Chapter 1.pptx operations strategy overall
- 2. Why Investments? • Investments are crucial for financial growth and wealth accumulation. By allocating funds strategically, individuals can generate returns that outpace inflation, preserving and enhancing their purchasing power over time. • Investments provide a means to achieve long-term goals such as retirement, education, and homeownership. INVESTORESULT
- 3. Financial Goals • When we assign amounts and timelines to objectives, we convert these into financial goals. • Goal setting is an essential exercise while planning for investments. • The first step in goal setting is identifying major life events. • After identifying the events, one needs to assign priorities–which are more important than the others. • A financial advisor may only guide and help one make an appropriate decision. • After that, one must assign a timeline and the funding required during such events. • The timeline and amount are critical for one to plan to achieve the goal. INVESTORESULT
- 4. Savings vs Investment • The word “saving” originates from the same root as “safe”. The safety of money is of critical importance here. Whereas when one invests money, the primary objective is earning profits. • The critical point to note here is that there is a trade-off between risk and return. • The other difference is evident from the dictionary definition of “saving”– reducing the amount of money used. This definition refers to reducing consumption so that some money is saved. • It is this saved money that can be invested. In other words, saving and investing are not to be considered as two completely different things but two steps of the same process – to invest money, one needs to save first. • Thus, saving precedes investing. INVESTORESULT
- 5. Inflation • Inflation refers to the general increase in prices or the money supply, both of which can cause the purchasing power of a currency to decline. • Suppose you have 5,000 rupees today, and the inflation rate is 3%. In a year, due to inflation, the prices of goods and services may increase by 3%. Therefore, the things that cost 5,000 rupees today might cost 5,150 rupees a year later. This means that if your money doesn't grow or earn interest, you may find it more challenging to afford the same items with the same amount of rupees as time goes on. Inflation illustrates the decrease in purchasing power of a currency over time. INVESTORESULT
- 6. Real Return vs Nominal Return • Nominal return is the total percentage change in an investment, including the actual return and the impact of inflation. • Real return adjusts for inflation, providing a more accurate measure of an investment's purchasing power. It represents the increase or decrease in wealth, helping investors assess the value gained or lost after accounting for the cost-of-living (Inflation) changes. INVESTORESULT
- 7. Factors to evaluate investments:- • The three most important factors in evaluating investments are:- 1. Safety 2. Liquidity 3. Returns INVESTORESULT
- 8. Different Asset Classes • The four broad categories:- 1. Real estate 2. Commodities 3. Equity 4. Fixed income INVESTORESULT
- 9. Real Estate • It is considered the most important and popular asset class. However, the popularity of this asset category is largely because of a reason unrelated to investment. • Real estate could be further classified into various categories: residential, land, commercial, etc. • Some unique characteristics of real estate- 1. Location is the most important factor impacting the performance of an investment in real estate 2. Real estate is illiquid 3. It is not a divisible asset 4. One can invest in physical real estate, as well as in the financial form 5. Apart from capital appreciation, it can also generate current income in the form of rents INVESTORESULT
- 10. Commodities • One can invest in commodities in two ways- commodities derivatives are available on many commodities. • It may not be wise to call these “investments” for two reasons, 1. These are leveraged contracts, i.e., one can take considerable exposure with a small of money, making it highly risky. 2. These are usually short-term contracts, whereas the investors’ needs may be for more extended periods. • Another way is investing in precious metals like gold and silver. It is easy to understand the prices of gold and silver across countries by looking at the foreign exchange rate between the two countries’ currencies and adjusting for various costs and restrictions imposed by any of the countries. INVESTORESULT
- 11. Fixed Income • Bonds are generally considered to be safer than equity. However, these are not free from risks. • Bonds can be classified into subcategories based on issuer type, i.e., issued by the government or corporates, or based on the maturity date: short- term bonds (ideal for liquidity needs), medium and long-term bonds (income generation needs). INVESTORESULT
- 12. Equity • This is the owner’s capital in a business. Someone who buys shares in a company becomes a part-owner of the business. • In that sense, this is risk capital since the owner’s earnings from the business are linked to the business’s fortunes, and hence the risks. • When one buys the shares of a company through the secondary market, the share price could be high or low compared to the fair price. • Historically, equity investing has generated returns over inflation, which means the purchasing power of one’s money has increased over the years. INVESTORESULT
- 13. Investment avenues classified under different asset categories INVESTORESULT
- 14. Liquidity Risk • Investments in fixed-income assets are usually considered less risky than equity. Even within that, government securities are considered the safest. • To avail the full benefits of the investments or to earn the promised returns, there is a condition attached. The investment must be held till maturity. If one needs liquidity, there could be some charges, or such an option may not be available. • Some investment options offer instant access to funds, but the value of the investment may be subject to fluctuations. • Equity shares, listed on stock exchanges, exemplify this. • While it is easy to sell shares to get cash in the case of most of the listed shares, the equity prices go up and down periodically. Such investments are not appropriate for funding short-term liquidity needs. INVESTORESULT
- 15. Investment Risks • Inflation Risk: Inflation or price inflation is the general rise in the prices of various commodities, products, and services we consume. Inflation erodes the purchasing power of the money. • Liquidity Risk: This risk is also very closely associated with real estate, where liquidity is very low, and often it takes weeks or months to sell the investment. • Credit Risk: Any delay or default in the repayment of principal or payment of interest may arise due to a problem with one or both two reasons: (1) the ability of the borrower or (2) the intention of the borrower. • Market Risk and Price Risk: Market risk is the risk of losses in positions arising from movements in market prices. There is no unique classification, as each may refer to different aspects of market risk. The risk occurs when the asset’s prices and futures contracts are not in tandem. Location-based risk arises when the underlying asset is in a different location from where the futures contract is traded. So, in a way, both risks are similar. • Interest Rate Risk: Interest rate risk is the risk that an investment's value will change because of a change in interest rates. This risk affects the value of bonds/debt instruments more directly than stocks. Any reduction in interest rates will increase the device’s value and vice versa. INVESTORESULT
- 16. Interest Rate Risk Example • Today • Interest Rate in market = 10% • Investment in bonds= Rs. 1000 • Interest Received= Rs. 100 • After 6 Months • Interest Rate in Market= 15% • Investment in bonds= Rs. 1000 • Interest Received= Rs. 150 INVESTORESULT
- 17. Behavioural Biases in Investment Decision-Making Availability Heuristic Confirmation Bias Familiarity Bias Herd Mentality Loss Aversion Overconfidence Recency Bias INVESTORESULT
- 18. Risk Profiling • To ascertain the risk appetite, the following must be evaluated: 1. The need to take risks 2. The ability to take risks, and 3. The willingness to take risks INVESTORESULT
- 19. Understanding Asset Allocation Strategic Asset Allocation is allocation aligned to the individual’s financial goals. It considers the returns required from the portfolio to achieve the goals, given the time horizon for the corpus creation and the individual’s risk profile. Tactical Asset Allocation is when one may choose to change the allocation between the asset dynamic categories. The purpose of such an approach may be to take advantage of the opportunities presented by various markets at different points in time. Still, the primary reason for doing so is to improve the portfolio’s risk-adjusted return. Rebalancing: An investor may select any of the asset allocation approaches; however, there may be a need to make modifications in the asset allocations. This rebalancing of the portfolio as per the initially agreed ratios is called rebalancing. INVESTORESULT