Hidden Costs While Buying Property

All eyes dream of owning a home. The decision of buying a house is one of the most important ones as it not only involves a lot of money but has many emotions attached to it as well. For majority of the people, all their dreams and savings get invested when they plan to own a house.

At the first go the house that you plan to buy may look manageable but after buying it you realize there are many other costs also involved. It happens that the payment varies with what you might have calculated. Actually, your calculations are done by multiplying the cost per square feet with the total area. But this is not what you actually have to pay.

There are some other costs such as registration cost, stamp duty, service tax, property tax etc that go unaccounted for in your calculations but they exist and finally get added in the cost that is reflected in your final payment schedule. The additional costs also vary from builder to builder and facilities that your house is equipped with.

Obviously, if the cost of home turns out to be more than what you have calculated it becomes difficult to go for it. There are number of add-ons that the developers and real estate agents disclose later and that shoots up the actual cost of the place by approximately 20% to 25%. It goes without saying that it is important for you to be well prepared and have a clear view about all the additional costs and add-ons that might come in the way when you are buying a house.

What are the Hidden Costs?

Following are the additional costs that you might have to incur when you plan to purchase your dream home. Take a look.

Parking Space – When it comes to large residential buildings, an additional amount is charged under the head of Parking Space allotment. This is quite a new trend in the Indian realty market and a good amount is charged to you for providing you with an exclusive parking space for your vehicle. The type of property decides this amount. This amount may vary from Rs 2 Lacs – Rs 5 Lacs. Primarily, factors like locality, type of property and parking space are taken into consideration prior to fixing the amount under this head. Going by the ruling of Supreme Court after March 2012, additional amount for parking rights at residential areas cannot be charged by the developers but this ruling is being by-passed and the amount is being still included in the property cost.

Registration Costs – The registration charge is based on the actual worth of your property. There are a number of states wherein approximately 6% to 10% amount of the property cost falls under the head of legal charges in form of registration fees and stamp duty etc. About 5% to 7% of the cost of property forms the stamp duty. For example – If your property is worth Rs 10 Lac then you will be required to purchase a stamp of Rs 50K in order to get the sale deed typed. The registration fees of approximately 1% - 2% of the cost of property is also charged that is payable to the court. This does not end here. Apart from these costs you will also bear the cost of number of miscellaneous expenses like fees of lawyers and notary who represent you and get your job done in the court.

Loss of Tax Rebate, Interest and Rental – A number of reasons call for delay in the projects and this is very common - almost everywhere around us. These delays in project add to your worries. They not only add to your additional expenses in form of extra interest that you pay towards your home loan but they also lead to price escalations. Projects are generally expected to get delayed by six months to one year. It is always advisable to include the extra interest that you might have to pay due to delay in project while you plan your finances for buying property. The rental earnings for the delayed period are also to be kept into account. Till the time the property is not completed and handed over to you, you also lose on to the tax rebates that are applicable on home loans. These costs cannot be ignored while you plan your budget for purchasing a property.

Deposit for Maintenance – Many of the builders take an upfront maintenance deposit that may range from a period of 10 years or more and for lifetime, at places. The buyer suffers a loss due to charges under this head. You are required to pay a good lump-sum amount on the initial level and bear interest on such borrowings. Going by the trend of inflation the amount that is charged for the above mentioned period is likely to run out earlier than predicted. You will then be required to pay another lump-sum amount under the head of deposit for maintenance. Developers keep insisting on the deposit for maintenance to be paid initially as it provides them with more capital.

Cost of Interiors – You simply cannot ignore the fact that your choices and preferences are ought to be different from the developer. Once you acquire the property of your choice you will, for sure, spend on the interiors of your newly acquired home as per your requirements and choice. Generally, when we plan for purchasing a property, expenses under this head somehow escape our mind. However, we cannot ignore the fact that this head may also require substantial amount to be invested depending on the type and nature of interior work that is opted by you. To be on the safer side, approximately 1%-1.5% of the cost of property may be dedicated to this head of expense.

Preferential Location Charges (PLC) – These charges are clamped by the builder for your choice about the floor on which your want to purchase your home or you want your home to be east facing or corner one and so on. Developers generally charge you for providing you with preferential locations. The amount, however, varies with how many preferential options you have opted for.

Apart from the above mentioned costs, there are charges like unpaid civic authority dues; unapproved plans etc may also add to your pain. Therefore, it is always advisable to keep a surplus of approximately 20%-25% over and above the initial cost of property before you plan to buy your dream home. Clear knowledge about the add-on costs help you in planning your finances accordingly. It saves you from facing the ugly situation of “buy or not to buy” once you have set your heart on your favorite property after the add-ons get revealed.

Common Mistakes to Avoid in Personal Finance Planning

Financial planning involves a complete understanding of one’s financial needs and future goals. Once these are established it is easy to finalise on a comprehensive solution. In the journey towards securing ourselves financially there are some common mistakes that we commit. Some of the mistakes to avoid and the solution are discussed in detail.

No Concrete Budget Plan in place

This is the most unhealthy personal finance habit that we must be wary of. This has two disadvantages: firstly we end up spending excessively in areas that are not necessary and secondly we end up not spending money where it is needed. This could leave you high and dry, in spite of all your hard work and years of service. A sound budget is one that includes all the expenses (don’t forget to allocate funds towards entertainment, house repair and renovation and retirement savings) and factors in affordability and consistency. This must be backed by proper execution of the plan. Ensure financial discipline by all family members.

Trying to Make a Quick Buck When Investing

Many of us plan and budget well, but we skid and slip in the execution phase. Temptation gets the better of us and we try to put hard earned money in schemes that lure the investors with false promises. Most of these investments turn sour and we end up losing our investments. It is better to keep safe distance from such companies that promise say, to double your money in one month or give returns as high as 40-50% etc.

Making Investments That You Can’t Really Afford

Do not make investments that you cannot afford. Example, do not invest in life insurance that requires you to pay a huge sum as premium at the beginning of your career. Plan the amount of investment in each instrument with care and ensure you have enough to spend for rest of your needs.

Buying a Product Because it Looks Attractive

You must have your future in mind before buying an investment product. For e.g. taking a health insurance plan when you are already covered in a previous policy becomes redundant, however attractive the product may seem. Similarly, there could be newer and better sounding products that surface from time to time. It is imperative to check if these are suited to your needs and fit into the general scheme of things before you invest in them.

Investing – as a Quick Fix Solution

Investment cannot be done as a quick fix option to existing situation. For instance, in order to save tax you should not buy a product which cannot be serviced or continued in the future. Instead the extra tax liability can be paid for one year and a proper tax saving cum investment option should be planned for the years ahead.

Listen to Advice, Implementation Can Wait

Procrastination can defeat the purpose of listening to advice. If you postpone the actual investment to a later date, the features of the plan or even its availability could vary. Deciding on what to buy and implementing the decision at the earliest are both equally important.

Portfolio Without Diversity

Putting all the eggs in the same basket may spell danger as far as investments go. Remember, diversifying portfolio reduces the risk associated with a single industry. Not only should you invest in various schemes like pension, life insurance, medical insurance etc…, but also varied options like insurance, bonds, stocks of blue chip companies, gold, real estate etc.

Only One Person in the Family Knows Where the Money Goes

This situation should be avoided due to the uncertainties associated with human life. In case of an emergency it is always preferable that more than one person in the family knows where the funds have been invested. Details regarding medical claim, insurance claim should be shared with the spouse. Physically held investments like bond certificates, gold, etc. should be secured in lockers and the key should be kept safe. 

There is No Emergency Fund

We are living in an era of ATMs and therefore may be tempted to leave the money in the bank as long as we can, so that it can earn interest till we find the need for the cash. While this lends so seamlessly to logical thinking, care must be taken before you empty the house of the minimum cash which may be required during times of emergency. There are times when the ATMs near the house do not work or are out of cash. Some vendors do not believe in credit cards and hence do not accept them.

Children are Kept Away From Money Concepts

In the fast paced world it is very important to teach children about money matters. Children should be allowed not only to buy what they need from nearby shops, they should also be told about the finances of the house to the extent understandable by them. This will help them draw up their budget and plan their expenses when they start earning. While this will make them avoid unwanted expenses, it will also encourage them to spend where required.

Employee Benefits aren’t Well Understood or Utilized

There are certain benefits given by employers for the benefits of employees. It is imperative to understand these correctly and utilize them as they are intended to be utilised. For instance your company could make a part of the payment in the form of food coupons. Make sure you collect them and use them in the relevant outlets.

Renting Your Living Accommodation Rather Than Buying It

If you do this you will end up paying a lower rent, nevertheless at the end of the many years of paying increasing rent you will retire without a roof over your head. Investing in a house is important as it saves the tax that you need to pay, while creating an asset for you.

The points discussed above are broad guidelines which will help you in planning your finances. As a final word of caution I would like to add that there are no quick ways of making money. Better be safe than sorry!

Basic Investment Principles for Beginners

Investment is like planting a tree today so that in future you and your family may be able to enjoy its fruits and also be able to rest in its shade comfortably. You all know how important it is for you to provide financial security to your family and yourself.

It is needless to say that all the hard work and effort that you put in from morning to evening in earning those dollars and rupees is aimed at providing your family and yourself a good standard of living and also securing future. The best way to manage your hard earned money is to invest it sensibly so that in future it not only helps you when in need but also multiplies itself in the due course of time.

There cannot be a rule book that can guide you through with your investment planning and procedure but there are a few basic principles or guidelines that can help you to become a successful investor. These are: 

1. Investing Early – It is always advisable to start investing as soon as you start earning. It is quite obvious that you may be able to invest say as little as Rs 500 every month but you should not forget that compounding earns you good margins even with small savings. This also cultivates a habit of investing regularly in a disciplined manner. It is also advisable to re-invest the interest that you earn and just wait and watch how magically it grows through compounding formula. 

2. Analyze Yourself – This means it is important for you to identify the kind of investor you are. It is important for you to realize if you are the one who will get deeply involved in the art of investing and put in your time and energy in exploring every possible lucrative investing option thus earning higher returns, or are you an individual who will put in less effort and time and will be satisfied with a lower profit margin. 

3. Know the Market in which you will Invest – It is important for you to gather as much information as possible about the scheme, plan or options in which you plan to invest. It is also important for you to take a glance at all the market players who are offering the same or similar schemes and plans and the returns or commitments that each one of them is giving. This will help you in cracking the most profitable deal for your investment. It is very important for you to understand completely the plan you are investing in, the player you are investing with and the returns you are aiming at. 

4. Investment Goals – It is advisable for you to comprehend your goals pertaining to your investment. This would include the assessment of your current financial condition, the amount you can spare from your expenditure, time frame i.e monthly, quarterly, half-yearly etc, the kind of investment and also the kind of returns that you wish to have which again maybe based on your personal requirements like for a retired individual monthly credit of interest seems to be quite apt. 

5. Diversification of Funds – As the famous phrase goes “You should never put all your eggs in one basket” it is very important for you to diversify your funds i.e do not put all your money in one particular scheme or plan. Always invest in a bouquet of funds in order to balance the risk. 

6. Time Factor – When it comes to time, you need to keep in mind two factors related to time. First is the time when you enter the market and the second is the duration for which you play in the market. It is very difficult to anticipate the movements in the market. You need to be clear and specific about when you enter the market and for how long you have to stay there. 

7. Long Duration Investment – It is always advisable to stay tuned in market for a longer duration. The duration of investment determines the risks and returns on your investment. It depends on you as to how much return you aim at and the risk you are ready to take. Generally if you stay invested for long duration, your risk gets balanced due to an average market condition thereby bringing better returns. Put it this way - it is important for you to analyze the risk that you can take. 

8. Adopt a conservative approach when it comes to valuation of profits – you need to understand that you can not be overly optimistic about the investments you are making. You need to adopt a conservative approach while weighing your returns from a particular investment. It is very important to be cautious and careful while computing your future growth rates. 

9. Hallo and Horn Effect – Do not get affected by the Hallo and Horn Effect. This means that you should not judge an investment plan or scheme merely on the basis of its past performance or solely because it benefited your friend so it will benefit you as well. You cannot totally neglect the past performance of the stock but you cannot predict the future of the same solely on past performance. 

10. Don’t let one slump affect future prospects – It is very important to be cautious. So goes the famous phrase “once bitten twice shy” but it emphasizes on being cautious, learning from past experiences but it doesn’t say that you will let one market slump hinder your long-term investment planning. Do not get discouraged by the bulls and bears of the market. 

11. Once sold, it is gone – It is always advisable to let bygones be bygones. Once you have taken a decision of selling your stock, do not check the price of your stock once you have sold it. You have just started investing. It’s a big life and a long game. “Ohhh I sold it…should have waited more.” This can always tickle your mind after you have sold your stock. But what if you had waited and the returns have been less than what you gained today? Seize the day and go ahead with no regrets. 

12. Keep Patience – There are moments when we all run out of patience and when its money that you are playing with it is obvious to be anxious and be impatient. But keeping your cool will always help you to sail smoothly through the lows and highs of the market. 

13. Monitoring your Portfolio – It is very important for you to keep yourself updated with the market scenario and keep a constant check on your portfolio. You cannot hold on to a stock forever. So keep updating your portfolio with the ever changing scenario of the volatile market. 

14. Accept, you can not be right always – You need to accept this before you get started that you are a human being and you are bound to make mistakes. You can not always make a right decision for every investment that you make. The key is to make the best out of the right choice and to learn from the wrong ones. 

Financial Investment Options

There are a number of financial investment options available in the market and you can pick and choose as per your requirement from the bouquet of options which are as follows:

• Equities
• Precious Stones
• Gold/Silver
• Bonds
• Mutual Funds
• Fixed Deposits
• Recurring Deposits
• Real Estate
• Insurance Plans

Five Easy Ways to Save Tax

A year of hard work and part of the salary vanishes in the name of tax. It is quite obvious that working people would want to make use of their payments in a better way. The government has given many avenues to do so and a person who is aware of these easy methods can utilize it to the maximum extent.

For example consider the basic necessities of modern day living, food, shelter, travel, health care, investments and consider the possible ways of saving tax on these.

1. Food: The taxable amount on a salaried employee will reduce if the company offers food to the employee during the working hours. The cost of the meal can be a maximum of Rs 50 and the annual total of this expense is deducted from the taxable amount of employee. 
2. Shelter: If the employee is living in a rented house then certain percentage of the basic pay is allowable as house rent and this amount also gets deducted from the taxable sum of the employee. For this purpose a receipt from the owner of the house for rent paid is required. So if you are living in a rented house start collecting these receipts that help you during the end of the financial year.If the person (irrespective of salaried or self employed) is repaying a home loan then he/she can get a claim up to Rs 1 lakh on the repayment of principal and Rs 1.5 lakh on the amount paid towards interest on housing loan annually.
3. Health care: The next important factor in a person’s life would be the health and there is an allowance towards the expenses made towards medical treatment. An amount of Rs 15,000 is deducted from taxable amount if proper receipts are produced by the employer for the expenses that are incurred in a financial year.  Make sure that the receipts contain the Tax Identification Number (TIN). An additional Rs.15,000 is allowable as exemption from tax if this amount is paid towards the health insurance scheme of parents. So if your parents are not insured with health insurance, it is a good idea to shop for a policy now. 
4. Travel: Conveyance allowance is paid for the expense of the employee’s travel from and to the office. This is a very small amount but yet, can be accounted for, to some extent if you use the mass transport system. The allowance is up to Rs 800 per month. There is also an allowance called  leave travel allowance(LTA). This allowance lets you travel with your family and the expense to certain extent is deducted from the taxable income.
5. Investments: Government also encourages investments in mutual funds, insurance schemes, ELSS, Public Provident Fund etc. There is a tax exemption of Rs 1 lakh that you get on investments made towards these schemes. The Government has increased the limit of investment in PPF from Rs.70000/- to Rs.100000/- to encourage savings in long term investments. There is another simple way to divert your income towards your personal benefits like, purchasing a life insurance policy for self while you also reduce the taxable income on the other hand. These are more a benefit because it helps the tax payer make use of his income in the best possible way by removing off some basic expenses through these deductions in tax.

Tax planning, the right way...

Tax planning probably sounds a bit weird now, because the tax filing season just got over and nobody is really thinking about it or doing anything. Tax consultants are going on holiday this month. But smart people will realise how important it is to do tax planning right now. To save tax, you are better off starting now than later because you will have a lot more options now, time to think and make the right decision and no HR person sitting on your head to do the needful as soon as possible.

Myths and reality

Many people still have this notion that tax planning is wrong and responsible citizens should pay their taxes and not cheat. Tax planning is not tax evasion or tax avoidance. Tax evasion or tax avoidance is illegal where the letter and spirit of the law are broken. Tax planning is done well within the framework of the law and the government actually encourages you to plan your taxes by seeking investment in tax saving bonds, giving benefits under various sections etc.

Another misconception about tax planning is that it is all about investing in 80C.

People ask which is better, PPF or ELSS for tax planning? Tax planning is much more than 80C investments. It requires thoughtful planning of how your income is accounted, how you spend and invest your money and a few more nitty gritties. It is also a myth that tax planning is cumbersome and quite tricky for an average person to comprehend. Of course the tax laws are complex and dynamic, but what is applicable to the normal common person is rather simple.

Tax planning has to be integrated with your overall financial plan. In everything you do, you have to find a tax efficient way of doing it. For eg: You can invest in liquid funds or short term debt funds for emergency needs. But depending on your tax bracket, the short term funds can be more advantageous than the liquid funds or vice versa.

How to save tax?

Invest your surplus savings or use your income in any of the following ways and your total taxable income will come down to that extent, subject to a maximum of Rs 1 lakh.

Repay your home loan – the principal portion can be claimed for deduction

Pay tuition fees for children's education (maximum 2 children)

Pay life insurance premium

Invest in national saving certificate.

Invest in public provident fund

Invest in equity linked savings schemes (ELSS)

Invest in banks and post office fixed deposits of five years.

You can claim tax exemption on house rent allowance received as part of your salary if you are staying in a rented house.

Home loan
If it is a self occupied property, you can claim upto R1.5 lakh paid as interest as loss on house property. That will bring down your overall taxable income. If your property is rented out, on one side you will have to add the rent with your other income and pay tax, meanwhile you can deduct all the interest amount (without any limit) from your overall income and bring down taxable income.

Education loan
The interest paid on an education loan taken for higher education of self, spouse or children can be deducted under Section 80E and thereby your total taxable income can come down.

Protect your health
If you pay premium for a medical insurance policy for self or spouse or dependent children/ parents you can claim tax rebate under Section 80D. And from the current year, a sum of R 5,000 can be claimed if you or your dependants do a preventive health check up.

Social cause
Under Section 80G donations to particular institutions/ funds get tax benefits. While it is true that tax planning is a critical activity, a financial decision to buy a house or make an investment should not be motivated by tax saving. It is the financial plan that should tell you what to do with your money, but within the options, you should choose the most tax efficient one to get the best benefits

DuPont Analysis – Return on Equity (ROE) Analysis

Financial statement analysis is employed for a variety of reasons. Outside investors are seeking information as to the long run viability of a business and its prospects for providing an adequate return in consideration of the risks being taken. Creditors desire to know whether a potential borrower or customer can service loans being made. Internal analysts and management utilize financial statement analysis as a means to monitor the outcome of policy decisions, predict future performance targets, develop investment strategies, and assess capital needs. As the role of the credit manager is expanded cross-functionally, he or she may be required to answer the call to conduct financial statement analysis under any of these circumstances. The DuPont analysis is a useful tool in providing both an overview and a focus for such analysis.

History of DuPont Analysis

The DuPont model of financial analysis was made by F. Donaldson Brown, an electrical engineer who joined the giant chemical company’s Treasury department in 1914. A few years later, DuPont bought 23 percent of the stock of General Motors Corp. and gave Brown the task of cleaning up the car maker’s tangled finances. This was perhaps the first large-scale re-engineering effort in the USA. Brown devised formulae to analyse the source of shareholder returns generated by these companies. These formulae or methods came to be known as DuPont system of analysis. Ensuing success launched the DuPont model towards prominence in all major U.S. corporations. It remained the dominant form of financial analysis until the 1970’s. The DuPont analysis is known by many other names, including DuPont Equation, DuPont Framework, DuPont Identity, DuPont Model, DuPont Method, or Strategic Profit Model.

Framework of DuPont Analysis

The DuPont Analysis is a wonderful synthesis of the different ratios to end up with the Return on Equity (ROE).  ROE effectively measures how much profit a company can generate on the equity capital investors have deployed in the business, and can be used over time to evaluate changes in a company’s financial situation. Simply, ROE indicates the amount of earnings generated by each dollar of equity. It can be a valuable insight into a company’s operations. In general, the higher the ROE the better, as high ROE companies, all other things being equal, will produce more earnings and free cash flow that can be used to support a higher level of growth, keep the company financially strong, and provide cash returns to shareholders.

The DuPont analysis breaks down a company’s return on equity (ROE) into three components.

1. Profit Margin as measured by net income as a percentage of sales (net profit/sales)
2. Asset Turnover which is net sales divided by the total assets of a firm (sales/assets)
3. Degree of Financial Leverage as measured by the equity multiplier which is the ratio of total assets financed by stockholders’ equity (assets/equity)

Under DuPont analysis, Return on Equity (ROE) is equal to the Profit Margin multiplied by Asset Turnover multiplied by Financial Leverage.

Return on Equity (ROE) = Profit Margin x Asset Turnover x Financial Leverage = (Net Profit/Sales) x (Sales/Assets) x (Assets/Equity)

• Profit margin is an indicator of a company’s pricing strategies and how well the company controls costs. Profit margin is calculated by finding the net profit as a percentage of the total revenue. If the profit margin of a company increases, every sale will bring more money to a company’s bottom line, resulting in a higher overall return on equity. Even though the common consensus is that the higher the net profit margin the more preferable it is, executives may often intentionally decrease this ratio this in an attempt to attract an increase in sales.
• Asset turnover, on the other hand, measures the efficiency of the company in generating sales for every dollar of asset. Asset turnover tends to have an inverse relationship with profit margin, meaning that if a firm has a high profit margin it generally has a low asset turnover. Similar to profit margin, if asset turnover increases, a company will generate more sales per asset owned, once again resulting in a higher overall return on equity.
• Lastly, the equity multiplier of Financial Leverage shows how leveraged a company is by computing how much financing stockholders provided for every dollar of asset. As was the case with asset turnover and profit margin, increased financial leverage will also lead to an increase in return on equity. This is because the increased use of debt as financing will cause a company to have higher interest payments, which are tax deductible. Because dividend payments are not tax deductible, maintaining a high proportion of debt in a company’s capital structure leads to a higher return on equity.

Breaking ROE into these three parts allows evaluation of how well one can manage the company’s assets, expenses, and debt. Financial managers have basically three ways of improving operating performance in terms ROE. These are:

1. Increase operating profit margins
2. Increase capital asset turnover
3. Change financial leverage

The above DuPont equation is the 3 step DuPont analysis. There is also the 5 step DuPont analysis. The additional parts are derived from the profit margin part. Instead of a single profit margin, we break up the profit margin component into three parts.

Return on Equity (ROE) = (Net Income/EBT) x (EBT/EBIT) x (EBIT/Sales) x (Sales/Assets) x (Assets/Equity)

The first three parts are the profit margin component. Notice how the terms can be cancelled out and Net Income/Sales stands out after cancellation. The ratio (Net Income/EBT) called as tax burden, this is also given by (1- Effective Tax Rate). The higher the tax expense, the lower will be this fraction. Remember this part will be less than 1. When using in the main equation denote this in decimal, not percentage. The second ratio (EBT/EBIT) called as interest burden. The higher the interest expense, the lower will be result of this fraction. Remember this part will also be less than 1 unless interest expense is nil. Lower this number, worse off the ROE will be. Denote this is also in decimal, not percentage. The third ratio (EBIT/Sales) called as Operating Profit margin.

There is an inter-relationship between the above three ratios in 5 step DuPont analysis. For example if debt is low in a company, interest burden might be low resulting in higher EBT/EBIT ratio; but the offset will take place in the financial leverage part of the equation (Assets/Equity). Lower debt means higher equity, thus lower financial leverage.

The DuPont analysis is an excellent method to determine the strengths and weaknesses of a company. A low or declining ROE is a signal that there may be a weakness. However, using the analysis you can better determine the source of weakness. Expressing the individual components rather than interpreting ROE itself may identify these weaknesses more readily.

There are some disadvantages in using ROE alone in financial statement analysis. ROE may be volatile due to the business’s normal sales cycles, or ROE may be lower or higher depending on the general profitability of the industry in which the company operates. A company may have an inflated ROE because of a very small value of book equity on its balance sheet, perhaps due to rapid growth or because the company has made large share repurchases. Likewise, the company may have taken on a large debt burden, increasing its leverage and potentially increasing ROE without increasing profitability or efficiency.

Financing of Current Assets

Current assets of enterprises may be financed either by short-term sources or long-term sources or by combination of both. The main sources constituting long-term financing are shares, debentures, and debts form banks and financial institutions. The long term source of finance provides support for a small part of current assets requirements which is called the working capital margin. Working capital margin is used here to express the difference between current assets and current liabilities. Short-term financing of current assets includes sources of short-term credit, which a firm is mostly required to arrange in advance. Short-term bank loans, commercial papers etc. are a few of its components. Current liabilities like accruals and provisions, trade credit, short-term bank finance, short-term deposits and the like warranting the current assets are also referred to a short-term term sources of finance.Spontaneous financing can also finance current assets, which includes creditors, bills payable, and outstanding receipts. A product firm would always opt for utilizing spontaneous sources fully since it is free of cost. Every concerns that can no more be financed by spontaneous sources of financing has to decide between short-term and long-term source of finance along with relevant proportion of the two. 

There are three approaches of financing current assets that are popularly used. They are;

• Matching Approach 

  As the name itself suggests, a financing instrument would offset the current asset under consideration, bearing financing instrument bearing approximately same maturity. In simple words, under this approach a match is established between the expected lives of current asset to be financed with the source of fund raised to finance the current assets. For this, reason a firm would select long-term financing to finance or permanent current assets to finance temporary or variable current assets. Thus, a ten-year loan may be raised for financing machinery bearing expected life of ten years. Similarly, one-month stock can be financed by means of one-month bank loan. This is also termed as hedging approach.

• Conservative Approach 

  Conservative approach takes an edge over and above matching approach, as it is practically not possible to plan an exact match in all cases. A firm is said to be following conservative approach when it depends more on long-term financial sources for meeting its financial needs. Under this financing policy, the fixed assets, permanent current assets and even a part of temporary current assets is provided with long-term sources of finance and this make it less risky nature. Another advantage of following this approach is that in the absence of temporary current assets, a firm can invest surplus funds into marketable securities and store liquidity.

• Aggressive Approach 

  As against conservative approach, a firm is said to be following aggressive financing policy when depends relatively more on short-term sources than warranted by the matching plan. Under this approach the firm finance not only its temporary current assets but also a part of permanent current assets with short-term sources of finance.In nutshell, it may be concluded that for financing of current assets, a firm should decide upon two important constraints; firstly, the type of financing policy to be selected (whether short-term or long term and secondly, the relative proportion of modes of financing. This decision is totally based on trade-off between risk and return. As short-term financing is less costly but risky, long-term financing is less risky but costly.

Why is Long Term Investment Important?

Long Term Investments are those when you hold your stock, assets, bonds etc for a duration which is more than a year, may be ten years or something that you intend to hold for even much longer. If you are the one who is not running after quick returns then long term investments are your cup of tea. Long term investments grow substantially in good number of years and give you higher returns in the long run.

However, long term investments demand a high level of commitment, discipline, effort and time but the result is worth the wait. Experts advise you to make long term investments as they help you to remain focused and disciplined and provide you with higher profits as compared to short term investments.

You have heard the story of the tortoise and the rabbit and you know it well that slow and steady wins the race. Same applies to long term investments. You may click on short term growing funds in order to make steady cash but if you go for long term investments you let the compounding magic work for you.

Advantages of Long Term Investment

• It is not always possible to have high returns all the time. While you invest in short term funds it is not necessary that the fund in which you have invested will grow in the short span. On the other hand, if you go in for long term investment you will be able to sail through the highs and lows of the market and get substantial returns on your investments.
• Long term investments help you grow your money through the magic of compounding. The early you start the better for you. While playing in long term stocks, you do not get distracted by short term conditions.
• It is very difficult for you to predict the performance of market in short term whereas if you have a look at the performance of a stock over a period of time you will realize that the stock has showed upward movement.
• Long term investment helps you to build a diversified portfolio. It is important for you to accept that you are a human being and you cannot make right choices always and long term investment will help you run smoothly through the peaks and valleys of the market and also provide you with higher returns as you will have a good amount of varied options in your portfolio. If you keep updating your portfolio by getting rid of the non-performing chunk and catching hold of the performing stocks you will be able to yield good returns.
• Long term investments offer lower risk as compared to short term investments. One wrong move in your short term investment and you are gone whereas when it comes to long term investment you can slowly and steadily choose your investment options which will at least leave you well-off and it will surely not be strenuous for you.
• Long term investment seems more direct and easy than day trading. Day trading requires a lot of caution and time.
• In case of long term investments, investors need to be proactive and is less cumbersome. You do not have to sit at the edge of your chair. Even passive investments prove to be convenient.
• Even if you have made a mistake while making investment decisions, long term investment gives you a chance to mend them. You have time at your disposal to rectify where you have gone wrong. You can make up for the bad year of performance of your stock easily in coming years.
• When you opt for long term investment your portfolio turnover comes out to be less as compared to short term investments where whatever you sell becomes subject to taxes. With long term investments at your disposal you can grow money through compounding and delay tax liabilities.
• If we talk about the commission expenses then it goes without saying that such expenses are far less in long term investments. 

Experts do advise long term investments as they help you meet your long time financial goals. As you play in a diversified portfolio you are able to nullify the effect of a bad year of stocks with the coming years. However, while you plan to invest for long term you need to analyze the time that you have at your disposal. You need to plan well in advance the amount you can spare, the years for which you can stay invested and whether you will require that money in the next few years or not.

When you stay invested for long you do extend your risk to the following years but you indeed have a fair chance of rectifying your mistakes if you have landed yourself with a non-performing stock.

Long term investments pay off well in long durations like five years or ten years or above. If in any year during this period your stocks fall, you need not panic because if you sell off your stocks while the market is low you are bound to lose but remember that the market cannot remain the same, it will surely recover and you can easily make up for the loss.

Following are few of the options that are available for making long term investments: 

• Equity Shares
• Mutual Funds
• Post Office Saving Schemes
• Bonds and Debentures
• Public Provident Fund
• Life Insurance
• Real Estate
• Commodities
• National Saving Certificates
• Fixed Deposits

Investment and Portfolio Diversification

The famous phrase “Never put all your eggs in one basket” holds very true in case of your investments too. Portfolio diversification is a tool or a technique that helps you minimize your risk by investing in different schemes and plans.

It’s just like if you put all your eggs in one basket and if it drops, you may lose all of them. Similarly, if you invest all your savings in a particular plan or scheme and in case the market goes down you are bound to loose your precious money.

What works behind diversification of funds is the rational that those who diversify their investments earn, on an average, higher returns thereby reducing investment risks. Thus, it is always advisable to scatter your investments so as to avoid being hit adversely. 

Diversification helps you remain shock-proof - if one plan fails at least you have the other to save you from the blow.

Undiversifiable and Diversifiable Risks

Undiversifiable Risk – These are risks that cannot be eliminated through diversification as they are caused by factors like inflation, political instability, war etc. These are risks that an investor cannot overcome or reduce.

Diversifiable Risk – These risks can be reduced or eliminated by using the technique of diversification of funds. In order to avoid these risks it is important to choose different funds so that market lows and highs do not affect all of them in the same manner.

How to Diversify Your Portfolio 

1. Investment Plan – Before you go around for any kind of investment it is important for you to have an investment plan that includes the tenure for investment, the minimum amount, returns expected and the mode of payment and return i.e monthly, quarterly, half-yearly or yearly. 

2. Choose different Investments of low correlation - Correlation means the relationship between two schemes or plans. In simple words it means the interdependence of schemes in your portfolio. This means that you need to choose your investments that go up and come down at different times. This helps you to sail comfortably through the bulls and bears of the market. 

3. Monitoring – It is mandatory for you to keep a close watch over your assets and keep rebalancing and monitoring your portfolio. The work of portfolio diversification does not end by simply selecting different options. It extends to rebalancing your portfolio by selling and buying. 

4. Stay invested and watch out for new opportunities – It is important for you to keep yourself invested for a longer duration in order to reap good returns and also keep a close watch on the new opportunities coming your way. Search for new investments and get rid of the non-profitable chunk. 

5. Investment Principles Work – Invest by following the investment principles. Merely going by predictions may land you in deep waters as no one can accurately predict the future. Create a quality portfolio and avoid being solely carried away by predictions. 

Where To Invest 
As stated earlier, it is very important to ensure that your investments are spread across different schemes and plans. Correlation can particularly prove beneficial while you diversify your portfolio.

There are many such examples that can guide you through while you invest in different plans. One such example is that of equity and debt. It is worth noticing that equity and debt have a correlation. It is seen that whenever there is a rise in interest rates the earning from debt plans grow significantly whereas returns from equity investments drop. So while you see that the interest is on a hike it goes without saying that those who have more of debt in their portfolio will benefit more in comparison to those who have less debt and vice versa happens when interest rates go down. Here, if you have a diversified portfolio it will work well for you. Moreover, the high rated debt instruments come handy with almost zero risk.

It is always advisable to create a combination of defensive stocks and high beta stocks in your portfolio. High beta stocks are ones that will fetch you a good growth when the market is at a rise but may become a pain for you during market slumps. They reap good but come with a considerable high risk. Stocks like that of FMCG and Pharmaceuticals are defensive stocks and trends show that they have been consistent with their performance in the market even when stock market has not been at its best. So using a combination of defensive stocks with high beta stocks may work well for those who like playing in equity.

Those of you who have bought two mutual fund plans and feel you have diversified your portfolio; it is time for a reality check. This assumption does not hold well if you feel that selecting and investing in different schemes of mutual fund would lead to diversification of portfolio. What will you do if you opt for two different mutual fund plans that have number of common factors between them? Always look out for schemes which are well diversified in the same category.

Assets like gold work in the interest of diversification of portfolio. It goes without saying that gold yields good returns even in hours of crisis. It is advisable to hold gold in your portfolio. Moreover, it shares a negative relation with debt and equity thus acting as asset for you when debt and equity both suffer a hit.

It is important for you to understand that having a big portfolio will not help. It is important to balance it out with right choices. If you want to draw best from your portfolio make sure you follow the rule of correlation while creating your portfolio.

Save yourself from Over-DiversificationIt is very important to strike equilibrium in case of diversifying your portfolio. In order to create a diversified portfolio do not get so much carried away that you end up investing in too many assets, schemes and plans. You should not spread your money so thin that all the effort goes in vain. Over diversification may shield you from great losses but it would surely lead you to losing good gains. So while you create your diversified portfolio do keep in mind that you need to strike the right balance without over indulgence as too many cooks spoil the broth.