Investment IQ & Risk vs Returns

Investment IQ Test

http://www.moneycontrol.com/planning_desk/investmentiq.php

Use this tool to evaluate whether you should manage your investments yourself or whether you should approach/ use a professional manager. This evaluation will consider your temperament, aptitude and technical knowledge. It should take you between 5 and 8 minutes to answer the 20 questions below.

	How do you.... Review implies tallying your bank statements against your transactions. Have you ever... Answer yes only if you have prepared a budget as well as implemented it. Have you made... If your assets are always in joint names, this would qualify under "assigned nominees to all your assets".
	1. How often do you review your bank account statements? Atleast once a month. Definitely every quarter. Less frequently than once a quarter. 2. According to the Rule of 72 The money you need to retire is approximately 72 times your annual income. If you save only 5 percent of your income a year, the earliest you can retire is at age 72. The time it will take for your money to double is 72 divided by a given interest rate. The mortality age that Indians should plan their retirement fund for is 72. Don't know. 3. EVA is commonly understood as Estimated Value of Annuity. Economic Value Added. Enterprise Value Addition. Efficient Value Arbitrageur. Don't know. 4. Net present value refers to The sum total of all future cash flows. The current value of future cash flows adjusted by a discount rate. The valuation of a business after including intellectual capital. The value of a business after adjusting for the interests of the minority shareholders. Don't know. 5. Mutual Funds are attractive to investors who want Guaranteed returns. The ability to diversify their portfolio and are seeking professional money managers. A downside protection. To benefit from the contribution of other investors who will buy later. Don't know. 6. Have you ever prepared a budget and implemented it? Yes. No. 7. A payout ratio is The cost of debt for a company. The percentage of a firm's profits that is paid to shareholders in the form of dividends. The annual fees charged by the asset management company for managing a mutual fund. Don't know. 8. The commonly understood meaning of Asset Allocation refers to The distribution of assets of a deceased person amongst his/her heirs. The process of differentiating assets dependent on whether they are liable to income-tax or wealth tax. Planning the holdings of an HUF to minimise the tax liability. The apportioning of investment funds among asset classes such as equity shares, debt, real estate, etc. Don't know. 9. Which of the following statements best describes your approach to insurance? I invest in insurance mainly to save taxes. I have invested in insurance policies after carefully studying my family's financial needs in the event of my death. I believe insurance is expensive. I have a net worth well in excess of my family's financial needs and hence, do not need insurance. I do not have any dependants and hence, do not invest in insurance. 10. In life insurance, premium payable for a fixed-term policy is cheaper than that payable for whole life policy as Fixed-term policies have been available longer than whole life policies. Fixed-term policies offer risk cover only for a limited period and hence, does not build a cash value. Fixed-term does not pay you the entire sum assured in the event of death. Fewer individuals opt for whole life policies in comparison to fixed-term policies. Don't know. 11. Have you made a will or assigned nominees to all your assets? Yes. No. 12. Short selling refers to The sale of stocks that are expected to announce results that fall short of market expectations. The sale of short term investments. The sale of investments that have fallen short of your expected returns. The sale of a security by a person who does not own the security. Don't know. 13. Accounting on an accrual basis refers to Reporting income and expenses in the financial year in which they are incurred. Reporting income and expenses in the year they are received and paid. Accumulating expenses and deducting them after the corresponding income is received. Adding all free cash flows in a financial year to the previous year's capital to arrive at the current year's capital. Don't know. 14. You save Rs10,000/year from age 25-33 and your twin sister saves the same from 33-60 - at 10% p.a. who will be richer at 60? You. Your Sister. Don't know. 15. On investing Rs 20,000/year, which would give a better return after 20 years, if you are in the highest tax slab? National Savings Certificate wherein the interest is re-invested. Public Provident Fund. A monthly income plan from a mutual fund that offers a guaranteed return of 10.75%. An insurance policy that offers high returns. Don't know. 16. Which of the following statements best describes you? It is really difficult for me to find time for anything other than my work. I barely manage to find time to meet my family and social commitments. I have enough time to pursue my hobbies and special interests. I never have a problem finding time. Don't know. 17. For a company, Return on Net Worth refers to The net profit divided by the net worth. The amount of dividend paid per share divided by the market price of the share. The amount of dividend paid as a proportion of the net worth. The revenues divided by the net worth. Don't know. 18. Which of the following is taxable? Income from capital gains. Insurance receipts. Gifts. Income from exports. Don't know. 19. Opportunity cost is best described as Using every opportunity to sell your bad investments at cost. The cost of identifying investment opportunities for investment. The value of what you give up to avail of an alternate option. The strike price of a stock option. Don't know. 20. Academically speaking, which of the following investment portfolios have the lowest risk to loss of capital Equity shares of multinational companies. Company debentures with the highest credit rating. Government securities. Debt mutual funds. Don't know.

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Risk vs Returns

http://www.moneycontrol.com/planning_desk/riskreturns.php

Every investment has an attached risk

Just buy this blue-chip stock, there�s no risk at all.� For most people who invest in shares there is a good chance that you�ve heard someone say this before. For most people who just put their money away in bonds or deposits, one of your main reasons for this probably is -�I don�t want to take any risk at all, I just want my money safe.� Are these statements true? Is investing in bonds or deposits completely risk-free? Or investing in blue-chip stocks necessarily very low risk? NO. Whenever more than one outcome is possible from an investment, there is always some amount of risk. Only the level of risk is different.

Use risk to analyse expected returns

While investing, risk is measured to evaluate the kind of returns you should expect from the investment. Or your return expectations should be based on the level of risk you can bear. In principle, the higher the risk, the higher the returns that should be required. Empirically returns across various asset classes show that investment in equity shares give the highest level of returns in the long-term, followed by corporate bonds and deposits and lastly bank deposits and government debt. Not surprisingly, the level of risk is also in the same order. You might be saying - how can debt be risky? It is. Companies that run into financial trouble could delay your interest payments or even default on paying back your money. Even government debt has some amount of risk. How? Simply put, governments like companies also face the risk of financial problems. However, lack of funds for a company could result in the company defaulting on a loan repayment. But a government can always print more currency and repay its borrowings. So you will get your money back. BUT, there is a hidden cost (risk). Printing more currency is likely to lead to higher inflation and hence lower real returns on your investment (see our article Running to Stand Still to understand about real returns). Agreed that the chances of governments or well-managed companies getting into serious financial troubles are low. But that is only difference in the level of risk. There is a risk attached, and that cannot be questioned.

Understanding risk vs return essential for good financial planning

You might ask - why is it so important to understand the risk versus return relationship? Because if you don�t, it is quite likely that your investment returns will not match your risk profile and consequently you are not managing your hard-earned money well. A wasted opportunity, as even a small difference in your investment returns (at the same level of risk) can make a BIG difference to your financial wealth (due to the astounding Power of Compounding). To understand the importance of managing your money well read Guide To Financial Planning. This article highlights why financial planning is not as difficult as it sounds and how you can easily make your hard-earned money work for you. Also you can use our Risk Analyser to understand your risk profile (both your risk-taking capacity and your risk tolerance level) and read The Need To Diversify to understand how you can increase your expected returns while not increasing your level of risk.

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The Need to Diversify

http://www.moneycontrol.com/planning_desk/needdiv.php

Reduce risk without compromising returns.

In our article Risk versus Return we highlight how every investment has a risk attached. And how the higher the risk, the higher should be the expected return from any investment. This probably then imply that if you want to reduce the risk in your portfolio, the only choice for you is to move your investments into low yielding investments. Right? Wrong.

Diversification across investments is another way to reduce the risk of your portfolio.

To understand how, look at this simple example (it involves some basic statistical concepts but don�t get turned off, its simple to understand and you can get into the calculations only if you want) - Say, there are two assets A and B. Both assets have a potential return of 10% and a standard deviation (a statistical measure which measures the variability (i.e. risk) of the potential returns) of 20%. Also, the returns of both these assets are uncorrelated i.e. the performance of Asset A is not dependent at all on the performance of Asset B. Now assume you invest equally in both these assets. Your weighted potential return (0.5 * 10% + 0.5 * 10%) will equal 10% - this is the same return as that for the individual assets. However, due to the fact that you have now spread your risk over two uncorrelated assets, the standard deviation (i.e. risk) of your portfolio will be 14.1% (lower than the 20% for each individual asset). Refer to the supporting Statistical Analysis if you want to understand how. It is important to understand what this means. You would have been able to reduce the risk profile of you�re the returns on your portfolio to 14.1% (from 20% for an individual asset) without having to compromise on your returns, merely by diversifying. So, by choosing two assets whose returns are not correlated (this is important) like say Stock A which is a pharmaceutical company and Stock B which is a software company, you can reduce your risk while not necessarily having to reduce your returns. In summary, there are two things that are important to keep in mind while planning your investments -

1. Every asset has a risk attached to it.

And, the higher the risk, the higher should be its expected returns.

2. Don�t put all your eggs in one basket.

By diversifying across assets, you can reduce your risk without necessarily having to reduce your returns. You don�t have to get into calculating standard deviation of the return of your assets, you need to just be aware that if you diversify your portfolio, your overall portfolio risk will be lower. To get the maximum benefit of reducing your risk through diversification spread your portfolio across different assets whose returns are not 100% correlated. Different assets should ideally span across different asset classes such as fixed income, equity, real estate, gold as well as different investment options within these asset classes e.g within equity shares, your exposure should be to companies in different sectors; or within fixed income investments, partly government risk and partly corporate risk.

As a thumb rule, diversify your investments across 15-20 different individual assets.