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How minimum investment can hit returns

November 30, 2009 16:08 IST

Most people think that small investments will lead to lower risks. But the returns are adversely impacted.

Every option in the market has a specific minimum that investors must put in. This might seem basic but it often becomes a barrier for the individual, because a higher amount can prevent many from considering this as an appropriate option.

The alternative of a smaller minimum investment is often considered good. While, a lower amount might increase the choice for the investor.

This has to be considered in the light of other conditions relevant for the investment.

Minimum and actual investment

Minimum investment refers to the lowest figure or amount required for starting a particular investment. This is the figure that can ensure the investor is able to make use of the facility of a particular investment.

For example, the minimum investment limit for a one-time investment in most mutual funds (MFs) is Rs 5,000. Similarly, the minimum limit for a particular bond issue might be Rs 10,000. This has to be separated from the actual investment i.e. the amount finally invested.

Every investor has a choice of making an investment that is between the minimum and maximum permissible limit. In many cases, going for a very small investment can actually hurt the investor in several ways. So, this factor has to be at the forefront while making investment choice.

Mutual Funds

There is an amount fixed for minimum MF investment, so that a larger number of people are attracted towards the scheme.

This can range from Rs 5,000-10,000 for a single investment, while the regular monthly figure (forĀ  systematic investment plan) could start from as low as Rs 50 a month. This makes for a situation where the investor can consider the investment possibilities and then choose.

The first point to consider is the cost involved in making the actual investment. With the entry load ban, there is an amount that has to be paid directly to the distributor.

If this is fixed at, say, Rs 25 per scheme, then paying Rs 500 for 12 months will lead to an investment of Rs 6,000 and a cost of Rs 300, which works out to five per cent of the investment.

The same rate where the amount invested is Rs 24,000 will bring down the cost to 1.25 per cent. This is a situation where a small investment amount will hurts.

On the other hand, in a debt option, a large part of the return could be wiped out in case of a small investment, where the return is low (4-6 per cent a year). Then even a small cost on a lower base can impact the return significantly.

Example: If cost of investing is Rs 100, then a small investment of Rs 5,000 is a cost of two per cent. This figure can take 33-50 per cent of the return earned in the debt option, which can be a very high cost. The same situation with a Rs 50,000 investment will bring the cost down insignificantly.

Insurance

There is also a minimum amount that has to be paid as premium on an insurance policy. This needs to be considered, especially for unit-linked policies (ULIPs), where there is a choice for the investor to select a fund and then get returns based on the performance of the fund. Again, the ultimate impact for the investor is important, as this can make the situationĀ  difficult to manage.

Sample this, the minimum investment is Rs 12,000 for a ULIP, in the form of a premium paid by an investor. There are a lot of expenses that are deducted from this figure and the net amount is then invested for the investor in the required fund. While several expenses are in percentage terms, some are absolute expenses.

There could be a situation where the expense is 15 per cent for the first year, plus Rs 1,000 and 5 per cent in the next year plus Rs 1,000. Here, the deduction is Rs 2,800 and Rs 1,600 in the first two years, while for an investor putting in Rs 50,000, the figure is Rs 8,500 and Rs 3,500. It can be seen that the rise in the expense has been less than proportionate, so the small investor actually loses by putting in a tiny amount.

Stocks

The situation is different in case of stocks where the minimum investment is just one share. There are two points to be noted here.

First, there is a minimum charge of Rs 25-30 for getting the share credited in the demat account. Next is the brokerage and other charges.

So, if you buy one share worth Rs 500, then the cost that comes to you could be 12-15 per cent, which too high. A higher amount of purchase will bring down the cost proportionately. This kind of situation has to be avoided, but investors face this many a time.

Second situation is where the traded value of the share might be Rs 700, while the impact of converting shares into demat form and selling is Rs 1,000. In this case, waiting till the amount recovered is more than the cost would be better.

Also, when it comes to record keeping, it can be a nightmare, as the calculations for tax purpose can be numbing. Assume, that an investor has accumulated 25 shares by purchasing a share at a time on 25 occasions.

When these are sold and the gains are tallied, this might come to a few hundred rupees but the extent of calculations required will be disproportionate.

The writer is a certified financial planner.

Arnav Pandya in Mumbai
Source: source
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