Why some assets are riskier than others

Posted by Mehul Kothari | Published on 04 Feb 2019
Image
Why some assets are riskier than others

Be it stocks, mutual funds, bonds, exchange-traded funds or real estate, there is an element of risk in all types of investment.

The only thing that separates them is the degree of risk.

In order to understand this better, let’s look at factors such as investment risk management, investment risk and return etc., amongst others that determine the risk level of each investment option.

Factors that influence risk element of each asset

What is investment risk? The risk level of each asset is dependent on its characteristics, investment horizon and behaviour (the way an asset reacts to change in overall market, political and economic environment, interest rates etc.).


• Level of volatility
Volatility indicates how rapidly the value of an investment asset can change in a specific time period.

This is why stocks are considered volatile. That’s because share prices can change several times in a short time. This means that you can either make a large profit or lose a large chunk of your investment in a short time. A fixed deposit, on the other hand, is less volatile because its value doesn’t change intermittently. This is why fixed deposit returns you receive are fixed.

• Time horizon
Duration of an investment can determine the risk level as well. For example, a short-term equity investment can be risky because its value changes constantly. But when it’s held for a longer period of time, various studies show that equity is a high-performing asset class. That’s because the price of equity usually flattens in the long run. There is a sense of stability in the long run.

Meanwhile, debt investments are relatively safe for short- to medium-term goals. That’s because they provide steady returns if not kept for very long. They can be a long-term investment option as well but the returns may not be able to beat inflation. This is why people usually opt for equity over the long-term and debt investment for a shorter time period.

• Nature and characteristics
You also need to look at the nature of an asset class (equity, debt and gold are some examples of an asset class). Let’s take the example of stocks again. Owning shares of a company means you own a part of their business. You are entitled to company’s profit. You are also expected to bear the loss. This is why stock investments can be a high-risk, high-reward investment.

On the other hand, investing in bond means lending money to an entity (it can be a government or a corporate) for a defined period. The chances of losing your money in such cases occur only if the company or the government default.

• Asset behaviour towards economy
Risk can also be assessed by particular asset’s behaviour towards prevailing economy. For example, market value of bonds reduce with an increase in interest rate and vice versa.

Equity investments also get impacted by everyday price movement, industry performance and many other factors.

• Individual investor’s risk tolerance
In the end, everything boils down to an investors’ ability to take risk. For example, investing in equity can be a risky proposition for a retired person because they usually look at an asset class that can provide them a steady source of income. In contrast, the risk appetite of a younger person is usually higher and may opt for equity. That’s because they can absorb the short-term volatility and wait for the investment to potentially provide high returns in the long run.

To sum up
Every financial asset has a degree of risk. Understanding the nature and level of risk helps you manage those risks effectively to pursue your financial goals. This is why IndiaNivesh can offer you specialised solutions to achieve your financial goals.

PREVIOUS STORY

Tips for financial planning

Posted by Mehul Kothari | Published on 28 Jan 2019

You might not be born rich but you can grow into wealth. After all, becoming rich is not luck. It is effective financial planning. And to make an effective financial plan, you need to employ a few basic financial planning tips and avoid mistakes that can jeopardise your entire financial plan.There are some best financial planning tips which, when followed, lead to effective financial planning. Do you know these financial planning tips India? They are simple to follow and can easily manage your debt. Here are some:• Save first, spend laterThis is the first tip for you to follow in your financial planning process. Whenever your income is credited, save a portion of it first. At least 30% of your income should be directed towards savings for your financial goals. Of this 30%, hold 10% in an emergency fund for unforeseen expenses. (Link to thumb rule article). Also, another 10% should go towards a retirement corpus. This way, you start retirement planning early and retire rich. • Plan your taxes and tax savingTax is an integral part of your income. Breaking it into relevant sections like medical, travel, etc. can be a nice trick. It can help you make the most of all possible tax exemptions and deductions. Here are some tips to maximise tax benefits:• Section 80C lets you save up to Rs.2 lakh of your taxable income from tax. Use the investment avenues of this section to maximize tax-saving. You can choose from PPF, ELSS, 5-year Fixed Deposits, National Savings Certificates, etc. This includes the additional Rs.50,000 deduction that you can get through National Pension Scheme (NPS). • Section 80D lists tax-saving options on health insurance for self, spouse children and dependent parents. You can save up to Rs.60, 000 of your taxable income if you pay premiums for health insurance policies of your family and your parents. Also make use of the tax deductions on medical expenses. • Home loans can save tax in two ways. You may know about the deduction on principal repayment as a part of 80C. But do you know that the interest component also gets a tax deduction, over and above the limit of Section 80C? This is as per Section 24 that allows interest on home loan to get you a tax deduction. This section’s provisions can be utilised for maximum tax-saving.• Manage your debts: Control bad loans, optimise good loansThe next important tip is managing your debt. Repay your loan instalments on time to avoid damaging your credit score and high interest payments. Stay away from or get rid of bad loans and optimise good loans. Here are some ways how: Bad Loans:1. Credit card loans involve very high interest. Also, the interest is charged on a per day basis until you pay off the debt. Thus, the interest compounds and your net cost rises too high. So, pay off your credit card loans first. Never revolve credit card outstandings.2. Personal loans also have high rate of interest and little tax efficiency. After you pay your costly credit card debt, prepay or pay off your personal loan debt next. Refinance loans to lower interest rates if possible too. 3. Car loans being secured loans have a lower rate of interest. But they can be paid off at the earliest too. After all, they provide no tax relief, unless you are classified as a ‘professional’ in the tax system. Good Loans:1. Home loans are good loans as they help you save tax. We read earlier about the tax deductions on your home loan principal and interest repayments. So, if you have a home loan, don’t rush to prepay it.2. Similarly, zero-interest finance options need not be prepaid. Instead, use your excess funds for investment to generate good returns.3. Education loans too provide tax benefits. So, think twice before prepaying these too. • Don’t put all eggs in one basket: Diversify your investmentsDon’t favour one investment avenue. Diversify. Have a good equity-debt mix in your portfolio. The proportion of debt investment in your portfolio should be equal to your age. As you grow older, your debt investments can increase as your risk-taking ability reduces with age. Of course, don’t confuse this with loans and other debt liabilities. Equity allocation should depend on your risk appetite.• Pen your goalsGoals are best understood and remembered only when they are penned down. Analyse whether your goals are short-term or long-term ones. At least 10% of your investments should be directed towards long-term goals, while the rest can be directed for short-term investments. Pick the right investment avenues based on the horizon of your goals. Don’t invest in long-term investments for your short-term goals.

read more

NEXT STORY

Risk mitigation through diversification

Posted by Mehul Kothari | Published on 04 Feb 2019

Risks are a constant in the world of investment. They cannot be eliminated. But, there are strategies to minimise them. How to reduce investment risk? Investment risk can be reduced by risk mitigation strategies to ensure that the end goal is not adversely affected. How to manage investment risk? Risk management can be adequately managed through a fundamental component of in investment approach. It is needed to improve investment outcomes. The right strategy keeps losses within an acceptable boundary during hard times and helps to cover up losses during good times. Diversification is one such time-tested risk mitigation strategy. Here are some tips to diversify investment risk. What is diversification?Diversification is a means of managing an investment portfolio. Through this one can invest in a wide range of financial assets. So, even if a certain set of your assets do not perform well, it can outweigh the declining performance of the rest of your portfolio. Diversifying balances out and reduces the overall risk associated with a portfolio. Every asset performs differently based on the prevailing market conditions. Diversification is all about investing in various non-related assets to balance out the risk exposure. Non-related assets are assets like equity, bond and gold, whose performance does not depend on each other.Some assets are also co-related to each other’s performance. For example, equity markets tend to slump during an economic downturn. During such times, the Reserve Bank of India (RBI) tries to stimulate economic growth by lowering interest rates. As interest rates start to fluctuate, co-related assets such as bond prices also tend to go up and down. Thus, equity and debt are inversely correlated to some extent. In short, diversification simply refers to ’don’t put all your eggs in one basket’. Instead of investing in a single investment avenue, you can invest in multiple financial assets such as stocks, bonds, mutual funds and real estate etc. Moreover, you can also choose to diverse the investments within the same asset class. For example, you can invest Rs. 10 in different shares of varied sizes, industries and sectors. In doing so, you are at a minimal risk of loss in the event of a fickle market environment.Thus, a well-diversified portfolio helps you in the long run by spreading out the risk of an asset and minimising overall investment risk, thus helping you to pursue your investment objective. Here it is important to note that though diversification effectively reduces overall risk, it cannot completely erase it. *The table suggests that the average risk of the portfolio reduces with the rise in the portfolio size.How to diversify investment risk? Spread your investments across different assets. The risk and return profile of each asset class could vary. Equities are riskier than bonds. Hence, choosing a proper mix of less, moderate and high risk investment avenues can also help in diversifying as per your risk profile and time frame to achieve investment objective. Every asset class responds differently to economic changes. Therefore, figuring out the right mix based on your investment plan is the key to diversification. Consider different assets within the same asset category. To build a diversified equity portfolio, buy 15-20 stocks across varied sectors. Opt for negatively correlated stocks. For example, you can choose to invest in shell stock (oil production companies) and airlines (oil consumer) as the price of these company shares are negatively correlated. Negatively correlated stocks perform better if the other one drops, i.e. contra performance. Thus, diversification helps in averaging out the returns so that if one asset class does not perform well in a timeframe, the other one would make up for it. Remember diversification is an ongoing process. You need to constantly review your portfolio and rework on your diversification strategy based on your current need and situation. A disciplined approach can help you survive the ups and downs of a volatile market. Take expert help. Seeking help of financial experts can help you in building a well-diversified portfolio. Financial experts can help in designing a diversification strategy that can effectively reduce risks and maximize your potential returns in the long run. ConclusionIn a nutshell, diversifying your investment among various asset classes protects you against significant losses by mitigating risks. Follow an asset allocation strategy as per your risk tolerance, investment goals and financial circumstances. Diversify among and within various asset classes to reduce risks and achieve your financial goals. Get guidance from a financial professional on asset allocation and diversification for your portfolio. IndiaNivesh expertise in the field can help you mitigate the risk through diversification to achieve your financial goals.

read more

Are you Investment ready?

*All fields are mandatory

related stories view all

  • What is a Unit Linked Insurance Plan, Types & Benefits
    Posted by Rushabh H. Mehta | Published on 06 Mar 2020

    What is ULIP? Insurance plans are meant to provide financial security to you so that in case of premature demise, your family does not face any financial trouble. Though insurance plans provide unmatched financial security, many individuals also seek good investment returns on their premiums. Keeping this sentiment in mind, ULIPs were launched in the year 2000 when private life insurers were also allowed to operate in the insurance domain. Today, ULIPs have become quite popular, and insurance companies are offering different types of ULIPs to their customers. Let’s understand ULIP meaning in detail and its benefits – What is a ULIP plan? ULIP’s full form is Unit Linked Insurance Plan. A ULIP is an investment-oriented life insurance plan. The plan gives you the dual benefits of investment returns and insurance coverage. The premiums that you pay for the plan are invested in market-linked investment funds, which offer attractive growth. Returns under ULIPs are, therefore, not guaranteed but can be attractive if given time. How do ULIPs work? ULIPs are considered to be a transparent insurance plan as the premiums you pay, and the growth can be easily monitored. When you buy a ULIP, you can decide the amount of premium you wish to pay (provided it is at least the minimum required premium under the plan). The sum assured is then calculated based on the amount of premium paid. ULIPs have different kinds of investment funds which include the following – Equity fund wherein at least 65% of the portfolio is invested in equity-oriented securities Debt fund wherein at least 65% of the portfolio is invested in debt-oriented securities Balanced fund which combines both equity and debt investments for moderate risks and moderate returns You can choose one or more of these investment funds as per your risk appetite. After that, relevant charges are deducted from the premium, and the premium is directed towards the selected fund. As the value of the underlying assets grows, the value of the fund grows. Your investment in the fund also grows, and you get market-linked returns. ULIPs also provide you with various flexible benefits which are as follows – Switching – under switching, you can change the investment funds if your investment preference has changed Partial withdrawal – you are allowed the flexibility of withdrawing from your fund value partially after the first five years of the policy have expired Top-ups – additional investments can be done towards the plan through top-up premiums Premium redirection – you can choose to redirect your subsequent premiums to another fund from the next policy year under this facility Surrender of the plan – if the first five years of the policy have been completed, you can surrender your policy to terminate the coverage before the chosen term. When the policy is surrendered, the available fund value is paid as surrender value, and the plan is terminated. Benefits payable under ULIPs Under most unit-linked plans, you get either a death benefit or a maturity benefit. These benefits are as follows – Death benefit – the death benefit is higher of the available fund value as on the date of death or the sum assured. If the fund value is higher than the sum assured, the fund value is paid otherwise, the sum assured is paid. Maturity benefit – when the term of the plan comes to an end, the fund value is paid as maturity benefit. The maturity benefit can be taken in a lump sum, or you can also avail the benefit in instalments over the next five years through the settlement option feature, which is available under most unit-linked plans. Types of ULIPs Though ULIPs are aimed at creating wealth, there are different types of ULIPs based on the financial goal that they fulfil. These types include the following – Investment ULIPs Investment ULIPs are the most common unit-linked plans which aim to create wealth over the term of the policy. Child ULIPs Child ULIPs are especially designed unit-linked plans for the financial security of the child if the parent is not around. Under these plans, the parent is insured while the child is the beneficiary. These plans have an inbuilt premium waiver rider. If the parent dies during the policy tenure, the death benefit is paid. However, the plan does not terminate. The policy continues, and future premiums are paid by the company on behalf of the insured parent. On maturity of the policy, the fund value is again paid as the maturity benefit which provides the child with the financial corpus needed to pursue his/her dreams. Pension ULIPs These are other specific unit-linked plans which help in creating a retirement fund. Pension ULIPs are deferred annuity plans wherein you pay premiums during the policy tenure to build up a retirement corpus. In case of death, the death benefit is paid. However, if the policy matures, pension ULIPs allow you to receive annuity pay-outs from the corpus created or defer the vesting age from which you would receive an annuity, or withdraw 1/3rd of the corpus in cash and use the remaining fund value to receive annuity payments. Thus, pension ULIPs create a source of income after retirement and are suitable for individuals looking to fulfil their retirement planning needs. Benefits of ULIP A ULIP is popular because of the following benefits it provides – It allows you to avail insurance coverage as well as investment returns in a single product The premiums paid and the benefits received under ULIPs are completely tax-free in nature helping you save tax The flexible benefits of ULIPs allow you to manage your investments as per your investment strategy The different types of ULIPs help you fulfil the various financial goals that you might have Switching and partial withdrawals do not attract any tax making ULIPs tax efficient Since the returns are market-linked, you get inflation-adjusted returns from ULIP ULIPs are attractive insurance policies that give you coverage as well as returns. Now that you understand ULIP meaning, its types and advantages, use our IndiaNivesh platform to invest in a plan as per your insurance and investment needs and enjoy all the benefits that the plan has to offer.   Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.

    read more
  • What is CAGR & How to Calculate it?
    Posted by Rushabh H. Mehta | Published on 06 Mar 2020

    There are different types of investment avenues in the market and each of these avenues promises you a compounded rate of growth if you remain invested. Compounding of return means earning a return on the return earlier generated. So, if you invest INR 100 and earn a return of 10% in the first year, the amount would become INR 110. Thereafter, in the second year, you would earn 10% on INR 110 giving you a return of INR 11. This compounding helps grow and multiply your wealth considerably over a period of time. In the case of market-linked investments, the rate of return is not guaranteed. It varies over the investment period. To know the average rate of return on your investments, the concept of CAGR is used. Let’s understand what CAGR is and how it helps you find the growth of your market-linked investments. What is CAGR? CAGR’s full-form is Compound Annual Growth Rate. The Compound Annual Growth Rate, in simple terms, is the average rate of return of an investment over a one year period. CAGR takes into account two important factors - the time period of the investment and the fluctuations in the return. Since the returns vary depending on the market fluctuation, finding the return over a specific time period becomes difficult. CAGR gives you the average growth rate offered by the investment over the said time period. CAGR shows the approximate growth rate considering that there is no market fluctuation and that the returns earned are reinvested into the investment. How to calculate CAGR? It is very easy to calculate CAGR. There is a CAGR formula which you can use to find the Compound Annual Growth Rate of your investment. The CAGR formula needs three important details which are as follows – Value of the investment made initially (VI) Term of investment (T) Value of the investment at the end of the term (VE) Using these three inputs, the CAGR formula becomes – CAGR = (VE / VI) ^ (1/T) – 1 Let’s understand with an example – Mr. A invested INR 10,000 in a market-linked investment avenue. After 3 years, the value of his investments stands at INR 13,500. The CAGR for Mr.A’s investment could be calculated as below – VI – INR 10,000 T = 3 years VE = INR 13,500 CAGR = (13500/10000) ^ (1/3) – 1 = 10.52% How CAGR helps understand the mutual fund growth rate? Mutual funds are market-linked investment avenues which do not offer a guaranteed rate of return. Since the returns are subject to market fluctuations, CAGR becomes an accurate tool to measure the performance of the fund over a specified period. Investors can check the annual CAGR of mutual fund schemes and use the rate to find out which scheme offers better returns than others. The fact sheet offered by the mutual fund house contains returns generated by the fund over different time frames. These returns can prove to be confusing and so CAGR is an easier alternative to understand the performance of the fund. CAGR acts as a ready reckoner for investors to assess returns from a mutual fund scheme and also highlights the compounding of returns on mutual fund investments. Important points to know about CAGR The investment risk inherent in the scheme is not highlighted by CAGR. CAGR is merely a yardstick to measure the growth rate CAGR proves to be a good measure of growth for a short-term period, i.e. up to 6 or 7 years. If you are considering long-term investments, the growth trends over a short-term period would be averaged out. In such cases, CAGR would give an average rate even if the fund performed excessively well in a two or three year period and then the returns fell in later years. CAGR changes every year since the investment period changes CAGR for two investment funds can match one another even if the funds are different. This might happen if one fund performed well initially and the other one performed well in the last few years. As a result, the performance is averaged out and the CAGR Other modes of calculating returns from investments Besides CAGR, there are other ways to calculate the returns generated by market-linked investments. These ways are as follows – Returns since launch Under this model, the return earned by the fund ever since it was launched and till the present date is calculated. Trailing returns Under the trailing returns approach, you measure the performance of your fund daily, weekly, bi-weekly, monthly or annually. Annualised returns Annualised returns are calculated as the geometric average of the return yielded by the fund over a given period of time. CAGR v/s Absolute returns Absolute returns measure the total return yielded by an investment. The time period is not considered. CAGR, on the other hand, measures the return over a specific time period. For instance, in the previous example, INR 10,000 grew to INR 13,500 over a 3-year period. The absolute return would be 35% since it measures the total return earned on the investment. However, when CAGR is considered, the time period of investments is also taken into consideration thereby considering the time value of money. As such, CAGR comes to 10.52% which is a more realistic figure. While absolute returns show the returns generated, the time period is missing. You cannot figure out how many years it took the investment to generate this return. But CAGR shows you the annual return making it easier to make a judgement on the performance of the fund. The next time you invest in mutual funds, stocks or other market-linked investment avenues, consider their CAGR to choose the fund or investment which has better returns over its peers. So, visit IndiaNivesh and find out a mutual fund scheme of your choice and then compare the scheme’s CAGR with its peers to choose the best performing fund.   Disclaimer: Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing. 

    read more
  • Capital Market – Meaning, Types & Functions of Capital Market
    Posted by Mehul Kothari | Published on 20 Nov 2019

    We all know how various companies and industries raise funds for their short term requirement through the money market. However, when they need funds for long term, capital market is their source. The capital market is just like the money market but with a difference that funds raised in the capital market can be used only for long term. In this article, you will learn about the concept of capital market in detail. Let us first understand what is the capital market? Understanding Capital Market Capital market in simple words means the market for long term investments. These investments have a lock-in period of more than one year. Here, the buyers and sellers transact in capital market instruments like bonds, debt instruments, debentures, shares, derivative market instruments like swaps, ETFs, futures, options, etc. Let us now understand the types of capital market. Types of Capital Market The capital market is of two types i.e. Primary Market and Secondary Market. Primary Market The primary market is also called “New Issue Market” where a company brings Initial Public Offer (IPO) to get itself listed on the stock exchange for the first time. In the primary market, the mobilisation of funds is done through right issue, private placement and prospectus. The funds collected by the company in the IPO is used for its future expansion and growth. Primary markets help the investors to put their savings into companies that are looking to expand their enterprises.  Secondary Market The secondary market is a type of capital market where the securities that are already listed on the exchange are traded. The trading done on the stock exchange and over the counter falls under the secondary market. Examples of secondary markets in India are National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). After learning about the types of capital market, let us now learn about the capital market instruments through which money is raised. Ways of Raising Funds Offer through Prospectus In the primary market, the prospectus is used to raise funds. The company invites the investors and the general public through an advertisement known as the prospectus to subscribe to the shares of the company. The shares or debentures are allotted to the public on the basis of subscription. If the company receives a high subscription then allotment is done to them on pro-rata basis. The company hires merchant bankers, brokers or underwriters to sell the shares to the public.  Private Placement Some companies try to avoid the IPO route to raise funds as it is very costly. Instead, they give investment opportunity to few individuals via private placement. Here the companies can offer their shares for sale to select individuals, financial institutions, insurance companies and banks. This way they can raise funds quickly and economically. Rights Issue The structure of capital market allows the companies in need of additional funds to first approach their current investors before looking at the other sources for finance. The right issue gives the current investors the first opportunity to make additional investments in the company. The allotment of right shares is done on pro-rata basis. However, if the current shareholders of the company do not want to exercise their rights, the shares can be offered to the public. e-IPO e-IPO means Electronic Initial Public Offer. e-IPO is an agreement between the stock exchange and the company to offer its shares to the public through online mode. It is a fast and speedy process. The company here needs to appoint registrar to the issue and brokers to accept the application received from the public. The above mentioned are the ways of raising funds through the capital market. Let us now learn about the various functions of the capital market. Functions of the Capital Market Helps in the movement of capital from the people who save money to the people who are in need of it. Assists in the financing of long term projects of the companies. Encourages investors to own the range of productive assets. Minimises the transaction cost. Helps in the faster valuation of financial securities like debentures and shares. Creates liquidity in the market by facilitating the trading of securities in the secondary market. Offers cover against price or market risks through the trading of derivative instruments. Helps in efficient capital allocation by way of competitive price mechanism. Helps in liquidity creation and regulation of funds. The above mentioned are the functions of the capital market. The capital market performs its functions with the help of buyers and sellers who interact and transact. The structure of the Indian capital market is well regulated and highly organised. The capital markets may be sometimes termed risky because they do not give fixed returns annually. But when looked from a long term perspective, their performance has always been good and rewarding for the investors. If you want to learn more about the capital market or put your savings in the capital market, you can contact IndiaNivesh Ltd.Disclaimer: "Investment in securities market and Mutual Funds are subject to market risks, read all the related documents carefully before investing."

    read more