The Diversification Hot Seat

The machinery of a bull run has started working again. While the pundits are talking about the extent of the recovery and the monsoon recovery and the flows and the whatnot, the punter can feel it in his bones. Every day, the brokers' boys (relationship managers, in modern language) call armed with the results of their 'research', and almost miraculously, they are right. They say a stock will move and it does move. It's almost like the good old days of 2006 and 2007 once more.

However, there's always an however. Last time around, when things started to go wrong, first in mid-2007 and then later in January, 2008, these momentum stocks were the ones that caused the deepest grief to investors. The reason is very simple. Selecting investments in this fashion invariably results in a portfolio that's composed largely of mid- and small-cap momentum stocks. These are the only type of stocks that can produce large movements quickly enough to satisfy the expectations of gains that come with the trading mindset. Not just that, such portfolios are typically also concentrated in whatever is the hot sector of the moment. Last year, more traders' were trapped into huge losses in the real estate counters than any other.

Now that we're seeing the beginning of another heady phase, there is a danger that along with the hot gains, we'll also get the same set of problems. The solution is also simple - while it's great to make money in the hot stocks, the basics of portfolio construction cannot be forgotten. And it goes without saying that the most important principle of portfolio construction is that of diversification. Diversification across companies, across sectors and across capitalisation. While an individual investor should not be expected to get into the portfolio construction theories, some basic rules of thumb should be followed.

Here are my suggested thumb rules to ensure that at least a minimum discipline is maintained:

* Own at least 10 stocks. The largest holding should be at most 15-20 per cent and the smallest no less than 5 per cent of the total;

* Own stocks in at least 3 distinct sectors, with no single sector taking up more than half of your portfolio;

* Do not have exposure only to smaller companies. Make sure that at least around half of your equity exposure is to BSE 100 companies. Alternatively, you could keep about that much of your equity exposure in a good diversified equity mutual fund that is focused on large-cap stocks.

Make sure you maintain the above rules dynamically. When changes in stock prices can take you beyond these limits, you must rebalance your portfolio to come back within the limits or it's of no use.

Psychologically, it won't be easy to stick to these rules. Without a doubt, following these rules will reduce your gains during the hot periods of the markets, the same as staying within the speed limit takes the fun out of driving a fast car on an open road. However, the purpose is the same - when there's a crash, there will be a lot less damage.

When there's trouble in the markets, following these rules will ensure that you lose less and your overall gains are actually higher.

Source: valueresearchonline.com

How to choose the right insurance policy

With the increasingly uncertain times, what with terrorist attacks and tumultuous financial markets, getting an insurance cover for you and your family has become imperative. However, many of us do not take decisions because of it being such a big ball of wax.

Choosing the right kind of insurance cover not only determines the care that we receive should our health take a wrong turn, but it can be the wild card in your financial plan.

There are many benefits of an insurance cover; however, topping the list of benefits is the financial support that a family gets in the event of the untimely death of the income provider. As getting the insurance cover is an important aspect of a sound financial future, choosing the right insurance cover is equally important.

First and foremost, choosing an insurance policy must be based on your current and projected income or simply put your current and projected ability to pay the insurance premiums, your medical state, your age, future financial plans, etc.

Secondly, you also need to look at:

Cost-Benefit Ratio

The cost of the insurance cover depends upon many reasons, some mentioned above and other factors depending on what is covered in the cover or its riders. Thus, you have to keep a close eye on the cost of buying insurance and ensure that it justifies the benefits covered under the policy. Simply put, a right balance must be struck between the cost and benefits available.

Cover

You need to ensure that the insurance covers all your dependants and that it also covers the majority of health problems.

Thirdly, the promises made by different insurance companies are all fine; however, it depends on you whether you need a pure insurance cover or you need an insurance cover coupled with an investment opportunity. The four major kinds of insurances that most people opt from are:

Term Insurance: Term life insurance or term assurance is life insurance which provides coverage for a limited period of time.

Endowment Policy: An endowment policy is a life insurance contract designed to pay a lump sum after a specified term (on its 'maturity') or on earlier death.

ULIPs: Unit Linked Insurance Plan (ULIP) provides for life insurance where the policy value at any time varies according to the value of the underlying assets at the time.

Money-back Policy: Unlike ordinary endowment insurance plans where the survival benefits are payable only at the end of the endowment period, money back policies provide for periodic payments of partial survival benefits during the term of the policy.

When comparing between these plans it is important that you keep in mind the factors that were talked about in the first point. Let's take a look at an example:

Arun is a 25 year old businessman who wishes to take an insurance cover for Rs. 20 lakh for a period of 20 years. There are two options he can choose from.

Option 1 - He can opt for an endowment/money-back policy and pay a premium of Rs 90,000 annually. If he survives through the policy term, he shall be eligible to receive the entire sum assured and vested bonuses, if the same are declared by the insurance company.

Option 2 - He pays Rs 4,000 annually and enjoys the risk cover of Rs 20 lakh. Being a term insurance cover, he is not eligible to gain any survival benefit from the insurance company and the insurance premium paid can thus be treated as the cost of covering his life for 20 years.

Whereas under Option 1, he has earned an annualized return of about 6%; Option 2 gives him about 9% returns during the period. Therefore, it is important for Arun to decide what he wants and opt for a plan accordingly.

It's important to correctly identify your dependants' financial needs to establish just how much life insurance cover to arrange. A general rule is to choose a policy providing at least ten times your salary, but more may be appropriate, with the amount varying depending on how you intend it to be used. Basically you decide how much you want your dependants to receive in the event of your death, and your premiums will be determined accordingly.

Hence, make sure you keep all these factors in mind, compare different plans and choose your cover accordingly.

Courtesy: bankbazaar.com

Options in paying life insurance premiums

Who can predict where your life will take you, or how it will end?

While the question might seem somewhat morbid, you do need to consider the practical aspect of the welfare of your near and dear ones, and ensure their wellbeing, at least monetarily, in the event of your retirement, and eventually, your death.

If you've settled on the type of insurance to buy, then paying out the premium on your insurance policy needs to be factored in to your planning.

There are a number of ways in which you can make this payment.

While cash seems the easiest and most direct way to pay your premium, be aware that there are legal issues surrounding the amount of cash that your insurance agent is actually authorised to handle.

The limit for cash acceptance is Rs 50,000, to control fraudulent activities such as money laundering, so if your policy is for Rs 5 lakh and the yearly payment is Rs 60,000 over 5 years, then seek alternative means to cover the premium, either by cheque or draft.

This might lead you to review the type of policy you choose. Either choose a policy within the cash investment limit of Rs 50,000, or opt for different policies from different insurance companies so the total limit in either of the companies does not exceed Rs 50,000.

The best way to get adequate cover for your family is via a term life-without return of premiums type of policy. This is a pure risk cover without any investment option.

Review the level of cover each year. Then apply a simple formula to find out if you need more insurance or not.

If your investments are equal to or greater than the value of insurance required, you do not need to continue your insurance cover.

In single premium policies, the policyholder pays the premium just once and enjoys its benefits throughout the policy term. Earlier, single premium policies were more of an investment product, offering large returns on an assured basis.

Often there was little in terms of insurance coverage. But because that goes against a purpose of an insurance policy, which is primarily to offer coverage, conditions have evolved for these policies over a period of time. These conditions make single premium policies beneficial only to some people and not all.

A single-premium policy requires a much higher payment compared with products that require paying smaller premiums spread across several years.

But market studies show that investors are shying away from buying life cover that requires long-term financial commitment, opting instead for those that require paying premium just once.

The other ways in which you can pay your premium is on a Yearly, Half yearly, Quarterly or Monthly basis, depending on the plan that you opt for.

Remember that the type and amount of premium you pay is a direct result of the type of policy you choose, so choose very carefully. For example, with term life insurance, the premium on such type of policies is comparatively quite low when compared with other types of life insurance policies, mainly due to the fact that these policies do not carry a cash value.

With whole life policies, the premiums are usually made annually, and are fixed and known, giving you enough rope to accumulate the necessary amount to pay towards the policy.

As important as it is to buy life insurance, it is even more important to pay your premiums on time.

Courtesy: BankBazaar.com

Read the fact sheet before opting for mutual fund

The mutual fund industry thrives on transparency and disclosures. Most fund houses come out with a fund fact sheet for each scheme every month. They provide information about the investment particulars of the corpus (company and sector wise), credit ratings, market value of investments, NAVs, returns, repurchase and sale price of the schemes.

The effort is to help an existing and potential investor take an informed decision to invest, stay invested or redeem out of the fund. It is an important piece of document as it communicates the fund house’s philosophy and past performance. It is also used by distributors as a marketing tool.

Here are some important points that an investor should look at in a fund’s fact sheet:

INVESTMENT OBJECTIVE

It explains what the fund intends to do. Each category of funds is backed by an investment philosophy, which is pre-defined in the objectives of the fund. An investor can align his/her investment needs with the funds objective and invest accordingly.

Based on the investment objectives, various schemes can be broadly classified as follows:

Equity/growth schemes: These aim to provide capital appreciation over a medium to long term. In these schemes a majority of the portfolio is invested into equities.

Income/debt schemes: These aim to provide regular and steady income by investing into fixed-income instruments such as corporate and government bonds, debentures and other debt securities.

Balanced schemes: These aim to provide both growth and income. They invest in equities and fixed income securities, in a proportion which is pre-defined in the investment objective of the scheme.

Liquid funds/schemes: These aim to provide capital preservation and easy liquidity. They invest in relatively safer instruments such as inter-bank call money, T-bills, certificate of deposits and commercial papers.

PORTFOLIO & PERFORMANCE

The equity/balanced fund’s portfolio diversification can be explained under two parts:

Top 10 stocks: The percentage of the top 10 holdings accounts for of the net assets of a fund can reveal whether the fund is well-diversified or is a concentrated one. A concentrated portfolio has the potential to generate higher returns but at the same time is more volatile as compared to others. The consistency in the top stock holdings can also reveal a lot about the fund’s management style.

Sector allocation: A diversified equity fund is expected to invest across various sectors. A concentrated portfolio across a few sectors enhances the fund’s risk profile and makes it prone to volatility. Funds at times tend to have higher allocations towards a single sector.

While the same could be indicative of the fund manager’s confidence in stocks from a given sector, it also makes the fund an over-leveraged one. Income/debt schemes and liquid schemes normally invest in debt instruments of government, banks, financial institutions and corporates carrying different ratings and maturity profiles.

The portfolio is constructed depending on the risk return profile as well as the liquidity needs of the portfolio in compliance with the scheme objective.

The fact sheet contains returns of funds vis-ीं-vis the respective benchmark across various time frames. The hallmark of a good fund is in its ability to deliver superior performance year after year.

The objective of any active investment strategy is to outperform the benchmark, and this extra return is what is called as the fund managerङs alpha. It is therefore important to identify funds with a track record of beating the benchmark. Thus, an investor should ensure consistency in returns over different periods of time before investing.

EXPENSE RATIO

AMCs usually disclose the expense ratios and load structure in the fact sheets. The load and the expense ratios affect the fund’s performance. Higher expenses charged to a scheme can alter the scheme’s performance. The impact is more in case of debt funds as here the payback is less than for equity funds.

However, investors should understand that although loads and expense ratios have a direct impact on the returns, they cannot be used as the sole criterion for evaluating a fund. The fund’s investment style and performance are far key parameters than load and expenses while evaluating a fund.

PERFORMANCE EVALUATION PERIOD

This is one of the key aspects of a fund’s performance evaluation. Each type of a scheme has different investment objective and time horizon of investment for risk-adjusted return expectation.

A liquid fund’s performance should be evaluated over a short period (say for 3-6 months) and an income fund’s performance should be evaluated over 6-18 months whereas an equity/balanced fund should be evaluated over medium to long term (2-5 years). Such an evaluation is necessary to get an appropriate perspective of the fund’s performance profile and help investor to take right decision.

Source: economictimes.com

Mistakes you must avoid while investing

Investing is like reality gameshows such as Kaun Banega Crorepati and Dus Ka Dam. You continue answering right and the winning amount keeps growing but make a single mistake and you lose substantially.

While it might not be possible to be always right while investing in the stock market, one must avoid making common mistakes. SundayET lists some mistakes that one can and must avoid while investing.

There’s a common belief that a share with lower price is cheaper and can multiply faster. However, one forgets that the price in rupee terms is not the right criteria to decide which stock is cheaper.

According to Kishor P Ostwal, CMD at CNI Research, this is the psychology of small investors and also one of the reasons why they may not be able to buy stocks in lots of a company whose share price is high. However, one should look at price to earning (PE) ratio and other fundamental factors to judge.It is usually seen that companies with relatively low share price are less traded and hence less liquid. Even the BSE 100 companies show a similar trend.

For instance, 50 companies with lower share price had a trading volume of Rs 1,468 cr, whereas, the other 50 companies with higher share price enjoyed a trading volume of Rs 1,849 cr on September 2. In fact, a similar trend has been observed in the last one month. Hence, one may face difficulties in selling very low priced stocks.

Many investors also get attracted towards stocks that have been witnessing a price rise, thinking that the rally will continue. However, by following this strategy investors end up buying shares at a very high price or end up with losses.

Also, one must understand that the same stocks and sectors will not continue heading north. Under any given economic condition, only a few sectors and stock do well. As soon as the economic scenario changes, new sectors and stocks shine out.

For instance, during 2007, metals, capital goods, oil and gas and realty outperformed the Sensex, whereas, these underperformed the Sensex during 2008. While, BSE Realty and BSE Metal lost as much as 83% and 74% in 2008, they appreciated by 70% and 119% in 2007, respectively.

Blind faith in a particular person is a sure shot way to lose money in the stock market. Several brokers and financial planners say a large set of investors tend to believe strongly in their advisers and follow them religiously.

Also, there is a belief among a few investors that if a particular investment bank comes out with an initial public offering the market price of that stock will never come down below the issue price. All these are misconceptions. One should not believe anyone blindly when it comes to investing your hardearned money.

Stock tips are enchanting for investors. Relationship managers (RM) send stock tips on a daily basis to ensure that their trading targets are achieved. Many of these tips don’t even come from the research desk that brokers have.

Investors willing to make serious gains should avoid these tips as these are in more favour of RM than investors. One must do a thorough research before investing in any stock rather than just seeing the SMS sent by his/her RM.

Also, it is seen that generally people go for a second opinion before investing. A broker who did not wish to be identified said, “Many of our clients are very intelligent and have a good understanding of the stock market. But even after doing a detailed analysis, they always ask their RM that ‘chalega na’ (will it go up) and the answer is always yes.”

“Taking a second opinion is not a bad idea but one must seek a second advice from the right person,” Ashish Kapur, CEO of Invest Shoppe India, said.

Never get carried away by vague terms such as long-term and shortterm. Ask an investment adviser and he will advise you investing for longterm. The words long-term or shortterm do not say anything. One must be very particular about the investment horizon. According to Kapur, rather than following such terms one should have return estimation in mind and strictly follow that.

Since, prices may not continue moving up, one should not be greedy and the moment a stock touches the targeted level one should exit. Similarly, one must know how much loss one can afford to absorb.

Once prices fall below that level one should get out of it rather than turning it into long-term investments to avoid booking the losses. If the investment objective is very important like children’s marriage or education, it is better to invest in other financial instruments.

Many small investor believe that shares with lower price are cheaper and can multiply faster.

Look at PE ratio to decide which stock is cheaper. Cos with relatively low share price are less traded.

Don’t get attracted towards any stock by just seeing its rising price. Don’t have blind faith in a particular person. Stock tips are enchanting but may not be in investors’ interest.

Seek second opinion from the right person. Rather than following a long-term or shortterm strategy, have your own return estimation.

Know how much loss you can afford & sell if prices fall below that target.

Source:economictimes.com