Mutual Funds - Direct Plan vs Regular Plan

Since 2013 Sebi has given an option for the MF investors to choose a Direct plan vs a Regular plan. 

As a prima facia, if you are an aware & informed customer having time, knowledge, skills then you can invest in a Direct plan of mutual funds without the help of an advisor. However, you need to manage your own and no services would be given by any MF distributors. For any transactions like purchase, redemption, or switch, you have to approach to respective AMC directly. You won't get any kind of MF software to monitor your portfolio performance. Remember, after a certain period, each asset class & portfolio need to be rebalanced as per your risk appetite and asset allocation, in which more than 90% of investors fail to do so.

On the other hand, a Regular plan provides support from the person who is an MF expert. You get all kinds of investment services, software, rebalancing of portfolio, etc free of charge. You might be requiring the need for handholding when the market gets into deep correction or euphoria mode.

Therefore, choose your option carefully after studying the pros & cons of these two options.

Direct MF Plan Investments:

Pro:     

• Can invest without MF distributors or intermediatory 
• Expenses ratio are lower compared to Regular plan
• Get higher return compared to Regular plan
• Prefer if you can keep your emotions out - greed, fear, biases, human behavior, etc.
• Go for it if you are an expert in MF and can do your own investment analysis
• Can avail paid services of fee base RIA, if required

Cons:

• Required in-depth research, time & skillset to pick MF scheme
• Need advisor in case of the market turmoil & volatility to guide you properly
• Not suitable for conservation, senior citizen or first-time investor
• Investment advice not available free, you have to pay for that
• Portfolio tracking & market awareness - self
• Paper documents & KYC - to do your own
• Although expenses ratio are lower compared to Regular plan your one mistake can prove much costlier than saving on the expense front

Regular MF Plan Investments:

Pro:     

• Can invest through MF distributors or intermediatory 
• Get support from MF distributors for their entire financial & allied services
• Get free software to access & transact your own
• You need to have a financial expert to support, assist & handhold, whenever required
• Investment advice available free

Cons:

• Expenses ratio are higher compared to Direct plan
• Get lower return compared to Direct plan
• Choose your MF distributor carefully. Wrong MF distributor or incompetent distributor would not solve the purpose

Although it is projected that you get a higher NAV, higher returns & lower expenses ratio under the Direct plan through which you can save a lacs of rupee in the longer term, the fact is that no one can become wealthy just by saving on the brokerage or fee side. Your one wrong decision without an advisor can put you years behind. 

Remember, Mutual Fund Sahi Hai, but Advisor Jaruri Hai.

 

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Which one is better - Direct Equity or Mutual Funds?

Many investors get confused about whether they should go directly into the Equity market or choose the Mutual Fund route to invest. There are pros & cons of each option and one should also know their strength & weakness before taking a call.

Equity Investments:

Pro:     

• You have direct control over your investment & portfolio
• Start independent stock picking
• Get into multi-bagger stock
• Can create aggressive / concentrated portfolio
• Get equity ownership & the right to participate in AGM
• High risk - high reward

Cons:

• Required in-depth research, time & skillset
• understand future business prospects thoroughly
• Need technical and/or fundamental qualified
• Stock picking is more of an art rather than a science
• Timing is equally important when to buy & sell
• One wrong call can deteriorate overall portfolio performance drastically
• Should be alert & watch the market on a daily basis
• Riskier than MF investment
• Need a large amount to invest
• Demat is mandatory
• Comparatively more volatile than MF
• Not suitable for conservation, senior citizen or first-time investor

Mutual funds Investments:

Pro:     

• Get professional fund management
• Convenient & simple to invest
• Transparency
• Flexibility
• Tax benefit u/s 80C under ELSS
• Easily liquidate
• The economy of scale & minimum transaction cost
• Proper diversification & asset allocation
• Can do saving to investing
• Start with a small lump sum amount & can do SIP
• Demat is not mandatory
• MF follows certain investment strategy, process & system
• Comparatively low risk than direct equity investment
• Dully regulated by SEBI

Cons:

• Need to do homework on scheme selection but lessor than stock selection
• No customized portfolio
• No control on picking & holding stock
• One should very clear about their investment time horizon & goal
• Fund Manager non-performance or change in fund management can drag the return

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Gold - An Asset Class

We Indians are very affectionate with Gold for generations. Although Gold is purely an international asset class, it plays a very vital role in our portfolio. 

Gold possesses certain properties & advantages:

• Hedge against inflation risk
• Protect currency risk
• Hedge against uncertainty
• Highly liquid asset
• Available in paper as well as physical form (fall into a financial asset and hard asset)
• Price is driven by the international market
• Provide diversification in a portfolio & mitigate risk
• Help to create wealth in the long term
• No credit/default risk
• Gold is a precious metal and carries a 'store of value'
• Reserve currency by many central banks
• Can be pledged for emergency need
• Can be invested as low as Rs. 500/-
• SIP option available

If we see the last 40 years' data of Gold from the year 1980 (@1000 / 10 grams) to the year 2020 (@51,000 / 10 grams), the rate of return given by Gold comes out to be @10.25% CAGR. Although Gold stood third in terms of the return in comparison with Real estate who scores second and Equity at the top.

There are the following ways to buy Gold:

• Physical form
• Jewelry shops / Bank / E-Commerce site
• Financial form
• Gold ETF
• Gold Mutual Funds
• Digital Gold or E-Gold
• Gold Sovereign Bonds
• Commodity Exchange (MCX / NCDEX)
• Gold Future & Option in the Derivatives segment

One can add Gold from 5% to 15% to have a better risk-adjusted return in the portfolio.

Importance of Estate Planning

A Will is a legal declaration of the intention of a person (testator) with respect to his own property / asset / possession / wealth which he desires to be distributed after his death. A Will ensures that the person can bequeath wealth to his successors as per his wishes

The personal law will come into play only for assets that are not specifically mentioned in the Will. While the Will is made when a person is alive, it comes into effect on his death. It is viewed as the last declaration of the deceased person. Intestate death can be prevented through timely Estate Planning.

We need to make a Will to get the following benefits:

• Smooth transmissions of the Estate to the intended beneficiary
• An efficient way of tax planning
• Avoiding disputes/conflicts after the death
• Will escape prolonged Legal battles
• Minimizing court procedure/litigation costs
• Avoid delay in the distribution of assets & resolution of the estate

There are certain checkpoints to ensure proper & effective Will

• Make a will at a young age – it is advisable to get a medical certificate – testator is of sound mind.
• If changes required, can be done by a supplement called Codicil.
• Will need to be signed by a Testator in presence of at least two witnesses.
• The will needs to be dated. 
• If one has made multiple wills then one of the latest dates would be considered. It is advisable one prepares a letter nullifying unwanted wills & hence no scope of confusion or duplication.

A simple Will can be prepared with just 10K-15K and one should always take the help of a legal advocate who is a pioneer in making the estate planning rather than you do it your own. This can save a lot of the amount, time, energy of your successor in the future, for sure!

Why Retirement Planning is important at early stage?

Retirement Planning is very different from our other goals of life in many aspects and it has a large significance in overall financial planning due to the following reasons. For Retirement, the distinctive features are:

• Long accumulation period
• Long distribution period
• Retirement is not optional
• Corpus required is very huge
• Can’t meet retirement expenses via EMI

Therefore, one should start planning for their retirement at an early stage because of:

1. Breakdown of the joint family system
2. Rising cost due to inflation
3. Health-related problems - Rising medical bills
4. Increase in life expectancy
5. Upgraded lifestyle, luxury & comfort
6. Reduction in working years
7. Clashing of other financial goals

Now million dollar question is why do we fail in Retirement Planning? Some of the reasons could be...

1. Financial Short-sightedness
2. Instant Gratification
3. Underestimating Inflation effect
4. Complicated Corpus calculations
5. Investment is the game of  consistency, discipline & patience
6. Risk in Investments
7. Improper Asset Allocation / lack of investment skills
8. Inadequate Protection plan
9. Behavior Finance
10. Procrastination 

Understand, neither your parents are your emergency fund nor your children will be your retirement fund. You have to create your own retirement corpus. 

How would you like to spend your golden years post-retirement, its absolutely in your hand only!

Consequences of Inadequate Protection Plans

The most misunderstood concept among Indians is Insurance. People don't know the purpose behind taking an insurance policy and how actually insurance work. The two major misbeliefs with regard to insurance is that:

I) I have already taken an insurance policy and it is sufficient for me

II) The future projected lifetime cash flow is more than enough to buy an insurance policy 

It is an altogether wrong idea to get into insurance without understanding your own need. Insurance is the tool to compensate for the financial risk in case of causality of the insured person/asset. It mitigates the risk that arises out of the uncertainty and the objective is not to earn profits but to protect the losses. 

However, people buy insurance mainly because of the investment returns and protection goes into the back seat. Very few actually calculate how much sum assured (SA) is enough for them and whether their existing policy suffices enough to provide that kind of protection in case of any mishappening.

One must cover the following types of protection plans to get Sampurna Suraksha.

1. Life Policy - Term Plan with SA of 15x of your annual income
2. Health Policy - Medical Floater Policy with SA of  1x of your annual income (including top-up plan)
3. Personal Accidental - Temporary & Permanent disability features with SA of 5x of your annual income
4. Critical Illness - Income protection with SA of 5x of your annual income
5. Vehicle Comprehensive Insurance - as per IDV of vehicle
6. Home Insurance - As per the current market valuation
7. Travel Insurance - As & when required
8. Business Insurance - Keyman to protect the business
9. Liability Insurance - As per profession

Some of the good quotes about insurance are:

• My name is ‘Insurance’ and I am not an ‘Investment’
• Insurance is like Parachute if you don’t have it when you need it the most… probably, you never need it again!
• Buying insurance is like fixing a leak in the roof... the longer you wait the more expensive it gets.
• You don't buy life insurance because you are going to die, but because your loved ones are going to live!
• No insurance can fulfill your emptiness in the family, but at least it can financially support them.
• You need life insurance if somebody will suffer financially when you die.
• It's not about your need; it's about what your family needs if you aren't there.
• If a child, a spouse, or a parent depending on your income, you need life insurance.
• By the time people realize they need Life Insurance, it may be too late to get one.

Remember, an Insurance premium is less expensive than you think!

Significance of Contingency Funds!

We all invest in the various asset classes keeping our future goals insight with a tentative time horizon.  However, many investors miss out on one crucial parameter i.e. contingency requirement. You may need money at any time in case such an emergency arises due to:

• Health reasons / Medical treatment
• Accident
• Death
• Job loss / Business loss
• Natural calamities
• Unplanned / unexpected expenditures

Therefore, a proper provision is required to maintain adequate funds for emergency needs to pump required liquidity just in time. A separate account can be created for this purpose preferably jointly with one of the family members on an 'E or S' operating basis or have access to operate online as & when required without any hassle. Mote importantly, your spouse or family member must know about it and how to operate it.

The funds can be parked either with a savings bank or a liquid mutual fund. The quantum of amount varies from person to person and depends on your lifestyle, generally, it should be 6 months of your monthly expenses at least. 

One can not wait for their relatives or friends to support them financially in case of any emergency, everyone is financially stressed nowadays. It's better to make our own provisions and this will be like your insurance protection.

Never ever ignore contingency funds, again if utilized due to some casualty, try to fill it back ASAP.  

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Four Pillars of Financial Planning

There are two ways you can deal with FINANCE in your life:

Without Planning: wherein at some point in time in the future, you will have money and then you will decide how to use that for your goals.

With Planning: you decide well in advance what are your goals and how you will achieve them.

Obviously, anyone would like to go with a proper planning way, however, 90% of the people prefer to invest on adhoc basis and not systematically planned way.

Financial Planning is the process of meeting LIFE GOALS through proper management of finances. It gives us a clear idea about:

• How long to go on investing
• How much amount to invest
• How & where to invest
• When to withdraw

A process to ensure that the right amount of money is available in the right hands at the right point in time. To ensure this one has to create four following pillars to achieve whatever you want in your financial life.

                                        

A) Protection: Every financial planning has to starts with creating a strong base for the foundation through insurance. How much you are well planned with asset allocation, if adequate protection is not available whenever required, all go in vain.

 

B) Creation: The second objective of financial planning is wealth creation & protection. This already been discussed in previous blogs on how to fix goals, risk profiling, time horizon, asset allocation & rebalancing.

C) Taxation: Insurance or investment should not be done to avail only tax benefit. It is not their primary objective. Rather, once you are done with insurance need & investment goal then only fine-tune to take benefit of tax relief. 

D) Succession: In India, more than 95% of people do not plan for their succession because of two reasons. One, they know that they are going to die someday, however, they fail to think (plan) after their death. Second, they want to retain their ownership/power/position till the end and don't want the next generation to intervene in their work.

Will write more on Succession in my next blog.

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Investment is the Game of Patience

Have you ever heard about the Chinese Bamboo Tree? If not, let me share with you the Bamboo Tree story. 

The Bamboo seeds are bow underground and required watering on daily basis. Initial three years nothing happens even then it needs to be watered daily without fail. During the fourth year, it gets sprouted from the ground and gains a height of 10 feet but actual magic happens in the fifth year in which it retains the height up to 100 feet. 

In fact, 90% of growth obtained in the last 6 weeks only. It also means that in the entire growth cycle from seed to tree, the major height gets attended in just 2% of the time period. For the remaining time, its root was expanding under the earth to create a strong foundation for such an astonishing height, which we don't see or feel. 

Our investments work in a similar fashion. If you are not getting returns on SIP investments for the initial 5 - 7 years, it means the market is under consolidation or correction period and creating a strong base for you with accumulating more & more units every month. The magic will start for sure, maybe after 7 or 10 years but need a lot of patience to handle such future phenomenon growth. Everyone doesn't deserve such kind of high return and exit much before the plant actually gets fertile above the ground level.     

Investment is a game of patience. What you need is consistency in investments & patience w.r.t. the time period. The day will come, for sure!

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Complicated Mathematical Calculations

In mathematics, during class VI we learned the below-mentioned power of compounding formula and we had solved more than hundreds of problems based on that. However, in actual life, we never learned how to take compounding benefits despite knowing the compounding formula since childhood.

The actual problem is that in a market-linked instrument, where the interest is not guaranteed like FD, the rate of return is not in our hands and we should never ever focus on that. What is in our hands is the time period & principal amount to deploy. However, the majority of investors are not sure about their investment time horizon. Their short term investments become long term & vice versa and this mainly depends on the market & scheme performance. 

There are certain things to observe & follow appropriately:

First, MF category & Scheme should be selected based on the investment time horizon and not on the return generated.

Second, The impact of power of compounding starts from day one, however, it is clearly visible only after 2 decades when your investments get manyfold. The human behavior is like that majority of the SIP get stopped in the first 2 years and who is going to have patience till next 20 years?

Third, people can wait for decades & decades in FD, small saving schemes like PPF, EPF, also in insurance, gold, property but nobody wants to give time for equity to grow which has the highest potential to create wealth in the long term than any other instruments.

Forth, even today people invest in equity for short-term profit generation and try to speculate rather than invest.

The formula for SIP investment & compounding gets more complicated and one should not try to get into the nitty-gritty of this, rather focus on investment time horizon and select asset class accordingly.

Finally, one should also understand 12% CAGR in lumpsum investment and 12% CAGR in SIP investment, both will have different maturity value and should not compare with one another. 

Is lifestyle Inflation more dangerous?

Lifestyle inflation refers to an increase in spending when an individual's income goes up. It means you keep on updating your lifestyle & increase related expenses whenever there is a rise in income. You become habitual after a certain point in time. If there is a bonus, windfall, or unexpected income, all goes towards luxury spending, and nothing is left for savings eventually. It becomes difficult to get out of debt, save for retirement, or meet other financial goals.

Lifestyle makes you feel good right now, however, if you are not saving & thereafter investing enough for your future goals, it may drain you out completely. And this you will come to know only after a decade or two already been passed and nothing can be done now. We have seen lot many examples of big tycoons, industrialists, celebrities & affluent personalities who went to the extent of bankruptcy even, from their luxurious life they had one point in time.

Life is always a mix of ups & downs like a roller coaster and so is our cashflow. Therefore, to safeguard future expenses, it is always advisable to have multiple sources of passive income.

Many people underestimate the compounding effect of inflation and how purchasing power can be reduced over a period of time. If we take general inflation 7%-8% p.a. then lifestyle inflation could be 5%-8% p.a. further.

For example, at the start of the career at your young age, you might be riding with a bike and now upgraded to a sedan car or SUV after marriage. 

                                            2010                                2020

Vehicle  owned                    Bike                                SUV

Vehicle Cost                        60,000                            10 lacs

EMI (5 years)                     1,300                               21,000

Petol / liter                           35                                   90 

Average (km/liter)               60                                   15  

As you have upgraded your vehicle, your EMI increased drastically, the average of the vehicle come down and not only that cost of petrol also increased over a period of time.

This is lifestyle inflation... very very common for young generation w.r.t. a bigger house, bigger car, foreign trip, luxury mobile, costly household purchases, hotel, food & amusement cost, children marriage, etc. 

Never under estimate Inflation effect

Inflation is the decline of the purchasing power of a Rupee over time. It is measured by the rate of rising prices of goods & services in an economy. Inflation works as a hidden dragon that eats out our purchasing power and we hardly come to know it. It's like a slow poison. 

In 1963 the cost of 1 letter petrol was just 72 paise/liter and today it is Rs. 90 / liter. If we see a CAGR of rising in fuel cost over 57 years which comes out to be @ 9% p.a. 

                                                

In fact, every 10 years our purchasing power is reduced by 50%. Unless we take care to grow our investments, Inflation will make us much poorer in the long run. We can see from the below chart the value of the Rupee has eroded by 95% in the last 40 years. What that means is if we go to the market to purchase any goods/services for Rs. 1000/-,after 10 years we have to spend Rs. 2000/- for the same quantum of goods/services. 

There is also lifestyle inflation which adversely impacts us more than CPI & WPI, will be discussing this in my next blog in detail.

Instant Gratification

Instant gratification is a desire to experience pleasure or fulfillment without any delay or deferment. It also refers to the temptation and tendency to forego more benefits in the future in order to obtain less rewarding immediate benefits. 

We all know that the money received today has more purchasing power than the money to be received in the future. In other words, a rupee today represents a greater real purchasing power than a rupee a year after. That is why we need to invest our surplus saving in an instrument that has the potential to beat the inflation in the longer-term so that our future money could retain more real power than today. However, at a subconscious level, we think like - 'A bird in a hand is better than two in the bush'!

The irony of human behaviour is that we want to spend whatever is in hand and if in case something is left then we park in an instrument which does not have a capacity to fight with inflation.

Ideally one should think for their long term goals and how to achieve that by prudent investing and thereafter spending should be done. The need for instant gratification distracts us from long term success.

Unfortunately, missed financial opportunities could only be realized after 2-3 decades when nothing can be done then!

Financial Short-Sightedness

Do you know our brain is programmed like that we can not think beyond a certain point of time? That is the reason we mainly focus only on the goals which are going to hit in the short term within 5 years max. Beyond that, we are either incapable to think or we do not want to think.

The majority of people want to be wealthy and desperately desire to accumulate 1 crore, 10 crores, or 100 crores in their lifetime, but how many actually believe and plan to get it in long term through investments. In fact very handful of investors able to do so. The reason for failure could be many but the reason for success is clarity of vision!

Generally, it is a 20 - 20 - 20 formula which says the first 20 years you should accumulate 1 crore, then 10 crores in the next 20 years and you will have 100 crores in another 20 years thereafter. The problem here is that we never plan for the initial 20 years and therefore subsequent 20 + 20 years have to get deviated from the targeted amount by a very wide margin. This results in generation after generation struggling for financial independence.

Financial Short-Sightedness is thinking only of today, tomorrow, or next year and not the next decades & onwards. An inability to see the future clearly unless it is relatively close!

Also remember, It is the law of the Universe that says if no one had planted a tree, nobody would get the fruits - all will be deprived of it forever. Thinks of your some investments for a pretty long term of 20, 40, or 60 years. What will happen if you don't get the fruits in your lifetime, probability of your next generation to get it, would be high! If you belong to a salaried middle-class category, then the sacrifice of one generation required to achieve financial freedom for the next generation. 

Are you ready?.

Why Do People Fail in Wealth Creation?

Have you ever wonder most Indian investors want to be rich like Warren Buffet but nobody wants to follow his philosophy. Getting wealthy is not an overnight or short term process, it requires a lot of efforts, process, conviction & mindset  

There are mainly 10 reasons why people aren't able to create wealth through equity/equity MF or through SIP mode of investments.

1. Financial Short-Sightedness 
2. Instant Gratification
3. Under-estimate Inflation
4. Improper Asset Allocation
5. Complicated Mathematical Calculations
6. Investment is the Game of Patience
7. Risk in Investment
8. Inadequate Protection Plans
9. Forget Succession
10. Behavior Finance

I will be discussing the above in my coming blogs in detail.

The funda is that your money should work for you rather than you work for the money for your entire life. Focus on creating multiple sources of passive income where your physical presence is no longer required.

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Creating Legacy Through SIP

You all invest in mutual funds for wealth creation over a period of time or to achieve your personal goals. But, how many of you really invest through MF to create a legacy for your third-generation, not even 1%. Forget about the third generation, most even don't plan for their second-generation via MF mode. You might be running a business and having succession planning to handover it to your next generation and also might be asset holding like gold, real estate, or FD to pass on but not MF or Equity. 

MF (equity & Hybrid), despite having the highest potential to generate a return in long term, the investor just holds on an average 3 - 5 years max and therefore fails to get real fruits from compounding benefits. You all know equity is a volatile asset and recommended for the long term so as MF SIP. The returns are not guaranteed in gold or real estate either, even then people hold it for years & years. However, in the case of MF, people seek guarantee & returns in short term, which altogether the wrong approach to look at this wonderful asset class. MF is the only vehicle that provides you facility from savings to investing. In the short term, safety is more important and in long term looks for the returns and therefore change asset class category within the MF accordingly.

How many of you plan to receive 10 crores or 100 crores through SIP mode. I bet, none; the reason being SIP holding period on an average is just 3 years in 90% of the cases. And when you talk about 40 to 60 years SIP, nobody interested to create that legacy after so many years. Everyone wants quick money overnight basis and even today equity investment is considered as an immediate profit mode. It doesn't matter whether you invest 10,000 or 20,000 p.m., more important is the longer time period which is an essential part of compounding growth and set you to become financially independent. 

A million-dollar question is who is interested to sacrifice one generation for the next generation? Is it a matter of investing 10k or 20k for 40 - 60 years, not really? It's a matter of long patience, conviction, and behavioral finance. Unfortunately, everyone wants to be financially free but nobody wants to act in that direction to achieve that!

Disclaimer: Mutual Funds investment are subject to Market Risk

Market Return vs Investor Return

We all know Equity has the potential to provide the highest return followed by Real Estate. However, it is also observed that 90% of investors do not get much benefit as compared with other asset classes for example Real Estate, Gold, Insurance, Bonds, etc.

There are mainly 3 reasons for getting poor returns from Equity.

• Behaviour Finance: 
Investor perception changes when investing in Equity vs other asset classes. Investors remain invested in other asset classes even if they make losses in the short to medium term, but in the case of equity, they exit in panic. For example, they will never exit from Gold or Real Estate in loss even if they have to hold for 10 - 20 years and they hold it without losing their patience. On the other hand, Equity is a unique asset class where people are more comfortable buying at high and selling at low. Equity says if you don't accept me at my worst, you don't deserve me at my best. 

• Volatile Asset: 
Equity falls under the highest volatile asset class. The problem is that investors look at the valuation of Equity on a daily / weekly basis. Being a volatile asset, the portfolio value fluctuates on daily basis. Whereas in the case of real estate or insurance, you hardly know the valuation on a month to month basis. Because you see portfolio frequently, you fear of losing deployed amount in case of correction or early exit in case of rally or try to time the market and start trading in equity without acquiring requisite qualification to do so. Investors' decisions not always rational.

• Profit machine for speculation: 
We consider Equity for overnight profit generation tool. Equity is recommended for long-term wealth creation and as pointed out earlier, Equity generates the highest return among all other asset classes, however, investors do not hold till the long term and they fail to get the actual benefit associated with Equity.

The market generates the return, unfortunately, most of the people failed to enchase it and do not enjoy the fruits of Equity.

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Systematic vs Unsystematic Risk

There is no investment that is absolutely risk-free, you name any... equity, bond, gold, FD, real estate, MF, insurance, etc. The problem is that we see risk only in equity & MF and not in other investment options.

We need to understand what kind of risks any product could have. Risk can be divided into two parts: 

                    

Total Risk = Systematic Risk + Unsystematic Risk

(Standard Deviation is the measure of total risk in the portfolio)

Systematic Risk: This works at the Macro-level. This can not be controlled and impact the overall financial market. It is also known as non-diversifiable risk. Beta measures systematic risk. Examples are 

• Inflation risk
• Interest rate risk
• Reinvestment risk
• Currency risk
• Economical risk
• Social  / Political risk
• Global risk
• Country risk
• Natural calamities
• Market risk

Unsystematic Risk: This works at the Micro-level and is also known as Specific Risk. This can be controlled/eliminated with proper risk management tools such as diversification. It impacts specific industries or markets. Examples are 

• Credit / Default risk
• Liquidity risk
• Sector-specific risk
• Company-specific risk
• Management risk
• Business risk
• Concentration risk
• Labor strike risk      

Now, one should also understand that which asset class contains which kind of risk before making any investment decision:

CASH (FD / Liquid fund): Inflation risk, Credit / Default risk, Devaluation risk

DEBT (Bonds / Debentures):  Inflation risk, Interest rate risk, Reinvestment risk, Credit / Default risk, Liquidity risk

GOLD: Currency risk, Inflation risk

INSURANCE: Liquidity risk, Reinvestment risk

REAL ESTATE: Liquidity risk, Encroachment risk, Title ownership risk, Estate planning risk

EQUITY: Economical risk, Social  / Political risk, Global risk, Country risk, Natural calamities risk, Market risk, Sector-specific risk, Company-specific risk, Management risk, Business risk, Concentration risk      

No asset class is risk-free in the true sense!

Disclaimer: Investment in securities & mutual funds are subject to Market Risk

Risk vs Uncertainty

Many people don't differentiate between Risk & Uncertainty. For them, both are one & the same thing, actually, it is not. There is a lot of difference between the two.

                        

RISK:

Risk is the possibility of a number of different outcomes resulting from a given action. The chance of actual return may differ from the expected return. There could be a possibility of losing some or all of the investment. 

Risk is also the volatility associated with the prices/returns of investments. 

A risk is an event whose outcome is known to you

UNCERTAINTY:

One can not predict uncertainty and hence the outcome is not known in advance. 

Risk is not inherently bad and need not be avoided totally. What do you think which one is riskier - driving a car or traveling in an airbus?

Why negative correlation among asset classes is important?

Correlation of assets measures how an asset class moves in comparison to another asset class. When two assets move in the same direction together, they are considered to be highly correlated. When these asset classes move in the opposite direction, they would be negatively correlated. 

A positive correlation would mean that when one asset class return increases the other asset class return also increases. A correlation of '1' would mean that the assets have a perfect positive correlation. Investing equally in large-cap, mid-cap & small-cap does not modify the risk of the portfolio at all.

A negative correlation would mean when both asset class returns move in the opposite direction. That is when one asset class return increases the other decreases. A correlation of ‘0' means no correlation and a '-1' indicates a perfect negative correlation.

One should develop a Strategic Asset Allocation Plan. Portfolio construction and diversification are heavily influenced by the correlation between different assets.  Adding negatively correlated assets like gold, bonds, international equity along with domestic equity reduces the risk considerably.  The best asset allocation comes from combining negatively correlated assets.

Low correlation reduces the volatility of a portfolio without necessarily affecting the expected level of return. Measuring correlation provides two kinds of information:  

(a) whether the asset class returns are moving in the same or opposite direction over the long term 

(b) what is the extent to which they co-move  

We can observe from the below matrix that 4 asset classes (domestic equity, international equity, gold & debt) are mostly uncorrelated or minorly negatively correlated to each other.

Each cell represents the correlation between the two corresponding assets.

Cell Color Description Diversification Benefit -1.00 to -0.40 Asset pair with negative correlation Excellent Diversification -0.40 to 0.00 Asset pair with slight negative correlation Good Diversification 0.00 to 0.60 Asset pair with mild positive correlation Moderate Diversification 0.60 to 1.00 Asset pair with strong positive correlation Poor Diversification

Different Asset Classes Perform Differently in Market Cycle

Many of the investors get into the fallacy of selecting the best performing scheme based on the past returns received. They forget the disclaimer that past returns are not an indication of future performance. That is why they pick the scheme at the top or near the top and thereafter said scheme goes into burst for many years. 

One very basic thing they forget that every asset class keeps on performing as per the rotation and nobody actually can predict which one is going to be the best or worst performer the next year or so.

You can see from the given below data table for various asset classes - Domestic Equity, Internation Equity, Gold & Bond, no one remain at the top consistently.

Last 15 years, you can clearly see there is a shift in the asset class performance.

The logic is simple, take some money out from the best-performing asset and infuse in worst performing and keep on rebalancing it every year.

Risk Profile Questionnaire

Attain all 10 MCQ to know your Risk Profililing:

A What would you consider "most important" with respect to your investments?
1 Low Risk with Low Returns
2 Moderate Risk with Moderate Returns
3 High Risk with High Returns

B You are on a TV show and can choose one of the following. Which one would you choose?

1 Rs. 10,000 in cash (guaranteed)
2 A 50% chance of winning Rs. 1 lac
3 A 10% chance of winning Rs. 10 lacs

C Your portfolio unexpectedly drops 30% in 3 months. What would you do?
1 Sell most of your holdings and stop your SIP
2 Do nothing - adopt a wait and watch strategy
3 Invest more in the market to take advantage of the reduced prices

D Your Financial Goals are predominantly
1 Short Term (< 3 years)
2 Medium Term (3 to 7 years)
3 Long Term (> 7 years)

E What is the first thought to cross your mind, when you invest your money?
1 I should not lose my money
2 This should not turn out to be a bad investment
3 I know this is a good decision

F How would you feel if the performance of your recent investments are below expectations
1 Very upset
2 Uneasy, but hope that it will improve in the future
3 Not upset because I know that all investments carry Risk

G Your personal investment objectives and financial goals are best described as:
1 Protect and preserve my capital
2 Produce a regular and stable income stream
3 Deliver high capital growth over longer-term are subject to high risk and volatility

H Your "cash need" is best described as:
1 My investments support my daily cash needs
2 I have regular income to support my daily cash needs, however, I appreciate the extra cash flow
3 My investment is for capital growth in the long term hence I don’t bother about interim payouts

I When you are looking for an instrument to invest in, what do you care about more?
1 Minimizing Losses
2 Both Equally
3 Maximizing Gains

J Please select the profile that best describes your willingness to accept losses on your portfolio
1 I am prepared to accept between 0% to 10% capital losses only
2 I am prepared to accept up to 20% capital losses only
3 I am willing to accept greater than 30% capital losses for the prospect of higher returns

Assign the score for each question as 1, 2, or 3 and aggregate to find out your final score.

Score Range	Investor Category	Risk	Debt %	Equity %
10-13	Conservation	Low	90%	10%
14-17	Conservation to Medium	Low to Medium	75%	25%
18-22	Medium	Balanced	50%	50%
23-27	Medium to Aggressive	Medium to High	25%	75%
28-30	Aggressive	High	10%	90%