are you will have to go to a gold merchant, or a jeweller. Many of these jewellers might charge you a hidden transaction fees, i.e., they will not pay you a full price for what your gold is worth. Also, if you are selling your jewellery to them, many will not pay for the workmanship associated with the jewellery. As a result, you might not recover the same prices as you paid for the jewellery, even if the price of gold has not moved at all since you first bought.

Selling physical gold is generally easy, but comes with some associated transaction costs.