Investing Basics:I
Money is the root of all evil, and yet it is such a useful root that we cannot get on without it any more than we can without potatoes……………………….. Loisa MayAlcott(1832-1888)……..Who doesn’t nourish a desire to ride on a Mercedes Car and sleep on the bed of roses!! But then hardly a few of them are able to transcend. It’s all because people never know where to park their money and add values to it as time passes. Making money is in itself an art too easy to be mastered.
The flow of Money is cyclic and the only thing true about it is that it keeps rotating from one hand to the other thus meeting the needs of all. Income, in general is of two types: Earned and Unearned. Earned income is that what you get as wages or rewards for your work and Unearned Income is the one which you get not as a reward of some work but because you park it to a place which adds value to it and offers liquidity. Liquidity means the property by virtue of which a particular sum of money which for the time being is of no use to a particular person can be used by someone else to trade goods and services and meet their needs. Value addition means the cost charged for lending a particular sum of money to a person too needy at that time copmpared to the other. This article is to explore the myths of mechanism which adds value to your “Money” and helps you grow richer and richer.
As time passed and civilization grew, people grew more and more dependent on each other to meet their respective needs and soon the concept of globalization came and swept almost the whole of world. This increase in interdependency and the feature of globalization led to several new concepts of trading by means of which people now have options to pick up large sum of money from an even bigger market to start their own business and several other big and small needs. Before we proceed further and deal with each one of them let us first understand the fundamental of investment which states that the art of making money through investment is but directly proportional to the amount of risk involved, i.e. the more the risk the more is the profit and the vice-versa. Thus we have two types of mechanisms: 1.Low Risk Mechanism 2.High Risk Mechanism. Investments in Banks such as: Savings Bank Acct, Current Account, Fixed Deposit, Recurring Bank Deposit, Certificates of deposits, Insurance Policies etc are low risk investments and hence they have lesser values of returns. On the other hand there are stocks, bonds, mutual funds etc with higher risks and higher values of return as well. Before we touch the sensitivity of stocks and all those high risk mechanisms of investment which I shall do in my next article, let us understand what values can these low risk low return banks add to our Money.
A bank is nothing but a financial institution or a system wherein people deposit a certain sum of money which then gets accumulated into a larger pool and help others take as much money as needed but of course at a certain predetermined cost. This predetermined cost then adds value to the money and helps bank earn a profit which generally comes from the difference in interest paid to depositors and the interest earned on loans given to people. Not only this, banks also provide a security to the money deposited into it and makes sure that your money is parked at a risk-free place. However these banks are also regulated by a Federal Reserve Board which is the Reserve Bank in case of India constituted under RBI Act 1934 to regulate the issue of bank notes and the keeping of reserves with a view to secure monetary stability in India and generally to operate the currency and credit system of the country to its advantage. Banks are critical to any economy as it is this which is responsible for the liquidity by keeping a portion of total money in its treasury. Phew!! The money into its treasury is also for you only. Let us assume that acertain bank has some 1000 bugs with it. Then it lends 900 bugs back to economy in terms of loans and interests to others and keep some 100 bugs reserved with it. The 900 bugs which flowed into economy also in one way or the other get deposited to the some bank. 90% of this 900, i.e. some 810 bugs is then again flowed back to economy in several forms and some 90 bugs are kept reserved. In this way the wheel of vicious cycle of money keeps rotating and the money reserved is a certificate of security to the economy during bad times like recessions etc.
Banks have different schemes under which people can deposit their money and earn interests depending upon the volume of money, the time-frame of investment etc. A Savings Bank Acct is the one which gives maximum security to the money deposited and also offers ample liquidity to the investors allowing them to draw money as and when required and at the same time also inculculates in them a habit of savings. These accts offer lesser interests. Yet another kind of acct is Checking Accounts which is nothing but a transactional acct held at a financial institution and the money held in these accts is very liquid and can be withdrawn using checks, ATM’s and other electronic media. Because of the high liquidity that it offers, it doesn’t pay large interest. Then we have Fixed Deposits/Term Deposits where in a predetermined interest is paid to the investor at the end of the period but they offer no liquidity. A typical investment scheme is that of Certificate of Deposit in which the instituition pays a fixed interest rate on the lender’s money for a fixed time and the investor has the discretion to withdraw the money accrued to him as interest but then the investor can’t take the principal back.Yet another type of account is current account which is meant for businessmen, limited companies, partnership concerns, Clubs, Societies etc and meant neither for earning interests nor for savings but just for the sake of business. If one wants to save a certain amount of money regularly and earn interest on it then one can opt for Recurring Bank Deposit and get the principal and interest back after a fixed time.
Things discussed above were for the financial institutions which serve common people and individual needs. These apart, there are other financial institutions which serve specific purposes.MMX, Multi Commodity Exchange is another kind of de-mutualized financial institution/exchange recognized by the govt. of India for organizing future trading in a few listed commodities. Presently the key shareholders of MMX include MMX Financial Ltd, SBI, HDFC, Fidelity Management, NSE. Futures trading is an agreement between a buyer and a seller obligating the seller to deliver a said asset of said quality and quantity to the buyer on a said date at a said place and the buyer, in turn, is obligated to pay to the seller a pre-determined price in exchange of the delivery. Futures trading perform two important functions: Fixes Prices and hedging of price risk in a commodity. Hedge fund aims at gaining a fixed return from a deal irrespective of market conditions. It is nothing but a way of protecting and controlling prices which I shall discuss later. Few commodities which are traded in Futures Trading are Agri-commodities, Pulses, Oil and Oil-seeds, Ferrous and non-ferrous metals etc.
Keeping uncertainties prevalent in life and also in market, several financial institutions have different schemes to ensure life, property, firm and several other things which may meet financial losses due to happening of any unexpected untoward incidents on any future date. These insurance policies can be Life Insurance Policies for oneself or for those dependent on them.In the beginning it was only the LIC of India which had these policies for the common being but these days almost all financial institutions have different schemes.But then all these schemes dealt so far are low risk and low profit schemes and to make a larger sum of money one needs to look for equities, shares, bonds and mutual funds etc. I shall deal with each of them in my next article.
Note:The author is an amateur writer and a neophyte in economics and all contents put here have been taken from various sites many of which are already added in his blogroll. Queries, if any,can be sent to him at mihirjha27@gmail.com and comments are always welcome.
Thanx And Regards
Mihir Jha
