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RBI Repo Rate Cut: The Good, Bad and Worst

By in Banking, Fixed Income | 1 comment

Dr Raghuram Rajan remind me of Harvey Specter from Suits… Not only both look dashing in their suits but also share similar trait of… Surprising the surroundings. So last week when Dr Rajan decreased the Repo Rate by 50 bps (.5% as 100 bps =1%) which was more than anticipated and asked, he was called Santa Clause and a Hawk. Media covered the event like cricket and confused political anchors tried to make understand the implication of this event making everyone more confused. Image courtesy of cooldesign at Well our Harvey (Hemant) and Mike (Madhu) could not resist and sat in the morning to figure this comet which just passed the earth. Here is the transcript of their discussion: Hemant: Dr. Rajan has reduced Repo Rate by 50 basis points and everyone is saying that this is good for the market. Loan EMI may also come down. Howthis repo rate cut means actually? I want to understand this.  Madhu: To understand this you first need to know, how does a bank function. Because it is the interlinkages between the two very important function of bank viz source of fund and utilization of funds. Hemant: Than tell me – what does a bank do? My understanding is primarily a bank takes money from depositors in form of deposits (Savings and FDs) and gives loan to earn interest. That way they keep everyone happy and make a profit also.  Madhu: Correct, but there are more to it as bank has one more source of fund- RBI. Let me explain this in a very simplistic way. Bank needs money. Bank can get money from depositors like you and me and also from RBI. But bank also needs to pay certain interest to us and also to RBI.  Hemant: Ok.  Madhu: Let us try to understand first – what happens when we deposit, say, Rs. 100 with a bank.  Hemant: I know that. Bank gives that Rs. 100 to someone who needs a loan.  Madhu: No, it is not that simple. Remember, though bank can earn interest by giving away loans, but it is also very risky business. There are many cases of loan defaults in recent years and this increases banks NPA (Non-performing assets). This will make banks put all our money into high risk areas. It has to be protected.  Hemant: How?  Madhu: Ok, RBI has made it mandatory that upon receiving, say, Rs. 100 – banks first have to deposit Rs. 4 with RBI. RBI keeps this Rs. 4 in its current a/c and hence banks do not receive any interest on this money. This is known as Cash Reserve Ratio or CRR, which is currently at 4%.  Hemant: Hmmm, then?  Madhu: RBI has also made it mandatory that upon receiving, say, Rs. 100 – banks need to compulsorily buy central and state govt. securities of Rs. 21.50. Of course banks will earn some interest income here. This is known as Statutory Liquidity Ratio (SLR), which is currently at 21.50%.  Hemant: Ok, so you mean to say that upon receiving Rs. 100, banks can spend only Rs. 74.50 at its own will.  Madhu: Correct. 100 – (4 + 21.50) = 100 – 25.50 = 74.50  Hemant: But you were saying that banks can also borrow from RBI. What interest banks pay to RBI?  Madhu: Before 30th September, banks were paying 8.25% interest to RBI when it borrows money from RBI. Now this rate has been reduced by 50 basis points. So banks now need to pay interest to RBI, if it borrows from RBI, at the rate of 7.75%. This is known as Repo Rate.  Hemant: Can fixed deposit rate be affected by reduction of Repo Rate?  Madhu: Of course. If banks get money from RBI @7.75%, why will banks pay higher interest to you and me? One year FD rate is already revised by many banks and it is equal to or very close to 7.75%.  Hemant: But as now banks are getting money at a cheaper rate, then they should reduce the loan interest rate i.e. passing on the benefits it receives.  Madhu: Correct. They should. And on that hope market is cheering. If companies get loan at a cheaper rate, they will likely to expand their businesses. That will create more jobs, more income and boost the economy. However banks have not passed entire 50 bps to consumers.   Hemant: How is inflation linked to this?  Madhu: See, when loan becomes cheaper, people tends to borrow more. That means people will have more money to spend. This will increase the demand for goods, and if supply does not increase to match this demand, then prices will increase.  Hemant: So there is a chance, that inflation may rise also?  Madhu: Well, yes. That is why first RBI convinces itself that the demand will be catered by supply, than only they can reduce rates. Also this is the reason the rates are decreased or increased in tranches instead of one go decision. But inflation depends on many other factors as well, like production (industrial and agricultural), manufacturing, export – import, foreign currency movement etc. So inflation may increase or may not.  Hemant: One last question. Like we deposit our money with banks, can banks also deposit their money with someone?  Madhu: Yes, they can deposit with RBI and earn interest too. This interest is typically 1% less than the repo rate....

Your Kids & Personal Finance: When and What to tell?

By in Financial Planning | 2 comments

Recently at a mall I saw another ‘wonder of the world’. Usually the most happening area is the toy area where you will see kids grabbing, crying, howling, praying and going to any extent to get the toy they want. I usually hate that area as who likes crying kids, but what I saw pushed me to write this article. There was this girl around 6-7 years and she herself went to the toy section, saw all the dolls on display. This means she checked the rates and size everything. And finally she selected two different dolls and took them to her father and said “Papa, I liked these two in our budget.” I was astonished to see the poise and maturity of this little girl. How can she know what is right and wrong for her- money wise… Image courtesy of David Castillo Dominici at Look at the Irony… mine and your whole life revolve around money and we work hard to meet both the ends,… but our kids are not taught about this at school. They will be good in language or mathematics or civic life but when itcomes to finance they lack basic terms. For a kid particularly below 8, ATM is the magician which prints money. They have no clue what is a bank, how do their parents receive salaries or income and what is the relationship of parents going to office and ATM dispensing notes at disposal? But as I mentioned, no one taught us this and unfortunately the education system has still not recognized the value of personal finance. Finance is a subject a kid is going to use his entire life. Kid’s realization that money is very important in life starts in his toddlers’ days itself. When he sees that he gets ice-cream, candies and dresses only when dad hands over some printed papers to the shopkeeper. The restaurants he loves to dine can be left when the bill is paid. Sometime he is denied viewing of his favorite cartoon daily soap since his father forgot to pay the DTH subscription fees. He understands the value of money but the linkages are absent. So the responsibility of educating about finance come to parents. Most of the parents know the basics but lack on two things: the exact words/phrases/examples and the structure -when to teach what? Internet is full of subjects on parenting, developing skills for your kids but a course or guide on personal finance for kids… a big vacuum again. Let me help you on this. Children need basic terms and concept to understand the larger financial topics when they grow young. For this one need to decide what we should be sharing with kid and what not. I have decided this age-wise so that we may also develop a structure. Age Group in Years Term/Concept How to explain it? 2-5 Money The importance of money is that it can be exchanged with things that are required. Try to simulate the barter system of exchanging goods and why the currency or coins were required. Try explaining the denominations of notes and coins and attach it to additions and subtraction that kid is learning at his school. Show him your wallet and tell him to count or arrange notes and coins. 3-7 Pocket Money/Allowances The pocket money is not about freedom to spend. It is a feel that kid experience that he can take decisions regarding purchases. Don’t confuse it with the piggy bank. Make the kid realize that pocket money is not to play but to take wise decisions. Here kid learns to prioritize his needs, wants and desires. Also he is introduced to world of being financially independent. 5-9 Savings Kids always have things to acquire in mind. A toy, a board game, a candy is always there short term goal. Make them plan for it by introducing the simple concept of saving and contributing to the purchase. Tell him that if X thing cost Rs 200, you want the child to contribute Rs 20 this time. Explain him how you save for vacations the family enjoys or some recent purchase like a house or a car, which was purchased by your disciplined savings. 5-9 Salary/Income The correlation between your hard work and income is very essential not only for his understanding in finance but for his future life. A kid needs to understand that it is easy to spend but hard to earn. Parents spend entire day in office to earn a decent living and it is not the ATM machine that supplies the money benefits. 5-9 Budget Introduction to household budget to kids is very important. Budget helps them to understand the planning for a purchase and tradeoff between 2 or more goods. He understands what is available to spend and what is being invested for future use. He also understands the concept of disposal income and savings. He correlates from where the money is coming and going. 10-14 Loan A kid needs to know when it’s better to leverage and when not. Clearly explain him/her that the monthly/small expenditure is done from monthly earnings/savings but larger expenditure needs to be loaned partly. The credit is not bad if taken to achieve a good asset. Tell them about education loan. 10-14 Interest Not everything is free. If you take loan you have to pay and pay more...

Your Wealth Wisher has a new Admin …!!!

By in Miscellaneous | 4 comments

Dear Reader, “Creation is only the projection into form of that, which already exists.” in itself is a destined platform to help you make informed decision on personal finance matters, but after a break… we resume with a difference… I Madhupam Krishna, with the blessings of Radhey Sharma, announce the change of guard at your favorite blog Thank You Radhey… Radhey is the person who started “wealthwisher” and has made it huge. He describe himself as an “ordinary guy with no superhuman skills”, but when I look, what he has created it’s certainly an unhuman task. I thank you from bottom of my heart for trusting me to take your creation ahead. “A gift is pure when it is given from the heart to the right person at the right time and at the right place, and when we expect nothing in return”- BhagwadGeeta All I can say at this moment is, you have handed me this at a very right time and right place. Thanks again. I am very proud to continue the legacy Radhey leaves behind. I look forward to lead “wealthwisher” as I continue to execute our common philosophy to spread awareness in asset management, retirement, risk-protection and other personal finance discipline. About Me I always see around that “we’re under-saved, we’re under-insured and we’re under-advised. These three issues has plagued the entire cycle of Savings and Investments with Risk protection. I have always felt that I can do something about these issues. I have been sticking-to-guns, in personal finance industry for around last 14 years and like vanvasa, it’s been a multi-disciplined journey. I have sold and supervised sales both as intermediary and manufacturer of personal finance product. Have worked/working with MNCs and super-houses belonging to Indian Capitalists. I have seen times when product was sold and times when things were pushed below throat… it’s a long journey to unfold. If you want to check milestones, please search on Linkedin & know my personal side on About us page. With full gratitude to Radhey, I am starting what I love to do… I need your patronage… wish me guys… Madhupam Disclaimer: I work for a firm which is manufacturer in personal finance product. I hereby declare that all my ideas/posts have no connection to my employer and in no way be connected to their philosophy and business. Blogging is my personal endeavor, hence all things mentioned on this blog are my personal wisdom and...

The magic of power of compounding [infographic]

By in Financial Planning | 7 comments

The magic of power of compounding has been explained innumerable times by personal finance experts all over the world. Albert Einstein has very famously quoted the below on this concept – “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” And it cannot be farther from the truth. Understanding the concept will help you make smart decisions early on in your life. There is not much fun in clearing the concepts when you are say, 5 years away from a big financial goal that you want to achieve and for which you have no money today. You should have started saving early on in life based on goal based investing concepts and the credit of the fact that it will work is based on the wonderful concept of power of compounding. The problem with our education system is that they teach you right but they don’t necessarily teach you the practical aspects of what you learn. There is a concept of 70:20:10 of learning in a person’s life. It says that 10% of a persons learning is based on things he learns in his classroom – our schools that is. 20% of a person’s learning comes through mentoring. And 70% of the learning comes from learning on the job. Now imagine applying that to personal finance. They teach the power of compounding to you in school but you seldom get mentors who will sit down with you and tell you to start saving early on in life, say from your very first salary. And if you have to learn on the job, then you must have already lost your shirt in the stock market in the process. So if you reading this, and I would consider you lucky if you are less than 30 years of age as you have the biggest advantage of time on your hands to make most of the power of compounding, my humble request is to read this and talk to someone who can tell you practically how to implement the concept of power of compounding in your life. The power of compounding explained Imagine you love mangoes. Imagine that one day a fairy tale appears and gives you a mango seed. She tells you, you have two choices what to do with this seed. The first is to simply throw it away and forget about it as after all it is a darn seed left over by someone who ate the bloody mango. The second is to sow the seed with the expectation that the seed grows into a tree and produces some darn good mangoes; you then get to eat mangoes and plant more seeds resulting into more mangoes. The problem is that the latter option will take a long time, a really long time. And with investors looking for instant gratification, the option might not be a huge sales hit. Some of you reading this will go with option one while others will go for option two. If you think back and contemplate, the second option is one that will make your future full of mangoes which you and possibly your family can feast on while the first one is a lost opportunity. Compounding works similarly, just replace the mango seed with rupees. Let me explain. You have some money on you, don’t you ? Let us call it the principal. Let us also say that the principal, aka the seed, generates a small amount of money called interest when you save it and invest it in an investment avenue – this is akin to generating more mangoes in the future when you plant the seed you have today instead of putting the seed in the dustbin. Imagine you keep on planting all the seeds that the future mangoes generate and you build a darn good farm of mango plants. That will we worth a lot in monetary terms. You have effectively built a huge mango farm from a single seed. Let’s cut to the chase in monetary terms. You have UnHappy Singh, OK Singh and Happy Singh. UnHappy Sing invests one time Rs 30,000 for 30 years which earns him  12% interest each year. The catch is that this is simple interest is money will be earning. OK Singh, invests 1/3rd of what UnHappy Singh puts in for the same duration and this earns the same interest, the catch here again it that the money is earning compounding interest each year. The results are amazing, although OK Singh invested a lot less (one third) of what UnHappy Singh put in, he ended up with twice the amount (Rs 2,99,599) that UnHappy Singh received (Rs 1,38,000). That is the magic of power of compounding as against simple interest. In fact, if you add a small amount of money each month to your initial investment and make this a recurring monthly investment, the results are mind boggling – you shall see that in the graphics below in a bit. For now, check the graph below to show the figures. And if you want to see how the money is growing each year by simple versus compound interest, check below. FV = Future Value. Let’s pause for some learning from Wiki. Interest is a fee paid by a borrower of assets to the owner as a form of compensation for...

How to invest your money wisely [infographic]

By in Financial Planning | 1 comment

Are you a new beginner to investing and wanting to understand how to invest your money wisely in India or anywhere in the world ? Or is it that you have put your neck deep into the underbelly of the stock markets, have burned your fingers and are looking to start afresh ? Whatever be the case, wise investing is something which can turn any amateur investor into a successful one. So while the big mouthed people talk about making a killing on the stock market and real estate, you can sit on the sidelines and listen and laugh, because you know that they are going to have their page 3 of recognition only till the boom lasts but when the tide turns, only then will the world know who is swimming naked (heard that somewhere before !). If you are a wise investor, you will have the last laugh. Here is how. Read the below detailed guide on how to invest your money wisely – this is more than handful in these times of economic distress when from 2008 – 2013 the returns from all investment classes have been pathetic, when India’s GDP has just been predicted to grow below 5% and the rupee has wet the roof in-spite of so many diapers on it. How to invest your money wisely anywhere in the world Use rules of thumb to start First things first, your knowledge on personal finance is going to take a while to become top notch so don’t aim for perfection to start with, aim for progress. Start with thumb-rules on what to do with your income. Many financial planners might rubbish this but remember progress is your aim, not perfection at the moment. Use these personal finance rules of thumb to distributing your income wisely between spending and saving. Remember it is easier said than done, but saving early on in life is very very tough when you have just got out of college and you want to spend on those beautiful things in life that you planned while you burned the midnight oil. But saving money early in your life matters. If you understand and adsorb this in your mind, half the battle is already won. Start with the thumbrules. Avoid bad debt Don’t get carried away and run into bad debt. So if you love credit cards and personal loans, it would be better if you love anything else except these. Both have been the single most reason for early savers to go down the drain. A huge debt will leave little money for you to save. And if you are paying the minimum on your credit card, God bless you. You need to avoid credit card debts and say no to personal loans. But the cause of bad debt is really the failure of investors, new or old, to differentiate between needs and wants. And discretionary and non discretionary expenses. Of all the clients that I have had, controlling expenses has been the biggest challenge always. Including mine ! You can become an expert on how to invest your money wisely but if you rake up bad loans, you will be anything but wise. Plan where you will spend your money I am of the firm belief that 99% of Indian households do not do budgeting. If you do not know what to track against, how will you ever control it ? What will be your benchmark ? So the first logical step is to assess your financial situation (and remember if you are a beginner you do not know what to assess !) and follow that up with budgeting. This is one of the most basic and often missed steps in financial planning – master this and you would have taken a significant step to know how to invest your money wisely. Budgeting is simply telling yourself that you are planning to spend your money for the next 1 year into some categories as below : Transportation (Auto EMI, Fuel, Cabs, Maintenance) Home (Groceries, Rent,Furniture, Maintenance, Misc Supplies) Utilities (Gas, Phone, Internet, Cable TV, Electricity etc) Heath (Doctor’s fees, Medicines etc) Entertainment (Eating out, movies, hobbies, music, vacation) Others (Gifts, Clothes, Donations) Then you track your actuals and see how you did against what you had planned earlier and make amends. Also, remember to save first, spend later. This is one of my favorites. Most of investors do it the other way round, they spend first and save whatever is left. However, the opposite is what should actually happen. That way, you will always end up spending on items you necessarily need and in the process save as well. Understand how much risk you can take Understanding how much risk you can take now is one of the most important step in understanding how to invest your money wisely. Risk depends on a lot of factors. Your age, where you work, how many people are dependent on you for their livelihood and what are the liabilities you have are some of the parameters. Your asset allocation is the holy grail to your investment philosophy and understanding how much risk you can take in life is a key part to that. Stick to your asset allocation and your risk matrix at all times. You will be safe than sorry. List down your financial goals Write down what you want o achieve...

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