Our financial planner, Kartik Jhaveri
Me: I don't want to take any more loans. I am having a hard time paying my existing ones!
Debt: Agreed, and I am not giving you money. Instead I am asking for your money. Investing in me could be a wise thing to do!
Me: What do you mean 'asking'? and making an investment? Now am I going to give you a loan?
Debt: Yes
Me: And, why would I do that?
Debt: Very simple. For instance: Notice the 'bank interest' credited in your bank statements? You will earn, say 3 to 4 per cent per annum when your money is lying in the savings account of your bank. That's a dismal 0.25 per cent per month plus assuming you pay taxes at 30 per cent or so on this.
Instead of keeping that money idle in your bank account, I can give you (a minimum of) double that percent, that is 0.5 per cent per month and that too almost risk free!
Me: But there must be something to this. Why else do people not invest in it?
Debt: They don't know that's why.
Me: What's the risk?
Debt: Not much. Well, you see I collect money from many small investors like you and create a pool. Debt securities are bought from this pool. Each such security has a coupon or interest rate attached to it. This security is issued by a Government body or corporate or other large companies and institutions who need money. The pool gives them money knowing very well in advance what the rate of interest is – as it is fixed. Over time, the lender pays the pool and in turn you are paid this return. That's straightforward. To make things better credit rating agencies give a rating to the institution. Rating signifies financial risk and strength of the institution to borrow. Thus a rating of say AAA (triple A) is very good. That's it.
Here's the twist, though. Each security is issued at a price or face value. Say Rs 100 is the face value and 8 per cent is the fixed interest rate. Now, this security is traded and so there comes the risk part. So, if interest rates go down to say 6 per cent, we will earn lesser on new investments. That is, there is demand for an investment that is fixed at 8 per cent. So if you and me hold it and someone wants to buy this from us naturally we will ask for a higher price than Rs 100. Thus his return will drop to say 7 per cent but that is still higher than 6 per cent. Thus it's a win-win for both. You and I enjoy 8 per cent till someone decides to buy our debt security and when that happens we make a capital gain also.
The reverse happens when interest rates rise.
Me: That is quite simple.
Debt: Yes, indeed it is. In a scenario when inflation is high; interest rates also tend to be higher. So, keep investing new money at higher yielding securities or debt funds. Move out from funds that give you lesser and move into funds at higher rates. Such funds are run by mutual funds and you can take advantage of that. Liquidity is ensured at any time you want.
Me: So how do I go about this?
Debt: For starters, look at the surplus money you have in your bank account. Calculate how much you need for next 2 to 4 weeks. The balance money - just transfer here. You will make the most of your idle money. If you are a professional or a business person who has a current account – then note that you earn nothing by keeping the money in the bank. Rather mover all of it here.
Me: What is the impact on taxation?
Debt: Half of what you pay, approximately! You pay about 30 per cent plus cess etc. Here you take a dividend from a fund and your tax reduces to about 14 per cent which is deducted at source.
Disclaimer: The contents of the above article are the intellectual property and copyright of the author, Kartik Jhaveri. No part may be used or reproduced in any form or manner. If you choose to act upon the information contained in the above article it is at your own risk. This article is purely educative and you are strongly advised to consult an expert prior to taking any significant decision.
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