Understanding Risk-Return for Various Investment Asset Classes

This blog has been contributed by our guest blogger, Ms Snehil Gupta. She is leading the marketing & business development for CrediFiable (https://credifiable.com)

Investing is putting your money at work so that it grows in value over time and generates returns for you. You should not confuse investing with savings. You save when you simply put aside a part of your income in a safe place so that it is almost risk-free such as money in your saving bank account. Your money hardly grows in value over time when you just save. On the other-hand investing is committing your money to a financial product such as mutual fund or bond or direct stock, so that your money is exposed to some amount of risk in exchange of higher expected returns.

Understanding Risk & Return on Investment

In a very layman’s definition, return on investment is the amount by which the value of your original money changes. When the sum of your invested money increases, you have positive returns and when your sum of money decreases then you have earned negative returns.

Risk is defined as probability of deviation of the actual returns from the expected returns on your invested money. What this means is that if you put your money in a risky investment then there is a chance that you may lose some or even all your initial investment. There is also a chance that your investment grows in value and you stand to gain much higher returns than the traditional risk-free financial instruments.


There is a principle of risk-return trade-off, as per which, as the risk potential increases the likely return on investment also go-up. Thus, if you invest money in a riskier small start-up you are likely to gain higher returns in contrast to investing in relatively safer large-cap equity mutual fund. Money invested in a start-up company may grow up to 3X or even higher in value. A large-cap equity mutual fund typically gives compounded annual return of 15% – 20% over 3 – 5 years of time. But if the start-up fails, you may lose all your initial investment. Whereas money invested in a large-cap equity mutual fund will not become zero but continue to grow albeit at a slower rate even in a bear-market.

How Time Impacts Risk and Return?

Time has an important role to play in expecting return on your investment. Under the concept of Time Value of Money, a Rupee today is worth more than a rupee tomorrow.

One of the reasons behind this is the inflation which leads to decrease in the “real-value” of your money over time. If your money does not increase by an amount at least greater than inflation, then it may be better to rather spend it today. For example, say you can buy 5 apples today for Rs.100 and a year later because of inflation you need to spend Rs.105 to buy the same 5 apples. But your money has increased only to Rs.103 over one year. Now it makes more sense to use your Rs.100 to buy 5 apples today instead of less than 5 apples after a year with Rs.103.

Another reason behind decrease in the worth of money with time is the concept of opportunity cost. So, if you choose to invest money in say equity mutual fund, you are forsaking the interest you will earn on this money if kept in a bank account or as an FD.

There are two takeaways here:

  1. Whenever you invest, it is important to start early. The earlier your start, your money is worth more than what it will be later.
  2. It is essential for you to invest your money, if not then inflation will eat away all your savings. Gradually over time your money will lose its purchasing power. If you will recollect, a movie ticket was much easier on your pocket 5 years ago, than it is now.

Risk-Return Trade-Off for Different Asset Classes

Asset is something which generates money. For example, if you have a house from which you generate rental income, it becomes an asset. For a business, its’ factory is an asset because it is used for the manufacturing of goods sold. Likewise, a financial instrument is an asset because it increases the value of money over time. Hence you invest your money in a financial asset. Asset class is a group of financial instruments having similar characteristics and which are subject to same regulatory guidelines.

Asset class is fundamental in financial planning. An asset class has unique risk and return characteristics. Now, depending upon an investor’s risk preference his / her financial planner may allocate different sum of money to different asset classes.

Types of Asset Classes

Mainly asset class are of 5 types with different degree of associated risk and rewards with each asset class. Let us look at the various asset classes available for you.

1. Cash

In all fairness cash is not an investment, but it is just an asset class. It is least risky but at the same time yields least returns as-well. But you must maintain an optimum amount of liquid cash either in the form of bank account savings or as a fixed income liquid mutual fund for transactions or any eventualities that may arise in future. Financial advisors suggest you to maintain 6 months’ equivalent of your expenses in form of cash or cash-equivalents.

2. Fixed Income

The most popular traditional investment vehicles in form of a Bank FD or small savings schemes offered by government are typical examples of Fixed Income asset class. A fixed income or a debt instrument is characterised with fixed repayment schedule over a fixed tenure. Of late, fixed income mutual funds which invest into corporate debt as well as government papers have started getting popular with retail investors. These carry higher risk than government schemes and offer better returns than them.

3. Equity

If you invest for a long term, then equity as an asset-class out-performs other asset classes. You can invest in equity by way of holding direct stock of companies or through the equity mutual funds. You should have sound knowledge of stock market to be able to successfully invest in direct stocks. Investing via the mutual fund route is simpler as they are managed by professional fund managers. Further, if chose to invest through the SIP mechanism you need not even worry about short volatility of the market. However, you must remember that equity is a risky asset in the short-term because of market movements. While there is a potential to gain higher return, you can also lose a lot of money without proper know-how.

4. Commodity

As Indians, we have been used to invest in gold, which is a typical commodity. Gold as an asset class has given rich dividends to its investors over long term. You can also invest and trade in other commodities such as metals, agricultural produce etc. through the commodity exchange. Commodity prices tend to have cyclical price pattern and you should equip yourself with required knowledge before investing. If you are not ready, better stay away.

If you just want to invest in gold as an asset class, then again you can take the easier route of investing through the Sovereign Gold Bond scheme as launched by Government of India or the Gold ETFs.

5. Real Estate

For long investor, have flocked to real estate as an asset class. You can invest either in commercial or residential real estate or a land parcel depending on the sum you want to invest. In the long run, real estate helps you multiply your investment but there are a few challenges associated with buying real estate. Clear titles, transaction cost and transparency are major hindrances you will face when buying. Even at the time of selling you would bear higher transaction cost than financial products. Moreover, you cannot sell your real estate investment in parts or even if you want to sell-off the entire asset then finding the right buyer at right price point may become a challenge. Real estate investment therefore, tend to be least liquid as compared to the others.

The Alternate Investment Asset Class

In addition to the above-mentioned traditional asset classes, you also have the option to diversify your portfolio with Alternate Investment Asset Classes. Let us look at few of the prominent Alternate Investment Asset Class in India.

The Alternate Investment Fund (AIF)

If you are an HNI (High Net Worth Individual) investor, you have the option to invest via Alternate Investment Funds (AIFs). These are privately pooled funds formed under the structure of trust permitting you to invest in higher risk bearing financial structures to earn superior returns. These funds have a dedicated fund manager to manage the pooled money and are typically closed ended funds. Through the AIFs you get a chance to invest start-ups, early-stage ventures, infrastructure or social ventures even if you don’t have professional knowledge of any of these sectors.

The Collectibles

Collectibles such as works of art, vintage cars, stamp collection and even race horses are another set of alternate asset class. Yet again, these are within the reach of ultra HNI and wealthy investors. One drawback of collectibles is that their market is not yet fully developed in India and is still illiquid. What this means is that while you may invest money in any of the collectibles, but it may not be possible to sell it for the right value at your desired time of sale. This is because there may be limited number of total buyers for such items and finding the right buyer at the time you want may not always be possible.

Game-Changer in Alternate Investment – P2P Loans

So far, alternate investment vehicles were meant only for the wealthy and affluent. With technology changing the entire financial services landscape, a new and genuine alternate investment asset class has come-up in the form of P2P loans. This asset class is within the reach of an average investor. You need not bring in millions of rupees to start investing in P2P loans.

P2P or Peer-to-Peer loans are online market places where an individual can borrow directly from another individual. When you become a lender on a P2P platform, you are investing your money which comes back to you every month with interest as EMI. You can earn anywhere between 14% – 25% depending on who you wish to lend money to. P2P loans are in-between debt and equity in terms of risk-reward metric. They have the characteristic fixed repayment schedule like a debt instrument but the risk associated with them is higher. Plus, you can diversify the risk by lending smaller amount to higher number of people. The distribution helps in limiting the default risk on the loan.

But you must note that the RBI regulations still do not cover the P2P loans. RBI has finalised its regulations but not yet brought them out. It had also published a consultation paper on P2P loans in 2016. Hence, before investing, you are advised to be aware about the risks associated with P2P business model.

You must choose your asset class keeping in mind your risk appetite. It is also advisable to consult a financial planner to assess your goals, investment horizon and then chalk out your investment strategy.

I know nothing about finance, where do I start? – Part 1

This is a question that comes up often, and one that I find quite difficult to answer. First, I think it’s useful to start by just defining what you mean by finance, and spending some thought on that.

I think it is useful to narrow down finance to personal finance because that’s what people are really interested in when they say they want to learn about finance.

I think of personal finance as the following:

Managing your cash flow to build wealth.

I think this is simple enough to understand and covers the essence of financial planning or personal finance.

The idea is to build wealth so you can meet your life’s financial goals and have enough money during the days of your retirement.

The way you build wealth is by saving money and investing it.

This is not an “either or” thing, you have to do both to really make it work. Spend wisely, and invest intelligently. Doing one but screwing up the other will nullify whatever good work you’ve done in the other area.

I think life and health insurance are also an important parts of this equation, as they help you protect your wealth when you face an emergency.

What is personal finance?

So, in that context I think everything that you talk about in personal finance will be covered under one of the blocks above and you have to understand not only things within each box, but their interplay as well.

For example, frugality is something that a lot of personal finance blogs focus on (unfortunately not this one so much), and they have tips to save money and manage your credit card debt etc. and that’s really important because if you’re paying 2% per month on your credit card, then there’s no point in making a fixed deposit of 9% on which you will pay 30% tax.

On the other hand you need to understand what inflation does to your wealth or the benefits of compounding to building wealth without which you will never fully appreciate why fixed deposits alone will not do the trick for most people if you want to build solid long term assets.

Life insurance and medical insurance are important because they help you deal with life’s uncertainty and ensure that one event doesn’t ruin your life’s savings.

Investing is where it gets really interesting because that’s the area where you have unlimited products to invest in and you can spend a lifetime understanding it but still cover only a small percentage of products. Luckily for us, understanding a few products are enough to get by, and even do well.

I feel that tax is also a part of investing because the goal of investing is generating most after tax returns, and to that extent your tax planning is part of your investment planning.

I haven’t spoken about economy here because while it’s good to know what CRR is or how much external debt a country has, I feel it’s not necessary to know micro or macro economics to manage  your money. If you keep a general tab on what’s going on in the country by reading newspapers then that should be sufficient.

At a high level, if you don’t know anything about personal finance, and don’t know where to start, then I think this is the way to start, defining it and understanding what it means.

You now know what you don’t know and I’m going to build a series of posts to cover each of these topics.

I’d really be grateful if you give me suggestions on what this series should contain as well as the sequence, for example, what should the next post be about?

Part 2: How should beginners approach investing in the stock market?

In part 1 of this series, I wrote about how most people get hooked to the stock market and how they evolve through the various stages of a speculator / investor.

I closed that post summing up my preference for long term investing, and in this post I’m going to write about two things that I feel are particularly important. First is an implicit assumption that long term investors make and second is how you should view a share or a mutual fund.

I think it bears mentioning that there will be a third part of this series as well.

The Assumption

If you are a long term investor you should recognize that there is an implicit assumption in what you’re doing, and that implicit assumption is that over the long term the stock market will go up.

The stock market is a barometer of the economy, and if the GDP rises then the stock market indices will also rise with it. About a year ago, Mr. Mukesh Ambani said that Indian nominal GDP could cross $30 trillion by 2030, and if the economy were to roughly grow at 15% – 16% in the next 20 years – I think the target will be met. Now, remember this is the nominal GDP growth rate (which doesn’t take into account inflation) and not the real GDP growth rate and that’s why it sounds high, but in reality this is close to the nominal growth we see today.

So, if the economy were to grow to 15 times its size in the next 20 years, you can expect the stock market to grow along those lines as well. There won’t be a perfect correlation, but if the economy grows then the stock market should rise as well.

By and large most stock markets have shown this to be possible, but there are exceptions like Japan whose stock market is just 20% of what it was 30 years ago and then there are long periods of time when the Dow didn’t move anywhere at all.

In India’s context, I think the risk is more political than anything else. If the political class doesn’t screw up policies and business environment then this growth should be attainable. From recent experience, we know that they are capable of screwing it perfectly well.

It’s important to understand that long term investing does rest on this assumption because if you don’t understand this then you can be lulled into thinking that the market will always go up no matter what so it is safe to have all of your cash in the stock market. There is no guarantee that the market will always go up so it is best to have a portfolio that is diversified between shares and fixed income products.

The next thing that I think is important from the perspective of a long term investor is to understand the nature of a stock or share – to know what is it that you are buying or selling.

What is a share?

Long term investors and traders view a stock or share very differently. While traders are more concerned with the price and volume action of the stock, long term investors are concerned about the underlying business of the company.

They view the share as part ownership in the company and the correlation in their mind is between earnings and share price. If the company continues to grow profits many years down the line then the stock price will also rise to match that growth.

If you think of stocks like this you will start thinking of expensive or cheap stocks with relation to the money they make. So, when you look at a company you will think in terms of how much money the company makes (earnings or free cash flow) and how much it is selling for (market capitalization) and base your value decision on that.

A lot of investors will never buy individual stocks and there’s good reason for that but even then you need to be able to view stocks in this way to stomach the inevitable volatility that exists in the market. This outlooks helps stomach volatility because when the market falls by 20% or 30% in a short period of time you are able to look at the earnings of the companies whose shares have fallen and say to yourself, surely this company will not go bust and the stock price will not go to zero.

I believe this kind of outlook helps people deal with the volatility that has been part of the Indian markets for very long and will most likely continue to exist in the future as well.

Even if you buy mutual funds – it is the same thing since a mutual fund in turn holds shares and it is nothing but a representative of the value of the shares that the fund holds.

This of course is not true if you’ve been buying penny stocks or hot stocks which can go down very fast, and then never recover, but if you have been steadily buying decent stocks over a long period of time then this will hold true.

So, to sum it up, long term investors do rely on the somewhat obvious (even if unspoken) assumption that in the long run, the market will move upwards and you have to view a share as part ownership in the company to be able to truly appreciate what you are buying.

Next, Monday I’ll have the third part of this series and if you haven’t read the first part which deals with how people get hooked to the markets and how they evolve through different stages, then I recommend you read that as well.

Part 1: How should beginners approach investing in the stock market?

Krishna left the following comment (slightly edited) a few days ago:

I am a techie and I am preparing myself to start investing in stocks. Google revealed your post & I really admire your work.It will be more helpful if there is a post describing investing for novices like me.


This is an interesting comment not only because of the nature of the question but also because of its timing. I wrote a post titled Why I continue to invest in stocks? in December of last year, and in that post I laid out the reasons that made me continue to invest in stocks in the pessimistic environment that existed then.

That title sounds fairly ridiculous today, but remember at that time and this is just 3 months ago, there was a lot of doom and gloom with respect to the situation in Europe and a lot of people were simply disgusted with the way stocks had dropped.

The common concern at the time was whether it made sense to continue with SIPs or should you sell all your stocks and invest in fixed deposits? Not many people were gearing up to invest in stocks because of all the pessimism that surrounded them and there were hardly any new entrants to the market.

From the time that I wrote the post to the time this comment appeared, the market had rose by some 15% and some smaller stocks had risen by a lot more than that.

I think it is important to remember the background here because a market that goes up rapidly draws a lot of first time investors who really are speculators at the time. I know that I was attracted to the market because of this and I know countless other individuals who were drawn to the market with the hope of a quick buck.

At this stage all you’re interested in is speculation and day trading, and you are getting quite the thrill out of it. You have no idea of fundamental analysis and you don’t care about any technical analysis as well.

I’ve seen people who stay at this stage for years, and you can easily identify people in this category by the the kind of reasons they give for why something will go up or down. The reason will always be rooted in something that they have personally seen like this share never goes under Rs. 80 or the share market does well before the budget or something similar to that, and this reason will usually sound very fantastical to anyone else.

You should try to get out of this stage as soon as possible losing as little money as possible. It’s very hard to convince anyone that they will lose money before they lose money so the next best thing I can say is that you should speculate with only small amounts of money and then don’t lose heart when you lose it because there is a better way to invest in the stock market.

At the end of the first stage, one of three things will happen –

  1. You will blame the market for your failure, be disgusted by it and never put any money in it again.
  2.  You will blame yourself for your ignorance and learn more formal methods of technical trading and trade.
  3. You will blame yourself and learn about long term investing and investing in stocks through mutual funds and SIPs.

Normally, the people who blame the market for their failure are the people who have been at it for a few years, and keep trying the same thing over and over again and hope that this time they get different results even though this has never worked for them earlier.

If you fall under this category meaning you’ve traded for a number of years but have never read a book on trading then instead of blaming the market you should blame your process and get into doing something more structured – whether it is technical or fundamental analysis.

Far more people fall from the first stage to the second category and I think that’s because trading is a lot sexier than long term investing and the kick you get out of trading – you can never get out of buying and holding.

In this category you will find people who are familiar with things like Elliot Waves, Head and Shoulders Patterns, RSI, MACD and other technical analysis tools and I think trading like this is better than trading without any knowledge of technical trading at all but I am skeptical on how effective this is.

I’ve not seen any really successful technical traders but then I’m not the kind of person who knows many traders either. However, I do feel that it must be very hard to do a full time job and trade on the markets since you have to be in front of the terminal so often and it can’t be practical for someone with a regular day job to do that.

In any case, this has not worked for me so I’m biased against it and I wouldn’t recommend anyone with a regular job to get into technical trading. If you’re interested in this then there are far too many investment sites and blogs that cater to this and you should follow one of them and see if it works for you. If it doesn’t, then, well, try long term investing after that.

In my opinion it is far better to take a longer term approach to investing and get into the third category of investors. This blog is primarily geared towards long term investors and later in the week I will have a second part to this post on what this constitutes, and how a newbie can approach long term investing.

This post is from the Suggest a Topicpage



Difference between shares and mutual funds

The best way to understand shares and mutual fund is to look at them from the perspective of the company that issues them rather than an investor. This may sound counter – intuitive at first because almost everyone tries to figure out what they mean from the perspective of an investor but somehow I find it a lot easier to explain them from the other perspective, and I think it will work for you as well.

What are shares?

Let’s say I run a space tourism company and run trips to the moon. I have had a successful business so far but I need some Rs. 100 crores for further expansion and invest in technology that will help me launch space trips to the Mars.

I own this company and I can raise the money by either going to a bank for loan or raising money from the public by issuing them shares in my company which will guarantee them a share of ownership in the company.

Let’s say my whole company is valued at Rs 500 crores, and that means I can issue 20% of my company’s shares to the public at Rs. 100 crores.

This is essentially what an IPO or Initial Public Offering is where a company comes out with an offer of its shares to the general public for the first time. A Follow On Public Offer or FPO would be when my company comes to the market for a second time.

Now suppose I do the IPO of my company and you buy shares worth Rs. 5 crores in the IPO – that will give you ownership of 1% of my company with voting rights equivalent to 1% and rights on the profits of 1% of the company.

In real life, common investors hold a lot lesser than 1% of a company and that’s why you rarely ever think in these terms but when you own a share – this is exactly what you own.

After the IPO – the shares of my company will trade in a stock exchange like the NSE or BSE, and people can buy or sell the shares from the stock exchange. In order to buy or sell these shares they will need a stock trading account and a Demat account.

Now, you must remember that when you buy a share in the IPO or FPO you buy it from the company, but when you buy it later on in the stock exchange you buy it from another investor or trader like you and that’s the reason this is called a secondary market.

The next thing to remember is that while you will continue to hear that I own the company, that’s not entirely true – I own only 80% of the company, and the rest of the 20% is owned by other investors like you.

Sometimes when a fraud is committed at a company – you can hear people say why did he steal from his own company?

And the answer is because it was not his own company!

While he may be running the company, he may only be an owner of 25% of the shares, and thereby only 25% of the earnings, and therefore he never had a right to the other 75% of the profit.

The other silly thing that I’ve heard from time to time is when someone criticizes really rich people like Azim Premji for calling their wealth “paper wealth”.

What people like Premji mean is that the wealth reported by magazines is based on share price, and these share prices keep fluctuating so the wealth keeps fluctuating as well. And anyway most promoters don’t have any intention of selling their shares so it’s all on paper anyway. This is not an arrogant statement, it’s just based on the fact that wealth is calculated based on fluctuating share prices that’s all.

Now, let’s get back to our original example and say that you tell your wife about the shares you buy in my company for Rs. 5 crores, and she is furious with you and says that this is a hare brained idea, and that you can’t bet all your money in just one company that may blow up any time!

You realize your mistake because after all if my Mars mission doesn’t get successful my company will go bankrupt and that will render your investment worthless.

So, you sell Rs. 2.5 crores worth of shares on the stock exchange and get that cash. Now, remember me or my company never get this money, somebody else like you bought it from you.

Now, you take this money and buy shares of my competitor company who is planning trips to Venus and you are feeling pretty proud of yourself and go to tell your wife about your latest strategy.

She is of course furious with your whole obsession with the space travel industry and asks you what will happen if the whole industry fails and every company goes bust?

You’re hit by a lightning bolt as you think about real estate stocks and IT stocks before them, and you decide to buy more companies.

But you don’t have the time or patience to go through the thousands of companies listed on the stock exchange to select an investment worthy one from it.

What are Mutual Funds?

This is where mutual funds come in.

They take money from thousands of investors like you and invest in stocks on your behalf. They hold many companies so that even if one is gone – you don’t lose all of your money.

They charge you a fee to manage these funds, and that’s expressed as something called as an “Expense Ratio”. This is a percentage of assets that they can use to cover their expenses and make profits, and the lower this is the better it is.

Mutual funds buy shares of companies, and they can calculate the value of their holdings by aggregating all the shares they have, and at the end of every day they publish a number called Net Asset Value or NAV. This is the value of the fund and how much it is worth at that point in time.

You have to buy or sell mutual funds directly from the fund house, and you can’t buy or sell them from another investor on the stock market like shares of a company.

Mutual funds are based on themes and are of different types but the main idea behind them is that they are an investment vehicle that help you spread out your investments in the underlying theme or asset class.

Another thing about them is that mutual funds are actively or passively managed. Actively managed means that there will be a fund manager who buys and sells stocks actively, and looks out for opportunities to buy and sell in the market all the time.

Passively managed funds are funds that just follow an index like the Nifty or the Sensex, and don’t try anything fancy. They own the same stocks as the ratio of their index and are content with matching their returns.

These type of mutual funds were born because research shows that most active funds aren’t even able to beat an index so it just makes sense to bring out a lower cost option that at least matches the index returns. However, they still do a better job than owning a few shares on your own and risk blowing up your capital if one of the companies go bust.

I think this covers the basic differences between the two and here is another post that goes into more details on how mutual funds work if you are interested in learning more about them.

As always, questions and comments are most welcome!

This post was from the Suggest a Topic page.

Risk is harder to read

Almost every other day there’s a comment from someone who wants to know what the best investment is – one that will give him the highest return.

There’s no inquiry about risk, and that’s not surprising because people new to investing don’t really understand or even think about risk. It’s only after you’ve burned your fingers a few times that the concept begins to sink in.

Talking about return without talking about risk is meaningless. If you’re going to go after high returns know that you’re taking a greater risk as well.

If you buy debt backed by the US government you will get very little by way of returns but it’s very unlikely that your investment goes to zero.

If you buy a penny stock then it might double next year, but then there’s a very real chance that it halves as well.

So, that’s the simple message I want to convey with this post, and this image which I’ve grown quite fond of in the 15 minutes of its existence.

Risk is harder to read
Risk is harder to read

If you hear someone talk about returns without talking about risk – tell him his folly. And please do share this picture with people new to investing, and others who you think will benefit from the message.

Investing for beginners: Tax implications on various debt instruments

As part of our investing for beginners series we looked at volatility last week, so I thought I’d take this week to look at debt instruments and more specifically – the different type of taxes that a debt instrument may attract, so when a new debt offer comes you know what questions to ask with respect to tax.

Very briefly, these are the questions about tax you should ask:

  1. Do I get a reduction in my taxable income in the Rs. 1 lakh limit?
  2. Do I get any additional reduction in my taxable income over and above the Rs. 1 lakh?
  3. Is the interest income tax free?
  4. Will TDS be deducted from the interest income of this instrument?
  5. Even if TDS is not deducted – will I have to pay tax on the interest earned from this debt instrument?
  6. If I sell this on listing and earn a profit will I have to pay capital gains tax on this?
  7. What is the tax that I pay on the maturity of this instrument?

Tax implications of different debt instruments.

Do I get a reduction in my taxable income in the Rs. 1 lakh limit (Section 80c)?

When it comes to taxes – one of the first questions on everyone’s mind is if this instrument is eligible under the 1 lakh limit. So, you need to check that first – will investing in this debt instrument make you eligible for reducing your taxable income under Section 80C or the 1 lakh limit.

An example of this is tax saving fixed deposits that make you eligible for deduction under this section with a cap of Rs. 1 lakh.

Do I get any additional reduction in my taxable income over and above the Rs. 1 lakh (Section 80CCF)?

The recent infrastructure bonds reduced your tax liability by reducing your taxable income over and above the 1 lakh limit mentioned in the earlier point.

What this means is if you invest in the bonds – your taxable income will be reduced by a maximum of that much amount with a cap of Rs. 20,000, and consequently the tax you pay will get reduced.

Is the interest income tax free?

Bond issuers will give you an option of getting interest paid semi-annually, annually or at any other interval. Since this is your income this will be added to your income and you will have to pay tax on this. Unless otherwise stated, the interest is taxable.

I don’t think there is any instrument currently offered that pays you tax free interest.

Will there be TDS on the interest income of this instrument?

Some instruments will have interest payments on which tax will be deducted at source, whereas others will pay you the full sum, and then you’ll have to declare your interest income at the time of filing returns.

Most fixed deposits with banks will attract TDS if you reach a certain level.

Even if TDS is not deducted – will I have to pay tax on the interest earned from this debt instrument?

This ties back the last point where someone may say that there is no TDS on this particular instrument, but then you need to ask if the interest is still taxable or not.

A debt instrument that is issued in dematerialized format and listed on a stock exchange doesn’t get tax deducted on source on it, but that doesn’t mean that there is no tax on it – just that there will be no TDS on it. You will still need to add this interest income to your other income and pay the tax. The SBI retail bonds are an example of this.

If I sell this on listing and earn a profit will I have to pay capital gains tax on this?

You are seeing bonds that list on the stock exchange, and there may be a situation when these bonds list at a premium, and if you sell them at that time you will have to pay capital gains tax. So, if you bought the SBI retail bonds which then list at a premium and you decide to sell them then you will have to pay tax on capital gains at the applicable rates.

What is the tax that I pay on the maturity of this instrument?

Some instruments reinvest the interest and then pay a lump-sum at the end of the maturity period. So the question is whether this lump-sum will be taxable at the end of the period or not.

The Public Provident Fund (PPF) is an example of a product where the sum you get at maturity is not taxable whereas the National Savings Certificate (NSC) is an example of a product where the sum received at the end of the term is in fact taxable.

How can I know if a particular instrument offers a tax  benefit or not?

Look outside your window, and if you don’t see the issuer shouting a particular benefit at the top of their lungs – that benefit is not available in that instrument.

So if a issuer says you will get 80C benefits but is silent about TDS then in all likelihood you will have to pay TDS.

Keep these points in mind when evaluating the tax benefits of any debt instrument, and you will be better equipped to take a final decision on whether the instrument suits you or not.

Investing for beginners – Dealing with Stock Market Volatility

This post is next in my investing for beginners series (earlier posts include asset allocation, diversification, things to do before you start investing), and for this post I wanted to talk about volatility and dealing with it.

State Bank of India (SBI) is one of the bluer blue chips in India, and a look at its 52 week high / low on BSE reveals that the 52 week low was Rs. 1,863 and 52 week high was Rs. 3,222.

So, what happened in the last year to warrant this? Why did the stock price move up about 70% from 1,863 to the 3,200 it is today?

Did SBI fundamentals change so dramatically that they triggered a 70% jump? Just what exactly did it do to jump that much in a year?

Let’s go back in time to about 2 years ago when the world was falling off a cliff, and see what happened to the price of the SBI stock then.

SBI was Rs. 1,650 on September 8 2008 from where it dropped to Rs. 895 on 09 March 2009. In a six month period the stock dropped about 45%!

SBI Sep 08 to Mar 09
SBI Sep 08 to Mar 09

The steep drop from 1,650 to 900 or so makes you wonder if a bonus was declared, but I couldn’t find one. But even if SBI is a blue chip, it’s still a stock, so let’s take a look at an Index itself to see if that’s volatile too.

What about the Nifty? How did it perform in the same time period?

CNX Nifty Sep 08 - Mar 09
CNX Nifty Sep 08 - Mar 09

From 4,500 it dived to 2500 in a matter of weeks!

So, what do you think happened in the next six months?

Nifty doubles in value in 6 months
Nifty doubles!


These might seem like crazy moves to you, but they are still better than most because I took a look at a huge stock and an index itself, which are much less volatile than the rest of the market. During the real estate crash or the IT bubble burst – there were several stocks that lost much more than 50% of their value in a much shorter time – frame.

If you’re thinking that this crash was because I’ve taken a time period which saw us having a really bad recession, a quick look through news archives will show you that we’re habitually thinking that the end is near, and crashes are part of life.

You can go take the yearly highs or lows of any stock from an old paper and you will see that there is big gap between the two prices, but there aren’t that many fundamental changes with the company in question. SBI didn’t shut down half of their branches to see the stock plunge that much – that’s the nature of the stock markets.

So, given all this – how do you deal with the volatility in the stock market?

Do you stay completely away from the stock market?

One obvious answer is just stay away from stock markets, and focus on other investments that are not so volatile and which don’t expose you to such huge swings. You could do that, and you should certainly have some allocation towards safer assets but if you stay completely away from the stock market you won’t even be able to beat inflation that runs high in India. So you can diversify in other assets, but for most young people staying away from the market is probably not a practical option.

Do you try to time the market?

All you have to do is buy low and sell high right? That sounds simple enough, but when do you know the market has over-heated or when do you know the bottom has been reached? Timing the market is impossible – no one knows how the market will behave in the short run so you can’t really go all in at one shot or sell everything at another. In fact in October 2008 I wrote a post about not trying to catch falling knives, and how I was gradually accumulating stock even though they were dropping, so while over a period of time it is possible to accumulate stock at lower prices  – if you go all in, and the market falls more then you are stuck with it.

Timing doesn’t work for most, so it very likely won’t work for you also, and while increasing your stock purchases when the market crashes and booking profits when the market is at highs might help – if you just decide to catch every top and bottom – that won’t work at all.

Understand that volatility is an inherent part of the market and be ready for it

If you haven’t seen a market crash yet, then brace for it – no one knows when it’ll take place but violent downswings and upswings are just part of the market, and if you know they’re coming – you don’t get scared when you are in the middle of it, and end up selling all your stock at yearly lows.

If you have a diversified portfolio and assets other than stocks then you will have a much easier time dealing with volatility because all your eggs are not in one basket. Sure you stand to lose money, but at the same time some part of your investment is secure and that will give you comfort.

At times such as these don’t let panic set in, but instead continue your SIPs or think about investing in some large blue chip stocks.

Look at it this way – a company like Tata Steel has been around for more than 100 years, and it’s seen a lot more ups and downs than you have, so although there are chances that it may go to zero (remember Lehman?) they are not as high as they would be with a smaller company.

Think about State Bank of India – if SBI goes to 0 then you have much bigger things to worry about than your stock.

It’s really hard to think that the world is not going to end when everyone else around you says that it will. In such times it is really difficult to keep the faith, but if you are well diversified, have bought companies with good fundamentals, and are in it for the long run – you will find the going much easier.

Volatility is part and parcel of the market and the sooner you learn to deal with it the better it is.

Getting started as an investor: Consider Asset Allocation

This is the next article in my series for investing for beginners (first, and second post), and focuses on asset allocation.

What is Asset Allocation?

Most people start out investing without having a strategy, and invest their money in different assets without necessarily thinking about the distinction between them, and how the risk – return profile vary from one to the other.

Asset Allocation means taking your money, and investing it across different classes of assets like stocks, fixed deposits, commodities like gold, silver, crude etc., postal deposits, provident fund, and of course cash in a certain percentage that helps spread risk.

The way I look at asset allocation is to first have some liquid cash for emergencies stashed away in a savings account, and then start thinking about spreading your investing corpus in other asset classes.

Avenues for Asset Allocation

This is how I think of the major asset classes where you can put your money:

1. Savings account: Savings account give out 3.5% interest per annum, and with inflation rates close to 10%, the real return on this is negative. So, I’d consider this only for emergency funds, and day to day expenses. A lot of you might feel that this is not really an asset class, so just think of this as a placeholder for emergency funds. You can replace this with cash if you like that better.

2. Government of India bonds, Postal deposits: This is an ultra – safe investment class if you are in India, because the bonds are backed by the Government of India. The returns are higher than that of savings account, but lower than that of fixed deposits from banks.

3. Bank and Company Fixed Deposits: You can make fixed deposits with banks or companies, and in general — companies pay a higher interest rate than banks. Fixed deposits with companies are considered to be riskier than banks, so they give you a slightly higher interest rate. In general, I see that the fixed deposit rates are closer to the inflation rates, so you can hope for your money to keep pace with inflation, and over the longer run, have a real return of  a few percentage points.

4. Debt Funds: There are plenty of mutual funds that invest in debt instruments, and if you don’t want to go the way of a bank or company fixed deposits because you are interested in investing periodically instead of lump – sum, then you can choose  a bond fund.

5. Equities: Equities consist of investment in mutual funds, ETFs and directly investing in stocks.  This class is the riskiest because there is no guarantee of returns, and in fact a lot of people do lose money in equities. Over the long run however indices like Nifty have given a much higher return than fixed deposits. Again, this doesn’t mean that everyone who invests in equities makes that higher return, if that were the case then there wouldn’t be any need for asset allocation at all. This simply means that if you look at the last ten years or twenty years – Sensex has risen faster than the returns offered by banks, but there has been a lot of volatility which has led to losses as well.

6. Gold: I really don’t know how to place gold in all of this. It is conventionally thought of as a safe haven, but given the recent interest in gold, there is a lot of speculative interest built up on this, and I feel that it is riskier than it once used to be, and would ask investors to treat it with caution.

7. Real estate: A lot of people consider real estate as an asset class, when they shouldn’t. Personally, I don’t think that the house you live in is really an asset. If you are still paying an EMI on it, then it is probably more of a liability than an asset. Sure, you are leveraged and if the prices are rising, then you can make some money out of it, but if prices fall, then you are stuck with it as well. This is what happened in the US recently, and Japan in the late 80’s. Real estate prices crashed, and people who were leveraged had a really tough time, as is quite well documented by now.

For me, real estate is only an asset if it is a second house, if it is commercial property or farmland, and is not a place I call home. The real estate mutual funds I have looked in India primarily invest in companies engaged in real estate and don’t directly invest in real estate, so to me, they fall under the umbrella of equity more than they fall under real estate.


These are some asset classes that come to my mind, and each of these can be further broken down, like debt can be broken down into floating rate bond funds, gilt funds or equities can be broken down into large caps, small caps, international equities, gold into gold coins, gold ETFs.

But for now, the takeaway from this post should be understanding that different asset classes give you different risk – returns, and your portfolio should be balanced.

If you have too many stocks then you risk losing a lot of money if the market crashes, as Tony recently told us in his story.

On the other hand – I spoke with a friend yesterday who has all his money in his savings account. The number that he spoke of was quite significant, and he just never got around to doing anything about his savings. And now inflation is eating it up, obviously this is a much better problem than having no money at all, but at some point he will have to face the fact that his real return is negative, and he has to invest the money somewhere.

So understand the importance of asset allocation, and think about your own risk profile, and which of these asset classes interest you.

Once you have determined what your asset allocation should be, the next step is to look at each of these categories, and determine where to invest in that. It is not necessary for one person to invest in all of these categories, so for example – you could have some liquid cash, fixed deposits, and equities, and that way your risk is spread, which is what asset allocation aims for.

The key is to understand that different asset classes have different risk – reward structure, and then build a portfolio according to that.

Getting started as an investor? – Diversify

Reader Allwyn wrote to me a few days ago inquiring about books, and websites that help people  get started with investing, or if there was such a series here on OneMint, and since there is none, and it is such a great idea – I thought I will write one now.

In February this year, I wrote a post about 5 factors you should think about before you start investing, and to me that’s really the first post in this series.

Before you start investing, you need to develop some prudent financial habits so that you have enough savings to actually get started with investing.

Here is a quick recap of the five points:

1. Pay down your education loan

2. Don’t get into credit card debt

3. Understand Risk (or at least think about it)

4. Invest in tax saving instruments

5. Stay away from short term trading.

If you haven’t read that post, then spend some time going through that and thinking about some of the things written in that post, and how they apply to your own life. Then come back, okay?

The next prudent habit that I can think of is to create an emergency fund. A lot has been written about emergency funds, and I don’t know that I can add anything useful to the echo chamber about it, so I will skip that step, and write about something else (I will write about it or link out to other useful posts about emergency funds later in the week).

Now let me write about some boring but important stuff.


A few days ago I reproduced this amazing info-graphic from the Wall Street Cheat Sheet, and as far as the Indian markets are concerned I think we are somewhere between Optimism and Belief.


There are a lot more people interested in the stock market than when it was really down, and people are wondering where to invest their money once again, as opposed to just stuffing it in their pillows or putting it in fixed deposits.

If you are a first time investor, then there’s probably a very strong urge to invest in the stock market, and with every rise in the market, you might feel that you are missing out on the rally.

You must remember though that the market moves in cycles, and if you are starting off now, then you don’t want to put all your money in the stock market at one go, and risk losing all of it if the market crashes.

Here is a chart of the P/E multiple of Nifty for the past 10 years, and that shows you how we are at one of the higher ends.


Now it can certainly happen that the earnings of Indian companies grow consistently in the next few months or even years, and that you don’t suffer a crash at all, but it is better to diversify your savings between safe instruments like fixed deposits, and risky instruments like mutual funds and stock market, and reduce your chances of getting screwed.

There are several factors that influence how much money  you put in stocks versus fixed deposits or bond funds, but the first thing is to make a decision that some of your money will find its way into safer instruments like fixed deposits.

If the recent rise in the stock market is tempting you to go all in, and put all your money in the stocks, then resist that urge and decide to take a diversified approach.

This is certainly the boring way to go, but one that protects you in case of sudden market crashes like the ones we are only too familiar with.

Diversification is key to building long term wealth and a profitable portfolio, and an idea that you should understand and embrace early on in your quest of investing knowledge.

I will write more about diversification in a later post, as there are several factors that affect diversification, and it merits an entire post on its own right.

In the meantime, please leave comments to let me know what you think about diversification, and also about the topics that should be covered as part of this series.