Thursday, August 18, 2011

Guaranteed ways to lose money

We all have read a lot about various financial products that help you in creating and protecting wealth. But there also exist lot of products or say practices which often lead to wealth destruction. Each and every product and asset class has it's unique features, but it is important to understand that every asset class is different from the other and is having it's own peculiar risks. If you play with an asset class in a wrong way, it can destruct your wealth in a big way rather than creating it for you. Let's have a look at some of the practices, which help in losing money.
  1. Stock Market speculation: Stock Market speculation or Day trading, simply put is the activity of buying and selling the shares for a very short duration without taking any deliveries with a purpose to gain from the daily volatility in the stock prices. Day trading is the most common practice followed by new entrants into Equity investing. It is the most exciting feature as the prospect of making millions by sitting in front of the screen and just guessing the right prices is a mouth watering one. Always remember that fluctuations in share prices during the day does not truly represent the functioning of the company. The person who makes the most money through day trading is the broker. For an investor, the chances of making money in day trading are as good as winning a toss. The greatest investors in the history like Warren Buffent, John Templeton, etc. have created wealth not by guessing price movements but by making fundamental long term investment decisions.
  2. Investing in FD's which double your money over 6-8 years: Investors are obsessed with the safety of their investments and jump on any product giving guaranteed returns. Fixed Deposits as an asset class are good for short term investments of 1-2 years. By doing an FD for a tenure of 6-8 years investor only ends up losing money as the value of money also keeps on declining due to inflation. So, if you have got a return of 8.5% on your FD and the inflation during the period was 8%, your actual rate of return is 0.5%. Take taxes into account and your return is negative. So, if you are investing for 6-8 years you are increasing your negative returns for that long a period.
  3. Derivative Trading: Futures & Options are available in the stock market for the purpose of a better price discovery and for hedging your investments. Unfortunately, these derivatives are used as tools for making quick money and they turn out to be more dangerous than day trading. In derivative trading you can trade for 2-5 times more than the money you have. So if you are having Rs. 100, you can trade for Rs. 500 through derivatives. So with the same investment you can make 5 times more profit (and conversely 5 times more losses, wiping out your capital). Derivatives are for use of professionals and playing in them without their guidance can be highly dangerous.
  4. Keeping cash: Another Myth for keeping money safe, is to keep it in cash. Cash not only has it's own risks for storage but is also the only asset class which gives “0” returns. The value or the purchasing power of your cash goes down on a continuous basis due to inflation. This can be best understood, if you list down the items which could have been bought in Rs. 100, 10 years back and the price of those items now. You should keep cash only for the purpose of ensuring your basic needs. With the advent of ATM, cash is now readily available round the clock at an ATM near you, so better to keep it in your bank account rather than keeping huge quantities at your home.
  5. Using your credit card as free money instrument: Credit cards are most widely used instruments these days in place of cash. It gives lot of convenience as you don't need to pay at the time of purchase. Infact, you enjoy an interest free period of upto 45-60 days on your purchases. But many a times, people tend to overspend on the credit card. It is important to pay your dues back on time, else you can be subjected to interest rates as high as 3.5% compounding per month (which works out to an annual rate of 51% interest). Never fall in the trap of skipping your credit card payments or paying “minimum amount due” as you start getting charged heftily on all transactions done then on. The interest rates are so high that if you default you might end up paying higher interest than the principal amount. Though, if you keep paying on time, there is no better option than a credit card. Besides you also keep earning reward points for the money spent by you.
It may take you long time to create your wealth, but to lose it can be done in a matter of seconds. It is better to stay away from practices that can erode your wealth and make good use of every product available in the right way. That way, we will not only save wealth but also will be able to sleep peacefully.

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