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Market Cap to GDP Ratio?

The sense and nonsense of market cap to gross domestic product ratio

Punditry of all kind has jumped on to the bandwagon and this ratio has become one of the most used and abused in the financial markets

Rajeev Thakkar, Mint 23/2/15


Still, it is probably the best single measure of where valuations stand at any given moment.” So said Warren Buffett in December of 2001, in reference to the market capitalization to gross national product ratio (he used GNP in 2001 and GDP, or gross domestic product, while giving a talk earlier in 1999).

Buffett used the ratio in 1999 to illustrate that stock market returns were far higher than the rate of growth of the economy over a 17-year period and that stock valuations looked expensive. Sometime later, the Dot Com boom went bust and the rest, as they say, is history.

Since then, punditry of all kind has jumped on to the bandwagon and this ratio has become one of the most used and abused in the financial markets.

These days it is almost heresy to argue against what Buffett has said. However, the ways in which the market cap-GDP ratio is used these days is not right. Buffett himself has not given an unconditional support to this ratio. In the same article, in Fortune, he says, “The ratio has certain limitations in telling you what you need to know.”

Cross-country comparison

When we use the market-cap-GDP ratio to do cross-country comparisons, we come to strange conclusions. Let us look at an example. Say, the US GDP is approximately $17 trillion and the market cap is $22 trillion.

The ratio of the two works out to 1.29. At the other end, let us look at Saudi Arabia. Here the GDP is about $745 billion and the market cap is only $483 billion. So, the market cap-GDP ratio would be 0.64. Does this mean that Saudi Arabian stocks are undervalued and American stocks are overvalued? (We are not considering oil prices here.)

What if I told you that the estimated market value of Saudi Aramco, the national oil company which is not listed, was estimated at $7 trillion by The Financial Times?

If this company were to be listed on the Saudi Arabian stock exchange, the market cap-GDP ratio of the country would immediately jump to more than 10.

In cases of communist countries such as Cuba, there may not be any market cap as there are no listed companies, while obviously there is GDP.

Hence, conclusion No.1: Cross-country comparisons do not always make sense. The ratio would get skewed because each country would have a different proportion of listed versus unlisted enterprises.

Let us do a thought experiment. Assume that all the states in the US are independent countries. Would it make sense to compare the market cap-GDP ratio of California (which has high-tech industries, entertainment, tourism, and more) to that of Nebraska (agriculture) or Texas (mainly oil and agriculture)?

In the same way, it does not make sense to compare Russia or Australia with India on this parameter.

Conclusion No.2: The composition of each economy differs. Some economies are material-led and have sectors such as mining and oil and gas. Some have manufacturing companies while others are services-led. In such cases, too, cross-country comparisons do not work.

Comparison across time

So what about comparing an economy over a certain period? Surely monitoring the market cap-GDP ratio of the Indian market over the years would indicate some trends on valuation? Maybe not. For one, the proportion of listed businesses versus the unlisted ones keeps changing over time. For example, we did not have companies like Tata Consultancy Services Ltd, Coal India Ltd and DLF Ltd listed on Indian stock exchanges in 2003. These businesses existed for many years before getting listed. But the fact is that even just these few companies may account for as much as 8% of India’s stock market’s market cap today.

And we still do not have entities such as Indian Railways, Life Insurance Corp. of India, Bharat Sanchar Nigam Ltd and Air India Ltd listed on the exchanges. If these organizations were to get listed, say, over the next decade, comparing the market cap-GDP ratio for Indian markets over a period of time would again not make sense.

This means that using comparing this ratio for the same economy over time is also fraught with risks. So, take the pontifications of gurus on this ratio with a pinch of salt.

Market cap-GDP ratio versus interest rates

Investors are looking at opportunity cost all the time. Some may patiently wait, keeping their money in a bank account till the right opportunity arrives. Ultimately the money has to be put to work and returns that one gets depend on the investing environment.

One of the important factors governing the investing environment is the prevailing level of interest rates on risk-free government bonds. Buffett refers to this in his 1999 and 2001 articles. The market-cap-GDP ratio was low at the time when government bond yields had gone up to 15% per annum. Conversely, when interest rates are down and are expected to stay low, the ratio increases.

This brings us to another conclusion, that the ratio also has to be seen in the context of the prevailing interest rates and the opportunity cost of capital.

The ratio is not something that can be used to pass judgement on where a market is in terms of valuations and whether it is attractive or not. Many people use the ratio to call market tops or to give buy advice. It is incorrect to do so.

Rajeev Thakkar is chief investment officer and director, PPFAS Asset Management Pvt. Ltd.


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Be Smart with Credit Cards

Credit Cards, otherwise called as Plastic Money is an Unavoidable Deadly Friend in today’s world. Deadly, if you don’t use it sensibly, and a great Friend if you follow simple steps, procedures in using it. Since there are many advantages as well, I am not going to ask you the question: if you really require a card? We all do!

by Vivek Karwa, 18/1/2015


1. Applying for a new card: Most banks have both free cards and chargeable cards now days. Some cards are free while applying and also free from any recurring charges. Some cards come with application fee but no recurring charges and the other category is fee while applying with an AMC every year!

The features and the credit limits differ in each category and their sub-categories!

As a first timer it is better to apply for the basic, all free card. The same can be upgraded later. Take a copy of the features while handing your application to the bank or its agent.

2. Credit Limit: If you are an impulsive shopper, it is better to have a card with lowest possible limit. Self control over expenses is the first requirement in safe usage of cards. Say if your limit is Rs.10000/- every time you hit the limit you can pay and then use again. This method controls your spends. Keep in mind having large limit is not something prestigious! You can be smart even with very low limit. You can always call the customer care and get your limit decreased.

3. Secondary Cards: Many banks offer secondary cards with the main card. Meaning a spouse can have the primary card and give the secondary card to the other partner, you can have the primary and give the secondary to your children. Remember in such cases the liability of entire spend is on the primary card holder!

4. PIN and Passwords: Now days as an added facility all cards come with mobile password facility for very transaction done online. Always keep the PIN and your passwords with you alone. Never ever share the same to anyone calling you even though at times they may say that they are calling from the bank! Remember banks don’t require your PIN so they will never ask you.

5. Payments: Always pay in full. The banks give you minimum payment facility but then you are charged hefty as interest rates! Certain cards charge you 3.5% per month as interest! That’s whooping 42% per year! This is the reason in the above point I asked you to keep the limit low so that you would spend within limits. Paying in full keeps your CIBIL score strong!

6. Cash Facility: Never avail this facility. It sounds good in case of emergencies but even if you take it, pay it immediately within the due dates.

7. Credit Transfer Facilities: Banks will offer you to transfer other card dues to their cards at No Charge! Just ask yourself are Banks fools? Hope you got the answer hence never avail this facility!

8. Always Remember the Statement Dates: Every card will have their own billing cycle dates! Say today is 10th of the month and your statement is prepared on 12th of every month, then you can very well wait for two days and then spend on the card! This way the bank funds you for almost 40 days! Then pay on time! I have statement date written on every card of mine and always spend on the card which has farthest billing date! Actually banks lose every month due to me!

9. Be aware of all programs and benefits: Have you not seen shops offering special discounts to certain card holders? Every bank comes with unique offers! Know them and benefit out of them.

10. Spend only on Needs: Don’t spend just to avail an benefit! Avail the benefit when you are actually spending! Confused? I mean always spend on your Needs and not on Wants! Wants will always be there, just because a discount is running on a product, you need not go and buy it!

Cards are surely of immense use! You need not load your wallet and move around! Even if stolen the person may not be able to use it if you have activated the PIN. You just cannot avoid plastic 😉



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Wealth after you’re gone!

The outlook towards succession planning and distribution of wealth is changing

Vivina Vishwanathan, 17/8/2014 Mint

Overall outlook towards succession planning and distribution of wealth has changed in India, especially when it comes to the First-Generation Rich.


In 2008, Ramamurthy Thyagarajan, chairman of Chennai-based Shriram Group with annual revenue of Rs.13,600 crore, had set up a trust—Shriram Employees Welfare Trust. According to him, through this trust all executives who have participated in the growth of the group’s business would be beneficiaries and none of his family members would be part of the management or ownership. This is contrary to traditional Indian families’ approach to passing on wealth to its next generation.

Industry experts say that over the years, the overall outlook towards succession planning and distribution of wealth has changed in India, especially when it comes to the first-generation rich. “Private trusts have not been considered by rich families in India. Unlike the West, where private trusts are a way of life both from a succession standpoint and a tax perspective, families in India have not seen the need to set up private trusts for future generations. Increasingly, however, families, particularly those with a business background, are now seeing the need for private trusts,” said Sameer Kaul, head, Citi Private Bank, India.

Why a trust? Wealth managers say that as wealth increases, so do complexities. A trust can be a useful tool here. Hence, the ultra wealthy are now considering private trusts as a vehicle for succession planning, and to avoid complications and legal tussles. “There are often complications arising with partnerships between siblings or cousins, or partner consortium. Whenever we meet the founder, succession is a critical issue on their minds but often unattended partly due to lack of knowledge or clarity and often due to an unknown fear of rocking the boat too early,” said Satya Bansal, chief executive officer-wealth and investment management, India, Barclays Wealth.

Succession planning through trusts has several benefits over wealth transfer done through a Will. For instance, in case of real estate, a Will can be contested and requires to be probated. Not so with a trust. This may be one of the main reasons why the rich prefer to go the trust way in India, where 86% of households’ wealth is in assets such as realty and gold, according to Credit Suisse estimates. “Of our 10 very affluent clients, at least 7-8 either have or want to start a private trust. So the popularity of private trust is increasing,” said Feroze Azeez, director and head, investment products, Anand Rathi Private Wealth. Keeping things as clear as possible also seems to be a reason. “Most families are now open to explore structures such as family trusts, family constitution and family boards.

Many business families are now reviewing their complicated cross-holding investment companies and looking at limited liability partnerships and trusts or a combination of these two to simplify this in line with their succession needs. They often review shareholders’ agreements in favour of more robust family trust structures as a holding vehicle, as it provides greater flexibility and its own governance and rules in a bespoke manner,” said Bansal. What is a trust? A trust is created when a property—a trust’s corpus—is held by someone, say, trustees, for the benefit of another—the beneficiaries.

A trust is basically a vehicle to transfer wealth to the beneficiary. “It gives you the flexibility to transfer wealth. It helps maintain confidentiality of the last wishes of the owner of the wealth, optimizes legal costs and is a useful asset protection tool. Seamless transfer of wealth, asset preservation, consolidation, separation of ownership from management and tax neutral structure are other elements of a trust,” said Sonali Pradhan, managing director, RBS Financial Services.

Is a Will not enough for succession planning? “Most rich families have seen enough challenges around Wills as a succession tool. Also, a Will is often seen as a default option rather than one chosen by design. They have witnessed enough litigation around ownership. Equally challenging is distributed ownership whereby the future stakeholders are often not aligned to steer the business in a clear direction,” said Bansal.

How to form a trust? “First, you have to examine whether there is a need for a trust. You will then have to design the required structure. Once you draft the trust deed, you will have to accordingly get it registered,” said Azeez. “The process involves identifying a service provider, followed by a sit-down session to give a background of the family, the business structure and assets. Once the service provider has an understanding of the family’s requirements, it can provide solutions in terms of ‘type of trust’ structure, the composition of the trustees, and a solution on how the trust funds will be managed,” said Kaul.


You can form a family trust, a private trust, or, like Thyagarajan, an employee trust. The average fees could start from Rs.3 lakh. “For families where the source of income is from business, it is recommended that a succession plan be in place as soon as the children become legally adults in order to use the private trust to divide their assets according to their discretion,” said Kaul. Succession planning has always been an area of concern. Widely reported litigation cases have only thrown more light upon this. That in itself is reason enough for the wealthy, with new money or old, to form private trusts.



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Basics of Investing from Warren Buffett

The veteran investor’s advice to his company’s shareholders remains the same—buy and hold

Rajesh Kumar, Mint 28/2/2014


The annual letter to the shareholders by Warren Buffett, one of the most successful investors of all time, is an eagerly awaited event in the world of investing. Every word from this “Sage of Omaha” is followed by investors across the world. This time was no different. An excerpt of his annual letter was published by the Fortune magazine on its website on 24 February and is being discussed all over the world.

Warren Buffett, according to the Forbes, had a net worth of $58.5 billion as on September 2013. Buffett is chairman and chief executive officer of Berkshire Hathaway Inc. The company and its subsidiaries are in diverse businesses including insurance and re-insurance, finance and manufacturing.

The published excerpt is basically an essay on fundamentals of investing, which can be followed by all investors to maximize gains in the long term. The basic essence of the essay is that it does not require a great deal of expertise to be a successful investor. However, it does require a great amount of patience and the ability to ride through business cycles. Buffett this time illustrated examples of his two real estate deals to drive home the point that one needs to identify a good investment idea and then hold on to it for the long term to reap gains.

Here are five key takeaways from his essay that investors can use while putting in their money.

Keep it simple

In order to get reasonably good returns, you don’t need to be an expert in the asset class that you are investing in. In order to explain this, Buffett uses the example of a farm that he bought in 1986. He had very little idea about farm operations. But with the help from his son, he did a quick calculation on how much the farm will yield and what will be the operating cost. Around 28 years down the line, the output of the farm has gone up three times and its value has gone up five times. The basic argument is that you need to “keep things simple and don’t swing for the fences”.

Focus on productivity

Buffett argues that you need to understand the future earning potential of the asset that you are buying. If you are not able to do that, just move on. The idea here is that you must understand the business or the asset that you are buying. Buffet and his partner, Charlie Munger, evaluate businesses in the same way irrespective of whether they are buying a small stake in the business or the entire company.

Avoid predicting price changes

Thinking about price changes is speculation. Also, Buffett argues that something that has appreciated in the recent past should not be your reason for buying. People tend to buy when prices have run up quite a bit and sell when it has already fallen. Investors, in fact, should be doing exactly the opposite. “A climate of fear is your friend when investing; a euphoric world is your enemy,” Buffett wrote.

Avoid constantly tracking stock prices

Buffett’s style of investing is that once you have bought an asset, you should not be worried about its price every day. This is what normally happens in real estate investments. People don’t go out to buy and sell every day. However in the stock market, since prices are available on a real-time basis, there is temptation among investors to do something which should be avoided. Says Buffet: “If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.”

Don’t waste time on macroeconomic and market predictions

Listening to market predictions and macroeconomic opinions, according to Buffett, is of no use in investing. The message is that once you have bought a good asset, you should hold it for the long term. There will be economic and business cycles in between but a good asset, bought at a reasonable valuation, will give you good returns in the long run.

Buffet further says that if you are a non-professional and cannot pick stocks, you still have an option of investing in stocks. All you need is a diversified portfolio of good businesses which you can easily own through index funds. “The goal of the non-professional should not be to pick winners—neither he nor his “helpers” can do that—but should rather be to own a cross-section of businesses that in aggregate are bound to do well,” he argues.

Most of the things that Buffett talked about in his essay are not new for people who follow the principles of value investing. Says Raamdeo Agrawal, joint managing director, Motilal Oswal Financial Services Ltd, “It is the reiteration of what he has said before, which is basically buy and hold works.”

Experts argue that investors should buy good companies and hold it for the long term. In case you find it difficult to identify stocks, you can simply invest through an index fund which is also cost effective in terms of management fee. The idea is to own businesses which will do well and create wealth over time.

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Trading in commodities? Learn ways to cut losses

R Srividhya, Financial Chronicle 7/5/12


Commodity trading is prone to risk due to price fluctuations. Lately, some of the commodities trading in the futures market have been undergoing high levels of volatility. However, the market itself offers ways to mitigate losses and maximise gains in commodity trading.

“Futures trading offers high level of leverage as one can trade with the margin money. However, in commodities where daily level of fluctuation is greater than the margins, the investor can suffer heavy losses. In such cases, we always advise to limit the exposure. Further, there are orders which can be placed to mitigate loss and maximise returns,” said Santosh Kumar Narayanan, product-in-charge, zonal, JRG Wealth Management.

An order helps the investor decide when to enter and exit the market, and also decide at what price and time the position could be executed.

Limit order: This is mainly used to determine the price at which one wants to enter and exit a commodity. When the buy limit order is set, the broker will automatically buy commodity when the price arrives. Similarly, after having taken a position, one can set a limit order for selling the commodity and the order will be automatically executed if the commodity touches that price. This helps the investor to plan the returns he expects from a particular commodity trading.

Stop loss order: This is given to limit the losses in a position if the prices move down beyond one’s expectations. Stop loss order will help determine how much loss one can bear on a position. This also helps the investor when he is not constantly checking the price movement or is on a holiday.

Trailing stop loss: This order helps the investor set a percentage below the present market price. If the market price moves heavily down and goes beyond the set percentage, a sell order is triggered.

Generally, these orders expire in one day. If one wants to place orders for a specific time span, there are a few other orders available.

Good-till-cancelled (GTC) order: This makes the stop loss, limit of trailing stop loss order last till the expiry of the contract or till the contract is cancelled.

Similarly, one can specify the date for the contract to be executed. For this good-till-date (GTD) order can be placed along with the stop loss or limit order.

“Orders help one to plan the extend of losses and returns from a contract. But, one need not necessarily be able to buy or sell at the same price he had placed the order for. It also depends upon the availability of a seller or buyer at that price point. Once the order is triggered, it will be filled with the best possible price. This would be invariably lesser than the specified price in the order. But the investor can either wait to execute at the specified price or execute at the price available,” said Narayanan.

According to him, the awareness level about the orders is not adequate in the Indian commodity market. While an order can limit losses, it can also cap the returns in a bullish market. “Generally, investors are advised to use stop loss or trailing stop loss orders. The number of them who use the orders are gradually increasing,” he added.


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