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Learn to Earn
 Putting Your Money to Work for You
and becoming Financially Independent
In this Module we will Cover:
 1. Asset vs Liability          2. Active vs Passive Income 3. Magic of Compounding
  (Investment vs Consumption)        (Financial Independence)         (Start Young)




 4. Delayed Gratification                 5. Fear & Greed          6. Risk vs Reward
         (Learn Self-Control)               (Control Emotions)        (Risk Appetite)




                                    8.Your Intellectual          9. Risk Management
    7. Asset Classes
                                    Property - an Asset



  10. How to Invest                   11. Life Insurance         12. Financial Planning
1. Asset vs Liability         2. Active vs Passive Income 3. Magic of Compounding
    (Investment vs Consumption)        (Financial Independence)         (Start Young)




4. Delayed Gratification                 5. Fear & Greed             6. Risk vs Reward
     (Learn Self-Control)                   (Control Emotions)            (Risk Appetite)




                                      8. Your Intellectual         9. Risk Management
    7. Asset Classes
                                      Property - an Asset



  10. How to Invest                     11. Life Insurance        12. Financial Planning
So you have got a job - your own disposable income at
last... to blow as you please!
o

First Stop - Credit Card!
oo

Next - a swanky car!
But, will you be using your credit card for the convenience
and safety of not carrying too much cash around...
Or, will you use it for rolling credit?

I.e. borrow against your credit limit and then repay the
amount over months in easy installments
And, is your new, swanky car an asset or a liability
Let’s look at the credit card debt first...
Carrying a credit card debt, i.e. not clearing the balance on
your credit card every month and rolling the debt can be
very expensive
Cred
                              it Car
                           BILL d
                      Due
                                 : $1,0
                     Minim             00
                    Paym um
                         ent
                             :    $25




Say, you buy your much desired electronic gizmo for $1,000
with your credit card, because you know you can easily pay
the minimum amount due each month
Cred
                                       it Car
                                D
                                    BILL d
                                      ue
                                                  : $1,0
                              Minim                     00
                             Paym um
                                  ent
                                      :            $25
                             Fine p
                                   rint: A
                                           PR =
                                                  18%




The interest rate your credit card company charges is 18%
(some credit companies charge 36% or more)

And, the minimum amount you have to pay each month is $25
$1,
                                                       538
        $1,
           000




To get rid of your debt, it will take you 5 years

And you will pay an interest of $539

That is, the $1,000 electronic gizmo has cost you $1,539
Plus, chances are, your electronic gizmo will go out of fashion
within a year of purchase but you will have to keep paying for
four more years!
oo

How about the swanky car - is it an asset or a liability?
In the best-selling book,
    ‘Rich Dad Poor Dad’,
    author Robert Kiyosaki
e
    gives a very easy to
    understand definition of
    assets and liabilities...
Asset
                                         T
                                            $$
                                           $$
                                           $$



An ASSET is something that puts money in your pocket,
whether you work or not
(or you can think of asset as an investment - something that creates value)
$$
                                 $$ T
                                 $ $ Liability

A LIABILITY is something that takes money out of your pocket
(or you can think of liability as consumption - something that does not create value)
ts
                                                          stal lmen
                                               ont hly in
                                             M
                                        e
                                                   Fuel




                                             e
                   I LITY
              LIAB                                       ntenanc
                                                                 e
                                                     Mai




                                                   e
Viewed like this, your swanky new car is really a liability
because it takes money out of your pocket

       for the monthly installments you have to pay
       (assuming you took a loan to buy the car)

       cost of fuel and maintenance
Utility value?                       Convenience value?




You say, how about the utility value of the car - the fact
that you can reach office on time because you have a car?

Plus, its convenience value - no more struggling in public
transport?
Takes Money out of your Pocket                 Puts Money in your Pocket (indirectly)


                                        ents
                                  stallm
                          th ly in
                       Mon
                   e
                       e   Fuel
               Y                                Utility value?
          ILIT                       nance
                                                                        Convenience value?
    L IAB                      Mainte
                         e




What you have to see is the NET IMPACT
Does the car add more to your pocket than it takes away?
Takes Money out of your Pocket                    Puts Money in your Pocket (indirectly)

                                           ents
                                  stallm
                            ly in
                      Month
                  e
                      e   Fuel
              Y
         ILIT                        nance             Utility value?          Convenience value?
   L IAB                      Mainte
                          e




Consider: Do you really need a swanky car, primarily to
impress your friends? Can you not buy a second hand car
for utility and convenience?
Asset
             T
                $$
               $$
               $$            vs
                                      $$
                                     $$ T
                                     $ $ Liability
The first Building Block on Financial Literacy is being able to
distinguish between Assets and Liabilities

So that you invest in assets that put money in your pocket,
before you buy liabilities
Purchase swanky
                                                stuff from this income




                                        l
                              Earn Income


                     l
         Create Assets




Putting your money to work for you means:
 ✓ First creating assets that generate income
 ✓ Then, from the income of these assets, buying liabilities -
    non-income generating heart’s desires like jewellery, swanky car, posh house...
What are income generating assets?
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)           (Start Young)




4. Delayed Gratification                  5. Fear & Greed               6. Risk vs Reward
      (Learn Self-Control)                   (Control Emotions)            (Risk Appetite)




                                      8. Your Intellectual            9. Risk Management
    7. Asset Classes
                                      Property - an Asset



  10. How to Invest                     11. Life Insurance          12. Financial Planning
Some examples of income generating assets

   ✓ Stocks (shares of companies)

   ✓ Bonds (government or corporate)

   ✓ Art (paintings)

   ✓ Intellectual Property (book, song, music)

   ✓ Precious Metals (gold, silver)

   ✓ Real-Estate (provided it generates net income)
Incom
                                              e
                                       Asse
                                            t




You could argue that you yourself are an income generating
asset - after all, now that you have a job, you get a monthly
income!
Active Income     Passive Income
Your Job or
Business

                    Salary or
                    Income




 There are two types of income-streams
     ✓ Active Income stream: the salary you get from a job,
       or profits you earn if you are self-employed

     ✓ Passive Income stream: is the income your assets
       generate for you
The game, Monopoly,
k   reiterates some of these
    building blocks of
    financial literacy
Roll the dice > Complete a round >
                        b   Collect money


You earn income on completing one round of the board -
this is your Active Income because you have to work to
complete a round
Buy Property (asset) and
                           b
                               earn rent (passive income)




Once you have bought a property (asset) you start
earning Passive Income from rent (when a fellow player
lands on your property)
Build houses and hotels (more
                           b
                               assets) on your property and
                               increase your passive income




When you build houses and hotels (more assets) on a
group of properties your (rental) passive income increases
Your financial assets
                              keep you afloat




Financial Independence could be thought of as Financial
Survivability

That is, if you were to quit your job today how long could
you live, maintaining your desired lifestyle
Active Income when          Passive Income once
     you are working             you have retired




This is so because at some point in time you have to live
off your passive income stream

Mostly we think of this as retirement - say when you are
65 or 75 years old
Live on passive income     ...till you die!
Active Income when
                      once you have retired...
you are working




From that time on, till you die, you have to ensure that you
have enough passive income to live on, leading a lifestyle of
your choice (like a location of your liking, pursuing your
interests and hobbies like travel, good food...)
Need to live on passive income 20-30 years, or more



Given the advances we are making in healthcare, chances are
bright that you will live till you are 95
If you retire at 70, it implies that you need passive income
streams to support your desired lifestyle for another 25 years
Your assets need to generate an annual income commensurate
      with your desired lifestyle, for these 20-30 years

Say, you have decided that after retirement you will live in
Shangri-La (any place of your liking)

Adjusted for inflation, you calculate that you will need
$50,000 every year to live your desired lifestyle in Shangri-La

That is, for 25 years, from retirement till you die, you will
need a passive income stream of $50,000 every year
To generate $50,000 every year, for 25 years, you need
                  a kitty of at least half a million dollars


To make this come true, while you are working, you need to
put together assets that will generate $50,000 (and more, to meet
inflation) every year for 25 years

If your assets can generate 10% return per year, you need to
build a kitty of half a million dollars (you could dip into the kitty in the
last few years, but to keep calculation simple let’s assume that you want to leave the
kitty for your next of kin, or bequeath it to charities)
You want to quit your job and pursue
  You are 25                 other interests when you are 45...
  years old




Here’s a more delicious thought

Say you are 25 years old and you want to quit your job
by the time you are 45, so that you can pursue your
other interests, like fashion photography, amateur astronomy, travel...
You need assets that generate
                                adequate passive income streams to
                                sustain your lifestyle for 50 years...




If you can put together assets that will generate passive income
stream, adequate for you to lead your desired lifestyle from age
45 to age 95, you can go ahead and quit your job!
You think that’s day dreaming!
1. Asset vs Liability          2. Active vs Passive Income 3. Magic of Compounding
   (Investment vs Consumption)        (Financial Independence)        (Start Young)




4. Delayed Gratification                 5. Fear & Greed            6. Risk vs Reward
      (Learn Self-Control)                 (Control Emotions)           (Risk Appetite)




                                     8. Your Intellectual         9. Risk Management
    7. Asset Classes
                                     Property - an Asset



  10. How to Invest                    11. Life Insurance        12. Financial Planning
P e c u n ia
C o m p o u n d o .. .




Well, the Magic of Compounding is more powerful than
Harry Potter’s magic...
Invest $500 every month,   l
          starting at age 35
                                             @ 8% interest,
                                         b
                                             compounded annually




Let’s say that wisdom dawns on you when you are 35 years old

And you decide to invest $500 (or Rs 500) every month in assets
that generate 8% interest compounded annually (that is, you reinvest
the interest back into the asset)
b
              After 10 years you will have around $87,000



After 10 years (that is at age 45, when you want to retire), you will
have a kitty of around $87,000 (or Rs 87,000)
“That’s not enough to retire on!”, you say
Instead of 35, if you start at 20               l
(investing the $500 @ 8% compounded annually)




                                                    b
                                                At age 45 you will have over $435,000

  If you became wise at 20 years of age and decided to
  invest the same $500 at 8% interest compounded annually

  Then at 45, you will have a kitty of over $435,000
At age 20, if you invest Rs 2,000 a month   l
(@ 8% compounded annually)




                                                 b
                                            At age 45 you will have over Rs 175,000

 If, at age 20, you start investing $2,000 (or Rs 2,000) every month
 into the same assets...

 ...at age 45, if you have not taken out anything from this investment, you will
 have a kitty of over $1.75 million (or Rs 17.5 lakhs)!
The earlier you start the more the Magic of
Compounding works in your favour
D o l o r is
        M a x im u s .. .




When you don’t pay the full amount due on your credit card
every month and roll credit, the credit card companies use
the same Magic of Compounding to their advantage - for you
it becomes the Voldemort Magic of Compounding!
To be financially savvy you also need to understand
the concept of Delayed Gratification
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
 (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification               5. Fear & Greed               6. Risk vs Reward
       (Learn Self-Control)               (Control Emotions)             (Risk Appetite)




                                    8. Your Intellectual           9. Risk Management
  7. Asset Classes
                                    Property - an Asset



10. How to Invest                    11. Life Insurance           12. Financial Planning
You need to make sure you diligently and regularly invest in
assets, even when your friends are spending their money on
smart-phones, or swanky cars (remember they are liabilities because they
take money away from your pocket)
1.

                                   2.


                                   3.


You will too have have these mouth-watering liabilities but
you will buy them from the passive income stream your
assets generate after a while
1.
    1.
                           2.

    2.                                    Going from 1 to 2 to 3 is
                           3.             Delaying Gratification


This ability to overcome your impulse and delay buying
liabilities till you have invested in passive income generating
assets is Delayed Gratification
Let’s consider an example to better understand
the benefits of Delayed Gratification...
Person-A
                                           Salary / Income



                          Essential Expenses             Liabilities
                             (house rent, food)     (take money out from your pocket)




Let’s say Person-A and Person-B both earn 5,000 per month
(currency depends on where they are based)

Person-A spends all the salary on all sorts of liabilities - some
are essential expenses like house rent and food, but rest is
spent on branded watches, expensive jewelry and latest
electronic gizmos
Salary / Income
      Person-B


                        Essential Expenses             Assets
                         (house rent, food)       (put money into your pocket)
                                                        Share
                                                                Share




                                              Passive Income Stream
                                                (dividend, capital gain)

Person-B too spends part of the salary on house rent, food and
other essentials, but instead of buying a branded watch buys an
ordinary watch and invests 2,000 every month in an asset that
generates 8% interest compounded annually
After 5 years...
               Person-B              Passive Income = 1,000
                                 e




                                 e
                                     Assets = 140,000

In just 5 years, Person-B would have accumulated a kitty of
140,000, which will be generating a passive income stream of
around 1,000 every month
Person-B
                              Passive Income = 1,000
                          e               e




Person-B could then use some of this passive income to buy
branded jewellery, and electronic gizmos, still diligently
investing from the active income
While Person-A would not have built any asset (that is no
kitty) and will not be generating any passive income
Self-Discipline and Impulse Control

                 e are the keys to Delayed Gratification




This is Delayed Gratification - instead of satisfying your
desires immediately, you have enough self-discipline to
control your impulse and wait for gratification in the future
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification               5. Fear & Greed                 6. Risk vs Reward
      (Learn Self-Control)                (Control Emotions)               (Risk Appetite)




                                      8. Your Intellectual           9. Risk Management
    7. Asset Classes
                                      Property - an Asset



  10. How to Invest                    11. Life Insurance           12. Financial Planning
Desire




                                    i
           i




Uncontrolled desires usually end up as greed

On the other end of the spectrum lurks fear - fear that if
you invest in assets, you may lose all your money
k
                                   Stoc t
                                        e
                                   Mark ies
                                        ed
                                   Trag




This is especially true if you have been told, since you were a
kid, that investing in the stock markets is like gambling
Well, if you invest without doing any homework then it is
speculation

But if you invest in becoming financially literate, before you
invest in the stock market and understand how you can
manage risk, then it is not gambling
i           i
                                              Investing in Art
        Investing in Gold         i
                                   Investing in Own IPR

If you are still not comfortable with stock markets there are
other passive income yielding asset classes - like investing in
art, or investing in creating your own intellectual property
that result in passive income yielding assets (asset classes are
discussed later in this module)
What is important is that you understand the importance of
being self-aware and emotionally mature, when you put your
money to work

Neither fear nor greed should drive your financial decisions
Wall Street Predicted 9 out of 5 Recessions



                                              If you can keep your
                                              head when all about
                                              you are losing theirs...
   Double dip recession looms                       - from the poem‘If’ by Rudyard Kipling




You should not get swayed by emotions - when media blows
financial news beyond proportions and everybody around you is
losing their head - you must have the emotional maturity to
stick with your financial plan (financial planning is covered later in the module)
Conventional wisdom tells us to chase better paying jobs or
promotions

While higher income is welcome, what matters more is using
the higher salary to create assets not liabilities
REMEMBER

  A ‘non finance literate’ person does this...
    Your Job or
    Business
                                   Salary / Income



                  Essential Expenses             Liabilities
                     (house rent, food)     (take money out from your pocket)
A financially savvy person does this...
Your Job or
Business                    Salary / Income



              Essential Expenses             Assets
               (house rent, food)       (put money into your pocket)
                                              Share
                                                      Share




                                    Passive Income Stream                  part

                                      (dividend, capital gain)      par
                                                                       t

                                                                                  Liabilities
                                                                 (take money out from your pocket)
Let’s now turn to managing risk
Risk vs Reward
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification                 5. Fear & Greed              6. Risk vs Reward
      (Learn Self-Control)                  (Control Emotions)            (Risk Appetite)




                                      8. Your Intellectual           9. Risk Management
    7. Asset Classes
                                      Property - an Asset



  10. How to Invest                    11. Life Insurance           12. Financial Planning
Different passive income generating assets have varying
levels of risks...
Your Job or
Business
                             Salary / Income


              Essential Expenses          Assets
               (house rent, food)     (put money into your pocket)


                                    Option-1: Savings Bank Account
                                    (with a bank that your country’s Central Bank has guaranteed
                                    to support in case there is a run on your bank)

                                     ✓ You Deposit: $1,000

                                     ✓ Your Reward: interest rate of 2% per year

                                     ✓ Your Risk: none
                                            (if your bank fails the Central Bank has guaranteed to
                                            repay you; there is an inflation risk)
Your Job or
Business
                             Salary / Income


              Essential Expenses          Assets
               (house rent, food)     (put money into your pocket)



                                    Option-2: Lend money to a reputed
                                    Company (this is called investing in Bonds)

                                      ✓ You Lend: $1,000
                                      ✓ Your Reward: interest rate of 5% per year
                                      ✓ Your Risk: company could fail, but
                                           chances are low, so overall risk is low
Your Job or
Business
                             Salary / Income


              Essential Expenses          Assets
               (house rent, food)     (put money into your pocket)



                                    Option-3: Buy shares of a reputed company
                                    ✓ You Invest: $1,000
                                    ✓ Your Reward: company may pay dividend
                                       and/or its share price may rise - say this
                                       gives you a 10% return on your investment

                                    ✓ Your Risk: share markets are very volatile, so
                                       risk is higher than Bonds
Your Job or
Business
                             Salary / Income


              Essential Expenses           Assets
               (house rent, food)      (put money into your pocket)


                                    Option-4: Buy gold because you believe price
                                    of gold always rises

                                    ✓ You Invest: $1,000
                                    ✓ Your Reward: price of gold could go up by 15%
                                    ✓ Your Risk: price of gold could go down by 20%
                                       and because you needed money you sell it at
                                       the lower price and lose $200 of the principal
                                       amount
Your Job or
Business
                             Salary / Income


              Essential Expenses            Assets
               (house rent, food)       (put money into your pocket)


                                    Option-5: Give loan to a friend, who is starting
                                    a new internet company
                                     ✓ You Invest: $1,000
                                    ✓ Your Reward: your friend gives you a 5% stake in
                                       the company and according to his plans, your
                                       stake could grow a 100 times!
                                    ✓ Your Risk: the company may not survive and you
                                       could lose ALL your money
Let’s plot the risk and reward of various options
on a graph...
e       option-5: return = 100 times,
                                                                                            x
                                                                                                risk = very high




         30

         25
Reward




         20
                                         d
         15                                   x   option-4: return = 15%, risk = high


         10                 c
                                x   option-3: return = 10%, risk = low
                   b
         5          x   option-2: return = 5%, risk = low
              ax   option-1: return = 2%, risk = 0
         0
                                                     Risk
e x
                                                                                         option-5: return = 100 times,
                                                                                         risk = very high




              30

              25
     Reward


              20
              15                     d       option-4: return = 15%, risk = high
                                         x
              10           cx   option-3: return = 10%, risk = low
                   b
              5     x option-2: return = 5%, risk = low
               a x option-1: return = 2%, risk = 0
              0
                                             Risk
Risk and Reward
   Higher the Return you want, Greater the Risk you have
   to take
   What risk-reward combination you choose, depends on
   your particular circumstances
Risk Appetite



                              Age


Typically: younger you are, more your risk appetite

This is because when you are young you have more time to
make up for any losses you might make in high-risk, high-
return investments
You are 25 years old


                       Salary = $5,000 p.m.


                        You Save and Invest $10,000 in
                       high-risk, high-return investment


                                You lose it ALL!


                                                   You can save again because
                                                   you have many years of
                                                   active income left (and have
                                                   gained useful experience)
You are 25 years old
                                                           Since you are
                                                              young,
                       Salary = $5,000 p.m.
                                                         you also have the
                                                              Magic of
                         You Save and Invest $10,000 in  Compounding in
      ia               high-risk, high-return investment    your favour
Pe cun ndo...
      ou
C omp

                               You lose it ALL!


                                                  You can save again because
                                                  you have many years of
                                                  active income left (and have
                                                  gained useful experience)
But a person nearing retirement...


                        Salary = $15,000 p.m.


                           Saves and Invests $100,000 in
                         high-risk, high-return investment


                                     Loses it ALL!


                                                     Difficult to accumulate a
                                                     kitty again because not many
                                                     years of active income left
Building Blocks of Financial Literacy
we have looked at so far are...
Asset
                        T
                           $$
                          $$
                          $$



Assets: add money to your pocket
$$
                    $$ T
                    $ $ Liability

Liabilities: take money out of your pocket
Your Job or
                     Business




Active Income: is income you have to work for (like a job,
self-employment)
i           i
                                         Investing in Art
   Investing in Gold        i
                              Investing in Own IPR


Passive Income: is when your assets earn income for
you (i.e. when your money makes more money)
You are 25 years old
                                                                          Since you are
                              Salary = $5,000 p.m.                           young,
                                                                        you also have the
                                                                             Magic of
                                You Save and Invest $10,000 in          Compounding in
                               high-risk, high-return investment
          unia
       Pec oundo
                 ...                                                       your favour
           p
       Com

                                        You lose it ALL!


                                                           You can save again because you
                                                           have many years of active income
                                                           left (and have gained a very
                                                           important experience)



Start Young: because the younger you start, the better
the Magic of Compounding works
1.
     1.
                           2.

    2.                                   Going from 1 to 2 to 3 is
                           3.            Delaying Gratification



Learn Self-Control to Delay Gratification: don’t fall for peer
pressure, learn self-control so that you can defer gratification
e x
                                                                                             option-5: return = 100 times,
                                                                                             risk = very high




                 30

                 25
        Reward

                 20
                 15                      d       option-4: return = 15%, risk = high
                                             x
                 10           cx    option-3: return = 10%, risk = low
                       b
                 5      x  option-2: return = 5%, risk = low
                  a x option-1: return = 2%, risk = 0
                 0
                                                 Risk

Understand Risk vs Reward: higher the return you want,
greater the risk you have to take; typically, younger you are,
more your risk appetite
Let’s now turn to the Different Types of Assets
that generate passive income streams
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification                 5. Fear & Greed               6. Risk vs Reward
      (Learn Self-Control)                  (Control Emotions)             (Risk Appetite)




                                      8. Your Intellectual           9. Risk Management
     7. Asset Classes
                                      Property - an Asset



  10. How to Invest                    11. Life Insurance           12. Financial Planning
This is just a broad overview and not an exhaustive list of
different types of assets you can invest in
✓ Shares (or Stock)
✓ Bonds
✓ Real-Estate
✓ Commodities
✓ Art / Antiques
✓ Cash
✓ Your own Intellectual Property
Option-1: increase capital by
                    a company needs money          issuing more shares
                    to expand its business
                                                   Option-2: take a loan from
                                                   bank or from general public


When a company needs money for say, expanding its business,
it has two main options to raise funds
- Issue Shares (i.e. increase capital)
- Take Debt (e.g. take a loan from a bank, or take a loan from the general public)
Option-1: increase capital
         a company needs
                                      by issuing more shares
         money




                                                         i
         to expand its business




                                  If you think the company has good prospects you can
                                  buy its shares as one component in your assets basket


If a company is offering shares to raise capital and you like
the ‘story’ of the company (i.e. you believe the company will prosper in
future and give good returns), you can buy its shares or stock
(assuming it is a publicly traded company)
Option-2: take a loan from bank or
        a company needs             from general public
        money




                                                      i
        to expand its business




                                 If you believe the company will not go bankrupt and it
                                 is paying good interest on its debt, you can buy its Bonds

Or, if the company wants to raise debt by taking loans from
the general public, it issues Bonds

If you believe that the company will not go bust and will
return its debt, plus you like the interest rate it is offering,
you can buy its Bonds
Rate of Interest on Bonds is called ‘Coupon’ because Bonds used to have Coupons
attached to them that were like ‘IOU’ for the interest payable (I promise to pay the bearer...)


  Bonds are also called Fixed Income Assets because most
  bonds have a fixed interest rate (called Coupon) that is known
  upfront and a fixed date of maturity (when you get the principal
  amount back)

  Due to the relative certainty of returns corporate Bonds are
  considered lower risk than company Shares
Governments also issue bonds to raise funds

Government Bonds are considered risk-free because
governments can simply print more money to repay its debt
(though this has other negative ramifications like inflation)
x High Yield Bonds




                              Reward
                                                                      x Common Shares

                                                                x Preferred Shares


          Typical                                      x Company Bonds; Higher Return; more Risk

 Risk-Reward Relationship                    x Municipal (local government) Bonds

                                       x Government Bonds; Low Return; Zero Risk
   of Shares and Bonds

                                                                           Risk

Risk on shares is higher than in bonds because company
shares do not have an assured return and if the company goes
bankrupt shareholders are the last to get their money back
(after paying all other company debt like bank loans and bonds)
Real-Estate can be
    residential or commercial



Real-Estate: investing in real-estate, where the returns (i.e. rental
income and/or higher future value of the property), are higher than the
outflow (e.g. monthly installment, initial down payment and payments made), is
another asset class you can consider
Commodities

Commodities is yet another asset class you can invest in:
commodity is a raw-material that is hard to distinguish - for
example, gold mined in US or Africa is the same (silver, oil, corn,
wheat, copper are other examples of commodities)
Investing in Art:
                            h     buy master pieces,
                              or bet on upcoming artists h




Art as an Asset Class: if you can afford you can buy established
artists, or if you have a good eye you can bet on an upcoming
artist, or you can look for specialized funds that invest in art
A passion for collecting old coins, old stamps, old maps, or other antiques can also be
converted into a passive income generating activity
Sometimes Cash can indeed
        be the King!




Cash: you need to have liquidity (i.e. cash) so that you can
immediately buy an asset when a good opportunity comes along

Also, cash can be traded across currencies, though forex trade is
meant more for mature investors
Your Own Intellectual Property as an Asset
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification                 5. Fear & Greed               6. Risk vs Reward
      (Learn Self-Control)                  (Control Emotions)             (Risk Appetite)




                                    8. Your Intellectual             9. Risk Management
    7. Asset Classes
                                    Property - an Asset



  10. How to Invest                    11. Life Insurance           12. Financial Planning
My




                            m
                My A
                                           ooks




                       m
                      pps               eB
                            My V
                                ideos               Ship To
                                                  Google, Lulu,
                                                  Apple, Amazon




In the 21st century specialized knowledge has lot of value

Information technology has made packaging of such
knowledge into digital bits very easy - apps, books, podcast, videos

Digital distribution platforms like iTunes App Store, Amazon, Google
Books, iBookStore, Lulu, Create Space,YouTube... let you self-publish and
sell to a global audience
l
                             rty
         Intell ectual Prope
                   Inside




                                                       ©©©©©©©
                                        ®®®®®®
If you have specialised knowledge that can be packaged as
an Intellectual Property (hard intellectual property like a Patent, or soft
intellectual property like copyright), you should look at making it a
passive income generating asset
A soft IPR could be a book you write and self-publish on iBookStore, Amazon or
Google Books, or a music CD that you sell on Lulu or CreateSpace, or learning
content you sell online
create own digital IPR
                        0   1e                 e1
                                                  00
                    101                              101




This conversion of your specialised knowledge into an income
generating intellectual property can happen at any stage of your
life - when you are young (e.g. a music CD you cut), or when you have
retired (e.g. a book you self-publish on your life experiences)
own
             digit
                  al IP
                       R... 1
                                00
                                     101




                                                                        Stoc
                                                                    k Pr
                                                                ices




Invest in an asset class that interests you

What is most important is that you invest in asset classes in which
you have interest because only then will you enjoy spending time
learning about the domain and developing expertise
Only when you take a deep dive into a asset class do you develop enough competence to
invest prudently in that asset
Minimizing Risk of your Asset Portfolio
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification                 5. Fear & Greed               6. Risk vs Reward
      (Learn Self-Control)                  (Control Emotions)             (Risk Appetite)




                                      8. Your Intellectual          9. Risk Management
    7. Asset Classes
                                      Property - an Asset



  10. How to Invest                    11. Life Insurance           12. Financial Planning
Reward                                             x Company Shares and Commodities

                                             x
                                                 Real Estate

                                     x Art

                            x Company Bonds; Higher Return; more Risk



           x
               Cash at Bank and Government Bonds - Lowest Risk and Low Returns



                                                               Risk

Usually, these Asset Classes have the above Risk-Reward Profile
Objective: to Maximize Value of your Portfolio and Minimize its Risk


         For portfolio of ‘n’ independent
             assets, the risk or variance
                                             =     Standard Deviation
                                                                           =
                                                    Square Root of ‘n’



              more the number of ‘independent assets’ (i.e. different asset
        e classes) the higher the denominator and hence lower the portfolio risk



It is better to invest in different asset classes (shares, fixed income
bonds, real-estate, commodities...) so that you have a diversified portfolio
that minimizes risk
Even within a asset class you should prudently diversify - e.g. if you buy shares diversify
your share portfolio by buying shares of companies in developed markets as well as
emerging markets, or large caps and small caps
Buying a security regularly over a period
   of time averages out the cost




Cost Averaging
Trying to time the market, i.e. trying to predict the highs and
lows of a particular stock is never a good idea

You should instead spread your purchase over a period of time,
say over a few months, such that the total cost averages out
How to Invest in these Asset Classes?
Following is just an overview, in a subsequent module I will cover this topic in
more detail
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification                 5. Fear & Greed               6. Risk vs Reward
      (Learn Self-Control)                  (Control Emotions)             (Risk Appetite)




                                      8. Your Intellectual           9. Risk Management
    7. Asset Classes
                                      Property - an Asset



    10. How to Invest                  11. Life Insurance           12. Financial Planning
Valuation     Cash Flow

                      ll               RoE
                                              P/E
                                                      PEG


                                             EBITDA      DCF




Stock Picking: If you have the confidence that you can choose
the shares and bonds you want to invest in, by educating
yourself, then you can go ahead and trade yourself using a
broker or an online trading platform
“Not buy buy”, I said,
             e “Bye, bye!”




Stock Broker: you can trade in shares, bonds, mutual funds and
ETFs through a stock broker (or a sub-broker)

You need to find out the fee/commission, minimum investment
you have to make, non-trading fee and in case of sub-brokers,
their reputation
Online Financial Services Providers: you can also use online
trading platforms and money supermarkets
You need to compare the commission/fee structure, inactivity fee, what stock
exchanges does the online platform cover, reputation, whether they also provide
company research and reports...
Mutual Funds: If you are not so sure that you can choose
stocks and bonds yourself then you can look for an
appropriate Mutual Fund

Mutual Funds pool money from thousands of investors and
their professional managers buy stocks, bonds and other
securities (giving you a choice of asset classes)
There are many types of mutual funds - open-ended, close-ended, fixed-
income (invest in bonds only), equity/growth (invest in shares), large-caps (invest in
shares of large companies), mid-caps, smalls-caps

Mutual Funds thus offer a lot of choice on different types of
asset classes you want to invest in
You need to consider the costs involved in investing in
Mutual Funds (to compare different mutual funds consider their respective
‘expense ratios’)
     -   Cost of buying and selling shares of a mutual fund (called entry and exit
         load)
     -   Management/Administrative fee, which is a usually a fixed percentage
     -   Cost of buying and selling securities with-in the fund by the fund managers
         (called Turnover), which may incur additional charge of capital gains tax
Critics of Mutual Funds argue that the expenses of funds are
too high and eat into the investors’ return
S&P 500
      S&P 500
                                      Linked                          Investor
       Index
                                    Mutual Fund

                              e
                           Buys the shares in the S&P 500 Index


Index-Linked Mutual Funds: are mutual funds that simply
replicate an index - i.e. the portfolio of securities held in the
fund broadly match that of the index it is tracking
For example, an index-linked mutual fund could simply be tracking the S&P 500 index
(i.e. the fund will have all the securities included in the S&P 500 Index), or a Russell
2000 Index Fund will have own shares of small companies listed in the index, or the
MSCI Emerging Market Fund will have the emerging markets equities in the fund
dex
                       In ed
                        L ink al
                            utu
                         M nd
                            Fu




While it is a passive form of investing, given that most mutual
funds are expensive, fail to beat broad indexes, and for a
rookie investor picking own shares and bonds can be
expensive, Index-Linked Mutual fund offer a relatively safer
way to invest, with decent returns
Commodity               Listed in Stock Exchange
                                 ETF                        e

  e                                 e                       ETF
Underlying Asset                 ETF                                                Investor
 e                                  e                     Provider
          S&P 500                S&P 500
           Index                   ETF



   Exchange Traded Fund (ETF): is a fund that tracks an index, or a
   basket of assets, but trades like a stock on a stock exchange
   Only large players like a financial institutions can buy shares directly from the ETF, that
   too in bulk quantity, and then they in turn can sell to investors in smaller quantities in the
   open market
Large ETF




                                       Low Cost




The ETFs can be very large, yet have very low costs
Thus, the ETF does not have to keep funds aside (called float) to meet the daily buying
and selling needs and has more funds to invest than a mutual fund, they have lower
administrative costs and are passively managed (i.e, have lower management fee)
ETF
                                Some Risks Ahead



ETF Risks
A Physical ETF owns all or a selection of the asset it is based on (e.g. shares of
companies in the index it is tracking); a Swap-based or Synthetic ETF may not own
any of the underlying asset, instead it may be relying on a swap contract with third-
party at a future date

Synthetic ETF is thus subject to third-party solvency risk and if the third-party (with
whom the ETF has a swap contract) goes bankrupt you will lose some money (in
Europe, swap-based ETFs by law can only take 10% counter-party risk)

A physical ETF could also have a counter-party risk as it may be lending its stock to
third-party who may become insolvent and not in a position to give the stock back
Mind the Risk




Swap-based ETF is thought to be cause of scandal at UBS in Sept 2011 (when a rogue
trader led to a loss of over £1b for the bank though no individual investor lost money)

Experts point out that even Mutual Funds sometimes lend their stock and thus take on a
different type of counter-party risk (like physical ETFs)

ETFs have become very popular due to their simplicity, cost-effectiveness and ease of use

As an investor you need to do your homework well and find
out what risks your investment may be subject to
TF
                                                                Real -Estate E
        Real-Estate                                                              d
                    A  gent                            e         or M utual Fun



                           z
                                                        e
        Property Developer      e                               REIT



Real-Estate: you can buy and sell a property through a real-estate
agent, or buy in the primary market from a property developer
Or, you can invest in a Real Estate Investment Trust (REIT), which is a company that invests
in real estate and its shares are traded

Or, you can invest in a Real Estate Mutual Fund or Real-Estate Exchange Traded Fund (ETF)
Shares of co
            mpanies
producing c                                     Comm odity ETF
            om modities                     e


                          z
                              Commodities         Mutual
                                            e               Fund of
   Buy Gold or Silver     e                      Commod
                                                          ity Produ
                                                                    cers
                                                or Trade
                                                         rs


Commodities: for trading in commodities you can buy Mutual
Funds of companies dealing in commodities (producers or commodity
trading companies), or buy Exchange Traded Funds (ETF) whose
underlying asset is a particular commodity or a basket of
commodities, or purchase commodities like Gold or Silver
Life Insurance Overview
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)            (Start Young)




4. Delayed Gratification                 5. Fear & Greed               6. Risk vs Reward
      (Learn Self-Control)                  (Control Emotions)             (Risk Appetite)




                                      8. Your Intellectual           9. Risk Management
    7. Asset Classes
                                      Property - an Asset



  10. How to Invest                   11. Life Insurance            12. Financial Planning
“Insure all my nine lives
                                 e for the price of one, eh?”




Life Insurance is an agreement between you and an insurance
company, where you agree to pay a certain amount every year
(called premium) and the insurance company agrees to pay a certain
amount of money to a person of your choosing (called nominee or
beneficiary)
Life Insurance

                       f          g
                 Term Life           Whole Life




Life Insurance policies are broadly of two types - Term Life and
Whole Life

Besides death, a life insurance policy may also cover Total and
Permanent Disability (TPD)
nt
                                                               age     Low Premium
                                                          va




                                                    g
                                                    Ad
                           For a fixed duration
     Term Life
                     g     say 10 or 20 years     Di
                                                      g
                                                    sad
                                                      va
                                                         nt
                                                                       Coverage only for a
                                                               ag
                                                                   e
                                                                       fixed duration


In a Term Life Policy your insurance is valid for a fixed duration
only, say 10 or 20 years (you decide the duration based on your
circumstances) and you pay a fixed premium in those years

Premium depends on your age and risk profile - smoker or non-
smoker, nature of job - risky or non-risky, your health...
Term Life
                                       i.e. objective of Term Life is to give money to
         g
                                       your nominee/beneficiary in the event of
         Death benefit only
                                 g     your death - e.g. to repay a loan, or pay
                                       college fee for your children in case you die



In term insurance the death benefit (sum insured) is paid only if the
insured person dies before the policy expires (i.e. you don’t get back
any of the premium you have paid if you don’t die in the period for which you have term
insurance)

Think of it as paying insurance on your car and never meeting with an accident - which is
better than having an accident simply because you have insurance. Having term life
insurance but not dying is infinitely better than dying simply because you have insurance!
- Covered for life
                                          v  ant
                                                 age
                                                         - Death benefit + there may be




                                       g
                                       Ad
                                                            additional cash-in
 Whole Life         Lifelong cover
               g
                                     Di
                                         g
                                       sad
                                         va
                                            nt   ag
                                                     e   - Higher premium


In a Whole Life Policy your insurance covers you till you die and
there is usually a death benefit and an additional cash-in value

You pay a fixed premium (either all your life, or for a certain period) and the
premium you pay could be 3 to 10 times more than what you
pay in a Term Life policy
Critics of whole life policy say you
  Whole Life Policy Premium        could invest this difference
                                   yourself in assets that generate a
  - Term Life Policy Premium       higher return than the cash-
                 Difference        benefit given by a whole life policy



In a Whole Life policy, part of the premium you pay goes into
your death benefit and part is invested to generate a cash
value but critics say the returns generated in the cash-value
component are lower than what you get from investing this
amount yourself, especially given the administrative and other
overheads a insurance company has to pay for managing
investments to generate cash-value
Returns if you Invest    Return on Whole Life Policy




Advocates of Whole Life Insurance point out that the returns
on investments you make in the open market are too volatile
and hence may be lower than the guaranteed benefits whole
life policies offer

There may also be tax advantages of Whole Life policies
Term Life Insurance
 Insura nce Multiple
 Cho ice Test
                                             Whole Life Insurance

                               f...          Universal Life Insurance
              ro s an d cons o
   Write the p
                                             Variable Universal Life Insurance

                                             Indexed Universal Life Insurance



Newer type of whole-life policies, called Universal Life and
Variable Universal Life are also becoming popular
They offer more flexible premium plans and allow you some choice on how the cash-
value part of the premium should be invested
How to decide on a Life Insurance Policy?
You need to ask yourself 3 Questions?

     -   Do I need an insurance policy?
     -   How much insurance do I need?
     -   What type of insurance policy should I buy?
o
                     How will I pay
                     for the baby’s
                     education...




1. Do I need an insurance policy?
If there is someone financially dependent on you, or will suffer
financially if you were to die then you will be better off with life
insurance
E.g. your parents, spouse or children totally depend on you because you are the sole or
main income earner in your family; or, you have taken a house on mortgage and if you
were to die no one else in your family can pay the monthly installments
e
                               Mortgag




                                           School
                                            Fee


                                           Credit
                                            Card
                                           Debt

                                       Medica
                                             l




2. How much insurance do I need?
You need to figure out your family’s financial needs - current
expenses like family living expenses, medical costs, loans and debts you have and impact of
inflation on these expenses; future expenses like your children’s college education, or
your own post-retirement financial needs
Sources of Funds      Financial Needs

               • Spouses Income     • Mortgage
               • Your Savings       • School Fee
               • Your Investments   • Credit Card Debt
                                    • Medical Expenses

You then need to figure out what all sources of funds you have
to meet these financial needs - like your spouse’s income, your
savings and investments and returns they will generate
Your Family’s Financial Needs - Your Current Sources of Funds
                     = Life Insurance Required




To cover the difference between your family’s current and
future financial needs and sources of funds available, you need
insurance
Sources of Funds                 Financial Needs
                                                                                   vered
                                                         Mortgage expense is not co
            • Spouses Income              • Mortgage l                       d

                                                                  Term Life Insurance that
            • Your Savings                • School Fee
                                                                  pays the mortgage in the
            • Your Investments            • Credit Card Debt      event of your death may
                                                                   be the best option
       Your funds cover these ex l
                                 penses   • Medical Expenses

3. What type of Life Insurance Policy?
This depends on how long you want the insurance for and how
much money do you have for the premium payment?
E.g. your spouse’s income covers most of your family’s expenses but does not cover a 15-
year mortgage you have on your house. In this case you may take a term life insurance
policy for 15 years such that in the event of your death your insurance cover is adequate
to pay off the outstanding mortgage.
Disposable
                          Income          You need to see if you can
                                          afford the higher premium
                                     e on whole life policies




If your budget for paying insurance premium is low (given that whole
life and universal life insurance premiums are significantly higher) your best bet
would be term life insurance
You must shop around for the right insurance policy for you,
compare the pros and cons, insurance agents get a trailing commission and
you may be able to negotiate better terms (like cash back on your premium)

Depending on your circumstances you may opt for term life,
whole life, or a mix of the two (i.e. put a low percentage of your total
portfolio/budget into whole life policy, if you can afford it)
You should also consider taking insurance for
  ✓ Your health (medical insurance)

  ✓   Your mortgage
  ✓   Your income
  ✓   Your investments (e.g. physical assets like art, or old coin collection,
      valuable stamp collection)
Creating a Financial Plan
Bringing it all together
1. Asset vs Liability          2. Active vs Passive Income      3. Magic of Compounding
   (Investment vs Consumption)         (Financial Independence)           (Start Young)




4. Delayed Gratification                 5. Fear & Greed               6. Risk vs Reward
      (Learn Self-Control)                  (Control Emotions)            (Risk Appetite)




                                      8. Your Intellectual           9. Risk Management
    7. Asset Classes
                                      Property - an Asset



  10. How to Invest                    11. Life Insurance         12. Financial Planning
Financial Plan

                                           Risk
                                       e
                                                        Destination




                         Quantum
                                                    x
                                       e
                                           Return
                                    Time


A Financial Plan helps you get from where you are to where
you want to go, in a given time-period, with as little risk as
possible
E.g. if you are 25 you may want to plan for life phases soon to come, like further
education, or early retirement, or marriage, perhaps children, their education, what
happens to your spouse, children and other dependents like your parents if you were
to meet with a permanent disability or death
Plan
Evaluate        Budget          Invest          Protect        Plan      Review
Evaluate        Budget          Invest          Protect     Retirement
                                                            Retirement   Review



                               Financial Planning
                                Financial Planning



Step-1: Evaluation
Evaluate your current financial position - your income, your
expenses, your savings, your investments, tax you pay...
Write down your life aspirations - generate passive income stream, buy
a car, buy a house, get married, plan early retirement...
Plan
Evaluate      Budget          Invest        Protect       Retirement      Review



                             Financial Planning


Step-2: Budgeting
   ✓ Are your expenses lower or higher than your income?

   ✓ What expenses can you prune to create a Surplus (or savings)?

   ✓ Even if you start small you must start creating a surplus

Besides creating assets (or investments) that generate passive income stream from
the surplus, you may also consider creating a Emergency Fund, which will provide
you liquidity, and more importantly, peace of mind
Plan
Evaluate   Budget     Invest     Protect    Retirement   Review



                      Financial Planning

Step-3: Investing

As we have discussed earlier in this module, financial
savviness is really about creating assets or investments that
generate passive income streams

What type of assets should you invest in depends on your
life situation and your risk appetite
Plan
Evaluate     Budget       Invest       Protect     Retirement       Review



                          Financial Planning


Step-4: Protection
   ✓ Is your income protected? Are your investments protected? Is
      your house protected?

   ✓ Are people who are financially dependent on you protected in
      case something were to happen to you (death or disability)?

   ✓ This will help you determine your insurance needs (also see
     section on Insurance)
Plan
 Evaluate        Budget          Invest        Protect       Retirement       Review



                                Financial Planning


Step-5: Think about Retirement or Early Retirement

How many years before you retire? (when your active income stream will
cease and you will need to live your desired lifestyle only on your passive income stream)

Also think about Estate Planning (what will happen to your assets once you
are no more - who will get what); or, if you want to give away your wealth, think about
options
Plan
   Evaluate       Budget         Invest        Protect       Retirement     Review



                                Financial Planning           Write a Will




Write a Will: so that your wishes and not the government policy
determines what happens when you die; this also includes making it clear
who should look after your young children if anything were to happen to both you and
your spouse
Plan
Evaluate    Budget     Invest     Protect   Retirement   Review



                      Financial Planning


Step-6: Review Regularly

At least once a year review your financial plan to see if your
investments are optimal, has the risk-reward equation
changed, have your personal circumstances changed...

Reallocate the fund deployment in your portfolio accordingly
RECAP: We Covered...
 1. Asset vs Liability         2. Active vs Passive Income 3. Magic of Compounding
 (Investment vs Consumption)        (Financial Independence)         (Start Young)




4. Delayed Gratification                 5. Fear & Greed          6. Risk vs Reward
        (Learn Self-Control)               (Control Emotions)        (Risk Appetite)




                                   8.Your Intellectual          9. Risk Management
   7. Asset Classes
                                   Property - an Asset



 10. How to Invest                   11. Life Insurance         12. Financial Planning
But remember the adage...

Money Doesn’t Buy Happiness




                            For more on Happiness and Well-
                            Being, check out the modules in
                       g
                            the section ‘Learning to Be’ -
                            http://timelesslifeskills.co.uk/
                            learn-to-be
Good Reads and Resources
 • ‘Rich Dad Poor Dad’ - Robert T. Kiyosaki
 • ‘Learn to Earn’ - Peter Lynch
 • Khan Academy Videos on Finance, especially the ‘Finance’ and
   ‘Valuation and Investing’ playlists - http://www.khanacademy.org/

 • Learning Markets videos
   - http://www.learningmarkets.com/videos-and-courses/

 • Yale course on ‘Financial Markets‘
   - http://academicearth.org/courses/financial-markets

 • More video resources are listed here
   - http://www.diigo.com/list/atulpant/financialliteracy
Author & Illustrator

    Atul Pant

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Learn to Earn

  • 1. Learn to Earn Putting Your Money to Work for You and becoming Financially Independent
  • 2. In this Module we will Cover: 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8.Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 3. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 4. So you have got a job - your own disposable income at last... to blow as you please!
  • 5. o First Stop - Credit Card!
  • 6. oo Next - a swanky car!
  • 7. But, will you be using your credit card for the convenience and safety of not carrying too much cash around...
  • 8. Or, will you use it for rolling credit? I.e. borrow against your credit limit and then repay the amount over months in easy installments
  • 9. And, is your new, swanky car an asset or a liability
  • 10. Let’s look at the credit card debt first...
  • 11. Carrying a credit card debt, i.e. not clearing the balance on your credit card every month and rolling the debt can be very expensive
  • 12. Cred it Car BILL d Due : $1,0 Minim 00 Paym um ent : $25 Say, you buy your much desired electronic gizmo for $1,000 with your credit card, because you know you can easily pay the minimum amount due each month
  • 13. Cred it Car D BILL d ue : $1,0 Minim 00 Paym um ent : $25 Fine p rint: A PR = 18% The interest rate your credit card company charges is 18% (some credit companies charge 36% or more) And, the minimum amount you have to pay each month is $25
  • 14. $1, 538 $1, 000 To get rid of your debt, it will take you 5 years And you will pay an interest of $539 That is, the $1,000 electronic gizmo has cost you $1,539
  • 15. Plus, chances are, your electronic gizmo will go out of fashion within a year of purchase but you will have to keep paying for four more years!
  • 16. oo How about the swanky car - is it an asset or a liability?
  • 17. In the best-selling book, ‘Rich Dad Poor Dad’, author Robert Kiyosaki e gives a very easy to understand definition of assets and liabilities...
  • 18. Asset T $$ $$ $$ An ASSET is something that puts money in your pocket, whether you work or not (or you can think of asset as an investment - something that creates value)
  • 19. $$ $$ T $ $ Liability A LIABILITY is something that takes money out of your pocket (or you can think of liability as consumption - something that does not create value)
  • 20. ts stal lmen ont hly in M e Fuel e I LITY LIAB ntenanc e Mai e Viewed like this, your swanky new car is really a liability because it takes money out of your pocket for the monthly installments you have to pay (assuming you took a loan to buy the car) cost of fuel and maintenance
  • 21. Utility value? Convenience value? You say, how about the utility value of the car - the fact that you can reach office on time because you have a car? Plus, its convenience value - no more struggling in public transport?
  • 22. Takes Money out of your Pocket Puts Money in your Pocket (indirectly) ents stallm th ly in Mon e e Fuel Y Utility value? ILIT nance Convenience value? L IAB Mainte e What you have to see is the NET IMPACT Does the car add more to your pocket than it takes away?
  • 23. Takes Money out of your Pocket Puts Money in your Pocket (indirectly) ents stallm ly in Month e e Fuel Y ILIT nance Utility value? Convenience value? L IAB Mainte e Consider: Do you really need a swanky car, primarily to impress your friends? Can you not buy a second hand car for utility and convenience?
  • 24. Asset T $$ $$ $$ vs $$ $$ T $ $ Liability The first Building Block on Financial Literacy is being able to distinguish between Assets and Liabilities So that you invest in assets that put money in your pocket, before you buy liabilities
  • 25. Purchase swanky stuff from this income l Earn Income l Create Assets Putting your money to work for you means: ✓ First creating assets that generate income ✓ Then, from the income of these assets, buying liabilities - non-income generating heart’s desires like jewellery, swanky car, posh house...
  • 26. What are income generating assets?
  • 27. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 28. Some examples of income generating assets ✓ Stocks (shares of companies) ✓ Bonds (government or corporate) ✓ Art (paintings) ✓ Intellectual Property (book, song, music) ✓ Precious Metals (gold, silver) ✓ Real-Estate (provided it generates net income)
  • 29. Incom e Asse t You could argue that you yourself are an income generating asset - after all, now that you have a job, you get a monthly income!
  • 30. Active Income Passive Income Your Job or Business Salary or Income There are two types of income-streams ✓ Active Income stream: the salary you get from a job, or profits you earn if you are self-employed ✓ Passive Income stream: is the income your assets generate for you
  • 31. The game, Monopoly, k reiterates some of these building blocks of financial literacy
  • 32. Roll the dice > Complete a round > b Collect money You earn income on completing one round of the board - this is your Active Income because you have to work to complete a round
  • 33. Buy Property (asset) and b earn rent (passive income) Once you have bought a property (asset) you start earning Passive Income from rent (when a fellow player lands on your property)
  • 34. Build houses and hotels (more b assets) on your property and increase your passive income When you build houses and hotels (more assets) on a group of properties your (rental) passive income increases
  • 35. Your financial assets keep you afloat Financial Independence could be thought of as Financial Survivability That is, if you were to quit your job today how long could you live, maintaining your desired lifestyle
  • 36. Active Income when Passive Income once you are working you have retired This is so because at some point in time you have to live off your passive income stream Mostly we think of this as retirement - say when you are 65 or 75 years old
  • 37. Live on passive income ...till you die! Active Income when once you have retired... you are working From that time on, till you die, you have to ensure that you have enough passive income to live on, leading a lifestyle of your choice (like a location of your liking, pursuing your interests and hobbies like travel, good food...)
  • 38. Need to live on passive income 20-30 years, or more Given the advances we are making in healthcare, chances are bright that you will live till you are 95 If you retire at 70, it implies that you need passive income streams to support your desired lifestyle for another 25 years
  • 39. Your assets need to generate an annual income commensurate with your desired lifestyle, for these 20-30 years Say, you have decided that after retirement you will live in Shangri-La (any place of your liking) Adjusted for inflation, you calculate that you will need $50,000 every year to live your desired lifestyle in Shangri-La That is, for 25 years, from retirement till you die, you will need a passive income stream of $50,000 every year
  • 40. To generate $50,000 every year, for 25 years, you need a kitty of at least half a million dollars To make this come true, while you are working, you need to put together assets that will generate $50,000 (and more, to meet inflation) every year for 25 years If your assets can generate 10% return per year, you need to build a kitty of half a million dollars (you could dip into the kitty in the last few years, but to keep calculation simple let’s assume that you want to leave the kitty for your next of kin, or bequeath it to charities)
  • 41. You want to quit your job and pursue You are 25 other interests when you are 45... years old Here’s a more delicious thought Say you are 25 years old and you want to quit your job by the time you are 45, so that you can pursue your other interests, like fashion photography, amateur astronomy, travel...
  • 42. You need assets that generate adequate passive income streams to sustain your lifestyle for 50 years... If you can put together assets that will generate passive income stream, adequate for you to lead your desired lifestyle from age 45 to age 95, you can go ahead and quit your job!
  • 43. You think that’s day dreaming!
  • 44. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 45. P e c u n ia C o m p o u n d o .. . Well, the Magic of Compounding is more powerful than Harry Potter’s magic...
  • 46. Invest $500 every month, l starting at age 35 @ 8% interest, b compounded annually Let’s say that wisdom dawns on you when you are 35 years old And you decide to invest $500 (or Rs 500) every month in assets that generate 8% interest compounded annually (that is, you reinvest the interest back into the asset)
  • 47. b After 10 years you will have around $87,000 After 10 years (that is at age 45, when you want to retire), you will have a kitty of around $87,000 (or Rs 87,000)
  • 48. “That’s not enough to retire on!”, you say
  • 49. Instead of 35, if you start at 20 l (investing the $500 @ 8% compounded annually) b At age 45 you will have over $435,000 If you became wise at 20 years of age and decided to invest the same $500 at 8% interest compounded annually Then at 45, you will have a kitty of over $435,000
  • 50. At age 20, if you invest Rs 2,000 a month l (@ 8% compounded annually) b At age 45 you will have over Rs 175,000 If, at age 20, you start investing $2,000 (or Rs 2,000) every month into the same assets... ...at age 45, if you have not taken out anything from this investment, you will have a kitty of over $1.75 million (or Rs 17.5 lakhs)!
  • 51. The earlier you start the more the Magic of Compounding works in your favour
  • 52. D o l o r is M a x im u s .. . When you don’t pay the full amount due on your credit card every month and roll credit, the credit card companies use the same Magic of Compounding to their advantage - for you it becomes the Voldemort Magic of Compounding!
  • 53. To be financially savvy you also need to understand the concept of Delayed Gratification
  • 54. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 55. You need to make sure you diligently and regularly invest in assets, even when your friends are spending their money on smart-phones, or swanky cars (remember they are liabilities because they take money away from your pocket)
  • 56. 1. 2. 3. You will too have have these mouth-watering liabilities but you will buy them from the passive income stream your assets generate after a while
  • 57. 1. 1. 2. 2. Going from 1 to 2 to 3 is 3. Delaying Gratification This ability to overcome your impulse and delay buying liabilities till you have invested in passive income generating assets is Delayed Gratification
  • 58. Let’s consider an example to better understand the benefits of Delayed Gratification...
  • 59. Person-A Salary / Income Essential Expenses Liabilities (house rent, food) (take money out from your pocket) Let’s say Person-A and Person-B both earn 5,000 per month (currency depends on where they are based) Person-A spends all the salary on all sorts of liabilities - some are essential expenses like house rent and food, but rest is spent on branded watches, expensive jewelry and latest electronic gizmos
  • 60. Salary / Income Person-B Essential Expenses Assets (house rent, food) (put money into your pocket) Share Share Passive Income Stream (dividend, capital gain) Person-B too spends part of the salary on house rent, food and other essentials, but instead of buying a branded watch buys an ordinary watch and invests 2,000 every month in an asset that generates 8% interest compounded annually
  • 61. After 5 years... Person-B Passive Income = 1,000 e e Assets = 140,000 In just 5 years, Person-B would have accumulated a kitty of 140,000, which will be generating a passive income stream of around 1,000 every month
  • 62. Person-B Passive Income = 1,000 e e Person-B could then use some of this passive income to buy branded jewellery, and electronic gizmos, still diligently investing from the active income
  • 63. While Person-A would not have built any asset (that is no kitty) and will not be generating any passive income
  • 64. Self-Discipline and Impulse Control e are the keys to Delayed Gratification This is Delayed Gratification - instead of satisfying your desires immediately, you have enough self-discipline to control your impulse and wait for gratification in the future
  • 65. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 66. Desire i i Uncontrolled desires usually end up as greed On the other end of the spectrum lurks fear - fear that if you invest in assets, you may lose all your money
  • 67. k Stoc t e Mark ies ed Trag This is especially true if you have been told, since you were a kid, that investing in the stock markets is like gambling
  • 68. Well, if you invest without doing any homework then it is speculation But if you invest in becoming financially literate, before you invest in the stock market and understand how you can manage risk, then it is not gambling
  • 69. i i Investing in Art Investing in Gold i Investing in Own IPR If you are still not comfortable with stock markets there are other passive income yielding asset classes - like investing in art, or investing in creating your own intellectual property that result in passive income yielding assets (asset classes are discussed later in this module)
  • 70. What is important is that you understand the importance of being self-aware and emotionally mature, when you put your money to work Neither fear nor greed should drive your financial decisions
  • 71. Wall Street Predicted 9 out of 5 Recessions If you can keep your head when all about you are losing theirs... Double dip recession looms - from the poem‘If’ by Rudyard Kipling You should not get swayed by emotions - when media blows financial news beyond proportions and everybody around you is losing their head - you must have the emotional maturity to stick with your financial plan (financial planning is covered later in the module)
  • 72. Conventional wisdom tells us to chase better paying jobs or promotions While higher income is welcome, what matters more is using the higher salary to create assets not liabilities
  • 73. REMEMBER A ‘non finance literate’ person does this... Your Job or Business Salary / Income Essential Expenses Liabilities (house rent, food) (take money out from your pocket)
  • 74. A financially savvy person does this... Your Job or Business Salary / Income Essential Expenses Assets (house rent, food) (put money into your pocket) Share Share Passive Income Stream part (dividend, capital gain) par t Liabilities (take money out from your pocket)
  • 75. Let’s now turn to managing risk Risk vs Reward
  • 76. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 77. Different passive income generating assets have varying levels of risks...
  • 78. Your Job or Business Salary / Income Essential Expenses Assets (house rent, food) (put money into your pocket) Option-1: Savings Bank Account (with a bank that your country’s Central Bank has guaranteed to support in case there is a run on your bank) ✓ You Deposit: $1,000 ✓ Your Reward: interest rate of 2% per year ✓ Your Risk: none (if your bank fails the Central Bank has guaranteed to repay you; there is an inflation risk)
  • 79. Your Job or Business Salary / Income Essential Expenses Assets (house rent, food) (put money into your pocket) Option-2: Lend money to a reputed Company (this is called investing in Bonds) ✓ You Lend: $1,000 ✓ Your Reward: interest rate of 5% per year ✓ Your Risk: company could fail, but chances are low, so overall risk is low
  • 80. Your Job or Business Salary / Income Essential Expenses Assets (house rent, food) (put money into your pocket) Option-3: Buy shares of a reputed company ✓ You Invest: $1,000 ✓ Your Reward: company may pay dividend and/or its share price may rise - say this gives you a 10% return on your investment ✓ Your Risk: share markets are very volatile, so risk is higher than Bonds
  • 81. Your Job or Business Salary / Income Essential Expenses Assets (house rent, food) (put money into your pocket) Option-4: Buy gold because you believe price of gold always rises ✓ You Invest: $1,000 ✓ Your Reward: price of gold could go up by 15% ✓ Your Risk: price of gold could go down by 20% and because you needed money you sell it at the lower price and lose $200 of the principal amount
  • 82. Your Job or Business Salary / Income Essential Expenses Assets (house rent, food) (put money into your pocket) Option-5: Give loan to a friend, who is starting a new internet company ✓ You Invest: $1,000 ✓ Your Reward: your friend gives you a 5% stake in the company and according to his plans, your stake could grow a 100 times! ✓ Your Risk: the company may not survive and you could lose ALL your money
  • 83. Let’s plot the risk and reward of various options on a graph...
  • 84. e option-5: return = 100 times, x risk = very high 30 25 Reward 20 d 15 x option-4: return = 15%, risk = high 10 c x option-3: return = 10%, risk = low b 5 x option-2: return = 5%, risk = low ax option-1: return = 2%, risk = 0 0 Risk
  • 85. e x option-5: return = 100 times, risk = very high 30 25 Reward 20 15 d option-4: return = 15%, risk = high x 10 cx option-3: return = 10%, risk = low b 5 x option-2: return = 5%, risk = low a x option-1: return = 2%, risk = 0 0 Risk Risk and Reward Higher the Return you want, Greater the Risk you have to take What risk-reward combination you choose, depends on your particular circumstances
  • 86. Risk Appetite Age Typically: younger you are, more your risk appetite This is because when you are young you have more time to make up for any losses you might make in high-risk, high- return investments
  • 87. You are 25 years old Salary = $5,000 p.m. You Save and Invest $10,000 in high-risk, high-return investment You lose it ALL! You can save again because you have many years of active income left (and have gained useful experience)
  • 88. You are 25 years old Since you are young, Salary = $5,000 p.m. you also have the Magic of You Save and Invest $10,000 in Compounding in ia high-risk, high-return investment your favour Pe cun ndo... ou C omp You lose it ALL! You can save again because you have many years of active income left (and have gained useful experience)
  • 89. But a person nearing retirement... Salary = $15,000 p.m. Saves and Invests $100,000 in high-risk, high-return investment Loses it ALL! Difficult to accumulate a kitty again because not many years of active income left
  • 90. Building Blocks of Financial Literacy we have looked at so far are...
  • 91. Asset T $$ $$ $$ Assets: add money to your pocket
  • 92. $$ $$ T $ $ Liability Liabilities: take money out of your pocket
  • 93. Your Job or Business Active Income: is income you have to work for (like a job, self-employment)
  • 94. i i Investing in Art Investing in Gold i Investing in Own IPR Passive Income: is when your assets earn income for you (i.e. when your money makes more money)
  • 95. You are 25 years old Since you are Salary = $5,000 p.m. young, you also have the Magic of You Save and Invest $10,000 in Compounding in high-risk, high-return investment unia Pec oundo ... your favour p Com You lose it ALL! You can save again because you have many years of active income left (and have gained a very important experience) Start Young: because the younger you start, the better the Magic of Compounding works
  • 96. 1. 1. 2. 2. Going from 1 to 2 to 3 is 3. Delaying Gratification Learn Self-Control to Delay Gratification: don’t fall for peer pressure, learn self-control so that you can defer gratification
  • 97. e x option-5: return = 100 times, risk = very high 30 25 Reward 20 15 d option-4: return = 15%, risk = high x 10 cx option-3: return = 10%, risk = low b 5 x option-2: return = 5%, risk = low a x option-1: return = 2%, risk = 0 0 Risk Understand Risk vs Reward: higher the return you want, greater the risk you have to take; typically, younger you are, more your risk appetite
  • 98. Let’s now turn to the Different Types of Assets that generate passive income streams
  • 99. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 100. This is just a broad overview and not an exhaustive list of different types of assets you can invest in
  • 101. ✓ Shares (or Stock) ✓ Bonds ✓ Real-Estate ✓ Commodities ✓ Art / Antiques ✓ Cash ✓ Your own Intellectual Property
  • 102. Option-1: increase capital by a company needs money issuing more shares to expand its business Option-2: take a loan from bank or from general public When a company needs money for say, expanding its business, it has two main options to raise funds - Issue Shares (i.e. increase capital) - Take Debt (e.g. take a loan from a bank, or take a loan from the general public)
  • 103. Option-1: increase capital a company needs by issuing more shares money i to expand its business If you think the company has good prospects you can buy its shares as one component in your assets basket If a company is offering shares to raise capital and you like the ‘story’ of the company (i.e. you believe the company will prosper in future and give good returns), you can buy its shares or stock (assuming it is a publicly traded company)
  • 104. Option-2: take a loan from bank or a company needs from general public money i to expand its business If you believe the company will not go bankrupt and it is paying good interest on its debt, you can buy its Bonds Or, if the company wants to raise debt by taking loans from the general public, it issues Bonds If you believe that the company will not go bust and will return its debt, plus you like the interest rate it is offering, you can buy its Bonds
  • 105. Rate of Interest on Bonds is called ‘Coupon’ because Bonds used to have Coupons attached to them that were like ‘IOU’ for the interest payable (I promise to pay the bearer...) Bonds are also called Fixed Income Assets because most bonds have a fixed interest rate (called Coupon) that is known upfront and a fixed date of maturity (when you get the principal amount back) Due to the relative certainty of returns corporate Bonds are considered lower risk than company Shares
  • 106. Governments also issue bonds to raise funds Government Bonds are considered risk-free because governments can simply print more money to repay its debt (though this has other negative ramifications like inflation)
  • 107. x High Yield Bonds Reward x Common Shares x Preferred Shares Typical x Company Bonds; Higher Return; more Risk Risk-Reward Relationship x Municipal (local government) Bonds x Government Bonds; Low Return; Zero Risk of Shares and Bonds Risk Risk on shares is higher than in bonds because company shares do not have an assured return and if the company goes bankrupt shareholders are the last to get their money back (after paying all other company debt like bank loans and bonds)
  • 108. Real-Estate can be residential or commercial Real-Estate: investing in real-estate, where the returns (i.e. rental income and/or higher future value of the property), are higher than the outflow (e.g. monthly installment, initial down payment and payments made), is another asset class you can consider
  • 109. Commodities Commodities is yet another asset class you can invest in: commodity is a raw-material that is hard to distinguish - for example, gold mined in US or Africa is the same (silver, oil, corn, wheat, copper are other examples of commodities)
  • 110. Investing in Art: h buy master pieces, or bet on upcoming artists h Art as an Asset Class: if you can afford you can buy established artists, or if you have a good eye you can bet on an upcoming artist, or you can look for specialized funds that invest in art A passion for collecting old coins, old stamps, old maps, or other antiques can also be converted into a passive income generating activity
  • 111. Sometimes Cash can indeed be the King! Cash: you need to have liquidity (i.e. cash) so that you can immediately buy an asset when a good opportunity comes along Also, cash can be traded across currencies, though forex trade is meant more for mature investors
  • 112. Your Own Intellectual Property as an Asset
  • 113. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 114. My m My A ooks m pps eB My V ideos Ship To Google, Lulu, Apple, Amazon In the 21st century specialized knowledge has lot of value Information technology has made packaging of such knowledge into digital bits very easy - apps, books, podcast, videos Digital distribution platforms like iTunes App Store, Amazon, Google Books, iBookStore, Lulu, Create Space,YouTube... let you self-publish and sell to a global audience
  • 115. l rty Intell ectual Prope Inside ©©©©©©© ®®®®®® If you have specialised knowledge that can be packaged as an Intellectual Property (hard intellectual property like a Patent, or soft intellectual property like copyright), you should look at making it a passive income generating asset A soft IPR could be a book you write and self-publish on iBookStore, Amazon or Google Books, or a music CD that you sell on Lulu or CreateSpace, or learning content you sell online
  • 116. create own digital IPR 0 1e e1 00 101 101 This conversion of your specialised knowledge into an income generating intellectual property can happen at any stage of your life - when you are young (e.g. a music CD you cut), or when you have retired (e.g. a book you self-publish on your life experiences)
  • 117. own digit al IP R... 1 00 101 Stoc k Pr ices Invest in an asset class that interests you What is most important is that you invest in asset classes in which you have interest because only then will you enjoy spending time learning about the domain and developing expertise Only when you take a deep dive into a asset class do you develop enough competence to invest prudently in that asset
  • 118. Minimizing Risk of your Asset Portfolio
  • 119. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 120. Reward x Company Shares and Commodities x Real Estate x Art x Company Bonds; Higher Return; more Risk x Cash at Bank and Government Bonds - Lowest Risk and Low Returns Risk Usually, these Asset Classes have the above Risk-Reward Profile
  • 121. Objective: to Maximize Value of your Portfolio and Minimize its Risk For portfolio of ‘n’ independent assets, the risk or variance = Standard Deviation = Square Root of ‘n’ more the number of ‘independent assets’ (i.e. different asset e classes) the higher the denominator and hence lower the portfolio risk It is better to invest in different asset classes (shares, fixed income bonds, real-estate, commodities...) so that you have a diversified portfolio that minimizes risk Even within a asset class you should prudently diversify - e.g. if you buy shares diversify your share portfolio by buying shares of companies in developed markets as well as emerging markets, or large caps and small caps
  • 122. Buying a security regularly over a period of time averages out the cost Cost Averaging Trying to time the market, i.e. trying to predict the highs and lows of a particular stock is never a good idea You should instead spread your purchase over a period of time, say over a few months, such that the total cost averages out
  • 123. How to Invest in these Asset Classes? Following is just an overview, in a subsequent module I will cover this topic in more detail
  • 124. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 125. Valuation Cash Flow ll RoE P/E PEG EBITDA DCF Stock Picking: If you have the confidence that you can choose the shares and bonds you want to invest in, by educating yourself, then you can go ahead and trade yourself using a broker or an online trading platform
  • 126. “Not buy buy”, I said, e “Bye, bye!” Stock Broker: you can trade in shares, bonds, mutual funds and ETFs through a stock broker (or a sub-broker) You need to find out the fee/commission, minimum investment you have to make, non-trading fee and in case of sub-brokers, their reputation
  • 127. Online Financial Services Providers: you can also use online trading platforms and money supermarkets You need to compare the commission/fee structure, inactivity fee, what stock exchanges does the online platform cover, reputation, whether they also provide company research and reports...
  • 128. Mutual Funds: If you are not so sure that you can choose stocks and bonds yourself then you can look for an appropriate Mutual Fund Mutual Funds pool money from thousands of investors and their professional managers buy stocks, bonds and other securities (giving you a choice of asset classes)
  • 129. There are many types of mutual funds - open-ended, close-ended, fixed- income (invest in bonds only), equity/growth (invest in shares), large-caps (invest in shares of large companies), mid-caps, smalls-caps Mutual Funds thus offer a lot of choice on different types of asset classes you want to invest in
  • 130. You need to consider the costs involved in investing in Mutual Funds (to compare different mutual funds consider their respective ‘expense ratios’) - Cost of buying and selling shares of a mutual fund (called entry and exit load) - Management/Administrative fee, which is a usually a fixed percentage - Cost of buying and selling securities with-in the fund by the fund managers (called Turnover), which may incur additional charge of capital gains tax
  • 131. Critics of Mutual Funds argue that the expenses of funds are too high and eat into the investors’ return
  • 132. S&P 500 S&P 500 Linked Investor Index Mutual Fund e Buys the shares in the S&P 500 Index Index-Linked Mutual Funds: are mutual funds that simply replicate an index - i.e. the portfolio of securities held in the fund broadly match that of the index it is tracking For example, an index-linked mutual fund could simply be tracking the S&P 500 index (i.e. the fund will have all the securities included in the S&P 500 Index), or a Russell 2000 Index Fund will have own shares of small companies listed in the index, or the MSCI Emerging Market Fund will have the emerging markets equities in the fund
  • 133. dex In ed L ink al utu M nd Fu While it is a passive form of investing, given that most mutual funds are expensive, fail to beat broad indexes, and for a rookie investor picking own shares and bonds can be expensive, Index-Linked Mutual fund offer a relatively safer way to invest, with decent returns
  • 134. Commodity Listed in Stock Exchange ETF e e e ETF Underlying Asset ETF Investor e e Provider S&P 500 S&P 500 Index ETF Exchange Traded Fund (ETF): is a fund that tracks an index, or a basket of assets, but trades like a stock on a stock exchange Only large players like a financial institutions can buy shares directly from the ETF, that too in bulk quantity, and then they in turn can sell to investors in smaller quantities in the open market
  • 135. Large ETF Low Cost The ETFs can be very large, yet have very low costs Thus, the ETF does not have to keep funds aside (called float) to meet the daily buying and selling needs and has more funds to invest than a mutual fund, they have lower administrative costs and are passively managed (i.e, have lower management fee)
  • 136. ETF Some Risks Ahead ETF Risks A Physical ETF owns all or a selection of the asset it is based on (e.g. shares of companies in the index it is tracking); a Swap-based or Synthetic ETF may not own any of the underlying asset, instead it may be relying on a swap contract with third- party at a future date Synthetic ETF is thus subject to third-party solvency risk and if the third-party (with whom the ETF has a swap contract) goes bankrupt you will lose some money (in Europe, swap-based ETFs by law can only take 10% counter-party risk) A physical ETF could also have a counter-party risk as it may be lending its stock to third-party who may become insolvent and not in a position to give the stock back
  • 137. Mind the Risk Swap-based ETF is thought to be cause of scandal at UBS in Sept 2011 (when a rogue trader led to a loss of over £1b for the bank though no individual investor lost money) Experts point out that even Mutual Funds sometimes lend their stock and thus take on a different type of counter-party risk (like physical ETFs) ETFs have become very popular due to their simplicity, cost-effectiveness and ease of use As an investor you need to do your homework well and find out what risks your investment may be subject to
  • 138. TF Real -Estate E Real-Estate d A gent e or M utual Fun z e Property Developer e REIT Real-Estate: you can buy and sell a property through a real-estate agent, or buy in the primary market from a property developer Or, you can invest in a Real Estate Investment Trust (REIT), which is a company that invests in real estate and its shares are traded Or, you can invest in a Real Estate Mutual Fund or Real-Estate Exchange Traded Fund (ETF)
  • 139. Shares of co mpanies producing c Comm odity ETF om modities e z Commodities Mutual e Fund of Buy Gold or Silver e Commod ity Produ cers or Trade rs Commodities: for trading in commodities you can buy Mutual Funds of companies dealing in commodities (producers or commodity trading companies), or buy Exchange Traded Funds (ETF) whose underlying asset is a particular commodity or a basket of commodities, or purchase commodities like Gold or Silver
  • 141. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 142. “Insure all my nine lives e for the price of one, eh?” Life Insurance is an agreement between you and an insurance company, where you agree to pay a certain amount every year (called premium) and the insurance company agrees to pay a certain amount of money to a person of your choosing (called nominee or beneficiary)
  • 143. Life Insurance f g Term Life Whole Life Life Insurance policies are broadly of two types - Term Life and Whole Life Besides death, a life insurance policy may also cover Total and Permanent Disability (TPD)
  • 144. nt age Low Premium va g Ad For a fixed duration Term Life g say 10 or 20 years Di g sad va nt Coverage only for a ag e fixed duration In a Term Life Policy your insurance is valid for a fixed duration only, say 10 or 20 years (you decide the duration based on your circumstances) and you pay a fixed premium in those years Premium depends on your age and risk profile - smoker or non- smoker, nature of job - risky or non-risky, your health...
  • 145. Term Life i.e. objective of Term Life is to give money to g your nominee/beneficiary in the event of Death benefit only g your death - e.g. to repay a loan, or pay college fee for your children in case you die In term insurance the death benefit (sum insured) is paid only if the insured person dies before the policy expires (i.e. you don’t get back any of the premium you have paid if you don’t die in the period for which you have term insurance) Think of it as paying insurance on your car and never meeting with an accident - which is better than having an accident simply because you have insurance. Having term life insurance but not dying is infinitely better than dying simply because you have insurance!
  • 146. - Covered for life v ant age - Death benefit + there may be g Ad additional cash-in Whole Life Lifelong cover g Di g sad va nt ag e - Higher premium In a Whole Life Policy your insurance covers you till you die and there is usually a death benefit and an additional cash-in value You pay a fixed premium (either all your life, or for a certain period) and the premium you pay could be 3 to 10 times more than what you pay in a Term Life policy
  • 147. Critics of whole life policy say you Whole Life Policy Premium could invest this difference yourself in assets that generate a - Term Life Policy Premium higher return than the cash- Difference benefit given by a whole life policy In a Whole Life policy, part of the premium you pay goes into your death benefit and part is invested to generate a cash value but critics say the returns generated in the cash-value component are lower than what you get from investing this amount yourself, especially given the administrative and other overheads a insurance company has to pay for managing investments to generate cash-value
  • 148. Returns if you Invest Return on Whole Life Policy Advocates of Whole Life Insurance point out that the returns on investments you make in the open market are too volatile and hence may be lower than the guaranteed benefits whole life policies offer There may also be tax advantages of Whole Life policies
  • 149. Term Life Insurance Insura nce Multiple Cho ice Test Whole Life Insurance f... Universal Life Insurance ro s an d cons o Write the p Variable Universal Life Insurance Indexed Universal Life Insurance Newer type of whole-life policies, called Universal Life and Variable Universal Life are also becoming popular They offer more flexible premium plans and allow you some choice on how the cash- value part of the premium should be invested
  • 150. How to decide on a Life Insurance Policy?
  • 151. You need to ask yourself 3 Questions? - Do I need an insurance policy? - How much insurance do I need? - What type of insurance policy should I buy?
  • 152. o How will I pay for the baby’s education... 1. Do I need an insurance policy? If there is someone financially dependent on you, or will suffer financially if you were to die then you will be better off with life insurance E.g. your parents, spouse or children totally depend on you because you are the sole or main income earner in your family; or, you have taken a house on mortgage and if you were to die no one else in your family can pay the monthly installments
  • 153. e Mortgag School Fee Credit Card Debt Medica l 2. How much insurance do I need? You need to figure out your family’s financial needs - current expenses like family living expenses, medical costs, loans and debts you have and impact of inflation on these expenses; future expenses like your children’s college education, or your own post-retirement financial needs
  • 154. Sources of Funds Financial Needs • Spouses Income • Mortgage • Your Savings • School Fee • Your Investments • Credit Card Debt • Medical Expenses You then need to figure out what all sources of funds you have to meet these financial needs - like your spouse’s income, your savings and investments and returns they will generate
  • 155. Your Family’s Financial Needs - Your Current Sources of Funds = Life Insurance Required To cover the difference between your family’s current and future financial needs and sources of funds available, you need insurance
  • 156. Sources of Funds Financial Needs vered Mortgage expense is not co • Spouses Income • Mortgage l d Term Life Insurance that • Your Savings • School Fee pays the mortgage in the • Your Investments • Credit Card Debt event of your death may be the best option Your funds cover these ex l penses • Medical Expenses 3. What type of Life Insurance Policy? This depends on how long you want the insurance for and how much money do you have for the premium payment? E.g. your spouse’s income covers most of your family’s expenses but does not cover a 15- year mortgage you have on your house. In this case you may take a term life insurance policy for 15 years such that in the event of your death your insurance cover is adequate to pay off the outstanding mortgage.
  • 157. Disposable Income You need to see if you can afford the higher premium e on whole life policies If your budget for paying insurance premium is low (given that whole life and universal life insurance premiums are significantly higher) your best bet would be term life insurance
  • 158. You must shop around for the right insurance policy for you, compare the pros and cons, insurance agents get a trailing commission and you may be able to negotiate better terms (like cash back on your premium) Depending on your circumstances you may opt for term life, whole life, or a mix of the two (i.e. put a low percentage of your total portfolio/budget into whole life policy, if you can afford it)
  • 159. You should also consider taking insurance for ✓ Your health (medical insurance) ✓ Your mortgage ✓ Your income ✓ Your investments (e.g. physical assets like art, or old coin collection, valuable stamp collection)
  • 160. Creating a Financial Plan Bringing it all together
  • 161. 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8. Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 162. Financial Plan Risk e Destination Quantum x e Return Time A Financial Plan helps you get from where you are to where you want to go, in a given time-period, with as little risk as possible E.g. if you are 25 you may want to plan for life phases soon to come, like further education, or early retirement, or marriage, perhaps children, their education, what happens to your spouse, children and other dependents like your parents if you were to meet with a permanent disability or death
  • 163. Plan Evaluate Budget Invest Protect Plan Review Evaluate Budget Invest Protect Retirement Retirement Review Financial Planning Financial Planning Step-1: Evaluation Evaluate your current financial position - your income, your expenses, your savings, your investments, tax you pay... Write down your life aspirations - generate passive income stream, buy a car, buy a house, get married, plan early retirement...
  • 164. Plan Evaluate Budget Invest Protect Retirement Review Financial Planning Step-2: Budgeting ✓ Are your expenses lower or higher than your income? ✓ What expenses can you prune to create a Surplus (or savings)? ✓ Even if you start small you must start creating a surplus Besides creating assets (or investments) that generate passive income stream from the surplus, you may also consider creating a Emergency Fund, which will provide you liquidity, and more importantly, peace of mind
  • 165. Plan Evaluate Budget Invest Protect Retirement Review Financial Planning Step-3: Investing As we have discussed earlier in this module, financial savviness is really about creating assets or investments that generate passive income streams What type of assets should you invest in depends on your life situation and your risk appetite
  • 166. Plan Evaluate Budget Invest Protect Retirement Review Financial Planning Step-4: Protection ✓ Is your income protected? Are your investments protected? Is your house protected? ✓ Are people who are financially dependent on you protected in case something were to happen to you (death or disability)? ✓ This will help you determine your insurance needs (also see section on Insurance)
  • 167. Plan Evaluate Budget Invest Protect Retirement Review Financial Planning Step-5: Think about Retirement or Early Retirement How many years before you retire? (when your active income stream will cease and you will need to live your desired lifestyle only on your passive income stream) Also think about Estate Planning (what will happen to your assets once you are no more - who will get what); or, if you want to give away your wealth, think about options
  • 168. Plan Evaluate Budget Invest Protect Retirement Review Financial Planning Write a Will Write a Will: so that your wishes and not the government policy determines what happens when you die; this also includes making it clear who should look after your young children if anything were to happen to both you and your spouse
  • 169. Plan Evaluate Budget Invest Protect Retirement Review Financial Planning Step-6: Review Regularly At least once a year review your financial plan to see if your investments are optimal, has the risk-reward equation changed, have your personal circumstances changed... Reallocate the fund deployment in your portfolio accordingly
  • 170. RECAP: We Covered... 1. Asset vs Liability 2. Active vs Passive Income 3. Magic of Compounding (Investment vs Consumption) (Financial Independence) (Start Young) 4. Delayed Gratification 5. Fear & Greed 6. Risk vs Reward (Learn Self-Control) (Control Emotions) (Risk Appetite) 8.Your Intellectual 9. Risk Management 7. Asset Classes Property - an Asset 10. How to Invest 11. Life Insurance 12. Financial Planning
  • 171. But remember the adage... Money Doesn’t Buy Happiness For more on Happiness and Well- Being, check out the modules in g the section ‘Learning to Be’ - http://timelesslifeskills.co.uk/ learn-to-be
  • 172. Good Reads and Resources • ‘Rich Dad Poor Dad’ - Robert T. Kiyosaki • ‘Learn to Earn’ - Peter Lynch • Khan Academy Videos on Finance, especially the ‘Finance’ and ‘Valuation and Investing’ playlists - http://www.khanacademy.org/ • Learning Markets videos - http://www.learningmarkets.com/videos-and-courses/ • Yale course on ‘Financial Markets‘ - http://academicearth.org/courses/financial-markets • More video resources are listed here - http://www.diigo.com/list/atulpant/financialliteracy
  • 173. Author & Illustrator Atul Pant