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Investment Philosophy

What Is an Investment?

An investment is an asset or item acquired with the goal of generating income or appreciation. In an economic sense, an investment is the purchase of asset today but is used in the future to create wealth. To invest is to allocate money in the expectation of some benefit in the future. In financial term, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a gain or profit. The benefit from an investment is called a return. The return may consist of a gain (or loss) realised from the sale of a property or an investment, unrealised capital appreciation (or depreciation), or investment income such as dividends, interest, rental income etc., or a combination of capital gain and income. The return may also include currency gains or losses due to changes in the foreign currency exchange rates if invested in in any asset abroad. Taking an action in the hopes of raising future revenue can also be considered an investment. For example, when choosing to pursue additional education, the goal is often to increase knowledge and improve skills in the hopes of ultimately producing more income. Investing is oriented toward future growth or income, there is risk associated with the investment in the case that it does not pan out or falls short. For instance, you lose money invested in a company that ends up going bankrupt or a project that fails. This is what separates investing from saving - saving is accumulating money for future use that is not at risk, while investment is putting money to work for future gain and entails some risk.

Investors generally expect higher returns (compared to the bench mark) from riskier investments. When a low risk investment is made, the return is also generally low. Similarly, high risk comes with high returns.

Making smart investments can help you generate income by putting your money to work. While you may work hard to earn money, it may not always be enough to fulfill your dreams and goals. To start investing, you can consider either growth-oriented or fixed-income investment instruments. People often get confused between savings and investments, which play different roles in your personal financial planning. While both savings and investments are important, they have different objectives. The intent or purpose of keeping the money aside is the first differentiating factor. You usually save money or keep some money aside for emergencies. However, investing is when you put this money in smart investment avenues, with the hope to generate higher wealth for the future use. Savings and investments vary in the way wealth is accumulated. While savings are considered as a passive way of wealth accumulation, well-planned investment strategies can help in accumulating more wealth.

What`s difference between Investment & Speculation?

An investment is an asset or item acquired with the goal of generating income or appreciation in the future. Investing can come in many different asset classes. In the financial sense of the term, investing means the buying and selling of securities

Speculation is a financial transaction that has substantial risk of losing all or most of the value, but with the expectation of a significant gain. Speculating is the act of putting money into financial endeavors with a probability of failure. Speculation seeks abnormally high returns from bets that can go one way or the other. For many speculating is likened to gambling.

What is Investable Surplus?

Investible surplus is the sum of money remaining with you after you have met all your expenses. An important element of financial planning, investible surplus determines whether your goals can be realistically achieved. Your Investible surplus is the amount of money remaining with you after meeting all your expenses e.g. monthly income minus monthly expenses. It is the money you don’t need now or in the near future, and is available for long term investing. It’s an important factor in your planning, as it determines whether & when you can meet your goals. Your plan should be to put the entire investable surplus to work hard for you. And that is by staying invested for long and letting the magic of compounding work for you.

Benchmarking of Investment Returns:

A benchmark is a standard or measure that can be used to analyze the allocation, risk, and return of a given portfolio. An investor, who invests or chooses investments based on such benchmarks, could end up making some decidedly suboptimal investments. One could exceed all types of frequently used average benchmarks and still be a loser. The real benchmark that an investor should follow would be based on something that aligns with your own needs. It provides an indicative value of how much one’s investment should have earned, which can be compared against how much it has earned in reality.

For Equity it can be NIFTY (50) or Sensex (30) CNX Midcap and Small cap, BSE 200 performance. One can look at GDP Growth (nominal plus inflation).

For Debt: It can be yield of 10 year treasury/government Bond, or NSC interest rate offered by Post office or for tax free returns it could be PPF Interest rate. One can look at a simple one like Repo Rate plus 2-3%.

Mutual Funds or Professional Fund Manager may adopt complicated bench mark but as Investor keep your bench mark simple & easy to understand or comprehend and track that benchmark.

Pre-tax vs. Post Tax Returns

As an investor, one should look for investment options that not only helps you save tax but also generate tax-free income. However, many fund managers take tax rate at maximum marginal rate of 31.2% (30% plus Cess @4%). However many investors may not be in that bracket and hence they can use their average rate (total Income Tax liability under new tax regime on estimated income)because that is what they actually pay. One cardinal principle is that no investment decision should be based on taxation. Tax planning is an integral part of financial planning, but should not be the key driver of investment decisions. Once he figures out our financial plan, putting aside money to make the most of the available tax breaks will become easier. And with new tax regime, it is becoming lot easier and predictable. So do not fall in the trap of Pre Tax Returns 7 post tax returns used as sales pitch by Sales person marketing an investment product to you.

What is Short Term, Medium Term & Long Term Investment?

Investments that are short, medium or long term in nature each have their own implications and require their own approach to financial planning.

Short-term investments

When we talk about the ‘short term’, we’re usually looking at a 3 months to 18 months’ time horizon. Your goal with a short-term investment might be a holiday trip, a new car, or a similar big-ticket purchase. One of your primary goals with short-term savings is to not lose money – and that’s why some financial advisers would tell you that, for this time horizon, a savings account or a money market investment is a safer choice than more volatile investments such as equities or property.

Medium-term investments

‘Medium-term’ refers to investments with 18months to 3-year time horizon. So your goal is further away than a short-term investment, but it’s not in the distant future like, say, your retirement. Medium-term investment goals might include paying for a wedding in the family, starting a business, planned foreign trip, paying for your children’s education, or something similar. What makes medium-term investments so interesting (or complicated) is that you can afford to ride out some market volatility, which you can’t do in a short-term investment. On the other hand, though, the time horizon is still relatively short in investment terms, you’ll have less time to make adjustments than you would in a long-term investment. Remember that you’ll want your money to be relatively accessible, and that you’ll be able to incur some risk in exchange for a higher return.

Long-term investments

Long-term investments sit on the distant horizon. Your goal is usually more than 3 years away, but can be up to 20 or 30 years in the future – like your retirement, children`s higher education, children`s wedding, second home, etc. It’s out of sight, but not entirely out of mind. You’ll have to do some low-level management of your long-term investments, checking in once or twice a year to ensure your investment is growing and that you’re still on track for your goal. If it’s retirement that you are saving for, run your numbers yearly. That long time horizon gives your money time to work, and time to enjoy the benefits of compound interest. It also means you’re able to diversify your portfolio, including a mix of assets that offer a healthy blend of risk and reward, and with sensible protection and varied exposure. Time is (relatively speaking) on your side, so you should be able to ride out the volatility of the market.

What are broad classes of Investors?

There are broadly two types or classes of investors: Passive investor and Active investor. There are Investors who are Professional Investors and then there are Ordinary Investors. Each level builds on the skills of the previous level below it. Each level represents a progressive increase in responsibility toward your financial security requiring a similarly higher commitment of effort.

Active investor, as its name implies, takes a hands-on approach. The goal of active money management is to beat respective market’s average returns and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular asset class. Active investing requires confidence that whoever is investing the portfolio will know exactly the right time to buy or sell. Successful active investment management requires being right more often than wrong.

Passive Investor is for investing for the long haul. Passive investors limit the amount of buying and selling within their portfolios, making this a very cost-effective way to invest. The strategy requires a buy-and-hold mentality. That means resisting the temptation to react or anticipate respective market’s every next move.

The prime example of a passive approach is to buy an index fund that follows one of the major indices When you own tiny pieces of thousands of stocks, you earn your returns simply by participating in the upward trajectory of corporate profits over time via the overall stock market. Successful passive investors keep their eye on the prize and ignore short-term setbacks—even sharp downturns.

The Aggressive Investor: This investor wants results, and is hard-charging and impatient. An aggressive investor is a risky investor unless he has a very long time span and can limit impulse buying and selling.

The Flexible Investor is neither innately aggressive nor defensive; rather, he is pragmatic, open-minded and adaptive. A flexible investor is also someone that naturally avoids syndromes such as overconfidence or self-attribution that promote poor results. People that are pragmatic seem to contain an inherent ability to restrain such impulses.

The Defensive (Cautious) Investor is innately cautious, even timid. Risk frightens him and security reassures him. Even if he is young, the defensive investor is likely to avoid a portfolio heavy with growth or speculative issues. In fact, merely having a high proportion of stocks in a portfolio may cause unease.

The Nervous Investor is a different kind of profile. A jumpy investor might be aggressive or pragmatic or cautious, but simply can’t overcome a habit of being anxious. This anxiety almost inevitably leads to poor investment decisions, overselling and frequent changes in portfolio strategy.

The Trader loves transactions and the rush of the trade. He is looking for short-term gains that he either believes are possible with the right system or market/investment knowledge. The trader is usually quick-witted and may be very intelligent and a good student.

Investing is not an empirical science. It might even be a combination of art and science. Fundamental and technical analyses certainly count. So does investor psychology.

Goals & Expected Returns

Goal-based investing emphasizes attaining life goals.

Important goals for investment:

ü Generate income to supplant working lifestyle

ü Preserve the capital, make safe decisions maintain your net worth but not erode it,

ü Maintain liquidity so as to access to it,

ü Minimising cost to buy into investment product

ü Selectively indulge in speculation so as to make fast money when opportunity is available to build wealth

What Is Expected Return?

Expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). Achieving alpha, or improve return on your investment or portfolio as compared to a standard benchmark, such as a market index.

What is Investment Psychology?

Psychology plays a key role in investing. Emotions that affect investing include fear and greed, but are more diverse and can significantly impact results. Investor psychological profiles affect how an investor's portfolio performs because investing decisions are directly linked to emotions. Psychology, emotions and irrationality do play key roles in investing. A smart investor is one that harnesses his or her emotions.

Overconfidence is an exaggerated belief in one’s abilities compared to reality. In investing, overconfidence can lead to overtrading. An investor ‘substitutes’ his sense of confidence for actual knowledge, leading to errors.

Self-attribution is another form of investing bias. People exhibiting this characteristic attribute positive, successful investment results to themselves and bad results to external factors. While emotionally comforting, self-attribution will likely harm returns over time.

Selective memory keeps certain memories and expels others from our consciousness. It can push us to remember our good decisions and forget the bad ones. Selective memory skews the investor’s rear view and encourages overconfidence.

Self-handicapping is a term for investors creating preliminary excuses should an investment go wrong. An example is “the stock did poorly; I must not have done the right research.” This is another emotional habit that assigns too much power to the investor and distorts buy or sell decisions.

Herding is following the crowd. This can lead to too-casual research or purchasing a stock that is riding on reputation. Running with the herd may also lead to an investor missing out on unsung but sound stocks on the investment landscape.

Risk appetite- Types of Investments

Risk appetite is a concept to help guide person's approach to risk. Risk appetite is the amount of risk you can take on your investment. It is the point till which you feel that you should remain invested in an asset class because still in the long run you will be rewarded finally. Till that point there will not be enough change in your mental state.

It’s a personal thing, there is nothing like good or bad investment. It’s a subjective matter. At last everything boils down to “You get what you wanted”, it must give you emotional satisfaction and joy. There are people who are fine with 9% return per Annam and there are people who are not even satisfied with 20% returns. Risk and returns are always proportional. Normally people choose a product which matches there return expectation and then compromise with the risk and then later on when there is loss more then there risk appetite, they cry.

Before you start investing, it is best to understand the different types of investments.

For most investors, investments vary in terms of risk levels

Ø low risk,

Ø medium risk and

Ø high risk

Here’s a look at these investment options in detail:

Low-risk investments – These are instruments which pay fixed income – irrespective of the changes in the business or economy. Bonds, debentures and fixed deposits come under this category. Also, special investment vehicles – PPF, EPF, SCSS, Sukanya Samriddhi, National Savings Scheme and other small Post Office Schemes which are created by a government statute for specific purposes are low risk as they guarantee the returns. The returns are periodic and pre-determined. Low-risk investments are not linked to the stock market movements and are usually governed by the interest rate movements of the financiers. However, there is always the returns are always guaranteed. Government bonds and life insurance policies provide good returns; however, they have long lock-in periods. So, you will have to wait for a long time to earn substantial returns from these investment options. Fixed deposit is one of the very few low-risk investments that offer stable, high returns and immediate liquidity.

Medium-risk investments – These are investments which might have a certain percentage of risk but these also pay higher returns to investors willing to invest in them. Debt funds, balanced mutual funds, and index funds fall in this category. Such instruments do have an element of debt and stability, but they have their volatility linked to the markets which can hamper your principal amount. The irregularity in earnings can make any fixed income from such investment impossible.

High-risk investments – These are investments where there is no limit to the upside along with the downside of risk-returns. These are stocks of companies, equity mutual funds, even stocks, and derivatives. The return on these instruments can give huge returns as well as chances of losses depending on various external factors to the company and internal ones. The quantity and timing of returns on these instruments are not fixed. Hence, they are at high risk.

A number of risks investors face are:

Business Risk: While running a Company they face various business risks such as Government policies, technological changes, natural disasters, change of consumer behavior and dependence on key management personnel. As an example, famous case of Kodak is text book for Business failure. With a stock, you are purchasing a piece of ownership in a company. With a bond, you are loaning money to a company. Returns from both of these investments require that that the company stays in business.

Volatility Risk: Market fluctuations can be unnerving to some investors. A stock’s price can be affected by factors inside the company, such as a faulty product, or by events the company has no control over, such as political or market events.

Inflation Risk: Inflation is a general upward movement of prices. Inflation reduces purchasing power, which is a risk for investors receiving a fixed rate of interest. The principal concern for individuals investing in cash equivalents is that inflation will erode returns.

Interest Rate Risk: Interest rate changes can affect a bond’s value. If bonds are held to maturity the investor will receive the face value, plus interest. If sold before maturity, the bond may be worth more or less than the face value. Rising interest rates will make newly issued bonds more appealing to investors because the newer bonds will have a higher rate of interest than older ones. To sell an older bond with a lower interest rate, you might have to sell it at a discount.

Liquidity Risk: This refers to the risk that investors won’t find a market for their securities, potentially preventing them from buying or selling when they want. This can be the case with the more complicated investment products.

Fear & Greed factor in Investing

Greed and fear refer to two opposing emotional states theorized as factors causing the unpredictability and volatility of the markets, and irrational market behavior inconsistent with the efficient-market hypothesis. Greed and fear relate to an old Wall Street saying: “financial markets are driven by two powerful emotions – greed and fear.”

Greed is one aspect of our need to meet our investment goals. Fear is another aspect of our need to avoid losses that can dash our investment hopes. Greed and fear don’t really capture the full spectrum of investing emotions, but they are the symbols of the emotional nature of investing.

You need to accept a greater risk of losing some of your original investments to actually grow the money you need to retire. Greed represents the willingness to take on more risk. Fear represents the willingness to recognize the risks and appropriately manage them.

Greed and fear are among the animal spirits that Keynes identified as profoundly affecting economies and markets. Warren Buffett found an investing rule in acting contrary to such prevailing moods, advising that the timing of buying or selling stocks should be "fearful when others are greedy and greedy only when others are fearful." A jargon in market is “The greedy bulls are battling with the fearful bears”

Investing Fears

Ø Fear of losing the money

Ø I will never be able to retire and have to continue earning till I live to support my family

Ø Stock market is going to Crash

Ø A Catastrophic event will bankrupt me

How you can overcome any fear in Investing

ü Knowledge: Know what you are doing

ü Preparation: Be prepared for emergencies

ü Action: Act on your knowledge when the time is right

Big Concerns of Investors

· Rising trade tensions, falling manufacturing growth and rising input costs

· Domestic Politics Uncertainty

· International Geopolitical tensions

· Economy performing

· Inflation, sudden spike

· Interest Rates, volatile

· Regulation/De-Regulation, sudden changes with change of rulers

How does one monitor Investments?

Investing is not an end unto itself, but rather a means to an end for most people. Whether your goal is a comfortable retirement, funding your kid's college education, or buying a house, your savings and investment activity is a means to those ends.

Following are some ways you can monitor your investments:

Create a financial plan: A financial plan helps you determine how much risk you need to take to potentially earn the types of returns to fund your goals over the desired time frame.

Review: It is critical to review your investments as a total portfolio across all of your accounts. Look at the overall allocation to determine if it is in sync with your financial plan.

Establish benchmarks: Just like you need a financial plan to help you decide where you are going with your investments, you need a benchmark to help you determine if you are on track.

Evaluate your individual holdings. Once you've determined that your overall allocation is in line and you've looked at how you are doing versus the overall benchmarks, it's time to look at your individual holdings. This is also referred to as monitoring the investments.

Frequency of monitoring:

Investments held for short term should be monitored regularly, say weekly. Investments held for long term should be monitored monthly or quarterly. Some Investments such as Real Estate should be monitored yearly or once in 2-3 years.

Frequency of Investments:

Frequency of Investments should be linked to regularity of source. If surpluses (Income minus expenses) are from salary, it should be invested monthly. If it`s from Income from Investments, it should be matched with frequency of Income. Dividends are normally annual sometimes in September or Interest on quarterly. If we have to choose option on monthly, quarterly or annual basis, we should choose annually as principle of compounding benefits you. If you have to choose frequency in Pension Plan, then obviously option should be monthly.

What is SIP?

A Systematic Investment Plan (SIP), more popularly known as SIP, is a facility offered by many Institutions including mutual funds to the investors to invest in a disciplined manner. SIP facility allows an investor to invest a fixed amount of money at pre-defined intervals in the selected scheme. Thus SIP is a facility not a plan or product. It is just a matter of discipline but many MFs & Fund Managers are mis -selling SIP as Product.


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