Basics of Financial Markets
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.
Why should one invest?
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.
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 a cumulating the principal and the interest or dividend earned on it, year after year. The three golden rules for all investors are:
- 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. Verify the legitimacy of the investment.
4. Find out the costs and benefits associated with the investment.
5. Assess the risk-return profile of the investment.
6. Know the liquidity and safety aspects of the investment.
7. Ascertain if it is appropriate for your specific goals.
8. Compare these details with other investment opportunities available.
9. Examine if it fits in with other investments you are considering or you have already made.
10. Deal only through an authorised intermediary.
11. Seek all clarifications about the intermediary and the investment.
12. Explore the options available to you if something were to go wrong, and then, if satisfied, make the investment.
These are called the Twelve Important Steps to Investing.
What are various options available for investment?
One may invest in:
- Physical assets like real estate, gold/jewellery, 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 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 Account is 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 maximise 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. A bonus of 10% is paid at the time of maturity. Premature withdrawal is permitted if deposit is more than one year old. A deduction of 5% is levied from the principal amount if withdrawn prematurely; the 10% bonus is also denied.
- Public Provident Fund: A long term savings instrument with a maturity of 15 years and interest payable at 8% per annum 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.
- Company Fixed Deposits: These are short-term (six months) to medium-term (three to five years) borrowings by companies at a fixed rate of interest which is payable monthly, quarterly, semi annually or annually. They can also be cumulative fixed deposits where the entire principal along with the interest is paid at the end of the loan period. The rate of interest varies between 6-9% per annum for company FDs. The interest received is after deduction of taxes.
- 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. A bond is generally a promise to repay the principal along with a fixed rate of interest on a specified date, called the Maturity Date.
- Mutual Funds: These are funds operated by an investment company which raises money from the public and invests in a group of assets (shares, debentures etc.), in accordance with a stated set of objectives. It is a substitute for those who are unable to invest directly in equities or debt because of resource, time or knowledge constraints. Mutual fund units are issued and redeemed by the Fund Management Company based on the fund’s net asset value (NAV), which is determined at the end of each trading session. 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 are some categories of mutual funds, such as money market mutual funds which are short term instruments.
What is an ‘Equity’/Share?
Total equity capital of a 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 Rs 10 is called a Share. Thus, the company then is 11 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.
Non-Resident Indians (NRIS)
Who is an NRI?
Any person holding Indian passport who has left India for an indefinite period for the following purposes:
- Any other purpose
For tax purposes 182 days period is a cut off mark. Students going abroad for education is also considered an NRI.
Who is PIO?
A citizen of a foreign country (other than a citizen of Bangladesh or Pakistan) is a PIO if:
- He / She at any time held an Indian Passport.
- He / She or either of his / her parents or any of his / her grandparents was a citizen of India.
- He / She is a Spouse (not being a citizen of Bangladesh or Pakistan) of an Indian citizen (a) or (b) above.
What are the products offered to NRI/PIO by OPTIMUS
- Investments in Equities through IPOs (Initial Public Offerings)
- Investments in Mutual Funds.
- Investment in corporate fixed deposits, bonds.
- Life Insurance.
What are the different types of rupee accounts that are permitted and can be maintained by NRIs?
The three types of rupee accounts permitted, that can be maintained by NRIs are as follows:
- a. NRE : Non-Resident (External) Rupee Account.
- b. NRO : Non-Resident (Ordinary) Rupee Account.
- c. FCNR – B : Foreign Currency (Non –Resident) Accounts (Banks).
Note : With effect from 01/04/2002, both NRSR and NRNR deposit schemes have been discontinued.
What are NRE and NRO accounts?
- Non-Resident (External) Rupee (NRE) account is a rupee account from which funds are freely repatriable. It can be opened with either fund remitted from abroad or local funds maintained in NRE/ FCNR accounts, which can be remitted abroad. The deposits can be used for all legitimate purposes. The balance in the account is freely repatriable.
- Non-Resident Ordinary Rupee (NRO) account is a rupee account and can be opened with funds either remitted from abroad or generated in India. The amounts in such an account are generally non-repatriable. However, funds in NRO accounts can be remitted abroad subject to/as per various directives in force at the time of repatriation.
- Balances held in NRE accounts can be repatriated abroad freely including transfer to NRO account, whereas funds in NRO accounts cannot be remitted abroad neither can be transferred to NRE account but have to be used only for local payments in rupees.
- Funds due to the non-resident accountholder which do not qualify, under the Exchange Control regulations, for remittance outside India are required to be credited to NRO accounts.
What is PIS?
- Portfolio Investment Scheme (PIS) is a scheme of the Reserve Bank of India (RBI) under which the ‘Non Resident Indians (NRIs)’ and ‘Person of Indian Origin (PIOs)’ can purchase and sell shares and convertible debentures of Indian Companies on a recognized stock exchange in India by routing all such purchase/sale transactions through their account held with a Designated Bank Branch.
- There are two types of PIS accounts viz. NRE PIS and NRO PIS.
- Only one PIS account can be opened by NRI/PIO with any designated bank.
- Any investment done in secondary market should be routed through a PIS account.
Can an NRI have investments under PIS on repatriation and non-repatriation basis?
- Yes. Investment can be made on repatriation as well as non-repatriation basis.
- However, an NRI will have to open NRE account as well as NRO account with designated bank branch as the sale proceeds of non-repatriation investment can only be credited to NRO account.
In case a resident Indian becomes a non-resident, will he / she be required to change the status of his / her holding from Resident to Non-Resident?
- As per section 6(5) of FEMA, an NRI can continue to hold the investments, which he / she had purchased as a resident Indian, even after he / she has become a non-resident Indian, but has to transfer the investments to his / her NRO (Non Resident Ordinary) account.
Does an NRI, PIO, FII requires any approval from the RBI to invest in mutual fund schemes?
- No special approval is required. NRIs have been granted a general permission by RBI [Schedule 5 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000] for investing in/redeeming units of the schemes subject to conditions set out in the aforesaid regulations.
- NRIs can also make investments in securities in primary market (IPO) and secondary market without any permission. The issuing company is required to take specific or general permission from GOI/RBI.
What types of transactions are allowed under NRE / NRO Savings Account?
- Investments in ETFs & Exchange Traded Debentures.
- Investment in IPOs (Initial Public Offerings).
- Personal Expenses & Gifts to relatives or otherwise.
- Investment in Mutual Funds.
What are the provisions for corporate benefits for investment on repatriation and non-repatriation basis?
- Corporate benefits may be in the form of dividend, interest, rights, bonus, etc. Any corporate benefit resulting out of investment in securities on non-repatriation basis will not carry the right of repatriation.
- Similarly any corporate benefit resulting out of investment in securities on repatriation basis will carry the right of repatriation. This is subject to change depending on prevailing RBI regulations.
How will the redemption proceeds be paid?
- Redemption proceeds will be paid by cheque. The cheque will be payable to the first unit holder and will include the bank account number.
- Alternatively the redemption proceeds will be credited directly to the investor’s bank account. This facility is available with selected banks as mentioned in our application forms.
- Redemption proceeds/repurchase price and/or dividend or income earned (if any) will be payable in Indian Rupees only. The fund will not be liable for any loss due to exchange fluctuations, while converting the Rupee amount into US Dollar or any other currency.
What is the tax liability on redemptions?
- Under Section 2(42A) of the Income Tax Act, units of the fund held as a capital asset for a period of more than 12 months immediately preceding the date of transfer, will be treated as a long-term capital asset for the computation of capital gains, thus qualifying for the long-term capital gains tax rate.
- In all other cases, it would be treated as a short-term capital asset and would be taxed at the short-term capital gains tax rate.
What is the tax liability for income received from your mutual funds?
- As per Section 10(35) of the Income Tax Act, 1961, income received from mutual fund units specified under Section 10(23D) is exempt from income tax in India and the mutual funds are subject to deduction of distribution tax in debt oriented schemes.
- Hence all dividends are tax-free in the hands of non-resident investors and no TDS is applicable on the same.
Is the indexation benefit available to NRIs?
- Yes, if units are held for more than 12 months i.e. on long-term capital gains.
Can a Power of Attorney (POA) invest on behalf of the NRI investor?
- Yes, unlike banks where a POA holder cannot open an account on behalf of the NRI/FIIs, in a mutual fund the POA has the authority to invest on behalf of the investor and sign documents for initial and additional purchases as well as redemptions.
- While applying for purchase of units the POA holder needs to submit the original POA or a copy duly notarized should be submitted. The Power of attorney should contain the signature of both the first holder and the POA holder.
- Only when the POA is registered does the POA holder have the right to transact on behalf of the NRI/FII investor. His signature will be verified for processing any transaction/request.
Is nomination by NRIs allowed in Mutual Funds?
- Yes, it is allowed only for Individuals.
Can a resident Indian have an NRI as nominee?
- Yes, the same rules apply for nominees to resident Indian accounts. An NRI can be a nominee to an account which is in the name of a resident Indian.
Fixed Maturity Plans (FMPS)
When does the term of an FMP start, from the date of purchase or the date of closing of NFO?
The term of an FMP starts from the date of allotment which can differ from the closing date of NFO. The allotment process is usually completed within 5 days of closure of NFO and the units are credited to investors' accounts.
How do I redeem after maturity?
You do not need to file a redemption request with the fund house at maturity of the scheme. AMCs are bound to transfer redemption proceeds within 10 days from the date of maturity. The amount you get will be determined by the scheme NAV on the redemption date. This amount will be automatically credited to your registered bank account if direct credit option is available with your bank or else redemption warrants will be issued to you.
Do I need a demat account for redemption of FMP?
You don't need a demat account to get the redemption proceeds. However, you need one if you want to trade the FMP on exchange before maturity.
How are FMPs different from short term funds?
Liquidity is the biggest differentiating factor between the two funds. While FMPs are closed-end, short-term funds are open-ended, meaning you can enter or exit short-term funds any time.
FMPs invest in instruments with same or lower maturity than the scheme. This means that regardless of change in interest rates, the returns that would be realised are known. Short-term funds, through, can invest in instruments with varying maturity, depending on the fund manager's outlook for interest rates. So if a short-term fund has invested in bonds with longer maturity it can suffer interest rate risk.
I want to invest in current FMPs through secondary market. How do I
go about this?
All FMPs have to be compulsorily listed on exchange. If you are able to find a seller for the FMP you want to invest in, you can buy units of the scheme from the stock market like you buy an equity share. As explained earlier, it is highly unlikely that you will find sellers and therefore low liquidity.