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National Thoughts
Business

INTRODUCTION TO INVESTMENT

WHAT IS A BUSINESS?

By- Ved Prakash Gupta, Finance Expert & Chairman of National Thoughts

A business plan is a formal statement of a set of business goals, the reasons why they are believed attainable, and the plan for reaching those goals .It may also contain background information about the organization or team attempting to reach those goals.

One can start the business in either of the following ways:

  • PROPRIETORSHIP: – In this type there is only one owner of the business. He puts in all money that is required by the business.

  • PARTNERSHIP: – The India partnership act defines partnership as “the relation between two persons who have agreed to share profits of a business carried on by all or any one of them acting for all.”

  • REGISTERED COMPANIES: – There are companies which are formed and registered   under the companies act 1956.

  • COMPANIES LIMITED BY SHARES:- In these companies, the liability of the members called the shareholders, does not exceed the unpaid amount, if any, on the shares held by them. Most of the companies fall under this category.

 

SHARE

 PROFIT

   LOSS

LIABILITY

PROPRIETOR

100%

100%

100%

unlimited

PARTNERSHIP

As per deed

As per deed

As per deed

unlimited

COMPANY

As per your investment

Dividend -paid by the companies

———–

Max upto your investment

What is investment?

The money you earn is partly spent and the rest saved for meeting future expenses. Instead of keeping the savings idle you may like to use savings in order to get return on it in the future. This is called Investment.

Investment may be defined as, “putting your spare money into something without getting involved in that for full time, to earn better returns/profits on it”.

One needs to invest to :

  • Earn return on your idle resources.

  • Generate a specified sum of money for a specific goal in life.

  • Make a provision for an uncertain future.

One of the important reasons why one needs to invest wisely is to meet the cost of inflation. Inflation is the rate at which the cost of living increases. The cost of living is simply what it costs to buy the goods and services you need to live. Inflation causes money to lose value because it will not buy the same amount of a good or a service in the future as it does now or did in the past. For example, if there was a 6% inflation rate for the next 20 years, a Rs. 100 purchase today would cost Rs. 321 in 20 years. This is why it is important to consider inflation as a factor in any long-term investment strategy. Remember to look at an investment’s ‘real ‘rate of return, which is the return after inflation. The aim of investments should be to provide a return above the inflation rate to ensure that the investment does not decrease in value. For example, if the annual inflation rate is 6%, then the investment will need to earn more than 6% to ensure it increases in value. If the after-tax return on your investment is less than the inflation rate, then your assets have actually decreased in value, that is, they won’t buy as much as they did last year.

When to start investing?

The sooner one starts investing the better. By investing early you allow your investments more time to grow, whereby the concept of compounding (as we shall see later) increases your income, by accumulating the principal and the interest or dividend earned on it, year after year. The three golden rules for all investors are:

  • Invest early

  • Invest regularly

  • Invest for long term and not short term

What care should one take while investing?

Before making any investment, one must ensure to:

  1. Obtain written documents explaining the investment.

  2. Read and understand such documents.

  3. Find out the costs and benefits associated with the investment.

  4. Assess the risk-return profile of the investment.

  5. Know the liquidity and safety aspects of the investment.

  6. Ascertain if it is appropriate for your specific goals.

  7. Compare these details with other investment opportunities available.

  8. Examine if it fits in with other investments you are considering or you have already made.

  9. Deal only through an authorized intermediary.

  10. Seek all clarifications about the intermediary and the investment.

Of all the points listed above, following 3 aspects are the most important. These are called “Golden rules for investing”.

  • Safety

  • Liquidity

  • Return

What is meant by interest?

When we borrow money, we are expected to pay for using it- this is known as interest. Interest is an amount charged to the borrower for the privilege of using the lender’s money. Interest is usually  calculated as a percentage of the principal balance(the amount of money borrowed ). The percentage rate may be fixed for the life of the loan, or it may be variable, depending on the terms of the loan.

What factors determine interest rates?

The factors which govern these interest rates are mostly economy related and are commonly referred to as macroeconomic factors. Some of these factors are:

  • Demand for money

  • Level of Government borrowings

  • Supply of money

  • Inflation rate

  • The Reserve Bank of India and the Government policies which determine some of the variables mentioned above.

What are various options available for investment?

One may invest in :

  • Physical assets like real estate, gold/ jewelry, commodities etc.

  • Financial assets such as fixed deposits with banks, small saving instruments with post offices, insurance/provident/pension fund etc. or securities market related instruments like shares, bonds, debentures etc.

What are an ‘Equity’ / Share ?     

 Total equity capital of company is divided into equal units of small denominations, each called a share. For example, in a company the total equity capital of Rs 2,00,00,000 is divided into 20,00,000 units of Rs 10 each. Each such unit of Rs10 is called a share. Thus, the company then is said to have 20,00,000 equity shares of Rs 10 each. The holders of such shares are members of the company and have voting rights.

What is a ‘Debt Instrument’ ?

Debt instrument represents a contract whereby one party lends money to another on pre-determined terms with regards to rate and periodicity of interest, repayment of principal amount by the borrower to the lender .In the Indian securities markets, the term ‘Bond’ is used for debt instruments issued by the Central and State governments  and public sector organizations and the term ‘debenture’ is used for instruments issued by private corporate sector.

What are the various Short- term financial options available for investment?

Broadly speaking, savings bank account, money market/liquid funds and fixed deposits with banks may be considered as short- term financial investment options:

Savings Bank Accountis often the first banking product people use, which offers low interest (4%-5% p.a.), making them only marginally better than fixed deposits.

Money Market or Liquid funds are a specialized form of mutual funds that invest in extremely short-term fixed income instruments and thereby provide easy liquidity. Unlike most mutual funds, money market funds are primarily oriented towards protecting your capital and then , aim to maximize returns. Money market funds usually yield better returns than savings accounts, but lower than bank fixed deposits.

Fixed deposits with banks are also referred to as term deposits and minimum investment period for bank FDs is 30 days. Fixed Deposits with banks are for investors with low risk appetite, and may be considered for 6-12 months investment period as normally interest on less than 6 months bank FDs is likely to be lower than money market fund returns.

What are various Long – term financial options available for investment?

Post office Savings Schemes, Public Provident Fund, company Fixed Deposits, Bonds and Debentures, Mutual Funds etc.

Post office Savings : Post office Monthly Income Scheme is a low risk saving instrument, which can be availed through any post office. It provides an interest rate of 8% per annum, which is paid monthly. Minimum amount, which can be invested, is Rs 1,000/- and additional investment in multiples of 1,000/-. Maximum amount is Rs. 3,00,000/- (if single ) or Rs. 6,00,000/- (if held jointly) during a year. It has a maturity period of 6 years. Premature withdrawal is permitted if deposits is more than one year old. A deduction of Rs 5% is levied from the principal amount if withdrawn prematurely.

Public Provident Fund :A Long term savings instrument with a maturity of 15 years and interest payable at 8% per annul compounded annually. A PPF account can be opened through a nationalized bank at anytime during the year and is open all through the year for depositing money. Tax benefits can be availed for the amount invested and interest accrued is tax- free. A withdrawal is permissible every year from the seventh financial year of the date of opening of the account and the amount of withdrawal will be limited to 50% of the balance at credit at the end of the 4th year immediately preceding the year in which the amount is withdrawn or at the end of the preceding year whichever is lower the amount of loan if any.

Bonds: It is a fixed income (debt) instrument issued for a period of more than one year with the purpose of raising capital . The central or state government, corporations and similar institutions sell bonds. Bond is generally a promise to repay the principal along with a fixed rate of interest on a specified date, called the Maturity Date.

Debentures: Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company’s general meetings of shareholders. A type of debt instrument that is secured by physical asset or collateral . Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, Debentures are documented in nature.

Mutual Funds: A Mutual fund is a body corporate registered with SEBI (Securities Exchange Board of India ) that pools money from individuals/corporate investors and invests  the same in a variety of different financial instruments or securities such as equity shares, Government Securities , Bonds, Debentures etc. Mutual Funds can be considered as financial intermediaries in the investment business that collects funds from the public and invest on behalf of the investors .Mutual funds issue units to the investors. The appreciation of the portfolio or securities in which the mutual funds has invested the money leads to an appreciation in the value of the units held by investors. The investment objectives specify the class of securities a Mutual Fund can invest in. Mutual Funds invest in various asset classes like equity, bond, debentures, commercial paper and government securities. The schemes offered by mutual funds vary from fund to fund. Some are pure equity schemes; others are a mix of equity and bonds. Investors are also given the option of getting dividends, which are declared periodically by the mutual fund, or to participate only in the capital appreciation of the scheme.

It is a substitute for those who are unable to invest directly in equities or debt because of resource, time or knowledge constraints. Benefits include professional money management, buying in small amounts and diversification. NAV is calculated as the value of all the shares held by the fund, minus expenses, divided by the number of units issued. Mutual Funds are usually long term investment vehicle though there some categories of mutual funds, such as money market mutual funds which are short term instruments.

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