Basics of investment

Investment definition
A sacrifice in the present consumption with a hope of deriving future benefit. So three major things are emerging..current sacrifice and future benefits and that too in course of time . It is postponed consumption Benefits occur in future so they are not certain. So Risk and return are two key determinants of investment process.

Why Invest ?
To improve our future welfare. Foregoing the consumption today will enhance our future consumption possibilities. Anticipated future consumption will give the direction of how much to invest now .. Child education , Daughters marriage , retirement planning or Buying a house will lead to investment decision. But regardless why we invest we must manage our wealth effectively and obtain the most for it.

Investment Goals
Near term high priority goal : These are goals which have a high emotional priority and he wants to achieve it within a few years. (A new house) Fixed income securities with a fixed maturity date. Since the goal has a high priority investor will remain risk averse in this case. Low priority Goal : These goals are set at a lower end of the priority scale and not painful if not achieved. Having a World Tour with family Investment remains in risky instruments.

Constraint of investment
An investor seeking fulfillment of one of the above goals operates under certain constraints. Liquidity. Age Need for regular income. Time horizon Risk tolerance Tax liability So one need to create a balance while choosing their investment options subject to their constraint.

Investment Vs Speculation
Basis Acquisition Attitude Background Risk quantum Stability of income Time period Source of Income INVESTMENT Outright purchase Cautious and conservative Research based (intrinsic) Small Very stable Long term Earning and dividend SPECULATION Often on margin Daring and careless Tips , rumour Huge Uncertain Short period Change in market price

Investment process
A typical investment decision undergoes a five step procedure which forms the basis of investment process. Determine the investment objective and policy. Undertake Security Analysis Construct a portfolio. Review the portfolio Evaluate the performance of the portfolio. This five step process is relevant for both individual and institutional investors.

Investment Objectives and Policy Work out objective and then evolve a suitable policy to attain the same. If your objective is large money it is not possible without the risk of large losses. So the objective must be decided in terms of risk and return. In framing policy decide the categories of asset you should concentrate. Security Analysis Now after the asset class is determined then one should concentrate the securities to be included . One need to find out Mispriced securities and there are two ways to do the same.

 Technical Analysis :- Study past movement of prices to find out the future price trends and pattern of movements. CMP is compared to predicted price Fundamental analysis :- Working out the intrinsic value and comparing it with the CMP. The intrinsic value is the present value of all cash flows that the owner of the security expects to receive during and at the end of his holding period. Portfolio construction Once securities are identified now it will become important to determine the proportion of the investors wealth to be invested in each . Aggressive and Conservative investors. Within the broad group also one need to pick the share of a specific company. The major problem is selectivity and their timing as it will involve a micro level forecast. All possible efforts should be made to minimize the risk of portfolio . So it should be properly diversified. Portfolio Revision and Performance Over the period of time stock will loose its flavour .. And a new stock will emerge with promises of high return with a relative low risk profile. Liquidate the unattractive and buy the new stars. A rational investor should examine the performance of his portfolio on the basis of average return and risk with respect to a well thought out benchmark.

Approaches to Investment decision making

There are four broad approaches . 1. Fundamental Approach 2. Psychological approach 3. Academic approach 4. Eclectic Approach

Fundamental approach :There is an intrinsic value of securities and this depends on economic and fundamental factors. There might be difference between intrinsic value of securities and its price and sooner or later the market will be in that line. Superior returns can be earned by buying an undervalued securities and selling an over valued securities.

Psychological Approach : stock prices are guided by emotions rather than reason. It is based on the moods of the investors. When there is greed and euphoria in the market price rises to new high and price fall drastically when fear and despair envelope the market. It has been observed those subscribe to this approach goes for a technical analysis which shows that there is a price pattern which may be repeated in near future by analysing the market data . Academic approach :Stock markets are reasonably efficient in reacting quickly and rationally to the flow of information. Market value =Intrinsic value. Stock price behaves like a random walk . Successive price changes are independent. Expected return is based on the risk factors. Eclectic Approach :More insight be given apart from Fundamental analysis.More fine tuning necessary. Excessive reliance on technical analysis can be hazardous also. Market discounts everything Conduct fundamental analysis to establish certain value .. Do technical analysis to assess the mood of the market Combine the both to determine which one to buy/sell/hold. Respect market prices do not show excessive zeal to beat the market. Always have a balanced approach on Risk return trade off.

Common errors made in an investment

Inadequate comprehension of Return and risk. Vaguely formulated investment policy. Nave extrapolation of the past past trend can not show the future trend so no extrapolation. Cursory decision making Go by tips and rumors , Set aside various investment risk , Uncritically follow others. Untimely Entry and Exit irrational Start and stop. High costs :- transaction costs wipe out profit for frequent trading. Over diversification and Under diversification. Wrong attitude towards losses and profit.

Successful Investment Qualities

Contrary thinking : Do not follow the crowd. Avoid stocks which have high P/E ratio. Do not fall in temptation to play a wrong game. Sell to the optimist and buy from the pessimist.

 Discipline your buying and selling habits and work on targets. Never look back after a sale or purchase whether you should have waited or not. Have patience - dont look for instant result and have faith and confidence on your investment.

Successful investing
Composure :- understand your own impulses and instincts towards greed and fear. Control your emotions so that it does not change your conviction . Capitalize on the greed and fear of other investors . Maintain certain distance from market place. You can avoid those two virus. Rely more on numbers and less on judgement. Flexibility and openness :- Do not be over protective to your judgementskeep your mind open and embrace the changes. It should not be blocked by prejudices and biases. Decisiveness :- It means a creation of balance of factors some may be well understood and some may not and then act accordingly. Create some bold positions consistent with your own conviction.

Criteria for evaluation

Rate of return calculation Risk - Variance , Standard Deviation , Beta Marketability :- Quick transaction , Low transaction cost , Price change between two successive transaction is negligible. Depth When the volume of securities traded are very large . This ensures entry and exit at any point of time Breadth Large number of rational participants with homogenous expectations in the market. No one can influence the market . Resilience New order emerges in response to price changes. High marketability helps investors to change their mind.