Chapter 4 Investment Options – Risky Investments
Before undertaking a project, ponder what will be gained,
Lost and ultimately achieved. Thirukkural Verse 46
Paraphernalia:
Following investments need certain basic requirements. They are 1. Bank account 2. PAN Number 3. DEMAT account.
Permanent Account Number (PAN) is a ten-digit alphanumeric number, issued in the form of a laminated card, by the Income Tax Department. It is also essential that the PAN should be quoted in documents regarding money transactions mentioned by Central Board of Direct Taxes.
The Income Tax department has authorized UTI Investor Services Ltd (UTIISL) to set up and manage IT PAN Service Centers in all places where an Income Tax office is there.
Form 49A should only be used for making a PAN application. We can download a PAN application from the official website of Income Tax department or UTIISL or NSDL. It is also available at IT PAN Service centers and TIN Facilitation centers. The PAN is allotted with priority and sent through email, when the application is submitted through internet and credit card payment is made.
Individual applicants should affix one recent, colored photo on Form 49A, any one proof of 'Identity' and 'Address' and Designation. Also, code of the concerned Assessing Officer of Income Tax department should be mentioned in Form 49A.
In case the applicant is a minor, any of the above documents of the parents or guardian of such minor should be submitted as a proof of Identity.
An Assessing Officer Code can be obtained from the Income Tax Office where the return of income is submitted.
If in case the applicant cannot sign in the PAN form, an impression of the Left Hand Thumb of the applicant should be affixed at the place where signatures are to be put and it should be attested by a Magistrate or a Notary Public or a Gazetted Officer, under official seal and stamp.
UTIISL and NSDL are given the authority to collect Rs.85 + Service Tax as applicable, per PAN application and this includes cost of a tamper proof PAN card. It takes about 15 days to get a new PAN allotted.
Any financial transaction, sale/purchase of property, vehicle or payment of cash for amount exceeding a certain limit, should have the PAN quoted in the pertaining document. Also, PAN should be quoted for deposits (in Bank or Post Office) exceeding Rs. 50,000/- .
So it’s mandatory for any tax payer to obtain the PAN from the concerned authority (UTIISL and NSDL)
Demat Account
For risky investments (such as Mutual Funds and Stocks) first requirement is a DMAT Account.
‘Demat’ refers to a dematerialized account.
Just as you have to open an account with a bank if you want to save your money, make cheque payments etc, you need to open a demat account if you want to buy or sell stocks.
So it is just like a bank account where actual money is replaced by shares.
You have to approach the DPs (remember, they are like bank branches), to open your demat account.
Let's say your portfolio of shares looks like this: 400 Reliance , 250 of SBI, 75 of ITC and 200 of L&T. All these will show in your demat account.
Though the company is under obligation to offer the securities in both physical and demat mode, you have the choice to receive the securities in either mode.
If you wish to have securities in demat mode, you need to indicate the name of the depository and also of the depository participant with whom you have depository account in your application.
It is, however desirable that you hold securities in demat form as physical securities carry the risk of being faked, forged or stolen.
Just as you have to open an account with a bank if you want to save your money, make cheque payments etc, nowadays, you need to open a demat account if you want to buy or sell stocks.
HOW TO OPEN A DEMAT ACCOUNT?
Opening an individual Demat account is a two-step process: You approach a DP and fill up the Demat account-opening booklet. The Web sites of the NSDL and the CDSL have listed the approved DPs. You will then receive an account number and a DP ID number for the account. Quote both the numbers in all future correspondence with your DPs.
So it is just like a bank account where actual money is replaced by shares. You have to approach the DPs (remember, they are like bank branches), to open your demat account. So you don't have to possess any physical certificates showing that you own these shares. They are all held electronically in your account. As you buy and sell the shares, they are adjusted in your account. Just like a bank passbook or statement, the DP will provide you with periodic statements of holdings and transactions.
Is demat account a must?
Nowadays, practically all trades have to be settled in dematerialized form. Although the market regulator, the Securities and Exchange Board of India (SEBI), has allowed trades of up to 500 shares to be settled in physical form, nobody wants physical shares any more.
So a demat account is a must for trading and investing.
Most banks are also DP participants, as are many brokers.
You can choose your very own DP.
To get a list, visit the NSDL and CDSL websites and see who the registered DPs are. A broker is separate from a DP. A broker is a member of the stock exchange, who buys and sells shares on his behalf and on behalf of his clients.
A DP will just give you an account to hold those shares.
You do not have to take the same DP that your broker takes. You can choose your own.
What's the difference between a depository and a depository participant?
A depository is a place where the stocks of investors are held in electronic form.
The depository has agents who are called depository participants (DPs).
Think of it like a bank. The head office where all the technology rests and details of all accounts held is like the depository. And the DPs are the branches that cater to individuals.
There are only two depositories in India -- the National Securities Depository Ltd (NSDL) and the Central Depository Services Ltd (CDSL). There are over a 100 DPs.
Documents required to open a DMAT account:
Get your documents in place
Once you approach your DP, you will be guided through the formalities of opening an account.
You must fill up an account opening form and sign an agreement with your DP.
The DP will ask for some documents as proof of your identity and address.
Check with them what they require. For instance, some may accept a driver's license, others may not.
Here is a broad list (you won't need all of them though):
• PAN card
• Voter's ID
• Passport
• Ration card
• Driver's license
• Photo credit card
• Employee ID card
• Bank attestation
• IT returns
• Electricity/ Landline phone bill
While they only ask for photocopies of the documents; they will need the originals for verification.
You will have to submit a passport size photograph on which you sign across.
A demat account can be opened with no balance of shares.
Banks are also advantageous because of the number of branches they have. Some banks give the option of opening a Demat account in any branch, while others restrict themselves to a selected set of branches.
Some private banks also provide online access to the Demat account. So, you can check on your holdings, transactions and status of requests through the net banking facility. A broker who acts as a DP may not be able to provide these services.
DEMAT ACCOUNT OPENING COST AND OTHER CHARGES
The cost of opening and holding a Demat account:
There are four major charges usually levied on a Demat account: Account opening fee, annual maintenance fee, custodian fee and transaction fee. All the charges vary from DP to DP.
Depending on the DP, there may or may not be an opening account fee. Private Banks, such as ICICI Bank, HDFC bank and UTI bank, do not have it. However, players such as Karvy Consultants and the State Bank of India charge it. But most players levy this when you re-open a Demat account, though the Stock Holding Corporation offers a lifetime account opening fee, which allows you to hold on to your Demat account over a long period. This fee is refundable.
Annual maintenance fee: This is also known as folio maintenance charges, and is generally levied in advance.
Custodian fee: This fee is charged monthly and depends on the number of securities (international securities identification numbers – ISIN) held in the account. It generally ranges between Rs. 0.5 to Rs. 1 per ISIN per month.
DPs will not charge custody fee for ISIN on which the companies have paid one-time custody charges to the depository.
Transaction fee: The transaction fee is charged for crediting/debiting securities to and from the account on a monthly basis. While some DPs, such as SBI, charge a flat fee per transaction, HDFC Bank and ICICI Bank peg the fee to the transaction value, subject to a minimum amount.
The fee also differs based on the kind of transaction (buying or selling). Some DPs charge only for debiting the securities while others charge for both. The DPs also charge if your instruction to buy/sell fails or is rejected.
In addition, service tax is also charged by the DPs.
Benefit to the Company
The depository system helps in reducing the cost of new issues due to less printing and distribution cost. It increases the efficiency of the registrars and transfer agents and the Secretarial Department of the company. It provides better facilities for communication and timely services with shareholders, investor etc.
Benefit to the Investor
The depository system reduces risks involved in holding physical certificated, e.g., loss, theft, mutilation, forgery, etc.It ensures transfer settlements and reduces delay in registration of shares. It ensures faster communication to investors. It helps avoid bad delivery problem due to signature differences, etc.It ensures faster payment on sale of shares. No stamp duty is paid on transfer of shares. It provides more acceptability and liquidity of securities.
Benefits to Brokers
The depository system reduces risk of delayed settlement. It ensures greater profit due to increase in volume of trading. It eliminates chances of forgery – bad delivery. It increases overall of trading and profitability. It increases confidence in investors.
A : Mutual fund
A mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests typically in investment securities (stocks, bonds, short-term money market instruments, other mutual funds, other securities, and/or commodities such as precious metals). The mutual fund will have a fund manager that trades (buys and sells) the fund's investments in accordance with the fund's investment objective. In the U.S., a fund registered with the Securities and Exchange Commission (SEC) under both SEC and Internal Revenue Service (IRS) rules must distribute nearly all of its net income and net realized gains from the sale of securities (if any) to its investors at least annually. Most funds are overseen by a board of directors or trustees (if the U.S. fund is organized as a trust as they commonly are) which is charged with ensuring the fund is managed appropriately by its investment adviser and other service organizations and vendors, all in the best interests of the fund's investors.
Income tax
Dividends from mutual funds are fully exempt from income tax under Section 10(33).
When to invest in Mutual funds:
This is once again a million dollar question. Majority of salaried individuals, after sleeping for ten months, invest in some tax-saving scheme during the month of February thinking that it is likely to give a phenomenal return. But after two years majority of such funds are quoting below purchase value. It would have been more prudent to pay tax rather than investing in such mutual funds.
All individual investors baring a few are not interested in taking risk on their investment decisions. But they are happily willing to give their money to somebody else (fund managers) to take risk on their money. I do not know what gives them the confidence to believe that the fund managers are great financial wizards and have the Midas’ touch to turn your paper money in to gold! But the fact remains otherwise. Whenever there was a market crash in US the first persons to lose jobs are the MBAs from great universities who are managing money as fund managers. One thing every investor should know is that it is not the intelligence of the fund managers that makes money but it is the BULL RUN which makes everybody a financial wizard and their investment to yield great return. If you try to swim against the current then you will lose everything you possess.
Hence it is better to know the trend of the market in which the mutual fund is going to invest for ensuring your returns. You should invest in Mutual funds when the market is very low and everybody is running away from the market .You should sell all your mutual fund holdings when the market is very high.
B : Stock Market
Another risky option for investment is the stock market. A stock market or equity market is a public market (a loose network of economic transactions, not a physical facility or discrete entity) for the trading of company stock (shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately.
The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organization specialized in the business of bringing together “buyers and sellers” and “listing of stocks and securities”.
Stock prices fluctuate widely, in marked contrast to the stability of (government insured) bank deposits or bonds. This is something that could affect not only the individual investor or household, but also the economy on a large scale.
“With each passing year, the noise level in the stock market rises. Television commentators, financial writers, analysts, and market strategists are all overtaking each other to get investors' attention. At the same time, individual investors, immersed in chat rooms and message boards, are exchanging questionable and often misleading tips. Yet, despite all this available information, investors find it increasingly difficult to profit. Stock prices skyrocket with little reason, then plummet just as quickly, and people who have turned to investing for their children's education and their own retirement become frightened. Sometimes there appears to be no rhyme or reason to the market, only folly”.
This is a quote from the preface to a published biography about the long-term value-oriented stock investor Warren Buffett. Buffett began his career with $100, and $100,000 from seven limited partners consisting of Buffett's family and friends. Over the years he has built himself a multi-billion-dollar fortune. The quote illustrates some of what has been happening in the stock market during the end of the 20th century and the beginning of the 21st century.
It is definitely possible for you also to build a financial empire if you follow the path of
Warren Buffett’s long term investment in right stocks at the right time.
Chaos Theory
Nature as well as Stock Market is highly complex, and the only prediction you can make is that it is unpredictable. The amazing unpredictability of nature is what Chaos Theory looks at. Why? Because instead of being boring and translucent, nature is marvelous and mysterious. And Chaos Theory has managed to somewhat capture the beauty of the “unpredictable” and display it in the most awesome patterns. Nature, when looked upon with the right kind of eyes, presents herself as one of the most fabulous works of art ever wrought.
Chaos Theory is a mathematical sub-discipline that studies complex systems. Examples of these complex systems that Chaos Theory helped fathom are earth's weather system, the behavior of water boiling on a stove, migratory patterns of birds, or the spread of vegetation across a continent. Chaos is everywhere, from nature's most intimate considerations to art of any kind and also Stock market. Complex systems are systems that contain so much motion (so many elements that move) that computers are required to calculate all the various possibilities.
Upto the Quantum Mechanical Revolution, people believed that things were directly caused by other things, that what went up had to come down, and that if only we could catch and tag every particle in the universe we could predict events from then on. Chaos Theory however taught us that nature most often works in patterns, which are caused by the sum of many tiny pulses. Just like nature, stock market behavior is a collective expression of millions of investors’ behavior which is also unpredictable.
The Uncertainty Principle prohibits accuracy. Therefore, the initial situation of a complex system cannot be accurately determined, and the evolution of a complex system can therefore not be accurately predicted. The first Chaos Theorists began to discover that complex systems often seem to run through some kind of cycle, even though situations are rarely exactly duplicated and repeated. Plotting many systems in simple graphs revealed that often there seems to be some kind of situation that the system tries to achieve, equilibrium of some sort. Take for example the weather. Weather is the total behavior of all the molecules that make up earth's atmosphere. We can't get an accurate fix on the present situation, just a mere approximation, and so our ideas about the weather are doomed to fall into misalignment in a matter of hours, and completely into the nebulas of fantasy within days. Nature and stock market will not let itself be predicted.
Stock market also exhibits cyclical patterns. If you are able to perceive these patterns ahead of others then it will be very easy for picking the right stock at the right time for buying or selling. The person who makes money is the one who can identify the patterns that signals turning around cycles and hop onto it with perfect timing for surf riding.
How to foresee turnaround patterns? How to choose the right stock at the right time both for buying and selling? What are the undercurrents that are flowing in the market? How to overcome the invisible danger? We will be discussing in great detail in the forth coming chapters.
Dr.Felisleo
14.11.10
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