Flame Newsletter - January 12, 2012


QUOTE OF THE WEEK:

 

The general remedy of those who are uneasy without knowing the cause, is change of place: Samuel Johnson

An investor may think that he doing everything in his capacity to make sensible investments, but he may still not get the desired results. In such a case, he should try to diversify his investments among different asset classes to maximize his gains or offset his losses. This way, he would still be in the markets but would be limiting his exposure to equities alone.  For those investors who do not wish to be exposed only to equities, there is an option to spread their wealth among different asset classes by way of mutual funds. Mutual funds give the investor an exposure to stocks, bonds, government securities and other money market instruments. This way, even if one asset class is not performing particularly well, the losses are offset by the performance of other asset classes. An investor should discuss all options with his financial advisor before choosing a fund and keep in mind his risk appetite and time horizon for the investments to bear fruit. Also, he must constantly review his investments and replace the non/under performing ones with those which perform.

All Mutual Funds Are Not Alike

Mutual funds are considered a good means of investment in comparison to investing in the stock market which could be risky as it involves careful planning and a good understanding of how the market works, with most people unable to grasp the nuances well. Mutual funds are very cost-efficient and easy to invest in. A fund manager pools the money of a group of investors to purchase a diverse portfolio of securities. By doing so, investors can purchase securities at much lower trading costs compared to individual investments. A key advantage of mutual funds is diversification; they allow investors to spread their money across different investment vehicles. Furthermore, when one investment turns sour, another can offset the loss incurred, thereby reducing any risk significantly.

Types of mutual funds: Mutual funds can be classified according to their structure and objective. One can get an idea by looking at some of them.

Closed-end and open-end funds: The former have a set number of shares issued to the public through an IPO, while open end funds are operated by a mutual fund house by raising money from shareholders and investing in various asset classes.

Large cap mid-cap funds: Large cap funds seek to grow capital by investing mainly in large blue chip companies, whereas the latter invest in small and medium sized firms.

Equity funds: These mutual fund types are also called stock mutual funds because the pooled amounts are invested in stocks of public companies.

Balanced funds: Also called hybrid funds, balanced mutual funds buy an assortment of common stock, preferred stock, bonds, and short-term bonds.

Exchange traded funds: ETFs are traded on an exchange just as a stock is and comprise a basket of securities. They are unlike conventional mutual funds.

Value funds: Value funds focus more on safety than on growth and often choose investments that provide both dividends and capital appreciation.

Money market funds: These mutual fund types invest exclusively in money market instruments which are forms of debt that are very liquid and mature under a year's time.

Fund of funds: A FoF is an investment fund that holds a portfolio of other investment funds instead of investing directly in securities.

Besides these types, there are international mutual funds, regional mutual funds and sector funds which invest in securities on a global scale, in a specific geographic area and in a particular sector, respectively.

DID YOU KNOW?

Mutual Funds were first sold in the US in the 1920s.  They were then called investment trusts and often were sold by unscrupulous brokers.  In 1929 over $2 bln was invested.  However, only a small portion of this was invested in what today would be called an Open-ended mutual fund.

A PICTURE SPEAKS A THOUSAND WORDS...

 

Rebalance you portfolio to stay on track

 

YOUR FINANCE DEMYSTIFIED:

 

Measuring Risk Appetite

 

Risk appetite – This is one term you may have heard several times when it comes to investing. But how much risk is enough? How much can you digest if things go awry? The answers to these questions are purely subjective and individualistic.

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.

IN THE NEWS THIS WEEK:

After much of the ruckus over FDI in retail in the winter session of Parliament 2011, the Government has finally managed to pull off part of its new FDI reform. On Tuesday, the Government formally notified 100% FDI in the single-brand retail from the 51% limit earlier. This move raises hopes that FDI in multi-brand retail will soon enter the country on the heels of 100% FDI in its single-brand counterpart.

Govt notifies 100% FDI in single-brand retail

Thursday would also be significant in terms of the domestic economic scenario with inflation and IIP numbers out today. The Index of Industrial Production has recorded growth of 5.9% in November versus a contraction of 5.1% in October. The Government, since a long time now, has been trying to control inflation while balancing growth. The task has been difficult and growth visibly took a hit in October when the nation’s industrial production actually contracted after the RBIs relentless rate hikes. The apex bank had been cutting key lending rates to curb liquidity in the system and thereby control inflation. In the bargain, credit became very expensive for individuals and corporates and growth in the economy stalled. The general expectation now is that the RBI would soon start cutting key interest rates to revive growth, as inflation is showing signs of cooling.

So what are these key rates?

Cash Reserve Ratio or CRR, Repo rate and Reverse Repo rate are known as the key interest rates. Click on the following link to understand them better…

What is CRR, repo and reverse repo rate?

CALCULATORS

Since we have spoken about mutual funds in this newsletter, here is a calculator to help you understand what should be your SIP amount to get a big sum of money in future.

An SIP or a Systematic Investment Plan is a mutual fund instrument with a lock in period where an individual deposits small sums of money at fixed intervals.

At maturity, investors can either reinvest their returns or encash them.

SIP as per need







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.

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