Friday, January 05, 2007

Linkfest #2: Investing Thoughts

After a long vacation, I am back. Sorry for not informing you all about this long vacation. I am preparing an article on "Risk of Inflation" for the game plan series. Found good articles while browsing, hope you wouldnt like to miss it.

Hope you remember the first step of the Game Plan, Invest in yourself. Bye for now, would be back with interesting posts.

Thursday, December 28, 2006

Game Plan: Step 2 - Know your risk tolerance

Know your risk tolerance. There are two kinds of risks in investing: the risk of losing money and the risk of losing an oppurtunity to make money. Both are in conflict. Take for the case, if you invest in some instruments, it may lose some or all of your money. But due to the fear of losing your money you are missing out on making some good returns through investing. We should always have a good defence in the form of risk tolerance/protection built into our investment game plan.

Without having a risk protection built into your investment game plan, you are driving a F1 racing car without any brakes. You will experience high speeds and the thrill of that, but without brakes you will end up in a crash. There are few questions which when answered will help you in gauging your risk tolreance. See yourself in the situation explained and answer honestly to the questions, this would be a revelation to you.

Risk Quiz:

1. Your portfolio of investments is invested 40% in Debt funds and 60% in Equity funds, according to a long term goal plan. After 6 months you find that your equity funds are down 10 percent, even sensex is down 8%. Market analysts are not sure which way the market will slide to, You..

  1. Sell all of your equity funds and invest those in Debt funds
  2. Stick with your investment game plan
  3. You will sell your Debt funds and invest in equity funds

2. Your equity fund gave a return of 25% in 1995, 20% in 1996. It looked good to you, so you invested in that fund. Now the returns from that fund are as follows:

  • 1997 : 18%
  • 1998 : 15%
  • 1999 : 12%
  • 2000 : -8%
  • 2001 : -20%

During this period, you...

  1. Can't take the pain of 2000 into 2001 and sell
  2. Decide to hold through all the five years
  3. Move to a IT fund in 1999.

3. Your core fund has given you an year on year return rate of 10 %. You hear about an infrastructure fund which is posting nearly triple digit returns, and you heard good about the fund manager, You...

  1. Do nothing
  2. Sell 5% of your core fund and invest those in the infrastructure fund
  3. Sell 35% or more of your core fund and invest those in the infrastructure fund

4. Following question 3, say you invested 5% of your portfolio in the hot infrastructure fund and after 2 years, this fund represets 12% of your portfolio, You...

  1. Were the one who selected option 1 in question 3 and still wont do anything
  2. Sell half of the units in the infrastructure fund. You still have confidence but still you want to take some money back
  3. Thrilled by this infra fund, you invest more 10% of your portfolio in this

5. In early 2000, you learn that an IT fund gave a 120% return in 1998 and 170% return in 1999. You invest in this fund. By the end of 2000, the fund crashes and loses 90% and you dont expect the market to rebound soon. You..

  1. Would have never touched this fund ever
  2. Sell and take almost 10% of your investment which is left
  3. Stay the course while you watch another 70% of what was left disappear in 2001

Give 1 point where you have chosen 1st option, 2 points where you have chosen 2nd option and 3 points where you have chosen 3rd option. Not calculate your score.

  • 5 - 7 points - Conservative (Risk averse)
  • 8 - 12 points - Moderate (Risk steady)
  • 13 - 15 points - Aggressive (Risk seeker)

There are various other surveys which can give more better and accurate results. Some of them are

Wednesday, December 27, 2006

Game Plan: Third C - Courage

We would be discussing about the third C, "Courage". Commitment and Consistency are the pillars of your investment game plan but Courage is the foundation of these pillars. When markets go burst like in May and in December, only Courage will help you stay the course. Only courage can help you to follow your belief and your investment game plan i.e system. As we have seen in the previous post Game Plan: Consistency, to make probability work for you and not against you, You should have the courage to believe in your system, since its yours. This doesn't mean that we shouldn't learn from the mistakes we make. This means that you shouldn't avoid believing your system just because the market crashed and things like that which are not rationale.

Remember the tech bubble which got burst! People who had invested earlier where getting very good results. But you had after looking at company valuation (will tell later in the series, how to valuate a company), you decided that their fundamentals are not right. So you didnt invested in these companies, but looking at the returns your peers are getting, you start thinking that you have made a wrong decision.

So you enter into the market when the market is at its high and you loose all your money. This is the result of having no courage to believe in your methods. If you had courage to believe in your method and system, then you would not have invested into the tech sector. This is the worth of courage.

The biggest challenge in investing is to stay away from investing while others are printing money!!

Hence Step 1 is not about calculating your long term, medium term and short term goals. Rather its about fine tuning your mind to these set of values. Remember, stock exchange is not going to be closed tomorrow. Stop worrying that you may miss the bus. Stock exchange will remain there always but before the next bus arrives, be sure to make yourself learned enough to avoid missing the bus. You have to invest in yourself first, so that you have confidence in your methods.

Any financial planner can chart your long-term, medium-term and short-term goals. But if you dont follow the plan, will you be able to achieve your goals? You should have

Commitment to your plan,
Consistency with your plan
Courage to follow your plan

This will help you in the long term.

Quote of the Day:
The easiest person to deceive is one’s own self.
--Edward George Earle Bulwer-Lytton

Tuesday, December 26, 2006

Game Plan: Consistency

Consistency is a very essential attribute for an investor. You should be consistent with the way you approach the task of investing. If you are not consistent enough, you may lose this game. Basically investing is a game of probability. When you toss a coin, the probability of getting either an head or a tail is 50%. Now you toss the coin 3 times and the coin turns up as head, you would probably believe that now its the time of the tail to turn up. The probability of getting a tail is higher now. Right?? Answer is NO. The probability of getting tail/head is still 50%.

This is same as in investing. If your approach is right and when you calculate your risk properly and increase the probability of being right to 80%. So you have set up your investing process. Now following this investing process, you start investing but you are making steady losses. After some more losses, you start having doubts on your methodology and eventually, you move to some other process. But you would never know the losses which you were making were 20%. This is why you should have consistency. You should have belief in your system.

How can you be consistent? You can be consistent by saving a certain amount of money every month. You can be consistent by keeping on reducing your expenses regularly. You can be consistent enough by increasing the cash flow, the buzz word is being consistent. These are small drops, but eventually these small drops would form the ocean.. Keeping on waiting for the rain will not help.

I would like to be consistent in these following areas:

  1. To keep myself updated in all financial areas
  2. To save 50% of my monthly salary (I am a bachelor, so can help with 50%)
  3. Read atleast 4 financial books a month
  4. To reduce my expenses 10% a month.

Whatever field you want to be consistent in, just make it quantifiable. If you maintain it for a month, give yourself an inexpensive treat. This way you would keep the tempo high.

Let me know what you would like to be consistent. How?, by adding comments.. By stating it you make an commitment to yourself. (Haven't read about commitment, read this post Game Plan: The Three C's)

I am making my commitment to be consistent in the mentioned points.

Are you committed to be consistent??