Tag: aarati krishnan

4 mantras to help you borrow wisely

Personal Finance

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There’s plenty of personal finance advice on saving and investing wisely. But for most young folks, borrowing to fund their lifestyle often precedes investing.

Biting off more loans than you can chew early in life can put a spoke in your wealth creation plans even before you get started. With many lenders jostling for the retail loan pie, loan products today come in slick disguises too. So here are some tips to avoid the pitfalls and borrow wisely.

Borrowing for a good purpose

Any kind of borrowing entails taking on future hardship in the form of loan obligations to gratify an immediate need. But getting into the habit of instant gratification for all your needs, wants and luxuries locks up your future incomes in EMIs and robs you of the flexibility to make career or life decisions.

This makes it important for you to put some thought into the kind of spending for which you will borrow. To ensure that loans don’t deplete your wealth, distinguish between appreciating assets and depreciating ones.

When you borrow to invest in an appreciating asset such as land, a home, or an educational degree, returns you earn in the long run can compensate, at least partly, for the interest costs you incur.

But if you borrow to fund depreciating assets, you face the double whammy of interest costs on top of eroding asset value. Folks who take loans to replace their smartphone every year would know the pain of paying EMIs, long after an item has outlived its usefulness.

Don’t step-up EMIs

When assessing if they can afford a new car, consumer appliance, or home loan, most folks look at only the EMI or equated monthly installment. Knowing this, lenders obligingly structure their EMIs ‘flexibly’ as step-up or balloon EMIs, so that the initial EMIs are small, but expand as time goes by.

But this gimmick hurts more than helps you as a borrower. Lower EMIs at the beginning of your loan term merely postpone your repayment and help the lender load extract additional interest, adding to your total outgo.

Take the case of a ₹10 lakh car loan for 5 years, at a fixed rate of 7.5 per cent. The EMI based on the old-fashioned fixed calculation would be ₹20,038 per month. This essentially means a total outgo of ₹12.02 lakh including interest on the ₹10 lakh loan at the end of 5 years.

Should you opt for a step-up EMI, where you pay ₹8,990 for the first six months and ₹22,240 for the next 54 months, you end up shelling out ₹12.55 lakh for the same term. In a balloon repayment scheme, which stretches your loan tenure to 7 years, you start with an EMI of ₹11,110 in the first year, going up to ₹12,220 in the second year, and so on until your EMI hits ₹99,990 in the last month. In this case, you’d end up shelling out ₹14.12 lakh to the lender. That’s 17 per cent more than the simple EMI.

Shop around for better rates

When it comes to investment products, most folks are constantly on the hunt for better rates. But with loans, they carry a misplaced sense of loyalty to their lender and pay EMIs like clockwork.

Worries about processing charges and paperwork are also deterrents to making any switch.

However, Indian lenders are no longer allowed to charge prepayment penalty on floating rate loans.

Most lenders are quite willing to offer attractive deals with minimal paperwork to customers jumping ship from their competitors because they like to add new clients with a readymade repayment record.

Your existing lender may take his own sweet time to reset your interest rate when market interest rates are falling.

But most lenders are quite willing to offer much lower rates to their brand-new customers. This makes transferring your home loan balance to a new lender the best way to expedite rate resets.

Given the size and tenor of home loans, a simple switch from one lender to another can make quite a difference to your wealth in the long run. Switching a ₹30 lakh home loan with a remaining tenure of 15 years, from a bank charging 8 per cent interest to one charging 6.75 per cent, can reduce your EMI outgo from ₹28,670 a month to ₹26,547 and your total loan repayment from ₹51.6 lakh to ₹47.7 lakh.

Prepay at every opportunity

Loans, as we explained earlier, can rob you not just of the ability to spend, but also of career and financial flexibility. This makes it important for you to pay down your loan whenever you accumulate a reasonable lump sum.

If you’ve built up significant sums in your bank deposits from salary cheques, bonus from your employer, or a windfall from the stock market, use that to prepay your loans as soon as you can.

While prepaying, prioritize high-rate loans and keep tax benefits in mind. But ultimately, if you have sufficient sums saved up to prepay your home loan, don’t let tax considerations nudge you into continuing with EMIs.

The tax saving on a home loan repayment only lets you save on your interest costs and doesn’t really bolster your income or wealth.

This is a free article from the BusinessLine premium Portfolio segment. For more such content, please subscribe to The Hindu BusinessLine online.)

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Why you need to know yourself to succeed at stock investing

Personal Finance

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With friends and colleagues minting money in stocks, many investors write to us today asking how they should make a start on equity investing. I’d like to do SIPs in a dozen high-dividend yield stocks to become rich, can you suggest some? What are the books or blogs to learn technical and fundamental analysis? Should I buy smallcases instead of SIPs in mutual funds? These questions show that, while the person asking them is keen to invest in stocks, he or she isn’t quite sure why they’re doing it. It’s hard to succeed at equity investing without being crystal-clear about your objectives. Before taking the plunge, here are the questions to ask yourself.

Holding period

How much time are you willing to give for your stock holdings to deliver? In a trending bull market, it is easy to believe that a year or two is all you need to double or treble your money in stocks. But stocks that double or treble in a few months when the momentum is strong can fall 50-60 per cent equally quickly if the sentiment turns. To create durable wealth from stock investing, you need to view it as owning a piece of a business. If you own companies that compound their earnings over long periods of 5 to 10 years and markets recognise this, that’s when you have multi-baggers on your hands.

To know whether a company is capable of compounding its profits, you need to understand its business (fundamental) drivers.

A fundamental investor must be willing to commit to a 7-10 year holding period to earn good returns.

If your intention is just to make the most of market momentum over a 2-3 year period, knowing how to read technical charts and momentum indicators is a must. If you’re doing the latter, allocate only a small portion of your net worth to equities and don’t carry too many open positions at a time.

Return expectations

Are you happy with a FD-plus return from equities or are shooting for a 20 per cent plus CAGR? This will decide whether you should attempt direct stock investing or go for a diversified portfolio via mutual funds. If you are investing in equities to get a 9-10 per cent CAGR and beat inflation, there’s no need for you to invest time or effort in stock picking.

Index funds that mimic bellwether indices at low costs are good enough to get you to that return over the long run. If your return aspirations are at 20-25 per cent, then diversified portfolios such as mutual funds may not deliver it and you may need to acquire skills for direct stock picking.

If you have in-between expectations, actively managed flexicap/midcap/small equity funds or smallcases can be your choice.

Risk appetite, mode of returns

Equity investing brings with it the risk of losing your principal, so how much of your capital are you willing to lose? If you can be philosophical about losing half of your investment value in a trice, you are cut out for short-term trading investing.

Your appetite for risk will also decide if you should invest directly in stocks or bet on a diversified equity fund.

In a correction, a portfolio of direct stocks is likely to fall much more than the NAV of a diversified equity fund.

Are you looking for your equity portfolio to deliver sizeable dividend income to supplement your earnings over time? Or are you a growth investor, seeking capital appreciation first and foremost?

This will decide the kind of filters you use to pick stocks. Stocks offering high dividends often hail from slow-growing sectors and mature businesses that can afford to pay out a large part of their profits and don’t need it in the business. For this reason, high dividend yield stocks seldom deliver bumper capital appreciation in the long run.

If capital appreciation is your primary objective and you aren’t looking to dividends, you should identify companies in sectors with high growth potential, high profit margins and the ability to deliver high return on equity without frequent recourse to equity or debt fund-raising.

Companies in growth businesses like to plough back their profits into the business rather than pay out high dividends to their shareholders.

Time and skill

Building a good direct stock portfolio that can make a difference to your net worth is a highly time-consuming exercise.

It requires you to study sectors and companies, identify their key drivers of success, track stock prices closely and identify good entry and exit points based on valuation.

As most of your time in building a sound stock portfolio is spent in patiently holding stocks, you’ll need to remain on top of corporate actions, quarterly results and regulatory developments that affect the company’s earnings to decide whether to hold or bail out.

Investing in readymade portfolios such as smallcases also requires a fair degree of knowledge about businesses, market themes and sectors, as these portfolios can be quite concentrated. Being a short-term investor/trader requires even more intensive tracking of price action, corporate actions and macro and other drivers that can affect the liquidity in a stock.

Most successful stock traders are full-time. If you don’t have the time, knowledge or passion to devote to such tracking, you should prefer mutual funds for your equity investing.

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Do shareholders gain from Britannia’s bonus debentures?

Personal Finance

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Sujoy and Minnie, two working professionals met up over Teams, to share notes on their investments.

Sujoy: Hi Minnie! How are you spending your time?

Minnie: Mostly on the Cowin app, trying to get a slot. And, there’s my first love – playing the markets.

Sujoy: Nowadays it’s easier to make money on the markets than book vaccine slots, I must say. I called for a very specific thing, Minnie. I read somewhere that Britannia, the cake and biscuit company is issuing bonus debentures. I know it’s a solid company, so how do I invest in them?

Minnie: A bonus debenture issue, unlike a normal one from a company, isn’t open to the public. Britannia is issuing these debentures to its existing shareholders only. For every Britannia share, they’ll get one free bonus debenture.

Sujoy: Oh, the free part sounds good, but how is this different from dividends or bonus shares?

Minnie: When a company pays out a dividend, it simply distributes a part of its retained profits to its shareholders. In bonus issues, it issues free shares against equity already held. In the case of bonus debentures, the company issues free bonds to its shareholders. It promises to pay regular interest and the principal at maturity. In Britannia’s case, if you held 10 shares, you will get 10 debentures of face value of ₹29 each. You will get interest at 5.5 per cent (of ₹29). At the end of 3 years, you will get ₹290.

Sujoy: But in a normal bonus issue, I would get Britannia shares which add to my long-term portfolio and returns!

Minnie: When you get bonus shares, their value may go up or down over the years. But here, you are getting an assured return. I agree that the benefit however, is much smaller. Against a Britannia share of over ₹3400 apiece, you are getting a bonus debenture worth ₹29 and an even smaller interest on it.

Sujoy: Why do companies do this?

Minnie: Britannia’s intent is to reward shareholders. Instead of paying dividend at one go, it now gets to retain the money for a few years and use it for expansion or to repay debt. In a normal debenture, Britannia would pay interest to outsiders. Here, it converts part of its retained profits into debt and pay interest to its own shareholders. Plus, interest is tax deductible.

Sujoy: Then why don’t more companies do it?

Minnie: Well, a few have – HUL, NTPC and Britannia. But the issue of bonus debentures is complicated requiring a scheme of arrangement, NCLT approval etc.

Sujoy: So net-net I can’t buy these debentures?

Minnie: These will be listed on the bourses. If some shareholder sells, you can grab them!

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Why betting on stocks based on big-picture themes doesn’t work

Personal Finance

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No one can resist the onward march of an idea whose time has come, Victor Hugo said. In bull markets, there are many who apply this to stock investing as well. While conventional investors run screeners, scan company filings and analyse quarterly numbers to identify buys, idea investors believe that to find multi-baggers, all they need to do is latch on to a powerful idea.

So, the moment the Centre announces an Atmanirbhar Bharat push, they’re buying chemical or pharma intermediate companies. In a Digital India push, they’re buying fibre-optic cable makers. When it announces higher FDI in insurance or defense, they’re buying up listed insurers or PSU defense equipment makers. If e-commerce is taking off, they buy logistics stocks and if States are ramping up Covid testing, they bet on diagnostic labs.

But exciting as it may seem, selecting stocks based on such big-picture themes seldom adds durable wealth to one’s portfolio. If you’re itching to try it out, watch out for these pitfalls.

Skipped homework

Most long-term winners in one’s stock portfolio come from understanding a company’s business better than others in the market, spotting a sector trend early or buying a business when the market is under-estimating its potential. But when you’re chasing hot new ideas, there’s often no room for deep study of a company or a sector. Being in a hurry to ride a wave before it fizzles out, can force you to skip necessary homework, leading you to buy lemons.

A recent and somewhat extreme example of an idea stock that proved to be full of hot air is Bombay Oxygen Investments. As the media filled with reports of oxygen shortages during the second wave of Covid, thematic investors scrambled for companies that would gain from this theme. Bombay Oxygen Investments, thanks to the keyword in its name, shot up by 140 per cent between end-March and mid-April from ₹10,000 to over ₹24,000. But after little digging revealed that the ‘oxygen’ in the company’s name was a legacy of the past, the stock crashed 40 per cent.

The company, earlier in the business of manufacturing industrial gases, had discontinued this activity in August 2019 to secure a NBFC license from RBI. Since December 2019, it has been engaged in investment operations that have nothing to do with oxygen.

Shifting focus

While Bombay Oxygen may not have set out to deliberately mislead investors, there are many companies in the Indian market that are ever willing to oblige fickle markets by entering any business that seems to be the current flavour of the season. Scores of obscure firms attached ‘cyber’ to their names during the dotcom boom, construction companies transformed into ‘infra’ firms in the 2007-08 bull market and several new ‘logistics’ companies cropped up in the e-commerce boom. Owning such companies can be quite a roller-coaster, because you may find that instead of sticking to and scaling up in the business you bet on, they are constantly shifting shape to cater to market preferences.

Investors in Vakrangee Software have seen it morph from a company focussed on last-mile financial inclusion, to a play on e-governance and Digital India, to a retailer for Bharat in a short five-year span. Originally a franchisee for the Aadhar UID project in 2010, Vakrangee pivoted to being an e-governance firm that helped folks in tier-3 towns and villages perform internet-related tasks through an extensive network of over 40,000 Vakrangee Kendras in 2016-17. It then made unrelated forays, through subsidiaries into providing logistics for e-commerce giants and retailing gold. Even as the company’s revenues have taken a sharp tumble, it is readying yet another pivot, from e-governance to setting up a pan-India ATM network. While the stock has crashed over 90 per cent from its peak of ₹500, the company has run into governance issues as well after scotching a ₹1000 crore buyback plan, abrupt resignation of its auditor and penalties from SEBI for fraudulent trading in the stock.

To avoid betting on such wrong horses, run a check on the company’s annual reports and management commentary over the years. Frequent business pivots are a sign that the management is more focused on managing its stock price than on building a scalable business.

Execution woes

Idea investors focus a lot on big-picture trends that will play out in future. In the process, they may forget to check if the company they’re betting on has the execution capability to translate its larger-than-life vision into reality.

A good example of a great-sounding idea turning out to be a pipe dream is Educomp Solutions, a favourite stock with idea investors between 2008 and 2010. Listed in 2006, the company’s management successfully marketed the idea that Indian schools mostly using old-world methods of chalk-and-board teaching, were ripe for digital transformation pan-India. The hardware company, engaged in the computerization of schools pan-India, showcased itself as a high-growth play on ed-tech solutions for K-12 education. Within three years of listing, it was reporting 100 per cent revenue growth with operating profit margins of 48 per cent. Having installed its Smartclass solutions in about 2500 schools, it set itself a target of expanding to 15,000 schools and a ₹1000 crore revenue. It later transpired that in its aggressive bid to sign on more schools, Educomp didn’t pay attention to whether these school tie-ups actually translated into revenues. After many delayed or skipped payments, the company faced mounting receivables and debt, defaulted on bank loans and turned an NPA in 2016. It was later subject to CBI raids. The stock which hit dizzying heights of over ₹1000 in its heydays is currently at ₹3.

Educomp’s story is a lesson that captivating big-picture ideas need not translate into profits on the ground. It pays to be particularly wary of managements who set order-of-magnitude targets and sell you big dreams.

Not all idea-based stocks turn out to be lemons on the scale of a Bombay Oxygen or an Educomp or a Vakrangee. Investors in the stocks of diagnostic chains or pharma API companies have for instance, made significant gains in the last one year. But this is more because such companies already had established business models that had evolved over many years and had operating metrics, even before the Covid opportunity came by. Even in such cases, long-term investors may need to ask two questions – whether the big pop in earnings from the opportunity will sustain and whether stock valuations already factor in a best-case scenario.

Overall, even if idea-based investing excites you, it may be best allocate only a fixed portion of your portfolio to such opportunistic bets.

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