Here are five key constituents of financial literacy which investors needs to equip with, in order to become financial literate
Financial literacy is the key to the empowerment of investors and helps in developing a healthy financial system. It has been often seen that in absence of financial literacy, many investors often get cheated. This applies to even otherwise educated persons, who are found lacking in financial literacy. So what is financial literacy and what are the key constituents of financial literacy. The President's Advisory Council on Financial Literacy in US defines personal financial literacy as "the ability to use knowledge and skills to manage financial resources effectively for a lifetime of financial well-being." This definition gives a clear cut understanding of financial literacy and emphasises the fact that certain types of knowledge and skills are required to become financial literate. While the definition has been used in the context of US, in the context of India, the situation can be different, although the basic tenets of financial literacy remain the same.
What are the key requirements to be financially literate? How can an individual acquire skills and knowledge to make him financial literate? Here are five key constituents of financial literacy which investors need to equip with, in order to become financial literate:
Understanding compounding and discounting
Every investor needs to understand how his investment generates return. In order to understand this, it is important that every investor understands how compounding works. Compounding gives an accumulated value of an investment considering reinvestment periodically. While it is possible for some investors to understand compounding as we read this during school days, discounting is very difficult to understand. Discounting helps in identifying present value of investments which is the key to compare returns like compounding. These days excel functions are available to understand compounding and discounting which every investor needs to familiarize himself with.
Understanding difference between savings and investments
Savings in itself is not enough and investors need to convert savings into investments. Savings are a part of money which an investor has to keep to meet short-term requirements. Savings are liquid funds which are maintained in order to meet some immediate returns while investments have long term horizon. Investments are driven by wealth-building objectives. It is important that investors invest their money in those investments which not only generate long term returns but also help them beat inflation. Inflation adjusted returns (often called as real returns) should be the driver of every investment objective.
Understanding risk and return of investments
Before making investments, an investor should understand the risk and return of investments. This is one of the most important components of financial literacy. Investments like equity carry high risk and have potential to generate high returns. However, it is important to note that taking high risk does not result into high returns essentially. Since risky investments carry potential of capital erosion, investors should understand risk element before making investments. If any entity is ready to offer an investor a very high return, then that investment should be avoided. Anybody offering an extremely high rate of return is generally desperate to borrow. Also, it is important to understand that projected returns in an investment are not the real return.
Understanding financial products
There are various financial products on offer in financial markets. While it is difficult to understand all these financial products, it is critical to understand plain vanilla financial products available in the financial market. Understanding financial products equips an investor to take informed decisions. The key objective of having this understanding is to select products which suit the requirements of investors. One of the key things that financial literacy equips an investor with is that one should never venture into those financial products in which an investor does not invest.
Understanding protectors of financial system
As part of financial literacy, one must understand as to who are the protectors of financial system.. These institutions are often called as regulators. While regulators may not help solve all financial woes of an investor, they are definitely the first step in solving financial grievances.
While there are various other aspects of financial literacy, it is important to equip oneself with bare minimum skills and knowledge necessary to become financially literate. Many investors end up losing their hard-earned wealth in the absence of financial literacy, so it is better that one equips oneself with financial literacy.
(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)
SEBI chairman has written to the Maharashtra government that it has a well-oiled system of handling complaints and it should be used instead of police action in cases of disputes involving securities and stock exchange. This is a laughable claim, given how faulty SEBI’s grievance handling mechanism is, as Moneylife has pointed out repeatedly.
Mr UK Sinha, chairman of The Securities and Exchange Board of India (SEBI), has written to state chief secretary Jayant Banthia, that complaints were being lodged with the police against brokers without exploring SEBI’s complaint marvellous handling system. The SEBI chief mentioned that they have a “well-oiled grievance redressal mechanism in place, which aggrieved persons can access to settle disputes. But clients often approach police even before availing of the redressal mechanism, or when disputes are still being resolved at the stock exchange.” Mr Sinha’s claim about SEBI’s system called SCORES (SEBI Complaints Redressal System) is laughable. If it was indeed effective, aggrieved investors would have chosen it as the first and only route and SEBI would have had a long list of success stories to talk about.
Those who have filed complaints through SEBI’s grievance redressal system would know that the regulator rarely investigates the complaint and merely functions like a post office. It passes it on to the accused broker or company for their reply and resolution, functioning more like an 'in and out' mail system. With poor redressal of complaints, investors would have found it easier to approach the police.
Investors’ complaints filed with the market regulator either remain unheard, or are disposed off with vague replies. Moneylife has had a direct experience of this. What SEBI could not care less is that the grievance redressal mechanism is so poor and fraught with delays that the investor gets harassed even more in the bargain. The brokers get away scot-free or with a minor punishment, and it is not long before they get back to their malpractices. This is one of the main reasons why the investor population is dwindling. (Read: Does SEBI really pay any heed to investors’ complaints?)
Last year, we wrote about the harrowing tale of a 78-year old veteran from the Air Force, whose life savings was wiped out at Motilal Oswal Securities by using a forged power of attorney (PoA). SEBI, which is mandated by law to protect investors, made no attempt to contact senior citizen, but simply accepted the submissions made by Central Depository Services (CDSL) and Motilal Oswal Securities, without even looking at the correspondence exchanged between the 78-year old, despite knowing that he has a ruling from a District Consumer Redressal Forum against MOSL regarding the forged Power of Attorney (PoA). (Read: Wiped out by Motilal Oswal, shunned by a callous SEBI & ministry, the 78-year old's fight continues, Wiped out by Motilal Oswal, an aggrieved small investor won in consumer court but got shafted by SEBI)
Similarly, Moneylife has written in the past about how letters from retired Union Secretaries like EAS Sarma, specifically addressed to SEBI chairman UK Sinha, were dumped into the automated redressal system called SCORES leading to a similarly mindless response to him. Mr Sarma, in his letter to the SEBI chairman (Mr Sinha) had questioned about non-disclosures by Reliance Industries (RIL) regarding the Krishna Godavari (KG) basin reserves. Instead of a proper reply, SEBI sent an automated reply to the former secretary in a tome and language, which ensures that the market regulator could wash its hands off any responsibility of responding. In its response, SEBI said: “Please note that while the entity (RIL) is directly responsible for redressal of your complaint, SEBI initiates action against recalcitrant entities on the grounds of their unsatisfactory redressal of investor complaints as a whole”. (Read: What is wrong with SEBI's treatment of investors?, Does SEBI understand difference between a complaint and suggestion?)
Moneylife has been regularly writing about SEBI's hands-off approach on complaints and investors' grievances. (Read: 'Investor interest: SEBI's hands-off approach'.) SCORES is a "web-based centralised system for the speedy redressal of grievances" that was launched in the last few days of the tenure of former chairman CB Bhave. (Read: 'Complaints redressal: SEBI's high cost experiment'.) Its scores pretty low in investor’s experience. Mr Sinha would do well open his eyes and ears to what it happening on the ground before dashing off letters with tall claims.
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