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Basics Of Wealth Mgt


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Basics Of Wealth Mgt

  1. 2. Saving &Investing…
  2. 3. <ul><ul><li>What is investing? </li></ul></ul><ul><ul><li>An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting these requirements are Speculative </li></ul></ul><ul><ul><li>- Benjamin Graham – The Intelligent Investor </li></ul></ul><ul><ul><li>Investing is the act of seeking value at least sufficient to justify the amount paid. Consciously paying more in the hope that it can soon be sold for a still higher price should be labeled as speculation </li></ul></ul><ul><ul><li>- Warren Buffet – The Making of An American Capitalist </li></ul></ul>Investing ….
  3. 4. <ul><ul><li>What is investing? </li></ul></ul><ul><ul><li>Investing is a method of purchasing assets to gain profit in the form of reasonably predictable income (dividend, interest or rentals) and / or appreciation over the long term </li></ul></ul><ul><ul><li>Burton G Malkiel – A Random Walk Down Wall Street </li></ul></ul><ul><ul><li>Investing is a Act of faith, a willingness to postpone present consumption and save for the future. We entrust our capital to corporate stewards in the faith –at least with the hope that their efforts will generate high rates of return on our investments </li></ul></ul><ul><ul><li>- John C. Bogle – Common Sense on Mutual Funds </li></ul></ul>Investing ….
  4. 5. Speculation…
  5. 6. <ul><li>There are two times in a man’s life when he should not speculate: when he can’t afford and when he can. </li></ul><ul><li> Mark Twain, Following the Equator </li></ul>
  6. 7. <ul><ul><li>Speculation </li></ul></ul><ul><ul><li>Investors “speculate&quot; every time they commit money to something they don't understand. </li></ul></ul><ul><ul><li>Say you overhear your best friend’s uncle talking about a company called Frontier Industries at a cocktail party. &quot;This thing is surely going to go through the roof in the next few months,&quot; he says. If you call your broker the first thing the next morning to place an order for 100 shares, you've just speculated. </li></ul></ul>Investing ….
  7. 8. <ul><ul><li>Speculation </li></ul></ul><ul><ul><li>Do you know what Frontier Industries does? </li></ul></ul><ul><ul><li>Are you familiar with its competition? </li></ul></ul><ul><ul><li>What were its earnings last year / last quarter? </li></ul></ul><ul><ul><li>There are a lot of questions one should ask about a company before investing in a &quot;hot&quot; stock. There's nothing too hot about losing money in such speculative investments because the investor didn't take the time to understand what he was investing in. </li></ul></ul>Investing ….
  8. 9. <ul><ul><li>Speculation </li></ul></ul><ul><ul><li>Speculation can be compared to a lottery jackpot, wherein the odds of winning are abysmally low. Depending on the lottery it may be 1 in 7 million, or 1 in 18 million, or somewhere in between. The chances of dying from flesh eating bacteria (1 in a million) are far higher than that of winning a jackpot. </li></ul></ul><ul><ul><li>Remember: Every rupee that is used for speculation and lost is not working for the investor over the long-term to create wealth. </li></ul></ul><ul><ul><li>Speculation promises to give everything one wants right now but rarely delivers; patience almost guarantees those goals down the road through the power of compounding . </li></ul></ul>Investing ….
  9. 10. Power of Compounding…
  10. 11. <ul><ul><li>Power of Compounding? </li></ul></ul><ul><ul><li>If you leave a small portfolio invested, its value will mushroom over time through the miracle of compounding. As you earn investment returns, your returns begin to gain returns as well, allowing you to turn a measly investment into thousands of rupees if you leave it invested long enough.The more money you save and invest today, the more you'll have in the future. </li></ul></ul><ul><ul><li>An amount of Rs. 100,000 which compounds @ 15% after 50 years is worth, hold your breath Rs. Eleven Crores. </li></ul></ul><ul><ul><li>The power of compounding can be expressed using the following time value of money expression </li></ul></ul><ul><ul><li>FV= (PV) *(1+k)^n </li></ul></ul>Investing ….
  11. 12. <ul><ul><li>Power of Compounding? </li></ul></ul><ul><ul><li>FV = future value </li></ul></ul><ul><ul><li>PV = present value </li></ul></ul><ul><ul><li>K = rate of compounding </li></ul></ul><ul><ul><li>n = no. of years </li></ul></ul><ul><ul><li>Real wealth, the stuff of dreams, is in fact created almost magically through the most mundane and commonplace principles: patience, time, and the power of compounding. </li></ul></ul><ul><ul><li>Systematic Planning is an essential ingredient of a good investment programme. </li></ul></ul>Investing ….
  12. 13. Power of Compounding it works…
  13. 14. <ul><li>Planning & Setting Goals… </li></ul>
  14. 15. Human Life Cycle – Disciplined Planning Income Age Birth & Education Earning Years Retirement Phase I Phase II Phase III 22 yrs 60 yrs Marriage Child birth Child’s Education Child’s Marriage Housing 22 yrs 38 yrs Over 25 - 30 yrs Having a Financial Goal is primary to starting a Investment Plan.
  15. 16. Financial Planning is … <ul><li>To develop well defined goals </li></ul><ul><li>Divide the goals into short term and long term goals </li></ul><ul><li>To look at the current income, expenses and savings </li></ul><ul><li>To map out well defined strategies to turn the dreams into reality </li></ul>
  16. 17. Steps in Financial Planning <ul><li>Identifying the investment objectives </li></ul><ul><li>Investment Objectives – needs and requirements </li></ul><ul><li>Determine the required returns to meet the financial objectives </li></ul><ul><li>Determine the risk tolerance of the individual </li></ul><ul><li>Design an asset allocation to meet the risk and returns </li></ul><ul><li>Modify the asset allocation based on any change in needs or risk tolerance </li></ul>
  17. 18. Retirement Planning <ul><li>Assessment of current financial status </li></ul><ul><li>Ascertain post retirement needs </li></ul><ul><li>Determine what you need to save and how </li></ul><ul><li>Find extra money for savings </li></ul>
  18. 19. Tax Planning <ul><li>Incomes exempt from tax under sec. 10 </li></ul><ul><li>Deductions under chapter VI A for amounts utilised towards certain purposes qualifies as deduction from total income </li></ul><ul><li>Splitting income by creating several entities such as HUF or Trust. </li></ul><ul><li>Making gifts within specified limits </li></ul><ul><li>Making investments which qualify for rebates </li></ul><ul><li>Reducing taxable income by claiming expenses </li></ul>
  19. 20. <ul><ul><li>Investing is like a long car trip… </li></ul></ul><ul><ul><li>A lot of planning needs to go into it. </li></ul></ul><ul><ul><li>How long is the trip? (What is the investors &quot; time horizon &quot;?) </li></ul></ul><ul><ul><li>What should one pack? (What type of investments will the investor make?) </li></ul></ul><ul><ul><li>How much petrol is required for the trip? (How much money will the investor need to invest to reach his goals?) </li></ul></ul><ul><ul><li>Will the trip require a stop over along the way? (Does the investor have short-term financial needs?) </li></ul></ul><ul><ul><li>How long is the stay? (Will the investor need to live off the investment in later years?) </li></ul></ul>Planning and Setting Goals….
  20. 21. <ul><ul><li>Running out of gas, stopping frequently to visit restrooms, and driving without sleep can ruin the trip. So can saving too little money or investing erratically </li></ul></ul><ul><ul><li>An investor must answer the following questions before he can successfully set about the savings / investing journey: </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>What are the investors goals? </li></ul></ul><ul><ul><li>Is the investment for retirement? A down payment on a house? </li></ul></ul><ul><ul><li>Child's education? A second home? …. </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>How much money can the investor devote to a regular investing plan? </li></ul></ul>Planning and Setting Goals….
  21. 22. <ul><ul><li>Ask some more pointed questions: </li></ul></ul><ul><ul><li>How much will college cost (at the time the child needs to go)? </li></ul></ul><ul><ul><li>How much yearly income is reasonable for retirement? </li></ul></ul><ul><ul><li>The more specific the investor can be, the more likely he is to set and achieve reasonable goals. </li></ul></ul><ul><ul><li>Once the investor has a rough idea of how much money he will need and how much time he has to get there. He can start to think about what investment vehicles might be right for him and what kind of returns he can reasonably expect. He needs to understand his investment style in order to match it with the various available investment choices. </li></ul></ul>Planning and Setting Goals….
  22. 23. Financial Planning – Increasing complexity <ul><li>Indian markets opening up </li></ul><ul><ul><li>Increased volatility in the debt and equity markets </li></ul></ul><ul><li>Investment Options available with the individuals are increasing </li></ul><ul><ul><li>Equities, Bonds, Mutual Funds, Derivatives, real estate </li></ul></ul><ul><ul><li>There are now around 30 mutual funds in India offering 400schemes </li></ul></ul><ul><li>Investment options expected to increase going forward </li></ul><ul><ul><li>Commodities trading, forex </li></ul></ul><ul><li>Tax Planning requires an expert </li></ul>
  23. 24. Financial Planner would provide… <ul><li>A comprehensive platform of tailor made services </li></ul><ul><li>Customised strategies and product application </li></ul><ul><li>The highest quality in advise </li></ul><ul><li>Confidentiality </li></ul><ul><li>Single Point contact and personalized service </li></ul><ul><li>An experienced Investment Advisor </li></ul><ul><li>Resources and capabilities to ensure timely and accurate execution </li></ul>
  24. 25. Determining Investment Style…
  25. 26. <ul><ul><li>Investment style can be compared to batting styles of different batsmen in a game of cricket. </li></ul></ul><ul><ul><li>A swinger-for-sixes & fours - takes big risks for big gains. </li></ul></ul><ul><ul><li>Slow & steady - hitting singles and doubles. </li></ul></ul><ul><ul><li>A spectator sitting in the stands, chatting with his companions and occasionally cheering his home team on. </li></ul></ul><ul><ul><li>  </li></ul></ul><ul><ul><li>There are two major variables in figuring out ones investment style – the risk tolerance ( can you afford to get out ? ) and amount of time the investor can dedicate to investing ( One day or test match ? ) </li></ul></ul>Determining Investment Style….
  26. 27. <ul><ul><li>Risk Tolerance </li></ul></ul><ul><ul><li>How comfortable will you be seeing your investment decrease in the near term while waiting for it to increase over the long term? </li></ul></ul><ul><ul><li>How comfortable will you be to invest in something in which the price changes every day - sometimes adversely. </li></ul></ul><ul><ul><li>An investor X may be very comfortable with a downside of 25% in an investment whereas Investor Y could shy away from any downside in his investments. </li></ul></ul>Determining - Investment Style….
  27. 28. <ul><ul><li>Risk Tolerance </li></ul></ul><ul><ul><li>There are various degrees of risk across the investment spectrum, from government savings bonds (carries only sovereign risk and credit risk), which are considered risk-free as they are guaranteed by the government, to equities, commodities and options, where one can lose significant amount of the invested money. </li></ul></ul><ul><ul><li>Remember : Though GOI savings bonds and bank fixed deposits are the safest, the safest road isn't always the best one. </li></ul></ul>Determining - Investment Style….
  28. 29. <ul><ul><li>The important thing to remember about stocks, though, is that an investor doesn't lose anything until he sells them. </li></ul></ul><ul><ul><li>What if you invested when the market was at a high, then comes a big crash? </li></ul></ul><ul><ul><li>If you don’t panic and sell during a crash ( eg May 2006 when the Sensex fell from 12000 to 9000 ), you would have done quite nicely as the market rebounded subsequently ( Sensex rose to 15000 in Aug 2007 ! ). </li></ul></ul><ul><ul><li>Golden rule - when one is investing in the stock market, think long-term. Don’t invest any money in stocks that you will need in the short term. </li></ul></ul><ul><ul><li>  </li></ul></ul>Determining Investment Style….
  29. 30. <ul><ul><li>The Second Factor – Time …. </li></ul></ul><ul><ul><li>How much time do you want to/are able to spend on investing? </li></ul></ul><ul><ul><li>How active do you want to be in the management of money? </li></ul></ul><ul><ul><li>If an investor wants to spend 15 minutes a year on investing, then maybe one should consider using Passive Strategies. </li></ul></ul><ul><ul><li>If one is planning to set out eight hours a week, then you should consider researching companies and pouring over financial statements to pick individual stocks. </li></ul></ul>Determining Investment Style….
  30. 31. <ul><ul><li>Another time factor is : </li></ul></ul><ul><ul><li>When does the investor need the money (time horizon) ? </li></ul></ul><ul><ul><li>Whether the money is needed next week or in a hundred years will dramatically affect what investment vehicle to use. </li></ul></ul><ul><ul><li>Caution - Although stocks deliver great long-term returns, the returns over periods of three years or less can be downright scary. </li></ul></ul><ul><ul><li>Hence setting investment goals, planning the outlay of investment amount and time horizon and making appropriate investment choices in line with investor profiles is essential for the success of any investment programme. </li></ul></ul>Determining - Investment Style….
  31. 32. Investment Avenues High Low Don’t Invest here RETURN Equity Index Funds Growth Funds RISK Balance Funds Optimal Aggressive Stance ## the size of the circle denotes the level of liquidity Low RBI Comp FD P.O. Income Funds GOI Sec Liquid Fund Gilt Funds Sedate Zone Bank FD High
  32. 33. Investment Products <ul><li>Stocks-offer dividend & capital appreciation. </li></ul><ul><li>Bonds-offer safe return. </li></ul><ul><li>Real estate-offers rent & capital appreciation. </li></ul><ul><li>Precious metals-appreciate over time and are a hedge against uncertainties. </li></ul><ul><li>Art work-appreciate over time. </li></ul><ul><li>Insurance-used as security against risk of uncertainties. </li></ul>
  33. 34. Portfolio Construction - Matching investor profile with investment options …
  34. 35. Asset Allocation An asset allocation is a strategy of dividing the portfolio among various asset classes so as to obtain the desired portfolio characteristics to suit distinct investor profiles. Bonds, Stocks and Cash equivalents are the most commonly used asset classes in any asset allocation. It is an organized and effective method of diversification Stocks Bonds Cash The asset allocation for an investor depends on the investors expectations of returns and the risk the investor is willing to take.
  35. 36. Investments : Key Determinants Security Selection 4.6% Market Timing 1.8% Other Factors 2.1% <ul><li>The most important determinant of portfolio return is asset allocation . </li></ul>Asset Allocation 91.5% Source: Brinson, Singer & Beebower ( 1991 )
  36. 37. Asset allocation <ul><li>Asset Allocation encompasses the following: </li></ul><ul><li>Selection of the asset classes </li></ul><ul><li>Proper blending of these asset classes in a portfolio </li></ul><ul><li>Managing the asset mix over time. </li></ul>
  37. 38. Lifecycle Investment Guide
  38. 39. Asset Allocation Principles <ul><li>Risk and return are related </li></ul><ul><li>Risk depends on the length of time one holds the investment </li></ul><ul><li>Rupee Cost Averaging can reduce the risks of investing </li></ul><ul><li>Risks that an investor can take depends on the investor’s capacity to take risks and his attitude to take risks. </li></ul>
  39. 40. Asset Allocation drivers <ul><li>Asset allocation must take into account 2 factors: </li></ul><ul><li>Time horizon: the number of years you have to invest </li></ul><ul><li>Risk tolerance: your ability or willingness to endure short-term declines in the value of your investments as you pursue your long-term investment goal </li></ul>
  40. 41. Asset Allocation Styles-Strategic Asset Allocation <ul><li>Strategic asset allocation is a method that establishes and adheres to what is called a 'base policy mix'. This is a proportional mix of assets based on expected rates of return for each asset class </li></ul><ul><li>E.g. I f stocks have historically returned 10% per annum and bonds have returned 5% per annum, a mix of 50% stocks and 50% bonds would be expected to return 7.5% per year </li></ul>
  41. 42. Asset Allocation Styles-Tactical Asset Allocation <ul><li>In the short term , the investor may occasionally engage in tactical deviations from the mix in order to capitalize on unusual or exceptional investment opportunities </li></ul><ul><li>This flexibility adds a component of market timing to the portfolio, allowing investors to participate in economic conditions that are more favourable for the performance of one asset class than for others </li></ul>
  42. 43. Asset Allocation Styles-Tactical Asset Allocation <ul><li>Tactical asset allocation can be described as a moderately active strategy, since the overall strategic asset mix is returned to when desired short-term profits are achieved </li></ul><ul><li>This demands some discipline from the investor or portfolio manager, as he or she must first be able to recognize when short-term opportunities have run their course, and then rebalance the portfolio to the long-term asset position </li></ul>
  43. 44. Asset Allocation Styles-Dynamic Asset Allocation <ul><li>Dynamic asset allocation is when the mix of assets is constantly adjusted as markets rise and fall and the economy strengthens and weakens </li></ul><ul><li>E.g. In a dynamic portfolio, if the stock market is showing weakness, stocks are sold in anticipation of further decreases in stock values, and if the market is strong, stocks are purchased in anticipation of continued market gains </li></ul>
  44. 45. Which Asset Allocation style is best ? <ul><li>Asset allocation can be an active process in varying degrees or strictly passive in nature. </li></ul><ul><li>Choice of a precise asset allocation strategy or a combination of different strategies depends on one’s goals, age and risk tolerance </li></ul><ul><li>These are only general guidelines on how investors may use asset allocation as a part of their core strategies </li></ul><ul><li>Allocation approaches involving anticipating and reacting to market movements require a great deal of expertise and talent in using particular tools for timing these movements. </li></ul><ul><li>Accurately timing the market is next to impossible, so make sure your strategy isn't too vulnerable to unforeseeable errors </li></ul>
  45. 46. Evaluate Investment Options…
  46. 47. Research Your Investments Once you know HOW to invest. It’s time to figure out where to put your money.
  47. 48. Research Your Investments What do I need to know?
  48. 49. Research Your Investment <ul><li>Discover historical trends </li></ul><ul><li>Perform financial analysis </li></ul><ul><li>Compare with the peer group </li></ul><ul><li>Obtain relevant economic news </li></ul><ul><li>Forecast future performance </li></ul><ul><li>View recommendations of the experts </li></ul>To....
  49. 50. Creating a portfolio: Once the asset allocation decision has been made the second step is to select individual securities and build a portfolios for each of the asset class under consideration. The process begins with selecting securities from the investment options in the assets class and adding the selected securities to form a portfolio <ul><li>The standard deviation ( σ p ) of a portfolio decreases as securities are added, because they would not be perfectly correlated with the existing portfolio. </li></ul><ul><li>Expected return of the portfolio would remain relatively constant </li></ul><ul><li>Eventually the diversification benefits of adding more securities dissipates (after about 10 securities). For example in large equity portfolios, σ p tends to converge to  20%. </li></ul>
  50. 51. Let us now create a portfolio of a stock A and a bond B. Stock A is expected to deliver a return of 20% per annum with a volatility of 25% and bond B is expected to deliver a return 6% per annum with a volatility of 5%. In case if we allocate the assets in equal proportion 50% in A and 50% in B than the resultant portfolio is expected to deliver a return of (0.5)*20% + (0.5)*6% = 13.0% with an approximate volatility of 15% Creating a Portfolio
  51. 52. Now if we change the allocation to 25% in A and 75% in B than the resultant portfolio is expected to deliver a return of (0.25)*20% + (0.75)*6% = 9.5% with an approximate volatility of 10% It can be observed from the above that as one changes the asset allocation the returns as well as the risk profile of the portfolio changes considerably. Hence asset allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, debt and equity based on the risk profile and financial needs of the investor Creating a Portfolio
  52. 53. Asset class characteristics <ul><li>The purpose of using various risk categories in portfolios is to reduce risk through diversification thereby enhancing the risk/return ratio. </li></ul><ul><li>The proper allocation of assets in a portfolio begins with determining the proportion of the total portfolio to invest in each asset class. </li></ul>
  53. 54. Maximize returns, minimize risks
  54. 55. Risk / return characteristics of asset classes <ul><li>It is useful to calculate returns and measure risk for asset classes over various past intervals </li></ul><ul><ul><li>Helps to evaluate the behavior of the asset class over different economic cycles. </li></ul></ul><ul><ul><li>May be taken as representative of the returns that investors may have expected to earn over the period. </li></ul></ul><ul><ul><li>May in turn be useful in establishing benchmarks as to what returns investors might be expecting to earn in future. </li></ul></ul><ul><ul><li>Availability of realized return and risk measures can be used to compare the relative performance behavior across asset classes. </li></ul></ul>
  55. 56. Asset class characteristics Security Class Maturity of security Form of return Risk Cash Equivalents Short Interest Low Fixed Deposits Long Interest Medium Govt Securities Long Interest Medium Corporate Bonds Long Interest Medium Preference Shares Perpetual Dividend Moderately high Equity Shares Perpetual Dividend and capital gains High
  56. 57. Tracking Your Portfolio <ul><li>Follow market trends </li></ul><ul><li>Read the financial news </li></ul><ul><li>Monitor your selected investments </li></ul><ul><li>Share information with others </li></ul>Follow the performance of your selections
  57. 58. Do’s and Don’ts <ul><li>Do keep informed of your investments once you purchase them. </li></ul><ul><li>Do understand the advise of experts before you take it. </li></ul><ul><li>Do invest for the long term. </li></ul><ul><li>Don’t be discouraged. An investment in your future is worth the effort. </li></ul><ul><li>Don’t buy what you don’t understand. </li></ul>
  58. 59. Understanding Risk & Returns …
  59. 60. Investment returns The rate of return on an investment can be calculated as follows: (Amount received – Amount invested) Return = _________________________________ Amount invested For example, if Rs.1,000 is invested and Rs.1,100 is returned after one year, the rate of return for this investment is: (Rs.1,100 – Rs.1,000) / Rs.1,000 = 10%. In case if we adjust the return obtained from above for inflation we arrive at the real return in the investment
  60. 61. Return Variability A B C Investment A: no return variation, no risk Investment B: some return variation, some risk Investment C: wide return variation, much risk 4.0% 2.5% 6.00% 15% -8%
  61. 62. Nature of Risk <ul><li>The more variable an investment’s return, the greater its risk </li></ul><ul><li>A highly variable return could lead to investment losses if the investment needs to be sold </li></ul><ul><li>However, the longer the investment is held, the greater the chances of earning the long-run rate of return </li></ul>
  62. 63. What is investment risk? <ul><li>Investment risk is related to the probability of earning a low or negative actual return. </li></ul><ul><li>The greater the chance of lower than expected or negative returns, the riskier the investment. </li></ul><ul><li>Two types of investment risk </li></ul><ul><ul><li>Stand-alone risk </li></ul></ul><ul><ul><li>Portfolio risk </li></ul></ul>
  63. 64. Breaking down sources of risk <ul><li>Stand-alone risk = Market risk + Firm-specific risk </li></ul><ul><li>Market risk – portion of a security’s stand-alone risk that cannot be eliminated through diversification. Measured by beta. </li></ul><ul><li>Firm-specific risk – portion of a security’s stand-alone risk that can be eliminated through proper diversification. </li></ul>
  64. 65. Standard Deviation <ul><li>In investments risk is measured in terms of standard deviation </li></ul><ul><li>Most important measure of variation </li></ul><ul><li>Shows variation about the mean </li></ul><ul><li>Has the same units as the original data </li></ul><ul><ul><li>Standard Deviation: </li></ul></ul><ul><ul><li>Xi=Observation </li></ul></ul><ul><ul><li> = Mean </li></ul></ul><ul><ul><li>N = Total No. of observation </li></ul></ul>
  65. 66. Comparing Standard Deviations Mean = 15.5 s = 3.338 11 12 13 14 15 16 17 18 19 20 21 11 12 13 14 15 16 17 18 19 20 21 Data B Data A Mean = 15.5 s = .9258 11 12 13 14 15 16 17 18 19 20 21 Mean = 15.5 s = 4.57 Data C It can be seen from above that data sets with same means could have widely different standard deviations depending on the variance from the mean
  66. 67. What is the market risk premium? <ul><li>Additional return over the risk-free rate needed to compensate investors for assuming an average amount of risk. </li></ul><ul><li>Its size depends on the perceived risk of the stock market and investors’ degree of risk aversion. </li></ul><ul><li>Varies from year to year, but most estimates suggest that it ranges between 4% and 8% per year. </li></ul><ul><ul><li>The difference between the return on a risky asset and less risky asset, which serves as compensation for investors to hold riskier securities is known as Risk premium. The risk premium is one of the basis for any asset allocation decision. </li></ul></ul>
  67. 68. Risk and Return are related Source: Ibbotson Associates, Stocks, Bonds, Bills, and Inflation: 1997 Yearbook Average Annual Return (1926 – 97) Risk Index Small company common stocks 12.7% 33.9% Common stocks in general 11.0% 20.3% Long Term bonds 5.7% 8.7% Treasury bills 3.8% 3.2% Inflation Rate 3.1%
  68. 69. Risk depends on the length of time one holds the investment
  69. 70. Sensex Returns Analysis -1979 to 2004 Equities deliver superior risk adjusted returns over the long term
  70. 71. Market Timing is Dangerous… The opportunity loss incurred when attempting to time the market could be exceptionally high Patience and discipline are required to avoid a wrong move Annual Return of Sensex over last 24 years 15.90% 5.54% 0.65% -16.93% -20.00% -15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 15.00% 20.00% Always Invested Missed 10 best Missed 20 best Missed 72 best
  71. 72. Rupee Cost Averaging can reduce the risks of investing-buy less when price is high & more when price is low. Period Investment amount Price per Share Qty of Shares Purchased 1 Rs.150 Rs. 75 2 2 Rs.150 Rs.25 6 3 Rs.150 Rs.50 3 Total Cost Rs.450 Average Price Rs.50 Total Shares owned 11 Weighted Average Cost: Rs. 40.91 ( 450 / 11)
  72. 73. Measurement of Risk <ul><li>Risks can be classified as Systematic risks and Unsystematic risks. </li></ul><ul><li>Unsystematic risks: These are risks that are unique to a firm or industry. Factors such as management capability, consumer preferences, labour, etc. contribute to unsystematic risks. Unsystematic risks are controllable by nature and can be considerably reduced by sufficiently diversifying one's portfolio. Systematic risks: These are risks associated with the economic, political, sociological and other macro-level changes. They affect the entire market as a whole and cannot be controlled or eliminated merely by diversifying one's portfolio. </li></ul>
  73. 74. What is Beta? <ul><li>The degree to which different portfolios are affected by these systematic risks as compared to the effect on the market as a whole, is different and is measured by Beta. To put it differently, the systematic risks of various securities differ due to their relationships with the market. The Beta factor describes the movement in a stock's or a portfolio's returns in relation to that of the market returns. For all practical purposes, the market returns are measured by the returns on the index (Nifty, Mid-cap etc.), since the index is a good reflector of the market. </li></ul>
  74. 75. <ul><li>Beta is calculated as : </li></ul><ul><li>where ra measures the rate of return of the asset, rp measures the rate of return of the portfolio of which the asset is a part and Cov( ra , rp ) is the covariance between the rates of return. In the CAPM formulation, the portfolio is the market portfolio that contains all risky assets, and so the rp terms in the formula are replaced by rm , the rate of return of the market. </li></ul><ul><li>Beta is also referred to as financial elasticity or correlated relative volatility , and can be referred to as a measure of the sensitivity of the asset 's returns to market returns, its non-diversifiable risk , its systematic risk or market risk. </li></ul><ul><li>Covariance measures how two variables co-vary, and is given by : </li></ul><ul><li>Sum (x- mean(x)) (y-mean(y)) / N-1 </li></ul><ul><li>Where, N denotes the total number of observations. </li></ul><ul><li>In order to calculate the beta of a portfolio, multiply the weightage of each stock in the portfolio with its beta value to arrive at the weighted average beta of the portfolio </li></ul>Beta: Methodology / Formula                                               
  75. 76. Understanding Historical Trends is the key to success in Asset Allocation…
  76. 77. <ul><ul><li>Investing is a lot of numbers. One needs to get used to that, and quickly. </li></ul></ul><ul><ul><li>An investor can see exactly what he needs to get to his destination, and can be accountable to himself along the way. </li></ul></ul><ul><ul><li>Bonds and stocks are the two major asset classes that have been used by investors over the past century. </li></ul></ul><ul><ul><li>Knowing the total returns on each of these, and their associated volatility, is crucial to deciding where an investor should put his money. </li></ul></ul>Looking through the rear view mirror makes the journey safer ….
  77. 78. Investment Terminology…
  78. 79. <ul><ul><li>Asset </li></ul></ul><ul><ul><li>Anything that has monetary value. Typical personal assets include stocks, real estate, jewelry, art, cars, and bank accounts. </li></ul></ul><ul><ul><li>Asset allocation </li></ul></ul><ul><ul><li>Dividing investment dollars among various asset classes, typically among cash investments, bonds, and stocks. </li></ul></ul><ul><ul><li>Asset classes </li></ul></ul><ul><ul><li>The three major asset classes are cash (also called cash reserves, money market instruments, etc.), bonds, and stocks. </li></ul></ul><ul><ul><li>Diversification </li></ul></ul><ul><ul><li>Investing in separate asset classes (stocks, bonds, cash) and/or stocks of different companies in an attempt to lower overall investment risk. </li></ul></ul>Investing terminology ….
  79. 80. <ul><ul><li>Portfolio </li></ul></ul><ul><ul><li>All the securities held by an individual, institution, or mutual fund. </li></ul></ul><ul><ul><li>Compounding </li></ul></ul><ul><ul><li>When an investment generates earnings on reinvested earnings. </li></ul></ul><ul><ul><li>Capital appreciation </li></ul></ul><ul><ul><li>One of the two components of total return, capital appreciation is how much the underlying value of a security has increased. If you bought a stock at Rs.10 per share and it has risen to Rs.13, you have enjoyed a 30% return or appreciation on the original capital you invested. Dividend yield is the other component of total return. </li></ul></ul>Investing terminology ….
  80. 81. <ul><ul><li>Dividend </li></ul></ul><ul><ul><li>A share of a company's earnings paid to each stockholder. </li></ul></ul><ul><ul><li>Dividend yield </li></ul></ul><ul><ul><li>The annual percentage rate of return paid in dividends on a share of stock. To figure out the dividend yield (or just &quot;yield&quot;), divide the annual dividend by the current share price of the stock. </li></ul></ul><ul><ul><li>Inflation </li></ul></ul><ul><ul><li>A rise in the prices of goods and services. </li></ul></ul><ul><ul><li>Real return </li></ul></ul><ul><ul><li>The inflation-adjusted returns of an investment. </li></ul></ul>Investing terminology ….
  81. 82. <ul><ul><li>Risk-adjusted return </li></ul></ul><ul><ul><li>A measure of how much risk a portfolio has employed to earn its returns. </li></ul></ul><ul><ul><li>Unrealized capital gain/loss </li></ul></ul><ul><ul><li>An increase (or decrease) in the value of a stock or other security that is not &quot;realized&quot; because the security has not yet been sold for a gain or loss. </li></ul></ul><ul><ul><li>Annualize </li></ul></ul><ul><ul><li>To make a period of less than a year apply to a full year to facilitate comparative analysis. </li></ul></ul><ul><ul><li>Volatility </li></ul></ul><ul><ul><li>The degree of movement in the price of a stock or other security. </li></ul></ul>Investing terminology ….
  82. 83. <ul><ul><li>Risk tolerance </li></ul></ul><ul><ul><li>The measurement of an investor's willingness to suffer a decline (or repeated declines) in the value of investments while waiting and hoping for them to increase in value. </li></ul></ul><ul><ul><li>Standard Deviation </li></ul></ul><ul><ul><li>A measure of variation about the mean </li></ul></ul><ul><ul><li>Beta </li></ul></ul><ul><ul><li>A measure of the relative volatility of a stock or other security as compared to the volatility of the entire market (usually measured by the S&P 500 index). A beta above 1.0 shows greater volatility than the overall market, and a beta below 1.0 is less volatile. </li></ul></ul>Investing terminology ….
  83. 84. <ul><ul><li>Broker </li></ul></ul><ul><ul><li>One who sells financial products. Whether in insurance, real estate, or stocks, most brokers work under compensation structures that are at direct odds with the best interests of their clients. When using a broker, you should always find out how he or she is compensated. </li></ul></ul><ul><ul><li>Order </li></ul></ul><ul><ul><li>A request from a client to a broker to buy or sell stock, either at the market price or at a specific price. </li></ul></ul><ul><ul><li>Bear </li></ul></ul><ul><ul><li>A person with a generally pessimistic market outlook or a pessimistic view on a sector or specific stock. </li></ul></ul>Investing terminology ….
  84. 85. <ul><ul><li>Bear market </li></ul></ul><ul><ul><li>When the overall market loses value over an extended period of time. </li></ul></ul><ul><ul><li>Bull </li></ul></ul><ul><ul><li>A person with a positive or optimistic outlook for the general market, a market segment or industry, or for particular stocks </li></ul></ul><ul><ul><li>Bull market </li></ul></ul><ul><ul><li>A market that has been gaining value over a prolonged period. </li></ul></ul>Investing terminology ….
  85. 86. <ul><ul><li>Buy-and-hold </li></ul></ul><ul><ul><li>A strategy that employs buying shares of companies with the intention of keeping those holdings for a long time, preferably indefinitely, and participating in the long-term success of being a partial owner of the business underlying the stock. </li></ul></ul><ul><ul><li>Market timing </li></ul></ul><ul><ul><li>An investment strategy based on predicting short-term price changes in securities, which is virtually impossible to do. </li></ul></ul><ul><ul><li>Churn </li></ul></ul><ul><ul><li>Churning is unconscious or conscious overtrading by a broker in a customer's account. Since brokers are most often compensated by the number of transactions made on a customer's behalf, there is temptation to trade too frequently, whether that's in stocks, bonds, or mutual funds with loads. </li></ul></ul>Investing terminology ….
  86. 87. <ul><ul><li>Capital gain/loss </li></ul></ul><ul><ul><li>The difference between the price at which an asset is sold and its original purchase price (or &quot;basis&quot;). </li></ul></ul><ul><ul><li>Long-term capital gain </li></ul></ul><ul><ul><li>A profit on the sale of stock, mutual fund shares, or other securities that have been held for more than one year. Taxes owed on long-term capital gains are lower than those on short-term capital gains. </li></ul></ul><ul><ul><li>Short-term capital gain </li></ul></ul><ul><ul><li>A profit on the sale of a security that has been held for one year or less. Short-term capital gains are taxed as ordinary income. </li></ul></ul>Investing terminology ….
  87. 88. <ul><ul><li>Bond </li></ul></ul><ul><ul><li>An interest bearing or discounted debt security issued by corporations and governments. Bonds are essentially loans by the investor to the issuer in return for interest payments. </li></ul></ul><ul><ul><li>Common stock </li></ul></ul><ul><ul><li>A security representing partial ownership in a public or private corporation. </li></ul></ul><ul><ul><li>Blue-chip stocks </li></ul></ul><ul><ul><li>Really good, large companies -- often INDEX components -- that have been around long enough to have a solid history of rewarding shareholders. </li></ul></ul>Investing terminology ….
  88. 89. <ul><ul><li>Index </li></ul></ul><ul><ul><li>An unmanaged selection of securities whose collective performance is used as a standard to measure investment results. </li></ul></ul><ul><ul><li>Mutual fund </li></ul></ul><ul><ul><li>The pooled cash of many unitholders that is invested according to a stated objective, as defined by the fund's prospectus. </li></ul></ul><ul><ul><li>Open-end fund </li></ul></ul><ul><ul><li>A mutual fund that has an unlimited number of units available for purchase. Most mutual funds are open-ended. </li></ul></ul>Investing terminology ….
  89. 90. <ul><ul><li>Net asset value (NAV) </li></ul></ul><ul><ul><li>The net asset value is the price of each unit of a mutual fund. It is calculated by subtracting the fund's liabilities from its total assets, and dividing that figure by the number of units outstanding. The NAV is the amount of money that an investor would receive for each unit if the mutual fund sold all of its assets, paid off all of its outstanding debts, and distributed the proceeds to unit holders. </li></ul></ul>Investing terminology ….
  90. 91. OPT 4 MORE OPT 4 More is a tool to identify the risk return profile of an individual and suggests investments in a basket of Short term & Hybrid MF Income Plans, Equity MF and sacred assets like Bank FD and GOI bonds to suit each profile.
  91. 92. OPT 4 MORE - Asset Allocation based on risk profile <ul><li>OPT 4 MORE is a asset allocation product based on the risk profile of the investor. </li></ul><ul><li>Asset allocation is a disciplined, long-term financial strategy for investing money into various asset classes based on the investment goals, time horizon, and risk tolerance. </li></ul><ul><li>Asset Allocation is an investment portfolio technique that aims to balance risk and create diversification by dividing assets among major categories such as cash, debt and equity based on the risk profile and financial needs of the investor </li></ul>
  92. 93. Know your Risk Profile <ul><li>Risk profiling is a well-established scientific and robust way of profiling risk among investors </li></ul><ul><li>Research has established clear relationships between demographic attributes of investors and their investment risk appetite </li></ul><ul><li>OPT 4 MORE has a detailed client profiling form which would help the client in under standing his risk profile. This helps the investor to invest in the right asset allocation based on his needs. </li></ul>
  93. 94. Conservative Risk Profile <ul><li>This profile is suitable for investors who prefer to preserve capital and do not intend to taking any exposure to high risk investments. This investment profile aims to obtain marginally higher return predominantly through bank fixed deposits and a mix of debt schemes and does not invest in equity or related instruments. </li></ul>
  94. 95. Moderate Risk Profile <ul><li>This profile is suitable for investors who are willing to take an exposure of upto 30% in higher risk investments like equity related products with a medium term horizon in mind. This moderate equity exposure is to enhance the returns on the portfolio. </li></ul>
  95. 96. Aggressive Risk Profile <ul><li>This profile is suitable for aggressive investors who are willing to invest upto 50% of their portfolio in equity related products and clearly are well informed about the potential downside that could arise in case of a sharp fall in the markets. Over the long term period of upto 5 years this portfolio has the potential to outperform and deliver above average returns. </li></ul>
  96. 97. Opt 4 More – Current Asset Allocation
  97. 98. Opt 4 More – Performance Actual Performance
  98. 99. What is Systematic Investment Planning (SIP) ?
  99. 100. Systematic Investment Planning (SIP) <ul><li>Disciplined way of investing fixed amount at a regular frequency…. A time tested investment approach </li></ul><ul><li>Reduces the market risk by using the concept of rupee cost of averaging </li></ul><ul><li>Allows power of compounding help create wealth over a long term </li></ul>
  100. 101. <ul><li>Disciplined investing in equity funds over longer time frames helps generate superior returns </li></ul>
  101. 102. Rupee Cost Averaging An investor would have lost 26% if he made a one time investment in March’00 as compared to the SIP loss of 7.6% Average cost – INR 56.60 In a falling market, SIP results in a better downside Protection
  102. 103. Rupee Cost Averaging… In the backdrop of a sharp rally , a SIP may under- perform a single entry strategy for a short period of time. Average cost – INR 78.22
  103. 104. Systematic Investment Planning (SIP) The value of INR 1000 invested every month for the last 2 year period in a systematic investments plan in the following equity funds would be….
  104. 105. Systematic Investment Planning (SIP)
  105. 106. <ul><li>Investing INR 1000 per month from January’97 to </li></ul><ul><li>December’04 in Franklin India Bluechip Fund would have generated return of 36% over the the past eight years </li></ul><ul><li>A Savings corpus of INR 4.24 lakhs could have been built in eight years by saving INR 1000 per month through an SIP in an equity fund by investing INR 96,000 </li></ul>Examples (Ten Year SIP)
  106. 107. Examples (Five Year SIP) <ul><li>Investing INR 1000 per month from January’99 to over the last December’04 in Pru-ICICI Power would have generated return of 37% p.a. over the last five years </li></ul><ul><li>A Savings corpus of INR 1.46 lakhs could have been built over a five year time period by saving INR 1000 per month through an SIP in an equity fund by investing a sum of INR 60,000 </li></ul>