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Beginner’s Guide to the Capital Markets
Financial Education
An overview of capital market
Products available in capital market
Securities and Exchange Board of India – An
Introduction
Securities and Exchange Board of India and
investor protection
INTRODUCTION
Financial Education
1. Basics
a. Importance of financial education: As much as skills are required to
earn money, it is required in equal measure in spending it wisely.
Accordingly, financial education provides you the basic life skill to build a
secure financial future. Proper financial knowledge can improve your
ability to save for your long term goals and prevent you and your family
from financial exigencies. It is important to know the following concepts:
b. Savings and Investing
Saving is the excess of your income over your expenditure. Generally,
savings is in the form of savings bank account and cash. Your money is
very safe in a savings account, earning a small rate of interest and you
can get back your money as and when you need it (high liquidity).
Whereas when you are investing, you are setting your money aside for
long term goals. It is normal for investments to rise and fall in value over
time. However, in the end, prudent investments can earn a lot more than
in your savings account.
c. Budgeting
The first step in your financial planning is budgeting - a process for
tracking, planning and controlling the inflow and outflow of your income. It
entails identifying all the sources of income and taking into account all
current and future expenses, with an aim to meet your financial goals. The
primary aim of a budgeting is to ensure reasonable savings after providing
for all expenses.
Benefits of budgeting
• it puts checks and balances in place in order to prevent overspending
at various levels;
• it takes into account the unexpected need for funds;
• it disciplines you in matters of earning and spending; and
• it helps you to maintain same standard of living even after post
retirement
d. Inflation effects on Investments
While planning your investment, it is important to take into account the
effects of inflation on your investments. Inflation is the rise in prices of
goods and services. As the prices of goods and services increase, the
value of rupee goes down and you will not be able to purchase as much
with those rupees as you could have in the last month or last year.
The effect of inflation on investment can be better understood with the
following illustration:
Say that your monthly consumption of petrol is 10 litres, costing you ` 500
@ ` 50 / litre. Further, you meet this expense out of the monthly interest
income of ` 500, earned from your fixed deposit. If the inflation rate during
the year is 10%, then price of petrol per litre would increase from ` 50 to `
55 / litre. Accordingly, the next year you will not be able to purchase 10
litres of petrol, now costing ` 55 / litre, out your interest income of ` 500
from your fixed deposit. Hence your financial plan should aim to earn
returns above the rate of inflation.
e. Risk and Return
Risk and return go hand in hand. Risk is loosely defined as the chance of
loosing all or part of your money invested. The good news is that
investment risk comes with the potential for return – which makes the
activity worthwhile.
The basic thing to remember about risk is that it increases as the potential
return increases. Essentially, higher the risk, the higher is the potential
return. (Do not forget the two words - “potential return”. There is no
guarantee).
f. Power of Compounding
As you pursue your financial planning, the most powerful tool for creating
wealth safely and surely is the magical ‘power of compounding’. If you
park your money in an investment with a given return, and then reinvest
those earnings as you receive them, your investment grows exponentially
over time.
Illustratively, if you set aside a sum of say ` 5,000 every month from the
age of 25, earning interest at the rate of 10% p.a., in 60 years you will
have with you funds worth more than ` 1 crore. However, if you start at 40
with the same amount and rate of interest, the fund accumulated will
amount to only around ` 33 lakh.
Hence, it is always advisable to start savings early to enjoy the benefits of
power of compounding
g. Time Value of Money
Money has time value. As the time passes, the value of money decreases.
This means that the value of a thousand rupee note you have today is
higher than its value five years hence, even if there is no inflation. This is
because we prefer consumption today to consumption in future which is
uncertain. That is why, if you invest ` 1,000 today at 5% per annum, you
would receive ` 1,050 after a year. Thus, ` 1,000 today is equivalent to `
1,050 received after a year or its value one year hence.
2. Products Available: There are a large variety of financial products available
for investment. You need to choose the best product or the best combination
of products to meet your preference and objectives. Your choice generally
takes a balance view of three factors, namely, Liquidity, Safety and Return
depending on the stage of life.
a. Savings Related products
Bank deposits are generally safe because they are partly covered by
deposit insurance and banks have high capital requirements. The banks
are regulated by the Reserve Bank of India. They offer various types of
deposits, depending on the needs of the customer. Bank deposits are
preferred more for their liquidity and safety than for their returns.
b. Investment Related Products
Company fixed deposits are fixed deposit scheme offered by
(manufacturing) companies. They are similar to bank fixed deposits but
entail lesser liquidity and usually carry higher risk and return.
Capital market offers products like equity, debt, hybrid instruments and
various mutual fund schemes. Each of this investment class carries
different risk-return profile and is covered separately under ‘products
available in capital markets’.
c. Protection Related Products
• Life Insurance is a contract providing for payment of a sum of money
to the person assured or, following him to the person entitled to receive
the same, on the happening of a certain event.
• Term Life Insurance Lump sum is paid to the designated beneficiary
in case of the death of the insured.
• Endowment Policies Provide for periodic payment of premia and a
lump sum amount either in the event of death of the insured or on the
date of expiry of the policy, whichever occurs earlier.
• Units Linked Insurance Policy (ULIP) provides a combination of risk
cover and investment.
For more details on insurance products, please refer to the website of the
Insurance Regulatory and Development Authority (IRDA), www.irda.org.in
d. Pension Products
• New Pension System (NPS): You can build your retirement corpus
during your working days by regularly contributing (the minimum
amount being ` 6,000 p.a.) to the NPS till the age of 60. Your
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