Build Wealth with Confidence 3

In personal finance, a portfolio

means acollection of investments
held by an investor, generally all
the investments that one has.
However , the words meaning in
personal finance has evolved a
great deal. At Value Research, we
dont think it makes sense to use
the word to just refer to a collection
of all of someones investments. A
portfolio is a lot more than a collec-
tion. For individuals, the best way
to plan their investments is to have
a separate portfolio for each finan-
cial goal.
Different mixes of funds, stocks
and other assets lead to different
risk levels and different gain expec-
tations. Most people find it difficult
to match these to what they want. If
youre asked, What is your risk
level? youll probably give an
answer of some sort but it will just
be a gut feel thing.
However , if you think of specif-
ic financial targets and think of the
money needed for them, then you
will be able to answer questions
about risk and returns precisely .
For example, youll need money for
your daughters higher education
after three years. Youd like to buy a
house at least ten years before
retirement. Youd like to go on a
vacation to Europe after two years.
Youd like `2 lakh to always be
available for emergencies.
Each of these goals is very pre-
cise. The risk you can take with it,
as well as the amount of money
needed can be quantified quite pre-
cisely. Therefore, it is relatively
easy to decide what kind invest-
ments should be made for each of
APortfolio Just for You
PORTFOLIO IS MUCH MORE THAN A LIST OF ALL YOUR INVESTMENTS
Build Wealth with Confidence 4
them. When you follow our way of
thinking, there is no concept of an
individuals portfolio. Instead each
individual must have many portfo-
lios, one for each financial goal.
The other important thing is that
a portfolio is not simply a collec-
tion. It has different parts that fit
together in specific roles and com-
plement each other. There could be
three funds, of which one provides
gains and two stability.
In hindsight, itll later appear
that you could have stuck with one
or the other but both types played a
role. With time, you will know the
basics of constructing a portfolio.
One can accordingly build portfo-
lios to meet investor specific needs
from combination of funds that col-
lectively work towards reading the
desired financial goal.
HOWTOBUILDAPORTFOLIO
The first step towards building a
portfolio is to have a goal. Once you
have that, then its relatively easy to
build the rest of the portfolio thats
suitable to meet your goals.
Goals that need to be fulfilled in
the short-term are fundamentally
different from long-term goals.
Short-term goals are best fulfilled
using fixed-income investments.
These could be a bank or a fixed
deposit or a post office deposit.
For fulfilling long-term financial
goals, the best option is to use a
portfolio comprising of equity
mutual funds, as equity is one of
the asset class that has the potential
to grow your money faster than
inflation and not lose value in real
terms.
However, equity mutual funds
can be volatile and thus only suit-
able for long-term investments.
Over the short-term, the ups and
downs of the stock markets could
very well lead to temporary losses.
Because of this, we do not recom-
mend investing in equity mutual
funds if your financial goal is near-
er or about three to five years.
A portfolio is not simplya collec-
tion. It has different parts that fit
together in specific roles and com-
plement each other
What looks riskyin the short-term
can work verywell in the long-term.
What looks like volatilitycan actu-
allybring great returns
Advantage of a portfolio
Build Wealth with Confidence 5
For anyone who is good at doing
business, the best way to invest is
in your own business. Fortunately,
because of the existence of stock
markets, any of us can become
owners (or rather, part-owners) in a
business. We can reap the financial
advantages of being owners with
very few challenges that the real
owners face.
When you boil it down to the
basics, you can only do two things
with your money: 1) you can store
it for safe-keeping; and 2) you can
make it grow. Under option 1, there
are two sub-options, the foolish one
and the wise one:
1a) The foolish option: store it in a
way that it loses a lot of its
value because of inflation.
1b) The wise option: store it in a
way that it doesnt lose much of
its value to inflation.
When we say storage of money, we
mean all kinds of deposits, be it
banks or post office or government
deposits like the 5-year and 10-year
National Savings Certificates or the
15-year Public Provident Fund and
others. It could even mean actual
cash. While cash doesnt make
sense except for the small amount
held in your pocket, the other
options do have utility, especially
in growing your savings.
Still, this storage of money
makes sense only if you need it
after just a short period of time-
anything from a few days to a cou-
ple of years. When you need the
money just after a short-time, then
it is better to invest it in a simple
and safe way.
For anything else, the only sensi-
Investing for Growth
INVESTING FOR GROWTH INEVITABLY MEANS INVESTING IN EQUITY
Build Wealth with Confidence 6
ble thing is to try and make the
money grow as much as it can. And
investing for growth inevitably
means investing in equity.
Equity could mean buying
shares but for beginners it general-
ly means investing in equity-based
mutual funds. The emphasis to
equity is necessitated because, in
the long run, equity as an asset
class has the potential to beat infla-
tion and post real returns to
achieve growth.
To understand this, one should
understand the source of equity
profits. The ultimate source of prof-
its in equity is the general growth of
the economy. On the whole, stocks
grow at a rate that is at least equiv-
alent to the growth of the economy.
And the inflation rate is built into
the growth of the economy. If infla-
tion is 5 per cent and the real econ-
omy grows at 5 per cent, then
stocks on the whole will at least
match 10 per cent.
And thats just the average. On
top of that, as an investor, if you are
able to select stocks that are better
than the average (through a good
equity mutual fund, for example),
then you can beat the general rate
of economic growth by a fairly larg-
er margin.
Beating the average isnt easy,
but if you keep a few simple rules
in mind and go about things sys-
tematically, which is what you will
be able to do by using this booklet.
Through this initiative, you can
educate yourself and be equipped
to manage your finances better and
achieve your financial goals.
On the other hand, fixed-income
investing (the storage option) is
inherently linked to the inflation
rate in the economy. Bear in mind
though, that these gains are a mean,
and average that all equity delivers.
There are variations across individ-
ual investments and variations in
time. To get the gains, you have to
hold on for a minimum of three
years and preferably longer.
A saver can either adopt the
approach of just saving money, or
he can make it work for growing by
investing it
The onlyreliable wayof growing
your savings at a rate faster than
that of inflation is to invest it into
equityor equity-based investments
Equity over savings
Build Wealth with Confidence 7
At present, we Indians are under a
specially sharp attack from infla-
tion, with the rising price of goods
all around us and its cascading
impact on our finances.
We have the lethal combination
of high inflation and relatively low
interest rates. This means that the
inflation-adjusted interest rates that
we earn from fixed-income invest-
ments like deposits are very low.
What is worse is that at this
juncture, neither of these problems
is going to get solved in a hurry. It
could well be years before fixed-
income returns go up significantly.
Hence, your portfolio needs expo-
sure to equity investments, which
has the potential to beat inflation.
It is for this reason that your
portfolio should have a significant
exposure to investments in equity.
For the normal Indian investor,
investments in equity is psycholog-
ically the equivalent of risk. The
risk of losing their money when
investing in equity, keeps most
Indians away from investing in
these instruments. We have been
brought up to mentally equate
investing in equity with the volatil-
ity of the stock markets.
In reality, the returns from equi-
ty could be high. How can this be?
How can returns from a type of
investment that is volatile be high?
The answer is to understand that
the same thing can look very differ-
ent at different scales.
Heres a question that will
demonstrate the point: How long is
the coastline of India? The official
answer is 7,517 km. Do you think a
person walking exactly along the
Equity for the Long Term
IN THE LONG RUN ONLY EQUITY MANAGES TO BEAT INFLATION
Build Wealth with Confidence 8
coast line from Gujarat to West
Bengal would come up with this
answer? What about an ant? If an
ant walked the entire distance,
would it come up with the same
answer? How about an aeroplane?
If you flew an aeroplane along the
coastline, would you arrive upon
the same answer? No.
In each of these cases the answer
would be very different. The ant
may come up with an answer thou-
sands of km higher because it
would follow each nook and corner
of the coast at the scale of millime-
tres. A human being would follow
it on a scale of feet and come up
with a lower answer. An aeroplane
would follow it only on the scale of
many kilometres and would come
up with a far lower answer.
Stock market volatility is a bit
like this. If you track the markets
everyday, you will get many ups
and downs. If you track it once a
month, there will be fewer ups and
downs. On the scale of an year, the
ups and downs would be even
fewer and if you were to pay atten-
tion to the markets only once every
two or three years, there would
hardly be any volatility.
Now, imagine the scenario once
in a decade or for even longer peri-
ods. If you had invested in equity in
1990 and then bothered to check
your investments only once in five
years, then sometimes your invest-
ments would rise more and some-
times they would rise less but there
would be nothing that would justi-
fiably count as volatility. Over
longer time such as a decade or
more, the movement of Sensex
evens out and reduces volatility.
The moral of the story is quite
clear: the idea that investing in
stocks can lead to frequent losses
only if you are a short-term trader.
Over sufficiently long periods of
time, you are like the aeroplane fly-
ing over the coastline. The little
twists and turns that vex the ant are
not your concern.
Inflation-adjusted interest rates
that we earn fromfixed-income
investments like deposits etc are
actuallynegative
It could well be years before fixed-
income returns rise above the infla-
tion rate in anymeaningful wayand
earn positive returns
The power of equity
Build Wealth with Confidence 9
There are two ways of investing in
equity . One, buy and sell stocks
yourself. And two, invest through
equity funds. The final goal is the
sameto benefit from the potential
returns that equity investing offers.
However, the two activities are
completely different. Unless you
are an expert, it doesnt make sense
to invest yourselffunds are the
right choice.
But why should this be the case?
Heres an interesting comment that
illustrates the reason. Warren
Buffett is an 83-year old American
who is widely regarded as one of
the greatest investors ever.
Hes the chairman of the con-
glomerate Berkshire Hathway
whose investors have earned
returns of an average 19.8 per cent
for the past 50 years. At the recent
Annual General Meeting of the
company, an exchange with an
investor was thus described by The
New York Times: A shareholders
asks if buying shares in the 20 best
companies in the United States
would be better than investing in
an index fund. Mr. Buffett replies
that the results would probably be
similar. Then he launches into a
bigger point: there are professional
investors, and then there are ama-
teurs who invest. Being the former
requires a lot of work and research.
Several amateurs dont have the
time or the inclination to do or do
not have the necessary skills.
The main problem for most peo-
ple, he says, is trying to behave
like a professional when you arent
spending the time in the game
needed to be a professional.
Why Equity Funds?
LOWCOST AND DIVERSIFICATION ARE SOME OF THEIR BENEFITS
Build Wealth with Confidence 10
CONVENIENCE
Buying mutual funds is very
straightforward compared to
investing in stocks. The paperwork
needed is simpler and you dont
have to open a demat account.
Unlike stocks, its much easier to
operate yourself as far as the trans-
actions go by investing online.
Also, when you invest directly
without going through a broker
(something thats not possible with
stocks), you actually reap the bene-
fit of the slightly lower cost.
PROFESSIONALFUNDMANAGEMENT
Its not just a question of the
research, but also the constant
monitoring of your investments
and evaluation of the possible
opportunities. A large mutual fund
company may have many people
carrying out the function of
research, analysis and trading, all
of which an individual investor
will have to do the equivalent of for
his portfolio.
Moreover the mutual fund com-
pany will also have access to far
more data and outside analysts
than you would ever do. For
instance, they would be visiting
companies in which they invest
and interacting with the manage-
ment. Besides professional research
and fund management, there are a
number of other factors that make
investing through a mutual fund
the better choice.
SMALLTICKETSIZE
If you try to build a diversified port-
folio with all types of stocks by
buying them directly, youll need a
relatively large sum of moneyat
least several thousands to begin
with. In mutual funds, you can
start off by owning the same with a
few thousand rupees.
DIVERSIFICATION
When individuals invest, they tend
to build a portfolio in a bottom up
approach whereas professional
Unlike stocks, its much easier to
operate an equitymutual fund
yourself as far as the transactions
go byinvesting online
When you are trading stocks your-
self, you are exposed to taxliabili-
ties. In comparison, mutual fund
investing is more taxefficient
Case for equity mutual funds
Build Wealth with Confidence 11
fund managers do it in top-down
approach. This sounds complex but
is a very simple idea. Bottom up
means that if you think a stock is a
good investment, you buy it.
Thats the same as what you would
do in top- down, except that in top-
down each stock has to fill in a larg-
er framework. A fund manager
could have a set of rules defining
the investments, such as there must
be at least 15 or 20 stocks with no
less than X per cent of the total
portfolio. The stocks must be
spread over at least 5 sectors with
no sector being less than Y per cent.
At least Z per cent must be held
only in large companies because
they tend to be more stable in bad
times. And so on and so forth.
Taken together, such rules define
a framework which ensures that the
portfolio stays diversified and safe
from shocks that may strike indi-
vidual stocks, sectors or types of
stocks. Individuals who manage
their own stock investing would
rarely have the knowledge or the
discipline to do all this continuous-
ly. Even if the investor has the
knowledge and the discipline, hes
unlikely to have the time for all the
attention needed regularly to be up
to date with their investments and
its performance.
TAXEFFICIENCY
All equity portfolios need some
buying or selling as individual
stocks become more or less desir-
able. If you are trading stocks your-
self then these transactions may
mean a tax liability. However, in an
equity mutual fund, this trading is
done by the fund manager inside
the fund. You dont have a tax lia-
bility because you havent made
transactions yourselves.
Investments in equity funds are
subjected to zero capital gains tax,
when the units are held for more
than a year. But, if the units are
redeemed before completion of a
year, short-term capital gains at 15
per cent on the gains is applicable
with an additional 3 per cent cess.
Professional fund management
makes investing in equitymutual
funds safe, easyand profitable in
the long run
You can start investing in mutual
funds through small sums of
money, which makes themafford-
able and within ones reach
Case for equity mutual funds
Build Wealth with Confidence 12
A knowledgeable investor thinks
not in terms of investments, but
portfolios. A common goal for a
group of investments define them
as a portfolio. A goal is defined by
a particular purpose that the money
will be used for, as well as a time-
frame. Example goals could be
Childs Higher Education which
might be needed in 8 years, or
House Purchase in about 5 years.
As you can see, both the role of
the goal in your life as well as its
time frame can vary. Some goals
have a precise time-frame (like a
childs college education) while
others, like an expensive holiday,
would be nice to have but not cru-
cial. Again, some things cant be
postponed but others can be. There
are also general goals like having
enough emergency money.
THEDIFFERENTGOALSAPPROACH
Conventionally, financial advisors
treat all of an investors invest-
ments as a single portfolio and try
and tune this to the investors self-
perceived risk-tolerance. They try
to fathom this risk-tolerance by ask-
ing some questions and/or by rules
of thumb based on age, income sta-
bility and some other factors.
Such an approach is not neces-
sarily useful. As youll realise when
you think about some of the exam-
ples above, each goal has a different
risk level. This risk level itself
varies not just with the nature of the
goal but with how far into the future
the targeted goal fulfilment is. The
lesson is clear: when the time-frame
is long, the risks of equity are mini-
mal and the returns are high.
Using Equity Funds
INVEST IN PORTFOLIO THAT MEETS YOUR SPECIFIC NEEDS
Build Wealth with Confidence 13
Therefore, adopt an approach to
portfolio construction that is based
largely on the time-frame for which
you are investing. Here are a
sample set of portfolios of varying
risk levels and returns
expectations. It must be noted that
the perceived risk level is one of
short-term volatility. If these
portfolios are used for the specified
time-frame, then the actual risk of
loss is minimal.
One important implication of
this approach is that eventually, the
long-term becomes short-term and
then becomes imminent. Your
eight-year old daughter will start
her higher education in 2024 and
thats a long-term goal. But by the
time 2020 arrives, itll be a medium
term goal and in 2022 itll be a
short-term goal. Therefore, the way
these investments are treated must
change with time.
Here are four sample portfolios.
These dont have precise recipes in
terms of the actual funds that you
will select.
AGGRESSIVEGROWTHPORTFOLIO
Time Frame: 7+Years. Designed to
get good returns. It does so by
emphasising equity investment and
within equity, smaller and medium
sized companies. The portfolio is
likely to face heavy volatility and
its value will likely see sharp falls
many a time. However, the long-
term gains can more than compen-
sate for the volatility.
GROWTHPORTFOLIO
Time Frame: 5+Years. Designed to
generate growth from equity invest-
ment while keeping the equity risk
somewhat limited. A bulk of the
portfolio is made up of equity , with
much less emphasis on smaller
companies and a bulk of the invest-
ments are large cap funds that have
a proven track-record.
Even so, you can expect this
portfolio to be volatile and in times
when the stock markets decline, it
will suffer from short-term losses.
However, in the longer term the
gains can balance out these losses.
If the moneyinvested in a portfolio
is not needed for the longest time,
then there is no harmwith higher
equityallocation
Hybrid equity-oriented funds by
themselves can fulfil the need of
providing growth without too much
risk with regular asset rebalancing
Different hues of equity
Build Wealth with Confidence 14
STABLEGROWTHPORTFOLIO
Time Frame: 3+ Years. This is a
unique type of portfolio as it is
entirely made of just a single type
of fund, which are balanced funds.
These funds typically have over 70
per cent equity and 30 per cent
fixed-income investments. They
automatically rebalance their expo-
sure between equity and debt.
The relatively large fixed-
income exposure helps stabilise
returns during volatile times. Also,
the automatic rebalancing means
that gains that the equity part
makes during the times when the
stock markets are doing well get
shifted to fixed-income and are
thus protected from losses when
the stock markets are doing badly.
Even so, these funds are not
immune to volatility. From the risk
standpoint, 70 per cent equity is
quite a lot and when the stock mar-
kets decline, these funds will lose
money, even though the losses
should be less than that of other
equity funds.
CONSERVATIVEGROWTHPORTFOLIO
Time Frame: 1+Year. The conserva-
tive growth portfolio aims to limit
risk. At the same time, the limited
equity exposure in such funds tries
to benefit from the growth potential
of equity. This portfolio does so by
using hybrid (balanced) funds, but
of a subtype that is much more
conservative, and thus relatively
light on equity.
In this case, the relatively low
equity exposure helps stabilise
returns during volatile times.
However, like the equity-orient-
ed hybrids in that portfolio, these
will also implement automatic
rebalancing between equity and
fixed-income and thereby aims to
protect portfolio returns.
This portfolio has a much small-
er degree of volatility than the ear-
lier ones but even then the volatili-
ty does exist. When the stock mar-
kets go down sharply, you can
expect some losses. However, these
are likely to be covered up before
too long.
Disclaimer: Not hi ng cont ai ned i n t hi s document shal l be const rued t o be an i nvest ment advi se
or an assurance of t he benefi t s of i nvest i ng i n t he any of t he Schemes of ICICI Prudent i al Mut ual
Fund. The i nformat i on cont ai ned herei n i s onl y for t he readi ng and underst andi ng purpose. ICICI
Prudent i al Asset Management Company Li mi t ed t akes no responsi bi l i t y of updat i ng any
dat a/ i nformat i on i n t hi s mat eri al from t i me t o t i me. The reci pi ent al one shal l be ful l y responsi -
bl e/ are l i abl e for any deci si on t aken on t hi s mat eri al .