Beginner’s Guide to the Capital Markets - :: SEBI Investor

1 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.

2 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.

3 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.

4 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.

5 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.

6 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.

7 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% , 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.

8 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.

9 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.

10 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.