What is investing

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Investing philosophy

  What is investing?
A: Investing lets your money earn some more money, thus getting it to work harder for you. In effect, your savings do not sit idle, but help you profit from them.
  Why should you invest?
A: There are two main reasons why you should invest:
To stay ahead of inflation
As the cost of living keeps increasing and day-to-day expenses keeps rising, investing lets you keep pace with these
changing market conditions.
To achieve financial goals As the saying goes A journey of a thousand miles, begins with a single step. Investing small amounts of money over a period of time brings you closer to your financial goals.
  When should you invest?
A: With investing, time makes money. Thus, the earlier you start investing the better, since you can reach your financial goals faster. So, regardless of your financial position, investing ensures that you accrue wealth over time.
  Where do I start if I have no savings?
A: The first step to investing begins with saving. You can stay invested, even by saving small portions of money on a monthly basis. Thus, the first successful investment decision, is the decision to start saving, however difficult it may seem at first. After all, where there is a will, you will always find a way!
For eg: If your monthly salary is Rs 20,000 per month and your monthly expenditure is Rs16,000 per month, park the difference of Rs 4,000 into an investment avenue of your choice immediately.
  What's the next step after my first investment?
A: Investing is a lifelong activity; you need to keep investing regularly. To keep track of your investments, make use of Portfolio Tracker.To know about investment opportunities, keep reading up about financial markets and companies. As you move to Chapter 2,you can gain a deeper understanding into this subject.
  How Do I Get to My Allocation Goal
A: Financial goals can be separated into two types:
Short-term goals - Are immediate goals,ones you would want to achieve now or within a year.For ex- Buying a computer,a bike,a mobile, music system, DVD player etc.Generally,it takes less money to reach these short-term goals.
Long-term goals - Take you a longer time to reach and need adequate investment planning, as they involve larger sums of money.
For ex. Buying a luxury car,buying a house,and even starting a business.
Often, it is the first step towards investment that seems to be the hardest.However, with adequate planning and a clear focus on the objectives, you could attain your goals with ease.You should always plan for your goals taking into consideration your risk-return appetite and accordingly apportion your funds into various channels.

Investment and Basic types of Investments

Investment refers to purchasing assets, keeping funds in a bank with an expectation of having a return which is beneficial. Understanding the core concepts of investments will help to maximize the portfolio of investment and its return, and it will also help to reduce the risk associated with the investment.
There are various types of investments which includes the following:-
1- Cash Investments are those investments which gives a low rate of interest than other investments. Investments rate of return is further lower in the period of inflation. These investments include depositing money in bank, saving accounts etc.
2- Stocks will make the purchaser the partial owner of the company and will entitle the purchaser to have a share in the company’s profit.
3- Mutual Fund is a combination of both the bonds and securities and it also includes an intermediary to select securities for an individual. In this type of investment one does not need to track with the investment.
4- Commodities are kind of investments in which industrial and agricultural products are traded. Commodity trading is associated with a high level of reward as well as with a high level of risk. In depth analysis is the basic requirement of commodity trading.
5- Real Estate is a type of long term investment which requires long term commitment of the capital which is invested. The return can be generated through rental income, appreciation in the value of real estate and lease in come.
Before Investing one should have a very clear idea of each type of investment and then he should select in which type he wants to invest keeping in mind his own financial position and his financial strength.

Investment Management

Steps of Investment Management Process

Before investing, investment management should be done. Investment Management is a five step process. Following are the 5 steps of investment management:-
1- Setting the Investment Objectives:-
The first and the basic step for investment is that the investor should set his investment objectives. These investment objectives vary from person to person. For example for an individual the objective may be to optimize the rate of return.
2- Establishing Investment Policy:-
Establishing investment policy refers to the allocation of asset amongst the major allocated assets in the capital market. The range of allocated asset is from equities, debt, fixed income securities, real estate, foreign securities to currencies. Restraint of environment and that of investor should be kept in mind while establishing the investment policy.
3- Selecting the Portfolio Strategy:-
The portfolio strategy selected should be in accordance and in conformity with the investment objectives and investment policies. If these are not in accordance with each other then the whole investment management process will collapse.
4- Selecting the Assets:-
The assets to be placed in the portfolio have to be selected by the investor. This is the point where real creation of portfolio will take place after the selection of assets in which to invest by the manager or investor. That asset will be selected which will give best return in available resources and which involves lowest risk. The assets can be shares, stocks, art objects, securities, gold, property etc.
5- Measuring and Evaluating Performance:-
In this step the performance of the portfolio will be measured in comparison to the realistic benchmark or the standard set by the investor. Risk and return will be evaluated by the manager. Measuring and evaluating the portfolio will give the feedback to the investor and will in turn help the investor to improve the quality as well as the performance of the portfolio of investment.

Determining Risk And The Risk Pyramid

You might be familiar with the risk-reward concept, which states that the higher the risk of a particular investment, the higher the possible return. But many investors do not understand how to determine the risk level their individual portfolios should bear. This article provides a general framework that any investor can use to assess his or her personal risk level and how this level relates to different investments.

Risk-Reward Concept
This is a general concept underlying anything by which a return can be expected. Anytime you invest money into something, there is a risk, whether large or small, that you might not get your money back. In turn, you expect a return, which compensates you for bearing this risk. In theory the higher the risk, the more you should receive for holding the investment, and the lower the risk, the less you should receive.

For investment securities, we can create a chart with the different types of securities and their associated risk/reward profiles.

Although this chart is by no means scientific, it provides a guideline that investors can use when picking different investments. Located on the upper portion of this chart are investments that have higher risks but might offer investors a higher potential for above-average returns. On the lower portion are much safer investments, but these investments have a lower potential for high returns.

Determining Your Risk Preference
With so many different types of investments to choose from, how does an investor determine how much risk he or she can handle? Every individual is different, and it's hard to create a steadfast model applicable to everyone, but here are two important things you should consider when deciding how much risk to take:

Time Horizon
Before you make any investment, you should always determine the amount of time you have to keep your money invested. If you have $20,000 to invest today but need it in one year for a down payment on a new house, investing the money in higher-risk stocks is not the best strategy. The riskier an investment is, the greater its volatility or price fluctuations. So if your time horizon is relatively short, you may be forced to sell your securities at a significant loss.
With a longer time horizon, investors have more time to recoup any possible losses and are therefore theoretically more tolerant of higher risks. For example, if that $20,000 is meant for a lakeside cottage that you are planning to buy in 10 years, you can invest the money into higher-risk stocks. Why? Because there is more time available to recover any losses and less likelihood of being forced to sell out of the position too early.
Bankroll
Determining the amount of money you can stand to lose is another important factor of figuring out your risk tolerance. This might not be the most optimistic method of investing; however, it is the most realistic. By investing only money that you can afford to lose or afford to have tied up for some period of time, you won't be pressured to sell off any investments because of panic or liquidity issues.
The more money you have, the more risk you are able to take. Compare, for instance, a person who has a net worth of $50,000 to another person who has a net worth of $5 million. If both invest $25,000 of their net worth into securities, the person with the lower net worth will be more affected by a decline than the person with the higher net worth. Furthermore, if the investors face a liquidity issue and require cash immediately, the first investor will have to sell off the investment while the second investor can use his or her other funds.

Investment Risk Pyramid
After deciding how much risk is acceptable in your portfolio by acknowledging your time horizon and bankroll, you can use the risk pyramid approach for balancing your assets.

This pyramid can be thought of as an asset allocation tool that investors can use to diversify their portfolio investments according to the risk profile of each security. The pyramid, representing the investor's portfolio, has three distinct tiers:

Base of the Pyramid – The foundation of the pyramid represents the strongest portion, which supports everything above it. This area should consist of investments that are low in risk and have foreseeable returns. It is the largest area and comprises the bulk of your assets.
Middle Portion – This area should be made up of medium-risk investments that offer a stable return while still allowing for capital appreciation. Although more risky than the assets creating the base, these investments should still be relatively safe.
Summit – Reserved specifically for high-risk investments, this is the smallest area of the pyramid (portfolio) and should consist of money you can lose without any serious repercussions. Furthermore, money in the summit should be fairly disposable so that you don't have to sell prematurely in instances where there are capital losses.

The Bottom Line
Not all investors are created equally. While others prefer less risk, some investors prefer even more risk than others who have a larger net worth. This diversity leads to the beauty of the investment pyramid. Those who want more risk in their portfolios can increase the size of the summit by decreasing the other two sections, and those wanting less risk can increase the size of the base. The pyramid representing your portfolio should be customized to your risk preference.

It is important for investors to understand the idea of risk and how it applies to them. Making informed investment decisions entails not only researching individual securities but also understanding your own finances and risk profile. To get an estimate of the securities suitable for certain levels of risk tolerance and to maximize returns, investors should have an idea of how much time and money they have to invest and the returns they are seeking.