What to look while you choose a mutual fund :)

One of my readers was confused with the question “Which mutual fund should he invest in through SIP ? ”

He started an SIP of 1000 in Reliance Regular Saving mutual fund , suggested by an agent . How was his investment? It is a mistake or a good decision? This is a common problem with investors .

Let me today give you a simple way to think and a methodology to choose mutual funds for your investment depending upon your requirement . In this article we will only talk about investment in Equity Diversified mutual funds for long term (5+ years) .

choose mutual fund

For Beginners : Read what are mutual funds

Question : What does the return from mutual funds tells us? and how do you interpret it?

Ans : Understand that the returns of a mutual fund shows you how did it perform over than period, How did it manage his funds and took there investment decisions in good times and bad times. It means that you should see its performance in good times and bad times.

A simple analogy can be how do you want your wife/husband to be like, One who is really great in good times and excellent person to be with in Good Times, when everything in life goes great.

Or you want a person who is there with you in good and bad times, supports you in good and bad times. When times are good, everyone behaves good and performs well, There is a saying “Don’t judge people by there Sunday appearances”. Look at a bigger Picture.

Looks how a mutual fund performed in good times, in bad times, did it invest according to there plan, Is there management excellent. It does not matter if they were No 1 or No 2 this year or that year.

But if they were just good in every year, and perform well above there benchmark, and keep performing over time, Its bound to be become an excellent long term consistent performer.

Question : What about the last 3 yrs returns of a mutual funds?

Answer: It will give you a good indication, but not an overall picture. If you see 3 yrs return, you have to understand that out of those 3 yrs, 1st and 2nd years were strong bull markets, where any dog and cat has also performed very good if not excellent. and in last year they gave very bad returns.

So ultimately they will be in positive returns in 3 yrs. You should also look at there 5 yrs return and 3 yrs returns. Both in synergy with each other.

When you see Reliance Regular Savings Fund you can see that its 3 yrs returns are 7.82% which is very good compared to other funds (this fund is Rank 2/135 in the 3 yrs category ), but when you see its 1 yrs returns, you can see actual face, the returns are -51%, if you see the rank for 1 yr, its 127/210.

If you look at its portfolio allocation at https://www.valueresearchonline.com/funds/portfoliovr.asp?schemecode=2790

you can see that its allocation to mid cap and small cap companies is very high, It can give you good returns but also it has very high risk. Please understand that i am trying to say that this fund is good or Bad. No !! I am trying to tell you what to see, how to interpret.

What factors should you keep in mind before choosing a Mutual Fund?


People get excited by seeing returns of years 2003-2007, that was in range of 35-50%. Which is not possible in long term. Now from this point on (2009), the returns in long term will be in range of 12-15% (max 20%). Its difficult to see this kind of bull run in another medium term (5-7 yrs).

Now you should just expect normal 12-15% kind of returns in long term.

So, whom should you rely on, On mutual funds who launched them selves near 2001-2002 and gave great returns from there onwards because they them selves don’t know how they gave them.

Or shall you choose those mutual funds who have seen all types of markets in India and continuously gave much better than average returns from long term, They performed in good market, bad market, quiet market and roaring market.

So the things you should look at mutual funds are :

1. Long term performance, It should figure out in top 10-15 at least over 5 yrs returns.

2. They should have a track record of consistently outperforming its Bench mark (this shows that they did better than what they were based on and tracking ).

3. See that its management is good, Don’t just buy Any Idiot MF just because it returns 45% last year, but you have never heard of its parent name. Some long term Great AMC’s are DSP, SBI, Sundaram, HDFC, KOTAK, PRINCIPAL, HSBC, RELIANCE (In order of my liking), Make sure you dont follow this, it is just to give an idea. DSP is one of the best and old AMC in India, dont look only for Indian names.

4. Once you shortlist some mutual funds, then look for its portfolio allocation, see how it has put its money for large, Medium and small cap companies. If its concentration is high on Mid and small cap funds, it means that it has more than average risk, but potential for very great returns also, choose it if it fits your risk appetite.

For people who just want to take a short route and want to choose some mutual fund based fast, but with not great accuracy, you can just see the list of mutual funds appearing on 5 yrs returns list or since inception returns (Should be greater than 3-4 yrs at least) and choose any one of them.

This will make sure that you have not made a bad choice, if not great.

Some links :

To see the rankings of mutual funds and compare them on different parameters

1. Go to https://www.valueresearchonline.com/funds/default.asp

2. In the right side, you can see “Compare Fund”, choose “Open Ended” in the first box and for the second part choose “Equity Diversified” or “Tax Planning” or any other thing which you want to compare. and now click on Go.

3. You can now see a list with different parameters like Snapshot, Performance, Portfolio etc etc.

4. Click on Performance and then you can see different parameters like 1 month, 6 months, 1 yr, 3 yr, 5 yrs and ranks. You can sort them by clicking on 5 yrs or 5 yrs ranking to see the ranking. Example. When you click on 5 yrs returns on the top, you can see the ranking either in ascending or descending form (click once again to see in different order).

5. In the same way you can choose different parameter also.

This article gave you a general idea on how to choose a mutual fund and interpret different things. You can also do some advanced analysis the way I discussed in one of my previous article : https://www.jagoinvestor.com/2009/01/95-of-salaried-people-are-rushing-to.html

Question : Which Mutual funds I will invest in if given a choice?

Ans : I hate this part for suggesting some mutual funds, but i know people look for it and expect so let me give some.

Equity Funds :

1. Sundaram BNP Paribas Select Focus Reg
2. DSPBR Equity-D
3. Magnum Contra
4. Sundaram Taxsaver (For TAXSAVING) : see this for more
5. Nifty Beas (Index Fund, take SIP in this) : see this article for more

If this article helps you in anyways, please comment to tell if you liked it and learned anything important from this. I would be glad to hear from you. If it helped u anyways, this article would be considered as success.

I write this article on Saturday, 3:00 Pm after a chat with one of my readers. I am now getting ready for a Trek next morning. Looks like I have written for next 2-3 days of my quota, huff … Feeling tired now. (kidding).

Disclaimer : I think Reliance Regular Savings FIf this helps you in anyway und is a good fund. But there may be much better choices for long term. I hold no mutual funds other than some tax saving funds.

The Chemistry of Equity and Debt

Following is a small Table which discusses the Equity and Debt allocation for your Investments . (Click on the chart to enlarge it). It will tell you how Equity and Debt should be used for long and short term financial goals .

 

It has two parameters .

1. Importance of your investment goal (Left Downside)
Low : Buying an a/c for you car , Going for a vacation .
Medium : Buying a Car , Saving for a second home
High : Retirement , Child Education , Family health Related things , Down payment for Home Loan .

2. Time Duration of your Goal . (Upper Right)

– Short term : 1- 2 years
– Medium Term : 3-7 years

– Long Term : 8+ years

Basic Idea : It is based on the following facts .

– Equity is extremely risky in short term
– Equity is highly rewarding in long run with almost no risk
– Debt is safe always
– Debt eats away your money purchasing power.

So on based of these observation. Your Equity : Debt allocation should be based on both parameters of Importance and duration of goal , not just one one them


Some Examples

Example 1 : Ajay wants to invest 1,00,000 for his brother Education in next 1 year .

His Action : This is extremely important thing and cant be risked with , also its a short term goal. Equity should not be used . He should invest in anything giving him pure protection of his money (even though he does not get high return) . A plain FD for 1 yr will be good enough .

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Example 2 : Robert want to save some money for his house down payment in next 4-5 yrs .

His Action : As this is an important thing with time goal of medium term , His investment should be mixed in both Equity and Debt . He should invest 35-40% in Equity (SIP in mutual funds) and rest in Debt products like Tax FD’s and Debt funds% .

Alternative : He can also choose to invest his money Balanced mutual Funds (as they have mix of both Debt and Equity built in)

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Example 3 : Ankit wants to retire in next 25 yrs .

His Action : Now this is a important thing , with a goal tenure of around 25 yrs . There is no reason why Debt must be involved here at all . The matter that Equity is risky does not apply here its true for short – medium term , not for Long term like 25 yrs . (probabilistically only , If you are extra unlucky , what can one do) .

He must invest 50% in some good 3-4 Equity Diversified Mutual funds though SIP route and and he can invest 50% of his money also in some very good fundamentally strong mid caps and large caps stocks directly .

Note : Understand that , your definition of “Importance of Goal” and “Duration” depends on your situation , For me buying a Car is “Not Important” ,whereas for some one with a family of 4 and requirement of often going places can be “Important” .

What can Repiblic Day teach us about Financial Planning

India gained its Independence in 1947 . At that time India was free , and ready to grow on its own , with its own decisions . But it was not possible without a set of guidelines to guide the decision making process .

Success comes when you are disciplined and have a decision making process. On Jan 26 , 1950 our Constitution came into effect and now we had laws for different things .

Financial Planning

We knew exactly what we have to do when thing happens . We had a road map to follow. From there on we progressed and have came a long way . We can now say that we are much better than we were at that time and we continue to grow and make better decisions.

We need amendments from time to time and that helps us to change the bad laws and adapt to new situations.

How do we relate it to Investing?

We can learn from anything … really anything . Let us try to map each event discussed above and relate it to our Investing world .

1. Gaining Independence

When we get a job and start earning on our own, we are full of confidence. we are independent, We don’t need to ask for money from our parents. Rather we have to support them. We have responsibilities. There are many goals for us like buying house, car, saving for our retirement, Marriage etc etc.

2. Republic day

This is the day when we understand that we need to do our financial planning and have a set of guidelines to guide our decision making regarding our investments .When we know how exactly we are going to invest to achieve our goals, we have a clear road map and time duration .

We just need to follow it with discipline.

Example : If a young 25 yrs old want to retire at 55 with 2 crores at the end . He can take two approaches .

a) He can try to save money here and there, some month he can invest 10k, and some month he can skip it and down the line, he has a vague idea where is he going and how is he making progress. This kind of approach often leads to failure, because there is no road map and sometime will come when you will have no idea whats happening.

b) Second approach can be very easy . You have to make sure that you understand some thing very well and be clear about somethings. Those are

– Equity outperforms every other asset class in long term .
– Equity in long term has given 15%+ returns and its possible in future too .
– You should have understanding about the power of compound interest.

Now when you are clear crisp about this idea , then you can use a simple compound interest formula to see , how much you need to invest every month for rest 30 years (55 – 25) , which can generate 2 crores at 15% annual return .

The formula is

Final_amount = monthly_contribution * (1+rate) * ((1+rate)^months – 1)/rate

where
rate = monthly rate = 15% / 12 = .15/12 = .0125
months = total number of months you will invest = 30 * 12 = 360

Now you can calculate what monthly_contribution fits the values .

The amount comes to little below 3,000 per month .

Which means if you invest 3,000 per month for next 30 years , you can achieve your retirement target easily without fail. (Invest in Equity Diversified Mutual funds to target 15% returns for long tenure).

When you do this, you go with a plan (constitution) and dont have to doubt your self and you will not get lost. Just follow it with discipline without fail.

3. Amendments

Just like amendments are made in Law , because of change in environment and situations . You also may have to change you plans with market change and new products coming in (this happens rarely , because fundamental things remain same) .

Summary and Learning

What I want to point out here is that just earning money and being independent in not enough and cant make you successful with money , Discipline and proper understanding with good planning will help .

So if you are Independent but have not put your constitution in place , do it soon to really succeed . Make this day as your teacher and learn from it . Don’t be afraid of mistakes .

“Success is a ladder where every step is made up of Failure . If you cant fail !! , Winning will not be easy ” .
Manish

Review of Jeevan Astha Collections

Few days back I had talked about “why an investor should avoid Jeevan Astha Policy”

But looks like Indians have developed unshakable belief and trust in these companies. Let us see some statistics about the policy.

review of jeevan astha collection

A report from Economic times (Thursday, 22nd Jan 2009) says

“Collections for the policy which closed on Wednesday is expected to cross Rs.8,000 Crore. Some insiders say that collection could go even higher. Although the corporation had said that it targeted collections of Rs.25,000 Crore this was seen as a marketing gimmick not a real target.

– A sports person is understood to have put Rs.35 crores.
– A leading Film actor has invested Rs.8 Crores.
– A little known business family has invested Rs.50 Crores.
– Insiders day that over thousand of policies are over Rs.1 crore plus.

The policy has helped to bring LIC’s flagging mark ship back on the track and has enabled several offices in metro centers to achieve there targets for whole year.”

Despite the success the scheme has some limitations. Jeevan Astha is more of a bond and less of an insurance policy. Although the sum insured is five times the premium in its first year, the cover declines to 2 times in the second year. Smaller investor who were not all that savvy in reading the fine prints were mis-sold the policy promising returns of 10%.

My comments :

Goodwill and trust is the biggest thing, especially in country in India where people are not not much educated and can not take much informed decisions.

I can imagine SBI failing or running with public money, but not LIC (pun intended). That’s the kind of faith and trust in India. Which is fatal.

It may make sense for a filmstar or a sportsperson or a big business family to put there money in this kind of Policy, because there 10 crores will become 20 crores in 10 years (10 crores in 10 years is the return), and I am sure even if that is 7% CAGR return, its a good return for them as 10 crores is a big money. But we have to see it as a small investor point of view and goals.

A small investor who invests 10,000 or 50,000 in it and get double of his money after 10 years.

I am not sure if he is getting any return at all when you consider 6-7% of inflation. He is just getting his capital back with almost same purchasing power.

I come from a very small town in UP and I am sure that it represents India when you see per capital income, education level and living standard. And people there are not ready to hear anything other than LIC policies and FD’s of SBI or some other nationalized bank, will a small percentage having heard of Mutual funds or ULIPS even term insurance etc.

This is the story of India.

When millions of uninformed and unrealistic investors come together and put there small money together in these kind of polices, its bound to generate thousands of Crores of Rupees.

But I am sure of one thing, who ever invested in these kind of policies will get guaranteed returns, but I am not sure if he will get guaranteed and benefit for there investments when you take it for 10 yrs period. People investing there money in this policy are going to double there money in 10 years to buy something which will more than double in price in 10 years.

Fear is an excellent thing to take advantage of, when financial markets are down heavily and thing are looking bleak in short term, Anything with guaranteed “tag” will act like a magnet to hard earned money.

I am happy to not invest in anything like this and do not want my money to double in 10 years.

Jago Investor, ab to Jago !!!

Do you have an insurance policy? -Read an amazing irony about Insurance

Imagine you are 25 years old earning 6 lacs/year, with a family to support financially. A Term insurance policy with some cover (may be 25 lacs) will have premium of 5k per year (for 25 years old) as the premium for this policy.

Almost 99% people need Term Insurance, But most of the people show good amount of reluctance, because they see “wastage of premium” incase nothing happens to them.

The amazing irony about Insurance

Let us try to see what are the reasons for this?

This happens because of some psychological reasons. Some of the reasons and counter arguments are :

1. People are not ready to accept subconsciously that they have equal probability of death like others; everyone assumes themselves to be little safer than others.

Counter Argument : A different case, someone tells this person that he has chances of dying within 20 years somehow explicitly, there are greater chances that his perspective about Term Insurance will change and he may go for a good amount of cover with this premium, the reason is that now he sees these [premiums as risk cover fees and not wastage.

Now he has convinced himself that there are good chances that his “death” is possible and his family needs some good cover, although there has not been any change in his lifestyle or life in general, all what matters is his attitude towards Risk coverage.

2. People do not concentrate on the value provided by Term Insurance and its cheapness, it is taken for granted.

Counter Argument : I did this very small survey where i asked my friends online. See one of them below

manish_chn:
if your company says that it will cover your family for 25 lacs, but will cut your salary to some %
manish_chn:what will be the max % you are ok with
manish_chn:just the first number which comes to your mind
manish_chn:no calculation
manish_chn:please
rajagopal: hi
rajagopal: never thought about such things.
rajagopal: probably 5%?
rajagopal: without any calculations

This shows that a person somehow feels comfortable with 5% of his salary getting cut for just 25 lacs of cover for his family; it means that he can pay the price of 5% of his salary per year for 25 lacs cover.

Some people were even ok with 10% or 7%, on the average it was greater than 5%, whereas the real worth of cost is less than 1% of their salary (everyone’s salary is more than 6 lacs/year ). Cost of 25 lacs cover in market = 5k – 5.5k per year.

3. People pay money from their pocket after getting salary, so it feels that they are giving money unnecessarily.

Counter Argument:

If you make term insurance mandatory for everyone and cut 1% from their salary (6 lacs salary, and cut 500 per month for insurance premium of 25 lacs). In this case there are very high chances that almost everyone will feel that it’s a good thing. And they will even appreciate this move (there are always exceptions, but i can’t help those people).

What it shows is that people are lazy, when you do things purposefully; there are great chances that they will understand the importance of something.

So, if you give them 100% salary, they might not take the term insurance.

But if you give 99% salary and 1% is cut as insurance premium, many people will tell others how great there Company is !! (You can also just cut 1% and put it in your pocket and give them 99%, some people don’t even notice these things)

Summary

Understand that a lot depends upon yours perspective about something. When you see things in a different way, its meaning and importance chances totally for you.

What is Nifty BeEs ?

Nifty BeEs an Index based ETF, which tracks Nifty index . Nifty BeEs can be a important part of your portfolio.

One unit equals around 10% value of index , Means if Nifty is around 3000 , one unit of Nifty BeEs will be around 300 (can be less or more a bit also , depending on demand and supply)

Some Advantages of Nifty BeEs

Simplicity : It is very simple to invest in Nifty BeEs, You can buy and sell it easily on stock exchange from your demat account, treat it just like a share.

Economical : It has no load scheme. The annual expense ratio including management fees is a maximum of 0.80% of the Daily Average Net Assets, which is one of the lowest for any mutual fund scheme in India. The costs reduce further to 0.65%.

Liquidity : Any time you want money, you can sell your units in the markets.

No Human Error or Bias : The performance of Nifty Baes is simply the result of performance of shares in the S&P CNX Nifty Index and demand & supply in the market. There is no Fund manager bias. Hence there is no chances of Human error.

If you see the returns, it has consistently outperformed Nifty.

Annual Returns
2008 2007 2006 2005 2004
Fund Return -51.28 55.97 41.49 37.75 12.30
Rank In Category 7/22 4/22 10/22 8/20 8/18
Category Average -51.78 49.97 39.13 37.22 10.16
S&P CNX Nifty -51.79 54.77 39.83 36.34 10.68
Sensex -52.45 47.15 46.70 42.33 13.08

What are the disadvantages of ETF?

As such, there are no disadvantages , but obviously there may be many mutual funds which may perform better than Nifty BeEs, It may be because of good decision or pure luck.

Who do ETF work?

See this article from Deepak Shenoy to know about this.

My view

Any one who wants to participate in long term growth and with less risk can divert some part of his cash in Nifty BeEs. It scores really high when it comes to convenience and returns over long term. Its easy to purchase. Just invest some small amount every month with discipline over long term.

Other ETF’s

There are many other ETF’s you can go for, they are

ICICI Prudential SPIcE : Tracking NIFTY
UTI Nifty Index : Tracking NIFTY
PSU Bank BeES : Tracking Banking Stocks

ETF’s are the best way to invest in a sector, you can also go for sectoral funds , but these are ETF’s.

Secure Your Family , Risk Management Part 2

Why do we invest ?

Answer : For ourself, for our Family, for there better future , for our kids , for there better life , for financial independence, at last the answer comes down to Our Family.

But, before investing, do we make sure that , do we secure our family at first place against any risk and problems which may arise. You can invest in great things, whatever it is like Mutual funds, ULIPS, direct shares, gold, blah blah blah …

Why Do We Invest

But what if some bad things happens to you and your family is left behind with no money at present, what is your wife, kids or your parents meet some accident and go to hospital. Is that more important or creating your wealth for future.

What is more important is to first concentrate on “Now” and if everything is taken care of, only then think about the future. How do you secure your family.

There are two things :

1. Life Insurance for yourself (assuming you are the bread winner)
2. Health Insurance for your entire family, especially if your have old parents, or going to become old in some years 🙂 .

1. Life Insurance : Read https://finance-and-investing.blogspot.com/2008/06/life-insurance-revisited-one-of-my-good.html for understanding it better .

2. Health Insurance : Read https://finance-and-investing.blogspot.com/2008/07/health-insurance-what-is-health-or.html

Let me talk about a case study .

– Robert is in his 30’s earning 5,00,000/Annam. He is married and has 2 kids .

Robert needs life insurance of around 50 lacs to secure him Family . also he should take a health cover of 4-5 lacs each .

He can take a term cover of 50 lacs for 6367 . He can also take Health Insurance of Rs 4 lacs each for him , his wife and his 2 kids (family floater plan) @Rs 5000 (Check click2insure.in for these quotes) .

Means , he can take both of these things at 21,000 / year . It comes out to be 4.2% of his yearly Income.

Now think , can you spend 5% of your yearly salary for safety and coverage of your Family ? I thing YES !!

Once you do this , you are free of any tension , and now you can use your 95% money to generate long term wealth for your family and there security . You can effectively use your 95% , only if you use your 5% for your risk management .

There can be many cases when you dont cover your family and things can go wrong, like

1. You invest heavily in Mutual funds or ULIP’s or what ever and in 2 years you die in an accident, what will happen then …

2. You invest your money in ELSS (tax saving mutual funds) for last 2 yrs and have life insurance also , but suddenly you wife meets an accident and you require 5 lacs for an operation , but you never took Health Insurance .

Investing your money is important, Covering your risks are Vital !!

Live in the moment, “now” is the truth … Keep you family happy with covering then and yourself now .

Some tips :

– Take a life cover ASAP if you have not taken it yet.

– Buy a family floater plan if your family has spouse and kids, for Parents you need to take a separate individual policy, as parents are not covered in Family floater plans.

– You can also claim tax benefit for this under section 80D.

– Don’t feel that life insurance from other companies (other than LIC) are very risky and anything like that . Insurance sector is now getting mature enough and govt is taking all measures to confirm that the companies which enter Insurance Industry are from great Business families and conform with the guidelines . But its true that LIC will always be the safest (100%) .. but 99.999% is also safe …

Summary

Its more important to cover your Life risk and family Health risks first before any investments for future , when you put your money in Insurance and Health Insurance you are already taking steps for strong invesments for future which is safety of your family , which is of supreme importance . Dont ignore it … Take appropriate cover .

Game of Trading , Risk Management Part 1

Lets play a game, the name of the game is “Game of Trading”. I am stock market and you are investor. You have got 2 chances of investing you money, One time I will give you 200% return and other time I will give you -80%, or in reverse order, so it can either be

200%, -80%

OR

-80%, 200%

You have to decide in advance that how much percentage of your total capital you will invest each time (invest capital) and how much you will keep safe money (safe capital), you have to decide for both the times in the start only.

Lets analyse different cases.

Case A : You choose invest capital as 100% first time and 20% for next chance

Case A.1 : Return was -80% first time and 200% next time.


Case A.2 : Return was 200% first time and -80% next time .


Case B : You choose invest capital as 20% first time and 100% for next chance

Case B.1 : Return was -80% first time and 200% next time.

Case B.2 : Return was 200% first time and -80% next time.

You can see that at last A.1 = B.2 and A.2 = B.1 , so it means that order of your invest capital ratio does not affect your result , it both the cases it can either become 28 or 252 (depending on the return order) …

What should you do?

100% and 20% choice will always loose in long run, if you play this game over and over again for long run, Understand that in this game, you can make it “high risk high return” Game or “Extremely no risk, low return game”, And your choice of your invest percentage will decide which game is it.

Characteristic of “High return High risk game” : Its possible to make great money in short term, but in long run you will loose.

Characteristic of “Low risk, low return game” : You will Not make great return in short term, but with compounding effect, you are bound to be a winner in long run.

Let see if we can choose a ratio (invest percentage) can give us some profit irrespective of the return order.

Lets choose 25% invest capital :

Case A.1 : Return was -80% first time and 200% next time.


Case A.2 : Return was 200% first time and -80% next time.

You can see that in any case your 100 becomes 120, which is 20% return.

What if you choose 80% invest capital : In that case at last you will have 93.6 (calculate yourself). So what should be the best percentage capital to deploy each time in this game.

I tried to make an Equation, with all variables

p = profit times (2 or 200/100)
l = loss times ( -.8 or -80%/100 )
C = Capital at the start
T = Trade factor (.25 means, 25% of the capital will be invested at any time)

We want to find optimum T, given any p and l (assuming that the trade will be done 2 times)

So, If you calculate the total capital after the 2 trades (do the math), you will get

Total capital = C (1 + pT) * (1 + lT)

So our original capital is getting multiplied by (1+pT)*(1+lT), and we have to maximize this number.

lets say I = (1+pT) * (1+lT)
I = 1 + plT^2 + pT + lT

If we do some differentiation here with respect to T (people who don’t know differentiation, just leave it), and put dI/dT = 0

2plT + p + l = 0
T = – (p + l) / 2pl

So the best valeuof T is -(p+l)/2pl ..

For our earlier example , p = 2 , l = -.8

we get – (2 – .8)/ (2 * 2 * -.8) = .375

Which means, 37.5% of capital will be invested everytime, and with that our capital will become 122.5 and that is the max you can make without risk.

What if return = 200% and -90% , in that case p = 2 , l = -.9 , so T = 2 – .9 / 2 * 2 * .9 = 1.1/3.6 = 11/36, means investing capital will be 30.555% always and that will give us max return.

What is the point i am trying to make?

In any given situation of making money, there may be a big risk of loosing it, we should always use these kind of tools and always be safe. Don’t try to be very bold in stock markets.

People who make killing in the start often get killed somewhere on the way and people who make respectable and sufficient money with satisfaction become winner over long term.

Summary

When you do Investment or do trading, you should never put all your capital into it, one bad trade or investment and you will be ruined forever, better to risk only that much capital which can not take out of of the game, but just hurts a bit.

Take small and risk-less profits if possible, Investing and trading is all game of probabilities. Use math’s and logic to take smart decisions like discussed in this article.

“There are old investors and there are bold investors, but not both”.

Check out this blog for Risk Management Part 2.

 

The Straw That Broke the Camel’s Back

One of my friend is fond of shares and options trading , from a capital of Rs.50,000 , he grew it to Rs 2,00,000 , whereas I am almost at the same place from where I had started because I do some thing called “Risk Management” … Every time I take a trade or invest in anything . This is how I go about it .

– Either I don’t take the trade
– Or I take the trade, but work on risk management, I hedge it using PUTS or invest less in that.

Because of these two things I either miss big profits or make very small profits. managing risk involves cost and that’s the cost you have to pay for trying to be “safe”.

Last week we both purchased some thing which gave him 50% return, but gave me just 7-8% return over my investment. The reason was that I also hedged my position and tried to be “smart”, which my friend didn’t Acknowledge.

There are many incidents like this, because of which I always lag behind him when it comes to performance, and I am always ahead of him in being safe which never helped until now.

Jan 7 2008 :

10:30 AM :

Markets were a bit up and things looked good , He bought Satyam’s Calls with almost all of his capital, He has good intuition of which options may work and which may not, but I tried to convince him that buying a PUT on a lower strike price will save him in case he is wrong.

But to my expectation, he was “sure” that it would work, He put SL at 175 just to show me because of the fact that he knew it wont be touched at least today.

11:30-12:00 PM :

Satyam Fiasco news came in and within no time Share was down 30-40%, No surprise that even SL was not entertained … because prices never stopped .. everyone was just in a rush … With in some time Share plunged to 60-70, My friends calls were worthless and It doesn’t look that it will now move up from this point.

In short He is dead … He is out of this game now … He has 20,000 cash and all 1,70,000 or 1,80,000 he had put in calls are not even worth 4,000 – 5,000.

Price of Satyam 120 PA Jan 29

11:00 AM : Rs.1
2:30 PM : Rs.90

Return : 9,000% in 3 hrs.

What is the point I’m trying to make?

Everybody likes to make big profits and we should but not at the cost of risk of blowing up all our capital. Its not just related to Share markets or options. It also applies to Debt market, Mutual funds.

Do everything you can do to minimize or avoid the risk. Its very true that returns comes with risk. I am not saying “not to take risks”, i am talking about “managing risk”.

“Managing Risk” is the biggest measure you should take if you are in this field.

In some of the next posts we will try to see what are the different kind of “risk management” techniques and its importance.

Tax Exemptions Rules , Who is included and who is not

Following is a chart showing the list of people for whom you can claim deductions for tax exemption. For example, if you pay the LIC Insurance premium, you can claim if the got premium paid for.

  • Yourself
  • Spouse
  • Children

For further details … see this table … Click to enlarge it.

To know about the tax slab and an example for calculating tax .. see : http://finance-and-investing.blogspot.com/2008/04/tax-information-for-2008.html