Bitcoin: How it works & Why You should/should not choose it.

Bitcoin: How it works & Why You should/should not choose it.


How Bitcoin transactions work?

Bitcoin transaction takes place through a wallet which is simply a mobile app or a computer program that allows the users to maintain as well as send and receive Bitcoins. Once installed, it generates an address for the user.

All the transactions ever carried out using Bitcoins is saved in a backend database ledger called “block chain”. Block chains are replicated graph data structures that store all Bitcoin activity in an encoded form in terms of public keys. Each block consists of a number of transactions. The blocks serve to timestamp the transactions that it contains and guarantee its validity. The block chain is available to all the system users. High end encryption techniques using digital signatures are used to maintain authenticity of transactions. The simplicity in the transaction process makes payments easier to make than debit or credit card purchases without a merchant account. Payments are made from application software by entering the recipient’s address, the payment amount, and pressing send. However, the underlying system is complex. The transactions are broadcasted between the users and confirmed by the bitcoin network in the next ten minutes by an intelligent process of mining. This is the process by which new bitcoins are created.

This system allows users to mine Bitcoins by sharing their processing power, reducing the load on its servers and thus get rewarded with Bitcoins in the proportion of the work done by their systems in creating a block (i.e. performing numerous calculations to solve a mathematical problem). The reward for solving a block is period dependent and is halved every four years. Also, as the number of people involved in generating new coins increases, the difficulty of the mathematical problem also increases.

Advantages of Bitcoin


Bitcoin offers a higher degree of freedom than that offered by the banking system. Any amount of money can be transferred instantaneously and there are no hassles like bank holidays, cross currency risks etc. The payments are either free or charged very low processing fees and there is also protection of personal information due to its simple payment procedure where personal details are not required to be entered. The use of military grade encryption through it cryptographically secure protocol offers strong protection against identity and monetary theft thus reducing risks for both – buyers and sellers. The transparency of the transactions due to its block-chain structure ensures real-time verifiability and maintains trust amongst its users.

Disadvantages of Bitcoin

The major disadvantage lies in the liquidity risk involved in holding Bitcoins as there is a limited acceptance for Bitcoins, being a virtual and unregulated/illegal currency. Also, as seen over the last year there is a high volatility in value of Bitcoin due to the small market size in terms of coins available for circulation and the actual user base which shies away merchants and users from accepting this currency. Although, this may decrease in the future if the Bitcoin market matures.

Bitcoin software is still in a beta stage and there is stilldevelopment work to be done in terms of features and services in order to improve reliability and acceptability amongst the users.

Anonymous nature of Bitcoin also make it dangerous as there are lots opportunities and incentives for money laundering. There is no third party verification of transactions which reduces the cost of money transfer but also makes it impossible to trace any thefts or wrong doing. An alphanumeric private key is used to secure transactions made by individuals and if this long key is lost or stolen, individuals cannot reclaim the key and their money is lost. There have been many instances of theft of Bitcoins from individuals and exchanges which are impossible to trace and this makes Bitcoin a very perilous investment option. These days’ people are even weary about fiat money like dollar, INR, and are investing in real assets like gold, real estate etc. which makes it harder for Bitcoin to become a widely used currency.

Bitcoins in India

According to SourceForge, since the launch of Bitcoin in the country on November 9, there has been 35,648 downloads. Kolonial, a restaurant in the posh area of Worli, Mumbai has started accepting payment through bitcoins thus becoming the first Indian eatery to accept the currency. The only other business establishment in India which accepts bitcoins is Castle Blue Spa and Saloon in Mumbai. Microsoft Ventures, a Bangalore based technology start-up accelerator has offered to lend its office space for the country’s first Bitcoin meet up in 2014.

In countries like Germany, Canada, Thailand, Bitcoin has got legal status. But RBI is sceptical of using Bitcoin as the digital currency. According to RBI, “it poses significant financial and security risks”. RBI in its circular on December 24th, 2013 cautioned that there is no established framework for recourse to customer problems /disputes / chargeback. It may also lead to money laundering and help the financing of terrorism as there is an absence of information in these peer-to-peer anonymous/pseudonymous systems.

RBI fears that Bitcoins can also be used for illicit and illegal activities. For example, Bitcoins were used on Silk Road, an online black market for illegal drugs that was shut down by FBI earlier this year where the agency also seized $28.5 million worth of Bitcoins. Another such website included “Assassination Market”, a crowd-funding service website that lets users contribute Bitcoins anonymously towards a bounty for political assassinations.

This RBI warning caused various domestic exchanges including India’s largest Bitcoin exchange – which even faced police raids to temporarily suspend their operations. However, after Unocoin, an Indian Bitcoin exchange resumed its operations on 8th January 2014, other exchanges are soon expected to follow. Advocates of Bitcoin and related entrepreneurs recently formed “Bitcoins Alliance India” to advocate and lobby on their behalf.

Future of Bitcoin

The conventional currency of the ‘fiat money’ is viable because of the backing of the government and the sense of reliability and stability it offers. There is no way that the government and central banks would allow a rogue currency to flourish. Perhaps a wise guess would be that there will be some regulations on Bitcoin and it may serve as a niche financial product for exchange in OTC markets.

Virtual currencies, in contrast to traditional payment systems, are not regulated; and hence the legal uncertainty around these currencies constitutes a challenge for the government authorities. Bureaucracy is a danger to Bitcoins well seen by the recent suspension of all Bitcoin exchanges by OKPay. A mounting pressure on online money exchanges from US regulators have resulted in smaller Bitcoin organisations finding themselves suddenly unbanked and the banks simply now insist that they do not wish to provide them with accounts any more.

Sudden rise in Bitcoin value has generated high interest among speculators. As a result of frenzy currency speculation, its value against the dollar is highly unpredictable. Traders have turned their attention to it (Bank of America began publishing research on it). This threatens to turn it into a Ponzi scheme – its price fluctuates manically as the slightest hint of action or inaction from regulators, or comment from self-proclaimed experts. This volatility makes it difficult for Bitcoins to gain acceptability as genuine currency, because businesses will be wary of accepting a currency whose value is so unpredictable.

In order to succeed and be popular, it needs to first become a widely used medium of exchange. For that to happen, Bitcoin should be able to be convertible into something else. It could be convertible simply into commodities, but it also needs to be generally and widely accepted for that to happen. Bitcoin must be convertible into fiat currency like pounds, dollars and Euros etc. to suffice for the stores that do not accept Bitcoins. Another problem is there needs to be some entrance for the Bitcoin into the current international financial system.

Many international financial systems have a connection with the US system. And if the US bureaucracy which oversees that US financial system happen to decide that it doesn’t like people dealing with Bitcoin, or if it doesn’t like people who in turn deal with people dealing with Bitcoin, then much is the possibility that Bitcoin won’t have access to the international financial system. It is not a matter of only pure legality. Bitcoin itself certainly isn’t illegal, also paying for something with it isn’t, and subsequently changing $ into $B isn’t and so on. But there are various regulations about who can do what with whom in the financial system that could be of a help for a determined bureaucracy to freeze someone out of it.

What happened with WikiLeaks signifies the above said. It’s not a mere coincidence that the world’s banks gradually stopped to process donations for WikiLeaks. Just the smallest hint that there might be more audits than usual would be just enough to steer a bank away from handling Bitcoin (or say WikiLeaks) transactions. And clearly that’s where the WikiLeaks matter ended up – at one point of time, the only way to donate was through Bitcoin.

It is not known what the US bureaucracy has in store for Bitcoin, but various refusals and withdrawals of banking services has something to do with it. Pressure is rumoured to be put on people not to handle the currency and hence the Bitcoin currency is likely to fail. People’s Bank of China too prohibited financial institutions and payment institutions from dealing in Bitcoins after making it very clear that it doesn’t consider Bitcoin a currency or legal tender, and that it shouldn’t be used to pay for real goods and services.

On the other hand, Bitcoin boosters believe that Bitcoin doesn’t actually need any of the rest of the financial system. They think it is so good that it will be able to replace it. The debate would be best answered in the time to come.



Bitcoin: Currency of the future?

Bitcoin: Currency of the future?



Have you heard of a currency that has gone up 200,000% within a year? There is but only one currency – Bitcoin (abbreviated as BTC). The Bitcoin concept has become so popular that its features and future are even discussed at investment conferences. This has attracted many well-known investors including the Winklevoss twins of Facebook fame who believe its value can easily touch USD 40,000 from the present roughly USD 900.

Bitcoin is a digital currency and the first crypto-currency (a concept first described by Wei Dai) which is claimed to have been developed by an unknown person or group known as Satoshi Nakamoto in 2009. The market size is estimated to be USD 4 billion with around 12 billion bitcoins in circulation.

Mt.Gox USDbtc all time arith (1)

Fig: Value trend of Bitcoin on Mt. Gox (in USD)


The cryptographic protocol and software used in Bitcoin are open source. Bitcoins are snippets of code that use encryption to prevent counterfeiting and double-spending. It is pseudo-anonymous in the sense that its ownership is anonymous but the transactions are transparent. Complex algorithms control the supply of Bitcoins which can be generated or “mined” by running a program on a powerful computer. Bitcoins grow at a rate known to all parties in advance (it grew at a rate of 25 coins per 8 minutes on 11th April 2011). The total number of Bitcoins can’t exceed 21 million (which will be reached in around the year 2140) but their value depends purely on market forces. It is a purely virtual currency which is not backed by any security or government obligation. Its value is determined by the demand and supply forces, is traded Bitcoin exchanges like BTC China, Bitcoin 24 and Mt. Gox.

Screenshot from 2014-02-18 16:23:23

Fig: Life of a Bubble (Expected Life of Bitcoin)

Nowadays, Bitcoin is increasingly being accepted as a mode of payment for products and services by vendors that accept Bitcoin payment such as WordPress, Reddit, OkCupid. There are even mobile apps that allow Bitcoin payment and spot trading facility. Surprisingly, many start-ups have been listed on the Global Bitcoin Stock Exchange where bonds and stocks can be traded. The ‘cryptocurrency’ wave has hit the world of financial markets and there have been a lot of speculations as to what the future unfolds. Understandably, there has been apprehension of wide spread money laundering and criminal fraud due to complete anonymity of Bitcoin transactions. Also, Bitcoins at present is highly volatile and the graph below shows the fluctuation in its value over the past two years.

Alternatives to Bitcoins

Bitcoin is one of the many virtual currencies which presently exist. Some of the other popular virtual currencies include:

  • Litecoin: It is a peer-to-peer currency enabling instant payments also based on the bitcoin protocol and its network is scheduled to produce about 84 million currency units.
  • Peercoin: It is the first cryptocurrency whose creation was inspired by bitcoin and is based upon a proof-of-work system.
  • NovaCoin
  • NameCoin
  • Protoshares
  • AnonCoin
  • MegaCoin

Though being different from Bitcoins, the following virtual currencies were popular in the past:

  • WebMoney: It is a virtual payment system which aids internet users for conducting real time transactions using WebMoney unit
  • Pecunix: It is a digital currency backed by gold
  • World of Warcraft Gold: Designed by Blizzard Entertainment, it is a virtual currency that is used by a popular online role-playing game
  • Nintendo Points: It is a virtual currency which has been established by Nintendo and it can be redeemed at Nintendo’s games/shops
  • Linden Dollars (L$): It is a virtual currency wherein digital characters can be customised
  • There have been instances where some virtual currencies have ceased to operate like:
  • Facebook Credits: It was a virtual currency that was introduced by Facebook in 2009 and ceased its operation in 2012. It allowed users to buy virtual goods in the form of applications on the Facebook platform
  • Liberty Reserve: It was a centralized currency based on Costa Rica which promoted itself as the oldest, safest and most popular payment processor. It was shut down by none other than the U.S. government due to accusations of money laundering


What is the future of Bitcoins, What is its status of Bitcoins in India? Please read on to Bitcoin: How it works & Why You should/should not choose it.




Budget 2013 : Where to Invest

Budget 2013 : Where to Invest

Union Budget 2013 is out and finance minister Mr. P. Chidambaram has several different proposals for investors to invest in the specific areas. Here are some of the areas where the amount can be invested

1. Tax Free Infrastructure Bonds

The Finance Minister has given permissions to several institutions to issue tax free infrastructure bonds for one more year. As many as four infrastructure debt funds have been registered. So, for investors who want to earn tax free income, this is a place where they can put some of their funds. But the thing that is to be kept in mind is the nature of these infrastructure bonds. These are long term investments and are typically for a period of 10 and 15 years

2. Equity Mutual Funds

The Security Transaction Tax (STT) that was levied on equity oriented mutual funds has been brought down significantly. This is valid for the transactions done through stock exchange as well as directly with the mutual fund. This reduces some of the additional expenses that an investor used to incur earlier and hence it becomes a suitable low cost investment for an investor to park some of his/her funds. The finance minister has reduced the STT on mutual fund sale and purchase at the counters from 0.25% to 0.001%. For mutual funds sold on the exchange, the STT will be 0.001% compared to 0.1% earlier, for the seller side only

3.       Inflation Linked Bonds

With the rising inflation, investors would like to ensure that their fixed income investments are protected against the rise in inflation. In the Union Budget 2013, the finance minister announced the introduction of inflation linked bonds in the Indian market. This will enable protection for investors against the inflation so some part of their funds can be allocated to these investments. These kinds of investments are known to have a “real rate of return”. Removing the effects of inflation from the return of an investment allows the investor to see the true earning potential of the security, without external economic forces. For example, say an investor held a bond that returned 4% over one year. Examining only the return shows that this bond earned a positive income. However, if inflation for the year was 5%, the real rate of return on the bond becomes -1%. This is an approximate measure. The exact measure is given by the following formula:-

Real Rate of return = (1+ rate of return) / (1+ inflation rate) – 1

In India, the Inflation linked bonds are linked to the Whole Sale Price Index (WPI). Here, WPI is the average inflation of common commodities pertaining to household, power and manufactured items, giving a fair figure of inflation level in the market.

Let’s say that you buy a regular bond for Rs. 100 with a coupon rate of 3%. Consider that the inflation rate is 5% when the bond matures. Therefore, the actual value of the bond is Rs. 105 but the coupon payment is Rs. 103. Thus, in actual terms we are at a loss of Rs. 2. With Inflation-Indexed Bonds such problems are taken care of. This is because the bond is indexed to the inflation rate. This means that for the same situation as above, the bond is indexed to the inflation rate of 5%. Therefore, the face value of the bond increases to Rs. 105 instead of Rs. 100. The coupon rate of 3% is now calculated on this Rs. 105. Therefore, the payment comes to Rs. 108.15. In this manner the buyer of bond does not incur any loss. Same is the case during a depression when the rate is low, except that the process is reversed. The face value is reduced below Rs. 100. In this way the issuer does not face any loss.

For stronger inflation indexed bonds, indexation is applied on interest also.  In the above scenario the 5% inflation is applied on the coupon rate, increasing it to 3.15% from 3%, giving you a net return of Rs.108.30.


4. Rajiv Gandhi Equity Savings Scheme

In Union Budget 2012, the finance minister announced the introduction of Rajiv Gandhi Equity Savings Scheme (RGESS). This scheme was meant for the new investors who either do not own a Demat account or for the investors who have opened a Demat account but haven’t made any transaction till the announcement of scheme. The deduction under this Scheme shall be available to individual investor whose Gross total income for the financial year is less than or equal to Rs. 10, 00, 000. Maximum investment amount under this scheme is 50,000 and the deduction allowed is 50 % of the investment amount.

In Union Budget 2013, the finance minister announced an extension to this scheme. Individuals with Gross total income up to Rs. 12, 00, 000 can avail the benefits of this scheme. Scheme is now available for three successive years so that an individual can invest Rs. 50, 000 each in these three years in the specifies securities and funds


Credit Ratings and the Credit Rating Agencies

Credit Ratings and the Credit Rating Agencies


Credit Rating evaluates the credit worthiness of debt instruments, companies, governments, local bodies, etc. based on a robust and clearly articulated analytical framework. Credit rating agencies evaluate the debtor’s ability to pay back the debt and the likelihood of default. These agencies evaluate the qualitative and quantitative information for a company or government. The analysts of these credit rating agencies have an access to the non-public information of companies. The largest credit rating agencies which tend to operate worldwide are Moody’s, Fitch, Standard and Poor’s, Dun and Bradstreet. In India, CRISIL is the largest and most influential credit rating agency.

Ratings are based on experience and judgment rather than mathematical formulae. Credit ratings are used by individuals and other entities for deciding whether the company will pay its debt obligations or not. A poor credit rating indicates that there is a very high risk of defaulting.

CRISIL (Credit Rating and Information Services of India Ltd.) covers more than 45,000 entities in India including over 30,000 SMEs. It is the undisputed leader in the field of ratings, research, risk advisory, etc. Standard and Poor’s has the majority of stake in CRISIL. Some of the debt obligations rated by CRISIL are:-

  • Non-convertible debentures/bonds/preference shares
  • Commercial papers/certificates of deposits/short-term debt
  • Fixed deposits
  • Loans
  • Structured debt

Apart from the debt obligations, the entities which are rated by CRISIL include:-

  • Industrial companies
  • Banks
  • Non-banking financial companies (NBFCs)
  • Infrastructure entities
  • Microfinance institutions
  • Insurance companies
  • Mutual funds
  • State governments
  • Urban local bodies

According to CRISIL, their credit ratings are

  • An opinion on probability of default on the rated obligation
  • Forward looking
  • Specific to the obligation being rated

But they are not

  • A comment on the issuer’s general performance
  • An indication of the potential price of the issuers’ bonds or equity shares
  • Indicative of the suitability of the issue to the investor
  • A recommendation to buy/sell/hold a particular security
  • A statutory or non-statutory audit of the issuer
  • An opinion on the associates, affiliates, or group companies, or the promoters, directors, or officers of the issuer

India’s Credit Rating

            Slowing growth rate, depreciation of rupee, high inflation, rising fiscal deficit have been the issues of serious concern for India in the recent past. Credit rating agencies have a negative outlook towards India. At present, India’s credit rating is BBB- (According to Fitch and Standard and Poor’s), the lowest investment grade rating. There have been warnings that India’s credit rating can be further downgraded to “Junk” status or to the speculative grade which puts India in the danger of being the first BRICS group of fast growing economies to be downgraded to “Junk” status. A credit rating downgrade would make it more difficult for the government and corporates to raise foreign loans and they would end up paying higher interest rates as well. The negative outlook will also lead to foreign investors turning more cautious about putting their money in the country. This reduction in the flow of much-needed foreign funds would adversely impact investment and increase pressure on the weakening rupee.

Government has announced reform measures, such as increasing domestic diesel price by about 12% and allowing up to 51% foreign ownership in multi-brand retail stores. The government also announced plans to increase the foreign ownership limit to 49% in insurance companies. In addition, the cabinet approved foreign investors owning up to 26% (or 49%, depending on the successful enactment of the amended insurance laws) in pension-related businesses. After a long wait, the government seems to have reignited reform efforts, and that bodes well for the future development of India and to make it an investment friendly economy. Can these reforms be the light at the end of tunnel? Looking at the present situation, we can just speculate it.





According to IMF definition, the acquisition of at least ten percent of the ordinary shares or voting power in a public or private enterprise by non-resident investors makes it eligible to be categorized as foreign direct investment (FDI). In India, a particular Foreign Institutional Investor (FII) is allowed to invest up to 10% of the paid up capital of a company, which implies that any investment above 10% will be construed as FDI, though officially such a definition does not exist. FIIs can individually purchase up to 10% and collectively up to 24% of the paid-up share capital of an Indian company.

However, it may be noted that there is no minimum amount of capital to be brought in by the foreign direct investor to get the same categorized as FDI. FII denotes all those investors or investment companies that are not located within the territory of the country in which they are investing. “SEBI’s definition of FIIs presently includes foreign pension funds, mutual funds, charitable/endowment/university funds etc. as well as asset management companies and other money managers operating on their behalf.”
Following are the few features one should know about FDI and FII:-

1. Foreign direct investment (FDI) flows into the primary market whereas foreign institutional investment (FII) flows into the secondary market, that is, into the stock market.

2. FDI is a long term investment whereas FII is generally short term

3. Entry and exit in markets for FDI is far more difficult than FII. It is relatively effortless for a foreign institutional investor (FII) to enter the capital market. A SEBI registration, preceded by a fairly perfunctory due diligence, is all it takes before an FII can enter the Indian stock market and commence trading. Exit is equally simple. For FDI, however, both entry and exit are far more difficult. Even in sectors opened to FDI on paper, problems remain at the grassroots. There are innumerable clearances that need to be obtained at the state and district levels. There are also a number of practical hurdles, such as infrastructure bottlenecks, all of which make entry difficult. Exit is even more complicated. Archaic labour laws, such as the Industrial Disputes Act, prohibit the closure of any company employing more than 100 workers without obtaining prior state government permission.

4. FDI is perceived to be more beneficial because it increases production, brings in more and better products and services besides increasing the employment opportunities and revenue for the Government by way of taxes. FII, on the other hand, is perceived to be inferior to FDI because it only widens and deepens the stock exchanges and provides a better price discovery process. FDI is thought to be more useful to a country than investments in the equity of its companies because equity investments are potentially “hot money” which can leave at the first sign of trouble, whereas FDI is durable and generally useful whether things go well or not.

5. FII is a fair weather friend. It can wreck havoc with the rupee when FIIs sell in big number. This situation takes back the dollars that were brought in the economy.

5 Common Mistakes That Young Investors Make

5 Common Mistakes That Young Investors Make


Procrastinating(the act of replacing high-priority actions with tasks of lower priority)

Procrastination is never good, but it can be especially detrimental while investing because the markets move so quickly. Good investment ideas are not always easy to find. If, after doing research, a good investment idea arises, it is important to act on it before the rest of the market takes note and beats you to it. Young investors can be prone to not acting on a good idea out of fear or inexperience. Missing out on a good idea can lead a young investor to two very bad scenarios:

The investor will revise his opinion upward and still buy an asset when it is not warranted. Perhaps the investor rightly develops an opinion that an asset priced at Rs.250 should be worth Rs.500. If it moves up to Rs.500 before he or she buys it, the investor may artificially revise the price target to Rs.600 to rationalize the purchase.
The young investor will look for a replacement. In the previous example, the investor who failed to buy the asset that rose from Rs.250 to Rs.500 may quickly try to identify the next asset that will double. As a result, the investor might purchase another asset quickly, without doing the proper work and research, in order to try to make up for the previous “missed opportunity.” Young investors often find themselves with too many options and not enough money. Read more in Competing Priorities: Too Many Choices, Too Few Dollars.

Speculating Instead of Investing

A young investor is at an advantage in his or her investing life. Holding the level of wealth constant, an investor’s age affects how much risk an he or she can take on. So, a young investor can seek out bigger returns by taking bigger risks. This is because if a young investor loses money, he or she has time to recover the losses through income generation. This may seem like an argument for a young investor to speculate, but it is not.
Young investors will have an inclination to speculate if they do not fully understand the investment process. Speculation is often the equivalent of gambling, as the speculator does not necessarily have a reason for a purchase except that there is a chance that it may go up in value. This can be dangerous, as there are many experienced professionals waiting to take advantage of their less-experienced counterparts.

Instead of speculating and gambling, a young investor should look to invest in companies that have higher risk but greater upside potential over the long-term. So, while a diversified portfolio of small-cap growth stocks(higher risk hence higher return) would not be appropriate for an investor nearing retirement, a young investor is better equipped to take on that risk and can take advantage accordingly.

Using Too Much Leverage (The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment)

Leverage has its benefits and its pitfalls. If there is ever a time when investors have the ability to add leverage to their portfolios, it is when they are young. As mentioned earlier, young investors have a greater ability to recover from losses through future income generation. However, similar to speculation, leverage can shatter even a good portfolio
If a young investor is able to stomach a 20-25% drop in his or her portfolio without getting discouraged, the 40-50% drop that would result at two times leverage may be too much to handle. The consequences of such a drop are similar to those resulting from a loss due to speculation: the young investor may become discouraged and overly risk averse for the rest of his investing life. (Want to learn more about leverage? See Leverage’s “Double-Edged Sword” Need Not Cut Deep for more.)

Not Asking Enough Questions

If a stock drops a lot, a young investor might expect it to bounce right back, but more often than not, it is down for good reason. One of the most important factors in forming investment decisions is asking why. If an asset is trading at half of an investor’s perceived value, there is a reason and it is the investor’s responsibility to find it. Young investors who have not experienced the pitfalls of investing can be particularly susceptible to making decisions without locating all the pertinent information

Not Investing

As mentioned earlier, an investor has the best ability to seek a higher return and take on higher risk when they have a long-term time horizon. Investors have their longest time horizons, and a high tolerance for risk, when they are young. Young people also tend to be less experienced with having money. As a result, they are often tempted to focus on how money can benefit them in the present, without focusing on any long-term goals (such as retirement). Spending money now instead of saving and investing can create bad habits and contribute to a lack of savings and retirement funds. For more on this, read Young Investors: What Are You Waiting For?

The Bottom Line

Young investors should take advantage of their age and their increased ability to take on risk. Applying investing fundamentals early can help lead to a bigger portfolio later in life. There are also many risks that a young/less-experienced investor will face when making decisions. Hopefully, avoiding some of the common mistakes above will help young people learn investing early and embark on a fruitful investing career.


5 Tips for Young Investor

5 Tips for Young Investor

You’re a twenty something, just out of college or a few years into working life. It’s time to start some serious investing. That’s because time is the young investor’s best friend, and you have plenty of it — perhaps two decades to save for a child’s college costs, and probably four decades to build a nest egg for retirement. I know — retirement seems eons away and thinking about it makes you feel so settled and middle-aged.

But look at it this way: If you invest a little each month starting now, you won’t have to invest as much as you would if you were to wait another 10 or 20 years to get going.

Imagine, for example, that you want to have 1 crore rupees by the time you retire in 40 years. That would be enough to provide an annual retirement income of 4,00,000 for the rest of your life.

But in fact, you’ll need 7 crore rupees, because if inflation averages 5 percent a year, that’s how much it will take to buy what 1 crore rupees buy today. 7 crores should produce an annual income of 28,00,000 rupees — equal to 4,00,000 today.

Start investing now and earn an average annual return of 10 percent — ambitious, but possible — and you’d have to invest about 1,58,000 a year to get to 7 crores in 40 years. But if you wait 10 years to start investing you’ll have to set aside nearly 4.25 lacs a year.Start early with whatever you can afford. It will make life much easier later.So what are the key things to know as you launch a long-term investing plan? Here are five tips:

Stocks, stocks, stocks

Stocks are riskier than bonds or bank savings, so in any given year you could lose money. But overall, the stock market doesn’t often lose money over periods longer than five years, because there are fewer losing years than winning ones.

Over long periods, returns in the stock market have averaged about 10 percent a year, while bonds earn a little over 7-8 percent. Cash, such as bank accounts or money market funds, averages about 4-5 percent.

Every young investor should keep in mind that investing in stocks is a long-term strategy, not something you do with next month’s rent money. If you can whether the downturns you should be pleased with the results.

But remember, when you hear that stocks have returned an average of 10 percent a year, it refers to investments that were left alone, with all dividends and other earnings reinvested. If you make 15 or 20 percent one year, leave it all in the account to continue growing. Don’t take out the “extra” earnings to spend, because they’re needed to offset the years when you make less than 10 percent.

Look at mutual funds

Though the stock market offers good returns over time, many individual stocks lose money and never recover.

You would need at least 20 or 30 different stocks to safely “diversify” your money — spread it around to cut risk. To find them you might have to read prospectuses, annual reports and news accounts on 200 or 300 stocks. Even if you know enough to do this — and most investors don’t — it’s an enormous amount of work.

Fortunately, we have mutual funds, which are investment pools run by professionals. Even if you have just a few thousand dollars to invest, with a single fund you can spread your money among dozens of stocks, sometimes hundreds. For a small fee, the fund manager does all the hard stock picking.

Focus on fees

The average stock-owning mutual fund charges investors annual fees equal to about 1 percent of assets — Rs.1 for every 100 rupees in your account. That little bit adds up. If your fund held stocks that returned 10 percent, the fee would cut your fund’s return to 9 percent. Instead of making 10 rupees for every 100 rupees invested, you’d make 9 rupees. You’d take a 10 percent pay cut.

Suppose you invested 1,000 rupees today in a fund that earned 9 percent once fees were figured in. You’d end up with about 31,000 after 40 years. Now suppose you can find a fund owning the same stocks but charging only 0.2 percent. Your 1,000 rupees will grow to about 43,000 rupees.

It’s an enormous difference. That’s why millions of investors turn to index-weighted funds that charge 0.2 percent or less. Instead of trying to find hot stocks, they simply buy and hold the stocks in a broad market index.

Many studies have shown that index funds actually beat most “managed” funds over time, because most fund managers can’t successfully pick enough winners to overcome the damage from their high fees. Index funds also tend to produce lower annual tax bills. And because their investing strategy is essentially automated, you don’t have to worry that your fund manager will quit or retire.

Minimize taxes

Since taxes chew away at returns the same way fees do, savvy investors use a variety of tax strategies.

You should open a PPF (Public Provident Fund) account as soon as you get into job even if you are investing through EPF (Employee Provident Fund). We are not suggesting young investors that they should put the maximum amount permissible. But one should open the PPF account and just put little bit so that at least the account completes its lock-in period as soon as possible.

Also one must start SIP (Systematic Investment Plan) in Diversified Equity Funds. This should be at least 10% of your monthly income.

Also, there’s no annual tax on investment profits, meaning money that otherwise would be used to pay taxes can instead keep growing as an investment.

Also one must start SIP (Systematic Investment Plan) in Diversified Equity Funds. This should be at least 10% of your monthly income.

Loans for Young People

Loans like Education Loan or Home loan are good but in case one takes loan for buying expensive Car or exotic holidays that is a wrong approach. Also use of credit card should only be to substitute handling of cash  and ease of payment and strictly it should not be used as tool to get loan.