Investment Planning.pdf

Module 4

Investment Planning Certified Financial Planner

Module 4: Investment Planning

This session will help you understand • The importance of investment planning in the financial planning process. • The types of investment products and their risk return characteristics. • How to evaluate investment choices in the light of the client’s financial needs. • Understand what client portfolios- how they are created, monitored and rebalanced based on needs. • How to recommend a investment portfolio. Certified Financial Planner

Module 4: Investment Planning

Purpose of Investments • Investment is nothing but using money to make more money. • It involves sacrifice of something now for the prospects of getting something in future. • To part with money, investors need compensation for: – Time period for which the money Is parted with. – The expected rate of price rise- Inflation – The uncertainty of payments in future. • Investment planning is an important part of overall financial planning. Certified Financial Planner

Module 4: Investment Planning

The Financial Planning process involves 6 steps

Monitoring the recommendations

Establishing and Defining the clientPlanner relationship Gathering Client Data & Goals

Analysing and Evaluating Financial Status

Implementing the Financial plan recommendations Developing and Presenting Financial Planning Recommendations/ Alternatives Certified Financial Planner

Module 4: Investment Planning

Financial Planning Steps •

•

•

Establishing the relationship: – The Financial Planner will describe the services that he is offering. The client and planner to mutually decide on their respective responsibilities.The remuneration is also to be decided upon. Gathering the data and goals of the client: – The financial planner is to gather information on the client’s financial situation.Both mutually define personal and financial goals, set time frames for results with the planner evaluating the clients appetite for risks. Analysis and evaluation of clients financial status: – The financial planner will then evaluate the clients financial status, assess the current situation and then decide on what needs to be done to achieve the set goals.This could include analysis of assets, liabilities and cash flows, insurance coverage, investment or tax strategies.

Certified Financial Planner

Module 4: Investment Planning

Financial Planning Steps •

Developing plan and making recommendations: – The financial planner will then make recommendation to the client based on the goals and objectives of the client. The financial planner should go over the plans with you to help the client understand the risks involved. – The financial planner should revise the recommendations when possible, based on your concerns. • Implementation: – The Financial Planner will then implement the plan on the basis of the consensus arrived at with the client.In some cases, the planner may act as a coach, co-ordinating the whole process with you and other professionals. • Monitoring the financial recommendations: – The Financial planner and the client should agree on who will actually monitor the progress that is being made towards the goal. In case the Financial planner is in charge, he/ she should periodically report to you and make recommendations. Certified Financial Planner

Module 4: Investment Planning

RISK AND RETURN

Certified Financial Planner

Module 4: Investment Planning

Introduction to Risk & Return • Return and risk are two important characteristics of any investment product. • Generally return and risk go hand in hand. • A rational investor likes return and dislike risk, so most of the investment is a tradeoff between risk and return. To part with money, investors require compensation for • The time period for which the resources are committed • The expected rate of price-rise • The uncertainty of the payments in future

Certified Financial Planner

Module 4: Investment Planning

Type of returns • Total return or Holding period return: The period during which the investment is held by the investor is known as holding period and the return generated on that investment is called as holding period return during that period. • Annualized return (CAGR): It is also known as compounded annual growth rate. The year-over-year growth rate of an investment over a specified period of time. The compound annual growth rate is calculated by taking the nth root of the total percentage growth rate, where n is the number of years in the period being considered.

Certified Financial Planner

Module 4: Investment Planning

Measurement of return •

Return is reward for undertaking investment.

Historical return

•

A) Total return: The total amount of earnings on an investment is "total return". And this is generally broken down into two main components. Current Income – Income received regularly over the course of the investment (dividends, interest or rent) Capital Gains – the increase in the market value of the specific investment vehicle. This return is generally not received or recognized until the asset is sold. B) Average return: It is a measure of return that gives summary of a series of return .It represents the series with one number. The sum of annual return is divided by the number of years it shows now much on an average investment has grown over a period of time. It is also called as arithmetic mean. Certified Financial Planner

Module 4: Investment Planning

Expected return The expected rate of return is the weighed average of all possible returns multiplied by their respective probabilities. n E(R) = ∑Ri Pi i=1 Where, E(R) = Expected return from the stock Ri = Return form the stock under state i Pi = Probability that the state i occurs n

= Number of possible states of the world

Portfolio return The expected return on a portfolio of securities weighted average of expected return for the individual investment in a portfolio.

Certified Financial Planner

Module 4: Investment Planning

How much risk can an investor take? This would depend on the following factors:

Risk Tolerance How much are you prepared to lose over one year without giving up on investment?

Certified Financial Planner

Age Younger investors can usually afford to be more aggressive

Goals If you are saving to buy a house or starting to invest for retirement, you will need to invest in growth stocks. This means taking on more risk

Time horizon The longer you can afford to wait, the less risk is involved. Do not invest in risky assets if you may need funds in the short term.

Module 4: Investment Planning

Types of Investment Risks Systematic/ Market Risks

The element of return variability from an asset which results from fluctuations in the aggregate market

Non Systematic/ Non Market Risks

The variability in a security's total returns not related to overall market variability

Certified Financial Planner

Re-investment Risks

Interest Rate Risks

The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment.

The possibility of a reduction in the value of a security, especially a bond, resulting from a rise in interest rates. Such changes generally affect security prices inversely

Module 4: Investment Planning

Types of Investment Risks Purchasing Power Risks

The risk of loss in the value of cash due to inflation. This is also known as inflation risk

Re-investment Risks

The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment

Certified Financial Planner

Interest Rate Risks

The possibility of a reduction in the value of a security, especially a bond, resulting from a rise in interest rates.

Political Risks

The risk of loss when investing in a given country caused by changes in a country's political structure or policies

Exchange Rate Risks

The risk that a business' operations or an investment's value will be affected by changes in exchange rates

Module 4: Investment Planning

Managing risk •

Avoiding Risks: Simply avoid the risk altogether. Don’t invest in the financial market to avoid financial loss. However, some risks are unavoidable.

•

Controlling Risks: Put in place some control measures for the risks. For example, you can install sprinkler systems in your office to control the risk of loss due to a fire.

•

Accepting risk: Assume all financial responsibility of a risk. Self Insurance falls under this. For example, An employer can self insure a medical expense benefits plan for his employees by setting aside a sum of money for this.

•

Transferring Risks: Shifting the financial responsibility for that risk to the other party, generally in exchange for a fee. Purchasing Insurance is the most common method of transferring risk from the individual to the insurance company

Certified Financial Planner

Module 4: Investment Planning

Measurement of risk •

Being able to measure and determine the past volatility of a security is important in that it provides some insight into the riskiness of that security as an investment. Historical risk: Variance: Variance is the standard measure of total risk. It measures the dispersion of returns around the expected return. The larger the dispersion, the more risk involved with an individual security. Variance is an absolute number and can be difficult to interpret. The square root of variance is standard deviation. Standard Deviation: Standard Deviation is a measure of variability of returns of an asset as compared with its mean or expected value. It measures total risk. There is a direct relationship between standard deviation and risk. The larger the dispersion around a mean value, the greater the risk and larger the standard deviation for a security. The standard deviation of a portfolio is the not the average of the standard deviations of individual assets. The standard deviation of a portfolio is usually less than the average standard deviation of the stock in the portfolio. Certified Financial Planner

Module 4: Investment Planning

Steps to calculate historical standard deviation • For each observation, take the difference between the individual observation and the average return. • Square the difference. • Sum the squared differences. • For sample SD, divide this sum by one less than the number of observations. For population SD, divide this sum by the total number of observations • Take the square root.

Certified Financial Planner

Module 4: Investment Planning

Beta: Beta is a measure of the systematic risk of a security that cannot be avoided through diversification. Beta is a relative measure of risk-the risk of an individual stock relative to the market portfolio of all stocks. If the stock has a beta of 1, the implication is that the stock moves exactly with the market. A beta of 1.2 is 20 percent riskier than the market and 0.8 is 20 percent less risky than the market. Expected Risk: The variance of a probability distribution is the sum of the squares of the deviation .the variance of a probability distribution is the sum of the squares of the deviations of actual returns from the expected return, weighted by the associated probabilities. • σ 2 = ∑ Pi Ri –E (r) 2 Where, E(r) = expected return from the stock Ri = return from stock under state Pi = probability that the event i occurs n = number of possible events Certified Financial Planner

Module 4: Investment Planning

Portfolio risk •

•

• •

Portfolio risk is computed by risk attached with each of the securities in the portfolio i.e. standard deviation or variance as well as the interactive risk between the securities i.e. covariance. Covariance is a measure of the degree to which two variables move together over time. A positive covariance indicates that variables move in the same direction, and a negative covariance indicates that they move in opposite directions. Covariance is an absolute number and can be difficult to interpret. Correlation coefficient (r) is a measure of the relationship of returns between two stocks. Correlation coefficient of (+1) means that returns always move together in the same direction. They are perfectly positively correlated. Correlation coefficient of (-1) means that returns always move in exactly the opposite directions. They are perfectly negatively correlated. A correlation coefficient of zero means that there is no relationship between two stocks' returns. They are uncorrelated. Certified Financial Planner

Module 4: Investment Planning

Measuring Risks • Coefficient of determination (R2) gives the variation in one variable explained by another and is an important statistic in investments. • R2 is calculated by squaring the correlation coefficient (r). It is a measure of systematic risk; • I - R2 is defined as unsystematic risk. The beta coefficient reports the volatility of some return relative to the market. • The strength of the relationship is indicated by R2. If R2 equals 0.15, an investor can assume that beta has little meaning because the variation in the return is caused by something other than the movement in the market (unsystematic risk). If R2 equals 0.95, the variation in the market explains 95 percent of the variation in the return (systematic risk-where beta is a good measure of risk). Certified Financial Planner

Module 4: Investment Planning

Managing Risks • Diversification

• Diversification means spreading your money over a number of investments in order to reduce unique risks associated with individual investments • When you invest in the stock market you face both market risk and unique risk. You can mitigate unique risk by taking a diversified approach to investing. • The more stocks you add to your portfolio (your collection of individual investments) the more unique risk you eliminate and the smoother your overall returns become.

Certified Financial Planner

Module 4: Investment Planning

Diversification • There are three main practices that can help you ensure the best diversification: – Spread your portfolio among multiple investment vehicles such as cash, stocks, bonds, mutual funds, and perhaps even some real estate. – Vary the risk in your securities. You're not restricted to choosing only blue chip stocks. In fact, it would be wise to pick investments with varied risk levels; this will ensure that large losses are offset by other areas. – Vary your securities by industry. This will minimize the impact of specific risks of certain industries. Certified Financial Planner

Module 4: Investment Planning

Types of Diversification Company Diversification

Balancing potential risk of negative returns from one country by investing in other countries that don’t face the same risk.

Geographical Diversification

Spreading your risks by investing in different countries or in different regions in a particular country.

Manager Diversification

Using different fund managers with different investment styles and philosophies to reduce risks.

Asset Allocation

Putting some of your money in more risky funds and putting some in less risky, fixed income yielding instruments is called asset allocation.

Certified Financial Planner

Module 4: Investment Planning

Managing Risks • Hedging: • Hedging is a strategy to protect oneself from losing by a counterbalancing transaction. It can be used to protect one financially--to buy or sell commodity futures as a protection against loss due to price fluctuation or to minimize the risk of a bet. • Hedging against investment risk means strategically using instruments in the market to offset the risk of any adverse price movements. In other words, investors hedge one investment by making another. Technically, to hedge you would invest in two securities with negative correlations

Certified Financial Planner

Module 4: Investment Planning

How do investors hedge? • Hedging techniques involve using complicated financial instruments known as derivatives, the two most common of which are options and futures. • Keep in mind that because there are so many different types of options and futures contracts an investor can hedge against nearly anything, whether a stock, commodity price, interest rate, or currency. • Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the benefits received from it justify the expense. Remember, the goal of hedging isn't to make money but to protect from losses.

Certified Financial Planner

Module 4: Investment Planning

Relationship between risk and return RISK/RETURN TRADEOFF

R E T U R N

Higher Risk, higher potential return

Low return high risk

Risk (Standard Deviation)

Low levels of uncertainty (low risk) are associated with low potential returns. High levels of uncertainty (high risk) are associated with high potential returns. The risk/return tradeoff is the balance between the desire for the lowest possible risk and the highest possible return. Other factors you will need to consider for investments are; how long you want to invest the money for and whether you need quick access to it at any time during the investment period. Certified Financial Planner

Module 4: Investment Planning

Compounding

+

=

Compounding is the money that money makes, added to the money that money has already made. And each time money makes money, it becomes capable of making even more money than it could before! Certified Financial Planner

Module 4: Investment Planning

Compounded Annual Growth Rate (CAGR) •

• • •

•

CAGR measures a market's annual growth over a period of time (usually several years). This measure is a constant percentage rate at which a market would grow or contract year on year to reach its current value. CAGR is a formula used to express the rate of growth in sales, earnings, units or some other measure over a number of years. The CAGR is a more representative measure of annual growth over a number of years. CAGR = ((Y / X) ^ (1 / N)) - 1 – Where: (“^ " ) denotes "to the power of” – Where: Y is the value in the final year – Where: X is the value in the first year – Where: N is the number of years included in the calculation CAGR-based forecasts do not show the effects of inflation that would impact the overall dollar value in the future Certified Financial Planner

Module 4: Investment Planning

Real Returns • The earnings from an investment above the prevailing inflation rate is called the real return on that investment. • The real returns are determined with the help of the following formula: – [{(1 + nominal rate)/ (1+ inflation rate)}-1]*100 • Where the nominal rate is the absolute return and the inflation rate is the rate of inflation for the period.

Certified Financial Planner

Module 4: Investment Planning

Risk Adjusted Returns •

In determining the various returns earned by a portfolio, a higher return by itself is not necessarily indicative of superior performance. Alternately, a lower return is not indicative of inferior performance.

•

In order to determine the risk-adjusted returns of investment portfolios, several eminent authors have worked since 1960s to develop composite performance indices to evaluate a portfolio by comparing alternative portfolios within a particular risk class. The most important and widely used measures of performance are: – – – –

The Treynor Measure The Sharpe Measure Jenson Model Fama Model

Certified Financial Planner

Module 4: Investment Planning

Measures of Performance •

Treynor Measure: Developed by Jack Treynor, this performance measure evaluates funds on the basis of Treynor's Index. This Index is a ratio of return generated by the fund over and above risk free rate of return during a given period and systematic risk associated with it (beta). • Symbolically, it can be represented as: – Treynor's Index (Ti) = (Ri - Rf)/Bi. • Where, Ri represents return on fund, Rf is risk free rate of return and Bi is beta of the fund. •

Sharpe Measure: According to Sharpe, it is the total risk of the fund that the investors are concerned about. So, the model evaluates funds on the basis of reward per unit of total risk. • Symbolically, it can be written as: – Sharpe Index (Si) = (Ri - Rf)/Si • Where, Si is standard deviation of the fund. Certified Financial Planner

Module 4: Investment Planning

Measures of Performance •

Jenson Model: developed by Michael Jenson (sometimes referred to as the Differential Return Method) involves evaluation of the returns that the fund has generated vs. the returns actually expected out of the fund given the level of its systematic risk. The surplus between the two returns is called Alpha, which measures the performance of a fund compared with the actual returns over the period. • Required return of a fund at a given level of risk (Bi) can be calculated as: – Ri = Rf + Bi (Rm - Rf) • Where, Rm is average market return during the given period. After calculating it, alpha can be obtained by subtracting required return from the actual return of the fund. Higher alpha represents superior performance of the fund and vice versa.

Certified Financial Planner

Module 4: Investment Planning

Measures of Performance •

The Fama Model: The Eugene Fama model is an extension of Jenson mode and compares the performance, measured in terms of returns, of a fund with the required return commensurate with the total risk associated with it. • The difference between these two is taken as a measure of the performance of the fund and is called net selectivity. • The net selectivity represents the stock selection skill of the fund manager, as it is the excess return over and above the return required to compensate for the total risk taken by the fund manager. Higher value of which indicates that fund manager has earned returns well above the return commensurate with the level of risk taken by him. – Required return can be calculated as: Ri = Rf + Si/Sm*(Rm - Rf) • Where, Sm is standard deviation of market returns. The net selectivity is then calculated by subtracting this required return from the actual return of the fund. Certified Financial Planner

Module 4: Investment Planning

Post- Tax Returns • The amount of taxes paid will affect an investor's total return. Therefore it is important for an investor to understand the impact of taxes on the performance of investment. • There are many different assumptions to use in calculating the impact of taxes on investment returns. The post-tax return is calculated by multiplying the pretax rate by the quantity one minus the marginal tax bracket of the investor.

Certified Financial Planner

Module 4: Investment Planning

Holding Period Returns •

The amount of taxes paid will affect an investor's total return. Therefore it is important for an investor to understand the impact of taxes on the performance of investment.

•

There are many different assumptions to use in calculating the impact of taxes on investment returns. The post-tax return is calculated by multiplying the pretax rate by the quantity one minus the marginal tax bracket of the investor.

•

The holding period return (HPR) is the total return and is determined by taking the total return divided by the initial cost of the investment: – HPR= (PI - Po + D)/ Po Where, PI is the sale price, Po is the purchase price, and D is the dividend paid. There is a major weakness in using the holding period. It does not consider how long it took to earn the return.

• •

Certified Financial Planner

Module 4: Investment Planning

Yield to Maturity (YTM) •

The yield to maturity is the internal rate of return of a bond if held to maturity

•

Internal rate of return is the discounted rate that makes the present value of the cash outflows equal to initial cash inflows such that the net present value is equal to zero.

•

YTM considers the current interest return and all price appreciation or depreciation. It is also a measure of risk and is the discount rate that equals the present value of all cash flows. From a firm perspective, it is the cost of borrowing by issuing new bonds. From an investor perspective, it is the internal rate of return that is received if the bond is held to maturity.

•

The yield to maturity can easily be solved using a financial calculator, in the same way as finding the internal rate of return.

Certified Financial Planner

Module 4: Investment Planning

Investment Portfolio • A portfolio is a combination of different investment assets mixed and matched for the purpose of achieving an investor's goal(s). • Items that are considered a part of your portfolio can include any asset you own--from real items such as art and real estate, to equities, fixed-income instruments, and cash and equivalents. • The Following are the various types of portfolio strategies: – Aggressive Investment Strategy: Search for maximum returns from an investment. Suitable for risk takers and for a longer time horizon. Higher investment in Equities. – Conservative Investment Strategy: Safety of investment is a high priority. Suitable for those who have a low risk appetite and a shorter time horizon. High investments in cash and cash equivalents, and high quality fixed income yielding assets. Certified Financial Planner

Module 4: Investment Planning

Investment Portfolios • Moderately Aggressive investment strategies: These are suitable for people who have a large an average appetite for risk and a longer time horizon. The objective is to balance the amount of risk and return contained within the fund. The portfolio would consist of approximately 50-55% equities, 35-40% bonds, 5-10% cash and equivalents. • You can further break down the above asset classes into subclasses, which also have different risks and potential returns. More advanced investors might also have some of the alternative assets such as options and futures in the mix. As you can see, the number of possible asset allocations is practically unlimited.

Certified Financial Planner

Module 4: Investment Planning

Why is important to maintain a portfolio? • Diversification which works on the principle of “Not putting all your eggs in one basket”. • Different securities perform differently at any point in time, so with a mix of asset types, your entire portfolio does not suffer the impact of a decline of any one security. • When your stocks go down, you may still have the stability of the bonds in your portfolio. • If you spread your investments across various types of assets and markets, you'll reduce the risk of catastrophic financial losses.

Certified Financial Planner

Module 4: Investment Planning

Investment Vehicles Small Savings • Small savings continue to be a favorite investment alternative for a large section of investing population despite the emergence of a number of alternative avenues such as mutual funds and unit-linked insurance plans (ULIPs). • Small savings scheme in India generally include National Savings Scheme (NSC), Public Provident Fund (PPF) and Kisan Vikas Patra (KVP). • All small savings schemes tend to be characterized as the same despite the fact that they vary on parameters including tenure, returns and liquidity. There is much more to these schemes than just the safety and returns.

Certified Financial Planner

Module 4: Investment Planning

Small Savings • Public Provident Fund: • It presently offers a return of 8% per annum and has a maturity period of 15 years. Contributions can vary from Rs 500 to Rs 70,000 per annum. • Investment under PPF is not very liquid. Withdrawals are permitted only after the expiry of 5 years from the end of the financial year of the first deposit. Also only a small portion can be withdrawn • Investors are entitled to claim tax-benefits under Section 80 C for deposits made up to Rs 70,000 pa in the PPF account and interest exemptions under Section 10 of the Income Tax Act. • Suitable investment option for investors who have age on their side and for whom liquidity is not a concern. Certified Financial Planner

Module 4: Investment Planning

Small Savings • •

•

•

•

National Savings Certificate: NSC is another attractive instrument offering a return of 8% pa. Investors are required to make a single deposit and the interest component is returned along with the principal amount on maturity. NSC has an edge over its peers on account of a relatively lower tenure i.e. 6 years. Premature encashment of certificate is allowed under specific circumstances only, such as death of the holder(s), forfeiture by the pledgee or under court's order. Investments in NSC enjoy tax-benefits under Section 80 C of the Income Tax Act. The interest is entitled for exemption under section 80L of the Income Tax Act. An added incentive is that the accrued interest is automatically reinvested, and qualifies for benefit under Section 80 C. Investors who offer more weightage to tax benefits vis-à-vis other factors like liquidity should consider investing in the NSC

Certified Financial Planner

Module 4: Investment Planning

Small Savings • Kisan Vikas Patra • KVP falls under the category of small saving schemes which don't offer any benefits under the Income Tax Act. The scheme runs over a tenure of 8 years and 7 months (which is a fairly longish horizon) and doubles the amount invested. This makes the return one of the most attractive one amongst its peers. • Investors are permitted to liquidate their investments in KVP any time after 2.5 years from the investment date. However a loss of interest has to be borne. In terms of tenure for withdrawal (2.5 years) it scores far better than the NSC and PPF on this parameter. • Investors whose priority is earning attractive returns while maintaining a reasonable degree of liquidity should consider investing in the KVP. Also KVP will hold appeal for investors in cases where tax benefits are not a priority. Certified Financial Planner

Module 4: Investment Planning

Small Savings • • • •

• •

Post office monthly income scheme: This scheme provides monthly income (at 8% pa) to investors. On competition of 6 years, a 10% bonus on the principal sum is provided. POMIS offers investors an exit option after 1 year from the investment date. An exit after 1 year would also entail a loss of 5% of the amount invested. As a result, while the investor would not suffer any loss in interest earnings, but the loss of principal can be a significant one (especially for investors with high investments). Investors have to wait for a 3 year period if they wish to liquidate their holdings without any loss of principal. The interest on investments as well as bonus received on maturity qualifies for tax benefits under Section 80L of the Income Tax Act. POMIS is best suited for investors like retirees who are looking for regular returns. The combination of assured returns with tax benefits makes POMIS an attractive proposition.

Certified Financial Planner

Module 4: Investment Planning

Small Savings • Post office Time Deposits: • Fixed deposits of varying tenures offered under the domain of small saving schemes. These deposits are available for periods ranging from 1 year to 5 years with the interest rates varying correspondingly. Interest payments are made annually. POTD have emerged as one of the most favoured instruments in recent times. • Investors can exercise the exit option within 6 months without receiving any interest (1-Yr lock-in for exit with interest receipt). However the penalty clause is applicable depending on the interest rates offered by the time deposit. A flat penalty of 2% is deducted from the relevant rate in case of premature withdrawals. • Interest on POTD is eligible for tax benefits under Section 80L of the Income Tax Act. • POTD fit into most portfolios across investor classes. Certified Financial Planner

Module 4: Investment Planning

Small Savings • Senior Citizens Savings Schemes: • The scheme has been reserved for citizens above 60 years of age, albeit citizens above 55 years can invest in the same subject to certain conditions being fulfilled. SCSS offers a return of 9% pa, making it a must have proposition for the target audience. The SCSS in tandem with the POMIS can prove to be a very lucrative option for senior citizens who need regular income without taking on any risk.

Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments •

Securities: – Government Securities (G-Secs): – Government Securities (G-Secs) market comprises almost 95% of the debt market. – Government Security is a sovereign debt issued by the Reserve Bank of India (RBI) on behalf of Government of India. These securities are issued to cover the Central Government's annual market borrowing programme to fund the fiscal deficit. The term "Government Security" includes: * Central Government Dated Securities * State Government Securities * Treasury Bills (TBs). – The market borrowing of the Central Government is raised through the issue of dated securities and 364 days TBs either by auction or by floatation of fixed coupon loans. In addition, TBs of 91 days are issued for managing the temporary cash mismatches of the Government. These do not form part of the borrowing programme of the Central Government. Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • Government securities are of 2 types: (a) Dated Securities are generally of fixed maturity and fixed coupon securities usually carrying semiannual coupon. These are called dated securities because these are identified by their date of maturity and the coupon * They are issued at face value. * Coupon or interest rate is fixed at the time of issuance and remains constant till redemption of the security. * The tenor of the security is also fixed. * Interest /Coupon payment is made on a half yearly basis on its face value. * The security is redeemed at par on its maturity date.

Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments (b) Zero Coupon Bonds are bonds issued at discount to face value and redeemed at par. The key features of these bonds are: • They are issued at a discount to the face value. * The tenor of the security is fixed. * The securities do no carry any coupon or interest rate. The difference between the issue price and face value is the return on this security. * The security is redeemed at par on its maturity date. – Though the benchmark does not change, the rate of interest may vary according to the change in the benchmark rate till redemption of the security. The tenor of the security is also fixed. * Interest /Coupon payment is made on a half yearly basis on its face value. * The security is redeemed at par on its maturity date. Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments (c) Floating Rate Bonds are bonds with variable interest rate with a fixed percentage over a benchmark rate. There may be a cap and a floor rate attached, thereby fixing a maximum and minimum interest rate payable on it. The key features of these securities are: • They are issued at face value. * Coupon or interest rate is fixed as a percentage over a predefined benchmark rate at the time of issuance. The benchmark rate may be TB rate, Bank rate, etc (d) Treasury Bills: There are different types of TBs based on the maturity period and utility of the issuance like, ad-hoc TBs, 3 months, 12 months TBs etc. At present, the TBs in vogue are the 91-days and 364-days TBs.

Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • State Government Securities: • State Government Securities are securities/loans issued by the RBI on behalf of various State Governments for financing their developmental needs. • The RBI auctions these securities from time to time. These auctions are of fixed coupon, with pre-announced notified amounts for different States. • The coupon rate and year of maturity identifies the government security. • For Central Government securities and State Government securities the day count is taken as 360 days for a year and 30 days for every completed month. However, for TBs it is 365 days for a year.

Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • Yield to maturity (YTM) is the discount rate that equates present value of all the future cash inflows to the cost price of the security and is also called the Internal Rate of Return (IRR). The concept of Yield to Maturity assumes that the future cash flows are reinvested at the same rate at which the original investment was made. The price of a security/bond is inversely related to its yield. As the yield increases, the price decreases and if the yield falls there is an increase in the price. • All entities registered in India like Banks, Financial Institutions, Primary Dealers, Companies, Corporate Bodies, Partnership Firms, Institutions, Mutual Funds, Foreign Institutional Investors, State Governments, Provident Funds, Trusts, Nepal Rashtra Bank and even individuals are eligible to purchase Government Securities. Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • Advantages of State Government Securities: • No TDS - Interest income up to Rs.12000/- is exempt under section 80L of Income Tax Act. The additional benefit of Rs.3000/- is also available for interest earned on Government securities • Zero default risk, being a sovereign paper • Regular income in the form of half yearly interest payments • Highly liquid due to active secondary market • Simplified and transparent transactions • Hassle free settlement through Demat / SGL accounts • Easy loans available from Banks • Holding possible in dematerialized form Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • How to invest in Government Securities: • Investment in Government Securities can either be made in the primary market by participating in the RBI auctions or by purchasing from the secondary market. • RBI has recently introduced the scheme of NonCompetitive Bidding for the benefit of retail investors. Under this scheme non- institutional participants will be allotted securities at the weighted average cutoff rate. • Up to 5% of the issue size is reserved for investors under this scheme. • Investors can invest in a hassle free manner by opening a Demat account. • Investors can contact any Primary Dealer to make an investment in Government Securities. Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • • •

• •

•

Corporate Bonds: Corporate bonds are debt obligations, issued by private and public corporations. They are typically issued in multiples of Rs 1,000. Companies use the funds they raise from selling bonds for a variety of purposes, from building facilities to purchasing equipment to expanding the business. When you buy a bond, you are lending money to the corporation that issued it. The corporation promises to return your money, or principal, on a specified maturity date. Until that time, it also pays you a stated rate of interest, usually semiannually. The interest payments you receive from corporate bonds are taxable. Unlike stocks, bonds do not give you an ownership interest in the issuing corporation. Benefits of Investing in Corporate Bonds

Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • •

Why Corporate Bonds? Attractive yields: Corporates usually offer higher yields than comparable-maturity government bonds or CDs. This high-yield potential is generally accompanied by higher risks. • Dependable income: People who want steady income from their investments, while preserving their principal, include corporates in their portfolios. • Safety: Corporate bonds are evaluated and assigned a rating based on credit history and ability to repay obligations. The higher the rating, the safer the investment. (See Understanding Credit Risk) • Diversity: Corporate bonds provide the opportunity to choose from a variety of sectors, structures and credit-quality characteristics to meet your investment objectives. • Marketability: If you must sell a bond before maturity, in most instances you can do so easily and quickly because of the size and liquidity of the market. Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • Types of Corporate Bonds: – Short-term notes – Maturities of up to 5 years – Medium-term notes/bonds – Maturities of 5-12 years – Long-term bonds – Maturities greater than 12 years

Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • Structure of Corporate Bonds: Another important fact to know about a bond before you buy is its structure. • With traditional debt securities, the investor lends the issuer a specified amount of money for a specified time. In exchange, the investor receives fixed payments of interest on a regular schedule for the life of the bonds, with the full principal returned at maturity. • In recent years, however, the standard, fixed interest rate has been joined by other varieties.

Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments • Structure of Corporate Bonds: – Fixed-rate Most bonds are still the traditional fixed-rate securities – Floating-rate These are bonds that have variable interest rates that are adjusted periodically according to an index tied to short-term Treasury bills or money markets. While such bonds offer protection against increases in interest rates, their yields are typically lower than those of fixed-rate securities with the same maturity. – Zero-coupon These are bonds that have no periodic interest payments. Instead, they are sold at a deep discount to face value and redeemed for the full face value at maturity. Certified Financial Planner

Module 4: Investment Planning

Fixed Income Instruments •

Benefits to a developing economy- In any developing economy, it is imperative that a well developed bond market with a sizable corporate bond segment exists, alongside the banking system, as : – A developed and freely operating corporate bond market may judge the intrinsic worth of investment demands better in view of the disciplinary role of free market forces; – The corporate bond market could exert a competitive pressure on commercial banks in the matter of lending to private business and thus help improve the efficiency of the capital market as a whole; and – The debt market must emerge as a stable source of finance to business when equity markets are volatile.

Certified Financial Planner

Module 4: Investment Planning

Deposits 1. Bank Deposits: • Bank Savings Accounts: The simplest kind of short term (or cash) investment is a savings account. Returns are low compared to other investments, but returns are guaranteed by the supplier - so your investment won't drop in value in the short term like others might. You can withdraw part or all of your money whenever you want (total liquidity). • Bank fixed term investment : You keep a fixed lumpsum amount of money for a fixed period of time with the bank for a higher rate of interest. Good for short to medium term investment. Returns are high but is not very liquid.

Certified Financial Planner

Module 4: Investment Planning

Deposits 2. Company Fixed Deposits: • Fixed deposits in companies that earn a fixed rate of return over a period of time are called Company Fixed Deposits. Financial institutions and Non-Banking Finance Companies (NBFCs) also accept such deposits. Deposits thus mobilised are governed by the Companies Act under Section 58A. These deposits are unsecured, i.e., if the company defaults, the investor cannot sell the company to recover his capital, thus making them a risky investment option. – NBFCs are small organisations, and have modest fixed and manpower costs. Therefore, they can pass on the benefits to the investor in the form of a higher rate of interest. – NBFCs suffer from a credibility crisis. So be absolutely sure to check the credit rating. AAA rating is the safest.According to latest RBI guidelines, NBFCs and comapnies cannot offer more than 14 per cent interest on public deposits. Certified Financial Planner

Module 4: Investment Planning

Deposits •

Investment Objectives: – A Company/NBFC Fixed Deposit provides for faster appreciation in the principal amount than bank fixed deposits and post-office schemes. However, the increase in the interest rate is essentially due to the fact that it entails more risk as compared to banks and post-office schemes. – Company/NBFC Fixed Deposits are suitable for regular income with the option to receive monthly, quarterly, half-yearly, and annual interest income. Moreover, the interest rates offered are higher than banks. – A Company/NBFC Fixed Deposit provides you with limited protection against inflation, with comparatively higher returns than other assured return options. – You can borrow against a Company/NBFC Fixed Deposit from banks, but it depends on the credit rating of the company you have invested in. Moreover, some NBFCs also offer a loan facility on the deposits you maintain with them. Certified Financial Planner

Module 4: Investment Planning

Deposits •

Investment Objectives: – Company Fixed Deposits are unsecured instruments, i.e., there are no assets backing them up. Therefore, in case the company/NBFC goes under, chances are that you may not get your principal sum back. It depends on the strength of the company and its ability to pay back your deposit at the time of its maturity. While investing in an NBFC, always remember to first check out its credit rating. Also, beware of NBFCs offering ridiculously high rates of interest. – Income is not at all secured. Some NBFCs have known to default on their interest and principal payments. You must check out the liquidity position and its revenue plan before investing in an NBFC.

Certified Financial Planner

Module 4: Investment Planning

Deposits •

Investment Objectives: – If the Company/NBFC goes under, there is no assurance of your principal amount. Moreover, there is no guarantee of your receiving the regular-interval income from the company. Inflation and interest rate movements are one of the major factors affecting the decision to invest in a Company/NBFC Fixed Deposit. Also, you must keep the safety considerations and the company/NBFC's credit rating and credibility in mind before investing in one. – Company/NBFC Fixed Deposits are rated by credit rating agencies like CARE, CRISIL and ICRA. A company rated lower by credit rating agency is likely to offer a higher rate of interest and vice-versa. An AAA rating signifies highest safety, and D or FD means the company is in default.

Certified Financial Planner

Module 4: Investment Planning

Deposits •

Some of the options available are: – Monthly income deposits, where interest is paid every month. – Quarterly income deposits, where interest is paid once every quarter. – Cumulative deposits, where interest is accumulated and paid along with the principal at the time of maturity. – Recurring deposits, similar to the recurring deposits of banks.

Certified Financial Planner

Module 4: Investment Planning

Insurance based investments • •

• • •

Three main characteristics of insurance based investments are Income Protection Capital Appreciation and Tax-deferred Savings. There are two very common kinds of life insurance, these are "Term Life" and "Permanent Life". Term life insurance is usually for a relatively short period of time, whereas a permanent life policy is one that you pay into throughout your entire life. Most life insurance policies carry relatively small risk because insurance companies are usually stable and are heavily regulated by government The advantage is Insurance coverage and low risks. The disadvantage is that your family will not get the full value of the funds in case you live long. Also Cash Value funds can fluctuate, based on market conditions.

Certified Financial Planner

Module 4: Investment Planning

Insurance based investments • •

•

Annuity: These offer- Capital Appreciation, Tax-Deferred Benefits and a safe investment options. A series of fixed-amount payments paid at regular intervals over the specified period of the annuity. Most annuities are purchased through an insurance company. Two types: – Fixed Annuity: the insurance company makes fixed rupee payments to the annuity holder for the term of the contract. This is usually until the annuitant dies. The insurance company guarantees both earnings and principal. – Variable Annuity: at the end of the accumulation stage the insurance company guarantees a minimum payment and the remaining income payments can vary depending on the performance of your annuity investment portfolio.

Certified Financial Planner

Module 4: Investment Planning

Insurance based investments •

Annuities are advantageous because deferred annuities

•

allow all interest, dividends, and capital gains to appreciate tax free until you decide to annuitize (start receiving payments) and the risk of losing your principal is very low, annuities are considered to be very safe. However, fixed annuities are susceptible to inflation risk because there is no adjustment for runaway inflation. Variable annuities that invest in stocks or bonds provide some inflation protection and if you pass away early then you will not get back the full value of your investment

Certified Financial Planner

Module 4: Investment Planning

Insurance based investments •

ULIP’s:

•

Combines insurance protection and a lucrative investment tool. By selecting from amongst our financial funds, you choose your own investment strategy, which you can change during the course of the policy period depending on the status of the individual financial markets. You have the option of drawing on some of your savings and the possibility of depositing additional money in the form of extraordinary premiums. You can choose from our total of six financial funds. In this way you determine the level of risk and potential yields which are most acceptable for you.

•

•

•

Certified Financial Planner

Module 4: Investment Planning

Insurance based investments •

ULIP’s:

•

Some of the Advantages are as follows: – You decide whether you are willing to take risks for the possibility of higher returns or if you want secure returns. – There is unparalleled flexibility with ULIPS. – Transparency in the product. – You are allowed to make partial withdrawals- better liquidity. – The sum assured can be altered as per your needs and requirements.

Certified Financial Planner

Module 4: Investment Planning

Mutual Funds • A mutual fund is nothing but money pooled in by a large group of people that is professionally managed. • A mutual fund manager proceeds to buy a number of stocks from various markets and industries. Depending on the amount you invest, you own a part of the overall fund. The advantages of mutual funds are as follows: – Professional Management & Convenient Administration. Also well regulated. – Diversification and good return potential. – Low costs and liquidity. – Transparency and flexibility. – Tax Benefits. – Wide choice of schemes. Certified Financial Planner

Module 4: Investment Planning

History of Indian Mutual Fund Industry • First Phase- 1964 to 1987 – UTI was setup by the RBI in 1963. – In 1978 UTI was delinked from RBI – First scheme launched by UTI was Unit Scheme 1964. – By the end of 1988, UTI had Rs. 6700 crores of assets under management. • Second Phase- 1987 to 1993 – Market the entry of public sector in the mutual fund market with LIC, GIC and some Public Sector banks setting up mutual funds. – At the end of 1993, the mutual fund industry had assets under management of Rs.47,004 crores. Certified Financial Planner

Module 4: Investment Planning

History of Indian Mutual Fund Industry • Third Phase- 1993 to 2003 – Marked the entry of Private sector in the mutual fund market. – Also, 1993 was the year in which the first Mutual Fund Regulations came into being, under which all mutual funds, except UTI were to be registered and governed. – Kothari Pioneer was the first private sector mutual fund registered in July 1993. – The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996. Certified Financial Planner

Module 4: Investment Planning

History of Indian Mutual Fund Industry • Fourth Phase – Since February 2003 – UTI was bifurcated into two separate entities. – One is the Specified Undertaking of the Unit Trust of India with assets under management of Rs.29,835 crores as at the end of January 2003, representing broadly, the assets of US 64 scheme, assured return and certain other schemes – The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations. – As at the end of September, 2004, there were 29 funds, which manage assets of Rs.153108 crores under 421 schemes. Certified Financial Planner

Module 4: Investment Planning

Growth in assets under management

Certified Financial Planner

Module 4: Investment Planning

Advantages and Disadvantages of Mutual Funds • Advantages – Diversification, professional management and convenience. – Funds offer lower costs by virtue of their size – Spread many internal costs over a large shareholder base, allowing for economies of scale.

Certified Financial Planner

•

Disadvantages – Make tax planning difficult. – May be somewhat difficult to track in terms of what they actually are investing in. – So called non-substantial changes in the way the funds are managed (such as manager switches) may not be disclosed to investors by fund companies in a timely manner.

Module 4: Investment Planning

Equity Shares • Common stock- these share in the ownership of the company. The share holders are entitled to a share in the profits of the company and voting rights. • Profits are paid in the form of dividends. • History has dictated that common stocks average 11-12% per year and outperform just about every other type of security including bonds and preferred shares. Stocks provide potential for capital appreciation, income, and protection again moderate inflation. • Risks associated with stocks can vary widely, and usually depends on the company. Purchasing stock in a well established and profitable company means there is much less risk you'll lose your investment whereas by purchasing a penny stock your risks increase substantially. Certified Financial Planner

Module 4: Investment Planning

Equity Shares • Advantages– Easy to buy and sell – Very easy to locate reliable information on public companies. – There a thousands of companies to choose from. • Disadvantages– Your original investment is not guaranteed. – Your stock is only as good as the company you invest in, if you invest in a poor company, you will suffer from poor stock performance.

Certified Financial Planner

Module 4: Investment Planning

Equity Shares • Shares- By investing in shares in a public company listed on a stock exchange you get the right to share in the future income and value of that company. • Your return can come in two ways: – Dividends paid out of the profits made by the company. – Capital gains made because you're able at some time to sell your shares for more than you paid. Gains may reflect the fact that the company has grown or improved its performance or that the investment community see that it has improved future prospects.

Certified Financial Planner

Module 4: Investment Planning

Direct Investment • You can invest directly in term deposits, bonds, shares and property or you can place your money in a superannuation scheme or managed fund and have full time specialists look after the investment decisions for you. • Direct investment in shares in specific companies or selected rental properties should only be undertaken if you have detailed knowledge or are prepared to pay for specialist advice. • If you want to invest directly in shares or property remember the importance of duration, risk, diversification, returns and liquidity.

Certified Financial Planner

Module 4: Investment Planning

Managed Funds • In a managed fund your money is pooled with other investors, and a professional fund manager invests it in a variety of investments • Managed funds come in many forms - different funds invest in different types of assets for different objectives. Some funds target all-out growth and invest more in high risk shares than others - they could rise dramatically or just as easily drop dramatically. • Other funds look for solid long term growth from a range of deposits, bonds, and shares - a better place for a lump sum intended for your retirement. Financial advisors, banks and insurance companies can all advise you on managed funds that match your investment needs. • Managed funds usually involve paying management and administration fees. These can vary a lot, so check to see what you'd have to pay. Certified Financial Planner

Module 4: Investment Planning

American Depository Receipt • Introduced to the financial markets in 1927, an American Depository Receipt (ADR) is a stock which trades in the United States but represents a specified number of shares in a foreign corporation. • ADRs are bought and sold on American stock markets just like regular stocks, and are issued/sponsored in the U.S. by a bank or brokerage. • The majority of ADRs range in price between $10 and $100 per share • The main objective of ADRs is to save individual investors money by reducing administration costs and avoiding duty on each transaction.

Certified Financial Planner

Module 4: Investment Planning

American Depository Receipt • Analyzing foreign companies involves more than just looking at the fundamentals as there are some different risks to consider such as: – Political Risk - Is the government in the home country of the ADR stable? – Exchange Rate Risk - Is the currency of the home country stable? ADRs track the shares in the home country, therefore if their currency is devalued it trickles down to your ADR and can result be a loss. – Inflationary Risk - This is an extension of the exchange rate risk. Inflation is a big blow to business, the currency of a country with high inflation becomes less and less valuable each day.

Certified Financial Planner

Module 4: Investment Planning

Closed End Investment Fund • An investment fund that issues a fixed number of shares in an actively managed portfolio of securities. • The shares are traded in the market just like a stock, but because closed-end funds represent a portfolio of securities they are very similar to a mutual fund. • Unlike a mutual fund, the market price of the shares are determined by supply and demand and not by net asset value. • Closed end funds are usually specialized in their investment focus • There are also "dual purpose" closed-end funds which simply mean that there are two classes of shareholders: preferred shareholders who receive mainly dividends as income, and common shareholders who profit from the capital appreciation of the funds share price. Certified Financial Planner

Module 4: Investment Planning

Closed End Investment Fund •

•

Advantages are: – funds are easy to buy and sell on financial markets, furthermore they are regulated by the Securities and Exchange Commission. – the funds usually invest in hundreds of companies so offer good diversification in certain areas. – if bought in a tax deferred account closed-end funds are a great investment for long term capital appreciation. Weaknesses are: – fixed interest payments are taxed at the same rate as income. – the price of the closed-end fund is not exclusively linked to the performance of the securities held by the fund. The funds share price depends on supply and demand in the open market.

Certified Financial Planner

Module 4: Investment Planning

Zero Coupon Securities • A zero coupon security, or a "stripped bond" is basically a regular coupon paying bond without the coupons. • The process of "stripping" or "zeroing" a bond is usually done by a brokerage or bank. The bank or broker stripping the bonds then registers and trades these zeros as individual securities. • After the bonds are stripped there are two parts, the principal and the coupons. • The interest payments are known as "coupons", and the final payment at maturity is known as the "residual" since it is what is left over after the coupons are stripped off. • Both coupons and residuals are bundled and referred to as zero coupon bonds or "zeros".

Certified Financial Planner

Module 4: Investment Planning

Zero Coupon Securities • Advantages are: – zero's can be bought at huge discounts – once you buy a zero coupon security you essentially lock-in the yield to maturity. • Weaknesses are: – if the company issuing the zero goes bankrupt or defaults then you have everything to lose. Whereas with a regular coupon bond you may have at least gotten some interest payments out of the investment. – interest earned on the zero coupon bond is taxed as income (a higher rate) rather than a capital gain.

Certified Financial Planner

Module 4: Investment Planning

Convertible Securities • Convertibles, sometimes called CVs, are referring to either a convertible bond or a preferred stock convertible. A convertible bond is a bond which can be converted into the company's common stock. • Convertibles typically offer a lower yield than a regular bond because there is the option to convert the shares into stock and collect the capital gain. • But, should the company go bankrupt, convertibles are ranked the same as regular bonds so you have a better chance of getting some of your money back.

Certified Financial Planner

Module 4: Investment Planning

Convertible Securities •

•

Advantages are: – Your original investment cannot go lower than the market value of the bond, it doesn't matter what the stock price does until you convert into stock. – Convertibles can be purchased through tax-deferred retirement accounts. – CVs gain popularity in times of uncertainty when interest rates are high and stock prices are low. This is the best time to buy a convertible. Disadvantages are: – the return on the bond or preferred stock is usually quite low. – "forced conversion" means that the company can make you convert your bond into stock at virtually anytime, pay very close attention to the price at which the bonds are callable.

Certified Financial Planner

Module 4: Investment Planning

Futures Contract • Futures are contracts on commodities, currencies, and stock market indexes that attempt to predict the value of these securities at some date in the future. • They are a form of very high risk speculation. • A futures contract on a commodity is a commitment to deliver or receive a specific quantity and quality of a commodity during a designated month at a price determined by the futures market. • It is important to know that a very high portion of futures contracts trades never lead to delivery of the underlying asset, most contracts are "closed out" before the delivery date.

Certified Financial Planner

Module 4: Investment Planning

Futures Contract • Strengths: – Futures are extremely useful in reducing unwanted risk. – Futures markets are very active, so liquidating your contracts is usually easy. • Weaknesses: – Futures are considered to be one of the most risky investments in the financial markets, this is for professionals only. – Losing your original investment is very easy in volatile markets. – The extremely high amount of leverage can create enormous capital gains and losses, you must be fully aware of any tax consequences. Certified Financial Planner

Module 4: Investment Planning

Treasuries •

Also known as a Government Security, treasuries are a debt obligation of a local national government. • Because they are backed by the credit and taxing power of a country they are regarded as having little or no risk of default. • This includes short-term treasury bills, medium-term treasury notes and long-term treasury bonds. • One major advantage of treasuries is that they are exempt from state and municipal taxes, this is especially lucrative in states with high income tax rates. • Strengths: – Treasuries are considered to have almost no risk. – This low risk makes it fairly easy to borrow against the bonds. • Weaknesses: – Rates of return are not that great compared to other debt instruments. Certified Financial Planner

Module 4: Investment Planning

The Money Market • The money market is a fixed income market, similar to the bond market. • The major difference is the money market is a securities market dealing in short-term debt and monetary instruments. • Money market instruments are forms of debt that mature in less than one year and are very liquid. • Money market securities trade in very high denominations, giving the individual investor limited access. • The easiest way for retail investors to gain access is through money market mutual funds or a money market bank account. • These accounts and funds pool together the assets of thousands of investors and buy money market securities.

Certified Financial Planner

Module 4: Investment Planning

The Money Market • Money market funds are low risk investments because they invest in short term government treasuries like T-bills and highly regarded corporations. • The one downside with money market funds is that they are not covered by the same federal securities insurance that bank accounts are, although some funds pursue insurance through private companies. • Advantages- gains on money market funds are usually tax exempt as they invest in G- Secs ,any dividends are taxable. Good Low risks investments used as defensive investments when the stock markets are declining. • Disadvantages- offer lower returns than equities/ bonds. Some securities can be very expensive and difficult to purchase. Certified Financial Planner

Module 4: Investment Planning

Options •

•

• •

Options are a privilege sold by one party to another that offers the buyer the right to buy (call) or sell (put) a security at an agreed-upon price during a certain period of time or on a specific date. A call gives the holder the right to buy an asset (usually stocks) at a certain price within a specific period of time. Buyers of calls hope that the stock will increase substantially before the option expires, so that they can then buy and quickly resell the amount of stock specified in the contract, or merely be paid the difference in the stock price, when they go to exercise the option. A put gives the holder the right to sell an asset (usually stocks) at a certain price within a specific period of time Buyers of puts are betting that the price of the stock will fall before the option expires, thus enabling them to sell it at a price higher than its current market value and reap an instant profit.

Certified Financial Planner

Module 4: Investment Planning

Options • Speculators simply buy an option because they think the stock will either go up or down over the next little while. Hedgers use options strategies such as a "covered call" that allows them to reduce their risk and essentially lock-in the current market price of a security. Using options (and futures) is popular with institutional investors because it allows them to control the amount of risk they are exposed to. • Advantages- Allows you to drastically increase your leverage in stock. Options in shares will actually cost you lesser than purchasing shares. Can be used as a useful hedging tool. • Disadvantages- Highly complex, requires a close watch, high risk tolerance and in- depth information of the stock market. You may lose a lot of money Certified Financial Planner

Module 4: Investment Planning

Preferred Stock • Represents ownership in a company but usually don’t have voting rights. • Usually get a fixed dividend, throughout and enjoy better position in case of liquidation of the company. • Preferred stock may also be callable, meaning that the company has the option to purchase the shares from shareholders at anytime, and usually for a premium. • The major objective of a preferred stock is to provide a much higher dividend. These are not as volatile or risky as common stock. • Advantages- Higher dividend, lesser risk, better benefits in case of liquidation. • Disadvantages- Higher dividend means higher taxes. Also the returns offered are the same as corporate bonds, which are less risky. Certified Financial Planner

Module 4: Investment Planning

Derivatives • These are financial instruments that “derive” their value from the underlying, which can be a commodity, a stock or stock index or even a complex parameter like the interest rate. • It has no independent value. • Include forwards, futures or option contract of predetermined fixed duration, linked for the purpose of contract fulfillment to the value of specified contracts underlying. • Derivative markets can be classified into commodity and financial derivative markets, which each have various subbranches.

Certified Financial Planner

Module 4: Investment Planning

Derivatives

Futures• “Forwards” trading in commodities emerged the commodity “Futures”. • The development of futures trading is an advancement over forward trading • Futures trading represent a more efficient way of hedging risk. • A Futures contract just like a forward agreement to buy or sell an asset at a certain future time for a certain price. However, unlike a Forward, Futures are traded on the exchange. Certified Financial Planner

Module 4: Investment Planning

Forwards V/S Futures Feature

Forward contracts

Futures contracts

Operational mechanism

Traded directly between two parties and not the exchanges

Traded on the exchange

Contract specifications

Differ from trade to trade.

Standardised

Flexibility

Flexibility to structure the contract price, quantity, quality (in case of commodities), delivery time and place of delivery

Counter-party risk

Exists

Assumed by the clearing house, which becomes the counter-party to all the trades or unconditionally guarantees their settlement.

Liquidity

Low, as contracts are tailor made contracts.

High, as contracts are standardized exchange traded contracts.

Price discovery

Low liquidity hampers price discovery

High liquidity enables price discovery

Examples

Currency market in India

Index, Stock and Commodity Futures

Certified Financial Planner

Module 4: Investment Planning

Terminologies • Spot price: The price at which an asset trades in the cash market. • Futures price: The price at which the futures contract trades in the futures market. • Contract maturity: The period over which a contract trades. The maturity is 1, 2, 3 months in India. • Expiry date: The last trading day of the contract. • Contract size: The notional value of the contract worked out as Futures Price multiplied by the volume of units. • Basis: Spot Price - Futures Price. Basis should theoretically be negative. • Cost of carry: Though the term originated from Commodity Futures for financial futures it reflects the relationship between futures and spot. It can be summarized in terms of an interest cost the futures buyer is paying over the spot price today. • Initial margin: Upfront amount that must be deposited in the margin account prior to trading. • Marking-to-market: The process of Revaluing each investor's positions generally at the end of each trading day and computing the profit or loss on the positions accordingly. Certified Financial Planner

• Forwards: A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price. • Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts which are standardized exchange-traded contracts. • Options: Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. • Warrants: Options generally have life of upto one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. • LEAPS: The acronym LEAPS means Long Term Equity Anticipation Securities. These are options having a maturity of upto three years. LEAPS are not currently available in India. Module 4: Investment Planning

Terminologies • Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options. • Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. Currency swaps: These entail swapping both principal and interest between the parties with the cashflows in one direction being in a different currency than those in the opposite direction. • Swaption: Swaption are options to buy or sell a swap that will become operative at the expiry of the options. Thus a Swaption is an option on a forward swap. Rather than have calls and puts, the Swaption market has receiver Swaption and payer Swaption. A receiver Swaption is an option to receive fixed and pay floating interest. A payer Swaption is an option to pay fixed and receives floating interest..

Certified Financial Planner

Module 4: Investment Planning

Option • Option is a security that represents the right, but not the obligation, to buy or sell a specified amount of an underlying security (stock, bond, futures contract, etc.) at a specified price within a specified time. • Option Holder is the buyer of either a call or put option. Option Writer is the seller of either a call or put option. • Options unlike futures are also concerned with speed of the trend and not just the underlying trend. They are more complex. • Directional strategies can be implemented using Options • Options can be categorized as call and put options. The option, which gives the buyer a right to buy the underlying asset, is called Call option and the option, which gives the buyer a right to sell the underlying asset, is called Put option. Certified Financial Planner

Module 4: Investment Planning

Four Basic Positions •

Calls: A call represents the right, but not the obligation, to buy an underlying instrument at a fixed price (E), within a fixed period of time (T). A simple way to understand options is to observe the cash flows for the option considered i.e. what is an inflow and what's an outflow. Now in the following case, a long call option, strike and premium is what goes out (a cash outflow) and spot price i.e. the price of the underlying comes in (a cash inflow).

For the Buyer (Long) Risk

Limited to premium (P) paid

Reward

Unlimited

Breakeven Price

Exercise price (E) + Premium (P)

Profit or Loss (P/L) at expiration

Intrinsic Value (I) - Premium (P)

Intrinsic Value

Spot price (S) - Exercise price (E)

Certified Financial Planner

Long Call Module 4: Investment Planning

Four Basic Positions For the Seller (Short)

Risk

Limited by zero to Ex. price (E) - Premium (P)

Reward

Limited to the premium (P) received

Breakeven Price

Exercise price (E) - Premium (P)

Profit or Loss (P/L0 at expiration

Premium (P) - Intrinsic Value (I)

Certified Financial Planner

Short Call

Module 4: Investment Planning

Four Basic Positions For the Buyer (Long) Risk

Limited to premium (P) Paid

Reward

Limited by zero to Ex. price (E) - Premium (P)

Breakeven Price

Exercise price (E) Premium (P)

Profit or Loss (P/L0 at expiration

Certified Financial Planner

Intrinsic Value (I) Premium (P)

Long Put

Module 4: Investment Planning

Four Basic Positions For the Seller (Short)

Risk

Limited by zero to Ex. price (E) - Premium (P)

Reward

Limited to premium (P) received

Breakeven Price

Exercise price (E) Premium (P)

Profit or Loss (P/L0 at expiration

Premium (P) - Intrinsic Value (I)

Certified Financial Planner

Short Call

Module 4: Investment Planning

Options Options Options are deferred settlement contracts Settlement i.e. delivery and payment takes place in the future Give the buyer the right and no obligation Give the seller the obligation and no right To buy or sell (call or put options). A specific asset (called underlying and outrightly defined). At a specific price (strike or exercise price). On/on or before a specific date (European/American options).

Certified Financial Planner

Module 4: Investment Planning

Components of Option Value Options Premium = Intrinsic value + Time Value •

Intrinsic value is the value which you can get back if you exercise the option.. – For calls, it is stock price – exercise price. – For puts, it is exercise price – stock price.

•

Time Value = The price (premium) of an option less its intrinsic value. Time value is made up of two components: insurance value and interest value.

•

Insurance value is the premium component of time value based on the probability of the underlying reaching the exercise price. Interest value is the interest component of time value based on the carrying cost of the underlying. Interest value can be positive (calls) or negative (puts). Option premium (price) = Intrinsic value + Time value = Intrinsic value + (Insurance value + Interest Value) Certified Financial Planner

Module 4: Investment Planning

Intrinsic value versus time value for a call option

Certified Financial Planner

Module 4: Investment Planning

Key Features •

Call option Key features: A call option has intrinsic value when its exercise price is below the underlying security price. In other words, a call option with intrinsic value gives the holder the right to buy the underlying security at a price below the current market level. Call intrinsic value = Underlying security price – Exercise price The higher the price of the underlying security in relation to the exercise price, the greater the option’s intrinsic value and therefore the value of the option.

•

Put option Key features: A put option will have intrinsic value when its exercise price is above the current market price of the underlying security. This gives the holder the right to sell the underlying security above the current market level. Put intrinsic value = Exercise price – Underlying security price Intrinsic value is also the amount that an option is in-the-money. An option with no intrinsic value is out-of-the-money. The intrinsic value of an option is always a positive figure. Certified Financial Planner

Module 4: Investment Planning

Market Scenario

Call Option

Put Option

Market price > Strike price

in-the-money

out-of-the-money

Market price < Strike price

out-of-themoney

in-the-money

Market price = Strike price

at-the-money

at-the-money

Market price ~ Strike price

near-the-money

near-the-money

Certified Financial Planner

Module 4: Investment Planning

Real Estate • Real estate investing doesn't just mean purchasing a house, it can include vacation homes, commercial properties, land (both developed and undeveloped), condominiums, along with many other possibilities. • The value of the real estate is arrived at by considering a number of factors, such as the location, the age and condition of the home, improvements that have been made, recent sales in the neighbourhood, if there are any zoning plans and so on. • Holding real estate involves significant risks- property taxes, maintenance, repairs among other costs of holding the asset. • These are usually purchased via brokers, who get a percentage of the amount. It can also be purchased directly.

Certified Financial Planner

Module 4: Investment Planning

Other Investments •

•

•

Collectibles: is a general name for any physical asset that appreciates in value over time because it is rare or is desirability by many. Some examples are things like stamps, coins, art, or sports cards but there are no strict boundaries as to what a collectible is. Investment in collectibles provides capital appreciation to investors with medium to long term investment horizon. It can also be an efficient hedge against inflation and also gives a sense of self fulfillment. Investment objectives can vary depending on the person and the collectible. Major Weaknesses: – Not very liquid, they can often be hard to sell at a desirable price. – They do not provide any tax protection. – Collectibles do not offer any income to the investor. – The true value can often be difficult to determine. – Because there are so many uncertainties don't count on any collectible for your retirement.

Certified Financial Planner

Module 4: Investment Planning

Other Investments •

• •

Bullion & Precious Metals: Bullion is a coin or other object composed primarily of a precious metal (such as gold, silver or platinum) with little to no numismatic value over and beyond that of the metal itself. Gold, silver and the platinum group metals are known as the precious metals. The volatility of equity markets and the arrival of low interest rates have increased the investor presence in alternative investments such as gold and other precious metals. The reasons for investing in bullion and precious metals have remained much the same over its long history. – Gold is a safe haven in times of economic and financial instability – An excellent hedge against inflation over the long term. – They have solid value – Excellent investments to diversify your investment portfolio – They are recognized in every country. – It is easily and discreetly bought and sold. It can be easily converted to cash at any time.

Certified Financial Planner

Module 4: Investment Planning

Investment Strategies • Active Investment: – An investment strategy involving ongoing buying and selling actions of the investor. Active investors will purchase investments and continuously monitor their activity in order to exploit profitable conditions. – Active investing is highly involved. • Passive Investment: – An investment strategy involving limited ongoing buying and selling actions. – Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. – Also known as a buy-and-hold or couch potato strategy, passive investing requires good initial research, patience, and a well diversified portfolio. Certified Financial Planner

Module 4: Investment Planning

Advantages and disadvantages Active Management • •

• •

Advantages Expert analysis — seasoned money managers make informed decisions based on experience, judgment, and prevailing market trends. Possibility of higher-than-index returns — Managers aim to beat the performance of the index. Defensive measures — Managers can make changes if they believe the market may take a downturn.

Certified Financial Planner

• • •

•

Disadvantages Higher fees and operating expenses. Mistakes may happen — there is always the risk that managers may make unwise choices on behalf of investors, which could reduce returns. Style issues may interfere with performance — at any given time, a manager's style may be in or out of favor with the market, which could reduce returns.

Module 4: Investment Planning

Advantages and disadvantages Passive Management •

•

Low operating expenses: The costs are greatly lesser in this form of management. No action required — There is no decision-making required by the manager or the investor.

Certified Financial Planner

•

•

Performance dictated by index — Investors must be satisfied with market returns because that is the best any index fund can do. Lack of control — Managers cannot take action. Index fund managers are usually prohibited from using defensive measures, such as moving out of stocks, if the manager thinks stock prices are going to decline.

Module 4: Investment Planning

Tactical Allocation • Tactical allocation among specific types of stocks (such as small or large, value or growth, foreign or domestic) and bonds (such as long or short, high-quality or low-quality) can be handled in one of two ways: – Investors retain the tactical asset allocation decision and actively manage the exposure to various categories. Most investors fall in this category whether they manage allocations in a disciplined, predetermined fashion or simply let it fall where it may, as a residual of other decisions. – The investor ignores tactical allocation by selecting a neutrally weighted portfolio that reflects the entire available investment universe. Few investors select this truly passive asset allocation strategy. Given factors such as homeland bias, investors tend to over-emphasize areas closer to home, consistently under-weighting foreign securities. • Only after both the strategic stock/bond allocation and the handling of the tactical allocation are decided upon, can we begin examining the merits and pitfalls of passive versus active investment selection strategies.

Certified Financial Planner

Module 4: Investment Planning

Tactical Allocation • With the context of comprehensive planning, understanding the main drivers of portfolio returns is a major step in properly implementing an investment strategy. • In order of their influence on results, these drivers are: – Strategic asset allocation investment policy between growth and fixed-income investments. This allocation should be based on each client’s unique objectives and risk tolerance. The policy allocation should be the foundation block of any long-term investment strategy. – Actively managed tactical allocation versus a market neutral, static allocation. Significant value can be added (or detracted) by concentrating the portfolio in certain asset categories. – Selection of investments for each asset category may add (or detract) an additional layer of value.

Certified Financial Planner

Module 4: Investment Planning

Advantages and Disadvantages • • •

•

•

Investment selection—passive strategies. Passive investing presents some obvious advantages that are often publicized by indexing supporters. Low cost—offers an incremental advantage that is both meaningful and certain. An active manager has to add enough value to overcome the cost disadvantage. Reduced uncertainty of decision errors—investors are exposed to market risk simply by being invested. Reaching for returns in excess of those provided by the market brings about the additional risk of selecting the wrong investments. Style consistency—if the appropriate indexes are selected, indexing, at least in theory, allows investors to control their overall allocation. Investors could only do this effectively through successful tactical allocation. There are no guarantees they will succeed. Tax efficiency—indexing is generally regarded as more tax efficient, though it is mostly the case for larger-cap indexes that are fairly stable and involve less trading. In smaller-cap indexes, where successful stocks grow in size and leave the index, tax liabilities resulting from more frequent rebalancings quickly accumulate.

Certified Financial Planner

Module 4: Investment Planning

Advantages and Disadvantages •

•

•

•

Investment selection—active strategies. The efficient market theory in its purest form strongly supports passive investing, as it dismisses the possibility for superior returns through investment selection. In reality, there are multiple market “anomalies” that do not support the efficient market theory, at least not in its purest form. Deeply rooted psychological biases negate the assumptions that all investors will act rationally. Passive strategies are also subject to certain natural biases, which may open the door to superior returns by active strategies. Natural biases: Large cap bias—Most indexes are market capitalization weighted. The largest holdings account for most of the return, causing indexes to out-perform active managers when large stocks do well, but under-perform when smaller companies are in favor. Historically, small companies have produced better returns than large ones. Large market bias—The weighted nature of indexes also causes passive investors to maintain most investments in the largest markets. The largest markets are not necessarily the best performing. The overemphasis on Japan in the EAFE index, for example, allowed most active international managers to out-perform that index for years.

Certified Financial Planner

Module 4: Investment Planning

Advantages and Disadvantages •

•

•

Investment restrictions bias—many large institutions are restricted by charter as to the types of securities they are allowed to purchase. Banks and insurance companies, for example, have many investment restrictions in building their bond portfolios. Such restrictions decrease market efficiency and leave openings to be exploited by opportunistic, skillful bond managers. Psychological biases: Cause and effect mismatches—Mistaking cause for effect could explain why investors tend to overbuy stocks with impressive earnings history, or with high past returns. Many investors assume that past results are representative of future results. In reality, past results are representative of past events and will not necessarily repeat in the future. Excessive buying of stocks with high past returns leads to over-valuation. Active managers that are aware of this bias could benefit by avoiding many over-valued situations. Conservatism bias—Once people have formed an opinion, it is difficult to change it. The stocks of companies posting either positive or negative earning surprises tend to slowly reflect new information. Investors are initially unwilling to accept the new evidence of improved or diminished prospects. Active managers that recognize this fact could obtain superior returns by more quickly recognizing the new economic realities of the companies they research.

Certified Financial Planner

Module 4: Investment Planning

Advantages and Disadvantages •

•

• •

Ironically, the very success of indexing is based on the research work performed by active managers. The information disseminated through research by active managers leads to market efficiency. In a sense, passive investors are “free riders,” benefiting at no cost from the work of all active managers. But the more investors select indexing, the less efficient the markets become due to decreased research coverage. Opportunistic, active managers could exploit increased inefficiencies and deliver market-beating returns. As a result, more investors would migrate to active styles in search of better returns. Research coverage, in turn, would increase, also increasing the efficiency of markets, therefore the relative attractiveness of passive management. Passive management could not exist without active managers keeping the markets efficient. This apparent paradox serves as a natural “checks and balances” system in the markets. Unbiased investment advisors who correctly identify the advantages and disadvantages of both passive and active strategies can help their clients create investment portfolios that allow for the benefits of both worlds.

Certified Financial Planner

Module 4: Investment Planning

What makes a good index? • An index should accurately represent the universe of investment choices as well as the performance of the asset category it represents • An index should be investable • An index should be truly passive and objective

Certified Financial Planner

Module 4: Investment Planning

How to select an active investment manager? •

•

One can expect consistently poor-performing managers to continue to perform poorly. The same cannot be said about managers who have demonstrated superior returns. These managers may not necessarily continue to do well, no matter how much most investors want to believe it. Let’s examine some of the reasons why previously successful managers may not repeat their index-topping performance in the future: – Success leads to asset growth, lower flexibility, and reduced investment alternatives. – Success may lead to lack of focus (marketable star managers may be used to launch new products or simply in other non-investing capacities). – Star managers may be lured away with higher pay by other firms. – Star managers may quit to start their own firms, or simply lose interest and motivation. – Success could lead to overconfidence, sloppiness, and downplaying risks. – Buyout of successful firms could lead to a multitude of integration problems. Certified Financial Planner

Module 4: Investment Planning

Attributes of Successful managers • • •

• • • •

Disciplined and research-oriented, providing a clearly articulated process Low expenses—show commitment to higher returns to investors A true passion for investing rather than a passion for empire building—shareholder interests should come ahead of the management company’s interest Close-knit investment teams—people who like each other tend to achieve better results as a team and are less likely to split Consistency between the advertised investment process and the reality of operations Interests of the managers are aligned with the interests of the shareholders through incentive systems Unique investment edge: a successful proprietary valuation model, specific knowledge in any one area, quicker access to information, and so on

Certified Financial Planner

Module 4: Investment Planning

Asset Allocation •

Apportioning of investment funds among a broad array of asset classes such as stocks and bonds. Its objective is to determine an asset mix which is most likely to meet the investment goals of a client with the acceptable risk appetite of the client. • The asset allocation process may comprise following steps: – Analysis of the client’s investment objective & risk tolerance – Analysis of expected returns from various asset classes and risk-return trade-off – Determination of the asset classes to be included in the portfolio – Determination of proportionate weighting of each asset class • Asset categories typically include: equity, fixed income securities, money market instruments, real estate, precious metals and other assets Certified Financial Planner

Module 4: Investment Planning

Factors to be considered for asset allocation •

The economic environment, market valuations and sentiment indicators: – A study of the economic environment helps to find out which stage we are in the business cycle. – Managers need to examine recent returns versus historical experience, price-to earnings ratios, dividend yields, price cash flow ratios, real interest rates and so on, to determine if an asset category is over- or undervalued. – Next, “sentiment” indicators are used to identify the consensus view and provide useful insight into the psychology of the markets. – The goal here is to determine where capital flows might head next.

Certified Financial Planner

Module 4: Investment Planning

Factors to be considered for asset allocation •

Expectations and client objectives: – Income needs. – Growth requirements – Inflation and purchasing power – Risk tolerance. – Investment time horizon – Liquidity requirement – Tax situation – Legal issues, unique needs and preferences

Certified Financial Planner

Module 4: Investment Planning

Steps in construction of preliminary portfolio mix 1. Deciding which asset classes to include and which to exclude from the portfolio. 2. Deciding on the normal (long-term) percentages of commitment to be represented by each asset class allowed in the portfolio. This is based on the investor’s objectives, constraints and risk tolerance. 3. Altering the asset mix weightings away from the initial parameters in an attempt to capture excess returns caused by short-term fluctuations in asset prices (known as market timing). 4. Selecting individual securities within an asset class to achieve superior returns relative to that class (security selection). Certified Financial Planner

Module 4: Investment Planning

Portfolio Rebalancing • Portfolio rebalancing involves periodically readjusting the portfolio (mix of assets) to match the original allocation of different assets or asset classes following a significant change in one or more. • More simply stated, it is returning your portfolio to the proper mix of stocks, bonds and cash when they no longer conform to your original or target plan.

Certified Financial Planner

Module 4: Investment Planning

Say you have determined that given your risk tolerance, time horizon and financial goals that your portfolio should look like this: Stocks 60% Bonds 35% Cash 5% Total 100%

Rs60,000 Rs35,000 Rs5,000 Rs100,000

A couple of your stocks have done well in the market and your portfolio looks like this: Stocks 66% Bonds 29% Cash 4% Total 100%

Rs 80,000 Rs 35,000 Rs 5,000 Rs120,000

Your portfolio is up by Rs20, 000 This is where the conservative investor will step in and bring the portfolio back to the original allocation. This can be done in a number of ways. Certified Financial Planner

Module 4: Investment Planning

How to bring the portfolio back to the original allocations • First, you could sell off some of the stock that had the recent run up and invest the profits in bonds and cash until the original percentages are achieved. • Another alternative would be to look at your other stock holdings and sell any underperformers to generate the cash to invest in the other two asset classes. • The third alternative would be to invest new money into your portfolio in the bonds and cash portion to bring those percentages up to proper levels. • As a rule of thumb, when your assets drift 5% or more away from your allocation, you should re-balance. This can occur naturally over time or following an abrupt rise or decline in one or more asset classes. Certified Financial Planner

Module 4: Investment Planning

What happens if you do nothing? • If you are risk adverse, a portfolio that becomes more heavily weighted in volatile stocks will keep you up at night. • Consider what happened to many investors during the tech stock boom of the late 1990s. Not only did they let the technology stocks grow out of any reasonable allocation, many also sold off other stock to buy more technology companies. • When the market crashed, the investors who had let technology balloon to a hugely disproportionate percentage of their portfolio had nothing to fall back on. • Portfolio rebalancing is an important part of sticking to your game plan. You should look at your portfolio at least quarterly in terms of rebalancing and more frequently if you have had a significant gain or loss in any asset class. Certified Financial Planner

Module 4: Investment Planning

Thank you!

Certified Financial Planner

Module 4: Investment Planning