FLAME Newsletter - April 11, 2012


QUOTE OF THE WEEK:

 

Greed in an inevitable temptation one possesses in the stock markets. The key is to determine where to draw the line between need and greed. An investor must assess his risk appetite and time horizon and set his targets if he wants to avoid his fingers getting burnt while playing the market.  While it might be tempting to hold on to your investments when they gain more than expected, you might end up losing more than you gained if things turn around. Set a target price to exit the investment and stick with it. Greed and bubbles are actually related to some extent. Greed fuels the formation of bubbles. Like in the case of the dot com bubble in the 90s, investors would buy any internet stock, big or small, expecting it to rise. With every rise, investors got even more sanguine and greedy and continued investing in IT stocks, leading to astronomical price rises in these stocks. The bubble did eventually burst in 2000 and the recovery continued through the next couple of years.   


DID YOU KNOW?

The Wall Street has an old belief - the market is driven by just two emotions: greed and fear.

 

A PICTURE SPEAKS A THOUSAND WORDS...

 

YOUR FINANCE DEMYSTIFIED:

When we get blinded by greed, we lose our direction in the stock market. We get so busy trying to chase our investments that we forget the limits we have set for ourselves. When one takes more risk than he can digest, the results can be catastrophic if the market situation turns ugly. While equities, by nature, are risky investments, one must not get so carried away that he burns his fingers.

 

Measuring Risk Appetite

Risk can be defined as the possibility of an undesirable outcome that a chosen action or activity has the potential to lead to. People usually think of risk in the negative sense, one that should be avoided or a threat that nobody wants to confront. However, in the investment world, risk and performance are inseparable, and is in fact, simply necessary. Understanding risk is one of the most important parts of financial education. Risk appetite and risk capacity are two concepts that need to be understood clearly before making investment decisions because they help determine the amount of risk that should be taken in a portfolio of investments.

 

 

Risk Appetite: This is the degree of risk that an investor is comfortable taking, or the level of uncertainty he is confident of handling. Risk appetite often varies with age, income and financial goals. It can be determined by many methods, including questionnaires designed to assess the extent to which an investor can invest, while still remaining comfortable.

 

Risk Capacity: Unlike appetite, risk capacity is the amount of risk that the investor ‘must’ take in order to reach his financial targets. The rate of return required to meet these targets can be estimated by assessing time frames and income requirements. The rate of return information can then be used to help the investor decide what investments to engage in as well as the level of risk that should be taken.

 

Balance of Risk: For many investors, their risk appetite and capacity do not match, resulting in problems. When the amount of necessary risk surpasses the comfort level of the investor, future goals cannot be reached. Conversely, when risk tolerance is higher than required, the investor takes undue risk. Such investors are sometimes referred to as risk lovers. One should therefore, take time to be aware of one’s personal risk situation and should have a sound financial plan ready. Seeking the help of a professional is always helpful.

 

Many might confuse the ability of taking risk with the willingness to take it. Here is a short story to help you understand it better…

 

Two friends Ability and Willingness both 6 ft tall are walking down a forest trail. They come across a ditch 2 ft wide and both decide to jump it since they are confident of their athletic skills. They jump together and clear easily. Next they come across a 5 ft deep ditch which they decide to jump again. Ability knows he can clear the 5 ft ditch and he crosses with ease. Willingness believes in himself that he can cross the ditch but falls short and lands in the ditch. The ditch was 7 ft deep and it was beyond Willingness to climb up by himself. He has to be helped up by Ability and it is only then that he realizes that the real question was not if he could clear the 5 ft jump or not, but whether if he could get out of the 7 ft ditch in the event that he fell short? Going forward, they come across a 10 ft ditch. Both now know that it is beyond them to clear the ditch in a single jump. But seeing that the ditch was only 4 ft deep they take a shot. Both fall short by a large margin yet are able to scale up the other side and continue on their way learning an important lesson

 

We Indians are passionate about what we do. We love taking risks and rising up to our challenges. However, one should be prudent enough to respect the risks associated with the market and money in general and chose our fights accordingly.

 

Risk taking should always be a product of our risk appetite which is an index how much risk we can take in terms of a hit rather than in terms of our will. The market doesn't care if you are willing to take a risk or not, rather it only cares if you have the ability at present to take that risk. Hence simply put, risk is dependent not on its probability of happening but on its IMPACT if it were to happen.

 

You can take into your stride the losses that you may suffer in the market, since you know that in the long run, you can always recover your invested amount. This is your willingness to take risk. But if that loss occurs just a week before you wanted to take out money to create liquid fund for a down payment, then you are in a terrible soup. Had the timing been different, the same loss would have received a more placid reaction from you. This factor of current personal situations is your ability to take risk. You were willing but you were not able to.

 

Before entering a transaction, always remember that it is not important whether you can jump the ditch or not, but rather your ability to climb back up if you were to fall.

 

While there is never any sure shot technique to make gains or avoid losses in the stock markets, here are some mistakes investors can avoid making…

 

Investing mistakes you must avoid

 

IN THE NEWS THIS WEEK:

The week gone by may have been filled with holidays, but much to the relief of the government and consumers, jewellers across the country ended their 21-day long break from work to reopen stores. Jewellers and traders called of the strike that commenced on Mar 17 protesting the 1% hike in excise duty on unbranded jewellery and doubling of customs duty on gold imports proposed in the Union Budget 2012-12. The strike was called off after assurances from Finance Minister Pranab Mukherjee that the government would consider the industry’s demands.

 

Jewellers call off long-running strike on FM’s assurances

 

WHAT TO WATCH OUT FOR THIS WEEK

 

The remainder of this week and start of the next promises to be action packed in terms of economic data and policy announcements.

Apr 12 – Thursday – IIP data for March, Decision likely of FDI investment in aviation by foreign carriers

Apr 13 – Friday – Monthly Wholesale Price Index for March

Apr 17 – Tuesday – Reserve Bank of India’s Monetary Policy Review

 

ABOUT FLAME

FLAME (Financial Literacy Agenda for Mass Empowerment) is an IIFL initiative to promote financial literacy amongst the masses in order to make them an integral part of India's spectacular growth story.

 

In an era of accelerating GDP and rising per capita growth, financial literacy has become more critical than ever before such that we all reap the tangible benefits of the nation's economic prosperity. Financial inclusion has been quite high on the governmental agenda, given its emphasis on widening the Banking & Financial services network across the country. IIFL's FLAME initiative stands committed to complement this effort by helping common people gain financial growth and security though better awareness and education on the variety of financial products while avoiding the lure of and loss from unrealistic claims made by unscrupulous agents and ponzi schemes.

 

Our objective is to light a FLAME, as the name suggests, which will set ablaze a chain of FLAMEs across the country. The new-found light of knowledge will undoubtedly dispel the dark clouds of financial illiteracy and ensure the bright sunshine of financial growth and prosperity.

 

This portal is but one of the various IIFL initiatives that would be part of FLAME.

 



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