Do You Mainly Depend Upon Past Performance before You Invest?

 

While investing in stocks, bonds and mutual funds, past performance becomes a strong input in making investment decisions. Question, should keep on relying on it excessively or there are other indicators available to investors, on which they can rely on to make investment decisions.

 

While looking at past performance look at the future too...

 

However, for a lay investor, it will not be easy, as the famous economist, John Keynes had said, in the long run we are dead. As investment in stocks and mutual funds are normally long term, investors may use this indicator too to support their past performance data.

 

Past Performance is one of the factors to be considered before taking the investment decision and past performance is not the only factor to be considered. Are you relying mainly or only on the past performance?  It is like looking at the rear view mirror and driving. You are headed towards a fatal accident.

 

What are all the other factors to be considered before looking at the past performance?

 

Diversify your portfolio...

 

There is an old saying. Never put all your eggs in one basket. In today’s risk management language it is called concentration risk. In fact in banks, concentration risk is considered one of the most important credit risk factors for the bank. Reserve Bank of India, as a policy measure, have recommended banks to strictly follow exposure norms, i.e., not to lend a borrower or a group of borrower or in a particular industry or business or financial instrument or geographical location beyond a certain percentage of the capital of the bank.

Investors may take an important lesson from this guidance of the Reserve Bank while deciding on the composition of their investment portfolio. To spread the investment in to different segments of business, industry, types of instruments, and then may invest.

 

Have a judicious mix of equity, debt and precious metal in your portfolio...

 

If you are less than 40 years, you may have a mix of portfolio, where equity would be say 50%, Debt 30% precious metals and other investment 20%. As you advance in age the equity portion will reduce and others should increase. In India, the returns on equities in the last 40 years have outstripped far higher compared to all other investment options. But, please remember, return on equity should be always expected in the long run.

 

Factor in time diversification... 
 

Market or business cycles vary from industry to industry, business to business. Also business cycles should be also factored in to for long term.. Longer the time period we take and more businesses or industries we diversify, the peaks and lows of business cycle even out.

 

Investors would definitely argue, if we only invest in the long run, what about short term fund requirements. For short term investment bank FDs, and income funds are the best instruments. For income funds you may check the duration of the income funds, and match the duration of the income fund with your investment time horizon.

Say if your investment time horizon is 1 year you may choose an income fund with duration of approximately 1 year.

 

You need to diversify your investments across different time horizons like long term, medium term, short term, and ultra short term. So that your portfolio will participate in different stock market cycles and interest rate cycles and generate better return by reducing the overall risk.  To neutralise the over dependence on past performance of your stocks/ bonds/ mutual funds, the above options will be helpful to give a good return on your investments while minimsing the associated risks.

 

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company.   

 

3 Questions to Answer before you Choose an Investment

                                       

3 Questions to answer before you choose an investment

When you plan to make an investment, you must be fully aware of the ins and outs of your investment. Therefore, a good advice is to find answers to a few very necessary questions, before you can actually decide upon an investment. Let us explore what these questions are, where an investor needs to lay his focus on before investing his hard-earned money.

1.       Do I have an Exit Strategy?

It is good to always plan your exit, before entry – especially in case of any investment acquisition.Wondering why? Because no investment can be convenient for you, forever. With time, your objectives are most likely to change. There is a reason behind you acquiring an investment. As those reasons contravene, it is the right time for you to make an exit without much delay. Therefore, it is important for you to know your exit reasons well in advance.

Exit can be healthy, in a condition when your investment turns feeble. Such a step then, will make a room for new growth to take place. Everything is volatile, so should your portfolio be. This will help keep it harmonious with the time.

There is nothing like a permanent investment. Therefore, you must always have your exit strategy pre-defined, to avoid your first loss from turning into your worst loss. You should always keep saving capital, to be prepared for investing in the very next opportunity. Trimming your portfolio of troubled investments, you are making a space for new growth opportunities.

2.       Did the investment pass the ‘business common sense’ test?

Every investment must have some business sense behind it, after all, investment is eventually about business. Your earnings, valuation and ROI must be compatible with the benefits and obstacles, possessed by the underlying business. It is really not a good thing if you lose money through your investment. This Business Common Sense test can be used with perseverance, to help you escape from troubling investment speculations and obsessions that may cause losses.

Here, one must know the Common Business Sense Test, to help them avoid getting stuck in a hoax. This test is not just limited to dodging manias and speculations, but the same can also be used to detect possible frauds.

Always remember that your investment is like a property on either your assets or the earning power of your business. Whether in case of debt, equity or real estate – one must eventually be able to make a business sense out of the promised returns. If that is not happening, then something is fishy. Never forget the common sense investment advice that if it’s sounding too good to be real, then it probably not is.

3.       How does the investment affect my portfolio’s risk profile and mathematical expectancy?

Never make an investment that either does not raise the overall returns in your portfolio, or lowers its risk. By matter of choice, you should aim for getting both these things accomplished. All of the investments should be therefore analyzed for their risk profile, and mathematical expectation on how much should they return over time.

Winning or losing the game of investing is entirely based upon your intensity in the front line. Therefore, you must ask the questions as mentioned above, till the time you have the answers for making a wise decision.

The bottom line

Finding answers to these diligence questions can help you save yourself from the most common, but very expensive down the road and help you retire rich and quick.The bottom line lies in building a well-diversified portfolio, for a consistent and long-term investment growth.

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company

3 Steps to Control Risk in your Investment Portfolio

 

              3 Steps to Control Risk in your Investment Portfolio  

Any investor would agree that ignorance and lack of awareness in the investment field can prove to be expensive. In the world of finance and investment, risk management is very closely related, rather necessary for measuring performance. Understanding risks is therefore, a crucial part of building your financial and investment knowledge.

 

Before making any investment, it is common for us to explore the benefits it offers. However, it is all the more important to be aware of the risks involved in the investment. Knowledge of the potential risks, will help us to manage and control the hidden losses that it can cause.

 

Therefore, a good advice here is a detailed investigation of the investment, before actually jumping into it. Sometimes, this may involve a lot of hard work but down the line, it will surely save you from expensive losses.

1.       Understand the Risk Management

Managing risks is an important factor, to lay your focus on before making an investment. We usually have a tendency of considering risk as something negative. Here, we are likely to forget the notable paradox, which suggests that we do not completely understand any investment, till we know all its related means of losing money from it.

 

In other words, we should identify all the major risks that could lead to probable losses, well in advance. Thereafter, we need to proactively manage all the feasible risks. Let us now have a detailed understanding of the risk management process.

2.       Identify the Risk Profile:                                                            

The primary step will involve identification and grouping of the risks, associated with your investment.With a well-designed investment portfolio and strategy, it is possible to manage every critical risk, except for a certain uncontrollable risks.

Let us now study about some specific inherent risks, classified into four major categories.

 

                                 i.            Company-specific:

These include anything that is particular only to the company, and is not a part of the industry as a whole. Example of such risks are lawsuits, mismanagement, etc. Such risks can be controlled via diversification.

                               ii.            Industry-specific:

These comprise of alterations in the consumer preferences, technologies and industry laws. These can be controlled via not restricting your industry portfolio to any single domain.

 

                              iii.            Investment Style:

 These risks may be associated with value vs. growth, or large cap vs. micro cap investments. The market varies with how it manages different investment styles over time. These risks can also be managed by not concentrating on a particular investment style.

 

                             iv.            Market Risks:

 These risks are manageable through self-discipline, or by diversification into non-correlated markets such as real-estate, cash & commodities, international equities, etc.

 

3.       Creating a Controlled Risk Profile:

Post understanding the risk profile, you must design ways to control possible risks. In the second place, you must accept only those investments whose unmanaged risk profile does not overlap with other investments of your portfolio. This will result into minimizing the overall risks. 

Each investment has its own set of exclusive tools available for risk management. This results from the unique features of the investment and its trading markets. Every market, having its unique characteristics, can thus be utilized for effective risk management. This is because, what works for one market, may not work for the other. 

The symbol of a good investment, is not just achieving strong positive profits, but also consistent and risk-free returns in all market scenarios.

Conclusion:

Risk is integral to return. Every investment thus, accompanies some degree of risk with itself. Risk is a quantitative measurement, both in absolute and relative terms. Therefore, a strong understanding of risk and its different forms can surely help investors in better decision-making. This will also help them better comprehend the opportunities, settlements and costs involved in different investment approaches.

 

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company