Friday, January 2, 2009

When US markets go bust, refer to these 5 basics

LEHMAN Brothers has filed for bankruptcy. Merrill Lynch was bought by Bank of America. And America's largest insurer AIG is in need of funds.

This is a result of what has come to be known as the sub-prime crisis. Sub-prime lending refers to lending (at slightly higher interest rates) to people who may not be eligible for a loan under normal circumstances. Maybe they don’t have a regular job or income, or have defaulted in the past.

When the Federal Bank (the US equivalent of RBI) started increasing interest rates, the sub-prime borrowers started defaulting and banks started selling off the mortgaged properties. As more and more properties came into the market for selling, the property prices fell.

In the meantime, the mortgage banks had borrowed money against the mortgages on the condition that they would repay to lenders as soon as they recovered their mortgages. The lenders in this case were financial institutions (like Bear Sterns, Lehman and Merril Lynch) who in turn sold retail bonds to individuals.

Sadly, the repayment never happened. And institutions like Bear Sterns, Lehman, Merrill Lynch and AIG were the casualties.

So, where does this leave you (the investor) and your money?
Well, the good news is that if America has caught a severe infection, we have got away with barely a sneeze. There is only indirect collateral damage such as: Foreign Institutional Investors (FIIs) pulling out (which will leave the Sensex volatile for now), employees working in the India offices of these three organisations facing a job loss, and credit cards and loans costing more.

So for most part you are safe, if you have stuck to the investing basics. wealth revisits the basics and gives you five tips on what you should be doing to insulate yourself from this financial meltdown.

1. Invest 10-15 per cent of your portfolio in gold; it's an effective hedge during uncertain times. And,
do not buy physical gold. Instead Exchange Traded Funds (ETFs).

2. Allocate 15 per cent to relatively safe gilt funds.

3. Cash can command around 10 per cent.

4. Invest the remaining 60 per cent in equity, but not as a lump sum. But as Systematic Investment Plans (SIPs).

5. Hold fast, hold tight and hold out. If you are a long term investor, don't scramble to exit investments. Just stick to these basics and the storm shall pass.

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