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FINANCIAL STRATEGY
- What should Calcuttans do after buying a house'

Recently I gave a talk in Calcutta. At its end, I met some of my audience ' amongst them, quite a few appreciative readers of mine. They all read me in The Telegraph, but many of them had not even heard of Business World. A number of them were doctors. Despite a quarter century of communism, quite a few people have got moderately rich in Calcutta. Medical practice was one of the paths to prosperity; but in Calcutta economists and even less useful characters have prospered. Then there are people who have made money abroad, and have returned to Calcutta because the money goes further there. But they grew up in a society that is not used to wealth; so they have not picked up the first principles of investment. The first asset they buy is a house ' as shelter, not as investment. This preference for housing is behind the frenetic construction boom in Calcutta. After that, one could buy a second and third house. But landlordship is not a good idea in Calcutta.

One has to make sure that tenants pay rent and, if they do not pay, they get out; and that is not easy. So large-scale property ownership is not common. Nor is business promising. Many of these newly rich people are in a kind of business ' they are professionals. But expanding business means employing people, and very soon employees become a headache. Once they reach a critical minimum number ' say, a dozen 'they indulge in the Calcutta pastime of getting together and shouting abusive slogans. Then they join a trade union, usually CITU; the combination of unionism and government can make things quite uncomfortable for an employer. So people just grow their business to a size that gives them comfort, even luxury, but do not use it to multiply money as other Indians do.

What do these people do after they have got a house' Those I met apparently invest in mutual funds. Mutual funds are now being marketed by banks; those with a bank account yield to their bankers' sales talk. And just now, when the stock market is booming, many people have been investing in equity funds. But if I asked them about particular shares ' for instance, about Reliance ' their faces went blank. Like many of us who speak prose without knowing it, these people are investing their savings without knowing anything about investment. They are sleepwalkers in a minefield. Unfortunately, they have no better option. The profession of investment advisers or investment managers is undeveloped in this country. Having grown up in Poona and Bombay, I had friends who were sons of industrialists and stockbrokers, and was dabbling in the stock market from the time I got my first job. And the stock market is not just a gateway to equities; it is the gateway to knowledge about how business in India works. This gateway is largely closed to my esteemed readers in Calcutta.

So what can they do' They need to make themselves familiar with three concepts: liquidity, return and risk. Liquidity is the degree of an asset's similarity to money. Money is fully liquid; everything else is as liquid as it is easy to sell it. Thus, a fixed deposit can normally be instantaneously converted into cash and is therefore highly liquid, although breaking a deposit may entail some cost. Mutual funds are also generally extremely liquid. What few people realize is that shares too are extremely liquid. Stock exchanges are now on one-day settlement, and one can get cash for shares the day after sale ' two days if the stockbroker is lax. Property, on the other hand, is extremely illiquid. It takes months to cash it, after much hassle. A car is somewhere in between; now that second-hand car dealers are coming up, cars are getting increasingly liquid.

Return is the change in the value of an investment. Interest or dividend is only a part of the return. The other part is the change in the market value of the asset. Thus, if the market price of a house goes up, the rise in its price is a part of the return ' and so is a fall in the price. Many are today seduced by the way share prices are going up. They panic, thinking that if they wait, prices will go up further, and they will lose a chance of making a killing. So they buy in a panic. It is typical of the human mind that immediate events influence it more than remote events. People forget that prices of assets can fall, and that when they fall, their owners will try equally to sell in a panic.

That brings me to the third concept ' risk. Its measure is the probability of the return being different from its long-term average. The probability is zero for cash. It is close to zero for fixed deposits; the only risk is that the bank will fail. For all traded assets, there is a risk that the market price will change; it can fall as well as rise.

One reason why asset prices rise or fall is that interest rates change. Take assets that give a fixed rate of interest ' bonds, debentures or government securities. For each of these classes, there is a market rate of interest. It is the rate earned on an asset whose market price is Rs 100. If the market rate of interest on securities is 8 per cent, the price of an 8 per cent bond will be Rs 100. If the market rate rises to 10 per cent, the price of that bond will fall to Rs 80, and the return on it at that point of time will become Rs 20 ' its holder will make a loss of Rs 20. Conversely, if the market rate comes down to 6 per cent, the price will go up to Rs 133.33; the bond will give an instantaneous return of 33.33 per cent.

Interest is the return one gets for parting with liquidity ' by giving money to someone. Since money is used to buy all assets, their prices go up and down with the price of money ' with the rate of interest. They can vary with other things also. For instance, share prices vary with dividends, and, most important, with how optimistic or pessimistic investors are about a company's future performance. One reason for the stock market boom is that foreign investors are insanely optimistic about the Indian economy. But the interest rate is one parameter that affects prices of all assets.

Investment strategy entails working out what combination of liquidity, return and risk is right for one, and translating the decision into holdings of various assets. One should not be dazzled by the current return on equities; one should ask oneself how much liquidity one needs, and how much risk one can afford to take. That depends on one's stage in life and financial circumstances. As one's wealth grows relatively to one's needs, one can afford to reduce liquidity and take more risk. Whether one can translate higher risk into higher return depends on one's understanding of asset markets. And there are assets other than mutual funds.

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