Investing Handbook for Indians: Chapter 3
Greetings to ABCDE(s) in our Economic Machine
Welcome to chapter 3 of this series. In case you haven’t been with us, please find the previous chapters here: Chapter 1 & Chapter 2.
This one’s going to be short and sweet. Let me tell you why…
We will briefly understand how each component works and try covering it with a real-time example. Once we are done, you would have covered and understood something which will help you understand every policy document, every mutual fund portfolio, every retirement plan and more.
And with this amazing thought in mind, let’s get going!
Disclaimer: the idea is to understand the workflow not create your own economic system from zero hence what you learn here will be enough to help you sail.
Annuities are a contract between you and any insurance company. Specifically insurance companies because of the nature of the investment. An annuity is bought keeping a long term goal in mind. The simplest use case would be investing in a pension scheme that will give you said fixed monthly or quarterly or annual income. The nature of an annuity investment can be lumpsum or in SIP format. Annuity payouts are of two categories: deferred and immediate. (Exactly like a life insurance policy)
My other favorite ‘A’ word: Assets
Why? Your net worth is the summation of all your assets. Liquid and otherwise. It’s wise to distribute your money among multiple asset classes you have confidence over. The old saying: not all eggs in the same basket.
Bonds are the hardcopy/digital version of an agreement of exchange between a lender & a borrower. It’s will contain the fine details of this exchange. Terms and conditions of the repayment. They are generally issued by bodies and organisations in positions of power like the government or corporates. It’s a popular investment category under the umbrella of “debt” instruments. You can choose to invest in bonds directly or via mutual funds where a fund manager will dig up a bunch of bonds and help generate returns. Needless to say the returns are dramatically lesser than equity schemes hence the returns are lower and safety is higher.
My other favorite ‘B’ word: Bull-Market
Why? A bull market is the market on the rise. This means that the top and biggest companies in the market are rising in value which means the market on an average is moving upwards.
Cash components are those instruments that are easily available or to use the exact word “Liquid”. It can be money lying idle in your savings Bank account. Money invested in debt funds that have high liquidity. For example: money invested in your Provident Funds(say PPF) is not cash because it has a lock-in period (15years). When emergency knocks your PF amount is as good as ZERO because you do not have access to it. On the other hand, money put into a fixed deposit or in a liquid mutual fund or short term mutual fund is liquid cash because you can redeem the amount and access it within hours for almost zero or little penalty.
My other favorite ‘C’ word: CAGR
Why? Compound Annual Growth Rate aka CAGR. Let’s take you have invested ₹10,000/- and after 5 years it has become ₹20,000. Your money grew 2times or to say in percentage terms, its grown 100%. This 100% growth is the absolute return. Not the actual return. While the math might seem correct, we’ve not accounted for the most important parameter. Time. CAGR tells you what is the return percent on a year on year basis.
Debt can be perceived in two ways. One where you owe money and the other where you are owed money. I am sure most of you would want to be in the shoes of the latter and that my friend is a perception we need to modify. Debt can turn out to be one of your most productive friends. Look out for the ‘good debt’.
The english meaning of this word is “something that is due”.
Let’s take the example of credit cards. Do not be scared of them. What a credit card essentially does is help you purchase or spend money that is not yours and make huge profits from you not being able to repay on time. The catch is ‘re-paying on time’. By using credit cards, you are acquiring some debt & falling into the 1st category of people by owing money to the credit card company.
Then where is the good part you ask?
Here it is: You are being bought time. Rather than making the payment upfront for the goods you are purchasing, you can choose to pay at a later point(usually after 15–30 days based on your billing cycle).
Coming to the bigger picture, debt is usually a financial instrument where an X amount of money is lent out for a said rate of interest. When it comes to bigger organizations like the national govt. or bigger corporates, the amount is huge hence the repayment period is longer(months/years) making it a market option for small investors like you and me to make money over.
Equity is a synonym for stocks of a company. Stock, share, equity are one and the same & are used interchangeably. When you own equity, you own a part of the business the company is running. You become part owner of the company. Any and every financial instrument that invests in equity is ultimately buying company stocks. When you invest in a mutual fund under the equity category, you are essentially sending your money to a pool that will be used to buy stocks of multiple companies as sought best by the mutual fund’s management. When you are trading in the stock market (buying and selling), you are dealing with equities.
My other favorite ‘E’ word: EMIs
Why? EMIs are attached to loans. It gives you the liberty to purchase something you would have otherwise been unable to if you did not have 100% of the cost amount readily available. EMIs work on monthly basis where you repay the loan amount with interest over an agreed number of months. Look out for no cost EMI options against the payment mode. Mostly credit cards have this benefit attached.
You will find ABCDE in different proportions and occurrences in every investment instrument and around the financial universe. Know where your money is going. Understand why your money is going there. Go through the documents, even the summary from standard websites will do. Add vigilance to your investments. Invest because you have confidence and not because Mr. Finance smart neighbor or colleague advised so. Let’s be honest here, tomorrow when the market caves like a bear or the fund you have invested in takes a downhill detour, you’re not going to think an extra minute before blaming the good advice. Just as you did not take a minute to find the pick that suits your appetite best.
Congratulations!
You’ve just build yourself a stronger finance vocabulary. Next time you are looking at any instrument/avenues to invest in, peek into the details without worry. Google it out. Watch a short video.
Do anything but escape or ignore 😃
This is no goodbye. Move on to Chapter 4 next. Let the journey continue.
