Risk-Reward Ratio in Trading

Risk-Reward Ratio in Trading

It is very easy to find hundreds of articles about risk/reward ratio in trading, but the problem is that most of those articles are not written by real traders who trade for a living or have been working as professional traders for a while. Most of them are written by freelance writers who are paid to write articles or bloggers and webmasters who want to drive some traffic to their weblogs and websites.

Most of these writers have never placed any order on the market throughout their lives. The bigger problem is that novice traders believe each and every word of these articles, just because they are published on the internet, but they don’t know that the directions that these articles give are not applicable in live trading. After reading these articles, novice traders try to apply them in their trades and after such a long time of trial and error, they will think that they are not able to follow the trading rules and so they give up, whereas it is the information and directions of the articles that can not be applied in live trading.

For example, on most of the articles you read about risk/reward ratio, it is strongly recommended that novice traders should not even think about taking positions with a risk/ratio of as high as 1:1 or even 1:2 (I will explain what these numbers mean later in this article) and the maximum risk/reward ratio of the positions that new traders take should be 1:3. There is nothing wrong with it so far, but the problem is that these articles never clarify if traders should have a low risk/reward ratio through having wide targets OR tight stop losses. As nobody likes to lose, specially new traders, they all think that they should make their stop loss as tight as possible to have a low risk/reward ratio trade, whereas this is a big mistake. No matter how tight or wide the targets are, a trader can not fool around with the stop loss. Choosing the stop loss has its own rules that can not be ignored or broken. If you set your stop loss tighter than what it has to be, you will be stopped out easily even when your position is correct.

Something that looks even stranger in these articles is that they emphasize that “novice” traders should not take positions with 1:1 or 1:2 risk/reward ratios. Does it mean that experienced traders can do it? Are there different trading rules and techniques for novice and experienced traders? Maximizing the profit and having 1:3 or 1:5 trades can be done by professional and experienced traders, but there are some technical and emotional difficulties in front of novice traders to do that. For example, to achieve a successful 1:5 trade, you may have several losing trades (I will tell you why). This is not a problem for professional traders at all, but for a novice trader who is learning the techniques and has to build his/her confidence at the same time, having losing trades can cause lack of confidence and excessive fear that prevent him/her from advancing to the next steps.

So we can not believe and apply whatever we read over the internet. There are zillions of systems, techniques, indicators, robots and… that are absolutely useless when it comes to live and real trading.

After the above introduction, lets see what risk/reward ratio is and why it is important in forex trading. Risk is the amount of the money that you may lose in a trade. If you have already read the money management article, you know that we should not risk more than 2-3% of our capital in each trade. It means when we find a trade setup and we find a proper place for the stop loss, we have to choose our position lot size in the way that if the market hits our stop loss, we lose maximum 2-3% of our capital. For example we have found a trade setup with EUR-USD that has to have an 80 pips stop loss. We have a $5000 account. If EUR-USD hits our stop loss, we should lose $150 which is 3% of our capital (0.03 x $5000 = $150). It means 80 pips equals $150 (you can use the position size calculator I have on the money management article). This $150 is our risk. But what is the reward? Reward is the profit that we can make in a trade. In the above example, if we choose a 160 pips target for our trade and EUR-USD hits this target, we will make $300 (when 80 pips equals $150, so 160 pips equals $300). This $300 profit is the reward.

So what is the risk/reward ratio of this trade? 150:300 = 1:2

The larger the profit (target) against the loss (stop loss), the smaller the risk/reward ratio which means your risk is smaller than your reward. For example if your stop loss is 20 pips in a trade and your target is 100 pips, your risk/reward ratio will be 1:5 in this trade.

What is the recommended risk/reward ratio in  trading?

1:3 or 1:5 risk/reward ratio is achievable when the market forms a trend and you succeed to enter on time. In most cases you should be able to hit the top and bottom of the trends, no matter on what time frame you trade. Or if you enter at the middle of the way, the trend should be strong enough to give you another big movement and make a profit which is 3 or 5 times bigger than your stop loss. You can do that. Why not? But there are just a few problems: 1. Markets form a trend in less than 30% of the cases; 2. Some trends are not strong enough that if you enter with delay and while they are at the middle of the way, they can hit your target which is 3 or 5 times bigger than your stop loss. 3. There are many cases that you miss the trends; you hesitate to enter and so you miss the chance; you think you have found a trend whereas you are wrong and it returns and hits your stop loss and… . So you lose in many trades, because you want to catch a big one.

So in reality, you have to lose in many trades, or have many of your trades closed at breakeven by the stop loss (because you will have to move the stop loss to breakeven when you are in a special amount of profit), or not to trade for such a long time waiting for a strong trend, until you can have a 1:3 or 1:5 trade.

How is it possible to catch a 1:3 or 1:5 trade without losing so many other trades?

If you take a position with 1:3 or 1:5 stop loss to target ratio and then you wait for it to hit your stop loss or target, you will have so many losing trades before having a winning trade. The reasons are mentioned above.

The solution is in moving the stop loss. You should not let your stop loss remain at its initial position. To have a 1:3 trade, the distance of your entry and your final target should be splitted into 3 parts (at least), while each part is equal to your original stop loss value. For example if you have a 50 pips stop loss, you should have a final target for 150 pips which should be splitted into three 50 pips levels. Then you should move your stop loss in three stages (in this example I assume that you take a 3% risk in each trade):

1. If the price reaches to the first 1/3 level, you should move the stop loss to breakeven. At this stage, if the price goes against you and hits the stop loss, you will get out without any profit/loss, BUT you should consider that you had an initial risk of 3%.

2. If it reaches the 2/3 level, you should move the stop loss to 1/3 level. At this stage, if the price goes against you and hits the stop loss, you will get out with a profit which equals your initial risk. For example if your stop loss has been 3% of your account, you will get out with a 3% profit. Therefore, such a trade will be ended as a 1:1 risk/reward trade.

3. If it becomes so close to the final target, you should move the stop loss to 2/3 level. Then you have to wait until it hits the final target or returns and hits the stop loss. At this stage, if it goes against you and hits the stop loss, you will get out with a profit which is twice of your initial risk. For example if your stop loss is 3% of your account, you will get out with a 6% profit. Therefore, such a trade will be ended as a 1:2 risk/reward trade. If the price hits the final target, your trade will be closed with a 9% profit and so you will have a 1:3 risk/reward trade.

So, to have a 1:3 trade, you will have some -3% trades which are those trades that hit the stop loss at its initial position. You will also have some 0% trades that are those trades that hit the stop loss at breakeven. Some of your trades will be +3% trades which are those that hit the stop loss at 1/3 level. Some will be +6% trades which are those that hit the stop loss at 2/3 level. And finally, some trades will be +9% trades which are those that trigger the final target.

Now the question is what percent of your trades will be -3%, 0%, +3%, +6% and 9% trades?

It is impossible to answer the above question, because it depends on many things including the trading strategy and market condition. However, there is something that gives us a clue about the number of our 1:3 and 1:5 trades. It is the fact that says market trends only in 30% of the cases and it makes ranging, 70% of the time. To have 1:3 and 1:5 trades, we should have a strong trend, otherwise our stop loss will be triggered in one of the stages before reaching the final target, no matter what time frame you use to take your position.

No need to remind again that in any of the -3%, 0%, +3%, +6% and 9% trades your risk is the same which is 3%. The first conclusion is that taking the risk and the position is up to you, BUT it is the market that determines how your trade should be ended. This is something that all traders, specially novice ones should consider. When you read in different websites and web pages that your trades should only be 1:3 and 1:5 trades, you should consider that you really never know how many of your trades will be ended as 1:3 and 1:5 trades.

The stop loss of the positions that I take are chosen based on the technical analysis rules that I have for myself. I will never break any of these rules. Some traders think that my stop losses are too wide, but they are not. Unlike some other traders who have a constant value for their stop loss (for example any position they take, with any currency pair and any time frame, has a 120 pips stop loss), I mainly follow the rule of thumb we have for setting the stop loss. The rule says that you should place your stop loss in a position that becomes triggered only when the direction you choose is completely wrong. So when I want to set the stop loss, I ask myself under what condition the position I have taken is wrong. The answer I give to this question is the position of the stop loss. In one of the articles I published long time ago, I have explained about setting the stop loss and target orders.

So my stop losses can not be tighter. What about the targets? Can they be wider?

In the way that I choose the entries, most of our trades can have bigger targets and having 1:2 and 1:3 trades is possible with most of the positions we take, because our entry point is always well-chosen. Of course it can be different in different days, weeks and months. I will tell you how to trade my signals in the way that you can have 1:3 trades.

Now the question is if my signals can be used to have 1:3 and even 1:5 positions, why my targets are smaller than what they can be?

As you know in the typical signals that I send the members, usually there are two targets. The first target is usually half of the stop loss size and the second target is the same size as the stop loss. Traders can close 50% of their positions at the first target and then move the stop loss to breakeven. Then they can close the second 50% at the second target. There is a second way too. They can just move the stop loss to breakeven when the price reaches the first target and then close the whole position at the second target. In the last performance report I have published, I have explained 4 different ways that members can trade the signals I send them.

To answer the above question that why my targets are small, I have to say that they are small because there are different traders with different levels of skill among the members. Advanced traders know how to maximize their positions. They just use my signals to enter. However there are many other members who like to take as many positions as they can and they like to see them finished all green and positive. As I said above, they are building their confidence while they are learning the techniques. They need to see the positive result of the things they are learning. They are not disciplined and patient enough yet to maximize their trades and it is so painful to them, if a position which is in a good profit, suddenly goes against them and hits the stop loss at breakeven and they get out without any profit. The tight targets I have in the signals I send the members, are for these members. Unlike the others who believe novice traders should start with 1:3 and 1:5 trades, I believe they should start with 1:1 and even bigger risk/reward ratios to build their confidence. When they become more skilled, which can take them a few years at least, they can maximize their profits and have 1:3 and 1:5 positions. I am 100% sure that those who say novice traders should only take 1:3 and 1:5 positions, are not real traders and know nothing about live and even demo trading. Unfortunately there are zillions of them these days who develop  websites, weblogs and even robots and e-books. Forex is just a market for them to make money, not through  trading, but through selling useless  related products to “novice” traders.

Anyway!

From now on, each signal comes with two sets of targets. In the first set, the targets will be the same as they were used to be in the signals I sent. In the second set, the targets will be for a 1:3 risk/reward trade. The stop loss will be the same in both sets, because as I said I can not make the stop losses tighter. It is up to the members to choose the way they like to trade. We will have enough instructions in members area to help members to take their positions with any level of risk/reward ratio they like.

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Gann Theory - Gann analysis

Gann Theory

 Investment strategy developed by W D Gann, a successful twentieth century Wall Street trader, using continuous detailed analysis of the rate of change of stockmarket prices and applying strict trading rules, especially stop-loss levels.  The Gann analysis is based on Natural Law, geometrical proportions, and the Gann’s law of vibration, where every asset has its own vibration according to its individual energy.

Gann analysis

William Delbert Gann, was the creator of the  very popular Gann analysis, which includes such tools as  the Gann Fan, Gann Trend and Gann Grid. Gann used Natural Law (the usage of reason to analyse human nature and its moral acts) and geometric proportions based on the circle, square and triangle, to forecast prices and to provide a base for his theories. His analyses were based only on the relationship between time and price. 

Another theory  which the general Gann analysis is based on is the Law of Vibration. The principles of  Gann’s Law of Vibration, applied to the capital markets, were first presented to the public in his interview in 1909 to the “Ticker and investment digest”, and may be summarised as follows:

Each stock has its own distinctive path and range of activities based on trade volume, direction and others. All of them  move according to their individual patterns or as defined by Gann “Vibrations”. Gann also compared the stocks to atoms by stating that the first are also a kind of centre of energy which may also be defined mathematically. Another interesting statement from Gann is the opinion that stocks possess powers just as magnets do - they can attract and repel - meaning that sometimes they may be leaders in a market for a moment, and in the next, just stagnate.

 

Together with the above theories, Gann concepts were mostly based on mathematics, and its numbers retrieved from ancient history, like egyptology or even the bible. Some numbers had special meaning in his concepts of price forecasting, the most significant being 16, 25, 36, 49, 64, 121 and 144. According to Gann, these numbers together with geometry and  natural law have provided the proposed tools with a very significant forecasting ability.

Rule of thumb

• Gann's theoretical approach may seem to be rather enigmatic, however its practical application on financial markets comes down to usage of a number of tools
• The  most important are described within this section, and it can be quite simple

Gann Line

Gann Line is a simple tool indicating the direction of a current market tendency and its possible points of reversal.
The Gann Line is the most basic tool among the array of forecasting instruments based upon the theory created by W.D. Gann. The method is constituted by a line, drawn at an angle of 45 degrees, either ascending or descending. According to Gann’s theory, the trendline at 45 degrees represents a long-term trendline.

In the case of an ascending line, as long as prices remain above the trendline, the market is considered to be bullish. A fall of a price below that level may indicate a discontinuation of  a rising trend. On the other hand, prices below the descending line signal a significant downward market trend.

Rule of thumb

• The Gann Line is based on the theory that the long-term trends follow a 45 degree line

• As long as the prices remain above this line, the market tendency is considered to be bullish

Gann Grid

 
The Gann Grid may appear to be chaotic at first glance, however once properly set, it may provide insight into the development of the situation on the market.

Gan Grid is a variation of the 45 degrees Gann’s Line.

The 45 degree trendline is considered a long term trend, and prices  above that line are considered to be bullish. A situation when the market prices remain under the 45 degree line is considered to be bearish. Instead of having only one 45 degree trendline, the grid compiles a set of 45 degree lines plotted over a price chart. Whenever the price stays above one of the ascending lines, the asset is considered to be in a bullish movement.

On the other hand, whenever the price stays below one of the descending lines, the asset is considered to be in a bearish movement.

Rule of thumb

• Gann Grids implement the Gann’s theory, where a grid of lines at 45 degrees indicates  possible market patterns.

Gann Fan

 
Gann Fan is based on the theory that the relationship between time and prices follows certain patterns, and the tool is aimed at the separation of bullish from bearish prices.

The Gann Fan is one of the many techniques W.D. Gann developed to study price movements.

For the Gann Fan, it is required for charts to be drawn with equal time and price intervals, so that a price movement for each time interval equals a 45 degree angle. Gann believed that the ideal balance between time and price exists when prices move at a 45 degree angle, relative to the time axis.

Based on Gann theories, the Gann Fan is made up of 9 trendlines, which function as  support and resistance lines. When a price breaks one line, it should move to another line. The most important line in the Gann Fan is the 1x1 trendline (based on the 45 degree Gann line). Depending on the price being above or below this line, it will indicate a bull  or bear market. Besides this major trendline, Gann indicates 8 other minor trendlines, with angles greater/less than 45 degrees (4 greater and 4 less than 45 degrees). These minor trendlines are 1x2, 1x3, 1x4, and 1x8.

Rule of thumb

• The Gann Fan is generally used to determine trends - general market directions and potential support and resistance lines.

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Mistakes of stock Investment.

 5 mistakes of my first stock Investment

Do you remember your first stock market trade and how you behaved at the time? Just like you, even I, have made some really stupid mistakes while investing. Today, I would like to share some mistakes (only the big ones :)) which I made during my first trade in stock markets. Its worth discussing, how I could have avoided those mistakes. You can learn from them too!

Mistake 1 : Buying on Others Recommendation.

27th Nov 2007 : I had just got my spanking new trading account and I was so eager to trade and make lots of money(How to start in Stock Market) . I saw an Orkut community recommending GTC India – a “Buy” Recommendation. There were several good reasons discussed there, and an extrapolation on how it can reach from current price of 600 to 2000 in some months.  It looked like a “don’t-miss” trade. I bought 10 shares @ 560/-.
Mistake : Buying only on recommendation and not analysing the opportunity well, over relying on others recommendation, buying a company which I do not understand enough .
Learning : Never buy, just on recommendation! Do your own study and analysis. When you buy on others recommendation, you don’t take responsibility if there is any loss, which is dangerous in markets. Hear others but listen to your self. See other factors like market trends, sector view, global markets, future prospects et al. Once you are fully confident that its a good trade and you feel comfortable with it… go for it.

Mistake 2 : Being too greedy

After 3 days : Just after I bought the shares, it went up from 560 to 800 in 3-4 days. I thought that its moving as expected, and bought 10 more shares at 800. Within another week, it went up more to 950! Now, I was flying! I bought 10 more shares @955 again, to reach the target of 1500+ . My average buy price was now 772 . I was feeling little bad for not buying 30 shares directly @560 in the start .
Mistake : Greed! Pure & simple… This is a very common mistake, a big mistake at that – so big that it will be among the top mistakes investor and traders do. Buying more wasn’t wrong. It was the intention behind the buy. There is nothing wrong in increasing the position once it moves to your target, but it has to be backed up with strong reasons and study. It should be a trade with high probability of success. In my case, it was not. It was just a recommendation from someone in an orkut community, with a couple of lines, explaining, why it will go up .
Learning : There was no need to buy more shares that point in time. I should have just sat back and watched. The Stock market is just like our life, you need to have a level of satisfaction in your life and stock markets. If you want more and more and more, you might not get anything. In fact, you can lose heavily. Because of greed, I invested more than I could afford to lose. I took an unwanted and unaffordable risk, because I only saw profits and never the potential losses.

Mistake 3 : No profit booking on Time

After 1 week : The prices were not moving now. It was going up a bit then coming down again and was stuck in a range of 900-1000. It went up to 990 once. For a time being there was doubt in my mind if it will not move up to 2000 and will return back to my buy price levels.
Mistake : No profit booking. There was a sharp rise in shares price from 550 to 900 in just 2-3 weeks and that is rare. It doesn’t happen to every stock, it was an excellent return, but i did not book profits. Instead of making the best of the situation and taking the (not so bad) profits, the market was offering me,  I wanted more and more and lost even what I was getting.  The reason was Greed, again.
Learning : The better thing to have done, was to book profits, at least partially… Situations change in markets, I never checked on any news regarding the company after i bought the shares, and I was never updated about it. Every time you get some good profit, its a wise idea to at least book some partial profits out of it (Unless you have really strong reasons to hold it for long) .

Mistake 4 : Having Ego

In next 1 week : Prices now started coming down. It came to 900 first, I was scared and told myself that I will book profits once it goes back to levels of 950+. It never did! Then it came back to 800 and I regretted not booking a profit at 900 and said to myself again “I will book it for sure when it comes to 850.” Guess what? It never did! Then it went up a bit again and went up to 850 . I forgot my promise to myself & allowed my greed to take over my promise. It went down again after that and now it was near my average buy price. This was the time I was feeling, “What a big fool am I, for not booking Great profits!” I could have sold it at 0% profit, & yet I didn’t, because I would look a fool in my own eyes. Why Stock Markets Attract and Look Easy
Mistake : Ego ! Fear of losing part of profits, another mistake was the fear of not making any profits and fear of losing some money . Fear! Fear! Fear!
Learning : “When your boat starts sinking, you don’t pray… just jump” Once you are doubtful, surrender to markets wish. See what markets are showing you, not what you wanted to see. Markets are supreme and no one can be smarter than the markets. Leave your ego at your home, when you go in front of Markets. The markets tell you what’s going to happen, not vice versa. Accept that you are wrong and you made a mistake. Then move on.

Mistake 5 : No Patience

After few days : Then the prices started falling and plummeted to 600 (my original buy price). Now I was in loss. I was proven wrong, but I just couldn’t accept it. I kept trying to prove myself right by holding it and hoping it would come back up. Yea, you know… It never did . It went lower and lower and lower and I was just praying &  hoping that it’d return back to a level where I’d be happy to sell it. It never did! It went up to 300 and I sold it all in frustration. Then, I saw it go down to 250 and bounce back to 500! Now, I was feeling like I was cheated by the market for not giving me the right opportunity to exit.
Mistake : Impatience, Fear  and not cutting my losses short. I exited at a very bad time, at almost the lowest price then. There was an opportunity for me to exit at small loss, but taking a loss hurts the ego and it did. Not cutting my loss in time was the result, of my not defining my loss early enough. I should have had thought of it earlier. Then, I’d just pull a trigger, when it reached that level, without emotions. Fear overtook common sense, Fear overtook logic .
Learning : I should have defined my Target and Losses before taking the trade. I should have been realistic and logical. I should have waited little more time and then exited at a better price. I should have consulted someone, better than me (At that time though, even a street dog could have given a better advice than me :))

Price of GTC INDIA after this Incident : It never went above price levels after that and went to Rs 55 after couple of months , even  (Nov , 2010) , its hovering below Rs 65 only .

Conclusion and Summary

My first trade was not at all planned and “no plan” is “a plan to fail” . Fear! Greed! Emotion! Ego! Impatience! . These are the elements of Failure in Stock markets. Manage them well and you’ll do better!

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5 difference between stock & mutual funds Investing

When we say Equity, what comes to your mind – Stock or Equity Mutual Fund? While a single stock or a mutual fund both comes under the category of Equity and they are good option for long-term investment and needs periodic review. There are some differences between stock investing and mutual fund investing that is done by a common man. It’s a good idea to know where they differ and in which situation they differ, so that one can take better investing decisions. Let’s look at the main differences.

Volatility

When you invest in a single stock or bunch of stocks (3-5 scrips), the change in it’s value is very high. On a given day it can be extremely volatile. It can give you 20% return and sometimes -10% loss also depending on the environment. This can be very exciting and at the same time very disheartening and gives you a feeling that you need to “act fast”. 

Mutual fund on the other hand is not that much volatile by nature, as the diversification is very large and at a time 50-100 stocks are covered. Different kinds of stocks from different sectors and market capitalization are involved in mutual fund and the over all change in value is thus less volatile (other than extreme days).

Return Potential

This is very much in line with the above point but still let’s look at it separately. There are lot of success stories where someone got quick rich by investing in equities directly and it can happen, but those are rare happenings and require lot of work and analysis, patience and belief in what you have picked. If you want superb returns in short time and you believe you can research well, you can go for stock investing directly but then risk is also more.

Mutual funds are known to deliver good returns (not in line with stocks, but still very good). So you can expect handsome returns from mutual funds but not unbelievable like stocks return. This is mainly because the money is diversified across different stocks (read ideas) and chances of all of them becoming a super success in short time is impossible.

Monitoring Required

Stock investing is a personal affair and you are doing it on your own the decision of what to sell and what to buy is on you. Even in case of long-term investing, you might have to keep an eye every quarter or yearly unless you have really spent some good time in picking the good stock. You need to also keep an eye on news and sector specific developments.

Monitoring in mutual funds is relatively low because the job of monitoring is anyways done by the fund manager who is paid SALARY to filter through the fluctuations. He constantly adds and removes the stocks from the portfolio. This can be a positive point, but sometimes it can be a negative point also if there is too much of churning.

SIP Investment

Mutual funds are known for possibility of SIP (monthly investment). SIP in mutual fund works and is recommended as a great way for a salaried person to invest in equity markets for long-term basis without understanding the working of equity markets.

However SIP in stocks do not work. Yes, some companies provide you the facility of SIP in stocks, but it’s a terrible concept. There is no diversification and SIP in a particular stock does not make sense because the risk is with single stock. A stock can be in a bad phase for years and decades, whereas in a mutual fund the bad performing stock is weeded out.

Asset Class Restriction

Stocks investing is restricted to Stocks only. You can choose a large cap stock, mid cap stock or small cap stock, but finally it will be equity asset class. However, mutual funds can invest in mix of asset classes. There are equity funds, debt funds, gold funds, Mix of Equity and debt also. To top up, even balanced funds are there which can adjust the asset allocation on its own, so in a way mutual funds are more superior in terms of features compared to a single or bunch or stocks.

Conclusion

Mutual Funds are actually collection of stocks only but just because it’s a group of stocks the characteristics are not very similar to that of stocks. You should be clear about all the points of difference and only after that you should decide whether to invest in Stocks directly or take the Mutual Fund route.

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5 major changes in life insurance policies

5 major changes in life insurance policies from Jan 1, 2014 – How it affects you ?

Some major changes are going to happen in life insurance industry from Jan 1, 2014, especially in traditional policies like Endowment Plans, money-back plans and even ULIP’s. You will surely have a LIC policy or any other private sector traditional plans or might buy them in coming times. Here are 5 major changes which you should be aware about and they will come  into effect from Jan 1, 2014.

1. Service Tax introduced in LIC Policy Premium

Till now LIC was not charging the service tax of 3% from the customers and paying it to govt from the pool of money collected itself, but now the service tax will have to be charged separately from policy holders. Which means that if your LIC premium was Rs 50,000 per annum, now it will be 3.09% higher in first year, which is Rs 51,500  and after 1st year, it will be 1.545% as per moneylife article.

While customers see it as additional burden, note that its not the case exactly, Earlier – LIC was paying the service tax from the pool of money collected from investors only, which reduced the bonus amount given back to them. But now because it will not be taken out from the funds, that means the bonus declared each year will go up by that much margin and will come back to investors only. Note that Pvt companies were charging the service tax already, so nothing changes on their side. Only LIC was not charging it separately, which they will have to do from Jan 1, 2014 deadline.

2. Increase in Surrender Value

One of the major changes which has happened, is the change in surrender value for policy holders. The rules of surrender value depends on the premium paying term of the policy. If the premium paying term for policy is less than 10 yrs. Then the policy will acquire the surrender value after paying premium for 2 yrs (earliar it was 3 yrs), however if the premium paying tenure is more than 10 yrs , then the surrender value will be acquired only after paying 3 yrs premium.

In both the cases, the minimum surrender value would be 30% of the premiums paid without excluding the first year premium. Note that earlier, if you used to surrender after paying 3 premiums, you got 30% of premiums paid MINUS first year premium, but now as per new rules, the first year premium will not be deducted. Learn everything about LIC policies working before Oct 1

Another good change is that, from 4th-7th year, the minimum surrender value would be 50% of the premiums paid, and has to reach 90% of premiums paid in last 2 yrs of policy paying tenure.

3. Possible Decrease in Premium on LIC Policies

There is a great possibility that the premiums on LIC policies will come down by some margin, because the mortality rates will now be revised by LIC in calculating the premiums.

Mortality rates are the rates at which the insurance company deducts the fees for insuring you based on your age. LIC had been using old mortality rates till now, but now they will have to use new mortality rates . Just to give you an idea on reduction of premium, when I check the mortality rate for a 40 yrs old person in old table, its 0.001803 . But in new rates its 0.002053 . Which is approx 10% better. Lets not go into detailed calculation at the moment, but your risk premium part should go down by 10% (not the full premium, because only some part of whole premium in traditional policies are risk premium and rest is investment part) .

4. Higher Death Benefit

If the policy holder is above 45 yrs of age, then the Sum Assured has to be more than 10 times the annual premium, and for those who are less than 45 yrs old, it can be minimum 7 times the premiums. Note that for claiming the tax exemptions, your sum assured has to be 10 times the base yearly premium. So when you buy the policy in-case, you need to keep it in mind. BasuNivesh has done a great point by point notes on each aspect of regulation, in-case you want to go into details.

5. Agents’ incentives have now been linked to the premium paying term

Now agents commissions is linked to the premium paying tenure. Earlier a lot of agents used to sell the policies which had higher maturity tenure, but limited premium paying tenure (like 30 yrs policy with 10 yrs premium payment) . Here is the new commission structure taken from Moneylife article 

In case of regular premium insurance policies, a policy with a premium paying term (PPT) of five years will not pay more than 15% in the first year. Products with PPT of 12 years or more will have first year commissions up to 35% in case the company has completed 10 years of existence and 40% for the company in business for less than 10 years.

The funny aspect is that a lot of LIC agents tried to mislead many new investors by projecting date Jan 1, as the deadline when a lot of LIC products will stop giving good features using the official notification. LiveMint has even captured it in this image.

What should you do ?

The insurers have to refile all their products to IRDA and already lots of products have been approved and many are still waiting for approvals. So if you have a insurance policy, then you will get the communication from your insurer about any changes if any. Right now, for sure the traditional plans have got better, compared to their past avatars.

If you are adamant on buying endowment plan, better wait for some time and let things get more clear. Let me know about your thoughts on this change ?

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Transfer PPF account from Post Office to Bank

How do you transfer PPF account from Post Office to SBI Bank? This has been a big question mark for all the PPF account holders who opened their PPF account in Post Office and now want to transfer PPF account to SBI Bank or other banks so that they can take benefits of online money transfer to their PPF accounts. Also it becomes easy for them to do other kind of activities if PPF account is in some bank.

So, in this article we will see the steps required to transfer PPF account from Post office to any Bank. In this example we will use SBI as the example. But you can use the same procedure for any SBI Bank or its subsidiaries or even ICICI Bank which has recently started providing PPF accounts.

Steps required to Transfer PPF account from Post Office to SBI Bank

Step 1	First step is to make sure your PPF Passbook is updated with all the interest credited till date. You need to go to Post Office and get it updated.
Step 2	Fill up following documents PPF Transfer Form SB-10(b) . Download Form to transfer PPF Account here An application on plain paper requesting PPF Account transfer from Post Office to SBI Bank Incase you already have a SBI Account, then SBI passbook (Will fasten the process) PAN/Address Proof (Can be confirmed at Post Office)
Step 3	Submit the form to Post Office Head PostMaster, He will verify your signature with the records at Post Office and verification will be completed.
Step 4	The balance in your PPF account in Post Office will be taken out and your PPF account will be closed by Head Post Master and he will note the remark of Transfer of PPF Account to SBI Bank on all the relevant documents.
Step 5	The balance amount in your PPF account will then be remitted back to State Bank of India through Cheque or Demand Draft along with other relevant documents.
Step 6	Your PPF account will then be opened (transferred) at SBI Branch and you will be notified on this. It would be better to not wait for it and you yourself keep track of the progress.

Go to SBI bank after all these steps are done and collect your new PPF Passbook. Note that all the previous entries of your Interest payments etc will not be present in the new PPF Passbook. It will only have the new and current entries now. So in-case you needed the previous information for claiming tax deductions, better take the printout of the previous PPF Passbook and keep photocopies of all the documents you filled and submitted for PPF Account Transfer.

What about interest part when you Transfer PPF account from Post Office?

Do you know How PPF interest is calculated ? Its only monthly basis , but credited yearly. Now as per PPF Rules, the bank or the post office transferring the account will add interest up-to the preceding 31st March in the account before the it is transferred. The interest from 1st April onwards will be added by the transferee office after the close of the year. As per rule 8 of the scheme the interest in the account has to be added at the end of the year and not in the middle of the year in any case. So make sure to ask and confirm from Post Office Postmaster if he will do this step or not. And once the PPF Account is transferred, at the end of the year, make sure you get the total interest in your account. Just verify it at the end of the year.

What Problems you are can face while Transfer of PPF Account?

Problem 1 : The biggest problem you will face is the ignorance SBI & Post office employees have about this whole process. I think Post Office Employee has more information (and less ego) than SBI Employees. They might reject the whole idea and say “Its not possible to transfer”.

In that case, take the print out of Rule 153 of this document which is at Post Office website and clearly defines the rules to Transfer PPF Account from Post Office to SBI Bank. Another thing you can do is very humanly and in a soft voice, tell them you will file an RTI to know the process of PPF Transfer from Post Office to SBI Bank and would come back with that RTI query (Post Office and SBI comes under RTI incase you didn’t know). I am sure this will be enough to speed up the whole process.

Problem 2 : Another problem you may face is documentations, I am not very sure if PAN card/Address proof is required or not and what other documents, but in that case again take help of your Post Office Head Post Master, he will surely help you. If you are stuck at any points, use sentences like “I will file an RTI and … ” . That might help you.

 

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Public Provident Fund (India)

Have a PPF Account? Read This

Till date, the Public Provident Fund (PPF) scheme is the most popular investment in India. If you’re looking for an exemption on the money you invest, interest that is non-taxable and a maturity amount that is exempt from tax as well, this is the instrument for you.

So it’s no surprise that with these 3 very prominent benefits, almost every individual in the country has a PPF account and contributes to it religiously every year.

But do you really have total PPF knowledge? Are you aware of interest rate changes in the PPF over time? Do you know that this money can never be attached to any debt or liability i.e. it is yours forever? There are many ways in which you can derive the maximum benefit from your PPF account. Let’s see if you know everything you need to know about this incredible investment instrument.

Let’s get straight to the facts...

1. PPF stands for Public Provident Fund - a government backed, long term, retirement savings instrument.

With a 15 year lock in, this is the longest horizon for an investment that exists in India. If you are keen on a safe investment, a decent rate of return, tax benefits (deduction and tax free interest) and have a long term investment horizon, then the PPF is for you. It is a disciplined investment avenue as your money is blocked for 15 years. PPF also offers loan against the account which can help you during occasions like a wedding in the family, further studies of your children, etc.

2. The main features are:

1. the 15 year lock in,
2. the E-E-E status (tax exemption on investment, interest and maturity) under Section 80C,
3. the minimum investment of Rs. 500 p.a. and maximum of Rs. 1 lakh p.a. (w.e.f 01-Dec-2011)
4. and the interest rate which currently stands at 8.8% for this fiscal year. The interest rate will be announced annually, it is no longer fixed at 8% p.a.
   
   

In fact, the PPF interest rate has steadily dropped over the years, and can be expected to slowly fall as the years proceed. Here’s a look at what rates used to be in the hey-days of the PPF account:

Period	Interest Rate p.a.
01 April 1986 - 14 Jan 2000	12%
15 Jan 2000 - 28 Feb 2001	11%
01 March 2001 - 28 Feb 2002	9.50%
01 March 2002 - 28 Feb 2003	9.00%
01 March 2003 - 30 Nov 2011	8.00%
01 Dec 2011 - 31 March 2012	8.60%
01 April 2012 till date	8.80%

01.04.2014

Present

8.7%

3. An NRI can’t open a PPF account.

The rule of 25th July, 2003 states that ‘Non Resident Indians are not eligible to open an account under the PPF Scheme’. However ‘Provided that if a resident who subsequently becomes a Non Resident during the currency of the maturity period prescribed under the PPF scheme may continue to subscribe to the Fund till its maturity, on a Non Repatriation Basis.’

So if you open it as an RI, and during the 15 year tenure become an NRI, you can continue to invest, but on a non-repatriable basis.

4. You can make up to 12 investments in a year into your PPF account, in multiples of Rs. 5.

5. You can transfer your account from one ‘Account Office’ to another for example for convenience if you shift home.

6. The best time to invest is between the 1st and the 5th of any month, preferably April each year. Interest is calculated for the calendar month on the lowest balance at credit of your account, between the close of the 5th day and the end of the month, and is credited at the end of every year.

7. Regarding withdrawals from your PPF account, there are 3 things you need to know:

a) Any time after the expiry of the 5th year from the date that the initial subscription is made, you become eligible to withdraw an amount of not more than 50% of the previous year’s balance or of the 4th year immediately preceding the year of withdrawal, whichever is less. If you have taken any loan on your PPF, this also gets factored in and reduces your balance.

b) You cannot make more than a single withdrawal in the year. you need to apply with Form C for any withdrawals.

c) Our PPF Calculator helps you see exactly how much you can withdraw from your PPF account and also how much loan you are eligible to avail, and in which years.

8. You can close your account or continue your account without deposits after maturity...

Any time after your account matures i.e. after the 15 year tenure is over, you can withdraw the entire balance using Form C. Interest will continue to be paid on your account and you will receive the total amount including interest up to the last month preceding the month in which you apply for a withdrawal.

9. You can even continue your account with deposits after maturity...

Few people know this, but the PPF account is indefinitely extendable. It has a 15 year lock in, but then you can extend it for periods of 5 years at a time, indefinitely. Your account continues to operate normally i.e. you make deposits of up to Rs. 1 lakh, earn interest and renew after 5 years if you wish. Everything remains E-E-E. To extend by a block of 5 years, use Form H.

10. You can withdraw, even if you choose to extend...

If you choose to extend by subscribing for a 5 year block, you can make partial withdrawals (using Form C again) of up to 60% of the amount standing at your credit at the beginning of this 5 year block period.

11. At any point in your life, you are allowed to have only 1 PPF account in your name.

You can also have an account in the name of a minor child of whom you are the parent / guardian. However that will be the child’s account, you will simply be the guardian.

If at any time it is seen that you have more than 1 account in your own name, the second account will be deactivated, and only your principal will be returned to you.

12. If you choose to take a loan against your PPF account, you can repay it within 36 months from the 1st day of the month following the month in which the loan was sanctioned. So if your loan is sanctioned in June, 2012, the following month is July 2012, and you have until end July 2015 to repay your loan. The interest rate charged is 2% p.a. over the prevailing PPF interest rate.

Conclusion

There’s a lot to know that can help you make the most of your PPF account. And if past rate changes are anything to go by, you can expect 8.80% interest to not last forever. As it stands today, the PPF remains E-E-E, so make the most of it to add to your retirement corpus. Feel free to use the PPF Calculator.

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10 points you must know while investing in Mutual Funds

10 points you must know while investing in Mutual Funds

Today, with over 3,500 mutual schemes available in the market the task of picking the right mutual fund can be rather mind boggling. Moreover with a tendency amongst investors to fall for the "Rs 10" investment proposition - offered by New Fund Offerings (NFOs), the task of picking the right ones can be even more daunting. While many investors also do feel that 'any' mutual fund can help them achieve their desired goals, let us apprise you that each mutual fund scheme is unique and caters to a certain risk profile. Moreover, selecting winning mutual funds involves a rigorous process, where both quantitative and qualitative parameters are considered, as it is imperative to have consistent performers in your portfolio; those who can stand by you in sickness and health.

Thus while there are host of factors to be studied, while picking a good mutual fund (which may not be everyone’s cup of tea to evaluate), we recommend that one can broadly look at the following 10 points, which can enable in selecting the right one:

1. A fund sponsor with integrity
   
   Fund sponsor are individuals who think of starting a mutual fund house. They approach the capital market regulator - Securities and Exchange Board of India (SEBI), who then provide them approval to enter the mutual fund business (after having ascertained their credentials). After having given the approval by SEBI, the sponsors then establish a Trust under the Indian Trust Act, 1882, and the trustees of which appoint an Asset Management Company (AMC), who then manages investors’ money.
   
   It is vital for you investors to recognise this 3-tier structure of a mutual fund house, as the linkage of the same will help you understand who the promoters are, their record in the financial services domain and the experience which carry along with them. While SEBI would grant a permission to start a mutual fund only to a person of integrity, with significant experience in the financial sector and a certain minimum net worth; it imperative for you to be satisfied (by your own judgement) on these aspects. We believe these background checks are necessary be it sponsors from India or abroad.
   
   
2. Experience of the fund management team
   
   While the trustees assign the job of managing investors’ money to the Asset Management Company (AMC), a check over the experience of the fund management team may ensure that you give your hard earned money in competent and deserving hands.
   
   While many investors’ often get impressed seeing more number of schemes managed by the fund manager (of a respective fund houses); in our view this is rather worrisome since it reflects transcending pressure on the fund manager while managing investors’ hard earned money. It may so happen that he may simply replicate the portfolio, and in the bargain defeat the unique mandate of each scheme managed by him. In our view, ideally, a fund manager should not be managing more than 5 schemes; as such a "funds-to-fund manager ratio" can help in bringing in efficiency while managing your hard earned money.
   
   Also we think that one should not merely invest in a respective mutual fund scheme of a fund house, just because it is managed by a star fund manager. Many mutual fund distributors / agents / relationship managers may persuade you to invest in mutual fund scheme managed by a star fund manager; but then you need to ask relevant questions on track record of performance of all the mutual fund schemes managed by the star fund manager (which your mutual fund distributor / agent / relationship manager has high regards), where you need to check the following:
   
   
   • Returns of the respective mutual fund schemes
   • Risk investors are exposed to (as revealed by the Standard Deviation)
   • Risk- adjusted returns achieved by the fund (as revealed by the Sharpe Ratio)
   • Portfolio churning (as revealed by the Portfolio Turnover Ratio)
     
     
   Moreover, as a litmus test you also need to ascertain how the respective mutual fund schemes managed by the star fund manager has sailed during various market cycles (i.e. during bull and bear phases of the markets). Mind you, while your mutual fund distributor / agent / relationship manager may have everything to boast about the star fund manager during the bull phases, the true test of the fund manager (he's promoting) lies during the bear phase. This is because the respective mutual fund schemes managed by the star fund manager must display limited downside risk during the turbulence of the equity markets, thereby attempting to protect wealth erosion. And indeed if the fund manager has delivered a luring performance, then you got to ponder over the question of what should you do if the fund manager leaves the organisation (for better career prospects, or even when he retires). While this may sound a bit too much of long- term thinking, in our opinion it is imperative if the mutual fund house is not process and systems driven, whereby the fund manager has been given the leeway to manage a mutual fund scheme based on his individual fund management traits.
   
   
3. Investment philosophy, processes and systems followed at the fund house
   
   After having done an evaluation on the fund manager and his team’s experience, what is the broader investment philosophy at the fund house should be well recognised. Moreover, you also need to assess whether investment processes and systems have been well laid down by the respective mutual fund house. It is noteworthy that prudent investment processes and systems have a major impact of individual mutual fund schemes perform, and moreover tend to sail well during the turbulence of the equity markets and also when the fund manager quits or retires from his job. This is because everything is well-defined through an investment process and system (along with a mandate which a respective fund follows), and is not left to the fund manager’s whims and fancies. It is noteworthy that getting a fund house following strong investment processes and systems is the first, right and very important step in making a prudent investment decision in mutual fund investing. Hence it is important for you as investors to delve a little deeper in understanding all these aspects before entrusting your hard earned money to a respective fund house.
   
   
4. Investment objective
   
   Every mutual fund scheme, irrespective of the category - whether equity or debt has an investment objective. It is this investment objective which entails them to invest in various asset classes in defined proportions. As investors it is imperative to check the investment objective of the respective mutual fund scheme, and thereby see whether it suits your objective of investing as well. For example, if you have an objective of capital appreciation with a long-term investment horizon in mind and is willing to take high risk, then you should be looking at equity oriented mutual funds. Similarly if you are a risk averse investor, you should be looking at suitable debt mutual fund schemes (depending upon your investment time horizon).
   
   
5. Investment style
   
   Further depending upon your risk appetite, you can also structure your mutual fund portfolio as per market capitalisation bias (i.e. large cap, mid cap, small & micro-cap, mutli cap and flexi cap) and fund management style (i.e. opportunities style, value style, growth style and blend style). While one may argue over how the layman can judge which market cap bias and investment style the mutual fund scheme follows; we would like to apprise you that it’s all there in the mutual fund scheme’s offer document, which you ought to read well before parking your hard earned money.
   
   
6. Fund performance
   
   The past performance of a mutual fund scheme is important in analysing a mutual fund. But remember that, past performance is not everything, as it may or may not be sustained in future and therefore should not be used as the only parameter to select winning mutual funds. While during good times your mutual fund distributor in pomp, may exhibit you performance charts and tables, you also need to evaluate them in context to:
   
   
   • Risk they have exposed you to
   • Risk-adjusted returns clocked
   • Portfolio which they held (and its characteristics)
   • How often the fund has churned its portfolio
     
     
     
   Moreover, merely studying these numbers in isolation can do no good to you. On the contrary a comparative study on these, along with analysing performance across market cycles can help you in picking the good ones.
   
   While one may say why not invest in star rated funds if such vigorous process has to be followed, we would like to acquaint you that merely relying on star ratings (which are illustrated taking into account only quantitative parameters) may not enable you to have rock stars or winning mutual fund schemes in your portfolio. This is because when quantitative parameters (on which they are rated) undergo a change, mutual fund schemes would also play musical chairs. A fund which is "5 star" rated today, may become "3 star" in the ensuing year. The financial crisis of 2008 has shown that credit rating agencies were happy to sell their star system to those who offered them money. The saddest part is that, this completely misled the investors.
   
   Mind you, at PersonalFN we have never followed an "issuer pays" rating model. Our rankings are completely unbiased and independent, taking into account both quantitative as well as qualitative parameters. We never, put anything before the interest of our investors'. And that makes us unique.
   
   
7. Expense ratio
   
   Like any other organisation, a mutual fund house also incurs annual expenses (such as administrative costs, management fees, etc.) to run it business. Expense Ratio is the percentage of assets that go towards these expenses. Every time the fund manager churns his portfolio, he pays a brokerage fee, which is ultimately borne by investors in the form of an Expense Ratio. It is noteworthy that, higher churning not only leads to higher risk, but also higher cost to the investor for all the brokerage charges and taxes incurred on every trade. Costs are always there and are deducted immediately, but the returns and a higher NAV are a hope for all investors. Hence it is always recommend to select a mutual fund scheme, which has got a low expense ratio as compared to its peers.
   
   
8. Exit load
   
   Likewise, you should also be checking the exit load which a respective mutual fund scheme would charge. An exit load is levied when you sell your units of a mutual fund within a particular tenure; most funds charge if the units are sold within a year from date of purchase. As exit load is a fraction of the NAV, it eats into your investment value. Thus it is imperative that you invest in a fund with a low exit load, and more importantly stay invested for the long-term.
   
   
9. Investor service and transparency
   
   Services offered by mutual fund houses may vary across funds. Some fund houses are more investor friendly than others, and offer information at regular intervals. For instance, fact sheets of some mutual fund schemes are not disclosed in entirety, where the undisclosed portfolio holds a large composition, thus making one wonder in which securities is the money parked by the fund house.
   
   Thus while investing, it important to delve a little detail and assess whether the fund house and the respective mutual fund scheme adopts good disclosure norms, thus making you exude confidence in them and take a prudent investment decision.
   
   
10. The tax implications
    
    Many a times investors go by the word of their mutual fund distributor / agent / relationship manager and invest in mutual funds. While we aren’t debating about quality of the advice they provide (on a respective mutual fund scheme per se), we think that it is necessary for you to be aware of the tax implications of a respective mutual fund schemes.
    
    Apart from being aware of tax status for Equity Linked Savings Schemes (ELSS) - where you are entitled to a deduction under section 80C of the Income Tax Act, 1961 for the investment made upto a sum of Rs 1 lakh; through experience we can say that many investors aren’t aware of the other tax implications of investing in equity and debt mutual fund schemes.
    
    It is noteworthy that in equity mutual funds, if you have opted for the dividend option (for the reason that you want cash inflows to be managed through dividends), then the dividends which you received under the scheme is completely exempt from tax under section 10(35) of the Income Tax Act, 1961.
    
    If you are caught in the wrong habit of short-term (period of less than 12 months) trading, then you got to forgo your profits/capital gains, if any, in the form of Short Term Capital Gains (STCG) tax. STCG are subject to taxation @ 15% plus a 3% education cess. However, if you are the one who deploys money for the long-term (over a period of 12 months) and thus subscribe to a good habit of long-term investing, then there is no tax liability towards any Long Term Capital Gain (LTCG). Moreover, at the time of redeeming your units you will also have to bear a Securities Transaction Tax (STT) @ 0.25%.
    
    Similarly in debt mutual fund schemes too, if you have opted for the dividend option (to manage your cash inflows), then the dividend which the scheme declares will be subject to an additional tax on income distributed. Hence, in such a case you as an investor are actually paying the tax indirectly.
    
    Unlike equity funds, in debt funds, you are liable to pay a tax on their Long Term Capital Gains (LTCG) tax, which is 10% without the benefit of indexation and 20% with the benefit of indexation. However in case of Short Term Capital Gains (STCG), you will be taxed at the marginal rate of taxation i.e. to simply put, in accordance to your tax slab. As far as STT is concerned, debt mutual fund investors do not have any liability to defray the same.
    
    Thus you got to be aware of all these tax implications, which in turn would help you making a wise investment decision.
    
    

It always important to remember that investing is a serious business; and thus it is vital that you adopt enough prudence before you invest your hard earned money. Moreover, a disciplined approach to investing can help you to create wealth in the long run.

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