Sunday, May 26, 2013

Fixed Deposits could get stuck forever- Some Pointers if You have to

People losing money through Fixed Deposits keep happening at an alarming rate. So thought it would be useful to bring home some pointers.' Fixed Deposits with companies have always been an avenue for savers. It is essentially an instrument of ‘trust’. You place your money for periods ranging from six months to five years. Interest is paid quarterly, half yearly, annually or compounded and paid with principal, at maturity. I have also seen people splitting their deposits in to chunks of Rs.45,000/- and put it in to many companies, to escape the TDS net. In doing so, they end up putting money in to high risk areas and the need to follow up with many companies for interest, repayment etc. Most often, we do not do any homework about which company we give it to. We either go by broker recommendation or by our perception of the company or on the basis of interest rate offered. Fixed Deposits with companies are one of the riskiest investments. There are hundreds of companies where people lost money due to default. Leasing companies in the eighties were amongst the biggest to default. Unlike any other borrowing by a company, Fixed Deposits are not regulated or vouched for by anyone. The law simply allows every public limited company to raise money from the public. This is as good as permitting them to carry on banking. There is no security or any guarantee provided by anyone. In the event the company goes in to liquidation, the Fixed Deposit holder is the last in queue. However, FDs do offer the highest rate of interest as compared to other forms of investments. Perhaps they offer the only returns that help you to battle inflation. If inflation is at ten percent, a bank fixed deposit that gives you eight percent or nine percent means that you actually erode your purchasing power. The risk that we assume is that in a company FD, we may lose the amount invested if we choose without thought and homework. Just pause to think. Why is a company raising money through this route? Surely it must be due to reasons of poor credit standing or bankers’ reluctance to lend them more money. There is one class of companies that raise FDs on a regular basis from the public. They are NBFCs and Housing Finance Companies. Here the key issue is that whilst you put in your money for one to three years, they may be lending for longer tenures. In essence, unless they keep finding new investors on a regular basis, they will have problems of finding money to repay. If the Fixed Deposit tap were to be suddenly turned off, the NBFCs and Housing Finance Companies with less than high reputation or credit standing will be hard put to repay. That is what happened to the leasing companies in the eighties. Only a handful survived. If you have to invest in Fixed Deposits, look at the following: i) A credit rating that is at least of AA (Double AA) level, signifying “High Credit”quality. And ideally they must have this rating from a minimum of two well known rating agencies. ii) Keep the duration to one year ideally, ask for repayment and then reinvest. If the credit rating is the highest (AAA or Triple A) from two agencies, then you could consider a longer duration. iii) Stick to companies that can service your investments in the city you live in. That makes it easier to follow up in case of need. iv) Do not get tempted by higher returns or incentives that may be offered. If someone is offering a high rate of interest, surely the risk is very high. v) If there is a choice between ‘listed’ debentures and fixed deposits, opt for the debentures. Presently, on listed debentures, there is no TDS. Listed debentures can be bought through a broker. vi) Never go in for automatic renewal of deposits. Take the repayment and then re-invest, if required. This will ensure that you check the repayment systems also. vii) Be very sure that you can afford to wait for the maturity period. Whilst some companies may offer premature withdrawals, it is better to be safe than sorry. viii) Avoid new companies or small sized companies. Go for companies with ten to fifteen years of standing and reputation in the industry. ix) Check on the internet for any news about the company that may warn you for any signs of trouble. Google is a fantastic resource for checking news. x) Avoid unlisted or private limited companies or industries that do not have regular cash flows (engineering, real estate, infrastructure, capital goods etc).

Tuesday, May 7, 2013

MANAGING GREED- Chit Funds and other pickpocketing schemes

The latest financial scam where people lost money (the Saradha Chit fund of West Bengal) proves just two points: i) There is still a lot of financial illiteracy; and ii) Those who are literate find it difficult to curb greed. We can assume that some of the investors had no idea about anything other than bank deposits and were simply lured by high profile selling tactics of the neighbourhood agent and lost their moneys. Surely, there will also be a large bunch, who were lured in to it by what they thought was “easy money “. Today, there are thousands of schemes floating out there that will leave you poorer. Whether it is a gold deposit scheme or a booking scheme in some real estate project or a MLM scheme or a fixed deposit scheme with fancy returns, each one of them is fraught with risks of the unknown. Almost all of them have exhausted their legitimate ways of raising money and are banking on the gullible Indian to lend them money. It is possible that a few of them may not have bad intentions. They may genuinely believe in their project which may be dependent on too many things going right and exactly as per their expectations. Let us do some logical thinking. If a bank deposit can give us, say, nine percent per annum for a three year period, some else can give us nor more than two or three percentage points more than that. If they are willing to offer you, say, eighteen percent per annum, it means that after all expenses; they should be able to earn more than that. There are very few businesses that earn this kind of money and those businesses are unlikely to need or borrow money. This has to be your starting point. Find out what are they going to do with the money they take from you. Often, you will get stories of your money getting invested in land or property. This is the biggest risk and there are no guarantees that the price will rise and one can sell it in time to repay any money. The other thing you will notice is that none of these borrowers and fund raisers will tell you how many legal and illegal entities they run, what are the financials, who are the directors etc. It generally means that the only business of the borrower is to raise money and keep on doing it till the whole thing collapses. And most of them will never give you a full picture of who the promoter is, what his background is, what success he has achieved in any domain of business etc. There are salesmen who push these schemes at you. They get very high commission rates. They may be called agents or some such designations. Apparently this is the only income that person may be having. If someone comes, ask him directly about what commission he gets. You will never hear the truth and get some evasive answers. Real estate bookings are another area for you to lose money. The company, again, will not show you any balance sheet. One plot of land in a far away location, perhaps one model house and no government permissions in place but asking you for money is another sure road to losing money. Most likely, you will end up with a piece of land that will never be saleable at any price. Similarly, booking apartments is another high risk game. I had personally booked an apartment in a property called “Estancia” by a builder called Arun Excello near Chennai. The handing over is delayed by five years and what appreciation I hoped for is a mirage. The best of builders cannot withstand a slow down or a delay. So if you are investing in property, go for ready property in prime location. I would urge people to make a checklist of a few questions they should ask before they invest money: i) Who are the promoters? Any track record? ; ii) Their latest accounts are a must; iii) What are group companies? Any record of success? iv) What business is it that earns more money than the interest it promises to pay you? v) Why can it not get money from a bank and is approaching you? vi) Is there a way to know how much money they have raised? Will raise? vii) What is the entity that is borrowing? If it is not a listed company, the chances of losing are so much higher. Not because listing gives any guarantee but because there are some regulators and there is disclosure. viii) Do not lend or invest money in proprietary, partnership, cooperative or private limited entities. ix) Never invest money in a scheme where the name of the borrowing entity is not disclosed; x) If they accept cash, stay away. You will lose your money for sure. xi) Invest only if it is a scheme like a FD or Debenture that has a credit rating in the public domain xii) Be sceptical about everything and everyone when it comes to money. Ideally, one should keep away from all these schemes designed to transfer wealth from your pockets to someone else’s.