What is the Sensex P/E?

Of all the fundamental statistics available for comparing stocks, the Price/Earnings ratio is the most widely used.

What is the P/E and the Sensex P/E? How is it calculated?

We frequently hear that the Sensex is fairly valued or trading near or above its historical price-to-earnings multiple of 18 times. The price-to-earnings ratio, or P/E, is a valuation measure that compares the stock price to company profits, providing investors with a sense of the stock’s value.

Let’s try to understand what P/E is and how the Sensex valuation can be interpreted from it.

Mathematically, the P/E multiple can be expressed as ratio of market price of a stock to its earnings per share, or EPS. For example, let’s say the stock price of Reliance Industries Ltd is Rs 900/share and its EPS is Rs 90.

Since P/E = Price/EPS, the P/E of Reliance is 10. This implies that investors are willing to pay 10 times Reliance’s EPS for that year. Do note, this is not a static figure and the latter can change every time the company declares its quarterly results. As for the stock price, it fluctuates daily. Naturally, the P/E changes accordingly.

In general, investors are greedy for highly profitable or high growth opportunities and stingy with opportunities not as attractive. Similar behaviour is displayed in P/E multiples where high growth companies trade at higher P/E multiples and lower growth companies trade at lower multiples. For example, software companies like TCS and Infosys, and consumer goods companies like Hindustan Unilever and ITC, trade at P/E multiples greater than 20. On the other hand, companies in the energy sector are trading at less than 15 P/E multiples, thanks to the current subdued oil price environment. A lower P/E can also indicate a company’s lower future earnings potential.

The above can also be seen in Sensex P/E multiples.

The Sensex composes of 30 stocks which are traded on the Bombay Stock Exchange, or BSE. The index is constructed on the basis of the free floating market capitalization of these 30 stocks traded relative to 1978-79 taken as base value of 100.

Free float based market capitalization implies all shares which are freely available for trading. Therefore, promoter equity and equity held by other entities are kept out of the free float calculation.

The Sensex P/E is the ratio of price of the index to its EPS. Price per share is derived by dividing the combined free floating market cap of all the 30 index constituents by their total outstanding shares. Similarly, EPS is the ratio of the aggregate earnings of all the 30 stocks comprising the index to their total outstanding shares. In a way, the Sensex P/E is nothing but a reflection of the individual PE's of its index constituents.

Historically, the Sensex has traded at an average P/E of 16-18 and in a range of 9-24 times EPS. During up cycle or periods of strong growth, the Sensex has traded at the higher end of the range as the earnings of the index constituents start growing strongly. Conversely, in a down cycle or during periods of subdued growth, aggregate earnings of index constituents fall or the rate of growth slows and investors are not as willing to pay a premium to earnings. Consequently, P/E multiples fall to the lower range. If the sectors which have a higher weight-age in the index do well, the Sensex P/E would largely increase.

In a given time period, different sectors trade on different P/E multiples. Currently, stocks in sectors such as oil and gas, and metals, which are facing subdued operating conditions, are trading at P/E multiples much below that of the Sensex P/E. For example, RIL and ONGC are each trading at around 9-10 times EPS.

On the other hand, sectors which are doing well, such as fast moving consumer goods, healthcare and information technology, are trading at rich multiples of 20-40 times EPS, much higher than the Sensex P/E.

Many of these richly valued stocks require a much lower capital expenditure and generate strong free cash flows with high operating margins. Keeping this in mind, investors are ready to pay a hefty premium for these stocks. Hence, when making relative valuation comparisons of the Sensex P/E to another country’s P/E, it is important to know if the index in question has a similar sectoral representation, else the conclusion would be erroneous.

Similarly, comparing the Sensex P/E in 2015 to that of the Sensex in 2005 or 1995 should also be kept in context. After all, the index composition during all these time periods would differ.

So while it’s one of the oldest and most frequently used metrics, ensure that you use it within context.

http://www.morningstar.in/posts/32232/what-is-the-sensex-pe.aspx?utm_campaign=shortanswer&utm_medium=email&utm_source=morningstar

Make your 50's work

Make your 50's work

UMA SHASHIKANT

Plan so that you can enjoy your retirement years without fretting about finances

My friends and I are now in the smug 50s. We began with very simple careers and modest incomes. But we were the generation that was at the right place at the right time. When the economy opened up in 1991, we were the qualified, skilled and enthusiastic youth that grabbed the opportunities with both hands. A combination of good old saving habits and rising income has left us with assets we never thought we would accumulate in our lifetime. As the dreaded “R“ word is now looming large, we are taking stock of how our life will be when we are the end of the job-life as we know it.

Many of us do not even believe we will retire. There is the confidence that we will continue to find work and be paid for our “expertise“. The problem in this assumption is that the younger generation has outsmarted us and will continue to do so. The managers who we hope will engage us, are likely to have had better schooling, larger global exposure, finer social skills and higher expectations for performance. It is time we defined what our expertise would be, and how it would get priced in a competitive post-retirement world. If we see ourselves as “mentors“ it is time we enrolled into programs that certify these skills and begin to read, write, blog and publish to establish our credentials.

We are proud of our networks. Our friends have done well for themselves too, reaching powerful positions in their career. We are happy to be in their circles and think that this might help when we retire. May be not. The CFO of the billion dollar company derives his power from the treasury he manages. Once he gives up that job, the power quotient vanishes.So is the HR head who has the power to recruit, promote or fire management trainees to CXOs. Once he retires, people will soon figure out that he is now in the queue for jobs. Retired bankers have been aghast at the nonchalance of erstwhile colleagues, who do not even return calls.While it may provide immense scope for a good life of laughter and fun, the buddy network might not come of use for a post retirement career. Adding new young ones to the list is not easy . Many retirees find they are “being avoided“ while bragging about their glorious past.

Not everything is bleak though. There is the nice pile of assets that should serve our needs very well, and some more. With zero debt and peak income, the 50s is the time to give those assets the final push to even bigger size. It is also the time to rebalance and reallocate, when we still have the power of our job and income.It is time to ask whether that terrace flat in Navi Mumbai, or the bungalow in Gurgoan, will be useful. Will it fetch a decent rent (ask whether someone who can rent a luxurious house would have bought a property instead)? Would the child for whom it was bought bother to take a few days' leave to come over to get the stamp and registration tasks done?
Assets are all good as long as they serve a purpose. A farm house that takes more to maintain and enjoys 20% annual occupancy is a dead asset in retirement, when there are no fancy parties to throw for building professional networks. A small one-bedroom in the heart of the city might be low on prestige value, but earns a steady inflation-adjusted rental.Take charge of those assets. List them, evaluate their use, and make sure they will all work for you. Each rupee invested in your earning life, should work for you in retirement.

Many of us are so bitten by the “giving“ bug. We are eager to do something for the society and give back. But we need a plan to do that. If our assets generate adequate income and security, we can devote our retired lives to enjoyable charitable work. There are thou-sands of organisations run by spirited youth so short on time and resources. The job can be immensely satisfying and make a real dif-ference to the society . Find the causes that are dear to you. Find out organisations you like to support. Check out how they are run and how they are funded. Begin your association even as you are working. Ensure that your networks, power and mentoring activities help the organisation. Build equity and add value. Go that extra mile when you still have the energy and your limbs have not weakened. Do not wake up after retirement to announce that you are now willing to help. Many retirees have been ripped off or handed a raw deal when they make their eagerness too well known. Create your giving strategy much before retirement, with the same smartness you bring to your job.

If there is one thing in common among the 50-somethings today, it is the strong desire to live, travel, work, and have all the fun after retirement. But getting there needs investment of both money and time, now in the 50s. If you dislike weak bones and lifestyle diseases, that modification to food, work and workout should be done now. It can't wait until you retire. Get to work on your second innings, before your power, networks and health begin to decline in value.

The author is MD, Centre for Investment Education and Learning

http://epaperbeta.timesofindia.com/Article.aspx?eid=31805&articlexml=Make-your-50s-work-30032015012016

Please find below a good article as appeared in Advisor Khoj for your reading:

How can financial advisors grow their share of wallet from existing clients?

One of the biggest challenges that many financial advisors face, is seeing revenues plateau off after an initial period of growth. The most obvious response is to look for new clients, but it is easier said than done. Independent financial advisors today are faced with a multitude of competitive forces ranging from other financial advisors to wealth management channels of large banks to direct channels of mutual fund houses and also online portals pushing financial products. One of the ways to overcome this challenge is to get a bigger share of the wallet from existing customers, while continuously looking for opportunities to expand the client base. Getting a greater share of wallet from the existing customers has a significant business potential for the following reasons:-

• Equity investment is still a very small proportion of the total savings and investment corpus of the average Indian investor


• Majority of Indians are underinsured as far as life insurance is concerned. Insurance buyers often do not buy the right life insurance product


• Majority of Indians do not have adequate health insurance or Mediclaim. Additional tax benefits have been announced for Mediclaim premium under Section 80D of IT Act in this Budget


• The increase in 80C tax saving investment limit from र 1 lac to र 1.5 lacs announced in last year’s budget, provides an opportunity to get a bigger share of the client’s wallet towards tax savings schemes


• Additional र 50,000 tax savings over and above the र 1.5 lacs 80C limit was announced in this Budget for investments in the National Pension Sche

Deepen engagement with Clients

To grow their share of wallet from existing customers, financial advisors need to deepen their engagement with their customers. With the proliferation of digital technology and the internet, information is available today on the fingertips of the investors. Therefore, financial advisors need to keep themselves updated about the market and the industry, more than even before. Financial advisors should segment their clients by age groups, income levels and financial awareness levels to customize their engagement with them. The mode of engagement also has to be tailored as per the client’s preference. Some clients prefer face to face meeting, while others prefer communication over the phone or emails. It is often seen that financial advisor communicate with their clients only when they are doing a sales call or fulfilling a service request. This does not necessarily deepen the engagement with a client. An excellent way to deepen engagement with clients is to conduct regular portfolio reviews. A survey of under 50 high net worth wealth management clients in the US has shown that these clients prefer to have weekly or monthly review meetings with their financial advisors. While engagement needs differ from customer to customer, financial advisors need to figure out what works best for their customer. The primary objective of portfolio review meetings should be to review the portfolio performance and progress against different financial goals set by the client. Financial advisors should not deviate from this primary objective. They should also use these meetings to gather more information from the client, so that they can provide more holistic financial advice to clients factoring in income and expenses, assets and liabilities, tax situation and other considerations. Financial advisors can ask for more business from their clients in these meetings only if it relates to the primary objective of the meeting, which is to review progress against the financial goals of the client.

End to end servicing for the client’s entire portfolio

Financial advisors can offer end to end servicing of the client’s entire portfolio holding, irrespective of whether the client did the transaction with the financial advisor or through some other intermediary / broker. At the beginning this may be too much effort with no tangible gains and therefore financial advisors should exercise their judgement in offering this service to their clients. But this offering definitely has benefits for both the client and also the financial advisors. Mutual fund advisors can offer to service the entire mutual fund portfolio of a client and then gradually expand to life insurance policies, fixed deposits, post office savings, equity holding (Depositary Participant Holding), home loan etc. Advisors can take advantage of several online resources available in the market. Some of these online resources are available free of cost, while others are available for a fee. Servicing the entire portfolio of a client, not only deepens the client advisor relationship, but also provides insights into liquidity events. Liquidity events are situations when the client has additional liquidity or investible cash. Examples of liquidity events are maturity of life insurance policies, fixed deposits, national savings certificates, close ended mutual funds, debentures, sale of a large block of shares, house etc. Financial advisors need to be focused on capturing a portion of the proceeds from these liquidity events to grow their share of wallet.

Develop expertise in multiple product classes

Financial advisors should build expertise in multiple product classes, to expand their scope of financial advisory to their clients. For example, insurance advisors can broaden their advisory scope to mutual funds and other investment products. Getting additional professional certifications like IRDA certification, AMFI certification, Certified Financial Planners (CFP) etc is always helpful in expanding your financial advisory business. Even if financial advisors do not sell a particular product class, building knowledge across multiple product classes is always useful because they can help their clients make the correct financial decision and in turn expand their share of wallet. For example, a mutual fund advisor with life insurance expertise can help their clients buy adequate life cover through term plans and in turn get a bigger share of their client’s wallet for mutual fund investments that may have otherwise gone into paying premiums of life insurance investment plans. Financial advisors can also diversify into alternative asset classes, e.g. real estate. However, financial advisors should always ensure that focus on multiple fronts should not take away their focus from the core business.

Build Income Tax Knowledge

Though tax advisory and IT returns filing typically falls in the realm of Chartered Accountants, tax knowledge can be very beneficial for financial advisors in growing their share of wallet from existing customers. Tax knowledge should go beyond the provisions of Section 80C of Income Tax Act, which most financial advisors are familiar with. Financial advisors should be able to provide tax related guidance with regards to multiple asset classes and help their clients make the most tax efficient investment decisions. This not only will help financial advisors build more credibility with their clients but it also can help financial advisors get more business from their clients.

Financial advisors should build a differentiated offering and brand

While all the above strategies are enabling mechanisms for financial advisors to grow their share of wallets from existing clients, financial advisors should ask themselves one fundamental question for these strategies to work. Why should a client do business with him or her and not with another financial advisor or other wealth management channels? What are the key differentiating attributes and offerings that make it beneficial for the client to do business with a financial advisor? Financial advisors should think about these attributes, not from his or her perspective, but from the client’s perspective. The advisor should not only be able to communicate these attributes very clearly but more importantly, they should ensure that the client experiences them in each and every interaction.

Conclusion

Once they reach a critical mass, financial advisors should prioritize client retention and growing their share of wallet from existing customers to acquiring new customers. In fact, a great by-product of client retention and consolidation is getting client referrals, which can help advisors further expand their business.

https://www.advisorkhoj.com/articles/Financial-Advisory/How-can-financial-advisors-grow-their-share-of-wallet-from-existing-clients#.VRjduvyUcac

Is over diversification a problem?

Could it be possible that one over diversifies their portfolio? Would that be a problem?

In the overall scheme of investor problems, over diversification isn't the worst sin. Having too many holdings won't wreak the same havoc that under saving will, or performance-chasing.

Nevertheless, at Morningstar we believe that there's a practical risk to being too diversified. When you own too many stocks and mutual funds, it becomes nearly impossible to get a good knowledgeable grasp on each holding. When you lose your focus, you lose your competitive advantage as an investor. Instead of having a competitive insight, you begin to run the risk of missing things.

Christine Benz, Mornigstar’s director of personal finance who is based in Chicago, says that for every single portfolio she receives that is whippet-thin -- without an excess stock, fund or ETF to spare – she comes across 10 more that have 50, 60 or even 100 individual holdings. She refers to over diversification as portfolio sprawl and believes that it can add to investors' oversight challenges.

It can simply be difficult to keep track of the fundamentals of so many holdings, especially if those holdings include individual stocks along with actively managed mutual funds of various categories. The investor with too many holdings may have trouble figuring out asset allocations or knowing when or how to re balance.

No matter how logical an investor you believe you are, you could get carried away and buy on whims or fall for the latest market craze. Some investors pick up certain funds or stocks which have a “cult status” so to speak. Splintering your portfolio into too many different funds and can dilute the impact of any one investment. An over diversified portfolio can stunt returns and amplify risk. By blindly assuming more is safer, over diversification gives a false sense of security.

Cut off the excess

You need to diversify smartly. Having a glut of funds is not smart diversification. For instance, a portfolio with three mid- and small- cap funds, three sector funds, an index fund and three large-cap funds is not a well diversified one just because it has 10 funds.

Does the index fund track a large-cap index such as the Nifty or Sensex? That would translate into four large-cap funds. Are three sector funds necessary when the other funds are diversified equity funds investing in all the relevant sectors? Does one need an exposure to three different mid-cap funds or would two just suffice – one with a value blend and the other with a growth tilt? Does the overall portfolio have sufficient debt exposure since none of the funds are balanced or debt oriented? Such questions would need to be answered when viewing the portfolio as a whole and preferably with the help of a financial adviser.

When trimming the flab, view in totality your portfolio of equity, debt and tax planning instruments.

Consolidate the portfolio

Reduce the number of holdings in your portfolio and ensure that each is best of breed. But don’t focus exclusively on trailing returns. If you find duplicative holdings in a similar space, the natural tendency is to kick to the curb the one with the lower trailing returns. By focusing disproportionately on investments with happy-looking trailing returns -- especially over the past 1 to 3 years, investors may inadvertently tilt their portfolios toward higher-risk, higher-volatility investments. 

Investing in stocks directly

Many investors use mutual funds for the bulk of their portfolios while also maintaining a smaller basket of stocks on the side. If that describes your setup, reflect on your past behavior and performance as a stock investor. If you have tended to do your homework on your companies and have generated strong performance with this part of your portfolio, that may argue for making individual stock holdings an even larger part of your portfolio than they already are. But if you have amassed a portfolio of individual equities more haphazardly -- and monitored them not at all -- it's a good time to ask yourself what those small positions are actually doing for you. If your total position is fairly small, it's adding to the clutter in your portfolio but doesn't have the potential to dramatically alter your bottom line, for better or for worse.

It is not without reason that diversification is referred to as the only free lunch in investing. But it is possible to have too much of a good thing.

http://www.morningstar.in/posts/32352/is-overdiversification-a-problem.aspx?utm_campaign=shortanswer&utm_medium=email&utm_source=morningstar

regards

Dear all,

Please find below a good article as appeared in Advisor Khoj for your reading:

Common retirement planning mistakes one should avoid

Retirement planning is one of the most ignored aspects of financial planning in India. But with changing socio economic conditions in our country, retirement planning now is more important than ever before. In this blog we will discuss 6 common retirement planning mistakes that individuals must avoid, in order to achieve financial independence and be free from financial stress during their retirement years.

• Not starting retirement planning early enough: Most individuals do not think about retirement planning early in their careers, but start to worry about it only when they are nearing retirement. Starting to invest for your retirement from early age has great benefits. The earlier you start the better are the chances for creating wealth as you get more return for more time on your investments. Many investors are not aware of the power of compounding. If an investor wants to set a goal of creating a retirement corpus of र 1 crore at age 60, he or she can achieve it with a much smaller amount simply by starting earlier, as shown in the chart below.
  
  
  
  
  
  
  We can see from the chart above that starting early has major benefits. Starting too late, on the other hand, will put your retirement planning at serious risk.


• Ignoring the impact of inflation in retirement planning: Another common mistake is to ignore or even underestimate the impact of inflation on expenses. Inflation cannot be wished away as it reduces the value of savings. The chart below shows the annual (December to December) CPI inflation rates in India from 1984 to 2014.
  
  
  
  
  
  
  The chart above shows that except for a 5 – 6 years period from 2000 to 2006, the annual inflation rate in India has been mostly above 6%. The geometric mean annual inflation rate over the last 3 decades has been 7.8%. This means than an expense of र 1,000 in 1984 would be nearlyर 10,000 today. Now, if we extrapolate this 20 years forward, an expense of र 10,000 today, would be nearly र 45,000 20 years from now. Even if we expect inflation to moderate in the long term to an average of 5 – 6%, living expenses will be at least 3 to 5 times higher 20 or 30 years later. In other words, if you are 30 years old and your monthly expense is र 20,000, you should expect your monthly expense at the same lifestyle to be over र 1 lac by the time you retire. When you set a retirement goal for yourself, you should always factor in the effect of inflation.


• Misconception with regards to risk in retirement planning: Most investors believe that investing in risk free or low risk investment options is the best retirement planning strategy. Accordingly, they opt for investment options like PPF, VPF, NSC and life insurance endowment plans. Investing in low risk investment options can actually result in taking a risk with your retirement plan. Risk free or low risk investment options often fail to beat inflation, which leaves the investor short of his retirement needs. Let us take for example life insurance endowment plans. Historically, returns of life insurance endowment plans have been around 6%, which is well below the average historical inflation rate discussed above. Post tax returns of other risk free investment options have also struggled to beat inflation. Equity as an asset class has historically been able to beat inflation in the long term and create wealth for the investor. The chart below shows the Sensex returns and the annual inflation rates from 1999 to 2014.
  
  
  
  
  
  
  We can see from the chart above, that while Sensex returns have been volatile, it has managed to beat inflation. The compounded annual growth rate of the Sensex from 1999 to the end 2014 is around 16%, while the geometric mean average inflation rate during this period was 6.5%. Long term investors must not equate volatility with risk. Investors should understand that volatility is a short term phenomenon and does not impact the long term objectives. For long term investors, not meeting the financial goal is the real risk. It is essential that equities form a significant portion of your investment portfolio to help you meet your retirement goals.


• Not having enough health insurance: Healthcare costs in India are increasing at a distressing rate. Based on some estimates, the annual healthcare inflation is in the range of 15 – 25%. A hospitalization for a serious illness can cost र 5 lacs or above. While health insurance or Mediclaim is essential for all, it is even more relevant for senior citizens, because health risks increase substantially with advancing age. In the absence of Mediclaim, a serious illness in your family can cause financial distress at a time when you least expect it. While many companies offer group health insurance cover for their employees, there are companies which do not. Even if employees are covered under the group insurance plan of their employers, they should check what kind of benefits their employer’s group health insurance policy offers, total amount of cover, and nature of illnesses covered. Employees who are covered under their company’s group health insurance policy lose their health cover on retirement. This puts them and their dependents at serious risk. IRDA's portability guidelines cover policy transfers from group to retail, allowing retiring employees to switch to the retail policy of the insurer offering the group insurance plan to their former employer. However, the premiums and the policy terms may change once you switch to the retail plan. Alternatively senior citizens can consider buying an individual or family floater Mediclaim from an insurer of his or her choice.


• Not being debt free early enough: We should understand that, debt in any form has a cost associated with it. Home loans, vehicle loans, credit card loans etc, have interest cost which comes out of our savings. For unsecured debt, like credit card loans the interest cost can be quite high. Many investors over extend themselves buying a house and the home loan EMIs constitute a large chunk of their incomes. Interest costs comprise the major part of the home loan EMIs in the early and mid part of the home loan term. The higher the interest and the longer we pay it, the more we put our long term financial goals at risk. We should strive to be debt free early in life, so that we can free up our savings to work towards our retirement planning.


• Completely avoiding risk after retirement: While the conventional financial wisdom dictated that we avoid risks after retirement and allocate our accumulated corpus to safe investments like fixed income, longer life span and high inflation necessitates a rethink of this approach. Retired lives can now easily 25 years or even more. On account of high inflation and increased longevity, you can run out of your funds if they are deployed in low yielding assets. Let us try to understand with the help of a couple of examples. Suppose you have accumulated a retirement corpus of र 50 lacs. After retirement you deploy your funds in risk free assets like fixed deposits giving you post tax return of 7%. Let us assume your monthly expense is र 50,000 and the inflation rate is around 7%. You will run out of your funds in only 8 years. Even if you accumulate a corpus of र 1 crore and deploy it in risk free assets with a post tax yield of 7%, with a monthly expense of र 50,000 and inflation of 7%, you will run out of your funds in 16 years. If you live till 85 to 90, you will have to financially dependent on someone else for the last 10 to 15 years of your life. Now let us see what if you deploy 25% of your corpus in high yielding assets like equity and the balance in low risk debt investment. Assuming you get 20% return on your equity investment, a र 1 crore can last more than 23 years. Therefore, it is prudent not to completely avoid equity after retirement. You should set your asset allocation depending upon your financial situation.

Conclusion

In this article, we have discussed some common retirement planning mistakes that we should avoid. Retirement planning is a very important part of financial planning. We should take retirement planning seriously from an early stage of our careers, so that we can have a happy and fulfilling retirement.

https://www.advisorkhoj.com/company/ICICI-Prudential-Mutual-Fund/articles/6-common-retirement-planning-mistakes-one-should-avoid#.VOq9YPmUdJc

regards

Dear All,

Please find below a good article as appeared in Morning Star for your reading:

How important is liquidity in a portfolio?

What is liquidity and how important is it in a portfolio?

Let’s play out a scenario.

One Sunday you sit to chalk out your net worth and come away fairly impressed.

For one, you own an apartment which you give out on lease. The rent from the latter gives you a fairly steady income (in addition to your own monthly salary) and the property only grows in value over time.

A beautiful masterpiece by a world-renown artist adorns your wall. You might have paid a tidy sum to own it and then spent more to insure it. You won't get a steady stream of income by way of dividends or rent. But you are certain that this painting will fetch you a jaw-dropping price when you decide to sell it.

Soon an unfortunate financial emergency befalls you and you need cash urgently. You will immediately realise that you cannot sell the painting so easily. Apparently half the market is traded privately. Also appraisals must be made and buyers must be approached and courted. This will take time and you don’t have time. But you would have gained an instant understanding on why art is an illiquid investment.

Liquidity refers to how easily an asset can be sold for cash without the sale affecting its price.

So let’s say you decide instead to sell the apartment. To get the price you are asking, you may have to wait for weeks and months before the right buyer comes to your doorstep. Sure, you can sell it quite quickly if you lower the price sufficiently. But if you have to knock off a substantial amount off your desired asking price just to get traffic in the door, then that does not make it a liquid asset either. It is not just how easily it can be sold, but how much a quick sale will affect its price. The more you have to lower the price, the less liquid the asset really is. Real estate too is not a very liquid asset.

For this reason, at least some portion of your portfolio must be liquid. It is what financial planners refer to as an emergency fund. Money here will be kept in a savings account or a liquid fund or a bank fixed deposit.

Every investment you make requires you juggle between risk, return and liquidity.

In the case of the emergency fund, you would look for high liquidity and low risk. Of course the trade-off will also be a lower return.

On the other hand, when you buy property, you are looking at low risk and a fairly high return – by way of rentals and appreciation. You will have to compromise on liquidity though, as the above example exemplifies.

If you are investing for the long term, you want a higher return and so are willing to go with stocks or equity mutual funds. They are liquid too but you take on more risk.

One component of liquidity is the speed at which you can perform a transaction—the time elapsed between when you put up the asset as a seller and when you find a buyer. In this sense, stocks are very liquid investments as they can be traded on any working day on the stock exchange. Millions of transactions take place daily and the market activity on the stock exchange sets the price for the stock.

The other component of liquidity is the ability not to take a price hit. Here, stocks could falter. After all, if you are selling when the market is in the doldrums, you will get your money quickly but not at the rate you would have desired. Or, it could be that the market is on a roll but you are selling small cap stocks which are not in demand at that point in time. In that sense, blue chips are more liquid than small caps.

A liquid investment is easy to cash up; an illiquid investment is difficult to sell without taking a price hit. It’s not at all wrong to have illiquid assets. But they are worth it if you don’t need to sell them to bail you out of an emergency. Such investments are great if you can hold on to them till the opportune moment when they have appreciated in value.

It’s just as vital to have some wealth in assets that you can sell quickly if needed. So should a medical emergency come up, or should you lose your job, the liquid portion of your portfolio can help you sustain that period and you need not derail your entire investment plan.

Liquidity, unfortunately, is an investment attribute that slips below the radar for many investors, only to be sharply reminded of its importance during an emergency.

http://www.morningstar.in/posts/31439/how-important-is-liquidity-in-a-portfolio.aspx?utm_campaign=shortanswer&utm_medium=email&utm_source=morningstar

regards

‘Wish I’d known’ lessons from finance gurus

Dear All,

Please find below a good news article as appeared in Live Mint for your reading:

‘Wish I’d known’ lessons from finance gurus 

Starting early is the easiest and smartest financial lesson. Even leaders of the industry agree 

Anyone who has just joined the workforce for the first time has a list of things to spend on—from clothes to gadgets, and more. Saving and investment rarely feature in this list. This may sound boring and even unimportant, but if you don’t want to be financially lost, you must plan your finances. Here are a few things you can do with your income in the early stages of your career. 

Start early 

When it comes to growing your money, the earlier you start saving and investing, the easier it will be to build a corpus. “You should understand the power of compounding. Unfortunately, people don’t understand it and how starting early will enable lower investment savings,” said Dilshad Billimoria, director, Dilzer Consultants Pvt. Ltd.

Say, you are 25 years old and plan to retire at 60. If your current annual expense is Rs.10 lakh, the expenses in your first year of retirement would be Rs.77 lakh, assuming annual inflation of 6%. So, you will need a corpus of Rs.10.7 crore at age 60, for which you need to invest Rs.28,000 per month till retirement age and earn return of 10% on it. If you delay and start investing only when you turn 30, you would need to save Rs.35,365 per month. So, the later you start, the more you need to save. 

Identify goals later 

You may be wondering, why invest when you don’t have goals. Imagining about retirement or any other kind of long-term goal is difficult when you are in your 20s. “Many financial commitments come in the form of events. The older you get, the more difficult it gets to catch up to the expenses. People don’t think about this in their 20s,” said Leo Puri, managing director, UTI Asset Management Co. Ltd. 

How does one overcome this difficulty? 

“It is a simple thing. Generally, your financial goals will include retirement, buying a house, marriage, children, their higher education and marriage, your higher education, travel and spending on gadgets or white goods. Even if none of these make into your list right now, they will soon creep in,” said Suresh Sadagopan, a Mumbai-based financial planner. Even if you don’t have a goal, keep a part of your salary aside to be used for future needs. 

Insure yourself

Once you have decided to save a certain portion of your income, the next step you may assume is to invest. It’s not. the next step should be buying health insurance so that medical liabilities are taken care of. “Life insurance can wait. But you should take medical insurance immediately. You may think that your employer will take care of it. But health issues can occur any time, say, when you are in between jobs. Consider taking health cover of at least Rs.3 lakh, which will cost you under Rs.4,000 per annum,” said Sadagopan. You don’t want to dip into your savings or investments when you have an option to hedge. 

Understand products 

After health insurance comes investing. You must remember that over time, money loses value due to inflation and taxes. So, leaving all your money in a savings account is not prudent. Of course, that doesn’t mean that you invest in any product that gives you higher returns than a savings deposit. You should calculate the returns you get after factoring in inflation and tax. “People don’t understand the difference between real return and nominal return. They misunderstand nominal return to be the real return. Always remember to factor in inflation when you are investing,” said Vivek Dehejia, professor of Economics at Carleton University in Ottawa, Canada. 

So, which product to choose? Since you have time on your side, you are in a better position to take risk. 

“Equity-oriented products are a good option. But you should invest at least 40% of your money in lock-in products such as Public Provident Fund as it will help you build financial discipline,” said Sadagopan. 

You can create a corpus by investing in short-term products such as debt funds or even bank fixed deposits. This will help build financial discipline. 

Though you should save and invest regular, it doesn’t mean that you can’t indulge. “You can buy a new gadget or go for a vacation, but it doesn’t mean that you go overboard with you credit card and spend more than you can afford,” said Sadagopan. 

If you have basic understanding of financial products and how they work, you will be able to make the right decisions about your money life. Doing so will earn healthy returns.
Read more at: http://www.livemint.com/Money/NBuCcrV9IT3E65yN6eBH3L/Wish-Id-known-lessons-from-finance-gurus.html?utm_source=copy

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