Wealth

Management
Saving &Investing…
Investing ….

What is investing?
An investment operation is one which, upon thorough
analysis promises safety of principal and an adequate
return. Operations not meeting these requirements are
Speculative
- Benjamin Graham – The Intelligent Investor

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
- Warren Buffet – The Making of An American
Capitalist
Investing ….

What is investing?
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
- Burton G Malkiel – A Random Walk Down Wall
Street

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
- John C. Bogle – Common Sense on Mutual Funds
Speculation…
Investing ….

Speculation
Investors “speculate" every time they commit money to
something they don't understand.

Say you overhear your best friend’s uncle talking about

a company called Frontier Industries at a cocktail party.
"This thing is surely going to go through the roof in the
next few months," he says. If you call your broker the
first thing the next morning to place an order for 100
shares, you've just speculated.
Investing ….

Speculation
Do you know what Frontier Industries does?
Are you familiar with its competition?
What were its earnings last year / last quarter?

There are a lot of questions one should ask about a

company before investing in a "hot" 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.
Investing ….
Speculation
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.

Remember: Every rupee that is used for speculation and

lost is not working for the investor over the long-term to
create wealth.
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.
 Power of
Compounding…
Investing ….
Power of Compounding?
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.

An amount of Rs. 100,000 which compounds @

15% after 50 years is worth, hold your breath Rs.
Eleven Crores.

The power of compounding can be expressed

using the following time value of money
expression

FV= (PV) *(1+k)^n

Investing ….
Power of Compounding?

FV = future value
PV = present value
K = rate of compounding
n = no. of years

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.

Systematic Planning is an essential ingredient of a

good investment programme.
Power of Compounding it
works…
FMP Sensex Franklin India MF
Blue Chip Average
Years 6% 16% 27.9% 20.0%
0 100,000 100,000 100,000 100,000
1 106,000 116,000 127,900 120,000
2 112,360 134,560 163,584 144,000
3 119,102 156,090 209,224 172,800
4 126,248 181,064 267,598 207,360
5 133,823 210,034 342,257 248,832
10 179,085 441,144 1,171,401 619,174
15 239,656 926,552 4,009,204 1,540,702
20 320,714 1,946,076 13,721,794 3,833,760
25 429,187 4,087,424 46,963,841 9,539,622
30 574,349 8,584,988 160,737,176 23,737,631
35 768,609 18,031,407 550,134,722 59,066,823
Planning & Setting
Goals…
There are two times in a man’s life
when he should not speculate: when he
can’t afford and when he can.

Mark Twain, Following the Equator

Guidelines to tailoring a Lifecycle
Investment Plan
 Specific needs require dedicated
specific assets.
 Recognize your tolerance for risk.
 Persistent savings in regular amounts,
no matter how small, pays off
Human Life Cycle – Disciplined
Planning
Phase I Phase II Phase III
Income

Child’s Marriage

Child’s Education
Having a
Housing Financial Goal is
primary to
starting a
Investment
Child birth
Plan.
Marriage

22 yrs 38 yrs Over 25 - 30 yrs

Birth & Education Earning Years Retirement Age

22 yrs 60 yrs
 Determining
Investment Style…
Determining Investment Style….
Investment style can be compared to batting styles
of different batsmen in a game of cricket.

A swinger-for-sixes & fours - takes big risks for big gains.

Slow & steady - hitting singles and doubles.
A spectator sitting in the stands, chatting with his
companions and occasionally cheering his home team on.
 
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 ? )
Determining - Investment
Style….
Risk Tolerance
How comfortable will you be seeing your investment
decrease in the near term while waiting for it to increase
over the long term?

How comfortable will you be to invest in something in

which the price changes every day - sometimes adversely.

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.
Determining - Investment
Style….
Risk Tolerance

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.

Remember : Though GOI savings bonds and bank

fixed deposits are the safest, the safest road isn't
always the best one.
Determining Investment Style….
The important thing to remember about stocks, though,
is that an investor doesn't lose anything until he sells
them.

What if you invested when the market was at a high,

then comes a big crash?

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 ! ).

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.
 
Determining Investment Style….
The Second Factor – Time ….

How much time do you want to/are able to spend on

investing?
How active do you want to be in the management of
money?

If an investor wants to spend 15 minutes a year on

investing, then maybe one should consider using Passive
Strategies.

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.
Determining - Investment
Style….
Another time factor is :

When does the investor need the money (time

horizon) ?
Whether the money is needed next week or in a hundred
years will dramatically affect what investment vehicle to
use.

Caution - Although stocks deliver great long-term

returns, the returns over periods of three years or
less can be downright scary.

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.
Financial Planning is …
 To develop well defined goals
 Divide the goals into short term and long
term goals
 To look at the current income, expenses
and savings
 To map out well defined strategies to
turn the dreams into reality
Steps in Financial Planning
 Identifying the investment objectives
 Investment Objectives – needs and
requirements
 Determine the required returns to meet
the financial objectives
 Determine the risk tolerance of the
individual
 Design an asset allocation to meet the
risk and returns
 Modify the asset allocation based on any
change in needs or risk tolerance
Planning and Setting Goals….
Investing is like a long car trip…

A lot of planning needs to go into it.

• How long is the trip? (What is the investors "time
horizon"?)
• What should one pack? (What type of investments will
the investor make?)
• How much petrol is required for the trip? (How much
money will the investor need to invest to reach his
goals?)
• Will the trip require a stop over along the way? (Does the
investor have short-term financial needs?)
• How long is the stay? (Will the investor need to live off
the investment in later years?)
Planning and Setting Goals….
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

An investor must answer the following questions before he

can successfully set about the savings / investing journey:
 
What are the investors goals?
Is the investment for retirement? A down payment on a
house?
Child's education? A second home? ….
 
How much money can the investor devote to a regular
investing plan?
Planning and Setting Goals….
Ask some more pointed questions:
• How much will college cost (at the time the child needs
to go)?
• How much yearly income is reasonable for retirement?

The more specific the investor can be, the more likely he
is to set and achieve reasonable goals.

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.
Financial Planning – Increasing
complexity
 Indian markets opening up
 Increased volatility in the debt and equity
markets
 Investment Options available with the
individuals are increasing
 Equities, Bonds, Mutual Funds,
Derivatives, real estate
 There are now around 30 mutual funds in
India offering 400schemes
 Investment options expected to increase
going forward
 Commodities trading, forex
 Tax Planning requires an expert
Financial Planner would
provide…
 A comprehensive platform of tailor made
services
 Customised strategies and product
application
 The highest quality in advise
 Confidentiality
 Single Point contact and personalized
service
 An experienced Investment Advisor
 Resources and capabilities to ensure
timely and accurate execution
Investment Products

 Stocks-offer dividend & capital

appreciation.
 Bonds-offer safe return.
 Real estate-offers rent & capital
appreciation.
 Precious metals-appreciate over time and
are a hedge against uncertainties.
 Art work-appreciate over time.
 Insurance-used as security against risk of
uncertainties.
 Disciplined Investment Planning

Derivatives & Aggressive

Assets
Equity Mutual
Funds

Income Funds &

Real Estate
Serious Assets

GOI Relief
Bonds
Bank Fixed
Deposits Sacred Assets
 Investment Avenues
Equity
H Growth
i
Funds
g
R h
I Index
S
Don’t Invest here Balance Funds
K
Funds
Gilt
Funds
Aggressive
Income
Stance
Funds

RETURN High
Low

Liquid Comp FD
Fund

GOI Sec
P.O.
Sedate Zone Bank FD Optimal
L
RBI o
w

## the size of the circle denotes the level of liquidity

Investments : Key Determinants
 The most important determinant of portfolio
return is asset allocation .
Security Selection 4.6%

Market Timing 1.8%

Other Factors 2.1%

Asset
Allocation
91.5%

Source: Brinson, Singer &

Beebower
( 1991 )
What is Asset Allocation?

Asset allocation refers to the strategy of

dividing your total investment portfolio among
various asset classes, such as stocks, bonds
and money market securities. Essentially,
asset allocation is an organized and effective
method of diversification  
Asset allocation
Asset Allocation encompasses the
following:
 Selection of the asset classes
 Proper blending of these asset classes in a
portfolio
 Managing the asset mix over time.
Lifecycle Investment Guide
Mid Twenties Late Thirties to Early Forties

10% 10%
5% REAL ESTATE 5% REA L ESTA TE
CA SH CA SH
20% 55%
BONDS BONDS
30%
65% STOCKS STOCKS

Mid Fifties Late Sixties and beyond

13%
25% 15%
5% REAL ESTATE REAL ESTATE
44% CA SH 10% CASH
BONDS BONDS
STOCKS STOCKS
38%
50%
Asset Allocation Principles
 Risk and return are related
 Risk depends on the length of time one
holds the investment
 Rupee Cost Averaging can reduce the
risks of investing
 Risks that an investor can take depends
on the investor’s capacity to take risks
and his attitude to take risks.
Asset Allocation drivers
Asset allocation must take into account 2
factors:
 Time horizon: the number of years you have
to invest

 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
Asset Allocation Styles-Strategic
Asset Allocation
 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
 E.g. If 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
Asset Allocation Styles-Tactical
Asset Allocation
 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
 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
 Asset Allocation Styles-Tactical
Asset Allocation
 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
 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
 Asset Allocation Styles-Dynamic
Asset Allocation
 Dynamic asset allocation is when the mix of
assets is constantly adjusted as markets rise
and fall and the economy strengthens and
weakens
 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
 Which Asset Allocation style is
best ?
 Asset allocation can be an active process in varying
degrees or strictly passive in nature.
 Choice of a precise asset allocation strategy or a
combination of different strategies depends on one’s
goals, age and risk tolerance
 These are only general guidelines on how investors may
use asset allocation as a part of their core strategies
 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.
 Accurately timing the market is next to impossible, so
make sure your strategy isn't too vulnerable to
unforeseeable errors
Asset class characteristics
 The purpose of using various risk
categories in portfolios is to reduce risk
through diversification thereby
enhancing the risk/return ratio.

 The proper allocation of assets in a

portfolio begins with determining the
proportion of the total portfolio to invest
in each asset class.
Risk / return characteristics of
asset classes
It is useful to calculate returns and
measure risk for asset classes over various
past intervals
 Helps to evaluate the behavior of the asset
class over different economic cycles.
 May be taken as representative of the
returns that investors may have expected
to earn over the period.
 May in turn be useful in establishing
benchmarks as to what returns investors
might be expecting to earn in future.
 Availability of realized return and risk
measures can be used to compare the
relative performance behavior across asset
classes.
Asset class characteristics
Security Class Maturity Form of return Risk
of security
Cash Equivalents Short Discount Low

Fixed Income / US govt Long Coupon Medium

Municipal Long Coupon Medium

Corporate Long Coupon Medium

Preferred Stock Perpetual Dividend Moderat

ely high

Common Stock Perpetual Dividend and capital High

gains
Maximize returns, minimize
risks
 Understanding
Risk & Returns …
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
Return Variability
15%
6.00%
4.0% 2.5%

A B C
-8%
Investment A: no Investment B: Investment C:
return variation, some return wide return
no risk variation, some variation, much
risk risk
Nature of Risk
 The more variable an investment’s return, the greater
its risk
 A highly variable return could lead to investment losses
if the investment needs to be sold
 However, the longer the investment is held, the greater
the chances of earning the long-run rate of return
What is investment risk?

 Investment risk is related to the probability of earning

a low or negative actual return.

 The greater the chance of lower than expected or

negative returns, the riskier the investment.

 Two types of investment risk

 Stand-alone risk
 Portfolio risk
 Standard Deviation
 In investments risk is measured in terms of standard
deviation
 Most important measure of variation
 Shows variation about the mean
 Has the same units as the original data
N

 Xi   
2

  i 1

 Standard Deviation: N

Xi=Observation
µ= Mean
N = Total No. of observation
 Comparing Standard Deviations
Data A
Mean =
15.5
s = 3.338
11 12 13 14 15 16 17 18 19
20 21
Data B
Mean =
11 12 13 14 15 16 17 18 19 15.5
20 21 s = .9258

Data C
Mean =
15.5
11 12 13 14 15 16 17 18 s = 4.57
19 20 21
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
Breaking down sources of risk
Stand-alone risk = Market risk + Firm-specific risk

 Market risk – portion of a security’s stand-alone risk

that cannot be eliminated through diversification.
Measured by beta.

 Firm-specific risk – portion of a security’s stand-

alone risk that can be eliminated through proper
diversification.
What is the market risk
premium?

 Additional return over the risk-free rate needed to

compensate investors for assuming an average
amount of risk.
 Its size depends on the perceived risk of the stock
market and investors’ degree of risk aversion.
 Varies from year to year, but most estimates suggest
that it ranges between 4% and 8% per year.

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.
Risk and Return are related

Average Annual Return Risk Index

(1926 – 97)

Small company 12.7% 33.9%

common stocks

Common stocks in 11.0% 20.3%

general

Long Term bonds 5.7% 8.7%

US Treasury bills 3.8% 3.2%

Inflation Rate 3.1%

Source: Ibbotson Associates, Stocks, Bonds, Bills, and Inflation: 1997 Yearbook
Risk depends on the length of
time one holds the investment
Range of Annual Returns on Common Stocks for Various
Time Periods, 1950-97
60.00%
52.62%

50.00%

40.00%

30.00% 23.92%
19.35%
17.52%
20.00% 16.65%
13.10%

10.00%

0.00%
1.24% 4.31% 5.53% 7.90%
1 Year 5-2.36%
Years 10 Years 15 Years 20 Years 25 Years
-10.00%

-20.00%
Maximum
-30.00%
-26.47% Minimum
-40.00%
 Sensex Returns Analysis -1979
to 2004
275
250
225 Average Return (%)
200 Highest Return (%)
175
Lowest Return (%)
Returns (%)

150
125
100
75
50
25
0
-25 1 3 5 7 10 15
-50
Time Horizon (years)

Equities deliver superior risk adjusted

returns over the long term
 Market Timing is Dangerous…
Annual Return of Sensex over last 24 years
15.90%
20.00%
15.00%
10.00% 5.54%
0.65% -16.93%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
-20.00%
Always Missed Missed Missed
Invested 10 best 20 best 72 best

The opportunity loss incurred when attempting to

time the market could be exceptionally high
Patience and discipline are required to avoid a
wrong move
Rupee Cost Averaging can reduce
the risks of investing-buy less
when price is high & more when
price is low.
Period Investment Price per Share Qty of Shares
amount 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 11
owned
Weighted Average Cost: Rs. 40.91 ( 450 / 11)
 Understanding
Historical Trends is
the key to success in
Asset Allocation…
Looking through the rear view
mirror makes the journey
safer ….
Investing is a lot of numbers. One needs to get used to that, and
quickly.

An investor can see exactly what he needs to get to his destination,
and can be accountable to himself along the way.

Bonds and stocks are the two major asset classes that have been
used by investors over the past century.

Knowing the total returns on each of these, and their associated

volatility, is crucial to deciding where an investor should put his
money.
India attracts international
attention. . .
The BRICs Report projections
 Focuses on 4 largest developing economies:
Brazil, Russia, India and China over the next 50
years
 In less than 40 years, the BRICs economies
together would be larger than the G6
 India’s economy would be the 3rd largest
in 30 years (behind US and China)
 India has the potential to show fastest growth
over the next 30 to 50 years (above 5%)
 Per capita income (USD) could rise to 35 times
the current levels by 2050
 Drivers of the Indian Equity
Market
Resilient Pockets of Consensus on
economy exceptionally economic
capable of high growth reform despite
relatively high political
GDP growth ‘ change

Growing
consumer
Infrastructure
class that is
Spend
acquiring
critical mass

Sustained Corporate
growth in FDI sector set to
and foreign invest in
portfolio capacity
investment World class additions
market
infrastructure
and
regulations
Changing Demographics of India
100%
6.7% 7.0% 7.5% 8.0% 8.4% 8.9%
90%
80%
70% 45.9% 47.9% 50.7% 53.1% 54.4% 55.0%
60%
50%
40%
30%
47.5% 45.1%
20% 41.8% 38.9% 37.2% 36.0%
10%
0%
FY1996 FY2001 FY2006 FY2010 FY2013 FY2016
0-19 years 20-59 years 60 years & above

Source : Smith Barney Research Consumption Demand

Translation
 Household sector – Savings
Pattern
2.2% Est. total stock of
Mutual Funds
savings
Shares 1.5%
USD 1,500 bn
Gold 10.0%

Bank Deposits 20.0%

Insurance / PF / SSS 27.0%

39.3%
Others

0% 5% 10% 15% 20% 25% 30% 35% 40%

Others include physical assets like real estate.

•In US mutual funds constitute about 50% of the overall

savings stock ….. Miles to go despite favourable tax regime
Source : NCAER, 2002
 Understanding
Investor Behaviour
 Investor Behaviour

“ Success in investing doesn’t

correlate with IQ once you are
above the level of 25. Once you
have ordinary intelligence, what
you need is the temperament to
control the urges that get other
people into trouble in investing.”
- Warren Buffet
 Behavioural Finance-aspects of
investor behaviour

 Equities is the preferred asset class due

to its superior returns.
 Investors behave differently when they
become part of the market ( herd
mentality )
 Behavioural anomalies distort our
thinking and make us take decisions
against our financial interest.
 Behavioural Finance-classical
economic theory v/s
behavioural economic theory
If I say I found a worn out Rs 100 while
walking down a busy road, the classical
economists would call it impossible
because the markets being efficient, one
among the many people using that road
would have anyway found it.

But in reality, it can happen…..which

proves that markets are imperfect.
Behavioural Finance explains why
we…
 Hold on to stocks that are crashing.
 Sell stocks that are rising.
 Ridiculously overvalue and undervalue stocks.
 Buy stocks that have peaked in a rally just
before the price declines.
 Take desperate risks and gamble wildly when
our stocks fall.
 Avoid taking reasonable risk of buying promising
stocks unless there is ‘assured profit’
 Never find the right price to buy or sell stocks.
 Prefer fixed income over stocks.
 Buy when we have to sell & vice versa.
 Buy or sell because others are doing so.
 Behavioural Finance…
 Seeks to bridge the gap between economics &
psychology; between how we make decisions &
how we should make decisions.
 Creates investment strategies that capitalises
on irrational investor behaviour.
 Seeks to identify market conditions in which
investors are likely to overreact or underreact to
new information.
 Invest or disinvest in securities before most
investors recognise their error.
 Benefits from a reversal of fall or rise when the
reversal happens.
 Fallacies in Investor Behaviour
Loss aversion fallacy :
Scenario 1: you have Rs.1000 and two options.
a) Guaranteed profit of Rs.500
b) Flip a coin; heads you gain Rs
1000, tails
you gain nothing
Scenario 2: you have Rs 2000 and two options.
a) Guaranteed loss of Rs.500
b) Flip a coin; tails you lose Rs.1000,
heads
you lose nothing.

Which option will you choose in each scenario ?

 Fallacies in Investor Behaviour
Loss aversion fallacy :
In scenario 1 you are more likely to choose option
‘a’ because it has an assured profit of Rs.500
v/s a probable uncertain profit of Rs.1000.

In scenario 2 you are more likely to choose option

‘b’ because you wanted to avoid an assured
loss v/s an uncertain ‘zero’ loss possibility.

In scenario 2 you were willing to take a greater

risk to avoid an assured loss.
 Impact of Loss Aversion
 Fear of losing drives investors towards fixed
income securities, particularly after a major
market crash, when actually good stocks are
available at attractive valuations.
 Early profit booking and aversion towards
booking loss, instead of riding profits & cutting
losses makes overall returns low to negative.
 Madness induced by pain of loss makes
investors take bigger risks and lose more.
 Tax aversion – seeing tax as a loss. In fact tax is
related to profit, and you save tax when you
make a loss.
Fallacies in Investor Behaviour
Sunk Cost Fallacy :
Scenario 1:
You have complimentary tickets for a Filmfare
awards night. On the evening of the program,
traffic is disrupted due to floods. You have a
long distance to travel. Would you go for the
function?

Scenario 2:
You have bought a ticket for the same program
for Rs.1500, and the same situation happens.
Would you go?
 Fallacies in Investor Behaviour
Sunk Cost Fallacy :
Most people would go for the show if they paid for
the ticket, but avoid it if was complimentary.

Actually this distinction does not make sense, as

the money for the ticket is already spent.
Whether you go or not the money will not come
back.

We must rather look at the additional risk of

braving the floods, and additional costs in case
the car is damaged, and we fall sick. The
danger posed by floods is same whether the
tickets were paid for or were free.
 Impact of Sunk Cost Fallacy
 Buying more when the stock price falls even
when the fall is due to fundamental weakness,
thinking that average cost of purchase will be
lower.
 Spending more money on repairs instead of
replacing an asset, because you have already
spent heavily on repairs, so you want to use it.
 Spending money on unviable projects, because
already lot of money is spent on it.
 Eating beyond your capacity, because you paid
a lot for the buffet dinner, disregarding your
health.
 Tax
Planning
 Incomes exempt from tax under sec. 10
 Deductions under chapter VI A for amounts utilised
towards certain purposes qualifies as deduction from total
income
 Splitting income by creating several entities such as HUF
or Trust.
 Making gifts within specified limits
 Making investments which qualify for rebates
 Reducing taxable income by claiming expenses
 Retirement
Planning
 Assessment of current financial status

 Ascertain post retirement needs

 Determine what you need to save and how

 Find extra money for savings

 Nature of
Insurance
Sharing of risk
Insurance is a device to share the
financial losses which might befall on an
individual or his family on the happening
of a specified event. The event may be
death in case of life insurance, fire in fire
insurance etc. If insured the loss arising
from these events will be shared by all
insured in the form of premium.
Why Insurance
 What if our children disown us when we retire ?
 What if we have an accident ? What will happen
to our loved ones, till they are financially
independent.

Insurance is a risk management tool to provide

financial protection against unforeseen events. It
also provides tax benefits.
 Non-life v/s life insurance

 In life insurance, the purpose is not to make good the

financial loss suffered. The insurer promises to pay a fixed
sum on the happening of an event ( either death or expiry
of term). If the event or the contingency takes place, the
payment falls due if the policy is valid and in force at the
time of the event.
 In other insurance contracts, the contingency such as fire
or the marine perils etc., may or may not occur. So, if the
contingency occurs, payment is made, otherwise no
amount is given to the policy-holder.
How much Insurance
Avoid being under-insured or over insured
 Ideally life cover = annual household
income * 7
 10%-15% of annual income should go
towards insurance.
 Mutual
Funds
It pools money of several investors and
invests this in stocks, bonds, money
market instruments and other types of
securities.

Buying a mutual fund is like buying a

small slice of a big pizza. The owner of a
mutual fund unit gets a proportional
share of the fund’s gains, losses, income
and expenses.
Each mutual fund has a specific
stated objective
Fund Objective What the fund will invest in

Equity (Growth) Only in stocks

Debt (Income) Only in fixed-income

securities

Money Market (incl Gilt) Short-term money market

instruments
(incl.govt.securities)

Balanced Partly in stocks and partly

in fixed-income securities, in
order to maintain a 'balance'
in returns and risk
 Types of Mutual Funds-by
management style
In terms of fund management, mutual funds can be broadly
classified into two categories: actively managed funds and
passively managed – better known as index funds.

In an actively managed fund, the fund manager uses his

expertise and skills to select stocks across sectors and
market segments. The sole intention of actively managed
funds is to identify the best investment opportunities and
exploit it in order to generate superior returns, and in the
process outperform the benchmark index.

On the contrary, index funds are aligned to a particular

benchmark index like the Nifty or Sensex. They attempt to
mirror the performance of the designated benchmark
index, by investing only in the stocks of the index with the
corresponding allocations.
 Types of Mutual Funds-by structure

 Open-ended Funds : An open-end fund is one that is

available for subscription all through the year. These
do not have a fixed maturity. Investors can
conveniently buy and sell units at Net Asset Value
("NAV") related prices. The key feature of open-end
schemes is liquidity.

 Closed-ended Funds : has a stipulated maturity period

generally ranging from 3 to 15 years. Open for
subscription only during a specified period. Investors
can invest in the scheme at the time of the initial public
issue and thereafter they can buy or sell the units of
the scheme on the stock exchanges where they are
listed. In order to provide an exit route to the
investors, some close-ended funds give an option of
selling back the units to the Mutual Fund through
periodic repurchase at NAV related prices. SEBI
Regulations stipulate that at least one of the two exit
routes is provided to the investor.

 Interval Funds Interval funds combine the features of

open-ended and close-ended schemes. They are open
for sale or redemption during pre-determined intervals
at NAV related prices.
 Types of Mutual Funds-by
investment objective
 Growth Funds : Aims to provide capital appreciation over the
medium to long- term. Normally invest a majority of their
corpus in equities. Ideal for investors having a long-term
outlook seeking long term growth.
 Income Funds :Aims to provide regular and steady income to
investors. Generally invest in fixed income securities such
as bonds, corporate debentures and Government
securities. Ideal for capital stability and regular income.
 Balanced Funds : Aims to provide both growth and regular
income. Such schemes periodically distribute a part of
their earning and invest both in equities and fixed income
securities in the proportion indicated in their offer
documents. In a rising stock market, the NAV of these
schemes may not normally keep pace, or fall equally when
the market falls. Ideal for investors looking for a
combination of income and moderate growth.
 Money Market Funds : Aims to provide easy liquidity,
preservation of capital and moderate income. Generally
invest in safer short-term instruments such as treasury
bills, certificates of deposit, commercial paper and inter-
bank call money. Returns on these schemes may fluctuate
depending upon the interest rates prevailing in the
market. Ideal for Corporate and individual investors as a
means to park their surplus funds for short periods.
Types of Mutual Funds-other schemes

 Tax Saving Schemes : Offer tax rebates to the investors under specific
provisions of the Indian Income Tax laws as the Government offers tax
incentives for investment in specified avenues. Investments made in Equity
Linked Savings Schemes (ELSS) and Pension Schemes are allowed as
deduction u/s 88 of the Income Tax Act, 1961. The Act also provides
opportunities to investors to save capital gains u/s 54EA and 54EB by
investing in Mutual Funds.

 Industry Specific Schemes : Invest only in the industries specified in the offer
document. The investment of these funds is limited to specific industries
like InfoTech, FMCG, Pharmaceuticals etc.

 Index Schemes : Attempt to replicate the performance of a particular index

such as the BSE Sensex or the NSE 50.

 Sectoral Schemes : Invest exclusively in a specified industry or a group of

industries or various segments such as 'A' Group shares or initial public
offerings.
 Benefits of Mutual Fund investment

 Professional Management : MFs provide services of experienced and skilled professionals.

 Diversification : MFs invest in a number of companies across a broad cross-section of

industries and sectors. This reduces risk because seldom do all stocks decline at the
same time and in the same proportion. You achieve this with far less money than you
can do on your own.

 Convenient Administration : Investing in a MF reduces paperwork and helps you avoid many
problems. Saves time and money.

 Return Potential : Over a medium to long-term, MFs have the potential to provide a higher
return as they invest in a diversified basket of selected securities.

 Low Costs: MFs are a relatively less expensive way to invest compared to directly
investing in the capital markets because the benefits of scale in brokerage, custodial
and other fees translate into lower costs for investors.

 Liquidity : In open-end schemes, the investor gets the money back promptly at net asset
value related prices from the MF. In closed-end schemes, the units can be sold on a
stock exchange at the prevailing market price or the investor can avail of the facility of
direct repurchase at NAV related prices by the MF.
 Benefits of Mutual Fund investment

 Transparency : You get regular information on the value of your investment in addition to
disclosure on the specific investments made by your scheme, the proportion invested in
each class of assets and the fund manager's investment strategy and outlook.

 Flexibility: Through features such as regular investment plans, regular withdrawal plans
and dividend reinvestment plans, you can systematically invest or withdraw funds
according to your needs and convenience.

 Affordability: Investors individually may lack sufficient funds to invest in high-grade

stocks. A mutual fund because of its large corpus allows even a small investor to take
the benefit of its investment strategy.

 Choice of Schemes: MFs offer a family of schemes to suit your varying needs over a
lifetime.

 Well Regulated: All MFs are registered with SEBI and they function within the provisions of
strict regulations designed to protect the interests of investors.
Investing in index funds is relatively less cumbersome. Here, the
two most important points which investors have to look out for are
the expense ratio and the tracking error (i.e., the difference
between the returns clocked by the benchmark index and index
funds).

On the other hand, actively managed funds have to capitalise on

the opportunities in the market to generate superior returns.
Thus, in the process they employ more resources (more
analysts/fund managers) and in turn charge higher expenses than
index funds.

In the Indian context, the mutual funds segment is dominated by

actively managed funds. Index funds occupy a much smaller share
of the market. This is because Indian stock markets, being in a
developing phase, still offer enough investment opportunities that
if identified earlier on can outperform the benchmark index over
the long-term (3-5 years). So well-managed actively managed
funds have done a reasonable job of going one up over the index
over the long-term.
 What is an exchange-traded fund (ETF)

An exchange-traded fund is open-ended index fund

that can also be traded on the stock exchange. The
fund attempts to combine the advantages of an
open-ended fund with that of a close-ended fund.
This means that unlike open-ended funds, an
investor can exit from an ETF by selling his units on
the stock exchange during trading hours.
 To which index can an ETF be linked

An ETF can be linked to any popular index like

the BSE Sensex, S&P CNX Nifty, BSE 100.
The Nifty BeES (an ETF launched by
Benchmark AMC) is linked to the S&P CNX
Nifty. (NSE Code - NIFTYBEES)
Open-Ended Schemes
Mutual fund schemes that continuously offer
new units to the public are called open-
ended schemes. They offer units for sale
without specifying any duration for
redemption.

Closed-End Schemes
A mutual fund scheme in which the
investors commit their money for a
particular period.
  Expense Ratio
A mutual fund's operating expenses,
expressed as a percentage of its average
net assets. Mutual funds with lower
expense ratios are able to distribute a
higher percentage of their total returns
to their shareholders.
Entry Load
The commission charged at the time of
buying the fund. It is also called front-end
load.

Exit Load
The commission or charge paid when an
investor exits from a mutual fund. They are
basically imposed to discourage
withdrawals.
Sharpe Ratio
The Sharpe ratio is calculated using standard deviation and
excess return to determine reward per unit of risk.
First, the average monthly return of the risk free security
is subtracted from the fund's average monthly return.
The difference in total return represents the fund's excess
return beyond that of the risk-free investment.
An arithmetic annualized excess return is then calculated
by multiplying this monthly return by 12.
To show a relationship between excess return and risk, this
number is then divided by the standard deviation of the
fund's annualized excess returns. The higher the Sharpe
ratio, the better the fund's historical risk-adjusted
performance.
 Calculation of NAV

NAV is simply the net value of Assets divided by the number

of units outstanding.

Asset value is equal to Sum of market value of

shares/debentures + Liquid assets/cash held, if any
+ Dividends/interest accrued - Amount due on
unpaid assets - Expenses accrued.
Expenses including management fees, custody
charges etc. are calculated on a daily basis.
Evaluate Investment
Options…
 Research Your Investments

It’s time to
Once you
figure out
know HOW to
where to put
invest.
your money.
Research Your Investments

What do I need
to know?
Research Your Investment
To....

• Discover historical trends

• Perform financial analysis
• Compare with the peer group
• Obtain relevant economic news
• Forecast future performance
• View recommendations of the experts
 Portfolio
Construction
- Matching investor profile
with investment options …
 Asset Allocation
C Stocks
An asset allocation is a group ash
of assets held together so as
to obtain the desired portfolio
characteristics to suit distinct
investor profiles.

Bonds, Stocks and Cash Bonds

equivalents are the most
commonly used asset classes
in any asset allocation.

The asset allocation for an investor depends on the

investors expectations of returns and the risk the
investor is willing to take.
Asset Allocation

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%
Asset Allocation

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:
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

The standard deviation (σp) of a portfolio decreases as

securities are added, because they would not be
perfectly correlated with the existing portfolio.
Expected return of the portfolio would remain relatively
constant
Eventually the diversification benefits of adding more
securities dissipates (after about 10 securities). For
example in large equity portfolios, σp tends to converge
to ≈ 20%.
Creating a portfolio:
Illustrating diversification effects of a
equity stocks portfolio

σ p (%) Company-Specific Risk

35
Stand-Alone Risk, σ p

20
Market Risk

10 20 30 40 2,000+
0 # Stocks in Portfolio
Tracking Your Portfolio

Follow the performance of your

selections
 Follow market trends
 Read the financial news
 Monitor your selected investments
 Share information with others
Do’s and Don’ts

 Do keep informed of your investments once

you purchase them.
 Do understand the advise of experts before
you take it.
 Do invest for the long term.

 Don’t be discouraged. An investment in your

future is worth the effort.
 Don’t buy what you don’t understand.
 Investment
Terminology…
Investing terminology ….
Asset
Anything that has monetary value. Typical personal
assets include stocks, real estate, jewelry, art, cars, and
bank accounts.

Asset allocation
Dividing investment dollars among various asset classes,
typically among cash investments, bonds, and stocks.

Asset classes
The three major asset classes are cash (also called cash
reserves, money market instruments, etc.), bonds, and
stocks.

Diversification
Investing in separate asset classes (stocks, bonds, cash)
and/or stocks of different companies in an attempt to
Investing terminology ….
Portfolio
All the securities held by an individual, institution, or
mutual fund.

Compounding
When an investment generates earnings on reinvested
earnings.

Capital appreciation
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.
Investing terminology ….
Dividend
A share of a company's earnings paid to each stockholder.

Dividend yield
The annual percentage rate of return paid in dividends on
a share of stock. To figure out the dividend yield (or just
"yield"), divide the annual dividend by the current share
price of the stock.

Inflation
A rise in the prices of goods and services.

Real return
The inflation-adjusted returns of an investment.
Investing terminology ….
Risk-adjusted return
A measure of how much risk a portfolio has employed to
earn its returns.

Unrealized capital gain/loss

An increase (or decrease) in the value of a stock or other
security that is not "realized" because the security has
not yet been sold for a gain or loss.

Annualize
To make a period of less than a year apply to a full year
to facilitate comparative analysis.

Volatility
The degree of movement in the price of a stock or other
security.
Investing terminology ….
Risk tolerance
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.

Standard Deviation
A measure of variation about the mean

Beta
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.
Investing terminology ….
Broker
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.

Order
A request from a client to a broker to buy or sell stock,
either at the market price or at a specific price.

Bear
A person with a generally pessimistic market outlook or a
pessimistic view on a sector or specific stock.
Investing terminology ….
Bear market
When the overall market loses value over an extended
period of time.

Bull
A person with a positive or optimistic outlook for the
general market, a market segment or industry, or for
particular stocks

Bull market
A market that has been gaining value over a prolonged
period.
Investing terminology ….
Buy-and-hold
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.

Market timing
An investment strategy based on predicting short-term
price changes in securities, which is virtually impossible
to do.

Churn
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
Investing terminology ….
Capital gain/loss
The difference between the price at which an asset is sold
and its original purchase price (or "basis").

Long-term capital gain

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.

Short-term capital gain

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.
Investing terminology ….
Bond
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.

Common stock
A security representing partial ownership in a public or
private corporation.

Blue-chip stocks
Really good, large companies -- often INDEX components
-- that have been around long enough to have a solid
history of rewarding shareholders.
Investing terminology ….
Index
An unmanaged selection of securities whose collective
performance is used as a standard to measure
investment results.

Mutual fund
The pooled cash of many unitholders that is invested
according to a stated objective, as defined by the fund's
prospectus.

Open-end fund
A mutual fund that has an unlimited number of units
available for purchase. Most mutual funds are open-
ended.
Investing terminology ….

Net asset value (NAV)

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.
OPT 4 MORE - Asset Allocation
based on risk profile
• OPT 4 MORE is a asset allocation product based on the
risk profile of the investor.
• 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.
• 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
Know your Risk Profile
 Risk profiling is a well-established scientific and robust
way of profiling risk among investors
 Research has established clear relationships between
demographic attributes of investors and their
investment risk appetite
 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.
Conservative Risk Profile
 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.
Moderate Risk Profile
 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.
Aggressive Risk Profile
 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.
What is OPT 4 MORE ?

Equity Plans

Returns

Hybrid Income Plans

Short Term Plans

Bank FDs / GOI Bonds

Risk

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.
Opt 4 More – Current Asset
Allocation
Scheme Conservative Moderate Aggressive
Allocation (%) Allocation (%) Allocation (%)
1 2 3
Equity Plans
HSBC Equity Fund - - 10
Franklin India Bluechip - - 10
DSPML Opportunities Fund - 10 10
Reliance Vision Fund - 10 10
Prudential ICICI Power - 10 10
Sub Total - 30 50
Short Term Plans
Prudential ICICI Short Term Plan 10 10 10
Sub Total 10 10 10
Floating Rate Plans
Grindlays Floating Rate Fund - LT 15 10 10
Prudential ICICI Floating Rate Fund- LT 15 10 10
Sub Total 30 20 20
Long Term Bonds
GOI Savings Bonds - 8%(taxable) 20 10 10
Sub Total 20 10 10
Fixed Deposits
ICICI Bank Deposits 40 30 10
Sub Total 40 30 10
Grand Total 100 100 100
Opt 4 More – Performance

Actual
Performance
Conservative Moderate Aggressive
Allocation (%) Allocation (%) Allocation (%)
One Year Returns 4.5% 17.6% 22.9%

Volatility 0.4% 7.8% 11.8%

Sharpe Ratio 0.0 1.7 1.6
What is Systematic
Investment Planning
(SIP) ?
Systematic Investment
Planning (SIP)
 Disciplined way of investing fixed amount at a
regular frequency…. A time tested investment
approach
 Reduces the market risk by using the concept
of rupee cost of averaging
 Allows power of compounding help create
wealth over a long term
Disciplined investing in equity funds over
longer time frames helps generate
superior returns
 Rupee Cost Averaging
In a falling market, SIP results in a better downside
Protection
Month NAV SIP Units
Mar-00 70.87 1000 14
Apr-00 64.55 1000 30
An investor would have
May-00 56.79 1000 47
lost 26% if he made
J un-00 56.28 1000 65
a one time investment
J ul-00 61.66 1000 81
in March’00 as
Aug-00 53.99 1000 100
Sep-00 58.72 1000 117
compared to the SIP
Oct-00 51.63 1000 136 loss of 7.6%
Nov-00 49.72 1000 156
Dec-00 53.01 1000 175
J an-01 52.28 1000 194

Average cost – INR 56.60

 Rupee Cost Averaging…
Month NAV SIP Units
Mar-03 55.86 1000 18
Apr-03 53.84 1000 36
May-03 54.77 1000 55 In the backdrop of a
J un-03 60.86 1000 71 sharp rally , a SIP may
J ul-03 67.31 1000 86
under- perform a single
Aug-03 73.91 1000 100
Sep-03 84.70 1000 111 entry strategy for a
Oct-03 87.62 1000 123 short period of time.
Nov-03 100.83 1000 133
Dec-03 106.23 1000 142
J an-04 124.22 1000 150
Feb-04 120.38 1000 158
Mar-04 129.35 1000 166

Average cost – INR 78.22

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….
Value of Invested
Equity Fund Amount
Reliance Growth Fund 46,280
DSPML Opportunities Fund 40,570
HSBC Equity Fund 38,072
Templeton India Growth 38,050
Prudential ICICI Power 37,860
Prudential ICICI Growth 33,680
Systematic Investment
Planning (SIP)

Equity Fund Return(%)

Reliance Growth Fund 77.9
DSPML Opportunities Fund 59.6
HSBC Equity Fund 72.0
Templeton India Growth 51.2
Pru-ICICI Power 50.6
Pru-ICICI Growth 36.2
Examples (Ten Year SIP)

Investing INR 1000 per month from January’97 to

December’04 in Franklin India Bluechip Fund
would have generated return of 36% over the
the past eight years

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
Examples (Five Year SIP)

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

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