CHAPTER 1 Investment Landscape

Investment and their Financial Goals

• Assigning amounts and timelines to the objectives are referred as financial goals. Example: Funding a child’s education, buying a vehicle, cost of one’s son or marriage.
• Financial goals are about the need for money that cannot be fulfilled through the inflow at that time.
• One needs to invest money as the income (from salary, professional fees, etc.) may be less than the amount required to fund the goal even though the expenses for the goal may be high or low.
• While assigning amounts to long term financial goals, inflation adjustment for goal value must be considered as the cost are likely to go up. On the other hand, the immediate term and near-term goals may not have a big impact due to changes in price.

Step 1: Identify the Goals: Desirable or Undesirable.

Step 2: Assign priorities: Which goal is more important than the other.

Step 3: Assign timeline as well as the amount of funding required at the time of event.

Factors to Evaluate Investments 

• Convenience wrt investing, withdrawing money, checking current value
• Liquidity (How easily can one convert investments into case)
• Returns (Current income, Capital Appreciation/Capital Gains)
• Ticket Size: Minimum amount required for investment
• Taxability of Income (Lower Tax on Less Risky Products)
• Tax Deductions

DIFFERENT ASSET CLASSES:

An asset class is a grouping of investments that exhibit similar characteristics. There are four broad asset categories or asset classes-

1. Real estate
2. Commodities
3. Equity
4. Fixed Income

     1. Real State

Certain traits of real estate as an asset category are:

• Location.
• Illiquid Asset.
• Investment can be in physical real estate as well as in the financial form.
• Transaction cost eg. Brokerage, registration cost are high which would bring down ROI.
• Cost of maintenance of property and taxes payable must be adjusted before calculating ROI.

    2. Commodities

While commodities derivatives are available on many commodities, two commodities that many investors are quite familiar with as investment avenues, viz., gold, and silver. They can be used as investments or storage of value for long.

 3. Fixed Income

• These securities include bonds and debentures.
• Issuers: Companies, Union Government, State Government, Municipal Corporations, Banks, FIs.
• Regular Interest.
• Safer than equity.
• Type: short term bonds (ideal for liquidity needs), medium term bonds, and long-term bonds (income generation needs).

 4. Equity

• Owner’s capital in a business.
• Equity investing has generated returns in excess of inflation, which means the purchasing power of one’s money has increased over the years.
• Capital Appreciation & dividends out of profits from business operations.

Investment Risk-

1. Inflation Risk: General rise in the prices of various products, and services that we consume. This risk hits hard over long periods. If this is not properly accounted for in the investment plan, one may fall short of the target when the need arises. The investment return should be at least as much as inflation.

2. Liquidity Risk: Investments in fixed income assets are usually considered less risky than equity. Some products like PPF may offer no liquidity for a certain period, and even after that, there may be only partial liquidity.

3. Credit Risk: When someone lends money to a borrower, the borrower commits to repay the principal as well as pay the interest as per the agreed schedule. Credit Risk arises when either the issuer pays the dues with some delay or issuer does not pay principal or interest at all

4. Interest Rate Risk: It is the risk that an investment’s value will change as a result of a change in interest rates. This risk affects the value of bonds/debt instruments more directly than stocks. Any reduction in interest rates will increase the value of the instrument and vice versa.

5. Market Risk & Price Risk: When there is a possibility of a country getting into a warlike situation, the prices of all or at least a large number of stocks in the market may witness a fall. This is a market-wide fall. On the other hand, Price risk may arise when the sales of a company’s products fall either due to technological changes, or the arrival of a better product, the company’s share price falls while shares price of other companies may rise.

BEHAVIORAL BIASES IN INVESTMENT DECISION MAKING

• Availability Heuristic
• Confirmation Bias
• Familiarity Bias
• Herd Mentality
• Loss Aversion
• Recency bias
• Overconfidence
• Interest of the investors

ASSET ALLOCATION

Asset Allocation is a process of allocating money across various asset categories in line with a stated objective. The two popular approaches to asset allocation are:

Strategic Asset Allocation is allocation aligned to the financial goals of the individual. Such an analysis would help a mutual fund distributor to arrive at allocation between various asset categories in percentage terms.

Tactical asset allocation is where one may choose to dynamically change the allocation between the asset categories. The purpose is to take advantage of the opportunities presented by various markets at different points in time and improve the risk-adjusted return of the portfolio.

Risk Measures and Management Strategies-

Many of the risks cannot be eliminated, and the investor must take some of those, in order to earn decent returns on one’s investment portfolio:

1. Avoid: Investments which one does not understand or does not want to take risk.

2. Take a position to benefit from some event/development : An investor can also take an investment position in anticipation of some developments in the market.

3. Diversity: Investor shall diversify various investment options. This spreads the risk of loss and thus the probability of losing everything can be significantly reduced through diversification.

Risk Profiling

The risk profilers try to ascertain the risk appetite of the investor so that one does not sell mutual fund schemes that carry a higher risk than what the investor can handle. Risk appetite must be evaluated on the followings:

    1. The need to take risks: which arises when the investor needs higher returns to reach one’s goals.

    2. The ability to take risks: refers to the financial ability, and the investment horizon.

    3. The willingness to take risks: willingness is linked to the psychological capacity to handle risk

    4. The distributor has to evaluate and strike a balance between them, whenever there is a conflict.

CHAPTER 1: Investment Landscape

CHAPTER 2 : Concept And Role Of A Mutual Fund

Chapter 3: Legal Structure Of Mutual Funds In India

Chapter 4: Legal And Regulatory Framework

Chapter 5: Scheme Related Information

Chapter 6: Fund Distribution & Channel Management Practices

Chapter 7: Net Asset Value, Total Expense Ratio & Pricing Of Units

Chapter 8: Taxation

Chapter 9: Investor Services

Chapter 10 : Risk, Return And Performance Of Funds

Chapter 11 : Mutual Fund Scheme Performance

Chapter 12 : Mutual Fund Scheme Selection