October 2012

Measures of Risk ~ Equity & Debt

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Measures of Risk, Performance, Mutual Funds , Stocks, Standard Deviation, Variance, Beta, Modified duration, Credit Risk, Interest Rate Risk, Weighted Average Maturity  ,Yield Spread,

Investors generally focus on the returns of any asset. They largely ignore the risk factors and most importantly are ignorant of the measures of risk. 

And so, the real Risk comes from not knowing what they are doing ~ Warren Buffett

This post talks about the measures of risks in equities & debt. The awareness of the measures of risk is extremely helpful in designing a comprehensive financial plan, investing, asset allocation etc.

Fluctuation in returns is used as a measure of risk.

Therefore, to measure risk, generally the periodic returns (daily / weekly / fortnightly / monthly) are first worked out, and then their fluctuation is measured.

The fluctuation in returns can be assessed in relation to itself, or in relation to some other index. Accordingly, the following risk measures are commonly used.

Variance

Suppose there were two stocks, with monthly returns as follows: Stock 1: 5%, 4%, 5%, 6%. Average=5%  & Stock 2: 5%, -10%, +20%, 5% Average=5%

Although both stocks have the same average returns, the periodic (monthly) returns fluctuate a lot more for Stock 2. Variance measures the fluctuation in periodic returns of a asset, as compared to its own average return. This can be easily calculated in MS Excel using the following function:

=var(range of cells where the periodic returns are calculated)

Variance as a measure of risk is relevant for both debt and equity.

Standard Deviation

Like Variance, Standard Deviation too measures the fluctuation in periodic returns of a scheme in relation to its own average return. Mathematically, standard deviation is equal to the square root of variance.

This can be easily calculated in MS Excel using the following function: =stdev(range of cells where the periodic returns are calculated)

Standard deviation as a measure of risk is relevant for both debt and equity schemes.

Beta

Beta is based on the Capital Assets Pricing Model, which states that there are two kinds of risk in investing in equities – systematic risk and non-systematic risk.

Systematic risk is integral to investing in the market; it cannot be avoided. For example, risks arising out of inflation, interest rates, political risks etc.

Non-systematic risk is unique to a company; the non-systematic risk in an equity portfolio can be minimized by diversification across companies. For example, risk arising out of change in management, product obsolescence etc.

Since non-systematic risk can be diversified away, investors need to be compensated only for systematic risk. This is measured by its Beta.

Beta measures the fluctuation in periodic returns in a scheme, as compared to fluctuation in periodic returns of a diversified stock index over the same period.

The diversified stock index, by definition, has a Beta of 1. Companies or schemes, whose beta is more than 1, are seen as more risky than the market. Beta less than 1 is indicative of a company or scheme that is less risky than the market.

Beta as a measure of risk is relevant only for equity schemes.

Modified Duration

This measures the sensitivity of value of a debt security to changes in interest rates. Higher the modified duration, higher the interest sensitive risk in a debt portfolio.

The returns in a debt portfolio are largely driven by interest rates and yield spreads.

Interest Rates

Suppose an investor has invested in a debt security that yields a return of 8%. Subsequently, yields in the market for similar securities rise to 9%. It stands to reason that the security, which was bought at 8% yield, is no longer such an attractive investment.

It will therefore lose value. Conversely, if the yields in the market go down, the debt security will gain value. Thus, there is an inverse relationship between yields and value of such debt securities which offer a fixed rate of interest.

A security of longer maturity would fluctuate a lot more, as compared to short tenor securities. Debt analysts work with a related concept called modified duration to assess how much a debt security is likely to fluctuate in response to changes in interest rates.

In a floater, when yields in the market go up, the issuer pays higher interest; lower interest is paid, when yields in the market go down. Since the interest rate itself keeps adjusting in line with the market, these floating rate debt securities tend to hold their value, despite changes in yield in the debt market.

If the portfolio manager expects interest rates to rise, then the portfolio is switched towards a higher proportion of floating rate instruments; or fixed rate instruments of shorter tenor. On the other hand, if the expectation is that interest rates would fall, then the manager increases the exposure to longer term fixed rate debt securities.

The calls that a fund manager takes on likely interest rate scenario are therefore a key determinant of the returns in a debt fund – unlike equity, where the calls on sectors and stocks are important.

Yield Spreads

Suppose an investor has invested in the debt security of a company. Subsequently, its credit rating improves. The market will now be prepared to accept a lower yield spread. Correspondingly, the value of the debt security will increase in the market.

A debt portfolio manager explores opportunities to earn gains by anticipating changes in credit quality, and changes in yield spreads between different market benchmarks in the market place.

Weighted Average Maturity

While modified duration captures interest sensitivity of a security better, it can be reasoned that longer the maturity of a debt security, higher would be its interest rate sensitivity. Extending the logic, weighted average maturity of debt securities in a scheme’s portfolio is indicative of the interest rate sensitivity of a scheme.

Being simpler to comprehend, weighted average maturity is widely used, especially in discussions with lay investors. However, a professional debt fund manager would rely on modified duration as a better measure of interest rate sensitivity. 

More on Mutual Funds

How do you compare and evaluate Mutual Fund Performance

 Risk-adjusted Returns, Evaluating Mutual Fund Performance, Sharpe Ratio, Treynor Ratio, Beta, Alpha, tracking error, Index funds, .

Risk-Adjusted Return is one of the concept investors should be aware when comparing returns of mutual funds.  

One way of comparing the returns between two different funds is to look at the their relative returns over a period. However, a weakness of this approach is that it does not differentiate between two schemes that have assumed different levels of risk in pursuit of the same investment objective.

It is possible that although two schemes share the benchmark, their risk levels will differ, and sometimes quite dramatically as well. Evaluating performance, purely based on relative returns, may be unfair towards the fund manager who has taken lower risk but generated the same return as a peer.

An alternative approach to evaluating the performance of the fund manager is through the risk reward relationship.

The underlying principle is that return ought to be commensurate with the risk taken.

A fund manager, who has taken higher risk, ought to earn a better return to justify the risk taken. A fund manager who has earned a lower return may be able to justify it through the lower risk taken. Such evaluations are conducted through Risk-adjusted Returns.

There are various measures of risk-adjusted returns. We’ll look at the three most commonly used :

Sharpe Ratio

An investor can invest with the government, and earn a risk-free rate of return (Rf). T-Bill index is a good measure of this risk-free return.

Through investment in a scheme, a risk is taken, and a return earned (Rs).

The difference between the two returns i.e. Rs – Rf is called risk premium. It is like a premium that the investor has earned for the risk taken, as compared to government’s risk-free return.

This risk premium is to be compared with the risk taken. Sharpe Ratio uses Standard Deviation as a measure of risk. It is calculated as

(Rs minus Rf) ÷ Standard Deviation

Thus, if risk free return is 5%, and a scheme with standard deviation of 0.5 earned a return of 7%, its Sharpe Ratio would be (7% – 5%) ÷ 0.5 i.e. 4%.

Sharpe Ratio is effectively the risk premium per unit of risk. Higher the Sharpe Ratio, better the scheme is considered to be. Care should be taken to do Sharpe Ratio comparisons between comparable schemes. For example, Sharpe Ratio of an equity scheme is not to be compared with the Sharpe Ratio of a debt scheme.

Treynor Ratio

Like Sharpe Ratio, Treynor Ratio too is a risk premium per unit of risk.

Computation of risk premium is the same as was done for the Sharpe Ratio. However, for risk, Treynor Ratio uses Beta.

Treynor Ratio is thus calculated as: (Rf minus Rs) ÷ Beta

Thus, if risk free return is 5%, and a scheme with Beta of 1.2 earned a return of 8%, its Treynor Ratio would be (8% – 5%) ÷ 1.2 i.e. 2.5%.

Higher the Treynor Ratio, better the scheme is considered to be. Since the concept of Beta is more relevant for diversified equity schemes, Treynor Ratio comparisons should ideally be restricted to such schemes.

Alpha

The Beta of the market, by definition is 1. An index scheme mirrors the index. Therefore, the index scheme too would have a Beta of 1, and it ought to earn the same return as the market. The difference between an index fund’s return and the market return, as seen earlier, is the tracking error.

Non-index schemes too would have a level of return which is in line with its higher or lower beta as compared to the market. Let us call this the optimal return.

The difference between a scheme’s actual return and its optimal return is its Alpha – a measure of the fund manager’s performance. Positive alpha is indicative of out-performance by the fund manager; negative alpha might indicate under- performance.

Since the concept of Beta is more relevant for diversified equity schemes, Alpha should ideally be evaluated only for such schemes.

These quantitative measures are based on historical performance, which may or may not be replicated.

Such quantitative measures are useful pointers. However, blind belief in these measures, without an understanding of the underlying factors, is dangerous. While the calculations are arithmetic – they can be done by a novice; scheme evaluation is an art – the job of an expert. 

Source : NISM
 
More on Mutual Funds

May 2012

Options Delta : The Basics

options, call, put, hedging, risk , return, delta, delta neutral strategy, options basics, enrichwise

Options Delta is the ratio of the change in the price of the stock option to the change in the price of the underlying stock

Delta = instantaneous change in value of asset with respect to an underlying risk factor. Option’s delta changes continuously as underlying risk factor changes

Here are some basic characteristics of Options Delta :

  • It is the change in the price of an option for a one point moves in the underlying
  • Delta of a call option is positive
  • Delta of a put option is negative
  • Delta increases – in decreasing index
  • Delta decreases – in increasing index
  • Call options: 0 < Option Delta < 1
  • Put options: -1 < Option Delta < 0
  • In-the-money options: Delta Option approaches 1 (call:+1,put:-1)
  • At-the-money options: Delta is about 0.5 (call:+0.5, put: -0.5)
  • Out-of-the-money options: Delta Option approaches 0
  • Call Option Delta can be interpreted as the probability that the option will finish in the money
  • An at-the-money option : which has a delta of approximately 0.5, has roughly a 50/50 chance of ending up in-the-money
  • Put Option Delta can be interpreted as -1 times the probability that the option will finish in the money

Impact of Time : As time passes, the delta of In-the-money options: increases & Out-of-the-money options: decreases

Impact of Volatility : As volatility falls, the delta of In-the-money options: increases & Out-of-the-money options: decreases

Hedging using Options – Delta to neutralize market risk :

  • In order to maintain a riskless hedge using an option and the underlying stock, need to adjust holdings in the stock periodically
  • An important parameter in pricing and hedging of options
  • No. of units of stock should hold for each option shorted in order to create a riskless hedge
  • Construction of a riskless hedge is sometimes referred as delta hedging

To get more information on Options Greeks , read Options Basics of Vega ,  Gamma 

“The greatest ignorance is to reject something you know nothing about”…If you are invested in Markets, it makes sense to be aware of & have an idea about Options

March 2012

August 2010

What and How of Nifty Index!!!

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One of my friend recently just wanted to get an idea about Nifty and How it is calculated. I am presenting some basic facts about Nifty here….

Background of Nifty

S&P CNX Nifty is a well diversified 50 stock index accounting for 21 sectors of the economy. It is used for a variety of purposes such as benchmarking fund portfolios, index based derivatives and index funds.

S&P CNX Nifty is owned and managed by India Index Services and Products Ltd. (IISL), which is a joint venture between NSE and CRISIL. IISL is India’s first specialised company focused upon the index as a core product. IISL has a Marketing and licensing agreement with Standard & Poor’s (S&P), who are world leaders in index services.

  • The traded value for the last six months of all Nifty stocks is approximately 44.89% of the traded value of all stocks on the NSE
  • Nifty stocks represent about 58.64% of the total market capitalization as on March 31, 2008.
  • Impact cost of the S&P CNX Nifty for a portfolio size of Rs.2 crore is 0.15%
  • S&P CNX Nifty is professionally maintained and is ideal for derivatives trading

What and How of Nifty Index, How is stock selected in Index, Sensex, India Index Services and Products Ltd. (IISL)NSE, CRISIL, Liquidity,  Impact Cost, Floating Stock, index calculation

How Stocks are selected :

The constituents and the criteria for the selection judge the effectiveness of the index. Selection of the index set is based on the following criteria:

Liquidity (Impact Cost)

For inclusion in the index, the security should have traded at an average impact cost of 0.50% or less during the last six months for 90% of the observations for a basket size of Rs. 2 Crores.

Impact cost is cost of executing a transaction in a security in proportion to the weightage of its market capitalisation as against the index market capitalisation at any point of time. This is the percentage mark up suffered while buying / selling the desired quantity of a security compared to its ideal price (best buy + best sell) / 2

Floating Stock

Companies eligible for inclusion in S&P CNX Nifty should have atleast 10% floating stock. For this purpose, floating stock shall mean stocks which are not held by the promoters and associated entities (where identifiable) of such companies.

Others

a) A company which comes out with a IPO will be eligible for inclusion in the index, if it fulfills the normal eligiblity criteria for the index like impact cost, market capitalisation and floating stock, for a 3 month period instead of a 6 month period.

b) Replacement of Stock from the Index:

A stock may be replaced from an index for the following reasons:

i. Compulsory changes like corporate actions, delisting etc. In such a scenario, the stock having largest market capitalization and satisfying other requirements related to liquidity, turnover and free float will be considered for inclusion.

ii. When a better candidate is available in the replacement pool, which can replace the index stock i.e. the stock with the highest market capitalization in the replacement pool has at least twice the market capitalization of the index stock with the lowest market capitalization.

With respect to (2) above, a maximum of 10% of the index size (number of stocks in the index) may be changed in a calendar year. Changes carried out for (2) above are irrespective of changes, if any, carried out for (1) above.

And Finally how is the index calculation done

S&P CNX Nifty is computed using market capitalization weighted method, wherein the level of the index reflects the total market value of all the stocks in the index relative to a particular base period. The method also takes into account constituent changes in the index and importantly corporate actions such as stock splits, rights, etc without affecting the index value.

Source : NSE

Selling Options : Sometimes it can be made to good use.

Selling Options , Calls, Puts, Tutorials, Options Strategies, Butterfly, Straddle, Strangle,  What Investors should know.

Options, by definition, are a wasting asset. The time decay, declining volatility etc. eat away into the premiums of the options.

Many option buyers learn this fact the hard way by watching their option contracts expire worthless many times. The majority of options expire worthless (estimates are somewhere > 80%). Given that the majority of option buy positions are worthless at the time of expiration, some investors decide that they will sell options and collect the premium. Prima Facie, this sounds like an easy way to make money.

However, there is no free lunch in the investment field as well. There are stories of how some of the brightest people in the world have blown up their accounts while selling ‘Naked’ options. Selling options, when there are no underlying holdings to support in case of adverse move is known as ‘Naked’ Selling.

Nevertheless, Options selling, when used intelligently, can be used to complement/protect your portfolio holdings to a certain extent and also make income in return.

Investors earn a premium for every put and call option which they sell. This premium is paid by Option Buyers.

Selling Short

When you sell shares of a company which you do not own, then it is called short selling. Selling a stock short is taking a view that the shares will keep going down. One way of doing this is by selling Futures. And another way of doing this is by selling Call Options.

In a short sale you have to buy back the shares at some point. And thus, short selling exposes you to unlimited risk, if the price of the stock starts to increase.

There are numerous strategies in Options. I will present just one example of how the selling of call options can be used by investors :

 

Covered Call Strategy

A covered call strategy is strategy for bullish investors to make some money and benefit from a stock that will move little over the short term.

This is often employed when an investor has a short-term neutral view on a stock or when the Stock has made a decent up move in a relative short period of time, and is expected to be range bound in the near term.

Let us take the example of Larsen and Toubro (LNT) recent price action again.

Assume, Investors bought the stock @ 1400 or Traders bought it at the breakout above 1660 in early June. Next, the stock made a decent up move in a month’s time frame and touched almost 1900. Investors could have written an options contract selling one call option of LNT Jul 2010 strike price 1900 at Rs 40. (However, Remember that one call option gives an investor the right to buy 125 shares).

You would earn income because the buyer of the call option has to pay you a premium for the option. If the stock’s price drops stays below the strike price (In this case , LNT did close well below Rs 1900 by Jul end) , the call buyer will never exercise the contract and the entire premium is yours to keep (Remember one lot of LNT is 125 and that makes the premium monies Rs 125 * 40 = Rs 5000).

If the stock’s price increases above the strike price, the call buyer may choose to exercise the contract. You would then either have to buy shares on the open market or deliver your shares to the buyer.

This is one of the common ways in which large institutional players generate income on the basis of their large holdings which they can always use to hedge in case of any adverse move against their options position.

Again, the intention of this article is to arouse interest and make aware of Options Selling. It does not advocate that you start selling options. Please understand, when selling options, remember that although your profit potential is limited to the amount of the premium that you receive, your losses can be rather large.

Also, My personal view is that selling PUT Options carries higher risk than Selling CALL options. This is because , in general, stocks generally use the stairs when going up (Sellers of Call Options can manage risk here ….) , But Jump out of the window when coming down. (Sellers of Put options can run out of exit options or get trapped …)

LNT has indeed made a good move from 1660 to 1900 and which I have been tracking since Early June …

You might be interested to know about Buying Options here…

July 2010

Buying Options : What Investors should know

“The greatest ignorance is to reject something you know nothing about”

If you are invested in Equity Markets or Mutual Funds, it is wise to be AWARE of the derivative product called ‘Options’.

Buying Options , Calls, Puts, Tutorials, Options Strategies, Butterfly, Straddle, Strangle,  What Investors should know

Options have seen increase in popularity over the past few years. Television shows like CNBC, NDTV Profit, ET Now etc devote a significant amount of time discussing option strategies for investors. Investors and traders are attracted to options due to the low cost involved. There is a possibility of high return potential in case of options trading as well. However there is an equal or more probability of downside of trading in options which needs to be understood as well.

Let us take a look at a few of the more popular strategies for buying options.

Types of Options

Call Options

Call options give an investor the right to buy shares at an agreed upon price. Investors that buy calls are not obligated to ever exercise the option. Call options can be owned for as short as a few days or long as a year. Investors that purchase call options are bullish on a particular stock.

Put Options

Put options are just like call options except they give investors the right to sell shares of a stock. Bearish investors buy put options so that they can benefit from a stock that they expect to decline. Watching the activity in put options is a great way of judging when investor sentiment is turning bearish.

Buying call options are cheaper than buying shares of stock.

Call options allow investors to buy shares of a company for a much cheaper price than buying the actual shares themselves. For example, say you wanted to buy 125 shares of LNT (Larsen and Toubro) at 1700. Your total cost would be Rs 2,12,500. I have taken the figure of 125 shares because lot size of LNT is 125. (Pls note that futures and options are bought in lots)

A cheaper option would be to buy call options. You could buy one CALL option of Jul 2010 series , strike price 1700 (lot size 125) for Rs 50. Your total cost would be Rs 6,250 (125 shares x Rs50). You would only pay Rs 6,250. If shares of LNT are higher than 1750 (Strike price + cost of purchase Rs 50) by series end, you could exercise the option and make a profit. If not then you can just let the option expire. Your total risk is only Rs 6,250. For this investment you could control 125 shares of LNT.

Buying put options can limit your downside risk.

Buying a put option is a great way for investors to limit their downside risk. It is like taking insurance against your assets.

Let’s say you already owned 125 shares of LNT and the stock is currently at Rs 1700. Let us assume that you are sitting in good profits, you are afraid that the stock is going to decline, and at the same time you do not want to sell your shares.

You could protect your profits by buying a put option.

You could buy one PUT option of Jul 2010 series, strike price 1650 (lot size 125) for Rs 50. . If shares of LNT are lower than 1650 (Strike price – cost of purchase Rs 50) by series end, you would exercise the option and make a profit. By doing this, you have unlimited profit potential on downside and at the same time have limited your losses (which is depreciation of holdings of LNT against profits made by the PUT option.)

This strategy is known as a protective put strategy. If the stock drops substantially, you can always exercise your put option. If shares rise you can do nothing and just let the option expire.

Put investors can also employ a married put strategy. A married put strategy is when an investor buys shares of a stock and buys a put option on the same shares at the exact same times. The stock and option are considered married since they were both purchased at the same time.

If used properly, options can cost less, limit risk, and have the potential for higher returns.

Many investors are completely unaware about options. The intention behind this article is to make aware of the basics of options. Nevertheless, One should definitely understand the implications and understand the risks involved before buying or trading in options.

ps: I have used the example of LNT (Larsen and Toubro), because it has been on my radar since it broke out of 1700 range earlier this month. More here …..

I will cover selling options and implications later sometime.

RBI hikes short-term rates; CRR unchanged

rbiThe central bank raised interest on Tuesday in the face of inflation has been above 10 percent for the past five months. The Reserve Bank of India said it would continue to normalize policy in line with the growth and inflation rate in the economy.


The RBI lifted the repo rate, at which it lends to banks, by 25 basis points to 5.75 percent, which was in line with expectations, but raised the reverse repo rate, at which it absorbs excess cash from the system, by a steeper than expected 50 basis points to 4.50 percent.

The central bank left the cash reserve ratio (CRR) unchanged at 6 percent.

Inflation in India emerged last year in the wake of a poor monsoon that drove up food prices but has spread broadly throughout the economy, spawning protests against a government whose voter base is predominantly poor and rural.  New Delhi’s decision to increase fuel prices is expected to add nearly a percentage point to wholesale price index (WPI) inflation starting in July and led the opposition to call a one-day nationwide strike early this month.

The government is hoping on normal summer monsoon rains to results in better crop yields and ease pressure on food prices, and has said inflation should decline to 6 percent by December, which in my opinion is a task in itself…..

The Simple rules to Successful Investing – Part 1

The Simple rules to Successful Investing , Understanding Investing, Stocks, Mutual Funds, Tax, Insurance, Estate, Wills.

“No amount of talking or reading can teach you swimming. You will have to get in the water.”

There are these little general rules which are applicable and useful for decision making and taking actions. And these simple rules are applicable in so many aspects of life, they are just some small reminders, some common-sense stuff which are really useful.

And yes most of them are applicable in investment planning as well.

a. Perfect Plan – Forget it.There is no such thing as a perfect investment plan and no such thing as a perfect time. The right time is now. Tomorrow is and always will be uncertain. Perfectionism is the enemy of action. Do not let perfect investment plan or a perfect time to invest stop you from starting.

b. Analysis Paralysis – Too much thinking will often result in getting stuck.Some thinking is good — it’s good to have a clear picture of where you’re going or why you’re doing this — but don’t get stuck thinking. Just do.

c. Get the Broad Picture and Start. You need to get the broad picture in your mind. You need to understand your future requirements or what do you want to achieve (goals). You need to know the time you have to meet those requirements. And, then you should have the broad plan to meet the goals. Once you have the broad picture. Get going.
All the planning will take you nowhere unless you take that first step, no matter how small it is.

d. Keep things Simple and take Small Steps. Small steps always work. Little tiny blows can break down that mountain. And then each step counts. Keep the big picture in mind, but start by taking small steps.

Understand the advantage of Investing Early here.

The Little Rules to successful action To be contd … Part 2.

Why you should never invest in ELSS , Dividend Reinvestment Scheme !

Why you should never invest in ELSS , Dividend Reinvestment Scheme, Section 80C, Mutual Fund Investment, Tax Saving Planning.

Equity Linked Savings Scheme (ELSS) is an instrument which many investors use to get advantage in Section 80C, Rs 1 Lac, deduction in Income.

There is a 3 year lock in in these schemes.

If you choose the Dividend reinvestment Scheme, then the reinvested portion gets locked again for 3 years from the date of dividend.

Even if the schemes declare dividends once every three years , part of your investments can be locked in for ever.

Options:

1.  Do not opt for Dividend Reinvestment Scheme in case of ELSS

2. In case you already have invested in such an option in ELSS , then change the option to Dividend Payout. (This is provided you are lucky that the dividend has not yet been declared) (Pls note that Fund House will not allow you to change to Growth)

Sensex touches 18000 again , two kinds of investors, two different views ….

chart.

“The investor’s chief problem – and even his worst enemy – is likely to be himself.” ~ Benjamin Graham

Sensex is at 18000 once again.

(A) Many Investors who had invested since 2007  when the markets were around the same levels are not happy. Most of them are waiting to get out of the markets when they are able to get cost to cost. Reasoning — they could have got better returns in Bank FD’s in last 3 years.

(B) Many Investors who invested in Markets in 2009 are super excited as almost all their investments have doubled.  Most of these investors have become developed short term view. They believe that they know everything about markets and they can easily generate good returns time and again. Many want to get out at these levels and reenter at sensex 12000 levels only now. They are experts you see.

Greed and Fear works in both the directions of the markets.

Investors who fall in the above categories do not realize the following fundamental rule of nature which is applicable to markets as well : “THIS TOO SHALL PASS AWAY”.

My view is that investors in either of the above categories will probably never be successful over a investment lifecycle of 3 – 5 – 10 years.  Period. Because the above reasoning of exit from market is based purely on market returns and not based on fulfillment of life objectives. And this kind of reasoning falls in the category of speculation.

Do you fall in any of the categories mentioned above…..

“Free Lunch” Seminars—Avoiding the Heartburn of a Hard Sell

"Free Lunch" Seminars,Avoiding the Heartburn of a Hard Sell , Retirement Planning, Investment Planning, Tax Planning, Life insurance selling malpractices.

BEWARE —-Investors frequently get invited to free seminars. These seminars make tall promises. To educate  about investing, or profit from home trading strategies or about managing money in retirement. They also provide VIP treatment , sometimes provide an expensive meal at no cost.

Please remember that , just because someone buys you breakfast, lunch or dinner does not mean you that you have to buy into whatever these guys they are saying. And definitely you need not buy into all what they are selling. Believe me , you will avoid some serious heartburns……… Use your judgment to arrive at a decision later point in time.

The same holds true when specially you go to buy a car. Most people spend a good time looking at the car and take a test drive. Now just because the salesman spent his 30mins — does not mean that you need to buy the car.

The same holds for when you are being sold — Life Insurance, General Insurance, Boutique stores, Electronics etc.

Be careful – If you do not wish to purchase and are being forced into a deal , Use your judgement and Learn to say No – firmly. We live in an age where it is still a buyer’s market – do not forget this.

May 2010

Investing in Mutual Funds because they are less risky?

Investing in Mutual Funds because they are less risky, Investing in stocks, Risk , Return, Sharpe Ratio, Treynor Ratio, .

Most of the investors begin investing using Mutual funds.

I am surprised when many people come to  me and ask my advise for investing in Mutual Funds rather than equities because they perceive investing in Equity oriented Mutual Funds to be much safer than investing in equities directly. If you think so, Think again!!

This is an incorrect understanding.

Equity oriented Mutual Funds are as good (or as bad) as the investments made by the Mutual Fund Manager, the underlying assets which the fund manager  invests etc.

The risks and returns are linked to the funds holdings (In case of Equity oriented mutual funds, it is the underlying stocks, their performance and the overall performance of the stock markets). The returns and risks are also linked to the the ability of the fund managers performance in trying to time the entry and exit and generating the ‘ALPHA’ returns .  [[  From Investopedia — Alpha is one of five technical risk ratios; the others are beta, standard deviation, R-squared, and the Sharpe ratio. These are all statistical measurements used in modern portfolio theory (MPT). All of these indicators are intended to help investors determine the risk-reward profile of a mutual fund. Simply stated, alpha is often considered to represent the value that a portfolio manager adds to or subtracts from a fund’s return.]]

If the Stock Market tanks or crashes, the mutual funds NAV also comes crashing down.  Near term performance of Mutual Funds is virtually linked to the vagaries of the market movements. Long term performance depends on the fund’s objectives, fund manager’s performance etc.

So, please understand that if you wish to invest in mutual funds….. go ahead. But please remove the perception that they are less risky than investing in stocks directly.

If one is a saver kind of investor, a Systematic Investment Plan (SIP) in either A-Category stocks or Mutual Funds  will meet the returns expectations over long periods of time. In fact considering the annual expenses of the Mutual Funds involved, investing in stocks and holding over long period of times might even beat the returns of the Mutual Funds handsomely.

Conclusion
Whether picking stocks or Mutual Funds , you need to stay up to date on the sector or the stock in order to understand the underlying investment fundamentals. You do not want to see your investments go down the drain as time passes.

March 2010

Costly Investment Mistakes to avoid at all costs – Part III

Costly Investment mistakes Part 3, Investment Planning, Financial Planning, Stocks, Mutual Funds Investing, Life Planning, Goal Oriented Planning.

In the process of investing, one often makes mistakes.

Here are some of the most common investing mistakes which investors generally make and some of which even I had made in the earlier part of my investment years

Of course, learning from the mistakes, continually, the investing experience has truly been rewarding experience.

You can also cultivate good habits of investing by avoiding the following mistakes.

This series is in continuation to the earlier 2 posts which contains the first 5 common mistakes committed by investors. You can read posts here at ( Part I and Part II )

This post ( Part III )  will throw light on the following common mistakes generally committed by investors:

#6. Having Unrealistic Expectations from Investments & Wrong understanding of Risk

Indexes (Sensex and Nifty) have gained more than 85% returns from the lows of March 2009. All the TV channels and newspaper headlines have started to focus on this aspect a lot andfuel greedin common people. Similarly just 2 months earlier to March 2009, or so,  when there seemed no end to the global markets falling down, were down more than -ve 50% , the same TV channels and newspapers were fueling fearsinto the minds of the people.

Expecting similar returns consistently from the stock markets is one of the common mistakes. This happens when expectations from the market are unrealistic (like doubling money in 1 year. etc).

The other side is when there is fear in the markets there perception that markets are extremely risky and all investments should be moved to safe instruments like FD’s etc.

Point is :

Markets test patience and reward conviction.

1. Equity Markets cannot keep rising 100% year on year every year & cannot keep falling 50% year on year every year.

2. There are various phases to the markets, long periods of range bounded ness, sudden spurts either up or down due to sentiments, global factors etc.  All this causes violent moves in the markets in short term. In the long run or long periods of time 5yr, 10yr, 15yr the ups and downs and returns from the marketseven outtoyield mean (or average) realistic returns. Being aware of this point is important.

3.Riskin equity marketsappears very highin short period of time. HoweverRisk in Equity markets is reduced significantly when investments are spread over long periods of time.

4. Risk and Returns are inseparable. Once the objective is clear which is get better returns over a period of time, then you must be willing to invest in instruments which carry more risk, intelligently. And marry the risk with passage of time to yield good returns.

#7. Leaving Investments in Auto Mode – No Periodic Assessment, No periodic Re balancing

You do periodic health checkup with the objective of finding if there is any need to take preventive measures to keep the body in good shape. If you are gaining weight and becoming overweight, you need to start taking steps to cut down on the weight. Similarly, if you are losing weight and have become underweight, you need to start taking steps to regain health.

Similarly, periodic assessment of portfolio (once a quarter, every 6 months at least) is necessary. This has to be done with the similar objective of taking preventive measures (if at all required) to keep the portfolio in good shape. Portfolio rebalancing has to be done as per asset allocation.

However, many investors make mistake of leaving the portfolio in auto mode once the investments have been made. Investments is indeed a long term process, but If some investment goes sour, and it is not acted upon in a timely manner,  it probably becomes too late / or too costly to get the portfolio back on track , if preventive measures are not planned and executed.

Final Part to be contd…… You can read the final installment here at Part IV